American Stores Co. v. Comm'r of Internal Revenue

• Decision Date: 26 May 2000
• Docket Number: No. 13142–97.,13142–97.
• Citation: 114 T.C. No. 27,114 T.C. 458
• Parties: AMERICAN STORES COMPANY and Subsidiaries, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

114 T.C. 458

114 T.C. No. 27

AMERICAN STORES COMPANY and Subsidiaries, Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 13142–97.

United States Tax Court.

May 26, 2000.

Corporate taxpayer petitioned for redetermination of deficiencies arising from disallowed business deductions for legal fees incurred defending against state antitrust suit. The Tax Court, Ruwe, J., held that legal fees were incurred in connection with taxpayer's acquisition of company and had to be capitalized into cost of acquisition.

Decision for IRS. Fredrick J. Gerhart, Kevin M. Johnson, and Thomas Edward Doran, for petitioner.

Mark H. Howard, for respondent.

OPINION

RUWE, J.

P purchased the stock of LS. Prior to purchasing LS, P had negotiated with the Federal Trade Commission to satisfy the antitrust concerns about the purchase. Shortly after P's purchase of LS, and 1 day after the FTC entered its final consent order, the State of California filed an antitrust suit in Federal District Court objecting to P's purchase of LS. The State asked for various remedies including divestiture. The District Court issued a temporary injunction prohibiting P from integrating the business operations of LS and P. The District Court's opinion was the subject of an appeal and was ultimately resolved by the Supreme Court. Thereafter, P and the State settled the antitrust suit. P incurred substantial legal fees in defending against the State's antitrust suit. Those legal fees were deducted as ordinary and necessary business expenses. R disallowed those deductions based on R's determination that the legal fees should be capitalized.

Held: P's legal fees incurred in defending against the State's antitrust suit arose out of, and were incurred in connection with, P's acquisition of LS. The origin of the State's antitrust claim was P's acquisition of LS. P's legal fees must be capitalized.

Respondent determined deficiencies of $7,963,850 and $1,773,964 in petitioner's Federal income tax for its taxable years ending January 28, 1989, and February 3, 1990, respectively (hereinafter referred to as the 1989 and 1990 tax years). After concessions, the only issue for decision is whether petitioner may deduct or must capitalize legal fees and costs (legal fees) incurred in defending an antitrust suit brought by the State of California subsequent to petitioner's acquisition of Lucky Stores, Inc. This case is before the Court fully stipulated. See Rule 122. The stipulation of facts and the attached exhibits are incorporated herein by this reference.

Background

Petitioner is an affiliated group of corporations which annually files a consolidated Federal income tax return. American Stores Company (American Stores) is the common parent of the affiliated group, and it filed the petition on behalf of all eligible members of the group pursuant to section 1.1502–77, Income Tax Regs. At the time the petition was filed, American Stores, a Delaware corporation, maintained its mailing address and principal office at 709 East South Temple, Salt Lake City, Utah. Petitioner files its income tax returns on the basis of a 52–53–week fiscal year ending on the Saturday nearest to each January 31. Petitioner prepared and filed the consolidated income tax returns for its 1989 and 1990 tax years using the accrual method of accounting.

By January 28, 1989, American Stores and its subsidiaries operated approximately 1,917 retail units in 39 States. During the 1989 and 1990 tax years, petitioner principally engaged in the retail sale of food and drug merchandise. Petitioner is one of the nation's leading retailers, operating combination drug/food stores, super drug centers, drug stores, and food stores. Petitioner sells both food and nonfood merchandise such as prescription drugs, tobacco products, housewares, health and beauty aids, and sundry merchandise for home and family use. Petitioner maintains a substantial inventory for its various retail grocery and drug stores throughout the nation.

Prior to its acquisition of Lucky Stores, Inc. (Lucky Stores), petitioner conducted its activities through American Stores' wholly owned subsidiaries: American Super Stores, Inc., comprised of Acme Markets, Inc., Jewel Food Stores, Star Market and Jewel OSCO; American Food and Drug, Inc., comprised of Skaggs Alpha Beta and Buttrey Food–Drug; American Drug Stores, Inc., a nationwide drug chain; and Alpha Beta Company (Alpha Beta). During the 1989 tax year, American Stores also acquired and commenced operations through Lucky Stores. Lucky Stores operated food stores in California, Arizona, Nevada, and Florida.

Acquisition of Lucky Stores

In December 1987, the second and third largest grocery store chains in the State of California, Vons and Safeway, merged. American Stores determined that acquiring Lucky Stores would complement Alpha Beta's operations in California. On March 21, 1988, American Stores initiated a hostile takeover bid or tender offer for all the outstanding shares of Lucky Stores for $45 per share (tender offer). At the time of the tender offer, Alpha Beta stores constituted California's fourth largest retail grocery chain. Alpha Beta operated 252 supermarkets in California, 54 in northern California, and 198 in southern California. Lucky Stores operated 340 stores located throughout California, and it was the largest grocery store chain in the State of California.

On May 23, 1988, American Stores amended its tender offer increasing the offer to $65 for each Lucky Stores share. This increase in price was attributable, in part, to competing bids by other companies interested in acquiring Lucky Stores. On May 23, 1988, the board of directors for Lucky Stores approved the amended tender offer and a merger proposal with American Stores.

FTC'S Actions

On March 21, 1988, American Stores gave notice of its intention to purchase all the stock of Lucky Stores to the Federal Trade Commission (FTC), pursuant to the Hart–Scott–Rodino Antitrust Improvements Act of 1976, Pub.L. 94–435, sec. 201, 90 Stat. 1390, codified at 15 U.S.C. sec. 18a (1997). In response to American Stores' Hart–Scott–Rodino filing, the FTC conducted an investigation of the proposed merger and worked to negotiate a settlement with American Stores.

The FTC and American Stores negotiated a preliminary settlement of the FTC's concerns about the tender offer. This preliminary settlement was reflected in two simultaneous actions taken by the FTC on May 31, 1988. First, the FTC filed an administrative complaint charging that American Stores' acquisition of Lucky Stores violated section 7 of the Clayton Act, ch. 323, 38 Stat. 731 (1914), as amended and codified at 15 U.S.C. sec. 18 and section 5 of the Federal Trade Commission Act, ch. 311, 38 Stat. 719 (1914), as amended and codified at 15 U.S.C. sec. 45. Second, the FTC filed a proposed consent order (proposed consent order). As part of the proposed consent order, the tender offer was permitted to proceed subject to certain conditions. The conditions were contained in an agreement titled “Hold Separate Agreement” (hold separate agreement). That agreement required American Stores to:

a. refrain from integrating the assets of American Stores and Lucky Stores until American Stores had divested itself of 24 of its 54 Alpha Beta supermarkets in Northern California;

b. maintain separate books and records for the acquisition;

c. prevent any waste or deterioration of Lucky Stores' California operations;

d. refrain from replacing the executives of Lucky Stores;

e. maintain Lucky Stores as a viable competitor in California;

f. refrain from selling or otherwise disposing of Lucky Stores' California warehouses, distribution or manufacturing facilities, and retail grocery stores;

g. preserve separate purchasing for Lucky Stores' retail grocery sales.

Relying on the FTC's proposed consent order of May 31, 1988, American Stores proceeded with its tender offer to purchase 100 percent of Lucky Stores stock. American Stores' tender offer for Lucky Stores stock was carried out by a wholly owned subsidiary of Alpha Beta, Alpha Beta Acquisition Corp. (ABAC). ABAC had been formed solely for the purpose of acquiring the stock of Lucky Stores. On June 2, 1988, ABAC acquired more than 80 percent of the Lucky Stores common stock at $65 per share. As between ABAC and the former Lucky Stores shareholders, ABAC's acceptance and purchase of stock was final and irrevocable.

Petitioner's objective in acquiring Lucky Stores was to achieve future long-term benefits from the merger of the Alpha Beta chain of stores and Lucky Stores. The long-term benefits being sought were a greater market share in the California grocery market, greater operating efficiencies in the combined operations of the two chains, and the adoption of some of the management/operating policies of Lucky Stores such as Lucky Stores' “everyday low pricing” policy.

On June 9, 1988, ABAC was merged with and into Lucky Stores, pursuant to short-form merger provisions of the Delaware General Corporation Law. As a result of the short-form merger, ABAC disappeared and Lucky Stores became a wholly owned subsidiary of Alpha Beta. The total consideration paid by American Stores in the tender offer and merger exceeded $2.5 billion. For purposes of State law, the merger was final and irrevocable. After its acquisition of Lucky Stores, American Stores complied with the requirements of the hold separate agreement and did not integrate the operations of Lucky Stores with the operations of Alpha Beta.

State of California's Actions

In April 1988, American Stores provided the State of California with the filings it had made with the FTC pursuant to section 7 of the Clayton Act. Through that filing, American Stores gave formal notice to the State of California of its intentions to acquire all of the Lucky Stores stock and to merge ABAC into Lucky Stores.

The FTC allowed, in accordance with its regulations, a comment period during which...