# Appendix — Shahadi v. United States > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385602_0502%3A7 ## Record - **Collection:** Supreme Court brief - **Document type:** Appendix - **Published:** January 1, 1965 - **Citation:** 381 U.S. 903 ## Text la 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 - 4a 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. 5a 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 8a 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.’’ 9a 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.