Opinion
Docket No. 8681.
1947-06-26
SOUTH AMERICAN GOLD & PLATINUM COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Edgar J. Goodrich, Esq., Lipman Redman, Esq., and Edward First, Esq., for the petitioner. Walt Mandry, Esq., for the respondent.
Legal expenses paid by a parent holding company in negotiating and carrying out an agreement whereby litigation and adverse claims against mining rights of its subsidiaries were settled and the subsidiaries acquired additional mines and concessions, held, not deductible by the parent as an ordinary and necessary expense because (1) not incurred in carrying on the parent's business and (2) made to hold or to acquire capital assets. Edgar J. Goodrich, Esq., Lipman Redman, Esq., and Edward First, Esq., for the petitioner. Walt Mandry, Esq., for the respondent.
The Commissioner determined a deficiency of $11,504.46 in petitioner's income tax for 1942, in part by disallowing the deduction of a legal fee paid for negotiating and carrying out an agreement whereby litigation and adverse claims against mining rights of its subsidiaries were settled and the subsidiaries acquired additional mines and concessions. Petitioner contends that the fee was an ordinary and necessary expense of conducting its business of directing, guiding, and supervising its subsidiaries.
FINDINGS OF FACT.
Petitioner, a Delaware corporation with principal office at 61 Broadway, New York, New York, filed its income tax return for 1942 with the collector of internal revenue for the second district of New York. Petitioner owns the entire stock of many subsidiaries engaged in mining in South America; its officers and directors normally determine the subsidiaries' policy, coordinate their activities, and, through engineers whom it employs, supervise their operations. Among the subsidiaries are Compania Minera Choco Pacifico, S.A. (hereinafter called Choco), and Compania Minera de Narino, S.A. (hereinafter called Narino), both organized as Colombian corporations to engage in dredge mining. In 1933 Choco leased mining rights in two five-kilometer stretches of the Telembi River, agreeing to pay a royalty on the ores of gold and platinum extracted. The lessors, members of the family del Castillo, held a concession thereto issued by the Colombian Government in 1898, which granted them in perpetuity the right to prospect for, exploit, and dispose of mines discovered in the river bed and banks. After prospecting and drilling in 1935, Choco imported a dredge from the United States, and in 1937 transferred the dredge, lease, and options on other mining properties to Narino, which began the mining of gold and platinum. The same year operations were stopped by administrative action of the Colombian Government after Colombian Placers, S.A., had acquired mining concessions in conflict with those of the del Castillo. The del Castillo, with the financial backing of Narino, brought a suit for possession which in 1942 was decided in their favor on the ground that the Colombian Government could not stop mining operations by administrative action, and Narino thereafter resumed operations. The Colombian Government then instituted suit to determine the validity of the del Castillo claim. This suit has not been decided.
In 1936 Colombian Placers, S.A., was organized in San Francisco, California, by a group who were given confidential information by a former driller of Choco. Colombian Placers, S.A., acquired mining concessions previously granted by the Colombian Government to one Dougherty, and engaged in prospecting, but not in mine operation.
Choco also acquired and assigned to Narino the right to prospect and exploit mines in the Tamana River from one Antonio Asprilla, who held 7 or 8 concessions covering 20 to 25 miles of the river bed. Thereafter one Valencia and others applied for and procured a conflicting concession covering nearly the entire length of the Tamana River, and transferred a part of it to the Tamana Gold Dredging Co., a wholly owned subsidiary of the International Mining Corporation (hereinafter called (International). Asprilla brought a possessory action to confirm his rights, but lost in the lower court. The case is still pending on appeal.
Under Colombian law concessions to mine in river beds and land contiguous to the banks are obtained from the Colombian Government by contract which request the payment of royalties to the Government. River bed concessions can be assigned, canceled or renounced under certain conditions, with Government consent. By the payment of a lump sum in lieu of the 20 annual payments required, the concessionaire can procure rights in perpetuity. The del Castillo held such rights in their concessions.
International is a Delaware corporation which owns all the stock of several subsidiary Colombian corporations, formed to engage in mining operations. In 1938 the group which owned Colombian Placers, S.A., interested it in the acquisition of more mining properties and in consolidating its position on the Telembi River. International sent a representative to Colombia, organized subsidiaries there, and had them apply for or acquire by assignment mining concessions on properties overlapping concessions owned or controlled by Narino. Colombian Placers, S.A., also granted International rights to interests acquired by it from certain individuals. As a result, more controversies and litigation followed between the subsidiaries of petitioner and those of International, and the subsidiaries engaged and paid Colombian attorneys to represent them. Petitioner took no part directly in this litigation and did not pay the attorneys' fees, but it brought two suits in California against Colombian Placers, S.A., seeking damages and an injunction to end interference with its subsidiaries' operations in Colombia.
For the avowed purpose of settling out of court all the litigation and disputes relating to subsidiaries' conflicting rights and concessions in Colombia, the parent companies, petitioner and International, on July 17, 1942, entered into and carried out a formal agreement whereby International bound itself:
To transfer or cause to be transferred to petitioner or to petitioner's nominee certain mining concessions and applications for concessions held by its subsidiaries and others which were in conflict with rights claimed by petitioner or its subsidiaries, and further to cause Colombian Placers, S.A., and others to renounce other concessions and to use its best efforts with the Colombian Government to have such concessions canceled and regranted to a subsidiary of petitioner;
To cause to be transferred to Narino the Cargazon mine and all assets of Colombian Placers, S.A., (except cash and stock received under this agreement) free of liabilities, and to cause Colombian Placers, S.A., to be liquidated;
To use its best efforts in causing numerous named individuals to sign documents setting forth their conformity with and acceptance of the settlement and release of petitioner and its subsidiaries from certain claims; to cause one J. T. Boyd to transfer to petitioner or petitioner's subsidiary a purchase option on the mines Terraimbe and Cumainde; and to cause one Guy Standifer to deliver to petitioner or its nominee a release of any agreements which he might have with Dougherty's heir affecting mining claims on the Telembi River;
To deliver to petitioner or its subsidiaries all the capital stock of five Canadian dredging corporations, registered in Colombia, which were subsidiaries of International; and
To transfer to petitioner or its nominee certificates for the importation into Colombia of at least $300,000 U.S. currency, applicable to investments made by International or Colombian Placers, S.A.
By the same instrument petitioner bound itself:
To discontinue its two suits against Colombian Placers, S.A., pending at San Francisco, California;
To deliver to International $11,500 and 50,000 shares of its stock of a par value of $1 each; to cause its subsidiary Narino to pay International 400,000 Colombian pesos and to cause two other subsidiaries to pay International the purchase price (not to exceed 100,000 Colombian pesos) of royalty rights owned by third parties in some of the disputed concessions. It was expressly understood that the payments of 400,000 and 100,000 pesos were to be made by the subsidiaries on their own account and not for the account of petitioner. Other provisions of the agreement required the surrender or cancellation of options covering certain of the rights in controversy.
Petitioner's attorney and director, Charles S. Guggenheimer, of the firm of Guggenheimer & Untermyer, New York, New York, conducted for petitioner the negotiations leading up to this agreement. His services comprised numerous conferences with petitioner's officers and South American representatives and with International's attorneys and the preparation of the agreement, releases, stipulations, and arrangements connected with the final settlement. For these services the firm presented on December 26, 1942, a bill for $25,000, which petitioner paid. On its income tax return for 1942 petitioner deducted this fee as an ordinary and necessary business expense. The Commissioner disallowed it.
OPINION.
JOHNSON, Judge:
Petitioner claims the right to deduct the fee of $25,000 which it paid for legal services in negotiating, procuring, and carrying out the agreement between itself and International in settlement of the disputes and conflicting claims of its Colombian subsidiaries of the one part, and of Colombian Placers, S.A., the subsidiaries of International, and various individuals of the other part. Petitioner concedes, as it must, that it was not engaged in business in Colombia and that it acquired no assets and cleared no title to property owned by it by virtue of the agreement. But it contends that the parental control and the exercise of its supervisory functions over the activities of its subsidiaries constituted a trade or business within the meaning of section 23(a)(1)(A), Internal Revenue Code, and that it is entitled to deduct the fee as an ordinary and necessary expense paid in carrying on that trade or business.
While the passive ownership of corporate shares falls short of qualifying as a business, we accord merit to the view that a holding company, having the care of investments and, through voting rights, the control of various subsidiaries, may be engaged in the conduct of a business and that it may incur deductible expenses in connection therewith and make expenditures designed to safeguard its holdings and protect its investments. But a clear distinction is to be drawn between activities constituting the business of the shareholding investor, as such, and the business of the corporation which he owns. The fee here in controversy was obviously incurred in connection with a business, and to this extent it meets the test prescribed by Kornhauser v. United States, 276 U.S. 145, and other cases on which petitioner relies. But that business was of the subsidiaries, not of petitioner. It is recited in the opening paragraph that the agreement's purpose is to settle litigation and disputes between petitioner's subsidiaries and those of International, and the terms of the agreement provide for the freeing of the subsidiaries' mining concessions from interference by adverse claimants, the acquisition of other mines and concessions by the subsidiaries, and the liquidation of Colombian Placers, S.A., and surrender of the shares of International's five subsidiaries which held many of the adverse claims.
Assuming, arguendo, that if paid by the subsidiaries the fee is of such character as to be an expense deductible by them, we are of opinion that it is not so available to petitioner. The subsidiaries are entities distinct from the parent, and, although their economic advantages redound to the parents' benefit, the Supreme Court has meticulously distinguished between the two in an application of section 23(a). In Interstate Transit Lines v. Commissioner, 319 U.S. 590, it said:
* * * That subsection limits permitted deductions to those paid or incurred ‘in carrying on any trade or business.‘ * * * It was not the business of the taxpayer to pay the costs of operating an intrastate bus line in California. The carriage of intrastate passengers (by the taxpayer's subsidiary) did not increase the business of the taxpayer. The profit earned on their carriage increased the taxpayer's profit but so would any other profitable activity wholly disconnected from the taxpayer's own business. * * *
To the same effect are Deputy v. du Pont, 308 U.S. 488, and Missouri-Kansas Pipe Line Co. v. Commissioner (C.C.A., 3d Cir.), 148 Fed.(2d) 460. And in denying a parent the right to deduct interest of 3 per cent paid by it on a loan to its subsidiary, which loan it had guaranteed, this Court said in Eskimo Pie Corporation, 4 T.C. 669; affd. (C.C.A., 3d Cir.), 153 Fed.(2d) 301:
* * * Payments made by a stockholder of a corporation for the purpose of protecting his interest therein must be regarded as additional cost of his stock and such sums may not be deducted as ordinary and necessary expenses. W. F. Bavinger, 22 B.T.A. 1239; Michigan Central Railroad Co., 79 Fed.(2d) 427, affirming 28 B.T.A. 437, 444, on this point. * * *
But the assumption that the fee, if paid by the subsidiaries, would have been deductible as an expense by them is not in fact supported by the evidence, and hence, a fortiori, it is not deductible by petitioner. The settlement agreement whereby the fee was incurred involved proprietary rights of the subsidiaries and further acquisitions by them, and, significantly, they and not the parent were bound to pay up to 500,000 Colombian pesos in making the settlement, while petitioner itself paid $11,500 and issued to International $50,000 par value shares of its stock.
Petitioner argues that the fee was not paid in defense of title to property because it held no title to any of the rights attacked; that ‘it simply engaged the help of counsel for its business of directing, guiding and supervising, as a parent, its subsidiary corporations.‘ We can not take so narrow a view of the settlement. By it the subsidiaries not only removed clouds from mining rights already held by them, but acquired new rights, paying about 500,000 Colombian pesos therefor, and petitioner itself paid $11,500 and issued $50,000 par value of its shares to effect the settlement. Legal fees and compromise payments for the clearing of title and acquisition of property are capital expenditures, Farmer v. Commissioner (C.C.A., 10th Cir.), 126 Fed.(2d) 542; Moynier v. Welch (C.C.A., 9th Cir.), 97 Fed.(2d) 471; Porter Royalty Pool, Inc., 7 T.C. 685; Louisiana Land & Exploration Co., 7 T.C. 507; affd. (C.C.A., 5th Cir.), 161 Fed.(2d) 842, and had the subsidiaries paid the fee in issue, clearly it would have represented a capital investment in the rights acquired or confirmed. That character is not altered by the fact that petitioner paid it. Petitioner thereby directly acquired no new asset, but by the payment it made a contribution to the capital of its subsidiaries, and for this no deduction is allowable.
Decision will be entered for the respondent.