Townsend Industries v. United States ( 2003 )

United States Court of Appeals
FOR THE EIGHTH CIRCUIT
___________
No. 02-3756
___________
Townsend Industries, Inc., *
*
Appellant, *
* Appeal from the United States
v. * District Court for the
* Southern District of Iowa.
United States of America, *
*
Appellee. *
___________
Submitted: May 16, 2003
Filed: September 15, 2003
___________
Before BOWMAN and BYE, Circuit Judges, and ERICKSEN,1 District Judge.
___________
BOWMAN, Circuit Judge.
This is a case about the taxability of business and entertainment expenses spent
on a Canadian fishing trip. After the Internal Revenue Service determined that the
per-employee cost of Townsend Industries' annual fishing trip was wages, it assessed
deficiencies against the company for the 1996 and 1997 tax years. Townsend paid
a portion of the deficiency and filed a 26 U.S.C. § 7422 (2000) suit seeking a refund.
After a bench trial, the District Court found in favor of the Government, held that the
1
The Honorable Joan N. Ericksen, United States District Judge for the District
of Minnesota, sitting by designation.
expenses involved in the trips were employee wages within the meaning of the
Internal Revenue Code, and ruled that a portion of these wages should have been
withheld for income tax and Social Security and Medicare taxes. Townsend appeals
that decision, and we reverse.
Townsend Industries, based in Altoona, Iowa, manufactures the T-51, a product
that allows offset printers to produce two-color documents in a single pass through
the printing press. For the last forty years, Townsend has gathered its salespeople2
for an annual, two-day meeting at its headquarters involving its corporate staff and
some factory workers. Following that meeting, the company has sponsored a four-
day expense-paid fishing trip to a resort in Ontario, Canada (two of the four days
spent traveling to-and-from the resort on a bus). Aside from a dinner at which the
company owner, Robert Townsend, and its CEO, John Jorgenson, spoke about the
state of the company, the employees and salespeople spent their time largely as they
wished (though the vast majority fished). Nevertheless, business discussions were
conducted on an on-going basis during the trip.
We apply the same standards of review that we apply in other cases when we
review a district court's decision in a taxpayer's suit to reclaim taxes paid. See United
States v. Boyle, 469 U.S. 241, 249 n.8 (1985). Accordingly, we review the District
Court's findings of fact for clear error and its conclusions of law de novo. Boles
Trucking, Inc. v. United States, 77 F.3d 236, 242 n.3 (8th Cir. 1996) (citing Boyle,
469 U.S. at 249 n.8). The District Court's holding that Townsend failed to establish
that its trips had a business purpose is a legal conclusion that we review de novo. Cf.
Boyle, 469 U.S. at 249 n.8 (explaining that presence of elements constituting
"reasonable cause" is a question of law).
2
Townsend's salespeople are not company employees; rather, they are
independent business owners.
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The question of whether the per-employee cost of the trips amounted to taxable
wages and whether Townsend should have withheld a portion of these costs turns on
whether each employee could have deducted these costs as business expenses. A
taxpayer may exclude certain fringe benefits from his or her gross income and thereby
avoid paying income tax on these benefits. Section 132(d) of the Internal Revenue
Code excludes "working condition fringe" benefits from an individual's wages and
provides that "'working condition fringe' means any property or services provided to
an employee of the employer to the extent that, if the employee paid for such property
or services, such payment would be allowable as a deduction under section 162 or
167." 26 U.S.C. § 132(d) (2000).
In turn, § 162(a)(2) allows a deduction for "traveling expenses (including
amounts expended for meals and lodging other than amounts which are lavish or
extravagant under the circumstances) while away from home in the pursuit of a trade
or business." 26 U.S.C. § 162(a)(2). Any deduction for travel and entertainment is
substantially limited by § 274, which disallows deductions for certain expenses and
provides heightened reporting requirements. Section 274(a)(1)(A) disallows
deduction for entertainment expenses:
With respect to an activity which is of a type generally considered
to constitute entertainment, amusement, or recreation, unless the
taxpayer establishes that the item was directly related to, or, in the case
of an item directly preceding or following a substantial and bona fide
business discussion (including business meetings at a convention or
otherwise), that such item was associated with, the active conduct of the
taxpayer's trade or business.
26 U.S.C. § 274(a)(1)(A) (emphasis added). Section 274(d) adds an important
substantiation requirement and forbids deductions for entertainment expenses:
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unless the taxpayer substantiates by adequate records or by sufficient
evidence corroborating the taxpayer's own statement (A) the amount of
such expense or other item, (B) the time and place of the travel,
entertainment, amusement, recreation, or use of the facility or property,
or the date and description of the gift, (C) the business purpose of the
expense or other item, and (D) the business relationship to the taxpayer
of persons entertained, using the facility or property, or receiving the
gift.
26 U.S.C. § 274(d)(4).
The Treasury Department has promulgated regulations that provide a further
gloss on the Internal Revenue Code and that govern whether "working condition
fringe" benefits and travel and entertainment expenses are deductible. For purposes
of this case, 26 C.F.R. § 1.132-5 (2003), which governs "working condition fringes,"
adds nothing. Section 1.162-2, which deals with traveling expenses, adds some
important requirements to the deductibility of travel expenses and § 1.162-2(a)
provides that "[o]nly such traveling expenses as are reasonable and necessary in the
conduct of the taxpayer's business and directly attributable to it may be deducted."
26 C.F.R. § 1.162-2(a) (emphasis added). The regulation then explains that where
personal and business travel are mixed, travel expenses may only be deducted "if the
trip is related primarily to the taxpayer's trade or business." 26 C.F.R. § 1.162-
2(b)(1). However, even if the trip is not primarily business-related, expenses "which
are properly allocable to the taxpayer's trade or business" may still be deducted. Id.The regulations governing § 274 of the Internal Revenue Code add additional
requirements for this section's "directly related to" and substantiation requirements.
Section 1.274-2(c)(3) add's four requirements that the taxpayer must meet in order to
deduct entertainment and travel expenses. The expense will only be considered
directly related to, or associated with, the active conduct of business if:
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(i) . . . the taxpayer had more than a general expectation of deriving
some income or other specific trade or business benefit . . . .
(ii) . . . the taxpayer actively engaged in a business meeting, negotiation,
discussion, or other bona fide business transaction, other than
entertainment, for the purpose of obtaining such income or other specific
trade or business benefit . . . .
(iii) In light of all the facts and circumstances of the case, the principal
character or aspect of the combined business and entertainment . . . was
the active conduct of the taxpayer's trade or business . . . It is not
necessary that more time be devoted to business than to entertainment
to meet this requirement. The active conduct of trade or business is
considered not to be the principal character or aspect of combined
business and entertainment activity on hunting or fishing trips . . . unless
the taxpayer clearly establishes to the contrary.
(iv) The expenditure was allocable to the taxpayer and a person or
persons with whom the taxpayer engaged in the active conduct of trade
or business during the entertainment . . .
26 C.F.R. § 1.274-2(c)(3)(i)–(iv). Temporary regulations govern the "adequate
records" requirement in § 274(d) and explain that in the absence of written,
contemporaneous records, the taxpayer must establish the business nature of the
expense "[b]y his own statement, whether written or oral, containing specific
information in detail . . . and [b]y other corroborative evidence sufficient to establish"
the business nature of the expense. Id. § 1.274-5T(c)(3)(i)(A)–(B).
What these many statutes and regulations boil down to is a requirement that
Townsend prove that its fishing trips were reasonable and necessary business
expenses that were directly related to, or associated with, the active conduct of
Townsend's business. Further, Townsend must demonstrate its business purpose by
showing: that it had more than a general expectation of deriving some income or
other trade or business benefit from the trip; that its employees actively engaged in
business meetings, negotiations, discussions, or other bona fide business transactions;
and that the principal character of the combined business and entertainment was the
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active conduct of Townsend's trade or business. Finally, Townsend faces an
evidentiary hurdle and must prove the business nature of its expenses by "adequate
records," by its own statements, or by other corroborative evidence.
The District Court determined that Townsend failed to establish a business
purpose and ruled in favor of the Government. The District Court first determined
that the "fishing trips were not an ordinary and necessary business expense in light
of the lax attendance policy for the trip, and the disconnect between the sales meeting
and the fishing trip." Order at 7 (Aug. 21, 2002). Notwithstanding Townsend's
unusual, inclusive business philosophy, the District Court determined that there was
only a brief business meeting held during each of the trips and that it could not say
that "a voluntary, company-wide, all-expense-paid, employer-sponsored fishing trip
with one brief business meeting [was] an ordinary and necessary business expense."
Id. at 8. Nor, the District Court ruled, could Townsend have met the test set out in
§ 1.274-2(c)(3)(i)–(iv). The District Court concluded that each trip was "not an
integral part of Townsend employees' ability to perform their jobs, it was not a part
or a continuation of a sales meeting, but rather was a relaxed and fun event where
business was discussed as part of the background to the primary fishing endeavor."
Id. at 10. Further, Townsend's general "expectation to derive uncertain future
benefits, particularly in the way of improved comradery [sic] and relations among its
employees and sales personnel[,] . . . is not enough to allow the trips to qualify as
directly related under section 274(a)." Id. Further still, the District Court concluded
that Townsend could not establish "that its trips were associated with the active
conduct of its business" because the trips were not conducted before or after a
business discussion and, therefore, the "business discussions that occurred in Iowa
on Monday and Tuesday were too far distanced temporally from the fishing trip that
took place the following four days for this Court to find the 'associated with' test
met." Id. at 10–11. Finally, the District Court concluded that, in any event,
Townsend failed to meet the substantiation requirements insofar as the witnesses'
recollections of fishing trips from different years ran together and the trial testimony
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"lacked the necessary specificity" about Townsend's business purpose. Id. at 12. We
disagree with the District Court's holding that the evidence presented at trial failed
to establish a business purpose for Townsend's 1996 and 1997 trips.
Simply put, the testimony elicited at trial clearly established that the 1996 and
1997 trips were business trips and that Townsend properly excluded the trip expenses
from its employees' gross income. Although the amount of contemporaneous, written
evidence was negligible, Townsend and the Government provided sufficient
"statement[s] . . . containing specific information in detail . . . to establish" the
business nature of the trips. 26 C.F.R. § 1.274-5T(c)(3)(i).3
In the first place, we cannot agree that District Court's conclusion that the
voluntary nature of the trips rendered them an undeductible business expense.
Although the trips were voluntary, nearly all of the Townsend employees who
testified felt an obligation to attend and some felt that it was part of their job.
Moreover, Robert Townsend, the owner, testified that while he felt it would be
antithetical to his business philosophy to make the trips mandatory, he and other
senior management "definitely encourage" employees to attend and that "[w]hat we
want to do is to get them to go, and we do lean on them." Trial Tr. at 21, 31. John
Jorgensen, the CEO, testified that "I encourage them to go. I visit with them about
the fishing trip, about the activities. I definitely encourage everyone to go." Id. at
98. Jorgensen further testified about specific attempts he made to encourage different
3
In this case, the lack of contemporaneous, written evidence is not entirely
surprising for two reasons. First, Townsend followed the same practice and
procedure (without interference) for its annual trip since instituting it in the 1960's.
Second, one salesperson explained (during the Government's cross-examination) that
the absence of some of the written corroboration could be attributed to Townsend's
corporate culture: "They love surprises." Trial Tr. at 329.
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employees to attend the event.4 Dean Evans, the chief engineer, added that he felt a
responsibility to attend and that, for his part, he did not even look forward to the
event:
I like the environment up there. It's very beautiful, but it's actually the
culmination of a year's worth of work, because the fishing trip is where
we launch products, introduce it to our staff, and so it's a pretty tough
time. Usually we've been at it pretty hard to get it done at that particular
date, so it's trying times.
Trial Tr. at 196. In short, the record leaves us with little doubt but that the Townsend
employees viewed the annual trip as part of their regular course of business.
4
For instance, Dale Hoover, the purchasing manager and a Government
witness, testified as follows:
Q: [Government] And did you feel obligated to go on the fishing trip?
A: [Hoover] I would say–that's a good question. I would say out of
respect for my employer, I feel obligated to go. Out of respect for my
career and the responsibility of my job duties, I feel obligated to go.
Has anybody ever said, "Dale, you must go"? No, but I feel it's
my duty to.
We could go on a tennis trip, and I would still feel obligated to go
and I don't play tennis, so . . .
Q: And is part of that, as you say, respect for your employer? You
appreciate that your employer is a generous man and has offered you
this–to take you to this fishing lodge?
A: I guess I don't really look at it as a vacation. It's nice because it has
to do with a particular sport I like to do, and I am very appreciative of
the opportunity, but I still believe it's a job function.
Trial Tr. at 421–22. Having elicited this testimony, the Government quickly ended
its direct examination of Mr. Hoover.
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More so than the voluntary or involuntary nature of the trip, the real crux of the
matter for Townsend is the extent to which it could prove the trips were a reasonable
and necessary business trip; whether they were directly related to, or associated with,
the active conduct of Townsend's business; and whether the principal character of the
events was the active conduct of business. Our review of the entire record convinces
us that the business nature of the trip was well established by the witnesses who
testified both for and against Townsend. Although some witnesses did admit that the
several-dozen annual trips ran together, more witnesses agreed that specific
Townsend-related business was conducted during the 1996 and 1997 trips and that
certain business-related activities were always conducted.
For instance, a number of witnesses testified that in 1996 many discussions
focused on the need to introduce a new model to compete with the Ryobi 3302 press
and that in 1997, the new Anniversary Edition (AE) press was introduced. Dean
Evans described the genesis of the AE press saying:
In '96, the fishing trip in '96, there was some competition for our
product. It was called a 3302 Ryobi, and it was beating us up pretty
good, so a lot of people wanted us to come up with something more user
friendly that would compete directly and enhance the product enough
that people would look our way rather than to the Ryobi 3302, and that
was probably the initiation of the AE, because that was what we tried to
develop, something to compete directly with the 3302.
Trial Tr. at 197. For his part, Russell Brock, an independent distributor, testified that
"there would have been a tremendous amount of discussion about [the new press] at
the fishing trip." Id. at 303. He further testified, during the Government's cross-
examination, that "I think the purpose of the sales meeting fishing trip was to launch
the AE [Anniversary Edition press]" and that Townsend intended to "show it to us at
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the sales meeting. We would then have any discussions that we needed to on the
fishing trip as a carryover." Id. at 327. The testimony of David DeJoode, Edward
Kalupa, and Roger Perin regarding the conception and birth of the AE press was to
the same effect.
In addition to testimony about the Anniversary Edition press, many witnesses
testified about discussions regarding the complexity of the T-51 press and problems
that customers, employees, and salespeople (who also repaired the machine) had with
its 800 parts. For example, Edward Kalupa and Russell Brock (independent
salespeople) both testified that they had discussions with several Townsend
employees regarding the cylinder problems in Townsend's 4610 model. Id. at
262–63, 307, 309; see also id. at 264–65, 295 (problems with the 1650 model in
1996), 253–57, 295 (problems with S-1 model in 1996). Many witnesses also
testified that the fishing trips were a unique opportunity for the national sales team
to interact with the Townsend employees who manufacture and assemble the intricate
parts and those who send out replacement parts. This interaction was important, they
stated, because small changes in the attention that the factory workers paid to their
work (such as removing all the burrs on metal parts) had a major impact on the
amount of repair work the sales force had to do and decreased the number and
frequency of repairs. See e.g., id. at 38. Thus, the opportunity for one of the
independent salespeople to tell a Townsend employee in person about his six-hundred
mile round trip to repair a press damaged by too many burrs left on a gear made a
major impression. More generally, factory employees and sales people stated that
they gained a better understanding of Townsend's business at these events. See, e.g.,
id. at 423.
Further, replacement parts are a major part of Townsend's business and both
the sales staff and the Townsend employees involved in parts distribution indicated
that improvements (such as new parts codes and increased accuracy in the parts sent)
were conceived on the trips. Id. at 231–32, 310. In fact, such was the pace of life at
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the Townsend plant that one employee in the parts department indicated that the
fishing trip was one rare opportunity that he had to have a reasoned conversation with
his supervisor about their work. Id. at 488–89; see also id. at 228 (supervisor
confirms conversation).
Another particularly telling piece of evidence that buttresses our conclusion
that Townsend met its burden and established a bona fide business purpose for its
trips is the fact that Townsend stopped including its plastics division in the annual
trip in 1994, three years before Townsend sold the division. The division was sold
and its employees excluded from the annual meeting because:
Their product was becoming different than just the plastic we needed
that we bought it for, so that company was getting into a business that
was somewhat foreign to us, and . . . it was becoming a disruption
during our T-51 press division sales meetings, our fishing trip, our
meetings afterwards, so we felt to get the best business and the best
results, we separated those trips and did not include the plastic division
in 1996 and 1997 on our trip and in our sales meeting.
Id. at 75–76. This decision, to our minds, indicates that Townsend clearly had a
specific business purpose for these trips. If Townsend was merely providing a free
vacation to its salespeople and employees, it would not have mattered if they
continued to include the plastics division.
We need not rehash the extensive trial testimony relating to sales tactics, see,
e.g., id. at 212–13, 271–72; quality control, see, e.g., id. at 310–11; issues relating to
specific clients, see, e.g., id. at 264–65, 267–68; and other problems solved or
discussed on the 1996 and 1997 trips, see, e.g., id. at 237–38 (molleton & aqua-flow
parts), for the trial record that we have reviewed is replete with evidence of specific
and general business benefits that Townsend realized from the trips. Contrary to the
District Court's conclusion that Townsend merely had a general "expectation to derive
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uncertain future benefits, particularly in the way of improved comradery [sic] and
relations among its employees and sales personnel," Order at 10, we conclude that
Townsend had a realistic expectation to gain concrete future benefits from the trip
based on its knowledge of its own small company, its knowledge of the utility of
interpersonal interactions that probably would not occur but for the trip, and its
knowledge of its own past experience. As such, the trips and their expenses qualified
as working condition fringe benefits under § 132 and a bona fide business expense
under §§ 162 and 274 of the Internal Revenue Code. Necessarily, we also conclude
that the trial record developed by Townsend and the Government provided adequate
substantiation in the form of its "own statement[s] . . . containing specific information
in detail [and] [b]y other corroborative evidence sufficient to establish" the business
nature of the expense. 26 C.F.R. § 1.274-5T(c)(3)(i)(A)–(B).
The Government urges that Danville Plywood Corporation v. United States,
899 F.2d 3 (Fed. Cir. 1990), governs the case at hand. We think that case, which
concerned the deductibility of a corporate trip to the Super Bowl, is distinguishable
from the case at hand. In Danville, the Federal Circuit held that the taxpayer was
unable to demonstrate that its Super Bowl weekend trip was a reasonable and
necessary business expense and was directly related to, or associated with, the active
pursuit of its business. In so holding, the Federal Circuit emphasized that on the
narrow facts presented to it, it was compelled to rule that "[t]he Super Bowl
weekend," which involved spouses and children, "appears to have been little more
than a group social excursion with business playing a subsidiary role." Id. at 9. Here,
in contrast, there was no lack of evidence concerning specific and general business
discussions and the attendant benefits. Moreover, the absence of spouses and
children in this case is important for, as more than one Townsend employee noted,
the trip was not some sort of paid vacation because, logically enough, "I don't go on
vacation with 60 people I work with. I go on vacation with my wife and kids." Trial
Tr. at 361.
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Nor do we think the present case is like Hippodrome Oldsmobile, Inc. v.
United States, 474 F.2d 959 (6th Cir. 1973), a case in which the parties conceded that
"the company customers entertained [on the boat] were not subjected to any specific
exposure to taxpayer's products or suggestion that they buy them while being thus
entertained" and that the taxpayer was merely using the boat to generate future good
will. Id. at 960. In the case at hand, as we have noted, the employees and salespeople
were exposed to Townsend products, a new Townsend product was initiated and
subsequently introduced during the years in question, complaints and suggestions
were discussed about current Townsend products, and Townsend business practices
were discussed at length. Given this evidence, we conclude this was not a case where
the taxpayer had no specific business purpose and was merely trying to generate good
will. See Rowell v. Comm'r., 884 F.2d 1085, 1088 (8th Cir. 1989) (holding that
expenses related to hunting and fishing trips were not directly associated with the
active conduct of taxpayer's business where taxpayer was often not present and only
had an "expectation of future goodwill"); Berkley Mach. Works & Foundery Co. v.
Comm'r., 623 F.2d 898, 904 (4th Cir.) (holding that expenses related to company-
owned hunting lodge were not business expenses because, at most, company merely
derived "general business goodwill"), cert. denied, 449 U.S. 919 (1980); Handelman
v. Comm'r., 509 F.2d 1067, 1071–75 (2d Cir. 1975) (holding that expenses related to
forty-six foot sailing sloop "Chee Chee V" were not deductible based on "unspecific
and imprecise evidence with no corroboration" of a business purpose for the vessel).5
5
Section 1.274-2(c)(3)(iii)'s requirement that the "principal character" of the
expense be the active conduct of business does not mean that more than fifty percent
of the time be spent on business. 26 C.F.R. § 1.274-2(c)(3)(iii). Rather, that
regulation explicitly states that "[i]n light of all the facts and circumstances of the
case, the principal character or aspect of the combined business and entertainment to
which the expenditure related was the active conduct of the taxpayer's trade or
business." Id. The regulation then adds that "[i]t is not necessary that more time be
devoted to business than to entertainment to meet this requirement." Id. Instead, the
fifty percent of time or use requirement can be found in regulations pertaining to pre-
1979 expenditures on airplanes, yachts, and other facilities. See 26 C.F.R.
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We pause to note that our decision does not stand for the proposition that in all
cases in which a corporation sponsors hunting, fishing, or other trips to "luxury"
vacation spots that the sponsoring corporation can avoid including the per-employee
cost of the trip in its employees' wages merely by presenting testimony relating to
business allegedly conducted during the sojourn. A district court should be
suspicious of oral, non-contemporaneous evidence provided in such cases, see 26
C.F.R. § 1.274-5T(c)(1); Reynolds v. Comm'r., 296 F.3d 607, 616 (7th Cir. 2002);
and it may well be that in most cases the cost of these trips would amount to income
taxable to each employee. This caveat notwithstanding, in the case at bar, we have
little trouble concluding that Townsend Industries presented adequate evidence to
substantiate its business purpose. Though we have reached this conclusion as a
matter of law, even if "business purpose" were to be treated as a question of fact, we
are satisfied the nature and quantity of the evidence presented could compel no
reasonable conclusion other than that Townsend had a bona fide business purpose for
its 1996 and 1997 trips. Accordingly, the decision of the District Court is reversed
and the matter remanded with instructions to enter judgment in favor of Townsend
Industries.
A true copy.
Attest:
CLERK, U.S. COURT OF APPEALS, EIGHTH CIRCUIT.
§ 1.274-2(e).
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