                       114 T.C. No. 27



                UNITED STATES TAX COURT



AMERICAN STORES COMPANY AND SUBSIDIARIES, Petitioner v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 13142-97.                      Filed May 26, 2000.



     P purchased the stock of LS. Prior to purchasing
LS, P had negotiated with the Federal Trade Commission
to satisfy the antitrust concerns about the purchase.
Shortly after P’s purchase of LS, and 1 day after the
FTC entered its final consent order, the State of
California filed an antitrust suit in Federal District
Court objecting to P’s purchase of LS. The State asked
for various remedies including divestiture. The
District Court issued a temporary injunction
prohibiting P from integrating the business operations
of LS and P. The District Court’s opinion was the
subject of an appeal and was ultimately resolved by the
Supreme Court. Thereafter, P and the State settled the
antitrust suit. P incurred substantial legal fees in
defending against the State’s antitrust suit. Those
legal fees were deducted as ordinary and necessary
business expenses. R disallowed those deductions based
on R’s determination that the legal fees should be
capitalized.
                               - 2 -

          Held: P’s legal fees incurred in defending
     against the State’s antitrust suit arose out of, and
     were incurred in connection with, P’s acquisition of
     LS. The origin of the State’s antitrust claim was P’s
     acquisition of LS. P’s legal fees must be capitalized.



     Fredrick J. Gerhart, Kevin M. Johnson, and Thomas Edward

Doran, for petitioner.

     Mark H. Howard, for respondent.



                              OPINION


     RUWE, Judge:    Respondent determined deficiencies of

$7,963,850 and $1,773,964 in petitioner’s Federal income tax for

its taxable years ending January 28, 1989, and February 3, 1990,

respectively (hereinafter referred to as the 1989 and 1990 tax

years).   After concessions, the only issue for decision is

whether petitioner may deduct or must capitalize legal fees and

costs (legal fees) incurred in defending an antitrust suit

brought by the State of California subsequent to petitioner’s

acquisition of Lucky Stores, Inc.    This case is before the Court

fully stipulated.   See Rule 122.   The stipulation of facts and

the attached exhibits are incorporated herein by this reference.

                            Background

     Petitioner is an affiliated group of corporations which

annually files a consolidated Federal income tax return.

American Stores Company (American Stores) is the common parent of
                                - 3 -

the affiliated group, and it filed the petition on behalf of all

eligible members of the group pursuant to section 1.1502-77,

Income Tax Regs.   At the time the petition was filed, American

Stores, a Delaware corporation, maintained its mailing address

and principal office at 709 East South Temple, Salt Lake City,

Utah.   Petitioner files its income tax returns on the basis of a

52-53-week fiscal year ending on the Saturday nearest to each

January 31.   Petitioner prepared and filed the consolidated

income tax returns for its 1989 and 1990 tax years using the

accrual method of accounting.

     By January 28, 1989, American Stores and its subsidiaries

operated approximately 1,917 retail units in 39 States.     During

the 1989 and 1990 tax years, petitioner principally engaged in

the retail sale of food and drug merchandise.     Petitioner is one

of the nation’s leading retailers, operating combination

drug/food stores, super drug centers, drug stores, and food

stores.   Petitioner sells both food and nonfood merchandise such

as prescription drugs, tobacco products, housewares, health and

beauty aids, and sundry merchandise for home and family use.

Petitioner maintains a substantial inventory for its various

retail grocery and drug stores throughout the nation.

     Prior to its acquisition of Lucky Stores, Inc. (Lucky

Stores), petitioner conducted its activities through American

Stores’ wholly owned subsidiaries:      American Super Stores, Inc.,
                               - 4 -

comprised of Acme Markets, Inc., Jewel Food Stores, Star Market

and Jewel OSCO; American Food and Drug, Inc., comprised of Skaggs

Alpha Beta and Buttrey Food-Drug; American Drug Stores, Inc., a

nationwide drug chain; and Alpha Beta Company (Alpha Beta).

During the 1989 tax year, American Stores also acquired and

commenced operations through Lucky Stores.   Lucky Stores operated

food stores in California, Arizona, Nevada, and Florida.

Acquisition of Lucky Stores

     In December 1987, the second and third largest grocery store

chains in the State of California, Vons and Safeway, merged.

American Stores determined that acquiring Lucky Stores would

complement Alpha Beta’s operations in California.   On March 21,

1988, American Stores initiated a hostile takeover bid or tender

offer for all the outstanding shares of Lucky Stores for $45 per

share (tender offer).   At the time of the tender offer, Alpha

Beta stores constituted California's fourth largest retail

grocery chain.   Alpha Beta operated 252 supermarkets in

California, 54 in northern California, and 198 in southern

California.   Lucky Stores operated 340 stores located throughout

California, and it was the largest grocery store chain in the

State of California.

      On May 23, 1988, American Stores amended its tender offer

increasing the offer to $65 for each Lucky Stores share.   This

increase in price was attributable, in part, to competing bids by
                               - 5 -

other companies interested in acquiring Lucky Stores.   On May 23,

1988, the board of directors for Lucky Stores approved the

amended tender offer and a merger proposal with American Stores.

FTC’S Actions

     On March 21, 1988, American Stores gave notice of its

intention to purchase all the stock of Lucky Stores to the

Federal Trade Commission (FTC), pursuant to the Hart-Scott-Rodino

Antitrust Improvements Act of 1976, Pub. L. 94-435, sec. 201, 90

Stat. 1390, codified at 15 U.S.C. sec. 18a (1997).   In response

to American Stores’ Hart-Scott-Rodino filing, the FTC conducted

an investigation of the proposed merger and worked to negotiate a

settlement with American Stores.

     The FTC and American Stores negotiated a preliminary

settlement of the FTC's concerns about the tender offer.    This

preliminary settlement was reflected in two simultaneous actions

taken by the FTC on May 31, 1988.   First, the FTC filed an

administrative complaint charging that American Stores’

acquisition of Lucky Stores violated section 7 of the Clayton

Act, ch. 323, 38 Stat. 731 (1914), as amended and codified at 15

U.S.C. sec. 18 and section 5 of the Federal Trade Commission Act,

ch. 311, 38 Stat. 719 (1914), as amended and codified at 15

U.S.C. sec. 45.   Second, the FTC filed a proposed consent order

(proposed consent order).   As part of the proposed consent order,

the tender offer was permitted to proceed subject to certain
                                 - 6 -

conditions.   The conditions were contained in an agreement titled

“Hold Separate Agreement” (hold separate agreement).    That

agreement required American Stores to:

         a. refrain from integrating the assets of American
     Stores and Lucky Stores until American Stores had
     divested itself of 24 of its 54 Alpha Beta supermarkets
     in Northern California;
         b. maintain separate books and records for the
     acquisition;
         c. prevent any waste or deterioration of Lucky
     Stores’ California operations;
         d. refrain from replacing the executives of Lucky
     Stores;
         e. maintain Lucky Stores as a viable competitor in
     California;
         f. refrain from selling or otherwise disposing of
     Lucky Stores’ California warehouses, distribution or
     manufacturing facilities, and retail grocery stores;
         g. preserve separate purchasing for Lucky Stores’
     retail grocery sales.

     Relying on the FTC’s proposed consent order of May 31, 1988,

American Stores proceeded with its tender offer to purchase 100

percent of Lucky Stores stock.    American Stores’ tender offer for

Lucky Stores stock was carried out by a wholly owned subsidiary

of Alpha Beta, Alpha Beta Acquisition Corp. (ABAC).    ABAC had

been formed solely for the purpose of acquiring the stock of

Lucky Stores.   On June 2, 1988, ABAC acquired more than 80

percent of the Lucky Stores common stock at $65 per share.     As

between ABAC and the former Lucky Stores shareholders, ABAC’s

acceptance and purchase of stock was final and irrevocable.

     Petitioner’s objective in acquiring Lucky Stores was to

achieve future long-term benefits from the merger of the Alpha
                                - 7 -

Beta chain of stores and Lucky Stores.   The long-term benefits

being sought were a greater market share in the California

grocery market, greater operating efficiencies in the combined

operations of the two chains, and the adoption of some of the

management/operating policies of Lucky Stores such as Lucky

Stores’ “everyday low pricing” policy.

     On June 9, 1988, ABAC was merged with and into Lucky Stores,

pursuant to short-form merger provisions of the Delaware General

Corporation Law.   As a result of the short-form merger, ABAC

disappeared and Lucky Stores became a wholly owned subsidiary of

Alpha Beta.   The total consideration paid by American Stores in

the tender offer and merger exceeded $2.5 billion.    For purposes

of State law, the merger was final and irrevocable.   After its

acquisition of Lucky Stores, American Stores complied with the

requirements of the hold separate agreement and did not integrate

the operations of Lucky Stores with the operations of Alpha Beta.

State of California’s Actions

     In April 1988, American Stores provided the State of

California with the filings it had made with the FTC pursuant to

section 7 of the Clayton Act.   Through that filing, American

Stores gave formal notice to the State of California of its

intentions to acquire all of the Lucky Stores stock and to merge

ABAC into Lucky Stores.
                               - 8 -

     The FTC allowed, in accordance with its regulations, a

comment period during which the public was invited to submit

comments on the proposed consent order.    The attorney general of

California submitted comments expressing concern that American

Stores’ acquisition of Lucky Stores would reduce competition in

the retail supermarket industry in California.

     The FTC entered a final consent order on August 31, 1988.

On September 1, 1988, the State of California filed suit against

American Stores, ABAC, and Lucky Stores in the United States

District Court for the Central District of California (District

Court).   The State of California claimed that the merger violated

Federal and State antitrust laws by decreasing competition in the

supermarket industry in California.    The State of California

requested various forms of relief, including rescinding the

merger transaction, a divestiture of Lucky Stores or,

alternatively, a permanent “hold separate agreement” like the one

that American Stores had entered into with the FTC.

     The District Court issued a temporary restraining order

against American Stores and Lucky Stores on September 29, 1988.

The order required the continuation of the hold separate

agreement and the maintenance of the status quo at American

Stores and its subsidiaries and Lucky Stores and its subsidiaries

until a hearing on the preliminary injunction could be held.     The

opinion of the District Court in this matter was published as
                                - 9 -

State of Cal. v. American Stores Co., 697 F. Supp. 1125 (C.D.

Cal. 1988).    American Stores appealed the decision of the

District Court.    The Court of Appeals for the Ninth Circuit

published its opinion in that appeal as State of Cal. v. American

Stores Co., 872 F.2d 837 (9th Cir. 1989).      The Court of Appeals

affirmed the District Court's finding that California had shown a

likelihood of success on the merits of the case and possible

irreparable harm.    The Court of Appeals, however, found that the

preliminary injunction ordered by the District Court was

tantamount to an indirect divestiture which was not a remedy

available to private plaintiffs under section 16 of the Clayton

Act.    The United States Supreme Court granted certiorari to the

State of California.    See California v. American Stores Co., 493

U.S. 916 (1989).    Prior to granting certiorari, Justice O’Connor

entered a stay continuing the District Court’s injunction pending

further review by the Supreme Court.    See California v. American

Stores Co., 495 U.S. 271, 278 (1990).

       The Supreme Court reversed the judgment of the Court of

Appeals for the Ninth Circuit and remanded the case for further

proceedings.    The Supreme Court held that divestiture is a form

of injunctive relief within the meaning of section 16 of the

Clayton Act and that the District Court had the authority to

divest the acquirer of any part of the acquirer’s ownership

interest in the acquired company.    See id.    The Supreme Court
                             - 10 -

answered the specific question before it stating:

     We are merely confronted with the naked question
     whether the District Court had the power to divest
     American of any part of its ownership interest in the
     acquired Lucky Stores, either by forbidding the
     exercise of the owner's normal right to integrate the
     operations of the two previously separate companies, or
     by requiring it to sell certain assets located in
     California. We hold that such a remedy is a form of
     “injunctive relief” within the meaning of section 16 of
     the Clayton Act. * * * [Id. at 296.]

The Supreme Court remanded the matter for further proceedings.

The Court of Appeals for the Ninth Circuit vacated part of its

earlier opinion and remanded the case to the District Court.

     The preliminary injunction obtained by the State of

California was modified on at least four occasions.   A

modification filed with the District Court on November 7, 1989,

permitted American Stores to integrate specified northern

California operations of Alpha Beta with specified northern

California operations of Lucky Stores following a stipulated

divestiture of specified Alpha Beta assets.   American Stores

ultimately settled the dispute with the attorney general of

California by entering into a stipulation for entry of consent

decree on May 16, 1990 (the California consent decree).    The

California consent decree did not require American Stores to

divest any of its Lucky Stores stock, and Lucky Stores remains a

wholly owned subsidiary of American Stores.   Instead, the

California consent decree required American Stores to dispose of

approximately 152 of its 175 southern California Alpha Beta
                              - 11 -

Stores and 9 of its newly acquired southern California Lucky

Stores, together with most of the related Alpha Beta support

facilities.   The California consent decree did not require

petitioner to divest any supermarkets in northern California or

Nevada beyond those specified in the November 7, 1989,

modification.

     On June 17, 1991, pursuant to the California consent decree,

American Stores sold its stock in Alpha Beta Company for

approximately $251 million to Food-4-Less Supermarkets, Inc.   At

the time of the sale, the assets of Alpha Beta included 145

stores located in southern California.    The attorney general of

California and the District Court approved this transaction as

fulfilling the requirements of the settlement agreement and the

California consent decree.

     From June 2, 1988, and continuing throughout the course of

antitrust litigation with California, Lucky Stores was a member

of American Stores’ consolidated group.   As such, American Stores

included Lucky Stores in its consolidated financial statements

and consolidated Federal income tax returns.   Lucky Stores

accounted for $3,697,086,836 of the total American Stores’

affiliated group gross revenue of $19,096,763,598 for the 1989

tax year (Lucky Stores was only a member of American Stores’

consolidated group during the 1989 tax year for the period from

June 2, 1988 to January 28, 1989) and $6,281,249,713 of the total
                               - 12 -

American Stores’ affiliated group gross revenue of

$22,450,415,818 for the 1990 tax year.

       In the 1989 tax year return, petitioner did not claim an

ordinary and necessary business expense deduction for the legal

fees attributable to the FTC proceeding involving the acquisition

of Lucky Stores.    Petitioner incurred approximately $2.6 million

in such legal fees in the 1989 tax year.    Petitioner also did not

deduct investment banking fees incurred in the acquisition of

Lucky Stores stock.    Instead, petitioner capitalized all of these

expenditures as costs incurred in the process of acquiring Lucky

Stores.

       From June of 1988 until the end of the 1989 tax year,

American Stores’ subsidiary, Lucky Stores, paid $1,074,867 in

legal fees to defend against the claims of the attorney general

of California for violations of Federal and State antitrust laws

arising from the acquisition of Lucky Stores.    American Stores

charged these legal fees to account No. 650800/7025, Lucky

Acquisition, and moved these expenses to American Food and Drug,

Inc.    In the financial books and records of American Food and

Drug, Inc., for the 1989 tax year, American Stores capitalized

the $1,074,867 for legal fees associated with the antitrust

litigation with the attorney general of California.    Petitioner’s

accountants prepared a journal entry for these legal fees.
                              - 13 -

     On its consolidated corporation income tax return for the

1989 tax year, petitioner reported on Schedule M-1 a deduction

for “LEGAL AND RELATED EXPENSES IN CONNECTION WITH: CA ATTORNEY

GENERAL LITIGATION” in the amount of $1,074,867.   This deduction

is found on the tax return Schedules M-1 and M-2 at the second

page of Statement 429 of the 1989 return.   The 1989 tax return

includes this amount as a Form-1120, U.S. Corporation Income Tax

Return, line-26 deduction as detailed on Statement 82 of the

return.

     During the 1990 tax year, American Stores’ subsidiary, Lucky

Stores, paid $2,666,045 for legal fees associated with the

antitrust litigation with the attorney general of California.

American Stores charged these legal fees to account No.

650800/7025, Lucky Acquisition, and moved these expenses to Alpha

Beta.   American Stores capitalized the $2,666,045 for legal fees

on the financial books and records of Alpha Beta for the 1990 tax

year.   Petitioner’s accountants prepared documentation for these

legal fees.

     On petitioner’s corporation income tax return for the 1990

tax year, petitioners claimed a deduction for “LEGAL FEES - CA

ATTORNEY GENERAL LITIGATION” in the amount of $2,666,045.    The

1990 return includes this amount as a Form-1120, line-26

deduction.
                               - 14 -

     During the 1990 tax year, American Stores’ subsidiary, Lucky

Stores, paid $175,630 for legal fees associated with the

antitrust litigation with the attorney general of California.      Of

the $175,630, Lucky Stores paid $95,355 to the law firm of

Sonnenschein, Carlin, Nath for legal work on the antitrust case

and paid $80,275 for other expenses related to the antitrust

case.

     On petitioner’s corporation income tax return for the 1990

tax year, petitioner claimed a deduction on Form 1120, line 26

for various items including “Litigation Expenses” of $10,706,713.

American Stores included the $175,630 for legal fees and costs

identified above in the “Litigation Expenses”.

     For financial reporting purposes, American Stores was

required to account for its acquisition of Lucky Stores using the

“purchase accounting” method pursuant to Accounting Practices

Board Opinion No. 16 (“APB 16").   Under this method, American

Stores’ acquisition was treated as an acquisition of Lucky

Stores’ assets.   Lucky Stores’ liabilities were treated as if

they were assumed by American Stores in this hypothetical asset

acquisition.1   Under the purchase accounting method, petitioner

was required to identify and quantify all of Lucky Stores’



     1
      On Mar. 13, 1989, American Stores filed a Form 8023,
Corporate Qualified Stock Purchase Elections, related to the
acquisition by American Stores of Lucky Stores and related
entities in the Lucky Stores affiliated group.
                              - 15 -

liabilities, including liabilities for current and pending

litigation.   The legal fees associated with Lucky Stores’ current

and pending litigation were required to be capitalized under the

purchase accounting method because they were considered

liabilities that American Stores assumed in the hypothetical

asset purchase, and as such, the legal fees and other liabilities

were treated as additional consideration that American Stores

paid for Lucky Stores’ assets.   In addition to the legal fees

related to the State of California’s antitrust suit, petitioner

also capitalized under the purchase accounting method more than

$1 million of Lucky Stores’ legal fees incurred in connection

with employment discrimination suits, torts, and other

litigation.   Although petitioner capitalized these legal expenses

for financial accounting purposes under the purchase accounting

method, petitioner claimed them as ordinary and necessary

business expenses on its consolidated Federal income tax returns

for the 1989 and 1990 tax years.   With the exception of the legal

fees incurred in connection with the State of California's

antitrust suit, respondent allowed petitioner to deduct for

Federal income tax purposes the legal fees related to Lucky

Stores that petitioner had capitalized under the purchase

accounting method for financial reporting purposes.

     In the notice of deficiency, respondent disallowed legal

fees incurred by petitioner in defending against the State of
                               - 16 -

California’s antitrust suit.   Respondent disallowed $1,074,867 of

deductions for legal fees claimed for the 1989 tax year and

disallowed separate deductions of $2,666,045 and $175,630 for

legal fees claimed for the 1990 tax year.

                             Discussion

     The issue for decision is whether legal fees incurred in

connection with the State of California’s antitrust litigation

are deductible as ordinary and necessary business expenses under

section 162.2   Respondent determined that the legal fees must be

capitalized pursuant to section 263(a).    Petitioner argues that

the legal fees were postacquisition expenditures incurred in

defending its business operations.

     Income tax deductions are a matter of legislative grace, and

the burden of clearly showing the right to the claimed deduction

is on the taxpayer.   See Rule 142(a); INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 84 (1992).     Moreover, deductions are

strictly construed and allowed only “as there is clear provision

therefor.”   INDOPCO, Inc. v. Commissioner, supra at 84 (quoting

New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934)).

     The principal difference between a deduction and an item

that must be capitalized and amortized is the timing of the

recovery of the expenditure.   The Supreme Court in INDOPCO, Inc.


     2
      Unless otherwise indicated, section references are to the
Internal Revenue Code applicable to the subject years, and Rule
references are to the Tax Court Rules of Practice and Procedure.
                              - 17 -

v. Commissioner, supra at 83-84, explained:

     The primary effect of characterizing a payment as
     either a business expense or a capital expenditure
     concerns the timing of the taxpayer's cost recovery:
     While business expenses are currently deductible, a
     capital expenditure usually is amortized and
     depreciated over the life of the relevant asset, or,
     where no specific asset or useful life can be
     ascertained, is deducted upon dissolution of the
     enterprise. * * * Through provisions such as these, the
     Code endeavors to match expenses with the revenues of
     the taxable period to which they are properly
     attributable, thereby resulting in a more accurate
     calculation of net income for tax purposes. * * *

     To qualify as an allowable deduction under section 162(a),

an item must (1) be paid or incurred during the taxable year, (2)

be for carrying on any trade or business, (3) be an expense, (4)

be a necessary expense, and (5) be an ordinary expense.

Commissioner v. Lincoln Sav. & Loan Association, 403 U.S. 345,

352 (1971).   Respondent argues that the legal fees were neither

“ordinary” nor “for carrying on any trade or business” but were

expenditures associated with the acquisition of a capital asset.

      In one sense, the term “ordinary” in section 162 prevents

the deduction of expenses that are not normally incurred in the

type of business in which the taxpayer is engaged (“ordinary” in

the sense of “normal, usual, or customary” in a taxpayer’s trade

or business).   Deputy v. Du Pont, 308 U.S. 488, 495 (1940). More

importantly, the term “ordinary” serves as a means to “clarify

the distinction, often difficult, between those expenses that are

currently deductible and those that are in the nature of capital
                               - 18 -

expenditures, which, if deductible at all, must be amortized over

the useful life of the asset.”    Commissioner v. Tellier, 383 U.S.

687, 689-690 (1966).

     Expenses incurred in defending a business and its policies

from attack are generally ordinary and necessary--and deductible-

-business expenses.    See, e.g., Commissioner v. Heininger, 320

U.S. 467 (1943) (a dentist's mail order business faced ruin when

the Postmaster General deprived him of access to the mails; the

Supreme Court held that his legal fees, incurred in litigating

the propriety of the Postmaster General’s order, were properly

deductible as ordinary and necessary business expenses);

Commissioner v. Tellier, supra (holding that the taxpayer’s legal

costs “incurred in his defense against charges of past criminal

conduct” arising out of his business activities were deductible

under section 162).    On the other hand, no current deduction is

allowed for a capital expenditure.      See sec. 263(a);   INDOPCO,

Inc. v. Commissioner, supra at 83.

     A particular cost, no matter what its type, may be

deductible in one context but may be required to be capitalized

in another context.    Simply because other cases have allowed a

current deduction for similar expenses in different contexts does

not require the same result here.    For example, in Commissioner

v. Idaho Power Co., 418 U.S. 1, 13 (1974), the Supreme Court made

the following observation about wages paid by a taxpayer in its
                              - 19 -

trade or business:

     Of course, reasonable wages paid in the carrying on of
     a trade or business qualify as a deduction from gross
     income. * * * But when wages are paid in connection
     with the construction or acquisition of a capital
     asset, they must be capitalized and are then entitled
     to be amortized over the life of the capital asset so
     acquired. * * *

Petitioner’s reliance on El Paso Co. v. United States, 694 F.2d

703 (Fed. Cir. 1982), and E.I. du Pont de Nemours & Co. v. United

States, 432 F.2d 1052 (3d Cir. 1970), to support the proposition

that expenses incurred in an antitrust defense are always

deductible is misplaced.   As previously indicated, expenditures

which otherwise might qualify as currently deductible, must be

capitalized if they are incurred “in connection with” the

acquisition of a capital asset.   Commissioner v. Idaho Power Co.,

supra at 13.   As stated in Ellis Banking Corp. v. Commissioner,

688 F.2d 1376, 1379 (11th Cir. 1982):

     The requirement that costs be capitalized extends
     beyond the price payable to the seller to include any
     costs incurred by the buyer in connection with the
     purchase, such as appraisals of the property or the
     costs of meeting any conditions of the sale. See,
     e.g., Woodward v. Commissioner, 1970, 397 U.S. 572, 90
     S.Ct. 1302, 25 L.Ed.2d 577; United States v. Hilton
     Hotels Corp., 1970, 397 U.S. 580, 90 S.Ct. 1307, 25
     L.Ed.2d 585. Further, the Code provides that the
     requirement of capitalization takes precedence over the
     allowance of deductions. §§ 161, 261; see generally
     Commissioner v. Idaha Power Co., 1974, 418 U.S. 1, 94
     S.Ct. 2757, 41 L.Ed.2d 535. Thus an expenditure that
     would ordinarily be a deductible expense must
     nonetheless be capitalized if it is incurred in
     connection with the acquisition of a capital asset.6
     The function of these rules is to achieve an accurate
     measure of net income for the year by matching outlays
                              - 20 -

     with the revenues attributable to them and recognizing
     both during the same taxable year. When an outlay is
     connected to the acquisition of an asset with an
     extended life, it would understate current net income
     to deduct the outlay immediately.   * * *
          6
           We do not use the term “capital asset” in the
     restricted sense of section 1221. Instead, we use the
     term in the accounting sense, to refer to any asset
     with a useful life extending beyond one year.

     Distinguishing between expenses that can be deducted under

section 162 and those that must be capitalized under section 263

is not always an easy task.   As the Supreme Court has noted, “the

cases sometimes appear difficult to harmonize,” and “each case

‘turns on its special facts.’”   INDOPCO, Inc. v. Commissioner,

supra at 86 (quoting Deputy v. Du Pont, supra at 496).   After

considering all the facts and circumstances, we must determine

whether the costs incurred in defending the State of California’s

antitrust litigation are better viewed as costs associated with

defending a business or as costs associated with facilitating a

capital transaction.   See Woodward v. Commissioner, 397 U.S. 572

(1970).

     In Woodward, the Supreme Court rejected a subjective

“primary purpose” test in favor of the objective “origin of the

claim” test used in United States v. Gilmore, 372 U.S. 39 (1963).

Under the origin of the claim test, the nature of the transaction

out of which the expenditure in controversy arose governs whether

the item is a deductible expense or a capital expenditure,

regardless of the motives of the payor making the payment.    See
                                - 21 -

Woodward v. Commissioner, supra at 578.    In determining whether

legal fees paid for business advice and counsel are capital, we

look to the nature of the services performed by the adviser

rather than the designation or treatment by the taxpayer.    See

Honodel v. Commissioner, 76 T.C. 351, 365 (1981), affd. 722 F.2d

1462 (9th Cir. 1984); Cagle v. Commissioner, 63 T.C. 86, 96

(1974), affd. 539 F.2d 409 (5th Cir. 1976).   Our inquiry focuses

on whether the services were performed in the process of

defending the business or whether the services were performed in

the process of effecting a change in corporate structure for the

benefit of future operations.    See INDOPCO, Inc. v. Commissioner,

503 U.S. at 89.

     In United States v. Hilton Hotels Corp., 397 U.S. 580

(1970), the Supreme Court held that litigation expenses incurred

to determine the price of stock, whose title had already passed

to the acquiring corporation under State law, were costs that

arose out of the acquisition process itself and therefore capital

and nondeductible.   In Norwest Corp. & Subs. v. Commissioner, 112

T.C. 89 (1999), this Court analyzed a similar question by asking

whether the expenses were sufficiently related to the acquisition

process and essential to the achievement of the long-term

benefits of the acquisition.     See id. at 102.   In applying the

origin of the claim test, courts look beyond the formal

characterization of the claim.    See Clark Oil & Refining Corp. v.
                             - 22 -

United States, 473 F.2d 1217 (7th Cir. 1973).   All the

circumstances surrounding the claim must be considered.   See id.

at 1220.3

     The District Court described the State of California’s

antitrust complaint in the following terms:

     The State requests a preliminary injunction “preventing
     and restraining [Alpha Beta and Lucky], and all persons
     acting on their behalf, from taking any action, either
     directly or indirectly, in furtherance of the proposed
     acquisition of Lucky, and requiring Alpha Beta to hold
     and operate separately all of Lucky’s California assets
     and businesses pending final adjudication of the merits
     of this action; and ... such injunctive relief,
     including recission ... as is necessary and appropriate
     to prevent the effect of the unlawful activities
     alleged.” Complaint at 14. Furthermore, the State
     seeks to “permanently enjoin [Alpha Beta and Lucky]
     from carrying out any agreement, understanding, or
     plan, the effect of which would be to combine the
     supermarket business of [Alpha Beta] and Lucky.” * * *
     [State of Cal. v. American Stores Co., 697 F. Supp.
     1125, 1133 (C.D. Cal. 1988).]

The Supreme Court described the complaint in the following terms:

     The State sued, claiming that the merger violates the
     federal antitrust laws and will harm consumers in 62
     California cities. The complaint prayed for a
     preliminary injunction requiring American to operate
     the acquired stores separately until the case is
     decided, and then to divest itself of all of the
     acquired assets located in California. * * *
     [California v. American Stores Co., 495 U.S. 271, 274
     (1990).]


     3
      In Brown v. United States, 526 F.2d 135, 139 (6th Cir.
1975), legal expenses paid in settlement of a derivative action
were held to be nondeductible capital expenditures. The court
found that the origin of the derivative claim was the taxpayer’s
efforts to acquire the shareholder’s stock. The court stated
that although conserving the stock’s value was the immediate
purpose of the derivative action, the test of deductibility
relates to the origin rather than the purpose.
                                 - 23 -


The Supreme Court held: “the District Court had the power to

divest American of any part of its ownership interests in the

acquired Lucky Stores, either by forbidding the exercise of the

owner’s normal right to integrate the operations of the two

previously separate companies, or by requiring it to sell certain

assets located in California” under section 16 of the Clayton

Act.    Id. at 296.

       The claim of the State of California that gave rise to

petitioner’s legal fees was an alleged violation of section 7 of

the Clayton Act.      That section prohibits the acquisition of stock

or assets in another company if “the effect of such acquisition

may be substantially to lessen competition, or tend to create a

monopoly.”    15 U.S.C. sec. 18.   The antitrust claim in the

instant case involved American Stores’ right to acquire Lucky

Stores.    The legal fees incurred in the antitrust action arose

out of, and were incurred in connection with, petitioner’s

acquisition of Lucky Stores.

       Petitioner places great emphasis on the fact that legal

title to all the Lucky Stores shares had passed before the

antitrust litigation was commenced.       In United States v. Hilton

Hotels Corp., supra at 584, the Supreme Court noted that the

prior passage of title in the underlying stock acquisition in

question was “a distinction without a difference” in deciding

whether costs of litigation arose out of the process of
                               - 24 -

acquisition.   This Court reached a similar result in Berry

Petroleum Co. & Subs. v. Commissioner, 104 T.C. 584, 622 (1995),

affd. without published opinion 142 F.3d 442 (9th Cir. 1998).

     At the time the antitrust legal fees were being incurred,

the Supreme Court described the status of the “merger” involved

in this case in the following terms:    “Thus, as a matter of legal

form American and Lucky were merged into a single corporate

entity on June 9, 1988, but as a matter of practical fact their

business operations have not yet been combined.”    California v.

American Stores Co., 495 U.S. at 276.    On this same point, the

District Court noted:

     If the Hold Separate Agreement has meaning, this is not
     a completed merger. Alpha Beta and Lucky, pursuant to
     the Hold Separate Agreement, are performing numerous
     functions as separate entities. They retain their
     separate names and with them their respective corporate
     identities. While defendants maintain that it is
     “verbal calisthenics” to issue injunctive relief to
     stop a merger contending that such is tantamount to
     divestiture, they, nevertheless, ask the Court to
     perform a linguistic triathalon to understand how a
     Hold Separate Agreement is equivalent to a completed
     merger. The Court is unable to make such a leap in
     reasoning. [State of Cal. v. American Stores Co., 697
     F. Supp. at 1134; fn. ref. omitted.]

     When the legal fees were incurred, the substance of the

merger was not complete, despite the passage of title in the

Lucky Stores shares.    The hold separate agreement and the

subsequent injunction issued by the District Court preserved the

status quo that existed prior to the Lucky Stores acquisition by

preventing the integration of the two supermarket chains in order
                              - 25 -

to protect the California consumers from anticompetitive

behavior.   Until the injunction was lifted, American Stores faced

the possibility of divestiture.   Petitioner’s objective in

acquiring Lucky Stores was to achieve future long-term benefits

from the merger of the Alpha Beta chain of stores and Lucky

Stores.   These benefits could not be realized if the State of

California’s antitrust suit was successful.   Although petitioner

became the owner of Lucky Stores, it was unable to realize the

long-term benefits being sought until the antitrust suit was

resolved.

     The origin of the State of California’s antitrust suit was

American Stores’ acquisition of Lucky Stores.   The expenditure of

funds to defend against the antitrust litigation conferred long-

term benefits on American Stores.   American Stores was not

defending an existing business structure from attack; rather it

was attempting to establish its right to create such a structure.

These benefits are comparable to the benefits that were required

to be capitalized in INDOPCO, Inc. v. Commissioner, 503 U.S. 79

(1992).

     We hold that petitioner is not entitled to deduct the legal

fees it incurred in contesting the State of California’s

antitrust suit.



                                         Decision will be

                                    entered under Rule 155.
