Petition for Writ of Certiorari — South Texas Rice Warehouse Co. v. Commissioner

Supreme Court brief1967

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Text

Supe Gt tte Md aes

* October = 1966

| SOUTH TEXAS RICE WAREHOUSE CO., Petitioner |

| | v. | :

COMMISSIONER OF INTERNAL REVENUE,

_ PETITION FOR A WRI OF ‘CERTIORARI es

TO THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

| 9 > Rosser J. Pmo

Baxer, Borts, SHEPHERD 1600 Esperson B |

‘& Coates © * Houston, Texas. 77002

ico a : Attorneys for Petitioner

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INDEX

: Page

Opinions of the Courts Below ...... Flere Pes : 1

Jurisdiction ...... eet es Fer OA Sr ge ee Se

' Statement Concerning The Record.............. ie 2

Questions Presented ....... epee a, Saori x ae

Statutes Involved 2 Re A Aree Keane eG * 8

Statement 2 LSI A eee re re 9

Reasons For. Granting The b cea Cece ae 15

Conclusion......... Pe Sele ie eae Ar Teper es GAR a 24

Appendix Bees Woe ee hy ae tues a ee

Opinion of Court of emai aie a obs hers £ pa

Judgment of Court of Appeals ...... iia en _ 42

Order of Court of Appeals Denying Motion For

Ns el oo os sora a eee 43

Appendix B . Par rd geen ee ee ‘440

CITATIONS natehe

CASES " Page -

Anaheim Union Water Company v. Commissioner,

Ee ea ee aoe Sri |

C.LR. v. Brown, 380 US. 16-—- 25.

~—Cullers v. “Commissioner, 237 F.2d 611, 617..;.... 6,19

Foran v. Commissioner, 165 F.2d 705, 707 1. ey. “6,16

Gregory v. Helvering, 293 U.S. 465, 469........ a >

Hanover Bank v. Commissioner, 369 U.S. 672... .. 26.

Loesch & Green Const. Co. v. Commissioner, 211 |

> MRR Sma eermrone Seu S Dai tee 6, 17, 30

- Mayson Manufacturing Colemeny v. ‘Commissioner, Pe 2.

ee (3s oa eee os ees,

___J.M. Perry & Co., Inc. v. ¥. Commainioner, 120 F.2d

SES TORE, AN NOAA eee ON oc 6,17

J. H. Robinson Truck Lines, Inc. v. Commissioner,

oe oe “ee a eee 6, 16

Turnbow v. Commissioner, 368 US. RE ie:

_ ‘MISCELLANEOUS. ’

. 2 USC., § 1254(1)- ae ee Se nace a7

Sec. 482, LR.C ete Ty t6 et at CP ask a a on re

Art. 5. 10 Texas Business Corporation Act... .. - 7,8

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NO.

IN —— <i . re.

Supreme Court of the Bniten States

October Term, 1966

SOUTH TEXAS RICE WAREHOUSE CO., Petitioner

| v. |

COMMISSIONER _OF | INTERNAL REVENUE,

- Respondent

PETITION’ FOR A WRIT OF CERTIORARI ©

TO THE UNITED STATES COURT OF APPEALS |

FOR THE FIFTH CIRCUIT .

Petitioner, South Texas Rice Wareliouse Co., herein

_ called “Warehouse Company”, prays that a writ of certio-

rari issue to review the judgment of the United StatesCourt of

Appeals for the Fifth Circuit, entered in the above-entitled .

case (No.. 22,834 below), affirming the judgment of the

Tax Court of the United. States adverse to petitioner.

CITATION TO OPINIONS BELOW

The opinion of the Tax Court (R. 184-254), is re-

ported in 43 T.C. 540. The opinion of the Court. of | Ap-'

ry SAMI ain Re BTR OIA aati sda.

eS Ly ; i el

sail (R. 267-283, on Appendix A, p. 27) j is not yet

reported.

gence |

The judgment of the Court of Appeals, affirming the

judgment of the Tax Court against petitioner, was entered

on August 22, 1966 (R. 285, infra, Appendix A, p. 42)..

On September 12, 1966, petitioner filed its Motion for

Rehearing (R. 286-288). Ning.copies of that Motion are

filed with the Court herewith.” The order of the Court of

Appeals denying the Motion for Rehearing was entered on

October 4, 1966 (R. 297, infra, Appendix A, p. 43). Juris-

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

STATEMENT CONCERNING THE RECORD

As the record in this case is out of the ordinary, we pray

the indulgence of the Court i in a ‘short, explanatory state-

ment.

Ps $ .

About 1933 five families, Davant, Woods, Savage, -

Pegram, and L. D. Clements, formed South Texas Water

Company, herein called Water,Company, to rurt an irriga- ;

tion system for rice growing around: Rosharon in south

Texas. In 1934 L. D. Clements brother, S. M. Clements,

incorporated Warehouse Company as its sole owner and

had it build at Rosharon the warehouse involved in this

case. In 1939 S. M. Clements bought the stock of Woods

in the Water Company and sold to the others stock in the

Warehouse Company. Several years prior to July 1, 1957,

Savage died and the other four families bought his interest

in both companies and since that time both have been

owned by the Davant, Pegram, I.. D. Clements and S. M.:

Clements families in equal proportions. In the late 1940’s.

_when rice driers. were - perfected ‘Warehouse’ Compeny in-

_ stalled such a drier, as oo

In 1957 the Davant and Pegram families and the children

of L. D. Clements and S. M. Clements formed a partnership,

: . South Texas Enterprises (herein called Enterprises) , in which

_the Davant and Pegram families each owned 25% and the

children of L. D. Clements and $. M. Clements each owned . -

25%: L. D. Clements and S. M. Clements, who together

‘owned 35% of the stock of both companies, had no interest

in the partnership. :

In 195 7, after extended argument between the’ partners

in the partnership-and L: D. Clements and S$. M. Clements,

it was agreed that the: Warehouse Company’ should lease.

its properties to the partnership for $48,000 a year. plus

the cost of i insurance on its properties.

Three years later, in 1960, the Water Company acquired

_all the assets ‘of the Warehouse ° Company for $700,000,

and the Warehouse Company. dissolved and distributed

its cash, purely for the purpose of this statement at. this

point, to its stockholders, who reported their gain on a

capital gain basis. ee -

The Catala asserted (1) that the partnership was a.

shamzand should be disregarded and (2) that under section

482 of the Internal Revénue Code the rental should be .

$78,000 a year and the Warehouse Company should be

taxed on that basis. The Tax Court held the partnership

was valid but the rent should ‘be $78,000 a year. i

In the. individual’ case, known below as that of J. E.

-Davant and Kathryn. Davant, et al., the Government -con-

tended that the 1960 sale and liquidation of the Warehouse

Company was a reorganization of the Warehouse Company

Po an sar hint ANS,

and the Water Company, and that the money ‘received by”

- Davant, et al., was a distribution taxable as a dividend.

>. Thus the. two: éases involve entirely separate matters.

However, to avoid a duplication in the. presentation of

-. evidence, the Tax Court ordered that the Warehouse Com-

' pany case be tried first and that the evidence taken therein

_should be considered as evidence in the individual Davant

_ case. We quote the following from the proceedings of

the Tax Court (R.. 22): .

d e.

“The Court:

The stipulation is now we will try the warehouse

case with the stipulation that all evidence taken in the

' warehouse case will be evidence in the individual cases,

_ but that we will proceed then to try the individual

cases for what -further evidence i is needed.”

In the Court of Appeals ‘i Court entered an order

reading i in part as follows (R. 2): as

**(2) The minutes of. the. es before the

_ Tax Court on April 23, 1964, covering the proceed-

ings in No. 22,834 and. the Findings of Fact and Opin-

ion: of the Tax Court therein shall be printed in the

‘ printed record only in No. 22,834, but pursuant to

the stipulation may be considered by the Court as part

of the record in No. 22,835.”

In the Court of Appeals for the Fifth Circuit, the Ware-

house case was No. 22,834 and the Davant case was No. .

22,835. The taxpayers in both cases are filing simultaneously

their petitions to this Court for writs of certiorari. There .

- are being filed with this Court in the Warehouse case

nine copies of the printed: record in No. 22,834 below in

' addition to the copy certified by the clerk below. In the

Davant case the petitioners are filing, in addition to the.

* copy certified by the clerk below, nine copies of the record

in the Davant case but aré not filing an additional nine .

copies of the record in the Warehouse case as they are not

available, |

The, Tax Court essited down one consolidated opinion,

set forth in the Warehouse record at R. 184 to 255. As

that opinion is set forth therein and is 72 pages in length,

. we are not printing a copy of that opinion as an Appendix

to our petitions for certiorari in either case and pray the

Court ‘to refer to it in the printed record in the Warehouse

case, y,

QUESTIONS PRESENTED

This petition presents the following important ques-

tions involving the proper interpretation of sec. 482 ‘of

the Internal Revenue Code of 1954.

1. In determining whether two organizations are owned

or controlled by the same interests for purposes of sec. 482,

does the phrase “by the same interests” mean “by the same

persons” as contended ‘by the Warehouse Company or does

it mean “by the same families” as determined by the Court

of Appeals? The resolution of this issue is extremely im-

portant to the administration of the Federal income tax

laws both because of the potentially sweeping effect the

interpretation by the Court of Appeals will have on the

application of sec. 482 and because it marks the first time

that a court has applied the concept of constructive owner-

ship to any section of the Intefnal Revenue Code other

than those sections to which sec.:318 or similar sections

are specifically made applicable.

2. Isa determination of fact made by the Commissioner

in his notice of deficiency , only ‘presumptively true until

Sorensen te

aaa a a ea Ee

evidence to the contrary is introduced or is it in itself evi-

dence of the truth of that fact so that a court is free to

disregard in toto the uncontradicted testimony of Ware-

house’s impartial expert and find for the Commissioner

even though there is no evidence by the Government or

- otherwise to. support the Commissionér’s position. The

Court of Appeals, in substance, so held in this case and

in sd doing took a position contrary to the holdings of the

Fifth Circuit in J. H. Robinson Truck Lines, Inc. v. C.LR.,

183 F.2d 739, and Foran v. C.I.R., 165 F.2d 205; those of

the Ninth Circuit in J. M. Perry & Co., Inc: v. C.LR.,

120 F.2d 123, and Anaheim Union Water Company v.

C.I.R., 321 F.2d 253; those of the Sixth Circuit. in Loesch

& Green Const. Co. v. C.I.R., 211 F.2d 210, and Mayson

Manufacturing Company v. C.I.R., 178 F.2d 115, and that

of the Eighth Circuit in Cullers v. C.I.R., 237 F.2d 611.

_ 3. Where there is no evidence to. support the Com-

missioner’s determination of the rental value of the prop-

erty,-and where there is abundant evidence to support

the value fixed by Warehouse, is a court authorized to sus-_

tain the determination by the Commissioner because, based on

_ purely theoretical economic concepts, not cognizable as

a matter of judicial knowledge and not true as a matter of fact

or law, the court feels that the determination .of the Com-

missioner is not inherently reasonable? The Court of Ap-

peals so held in this case and in so ‘doing took a Sarria in

conflict with the decisions set forth in Question 2 above. _

"4, Where the undisputed evidence showed that L. D..and_

S.M. Clements, who together owned 35% of the Ware-

house stock and owned no interest in. the partnership,

actively represented Warehouse and their own personal in-

. terests in negotiating with the partnership to ensure that

the rent provided for in the lease would be fair and reason-

‘ able, and that, as a result of bute arms length long trad-.

ing session with the partners of Enterprises, forced them

to raise their offer of $36,000 a year to $48,000 a year,

and where some of the partners testified that they would

not have leased the property if the rent had. been higher,

. does sec. 482 authorize the: Commissioner and the courts

to override this hard fought determination of these tax-

_ payers and to substitute their own ex post facto opinion,

unsupported: by any evidence, that the rental should be

$78,000 a year?

5. Since Article 5.10 of the Texas Business Corporation of

Act (page 8, infra) required the approval of the holders |

of 80% of the stock of Warehouse before the lease could

be panes and since the approval of L. D. and S. M.

Clements was necessary because they owned 35% of the

stock, may the Commissioner and the courts say. that for.

the purposes of sec. 482 the Warehouse and Enterprises ©

were under common control merely because children of

L. D. and S. M>-Glements were in. the partnership? |

6. Where t e whole\jdea of creating the partnership and

leasing the properties ‘originated with the Davants and

Pegrams and the next generation of the Clements and the

two elder Clements refused to go into the partnership,

_were’ the- Tax Court and the Court of Appeals justified

in holding that the partnership was formed for the purpose

of letting the Clements families’ children receive a larger

part of the income from the drying and storage business?

7. May the Tax Court and the Court of Appeals avoid —

the rule so firmly established by the decisions cited in ©

Question 2 preceding that the presumption of the correct-

ness of the Commissioner’s finding that $78,000 was -a

reasonable rental is completely overcome where competent

evidence to the contrary is introduced, by their holding

a a LE 4

_ certain things were evidence that $78,000 was a reasonable

rental when those things were not. evidence as to the

reasonableness of the rental at all? |

8. May the’ Government stretch the import of sec. 482

to the extent that it can say to honorable, unimpeached

taxpayers that they may not carry on their business arrange-..

ments established by hard trading but must treat them in

such manner as those then representing the Government

may thereafter direct even though they never would have

gone. into them originally on the Government’s basis?

STATUTES INVOLVED >

Statutory provision involved is section 482 ‘of ‘the In-

ternal Revenue Code of 1954, 26 U.S.C. 1958 ed. sec. 482:.

Sec. 482. ALLOCATION OF INCOME AND >

DEDUCTIONS AMONG TAXPAYERS.

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 ‘may

' distribute, apportion, or allocate gross income, deduc-

tions, credits, or allowances: between ‘or among such

organizations, trades, or businesses, if. he determines that

such . distribution, apportionment,. or allocation is

necessary in order to prevent evasion ‘of. taxes’ or

clearly to reflect the income of any of such organiza- -

tions, trades; or businesses.

The pertinent provisions of Art. 5.10 of the Texas Busi-

ness Corporation Act provide that, if a lease of substan-

tially all the property of the corporation is proposed, a

"meeting of the shareholders shall be ‘called, and it then

provides:.

9 -

(3) At such. meeting, the shareholders may au-

thorize such sale, lease, exchange, mortgage, pledge, or

other disposition and may fix, or may authorize the

board of directors to fix, any or all of the terms and

conditions thereof and the consideration to be. received

by the corporation therefor. Each outstanding share

of the corporation shall be entitled to. vote thereon,

whether or not entitled to vote thereon by the pro-

visions of the articlesof incorporation. Such authoriza-

tion shall require the affirmative vote of the holders

of at least four-fifths of the. outstanding shares of the

corporation.” (Emphasis added).

STATEMENT

From 1933 to 1957 Warehouse was engaged first in rice

warehousing and later also in rice drying around Rosharon

‘in south Texas. In 1957 several of the younger stock-

holders of Warehouse who were active in the-management™

and operation of Warehouse decided that they would like |

to form a partnership to engage in the rice drying and

warehouse business and in connection therewith to lease ©

“the assets from Warehouse, and as opportunities might

arise to lease other warehouse and drying facilities (R. 27, .

51-52). Most of the stockholders were agreeable to going

into the new partnership, but S. M. Clements and L. D. -

Clements were unwilling to do so because, as S. M.

Glements testified (R. 132): |

: e : ° : i :

“Well, I was not optimistic about the future of the |

storage business and the drying business at that time.

And competition was great, and I chose.to go along

with my brother for as‘much rent as we could get —

» out of the younger ones who were going to do the

work, anyway, They wanted to take a chance, and I

° didn’t.” . .

BD ERB AAR Ko isin BE

In June, 1957, tlie younger siialibeibines came to the

- undersigned, Homer L. Bruce, to ask him to form a part-

nership agreement for them and to inquire whether they

could lease the warehouse property from the Warehouse. |

Company. The undersigned prepared the partnership agree- |

ment for them and told them that they could lease the

warehouse assets so. long as they were. willing to pay a~

reasonable rental for them. After considering the matter,

the partners reached the tentative conclusion that a fixed

rental of $36,000 a year would be a reasonable -rental and

suggested that the petitioner lease the properties for that.

amount. As one of the. partners, Mr. Clark, testified *

(R. 105): a: eae

“We proposed a rental of $36,000, which we

thought, in my opinion, I thought was adequate rental,

three thousand dollars per month, to operate those

facilities. It is quite a responsibility as far as owner-

ship; there is a good deal of liability to be considered

in operating a warehouse company and drying rice and

storing rice, to be liable for the damaging of it. So I

thought $36, 000 was very reasonable rent for the.

lessor.”

However, ‘this proposal was unsatisfactory to L. D. and —

S. M. Clements, as S. M. Clements testified (R. 133, 137):

“And my brother was of ae opinion that fifty

thousand dollars was’a fair rental, and that was what he

was holding out ‘for, which was quite a bit more than

they had in mind to begin with.

% * %

“Of course, we were trying to get all the money we

could that was coming to us.” —

In order to resolve this dispute the partners on the one

hand and L,. D.-and S. M. Clements on the other met in

the office of the undersigned Homer L. Bruce to work out

a solution.” After a long and heated" argumént lasting ap-

proximately two hours, an agreement was reached to lease

the facilities for $48,000 a year for one year with an op-

tion to renew for two years. However, it was the expecta-

tion’ of all parties that the lease would be continued for

indefinite period of time. In fact the record~shows that —

_.the lease. was still in effect ect on. the date of the trial of the

«case before the Tax ‘Court in. April, 1964 (R. 59-60). In-

_ «deed, the lease is still in effect and the assets are still being

operated by the paren as of the date of the sting of

this petition.

: oo audit of Warehouse’s income tax returns for

- June 30, 1957, 1958 and -1959, the Commissioner proposed

tax deficiencies based on the proposition that all of the in-

come earned by the partnership was the income of Ware-

house and in the alternative that under sec. 482 he proposed

to allocate: $30,000 of such income to Warehouse because .of

his determination that $78, 000 and not $48,000 was the fair

‘rental value.

The Tax Court held against the Commissioner on ‘the

first issue and ‘no*appeal was taken.

With respect to the second issue, Warehouse contended

that sec. 482 was not applicable because the two organiza- |

tions were not controlled by the same interests and because

the rent agreed upon by the parties was the reasonable rent

for the properties. |

In support of its position Warehouse proved not only the

arm’s length character of the lease negotiations as, dis-

cussed above, but proved through the testimony. of an im-

partial expert, as well as by the testimony of parties to

the lease. transaction, that the fair rental value ‘of ‘the

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properties was $48,000. A summary of this evidence is set »

out in Appendix B at pages 44 to 55 of this petition.

In rebuttal, the Commissioner introducéd no testimony

or other evidence directly relating to the question of the

fair rental value of the property. At most the courts be-

low based their holdings on the following: ”

1. That in the fiscal years 1955, 1956, and 1957, Ware-

house earned a substantial amount of income from the -

operation of its business. .

2. That che leased assets had a fair market value of

$700,000. :

3. That he the fiscal years 1958, 1959 and 1960, Ware-

house’ suffered a.net taxable loss of $33,041.82, $18,011.68

and $12,389.30, respectively, even though during this same

period it had enjoyed a net cash gain after taxes of over

$150,000, and still owned assets having a fair ‘market value. -

of $700,000.

4. That during the war years che 1940’s, Witla

in connection with the sale of the entire rice crop, leased

the warehouse facilities to thie purchaser for .$50,000 for

‘a single year (R. 133- 134).

§. That a ‘small. drying facility located aiiieainile

60 tiles away had been leased for a contingent rent of

10 cents per bushel dried and that, if such rate had been

used in the Warehouse lease, the rent would have oe .

$28,000 per year for the driers alone. |

Although all the evidence established both that L. D.

- Clements and S. M. Clements refused to go into the part-

nership for bona fide economic reasons, and that they

would not agree to ‘let Warehouse lease the asséts to the

partnership winless a fair rent was paid, the Tax Court .

Rai

and ou Court of eile found that the existence of the

family relationship between the elder Clements and their chil-

dren in the partnership and the fact that the elder Clements

agreed to the existence of the lease was-enough to establish

that. Warehouse was controlled by the same interests. For’

<r the Court of Appeals stated (R. 273, 274):

“We agree wih the Tax Court that these businesses

were under common control. The statute applies

whether the control is direct or indirect. Viewed in

the broadest sense, both Enterprises and Warehouse

were owned by exactly ‘the same interests.’ Each fam-

ily as a unit retained its 25% interest in the income

generated ad the businesses . . .”

* & %

. The fact that the tine elder Clements could .

veto any reallocation of income even for the short

three-year period by blocking the lease of Warehouse’s

physical properties demonstrates the degree. to which.

the assets involved were to be controlled as they de-

sired.”

In so conchiding, that court confuses “compromise” with

_ control. A majority of the owners. wanted to operate as

a partnership.. The’ fact that they agreed to the lease of ‘

the properties ‘on condition that an adequate rent was paid

shows prudent business judgment, not control.

With respect to the fair rental value of the property,

the courts below took the position that the fact that the.

property had a fair market value of $700, 000 was in itself

evidence that the fair rental value. ‘was $78,000 and not

$48,000..The second basis for this holding is that a rental

charge which does not produce a net taxable income is ipso

facto” unreasonably low. (The fact that without risk or

14,

liability Warehouse could in a three-year period net $150,- |

- 000. after taxes and still own assets worth $700,000 was

disregarded. )

In connection with the foregoing we would like to call

this Court’s attention to the father strange’ statement by

the Court of Appeals (R. 278): °

“As a result a strange dichotomy developed in the -

argument of the two cases. In this case Warehouse

attacks the Tax. Court’s finding that the physical

properties of Warehouse were worth $700,000, while

in Davant the petitioners struggle to insure that it

will be sustained. Like ourselves, the Tax Court was

bothered by this dual argument. Taking the record

in this case alone there was little if any evidence show-

ing the assets to be worth less than $700,000, while

there was sufficient evidence that they were worth at

least: $700,000.” . ,

We do not understand how the Court of Appeals could

have made such an erroneous statement as to our arguments

.in the Warehouse case and in the Davant case. In the Ware-

house case we did not contest that the properties were -

worth $700,000 -but said- that that value standing alone ~

Was not any evidence under the circumstances as to what

a reasonable rental should be. In the Warehouse case the |

Government did introduce a statement by Clark that, the

property was worth $700,000 (R. 163-164), On the other |

hand, in the Davant case the Government strongly argued

. that the value. was far below $700,000 and even said that .

the court should take only the depreciated value of thé:

warehouse assets under consideration. Thus it is clear that

it was the Government that took these inconsistent posi-

tions and not the taxpayers. 7

Warehouse arene ‘eu hese facts are not sufficient to

permit a person or court not familiar with the area to.

_ - teach any conclusion-as to the rental value of the property.

. It is apparent, therefore, that the holding of the courts”

below is based on the erroneously assumed right of the

Tax’ Court to ignoré the unimpeached testimony of an

_. impartial expert and find for the Commissioner solely

because of the presumption of the correctness of deter-

minations by the Commissioner. As will be shown, this it .

may not do,

REASONS FOR GRANTING THE WRIT

There is at hs present time a conflict among the Courts

of Appeals (and even among different panels on the same

' court) as to whether a determination. of fact .made by

the Commissioner in his notice of deficiency is merely pre-

sumptively correct until evidence to the contrary is in-

troduced during the trial or whether the Commissioner’s

‘determination is in itself evidence of the truth of his

determination. The corollary to this issue is whether the

Tax Court in determining a. reasonable fixed rent for the

lease of business property may disregard all of the sworn

uncontradicted testimony of the witnesses, includirig that

of an impartial expert, afid, with respect to a matter of which

it has-no knowledge or experience, exercise its independent

judgment as to what the. proper rental value is.

The decision of the court below is based’ on the premise

that the Tax Court may disregard all of the evidence.in

‘the record relating to the question of reasonable rental

value dnd then sustain the determination of the Commis-

. sioner simply by holding that a rental ‘of $78,000 is not

“inherently unreasonable”. (R. 280),

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RO TEI AA ET

et”

. Petitioner submits that such a rationale should be passed

on by this Court because it is erroneous and because it is

in conflict with-the decisions by various Courts of Appeals .

discussed immediately below.

The Court of Appeals for the Fifth Circuit, in J. H.

Robinson Truck. Lines, Inc. v. Commissioner of Internal

~ Revenue, 183 F.2d 739, in reversing the Tax Court on a

similar question said at page 740:

“The Commissioner offered no ae

“The Tax Court rejected all of the evidence of all

of the witnesses, and upon a record containing no

evidence whatever supporting them, ‘sustained the

Commissioner’s determinations that the rents and

salaries were excessive. |

“Upon settled principles, it cannot do this, and in. -

doing so, it‘erred. Crude Oil Corp. of America v.

Com., 10 Cir., 161 F.2d 809; and the many cases it

cites; Foran v. Com., 5 Cir. 165 F.2d 705; Grace.

Bros., Inc. v..Com., 9 ‘Cx. 173 F.2d 170 at page 174;

’ Howell Turpentine Co. v. Com., 5 Cir., 162 F.2d 319;

Mayson Mfg. Co. v. Com., 6 Cir., 178 F.2d 115.”

That same Court in Foran v. Commissioner of Internal

Revenue; 165 F.2d 705, had ‘before it the question of ©

whether a taxpayer Foran had held property as an in- -

vestment and not for sale to’ customers. Foran testified

that he did hold it for investment. The Tax Court ‘held

that it was not held for investment but the Court of Ap-’

peals in reversing the Tax Court said at page 707:

“Here there is direct and positive evidence from the ..

witness who best knows, that this property was for

eighteen months being held as an investment and not’

held for sale’ to customers. His testimony ‘is consistent

with every: proven fact. He gives a credible reason

why it was not for sale and why finally in 1941 he

did sell it. We think the court’s refusal to follow: the

sworn testimony is contrary to law, and requires the

setting aside of its fact-finding as it would that of a

jury.” €Emphasis added)

In J. M. Perry & Co., Inc, v. Commissioner of Internal

Revenue, 120 F.2d 123, the Ninth Circuit Court of Ap- _

peals said at 124: .

“When such evidence has beerf“adduced the issue de-

pends wholly upon the evidence so adduced and ‘the

evidence to be adduced by the Commissioner. The |

Commissioner cannot rely upon his determination as

evidence of its correctness either directly or as affect-

ing the burden of proof. Welch v. Helvering, 290 U.S.

111, 115, 54 S.Ct. 8, 78 L.Ed. 212; Helvering v. Na-

tional Grocery Co., 304 U.S.282, 294, 295, 58 S.Ct.

932, 82 L.Ed. 1346; Helvering v. Talbott’s Estate, 4

Cir., 1940, 116 F.2d 160, 162.” (Emphasis added).

In Loesch & Green Const: Co. v. Commissioner of In-

ternal Revenue, 211 F.2d 210, where the question was in

reference to the reasonableness of salaries, the Sixth Cir-

cuit Court of Appeals in reversing the Tax Court said at °

page 211:

“Officers of similar and competing businesses, who >

IRE AOR NS

were well acquainted with petitioner’s business and .

_ its officers and their work, testified on the hearing that

the salaries paid were ‘yery much’’on the reasonable -

side, and were in line with the- amounts paid for the

same and similar services in other construction com-

panies. Their testimony was unimpeached and should

have beén accepted by the Tax Court i @ matter in ~

: ‘ é

of Poe Reno rerte RM TE mr me

18 ri

which it had no knowledge or experience upon which

it could exercise’ independent judgment; and such

evidence. cannot be arbitrarily disregarded. Capitol-

Barg Dry Cleaning Co. v. Commissioner, 6 Cir., 131

F.2d 712. Petitioner’s witnesses were qualified, unim- -

peached, and no evidence was given to-the contrary.

Their testimony should have been accepted. Wright-

-Bernet, Inc. v. Commissioner, 6 Cir., 172 F.2d 343.

. The Tax Court cannot reject the evidence of all of the

witnesses and, upon a record containing no eyidence

to support its decision, make a determination that

- salaries are excessive. J. H. Robinson Truck Lines,

Inc, v. Commissioner, 5 Cir.; 183 F.2d 739.” (Emphasis

added) payee

In Mayson Manufacturing Company v. Commissioner of

Internal Revenue, 178 F.2d 115, the Sixth Circuit Court

of Appeals in reversing the Tax Court said at page 121:

' “This is another case, similar to others referred to

herein, where all the testimony before the Tax Court

was on behalf of the -petitioner. The Commissioner in-

troduced no witness in his behalf. No witness testified

‘ that the compensation fixed by the Tax Court for

each of the three officers was in fact reasonable com-

pensation for. the services rendered. We do not’ know «

from the record how those figures were arrived at. On.

the contrary, petitioner’s testimony was that. the cam-

pensation actually paid was reasonable compensation

in each instance. No opportunity was afforded peti-

tioner to cross-examine any witness-who might have

‘testified for the respondent to the contrary or to test

the correctness or fairness of the figures selected by

the respondent and the Tax Court. * * * We recog-

nize that in the present case petitioner’s evidence on

the \issue was not from impartial witnesses. But, never-

' theless, it was uncontradicted and was not referred

to in the opinion of the Tax Court as being/unworthy

of belief. Under such. circumstances, the failure of

the Commissioner to introduce testimony supporting

‘the deductions made by him lends considerable sup-

port to our view, gathered from other undisputed —

facts in the case, that the findings’ of the Tax Court

on the issues involved are clearly erroneous and should

be set aside.” (Emphasis added)

In Cullers v. Commissioner of Internal Revenue, 237

F.2d 611, the Eighth Circuit Court of Appeals, in revers-

ing ‘the Tax Court: said at page 617:

“— colt seem that, if the. tdvation placed upon

‘the real estate by the taxpayers and their. witnesses

- was too low, the Commissioner cul have produced

some qualified witnesses who would have said so. The

lack of such evidence operates against the Commis-

sioner’s contentions. See Baltimore Dairy Lunch,. Inc.

v. United States, 8 Cir., 231 F.2d 870; Mayson Manu-

snare. Co. Vv. Commissioner, 6 Cir., 178 F.2d 115.”

The two courts below based their decisions that $7 8,000.

was a reasonable rental on the ground that at $48,000 the

Warehouse Company showed a loss for the three years

involved. How can the fact that the Warehouse Company

had a technical income tax loss on the $48,000 rental basis

“prove that $78, 000 was the reasonable rental figure? If

the rent is fair, it is immiaterial that’ the Warehouse Com-

pany had a taxable loss,- This point was forcefully made

in Anaheim Union Water Company v. Commissioner,

321 F.2d 253 (9th Cir. 1953). There a corporation

was in the business of selling water to owners of sur-

rounding land. These owners also owned the stock in the

corporation. The price at which the corporation sold the

water was insufficient to cover the expenses incurred in

gathering it. The Commissioner sought to disallow the loss

sustained by the Water Company, on the grounds, among

others, that the value of the water was its cost to the tax-

payer. The Court of Appeals forcefully pointed out the

fallacy of this position in the following language at p. 260:

“The opinion assumed the value of the water to be

the cost of bringing it to the point where it was de-

*livered to the shareholders,-and found the amount of’

the net income to be the amount by which the value of

the water exceeded the amounts paid for the water by

shareholders. © .

“It is evident, of course, that the soundness of this

opinion is dependent upon the assumption that the cost

of the’water was its fair market value. Unless the fair

market value of the water exceeded the price which the

shareholders paid, the ‘shareholders received nothing

_ more than what they paid for and there was no distri-

bution of income or property. In the court below, re-.

spondent offered no evidence concerning the fair market

value of the water. On the other hand, Anaheim. had

testimony of a competent witness that the charge'made

by Anaheim for its water was its fair market value; and -

the witness testified, further, that if the rate had-been

raised substantially, the result would have been that

he and other water users would have sought water from.

sources other than’ Anaheim. In addition, Anaheim

produced evidence that SAVI, the water company most

comparable to Anaheim, during the years in question

charged its shareholders less for water than did Ana-

‘heim. The testimony as to the fair market value of the

water being uncontradicted and unimpeached, it was

not permissible to assume. a value at variance with the

testimony. . ...” (Emphasis added)

The rationale of the Anaheim case is directly in point

here.

To sustain this position that the Warehouse Company

had these losses the Tax.Court gave the following figures —

for the three fiscal years involved (R..206):

Fiscal years ended June 30

1958 89 «1959 1960 |

Total Income $48,004.73 $49,583.18 $51,199.39

‘ Bad Debts .

Repairs — ce 45.00 55.00

Rents 2 ‘ ~ 36.00 36,00 —

Taxes © « - . §,635.51 ~. 5,538.82 ~ 6,659.52

Amortization | 33,156.89 33,156.89 33,156.89

Depreciation - 38,893.42 24,108.32 20,183.74

Other deductions 3,360.73 3,590.27 . 3,367.09"

Interest . a 119.56 130.45

. Total deductions $81,046.55 $67,594.86 $63,588.69

Excess of :

deductions |

over in-

come-loss ~ $33,041.82 $18,011.68 $12,389.30

The fallacy of such argument is easily pointed out. Of

the above. deductions those for amortization and deprecia-

tion did not involve any cash outlay. Actually when they |

are offset against the so-called loss, the -Warehouse Com-

pany for each of said three years was actually better off

cash-wise by $120,213.35, without paying any income tax

at all, as shown by the following figures, ‘taking into ac-

count that amortization and depreciation deductions do .

not involve cash outlays:

Fiscal Years Ended

; 6- 30- 58 6-30- “$2 6-30-60

Amortization - $33,156.89 $33,156.89 $33,156.89

Depreciation ' 38,893.42 25,108.32 20,183.74

Total non-cash . eae ae

‘deductions f 72,050.31 58,265.21 © 53,340.63

“Tax loss ? (33,041.82) (18,011.68) (12;389.30)

Actual net cash gain 39,008.49 40,253.53 40,951.33 |

Py ‘

ean Seer re nae

4 ARIE: SAO ANON ORES AR LN ETI iad

‘Another fallacy is in reference to thé amortization figure.

The Tax Court pointed out that the Warehouse Company

- in.1956 had installed new facilities’ ata Cost of $165 784.45.

As the Warehouse Company was in the agricultural field, it.

had obtained the necessary: certificate under section 169 of .

the Internal Revenue Code to allow it to amortize this

amount over a period of five years or at the above amortiza-

tion rate of -$33,156.89. The Tax Court then said

(R239):

“If the approximate $33,000 a year of amortization on

_ this facility were considered as a fair rental value of.

that facility, only $15,000 of the $48,000 rental pro-

vided. for in the lease remains for all’ of Warehouse’s

other facilities.”

~ How could the Tax Court say that the Warehouse Com-

pany could charge that $33,000 as part of the rent when

in five years it would have recovered its entire cost of the

new facilities, and then would the Tax Court say that the

. ent should be reduced by this $33,156.89?

The Tax Court said that a rice drier had been rented

for 10 cents a barrel for each barrel of rice dried. (R. 238)

Davant had simply testified that he knew of one rice drier

far away that had been rented for one year on that basis.

(R. 68-69) However, there was nothing to show whether

the properties were at all comparable, In addition here was

a fixed rent whether any rice was. dried or not whereas in

that 10 cents per barrel case the rent depended entirely on

whether rice was dried ‘or not.

The Tax Court also said that back in 1940 the warehouse

properties had been rented for $5 0,000 a year (R.'238):

“The otis shows that during the 1940’s when |

Warehouse’s assets did ‘not include a dryer ‘or bulk

storage of any. consequence, it leased its facilities for

one year at.a rental of- $50,000.”

~~~Aetually_the caby testimony in reference to that was by

S. M. Clements (R. 133-134):

“QO, Do you recall the ian of the warehouse facilities

in the 1940’s, do you recall the lease of the ware-

house facilities prior to the building of the dryer,

to Mr. Robert Holland?

Yes, sir.

What * was the lease ‘rental at that time, do you

recall?

My recollection is that they paid us fifty thousand

dollars for one year, for all the facilities.

That was before the construction? .

- That included the personnel and everything.

At that time—

They just took over the business.

What was that?

Everything that the Warehouse Company owned

belonged to Mr. Holland for a year. »

What date, do you recall?

No, I sure don’t.”

PO AiccieShceigSia > OP

As there was no evidence to show the nature of the lease

' to Holland or the surrounding circumstances, and as that

lease had been back some time during the war years, it had

_ no bearing on the rental in 195% and we wed not deem it

_ Necessary to go into that 1940 lease at all.

Actually, we ask the Government. how they came to

the rental figure of $78,000°a year? It is perfectly obvi- ©

ous how the revenue agent came to that figure. As pointed

out by the Tax Court (R. 206), and as shown on page 21

of this petition, the Warehouse Company reported for

the fiscal years. of June 30, 1958, 1959 and 1960, losses

of $33,041.82, $18,011.68 and $12,389.30, respectively.

These losses had been carried back to the years ended June

30,.1955, 1956 and 1957, ‘respectively, with the result that

the District Director had refunded to the Warehouse Com-

pany for those years $8,590.87, $17,956.96 and $6,442.44,

respectively. (R. 168) By raising:the rent from $48,000

to. $78; 000, or by $30,000 a year, the revenue agent could

wipe out these losses for the three years and prevent the

Warehouse Company from carrying any losses back to.

June 30, 1955, 1956 and 1957. This is exactly what the

revenue agent did, with the result that the Government

reassessed the three amounts above listed for those three

prior years. (R.-168) And that is the only basis on which é

the rent was raised from $48, 000 to $78,000.

We submit that there is not one line af evidence in this

case to support the Government’s contention that the

rental should be $78,000.

_ CONCLUSION

We respectfully urge this Court not to consider this as

a simply isolated case. It involves the very fundamental

question as to whether honorable taxpaying citizens may -

conduct their business in a fair and reasonable way. with-

out being subject to arbitrary supervision by revenue agents .

and then subject to the decision of some judge. All of

which brings to mind the statement by the’ Sixth Circuit

in Loesch & Green Const. Co. v. Commissioner of Internal

. Revenzie, 211 F.2d 210, quoted at pages 17-18 of this peti-

tion, as follows: :

“Their testimony was unimpeached and should have

been accepted by the Tax Court in a matter in which.

it had no knowledge or experience upon which it could

. 3

“exercise nidepentent judgment; and such evidence. can-

not be arbitrarily \disregarded.”

We respectfully submit that the sas of ie Tax ‘Court

who heard and decided this case was dealing with’ the fair

rental of a rice drier in south Texas as to which she had.

no knowledge or experience. upon which she could exercise

independent judgment.

_ Those represerfting the Government in all tax cases now

are continually. citing Gregory v. Helvering, 293 U.S. 465,

and saying that the courts must not \apply the Internal _

Revenue Code as written but must look at the substance

of a- transaction and forget its form. What, however, has

* become of the rule laid down by this Court in the Gorgery

case at 293 U.S. 469: \

“The legal right of a racine to decrease the amount

_of =D gy otherwise would be: his taxes, or altogether

_avoid them, by means which the law permits, cannot

be doubted. United States v, Isham, 17 Wall, 496, 506;

Superior Oil Co. v. Mississippi, 280. U.S. 390, 395-6;

Jones v. Helvering, ‘63 App.D.C. 204; 71 F.2d 214,

aut

Actually, this Court in its recent cases and ‘uilenhaile

in Commissioner of Internal Revenue v. Brown, 380 U.S.

§63, Turnbow v. Commissioner of Internal Revenue, 368

U.S. 337,.and Hanover Bank v. Coymissioner of Internal

Revenue, 369 U.S. 672, has very strongly told the other

° courts that they must apply the tax laws as they are written

and we think that the same rule should apply in. this case.

This lease is still in effect in the -tenth year, and the

properties are now owned by South Texas Water Company.

If this case is not decided in favor -of the ‘Warehouse Com-

we co fin note iid AE

RON the CR ME tele RT a

' 26,

pany, this matter will have to be litieaved again by the

Water Company for subsequent years because we. submit

that the taxpayers were right in fixing the rental at $48,000

per year, — wees

We neds pray that this petition for a writ of

certiorari be granted, ‘

| Respectfully Submniveed,

Homer L. Bruce

ILLIAM C. GRIFFITH

* Rosert J. Piro.

- Counsel for Petitioner

1600 Esperson Building

Houston, Texas. :77002

BAKER, Botts, SHEPHERD .

& GoarTEs.

- Of Counsel

APPENDIX A

IN THE

nied Stites Court of Appeals |

FOR THE FIFTH CIRCUIT

No. 22834

_ SOUTH’ TEXAS RICE WAREHOUSE CO., Petitioner,

_ versus .

COMMISSIONER. OF INTERNAL REVENUE,

Respondent. |

Petition for Review of Decision of the Tax Court of the

United States, (Texas Case).

(August 22, 1966.)

Before RIVES and BELL, Circuit _— and FULTON,

District Judge.

' RIVES, Circuit Judge: This is a companion. case to

Davant v. Commissioner, .... F.2d . (5 Cir. 1966)

(No. 22835). While this case ‘eal oe contain certain

common issues of fact, they each involve distinct questions .

of law. For that reason we have elected to write separate

* -opinions. The Tax Court held that the Commissioner did

‘not abuse the discretion conferred by section 482" when he

1. All section references are to the Internal ‘Meee Code

of 1954.

pa Bad oka .

reallocated certain income between South Texas Rice Ware-

house Company,” the petitioner in this case, and a partner-__

ship formed for the purpose of operating the assets of -

Warehouse, 43 TC. 540 (1965). We affirm.

The stock in Warehouse was owned by four. families,

each possessing ‘a one-fourth interest. Within each family .

unit there was varied division of stock among family mem--

bers, Warehouse owned drying and storage facilities used

to pracess rice. The rice dried and stored by Warehouse

came primarily from land-owned. by the four families”

intefests and worked by sharecroppers.* ~~

_ The original storage facilities built in 1936, compared to

_ présent day structures, were somewhat primitive. The rice

“was ‘stored in sacks, and was not artificially dried. About

1949 Warehouse constructed a rice dryer and -bulk: storage

facility. Additional bulk ‘storage buildings and machinery

- were added in 1951 and 1953; A 65,000 barrel bulk storage

area costing $165,748.48 was ‘built in 1957. Minor im-

provements were added... throughout... the remaining tax

years here in question.‘ Te

In May of 1957, R. Q. Pegram, Jr., E. W. Clark, Thur-

man S. Clements, and John E. Davant consulted Homer L.

y & Hereafter, Wasutenne

3. As .a general rule, in addition to the rice received as rent

and.. processed’ through Warehouse, the co-tenants or share-

croppers also dried and stored their rice in Warehouse’s fa-

cilities. Some rice from independent sources was also dried and ~

stored in Warehouse’s facilities. For the relationship of the

families’ various interests, see our opinion in Davant v. Com-

missioner, F.2d (5 Cir. 1966). See also the’ opinion of

the’ Tax Court! 43 T.C. 540 (1965).

4. The (linuistetonee seeks to attribute $30, 000 of the part-

nership’s income to Warehouse as rent for each of the fiscal

~years ending June 30, 1958, 1959 and 1960.

> ee

@ 29

Bruce, Esq., an attorney who. had represented: Warehouse

and the four families for many years. They asked: whethér

_a partnership could be formed for the purpose of leasing

and operating the assets of Warehouse. Bruce told them that

this could be done if a reasonable rent was paid for the

use of Warchouse’s operating assets.

South Texas Rice Enterprises,® a partnership, was formed

about June 1, 1957. The managing partners borrowed be-

tween $15,000 and $20,000 to initiate the partnership, but

no other initial capital investment was made.° Enterprises,

like Warehouse, was owned by the same four families with

each family receiving a one-fourth interest.’ The two older

5. Hereafter, Enterprises.

6. .Another of. the families’ corporate entities was enithoriaed

to guarantee loans to the partnership should that have become

necessary:

: as ii . Percent, of

: ; Percent « _ family

Percent of _ of ownership + -owner-

stock in of Enterprises in ship

Individuals Warehouse 1957 19581960 in each

1. L. D. Clements 20 P 25

2. Thurman S. .

Clements 2-1/2 12-1/2 12-1/2

3-4. Betty Dickson

Clements Fly and *. : :

William S. Fiy 2-1/2 12-1/2. 12-1/2

'5. John E. Davant - 7-6/7 10-5/7 . 7-6/7 25

6. Hortense E. 7 ane

Davant . _ 2-6/7 0 2-6/7

7. Mary Anne Davant jae

Dunnam 7-1/7 7-1/7 7-1/7"

8. Kathryn Davant . .

Dodson 7-1/7 FAST 7-1/7

9. S.M.Clements ~ — 15. 25

10-11. ” Marienne

Clements Clark | .

& E. W. Clark 10 25 25

12. Raye W. Pegram 8 5 5 25

: Clements were no longer active in the business. Their shares

in the partnership were given: to their children, who were

active. There was also a slight variance in the distribution

of ownership within the Pegram family.*

A meeting was held in Mr. Bruce’s ‘hee at which it

was agreed that $4,000 per month would be paid as rental

by Enterprises to Warehouse for use of its operating assets.”

On July 1, 1957, E. W. Clark acting for both Warehouse

- and Enterprises signed the lease agreement. The lease was

for one year. with Enterprises given the right to extend

the lease one year at a time for two successive years.. In

June 1960 Warehouse and Enterprises executed another

lease susbtantially the same as the first, except that the rent -

was raised to $4,166.66 per month.in order to reflect new

improvements made by Warehouse.

- Enterprises, like Warehouse, before the leases, Was a very.

successful business venture. The leases, however, separated _

13. R. Q. Pegram, Jr. ° 8

14. Joyne Pegram :

Jones 3

15. Peggy Pegram

Elliott - 3

16. Ray Beth Foster 3

The persons whose names are indented in the foregoing

tabulation were children of the firstnamed person in the

family, except that John E. Davant was the brother of Kath-

ryn Davant Dodson and Mary Anne Davant Dunnam and the

nephew of Hortense KE. Davant.

8. The partnership was formed for the purpose of letting the

Clements families’ children receive a larger part of the income

generated by the rice drying and storage business. Each of the

older Clements told his children that they could have the

family’s full one-fourth of the partnership if they wanted it.

9. .The Tax Court found that the negotiations at this meeting

_ were not arms-length but were merely for. the purpose of giv-

ing the appearance that a full, fair and reasonable rent was

’ heing charged.

s *

the entity that was depreciating’® the assets from the entity

that was receiving the income occasioned by operating’ the

assets. Because of this separation and the fact-that the rent

paid by Enterprises. was not sufficient to cover Warehouse’s

book expenses, Warehouse showed a yearly loss. Warehouse

attempted to carry this loss back to previous years and filed

a return asking for a tax refund. The Commissioner ob-

jected, taking the position that under séction 482 Enter- .

prises’ income and expenses should be attributed to Ware-

house. In the alternative, the Commissioner contended that

the rent: paid for Warehouse’s assets was insufficient. Under

section 482 the Commissioner sought to attribute suf-

ficient income from Enterprises to Warehouse to constitute |

what the Commissioner conceived to be a reasonable rent,

i.e., $78,000. |

‘The Tax Court found against the Commissioner on his

first contention. No appeal having been taken from this

part of the Tax Court’s opinion, we can give the Com-

missioner no relief. The Tax Court did, however, find for

the Commissioner on his alternative argument that $78, 000

was a reasonable rent, :

_ Warehouse contends that the Tax Court erred because

section 482 should not apply in this case and because -

$48,000, not $78,000, was a reasonable: rent. Section 482

reads as follows:

°.

“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 con-

trolled directly or indirectly by the same interests,

10. The amounts deducted by Warehouse | for depreciation,

amortization or other business: expenses are shown in the

opinion of the Tax Court. 43 T.C. at 549.

the Secretary or his delegate may distribute, ap-

portion or allocate gross income, deductions,

credits, or allowances between or among such

organizations, trades, or businesses, if he determines

that such distribution, apportionment, or alloca-

Lion is necessary in order to prevent evasion of

taxes or clearly to reflect the income of such

organizations, trades, ‘or: businesses.” |

Two elements must coalesce for the Commissioner to use

. his section 482 power: 1) The businesses must be under

common control. 2) The reallocation must be necessary

to reflect the: proper’ income .of the businesses or prevent

tax evasion. ,

We agree with the Tax Court that these businesses were

under common control, The statute applies whether the

control is direct or indirect, Viewed in the broadest sense,

both Enterprises and Warehouse were owned by exactly

“the same interests.” Each family as a unit retained its 25 %

interest in the income. generated by the businesses. Indi-

viduals who owned 65% of Warehouse’s stock owned all of

Enterprises’, The only two persons who did not participate

in both were the older Clements. Under the circumstances,

of this case, we do not believe that their lack of absolute

control over the assets involved for periods not in excess

of three years was sufficient to defeat the operation of

section 482. | iis :

The purpose of forming Enterprises was to effect a

short-term reallocation of income among the family mem-

bers of certain units without in any way affecting their

long-term ownership or control. The Tax .Court found

(43 T.C. at 560) ;.

“This partnership was not a sham. It was orga-

nized for, the business purpose of transferring

to the adult children of L. D. and S. M. Clements,

the fathers’ interest in the rice drying and ware-

housing operation, while permitting the fathers

to retain their ownership interests in the physical

properties.” ?

In this statement the Tax Court was only half right. Cer-

tainly the partnership was not a sham in the sense that it

made only a fleeting appearance as a shield for some other

transaction. The partnership was a real functional entity

intended to last at least from one to three years,

But whether the intention to shift income Within a

family unit is a “business purpose” justifying its recogni-

tion, as a distinct noncontrolled business entity must be

judged by the statutory function of section 482. The entire

purpose of section 482 is to prevent the use of two organi-

zations ‘to distort.income or avoid taxes. That purpose

would be frustrated:if a short-term diversion of income

were sufficient to defeat a finding of contro] where the

shift is among’ related family members and no change

takes place in the actual ownership of the “physical prop-

erties.” es ia.

Warehouse argues that the income involved in this case

was really generated not by the “physical properties” in-

volved but by the diligent efforts of those managing the

business. In this way it is argued that\no distortion of in-

. come took place and that there is really no identity of

ownership of the income generating properties. This argu-

ment misses the mark. Not all of those receiving income

through either Warehouse or the partnership actually took

part in their management. What is more important is that

the argument depends upon what is a fair salary for the

executives running the business enterprise. Even if all of.

Enterprises’ income were attributable to Warehouse, under

34 zi

section 482 Warehouse would be entitled to deduct reason-

able salaries for its and Entérprises’ employees. The question

here is whether splitting the distribution. of income gene-

rated by this business from the entity that retained owner-

ship of the ‘assets can be used to create a tax loss and to

receive a refund of back taxes.

Moreover, this record does not — that it was the

extraordinary effort of any one individual as opposed to

the operating assets of Warehouse and its accumulated good ©

will that generated the income in question. We cannot say

that a three-year reallocation of income approved by the

‘elder Clements with a donative intent brought the type

of break in continuity of interest or contro] that would

prevent the application of section 482 in this case. See

Advance Machine Exch. v. Commissioner, 196 F.2d 1006.

(2 Cir. 1952), cert.den., 320. U.S. 794; Cf. Section 673;

also compare Cunitheiees v. Owens, 69 F.2d 597 (5 Cir.

1934).

Warehouse further argues that the requisite common

control could not exist, because under ‘Texas law’’ 80%

of the stockholders must approve a lease of substantially all

of a corporation’s assets. The partners of Enterprises owned

65% of Warehouse’s stock. Thus at all relevant times they

were in effective control of Warehouse, with but one possible

“exception. That exception is the moment.at which Ware-

_ shouse leased all of its operating assets to Enterprises. If we

test control at that moment, the case for the Commissioner |

is even stronger, Rather than negating an inference of

control, the fact that the two elder Clements could veto

11. Article 5.10 of the Texas Business Corporation Act re-.

quires “the affirmative vote of the holders of at’ least four-

fifths of the outstanding’ shares of the corporation” to approve

the lease.

“a

any reallocation of income even for the short three-year

period by blocking the lease of Warehouse’s physical prop-

erties demonstrates the degree to which the assets involved

were to be controlled-as they desired.’ The only change

occasioned by the introduction of the partnership was in

who received the income; the business was carried on es-

sentially as before. Such a change of form designed ‘solely

to alter the allocation of income in the short run is not

the proper occasion for allowing a tax loss to be created by

splitting depreciation from income.

Lastly, it is argued that these businesses should be viewed

as distinct, uncontrolled enterprises because the partnership »

had real and distinct liabilities. Chief among these was the

$48,000 per year rent that it owed to Warehouse whether

or not it had a profitable year. It should be remembered

that the partners were practically paying 65% of this rent

to themselves as stockholders. of Warehouse. Given the

family relationship and the fact that the elder Clements

had agreed tothe lease so. that their children could get

a larger part of the business income, we conclude that the

Tax Court’ did not err in discounting this factor,

}2. The Tax Court noted (43 T.C. at 526): “Under the facts

of the instant case, that common control of Warehouse and

_Enterprises existed is shown not only by the relationship ‘of

father and child with respect to the stockholders in Warehouse

who permitted their family interest in the partnership to -be ~

taken over by their children but also by the fact that the .

entire operations of Enterprises: were dependent on the over-

all family interests in various business entities. Obviously, for

Enterprises to operate its rjce drying and warehousing busi-

ness, it was necessary that it not only have the lease of the

dryer -and warehousing facilitiés of Warehouse but also have

available to put through its dryer the rice produced by: Rice

Farms on lands irrigated and leased from Water Co. Water Co.

and Rice Farms were owned by the same individuals who

owned the stock in Warehouse.” —

LOL ORAM

‘

PEED LPR FEIT PT TN RL

(36

To repeat, under section 482 control may be indirect as

well as direct. As to the family units in the instant case,

there-was:complete identity of control. of both entities at

all times. As to the individuals, the circumstances’ of this

case require us to find ‘that the three-year lease to related

persons does not so interrupt the individuals’ control as to

prevent the operation of section 482. In the instant case

individuals owning 65% of Warehouse’s stock owned Enter-

prises. Within this family context, this is substantial inden-

tity of control ‘viewed in the light of the purpose of sec-

tion 482. These three factors taken together amply support

the Tax Court’s finding of control.

The only question. remaining is whether the use of En-

terprises distorted Warehouse’s income so that reallocation

is necessary to prevent tax avoidance or to properly reflect

_ income. We agree with the Tax Court that this requisite

of section 482 was also fulfilled. Warehouse argues that

the lease terms were reasonable and, since $4,000 a month

or $48,000 a year was a ‘reasonable rent, that no reallocation

_ of income ‘is necessary. Accepting petitioner’ S premise that

if $48,000 were a reasonable rent Warehouse would be

removed from the reach of section 482, we agree with the _

Tax Court that $78,000, and not $48,000, was a reasonable

rent.

The Tax Court found that the’ ‘physical properties leased

- to Enterprises were worth $700,000. Originally the records

‘in this case and the Davant case were to be printed as a

single record on appeal, However, as a convenience to

respondent, the Court granted permission to print them

separately. As a result a sttange dischotomy developed in

the argument of the two cases. In this case Warehouse at-

tacks the Tax Court’s finding that the physical properties

of Warehouse were worth $700,000, while in Davant the

petitioners struggle to insure that it will. be sustained. Like

ourselves, the Tax Court was bothered by this dual argu-

ment. Taking the record in this case alone there was little

if any evidence showing the assets to be worth less than

$700,000,"* while there was sufficient evidence that they

were worth at least $700, 000.

In the instant case, Enterprises. received more hin the

physical property of Warehouse, it actually received over

20 years of good will accumulated by Warehouse, Its pri-

mary source of supply was another family-owned entity

that rented riceland on a sharecrop basis.

Prior to the lease, in fiscal years 1955, 1956 and 1957

-Warehouse’s net income was respectively $130,710.77,

$171,021.42 and $75,594.29. Enterprises’ respective net in-

come’* for 1957, 1958, 1959 was $127,400.12 (from July 1,

.1957—December 31, 1957), $75,967.89, $109,978.13.'° As

a result of confining the income to Enterprises, Warehouse

showed a loss of $33,041.82 in 1958, $18, O11. 68-in 1959,

and $12,389.30 in 1960. Pea: : |

13. Mr. Clark’ at one time estimated the value of the assets _

as about $600,000.

14. Enterprises’ gross receipts, prior to paying its $4,000 per

month rent and other .expenses, were much higher. than its

net income. For example, from July 1, 1957 to December 31,

1957 Enterprises had gross receipts of $219,577.96.

15. Had the ‘entity Enterprises not been used, during this

period, Warehouse would have had net profits of $151,400.12

(from July 1, 1957-December 31, 1957), $123,967.89, $157,978.13..

This figure is reached by adding back the rent paid to Ware-'

house which was .deducted in arriving at Enterprises’ net

profits.

16. Thus a. $123,967.89 net profit on the drying and storing

business was turned into a $33,041.82 loss in 1958: and a $157,-

978.13 net profit was turned into a $18,011.68 loss in 1959. (It

should be noted that these figures do not adjust for the var-:

iance in fiscal years.)

ree

AT a ay

The Tax Court suggested a number of ways to compute

a reasonable rent. One witness had heard of a small drying

facility on the periphery of the rice-growing area that

rented its properties for 10 ‘cents per barrel of rice dried.

= During 1940 Warehouse had leased its less sophisticated

storage facilities for one year at a rental of $50,000,"

The Tax Court indicated that if Enterprises ouaans just

Warehouse’s drying facilities at a 10.cent per barrel dried

Tent, it would have paid approximately a $28,000 per year

rental. If Enterprises also rented Warehouse’s storage facili-

ties for $50,000, the total rent would be approximately

$78,000.°° - \

Warehouse points out - thet the 10 cent per barkel rental

referred to was not one where there was an absolute liability,

as here. That is to-say, here Enterprises must pay $48, 000.

per year rent whether it dries rice or not, while. there if .-

no rice was dried no rent was paid. For the reasons stated

earlier when we discussed the element of control, we do not

think that the absolute $48,000 rental alters this case. Nor

would a rental of $78,000 for property and good will

worth in excess of $700,000 be inherently unreasonable.

_. Nothing in this record explains why a corporation which

enjoyed: the earnings record of Warehouse and which could

have enjoyed the earnings record of Enterprises would, just

after completing a new storage facility costing over $165,-

_ 000, lease its. properties for $48,000 per year, a sum not

sufficient to cover its fixed book expenses. The conclusion

17. This lease was made before Warehouse built any drying

facilities or added the more modern storage facilities involved

- in its lease to Enterprises.

18. For’a more detailed explanation of this method of com-

puting Enterprises’ rent, see the opinion of the Tax Court.

43 T.C. 540 (1965) at 550-51. .

wey

is inescapable, that if Enterprises’ income were not going

to family members the lease would not’ have been con-

summated, i.e., no independent party could have negatiated

such a lease in an arms-length transaction.

- Warehouse emphasizes that rice drying is a risky business

and that a storm might destroy the entire rice crop. Thus,

it says, $48,000 is a reasonable rent. This assumes that the

family actually would force collection of the rent regardless

of industry conditions. For the reasons we have stated be-

The earnings record of Warehouse and Enterprises also

belies this contention, When Enterprises was created, the

Purpose was to reallocate income. Both Warehouse and

Enterprises ‘faced the same risks and there is no reason to

allow. this entity under -the circumstances of this case to -

be used to create a tax loss and refund of income by arti- |

ficially severing depreciation and amortization from the

income generated by operating the business,

Warehouse had the burden in the Tax Court of proving

that '$78,000 was not a reasonable rent. It also had the

burden of proving what was a reasonable ‘rent if $78,000

was not reasonable: The weight and sufficiency of the

Cdimmissioner’s evidence is’ challenged by petitioner who

also argues that it has. carried its. burden,

Warehouse argues that the government put on no evi-

dence of its own and that the partners and their “expert”

- testified that $48,000 was a fair rental. From this we are

to conclude that the Tax Court as a matter of law could

not find to the contrary. See J. H. Robinson Truck. Lines v, a

Commissioner, 183 F.2d 739 (5 Cir. 1950) (where no

evidence to the: contrary, the Tax Court must decide for

petitioner). We think the rule is otherwise. Judge Hutche-

_ son in Hightower v. Commissioner, 187 F.2d 535° (5 Cir.

~~ hae

/ wv

1951), at 536, distinguished: his opinion in J. H. Robinson

Truck Lines, and this Court had occasion to reexamine the

problem in Burford- ‘Toothaker Tractor Co. », Commis-

sioner,.192 F.2d 633 -(§ Cir. 1951). cE

In Burford the petitidner called four witnesses who gave

their opinions and. the Commissioner called none. This

. Court said cine 3 F.2d at 635): ‘

“In the present case in addition to the opinions ~

of the witnesses there was factual evidence from

‘which reasonable inferences could be drawn. * * *

nibs ealiodiadd

“The Tax Court was not concluded by the opini-

ions of the witnesses.” '

~ We think the rule is clear, the Tax ‘Court is not bound by

the conclusory statéments of any witness, even an “expert.”

The. Court must look:at the, substance of a witness’ testi-

mony as well as his conclusions..The testimony must be

- weighed along with all other relevant evidence. Here the

Tax Court ppinted out that the witnesses overlooked several

significant factors in reaching their conclusions. The Com-

missioner relied on the testimony adduced from petitioner’s

' witnesses both during direct and cross-examination and the

other evidence in the record, The only question is whether

the Tax Court’s finding that $78, 000 was a reasonable

rental was clearly erroneous in view of all of the evidence

in this record. San Marco Shop, Inc. v. Commissioner, 223 .

F.2d 702 (5 Cir. 1955); Burford-Toothaker Tractor Co. v.

Commissioner, 192 F.2d. 633 (5 Cir. 1951), cert. den., 343

U.S. 941 (1952); Stein v. Commissioner, 322 F.2d 78

(5. Cir. 1963); Golden Const. Co. v. Commissioner, 228

_ -F.2d..637--10 Cir. 1955); Oswald Co., Inc. v. Commis-

| sioner, 185 F.2d 6 AZ Cir. 1950).

Taking this record as a whole, we cannot say that the

Tax Court’s factual finding that $78,000 was a reasonable

‘ rental was clearly erroneous. The purpose of section 482

‘is to prevent just such tax avoidance or income distortions

as occurred here.’* Hall v. Commissioner, 294 F.2d. 82 (5

Cir. 1961); Tennessee Life Insurance Co..v. Phinney, 280

F.2d 38 (5 Cir. 1960); Grenada Industries Inc. v: Com-

missioner, 17 T.C. 231 (1951), aff'd, 202 F.2d 873 (5 Cir.

1953), cert. den., 346 U.S. 819; Advance Machine Exch,

—v. Commissioner, 196 F.2d 1006 (2 Cir. 1952), cert. den.,

320 U.S. 794. The opinion of the Tax Court is therefore

- AFFIRMED.

19. When the same persons control two or more entities they

‘ may. cast their transactions between those entities in any form

that they desire. The restraining force of outside ‘interests is |

absent. Section 482 is designed “to prevent evasion of taxes”

or distortion of income caused by the form that these pereune '

i arene in casting their transactions.

STEPPING LO TE

Anited States Court uf Appeals

FOR THE FIFTH CIRCUIT

October Term, 1965 ¥

NO. 22,834.

Ps D. C. Docket No. 1048-63

’ _».SOUTH TEXAS RICE WAREHOUSE CO., Petitioner

versus

COMMISSIONER OF INTERNAL rca hae

ai acer

‘Petition for Review of Decision of the Tax Court

of the United States (Texas von) ;

Before RIVES “aid BELL, ‘Clecdix Judges, and FULTON,’

. _ District Judge.

JUDGMENT

_ This cause came on to be heard on the petition of South

Texas Rice Warehouse Co. for review of a decision of the

Tax Court of the United States, and was argued sd coun-

sel;

ON. CONSIDERATION WHEREOF, It is now here

’ ordered, adjudged and decreed by this Court that the de-

cision of the Tax Court in this cause be, and the -same is

hereby, affirmed. |

. August 22, 1966

Issued as Mandate: oi

IN THE .

UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

NO.. 22,834

‘SOUTH TERMS RICE "WAREHOUSE CO., Petitioner

. versus

COMMISSIONER OF INTERNAL REVENUE,

‘ Respondent

Petition for Review of Decision of the:Tax Court

of the United States (Texas Case)

"ON PETITION FOR REHEARING -

(October 4, 1966)

—

Before RIVES and BELL, Circuit Judges, and. FULTON,

District Judge. . :

PER CURIAM:

The petition for rehearing- filed by the petitioner in this

case is hereby DENIED.

Canoe

APPENDIX B

The undersigned Homer L. Bruce, who had represented.

these rice people since around 1933, said in his opening

statement on. the ‘trial of this case on April 23, 1964 _

» (R.27):

- “The younger ones wanted to form a partnership to

go into the rice drying business and farming, ‘them-

_ selves, not only for the rice drying proposition, but

. other parts of the country, although they | have -not

expanded..

“So, tn July—in June of 1957, these partners, the

younger ones, formed a partnership called the South

Texas Rice Enterprises.. Then they proposed to lease

the warehouse property from the South Texas Rice

‘Warehouse Company. °

, “They met in my ‘office and I advised eens: that |

- they had the right to do it if they wanted to, but that.

they must pay a reasonable rental. That would -be an.

issue. [24] “And it might be litigated. So they. had

quite an argument there in my office there. Some of

‘them starting out at thirty-six thousand: — Dick

Clements wanted -fifty thousand dollars, and they

finally agreed to forty-eight thousand dollars rental.

The lease was made July 1, 1957, for $48,000 a year. °

“The lease—I forget—I think it ran three years, but .

it had the option to—they had the option to extend it.

The warehouse company later put in about thirty |

thousand dollars more property, and the rental was

raised to fifty thousand dollars.

. “That lease is still in effect, Your Honor. * * *”

John E. Davant testified that he was 52 years of age and

had been in the rice business all of his life with his father,

W. E. Davant (R. 42-43). Up until the early 1940’s

there was no machinery for drying ice but about that

time a new method was developed under which rice could

be dried and the Warehouse Company put in a. dryer in

1948. The general business of petitioner was to dry rice for

farmers and store it for them in the warehouse if they de-

sired. He further testified:

State whether-or not you and Bob Pegram, that’s

“Q.

R. Q., Jr., and Eddie Clark, and at that time,

Thurmon Clements, came up to see me some time

in May, 1957, about the possibility of forming a

partnership and leasing this property from the

Warehouse Company. :

A. We did. - | rae

Q. Do you recall, in substance; what I told you about

it?, ,

A. Yes, sir.

Q. What was that? ‘ear

A. You said that we could lease the property but we

_ ‘would have to pay a reasonable rent. ae dl

Q. You then asked me to get up the partnership

- agreement, did you not? |

_ A. Yes, sir, we employed you to do that for us.

rPOr 0

“OQ,

% + %

Now, what was your purpose in going into that

partnership agreement, Mr. Davant? :

Well, I felt like— )

What caused you to want to go into it?

. I felt like it was an opportunity for us to make

some money -at that time. And, of course, we had

_ discussed -the possibility of even leasing a mill and

leasing other properties. (R. 51-52).

. % % * of ‘ 2

Now, did you finally come to any agreement with

the other stockholders that didn’t go in, Mr. S. M.

Clements and others, how did you come to an un-

derstanding that this first year, or: the rental under °

~ the first, lease would be forty-cight thousand dol-

month— |

. Now, who was up-there? ‘You said “we.”

O>o -

lars a year or four thousand dollars.a month?

. We came up to your office and we had been dis-

cussing it on the basis of three thousand dollars a

Jr., and myself, and I believe Dick Clements or

L. D.'Clements and S. M. Clements.

They were there? ,

Yes, sir. Hay

What did you all do about fixing the rent, Mr. L.

D. Clements and S$. M. Clements not being in

the partnership, how did you come to a figure?

- We made an offer of $3,000 a month, coming to

$36,000 a year, Dick wouldn’t hear to it.

wanted fifty thousand dollars cash.

‘We finally, after, I‘guess, about an hour of ar-

gument or a little longer, arrived .at 34,000 a

month. We wanted it on a monthly basis. And

that was $48,000, and he finally agreed to that.

What was Mr. S. M. Clements’ attitude -about

your thirty thousand and fifty thousand: dollars?

- Mr: S.- M.- Clements was right along with Mr.

. Dick Clements.’ They wanted what they: consid-

ered a better rental than we had offered them,

They didn’t want to lease it and wouldn’t agree

to it until we came up with a forty-eight thousand _

dollar figure. a

Well, now, Mr. Dick Clements owned twenty

per cent of the stock at that time, and S. M.

Clements owned fifteen per cent, and they

wouldn’t agree to any. lease unless you did come

up? sae

That’s correct. _

You say you were there about an hour and a half?

+ We were there longer than that, but at least that

one thing was discussed for at least an hour and a

half. (R. 53-54).

“Q. All right. i

Mr. Davant, if that rent, if they had demanded

~ $78,000, like the government is claiming in this.

case, as the rent, state whether or not you would

- have gone into this partnership and rented it for

“4,

$78,000 a year. a

MR. FRIEDMAN: Objection.: The question

calls for ‘conclusion on the part of the witness,

“THE COURT: Ie calls for an opinion, but I

am receiving it: I have grave doubts, Mr. Bruce,

how much this is worth because it’s something that

didn’t happen, and. it’s highly speculative, but I

am receiving it purely as his opinion of what he

might have done. The Court will let him answer,

No, sir, I wouldn’t, But I would like to explain

. ‘that. (R. 54-55)

+ + *°

“BY MR. BRUCE: ‘teat

Mr. Davant, from your opinion and your experi-:

ence, do you think this $48,000, and later $50,-

000 a year was reasonable rent to pay for this

property? ie

I thought it was high. |

You thought it was above the value?

Yes, sir, and I do now. (R. 68).

Edward W. Clark, whose wife is Marienne Clements

Clark, the daughter of S. M. (Spence) Clements, testified:

-.On July 1, 1957, he had-been President of petitioner for

many ‘years:and has since been the managing partner of

the partnership. (R. 101). ‘

Mr. -Clark, you have heard Mr. Davant testify:

as to the formation of the South Texas Enter-

prises, and I believe the record shows that Ory July

1, 1957, when that lease went into effect, Mr. S.

. me — —

M. Clements owned fifteen per cent of the stock of

the Warehouse.Company and you and your wife

owned ten per cent, but: when you formed the

Enterprises, you and your wife owned twerity- —

five per cent? : .

Yes, sir.

Now, tell the Court why you wanted to go

into this Enterprises partnership and go into this

activity? ? : f |

. Well, I started to work down in Rosharon:down in

1948 when they built the dryer, and -had been

there from 1948 to 1957, which is about nine

years. The previous five to that, I was probably ~

manager, president and: manager of the Warehouse —

Company with. a ten percent interest and-an aver-

age small salary. :

With my ten percent interest in the Warehouse

Company, I wasn’t.actually realizing much income

from those facilities. And I was in favor of trying

to have the opportunity of making some addi-

_ tional income. And through a partnership — Mr.

> -

- He said he didn’t want any interest in the part-

Clements wasn’t interested. in going into it for

whatever his reasons might be — and I could ac-

quire, my wife and I could acquire a full twenty-

five per cent interest. If there was to be any in-

come, I would be benefited from that, rather than

have a ten per cent in the carporation. me

Now, what was Mr. Clements’ attitude about go- _

nership, at‘the meeting at your office, that if I -

wanted a full twenty-five per cent of it, I could _-

have it, which was a family ‘proportion. _

+ + .

You had that meeting, testified to by Mr. Davant,

in my office. Do you recall when you had it and

came to an agréement as to what the rental would

be? .

Yes, sir, T recall.:

on:

Q. And just tell the Court briefly what happened

there and what the attitude of Spence Clements '.

and L. D. Clements and $. M. was and what your

attitude: was. 3 : |

A.. We proposed a rental of $36,000, which. we

thought, in my opinion, I thought was adequate

‘rental, three thousand dollars per month, to operate

_ those facilities. It is quite a responsibility as far as

ownership; there is a good deal of liability to be

‘considered in operating a warehouse company and ,

drying rice and storing rice, to be liable for the

damaging of it. So I thought $36,000 was very.

reasonable rent for the lessor. And Mr. Dick Cle- -

ments thought it should be more. I don’t know

whether it was forty-eight or fifty or fifty-two, or

whatever figure it was, but we finally decided, or

he made a remark, that forty-eight would be all:

» right with him. |

And he said, ‘Well, boys, I don’t think I] want

any part of it, a partnership. I don’t want any part

of it. But you all are young. If you go busted or

broke, you have a chance to come back. But I

am older and I don’t want any liabilities from.

damaging of rice that you boys don’t realize could

happen to you.’

Q. So he refused to go into it? 7 |

A. Yes, sir. His brother, Spence Clements, I imagine

felt the same’ way after. Mr. Dick expressed his

opinion. Anyway, he told me if I wanted a full

'. twenty-five per cent, I could have it: He didn’t

want any of it. ~ a

Q. Would you have gone into it and rented. that if

. Mr. Dick Clements held out for higher rent?

. A. I don’t think so, I might have paid fifty thousand

"dollars, but that would have been the most I think. °

I would have paid, in my opinion, at that time, and --

I would have paid less.” (R. 105-106).

* +

a eee MOD 49

-, William S. Fly, the son-in-liw of L. D. (Dick) Clements,

testified: - : es

“Q.

Mr. Fly, you have been present during the testi-

_-mony and have heard the testimony with reference.

to the formation of South Texas Enterprises @art-

nership and the lea@ffig of these properties from the

‘O>

> 0

QrPO > ©

Warehouse Company. It’s been testified that you _

were at the conference in my office when it was -

finally agreed, in June, 1957, the first rent would

be $48,000? ,

Yes, sir. — r

‘Would you tell the Court, briefly—when -I say

briefly, in the light of what has been testified—as

to whether or not what happened there was. sub-

stantially the same as Mr. Davant and Mr. Clark

testified to? ,

> : * ca *

. My recollection is substantially the same. My

father-in-law, Mr. Dick Clements, did not want

to go into it. We argued with him relative to the

og of rental, as Mr. Davant ‘and Mr.- Clark

said. Mineo

State whether or not there was considerable dis-

cussion as to-what the lease would be.

There was considerable discussion and we were put-

ting some pressure pretty good on Mr. Dick to -

try to get this rent down to where we thought we °

could make some money. 3

And yow didn’t think that was going to endanger

your marital relationship with your father-in-law?

No. We worked on it pretty hard, but he went.

along with it finally.. ; =

Why did you want to go into this?. }

I wanted the opportunity to make some money.

You had a bigger increase in’ the percentage, an*

increase in the Enterprises than. you had. in the

Warehouse Company? =—S—se

That is true.” -(R. 127-129). .

S. M.

(Spence) Clements testified that hie built the first

warehouse and then in 1939 bought into the South Texas

Water Company. ,

. ee

Sometimes I call you by your first name because

I don’t remember the Mister.

“Spence, state whether or not when this matter |

of forming the South Texas Rice Farming Enter-

_. prises came up, did you want to be a partner?

PO >

I did not.

Why?

Well, I was not optimistic about the future of the

. Storage business, and the drying business ~-at. that

time. And competition was great, and I: chose to

go-along with my brother for as much rent as we

~ could’ get out of the younger ones who were going

PO >

to do the work, anyway.. They’ wanted to take a

chance, ‘and I didn’t. cs .

- How much work did you do on the Warehouse

Company; or the Farms? |

Welk\I haven’t done any in-a long time, Homer. —

All .

“Now, state whether or not you know what — !

legal liability of a partner is in a partnership an

what can happen to’ you..

Yes, sir, I think I do know. |

What is your idea? ,

My idea is that a partner is liable for everything, |

everythirig his partner is due ‘and him, too. There

is no limit. | : |

ee + % #,

You have heard the testimony here as to the cdn-

‘ ference that was had in’ my room when -Mr.

Davant, Mr. Pegram, Bill Fly and: you and Dick - °

Clements ‘were there, and how you came to arrive

. Yes, sir, I remember we argued back and forth:

quite a while. And niy brother was of the opinion.

that fifty Simian’ dollars was a fair rental, and.

that was what he was holding*out for, which was

quite a bit more than they had-in_mind ‘to begin

with. But we finally settled on four thotisarid dol- .

lars a month.

Did‘ you gd along with Dick? .

I went along with Dick, my brother. (R. 131- 133).

R. Q. Pegram, Jr. cestified that he was the son of the

original R. Q. Pegram and that Raye W. Pegram is his |

mother and his sisters are Joyce Pegram Jones, Peggy, a.

liott and Raye Beth Foster; that he had been connected :

with the Water Company since 1949 and. has been its

President since prior to 1957 (R. 139-140).

“BY MR. BRUCE:

Mr. Pegram, you have heard the witnesses testify

about the conference that was had between mem-

bers of the Rice Enterprises partnership and Dick

- Clements and Spence Clements and myself up in

(PR OPOD

in my office about how this was fixed? .

Yes, sir.

. Were you at that snide’

Yes, sir.

What was your thought at that time as to hun

rent you should pay?

I thought x le thousand dollars a year or hes

thousand dollars a month was entirely adequate, and -

all we could afford to pay.

What was Mr. Dick Clements’ atticude! 2

Mr. Dick Clements’ attitude was that it should

bring at least fifty thousand dollars a year into the .

corporation.

And you finally agreed on th a thousand

dollars? :

Yes, sir, four thousand dollars a month,

“ a

* Q. State whether or not, Mr. Pegram, there are in-

herent risks that eccur in the rice drying business

_ that might cause some years to be good and some

years to be bad. =

A. That is true.

Q. What are some of those risks?

A. Your risks from hurricanes, loss of crops in the

field, intermittent weather conditions that delay

orders, rush of business at various times over and

above what your capacity will permit you to take

in. You have to divert rice to other areas. There is

always the danger in handling the rice through the

drying process tliat someone may be neglectful and’

‘ the rice will be damaged;-the operator of. the

facilities would certainly be liable for any damages

‘suffered to the rice. (R. 141-142)

Marcus W, Mauritz testified that he was 55 years old,

he had no connection with the petitioner or. any of the |

people interested in it or in the Water Company, that his

father was one of the leading: businessmen and farmers

‘around Ganado, Texas, some 75 miles from where the peti-

tioner had its operations and that he had been in the rice

business all of his life.

“OQ.

the rice drying business and the rice storing busi-

Now, will you tell the Court: what connection you

have had with the rice business and particularly

ness in the last years, up to July 1, 1957,.and on.

-up to date, particularly prior to July 1, 1957.

Well, being the only son in all of this family you

are just speaking of, I was more or less started out.

as errand boy, then grew up to more or less man-

aging them. And in about 1942 I took over the

active management of all the rice farming. _

“And in 1945 we built the second dryer that was

built in ‘Texas, and we have operated that dryer

ALT, ENTIRE TR EIEN

POLLS Ry ILS

ever since, ‘and I have been the active <i of

it, ; |

“Prior to building the dryer in 1945, we oper-

ated, as has been brought out here. taday, ware-

housing where we took in sacked rice and stored it

‘in the warehouses and sold it for the farmers.

“Since 1957, actually” in 1949, I helped organize

what is called "Tones Rice Peomcrional Association, :

a voluntary organization that’has its main object

as promoting the consumption of-rice in the United

States. It has since been merged into a rice coun-

cil, which is now a national organization that still

thas the same objects. And our principal concern

is. how, much rice is produced, how much of it is

sold, where it’s sold, and how much we can increase

the ‘sales so as to increase the production that the

farmer is allowed to produce. .

% % +

Mr. Mauritz, you have heard the testimony here

in connection with the facilities down there at the.

Warehouse Company, and I will ask you_if you

have seen a copy of the lease that was executed |

effective. July 1, 1957, from South Texas Rice

_ Warehouse Company to South Texas Rice Enter-

prises, -

Yes, sir, I have,

_ And that lease, I believe, provides for a rental of

forty-eight. thousand dollars per year for those

facilities.

Yes, sir.

Now, to refresh your memory, Mr. Mauritz, I .

would like to show: you Petitioner’s Exhibit No.

18, which gives the annual receipt of rough rice

‘at the Rosharon dryer, and that is the South Texas

Rice Warehouse Company, during the crop years

from 1949 to 1963. I will ask you whether or not’

Or O>

you have’ seen a copy of that: and have studied it »

heretofore.

. Yes, sir, I have. . | F

. And_you are more or less familiar with the volume

‘that went throughrthat rice dryer down there?

- Yes, ‘sit. | a Se

- Now, Mr. Mauritz, have you become personally

familiar with the business properties at Rosharon

that constitute this South Texas’ Enterprises rice

warehouse and dryer?

Yes, ‘sir, I have.

I believe the record shows that they have a silo —

with a capacity of 65,000 barrels, .a quonset ware-

housé of 36,000 barrels, and a dryer of- 36,000 bar-

rels and a warehouse of .137 by 400 feet, with the

‘machinery that goes along with such a warehouse. _

“Now, Mr. Mauritz, from your experience in |

the rice business, state whether or not in your opin-

ion the rental of $48,000 that was provided for in

this lease effective July 1, 1957,. would be a rea-

sonable rental-to pay for the rent of this warehouse

property.

. In my opinion it is excessive. (R. 149-152)

Speen eS WG: RECT ae ates eae eae BOR RO RENTER NR TP LPR EE

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.