Decision will be entered under
Petitioner was parent of a foreign subsidiary. It filed an application for a favorable
*1019 By letter dated March 28, 1972, respondent determined a deficiency in income taxes due from petitioner Gerli & Co., Inc. (Gerli), and its subsidiaries, for their taxable year ended December 31, 1965, in the amount of $ 346,448.50. Gerli and its subsidiaries 1 had filed as a consolidated group for that taxable year. Gerli is, therefore, for purposes of this case, the sole agent for the consolidated group and is authorized to act in its own name in all matters relating to the consolidated *1020 group's tax liability for the taxable year before us. See
FINDINGS OF FACT
Some of the facts were stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.
Gerli is a Delaware corporation which at all times relevant hereto had its principal offices in New York, N.Y. The return herein was timely filed on the accrual basis with the District Director of the District of Manhattan, New York, N.Y.
Petitioner is merely the last of a series of corporate predecessors stretching back to 1922. Petitioner's first predecessor was La France Art Co., incorporated in 1922. La France Art Co. became La France Textile Industries in 1924. In 1929, La France Textile Industries changed its name to La France Industries, Inc. (hereinafter referred to from time to time as LFI-US). *178 In 1959, La France Industries, Inc., changed its name to LFI Corp. In 1960, LFI Corp. changed its name to Gerli & Co., Inc.
La France Plushes, Inc. (Plushes), was incorporated as a foreign subsidiary of La France Textile Industries in the province of Ontario, Canada, in 1927. LFI-US or its corporate predecessor owned over 99 percent of the authorized and outstanding shares of Plushes throughout Plushes' existence. On January 31, 1933, La France Textiles Ltd. (LFT) was incorporated as a Dominion corporation in Canada. LFT was capitalized with but one class of common voting stock.
In 1933, a plan of reorganization was adopted for the purpose of transferring Plushes' assets and liabilities to LFT. On June 10, 1933, the shareholders of Plushes exchanged 2,943 shares of *1021 common stock and 27 shares of preferred stock in Plushes for 2,970 shares of common stock in LFT. Thereafter, and at all times relevant hereto, LFI-US or its corporate successors owned over 99 percent of the authorized, issued and outstanding shares of LFT. On September 23, 1933, LFT acquired, for $ 1, all of the assets and liabilities of Plushes. Plushes surrendered its corporate charter in 1934.
Neither petitioner *179 nor any of its corporate predecessors requested, nor did they receive, a ruling from the Commissioner pursuant to the predecessor of
LFT engaged in the textile business in Canada as a wholly owned subsidiary of LFI-US until 1959. On August 31, 1959, after incurring substantial losses for several taxable years, LFT sold its plants, equipment, and inventories and curtailed its business activities. After several more years of unsuccessfully searching for an appropriate business into which LFT could be launched, Gerli concluded that LFT should be liquidated.
On October 26, 1964, Gerli filed with the rulings section of the reorganization branch of respondent's national office a request for a
| Current assets | $ 1,756,684.27 |
| Current liabilities | 52,068.35 |
| Capital stock (4,007 shares of $ 100 par value) | 400,700.00 |
| Surplus | 1,355,590.62 |
| Liabilities and capital | 3 1,756,684.27 |
After having filed this ruling request, petitioner, through its counsel, engaged in discussions with representatives of the Commissioner with respect to the Commissioner's requirements for issuing a favorable
On December 2, 1964, as a result of these communications from respondent, petitioner filed a document entitled "Addendum to Request for
Under date of *181 October 26, 1964, you filed, on our behalf, a request for a
We understand that this letter will be attached by you and incorporated by reference in an addendum to the original request for ruling, which you will file in the near future. We further understand that the commitment made in this letter, which is recited hereinafter, will constitute an agreement between our company and the Commissioner.
Fully bearing the foregoing understanding in mind, Gerli & Co., Inc., agrees that in the event it proceeds with the liquidation of LFT, Ltd., pursuant to a ruling by the Commissioner issued on the basis of the solicitation of October 26, 1964, current and accumulated earnings of LFT, Ltd., at the time of liquidation will be treated by Gerli & Co., Inc., as dividend income in the year of LFT, Ltd., liquidation, subject to applicable foreign tax credits.
A copy of this "addendum" was transmitted by petitioner's attorneys to respondent, along with certain other documents requested by respondent *182 with respect to the ruling, under cover of letter dated December 2, 1964. In this letter, the addendum was described as:
A commitment of Gerli & Co., Inc., by and through the president of the corporation, agreeing that if the Canadian subsidiary, LFT, Ltd., is liquidated pursuant to its request for ruling of October 26, 1964, current and accumulated earnings of the subsidiary at the time of liquidation will be treated by Gerli & Co., Inc., as dividend income in that year, subject to the foreign tax credits applicable against such dividend income.
Following petitioner's representations to respondent, respondent issued a letter ruling on January 15, 1965, to petitioner which provided as follows:
This is in reply to the letter dated October 26, 1964, from Mr. Bert B. Rand, *1023 in which a ruling is requested that the proposed transaction described below is not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes within the meaning of
* * * *
It is stated that *183 the current and accumulated earnings of L.F.T. at the time of its liquidation will be treated as dividend income by Geril in the the year of L.F.T.'s liquidation, subject to any available foreign tax credits on such income.
Based solely upon the information submitted, and upon the foregoing representations, it is held as follows:
(1) The proposed complete liquidation of L.F.T. is not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes within the meaning of
(2) In accordance with section 332(a), no gain or loss will be recognized to Gerli upon the receipt of L.F.T.'s assets provided all of the requirements of section 332(b) are met.
(3) The basis of L.F.T.'s assets received by Gerli will be the same as the basis of such assets in the hands of L.F.T. immediately prior to the transfer (section 334(b)(1)).
It is important that a copy of this letter be attached to the Federal income tax return of Gerli for the taxable year in which the transaction is consummated.
LFT was subsequently liquidated in 1965. While petitioner liquidated LFT pursuant to the provisions of section 332, it did not include in its income any amount *184 attributable to LFT's current or accumulated earnings and profits. Included as page 7 of petitioner's 1965 Federal income tax return was a page entitled "Statements in Lieu of Form 2950[,] 2952 and 3646." One of the statements made on this page was the following: "Approval for a tax-free liquidation of LFT, LTD. was received from the Treasury Department, Washington, D.C. on January 15, 1965." 4 A copy of respondent's
Upon the liquidation of LFT in 1965, petitioner received cash and assets having a total value net of liabilities of $ 1,780,296.43. Petitioner's basis in its LFT stock in 1965 at the time of LFT's liquidation was $ 400,700.
Petitioner paid legal fees and expenses in 1965 of $ 9,583 to the law firm of Trammell, Rand & Nathan (Trammell) with respect *1024 to the liquidation of LFT. Trammell had been employed in the summer of 1964 by Gerli's tax accountants to prepare an information return for Gerli. Thereafter, Trammell had assisted in the liquidation of LFT as special counsel. Trammell obtained the
The petition herein was filed on June 22, 1972. Respondent's answer thereto was filed on July 31, 1972. On June 10, 1977, petitioner filed a motion for leave to file an amended petition and an amended petition. This motion was granted on June 15, 1977. By its amended petition, petitioner conceded the correctness of respondent's adjustments for general and miscellaneous expenses, that this action was not barred by the statute of limitations, as well as certain other additional items. Respondent filed his answer to petition as amended on August 15, 1977. By this amended answer, respondent first claimed an addition to tax under section 6653(a), in the amount of $ 17,326.40, for petitioner's alleged intentional disregard of rules and regulations resulting in the deficiency claimed. At the trial herein, respondent conceded that he has the burden to prove the applicability of section 6653(a) to petitioner.
OPINION
The primary *186 issue for our decision herein is the effect of petitioner's failure to include LFT's current and accumulated earnings and profits in income as a dividend in the year LFT was liquidated. Respondent argues that, as petitioner failed to abide by the express requirements of his
Petitioner argues simply that the condition of respondent's *187 ruling requiring that it include LFT's earnings and profits in income was an illegal condition separable from the rest of respondent's ruling. Petitioner argues that it was not obligated to comply with this illegal condition, which it likens to a "fee" demanded by respondent to issue a favorable ruling, although it may still rely upon that portion of respondent's ruling which finds that petitioner's liquidation of LFT was "not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes" within the meaning of
As it stood in 1965,
In determining the extent to which gain shall be recognized in the case of any of the exchanges described in section 332 * * * a foreign corporation shall not be considered *189 as a corporation unless, before such exchange, it has been established to the satisfaction of the Secretary or his delegate that such *1026 exchange is not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes. * * *
Originally enacted as section 112(k) of the Revenue Act of 1932, Pub. L. 72-154, 47 Stat. 169,
To prevent * * * [tax] avoidance * * * [sec. 112(k)] withdraws the transaction from the operation of the nonrecognition sections where a foreign corporation is a party to the transaction, unless prior to the exchange the Commissioner is satisfied that the transaction is not in pursuance of a plan having as one of its principal purposes the avoidance of taxes. It will be noted that under this provision a taxpayer acting in good faith can ascertain prior to the transaction, by submitting his plan to the Commissioner, that it will not be taxable if carried out in accordance with the plan. Of course, if the reorganization or the transfer is not carried out in accordance with the plan submitted the Commissioner's approval will not *190 render the transaction tax-free. [S. Rept. 665, 72d Cong., 1st Sess. (1932), 1939-1 C.B. (Part 2) 496, 515. Emphasis added.]
Thus, at all times relevant hereto,
In our view, the case put to us by the parties is simple: Petitioner wished section 332 treatment for its liquidation of LFT. It made application, therefore, to the respondent for a ruling under
The regulations under
*1027 Sec. 1.367-1. Foreign corporations. -- * * * If the transaction is not carried out in accordance with the plan submitted, the Commissioner's approval will not render the transaction tax-free.
The intendment of this statement is clear: A taxpayer who obtains a favorable ruling based upon a certain set of representations cannot rely upon that favorable ruling if its representations are later shown to be false. As we see it, the question for our decision is simply this: Was the transaction carried out in accordance with the plan transmitted to the Commissioner? Clearly it was not.
Simply put, petitioner would have us bifurcate respondent's ruling into two freestanding conclusions: (1) The proposed liquidation did not have as one of its principal purposes the avoidance of tax, and (2) the *192 requirement that the U.S. parent include in its income the undistributed current and accumulated earnings and profits of the foreign subsidiary. We are "underwhelmed" by the argument. We accept respondent's position that petitioner could not have one without the other.
At all times relevant hereto,
We noted the existence of this practice, for example, in our case
Even if we were to go so far as to limit respondent's authority under
We need not determine whether, under any circumstances, this Court can pass judgment with respect to the reasonableness of the conditions posed by the respondent for a favorable
To us, it follows that as petitioner decided to structure the liquidation of LFT in such a way as to fall outside the ruling at issue, it forfeited its right to rely on that ruling. Gerli cannot, therefore, now be heard to claim that it has "before such exchange * * * established *195 to the satisfaction of the Secretary or his delegate" that the liquidation exchange before us is "not [an exchange] in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes." Consequently, petitioner has failed to meet the requirement of
Section 331(a)(1) provides that "Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock." Section 331(a)(1) requires, therefore, that the liquidation of LFT be treated as an exchange of property for stock. But *196 if no favorable ruling under
Section 1248 provides that, if a U.S. person, as defined, sells or exchanges stock in a foreign corporation, or if a U.S. person receives a distribution from a foreign corporation, which is treated as an exchange under section 331, and if certain other requirements are met, 9*197 then the gain, if any, recognized on the sale or exchange of such stock shall be included in the gross income of such person as a dividend to the extent of the earnings and profits of the foreign corporation attributable to such stock which were accumulated in taxable years of such foreign corporation beginning after December 31, 1962, and during the period or periods the stock sold or exchanged was held by such person while such foreign corporation was a controlled foreign corporation.
As section 1248 clearly applies to the liquidation at hand, the next question we must face relates to the amount of earnings and profits cognizable under section 1248 includable in petitioner's income as a dividend. In this connection, we note that the parties stipulated that "If the period for computing the
Next, we address petitioner's claim for a deduction with respect to certain attorney's fees. At issue here is $ 9,583 paid in 1965 to the firm Trammell, Rand & Nathan (Trammell). Very little evidence was contained in the record with respect to this payment. We have found that Trammell was employed by Gerli's tax accountants in the summer of 1964 to prepare a Form 959 return for a controlled foreign corporation, presumably LFT. Thereafter, Trammell was asked to assist in the liquidation of LFT as Gerli's special counsel. The firm obtained the
The record with respect to the claim is weak. We have before *199 us the bare claim for a deduction supported only by a stipulated narrative of an attorney who worked for Trammell at the relevant time, describing in general terms what he and his firm did for Gerli in 1964 and 1965. 11 No relevant evidence was included in the record with respect to the question of whether 1965 was the appropriate year in which to accrue the deduction of attorney's fees here at issue, assuming they are deductible, although the record clearly shows that the vast majority of the services for which the amount in issue must have been paid were performed in 1964. There is no record of exactly what work was performed or when. There is no itemized bill. There is no attempt to allocate the deduction between the various types of work it is claimed was done.
Respondent argues that no part of the amount in issue is *1031 currently deductible because petitioner has failed to carry its burden of proof that the amount involved, or any part of it, is not capital in nature. Petitioner's response to respondent's argument is to cite several cases 12 involving *200 the deductibility to a liquidating, partially liquidating, or reorganizing corporation, of its liquidation expenses. Unfortunately, as Gerli neither liquidated, partially liquidated, or reorganized, these cases are inapposite.
In determining the character, as capital or ordinary, of a particular expenditure, the appropriate inquiry is the origin of the expense. See
The facts before us show that those of petitioner's expenditures allocable to obtaining the
Thus, at least a portion of the expenses in issue is clearly capital. But that portion of the expenses which is not capital cannot be determined from the record. It would appear that Trammell prepared a Form 959 for Gerli in 1964. Petitioner's expenses allocable to the preparation of a tax return are clearly currently deductible under section 162. But there is no evidence which would allow us to conclude that petitioner did not accrue and pay for this work, which was done in 1964, until 1965. Further, we have no basis upon which we could make even an intelligent guess with respect to the proper allocation between capital and ordinary items -- even if we were to believe that such an allocation was warranted. We have no alternative, therefore, but to find that all of the expenses before us are capital. The amount in issue should, therefore, go to reduce petitioner's capital gain on the liquidation of LFT.
The final issue for our decision involves respondent's claim for a section 6653(a) negligence penalty. Initially, we need to consider petitioner's argument that *203 respondent's claim was not properly before the Court. Petitioner's argument revolves around (1) its view that respondent was required to obtain the Court's permission under
We believe that respondent's view is correct. Because the claim for the section 6653(a) addition to tax was asserted by respondent before the conclusion of the trial in this case, we have jurisdiction to redetermine such increased deficiency. Sec. 6214(a);
We think that the question before us is governed by
Petitioner does not, nor could it, claim that it would be prejudiced in any way by our hearing respondent's section 6653(a) claim. See
In sum, the only prejudice possible to petitioner at this point is to have the Court consider whether it was negligent or intentionally disregarded rules or regulations in reporting the transaction in issue. Respondent, on the other hand, would suffer great prejudice in that he would not be able to fully present his case, despite having given adequate warning of all his claims to petitioner. We conclude that respondent's section 6653(a) claim is validly before the Court.
*1034 We now address, *206 therefore, the substance of respondent's claim itself. We think the conclusion inescapable that petitioner's "intentional disregard of rules and regulations" is the source of the underpayment that we have found owing herein. Petitioner received a favorable ruling, purported to take advantage of the ruling's benefits, yet ignored the ruling's conditions. We believe that petitioner had a choice. It could follow the requirements of the ruling and thereby become entitled to the benefits provided by the ruling, or it could ignore the ruling and report the appropriate income. It intentionally and knowingly did neither. To find for petitioner in this case would be to condone actions which border on misrepresentation. We hold that respondent has carried his burden and that petitioner is liable for the addition to tax described in section 6653(a).
Decision will be entered under
Footnotes
1. The subsidiary companies of petitioner are: Cheney Bros., Southern, Inc.; Cheney Bros., Inc.; Pemco Corp.; C. & V. Fabrics, Inc.↩
2. Petitioner has conceded respondent's disallowance of a claimed deduction of $ 1,080 for "general and miscellaneous expenses," and has not challenged respondent's allowance of an additional $ 2,443.92 as a depreciation deduction.↩
3. This table represents verbatim a joint exhibit of the parties.↩
4. A similar statement was included on p. 13 of petitioner's 1965 income tax return.↩
5. The following language is taken from petitioner's main brief:
"Under the explicit language of
I.R.C. sec. 367 the Secretary is authorized only to determine the purposes of a plan of liquidation and if one of the principal purposes of the plan is not the avoidance of federal income taxes,I.R.C. sec. 367↩ requires that without any further conditions the Secretary so rule. * * * His attempt to exact a toll charge merely as an added cost of liquidating of LFT-Canada does not have even the color of statutory approbation. To the extent a toll charge is not necessary to prevent the avoidance of federal taxes, it is illegal. Any appendage to the ruling letter requiring payment of such a toll charge is unenforceable and Petitioner is in full compliance with the ruling if the liquidation of LFT-Canada was not for the purpose of avoiding federal taxes."6. See also H. Rept. 1447, 87th Cong., 2d Sess. (1962),
1962-3 C.B. 405, 480-481 ; H. Rept. 2508, 87th Cong., 2d Sess. (1962),1962-3 C.B. 1129↩, 1163 .7. S. Rept. 94-938 (1976), 1976-3 C.B. (Vol. 3) 57, 299-302.↩
8. Referring again to the 1932 Senate Finance Committee report, we are told that "For all other purposes [i.e., for purposes of all those sections other than those described in
sec. 367↩ ], including the nonrecognition of loss in any transaction described in the foregoing subsections, the tax status of a foreign corporation is not affected by the new subsection." S. Rept. 665, 72d Cong., 1st Sess. (1932), 1939-1 C.B. (Part 2) 496, 515.9. The other requirements that need to be met are described in sec. 1248(a)(2). They are that the U.S. person own, or be considered as owning, 10 percent or more of the total combined voting power of all classes of stock, within the meaning of sec. 958, and that the foreign corporation be a "controlled foreign corporation" as defined in sec. 957. Both these additional requirements are met herein.
10. As neither party raised the applicability of sec. 1248(g), we do not reach that subsection's applicability or inapplicability to the facts before us.↩
11. The entire record on this claimed deduction consists of a joint exhibit entitled "Stipulated testimony of Bert B. Rand, Esquire."↩
12.
Gravois Planing Mill v. Commissioner, 299 F.2d 199, 208 (8th Cir. 1962) ;United States v. Transamerica Corp., 392 F.2d 522, 523 (9th Cir. 1968) , affg.254 F. Supp. 504, 512 (N.D. Cal. 1966) ;E. I. duPont de Nemours & Co. v. United States, 432 F.2d 1052, 1058-1059↩ (3d Cir. 1970) .13.
Chanik v. Commissioner, T.C. Memo. 1972-174 , affd.492 F.2d 1182↩ (6th Cir. 1974) .