Snow, Edwin A., et al. v. Comm.

Harold W. Walker, Burgess L. Doan, 522 Dixie Terminal Bldg., Cincinnati, Ohio, Lawrence M. Stone, Ronald L. Blanc, Rudolph R. Loncke, Irell & Manella, 1800 Ave. of the Stars, Suite 900, Century City, Los Angeles, Calif., for amici curiae. Scott P. Crampton, Assistant Attorney General, Jane M. Edmisten, Meyer Rothwacks, Bennet N. Hollander, Department of Justice, Washington, D. C. 20530, Lee H. Henkel, Jr., Chief Counsel, Internal Revenue Service, 1111 Constitution Ave., N. W., Washington, D. C., for respondent-appellee.

Before EDWARDS and MILLER, Circuit Judges, and LAMBROS,/*/ District Judge.

Petitioners (joint taxpayers) seek review of the decision of the United States Tax Court, reported at 58 T. C. No. 60 (June 30, 1972). The Tax Court determined a deficiency of income taxes due from taxpayers in the amount of $6,247 for the taxable year of 1966 by denying that a deduction of $9,195.11 claimed by Edwin A. Snow was properly claimed as research and experimental expenditures within the scope of Section 174 of the Internal Revenue Code of 1954. In applicable part this section says:

§ 174. Research and experimental expenditures

        (a) Treatment as expenses--

Snow invested $10,000 in the Burns Investment Company and had made similar investments in two other companies (Courier Enterprises and Echo Development Company) in which an inventor named Trott was the actual principal. In relation to Burns Investment, however, Trott invested no cash. As a consequence, Trott was not entitled (under his agreement with other shareholders) to share in any tax deduction derived from the expenditure by Burns of some $36,000 on seeking to develop the trash burner in 1966, the year in which the company was formed.

The company filed a return electing to expense the research and development expenses pursuant to Section 174(a), and claimed a loss of $36,780.44, of which appellant Snow's share was $9,195.11.

It is undisputed that Burns Investment Company was just beginning its operation in 1966 and did not sell or offer to sell any of its products during that year. Nor did it have a patent issued or pending on the trash burner, or any income from sale of licenses or any other source. Trott's first patent application on the trash burner was filed in 1968 and a patent was issued in 1970. The Tax Court held on these facts that Burns Investment was not engaged in trade or business in 1966 and that the expenditures were not "paid in connection with" its trade or business.

The Tax Court also held that Snow was not employed in the trade or business of inventing or development of inventions because of his investment in Burns and similar investments in two other small companies similarly organized by Trott to develop two other devices.

Appellants, including amici curiae representing small business and inventors, protest the unfairness of this decision. Snow claims that he is engaged in trade or business in relation to his investments in these several companies organized to develop and exploit inventions. He also claims that his participation in Burns Investment Company by organizational management and asserted technical suggestions pertaining to the invention constituted his participating in a trade or business. In addition, he asserts (and here the amici curiae join) that any small business must start somewhere and that refusal to allow first-year development expenditures is inconsistent with the congressional purpose in adoption of Section 174, which purpose was stated in part in the Congressional Record as follows:

     [T]o prevent tax discrimination between large businesses

The Tax Court founded its decision of this case on the conclusion that neither basis of Snow's claims for deductions constituted expenditures "paid in connection with a trade or business" as that phrase had been construed at the time of the Congressional enactment of Section 174.

We agree with the Tax Court that "the issue is whether they [the expenditures for research and experimentation] were paid or incurred by Snow `in connection with his trade or business'" or the trade or business of Burns Investment Company.

The best known definition of these critical terms is that of Mr. Justice Frankfurter in a concurring opinion in Deputy v. DuPont , 308 U. S. 488, 499 (1940), where he said, "`. . . carrying on any trade or business,' . . . involves holding one's self out to others as engaged in the selling of goods or services." This definition was quoted and adopted by the Fourth Circuit. Helvering v. Highland , 124 F. 2d 556 (4th Cir. 1942). The Fifth Circuit employed similar language, but added that "extensive activity over a substantial period of time" was required. Stanton v. Commissioner , 399 F. 2d 326, 329 (5th Cir. 1968).

It seems clear to us, as it did to the Tax Court, that Burns Investment Company in 1966 was not holding itself out to others as being engaged in the selling of goods and services. It was engaged, of course, in experimental work preparatory to going into business, but the expenditures were not made (as required by Section 174) "in connection with [its] trade or business," since as of 1966 it had no product to offer.

In a somewhat different fact situation, Judge Sobeloff of the Fourth Circuit construed the language "carrying on any trade or business" in the context of Section 162(a) dealing with ordinary and necessary business expenses:

     The uniform/1/ teaching of these several cases is that,

Similarly, in our instant case we hold that the expenditures sought to be deducted by Burns Investment Company in 1966 were "pre-operating" expenses and not deductible under Section 174. We cannot hold that the comment previously quoted from Representative Camp concerning "beginning enterprises" demonstrates a Congressional intent to set aside the settled interpretation of the language "trade or business" as used in Section 174.

Appellants rely upon Cleveland v. Commissioner , 297 F. 2d 169 (4th Cir. 1961). We are by no means certain that Cleveland involved any dispute over whether the joint enterprise therein concerned was engaged in a trade or business. If, however, it be read as in conflict with our view in this case, we prefer the logic of the later Fourth Circuit holding in Richmond Television Corp. v. United States, supra, to the Fourth Circuit's earlier holding in Cleveland.

Snow also contends that he should be allowed to deduct these same expenditures (even if Burns is not held to be in business in 1966) because he was himself engaged in the business of developing inventions.

Concerning this contention of Snow's, the Tax Court said:

     Snow contends that because, in addition to Burns, he was

     In Stanton v. Commissioner , 399 F. 2d 326 (C. A. 5, 1968),

While it is true that a taxpayer may be engaging in more than one business, George A. Butler, 36 T. C. No. 1097 (Sept. 19, 1961), Snow's activities as shown by this record were clearly not such as to warrant his claiming to be engaged in the business of inventing. A somewhat less unsubstantial claim might be an assertion that he was engaged in the business of development of inventions by investment. In this connection the record shows that he had made minority stockholder investments in three companies ($10,000 in Burns, $5,000 in Courier, and $15,000 in Echo). In 1966 none of these companies had a product for sale to the public, although Courier and Echo had each developed a device to the point where they were available for licensing.

If investing in development of inventions could properly be held to be carrying on a trade or business, we would agree with the Tax Court that Snow's investment activities in relation to these three companies were not sufficiently continuous or regular enough when taken together to represent his engaging in carrying on a trade or business.

We believe, however, that the Supreme Court decision in Whipple v. Commissioner , 373 U. S. 193 (1963), forecloses our consideration of Snow's claim to be engaging in a trade or business as an investor in inventions. In Whipple the taxpayer was engaged full time (not sporadically in time off from a $200,000 executive post) in management of his investments in corporations in which he had a majority interest. He claimed a deduction for a bad debt on an unpaid loan he had made to one of the corporations which went bankrupt. The Supreme Court rejected the bad debt deduction under Section 23(k)(1) because it held taxpayer's activities in investing and managing his investments did not constitute a trade or business.

The Court said:

     Devoting one's time and energies to the affairs of a

For the reasons set forth above, we affirm the judgment entered by the Tax Court. We have not sought to distinguish between those aspects of the Tax Court's decision which we affirm because they are findings of fact which are not clearly erroneous, Commissioner v. Dubcrstein , 363 U. S. 278, 289-91 (1960), and those which we agree with as conclusions of law since we would affirm all relevant findings and conclusions on either basis.

¹Southeastern Express Co., 19 B. T. A. 490 (1930), the only authority contra, has not been followed or even mentioned in later Tax Court cases.

² Compare concurring opinion of Mr. Justice Frankfurter, Deputy v. DuPont , 308 U. S. 498, 499, 60 S. Ct. 363, 369, 84 L. Ed. 416 (1940), " `* * * carrying on any trade or business.' * * * involves holding one's self out to others as engaged in the selling of goods or services." See also the following cases construing the terms "trade or business" as used in section 174(a)(1), Internal Revenue Code of 1954, 26 U. S. C. A. § 174(a)(1)(1955), dealing with research and experimental expenses: Koons v. Commissioner of Internal Revenue, 35 T. C. 1092 (1961), " `trade or business' presupposes an existing business with which the taxpayer is directly connected"; Mayrath v. Commissioner of Internal Revenue, 41 T. C. 582 (1964), " `trade or business,' is used in the practical sense of a going trade or business."

³ Cf. Myron E. Cherry 26 T. C. M. 557 (1967); Charles H. Schafer, 23 T. C. M. 927 (1964); William S. Scull, II, 23 T. C. M. 1353 (1964).