Memorandum in Opposition — Ach v. Commissioner

In te Supreme Gourt of the Cited i ines

_ OCTOBER TERM, 1966

No. 396

PavuLine W. ACH, PETITIONER |

a * <a

CoMMISSIONER OF INTERNAL REVENUE

Estate or Ernest H. AcH, ET AL., PETITIONERS ~

_ COMMISSIONER OF INTERNAL REVENUE

ON PETITION FOR A WRIT OF CERTIORARI TO THE UNITED

STATES COURT OF APPEALS FOR THE SIXTH CIRCUIT

MEMORANDUM FOR THE RESPONDENT IN OPPOSITION

This case involves the scope of the Commissioner’s, °

statutory power under 1954. Code § 482 to reallocate

income between entities which are under common con-

trol. Section 482 provides:

In any. case of two or more organizations, |

trades, or businesses (whether or not incorpo-

rated, whether or not organized,in the United |

States, and whether or not affiliated) owned oF

controlled directly or indirectly- by the same in-

_terests, the Secretary or his delegate may dis-

tribute, apportion, or allocate gross income, —

(1)

280-439—66

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deductions, credits, or allowances between or

_ among such. organizations, trades, or businesses,

if he determines that such distribution, appor- .

tionment, or allocation is necessary in order

to prevent evasion of taxes or clearly to reflect

the income of any of such organizations, trades,

‘or businesses.

Prior to August 1953, ‘Pauline és owned and

Operated, as an, individual, a successful dress shop,

~ earning approximately $30,000 per year. Her two.

sons were the sole stockholders of a corporation

which had previously engaged unsuccessfully in the ©

operation of a dairy business but which, having ac-

cumulated ‘substantial net opetating losses, had dis-

continued that business and was inactive and

insolvent. The corporation owed a large sum to

‘Ernest Ach, the father of the corporation’s stockhold-

ers and Pauline’s husband. Because of the hopeless,

financial condition of the inactive corporation, this

debt was uncollectible. ;

On. August 1, 1953, Pauline transferred to the cor-..

poration certain assets of her dress business in ex-

' change for a non-interest-bearing note for $30,705,

which was the assets’ book value. She did.not, how-—

ever, transfer to the corporation certain intangible

assets—the right to use’ her name or the name under .

which she had operated the business, the right to her

managerial services, the goodwill attendant upon her

‘identification with and operation of the business,

ete.—which the Tax Court found to be the most im-

portant and valuable aspects of the business. There-

after, Pauline<continued to manage and operate the

dress shop in the-same manner as before. Although

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the corporation purported to pay her no salary, it.

did, over the five years here in question ( 1954-1958),

pay Pauline and her husband the bulk of the profits

from the dress business, allegedly on account of the

corporation’s debts to them. And in mid-1959. Paul-

ine’s sons transferred to her all of. the corporation’s

stock without further consideration.’ (Pet. 1a+9a,

R. 101a.) . }

On her tax returns for those years, Pauline re-

‘ported no income from her activities in connection

' with the dress business; the corporation. reported the

profits of the dress. business but used the net operat-

ing losses previously incurred in the dairy business to

wipe out any liability for taxes. The Commissioner

took alternative positions, claiming, first, that the .

net income of the dress business should be reallocated

to Pauline under 1954 Code § 482, and, second, that. to

the extent the income was taxable to the corporation,

its claimed net operating loss ii dzone should be

denied.

In the Tax Court, ir ddimaid the appli-

cability of § 482 on the ground that Pauline, fol-

lowing the transfer of the physical assets of her

dress, business to the corporation, was no longer en-

gaged in a “‘business” and that she did. not, en

constitute an independent “organization, ” “trade,”

or “business”? to which incomé might be reallocated

under § 482." The Tax Court found that the most

' valuable income-earning aspects of the business—the

_ 1The lower‘courts found that Pauline had actually acquired

. beneficial ownership to the corporation’s stock at the time

she transferred the assets of her dress business to the corpora-

tion in August 1953.

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intangible assets—had. been retained by Pauline, and —

that her continued activity constituted a ‘‘business.”

It determined that 30 percent of the business income

was attributable to the assets owned by the corpora-

tion andthe balance to the aspects of the business:

which remained with Pauline; it therefore held that

70 percent of the income was taxable to Pauline and

30 percent to the corporation.’ The court of appeals

affirmed.* *(R. 99a-110a, Pet la-9a. )

*The Tax Court stated (R. 101a):

Plainly, [the transfer of assets by Pauline to the

_ corporation ] was not, an arm’s length transaction. The

corporation was hopelessly insolvent, and it is ‘utterly be-’

yond belief that any unrelated third party would have sold

- @ prosperous business for a non-interest bearing $30,705.57

note of such an insolvent maker where the level of earn-—

ings of that busihess was about $30,000 a year and rising,

and where the sellét. contemplated continued full-time

management of the business without compensation.. Not-

withstanding testimony indicating otherwise, it is all too

clear to us on this record that Paulinggwas acquiring con-

trol of this moribund corporation : i purpose of at-

_ tempting to utilize the net operating

earnings of her successful dress business and to obtain the

actual benefits of those tax-free earnings by having the

corporation pay off, first, her $30,705.57 note, and then the

notes of some $280,000 held by her husband which were ~

otherwise uncollectable—all of which would be received

free of tax!

* The lower courts also sustained the Commissioner’ s slit

tive position that 1954 Code § 269 prevented the corporation .

from carrying forward its previous net operating losses from

the discontinued dairy business, and thus that the corporation

was taxable on the 30 percent of the dress business income

which was allocable to, it. The corporation has not filed a —

petition for a writ of certiorari and the lower courts’ deter-

mination on that.i issue is now final.

carryover of the

dairy business, to offset the resulting; deductions against .

The decisions of the lower courts were correct.

There is no coriflict of — or . other —

warranting further review.

1. Petitioners argue that Pauline’ s activities were -

‘not sufficient to constitute a ‘‘business’’ and that the

Commissioner was thus precluded from reallocating

income to. her under § 482. The Tax Court found

sthat Pauline’s retention of the intangible assets and -

~ her use of them in the continuing operation amounted

to a “business.* Whether a. particular taxpayer’s »

activities are sufficient to constitute a trade or busi-

ithin the meaning of the Code depends priuci-

pally on the facts of each case, and the question is not

readily ‘susceptible to a rule of general applicability.

Moreover, this Coutt has reviewed several cases ih-

_ volving ‘this question under other sections of the —

Code,‘ and there is no present need for the Court to

‘review this question in the context of the particular

_ facts of the case at bar.’

2: There is no conflict between the fevidiniit ey

and the cases cited by petitioners (Pet. 7-8).

Whipple v. ht weenie infra, this Court held on

that “[dJevoting one’s time and energies to the af-

4 See, ¢.g., Whipple v. Commissioner, 373 U.S. 193; Burnet v

Clark, 287 U.S.. 410; Higgins v. Commissioner, 312 U.S. 212;

‘see also Folker .% Jolason, 230 F. 2d 906 (C.A. 2); Schmid-

lapp v. Commissioner, 96 F. 2d 680 (C.A. 2); Noland v. Com-

missioner, 269 F.2d 108 (C.A.4).

* Since, as the Tax Court found, Pauline had retained yalu-

- able intangible assets, petitioners are incorrect in asserting (Pet.

6) that the instant decision will apply to any case where “a

controlling _ shareholder * * * has elected not to demand from

the corporation a Salary commensurate with the value of his

service.” ,

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fairs of a corporation is not of itself, and without”

| more, a trade or business of the person so engag

(p. 202). However, the Court recognized that if ad-

ditional facts were present, a court might be justified

in holding that the shareholder-employee was engaged

in a trade or business (pp. 203-205). |

Nor does the instant decision conflict with Com- .

‘missioner v. Gross, 236 F. 2d 612 (C.A. 2), since that

ease involved only 1954 Code § 61. The Commissioner

did not there attempt to invoke, .and the courts thus

did not consider, the special remedial provisions of

§ 482, the provision here im question. Cf. Tennessee-

Arkansas Gravel. Co. v. en 112 F. 2d 508,

510 (C.A. 6).°

‘Finally, Moline ‘Properties, Ine. Vv. Gnedidbiiae :

319 U.S. 436, is entirely inapposite since the lower |

courts did not refuse to treat the corporation as a

. Separate - “taxable entity. On the contrary, the Tax

Court. found there was a genuine transfer of tangible

assets to the corporation and that the. portion of the

dress business’. income: properly attributable to those

assets (30 percent) should be taxed to the a toned |

tion (R. 10la—102a, 106a).

°In Tennessee-Arkansas the taxpayer corporation rented: prop-

erty to a related corporation but did not collect any rent. The

Commissioner attempted to tax the lessor corporation on rental .

_ Income without giving the-lessee corporation a corresponding de-

duction for rent paid. . The court held that the Commissioner

may not create income in ‘this manner, but) suggested that the Com- |

missioner might (as he has done in the instant case) use § 482 or .

its predecessor to reallocate some of the reported income from one 9

. Telated taxpayer to another. | |

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Therefore, the petition for a writ of certiorari

should be denied.

Respectfully submitted.

| THURGOOD Marswat,

Solicitor General.

Ricwarp C. Puan,

. Acting Assistant Aitorney General. '

Harotp C. WILKENFELD, __

ip Wit A. FRIEDLANDER,,

9 ae 2 , Attorneys.

' SEPTEMBER 1966. = : :

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