Cal-Maine Foods, Inc. v. Commissioner, Docket No. 7092-74
| Decision Date | 30 March 1977 |
| Docket Number | Docket No. 7092-74,7093-74. |
| Citation | 36 TCM (CCH) 383,1977 TC Memo 89 |
| Parties | Cal-Maine Foods, Inc., Successor to Adams Egg Farms, Inc. v. Commissioner. Cal-Maine Foods, Inc., Successor to Adams Foods, Inc., (Formerly Simpson County Hatchery, Inc.) v. Commissioner. |
| Court | U.S. Tax Court |
Hugh C. Montgomery, Jr., 1800 Deposit Guaranty Plaza, Jackson, Miss. for the petitioner. Robert W. West, for the respondent.
Memorandum Findings of Fact and Opinion
The Commissioner determined the following deficiencies in petitioner's Federal income taxes:
_______________________________________________________________________________________________________
Docket Taxable Year
Petitioner Number Ended Deficiency
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Cal-Maine Foods, Inc., Successor to Adams Egg Farms, Inc. ....... 7092-74 9/ 8/66 $ 3,124.00
Cal-Maine Foods, Inc., Successor to Adams Foods, Inc. (Formerly
Simpson County Hatchery, Inc.) ................................ 7093-74 5/27/67 $36,304.77
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Concessions having been made, the sole issue for decision is whether payments made by Adams Egg Farms, Inc., to Cargill, Inc., constitute rental payments within the meaning of section 162(a)(3),1 Internal Revenue Code of 1954, or were in reality payments for the purchase of property.
Some of the facts have been stipulated. The stipulation of facts and the exhibits attached thereto are incorporated by this reference.
Petitioner Cal-Maine Foods, Inc., a Delaware corporation, maintained its principal office in Jackson, Mississippi, at the time it filed its petitions in this proceeding. It is the successor to Adams Egg Farms, Inc., and Adams Foods, Inc. Adams Egg Farms, Inc. (hereinafter Farms) filed a Federal corporate income tax return for its taxable year beginning February 1, 1966 and ending January 31, 1967, with the District Director of Internal Revenue, Jackson, Mississippi. It subsequently filed an amended return for the taxable period ending September 8, 1966, the day prior to the acquisition of all of its stock by Adams Foods, Inc. (hereinafter Foods). A consolidated Federal income tax return was filed by Foods and Farms for the taxable period ending May 27, 1967, with the District Director of Internal Revenue, Jackson, Mississippi.
Farms was organized under the laws of the State of Mississippi on January 31, 1961. Ten shares of common stock, the original capitalization, were issued to Fred Adams, Jr. On February 21, 1963, Cargill, Inc. (hereinafter Cargill) acquired 51 percent of the outstanding capital stock of Farms. During Farms' taxable year ended September 8, 1966, Cargill owned 51 percent of the outstanding stock of both Foods and Farms, while Fred Adams, Jr., owned the remainder. On September 9, 1966, Foods purchased 51 percent of the outstanding stock of Farms from Cargill; on the same date the 51 percent interest in Foods owned by Cargill was acquired by Mr. Adams, who contributed his 49 percent interest in Farms to Foods on such date. As a result of the above transactions, Mr. Adams owned all of the stock of Foods, which owned all of the stock of Farms.
The principal business activity of Farms is the production and sale of eggs. In 1963 and during the years in question, the commercial egg business was speculative, cyclical, and highly competitive. Since 1963, major egg producers have gone out of business as the result of bankruptcy or lack of working capital. Egg consumption per capita and the number of laying chickens in the United States have decreased.
The Federal income tax returns and balance sheets of Farms for the taxable years ended January 31, 1963, and January 31, 1964, reflect the following amount of assets, liabilities and taxable income:
Taxable Taxable
Year Year
Ended Ended
1/31/63 1/31/64
Total current assets ....... $321,661 $565,086
Total current liabilities .. 366,627 518.221
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Net Working capital ........ $ - 0 - $ 46,865
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Total assets .............. $395,096 $676,606
Total liabilities ......... 377,327 527,061
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Stockholders' equity ...... $ 17,769 $149,545
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Taxable income (loss) ..... $ 165 ($124,423)
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In 1962 Mr. Adams prepared a "Plan for Producing Commercial Eggs" which he believed would result in a substantial decrease in production costs and increase profits. The facility contemplated by the plan was unique for Mississippi and the southern part of the United States in that it represented a new and unproven concept in at least two respects: (1) chickens were kept closely confined on wire rather than allowed to run loose on litter, and (2) a large number of chickens were concentrated in one area. Previously, the majority of eggs produced throughout the South were under contract egg-production arrangements whereby hens were "farmed out" to many independent farmers who provided the necessary buildings, equipment and care. The concentration of over 1,000,000 hens at one location, as proposed, was considered by many persons knowledgeable in the egg business to create a hazardous disease potential. The plan contemplated a lessor who would be willing to construct a specified egg production facility and lease it to Farms, for the financial condition of Farms would not have permitted it to construct the facility with borrowed funds. The plan was based on an estimated facility cost of $2,000,000, which facility would be leased to Farms at a rental of $12.50 per $1,000 of cost. There was no mention in the plan of an option to purchase the facility during or at the end of the lease term.
After learning that Cargill had an investment department and might be interested in the plan, Mr. Adams began negotiations with Cargill over the construction and leasing of the facility. An agreement entitled "Agreement of Lease" was subsequently executed on March 16, 1963, by Cargill and Farms which provided for the construction and rental of the facilities envisioned in the proposed plan. The negotiations were devoted mainly to the primary term of the lease and rental payments. Little thought was given by the parties to the inclusion in the lease of an option to purchase.
The lease agreement required Cargill, the lessor, to acquire certain equipment and construct certain improvements on a particular parcel of land and to lease the land, equipment and improvements to Farms. The improvements and equipment consist of a complete facility of specialized buildings and equipment designed specifically for the brooding, growing and caring of laying chickens, including 16 brooder houses, 32 cage growing houses, 178 cage laying houses and an egg processing plant. The land on which the leased facility was constructed consists of approximately 1,080 acres, and the buildings are spread over essentially all of the land. At the time the lease was executed the buildings, improvements and equipment could not have been removed from the land economically.
The term of the lease is divided into the following parts: (1) the preliminary term, the period of time beginning on March 16, 1963, and extending to the completion of the construction of improvements and the acquisition of equipment, and (2) the primary term, the period of time beginning on the first day of the month following the termination of the preliminary term and continuing for 12 years. Certain equipment was acquired and certain improvements were constructed prior to the completion of the acquisition of all equipment and construction of all improvements. Pursuant to the second, third and fourth amendments to the Agreement of Lease, the primary term for the specific improvements and equipment listed in the respective amendments commenced. The date of the second amendment, which included the land, was July 8, 1964. By the fourth amendment to the Agreement of Lease, the parties agreed to terminate the primary term for the land and all improvements and equipment on October 31, 1976.
The Agreement of Lease provides that rental payments during the primary term of the lease are to be based upon a monthly payment of $11.10 for each $1,000 of the "Lessor's total original cost." Cargill's total original cost for the land involved was $136,366 and its cost for the entire leased property was $2,505,251. Although rental payments under the lease agreement were not separately computed for the land, such payments attributable to the land were in the amount of $1,513.66 per month or $18,163.92 per year based on the rental formula contained in the lease. Rental payments attributable to the cost of the land began on June 1, 1964, and totaled $225,535.34 over the entire primary term of the lease.
Rental payments made prior to January 1, 1966, the date of the fourth amendment to the Agreement of Lease, were as follows:
Amount per
Date Month Total
6/1/64 to 1/1/66 .... $16,009.54 $304,181.26
2/1/65 to 1/1/66 .... 8,393.24 92,325.64
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$396,506.90
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As provided in the fourth amendment to the Agreement of Lease, total rental payments under the...
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