Reply Brief of Petitioner — Your Host, Inc. v. Commissioner

No. 73-1652

IN THE

Supreme Court of the United States

October Term, 1974

YOUR TIOST, INC., e¢ al.,

Petitioners,

v.

COMMISSIONER OF INTERNAL REVENUE.

On PETITION FoR A Writ OF CERTIORARI TO THE UNITED

Srares Court or APPEALS FOR THE SECOND Circuit.

REPLY BRIEF FOR PETITIONERS

ALBRECHT, MAGUIRE, HEFFERN

& GREGG,

Attorneys for Petitioners,

2110 Main Place Tower,

Buffalo, New York 14202.

Of Counsel:

Ratpeu J. GReGG,

GeorGcE M. ZIMMERMANN.

BATAVIA TIMES, APPELLATE COURT PRINTERS <=

A. GERALD KLEPS, REPRESENTATIVE

BATAVIA, N.Y. 14020

716-343-0487

INDEX.

PAGE

Purpose for use of ¢ 482 tacitly admitted ............ 1

Response attempts to confuse the facts and issues .... 2

Bi Wie Se I oo no npn ie Zed oc ckcicnss cs 2

As to the Petitioners’ Contentions and the facts .... 3

SN an wa vac er ee pus aie cau bee teser ce. 8

CITATIONS.

Advance Machinery Exch. v. Commissioner, 196 F. 2d

oe ee Ls rr ere 4,5

Automobile Club v. Commissioner, 355 U.S. 180 ...... 7

Commissioner v. Chelsea Products, Inc., 197 F. 2d 620 4,5

Hamburger’s York Road, Ine. v. C.I.R., 41 T.C. 821 .. 5

STATUTES.

Supreme Court of the United States

No. 73-1652

October Term, 1974

YOUR HOST, INC., et al.,

Petitioners,

Vv.

COMMISSIONER OF INTERNAL REVENUE.

Own PETITION FoR A WRIT OF CERTIORARI TO THE UNITED

States Court oF APPEALS FOR THE SEconD Crrcvir.

REPLY BRIEF FOR PETITIONERS

Purpose for use of § 482 tacitly admitted

The real significance of the Response filed by the Solicitor

General is his tacit admission that the only reason the

Commissioner consolidated the income of these corpora-

tions under §¢ 482 was to disallow surtax exemptions by

the adroit trick of putting all of the income of fourteen of

them on the tax returns of the first two corporations formed

by Wesson and Durrenberger.

2

The Solicitor General requested an extension of time to

confer with the Internal Revenue Service about certain

of the contentions in the Petition. If he conferred about

this, he found that the revenue agents had candidly ex-

plained to the petitioners that this was exactly what they

were doing.

In defense of this action, he argues that “Congress

specifically contemplated the possibility” that revenue

agents would use §§ 482 and 269 interchangeably, quoting

two sentences from a Senate Committee Report which were

never intended to be interpreted in this cavalier fashion

(Response, p. 12).

Response attempts to confuse the facts and issues

Otherwise, in what purports to be a Response to the

Petition, the Solicitor General has misconstrued, mis-

stated, twisted, distorted, and even tortured the issues,.

the petitioners’ contentions, the facts and the decisions of

the Cireuit Courts for no apparent reason other than to

confuse and mislead this Court.

As to the Section 482 Issue

1. This is immediately apparent from the Solicitor

General's version of the issue. The way he would have it

is whether the Commissioner may use § 482 “to reallocate

all of the net income of one commonly controlled ecorpora-

tion to another such corporation”. (Response, pp. 1-2).

This is a simplistic straw man. Surely he ean if the

owner arbitrarily shifts income from a genuine corpora-

tion that earns it to a phony or sham corporatior that

doesn't.

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3

But that is neither the issue nor the facts of this case.

Here, there was no shifting or distortion of income of any

description by the owners to be reallocated under any Sec-

tion of the Code. It was the Commissioner who arbitrarily

shifted the income of thirteen healthy and viable, taxable

entities to a fourteenth (and of the fifteenth to a sixteenth)

so that he could tax all but the first $25,000.00 of the total

at 48% and thereby deprive fourteen corporations of their

right to have up to $25,000.00 apiece taxed to 22%.

2. The Solicitor General repeated this ploy by re-

phrasing the second question as though it were a mere

coincidence that the Commissioner’s 100% allocation de-

prived fourteen of sixteen corporations of their surtax

exemptions (Response, p. 2).

It was not a mere coincidence. The revenue agents

candidly explained that this was their reason for using

§ 482—not to reallocate income shifted by the owner—but

to indirectly disallow surtax exemptions and, if that strat-

egy did not succeed, to disallow their surtax exemptions

directly under § 269.

As to the Petitioners Contentions and the facts

The Solicitor General adheres to the same pattern

throughout his Brief—subtly misstating the petitioners’

contentions to provide himself with easy answers and to

mislead and confuse the Court. The major misstatements

are discussed below:

1. Petitioners did not “urge that the Commissioner is

never authorized to allocate all of the net income of one

corporation to another because the result would be equiva-

lent to the result achieved by the filing of a consolidated

return” (Response, p. 6).

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4

The Solicitor General said this so that he could cite

Advance Machinery Exch. v. Commissioner, 196 F. 2d 1006,

cert. den., 344 U.S. 835, for the proposition that this inter-

pretation would permit “the most flagrant evasion by the

arbitrary shifting of income” (Response, p. 7); thereby

creating the false impression that there was some evidence

of evasion here.

Advance Machinery was a case in which:

“There was evidence that large numbers of purchase

invoices had heen altered to attribute them to one or

another of these taxpayers and that these changes

were made without any set policy to indicate that there

was any motive in doing so other than to divert income

from the petitioner.”

“The two (father and son) operated the business

. in such a way that the net profit of each (of the

four businesses) could be manipulated as they saw

fit”. 196 F. 2d 1006, at 1008.

The Second Cireuit in Advance Machinery did not, as

the Solicitor General claims (Response, p. 6) reject the

decision of the Third Circuit in Commissioner v. Chelsea

Products, Inc., 197 F. 2d 620. On the contrary, it said:

“This is consistent with the manner in which § 45

is applicable; the reallocation of income thereunder

being based not on a disregard of taxable entities but

on the correction of business entries’. 196 F. 2d 1006,

1010.

Chelsea Products stands solidly for the proposition for

which the petitioners actually contend—that the Commis-

sioner may not disregard corporate entities and use § 482

to consolidate the net income of corporations which were

formed for sound business reasons, conducted their own

businesses and earned their own income.

5

2. The Solicitor General creates the inference that the

Commissioner “examined transactions between (these) con-

trolled taxable entities in order to determine whether they

would have been concluded in an arms-length negotiation

between strangers and made a reallocation where they

failed to meet that standard”. (Response, p. 6). This is

false.

The revenue agents didn’t even inquire into intercorpo-

rate transactions. They said that Durrenberger had the

benefit of too many surtax exemptions; that Hamburger’s

York Road had shown them the way to nullify surtax ex-

emptions by using § 482 instead of § 269; but that they

would also set up deficiencies under ¢ 269 anyway to pro-

tect the revenues.

3. The petitioners did not, as the Solicitor General

claims (Response, p. 7), cite Commissioner v. Chelsea

Products, Inc., swpra, for the proposition that “the Com-

missioner cannot as a matter of law allocate all of a cor-

poration s income under § 482”. Of course he can if a com-

mon owner, as in Advance Machinery, arbitrarily diverts

income from a corporation that earns it to dummy or sham

corporations to evade taxes.

There is no conflict among the Circuits as to this ques-

tion. But a very serious conflict has arisen among the

Circuits, as explained in the petition, where the separate

corporations actually earn and report their own income.

4. The Solicitor General’s version of the income and

expense of Chef Foods, Inc. appearing on Pages 8 and 9

of his Response is absolutely untrue. The Solicitor General

would have the Court believe that Chef Foods, Ine. had

annual receipts averaging $160,000.00 for the four years of

issue but that it spent only $179.00 for repairs and $160.00

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6

for supplies during that period, leaving it with a net profit

‘in the excess of $159,900.00 annually. This is not only

absurd but grossly false and deceptive.

' The exhibits from which the Solicitor General purports

to extract this information show that Chef Foods paid out

an average of $100,105.00 a year for inventories and an

average of $25,829.75 a year for salaries and wages, office

and administration and car expense, rent, real estate taxes,

sales taxes, utilities, insurance, licenses and for deprecia-

tion on buildings anc equipment, leaving an average net

profit of only $37,866.75 per annum.

It is also undisputed in the record that Chef Foods, Ine.

paid its own bills and earned its own income; that Your

Host, Ine. operated retail restaurants and nothing more,

did not engage in the cigarette vending machine business,

shad no interest in the real estate from which Chef Foods

derived over $30,000.00 of its gross income and did abso.

lutely nothing to earn the income of Chef Foods, Inc.; that

there was no basis for allocating the income of Chef Foods,

Ine. to Your Host, Ine. and that Your Host, Inc. was chosen

only because it was Durrenberger’s first corporation.

5. The Solicitor General’s defense of the 100% alloca-

tion of the income of Your Host Bakery, Ine. to Sher-Del

Foods, Ine. demonstrates the validity of the petitioners

contentions—that the Cireuit Courts are confused as to the

rule to he applied where a 100% allocation is obviously

arbitrary and inappropriate and a remand would afford the

taxpayer an opportunity to prove the exact dollar amount

of the allocation the Court defined as being the proper one.

' Here the finding was that Sher-Del Foods, Ine. had not

charged Your Host Bakery, Ine. for billing and delivery

en

7

expense. The Solicitor Generad defends the Second Cir-

cuit in denying the petitioner the opportunity, on remand,

to prove the exact dollar amount. Both are in disagree-

ment with the Supreme Court and the Fifth and Seventh

Circuits, the Solicitor General’s wordy protestations (Re-

sponse, pp. 10-11) to the contrary notwithstanding.

6. The petitioners did not claim that it is a violation of

due process if the Commissioner reverses determinations

made by his agents in prior audits (Response, p. 12).

The violation of Jue process described on Pages 12-14

of the petition was not considered in Automobile Club v.

Commissioner, 355 U.S. 180, which involved the correction

hy the Commissioner of “a mistake of law” by a retroaetive

ruling.

Here the Commissioner and the Trial Court deprived the

taxpayers of a fair trial of the issues, the Commissioner

by raising the issue for the first time after everybody was

dead and the facts were buried in history and the Trial

Court by refusing to hear any evidence that might show that

the Commissioner and his agents were being unreasonable,

arbitrary and unfair.

8

Conclusion

The petition for a writ of certiorari should be granted.

Respectfully submitted,

ALBRECHT, MAGUIRE, HEFFERN

& GREGG,

Attorneys for Petitiwners,

2110 Main Place Tower,

Buffalo, New York 14202.

Dated: September 9, 1974.

Of Counsel:

Ratpx J. GREGG,

Grorce M. ZIMMERMANN.