McNamara v. Commissioner of Internal Revenue

• Decision Date: 23 February 1954
• Docket Number: No. 10915.,10915.
• Citation: 210 F.2d 505
• Parties: McNAMARA v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Seventh Circuit

210 F.2d 505 (1954)

McNAMARA v. COMMISSIONER OF INTERNAL REVENUE.

No. 10915.

United States Court of Appeals, Seventh Circuit.

February 23, 1954.

Herman A. Fischer, Chicago, Ill., Ellsworth C. Alvord, Washington, D. C., William H. Quealy, Chicago, Ill., for petitioner.

H. Brian Holland, Asst. Atty. Gen., Harry Marselli, Ellis N. Slack, Joseph F. Goetten, Sp. Assts. to Atty. Gen., U. S. Dept. of Justice, for respondent.

Before MAJOR, Chief Judge, and DUFFY and SWAIM, Circuit Judges.

SWAIM, Circuit Judge.

The petitioner, Harley V. McNamara, filed his petition in the Tax Court of the United States for a redetermination of a tax deficiency found by the Commissioner on the petitioner's individual income tax for the years 1946 and 1947. The Commissioner had determined that the petitioner owed additional income tax in the amount of $61,244.87 for the year 1946, and $64,215.93 for the year 1947.

The Commissioner contended that these additional amounts of tax were due because of the purchase by the petitioner in the years 1946 and 1947 of corporate stock of his employer, the National Tea Company, pursuant to an option granted to the petitioner by the National Tea Company to purchase the stock at a price less than the fair market value of the stock in consideration of services of the petitioner. The petitioner contends that he was granted this option not as compensation but in order to give him a proprietary interest in his employer's business; that, if the option were intended as compensation, it could only be considered as compensation to the extent of the difference between the option price and the fair market price of the stock when the option was granted in 1945; and that it, therefore, should be considered as income to him only in 1945, and not in 1946 and 1947 when the option was exercised. During the years 1945, 1946 and 1947, the petitioner filed his income tax returns on a cash receipts and disbursements basis.

Prior to March 1, 1945, the petitioner was employed by the Kroger Grocery and Baking Company as manager of its Chicago branches. In this employment he received a fixed salary and a percentage of the profits. Early in 1944 the petitioner and Mr. John F. Cuneo had a talk concerning the possible acquisition by Cuneo of stock in the National Tea Company. This stock had been selling at a low price, which they agreed resulted from poor management of National. In 1944 Cuneo, after acquiring a large block of National stock, talked to the petitioner about leaving Kroger and taking over the management of National. The petitioner indicated that he would be willing to do this at a slight increase in salary, but that if he did so he would also want an opportunity to acquire some of the National stock. Cuneo told the petitioner that he (Cuneo) would recommend such an arrangement to the board of directors of National.

On February 2, 1945, the petitioner received a letter from Cuneo enclosing a proposed contract of employment of the petitioner, and asking for the petitioner's assurance that he would sign the contract if Cuneo could secure its approval by National. This proposed contract was for one year and provided for an annual salary of $27,500.00 and additional compensation of 2 per cent of the net profits of National in excess of $300,000.00, but limited the aggregate annual compensation to the petitioner to $60,000.00. The contract also provided that, "In consideration of the Employee's acceptance of employment hereunder, the Company agrees to set aside 12,500 shares of its Capital Stock now in its Treasury, subject to an option to purchase by the Employee at any time during the term of this contract at the price of $12.00 per share." The stock was then selling at $15.25 per share. Prior to the annual meeting of the shareholders of National, which was held on March 21, 1945, Cuneo sent a notice to the stockholders notifying them that he was going to recommend to the directors the employment of petitioner as executive vice president and general manager in accordance with the terms set out above.

At the meeting of March 21, 1945, the petitioner was elected a director of National, and at the meeting of the directors on the same date the proposed contract of employment with the petitioner was discussed, but it was decided that no action should be taken on the contract prior to its approval by the Wage Stabilization Board. On the same date the petitioner was elected executive vice president and general manager of National, in which position he served until he was elected president of the company on March 21, 1947.

On August 23, 1945, the executive committee of National instructed the treasurer of the company to procure from the Wage Stabilization authorities their approval of the proposed $27,500.00 salary for the petitioner and of the granting of the option for the purchase by the petitioner of the National stock. On the following day, August 24, 1945, National entered into an employment contract with the petitioner for two years, and the board of directors adopted the following resolutions concerning the petitioner's salary and the option for his purchase of shares of its stock:

"Whereas, at its 1945 annual meeting this Board deferred to a subsequent meeting the fixing of the compensation of Harley V. McNamara, as General Manager of this corporation, he in the meantime to draw stated amounts generally on account of salary, and

"Whereas, the Executive Committee of this corporation has recommended that, in addition to such stated cash payments on account of salary and such additional contingent compensation as is now in effect, the compensation of Harley V. McNamara * * * for the current year shall include the option hereinafter specified:

"Now, Therefore, Be It Resolved that the compensation of said officer for the present fiscal year shall be and the same is hereby fixed at cash salary of $27,500 for said Harley V. McNamara * * * and in addition thereto, stock option, as provided for in the next succeeding paragraph.

"Resolved that the Vice President and Secretary be and they are hereby directed to execute the following option to Harley V. McNamara * * * and that the officers of this corporation be and they are hereby authorized and empowered to issue stock certificates to Harley V. McNamara * * * upon the receipt of considerations mentioned in the option agreement * * *." (Our emphasis.)

On the same date National entered into an employment contract with the petitioner for two years pursuant to the terms which had been discussed and also granted to the petitioner and "his heirs, executors, administrators and assigns" an option, to expire on August 24, 1947, to purchase from National 12,500 shares of its common stock at a price of $16.00 per share on the condition that not more than 3,125 shares should be purchased prior to February 24, 1946, not more than 6,250 shares should be purchased prior to August 24, 1946, and not more than 9,375 shares should be purchased prior to February 24, 1947. The petitioner signed an acceptance of the option on September 12, 1945. The fair market value of the stock was $19.00 per share on August 24, 1945, and $20.00 per share on September 12, 1945. Pursuant to the terms of the option, the petitioner purchased 6,250 shares of National common stock on March 12, 1946, and the remaining 6,250 shares on March 6, 1947. The fair market value of the stock on these two dates was $28.50 and $27.50, respectively.

The Tax Court held, 19 T. C. 1001, that the gain derived by the petitioner from the exercise of the option in each instance was equal to the difference between the option price and the fair market value of the shares on the dates of the purchases, and that this gain was intended by the parties as compensation to the petitioner and should, accordingly, be taxed as income received during the years 1946 and 1947.

We, of course, are not permitted to disturb findings of the Tax Court which are based on substantial evidence. Commissioner of Internal Revenue v. Scottish American Inv. Co., 323 U.S. 119, 124, 65 S.Ct. 169, 89 L.Ed. 113; Rule 52 of the Federal Rules of Civil Procedure, 28 U. S.C.A. We think that the...