UNITED STATES v. HILTON HOTELS
Legal provision: Internal Revenue Code
Argument of Johnnie Mck. Walters
Chief Justice Warren E. Burger: Number 528, United States against Hiltons Hotels Corporation.
Mr. Walters, you may proceed whenever you are ready.
Mr. Johnnie Mck. Walters: Mr. Chief Justice and may it please the Court.
The relevant facts in this case were stipulated and may be summarized in pertinent part.
In August 1953, Hilton Hotels Corporation owned some 325,370 shares of the 366,040 shares outstanding of the Hotel Waldorf-Astoria leaving some 40,670 shares of Waldorf outstanding in the hands of others.
Contemplating a merger, Hilton retained consultants to do a study to determine a fair basis for exchange of Hilton shares for Waldorf shares.
Hilton and Waldorf agreed upon a proposed merger with Hilton to be the surviving corporation.
Under the proposed plan, Hilton offered to exchange 1.25 shares of its stock for each share of the Waldorf stock it did not already owned.
Prior to the agreement of merger, however, shareholders owning some 20,000 shares of Waldorf filed with Waldorf an objection to the merger and demanded payment for their Waldorf stock.
Thereafter, on December 28 and 29, 1953 more than 2/3 of the stock holders of each of the two corporations voted approval of the merger and on December 31, 1953, the merger agreement and certificate of consolidation were filed with the Secretary of State of New York.
The applicable New York law provided that in such a case the stockholder demanding payment for his Waldorf shares have no right to receive dividends payable on those shares after the close of business on the day preceding to the date that the Waldorf stockholders voted approval of the merger and that upon that vote the dissenting stockholder ceased to have any of the rights of a stockholder of Waldorf except the right to receive payment of the value of the stock.
Under the New York law, the dissenting stockholder or the corporation have the right to have the stock appraised in a Court proceeding.
Complying with New York law on January 7, 1954, Hilton offered to the Waldorf stockholders $24.54 for each share of Waldorf stock it did not already own.
Those stockholders who had dissented from the merger rejected the offer and began Court proceedings under state law for a determination of the buyer of their shares.
Hilton again retained the same consulting firm to determine the value of those Waldorf shares on the date prior to the vote of approval of the merger.
In addition to paying those consultants, Hilton also paid almost $40,000.00 to lawyers and others in connection with the Court proceedings to develop that value.
Hilton claimed a deduction as an ordinary and necessary business expense under Section 162 of the code for all of the fees paid to the consulting firm, attorneys and others including the fees that have been paid to the consultants prior to the vote of the merger.
The Commissioner of Internal Revenue disallowed the deduction.
Hilton paid the asserted deficiency and commenced a suit for refund.
The District Court held that the appraisal costs were deductible but that the consultant's fees that were incurred prior to the merger were nondeductible capital expenditures.
Hilton conceded as to those pre-merger fees and the Seventh Circuit affirmed the District Court allowing deduction of the appraisal fees.
Justice Potter Stewart: This was a taxable year 1955.
Mr. Johnnie Mck. Walters: This began in 1953 sir.
Justice Potter Stewart: Well, the transaction began in '53, I would guess probably the taxable year involved of 1954?
Mr. Johnnie Mck. Walters: Yes sir.
Justice Potter Stewart: How on earth did it take 16 years?
Mr. Johnnie Mck. Walters: Mr. Justice Stewart, I cannot answer that it seems an awful long time.
Justice Potter Stewart: It is an awfully long time.
This is supra refund on the District Court.
Mr. Johnnie Mck. Walters: Yes sir.
Justice Potter Stewart: Is this expanded just in terms of the delays and in the Northern District of Illinois and in the Seventh Circuit Court of Appeals or what?
Mr. Johnnie Mck. Walters: No doubt that's part of it and I would assume that in a situation such as this where you have large corporations involved, the administration on audits probably did not come until late in the statutory period and then all of the proceedings that followed that each eating up a little time.
Justice Potter Stewart: Of course it's only money I suppose.
Mr. Johnnie Mck. Walters: The sole issue here then is whether the fees paid to the consultants, lawyers and others, in connections with the appraisal proceedings that followed the merger are deductible ordinary and necessary business expenses are non-deductible capital expenditures.
What we're concerned in this case with Section 162 which deals with business expenses and also with Section 263 again as in the last case, we nevertheless are concerned with the same basic principles that were involved in the Woodward case.
Section 162 provides a deduction for the ordinary and necessary expenses paid or incurred during the taxable year and the carrying on of the trade of business.
It does not provide a deduction for a capital expenditure.
Section 263 on the other hand prohibits deductions of a capital expenditure.
The origin and character of the claim with respect to which an expenditure is incurred determines or contributes to the determination of whether an expenditure is or is not deductible.
The cost of acquiring an asset and capital stock are not deductible.
They are nondeductible capital expenditures.
Justice Byron R. White: What about the legal expenditures next to the mergers itself.
Mr. Johnnie Mck. Walters: They are capital items, sir.
Justice Byron R. White: They are not deductible?
Mr. Johnnie Mck. Walters: No sir.
All of the expenses --
Justice Byron R. White: The lawyers fees were ignored at merger client and in fact they're non-deductible.
Mr. Johnnie Mck. Walters: That's right sir.
Justice Byron R. White: After Woodward.
Mr. Johnnie Mck. Walters: Yes sir.
Just as the Seventh Circuit noted below, the expenditures incurred in connection with a corporate reorganization such as the ones that Mr. Justice White just asked about are nondeductible capital expenditures.
In considering these keys along side the Woodward case, there is only one additional item that we think we should mention.
In Woodward, the majority shareholders did not acquire title to the (Inaudible) stock prior to the appraisal proceedings whereas in this case, under the applicable New York law, the merger and the acquisition were both accomplished prior to the appraisal proceeding.
This difference in timing is only one that we think we need to address attention.
The timing --
Justice Byron R. White: Well, the Eighth Circuit has decided this case very recently, am I right?
The Eighth Circuit decision, Woodward was before this one.
Mr. Johnnie Mck. Walters: I don't recall Mr. Justice, which came first calendar-wise.
No sir, it did not.
The timing of the appraisal proceeding with respect to the title passage is immaterial.
The appraisal proceeding in this case too was directly and functionally related to and an integral part of the overall proceeding which was a corporate reorganization.
This was not a causal relationship.
It was part and partial of the overall transaction the corporate reorganization and the acquisition of the Waldorf shares.
Thus, again, we note that the tax law does not permit fragmenting of transactions.
It requires events that are functionally related to be looked at together even though they maybe temporally separated time-wise.
We submit that such differences as exist between this case and the Woodward case are immaterial.
In the context of these cases, the differences in timing of the stock appraisals is not material and likewise the differences between the New York and Iowa statutes are not material.
The federal tax rules in the two cases should be the same.
In neither case should the cost of these appraisal proceedings be deductible and Woodward, the Eighth Circuit held at the appraisal cost were not deductible capital expenditures incurred in connection with the acquisition of capital stock.
In this case, the cost of the appraisal likewise should be considered a part of the cost of acquisition of the Waldorf stock.
In either case, the appraisal cost were capital expenditures.
Chief Justice Warren E. Burger: Thank you, Mr.Walters.
Argument of Milton A. Levenfeld
Mr. Milton A. Levenfeld: Mr. Chief Justice and may it please the Court.
The Government concedes that total expenses in the appraisal proceedings are deductible under Section 162 if they are not capital cost.
My argument will be first directed to demonstrate that the Government's contention is erroneous because the legal contractual and economic position of the dissenting shareholders changed from that of stockholders to creditors when they objected to the merger and demanded payment for their stock.
I will then show that the merger and the appraisal proceedings were not functionally related, so that rules with respect to mergers are not applicable to the appraisal proceeding.
Underlying both arguments will be an analysis of state law because without section analysis, one does not know whether an acquisition has occurred.
Chief Justice Warren E. Burger: Well, would they have engage in this process of valuing their shares if they have not been going the acquire them?
Would there have been any occasion for all this expense?
Mr. Milton A. Levenfeld: The occasion for this expense was not the merger itself, Mr. Chief Justice.
The occasion for the expense was the objection and demand for payment by the dissenters and the failure to agree on price.
The merger would have been effective in any event assuming two-thirds.
Chief Justice Warren E. Burger: I was putting on the emphasis on the acquisition as distinguished from the merger to the extent that you --
Mr. Milton A. Levenfeld: The acquisition --
Chief Justice Warren E. Burger: --separate them.
Mr. Milton A. Levenfeld: -- was not by Hilton, Your Honor.
The acquisition was by Waldorf.
The stock ceased to be outstanding stock of Waldorf at the date of the objection and demand for payment.
Hilton was not acquiring the stock.
At the time of the objection and demand for payment, the New York statute specifically provides that the dissenters ceased to be shareholders.
Chief Justice Warren E. Burger: But which was the surviving corporation?
Mr. Milton A. Levenfeld: Hilton was the surviving corporation.
But prior to the merger upon the dissent, the dissenting shareholders headed dissent prior to devote for the merger.
Prior to the merger, they became creditors of Waldorf.
Hilton assumed the liability of Waldorf as a debtor to the dissenters by operation of lot upon the merger.
Hilton did not pay in its stock for the dissenting shareholders' stock.
There was a change of status for the dissenting shareholders from that of stockholder to that of creditor.
The only evidence pertinent in the appraisal proceeding was evidence as to values of shares of the shares of dissenting shareholders.
There was no evidence introduced or which could be introduced as to the value of the Hilton shares or to the effectiveness of the merger.
A debtor-creditor relationship was established between the dissenters and Waldorf and the debt of Waldorf was assumed by Hilton by operation of law on the merger.
The relationship of debtor and creditor is established amply by the state law and case law citations in our brief.
After the demand for payment in the objection to merger, the dissenters have none of the attributes of stock ownership.
Under state law, they could not vote on any matter relating to Waldorf or Hilton.
They could receive no dividends by Waldorf or Hilton.
They could receive no liquidation proceeds.
In addition, it has been decided that by the federal court that once a dissenter elects to receive payment for the stock, he cannot bring a derivative suit in a capacity as shareholder even while the appraisal proceedings is in progress.
In addition, the dissenters had all the attributes of sellers of stock, entitled to receive payment for stock.
They became creditors of Waldorf and then Hilton.
Had Hilton become a bankrupt, they would have been entitled to receive distributions from the Hilton as general creditors paired to pursue with other general creditors prior to any distribution to the stockholders of Hilton.
In addition, this was held in Southern Production Company versus Samoth cited in our brief.
In addition, the dissenters would have been entitled to the federal protection of SEC Rule 10(b) relating to full disclosure with respect to the merger because they would have been considered sellers of stock.
In this protection, what have been afforded to them even while the appraisal proceeding was in progress.
This was cited -- this was decided in the Bouge case cited in our brief.
As prior counsels brought out, this Court in Apsey versus Kimball, 221 U.S. would have decided had Waldorf been a banking corporation and had its shareholders been subject to additional liability, this Court decided that such additional liability could not yet been imposed upon dissenters who had elected appraisal rights.
Justice Byron R. White: What happened to the stock once it's held, treasury stock or (Inaudible)?
Mr. Milton A. Levenfeld: The -- as I read the statute, Mr. Justice White the stock became treasury stock and Waldorf was obligated to pay for it at its fair value.
Justice Byron R. White: How does the purchase price of the stock and I mean, the tax loans, is that concededly a capital expenditure?
Mr. Milton A. Levenfeld: That is conceding capital expenditures.
Justice Byron R. White: Why did you concede that?
Mr. Milton A. Levenfeld: I concede that Your Honor because of the fact that it was unnecessary for Hilton to exchange the one in a quarter shares for this shares that has ceased to become outstanding shares of Waldorf.
It was the purchase price --
Justice Byron R. White: Why wasn't -- why wasn't the expenditure for the actual price of the stock, why wasn't that as deductible as the miscellaneous expenses connected with the acquisition?
Mr. Milton A. Levenfeld: My point, Your Honor, is that miscellaneous expenses are not connected with the acquisition.
There is no functional relationship between the acquisitions and these expenditures.
Justice Byron R. White: No what?
Mr. Milton A. Levenfeld: Functional relationship.
My point is --
Justice Byron R. White: You mean, you wouldn't have incurred these expenditures any way that you haven't required the stock?
Mr. Milton A. Levenfeld: It wasn't that, it was because we could not agree on price that we incurred these expenditures.
Justice Byron R. White: Right but you still want to divide the stocks?
Mr. Milton A. Levenfeld: We have already inquired the stock, Your Honor.
Justice Byron R. White: I suppose you could've backed out.
Mr. Milton A. Levenfeld: We could not back out if nor could have the dissenting shareholders.
Justice Byron R. White: But you knew in advance of the merger, if anybody consented you would have to buy the stock.
Mr. Milton A. Levenfeld: We know that if they did exercise their rights we would have had to buy the stock.
Justice Byron R. White: But if certainly absent some dissent and absent the acquisition of stock, you wouldn't think (Inaudible)?
Mr. Milton A. Levenfeld: That is correct, Your Honor.
Absent the creation of an obligation on the part of Waldorf assumed by Hilton to pay for the stock, the appraisal procedure expenses would not have been made.
The dissenters, when they dissented and demanded payment, elected to share their shares under terms set forth by the State of New York in its statutes.
The State of New York determined who the parties to the sale were, the number of shares to be sold and the date of the sale.
In the State of New York by statute also determined the purchase price of the shares.
The State of New York determined that the purchase price of the shares was the value of the shares on the day before the meeting of Waldorf approving the merger.
Neither party, neither the dissenters nor Hilton could vary the price to be paid by the sharers, for the sharers.
This is somewhat similar to the situation Keiselbach versus Commission 317 U.S. where this Court said that the purchase price in a condemnation proceeding is settled as of the date the property was taken.
The appraisal proceeding was not part of an acquisition process because the parties were not negotiating as to mutually acceptable terms as a condition to sale.
This is not analogous to try to finding a buyer by paying broker a commission nor is it analogous to the parties bargaining as a condition to sale as to purchase price.
Without an agreement as to purchase price there would have been no sale in the ordinary circumstance.
In this circumstance the purchase price had been imposed upon by the state and the sale that have been imposed upon the party by the state once the election was made.
This is not in any way analogous to an attorney preparing documents to consummate a sale, without the signing of which there would be no sale.
This was a complete sale not subject to renegotiation by either party to the sale.
The dissenters could not unilaterally cancel their consent and resume their status as shareholders of Hilton.
They were in the same precision as a private seller who had sold his stock and in a deferred payment and the payment could either been a fixed purchased price or a formula purchase price or a price to be determined by an objective standard such as a State of New York in this case said it would be the objective standard being fair value.
After the demand for payment, the shareholders, the dissenters had no interest in Waldorf as shareholders.
They were not interested in whether the price of Waldorf stock when up or down and they were not interested whether the price of Hilton stock went up or down.
They had ceased to have any interest as equity owner and merely were creditors.
This reflects --
Justice Byron R. White: What if the buyer and seller signed a contact for the purchase of the assets of a company and they signed the contract both sides are obligated to and they set that the two bought through with the transaction and they set the price of every item except one piece of real property over which they can't agree but they both agree that the name the appraiser will set the value and that's the price that will be paid and then the appraisers sets at the chargers of them of a good fee and they split it what about the buyer there on that appraisal be, doesn't he have to capitalize that expense?
Mr. Milton A. Levenfeld: I will think Your Honor that that is part of the agreement as to purchase price prior to the consummation of the sale.
Justice Byron R. White: Well, he doesn't know what it is going to be.
Mr. Milton A. Levenfeld: But they have agreed that it will be what is to be determined by the third party.
Justice Byron R. White: Well, your answer is yes it would be a capital expenditure.
Mr. Milton A. Levenfeld: I think the answer is it probably would be a capital expense.
The public policy of the State of New York and this appears to be very correct because if the Waldorf dissenters could resume their status of shareholders and Hilton stock were to go higher, they could have taken advantage of the increase in price of Hilton stock while in any event having a downward protection because of Hilton stock went lower, they could always have their demand for the fair value of their stock.
The fact of the -- dissenters did not have this choice, demonstrates once again that they were in the position not as shareholders when the appraisal proceeding was commenced but as creditors and the purpose of the appraisal proceedings was to determine the amount owed to them as creditor.
In summary, on this point the dissenters had sold their stock on the date they objected to the merger and demanded payment for their stock.
They have no claim against Waldorf or Hilton as share holders and they had only the right to receive payment and all of these events had occurred prior to the appraisal proceeding.
The appraisal proceeding could in no way affect the acquisition.
The appraisal proceeding was not an equitable proceeding to revise or modify the terms of a sale and it was not necessary to achieve an enforceable bargain because an enforceable bargain had been imposed by the State of New York.
It was also not necessary to achieve the essential formalities of sale because those formalities were taken cared of by law and it was not necessary to establish acceptable terms of acquisition because the terms of acquisition had been imposed by law.
The appraisal proceeding was not part of the cost of acquisition because shares were acquired prior there to and the appraisal proceeding had no effect on the acquisition.
Title involvement has always been a necessary element to determine whether an item is to be capitalized as being part of the cost of acquisition, perfection or defense of title because one cannot acquire a title or acquire anything without title being involved.
Title involvement its necessary touchstone is absent from the appraisal proceeding because title to shares of stock of the dissenters had from them long before the appraisal proceeding was started.
Most of the Government cases sighting the application of the windmill rationale involved title, so the cases cited by the Governments are clearly not applicable and if the cases didn't involve title, they involved the recasting of sales price by a Court with respect to a sale induced by fraud.
Again, a bargaining process or the cases involved the reaching of agreement by as to price prior to title being passed or the cases involved taking the necessary steps to consummate the sale.
The more appropriate cases as authority for this case is a case of Petrick decided by the Second Circuit involving a confiscation proceeding.
In that case, the taxpayers' property was confiscated by a foreign government and the proceeding determining the award was based upon the value of the property confiscated.
There the Second Circuit held at the legal cost in the proceeding were deductible.
Another relevant cases the Naylor case decided by the Fifth Circuit.
In that case an option was exercised to purchase stocks and the parties agreed that title had passed but the option price was set at the book value of the shares of stock at a certain date and the taxpayer hired an attorney because a dispute arose as to book value.
The attorney's fees were held to be deductible because title had passed before the attorney was hired and he was hired merely to collect the correct amount of the purchase price which was a standard set by agreement among the parties' book value.
The Government's reliance upon titled cases is misplaced and rather the Petrick case and the Naylor case are more appropriate.
The Government contends that the origin and character of the appraisal proceeding was in the merger.
Essentially, the argument is had there been no merger, there be appraisal proceeding.
But the cause of the appraisal proceeding was not the merger.
The cause of the appraisal proceeding was in the objection and demand for payment by the dissenters, had there been no such objection or demand for payment there would be no appraisal proceeding.
The merger had been completed and the dissenters could not affect the merger.
The acquisition of the dissenters' stock had been completed and the dissenters could not affect such acquisition.
It was not from the merger or as a part of the acquisition that the appraisal proceeding arose but it wasn't a debtor-creditor relationship established between the dissenters in Waldorf and the fact that they could not agree on the fair value of the dissenters' shares.
There was no functional relationship between the appraisal proceeding and the merger and the rules with respect to mergers should not apply.
The Government states that distinctions in state law should not govern federal tax consequences and the Government in its brief cites cases where there was no substantive difference in state law or where state law put different labels on the same property rights as authority for the statement.
However, we all know that in private contracts trying to accomplish similar ends, different tax consequences can depend upon title.
There is one case in the lower courts other than Woodward in which the appraisal proceedings were held and to be deductible.
This is a District Court case Boulder Building Corporation and it was decided under the appraisals statute at 18 Oklahoma statutes annotated 1.161(a) 1953.
I will quote this statute to you.
“Holders of dissenting shares of a domestic corporation shall continue to have all the rights and privileges incident to their shares except just expressly limited by this section until such time is a fair value of such shares be agreed upon or determined by judgment.”
There were no appraisable limitations under this section.
I submit that under the Oklahoma statutes, the dissenters remain shareholders and they could have resumed their status shareholders which is entirely different in the state law in New York when they had forever lost their status as shareholders.
The Government says, ignore title when you decide this case but one must always be concerned with title if one is going to impose capitalization because the title acquisition is involved.
Hilton does not urge the use of the primary purpose test in this case because the sole purpose of the appraisal proceeding was to determine the value of the shares, the amount of the debt owed by Hilton and there was no element of title involved in the appraisal proceeding.
Justice Byron R. White: I gather, that sounds to me on that argument that you could if you're right you should be able to deduct the price to the dissenter.
Mr. Milton A. Levenfeld: Your Honor, I think there is a distinction between setting a price and paying a price.
We have agreed, Hilton had agreed to pay a price.
It was a price that was imposed upon it by state law and the state law had evolved a procedure to determine the price.
We are questioning -- the problem we have is to categorize the expenses in determining the price.
There is no question that the price itself was for an acquisition yet title was not involved in the price determination proceeding.
The title was involved in the acquisition which had incurred for the price determining proceeding.
In summary, the expenses of Hilton in the appraisal proceeding should not be capitalized because title was not involved in the appraisal proceeding and Hilton acquired nothing as a result of the appraisal proceeding.
In addition, the appraisal proceeding having resulted from the demand for payment and the inability for the debtor and creditor to agree in price was not functionally related to the merger, so the merger rules should not apply.
It is respectfully submitted that those expenses in the appraisal proceeding are ordinary and necessary expenses deductible under Section 162 of the Internal Revenue Code.
Chief Justice Warren E. Burger: Thank you Mr. Levenfeld.
Rebuttal of Johnnie Mck. Walters
Mr. Johnnie Mck. Walters: Mr. Chief Justice, may it please the Court.
I'll just mention on or two items briefly.
Again, we submit these two cases bring to this Court two instances where a taxpayers would deduct the cost of determining the value of capital stock which capital stock had to be acquired at one instance by individual taxpayers and the other by corporation in connection with corporate action.
The fact that the timing of this cost came either before or after, we submit, is immaterial.
These costs were incurred as a part and parcel of the overall transaction in each instance.
Accordingly, we submit that the Court should decide these two cases alike and the Eighth Circuit held that they were capital expenditures and the Woodward case and the Hilton case the Seventh Circuit held they were deductible.
We think that they Eighth Circuit is right and that the Seventh Circuit is wrong but we submit most urgently that whatever the answer is we need one rule.
These are not isolated instances.
There are many, many corporate reorganizations, mergers and other items actions taking place today where this is going to be a recurring event so we need a rule for taxpayers and the Government alike.
Justice Byron R. White: Are there other decisions in the lower courts that the courts have gone opposite direction.
Mr. Johnnie Mck. Walters: Mr. Justice, there are several decisions.
Justice Byron R. White: Some of the District Courts?
Mr. Johnnie Mck. Walters: Yes sir, where they've gone both ways really.
We submit that the better view is that applied in the Woodward case because we do not see how you can separate out this appraisal proceeding which is required to determine the value or the price of the stock from the overall transactions.
Now, as to the possible distinctions between the two statutes involved in this case, again, we say they're immaterial because if you cut away the brush and look at the main transactions that we have here, it seems clear to us that these expenditures were incurred in the purchase of capital stock.
You do not see how can find otherwise when you look at the whole picture.
We have mentioned very briefly the point Mr. Justice White has brought out in questioning if Hilton felt that the timing was as important as it is then we submit that they could very well have justified, at least arguably deducting the cost, the price that they paid for the stock too because that came before the acquisition also.
In fact, we submit that the concession by Hilton that the pre-merger expenses incurred, expenditures for the consultants, constitute nondeductible capital expenditures indicates that they too feel that the decision in the Woodward case is correct.
Chief Justice Warren E. Burger: Thank you.
Mr. Johnnie Mck. Walters: Mr. Chief Justice, I would like a few minutes of rebuttal.
Chief Justice Warren E. Burger: Yes, you have -- excuse me.
We got two cases here, I just thought make it unsorted.
Mr. Walters had had rebuttal.
You have no rebuttal left.
Mr. Walters was in rebuttal on this case.
You've exhausted all your time.