Petition for A Writ of Certiorari — International Shoe Machine Corp. v. United States

os .

LISRARY | TER.

teu RT, ‘Je 5. |

an the

Supreme Court of the Riited States

_Octroszr Tzrm, 1973

m 39-1754

INTERNATIONAL SHOE MACHINE CORPORATION,

PETITIONER,

Sere ernie.

UNITED STATES OF AMERICA,

RESPONDENT.

PETITION FOR WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS

FOR THE FIRST CIRCUIT

Evan Y. Semensuan

Hatz anp Dorg

28 State Street

Boston, Massachusetts 02109

Counsel for Petitioner

————_—_—X—X—X_——————_—_—_—a—asagrpra wz

Blanchard Press, Inc., Boston, Mass. — Law Printers

INDEX

Opinions Below 1

Jurisdiction ......... o7 ee eh ae bs 2

Questions Presented __. Sate tie etary. cB PEL Cas nde 2

FC a TS es Sennen LS 2

Statement of Case ...._.... Ae ee ee

Reasons For Granting The Writ - eee eek a ee nin 6

A. The Decision Below Contravenes This Court’s

Decision in Malat v. Riddell ................. 6

B. The Decision Below Augments Serious Confu-

sion And Conflict Among The Circuits ........ 10

1, Does “‘primarily’’ modify ‘‘for sale’’ or ‘‘in

the ordinary course of business’? ......... 11

2. Does Corn Products Co. v. Commissioner,

350 U.S. 46 (1955), apply to §1231 assets? .. 12

3. Is there a ‘‘rental-obsolescence’’ requirement

NT I ee ye es 13

4. Does §1231 require a liquidation of inventory? 14

€. The Proper Construction Of §1231 Should Be

Defined And Settled By This Court. sis 15

CRIN ices cot eee ty tal, caine - Si cit aoe ae

Appendix A: 26 U.S.C. §1231 ...... Sa

Appendix B: District Court Opinion .=sss—i(itstéists:C«

Appendix C: Court of Appeals Opinion... = ss—(‘CSC~CéZ*Y

Appendix D: Court of Appeals Judgment sss. |

Appendix E: Court of Appeals Memorandum And

Order On Petition For Rehearing _. 38

TaBLe or Citations

Cases

Albright v. United States, 173 F.2d 339 (8th Cir. 1949) 10,

11, 13

Corn Products v. Commissioner, 350 U.S. 46 (1955) .. 12

Dawson v. Thomas, 51-1 U.S.T.C. 617 (D.N.D.Tex.

RRA s Noe Es nol gious no keene ea eame 7

Deltide Fishing & Rental Tools, Inc. v. United States,

279 F.Supp. 661 (D.E.D.La. 1968) ....... 12

Grant Oil Tool Company v. United States, 381 F.2d 389

(Ct.Cl. 1967)

PRE OLIELIORIE | OPIS

ii Index

Page

Heller Trust v. C.1.R., 382 F.2d 675 (9th Cir. 1967) 11

Hillard v. C.I.R., 281 F.2d 279 (Sth Cir. 1960) ..... 14

Hollywood Baseball Association v. Commissioner, 352

F.2d 350 (9th Cir. 1965), vac. & rem., 383 U.S. 824

(1966) ; S.C., 423 F.2d 494 (9th Cir. 1970) ....... 12

Malat v. Riddell, 383 U.S. 569 (1966) ... 2, 5, 6, 7, 8, 9,

10, 11, 12

Municipal Bond Corp. v. CLR. 341 F.2d 683 (8th

SS Seah cee ota Pek ene 7, 9, 10, 11, 12

Municipal Bond Corp. v. C.1.R., 382 F.2d 184 (8th Cir.

RES BA aed tdi S irac thal GA, Shy ha tesa 8

Philber Equipment Corp. v. C.I.R., 237 F.2d 129 (3d

ee aay Ne eer! isco: oe ee 13, 14

Recordak Corp. v. United States, 325 F.2d 460 (Ct.Cl.

tte. Loe eee ota ener nae Sepe OF |

Scheuber v. C.1.R., 371 F.2d 996 (7th Cir. 1967) .... 11, 13

United States v. Bennett, 186 F.2d 407 (5th Cir. 1951) 10,

11, 18

United States v. Healy, 376 U.S. 75, 78 (1964) Lasts 2

Statutes

Oe cascsti cies aah Yo noes tare

| | Reet ara a Fee FO ee er ae

§1231(b)(1)(A) ....... Fe pois Abeta oe

§1231(b)(1)(B) .......... eee

yr Wei nn et cae 2

Mire coe co esis Seay ca eet 3

CERI 6S. 85s ew Se Axeihg

Ms lee ie

Index iii

Page

Other Authorities

Bernstein, ‘‘Primarily For Sale’’: A Semantic Snare,

BO Beams: Ea BOW Be Cee ov be oe eee 9

Comment, 45 Temple L. Q. 291 (1972) ............... 12

Comment, 45 Tulane L. Rev. 432 (1971) ... ee:

Comment, 23 U. Fla. L. Rev. 609 (1971) ............. 12

Comment, 24 Vand. L. Rev. 181 (1970) .............. 12

Hanson, ‘‘When Will The Dealer In Real Estate Re-

ceive Capital Gains?’’ Journal of Taxation 40 (Jan.

SRS te ait Sh rae cl ae ore eso RR 13

Mertens, Law of Federal Income Taxation, Code Com-

SEs Wee ie RIE hs as ss ee ee Siew es 7

In the

Supreme Court of the United States

Octoser Term, 1973

No.

INTERNATIONAL SHOE MACHINE CORPORATION,

PETITIONER,

v.

UNITED STATES OF AMERICA,

RESPONDENT.

PETITION FOR WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS

FOR THE FIRST CIRCUIT

Opinions Below

The Memorandum of Decision of the District Court is

reported at 369 F.Supp. 588 (D. Mass. 1973) and printed

in Appendix B. The opinion of the Court of Appeals is

reported at 491 F.2d 157 (1st Cir. 1974) and printed in

Appendix C. The Memorandum and Order of the Court of

Appeals on petition for rehearing is printed in Appendix E.

9

_

| Jurisdiction

The judgment ‘sought to be reviewed was entered on

January 23, 1974. The order denying petition for rehearing

was entered on February 25, 1974. Jurisdiction to review

the judgment of the Court of Appeals by writ of certiorari

is based on 28 U.S.C. §1254(1). This Petition has been filed

within 90 days after the date on which the petition for

rehearing was denied by the Court of Appeals. 28 U.S.C.

§2101(c). United States v. Healy, 376 U.S. 75, 78 (1964).

Questions Presented

1. Whether the Petitioner’s shoe machines, which were

on. lease to its lease customers for an average of eight

and one half years, were not held primarily for sale to

customers in the ordinary course of its trade or business,

so that gains realized from their sale were taxable as

capital gains under 26 U.S.C. §1231 rather than as ordi-

nary income. ©

2. Whether the Court of Appeals’ construction of 26

U.S.C. §1231(b)(1)(B) is erroneous and contrary to Malat

v. Riddell, 383 U.S. 569 (1966).

Statute Involved

The pertinent provisions of 26 U.S.C. §1231 are lengthy

and are set forth in Appendix A, The portions thereof

directly in issue appear in 26 U.S.C. §1231(b)(1)(B):

‘‘property held by the taxpayer primarily for sale to cus-

tomers in the ordinary course of his trade or business’’ does

not qualify as ‘‘property used in the trade or business.’’

‘

Statement of Case

This is a suit for refund of income taxes and interest

for the years 1964, 1965 and 1966 en gains realized from

the sale of shoe machines on lease for more than 6 months.

Jurisdiction in the District Court was based on 28 U.S.C.

§1340 and §1346(a)(1).

The Petitioner is in the business of manufacturing and

leasing shoe machines. Its purpose and policy with respect

to the machines in question were to lease, not to sell (A. 27,

33, 44, 51-52, 124, 156). This purpose and policy included

striving to maintain its machines on lease and to get even

more lease business (A. 205). Leasing was more profitable

than selling (A. 27, 129), and the overwhelming majority

of the Petitioner’s business was in leasing (A. 212).

The Petitioner offered free service on its lease :na-

. chines, but not on those it sold (A. 31). It maintained no

sales force to sell machines, and did not solicit purchases

(A. 35). Its salesmen received incentive payments for

leases, but not for sales (A. 34, 78), and were not author-

ized to sell machines which were on lease (A. 34, 48, 103).

Its leases contained no purchase options, and specified that

the leased machinery ‘‘shall at all times remain and he

the sole and exclusive property’’ of the Petitioner (A. 32:

Ex. 16). With respect to ail of its shoe machines on

lease, including those in dispute, the Petitioner carried

them on its books in leased equipment accounts (A. 134-5,

140), did not offer them for sale (A. 52, 53), did not

advertise them for sale (A. 27), did not publish any price

lists (A. 29, 31, 60, 159, 173) and did nothing to make

them more attractive for sale (A. 48). Its direct mail

advertising stressed the advantages of leasing (Exs. 150,

151).

During the taxable years, the shoe industry had profit-

able times and more cash (A. 46). At the same time, the

4

new investment tax credit made it attractive for some shoe

manufacturers to consider buying rather than leasing (A.

46, 74). When lessees expressed a desire to purchase

machines on lease, the Petitioner tried to persuade them

not to buy (A. 56, 158, 204, 208-9, 210). The initiative

to buy the machines in question always came from the

lessee (A. 38, 39, 48, 103, 203; Exs. 264, 307-308). Unlike

leasing, such matters were unusual and were referred to

high-level management for consideration and decision (A.

34, 42, 56, 58, 79, 96, 97, 98, 157, 164; Exs. 301, 307).

The Petitioner did all it could to resist and avoid selling

its leased machines (A. 38, 66, 105, 211). It set its prices

high to discourage their purchase (A. 33, 76, 209), and

sold the ones in question only as a last resort (A. 37,

210, 211) after being ‘‘pushed into a corner’’ (A. 165),

which meant pressure from an adamant customer who

would throw the Petitioner out entirely if it did not sell,

thus jeopardizing the Petitioner’s leasing program and

exposing it to competitive losses on new lease business

(A. 203-205).

In the years 1964, 1965 and 1966, certain lease customers

purchased from the Petitioner 147, 69 and 55 shoe ma-

chines, respectively, which had been on lease for more

than 6 months at the time of purchase. The gains realized

from these sales are at issue in this case. The total periods

the machines in question were held by the Petitioner prior

to sale were as follows:

Taxable No. of Average Period

Year Machines Held

1964 147 7.6 years

1965 69 9.8 years

1966 5d 9.1 years

Combined: 271 8.5 years

5

Further, most of the purchases in dispute were made in

bulk by a few large lease customers, and all of tiem were

made by lease customers with respect to machines already

on lease to them (Exs. 7-15).

These purchases constituted generally less than 5% of

the more than 2,600 shoe machines on lease during each

taxable year (Ex. 26). At the same time, lease revenues

increased but revenues from outright sales did not (Ex.

27). In fact, the revenues from the sales in dispute were

only a fraction of the revenues from sales of shoe cement,

and were only 3% of the total gross revenues for the same

vears, whereas revenues from shoe machine leases approxi-

mated 60% of the same total gross revenues (Ex. 27).

For the taxable years, the Petitioner reported capital

gains from the sales in dispute in the amounts of

$437,374.32, $89,845.46, and $133,201.16. The Respondent

determixed these gains to be ordinary income rather than

capital gains on the ground that the shoe machines in

question were includible in the Petitioner’s inventory or

held for sale to its customers in the ordinary course of

business. The Respondent thereupon assessed deficiencies

for these taxable years in the amounts, respectively, of

$107,895.97, $20,549.48 and $30,636.27, which the Petitioner

paid together with interest (Exs. 46). The Respondent

denied the Petitioner’s refund claims.

Although the District Court agreed that ‘‘generally

speaking the purpose of selling its shoe machines was

not of first importance to plaintiff’? (Appendix B, infra,

p. 25), and that the leased shoe machines in question

were not held primarily for sale to customers under the

definition of ‘‘primarily’’ in Malat v. Riddell, 383 U.S.

569, 572 (1966) (Appendix B, infra, p. 28), the District

Court nevertheless concluded that the Petitioner was not

entitled to capital gains treatment under §1231. The Court

of Appeals affirmed, entered judgment for the Respondent,

PRE HEX,

PP PEPER a

6

(Appendix C and D, mfra, pp. 31, 37), and denied the

petition for rehearing (Appendix E, infra, p. 38).

Reasons For Granting The Writ

A. Tue Decision Betow Contravenes Tuis Covrt’s

Decision 1n Malat v. Riddell.

In relevant part, 26 U.S.C. §1231(a), provides that,

‘if, during the taxable year, the recognized gains on sales

or exchanges of property used in the trade or business...

exceed the recognized losses from such sales [or] ex-

changes,...such gains and losses shall be considered as

gains and losses from sales or exchanges of capital assets

held for more than 6 months.’’ Section 1231(b)(1) specifies

that ‘‘the term ‘property used in the trade or business’

means property used in the trade or business, of a charac-

ter which is subject to the allowance for depreciation

provided in section 167, held for more than 6 months...,

which is not — (A) property of a kind which would prop-

erly be includible in the inventory of the taxpayer if on

hand at the close of the taxable year, (B) property held

by the taxpayer primarily for sale to customers in the

ordinary course of his trade or business... .’’

Thus, as prerequisites to capital gain treatment, (1231

requires that the shoe machines in question

(1) be used in the Petitioner’s trade or business,

(2) be subject to the allowance for depreciation,

(3) be held for more than 6 months prior to sale,

(4) not be property of a kind properly includible in

the Petitioner’s inventory if on hand at the close

of the taxable year, and

(5) not be held by the Petitioner primarily for sale to

customers in the ordinary course of its trade or

business.

7

The Respondent disallowed the Petitioner’s claim for

capital gain treatment on the ground that the machines

did not qualify under requirements (4) and (5)! (Exs.

4-5). The Respondent did not dispute that they qualify

under requirements (1), (2) and (3) (Exs. 3-5; A. 140-

141, 216-217).

The key question, then, appears to be whether the shoe

machines in dispute were held by the Petitioner ‘‘ primarily

for sale to customers in the ordinary course of its trade

or business.’’ Accordingly, it seems from the face of the

statute that if the primary purpose for which the Peti-

tioner held the shoe machines in question was for leasing,

not for sale, then they should qualify for capital gains

treatment.

The District Court and the Court of Appeals acknowl-

edged that the word ‘‘primarily”’ in the governing clause

of §1231(b)(1)(B) means ‘‘of first importance’’ or ‘‘prin-

cipally’’ under Malat v. Riddell, 383 U.S. 569, 572 (1966).

Although this Court in Malat was dealing with §1221 rather

than §1231, the clause in question appears in both sections,

and this Court made clear that it was construing the word

‘*primarily’’ in its ordinary, everyday sense and by a

literal reading, Jd. at 571-572, a construction equally appli-

cable to the same word in §1231. Accord, Municipal Bond

1 Requirements (4) and (5) appear to overlap completely. The

cases do not distinguish between them, concluding that if property

is not held primarily for sale it is not properly includible in inventory.

See, e.g., Grant Oil Tool Company v. United States, 381 F.2d 389,

397, 398 (Ct. Cl. 1967) (“Inventory is, in its present context,

simply stated, property that is held for sale . . . To be consistent

with the scope and purpose of §1231, ‘the inventory’ it excludes

must be that from which the taxpayer gets his normal sales profits . . .

Merchandise, to be ‘properly includible’ in ‘the inventory’ that §1231

excludes, must be held for sale at a profit”); Dawson et al. v. Thomas,

51-1 U.S.T.C. 617, 618 (D.N.D.Tex. 1948); Mertens, Law of

Federal Income Taxation, Code Commentary, §1221:2, p. 16. In any

event, the Petitioner keeps no inventory of shoe machines (A. 122-

123) and the shoe machines in question would not be property of

a kind includible therein.

8

Corp. v. C.I.R., 341 F.2d 683, 686-689 (8th Cir. 1965)

(a §1231 case cited with approval in Malat at 571 ftn. 3);

Municipal Bond Corp. v. C.1.R., 382 F.2d 184, 195 (8th

Cir. 1967).

The Malat case involved the sale of real estate whose

resulting profits the taxpayers reported as capital gains.

The undisputed findings in that case were that the tax-

payers, at the time of acquiring the real estate, intended

either to sell the property or develop it for rental,

depending on which course appeared to be most profitable.

Id. 570. The Government argued, and the lower courts

agreed ,that such a dual purpose was not entitled to capital

gains treatment. This Court, however, vacated and re-

manded the case because the courts below applied ‘‘an

incorrect legal standard’’ with regard to how the property

was primarily held. Id. 572.

Thus, in a case where there was admittedly a dual

purpose at the outset in holding property, the ‘‘primarily’’

test as defined by this Court was held to require a finding

one way or the other as to which of the purposes was

the primary one, aud this Court obviously envisioned a

plausible finding that even such a dual purpose for the

entire duration of the holding period could result in capital

gains treatment.

On that basis, this Court would have even less difficulty

with the shoe machines in the case at bar, since the Peti-

tioner here had no dual purpose at the outset in holding

the machines, but was determined throughout to hold them

as equipment for leasing, not for sale. And in fact the

Petitioner held them for this sole purpose for an average

of 8% years per machine. The decision to sell each of

the machines in question came much later at the end of

the holding period, reluctantly and at the time of sale,

at the insistence of the lease customer; and through no

plan or preconception of the Petitioner. Accordingly,

PTR ST

9

these machines appear to fall clearly within the Malat test

to qualify them for capital gains treatment.

However, both courts below openly rejected the words

of 41231 and the Malat test. The District Court stated

that ‘‘the statutory provision should yield or be ignored’’

(Appendix B, infra, p. 28). The Court of Appeals said:

‘‘We cannot agree that Malat is dispositive. Even if

‘primarily’ is defined as ‘of first importance’ or ‘princi-

pally’, the word may still invoke a contrast between sales

made in the ‘ordinary course of... business’ and those

made as liquidations of inventory, rather than between

leases and sales’’ (Appendix C, infra, pp. 33-34). The Court

below relied on Recordak Corp. v. United States, 325 F.2d

460, 463 (Ct. Cl. 1963), for this conclusion, although recog-

nizing the legitimacy of challenges to Recordak’s vitality

in view of Malat (Appendix C, infra, p. 34). Indeed,

one such criticism appears in Bernstein, ‘‘Primarily for

Sale’’: A Semantic Snare, 20 Stan. L. Rev. 1093, 1114

(1968) :

[Recordak’s] reasoning appears to run counter to the

legislative history of the statute, which shows that

‘*primarily’’ was not intended to modify ‘‘in the ordi-

nary course of business’’ but rather to invoke a

contrast between holding for sale and holding for

another purpose. The Recordak approach, further-

more, has been undermined by Malat. Recordak dis-

tinguished only between sales inside and outside the

normal course of the business, in effect ignoring the

word ‘‘primarily’’ despite the court’s implicit claim

to the contrary. This would seem to run counter to

the Malat command that the word ‘‘primarily’’ be

given literal effect (emphasis added).

Furthermore, this Court in Malat approved Municipal

Bond Corporation v. C.1.R., 341 F.2d 683 (8th Cir. 1965),

eas

SS a ara

10

for its construction of ‘‘primarily’’. 383 U.S. 569, 571, ftn.

In Municipal Bond, the court (at 687) relied on United

States v. Bennett, 186 F.2d 407 (5th Cir. 1951), where

it was held that gains from sales of cattle culled from

a breeding herd were entitled to capital gains treatment.

Bennett was also approved in Malat. 383 U.S. 569, 571, ftn.

In addition, Municipal Bond relied on Albright v. United

States, 173 F.2d 339, 344 (Sth Cir. 1949), where the court

held that a capital gain was derived from selling culls

from a dairy herd on a consistent basis, and said that

‘‘a dairy farmer is not primarily engaged in the sale of

beef cattle. His herd is not held primarily for sale in the

ordinary course of his business. Such sales as he makes

are incidental to his business and are required for its

economical and successful management.”’

Here, where certain shoe machines on lease were sold

on an inconsistent basis, where there is no dispute that

the Petitioner was not primarily engaged in seiling shoe

machines and where such sales were clearly incidental to

its lease business, the court’s denial of capital gains treat-

ment runs counter to Malat. The crucial question neverthe-

less has been raised by the Court of Appeals and requires

a definitive answer: What does ‘‘primarily’’ modify?

In view of the importance of the issue with respect to

all taxpayers, including the Petitioner, whose reliance on

the Malat test in §1231 transactions has been rendered

insecure in the First Circuit, granting the writ of certio-

rari would be most appropriate and timely in this case.

B. Tue Decision BeLow AuGMENTs Serious ConFrusion

AND ConFLict AMONG THE CiRcuITs.

The District Court and the Court of Appeals in this

case construed_and applied $1231 so as to augment an

11

existing disarray among several federal courts. Significant

questions are involved:

1. Does ‘‘primarily’’ modify ‘‘for sale’’ or ‘‘in the

ordinary course of business’’? The courts below and the

Court of Claims in Recordak adopted views totally con-

trary to the approaches taken by the Eighth and Fifth

Circuits in Municipal Bond Corporation v. C.I.R., 341 F.2d

683 (8th Cir. 1965), Albright v. United States, 173 F.2d 339

(8th Cir. 1949), and United States v. Bennett, 186 F.2d 407

(5th Cir. 1951), all of which are discussed above. Indeed,

unlike the First Circuit in this case, the Munictpal Bond

court also noted that, ‘‘upon the capital gain issue, purpose

or intention must be determined with respect to each tract

and such purpose may vary with respect to the different

tracts.’’ 341 F.2d at 689-690.

The opinion below is also contrary to the rationale of

Heller Trust v. C.I.R., 382 F.2d 675 (9th Cir. 1967), and

Scheuber v. C.1.R., 371 F.2d 996 (7th Cir. 1967) (purpose

in holding the property is the test under Malat). In

Scheuber, as in Municipal Bond, the court listed the rele-

vant guidelines such as frequency of sales, improvements

(or absence of same) to make the property more market-

able, length of time the property is held, substantiality of

income, purpose of acquisition and extent of advertising;

and the Government agreed that these guidelines were

relevant. 371 F.2d at 998. The decision below ignores these

factors. Indeed, the courts in Heller and Scheuber held

for the taxpayers even though the taxpayers had an inten-

tion to sell the property in question from the outset of

the holding period, although it was not the primary inten-

tion. Here, there was no such intention to sell from the

outset, and the Petitioner held the machines on lease for

an average of 814 years, received rent on them, depreciated

them, repaired them for further renting, and wanted to

keep them on lease throughout the holding period.

12

2. Does Corn Products Co. v. Commissioner, 350 U.S.

46 (1955), apply to §1231 assets? The District Court held

that ‘‘generally speaking the purpose of selling its shoe

machines was not of first importance to plaintiff,’ but

denied capital gains treatment despite Malat by invoking

Corn Products and concluding that ‘‘the income from

plaintiff’s questioned sales arose from the everyday oper-

ation of the business and did not represent liquidation

of an investment’’ (Appendix B, infra, p. 25). The Court

of Appeals below did not expressly cite Corn Products,

but implicitly relied on it by affirming the District Court

and relying heavily on the identical rationale (Appendix

C, infra, p. 34). In Corn Products this Court held that

the taxpayer’s corn futures did not qualify as ‘‘capital

assets’’ under $1221 because there was no real difference

between its corn futures and its raw corn, which in no

event would be a ‘‘capital asset.’’ The reasoning and

factual basis for Corn Products would seem to render it

inapposite to the case at bar.

Extension of the Corn Products doctrine to §1231 assets

has been explicitly rejected in Deltide Fishing & Rental

Tools, Inc. v. United States, 279 F.Supp. 661 (D.E.D. La.

1968), but attempted in Hollywood Baseball Association v.

Commissioner, 352 F.2d 350 (9th Cir. 1965), vacated and

remanded [for further consideration in light of Malat v.

Riddell, 383 U.S. 569 (1966)], 383 U.S. 824 (1966); S.C.,

423 F.2d 494 (9th Cir. 1970). The Hollywood Baseball

approach has been uniformly criticized by commentators

in legal journals. Comment, 24 Vand. L. Rev. 181 (1970).

Comment, 45 Tulane L. Rev. 482 (1971). Comment, 22

U. Fla. L. Rev. 609 (1971). Comment, 45 Temple L. Q. 291

(1972). At the same time, the Court of Claims has refused

to extend Corn Products to §1231, Grant Oil Tool Co. v.

United States, 381 F.2d 389, 398 (Ct. Cl. 1967). Such

extension has not been successful in any other circuit, and

13

is plainly contrary to the approaches taken in Municipal

Bond Corporation v. C.1.R., 341 F.2d 683 (8th Cir. 1965) ;

Albright v. United States, 173 F.2d 339, 344 (8th Cir.

1949); United States v. Bennett, 186 F.2d 407 (5th Cir.

1951) ; and Scheuber v. C.I.R., 371 F.2d 996 (7th Cir. 1967).

The law seems to be in utter confusion in this regard.

See Hanson, ‘‘When Will the Dealer in Real Estate Re-

ceive Capital Gains?’’ Journal of Taxation 40 (Jan. 1970).

3. Is there a ‘‘rental-obsolescence’’ requirement under

$1231? Recognizing the conflict among the federal courts,

the court below sought to distinguish e-vtain contrary

decisions by characterizing them as ‘‘rental-obsolescence’’

decisions ‘‘which hold that the sale of rental equipment,

no longer useful for renting, is taxable at capital gains

rates’’ (Appendix C, infra, p. 35). However, this charac-

terization appears erroneous since those decisions did not

turn on any such factor, are inconsistent with the approach

taken by the court below, appear to follow the words of

§1231, and anticipate the Malat rationale.

For example, in Philber Equipment Corp. v. C.1.R., 237

F.2d 129 (3d Cir. 1956), the court at great length inquired

into the purpose of the taxpayer’s holding the property

in question. It may be that in Philber ‘‘equipment was

sold only after its rental income-producing potential had

ended’’, but that circumstance was determined by the tax-

payer’s decision to sell, not by any independent fact that

made the equipment worthless for rental purposes. Indeed,

in Philber, the taxpayer testified:

‘‘It is our intention always that we will take a fleet

back to dispose of it in some manner. If we can

release it favorable [sic], we rel-lease [sic]. it, but

if we can sell it more favorably, we will, of course,

sell it.’? 237 F.2d at 132, ftn.

14

No such dua! purpose is present in the case at bar. Indeed,

the facts in Philber showed that, unlike the Petitioner here,

the taxpayer in Philber always knew throughout the hold-

ing period that each piece of rented equipment would be

sold. The fact that the ‘‘sales were the natural conclusion

of a vehicle rental business cycle’’ was not a determining

factor in that case, and was not held to be a requirement

for capital gains treatment but rather a circumstance

showing that the sales were incidental to the taxpayer’s

renta! business. The case at bar is stronger for the

taxpayer than Philber since the Petitioner here had no

dual purpose during the holding period of each machine

in question. And even under Philber, there is no dispute

that the sales of Petitioner’s shoe machines were incidental

to its rental business. '

The same approach was taken by the court in Hillard

v. C.1.R., 281 F.2d 279 (Sth Cir. 1960). Rental vehicles

there had a certain rental life for depreciation purposes.

That factor was mentioned by the court only to show,

as in Philber, that the sales of those rental vehicles were

incidental to the taxpayer’s rental business for purposes

of determining the taxpayer’s purpose in holding the

vehicles under §1231. The court did not hold or even

suggest, as the opinion below does, that rental equipment

must become useless or worthless in order to qualify for

capital gains treatment under $1231. The Petitioner has

found no opinion which so holds, except for the opinions

below, and it now appears that the law of the First Circuit

cannot be reconciled with the law prevailing elsewhere.

4. Does §1231 require a liquidation of inventory? The

decision below holds that the word ‘‘primarily”’ in §1231

(b)(1)(B) invokes ‘‘a contrast between sales made in the

‘ordinary course of...business’ and those made as

liquidations of inventory, rather than between leases and

sales’’ (Appendix C, infra, pp. 33-34) (emphasis added). °

oan

Later, the opinion statcs: ‘Even ‘accepted and predicable’

sales might not...oceur in the ‘ordinary course of...

business’, For example, a final liquidation of inventory,

although accepted and predictable, would normally be

eligible for capital gains treatment’’ (Appendix C, infra,

p. 35) (emphasis added).

The opinion cites no authority for this ‘‘inventory

liquidation’’ concept, and the Petitioner has not found any.

In fact, §1231 itself shows the concept to be erroneous,

because §1231(b)(1)(A) denies capital gains treatment

where the property in question is ‘‘property of a kind

which would properly be includible in the inventory of the

taxpayer if on hand at the close of the taxable year’’

(emphasis added).

The foregoing conflicts among the courts of appeals and

the Court of Claims, and the confusion which now prevails

in §1231 cases, warrant the granting of the writ of certio-

rari to review the decision below.

C. Tue Proper Construction or §1231 SHovtp Be

DEFINED AND SETTLED By THis Court.

The District Court was troubied by the ‘‘apparent incon-

sistency’’ in its opinion, and was led to the astonishing

conclusion ‘‘that the statutory provision should yield or

be ignored’’ (Appendix B, infra, p. 28). It attempted to

‘‘make an effort at reconciliation’’ and proceeded with an

‘tex post facto approach’’ (Appendix B, infra, pp. 28-29)

and an analysis which paints with such a broad brush that,

if it were truly the law, no taxpayer could predict with

any satisfactory degree of certainty the tax consequences

of his $1231 transactions, Indeed, the District Court ad-

mitted that ‘‘the particular leased machines which would

be sold could not be identified at any particular time before

sale’? (Appendix B, infra, pp. 28-29). And, although it

(

16

concluded that ‘‘after their sale’’ they ‘‘had been held

primarily for salé’’, the District Court still ne ver identified

which of them were so held, why they were diferent from

others, and what specific facts colored these transactions.

Moreover, the District Court’s conclusion is plainly con-

tradicted by its opening observation that the Petitioner

‘had a ‘‘general purpose of holding leased machines pri-

marily for leasing’’ (Appendix B, infra, p. 28).

The Court of Appeals acknowledged that ‘‘the case

raises what has become a repeating source of difficulty

‘in applying §1231(b)(1)(B) ...’’ and posed several ques-

tions raised in this Petition (Appendix C, infra, p. 32).

The court’s observation is plainly illustrated by the

numerous federal cases and law review comments already

cited'and discussed above. ;

_ The inequity in the present state of the law lies not

only in the Petitioner’s case, which it believes has been

wrongly decided,? but also in the fact that in $1231

transactions, taxpayers in Boston, San Francisco, Atlanta

_ and St. Louis will be governed by different rules and may

well achieve different results based on the accident of their

location. If their circumstances permit, they may be

fortunate enough to be able to shop for the most suitable

forum to resolve their tax disputes. Further, this legal

2 The Petitioner strongly believes that the case has been wrongly

decided, not only for the reasons already set forth above, but also

for the reason that the opinion of the Court of Appeals contains

statements and conclusions of fact which were not mentioned by the

District Court and which the Petitioner believes cannot be supported

and are often contradicted by the record. See Memorandum and

Order denying petition for rehearing, Appendix E, infra, p. 38.

Certain other factual statements by the District Court are alsd, in the

Petitioner's view, not supported by the récord. There is no credibility

issue since the District Court decided the case on a completed record,

including transcripts, without hearing any testimony, the original

trial judge having withdrawn from the case after trial. However,

in order to preserve the brevity of this Petition, these matters have

not been detailed here. The reasons for granting the writ include,

but do not turn on, these matters.

17

situation renders tax planning exceedingly difficult for

numerous businesses across the United States, and creates

perplexing uncertainties which can be finally resolved only

by this Court.

Conclusion

For these reasons, a writ of certiorari should issue to

review the judgment and opinion of the Court of Appeals

for the First Circuit.

Respectfully submitted,

Evan Y. SEMERJIAN

Hare anp Dorr

28 State Street

Boston, Massachusetts 02109

Counsel for Petitioner

18 |

APPENDIX A

26 U.S.C.

Part [IV — Specrat Ruues For Determininc

CaprraL Garys anv Losses

= = > =

§ 1231. Property used in the trade or business and invol-

untary conversions.

(a) General rule.—If, during the taxable year, the

recognized gains on sales or exchanges of property used

in the trade or business, plus the recognized gains from

the compulsory or involuntary conversion (as a result of

destruction in whole or in part, theft or seizure, or an

exercise of the power of requisition or condemnation or

the threat or imminence thereof) of property used in the

trade or business and capital assets held for more than

6 months into other property or money, exceed the recog-

nized losses from such sales, exchanges, and conversions,

such gains and losses shall be considered as gains and

losses from sales or exchanges of capital assets held for

more than 6 months. If such gains do not exceed such

losses, such gains and losses shall not be considered as

gains and losses from sales »r exchanges of capital assets.

For purposes of this subsection—

(1) in determining under this subsection whether

gains exceed losses, the gains described therein shall

be included only if and to the extent taken into account

in computing gross income and the losses described

therein shall be included only if and to the extent

taken into account in computing taxable income, ex-

cept that section 1211 shall not apply; and

(2) losses (ineluding losses not compensated for

by insurance or otherwise) upon the destruction, in

whole or in part, theft or seizure, or requisition or

19

condemnation of (A) property used in the trade or

business or (B) capital assets held for more than

6 months shall be considered losses from a compulsory

or involuntary conversion.

In the case of any involuntary conversion (subject to the

provisions of this subsection but for this sentence) arising

from fire, storm, shipwreck, or other casualty, or from

theft, of any property used in the trade or business or

of any capital asset held for more than 6 months, this

subsection shall not apply to such conversion (whether

resulting in gain or loss) if during the taxable year the

recognized losses from such conversions exceed the recog-

nized gains from such conversions.

(b) Definition of property used in the trade or business

—For purposes of this section—

(1) General rule.—The term ‘‘property used in

the trade or business’? means property used in the

trade or business, of a character which is subject to

the allowance for depreciation provided in section 167,

held for more than 6 months, and real property used

in the trade or business, held for more than 6 months,

which is not—

(A) property of a kind which would properly be

includible in the inventory of the taxpayer

if on hand at the close of the taxable year,

(B) property held by the taxpayer primarily for

sale to customers in the ordinary course of

his trade or business....

20

APPENDIX B

Untrrep States District Court

District or MassacHUSETTS

Crvm. Action No. 70-317-G

INTERNATIONAL SHOE Macutne CorporATION,

PLAINTIFF,

v.

Unrtep States or AMERICA,

DEFENDANT.

MEMORANDUM OF DECISION

July 30, 1973

Garrity,J. This is a tax refund suit in which the plain-

tiff taxpayer asserts that the Commissioner of Internal

Revenue erroneously treated income realized from the

plaintiff’s sales of certain shoe machines as ordinary

income instead of treating the income under the capital

gains provisions of the Code. The court has jurisdiction

under 28 U.S.C. §§ 1340, 1346(a)(1).

The plaintiff, a well-known manufacturer of shoe ma-

chinery, is a Massachusetts corporation with its principal

place of business in Brighton, Massachusetts. During the

years in question—1964 through 1966—the main source of

its business income derived from the leases of its shoe

machinery equipment to shoe manufacturers throughout

the United States and abroad. During the years 1964, 1965

and 1966, plaintiff sold, respectively, 147, 69 and 55 shoe

machines to customers who, at the time of the sales, had

been leasing the machines for at least six months. For

the taxable years in question, plaintiff reported capital

gains from these sales in the amounts of $437,374.32,

$89,845.46 and $133,201.16. The Commissioner’s response

in each instance was to assess a deficiency, on the ground

21

that the shoe machines in question were includable in

plaintiff’s inventory or.were held for sale to customers

in the ordinary course of business and that, in either

event, the sales did not qualify under 26 U.S.C. § 1231 for

capital gains treatment. The plaintiff paid deficiencies in

the amounts of $107,895.97 for 1964, $20,549.48 for 1965,

and $30,636.27 for 1966, with interest for all these years,

and filed claims for refund, which were denied in all three

eases. It then timely filed this action. After trial and the

filing cf post-trial memoranda, a situation arose requiring

the disqualification of the trial judge and the case was

reassigned. The parties agreed to submit on the record,

filed further memoranda and presented oral arguments.

Plaintiff contends that the income from the sales in

question should be treated as capital gains under 26 U.S.C.

§ 1231, because the machines were not ‘‘property held by

the taxpayer primarily for sale to customers in the ordi-

nary course of his trade or business,’’ § 1231(b)(1)(B).

Defendant agrees that the issue before the court concerns

the applicability of this quoted subsection, and the parties

thus assume that the sales in question conformed other-

wise to the requirements of § 1231. They assume, in other

words, that the machines were ‘‘used in the trade or

business’’ and were ‘‘subject to the allowance for depreci-

ation provided i: section 167.’’ Plaintiff has argued that

the sales in question. were extraordinary events because its

policy has consistently been to lease, not sell, its shoe

machines. Undoubtedly plaintiff’s main interest was, dur-

ing the years in question and earlier, that of leasing its

shoe machines. Although it sold new, non-leased machines

to subsidiaries and affiliates in foreign countries and to a

very few domestic companies, these sales, the income from

1 The parties have settled a related suit, docket number C.A. 71-

515-G, concerning a deduction for bad debt reserves. Judgment in

that case will be entered for the plaintiff for $12,228.09 plus interest.

a SRO EO OE a

DELLE TOL GEE AI IG EIN ee ae -”

22

which plaintiff reported as ordinary income, comprised

approximately 15, 6 and 6 percent of total sales during

the years involved here.

Until 1963 plaintiff’s sales of machines to customers then

leasing the machines consistently constituted less than 1%

of plaintiff’s gross revenues. Plaintiff’s sales to its lease

customers increased tenfold in 1963 over 1962 and more

than thirtyfold in 1964 over 1962; revenue from such sales

between 1964 and 1966 comprised, however, only 7, 2 and

2 percent of gross revenues. Of further importance are

comparisons between lease and sales revenue during the

tax years in question. The ratios of lease revenues to sales

of leased machines during these years were 8, 40 and

30 to 1.

While sales of leased shoe machines did not, during the

tax years in question, make up a large portion of plaintiff’s

business, they nonetheless increased sharply in those years

over prior years. Plaintiffs attribute the increase to several

factors. The investment tax credit, enacted in 1962, made

it attractive for shoe manufacturers to buy shoe machinery

rather than lease it. Customers were also aware of the

decree entered against plaintiff’s principal competitor in

United States v. United Shoe Machinery Corporation, D.

Mass. 1953, 110 F.Supp. 295, aff’d per curiam, 1954, 347

U.S. 521, which ordered United Shoe, inter alia, not to

offer to lease its machines unless it also offered to sell

them. Plaintiff attributes much significance to the fact

that the interest in purchasing shoe machines, rather than

leasing, originated with the customer. Plaintiff points out

that it never developed a sales force, never solicited pur-

chases, often attempted to dissuade customers from pur-

chasing, set prices high to make purchasing unattractive,

and persisted, even in the face of customers’ demand, in its

policy of leasing shoe machinery equipment.

While these facts are pertinent, they do not paint a

23

complete picture. When customers expressed an interest

in purchasing the machine that they were leasing, plaintiff

did not simply say, ‘‘We do not sell our machines.’’ Such

a course of conduct would have been harmful to plaintiff’s

customer relations; not surprisingly, plaintiff did not

engage in it. Paul Hirsch, plaintiff’s Vice President of

Sales during 1964 through 1966, testified that ‘‘if a

customer asked us specifically and indicated a serious

desire and wanted to talk about purchase, I mean we had

no hesitation; we would tell him the price.’’ Plaintiff

adopted a policy of selling if the customer was persistent

enough, and a concomitant policy of non-discrimination;

as Mr. Hirsch put it, ‘‘{ W]e were also aware of the fact

that we have to treat everyone alike. We can’t refuse to

sell to some and sell to others.’’ Plaintiff made these

decisions when demand first started to increase rapidly

and selling became, if not a common, at least an accepted

aspect of plaintiff’s business. According to Michael M.

Becka, plaintiff’s executive vice president and general

manager, the determinations leading to these decisions in-

cluded ‘‘the fact that we didn’t want to lose the sale to

[our] competition.’’ After these decisions were made, it

was no longer necessary for sales personnel to seek a

decision from the highest level of management on each

purchase request. The policy was simply to sell if the

customer insisted on buying, despite the company’s prefer-

ences. The customer did not have to threaten to sue

plaintiff or to take his business elsewhere unless plaintiff

sold. In order to maintain good relations, plaintiff agreed

to sell when the customer leasing its machines evidenced

a strong interest in purchasing. In a competitive market,

plaintiff has no ultimate choice but to adopt these policies.

In plaintiff’s view the evidence establishes that the

machines leased to cust}mers for morc than six months

and then sold to the lessees were held by plaintiff primarily

ETE GE NSLP FOGLE PANT EO EE 1 eines

24

for lease and not for sale and, moreover, that the machines

were not held and sold in the ordinary course of business

_ because the sales were extraordinary events. We shall

first state why we disagree with the latter contention.

As we have found, when the demand from plaintiff’s

customers to purchase machines then on lease began to

increase, plaintiff made a pdlicy decision to try to dissuade

the customer, but to sell if the customer insisted. The fact

that plaintiff did not have a sales force is not of any

particular moment, because, first, the customers initiated

the negotiations and thus no selling effort was required of

the plaintiff and, second, personnel trained in the leasing

of shoe machines could, and did, consummate the sales

themselves. Moreover, the products involved were, of

course, the very same produets that plaintiff leased and

thus could not be said to be unusual property necessitating

the hiring of specially-trained sales personnel. Finally,

while the income from the sales did not constitute a major

portion of the plaintiff’s business, the sales were certainly

substantial in number, totalling 271 over the three-year

period. From the point when plaintiff decided to sell its

leased machines to customers who expressed a strong

desire to buy them, the plaintiff operated a business in

which selling was an accepted and prec:-table part of its

business. Plaintiff has not suggested that the machines

it sold differed in any way or were initially handled in

any different manner from the rest of its machines, nor

has it suggested that the proceeds of the sales were used

in any different manner from the proceeds of the leases.

On all the facts we conclude that the 271 machines were

held, and sold, in the ordinary course of plaintiff’s business.

See S.E.C. Corp. v. United States, $.D. N.Y. 1956, 140

F.Supp. 717.

In support of its contention that the machines in ques-

tion were held by plaintiff ‘‘primarily’’ for lease, and not

ESS PR LI ay es Oe ae LS — .

a it ROTO LRT Ee 5 OE EN PEPPER SLE OM SO EE Ae ees IS .

x ve = aN ee RE eye Sa ee?

25

for sale, plaintiff invokes the Supreme Court’s opinion in

Malat v. Riddell, 383 U.S. 569. In Malat, the taxpayer

had participated in acquiring a parcel of land; the purpose

of the venture was disputed by the parties; it was either

to develop the land for rental purpose, to sell it, or perhaps

merely to do whatever seemed most profitable in light of

future events. When selling came to appear to be the

most advantageous course, taxpayer sold. On those facts

the lower court found, and the Court of Appeals agreed,

that the primary purpose became one of selling, that the

sale was not the liquidation of an investment, and that

the income from the sale was thus ordinary income. In

a brief opinion, the Supreme Court reversed and remanded

for fresh findings of fact, giving its definition of ‘‘pri-

marily’’ as ‘‘of first importance’’ or ‘‘principally.’’ The

Court expressly disapproved of lower court holdings in

similar eases based on defining ‘‘primarily’’ to include

‘*substantially.’’ The Court added, ‘‘The purpose of the

statutory provisions with which we deal is to differentiate

between the ‘profits and losses arising from the everyday

operation of a business’ on the one hand (Corn Products

Co. v. Commissioner, 350 U.S. 46, 52) and ‘the realization

of appreciation in value accrued over a substantial period

of time’ on the other. (Commissioner v. Gillette Motor Co.,

364 U.S. 130, 134.)’’ Id. at 572.

When applied to this case, the two key pronouncements

by the Court in Malat—with respect to the word ‘‘pri-

marily’’ and to the purpose of the phrase ‘‘held by the

taxpayers primarily for sale in the ordinary course of his

trade or business’’—appear to lead to conflicting results.

On the one hand, generally speaking the purpose of selling

its shoe machines was not of first importance to plaintiff.

But on the other, the income from plaintiff’s questioned

sales arose from the everyday operation of the business

and did not represent liquidation of an investment.

EAE Ee ce Ni nr ei oe ee Fe —— —

me e — ie IE OIE ECE TRY a

26

In Corn Products Co. v. Commissioner, 1955, 350 U.S. 46,

the Supreme Court had occasion to discuss the broad policy

factors underlying the capital gain provisions. There the

taxpayer established a large position in corn futures in

order to insure that it would have a supply of corn for

use in its manufacturing operations. It sold or took

delivery on the future contracts as it deemed expedient

in light of the market supply. In upholding the lower

court’s conclusion that because the futures were bought

as an integral part of the plaintiff’s business operations,

the futures were not capi.al assets, the Court asserted:

‘‘Congress intended that profits and losses arising from

the everyday operation of a business be considered as

ordinary income or less rather than capital gain or loss.

The preferential treatment . . . applies to transactions in

property which are not the normal source of business

income. Jt was intended ‘to relieve the taxpayer from

...@xcessive tax burdens on gains resulting from a con-

version of capital investments, and to remove the deterrent

effect of those burdens on such conversions,’ Burnet v.

Harmel, 287 U.S. at 106.’’ 350 U.S. at 52. Although

plaintiff asserts that Corn Products involved the definition

of capital asset under the predecessor to 26 U.S.C. § 1221,

and did not involve construction of the phrase ‘‘held by

the taxpayer primarily for sale to customers in the ordi-

nary course of his trade or business,’’ the plaintiff has

minimized the significance of the Supreme Court’s having

specifically quoted from Corn Products in its Malat

opinion, which did deal with that phrase, albeit in a

§ 1221 context.

Recognizing the impact on its case that application of

the Corn Products principles would have, plaintiff con-

tends that Corn Products should not be applied to a case

arising under § 1231 but should be restricted to § 1221

cases. We do not agree. In the first place, the general

VEEN SEN SEY Pha elt Ie ELAN LANAI EG Sg i atc je a

. PP Nae PLOT ON DOG SOME TDN Gt ALALY ARON SAL LE ERGOT G2 PMG Ce SRE ete se

27

principles enumerated in Corn Products would be signifi-

cant in any case where there is a question whether a

business disposition of its products is to be accorded

capital gain or ordinary income treatment. Secondly, the

phrase in Malat that the Supreme Court construed, using

Corn Products as one of its guides, is identical to the

phrase in § 1231 which plaintiff invokes here. Sections

1221(1) and 1231(b)(1)(B) both exclude from capital gains

treatment income realized from sales of ‘‘property held

by the taxpayer primarily for sale to customers in the

ordinary course of his trade or business ....’? Thirdly, the

Court of Appeals for the Ninth Circuit, in Hollywood Base-

ball Assn. v. C.1.R., 9 Cir. 1970, 423 F.2d 494, held that

Corn Products applies to § 1231 assets in an opinion analyz-

ing a contrary holding in Deltide Fishing & Rental Tools

v. United States, E.D. La. 1968, 279 F.Supp. 661.

One of the arguments advanced by plaintiff was appar-

ently not presented to the court in the Hollywood Baseball

case, namely, that after the Corn Products decision Con-

gress enacted § 1245 in an effort to recoup losses in revenue

due to capital gains treatment of certain sales of property

on which taxpayers had taken depreciation deductions;

and there would be no need for such a section if Congress

had intended that the Corn Products decision apply to

§ 1231. See Note, 24 Vand. L. Rev. 181, 188 (1970). The

difficulty with this argument lies in its premise that gains

realized upon the sale of any and all property integrally

related to the business will under the Corn Products case

be treated as ordinary income. But the Corn Products

decision should not be read so broadly. It would, for

example, have no bearing on the sale of an oil drilling rig

by an oil company, see R. E. Cushing v. Commissioner,

11 T.C. Mem. Dee. 396, or of logging equipment by a lumber

company, see F’, M. Converse v. Earle, 51-2 U.S.T.C. 19481.

Assuming the other requirements in § 1231 were satisfied,

OSA EE US ATE SPER EROTIC we rep enatees ™ = “ a

28

Corn Products would not operate to exclude income from

the sales of such property from e¢spital gains treatment.

Therefore the application of the general Corn Products

principles outlined above, re-asserted in Malat, is not

inconsistent with the intent of Congress in enacting § 1245.

Returning to § 1231(b)(1)(B), the question becomes

whether the fact that plaintiff’s leased machines were,

generally speaking, not held by the taxpayer primarily

for sale to customers precludes applicability of the rule

of the Corn Products case. We believe that it does not.

If the apparent inconsistency should be irreconcilable,

we believe that cases such as Hollywood Baseball Assn. v.

C.LR., supra, Recordak Corporation v. United States,

Ct. Cl, 1963, 325 F.2d 460, and Continental Can Co. v.

United States, Ct. Cl., 1970, 422 F.2d 405, indicate that

the statutory provision should yield or be ignored. We

would prefer to eschew the type of elaborate rationale

found in those decisions and rely upon the principle

of statutory construction of revenue laws stated in the

opinion in the Malat case at 571-572, ‘‘Departure from

a literal reading of statutory language may, on occasion,

be indicated by relevant internal evidence of the statute

itself and necessary in order to effect the legislative

purpose.’’

We shall, however, make an effort at reconciliation. It

seems to us that the plaintiff’s general purpose of holding

leased machines primarily for leasing them does not

‘necessarily negate a finding that some of them were in

fact held primarily for sale. The volume of previous

sales of leased machines as an accepted part of the tax-

payer’s regular business together with growing competi-

tion made it predictable and indeed inevitable that sub-

stantial numbers of the machines out on lease would be

sold. While the particular leased machines which would

be sold could not be identified at any particular time before

29

sale, it may fairly be said after their sale that they had

been held by the taxpayer primarily for sale. We do not

consider that such an ex post facto aproach would be valid

generally as, for example, in automobile and truck rental

cases in which the sales of the rental equipment occurred

as ‘‘the natural conclusion of a vehicle rental business

eycle.’’ Philber Equipment Corp. v. Commissioner, 3 Cir.

1956, 237 F.2d 129, 132, Hillard v. Commissioner, 5 Cir.

1960, 281 F.2d 279. But in our view it is appropriate in

situations like the instant case where market forces induce

the taxpayer ‘to sell as well as rent its equipment long

before it becomes obsolete in order to maintain its com-

petitive position. See Bernstein, ‘‘Primarily for Sale’’:

A Semantic Snare, 20 Stan. L. Rev. 1093, 1115-1116 (1968).

Finally, we rely upon the reasoning in the Recordak

case, supra, at 463, as follows:

Nor can plaintiff sueceed by hitching its wagon to the

word ‘‘primarily.’’ Whatever the precise scope of

that troublesome term in other contexts, it does not

exclude from ordinary income the proceeds of sales

by one, like plaintiff, who conducts a dual enterprise

involving both rentals and sales of the same type of

goods. In that setting, ‘‘primarily’’ invokes a con-

trast, not between selling and renting, but between

selling in the ordinary course of business and selling

outside of that normal course: Accordingly, if the

entrepreneur holds out his wares either for sale or

for rental, the taxation of his business gain from

sales does not depend upon a comparison of sales to

rentals in the particular year. ... Regardless of that

ratio, the goods are held ‘‘primarily for sale to cus-

tomers in the ordinary course of .. . trade or business”’

because they are regularly offered for sale to cus-

tomers as part of the normal operation of the enter-

‘on

prise. No case of this kind has allowed capital gains

treatment. _

Paraphrasing the quoted language, it seems to us that in

this setting'‘‘primarily’’ invokes a contrast not between

selling and leasing, but between selling and investing,

whether the investment be in plant equipment or in the

trading markets. The only reason that plaintiff normally

leased its machines instead of sold them was that leasing

‘was the more profitable method of disposition; plaintiff

has not shown that its leasing business was investment-

oriented or that its leased machines were converted invol-

_ untarily. Plaintiff has not suggested, and we do not think

there is, any policy reason that would justify granting

preferential tax treatment on the distinction that plaintiff

normally leased, rather than sold, its shoe machines.

Indeed, we believe that to grant such relief in the cireum-

stances of this case would create a loophole in the capital

gains provisions finding no support in legislative history.

Accordingly, judgment will be entered for the defendant.

(s) W. Arruur Garrity, Jr.

United States District Judge

31

APPENDIX C

United States Court of Appeals

For the First Circuit

No. 73-1337

INTERNATIONAL SHOE MACHINE CORPORATION,

PLAINTIFF, APPELLANT,

v.

UNITED STATES OF AMERICA,

DEFENDANT, APPELLEE.

APPEAL FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MASSACHUSETTS

Before Corrin, Chief Judge,

Auprich and McEnrtes, Circuit Judges.

Evan Y. Semerjian, with whom James D. St. Clair and Hale and

Dorr were on brief for appellant.

Joseph M. McManus, Attorney, Tax Division, Department of

Justice, with whom Scott P. Crampton, Assistant Attorney General,

James N. Gabriel, United States Attorney, Meyer Rothwacks, and

Ernest J. Brown, Attorneys, Tax Division, Department of Justice,

were on brief, for appellee.

January 23, 1974

Corrin, Chief Judge. Appellant taxpayer contends that

the Commissioner of Internal Revenue erroneously treated

income realized from the appellant’s sales of certain shoe

machines as ‘‘property held by the taxpayer primarily for

sale to customers in the ordinary course of his trade or

business’’, 26 U.S.C. § 1231(b)(1)(B), thereby taxing it

as ordinary income instead of treating it under the capital

gains provisions of the Code, and assessing deficiencies

against the taxpayer. After having paid the deficiencies,

the appellant filed claims for refunds, which were denied,

32

and then instituted the present case. The district court

upheld the Commissioner’s disposition.

It is undisputed that during the years in question, 1964

through 1966, appellant’s main source of income derived

from the leases of its shoe machinery equipment, rather

than from their sales. The revenue from sales of the leased

machinery comprised, respectively, only 7 per cent, 2 per

cent, and 2 per cent of appellant’s gross revenues. In fact,

because the appellant preferred the more profitable route

of leasing its machines, it never developed a sales force,

never solicited purchases, set prices high to make pur-

chasing unattractive, and even attempted to dissuade cus-

tomers from purchasing them.

Yet the district court found that, beginning in 1964,

when the investment tax credit made it more attractive for

shoe manufacturers to buy shoe machinery rather than to

lease it, the selling of machinery became an accepted and

predictable, albeit small, part of appellant’s business. Since

appellant’s chief competitor was selling leased shoe ma-

chines, it was necessary for appellant to offer its customers

the same option. During the years in issue, appellant never

declined to quote a price, nor did it ever decline to make

a sale if the customer was persistent. Unlike previous

years, purchase inquiries were referred to the appellant’s

vice president for sales, normally charged with selling new,

non-leased machines, whereupon a price was negotiated.

A schedule was prepared, indicating the sales price of

leased machines, based upon the number of years that

the machines had been leased. In total, 271 machines were

sold to customers who, at the time of the sales, had been

leasing the machines for at least six months.

The case raises what has become a repeating source of

difficulty in applying § 1231(b)(1)(B), which denies highly

favored capital gains tax treatment to ‘‘property held...

primarily for sale to customers in the ordinary course of

33

his trade or business’’. In particular, does the word

‘*primarily’’ invoke a contrast between sales and leases,

as the appellant contends, or between sales made in the

ordinary course of business and non-routine sales made as

a liquidation of inventory? And, if the latter, how can

sales made in the ordinary course of business be distin-

quished from a liquidation of inventory?

In support of its contention that ‘‘primarily’’ refers to

a contrast between sales and leases, appellant relies upon

Malat v. Riddell, 383 U.S. 569 (1966). There, the taxpayer

purchased a parcel of land, with the alleged intention of

developing an apartment project. When the taxpayer

confronted zoning restricticns, he decided to terminate the

venture, and sold his interest in the property, claiming

a capital gain. The lower courts found, however, that the

taxpayer had had a ‘‘dual purpose’’ in acquiring the land,

a ‘‘substantial’’ one of which was to sell if that were to

prove more profitable than development. Therefore, since

the taxpayer had failed to establish that the property was

not held primarily for sale to customers in the ordinary

course of his business, his gain was treated as ordinary

income. The Supreme Court vacated and remanded the

case, stating that the lower courts had applied an incorrect

legal standard when they defined ‘‘primarily’’ as merely

‘*substantially’’ rather than using it in its ordinary, every-

day sense of ‘‘first importance’’ or ‘‘principally’’. Al-

though the Court in Malat was dealing with § 1221, rather

than § 1231, the same clause appears in both sections.

Appellant argues that the present case is analogous, since

the ‘‘first’’ and ‘‘principal’’ reason for holding the shoe

uiachinery was clearly for lease rather than for sale.

We cannot agree that Malat is dispositive. Even if

‘*primarily’’ is defined as ‘‘of first importance’’ or ‘‘prin-

cipally’’, the word may still invoke a contrast between

sales made in the ‘‘ordinary course of... business’’ and

34

those made as liquidations of inventory, rather than be-

tween leases and sales. Malat itself concerned the dual

purposes of developing an apartment complex on the land

and selling the land. Although these two possible sources

of income might be characterized as income from ‘‘lease’’

or ‘‘sale’’, a more meaningful distinction could be made

between on-going income generated in the ordinary course

of business and income from the termination and sale of

the venture. See Continental Can Co. v. United States,

422 F.2d 405, 411 (Ct. Cl. 1970) ; Recordak Corp. v. United

States, 325 F.2d 460, 463 (Ct. Cl. 1963).

We recognize that Recordak, invoking a contrast between

‘*selling in the ordinary course of business and selling

outside that normal course’’ was cited by the Supreme

Court in Malat within a footnote which also listed the

courts of appeals decisions then in conflict over the mean-

ing of ‘‘primarily’’, supra, 383 U.S. at 571 n. 3. Given,

however, that Recordak was not directly included within

the list, but merely cited as a case which had also

addressed the question, we think that Recordak’s interpre-

tation of the contrast invoked by the word ‘‘primarily’’

remains undisturbed by the Court’s opinion. Beyond

semantics, an additional justification for the interpretation

becomes obvious when one applies appellant’s logic to a

not unrealistic business situation: to rest the word ‘‘pri-

marily’’ on the distinction between lease and sale income

would lead to the absurd result that whenever lease income

exceeded sale income on the same item, the sale income

could be treated as capital gain.

The real question, therefore, concerns whether or not

the income from the sales of appellant’s shoe machinery

should have been characterized as having been generated

in the ‘‘ordinary course of... business’’. Appellant con-

tests the conclusion of the district court that selling was

‘fan accepted and predictable part of the business’’ by

35

pointing out that sales were made only as a last resort,

after attempts to dissuade the customer from purchasing

had ‘sailed. We think that the district court was correct

in its finding. While sales were made only as a last resort,

it seems clear that after 1964 such sales were expected to

occur, on an occasional basis, and policies and procedures

were developed for handling them. Purchase inquiries were

referred to the vice president for sales, a price schedule

was drawn up, and discounts wre offered to good customers.

Appellant may not have desired such sales. It is likely

that appellant would never have developed a sales policy

for its leased machines had it not been forced to do so

by the pressure of competition. But it was justifiable to

find that such occasional sales were indeed ‘‘accepted and

predictable’’.

Even ‘‘accepted and predictable’’ sales might not, how-

ever, occur in the ‘‘ordinary course of... business’’. For

example, a final liquidation of inventory, although accepted

and predictable, would normally be eligible for capital

gains treatment. Appellant’s final contention, therefore, is

that the sales in question represented the liquidation of

an investment. Appellant points out that the machines

were leased for an average of eight and one half years

before they were sold, during which tizae depreciation was

taken on them and repairs were made. Thus, appellant

seeks to bring itself within the scope of the ‘‘rental-

obsolescence”’ decisions, which hold that the sale of rental

equipment, no longer useful for renting, is taxable at

capital gains rates. Hilliard v. Commissioner of Internal

Revenue, 281 F.2d 279 (5th Cir. 1960) ; Philber Equipment

Corporation v. Commissioner of Internal Revenue, 237

F.2d 129 (3d Cir. 1956); Davidson v. Tomlinson, 165 F.

Supp. 455 (S.D. Fla. 1958).

In the ‘‘rental obsolescence’’ decisions, however, equip-

ment was sold only after its rental income-producing

36

potential had ended, and ‘‘such sales were the natural con-

clusion of a vehicle rental business cycle’’. Philber, supra,

237 F.2d at 131. Moreover, the equipment was specifically

manufactured to fit the requirements of lessees; it was

sold only when lessees no longer found the equipment

useful. Jd. In the present case, however, the shoe manu-

facturing equipment was sold, not as a final disposition

of property that had ceased to produce rental income for

the appellant, but, rather, as property that still retained

a rental income producing potential for the appellant.

Had appellant chosen not to sell the shoe machinery, the

machinery would have continued to generate ordinary

income in the form of lease revenue. Thus, the sale of

such machinery, for a price which included the present

value of that future ordinary income, cannot be considered

the liquidation of an investment outside the scope of the

‘‘ordinary course of... business’’.

Affirmed.

37

APPENDIX D

Unitep States Court or AppgEALs

For tHE First Circuit

No. 73-1337

INTERNATIONAL SHOE MacuineE Corporation,

PLAINTIFF, APPELLANT,

v.

Unrrep States or AMERICA,

DEFENDANT, APPELLEE.

JUDGMENT

Entered: January 23, 1974

This cause came on to be heard on appeal from the

United States District Court for the District of Massachu-

setts, and was argued by counsel.

Upon consideration whereof, It is now here ordered,

adjudged and decreed as follows: The judgments of the

District Court are affirmed.

By the Court:

(s) Dana H. Gative

Clerk.

[ec: Messrs. Semerjian and McManus. ]

38

APPENDIX E

Unrrep States Court or APPEALS

For THE First Circuit \

e

.

No. 73-1337.

INTERNATIONAL SHOE MacuiIne CorPoraTION,

PLAINTIFF, APPELLANT,

v.

Unrtep States or AMERICA,

DEFENDANT, APPELLEE.

Before Corrin, Chief Judge,

Avpricu and McEn tes, Circuit Judges.

MEMORANDUM and ORDER

Entered February 25, 1974

Petitioner has with tenacity called our attention to a

number of alleged misstatements of fact and misconstruc-

tions of cases. As to the former, we have reviewed the

record which, while containing selective support for peti-

tioner’s version of the facts, also supports our summary.

Our reference to the necessity that appellant ‘‘offer’’ a

sale option to customers adopts the language from an

affidavit used in examination. Perhaps ‘‘make available

for sale’’ would have been more clear, but no legal con-

clusion turns on the nuance. As to the business necessity

compelling the sale option, petitioner argues that the fact

that its competitor was selling was not the critical factor;

but such testimony as that ‘‘our attitude was that all

things being equal, we had to beat United to get the

business’? and ‘‘we didn’t want to lose the sale to [our]

competition’’ supports our view and that of the district

court that competitive forces dictated the policy to make

sales an available option.

A further challenge is made to our (and the district

et ¥ RIOT IE SRA RS OG IT

39

court’s) characterization that after 1964 sales procedures

were more routinized, after a decision was made that sales

would be made on a non-discriminatory basis if any shoe

manufacturer insisted. While appellant’s attitude re-

mained that of a reluctant seller, decisions could be made

at less than the highest level. Petitioner seeks to discount

the meaning of testimony that ‘‘thereafter’’ (i.e, after

1963-1964) top level consultation was not necessary.

Whether or not entirely new procedures distinguished the

new era from the old, the essential fact is that there was,

by force of the basic policy decision, some normalization

of the sales operation.

Petitioner also takes issue with our observations, as not

being founded on evidence, that if machines were not sold

they would have continued to generate lease income and

that sales prices included the present value of the otherwise

expectable future lease income. These statements repre-

sent not very startling economic assumptions. If the

machines were priced high enough to include the present

value of future income, our statements were justified.

If, however, they were sold at less than such value, then

appellant is in a worse position, in that it would have

been encouraging sales at sacrifice prices.

Petitioner also contests our view—irrelevant to its own

situation—of the capital gains eligibility of a liquidation

of inventory in a winding up context; of our interpretation

of Malat v. Riddell, 383 U.S. 569 (1966), and of our analysis

of certain decisions which we have treated as ‘‘rental-

obsolescence’’ cases. Several of petitioner’s points are

restatements of arguments already made. See our rule 15.

Nothing in the petition persuades us to change our views.

The petition is denied.

By the Court:

(s) Dana H. Gative

Clerk.

[ee: Messrs. Semerjian and McManus. |]