Petition for A Writ of Certiorari — Liberty Loan Corp. v. United States

| OCT 17 1974

| MICH Ac,

IN THE

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 1974

No. 44 - 44 3 {

LIBERTY LOAN CORPORATION, a Corporation,

Petitioner,

Vv

UNITED STATES OF AMERICA, 3

Respondent. &

PETITION FOR A WRIT OF CERTIORARI

To the United States Court of Appeals for the

Eighth Circuit

WILLIAM D. CRAMPTON

BRYAN, CAVE, McPHEETERS & McROBERTS

500 North Broadway Building ;

St. Louis, Missouri 63102

Attorneys for Petitioner

St. Louis Law Printing Co. Inc., 812 Olive Street 63101 314-231-4477

ee ry

INDEX

Page

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Statute and regulations involved ................-... 2

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Reasons for granting the writ ..................005. 5

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CITATIONS

Cases

Eisner v. Macomber, 252 U.S. 189 (1920) ......... ye

Commissioner v. First Security Bank of Utah, N.A., 405

ee PT Ce cael hts tea dae wea cone e 5,9

Texts

Bittker and Kaufman, Taxes and Civil Rights: “Constitu-

tionalizing the Internal Revenue Code,” 82 Yale L.J. 51

ECS RAL CCR aie E45 CoA RGAE S ORBAN S 9

B. Bittker & J. Eustice, Federal Income Taxation of Cor-

porations and Shareholders (3rd ed. 1971) ..........

Jenks, Treasury Regulations Under Section 482, 23 Tax

Lawyer 279 (1970) at pp. 280-1 ..................

K. Martin Worthy, The Chief Counsel’s Office in the Sev-

enties, 48 Taxes 5 (1970)

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IN THE

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 1974

GSE Riereeee

LIBERTY LOAN CORPORATION, a Corporation,

Petitioner,

V

UNITED STATES OF AMERICA,

Respondent.

PETITION FOR A WRIT OF CERTIORARI

To the United States Court of Appeals for the

Eighth Circuit

The taxpayer-petitioner, Liberty Loan Corporation (“Lib-

erty”), hereby petitions for a writ of certiorari to review the

judgment of the United States Court of Appeals for the Eighth

Circuit in this case.

OPINIONS BELOW

The opinion of the district court (Appendix A, infra, pp. Al

to Al4, inclusive) in favor of the taxpayer is reported at 359

F. Supp. 158. The opinion of the court of appeals ( Appendix

B, infra, pp. A15 to A30, inclusive) reversing the district court

is reported at 498 F. 2d 225.

JURISDICTION

The opinion and judgment of the court of appeals were

entered on May 31, 1974. Taxpayer's petition for rehearing

was timely filed on July 8, 1974 (pursuant to timely extensions

of time to that date) and was denied on July 19, 1974 (Ap-

pendix C, infra, p. A31). The jurisdiction of this Court is in-

voked under 28 U.S.C. 1254(1).

QUESTIONS PRESENTED

1. Does the Commissioner of Internal Revenue have the abso-

lute discretion under Section 482 of the Internal Revenue Code

to reallocate income among the individual corporate members

of a corporate group, without regard to the actual effect of the

underlying transaction on the income of each of those entities?

2. Did the Court of Appeals ignore fundamental principles

of tax law and disregard the rule of Eisner v. Macomber, 252

U.S. 189 (1920) by holding that an increase in a taxpayer's

net worth constitutes an increase in its net income?

STATUTES AND REGULATIONS INVOLVED

Section 482 of the Internal Revenue Code of 1954, in its en-

tirety, and the pertinent portions of Treasury Regulations on

Income Tax (§§ 1.482-1(a)(6), (b)(1), (d)(1) and 1.482-2

(a)(1) and (2)) are set forth in Appendix D, infra, pp. A32

to A35, inclusive.

STATEMENT OF THE CASE

This case was submitted to the district court on a stipulation

of facts and appended exhibits, briefs and oral argument. The

facts as found by the district court were as follows:

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—

Liberty is engaged in the consumer finance business. In the

year at suit, 1961, it operated through 40 branch offices and 399 .

subsidiaries (each having one or more offices) in making install-

ment loans directly to borrowers and purchasing (usually at a

discount) installment notes receivable issued to dealers by pur-

chasers of goods and services. (Appendix A, infra, pp. A2-A3).

It is the practice of finance companies to borrow funds; where

there is an affiliated group and large sums are required, the bor-

rowing is usually done by the parent on behalf of the group. For

1961, Liberty so borrowed $110,547,621 (computed on the

basis of a monthly average) and incurred interest expense in the

amount of $5,582,751, an effective interest rate of 5.55 percent.

Liberty was fully reimbursed, as follows: interest was charged

all branches! and all solvent subsidiaries at the rate of 5.75

percent; subsidiaries whose capital Liberty regarded as impaired

were charged no interest. Determination of whether a subsidi-

ary’s capital was impaired was made twice a year. In 1961 this

resulted in 28 of the subsidiaries paying interest at the rate of

5.75 percent for half a year only and 27 paying no interest at all

for the entire year. (Appendix A, infra, pp. A3-A7).

On audit, the Commissioner of Internal Revenue (“Commis-

sioner”) allocated interest to Liberty from the 54 subsidiaries at

the rate of 5 percent, less the interest paid to Liberty by those

subsidiaries ($198,542), or in the amount of $473,639. Lib-

erty paid the resulting tax and interest, and on disallowance of

its claim for refund, initiated this action by suit,in the disirict

court. The Commissioner did not challenge the treatment of

the transaction by any of the subsidiaries and they are not parties

to this litigation.

The trial court found that Liberty was fully reimbursed for

all but its own share of the borrowing costs it incurred on be-

\

1 This was an internal control procedure and resulted in no sepa-

rate tax consequence. (Appendix A, infra, p. A7).

52 aye a eh aaa RAE pas

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half of the group, that its 1961 return clearly reflected its in-

come and that there had been no evasion of tax on its part.

The trial court found that while the burden of reimbursing

Liberty for the interest expense it incurred on behalf of the

group was shifted away from the members of the group whose

capital was impaired to those whose capital was not impaired

in accordance with a pre-established formula, this did not dis-

tort Liberty's income. The trial court further found that the

Commissioner, in isolating the non-paying subsidiaries from the

remainder of the group, had ignored the substance of the group

relationship and therefore had not attempted to correct the dis-

tortion in incomes created among them, presumably in order

“to produce a higher harvest of revenue.” The trial court there-

fore concluded that the Commissioner’s allocation of interest

income from the impaired subsidiaries to Liberty distorted the

latter’s income and was accordingly unreasonable, arbitrary and

capricious. (Appendix A, infra, pp. A7-9, 10, 12-13).

In reaching its conclusions, the trial court was guided by

Reg. § 1.482-1(d)(1) (Appendix D, infra, pp. A33-34),

requiring the substance of the transactions in question to be

analyzed to determine the appropriate allocation, and Reg.

§ 1.482-1(b)(1) (Appendix D, infra, pp. A33), mandating the

Commissioner to allocate “between or among the controlled tax-

payers constituting the group” so as to determine “the true tax-

able income of each controlled taxpayer.” (Appendix A, infra,

pp. Al2-13).

The court of appeals reversed in a split decision. The dis-

senting judge, Senior Judge Van Oosterhout, would have affirmed

on the basis that the essential findings (quoted, see p. A28, infra)

of the trial court were supported by substantial evidence and were

not induced by any erroneous view of the law. (Appendix B,

infra, pp. A15-30).

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REASONS FOR GRANTING THE WRIT

The majority below reversed the trial court on two grounds:

(i) it found “. . . that the ‘group loan’ theory of the trial court

ignores the actual substance of the transactions under scrutiny

.” (Appendix B, infra, p. A19) and, that viewed inde-

pendently. the “no-interest” loans to the insolvent subsidiaries

distorted Liberty’s 1961 taxable income (Appendix B, infra,

p. A20), and (ii) it found a distortion in Liberty's 1961 taxable

income in any event (i.e., even if the “group loan” premise were

accepted) because the savings in taxes realized by its subsidi-

aries had the effect of increasing Liberty's net worth (Appendix

B, infra, p. A21).

With respect to (i), above, the majority below exceeded the

scope of review permitted by Rule 52(a), FRCP and erred as to

the scope of § 482. With respect to (ii), above it is in conflict

with a landmark decision of this Court, Eisner v. Macomber,

252 U.S. 189 (1920). Loan arrangements typified by the in-

stant case are common to the finance business, and to businesses

in general operating in a corporate group. Resolution of the ques-

tion posed by this case is therefore highly important to the

orderly administration of the tax laws.

1. Although Section 482 has been in the federal income tax

statutes since 19282 and has been increasingly used by the Com-

missioner, it has been considered on its merits by this Court

only once.* It has been labelled an “amalgam” of several im-

portant themes and policies of tax law whose regulations fail

to distinguish between the various facets and functions of the

2 It first appeared as Section 45 of the Revenue Act of 1928

(c.852, 45 Stat 791, 806).

3 Commissioner v. First Security Bank of Utah, N.A., 405 US.

394 (1972).

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section‘ That comment is particularly apropos here. Given

the propensity the Internal Revenue Service has exhibited to

date to explore in an aggressive manner its outer boundaries,

it is likely that the number of petitions for certiorari filed by tax-

payers involving Section 482 will continue to grow unabated.

This case presents a highly suitable vehicle for this Court to

resolve several of the uncertainties concerning its scope.

The Internal Revenue Service’s RIRA system® indicated as

of a recent date that there were 45 groups of taxpayers involving

83 separate docketed cases in the courts concerning proposed

intercompany interest allocations pursuant to Section 482.

There are, of course, many more cases pending in the courts

involving other facets of Section 482.° Many of these involve a

“prime” issue,‘ and hence will likely result in extended litiga-

tion. While the amounts in dispute in these cases, and in the

many cases which must still be in the administrative process,

are not readily available to the petitioner, such amount must be

very substantial indeed. In any event, it is clear that the vol-

ume of litigation in this area has created a further need for

this Court to act.

* B. Bittker & J. Eustice, Federal Income Taxation of Corpora-

tions and Shareholders (3rd ed. 1971) 15-21, 15-28.

* The Reports and Information Retrieval Activity program

(“RIRA”) is described in K. Martin Worthy, The Chief Counsel’s

Office in the Seventies, 48 Taxes 5 (1970) at pp. 10-11.

® Jenks, Treasury Regulations Under Section 482, 23 Tax Lawyer

279 (1970) at pp. 280-1. See also pp. 288 and 294 (inclg fn 55)

concerning retroactivity. The docketed cases involving § 482 in its

various facets number in the hundreds.

* The Internal Revenue Service first published its list of “prime”

issues in March, 1973. They are issues which the Service will ordi-

narily insist on litigating and that ordinarily will not be conceded or

compromised. This subject is discussed further in the article referred

to in fn 6, above. (Liberty is shown on the RIRA list, fn 6, supra, as

a “prime” issue case).

=| fo

Although the Eighth Circuit appears to be the first appellate

court to rule on this question, so that there is no present con-

flict of circuits, it is not feasible in the light of the potential

importance of the question to await the development of such a

conflict.

+. +

2. The majority below dismissed the trial court’s “group loan”

findings even though, as pointed out in the dissent, those findings

were supported by substantial evidence and were not induced by

any erroneous view of the law. (Appendix B, infra, p. A29).

Realizing the impact of the extremeness of its retrial of the

facts, the majority below sought to support its result by re-

versing the trial court as a matter of law. This it did in the

following manner (Appendix B, infra, p. A20-A21):

We note also that even if one were to accept the “group

loan” premise of the trial court, there is nevertheless a

distortion in taxpayer's income. As the trial court recog-

nized:

Low or no income subsidiaries would have signifi-

cantly less use for an interest expense deduction,

whereas a subsidiary corporation in a surtax bracket

would be able to utilize the deduction against higher

tax rates. The internal apportionment undoubtedly

led to substantial overall savings in taxes to the group,

taken as a whole. (Emphasis added. )

359 F.Supp. at 162-163.

We think it obvious that any savings in taxes realized

by the subsidiaries has the effect of increasing the parent's

net worth and hence distorting its true income. And as

one commentator has observed, “[t]he purpose of the

section is to prevent corporations within the same corpo-

rate family from utilizing their separate corporate struc-

tures to diminish the overall tax liability of the corporate

family.” Note, 6 N.Y.U.J.Int.L. & Politics 169, 171

neal ik

(1973). Thus, any distortion in the income of the sub-

sidiaries is necessarily a distortion of the parent’s income

as well.

Whether the majority below intended its holding to mean

generally, or just for purposes of Section 482, that an increase

in net worth represents an increase in taxable income, its de-

cision violates the teachings of Eisner v. Macomber, supra.

In passing on whether a stock dividend was taxable under the

Sixteenth Amendment, this Court stated in that case:

After examining dictionaries in common use (Bouv. L.

D.; Standard Dict.; Webster's Internat. Dict.; Century

Dict.), we find little to add to the succinct definition

adopted in two cases arising under the Corporation Tax

Act of 1909 (Stratton’s Independence v. Howbert, 231

U. S. 399, 415; Doyle v. Mitchell Bros. Co., 247 U. S.

179. 185)—“Income may be defined as the gain derived

from capital, from labor, or from both combined,” pro-

; vided it be understood to include profit gained through a

; sale or conversion of capital assets, to which it was applied

in the Doyle Case (pp. 183, 185).

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Brief as it is, it indicates the characteristic and distin-

gaishing attribute of income essential for a correct solution

of the present controversy. The Government, although

basing its argument upon the definition as quoted, placed

chief emphasis upon the word “gain,” which was extended

to include a variety of meanings; while the significance of

the next three words was either overlooked or misconceived.

“Derived—from—capital” ;—“the gain—derived—from—

capital,” etc. Here we have the essential matter: not a

gain accruing to capital, not a growth or increment of

value in the investment; but a gain, a profit, something of

exchangeable value proceeding from the property, severed

from the capital however invested or employed, and com-

aie aus:

ing in, being “derived,” that is, received or drawn by the

recipient (the taxpayer) for his separate use, benefit and

disposal;—that is income derived from property. Nothing

else answers the description. (252 U.S. at 207).

While that definition of income has been enlarged somewhat

since, we know of no decision of this Court which has gone so

far as to find taxable income from mere accretions in value.”

The holding of the majority below would presumably be ap-

plicable to all types of Section 482 adjustments, hence its mis-

chief is not limited to interest cases, nor just to the Eighth Cir-

cuit.

Because Eisner v. Macomber is a cornerstone in the structure

of the income tax law, no decision that impairs its integrity

should be permitted to stand. The decision below does precisely

this, and, for this reason alone, should be reviewed by this Court.

3. Whether or not the findings of the trial court reversed by

the majority below are reinstated in this case, there still remains

a serious question of law as to whether Section 482 permits the

Commissioner to make adjustments of the sort he made here,

thereby substituting his own brand of distortion for that he

seeks to cure. As stated by this court in the First Security case,

Section 482 “is designed to prevent ‘artificial shifting, milking.

or distorting of the true net incomes of commonly controlled

enterprises.” 405 U.S. 394 at 400. The increasing of the in-

come of Liberty for 1961 merely distorts its income. The only

way in which the “shifting” or “distortion” within the group can

* A leading commentator puts it even more strongly:

We might simply note that no revenue act in the nation’s

history has complied with even the most elementary require-

ment of the Haig-Simons definition. i.c., that increases in the

taxpayer's net worth (measured either annually or at the end

of some other appropriate account period) be included in com-

puting his income.

Bittker and Kaufman, Taxes and Civil Rights: “Constitutionalizing

the Internal Revenue Code,” 82 Yale L.J. 51, 64 (1972).

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be cured is by disallowing some of the interest deductions taken

by the solvent subsidiaries (the insolvent subsidiaries would be

allowed the aggregate amount disallowed).

Both lower courts agreed that Liberty, as the parent of the

corporate group, was fully reimbursed, (See Appendix B, infra,

at pps. Al7-18 for the appellate court’s concurrence), yet the

majority below in effect, held that the Commissioner could ig-

nore this fact as a matter of law in determining against whom

and in what amount reallocations were permissible. Aflirmance

of the majority opinion below will encourage the Internal Reve-

nue Service to attempt reallocations as it sees fit within the cor-

porate group, ignoring such relevant matters as the statute of

limitations, the inability otherwise to reach certain foreign mem-

bers of the affiliated group, whether the type of income involved

causes a taxpayer to become subject to the personal holding

company tax, etc. This case marks a significant departure in

permitting the Commissioner to choose his own remedy un-

limited by the language of Section 482 (or of some of his own

regulations).“ As one leading tax service commented, “As

things now stand, IRS's Section 482 allocation authority seems

unbridled.“'" Since the technique used by the Commissioner

* See particularly Reg. § 1.482-1(a)(6), § 1.482-1(b)(1) and

s 1.482-1(d)(1) relied upon by the trial court (Appendix A, infra,

pp. Al2-13) and set forth verbatim Appendix D, infra, pp. A32 to

A34 inclusive.

' The full text of that comment is as follows:

Comment—-Liberty Loan looked like the strongest case yet

for finding an abuse of IRS’ Sec. 482 discretionary allocation

authority. Contrary to the majority’s point that no income

was created, the case seems to be the clearest example of in-

come creation. The Eighth Circuit had to ask: Would an un-

related corporation have lent the funds to the subsidiary group?

The answer arguably would be yes. If the group loan theory is

correct, and the lender would get a reasonable interest rate

returned from the group as a whole, the fact some subsidiaries

paid no interest and others more than their share, would be

irrelevant to the lender. Of course, the lender would normally

also require some guarantee from the gain companies on total

=

here is equally applicable to all proposed Section 482 alloca-

tions, the granting of certiorari in this case will permit this Court

to remove much of the uncertainty as to the scope of that sec-

tion.

CONCLUSION

This petition for a writ of certiorari should be granted.

Respectfully submitted

€

WILLIAM D. CRAMPTON

BRYAN, CAVE, McPHEETERS &

McROBERTS

500 North Broadway Building

St. Louis, Missouri 63102

Attorneys for Petitioner

October 1974

principal repayment. The lower court's suggestion in Liberty

Loan that IRS more properly should have used its Sec. 482

power to reduce the interest deductions of the gain subsidiaries

rather than increasing the parent’s income would have solved

the problem. In effect, Liberty Loan’s net worth wouldn't then

be increased—a point that concerned the Eighth Circuit even if

the group loan theory were accepted. And there wouldn’t be

any income distortion at any level. The gain subsidiaries could

be viewed as contributing to the loss companies’ capital to the

extent they bore the loss companies’ interest expense. To

charge Liberty Loan with more interest income than IRS oth-

erwise would require to clearly reflect its income may be with-

out the intent of Congress. Also if Liberty Loan had made

advances only to the gain companies at 5.75% interest, and

the gain companies had contributed funds to the loss com-

panies, presumably IRS wouldn’t have stepped in. In substance

that’s what the lower court said happened. Hopefully Liberty

Loan will seek and receive Supreme Court review. As things

now stand, IRS’ Sec. 482 allocation authority seems unbridled.

Prentice Hall Federal Taxes, € 60,290 (6/13/74)

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