Anderson v. United States

Citation468 F. Supp. 1085
Decision Date30 March 1979
Docket NumberCiv. No. 1-76-423.
PartiesDonald C. ANDERSON and Gernhild Anderson, Plaintiffs, v. The UNITED STATES of America, Defendant.
CourtU.S. District Court — District of Minnesota



William R. Busch, St. Paul, Minn., for plaintiffs.

Lawrence E. Meuwissen, Tax Div., Dept. of Justice, Washington, D. C., for defendant.


MacLAUGHLIN, District Judge.

This case presents the troublesome issue of whether income to the grantee from the "release" of a "thirty (30) day right of refusal" to the original grantor should be treated for tax purposes as ordinary income or as capital gain. The plaintiff taxpayers in this action are Donald C. Anderson and Gernhild Anderson. Since Gernhild Anderson was not specifically involved in any of the transactions giving rise to this litigation, and is involved in this proceeding only because of signing a joint return, any reference in this order to the taxpayer refers to Donald Anderson. The Andersons were at all times material to this action residents of Rochester, Minnesota. Under the provisions of I.R.C. § 7422(f)(1), the United States of America is the proper party defendant in this action. This Court has jurisdiction under the provisions of 28 U.S.C. § 1346(a)(1).

This matter was tried before the Court without a jury. The Court, having considered all the testimony, exhibits,1 arguments, memorandum of counsel, files and records hereby makes the following findings of fact and conclusions of law pursuant to Federal Rule of Civil Procedure 52(a).


Plaintiff taxpayers filed a joint federal income tax return for the calendar year 1972 with the Internal Revenue Service Center in Ogden, Utah, paying in full the $233,529.18 amount due. The taxpayers later filed a claim for a partial refund of taxes paid under the 1972 joint return. After allowing six months for administrative action on their claim, they filed this tax refund action.

On November 1, 1962 the Sonor Hotel Corporation, a Tennessee corporation (hereinafter referred to as Sonor), acquired from the Holiday Inns of America, Inc. (hereinafter referred to as Holiday Inn) a Holiday Inn franchise, for a specified location in Rochester, Minnesota. Taxpayer Donald C. Anderson was one of the original shareholders in Sonor and a moving force behind the decision to develop a Holiday Inn franchise in Rochester. The Sonor franchise was restricted by the terms of the license agreement with Holiday Inn to the licensed territory described as the "N.E. Corner U.S. # 63 & 17 St. S.W." (1630 Broadway). The franchise was limited to the specific location granted in the license agreement and according to the agreement, the license or franchise was not transferrable by Sonor without Holiday Inn's written consent.

Sonor was formed in 1962 by six shareholders, including Anderson, and Lloyd Hobbs was selected president. The construction of the original Sonor facility at 1630 Broadway in Rochester was financed by a $750,000 mortgage loan that Sonor had obtained from a local bank. Donald Anderson and the other shareholders of Sonor were co-makers of that mortgage note. Sonor's motor inn facilities opened for business in November of 1963.

Anderson's records filed with the Internal Revenue Service show that on December 30, 1963, he purchased sixty-six shares of Sonor stock. On January 12, 1964, Anderson obtained an additional sixty-nine shares of Sonor stock from two other shareholders. Also in January of 1964, Sonor leased its motor inn facilities in Rochester to Anderson for a twenty-year term at a net rental of $8,500 per month, plus a percentage of the restaurant receipts. Anderson also entered into a written stock option agreement to buy the remaining 50% of outstanding Sonor stock from Hobbs.

In 1966, Anderson became involved in efforts regarding the construction of a possible new Holiday Inn franchised facility in the Rochester area. Anderson was also contemporaneously considering plans to expand the Sonor Holiday Inn facility to almost double its then existing capacity. During this time period, Anderson went to meet with Kemmons Wilson, Chairman of the Board of Directors of Holiday Inn. At that meeting, Anderson asked for and obtained assurances that if another Holiday Inn franchise were to be granted in the Rochester area, he would be given a certain length of time to begin developing it himself. Lloyd Hobbs, then president of Sonor, did not accompany Anderson to that meeting. These assurances from Kemmons Wilson were included in the following letter:

December 20, 1966

Mr. Donald C. Anderson Holiday Inn Rochester, Minn.

Dear Don:
We have been very happy with your operation in Rochester, and are happy to learn that you are planning to build 120 rooms to the North of your existing Inn.
We would be very glad to work with you and certainly would not give anyone else a franchise without giving you a thirty (30) day right of refusal.

Sincerely yours HOLIDAY INNS OF AMERICA, INC. /s/ Kemmons Wilson Chairman of the Board

In early 1967, in conjunction with the financing of the expansion of Sonor's motor inn facilities in Rochester, Sonor entered into a mortgage refinancing loan for $1,100,000. Sonor's mortgage note to the lending bank was personally guaranteed by both Anderson and Hobbs, who both also signed on behalf of Sonor. After the mortgage refinancing, Anderson's lease of Sonor's existing facilities was amended to increase the net rental from $8,500 per month to $14,166 per month, plus the existing percentage of the restaurant receipts. The mortgage refinancing loan allowed the Sonor facility to expand its operations by adding 80 new guest rooms. At the time of the negotiations between Anderson and Wilson, the issue of expansion had obviously been discussed since the letter of December 20, 1966, specifically made reference to plans to add "120 rooms to the North of your existing Inn."

In January of 1968, Anderson exercised his option to purchase the remaining Sonor stock from Lloyd Hobbs. At the time of the exercise of his option, Anderson's lease of Sonor's motor inn facilities in Rochester was terminated by mutual agreement and thereafter Sonor operated the motor inn facilities at 1630 Broadway. Anderson thus became the sole shareholder of Sonor. In January of 1970, Anderson completed payment of the purchase price for the remaining 50% of Sonor stock he had purchased earlier.

In 1971 an existing 350 room Sheraton Motor Inn operated by the Sheroc Corporation (hereinafter referred to as Sheroc), became available in downtown Rochester. Holiday Inn was considering taking over the former Sheraton facility and operating it under a management contract with Sheroc when Holiday Inn officials contacted Anderson and explained its opportunity to convert the existing Sheraton facility into a Holiday Inn. Anderson expressed his feeling that this was contrary to his understanding of the December 20, 1966 letter's thirty-day right of refusal and ultimately went to Memphis to meet with Holiday Inn officials.

As a result of negotiations, Holiday Inn and Anderson reached an agreement to release Holiday Inn from its obligations under the December 20, 1966 letter granting Anderson the thirty-day right of refusal. In exchange for the release of his right of refusal, Anderson received from Holiday Inn a $100,000 lump sum payment, plus a 20% annual share of the management fees received by Holiday Inn for its operation of the Sheroc facility for a 22-year period. The management fees received by Holiday Inn from the Sheroc facility were basically defined as five percent of the gross revenues of the Sheroc facility. The sums that were received by Anderson from Holiday Inn under the release agreement were reported in plaintiff's federal income tax return for 1972 and totaled $130,638.14. Anderson now maintains that the payments totaling $130,638.14 were reported erroneously as ordinary income on his 1972 federal income tax return and should instead have been reported as long-term capital gain from the sale or exchange of a capital asset. Anderson therefore concludes that he overreported and overpaid his 1972 federal income tax.

On April 13, 1976, Anderson filed a claim for refund on the ground that the 1972 income tax return was in error and that the $100,000 item should have been reported on Schedule D, "Capital Gains and Losses." In the refund claim the taxpayer contended that the $100,000 represented income received

for the termination and release of his exclusive franchise rights — first refusal rights in the Rochester, Minnesota area which he held from a national motel operating and franchise corporation . . ..

In the 1972 return the taxpayer also reported an item in the amount of $30,638.14 which was identified as "Commissions rec'd from Sheroc Corp. on sales in Holiday Inn — downtown — Rochester, Minnesota." This item was also entered on the 1972 return as ordinary income. At the time of trial, the plaintiffs sought leave to amend their complaint in this action to assert a claim that this "commission" item actually represented the first annual payment of management fees under the November 9, 1971, release and was thus also subject to capital gain treatment.


The first issue which must be resolved is the plaintiffs' motion under Federal Rule of Civil Procedure 15 for leave to amend their complaint. Rule 15(a) states that leave to amend a pleading "shall be freely given when justice so requires." The government maintains that leave to amend should be denied here since the taxpayer did not file a separate refund claim for the "commission" item. The government asserts that since the claim filed by the taxpayer sought a refund for only the $100,000 amount, the taxpayer should be barred for jurisdictional reasons from raising the issue of the additional $30,638.14 and the motion for leave...

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