Petition — Norton v. United States

SAR ee eH ee cee mmm

IN THE SUPREME COURT

OF THE UNITED STATES

October Term, 1977

No. 96-1756

EMMETT E. NORTON and FRANCES G. NORTON,

Petitioners,

Vv.

THE UNITED STATES,

Respondent.

PETITION FOR WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF CLAIMS

Charles P. Duffy

Counsel for Petitioners

1404 Standard Plaza

Portland, Oregon 97204

(503) 226-1371

cca

SUBJECT INDEX

Page

Opinion Delivered in Court Below 2

Jurisdiction 2

Questions Presented 2

Statutes Involved 4

Statement of Case 4

Reasons Relied on for Allowance

of Writ 7

Conclusion 15

Appendix A - Opinion of the Court

of Claims A-1 - A-10

Appendix B - Order Denying

Rehearing B-l1 - B-2

Appendix C - Sections 1221 and

1231, Title 26, U.S.C. C-1 - C=-3

ii

TABLE OF CASES CITED

Agway, Inc. v. United States,

(2978) »s se, SB, ;

524 F.2d 1194

Barclay v. Untted States,

(1964) 166 Ct. Cl. 421,

333 F.2d 847

Corn Products Refining Co. v.

Commissioner, (1975) 350

is -F 46

Deltide Fishing & Rental Tools,

Ince. v. United States,

(D.C. La. 1968) 279 F.Supp.

661

2,3,7,

9,10,11,

13,15,

16,17,

18

17

E. I. du Pont de Nemours Company v. 17

Untted States, (1961) 153

Ct. Cl. 274, 288 F.2d 904

Ferrer, Commissioner v.

(CCA 2, 1962) 304 F.2d 125

Grant Oil Tool Co. v. United

States, (1967) 180 Ct. Cl.

620, 381 F.2d 389

Hollywood Baseball Association v.

Commissioner, (CA 9, 1970)

423 F.2d 494

Philadelphia Quartz Company v.

United States, (1967) 179

Ct. Cl. 191, 374 F.2d 512

17

17

iii

TABLE OF STATUTES CITED

Section 453, Title 26, U.S.C.

Section 1221, Title 26, U.S.C.

Section 123l, Title 26, U.S.C.

Section 1255, Title 28, U.S.C.

Section 1491, Title 28, U.S.C.

MISCELLANEOUS

Eustice, "Contract Rights, Capital

Gain, and Assignment of

Income-the Ferrer Case (1964)

20 Tax L.Rev. 1, at 14

oa |"

iy

IN THE SUPREME COURT

OF THE UNITED STATES

October Term, 1977

No.

EMMETT E. NORTON and FRANCES G. NORTON,

Petitioners,

Vv.

THE UNITED STATES,

Respondent.

PETITION FOR WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF CLAIMS

Petitioners request that a writ of

certiorari be issued to review the deci-

sion of the United States Court of Claims

in the above-captioned case, which was

entered on March 23, 1977.

OPINION BELOW

The opinion of the Court of Claims

(App. A, tnfra, pp. A-1 to A-10) has not

yet been officially reported. It is

unofficially reported in 77-l U.S. Tax

Cases at 49296 and in 77 American Federal

Tax Reports 2d at 477-499.

JURISDICTION

The opinion of the Court of Claims

was entered on March 23, 1977. The order

denying the petition for rehearing (App.

B, tnfra, pp. B-1 to B-2) was entered

April 29, 1977.

The statutory provision believed to

confer on this Court jurisdiction to

review the decision in question is

Section 1255 of Title 28 of the United

States Code.

QUESTIONS PRESENTED

In the light of this Court's 1955

declaration in Corn Products Refining Co.

v. Commisstoner, 350 U.S. 46, that:

"Congress intended that profits

and losses arising from the every~-

day operation of a business be

considered as ordinary income or

loss rather than capital gain or

loss. The preferential treatment

provided by § 117 [the capital

gains provision, now Section 1221

of the Internal Revenue Code]

applies to transactions in pro-

perty which are not the normal

source of business income. It

was intended ‘to relieve the tax-

payer from * * * excessive tax

burdens on gains resulting from a

conversion of capital investments,

and to remove the deterrent effect

of those burdens on such conver-

sions.' Burnet v. Harmel, 287 U.S.

at page 106, 53 S.Ct. at page 75."

The questions presented here for

review are:

1. Whether the principles enunciated

by this Court in the Corn Products case

should have been applied by the Court of

Claims to a single sale in the final

liquidation of the taxpayer's business.

2. Whether the Corn Products princi-

ple should be applied to the sale of an

asset described in Section 1231 of the

Internal Revenue Code.

STATUTES AND INTERNAL REVENUE

REGULATIONS INVOLVED

The application of Sections 1221 and

1231 of the Internal Revenue Code are

involved. The pertinent provisions of

these statutes are set forth in Appendix

C, infra, pp. C-l1 to C-3.

STATEMENT OF THE CASE

l. Factual Background. This is a

tax refund action, the facts of which are

not in dispute. In January, 1968, peti-

tioner Emmett E. Norton entered into a

timber purchase contract with the Forest

Service of the United States Department of

Agriculture, by the terms of which he

acquired the right to cut and ownership of

certain designated timber in Alaska.

During the year 1968 and continuing until

March, 1969, Norton was engaged in the

business of logging the timber and sell-

ing the logs produced therefrom. In

March, 1969, Norton sold to Ketchikan Pulp

Company, an unrelated corporation, all of

the timber and timber cutting rights

acquired by him under the Forest Service

contract for the sum of $127,500, payable

as the timber was removed. During the

years 1969, 1970 and 1971, Norton received

the agreed purchase price from Ketchikan

Pulp Company in payment for the timber and

cutting rights.

In filing their joint federal income

tax return for the year 1969, petitioners

duly elected to report the sale on the

installment basis pursuant to Section 453

of the Internal Revenue Code.

In January, 1973, petitioners were

notified by the District Director of

Internal ° .enue in Anchorage, Alaska, of

proposed income .-.x deficiencies against

them for the years 1969, 1970 and 1971

aggregating $16,166, plus interest, based

upon treating the proceeds as ordinary

income rather than income from the sale of

a capital asset described in Section 1221

or from the sale of an asset described in

Secton 1231 of the Internal Revenue Code.

Thereafter, petitioners paid the income

tax deficiencies, plus interest, filed

timely refund claims and, when the refund

claims were disallowed, filed this timely

action in the Court of Claims in February,

1975. The basis for federal jurisdiction

in the Court of Claims was Section 1491 of

Title 28 of the United States Code.

2. Proceedings in the Court of

Claims. The facts not being in dispute,

in June, 1975, petitioners filed in the

Court of Claims their Motion for Summary

Judgment and in October, 1975, respondent

filed its Cross Motion for Summary Judg-

ment. The matter came on for oral argu-

ment before a three-judge panel of the

Court of Claims on January 14, 1977 and on

March 23, 1977 the Court rendered its

Opinion (Appendix A).

On April 4, 1977, petitioners filed a

timely Petition for Rehearing En Banc,

which was denied April 29, 1977 (Appendix

B).

REASONS FOR GRANTING THE WRIT

The decision of the Court of Claims,

in holding that the principle of Corn

Products applies to a single sale of

either a Section 1221 or Section 1231

asset, has decided a federal question in a

way in conflict with applicable decisions

of this Court. It also involves an impor-

tant question of federal law which has not

been, but should be, settled by this

Court.

I

The Timber Sale Contract itself was

a capital asset within the meaning of

Section 1221 of the Internal Revenue Code.

If the Court finds that the contract

itself (rather than the cutting rights or

timber which was the subject of the

contract) was sold by Emmett E. Norton to

Ketchikan Pulp Company, it should follow

that a capital asset was sold.

By the statutory definition in

Section 1221 of the Internal Revenue Code

(Appendix C), the term "capital asset"

includes all "property" held by a taxpayer,

exclusive of five listed exceptions, none

of which is apposite to this contract.

The contract itself was not depreciable

and was not real property, so the excep-

tion in Section 1221(2) would not be

applicable. If it were, then Section

1231(b) (1) would control; but the tax

result would be the same.

Since the decision in Commissioner v.

Ferrer, (CCA 2, 1962) 304 F.2d 125, the

courts have agreed that a contract is a

capital asset, and its sale at a profit

entitled to capital gains treatment, where

the contract rights created an equitable

interest in or an equitable encumbrance on

specific property which was itself a

capital asset. Eustice, "Contract Rights,

Capital Gain, and Assignment of Income--

the Ferrer Case" (1964) 20 Tax L. Rev. l,

at 14.

Did the Timber Sale Contract here

create in the vendee, Emmett E. Norton, an

equitable interest in the timber? In

interpreting a similar government timber

sale contract, the Court of Claims in

Barclay v. United States, (1964) 166 Ct.

Cl. 421, 333 F.2d 847, stated:

"Under this contract Dahl (one

of the plaintiffs) did not acquire

legal title to the timber on un-

allotted lands but he did acquire

beneficial ownership of all timber

on the tract..."

In addition to the five exceptions

listed in Section 1221 defining "capital

asset", there is, of course, the nonsta-

tutory exception enunciated in Corn

Products Refining Co. that profits and

losses arising from the everyday operation

10

of a business should be given ordinary

income tax treatment and that only trans-

actions in property which are not the

normal source of business income should

give rise to capital gains or losses. By

no stretch of the imagination can the

routine, day-to-day sale of corn futures

in the Corn Products case be equated with

Emmett E. Norton's one isolated sale of a

timber contract.

II

The timber which was the subject of

the Timber Sale Contract was “real pro-

perty used in the trade or business" of

petitioner Emmett E. Norton, within the

meaning of Section 1231(b)(1) of the

Internal Revenue Code.

If the Court finds that the cutting

rights or timber (as distinguished from

the contract itself) was sold, it should

follow that a Section 1231(b) (1) asset

(Appendix C) was sold, since it would come

11

within the definition of "~eal property

used in the trade or busines." found in

Section 1231(b)(1). In that event, the

sale of such property rights would still

be accorded capital asset treatment by

virtue of Section 1231.

In Corn Products this Court dealt

with a manufacturer of products made from

corn, which entered into contracts to sell

such products. In order to protect itself

from sharp increases in the cost of its

materials, it bought corn futures. In

other words, it was engaged in hedging

transactions. In one year it realized a

substantial profit from the sale of the

corn futures, and in other years suffered

losses. In computing its tax liability,

Corn Products originally reported these

amounts as ordinary profit and loss from

its manufacturing operations but subse-

quently took the position that the futures

were capital assets and that gains and

12

losses therefrom should have been treated

as arising from the sale of capital assets.

The Tax Court found as a fact that the

petitioner's futures transactions were an

integral part of its business designed to

protect its manufacturing operations

against price increases in its principal

raw material and to assure a ready supply

for future manufacturing requirements.

This Court held:

"Congress intended that profits

and losses arising from the

everyday operation of a business

be considered as ordinary income

or loss rather than capital gain

or loss. The preferential treat-

ment provided by (the capital

gains statute) applies to trans-

actions in property which are not

the normal source of business

income. It was intended 'to

relieve the taxpayer from...

excessive tax burdens on gains

resulting from a conversion of

capital investments and to remove

the deterrent effect of these

burdens on such conversions. '"

Until the opinion in this case was

issued, (Appendix A) neither the Court of

Claims nor any other court had ever

13

applied the Corn Products principle to a

single sale, whether or not in the final

liquidation of a taxpayer's business.

By definition, a Section 1231 asset

must be "used in the trade or business" of

the taxpayer. If the decision of the

Court of Claims is to be followed, the

statute could have no application to any

sale of a business asset and would, for

all practical purposes, be repealed.

Petitioner's one sale in liquidation

of the business can hardly be equated

with the number of sales of corn future

contracts (5,000 bushels each) by Corn

Products Refining Co. which totaled 755,

535 and 728, respectively, in the three

tax years involved there. Corn Products

Refining Co. v. Commisstoner, 16 T.C. 395,

at 397.

The sale of the Turn Point

contract was not a part of the everyday

business of petitioner Emmett Norton. It

14

was the only one he ever made and termin-

ated his business.

IIl

The opinion below did not respond to

the issues as presented by the parties.

Petitioners and defendant agreed in

their respective briefs filed in the lower

court that petitioners’ interest in the

Turn Point contract and the underlying

timber was real property used in the

petitioners’ trade or business within the

purview of Section 1231 of the Internal

Revenue Code. Despite this agreement of

the opposing parties the opinion holds to

the contrary. At the oral argument none

of the three judge panel indicated at any

time a disagreement with this basic

factual premise and the oral arguments

were, therefore, based upon an assumption

that this issue was not in dispute. We

submit that had the Court of Claims so

expressed itself, the parties would have

15

addressed themselves to this issue and

not assumed its acceptance.

Since the opposing parties agreed

that the timber sale contract was “real

property", the issues presented to the

Court of Claims in the briefs and on the

oral argument (in addition to petitioners’

alternate Section 1221 argument) narrowed

to the issue of whether or not the Corn

Products principle should be applied to

the sale of Section 1231 assets. By

declaring in its opinion that petitioners

did not acquire an interest in the timber,

the lower court avoided this issue. We

submit that the issue was fairly presented

to the Court of Claims panel and should

have been resolved by it.

CONCLUSION

We submit that this Court should

review this case because the Corn Products

principle has been applied in this and

countless other cases by the lower courts

16

during the past twenty years in various

and conflicting ways and has been extended

far beyond the originally intended scope

of this principle. As the Court of

Claims itself declared in its 1975 deci-

sion in Agway, Ine. v. United States, 524

F.2d 1194:

"Corn Products has been applied

in lower courts in a variety of

situations which possibly might

surprise the Corn Products court."

Before the decision of the Court of

Claims in the instant case, however, no

court had ever applied the Corn Products

principle to a single sale, whether or

not in the final liquidation of a tax-

payer's business.

It is also submitted that this Court

should hear this case to declare whether

or not the Corn Products principle should

be extended to the sale of depreciable

property ©r real property used in the

trade or business of the taxpayer, as

17

those terms are defined in Section 1231

of the Internal Revenue Code. Despite

agreement by petitioners (in the alterna-

tive) and respondent in the briefs filed

in the Court of Claims that the sale of

a Section 1231 asset was involved here,

the Court of Claims held to the contrary,

thus avoiding this issue. On three prior

occasions* the Court of Claims declined to

apply the Corn Products principle to the

sale of Section 1231 assets. There is an

extended discussion of the reasons why the

Corn Products principle should not be

applied to the sale of Seciion 1231 assets

in Deltide Fishing & Rental Tools, Ine. v.

*E. I. du Pont de Nemours Company v.

Untted States, (1961) 153 Ct. Cl. 274,

288 F.2d 904

Philadelphia Quartz Company v. United

States, (1967) 179 Ct. Cl. 191,

374 F.2d 512

Grant Otl Tool Co. v. United States,

(1967) 180 Ct. Cl. 620,

381 F.2d 389

18

United States, (D.C. La. 19608) 279 F.Supp.

661. On the other hand, the Court of

Appeals for the Ninth Circuit held on one

occasion that it could apply. dHollywood

Baseball Assoctatton v. Commisstoner,

(1970) 423 F.2d 494.

This apparent conflict should be

resolved by this Court.

It is submitted that a clarification

by this Court of the extent of the appli-

cation of the Corn Products principle

would be beneficial to these and other

taxpayers and even to the Internal Revenue

Service itself.

For these reasons, it is respectfully

submitted that this Petition for a Writ

of Certiorari should be granted.

Charles P. Duffy

1404 Standard Plaza

Portland, Oregon 97204

(503) 226-1371

Counsel for Petitioners

Gn the United States Court of Claims

No. 31-75

(Decided March 23, 1977)

EMMETT E. NORTON and FRANCES G. NORTON v.

THE UNITED STATES

Charles P. Duffy, attorney of record, for plaintiff. Duffy,

Stout, Georgeson & Dahl, of counsel.

C. Patrick Derdenger, with whom was Acting Assistant

Attorney General Myron C. Baum, for defendant. Theodore

D. Peyser, of counsel.

Before Davis, KasHiwa and Kunzic, Judges.

ON PLAINTIFFS’ MOTION FOR SUMMARY JUDGMENT AND

DEFENDANT'S CROSS MOTION FOR SUMMARY JUDGMENT

KasHiwa, Judge, delivered the opinion of the court:

This tax refund action involving the characterization of

gain realized by plaintiffs from their sale of a timber

cutting contract is before the court on cross motions for

summary judgment. The facts essential to the disposition of

the case are not in dispute. For the reasons set forth below,

we agree with the defendant that the gain realized by the

plaintiffs does not qualify as gain from the sale of a capital

asset. We, therefore, allow defendant’s cross motion for

summary judgment.

Appendix A - 1

2

Plaintiff,| Emmett E. Norton, an individual doing

business as the Norton Logging Company, on January 30,

1968, entered into a timber cutting contract? with the

United States Forest Service (hereinafter referred to as the

Turn Point contract). The Turn Point contract specified:

In consideration of the premises and the promises

hereinafter contained, Forest Service agrees to sell and

permit Purchaser to cut and Purchaser agrees to

purchase and cut included Timber.

All right, title and interest in and to any included timber

in the Turn Point contract remained in the Forest Service

until it had been cut, scaled and paid for; at that time, title

vested in the plaintiff who then had to remove the

processed timber from the contract sales area within the

period of the contract. All losses, except for negligence,

were to be borne by the party holding title.

Throughout the remainder of 1968 and until March 19,

1969, plaintiff was engaged in the logging business. This

entailed both the cutting of the standing timber located in

the South Tongass National Forest subject to the Turn

Point contract and the selling of the logs to Ketchikan Pulp

Company (hereinafter referred to as Ketchikan), an unre-

lated Washington corporation. The plaintiff did not operate

a sawmill nor was he engaged in manufacturing lumber,

veneer or other wood products. His sole activity was the

cutting of the standing timber and its sale to Ketchikan.

As the standing timber was cut and scaled, the plaintiff

was required to pay the Forest Service under the terms of

the contract $9.05 per thousand board feet for Sitka Spruce

and $2.32 per thousand board feet for Western Hemlock

and other species. To insure the performance of his

obligation under the Turn Point contract, the plaintiff

executed a performance bond in the amount of $5,000.

' Frances G. Norton is a party to this action only because she filed joint returns

with her husband, Emmett E. Norton, for the years in question. Where reference is

made to Mr. Norton acting individually, he will be referred to as the “plaintiff”;

where reference is made to both Mr. and Mrs. Norton, they will be referred to as the

“plaintiffs.”

* United States Department of Agriculture Forest Service Timber Sale Contract

No. 05-92. The contract relates to certain designated timber in the South Tongass

National Forest, State of Alaska.

Appendix A - 2

3

During the period January 30, 1968, through March 19,

1969, the plaintiff logged 9,919,040 board feet of the

estimated 30,000,000 board feet of timber subject to the

contract.

On March 19, 1969, 13% months after the plaintiff

entered into the Turn Point contract, he sold all of the

timber cutting rights under the contract to Ketchikan for

the sum of $127,500,° with no interest thereon, payable at

the rate of $8.50 per thousand board feet of logs produced.

In connection with the transaction, Ketchikan executed a

promissory note which recites that Ketchikan will pay the

plaintiff the $127,500, regardless of an over-run or under-

run of the volume of timber under the Turn Point

contract.*

Prior to the March 19, 1969, sale to Ketchikan, the

plaintiff had neither sold nor held for sale a Government

timber contract. After that sale, the plaintiff ceased

independent logging operations entirely and sold all

logging equipment, machinery and supplies to Ketchikan.

In filing their joint federal income tax return for the

year 1969, the plaintiffs elected to report the gain realized

from the sale of the timber cutting rights to Ketchikan on

the installment basis pursuant to § 453.° Their tax basis for

determining gain or loss was $7,400,° with a resulting 94.2

percent of gain. On their income tax returns for the years

1969, 1970 and 1971, the plaintiffs reported 94.2 percent of

the amount received from Ketchikan as long-term capital

gains.

Upon audit of plaintiffs’ tax returns, the Commissioner

of the Internal Revenue Service (Commissioner) deter-

? Even though the bill of sale specified that both the Turn Point contract and

various pieces of logging equipment were sold for $127,500, the Norton affidavit

makes it clear tisut the $127,500 was the purchase price of the timber cutting rights

alone.

* Since the total purchase price was not dependent upon the amount of timber cut,

plaintiff concedes that he did not retain an economic interest in the timber

transferred to Ketchikan within the meaning of LR.C. § 631(b). Therefore, L.R.C. §

1231(bx2) is not applicable to the instant case.

* Unless otherwise indicated, all section references are to the Internal Revenue

Code of 1954. :

* Plaint*fs’ tax basis is the sum of a $5,000 cash bond and a $2,400 advance

stumpage deposit with the Forest Service.

Appendix A - 3

4

mined that the gain recognized by plaintiffs in 1969, 1970

and 1971, attributable to the sale of the Turn Point

contract to Ketchikan, should have been reported as

ordinary income rather than as long-term capital gain. A

statutory notice of deficiency for 1969 through 1971 was

issued by the Commissioner on March 20, 1973. Thereafter,

plaintiffs received billings for the deficiency, which they

were unable to pay within 10 days because of lack of funds.

On November 21, 1973, the plaintiffs paid $8,000 to the

District Director, Anchorage, Alaska. On January 21, 1974,

the Division of Veterans Affairs of the Department of

Commerce of the State of Alaska paid, on the plaintiffs’

behalf, the remaining sum of $10,999.48 from the proceeds

of a loan.’

Plaintiffs filed with the Interna] Revenue Service (IRS)

Center at Ogden, Utah, their timely refund claims for the

years 1969 through 1971. The IRS not having acted upon

their refund claims for more than 6 months after the date

of filing, the plaintiffs filed a petition in this court based

upon the same grounds as set forth in the refund claims.

Plaintiffs argue that the timber cutting contract involved

herein was a capital asset, or in the alternative, plaintiff's

interest in the contract and underlying timber was “real

property used in the trade or business” of plaintiff within

the meaning of § 1231(bX1). Under either alternative,

plaintiffs contend that the gain realized on the sale of the

contract qualifies as long-term capital gain since the

contract was held by plaintiff for more than six months.

Nevertheless, plaintiffs concede that a portion of the

payments received by them on the sale of the Turn Point

contract should be imputed interest, taxable as ordinary

income.* Lastly, plaintiffs seek refund of the additions to

the tax, “late-payment penalties,” which they argue should

* Payments totaling $18,999.48 were received by the Internal Revenue Service:

$5,468.81 was allocated to plaintiffs’ 1969 tax year: $6,290.58 was allocated to

plaintiffs’ 1970 tax year; and $7,240.09 was allocated to plaintiffs’ 1971 tax year.

* LR. § 483; Treas. Reg. § 1.483-1(cX2), T.D. 6873, 1966-1 C.B. 101. In the case of

an installment contract which does not contain any provision for interest, the

amount of interest to be imputed is computed at the rate of 5 percent per annum

compounded semiannually. Although not applicable to the instant case, it should be

noted that T.D. 6873 was amended by T.D. 7394, 1976-1 CB. 135.

Appendix A - 4

5

not have been exacted from them since their failure to pay

the deficiencies within ten days of the date of the first

notice and demand therefor was due to reasonable cause—

inability to pay or undue hardship—and not due to willful

neglect within the purview of § 6651(aX3).

On the other hand, defendant contends that the gain

realized by plaintiffs from the sale of the Turn Point

contract does not qualify for capital gain treatment.

Initially, the defendant submits that plaintiffs interest in

the Turn Point contract and the underlying timber was

real property used in plaintiff's trade or business; it must

be treated as a noncapital asset by virtue of § 1221(2), but is

precluded from § 1231(a) treatment by the Corn Products®

doctrine since the contract was an integral part of the

plaintiff's business. Alternatively, defendant argues that

the Corn Products doctrine would exclude plaintiff's

contract from § 1221. Defendant has failed, however, to

address the plaintiffs’ last contention that their failure to

pay the deficiencies within ten days of the date of the first

notice and demand therefor was due to reasonable cause.

We are faced with the preliminary issue of whether

plaintiff's interest in the Turn “oint contract would qualify

either as a § 1221 asset or as a § 1231(bX1) asset, but for the

Corn Products doctrine. Of necessity, we then must

examine the Corn Products doctrine to determine its

applicability to the instant case.

Defendant contends and the plaintiffs submit as an

alternative argument that plaintiff's interest in the Turn

Point contract and underlying timber was real property

used in the plaintiff's trade or business. We find these

contentivns lack merit. To constitute realty plaintiff must

have acquired a present interest in the standing timber on

the execution of the contract. The facts before us do not

demonstrate that the parties to the contract intended to

transfer « present interest in the standing timber. As we

earlier recapitulated, the contract gave plaintiff the righi

to purchase and cut timber; however, until cut and paid

for, the title to that timber remained in the seller. This

* Corn Products Refining “> v. Comm'r, 350 U. S. 46 (1955).

Appendix A - 5

6

indicates an intent that no present interest in real

property, the standing timber, passed to the plaintiff. We

have considered our decision in Barclay v. United States,'°®

in addition to United States v. Giustina,'' which decisions,

while interpreting similar timber cutting sales contracts

with relation to the word “owner” in § 117(kX2) of the 1939

Code [now § 631(b) of the 1954 Code], held that such

contracts gave the holder beneficial ownership of all the

timber on the tract.'* To the defendant, the fact that

plaintiff had beneficial ownership in the timber is suffi-

cient to make the timber cutting contract real property.

Defendant reasons that standing timber is real property;

therefore, a timber cutting contract which gives beneficial

ownership in standing timber is real property. With this

reasoning we cannot agree. The above cases define owner

status for § 117(kX2) of the 1939 Code purposes; they do not

determine that the timber contract there in issue is real

property. In fact, this court in Barclay’* refused to consider

whether the timber contract there in issue qualified for §

117(a) of the 1939 Code [now §§ 1221 and 1222 of the 1954

Code] which thereby obviated the need to determine

whether the contract was real property used in the

taxpayer’s trade or business. Since we are convinced that

on the facts before us the parties did not intend to transfer

a present interest in the standing timber, we hold that

plaintiff's interest in the Turn Point contract was not real

property used in his trade or business. It should be noted

that our decision is compatible with the Tax Court’s

decision in J. R. Simplot Co. v. Commissioner,'* which held

that a similar contract was insufficient to transfer a

present interest in the standing timber.

To disqualify the Turn Point contract from § 1231(bX1),

we must also determine that it was not “property used in

the trade or business of a character which is subject to the

*° 166 Ct. Cl. 421, 333 F. 2d 847 (1964). See also Union Bag-Camp Paper Corp., 163

Ct. Cl. 525, 325 F. 2d 730 (1963).

** 313 F. 2d 710 (9th Cir. 1962).

** See also Treas. Reg. § 1.631-2ieX2) (1960) and Rev. Rul. 58-295, 1958-1 C.B. 249.

** 166 Ct. Cl. at 427, 333 F. 2d at 851.

‘* 26 T.C.M. (CCH) 488 (1967).

Appendix A - 6

7

allowance for depreciation provided in section 167.” Given

the nature of the contract, this task is not difficult. The

Turn Point contract was merely a sales contract obligating

the plaintiff to purchase a specific amount of timber—

whether cut or not—within a period of approximately

three years.'* Nonetheless, the contract was not the type

asset which diminished in value with use or passage of time

and it had neither a basis nor a useful life; consequently, it

was not of a character subject to the allowance for

depreciation. We, therefore, hold that the Turn Point

contract was not property used in the plaintiff's trade or

business within the definition of § 1231(bX1). However, we

do not agree with the plaintiffs who submit that the

contract is a § 1221 asset.

The plaintiffs argue that they sold the Turn Point

contract, itself, rather than the timber which was the

subject of that contract. They assert that the contract was

“property” which did not fall into any of the specified

exclusions of § 1221 and, therefore, the contract is a capital

asset, the sale of which gave rise to capital gain. The

plaintiffs also rely upon Commissioner v. Ferrer,‘* for the

proposition that a contract is a capital asset if the contract

rights created an equitable interest in specific property

which was itself a capital asset. By arguing that the

contract gave plaintiff an equitable interest in the timber

subject to the contract, citing Barclay v. United States,

supra, the plaintiffs reason that they sold a capital asset.

We disagree.

With respect to the treatment of amounts received on the

sale of contract rights, courts have approached in nu-

merous ways the question of whether the property disposed

of was the type of property that Congress intended to

classify as a capital asset.'’ Plaintiffs point to the approach

'* The contract was awarded on January 30, 1968, and was to terminae on

December 31, 1970.

** 304 F. 2d 125 (2d Cir. 1962).

‘7 Eustice, Contract Rights, Capital Gain, and Assignment of Income—the Ferrer

Case, 20 Tax L. Rev. 1 (1964). The approaches may be grouped into certain broad

categories: (1) Is the asset “property” which is a “capita) asset” under § 1221? See

Comm'r v. Gillette Motor Transport Co., 364 U.S. 130 (1960); Comm'r v. Ferrer, supra

note 16. (2) Do the amounts received by the taxpayer upon the sale of the contract

Appendix A - 7

8

utilized in Ferrer to support their argument. In Ferrer,

Judge Friendly summarized the immense body of deci-

sional law in the assignment of income area and wrestled

with the various complex issues that can arise from the

basic question of whether a taxpayer has transferred a

“property” right or an “income” right. Rather than utilize

this approach, we feel that the instant case can be decided

under the Corn Products doctrine exception to the statuto-

ry syllogism that all property is a capital asset unless

specifically excluded by the exceptions in § 1221.

The Supreme Court has stated that the sale of property,

though not literally within the exceptions of § 1221, may

nevertheless give rise to ordinary income or loss when the

asset is an integral part of the taxpayer’s business. Corn

Products Refining Co. v. Commissioner, supra note 9. The

application of the Corn Products doctrine to the instant

case seems clear to us. The plaintiff was engaged in the

logging buciness: cutting standing timber and selling the

cut timber to Ketchikan. The Turn Point contract gave the

plaintiff the right to cut timber; it insured the plaintiff a

ready source of supply of the logging business raw

material, timber. The contract, therefore, was essential to

and an integral part of plaintiffs logging business.

The contract gave plaintiff rights in the timber which were

so integrally related to his ordinary business objectives of

logging the timber that a “business use” intention rather

than an “investment” intent prevailed.'* In other words,

the contract was acquired by plaintiff with an intention

that it would serve an integral function in his regular

business activities and that motive had not changed at the

time of sale. Under the Corn Products doctrine, gain on the

sale of that contract is, therefore, part of plaintiffs

rights represent a substitute for future ordinary income that would otherwise have

been received by the taxpayer? See Comm'r v. P. G. Lake Inc., 356 U. 8. 260 (1958);

Comm'r v. Ferrer, supra. (3) Does the transaction constitute a “sale or exchange”? See

Fairbanks v. United States, 306 U. S. 436 (1939). (4) Was the property acquired with

an intention that it would serve an integral function in the taxpayer's regular

business activities? See Corn Products Refining Co. v. Comm'r, supra note 9.

** However, it should be noted that our approach here does not serve to read out of

the statute the obvious and important class of “business connected” assets covered

by § 1231

Appendix A - 8

—_—_—_— a

9

ordinary business income. We are not persuaded otherwise

by plaintiffs’ argument that since the sale of the Turn

Point contract represents the concluding phase of liquidat-

ing the logging business, the Corn Products doctrine should

not be applied.'®

Since we hold that the gain realized by the plaintiffs

from the sale of the Turn Point contract was ordinary

income within the rationale of the Corn Products doctrine,

we need not consider the applicability of § 483 to the

instant case.”° However, we must address plaintiffs’ argu-

ment that the additions to the tax, as provided under §

6651(aX3), should not have been exacted from them.

Plaintiffs argue that their failure to pay the deficiencies

within ten days of the date of the first notice and demand

therefor was due to their inability to pay which to them

was reasonable cause, not willful neglect.

Reasonable cause for failure to pay tax exists to the

extent the taxpayer can satisfactorily show that he

exercised ordinary business care and prudence in providing

for the payment of his liability, but was, nevertheless,

either unable to pay the tax or would have suffered “undue

hardship’’' if he paid on the due date.?* The burden of

proving that the failure to pay was due to reasonable cause

and not to willful neglect is on the taxpayer. If the

taxpayer offers no excuse, the penalty will be sustained by

the court.?*

In the instant case, plaintiffs have failed to introduce

any evidence to show that their failure to pay the tax was

due to reasonable cause. We must, therefore, sustain the §

6651(aX3) addition to the tax.

'* See J. R. Simplot Co. v. Comm'r, 26 T.C.M. (CCH) at 492. Cf. Hollywood Baseball

Ass'n v. Comm'r, 423 F. 2d 494, 499-500 (9th Cir.), cert. denied, 400 U. S. 848 (1970)

(Corn Products doctrine applied to § 337).

7° L RC. § 483fK3).

*' Undue hardship has the same meaning for § 6651(aX3) purposes as it does under

$ 6161, extensions of time to pay tax, Treas. Reg. § 1.6161-1(b) (1960).

** Treas. Reg. § 301.6651-lick1), T.D. 7133, 1971-2C.B. 415.

*? Deffendall v. United States, 386 F. Supp. 509, 512 (D. Or. 1974); Fischer v.

Comm'r, 50 T.C. 164, 177 (1968). Cf. Olshausen v. Comm'r, 273 F. 2d 23 (9th Cir.

1959), cert. denied, 363 U. S. 820 (1960) (I.R.C. § 294 of the 1939 Code, burden to prove

reasonable cause on the taxpayer).

Appendix A - 9

10

CONCLUSION

For the reasons hereinbefore stated, plaintiffs’ motion for

summary judgment is denied, defendant’s cross motion for

summary judgment is granted and plaintiffs’ petition is

dismissed.

Appendix A - 10

IN THE UNITED STATES COURT OF CLAIMS

No. 31-75

EMMETT E. NORTON and

FRANCES G. NORTON

Vv.

THE UNITED STATES

Before DAVIS, Judge, Presiding,

KASHIWA and KUNZIG, Judges.

ORDER

This case comes before the court on

plaintiffs' motion, filed April 4, 1977,

for rehearing en banc pursuant to Rules

7{d} and 151(b). Upon consideration

thereof, together with the response in

opposition thereto, without oral argument,

by the six active Judges of the court as

to the suggestion for rehearing en banc

under Rule 7(d), which suggestion is

denied, and further having been so con-

sidered by the panel listed above as to

the motion for rehearing under Rule

151(b),

Appendix B - l

IT IS ORDERED that plaintiffs’ said

motion for rehearing, filed April 4, 1977,

be and the same is denied.

BY THE COURT

/s/ Oscar H. Davis

Oscar H. Davis

Judge, Presiding

Appendix B - 2

APPENDIX C

APPLICABLE SECTIONS OF THE

INTERNAL REVENUE CODE OF 1954

"Sec. 1221. For purposes of this

subtitle, the term 'capital asset" means

property held by the taxpayer (whether

or not connected with his trade or busi-

ness), but does not include--

(1) stock in trade of the tax-

payer or other property of a kind

which would properly be included in

the inventory of the taxpayer if on

hand at the close of the taxable

year, or property held by the tax-

payer primarily for sale to custom-

ers in the ordinary course of his

trade or business;

(2) property, used in his trade

or business, of a character which is

subject to the allowance for depre-

ciation provided in section 167, or

real property used in his trade or

business;

(3) a copyright, a literary,

musical, or artistic composition, a

letter or memorandum, or similar

property, held by--

(A) a taxpayer whose per-

sonal efforts created such

property,

(B) in the case of a

letter, memorandum, or similar

property, a taxpayer for whom

such property was prepared or

produced, or

Appendix C - l

(C) a taxpayer in whose

hands the basis of such property

is determined, for purposes of

determining gain from a sale or

exchange, in whole or part by

reference to the basis of such

property in the hands of a tax-

payer described in subparagraph

(A) or (B);

(4) accounts or notes receivable

acquired in the ordinary course of

trade or business for services ren-

dered or from the sale of property

described in paragraph (1); or

(5) an obligation of the United

States or any of its possessions, or

of a State or Territory, or any poli-

tical subdivision thereof, or of the

District of Columbia, issued on or

after March 1, 1941, on a discount

basis and payable without interest at

a fixed maturity date not exceeding

one year from the date of issue."

"Sec. 1231. (a) GENERAL RULE.--If,

during the taxable year, the recognized

gains on sales or exchanges of property

used in the trade or business, plus the

recognized gains from the compulsory or

involuntary conversion (as a result of

destruction in whole or in part, theft or

seizure, or an exercise of the power of

requisition or condemnation or the threat

or imminence thereof) of property used in

the trade or business and capital assets

held for more than 6 months into other

property or money, exceed the recognized

losses from such sales, exchanges, and

conversions, such gains and losses shall

be considered as gains and losses from

sales or exchanges of capital assets held

Appendix C - 2

for more than 6 months. If such gains do

not exceed such losses, such gains and

losses shall not be considered as gains

and losses from sales or exchanges of

capital assets. ...

(b) DEFINITION OF PROPERTY USED IN

THE TRADE OR BUSINESS.--For purposes of

this section--

(1) GENERAL RULE.--The term

‘property used in the trade or busi-

ness' means property used in the

trade or business, of a character

which is subject to the allowance for

depreciation provided in section 167,

held for more than 6 months, and real

property used in the trade or busi-

ness, held for more than 6 months,

which is not--

(A) property of a kind

which would properly be includ-

ible in the inventory of the

taxpayer if on hand at the ciose

of the taxable year,

(B) property held by the

taxpayer primarily for sale to

customers in the ordinary course

of his trade or business, or

(C) a copyright, a liter-

ary, musical, or artistic com-

position, a letter or memoran-

dum, or similar property, held

by a taxpayer described in para-

graph (3) of sectio: 1221.

(2) TIMBER, COAL, OR DOMESTIC

IRON ORE.--Such term includes timber,

coal, and iron ore with respect to

which section 631 applies."

Appendix C - 3