Petition for a Writ of Certiorari — Rose Ann Coates Trust v. Commissioner

BR AE gi aA TAR SEITE SE

i

SUBJECT INDEX

Page

I. Opinions Below 1

II. Jurisdiction 1

2

2

2

3

7

III. Questions Presented .....

IV. Statutes Involved

V. Statement of the Case

VI. Reasons for Granting Writ

VII. Conclusion

TABLES OF AUTHORITY

Table of Cases

Commissioner v. Stickney, 399 F.2d 828 (1968), affg

sub nom., Henry McK. Haserot, 46 T.C. 864

eet tana er 3, 4,5,6

H McK. Haserot, 41 T.C. 562 (1964), remanded,

355 F.2d 200 (6th Cir. 1965) 22. ceeeeeceeeeee 4,5,6

Henry McK. Haserot, 46 T.C. 864 (1966) ................ 3, 4, 5,6

Statutes

i emnanoionasnans 1

Other Authority

Internal Revenue Code of 1954:

inal 2,5

Sec. 301(c)(1) 4,7

Sec. 302 2

Sec. 302(b) (1) 5

Sec. 302(d) 4,5, 6,7

Sec. 304 2, 4, 5, 6,7

Sec. 304(a) (1) 3,4

Sec. 351 2, 4,5, 6,7

SI ee he 4

Sec. 368

IN THE

Supreme Court of the United States

October Term, 1973

Rose ANN Coates Trust, RosBert N. Coates, Trustee;

Trust Under Will of SypNey N. Coates, Rosert N. Coates,

Trustee; PETER M. Coates; CHARLES N. CoATEs;

PAMELA L. Coates; Catuy A. CoATEs,

Petitioners,

Vv.

ComMISSIONER OF INTERNAL REVENUE,

Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

Petitioners pray that a writ of certiorari issue to review

the judgment of the United States Court of Appeals for the

Ninth Circuit entered on June 5, 1973.

OPINIONS BELOW

The opinion of the court of appeals (App. A, infra, pp.

A-1 to A-8) is not yet reported. The opinion of the United

States Tax Court (App. B, infra, pp. A-9 to A-27) is re-

ported at 55 T.C. 501.

JURISDICTION

The jurisdiction of this Court is invoked under 28 U.S.C.

§1254(1).

sa a ec

2

QUESTIONS PRESENTED

Whether Section 304 or Section 351 of the Internal Reve-

nue Code of 1954 prevails in a transaction where both

sections are applicable.

STATUTES INVOLVED

The pertinent provisions of Sections 301, 302, 304, and

351 of the Internal Revenue Code of 1954 are set forth in

Appendix C, infra, pp. A-28 to A-31.

STATEMENT OF THE CASE

In 1948, Sydney Coates incorporated his sole proprietor-

ship as Coates Electric Manufacturing Company; the name

of this corporation was subsequently changed to CAM In-

dustries, Inc. CAM manufactured a line of commercial and

industrial electrical equipment.

Sydney Coates, together with his son, Robert Coates,

and Sydney Coates’ two sons-in-law, Arthur Heinen and

Morgan Boyd, incorporated Washington Industrial Prod-

ucts, Inc. (hereinafter called “WIP”) to take over the as-

sets and contracts of a corporation in the related business

of manufacturing ovens for the food industry. The incor-

porators of WIP each received one-fourth of the corpora-

tion’s capital stock.

CAM and WIP operated as separate corporate entities

until 1965. Robert N. Coates managed CAM and succeeded

his father as president in 1963. Although Robert Coates

was generally familiar with the operations of WIP, the

company was managed by Arthur Heinen from 1955 until

1965. In 1965, the management of WIP and CAM, having

determined that substantial economies could be realized

by combining the personnel, inventories, purchasing and

OTHE oe laid The AGT agi

eemeennemeteiinen, vite PAROS STIL alee RO ee CLADE IRAE PARRA

3

machinery of both corporations, decided to combine WIP

and CAM.

Before his death in 1963, Sydney Coates gave most of

the CAM stock he owned to members of his family. Robert

Coates received control of over two-thirds of the voting

stock and 51% of the total stock of CAM. In combining

CAM and WIP, Robert Coates required that he have the &

same ownership interest in the resulting entity as he had in &

CAM. Since a reorganization under Section 368 was not

feasible, the shareholders of WIP, on May 20, 1965, ex- }

changed their shares in WIP for agreements from CAM to —

pay $1,000 per share of stock over a ten-year period with &

interest thereon. (App. A, pp. A-2 to A-3).

In his deficiency notices, the Commissioner of Internal

Revenue treated the transactions as a redemption by a §

related corporation under Section 304(a)(1) taxable as a &

dividend at the face value of the agreements. The United

States Tax Court sustained the Commissioner's position

with the exception that the fair market value of the agree- |

ments was determined to be 60% of their face value and

the court of appeals affirmed.

REASONS FOR GRANTING THE WRIT

I. The court below erroneously decided an important '

question involving the application of two sections of the =

Internai Revenue Code providing for radically different

tax treatment of the same transaction. The decision of the

court below is directly in conflict with the decision of the |

Court of Appeals for the Sixth Circuit in Commissioner v.

Stickney, 399 F.2d 828 (1968), aff'g sub nom., Henry McK.

Haserot, 46 T.C. 864 (1966). The existence of this direct ,

conflict was noted by the Ninth Circuit in its opinion in |

RDN RA atiie

a

Appendix A, infra, p. A-6. The Ninth Circuit based its deci-

sion on the separate opinion of Judge Tannenwald of the

United States Tax Court in Henry McK. Haserot, 46 T.C.

864, a decision of the full Tax Court.

The question is one of statutory interpretation and has

previously been decided in only one reported case, i.e.,

Commisioner v. Stickney, supra. Since the decision in

Stickney is the result of years of litigation requiring four

separate opinions before final resolution, it may be helpful

to clarify the history of the case.

The taxpayer, Henry McK. Haserot, controlled three

corporations, Northport Cherry Factory, Inc., Gypsum Can-

ning Co. and Haserot Co. Haserot Co. purchased the en-

tire production of Northport and Gypsum and furnished

the management and financing for those corporations. In

February 1958, the taxpayer, having decided to place

Northport and Gypsum under the direct control of Haserot

Co., transferred to Haserot Co. his shareholdings in these

corporations in exchange for $64,850 in cash and 2,432

shares of Haserot Co. A deficiency was determined by the

* Commissioner after the taxpayer failed to report income

’ from this transaction. The only issue before the Tax Court

+ was whether the cash received by the taxpayer was taxable

at capital gains rates as Section 351(b) “boot” or as divi-

- dend income under Section 301(c)(1) by virtue of Sec-

5 tions 304(a)(1) and 302(d). Since Section 304 is not

: _ self-executing, dividend treatment results only if both Sec-

1 tion 302(d) and Section 301(c)(1) are also applicable.

Ia Henry McK. Haserot, 41 T.C. 562 (1964), remanded,

355 F.2d 200 (6th Cir. 1965), the Tax Court held that Sec-

tion 351 prevailed over Section 304. on the ground that the

x

5 :

“Except as otherwise provided” limitations of Sections

301(a) and 302(d) indicated that Section 301 dividend

treatment can result only if no other provision in chapter 1

and subchapter C, respectively, requires other treatment.

The Sixth Circuit remanded the first Haserot decision

for findings on the issue of dividend equivalency without

deciding whether Section 304 or Section 351 took prece-

dence in the transaction. In the second Haserot decision

the majority of the Tax Court limited its decision to a

finding that the distribution of cash to the taxpayer by

Haserot Co. was essentially equivalent to a dividend with-

in Section 302(b)(1). Judge Tannenwald, however, in a

separate opinion in which Judge Simpson concurred, ex-

pressed the opinion that Section 304 should take prece-

dence over Section 351 where a transaction comes within

the literal language of both sections. On appeal, the Sixth

Circuit affirmed the first Tax Court decision in Haserot that

Section 351 takes precedence over Section 304 thus reject-

ing Judge Tannenwald’s reasoning.

As for the merits, little can be added to the above refer-

enced opinions which delineate the difficult question of

statutory interpretation presented herein. Ultimate resolu-

tion of this issue will depend primarily on the interpreta-

tion accorded the “Except as otherwise provided” limita-

tions in Sections 301(a) and 302(d). The Sixth Circuit

found the only reasonable explanation of the limiting clause

in Section 301(a) was that, when another section of the

chapter has application, the Section 301 treatment is to be

excluded. Petitioners submit the Stickney decision, which

gives effect to the limiting clauses of Sections 301(a) and

6

302(d), is correct. This question of statutory interpreta-

tion, having created a clear conflict in the circuit courts,

can only be resolved by this Court.

II. Resolution of the question presented is necessary to

provide for certainty in transactions by shareholders of

related corporations. The present conflict of decisions mag-

nifies the problems and uncertainties faced by shareholders

of related corporations who seek to restructure their own-

ership interests in such corporations. As stated in the find-

ings of fact set forth in the decision of the United States

Tax Court in the instant case, the purpose of the transac-

tion in question was to combine two family owned corpora-

tions which, because of the requirements of the majority

shareholder of CAM Industries, Inc., could not be accom-

plished by a reorganization under Section 368.

The transaction adopted to effect this combination, as-

suming the legal consequences were determined in accord-

ance with the Stickney decision, would have resulted in

no adverse tax consequences to the petitioners. This trans-

action, essentially a transfer of WIP shares for long-term

installment obligations of CAM which the Ninth Circuit

assumed for purposes of argument to be “securities”, would

have been governed by the provisions of Section 351. Since

no “boot” i.e., cash or other property, was received in this

transaction, the owners of shares in WIP would have

carried over their basis in such shares to the installment

obligations without immediate tax consequences.

Notwithstanding the decisions of the Tax Court in both

Haserot cases and the affirming opinion of the Sixth Cir-

cuit, holding that Section 351 takes precedence over Sec-

tion 304, the court below reached a contrary conclusion.

ye, SO

7

Rather than considering the transaction to be within the

non-recognition provision of Section 351, the Ninth Cir-

cuit requires that the transaction be considered a redemp-

tion under Section 304 with dividend treatment resulting

by application of Sections 302(d) and 301(c) (1). The con-

flict created by the Ninth Circuit decision leaves the Com-

missioner and all taxpayers uncertain of the statute to be

applied in ‘similar transactions. .

Until this Court provides a definitive solution, private

counsel will, as a practical matter, be unable to advise their

clients to resolve problems such as those raised here, short

of litigation. Unless the Court resolves the present conflict

in the circuits, taxpayers in control of related corporations

in different parts of the nation will be taxed differently

even though they consummate virtually identical trans-

actions concerning their shareholdings in related corpora-

tions.

CONCLUSION

The petition for a writ of certiorari should be granted.

Respectfully submitted,

Josern H. TRETHEWEY

GERALD R. HERGERT of

TRETHEWEY & BRINK

Attorneys for Petitioners

August 1973

EEE PEF IRAE I TE EIS EMER LIS ON a RA POE DON Se ena PA es i

LRT PEO HENNY

ah ee gets 2

A-1

APPENDIX A

UNITED STATES COURT OF

FOR THE NINTH CIRCUIT

Rose Ann. Coates Trust, Rosert N.

Coates, Trustee; Trust UNpER WiLL

OF Sypney N. Coates, Ropert N.

Coates, Trustee; PETER M. CoaTEs;

Cuarves N. Coates; PAMELA L.

Coates; Catuy A. Coates,

APPEALS

Nos.

71-1968

71-1969

> 71-1970

71-1971

71-1972

71-1973

Appellants-Petitioners,

v.

CoMMISSIONER OF INTERNAL REVENUE,

Appellee-Respondent.

[June 5, 1973]

Appeal from the Tax Court of the United States

Before: CHAMBERS, WRIGHT, and KILKENNY ;

Circuit Judges.

WRIGHT, Circuit Judge:

Sydney and Rose Ann Coates, together with their chil-

dren, children’s spouses, and grandchildren, owned all of

the shares of two corporations, CAM Industries, Inc. (here-

inafter called CAM) and Washington Industrial Products,

Inc. (hereinafter called WIP). After the death of Sydney

Coates, the family group agreed to combine the two cor-

porations by having CAM “purchase” the shares of WIP.

When the transaction was complete, CAM and WIP

shares were held by members of the family as follows:

A-2

Estate of Sydney Coates 75 664

Robert N. Coates 51 ~——- 11,640 2,250

Peter Coates 6 205

Cathy Coates 6 205

Pamela Coates 6 205

Charles N. Coates 6 205

Marjorie Coates (Mrs. Robt. ) 290

R. Morgan Boyd 63 10 422

Robert M. Boyd, Jr. 6 391

James Boyd 6 391

Ruby Boyd (Mrs. R. M.) 390 372

A. C. Heinen 57 10 375

Barbara Heinen 6 340

* Gary Heinen 6 340

= Richard Heinen 6 340

-~ Molly Heinen (Mrs. A. C.) 390 325

Totals 300 2,440 7,320

| The “purchase” was effected on May 20, 1965 when

CAM and the shareholders of WIP entered into agreements

in this form:

AGREEMENT FOR SALE OF STOCK

Agreement made this 20th day of May, 1965, by and

between the undersigned “Seller” and CAM INDUS-

TRIES, INC., a corporation, hereinafter called the

“Buyer.”

; Seller hereby sells to Buyer, and Buyer hereby pur-

3 chases from Seller. Ce eee shares of the common stock

of Washington Industrial Products, Inc., a Washington

corporation, at the price and on the terms and condi-

tions herein set forth.

1. Purchase Price. The price to be paid by Buyer to

Seller for said shares of common stock shall be $1,000.00

per share or an aggregate purchase price of ...................

2. Delivery of Stock and Payment of Purchase Price.

(a) The certificate or certificates for the shares of com-

mon stock sold hereunder by Seller are herewith

delivered to Buyer, duly endorsed for transfer to Buyer,

Pit ht ttn ble Diba sonds CesMN IE

Fe 2 Ti, She eet we wey ey duh! Hera ks lp ene? Anon awd dale

ee Ty NE ES EE a et peer Me NRE

A-3

and Buyer hereby wledges receipt of said certif-

icate or certificates.

May of each year thereafter until the 31st day of

May, 1975, at which time the entire unpaid ea |

the purchase price shall be due payable, Buyer

pay interest on the diminishing balance of said purchase

3

5

=

§

S.

§

3

:

8

s

3

a

ment shall inure to the b ; of and bind the successors

and assigns of Buyer and t. executors, administrators,

heirs, successors and assigns of Seller.

Subsequently, by order of the Superior Court of Wash-

ington for King County on September 23, 1965, Robert N.

Coates as Trustee of the Trust Under Will of Sydney

Coates received an undivided one-third interest in the

May 20 contract for the sale of 75 shares of WIP held by

the Sydney Coates Estate. By the same order Robert N.

Coates as Trustee for the Rose Ann Coates Trust! received

an undivided two-thirds interest in the May 20 contract for

the sale of the 75 shares held by the Estate?

1. Sydney and Rose Ann Coates had executed mutual wills. His will

gave the house, auto, bank accounts and personal effects to Rose Ann

Coates, with the residue of his estate going to the Trust Under Will of

Sydney Coates. Her will provided that, in the event Sydney Coates

predeceased her, she would convey by separate instrument her interest

in any community property “to the Trustee or Trustees as named under

the terms of the Trust created by the Will of Sydney N. Coates.” Pur-

suant to this agreement, the Rose Ann Coates Trust was created by

instrument dated August 21, 1965, executed by Rose Ann Coates,

trustor, and Robert N. Coates, trustee.

2. The court below determined that the WIP stock was held by

Sydney and Rose Ann Coates as community property. 37% shares be-

longing to each spouse. The odd apportionment is explained by the

Order Approving Final Account, Report and Decree of Distribution of

the Superior Court, which provided that in dividing the community

property “any disproportionate allocation necessary shall be made in the

respective ownership of the contract receivable for the sale of the Wash-

ington Industrial Products stock.”

Te eA Tee Re

dienes

ore)

aN NA RN aca ie Laban eb Rhea &

PBRverttencs: ee tateri oo:

A-4

In their 1965 income tax returns, all parties reported the

1965 transaction as a sale of their WIP stock entitling them

to capital gain treatment. In his notice of deficiences the

Commissioner treated the “sale” as a redemption by a re-

lated corporation under §304(a)(1) of the Internal Reve-

nue Code of 1954,’ taxable as a dividend at the face value

($1,000) of the agreements. The Tax Court upheld the

Commissioner's §304(a)(1) and dividend treatment,‘ but

found the fair market value of the agreements to be 60%

of their face value rather than 100% as determined by the

Commissioner. It is from this decision that the taxpayers

appeal.®

I.

Initially, petitioners contend that since the two trusts

were not in existence at the time of the transfer of the

WIP shares to CAM they are not taxpayers within the

meaning of §7701(a) (14), and that, accordingly, the Com-

missioner determined deficiencies against the wrong par-

ties. They would have us hold that since the WIP shares

were community property, the proper parties for taxation

are the Estate of Sydney Coates and Rose Ann Coates. We

decline to do so and affirm the Tax Court.

The Trust Under Will of Sydney Coates, under §§661

and 662, was a proper party to the proceedings below.

While the question raised as to the Rose Ann Coates Trust

is more difficult. we have concluded it also was a proper

party below. Upon the death of her husband, Mrs. Coates

held her community property interest in the WIP shares

subject to a restriction on their use, by virtue of the mutual

3. All section references hereafter are to the Internal Revenue Code

of 1954, as amended.

4. On October 24, 1969, the Tax Court entered decisions of no de-

ficiency in the following listed cases on the basis that the redemption of

their stock in WIP by CAM was substantially disproportionate pursuant

to §302(b)(2): Arthur C. Heinen and Molly M. Heinen; Estate of

Ruby M. Boyd, deceased, R. Morgan Boyd, executor; R. Morgan Boyd;

Robert W. Boyd and Judith K. Boyd; Gary A. Heinen; Richard CG.

Heinen; Barbara Gaye Heinen; James E. Boyd. Robert and Marjorie are

not parties in this case because of other matters with respect to their

1965 return which had not been resolved by the Service at the time this

suit was instituted.

5. The decision of the Tax Court is reported at 55 T.C. 501 (1970).

a

2 + Da RA WAN ORR RS

A-5

wills (see footnote 1 supra). Under Washington law her

~greement to transfer her half of the community property

into trust was specifically enforceable by the beneficiaries

roar In " Young's Estate, 40 Wash.2d 582, 244 P.Qd

1165 (1952).

Thus on May 20, 1965 when the WIP shares held by the

Estate were “sold,” Mrs. Coates held her half of the com-

munity property in constructive trust for the beneficiaries

of her agreement.® Cf. Healy v. Commissioner, 345 US.

278 (1953). We conclude, therefore, that the beneficial

the Rose Ann Coates Trust, and as such it was subject to

the tax on the transfer thereof. 2 Mertens, Law of Federal

Income Taxation, §17.08 (1967 Revision ).

Il.

Petitioners next contend that the agreements entered into

n May 20 between CAM and the WIP shareholders are

“securities” as that term is used in §351’ and that, since

after the May 20 transaction the WIP shareholders con-

trolled over 80% of the stock of CAM, §351 operates to

grant them either no tax liability or capital gain treatment.®

The Tax Court concluded that the agreements were not

securities, citing Warren H. Brown, 27 T.C. 27 (1956).

Petitioners argue that the Brown decision creates an

invalid distinction between an installment sales contract

and other long term corporate obligations. See Bittker &

6. It is noteworthy that at no time after the death of her husband did

Mrs. Coates obtain control over the WIP shares or the purchase agree-

ments. Also, the agreements did not pass through Mrs. Coates, but rather

were transferred directly from the Estate of Sydney Coates to the Rose

Ann Coates Trust.

7. Section 351(a) provides that:

No gain or loss shall be recognized if property is transferred to a

corporation . . . by one or more persons in exchange for stock or

securities in such corporation and immediately after the exchange

such person or persons are in control . . . of the corporation.

8. The taxpayers argue two alternative positions: (1) that all of the

agreements are securities, that §351 in [sic] applicable and, no “other

property” having been received, that the taxpayers did not incur any tax

liability on the transfer; or (2) that certain of these agreements are

“securities” but that some of them could be treated as “other property”

under §351, thus making the transaction taxable at capital gains rates

to the extent of the value of this other property.

TE TN Oe Oe ee eT ey

ee oe

figs

« : a

WEE RTE AN

A-6

Eustice, Federal Income Taxation of Corporations and

Shareholders 3-55 (3rd Ed. 1971); Comment, Section 351

Transfers to Controlled Corporations: The Forgotten

Term—“Securities,” 114 U.Pa. L. Rev. 314 (1965). We

do not reach that issue, however, for even assuming ar-

guendo that these ae are “securities” under §351,

we are convinced that the provisions of §351 are over-

ridden by those of §304 and that, accordingly, §304 and

not §351 applies to this transaction. See Henry McK.

Haserot, 46 T.C. 864, 872 (1966) (Tannenwald, J.) (sep-

arate opinion ).

In Commissioner v. Stickney, 399 F.2d 828 (6th Cir.

1968), affg Henry McK. Haserot, supra, the Sixth Circuit

reached a contrary result. While the statutory language

and legislative history reveal that Congress did not pro-

vide for or contemplate the possible conflict between the

tmissive policy of §351 and the preventive policy of

$304, we are convinced that our decision “best achieves the

underlying legislative intent and policy and . . . more

nearly reflects the manner in which Congress would have

‘straightened this ruck out if they had come across it.’”

Haserot, supra at 878 (Tannenwald, J.). Accordingly, we

decline to follow the Sixth Curcuit for the reasons so co-

gently set forth by Judge Tannenwald.®

III.

Petitioners next argue that the Tax Court erred in

holding that the transaction was a redemption through

the use of a related corporation under §304(a)(1). They

would have us hold that the “one or more persons” of

§304(a)(1)(A) refers to one person plus those persons

9. Our case reveals the ultimate inconsistency that would result if we

followed Stickney and held that the “except as otherwise provided” pro-

visos of §§302(d) and 301(a) precluded §304 applicability to these

taxpayers. Other parties to this transaction were taxed at the capital

gains rate by virtue of §§304(a) and 302(b) (2). See footnote 4, supra).

That result would not be altered were we to follow Stickney’s interpreta-

tion of the provisos. Thus Stickney’s rationale would lead us to hold that

those specifically excluded by Congress from dividend treatment ( by

virtue of §302(b)(2)) would be taxed at the capital gains rate, while

___ those Congress intended to be taxed at ordinary income rates (by virtue

* of §§304(a), 302(d), and 301(a)) would escape taxation altogether by

» §351. Such a result does not comport with our reading of the legislative

intent behind §§304 and 351.

a

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BAe MARAT Nc 2 BSI

Emme pe POEL EERIE ETAT ELEN BT EE PENS SS SI,

— AAD AE SARS SORT ARUN

A-7

whose shares are attributed to him under §318, and that

the concept of a ate control as prescribed by Reg.

§1.304-2(b *° and applied by the Tax Court departs from

the specific language and intent of the statute.

Petitioners misconceive the operation and effect of §304.

That section was not } these to be so narrowly con-

fined as to relate only to “family” transactions. To the

contrary, it was designed to apply to any closely held

corporations whether or not the parties were related by

blood. The phrase “or more persons” is not i agra.

as petitioners ultimately must contend, but er indi-

cates an attempt to expand the scope of §304(a)(1)

beyond the family relationship to include unrelated per-

sons who act in concert. See Radnitz v. Commissioner,

187 F. Supp. 952 (S.D.N.Y. 1960), aff'd per curiam, 294

F.2d 577 (2d Cir. 1961).

Since in the instant case the same group of persons

controlled both WIP and CAM, §304(a) (1) applies to

this transaction, and the property received by the WIP

shareholders must be treated as a distribution in redemp-

tion of the stock of CAM.”

IV.

To determine the tax consequences of a §304(a)(1)

redemption, it is necessary to refer to §302. Unless the

redemption qualifies as an exchange under one of the

categories of §302(b), it is to be treated under §301.”

sales and immediately subsequent to the last of such sales) shall be dis-

regarded, provided the other facts and circumstances indicate related

transactions.

11. Section 304(a)(1)(B).

12. It is undisputed that §301 treatment results in the distribution

being taxed to each of the taxpayers as a dividend under §§316 and

301(c) (1).

a

aa

SR Ra CE NT Se

i; Pe SERRE NG a VR GAS ot alm i

PLE LETS OPE Se

A-8

The only portion of §302(b) relevant here is §302(b)(1),

ore at 6 arr a age lt adh tee

The instant transaction resulted in no reduction in any

of the taxpayers’ proportionate interests in WIP. That

rg Sow case, the Tax Court correctly concluded that

the distribution did not qualify for the preferred treat-

ment under §302(b)(1).

Taxpayers attempt to distinguish Davis on the grounds

that that opinion applies only to 100% shareholders. The

rationale of Davis a not support such a distinction,

and we reject it without further » scorn

V.

Petitioners finally contend that the Tax Court erred in

determining .the fair market value“ of the agreements

te be $600 per $1,000 face value. We have carefully

examined the record and conclude that there was ample

support for the court's finding. It certainly was not

clearly erroneous.

The decision of the Tax Court is affirmed.

13. The relevant inquiry concerns the taxpayers’ respective interests

in WIP. Section 304(b) (1).

14. The amount of the distribution is the fair market value of the

property received. Section 301(b) (1).

A-9

APPENDIX B

UNITED STATES TAX COURT

a.

RosE ANN Coates Trust, Roperr N. Coates, TRUSTEE,

ET AL.,’ PETITIONERS v. CoMMISSIONER OF INTERNAL REvVE-

NUE, RESPONDENT

Docket Nos. 5810-68, 5813-68, 5834-68, 5870-68, 5872-68,

Filed December 15, 1970,

The Coates family owned all of the shares of CAM

corporation and WIP corporation, CAM “purchased”

the shares of WIP. Held:

1. The Rose Ann Coates Trust, not Rose Ann Coates,

was the proper taxpayer where Rose Ann Coates had

agreed by mutual will to place her community shares

in trust, and the transaction occurred after the death

of her husband.

cuted by the Estate of Sydney Coates was passed

through to the trust-beneficiary.

3. The transaction was a redemption by a related

corporation under sec. 304. Sec. 351 not applicable.

4. The redemption was essentially equivalent to a

dividend. Business purpose is irrelevant. United States

v. Davis, 397 U.S. 301 (1970).

Joseph H. Trethewey, for the petitioners,

Millard D. Lesch, for the respondent.

1. Proceedings of the following petitioners are consolidated here-

with: Trust Under Will of Sydney N. Coates, Robert N. Coates,

Trustee, docket No. 5813-68; Peter M. Coates, docket No. 5834-68;

Charles N. Coates, docket No. 5870-68; Pamela L. Coates, docket No.

5871-68; and Cathy A. Coates, docket No. 5872-68.

LE

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RNB A PLE REEL EPL DOR GLEE PLE

|

PP MATE AGATA EAST i

A-10

Dawson, Judge: In these consolidated cases respondent

determined the following deficiencies in petitioners’ Fed-

eral income taxes for the year 1965:

Petitioner Docket No. Deficiency

Rose Ann Coates Trust, Robert N. Coates,

CC Lehi cds Wend Gu Anes tc ié.00004.66 00.0 5810-68 $12,936.62

Trust Under Will of Sydney N. Coates,

Robert N. Coates, Trustee ............. 5813-68 5,313.41

oaks nach p undue seas eas 5834-68 654.42

GEN Oe: MINED coc ccnccccvsvvstveres 5870-68 427.00

PT III oda vances civics vevsvces 5871-68 427.00

I 65nd dnc vecddcensocenas 5872-68 602.87

By amendment to his answer, respondent has claimed the

following additional deficiencies:

Petitioner Docket No. Deficiency

Rose Ann Coates Trust, Robert N. Coates,

MEE DSSS eAUN er aah ener heb Raieoee 5810-68 $11,495.89

Trust Under Will of Sydney N. Coates,

Robert N. Coates, Trustee ............. 5813-68 4,966.42

NE I ee hac Gansvckcsccavecete 5834-68 511.06

SR MD occ ats oiwe cess wees 5870-68 419.20

it Oh so oho kv han dae dea aeens 5871-68 419.20

FE ner Rae 5872-68 470.03

The key issues presented for decision are: (1) Whether

the sale by petitioners of all of their stock in Washington

Industrial Products, Inc., to CAM Industries, Inc., on May

20, 1965, was a redemption through the use of a related

corporation under section 304(a)(1), IR.C. 1954;? (2)

whether the redemption of all of the stock in Washington

Industrial Products, Inc., by CAM Industries, Inc., was

essentially equivalent to a dividend to petitioners under

section 302(b)(1) so that the amounts received by them

are taxable as ordinary income; and (3) the fair market

value of the contracts received by petitioners from CAM

Industries, Inc., on May 20, 1965. There is a preliminary

oo as to whether the Rose Ann Coates Trust and

e Trust Under Will of Sidney N. Coates are proper parties

in these proceedings.

2. All statutory references are to the Internal Revenwe Code of

1954, as amended, unless otherwise indicated.

. =— -

weet a MA Meld TOR OAR Laces

A-11

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulation

of facts, supplemental stipulation of facts, together with

the ne attached thereto, are incorporated herein by

reference,

Petitioners Peter M. Coates, Charles N. Coates, Pamela

L. Coates, and Cathy A. Coates are brothers and sisters

who filed their individual income tax returns for 1965 with

the district director at Tacoma, Wash. They were residents

= Bellevue, Wash., at the time they filed their petitions

erein.

Petitioner Rose Ann Coates Trust, Robert N. Coates, trus-

tee, is a trust created under the laws of the State of Wash-

ington. Robert N. Coates, trustee, caused the trust to file its

Federal fiduciary income tax return for 1965 with the dis-

trict director at Tacoma. Wash. Robert N. Coates, trustee,

resided in Bellevue, Wash., at the time the trust filed its

petition herein.

Petitioner Trust Under Will of Sydney N. Coates, Robert

N. Coates, trustee, is a trust existing under the laws of the

State of Washington. Robert N. ates, trustee, caused the

trust filed its petition herein.

Sydney N. Coates and Rose Ann Coates were husband

and wife. Sydney N. Coates died on January 31, 1963. Rose

Ann Coates is stil] living. Robert N. Coates, Ruby Boyd,

and Molly Heinen are the children of Sydney N. Coates and

Rose Ann Coates,

Ruby Boyd is the wife of Morgan Boyd. Robert M.

Boyd, Jr., and James Boyd are their children.

Molly Heinen is the wife of A. C. Heinen. Barbara

— Gary Heinen, and Richard Heinen are their chil-

en,

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PRE PER 5 eA oT «

A-12

CAM Industries, Inc. (hereinafter sometimes call

CAM), began its existence as the sole proprietorship. of

Sydney Coates, doing business as the Coates Electric Man

Co. Coates Electric manufactured a line of com-

mercial and industrial electric equipment including

ovens and water-heating equipment for government and

private customers. The company was incorporated on June 1,

1948, and on May 18, 1965, changed its name to CAM

Industries, Inc.

At the time of Coates Electric’s incorporation in 1948

Sydney Coates received 696 shares of stock and Robert N.

Coates, R. Morgan Boyd, Arthur C. Heinen, and Zena M.

Gilbert received 1 share each. Subsequently the number of

shares issued to Sydney Coates was reduced from 696 to

426 since the original allotment should have been 426

shares.

On May 31, 1960, Coates Electric amended its articles of

incorporation as follows:

The capital stock of the corporation shall be 2,500 shares

of Class A voting common stock at a par value of $30.00

per share and 7,500 shares of Class B non-voting common

stock at a par value of $30.00 per share. Class A and Class

B shareholders shall have identical and equal rights to divi-

dends or to any other incidents arising from the ownership

of said stock except that only Class A voting common stock

shareholders shall be entitled to vote.

Shareholders were required to surrender their old shares:

For each ten shares delivered to the corporation each

shareholder shall receive twenty-five shares of non-voting

stocks together with 844 shares of voting common stock.

On October 13, 1960, the shares of Coates Electric were

held as follows:

Class A Class B Class A Class B

Sydney N. Coates. 1,610 4,830/ ArthurC. Heinen. 10 30

Robert N. Coates. 710 2,130 | Molly Heinen... 50 150

R. Morgan Boyd... 10 30/| Treasury shares.. 10 30

Ruby Boyd ...... 50 150 Total...... 2450 7,350

2 , sen Foy

A-13

tari nnd dz ch

rt p on August .

shares held by the children of and

spouses were received by them as gi from Sydney and

Rose Ann Coates. Sydney and Rose Ann Coates made

additional gifts of stock on October 13, 1960, January 2,

1961, and January 10, 1962, so that by May 20, 1965, prior

the acquisition by CAM of all the stock of ee

Industrial Products, Inc. (herei r sometimes

WIP), the stock of CAM was held as follows:

Class A Class B Class A Class B

Estate of Sydney ames Boyd ........... 391

| aS, 664 Rube Boyd ..... 372

Robert N. Coates. 1,640 2,250|4.C Heinen..... 10 «375

Peter Coates .......... 205 | Barbara Heinen ....... 340

Cathy Coates ......... 205 RRS RRR ARS 340

Pamela Coates ........ 205 | Molly Heinen 390 325

Charles N. Coates..... 205 | Richard Heinen .......

Marjorie Coates ....... 290 | Treasury shares 10 30

R. M Boyd. 10 422 Total 2 450 7,350

Robert M. Boyd, Jr. 391; —- Total... 4

WIP was incorporated on August 2, 1951, for the purpose

chase a large piece of machinery from the Campbell Co.

Finding the Campbell Co. in financial difficulty and near

default on its government contracts, the officers of Coates

Electric organized WIP to take over the assets and con-

tracts of Campbell. At that time Campbell manufactured

ovens for the food industry (dissimilar to Coates Electric

ovens ) and an industrial oven.

WIP, from which each deducted amounts sufficient to pay

off the bank note covering the purchase of the Campbell

assets.

On May 20, 1965 prior to the acquisition by CAM of

all the stock of WIP all the stock of WIP and all the stock

— RL PCR SES

taeda fe

B. Gy TOO... .. ce cccces 57 10

Barbara Heinen ........... De iccosckeses

Gary Heinen ............. _ 2) ORR

Richard Heinen ........... _ | SE

Molly Heinen (Mrs. A +) Es eee 390

ae 300 2,440 7,320

In 1951 the premises of WIP and Coates Electric were

located a half mile apart. Soon WIP was moved to the

Coates Electric plant, but operations remained physically

distinct except for the sharing of some heavy equipment.

In 1955 Coates Electric required more room, so WIP was

relocated 6 miles away.

Under the management of Arthur Heinen, WIP began

to compete with Coates Electric, particularly in the indus-

trial oven area. The two corporations also began subcon-

tracting work to one another. Coates Electric sold some

products to WIP for resale.

i ae LE LE ES DEO ee SSG A eR A RO a . 3

i Bertone ce canreaes anne a ee a

A-15

During this period Robert N. Coates enerally famil-

iar with the operations of WIP, and made himself nd the

resources of Coates Electric available to WIP. He did not

preside over day-to-day operations of WIP.

combining their businesses. They determined that by com-

bining office personnel, salesmen, inventories, purchasi

and machinery, they would realize substantial economies.

Before his death, Sydney Coates had transferred most

of the stock of CAM from his estate, and, in the process,

left his only son, Robert N. Coates, in complete control of

CAM. It was the wish of Sydney Coates to give Robert N.

Coates control of two-thirds of the voting stock and 51

percent of the total stock of CAM. At his death Sydney

Coates had accomplished his purpose.

only manner in which this could be accomplished was by

having CAM purcase WIP. A merger would have reduced

Robert N. Coates’ interests below the amounts he insisted

upon.

On May 20, 1965, CAM and the shareholders of WIP

entered into agreements of the following form:

AGREEMENT For SALE OF Stock

Agreement made this 20th day of May, 1965, by and be-

tween the undersigned “Seller” and CAM INDUSTRIES,

INC., a corporation, hereinafter called the “Buyer.”

Seller hereby sells to Buyer, and Buyer hereby purchases

from Seller, shares of the common stock of Wash-

ington Industrial Products, Inc., a Washington corporation.

at ~ price and on the terms and conditions herein set

forth.

1. Purchase Price. The price to be paid by Buyer to

Seller for said shares of common stock shall be $1,000.00

per share or an aggregate purchase eR

2. Delivery of Stock and Payment of Purchase Price.

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A-16

a) The certificate or certificates for the shares of com-

mon stock sold hereunder by Seller are herewith delivered

to Buyer, duly endorsed for transfer ye ne and Buyer

hereby acknowledges receipt of said ificate or certif-

icates.

(b) The purchase price shall be paid ................ , Or more

at Buyer's option, on or before May 31, 1966, and a like

sum, or more at Buyer's option, on the 3lst day of May of

each year thereafter until the 3lst day of May, 1975, at

which time the entire unpaid balance of the purchase

price shall be due and payable. Buyer shall pay interest

on the diminishing balance of said purchase price at the

rate of four percent per annum from the Ist day of June,

1965, which interest shall be deducted from each install-

ment payment and the balance of each payment applied

in reduction of principal.

3. Successors and Assigns. The provisions of this agree-

ment shall inure to the benefit of and bind the successors

and assigns of Buyer and the executors, administrators,

heirs, successors and assigns of Seller.

In Witness WHEREOF, the parties hereto have executed

this agreement the day and year first above written.

CAM liquidated WIP on May 31, 1965. On May 30,

1965, the accumulated earnings and profits of CAM were

$183,000.

The fair market value of the contracts between CAM

and the shareholders of WIP as of May 20, 1965, were

$600 per $1,000 face value.

Sydney N. Coates and Rose Ann Coates executed mu-

tual wills. Sydney Coates’ will gave the house, automobile,

bank accounts, and personal effects to Rose Ann Coates,

and the residue of his estate went to the Trust Under Will

of Sydney N. Coates. Rose Ann Coates’ will provided that,

in the event Sydney N. Coates predeceased her, she agreed

to convey by separate instrument her interest in any com-

munity property “to the Trustee or Trustees as named

under the terms of the Trust created by the Will of Sydney

N. Coates.”

A-17

The Trust Under Will of Sydney Coates provided, in

part, that:

The Trustee or successor Trustee or Trustees shall pay a

sum of not less than $500.00 a month to the said ROSE

ited thereto, said monthly income to come out of the in-

come of the property in Trust, or from the principal there-

of, provided that the said ROSE ANN COATES may, by

an instrument in writing, waive said monthly payments or

take a lesser sum during business depressions or emer-

gencies.

It further provided:

NINTH: In the event of the death of the said ROSE

ANN COATES, then the Trustee or successor Trustee or

Trustees is directed to distribute the remaining corpus of

the estate as follows:

A. To ROBERT N. COATES, a percentage of the estate

interest of the partnership assets of COATES & COATES,

equivalent to the percentage needed to give the said ROB-

ERT N. COATES fifty per cent (50% ) of said partnership

assets.

B. The remainder of the corpus shall be distributed to

the children of SYDNEY N. COATES and ROSE ANN

COATES, to-wit: ROBERT N. COATES, RUBY N. BOYD

and MOLLY M. HEINEN, share and share alike.

By order of the Superior Court of the State of Washing-

ton for King County dated September 23, 1965, Robert

N. Coates as trustee of the Trust Under Will of Sydney

N. Coates received:

4. 332 shares common stock in CAM Industries, Inc.

8. An undivided one-third interest in the contract dated

May 20, 1965, for the sale of 75 shares of Washington In-

dustrial Products common stock.

The Rose Ann Coates Trust, established by an agree-

ment dated August 21, 1965, provided:

A-18

ARTICLE II

DisTRIBUTION FROM THE TRUsT EsTATE

In that certain trust established under the Will of Syd-

ney N. Coates, it is provided that:

“The Trustee or successor Trustee or Trustees shall pay

a sum of not less than $500.00 a month to the said ROSE

ANN COATES to keep her and maintain her in the man-

ner to which she is accustomed, and to raise said amount

as the Trustee in his discretion may see fit, for any reason

whatsoever, such as for sickness or for travel, but not lim-

ited thereto, said monthly income to come out of the in-

come of the property in Trust, or from the principal there-

of, provided that said ROSE ANN COATES may, by an

instrument in writing, waive said monthly payments or take

a lesser sum during business depressions or emergencies;”

To the extent that the payments provided for Rose Ann

Coates in the trust established under the Will of Sydney N.

Coates are not made as provided therein, payment shall be

made from the trust herein established, provided, however,

that said payments hereunder shall in no event exceed

$250.00 per month.

ARTICLE V

ULTIMATE DISTRIBUTION

Upon the death of Trustor, the Trustee or successor

Trustee or Trustees are directed to distribute the remain-

ing ‘corpus of the trust to the children of SYDNEY N.

COATES and ROSE ANN COATES, to-wit: ROBERT N.

COATES, RUBY N. BOYD and MOLLY M. HEINEN,

share and share alike.

On March 25, 1966, Robert N. Coates, as trustee of the

Rose Ann Coates Trust, received by order of the Superior

Court of the State of Washington for King County:

4. 332 shares common stock in CAM Industries, Inc.

8. An undivided two-thirds interest in the contract

dated May 20, 1965, for the sale of 75 shares of Washington

Industrial Products common stock.

ee eee

A-19 7

In his notice of deficiencies the respondent treated the

“sale” of the WIP shares as a redemption by a related cor-

poration within the scope of section 304.

On October 24, 1969, the Tax Court of the United States

entered decisions of no deficiency in the following listed

cases. With res to the following listed ders of

Washington Industrial Products, Inc., the respondent de-

termined that the redemption of their stock in Washington

Industrial Products, Inc., by Cam Industries, Inc., was sub-

stantially disproportionate pursuant to section 302(b) (2),

LR.C. 1954:

Name Docket No.

Arthur C. Heinen & Molly M. Heinen.............. 5873-68

Estate of Ruby M. Boyd, deceased, R. Morgan Boyd,

executor Boyd LieRaN ine heaniirsnie eke cekiewties —-

EE EEE Ae 12-68

Robert M. Boyd & Judith K. Boyd................. 5842-68

ll RIES aig Rael 5861-68

EE EE er ey 5867-68

MEIN. |. os. caw concvneceecucceos 5868-68

RS IP Oe 5869-68

OPINION

This case arises out of a transaction between the members

of a family group and two corporations controlled by them.

Sydney and Rose Ann Coates, together with their children,

children’s spouses, and grandchildren, owned all the shares

of two corporations conducting related businesses. After

the death of Sydney Coates, the family group agreed to

combine the two corporations by having CAM “purchase”

the shares of WIP.

Respondent's position is that the transaction was a re-

demption Seeceh the use of a related corporation, within

the scope of section 304(a)(1).2 Under sections 302(d)

and 301 (a) and (c),° respondent would treat the amount

3. SEC. 304. REDEMPTION THROUGH USE OF RELATED

CORPORATIONS.

(a) TREATMENT oF CERTAIN Stock PURCHASES.—

(1) AcQuIsITION BY RELATED CORPORATION (OTHER THAN sUBSID-

1aRY).—For purposes of sections 302 and 303, if—

(A) one or more persons are in control of each of two cor-

porations, and

(B) in return for property, one of the corporations acquires

|

- en ce alan cna

A-20

of the distribution to the petitioners herein as dividends.

Some members of the adie have escaped dividend

treatment under section 302(b)(2). The case of Robert

N. Coates and Marjorie Coates was not joined herein with

these petitioners.

The trial of these related cases took place before the

decision of the Supreme Court in United States v. Davis,

397 U.S. 301 (1970). Much of the proof, therefore, was

directed at the issue of whether the transaction between

the stockholders and their two corporations had a “busi-

ness ” which might bring it within the scope of

section 302(b) (1). Respondent’s opening brief is devoted

largely to this issue. However, because of several exten-

sions of time for filing their brief, petitioners’ opening

brief was filed after the Davis case was decided. Conse-

uently, the petitioners have shifted their primary position

om the “business purpose” issue to another | ee

namely, the question of proper parties. Respondent, in

turn, was caught off balance in framing his reply. As a

result, we are faced with briefs reflecting the turmoil of

events. Moreover, both the parties and the Court are

handicapped by the vagaries of a record created primarily

for an issue which is now of uncertain status.

1. Proper Parties—Petitioners’ initial argument is that

“the Rose Ann Coates Trust and the Trust Under Will of

|

|

stock in the other corporation from the person (or persons) so in

control.

then (unless paragraph (2) applies) such property shall be treated

as-a distribution in redemption of the stock of the corporation acquir-

ing such stock. In any such case, the stock so acquired shall be

treated as having been transferred by the person from whom

acquired, and as having been received by the corporation acquiring

it, as a contribution to the capital of such corporation.

4. SEC. 302. DISTRIBUTIONS IN REDEMPTION OF STOCK.

: (d) ReDEMPTIONS TREATED AS DISTRIBUTIONS OF Property.—Except

: as otherwise provided in this subchapter, if a corporation redeems its

stock (within the meaning of section 317(b), and if subsection (a)

j of this section does not apply, such redemption shall be treated as a

distribution of property to which section 301 applies.

5. SEC. 301. DISTRIBUTIONS OF PROPERTY.

(a) In GeneraL.—Except as otherwise provided in this chapter, a

distribution of property (as defined in section 317(a)) made by a

EIEN SS IIS BH HE 2.

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A-21

Sydney Coates did not transfer shares in W.

Industrial Products, Inc., to CAM Industries, Inc., and

consequently are not chargeable with a dividend.” Peti-

tioners point out that the Rose Ann Coates Trust was

created after the agreement to transfer the WIP shares.

They argue that the agreement was made by the Estate

of Sydney Coates, administering community property,

and that the proper taxpayers are Rose Ann Coates and

the Estate of Sydney Coates.

In its reply brief, respondent “agrees with petitioners

that, if the [75 shares of WIP] stock of Sydney Coates was

the community property of S$ dney and Rose Ann Coates,

then the transaction would c taxable one-half to Rose

Ann Coates and one-half to the Estate of Sydney Coates.

Rose Ann Coates is not a party to this action.” Respond-

ent's position with respect to the Estate of Sydney Coates

is that the contract distributed to the testamen trust

would be deductible by the estate, and reported by the

trust. However, respondent contends that “The argument

that the stock of Sydney Coates was community property

was never raised in the pleadings or in petitioners’ opening

statement.”

corporation to a shareholder with respect to its stock shall be treated

in the manner provided in subsection (c).

(c) AmMounT TaxaBLe.—In the case of a distribution to which sub-

section (a) applies—

(1) AMOUNT CONSTITUTING DIVIDEND.—That portion of the dis-

tribution which is a dividend (as defined in section 316) shall be

included in gross income.

(2) AMOUNT APPLIED AGAINST BASIS.—That Portion of the distri-

bution which is not a dividend shall be applied against and reduce

the adjusted basis of the stock.

(3) Amount In Excess or Basis.—

(A) In GeneraL.—Except as provided 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.

(B) DisTRipuTIONS OUT OF INCREASE IN VALUE ACCRUED BEFORE

MarcH 1, 1913.—That portion of the distribution which is not a

dividend, to the extent that it exceeds the adjusted basis of the

stock and to the extent that it is out of increase in value before

March 1, 1913, shall be exempt from tax.

REREAD EEN det

A-22

Paragraph 5(f) of the petition alleges:

Washington Industrial Products, Inc., is a Washing-

ton n incorporated on August 2, 1951. As

of M 19, 1953, its shares were held by the follow-

ing families—75 shares each:

Mr. and Mrs. Robert N. Coates

Mr. and Mrs. Sydney N. Coates

Mr. and Mrs. R. Morgan Boyd

Mr. and Mrs. Arthur C. Heinen

The assets for which said shares were issued were

transferred from a pre-existing company, J. A. Camp-

bell Co., which was not related to anyone in either

company here. These assets were paid for by funds

earned by each of the four males above. ,

In his answer respondent admitted only that WIP was a

Washington corporation incorporated August 2, 1951, and

denied the remaining allegations of paragraph 5(f).

We think the statement that the shares were held by

husband and wife (“Mr. and Mrs.”) in a community

property State, the statement that the assets which bought

the shares were paid for with the husband's earnings, to-

gether with respondent’s denial, clearly place in issue the

status of the shares as community property.

The evidence presented indicates that the 75 shares of

WIP were held by Sydney and Rose Ann Coates as com-

munity property. The correspondence concerning their

estate planning shows that virtually all of their property

was held as community property. In particular, the WIP

: shares were paid for from Sydney's earnings. Usually,

property “acquired after marriage by either husband or

wife or both, is community property” in Washington. Wash.

: Rev. Code sec. 26.16.030. We note that by their mutual

: wills it was agreed that Rose Ann Coates would place her

so! tha a Leet ee ee

aye

share of the community property into the Rose Ann Coates

‘ Trust. The contract for sale of the 75 shares of WIP was

eventually distributed two-thirds to the Rose Ann Coates

Trust and one-third to the Trust Under Will of Sydney N.

Coates. The odd apportionment is explained by the Order

Approving Final Account, Report and Decree of Distribu-

tion of the Superior Court, which provided that in dividing

ferences eee ens ennoneneraeenteneteneenenmneeneen

ee

A-23

the community property “any disproportionate allocation

necessary s Of made in the respective ownership of the

contract receivable for the sale of the Washington Indus-

trial Products stock, as hereinafter set forth.”

Having determined that the 75 shares of WIP were held

as community property, we must examine respondent's

position that the transaction is therefore taxable one-half

to Rose Ann Coates, who is not a party. This concession in

respondent's reply brief would compel us to the conclusion

that Rose Ann.Coates, and not the Rose Ann Coates Trust

is the proper party as to half of the shares.¢ However, it

appears to us that this concession is based upon an errone-

ous interpretation of law. The stipulation of a conclusion

of law is not controlling. Davis v. Commissioner, 241 F.2d

701 (C.A. 7, 1957); Ohio Clover Leaf Dairy Co., 8 B.T.A.

1249 (1927), aff'd. 34 F.2d 1022 (C.A. 6, 1929); ef. Forbes

v. Commissioner, 82 F.2d 204 (C.A. 1, 1936). A fortiori,

we may disregard respondent’s concession on this point

of law.

In offering his concession, respondent has assumed that

if the shares were community property, then Rose Ann

Coates owned one half of them at the time of the trans-

action. But respondent has overlooked the existence of

the mutual wills. Rose Ann Coates had agreed that upon

Sydney’s death she would transfer her half of the communi-

ty property into trust. In the State of Washington this agree-

ment was specifically enforceable by the beneficiaries of

the agreement (who were Rose Ann and her children). In

re Young's Estate, 40 Wash.2d 582, 244 P.2d 1165 (1952);

Cummings v. Sherman, 16 Wash.2d 88, 132 P.2d 998

(1943); Allen v. Dillard, 15 Wash.2d 35, 129 P.2d 813

(1942). Therefore, upon Sydney's death and at the time

of the transaction, the equitable owner of the 37% shares

was the Rose Ann Coates Trust.

Since the Rose Ann Coates Trust was the owner of 374%

shares at the time of the transaction, it is a proper party

to this proceeding. In addition, the Rose Ann Coates Trust

reported the income as capital gain on the installment

basis on its tax return for 1965.

6. Nevertheless, the trust might be liable as a transferee.

A-24

We also conclude that the Trust Under Will of Sydne

N. Coates is a proper party to this proceeding. Al won

the Estate of Sydney N. Coates sold the shares to produce

the income, such income, when distributed, was deductible

by the estate and taxable to the beneficiary. See secs. 661

and 662. The Trust Under Will of Sydney N. Coates rec-

ognized the pass-through character of the income distribu-

tion from the Estate of Sydney Coates and reported such

income as capital gain on the installment basis on its tax

return for 1965.

2. Section 351.—Petitioners contend that the sale of their

WIP shares to CAM falls within the scope of section 351 as

well as within section 304. Relying on Commissioner v.

Stickney, 399 F.2d 828 (C.A. 6, 1968), affirming sub nom.

Henry McK. Haserot, 46 T.C. 864 (1966), they argue that

section 351 takes precedent over section 304, and that any

recognized gain is taxable at capital gains rates,

We agree with respondent that section 351 is inapplica-

; ble to this trarsaction. Section 351 applies where “property

‘a is transferred to a corporation ° ° * by one or more per-

4 sons solely in exchange for stock or securities in such cor-

poration.” Petitioners transferred their shares to a corpora-

__ tion for an agreement to pay an amount of cash plus in-

; terest in installments over a 10-year period. Petitioners do

not contend that the agreement is a “security,” and we

think it is not. See Warren H. Brown, 27 T.C. 27 (1956).

For the same reason, we think that petitioners did not do

“exactly what Mr. Haserot did” in Stickney. In combining

his businesses, Haserot received for his shares a cash credit

plus stock. Thus, without considering whether section 351]

or section 304 takes precedence when both apply, it is

plain here that section 351 does not apply.

3. Section 304.—Petitioners next contend that section

304 does not apply to this situation. They refer to the

language of section 304(a)(1)(A), which requires that

“one or more persons are in control of each of two corpora-

tions.” They argue that “one or more persons” refers to

control by one person plus the attribution persons de-

scribed in section 318.

This construction by the petitioners is contrary to section

4

Reo mn ‘ ’ LMS SORE HORSE RNGCO MSIE SAINTE RESIN IHS CUNT neneeneeeansrorcemest

2 eG

Se aN Ry,

A-25

1.304—2(b) and (c), Income Tax Regs., which refers

to ‘two or more Persons, in the aggregate” and gives ex-

amples of control by unrelated persons. Petitioners cite no

authority for their inte retation. We are persuaded that

e regulations present the Proper construction of the sta-

tute. Section 304(c) (2) makes the attribution rules of

section 318 expressly applicable for purposes of determin-

ing control. That being the case, the reference to “or more

persons” in section 304(a)(1)(A) would, by petitioners’

interpretation, become entirely superfluous.

Even if petitioners’ interpretation of section 304(a)(1) E

(A) were correct, Rose Ann Coates, or Rose Ann Coates E

together with persons whose shares are attributable to her, :

ad “control” of s ares in excess of the 50 percent of the ;

voting shares of each corporation. The shares of the estate

and the shares of her children and grandchildr

attributable to her. Sec. 318(a)(1) <) and (a)(2). It

is of no consequence that the shares of children can-

not be attributed to one another. Section 304 requires con-

trol by “one or more persons,” not control by each and

every person.

Accordingly, we hold that the sale of their stock by all

the sharehokie rs of WIP to CAM on May 20, 1965, was a

redemption through the use of a related corporation under

section 304(a) (1),

ments of section 302(b)(1). To the contrary, respondent

argues that the redemption of all the stock in WIP by CAM

was essentially equivalent to a dividend to petitioners.

We might agree with the petitioners that there was a

business purpose for combining WIP and CAM. Their

tion for the particular manner by which they achieved this

combination. We know that Sydney N. Coates and Robert

N. Coates wanted Robert N. Coates to maintain a two-

irds voting interest and a 50-percent ownership in the

‘ciate a SND SPER OY Se Ric ei

LAINE EYRE LES POOLEY TIE IY RINE NEMS! BNN A TEP NERSENS. SOIT RE RRREN

y NA eestoe sons POE LESAN MLA ST SEIS ANNE ET ’

re 4 SEAT earn EPRI:

A-26

tax consequences.

It is not necessary in this case for us “to dissect the dif-

ferences between corporate and shareholder business pur-

which have so often troubled the courts.” Perry S.

Lewis, 47 T.C. 129, 135 (1966); Estate of Moses L. Parsh-

elsky, 34 T.C. 946 (1960), revd. 303 F.2d 14 (CA. 2,

1962). We are relieved of that burden by the recent de-

cision of the Supreme Court of the United States that “ ‘the

business of a transaction is irrelevant in determin-

ing dividend equivalence’ under § 302(b)(1).” United

States v. Davis, 397 U.S. 301, 312 (1970). We do not un-

derstand petitioners to contend that a nonprorata redemp-

tion would by itself preclude dividend equivalence. Clear-

ly section 302 reaches nonprorata redemptions. See sec.

1.302-2(b), Income Tax Regs.; cf. United States v. Davis,

supra at 312.

Accordingly, we conclude that the distribution in re-

demption of petitioners’ stock was essentially equivalent to

a dividend.

5. Fair Market Value of Contracts—In return for their

stock in WIP, each shareholder received a contract from

CAM obligating CAM to pay $1,000 per share of stock. This

amount, plus interest of 4 percent on the unpaid balance,

was payable in annual installments over 10 years. It is

necessary to determine the fair market value a these con-

tracts because under section 301(b)(1)(A) the amount

of a distribution other than money is the “fair market value

= the other property received.” This question of value is

At trial the parties called expert witnesses who offered

their various opinions as to the value of the contracts. Their

conclusions were:

Per $1,000 face value

Mr. Morforde (1,000x.875x.65x.50)........-.---- $284.38

Mr. O'Farrell Teed cenbakasenaeed a

. e contract—15 percent....... .

Mr. Kleinberg small contract—18 percent....... 554.10

pe EES OAR,

nee eee a

Oe Nant! NT bin aE

ident of a discount corporation, impressed us as

who was most familiar with this type of contract, ha i

dealt with “similar” unsecured contracts, both —_

su

con-

Taking into account the testimony of the witnesses, and

the financial information made available to us concerning

CAM's ability to pay, we conclude that the fair market

value of the contracts was $600 per $1,000 face value.

To reflect the conclusions reached herein,

Decisions will be entered under Rule 50.

ee sosialsbabehiiadediiaaatiaiteeatomsbentts <caisecunmeamiil

A-28

APPENDIX C

Internal Revenue Code of 1954 (26 U.S.C.):

Sec. 301—DISTRIBUTIONS OF PROPERTY. (a) IN

GENERAL.—Except as otherwise provided in this chapter,

a distribution of property (as defined in section 317(a))

made by a corporation to a shareholder with respect to its

noy shall be treated in the manner provided in subsection

c).

(c) Amount TaxaBLe.—In the case of a distribution to

which subsection (a) applies—

(1) AMOUNT CONSTITUTING DIVIDEND.—That portion

of the distribution which is a dividend (as defined in

section 316) shall be included in gross income.

Sec. 302—DISTRIBUTIONS IN REDEMPTION OF

STOCK. Ln re

(d) Repemptions TREATED AS DisTRIBUTIONS OF Prop-

enTy.—Except as otherwise provided in this subchapter, if

a corporation redeems its stock (within the — of

section 317(b), and if subsection (a) of this section does

not apply, such redemption shall be treated as a distribu-

tion of property to which section 301 applies.

Sec. 304—REDEMPTION THROUGH USE OF RE-

LATED CORPORATIONS. (a) TREATMENT OF CERTAIN

’ Stock PURCHASES.—

(1) ACQUISITION BY RELATED CORPORATION (OTHER

| ee seer) purposes of sections 302 and

303, if—

| (A) one or more persons are in control of each of

‘ two corporations, and

(B) in return for property, one of the corporations

acquires stock in the other corporation from the per-

son (or persons) so in control,

then (unless paragraph (2) applies) such property shall

be treated as a distribution in redemption of the stock

of the corporation acquiring such stock. In any such case,

Sseienniaiaeiiiiataatatiata i

Oo tte ee ae” |

having been received by the corporation uiring it, as

a contribution to the capital of such corporation

(2) AceuisiTion By SUBSIDIARY. — For purposes of

(A) In return for property, one corporation acquires

from a shareholder of another corporation stock iy

such other corporation, and

(B) the issuing corporation controls the acquiring

corporation, then such pro shall be treated as a

distribution in redemption of stock of the issuing

corporation.

(b) Spectan Ruues ror APPLICATION OF SUBSECTION

(a).—

(1) RULE For DETERMINATION UNDER SECTION 302(b).

—In the case of any acquisition of stock to which sub-

section (a) of this section applies, determinations as to

whether the acquisition is, by reason of section 302(b),

to be treated as a distribution in part or full payment

in ex e for the stock shall be made by reference

to the stock of the issuing corporation. In applying sec-

tion 318(a) (relating to constructive ownership of

stock) with respect to section 302(b) for p of

this paragraph, sections 318(a)(2)(C) and 318(a)

(3)(C) shall be applied without regard to the 50

percent limitation contained therein.

(2) AMOUNT CONSTITUTING DIVIDEND.—

(A) WHERE suBSECTION (a) (1) aPPLiEs.—In the

case of any acquisition of stock to which paragraph

(1) (and not paragraph ( gf subsection (a) of

this section applies, the termination of the

amount which is a dividend shall be made solely by

reference to the earnings and profits of the acquir-

ing corporation.

(B) Were suBsEcTION (a)(2) aPPLies.—In the

case of any acquisition of stock to which subsection

(a)(2) of this section applies, the determination of

the amount which is a dividend shall be made as

if the property were distributed by the acquiring

zl

:

|

3

3

i

Prk Deeb 100%,

Seam

MM RE

A-30

corporation and immediately thereafter distributed

by the issuing corporation.

(c) ControL.—

1) In GeneraL.—For purposes of this section, con-

means the ownership of stock possessing at least

50 percent of the total combined voting power of all

classes of stock entitled to vote, or at least 50 percent

of the total value of shares of all classes of stock. If a

person (or persons) is in control (within the meaning

of the preceding sentence) of a corporation which in

turn owns at least 50 percent of the total combined

voting power of all stock entitled to vote of another

corporation, or owns at least 50 percent of the total

value of the shares of all classes of stock of another

corporation, then such person (or persons) shall be

treated as in control of such other corporation.

(2) ConsTRUCTIVE OWNERSHIP. — Section 318(a)

(relating to the constructive ownership of stock) shall

apply for purposes of determining control under para-

graph (1). For purposes of the preceding sentence,

sections 318(a)(2)(C) and 318(a)(3)(C) shall be

applied without regard to the 50 percent limitation

contained therein.

Sec. 351— TRANSFER TO CORPORATION CON-

TROLLED BY TRANSFEROR. (a) GENERAL RuLE.—No

ain or loss shall be recognized im property is trans-

erred to a corporation (including, in the case of transfers

made on or betore June 30, 1967, an investment company )

by one or more persons solely in exchange for stock or

securities in such corporation and immediately after the

exchange such person or persons are in control (as defined

in section 368 (c)) of the corporation. For purposes of

this section, stock or securities issued for services shall not

be considered as issued in return for property.

(b) Recewt or Property.—If subsection (a) would

apply to an exchange but for the fact that there is received,

in addition to the stock or securities permitted to be re-

ceived under subsection (a), other property or money,

then—

(1) gain (if any) to such recipient shall be recog-

but not in excess of—

oll

A-31

(A) the amount of money received, plus

(B) the fair market value of such other property

received; and

(2) no loss to su

ch recipient shall be recognized.