Page 461
37 T.C. 461 (1961)
CLAY B. BROWN AND DOROTHY E. BROWN, ET AL.,
[1]
PETITIONERS,
v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Nos. 83795-83800.
United States Tax Court.
December 19, 1961
William H. Kinsey, Esq., and James R. Moore, Esq., for the petitioners.
[A1]
Norman H. McNeil, Esq., and Aaron S. Resnick, Esq., for the respondent.
Petitioners transferred their stock in a corporate enterprise, along with two promissory notes totaling $125,000, to I, a tax-exempt organization, in consideration for a non-interest-bearing note in the amount of $1,300,000. I was obligated to pay petitioners 90 percent of the income it received from a lease of the corporate assets in payment on the note but was not otherwise bound to make payment. I liquidated the corporation, sold its current assets subject to liabilities (other than the $125,000 of notes), and leased the fixed assets for a period of 5 years to a new corporation, F, which had been set up by a third party separate from petitioners. F was obligated to pay rent equal to 80 percent of its net profits before taxes and depreciation. At the termination of the 5-year lease the corporate assets were returned to I, which entered into an amended agreement with petitioners permitting it to negotiate a sale thereof even though the $1,300,000 note was not paid in full. The assets were subsequently sold by I to the State of California for $300,000, thus terminating the transaction between petitioners and I. Held, the transfer of petitioners' stock to I in return for the promissory note constituted the sale of a capital asset. Held, further, no part of the amounts received by petitioners is allocable to interest.
SCOTT, Judge:
Respondent determined deficiencies in petitioners' income taxes for the years and in the amounts as follows:
| Docket |
Petitioner |
Taxable year |
Deficiency |
| 83795 |
Clay B. Brown and Dorothy E. Brown |
(1954 |
5,073.80 |
| 83796 |
Donald L. Brown and Ingrid R. Brown |
(1955 |
16,621.28 |
| 83797 |
Charles William Booth and Nancy H. Booth |
(1954 |
231.66 |
| 83798 |
Donald Lee Brown |
1953 |
1,445.28 |
| 83799 |
Philip F. Brown |
(1954 |
1.042.61 |
| 83800 |
Marilyn Brown |
(1954 |
1,003.39 |
Page 462 The principal issue for decision is whether the gain realized by petitioners upon the disposition of their stock in Clay Brown & Company is long-term capital gain from the sale of such stock as reported by petitioners or ordinary income from a transaction which does not come within the provisions of section 117(a) of the Internal Revenue Code of 1939, and section 1222(3) of the Internal Revenue Code of 1954 as determined by respondent. Respondent contends, in the alternative, that should it be decided that the disposition was a sale resulting in long-term capital gain, a part of the amounts received by petitioners in each of the years here involved was in payment of interest and taxable to petitioners as interest income under section 22(a) of the Internal Revenue Code of 1939 and section 61(a) of the Internal Revenue Code of 1954. FINDINGS OF FACT. Petitioners Clay B. Brown and Dorothy E. Brown are husband and wife residing in Portland, Oregon. They filed joint Federal income tax returns for the years 1953, 1954, and 1955 with the district director of internal revenue for the district of Oregon. Petitioners Donald L. Brown and Ingrid R. Brown are husband and wife now residing in Portland, Oregon. They filed joint Federal income tax returns for the years 1954, 1955, and 1956 with the district director of internal revenue at San Francisco, California. For the calendar year 1953 petitioner Donald L. Brown filed a separate Federal income tax return with the district director of internal revenue at San Francisco, California. Petitioners Charles William Booth and Nancy H. Booth are husband and wife residing in Milwaukie, Oregon. They filed joint Federal income tax returns for the years 1953, 1955, 1955, and 1956 with the district director of internal revenue for the district of Oregon. Page 463 Petitioner Philip F. Brown and petitioner Marilyn Brown, who reside in Portland, Oregon, each filed a separate income tax return for each of the years 1953, 1954, 1955, and 1956 with the district director of internal revenue for the district of Oregon. Petitioner Clay B. Brown (hereinafter sometimes referred to as petitioner) has for many years been engaged in the lumber business as an executive of various lumber concerns. He is the father of Donald L., Philip F., and Marilyn Brown. Clay Brown & Company (hereinafter sometimes referred to as the corporation) was incorporated under the laws of the State of Oregon on September 28, 1946, and until its dissolution on February 4, 1953, was qualified to do business in California. The corporation had authorized capital stock of 50,000 shares, par value $1 per share. Thirty-two thousand shares were issued and outstanding as follows:
| Name |
Date |
Number |
Cost |
Official title in Clay |
| |
acquired |
of shares |
|
Brown & Co. |
| Clay B. Brown |
9/30/46 |
6,000 |
$6,000 |
President. |
| Dorothy E. Brown |
9/30/46 |
6,000 |
6,000 |
None. |
| Donald L. Brown |
9/30/46 |
6,000 |
6,000 |
Ass't vice president. |
| Philip F. Brown |
9/30/46 |
6,000 |
6,000 |
None. |
| Marilyn Brown |
9/30/46 |
6,000 |
6,000 |
None |
| Charles W. Booth |
12/50 |
1,000 |
7,993 |
Secretary-treasurer |
| Nancy H. Booth |
4/52 |
500 |
4,000 |
None |
| C. A. Hill |
|
500 |
|
Vice president |
From the date of its incorporation through 1949, the corporation was engaged in the business of selling forest products at wholesale. In 1949 the corporation acquired millsite property at Fortuna, California. and constructed thereon a gang mill and planing mill with substantially all new equipment. The gang mill and planing mill were put into operation during February 1950. In the spring of 1951 the corporation completed an additional unit consisting of a circular sawmill which was converted into a band sawmill during the fall of 1951. The gang mill, of a Swedish design, was the first of its type in California. The gang mill lent itself to the utilization of the small timber in the area, and permitted the conversion into merchantable lumber of timber previously ringed and permitted to die by ranchers in the clearing of grazing land. The output of the gang mill, planing mill, and band sawmill was sold through the sales and executive offices of the corporation maintained in the United States National Bank Building, Portland, Oregon. The corporation also maintained a sales office in San Francisco. Balance sheets of the corporation contained in its income tax return for the fiscal year ended April 30, 1952, and a financial statement Page 464 for January 31,1953, set forth assets, liabilities, and stockholders' equity on the indicated dates as follows:
| |
Apr. 30, 1952 |
Jan. 31, 1953 |
| Cash |
$13,457.87 |
$30,738.41 |
| Receivables (less reserve for bad debts) |
135,076.99 |
117,332.76 |
| Inventories |
156,765.18 |
458,112.44 |
| Capital assets (less reserve for depreciation) |
567,282.16 |
521,280.79 |
| Timber (less depletion) |
75,603.55 |
47,549.78 |
| Miscellaneous |
19,700.04 |
10,983.11 |
| Accounts payable |
95,833.90 |
32,263.30 |
| Bonds, notes, mortgages |
320,417.29 |
529,407.60 |
| Accrued expenses |
38,432.77 |
28,114.05 |
| State and Federal income tax |
140,055.00 |
126,389.98 |
| Capital stock |
32,000.00 |
32,000.00 |
| Paid-in or capital surplus |
13,986.00 |
13,986.00 |
| Earned surplus |
351,796.10 |
448,471.63 |
The California Institute for Cancer Research (hereinafter referred to as the institute) was formed under the name of the ‘ Cancer Research Foundation of California’ on April 26, 1945, as a nonprofit nonstock corporation under the provisions of division 1, part 4, title 12, article 1 of the California Civil Code for such scientific, charitable, and educational purposes as are set forth in its articles of incorporation. The institute is an adjunct of the University of California at Los Angeles. On August 25, 1947, its name was changed to California Institute for Cancer Research. On February 25, 1957, the name was changed to West Los Angeles Institute for Cancer Research. The institute was a tax-exempt organization under the Federal Tax laws at the time the transaction here involved was entered into. None of the petitioners were founders of the institute, or had any connection with or interest in the institute, except that derived from the transaction hereinafter described. Petitioner never had heard of the institute before he was approached by its representative as hereinafter mentioned. During the summer of 1952, William B. Boone of the Portland, Oregon, office of Dean Witter & Co., investment counselors and brokers, was informed that his Los Angeles office was in touch with a prospective client interested in acquiring or buying small companies. Boone inquired of a number of people including petitioner as to any possible interest in selling. When contacted by Boone, petitioner stated that he was not particularly interested or looking for a sale or for a buyer, but that he would sell if the price was right, to which Boone replied that he had nothing definite in mind, but might come up with something. On August 8, 1952, Boone relayed the Clay Page 465 Brown & Company prospect to his Los Angeles office and was informed that the parties thought to be interested were not interested. Subsequently, Boone's Los Angeles office informed him that the institute might be interested in acquiring Clay Brown & Company. Louis H. Seagrave, who was then chairman of the board of directors of the institute, came to Portland and...
