Kahler Corp. v. Comm'r of Internal Revenue
| Decision Date | 20 June 1972 |
| Docket Number | Docket No. 2288-70. |
| Parties | THE KAHLER CORPORATION, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Robert J. Johnson, John W. Windhorst, Jr., and Michael Trucano, for the petitioner.
Robert F. Cunningham, for the respondent.
Petitioner, prior to and during the taxable years in question, advanced funds to its subsidiaries for working capital purposes. The advances bore no interest. Respondent determined, pursuant to the authority of sec. 482 and the regulations thereunder, that interest income should be allocated to petitioner in an amount equal to 5 percent of the balances on the advances outstanding at the end of each month during the taxable period. Held, the application of sec. 482 and the regulations thereunder to impute interest income to petitioner where the advances did not represent transactions out of which income was realized by petitioner or its subsidiaries reaches beyond the intent and purpose of the statute and constitutes an abuse of the Commissioner's discretion.
Respondent determined a deficiency in petitioner's income taxes for the years 1965 and 1966 in the amounts of $85,434.31 and $90,105.22, respectively. Because of concessions stipulated by both parties prior to trial, only one issue with respect to the application of section 482 remains for decision. A computation under Rule 50 will be necessary to reflect the pretrial concessions and the ultimate resolution of the remaining issue in the case.
Some of the facts have been stipulated. These stipulated facts and the exhibits attached thereto are incorporated herein by this reference.
The Kahler Corp. (hereafter Kahler or petitioner) is a Minnesota corporation engaged in the business of owning and operating hotel and motel properties. During the tax years in question, petitioner kept its books and reported its income pursuant to the accrual method of accounting, filed its annual corporation tax returns with the district director in St. Paul, and maintained its principal office in Rochester, Minn.
Prior to 1960, Kahler was engaged in the hotel business in Rochester through its operation and ownership of the Kahler and Zumbro Hotels, the former being the largest hotel in the State of Minnesota. Petitioner also engaged in the laundry and drycleaning business through its wholly owned subsidiary, Lawler's Inc.
The Kahler management in the early 1960's decided to expand its operations beyond the limits of the city of Rochester. In each city into which Kahler wished to expand, a wholly owned subsidiary would be established to operate and manage the new hotel and motel properties in that particular city and its environs. During the Kahler period of expansion, 1960 through 1966, Kahler subsidiaries were formed in Owatonna, Mankato, Minneapolis, Albert Lea, Hibbing, and Moorhead, Minn., and Fargo, N.D.
The wholly owned subsidiaries maintained their principal offices at the same location occupied by petitioner in Rochester. While petitioner's books were kept on a calendar year basis, the subsidiaries' books were kept on a fiscal year basis. The following schedule shows the date of incorporation, capitalization, and nature of the business conducted by each of petitioner's subsidiaries, including the laundry subsidiary of petitioner which was in operation prior to 1960:
In expanding its operations through subsidiaries, petitioner patterned the capital structure of its subsidiaries according to the prevailing norm in the motel-hotel industry. The industry standard was that the owner should contribute between 20 and 30 percent of the capital required by the corporation with the remainder to be obtained through other financing arrangements. If followed, the norm would approximate a ratio of 1:3 between owner's equity and noncapitalized funding.
In line with petitioner's long-standing predilection for internal financing, a major portion of the noncapitalized funding...
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