Petition — Greenberg v. Commissioner

Supreme Court brief1976

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IN THE

Supreme Court of the United States

OcroBerR TERM, 1975

No. 75-617 i

RAYMOND GREENBERG AND MARILYN GREENBERG,

Petitioners,

Vv.

COMMISSIONER OF INTERNAL REVENUE, Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS FOR

THE FOURTH CIRCUIT

WERNER STRUPP

3301 New Mexico Avenue, N.W.

Washington, D. C., 20016

Attorney for Petitoners

October 1975

Passes or Braon S. ADAMs Paintine, INc., WasHinoton, D. C.

INDEX

Page

CrtaTION TO OPINIONS BELOW .......seee ree eeeeeees 1

JURISDICTION 2... ccc cece cer ecc rec cersceeeseesseeees 2

QUESTIONS PRESENTED .....05seseseeeeerereeeeeeeres 2

STATUTES INVOLVED .....ceceeeeeceer en eeeeeeeeneees 2

SITATEMENT oc cc cccccccccccccccecesceccseveseeeess 2

Reasons ror GRANTING THE WRIT .....--0e sere eee 7

CONCLUSION ..ccccccccccccccscccescceccvesssescees 18

Appenpix A—StTatuTes INVOLVED .....600 sees eeeees la

B—Oprnions anp Jupoment BELow ....... 3a

CITATIONS

Cases:

Aldon Homes, 33 T.C. 582 (1959) ......eeeeeeeees 12,13

BéM Co. v. US., (5th Cir. 1971), 452 F. 94 986.... 15

Gould v. Gould, 245 U.S. 151, 38 S. Ct. 53 (1917) .... 15

Gregory v. Helvering, 293 U.S. 465, 55 S. Ct. 266, 799

L. Ed. 596 (1935) .....ceeeccceeveeceeeeeees 13, 14

Moline Properties v. Commissioner, 319 U.S. 436, 63

S. Ct. 1132, 87 L. Ed. 1499 (1942) ....-- ee ee eens 10

Walter L. Morgan, 33 T. C. 30 (1959), reversed on

other grounds (3rd Cir. 1961) 288 F. 2d 676.... 15

National Investors Corporation v. Hoey, (2nd Cir.

1944) 144 F. 2d 466, 467 «2... e eee eee eee eeees 11

Pacific Mills et al v. Kenefick, (1st Cir. 1938) 99 F.

OO DOD qc iccccccodecesusdsccccecesdsesccoress 17

Reineman v. U. S., (7th Cir. 1962), 301 F. 9a 267 .... 17

Shaw Construction Company, 35 T. C. 1102 (1961) .. 12,18

Southern Dredging Corp., 54 T. C. 709 (ERTS) coccces 12

U. §. v. Cumberland Service Co., 338 U.S. 451, 70 S.

Ct. 280, 94 L. Ed. 251 (1950) ....ceeeeeeeeeeens 15

U. S. v. Powell, 279 U. 8. 48, 85 S. Ct. 248 (1964) ..... 17

ii Table of Contents Continued

Page

STATUTES:

United States Code Title 28, Sect. 1254 (1) .......... 2

Internal Revenue Code (1954)

CEES ch evcccesccccdeceseednsesoseceaceeacens 13

OE 60.600 60e0besbindecbecsugececcsssasesaves 8, 14

REE cccccccecncesoecocsonssesevesecesees 2, 8,9, 14

BOE pscuvewentdiseecnadeseedhueess cedendetras 14

rrr rr rr ery rete 2,4,9

REE covccencdevensasncesesvcdenceécvacevens 14

BEE cccccsceceececdedsnscesssnecesssescducs 2

RTE ccccccécnenencccccesssacencesstecnesees 2

| | BIPPPPVPCTTTTTTIT ILLITE Le 2, 16,17

Internal Revenue Code (1939) :

CBRE) ccccccccccccccccecccsesscccccccccceoes 13

OTHER:

Senate Report to accompany H. R. 8863 (Revenue Act

of 1964); 88th Congress, 2nd Sess. U. 8. Code

Cong. & Adm. News, pp. 1823-24 ............005 14

A ET a

IN THE

Supreme Court of the United States

Ocroper TERM, 1975

No.

RAYMOND GREENBERG AND MARILYN GREENBERG,

Petitioners,

CoMMISSIONER OF INTERNAL REvENUF, Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS FOR

THE FOURTH CIRCUIT

Petitioners pray that a writ of certiorari issue. to

review the judgment of the United States Court of

Appeals for the Fourth Circuit, entered in the above-

entitled case on July 28, 1975.

CITATION TO OPINIONS BELOW

The findings of fact and opinion of the United

States Tax Court printed in Appendix B hereto, infra,

pp. 3a-33a are reported in 62 United States Tax Court

Reports at pages 331-351. The opinion of the Circuit

Court of Appeals, printed in Appendix B hereto,

infra, pp. 34a-35a is as yet unreported.

JURISDICTION

The judgment of the Circuit Court of Appeals was

entered on July 28, 1975. The jurisdiction of this

Court is invoked under 28 U.S.C. Section 1254(1).

QUESTIONS PRESENTED

1. When four corporations carrying out some sepa-

rate business activities are liquidated, and a fifth cor-

poration remains unliquidated, can the resulting dis-

tributions be lawfully treated as dividends rather than

capital gains? ,

2. Does a Tax Court subpoena, pursuant to which

an Internal Revenue agent acquires documents for tax-

able years that have previously been examined, violate

the provision of Section 7605 (b) of the Internal

Revenue Code, timiting the Commissiorer’s power to

examine a taxpayer’s records to one such examina-

tion for each taxable year?

STATUTES INVOLVED

The statutory provisions involved are Sections

331(a), 1202 and 7605(b), Title 26, United States

Code (Internal Revenue Code). These provisions are

printed in Appendix A, infra, pp. la-2a.

STATEMENT

The jurisdiction of the United States Tax Court

was invoked pursuant to Section 6213 of the Internal

Revenue Code; the jurisdiction of the Court of Ap-

peals to review the decision of the Tax Court is based

on Section 7482 of that Code.

This case arose from a proceeding in the Tax Court

which had sought redetermination of a deficiency as-

~—8 om owe

serted by the Commissioner of Internal Revenue

(hereinafter referred to as ‘‘Commissioner’’) with re-

spect to taxpayers’ Federal income tax returns for the

ealendar years 1966 and 1967. Following the filing of

the petition, answer and amended answer, trial was

held before the Honorable Irene F. Scott, Judge. A

pretrial hearing on taxpayers’ motion to quash sub-

poenas duces tecum was held by the trial judge and

resulted in an order which granted the motion in part

and denied it in part. Since the parties had agreed to

disposition of several of the adjustments in tax lia-

bilities initially raised in the pleadings, the Tax Court

was called upon to decide the sole question of whether

the corporate liquidations in 1966 resulted in ordinary

income or capital gain to the taxpayers. The Tax

Court resolved that issue in favor of the Commissioner

and entered its decision accordingly. The Court of Ap-

peals affirmed in a per curiam opinion.

The facts related to the transaction in dispute are

substantially undisputed. They show that as of May

20, 1966, taxpayer Raymond Greenberg (hereinafter

referred to as ‘‘Greenberg’’) owned one half of the

eapital stock of five corporations, known as Colt De-

velopment, Inc., Colt Builders, Inc., Colt Homes, Inc.,

Colt Properties, Inc. and Colt Contractors, Inc. Green-

berg also owned a 50% partnership interest in a part-

nership called Gerasi Associates from which the Colt

corporations had from time to time acquired land and

rented some of their equipment. The remaining capi-

tal stock in the Colt corporations and balance of part-

nership interest in Gerasi were owned by George Re-

vitz. Pursuant to an agreement dated May 20, 1966,

Revitz sold his one half interest in Gerasi to Green-

berg and Colt Development, Inc. also redeemed Re-

vitz’ stock interest in that corporation. Shortly there-

after, Greenberg and Revitz caused the other four

Colt corporations to adopt resolutions for their com-

plete liquidation whereby the assets of such corpora-

tions were to be distributed equally to Greenberg and

Revitz. The amount of distribution with respect to

each corporation appears in the findings of the Tax

Court. The total distribution of $213,994.53 was re-

ported on the taxpayers’ joint income tax return as a

capital gain. In accordance with that method of re-

porting these transactions, the taxpayers reduced that

total by $106,997.27 representing the deduction under

§ 1202 of the Internal Revenue Code applicable to dis-

position of capital assets owned for more than six

months, and included the balance in their gross in-

come for the taxable year 1966. The Commissioner

disallowed the § 1202 deduction holding the distribu-

tions to be reportable as ordinary income and the Tax

Court upheld that determination.

The evidence before the Tax Court consisted of testi-

mony and a large quantity of documents, the authen-

ticity of which was stipulated, but most of which were

admitted over the taxpayers’ objection.

The taxpayers’ direct testimony consisted of evi-

dence which showed that their accountant had been

served with a subpoena to appear at the trial of this

case and to produce numerous books and records. The

testimony further revealed that in substantial part

the records referred to had been previously examined

by the Internal Revenue Service. The accountant testi-

fied that he turned the books over to the Internal Reve-

nue Agent as a result of the subpoena and that he

did so at the direction of taxpayers’ counsel. The

agent himself testified that he had been assigned to

assist counsel for the Commissioner in this case and

that the purpose of the examination conducted by. him

was ‘‘to show that the five corporations are actually

one single operation.’’ Rebuttal testimony from Green-

berg showed that in connection with the subpoena

served on him, he made seven file cabinets of records

available to the agent and that some of these materials

extended back as far as 1958.

The evidence showed that the five Colt corporations

were organized in 1959 and 1960 by Greenberg, Re-

vitz and a third person who disposed of his stock

ownership in 1964. The various corporations at all rele-

vant times until May 1966, were engaged in the con-

struction of single family dwellings in Montgomery

County, Maryland. After the liquidation of four of

the corporations, Colt Development, Ine. continued

with these activities, but constructed a substantially

fewer number of houses than the five corporations had

done prior to that time.

The five corporations were initially formed by the

same three persons, one of whom was Greenberg. Their

corporate charters were identical and their bylaws

were essentially similar. In 1958, the same individuals

formed a partnership (Gerasi) which acquired the

land on which the Colt corporations built homes and

transferred the same to those corporations, as con-

struction progressed. Each of the five corporations en-

gaged in its own construction activities, although so-

called project costs were for the most part billed to

and paid by Colt Development, Inc. and thereafter

allocated among the other corporations. These alloca-

tions were based on the number of homes built by each

corporation in a given year. As the Tax Court noted,

actual construction costs, after building permits were

obtained and lots were transferred, were generally

paid by the individual corporations. The five corpora-

tions untilized common office personnel and accounting

procedures and incurred a number of expenses for

their common benefit. Among those were legal and ac-

counting, auto expenses, rent and office salaries. These

expenses were paid by Colt Development, Inc. and

subsequently allocated among the individual corpora-

tions. Advertising for sales of homes was similarly

earried out in common, but the sales representative

in two of the subdivisions testified that contracts for

the sale of homes were entered into in the names of

the separate building corporations. Construction con-

tracts were entered into between the individual cor-

porations and subcontractors either jointly or sepa-

rately and, on occasion, with Colt Development, Inc.

alone. Construction loans were made with respect to

the individual homes built and were disbursed to the

separate corporations, although the individual stock-

holders were usually liable on such loans.

Each of the three initial organizers of the five cor-

porations including Greenberg testified on rebuttal.

They testified that the principal reasons for the for-

mation of the separate corporations were limitation of

liability for negligence suits, subcontractors’ claims,

warranties made to purchasers and financial risks.

Greenberg further testified that after May 1966, he

decided to carry on his building activities through

only one corporation because of a substantial reduc-

tion in the number of homes constructed; he estimated

that he had built fewer than 100 homes since that

time.

The taxpayers requested the Tax Court by motion

to include the substance of the aforementioned rebut-

tal testimony, and of the testimony relating to inspec-

tion of records by the Internal Revenue Agent, in its

findings. That motion was denied.

REASONS FOR GRANTING THE WRIT

This case is one of first impression. It represents

the results of an attempt by the Commisioner—now

sanctioned by both the Tax Court and the Court of

Appeals—to treat distributions in complete liquidation

of a number of corporations as being equivalent to a

dividend, merely because of the previously related ac-

tivities to another corporation which remained active.

The lower courts upheld these actions on the part of

the Commissioner, not because they are supported by

the provisions of any statute, but as a consequence of

the finding, that the four separate corporations were in

effect ‘‘sham’”’ entities and should be regarded as part

of the single unliquidated business enterprise that con-

tinued to exist without interruption. The Court of Ap-

peals in affirming the decision of the Tax Court in this

case, has upheld a result that vests powers in the Com-

missioner of Internal Revenue that are far beyond

those that are delegated by the Congress. To imply a

grant of authority to disregard corporate entities

under the facts of this case, presents a position that is

totally at variance with the previous decisions of this

Court and, we submit, is of such far-reaching public im-

portance as to make review by this Court both desir-

able and appropriate.

Although initially having made the bare assertion

that the distributions from the Colt corporations re-

ceived by Greenberg were taxable as ordinary income

rather than capital gain, the Commissioner shortly be-

fore trial amended his answer to add two alternative

theories. He stated that capital gain treatment should

be denied either because the liquidated Colt corpora-

tions lacked a separate and independent business pur-

pose, or because in accordance with the provisions of

§ 269 of the Internal Revenue Code, Greenberg and

his associates had acquired their interests in the sep-

arate corporations for the purpose of evading or avoid-

ing Federal income taxes. Of course, the first theory

was adopted by the Tax Court and its decision rests

on it. The alternative contention advanced is briefly

referred to by the Tax Court, but no finding was made

that § 269 applied, nor that the principal purpose of

evasion or avoidance in fact existed. Accordingly, it

may be assumed that the Tax Court rejected the alter-

native theory of § 269 and we are, therefore not ad-

dressing ourselves to it.

It was undisputed that Greenberg in May 1966

owned one half of the outstanding capital stock of the

five Colt corporations and that at the time referred to,

four of those corporations terminated their separate

existence. It is also uncontroverted that one of the

corporations, Colt Development, Inc. continued in the

construction business after that time. Since the dis-

tributions received by Greenberg which are disputed

here were of all of the assets of the four corporations,

we submit that they fall squarely within the provisions

of § 331 of the Internal Revenue Code. The pertinent

portion of that section reads as follows:

“Sec. 331. Gain or Loss to Shareholders in Cor-

porate Liquidations.

(a) General Rule.—

(1) Complete liquidations.—Amounts distrib-

uted in complete liquidation of a corporation shall

be treated as in full payment in exchange for the

stock.”’

Inasmuch as no one questions that the capital stock

in the four corporations was held for more than six

months, it follows that the deduction of one half of the

gain provided in § 1202 of the Code is applicable. The

Tax Court recognized that if the transaction in ques-

tion was governed by the aforementioned statute, the

taxpayer must prevail. However, it concluded other-

wise holding that the four liquidated corporations

lacked a separate business purpose apart from the un-

liquidated corporation, and that, therefore, the distri-

butions received are to be taxed as dividends.

In considering the applicability of Section 331, it

should first be noted that nothing contained in this

statute, or in any regulation promulgated by the Com-

missioner, in any way suggests that its provisions are

available only to those taxpayers whom the Commis-

sioner finds eligible. There is no element of discretion

conferred on the Internal Revenue Service which

would make these distributions qualify or not qualify

as capital gains depending on whether they pass the

test of meeting certain factual criteria. The Congress

has established a single prerequisite for the treatment

of liquidations under this statute, and that is the pre-

requisite of completeness. We are not dealing here

with the allowance of deductions, which have often

been described as matters of legislative grace. There

is no requirement or stipulation that could extend

these provisions of law only to those corporations the

formation of which was caused by motives the Com-

missioner approves. The entire record demonstrates

that these corporations were distinct legal entities

which had a long history of separate recognition by

both the Government and the taxpayers. We submit

that the Tax Court’s inquiry should have ended here

and the decision for the taxpayers should have fol-

lowed. Instead, however, the lower court entered into

an analysis of the facts which may have been relevant

to a determination of whether related corporations are

entitled to multiple surtax exemptions, but has no re-

lationship to a resolution of the single question of

whether the four corporations had been subjected to

a complete liquidation.

We hasten to acknowledge that corporations which

are straws, so-called ‘‘dummies,’’ or otherwise have

purely a paper existence, need not be recognized for

tax purposes. A corporation, to be entitled to recogni-

tion for tax purposes, must carry out some business

function. The frequently-quoted words in Moline

Properties v. Commissioner; 319 U.S. 436, 63 8. It.

1132, 87 L. Ed. 1499 (1942) are meaningful here:

“The doctrine of corporate entity fills a useful

purpose in human life. Whether the purpose be

to gain an advantage under the law of the State

of Incorporation or to avoid or to comply with the

demands of creditors or to serve the creator’s

personal or undisclosed convenience, so long as

that purpose is the equivalent of business activ-

ity or is followed by the carrying on of business

by the corporation, the corporation remains a sep-

arate taxable entity.”’

In an opinion by Judge Learned Hand, in National

Investors Corporation v. Hoey (2nd Cir. 1944) 144

F. 2d 466, 467, the same principle is stated as follows:

‘‘ | | whatever the purpose of organizing the

corporation, ‘so long as that purpose is the equiv-

alent of business activity or is followed by the

carrying on of business by the corporation, the

corporation remains a separate taxable entity.’

319 U.S. 439, 63 S, Ct. 1134, 87 L. Ed. 1499. That,

as we understand it, is the same interpretation

which was placed on corporate reorganizations in

Gregory v. Helvering, 293 U.S. 465, 55 5. Ct. 266,

79 L. Ed. 596, 97 A.L.R. 1355, and which has some-

times been understvod to contradict the doctrine

that the motive to avoid taxation is never, as such

relevant. In fact it does not trench upon that doc-

trine; it merely declares that to be a separate

jural person for purposes of taxation, a corpora-

tion must engage in some industrial, commercial,

or other activity besides avoiding taxation: in

other words, that the term ‘corporation’ will be

interpreted to mean a corporation which does

some ‘business’ in the ordinary meaning; and that

escaping taxation is not ‘business’ in the ordi-

nary meaning.”’

The four liquidated Colt corporations clearly car-

ried out ‘‘some’’ business functions within the mean-

ing of these decisions. In fact, their activities were

substantial, as the record demonstrates. They took title

to lots, arranged to improve them, paid for construc-

tion, conveyed the completed homes to buyers and

issued their own individual warranties.

There is not the slightest doubt that the business

which Greenberg and his associates conducted through

the means of the five corporations had many interrela-

tionships and common elements. They transferred land

from a partnership organized by the same individuals,

shared development expenses and paid many admin-

istrative costs through the medium of a single corpora-

tion and later allocated them among the others. But

there were many important aiid valid business reasons

that prompted the organizers to select separate cor-

porations for doing business. According to the unre-

butted testimony, they were both conscious and con-

cerned about the risks inherent in the construction of

homes. They had not previously undertaken projects

of this magnitude and they were genuinely apprehen-

sive regarding the hazards and potential disputes in

dealing with purchasers as well as large numbers of

subcontractors. The fact that in the course of exercis-

ing this business judgment, the managing officers of

the Colt corporations would utilize a variety of com-

mon services, does not destroy the valid business pur-

pose of limiting liability. Southern Dredging Corp.,

54 T. C. 705 (1970). It is difficult to comprehend the

Tax Court’s conclusion that the corporations were ade-

quately insured against tort liability and that, there-

fore, the separateness of the corporations provided

no valid business reason. It would seem to have been a

matter of which the Tax Court could have almost

taken judicial notice that, no matter how adequate in-

surance coverage may seem, diffusing the considerable

hazards of the construction business among separate

corporations necessarily has to be a business advan-

tage. The Tax Court relies most strongly on its own

decisions in Aldon Homes, 33 T. C. 582 and Shaw Con-

struction Company, 35 T. C. 1102. Both of these cases

present the classic ‘‘multiple corporation”’ issue in

which the use of individual surtax exemptions is the

principal tax benefit involved. In both instances, the

Court found that the individual corporations had no

viable existence for tax purposes and held that their

gross income should be taxed as though they were one

entity. The statutory basis relied on in Aldon and

Shaw was § 22(a) of the 1939 Internal Revenue Code

which is the broad, almost all-inclusive, definition of

‘‘eross income,” now contained in § 61(a) of the 1954

Internal Revenue Code. Apart from the fact that the

Commissioner in his pleadings did not rely on § 61(a),

we find the emphasis on Aldon and Shaw misplaced

for other reasons. We submit that, as has been pointed

out above, sound business reasons for separate cor-

porations existed in the instant case. More impor-

tantly, however, we contend that a different standard

must be used to decide the shamness question when the

Commissioner seeks to deny the taxpayer the benefits

of a statutory complete liquidation, as compared with

the conclusion that the multiple gross income of sev-

eral corporations is to be regarded as being that of a

single enterprise.

It may well be that taxpayers such as those in Aldon

and Shaw forfeit the benefits of separate surtax ex-

emptions when they operate a multiple enterprise in

this manner. However, here we are not dealing with

the gross income of the corporations. We are faced

with an attempt by the Commissioner to revoke or

suspend a specific section of the Internal Revenue

Code that prescribes the tax results of a complete

liquidation. We submit that a different test of sham-

ness applies here. Here the rule of Gregory v. Helver-

ing, 293 U.S. 465, 55 S. Ct. 266, 79 L. Ed. 596 (1935)

should be applied. This Court in Gregory disregarded

the corporate entity because it found that the corpora-

tion had come into being without any business purpose

whatever for the sole purpose of taking advantage of

certain reorganization provisions. There was an unmis-

takable and direct connection between an unneeded

corporate entity and a predetermined tax result. We

have no findings by the Tax Court that would sustain

a shamness conclusion as in Gregory, predicated on the

existence of pre-arranged tax scheme. A finding under

§ 269, which requires a tax evasion or avoidance pur-

pose as an indispensable element, would pose a differ-

ent problem, if the record showed a specific violation

of that statute. However, the Tax Court reached no

such conclusion. In fact, it barely mentions the Com-

missioner’s § 269 argument and seemingly rejected it

by clear implication,

There is no undefined, residual authority delegated

to the Commissioner whereby he can arbitrarily strike

statutes, or nullify their operation at will. It is sig-

nificant that when the tax laws pertaining to multiple

corporations were revised as part of the 1964 Revenue

Act, the legislative history is silent on any intent to

limit :he provisions of § 331 upon liquidation of a mem-

her of an ‘affiliated group.’’ It is apparent from the

legislative history of the 1964 Act that Congress was

fully aware of the statutory weapons available to the

Commissioner through the use of Sections 269, 1551

and 482, whenever he perceived an allegedly improper

use of multiple corporations. See: Senate Report to

accompany H. R. 8363; 88th Cong. 2nd Sess. U. 8.

Code Cong. & Adm. News, pp. 1823-24.

The Tax Court appears to suggest that the benefits

of § 331 are available to only those taxpayers who can

prove that the liquidated corporation was not subject

to challenge because of some possible tax advantage as

a multiple corporation. We submit that this approach

violates all principles of interpretation that have been

long accepted in this field. Not only should tax statutes

not be extended beyond their clear meaning, but in case

of doubt they should be most strongly construed

against the Government. Gould v. Gould, 245 U.S.

151, 38 S. Ct. 53 (1917); B & M Co. v. U.S. (5th Cir.

1971), 452 F. 2d 986. As this Court has pointed out,

the Congress has drawn meaningful distinctions be-

tween tax consequences of transactions depending on

whether they occur at the corporate or shareholder

level. U.S. v. Cumberland Service Co., 338 U.S. 451,

710 S. Ct. 280, 94 L. Ed. 251 (1950). In the same way,

the restrictions that can be lawfully imposed on mul-

tiple corporations cannot, without statutory author-

ity be translated into new and different individual tax

levies. The Tax Court noted that it had found no case

dealing with the precise issue here presented. How-

ever, it referred to the case of Walter L. Morgan, 33

T. C. 30 (1959), reversed on other grounds (3rd Cir.

1961) 288 F. 2d 676. That case actually supports the

taxpayer’s position inasmuch as it was there held that

the fact that a corporation’s income was allocated to

another corporation, did not deprive the stockholders

of their right to treat gain from the liquidation of the

first corporation as a capital gain. In reaching this re-

sult in Morgan, the Tax Court particularly emphasized

that “disregard of corporate entities is an extraordi-

nary legal technique”’ (33 T. C. at p. 41).

In the final analysis, it appears that what the Gov-

ernment seeks is a kind of punitive action that would

impose serious monetary penalties on those who have

utilized multiple corporations for tax purposes. To

the extent that those penalties depart from specifically

enacted statutes, they are, of course, invalid. Under the

prior rulings of this Court, and the decisions of many

lower courts, the disregard of the corporate entity is

indeed an extraordinary step. In our view, that step

becomes all the more serious when its result is the ef-

fective suspension of an entire section of the Internal

Revenue Code by converting capital gains to ordinary

income. We submit that only the Congress can fashion

such measures and consequences.

The Tax Court rejected taxpayers’ argument that

under the pretext of serving a subpoena duces tecum,

the Commissioner had in effect conducted an illegal

second examination of the corporations’ books and

records. Section 7605(b) of the Internal Revenue Code

prohibits such a second examination, unless preceded

by a written notice from the Commissioner, or re-

quested by the taxpayers. No one has contended that

the Commissioner gave the aforementioned notice, nor

has it been denied that the records examined were re-

viewed for the second time. The Tax Court is simply

in error in concluding that Greenberg had ‘‘in effect

requested’’ the Internal Revenue Agent to inspect his

files. The record shows that, following a pretrial hear-

ing at which the Tax Court Judge quite properly en-

couraged the parties to stipulate undisputed facts, ac-

cess to such records was given by both the accountant

and Greenberg for that particular purpose. What took

place, however, was the conduct of a giant fishing ex-

pedition in which the Commissioner’s agent spent al-

most a full day searching for evidence calculated to

show ‘‘that the five corporations are actually one sin-

gle operation.’’ We submit that the fact that the per-

sons summoned could have produced the records at

trial is of no consequence. What the Government en-

gaged in purely and simply was a second audit. Section

7605(b) prohibits such actions under these circum-

stances, and it does so without regard to whether the

inspection is conducted for purposes of a trial, or

otherwise. Mr. Zoslow was just as surely an agent of

the Commissioner whether he gathered evidence for

an assessment or to furnish assistance to Government

counsel. Greenberg was simply lulled into cooperating

with the agent in the mistaken belief that he was com-

plying with the subpoena. What has taken place is a

misuse of the Commissioner’s power of examination in

a manner which the above-mentioned statute seeks to

prevent. Pacific Mills et al v. Kenefick (1st Cir. 1938)

99 F. 2d. 188. This Court has left no doubt that com-

pliance with the prerequisite of notice under § 7605(b),

in the absence of a taxpayer request, is an absolute

prerequisite. U.S. v. Powell, 379 U.S. 48, 85 S. Ct. 248

(1964). Disregard of the statute is a proper basis for

setting aside the deficiency. Reineman v. U.S. (7th

Cir. 1962), 301 F. 2d 267. Accordingly, the Tax Court

should have sustained the taxpayers’ objections to in-

troduction of evidence acquired in the above-described

manner.

The limitation that the statute places on the Com-

missioner’s power to examine taxpayers’ records is

founded on important public policy considerations, as

the Powell decision makes clear. The record in this case

demonstrates that the Internal Revenue Agent had a

predetermined, but uncommunicated purpose to use

the subpoena as a device to obtain access to the pre-

viously inspected books and records. In sanctioning

this procedure, the courts below have allowed a mere

formalism to thwart an unambiguous Congressional

intent.

CONCLUSION

For the reasons heretofore stated, petitioners sub-

mit that the writ of certiorari should be granted.

Respectfully submitted

WERNER StTRUPP

3301 New Mexico Avenue, N.W.

Washington, D. C., 20016

Attorney for Petitoners

October 1975

APPENDIX

APPENDIX A

Statutes Involved

Sec. 331. Gain or Loss to Shareholders in Corporate

Liquidations.

[Sec. 331(a)]

(a) Genera RuLE—

(1) Compete LiquipaTions.—Amounts distributed

in complete liquidation of a corporation shall be treat-

ed as in full payment in exchange for the stock.

(2) Partita Liguipations.—Amounts distributed

in partial liquidation of a corporation (as defined in

section 346) shall be treated as in part or full payment

in exchange for the stock.

Sec. 1202. Deduction for Capital Gains.

In the case of a taxpayer other than a corporation, if

for any taxable year the net long-term capital gain ex-

ceeds the net short-term capital loss, 50 percent of the

amount of such excess shall be a deduction from gross in-

come. In the case of an estate or trust, the deduction shall

be computed by excluding the portion (if any), of the

gains for the taxable year from sales or exchanges of

capital assets, which, under sections 652 and 662 (relating

to inclusions of amounts in gross income of beneficiaries

of trusts), is includible by the income beneficiaries as

gain derived from the sale or exchange of capital assets.

Sec. 7605. Time and Place of Examination.

(b) Restrictions on Examination of Taxpayer.—No tax-

payer shall be subjected to unnecessary examination or

investigations, and only one inspection of a taxpayer’s

books of account shall be made for each taxable year un-

2a 3a

less the taxpayer requests otherwise or unless the Secre- APPENDIX B

tary or his delegate, after investigation, notifies the tax-

payer in writing that an additional inspection is necessary. 62 T. C. No. 41

UNITED STATES TAX COURT

RaymMonp GREENBERG AND Marityn Greenserc, Petitioners

vy. ComMISSIONER OF INTERNAL Revenue, Respondent

Docret No. 176-71

Fitep June 18, 1974

Petitioner and two other persons organized a cor-

poration (D) to engage in land development and build-

ing of single family houses. Subsequently they orga-

nized four other corporations in which they each held

the same proportion of stock as they held in D. The

_four other corporations had no office separate from D,

no employees separate from 1), and conducted no busi-

ness independently of D. In May 1966 the four cor-

porations other than D each adopted resolutions of

liquidation and distributed to the stockholders their

assets which consisted, except for approximately $2,000

in one of the corporations, of cash and notes and ac-

counts receivable. D redeemed all of its stock except ~

that held by petitioner and petitioner continued to

conduct the home building business through D of

which he was then the sole stockholder.

Held: The four liquidated corporations were shams,

having no operations or business apart from that of

D. In substance upon the liquidation of the four cor-

porations, D distributed earnings and profits to peti-

tioner. The distributions constitute dividends taxable

as ordinary income to petitioner whether the forma-

tion of the corporations other than D is ignored and

the distribution considered to be a direct distribution

of earnings and profits from D to petitioner or the

stock purchased by petitioner in the four corporations

is considered in substance to be additional stock in D.

Under the latter view the distribution to petitioner in

redemption of part of his stock in D is a distribution

essentially equivalent to a dividend within the mean-

ing of sec. 302(b)(1), and under sec, 302(d) consti-

tutes a distribution of property to which sec. 301

applies.

Werner Strupp, for the petitioners.

Thomas C. Morrison and Howard L. Williams, for the

respondent.

Scorr, Judge: Respondent determined deficiencies in pe-

tioners’ Federal income taxes of $92,555.15 and $11,462.60

for the taxable years ending December 31, 1966 and 1967,

respectively. Some of the issues have been disposed of by

the parties leaving for decision whether petitioner’s multi-

ple real estate corporations were shams for tax purposes

so that $213,994.53 received upon the purported ‘‘liquida-

tion’’ of four of the five corporations is a distribution to

petitioner from the surviving corporation in the naivre

of a dividend taxable as ordinary income to him.

FINDINGS OF FACT

Some of the facts have been stipulated and are found

accordingly. Petitioners Marilyn and Raymond Greenberg

are husband and wife and resided in Bethesda, Maryland

at the time their petition in this case was filed. They filed

their joint Federal income tax returns for the calendar

years 1966 and 1967 with the district director of internal

revenue at Baltimore, Maryland.

Raymond Greenberg (hereinafter sometimes referred to

as petitioner) is in the real estate development business

and had been in that business for a number of years prior

to the years here at issue. Prior to 1966 he joined with

Simon Sherman (hereinafter Sherman) to form Colt Con-

struction Company partnership for the purpose of con-

structing about ten houses in an area called Colt Terrace

in Wheaton, Maryland. After this project had been com-

pleted, petitioner, Sherman, and George Revitz (herein-

after Revitz) decided to develop large residential subdivi-

sions. With the advice and assistance of their accountant,

in December 1958 they formed Gerasi Partnership (here-

inafter Gerasi), each of them being an equal partner. They

also formed five corporations, the names and dates of in-

corporation of each entity being as follows:

Total Total Date

Capital Shares __ Incor-

Name* Contribution Issued porated

Colt Development, Inc.

(Development) $3,000 1,500 2/3 /59

Colt Builders, Inc.

(Builders) 3,000 1,500 5/21/59

Colt Homes, Inc.

(Homes) 3,000 1,500 6/ 2 /59

Colt Properties, Inc.

(Properties) 3,000 1,500 2/15/60

Colt Contractors, Inc.

(Contractors) 3,000 1,500 2/29/60

* The five corporations will hereinafter be referred to

collectively as Colt corporations or Colt entities.

Petitioner, Sherman, and Revitz each contributed $1,000

“and received 500 shares of no par common stock of each

corporation. At all times each Colt corporation had only

one class of stock.

Gerasi and the five Colt corporations were engaged in

the development, construction, and sale of single family

houses in two areas, Burnt Mills Park and Foxhall, both

areas being located in Montgomery County, Maryland.

Gerasi acquired construction equipment which it rented to

the five Colt corporations.

The articles of incorporation of each of the Colt corpo-

rations contained similar provisions for each one’s incor-

poration under the laws of Maryland, corporate powers,

and original directors (Sherman, Greenberg and Revitz).

These articles set forth in identical clauses each corpora-

tion’s limitations and regulations, and designated the same

principal office and registered agent. The by-laws of each

corporation were essentially the same, with the exception

of different prescribed days and times for stockholders’

and directors’ meetings. Each corporation’s minute books

recorded similar resolutions regarding officers’ compensa-

tion, a bank account with Suburban Trust Company, and,

in the case of Builders, Contractors, Ifomes, and Prop-

erties, liquidation of the corporation.

The development and sale of the first Colt subdivision

known as Burnt Mills Park was carried out in the follow-

ing manner: Gerasi purchased the first tract of land con-

sisting of 60 lots and simultaneously transferred the land

at cost to Development on March 23, 1959, before any of

the other Colt corporations had been formed. Development

retained 24 lots, conveyed 15 lots to Builders in June 1959,

20 lots to Homes in September 1959, and 1 lot to Homes

in March 1960. Gerasi purchased a second Burnt Mills

Park tract in February 1960 consisting of 50 lots from

which it transferred at cost 20 lots to Properties and 17

lots to Contractors, both of which had been recently ere-

ated, and 12 lots to Development over the remainder of

1960 and 1961. A thirteenth lot was transferred to Devel-

opment in 1963,

Some time in 1960 Gerasi purchased lots in the Foxhall

subdivision and in a manner similar to that used for lots

purchased in Burnt Mills Park distributed most of these

during 1961 through 1967 to the various Colt corporations,

transferring a total of 76 lots to Development, 46 lots to

Builders, 58 lots to Homes, 57 lots to Properties, and 52

lots to Contractors. Payments for lots were treated as

open account indebtedness between Gerasi or Develop-

ment and the appropriate corporation, that is, as an ac-

count payable by the Colt corporation and an account re-

ceivable by Gerasi or Development. The Colt corporations

took the lots subject to purchase-money obligations exe-

cuted by Gerasi to the sellers, As each lot was sold, the

Colt corporation holding title paid the original sellers the

necessary amount to release the underlying purchase-

money lien.

The subdivision plan for Burnt Mills Park had already

received approval of the appropriate government author-

ity and was formally dedicated prior to Gerasi’s purchase.

With respect to Foxhall, Gerasi formally dedicated all

plats of the subdivision.

With regard to both Burnt Mills Park and Foxhall,

Gerasi and/or Development obtained the necessary per-

mits for grading streets and roadways. Development fur-

nished subdivision »onds and conducted various transac-

tions with the Montgomery County Department of Public

Works and the Washington Suburban Sanitary Commis-

sion regarding storm drains and sewers on behalf of the

entire subdivision.

Development was billed and paid for the extensive engi-

neering work necessary to prepare both development sites

for subdivision and construction of houses. These expenses

included:

Boundary survey, topographic surveys, tentative

subdivision plan, street grade and profile design, street

grade stakeout, street grade permit application, rec-

ord plats, petition preliminary stakeout and compli-

ance with authority for sewer and water, stakeout

property points for construction of sewer and water,

storm drain study, storm drain design and paving

plan, storm drain stakeout, paving stakeout, permit

applications, development plans, lot stakeouts, house

stakeouts, first floor grades, wall check surveys, final

house location surveys.

All project costs including rental of construction equip-

ment from Gerasi were billed to and paid for directly by

Development. At the end of each Colt corporation’s fiscal

year, Development allocated to it an amount representing

its share of project costs which was determined by multi-

plying the number of houses it sold during the period by

a flat per house rate. General journal entries of Develop-

ment show typical amounts charged to each corporation

for project costs as follows:

Date of

Journal

Entries Number Per

Made by Fiscal Year of Total House

‘harged To Development Ended Houses Amount Rate?

Development ! 10/31/62 10/31/62 12 54,300 5

Properties 12/31/62 11/30/62 17 yoren ‘aan

Builders 4/1/63 1/31/68 11 48675 —-4.495.00

Contractors 4/30/63 2/28/63 1 4,425 4,425.00

Homes 4/30/63 3/31/68 + = 9 48200 4.80000

Development 10/31/63 10/31/63 14 67,960 4,835.00

Properties 12/31/63 11/30/68 +=««17'—~Ss«195—s«' 835.0

Builders 4/1/64 1/31/64 —«12,—S—s—«~HDO.—«S«~SC*«BB5 OOD

Contractors 4/30/64 2/29/64 25 121,750 4.870,00

Homes 5/31/64 3/31/64 15 76,350 5,090.00

Development 10/31/64 10/31/64 16 85,520 5,345.00

Propert ies 2/ 1/65 11/30/64 13 85,520 . 6,578.46

Builders 4/ 1/65 1/31/65 16 74,960 4,685.00

Contractors 4/ 1/65 2/28/65 18 94,410 5,245.00

Ilomes 5/31/65 3/31/65 18 94,410 5,245.00

1 Portion of project costs was retained on Development's book entries

of these expenses,

representing its share

2In those instanecs where the journal entries did not show the per house rates the inter-

polated amount is given.

3 Officers’ snlarica for this year were determined on a basis of 13-home sales. However the

amount of the project cost allocation per house seems out of line and the total project ‘cost

amount more nearly coincides with 16 houses which there is some

be the correct number.

indication in the record might

Actual construction costs, predominantly consisting of

all expenses incurred after building permits were obtained

and lots were transferred to the various Colt entities, were

generally paid by the appropriate Colt corporation.

General and administrative expenses, along with adver-

tising expenses, were paid by Development and then allo-

cated to the other Colt corporations. Included among these

expenses were accounts labeled legal and accounting, auto

expense, rent, office salaries, taxes-payroll, donations, pro-

motion, dues, and subscriptions. Allocations were made

per month on a percentage basis and the percentage allo-

cated to each corporation varied from month to month.

Advertising of Burnt Mills Park and Foxhall homes

appeared in the Washington Post and Washington Star

newspapers. These advertisements used the words ‘‘ Built

by Colt,’’ or solely identified the project with Develop-

ment, and did not reveal the existence of Gerasi or the

other Colt entities. Development was billed and paid for

all ad costs as well as all indoor and outdoor home display

signs.

The books and records of all five Colt corporations were

maintained by one bookkeeper in a single office. Mach set

of books identified many construction cost accounts with

the same account code numbers. Of 49 construction cost

accounts, 43 accounts involved payments to at least one

subcontractor common to all five Colt corporations; five

accounts involved payments to one subcontractor common

to four Colt corporations; and one account involved pay-

ments to one subcontractor common to three Colt corpora-

tions. The Colt records show payments to other subcon-

tractors not common to all Colt corporations, but these

payments generally represent small, isolated transactions.

The common subcontractors generally charged each cor-

poration the same prices for work on the same type of

house but the charges varied in accordance with the type

of house being built. The styles and designs of Burnt Mills

10a

Park and Foxhall houses were rambler, split-level, or

two-story configurations. The variation in style and de-

sign was necessary to fulfill an FHA requirement. There

was no specialization among the five Colt corporations in

constructing any particular style of house.

Sometimes, a subcontractor would execute a single sub-

contracting agreement with all participating Colt corpo-

rations. Another typical arrangement was that a subcon-

tractor would simultaneously enter into separate subcon-

tracts with each Colt corporation, using identical terms

and prices. Upon occasion, a subeontractor would contract

solely with Development for work on houses owned by

Development and also houses owned by other Colt corpo-

rations. To obtain favorable prices for work, each Colt

corporation would execute subcontracts involving a sizable

number of houses. Even contracts with subcontractors who

had not previously done work for any of the Colt corpora-

tions would be for work on at least 25 houses in a 100-

house subdivision.

Subcontractors sometimes through error directed their

billing statements to the wrong Colt corporation. When

this happened, the entity receiving the bill would stamp

it with a rubber stamp providing the Colt portion of the

corporation’s name and a blank space for designating the

particular Colt entity tendering payment.

At all times here relevant, the five Colt corporations

either together or separately maintained substantial and

adequate liability insurance policies covering all risks aris-

ing from potential workmen’s compensation claims and all

other general liabilities. On February 12, 1965, their in-

surance broker was providing the following coverage:

(1) Workmen’s compensation coverage on carpenters

and/or laborers for an estimated payroll of $60,000; on

clerical employees for $7,000; and on executive supervisors

exercising supervision through superintendents and fore-

lla

men, but no direct supervision, for $40,000. This policy

covers Washington, Maryland, and Virginia.

(2) General liability coverage of $500,000 /$1,000,000, in-

cluding $25,000 property damage.

Gerasi also carried a contractor’s equipment policy

which covered liability insurance for various construction

equipment.

The Colt corporations were additionally protected by

certificates of insurance from the various subcontractors.

For example, the insurance coverages carried by one of

Colt’s subcontractors, Contee Sand and Gravel Company,

Inc., were as follows:

hensive General Liability—Bodily Injury,

$500 000 each person, $1,000,000 each accident

i iability— , Damage,

Comprehensive General Liability—Property

$100.000 each accident, $300,000 aggregate

i i iability—Bodily Injury,

Yomprehensive Automobile Liability—Bodily Injury

$500,000 each person, $1,000,000 each accident

Comprehensive Automobile Liability—Property Dam-

age, $100,000 each accident

. , es

Most subcontractors also carried workmen’s compensa

tion coverage.

All Burnt Mills Park and Foxhall homes were sold on a

commission basis exclusively through an independent real

estate agency. The real estate agency uniformly used a

preprinted contract form for all home sales. The contract

form showed only the printed name of the real estate

agency and subdivision. Upon sale of a home, petitioner,

Revitz, or Sherman would execute the sales contracts and

indicate the name of the appropriate Colt entity as seller.

The following schedules reflect the Colt corporations

taxable income and earned surplus and retained earnings

as reported on their Federal income tax returns for the

years 1959 through May 31, 1966:

13a

12a

TAXABLE INCOME EARNED SURPLUS AND RETAINED EARNINGS

DEVELOPMENT PROPERTIES BUILDERS CONTRACTORS HOMES

DEVELOPMENT PROPERTIES BUILDERS CONTRACTORS HOMES 2.3. 59 9-15-60 5-21- 59 3-1 -60 6-2-59

2-3-59 2-15-60 5-21-59 3-1-60 — Taxable Year to to to to to

Taxable Year to to to to ° 31- .31- -31-66 5-31-66 5-31-66

Ended 5-31-66 5-31-66 5-31-66 5-31-66 5-31-66 ‘ eres sa saess is wee

* 10-31-59 $26,769.97 © 1-31-60 $17,154.00

* 1.31-60 $24,505.72 © 3-31-60 $17,563.48

* 3.31.60 $25,132.24 10-31-60 28,062.52

10-31-60 13,879.96 * 11-30-60 $18,059.70

1-31-61 $17,029.55 © 2.986) $18,354.71

* 2.98.61 $26,780.68 3-31-61 29 914.08

3-31-61 $17,643.72 10-31-61 45,282.65

10-31-61 24,603.04 11-30-61 36,306.93

11-30-61 26,555.72 1-31-62 25,288.80

1-32-62 ( 3,729.88) 2.28.62 32,413.50

2.98.62 20,083.99 3-31-62 38,328.30

3-31-61 $12,020.32 10-31-62 . 58,248.12

10-31-62 18,522.10 11-30-62 54,245.84

11-30-62 25,914.39 1-31-63 43,470.04

1-31-63 24,294.67 2.28.63 38,157.43

2.28.63 8,205.62 3-31-63 50,928.14

3-31-63 17,999.77 10-31-63 71,440.38

10-31-63 18,846.09 11-30-63 72,637.76

11-30-63 26,858.17 1-31-64 58,287.23

1-31-64 21,167.42 2-29-64 63,238.97

2.29.64 40,009.46 -3-31-64 76,110.34

3-31-64 39,815.29 10-31-64 96,700.92

10-31-64 37,269.54 11-30-64 110,496.22

11-30-64 62,181.71 1-31-65 84,874.99

1-31-65 38,841.05 2-28-65 104,064.70

2-28-65 67,377.45 3-31-65 116,545.29

3-31-65 66,460.98 10-31-65 162,628.13

10-31-65 114,860.77 11-30-65 157,870.95

11-30-65 78,780.90 1-31-66 131,660.20

1-31-66 77,471.60 2-28-66 156,509.46

2.28.66 88,355.31 3-31-66 171,750.95

3-31-66 93,664.73 © 5.31-66 157,881.00

* 5-31-66 12.89 ® 5-31-66 130,741.85

® 5-31-66 ( 918.35) © 5-31-66 156,641.32

5-31-66 169.05 ® 5-31-66 192,081.10

® 5.31-66 26,596.44

* Short Periods

l4a

For the following taxable years, Gerasi reported the

following on its partnership returns (form

calendar years indicated:

EHSE |S ESRSSE [BS B =

s| £222 2 see¢82 Es 2 =

Sma a = a ed es i & = -

= sch os - i ot C1 Cl oO ot = 7

7 © alien! o 3 & S =

* - * ee ae

. 2 ~ & festeesls 282

e ~ e a S3eseseils acs

— ) = ~ ~

& on w. : ps Se S| LS Sele Sam

re C TOM Ho oi Shee aac

= er

-& ~ & g5ge8e38 #22

= = & io rth we cic ca a

zg] 2 £ & S5eeRhe Fee

ps x] ace Yo + io -wow

ei ra] - -

OO Or

-, & « [& $8288e8% F828

2] 2 £2 2 “232983 fees

21G 24 |% HSRAtntls ERAS

= = ci = oF os oe Ici cece

= = ee a el

a) 2 ¢ —& €828ss2/8 gF8s

=) 3 z 2 E£&eeees 5 — oe

é. ‘ y SRecsesis < 2-2

* e oo” = “(5 Slse

be wT

#2 | f# S8828e2Rle EEE

s|&" &F 2 dessersis sess

2/5 £§ 2 SegksszR 8333

= = ce we Ole coun

Lr Bis Gane

282.6 gee23 es $286

=| a e ges ~ A >

212" 2 | geeaE le SEEE

e ual no + aos : Suu a

= > © ° BB cll,

s F e

i 3 an - .

s°\3 3 Sale 28F :

-~ “SE spf SE écez

pEszé Pie eeezal sek E

é 2ECE| ERAREEF S| ZAP -

S ia =

1065) for ‘

d-yr

$1.004.20

1,004.19

1965

10-yr

5-yr

1964

$202.53

10-yr

4-yr

$1,453.33

1963

10-yr

5-yr

1962

10-yr

Invest. Credit

To: Greenberg

198

$31.95

31.95

202.53

$494.20

494.20

20.66

20.67

$20.67

th t t&

SES

om ee |

ae oe oe

“=

24 03 C1

Sherman

Revitz

1,453.34

1,453.33

$141,505.76 is derived from gross sales

1 Partnership listed itself as in the business of constructing homes. Gross profit of

totaling $698,653 minus construction costs of $557,148.

? Specific allocation of taxes for the years 1960 and 1966 is unavailable.

wiser

lida

Initially, Sherman was president of each of the five Colt

corporations; Greenberg was vice-president and treasurer ;

and Revitz was secretary.

Pursuant to a single buy-out agreement dated June 8,

1964, Sherman redeemed his shares in each Colt corpora-

tion and sold his one-third interest in Gerasi to Greenberg

and Revitz. After June 8, 1964, Revitz was president of

each of the five Colt corporations and Greenberg was sec-

retary anc treasurer.

Pursuant to a single agreement dated May 20, 1966,

Greenberg purchased Revitz’ interest in Gerasi, and Rev-

itz redeemed his 500 shares in Development; then Green-

berg and Revitz simultaneously ‘‘liquidated’’ Builders,

Contractors, Homes, and Properties. After May 20, 1966,

Greenberg was president of the then ‘‘unliquidated’’ De-

velopment and assumed the title of president for the then

‘‘liquidated”’ Builders, Contractors, Homes, and Proper-

ties for the purpose of carrying out final post-liquidation

matters.

In early years each Colt entity paid officers’ salaries to

petitioner, Sherman, and Revitz which were authorized by

separate corporate resolutions. After October 1962, gen-

eral journal entries show that officers’ compensation was

being calculated on an identical per house basis. Petitioner,

Sherman, and Revitz were paid $1,500 per house by each

Colt entity until Sherman withdraw from the business and

thereafter petitioner and Revitz each received $1,700 and

$2.000 per house. Development also had paid employees in

addition to its officers but at no time did any of the other

Colt corporations have any such employees.

Interest expense on purchase money mortgages was paid

by Gerasi and subsequently allocated to each Colt corpora-

tion by means of appropriate journal entries.

Construction financing, as well as loans to Gerasi for

acquisition of the land, was provided by Interstate Build-

16a

ing Association, H. L. Rust Company, and Suburban Trust

Company through individual mortgages on lots. These

construction loans were secured by separate deeds of trust

and separate insurance policies covering each house. The

aggregate amount of the construction mortgage loan pro-

ceeds was disbursed among the Colt corporations weekly

in a single transaction in accordance with a progress

schedule. Petitioner, Sherman, and Revitz were usually re-

quired to personally endorse the mortgage notes for con-

struction loans.

After Sherman left ue business, petitioner and Revitz

obtained additional operating capital through personal

loans from Suburban Teust Company. On November 23,

1965, petitioner and Revitz each requested separate $300,-

000 one year loans from the trust company. Revitz’ loan

application stated in part:

Purpose loans to corporations for operating capital

(Corporations will pay loans and accounts due to and

from each other)

Source of Repayment Liquidation of 4 corporations.

Collateral—None—Suggest we obtain a guarantee

from Greenserc, et ux and vice versa on each $300,-

000 loan

Remarks—Will maintain comnensating balances in all

accounts of at least $500,000. They have ample capital

now to continue construction program in Foxnat..

Twenty-cight houses under construction (twenty under

roof—eight footings, fourteen sold). Forty-three lots

to be built unon. Have built and sold 280 houses in

subdivision. After cornorations are liquidated in one

year, will continue building in one corporation and the

partnership.

In a later related loan application on March 8, 1966,

requesting an additional $50,000, Revitz again indicated

the plans to liquidate ‘‘some’’ of the corporations in the

following 3 to 6 months.

17a

Prior to the liquidation of the corporations, petitioner

and Revitz had disagreements concerning Revitz’ right to

engage in various unrelated business ventures exclusive

of petitioner. In order to resolve their dispute, petitioner,

Revitz, and Development entered into the previously men-

tioned buy-out agreement on May 20, 1966, providing for

Revitz’ sale to petitioner of his one-half interest in Gerasi

for $172,292.52; for Development’s redemption of Revitz’

500 shares of stock for $118,250.61; and Revitz’ 500 shares

of stock for $118,250.61; and Revitz’ resignation as an offi-

cer and director of Development. In addition petitioner

and Revitz agreed to cooperate with one another in effect-

ing the final dissolutions of Homes and Properties before

March 31, 1967.

On May 24, 1966, Greenberg and Revitz caused Builders,

Contractors, Homes, and Properties to adopt identical res-

olutions of liquidation.

Consistent with these corporate resolutions, Builders,

Contractors, Homes, and Properties filed final U.S. Cor-

porate income tax returns for short tax periods ending

May 31, 1966, which showed beginning balance sheets and

final earnings as follows:

Beginning balance sheets

on final returns: BUILDERS CONTRACTORS HOMES PROPERTIES

ASSETS:

Cash $163,299.49 $172,119,69 $161,361.02 $ 1,440.68

Notes and accounts receivable 21,238.57 14,150.80 20,666.46 185,877.35

Inventory — _ 26,531.81 —

Buildings, other fixed assets 2,699.04 -- -- --

$187,237.10 $186,270,49 $208,559.29 $157,318.03

? 22,079.69 26.336.78 25,213.00

208,550.18 234,896.07 212.551.03

—————— —

LIABILITIES :

Accounts Payable $ 759853 $ — $ 5,380.22 $ 3,501.06

Current Liabilities — — 1,500.00 on

Mortgages, notes, bonds (over 1 yr.) 10,214.53 40,560.83 9,876.11 12,606.49

Other liabilities /acerued taxes 34,763.84 8,279.89 43,388.79 35,552.53

$52,576.90 § 40,840.72 § 60,145.12 $ 51,660.08

Final reported earned surplus

Less: Treasury Stock from

Adjusted final earned surplus

% adjusted final earned surplus

Equity:

18a

Paid-in capital 3,000.00 3,000.00 3,000.00 3,000.00

Earned surplus 131,660.20 156,509.46 171,750.95 157,870.95

$187,237.10 $208,350.18 $234,896.07 $212,531.03

—- ee

— << —

$133,741.85 $159,641.32 $195,081.10 $160,881.00

Sherman Redemption 20,429.08 22,079.69 26,336.78 25,213.00

Consistent with the May 24, 1966, separate resolutions,

information returns were filed, showing the following dis-

tributions as of May 31, 1966:

Builders Contractors Properties

CASH

to Greenberg $ 481.70 $ 77,321.21 ¢$ 7,836.89

to Revitz 481.70 77,321.20 7,836.88

Total $ 963.40 $154,642.41 $ 15,673.77

NOTES AND

ACCOUNTS

RECEIVABLE

to Greenberg $ 54,078.43 $( 8,540.39) $ 59,997.11

to Revitz 56,174.69 ( 8,540.39) 59,997.12

Total $110,253.12 $(17,080.78) $119,994.23

EQUIPMENT

to Greenberg $ 2,096.25

to Revitz —-

Total $ 2,096.25

Grand Total $113,312.77 $137,561.63 $135,668.00

Greenberg’s

Total Share $ 56,656.38 $ 68,780.82 $ 67,834.00

Revitz’ Total Share 56,656.39 68,780.81 67,834.00

Total $113,312.77 $137,561.63 $135,668.00

$113,312.77 $137,561.63 $168,744.32 $135.668.00

$ 56,656.38 $ 68,780.81 $ 84,372.16 $ 67,834.00

Amount Realized

Gain Realized

Less: Claimed sec.

1202 deduction

Net Gain Reported $106,997.26

19a

After the ‘‘liquidations’’ Development continued to con-

struct and sell houses in Foxhall and subsequently in other

areas of Montgomery County, Maryland. Gerasi began

participating along with Development in the sale of Fox-

hall homes in 1966 and 1967.

After completion of the Foxhall subdivision, Develop-

ment and Gerasi began building homes in Stonegate sub-

division. Development entered into agreements with sub-

contractors for the construction of Stonegate homes as

early as September 1966.

Development presently maintains an address in Stone-

gate, Silver Spring, Maryland. The Stonegate subdivision

includes Crimson Oaks, the first part of which Develop-

ment built. The remaining houses in Crimson Oaks were

built by petitioner’s wholly-owned and unincorporated

Raymond Greenberg Construction Company. Development

is also. constructing homes in the 120-house Peachwood

subdivision. In Peachwood, Development contracts to buiid

houses for another partnership of which Greenberg is part

owner.

With respect to the distributions received from Builders,

Contractors, Homes, and Properties, Greenberg reported

the following on his 1966 joint Federal income tax return:

TOTAL | BUILDERS CONTRACTORS HOMES PROPERTIES

$42,367.03 $52,860.00 $68,134.32 $54,632.58

Cost of Stock 1,000.00 1,000.00 1,000.00 1,000.00

$106,997.27

Respondent in his notice of deficiency determined that

the amounts reported by petitioner as capital gains re-

ceived in exchange for his stock in fact constituted ordi-

nary income and disallowed Greenberg’s claimed section

1202 deduction.

$213,994.53 $41,367.03 $51,860.60 $67,134.32 $53,632.58

20a

ULTIMATE FINDINGS OF FACT

The four ‘‘liquidated’’ Colt corporations lacked any

separate or independent business purpose apart from the

unliquidated Development, whose inseparate and common

building business was not terminated or otherwise inter-

rupted by the four ‘‘liquidations.’’

The earnings and profits of the four ‘‘liquidated’’ Colt

corporations were solely derived from the earnings and

profits of a single business comprised of the five Colt cor-

porations which business was not terminated nor other-

wise interrupted by the four Colt corporations ‘‘liquida-

tions.’’

OPINION

Although at the trial petitioner’s objection to the intro-

duction of certain evidence on the ground that it was ob-

tained by respondent’s agent Zoslow prior to the trial of

this ease in violation of section 7605(b), IRC 1954,’ was

overruled, petitioner on brief argues that we should recon-

sider this ruling and disregard this evidence. This evi-

dence consists of parts of records which respondent sub-

poenaed from petitioner. Petitioner could have brought

the requested records to court. Instead, ‘‘because of the

scope and amount of material involved,’’ he chose to allow

respondent’s agent Zoslow access to seven file cabinets

from which to obtain information or copies from those

’ All references are to the [International Revenue Code of 1954,

unless otherwise noted.

Sec. 7605. Time AND PLACE oF EXAMINATION.

(b) Restrictions on Examination of Taxpayer.—No taxpayer

shall be subjected to unnecessary examination or investigations,

and only one in:pection of a taxpayer’s books of account shall be

made for each taxable year unless the taxpayer requests otherwise

or unless the Secretary or his delegate, after investigation, notifies

the taxpayer in writing that an additional inspection is necessary.

2la

books and records requested in the subpoenas duces tecum

for use at the trial. Zoslow’s review of petitioner’s files

was with the permission of petitioner who chose not to

ferret out the requested records by himself and in effect

requested that the agent go over the subpoenaed records

to relieve him of the trouble of bringing them to court.

Section 7605(b) is not directed to circumstances such as

here presented and none of the cases relied on by petition-

er bear any factual resemblance to the facts here present.

We will therefore not reconsider our ruling at the trial

admitting evidence obtained as a result of Zoslow’s inspec-

tion of subpoenaed records.

Respondent takes the position that distributions made

to petitioner allegedly in liquidation of four of the five

Colt corporations do not qualify for capital gains treat-

ment, since the formal disolution of Homes, Builders, Con-

tractors, and Properties did not interrupt or terminate

petitioner’s single integrated business enterprise of con-

structing residential subdivisions. Respondent bases his

argument primarily on the contention that the multiple

corporation were shams, that there was no real independ-

ent business purpose in their separate creation and utili-

zation, and that thoughout the existence of all the Colt

corporations in substance all income from the development

and sale of property was earned by Development which

continued in existence when the other corporations were

liquidated. Respondent contends therefore that the distri-

butions made to petitioner should not be considered liqui-

dating distributions in exchange for petitioner’s entire

stock interest under section 331(a)(1) * because petitioner

still holds 500 shares of Development which has not ceased

2Sec. 331. Gain or Loss TO SHAREHOLDERS IN CORPORATE

LIQUIDATIONS.

(a) General Rule. — |

(1) Complete Liquidations——Amounts distributed in complete

liquidation of a corporation shall be treated as in full payment

in exchange for the stock.

22a

doing business, and that the amounts paid to petitioner

are distributions of earnings and profits of an ongoing

enterprise, taxable as ordinary income.

In the alternative, if we find that the four Colt corpora-

tions were not shams, respondent contends that capital

gain treatment provided under section 331 must be disal-

lowed because petitioner, along with Revitz and Sherman,

acquired control of the Colt corporations for the principal

purpose of the ‘‘evasion or avoidance of Federal income

tax by securing the benefit of a deduction, credit, or other

allowance when such person or corporation would not

otherwise enjoy.’’ Section 269(a) (2).

We have faced the issue of the shamness of multiple

corporations previously in Aldon Homes, Inc., 33 T. C. 582

(1959), upon which respondent relies, and Shaw Construc-

tion Company, 35 T. C. 1102 (1961). Although there are

slight gradations of tone and minor variations in texture,

the facts and evidence in this case paint a picture which

in essence is the same as the Aldon and Shaw cases. In

Aldon, we found that the multiple corporations lacked any

substantial business purpose for organization as such and

that none of the corporations engaged in any independent

substantive business activities. Therefore, we did not rec-

ognize their separateness for tax purposes and under sec-

tion 22(a), IRC 1939, attributed their entire net income

to one corporate taxpayer.

In Shaw, we again upheld respondent’s attribution of all

income derived from the development and sale of residen-

tial property to the taxpayer, Shaw Construction Com-

pany, based on our finding that ‘‘the multiple corpora-

tions * * * were shams, existing in name only, serving no

business purpose and in reality performing no business or

other functions.’’ We consider respondent’s position in

the case at bar to be squarely supported by both these

cases.

meme a

23a

As we recognized in Aldon and Shaw, taxpayers are

entitled to cast their business transactions so as to min.-

mize their tax liability. Gregory v. Helvering, 293 U.S. 469

(1935); United States v. Cumberland Pub. Serv. Co., 338

U.S. 451 (1950). At the same time, the government may

challenge and disregard the form so chosen if it is unreal

or a sham. As stated in Moline Properties, Inc. v. Com-

missioner, 319 U.S. 436, 439 (1943), so long as the purpose

of a corporation ‘‘is the equivalent of business activity or

is followed by the carrying on of business by the corpora-

tion’’ it remains a separate entity, but ‘‘in matters relat-

ing to the revenue, the corporate form may be disregarded

where it is a sham or unreal. In such situations the form

is a bald and mischievous fiction.”’

We have considered the evidence both documentary and

testimonial in the record befvre us, and conclude that the

Colt entities, other than Development, were not organized

for any business purpose and did not engage in any busi-

ness separate from Development. These corporations

served served no purpose except to obtain a tax benefit

which is not ‘‘business’’ sufficient to grant them recogni-

tion as separate ‘‘tax-worthy’’ entities for Federal tax

purposes. National Investors Corporation v. Hoey, 144 F.

2d 466, 468 (C.A. 2, 1944); Aldon Homes, Inc., supra, at

597.

Petitioner contends that the five corporations were sep-

arate entities which took title to the property, arranged

for improvements to lots, paid for construction and ar-

ranged the sale of homes thereon, and that use of five cor-

porations instead of one was necessary to limit liability.

Petitioner further contends that there is no evidence that

he and his associates acquired control of the five Colt

corporations for the principal purpose of evading or avoid-

ing taxes, and that ‘‘even if there were such evidence, the

proposed disallowance of the capital gain credit is clearly

unauthorized by”’’ section 269.

24a

Finally, petitioner argues that, even if respondent can

successfully show a lack of business purpose during the

existence of a corporation, this does not preclude the ap-

plicability of section 331, ‘‘provided that the distribution

in liquidation was made by a corporation having separate

legal existence.’’

With regard to petitioner’s primary contention, we do

not consider the nominally separate activities of the Colt

entities to reflect the operation of five independent busi-

nesses. It is clear from the evidence in the record that

petitioner and his associates, either through Gerasi or

Development, performed all work necessary to the devel-

opment and sale of homes in Burnt Mills Park and Fox-

hall. The evidence shows that Homes, Builders, Contrac-

tors, and Properties were no more than shells. These ‘‘cor-

porations’’ had no employees or assets, shared offices, offi-

cers, and directors, and did not do any business unless

they could be considered to be doing business in the devel-

opment of the two subdivisions, Burnt Mills Park and Fox-

hall, which in our view in substance they cannot. The ac-

‘ual development activities were planned and carried out

as part of a single integrated venture, with no attempt to

distinguish between the Colt entities. The organization of

more than a single corporation added nothing to the enter-

prise and caused unnecessary duplication of bookkeeping

and other activities. Petitioner justifies this wasteful dupli-

cation of activities by claiming that management feared

tort and other liability inherent in developing a subdivi-

sion of such substantial size. Petitioner cites Southern

Dredging Corp., 54 T.C. 705 (1970), to illustrate that a

business purpose of limiting liability warrants the creation

and recognition of several corporations, despite identical

ownership and management and similar business activities.

In Southern Dredging, two brothers operating a partner-

ship decided to organize four corporations, one of which

leased and operated three dredges, each dredge being

owned by a separate corporation. The formation of sep-

25a

arate entities was precipitated by the expansion of opera-

tions into more hazardous dredging operations in inland

waterways. We recognized the presence of a valid business

purpose of insulating one corporation’s assets against the

others’ liabilities in this hazardous activity. We stated

that the fact that all four corporations shared the same

offices, address, telephone, repair service, and management

and had all their bookkeeping performed by one individ-

ual did ‘‘not detract from the validity of having separate

corporations for the realistic purpose of limiting liabil-

ity.’’ Southern Dredging Co., supra at 721. We also noted

that the formation of separate entities was further moti-

vated by the fact that a prerequisite to the sale of a for-

mer part-owner’s share of the business to the remaining

owners was that they form separate corporations to pro-

tect his creditor’s interest, a precaution readily understood

in light of the fact that marine and liability insurance

available was insufficient to eliminate the substantial tort

risk involved. The circumstances in that case do not equate

to the situation before us here. Petitioner’s business is

less hazardous and unpredictable than that of the taxpayer

in Southern Dredging Co., supra. Tort risk in petitioner’s

business is not of such magnitude so that a single claim

might exceed insurance coverage and jeopardize the well-

being of the entire enterprise. Petitioner’s business was

adequately protected by insurance.

The hazards which the Colt entities faced in their con-

struction business were similar to those encountered by the

taxpayers in Aldon and Shaw. In each of those cases we

rejected arguments that the need to limit various types of

liability justified having multiple corporations. We reject

these same contentions raised by petitioner. As we said in

Aldon, supra at 598:

There was little or no demonstration as to how they

would operate to the economic benefit of Aldon or the

alphabet corporations. Particularly is this true of the

purpose to avoid the possibility of a ‘‘general claim”’

26a

against the total project. We are left {) surmise what

the nature of such a claim might be with little to stim-

ulate our imagination in this respect, except the refer-

ence to a suit resulting from an accident in the devel-

opment of another tract. This, however, would appear

to fall under the limitation of tort liability purpose.

The benefits to be derived in this area from the use of

multiple corporations are likewise unclear, particular-

ly in view of the known custom of construction com-

panies, as well as most businesses, to carry liability

insurance, and the operation of workmen’s compensa-

tion laws. The income tax returns filed by the alphabet

corporations wherein deductions were claimed by each,

in substantially the same amounts, for both ‘‘Gener-

al’? and ‘‘Workmen’s Compensation”’ insurance, indi-

cate they were fully protected in both respects. The

stockholders already had the benefit of a ‘‘corporate

shield’’ in Aldon, and on the evidence shown, the seek-

ing of additional insulation through the formation of

16 more ‘‘corporate shields’’ was at best of minimal

business significance.

We also see little merit in the contention that the

use of multiple corporations was necessary to facili-

tate the handling of mechanics’ liens. As a general

rule mechanics’ as well as materialism’s liens, are

related in time of filing and in liability to the particu-

lar building or improvement for which they are fur-

nished, though this may be and frequently is changed

by the contract or arrangement under which they are

supplied. See 36 Am. Jur., Mechanics’ Liens, secs. 167-

175. Here the houses were built on a mass production

basis, that is, construction was initiated on lots in the

first block of the subdivision and progressed lot by lot

up and down the streets until the entire tract was

completed. Workers moved from house to house as

their phase of the work was ready to be done. Pre-

sumably materialmen’s and mechanics’ liens attached

to the houses as completed and it is not made clear to

us how the use of multiple corporations would ‘‘ease

the handling of mechanics’ liens’’ to any greater ex-

tent. * * * The recited purpose relating to the han-

dling of mechanics’ liens, as in the case of the first two

enumerated purposes, was but a ‘‘make weight’’ fac-

27a

tor secondary to the parties’ primary objective of

avoiding taxes.

Sherman testified that he regarded the multiple corpo-

rate structure as vital to avoid potential problems with

subcontractors. Although his testimony is unclear, we as-

sume that he was referring to such problems as shoddy

workmanship or a subcontractor’s failure to perform work

on schedule. However, he did not explain why problems

such as these could not just as easily be minimized by a

single corporation which could limit the amount of work

given to any single contractor. Instead, more often than

not, each Colt corporation contracted with the same sub-

contractors to perform a major part of the work through-

out the entire development. Such practice is not consistent

with the purported fear of problems with subcontractors.

Petitioner raised the proposition that the use of multiple

corporations might minimize the financial risks of building

a residential development of the magnitude of Burnt Mills

Park or Foxhall but did not explain how this result would

be attained. Since the Colt corporations built homes of the

same style and price in the same development, unfavorable

market conditions would most likely affect all five corpo-

rations in the same manner. In addition, petitioner, Revitz,

and Sherman gave personal guarantees on construction

and purchase-money loans on behalf of all five corpora-

tions, so that any claim arising from financial failure of a

single Colt entity would necessarily have direct financial

repercussions on all Colt entities. We find that this con-

tention lacks merit.

It is not clear that the financial risks of the enterprise

were ever really transferred to the Colt entities, since

there is no evidence to show that the Colt entities assumed

total liability for the purchase price of the Burnt Millis

Park and Foxhall tracts. As the findings of fact reflect,

Gerasi financed the purchase of the tracts and, as far as

the record shows, remained primarily liable not only on

28a

second mortgages in favor of the banks but also on first

mortgages issued to the respective sellers. When the lots

were transferred to or through Development to the other

Colt entities, no funds were transferred to Gerasi as pay-

ment. Rather, the purchase price of the lot was simply

shown in corresponding journal entrics as an open account

indebtedness until the lot was sold, at which time the re-

spective Colt corporation would pay the portion of the

sales price to obtain release of the seller’s underlying pur-

chase-money lien and, presumably, apply the balance to

the amount owed to Gerasi. Since the brunt of liability re-

mained on Gerasi, petitioner’s multiple corporate structure

did not alleviate this particular aspect of financial risk at

all.

Anticipating our conclusion that the Colt entities were

shams for tax purposes, petitioner submits that a finding

of shamness and lack of business purpose of a liquidating

corporation would not preclude the applicability of section

331, ‘‘provided that the distribution in liquidation was

made by a corporation having separate legal existence.”’

Petitioner does not refer us to any statute or case law to

support this proposition.* Contrary to petitioner’s posi-

tion, application of the ‘‘sham doctrine’’ to the case at bar

* We have found no case specifically involving this issue. In the

case of Walter L. Morgan, 33 T.C. 30 (1959), reversed on another

issue 288 F. 2d 676 (C.A. 3, 1961), we held that assets of one cor-

poration conld not be allocated to another corporation under section

45, I.R.C. 1939 (now sec, 482, I.R.C. 1954), and concluded that a

taxpayer was entitled to report cain on the liquidation of a cor-

poration the gross income and deductions of which had been allo-

cated to another corporation as capital gain. The respondent

acquiesced in this holding and it was not involved in the appeal.

In our view the Morgan case is distinguishable from the instant

ease both on its facts, the second liquidated corporation having had

its income and deductions allocated to the corporation we held in

the first issue to have been also properly liquidated. and as a matter

of law. since our holding there related solely to the application of

sec. 45, I.R.C. 1939, to the liquidation of a corporation.

29a

logically precludes a finding that the transactions struc-

tured as liquidations under section 331 were in fact liqui-

dations. To explain the impact of a finding of shamness,

once we determine that the five Colt entities are in reality

a single corporation, we attribute all earnings from sales

of homes in Burnt Mills Park and Foxhall subdivisions to

the single enterprise. Since this enterprise still exists as

Development and continues to carry out the business of de-

veloping residential subdivisions under the Colt name, the

distributions made by it cannot qualify for treatment un-

der section 331 within the plain wording of the statute.

If the entire transactions in the formation and use of

the corporations other than Development are ignored for

lack of substance, then all that has occurred here is that

Development has distributed its earnings and profits to

its shareholder, petitioner. It follows that this distribution

is a dividend to petitioner. In our view this is the proper

conclusion as to the substance of what occurred under the

facts here present.‘ The only other view that might be

taken of the substance of the transaction is that petition-

er’s acquisition of ‘‘stock’’ in the other Colt corporations

was in substance acquisitions of additional stock in Devel-

opment, and in substance petitioner received earnings and

profits of the corporation in redemption of a part of his

stock in the corporate enterprise so that tax treatment of

the distributions would be governed by section 302.°

* Petitioner makes no argument that in fact this is not the proper

conclusion if we hold the Colt corporations other than Development

were shams and that sec. 331 does not automatically apply to any

corporation which has a legal existence under state law. Petitioner

does not argue that if we hold the Colt corporations other than

Development to be shams we should consider whether the purported

liquidations of these corporations should be viewed as a partial

liquidation of Colt and the facts in the records are not sufficient to

make such a determination.

5’ Sec. 302. DistrisuTIons In RepeMPTION oF STocK.

(a) General Rule.—-If a corporation redeems its stock (within

30a

Section 302(a) allows exchange treatment, and concom-

mitant capital gains on certain categories of redemptions

outlined in section 302(b). Failure to qualify under one of

the meaning of section 317(b)), and if paragraph (1), (2), (3), or

(4) of subsection (b) applies, such redemption shall be treated as

a distribution in part or full payment in exchange for the stock.

(b) Redemptions Treated as Exchanges.—

(1) Redemptions not equivalent to dividends.—Subsection

(a) shall apply if the redemption is not essentially equivalent

to a dividend.

(2) Substantially disproportionate redemption of stock—

(A) In general.—Subsection (a) shall apply if the dis-

tribution is substantially disproportionate with respect to

the shareholder.

(B) Limitation.—This paragraph shall not apply unless

immediately after the redemption the shareholder owns

less than 50 percent of the total combined voting power of

all classes of stock entitled to vote.

distribution is substantially disproportionate if—

(i) the ratio which the voting stock of the corpora-

tion owned by the shareholder immediately after the

redemption bears to all of the voting stock of the

corporation at such time,

is less than 80 percent of—

(ii) the ratio which the voting stock of the cor-

poration owned by the shareholder immediately before

the redemption bears to all of the voting stock of the

corporation at such time.

For purposes of this paragraph, no distribution shall be

treated as substantially disproporticnate unless the share-

holder’s ownership of the common stock of the corporation

(whether voting or nonvoting) after and before redemp-

tion also meets the 80 percent requirement of the pre-

ceding sentence. For purposes of the preceding sentence,

if there is more than one class of common stock, the deter-

minations shall be made by reference to fair market value.

(D) Series of redemptions.—This paragraph shall not

apply to any redemption made pursuant to a plan the

purpose or effect of which is a series of redemptions re-

sulting in a distribution which (in the aggregate) is not

3la

the four categories set forth in section 302(b) results in

amounts paid being treated as distributions of property

under section 302(d) which, in conjunction with sections

301 and 316, causes the distribution to be ordinary income.

Section 302(b)(4) obviously does not apply in this case

since that subsection is limited to certain railroad corpo-

rations.

Since petitioner has not terminated his interest in the

Colt enterprise, he does not qualify under section 302(b)

(3) for exchange treatment. Nor does the transaction fit

within the confines of section 302(b)(2) which defines sub-

stantially disproportionate redemptions of stock. This

leaves for our consideration section 302(b)(1) which per-

mits capital gain treatment if the redemption is not essen-

tially equivalent to a dividend.

The determination of whether a distribution is essen-

tially equivalent to a dividend generally depends upon the

facts and circumstances of each case, but in United States

v. Davis, 397 U.S. 301 (1970), the Court stated that when

a sole stockholder causes a part of his shares to be re-

substantially disproportionate with respect to the share-

holder.

(3) Termination of shareholder’s interest.—Subsection (a)

shall apply if the redemption is in complete redemption of all

of the stock of the corporation owned by the shareholder.

(4) Stock issued by railroad corporations in certain re-

organizations.—Subsection (a) shall apply if the redemption

is of stock issued by a railroad corporation (as defined in

section 77(m) of the Bankruptcy Act, as amended) pursuant

to a plan of reorganization under section 77 of the Bankruptcy

Act.

e @ e 6 ® s ©

(d) Redemptions Treated as Distributions of Property.—Except

as otherwise provided in this subchapter, if a corporation redeems

its stock (within the meaning of section 317( b)), and if subsection

(a) of this section does not apply, such redemption shall be treated

as a distribution of property to which section 301 applies.

32a

deemed the ‘‘redemption is always ‘essentially equivalent

to a dividend’ within the meaning of that phrase in sec-

tion 302(b)(1) * * *.’’ In that case the Court further stat-

ed (at 313):

If a corporation distributes property as a simple div-

idend, the effect is to transfer the property from the

company to its shareholders without a change in the

relative economic interests or rights of the stockhold-

ers. Where a redemption has that same effect, it can-

not be said to have satisfied the ‘‘not essentially equiv-

alent to a dividend”’’ requirement of section 302(b) (1).

Rather, to qualify for preferred treatment under that

section, a redemption must result in a meaningful re-

duction of the shareholder’s proportionate interest in

the corporation. * * * [Emphasis supplied. ]

Clearly, the petitioner’s redemption of part of his stock

in the Colt enterprises would not qualify under the holding

in Davis since it would not be not essentially equivalent to

a dividend. After the redemption, petitioner was the sole

shareholder in the Colt enterprise. Therefore if the distri-

bution to petitioner is viewed as a redemption of part of

his stock in the Colt enterprise, section 302(d) imposes

ordinary income treatment on amounts distributed to pe-

titioner.

Because certain issues have been disposed of by agree-

ment of the parties,

Decision will be entered under Rule 155.

33a

UNITED STATES TAX COURT

Docket No. 176-71

Decision

Pursuant to the opinion of the Court filed June 18, 1974,

and incorporating herein the facts recited in the respond-

ent’s computation as to the findings of the Court, it is

Orperep and Decipep: That there are deficiencies in in-

come tax due from the petitioners for the taxable years

1966 and 1967 in the amounts of $88,151.38 and $6,711.20,

respectively.

JUDGE.

Entered:

* . * * *

It is hereby stipulated that the foregoing is in accord-

ance with the opinion of the Court and the respondent’s

computation, and that the Court may enter this decision,

Werner Strupp

Counsel for Petitioners

1705 DeSales Street, N.W.

Washington, D.C. 20036

(202) 296-2640

Meape WHITAKER

Chief Counsel

Internal Revenue Service

By:

Tuomas C. Morrison

Staff Assistant to Regional Counsel

422 Universal North Building

1875 Connecticut Avenue, N.W.

Washington, D.C. 20009

(202) 964-2065

34a

UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

No. 75-1084

Raymonp GreensBerc and Marityn GreEenBeRG, Appellants,

CoMMISSIONER OF INTERNAL ReveNnvE, Appellee.

Appeal from the United States Tax Court.

Irene F. Scott, Judge.

Argued July 9, 1975 Decided July 28, 1975

Before Craven, Burzyer, and Fiexp, Circuit Judges.

Werner Strupp for appellants; Carolyn R. Just, Attor-

ney, Tax Division (Scott P. Crampton, Assistant Attorney

General of the United States; Gilbert E. Andrews. and

Gary R. Allen, Attorneys, Tax Division, Department of

Justice, on brief) for appellee.

Per Curiam:

Raymond Greenberg and Marilyn Greenberg appeal

from a judgment of the Tax Court holding that Mr. Green-

35a

berg, a stockholder, received ordinary income rather than

a capital gain from the liquidation of four corporations

when he retained his ownership of stock in a fifth corpora-

tion which continued the business. We affirm on the opin-

ion of the Tax Court. The court’s cruciai “nding that the

five corporations were really one business entity, which is

amply supported by the evidence, justified treating dis-

tribution of the earnings and profits of the four liquidated

corporations as substantially equivalent to a dividend.

We find no error in the Tax Court’s refusal to quash

a subpoena duces tecum directed to the taxpayers and

their accountant, and in the consequent admission into

evidence of documents obtained by execution of the sub-

poena. The facts do not support the taxpayers’ charge

that the subpoena was illegally used to conduct a second

examination in violation of Section 7605(b) of the Internal

Revenue Code.

Nor did the court abuse its discretion in denying a mo-

tion for a new trial so that the taxpayer could produce

additional evidence in support of a claim of partial distri-

bution, a theory that neither party had briefed for trial.

AFFIRMED.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.