Burr Oaks Corporation v. CIR

• Decision Date: 16 August 1966
• Docket Number: No. 15344-15347.,15344-15347.
• Citation: 365 F.2d 24
• Parties: BURR OAKS CORPORATION, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. A. Aaron ELKIND and Rosella Elkind, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Harold A. WATKINS and Fannie G. Watkins, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Maurice RITZ and Esther Leah Ritz, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Seventh Circuit

365 F.2d 24 (1966)

BURR OAKS CORPORATION, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

A. Aaron ELKIND and Rosella Elkind, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Harold A. WATKINS and Fannie G. Watkins, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Maurice RITZ and Esther Leah Ritz, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Nos. 15344-15347.

United States Court of Appeals Seventh Circuit.

June 28, 1966.

Rehearing Denied August 16, 1966.

Rehearing Denied August 16, 1966.

Gerald J. Kahn, Herbert Morse, Milwaukee, Wis., for petitioners; James Ward Rector, Jr., Godfrey & Kahn, Milwaukee, Wis., of counsel.

Richard M. Roberts, Asst. Atty. Gen., Solomon Leo Warhaftig, Lee A. Jackson, Gilbert E. Andrews, Attys., Dept. of Justice, Washington, D. C., for respondent.

Before KNOCH, CASTLE and KILEY, Circuit Judges.

Rehearing Denied August 16, 1966, En Banc.

KNOCH, Circuit Judge.

The petitioners, Burr Oaks Corporation, A. Aaron Elkind and Rosella Elkind, Harold A. Watkins and Fannie G. Watkins, Maurice Ritz and Esther Leah Ritz, instituted these proceedings in the Tax Court to contest deficiencies in income taxes determined against them. Mrs. Elkind, Mrs. Watkins and Mrs. Ritz are in these cases only because joint income tax returns were filed. The cases were consolidated. The opinion of the Tax Court is reported at 43 T.C. 635, No. 51. The Tax Court held that the transfer of certain land by the petitioners A. Aaron Elkind, Harold A. Watkins and Maurice Ritz (hereinafter called "the individual appellants") to the corporate appellant represented a contribution to capital and not a sale. Accordingly, the Tax Court determined a deficiency against the corporate appellant for fiscal years ended September 30, 1958, 1959 and 1960. The Tax Court found deficiencies for one of the individual appellants, but also found an overpayment by all three of the individual appellants for 1959. The individual appellants have taken this appeal because of their concern as to adverse effect on future taxable years.

The three individual appellants acquired a tract of undeveloped land in 1957 for $100,000, which the appellants state to be less than the then market value.

After discarding plans to develop a regional shopping center or an industrial park, the individual appellants decided to subdivide the land, improve it and sell lots. The Burr Oaks Corporation was formed. The individual appellants transferred the land to it, and, in return, each received a two-year 6% promissory note in the principal amount of $110,000. The sum of $30,000 still due on the original purchase was entered on the corporation's books as "Mortgage Payable." Another account "Land Contract Payable" in the amount of $330,000 represented the three notes.

At the trial in the Tax Court, the appellants' expert witness testified that the property transferred to the corporation was worth at least $360,000. The Tax Court, however, found more convincing the testimony of the Commissioner's expert witness who stated that the land had a fair market value of only $125,000. On the basis of all the evidence adduced, the Tax Court found a fair market value of not more than $165,000 at the time of the transfer.

The wives and brothers of the three appellants transferred a total of $4,500 in cash to the corporation and received common stock as follows:

                  Shareholder                                  No. of Shares
                  Rosella Elkind (Mrs. A. Aaron Elkind)            150
                  Fannie G. Watkins (Mrs. Harold A. Watkins)       150
                  Philip M. Ritz (Maurice Ritz's brother)           75
                  Erwin M. Ritz (Maurice Ritz's brother)            75
                

They are the only stockholders of record. The officers and directors were:

Harold A. Watkins President Philip M. Ritz Vice-President Rosella Elkind Secretary-Treasurer Directors Harold A. Watkins Fannie G. Watkins Maurice Ritz Philip M. Ritz A. Aaron Elkind Rosella Elkind

However, all control of the corporation was relinquished to the three individual appellants, who dominated its affairs, despite engagement of a manager and an accounting firm.

Without the knowledge of the shareholders or formal authorization by the directors, the corporation at times transferred lots and parcels to the three individual appellants at no cost or at less than the amount the land would realize from sales to third parties. The Tax Court particularly noted some commercial property 70 by 120 feet transferred by a deed which purported to correct an error in the initial conveyance to the corporation.

The Tax Court decided that the three promissory notes did not represent a true indebtedness. In 1959, these three notes, in the amount of $110,000 each, were surrendered by payment of $23,000 in cash on each note, and a new one-year promissory note dated November 1, 1959, in the amount of $87,000 at 6% was given in exchange for each of these three notes. Later the same year, the corporation paid $8000 to each of three noteholders and issued new promissory notes in the amount of $79,000. On December 29, 1959, the corporation purported to pay these notes, although at the close of business that day it had a bank balance of only $5,398.88. Immediately after such purported payment, the three individual appellant-noteholders each lent the corporation $79,000 in return for three new one-year promissory notes dated December 31, 1959, in the amount of $79,000 each. The Tax Court construes this transaction as a mere extension of the maturity date. Cf. Arthur L. Kniffen, 1962, 39 TC 553, 565-566. Additional payments were made to each of the three individual appellants as follows:

                   8/31/60         $ 8,000
                   1/31/61          15,000
                  12/31/61          10,000
                

leaving a balance of $46,000 due each at the time of the trial. None of the earnings of the corporation were distributed to any of the shareholders of record.

Although the appellants all treated the transfer of the land in November, 1957, as a sale, the three individual appellants reported no gain until 1959 when the corporation "paid" the promissory notes issued at the transfer. In their returns for 1959, the three reported long term capital gains of $85,729.06. The Commissioner determined that this was ordinary income. The Commissioner increased the corporation's taxable income for 1958 through 1960 on the ground that the corporation claimed too high a basis or cost for the land it sold during that period.

The Tax Court considered the "notes" to be preferred stock because the three holders occupied a preferred position compared to the common stockholders, the 6% interest constituting a prior charge on the earnings of the corporation.

The three individual appellants contend that they transferred the Burr Oaks property, a capital asset held in excess of six months, to the corporation in return for promissory notes, valid indebtednesses incurred by the corporation, resulting in gain properly reportable in 1959 when the notes were paid in full. The Tax Court noted that the three individual appellants were all cash basis taxpayers who should have reported as income the fair market value of the notes received in...