Petition — Furrer v. Commissioner

Supreme Court, U. $,

FILED

MAR 24 1978

MICHAEL RODAK, JR., CLERK

IN THE

SUPREME COURT OF THE UNITED STATES

October Term 1977

no. @¢~- 1354

RALPH and ROSEMARIE FURRER,

Petitioners,

vs.

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

PRESTON C. HIEFIELD, JR.

WILLIAMS, STARK, HIEFIELD,

NORVILLE & GRIFFIN, P.C.

Attorneys at Law

775 Boise Cascade Building

_Portland. Oreaon 97201

Counsel ror retitioners

INDEX

OPINIONS BELOW

JURISDICTION

QUESTION PRESENTED

STATUTES INVOLVED

STATEMENT OF THE CASE

REASONS FOR GRANTING THE WRIT

CONCLUSION

APPENDICES

A

la

lb

AUTHORITIES CITED

CASES PAGE

Bisbee-Baldwin Corporation v.

Tomlinson, 320 F.2dq 929 (5th

Cir. 1963) - . - . - . > _ 7 . *. . 17

Commissioner v. Ferrer,

304 F.2d 125 (2d Cir. 1962) ... 14, 17

Commissioner v. Goff,

212 F.2d 875 (3d Cir. 1954),

cert. denied, 348 U.S. 829

(1954) . 2 «© © © © © © © © © © oe e) «616, 19

Commissioner v. Golonsky, 200 F.2d

72 (3d Cir. 1952), cert. denied,

345 U.S. 939 . _ . . . . * 7 . . 19

Commissioner v. McCue Bros. &

Drummond, 210 F.2d 752 (2d Cir.

. @ 6 6 See 6 oe 8 8. 4 eo 15

Commissioner v. The Pittston Company,

252 F.2d 344 (20 Cir. 1958), cert.

denied, 357 U.S. 919 (1958) ... 15, 19

Elliott v. U.S., 431 F.2d 1149

To Gas Be. « «| «#6484 18

Jones v. Corbyn, 186 F.2d 450 (10th

Gate 1950) —_ a . . . . > . +. 7 oe 18

Maryland Coal & Coke Co. v. McGinnes,

F. Supp. 654 (B.D. Pa., 1964),

aff'd per curiam, 350 F.2d 293

( d Cir. . a . . . . . - . . 16

Nelson Weaver Realty Co. v.

CommisSioner, 307 F.2d 897 (Sth

Cir. 1962) . a ee hlUuwelhlUrPMhlUC OhlmhUCUCOUmUC SMC U|]CU 16

United States v. Dresser, 324 F.2d

36 (Sth Cir. 1963) 2. 2. os wo 18

United States yv. Eidson, 310 F.2d 11l

i i ee 17

Wiseman v. Halliburton Oil Well

——

GOment ing Co., 301-F.20 654 (10th

re ) wt. 7 2 = oe Se eS oe et a 18

STATUTES

26 U.S.C.A. Section 1221 3. 4&3

26 U.S.C.A. Section 1222 6

28 U.S.C.A. Section 1254(1) 2

IN THE

SUPREME COURT OF THE UNITED STATES

October Term 1977

No.

RALPH and ROSEMARIE FURRER,

Petitioners,

vs.

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

Ralph and Rosemarie Furrer

petition for a Writ of Certiorari to review

the judgment of the United States Court of

Appeals for the Ninth Circuit entered

December 30, 1977.

OPINIONS BELOW

The Opinion of the Court of

Appeals (App. A) is reported at 566 F.2d

1115 (9th Cir. 1977). The Opinion of the

Tax Court (App. B) is reported as 35 T.C.M.

1525 (1976).

JURISDICTION

The Judgment of the Court of

Appeals was entered in December 30, 1977.

This Petition for Certiorari was filed

within ninety (90) days of that date. This

Court's jurisdiction is invoked under 28

U.S.C. Section 1254(1).

QUESTION PRESENTED

Whether a judgment award recovered

by Petitioner for an insurance company's

breach of contract is taxable as ordinary

income or capital gain.

STATUTES INVOLVED

26 USCA Section 1221. CAPITAL ASSET

DEFINED.

For purposes of this subtitle, the

term “capital asset" means property held by

the taxpayer (whether Or not connected with

his trade or business), but does. not

include--

(1) stock in trade of

the taxpayer 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 taxpayer primarily for

sale to customers 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

al lowance for depreciation

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

personal efforts created such

property,

(B) in the case of a

letter, memorandum or similar

property, a taxpayer for aise

such property was prepared or

produced, or

(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 taxpayer

described in subparagraph (A)

or (B);

(4) accounts or notes

receivable acquired in the

ordinary course of trade or

business for services rendered 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 political

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.

26 USCA Section 1222. OTHER TERMS RELATING

TO CAPITAL GAINS AND LOSSES.

x* *« &

(3) Long-term capital gain. --

The term “long-term capital gain" means gain

from the sale or exchange of a capital asset

held for more than 6 months if, and to the

extent, such gain is taken into account in

computing gross ‘income.

STATEMENT OF THE CASE

This is a petition for a

redetermination of the income tax liability

of the Petitioners pursuant to a deficiency

assessed by the Commissioner of Internal

Revenue for the calendar year 1970.

On May 1, 1959, Petitioner entered

into an Agreement with Industrial Hospital

Association (IHA) whereby Petitioner became

a special agent. The executed Agreement, in

content highly unusual and unique, granted

the Petitioner the right to develop, in any

area in which IHA was licensed to do

business, as an exclusive independent

contractor and not as an employee of the

company, individual insurance business for

IHA.

As special agent for IHA,

Petitioner had the exclusive right to

recruit agents to sell IHA's policies. He

was authorized to negotiate sales agency

agreements between the recruited agents and

IHA. In addition, Petitioner developed new

types of policies for IHA. He brought to

IHA his concept of a dollar deductible

health and accident insurance policy with an

80% co-insurance provision on a nonscheduled

basis.

The Agreement provided that

Petitioner would be compensated solely on a

commission basis, with commissions computed

as a percentage of the gross premiums paid

on all individual policies. While

Petitioner was associated with the IHA

companies, they provided him with office

space and secretarial help. He was obliged,

however, under the Agreement to bear all

other expenses he incurred in his work, such

as travel and telephone expenses.

The May l, 1959, Agreement

provided that it would remain in effect for

one year, at the end of which time it was to

be renewed automatically from year to year.

Both parties had the right to terminate at

the end of each renewal period by giving

Sixty days advance written notice. IHA,

however, was prohibited from terminating the

contract during any year in which net

premiums (gross premiums less sales

commissions) exceeded $500,000.00 and the

pure claims loss is 60% or less on the net

dues (gross dues less commissions paid).

During the period May, 1959,

through February, 1966, Petitioner built up

Substantial goodwill, files and _ records

co. taining the agency agreements between IHA

and the individual agents he _ recruited,

renewal agreements and correspondences

concerning claim disputes. Petitioner also

prepared a variety of sales literature and

brochures pertaining to the individual

policies offered, for which he received no

reimbursement.

By February, 1965, Petitioner had

created an agency sales force of over 800

agents, generating premiums received from

the sale of individual policies in 1965 in

excess of $900,000.00 per year, thereby

invoking the foregoing prohibition of

termination provision of the May l1, 1959,

Agreement.

In February, 1966, IHA notified

Petitioner that it was terminating the

special agency Agreement as of May 1, 1966.

During the year May 1, 1965, through April

30, 1966, however, the net premiums received

on policies sold by the taxpayer's acents

were sufficiently great and the percentage

of claims to premiums was sufficiently low

as to bar such termination by IHA with

respect to its IHA Oregon operations.

In subsequent declaratory judgment

and breach of contract actions, the

Multnomah County Circuit Court, with the

Oregon Supreme Court affirming, granted

Petitioner damages of $213,011.48. In

computing the amount of damages, the Trial

Court computed. the present value of the

commissions lost because of IHA's unlawful

termination and subtracted from this amount:

(1) the present value of the expenses

necessary to perform the contract, (2) the

present value of Petitioner's earnings

subsequent to the termination of the 1959

Agreement, and (3) certain payments already

made to Petitioner by IHA.

During the ensuing trial on the

damages claim, the only evidence Petitioner

presented relative to his damages pertained

to his loss of commission income. However,

it is noted by Petitioners’ attorney that

one way to calculate a loss of a property

right is by showing evidence of lost income.

On his 1970 Federal Income Tax

Return, Petitioner reported the $213,011.48

as capital gain income and allocated the

deduction for attorneys’ fees and court

costs between the award and interest

therein. In November, 1974, the

Commissioner asserted a deficiency enainet

the taxpayer as to his 1970 income tax in

the amount of $38,530.74. The large part of

that deficiency was attributable to the

Commissioner's determination that the award

taxpayer received from IHA was taxable as

ordinary income.

The United States Tax Court held

that the judgment award was taxable as

Ordinary income. It reasoned that the

characterization of a damage judgment for

tax purposes should hinge upon the nature of

rights being protected and injuries being

redressed. The Court took the view that the

injury redressed here was the loss of

commission income payable under the

Agreement and concluded that taxpayer's

damage recovery should be taxed as ordinary

income. The United States Court of Appeals

for the Ninth Circuit affirmed the decision

of the Tax Court.

Petitioner seeks review, and

reversal.

REASONS FOR GRANTING THE WRIT

This case involves a question

which has constantly been litigated in

American courts with inconsistent results,

for the various Circuits have no uniform

approach in determining the federal income

tax treatment to be accorded to contract

termination payments. In this area of

contract rights, termination by sale,

transfer or cancellation raises the

following questions: should the taxpayer's

gain in the sale or surrender be

characterized as ordinary income on the

ground that the sales price or termination

payment received is a substitute for the

future ordinary income that would have been

earned under the contract? Or should the

gain be characterized as capital gain on the

ground that contracts are like other capital

assets--property rights that have value in

the goodwill which attaches to them or

because of their ability to produce, or

contribute to the production of, future

ordinary income? A court will look to see

whether the asset “property” is a “capital

asset" under Section 1221, whether’ the

amount received represents a substitute for

future ordinary income, and whether the

transaction constitutes a "sale or exchange”

to answer these questions. |

The cases can nevertheless be

divided into three categories: first, those

decisions in which the disposition of a

contract right is treated simply as an

anticipation of future income, under a

Standard Hort-Lake analysis; second, at the

opposite pole, those which openly or

impliedly reject the Hort-Lake approach and

instead regard the termination of a contract

right as a sale of property qualifying for

capital gain; and third, those largely in

the Second Circuit, which are decided under

a rule of “substantiality” based upon an

assumed distinction between simple contract

Claims and possessory interests in the

nature of a lease. The cases in each

category, to repeat, uniformly apply a

concept of qualifying property, but with

differing results.

The trend of the recent decisions

in the Second Circuit is to analyze the

rights disposed of and, where appropriate,

to allocate the receipt between ordinary

income and capital gain. The leading case in

this area is Commissioner v. Ferrer, 304 °

F.2d 125 (2d Cir. 1962). Following a

"bundle of contract rights" approach, the

Court held that a portion of the rights

transferred as in the nature of goodwill and

the allocable part of the total purchase

price attributable thereto constituted

capital gain, and that a portion of the

rights was the right to receive a percentage

of the profits, constituting ordinary

income. In Commissioner v. The Pittston

Co., 252 F.2d 344 (2d Cir. 1958), the same

Circuit had previously determined that the

cancellation of taxpayer's exclusive right

to purchase certain coal did not constitute

a “sale or exchange" within the meaning of

the Section so as to entitle taxpayer to

treat the amount received as capital gain.

Yet in another Second Circuit case,

Commissioner v. McCue Bros. & Drummond, 210

F.2d 752 (2d Cir. 1954), the Court found a

payment received by a taxpayer lessee from a

landlord on the sale of his leasehold

interest subject to capital gain treatment,

~-)6=

finding the leasehold interest to be a

property right.

In Maryland Coal & Coke v.

McGinnes, 225 F.Supp. 854 (E.D. Pa., 1964),

affirmed per curiam, 350 F.2d 293 (3d Cir.

1965), the Court, citing Second Circuit

decisions, held that a taxpayer realized

Ordinary income on relinquishment of an

exclusive contract to sell the entire output

of a certain mine and receive commissions on

such sales. However, in Commissioner v.

taxpayer realized capital gain on the sale

of its contractual rights to act as mortgage

servicing agent for a life insurance

company.

This is seemingly contrary to

United States v. Eidson, 310 F.2d 111 (5th

Goff, 212 F.2d 875 (3d Cir. 1954), cert.

denied, 348 U.S. 939 (1953), the Court had

held that where taxpayers, who exchanged

their interest in an exclusive Buy-Sell

Agreement for stock in manufacturing

corporation, the transaction constituted a

Sale or exchange of capital assets, within

the meaning of the statute.

The Fifth Circuit, in Nelson

Weaver Realty Corp. v. Commissioner, 307

F..d 897 (Sth Cir. 1962) held that the

Cir. 1962) where the same Court held that a

taxpayer realized ordinary income on the

sale of its contractual rights to act as

general agent for a life insurance company.

In Bisbee-Baldwin Corp. v. Tomlinson, 320

F.2d 929 (5th Cir. 1963) they adopted the

Ferrer position and allocated a taxpayer's

gain on the sale of a mortgage servicing

business between capital gain and ordinary

income. The portion of the gain

attributable to goodwill, consisting

principally of relationships with mortgagors

and investors, was characterized as capital

gain. The portion of the gain attributable

to the mortgage servicing contracts was

treated as ordinary income.

-18-

In Wiseman v. Halliburton Oil Well

Cementing Co., 301 F.2d 654 (10th Cir.

1962), the Tenth Circuit held that’ the

taxpayer realized ordinary income on the

sale of an exclusive license to use and

Sublease a patented process. In United

States v. Dresser, 324 F.2d 56 (Sth Cir.

1963), the Fifth Circuit held that the

taxpayer realized capital gain on the sale

of its exclusive license to use a patented

process.

In Jones v. Corbyn, 186 F.2d 450

(10th Cir.1950), the Tenth Circuit held that

the lump sum payment which the plaintiffs

had received from a life time general

insurance agency contract had been properly

treated for tax purposes as a long term

capital gain. In Elliott v. United States,

431 F.2d 1149 (10th Cir. 1970), a lump sum

payment received for cancellation of a

general insurance contract was characterized

aS ordinary income, the Court now viewing

the payment as a substitute for the ordinary

income that would have been earned if the

contract had not been cancelled.

Petitioner is aware that this

Court has readily denied review in these

cases. Commissioner v. The Pittston Co.,

252 F.2d. 344 (2d Cir. 1958), cert. denied,

357 U.S. 919 (1958); Commissioner v. Goff,

210 F.2d 390 (5th Cir. 1954), cert. denied,

348 U.S. 829 (1954); Commissioner v.

Golonsky, 200 F.2d 72 (3d Cir. 1952),

cert. denied, 345 U.S. 939 (1953). However,

a forthright answer to this question,

important for the consistent administration

of the capital gain tax, would provide

judicial guidance by formulating a uniform

approach.

CONCLUSION

For the foregoing reasons,

-20-

Petitioners respectfully request a Writ of

Certiorari be granted.

Respectfully submitted,

WILLIAMS, STARK, HIEFIELD,

NORVILLE & GRIFFIN, P.C.

.4,! Kee PS

De

By

Preston C. Hiefield, Jr.

Attorney for Petitioner

la

APPENDIX A

UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

RALPH FURRER and ROSEMARIE FURRER,

Appellants, NO. 77-1588

vs. OPINION

COMMISSIONER OF INTERNAL REVENUE,

Appellee.

me ee ee ee ee ee ee

December 30, 1977

[566 F.2d 1115(1977)]

Before: HUFSTEDLER, SNEED and KENNEDY, Circuit Judges.

PER CURIAM:

In this case we review the finding of the

Tax Court that the damages taxpayer received for

breach of his agency contract with an insurance

company are taxable as ordinary income and not as

capital gain. We affirm.

Ralph Furrer was a special agent for

Industrial Hospital Association (IHA). His

2a

contract with IHA gave him the exclusive right to

recruit agents to sell IHA's policies; he also

developed new types of policies for IHA. He was

paid entirely on a commission basis, computed as a

percentage of gross premiums paid on policies. The

agreement provided for termination without notice,

but IHA was prohibited from terminating during any

year in which net premiums exceeded a certain

amount. Furrer maintained files containing the

agency agreements between the IHA and the

individual agents he recruited, renewal agreements,

and correspondence about claim disputes.

In violation of its agreement, IHA

terminated Furrer's contract in 1968. In

subsequent declaratory judgment and breach of

contract actions, Oregon state courts found that

the contract was wrongfully terminated and awarded

Furrer damages of $2,13.000.

The characterization of the damages

awarded depends upon both the nature of the claims

3a

asserted amd the actual basis of the recovery.

Thomson v. Commissioner, 406 F.2d 1006 (9th Cir.

1969); Spangler v. Commissioner, 323 F.2d 913 (9th

Cir. 1963). Thus, where there is a final judgment

(in contrast to a settlement before judgment), the

Court must examine both the claims set out in the

pleadings and the proof at trial, and the

characterization of the judgment by the awarding

court. Whether the claims presented and the

characterization of the award fit that aard into

the categories of “capital gain" or “ordinary

income" is a question of federal tax law. See

Gray v. Commissioner, 561 F.2d 753 (9th Cir.

1977).

Appellant Furrer presents two arguments

for characterizing the judgment as capital gain.

The first argument assumes that the judgment was

compensation solely for the loss of contract

rights but asserts that those rights were in

4a

viewed as giving appellant “substantial

intangible property rights," including a

nonterminable monopolistic right to “develop"

sales territories in states where IHA was

licensed to do buisness.

Appellant seeks to support his

characterization of the judgment with the

statement of the state trial judge who testified

before the Tax Court that:

the judgment which I awarded was

intneded to reflect the value of his

business efforts based upon his

exclusive business rights under the

agreement .. . and it was not intended

to reflect payment for loss of

prospective profits. I intended that an

entire insurance business be valued. .

- {capitalization of earnings] was just

One method available to me to determine

the value of the contract rights. It

was no different than valuing any other

asset.

Without deciding what weight may be

accorded to a judge's post hoc testimony about a

judgment he has rendered, we find this testimony

5a

judgment he has rendered, we find this testimony

affords appellant little comfort. Our holding

does not rest upon the fact that the trial court

arrived at the award through capitalization of

earnings, a method equally applicable to

determining the value of a capital asset. 1/ The

pleadings, proof or judgment simply contain no

evidence that the entire insurance business”

amounted to anything more than the right to earn

commissions.

If all contracts granting rights could be

considered capital assets, without inquiry into

1/ In calculating damages, che state court

Subtracted the present value of appellant's future

income, based upon his having secured ajob at

another company at a salary of $18,000 per year.

See Furrer v. International Health Assorance Co.,

756 Or. 429, 474 P.2d 759, 767-68 (1970). Such

mitigation is permisible only against an award for

lost income and not against the loss of capital

assets. If, on the other hand, the award was for

the loss in part of commission income and in part

of capital assets, some allocation would have been

expected, since the offsetting income could be

applied only against the former.

6a

the nature of the rights granted, almost all

Ordinary income from salaries, wages or

commissions could be transformed into capital

gain. Furrer's right was the right to earn

commission income. A long line of authorigy, some

dealing with insurance agents, supports the

conclusion that a lump sum payment for the

termination of an agency relationship is ordinary

income. This is true even though the contract be

nonterminable and exclusive. Vaaler v. United

States, 454 F.2d 1120 (8th Cir. 1972); Holt v.

Commissioner, 303 F.2d 687 (9th Cir. 1962);

Elliott v. United States, 431 F.2d 687 (10th Cir.

1970); Brown v. Commissioner 40 T.C. 861 (1963).

The fact that others are excluded from the sources

available to Furrer for earning income in no way

changes the fact that his income derived from

personal sevices and that what he lost through

7a

termnation was the right to earn future income.

And as we noted in Holt v. Commissioner, supra, at

691, "“({t]he nature of the right to receive future

income as ordinary income does not change into

capital gain by the mere receipt of a lump sum in

lieu of such future payments." Commissioner v.

P.G. Lake Inc., 356 U.S. 260 (1958); Hort v.

Commissioner, 313 U.S. 28 (1941). This attempted

transubstantiation of income into capital must

fail because the essential element - the capital

asset, tangivle or intangible - is not present.

Appellant's second argument is that the

termination of the agreement destroyed certain

capital assets which he developed and owned, and

that the judgment was, at least in part, in

compensationfor those assets. But appellant

presented no such argument in his pleadings or at

trial in the state court. Only before the Tax

Court did he argue that the termination resulted

pee a

8a

in a loss of valuable goodwil! and files of

documents and information. In a detailed

analysis, the Tax Court rejected this argument,

concluding that “ther real value was in the right

to receive future commissions.” It found no

evidence that the appellant had a right to

ownership or exclusive use of the files or that

those files contained anything not otherwise

available to IHA. It concluded that whatever

goodwill Furrer built up for IHA belonged to the

latter, and whatever goodwill he built up for

himself (such as personal contacts with the gents

he recruited) he retained after the termination.

See Vaaler v. United States, supra, at 1123.

Appellant presents to us no evidence which

undermines these largely factual conclusions.

In sum, appellant has failed to prove

that the contract rights were themselves capital

|

9a

assets or that the temination destroyed other

capital assets which he had developed. The

decisio of the Tax Court is therefore AFFIRMED.

APPENDIX B

T. Ce Memo. 1976-331

UNITED STATES TAX COURT

RALPH FURRER and ROSEMARIE FURRER, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 1246-75. Pile October 28, 1976.

Gary M. Anderson and Preston C.

Hiefield, Jr., for the petitioners.

Gary R. DeFrang, for the respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

FORRESTER, Judge: Respondent has

determined a deficiency in petitioners’ Federal

income tax for the taxable year 1970 in the amount

of $38,530.74. Concessions having been made, there

are two issues for our decision: (1) Whether a

judgment award recovered by petitioner for an

insurance company's breach of a special agency

contract is taxable as ordinary income or capital

gain; and (2) Whether claimed deduct ions for the

Operating and depreciation expenses of a boat s.ould

be disallowed pursuant to section 274(d).

FINDINGS OF FACT

Some of the facts have been stipuated

and are so found.

Petitioners Ralph Furrer and Rosemarie

Furrer, husband and wife, resided in Tigard, Oregon,

at the time they filed the petition herein.

Petitioners filed a joint Federal income tax return

for 1970 with the office of the Interal Revenue

Service at Ogden, Utah.

Petitioner Ralph Furrer (hereinafter

petitioner) worked for the National Hospital

Association (NHA) from 1935 to 1946. He returned to

NHA in 1953 to develop individual policies and an

agency force for NHA, which, at that time, was

primarily marketing group insurance am limited

individual policy coverage for group conversions.

Petitioner was executive sales manager and a member

of NHA's board of directors and, during the time he

worked for that company, he developed new individual

policies and an agency force of 400 to 500 agents.

lu.less otherwise indicated, all statutory references

are to the Internal Revenue Code of 1954.

On May 1, 1959, petitioner entered into

a special agency agreement with Industrial Hospital

Association, subsequently International Health

Assurance Co. (both companies hereinafter referred

to as IHA). The 1959 agreement was applied, by

mutual consent, to IHA of Washington and IHA of

Oregon which were wholly owned subsidiaries of IHA

formed in 1960 and 1963, respectively. By December

1965, both IHA and IHA of Washington hai merged into

IHA of Oregon.

Under the 1959 agreement, IHA appointed

petitioner as special agent and authorized him to

solicit qualified agents as sales repeneitinteus

for IHA's individual membership department and to

negotiate agency agreements with such agents on

behalf of IHA. Petitioner was also authorized to

sell IHA's individual insurance. The agreement

provided for petitioner's compensation on a

commission basis with such commissions computed as a

percentage of gross dues received by IHA on

indivudal insurance policies. Petitioner agreed

that such commissions would be his only compensation

from IHA and that all other expenses, such as travel

and telephone expenses, would be borne by him. The

agreement specifically provided that there was no

intention between the parties to create an employer-

employee relationship and that neither the agreement

nor any earned commission under it could be assigned

or transferred without the written approval of IHA.

The agreement could be terminated by either party

upon 60 days’ notice. However, if IHA terminated

the agreement, it was required to contime to pay

the special agent such compensation as he would have

been entitled had his services not been terminated

for a period of three years on all dues received and

accepted on individual policies sold by the special

agent personally or agents whose agency agreements

were negotiated by the special agent.

The 1959 agreement provided further that

it could not be terminated if the gross annual dues

received and accepted by IHA on individual policies

sold by the special agent, or agents whose

agreements were negotiated by him, exceeded a

de: ignated amount and if the claims on these

individual policies were below a specified

percentage of the gross dues received by IHA.

During the years 1959 to 1965,

inclusive, petitioner received compensation pursuant

to the 1959 agreement, and he reported such

compensation as ordinary income on his Federal

income tax returns filed for those years.

By 1965, petitioner haji developed an

agency force of over 800 active agents generating

gross dues from individual policies in 1965 in

excess of $900,000. Petitioner likewise was

instrumental in the development of the “dollar

deductible policy" which the IHA companies (IHA, IHA

of Oregon, and IHA of Washington) offered for sale.

However, insurance policies which are offered for

sale are filed with the Insurance Commisioner and

are available for inspection and copying by all

insurance companies. It is common for an insurance

company to use concepts developed by other companies

and, in fact, insurance concepts which petitioner

felt he had developed while associated with the IHA

companies were subsequently used by other insurance

companies.

Written agency agreements were executed

between the IHA companies and the insufance agents

who sold their insurance, and the IHA companies were

designated as the principal in these agreements.

However, several agents who worked under petitioner

at IHA have become agents for petitioner's

subsequent employer, Prudential Health Association

(PHA).

Petitioner was instrumental in the

development of these agency agreements. While

associated with the IHA companies, petitioner

maintained files on the agents that he supervised.

These files contained the agency agreements, renewal

agreements, and correspondence concerning claim

disputes. Upon termination of petitioner's special

agency agreement, the IHA companies took possession

of these files.

While petitioner was associated with the

IHA companies, they provided him office space and

secretarial help at no charge. During the period

fron 1959 to 1965, the IHA companies ii.cwrred

advertising expenses of $101,600. In connection

with his activities as a representative of the IHA

companies, petitioner incurred expenses of

approximately $60,000 for travel and other items for

which he received no reimbursement from the IA

compani es.

In February 1966, IHA of Oregon notified

petitioner that it was terminating the 1959

agreement as of May 1, 1966. On May 4, 1966,

petitioner filed a complaint for a declaratory

judgment in the Circuit Court of the State of Oregon

for Multnomah County. The case was tried without a

jury, and by a letter dated October 17, 1967, the

court notified the parties of its opinion. This

letter opinion held that IHA of Oregon (known as

International Health Insurance Co. at the time of

trial) had wrongfully terminated the 1959 agreement,

and the court awarded petitioner $150,000 as

compensation “for his services." This letter

opinion was later modified by eliminating reference

to the $150,000 award.

On December 20, 1967, petitioner filed a

supplemental complaint in the state court proceeding

seeking damages for breach of contract. At the

conclusion of the damages trial, the court entered a

decision for petitioner in the amount of

$213,011.48. In computing the amount of damages,

the trial court computed the present value of the

commissions lost because of MIHA's unlawful

termination and subtracted from this amount, (1)

the present value of the expenses necessary to

perform the contract, (2) the present value of

petitioner's earnings subseguent to the termination

of the 1959 agreement, and (3) certain payments

already made to petitioner by IHA. The trial court

decision was affirmed on appeal in 1970 by the

Supreme Court of Oregon in an opinion reported at

256 Ore. 429 and 474 P. 2d 759.

The pleadings in the above-described

state court proceedings did not assert claims for

the value of the records that petitioner maintained

or for the goodwill and agency force that he

developed during his association with IHA.

As a result of the circuit court's

decision, as affirmed by the Oregon Supreme Court,

petitioner, in 1970, received $213,011.48 as damages

for breach of contract and $24,307.29 as interest on

the judgment. He incurred expenses of $65,963.54

for attorneys’ fees and court costs.

On his 1970 return, petitioner reported

the $213,011.48 as capital gain income and allocated

the deduction for attorneys’ fees and court costs

between the award and the interest. On a schedule

attached as part of petitioner's return, he reported

the interest on the award, less the allocable

portion of attorneys' fees and court costs, as

ordinary income, but, inadvertently, this amount was

not carried forward from the schedule and included

as a part of petitioner's ajjusted gross income.

Petitioner has conceded such inadvertent error. In

his statutory notice, respondent determined the

amount received as damages and the interest thereon

to be ordinary income and allowed the full amount of

the attorneys' fees and court costs as a deduction

from ordinary income. 7

The parties have stipulated’ that

10b

petitioner should be allowed a deduction for

attorneys' fees and court costs totaling $65,963.54

for the taxable year 1970 regardless of the

characterization of the breach of contract award.

However, if the award is characterized as capital

gain income, then by stipulation, $58,700 of the

attorneys' fees and court costs should be applied as

a deduction in the computation of net long-term

capital gain income and the remainder of such fees

and costs should be applied as a reduction in

computing net interest income.

During 1970, petitioner incurred the

following expenses in connection with a boat that he

owned :

Repairs $ 857.97

Moor age 452.73

Gasoline, supplies, etc. 2,213.68

Insur ance 319.00

Depr eci at ion 919.27

Total : $4,762.65

In his petition filed herein, petitioner claims 75

percent of these expenses ($3,571.99) as a business

llb

Petitioner kept a boat guest register

for the period July 22, 1970 to September 20, 1970.

The register entries included the names of the

passengers and, in a few cases, their employer and

business address. Only one entry included

petitioner's business relationship to the passenger.

No records were kept of those occasions on which the

boat was used for personal purposes.

Petitioner has conceded that claimed

deductions of $3,086.53 for rental expenses and

$2,429.98 for travel and entertainment expenses were

properly disallowed by the Commissioner.

OPINION

The first issue for our consideration is

the treatment of an amount totaling $213,011.98,

which was awarded petitioner as damages for IHA's

breach of contract. Petitioner argues frist that

Claims an additional deduction of $924.28 for boat

Operating and depreciation expenses. Although the

stipulation of facts states that the boat expenses are

increased because certain expenses which are now listed

as boat expenses were included in other expense cate-

gories on the return, respondent has not asked that the

amount of any expenses, which he has previously allowed,

be decreased in order to offset the increase in the

Claimed deduction for boat expenses.

nse deduction. 2

oon his 1970 income tax return, petitioner only claimed

$2,647.71 (75 percent of $3,530.27) as a deduction for

oct expenses. In his statutory notice, respondent dis-

allowed such deduction. However, the petition herein

12

the 1959 agreement was highly unique and that his

collective rights thereunder constituted intangible

property rights which were capital assets as defined

under section 1221.3

For purposes of this subtitle, the term “capital

asset" means property held by the taxpayer (whether or

not connected with his trade or business), but does not

include--

(1) stock in trade of the taxpayer or other

property of a kind which would properly be included in

the inventory of the taxpayer if on hand at the close

Qf the taxable year, or property held by the taxpayer

SEC. 1221. CAPITAL ASSET DEFINED.

primarily for sale to customers 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

depreciation provided in section 167, or real property

used in his trade or business;

(3) a copyright, a literary, musical, or artistic

— a letter or memorandum, or similar property,

(A) a taxpayer whose personal 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 .

(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 axpayer described in subparagraph (A) or (B);

(4) accounts or notes receivable acquired in

13b

He contends that these intangible property rights

were transferred to IHA in exchange for the damages

award so that his gain is long-term capital gain

within the meaning of section 1222(3).4 Respondent

argues that the loss of petitioner's right to

receive commission income under the agreement was

the only asserted claim in the state court

proceedings and the only basis for which damages

were awarded by that court. Respondent's position

is that such a right is not a capital asset under

section 1221 and, accordingly, the amounts received

by petitioner constitute ordinary income.

The nature of the underlying claim and

the ordinary course of trade or business for services

rendered 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

political subdivision thereof, or of the District of

Columbia, issued on or after March 1, 1941, on a dis-

count basis and payable without interest at a fixed

maturity date not exceeding one year from the date of

ssue.

SEC. 1222. OTHER TERMS RELATING TO CAPITAL GAINS AND

LOSSES.

zx&xzr

(3) Long-term capital gain.-~The term “long-term

capital gain" means gain from the sale or exchange of a

asset held for more than 6 months, if and to the extent

such gain is taken into account in computing gross

gross income.

14b

the actual basis of recovery govern’ the

characterization of amounts received in a judgment

Settlement as either ordinary or capital gain

income. Thomson v. Commissioner, 406 F. 2d 1006

(9th Cir. 1969); Spangler v. Commissioner, 323 F. 2d

913 (9th Cir. 1963); State Fish Corp., 48 T.C. 465

(1967), and cases cited therein.

In the instant case, the complaints

filed in petitioner's declaratory judgment suit and

the subsequent damages trial assert claims based

solely on the petitioner's right to recieve

commission income under the 1959 agreement.

Although petitioner argues otherwise, these

complaints simply do not assert claims for the value

of any rights which petitioner may have possessed in

the goodwill, files and records or the agency force

which he created while associated with IHA.

It is true that the Oregon Supreme Court

took a broader view of the evaluation problem than

that delineated by the pleadings. However, even if

the damages awarded in the state court proceedings

: » intended to compensate petitioner for all the

15b

property transferred, if any, it is obvious that the

real value was in the right to receive future

commissions. Joseph W. Brown, 40 T.C. 861 (1963).

The damages award did not represent the

value of any goodwill, agency force, or records that

petitioner transferred to IHA. Petitioner did not

transfer any goodwill to IHA. Petitioner introduced

no evidence indicating that he entered into a

covenant not to compete with IHA. Apparently, he

was perfectly free to contact the agents that he haj

obtained for IHA and to enlist them as agents for

his new employer, PHA, as soon as his contract with

IHA was terminated. In fact, the record shows that

some IHA agents did become agents for PHA.

Accordingly, wh at ever goodwill

petitioner built up for IHA while acting as its

special agent resulted from his services as such

agent and belonged to IHA, and whatever goodwill

petitioner built up for himself as a special agent

or an insurance agent while he served IHA under the

special agency contract, he retained. Vaaler v.

United States, 454 F. 2d 1120 (8th Cir. 1972);

16b

1970); Harry M. Flower, 61 T.C. 140 (1973), affd.

505 F. 2d 1302 (Sth Cir. 1974).> Likewise, the

agents that petitioner obtained for IHA entered into

agency agreements with IHA as principal, and these

agents remained, as before, agents of IHA after

petitioner left IHA. Vaaler v. United States,

supra. Petitioner retained any personal goodwill

that he may have built up through his contacts with

these agents and the right to such personal goodwill

was the only property right that he had in the

agency force. Harry M. Flower, supra.

Furthermore, on the basis of the record

in this case, we cannot conclude that petitioner hai

a right of ownership in the records that he left

with IHA, or to the exclusive use of the information

contained therein. Petitioner has not shown that

these were personal records prepared for his own

“poy We Johnson, 53 T.C. 414 (1969), upon

which petitioner relies, is distinguishable on the

ground that the petitioners in Johnson entered into a

covenant not to compete with the buyer pursuant to the

contract for the sale of their general insurance agency

business. In Johnson (supra at 425-426), we said, "the

covenant not to compete was closely related to the sale

of goodwill and therefore failed to have any indepen-

de t significance apart from merely assuring the effec-

tive transfer of that goodwill."

17b

legitimate purposes so that they belonged to him.

Elliott v. United States, upra; Port. Inv. Co. v.

Oregon Mut. Fire Ins. Co., 163 Ore. 1, 94 P. 2d 734

(1939); National Fire Ins. Co. v. Sullard, 97 App.

Div. 233, 89 N.Y.S. 934 (2d Dept. 1904).

Additionally, petitioner has not shown that the

information contained in such records was

unavailable to IHA from other sources.

In Commissioner v. Gilletee Motor Co.,

364 U.S. 130, 134 (1960), Mr. Justice Harian,

writing for the Court, stated:

While a capital asset is defined

in section 117(a)(1) as “property held

by the taxpayer," it is evident that not

everything which can be called property

in the ordinary sense and which is

outside the statutory exclusions

qualifies as a capital asset. This

Court has long held that the term

“capital asset" is to be construed

narrowly in accordance with the purpose

of Congress to afford capital-gains

treatment only in stituations typically

involving the realization of

appreciation in value accrued over a

substantial period of time, and thus to

ameliorate the hardship of taxation of

the entire gain in one year. Burnet v.

Harmel, 287 U.S. 103, 106.

Accordingly, the damages award in this case did not

compensate petitioner for the loss of any property

18b

which qualifies as a capital asset under section

1221. The damages award represented the value of

petitioner's right to receive future commission

income under the special agency contract, which

right is not “property” for purposes of section 1221

and, therefore, not a “capital asset” as defined in

section 1221. Commissioner v. P.G. Lake, Inc., 356

U.S. 260 (1958); Vaaler v. United States, supra,

Commissioner v. Ferrer, 304 F. 2d 125 (2d Cir.

1962).

petitioner relies upon Jones v. Corbyn, 186 F. 2d

450 (10th Cir. 1950), and Sammons v. Dunlap, an

unreported case (N.D. Tex. 1952), 4a AFTR O24, 52-2 USTC

par. 9481), as authority for treating his rights under

the special agency contract as capital assets. these

cases, however, are not persuasive authority in support

of petitioner's position. In Elliott v. United States,

431 F. 2d 1149, 1154 (10th Cir. 1970), the court that

decided Jones v. Co noted that it no longer

“stood * * * as the law of this cirquit, unqualified

or unmodified." Likewise, the decision in the Sammons

case is unpersuasive because it is based on a very brief

Oral opinion without the citation of any case law or

the citation of any case law or authorit

whatever. Hyatt v. Commissioner, Fas

(Sth Cir. 1363), affg. a Memorandum Opinion of this

Court. Further more, the Sammons decision is subject

to the subsequent decision of the Court of Appeals for

the Fifth Circuit in Roscoe v. Commissioner, 215

F. 2d 478 (5th Cir. 1954), which although not citing

Sammons, strongly questions its rationale. See Maryland

Col & Coke Co. yv. McGinnes, 225 F. Supp 854 (E.D.

Pa. 1964), affd. 350 F. 2d 293 (3d Cir. 1965).

19b

Petitioner next argues that even if the

damages award represented only the value of his

right to future commissions, which is not a capital

asset under section 1121, he is, nevertheless,

entitled to have the proceeds of such damages award

treated as a capital gain by negative implication of

section 1253’ which specifies an instance in which

the transfer of an exclusive business franchise

7gpc. 1253. ‘TRANSFER OF FRANCHISES, TRADEMARKS, AND

TRADE NAMES.

(a) General Rule.--A transfer of a franchise,

trademark, or trade name shall not be treated as a sale

or exchange of a capital asset if the transferor retains

any significant power, right, or contiming interest

with respect to the subject matter of the franchise,

trademark, or trade name.

(b) Definitions.--For purposes of this section--

(1) Franchise.--The term “franchise” includes

an agreement which gives one of the parties to the

agreement the right to distribute, sell, or provide goods,

services, or facilities, within a specified area.

20b

"shall not be treated as a sale or exchange capital

asset." Petitioner reasons that since the breach of

the special agency contract constituted the transfer

of an exclusive business franchise® and since the

section 1253 prohibition does not apply, he is

therefore entitled to have the proceeds of such

damages award treated as a capital gain. We

disagree. We hold that in those transactions

covered by section 1253, the taxpayer is entitled to

capital-gains treatment only if the prohibition of

section 1253 does not apply and the requirements of

section 1221 and 1222 are met. Section 1222 defines

long-term capital gain as the gain from the (1)

sale or exchange (2) of a capital asset (3) held

for more than six months. The first sentence of

Section 1221 defines a capital asset as “property

held by the taxpayer" (emphasis supplied) subject to

several exclusions, one of which is section 1221(1)

excluding “property held by the taxpayer primarily

for sale to customers in the ordinary course of his

Swe assume, but do not decide, that the special

agency

cx atract is a franchise within the »roai definition of

section 1253(b)(1).

21b

trade or business."

Having found no cases on point, we have

looked to the legislative history of section 1253

which makes it clear that the section was intended

to deal with the problems of (1) whether the

transfer of a franchise is to be treated as a sale

or license and (2) whether the transferors are

selling franchises in the ordinary course of

business.? By a careful study of its legislative

history, we have concluded that, with respect to the

transfer of franchises, section 1253 was intended to

clarify the term “sale or exchange" as used in

section 1222 and to eliminate the interpretive

9Present law.--The substantial growth of franchising

t the United States in recent years has raised

two significant problems: First, whether transfers of

franchises are sales or licenses or, more particularly,

whether the retention of powers, rights, or a contiming

interest in the franchise agreement is significant enough

to preclude a sale; and, second, whether franchisors are

selling franchises in the ordinary course of business.

{H. Rept. No. 91-413 (Part 1), 91st Cong., ist Sess.

(1969), 1969-3 C.B. 200, 300.)

It is difficult to resolve under present law whether

the transfer of a franchise, trademark, or trade name

is to be treated as a sale or as a license, and whether

the transferors are selling franchises, trajemarks, and

trade names in the ordinary course of business. * * *

{s. Rept. No. 91-552, 9lst Cong., lst Sess. (1969),

1969-3 C.B. 423, 554.]

22b

problems arising under section 1221(1), but we have

found no evidence whatever that the section was

intended to change the meaning of the term

“property” for purposes of Section 1221 or to

eliminate the “capital asset" requirement as a

prerequisite for capital-gains treatment.

The courts have quite uniformly held

that the right to receive future income is not

“property” as defined by section 1221 so that gain

from its sale or exchange cannot be capital gain.

Vaaler v. United States, supra, and the cases cited

therein. We are not persuaded that section 1253 was

intended to change this well-established legal

principle absent a clear expression of congressional

intent to do so, accord, United States v. Barnes,

222 U.S. 513, 520 (1912), and we are unable to find

an expression of such intent in this instance.

Accordingly, we hold that petitioner is not entitled

to treat his gain from the damages award as capital

gain because it is not gain from the sale or

exchange of a capital asset amd Congress, by

enactment of section 1253, has neither changed the

23b

general definition of a capital asset nor has it

eliminated the “capital asset" requirement of

section 1222 with respect to the transfer of

exclusive business franchises.

We must next consider whether respondent

has properly disallowed claimed deductions for the

operating and depreciation expenses of a boat

pursuant to section 274(a).29 Petitioner's boat is a

facility used in connection with entertainment,

amusement, or recreation, and expenses with respect

to it are disallowed unless the petitioner

establishes that the facility is (1) used primarily

10sec, 274. DISALLOWANCE OF CERTAIN ENTERTAINMENT, ETC.,

EXPENSES.

xzx« tk

(a) Substantiation Required.--No deduction shall be

al lowed--

z«*«tk

(2) for any item with respect to an activity which

is of a type generally considered to constitute enter-

tainment, amusement, or recreation, or with respect to

a facility used in connection with such an activity * * *

zeke

unless the taxpayer substantiates by adequate records or

by sufficient evidence corroborating his own statement

(A) the amount of such expense or other item, (B) the

time and place of the travel, entertainment, amusement,

recreation, or use of the facility, or the date and

description of the gift, (C) the business purpose of the

expense or other item and, (D) the business relation-

ship to the taxpayer of person entertained, using the

facility, or receiving the gift. * * *

24b

for the furtherance of petitioner's trade or

business and (2) that the expense is directly

related to the conduct of such trade or business.

Sec. 274(a)

The Income Tax Regulations, promulgated

pursuant to secton 274(h), amplify and clarify the

requirements of section 274(d). These regulations

have been held to be generally in accordance with

the statute. William F. Sanford, 50 T.C. 823

(1968), affd. per curiam 412 F. 2d 201 (24 Cir.

1969). Section 1.274-5(c)(6)(iii), Income Tax

Regs., requires the taxpayer to maintain records of

each use of the facility containing such information

as tends to establish its primary use. For each

business use of the facility, such records should

contain the amount, time, place, and business

purpose of the entertainment, and the business

relationship to the taxpayer of the persons

entertained. For each personal use of the facility,

such records should contain an appropriate

description of the personal use including cost,

dat », number of persons entertained, the nature of

25b

the entertainment and, if applicable, information

such as mileage or its equivalent. Moreover, the

regulations state:

If a taxpayer fails to maintain adequate

records concerning a facility which is

likely to serve the personal purposes of

the taxpayer, it shall be presumed that

the use of such facility was primarily

personal .

Sec. 1.274-5(c)(6)(iii). Petitioner has failed to

maintain adequate records concerning his boat, a

facility likely to serve personal purposes, because

he has failed to make a record of each use of the

boat. Further more, petitioner has not overcome the

presumption of primary personal use as set forth in

section 1.274-5(c)(6)(iii), Income Tax Regs.,

because he has failed to substantiate--either by

adequate records or by sufficient evidence

corroborating his own’ statement--the business

purpose and the business relationship to petitioner

of the persons entertained for more than half of the

& 8

davs_on which the boat was used.’

Petitioner's self-serving testimony as to the business

purpose of such entertainment is uncorroborated except

the one occasion where Ray Brunkow, who testified in

for

the instant case, was entertained. The business purpose

the boat usage is not evident from the circumstance

the entertainment. Sec. 1.274-5(c)(2)(ii)(b), Income

26b

Since petitioner has not established

that more than 50 percent of the total calendar days

of boat usage were days of business use, we hold

that petitioner has not established that the boat

was used primarily for furtherance of his trade or

busines in that taxable year 1970. John L. Ashby,

50 T.C. 409 (1968); Sec. 1.274-2(e)(4)(iii), Income

Tax Regs.

Decision will be entered for the

respondent.

CERTIFICATE OF SERVICE

I hereby certify that I served the

foregoing Petition for a Writ of Certiorari

to the Court of Appeals for the Ninth

Circuit on the Counsel for Respondent by

enclosing a copy thereof in an envelope,

postage prepaid, addressed to:

Emory Langdon, Regional Counsel

Internal Revenue Service

810 Crown Plaza

1500 S.W. First Avenue

Portland, Oregon 97201

Gary DeFrang, Esq.

Internal Revenue Service

810 Crown Plaza

1500 S.W. First Avenue

Portland, Oregon 97201

Meade Whitaker, Chief Counsel

Internal Revenue Service

Washington, D.C. 20224

and depositing the same in the United States

mails at Portland, Oregon, on March 22,

1978, and further certify that all parties

required to be served have been served.

SRS Ty to. bind Sear 7.

Preston c. Hietfield, Jr.

Attorney for Petitioner