                                    United States Court of Appeals,

                                              Fifth Circuit.

                                              No. 92-1005.

                              In the Matter of PLACID OIL CO., Debtor.

                                 PLACID OIL COMPANY, Appellant,

                                                    v.

                             INTERNAL REVENUE SERVICE, Appellee.

                                             April 15, 1993.

Appeal from the United States District Court for the Northern District of Texas.

Before REYNALDO G. GARZA and GARWOOD, Circuit Judges, and ROSENTHAL, District
Judge.**

          ROSENTHAL, Distct Judge:

          Placid Oil Company ("Placid") appeals from decisions of the United States Bankruptcy Court

for the Northern District of Texas and United States District Court for the Northern District of Texas,

raising two issues:

          (1) whether the courts below erred in holding that Placid could not deduct the legal and

accounting fees it incurred for ordinary and necessary business operations during the bankruptcy

because Placid failed to prove the amount of the fees with sufficient specificity; and

          (2) whether the courts below erred in holding that Placid must capitalize all professional fees

and expenses incurred in connection with the bankruptcy without analyzing the underlying

transactions to determine whether the fees and expenses were currently deductible or amortizable

over the term of the underlying transaction or activity.

          For the reasons stated below, this court REVERSES the courts below and REMANDS this

case for further proceedings consistent with this opinion.

                                               Background

          Placid operates oil and gas interests both domestically and abroad. In 1983, Placid and certain


   *
       District Judge of the Southern District of Texas, sitting by designation.
wholly-owned subsidiaries borrowed approximately $1 billion. In 1985, Placid began attempting to

restructure these loans. A year later, Placid filed two lawsuits seeking to restructure its debt. In

August 1986, the lending banks began foreclosure proceedings against Placid. On August 29, 1986,

Placid filed suit under Chapter 11 of the Bankruptcy Code to protect its assets from foreclosure by

restructuring its bank debt.

       Placid emerged from bankruptcy in mid-1988. The Bankruptcy Court confirmed Placid's plan

of reorganization on September 30, 1988. In connection with the confirmation, Placid's lawyers and

accountants submitted detailed fee applications to the Bankruptcy Court, which included billing

statements and descriptions of the professional services rendered. The Bankruptcy Court approved

the payment of over $7 million in professional fees and expenses that Placid incurred during 1986 and

1987. Placid in turn deducted these fees and expenses on its tax returns. Some were for

bankruptcy-related matters; many were for matters unrelated to the bankruptcy.

       In mid-1988, Placid filed a motion in the Bankruptcy Court to determine its 1986 and 1987

federal income tax liability under 11 U.S.C. § 505. In December 1988, the IRS filed administrative

claims for federal income taxes that Placid allegedly owed for 1986 and 1987. The IRS administrative

claim focused on two issues, only one of which is now before this court: whether Placid could deduct

certain professional fees and expenses paid in 1986 and 1987.

       On May 3, 1989, Placid filed its initial brief before the Bankruptcy Court on the issue of its

right to deduct professional fees and expenses. The Bankruptcy Court heard argument in March

1990, and on May 15, 1990, issued its Second Revised Memorandum and Opinion. The Bankruptcy

Court ruled that Placid was not entitled to any deductions for bankruptcy-related or for ordinary and

necessary professional fees and expenses rendered during the bankruptcy proceedings.

       The Bankruptcy Court opinion held that Placid failed to satisfy its initial burden of production

to rebut the IRS' prima facie case. The Bankruptcy Court stated as follows:

       Placid has not provided the Court with enough information to categorize the fees and
       expenses of the debtor's professionals. Specifically, Placid has not properly defined categories
       of reorganization expenses versus ordinary expenses.... Placid has failed to meet its burden
       of production because it has not provided the Court with enough data indicative of Placid's
       proper segregation of bankrupt cy-related capital expenses from the ordinary business
       expenses.
In re: Placid Oil Co., 140 B.R. 122, 129 (Bankr.N.D.Tex.1990). The United States District Court

for the Northern District of Texas summarily affirmed the Bankruptcy Court's ruling that Placid did

not satisfy its "burden of proving the professional fees were deductible current expenses." In re:

Placid Oil Co., 148 B.R. 464, 464 (N.D.Tex.1991).

       On this appeal, t he IRS admits that the effect of the ruling below is to disallow some

deductible professional fees and expenses. However, the IRS seeks to uphold the rulings as to the

bankruptcy-related and non-bankruptcy-related fees and expenses on the ground that Placid did not

present sufficiently specific evidence as to the amounts of the deductions.

                                         Burden of Proof

       The Bankruptcy Court, the District Court, and Placid all agree on the applicable burden of

proof for the claim objection in the Bankruptcy Court. Once the IRS filed its proof of claim, it

created a prima facie case as to the validity and amount of the claim. Placid then had the burden to

produce sufficient evidence that its professional fees and expenses qualified for ordinary and

necessary business expense deductions to rebut the prima facie case. If Placid produced such

evidence, the burden would shift back to the IRS to show by a preponderance of the evidence that

Placid's professional fees and expenses were not deductible. The IRS had the ultimate burden of

proof. In Re: Fidelity Holding Co., Ltd., 837 F.2d 696, 698 (5th Cir.1988).

       The IRS agreed with Placid and with the courts below that Placid was entitled to deduct

professional fees and expenses that Placid would have incurred regardless of the bankruptcy. The

issue is whether Placid met its burden of producing sufficient evidence as to such fees and expenses

to rebut the IRS' prima facie case. If so, the IRS "must produce additional evidence to prove "the

validity of the claim by a preponderance of the evidence.' " In Re: Fidelity Holding Co., Ltd., 837

F.2d at 698. Once both parties have presented such evidence, the issue is then whether the fees and

expenses were currently deductible as an "ordinary and necessary expense"; amortizable as an

expense relating to an underlying transaction or occurrence with a useful life over which the fee or

expense can be spread; or allocated to basis as a fee or expense that relates to a transaction or

occurrence which has no useful life. See, generally, Mertens Law of Federal Income Taxation, §§
25.35-.37; 25.45-.47; 25.56-.58 (1990).

                                        Standard of Review

        Courts of appeal set aside a bankruptcy court's factual findings when such findings are clearly

erroneous; however, courts of appeal apply a de novo review to a bankruptcy court's legal

conclusions. In the Matter of Luce, 960 F.2d 1277, 1280 (5th Cir.1992); In the Matter of Nicholas,

956 F.2d 110, 111 (5th Cir.1992). In deciding whether a lower court erred in determining that a

party failed to satisfy its burden of proof, a reviewing court applies the clearly erroneous standard.

Bartmess v. Federal Crop Ins. Corp, 845 F.2d 1258, 1261 (5th Cir.1988); McDaniel v. Temple

Indep. School Dist., 770 F.2d 1340, 1346-47 (5th Cir.1985); Tulia Feedlot, Inc. v. United States,

513 F.2d 800, 806-07 (5th Cir.), cert. denied, 423 U.S. 947, 96 S.Ct. 362, 46 L.Ed.2d 281 (1975).

A reviewing court may set aside a lower court's finding when the reviewing court has a " "firm and

definite conviction that a mistake has been committed.' " McDaniel, 770 F.2d at 1347 (quoting Oil,

Chemical and Atomic Workers Int'l Union v. Ethyl Corp., 703 F.2d 933, 935 (5th Cir.1983));

Bartmess, 845 F.2d at 1261; Tulia Feedlot, 513 F.2d at 806-07.

                    Placid's Evidence as to its Professional Fees and Expenses

         Placid provided the Bankruptcy Court with different kinds of evidence as to the

bankruptcy-related and nonbankruptcy fees and expenses it paid its lawyers and accountants. The

Bankruptcy Court had the fee applications themselves, with detailed descriptions of the nature of the

services performed and the corresponding fee amounts. Placid took the fees and expenses of its

primary outside law firm, two other law firms, and two accounting firms, and allocated those into

three categories: substantive bankruptcy-related fees and expenses; procedural bankruptcy-related

fees and expenses; and "claims, operations, etc.," which encompassed ordinary business transactions

and ongoing business operations.

       Placid admits that it cannot establish the precise amounts of all the nonbankruptcy professional

fees and expenses it sought to deduct. However, many of the professional billings are broken down

by specific matters, such as the defense of cases in which Placid had been sued. As to these matters,

there appears to be little question as to the amounts or the nature of the underlying transaction or
event. Other professional billings for fees and expenses are not broken down into specific items.

Placid's allocations estimated the amounts of fees and expenses attributable to these matters. Placid

also provided supporting evidence as to the amounts and as to the nature of the underlying

transactions in the fee applications that the Bankruptcy Court had already considered and approved.

          This court holds that Placid did provide enough information to meet its burden and shift the

final burden of disallowing the claimed deductions to the IRS. The Bankruptcy Court should have

considered the evidence as to the existence and amounts of the professional fees and expenses at

issue. The evidence was sufficient to meet the IRS' prima facie case of nondeductibility and shift

back to the IRS the burden of proving that the nonbankruptcy fees and expenses be disallowed. In

particular, the three-part chart broke down the professional fees and expenses into categories that are

capable of being allocated among currently deductible expenses, amortizable capital expenses, and

expenses that must be allocated to basis.** See, e.g., Record Vol. 2, Exs. 2-5, pp. 50-57.

   **
        These categories are:

                  1. Bankruptcy Reorganization

                         a. Preparation of the Plan

                         b. Participation in hearings on the Plan

                         c. Participation in Confirmation of the Plan

                         d. Defense against Motion to Strike the Plan

                         e. Analysis of Adequate Protection

                         f. Substantive Consolidation of Subsidiaries

                         g. Equitable recast

                  2. Bankruptcy Proceedings

                         a. Preparation of Disclosure Statement and Schedules

                         b. Executory Contracts—acceptance or rejection

                         c. Employment and payment of consultants, attorneys, accountants, etc.

                         d. Court Procedures not related to claims

                                                                                        (continued...)
           The Supreme Court recently reiterated that the " "decisive distinctions' between current

expenses and capital expenditures are "those of degree and not of kind' " and that each case must be

decided according to its specific facts. Indopco, Inc. v. Commissioner of Internal Revenue, --- U.S.

----, ----, 112 S.Ct. 1039, 1044, 117 L.Ed.2d 226 (1992). In deciding whether a particular fee or

expense should be considered deductible, the Bankruptcy Court should consider a mix of factors,

including (1) the nature of the fee or expense; (2) the relationship between the fee or expense and

the reorganization; (3) the person or entity who incurred the expense; (4) the form and structure of

the particular transaction; (5) whether the transaction was actually consummated; and (6) the ability

of the taxpayer to identify with reasonable exactitude the functional steps of the reorganization to

which the fees and expenses relate. Boris I. Bittker & James S. Eustice, Federal Income Taxation

of Corporations and Shareholders, ¶ 5.06, 5-34 (5th ed. 1987); see, e.g., Woodward v. Commissioner

of Internal Revenue, 397 U.S. 572, 575-79, 90 S.Ct. 1302, 1305-07, 25 L.Ed.2d 577 (1970)

(examining nature of the claim and relationship of the expenses to the transaction); United States v.

Hilton Hotels Corporation, 397 U.S. 580, 583-85, 90 S.Ct. 1307, 1309-10, 25 L.Ed.2d 585 (1970).

           The Bankruptcy Court concluded that all Placid's professional fees and expenses incurred

during bankruptcy were to be capitalized to an intangible asset, without the benefit of amortization.


   **
        (...continued)
                         e. Exclusivity period

                  3. Claims, Operations, Etc.

                         a. Communications with creditors

                         b. Accounts reconciliation

                         c. Billings, except fee applications

                         d. Enforcement of Placid Claims

                         e. Defense of Claims against Placid

                         f. Cash Collateral

                         g. Sale of Assets

                         h. Ongoing business operations
The Bankruptcy Court reached this conclusion in part by finding that certain fees and expenses were

capital expenses, but then ruling that these expenses could not be segregated from nondeductible fees

and expenses.     On remand, the Bankruptcy Court should not bind itself by a sweeping

characterization that Placid's bankruptcy proceedings were "in substance" a "reorganization," with

the result that all Placid's bankruptcy-related fees and expenses must be capitalized to an intangible

asset without amortization. I.R.C. § 368. On remand, the Bankruptcy Court should analyze all the

fees and expenses to identify them as: 1) currently deductible; 2) amortizable over the period of the

useful life of the underlying transaction or event; and 3) allocated to nonamortizable intangible assets.

See The Denver & Rio Grande Western Railroad Co. v. Commissioner of Internal Revenue, 32 T.C.

43, 51-52 (1959), aff'd, 279 F.2d 368 (10th Cir.1960); see also, Woodward, 397 U.S. at 575-79, 90

S.Ct. at 1304-07; Hilton Hotels, 397 U.S. at 583-85, 90 S.Ct. at 1308-09; Great Western Power

Co. of California v. Commissioner of Internal Revenue, 297 U.S. 543, 546-47, 56 S.Ct. 576, 577,

80 L.Ed. 853 (1936). For example, professional fees and expenses that are related to restructuring

a specific debt and therefore conferred a specific long-term benefit are to be capitalized with an

amortization period equivalent to the useful life of that underlying transaction. Included in the

Bankruptcy Court's task on remand is to distinguish between professional fees and expenses for

initiating and administering the bankruptcy proceedings, as opposed to those fees and expenses that

are directly related to a particular asset or debt transaction.

        Given the evidence Placid presented to the Bankruptcy Court, this court is left with the firm

conviction that the Bankruptcy Court erred in holding that Placid did not sustain its burden to rebut

the IRS's prima facie case. Because it was error to hold that Placid did not sustain its burden, this

court REVERSES and REMANDS. On remand, the Bankruptcy Court is ordered to reexamine the

record to segregate among currently deductible, amortizable, and nonamortizable professional fees

and expenses for the 1986 and 1987 tax returns. If necessary, the Bankruptcy Court should allow

the parties an opportunity to supplement the record to provide a more detailed categorization of fees

and expenses, as outlined above.

        REVERSED AND REMANDED.
