JG Dudley Company v. CIR, 8436.
| Decision Date | 11 January 1962 |
| Docket Number | No. 8436.,8436. |
| Citation | 298 F.2d 750 |
| Parties | J. G. DUDLEY COMPANY, Incorporated (Formerly Headen Hosiery Mills, Incorporated), Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. |
| Court | U.S. Court of Appeals — Fourth Circuit |
John P. Allison, New York City (Arthur L. Kimmelfield, and Marshall, Bratter, Greene, Allison & Tucker, New York City, on the brief), for petitioner.
Morton K. Rothschild, Atty., Dept. of Justice, Washington, D. C. (Louis F. Oberdorfer, Asst. Atty. Gen. and Lee A. Jackson, Atty., Dept. of Justice, Washington, D. C., on the brief), for respondent.
Before SOPER, BRYAN and BELL, Circuit Judges.
This case involves the application of the carry-over provisions of Section 122 (b) (2) (B) of the Internal Revenue Code of 1939, 26 U.S.C.A. § 122(b) (2) (B), under which losses incurred by a taxpayer in earlier years may be carried over and deducted in computing the taxable income in the tax year. The benefit of this section was claimed by the taxpayer in this case for the years 1954 and 1955 but was denied by the Commissioner who determined deficiencies in income tax of $3,604.47 for 1954 and $5,907.96 for 1955 which were upheld by the Tax Court under the following circumstances.
J. G. Dudley Company, Incorporated, formerly Headen Hosiery Mills, Incorporated, a North Carolina corporation, was actively engaged in the business of manufacturing hosiery at Hickory, North Carolina, from 1947 until the death of A. R. Headen, its president and principal stockholder on January 26, 1950. At that time Headen owned 348 shares, his wife 1 share, and J. G. Dudley, 1 share of the stock of the corporation. Dudley was then engaged in the plumbing, heating and air conditioning business at Shelby, North Carolina, in his individual capacity. He was a close friend of Headen who consulted him on matters of business policy and made him vice president of the taxpayer corporation. After Headen died Dudley was elected president of the corporation and managed its affairs until they could be wound up. Upon Headen's death the First National Bank of Winston-Salem was appointed executor of his estate. At that time the corporation was heavily in debt. It owed the bank between $75,000 and $80,000 and had an estimated liability of not less than $25,000 for infringement of a hosiery patent held valid by this court in Baker-Cammack Hosiery Mills v. Davis Company, 181 F.2d 550.
In this emergency it was determined by the management in February 1950, acting upon the advice of counsel, to liquidate the assets of the corporation as quickly as possible but thereafter it was decided to keep the corporation alive for at least three years after 1950 to protect the stockholders against the liability for patent infringement, until it should be barred by limitations, and also to protect them against other unforeseen liabilities that might arise. Manufacturing activities were stopped in the summer of 1950 and the sale of goods was stopped early in 1951. In October 1950 the office of the company was moved from Hickory to Shelby. In January 1952 the land and buildings of the corporation were sold and the remaining assets were thereafter sold and the proceeds devoted to the payment of the debt owing to the bank and other indebtedness. No payment was made on the liability for patent infringement. The net assets after the payment of the indebtedness were conveyed to the estate of the deceased in the purchase and cancellation on October 7, 1952 of the 348 shares of stock held by it at the price of 348/350 of the remaining net assets of the corporation.
Meanwhile in March 1952 Dudley's wife purchased the share of stock held by Mrs. Headen and a son of Dudley purchased 1 share of stock from the corporation so that in October 1952 after the 348 shares held by Headen's estate were redeemed Dudley, his wife and son were the sole stockholders, and control of the corporation was in Dudley's hands. Thereafter, nothing was done with the corporation until February 1954 when its charter was amended so as to change its name to the J. G. Dudley Company, Incorporated, and to state that the corporate purposes were to engage in the business of electrical heating, plumbing, contracting and related types of work. On February 27, 1954 Dudley purchased 10 additional shares of stock in the corporation for $1,000 and on March 1, 1954 transferred to the corporation certain assets of his plumbing and heating business in exchange for 100 shares of stock, $1,262 cash and the assumption by the corporation of the liabilities of the plumbing business theretofore conducted by Dudley. In April 1954 Dudley transferred the remaining physical assets of his business to the taxpaying corporation which thereafter became engaged in the heating and plumbing business. In 1954 and 1955 the net income of the corporation was approximately $12,000 and $19,000 respectively. The taxpayer sought to deduct from this income losses of equal amounts which had been sustained by the corporation while engaged in the hosiery business during the years 1950 to 1953 in the aggregate sum of $52,000 but the Commissioner refused to allow these deductions as lawful carry-overs under the statute and determined deficiencies as aforesaid.
In order to show that the corporation was not acquired by Dudley for the purpose of avoiding income tax by securing the benefit of loss deductions to which he would not otherwise be entitled under the statute Dudley testified that at the time that he acquired control of the corporation he had no knowledge that the losses of the corporation in the preceding years might be used for tax purposes and that the corporation was kept alive for the protection of the stockholders as above described; and that he did not know of the carry-over advantages of such corporate losses until the year 1953 at which time he endeavored unsuccessfully to sell the corporation by advertisement in the Wall Street Journal, and that he finally determined to make use of the corporation in order to carry on his plumbing and heating business in corporate form and to transfer a share of the business to his sons. He testified, however, that in 1954 when he transferred his personal business to the corporation he knew that its earlier losses might be of some use in respect to future taxes and that this was a purpose of the incorporation although the primary purpose was to get the business in corporate form.
The Commissioner disallowed the loss deductions for the tax years 1954 and 1955, first, under the provisions of Section 129(a) of the Internal Revenue Code of 1939 since the holders of the capital stock of the corporation acquired control thereof for the principal purpose of evading the federal income tax by securing deductions not otherwise allowable; and second, under the provisions of Section 122 of the Internal Revenue Code of 1939 since the business which incurred the losses from 1950 to 1953 was substantially different from the business that the taxpayer operated in 1954 and 1955. On both points the Tax Court upheld the Commissioner's determinations. With respect to the first point the Tax Court, pointing out that the burden was upon the taxpayer to show that Dudley knew nothing of the tax use when he gained control of the corporation in October 1952, summarized the improbabilities of the taxpayer's evidence on this point as follows:
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