Billy Rose's Diamond Horseshoe, Inc. v. United States, 69 Civ. 1303.

• Decision Date: 08 January 1971
• Docket Number: No. 69 Civ. 1303.,69 Civ. 1303.
• Parties: BILLY ROSE'S DIAMOND HORSESHOE, INC. (In Dissolution), Plaintiff, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Southern District of New York

322 F. Supp. 76

BILLY ROSE'S DIAMOND HORSESHOE, INC. (In Dissolution), Plaintiff, v. UNITED STATES of America, Defendant.

No. 69 Civ. 1303.

United States District Court, S. D. New York.

January 8, 1971.

Hays, St. John, Abramson & Heilbron, by Osmond K. Fraenkel, New York City, for plaintiff.

Whitney North Seymour, Jr., U. S. Atty. for the Southern District of New York, by Michael I. Saltzman, Asst. U. S. Atty., for defendant.

RYAN, District Judge.

Plaintiff has moved for summary judgment for recovery of internal revenue taxes which it alleges were illegally assessed and collected.

Defendant has cross-moved for summary judgment, dismissing the complaint.

Plaintiff, Billy Rose's Diamond Horseshoe, Inc., was a New York corporation. It had its principal place of business in this District. It was dissolved on December 15, 1966, but under Section 1006 of the New York Business Corporation Law, McKinney's Consol. Laws, c. 4, it may maintain this action.

This action was filed on March 31, 1969. Service of process was made on the United States of America, who appeared and filed its answer on July 7, 1969.

Jurisdiction and venue is not contested. Plaintiff's claim for refund was filed timely on November 4, 1965, within the limitation period of Section 6511 (d) (2) of the Internal Revenue Code of 1954.

Following conferences between the attorneys and the Court, the parties on October 27, 1970 filed a stipulation as to facts. It appears from the pleadings and from the papers now submitted that additional facts are not in dispute. I find no factual issue. There is a single question of law presented.

Plaintiff maintained its books and reported on a fiscal year basis, ending on August 31st of each year.

Plaintiff seeks the return of $24,913.78 and interest, claiming improper rejection by the Internal Revenue Service of a net operating loss carryback from the fiscal year ending August 31, 1962 to the fiscal year ending August 31, 1959. It is not in dispute that, if that carryback had been allowed, the corporation would have had no taxable income for the fiscal year ending August 31, 1962 and the payment of $24,913.78 tax assessed for that year would be recoverable.

The Service maintained that three notes, one for $100,000 payable September 4, 1962; one ofr $50,000 payable January 7, 1963; and one for $150,000 payable September 1, 1963—all of which were paid when due—received by plaintiff from National Broadcasting Company, Inc., under an agreement between them dated June 28, 1962, must be included in plaintiff's taxable income for the fiscal year ending August 31, 1962. Plaintiff does not dispute that the notes were income for federal income tax purposes. The issue raised is in what taxable year or years the amount of the notes is to be included in plaintiff's gross income.

It is not in dispute that by agreement of August 26, 1955, plaintiff leased premises known as the Ziegfeld Theatre to the National Broadcasting Company for a term ending on October 31, 1962. Under the lease, N.B.C. covenanted to surrender "* * * the demised premises * * * in good order and repair and in approximately the same condition as received by the lessee, depreciation and reasonable wear and tear excepted."

It is undisputed that N.B.C. took possession of the demised premises and made substantial physical structural changes and alterations. It broke down walls for installation of color television cable equipment; it took out all orchestra seats; it broke up the stage and lower lounge, replacing them with concrete floors; rebuilt the dressing rooms; and reconstructed two floors backstage to install a new air conditioning system. All of the work was done without objection of plaintiff as within N.B.C.'s rights under the lease.

Plaintiff and N.B.C. on June 28, 1962 entered into two agreements.

One agreement, described as the "Settlement Agreement", provided for the settlement of "various rights and obligations" of plaintiff, lessee, and Billy Rose, who was a sublessee under the lease. It provided for the termination of the lease and the surrender of the premises, and then in paragraph "3" of the Settlement Agreement, there was a mutual remise, release and discharge of the parties from all actions which each of the parties could have against the other arising out of the lease. One of several covenants which was excepted from and which survived the release was the lessee's obligation to return the premises in the same condition as when received under the lease.

The second agreement, called the "Compromise Agreement", provided for the lessee's delivery of three promissory notes in the total amount of $100,000 in "full satisfaction and compromise of lessee's obligation to restore the Ziegfeld Theatre to approximately the same condition as the same was in when received by lessee as required by paragraph Twenty-Third of said lease, and by paragraph 3(c)" of the Settlement Agreement, to which plaintiff and lessee and Billy Rose were parties.

Plaintiff, in its income tax return for its fiscal year ending August 31, 1962, elected the installment method of reporting the receipts under the Compromise Agreement. Plaintiff received no payments on the notes in its fiscal year ending August 31, 1962 and it reported no income with respect to the transaction for that year. Plaintiff for that fiscal year did report a net operating loss of $111,452.50. It then filed a claim for refund of taxes for its taxable year ending August 31, 1959, the year in suit here, based on the carryback of its fiscal year 1962 net operating loss.

Plaintiff included the proceeds of the first two notes in its income tax return for the fiscal year ending August 31, 1963 and the proceeds of the third note were included in its income tax return for the fiscal year ending August 31, 1964.

The Commissioner determined that the entire face amount of the notes plaintiff received under the Compromise Agreement was reportable in its fiscal year ending August 31, 1962 as ordinary income, and this eliminated the claimed net operating loss reported by plaintiff. Plaintiff's claim for refund for its fiscal year 1959 was accordingly rejected, and this action was filed.

To restate the controversy: The Internal Revenue Service contends that the value or amount of these notes should be included in plaintiff's income in the taxable year in which they were delivered, to wit, fiscal year ending August 31, 1962. Plaintiff claims that it is entitled to elect to treat the transaction on an installment basis and that the taxable years after the year of delivery are the years in which the income should be reported, i. e., in the taxable years 1963 and 1964, when the notes were actually paid. The answer to these contentions is decisive of this action, for if plaintiff's claim is disallowed, not only does the additional income wipe out plaintiff's net operating loss for its taxable year 1962, but plaintiff also loses the advantage of a carryback loss to the taxable year in suit, fiscal year ending August 31, 1959.

The question presented is whether the "compromise" of the claim against lessee under the lease restoration clause is a "casual sale or other casual disposition" or real or personal "property" which entitled the plaintiff to elect the installment method of accounting.

The answer lies in the interpretation of Section 453(a) and (b) to the undisputed facts. We quote the statute in the footnote.¹

We start with the premise that a taxpayer properly electing the installment method need only report as income the proportion of installment payments actually received in that year which the gross profit realized bears to the total contract price.

The installment method of accounting applies to Section 453(b) (1) (A), (B):

"(b) Income from

(A) a sale or other disposition of real property, or

(B) a casual sale or other casual disposition of personal property * * *".

Plaintiff compromised its rights under the lease restoration clause. Plaintiff gave up a right it could have enforced under the lease restoration clause only by the filing of a suit to recover a sum of money; the transaction was a release and satisfaction of that right.

I conclude that, whether the transaction is a compromise, satisfaction or a release, it does not qualify as a "sale" or "other casual disposition" within the meaning of the installment sales provisions, and that plaintiff is not entitled to elect that method of reporting this income.

Nowhere in the installment sale section or elsewhere in the Code is the term "sale" defined. A sale in the context of the capital gains provisions, Section 1222(3), which requires inter alia, a "sale or exchange" of property before granting special tax treatment, has been defined in Commissioner of Internal Revenue v. Brown (1965), 380 U.S. 563, at 571, 85 S.Ct. 1162, at 1166, 14 L.Ed. 2d 75:

"`"A sale, in the ordinary sense of the word, is a transfer of property for a fixed price in money or its equivalent," Iowa v. McFarland, 110 U.S. 471, 478 4 S.Ct. 210, 214, 28 L. Ed. 198; it is a contract "to pass rights of property for money,—which the buyer pays or promises to pay to the seller * * *,"' Williamson v. Berry, 8 How. 495, 544, 12 L.Ed. 1170."

The absence here of a "transfer of property" is manifest; the lessee obtained nothing which could be denominated property or a right to property after the transaction. All that it had was the acquittance of a contract obligation.

It has long been held in this Circuit that the cancellation or release of contract rights does not transfer the rights to the transferee-payor and is not a "sale"; the rights are simply extinguished and vanish.² Pittston Co. v. Commissioner of Internal Revenue, 252 F.2d 344 (1958), cert. denied, 357 U.S. 919, 78 S.Ct. 1360, 2 L.Ed.2d 1364 (cancellation of exclusive right to purchase coal output); General Artists Corp. v. Commissioner of Internal Revenue, 205 F.2d 360 (1953), cert. denied, 346 U.S. 866, 74 S.Ct. 105...