TOWNSEND INDUSTRIES, INC., Appellant, v. UNITED STATES of America, Appellee., United States Court of Appeals, Eighth Circuit., 342 F.3d 890, No. 02-3756., Sept. 15, 2003., Submitted: May 16, 2003
TOWNSEND INDUSTRIES, INC., Appellant, v. UNITED STATES of America, Appellee.
United States Court of Appeals, Eighth Circuit.
342 F.3d 890
Sept. 15, 2003.
Submitted: May 16, 2003.
Filed: Sept. 15, 2003.
Bruce B. Graves, argued, Des Moines, IA, for appellant.
Joel McElvain, argued, Dept. of Justice, Washington, DC (Teresa E. McLaughlin, on the brief), for appellee.
Before BOWMAN and BYE, Circuit Judges, and ERICKSEN, 1 District Judge.
1. The Honorable Joan N. Ericksen, United States District Judge for the District of Minnesota, sitting by designation.
BOWMAN, Circuit Judge.
This is a case about the taxability of business and entertainment expenses spent on a Canadian fishing trip. After the Internal Revenue Service determined that the per-employee cost of Townsend Industries' annual fishing trip was wages, it assessed deficiencies against the compa╜ny for the 1996 and 1997 tax years. Town╜send paid a portion of the deficiency and filed a 26 U.S.C. ╖ 7422 (2000) suit seeking a refund. After a bench trial, the District Court found in favor of the Government, held that the expenses involved in the trips were employee wages within the meaning of the Internal Revenue Code, and ruled that a portion of these wages should have been withheld for income tax and Social Security and Medicare taxes. Townsend appeals that decision, and we reverse.
Townsend Industries, based in Altoona, Iowa, manufactures the T-51, a product that allows offset printers to produce two-color documents in a single pass through the printing press. For the last forty years, Townsend has gathered its sales╜people 2 for an annual, two-day meeting at its headquarters involving its corporate staff and some factory workers. Follow╜ing that meeting, the company has spon╜sored a four-day expense-paid fishing trip to a resort in Ontario, Canada (two of the four days spent traveling to-and-from the resort on a bus). Aside from a dinner at which the company owner, Robert Town╜send, and its CEO, John Jorgenson, spoke about the state of the company, the .em╜ployees and salespeople spent their time largely as they wished (though the vast majority fished). Nevertheless, business discussions were conducted on an on-going basis during the trip.
2. Townsend's salespeople are not company employees; rather, they are independent busi╜ness owners.
We apply the same standards of review that we apply in other cases when we review a district court's decision in a taxpayer's suit to reclaim taxes paid. See United States v. Bole, 469 U.S. 241, 249 n. 8, 105 S.Ct. 687, 83 L.Ed.2d 622 (1985). Accordingly, we review the District Court's findings of fact for clear error and its conclusions of law de novo. Boles Trucking, Inc. v. United States, 77 F.3d 236, 242 n. 3 (8th Cir.1996) (citing Bole, 469 U.S. at 249 n. 8, 105 S.Ct. 687). The District Court's holding that Townsend failed to establish that its, trips had a business purpose is a legal conclusion that we review de novo. Cf. Boyle, 469 U.S. at 249 n. 8, 105 S.Ct. 687 (explaining that presence of elements constituting "reason╜able cause" is a question of law).
The question of whether the per-employ╜ee cost of the trips amounted to taxable wages -and whether Townsend should have withheld a portion of these costs turns on whether each employee could have deduct╜ed these costs as business expenses. A taxpayer may exclude certain fringe bene╜fits from his or her gross income and thereby avoid paying income tax on these benefits. Section, 132(d) of the Internal Revenue Code excludes "working condition fringe" benefits from an individual's wages and provides that " 'working condition fringe' means any property or services provided to an employee of the employer to the extent that, if the employee paid for such property or services, such payment would be allowable as a deduction under section 162 or 167." 26 U.S.C. ╖ 132(d) (2000).
In turn, ╖ 162(a)(2) allows a deduction for "traveling expenses (including amounts expended for meals and lodging other than amounts which are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or busi╜ness." 26 U.S.C ╖ 162(a)(2). Any deduc╜tion for travel and entertainment. is sub╜stantially limited by ╖ 274, which disallows deductions for certain expenses and pro╜vides heightened reporting requirements. Section 274(a)(1)(A) disallows deduction for entertainment expenses:
With respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recre╜ation, unless the taxpayer establishes that the item was directly related to, or, in the case of an item directly preceding or following a substantial and bona fide business discussion (including business meetings at a convention or otherwise), that such item was associated with, the active conduct of the taxpayer's trade or business.
26 U.S.C. ╖ 274(a)(1)(A) (emphasis added). Section 274(d) adds an important substan╜tiation requirement and forbids deductions for entertainment expenses:
unless the taxpayer substantiates by ad╜equate records or by sufficient evidence corroborating the taxpayer's own state╜ment (A) the amount of such expense or other item, (B) the time and place of the travel, entertainment, amusement, re╜creation, or use of the facility or proper╜ty, or the date and description of the gift, (C) the business purpose of the expense or other item, and (D) the busi╜ness relationship to the taxpayer of per╜sons entertained, using the facility or property, or receiving the gift.
26 U.S.C. ╖ 274(d)(4).
The Treasury Department has promul╜gated regulations that provide a further gloss on the Internal Revenue Code and that govern whether "working condition fringe" benefits and travel and entertain╜ment expenses are deductible. For pur╜poses of this case, 26 C.F.R. ╖ 1.132-5 (2003), which governs "working condition fringes," adds nothing. Section 1.162-2, which deals with traveling expenses, adds some important requirements to the de╜ductibility of travel expenses and ╖ 1.162-2(a) provides that "[o]nly such traveling expenses as are reasonable and necessary in the conduct of the taxpayer's business and directly attributable to it may be de╜ducted." 26 C.F.R. ╖ 1.162-2(a) (emphasis added). The regulation then explains that where personal and business travel are mixed, travel expenses may only be de╜ducted "if the trip is related primarily to the taxpayer's trade or business." 26 C.F.R. ╖ 1.162-2(b)(1). However, even if the trip is not primarily business-related, expenses "which are properly allocable to the taxpayer's trade or business" may still be deducted. Id .
The regulations governing ╖ 274 of the Internal Revenue Code add additional re╜quirements for this section's "directly re╜lated to" and substantiation requirements. Section 1.274-2(c)(3) add's four require╜ments that the taxpayer must meet in order to deduct entertainment and travel expenses. The expense will only be con╜sidered directly related to, or associated with, the active conduct of business if:
(i) ... the taxpayer had more than a general expectation of deriving some in╜come or other specific trade or business benefit . . . .
(ii) . . . the taxpayer actively engaged in a business meeting, negotiation, discus╜sion, or other bona fide business trans╜action, other than entertainment, for the purpose of obtaining such income or oth╜er specific trade or business benefit . . . .
(iii) In light of all the facts and circum╜stances of the case, the principal charac╜ter or aspect of the combined business and entertainment ... was the active conduct of the taxpayer's trade or busi╜ness . . . It is not necessary that more time be devoted to business than to en╜tertainment to meet this requirement. The active conduct of trade or business is considered not to be the principal character or aspect of combined busi╜ness and entertainment activity on hunt╜ing or fishing trips . . unless the tax╜payer clearly establishes to the contrary.
(iv) The expenditure was allocable to the taxpayer and a person or persons with whom the taxpayer engaged in the active conduct of trade or business dur╜ing the entertainment . . .
26 C.F.R. ╖ 1274-2(c)(3)(i)-(iv). Tempo╜rary regulations govern .the "adequate rec╜ords" requirement in ╖ 274(d) and explain that in the absence of written, contempora╜neous records, the taxpayer must establish the business nature of the expense "[b]y his own statement, whether written or oral, :containing specific information in de╜tail . . . and [b]y other corroborative evidence sufficient to establish" the business nature of the expense. Id . ╖ 1.274-5T(c)(3)(i)(A)-(B).
What these many statutes and regula╜tions boil down to is a requirement that Townsend prove that its fishing trips were reasonable and necessary business ex╜penses that were directly related to, or associated with, the active conduct of Townsend's business. Further, Townsend must demonstrate its business purpose by showing: that it had more than a general expectation of deriving some income or other trade or business benefit from the trip; that its employees actively engaged in business meetings, negotiations, discus╜sions, or other bona fide business transac╜tions; and that the principal character of the combined business and entertainment was the active conduct of Townsend's trade or business. Finally, Townsend faces an evidentiary hurdle and must prove the business nature of its expenses by "adequate records," by its own state╜ments, or by other corroborative evidence.
The District Court determined that Townsend faded to establish a business purpose and ruled in favor of the Govern╜ment. The District Court first determined that the "fishing trips were not an ordi╜nary and necessary business expense in light of the lax attendance policy for the trip, and the disconnect between the sales meeting and the fishing trip." Order at 7 (Aug. 21, 2002). Notwithstanding Town╜send's unusual, inclusive business philoso╜phy, the District Court determined that there was only a brief business meeting held during each of the trips and that it could not say that "a voluntary, company╜wide, all-expense-paid, employer-spon╜sored fishing trip with one brief business meeting [was] an ordinary and necessary business expense." Id . at 8. Nor, the Dis╜trict Court ruled, could Townsend have met the test set out in ╖ 1.274-2(c)(3)(i)╜(iv). The District Court concluded that each trip was "not an integral part of Townsend employees' ability to perform their jobs, it was not a part or a continua╜tion of a sales meeting, but rather was a relaxed and fun event where business, was discussed as part of the background to the primary fishing endeavor." Id . at 10. Further, Townsend's general "expectation to derive uncertain future benefits, partic╜ularly in the way of improved comradery [sic] and relations among its employees and sales personnel[,] . . . is not enough to allow the trips to qualify as directly relat╜ed under section 274(a)." Id . Further still, the District Court concluded that Town╜send could not establish "that its trips were associated with the active conduct of its business" because the trips were not conducted before or after a business dis╜cussion and, therefore, the "business dis╜cussions that occurred in Iowa on Monday and Tuesday were too far distanced tem╜porally from the fishing trip that took place the following four days for this Court to find the 'associated with' test met." Id . at 10-11. Finally, the District Court con╜cluded that, in any event, Townsend failed to meet the substantiation requirements insofar as the witnesses' recollections of fishing trips from different years ran. to╜gether and the trial testimony "lacked the necessary specificity" about Townsend's business purpose. Id . at 12. We disagree with the District Court's holding that the evidence presented at trial failed to estab╜lish a business purpose for Townsend's 1996 and 1997 trips.
Simply put, the testimony elicited at tri╜al clearly established that the 1996 and 1997 trips were business trips and that Townsend properly excluded the trip ex╜penses from its employees' gross income. Although the amount of contemporaneous, written evidence was negligible, Townsend and the Government provided sufficient "statement[s] . . . containing specific infor╜mation in detail . . . to establish" the busi╜ness nature of the trips. 26 C.F.R. ╖ 1.274-5T(c)(3)(i). 3
3. In this case, the lack of contemporaneous, written evidence is not entirely surprising for two reasons. First, Townsend followed the same practice and procedure (without inter╜ference) for its annual trip since instituting it in the 1960's. Second, one salesperson ex╜plained (during the Government's cross-ex╜amination) that the absence of some of the written corroboration could be attributed to Townsend's corporate culture: "They love surprises." Trial Tr. at 329.
In the first place, we cannot agree that District Court's conclusion that the voluntary nature of the trips rendered them an undeductible business expense. Although the trips were voluntary, nearly all of the Townsend employees who testi╜fied felt an obligation to attend and some felt that it was part of their job. More╜over, Robert Townsend, the owner, testi╜fied that while he felt it would be anti╜thetical to his business philosophy to make the trips mandatory, he and other senior management "definitely encourage" em╜ployees to attend and that "[w]hat we want to do is to get them to go, and we do lean on them." Trial Tr. at 21, 31. John Jor╜gensen, the CEO, testified that "I encour╜age them to go. I visit with them about the fishing trip, . about the activities. I definitely encourage everyone to go." Id . at 98. Jorgensen further testified about specific attempts he. made to .encourage different. employees to attend the event. 4 Dean Evans, the chief engineer, added that he felt a responsibility to attend and that, for his part, he did not even look forward to the event:
4. For instance, Dale Hoover, the purchasing manager and a Government witness, testified as follows:
Q: [Government] And did you feel obligat╜ed to go on the fishing trip?
A: [Hoover] I would say-that's a good question. I would say out of respect for my employer, I feel obligated to go. Out of respect for my career and the responsibility of my job duties, I feel obligated to go.
Has anybody ever said, "Dale, you must go"? No, but I feel it's my duty to.
We could go on a tennis trip, and I would still feel obligated to go and I don't play tennis, so . . .
Q: And is part of that, as you say, respect for your employer? You appreciate that your employer is a generous man and has offered ═ you this-to take you to this fishing lodge?
A: I guess I don't really look at it as a vacation. It's nice because it has to do with a particular sport I like to do, and I am very appreciative of the opportunity, but I still believe it's a job function.
Trial Tr. at 421-22. Having elicited this testi╜mony, the Government quickly ended its di╜rect examination of Mr. Hoover.
I like the environment up there. It's very beautiful, but it's actually the cul╜mination of a year's worth of work, be╜cause the fishing trip is where we launch products, introduce it to our staff, and so it's a pretty tough time. Usually we've been at it pretty hard to get it done at that particular date, so it's trying times.
Trial Tr. at 196. In short, the record leaves us with little doubt but that the Townsend employees viewed the annual trip as part of their regular course of business.
More so than the voluntary or involun╜tary nature of the trip, the real crux of the matter for Townsend is the extent to which it could prove the trips were a rea╜sonable and necessary business trip; whether they were directly related to, or associated with, the active conduct of Townsend's business; and whether the principal character of the events was the active conduct of business. Our review of the entire record convinces us that the business nature of the trip was well estab╜lished by the witnesses who testified both for and against Townsend. Although some witnesses did admit that the several-dozen annual trips ran together, more witnesses agreed that specific Townsend-related business was conducted during the 1996 and 1997 trips and that certain business-related activities were always conducted.
For instance, a number of witnesses tes╜tified that in 1996 many discussions fo╜cused on the need to introduce a new model to compete with the Ryobi 3302 press and that in 1997, the new Anniversa╜ry Edition (AE) press was introduced. Dean Evans described the genesis of the AE press saying:
In '96, the fishing trip in '96, there was some competition for our product. It was called a 3302 Ryobi, and it was beating us up pretty good, so a lot of people wanted us to come up with some╜thing more user friendly that would compete directly and enhance the prod╜uct enough that people would look our way rather than to the Ryobi 3302, and that was probably the initiation of the AE, because that was what we tried to develop, something to compete directly with the 3302.
Trial Tr. at 197. For his part, Russell Brook, an independent distributor, testi╜fied that "there would have been a tremen╜dous amount of discussion about [the new press] at the fishing trip." Id . at 303. He further testified, during the Government's cross-examination, that "I think the pur╜pose of the sales meeting fishing trip was to launch the AE [Anniversary Edition press]" and that Townsend intended to "show it to us at the sales meeting. We would then have any discussions that we needed to on the fishing trip as a carry╜over." Id . at 327. The testimony of David DeJoode, Edward Kalupa, and Roger Pe╜rin regarding the conception and birth of the AE press was to the same effect.
In addition to testimony about the Anni╜versary Edition press, many witnesses tes╜tified about discussions regarding the com╜plexity of the T-51 press and problems that customers, employees, and salespeo╜ple (who also repaired the machine) had with its 800 parts. For example, Edward Kalupa and Russell Brock (independent salespeople) both testified that they had discussions with several Townsend employ╜ees regarding the cylinder problems in Townsend's 4610 model. Id . at 262-63, 307, 309; see also id . at 264-65, 295 (prob╜lems with the 1650 model in 1996), 253-57, 295 (problems with S-1 model in 1996). Many witnesses also testified that the fish╜ing trips were a unique opportunity for the national sales team to interact with the Townsend employees who manufacture and assemble the intricate parts and those who send out replacement .parts. This interaction was important, they stated, be╜cause small changes in the attention that the factory workers paid to their work (such as removing all the burrs on metal parts) had a major impact on the amount of repair work the sales force had to do and decreased the number and frequency of repairs. See e.g., id. at 38, Thus, the opportunity, for one of the independent salespeople to tell a Townsend employee in person about his, six-hundred mile round trip to repair a press damaged by too many burrs left on a gear made a major impression. More generally, factory em╜ployees and sales people stated that they gained a better understanding of Town╜send's business at these events. See, e.g., id . at 423.
Further, replacement parts are a major part of Townsend's business and both the sales staff and the Townsend employees involved in parts distribution indicated that improvements, (such as new parts codes and increased accuracy in the parts sent) were conceived on the trips. Id . at 231-32, 310. In fact, such was the pace of life at the Townsend plant that one em╜ployee in the parts department indicated that the fishing trip was one rare opportu╜nity that he had to have a reasoned con╜versation with his supervisor about their work. Id . at 488-89; see also id. at 228 (supervisor confirms conversation).
Another particularly telling piece of evi╜dence that buttresses our conclusion that Townsend met its burden and established a bona fide business purpose for its trips is the fact that Townsend stopped including its plastics division in the annual trip in 1994, three years before Townsend sold the division. The division was sold and its employees excluded from the annual meet╜ing because:
Their product was becoming different than just the plastic we needed that we bought it. for, so that company was get╜ting into a business that was somewhat foreign to us, and . . . it was becoming a disruption during our T-51 press divi╜sion sales meetings, our fishing trip, our meetings afterwards, so we felt to get the best business and the best results, we separated those trips and did not .include the plastic division in 1996 and 1997 on our trip and in our sales meet╜ing.
Id . at 75-76. This decision, to our minds, indicates that Townsend clearly had a spe╜cific business purpose for these trips. If Townsend was merely providing a free vacation to its salespeople and employees, it would not have mattered if they contin╜ued to include the plastics division.
We need not rehash the extensive trial testimony relating to sales tactics, see, e.g., id. at 212-13, 271-72; quality control, see, e.g., id. at 310-11; issues relating to specif╜ic clients, see, e.g., id. at 264-65, 267-68; and other problems solved or discussed on the 1996 and 1997 trips, see, eg., id. at 237-38 (molleton & aqua-flow parts), for the trial record that we have reviewed is replete with evidence of specific and gen╜eral business benefits that Townsend real╜ized from the trips. Contrary to the Dis╜trict Court's conclusion that Townsend merely had a general "expectation to de╜rive uncertain future benefits, particularly in the way of improved comradery [sic] and relations among its employees and sales personnel," Order at 10, we conclude that Townsend had a realistic expectation to gain concrete future benefits from the trip based on its knowledge of its own small company, its knowledge of the utility of interpersonal interactions that probably would not occur but for the trip, and its knowledge of its own past experience. As such, the trips and their expenses qualified as working condition fringe benefits under ╖ 132 and a bona fide business expense under ╖╖ 162 and 274 of the Internal Rev╜enue Code. Necessarily, we also conclude that .the trial record developed by Town╜send and the Government provided ade╜quate substantiation in the form of its "own statement[s] . .. containing specific information in detail [and][b]y other corro╜borative evidence sufficient to establish" the business nature of the expense. 26 C.F.R. ╖ 1.274-5T(c)(3)(i)(A)-(B).
The Government urges that Danville Plywood Corporation v. United States, 899 F.2d 3 (Fed.Cir.1990), governs the case at hand. We think that case, which con╜cerned the deductibility of a corporate trip to the Super Bowl, is distinguishable from the case at hand. In Danville, the Federal Circuit held that the taxpayer was unable to demonstrate that its Super Bowl week╜end trip was a reasonable and necessary business expense and was directly related to, or associated with, the active pursuit of its business. In so holding, the Federal Circuit emphasized that on the narrow facts presented to it; it was compelled to rule that "[t]he Super Bowl weekend," which involved spouses and children, "ap╜pears to have beer' little more than a group social excursion with business play╜ing a subsidiary role." Id . at 9. Here, in contrast, there was no lack of evidence concerning specific and general business discussions and the attendant benefits. Moreover, the absence of spouses and chil╜dren in this case is important for, as more than one Townsend employee noted, the trip was not some sort of paid vacation because, logically enough, "I don't go on vacation with 60 people I work with. I go on vacation with my wife and kids." Trial Tr. at 361.
Nor do we think the present case is like Hippodrome Oldsmobile, Inc. v. United States , 474 F.2d 959 (6th Cir.1973), a case in which the parties conceded that "the company customers entertained [on the boat] were not subjected to any specific exposure to taxpayer's products or suggestion that they buy them while being thus entertained" and that the taxpayer was merely using the boat to generate future good will. Id . at 960. In the case at hand, as we have noted, the employees and sales╜ people were exposed to Townsend products, a new Townsend product was initiated and subsequently introduced during the years in question, complaints and suggestions were discussed about current Townsend products, and Townsend business practices were discussed at length. Given this evidence, we conclude this was not a case where the taxpayer had no specific business purpose and was merely trying to generate good will. See Rowell v. Comm'r. , 884 F.2d 1085, 1088 (8th Cir. 1989) (holding that expense related to hunting and fishing trips were not directly associated with the active conduct of taxpayer's business where taxpayer was often not present and only had an "expectation of future goodwill"); Berkley Mach. Works & Foundry Co. v. Comm'r., 623 F.2d. 898, 904 (4th Cir.1980) (holding that expenses related to company-owned hunting lodge were not business expenses because, at most, company merely derived "general business goodwill"), cert. denied, 449 U.S. 919, 101 S.Ct. 317, 66 L.Ed.2d 147 (1980); Handelman v. Comm'r., 509 F.2d 1067, 1071-75 (2d Cir.1975) (holding that expenses related to forty-six foot sailing sloop "Chee Chee V" were not deductible based on "unspecific and imprecise evidence with no corroboration" of a business purpose for the vessel). 5
5. Section 1.274-2(c)(3)(iii)'s requirement that the "principal character" of the expense be the active conduct of business does not mean that more than fifty percent of the time be spent on business. 26 C.F.R. ╖ 1.274-2(c)(3)(iii). Rather, that regulation explicitly states that "[i]n light of all the facts and circumstances of the case, the principal char╜acter or aspect of the combined business and entertainment to which the expenditure relat╜ed was the active conduct of the taxpayer's trade or business." Id . The regulation then adds that "[i]t is not necessary that more time be devoted to business than to entertainment to meet this requirement." Id . Instead, the fifty percent of time or use requirement can be found in regulations pertaining to pre-1979 expenditures on airplanes, yachts, and other facilities. See 26 C.F.R. ╖ 1.274-2(e).
We pause to note that our decision does not stand for the proposition that in all cases in which a corporation sponsors hunting, fishing, or other trips to "luxury" vacation spots that the sponsoring corpora╜tion can avoid including the per-employee cost of the trip in its employees' wages merely by presenting testimony relating to business allegedly conducted during the sojourn. A district court should be suspi╜cious of oral, non-contemporaneous evi╜dence provided in such cases, see 26 C.F.R. ╖ 1.274-5T(c)(1); Reynolds v. Comm'r., 296 F.3d 607, 616 (7th Cir.2002); and it may well be that in most cases the cost of these trips would amount to income tax╜able to each employee. This caveat not╜withstanding, in the case at bar, we have little trouble concluding that Townsend In╜dustries presented adequate evidence to substantiate its business purpose. Though we have reached this conclusion as a mat╜ter of law, even if "business purpose" were to be treated as a question of fact, we are satisfied the nature and quantity of the evidence presented could compel no rea╜sonable conclusion other than that Town╜send had a bona fide business purpose for its 1996 and 1997 trips. Accordingly, the decision of the District Court is reversed and the matter remanded with instructions to enter judgment in favor of Townsend Industries.