Coast Quality Construction Corp. v. United States, 71-2624.

• Decision Date: 11 July 1972
• Docket Number: No. 71-2624.,71-2624.
• Citation: 463 F.2d 503
• Parties: COAST QUALITY CONSTRUCTION CORPORATION and Subsidiaries, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.
• Court: U.S. Court of Appeals — Fifth Circuit

463 F.2d 503 (1972)

COAST QUALITY CONSTRUCTION CORPORATION and Subsidiaries, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.

No. 71-2624.

United States Court of Appeals, Fifth Circuit.

July 11, 1972.

Gerald J. Gallinghouse, U. S. Atty., New Orleans, La., Charles G. Barnett, Atty. Tax Division, Dept. of Justice, Dallas, Tex., Scott P. Crampton, Asst. Atty. Gen., Gilbert E. Andrews, Jr., Meyer Rothwacks, Atty., Carleton D. Powell, Harry Baum, Tax Div., Dept. of Justice, Washington, D. C., Fred B. Ugast, Acting Asst. Atty. Gen., for defendant-appellant.

A. J. Schmitt, Jr., of Beard, Blue, Schmitt & Treen, New Orleans, La., for plaintiffs-appellees.

Before WISDOM, GODBOLD and RONEY, Circuit Judges.

GODBOLD, Circuit Judge:

Two noted commentators have forecast that applying the "substantially the same trade or business" requirement of § 382(a) (1) (C) of the Internal Revenue Code would present problems that would "be difficult to resolve in practice" and would "practically insure a high level of uncertainty." B. Bittker & J. Eustice, Federal Income Taxation of Corporations & Shareholders § 16.22, at 16-53 (3d ed. 1971). This appeal evidences the accuracy of the forecast. The District Court, in a trial without a jury, concluded that § 382(a) did not proscribe the corporate taxpayer's inclusion of net operating loss carryover in its tax computations for the years in question, D.C., 325 F.Supp. 500, and entered judgment accordingly. From this adverse judgment the United States appeals. We affirm.

The basic facts are not in dispute. Charles Kornman owned and operated in the New Orleans area four functionally related corporations, all engaged in some aspect of the purchase, development, and sale of residential property. Kornman Realty held a real estate brokerage license. Quality Realty Company purchased land and held title. Sunrise Homes, Inc. engaged primarily in the sale of developed property. Coast Quality Construction Company (hereinafter "Old Coast" to distinguish it from taxpayer) constructed homes. Thus, Quality Realty acquired unimproved real estate, developed and subdivided it and, as demand required, transferred lots to Sunrise Homes. Sunrise Homes contracted with Old Coast to build houses on the lots and sold the finished residential unit. Kornman also owned a 24 percent interest in Bayou Villa Estates, Inc., which was organized in 1960 to develop a tract of land located 30 miles from New Orleans across Lake Pontchartrain and known as Riverwood. A few lots there were improved and houses built on them and sold. By 1963, however, development and sales in Riverwood had virtually ceased, and the land was being held for future development.

In order to increase borrowing power and financial standing, Kornman, his brother, and four of their friends, all of whom controlled one or more corporations active in similar businesses in different geographic areas, arranged to transfer their stock in each such corporation to a non-operating corporation named Tremont in exchange for approximately one-sixth of the Tremont stock per participant. Pursuant to this arrangement Kornman relinquished his stock in Quality Realty, Sunrise Homes, Old Coast, and Bayou Villa for Tremont stock. By the date of exchange, November 30, 1962, Bayou Villa alone had sustained net operating losses of $154,000 since its formation.

Ten months later the four corporations previously controlled by Kornman (Quality Realty, Sunrise Homes, Old Coast and Bayou Villa) were merged into a Tremont subsidiary then known as Sunrise Dale, and the name of the corporation resulting from the merger was changed to Coast Quality Construction Corporation (hereinafter Coast Quality) in order to capitalize on the reputation, good will, and credit line of the former Kornman enterprise similarly named. Coast Quality is the taxpayer-plaintiff in this suit. By the date of the merger Bayou Villa's net operating loss had increased to $258,000.

Later in 1963 and during the early part of 1964 Kornman became dissatisfied with Tremont's policies and initiated negotiations for the withdrawal of his interest. On May 5, 1964 he formally offered to exchange his Tremont stock for the stock in Coast Quality, with Coast Quality to retain all property it then owned in Louisiana. The other Tremont shareholders, having personally endorsed a first mortgage on Riverwood, refused to risk their personal liability on Kornman's sole control of the property. An arrangement was worked out whereby on May 14, 1964 Riverwood was transferred to another Tremont subsidiary in exchange for Tremont's assumption of outstanding first and second mortgages on Riverwood and some intercompany accounts owed by Coast Quality, and on May 15, 1964 Tremont exchanged its Coast Quality stock for Kornman's interest in Tremont.

During the entire parent-subsidiary relationship between Tremont and Kornman-controlled corporations, Kornman remained president, a director, and full-time manager of each of the enterprises he had controlled. Until the merger into Coast Quality, each corporation retained its separate identity and operated essentially as a division of Tremont. Riverwood constituted 44 percent of the total value of Coast Quality's assets immediately prior to May 14. The principal assets remaining on the date of Kornman's acquisition consisted of approximately 125 lots in a New Orleans subdivision and a 22-acre tract zoned for apartments. Coast Quality continued negotiations for purchase of new properties that had begun before the change of ownership. Some, but not all, resulted in acquisitions. That land as well as the land owned on May 15 was developed in the customary manner. In 1966 Tremont went into receivership, and subsequently Kornman personally bought Riverwood.

On May 15, 1964 Coast Quality had accrued net operating loss carryovers totaling $288,178, exclusive of the amount useable by Tremont, and $258,876 of this was attributable to net operating losses incurred in connection with Riverwood prior to the 1963 merger that yielded Coast Quality. Coast Quality claimed net operating loss carryover deductions on its tax returns for 1965 and 1966. The Commissioner disallowed the portion attributable to Riverwood on the ground that it was barred by § 382 (a) (1) (C) because after the change in taxpayer's ownership Coast Quality had not continued to carry on substantially the same business as before.

The sole issue presented for our consideration is whether the District Court correctly held that Coast Quality continued to carry on a trade or business substantially the same as that conducted before the change in ownership, within the meaning of § 382(a). Before addressing that issue we must determine whether the applicable standard of review is that of Fed.R.Civ.P. 52(a) or one of law.

The distinction between law and fact is in many cases not susceptible to simple resolution. In this instance our judicial vision requires extrinsic aid to discern the line that separates the grey area bordering fact from the equally opaque boundary of law. We turn to the statutes governing net operating loss carryovers and their history and interpretive regulations for guidance. Congress provided in the 1939 Code for net operating loss carryovers and carrybacks "to ameliorate the unduly drastic consequences of taxing income strictly on an annual basis. They were designed to permit a taxpayer to setoff its lean years against its lush years, and to strike something like an average taxable income computed over a period longer than one year." Libson Shops, Inc. v. Koehler, 353 U.S. 382, 386, 77 S.Ct. 990, 1 L.Ed.2d 924, 928 (1957). To prevent abuse of this exception from general tax accounting rules there existed only a provision (now § 269) which disallowed net operating loss carryover and carryback deductions where the principal purpose of stock acquisition was tax avoidance. Operation of this limitation depended then, as it does now, on the taxpayer's intent as found by the trier of fact. See, e. g., Scroll, Inc. v. Commissioner of Internal Revenue, 447 F.2d 612 (5th Cir. 1971). In 1954 Congress concluded that the often insurmountable burden of proving the taxpayer's intent to evade taxes rendered § 269's predecessor ineffectual to limit use of the privilege for its intended purpose by prevention of trafficking in net operating loss carryovers. U.S.Code Cong. & Admin. News, 83d Cong. 2d Sess., p. 4067 (1954). Thus, a special limitation embodied in § 382(a) was added as an objective standard to be used along with the subjective test to cull out abuses. Id. at p. 4923. Section 382(a) prohibits a corporate taxpayer from claiming a net operating loss carryover when three conditions occur: "1. At the end of the corporation's taxable year, its ten principal shareholders own a percentage of the corporation's outstanding stock (taken at the total fair market value) that is 50 percentage points or more greater than they owned at the beginning of the same taxable year or at the beginning of the prior taxable year; 2. The increase results from a purchase of stock from an unrelated person or from a decrease in the amount of stock outstanding; and 3. The corporation has not continued to carry on a trade or business substantially the same as that conducted before any change in the stock ownership." B. Bittker & J. Eustice, Federal Income Taxation of Corporations & Shareholders, § 16.22, at 16-46 (3d ed. 1971).¹ The regulations direct that "in determining whether a corporation has not continued to carry on a trade or business substantially the same as that conducted before any increase in the ownership of its stock, all the facts and circumstances of the particular case shall be taken into account" and lists a number of relevant factors. Treas.Reg. § 1.382-3(h) (5).² Because the ultimate fact upon which hangs disallowance of a deduction depends in turn on subsidiary facts that vary widely from case to...