Appendix — Shahadi v. United States

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APPENDIX

UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

No. 19,372

Maxwe.i Harpware Compasy, a corporation,

Petitioner on Review,

Vv.

ComMMISSIONER OF INTERNAL REVENUE,

Respondent on Review.

[Mar. 30, 1965]

On Petition to Review the Decision of the

Tax Court of the United States

Before: Hamuey and Merritx, Circuit Judges, and

THompson, District Judge

THompson, District Judge:

This is a petition for review of a decision of the Tax

Court of the United States, jurisdiction of ~which is con-

ferred on this Court under Title 26, U.S.C., § 7482. The

Tax Court disallowed to Petitioner, Maxwell Hardware

Company, a co.poration, net operating loss carryover de-

ductions takca for its tax years ending January 31, 1957

to 1960, inclusive.

In summary, the facts are that Maxwell Hardware had

sustained approximately $1,000,000 of losses in a hardware

business. It entered into an agreement with two partners,

Beckett and Federighi, who were engaged in numerous

real estate development activities as partners and controll-

ing stockholders of corporations, whereby a real estate

department was established in Maxwell Hardware to de-

velep a subdivision, the funds therefor being furnished by

the two partners through purchases of non-voting pre-

ferred stock in the corporation for an amount which was

2a

approximately two-fifths of the then value of the common

stock of the corporation. The real estate departinent was

accounted for independently of the other corporate busi-

ness. The agreement provided that the real estate depart-

ment should not be discontinued for a period of six years,

that the preferred stockholders should not sell their stock

for this period, and thereafter, if the department were dis-

continued at the option of either the corporation or pre-

ferred stockholders, the preferred stock should be re-

deemed by distribution in kind of ninety per cent of the

department’s assets to the preferred stockholders. A vot-

ing trust agreement was established to restrict the coutrol

of the common stockholders over the corporation for a

period of five years. The voting trust agreement did not,

however, transfer such control to the new investors. The

hardware business was discontinued and the real estate

business (Bay-O-Vista Subdivisions) operated at a profit.

The net operating losses which had been previously sus-

tained by the hardware business were deducted as loss

carryovers from the real estate profits. The agreement

between the corporation and the new preferred stockhold-

ers was entered into on October 18, 1954, and was there-

fore governed by the provisions of Internal Revenue Code

of 1954.

The transactions and events giving rise to this dispute

are complicated and extensive. The Findings of Fact and

Oyinion of the Tax Court are published (Arthur T. Beckett

v. Commissioner, 41 T.C. 386). Inasmuch as this decision

will be of interest primavsily to the tax bar, to whom the

referenced publication is readily available, we see no justi-

fication in reprinting here the twelve odd pages of Find-

ings of Fact there published. They are adopted by refer-

ence. Neither have we undertaken here to repeat in detail

all the contentions and arguments discussed in the Tax

Court Opiniei. With one exception, the findings of the

Tax Court have not been contested on this appeal. Peti-

tioner complains that the finding that the ‘‘primary pur-

3a

pose of Beckett and Federighi in entering into the agree-

ment of October 18, 1954 with Maxwell Hardware was to

enable tke profits which they anticipated would be made in

the development of the Bay-O-Vista Subdivision to be off-

set by net operating losses which had been sustained by

Maxwell Hardware in prior vears"* is contrary to the evi-

dence. We think the finding to be amply sustained by

substantial evidence and not subject to review by ths

Court. United States v. First Security Bank (9 CCA

1964), 334 F. 2d 120, and eases there cited. Cur review of

the decision, therefo-s, is restricted to an interpretaiion:

and application of the law to the facts as found.

Preliminarily, we shouid note that in the Tax Court,

three petitions for redetey uination of deficiencies assessed

by the Commissioner, invol. ing the tax liabilities of Ar-

thur T. Beckett and G-rtrude E. Beckett, +93309, of

Frederick J. Federighi and Mary Helen Federighi, =95310,

and of Maxwell Hardware Company, +95311. arising out

of the related transactions, were consolidated for trial on

a single common fact issue. The Tax Court trial was a

complete trial with respect to the tax liability of Maxwell

Hardware Company, but only a partial trial with respect to

the tax liability of the individuals, Becketts and Federighis.

The common issue of faci consolidated for trial was

whether the income of the real estate department of Max-

well Hardware Company should have been returned by

Maxweli Hardware Company or by the partnership of

Beckett and Federighi, and derivatively, by the partners

individually. The Government contended that the trans-

actions were a sham, and that the operation of the real

estate business under the corporate cloak was pure subter-

fuge, without factual substance.

The Tax Court, relying upon substantial evidence, re-

so'ved this issue in favor of the bona fides of the transac-

tions in the sense that they were not sham, that there was

a genuine business purpose for using a corporation for the

-

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rea] estate development enterprise, and that the resulting

transactions were corporate actions of Maxwell Hardware,

not actions of Beckett and Federighi carried on under a

corporate name. The Tax Court held that the subdivision

income was properly returned as the income of Maxwell

Hardware Company. This conclusion is not excepted to

by either party on this appeal and constitutes the founda-

tion for our consideration of the case.

The reported opinion and decision of the Tax Court

(Judge Scott) demonstrates careful and thorough analysis

of the facts, understanding of the law, and clarity of ex-

pression. We do not, however, agree with the conclusions

of the Tax Court in applying the law to the established

facts.

APPLICABILITY OF THE LIBSON SHOP DOCTRINE

The Tax Court relied upon the decision of the Supreme

Court in Libson Shops, Inc. v. Koehler, 1957, 353 U.S. 382.

In that ease, the transactions generating the tax liability

occurred prior to the effective date of the 1954 Code. The

issue there was ‘‘whether ander §§ 23(s) and 122 of the

Internal Revenue Code of 1939, as amended, a corporation

resulting froiu a merger of 17 separate incorporated busi-

nesses, which had filed separate income tax returns, may

carry over and deduct the pre-merger net operating losses

of three of its constituent corporations from the post-

merger income attributable to the other businesses.’’

(Idem. 382). The Supreme Court denied the !oss carry-

over deduction, saying: ‘‘We conclude that Petitioner is

not entitled to a carry-over since the income against which

the offset is claimed was not produced by substantially the

same businesses which incurred the losses.’’ (Idem. 390).

The Commissioner, the Tax Court and Petitioner all agree

that if Libson Shops had arisen under the 1954 Code, the

same decision could not have been made inasmuch as Sec-

tion 381 of the 1954 Code would expressly allow the net

operating loss carryover and the limitations of Section

382 would be inapplicable.

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Whenever a Court adopts a rule of decision to sustain a

conclusion, interpreting statutory law then applicable, and

the legislative authority amends or changes the statutory

law to the effect that the same decision eculd not be reached

if the new statute were applied to the same facts, the case

is not controlling precedent for judicial interpretation of

the new law.’ By enacting the 1954 Code, Congress de-

stroyed the precedential value of the rule of decision of

of Libson Shops; that is, that for a loss carryover deduc-

1 While we have found no enunciation of the principle of stare

decisis in this exact language in the authorities, we think the state-

ment is necessarily implied. 21 C.J.S. 318: “‘Where the law on

a particular subject is radically changed or superseded by statute,

decisions under the old law become of little value as authority.’

Helvering v. Hallock, 1940, 309 U.S. 106: ‘‘But stare decisis is a

principle of policy and not a mechanical formula of adherence to

the latest decision * * *.’’ Great Northern Ry. Co. v. United

States, 1942, 315 U.S. 262 (overruling the interpretation in the

Stringham case of an 1875 Act of Congress) : ‘‘The conclusion that

the railroad was the owner of a ‘limited fee’ was based on cases

arising under the land grant acts passed prior to 1871, and it does

not appea* that Congress’ change of policy after 1871 was brought

to the Court’s attention. That conclusion is inconsistent with

the language of the Act, its legislative history, its early administa-

tive interpretation and the construction placed on it by Congress in

subsequent legislation. We therefore do not regard it as con-

trolliny.’’ Heivering v. Griffiths, 1942, 318 U.S. 371 (where the

Court was asked to overrule Eisner v. McComber): ‘‘Nothing in

the history or attitude of this Court should give rise to legislative

embarrassment if in the performance of its duty a legislative

body feels impelled to enact laws which may require the Court to

reexamine its previous judgments or doctrine. The Court differs,

however, from other branches of the Government in its ability to

extricate itself from error. It can reconsider a matter only when

it is again properly brought before it in a case or controversy ;

and if the case requires, as a tax case does, a stcautory basis for a

case, the new case must have sufficient statutory support.’’ Patter-

son v. United States, 1959, 359 U.S. 495: ‘* ‘[W]hen the questions

are of statutory construction, not of constitutional import, Con-

gress can rectify our mistake, if such it was, or change its policy at

any time * * *.’”’ (Hmphasis supplied. )

6a,

tion to be allowed, the income against which the offset was

claimed must have been produced by substantially the same

businesses which incurred the losses. This is not now the

law. It seems to us irrelevant that Libson Shops was de-

cided in 1957, long after the enactment of the 1954 Code.

The Supreme Court, in Libson Shops, decided the case by

deliberately interpreting and applying the Internal Rev-

enne Code of 1939, as amended, and, while noting a minor

change in the 1954 Code (Idem. 385, footnote 2), did not |

comment upon or consider how the case should be decided

if the 1954 Code were applicable.”

SECTIONS 172 and 382 LIMITATIONS

Recognizing the frailty of Libson Shops as a precedent

for decision in this case, the Government suggests alter-

native bases to sustain the Tax Court. One is the con-

tention that Section 172,? which establishes the net operat-

ing loss carryover deduction does not apply to Maxwell

Hardware. The argument is that, viewed realistically, the

transactions amounted to placing ‘‘two separately owned

businesses entities under a single corporate roof’’, and

that the net operating loss carryover deduction inures only

to the business entity which generated it. As a matter of

statutory interpretation, we find nothing in §172 which

justifies such a conclusion. We cannot disregard the find-

ing of the Tax Court that Maxwell Hardware Company, a

corporation, is the taxable entity in this case and that it is

the entity which suffered the losses as well as generated

1aTn Sansome v. United States, decided March 29, 1965, the

Supreme Court held its decision in Achilli v. United States, 1957,

353 U.S. 373, under the 1939 Code to be inapplicable to the same

problem arising under the new treatment in the 1954 Code. /

2§172(a): ‘‘There shall be allowed as a deduction for the tax-

able year an amount equal to the aggregate of (1) the net operating

loss earryovers to such a year, plus (2) the net operating loss carry-

backs to such year. For purposes of this subtitle, the term ‘net

operating less deduction’ means the deduction allowed by this

subsection. ’’

7a

the subsequent income sought to be taxed. The corpora-

tion is the ‘‘taxpayer’’ as defined in the Code [26 U.S.C.,

§$ 1313(b), § 7701(a) (1) (4)], and we see no justification for

a judicial departure from the carefully devised and inte-

grated concepts of the Code which would require a judicial

recognition of a taxable entity or ‘‘taxpayer’’ different

from those identified by Congress.

With respect to the limitations applicable to the deducti-

bility of net operating loss carryovers, the Government

says that the deduction is disqualified in this ease by the

special limitation provisions of Section 382(a).’

The Tax Court found Section 382(a) to be inapplicable,

and we agree. The conditions of subsection (C) have been

fulfilled, i.e., Maxwell Hardware did not continue to ‘‘carry

on 2 trade or business substantially the same as that con-

3 § 382(a)(1): ‘‘Purchase of a corporation and change in its

trade or business.—

‘‘In General.—If, at the end of a taxable year of a corporation-—

‘*(A) any one or more of those persons déscribed in paragraph

(2) own a percentage of the total fair market value of

the outstanding stock of such corporation which is at

least 50 percentage points more than such person or

persons owned at—

‘*(i) the beginning of such taxable year, or

‘*(ii) the beginning of the prior taxable year,

‘‘(B) the inerease in percentage points at the end of such tax-

able year is attributable to—

‘*(i) a pureuase by such person or persons of such

stock, the stock of another corporation owning

stock in such corporation, or an interest in a

partnership or trust owning stock in such cor-

poration, or rn

‘*(ii) a decrease in the amount of such stock outstand-

ing or the amount of stock outstanding of another

corporation owning stock in such corporation, ex-

cept a decrease resulting from a redemption to

pay death taxes to which section 303 applies, and

‘*(C) such corporation has not continued to carry on a trade

or business substantially the same as that conducted

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ductec before any change in the percentage ownership of

ihe fair market value”’ of the stock. It is also clear, how-

ever, that these complicated transactions did not result in

persons, as defined, owning fifty percentage points more of

the total fair market value of the outstanding stock of

such corporation than theretofore. The Tax Court found

that the stock acquired by Beckett and Federighi was ‘‘non-

voting stock which is limited and preferred as to divi-

dends’’ [26 U.S.C. § 382(c)], and said: ‘‘It is clear that

the issuance of the preferred stock to Beckett and Fede-

righi does not come within any of these provisions.’”’ (T.C.

417). Its concise statement of the problem remaining is

(T.C. 417): ‘*The problem is whether by specifying the

various circumstances in section 382 in which net operating

loss. deductions would be disallowed in whole or in part

where a change in stock ownership has occurred followed

by a change in corporate business, Congress intended to

provide that in all other imstances the loss corporation

would be entitled to deduct its net operating loss carry-

over from earnings from a different business enterprise

unless such deduction fell within the prohibition of section

269.’’ We disagree with the Tax Court’s negative answer

to this inquiry. We conclude from the legislative history

that it was the clearly expressed intention of Congress to

attempt to bring some order out of chaos, and, in effect, to

countenance ‘‘trafficking’’ in operating loss carryovers

except as affected by the special limitations of Section 382

and the general limitations of Section 381. (Other Code

sections, such as Section 269, are disregarded in this dis-

cussion and will be hereinafter considered separately).

before any change in the percentage ownership of the

fair market value of such stock,

the net operating ioss carryovers, if any, from prior taxable years

of such corporation to such taxable year and subsequent taxable

years Shall not be included in the net operating loss deduction for

such taxable year and subsequent taxable years.’’

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By adopting Section 172(a), Congress created a net

operating loss deduction, applicable to taxpayers gen-

erally. In Section 381, Congress dealt specifically with the

transfer of a variety of deductions, including net operating

loss carryovers [Sec. 381(¢)(1)] in cases of corporate re-

organizations and acquisitions; and in Section 382, Con-

gress provided special limitations by careful and specific

definition upon the right to take a net operating loss carry-

over deduction where there had been a change in owner-

ship of the corporate stock and a change in the corpora-

tion’s trade or business. Section 172 is a substantial

revision of Section 122 of the 1939 Code. U.S. Cong. &

Adm. News, 1954, Vol. 3, p. 4192 (House Report), p. 4847

(Senate Report). Sections 381 and 382 are entirely new,

and had no counterpart in the 1939 Code. Idem. pp. 4273,

4281 (House Report) ; pp. 4914, 4922 (Senate Report). We

cannot ascribe to a Congress which, after years of thorough

and careful committee consideration aided by the solicited

advice of the finest strdents of taxatiqn, has adopted a

fully integrated revenue code, the intention that its pro-

visions should be lightly disregarded by the ecurts. Neither

ean we conclude that new and unanticipable judge-made

rules are contemplated by a Congress which declares: ‘A>

a result, present practice rests on court-made law -which is

uncertam and frequently contradictory. Moreover, whether

or not the carryover is allowed should be based upon eco-

nomic realities rather than upon suck artificialities as the

legal form of the reorganization’’ (emphasis added), Idem.

p. 4066 (House Report), p. 4683 (Senate Report). The

Reports respecting Section 382 even more clearly demon-

strate Congressional intent to substitute statutory rules

for judge-made la». It is quite unlikely that the stated

* House Report, p. 4067:

‘*Under present law where a controlling interest in a corporation

is acquired.for the purpose of avoiding or evading tax liabilities

the Internal Revenue Service may disallow the benefits of a deduc-

10a

purposes of certainty, consistency and objectivity are to

be achieved if each court considering a loss carryover

eroblem adds a gloss of judicial exceptions reflecting what

a particular judge or group of judges thinks Congress

should have done, rather than what it did. An expression

like ‘‘trafficking in loss carryevers”’ is a question-begging

epithet which clouds reason. <A dispassionate considera-

tion, credit, or allowance which would otherwise be enjoyed by the

acquiring person or corporation. This provision has proved in-

effectual, however, because of the necessity of proving that tax

avoidance was the primary purpose of the transaction. It has

also been so uncertain in its effects as to place a premium on

litigation and a damper on valid business transactions.

‘‘The committee added a provision designed to limit undue tax

benefits of this character by restricting the amount of net operat-

ing loss carryover which may be deducted where 50 percent or

more of the participating interest in a corporation was acquired

by new owners. In such cases the net operating loss carryover

to the current and subsequent taxable years is to be reduced by

the percentage of new ownership acquired either by purchase or

by decrease in the participating stock outstanding. This provi-

sion does not apply to publicly held corporations.

‘This special limitation on net operating | ss carryovers pro-

vides an objective standard governing the availability of a major

tax benefit wiich has been abused through trafficking in corpora-

tions with operating loss carryovers, the tax benefits of which are

exploited by persons other than those who incurred the loss. It

treats a business which crr -iences a substantial change in its

ownership, to the extent of such change, as a new entity for tax

purposes.’’ (Emphasis added.)

Senate Report, p. 4484:

‘*Your committee has adopted a provision to limit the application

of this provision relating to purchase to those areas in which abuse

has most often arisen, that is, the purchase of the stock of a cor-

poration with a history of losses for the purpose of using its loss

carryovers to offset gains of a business unrelated to that which

produced the losses. Accordingly, your committee has provided

that if more than £9 percent of the stock of a corporation is pur-

chased within a 2-year period and if the corporation thereafter

engages in a different type of business, then the loss carryover

is eliminated.’’

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tion of the 1954 Code must lead to the conclusion, we be-

lieve, that Congress has deliberately sanctioned such so-

called ‘‘trafficking’’ in those situations where it is not ex-

pressly abjured.

This is not to say that the language of the 1954 Code is

to be given a sterile, mechanical, literal application. The

courts must give sense and vitality to that language, bunt

this must be done within the framework of the Code to

achieve the Congressional design.

APPLICABILITY OF SECTION 269

As a second alternate basis for affirmance, the Govern-

ment invokes the applicability of Title 26, U.S.C., § 269.°

Subsections (a) and (b) of this Section were carried for-

ward from Section 129 of the 1939 Code. Subsection (c),

providing a presumption of wrongful purpose in certain

circumstances was added by the 1954 Code. U.S. Cong. &

5 Title 26, 17.S.C., § 269:

‘* Acquisitions made to evade or avoid income tax

‘*(a) In general —If—

‘*(1) Any persor or persons acquire, or acquired on or after

October 8, 1940, directly or indirectly, control of a corporation, or

‘*(2) any corporation acquires, or acquired on or after October

8, 1940, directly or indirectly, property of another corporation,

not controlled, directly or indirectly, immediately before such

acquisition, by such acquiring corporat.on or its stockholders, the

basis of which property, in the hands of the acquiring corporation,

is determined by reference to the basis in the hands of the trans-

feror corporation,

and the principal purpose of which such acquisition was made is

evasion or avoidance of Federal income tax by securing the bene-

tit of a deduction, credit, or other allowance which such person or

corporation would not otherwise enjoy, then such deduction, credit,

or other allowance shall uot be allowed. For purposes of para-

graphs (1) and (2), control means the ownership of stock possess-

ing at least 50 percent «f the total combined voting power of all

classes of stock entitled to vote or at least 50 percent of the total

value of shares of all classes of stock of the corporation.

12a

Adm. News, 1954, Vol. 3, p. 4057 (House Report). The

new presumption is of no interest here as the Tax Court

found that the Maxwell Hardware aquisition by Beckett

and Federighi was made for the avoidance of Federal in-

come tax by securing the benefit of the net operating loss

deauction. Just as Section 382(a) requires more than

proof of a substantial change in the trade or business con-

ducted to disqualify the deduction, so does Section 269

‘*(b) Power of Secretary or his delegate to allow deduction, etc.,

in part.—I” any case to which subsection (a) applies the Secretary

or his deleyate is authorized—

‘*(1) to allow as a deduction, credit, or allowance any part of

any amount disallowed by such suusection, if he determines that

such allowance will not result in the evasion or avoidance of Fed-

eral income tax for which the acquisition was made; or

‘*(2) to distribute, apportion, or ailocat. gross income, and

distribute, apportion, or allocate the deductions. credits, or allow-

ances the benefit of which was sought to be secured, oetween or

among the corporations, or properties, or parts thereof. invoived,

and to allow such deductiuns, credits, or aHowances so distributed,

apportioned, or allocated, but to give effect to such allowance only

to such extent as he determined will not result in the evasion or

avoidance of Federal income tax for which the acquisition was

made ; or

**(3) to exercise his powers in part under paragraph (1) and

in part under paragraph (2).

‘*(¢) Presumption in case of disproportionate purchase rrice.—

The fact that the consideration paid upon an acquisition by any

person or corporation described in subsection (a) is substantially

disproportionate to the aggregate—

‘*(1) of the adjusted basis of the property of the corporation

{to the extent attributable to the interest acquired specified in

paragraph (1) of subsection (a)), or of the property acquired

specified in paragraph (2) of subsection (a); and

‘*(2) of the tax benefits (.o the extent not reflected in the ad-

justed basis of the property) not available to such pers 1 or cor-

poration otherwise than as a result of sucb acquisition,

shall be prima facie evidence of the principal purpose of evasion

or avoidance of Federal incon.e tax. This subs‘: tion shall apply

only with respect to acquisitions after March 1, 1954.’’

13a

require more than proof of a purpose to evade or avoid

taxes. The additional requirement is the acquisition di-

rectly or indirectly of control of a corporation, specifically,

the ownership of stock possessing at least fifty per cent

of the voting power or at least fifty per cent of the total

value of shares of all classes. The purchase by Beckett

and Federighi of preferred shares for $200,000 of a cor-

poration whose common shares were found to have a fair

market value of $500,000 on its face did not satisfy the

requirement of acquisition of fifty per cent of the total

value of the shares outstanding, and there is nothing in

this record which would justify a conclusion that the true

fair value of the preferred shares at the date of acquisition

exceeded the amount paid therefor.

Invoking Section 269, the Government argues that the

complex transaction between Maxwell Hardware and

Beckett and .»ederighi, viewed rea:stically, resulted in

the indirect acquisition by Beckett and Federigh: of fifty

per cent of the total combined voting power of the corpo-

ration. An integral component of the entire transaction

was the voting trust agreement which, although not men-

tioned in the basic agreement of October 18, 1954, bore

even date therewith. The agreement created an irrevoca-

ble voting trust of all the common shares of Maxwell Hard-

ware until January 31, 1961 and invested the trustee, The

San Francisco Bank, with all voting rights, limiting its

authority only in respect of the selection of the Board of

Directors. The agreement required the trustee to vote for

T. P. Coates, an officer of the Bank, and John M. Bryan,

as two members of the three man board. The trustee’s

selection of the third mercber was unfettered. The agree-

ment accomplished a relinquishment by the common stock-

holders of their voting control; but the condition for the

invoking of Section 269 is the acquisition by persons (here,

Beckett and Federighi) of fifty per cent voting control.

This is an integrated voting trust agreement which con-

l4a

trolled the trustee’s powers and responsibilities. It cannot

fairly be construed as an acquisition by Beckett and Fed-

erighi of any voting control.

True, the evidence proved and the Tax Court found that

it was understood that Federighi would be the third di-

rector of Maxwell Hardware (T.C. 399), and that there

was an oral agreement that Bryan would not be vetoed on

any reasonable business investment he wished to make on

behalf of Maxwe!l Hardware. Such evidence was proba-

tive and relevant on the issue of sham, an issue ~7hich has

been permanently resolved against the Government, and

on the issue under Section 269 of purpose to evade or

avoid, an issue which has been conclusively determined

against Petitioner, Maxwell Hardware. Such evidence,

however, does not, in our view, justify an inference, as the

Government asserts, that fifty per cent voting control was

thereby acquired by Beckett and Federighi. A voting

trust agreement is too valuable a vehicle for the effectua-

tion of innumerable commereia) transacticns to ve thus

lightly impagned; and the eagerness of the Commissioner

to collect taxes, a duty imposed en him by law, should not

lead the courts arbitrarily to disregard established and

useful forms of business relationships. The voting trust

agreement invested the voting control in the trustee, not

in Beckett or Federighi. If the evidence were such as to

sustify a finding that under all the circumstances, either the

trustee bank or T. P. Coates, a designated directer, was

under the domination and control of Beckett and Federighi,

the case would be different. There is ro such evidence.

The Tax Couri correctly said: ‘‘We think it clear that the

provisions of Section 269 are not applicable here because

of the absence of the type of acquisition provided for

therein.” (T.C. 414).

APPLICABILITY OF SECTION 482

Congress has given discretionary authority to the Secre-

tary of the Treasury in certain situations:

1lda

‘‘In any case of two or more organizations, trades,

or businesses (whether or not incorporated, whether

or not organized in the United States, and whether or

not affiliated) owned or controlled directly or indirectly

by the same interests, the Secretary or his delegate

ma; distribute, apportion, or allocate gross income,

deduciions, credits, or allowances between or araong

such organizations, trrdcs or businesses, if he deter-

mines that such distribution, apportionment, or allo-

cation is necessary in order to prevent evasion of taxes

or clearly to reflect the income of any of such organi-

zations, trades, or businesses.’’

The Government, in its arguments based on Sections 382

(a) and 269, infra, has repeatedly reemphasized that uider

the carefully designed legal relationships established by

these facts, two separate businesses owned and managed

by separate interests were being conducted under one cor-

porate roof.

The Tax Court found that the transactions were not a

sham, that Maxwell Hardware was the corporate taxpayer,

and that the subdivision profits were the taxable income

of Maxwell Hardware.

With respect to the tax liability of Maxwell Hardware,

no reliance may be placed on Section 482 to justify a de-

cision because the Commissioner did not rely upon it and

gave no notice of such issues in his Notice of Deficiency

to Maxwell Hardware. United States v. First Security

Bank (9 CCA 1964), 354 F. 2d 120; Coma. v. Chelsea

Products (3 CCA 1952), 197 F. 2d 620; Ross v. Comm. (5

CCA 1942), 129 F. 2d 310.

Section 482 was, however, mentioned in the Tax Court

opinion: ‘‘ Although respondent in his notice of deficiency®

8 The notice of deficiency referred to in this quotation is the notice

to the individuals, Becketts and Federighis, not to Maxwell Hard-

ware Co.

l6a

referred to section 482 of the Internal Revenue Code of

1954, he does not argue the application of this section and

in effect concedes that unless the transfer of the Bay-O-

Vista land to Maxwell Hardware is considered a sham,

section 482 is inapplicable in this case.’’ “nd we have not

alluded to it in this case just to raise a strawman and then

blow him down. Sometimes plain statutory language is

distorted by courts to achieve what appears to be a just

resuit in a particular case. The Government seeks tu have

this Court do that with respect to Sections 172, 382 and

269 to attain what it deems to be the just result in this case.

We decline to do so, and to justify ourselves to the faint-

hearted, we wondered whether Congress actually did leave

the Commissioner helpless in this situation.

The opening statements of counsel before the Tax Court

show that the Commissioner did rely upon Section 482 in

his notices of deficiency to the Becketts and Federighis as

individual taxpayers. Congress has not defined t..e mean-

ing of ‘‘owned or controlled’’ under Section 482 as it has

in Sections 382(a) and 269, and a broad definition has been

adopted in the Regulations [Regs. 1.482-1(a)(3)]:

‘The term ‘controlled’ includes any kind of control,

direct or indirect, whether legally enforceable, and

however exercisable or exercised. ,It is the reality of

the control which is decisive, not its form or the mode

of its exercise. A presumption of control arises if in-

come or deductions have been arbitrarily shifted.’’

It is arguable that the combination of factors in this

case, such as the basic agreemer.:, the preferred stock, the

management contract with Federighi, the voting trust, the

election of Federighi to the board of director:, the care-

fully drafted dissolution provisions allocating ninety per

cent of the subdivision profits to the preferred stock, are

sufficient to justify a conclusion that the subdivision busi-

ness of Maxwell Hardware was controlled by Beckett and

Federighi if the Commissioner, in his discretion, had pre;-

17a

erly so determined [Cf. Dillard-Waltermine Ine. v. Camp-

bell (56 CCA 1958), 255 F. 2d 453; National Securities Corp.

v. Comm. (3 CCA 1942), 137 F. 2d 600; Rooney v. United

States (CCA 1962), 305 F. 2d 681; Comm. v. Chelsea

Products, supraj, and if the Commissioner had also prop-

erly determined that it was necessary to aliocate ninety

per cent o* the subdivision income to the individuals to

‘*prevent evasion of taxes’’ (Sec. 482).

This, however, is not an issue before this Court on this

petition for review and our comment is only a comment and

not a judgment.

Nor do we suggest that the Section 482 issue is still alive

in the Tax Court’s consideration of the petitions for re-

determination of the individual taxes of the Becketts and

Federighis. The opening statements hefore the Tax Court

make it clear that the consolidated trial before the Tax

Court would definitely determine the common issue of

whether the subdivision income was pioperly taxable to

the corporation or to the individuals, and both parties on

this appeal have accepted the Tax Court determination

that the subdivision income was properly taxable to Max-

well Hardware.

SUMMARY

This decision is reached in 2 sticightjacket.’ We are

bound by the Tax Court finding that the Maxwell Hard-

ware transaction was a bona fide business transaction

creating substantial, and not illusory, business relation-

ships. We are concerned only with the tax liability of

Maxwell Hardware, which, the Tax Court found, properly

7Prior to the reception of evidence in the Tax Court, Judge

Seott expressed her opinion thst it was ‘‘very unsatisfactory’

to try all of one case and only part of others in a consolidated

trial involving alternative claims with respect to determination

of the taxpayer to whom taxable income should be assigned. We

agree. Judge Seott deemed herself bound by the order of con-

solidation earlier entered by another judge on stipulation of counsel.

18a

reported as its income the profit from the subdivision busi-

ness. We are faced only with the problem of whether the

net operating less deduction generated by the hardware

business may be taken against the income from its sub-

division business.

The Tax Court considered this a special case, and said:

‘*In so holding, we do not intend to establish a broad legal

principle but merely to apply already established princi-

ples to an unusual f: ctual situation.’’ We think special

cases are to be processed under Section 482 if applicable.

Libson Shops, decided under the 1939 Act, is no longer

law. It has been superseded by the 1954 Internal Revenue

Code which, in Section 382, dealt specifically and differ-

ently with the concept of continuity of business enterprise

upon which the Libson Shops decision was based.

Taxation is peculiarly a matter of statutory law, and

in applying that law to the determination and computation

of income and deductions, the Courts do not make moral

judgments. There is nothing perfidious or invidious in

enjoying a statutory deduction from reportable income.

It is not a matter of conscience but of statute and the de-

termination of Congressionui intent. In our opinion, Con-

gress has quite plainly said that net operating loss deduc-

tions should be allowed unless the special circumstances

interpreted within the letter and spirit of Sections 382(a)

and 269 obtain. The conditions disallowing the deduction

have not been established here. It is of much more im-

portance that businessmen, accountants, lawyers and reve-

nue agents should retain confidence that plain statuiory

language means what it says and what it reasonably im-

plics than that a particular defisisney assessmen shocid

be sustained. We cannot, within the statutory framework

applying a fair and reasonable interpretation to the lan-

guage used, disallow to Maxwell Hardware the net oper-

ating loss deduction.

The decision of the Tax Court is reversed.