Memorandum in Opposition — Burr Oaks Corp. v. Commissioner

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_OctoRER TERM, 1966

No. 7164:

Burr OAKs Corporaiion, ET AL., PETITIONERS

Vv.

CoMMISSIONER OF INTERNAL REVENUE

atts Va rer oe:

ON PETITION FOR A@WRIT OF CERTIORARI TO THE UNITED

‘STATES. COURT ‘OF APPEALS FOR°THE SEVENTH CIRCUIT .

. MEMORANDUM FOR THE RESPONDENT IN OPPOSITION —

Petitioner Burr Oaks Corporation was organized:

- for the purpose of developing, subdividing and selling —

‘improved lots from a parcel of land owned by peti-

tioners Elkind, Watkins and “Ri¢z (Pet. 35). The

corporation’s common stock was issued (for a total of

$4,500 in cash) one-third each to the wives of Elkind &

. and, Watkins and one-third, to two brothers. of Ritz.

- (Pet. 36). Shortly thereafter Elkind, Watkins and.

Ritz transferred their land to the corporation. Al-

though the land had a fair market value of not more

1 The Individizal’ petitioner’s wives’ are Wirtiog only tiedsitive

_ they filed joint returns with their husbands for the yee ae

question. wh 3

* 240-382—66. ig iag SD

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_ than’ $165,000, the corporation gave Elkind, | Watkins

and Ritz 6 percent promissory notes in ‘the total

‘amount of $33,000: (each receiving | a $110,000 note) .

(Pet. 37-38). .

‘Elkind,, “Watkins 2a Ritz: saieieniler dominated.

the corporetion’s affairs, and, without the knowledge o :

: of. the holders of the common stock’ or the board of -

directors, the corporation rhadé transfers of part of

‘the land back to them without charge or for less than

would have been realized from sales to- third parties -

- (Pet. 38-40). Elkind, -Watkins. and. Ritz received

- $64,000 apiece- during the years 1959-1961, as install- -

ment payments on the notes (Pet. 41-42). The .

‘corporation -has never distributed anything to its

common. stockholders (Pet. 42). ._The Tax. Court con-.

cluded that Elkind, Watkins and Ritz never had any |

intention of enforcing. the notes against the corpora-

tion. but placed: their land at the risk of the business,

using the notes only to obtain a continuing interest in

. the ‘corporation that would enable them to withdraw .

frorh ‘the corporation the developer’s profit norinally t

- inherent in the subdivision and sale of ai land (Pet.

+ 3B, 42, 46).

If the transaction had the dae effect Wopait for by

. petitioners, (1) the corporation would have been able ©

-- to use the inflated purchase ‘price as its cost basis in

_ ‘the land, eliminating substantially all of its profit on

the sale of the lots and minimizing its income tax lia-:

bilities, and (2) Elkind; Watk s and Ritz would have .;

vobtained capital gain treatment on the:difference be- .

tween the purported selling price to the corporation :

= tele original cost basis in the end...

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Both. courts tno ssiihdahd agreeing with the Com-

“missioner, concluded that in reality Elkind, Watkins

and Ritz had made an equity investment in the corpo-

-@ ratioh-to the extent of the land which they transferred

to it and that the promissory notes which they re-

. _ eeived in exchange for the land constituted, in sub-

® stance, preferred ‘stock in the corporation. “Conse-

*. quently, thé unified transaction whereby Elkind, Wat- .

@ kins, Ritz and their relatives transferred the land and

$4,500 cash to the. corporation upon its organization

constituted an exchange of property for stock within

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“the purview of §351(a) of the 1954 Code,.and the i

' gorporation’s basis in the land was :the same as the

basis which it had in the. hands of the transferors.

1954 Code §362(a). Thus,-the payments by the .. .

corporation to Elkind, Watkins and Ritz constituted,

‘not payments on indebtedness, but proportional re-

“demptions of preferred stock, taxable to them as divi- °

dend income undér § 302(d) to the éxtent of the corpo- Kes

ration’ s earnings and profits.. (Pet. 21-56.) © |

The decision below is correct, and. there is rio con-

flict of decision or other basis for further ‘review. .

Contrary to petitioner’s suggestion (Pet. 18), this

_ is not “the first case where payments on instruments

which were pure debt obligations under general Jaw

principles were taxed to the recipients as dividends on

- stock.” See, é.g:, Gooding Amusement Co. v: Commis-:

sioner, 236 F.2d 159 (C.A. 6), certiorari denied, 352 -

U.S. 1031; Fellinger v. United. States, 363. F..2d 826

~ (CA. 6). Moreover; it is well established that the

form of a. transaction i is. not determinative of whether rN :

oi i tess debt instrument in plassaassd panes

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” genuine iieebiedinenn: or an n equity incirialinanathé See,. :

_) @g- Gilbert v. Commissioner, 248 F. 2d 399:(C.A..2); _

'_. P.M. Finance Corp. v. Commissioner, 302 F. 24 786 —

. CRB Aronov* yy Construction Co. v. United States, -

223 -F. Supp.. 175 (M.D. Ala:), affirmed, 338 F. 2d --

* + 337 (C.A. 5); Arlington Park Jockey Club v. Sauber,

262 F. 2d 902 (CsA. 7); Gooding Amusement ‘Co. Vv. ~

Commissioner, green > As the lower courts found, the.

.transfer of the land to: the ‘corporation by Elkind, ..

Watkins and Ritz had all of the characteristics of an:

' equity investment. ye

The principal thrust’ of sities seu ae

ever, is that Commissioner v.~Brown, 380 U.S. 563, -

~ tacitly abolished the. fundamental proposition that a

transaction may be treated differently in the pradtical

— reference of federal income taxation than state law

‘y and the labels selected by the parties would Buggest..

* In Brown, this Court merely held that when property ©

ae disposed of at a reasonable price in arm’s-length |

Ae dealing to a buyer who i is not controlled by the seller, ee

the transaction constitutes a “sale” even though the

es A purchase price is collectible only out of the property

tfansferred and. its profits’ To be sure, in reaching

that result, this Court noted that the transaction there —

involved was a “sale”? under general law (p..571), but

that was the beginning. of the inquiry, not the end’ of

- it. The instant case_did not. involve a arm’s-length bar-

gaining, the purchase price was more ‘than twice the ‘ye°

i fair market value of the property transferred, and the. :

transferors controlled the transferee. Moreover, the _.

questionsin ‘the present: case is whether the purported _

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“note? ; aetniaity constitute te eqhigy interests so that § 351 |

will .apply. Finally, it is clear that Brown did not

‘overrule sub. ‘silentio all of the tax * deeisions in the

: ties as Viewed under state law.

~ Phe- betition for a writ. of certiorari should be.

denied’ | ° 4 ae

_- Respectfully submitted, .

: THURGOOD Marsan, -

Soa eae Solicitor General.

ef Pe | Minoneu Rocovin;

Tt ose "” Assistant Attosgney General.

_ G@uerv’E. ‘ANDREWS, :

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DECEMBER 1966 fo. :

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\ equity-vérsus-debt area holding that the substanee of oy

- the fransdetion controls and substitute, instead a.

| mechani¢al_ reference to the labels chosen. by the par- |

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