Effect of the Supreme Court's decision in INDOPCO.

On April 11, 1992, Tax Executives Institute submitted the following comments to Terrill A. Hyde, Tax Legislative Counsel for the U.S. Department of the Treasury, concerning the scope of the Supreme Court's decision in Indopco v. Commissioner. An article on the decision appeared in the March-April issue of The Tax Executive.

Following up on one of the subjects discussed during TEI's recent liaison meeting with Assistant Secretary Goldberg, you, and other representatives of the Office of Tax Policy, I want to underscore the Institute's belief that the Treasury Department and the Internal Revenue Service should take steps to clarify the scope of the Supreme Court's recent decision in Indopco.

During the meeting, you mentioned that the Treasury had not heard from many taxpayers about the Indopco decision. Let me assure you, I have heard from many TEI members. Although some of them may have been willing to concede the nondeductibility of the precise expenditures at issue in the case even before the Court handed down its unanimous decision, every one of them is discomfited by the potential breadth of the Court's opinion. Clearly, taxpayers and the government alike had hoped that the decision would bring certainty to the capitalization-versus-expensing issue albeit on different sides of the issue). TEI is concerned, however, that the result will not be certainty but confusion. Thus, like the high court's decisions in Cottage Savings and Arkansas Best, the decision in Indopco may well raise more questions than it answers. Indeed, the scope of the Court's holding is so ambiguous (and the burden it places on taxpayers so potentially high), that - absent some guidance from Treasury and the IRS National Office - Indopco could well spawn dispute after dispute for years to come.

For example, although the case itself deals with the treatment of expenditures incurred in connection with a friendly takeover, we are aware of revenue agents in many districts who stand poised to invoke the Court's broad language to disallow deductions for a whole range of historically deductible expenses. TEI believes that the Treasury Department and IRS National Office should act to bring a modicum of certainty to the area by providing clear guidance to field personnel (in the Examination Division and Counsel) on what the Indopco case does not stand for. Obviously, the decision's application to certain expenditures (e.g., those incurred in connection with a hostile takeover) may remain in dispute for some time (and may require additional litigation). I should hope, however, that the IRS (with appropriate input from the Treasury) will issue an announcement to the effect that some expenditures are beyond the capitalization pale of Indopco. Specifically, we believe that the IRS should confirm the agency's adherence to the principles contained in the following excerpts from the Solicitor General's brief in the Supreme Court:

Particularized rules have been

adopted to resolve recurring

questions that arise in specific

areas of business activity. For

example, the cost of repairs that

are recurring in nature and that

merely keep business property

in an ordinarily efficient operating

condition are currently

deductible even though an individual

item may last (and thus

yield a benefit to the business)

for more than a year ....

Recurring expenses that are

designed to maintain the condition

of capital - such as advertising,

repairs, and maintenance

- may create benefits

that are long-lived, but the constant

nature of their incurrence

renders deferral and amortization

of less significance in assuring

that the taxpayer's

method of accounting "clearly

reflect[s] income" (Section

446(b))....

Concededly, the Court's language in Indopco could be read as erecting a very high burden for taxpayers to overcome in establishing an expenditure's current deductibility. (I personally interpret the decision as establishing a balancing test, where the expensing/ capitalization issue turns on the "duration and extent of the benefits realized by the taxpayer," but a taxpayer's placement of the fulcrum may differ significantly from a revenue agents.(1)) Indeed, absent the exercise of self-restraint by the IRS, revenue agents may well read the decision as sanctioning the disallowance of current deductions for all manner of expenditures, including those for repairs, employee training, advertising, and maintenance. We do not believe the tax system would be well served by a wide-open facts-and-circumstances test, untethered by any bright lines.

Hence, TEI suggests that consideration be given to the issuance of guidance (perhaps in the form of "bracket rulings") that confirms that the IRS does not intend to use Indopco to challenge the current deductibility of expenditures for items such as advertising, employee training, repairs, and maintenance.

(1) Some have argued that Indopco is a very narrow decision, limited to its facts and, indeed, attributable to the taxpayer's failure of proof in the Tax Court. In this regard, I enclose an article by McGee Grisby and Cabell Chinnis of Latham & Watkins, which was published in the March-April issue of The Tax Executive. (A similar article by Philip Adams and Dean Hinderliter appeared in the April 6 issue of Tax Notes.) Although I personally find the argument attractive, it may be unrealistic to believe the IRS will quickly adopt that interpretation. At the same time, the decision should not be distended into a precedent without moorings that calls into question the deductibility of routine and recurring expenditures.