AINSLEY CORPORATION v. CIR

• Citation: 332 F.2d 555
• Decision Date: 27 May 1964
• Docket Number: No. 18964.,18964.
• Parties: The AINSLEY CORPORATION, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: United States Courts of Appeals. United States Court of Appeals (9th Circuit)

332 F.2d 555 (1964)

The AINSLEY CORPORATION, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 18964.

United States Court of Appeals Ninth Circuit.

May 27, 1964.

L. W. Wrixon, San Francisco, Cal., for petitioner.

Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, Harold C. Wilkenfeld, Edward L. Rogers, John Nolan, Attys., Dept. of Justice, Washington, D. C., for respondent.

Before CHAMBERS, Circuit Judge, MADDEN, Judge of the Court of Claims, and MERRILL, Circuit Judge.

MADDEN, Judge.

The taxpayer, The Ainsley Corporation, has filed this petition for review of a decision of the Tax Court of the United States. This court has jurisdiction under Section 7482 of the Revenue Code of 1954.

The taxpayer in its federal income tax return for 1958 took a deduction from income of $102,770, because, it said, the shares of stock of Santa Clara Frosted Foods Company, hereinafter called Santa Clara, owned by the taxpayer, and having a basis to the taxpayer of $102,770, had become worthless in 1958. This deduction from its income reduced the taxpayer's tax by some $25,000. The Commissioner of Internal Revenue disallowed the deduction, served the necessary notice of deficiency, and the taxpayer filed a petition with the Tax Court for a redetermination of the deficiency. The Tax Court's decision was adverse to the taxpayer, and this petition for review of the Tax Court's decision was filed.

Section 165 of the Internal Revenue Code of 1954 provides, among other things, the following:

"SEC. 165. Losses

"(a) General Rule. — There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise.

* * * * * *

"(g) Worthless Securities. —

"(1) General rule. — If any security which is a capital asset becomes worthless during the taxable year, the loss resulting therefrom shall, for the purposes of this subtitle, be treated as a loss from the sale or exchange, on the last day of the taxable year, of a capital asset.

"(2) Security defined. — For purposes of this subsection, the term `security\' means —

"(A) a share of stock in a corporation; * * *"

Santa Clara, whose stock, owned by the plaintiff, is the stock the worthlessness vel non of which is here in question, was a California corporation engaged in the processing of foods and vegetables such as lima beans, broccoli, spinach, brussels sprouts and peas. It purchased its vegetables from growers, harvesting some of them itself, in the fields and, purchasing some of them after they had been harvested by the growers. It packaged these vegetables and then turned them over to a storage company to be frozen and held in storage until it, Santa Clara, sold them to chain stores and other outlets which would sell them, directly or indirectly to consumers as frozen foods.

Santa Clara was incorporated in 1940. Its outstanding 2300 shares of stock were owner by the taxpayer, The Ainsley Corporation, which owned 925 shares, and William N. Lloyd, the president of Ainsley, who owner 1375 shares. Santa Clara was operated at a profit up to and including its fiscal year ending June 30, 1955. In the following fiscal years Santa Clara sustained operating losses, $16,113 in 1956, $231,656 in 1957, $244,448 in 1958, the losses in those three years aggregating $492,217. As of December 31, 1958, Santa Clara's liabilities exceeded its assets by $210,310.56 on a book value basis and $206,010.67 on a fair market value basis.

Approximately in March, 1958, Santa Clara began the following course of conduct: it made no more contracts with growers for the purchase of vegetables, although such contracts had to be made five or six months before crops matured in order to obtain vegetables for processing; it gradually laid off its employees, as their particular work was completed, the last employee being laid off in October or November, 1958; in March 1958 it caused the electric power to its only plant to be shut off, and thereafter obtained what little power it used by a makeshift arrangement with a neighboring enterprise; it disposed of all of its processed food in 1958, in some instances purchasing some kinds of processed food from other processors in order to be able to fill orders and thus be able to dispose of its own remaining stocks of the kinds of food which it still had on hand; the equipment in the plant was greased to prevent rusting, and the plant was padlocked; constant and diligent efforts were made during 1958 to sell the business, all possible purchasers known to the Santa Clara management having been solicited with brochures or personal contacts or both, but there being no prospect, at the end of 1958 of a profitable sale of the business.

Our question is whether the taxpayer's stock in Santa Clara became worthless in 1958. Would a prudent purchaser in an arms length transaction have regarded the stock in this enterprise as representing any equity at all in this debt-ridden inactive company with its history of several years of uninterrupted and ruinous operating losses? With deference, we are obliged to say that we cannot see even the possibility that that might have happened. The Tax Court has held that the stock had value, and we will consider its reasons for reaching that conclusion.

The Tax Court found that the assets of Santa Clara on December 31, 1964 had a fair market value of $184,233.20. It reasoned that if the Santa Clara enterprise, with its plant, history, geographical location, past relations with growers of vegetables and purchasers of frozen foods, had a value of more than $184,233.20, the fair market value of its physical assets, that would be proof that the stock in the corporation had not become totally worthless. The Tax Court said:

"In the instant case, as of December 31, 1958, there existed a going concern value to Santa Clara as a corporation in excess of the value of its assets. The evidence does not show this going concern value to be attached to anything other than the Santa Clara stock."

The taxpayer vigorously objects to the Tax Court's conclusion that Santa Clara, in the plight that it was in on December 31, 1958 had a going concern value. And government counsel in their brief and oral argument defending the Tax Court's decision, have omitted any mention of going concern value. Yet we suppose the quoted expression of the Tax Court is correct. At any rate, we do not have at hand any other expression to describe a situation in which an arms length purchaser would pay more for a lot of physical objects plus the history and other intangibles mentioned above, connected with...