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Churchill Downs Insists Entertainment Expenses Are Fully Deductible

JUN. 4, 2001

Churchill Downs Inc., et al. v. Commissioner

DATED JUN. 4, 2001
DOCUMENT ATTRIBUTES
  • Case Name
    CHURCHILL DOWNS INCORPORATED AND SUBSIDIARIES Petitioners v. COMMISSIONER OF INTERNAL REVENUE Respondent ON APPEAL FROM THE UNITED STATES TAX COURT (Docket No. 8140-99)
  • Court
    United States Court of Appeals for the Sixth Circuit
  • Docket
    No. 01-1274
  • Authors
    Leet, Byron E.
    Gorman, C. Tyson
  • Institutional Authors
    Wyatt, Tarrant & Combs LLP
  • Cross-Reference
    Churchill Downs Inc., et al. v. Commissioner, 115 T.C. No. 20; No.

    8140-99 (Sept. 26, 2000) (For a summary, see Tax Notes, Oct. 2, 2000,

    p. 77; for the full text, see Doc 2000-24768 (13 original pages) or

    2000 TNT 188-9 Database 'Tax Notes Today 2000', View '(Number'.)

    For text of Churchill Downs's opening appellate brief, see Doc 2001-

    11391 (32 original pages) [PDF] or 2001 TNT 87-53 Database 'Tax Notes Today 2001', View '(Number'.
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    business expense deduction, limits, meals and entertainment
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2001-17133 (12 original pages)
  • Tax Analysts Electronic Citation
    2001 TNT 126-70

Churchill Downs Inc., et al. v. Commissioner

 

=============== SUMMARY ===============

 

In a reply brief for the Sixth Circuit, Churchill Downs Inc. has argued that it should be allowed to deduct expenses incurred in producing certain Kentucky Derby and Breeders' Cup events without the fifty-percent limitation of section 274(n) for entertainment expenses.

Churchill Downs Inc. listed $397,000 in deductions on its 1994 and 1995 income tax returns arising from entertainment expenses it incurred in holding Kentucky Derby and Breeders' Cup events, such as the Sport of Kings dinner, cocktail parties, a press breakfast, and winners' parties. The IRS determined $73,000 in deficiencies for those years, asserting that the claimed deductions were limited by section 274(n)(1). Churchill Downs contested the disallowance of the expenses, arguing that the purpose of the events was to add to the "overall glamour and prestige" of its races. The corporation contended that all the claimed costs met the requirements for deductions as ordinary and necessary business expenses.

The Tax Court agreed with the IRS and held that the expenses were subject to the section 274 limitation, finding that even though the corporation was in the entertainment business, the costs at issue were entertainment expenses that could not be categorized as "part of the entertainment product." The court also rejected Churchill Downs's alternative argument that its expenses were excludable under section 274(e)(7) or (8) because they were used to pay for items available to the public and for entertainment sold to customers. The court found that, although the horse races were open to the public, the entertainment associated with them included invitation-only events for selected horsemen, Churchill Downs employees, media representatives, and local dignitaries. The court noted that these expenses were borne by Churchill Downs and the goods and services were given away. (For a summary of this opinion, see Tax Notes, Oct. 2, 2000, p. 77; for the full text, see Doc 2000-24768 (13 original pages) or 2000 TNT 188-9 Database 'Tax Notes Today 2000', View '(Number'.)

Churchill Downs insists that because the expenses at issue were incurred in the production of its premiere and unique entertainment products, they are not subject to the fifty-percent limitation of section 274(n). In the alternative, Churchill Downs maintains that the entertainment expenses are fully deductible and protected from the fifty-percent limitation by sections 274(e)(7) or (8) because they involved items available to the public or entertainment sold to customers.

 

=============== FULL TEXT ===============

 

IN THE

 

 

UNITED STATES COURT OF APPEALS

 

 

FOR THE SIXTH CIRCUIT

 

 

PROOF REPLY BRIEF OF PETITIONERS

 

 

Byron E. Leet

 

C. Tyson Gorman

 

Wyatt, Tarrant & Combs, LLP

 

2500 Citizens Plaza

 

Louisville, Kentucky 40202-2898

 

(502) 589-5235

 

Counsel for Petitioners

 

Churchill Downs Incorporated

 

and Subsidiaries

 

 

TABLE OF CONTENTS

 

 

Table of Authorities

 

Table of Contents

 

 

Argument

 

 

I. INCURRED IN THE PRODUCTION OF PETITIONERS' PREMIERE AND

 

UNIQUE ENTERTAINMENT PRODUCTS, THE EXPENSES AT ISSUE ARE NOT

 

SUBJECT TO I.R.C section 274(n)

 

 

II. ALTERNATIVELY, THE SUBJECT EXPENSES ARE FULLY DEDUCTIBLE

 

PURSUANT TO I.R.C. SECTION 274(E)(7) or (8)

 

 

Conclusion

 

 

Certificate of Service

 

 

TABLE OF AUTHORITIES

 

 

CASES

 

 

Comerica Bank, N.A. v. U.S., 93 F.3d 225 (6th Cir. 1996)

 

 

Wells Fargo & Co. v. C.I.R., 224 F.3d 874 (8th Cir. 2000)

 

 

Wolpaw v. C.I.R., 47 F.3d 787 (6th Cir. 1995)

 

 

STATUTES, REGULATIONS AND RULES

 

 

I.R.C. Section 274

 

 

I.R.C. Section 162

 

 

Treas. Reg. Section 1.274-2(a)(3)(ii)

 

 

REPLY

[1] Come the Petitioners, Churchill Downs Incorporated and Subsidiaries, by counsel, and for their Reply Brief state as follows:

[2] As "[t]he parties here agree that the expenses at issue are directly related to the active conduct of [Petitioners'] business, and that the expenditures have been properly substantiated," (Respondent's Brief, 15) the sole question before this Court is whether the fifty percent (50%) limitation on the deductibility of entertainment costs set forth in section 274(n) of the Internal Revenue Code of 1986, as amended ("I.R.C."), applies to expenses incurred by Petitioner in the production of certain Kentucky Derby and Breeders' Cup events. As an issue of statutory interpretation of Internal Revenue Code provisions and related Treasury Regulations, the Tax Court's decision below is subject to de novo review. Wolpaw v. C.I.R., 47 F.3d 787, 790 (6th Cir. 1995).

ARGUMENT

I. INCURRED IN THE PRODUCTION OF PETITIONERS' PREMIERE AND

 

UNIQUE ENTERTAINMENT PRODUCTS, THE EXPENSES AT ISSUE ARE NOT

 

SUBJECT TO I.R.C section 274(n).

 

 

[3] Respondent's brief asserts that the expenses Churchill Downs incurred in 1994 and 1995 in connection with the Kentucky Derby and the Breeders' Cup are subject to the fifty percent (50%) limitation of section 274(n) because they include food, drinks, and entertainment and advance Petitioners' public relations and/or advertising efforts. However, this argument oversimplifies the analysis called for by applicable regulations and ignores the fact that the subject events are an integral part of Petitioners' entertainment product. Expenses incurred in conjunction with these Kentucky Derby and the Breeders' Cup events, which advance those premiere horse races, are not just entertainment expenses. They are ordinary and necessary expenses, paid or incurred in carrying on a trade or business, deductible pursuant to I.R.C. section 162 without the limitation of section 274(n).

[4] The subject expenses are not simply entertainment expenses, just as a manufacturer's hosting of a show to display its wares is not entertainment for purposes of I.R.C. section 274(n). The parties have stipulated that the subject expenses were for events integrally connected to the Kentucky Derby and the Breeders' Cup. These events showcased the Kentucky Derby and the Breeders' Cup -- they displayed Churchill Downs' wares by showcasing the premiere horse races hosted by Churchill Downs.

[5] Treas. Reg. section 1.2174-2(a)(3)(ii) indicates that expenses incurred by a manufacturer to showcase its wares to potential customers are not subject to the fifty-percent (50%) limitation of I.R.C. section 274(n). The present circumstances are no different. The subject expenses were incurred to produce and promote events which Respondent concedes (by Stipulation) are important parts of Petitioners' biggest races, the Kentucky Derby and the Breeders' Cup. Events held in conjunction with Petitioners' biggest races and to showcase thoroughbred horse racing (Petitioner's product) are no different from the manufacturer's showcase mentioned in the applicable regulations, to which the fifty-percent (50%) limitation of I.R.C. section 274(n) does not apply.

[6] Whether an activity will be treated as "entertainment" for purposes of I.R.C. section 274(n) depends on the nature of the taxpayer's business. Treas. Reg. section 1.274-22(a)(3)(ii). Petitioners are in the entertainment business and their premiere entertainment products are the Kentucky Derby and the Breeders' Cup. The subject expenses were incurred in producing events which Respondents concede were a PART OF the Kentucky Derby and the Breeders' Cup (R. 7, Stip. paragraphs 22 and 38, JPX ___). Moreover, in the case of the Breeders' Cup, Petitioners were required to host the subject events in order to have that entertainment product to offer for sale to the public (R. 7, Stip. Ex. 11-J, JPX ___).

[7] Critical to Petitioners' financial success, the days leading up to the Kentucky Derby and Breeders' Cup have become major entertainment events. The attendance of members of the media, members of the horse industry, celebrities, and dignitaries, not only during the actual races but also in the days leading up to the races, is essential to provide the publicity and media attention necessary to sustain these races in the face of ever-increasing competition from other sports, entertainment, and gaming operations, including land- based, river boat, and cruise ship casinos and state lotteries 1 (R. 7, Stip. paragraph 40, JPX ___).

[8] The Kentucky Derby and the Breeders' Cup are the culminations of Petitioners' premiere entertainment products. The events held in conjunction with the Kentucky Derby and the Breeders' Cup, as much as the races themselves, represent the entertainment "product" that Petitioners offer their patrons and television viewers and are vital to the success of Petitioners. The fact that some of the subject events are designed to attract special customers of Petitioners (e.g., representatives of the horse industry, members of the media, and local dignitaries) does not alter the fact that they are an integral part of Petitioners' entertainment product which is offered for sale to the general public.

[9] Respectfully, Respondent's position ignores the business realities associated with staging a world class sporting event in a climate of intense competition. The Kentucky Derby is not just two minutes of horse racing. The build-up to the Kentucky Derby and the Breeders' Cup, with associated media attention and the bright light of publicity, is a necessary and integral part of the overall entertainment product that Petitioners' patrons and television viewers have come to expect. The vital importance of these preliminary events is evidenced by the fact that the contract between Breeders' Cup Limited and Petitioners REQUIRES those events to be held (R. 7, Stip. Ex. 11-J, JPX ___).

[10] The parties have stipulated that the events for which the subject expenses were incurred were PART OF the Kentucky Derby and Breeders' Cup. As such, they were PART OF the entertainment product that Petitioners created for presentation, promotion, and sale to the public and therefore critical to the success of the Kentucky Derby, the Breeders' Cup, and Petitioners' business in general. In the case of the Breeders' Cup, Petitioners were required to incur the subject expenses in order to have that entertainment product to offer for sale. That fact makes Petitioners' case all the more compelling for full deductibility of the Breeders' Cup expenses. Consistent with the applicable regulations, Petitioners should not be subject to the restrictions of I.R.C. section 274(n) with respect to expenses they incur in producing and showcasing their premiere entertainment products.

II. ALTERNATIVELY, THE SUBJECT EXPENSES ARE FULLY DEDUCTIBLE

 

PURSUANT TO I.R.C. section 274(e)(7) or (8).

 

 

[11] To the extent the subject expenses are "entertainment" under I.R.C. section 274, they are nonetheless protected from the fifty-percent (50%) deductibility limitation by subsections (e)(7) and (e)(8), which are exclusions from subsection (n). The subject expenses were incurred in the production of events which Respondent has correctly conceded are a part of Petitioner's premier entertainment products, the Kentucky Derby and the Breeders' Cup. Those products are "items available to the public" and "entertainment sold to customers" in as much as Petitioners make these races, and the entertainment they provide, available to patrons and television viewers around the world. The subject expenses accordingly fall within the protection of subsections (e)(7) and (e)(8) to I.R.C. section 274.

[12] The application of such exceptions to section 274(n) is discussed in Respondent's Tech. Adv. Mem. 9641005 (October 11, 1996)(the "TAM"). Although the TAM admittedly has no precedential value, it does provide evidence of proper statutory construction and agency interpretation. Wells Fargo & Co. v. C.I.R., 224 F.3d 874, 886 (8th Cir. 2000); Comerica Bank, N.A. v. U.S., 93 F.3d 225, 230 (6th Cir. 1996). The TAM is particularly relevant here because it addresses treatment of expenses incurred by casinos, which are among Petitioners' biggest competitors (R. 7, Stip. Ex. 10-J, JPX ___). According to the TAM, Respondent permits full deduction of certain "comps" provided to the best customers of casinos. If Petitioners are not allowed similarly to provide free events to customers who are critical to its business (i.e., the media, members of the horse industry, celebrities, and dignitaries), they will be placed at a distinct competitive disadvantage. The individuals who attended the subject events are just as critical to the overall success and profitability of Petitioners' entertainment product as the "high rollers" are to the casinos. To treat those situations differently cannot be reconciled and results in an inequitable competitive advantage for casinos.

[13] The events associated with the races, while limited in some respects, are nonetheless designed to showcase the Kentucky Derby and Breeders' Cup to the general public and to heighten public awareness of the upcoming races. It is the public availability of Churchill Downs's product, and the events' integral connection with that product, that makes the exclusions apply. According to the TAM, it does not matter that some patrons are "comped" while others are not. An analogy could be made to a private celebrity opening-night showing of a new movie. The private showing is just as much a part of the movie company's business as the public showing at the theaters even if not everyone attends the private showing.

[14] The Kentucky Derby and the Breeders' Cup are open to the general public, as are other races during Derby Week and Breeders' Cup Week. The parties have stipulated that the events for which the subject expenses were incurred were part of the Kentucky Derby and the Breeders' Cup. Because the Petitioners' expenses are an integral part of an entertainment product "available to the public" and "sold to customers", they fall within subsections (e)(7) and (e)(8) to I.R.C. section 274 and are not subject to I.R.C. section 274(n)(1)'s fifty percent (50%) limitation on deductibility.

CONCLUSION

[15] For the reasons set forth in Petitioners' Brief and Reply, Churchill Downs, Inc. and Subsidiaries respectfully request that this Court reverse the decision of the United States Tax Court.

Respectfully submitted,

 

 

Byron E. Leet

 

C. Tyson Gorman

 

WYATT, TARRANT & COMBS, LLP

 

2500 Citizens Plaza

 

Louisville, Kentucky 40202-2898

 

(502) 589-5235

 

 

Counsel for Petitioners

 

Churchill Downs Incorporated

 

and Subsidiaries

 

FOOTNOTE

 

 

1 A description of the competitive environment in which Petitioners operate is set in Exhibit 10-J of the Stipulation of Facts (R. 7, Stip. Ex. 10-J, JPX ___).

 

END OF FOOTNOTE
DOCUMENT ATTRIBUTES
  • Case Name
    CHURCHILL DOWNS INCORPORATED AND SUBSIDIARIES Petitioners v. COMMISSIONER OF INTERNAL REVENUE Respondent ON APPEAL FROM THE UNITED STATES TAX COURT (Docket No. 8140-99)
  • Court
    United States Court of Appeals for the Sixth Circuit
  • Docket
    No. 01-1274
  • Authors
    Leet, Byron E.
    Gorman, C. Tyson
  • Institutional Authors
    Wyatt, Tarrant & Combs LLP
  • Cross-Reference
    Churchill Downs Inc., et al. v. Commissioner, 115 T.C. No. 20; No.

    8140-99 (Sept. 26, 2000) (For a summary, see Tax Notes, Oct. 2, 2000,

    p. 77; for the full text, see Doc 2000-24768 (13 original pages) or

    2000 TNT 188-9 Database 'Tax Notes Today 2000', View '(Number'.)

    For text of Churchill Downs's opening appellate brief, see Doc 2001-

    11391 (32 original pages) [PDF] or 2001 TNT 87-53 Database 'Tax Notes Today 2001', View '(Number'.
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    business expense deduction, limits, meals and entertainment
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2001-17133 (12 original pages)
  • Tax Analysts Electronic Citation
    2001 TNT 126-70
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