Waterman, Largen & Co. v. United States

• Decision Date: 14 November 1969
• Docket Number: No. 14-65.,14-65.
• Citation: 419 F.2d 845
• Parties: WATERMAN, LARGEN & CO., Inc., v. The UNITED STATES.
• Court: U.S. Claims Court

419 F.2d 845 (1969)

WATERMAN, LARGEN & CO., Inc., v. The UNITED STATES.

No. 14-65.

United States Court of Claims.

November 14, 1969.

Joseph E. McAndrews, Washington, D. C., attorney of record, for plaintiff. Ivins, Phillips & Barker, Washington, D. C., of counsel.

Michael H. Singer, Washington, D. C., with whom was Asst. Atty. Gen., Johnnie M. Walters, for defendant, Philip R. Miller, Washington, D. C., and Joseph Kovner, Washington, D. C., of counsel.

Before COWEN, Chief Judge, and LARAMORE, DURFEE, DAVIS, COLLINS, SKELTON and NICHOLS, Judges.

OPINION

PER CURIAM:

This case was referred to Trial Commissioner Saul Richard Gamer with directions to make findings of fact and recommendation for conclusions of law under the order of reference and Rule 57 (a) since September 1, 1969, Rule 134 (h). The commissioner has done so in an opinion and report filed on September 20, 1968. Defendant took no exception to the commissioner's findings of fact but did except to his recommended conclusion of law that the stock purchased by the taxpayer was an ordinary asset, not a capital asset. Plaintiff took no exception to the commissioner's findings of fact or to his recommended conclusion of law. The case has been submitted to the court on the briefs of the parties and oral argument of counsel. Since the court agrees with the commissioner's opinion, findings and recommended conclusion of law, as hereinafter set forth, it hereby adopts the same as the basis for its judgment in this case.^* Therefore, plaintiff is entitled to recover and judgment is entered for plaintiff with the amount of recovery to be determined pursuant to Rule 131(c).

OPINION OF COMMISSIONER

GAMER, Commissioner:

Plaintiff sues to recover alleged over-payments on its corporate income taxes for its taxable years ending December 31, 1961, and December 31, 1962.

The sole issue is whether the loss on the sale of certain stock which plaintiff owned is, as contended by plaintiff, fully deductible under either section 162(a)¹ of the Internal Revenue Code of 1954 (26 U.S.C. § 162(a) (1964)) as one growing out of an ordinary and necessary expense incurred in carrying on its business, or section 165(a),² as an uncompensated loss sustained during a taxable year, or instead is, as contended by defendant, to be treated as a loss incurred on the sale of a capital asset under sections 165(f)³ and 1211(a),⁴ with the limitations on deductibility applicable thereto.

Plaintiff sold the stock in question in 1961, and on its income tax return for such calendar year reported the loss, amounting to $75,000, as a capital loss. However, in 1963 it filed timely claims for refund claiming a deduction as an ordinary loss in 1961 and a net operating loss carryover deduction for 1962. The claim not having been allowed, this suit followed.

In Booth Newspapers, Inc. v. United States, 303 F.2d 916, 157 Ct.Cl. 886 (1962), this court enunciated the basic principles governing cases such as these. It pointed out that although section 1221 of the Code defines the term "capital asset" as "property held by the taxpayer (whether or not connected with his trade or business)," (with certain exclusions, such as inventory)⁵ and that "as a general proposition * * * capital stock does constitute `property' and, aside from stock sold by dealers in the usual course of their business, does not fall within any of the express exclusions of section 1221," so that a stock transaction would normally be "encompassed by the literal language of that section," nevertheless, the Supreme Court in Corn Products Refining Co. v. Commissioner of Internal Revenue, 350 U.S. 46, 76 S.Ct. 20, 100 L.Ed. 29 (1955), established an "elastic concept" of the term which, in certain cases, permitted transactions which would otherwise fall within the literal "capital asset" definition to be considered instead as "ordinary" income or loss. 303 F.2d at 920, 157 Ct.Cl. at 894. In the Corn Products case, the Court held that the buying and selling of corn futures for the purpose of protecting against price increases of corn, the basic raw material of the taxpayer's business, constituted an integral part of its manufacturing operations and was therefore to be treated as an ordinary business expense, and not as a capital investment or speculation. "Congress intended that profits and losses arising from the everyday operation of a business be considered as ordinary income or loss rather than capital gain or loss." 350 U.S. at 52, 76 S.Ct. at 24.

After reviewing the various cases of stock transactions by corporate taxpayers which had been decided following Corn Products and which had applied the doctrine established thereby, the court in Booth Newspapers formulated the governing principles as follows:

* * * if securities are purchased by a taxpayer as an integral and necessary act in the conduct of his business, and continue to be so held until the time of their sale, any loss incurred as a result thereof may be fully deducted from gross income as a business expense or ordinary loss. If, on the other hand, an investment purpose be found to have motivated the purchase or holding of the securities, any loss realized upon their ultimate disposition must be treated in accord with the capital asset provisions of the Code.

* * * The fact that securities are "property," in the broad sense of that term, is not conclusive. 303 F.2d at 921, 157 Ct.Cl. at 896.

And, to determine whether the transaction involved thus falls within the "ordinary" or the "investment" category,

* * * the circumstances of the transaction (its factual background, the necessities of the particular business involved at the particular time involved, and the intentions of the taxpayer, both at the time the securities were originally purchased and at the time they were disposed of) are of crucial importance in the resolution of these cases. Ibid.

Applying these Booth Newspapers legal principles, and "factual background" criteria, including the "necessities" of plaintiff's business and the "intentions of the taxpayer" at the pertinent times, it is concluded that plaintiff has here carried its burden of establishing entitlement to the deduction in question as an "ordinary" loss.

Plaintiff was incorporated in May 1958 under the name of Waterman, Merrill, Largen & Co., Inc. Its business is the selling, on commission, of various types of yarn produced by its mill accounts. It grew out of the merging of the business interests of three yarn selling companies that had been previously operated by the three principals, Waterman, Merrill, and Largen. Their companies had specialized in the sales, as commission agents, of different types of yarn — Waterman's, based in Providence, Rhode Island, in cotton yarn, Merrill's, based in New York City, in worsted yarn, and Largen's, based in North Carolina, in synthetic yarn. The merging of the three companies into the plaintiff resulted in a single sales agency capable of offering a well-rounded line of yarns. The ability to offer such a broad range has many advantages. For instance, a salesman selling one type of yarn can sometimes discover uses by the customer for other types and thereby effect additional sales.

The largest account that Merrill brought to plaintiff upon its incorporation was that of the Elmvale Worsted Company, a Massachusetts corporation that manufactured worsted wool yarn at Pittsfield, Massachusetts. This fifty-year-old mill had one of the finest reputations in the country as a quality yarn producer. However, by 1957 it had become an unprofitable business. The dominant force behind the company was Carey R. Kinney, its president and owner of 83 percent of its stock.⁶ Kinney and Merrill had been longtime personal and business friends and associates.⁷ Elmvale had its own sales force selling its production of worsted weaving yarn. However, in an effort to stem Elmvale's unprofitable operation, Kinney, in the summer of 1957, requested Merrill to undertake a pilot experiment whereby Elmvale would enter the more profitable knitting yarn manufacturing field and Merrill would promote the sales of such yarn upon the usual sales agent's two percent commission. Merrill agreed and, indeed, succeeded to such an extent as, by May 1958, to warrant plaintiff's incorporation and the bringing into it of Merrill's accounts, including Elmvale, as its worsted division. By the latter part of 1958, the account had grown to the point that around thirty percent of Elmvale's production consisted of knitting yarn, with Elmvale becoming the third largest account plaintiff had and the principal factor in the worsted division of plaintiff's business.⁸

However, despite the increasing success Merrill was achieving in transforming Elmvale's production into the more profitable knitting yarns, the effort still did not result in transforming Elmvale into a profitable mill and, in early December 1958, Elmvale decided to terminate operations. Antiquated machinery and labor problems contributed significantly to its plight, as was then the situation in many New England mills. In addition, 1958 was a poor year in the textile industry.

The loss of this account was a serious blow to plaintiff. Elmvale was the most important segment of its worsted division, constituting its only substantial worsted wool account.⁹ One of the principal reasons for having organized plaintiff just eight months before was to have such a worsted division. The Elmvale account was a steadily growing one and was, by December 1958, generating commissions at the rate of over $2,000 a month. This amount contributed substantially to defraying the overhead of plaintiff's New York City office, including the salaries of Merrill and another salesman, Heyman, who spent much of their time on the Elmvale account.¹⁰ Plaintiff's own financial situation was weak. While it had been in operation only eight months, plaintiff had, as of December 31, 1958, incurred an operating loss during this...