Opposition Brief — Liberty Loan Corp. v. United States

In the Supreme Court of the United States

OCTOBER TERM, 1974

No. 74-443

LIBERTY LOAN CORPORATION, PEFITIONER

Vv.

UNITED STATES OF AMERICA

ON PETITION FOR A WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS FOR

THE EIGHTH CIRCUIT

BRIEF FOR THE UNITED STATES IN OPPOSITION

OPINIONS BELOW

The opinion of the district court (Pet. App. A-1 to A-14)

is reported at 359 F. Supp. 158. The opinion of the court of

appeals (Pet. App. A-15 to A-30) is reported at 498 F.2d

225.

JURISDICTION

The judgment of the court of appeals was entered on

May 31, 1974. A timely petition for rehearing was denied

on July 19, 1974 (Pet. App. A-31). The petition for a writ

of certiorari was filed on October 17, 1974. The jurisdiction

of this Court is invoked under 28 U.S.C. 1254(1).

QUESTION PRESENTED

Whether Section 482 of the Internal Revenue Code of

1954 authorizes the Commissioner of Internal Revenue to

adjust upwards the unreasonably low interest rates (aver-

(1)

Z

aging 1.48 percent) petitioner charged some of its sub-

sidiary corporations without making offsetting downward

adjustments in the reasonable rate (5.75 percent) charged

to other subsidiaries, when the result is to impute to peti-

tioner a small net profit on its relending transactions.

STATUTE AND REGULATIONS INVOLVED

Section 482 of the Internal Revenue Code of 1954, 26

U.S.C. 482, and the pertinent provisions of Section 1.482 of

the Treasury Regulations on Income Tax, 26 C.F.R. 1.482,

are set forth at Pet. App. A-32 to A-35, with the exception

of Section 1.482-1(d)(2) and (3) of those Regulations, the

pertinent provisions of which are set forth in the Appen-

dix, infra, pp. 7-9. Rule 52(a), Fed. R. Civ. P., is set

forth in the Appenidx, infra, p. 9.

STATEMENT

Petitioner is engaged in the consumer finance business

both directly, through branch offices, and indirectly,

through subsidiary corporations.' In the conduct of this

business, petitioner borrows substantial sums from unre-

lated lenders, which it in turn lends to its subsidiaries. This

procedure is followed because petitioner's credit rating is

better than those of the individual subsidiaries.

During 1961, the taxable year here at issue, petitioner

borrowed approximately $110,000,000 at an effective in-

terest rate of 5.55 percent. Petitioner charged its profitable

subsidiaries an interest rate of 5.75 percent for the funds

relent to them that year; however, it charged its unprofit-

able subsidiaries little or no interest (the average interest

rate charged those subsidiaries was 1.48 percent). As a

consequence, the average effective interest rate charged

by petitioner to its subsidiaries was 5.55 percent, and peti-

'The following statement of facts summarizes the findings of the

district court (Pet. App. A-2 to A-8).

3

tioner accordingly reported no net income from its relending

transactions. Petitioner stipulated at tria! that unrelated

lenders would have charged each of its subsidiaries interest

rates in excess of 5.75 percent.

The Commissioner of Internal Revenue determined that

the petitioner's income from the loans to the unprofit-

able subsidiaries was not clearly reflected in its return, and,

acting under the authority of Section 482 of the Internal

Revenue Code of 1954, he adjusted petitioner’s income—

and also the incomes of those subsidiaries—to reflect an in-

terest charge of 5 percent on those loans. (Section 1.482-2 _

(a)(2) of the Treasury Regulations on Income Tax, 26 C.F.R.

1.482-2(a)(2), prescribes a 5 percent rate of interest where

the rate charged between related taxpayers was less than 4

percent and the taxpayers fail to establish that a rate other

than 5 percent is more appropriate.) Although the 5.75

percent interest rate petitioner charged its profitable sub-

sidiaries was less than the fair market interest rate, it was

within the “safe haven” range of from 4 percent to 6 per-

cent then prescribed by the regulations, and therefore the

Commissioner made no adjustment in petitioner’s income

on account of its loans to those subsidiaries.

Petitioner paid the tax assessed by the Commissioner

and then instituted this refund suit in the United States

District Court for the Eastern District of Missouri. The dis-

trict court, apparently viewing all the subsidiaries together

as in effect a single entity and reasoning that petitioner

was entitled to relend at its own net borrowing cost, held

that the Commissioner was without authority to adjust

upwards the interest rates charged to the unprofitable sub-

sidiaries without making offsetting downward adjustments

in the rate charged to profitable subsidiaries.

The court of appeals reversed. Noting that “the Com-

missioner has broad discretion under §482 and his deter-

mination will not be upset unless proven by the taxpayer to

be arbitrary and capricious” (Pet. App. A-21), the court of

4

appeals held that the Commissioner had properly ad-

justed the interest rate on loans to the unprofitable sub-

sidiaries upward to 5 percent and that petitioner was not

entitled to offsetting adjustments in the rate charged to

profitable subsidiaries, both because the applicable regu-

lations limit offsets to transactions between the same two

taxpayers and because a downward adjustment in the 5.75

percent rate “would have the effect of moving those loans

even further away from the actual arm’s length rate” (Pet.

App. A-27).

ARGUMENT

The decision of the court of appeals properly applied

the statute and regulations to the facts of this case, and it

warrants no further review.

1. Petitioner argues (Pet. 7-9) that the court of appeals

exceeded the scope of review permitted by Rule 52(a),

Fed. R. Civ. P., and that its construction of Section 482 of

the Code conflicts with Eisner v. Macumber, 252 U.S. 189.

Neither argument has merit.

a. The argument with respect to scope of review is

based upon petitioner’s misconception that the district

court's treatment of petitioner’s 399 subsidiaries as a single

legal entity was a finding of fact. No finding of fact was in-

volved: the district court was simply ruling, as a matter of

law, that the Commissioner’s discretion under Section 482

to allocate income between a parent corporation and its

subsidiaries was limited by a requirement that the subsidi-

aries be treated as a single entity. That legal ruling directly

frustrated the underlying purpose of Section 482, “to pre-

vent corporations within the same corporate family from

utilizing their separate corporate structures to diminish

the overall tax liability of the corporate family” (Pet.

5

App. A-2)) and it was properly reversed. But even if the

district court’s determination may be categorized as

a finding of fact, it was in any event clearly erroneous;

petitioner had made not a “group loan,” as petitions“

suggests, but a series of separate loans to each subsid-

iary. As the court of appeals pointed out (Pet. App.

A-19):

The facts stipulated show that the loans were made

individually to each subsidiary; the interest rates i

charged the individual subsidiaries ranged from 0 to

5.75%, depending on the capitai status of each com-

pany; each subsidiary carried on its balance sheets

a note payable to its parent; and each subsidiary filed

a separate income tax return, reflecting the individual

loan from the parent. Although the parent, for ad-

mittedly sound business reasons, may have borrowed

a lump sum, nevertheless when it came to relending

the monies to the subsidiaries, it is evident that each

loan was a separate transaction requiring independent

scrutiny by the Commissioner.

-~

b. Petitioner’s allegation of a conflict between the de-

cision below and Eisner v. Macomber, supra, is frivolous.

It is based exclusively upon dictum that even if petitioner

had, contrary to the facts, made a “group loan,” the Com-

missioner would have been justified in reallocating the in-

terest income between petitioner and its unprofitable sub-

sidiaries because of the increase in petitioner’s net worth

resulting from the subsidiaries’ tax savings. That observa-

tion by the court of appeals did not form any part of the

basis of its decision and does not warrant review.

2. Contrary to petitioner’s claim (Pet. 5-7), the issue pre-

sented here is not of general importance. Although there

are, as petitioner states, several pending and recently de-

cided cases involving interest income adjustments between

Prarie ew rna re Bainen

oOo ’

parents and subsidiaries, those cases generally involve the

different question, not presented here, whether the bor-

rower must be shown to have income that is directly trace-

able to the use of the loan proceeds. See, e.g., B. Forman

Co. v. Commissioner, 453 F.2d 1144 (C.A. 2), certiorari

denied, 407 U.S. 934; Kahler Corp. v. Commissioner, 486

F.2d 1(C.A. 8); Kerry Investment Co. v. Commissioner, 500

F.2d 108 (C.A. 9).

' 3. Nor is there any “serious question of law as to whether

Section 482 permits the Commissioner to make adjust-

ments of the sort he made here” (Pet. 9). Petitioner’s ar-

' bitrary underassessment of interest on its loans to unprof-

itable subsidiaries was a transparent device intended to

minimize the corporate family’s overall tax burden by shift-

ing income from petitioner to those of its subsidiaries that

had net losses. The Commissioner properly invoked Section

482 “to prevent ‘artificial shifting, milking, or distorting of

the true net incomes of commonly controlled enterprises.” ”

Commissioner v. First Security Bank of Utah, 405 U.S.

394, 400. Petitioner’s contention that it must be treated as

if it derived no net income at all from its relending trans-

actions has no basis either in the statute or in economic or

business reality.

CONCLUSION

The petition for a writ of certiorari should be denied.

Respectfully submitted.

RopertT H. Bork,

Solicitor General.

Scott P. CRAMPTON,

Assistant Attorney General.

WILLIAM A. FRIEDLANDER,

JOHN A. TOWNSEND,

Attcomeys.

DECEMBER 1974.

t

APPENDIX

Section 1.482-1(d)(2) and (3) of the Treasury Regulations

on Income Tax, 26 C.F.R. 1.482-1(d)(2) and (3), in per-

tinent part provides:

FON ATA cea |

-

©

-

-

;

(2) Whenever the district director makes adjust-

ments to the income of one member of a group of con-

trolled taxpayers (such adjustments being referred to

in this paragraph as “primary” adjustments) he shall

also make appropriate correlative adjustments to the

imscome of any other member of the group involved in

the allocation. The correlative adjustment shall ac-

tually be made if the U.S. income tax liability of the

other member would be affected for any pending tax-

able year. Thus, if the district director makes an allo-

cation of income, he shall not only increase the income

of one member of the group, but shall decrease the in-

come of the other member if such adjustment would

have an effect on the U.S. income tax liability of the

other member for any pending taxable year. For the

purposes of this subparagraph, a “pending taxable

year” is any taxable year with respect to which the

U.S. income tax return of the other member has been

filed by the time the allocation is made, and with re-

spect to which a credit or refund is not barred by the

operation of any law or rule of law. Hf a correlative

adjustment is not actually made because it would have

no effect on the U.S. income tax liability of the other

member involved in the allocation for any pending

taxable year, such adjustment shall nevertheless be

deemed to have been made for the purpose of deter-

mining the U.S. income tax liability of such member

for a later taxable year, or for the purposes of de-

termining the U.S. income tax liability of any person

for any taxable year. The district director shall furn-

ish to the taxpayer with respect to which the primary

adjustment is made a written statement of the amount

and nature of the correlative adjustment which is

deemed to have been made. * * *

Jie Duara Seana & a

(3) In making distributions, apportionments, or

allocations between two members of a group of con-

trolled entities with respect to particular transactions,

the district director shall consider the effect upon such

members of an arrangement between them for reim-

bursement within a reasonable period before or after

the taxable year if the taxpayer can establish that such

an arrangement in fact existed during the taxable

year under consideration. The district director shall

also consider the effect of any other nonarm’s length

transaction between them in the taxable year which,

if taken into account, would result in a setoff against

any allocation which would otherwise be made, pro-

vided the taxpayer is able to establish with reasonable

specificity that the transaction was not at arm’s length

and the amount of the appropriate arm’s length charge.

For purposes of the preceding sentence, the term arm’s

length refers to the amount which was charged or

would have been charged in independent transactions

with unrelated parties under the same or similar cir-

cumstances considering all the relevant facts and with-

out regard to the rules found in §1.482-2 by which

certain charges are deemed to be equal to arm’s length.

For example, assume that one member of a group per-

forms services which benefit a second member, which

would in itself require an allocation to reflect an arm’s

length charge for the performance of such services.

Assume further that the first member can establish

that during the same taxable year the second member

engages in other nonarm’s length transactions which

benefit the first member, such as by selling products

to the first member at a discount, or purchasing prod-

ucts from the first member at a premium, or paying

royalties to the first member in an excessive amount.

In such case, the value of the benefits received by the

9

first member as a result of the other activities will be

set-off against the allocation which would otherwise

be made. If the effect of the set-off is to change the

characterization or source of the income or deductions,

or otherwise distort taxable income, in such a manner

as to affect the United States tax liability of any mem-

ber, allocations will be made to reflect the correct

amount of each category of income or deductions. In

order to establish that a set-off to the adjustments pro-

posed by the district director is appropriate, the tax-

payer must notify the district director of the basis of

any claimed set-off at any time before the expiration

of the period ending 30 days after the date of a letter

by which the district director transmits an examination

report notifying the taxpayer of proposed adjustments

or before July 16, 1968, whichever is later.* * *

* & a id ®

Rule 52(a) of the Federal Rules of Civil Procedure pro-

vides:

In all actions tried upon the facts without a jury

or with an advisory jury, the court shall find the facts

specially and state separately its conclusions of law

thereon, and judgment shall be entered pursuant to

Rule 58; and in granting or refusing interlocutory in-

junctions the court shall similarly set forth the find-

ings of fact and conclusions of law which constitute

the grounds of its action. Requests for findings are

not necessary for purposes of review. Findings of

fact shall not be set aside unless clearly erroneous,

and due regard shall be given to the opportunity of

the trial court to judge of the credibility of the

witnesses. The findings of a master, to the extent

that the court adopts them, shall be considered as the

findings of the court. If an opinion or memorandum

of decision is filed, it will be sufficient if the findings

of fact and conclusions of law appear therein. Find-

ings of fact and conclusions of law are unnecessary

on decisions of motions under Rules 12 or 56 or any

other motion except as provided in Rule 41(b).