Petition — Texstar Corp. v. United States

82-1297 JM TTD”

NO. 83-

Supreme Court of the United States

OcTOBER TERM, 1983

THE TEXSTAR CORPORATION, Transferee Of The

Assets Of Unitex Industries, Inc. And Its Subsidiaries,

Petitioner,

Vv.

UNITED STATES OF AMERICA,

Respondent.

PETITION FOR A WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

J. MICHAEL WILKES

Cox & SMITH INCORPORATED

600 National Bank of

Commerce Building

San Antonio, Texas 78205

512-226-7000

J. BURLESON SMITH

STANLEY E. CRAWFORD, JR.

Anpy A. TSCHOEPE II

Cox & SMITH INCORPORATED

RIcHARD D. WALKER

RICHARD D. WALKER, INC.

Attorneys for Petitioner,

The Texstar Corporation

Alpha Law Brief Co., Inc-—S606 Parkersburg—Houston, Texas 77036—223-3003

I

QUESTION PRESENTED

Original issue discount arises and a taxpayer is entitled

to amortize the discount for federal income tax purposes

if the taxpayer issues its debentures for its own preferred

stock and incurs, “as a result of the transaction, some

cost or expense of acquiring the use of capital.” Commis-

sioner of Internal Revenue v. National Alfalfa Dehydrat-

ing and Milling Co., 417 U.S. 134, 147 (1974). The

original issue discount is measured by the difference between

the debenture’s face amount (redemption value) and its fair

market value on the date issued (issue price). Id. at 143.

The question presented for review is whether the issue

price of the debentures can be determined when the de-

bentures exchanged do not have published market prices,

but they are exchanged for the preferred stock after arm’s

length negotiations and the value of the preferred stock

is established using the criteria set forth by this Court in

National Alfalfa.

LIST OF INTERESTED PARTIES

Petitioner, The Texstar Corporation, was the transferee

of the assets of Unitex Industries, Inc. (“Unitex”), a

Texas corporation, which through its subsidiaries carried

on various commercial enterprises. The Texstar Corpora-

tion and its whoily owned subsidiaries, through various

reorganizations and liquidations, are now wholly owned

second tier subsidiaries of The Hillman Company.

- Respendent is the United States of America.

ae es I.

Nee

TABLE OF CONTENTS

QUESTION PRESENTED ...........scscscssecesees

LIST OF INTERESTED PARTIES ...........-..0005- Ni

CREROCUS | LIW icisip as lc bc ceeescoecigersinccces

JURTRDICTION Fi sivleced spe edicvccncecevtcccnsencs

STATUTES AND REGULATIONS INVOLVED .......

STATEMENT OF THE CASE .........csccsssecsevees

REASONS FOR GRANTING THE WRIT .............

I. The Decision Below Conflicts With the Decision

Of This Court, The Decisions Of All Other Courts

Of Appeals And Internal Revenue Service Regu-

lations Which Permit The Use of Expert Testi-

mony To Determine The Value Of Securities Ex-

changed In A Recapitalization. ................

II. The Decision Below Conflicts With The Decisions

Of This Court And Various Courts of Appeals

Which Have Found Arm’s Length Exchanges Suf-

ficient To Establish An Equivalence In Value Of

The Items Exchanged. ........6seecccseeeeees

III. The Decision Below Capriciously Discriminates

Against Small And Closely Held Corporations. . ..

CONCLUSION co ccccicceccccvedccvecsccccecccccecces

APPENDIX A—Opinion of the United States Court of

Appeals for the Fifth Circuit, October 7, 1982 ..

APPENDIX B—Opinion of the United States District

Court for the Northern District of Texas, June .

29, 1981 co icccccccccvawecrocoeviveveecscces

APPENDIX C—Judgment of the United States Court of

Appeals for the Fifth Circuit, October 7, 1982 ...

APPENDIX D—Notice of Order Petition For

Panel Rehearing, November 4, 1982 ............

APPENDIX E—Relevant Provisions of the Tax Reform

Act of 1969, the Internal Revenue Code of 1954

and the Regulations thereunder ..............-.

13a

27a

Ty i

IV

TABLE OF AUTHORITIES

CASES

A. Pt Smith Manufacturing Co. v. United States, 364 F.2d

he Cl. 1966), cert. denied, 385 U.S. 1003 (1967) .

tores of Ohio, Inc. v. Bowers, 358 U.S. $22 (1959)

yer eib Topeka & ’ Santa Fe R.R. v. United States, 443

F.2d 147 (10th Cir, 1971) ......sssceeeseesesceerens

Barclay & Co., Inc. v. Edwards, 267 US. 442 (1925) .

Cities Service Co. v. United States, $22 F.2d 1281 (2nd

Cir. 1974), vert. denied, 423 US. 827 EADEED 2400 cases

Commissioner of Internal Revenue v. National Alfalfa De-

iy ating & Milling Co., 417 U.S. 134 (1974) ...cited throughout

Fed-Mart Cor

- orp. v. United States, 572 ¥.2d 235 (9th Cir.

SOVES Abn) 0.0 ov. t0 buibd de bee © he ba Mia's Ae biehs o0:0 Neelces

Gulf, Mobile & Ohio R.R. v. United States, 579 F.2d 892

COU Ce MOONE CUE ec hue he RMU ctype be mene ese oa pops

Heiner v. Donnan, 285 U.S. 312 (1932) .....cceessceess

International Freighting Corporation Inc. v. Sere wc ped

of Internal Recaln 135 F.2d 310 (2nd Cir. 1943) .

New Colonial Ice Co. v. Helvering, 292 U.S. 435 ( 1934) .

Philadelphia Park Amusement Co, v, United States, 126 F.

Su 184) (Ce. Ca ISSA iii os adv veenievisanee tanec

Hie Sencamaid v. Swint, US. , 102 S.Ct. 1781

SORRY sak cig ann cdakhun nae ceear ee pa ced pavnsen wes b anne

Southern Fertilizer & Chemical Co. v. Edwards, 167 F Supp.

7G COE Dy ies TIO): aC TU PbS cane teeetcceesns

Southern Natural Gas Co. v. United States, 412 F.2d 1222

CUR MOON): danke ch owddnusndns Uh ceebikehte sc hobuwe

Tasty “eed Co. v. United States, 393 F.2d 992 (Ct. Cl.

ROT Ua bis bi AER IN Be Welk eet eae kha Rabe a so opeees

United States v. Davis, 370 U.S. 65 (1962) ....-..600ees

United States v. General Shoe Corp., 282 F.2d 9 {6th Cir.

1960), cert. denied, 365 U.S. 843 (1961) ..........5.:

a pr tga v. United States Gypsum Co., 333 U.S. 364

BOGOR siss's al PGS ARg rho Mcabews Ure soon chknoees cease

Welch v. Henry, 305 U.S. 134 (1938) ....ccceceeeceenes

Vv

STATUTES

Tax Reform Act of 1969, Pub. L. No. 91-172, re

Bah. RM IOTD on heii cdl Moab vinvicieeS pul Wa'ke'e'gp ony 2, 10, 14

INTERNAL REVENUE CODE OF 1954 AND

REGULATIONS THEREUNDER

LR.C, § 163(a), 26 U.S.C. § 163(a) (1978) ..........05.

Treas. Reg. § 1.163-3(a)(1) (1968), T.D. 6984, 1969-1

CB. 38; 26 CFR. § 1.163-3(a)(1) (1982) ....0..005. 2,13

LR.C. 1232(b) (2), 26 U.S.C. § 1232(b)(2) (1982) ..... 2,9, 10, 14

Tres. Reg. § 1.1232-3(b) (2) (iii)(e) (1972), T.D. 7213,

1972-2 C.B. 482, 26 C.F.R. § 1232-3(b)(2) (ili) (e)

SN eS eis CUS tials TUKEY ibe o 2,10

Treas. Reg. § 1.1001-1(a) (1971), T.D. 7142, 1971-2 C.B.

295, 26 C.F.R. § 1.1001-1(a) (1982) ......ceeeeeeeees 2,9

Treas. Reg. § 20.2031-2(f) (1958), T.D. 6296, 1958-2 C.B.

432, 480, 26 C.F.R. § 20.2031-2(f) (1982) .........06. 2,14

“=

SS

al

NO. 83-

IN THE

Supreme Court of the United States

OcTOBER TERM, 1983

THE TEXSTAR CORPORATION, Transferee Of The

Assets Of Unitex Industries, Inc. And Its Subsidiaries,

Petitioner,

Vv.

UNITED STATES OF AMERICA,

Respondent.

PETITION FOR A WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

The Texstar Corporation petitions for a writ of certi-

orari to review the judgment of the United States Court

of Appeals for the Fifth Circuit in this case.

OPINIONS BELOW

The opinion of the United States Court of Appeals for

the Fifth Circuit is annexed hereto as Appendix A (“App.

A”) and is reported at 688 F.2d 362. The opinion of the

United States District Court for the Northern District of

Sat ANS S

2

Texas is annexed hereto as Appendix B (“App. B”) and

is reported at 528 F.Supp. 75.

JURISDICTION

The judgment of the Court of Appeals was entered on

October 7, 1982, and is annexed hereto as Appendix C.

A timely Petition For Panel Rehearing was denied on

November 4, 1982. See Appendix D. The jurisdiction of

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

STATUTES AND REGULATIONS INVOLVED

The statutory provisions and regulations involved in

this case are as follows: The Tax Reform Act of 1969,

§ 413(e), Pub. L. No. 91-172, 83 Stat. 487 (1970);

LR.C. § 163(a), 26 U.S.C. § 163(a) (1978); LR.C.

§ 1232(b)(2), 26 U.S.C. § 1232(b)(2) (1982); Treas.

Reg. § 1.163-3(a)(1) (1968), T.D. 6984, 1969-1 C.B.

38, 26 C.F.R. § 163-3(a)(1) (1982); Treas. Reg.

§ 1.1001-i1(a) (1971), T.D. 7142, 1971-2 C.B. 295,

26 C.F.R. § 1.1001-1(a) (1982); Treas. Reg. 1.1232-

3(b) (2) (iii) (1972), T.D. 7213, 1972-2 C.B. 482, 26

C.F.R. § 1232-3(b)(2) (iii) (1982); and Treas, Reg.

§ 20.2031-2(f) (1958), T.D. 6296, 1958-2 C.B. 432,

480, 26 C.F.R. § 20.2031-2(f) (1982). These provisions

are set forth in Appendix E.

STATEMENT OF THE CASE’

Petitioner’s action for a refund of erroneously assessed

federal income taxes and interest thereon is based on the

1. The operative facts are uncontested and are fully and fairly

set forth in the District Court Opinion.

3

denial of an income tax deduction under I.R.C. § 163(a),

supra, for amortizable debt discount. The basis for District

Court jurisdiction was therefor 28 U.S.C. § 1346(a)(1).

The amortizable debt discount arose when Unitex ex-

changed $2.00 cash and a $10.00 face amount debenture

for each share of its outstan‘ing preferred stock. The pre-

ferred stock and debentures were dissimilar in several

respects. The redemption values were different. The divi-

dend and interest rates were different, and, unlike the

preferred stock, the debentures were subject to a sinking

fund.

The exchange was precipitated by a corporate rehabili-

tation program initiated by new management in 1956.

During Unitex’s early history, it incurred losses resulting

in a deficit in earned surplus. New management decided

to eliminate the preferred stock because the accumulated

deficit in earned surplus was making it difficult for Unitex

to acquire additional financing. Elimination of the pre-

ferred stock would permit the recapitalization of Unitex

common stock and thereby eliminate the deficit in earn-

ings and profits. In pursuance of this objective, manage-

ment proposed to the preferred stockholders an exchange

of three (3) shares of common stock for each share of

preferred stock. The proposal was rejected, unlike the

proposed recapitalization in National Alfalfa which was

approved “in due course”. 417 U.S. at 139. A stockholder

resolution was then passed directing the formulation of a

plan to restructure the capitalization of Unitex in a man-

ner satisfactory to protective committees formed for each

of the common and preferred stockholder groups. Officers

of Unitex and Dr. Bill Zentz, a professor of economics

at Southern Methodist University and also economic ad-

visor to the First National Bank in Dallas, Texas, re-

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4

ported to the stockholders at their respective protective

committee meetings on the financial condition of the

corporation, the prices at which their stocks were trading

and the prospects for future income on their investment.

With this information in hand, the protective committees

negotiated for over two years, rejecting numerous pro-

posals and counterproposals, before the above described

exchange was agreed upon.

The United States initially characterized the exchange

as nothing more than a sophisticated adjustment of Uni-

tex’s capital accounts. It further contended the intent of

the parties controlled and that neither Unitex nor its

stockholders anticipated or agreed to criginal issue dis-

count on the exchange.’ Finally, the Government con-

tended no original issue discount was created because

Unitex acquired no new capital. Subsequent to the trial

of this case the Government’s contentions were rendered

meritless by this Court’s decision in National Alfalfa.

National Alfalfa set forth the guidelines for determining

whether debt discount arises when a corporation issues

debentures in exchange for its own preferred stock. The

controlling test is whether some cost of acquiring the use

of capital occurs. 417 U.S. at 147. Once this base upon

which debt discount can arise is established, the amount

of discount is measured by the difference between the face

and fair market values of the debentures issued. 417 U.S.

at 143. The United States then argued Texstar did not

establish the issue price of Unitex debentures at the time

of the exchange.

2. The jury found there was no agreement concerning discount.

The jury did not find, as stated by Fifth Circuit, that Unitex

did uctible as bond discount. App. A at 5a.

i

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5

Relying on National Alfalfa and Gulf, Mobile & Ohio

R.R. v. United States, 579 F.2d 892 (Sth Cir. 1978)

(“G M, & O”), the District Court determined Petitioner

had established the base upon which debt discount could

arise; that Unitex incurred as a result of its recapitaliza-

tion a substantial cost for the use of capital. App. B at

21a. As in G M & O, and unlike National Alfalfa, the

capital on the books of Unitex representing each out-

standing share of preferred stock, $8.11, was less than the

total of the face amount of the debenture and cash,

$12.00, exchanged for such share. Unitex also incurred

the additional cost of establishing a sinking fund for the

retirement of its debentures which was not a characteristic

of its outstanding preferred stock. Neither the United

States nor the Fifth Circuit challenged Unitex’s satisfac-

tion of the additional cost requirement.’

Relying on the valuation evidence presented at the

trial and this Court’s comparison of Southern Fertilizer &

Chemical Co. v. Edwards, 167 F.Supp. 879 (M.D. Ga.

1955) with the intracorporate exchange in National

Alfalfa, 417 U.S. at 151, the District Court determined

Petitioner had established the issue price of the Unitex

debentures. App. B at 23a. At the trial, Petitioner’s

expert witness testified that he considered four valuation

methods in reaching his conclusion that each share of

Unitex preferred stock had a fair market value of $3.99

on December 31, 1959, the date of the exchange. In de-

termining the investment value of Unitex stock, $3.99,

the expert considered Unitex’s financial condition at the

time of the exchange, including both its credit position

and its profits prospects and the availability and cost of

3. Footnote 11 discusses whet may be a challenge to the establish-

ment of a cost by the Fifth Circuit.

6

capital in the general market as well as from its preferred

stockholders. Of particular importance, he compared the

likely return on the preferred stockholders’ investment

in Unitex with what they would receive in the bond

market. The expert’s credentials and experience in the

field of valuing corporate securities were substantial. His

qualification to serve as an expert witness was unchal-

lenged. His testimony was uncontradicted and both a jury

and the District Court found the value of Unitex pre-

ferred stock to be $3.99 per share at the time of the ex-

change.‘ In Southern Fertilizer, an exchange which oc-

curred after unlisteu securities were exchanged following

two years of stockholder negotiations, the District Court

determined the parties were dealing at arm’s length, the

items exchanged were of equivalent value and the deben-

tures were issued at a discount. 167 F.Supp. at 881. Since

Unitex stockholder protective committees negotiated the

terms of the exchange at arm’s length for two years, just

as in Southern Fertilizer, the District Court equated the

value of Unitex preferred stock, $3.99, with the $2.00

cash and debenture received in exchange « arrive at an

issue price for the debentures of $1.99. The resultant dis-

count, the face amount less issue price, was therefore

$8.01 per debenture.’ App. B. at 23a.

The Court of Appeals for the Fifth Circuit reversed the

District Court. It held Petitioner did not establish the issue

4. The Honorable Leo Brewster impanelled an advisory jury.

5. The District Court reached this figure as indicated, and not

by subtracting the value of the preferred stock from the face amount

of the bond. App. A at Sa. Fifth Circuit is clearly mistaken

on this point. See footnote 11 for further evidence of the failure to

between incurring the requisite cost for debt discount and

measurement of the discount.

7

price of Unitex debentures because neither the debentures

nor the preferred stock were actively traded. It concluded

that, without active trading, published market prices were

not available in the Wall Street Journal. Without pub-

lished market prices, neither the presence nor the calcula-

tion of debt discount could be justified by the Court.

App. A at lla. It further held the exchange was in-

sulated from market forces, as in National Alfalfa, there-

by negating an equivalence in value of Unitex preferred

stock and Unitex debentures (plus cash).* App. A at

10a.

REASONS FOR GRANTING THE WRIT

I. The Decision Below Conflicts With The Decision

Of This Court, The Decisions Of All Other Courts

Of Appeals And Internal Revenue Service Regu-

lations Which Permit The Use Of Expert Testi-

mony To Determine The Value Of Securities Ex-

changed In A Recapitalization.

The decision below stands alone and is in direct conflict

with the decision of this Court in National Alfalfa con-

cerning the means for valuing securities, which is the

prerequisite to measuring debt discount. Indeed, the Fifth

Circuit acknowledged that the valuation testimony in this

case included those factors which this Court in National

Alfalfa “suggested were essential to a determination of the

value of untraded debentures.” App. A at 10a, footnote

6. Approximately two-thirds of the G M & O stockholders elected

exchange their stock for bonds. App. A at 7a. That one-third

did not dilute an equivalence

the Fifth Circuit found it did

ROE

3

“it is for the district court to determine what is the best

available market assessment of the value of the debentures

at issuance. As indicated in National Alfalfa, where there

is no available market evaluation, the district court's in-

quiry might include consideration of the taxpayers ‘finan-

cial condition at the time of the exchange including both

its credit position and its profits prospects, and the avail-

ability and cost of capital in the general market as well

as from its preferred shareholders.’ _.. U.S. at ——.,

42 U.S.L W. at 4803.” 522 F.2d at 1291. In Fed-Mart

Corp. the District Court received expert testimony as to

the market value of the bonds exchanged and devoted a

substantial portion of its opinion thereto, Giving due

regard to “the opportunity of the trial court to judge the

credibility of the witnesses”, and without rejecting the

applicability of expert testimony, the Ninth Circuit ap-

propriately affirmed the District Court because its factual

findings were not clearly erroneous, 572 F.2d at 238.

Further, a case preceding National Alfalfa, Atchison,

Topeka & Santa Fe R.R. v. United States, 443 F.2d 147

(10th Cir. 1971), was a bonds-for-bonds exchange in

which the issue price of the bonds was established by

evidence from experts.

Absent a specific statutory exception, the Internal

Revenue Service has consistently held that the fair market

value of property is a question of fact and only in rare

and extraordinary cases will property be considered to

have no ascertainable market value. Treas. Reg. § 1.10C1-

1(a), supra. That published market prices are generally

not needed for valuation purposes is further suyyported

by the regulations under ILR.C, § 1232(b)(2), supra,

a specific statutory exception applicable to the issue price

10

of bonds issued after May 27, 1969." The “published

market prices” requirement contained in the 1969 amend-

ment to IL.R.C, § 1232(b)(2), supra, is made specifically

inapplicable to obligations issued on or before May 27,

1969. The Tax Reform Act of 1969, § 413(e), supra;

Treas, Reg § 1.1232-3(b) (2) (iii) (e), supra. Unitex de-

bentures were issued on December 31, 1959.

Even the United States, against its own interest, stated

on page 5 of its Reply Brief filed below: “[w]e do not

argue that the bonds and preferred shares must be traded

on a national exchange before bond discount can arise,

..-” In the absence of a “published market prices” limita-

tion, the Fifth Circuit's reversal of the District Court’s

factual findings exceeded the proper scope of its review,

since such findings were not clearly erroneous, United

States v. United States Gypsum Co., 333 U.S. 364 (1948);

Pullman-Standard v. Swint, U.S , 102 S.Ct. 1781

(1982). By adopting such a limitation on original issue

discounts, the Fifth Circuit's holding is in conflict with

all prior precedent and should be reversed.

II. The Decision Below Conflicts With The Decisions

Of This Court And Various Courts Of Appeals

Which Have Found Arm’s Length Exchanges Suf-

ficient To Establish An Equivalence In Value Of

The Items Exchanged.

Upon ample uncontradicted evidence, the District Court

considered the subject exchange to be a voluntary free

market transaction. App. B at 21a. For this reason, the

7. §1232 sets forth the income tax consequences to the holder

Siraner belaed tho: stootie ef « “petal eepkat

it the adoption of a “published market a

Y hy a Wine ae

11

District Court properly assumed an equivalence in value

of the items exchanged. The Court of Appeals for the

Fifth Circuit held that the District Court erred in equating

the value of Unitex preferred stock with the value of

Unitex debentures because the transaction had been “in-

sulated from the marketplace” as in National Alfalfa.

App. A at lla.

The Fifth Circuit was wrong in equating the exchange

in issue with the intracorporate exchange involved in

National Alfalfa, National Alfalfa Dehydrating and Mill-

ing Co.’s preferred stock was redeemed pursuant to a

plan structured by the board of directors without stock-

holder input or negotiations. Its stock was redeemable at

the discretion of the board of uirectors; the preferred stock-

holders were in no position to negotiate. In complete con-

trast to National Alfalfa, the preferred stock now in issue

was exchanged only after two-thirds of both the common

and preferred stockholders agreed to a plan which pro-

tective committees had structured after two years of meet-

ings, bargaining and neyotiations. The resulting exchange

of debentures for outstanding preferred stock was not an

intracorporate exchange insulated from market forces. It

was an exchange identical in all material respects with the

Southern Fertilizer exchange discussed earlier and cited

by this Court in National Alfalfa as a free market ex-

change. 417 U.S. at 151. The decision below is therefore

in direct conflict with National Alfalfa and with this

Court’s decision in United States v. Davis, 370 U.S. 65

(1962). Davis involved the valuation of marital rights

exchanged for marital property, including securities. This

Court held that the taxable gain realized by the husband

under these circumstances could be determined by equat-

ing the values of the properties exchanged, stating: “Ab-

a7 =

12

sent a readily ascertainable value it is accepted practice

where property is exchanged to hold . . . that the values

‘of the two properties exchanged in an arms-length trans-

action are either equal in fact or are presumed to be

equal’.” 370 U.S. at 72, citing Philadelphia Park Amuse-

ment Co. v. United States, 130 Ct. Cl. 166, 172, 126

F.Supp. 184, 189 (1954). Obviously the marital rights

involved in Davis did not have published market prices.

This did not affect or alter the “accepted practice” of

equating the values of the properties which had been

exchanged at arm’s length.

The Fifth Circuit's decision also is in conflict with

substantial precedent established by various Courts of

Appeals and the United States Court of Claims. See, e.g.,

Southern Natural Gas Co. v. United States, 412 F.2d

1222 (Ct. Cl. 1969) (value of stock established by value

of materials and services for which it was exchanged);

Tasty Baking Co. v. United States, 393 F.2d 992, 993-

95 (Ct. Cl. 1968) (value of employees’ services deter-

mined by value of property contributed to employee pen-

sic trust); A.P. Smith Manufacturing Co. v. United

States, 364 F.2d 831 (Ct. Cl. 1966), cert. denied, 385

U.S. 1003 (1967) (contribution of stock to employees’

retirement trust); United States v. General Shoe Corp.,

282 F.2d 9, 11-13 (6th Cir. 1960), cert. denied, 365

U.S. 843 (1961) (contribution to retirement trust); In-

ternational Freighting Corporation, Inc. v. Commissioner

of Internal Revenue, 135 F.2d 310, 313 (2d Cir. 1943)

(distribution of stock bonus). See also, Atchison, Topeka

& Santa Fe R.R. v. United States, supra, (negotiations

between interested groups of security holders conducted

at arm's length gave rise to ataortizable bond discount).

None of these decisions involved negotiations or exchanges

13

more clearly conducted at arm’s length than the exchange

in this case. Yet in each case, the equivalence of the values

of the exchanged properties or rights was established by

the evidence. The Fifth Circuit’s decision below is in

direct conflict with these authorities and should be re-

versed.

III. The Decision Below Capriciously Discriminates

Against Small And Closely Held Corporations.

It has long been the law that tax deductions are a

matter of legislative grace and that Congress may dis-

criminate between certain classes of taxpayers. New Co-

lonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).

Nevertheless, deductions granted by Congress cannot be

capriciously denied those persons or entities intended to

be benefited. Heiner v. Donnan, 285 U.S. 312 (1932);

Allied Stores of Chio, Inc. v. Bowers, 358 U.S. 522, 527

(1959); Welch v. Henry, 305 U.S. 134, 145 (1938);

Barclay & Co., Inc. v. Edwards, 267 U.S. 442, 450

(1925). Successive Treasury Regulations, beginning with

Art. 150 of Treasury Regulations 33 (revised 1918),

issued under the Revenue Act of 1916, through and in-

cluding current Treas. Reg. 1.163-3(a)(1), supra, have

recognized debt discount as an additional cost incurred

in borrowing money, and have granted the issuers of

obligations an income tax deduction for same. It was

not until 1969, when Congress became aware of the

“whipsaw” problem* created by its amendment of I.R.C.

8. Prior to 1969, issuers of obligations were allowed a deduction

each year with respect to debt discount: The holder was not required

to income until he disposed of the obligation. § 1232 was

to provide that the holder and issuer be treated in a con-

sistent manner. With this amendment the “whipsaw” problem arose,

ie., the issuer claiming a low value for property received in order

14

§ 1232(b)(2), supra, that a “published market prices”

limitation was adopted. The amendment, its legislative

history and the regulations thereunder, make two points

abundantly clear. First, Congress was concerned with the

whipsaw problem and not the task or valuing unlisted or

thinly traded securities.’ The Internal Revenue Service

and courts had many years of experience with the valua-

n of securities and guidelines had been established for

such purposes in Treasury Regulations, Revenue Rulings

and court decisions too numerous to cite. Treas, Reg.

§ 20.2031-2(f); Rev. Rul. 59-60, 1959-1 C.B, 237. The

value of a security and whether that security’s value may

be determined in a specified manner so as to qualify for

certain benefits are totally unrelated issues. Second, Con-

gress chose not to make the new requirement retroactive.

The Tax Reform Act of 1969, § 413(e), supra, Had the

Fifth Circuit’s adoption of the “published market prices”

limitation been addressed to some existing inequity, an

argument against capriciousness could be made. But to

address a “published market prices” limitation, prior to

its effective date, to an. unrelated issue, i.e., the actual

valuation of securities. without published market prices,

Giccae Suc asin tos ca cucieete Dade to cade? <a ovsad ecigiaal

claiming value ‘or the propert order to avoid original

issue discount income. This was a lem because it was not possible

to bring both parties, together in same lawsuit or otherwise insure

9. In the bill which was approved by the House and by the Senate

Finance Committee, section 1232(b)(2), which defines issue price,

did not have the “published market prices” limitation. H. No.

91-413 (1969), 1969-3 C.B. 200, 269; S. Rept. No. 91-552 (1969),

1969-3 C.B. 423, $17. ris bill was then amended to include the

15

in the face of overwhelming conflicting authority, includ-

ing this Court’s guidelines set forth in National Alfalfa,

truly amounts to a usurpation of the legislative function

and the capricious deprivation of Congressionally granted

benefits, without prior notice, to the vast majority of

corporations which are either too small or too closely held

,to have published market prices for their securities.

CONCLUSION

Due to the Tax Reform Act of 1969 and National Al-

falfa, as unanimously construed by the Courts of Appeals

deciding pre-1969 original issue discount cases, Petitioner

felt this case was of no precedential value. The decision

below, however, by adopting an unprecedented extremely

restricted means of valuing securities, and by limiting the

markets (only published markets) in which informed

persons dealing at arm’s length can intelligently value the

items they are exchanging, will have enormous impact

in two principal areas. First, corporate bonds and deben-

tures are typically outstanding for twenty to thirty years.

The new “published market prices” limitation became

applicable only thirteen years ago. Statistics obtained

from the New York Stock Exchange indicate that in

excess of 99% of the corporations do not have published

market prices for their securities.*” Therefore, in reliance

on the Fifth Circuit’s opinion, the Internal Revenue Service

will be in a position to challenge the undoubtedly numer-

ous continuing amortization deductions by unlisted cor-

porations which issued their bonds or debentures in ex-

change for property other than listed securities or cash.

10. 1,526 corporations are listed on the New York Stock

u

Exchange, but there are 344,624 for profit corporations authorized

to do business in Texas alone.

if

til

tegral to the administration of our already too complex

This Court should resolve the conflict that has now arisen

regarding these fundamental valuation principles so in-

market conditions do not exist and that values cannot be

determined by persons negotiating at arm’s length

fair market value of unlisted securities. They have also

equated the values of property exchanged at arm’s length.

do not have access to published market prices, U

decision below, the courts have uniformly

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tax laws, The petition for a writ of certiorari should be

granted.

Respectfully submitted,

J. MICHAEL WILKES

Cox & SMITH INCORPORATED

600 National Bank of

Commerce Building

San Antonio, Texas 78205

512-226-7000

J. BURLESON SMITH

STANLEY E, CRAWFORD, JR.

Anpy A, TscHoepE II

Cox & SmiTH INCORPORATED

RICHARD D. WALKER

RICHARD D. WALKER, INC.

Attorneys for Petitioner,

The Texstar Corporation