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I. INSTRUCTIONS FOR MEMO:
a. Project Summary: For the tax research project, you will be writing a memo for your client, Apple Inc (Apple). The facts of the project and the text of the case you must use and apply in your memo are below.
b. Purposes of tax memos:
i. Tax professionals often must document and communicate their tax research.
ii. Clear written communication is important since tax planning ideas or IRS audits can cause prior tax returns to be amended or adjusted long after originally filed.
iii. The tax professional may have long since forgotten the reasons for his or her research conclusions, so it is essential that the relevant tax authorities and rationales be thoroughly documented and clearly explained.
iv. In some cases, the tax professionals who prepared the research memo may no longer be with the firm, increasing the importance of written communication that others can follow easily
c. Structure of tax memos:
i. Tax research memos should contain features allowing clients, partners, and others to read and understand their contents quickly
ii. In order to achieve this goal, tax memos should be written in a logical format.
iii. Parts of a memo: For the tax memo use the following structure (further discussed below):
1. Facts
2. Issues
3. Conclusions to the Issues
4. Law (summary of law discussed and applied in memo)
5. Analysis (explanation discussion of how the law applies to your facts and issue)
d. Facts Section:
i. In the fact section of a memo, provide a complete statement of the facts.
ii. All potentially relevant facts should be stated clearly.
iii. Careless or ambiguous statements of facts or omitted facts can lead to inefficient research and/or inappropriate conclusions
e. Issue Section:
i. Issues should be written in question form or whether or not form
ii. Number and arrange issues in the most logical order.
iii. Issues should be couched in the specific context of the client’s facts
iv. Issues should be stated clearly and unambiguously
1. Ambiguous:
a. Example: Did John request a determination letter to ascertain that a deductible charitable contribution was made?
b. The meaning of this issue is unclear.
c. Does the researcher wish to determine whether the donee organization possesses a determination letter?
d. Alternatively, the researcher may wish to know whether the contribution John made is deductible.
e. Perhaps the researcher has mistakenly assumed that John must ask for a copy of the organization
2. Too general and vague:
a. Example: How much can a taxpayer deduct for money donated to her church last year?
b. Better example: How much of the $60,000 Judy Smith donated to the First Universal Church in 2001 can she deduct?
i. Includes specific facts about the client and relevant to the issue and implies or indirectly refers to the tax law (i.e., taking tax deductions for charity donations)
3. Unclear Tax Concept:
a. Example: What is the tax treatment for a company under Treas. Reg Sec 1.162-5(c)(1) when it pays its employee’s tuition?
b. Better example: Can Borden Company deduct the $2,300 it pays to Smith to cover his tuition?
f. Conclusion Section:
i. For each issue stated in the Issue Section, write a clear and unambiguous conclusion
ii. The order of conclusions should match the order of the issues
iii. One purpose of the Conclusion Section is not to make the reader wade through the entire analysis before revealing the conclusions to the issues.
g. Law Section:
i. In the law section, the relevant Internal Revenue Code and Treasury Regulations sections, Internal Revenue Service’s private letter rulings and revenue rulings and court cases that you used to reach your conclusions to your issues are summarized and discussed
ii. Paraphrase the laws, rather than writing one quote after another
iii. Court cases and IRS publications should be discussed using the past tense since they occurred in the past.
1. Incorrect Example: In Revenue Ruling 73-173, the IRS states
2. Correct Example: In Revenue Ruling 73-173, the IRS stated that
h. Analysis Section:
i. In the Analysis Section, you discuss and explain how applied the law to the facts in order to reach your conclusions to the issues
ii. In other words, you are building a bridge that logically connects, for your reader, the applicable tax law to the facts to reach the conclusions to the issues.
iii. Example: Under Sec 62(a)(2)(D), Anne can take a $250 educator expense deduction for the biology textbooks she bought for her students because: 1) she is a tenth grade biology teacher; 2) she worked 900 hours during the 2014 to 2015 school year; and 3) the school district did not reimburse her for cost of the textbooks she bought
iv. Note: Sec 62(a)(2)(D) would be summarized in the Analysis Section
II. FACTS FOR TAX RESEARCH MEMO PROJECT:
After not paying a dividend in 17 years, in January 2012, Apple’s chief operating officer, Tim Cook, announced Apple’s plan for a dividend program and $10 billion share buyback program. After Apple’s announcement, one of Apple Inc.’s largest shareholders, Sam Winchester, who is the majority shareholder of Black Equity Group and is publicly considered as an activist shareholder and corporate raider, contacted Apple demanding a seat on Apple’s Board of Directors (Board) because he wanted Apple to increase the amount of its $10 billion share redemption program to $20 billion. By being an Apple board member, Mr. Winchester could propose that Apple increase its share redemption amount and then force Apple’s Board to vote on his proposal.
After Apple’s management rejected Mr. Winchester’s demand, in June 2012, he began a proxy contest to unseat the entire Apple Board and to replace it with a board of his own choosing and submitted a proposal to Apple’s shareholders to increase Apple’s redemption plan from $10 billion to $20 billion. Faced with Mr. Winchester’s proxy contest, Apple incurred the following expenses in connection with the proxy contest: 1) $100,000 of legal fees; 2) $10,000 of public relations fees; and 3) $5,000 for proxy solicitor’s fees. The public relations firm and the proxy solicitor worked with Apple’s attorneys to present Apple’s case to its stockholders in order to successfully block Mr. Winchester’s plan to unseat and replace Apple’s Board and to obtain a vote of confidence for its $10 billion redemption plan, rather than Mr. Winchester’s $20 billion redemption proposal. In December 2012, Apple’s shareholders met and voted against Mr. Winchester’s proposal.
As Apple’s tax advisor, your partner has asked you to write on memo on whether or not Apple can deduct as ordinary and necessary business expense the above fees it incurred in fighting Mr. Winchester’s proxy contest. Your partner also said that he knows of a case that is on point and wants you to use it in your memo.
III. Locke Manufacturing Companies v US, 237 F. Supp. 80 (Dist Ct Conn 1964)
Below is an edited version of the opinion issued by the US Federal District Court of Connecticut in Locke Manufacturing v US 237 F. Supp. 80 (Dist Ct Conn 1964) that you must use and apply to Apple’s issues. In the case, the plaintiff is Locke Manufacturing Companies and the defendant is the United States.
QUESTION PRESENTED
This action, tried to the Court without a jury, to recover $8,409.97 of federal corporate income taxes and assessed interest claimed to have been erroneously assessed and collected, raises the question whether portions of plaintiff’s proxy solicitation and shareholder relation expenses incurred in a proxy contest during plaintiff’s taxable year ending June 30, 1956 are deductible by plaintiff as ordinary and necessary expenses pursuant to Section 162(a) of the Internal Revenue Code of 1954.
The Court holds that such expenses are deductible by plaintiff as ordinary and necessary expenses.
PRIOR PROCEEDINGS
Of the total expenses in amount of $34,411.73 incurred by plaintiff in connection with the proxy contest which culminated in the meeting of plaintiff’s stockholders December 6, 1955, the District Director allowed $20,317.56 ($10,840.55 of legal fees and $9,477.01 of public relations fees) to be deducted as ordinary and necessary expenses within the meaning of Section 162(a). He disallowed the balance of $14,094.17 ($5,312.00 of public relations fees and $8,782.17 of proxy solicitor’s fees).
The disallowance of $14,094.17 resulted in a tax deficiency of $7,328.97, plus $1,081.00 of assessed interest. The total deficiency of $8,409.97 was paid by plaintiff March 2, 1959. A timely claim for refund was filed by plaintiff September 9, 1959 and was rejected January 7, 1960 by the District Director. The instant action was commenced January 4, 1962. The Court has jurisdiction pursuant to 28 U.S.C. § 1346(a) (1).
PLAINTIFF’S BUSINESS AND PLANS FOR INDIANA CHAIN MANUFACTURING PLANT
Plaintiff is a Connecticut corporation with its principal place of business in Bridgeport. It is on a June 30 fiscal year basis. During the period here involved, it had outstanding 110,000 shares of common stock with a par value of $5.00 per share, the holders of which were entitled to one vote per share. The stock was held by about 1000 stockholders; 13,700 shares were held by two stockholders; the remaining 96,300 shares were widely distributed throughout the country, the largest concentration of stockholders being in the New England area. The stock is registered with the Securities and Exchange Commission and is listed on the American Stock Exchange.
For many years plaintiff has been engaged in the manufacture of detachable steel sprocket chains and attachments used principally in the farm implement industry; it also is engaged in the manufacture and sale of power lawn mowers. Its chief customers are the recognized leaders in the farm implement manufacturing industry, including Allis-Chalmers, J. I. Case, Deere, Massey-Harris, Minneapolis-Moline, New Idea (Avco), Oliver, International Harvester and some 120 other equipment manufacturers and distributors, most of which are located in the mid-west.
For about a year prior to the spring of 1955, plaintiff had been planning either to move its chain manufacturing division from Connecticut to Indiana or to establish a branch chain manufacturing plant in Indiana. (Eventually it did move its chain manufacturing division to Huntington, Indiana.) Plaintiff’s primary considerations for making chain in Indiana were to reduce the cost of raw materials by being closer to the source of steel; to reduce freight charges on the finished products by being closer to the manufacturing plants of its principal customers; to speed up delivery of finished products and repair parts; and possibly to reduce labor costs. In short, plaintiff’s management was endeavoring more effectively to meet competition which had been increasing since World War II.
Plaintiff’s plans to make chain in Indiana included negotiations with financial interests for financing the new operations in Indiana. Such negotiations were underway in the spring of 1955 when one William L. Belknap, III, of Easton, Connecticut, appeared on the scene.
BELKNAP’S CHALLENGE OF PLAINTIFF’S CORPORATE POLICY
Belknap first contacted plaintiff through an attorney in April 1955, demanding a place on the Board of Directors. At that time he claimed to have 10,000 shares of the outstanding 110,000 shares of the company’s common stock; he had acquired 9,000 of these shares within the previous nine months and had kept such shares in street name; the other 1,000 shares had been acquired by him as co-trustee within two years of his demand to be placed on the Board. There being no vacancy on the seven man Board which had been elected the previous October, Belknap’s demand was rejected.
In his discussions with plaintiff’s officers and directors, Belknap made clear his opposition to at least three aspects of plaintiff’s corporate policy:
(1) The transfer to, or establishing in, Indiana, of a chain manufacturing plant, insofar as this involved borrowing approximately $800,000 to finance the expansion.
(2) The make up of the company’s “inside” Board, a majority of which consisted of officers and employees of the company.
(3) The company’s record (according to Belknap) of reduced earnings and dividends during the preceding years, especially when compared with the trend in the industry.
These three aspects of plaintiff’s corporate policy were the chief subjects of the proxy soliciting material which later went out to stockholders from both sides, i.e. from Belknap and from management.
THE PROXY CONTEST
After management’s rejection of Belknap’s demand for an immediate place on the Board and after rejection by Belknap of management’s offer to nominate him for election to the Board at the next annual meeting if he would cooperate with management particularly with respect to plans for establishing the chain manufacturing plant in Indiana, Belknap demanded plaintiff’s stockholder list so he could solicit proxies for the October 1955 annual meeting. Plaintiff refused voluntarily to furnish the list. Belknap thereupon instituted a mandamus action in the Superior Court for Fairfield County which resulted in an order granting him permission to inspect and copy the stockholder list. From this order plaintiff appealed to the Supreme Court of Errors. Pending appeal, Belknap instituted an injunction action in the Superior Court and obtained an order enjoining the holding of the annual meeting in October. Plaintiff thereupon withdrew its appeal in the mandamus action; Belknap was given access to the stockholder list; and the injunction was modified to permit holding of a delayed annual meeting on December 6, 1955.
Faced with a proxy contest in which Belknap challenged basic corporate policy of plaintiff and through that challenge sought, not merely a place on the Board for himself, but to unseat the entire Board and to replace it with a Board of his own choosing, plaintiff did what any prudently managed corporation would do when confronted with such a challenge: it retained a public relations consultant (David Karr of Market Relations Network) and a proxy solicitor (Robert A. Weaver, formerly of Squires & Company) to work with plaintiff’s counsel and its management in presenting plaintiff’s case to its stockholders and in endeavoring to obtain a vote of confidence in plaintiff’s challenged corporate policy by electing management’s slate of directors at the delayed annual meeting. The end result of this team effort was the election of the management slate of directors by a 70,075 to 29,673 vote.
PROXY CONTEST EXPENSES
For services to plaintiff in achieving a successful result in the proxy contest, legal counsel were paid $10,840.55 (all of which the District Director allowed as an ordinary and necessary expense); the public relations consultant was paid $14,789.01 (of which $9,477.01 was allowed as an ordinary and necessary expense); and the proxy solicitor was paid $8,782.17 (none of which was allowed as an ordinary and necessary expense). In short, of the $34,411.73 proxy expenses incurred by plaintiff, $20,317.56 were allowed as ordinary and necessary expenses, $14,094.17 were disallowed. The theory for the disallowance is anything but clear to the Court.
Once defendant has conceded the propriety of allowing a deduction under Section 162(a) for certain of the expenses incurred by management during the proxy contest a concession which logically recognizes that the proxy contest was over company “policy” it is difficult to follow defendant’s contention that the other expenses incurred at the same time and for the same purpose are not similarly deductible as ordinary and necessary. Here, as in any proxy contest, the work performed by management’s legal counsel, its public relations consultant and its professional proxy solicitor had one objective to obtain from a fully informed body of stockholders as many valid proxies as possible. For defendant to allow a deduction for all the fees of legal counsel, for part of the fees of the public relations consultant, and for none of the fees of the proxy solicitor, amounts to an illogical splintering of the roles played by these persons in what is essentially an indivisible joint effort. Neither authority nor reason supports defendant’s position.
APPLICABLE LAW
The Court holds that plaintiff has established by a clear preponderance of the evidence that all expenses incurred by it in the course of the proxy contest between Belknap and management were incurred in a dispute over “policy”, not “personalities”; that such expenses, which were reasonable in amount, were incurred for the benefit of all stockholders in the good faith belief on the part of management that it was in the best interests of all stockholders successfully to resist Belknap’s attempt to unseat the incumbent Board and to replace it with Belknap’s slate; and that payment of all proxy expenses incurred by plaintiff, accordingly, was proper.
Having decided the threshold question whether the challenged proxy solicitation expenses were properly paid by plaintiff corporation, we come now to the question whether such expenses are deductible under Section 162(a) as ordinary and necessary expenses. The bare language of Section 162(a) that “There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business” hardly solves the problem of its construction. While the judicial gloss upon the words “ordinary and necessary” is substantial, it is more conducive to confusion than to clarity. To attempt to harmonize the cases construing “ordinary and necessary” would be, as Justice Cardozo concluded, “a futile task.”
What is clear is that to be deductible under Section 162(a) an expense must be both ordinary and necessary. With regard to the latter, the Supreme Court has indicated that the federal courts “should be slow to override [the taxpayer’s] judgment” that expenses were “necessary for the development of the [taxpayer’s] business, at least in the sense that they were appropriate and helpful.” With regard to what is “ordinary”, the Supreme Court has said:
“Now, what is ordinary, though there must always be a strain of constancy within it, is none the less a variable affected by time and place and circumstance. Ordinary in this context does not mean that the payments must be habitual or normal in the sense that the same taxpayer will have to make them often. A lawsuit affecting the safety of a business may happen once in a lifetime. The counsel fees may be so heavy that repetition is unlikely. None the less, the expense is an ordinary one because we know from experience that payments for such a purpose, whether the amount is large or small, are the common and accepted means of defense against attack. Cf. Kornhauser v. United States, 276 U.S. 145. The situation is unique in the life of the individual affected, but not in the life of the group, the community, of which he is a part. At such times there are norms of conduct that help to stabilize our judgment, and make it certain and objective. The instance is not erratic, but is brought within a known type.” [quoting Welch v. Helvering, 290 U.S. 111, 54 S.Ct. 8 (1933)]
The instant case presents a close anology to the “once in a lifetime” lawsuit referred to in Welch v. Helvering, supra. Just as it was there recognized that the defense of an isolated lawsuit could be an “ordinary” business expense, clearly today it is equally “ordinary” for a company in the course of its first or only proxy contest to incur considerable expenses for legal counsel, proxy solicitors and public relations experts in order to defend the policies of its directors from attack by those who would oppose them.
It has been decided recently in two Circuits that expenses for proxy solicitation are properly deductible as “ordinary and necessary” expenses within the meaning of Section 212 of the Internal Revenue Code of 1954. No reason appears why a different construction should be given to the same language in Section 162(a).
In applying the statutory standard of “ordinary and necessary” to the facts of the instant case, it is appropriate to bear in mind Justice Cardozo’s observation in Welch v. Helvering, supra, that that standard is not a rule of law but a way of life:
“Here, indeed, as so often in other branches of the law, the decisive distinctions are those of degree and not of kind. One struggles in vain for any verbal formula that will supply a ready touchstone. The standard set up by the statute is not a rule of law; it is rather a way of life. Life in all its fullness must supply the answer to the riddle.”
A proxy contest has become a part of the corporate way of life; and the economic life of a corporation in all its fullness is the backdrop against which expenses incurred in a proxy contest must be analyzed to find the answer to the riddle whether they are ordinary and necessary from the revenue standpoint.
Struggles for corporate control have been going on for many years as long as the corporate form of organization has been recognized. During the past three decades the focus in proxy contests has been upon the SEC because of the duty entrusted to it by Congress of implementing a shareholder’s right to vote and protecting the investing public against misleading statements made in the course of a struggle for corporate control.
Congress made clear its intention in enacting the Securities Exchange Act of 1934 of promoting corporate democracy and shareholder participation in the affairs of the corporation: “Fair corporate sufferage is an important right that should attach to every equity security bought on a public exchange.”
Whether the ideal of corporate democracy is reflected in the proxy contest as we know it today is not for this Court to assess. But in analyzing expenses incurred by management for proxy solicitation and shareholder relations in a proxy contest in seeking to determine whether they comport with the statutory standard of “ordinary and necessary”, whether they were incurred as a “common and accepted means of defense against attack”, and whether there are “norms of conduct that help to stabilize our judgment, and make it certain and objective” we appropriately can draw upon the experience and expertise of the SEC for guidance as to the standard or norm of conduct in the life of the corporate community with regard to proxy solicitation.
One of the draftsmen of the Securities Exchange Act of 1934 testified unequivocally at the hearings on that statute in 1934 that Section 14(a) did not prohibit solicitation of proxies at the expense of the company, that being left to state law. After more than two decades of administrative experience under the Act, the SEC in 1957 stated, in response to an inquiry from Congress, that it was opposed to any substantive limitation on amounts spent in proxy contests:
[Question by Subcommittee of Senate Committee on Banking and Currency]:
“18. Does your experience indicate that some limitation, either in terms of absolute amounts, in terms of a percentage of assets, or in some other way, should be placed upon the amount of money spent in a proxy contest? If not, should the expenses incurred be filed with some public agency?
[Answer by SEC]:
“In their present form, the proxy rules require both sides in a proxy contest to estimate the amount of their proposed expenses (including proposed fees to attorneys, accountants, public relations or financial advisers, solicitors, printing, transportation, litigation and other costs incidental to the solicitation) and requires these estimates to be included in the soliciting literature of the respective contestants. Thus, not only are such estimated expenses required to be filed with a public agency but they are actually made a part of the proxy material distributed to the shareholders.
* * * * * *
“In view of these provisions of the proxy rules which enable security holders to appraise the importance of the proposed expenditures to them, it appears unnecessary to place limitations on the amounts to be expended by the parties. The amounts of such expenditures are in most cases governed by the particular circumstances and will vary with respect to such factors as the number *89 of shareholders and their accessibility as well as the extent and scope of the issues to be debated in the contest. Any substantive limits on the amount of permissible expenditures may well deprive shareholders of sufficient information to enable them to form intelligent judgments.”
The company in the instant case, in compliance with the SEC’s proxy rules, filed a proxy statement setting forth, among other things, the estimated cost and proposed method of solicitation, including the anticipated use of a professional proxy solicitor.
At the three day trial of this case, participants on both sides of the proxy contest testified, including Belknap (leader of the insurgents); Osborne, Lockwood and Mason (officers and incumbent directors of the company); Karr (the public relations consultant); and Squires (president of the proxy solicitation firm of which Weaver had been manager). The Court, in weighing their testimony, applied such recognized tests as: their demeanor while on the stand; any interest they might have in the outcome of the case; any bias or prejudice for or against either party; their opportunity to observe; any reason to remember or forget; the inherent probability of their testimony; its consistency or lack of consistency; and its corroboration or lack of corroboration with other credible evidence. The testimony of the witnesses, moreover, has been weighed in the light of and indeed has cast light upon the exhibits, including the proxy materials on both sides, the proceedings in the mandamus and injunction actions in the Superior Court, the minutes and other corporate records of the company, correspondence and depositions.
Upon the entire record, the Court finds that the proxy contest expenses incurred by plaintiff in the instant case were “ordinary and necessary” within the statutory definition. Indeed defendant has conceded the propriety of the deduction of the bulk of such expenses as ordinary and necessary.
CONCLUSION
The portions of plaintiff’s proxy solicitation expenses which were disallowed by the District Director ($5,312.00 of public relations fees and $8,782.17 of proxy solicitor’s fees), having been properly paid by plaintiff as corporate expenses, are deductible by plaintiff as ordinary and necessary expenses pursuant to Section 162(a) of the Internal Revenue Code of 1954.
Judgment accordingly may enter in favor of plaintiff to recover the sum of $8,409.97, representing the deficiency paid by plaintiff March 2, 1959, together with interest provided by law.
NOTES
1: Internal Revenue Code (IRC) 162 Trade or business expenses: “(a) In general. There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business…”
2: Plaintiff’s, Locke Manufacturing Companies, expenses incurred in the proxy fight are broken down as follows:
Legal fees (law firm, Pullman, Comley, Bradley & Reeves) $10,840.55
Proxy solicitor’s fees (Robert A. Weaver) 8,782.17
Public relations fees (Market Relations Network) 14,789.01
Total Proxy Expenses: 34,411.73
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