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Indopco, Inc. v. Commissioner - 503 U.S. 79, 112 S. Ct. 1039 (1992)


Expenses incurred for the purpose of changing the corporate structure for the benefit of future operations are not ordinary and necessary business expenses. Courts frequently have characterized such an expenditure as capital in nature because the purpose for which the expenditure is made has to do with the corporation's operations and betterment, sometimes with a continuing capital asset, for the duration of its existence or for the indefinite future or for a time somewhat longer than the current taxable year.


On its 1978 federal income tax return, petitioner "target corporation" INDOPCO, Inc. (“Indopco”, which was formerly named National Starch) claimed a deduction for certain investment banking fees and expenses that it incurred during a friendly acquisition in which it was transformed from a publicly held, freestanding corporation into a wholly owned subsidiary. On its federal income tax return for its short taxable year ending in August 1978, National Starch claimed a deduction for the $ 2,225,586 paid to investment firm Morgan Stanley, but did not deduct the $ 505,069 paid to law firm Debevoise or the other expenses. Upon audit, respondent Commissioner of Internal Revenue ("Commissioner") disallowed the claimed deduction and issued a notice of deficiency. Petitioner Indopco sought redetermination in the United States Tax Court, asserting, however, not only the right to deduct the investment banking fees and expenses but, as well, the legal and miscellaneous expenses incurred. The Tax Court ruled that, because long-term benefits accrued to Indopco from the acquisition, the expenditures were capital in nature and not deductible under § 162(a) of the Internal Revenue Code as "ordinary and necessary" business expenses. The Court of Appeals affirmed, rejecting Indopco’s argument that, because the expenses did not "create or enhance . . . a separate and distinct additional asset," they could not be capitalized under § 263 of the Code. Indopco sought review.


Were professional expenses, particularly investment banking and legal expenses, incurred by target corporation National Starch, later named Indopco, in the course of a friendly takeover by Unilever deductible by Indopco as "ordinary and necessary" business expenses under § 162 of the Internal Revenue Code? 




Affirming the judgment, the Supreme Court of the United States held that the expenses petitioner Indopco had incurred were capital expenditures and were thus non-deductible pursuant to 26 U.S.C.S. § 263, and were not deductible ordinary and necessary current business expenses under 26 U.S.C.S. § 162(a). The Court rejected Indopco’s argument that an expenditure had to serve to create or enhance a separate and distinct asset in order to be a capital expenditure. The Court also held that consideration of the future benefit of an expenditure was undeniably important. Noting the long-term benefits of Indopco’s takeover, the Court held that the expenses Indopco incurred for the purpose of changing the corporate structure for the benefit of future operations were not ordinary and necessary business expenses under Section 162(a).

As for the applicable burden of proof, the Court noted that an income tax deduction is a matter of legislative grace, and the burden of clearly showing the right to the claimed deduction is on the taxpayer.

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