63 T.C. 570">*570 OPINION

Respondent determined a deficiency in petitioner's Federal income tax for 1964 in the amount of $ 624,485.37. Some of the issues have been settled, and the sole issue remaining for decision is whether petitioner is entitled to a 63 T.C. 570">*571 1975 U.S. Tax Ct. LEXIS 188">*191 deduction for 1964 under section 461(f)¹ for the amount of funds transferred in trust under an instrument reciting that the sole purpose of the transfer was to provide funds for the payment of certain obligations as finally determined in pending litigation. The answer depends, more specifically, upon (1) whether the funds were placed beyond petitioner's control pending the settlement of the claims, and (2) whether the trust instrument was defective in that it was not signed by the persons asserting liability against petitioner.

All the facts are stipulated.

During the tax year in issue, petitioner Poirier & McLane Corp. (hereinafter petitioner), whose principal offices were located in Yonkers, N. Y., was a New York corporation engaged in the building of highways, viaducts, and tunnels. Petitioner prepared its income tax returns on the basis of the calendar year, employing the accrual1975 U.S. Tax Ct. LEXIS 188">*192 method of accounting.

In January 1956, petitioner entered into a contract with the New York City Transit Authority to reconstruct a subway tunnel and to enlarge a subway station in the Borough of Brooklyn, New York City. Under the contract, petitioner was obligated to hold the New York City Transit Authority harmless from all damage claims resulting from the work to be performed.

As a result of petitioner's performance of the work on this project, the Strand Building Corp. brought an action against petitioner for trespass and negligence. Actions for claimed damages and loss of revenue also were brought by several tenants of other properties located at the construction site. The combined amount of the damages claimed by these plaintiffs was $ 581,150.

In October 1958, petitioner entered into a contract with the State of New York as general contractor for the construction of a parkway in Yonkers, N. Y. Under this contract, petitioner was required to hold the State of New York harmless from all damage claims resulting from the work performed under the contract. To install the necessary pilings, petitioner employed Raymond Concrete Pile Co. (Raymond) as a subcontractor. Subsequently, 1975 U.S. Tax Ct. LEXIS 188">*193 during the driving of these pilings, an adjacent apartment building owned by Bronxville-Palmer, Ltd. (Bronxville), was alleged by Bronxville to have been damaged. In 1960, Bronxville brought actions against the State of New York, petitioner, and 63 T.C. 570">*572 Raymond, seeking damages of $ 14,200,000 for trespass and negligence allegedly arising from pile drivings which trespassed upon Bronxville's property, thereby permanently damaging the foundation and structure. ²

1975 U.S. Tax Ct. LEXIS 188">*194 The carrier of petitioner's liability insurance informed petitioner that its policies did not cover damages arising out of trespass, but that the carrier would undertake to defend all the above-mentioned actions because of the allegations of negligence.

On December 31, 1964, petitioner entered into an agreement, described below, with the Manufacturers Hanover Trust Co., as trustee, to hold United States Treasury bills and a certificate of deposit for the purpose of the payment of obligations expected to arise out of the litigation outlined above. Establishment of the reserve was prompted by advice given petitioner by its counsel, insurance carrier, and accountant.

The amount of the reserve was determined as follows:

Petitioner's agreement of December 31, 1964, with the trustee stated that petitioner, designated as settlor, had transferred a certificate of deposit and Treasury bills to the trustee to be held in trust "for the sole purpose" of the payment of petitioner's obligations expected to arise out of the litigation1975 U.S. Tax Ct. LEXIS 188">*195 pending against petitioner as a result of the two construction jobs. The agreement listed by name the corporations and individuals who had filed the suits to which the agreement referred. The agreement provided in pertinent part:

2. The principal and all accumulated interest and earnings shall be held by the Trustee for the sole purpose of the payment of the obligations of the Settlor which may arise out of litigation pending against the Settlor as a result of work performed by it in the construction of the Sprainbrook Parkway in the County of Westchester, State of New York and in the DeKalb Avenue subway reconstruction in the Borough of Brooklyn, County of Kings wherein judgments are demanded against the Settlor and others for damages alleged to have been sustained by the owners and operators of properties adjacent to the places at 63 T.C. 570">*573 which the work was performed. The claims and suits to which this agreement refers are those brought against POIRIER & McLANE CORPORATION by BRONXVILLE PALMER, LTD., STRAND BUILDING CORPORATION, DeKALB AVENUE RESTUARANT [sic], INC., ROSE DRINKS, INC., GAVARES SERVICE STATION & GLASS WORKS and HENRY A. DuFLON, JEANNE DuFLON CREED & DOROTHY DuFLON1975 U.S. Tax Ct. LEXIS 188">*196 SHAFFER.

3. The Trustee shall make such payments out of the corpus of the trust as are required to satisfy and discharge the obligation and responsibility of the Settlor to the plaintiffs or claimants in such litigation, whether by settlement or by judgment and to obtain funds for such purpose the Trustee may sell securities invested in accordance with Paragraph 1. hereof.

4. A request by the Settlor for the issuance of a check or checks payable to a plaintiff or claimant shall be sufficient to empower the Trustee to make the payment.

5. The Trustee shall deliver to the Settlor the balance of the fund remaining after the disposition of the claims on the statement of the Settlor that the claims, for the satisfaction of which this transfer has been made, have been determined and disposed of.

* * *

7. The Trustee may rely and shall be protected in acting or refraining from acting upon any written notice, instruction or request furnished to it hereunder and believed by it to be genuine and to have been signed or presented by the suitor.

8. The Trustee shall not be liable for any action taken by it in good faith and believed by it to be authorized or within the rights or powers conferred1975 U.S. Tax Ct. LEXIS 188">*197 upon it by this Agreement, and may consult with counsel of its own choice and shall have full and complete authorization and protection for any action taken or suffered by it hereunder in good faith and in accordance with the opinion of such counsel.

* * *

13. This trust has been executed and delivered pursuant to the provisions of Section 461-f of the 1964 Revenue Act, in the State of New York and it shall be governed by the laws of that state.

The trust agreement was not signed by the claimants mentioned in it. Relying on section 461(f), petitioner deducted on its income tax return for 1964 the amount of the funds transferred to the trustee.

The litigation brought by Bronxville, which included numerous claims, commenced in 1960. On September 8, 1969, after trial of the claims, the New York State Court of Claims awarded damages to the plaintiff in the sum of $ 11,600, plus interest, for negligence on the part of the State. ³ This amount was 63 T.C. 570">*574 apparently covered by petitioner's insurance against negligence.

1975 U.S. Tax Ct. LEXIS 188">*198 In October 1969, petitioner and its counsel notified the trustee that all claims referred to in the trust agreement were disposed of and that none of the plaintiffs had any present claim against petitioner for damages arising out of the two projects or for any other cause of action whatsoever. Petitioner requested return of the trust principal, plus any interest earned. The full amount of the principal of the trust, plus interest, less trustee fees, was returned to petitioner in November 1969. These amounts were not included in petitioner's income on its 1969 income tax return.

Respondent disallowed petitioner's accrual of the reserve transferred to the trustee, determining that the accrual failed to comply with section 461(a)⁴ and, alternatively, that petitioner's transfer did not meet the requirements of section 461(f).

1975 U.S. Tax Ct. LEXIS 188">*199 Under the accrual method of accounting, which petitioner used, an expense is deductible for the taxable year in which "all the events have occurred which determine the fact of the liability and the amount thereof can be determined with reasonable accuracy." Sec. 1.461-1(a)(2), Income Tax Regs.; Dixie Pine Co. v. Commissioner, 320 U.S. 516">320 U.S. 516 (1944). Notwithstanding this rule, however, the Internal Revenue Service generally took the position, prior to 1961, that the payment of a contested liability resulted in the item being considered deductible even though it was still contested. In 1961, the Supreme Court decided United States v. Consolidated Edison Co., 366 U.S. 380">366 U.S. 380 (1961), holding that a contested tax, though paid, does not accrue as a deduction for income tax purposes until the contest is terminated. The Court reasoned that, as long as the contest persists, all events determining the fact and amount of the liability have not occurred.

63 T.C. 570">*575 The effect of the Consolidated Edison decision, denying a taxpayer a deduction for contested items that have been paid, was to thwart the objective of matching receipts and1975 U.S. Tax Ct. LEXIS 188">*200 disbursements attributable to specific taxable years. Believing that "allowing the deduction of items in the year paid, even though they are still being contested in the courts or otherwise, more realistically matches these deductions up with the income to which they relate than would the postponement of the deduction * * * until the contest is settled," S. Rept. No. 830, 88th Cong., 2d Sess. (1964), 1964-1 (Part 2) C.B. 505, 604, Congress adopted section 461(f) in 1964, which is as follows:

(f) Contested Liabilities. -- If --

(1) the taxpayer contests an asserted liability,

(2) the taxpayer transfers money or other property to provide for the satisfaction of the asserted liability,

(3) the contest with respect to the asserted liability exists after the time of the transfer, and

(4) but for the fact that the asserted liability is contested, a deduction would be allowed for the taxable year of the transfer (or for an earlier taxable year),

Forrester, J., concurring: I concur in the result reached by the majority, but think the here critical portion of regulations section 1.461-2(c)(1) should be declared invalid if it is read as requiring the claimant-beneficiary to sign the written agreement.

The Code requires taxpayer to transfer money or property against the asserted liability, and the regulation quite properly requires it placed beyond taxpayer's control by a written agreement. But requiring the signature of the claimant adds nothing to taxpayer's loss of control and at the same time destroys, or at 63 T.C. 570">*582 least limits and narrows, his rights as remainderman. He is forced into the unnatural posture of admitting and defining his adversary's strength during negotiations with him, thus limiting taxpayer's field for maneuver.

The Code does not require this penalty. If the regulation does it is invalid.

Hall, J. I respectfully dissent. The "transfer" in this case did not meet the literal requirements of Treasury regulations section 1.461-2(c)(1) that a qualifying transfer under section 461(f)(2) must either be made "(i) to the person who is asserting1975 U.S. Tax Ct. LEXIS 188">*215 the liability," or "(ii) to an escrowee or trustee pursuant to a written agreement (among the escrowee or trustee, the taxpayer, and the person who is asserting the liability)." (Emphasis added.) The "transfer" therefore cannot qualify unless, as the majority holds, the regulation's requirement was a mere inadvertence or imprecision upon which the Commissioner may not rely, or unless, as Judge Forrester's concurring opinion finds, the regulation is invalid. Being unable to agree with either of these views, I would sustain the deficiency.

As I read the regulation, the Treasury has deliberately construed the statute to prevent a secret trust from qualifying. A trust is usually created by agreement between trustor and trustee. The unusual requirement here of the beneficiary's participation is, I believe, of great policy significance and was no mere inadvertence.

In fact, the requirement of participation by the other party to the litigation in a qualifying section 461(f) transfer was even more clearly spelled out in the proposed regulation:

A taxpayer may provide for the satisfaction of an asserted liability by transferring money or other property to the person who 1975 U.S. Tax Ct. LEXIS 188">*216 is asserting the liability, or with the agreement of such person to an escrowee or trustee to deliver the money or other property in accordance with the settlement of the contest, provided that the money or other property is transferred beyond the control of the taxpayer. [29 Fed. Reg. 9798, 9800 (1964); emphasis added.]

The Commissioner, unfortunately, raised a false issue by contesting this case on the ground that the entrusted funds were not transferred "beyond the control" of the petitioner. If that 63 T.C. 570">*583 were all that the regulation required, I would join the majority opinion. I do not doubt that the taxpayer created a valid trust, or that it placed the assets within the trustee's control pursuant to the terms of the trust instrument. But by no legitimate stretch of syntactical interpretation could there be an agreement among three parties which was unknown to one of the three.

Nor am I able to find the regulation invalid. The statute requires a "transfer." That this was not intended to be read entirely literally as covering any kind of transfer, however, is made clear by the committee report, which reads as follows:

A taxpayer may provide1975 U.S. Tax Ct. LEXIS 188">*217 for the satisfaction of an asserted liability by transferring money or other property to the person who is asserting the liability, or by a transfer to an escrow agent provided that the money or other property is beyond the control of the taxpayer. However, purchasing a bond to guarantee payment of the asserted liability, an entry on the taxpayer's books of account, or a transfer to an account which is within the control of the taxpayer is not a transfer to provide for the satisfaction of an asserted liability [S. Rept. No. 830, 88th Cong., 2d Sess., 1964-1 C.B. (Part 2) 746.]

The statute and committee report make clear that a transfer to the opponent or to an escrow agent will qualify if the property leaves the taxpayer's control. An escrow, of course, presumes two parties with adverse interests as well as a third-party escrow-holder, so that the litigation opponent, inferentially, would at least be aware of any escrow arrangement. The committee report does not, however, appear to anticipate the precise issue raised here -- the secret trust in which the taxpayer seeks the benefit of the special deduction without the litigation disadvantage of disclosing1975 U.S. Tax Ct. LEXIS 188">*218 his hand to the other party. The regulations do not permit the taxpayer seeking the solace of section 461(f) thus to have it both ways. In my view this construction does not overreach. In the first place, the legislative history, adequately set out in the majority opinion, and the Consolidated Edison case, clearly involved only arrangements known to both parties to the litigation. The secret trust was not adverted to by Congress. Secondly, the apparent lack of explicit congressional familiarity with such a device in a litigation context should be no surprise. There would normally be only one motive, a tax motive, to set up a secret trust. A defendant has too little brotherly solicitude for his opponent to be gratuitously setting up secret trusts for the plaintiff's benefit. Instead of arising in the normal litigation context which Congress adverted to in enacting section 461(f), 63 T.C. 570">*584 the secret trust in the present context is spawned by section 461(f) itself. It is a rare sport, not to be found in nature. It is simply an effort to enjoy the deduction without the effects on one's litigation posture of disclosure. And since virtually any large company is constantly1975 U.S. Tax Ct. LEXIS 188">*219 and increasingly beset as defendant with a swarm of lawsuits of varying degrees of merit, the majority's rejection of the regulation's deliberately established prerequisites of the litigation opponent's knowledge and participation in a section 461(f) arrangement opens the door to large-scale avoidance. Deductions will now be subject to being manufactured and timed to please, by the simple expedient of setting aside in secret trusts the amount sought to be deducted, as long as that doesn't exceed the maximum allowable litigation exposure. Little genuine change of business posture is involved, for if the litigation is won, the money will return; if lost the judgment must be paid anyway; in the meantime the secret trustor can enjoy the income, and the litigation opponent is none the wiser. Nothing in the legislative history suggests that Congress intended to establish any such regime, nor does it seem likely that it would have intentionally so legislated. We should resolve doubts in favor of the validity of Treasury regulations. Commissioner v. South Texas Lumber Co., 333 U.S. 496">333 U.S. 496 (1948). I cannot, under the circumstances, find the Treasury remiss 1975 U.S. Tax Ct. LEXIS 188">*220 in blocking this avenue to facile avoidance.

Section 461(f) was designed to alleviate a hardship created by a taxpayer who under pressure of litigation was forced to lay out cash before becoming entitled to a deduction. It was designed to meet bona fide exigencies of business litigation. The issue facing the Treasury in drafting its regulations was whether the statute should also be construed to permit a taxpayer to thrust himself artificially within its protection through a formalistically perfect arrangement designed for no apparent purpose except qualifying for the deduction, while avoiding the collateral litigation consequences of disclosure to the opponent. I cannot find it beyond the regulatory power for Treasury to decide that such an arrangement would be "an operation having no business or corporate purpose" and to find that "the transaction upon its face lies outside the plain intent of the statute." Gregory v. Helvering, 293 U.S. 465">293 U.S. 465, 293 U.S. 465">469, 293 U.S. 465">470 (1935).