Arkansas Best Corp. and Subsidiaries v. C.I.R.

• Decision Date: 09 September 1986
• Docket Number: Nos. 85-1702,85-1818,s. 85-1702
• Citation: 800 F.2d 215
• Parties: -5745, 86-2 USTC P 9671 ARKANSAS BEST CORPORATION AND SUBSIDIARIES, Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Appellant. ARKANSAS BEST CORPORATION AND SUBSIDIARIES, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.
• Court: U.S. Court of Appeals — Eighth Circuit

Page 215

800 F.2d 215

58 A.F.T.R.2d 86-5745, 86-2 USTC P 9671

ARKANSAS BEST CORPORATION AND SUBSIDIARIES, Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Appellant.

ARKANSAS BEST CORPORATION AND SUBSIDIARIES, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

Nos. 85-1702, 85-1818.

United States Court of Appeals Eighth Circuit.

Submitted Feb. 13, 1986.

Decided Sept. 9, 1986.

Vester T. Hughes, Jr., Dallas, Tex., for appellant.

Ernest J. Brown, Washington, D.C., for appellee.

Before HEANEY and BOWMAN, Circuit Judges, and HANSON, ^* Senior District Judge.

BOWMAN, Circuit Judge.

The issue in this case is whether a corporate taxpayer is entitled to ordinary loss treatment for losses incurred on transactions in the capital stock of another corporation. Both Arkansas Best Corporation (Arkansas Best) and the Commissioner of Internal Revenue (Commissioner) appeal the Tax Court's judgment upholding in part and disallowing in part the Commissioner's treatment of Arkansas Best's losses on such transactions as capital losses. Arkansas Best Corp. & Subsidiaries v. Commissioner, 83 T.C. 640 (1984). Arkansas Best also appeals the court's ruling upholding the Commissioner's disallowance of a claimed bad debt deduction. Id. at 660-62. We reverse insofar as the Tax Court allowed ordinary loss treatment for any of the capital stock transactions. In all other respects, we affirm.

I.

Arkansas Best is a diversified holding company. Its subsidiaries are engaged in various endeavors including interstate trucking, new tire sales, used tire retreading, and data processing. In 1968, Arkansas Best acquired approximately 65% of the stock of the National Bank of Commerce (Bank). In 1970, Congress amended the Bank Holding Company Act, Pub.L. No. 91-607, Title 1, Sec. 103, 84 Stat. 1763 (codified at 12 U.S.C. Sec. 1841 et seq.), to prohibit bank holding companies such as Arkansas Best from acquiring nonbanking businesses. Thereafter, in August 1971, Arkansas Best filed a notice of divestiture and began trying to sell its Bank stock. Once the notice was filed, Arkansas Best, although still a bank holding company, was free to acquire nonbanking businesses.

Because the Bank had made a series of bad loans, selling the Bank stock proved difficult. While actively trying to sell its interest in the Bank, Arkansas Best participated in preemptive rights offerings and capital calls to improve the Bank's capital structure. In 1972, Arkansas Best also bought the Bank president's personal holdings of Bank stock to secure his resignation and noninterference in the sale of Arkansas Best's interest in the Bank shares. In addition, in 1974 Arkansas Best bought the Bank stock held by one of its subsidiaries, an insurance company.

In 1975, Arkansas Best finally was able to sell over half of its holdings of Bank stock to a group of Texas investors. It received cash and a nonrecourse note secured by the stock. Shortly thereafter, Arkansas Best's independent auditors recommended that it charge off its books $4,485,876 of the face amount of the note, although the note was not in default, reducing its basis to $1,520,300. Three months later, Arkansas Best sold the note for $1,652,500. It also granted a third party an option to purchase its remaining shares of Bank stock in installments; by the end of 1980, Arkansas Best no longer held any shares of Bank stock. On its 1975 income tax return, Arkansas Best claimed an ordinary loss deduction of $9,995,688 from the disposition of the Bank stock, and on its 1976 income tax return, it claimed a deduction for an ordinary loss of $4,353,656 from the sale of the note. The Commissioner disallowed both deductions, deciding that the losses resulting from the sales of stock were capital losses subject to 26 U.S.C. Sec. 1221. Arkansas Best challenged those disallowances in a petition to the Tax Court. As an alternative in its petition, Arkansas Best claimed it was entitled to a deduction on its 1975 income tax return of $4,485,876 for the partial worthlessness of the note. Before the Tax Court, Arkansas Best dropped the 1976 claimed deduction and asserted only the claim for a 1975 deduction for the partial worthlessness (bad debt) of the note.

The Tax Court held that the loss realized on stock acquired from 1968 through 1972 was a capital loss because the Bank was not an integral and necessary part of Arkansas Best's business. The shares were an investment. 83 T.C. at 655. However, the court also held that the purchase of stock from the Bank president in 1972 was motivated by business purposes and that the loss upon sale of that stock was entitled to ordinary loss treatment. Id. at 657. Similarly, the court found that Arkansas Best's purchases of Bank stock after 1972 were made to protect its business reputation, and therefore that it was entitled to ordinary loss treatment for losses realized on the disposition of Bank stock acquired after 1972, except in the case of Bank stock that Arkansas Best acquired from a subsidiary in 1974. Id. The court further held that the Commissioner had not abused his discretion in denying the deduction for the partial worthlessness of the note as claimed in Arkansas Best's 1975 income tax return. Id. at 661.

On appeal, Arkansas Best challenges three aspects of the Tax Court's decision: (1) that its losses realized on stock acquired in preemptive rights offerings were not entitled to ordinary loss treatment; (2) that it is not entitled to ordinary loss treatment on its losses from the Bank stock purchased from its subsidiary; and (3) that it is not entitled to a bad debt deduction for the 1975 tax year for the losses attributable to the nonrecourse note. The Commissioner appeals the Tax Court's decision that Arkansas Best is entitled to ordinary loss treatment for losses incurred on stock acquired after 1972 and for losses incurred on stock acquired from the Bank president.

II.

Arkansas Best argues that all the purchases of Bank stock it made after declaring it would divest itself of the stock were made in the ordinary course of business. Distinguishing its concededly pre-August 1971 investment motives for buying the Bank stock, Arkansas Best asserts that its subsequent purchases were intended to preserve its business reputation by preventing the Bank from failing, and that losses incurred on the sale of the stock so acquired are ordinary business expenses that it can deduct in full from gross income.

Whether these arguments have merit depends upon whether any of the Bank stock that Arkansas Best acquired can be characterized as not being a "capital asset" within the meaning of 26 U.S.C. Sec. 1221. This section establishes a general rule defining capital asset as "property held by the taxpayer (whether or not connected with his trade or business)...." The corresponding federal regulation, 26 C.F.R. Sec. 1.1221-1(a), states that "[t]he term 'capital assets' includes all classes of property not specifically excluded by section 1221." The property that section 1221 excludes from the general rule is (1) stock in trade or inventory; (2) business property subject to the depreciation allowance or real property used in business; (3) copyrights, literary or artistic compositions, and similar property; (4) business-related accounts or notes receivable; and (5) federal government publications. Because capital stock plainly does not fall into any of the last four categories, we consider only the first exception, 26 U.S.C. Sec. 1221(1), which excludes from "capital asset"

stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business....

Generally, capital stock would meet this exception only if the taxpayer's business consisted of dealing in securities. See Campbell Taggart, Inc. v. United States, 744 F.2d 442, 449 (5th Cir.1984); 3A J. Rabkin & M. Johnson, Federal Income, Gift and Estate Taxation Sec. 34.01A(1), at 3405a (1986). ¹ Arkansas Best is not a dealer in securities. It is a holding company which provides management services to its subsidiaries in exchange for fees. Arkansas Best also realizes income from the dividends it receives on the stock it holds. Arkansas Best did not hold its Bank stock and it never has held its stock in any of its subsidiaries for sale to "customers." Rather, it holds capital stock to secure a controlling interest in each subsidiary and to derive income therefrom.

We conclude that the Bank stock was a capital asset because it does not fall into one of the statutory exceptions. The underlying purpose of section 1221 and its legislative history reinforce our conclusion. According to H.R.Rep. 704, 73d Cong. 2d Sess. (1934), the purpose of the tax code amendments, part of which defined "capital asset," was to increase revenue by preventing tax avoidance. Id. at 1. Elsewhere, the report specifically refers to the definition of capital asset: "It will be noted that the definition includes all property, except as specifically excluded." Id. at 31. This language is virtually identical to that of Federal Regulation 1.1221-1(a). See generally Troxell & Noall, Judicial Erosion of the Concept of Securities as Capital Assets, 19 Tax L. Rev. 185, 186 (1964).

Although a literal reading of section 1221 clearly requires capital stock to be treated as a capital asset, the decision of the Supreme Court in Corn Products Refining Co. v. Commissioner, 350 U.S. 46, 76 S.Ct. 20, 100 L.Ed. 29 (1955), placed a judicial gloss on the section. In that case, the Court considered the taxpayer's contention that income from trading in corn futures was entitled to capital gains treatment. The Court found that the purchases of corn futures by the taxpayer, which was a manufacturer of products derived from corn, were important to its business because they assured a...