Sharples v. United States, 63-73.

• Decision Date: 14 April 1976
• Docket Number: No. 63-73.,63-73.
• Citation: 533 F.2d 550
• Parties: Philip T. and Edith W. SHARPLES v. The UNITED STATES.
• Court: U.S. Claims Court

533 F.2d 550

Philip T. and Edith W. SHARPLES v. The UNITED STATES.

No. 63-73.

United States Court of Claims.

April 14, 1976.

William L. Goldman, Washington, D.C., for plaintiff; Thomas E. Jenks, Washington, D.C., atty. of record for plaintiff; John M. Skilling, Jr., Washington, D.C., and Herbert L. Awe, Washington, D.C., of counsel.

Allan C. Lewis, Washington, D.C., with whom was Asst. Atty. Gen., Scott P. Crampton, Washington, D.C., for defendant; Theodore D. Peyser, Jr., and Donald H. Olson, Washington, D.C., of counsel.

Before NICHOLS, KASHIWA and KUNZIG, Judges.

OPINION

KUNZIG, Judge.

In this income tax refund suit plaintiff seeks a 1966 deduction for legal expenses incurred while resisting a Venezuelan tax deficiency. The potential Venezuelan tax liability devolved on plaintiff as the recipient of assets from a liquidated corporation that would have incurred the tax. The issue comes before the court for resolution based upon the parties' stipulation of facts pursuant to Ct.Cl. Rule 134(b)(2). We hold that plaintiff is entitled to deduct the legal expenses under the provisions of subsection 212(3) of the Internal Revenue Code of 1954.¹

As stipulated, Philip Sharples (plaintiff)² was the majority shareholder of Sharples Oil Corp. (SOC), an entity organized under the laws of Delaware, until its 1963-64 liquidation. In 1957, SOC acquired a leasehold interest in certain Venezuelan oil properties. By 1960, SOC had decided to sell the leasehold to a subsidiary of Pure Oil Co. (Pure). SOC accomplished this objective by creating a subsidiary, Sharples-Venezuela Oil Corp. (S-V). SOC transferred the leasehold to S-V and received all of the S-V stock in return. S-V then sold the leasehold to Pure. Both Pure and S-V treated this 1960 transaction as a non-taxable sale under the Venezuelan law.

In 1963-64, SOC (including S-V) liquidated. Plaintiff received various liquidating distributions as a transferee. Dissolution became final in March 1964. Nearly seven months later, Venezuela issued a notice to SOC of proposed tax deficiencies from the 1960 sale. Delaware law would have imposed personal liability on the former SOC shareholders to pay the tax.³ However, plaintiff retained Venezuelan counsel to fight the Venezuelan tax deficiency.

Eventually these efforts were successful, and the tax avoided. Plaintiff paid Venezuelan counsel $168,609.15. In his 1966 U.S. income tax return, he deducted the legal expenses. The Internal Revenue Service (IRS) disallowed this deduction, treating the payments as an additional capital contribution to SOC. The IRS assessed a deficiency which plaintiff paid. After the IRS rejected his subsequent refund claim, plaintiff timely brought the present action.

Plaintiff justifies his 1966 deduction of the Venezuelan legal fees as "ordinary and necessary expenses paid or incurred * * in connection with the determination, collection, or refund of any tax." § 212(3), Int.Rev.Code of 1954. Plaintiff buttresses this argument by pointing to the income tax regulations. "Expenses paid or incurred * * * for tax counsel * * * or in connection with any proceedings involved in determining the extent of his tax liability or in contesting his tax liability are deductible." Treas.Reg. § 1.212-1(l).

Defendant resists plaintiff's use of the rather broad provisions of subsection 212(3) and the regulations by urging application of two exceptions to deductibility. Both exceptions involve variations of what has been called the "origin of the claim" rule.⁴ The first exception arises in conjunction with subsection 212(3). It looks to the origin of the tax claim in terms of the person liable for the tax. A taxpayer receives a deduction for expenses incurred in contesting his own tax, but cannot deduct expenses attributable to resisting a tax imposed on another. The Government argues that Sharples may not use subsection 212(3) in the present action because the Venezuelan tax was incurred by SOC, not plaintiff.

Until the instant case, the second exception has been applied to deny only subsection 212(2) and 162(a) deductions.⁵ This second version of the "origin of the claim" rule looks to the transaction from which the tax liability arose (initial transaction). As a general rule, a taxpayer must subtract from the proceeds of a capital transaction (i. e. capitalize) all expenses which arise, directly or indirectly, from the capital transaction. Defendant would have us enlarge this second exception in the present action to apply not only to subsection 212(2), but also to 212(3). Under this rationale, defendant argues, we would have to deny plaintiff's 1966 deduction because plaintiff incurred the legal fees as a result of the SOC liquidation, a capital transaction.

The court rejects defendant's attempts to remove this case from subsection 212(3) by use of the "origin of the claim" doctrine. We hold that plaintiff may deduct the legal expenses under subsection 212(3).

I. Subsection 212(3):

We begin our analysis by examining the provisions of subsection 212(3). This statute provides:

In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year * * * in connection with the determination, collection, or refund of any tax. § 212(3), Int.Rev.Code of 1954.

The legislative history of subsection 212(3) illustrates the breadth that Congress intended for this statute. "Any expenses incurred in contesting any liability collected as a tax or as a part of the tax will be deductible." H.Rep.No.1337, 83d Cong., 2d Sess. A 59 (1954) U.S.Code Cong. & Admin. News 1954, p. 4196. See also H.Rep.No. 1337, supra at p. 29 and S.Rep.No.1622, 83d Cong., 2d Sess., 34, 218 (1954).

Application of the clear language of subsection 212(3) would usually compel our holding for plaintiff, granting him the right to a deduction in the instant case for expenses incurred in fighting the Venezuelan tax. However, we must first deal with defendant's "origin of the claim" arguments in its attempt to override application of subsection 212(3).

II. Origin of the claim—person taxed:

In United States v. Davis, 370 U.S. 65, 82 S.Ct. 1190, 8 L.Ed.2d 335 (1962), reh. denied, 371 U.S. 854, 83 S.Ct. 14, 9 L.Ed.2d 92 (1962), a taxpayer paid his wife's legal expenses incurred pursuant to a divorce settlement. Part of such legal expense was directed toward his wife's tax treatment of property transferred during the divorce. The Supreme Court denied taxpayer's claim for a deduction, reasoning that subsection 212(3) only applied to the taxpayer's legal expenses and not expenses paid for the benefit of another.

As to the deduction of the wife's legal fees, we read the statute, if applicable to this type of tax expense, to include only the expenses of the taxpayer himself and not those of his wife. Here the fees paid her attorney do not appear to be `in connection with the determination, collection, or refund' of any tax of the taxpayer.

United States v. Davis, supra at 74, 82 S.Ct. at 1195, 8 L.Ed.2d at 344.

Later, in 1967, the Court of Claims further dealt with this subsection 212(3) exception. The court was faced with a case in which the taxpayer incurred legal expenses by resisting a tax liability of a corporation. Taxpayer's obligation to pay the debt was based on an indemnity agreement. The court held that the indemnity agreement did not make the corporation's legal expenses "those of the taxpayer" for purposes of subsection 212(3). Only if the taxpayer incurred the expense himself or by operation of law as a transferee could the expenses be deducted under subsection 212(3). Southern Arizona Bank and Trust Co. v. United States, 386 F.2d 1002, 1005, 181 Ct.Cl. 426, 429-30 (1967), cert. denied, 391 U.S. 967, 88 S.Ct. 2032, 20 L.Ed.2d 879 (1968).

In short, under the first "origin of the claim" exception the court must go beyond the statutory provisions of subsection 212(3) to determine the taxpayer's entitlement to a deduction. If the tax liability is personal to the taxpayer, either because it is his liability or because the liability is imposed on him by operation of law, subsection 212(3) applies. Southern Arizona Bank, supra. If, however, the tax obligation is that of another, subsection 212(3) is of no avail to the taxpayer.

Defendant would have the court find the instant tax liability to be that of SOC rather than plaintiff. The defendant is correct in its view that the original tax liability belonged to SOC. However, defendant ignores the fact that liability for the Venezuelan tax devolved upon plaintiff at the time of the liquidation by operation of Delaware law.⁶ Plaintiff's liability as created by Delaware law made him responsible for the debt within the test established by Southern Arizona Bank. The tax liability was personal to the taxpayer. Defendant's first argument is inapplicable to the present facts. Plaintiff is not precluded from gaining the benefit of subsection 212(3).

III. "Origin of the claim"—initial transaction:

Defendant further urges the court to enlarge the second "origin of the claim" exception in the instant case. In this second argument, defendant relies upon the rationale inherent in capitalization treatment of certain expenditures. Where expenses arise in connection with a capital transaction, the taxpayer must capitalize such expenses rather than deduct them from ordinary income. As stated above, defendant would have us enlarge this second exception to apply to subsection 212(3) as well as subsection 212(2). The liquidation of SOC was a capital transaction. Since the legal expenses arose in connection with a capital transaction reasons defendant, they should be capitalized by plaintiff rather than deducted under subsection 212(3).

We evaluate defendant's second argument in the context of the clear language of the statute, its legislative history, case law and policy considerations. Defendant's "initial transaction" version of...