Central Texas Sav. & Loan Ass'n v. U.S.

• Decision Date: 11 May 1984
• Docket Number: No. 83-1169,83-1169
• Court: U.S. Court of Appeals — Fifth Circuit
• Parties: 84-1 USTC P 9471 CENTRAL TEXAS SAVINGS & LOAN ASSOCIATION, Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant.

Page 1181

731 F.2d 1181

84-1 USTC P 9471

CENTRAL TEXAS SAVINGS & LOAN ASSOCIATION, Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant.

No. 83-1169.

United States Court of Appeals Fifth Circuit.

May 11, 1984.

Glenn L. Archer, Jr., Asst. Atty. Gen., Michael L. Paup, Chief, Jonathan S. Cohen, Terry L. Fredricks, Appellate Sect., Tax Div., Dept. of Justice, Washington, D.C., for defendant-appellant.

Beard & Kultgen, Pat Beard, Waco, Tex., for plaintiff-appellee.

Appeal from the United States District Court for the Western District of Texas.

Before RUBIN, REAVLEY and GARWOOD, Circuit Judges.

REAVLEY, Circuit Judge:

The government appeals the decision of the district court holding that expenditures made in investigating and establishing new branches of a savings and loan association were deductible expenses under 26 U.S.C. Sec. 162(a) (1976). We agree with the government's contention that such expenditures should have been capitalized.

I. Statement of the Case

Central Texas Savings & Loan Association (Central Texas), with its principal place of business and home office in Marlin, Texas, opened Texas branch offices in Waco (1973), Temple (1974), Rosebud (1976), and Mart (1976). The taxpayer made several expenditures in investigating and in starting up the new branches, including professional fees for economic research and analysis to determine the potential market at each location and attorneys' fees and permit fees attendant upon licensing the new locations. ¹ Central Texas initially amortized some of these expenditures. The Internal Revenue Service audited the taxpayer's tax returns for 1972 through 1975, disallowed these amortization deductions, and assessed the taxpayer additional taxes and interest, which the taxpayer paid.

In 1978 and 1979 Central Texas filed amended returns for the years 1972 through 1977, claiming current expense deductions under 26 U.S.C. Sec. 162(a) (1976), for the professional fees and the expenditures made in obtaining permits to open the branches. Some of these deductions were disallowed and others have not been ruled on. In December 1979 the taxpayer filed suit in the District Court, Western District of Texas, claiming a tax refund of $8,971. In the alternative, the taxpayer contended that the expenditures should have been amortized over the life of the "work product," presumably the period of time prior to approval of the permit during which the studies and applications were used.

The district judge ruled in favor of Central Texas, stating that addition of the same services by a newly established branch did not create a separate and distinct asset; it merely enabled the institution to accommodate changing business conditions. The judge also ruled that the expenditures for the permits and studies had no measurable value beyond the date of approval for the branch offices. He relied chiefly on NCNB Corp. v. United States, 684 F.2d 285 (4th Cir.1982) (en banc), in reaching these conclusions. For the reasons set out below, this court reaches a different result from that in NCNB.

II. Section 162(a) Deductions

Section 162(a) provides that "[t]here shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business...." (emphasis added). To qualify as an allowable deduction under this section an item "must (1) 'be paid or incurred during the taxable year,' (2) be for 'carrying on any trade or business,' (3) be an 'expense,' (4) be a necessary expense, and (5) be an 'ordinary' expense." Commissioner v. Lincoln Savings & Loan Association, 403 U.S. 345, 352, 91 S.Ct. 1893, 1898, 29 L.Ed.2d 519 (1971).

"Carrying on any trade or business" has been interpreted to mean that only an existing business, i.e., one that is fully operational, may take advantage of the provision. See Richmond Television Corp. v. United States, 345 F.2d 901, 907 (4th Cir.), vacated on other grounds, 382 U.S. 68, 86 S.Ct. 233, 15 L.Ed.2d 143 (1965). Hence, if a taxpayer were to start a new business, the pre-operational or start-up expenses would not be deductible under section 162(a). Similarly, if the taxpayer were to investigate the feasibility of acquiring an existing business or stock in such a business, such costs would not be deductible under section 162(a) but would be capitalized. See Ellis Banking Corp. v. Commissioner, 688 F.2d 1376, 1379 (11th Cir.), cert. denied, --- U.S. ----, 103 S.Ct. 3537, 77 L.Ed.2d 1388 (1983). It would seem anomalous to say that if a taxpayer purchases or merges with a savings and loan in another city, it must capitalize the investigative and start-up costs; but if it establishes a new office, these same costs may be deducted under Sec. 162(a).

Section 162(a) further requires that an item be paid or incurred and the benefit exhausted during the taxable year to be deductible. While the period of the benefits may not be controlling in all cases, it nonetheless remains a prominent, if not predominant, characteristic of a capital item. NCNB Corp. v. United States, 684 F.2d at 295 (Murnaghan, J., dissenting). See United States v. Mississippi Chemical Corp., 405 U.S. 298, 310, 92 S.Ct. 908, 915, 31 L.Ed.2d 217 (1972) (where security is of value in more than one taxable year, it is a capital asset). We still consider, therefore, that the continuation of the permit's value to the taxpayer for a period exceeding one year is evidence that the permit or its costs of acquisition are capital items. E.g., Shutler v. United States, 470 F.2d 1143, 1147 (10th Cir.), cert. denied, 411 U.S. 982, 93 S.Ct. 2275, 36 L.Ed.2d 959 (1973); Wells-Lee v. Commissioner, 360 F.2d 665, 669 (8th Cir.1966); Nachman v. Commissioner, 191 F.2d 934, 936 (5th Cir.1951). In this case, the permit was a one-time payment that gave the taxpayer the right to operate for an indefinite period of time. The benefit secured by the permit clearly extended beyond the year in which the fee payment was made. Furthermore, the fact that the fee payment was made only once supports the proposition that the outlay was a capital asset, rather than an annual expense. Wells-Lee, 360 F.2d at 670.

The third requirement of section 162(a) is that the expenditure be an ordinary and necessary expense. The courts have long had difficulty determining whether an expenditure is ordinary and necessary. ² The parties do not contest the necessity of the expenditures to establish the branches. Our inquiry is whether they were ordinary. In Lincoln Savings, the Supreme Court addressed the question whether a payment required by section 404(d) of the National Housing Act was deductible as an ordinary expense. 403 U.S. 345, 346, 91 S.Ct. 1893, 1895. The savings and loan association was required to pay a two percent premium of the increase in the total of its insured accounts. Id. at 348-49, 91 S.Ct. 1896. This premium was used to provide insurance for deposits in the participating institutions. Id. at 350, 91 S.Ct. at 1897. The institution retained a pro rata share in the reserve fund, but the interest was not transferable, except in case of merger or consolidation or similar transactions. Id. The taxpayer argued that the premium was an ordinary expense of doing business since it was an obligatory expenditure made by all similarly situated savings and loan institutions, with little possibility of future benefit. Id. at 354, 91 S.Ct. at 1899. The Supreme Court disagreed and stated the test for distinguishing an ordinary expense from a capital expenditure:

The presence of an ensuing benefit that may have some future aspect is not controlling. Many expenses concededly deductible have prospective effect beyond the taxable year.

What is important and controlling, we feel, is that the Sec. 404(d) payment serves to create or enhance for Lincoln what is essentially a separate and distinct additional asset and that, as an inevitable consequence, the payment is capital in nature and not an expense, let alone an ordinary expense, deductible under Sec. 162(a)....

Id. at 354, 91 S.Ct. at 1899. Our question, therefore, is whether the establishment of a new branch office creates a separate and distinct additional asset.

The district judge concluded that the expenditures in question related only to the acquisition of a permit and were of no use after the permit was received. We disagree. Section 162(a) must be read in tandem with section 263(a), which provides:

No deduction shall be allowed for--(1) any amount paid out for new buildings or for permanent improvements on betterments made to increase the value of any property or estate....

26 U.S.C. Sec. 263(a) (1976).

This provision has been construed to mean that expenditures incurred in the acquisition of a capital asset must generally be capitalized. Woodward v. Commissioner, 397 U.S. 572, 576, 90 S.Ct. 1302, 1305, 25 L.Ed.2d 577 (1970); Southland Royalty Co. v. United States, 582 F.2d 604, 606, 217 Ct.Cl. 431 (1978), cert. denied, 441 U.S. 905, 99 S.Ct. 1991, 60 L.Ed.2d 373 (1979). Expenditures "made with the contemplation that they will result in the creation of a capital asset cannot be deducted as ordinary and necessary business expenses even though that expectation is subsequently frustrated or defeated." Ellis Banking Corp., 688 F.2d at 1382 (quoting Union Mutual Life Insurance Co. v. United States, 570 F.2d 382, 392 (1st Cir.), cert. denied, 439 U.S. 821, 99 S.Ct. 87, 58 L.Ed.2d 113 (1978)). The district judge therefore erred by concluding that the expenditures had no measurable value to the savings and loan after it acquired approval to open the branch offices. The character of the item acquired determines the tax treatment of the expenditures made to acquire it. E.g., Nachman v. Commissioner, 191 F.2d at 936 (cost of liquor license good for remainder of year must be capitalized where asset could reasonably be expected to serve taxpayer in future years).

The court must look to the character of the...