CIR v. Stickney, 17703.

• Decision Date: 30 August 1968
• Docket Number: No. 17703.,17703.
• Citation: 399 F.2d 828
• Parties: COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. John M. STICKNEY, Executor of the Estate of Henry McK. Haserot, and Bonnie C. Haserot, Respondents.
• Court: U.S. Court of Appeals — Sixth Circuit

399 F.2d 828 (1968)

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. John M. STICKNEY, Executor of the Estate of Henry McK. Haserot, and Bonnie C. Haserot, Respondents.

No. 17703.

United States Court of Appeals Sixth Circuit.

August 30, 1968.

Gilbert E. Andrews, Dept. of Justice, Washington, D. C., for petitioner; Mitchell Rogovin, Asst. Atty. Gen., Lee A. Jackson, Lawrence B. Silver, Attys., Dept. of Justice, Washington, D. C., on brief.

John Lansdale, Jr., Cleveland, Ohio, for respondents; Edward J. Hawkins, Jr., Squire, Sanders & Dempsey, Cleveland, Ohio, on brief.

Before PECK and COMBS, Circuit Judges, and CECIL, Senior Circuit Judge.

JOHN W. PECK, Circuit Judge.

This is the fourth time that this case has been the subject of judicial consideration. The original determination made by the Tax Court in favor of the taxpayer was brought before this court for review by the Commissioner of Internal Revenue. Our order of remand again resulted in a conclusion favorable to the Taxpayer, albeit by a divided Tax Court, and the Commissioner has again petitioned for review here. During the pendency of these proceedings the Taxpayer principally concerned (his wife is a party hereto solely by virtue of their filing of joint returns) died and the executor of his estate has been substituted as a party. However, for simplicity the parties will herein be referred to as "Taxpayer" and "Commissioner."

The issue involves the tax consequences of a cash transfer to Taxpayer and of transfers of stock in three corporations, all of which were before and after the transfers controlled by Taxpayer. The corporations involved are Northport Cherry Factory, Inc., Gypsum Canning Company and Haserot Company. They will herein usually be referred to as "Northport," "Gypsum," and "Haserot" respectively. All have been in existence for many years (Haserot since 1894), and there is no suggestion of their corporate existence for other than legitimate business purposes.

Northport has been engaged since 1930 in the business of owning and operating cherry orchards and a fruit canning and packing plant at Northport, Michigan. Its products are principally cherries and apple juice, largely canned and marketed under the brand name "Northport," a registered trademark. At all material times it had 4,562 shares of stock outstanding. Gypsum has since 1900 been engaged in the business of owning and operating cherry orchards and the fruit and vegetable packing plant at Port Clinton, Ohio. Its products, principally cherry, tomato and pumpkin food products, have been largely packed under the registered trademarks "Ottawa Chief," "Lakeshore," and "Bellevue." Since its incorporation, Haserot has been engaged in the business of importing, blending, and roasting coffee; importing spices, condiments and other food products, and in wholesaling food products purchased from Northport, Gypsum and others.

With only unimportant exceptions Northport and Gypsum sold their entire output to Haserot, and had no sales or distributing organizations of their own. Haserot furnished the principal management for the other two companies as well as the seasonal financing necessary for their crops and canning operations. Cash advances averaged about $445,000 a year to each company. Haserot's purchases from them during the ten year period subsequent to 1952 varied from $649,745 (1952) to $1,420,860 (1959), and these purchases have constituted about 10% of Haserot's overall food purchases each year. The Tax Court found as a fact that these purchases were important to Haserot "beyond the dollar amounts directly involved" in permitting Haserot to furnish its customers with a greater variety of food products. This opened additional markets to Haserot's salesmen, and by increasing the number of items sold per sales call reduced sales expense per item. Control of the source of supply of the products involved assured it of continuity in its ability to purchase, removing for instance the problems created in bad crop seasons when independent or competing producers might give other customers preferences. Northport's and Gypsum's brand names were well and favorably known locally, and their regular presence among Haserot's offerings was a benefit to it. Quality control is particularly essential to a less than nationally known brand, and through control of the two other companies Haserot was able to insure the quality of products going into its brand named items.

The advantages of a common control of all three companies were demonstrated in a period 1942-1951, during which Taxpayer was president of Haserot while his father vice-president of Northport and Gypsum. Communication problems and the advanced age of Taxpayer's father (then in his late 80's) resulted in costly, inefficient production practices. In 1951 the elder Haserot gave his stock in Northport and Gypsum to Taxpayer, who thereby obtained control and thereupon assumed the presidency of those companies, as well as of Haserot.

Thereafter a greater efficiency of direct operation was enjoyed, and the directors began discussing and looking with favor upon a transfer of the stock to Haserot. The Tax Court found that their reasons for preferring direct stock ownership by Haserot as against such ownership by Taxpayer were as follows:

"(1) The loss of Northport and Gypsum as suppliers would have been extremely serious.

"(2) Divided control, even within the Haserot family and without loss of Northport and Gypsum as suppliers, had proved inefficient, unpleasant, and costly.

"(3) As long as the Northport and Gypsum stock was held by an individual there was a danger that those shares would become separated from the shares of Haserot, either by voluntary transfer (which had been responsible for the prior division of control), by involuntary transfer, by inheritance, or by other events after the death of the individual.

"(4) In early 1958, Taxpayer was 68 years old.

"(5) In assessing the chances of such an intervivos or testamentary division of the stock all parties involved were deeply influenced by the lack of judgment displayed by Taxpayer\'s father in his late years, and in particular by the latter\'s actual decision in 1942 to divide control."

Against this background, for the reasons indicated the transaction underlying this law suit was made. Before the transaction, the ownership of the shares in the three corporations was as follows:

"Northport (4,562 shares): Taxpayer, 1,999; Gypsum, 1,312; Haserot, 1,250; Others, 1.

"Gypsum (6,582 shares): Taxpayer, 4,486; Haserot, 2,022; Others, 74.

"Haserot (33,014 shares): Taxpayer, 18,895; Taxpayer\'s son, 1,023; Estate of taxpayer\'s father, 10,293; Others, 2,803."

After the transaction, the ownership was as follows:

"Northport (4,562 shares): Haserot, 3,249; Gypsum, 1,312; Others, 1.

"Gypsum (6,582 shares): Haserot, 6,508; Others, 74.

"Haserot (35,446 shares): Taxpayer, 29,188; Taxpayer\'s son, 3,455; Others, 2,803."

The increase in Taxpayer's Haserot shares resulted from his acquisition of his father's shares under his will; the increase in Taxpayer's son's Haserot shares resulted from the issuance to him as a gift of shares due Taxpayer.

In the transaction resulting in this shift of ownership of shares, Taxpayer exchanged all of his Gypsum and Northport stock for a money credit (57%) and stock (43%) in Haserot. (After the transaction he owned 82% of the Haserot stock.). It is from this aspect of the transaction that the central question of this law suit emerges. That question, as will be hereinafter detailed, is whether the monetary consideration received by Taxpayer was subject to capital gain treatment.

In his income tax return (for 1958, the year involved) Taxpayer made no reference to the transaction. After examination and audit, the Commissioner took the position that Taxpayer had received a dividend in the amount of the cash credit he received ($64,850) to be taxed as ordinary income, since it was essentially equivalent to a dividend and Section 304 (a) of the Internal Revenue Code of 1954 (26 U.S.C. 1958 ed. § 304(a))¹ applied. In the Commissioner's view Sections 301 and 302 required this result. Taxpayer contends that the exchange was covered by Section 351, and urges that the capital gain treatment should be accorded to the extent of the cash portion of the transaction.

Consummation of the transaction occurred February 21, 1958, when Taxpayer transferred his shares in Northport and Gypsum to Haserot. The latter credited Taxpayer's account on its books with the value of the Northport and Gypsum stock and debited his account in the amount of the value of the 2,432 Haserot shares which were issued to Taxpayer's son as a gift from him. Stipulation in the Tax Court established that the proper amount of the credit was $113,490 and that the fair market value of the stock was $48,640. In the deficiency notice issued by Commissioner after examination and audit of Taxpayer's 1958 return his taxable income was increased $113,490, the total of the cash ($64,850) and the fair market value of Haserot stock (determined by Commissioner to be $48,640) Taxpayer received in the transaction. The Tax Court found as a fact that, "In planning the transaction, Taxpayer was unaware that it involved either tax problems or tax advantages. He did not consult in advance with counsel or with anyone else as to the income tax consequences of the transaction."

This case has presented difficulties at every stage of the proceedings because the transaction falls within the literal language of both Section 351 and Section 304. Although the value of the 2,432 Haserot shares issued to Taxpayer is now conceded by the Commissioner not to have constituted taxable income, the parties are in disagreement as to how the $64,850 cash payment should be returned. If Section 351 controls, the gain is to be taxed as a capital gain while if Section 304 controls it should be taxed either as a capital gain or the cash...