Opposition — Ogiony v. Commissioner

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Supreme Cour US

FILED

~. No. 80-178 SEP 121980. |

a IR., CLERK 4

In the Supreme Court of the Hnited States

OCTOBER TERM, 1979

JOHN AND NORMA OGIONY, ET AL., PETITIONERS

Vv.

COMMISSIONER OF INTERNAL REVENUE

ON PETITION FOR A WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS FOR

THE SECOND CIRCUIT

MEMORANDUM FOR THE RESPONDENT

IN OPPOSITION

WADE H. McCreg, JR.

Solicitor General.

Department of Justice

Washington, D.C. 20530

(202) 633-2217

TABLE OF AUTHORITIES

Page

Cases:

Beran v. Commissioner, 40 T.C.M. (CCH)

BGS .socccnsisuccsionterssonessneetsesteevnilauuigiadieaneiin 6

Bolger v. Commissioner, 59 T.C. 760 w..ssscsssseesees 3

Collins v. United States, 386 F. Supp. 17,

affd per curiam, 514 F. 2d 1282 ................ 3, 4

Commissioner v. Chelsea Products, Inc.,

EFT FBO GED sscsccrecscosenssnctstunlincisansliaeaaiie 5

Grenada Industries, Inc. v. Commissioner,

M7 TK 23), a6, 22 F. 2 Se ction 5

Harrison Property Management Co. v. United

SONG, SIS F. BR GAP isccsvcssevntovaneens onsonenieaniseati 3

Helvering v. Lazarus & Co., 308 U.S. 2952 ......... a

Moline Properties, Inc. v. Commissioner, 319

UD, SDD | ccsnsccicesessssssscessasbineresenaaaaeanaaae 3, 4, 5

National Carbide Corp. v. Commissioner,

FIO VG. GG. cesciccsiceseresstebitsinaaasmenianianananaiaa 6

Paymer v. Commissioner, 150 F. 2d 334 .........0+. 3

Strong v. Commissioner, 66 T.C. 12, aff'd

without opinion, 553 F. 2d 94 wiciccccccsccsceeeeees 3

United States v. Brager Building & Land |

Corp., 124 2. ‘GB Fe :icsissstinientsisinteae

I

II

Page

Statutes:

Internal Revenue Code of 1954 (26 U.S.C.),

RIES CHIE dniicosessvesccoevsissscsseneedveennntaenenieniialian 4, 5

N.Y. Gen. Oblig. Law § 5-501 (McKinney

SNUNED: atsitsishistnsibeosstnnencssousinesecessecshbvaasscnshanieeenabletl 2

Miscellaneous:

Rev. Rul. 75-31, 1975-1 Cum. Bull. 10 ............... 6

Rev. Rul. 76-26, 1976-1 Cum. Bull. 10 ............... 6

Treasury Regulations on Income Tax,

Section 1.482-1(b)(3) (26 C.F.R.) cccccccccesseseeeees 5

In the Supreme Court of the Hnited States

OCTOBER TERM, 1979

No. 80-178

JOHN AND NORMA OGIONY, ET AL., PETITIONERS

V.

COMMISSIONER OF INTERNAL REVENUE

ON PETITION FOR A WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS FOR

THE SECOND CIRCUIT

——

MEMORANDUM FOR THE RESPONDENT

IN OPPOSITION

The sole issue in this federal income tax case is whether

the decision below correctly held that the net operating

. losses from the construction and operation of certain

apartment complexes were those of its corporate owners.

The pertinent facts may be summarized as follows:

Petitioners or their wholly-owned corporations formed

two partnerships (Garden Partnership in 1966 and Losson

Partnership in 1969) for the purpose of constructing

rental apartments on certain undeveloped property in

New York. They were unable to obtain loans for the

apartment projects because the market interest rate for

mortgage financing was in excess of the maximum rate

chargeable to individuals under the usury law of New

2

York.! However, loans at a higher interest rate were

available to corporations. Accordingly, petitioners decid-

ed to utilize two corporations, Garden Village Builders,

Inc., and Losson Gardens, Inc., to borrow the necessary

funds (Pet. App. 18-19, 31).

Garden Partnership and Losson Partnership then

transferred title in the parcels of land they intended to

develop to the corporations, so that the corporations

became the mortgagors of record and retained title to

those parcels during most of the period in question. In

turn, the corporations transferred all funds obtained from

the mortgage loans to the partnershivs, which thereupon

paid the expenses incurred in the construction and

operation of the apartment projects (Pet. App. 19-20).

On their individual income tax returns, petitioners

claimed distributive shares of the net operating losses

reported by the partnerships. Thereafter, on audit, the

Commissioner of Internal Revenue disallowed the claimed

losses on the ground that they could only be claimed by

the corporations and not the partnerships (Pet. App. 20).

In this suit brought by petitioners for redetermination of

the resulting deficiencies, the Tax Court ruled that the

corporations were the proper entities to report the income

and expenses generated from the construction and

operation of the apartment complexes (Pet. App. 49-52).

Moreover, the court rejected petitioners’ contention that

the deficiency determination was an arbitrary application

of Section 482 of the Internal Reverue Code because the

Commissioner’s determinations were not based upon that

provision (Pet. App. 51-52). The court of appeals

'N.Y. Gen. Oblig. Law § 5-501 (McKinney 1967) limited the

maximum rate chargeable to individual borrowers to 6%. In 1968, §

5-501 was amended to allow a maximum interest rate of 7 1/2%, and

in 1973 a max.mum rate of 8%.

3

affirmed. It held that “ ‘income from property must be

taxed to the corporate owner * * * unless the corporation

is a purely passive dummy * * *’ ” (emphasis in original)

(Pet. App. 20). The court of appeals also rejected

petitioners’ Section 482 argument, agreeing with the Tax

Court’s disposition of that issue (Pet. App. 21-22).

1. The decision below correctly held that the losses in

question were deductible only by the corporations and not

the partnerships. It is well settled that if a corporation is

organized for a business purpose, or if it engages in

business activity, it must be recognized for tax purposes.

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

(1943). The cases following Moline Properties have

generally held that income or losses from property

properly belong to the corporate owner unless the

corporation is purely passive. Strong v. Commissioner, 66

T.C. 12, 22 (1976), aff'd without opinion, 553 F. 2d 94 (2d

Cir. 1977); Harrison Property Management Co. v. United

States, 475 F. 2d 623, 626 (Ct. Cl. 1973); Collins v. United

States, 386 F. Supp. 17, 19-20 (S.D. Ga. 1974), aff'd per

curiam, 514 F. 2d 1282 (Sth Cir. 1975).

Here, the corporations were clearly not passive. The

formation of Losson Corporation and Garden Corpora-

tion was undertaken to circumvent the New York usury

law and to secure financing. The corporations therefore

served a valid business purpose, if not business necessity.

See Strong v. Commissioner, supra, 66 T.C. at 24; Collins

v. United States, supra, 386 F. Supp. at 21; Bolger v.

Commissioner, 59 T.C. 760, 766 (1973). Moreover, the

actual borrowing of funds by the two corporations was

undisputably a business activity, as were their ownership

of the property during construction and the discharge of

their legal obligation to make the debt service payments.

See Paymer v. Commissioner, 150 F. 2d 334, 336-337 (2d

Cir. 1945); Strong v. Commissioner, supra, 66 T.C. at 25;

4

Collins v. United States, supra. Accordingly, under

Moline Properties and the authorities that have followed

it, Losson Corporation and Garden Corporation are

separate taxable entities which are required to recognize

the income and losses derived from their properties.

Petitioners may not claim the losses of those corporations

as their own.?

2. Petitioners contend (Pet. 8-10) that the Com-

missioner improperly allocated their claimed deductions

to Losson Corporation and Garden Corporation under

Section 482 of the Internal Revenue Code of 1954 without

giving them notice of such allocation. Section 482

provides, inter alia, that the Commissioner may allocate

expenses between commonly controlled organizations if

he determines that such allocation is necessary to clearly

reflect the income of such organizations. But no such

2Helvering v. Lazarus & Co., 308 U.S. 252 (1939), and United

States v. Brager Building & Land Corp., 124 F. 2d 349 (4th Cir.

1941), upon which petitioners rely (Pet. 7-8), are not to the contrary.

In Lazarus & Co., this Court characterized a sale and leaseback of

property for 99 years as a ‘oan to Lazarus (the “seller”) secured by the

property and held that Lazarus was entitled to the depreciation

deductions since it effectively bore the burden of the wasting of the

business property. Helvering v. Lazarus & Co., supra, 308 U.S. at

254. Here, on the other hand, the construction loans were issued to

Losson Corporation and Garden Corporation, not to the partner-

ships or petitioners. The corporations were obligated to repay

the loans and they also bore the burden of the wear and exhaustion

of the apartment complexes during the years in question. Hence, the

corporations, in accordance with Lazarus, should be entitled to the

depreciation deductions from the property.

Moreover, Brager Building & Land Corp. is distinguishable. There,

the court ruled that the corporation involved could be disregarded for

tax purposes because it, unlike Losson Corporation or Garden

‘Corporation, had no business activities and served no business

purpose. (The corporation merely held title to real estate as an agent

for a partnership to avoid further complications upon the death of

one of the partners.)

5

notice was forthcoming simply because the Commissioner

did not act under Section 482 and the petitioners may not

compel him to do so. See Treasury Regulations on

Income Tax, Section 1.482-1(b)(3) (26 C.F.R.). As the

court of appeals noted (Pet. App. 21-22):

*** the record is clear that the Commissioner did

not invoke section 482 in denying appellants’

deductions. The statutory notices do not mention the

statute. Rather the Commissioner relied on the

principle that the corporations, as owners of the

property, were the proper parties to claim the

deductions. We agree with the Tax Court that there

is no reason in this case to depart from the general

rule that courts will not look behind the statutory

notice in order to ascertain which provisions the

Commissioner relied upon in making his determina-

tion. Branerton Corp. v. Comm’r, 64 T.C. 191, 200

(1975); Greenberg’s Express, Inc. v. Comm’r, 62 T.C.

324, 327 (1974). We are fortified in this conclusion by

the responses of the Commissioner to interrogatories

in which he repeatedly denied that his determination

had been based on section 482.[?]

Moreover, even if Section 482 were invoked, the result

would not be different. It would still be necessary to apply

Moline Properties and its progeny to determine whether

net operating losses should be allocated to the cor-

porations.

3Petitioners’ reliance (Pet. 9-10) on Commissioner v. Chelsea

Products, Inc., 197 F. 2d 620, 624 (3d Cir. 1952), and Grenada

Industries, Inc. vy. Commissioner, 17 1.C. 231, 251 (1951), aff'd, 202

F. 2d 873 (Sth Cir. 1953), is misplaced because in both cases the

Commissioner proceeded under the statutory predecessor of Section

482.

6

3. Contrary to petitioners’ final argument (Pet. 12), the

Commissioner’s position in the instant case is not

inconsistent with Rev. Rul. 76-26, 1976-1 Cum. Bull. 10,

and Rev. Rul. 75-31, 1975-1 Cum. Bull. 10. In those

rulings, limited partnerships were considered the owners

of certain housing projects for tax purposes although title

was passively held by Limited Profit Housing Cor-

porations. These special corporations were comprehen-

sively regulated and controlled by the state and were

characterized as “agents” of the limited partnerships.

Here, on the other hand, the corporations were not mere

agents or nominees of the partnerships, but themselves

engaged in substantial business activities (Pet. App. 49-

50). See National Carbide Corp. v. Commissioner, 336

U.S. 422, 437 (1949) (a corporation is not an agent of its

shareholders by virtue of their stock ownership in the

corporation).4

It is therefore respectfully submitted that the petition

for a writ of certiorari be denied.

WADE H. McCRreg, JR.

Solicitor General

SEPTEMBER 1980

4Beran v. Commissioner, 40 T.C.M. (CCH) 163, 168-169 (1980)

(Pet. 13), is likewise distinguishable. The Tax Court there held, in

part, that the shareholder was entitled to an interest deduction for

amounts he paid on a “reloan” from his controlled corporation which

had originally borrowed the funds from a bank on his behalf to

circumvent the state usury law. It was noted that the reloan to the

shareholder at the same interest rate that had been charged the

corporation should be treated as a loan for tax purposes. Here,

however, the borrowed funds were merely transferred, not reloaned,

to the partnerships. Accordingly, any mortgage interest payments

were made only on the loans issued to the corporations.

DOJ-1980-09