# Petition for Writ of Certiorari — Hempt Bros. v. United States

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Petition for Writ of Certiorari
- **Published:** January 1, 1974
- **Citation:** 419 U.S. 826

## Text

S| APR 1
Supreme Court of the United staia¢:*

——

October Term, 1973

No 73- 1523

HEMPT BROS., INC.., Petitioner
vz.

UNITED STATES OF AMERICA, Respondent

PETITION OF HEMPT BROS., INC.
FOR A WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF
APPEALS FOR THE THIRD CIRCUIT

Sheldon M. Bonovitz
John F. Fansmith, Jr.
DUANE, MORRIS & HECKSCHER

Attorneys for Petitioner

1600 Land Title Building
100 South Broad Street

Philadelphia, Pa. 19110

TWE LEG/1 IN7ZLLIGENCER, OS NORTH JUNIPER STREET, PHILA, PA. 19167

ja erga
Bete oO

TABLE OF CONTENTS

Page
Opinions I aside Geos Wc am Oe oo eek 1
SN cei occ cir eet tase sate dh bess oie s 2
Statutes Involved in the Case .................---- 2
ND ae RS cea s Cie nev aw es 3
oo eee kes eaetsenedeu sd 4
IN a im re rei claws e man enees 4
I IN ig ec evi had ote ew ke
ere ere 7
Court of Appeais Decision ...............-.-- 7
Reasons for Granting the Writ ................ 8

Assignment of income doctrine—Under the
assignment of income doctrine one
cannot dispose of his right to receive
ordinary income and thus avoid being

OR INTE 5. n.5 5s hns ganas Reet ere 8
Section 351—Neither the provisions of Sec-
tion 351 nor its legislative history pre-
clude an application of the assignment
of income doctrine ................. 10
The assignment of income doctrine applies
to Section 351 transferors ............ 14
Conia 5... 5. o4ccua eee cee ae er eee 18
Appendix
Memorandum Decision of the United States Dis-
trict Court fer the Middle istrict vf Pennsyl-
OE Tao cecxe os eases v ns esa peneseeeres 19
Clic Tine: TE BEE oon eos ch es por ecseee 37
pe err rapes peed Pe" 38
i

TABLE OF CONTENTS—(Continued)

Page
Opinion of the United States Court of Appeals
for the Third Circuit ».. 2.2.0.0... cece cceeees 39
DE 0064 day Wain Rew Bodh nee hee an ees 59
TABLE OF CITATIONS
Cases Cited:
Alderman, Velma W., 55 T.C. 662 (1971) ......... a
Bongiovanni v. Commissioner, 470 F.2d 921 (2d Cir.
ME in hodinattint «ates Ri aes reek kar ones 12
Bongiovanni, John P., 30 T.C. Memo. 1124(1971).... 12
Briggs, Thomas W., 15 T.C. Memo. 440 (1956) ....... 17
Burnet v. Leininger, 285 U.S. 136 (1932) ............ 8
Burnet v. Wells, 289 U.S. 670 (1933) ............... 8

Commissioner v. Culbertson, 337 U.S. 733 (1949) .... 4,8
Commissioner v. P. G. Lake, Inc., 356 U.S. 260

SN gh ons cab 24 a Kee a eR 4,8, 9, 10,17, 18
Commissioner v. Sunnen, 333 U.S. 591 (1948) ....... 8
Commissioner v. Tower, 327 U.S. 280 (1946) ........ S
Corliss v. Bowers, 281 U.S. 376 (1930) .............. S
Dearborn Gage Co., 48 T.C. 190 (1967) ............. 12
Divine v. U.S., 622 U.S.T.C. $9632 (W.D. Tenn.
DE oon BUaek ave Mew itke o's Faatha 15, 17
Douglas v. Willcuts, 296 U.S. 1(1935) .............. s
Ezo Products Co., 37 T.C. 385 (1961) ............... 12
Foster, T. J., 25 T.C. Memo. 1390 (1966) ............ 12
Harrison v. Schaffner, 312 U.S. 579 (1941) .......... 8
ii

RR CRRA, requires attribution of ordi-
nary income to the partnership at the time of the exchange;
that the assignment-of-income doctrine requires its prede-

3. Hereinafter “Commissioner.”

4. The parties agree that the Commissioner's determinaiion
was proper.

5. 1958, 356 U.S. 260 78 S.Ct. 691, 2 L.Ed. 2d 743. In Lake,
it was held that the transfer of an income interest in !and, ¢.g., a
carved-out oil payment, in exchange for consideration equivalent to
the present value of future payments derivable therefrom constituted
ordinary income to the transferor and not capital gain. It was also
decided that a similar assignment in return for an interest in real
estate was not a like-kind exchange.

bedatr

22

cessor to recognize income as amounts are collected by
plaintiff; that attribution of collections to plaintiff is im-
proper because inconsistent with its accrual method of ac-
counting; and that the individual partners should be re-
sponsible for the accounts receivable because the amount
of plaintiffs stock which each partner received was allo-
cated pursuant to proportional interests in the partner-
ship's capital account rather than with reference to indi-
vidual shares in transferred income items. These points
will be discussed seriatim.

The meaning of “property” is not defined by Section
351; however, known inclusions and exclusions suggest
that the term encompasses whatever may be transferred,®
including accounts receivable. Burke, Section 351: The
Beginning of Life in Subchapter C, 1970, 24 Sw.L.J. 742.
747-48; see Bongiovanni v. Commissioner, 470 F.2d 921
(2 Cir., filed Dec. 11, 1972); P. A. Birren & Son, Inc. v.
Commissioner, 7 Cir. 1940, 116 F.2d 718; Peter Raich,
1966, 46 T.C. 604; Pittsfield Coal & Oil Company, Incor-
porated, 1966, 25 CCH Tax Ct. Mem. 11; Arthur L. Kniffen,
1962, 39 T.C. 553; Ezo Products Company, 1961, 37 T.C.
385; Thomas W. Briggs, 1956, 15 CCH Tax Ct. Mem. 440;
Wobbers, Incorporated, 1932, 26 B.T.A. 322; Charles F.
Meagher, 1930, 20 B.T.A. 68; cf. Halliburton v. Commis-
sioner, 9 Cir. 1935, 78 F.2d 265, 268-270; American Ban-
tam Car Company, 11 T.C. 397, 403, aff'd per curiam, 3
Cir. 1949, 177 F.2d 513, cert. denied, 1950, 329 U.S. 920,
70 S.Ct. 622, 94 L.Ed. 1344. But see Merchants Bank Bldg.
Co. v. Helvering, 8 Cir. 1936, 84 F.2d 478, 481; Note, Sec-
tion 351 of the Internal Revenue Code and “Mid-Stream”
Incorporations, 1969, 38 U.-Cin.L.Rev. 96, 106-07. There is
a compelling reason to construe “property” to include
potential income items: a new corporation needs working
capital, and accounts receivable can be an important
source of liquidity. Cf. Halliburton v. Commissioner, 9 Cir.
1935, 78 F.2d 265, 269-70; Bittker, The Corporation and
the Federal Income Tax: Transfers to a Controlled Corpo-
ration, 1959 Wash. U.L.Q. 1,7.

6. H. B. Zachry Company, 1967, 49 T.C. 73, 80 n. 6.

23

Lake is not on point because it does not involve the
issue of income recognition upon the exchange of an item of
potential income for stock in a controlled corporation. H. B.
Zachry Company, 1967, 49 T.C. 73, 79-80. As the legisla-
tive history of a predecessor to Section 3517 makes clear,*
the purpose of the provision is to facilitate movement into
the corporate form by preventing immediate recognition
of gain or loss when there has been a mere change in the
form of ownership. Helvering v. Cement Investors, Inc.,
1942, 316 U.S. 527, 533, 62 S.Ct. 1125, 86 L.Ed. 1649;
Bongiovanni v. Commissioner, 470 F.2d 921 (2 Cir., filed
Dec. 11, 1972); Estate of Walling v. Commissioner, 3 Cir.
1967, 373 F.2d 190, 194; Mather & Co. v. Commissioner,
3 Cir., 171 F.2d 864, cert. denied, 1949, 337 U.S. 907, 69
S.Ct. 1049, 93 L.Ed. 1719; Portland Oil Co. v. Commis-
sioner, 1 Cir., 109 F.2d 479, 488, cert. denied, 1940, 310
U.S. 650, 60 S.Ct. 1100, 84 L.Ed. 1416. Therefore, when a
cash-method taxpayer transfers accounts receivable to a
controlled corporation solely in exchange for securities
therein, the recognition of any gain realized upon the ex-
change is deferred. Arthur L. Kniffen, 1962, 39 T.C. 553;
Charles F. Meagher, 1930, 20 B.T.A. 68. This best com- ©
ports with the policy of Section 351. Dauber, Accounts

7. Int. Rev. Code of 1921, ch. 136, Section 202(c)(3), 42 Stat.
230.

8. S.Rep. No. 275, 67th Cong., Ist Sess. 11 (1921):

“Section 202 (subdivision c) provides new rules for these ex-
changes or ‘trades’ in which, although a technical ‘gain’ may be real-
ized under the present law, the taxpayer actually realizes no cash
profit. . . . The existing law makes a presumption in favor of
taxation. The proposed act modifies that presumption by providing
. . . certain classes of exchanges on which no gain or loss is recog-
nized even if the property received in exchange has a readily realiz-
able market value. These classes comprise the cases . . . where an
individual or individuals transfer property to a corporation and after
such transfer are in control of such corporation.

“The preceding amendments, if adopted, will, by removing a
source of grave uncertainty and by eliminating many technical
constructions which are economically unsound, . . . permit busi-
ness to go forward with the readjustments required by existing
conditions. .. .”

24

Receivable in Section 351 Transactions, 1966, 52 A.B.A.J.
92; Hickman, Incorporation and Capitalization, 1962, 40
Taxes 974, 979; Riebesehl, Tax-Free Incorporations Under
Section 351, 1968, 46 Taxes 360.

However, the question of non-recognition upon the ex-
change itself is distinct from the issue whether the partner-
ship or the corporation is taxable when collections upon
transferred receivables are made. H. B. Zachry Company,
1967, 49 T.C. 73, 80n. 5. Plaintiff contends that such
amounts are properly attribuiabie to its predecessor at the
time cf cuiiection because the partnership performed all
the services upon which the right to paying depends.®

There is a tension which inheres in Section 351: al-
though its animating concept is that of a mere change in
form of ownership, the act of incorporation yields an
entity distinct from its predecessor which may inde-
pendently select many of its characteristics, e.g., its ac-
counting period and its methods of accounting, depreci-
ation and inventory valuation. White, Sleepers That Travel
With Section 351 Transfers, 1970, 56 Va.L.Rev. 37. There-
fore, it would be erroneous to assume that the assignment-
of-income doctrine is necessarily inapplicable. Biblin, As-
signments of Income in Connection with Incorporating
and Liquidating Corporations, 1969, 21 U.So.Cal.Tax Inst.
383, 385-87. However, for reasons to be enumerated, the
court holds that Hempt Bros., Inc. is properly taxable upon
collections made with respect to accounts receivable which
have been transferred to it in conjunction with the Section
351 incorporation of a going business by a cash-method
partnership for a legitimate business purpose.

9. See, e.g., Lucas v. Earl, 1930, 281 U.S. 111, 50 S.Ct. 241, 74
L.Ed. 731. The assignment-of-income doctrine is a common-law
acknowledgment that the dominant purpose of the revenue laws is
the taxation of income to those who earn it or who otherwise create
the right to receive and to enjoy the benefit of it when paid, rather
than to tax a mere collector or conduit through whom income passes.
Helvering v. Horst, 1940, 311 U.S. 112, 119, 61 S.Ct. 144, 85 L.Ed.
75.

25

The market value of the receivables notwithstanding,
they had a basis of zero to the partnership because no
collections were made prior to the transfer. Bongiovanni v.
Commissioner, 470 F.2d 921 (2 Cir., fiied Dec. 11, 1972);
P. A. Birren & Son, Inc. v. Commissioner, 7 Cir. 1940, 116
F.2d 718, 720 [26 AFTR 197]; Peter Raich, 1966, 46 T.C.
604, 610; Note, Section 357(c) and the Cash Basis Taxpayer,
1967, 115 U.Pa.L.Rev. 1154, 1165. Since the exchange was
solely for stock, plaintiff ’s carryover basis was also zero.
Int.Rev.Code of 1954, Section 362(a), as construed in, e.g.,
Ezo Products Company, 1961, 37 T.C. 385, 392-93. Upon
collection, plaintiff realized income which it must recog-
nize to the extent that the amounts received exceed basis.
P. A. Birren & Son, Inc. v. Commissioner, 7 Cir. 1940, 116
F.2d 718, 720; Thomas W. Briggs, [956,086 P-H Memo
TC] 1956, 15 CCH Tax Ct. Mem. 440; accord, Divine v.
United States, W.D. Tenn. 1962, 62-2 U.S. Tax Cas. 85,589;
Sohmer & Co., Inc. v. United States, S.D.N.Y. 1949, 86 F.
Supp. 670, 671; Wobbers, Incorporated, 1932, 26 B.T.A.
322; see Pittsfield Coal & Oil Company Incorporated, 1966,
25 CCH Tax Ct. Mem. 11.

This result facilitates the basic policy of Section 351.'°
Arent, Reallocation of Income and Expenses in Connection

10. In general, cases which have attributed income to the trans-
feror involve circumstances not present in the record before the
» court:

Commissioner v. Griffiths, 7 Cir., 103 F.2d 110, aff'd, 1939,
308 U.S. 355, 60 S.Ct. 277, 84 L.Ed. 319, is a case in which the tax-
payer devised an intricate tax-avoidance scheme to use a controlled
corporation as a conduit to defer immediate recognition of amounts
paid in settlement of a claim.

In Brown v. Commissioner, 2 Cir. 1940, 115 F.2d 337, the
taxpayer personally received payment which he then endorsed to the
corporation. In addition, the court found the corporation to be a sham
the sole purpose of which was tax avoidance.

Clinton Davidson, 1941, 43 B.T.A. 576, held that a life insur-
ance broker who transferred his going business to a controlled
corporation whose agent he then became for the purpose of procur-
ing insurance contracts was personally taxable on commissions
generated by such contracts because he had earned them; the con-

26

with Formation and Liquidation of Corporations, 1962, 40
Taxes 995, 996; Biblin, supra, at 407; Burke, supra, at 795;
Hickman, supra, at 977-83; White, supra, at 46; Worthy,
IRS Chief Counsel Outlines What Lies Ahead for Profes-
sional Corporations, 1970, 32 J. Tax. 88, 90. But see Note,
38 U.Cin.L. Rev., supra, at 112-13. Moreover, it is es-
pecially apposite because the partnership operated a busi-

Note 10—Continued

tracts were treated as his business; he and not the corporation was
licensed as an insurance broker; insurance companies, as a general
rule, decline to appoint corporations as agents; and Davidson per-
sonally received payment which he then endorsed to the corpora-
tion

Adolph Weinberg, 1965, 44 T.C. 233, aff 'd per curiam sub nom.
Commissioner v. Sugar Daddy, Inc., 9 Cir. 1967, 386 F.2d 836, cert.
denied, 1968, 392 U.S. 929, 88 S.Ct. 2282, 20 L.Ed.2d 1388,
involves a cash-method transferor who directed his obligors to deposit
proceeds due him from the sale of crops into the accounts of a number
of controlled corporations. The court found the transferor taxable with
respect to such proceeds because he had performed all services upon
which the right to collection depended and because no plausible
business purpose was shown for the existence of the corporations
except as shells or conduits for sales proceeds. The foregoing cases
illustrate, inter alia, the principle that income will not be shifted to
the transferee if it appears that the exchange was motivated primarily
by tax avoidance rather than being made for a legitimate business
purpose. This requirement will not be found in the language of
Section 351, but it appears to be fundamental to the provision. 3
Mertens, Law of Federal Income Taxation Section 20.46 at 127-33;
see Blanc, The Tax Treatment of Reserves Upon a Change in the
Form of Doing Business, 1967, 19 U.So.Cal. Tax Inst. 433, 474 n.
108; Lyon and Eustice, Assignment of Income: Fruit and Tree as
Irrigated by the P. G. Lake Case, 1962, 17 Tax L.Rev. 293, 425-26.
Weinberg is troublesome because its language implies that the
assignment-of-income doctrine might apply regardless of whether
the primary purpose of the transfer is tax avoidance. Nevertheless,
this court believes that Weinberg is properly limited to its facts. See
Biblin, supra, at 391-94. Since both parties agree that Hempt Bros.,
Inc. received the assets of its predecessor in an exchange made for
a legitimate business purpose in which tax avoidance played no
part, attribution pursuant to the assignment-of-income doctrine is

improper.

PASI SRG LE Be, GI LP LL ETE PEL TOO WE ig OF RINE ony YK PEND TSA CET PORTLET DOD CR LEDS LLY OLIN TE AO IRS ae NTA INE TN yey PLT

27

ness in which expenses were paid and income was earned
in the accounting period prior to that in which collections
were made and income was realized. Under these circum-
stances, taxation to the partnership would deter incorpora-
tion by generating a significant amount of taxable income
for which there might be no off-setting deductions: Match-
ing expenses of post-incorporation collections would already
have been deducted, and expenses subsequent to incorpo-
ration would be deductible by the transferee. Weiss, Prob-
lems in the Tax-free Incorporation of a Business, 1966, 41
Indiana L.J. 666, 681 & n.65. In addition, it seems anoma-
lous to require the partnership to account for income which
it never received and to which it cannot gain access with-
out the declaration of a taxable dividend. Biblin, supra, at
408; Burke, supra, at 795; Tritt and Spencer, Current Tax
Problems in Incorporation of a Going Business, 1958, 10
U.So.Cal.Tax Inst. 71, 95.
In support of its contention, plaintiff relies upon the
persuasive force of the application of the assignment-of-
income doctrine to transactions the tax consequences of
which are regulated by Section 311,'! Section 336'* and

11. Int. Rev. Code of 1954, Section 311. The legislative history
of the provision makes explicit that it is not intended to alter the
principle enunciated in Commissioner v. First State Bank of Stratford,
5 Cir. 1948, 168 F.2d 1004, viz., that the assignment-of-income doc-
trine applies to a corporation which declares a dividend the sub-
stance of which is the right to receive ordinary income. S.Rep. No.
1622, 83rd Cong., 2d Sess. 247 (1954). No similar endorsement ap-
pears in either the legislative history or the cases regarding Section
351.

12. Int. Rev. Code of 1954, Section 336. This section and
Section 311 are intended to be parallel provisions; to properly imple-
ment the legislative intent, the Bank of Stratford rule should be con-
sistently applied to both of them. Williamson v. United States, Ct.Cl.
1961, 292 F.2d 524, 155 Ct.Cl. 279; Lyon and Eustice, supra, at
396-97. Furthermore, a failure to attribute ordinary income to the
distributing corporation might yield complete tax avoidance in many
cases: The corporation could not be taxed on amounts collected
because its existence would have terminated and its property would
have passed to the shareholders; the shareholders might acquire a

28

Section 337.'5 However, other analogies are more instruc-
tive,'* especially those involving corporate reorganization. '®

4

Note 1 2—Continued

. Stepped-up basis in the distributed income items which would allow
them to amortize market value against income as collections were
made. Blanc, supra, at 451-52. This result does not obtain with
respect to Section 351 because the transferee's basis is assessed with
reference to that of its predecessor pursuant to Section 362.

13. Int. Rev. Code of 1954, Section 337. The purpose of Section
337 is to eliminate the problem exemplified in Commissioner v. Court
Holding Co., 1945, 324 U.S. 331, 65 S.Ct. 707, 89 L.Ed. 981, and
United States v. Cumberland Public Service Co., 1950, 338 U.S. 451,
70 S.Ct. 280, 94 L.Ed. 251, in order to permit the same tax.conse-
quences to a liquidating corporation whether it sells its assets or
distributes them to its shareholders for sale. S.Rep. No. 1622, 83rd
_ Cong., 2d Sess. 258 (1954). Since the provision was enacted to
eliminate a formalistic inequity rather than to create one, the assign-
ment-of-income doctrine is properly applied to Section 337 in the
same manner as it applies to Section 336. Commissioner v. Kucken-
berg, 9 Cir. 1962, 309 F.2d 202. In addition, its legislative history
indicates unambiguously that Congress did not intend to exempt
from corporate taxation income from sales in the ordinary course of
business. S.Rep. No. 1622, 83rd Cong., 2d Sess. 259 (1954). Since the
underlying operations which generate ordinary income are not
exempt, accounts receivable arising therefrom are properly taxable
to the corporation. Note, Tax-free Sales in Liquidation Under Sec-
tion 337, 1963, 76 Harv.L.Rev. 780, 795.

14. For example, Sections 1245(b)(3) and 1250(d)(3) express-
ly exclude the Section 351 exchange from recapture of excess
depreciation because the transferee receives a carryover basis in
which recapture potential is preserved. This is in contradistinction
to other transactions, e.g., pursuant to Sections 311, 336 and 337,
in which the recapture exemption is denied when the transferee’s
basis and holding period are assessed independently of those of its
transferor. Blanc, supra, at.443-46; O'Hara, Statutory Nonrecogni-
tion of Income and the Overriding Principle of the Tax Benefit Rule
in the Taxation of Corporations and Shareholders, 1972, 27 Tax
L.Rev. 215, 217-18 & n. 13.

Consider, too, the treatment of installment obligations, a type
of account receivable. When the Section 351 transferor has per-
formed all the services upon which the right to payment depends,
a shift of attribution with respect to future installments would
seem unlikely; yet, that is the result. Lyon and Eustice, supra, at

SELIM I IML SO CT a NYPD ANE TT FAL OSE OTN . BRIBE TERME ITN Ei ASIN AI pe hen PIL TENE

» 29

It is also argued that taxation to the transferor will
have no deleterious effect on incorporation because a ra-
tional taxpayer is unlikely to transfer items of potential in-
come and expense to a controlled corporation in any event
due to alleged uncertainty whether the Commissioner will
seek to apply the assignment-of-income doctrine; whether
transferred accounts payable will be deductible by the
transferee upon payment,'* and whether gain will be recog-

-—

—_~

427. Not only is the exchange not deemed a “disposition,” but any
post-transfer amounts received in payment have the same character
to the transferee which they would have had in the hands of the
transferor. Treas. Reg. Sections 1.453-9(c)(2) (1958) and 1.453-9
_(c)(3) (1958). In particular, amounts collected in excess of basis
are taxable as profit to the transferee. Divine v. United States,
W.D.Tenn. 1962, 62-2 U.S. Tax Cas. 85,589; Wobbers, Incor-
porated, 1932, 26 B.T.A. 322; H.Rep. No. 1860, 75th Cong., 3d
Sess. 29 (1938).

15. Int. Rev. Code of 1954, Section 381. Both cases and com-
mentators recognize the close relationship between Section 351 and
the reorganization provisions. Heivering v. Cement Investors, inc.,
1942, 316 U.S. 527, 533-34, 62 S.Ct. 1125, 86 L.Ed. 1649; Blanc,
supra, at 473-74 & n. 108; Bonovitz, Restoration to Income of Bad
Debt Reserves, 1966, 44 Taxes 300, 307-08. The exclusion of
Section 351 from those transfers to which Section 381(c) applies
creates no negative pregnant with respect to the incidence of taxa-
tion under the former section. H.Rep. No. 1337, 83rd Cong., 2d
Sess. Al35 (1954); S.Rep. No. 1622, 83rd Cong., 2d Sess. 276-77
(1954); White, supra, at 38 n. 8. To the contrary, the philosophy
of reorganization is that the propriety of carryover attribution
should depend upon economic reality and substance rather than

Y upon the form of a transaction. H.Rep.No. 1337, 83rd Cong., 2d
Sess. 41 (1954); S.Rep.No. 1622, 83rd Cong., 2d Sess. 52 (1954).
Presumably, a similar concern should animate analysis of conse-
quences pursuant to Section 351.

16. See, e.g., Merchants Bank Bldg. Co. v. Helvering, § Cir.
1936, 84 F.2d 478.

On March 1, 1957, the Board of Directors of Hempt Bros., Inc.
resolved to acquire the partnership's receivables, payables and
inventory in exchange for stock. The corporation does not contend
that it was disallowed deductions as payments on transferred
accounts payable were made. Rather, it argues that it has been the
policy of the Internal Revenue Service to challenge deductions

5

Vitek (ot aa >
SEN ae at enero nena OMe emma. = _
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30

nized upon the exchange itself to the extent that transferred
liabilities exceed the adjusted basis of transferred assets.'?
This is without merit. In many cases, the withholding
of accounts receivable would substantially impair corporate
operations by making it difficult to meet working capital
requirements. See Tritt and Spencer, supra, at 95; cf. Bitt-
ker, supra, at 7. Additionally, the policy of Section 351 re-
flects a realistic awareness that the incorporating entity is
itself likely to perceive the transaction as a formal change
which has little impact upon continuity of operation: the
more natural inference is to simply assume the transfer of
payables and receivables. However, a more basic problem
is that plaintiff's predecessor did precisely that which is
now asserted to be irrational. Assuming arguendo that
there exist circumstances in which it makes sense to with-
hold income items from a controlled corporation, this
hardly mandates reversing the tax consequences which
naturally arise when they are in fact transferred. The
parinership could have retained its receivables; having cho-

Note 16—Conftinued

unless closing agreements are entered into in which the transferee
agrees to report collections made on accounts receivable as income,
“and that this policy represents a fatal inconsistency with respect
to defendant's argument that there exists a continuity of interest
and operation between parties to a Section 351 exchange.

The court disagrees. It is true that the non-deductibility of
transferred payables would deter the incorporation of a going
business. However, the purpose of the closing agreement is merely
to facilitate a proper matching of revenue and expense to preclude
duplication or omission of items of income and deduction. Burke,
supra, at 797; Hennessey, Accounting for a Transfer of Assets:
Taxable vs. Nontaxable Acquisitions, 1972, 30 N.Y.U. Inst. on Fed.
Tax. 1677, 1680-81; see Benjamin, Problems in Transition From
Sole Proprietorship or Partnership to Corporation, 1968, 26 N.Y.U.
Inst. on Fed. Tax. 791, 805-06; Worthy, supra, at 90-91.

17. Int. Rev. Code of 1954, Section 357(c), as construed in
Peter Raich, 1966, 46 T.C. 604. Contra, Bongiovanni v. Commis-
sioner, 470 F.2d 921 (2 Cir., filed Dec. 11, 1972). In this case, both
parties agree that the exchange qualified for non-recognition, and
no issue has been raised regarding Section 357(c).

31

sen to transfer them. Hempt Bros., Inc. may properly be re-
quired to accept the consequences of the exchange. Pitts-
field Coal & Oil Company, Incorporated, 1966, 25 CCH Tax
Ct. Mem. 11.

The court does not suggest that the Commissioner is
powerless to make adjustments when necessary to prevent
income distortion or tax avoidance. Indeed, the assignment-
of-income doctrine might itself apply to transactions moti-
vated primarily by tax advantage. Arent, supra, at 1002.
However, the role of the doctrine seems relatively modest
in this context, primarily because other means are available
to reach the same result,'* e.g., the business-purpose
doctrine'® and the Commissioner's discretionary power
to allocate items of income and expense among related tax-
payers. Int.Rev.Code of 1954, Section 482, as construed in
Estaie of Walling v. Commissioner, 3 Cir. 1967, 373 F.2d
190; Rooney v. United States, 9 Cir. 1962, 305 F.2d 681; Na-
tional Securities Corporation v. Commissioner, 3 Cir. 137
F.2d 600, cert. denied, 1943, 320 U.S. 794, 64 S.Ct. 262, 88
L.Ed. 479.

Plaintiff 's remaining arguments require only brief dis-
cussion. The decision of the Tax Court in E. Morris Cox?®
is relied upon for the proposition that amounts collected
on transf.vea receivables cannot be attributed to the
corporation because to do so would be inconsistent with its
accrual method of accounting, pursuant to which income
is realized when earned rather than when collected. To the
contrary, Cox involved an accrual-method transferor who
realized income as billings were made; the court held that
the corporation was not taxable upon items billed by its
predecessor prior to the transfer. This is merely an appli-
cation of the principle that the amount of gain realized by
a Section 351 transferee is to be assessed with reference

18. Lyon and Eustice, supra, at 424-26. See generally Rubin
v. Commissioner, 2 Cir. 1970, 429 F.2d 650 (26 AFTR 2d 70-
5051;.

19. See note 10, supra.

20. 1555, 43 T.C. 448.

OO AAR QT Rt 4 oe Rae pe rerTees

32

to the basis of its transferor. Since plaintiff's carryover
basis in the receivables was zero, it realized income to the
full extent collections were made. See, e.g., P. A. Birren &
Son, Inc. v. Commissioner, 7 Cir. 1940, 116 F.2d 718.

Furthermore, the parties agree that the Commissioner
properly required the corporation to change its method of
accounting in order to clearly reflect income. Int. Rev.Code
of 1954, Section 446(b). Permissible alternatives include a
hybrid method which contains cash and accrual elements.
Int.Rev.Code of 1954, Section 446(c)(4); H.Rep. No. 1337,
83rd Cong., 2d Sess. A158 (1954); S.Rep. No. 1622, 83rd
Cong., 2d Sess. 300 (1945). The only requirements are that
the method be used consistently and that it properly match
items of income and expense. See Treas.Reg. Sections 1.446-
l(c 1ivXa) (1957) and 1.446-1(c)(2)ii) 61957). In effect,
Hempt Bros., Inc. has been placed on the accrual method
with respect to income earned subsequent to March 1, 1957,
and on the cash method for items transferred from the part-
nership. The Commissioner's decision will be set aside only
when it constitutes an abuse of discretion,?' and there
is no abuse when a Section 351 transferee is required to ac-
crue post-transfer items of income and expense while re-
porting as income amounts collected on accounts re-
ceivable acquired from its cash-method predecessor. See
Ezo Products Company, 1961, 37 T.C. 385; cf. Pittsfield
Coal & Oil Company, Incorporated, 1966, 25 CCH Tax Ct.
Mem. 11.

[2] Finally, it is asserted that the receivables are tax-
able to the individual partners because the stock which each
received upon the exchange was allocated in proportion to
respective interests in the partnership capital account
rather than with reference to shares in transferred income
items. Specifically, each partner was taxable upon twenty-
five percent of partnership income, whereas individual in-
terests in the partnership capital account and in plaintiff's

21. See, e.g., Commissioner v. Joseph E. Seagram & Sons,
Inc., 2 Cir. 1968, 394 F.2d 738, 743.

RE ETRE ho,

ee

33

stock were apportioned differently. The only authority cited
in support of this position is Turnbull, Inc. v. Commis-
sioner,?? in which it was held that the transfer of ac-
counts receivabie among related corporations for inade-
quate consideration in order to utilize the transferee’s large
net operating loss carryovers was a transparent tax-avoid-
ance scheme which required attribution of income to the
nominal seller. Even assuming that adequacy of considera-
tion were to be evaluated relative to proportional shares in
partnership income, the facts before the court do not resem-
ble those in Turnbull, and plaintiff ‘s argument is rejected.

The corporation’s second major contention is that it
is entitled to an opening inventory of not less than $351,-
266.05 for its first taxable year because the value of the
stock issued in exchange for partnership property reflected
the cost of transferred inventory, constituting to its prede-
cessor the recovery of a previously-expensed item the basis
of which must be restored to cost.2* However, since this
ground for recovery was not presented in the corporation's
claim for refund, the court lacks jurisdiction to entertain
it.

22. 5 Cir., 373 F.2d 91 [19 AFTR 2d 609}, cert. denied, 1967,
389 U.S. 842, 88 S.Ct. 72, 19 L.Ed. 2d 105.

23. Cf. Nash v. United States, 1970, 398 U.S. 1, 90 S.Ct.
1550, 26 L.Ed.2d 1.

An alternative argument originally propounded was based
upon the theory that a change of accounting method initiated by the
Commissioner requires that opening and closing inventory for the
year of change be valued consistently. Int. Rev. Code of 1954,
Section 481, as construed in Fruehauf Trailer Company, 1964,
42 T.C. 83. However, in its reply brief, plaintiff indicates that the
only issue with respect to inventory valuation is the applicability
of the tax-benefit rule. The corporation’s change of position rests
upon express acquiescence in the principle that Section 481 adjust-
ments are not made to the initial opening inventory of a Section
351 transferee because it has no “preceding taxable year” within
the meaning of that section. See, e.g., Dearborn Gage Company,
1967, 48 T.C. 190, 196-201. Therefore, the court does not reach

naam. DNs Aw a

34

Filing of a timely refund claim is a prerequisite to the
maintenance of an action to recover taxes alleged to have
been improperly assessed cr collected. Int.Rev.Code of
1954, Section 7422(a). It must set forth in detail each
ground upon which a credit or refund is claimed and facts
sufficient to apprise the Commissioner of the exact basis
thereof. Treas.Reg. Section 301.6402-2(b\1) (1954). A
corollary of the enumerated principles is that a court lacks
jurisdiction of an action to recover taxes except upon
ground reasonably encompassed by the claim for refund as
originally filed or properly amended,24 the purpose of
this rule is to facilitate administrative determination of
claims and to limit litigation to issues which the Commis-
sioner has considered and is prepared to defend. Austin v.
United States. 10 Cir. 1972, 461 F.2d 733; Herrington v.
United States, 10 Cir. 1969, 416 F.2d 1029; Thompson v.
United States, 5 Cir. 1964, 332 F.2d 657; Carmack v. Sco-
field, 5 Cir. 1953, 201 F.2d 360 [43 AFTR 154]; Tompkins
v. United States, Ct.Cl. 1972, 461 F.2d 1304; Union Pacific

24. See Real Estate-Land Title & Trust Co. v. United States,
1940, 309 U.S. 13, 60 S.Ct. 371, 84 L.Ed. 542; Austin v. United
States, 10 Cir. 1972, 461 F.2d 733; Sid W. Richardson Foundation
v. United States, 5 Cir. 1970, 430 F.2d 710, cert. denied, 1971, 401
U.S. 1009, 91 S.Ct. 1251, 28 L.Ed.2d 544; Herrington v. United
States, 10 Cir. 1969, 416 F.2d 1029; Thompson v. United Siates,
5 Cir. 1964, 332 F.2d 657; Goelet v. United States, 2 Cir. 1959,
266 F.2d 881; Fidelity-Philadelphia Trust Company v. United
States, 3 Cir. 1955, 222 F.2d 379; Scovill Manufacturing Company:
v. Fitzpatrick, 2 Cir. 1954, 215 F.2d 567; Carmack v. Scofield, 5
Cir. 1953, 201 F.2d 360; Nemours Corp. v. United States, 3 Cir.
1951, 188 F.2d 745; Pelham Hall Co. v. Carney, 1 Cir. 1940, 111
F.2d 944; Paul v. United States, $.D. Ill. 1971, 334 F. Supp. 1138
First National Bank & Trust Company of Chickasha v. United
States, W.D. Okla. 1971, 329 F. Supp. 1147; Egan v. United States
D.Del. 1971, 325 F. Supp. 1227, 1229 n.3; Lehigh Inc. v. United
States, E.D. Pa. 1968, 290 F. Supp. 584; Miniature Vehicle Leasing
Corp. v. United States, D. N.J. 1967, 266 F. Supp. 697; Schuylkill
Haven Trust Company v. United States, E.D. Pa. 1966, 252 F. Supp.
557; Tompkins v. United States, Ct.Cl. 1972, 461 F.2d 1304; Union
Pacific Railroad Company v. United States, Ct.Cl. 1968, 389 F.2d
437, 182 Ct.Cl. 103.

EEE MEN AER OE ET Wey Dee . —

FSG BOGE NI

TL FAO SSR BE IK

35

Railroad Company v. United States, Ct.Cl. 1968, 389 F.2d
437, 182 Ct.Cl. 103.

Plaintiff does not argue that its tax-benefit theory of
recovery was presented to the Commissioner.** Instead,
this is asserted to be irrelevant since the Commissioner is
alleged to have been apprised of all the operative facts upon
which the new theory depends and since, in any event, the
refund claim is not intended to be a legal brief in which the
taxpayer is required to elaborate all theories upon which
the claim is based.

To the contrary, the Commissioner is required to
examine only those points to which his attention is neces-
sarily directed,2® and this is especially apposite here be-

25. On June 24, 1965, plaintiff filed a claim for refund which,
in pertinent part, is as follows:

“The taxable income of Hempt Bros., Inc. (the taxpayer-
claimant herein) for its fiscal year ended February 28, 1958 has
been accordingly overstated as follows:

(a) By reason of Internal Revenue Service's failure to elimi-
nate March 1, 1957 inventories of stone, sand and gravel from tax-
able income $351,266.05. . . .”

The corporation amended its claim on July 9, 1965:

“Reference is made to claim for refund filed June 24, 1965
with respect to the above period. This ‘Amendment to Claim’ is filed
in further explanation and amplification of one of the issues set
forth in said claim.

“In respect of ‘(a)’ on page 3 of the rider attached to tax-
payer's claim for refund (failure to eliminate March 1, 1957 in-
ventories of stone, sand and gravel from taxable income) filed on
June 24, 1965, the Internal Revenue Service was in error because
for purposes of accounting, it was inconsistent in its treatment of
taxpayer's inventory for said period.

“The Internal Revenue Service changed taxpayer's method of
accounting from a cash basis method to an accrual basis for the
period March 1, 1957 to February 28, 1958 and for all taxable years
subsequent thereto. The Internal Revenue Service, pursuant to this
change, made an ‘Inventory Adjustment for the period of March 1,
1957 to February 28, 1958 whereby it set off against taxpayer's
cost of sales the amount of $258,201.35, which amount constituted
‘the value of stone, sand and gravel produced during and on hand
at the end of the taxable year. However, the Internal’ Revenue
Service erroneously failed to include taxpayer's beginning inventory

36

cause the corporation’s amended claim sets forth specific
reasons in support of its inventory argument the natural
effect of which is to induce the Commissioner to pursue
quite a different line of inquiry than is relevant to the
theory upon which plaintiff presently seeks to rely. Tomp-
kins v. United States, Ct.Cl. 1972, 461 F.2d 1304, 1314-15
(Dissenting Opinion). Similarly, it is immaterial that facts
which might support recovery pursuant to the tax-benefit
theory were before the Commissioner when he reviewed the
corporation's claim: the mere availability of information
is not equivalent to notice that a specific claim based there-
on is being made because the Internal Revenue Service can-
not be expected to discover every claim which a taxpayer
might conceivably assert. Herrington v. United States, 10
Cir. 1969, 416 F.2d 1029; Nemours Corp. v. United States,
3 Cir. 1951, 188 F.2d 745; Pelham Hall Co. v. Carney, 1 Cir.
1940, 111 F.2d 994; Commercial Solvents Corporation v.
United States, Ct. Cl., 427 F.2d 749, 192 Ct. Cl. 339, cert.
denied, 1970; 400 U.S. 943, 91 S. Ct. 242, 27 L. Ed. 2d 247;
Union Pacific Railroad Company v. United States, Ct. Cl.
1968, 389 F. 2d 437, 182 Ct. Cl. 103.

For the reasons given, plaintiff ’s motion will be denied,
and summary judgment will be entered for defendant.

Note 25—Continued es

of $351,266.05 in its cost of sales. Because the Internal Revenue
Service included the taxpayer’s ending inventory in income, it
should have eliminated beginning inventory from income in order
to put taxpayer on a consistent accounting method for such period
(March 1, 1957 to February 28, 1958). It was in error in failing to
put taxpayer on the same method of accounting with respect to both
beginning and ending inventory.”

In substance, this is the alternative argument which the cor-
poration originally made and then abandoned in this action. See
note 23, supra.

26. Stoller v. United States, 5 Cir. 1971, 444 F.2d 1391; Sid
W. Richardson Foundation v. United States, 5 Cir. 1970, 430 F.2d
710, cert. denied, 1971, 401 U.S. 1009, 91 S.Ct. 1251, 28 L.Ed.2d
544; Schuylkill Haven Trust Company v. United States, E.D. Pa.
1966, 252 F. Supp. 557; see Nemours Corp. v. United States, 3 Cir.
1951, 188 F.2d 745.

37
UNITED STATES DISTRICT COURT .
FOR THE MIDDLE DISTRICT OF PENNSYLVANIA

HEMPT BROS., INC.,

Plaintiff,
v. No. 68-484 Civil
UNITED STATES OF AMERICA,
Defendant.
ORDER

Plaintiff, Hempt Bros., Inc., having moved for sum-
mary judgment in the above captioned matter, and the
court having heard oral argument and having considered
the briefs and supporting documents of the parties,

It is ORDERED that summary judgment for the plain-
tiff, Hempt Bros., Inc., is denied.

It is FURTHER ORDERED that summary judgment
for the defendant, United States of America, is granted.

Ctl bakd GlurcLe
Chief Judge a
Middle District of Pennsylvania

Dated: December 30, 1972.

38

UNITED STATES DISTRICT COURT,
FOR THE S
MIDDLE DISTRICT OF PENNSYLVANIA

Civit Action Fite No. 68-484

HEMPT BROS., INC., Plaintiff
vs. JUDGMENT
UNITED STATES OF AMERICA, Defendant

This action came on for (hearing) before the Court,
Honorable Michael H. Sheridan, United States District
Judge, presiding, and the issues having been duly (heard)
and a decision having been duly rendered,

It is Ordered and Adjudged that pursuant to the

Court’s Order granting Summary Judgment for the defen--

dant, United States of America,
It is ordered and adjudged that the plaintiff take noth-
ing and the case be, and hereby is, dismissed with prejudice.

Dated at Scranton, Pa., this 30th day of December, 1972.

T. Harold Campion
Clerk of Court

oF iviale ats as (

By
Frank Kurdziei, Deputy Clerk

1

39

UNITED STATES COURT OF APPEALS
For THE THIRD CIRCUIT

No. 73-1296

HEMPT BROS., INC.,

Appellant,
v.

UNITED STATES OF AMERICA

APPEAL FROM THE UNITED STATES DistRICT COURT
FOR THE MippLe District OF PENNSYLVANIA.

(D.C. Civil No. 68-484)

Argued November 2, 1973

Before: ALpisERT and Wels, Circuit Judges, and
LatcuuM, District Judge.

OPINION OF THE COURT
(Filed January 14, 1974)

Sheldon M. Bonovitz, Esg. Scott P. Crampton,
John F. Fansmith, Jr., Esq. Assistant Attorney General
Duane, Morris & Heckscher Meyer Rothwacks,
Philadelphia, Pennsylvania Ernest J. Brown,
Attorneys for Appellant ‘Attorneys, Tax Division
Department of Justice
Washington, D.C.
Attorneys for Appellee

POEL RE Le TE IE IESE OEE TE AO T

ALpIsEeRT, Circuit Judge.

In this appeal by a corporate taxpayer from a grant of
summary judgment in favor of the government in a claim
for refund, we are called upon to decide the proper treat-
ment of accounts receivable and of inventory transferred
from a cash basis partnership to a corporation organized
to continue the business under 26 U.S.C. §351(a).! This
appeal illustrates the conflict between the statutory pur-
pose of Section 351, postponement of recognition of gain
or loss, and the assignment of income and tax benefit
doctrines.

The facts were wholly stipulated; therefore, they may
be summarized as set forth by this government in its brief:

The taxpayer is a Pennsylvania corporation with
its principal place of business in Camp Hill, Pennsyl-
vania. It files its federal income tax returns for a fiscal
year beginning March 1.

From 1942 until February 28, 1957, a partnership
comprised of Loy T. Hempt, J. F. Hempt, Max C.
Hempt, and the George L. Hempt Estate was engaged
in the business of quarrying and selling stone, sand,
gravel, and slag; 1.:anufacturing and selling ready-mix
concrete and bituminous material; constructing roads,
highways, and streets, primarily for the Pennsylvania
Department of Highways and various political subdivi-
sions of Pennsylvania, and constructing driveways,
parking lots, street and water lines, and related ac-
cessories.

1. Sec. 351. Transfer to Corporation Controlled by Transferor.

(a) General Rule.—No gain or loss shall be recognized
if property is transferred to a corporation (including, in the
case of transfers made on or before June 30, 1967, an invest-
ment 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.

PEDO EPID RECS SPL NEGO STA ETO Doty be RE ap + Phy RLY DOP SANS LEON TERE tm

41

The partnership maintained its books and
records, and filed its partnership income tax returns,
on the basis of a calendar year and on the cash method
of accounting, so that no income was reported until
actually received in cash. Accordingly, in computing
its income for federal income tax purposes, the partner-
ship did not take uncollected receivables into income,
and inventories were not used in the calculation of its
taxable income, although both accounts receivable re-
flecting sales already made and physical inventories
existed to a substantial extent at the end of each of the
partnership's taxable years. Rather than using the in-
ventory method of accounting, the partnership de-
ducted the costs of its physical inventories of sand,
gravel, and stone as incurred.

On March 1, 1957, the partnership business and
most of its assets were transferred to the taxpayer
solely in exchange for taxpayer's capital stock, the
12,000 shares of which were issued to the four mem-
bers of the partnership. These shares constituted
100% of the issued and outstanding shares of the tax-
payer. This transfer was made pursuant to Section 351
(a) of the Internal Revenue Code of 1954; ...
Thereafter, the taxpayer conducted the business form-
erly conducted by the partnership.

Among the assets transferred by the partnership
to the taxpayer for taxpayer's shares of stock were ac-
counts receivable in the amount of $662,824.40 arising
from performance of construction projects, sales of
stone, sand, gravel, etc., and rental of equipment prior
to March 1, 1957. Also among the assets transferred
were physical inventories of sand, gravel, and stone,
with respect to which the partnership had deducted
costs of $351,266.05 and the value of which was no less
than $351 266.05.

Commencing with its initial fiscal year [which]
ended February 28, 1958, taxpayer maintained its
books and filed its corporation income tax returns on

SALE OLIV TOLER TM MELE YSN BRED Eo ree a ew Ae a ge re

42

the cash method of accounting and, accordingly, did
not take uncollected receivables into income and did
not use inventories in the calculation of its taxable in-
come. In its taxable years ending in 1958, 1959, and
1960, taxpayer collected the respective amounts of
$533,247.87, $125,326.71 and $4,249.72 of the ac-
counts receivable in the aggregate amount of $662,-
824.40 (sic) that had been transferred to it, and in-
cluded those amounts in income in computing its in-
come for its federal income tax returns for those years,
respectively,

‘As a result of an examination extending over a
period of years, it was determined by the Commis-
sioner of Internal Revenue, and agreed to by the tax-
payer, that the use of the cash receipts and disburse-
ments method of accounting with regard to purchases
and sales, without taking into account merchandise
on hand at the beginning and end of the taxable year,
did not clearly reflect taxpayer’s income. Accordingly,
taxpayer's income was adjusted as set forth in an
examination report of August 24, 1964 . . . to accrue

_ unreported sales [accounts receivable] made during
the taxable years in question and to take into account
inventories in computing its cost of goods sold. In com-
puting taxpayer's cost of goods sold under the inven-
tory method, for the fiscal year ended February 28,
1958, the Commissioner of Internal Revenue, in con-
junction with his accrual method treatment, fixed the
beginning inventory of stone, sand, and gravel, which
had been transferred to the taxpayer by the partner-
ship, at zero, and the ending inventory at $258,201.35.
The result was an increase in taxpayer's taxable in-
come for the fiscal year ended February 28, 1958, in
the amount of $258,201.35.

The Commissioner of Internal Revenue assessed de-
ficiencies in taxpayer’s federal income taxes for its fiscal
years ending February 28, 1958, and 1959. The taxpayer

ORAL ES 3 PEO RAE ER NT! GAIN RRND te es

43

paid the amounts in 1964, and in 1965 filed claims for re-
fund of $621,218.09 plus assessed interest.2 The claims
were disallowed in full on September 24, 1968, and the dis-
trict court action was timely instituted on December 5,
1968.

The district court held: (1) ‘taxpayer was properly tax-
able upon collections made with respect to accounts re-
ceivable which were transferred to it in conjunction with
the Section 351 incorporation, and (2) the court lacked
jurisdiction to entertain taxpayer's contention that the
tax-benefit theory of recovery entitled it to an opening in-
ventory of not less than $351,266.05, since that theory of
recovery was not presented in taxpayer’s claim for refund.
Hempt Bros., Inc. v. United States, 354 F. Supp. 1172 (M.D.
Pa. 1973).

Taxpayer argues here, as it did in the district court,
that because the term “property” as used in Section 351
does not embrace accounts receivable, the Commissioner
lacked statutory authority to apply principles associated
with Section 351. The district court properly rejected the
legal interpretation urged by the taxpayer.

The definition of Section 351 “property” has been ex-
tensively treated by the Court of Claims in E. I. DuPont de
Nemours and Co. v. United States, 471 F.2d 1211, 1218-19
(Ct. Cl. 1973), describing the transfer of a non-exclusive
license to make, use and sell area herbicides under French
patents:

Unless there is some special reason intrinsic to. . .
[Section 351] . . . the general word “property” has

2. The Commissioner of Internal Revenue assessed deficiencies
in the amounts of $364,154.20 plus interest of $125,740.42, and
$75,995.46 plus interest of $24,343.53 for fiscal years ending in
1958 and 1959 respectively. Taxpayer filed claims for refund of
$456,218.76 plus assessed interest for fiscal 1958, $113,163.03 plus
assessed interest for fiscal 1959 and $51,836.30 for fiscal 1960.

a
§
estetews
’ S Be ce wp yr ne ee ate

PETER BEES RAEI BORE SLL TTS rae Pie pe SELLER ICED AY ORSON IE gts sR —

44

a broad reach in tax law. . . . For section 351, in par-
ticular, courts have advocated a generous definition
of “property,” . . . and it has been suggested in one
capital gains case that nonexclusive licenses can be
viewed as property though not as capital assets. . . .

We see no adequate reason for refusing to follow
these leads.

We fail to perceive any special reason why a restrictive
meaning should be applied to accounts receivables so as to
exclude them from the general meaning of “property.” Re-
ceivables possess the usual capabilities and attributes as-
sociated with jurisprudential concepts of property law.
They may be identified, valued, and transferred. Moreover,
their role in an ongoing business must be viewed in the con-
text of Section 351 application. The presence of accounts
receivable is a normal, rather than an exceptional accou-
trement of the type of business included by Congress in the
transfer to a corporate form. They are “commonly thought
of in the commercial world as a positive business asset.”
DuPont v. United States, supra, at 1218. As aptly put by the
district court: “There is a compelling reason to construe
‘property’ to include . . . [accounts receivable]: a new
corporation needs working capital, and accounts receivable
can be an important source of liquidity.” Hempt Bros. Inc.
v. United States, supra, at 1176.5 In any event, this court
had no difficulty in characterizing a sale of receivables as

“property” within the purview of the “no gain or loss” pro-

3. Du Pont v. United States, supra, at 1214, citing P. A. Birren
& Son, Inc. v. Commissioner, 116 F.2d 718 (7th Cir. 1940), ob
served that nonrecognition under Section 351 has been granted for
accounts receivable. In the recent case of Thatcher v. Commis-
sioner, — T.C. — (42 U.S.L.W. 2228, October 30, 1973), the Tax
Court reaffirmed its decision in Raich v. Commissioner, 46 T.C.
604 (1966), holding that accounts receivable transferred by a cash
basis taxpayer to a corporation under Section 351 had a zero basis.
By placing a tax basis in that which was transferred, the Tax Court
by implication assumed that accounts receivable are “property”
within the meaning of Section 351.

; ae . STI OS Pee etter rere —

45

vision of Section 337 as a “qualified sale of property within
a 12-month period.” Citizens Acceptance Corp. v. United
States, 462 F.2d 751, 756 (3d Cir. 1972).

The taxpayer next makes a strenuous argument that
“[t}he government is seeking to tax the wrong person.”4
It contends that the assignment of income doctrine as de-
veloped by the Supreme Court applies to a Section 351 trans-
fer of accounts receivable so that the transferor, not the
transferee-corporation, bears the corresponding tax liabil-
ity. It argues that the assignment of income doctrine dic-
tates that where the right to receive income is transferred
to another person in a transaction not giving rise to tax at
the time of transfer, the transferor is taxed on the income
when it is collected by the transferee; that the only require-
ment for its application is a transfer of a right to receive
ordinary income; and that since the transferred accounts
receivable are a present right to future income, the sole re-
quirement for the application of the doctrine is squarely
met. In essence, this is a contention that the nonrecogni-
tion provision of Section 351 is in conflict with the assign-
ment of income doctrine and that Section 351 should be
subordinated thereto. Taxpayer relies on the seminal case
of Lucas v. Earl, 281 U.S. 111 (1930), and its progeny® for
support of its proposition that the application of the doc-
trine is mandated whenever one transfers a right to receive
ordinary income.

On its part, the government concedes that a taxpayer
may sell for value a claim to income otherwise his own and

4. We put aside the pragmatic consideration that the trans-
feree-corporate taxpayer raises the argument that the partnership
should be taxed at a time when the statute of limitations has pre-
sumably run against the transferor partners, who ostensibly are
the stockholders of the new corporation.

5. United States v. Basye, 410 U.S. 441 (1973); Commissioner
v. First Security Bank of Utah, 405 U.S. 394 (1972); Commissioner
v. Culbertson, 337 U.S. 733 (1949); Commissioner v. Sunnen, 333
U.S. 591 (1948); Helvering v. Eubank, 311 U.S. 122 (1940); Hel-
vering v. Horst, 311 U.S. 112 (1940).

adie ae POE RP GA OT A EI ne en

46

he will be taxable upon the proceeds of the sale. Such was
the case in Commissioner v. P. G. Lake, Inc., 356 U.S. 260
(1958), in which the taxpayer-corporation assigned its oil
payment right to its president in consideration for his can-
cellation of a $600,000 loan. Viewing the oil payment
right as a right to receive future income, the Court applied
the reasoning of the assignment of income doctrine, nor-
mally applicable to a gratuitous assignment, and held that
the consideration received by the taxpayer-corporation
was taxable as ordinary income since it essentially was a
substitute for that which would otherwise be received at a
future time as ordinary income.

Turning to the facts of this case, we note that here
there was the transfer of accounts receivable from the
partnership to the corporation pursuant to Section 351. We
view these accounts receivable as a present right to receive
future income. In consideration of the transfer of this right,
the members of the partnership received stock—a valid
consideration. The consideration, therefore, was essentially
a substitute for that which would otherwise be received at
a future time as ordinary income to the cash basis partner-
ship. Consequently, the holding in Lake would normally
apply, and income would ordinarily be realized, and thereby
taxable, by the cash basis partnership-transferor at the time
of receipt of the stock. ;

But the terms and purpose of Section 351 have to be
reckoned with. By its explicit terms Section 351 expresses
the Congressional intent that transfers of property for stock
or securities will not result in recognition. It therefore be-
comes apparent that this case vividly illustrates how Sec-
tion 351 sometimes comes into conflict with another pro-
vision of the Internal Revenue Code or a judicial doctrine,®
and requires a determination of which of two conflicting
doctrines will control.

6. Weiss, Problems in the Tax-Free Incorporation of a Busi-
ness, 41 tnd. L.J. 666, 676 (1966). See, e.g., Henry McK. Haserot,
41 T.C. 562 (1964), rev'd and rem’d 355 F.2d 200 (6th Cir. 1965).

aa “at V@ ean a

PREETI OIE

Pttrerne neces ee on

47

As we must, when we try to reconcile conflicting
doctrines in the revenue law, we endeavor to ascertain a
controlling Congressional mandate. Section 351 has been
described as a deliberate attempt by Congress to facilitate
the incorporation of ongoing businesses and to eliminate
any technical constructions which are economicaliy un-
sound.’

Appellant-taxpayer seems to recognize this and argues
that application of the Lake rationale when accounts re-
ceivable are transferred would not create any undue hard-
ship to an incorporating taxpayer. “All a taxpayer [trans-
feror] need do is withhold the earned income items and
collect them, transferring the net proceeds to the Corpora-
tion. Indeed . . . the transferor should retain both accounts
receivable and accounts payable to avoid income recogni-
tion at the time of transfer and to have sufficient funds with
which to pay accounts payable. Where the taxpayer [trans-
feror] is on the cash method of accounting [as here], the
deduction of the accounts payable would be applied against
the income generated by the accounts receivable.” (Appel-
lant’s Brief at 32.)

7. “One of the purposes of this section [Section 202(c\3) of
the Revenue Act of 1921] was to permit changes in form [of
business} involving no change in substance to be made without
undue restriction from the tax laws.” Note, Section 351 of the In-
ternal Revenue Code and “Mid-Stream” Incorporations, 38 U. Cin.
L. Rev. 96 (1969). See, S Rep. No. 275,.67th Cong. Ist Sess. 11
(1921). This intention is also reflected in the report of the House of
Representatives accompanying §351 of the Internal Revenue Code
of 1954. H.R. Rep. No. 1337, 83rd Cong. 2d Sess. 34 (1954).

The House Ways and Means Committee recommended that
non-recognition treatment be granted for incorporation, reorganiza-

Sess. 10 (1921). The Senate Finance Committee added that such
treatment would eliminate “many technical constructions which
are economically unsound.” See S. Rep. 275, 67th Cong., Ist Sess.
12 (1921).

Weiss, supra, 41 Ind. L.J. 666 n.4 (1966).

48

While we cannot fault the general principle “that in-
come be taxed to him who earns it,” to adopt taxpayer's
argument would be to hamper the incorporation of ongoing
businesses; additionally it would impose technical construc-
tions which are economically and practically unsound.
None of the cases cited by taxpayer, including Lake itself,
persuades us otherwise. In Lake the Court was required to
decide whether the proceeds from the assignment of the oil
payment right were taxable as ordinary income or as long
term capital gains. Observing that the provision for long
term capital gains treatment “has always been narrowly
construed so as to protect the revenue against artful de-
vices,” 356 U.S. at 265, the Court predicated its holding
upon an emphatic distinction between a conversion of a
capital investment—“income-producing property”—and an
assignment of income per se. “The substance of what was
assigned was the right to receive future income. The sub-
stance of what was received was the present value of in-
come which the recipient would otherwise obtain in the
future.” Ibid., at 266. A Section 351 issue was not presented
in Lake. Therefore the case does not control in weighing the
conflict between the general rule of assignment of income
and the Congressional purpose of nonrecognition upon the
incorporation of an ongoing business.*

We are persuaded that, on balance, the teachings of
Lake must give way in this case to the broad Congressional
interest in facilitating the incorporation of ongoing busi-
nesses. As desirable as it is to afford symmetry in revenue
law, we do not intend to promulgate a hard and fast rule.®

8. A second issue in Fleming, a companion case to Lake,

“like kind” exchange under §112(b) (1) of the Internal Revenue
Code of 1939. The Court held that the exchange was not “like
kind” since its effect is a transfer of future income from oil leases
in exchange for real estate. There is no “like kind” requirement
under Section 351. See note 1, ante.

9. The Commissioner has apparently taken the position that

49

We believe that the problems posed by the clash of con-
flicting internal revenue doctrines are more properly deter-
mined by the circumstances of each case. Here we are in-
fluenced by the fact that the subject of the assignment was
accounts receivable for partnership's goods and services
sold in the regular course of business, that the change of
business form from partnership to corporation had a basic
business purpose and was not designed for the purpose of
deliberate tax avoidance, and by the conviction that the
totality of circumstances here presented fit the mold of the
Congressional intent to give nonrecognition to a transfer
of a total business from a non-corporate to a corporate
form.

But this too must be said. Even though Section 351(a)
immunizes the transferor from immediate tax conse-
quences, Section 358" retains for the transferors a poten-
tial income tax liability to be realized and recognized upon

351 transfers. “However, the Service's ruling policy apparently is
subject to the proviso that the taxpayer enter into a closing agree-
ment assuring that the corporation will report the income reflected
in the receivables upon their collection or other disposition. It
would also appear that favorable rulings will not be issued where
the timing of the transfer will be such as to result in a distortion
of income. For example, such a ruling presumably could not be
obtained if a seasonable business were to be incorporated during the
portion of the year occurring after sizeable operating expenses
had been incurred but before the income attributable thereto was
collected.” Weiss, supra, 41 Ind. L.J. at 681 (footnote omitted). '

10. Sec. 358. Basis to Distributees.

(a) General Rule.—Iin the case of an exchange to which
section 351, 354, 355, 356, 361, or 371 (b) applies—

(1) Nonrecognition property.—The basis of the property
permitted to be received under such section without the
recognition of gain or loss shall be the same as that of the
property exchanged—

(A) decreased by—

(i) the fair market value of any other property (ex-
cept money) received by the taxpayer,

(ii) the amount of any money received by the tax-
payer, and

EEE A LIE LPL OL CET EE TETRIS ESE NITION I PRS

a Di aE laa i ee

50

a subsequent sale or exchange of the stock certificates re-
ceived. As to the transferee-corporation, the tax basis of the
receivables will be governed by Section 362."!

The taxpayer contends that the court erred in ruling
that its inventory argument was not reasonably encom-
passed within its claim for refund, and that had the court
considered this contention for the fiscal year commencing
March 1, 1957, the taxpayer-corporation would have been
entitled to a beginning inventory of $351,266.05 instead of
zero by application of the tax benefit rule.

The government restates the reason for the district
court’s refusal to consider taxpayer’s argument but by its
brief advises: “We believe it unnecessary for this Court to
explore the often obscure distinction hetween the facts to
support a claim and the theory of a ciaim” and that

Note i@—Continued
(iii) the amount of loss to the taxpayer which was
recognized on such exchange, and
(B) increased by—
(i) the amount which was treated as a dividend, and
(ii) the amount of gain to the taxpayer which was
recognized on such exchange (not including any portion of
such gain which was treated as a dividend).
(2) Other property.—The basis of any other property
(except money) received by the taxpayer shall be its fair
market value.
11. Sec. 362. Basis to Corporations
(a) Property acquired by issuance of stock or as paid-in sur-
plus.—if property was acquired on or after Jume 22, 1954, by a
corporation—
(1) in connection with a transaction to which section
351 (relating to transfer of property to corporation controlled
by transferor) applies, or
(2) as paid-in surplus or as a contribution to capital, then
the basis shall be the same as it would be in the hands of the
transferor, increased in the amount of gain recognized to the
transferor on such transfer.

51

“[w]ithout joining in the debate over facts versus theory,
examination of the substance of taxpayer's claim for inven-
tory adjustment makes it clear that the facts asserted in its
claim for refund do not support it and the agreed facts
negative it.” (Appellee’s brief at 19.) Regardless of the
procedural question, we are persuaded that appellant's tax
benefit argument does not apply to this factual complex,
and “[w]Je pass at once to a consideration of . . . [the
merits].” B.F. Goodrich Co. v. United States, 321 U.S. 126
(1944).

The tax benefit rule can be simply stated: If a taxpayer
makes an expenditure or suffers a loss for which it takes
a deduction giving rise to a reduction in its income tax and
later recovers the funds or property that it has spent or lost,
it must take the amount recovered as income. Connery v.
United States, 460 F.2d 1130, 1132 (3d Cir. 1972); Alice
Phelan Sullivan Corp. v. United States, 381 F.2d 399, 401-
02 (Ct. Cl. 1967).

Applying this rule to the facts of this case taxpayer
contends that partnership’s receipt of stock in exchange for
inventory previously expensed but presently valued at
$351,266.05 constituted a “recovery” which stepped up the
basis of the inventory from zero to $351,266.05 and that
this stepped-up basis became the basis to the pened
and the corporation under Sections 358 and 362.

Relying on Nash v. United States, 398 U.S. 1 (1970),
and the various courts of appeals decisions in Commis-
sioner v. Anders, 414 F.2d 1283 (10th Cir. 1969); Spitalny
v. United States, 430 F.2d 195 (9th Cir. 1970); Connery v.
United States, supra, and Citizens’ Acceptance Corp. v.
United States, supra, taxpayer proceeds to equate “value”
of the inventory with tax “basis” as conceptualized in Sec-
tions 358 and 362. This keystone in the taxpayer's arch of
reasoning proves to be most fragile upon close inspection.

Although Justice Douglas in Nash addressed a transfer
of receivables under Section 351(a), the Court did not have
before it the critical question posed here—whether a part-
nership’s “basis,” and ultimately the corporation’s

52

“basis,” in a previously expensed inventory is equal to the
“value” of the inventory when transferred.

“In Nash the Court held that when eight partnerships
transferred their assets to eight newly formed corporations
in exchange for shares in the corporations—transfers that
produced no gain or loss under §351 of the Internal Reve-
nue Code—there was no ‘recovery’ of the bad debt reserves
under the tax benefit rule ‘[s]ince the reserve for purposes
of this case was deemed to be reasonable and the value of
the stock received upon the transfer was equal to the net
value of the receivables. . . .. 398 U.S., at 4, 90 S. Ct., at
1552 (emphasis in original).” Citizens’ Acceptance Corp.
v. United States, supra, at 754. While it is true that Justice
Douglas stated that “[a]ll that petitioners received from
the corporations were securities equal in value to the net
worth of the accounts transferred, that is the face value less
the amount in reserve for bad debts”, 398 U.S. at 4, the sole
issue before the Court was whether such receipt constituted
a “recovery” within the meaning of the tax benefit rule.
It was not necessary for the Nash Court ever to reach the
question of the tax “basis” in the hands of either the trans-
feror or transferee. Thus, the taxpayer would have us read
into Nash a holding which did not appear therein, which
was not posed by the facts, and which does not inexorably
nor logically follow therefrom.

Nor may the taxpayer find suiace in ine decisions of ine
various courts of appeals upon which it relies. At issue in .
Anders and Spitalny were inventories which had been com-
pletely expensed and therefore had a zero basis. After the
inventories were sold, the liquidated corporations attempt-
ed to assert a no-gain immunity from tax liability by virtue
of the operation of §337.!? In each case the court held the

12. §337. Gain or loss on sales or exchanges in connection
with certain liquidations
(a) General Rule.—If—
(1) a corporation adopts a plan of complete liquidation
on or after June 22, 1954, and

OLN IER IRIE AOE EI BRENT ENT SORE TEN OP AE ROR RR prea eu coomerm a nan 7

53

sale proceeds would not be considered as non-recognizable
gain.

We find nothing in the teachings of the Ninth and
Tenth Circuits supporting taxpayer's contention that in a
Section 351(a) transfer the accounting basis for property
must equal the actual or market value thereof. At the time
taxpayer's inventory was totally expensed on the cash basis
books of the partnership that property had mercantile value
in the sense as described by Justice Douglas in Nash, but
for accounting purposes and as a tax basis it still had a zero
value. The mere fact that an asset has been transferred
under Section 351(a) from a partnership ownership to a
corporate ownership does not in itself alter its tax basis.

We now turn to our decisions in Connery and Citizens.
The Connery issue was whether tax benefit principles ap-
plied following recovery of previously expensed prepaid
advertising. We agreed with the Commissioner in the ap-
plication of the tax benefit rule because the taxpayer real-
ized income equivalent to the value of the previously ex-
pensed advertising costs. We said that the taxpayer incurred
a tax liability based on the difference between a zero basis
and the amount previously expensed.

The difficulty presented in both Section 337 and Sec-
tion 351 cases is that the statute expressly provides for no-
gain and no-loss tax consequences by virtue of the actual
liquidation or transfer. Nothing in the statutory schema
permits an immunization of normal tax consequences aris-
ing out of those separate activities which may accompany a
liquidation under Section 337 or a transfer under Section
351 but which are not inherently a necessary aspect of the
liquidating or transferring process. The tax imposed in

(2) within the 12-month period beginning on the date of
the adoption of such plan, all of the assets of the corporation
are distributed in complete liquidation, less assets retained to
meet claims, then no gain or loss shall be recognized to such
corporation from the sale or exchange by it of property within
such 12-month period.

26 U.S.C. §337(a).

EDGES SEIT OP ES BARRE A RST RI PEA a, eS OT ET SA a
SS PE RP RPT SE

54

Connery was not the result of the liquidation process per se;
it was imposed because of the recovery of an item previously
expensed. The happenstance that the recovery took place as
an additional feature of the liquidating process does not
immunize that recovery from normal tax consequences. The
prepaid advertising expenses had a zero basis before the
liquidation process began; it had the same basis during the
liquidation process.

The Citizens issue was the extent to which the taxpayer
had recovered its previously deducted bad debt reserve.
Our holding in Citizens was simply a reiteration of the hold-
ing in Nash, that the receivables had to be valued on the
basis of face value less bad debt reserve. Citizens did not
involve an adjustment of the tax basis.

In the case before us, whatever may have been the
actual value of the inventory at the time of the transfer, the
“basis of . . . the property exchanged,” Section 358(a)(1),
remained the same as it appeared in the partnership's
books—zero. As to the distributees, the “basis of the . . .
[stock] permitted to be received under . . . {Section 351]
shall be the same as that of the property exchanged”—zero.
Section 358(a)(1).

As to the corporation, according to Section 362(a)
“the basis shall be the same as it would be in the hands of
the transferor [partnership]. . . .” This must be zero as
well. Accordingly, the taxpayer cannot prevail in his con-
tention that he is entitled to a basis for the inventory in the
amount of $351,266.05.

Ill.

Appellant raised at oral argument a question which,
on first blush, is extremely attractive and appealing. It ques-
tions the fundamental fairness of the Commissioner's
action in requiring a corporation to change from a cash to
an accrual basis without permitting adjustments to the
predecessor partnership. We note, however, that appellant
does not dispute the Commissioner's determination that its

Sy
cd

55

use of the cash receipts and disbursements method of
accounting with respect to purchases and sales, without
taking into account merchandise on hand at the beginning
and end of the year did not clearly reflect income. (Appendix
at 18a).

The argument is premised on the history of IRS audits
of the previous partnership books, and the failure of the
Commissioner to direct that the partnership change from
a cash to an accrual basis. To this is added the reality that
the identical partnership business was continued by the
corporation with present stock ownership reflecting past
partnership interests. The argument continues: requiring
the corporate taxpayer to make a sudden change in account-
ing methods, generating huge new tax liabilities, is basical-
ly unfair to the taxpayer; that at the very least, there should
now be permitted a reopening of the partnership books to
allow for adjustments under 26 U.S.C. §481 so that a new
basis for an opening inventory may be permitted and a dis-
tribution of increased tax liabilities shared by the previous
partnership.

Where a method of accounting differs from that under

13. Where the Commissioner has accepted over a long period
of years or approved a method of accounting by a taxpayer, this
fact will be given weight in determining whether the Commissioner
is justified in changing the method used by such taxpayer. Ezo
Products Co., 37 T.C. 385, 391 (1961); Geometric Stamping Co.,
26 T.C. 301 (1956). The Commissioner's authority to order a change
in accounting methods when the taxpayer has regularly employed
a consistent method depends upon the validity of his finding that
the taxpayer's method does not clearly reflect income. Glenn v.
Kentucky Color & Chemical Co., 186 F.2d 975 (6th Cir. 1951). The
Commissioner is not estopped from computing a taxpayer’s income
on an accrual method of accounting because he has not objected to
the method used by the taxpayer in his examination of prior re-
turns. Caldwell v. Commissioner, 202 F.2d 112 (2d Cir. 1953). The
Commissioner's regulation requiring that purchases and sales be
reported on an accrual basis where it is necessary to use an inven-
tory is one of long standing and has received the approval of the.
courts. Iverson’s Estate v. Commissioner, 255 F.2d 1 (8th Cir. 1958),
cert. denied, 358 U.S. 893 (1958).

STE HA LET ELI SEEL IA: ELLE MIE MELT PAS POE PENIS \ TI SSIS BE NE EI ee Tle I EE

56

which the taxpayer's income for a preceding calendar year
was computed, Section 481(a) provides for adjustments in
previous years which are détermined to be necessary solely
by reason of the change, in order to prevent an amount from
being duplicated or omitted. Notwithstanding the adjust-
ment provisions of Section 481(a), a corporation formed for
a business purpose is a separate entity 2nd a separate tax-
payer from the stockholders who are responsible for its
creation. Moline Properties v. Commissioner, 319 U.S. 436
(1943). And because of the separate taxable corporate
entity, it has been held that where the change in the ac-
counting practices is ordered for the first year of the cor-
poration’s existence, the corporation had no preceding tax-
able year, and therefore, Section 481 is inapplicable. Ezo
Products Co., supra, at 394. “Equally clearly, section 481
may be applied only to the petitioner [corporation] and not
to make adjustments with respect to its predecessor [part-
nership].” Dearborn Gage Co., 48 T.C. 190, 198, (1967)
citing E. Morris Cox, 43 T.C. 448 (1965); Ezo Products Co.,
supra.'4

Judge Tannewald’s observations in Dearborn seem
pertinent to our facts: “We recognize that, if petitioner
[corporation] had never been formed, and the predecessor
partnership had continued in business, and the issue before
us involved a comparable change in the latter’s method of

14. “The critical question which we must resolve is whether

. [there can be adjustments] in opening inventory for 1957.

In so doing, we must decide which of two general principles ap-
plies. The first principle requires that opening inventory must be
computed on the same basis as closing inventory . . . The second
principle requires that, . . . in a tax free exchange such as oc-
curred herein when the predecessor partnership transferred its
assets to petitioner, the basis of the transferred assets in the hands
of the latter is the same as it was in the hands of the former. In
implementing this second principle, it has been held that the basis

‘ of initial opening inventory in the hands of the transferee corpora-

tion should not be adjusted in order to correct for an erroneous
method of accounting for that inventory by the predecessor trans-
feror.”

Dearborn Gage v. Commissioner, supra, at 198.

AES RA AN RS ae EONS EM ETRE EME NILES LOLI He EB IRC TIEN, WE

57

accounting for overhead costs, respondent . . . would,
under the applicable decisions, have been required, in
making the necessary computations, to . . . [make ad-
justments] both in the opening inventory and closing in-
ventory for the . . . [previous years permitted by Section
481]. Thus, petitioner—a taxpayer separate and distinct
from its predecessor—appears to fare worse than its pred-
ecessor would have. We also recognize . . . the tax benefit
of the deductions . . . taken by petitioner’s predecessor
may not have been as great as the tax burden which our
rationale now requires petitioner to bear, e.g., because the
partners may have been in lower tax brackets or the partner-
ship may have operated at a loss in some of the prior years.
Moreover,- if the ownership of—petitioner’s stock had
changed prior to the taxable years herein involved, the
economic effect of the tax benefit would not inure to, nor
would the tax burden fall upon, the same persons. But these
are nothing more than some of the myriad of different con-
sequences which may result from a change to the corporate
form of doing business or from the acquisition of stock of a
corporation rather than corporate assets.” 48 T.C. at 199
200 (footnote omitted).

Applied to this case, these principles preclude a judicial
command that the Commissioner make adjustments in the
predecessor business entity to supplement the direction that
the new corporate taxpayer convert to an accrual basis.'®

15. Had these applicable principles permitted a:1 adjustment
to the predecessor partnership accounting principles. any attempt
by the Commissioner to increase the tax liabilities of the partners
would probably be barred by the statute of limitations. In Purseil
v. Commissioner, 38 T.C. 263, 276, (1962) aff’d per curiam, 315

F.2d 629 (3d Cir. 1963), we considered and rejected the approach
i similar to that urged by the taxpayer here: “Petitioners’ argument,
: if sustained, would logically require an examination of every tax-
; able year that . . . [taxpayer] has been in business, since it
{ appears that the sale of merchandise has always been an income
i producing factor. Section 481 would have to be interpreted as per-
mitting the correction of errors long since ordinarily barred by the
statute of limitations. We do not believe that Section 481 sanctions
such corrections, even if they could be accurately determined.”

OB tterercemmmnan POOP A LLP AR LOND CE

ve CEASA

58
We have carefully considered each of appellant's con-
tentions and have concluded that the judgment of the dis-
trict court will be affirmed.
A True Copy:

Teste:

Mok, z ont Do ut2, : Re
/1/ El wheck aa, Ce
M. Elizabeth Ferguson {
Chief Deputy Clerk «

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385607_1877%3A1. Public record. Not legal advice.