Memorandum — Snow v. Commissioner

ar Ss

SUPREME COURT. No 73-641

In the Supreme Court of the United States™

OCTOBER TERM, 1973

EpwIn A. SNOW AND HELEN B. SNow,

PETITIONERS

v.

COMMISSIONER OF INTERNAL REVENUE

ON PETITION FOR A WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS FOR

THE SIXTH CIRCUIT

MEMORANDUM FOR THE RESPONDENT IN OPPOSITION

Rosert H. Bork,

Solicitor General,

Department of Justice,

Washington, D.C. 20530.

, oe

In the Supreme Court of the United States

OcToBER TERM, 1973

No. 73-641

EDWIN A. SNOW AND HELEN B. SNow,

PETITIONERS

Vv.

COMMISSIONER OF INTERNAL REVENUE

ON PETITION FOR A WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS FOR

THE SIXTH CIRCUIT

MEMORANDUM FOR THE RESPONDENT IN OPPOSITION

The sole question presented in this federal income

tax case is whether petitioners were entitled to deduct

a pro rata share of amounts claimed by their partnership

as research and development expenditures under Section

174 of the Internal Revenue Code of 1954. Both courts

below held that the expenditures in question were not

deductible because they were not incurred in connection

with a “trade or business.”

1. Petitioner! was an executive vice president and

member of the board of directors of Proctor & Gamble

' References to petitioner are to Edwin A. Snow only. Helen

B. Snow is included as a petitioner solely because she filed a

joint income tax return with her husband for the taxable year

in issue.

(1)

2

_sCompany. In 1966, he invested $10,000 for a four percent

interest in a limited partnership known as_ Burns

Investment Company, which had been organized to assist

in financing the development of a trash burning device

(Pet. App. 14, 20-21). Petitioner and two other limited

partners supplied the financing; development of the

invention was to be performed by thé general partner

(Pet. App. 23).

In 1966, Burns Investment Company had no manu-

facturing plant, no office or separate facility, no separate

telephone, and no sign on the premises it shared with

another partnership. During that year most of the funds

contributed by the limited partners were exhausted, and

thereafter the general partner financed the further deve-

lopment of the device. The partnership did not file a

patent application until June 10, 1968, and no patent

was issued until March 3, 1970. A corporation was sub-

sequently organized to produce and market the device

(Pet. App. 23). During 1966, petitioner devoted at least

50 hours per week to his Proctor & Gamble employment,

an additional three to four hours to a race horse opera-

tion, and another hour to a joint venture oil operation.

He devoted some time to meetings and conversations

with the inventor about the trash burner and witnessed

some tests on models of the device (Pet. App. 26).

The partnership filed a partnership return for the

taxable period August 1, 1966 through December 31,

1966, showing capital as of August | to be $40,000,

claiming research and development expenses of $36,780.44,

and reflecting no income. It thereby showed a loss of

$36,780.44, which the company elected “to expense

in the current taxable year” as Section 174 research

and development expenses (Pet. App. 24). Petitioner

reported his share, $9,195.11, as a partnership loss

Nn ee re ee fe

deduction on his income tax return for 1966 (Pet. App.

24, 25-26). On audit, the Commissioner of Internal

Revenue disallowed the deduction on the ground that

neither petitioner nor the partnership met the “trade

or business” requirement of Section 174. The Tax Court

sustained the Commissioner’s determination (Pet. App.

26-34), and the court of appeals affirmed (Pet App.

35-44).

2. Section 174 of the Internal Revenue Code provides

that “{a] taxpayer may treat research or experimental

expenditures which are paid or incurred by him * * * in

connection with his trade or business as expenses which

are not chargeable to captial account. The expenditures

so treated shall be allowed as a deduction.”

The judicial decisions interpreting this provision and

the Treasury Regulations uniformly require that a tax-

payer must be engaged in a trade or business in order to

qualify for a research and development expenditure

deduction. Treasury Regulations on Income Tax (1954

Code), §§ 1.174-1 and 1.174-2; Stanton v. Commissioner,

399 F. 2d 326 (C.A. 5); Mayrath v. Commissioner, 357

F. 2d 209 (C.A. 5), affirming 41 T.C. 582; Koons v.

Commissioner, 35 T.C. 1092.

The term “trade or business” has a single meaning in

all sections of the Code, Cooper Tire & Rubber Co.

Employees’ Retirement Fund v. Commissioner, 36 T.C.

96, affirmed per curiam, 306 F. 2d 20 (C.A. 6), and

this Court has defined it, for purposes of other tax

statutes, as “holding one’s self out to others as engaged

in the selling of goods and services.” Deputy v. DuPont,

308 U.S. 488, 499. It has further held that the question

whether a trade or business exists is one of fact. Higgins

v. Commissioner, 312 U.S. 212. Qualification as a “trade

or business” activity requires the existence of a genuine

” nis he MPA pm =

wit ‘

stink ingiiticks

ee ee ee ee ae

profit motive (Lamont v. Commissioner, 339 F. 2d 377

(C.A. 2); Mercer v. Commissioner, 376 F. 2d 708, 711

(C.A. 9)), and that the activities involved be extensive,

varied, continuous, frequent and regular (Austin v.

Commissioner, 298 F. 2d 583 (C.A. 2); Wright v.

Commissioner, 274 F. 2d 883 (C.A. 6); Miller v. Com-

missioner, 102 F. 2d 476 (C.A. 9)).

In light of this standard, the holding of both courts

below that petitioner did not incur the expenditures

at issue in connection with his trade or business is

amply justified by the undisputed facts. During the

year in question, the partnership, in which petitioner was

merely an investor, was not holding itself out to others

as engaged in the selling of goods and services. Its

research and experimentation was not related to the

development or improvement of existing products or

new products developed in connection with an omen

trade or business. Cf. Best Universal Lock Co., Inc.

Commissioner, 45 T.C. 1.

Moreover, the legislative history accompanying the

enactment of Section 174 demonstrates that it was

designed to permit a taxpayer to deduct research and

experimental expenditures incurred “in connection with

his trade or business” without regard to the “ordinary

and necessary” standard. See H. Rep. No. 1337, 83d

Cong., 2d Sess., p. 28; S. Rep. No. 1622, 83d Cong.,

2d Sess., p. 33.2 This legislative policy explains the use

2 Congressman Reed of New York, Chairman of the Ways and

Means Committee, emphasized this purpose during House debate

on the measure when he stated that the imposition of the “ordinary

and necessary” standard led often to uncertainty regarding the

deductibility of such expenses, especially by “small businesses

which are developing new products and do not have established

research departments.” 100 Cong. Rec. 3425.

>

of the term “not chargeable to capital account.” The

extraordinary or nonrecurring nature of these designated

expenditures will not foreclose their current deductibility.

Thus, the aim of Section 174 was to equalize the treat-

ment of small businesses vis-a-vis large businesses and not,

as petitioner asserts (Pet. 9-12), to extend the deduction

to mere investors who cannot meet the “trade or

business” qualification.

3. The decision below does not, as petitioner urges

(Pet. 6-8), conflict with Cleveland v. Commissioner,

297 F. 2d 169 (C.A. 4). There, the taxpayer, a lawyer,

had made extensive loans over a long period of time to

an inventor who, for over ten years, had experimented

with the invention of an inorganic liquid binding

material and had applied for patents. After having made

a number of advances, taxpayer entered into a trust

agreement with the inventor regarding their respective

interests in the compound. The Tax Court disallowed a

claimed Section 174 deduction for the advances, holding

that the arrangement constituted, at most, a sale by

the inventor to the taxpayer of a one-half interest in

the invention in consideration of past monies advanced,

and that the expenditures were not made in taxpayer’s

trade or business. The court of appeals, however,

reversed and allowed the Section 174 deduction with

respect to the post-agreement advances. It characterized

the agreement as creating a joint venture which it held

to be a “trade or business” of the taxpayer.

Allowance of the deduction in Cleveland was based

upon the particular facts of the taxpayer’s active role

in the enterprise as a business and legal advisor and

negotiator as well as financier, the length of time the

inventor had been engaged in his work on the binding

material, and its advanced stage of development. Under

6

these circumstances, none of which were present in this

case, the court concluded that the post-agreement

expenditures were incurred in the taxpayer’s “trade or

business.”

Moreover, unlike the decision below, the Cleveland

opinion did not rest upon a definition of the term “trade

or business.” Subsequent to Cleveland, the Fourth Circuit

decided Richmond Television Corp. v. United States,

345 F. 2d 901, relied upon by the court below, which

construed the language “carrying on any trade or

business” in the context of Section’ 162(a). There,

the Fourth Circuit addressed the question of the defini-

tion of “trade. or business.” It held that even though a

taxpayer has made a firm decision to enter into business

and spends money over a considerable period of time

in preparation for entering that business, he has still

not engaged in carrying on a trade or business until

the business begins to function as a going concern

which performs those activities for which it was organized.

Significantly, the court indicated that this definition was

equally applicable to Section 174(a)(1) (345 F. 2d at

907, n. 7).

Accordingly, petitioner’s enterprise, which had no

plant, no separate office or facility, no telephone and

no marketing activity during the year in question, did

not meet the accepted definition of a “trade or business.”

For the reasons stated, it is respectfully submitted

that the petition for a writ of certiorari should be denied.

ROBERT H. Bork,

Solicitor General.

DECEMBER 1973.

.

CURRIE ERROR OMIT NE .

REIN LI 9 FP CRONIN R. 9