United States v. Georgia Railroad and Banking Company

Decision Date30 June 1965
Docket NumberNo. 20842.,20842.
Citation348 F.2d 278
PartiesUNITED STATES of America, Appellant, v. GEORGIA RAILROAD AND BANKING COMPANY, Appellee.
CourtU.S. Court of Appeals — Fifth Circuit

Louis F. Oberdorfer, Asst. Atty. Gen., John B. Jones, Jr., Acting Asst. Atty. Gen., Lee A. Jackson, David O. Walter, Robert J. Golten, Attys., Dept. of Justice, Washington, D. C., Donald H. Fraser, U. S. Atty., of counsel, for appellant.

James R. Harper, Atlanta, Ga., Paul R. Russell, New York City, Joseph B. Cumming, Augusta, Ga., Shearman & Sterling, New York City, Cumming, Nixon & Eve, Augusta, Ga., Cuba, Harper & Cuba, Atlanta, Ga., William J. Cooney, Thurmond, Hester, Jolles & McElmurray, Augusta, Ga., of counsel, for appellee.

Philip M. Lanier, Louisville, Ky., Roderick M. Nicol, Jacksonville, Fla., for Atlantic Coast Line R. Co., and Louisville & N. R. Co., amici curiae.

Before WISDOM and GEWIN, Circuit Judges, and BREWSTER, District Judge.

GEWIN, Circuit Judge.

This appeal presents for our consideration two novel questions of federal income tax law. First, we must decide whether a lessor under a 99-year "lease" of corporate securities is entitled to the dividends-received deduction which § 243 of the Internal Revenue Code of 1954, 26 U.S.C.A. § 243, affords to corporate shareholders.1 Second, we must answer the question whether the taxpayer-lessor, having distributed the reversion in certain of the leased shares to its own stockholders as a dividend in kind, may amortize over the remainder of the lease term its retained interest in the distributed shares, including its right to receive income under the lease.2 The district court allowed the taxpayer both the deductions it sought. We disagree and reverse on both issues.

The rather unusual transaction which gave rise to this suit had its genesis in the days prior to the Sixteenth Amendment and the advent of the now ubiquitous federal tax collector. On May 7, 1881, the Georgia Railroad & Banking Company entered into a "lease agreement" with William M. Wadley for a term of 99 years from April 1, 1881. The agreement covered all of the railroad properties owned by the taxpayer, including assets and securities of the Western Railway of Alabama and the Atlanta and West Point Railroad.3 The lessee covenanted to make an annual payment of $600,000 for the use of the properties covered by the agreement, payable in two semi-annual installments. In addition, the lessee agreed to return the properties unimpaired in value and as well adapted to the business of transportation as they were in 1881.4 The lessor had the right under the terms of the agreement to repossess the property upon breach of any of the covenants.5

Wadley's interest in the lease was eventually assigned to the Louisville & Nashville Railroad Company. The L & N in turn assigned one-half of its interest in the agreement to the Atlantic Coast Line Railroad, and the stock has been and is presently registered in the name of the L & N as trustee for itself and the Coast Line. After these assignments, the lease was amended by various supplemental agreements between 1899 and 1910.6

As of March 1, 1913, 9,361 shares of the Atlanta & West Point and 15,000 shares of the Western of Alabama were subject to the lease and the supplemental agreements. The number of leased shares and the proportionate ownership which those shares represent have remained constant since that date. Pursuant to § 1053 of the Internal Revenue Code of 1954, 26 U.S.C.A. § 1053, the property subject to the lease acquired a tax basis equal to its fair market value on March 1, 1913. Applying that standard, the district court found that the tax basis for a share of Atlanta and West Point was $150 and that of a share of Western of Alabama was $120.

On July 7, 1954, for business reasons relating to the regulatory policies of the Interstate Commerce Commission, the taxpayer in effect distributed its reversionary interest in 7,000 of the 9,361 shares of the Atlanta and West Point and 12,180 of the 15,000 shares of the Western of Alabama to its own shareholders as a dividend in kind. This distribution was accomplished by giving each stockholder Certificates of Participation which entitled him to receive a certain number of shares of each railroad or its equivalent after the expiration of the lease on April 1, 1980, or its earlier termination.7 The taxpayer, however, retained all present interest in the shares whose reversion had been distributed, including all rights to receive the entire $600,000 annual payments pursuant to the terms of the 1881 lease agreement. No gain or loss was recognized to the taxpayer on this transaction, but the taxpayer did write off of its books that part of the basis which was attributable to the 1913 fair market value of the distributed reversionary interest.8 The Internal Revenue Service ruled that the 1954 fair market value of the reversion was taxable to the recipient shareholders as dividend income in the year of receipt, and the taxpayer so advised the distributees of the certificates.9 At that time the reversion in a share of Atlanta and West Point had a fair market value of $3.25 and a share of Western of Alabama had a fair market value of $6.24.

In 1954 and all prior years, the taxpayer had reported the full $600,000 annual payment as rental income. In 1954, the taxpayer amended its return, claiming that a portion of the $600,000 payment represented constructive dividends against which it could offset the 85 per cent dividends-received deduction afforded by § 243. The dividends paid to the lessee on the leased stock during the fiscal period January 1, 1954, through October 6, 1954, totaled $84,361. Hence, the district court allowed the taxpayer a dividends-received deduction of $71,706.85.10

In addition, the taxpayer sought to depreciate under § 167 that portion of its 1913 basis in the stock whose reversion had been distributed which represented the 1913 fair market value of the right to receive income for the remaining 25¾ years of the lease on the theory that the rights the taxpayer retained upon distribution of the reversion constituted property held for the production of income which would be fully exhausted by April 1, 1980. The taxpayer and the district court imputed 63.57% of the 1913 basis of the stock to the interests retained by the taxpayer in the distributed shares, and the district court allowed a depreciation deduction of $15,501.21 for the period from July 7, 1954, to October 6, 1954.11

The Government appeals from both holdings of the district court. We shall discuss each issue separately below.

I

The taxpayer urges that it, rather than its lessees, is entitled to the dividends-received deduction since it is the beneficial owner of the shares of the two railroads.12 The argument runs substantially as follows: The transaction in question is a long-term lease, an arrangement which is generally held not to vest beneficial ownership of the leased property in the lessee. Taxpayer also concurs in the district court's conclusion that the lessees are mere conduits for the payment of dividends, since the dividends actually received by the lessees are paid over to taxpayer pro tanto as a part of the $600,000 annual payment for the use of the property subject to the lease. In this connection, the taxpayer notes that the portion of the $600,000 payment which is properly allocable to the use of the stocks approximates that proportion of the average earnings (and thus the dividends) of the two railroads which related to the leased stock during the five-year period immediately preceding the consummation of the 1881 agreement.13 Moreover, in the taxable year in question the amount paid for the use of the shares greatly exceeded the dividends paid out to the lessees. The lessor made the initial capital investment in the two railroads and, therefore, is the real shareholder in the two corporations.14 The lessees, on the other hand, have contributed no capital to the two enterprises. This argument taxpayer urges, comports with the purpose of § 243 to minimize the double taxation which would otherwise occur when one corporation invests in another. In substance, the transaction amounts to an anticipatory assignment of income for 99 years without the concomitant transfer of the underlying income-producing property. Under established principles, the assignor is properly taxable on such income and, of course, entitled to the benefit of any deductions which are directly related to the income so assigned.

We think the taxpayer's argument is unpersuasive in several respects. The purpose of § 243 is to eliminate the multiple taxation of corporate earnings which would otherwise occur whenever one corporation holds shares of stock in another corporation. Thus, the deduction seems to be directed more to the preservation of income from the stock than to the protection of the investment in the underlying company. This Circuit and other courts have recognized that, where ownership of shares of corporate stock is fleeting or uncertain, the dividends-received deduction is available only to the beneficial owner of the shares. See, e. g., Rupe Investment Corp. v. Commissioner of Internal Revenue (5 Cir. 1959), 266 F.2d 624; Joseph L. O'Brien Corp. v. Commissioner of Internal Revenue (3 Cir.), 301 F.2d 813, cert. denied, 371 U.S. 820, 83 S.Ct. 37, 9 L.Ed.2d 61 (1962). And, of course, the question of beneficial ownership must be measured according to the substance of the transaction as a matter of federal income tax law rather than according to technical forms and concepts of state property law. Thus, the question is not whether the transaction should be characterized as an assignment for a term or a lease, but rather whether the taxpayer had so little control over the stock during the 99-year period that he cannot be said to have retained beneficial ownership of the shares.15

An examination of the factors which indicate the situs...

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