ISSUE: Whether the amount for graphic design and package design expenditures is litigated expenses so that can be deductible under Sec 162. And whether the disputed item is ordinary income or an amount realized on the sale or other disposition of property.

FACTS: There are two facts under a same parent group. One is that R.J.Reynolds Tobacco CO. claimed a deduction for its graphic design and package design expenditures in the amount of $2,196,441. It claims that graphic design and advertising activities are indistinguishable in any way that would justify its inconsistent tax treatment because of the marketing activities and advertising strategies. Respondent argues that not all expenditures for ordinary business advertising are deductible under section 162.

Another fact is that Kuwait terminated the concession enjoyed by Aminoil to explore for and exploit certain natural resources in a Kuwaiti frontier area known as the Neutral Zone and expropriated certain of Aminoil's assets in Kuwait. Aminoil and Kuwait entered into an agreement to arbitrate the resulting dispute. The tribunal made an award to Aminoil in the amount of $179,750,764. Kuwait honored the decision of the tribunal and paid Aminoil the award on July 1, 1982. For purposes of taking the award into account for Federal income tax purposes, petitioner made allocations based on the methodology of the tribunal. Petitioner treated $55,147,935, the amount described by the tribunal as the “level of inflation” adjustment, as an amount realized on the sale or other disposition of the concession. Respondent does not agree with petitioner that the “level of inflation” adjustment is an amount realized on the sale or other disposition of the concession. Respondent believes that the “level of inflation” adjustment is ordinary income in the nature of interest.

HOLDINGS: The litigated expenses are ordinary business expenses so that can be deductible under Sec 162. the disputed portion of the arbitration award is an amount treated as ordinary income.

ANALYSIS: Section 162 allows a deduction “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business”. In addition, the section holds that no cash distinguishes between advertising execution and campaign expenditures so that the litigated expenses the company cost are advertising expenditures that are ordinary business expenses, which will be deductible under section 174.

The ‘inflation’ factor, like the ‘interest’ factor, was compensation for the delay in payment, and therefore, it is properly treated as ordinary income under section 61. Section 483 imputes interest (unstated interest) to a contract for the sale or exchange of property for which there is inadequate stated interest. Section 1.483-1(b)(1), Income Tax Regs., provides: “The term ‘sale or exchange’ includes any transaction treated as a sale or exchange for purposes of the Code.” Condemnation proceedings are treated as sales for Federal income tax purposes.

Both the RJR Nabisco case and the case we did in the class are regarding the graphic design of a product. Both cases are under section 162 but face different treatment. The case we discussed about in class talked about the improvement of external package of yoyo, which under Section 162 that this part of expense should be capitalized and cannot be deducted when the expense happened, while, the expense in this case is categorized as advertisement expense, which under Section 162 that this expense can be deducted.

Carson Chen
Corinne Mao