Sealy Corporation and Subsidiaries, f.k.a. The Ohio Mattress Company and Subsidiaries v. Commissioner ( 1996 )

107 T.C. No. 11
UNITED STATES TAX COURT
SEALY CORPORATION AND SUBSIDIARIES, f.k.a. THE OHIO MATTRESS
COMPANY AND SUBSIDIARIES, ET AL.,1 Petitioners v. COMMISSIONER OF
INTERNAL REVENUE, Respondent
Docket Nos. 18761-92, 3028-93, Filed October 21, 1996.
3029-93, 3030-93,
6266-93, 6267-93,
6268-93, 6269-93.
Ps had net operating losses for tax years 1989 to
1992 from deductible expenses they incurred to comply
with various requirements of Federal law; i.e., the
Internal Revenue Code, the 1934 Securities and Exchange
Act, and the Employee Retirement Income Security Act of
1974.
1
Cases of the following petitioners are consolidated
herewith: Sealy Corp. & Subsidiaries, f.k.a. The Ohio Mattress
Co. & Subsidiaries, docket nos. 3028-93 and 6266-93; The Ohio
Mattress Co. Licensing and Components Group & Subsidiaries,
f.k.a. Sealy, Inc. & Subsidiaries, docket nos. 3029-93, 6267-93,
and 6268-93; and Sealy Mattress Co. & Subsidiaries, f.k.a. Ohio-
Sealy Mattress Manufacturing Co. & Subsidiaries, docket nos.
3030-93 and 6269-93.
2
Net operating losses generally may be carried back
3 years. Sec. 172(b)(1)(A), I.R.C. However, specified
liability losses may be carried back 10 years. Sec.
172(b)(1)(C), (f)(1)(B), I.R.C. Ps treated their
losses as specified liability losses and carried them
back to their tax year ending Nov. 30, 1985.
Held, Ps' regulatory compliance costs are not
specified liability losses.
Stephen P. Kresnye and Joseph A. Castrodale, for
petitioners.
Elsie Hall, for respondent.
OPINION
COLVIN, Judge: This case is before the Court on
petitioners’ motions for partial summary judgment.
Respondent determined the following deficiencies in
petitioners' Federal income tax:
Petitioner Year Ending Deficiency
Sealy Corp. Nov. 30, 1983 $225,754.00
Sealy Corp. Nov. 30, 1984 648,717.48
Ohio Mattress Co. Dec. 30, 1984 3,630,737.24
Sealy Corp. Nov. 30, 1985 64,678.74
Ohio Mattress Co. Dec. 31, 1985 49,863.34
Sealy Corp. Nov. 30, 1986 6,816,632.00
Ohio Mattress Co. Dec. 30, 1986 447,617.00
Sealy Corp. Nov. 30, 1988 13,115,655.00
Petitioners seek a partial summary judgment relating to
their net operating loss carrybacks. They contend that
$2,447,933 of expenses they incurred from 1989 to 1992 is
specified liability losses under section 172(f)(1)(B) and thus
3
may be carried back 10 years. This is the first case in which
we, or, to the best of our knowledge, any court, has decided the
scope of section 172(f)(1)(B). As discussed below, we hold that
petitioners’ compliance expenses at issue here are not specified
liability losses, and we deny petitioners' motion for partial
summary judgment.
A motion for summary judgment or partial summary judgment
may be granted if there is no genuine issue of material fact and
the decision can be rendered as a matter of law. Rule 121;
Shiosaki v. Commissioner, 61 T.C. 861, 862-863 (1974). The
parties agree that there is no material fact in dispute relating
to the motion. The parties have settled all of the other issues
in this case.
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the years at issue. Rule
references are to the Tax Court Rules of Practice and Procedure.
Background
A. Petitioners
Petitioners are corporations the principal places of
business of which were in Seattle, Washington, when the petitions
were filed.
Petitioners used the accrual method of accounting and
reported their income on fiscal years ending November 30.
4
B. The 1970 Public Offering
Petitioners were privately owned before 1970 and thus were
not subject to the reporting requirements of the Securities and
Exchange Act of 1934 (the 1934 Act), ch. 404, 48 Stat. 881
(current version at 15 U.S.C. secs. 78a-78lll (1994)). The Ohio
Mattress Co. first offered its stock for public sale in February
1970. The reporting requirements of the 1934 Act have applied to
petitioners since 1970.
The 1934 Act requires petitioners to file quarterly and
annual financial reports with the Securities and Exchange
Commission (SEC). Petitioners incurred expenses of $1,808,309 in
taxable years 1989 to 1992 for professional services to comply
with reporting, filing, and disclosure requirements imposed by
the 1934 Act. Petitioners paid auditing and professional fees to
KPMG Peat Marwick, Ernst & Whinney, and Ernst & Young to
represent petitioners before the SEC’s chief accountant’s office
and to prepare SEC registration statements S-1 and S-4 relating
to public securities offerings. Petitioners incurred these
expenses to comply with section 13(a)(2) of the 1934 Act, 15
U.S.C. sec. 78m, which requires petitioners to file quarterly and
annual reports with the SEC and to have the annual reports
audited by an independent public auditor.
C. Petitioners’ Employee Benefits Plans
Before 1985, petitioners adopted various employee benefit
plans for their employees. As employee benefit plan
5
administrators, petitioners are subject to the Employee
Retirement Income Security Act of 1974 (ERISA), Pub. L. 93-406,
sec. 103(a)(1)(A), 88 Stat. 841, 29 U.S.C. sec. 1023(a)(1)(A)
(1994). ERISA requires administrators of employee benefit plans
to use independent qualified public accountants to publish
various reports relating to the plan. Id. As a result,
petitioners paid auditing and professional fees of $100,650 to
KPMG Peat Marwick, Ernst & Whinney, and Ernst & Young from 1989
to 1992 to examine and prepare financial statements for
petitioners and their employee benefit plans.
D. The 1986 Acquisitions and Section 338 Elections
In December 1986, Sealy Mattress Co., formerly known as
Ohio-Sealy Mattress Manufacturing Co., a subsidiary of the Ohio
Mattress Co., bought the stock of Slumber Products Corp., Sealy
Mattress Co. of Albany, Inc., Sealy Mattress Co. of Illinois,
Inc., Sealy of Minnesota, Inc., Sealy of Connecticut, Inc., the
Maryland Bedding Co., Sealy of Maryland and Virginia, Inc., the
Metcalfe Brothers, Inc., and Sealy Mattress Co. of Kansas City,
Inc. Sealy Mattress Co. bought Sealy of Michigan, Inc., in April
1987.
Each of these companies (the acquired companies) had license
agreements with Sealy, Inc., which is now known as the Ohio
Mattress Co. Licensing & Components Group. All but two of the
acquired companies owned voting stock in Sealy, Inc. After the
1986 acquisitions, the Ohio Mattress Co. indirectly owned 77.49
6
percent of Sealy, Inc. In December 1986, Sealy Mattress Co.
bought 4.37 percent of Sealy, Inc. from individual shareholders.
Thereafter, the Ohio Mattress Co. indirectly owned 81.86 percent
of Sealy, Inc.’s voting stock.
On September 15, 1987, petitioners timely elected to treat
the stock purchases (except Sealy, Inc., and Sealy of Michigan)
as asset acquisitions under section 338.
E. Petitioners’ IRS Audits
The Internal Revenue Service (IRS) audited petitioners’ tax
returns for the years ending November 30, 1987, November 30,
1988, April 24, 1989, November 30, 1989, November 30, 1990,
November 30, 1991, and November 30, 1992. The IRS examined
petitioners’ books, records, and tax filings relating to the
acquisitions. Petitioners paid Ernst & Young, American Appraisal
Associates, and other accounting and law firms for services
relating to the 1991 and 1992 IRS audits of petitioners’ 1987,
1988, and 1989 tax years.
Most of petitioners’ IRS examination expenses related to the
IRS audit of the acquisitions, the section 338 elections, and
petitioners’ return for the tax year ending November 30, 1987.
Petitioners paid $567,974 in 1991 and 1992 for accounting
and legal services relating to IRS audits of petitioners’ 1987
tax year. Petitioners incurred the expenses to comply with
7
section 7602, which allows the IRS to examine taxpayers’ books
and records to ascertain whether a return is correct.
Petitioners reported that they had losses of $26,441,402 for
1989, $60,447,014 for 1990, $35,262,161 for 1991, and $11,772,384
for 1992 before taking into account net operating loss carrybacks
or carryforwards.
On April 29, 1994, petitioners filed amended returns for
their tax years ending November 30, 1989, 1990, 1991, and 1992.
Petitioners filed an amended return for their tax year ending
November 30, 1985, on April 29, 1994. On it, petitioners claimed
a carryback of $6,484,484 for specified liability losses under
section 172(f)(1)(B). Specified liability losses reported on
petitioners’ 1989, 1990, 1991, and 1992 amended returns do not
exceed the amount of net operating losses reported on those
returns.
Respondent determined that petitioners may deduct $4,007,551
as specified liability losses and $2,476,9332 as a loss subject
to the general 3-year carryback and 15-year carryforward under
section 172.
2
Petitioners concede that they may not deduct $29,000 of
this amount. Thus, the amount in dispute is $2,447,933.
8
The following losses are in dispute:
Acctg fees re: Acctg fees re: Prof.
Tax audited financial employee benefits fees
year statements and SEC financial Re: IRS
ending regis. statements statements audit
11/30/89 $631,109 $34,450 --
11/30/90 552,000 24,500 --
11/30/91 337,700 24,500 $140,186.50
11/30/92 287,500 17,200 427,787.50
Petitioners reported that they had losses on their 1989,
1990, 1991, and 1992 returns, part of which petitioners carried
back as specified liability losses under section 172(b)(1)(C) to
the year ending November 30, 1985. Petitioners reported taxable
income of more than $6,484,484 on the returns they originally
filed for 1985. Petitioners' specified liability losses included
payments to their public auditors and to the SEC in connection
with petitioners’ compliance with the 1934 Act and ERISA and
payments for legal and accounting services in connection with the
IRS audits.
The parties agree that the SEC and ERISA professional fees
and the IRS examination expenses described above are deductible
under chapter 1.
Discussion
The parties have stipulated the amount of petitioners’ net
operating losses. The only issue for us to decide is whether
petitioners may carry those losses back 10 years or 3 years.
9
A. Ten-Year Net Operating Loss Carryback for Specified
Liability Losses
1. Ten-Year Net Operating Loss Carryback
Generally, a taxpayer may carry a net operating loss back 3
years before the loss year and forward 15 years after the loss
year. Sec. 172(b)(1)(A). However, a taxpayer that has a
specified liability loss under section 172(f) may carry that loss
back to each of the 10 tax years preceding the loss year. Sec.
172(b)(1)(C).
This 10-year carryback includes product liability and tort
losses and nuclear decommissioning expenses. Sec. 172(f)(1),
(3). The 10-year carryback was enacted for product liability
losses in 1978. Sec. 172(j); Revenue Act of 1978, Pub. L. 95-
600, sec. 371(b), 92 Stat. 2859. It was extended to specified
liability and tort liability losses and costs of decommissioning
nuclear power plants (section 172(k)) in 1984. Deficit Reduction
Act of 1984 (DEFRA), Pub. L. 98-369, sec. 91(d)(2), 98 Stat.
606.3
3
The Revenue Reconciliation Act of 1990, Pub. L. 101-508,
sec. 11811(b)(1), 104 Stat. 1388-532, combined sec. 172(j)
(relating to product liability losses) and sec. 172(k) (relating
to deferred statutory or tort liability losses and nuclear
decommissioning costs) and redesignated them as sec. 172(f)
(providing rules relating to specified liability losses),
effective for net operating losses for tax years beginning after
1990.
10
2. Specified Liability Losses
Section 172(f) defines a specified liability loss in
pertinent part as follows:
(1) In general.--The term “specified liability
loss” means the sum of the following amounts to the
extent taken into account in computing the net
operating loss for the taxable year:
* * * * * * *
(B) Any amount (not described in subparagraph
(A)) allowable as a deduction under this chapter
with respect to a liability which arises under a
Federal or State law * * * if--
(i) * * * the act (or failure to act)
giving rise to such liability occurs at least
3 years before the beginning of the taxable
year,
* * * * * * *
A liability shall not be taken into account under
subparagraph (B) unless the taxpayer used an
accrual method of accounting throughout the period
or periods during which the acts or failures to
act giving rise to such liability occurred.
(2) Limitation.--The amount of the specified
liability loss for any taxable year shall not exceed
the amount of the net operating loss for such taxable
year.
The 10-year carryback for specified liability losses
described in section 172(f)(1)(B) applies if:
(1) The taxpayer took the specified liability loss into
account in computing its net operating loss for the taxable year;
(2) the expense resulting in the specified liability loss is
deductible under chapter 1 of the Internal Revenue Code;
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(3) the liability with respect to which the taxpayer
incurred the expense arose under a Federal or State law;
(4) the act or failure to act which gave rise to the
liability occurred at least 3 years before the taxable year at
issue;
(5) the taxpayer used the accrual method of accounting
throughout the period in which the acts or failures to act giving
rise to the liability occurred; and
(6) the specified liability loss for any taxable year does
not exceed the net operating loss for that year. Sec.
172(f)(1)(B) and (2).
The parties agree that petitioners meet requirements (1),
(2), (5), and (6). To prevail, petitioners must also meet
requirements (3) and (4).
Deductions are a matter of legislative grace, and
petitioners bear the burden of proving that they are entitled to
any deductions they claimed on their returns. Rule 142(a);
Deputy v. DuPont, 308 U.S. 488, 493 (1940); New Colonial Ice Co.
v. Helvering, 292 U.S. 435, 440 (1934); Welch v. Helvering, 290
U.S. 111, 115 (1933).
B. Whether the Liability for Which Petitioners Incurred the
Expense Arose Under a Federal or State Law
1. Petitioner’s Liability To Pay for Professional Services
To be a specified liability loss, the liability with
respect to which petitioners incurred the expense must have
12
arisen under a Federal or State law. Sec. 172(f)(1)(B).
Petitioners argue that their liability to pay accounting and
professional fees and IRS examination expenses arose under
Federal law.
We disagree. It is true that the 1934 Act, ERISA, and the
Internal Revenue Code require petitioners to file financial
reports and disclosure statements, maintain and provide books and
records, and cooperate with IRS audits. However, those
provisions do not establish petitioners’ liability to pay the
amounts at issue. Petitioners’ liability to pay those amounts
did not arise until petitioners contracted for and received the
services. Petitioners' choice of the means of compliance, and
not the regulatory provisions, determined the nature and amount
of their costs. If, on the other hand, petitioners had failed to
comply with the auditing and reporting requirements or had not
obtained the particular services in issue here, their liability
would have been in amounts not measured by the value of services.
Thus, petitioners' liability did not arise under Federal law.
2. Enactment of the Specific Liability Loss Rule With the
Economic Performance Rules
Our interpretation is entirely consistent with the
legislative history which accompanied enactment of the
predecessor of the specified liability loss provision. Before
1984, an accrual basis taxpayer generally could deduct an expense
for the tax year in which (a) all events had occurred which
13
determined the fact of the liability and (b) the amount of the
liability could be determined with reasonable accuracy. United
States v. Anderson, 269 U.S. 422, 437-438, 441 (1926). DEFRA
sec. 91(a), 98 Stat. 606, provided that the all events test is
not met before economic performance occurs. Sec. 461(h)(1). In
the case of liability to pay a person who provides goods or
services to the taxpayer, economic performance occurs as that
person provides the goods or services to the taxpayer. Sec.
461(h)(2)(A)(i).
In the legislative history accompanying enactment of the
economic performance rules, Congress described the pre-DEFRA law,
gave an overview of the House bill, discussed the economic
performance rules added by DEFRA, and described the predecessor
of the specified liability loss rule. The conference report for
DEFRA states in pertinent part:
G. Accounting Changes
1. Premature accruals
* * * * * * *
Economic Performance
* * * * * * *
Net operating loss carrybacks
The House bill provides a 10-year carryback
for net operating losses attributable to certain
liabilities deferred under these provisions. The
bill also provides a special carryback rule for
losses incurred in connection with the
decommissioning of a nuclear power plant. Such
14
losses may be carried back to each of the taxable
years during the period beginning with the taxable
year in which the plant was placed in service. No
loss, however, may be carried back to a taxable
year beginning before January 1, 1984, unless it
may be carried back without regard to these rules.
The provisions of the bill apply generally to
expenses incurred (without regard to the economic
performance requirement) after the date of
enactment.
* * * * * * *
Conference Agreement
The Conference Agreement generally follows the House
bill, with modifications.
* * * * * * *
H. Conf. Rept. 98-861, at 871-873 (1984), 1984-3 C.B. (Vol. 2) 1,
125-127.
The conference report states that the 10-year carryback of
specified liability losses applies to "net operating losses
attributable to certain liabilities deferred under these
provisions." "These” provisions are the limits on premature
accruals; i.e., the economic performance rules of section 461(h).
This suggests that Congress intended the 10-year carryback to
apply only to liabilities for which deduction is deferred by the
economic performance rules. Petitioners' accrual of the
deduction for the expenses at issue was not deferred by the
economic performance rules. Since the economic performance rules
do not limit petitioners' accrual of the deduction for the
15
compliance expenses at issue, we conclude that Congress did not
intend those expenses to qualify as specified liability losses.
3. Categories of Property Eligible for a 10-Year Carryback
Section 172(f) provides a 10-year carryback for product
liability expenses, tort losses, and nuclear power plant
decommissioning costs, among other specified liability losses.
We think Congress intended the 10-year carryback for liability
losses under section 172(f)(1)(B) to apply to a relatively narrow
class of liabilities similar to the others identified by the
statute. Under the ejusdem generis rule of statutory
construction, general words that follow the enumeration of
specific classes are construed as applying only to things of the
same general class as those enumerated. Kansas City S. Ry. Co.
v. McNamara, 817 F.2d 368, 372 (5th Cir. 1987); Coleman v.
Commissioner, 76 T.C. 580, 588 (1981) (applying the rule of
ejusdem generis to interpret “other casualty”); Estate of Short
v. Commissioner, 68 T.C. 184, 193 (1977). We think that the
costs at issue here are routine costs and are not of the same
general type as those other categories.
Petitioners argue that according to the plain language of
section 172(f)(1)(B), petitioners’ costs of compliance with the
1934 Act, ERISA, and the Internal Revenue Code are specified
liability losses. We disagree. There is nothing in the statute
that plainly, or at all, for that matter, establishes that
petitioners may carry their compliance costs back for 10 years.
16
We conclude that petitioners' compliance costs and other
accounting expenses were not liabilities that arose under Federal
or State law.
C. Whether the Act or Failure To Act Which Gave Rise to the
Liability Occurred at Least 3 Years Before the Taxable
Years at Issue
To be a specified liability loss under section 172(f)(1)(B),
the act giving rise to the liability under a Federal or State law
must have occurred at least 3 years before the start of the
taxable year. Sec. 172(f)(1)(B)(i). Petitioners’ contention
that they meet this requirement follows from their contention
that their liability to pay those costs arose under Federal law
to which they were made subject more than 3 years before the
years at issue. We disagree for the reasons stated above at par.
B. Petitioners make no other argument that the liability at
issue arose more than 3 years before the years at issue. Thus,
we conclude that petitioners do not meet this requirement.
D. Conclusion
We hold that petitioners’ professional fees and IRS
examination expenses are not specified liability losses under
section 172(f)(1)(B), and thus are not eligible for the 10-year
carryback under section 172(b)(1)(C).
To reflect the foregoing and concessions,
Orders will be issued
denying petitioners' motions
for partial summary judgment.