Petition for Writ of Certiorari — Hydrometals, Inc. v. Commissioner

In the

: Supreme Court of the United States

i OCTOBER TERM, 1973

nod nets

HYDROMETALS, INC.

Petitioner,

v.

CoMMISSIONER OF INTERNAL REVENUE,

Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS FOR THE

FIFTH CIRCUIT

JOHN W. RUTLAND, JR.,

2300 Republic National Bank

Building,

Dallas, Texas 75201,

Counsel for Petitioner.

i Of Counsel:

J. W. BULLION

Burorp P. Berry

; THOMPSON, KNIGHT,

i Stmmons & BULLION

‘ 2300 Republic National

4 Bank Building

3 Dallas, Texas 75201

INDEX

Opinions Below

Jurisdiction

Question Presented

Statutory Provisions Involved

Statement of the Case

Reasons for Granting the Writ

1. The Decision Below Conflicts With the

Decision of Another Court of Appeals

2. The Decision Below Conflicts With a

Prior Decision of This Court

Conclusion

Appendices

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ii Table of Cases

Page

Helvering v. Horst, 311 U.S. 112 (1940) 13

Commissioner v. P. G. Lake, Inc., 356 U.S. 260 (1958) 12

J. A. Martin, 56 T.C. 1255 (1971), aff'd per curiam

72-2 U.S.T.C. © 9673 (5th Cir. 1972) 8

Estate of Frank D. Stranahan, 30 TCM 1078 (1971),

rev'd 472 F. 2d 867 (6th Cir. 1973) 8

In the

Supreme Court of the United States

OCTOBER TERM, 1973

HyYpROMETALS, INC.

Petitioner,

Vv.

CoMMISSIONER OF INTERNAL REVENUE,

Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS FOR THE

FIFTH CIRCUIT

Hydrometals, Inc., petitioner, respectfully prays that a

writ of certiorari issue to review the judgment and opinion

of the United States Court of Appeals for the Fifth Circuit

entered in this proceeding on November 9, 1973.

OPINIONS BELOW

The per curiam opinion of the Court of Appeals for the

Fifth Circuit appears in the Appendix hereto. It is un-

officially reported at 73-2 USTC £9778. The opinion of the

United States Tax Court, Memorandum Decision 1972-

254, also appears in the Appendix hereto. It is unofficially

reported at 31 TCM 1260.

2

JURISDICTION

The judgment of the Court of Appeals for the Fifth

Circuit was entered on November 9, 1973. This petition for

certiorari was filed within 90 days of that date. The juris-

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

QUESTION PRESENTED

Petitioner, to offset otherwise expiring net operating losses,

assigned future manufacturing revenues from two of its

operating divisions for a cash consideration of $1,300,000.

The question is whether, as petitioner contends, income was

realized by petitioner on the receipt of such cash payment,

which receipt occurred on September 30, 1966. Respondent

contends that the substance of the transaction was that of a

loan, and, therefore, no income was realized upon receipt

of the cash payment.

STATUTORY PROVISIONS INVOLVED

No statutory provision is directly involved.

STATEMENT OF THE CASE

Petitioner, herein referred to as taxpayer, was incorporated

under the laws of the State of Illinois on July 30, 1908. Its

principal place of business during the period from 1964

to date has been and is in Dallas, Texas. (R. 25).’

Taxpayer keeps its books and records and files its

income tax returns on the accrual method of accounting.

Taxpayer and its subsidiaries filed consolidated Federal

income tax returns for its fiscal years ended September 30,

1966, and September 30, 1967, with the District Director of

Internal Revenue, Dallas, Texas. (R. 25, 188, 251).

Until 1961 taxpayer was basically a producer and mar-

keter of zinc products through its Illinois Zinc Company

1 References are to the printed Appendix filed with the Court of

Appeals for the Fifth Circuit.

3

Division. In its year ended September 30, 1965, petitioner

disposed of this division. It is now a diversified manufac-

turer, the stock of which is listed on the American Stock

Exchange. (R. 26).

During the taxable year ended September 30, 1966, tax-

payer’s operations were conducted through two subsidiaries

and six divisions. One division, the Giller Tool Company

Division, sells electronic kits, survival kits, safety equipment

and tools, individually and in full kits, to the United States

defense forces, local government and to industry. Giller

also manufactures wooden chests and foot lockers. Another

division, the Thomas Beckett Company Division, is one of

the largest producers of fractional horsepower pumps in the

world, shipping over 280,000 units annually. This division

is also a leading manufacturer of floats and prefabricated

duct work for the air conditioning industry. It also produces

steel tool boxes. (R. 26-28) .

During its taxable year ended September 30, 1967, tax-

payer continued to conduct the operations it had conducted

during its 1966 year and also acquired U.S. Brass Company.

This company manufactures and sells plumbing valves, flex-

ible connectors and single lever faucets. (R. 28).

For its taxable year ended September 30, 1966 taxpayer

had a net operating loss carryover from its taxable year

ended September 30, 1961 in the amount of $1,928,557.59.

This loss would expire at the end of the taxable year ended

September 30, 1966 unless utilized to offset taxable income

realized during such year. (R. 28).

The management of taxpayer was very aware of the

possible expiration of the large loss carryover and, with

taxpayer’s accountants, the firm of Price, Waterhouse & Co.,

considered several methods of realizing income to offset the

loss. Consideration was given to the sale of certain real

property owned by taxpayer. Additionally, taxpayer con-

sidered acquiring oil and gas properties and thereafter carv-

ing out and selling an oil payment. Similar consideration

was given to the acquisition of uranium properties. (R. 148).

+

It was finally decided that taxpayer should sell future

manufacturing revenues and offset the proceeds of the

sale against the otherwise expiring loss carryforward. Tax-

payer was advised by Price, Waterhouse & Co. that the

proceeds of such a sale would constitute ordinary income.

Taxpayer was further advised, however, that as a prere-

quisite to the transaction resulting in the realization of

ordinary income, there must be a bona fide sale and there

could be no guarantee of any nature that the purchaser of

the manufacturing revenues would have a return of his

purchase price. (R. 54, 55, 78-80).

Taxpayer decided to offer for sale revenues from two of its

divisions, the Beckett Division and the Giller Division.

(R. 79).

Taxpayer approached several prospective purchasers of the

manufacturing revenues, one of which was the Catholic

Foundation, Dallas, Texas. Taxpayer's officers were aware

that in the past the Catholic Foundation had acquired sev-

eral oil payments in ABC and carved out oil payment

transactions. In such transactions the Catholic Foundation

had borrowed the funds with which to make the purchase.

In fact. on numerous prior occasions Monsignor McGill,

the executive director of the Catholic Foundation, had re-

quested of the chief executive officer of taxpayer that the

Catholic Foundation be considered as a prospective pur-

chaser in the event taxpayer should have occasion to enter

into a transaction similar to its oil payment transactions.

Taxpayer therefore felt that the Catholic Foundation would

be a prospective purchaser of the manufacturing revenues

since it viewed the sale as being similar to the sale of a

carved out oil payment. (R. 57, 80, 81, 110, 115).

Initially taxpayer and Monsignor McGill discussed the

sale and purchase of $1,400,000 of manufacturing revenues

for a discounted sales price of $1,300,000. Secondly, there

was discussed the sale of approximately $1,300,000 of man-

ufacturing revenues plus an additional amount of revenues

equal to interest at a specified rate on the unliquidated

balance of the principal sum. (R. 60, 86).

5

Taxpayer prepared and presented to Monsignor McGill

projections of expected revenues from the two divisions.

These were analyzed for Monsignor McGill by attorneys

for the Catholic Foundation and were reviewed by the Board

of the Catholic Foundation. Monsignor McGill personally

visited and inspected the Giller plant and the manufacturing

operations there being conducted. (R. 110, 111).

The projections reflected that upon the basis of the

terms and proposals discussed the purchaser of $1,300,000

of manufacturing revenues together with an amount equal

to interest at 8 on the unliquidated balance would re-

ceive all of the purchased revenues in approximately 11 to 12

months. (R. 89).

Taxpayer and Monsignor McGill were equally confident

that the proposed purchase would pay out and result in a

profit to the Catholic Foundation. However, each was fully

aware and understood that the risk of loss, however ap-

preciable, was with the Foundation in the event it made

the acquisition. (R. 58, 59, 81, 82. 112).

Following negotiations between Monsignor McGill and

taxpayer, and after a determination by the Board of the

Catholic Foundation to acquire the manufacturing rev-

enues, taxpayer, on September 30, 1966 assigned to Cathe-

dral Foundation, Trust C a part of the manufacturing rev-

enues of its Beckett and Giller divisions. There was as-

signed to Trust C seventy percent (70%) of the revenues

from the two divisions until it received from the assigned

revenues the sum of $1,300,000 plus an amount equal to in-

terest on the unliquidated balance of said sum at the rate

of 8% per annum. Cathedral Foundation, Trust C is a

Catholic charitable trust, and is a part of the Cathclic

Foundation. As consideration for the assignment of such

manufacturing revenues Cathedral Foundation, Trust C on

September 30, 1966 paid to taxpayer the sum of $1,300,000.

(R. 29, 108, 110, 111, 167).

Pursuant to the terms of the Assignment of Manufac-

turing Revenues taxpayer was obliged to continue the op-

erations of the business in a good and workmanlike manner.

6

to cause the facilities to be maintained in a good state of

repair and in good operating condition, to pay all costs, lia-

bilities, expenses and taxes in connection with the opera-

tions, and to carry customary insurance coverage. (R. 167).

Cathedral Foundation, Trust C borrowed the funds with

which to make the $1,300,000 payment to taxpayer from

Texas Bank & Trust Company of Dallas, Texas (herein-

after called “Texas Bank”). During the period covered by

its taxable years ended September 30, 1966 and 1967 Texas

Bank was taxpayer's principal banking connection. Mon-

signor McGill decided to borrow the purchase price of the

manufacturing revenue payment from Texas Bank because

he was aware that it was taxpayer's principal banking con-

nection and considered that such would facilitate the bor-

rowing of the funds. (R. 29, 30, 113).

Cathedral Foundation, Trust C executed and delivered

to Texas Bank its note in the prircipal amount of

$1,300,000 bearing interest at the rate of 7% per annum.

Cathedral Foundation, Trust C also executed and delivered

to Texas Bank a Mortgage and Assignment securing the

payment of the note by which there was assigned as se-

curity for the loan certain contracts and contract rights,

and gross profits to be realized thereunder previous!y as-

signed by taxpayer to Cathedral Foundation, Trust C. (R.

29, 30, 176, 179).

The borrowing by Cathedral Foundation, Trust C was

negctiated for and on behalf of Cathedral Foundation,

Trust C by Monsignor McGill. (R. 28).

Upon receipt of the $1,300,000 payment from Cathedral

Foundation, Trust C taxpayer acquired from Texas Bank

three Certificates of Deposit, each bearing interest at 5%.

One Certificate for $150,000 was due on November 15, 1966,

another for $150,000 was due on December 15, 1966, and the

other for $1,000,000 became due on January 15, 1967. Each

of the three Certificates was issued in the name of tax-

payer and was left with Texas Bank in safekeeping. By

letter dated October 3, 1966, from taxpayer to Texas Bank

it was stated that:

7

“This will constitute our agreement with and instruc-

tion to you that the above described Certificates of

Deposit are to be retained in your possession until the

maturities stated individually therein, at which time we

will instruct you as to all or any part, thereof in one

of the following two alternatives only:

1. Cashed to our account for application on our

indebtedness, if any, due and owing to you at that

time.

2. Cashed for reinvestment in new Certificate

Deposits at your bank under similar terms and with

this same letter of instruction.”

(R. 31, 328).

Texas Bank requested that taxpayer pledge the Certifi-

cates as security for the loan to Cathedral Foundation,

Trust C. Taxpayer refused to do so. Texas Bank also re-

quested that the Certificates be issued in bearer form and

be so held by the Bank as security for the loan. Taxpaver

again refused to do so. (R. 64, 65).

Taxpayer did not guarantee or otherwise agree in any

way to be responsible for the payment by Cathedral Foun-

dation, Trust C of its obligation to Texas Bank. (R. 64, 65,

82, 88, 113, 131, 133).

During the period covered by its taxable years ended

September 30, .966 and 1967 taxpayer had a $1.5 million

line of credit (reduced by borrowings from any other bank)

at Texas Bank. On September 30, 1966 taxpayer owed

Texas Bank $675,000 and Mercantile National Bank at

Dallas $275,000. The funds received by taxpayer were used

to acquire Certificates of Deposit rather than pay off exist-

ing debt as an accommodation to Texas Bank. By doing

this, taxpayer felt it would improve its banking relationship

and substantially increase its line of credit with Texas Bank.

The Certificates of Deposit acted as compensating balances

and thereby freed up funds that would otherwise be in a

compensating balance. (R. 29, 89-91, 99).

Denesrepe gener ween? i akin

8

Cathedral Foundation, Trust C received the entire amount

of manufacturing revenues assigned to it by April 17, 1967.

In total it received $1,338,907.25. (R. 31, 187).

In its income tax return for its taxable year ended Sep-

tember 30, 1966 taxpayer reported as taxable income the

$1,300,000 received from Cathedral Foundation, Trust C.

(R. 188).

The dominant motive for the transaction with Cathedral

Foundation, Trust C was to offset the net operating loss

carryover that would otherwise expire. (R. 28, 29).

The Tax Court relied upon its earlier decision in -J. A.

Martin, 56 T.C. 1255 (1971), which was affirmed per curiam

(unofficially reported at 72-2 USTC ° 9637) by the Fifth

Circuit, and held that in substance the transaction consti-

tuted a loan by Texas Bank through Trust C to taxpayer.

Therefore, it was held that taxpayer did not realize income

upon the assignment to Trust C of the manufacturing reve-

nues. Before the Tax Court taxpayer agreed that the Martin

case involved substantially the same situation and issue

as taxpayer's case, but argued the decision in the Martin

case was wrong. The decision of the Tax Court was appealed

to the Fifth Circuit and such appeal was presented to the

Fifth Circuit upon the record and briefs on file. The Fifth

Circuit, without hearing oral argument, affirmed the decision

of the Tax Court in a per curiam decision.

REASONS FOR GRANTING THE WRIT

1. The Decision Below Conflicts With the Decision of

Another Court of Appeals.

The decision in this case is erroneous and directly conflicts

with the recent decision in Stranahan v. Commissioner, 472

F. 2d 867 (6th Cir. 1973), reversing 30 TCM 1078 (1971).

In order to see how the conflict has arisen, it is necessary

to summarize not only the decision in Stranahan, but also

the decision in J. A. Martin, supra. Each case was a Tax

Court decision of the issue in the case now before this Court,

9

involving whether the particular taxpayer effectively caused

to be realized income by an assignment of future income for

a consideration.

In the Stranahan case the taxpayer sold to his son $122,820

in anticipated stock dividends from common stocks owned

by the taxpayer for a consideration of $115,000. The assign-

ment was made by the taxpayer in an effort to realize

income to offset a large interest deduction arising in the

taxable year. The assignment of dividends was for so long

a period as was necessary to receive dividends of the agreed

amount, the company on whose stock the dividends were

assigned had a long and consistent record of paying divi-

dends, and the taxpayer and his son were familiar with the

dividend records of the company as shareholders and

employees.

In the Martin case the taxpayers, in order to offset cur-

rent year’s losses, assigned future rents to a trust in return

for consideration in the amount of $225,000 plus a sum

equal to 7% per annum computed from time to time on the

unpaid balance of the $225,000.

In each case the Tax Court concluded, using basically the

same legal reasoning, that in substance the particular trans-

action was a lending transaction and therefore the taxpayer

did not realize income upon receipt of the consideration.

The Tax Court decision in Martin was affirmed per curiam

by the Fifth Circuit. The Tax Court decision in Stranahan

was reversed by the Sixth Circuit.

The case now presented to this Court was decided by the

Tax Court after the Fifth Circuit affirmed Martin. Thus,

the Tax Court followed its decision in Martin.

In the Martin case the Tax Court stated at page 1259:

“A close look at the transaction reveals that the part-

nership retained, at all times, the ownership of the

apartment building and ‘assigned’ only a specified dollar

amount of future rents plus a specified interest on that

amount. The ‘assignment’ did not result in any substan-

tial change in the partnership’s dominion and control

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10

over the property and no indicia of ownership in the

apartment building were given to the Vannie Cook

Trusts. In fact, Castle Gardens, Ltd., continued to lease

the apartment building and collect the rents. Thus,

when he caused the ‘Assignment of Rents’ agreement to

be executed, J. A. Martin merely exercised, in advance,

his power to dispose of the income from the apartment

building. In other words, the partnership kept the ‘tree’

but claims to have assigned part of the ‘fruit.’ Under

these circumstances, where there has been no effective

separation of the ‘fruit’ from the ‘tree,’ the law clearly

taxes income when and as received. Income from prop-

erty is taxable to the owner of such property, and a

mere assignment of the right to receive such income is

not enough to relieve the assignor of the tax. Helver-

ing v. Horst, 311 U.S. 112 (1940); Arthur T. Galt, 19

T.C. 892 (1953), affd. 216 F. 2d 41, 46 (C.A. 7, 1954),

certiorari denied 348 U.S. 951; and Iber v. United States,

409 F. 2d 1273, 1276 (C.A. 7, 1969).”

Because of the reliance on Martin, the above language

enunciates the legal premise upon which the decision in the

case before this Court is based. The cases cited and the

reasoning stated reveal that the Tax Court treated the

Martin case and this case as if they involved donative as-

signments of income.

As seen from the following language by the Sixth Circuit,

the Tax Court in Stranahan relied on substantially the same

line of reasoning.

The Sixth Circuit reversed the Tax Court in Stranahan

stating:

“The Tax Court in its opinion relied on three cases.

In Fred W. Warner, 5 B.T.A. 963 (1926), which in-

volved an assignment by taxpayer to his wife of all

dividend income respecting his 12,500 shares of General

Motors Corporation stock, it was held the dividends

11

were income to the taxpayer and were not diverted to

the wife through the purported assignment. However,

this was a mere gratuitous assignment of income since

apparently the only consideration for the assignment

was ten dollars. Alfred LeBlanc, 7 B.T.A. 256 (1927),

involved a shareholder-father assigning dividends to his

son for as long as the son remained with the father’s

corporation. The Court held that in effect the father

postdated his assignment to the dates when he was to

receive dividends and hence the dividends were income

to the father. However, here again it is apparent that

at the time of the assignment there was no considera-

tion. In Trousdale v. Commissioner, 219 F. 2d 563 (9th

Cir. 1955), a taxpayer-partner attempted to convert

future ordinary income into capital by selling his part-

nership interest. The Ninth Circuit determined that

the sale of future partnership profits cannot be con-

verted to capital gain but must be considered ordinary

income. It is significant to note that the consideration

for the assignment was recognized as ordinary income

in the year the assignment was executed even though

several outstanding accounts were apparently not col-

lected in full until the following year.

“Hence the fact that valuable consideration was an

integral part of the transaction distinguishes this case

from those where the simple expedient of drawing up

legal papers and assigning income to others is used.

The Tax Court uses the celebrated metaphor of Justice

Holmes regarding the ‘fruit’ and the ‘tree’, and con-

cludes there has been no effective separation of the

fruit from the tree. Judge Cardozo’s comment that

‘[m]Jetaphors in law are to be narrowly watched, for

starting as devices to liberate thought, they end often

by enslaving it’ (Berkey v. Third Avenue Railway Co.,

244 N.Y. 84, 94 (1926)) is appropriate here, as the

genesis of the metaphor lies in a gratuitous transaction,

while the instant situation concerns a transaction for a

valuable consideration.”

pene Pro dt Wat al eLeaiind

12

Preceding this statement the Sixth Circuit also made the

following statements with respect to principles involved.

1. “A taxpayer who assigns future income for con-

sideration in a bona fide commercial transaction will or-

dinarily realize ordinary income in the year of receipt.

Commissioner v. P. G. Lake, Inc., 356 U.S. 260 (1958);

Hort v. Commissioners, 313 US. 28 (1941).”

2. “A taxpayer is free to arrange his financial affairs

to minimize his tax liability, thus the presence of tax

avoidance motives will not nulify an otherwise bona fide

transaction.”

In this case taxpayer assigned future manufacturing

revenues to Trust C for a full and valid cash consideration.

Between taxpayer and Trust C the risk of loss with respect

to whether Trust C would gain or lose on its investment

was borne by Trust C. In Stranahan the issue was the same

and the facts differed only in the type of income (future

dividends) which was assigned and the relationship of the

parties (father-son).

It is submitted that the decisions by the Sixth Circuit in

Stranahan and in the case now before this Court are directly

in conflict, that the decision by the Sixth Circuit in

Stranahan is correct, and that the decision below is wrong.

2. The Decision Below Conflicts With a Prior Decision

of this Court.

The decision by the Fifth Circuit is in conflict with

Commissioner v. P. G. Lake, Inc., 356 U.S. 260 (1958).

In Lake the question before this Court was whether the

assignment of an oil payment for a lump-sum consideration

was taxable as ordinary income or entitled to capital gain

treatment. In that case several transactions were involved.

Most involved the following basic situation: There was

assigned an oil payment right in a principal amount plus

an amount equal to interest at a designated rate per year on

13

the unpaid balance remaining from month to month. At

the time of assignment it could have been estimated with

reasonable accuracy when the assigned oil payment right

would pay out. Except for one of the transactions, a cash

consideration was received by the assignor which was equal

to the principal amount of the income to accrue during

the term of the assignment, the assignee being compensated

by interest on his advance.

This Court held the lump sum consideration was essenti-

ally a substitute for what would otherwise be received at

a future time as ordinary income. This Court stated that

the teaching of Helvering v. Horst, 311 U.S. 112 (1940),

applicable to the case before it, was that if one entitled

to receive at a future date interest on a bond or com-

pensation for services makes a grant of it by anticipatory

assignment, he realized taxable income as if he had collected

the interest or received the salary and then paid it over.

This Court then stated at page 267:

“As we stated in Helvering v. Horst, supra, at 117,

‘The taxpayer has equally enjoyed the fruits of his

labor or investment and obtained the satisfaction of

his desires whether he collects and uses the income

to procure those satisfactions, or whether he disposes

of his right to collect it as a means of procuring them.’

There the taxpayer detached interest coupons from

negotiable bonds and presented them as a gift to his

son. The interest when paid was held taxable to the

father. Here, even more clearly than there, the tax-

payer is converting future income into present income.”

The ultimate holding was that taxpayer received ordinary

income upon receipt of the lump sum payments.

The decision below rejects the “conversion of future in-

come into present income” concept established in Lake

and is therefore in conflict with Lake.

a

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14

CONCLUSION

For the foregoing reasons, a Writ of Certiorari should

issue to review the opinion and judgment of the Fifth

Circuit.

Respectfully submitted,

JOHN W. RUTLAND, JR.,

2300 Republic National Bank

Building,

Dallas, Texas 75201,

Counsel for Petitioner.

Of Counsel:

J. W. BULLION

Burorp P. BERRY

THOMPSON, KNIGHT,

Simmons & BULLION

2300 Republic National

Bank Building

Dallas, Texas 75201

APPENDIX A

1. Opinion — Fifth Circuit

In the

United States Court of Appeals

FOR THE FIFTH CIRCUIT

No. 73-2591

Summary Calendar*

HYDROMETALS, INC.,

Petitioner-Appellant,

VERSUS

COMMISSIONER OF INTERNAL REVENUE,

Respondent-Appellee.

Appeal from a Decision of the Tax Court of the

United States (Texas Case)

(November 9, 1973)

Before THORNBERRY, GOLDBERG and Roney, Circuit Judges.

Per Curiam: Upon consideration of the briefs and record,

we AFFIRM on the findings and opinion of the Tax Court.

*Rule 18, 5 Cir.; see Isbell Enterprises, Inc. v. Citizens Casualty

Company of New York, et al., 5 Cir. 1970, 431 F. 2d 409, Part I.

see GEN)

2. Judgment — Fifth Circuit

United States Court of Appeals

FOR THE FIFTH CIRCUIT

October Term, 1973

No. 73-2591

Summary Calendar

T.C. No. 5855-69

HyYpDROMETALS, INC.,

Petitioner-Appellant,

VERSUS

COMMISSIONER OF INTERNAL REVENUE,

Respondent-Appellee.

Appeal from a Decision of the Tax Court of the

United States (Texas Case)

Before THORNBERRY, GOLDBERG and Roney, Circuit Judges.

JUDGMENT

This cause came on to be heard on the transcript of the

record from the United States Tax Court, and was taken

under submission by the Court upon the record and briefs

on file, pursuant to Rule 18;

On CONSIDERATION WHEREOF, It is now here ordered and

adjudged by this Court that the decision of the United

States Tax Court be, and the same is hereby affirmed;

It is further ordered that petitioner-appellant pay to

respondent-appellee the costs on appeal to be taxed by the

Clerk of this Court.

November 9, 1973

Issued as Mandate:

APPENDIX B

1. Memorandum Opinion — Tax Court

T. C. Memo. 1972-254

United States Tax Court

HyYpDROMETALS, INC.,

Petitioner,

v.

CoMMISSIONER OF INTERNAL REVENUE,

Respondent.

Docket No. 5855-69.

Filed December 26, 1972.

J. W. BULLION and Burorp P. Berry, for the petitioner.

W. J. BLacksHEar, for the respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

Scott, Judge: Respondent determined a deficiency in peti-

tioner’s Federal income tax for the taxable vear ended

September 30, 1967 in the amount of $410,420.20.

Certain issues raised by the parties in their pleadings have

been resolved by agreement. The only remaining issue is

whether petitioner should have reported $1,300,000 it re-

ceived from sales in its fiscal year 1967 as taxable income in

that year, or properly included the amount in its fiscal year

1966 as the price received for an assignment of future manu-

facturing revenues under an agreement it entered into with

Cathedral Foundation, Trust C, a tax-exempt charitable

trust.

FINDINGS OF FACT

Some of the facts have been stipulated and are found

accordingly.

B-2

Hydrometals, Inc. (hereinafter referred to as petitioner)

was incorporated under the laws of the State of Illinois on

July 30, 1908. Petitioner’s principal place of business at the

time of the filing of the petition in this case was and at all

times since 1964 has been in Dallas, Texas.

Petitioner keeps its books and records and files its Federal

income tax returns on an accrual method of accounting.

Petitioner and its subsidiaries filed consolidated Federal

income tax returns for its fiscal years ended September 30,

1966, and September 30, 1967, with the district director of

internal revenue, Dallas, Texas.

Until 1961 petitioner was basically a producer and mar-

keter of zinc products through its Illinois Zinc Company

Division. In its year ended September 30, 1965, petitioner

disposed of this division. It is now a diversified manufac-

turer. Its stock is listed on the American Stock Exchange.

During the taxable year ended September 30, 1966, peti-

tioner’s operations were conducted through two subsidiaries

and six divisions. The operations of these subsidiaries and

divisions during that year were as follows:

(1) Hydrometals International has its headquarters at

Geneva, Switzerland, and is a subsidiary serving as an

international licenser for Hydro-T-Metal, an alloy developed

by petitioner. This product is patented in 37 countries.

(2) The Peru Mining Company is a subsidiary, the prin-

cipal asset of which is all of the stock in the Shannon

Mining Company. The Shannon mines at Gleeson, Arizona,

contain proven deposits of silver, copper, and sulphur.

Although these mines had not been worked for several years,

petitioner in 1966 was evaluating either (a) reactivating the

mines, due to rising prices of these materials, (b) selling the

properties, or (c) trading them for another manufacturing

company.

(3) Giller Tool Company became a wholly owned sub-

sidiary of petitioner in 1964, Petitioner liquidated this sub-

sidiary on September 30, 1965 and since that time its opera-

B-3

tions have been conducted by the Giller Tool Company

Division. This division sells electronic kits, survival kits,

safety equipment and tools, individually and in full kits,

to the United States Military, local governments, and to

private industry. Giller also manufactures wooden chests

and foot lockers. The major purchaser for the Giller Division

during the years 1966 and 1967 was the United States Gov-

ernment which purchased tools from this division on bid

contracts for use in Vietnam.

(4) The Hydrographic Division distributes lithographic

plates and chemicals to the printing trade.

(5) Lenfor Products Company is a division specializing in

the manufacture of precision replacement parts for auto-

motive transmissions.

(6) The Thomas Beckett Company was established in

1938, Petitioner acquired this company in 1962. This division

of petitioner's operations is one of the largest producers of

fractional horsepower pumps in the world, shipping over

280,000 units annually. This division is also a leading manu-

facturer of floats and prefabricated duct work for the air

conditioning industry. It also produces steel tool boxes.

(7) The Roney Company was acquired as a division of

petitioner in 1963. It manufactures high precision valves,

fittings, gauges and couplings. Much of Roney’s output

goes to the butane and propane gas industry. In 1965 Roney

perfected new valves for anhydrous ammonia fertilizer tanks

and began marketing a new line of cylinder valves for the

butane and propane gas industries, along with introducing a

new underwater air valve for scuba divers. Roney’s opera-

tions are reflected in the financial statements of the Beckett

Division.

(8) Utility Pump Company is operated as a division. This

division is a leading producer of plastic recirculating pumps

and float valves for the evaporative cooler industry and, like

Roney, the results of its operations are reflected in the finan-

cial statements of the Beckett Division.

FOC weit

B-4

During its taxable year ended September 30, 1967. peti-

ticner continued to conduct the operations it had conducted

during its 1966 year and also acquired the U. S. Brass Com-

pany. This company manufactures and sells plumbing valves,

flexible connectors and single lever faucets.

Petitioner had a net operating loss carryforward from its

taxable year ended September 30, 1961 of $1,928,557.59,

which loss unless utilized to offset income which would other-

wise be taxable, would expire during petitioner’s taxable vear

ending September 30, 1966.

The management of petitioner was aware of the possible

expiration of the loss carryover from petitioner’s fiscal vear

1961, and numerous discussions, including discussions with

representatives of its accounting firm, were had concerning a

method of utilizing the loss. Several methods of utilizing the

loss including the possible sale of real estate or the possible

acquisition of oil and gas properties or uranium properties

from which a payment in kind might be carved out and sold

were considered by petitioner’s management.

Petitioner’s accountants, Price Waterhouse & Co., advised

petitioner that it should sell future receipts and offset the

proceeds of the sale against the net operating loss carryover

which would otherwise expire. Petitioner decided to offer

for sale the revenues from two of its divisions, the Beckett

Division and the Giller Division which were petitioner’s

principal revenue-producing divisions in 1966 and 1967.

Petitioner approached several prospective purchasers of its

manufacturing revenues, one of which was the Cathedral

Foundation, Dallas, Texas. Petitioner’s officers were aware

that the Cathedral Foundation had acquired with borrowed

funds several oil interests in transactions involving carved

out oil payments. One of petitioner’s officers had on several

occasions been requested by the directors of the Cathedral

Foundation to consider the Foundation as a prospective

purchaser if petitioner should have occasion to enter into a

transaction similar to the oil transactions in which the Foun-

dation had participated. The officers of petitioner and the

B-5

director of the Cathedral Foundation discussed the assign-

ment by petitioner to the Foundation of $1,400,000 of manu-

facturing revenues for a discounted payment by the Founda-

tion of $1,300,000 and also discussed the assignment to the

Foundation of $1,300,000 of manufacturing revenues plus

an additional amount of revenues equal to interest at a

specified rate on the unliquidated balance of the principal

sum.

Petitioner had prepared and presented to the Cathedral

Foundation projections of expected revenues from its Beckett

and Giller Divisions. These projections were examined by

the executive director and attorneys for the Cathedral Foun-

dation and were reviewed by the Board of the Cathedral

Foundation. The projections reflected that under the terms

of petitioner’s proposal to the Cathedral Foundation, the

Foundation would receive $1,300,000 of manufacturing rev-

enues together with an amount equal to 8 percent of the

unliquidated balance in approximately 11 or 12 months.

On September 30, 1966, petitioner and Cathedral Founda-

tion, Trust C (hereinafter referred to as Trust C), a Catholic

charitable trust, executed an instrument entitled, “Assign-

ment of Manufacturing Revenues.” On the same day peti-

tioner also executed and delivered to Trust C, an instrument

called an Assignment (hereinafter referred to as the Assign-

ment).

The “Assignment of Manufacturing Revenues” executed

by petitioner (referred to as the Seller) and Trust C (re-

ferred to as the Buyer) provided in part as follows:

3. Assignment. Seller, for and in consideration of the

sum of $1,300,000.00 cash to it in hand paid by Buyer.

receipt of which is hereby acknowledged, hereby sells,

transfers, assigns and sets over to Buyer seventy percent

(70% ) of all Manufacturing Revenues [from its Beckett

and Giller Divisions], as herein defined, that accrue to

Seller after the Effective Date; subject, however, to the

terms, provisions and limitations hereinafter set forth.

14 OLN

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— PERLE IT POR ROMS LIAS

B-6

4. Duration of Manufacturing Revenue Payment. This

Assignment shall remain in force until such time as

Buyer shall have received and realized from Assigned

Manufacturing Revenues actually received by Buyer

after the Effective Date the full aggregate sum of the

following amounts:

(a) The sum of $1,300,000.00; plus

(b) An amount computed (on the basis of a

365 day year) from the date hereof on the unliqui-

dated balance of the Primary Sum at the rate of

eight percent (8%) per annum, the first such

computation to be made on November 15, 1966 and

subsequent computations to be made on each Ap-

plication Date thereafter.

5. Application of Assigned Manufacturing Revenues.

All Assigned Manufacturing Revenues in the hands of

Buyer on the day preceding any Application Date shall

on such Application Date be applied, first, to the

amount provided for in Section 4(b) above to the extent

accrued to such Application Date, and, second, to the

reduction of the unliquidated balance of the Primary

Sum.

x * = x =

8. Covenants of Seller. Seller covenants and agrees

with Buyer that until the Manufacturing Revenue Pay-

ment has been fully liquidated and discharged,

(a) Seller will cause its business to be continu-

ously operated and maintained in good and work-

manlike manner and in accordance with all gen-

erally approved practices in the industry and in

strict conformity with all applicable federal, state

and local laws, rules and regulations and will use

its best efforts not only to maintain Manufacturing

Revenues at their present level but to increase

Manufacturing Revenues in the future;

(b) Seller will cause its facilities to be continu-

ously maintained in a good state of repair and to

be kept in good and effective operating condition

and all repairs, removals, replacements, additions

and improvements thereof or thereto needful to

such end to be promptly made and any required

easements or right of ways to be obtained, whether

by purchase, condemnation or otherwise;

«x x x * *

(f) Seller will not assign, encumber or otherwise

commit any Manufacturing Revenues or take any

action or incur any obligation which will impair the

ability of Seller to maintain and carry on its busi-

ness and timely pay and discharge its obligations

and liabilities out of Manufacturing Revenues not

included in Assigned Manufacturing Revenues:

* * * x *

9. Liability for Discharge. Buyer shall look solely to

Assigned Manufacturing Revenues for liquidation and

discharge of the Manufacturing Revenue Payment and

Seller shall not be personally liable for the payment

thereof; provided, however, nothing herein contained

shall relieve Seller of its obligation to respond in dam-

ages for any breach of any representation, warranty,

covenant, agreement or obligation herein contained or

arising hereunder.

On September 30, 1966, at the time petitioner executed the

“Assignment of Manufacturing Revenues” and the Assign-

ment, Trust C paid to petitioner the sum of $1,300,000 in

cash.

Trust C borrowed all of the funds with which to make

the $1,300,000 payment to petitioner from Texas Bank &

Trust Company (hereinafter referred to as Texas Bank).

Texas Bank is a large state bank doing a full service bank-

ing business in Dallas, Texas.

Trust C received the $1,300,000 from Texas Bank on

September 30, 1966, at which time Trust C executed and

delivered to Texas Bank its note due on or before one

year from date in the principal amount of $1,300,000 bear-

ing interest at the rate of 7 percent per annum. During

Pe a OR a ote ho | |

TUOAIMEEET™

ass Lah eta

B-8

petitioner’s fiscal vears 1966 and 1967 Texas Bank was

petitioner’s principal banking connection.

Payment of the note executed by Trust C was secured

by an instrument entitled, “Mortgage and Assignment”

executed and delivered to Texas Bank on September 30,

1966. The instrument mortgaged and assigned to Texas

Bank the right, title and interest of Trust C in the Assign-

ment made to it by petitioner, which Assignment was

attached as “Exhibit A” to the “Mortgage and Assign-

ment.”

The transaction between petitioner and Trust C and

the transaction between Trust C and Texas Bank were

closed on September 30, 1966, at the offices of Texas Bank.

Prior to the closing, representatives of petitioner, Trust C,

and Texas Bank had approved the form of the “Assign-

ment of Manufacturing Revenues” and the instrument

called an Assignment. The instrument referred to as an

Assignment was prepared at the primary insistence of

counsel for the Texas Bank as he thought it added to

the collateral value of the “Assignment of Manufacturing

Revenues.” At the same time, representatives of Trust C

and Texas Bank approved the “Mortgage and Assignment”

executed by Trust C. No representative of petitioner was

ever consulted with reference to the “Mortgage and Assign-

ment” executed by Trust C.

Petitioner’s dominant motive for the transaction with

Trust C was to generate income in its fiscal year 1966

to offset its net operating loss carryover that would other-

wise expire.

At the closing on September 30, 1966, at the offices of

Texas Bank at which representatives of petitioner, Trust C,

and Texas Bank were present, petitioner executed and

delivered the “Assignment of Manufacturing Revenues”

and the Assignment to Trust C. Trust C then executed

and delivered the “Mortgage and Assignment” to the Texas

Bank. Texas Bank then concurrently deposited $1,300,000

in the account of Trust C and pursuant to instructions

B-9

from Trust C, Texas Bank debited the account of Trust C

with $1,300,000 and credited a deposit of $1,300,000 into

the checking account of petitioner with Texas Bank.

During its fiscal years ended September 30, 1966, and

September 30, 1967, petitioner had a line of credit of

$1,500,000 (reduced by borrowings from any other bank)

with Texas Bank. On September 30, 1966, petitioner owed

Texas Bank $675,000 and Mercantile National Bank of

Dallas $275,000. At the time Trust C commenced negotia-

tions with Texas Bank for a loan on the security of the

Assignment of Manufacturing Revenues made by petitioner

to Trust C, it was aware that Texas Bank was petitioner’s

principal banking connection.

Pursuant to a representation made by petitioner to Texas

Bank at the closing on September 30, 1966, petitioner, on

October 3, 1966, purchased from Texas Bank three certifi-

cates of deposit each bearing interest at 5 percent and

aggregating $1,300,000. One certificate for $150,000 was

due on November 15, 1966, another for $150,000 was due

on December 15, 1966, and the other for $1,000,000 became

due on January 15, 1967. The three certificates were all

issued in petitioner’s name. Petitioner left them with Texas

Bank and Texas Bank issued to petitioner its customary

safekeeping receipt.

The minutes of the Senior Loan Committee of Texas

Bank, dated October 4, 1966, contain the following dis-

cussion concerning the loan of $1,300,000 to Cathedral

Foundation Trust C:

This request for new money is to discount a gross

pront payment purchased, by Cathedral Foundation

Trust C, from Hydrometals, Inc. This ABC trans-

action is secured by assignment of 70% of the gross

profits of Hydrometals, Inc. to Cathedral Foundation

Trust C. In addition we are to receive a negative

pledge agreement on $1,300,000.00 C/D at 5%, and

held in safe keeping. In addition, we are to receive an

assignment of the proceeds under government contract

B-10

work if assignable, and if not an assignment of non-

government contract proceeds in sufficient amount to

collateralize this loan. Profitability on this line has

been computed at 1.10%.

APPROVED.

A letter from petitioner to Texas Bank, dated October 3,

1966, contains the following statement:

This will constitute our agreement with and instruc-

tion to you that the above described Certificates of

Deposit are to be retained in your possession until

the maturities stated individually therein, at which time

we will instruct you as to all or any part, thereof in

one of the following two alternatives only:

1. Cashed to our account for application on our

indebtedness, if any, due and owing to you at that

time.

2. Cashed for reinvestment in new Certificate

Deposits at your bank under similar terms and

with this same letter of instruction.

Petitioner paid, and Trust C received, all of the moneys

it was entitled to receive under the provisions of the

“Assignment of Manufacturing Reserves.” The final pay-

ment was made on April 17, 1967, at which time Trust C

had received $1,338,907.25 representing the total primary

sum of $1,300,000 and an additional amount of $38,907.25.

On its Federal income tax return for its taxable year

ended September 30, 1966, petitioner reported as taxable

income the sum of $1,300,000 received from Trust C. On its

return for its fiscal year 1966 it showed a taxable income

before net operating loss deduction of $2,059,876.72, a net

operating loss deduction of $3,308,771.10 and under “tax-

able income” showed a loss of $1,248,894.38.

Petitioner on its Federal income tax return for its fiscal

year ended September 30, 1967, did not include in its gross

B-11

receipts the $1,300,000 paid to Trust C under the “Assign-

ment of Manufacturing Revenues.” Respondent in his

notice of deficiency for petitioner’s fiscal year 1967 increased

petitioner’s income as reported by $1,300,000 with the ex-

planation that petitioner had erroneously omitted this

amount “of gross manufacturing income which was produced

and realized in this year, but which was erroneously treated

as income of the taxable year ended September 30, 1966.”

OPINION

Petitioner takes the position that its assignment of

manufacturing revenues to Trust C was in both form and

substance a sale for a consideration of $1,300,000. Respond-

ent, on the other hand, contends that the transaction

between petitioner and Trust C was merely an attempt

by petitioner to assign future income and that petitioner

must in computing its taxable income include this income

in 1967 when the manufactured goods were sold. Respond-

ent states that the transaction between petitioner and

Trust C was in the nature of a loan by the Texas Bank

through Trust C to petitioner bearing interest at 8 per-

cent, the loan to be repaid by an assignment of manufactur-

ing revenues.

Both parties cite the case of J. A. Martin, 56 T.C. 1255

(1971), affirmed per curiam, F.2d (C.A. 5, Aug. 18,

1972). At the time the parties filed their briefs in this case,

the United States Court of Appeals for the Fifth Circuit

had not rendered its opinion in the Martin case.

The taxpayers in the Martin case were members of a

partnership which owned an apartment building from which

it received rental income. The taxpayers were also members

of another partnership which during the year 1966 sustained

large losses. In order to reduce their Federal income tax,

the taxpayers had the partnership which owned the apart-

ment building enter into an agreement as of December 27,

1966, to assign rents to be received in the following year

to a trust in return for an advance of $225,000 from the

B-12

trust to the partnership. The amount of the advance, with

a secondary sum of 7 percent of the unpaid balance of

the primary sum, was to be returned to the trust in the

following year or years solely from the assigned rents.

The taxpayers in the Martin case contended that the

$225,000 constituted proceeds from the sale in the year

1966 of rents to be received by the partnership and that

the $225,000 was properly includable in the partnership

income in 1966, whereas the Commissioner argued that

the transaction was in substance a loan to the partnership

and that the partnership received the rental income in

1967 and paid it over in discharge of the loan. We held

that in substance the transaction constituted a loan. We

pointed out that in effect the partnership merely exercised

in advance its power to dispose of the income from the

apartment building, and that the cases relied on by the

taxpayer including the case of Commissioner v. P. G. Lake,

Inc., 356 U.S. 260 (1958), were inapposite to the trans-

action there involved.

There is no substantive distinction between the situation

involved in J. A. Martin, supra, and that involved in the

instant case. In fact, petitioner does not contend that

there is any substantive distinction in fact or in law in

J. A. Martin, supra, and the instant case, but rather con-

tends that our decision in Martin is incorrect and should

not be followed. The Martin case has now been affirmed by

the United States Court of Appeals for the Fifth Circuit, the

Circuit to which an appeal in this case would lie. We are

therefore required in this case to follow our holding in

J. A. Martin, supra, as affirmed by the Fifth Circuit. See

Jack E. Golsen, 54 T.C. 742 (1970), affirmed 445 F. 2d 985

(C.A. 10, 1971).

However, in our view, our holding in J. A. Martin, supra, is

correct and for that reason should be followed in this case.

We hold in this case that the transaction between petitioner

and Trust C was in substance merely a loan by the Texas

Bank through Trust C to petitioner with repayment to be

from 70 percent of the manufacturing revenues from peti-

‘

i

&

B-13

tioner’s Beckett and Giller Divisions. Trust C did not “buy”

a property which it could retain and which might fluctuate

in value. All that Trust C acquired was the right to be repaid

$1,300,000 with interest at 8 percent, which $1,300,000 it had

in form borrowed from Texas Bank at 7 percent interest and

had deposited in petitioner’s bank account. Texas Bank was

to be repaid by Trust C as Trust C was repaid through the

assigned manufacturing revenues.

Petitioner argues that it in no way guaranteed the repay-

ment of Trust C’s lean to Texas Bank. In our view the facts

do not support this contention of petitioner. Petitioner left

for safekeeping with Texas Bank certificates of deposit for

$1,300,000 which it had purchased with proceeds it received

from the loan made by Texas Bank to Trust C. There was

in effect an agreement between petitioner and the bank that

these certificates would be maintained until Trust C had

repaid the $1,300,000 to Texas Bank. Furthermore. con-

sidering the nature and type of sales made by petitioner’s

Beckett and Giller Divisions, the assignment of 70 percent

of these sales was substantial collateral for the loan of Texas

Bank to Trust C. Under the facts shown in this record there

existed no real possibility of a failure of sufficient amounts

from the assigned manufacturing revenues to make the

$1,300,000 repayment to Texas Bank.

Sun Properties v. United States, 220 F. 2d 171 (C.A. 5,

1955), relied on by petitioner involved a bona fide sale and

therefore has no relevance to the instant case which involves

a transaction which in our view is not in substance a sale.

Cf. Bryant v. Commissioner, 399 F. 2d 800 (C.A. 5, 1968),

affirming 46 T.C. 848 (1966). Because of certain issues hav-

ing been disposed of by agreement of the parties,

Decision will be entered under Rule 50.

STL RY RE LONROTE

Pee cities ia rian ak oh. Cha nfo okuleiacs A A ac a a a “4

SARIN RET ES aD StI A IY TMT ES

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B-14

In the

Supreme Court of the United States

OCTOBER TERM, 1973

No.

HYDROMETALS, INC.,

Petitioner,

Vv.

CoMMISSIONER OF INTERNAL REVENUE,

Respondent.

CERTIFICATE OF SERVICE

/

I hereby certify that on this. 3/07 day of E

1974, four copies of the Petition for a Writ of @ertiorari wef#e

mailed by air mail, postage prepaid, to the Solicitor ar wef

Department of Justice, Washington, D. C. 20530 and on the

same day two copies of said Petition were mailed by air mail,

postage prepaid, to Scott P. Crampton, Esquire, Assistant

Attorney General, Tax Division, United States Department

of Justice, Washington, D. C. 20530. I further certify that

all parties required to be served have been served.

JOHN W. RuTLAND, Jr.,

2300 Republic National Bank

Building,

Dallas, Texas 75201,

Counsel for Petitioner.