Petition for Writ of Certiorari — Tulia Feedlot, Inc. v. United States

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Supreme Court, U. S.

LIBR?! ‘ ee ag

MICHAEL RODAK, JR., CLERK

IN THE

Supreme Court of the United States

OcToBER TERM, 1975

Sas

No @5-341 1

ne 4

“a

io.

“84

: Tuuia Freeport, INc., Petitioner,

* Unirep States or America, Respondent.

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et ;

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURTS OF APPEALS

FOR THE FIFTH CIRCUIT :

CLARENCE P, BraZiL1, JR.

P. O. Drawer 6170

Lubbock, Texas 79413

Attorney for Petitioner

Of Counsel:

NELSON, McCLEsKEY, HArrigeR & BRAZILL

P. O. Drawer 6170

Lubbock, Texas 79413

Press or Byron S. ADAMS PrinTING, INC., WASHINGTON, D. C.

EP LIP ELL CEL. OIG DI SE LAE LOE

PMT ald, OAe enum 4

INDEX 4

Page :

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JURIMDICTION ... 2... cnees yg NisSAbAdghs sebacea tae ee

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SUPINE ONE I ain chhadbcuksc kines. cus 2 é

Reason ror GrantiInG THE Wait: ,

In determining that the Petitioner failed to prove e

the deductions taken for fees paid to guarantors 2

of its line of credit were ordinary, necessary and Q

reasonable, the Court of Appeals for the Fifth S

Cireuit made interpretations of ‘‘ordinary and F

necessary’’ and ‘‘reasonableness”’ that are in con- :

flict with the decisions of this Court ............ 4 ‘

ORIN ids Ga ccna Mas wick dca Conk ks 10 ;

APPENDIX—

Decision of the United States Court of Appeals for

eres Ss oe oe as teres een la

Memorandum Opinion of the U. S. District Court for

the Northern District of Texas Lubbock Division 12a

Order of the U. S. District Court for the Northern

District of Texas Lubbock Division ............ 19a

26 U.S.C. Section 162(a) of the Internal Revenue

ok rere Sad 20a

TABLE OF CITATIONS

Casks:

A.A. & E.B. Jones Co. v. Commissioner, 19 TCM 1561

ces AOE EET ET he Sly ae et 7

Central Asphalt Paving Co., Inc. v. Commissioner, 37

P-H Tax Ct. Memo. 68,225 (1968) ............. 7 ;

et ——

AY SFT ANG RRR ED AE LIE EEE

SASL GLO ALL LR TIN RN BET SIT RS ANG I FEROS A iit

eo 7 panne’ Fav av Se TBA SINT AA SEEN DIN O1 ME

li Index Continued

Page

Commissioner v. Tellier, 383 U.S. 687, 16 L.ed. 2d 185,

Ob Se me Be: ae ae ee Perr 6, 7,9

Deputy v. duPont, 308 U.S. 488, 84 L.ed. 416, 60 S.Ct.

Se ME oi nS as Viney de ba ekes Che eed andes 7,9

R. L. Heflin, Inc. v. U.S., 58 F.2d 482 (Ct. Cl. 1932) 2

cert. den. 287 U.S. 631 (1932) 2... .. ccc cece ene 7

Lilly v. Commissioner, 343 U.S. 90, 96 L.ed. 769, 27

SRE NE IR oS acy ocak se wesw 4 O45 ON Kees 9

Long, M.A. v. Commissioner, 8 B.T.A. 737 (1927) .... 7

Monroe Sand & Gravel Co. v. Commissioner, 36 B.T.A.

mg Rey eae re er 7

Thornton, Davis B. v. Commissioner, 14 P-H Tax Ct.

ee NE 6 0d 6 bas 555564 0 h0'06ds 6600 7

Universal Milking Machine Co. v. Commissioner, 4

SGN, EE ES ee Sc cnn Wuncn a uate te cen 7

Welch v. Helvering, 290 U.S. 111, 78 L.ed. 212, 54 S.Ct.

RE a, 1 CRW ena aes Ce du dea sh bi caasvens 7,9

EXERT ORE HTN 4

IN THE

Supreme Cot of the United States

OcToBER TERM, 1975

(oe

Tua Freeport, Inc., Petitioner,

Vv.

Unirep States or AMeErtcA, Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

Petitioner prays that a writ of certiorari issue to

review the judgment of the United States Circuit

Court of Appeals for the Fifth Circuit in this case.

OPINION BELOW

The opinion of the United States Court of Appeals

for the Fifth Circuit is reported at — F. 24 — and is

reprinted in Appendix, infra, pp. la-11a.

ee PENSE PA RELA RRS TET ine MOET ME 8, WS OH HENRI UN te OM

JURISDICTION

The judgment of the United States Court of Appeals

for the Fifth Cireuit was entered on June 2, 1975.

(p. la*) The jurisdiction of this court is invoked under

28 U.S.C. § 1254(1).

QUESTION PRESENTED

Whether fees Petitioner paid to its shareholders for

guaranteeing its line of credit are deductible as ordi-

nary and necessary business expenses that are reason-

able in amount.

STATUTE INVOLVED

The statute involved is 26 U.S.C. §162(a) of the

Internal Revenue Code of 1954. (p. 20a).

STATEMENT OF THE CASE

Petitioner, Tulia Feedlot, Inc., brought this action

for refund of Federal Income Taxes for the taxable

year ended August 31, 1970.

Petitioner is a Texas corporation formed in 1962 for

the purpose of feeding customers’ cattle. The feeding

of customers’ cattle is not an unduly hazardous busi-

ness in itself. It is the owners of the cattle who run

substantial risk of loss due to declines in the market

price of beef. (p. 15a).

Petitioner’s feedlot capacity increased from 5,000

head of cattle in 1962 to 28,000 head of cattle in 1970.

At various times since its inception, Petitioner, not

having sufficient cattle in its pens to operate economi-

eally, purchased and fed cattle for itself. The pur-

* References to ‘‘a’’ are to the Appendix, infra.

chase of cattle and feed for such cattle required large

amounts of cash. The usual method of financing the

purchase of cattle is to put approximately thirty (30% )

percent down and borrow the other seventy (70%)

percent plus $100 per head for cost of feed. (pp. 12a

and 13a).

The lending institutions would not make the loans

unless they were secured not only by mortgages on the

cattle and feed but also by the personal guarantees of

the Petitioner’s shareholders. For all practical pur-

poses herein the Petitioner had twelve equal share-

holders and each shareholder was a director. The

guarantees given by Petitioner’s shareholders prior to

1970 were $5,000 each in 1964, $8,000 each in 1965, and

$45,000 each in 1968. In 1970 the guarantees were

increased from $91,000 each in January, to secure a

$1.1 million loan, to $125,000 each in March to secure

a $1.5 million loan, to $150,000 each in July to secure

a $1.8 million loan. (pp. 13a and 14a).

In 1968, Petitioner mortgaged its real and personal

property to an insurance company for $350,000 loan.

The insurance company required the shareholders to

guarantee the loan pro rata. At the beginning and

end of the fiscal year ending August 31, 1970 such

loan balance was $340,000 and $320,000 respectively.

(p. 14a).

On July 14, 1970, Petitioner’s directors agreed to

compensate themselves as shareholder-guarantors for

lending their credit to Petitioner. It was decided that

three (3%) percent of the $150,000 guaranty was to be

paid to each shareholder for use of his credit. Accord-

ingly, $4,500 was paid to each of twelve shareholder-

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guarantors for a total of $54,000, which amount was

deducted as an expense of doing business in the fiscal

year ending in 1970. (pp. 13a-16a).

The Government disallowed the $54,000 deduction

and assessed the resulting tax. Petitioner paid the

assessment, filed a claim for refund which was dis-

allowed, and timely brought suit for refund. (p. 18a).

In the subsequent trial of the case, the United States

District Court found that the guarantor’s fees paid by

Petitioner to its shareholders were ordinary, necessary

and reasonable business expenses. (pp. 12a-18a).

The Fifth Cireuit reversed the District Court in a

decision entered June 2, 1975, on the grounds that

there was no evidence showing it was ordinary or

necessary for cattle feedlots to charge fees for guaran-

tees or that the fees paid were reasonable. (pp. la-1la).

REASON FOR GRANTING THE WRIT

In determining that the Petitioner failed to prove the de-

ductions taken for fees paid to guarantors of its line of credit

were ordinary, necessary and reasonable, the Court of Ap-

yr 2 for the Fifth Circuit made interpretations of “ordinary

an. ‘scessary” and “reasonableness” that are in conflic’ with

the decisions of this Court.

The undisputed facts show that there was a need

for Petitioner to feed its own cattle in order to operate

economically ; that the purchase and feeding of its own

cattle did produce large net gains overall; that Peti-

tioner had to borrow large amounts of money to pur-

chase and feed its own cattle; that the financial insti-

tutions required Petitioner’s shareholders to person-

ally guarantee the loans; that it was customary for

financial institutions to require shareholders in the

feedlot business to guarantee loans; that the financial

RFR CBE REN Lf NS POND DIE LE TAS ORE ME NDE PEI LEI TANS SIE

institutions would not have made the loans without

the guarantees; that without the loans the Petitioner

could not have successfully operated its business; that

the ownership of cattle involved substantial risk of

loss; that the guarantees of Petitioner’s line of credit

adversely affected the guarantors’ personal credit and

subjected them to substantial risk; that the share-

holders over a period of years prior to the tax year

guaranteed smaller loans without requirement of a fee

but as the amount of the guarantee doubled and tripled

in the tax year (in comparison with the largest amount :

guaranteed in prior years) the shareholders insisted

on being compensated for such guarantees; and that

the Petitioner’s directors after much discussion con-

cerning the shareholders’ risk, the nature of Petition- :

er’s operations, the prevailing interest rates and seek-

ing outside advice to determine what a “‘proper guar-

antor’s fee’? would be, decided to pay 3% of the

amount guaranteed as a guarantor’s fee.

The Trial Court found upon the facts presented at

the trial, that the guarantor’s fees paid were deductible

as ordinary and necessary expenses and were reason-

able in amount. (pp. 12a-18a).

The Fifth Circuit reversed on the ground that the

District Court’s decision was clearly erroneous because

Petitioner failed to prove the guarantors’ fees were

ordinary, necessary and reasonable in amount. (pp.

la-lla).

Specifically, the crucial findings of the Fifth Circuit

are as follows (pp. 8a-9a) : :

PAG TOLL GLO GT CFI MOOG ERE. TILE IONE I

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1. No evidence was presented to show that it was

customary for a cattle feedlot’s shareholders to

charge a fee for their guarantees.

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2. No evidence was presented to show what fees,

given the risks involved, would be reasonable.

3. No evidence was presented as to the possibility

and likely cost of obtaining these guarantees in

an arm’s lergth transaction in the market.

The crux of meeting the burden of proof required

by the Fifth Circuit is that there be such proof in the

first place. Insofar as all parties concerned with Peti-

tioner’s case knew, the fees paid Petitioner’s share-

holder-guarantors were the first ever to be paid in the

cattle feedlot busines. There is no market place in

West Texas, or anywhere else insofar as Petitioner

knows, to obtain guarantees at arm’s length for a

closely held corporation in the risky’ cattle feedlot

business.

The precise issue of whether a new type of expense

in a given industry is deductible has not been directly

decided by this Court. Such issue presents an im-

portant question of federal law which has not been, but

should be, settled by this Court.

In Commissioner v. Tellier, 383 U.S. 687, at 689, this

Court held that the ‘‘origin and character of claims

with respect to which the expense was incurred, .. .”’

is the basic test of whether the expense was a business

expense. Further, the Court stated at 689 ‘. .. The

principal function of the term ‘ordinary’ in § 162(a)

is to clarify the distinction, often difficult, between

those expenses that are currently deductible and those

1The plight of ranchers and feedlots owning cattle on feed at

the present time is common knowledge and the tremendous losses

suffered in 1974 and 1975 in such businesses are documented in

the Federal Bankruptcy records.

—— . -_ — . - a on

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;

that are in the nature of capital expenditures, . . .’’.

Again, in Deputy v. duPont, 308 U.S. 488 at 495, this

Court held that the term ‘‘ordinary’’ requires that

the transaction which gives rise to the expense must

be of common or frequent occurrence in the type of

business involved. Here the Fifth Circuit acknowl-

edges Petitioner’s evidence shows personal guarantees

of the shareholders were commonly required in the

feedlot business (p. 8a). The Circuit Court’s require-

ment of evidence to show that it was customary for a

cattle feedlot’s sharehelders to charge a fee for their

guarantees goes beyond the burden required by this

Court in Commissioner v. Tellier, supra, and Deputy

v. duPont, supra.

Petitioner could not produce such evidence because

insofar as it knew, at the time of the payment of the

fees and at the time of the trial, it was the only feedlot

whose shareholders charged a fee.

No case has been discovered that holds that a new

expense resulting from a transaction that is common

in a given business is not deductible simply because

it had never been charged or deducted before.”

In the case of Welch v. Helvering, 290 U.S. 111 at

113, this Court stated that the fees paid therein ‘“‘were

* There is a dearth of cases concerning guarantees. The few

cases concerning the matter are generally inconclusive and do not

deal directly with the question of a new type of expense. See

A.A. & E.B. Jones Co. v. Commissioner, 19 TCM 1561 (1960) ;

Central Asphalt Paving Co., Inc. v. Commissioner, 37 P-H Tax

Ct. Memo {[ 68,225 (1968) ; R. L. Heflin, Inc. v. U.8., 58 F.2d 482,

(Ct. Cl. 1932), cert. den. 287 U.S. 631 (1932); Long v. Commis-

stoner, 8 B.T.A. 737 (1927); Monroe Sand & Gravel Co. v. Com-

missioner, 36 B.T.A. 747 (1937); Thornton, Davis B. v. Commis-

sioner, 14 P-H Tax Ct. Memo. § 45,011 (1945) ; Universal Milking

Machine Co. v. Commissioner, 4 B.T.A. 506 (1926).

ORS RT ROPE gta

necessary for the development of petitioner’s business,

at least, in the sense that they were appropriate and

helpful.’’ In this case there is ample evidence in the

record that the fees were necessary because the financial

institutions would not have ‘ent the money without the

guarantees; the shareholders would not have signed the

guarantees without the fee; and without the loans, the

feedlot business could not have been successfully car-

ried on and developed.

To meet the Fifth Cireuit’s requirement of ‘‘reason-

ableness’’ Petitioner would have had to show compara-

ble fees paid by other feedlots to their shareholders-

guarantors, and also show the possibility and likely cost

of obtaining such guarantees in an arm’s length trans-

action in the market. Petitioner could not produce such

evidence simply because insofar as it knew, at the time

the fees were paid and at the time of the trial, it was

the only feedlot paying guarantor’s fees. Likewise,

there is no market place in West Texas, or anywhere

else, insofar as Petitioner knew, to obtain guarantees

at arm’s length for a closely held corporation in the

risky cattle feedlot business.

The evidence does disclose that for several years

prior to 1970 Petitioner’s directors had discussed their

guarantees in the light of the risk involved, current

rates of interest, the nature of the business and the

negative effect on their personal borrowing capacity.

(pp. 14a-17a). The corporate minutes also reflect that

the directors sought outside advice ‘‘concerning the

proper guarantor’s fees’. The District Court found

that the three (3%) percent fee charged was reason-

able under the circumstances.

The Appellate Court erred in requiring a burden

of proof that cannot be carried where a new type of

expense is deducted. The burden placed on Petitioner

by the Fifth Circuit is not required by any pertinent

case dealing with the deductibility of business expenses

coming within the terms ‘‘ordinary, necessary and rea-

sonable’’ decided by this Court. See Commissioner v.

Tellier, 383 U.S. 687, 16 L.ed 2d 185, 86 S.Ct. 1118

(1966) ; Deputy v. duPont, 308 U.S. 488, 84 L.ed. 416,

60 S.Ct. 363 (1940) ; Lilly v. Commissioner, 343 U.S.

90, 96 L.ed. 769, 27 S.Ct. 497 (1952) ; Welch v. Helver-

ing, 290 U.S. 111, 78 L.ed. 212, 54 S.Ct. 8 (1933).

CONCLUSION

For the foregoing reasons, this petition for a writ of

certiorari should be granted.

Respectfully submitted,

CLARENCE P, Brazinn, Jr.

P. O. Drawer 6170

Lubbock, Texas 79413

Attorney for Petitioner

Of Counsel:

Netson, McCieskey, Harricer & Braziun

P. O. Drawer 6170

Lubbock, Texas 79413

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