Churchill Downs, Inc. and Subsidiaries v. Commissioner ( 2000 )

115 T.C. No. 20
UNITED STATES TAX COURT
CHURCHILL DOWNS, INC. AND SUBSIDIARIES, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 8140-99. Filed September 26, 2000.
P conducts horse races, including the Kentucky
Derby, at its facilities. The races produce revenues
through pari-mutuel wagering (including simulcast pari-
mutuel wagering), admissions and seating, concession
commissions, sponsorship revenues, licensing rights,
and broadcast fees. P’s largest source of revenues is
wagers placed on horse races. P incurred entertainment
expenses that were ordinary and necessary expenses
under sec. 162, I.R.C. The expenses at issue included
P’s cost of holding the Sport of Kings Gala, a brunch
following the post position drawing for the Derby race,
a week-long, hospitality tent for the press, Kentucky
Derby Winner’s Party, Breeders’ Cup press-reception
cocktail party and dinner, and the Breeders’ Cup press
breakfast.
P deducted the full amount of expenses incurred in
holding the above events. R determined the expenses
were only partially deductible pursuant to sec. 274(n),
I.R.C.
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Held: P’s claimed deductions are limited by sec.
274(n)(1), I.R.C., as determined by R.
Held, further: In incurring the expenses at issue
P neither provided goods and services to the general
public nor received adequate and full consideration for
the goods and services provided. Therefore, P’s
expenses are not excluded from the operation of sec.
274(n)(1) by sec. 274(n)(2) or (e)(7) or (8), I.R.C.
Paul J. Cox, for petitioners.
Andrew M. Winkler, for respondent.
OPINION
LARO, Judge: This case is before the Court fully
stipulated. See Rule 122.1 Respondent determined deficiencies
in petitioners’ 1994 and 1995 Federal income tax of $51,872 and
$20,658, respectively. The sole issue we must decide2 is whether
petitioners’ claimed deductions for expenses for parties and
other entertainment are limited by section 274(n)(1). We hold
they are. The stipulation of facts and the attached exhibits are
incorporated herein. The stipulated facts are hereby found.
Background
Petitioners are corporations which file a consolidated
1
Rule references are to the Tax Court Rules of Practice and
Procedure. Unless otherwise indicated, section references are to
the Internal Revenue Code in effect for the years in issue.
2
The parties had settled all other outstanding issues
before the case was submitted.
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Federal corporate income tax return. When the petition was
filed, petitioners’ principal place of business was located in
Louisville, Kentucky. Petitioners own the Churchill Downs
racetrack in Louisville, Kentucky, and three other race tracks.
Petitioners conduct live horse races, including the Kentucky
Derby, at their facilities. The races produce revenues through
pari-mutuel wagering (including simulcast pari-mutuel wagering),
admissions and seating, concession commissions, sponsorship
revenues, licensing rights, and broadcast fees. The main source
of petitioners’ revenues is wagers placed on horse races.
Petitioners do not directly compete with other racetracks
for local patrons because of the separation of facilities and the
differences in the seasonal timing of meets. However,
petitioners operate in a highly competitive industry. They
compete for patrons with other sports, entertainment, and gaming
operations, including land-based, riverboat, and cruise ship
casinos and State lotteries.
Petitioners’ biggest race is the Kentucky Derby. The
Kentucky Derby is held each year on the first Saturday in May.
Petitioners’ Kentucky Derby events include: The Sport of Kings
Gala, a brunch following the post position drawing for the Derby
race, a week long hospitality tent with coffee, orange juice, and
donuts for the press open from 4 a.m. to 9 a.m., the Derby race,
and the Kentucky Derby Winner’s Party.
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The Sport of Kings Gala includes a press-reception cocktail
party followed by a dinner and entertainment on the Thursday
evening of Derby week. The costs of the Sport of Kings Gala,
including those for food, beverages, and entertainment, are borne
by petitioners. Petitioners’ employees were in attendance at the
Sport of Kings Gala in 1994 and in 1995. In 1994, the Sport of
Kings Gala was held at the Sports Spectrum, an off-track betting
facility located in Louisville, Kentucky, and owned by
petitioners. In 1995, the Sport of Kings Gala was held at the
Kentucky State Fair and Exposition Center in Louisville,
Kentucky.
The Breeders’ Cup race rotates among several racetracks.
In 1994, petitioners hosted the Breeders’ Cup race, the Breeders’
Cup press-reception cocktail party and dinner, and the Breeders’
Cup press breakfast. Under petitioners’ contract with Breeders’
Cup Limited (BCL) they were obligated to conduct certain
promotional activities designed to enhance the significance of
the Breeders’ Cup day of races as a national and international
championship event for the sport of racing. Included in these
required promotional activities are the Breeders’ Cup press-
reception cocktail party and dinner and the Breeders’ Cup press
breakfast.
The 1994 Breeders’ Cup press-reception cocktail party and
dinner were held at the Galt House Hotel in Louisville, Kentucky,
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and sponsored by petitioners. Attendance at the Breeders’ Cup
press-reception cocktail party and dinner is by invitation only,
and the expenses for food, beverages, and entertainment were
borne by petitioners. Employees of petitioners were in
attendance at the dinner. Attendance at the Breeders’ Cup press
breakfast is by invitation only, and the expenses for food,
beverages, and entertainment were borne by petitioners.
Employees of petitioners were also in attendance at the
breakfast.
Petitioners have found that the key to their success is
their ability to present quality races. Critical to the ability
to present quality races is the ability to offer high purse
levels to attract the best available horses, trainers, and
jockeys.
Petitioners allocated blocks of tickets to the Sport of
Kings parties to horsemen, sponsors, staff, city/county VIP’s,
racing VIP’s, racing officials, media representatives, and
others. More tickets were allocated to the media than to any
other category.
The Kentucky Derby items and amounts in issue are:
Amounts in Issue
Item 1994 1995
Sport of Kings Gala $114,375 $85,571
Press hospitality tent -0- 7,803
Derby winner’s party 17,500 -0-
Total 131,875 93,374
collectively referred to as Derby expenses.
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The Breeders’ Cup items and amounts in issue are:
Item Amounts in Issue
Breeders’ Cup party $116,000
Post-draw brunch 21,885
Press breakfast 7,500
Total 145,385
collectively referred to as Breeders’ Cup expenses.
The miscellaneous items and amounts in issue are:
Amounts in Issue
Item 1994 1995
Kentucky thoroughbred
owners’ & trainers’ dinner $2,310 $2,150
Cummings reception 1,630 -0-
Farewell party 1,000 -0-
Stakes day buffet -0- 13,132
Music theatre - derby
eve gala table -0- 2,500
U.S. Senate restaurant -0- 538
Dinner for twenty-five
at $19.36 per person -0- 484
Dinner for fifty-five
at $20.35 per person -0- 1,119
Louisville Chamber of
Commerce dinner -0- 500
Green Herb cocktail party -0- 1,196
Total 4,940 21,619
collectively referred to as miscellaneous expenses.
Discussion
Respondent concedes that all of the expenses at issue meet
the requirements for deductions as ordinary and necessary
business expenses of petitioner under section 162 for the years
in issue. However, respondent argues that these deduction are
limited by section 274.
Petitioners argue they are in the entertainment business,
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and accordingly, they should not be subject to the restrictions
of section 274(n) with respect to expenses they incur in the
course of providing that entertainment. Alternatively,
petitioners argue the expenses at issue are excluded from the
provisions of section 274 by application of section 274(e),
paragraphs (7) and (8), and section 274(n)(2)(A).3
Section 162(a) allows a deduction for all ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on a trade or business. Section 274 disallows a
deduction in certain instances for expenses which would otherwise
be deductible under section 162. Section 274(a) provides in
part:
SEC. 274(a). Entertainment, Amusement, or
Recreation.--
(1) In general.--No deduction otherwise
allowable under this chapter shall be allowed
for any item--
(A) Activity.--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
3
Sec. 274(n)(2) provides:
Exceptions.--Paragraph (1) shall not apply to any
expense if--
(A) such expense is described in paragraph (2),
(3), (4), (7), (8), or (9) of subsection (e).
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(including business meetings at a convention or
otherwise), that such item was associated with,
the active conduct of the taxpayer’s trade or
business, * * *
Respondent does not dispute that the expenses at issue are
directly related to the active conduct of petitioners’ business.
There is also no dispute that the events were critical to the
success of the Kentucky Derby and the Breeders’ Cup. Some of the
expenses at issue were required to be provided under the contract
between petitioners and BCL.
Respondent argues that the deductions of the expenses at
issue are limited by section 274(n). Section 274(n) allows only
a portion of entertainment expense to be deducted. That section
provides:
SEC. 274(n). Only 50 Percent of Meal and
Entertainment Expenses Allowed as Deduction.--
(1) In general.--The amount allowable as a
deduction under this chapter for--
(A) any expense for food or beverages, and
(B) any item with respect to an activity
which is of a type generally considered to
constitute entertainment, amusement, or
recreation, or with respect to a facility used
in connection with such activity,
shall not exceed 50 percent of the amount of such
expense or item which would (but for this paragraph) be
allowable as a deduction under this chapter.
The Secretary was granted authority to promulgate
regulations to carry out the purposes of section 274. See sec.
274(o). Regulations were promulgated to clarify what type of
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activity would be considered entertainment. In pertinent part
they provide:
Objective test. An objective test shall be used to
determine whether an activity is of a type generally
considered to constitute entertainment. Thus, if an
activity is generally considered to be entertainment,
it will constitute entertainment for purposes of this
section and section 274(a) regardless of whether the
expenditure can also be described otherwise, and even
though the expenditure relates to the taxpayer alone.
This objective test precludes arguments such as that
“entertainment” means only entertainment of others or
that an expenditure for entertainment should be
characterized as an expenditure for advertising or
public relations. However, in applying this test the
taxpayer’s trade or business shall be considered.
Thus, although attending a theatrical performance would
generally be considered entertainment, it would not be
so considered in the case of a professional theater
critic, attending in his professional capacity.
Similarly, if a manufacturer of dresses conducts a
fashion show to introduce his products to a group of
store buyers, the show would not be generally
considered to constitute entertainment. However, if an
appliance distributor conducts a fashion show for the
wives of his retailers, the fashion show would be
generally considered to constitute entertainment. [Sec.
1.274-2(b)(1)(ii), Income Tax Regs.]
Petitioners argue that they are in the entertainment
business and that the Derby expenses, Breeders’ Cup expenses, and
miscellaneous expenses are all part of their entertainment
product and therefore should be fully deductible. Petitioners
conduct live horse races, including the Kentucky Derby, at their
facilities. The races produce revenues through pari-mutuel
wagering (including simulcast pari-mutuel wagering), admissions
and seating, concession commissions, sponsorship revenues,
licensing rights, and broadcast fees. Petitioners’ main source
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of revenues is wagers placed on horse races.
In determining whether the expenses in question are
entertainment expenses petitioners’ trade or business must be
considered. We would agree petitioners are in the entertainment
business. However, applying the objective test mandated by
section 1.274-2(b)(1)(ii), Income Tax Regs., the Derby, Breeders’
Cup, and miscellaneous expenses all constitute entertainment
expenses and cannot be properly categorized as “part of the
entertainment product”. Thus the Derby, Breeders’ Cup, and
miscellaneous expenses are subject to the restrictions imposed by
section 274(n)(1) unless they fall within one of the exceptions
set out in section 274(n)(2).
Petitioners alternatively argue that the Derby, Breeders’
Cup, and miscellaneous expenses are excluded from the operation
of section 274(n)(1) by paragraphs (7) and (8) of section 274(e).
Those paragraphs provide as follows:
(7) Items available to public.--Expenses for goods,
services, and facilities made available by the taxpayer to
the general public.
(8) Entertainment sold to customers.--Expenses for
goods or services (including the use of facilities) which
are sold by the taxpayer in a bona fide transaction for an
adequate and full consideration in money or money’s worth.
Petitioners provide entertainment to all of the public
through their different events. The Kentucky Derby and the
Breeders’ Cup Championship are open to the general public as are
other races during Derby Week and Breeders’ Cup week. In
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contrast, the events that give rise to the Derby, Breeders’ Cup,
and miscellaneous expenses are invitation-only events that are
attended by selected horsemen, petitioners’ employees, media
officials, and local dignitaries. They may be entertainment
events designed to make the Derby and Breeders’ Cup more
prestigious events and to heighten public awareness of the
upcoming events as petitioners claim. However, we can see no
meaningful difference between the expenses at issue here and
normal entertainment of selected clients and suppliers, which is
limited by section 274(n). The expenses at issue are not
expenses for goods, services, and facilities made available by
petitioners to the general public. The events at issue provide
goods and services to persons petitioner selects to entertain.4
4
Sec. 1.274-2(f)(2)(viii), Income Tax Regs., provides
useful guidance on the difference between providing goods and
services to the general public and providing them to a selected
clientele. Those regulations provide:
(viii) Items available to the public. Any
expenditure by a taxpayer for entertainment (or for a
facility in connection therewith) to the extent the
entertainment is made available to the general public
is not subject to the limitations on allowability of
deductions provided for in paragraphs (a) through (e)
of this section. Expenditures for entertainment of the
general public by means of television, radio,
newspapers and the like, will come within this
exception, as will expenditures for distributing
samples to the general public. Similarly, expenditures
for maintaining private parks, golf courses and similar
facilities, to the extent that they are available for
public use, will come within this exception. For
example, if a corporation maintains a swimming pool
(continued...)
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We therefore hold that the Derby, Breeders’ Cup, and
miscellaneous expenses are not excluded by section 274(e)(7) and
(n)(2).
We find no evidence in the record that the Derby, Breeders’
Cup, and miscellaneous expenses for goods and services were sold
by petitioners in a bona fide transaction for an adequate and
full consideration in money or money’s worth. Indeed, the record
indicates that the expenses were borne by petitioner and goods
and services were given without cost to the parties that were
entertained. We therefore hold that the Derby, Breeders’ Cup,
and miscellaneous expenses are not excluded by section 274(e)(8)
and(n)(2).5
We hold that petitioners’ claimed deductions for Derby,
Breeders’ Cup, and miscellaneous expenses are limited by
section 274(n)(1) as determined by respondent. In reaching the
4
(...continued)
which it makes available for a period of time each week
to children participating in a local public
recreational program, the portion of the expense
relating to such public use of the pool will come
within this exception.
5
Petitioners place reliance on the treatment afforded a
casino that provided comps to selected members of the general
public in Priv. Ltr. Rul. 96-41-005 (June 27, 1996). Based on
the letter ruling petitioners argue that the Derby, Breeders’
Cup, and miscellaneous expenses should be deductible in full. We
are unpersuaded that the reasoning used therein is applicable to
the present situation. We also note that the precedential value
of letter rulings is specified in sec. 6110(k)(3), which provides
in pertinent part: “a written determination may not be used or
cited as precedent.”
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holdings in this opinion, we have considered all arguments for
contrary holdings, and have rejected all arguments not discussed
as without merit or irrelevant.
To reflect the foregoing,
Decision will be entered
under Rule 155.