Cal-Maine Foods, Inc. v. Comm'r of Internal Revenue

• Citation: 93 T.C. No. 19,93 T.C. 181
• Decision Date: 08 August 1989
• Docket Number: Docket No. 22144-84.
• Parties: CAL-MAINE FOODS, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: United States Tax Court

93 T.C. 181

93 T.C. No. 19

CAL-MAINE FOODS, INC., Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 22144-84.

United States Tax Court

Filed August 8, 1989.

‘Farms‘ and ‘Dairy Fresh,‘ wholly-owned subsidiaries of P, are farming corporations. Before and for the year in issue, ‘Farms‘ and ‘Dairy Fresh‘ used the cash receipts and disbursements method of accounting for tax purposes. Pursuant to sec. 447(a) of the Internal Revenue Code of 1954, effective for the first taxable year beginning after December 31, 1976, ‘Farms‘ and ‘Dairy Fresh‘ were required to change to the accrual method of accounting unless one of the specific exceptions to sec. 447(a) applied. In order to satisfy the ‘family corporation‘ exception to sec. 447(a), P arranged, through loans, for A, P's president and controlling stockholder of its common stock, to purchase one-half of the outstanding shares of preferred stock of P from B, an unrelated corporation. Subsequently, P redeemed more than one-half of the preferred stock acquired by A.

HELD, the step transaction doctrine does not apply to A's purchase and P's subsequent redemption of the preferred stock. HELD FURTHER, for the year in issue, for purposes of sec. 447(a), P met the ‘family corporation‘ exception requirements. Hugh C. Montgomery, Jr., Charles L. Brocato, and Gilbert C. Van Loon, for the petitioner.

Frank Simmons, for the respondent.

HAMBLEN, JUDGE:

Respondent determined a deficiency in petitioner's Federal income tax for the fiscal year ended June 3, 1978, in the amount of $1,221,784.

After concessions by the parties, the issue for decision is whether for the fiscal year ended June 3, 1978, petitioner is entitled to use the cash receipts and disbursements method of accounting for its farm income from two of its subsidiary corporations, or whether that income must be reported on the accrual method of accounting pursuant to section 447(a). ¹

FINDINGS OF FACT

Some of the facts have been stipulated and are found accordingly. The stipulation of facts and attached exhibits are incorporated herein by this reference.

Petitioner is a Delaware corporation which is authorized to do business in Mississippi and other states. During the fiscal year beginning May 29, 1977, and ended June 3, 1978, (hereinafter referred to as ‘the fiscal year‘) and at the time of filing the petition in this case, petitioner's principal place of business was Jackson, Mississippi.

Petitioner filed a consolidated United States Corporation Income Tax Return (Form 1120) for the fiscal year. The results of operations of the following wholly-owned subsidiaries, all of whose fiscal years ended June 3, 1978, were included in this consolidated return: Cal- Maine Egg Products, Inc.; Cal-Maine Farms, Inc; Dairy Fresh Products Company; Nationwide Distributing and Brokerage Company; and D.F. Advertising, Inc. Petitioner had gross receipts of $376,509,206 for the fiscal year; it operated in fifteen states and seventeen or eighteen communities.

During the fiscal year, petitioner was a medium- to large-size farmer. It was the third or fourth largest egg producer in the United States.

Cal-Maine Farms, Inc. (hereinafter referred to as ‘Farms‘) and Dairy Fresh Products Company (hereinafter referred to as ‘Dairy Fresh‘) are both poultry farmers. Their operations include all of the steps relating to the raising of chickens and laying flocks; the production of eggs; and the marketing, sale, and distribution of both shell eggs and processed eggs. During the fiscal year, Farms and Dairy Fresh operated their poultry farming business on a national basis.

For the fiscal year and several years before, petitioner used the accrual method of accounting for itself and all of its wholly- owned subsidiaries for all purposes, except that, for tax purposes only, petitioner used the cash basis method of accounting for Farms and Dairy Fresh. Farms and Dairy Fresh first began using the cash basis method of accounting in 1957. Most of petitioner's competitors in the egg farming business use the cash basis method of accounting.

During the fiscal year, petitioner was a publicly held corporation with approximately 1,300 stockholders. ² Its stock was traded over-the-counter. For the fiscal year, petitioner's board of directors consisted of four ‘outside‘ directors and two ‘inside‘ directors. Fred Adams, Jr. (hereinafter referred to as ‘Adams‘) was one of the two inside directors.

For the fiscal year and several years before, Adams was petitioner's president, chief executive officer, and principal shareholder. As of May 28, 1977, petitioner had common stock outstanding of 2,495,512 shares. Adams owned 1,338,904 shares of the common stock, or 53.7 percent. As of the end of the fiscal year, petitioner had common stock outstanding of 2,495,952 shares. Adams owned 1,288,786 shares of this common stock, or 51.6 percent. At all times during the fiscal year, Adams owned not less than 51.6 percent of petitioner's common stock.

As of October 11, 1976, petitioner had 40,000 shares of five percent cumulative preferred stock outstanding (hereinafter referred to as ‘the preferred stock‘), which were convertible to common stock at the rate of twenty-two shares of common stock for one share of preferred stock. ³ The preferred stock was issued on March 29, 1972, under the authority of a ‘Certificate As To Resolution Adopted By Board of Directors‘ (hereinafter sometimes referred to as ‘the preferred stock agreement‘). The preferred stock was callable after January 1, 1979, at par value plus accrued dividends. Beginning in 1980, petitioner was required to redeem annually a minimum of 10,000 preferred shares if the preferred stock had not previously been converted into common stock. ⁴ As of October 14, 1976, DeKalb AgResearch, Inc. (hereinafter referred to as ‘DeKalb‘) owned all of the outstanding preferred stock. DeKalb had acquired the preferred stock under a stock purchase agreement dated March 29, 1972.

The preferred stock agreement subjected petitioner to various limitations and requirements with regard to business activity and financial maintenance. There were stringent covenants which restricted petitioner's business activity. Default in the performance of any of the obligations and covenants for a period of ninety days or failure to pay three consecutive dividends when due enabled the holder of the preferred stock to accelerate redemption dates and to elect to the board of directors the smallest number of directors empowered to act on petitioner's behalf. The preferred stock agreement also limited payment of dividends on common stock. During 1978, DeKalb waived noncompliance with a financial maintenance requirement through June 1979.

Several months, and possibly as long as one year, before October 11, 1976, DeKalb asked petitioner to repurchase the preferred stock in advance of the time that petitioner was required to do so under the preferred stock agreement. The initial discussions between petitioner and DeKalb regarding the possible repurchase of the preferred stock continued for several months. Petitioner did not become interested in pursuing repurchase of the preferred stock until after the passage on October 4, 1976, of section 207(c) of the Tax Reform Act of 1976, Pub. L. 94-455, 90 Stat. 1520, which added section 447 to the Internal Revenue Code. ⁵

Section 447 generally requires corporations and certain partnerships engaged in the trade or business of farming to compute taxable income from farming on the accrual method of accounting unless certain exceptions apply. Sec. 447(a); 447(c) (now sec. 447(d), see n. 13 infra). After the enactment of section 447, petitioner made some calculations of stock ownership and determined that, in order for Farms and Dairy Fresh to continue using the cash basis method of accounting, petitioner would have to make changes in voting stock ownership so as to satisfy the ‘family corporation‘ exception to section 447(a) contained in section 447(c) (now sec. 447(d)).

A specially called meeting of petitioner's board of directors was held on October 11, 1976, for the purpose of reviewing the effects on petitioner of the Tax Reform Act of 1976. At this meeting, Adams and petitioner's management proposed to the board of directors several alternatives which they believed would allow petitioner to meet the ‘family corporation‘ exception. Two of the alternatives discussed were: (1) Petitioner would repurchase all of the preferred stock held by DeKalb; or (2) Adams, individually, would buy approximately one-half of the preferred stock held by DeKalb if petitioner would loan Adams the money with which to make the purchase.

The minutes of the specially called meeting of the board of directors held on October 11, 1976, describe the events at this meeting in part as follows:

After full discussion as to the impact on the Corporation of the new tax act, the funds available for such purchase, and the current general financial position and prospects of the Corporation, the Directors were of the opinion that it would be in the best interest of the Corporation and its shareholders to enter into an agreement with DeKalb AgResearch, Inc. under the terms of which the Corporation or its assignee would have the right to acquire preferred stock of the Corporation held by DeKalb. On motion by Mr. Davis, seconded by Mr. McMullan, the following resolution was unanimously adopted:

RESOLVED, that the Corporation shall be and is hereby authorized to enter into an agreement with DeKalb AgResearch, Inc., under the terms of which the Corporation, or its assignees, Fred Adams, Jr. or the Cal-Maine Foods, Inc. Employee Stock Ownership Plan, shall be obligated to purchase 10,000 shares of its preferred stock from DeKalb AgResearch, Inc., at a purchase price of $1,100,000, plus accrued but unpaid dividends, with said agreement further providing that Cal-Maine shall have an option to acquire the balance of such stock held by...