Petition for Writ of Certiorari — Likins-Foster Honolulu Corp. v. Commissioner

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LIBRARY MOTION ESS |

5 | | : | Office-Suprame Court, U.S.

SUPREME COURT, U. S. og tO ee FILED

rake JAN 5. 1970

In the Supreme Court off fiié."* CLERK

United States"

OctToBER TERM, 1969 .

No..1.037

Lixtns-Foster Hono.utu Corp., et al.,

Petitioners,

VS.

CoMMISSIONER OF INTERNAL REVENUE,

Respondent.

joe:

Petition for a Writ of Certiorari to the

United States Court of Appeals

for the Tenth Circuit

' VALENTINE BROOKES

_ 1600 International Building

_| 601 California Street ;

San Francisco, California 94108

Bert W. Levit

— 465 California Street

San Francisco, California 94104

Epwarp E. Sous

2210 First National Building

Oklahoma City, Oklahoma 73102

Attorneys for Petitioner |

SORG PRINTING COMPANY OF CALIFORNIA, 346 FIRST STREET, SAN FRANCISCO 94105

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Jurisdiction

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Opinions Below

Questions Presented

Statutory Provisions Involved

Statement of the Case

‘ Reasons for Granting the Writ

Conclusion

» ;

TABLE OF AUTHORITIES CITED

CasES - Pages

Chapman v. United States, 169 F.2d 641 (C.A. 10, 1948), cert.

den. 335 U.S. 860 (1948) 20... ccccceceseseceec-o-o-- 14

Cold Metal Process Co. v. Commissioner, 247 F.2d 864 (C. vf

Mig RON edict Net arta Rone EI) Oe i ED Ze 11, 12

Commissioner v. Court Holding Co., 324 U.S. 331 ( 1945)........ 7,8,9 -

Commissioner v. Henry Hess Co., 210 F.2d 553 (C.A. 9, °

YEE Santana. 11, 12,/13, 14, 15

gic Wagon, Ine. v. Commissioner, 369 F.2d 629 (C.A.

2 BR NY LEER eel Aceh RN SET LORE ASE SE PL bbs CET 7,8

'. Kent Manufacturing Corp. v. Commissioner, 288 F.2d 812

Lk ey, | Pelee SMD SE De, © oral nen eae ear, 7, 8,9

Maxwell Hardware Co. v. Commissioner, 343 F.2d 713 (C.A.

ep ene Meme Se Ae ace ta Bens Reh 8 Dae RRNA? STAINS 20

Nitterhouse v. United States, 207 F.2d 618 (C.A. 3, 1953),

cert. den. 347 U.S. 943 (1954), reh. den. 347 U.S. 970

CEPNOY hase a eh 11

North American Oil B Burnet, 286 U.S. 417 (19382)................ a

Patrick MecGuirl, Inc. v. Commissioner, 74 F.2d 729 (C. A. Meret

1935), cert. den. 295 U.S. 748 , ll

‘Security Mills Co. v. Commissioner, 321 U.S. 281 (1944)...... 11

Towanda Textiles, Ine. v. United States, 180 F. Supp. 373

(Ct. Cl., 1960) poihasetas ign closlinessvoheiPeshduckicsids opbueieaciceicéed disc: 7

‘ United States v., Consolidated Edison Co., 366 U.S. 380

IESE Sead RM Rate brs ee EET NZ MP pine eal 11, 14

United States v. Cumberland Pub. Serv. Co. 338 U.S.'451

(2866) -....... ee eb

United States v. Miller, MEE Rie. OOO (EOEE cocci 14 -

United States v. Safety Car Heating Co., 297 U.S. 88 (1936),

_ Dixie Pine Co. v. Commissioner, 320 U.S. 516 (1944)... 11

, Wendell v. Commissioner, 326 F.2d 600 (CA. 2, 1964)... 8

Dest

1 RN EE Es we

TABLE OF AUTHORITIES CITED es ili

STATUTES ° Pages

Capehart Act (42 U.S.C. 1594(a), 70 Stat. 1111- 2, as amended "

by Pi. 86-104, Ti Bik: FOO nn roe 14

Federal Rules of Civil Procedure, Rule 714A (j)

Internal Revenue Code of 1954: ; OR:

Sections 61(a) (7). and 243 (a) : 17

Section 269 Pint Rhee SORA RIE Peco 23. 18, 19, 20

Section 337 ...... NRCS ICO RAC T 2, 3, 6, 7, 8, 9, 10, 11, 18, 14

Sections 381 and 382 ......... tno ee

~ Section 482 . ....3, 4, 6, 16, 17, 18, 19, 20

Seetion 1012 ........... 2 17

Section 1033, 1231 (a) 8

Section 1501 .......... : 3, 16

Section 1502 Rott LEN ALTOS 3, 16

Section 1503 See HER HOD LOR 3

WOUNSIIN SIN istsinsicrenctnsnppadccesansinceecogan teases od asad eee ae 3

Section 1551 REE NN de DERE ..8, 18, 19, 20

Treasury Regulations:

1.337-2(a) wt ecoctalcetnesseamnasseiedecact liom eee mee 9,10

1.1502-1A(a) . ; 17

1.1502-31A(b) .. : 17

1.482-1(b) (2) ..... A. ssc aenipecbatnscesiaatriontaips teat cra ies 18

28 U.S.C. 1254(1) ... as ae

31 U.S.C. 2038 . 13

MISCELLANEOUS

Fed. Housing Admin. Regs., 24 C.F.R. 803.23 wvseveeenesnoneweseneenees 13, 16

H. Rept. 2, 70th Cong., 1st Sess., pp. 16-17 18

H. Rept. No. 1337, 83rd ee 2d Sess., pp. 38-39,

A106-A107 7,8

Rey. Rul. 59-108, 1959-1 Cum. Bull. 72......... "4

S. Rept. No. 1622, 83rd Cong., 2d Sess. pp. 48-49, 258-259 ...... 7,8

In the Supreme Court of the

United States

OcroBer Term, 1969

Lixrins-Foster Honotuu Corp., et al.,

Petitioners,

vs.

‘COMMISSIONER OF INTERNAL REVENUE, -

_ Respondent.

Petition fora Writ of Certiorari to the -

United States Court of Appeals

for the Tenth Circuit

Likins-Foster Honolulu Corp.; Aliamanu Homes Lim- .

ited; Likins-Foster Olathe Corp.; Likins-Foster Topeka

Cann: Likins-Foster Salina Corp.; Cochiti Pumice Com-

pany, Lomita Homes, Inc.; Cardiff Homes, Ine. ; Highland :

Park Homes, Inc.; Biggs Rental €o.; Foster Homes, Ltd.;

Foster tcaloniieit Corp.; Central Development Co., Ltd.;

Likins-Foster Ord Corp., a liquidated corporation; Likins-

Foster Monterey ‘Corp., a liquidated corporation; Likins-

Foster Biggs Corp., a liquidated corporation; and Likins-

Foster El Paso Corp., a liquidated. corporation, ot seca

< 9

pray that a-writ of certiorari issue to review the judgment

- and opinion of the United States Court of Appeals for the

Tenth Circuit entered in this proceeding on November..16,

1969. :

OPINIONS BELOW

The opinion of the Court of Appeals -has not yet been

officially reported. It is unofficially reported, at 69-3 U.S.T.C.

| 9672 and is reproduced insAppendix A hereto. The opin-

ions of the Tax Court of the United States are reported

at 25 T.C.M. 1390 (1966) and 26 T.C.M. 1021 (1967). The

Tax Court opinions are reproduced in Appendices B and

. C hereto.

JURISDICTION

The judgment of the Court.of Appeals (App. A, p. 14)!

was entered on November 16, 1969. The jurisdiction of this

court is invoked under 28 U. S. C. 1254(1).

QUESTIONS PRESENTED |

1. Whether the date of the “sale or exchafige” for pur-

poses of section 337 of the Internal Revenue Code of 1954,

a remedial measure designed to avoid double taxation on

sales or exchanges in eorporate liquidations, is the date

title and possession pass, or is the date gain would be real-

» ized on the sale or exchange under ordinary circumstances.

The setting in which the question arises is a condemnation

of property, ‘where the court below applied a different rule

than that applied in other types of involuntary conversions

and in consensual! sales. .

2. Whether an accrual basis piper realizes gain from

a sale pursuant to a condemnation, prior to: the date the

| litigation over the amount of the condemnation award 1 is

terminated. 3

: eae are to, printed record in this case, the appendix in the Court —

of Appeals.

3. Whether Internal Revenue’ Code section 482 author-

izes allocating the entire profit/from- one. ‘member of a con--

solidated return group to another, in a manner contrary ©

to the consolidated¥eturn regulations, where ‘the trial court

has found that tax. avoidanee would otherwise ‘oeéur, but

the provisions of sections 269 and 1551, dealing with trans- :

fers to avoid sat do nig apply. An

STATUTORY PROVISIONS INVOLVED

Internal Revenue Code of 1954: ret |

Sec. 269. Acquisitions made to evade or avoid in- *

: come tax. (26 U‘S.C. 269.) :

Sec. 337. Gain or loss on sales or exchanges in con-

nection with certain liquidations. (26 U.S.

C. 337.) ;

See. 482. Allocation of income and deductions among

taxpayers. (26 U.S.C. 482.)

Sec. 1501. Privilege to file consolidated returns. (26

3 ‘U.S.C. 1501.)

~ See. 1502. Regulations. (26 U.S.C. 1502.)

See. 1503.. Computation and payment of tax. (26 U.S.

~*~, 1508.) }

See. 1504. Definitions. (26 U.S. C. 1504. ye

The above acetone are reproduced i in es D hereto.

STATEMENT OF THE CASE

Likins-Foster Honolulu Corp. (hereinafter ‘referred to

as: Honolulu Corp.): owned all the stock of Topeka Corp.”

and, until February 10, 1958, of the four Wherry corpora-

tions,’ and filed consolidated returns including them. After

2. Likins-Foster Topeka Corp.

3. Likins-Foster Ord Corp.; Likins-Foster Monterey Corp.;

Likins-Foster Biggs Corp.; Likins-Foster El ‘Paso Corp. The sep-

arate incorporation of the four was for business reasons appearing

in the Tux Court’s findings. (App. B, p. 28.)

; 4

the consolidation was broken, the Wherry soxporntions filed

separate returns until they were dissolved. (App. B, pp. 26-

27.) The returns were on the accrual basis.

a. Topeka Corp. owned 421: rental houses and a foe

in Topeka, Kansas, which it sold on July 1, 1956 to the

four Wherry corporations for a profit of $882,967.39. (App.

B, pp. 28-29.) This followed a, policy decision to dispose of

these properties to the public, because of recent* businéss

developmentts. The Wherry corporations continued the

rental business with the same staff for a year, but added

persons to handle the sales. (App. B, pp. 29-30.) The 421

buildings were sold at retail in individual sales in June,

1957 (App. 30), for prices totaling $387,654 more than the

Wherry corporations had paid for them (App. B, p. 30).

The gains from-these sales were reported in the consoli-

dated return as gains by the Wherry corporations, because

the Topeka sale te them was treated as an intercompany

transaction whder the consolidated return regulations,~

(App. B, pp. 30-31.) It was offset against the Wherry

corporations net operating loss carryovers, some of which

antedated the first year they were included in the consoli-

date return. (App. B; pp. 31-32.) ‘The Commissioner allo-

cated the entire gain to Topeka, assigning Sec. 482 as his -

authority (App. B, p. 33), and the Tax Court, finding that

the sale by Topeka to the Wherry corporations was made .

to avoid taxes (App. B, p. bail sustained his action, as ; did

the court below.

b. Each Wherry corporation owned a land lease on

which it constructed housing for rent to military person-

nel, at two different air or military bases. (App. B, p. 46.)

The loans made to finance the projects, were guarapteed

by the United States. (App. B, p. 28.) In-1957, the United

States filed complaints in the appropriate district courts to _

condemn tftse properties. In the Texas district it deposited

$2.00 as estimated just compensation,4vut incresed the de-

eo * ° o / oe

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posit. by $337,998.00 on June 6, 1958. In the California dis.

trict it deposited $782,053.00. (App. B, pp. 46-47.) The

defendant corporations answered, putting the amount of

just compensation in issue. (App. B, p. 47.) Trials of that

issue occurred, and on January 21, 1960 a jury verdict was

brought in in the California district, increasing the just

compensation to $1,106,000. Judgment in accordance there-

‘with was entered on June 23, 1960. (App. B,:p. dl.) An

appeal was taken and the judgment was affirmed on October

1, 1962. (App. B, p. 51.)

In the Texas district a jury verdict resulted in a judg-

ment entered on August 7, 1962, which increased the just

_ compensation to $1,700,000. That judgment Was not ap-

pealed. (App. B, p. 51-52.)

In its complaints the United States asked for immediate

possession, which it obtained. It then entered into so-called _

“three-party agreements” with the mortgage. creditors

under the debts it had guaranteed, undertaking to pay off

the debts under their terms. (App. B, p. 48.) ‘The Wherry

corporations did not sign these agreements. (App: B, p. 49.)

Thereafter, on August 11, 1958, the four corporations

adopted resolutions to dissolve, adopting plans of liquida-

dation. (App. B, p. 49.) Then, on August 19 and 20, 1958,

they filed sitions with the district courts to withdraw the _

funds deposited earlier by the United+States, and orders

permitting withdrawal were entered on August 20 and 25,

1968. The finds were actually withdrawn on August 27, 1958

and September 2, 1958. (App. B, p. 49.)

‘e. The income tax issues arising from these facts were,

together with many other issues arising from other facts,

taken to the Tax Court, which decided these issues ad-

versely to the taxpayers. The Tax Court held that the “sale

or exchange” in the condemnation occurred when title

‘passed to the United’ States, which was on the filing of the

complaint, and that in consequence the corporations had

adopted their plans of liquidation too late to enjoy the

benefits of LR.C. section 337, under which the gain would

have been tax-free at the corporate level. (App. B, pp. 97-

99.) On appeal, the Court of Appeals for the Tenth Circuit

agreed with the Tax Court that section 337 did not apply

for,the reason given by the Tax Court. (App. A, p. 7.)

Both courts also held that gain from the sale arose when

' the United States assumed the mortgage indebtedness for

which it had already been contingently liable as guarantor,

notwithstanding that the amount of the just compensation

remained contingent on the litigation not determined until

years later. (App. A, p. 6; B, pp. 97-98.) The Court of Ap-

peals disagreed with the Tax Court about the dates when

this occurred, and with respect to one of the Wherry corpo-

rations remanded for additional findings and consideration

on'this point. (App. A, p. 6.) The effect of this disagreement

is not to make section 337 applicable or otherwise to elimi-

nate the tax to the corporations in some period, unless the

remand proves to have this effect'as to one of the four.

On the Topeka issue, the Tax Court held that the Com-

missioner correctly allocated the entire profit on the sales

to Topeka, under section 482, notwithstanding the filing of

consolidated returns. (App. B, p. 66.) It based this decision

on its’ finding that the sale by Topeka to the Wherry corpo- .

rations was dictated by motives of tax avoidance. (App. B,

p. 64.) This aspect ofthe decision was affirmed by the Court

of Appeals (App. A, pp. 10-12), which held that section 482

justified the allocation of the entire profit to one corporation

in spite of the consolidated return regulations.

The Court of Appeals also affirmed other aspects of the

Tax’ Court’s decision which petitioners do not consider

issues suitable for raising in a petition for certiorari.

Papa

REASONS FOR GRANTING THE WRIT:

1. Section 337 of the Internal Revenue Code of 1954 is

remedial legislation designed to create a single tax, at the

shareholder level only, when a corporation dissolves and

incident_thereto its assets are sold. The’ immediate purpose

of the legislation is to establish a procedure to | void the.

close fact determinations (ef. Commissioner v. Court Hold-

ing Co., 324 U.S. 331 (1945), and United States v. Cumber-

land Pub. Serv. Co., 338 U.S. 451 (1950)) required by the |

only procedure available under prior law. This purpose is

fully explained in S. Rept. No. 1622, 83rd Cong., 2d Sess.,

pp. 48-49, 258-259, and in H. Rept. No. 1337, 83rd Cong.,

2d Sess., pp. 38-39, A106-A107. As the House ae stated

(p. A106) :

“.... under present law, the tax consequences arising

fram sales made in the course of liquidation depénd .

primarily upon the formal manner in which transae-

tions are arranged. The possibility that double taxa-

tion may occur in such cases results ‘in causing the

problem to be a trap for the unwary.” — - ;

The manner in which this remedial legislation is to be

applied to dissolutions triggered by involuntary conver-

sions is an important question of federal law which has not

—been but should be settled by this Court. As the courts be-

low both recognized (App. A, p.7; ; App. B, pp.97-98), section

337 is applicable to dispositions pursuant to involuntary

conversions as well as to those pursuant to consensual trans-

actions. Towanda Textiles, Inc. v. United States, 180 F.

Supp. 373 (Ct. CL, 1960) ; United States v. Morton, 387 F.

2d 441 (C.A. 8, 1968); Kent Manufacturing Corp. v. Com-

missioner, 288 F.2d 812 (C.A. 4, 1961); and dictum in Cov-

ered Wagon, Inc. v. Commissioner, 369 F.2d 629, 634 (CA.

8, 1966). There are no cases to the contrary, and respondent

conceded the rple below. See Rev. Rul. 59-108, 1959-1 Cum.

Bull. 72, which so holds. _

Ba aS oad Pt SRE eres

8 {

The courts have had difficulty in evolving a principle to

decide when the “sale or exchange” occurs* in an involun-

tary conversion,’ and have beea unable to produce a con-

sistent pattern. Thus they have held that in a condemnation

the “sale or exchange” occurs when the government files

notice of taking, if ed one to the government thereon.

Wendell v. Commissioner, 326 F.2d 600 (C.A. 2, 1964) ; Cov-

ered Wagon, Inc. v. Commissioner, 369 F.2d 629 (C.A. 8,

. 1967) (alternate ground only); and the instant case.

But.they have held that the “sale or exchange” does not

occur when property is destroyed by insured fire or explo-

sion. Kent Manufacturing Corp. v. Commissioner, 288 F.2d

812 (C.A. 4, 1961) ; United States v. Morton, 387 F.2d 441

(C.A. 8, 1968). Since title to, destroyed property is not

transferred, the courts were not distracted by the question

‘when title passed and went to the purposes and intended

function of section 337 to determine its meaning and effect.

The legislative history of section 337 shows that it was

intended -to eliminate the technicalities and emphasis on

formalities of the prior law. See 8. Rept. No. 1622 at pp.

48-49 and H. Kept. No. 1337 at pp. 38-39, cited above. Yet

under prior law the formality of passage of title was not

controlling. Commissioner v. Court Holding Co., 324 US.

331 (1954). Congress could not have intended to eliminate

formalities and technicalities and yet restore the impor-

tance of the one technicality which prior law accorded no

_ weight. | |

4. For section 337 to apply, a corporation must adopt a plan

of liquidation before the ‘‘sale or exchange by it of (its) property’’

if its gain or loss on the sale is not to be recognized. In addition,

the liquidation must be completed within 12 months of its

beginning. |

5. Involuntary conversions are treated as sales or exchanges.

Int. Rev. Code of 1954, §§ 1033, 1231(a).

Siig 9 ;

According transfer.of title such weight as is accorded it

below means that two taxpayers situated precisely alike in

their genéral relationship to-the United States Government

will have differing tax liabilities because, e¢.g., one owned

property condemned under New York law, where title passes

on filing, and the other owned property in Missouri, where

-< title does not pass os on aes of compensation is made.

See United States v. Morton, supra, 387 F.2d 441, where

that analysis of the case law appears. Such differences .

should be irrelevant under section 337.

Such emphasis on the moment of passage of title seems

improper for the further reason that it can extend indefi-

nitely the twelve month period permitted by the statute, in

consensual sales and exchanges. In voluntary contracts of

sale the parties can advance or retard the passage of title

as suits their purpose. Indeed, retention of title simply as

a security device is common, and thus could postpone sales

for section 337 purposes for 20 or 25 years. Recognition of

the unsuitability of passage of title as a test is what prompt-

ed the Government to take the position it did and this

Court to hold as it did in Commissioner v. Court Holding

Co., supra, 324 U.S. 331. If section 337 is interpreted to

sanctify this formality, no consensual sale or exchange need

ever occur prior to the adoption of a plan of liquidation.

-Yet section 337 was not adopted to overrule this Court’s

decision in Court Holding, but instead to provide an alter-

native rule not dependent on difficult questions of fact.

Where a corporation does not invoke the procedures of

section 337, the Court Holding rule-still governs. The legis-

lative history of section 337 suggests an entire absence of

purpose to extract any single formality and exhalt it to

controlling effect. The Treasury Regulations make the

same. suggestion and provide for reference to all “the terms

of the contract and the surrounding circumstances.” Treas.

Reg. 1.337-2(a).

Teter Me oes

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Consistently with the remedial nature of section 337, the

Treasury Regulations are liberal in instances of consensual

sales, allowing the corporation a maximum opportunity to.

adopt a plan of liquidation before the “sale or exchange”

will be deemed to have occurred. Treas. Reg. 1.337-2(a).

They provide that “the fact that negotiations for sale may

have been “commenced, either by the corporation or its

shareholders, or both shall be disregarded. Moreover, an

executory contract to sell is to be distinguished from a

contract of sale.” In any analogy to consensual sales, the

cases involving involuntary é¢onversions from fire or explo-

sion are correct and ‘those /involving involuntary conver-

sions are wrong, since there is not even so much as an

executory contract of sale where the price remains to be

negotiated or fixed. |

No reason is apparent why a treacherous and dangerous

test should be applied to treat condemnees more harshly

than victims of insured fires and explosions. The same ele-

ment of surprise and lack of control of the involuntary

_conversion is present in each, and in each events ordinarily

remove the opportunity of adopting a plan of liquidation

before fate or the sovereign unilaterally acts. The rule the

cases apply to fires and explosions can as easily be applied

to condemnations: this rule is that the sale does not occur

until the gain has been realized under standard tax con-

cepts. This is essentially the ‘rule the regulations apply to

consensual sales. Its application to condemnations would

relate section 337 to its purpose, which is to permit corpo-

rations to elect to dissolve before gain has been realized

from the disposition of their principal asset, and to elimi-

nate the tax at the corporate level if they do so. :

Under normal tax rules, the gain here was not realized —

either when title passed or the United States assumed the

corporations’ indebtedness.* The gain would not, have been

realized until the award was made. Patrick McGuirl, Inc. v.

Commissioner, 74 F.2d 729 (C.A. 2, 1935), cert. den. 295.

U.S. 748 (1935 Nitterhouse v. United States, 207 F.2d 618

(C.A. 3, 1953), cert. den. 347 U.S. 943 (1954), reh. den. 347

U.S. 970 (1954) ; Commissioner v. Henry Hess Co., 210 F.2d

553 (C.A. 9, 1954). Conceivably some of it would have been

realized when the court released the deposit to the condem-

nees, but this occurred after the plans of liquidation had

been adopted and therefore would not affect us adversely _

under the rule for which we argue. ‘ |

Accordingly, this case presents ‘important questions: un-

der section 337 of the Internal Revenue Code of 1954 which

this Court should decide not only to achieve equality of

treatment in all types of involuntary conversions but to

prevent adoption of an unsound rule extending to consen-”

sual contracts of sale. Hi Ne, eh bs

2. The decision bélow, in holding that gain in a con--

demnation taking accrues to’ a dissolving corporation prior *

to the making of the award in a contested matter, conflitts

specifically with’ Commissioner v. Henry Hess Co.; 210 F.2d

553 (C:A. 9, 1954), arid generally with Cold Metal Process:

Co. v. Commissioner, 247 F.2d 864 (C.A. 6, 1957); ‘TIt’also _

conflicts-in principle with decisions of this Court, ‘exempli-

fied by United States v. Safety Car Heating Co., 297 U.S...

88 (1936), Divie Pine Co. ve Commissioner, 320 U.S.'516

(1944), Security Mills Co. v. Commissioner, 321-US. 281

(1944); and United States v. Consolidated Edison Co., 366

U.S. 380 (1961). ‘This conflict is in an drea. where tax con-_ ,

troveries proliferate. It should be resolved. é

6. The corkerktions took no parti in that act, aiid. could not have ;

escaped continued liability to the United States had the ultimate

award been low enough. Concerning the lenders, the United States -.

~had been liable from the outset, having. guaranteed the debts. This )

aspect of,the case is more fully. analyzed under the second question es

presented, infra p, 11. © pices

The conflict with Henry Hess is direct. In both cases the

United States Government took title to’ privately owned

property under its power of condemnation, in both cases -

it had possession, in both cases there was a dispute about

just compensation, in both cases the owning corporation

was on the accrual basis, and in both eases the corporation

dissolved before the dispute about compensation was re-

solved. In Henry Hess the Court of Appeals for the Ninth

Cireuit held that in these circumstances the gain did not

accrue to the corporation and was not taxable to it. The

court below held to the contrary.

Cold Metal Process (supra, 247 F.2d 864), although it

did not involve the accrual of gain arising from a condem-

nation, presented essentially the same issue and was de-

cided by the Court of Appeals for the Sixth Cireuit in

accordance with Henry Hess, on which it relied.

The principle that neither contested income nor contested

deductions accrue to an accrual basis taxpayer until ‘the

contest has been determined is firmly based on the deci-

sions of this Court cited above. One of them (the Safety

Car Heating case, 297 U.S. 88) involves the accrual of.

income, and the others involve deductions. Nothing this

Court has said about the principle would distinguish be-

tween them. Indeed, the Safety Car Heating case, which in-

volved income, can be said to be the parent of the doctrine.

The court below here considered itself free to disregard .

the established: rule because the United States, in transac-

tions to which the corporations were “not parties, agreed |

with the mortgage creditors that it would be primarily

liable for the mortgage debt. The court below read too

much significance into this circumstance. The United’ States

had been guarantor of the mortgage debt from its incep-

tion. When it seized the assets and cut the corporations

off tani ha rental income required to service the debt, 1

it automatically triggered its own liability to the creditors

under its guaranty. Viewed in the light of these circum-

_ stances, its agreements with the creditors merely served to

avoid acceleration of the balance due and preserve its

right to’ pay the debt off in installments, by forestalling

foreclosure. on account of the condition: its own conduct

: had brought about.

The agreements with the creditors made their garnish-

‘ ment of the corporations’ claims against the United States

unnecessary, assuming such garnishment lawful under .the.

Assignment of Claims Act (31 U.S.C. 203). Obviously

it served the purposes of the United States to, make the

agreements. They did not, however, serve to y Siiniante” the

corporations’ liabilities, as principal debtors, to the United

States, the guarantor. The accounting between the United.

States and the four Wherry corporations remained to be

concluded in the court proceeding invoked by the United

States in condemning the properties in which the just com-

pensation remained to be determined. Not until 1962 did:

that occur. By that year the corporations had been dis-

solved and liquidated pursuant to section 337 liquidations.

begun on August 11, 1958 and timely concluded on August

8, 1959. Under Henry Hess no income could accrue to them

after August 8, 1959, and under that same decision no gain

could accrue to them while the award remained contingent

on litigation. y

Henry Hess and the instant case have another circum-

_ stance in common, not heretofore mentioned. In H enry Hess

partial compensation was paid on account in 1943, the year

after the corporate dissolution, and the remainder was paid

7. Other government regulations prohibited these corporations

from engaging in any other business (Fed. Housing Admin. Regs.,

24 C.F.R. 803.23). 7

eer

in 1944, In the instant ‘ease, partial compensation was re-

eased by the district court to the corporations in August

and September of 1958, after the steps to dissolve pursuant

to section 337 had been initiated. In Henry Hess the sig-

nificance of the payment on account was not decided be-

cause it occurred after the completion of the dissolution

and presented no issue different from the final payment.

* In the instant case it presents no issue of significance

either, since it was paid after the section 337 liqnidation

had been started. If, as we contend above, the earliest event

which could possibly constitute the “sale” under section

337 is the first receipt of ‘partial payment by the corpora-

tions, their receipt of that payment after their liquidation

had begun but before it was complete gives no difficulty.

If it needs.to be considered, however, there is a further

important question raised by:the receipt of part payment.

Even though it was released by the court, the corporations’

right to retain it depended on the size of the ultimate award.

_ The corporations or their transferees might have had to

repay it.’ The obverse of that contingency prevented accrual

in United States v. Consolidated Edison Co., supra, 366

U.S. 380.° The question is ae a contingency which -

would «prevent accrual of a deduction would also prevent

8. The Capehart Act (42 U.S.C. 1594(a), 70 Stat. 1111-2, as

amended by P.L. 85-104, 7I*Stat. 303) as it stood i in 1957 and 1958

provided that the release of the deposit was ‘‘without prejudice to

any party to the proceeding.’’ It thus retained the rule of United

States v. Miller, 317 U.S. 369 ( 1942), where this Court allowed the

Government to recover*the portion of a released deposit in excess

of the ultimate d. That rule is also stated in Rule 71A(j) of

the Federal Rules of Civil Procedure.

The amount of the deposit has ‘‘no bearing whatsoever on value’?

Chapman v. United States, 169 F.2d 641, 644 (C.A. 10, 1948), ‘cert.

den. 335 U.S. 860 (1948).

9. The result of that case would not obtain today under I.R.C.

section 461(f), but that code section involves deductions only, not

. the acerual of income. Nor would it apply to events in 1958 and

1959.

15 ;

accrual of income. No reason in principle appears why it

ghould not, and this Court has not distinguished between |

incorze and deductions in this respect. However, an earlier

decision (North American Oil v. Burnet, 286 U.S. 417

(1932)) may be to the contrary, although there the Court

expressly stated that the record was silent whether the tax-

Payer was on the accrual basis, and its statement that the

accounting mbthod employed was irrelevant related to the

issue presented by an earlier year, not the year of contin-

gent receipt. 3

Henry Hess was not called to the attention of the court

below, but the decisions from this Court cited above were.

It referred to them in its opinion (App. p. 7), without, |

however, perceiving their significance here. 5

In summary, there is a conflict between the decision below. -

and that of another court of appeals in‘ Commissioner v.

Henry Hess Co., 210 F.2d 553 (C.A. 9, 1954), which can be

avoided only by concluding that some of the gain accrued

when the partial payments were released to the corpora-

tions after their dissolution had begun. That conclusion,

while avoiding the conflict, would lead to the further con-

clusion that the dissolution was timely under section 337. In

that event the decision below would be wrong for the addi-

tional reason discussed above, which, as we have demon-

strated, is also an appropriate one for review.

i? (a) The decision below should be reviewed for the

further reason that it would establish a” principle of wide

application not heretofore found in the appellate cases, in’

a manner contrary to the code and regulations. It involves .

the improper resolution of a conflict between two code

sections.

The shareholders of Hontinis Corp. were at all times

the ultimate beneficial owners. of Topeka, the four Wherry

2.8

. 16 .

corporations, and Honolulu Corp. They were required by

Federal Housing Administration Regulations (24 C.F.R..

803.23) to place only Wherry housing activities and proper-

ties in the Wherry corporations. Those corporations had

losses from the Wherry housing business and could under

those regulations not embark on other businesses to produce

offsetting income. [{ /

DuNng the fiscal years ended in 1954, 1955; 1956, 1957

and 1958, Honolulu Corp. owned control of the Wherry.

corporations and also of Topeka, and filed’a consolidated

_ return for all of :them and itself.”° The privilege to do so

permitted the Wherry corporatiéns’ losses to be offset

against the income of other members of the consolidated

| group. In 1956 it appeared that Topeka’s assets should be

sold. They consisted of more than 400 houses near Topeka, -

Kansas. Topeka sold all of them to the Wherry corporations

- at a profit to itself of $882,967.39. The Wherry corporations

then retailed the houses to the general public for an addi-

tional profit of $387,654.00, and applied this profit against

their operating loss carryforwards. These transactions ap-

peared in the Honolulu corporation’s consolidated tax re-

turn, which included Topeka. —

The Commissioner allocated the entire profit, both whole-

sale and retail, to* Topeka, acting under the supposed

. authority of Internal Revenue Code section 482. However,

neither: Topeka nor the Wherry corporations had filed

separate tax reiurns. Instead, their gross incomes and

deductions were included in Honolulu corporation’s con-

solidated*return. The Treasury Regulations pertaining to

consolidated returns are true legislative regulations,” and

the election to file pursuant to them constitutes an accept-

10. Until February 10, 1958.

11. I.R.C. sections 1501, 1502.

Sil Pam Se te

. pany sales versus section 1012. They contain no authoriza-

ance of ices: Treas. Reg. 1.1502-1A(a). Moreover, in the

year in question the election to do so produced a two per-

cent additional tax. |

This two percent additional tax was paid for the privilege P

of freely having inter-consolidation transactions, including , :

the right to pay intercompany dividends without further

tax. In the years in question, the regulations SO providing

also contained this provision (Treas. Reg. 1.1502- 31A(b):

_“(b) Computations. In the case of affiliated corpo-

- rations which make, or are required to make, a con-

solidated return, and except as otherwise provided in-

the regulations under section 1502: iS

(1) Taxable income. The taxable income of each

corporation shall be computed in accofdance with the eu

provisions covering the determination of taxable-in- ae

\come of separate ronan tees

(i) There shall be eliminated unrealized profits and

losses in transactions between members of the affiliated®

group and dividend distributions from one member of - -

the group to anothér member of the group (referred

, to in the deh apis under section 1502 as intercom-

pany transactions). ,

EE LE EEN LEE I

The consolidated i regulation thus eliminated all

profit of Topeka on its sales to the Wherry corporations, :

whatever its amount, and allocated all of it to the Wherry

corporations. The effect of what was done. below was to

reverse the effect of the regulation. |

The decisions below were based on the Aupposed pra | Ae

of section 482. Until this case it had been thought that th

consolidated return’ regulations were the exclusive source

of rules governing intercompany transactions where con-

solidated returns were filed. They contain many provisions

in conflict with code sections of general application: viz.,

freedom of intereompany dividends from tax versus sec- 4

tions 61(a)(7) and 243(a) and carryover basis on intercom- 3

MEET SABA MACOS airstrip cae

18 ;

tion to apply section 482 so as to override the above regu-

lation. The section 482 regulation relied on below (Treas.

Reg. 1.482-1(b)(2)) can not be interpreted to override the

consolidated return regulations.

The legisletive history of section 482 shows it to be with-

out application to consolidated returns. It first appeared

in its present form as section 45 of ‘the Revenue Act of

1928. The 1928 Act removed all provision for consolidated

returns. Section 240 of the 1926 Act had permitted affiliated

groups to file consolidated returns, and section 240(f) was

the forerunner of section 45 (now sectiom 482), but with

significant differences. Section 240(f) permitted the Com-

missioner to “consolidate the accounts-of . .. related trades

or businesses,” and reqaired him to do so on the taxpayer’s

request. The new section was rewritten for the deliberate

purpose of requiring allocation between taxpayers instead

of consolidation of them. H. Rept. 2, 70th Cong., 1st Sess.,

pp. 16-17. |

When the provision for consolidated returns was reintro-

duced by section 159 of the’ 1942 Act (amending section 141

of the 1939 Act to extend it to all corporations instead of

merely railroad corporations), section 45 was left intact

and unchanged. Clearly, then, it was thought not to provide

for any type of consolidation.

(b) Moreover, section 482 was misapplied, assuming its

applicability to consolidated returns, to an extent that could

make it take over the rolés Congress imtended for sections

269 and 1551. The Tax Court found that the sale ‘from

Topeka to the four Wherry’corporations was motivated

by a desire to save taxes through applying.some of the.

net operating loss earryovers of those corporations to the

expected gain from the sale of Topeka’s houses. It and the

appellate court therefore applied a section 269 technique,

not a section 482 technique. The former would be to re-

create the situation to what it would have been if no tax

avoiding steps had Occurred. The latter would be to allocate

the income between Topeka and the four Wherry corpora-

tions, assigning the wholesale profit to Topeka and the

retail profit to the four Wherry corporations. That was not

done by the courts, although it was what the parties them-

selves had apparently attempted to do.

_ Section 269 could not have been applied. There are two

conditions for its application, and neither was present.

First, there was no shift in control. The transferor and

transferees were all owned by the same common parent

after the transfers as before, and section 269 is concerned

with transfers accompanied by an acquisition of or shift in

corporate control. Second, a new stepped-up basis in proy*

erty resulted from its purchase by the four Wherry corpora-

tions, and the second concern of section 269 is transfers of

property between corporations not theretofore commonly

controlled where the transferor’s basis carries over. These

limitations on the application of section 269 will be ren-

dered meaningless if section 482 can accomplish the same

thing as section 269 does where it applies.

Congress also provided section 1551 t6 overcome certain

types of tax avoidance by use of corporations. It, like sec-

tion 269, is inapplicable here. The transferee corporations

were already in business, so an essential condition of sec-

* tion 1551 is absent. The courts below simply avoided that

limitation by allocating the income away because of the tax

avoidance which would otherwise occur.

The Court of Appeals stated that this stretch of section

482 must be within the Congressional purpose because tax

avoidance would otherwise result. (App. p. 12). What the

court overlooked is that Congress deliberately wrote sec-

eT ee om

reat 7 Prey yew _ ~ oe ey ~ee

7 | ey ape? —

OY Pre ee See

tions 381 and 382 so that the parties could have done the

same thing by a merger of the four Wherry corporations

into Topeka. Cf. Maxwell Hardware Co. v. Commissioner,

343 F.2d 713 (C.A. 9, 1965). Because there was no shift of

beneficial interest, section 382 would not have provided for

any dilution of the effect of the carryovers.

It is important that courts observe the limitations the

statutes express on denying taxpayers the tax reductions

Congress has seen fit to confer. So long as corporations are

taxed differently than individuals, individuals will use the

corporate form to lighten the tax load of their businesses.

Congress is aware of this, and has not authorized a heavy

handed undoing of corporate tax advantages wherever they |

are obtained consciously. | .

To apply section 482 as was done here is to undo what

Congress has carefully wrought in writing the limitations

found in sections 269 and 1551, and to transform section

482 into a weapon it was not designed to be.

Section 482 is a much older section than sections 269 and

1551, dating back in substantially its present form to sec-

tion 45 of the Revenue Act of 1928. It does not depend for

effectiveness upon a finding of a tax avoidance purpose,

whereas sections 269 and 1551 do. Neither, unlike them,

does it authorize allocating to éne corporation all the income

it took two to create~It_speaks of “allocating” income—__

“among” corporations, not all to one and none to others.

This may be why Congress thought it would not do what

sections 269 and 1551 do, and enacted the latter two.

This Court should review this decision to prevent the

establishment of a precedent which will have the effect of

undoing the limitations Congress has designedly placed in

sections 269 and 1551.

CONCLUSION

The writ of certiorari should issue.

Respectfully submitted,

VALENTINE BROOKES

1600 International Building

601 California Street

San Francisco, California 94108

Bert W. Levit

465 California Street

San Francisco, California 94104

Epwarp EF. SouLe

2210 First National Building

Oklahoma City, Oklahoma 73102

Attorneys for Petitioner

January 1970

(Appendix A Follows)

Appendices B, C and D appear in separate volume.

In the United States Court of Appeals

for the Tenth Circuit |

Nos. 10060-10091

Likins-Foster Honolulu Corp., et al.,

Petitioners,

VS.

Commissioner of Internal Revenue,

Respondent.

. \ Before Picxert, Hiii and Hotxoway, Cireuit J udges.

\Pickerr, Cireuit Judge: Likins- Foster Honolulu Corpora-

tion and its shareholders petitioned for a review of adverse

decisions of the Tax Court redetermining deficiencies against

Honolulu and various wholly or partially owned subsidiaries

and the shareholders thereof. The tax liabilities of 20 trans-

feree shareholders are contingent upon the decision in the

principal case. The Commissioner has cross-petitioned as to

one of the issues in the principal case and im-erder to protect

-an alternate position, has cross-petitioned in 10 of the

transferee cases. :

The material facts giving rise to this controversy were

stipulated by the parties or are not in dispute, and were the

subject of extensive findings by the Tax Court. Four wholly-

owned subsidiaries of Honolulu owned Wherry Act housing -

projects' which were condemned by the United States

1. See 12 U.S. C. § 1748 et seq. This court has previously had

occasion to discuss the nature and operation of the ‘‘ Wherry Act.’”’

Sill Corporation v. United States, 10 Cir., 343 F. 2d 411, cert. denied,

382 U. 8. 840; Buena Vista Homes, Inc., v. United States, 10 Cir.,

F. 2d 476.

OES AMER POLE PRIS EME, ONE RE PII ARRON N EE ORRIN BREEN 0 Ro

OE OEE EEE TT LOTTIE Ne

IST

Ee CT a TE Le a TN ea

Bo Appendix

pursuant to the provisions of the Capehart Act, 42 U.S. C.

__§1594a, on October 30 and November 1, 1957. The projects

were located at Biggs Air Force Base, ee and Ft. Ord,

California. The complaints and declarations of taking filed

under 40 U. S. C. § 258a recited that the estate being taken °

consisted of all right, title and interest of the particular

_ Wherry corporation “subject to the interest of” the mort-

gagees. The Wherries contested the proceedings only with

. regard/o the issue of just compensation. In 1960 and 1962

judgments were entered on jury verdicts which were sub-

. Stantially in excess of the swm of money estimated to be just

compensation for the property taken and deposited in court

with the-declaration of taking.

_It was stipulated that subsequent to the dates of the filing

of the condemnation complaints and the declarations of

‘. takings the Wherries made no further payments to the mort-

gagees on the notes secured by the condemned properties.

‘Subsequent to the condemnation proceedings the United

States entered into agreements with the mortgagees assum-

ing the liabilities of the Wherries on the mortgages. These

agreements recited that they were executed “as of December

_ 27, 1957,” as to Biggs and El Paso and “as of November 1,

-.1957” with respect to Ord and Monterey. The Wherry Cor-

porations were not parties to these agreements and refused

to sign supplemental agreements submitted by one of the

mortgagees evidencing release of their liability as mort-

gagors.? For the fiscal years ending June 30, 1954 through

June 30, 1957 Honolulu and its subsidiaries filed consolidated

income tax returns. After February 10, 1958 es ceased

2. Counsel for the Wherries was of the opinion that his clients

were protected by the agreements and that there was no need to

“execute separate documents of release. When the supplemental

agreements were submitted counsel declined to execute them again

because he believed his clients were protected and also because he

believed signing the release might compromise his Clients’ position

in:the condemnation suits.

Appendix 3

to hold 80% of the stock of Ord, Monterey, Biggs and El

Paso and was no longer eligible to file consolidated returns

with these subsidiaries. Each of these corporations filed

separate-returns for the period February 11, 1958 to June 30,

1958 and for the fiscal year ending June 30, 1959.

Following disclaimer by the mortgagees the Wherries

withdrew the deposits pursuant to court order in August and

September, 1958. In the fiscal years 1958 or 1959 neither the

consolidation nor the subsidiaries in their separate returns

reported any income resulting from the condemnations. The

Commissioner determined that Honolulu and its subsidi-

aries had realized gain in the fiscal year ending June 30,

1958 in the amount of the excess of the mortgage principal

outstanding as of the dates of condemnation over the depre-

ciated cost basis of. the Wherries in the properties con-

demned, The Tax Court sustained this determination and

the taxpayers concede their liability, but dispute’ the date

upon which their gain was realized. It is the position.of the

taxpayers that the United States took the properties as a |

whole and became liable for just compensation for the

entire value of the respective projects without regard to

the amount due on the mortgages, and that at the time of

taking’ the United States was not liable for the payment of .

the mortgages. Consequently, it is said that because the tax-

payers were entitled to be paid for the whole property the

liability of the United States on the mortgages was not de-

termined at the date of taking and the continued liability of

the mortgagors affected their right to compensation. They

support this position by a broad attack on the power of the

United States to condemn the projects subject to the out-

standing mortgages. This issue was not raised in the con-

demnation proceedings. The sole issue tried there was the

amount of the compensation to be paid forthe taking of the

property. Likins-Foster Monterey Corporation v. United

States, 9 Cir., 308 F.2d 595. While this may be a collateral

Foe RRR Rn eee mena Sa sr

+ Appendix

attack upon the condemnation judgment,? we are satisfied

that by the enactment of the Capehart Act and supplemental

legislation, 70 Stat. 682, Congress intended to authorize the

-United States to condemn Wherry Act projects and to take

_ title to the owners interest therein subject to existing mort-

gages. United States v. Certain Interests m Property, Etc.,

7 Cir., 271 F.2d 379, cert. denied, 362 U.S. 974. The legisla-

tive history of the Act contains a summary of the procedure

to be followed in determining the sponsor’s interest and

concludes: “To determine the value of the lessee’s interest

it would be necessary for the Commissioner to ascertain the

difference between the purchase price as determined by him

,and the principal obligation (the Mortgage), plus accrued

interest.” In the following paragraph it is stated: “The Sec-

retary of Defense would assume or purchase subject to the

balance due under the insured note secured by the Mortgage

on such housing and make all future payments thereon.

3-U. 8S. Code Cong. and Admin. News 1956, page 4552, 84th

Cong., 2nd Session. See also the 1956 Amendments, 70 Stat.

1091 at 1112, indicating in the context of other types of con-

- demnations that the measure of compensation is the differ-

ence between the outstanding principal obligation plus

interest and the price of the property fixed by the court,

and thus confirming that it is the equity in Wherry Act

housing which is condemned.

We believe a reasonable interpretation of the Act to be

that condemnation of the equities was authorized by the

statutes, as was done in these cases. The takings were

effected under the statutes on the filing of the declarations

of taking and making of the deposits. 40 U. S. C. § 258a. As

it was obligated to do in such circumstances, the Govern-

ment thereafter made the mortgage payments. It also made

3. The Commissioner has not questioned the jurisdiction of the

Tax Court to consider this question. See Commissioner v. Gooch Co.,

320 U.S, 418; Taylor v. Commissioner of Internal Revenue, 2 Cir.,

, 258 F. 2d 89.

—_ °° °° on

7 .

P : Appindie ee 5

the assumption agreements with the mortgagees, as men-

tioned above. By such assumption of the mortgages with

the assent of the mortgagees the Government became di-

rectly and primarily liable to the mortgagees. Fitzgerald v.:

F “lanagan, 155 Towa ‘217, 135 N. W. 738; Union Stove &

Machine Works v. Caswell, 48 Kan. 689, 29 P. 1072. More-

over, such procedure in no way prejudiced the rights of the -

mortgagors to just compensation for their interests and

presented no Constitutional questions. We conclude that

‘such takings of the equities were authorized by the statutes

and not violative of the Fifth Amendment.

Tlie law is settled that where mortgaged property is sold

and the mortgagor’s indebtedness is canceled by the assump-

tion of the mortgage by a third party, the amount of gain

realized. by the seller is measured by the excess of the out-

standing mortgage principal over the seller’s basis in the

mortgaged property. Int. Rev. Code of 1954, §§ 61(a) (12)

and’ 1001; Crane v. Commissioner, 331 U. S. 1; Commis-

sioner v. Jacobson, 336 U.S. 28. It is also accepted law that

. for capital gains purposes, involuntary conversions such as

condemnations are treated as “sales or exchanges” under

the statute. Aveselbach v. Commissioner, 317 U. 8. 399;

Hawaiian Gas Products v. Commissioner of Int. Rev., 9 Cir.,

126 F.2d 4, cert. denied, 317 U. S. 653. See 3B Mertens, Fed-

eral Income Taxation, § 22.100. |

In the condemnation proceedings, as provided by 40

U.S. C. § 258a, title to the Wherry projects vested in the

United States upon the filing of the declarations of taking °

and the payment into court of ‘the estimated compensation.

Covered Wagon, Inc. v. C. I. R., 8 Cir., 369 F.2d 629; Travis

v. United States, Ct..Cl., 287 F.2d 916, cert. denied, 368

U. 8. 824. The nominal character of the initial deposits in

the Texas condemnations did not delay the vesting of title

in the United States. United States v. Cobb, 9 Cir., 328 F.2d

115. The date title vested in the United States is also the

date the “sale or-exchange” necessary for capital gains

“Sse ep aaa eae Sasi sees ORNS

EAR

tance

cana

SASS ANNE isk Rey en Sart LOS. IO a LL A ER AE one

Pay; oe

Ce oc

6 . - Appendix

treatment occurred. Kieselbach v. Commissioner, supra;

Covered Wagon, Inc. v. C. I. R., supra. See 3B Mertens,

supra, § 22.103.

Except as to Ord, which is discussed in the appendix

hereto, we conclude that gains to the mortgagors

in connection with the gancellation of their mortgage.

indebtedness occurred on the execution of the agreements

by the Government to assume the mortgage obligations,

together with the release of the mortgagors by the mort-

gagees. See Riss v. C. I. R., 10 Cir., 368 F.2d 965, 968; New-

mark v. C. I. R., 2 Cir., 311 F.2d 913; Clarke v. United

States, 94 F. Supp.: 548, 548 (I. D. Pa.); and 2 Mertens,

Federal Income Taxation, § 11.19. Although the right of the

mortgagors to have the Government take over the mortgage

obligations existed from the condemnation of the equities,

there was no assumption of their mortgage obligations until

the agreements were made and resulting gains to the mort-

gagors did not occur until there was an assmuption and a,

release of their obligations on the mortgages. See Riss v/

C.1. R., supra; cf. Nitterhouse v. United States, 3 Cir., 207

F.2d 618, cert. denied, 347 U. S. 943. To this extent ‘we

disagree with the views of the Tax Court. We treat the |

details as to the effect of the agreements with respect to

the four Wherry ‘corporations in the appendix hereto |

and there discuss our determinations. of. the effee-

_ tive dates of the release of the mortgagors on\ the mort-

gages, taking into consideration the differences in the agree-

ments. As to Ord, for reasons stated in the appendix, we

conclude that the Tax Court on remand should consider the

agreement and the surrounding facts and determine when

there was an effective release and resultant gain, See Card-

well Investment Co. v. United Supply and Marufacturing

Co., 10 Cir., 268 F.2d 857, at 860. 7 ‘

The Wherry Corporations commenced liquidation on

August 11, 1958 and terminated their existence on August 8, _

1959. The taxpayers contend they were entitled to nonrecog-

Appendix me 7

nition of gain treatment provided by 26 U. S. C. §937(a)

with respect to gain realized on the withdrawal of deposits

following the commencement of the liquidation. The Tax

Court held that § 337 was not applicable because the prop-

erties had not been sold within 12 months following the

adoption of their plans of liquidation. The taxpayers chal-

lenge this holding asserting that the “sale” required by § 337

was consummated after the adoption of the plan of liquida-

tion when the amount of compensation was determined.

Section 337 has no application here because the sale or ex-

change of the property occurred on the date of the taking

by the United States in the condemnation proceedings. The

courts have uniformly held that the necessary sale does not

occur within 12 months of the adoption of a plan of liquida-

tion where title to the condemned land had vested prior to:

adoption of the plan. Covered Wagon, Inc. v. C. 1. R., supra;

Dwight v. United States, 2 Cir. 328 F.2d 973; Wendell v.

C.T. R., 2 Cir., 326 F.2d 600, and cases cited therein: Rev.

R. 59-108, 1 Cum. Bul. 72; cf. West Street-Erie Boulevard

Corp. v. United States, N. D. N, Y.. 294 F. Supp. 145, aff’d::

in part (2 Cir.), — F.2d —; Feinberg v. C. I. R., 8 Cir.,:

St Fd 28 ot 3 |

Ifonolulu as parent of the consolidated group will become

liable for the gain realized by the Wherry Corporations as

a rath dr fie wade ae in fiseal 1958. Int. Rev. Code

of 1954 § 1552(a)(1) and (b); Treas. Regs. § 1.1502-30A.

4. The taxpayers’ reliance on United States_v. Morton, 8 Cir., 387

I", 2d 441, is obviously misplaced. The Eighth Ciréuit held that where

a plan of liquidation was adopted after a fire loss but before settle-

ment of ain insurance claim, the date of sale was the date of claim

settlement rather than the date of the fire. The Court, expressly

adhered te its earlier decision in Covered Wagon with respect to an

‘involuntary conversion by condemnation. In addition, the rationale

of Morton turned on the fact that the amount to be received by way

of reinibursement was unascertained prior to adoption of the plan of

liquidation, whercas the amount of the deposits sought to | be taxed

in this case as capital gain was determined either on the date of eon-

demnation or prior to the adoption of the plans of liquidation. x

* \

8 Appendiz

When the Wherries withdrew the escrow deposits in early

fiscal 1959, the funds were credited on the books of Honolulu

as “Gain on Sale of Assets” and thereafter were alterna-

tively treated as either “liquidated dividends” or as a col-

lection on the “chose-in-action” which the Honolulu Corpo-

ration was to receiva as a result of liquidation. Honolulu

now secks to offset against the 1959 liquidating dividends its

1958 liability for the taxes owed by the Wherries by treating

the Wherries liability as a retroactive account receivable,

thereby substantially reducing its tax liability for the fiscal

year eriding 1959, The total tax liability of the consolidated

group growing out of the condemnation of the Wherry proj-

ects was $605,794. The taxpayers assert that Honolulu,

which must now pay the tax, may treat it as a retroactive ac-

count receivable and offset proportionately the amount of

the liquidating dividend paid by each of the Wherries in

August and September, 1958. The Tax Court held the lia-

bility of the Wherries for taxes would not acerue until the

termination of this litigation in which liability is denied and

cannot be reflected on Honolulu’s 1959 tax’ return. In dis-

posing of this issue we agree with the following statement

of the Tax Court:

“Petitioners argue that since Honolulu is not only

liable as a transferee of its former subsidiaries but also

because for some years prior to the fiscal year 1959 it

filed consolidated returns with these affiliates, the hold-

ings in Arrowsmith v. Commissioner, 344 U.S. 6 (1952),

and James Armour, Inc., 43 T. C. 295 (1964), are in-

applicable. Any deficiencies in tax which may be deter-

mined when the decision of this Court is entered with

respect to Monterey and other ‘Wherry’ corporations

which Honolulu is required to pay are not a liability

which is finally determined until the decision of this

Court is entered. It was because such liability was not

. fixed or paid until a later year, and not merely because

the liability was a transferee liability, that formed the

Appendiz : 9

. basis of the holding in Arrowsmith v. Commissioner, °

supra, and in James Armour, Inc., supra, that the de-

duction should be taken in the later year. Therefore

under the holdings of these cases, Honolulu is not en-

titled to deduct any amounts of the liabilities of the

‘Wherry’ corporations which it may ultimately be called

upon to pay until they are either finally determined or

paid. In effect, Honolulu is attempting to obtain a de-

duction for the yet undetermined taxes of the ‘Wherry’

corporations which it may eventually be called upon to

.pay by reducing its gain from liquidating distributions

from such corporations in the fiseal year 1959 by the yet

undetermined amounts.”

See also U, S. v. Consolidated Edison Co., 366 U. 8. 380;

Security Mills Co. v. Comm’r., 321 U.S. 281; Dixie Pine Co.

v. Commissioner, 320 U. 8. 516. The remedial provisions of

26 U.S.C. §§ 1311-1315 have no application.

Likins-Foster Topeka Corporation, a non-Wherry sub-

sidiary, owned in excess of 400 houses in Topeka, Kansas

which it rented to the personnel of Forbes Air Force Base.

Topeka conveyed the separate units in this project to the

four Wherry Corporations about July 1, 1956 and in turn

each Wherry sold the parcels which had been deeded to it

prior to the end of fiseal 1957. At the time of the transfer

each of the Wherries had substantial operating carry-over

losses. They took the property subject to existing F. H. A.

mortgages but did not assume them. The consideration re-

ceived by Topeka upon conveyance to the Wherries was

substantially less than it would have received through sales

to third parties. The Tax Court concluded that tax evasion

purposes could be inferred from these transactions because

the value of the property transferred to each Wherry was

approximately equal to the amount of carryover available

to each. Following sale of the houses by the Wherries and

receipt of the downpayment and additional ee

5 = ewes

~ PUR Or ew re ee ae

——

—

N . {

10 Appendiz /

Wherries, having realized a gain which caused them to have

income, distributed the installment contracts of the pur-

chasers to the parent corporation as dividends. The sig-

nificance for tax purposes of this series of transactions is

that the Wherries then had income for fiscal 1957 against

which net operating loss carryovers could be offset. The

Wherries’ carryovers emanated from years for which each

had filed separate returns, and would have expired if not

— utilized in the fiseal year ending June 30, 1957. Topeka, on

the other hand, had no loss carryovers available to it, and

bgtause the Wherries’ carry-overs were for years in which

separate returns had been filed, the carry-overs were avail- _

able only to the Wherries and were not otherwise available

to the consolidation or other members thereof.) Pursuant

to 26 U.S.C. § 482, the Commissioner reallocated the total

gain from the sales ($472,841) as reported by the Wherries

hack to Topeka. The purpose of § 482 is to permit the Com-

missioner to distribute, apportion or allocate gross: income,

deductions, credits or allowance between organizations or

businesses controlled by the same interests to prevent eva-

sion of taxes or to clearly reflect the income of such organi-

zations. W. Braun Co. v. C. I. R., 2 Cir., 396 F.2d 264; Eli

Lilly and Company v. United States, Ct. Cl., 372 F.2d 990;

Charles Town, Incorporated v. C. 1. R., 4 Cir., 372 F.2d 415,

cert, denied, 389 U. S. 841; Spicer Theatres, Inc. v. C. I. R.,

6 Cir., 346 F.2d 704. The Commissioner contends that the

Wherries were used only as conduits for the disposition of

Topeka’s assets in order that the consolidation might re-

ceive the benefits of the Wherries’ loss carry-overs.

The Tax Court found a tax avoidance purpose and con-

cluded that the Commissioner had the power under § 482 to

— —— -—_--

5. Under the consolidated regulations, net operating loss earry-

overs from separate return years are available to a consolidation only

as offsets against the income of the affiliate which actually experi-

enced the preconsolidation loss. Treas. Regs., § 1.1502-31A(b) (3) ;

see Phinney v. Houston Oil Ficld Material Company 5 Cir., 252 F.

2d 357.

Appendiz 11

reallocate the income to Topeka. Taxpayers do not deny a

tax avoidance motive, but argue: that it is irrelevant since

§ 482 does not apply to intercompany transactions between

consolidated groups which are governed solely by § 1501 et

seq. It is argued that the income to be reflected in a consoli-

dated return is the income computed under the consolidation

sections; that since the Commissioner has ruled that trans-

fers between components of a consolidation are not trans-

fers resulting in gain or loss, there is no income to be allo-

cated under § 482. The Government counters urging that

since the regulations, § 1.482.1(b) (2), providing that § 482

applies in the case of any controlled taxpayer, “whether such

taxpayer makes a separate or a consolidated return”, have

been continued without change through several reenact-

ments of the I. R. C., the regulations are deemed to.have been:

given Congressional approval.¢

6. Section 1.482-1(b) is as follows:

‘*(1) The purpose of section 482 is to place a éontrolled taxpayer

on a tax parity with an uncontrolled taxpayer, by determining,

according to the standard of an uncontrolled taxpayer, the true

taxable income from the property and business of a controlled tax-

payer. The interests controlling a group of controlled taxpayers are

assumed to have complete power to cause each controlled taxpayer

so to conduct its affairs that its transactions and accounting records

truly reflect the taxable income from the property and business of

each of the controlled taxpayers. If, however, this has not been done, .

and the taxable iheomes are thereby understated, the district director

shall intervene, ‘and, by making such distributions. apportionments,

or allocations as he may deem necessary of gross income, deductions,

credits, or allowances, or of any item or element affecting taxable

income, between or among the controlled taxpayers constituting the

group, shall determine the true taxable income of each controlled

taxpayer. The standard to be applied in every ease is that of an

uncontrolled taxpayer dealing at arm’s length with another uncon-

trolled taxpayer.

**(2) Section 482 and this seetion apply to the case of any con-

trolled taxpayer, whether such taxpayer makes a separate or a con-

solidated return. If a controlled taxpayer makes a separate return,

the determination is of its true separate taxable income. If a con-

trolled taxpayer is a party to a consolidated return, the true con-

solidatel taxable income of the affiliated group and the true separate

taxable income of the controlled taxpayer are determined consistent-

ly with the principles of a consolidated return.”’

iN)

een ee Lt ene ee ae

12 Appendix

Aside from the various legal niceties, it seems apparent

that the taxpayer should not be allowed to prevail on the

basis of form over substance. It is true that 26 U.S. C. 1501

‘et seq. governs consolidated returns. However, § 1502 ex-

pressly delegates power to promulgate regulations to assure .

a proper reflection of income. One of those regulations—

which is not challenged by the taxpayer—provides that pre-

consolidation loss carry-overs can be offset only against

the specific affiliate that incurred the loss. Whether this is

accomplished by a direct transfer of loss carry-overs from

the loss corporation to the’ consolidation to offset the group’s

’ income (specifically prohibited and recognized as prohibited

by the taxpayers) or whether this is accomplished by trans-

ferring group income to the loss corporation (the method

employed here) should make little difference. In either case, —

the result works the same tax distortion and cannot be sus-

tained.

The final issue raised here arises out of a cross- Se

the Commissioner from an adverse decision of the Tax

Court concerning distributions during the fiscal year 1956 -

to Honolulu by two of its subsidiaries which cisteippons

were in excess of Honolulu’s basis in the stock of the dis-

tribuiting corporations.” At the time of ‘the distributions,

the subsidiaries making the distributions had no earnings

or profits. Consequently, payments were not dividends as

defined by 26 U. S. C. 316(a). Non-dividend distributions

“shall be applied against and reduce the adjusted basis of

the stock.” 26 U. S. C. 301(e)(2). The difficulty arises here

because the parent had already received the amount of its

basis in the stock. The Tax Court concluded that although

the distributions were not dividends, they were “intercom-

pany transactions” under Treasury Regulations 1.1502-31A

——

7. It is without dispute that the distributions were with respect

to stock as provided by § 301(a), I. R. C. 1954, and that § 301(c)

applies in the absence of a controlling provision of the consolidated

regulations.

Appendix 13

(b) (2) (iii)(a) and eliminated from income of the parent

corporation which received it for the purpose of making a

consolidated return. The Commissioner’s contention is that

the distributions in excess of Honolulu’s basis in the stock

of the subsidiaries are taxable under § 301(¢)(3)® and that

the consolidated return regulations do not provide for their

elimination from income. It is argued that because of the

permanent tax avoidance resulting from the Tax Court’s

decision the regulations relating to treatment of capital

gain in intercompany transactions should not be applied.

Specifically, the Commissioner contends that no carry-over

basis existed which would reflect gain upon the sale of the —

property to an outsider.? The Tax Court was of the opinion

that there was only a possibility thatthe distvibutions had

or would escape taxation. In this copMection tlie Court said:

“Expressed another ‘way, tgthe extent that the cash

which was distributed to the parent was accumulated

by the subsidiaries during consolidated years, it very

likely has in some way been taxed as an overall part

of the consolidation. The fact that respondent in con-

nection with redemption of stock issued a specific regu-

lation which. we will subsequently discuss, does not

justify reaching a conclusion specifically contrary to

another portion of his regulations where he has not

- chosen to change those regulations.”

8. 26U.S. C:301(c) (3) is as follows:

‘“‘Amount in excess of basis—(A) In general.—Except as pro-

vided in subparagraph (B), that portion of the distribution which’

is not a dividend, to the extent that it exceeds the adjusted basis of

the stock, shall be treated as gain from the sale or exchange of

property.’’

9. It appears that the Commissioner’s new regulation treating

this subject, § 1.1502-14(a) (2), would postpone recognition of the

income resulting from non-dividend distribution by recording it in

an ‘‘excess loss account’’ which is applied to the parent’s income

when the stock in the subsidiary is sold, or when the affiliation of the

subsidiary with the consolidated group is terminated. §1.1502-19(a)

and (b).

’

POR a ae EN Rk ty

1 BSP eT ae a Rage Sete

14 Appendix

Relying on American Water Works Co. v. Commissioner of

Int. Rev., 2 Cir., 243 F.2d 550, the Court also,concluded that

the reduction in basis of the stock of the subsidiaries in the

hands of the parent prevented tax avoidance. It is recog-

nized that the Commissioner’s treatment would be. correct .

in the normal non-consolidation situation. However, the con-

solidation. sections provide for non- recognition of gain on

intercompany transactions : .

“There shall be eliminated unrealized profits, and

losses in transactions between members of the affiliated

group and dividend distributions from one member of

the group to another... .” (§ 1.1502-31A(b) (1) (i))

Thus, the Tax Court holding that the regulations expressly

eliminated capital gain transactions between affiliates must

be upheld.

The decision of the Tax Court in these consolidated cases

is modified as stated herein and the cases are remanded for

further proceedings and recomputation of the tax liabilities

involved in accordance with this opinion and the appendix

thereto,

Appendix.

The four Wherry corporations involved were Monterey,

3iggs, Xl Paso and Ord. Separate three-party agreements

were executed pertaining to the obligations of each on its

note and mortgage. They were executed by the military de-

partment involved, the Federal Housing Administration

and the bank or insurance company holding the mortgage.

These agreements will be considered separately.

Monterey: The agreement recites that it was entered.

into as of November 1, 1957. However, it was acknowledged

by the Assistant. Commissioner for Operations of the Fed-

eral Housing Administration on July 8, 1958. The agree-

ment contemplated executed by three interested parties. We

» sche pee aed

: Appendix | 15-

conclude that the assumption and release agreement was

effective for the purposes of this case on. July 8, 1958, the

completion of its execution. See Kent Homes, Inc. v. United

States, 279 F. Supp. 650, 655 (D. Kan. 1967).

The agreement provided that the Government assumed

. the obligations of the note and mortgage. It also stated that

the parties agreed that the mortgagor was released from

all further liability and obligation on the note and mortgage.

For tax purposes we conclude that the gain of Monterey in :

connection with the discharge of the mortgage indebtedness

occurred on July 8, 1958. een

Biggs and El Paso: Except for an immaterial difference

in dates that may exist in-the last acknowledgment, the two

Separate agreements relating to Biggs and El Paso read

alike. The acknowledgment by the Assistant Commissioner:

for Operations of the Federal Housing Administration was

made in January, 1958, for both agreements, the exact date

heing illegible. We conclude that the agreements relating to

Biggs and El Paso were effective for tax purposes in Janu-

ary, 1958, the completion of their execution.

The agreements both contained the following provision,

with a difference in amount of the omitted indebtedness

being stated in each:

“ . ARTICLEI

ASSUMPTION AND RELEASE AGREEMENT

It is agreed by the parties hereto that the Department

assumes the obligation of and will make the payments

called for under the terms and provisions of the mort-

gage and note he reinbefore referred to and the Mort-

gagee agrees to.accept the obligation of the Depart-

ment to make such payments and the mortgagee and

the Department hereby agree that the unpaid principal

. balance of said mortgage pote on the day immédiately

preceding the effective’ date of this agreement is

SAB Stat teecanances The Department and the Commissioner

;

a nd ner eT

16 Appendix

agree that, without affecting liability of the peak:

ment under the foregoing assumption, the Mortgagee

may release Likins Foster... Corporation, the original

mortgagor, from all ee in_connection with the said

note and the mortgage and chattel mortgage securing

the payment of said note...”

We note that the mortgagee agrees to accept the obliga-

~ tion of the Government and the indication of intent to re-

lease the mortgagors in the caption of the article.as well.

W hile there is not the clear release as there was to Monterey,

we believe a release of the mortgagors was intended. On the _-

basis of Article I and the entire agreements we conclude

that they effected an assumption of the mortgage indebted-

ness of Biggs and El Paso by the Government and a release

by the mortgagee of their personal liability on the notes. We .

conclude that the gains of Biggs and El Paso in connection

with the discharge of their mortgage indebtedness occurred

in January, 1958.

Ord: In the ease of Ord the significant provision of the

three- party agreement reads as follows:

«| ARTICLE II

ASSUMPTION AND RELEASE

That the Department does hereby assume the obli-

gation of, and will make the payments prescribed by and

in accordance with terms and provisions of, said deed

‘of trust and the note secured thereby relating to prin-

cipal, interest, and mortgage insurance premiums (be-

ginning with the payment due November 1, 1957) ; that

the Mortgagee and the Commissioner do hereby accept

the obligation of the Department to make such pay-

ments. This undertaking by the Department shall be

without prejudice to the Government’s position in said

condemnation proceeding with respect to the pro-rating

of such payment obligation with the mortgagor for any

a | oe

Appendix 17

period during which any payment or part thereof is |

allocable to any period prior to the date of the filing of

the Declaration of Taking... .”*

In view of the deleted language concerning the release of

the mortgagor, Ord, we doubt that we should now hold as a

matter of law that the agreement alone released Ord. We

feel instead that we should leave this determination to be

made first by the Tax Court on remand. There, the agree-

ment and all the facts may be considered and the deter-

mination made from the record as to when an effective re-

lease of Ord by the mortgagee occurred, and thus, when a

gain by discharge of the mortgage indebtedness may have

resulted. See Cardwell Investment Co. v. United Supply

_and Manufacturing Co., 10 Cir., 268 F.2d 857, at 860. In this

connection we note that when the liquidation resolution of —

the corporation was adopted on August 11, 1958, the minutes

recognized that the corporation had been relieved of its

mortgage indebtedness by the three-party agreement. At

least by this date the record shows that there was a course

of conduct and mutual understanding between the parties to

, justfy an inference that the obligation of the mortgagors had

been extinguished. The mortgagee had agreed to the as-

sumption of the mortgage by the United States, accepted

the mortgage payments from it, and did not object to the

liquidation of Ord:

*The deleted language reads as follows:

‘*... and that the Department, the Commissioner, and the Mort-

gagee do hereby agree that the aforesaid mortgagor is released from

all further liability and obligation under said mortgage ard the

note secured thereby .. /’’

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.