NCNB Corp. v. U.S.

• Decision Date: 18 June 1981
• Docket Number: No. 78-1771,78-1771
• Parties: 81-2 USTC P 9501 NCNB CORPORATION, a North Carolina Corporation; North Carolina National Bank, Appellees, v. UNITED STATES of America, Appellant.
• Court: U.S. Court of Appeals — Fourth Circuit

Page 942

651 F.2d 942

81-2 USTC P 9501

NCNB CORPORATION, a North Carolina Corporation; North

Carolina National Bank, Appellees, v. UNITED STATES of America, Appellant.

No. 78-1771.

United States Court of Appeals, Fourth Circuit.

Argued Dec. 3, 1979.

Decided June 18, 1981.

Aaron Rosenfeld, Tax Division, Dept. of Justice, Washington, D. C. (Gilbert E. Andrews, Jonathan S. Cohen, Tax Division, Dept. of Justice, M. Carr Ferguson, Asst. Atty. Gen., Washington, D. C., Harold M. Edward, U. S. Atty., Charlotte, N. C., on brief), for appellant.

E. Osborne Ayscue, Jr., Charlotte, N. C. (John W. Johnston, William H. Higgins, Helms, Mulliss & Johnston, Charlotte, N. C., on brief), for appellees.

Before BRYAN, Senior Circuit Judge, WIDENER and MURNAGHAN, Circuit Judges.

MURNAGHAN, Circuit Judge:

Here we encounter the distinction between those business-related expenditures which under I.R.C. § 162 may currently be set off against a taxpayer's gross income for the present accounting period (expensed) and those expenditures which must be carried forward on the taxpayer's books as part of the cost of producing income which will be recognized in future accounting periods (capitalized and subsequently written off, amortized, or depreciated).

I.

The taxpayer ¹ in the instant case is a "full service" national bank offering a wide range of banking services to its customers. To further its goal of providing banking services throughout North Carolina, ² taxpayer has pursued for several years an expansion program involving over a dozen mergers with other banks, reconstruction of some of its existing facilities, and the establishment of new facilities ("branching"). Because taxpayer is a national bank, it must obtain the approval of the Comptroller of the Currency to establish a new branch or to retain and operate the existing branch of a bank with which it consolidates. ³

Varied are the costs incurred in the many aspects of taxpayer's expansion program, ranging from selecting an area of the state for expansion, to planning future branches in that area, to turning such general plans into a concrete course of action, to obtaining the approval of the Comptroller of the Currency. (During the tax years in question, four of taxpayer's applications for approval were protested and were later approved only after an evidentiary hearing held by the Regional Administrator of the Office of the Comptroller. In one instance, the protest resulted in extensive litigation, in which taxpayer ultimately was successful. ⁴) The costs involved in the expansion program were both internal (e. g., salaries, supplies, depreciation, amortization) and external (e. g., fees paid to the Comptroller, attorneys' fees, amounts paid to outside consultants for marketing studies).

As part of its long-range planning, the bank produced or purchased marketing studies of large metropolitan areas, reports which it called "Metro Studies." In addition to setting out long- and short-range recommendations regarding future branches, Metro Studies contained information which was used in planning future branches, data which were needed for applications to the Comptroller, and material which was relevant to action which might be taken in connection with existing branches. The District Court, in reaching its decision in taxpayer's favor on grounds independent of when anticipated revenues would match expenditures for Metro Studies, made no finding with respect to the useful life of the Metro Studies. Nevertheless, the record clearly implies that theirs was a multi-year utility, the value not being entirely restricted to nor exhausted within the single year of expenditure. Neither the parties nor the court made any allocation of that extended utility among (a) continued monitoring of the operations of existing branches, (b) planning for new branches, and (c) bringing those new branches into existence.

A second stage of planning produced what taxpayer calls "feasibility studies." The reports focused on specific locations for potential branches. To help management decide whether or not to open a new branch in the particular location, a feasibility study estimated additional income to be anticipated from a branch in the location, net of the further costs associated with opening a branch there. As with the Metro Studies, the court made no finding as to the duration of useful life. ⁵ Correspondingly, there was no finding as to whether the feasibility studies, in part at least, played any role in the production of current income.

In filing its corporate income tax returns for 1965-70, taxpayer treated all such planning and implementation costs as expenses currently deductible under I.R.C. § 162, ⁶ in the year incurred. That is, all expenditures connected with finding and selecting the best locations for future branches, with obtaining governmental permission to open branch banks in those locations, and with actually opening such branches, were charged against present income.

The Commissioner of Internal Revenue timely assessed a deficiency with respect to the returns. Because the costs of planning for, and of obtaining approval for, the branches were related to the production of the bank's future, rather than present, income, the Commissioner insisted that none of the expenditures were current expenses. Instead, he claimed that all the disputed costs had to be carried forward on the books of the bank, to be offset against income in some future period or periods as depreciation under I.R.C. § 167 ⁷ or, when it subsequently became evident that no income would be generated, as a loss under I.R.C. § 165. ⁸

The taxpayer paid in full the assessed deficiencies, it claimed refunds which the Commissioner denied, and it then timely sued for refunds in the District Court.

After a nonjury trial, the District Court entered judgment for the taxpayer, concluding that all the disputed expenditures were current expenses within the meaning of I.R.C. § 162. The court's decision was founded on the following conclusions of law: "The granting of permission to a bank to open a new branch does not create a separate and distinct asset. It produces nothing corporeal or salable. It does not create a capital asset within the meaning of the Internal Revenue Code of 1954." The Commissioner appealed.

We reject the Commissioner's flat contention that no current deductions at all could have been proper, but we also reject the District Court's conclusion that all of the expenditures at issue were currently deductible. It simply is not an all-or-nothing situation. Because the legal standards used by the District Court in reaching its decision were over-simple and incorrect, the court failed to make the necessary detailed factual findings which would permit allocation in whole or in part of certain costs between, on the one hand, the taxpayer's review of its current income-producing operations and, on the other, planning and implementing expansion for the production of income in subsequent tax years. Accordingly, we remand for further factfinding and for application of the proper legal standard.

II.

In attempting to discern Congress' intent in enacting § 162(a), we can infer much from the role which the section plays in the income tax as a whole. Basically § 162(a) implements Congress' fundamental policy decision to tax net income calculated annually, with minimal distortion. To arrive at a figure for annual net income for a given tax year, it is necessary to reduce gross revenues for the year by the costs of producing those revenues.

Section 162(a)'s central statutory phrase "ordinary and necessary expenses," therefore, embodies two requirements: (1) business relation and (2) currency. See Commissioner v. Tellier, 383 U.S. 687, 689-90, 86 S.Ct. 1118, 1119-20, 16 L.Ed.2d 185 (1966). ⁹ Although expenditures ¹⁰ which are "necessary" but not "ordinary" are no less business related than those which are both "ordinary and necessary," they may not be currently used in the calculation of net income. Such use must await tax years in which the taxpayer recognizes the gross revenues with whose production the expenditures are connected. It is that connection with some production of income which makes the expenditures "necessary" and which justifies the deduction in the first place.

Chief Judge Sobeloff said it well in Richmond Television Corp. v. United States, 345 F.2d 901, 907 (4th Cir. 1965), vacated on other grounds, 382 U.S. 68, 86 S.Ct. 233, 15 L.Ed.2d 143 (1965), original holding on this issue reaffirmed, 354 F.2d 410 (4th Cir. 1965):

Our system of income taxation attempts to match income and expenses of the taxable year so as to tax only net income. A taxpayer may, therefore, not deduct as a current business expense the full cost of acquiring an asset, tangible or intangible, which benefits the taxpayer for more than one year. The concept has been explained in United States v. Akin, 248 F.2d 742, 744 (10th Cir. 1957).

'(A)n expenditure should be treated as one in the nature of a capital outlay if it brings about the acquisition of an asset having a period of useful life in excess of one year, or if it secures a like advantage to the taxpayer which has a life of more than one year.'

The Commissioner concedes that the expenditures at issue in the instant case were adequately related to the taxpayer's trade or business (i. e., were "necessary"). The question, therefore, is to what extent, if at all, the expenditures were also "ordinary," i. e., were current, were part of the cost of producing the income which is reported on the disputed income tax returns. It is a matter of timing, the selection of the proper tax year or years against whose revenues the expenditures should be set off.

Obviously the question then becomes one of accounting. ¹¹ Allocating an expenditure to a particular tax year or years involves an accounting judgment. By incorporating the "ordinary" requirement in § 162(a), Congress imposed...