September 1998
| Articles |
| Ruminations on Section 482 Proof |
Strategic Defaults in Section 482 Proof
In Kenco Restaurants Inc., et al. v. Commissioner, (T.C. Memo. 1998-342 (9/24/98), the Court sustained the IRS's Section 482 allocation. Several shareholders had several unconsolidated related corporations, most of which were operating corporations, some of which were holding corporations and one of which was a corporation servicing the other corporations. The IRS determined that the taxpayers' (corporations's) allocation of the charges for services among the various corporations was incorrect and re-allocated based upon estimates of the services rendered. Unfortunately, the taxpayer had lost its time records upon which it allegedly based the original charges. The original charges just happened to be skewed in favor of the profit making entities and away from those which could not benefit currently for deductions for the charges. The IRS's reallocation gave the fisc net revenue because portions of the reallocated amounts were not that beneficial to some of the corporations. The taxpayer apparently did not produce much evidence at trial on the actual value of the services rendered to the various corporations, but rather sought to show that the IRS's allocations were "arbitrary, capricious, or unreasonable" so that the IRS would bear the burden of proof." At trial, the IRS had both its original determinations entitled to some effect in determining who had the burden of proof and also had an independent expert. The taxpayer misperceived the role of the independent expert, thinking that the expert's conclusions had superseded the original IRS determinations. The IRS on brief disabused the taxpayer of this notion, and the Tax Court agreed. The original determinations were the benchmark that the taxpayer must shoot at, and the IRS's expert simply supported the original determinations (although her opinion was perforce somewhat different). With that as the benchmark, the Tax Court determined that the taxpayer had not come close to proving that the IRS's allocations were "arbitrary, capricious, or unreasonable." The Tax Court also sustained the negligence penalty.
Normally, in the course of proving a Section 482 case, a taxpayer and/or the IRS will introduce sufficient evidence from which the Court can make a reasonable determination of the fair market price for goods or services. Stated otherwise, the evidence that shows that the IRS was "arbitrary, capricious, or unreasonable" also usually puts some parameters on the correct allocation (within a reasonable range) so as to permit the Court to reach a correct result rather than simply rejecting the IRS and sustaining the taxpayer's original return reporting position. .This taxpayer apparently limited its attack to just "cross-examining" the IRS's position without further persuasive affirmative proof that it was entitled to a better result. That, as the taxpayer found, is a risky adventure.