Commercial Solvents Corporation v. United States

• Decision Date: 12 June 1970
• Docket Number: No. 361-63.,361-63.
• Citation: 427 F.2d 749
• Parties: COMMERCIAL SOLVENTS CORPORATION v. The UNITED STATES.
• Court: U.S. Claims Court

427 F.2d 749 (1970)

COMMERCIAL SOLVENTS CORPORATION v. The UNITED STATES.

No. 361-63.

United States Court of Claims.

June 12, 1970.

Jay O. Kramer, New York City, attorney of record, for plaintiff; Morton M. Cohen, New York City, of counsel.

Gilbert W. Rubloff, Washington, D. C., with whom was Asst. Atty. Gen. Johnnie M. Walters, for defendant; Philip R. Miller and Joseph Kovner, Washington, D. C., of counsel.

Before COWEN, Chief Judge, and LARAMORE, DURFEE, DAVIS, COLLINS, SKELTON, and NICHOLS, Judges.

OPINION^*

LARAMORE, Judge.

This is an action to recover an alleged overpayment of Federal income tax paid for the tax year 1948, plus interest as provided by law. The controversy arises from a transaction whereby plaintiff-taxpayer agreed to receive a sum certain payable in installments in cancellation of an executory contract. The issues before us involve (1) whether plaintiff may claim a refund in this suit on grounds relating to the appropriate year or years for reporting taxable gain, which grounds were not included in plaintiff's refund claim but were advanced for the first time in plaintiff's amended petition, and (2) whether such gain is taxable as ordinary income or capital gain.¹ We hold that plaintiff is not entitled to recover; the pertinent facts incident to our holding follow.

Plaintiff, Commercial Solvents Corporation, is engaged in the manufacture, import, export, sale, and purchase of chemicals, solvents, drugs, fertilizers, and related by-products. During 1947, it operated a plant in Sterlington, Louisiana, where it produced anhydrous ammonia from natural gas. The output of the Sterlington plant was sold by plaintiff to fertilizer manufacturers in the Gulf States where it had developed a marketing network.

In January 1947, the Mathieson Chemical Corporation (Mathieson) had leased from the United States for ten years an ammonia plant located at Lake Charles, Louisiana.² At that time, Mathieson had little experience in the fertilizer industry, and its management had no specific plans for the use of the Lake Charles plant.

At about the same time, plaintiff's officers learned of successful experiments in applying anhydrous ammonia directly to the soil as a fertilizer. They correctly anticipated that this new development would result in a greatly increased demand for anhydrous ammonia. Since plaintiff's Sterlington plant was operating at full capacity, plaintiff's representatives approached officials of Mathieson for the purpose of discussing the possibility of plaintiff's purchasing and distributing the anhydrous ammonia production from Mathieson's Lake Charles plant.

As a result of these discussions, plaintiff and Mathieson entered into a contract on November 10, 1947, whereby Mathieson agreed to sell to plaintiff the entire anhydrous ammonia production from its Lake Charles plant, except for a reserved quantity not to exceed ten tons per day, for a period of eight years commencing July 1, 1949. Under the contract, plaintiff was to pay Mathieson the market price for all anhydrous ammonia purchased less deduction for (1) $2.50 per ton for freight equalization, (2) $2.50 per ton of ammonia shipped in plaintiff's tank cars, and (3) a commission of five percent of the market price, after deducting the allowances for freight equalization and for use of plaintiff's tank cars. Plaintiff intended to sell the major portion of this anhydrous ammonia as fertilizer for direct application to the soil by farmers in the same way and under the same method of distribution which plaintiff was then using to sell the anhydrous ammonia production of its Sterlington plant.

In April 1948, Thomas Nichols became the new president of Mathieson, and J. C. Leppart assumed the executive vice-presidency of that company. They immediately reviewed all outstanding contracts in the Mathieson files, including the executory contract with plaintiff. They concluded that the contract with plaintiff was improvident and undesirable for Mathieson in that it deprived Mathieson of the right to use or otherwise dispose of in more profitable ways the anhydrous ammonia production from its Lake Charles plant for a substantial period of eight years. Also, from Mathieson's point of view, they thought it important to prevent plaintiff from dominating the ammonia market in the Gulf States.

Accordingly, in September 1948, Nichols contacted plaintiff's president, Henry Perry (now deceased), and indicated that he desired to negotiate a cancellation of the executory contract before it became operative. For several months, the presidents of the two companies conducted frequent discussions in an effort to arrive at a mutually satisfactory basis for termination of the agreement. In the course of these discussions, both men had made independent estimates of plaintiff's projected earnings under the contract and, at least insofar as Nichols was concerned, he felt the most equitable method of terminating the contract would be for Mathieson to pay plaintiff an amount which, making certain assumptions, would be substantially equivalent to the profits which plaintiff would probably realize if the contract were fully performed. It is unclear whether Perry shared Nichols' method of approach in this regard. One of Perry's principal assistants, who was opposed to any cancellation or modification of the contract, believed that his president was simply uncomfortable in the face of Nichols' determined opposition to the contract and that the eventual figure agreed upon between the two presidents was, in Perry's view, merely an acceptable settlement of a difficult situation without specific correlation to plaintiff's anticipated profits.³

In any event, on December 30, 1948, the parties entered into an agreement canceling the 1947 contract. Under the terms of the cancellation agreement, Mathieson obligated itself to pay plaintiff $2.6 million in installments over an eight and one-half year period, $500,000 being payable upon execution of the agreement in 1948, $300,000 being payable on July 1 of each of the six succeeding years (1949-1954), and $150,000 being payable on July 1 of each of the final two years (1955-1956). The installment payments agreed upon were paid by Mathieson to plaintiff substantially in accordance with the cancellation agreement.

In its 1948 Federal income tax return, plaintiff included as ordinary income the first payment of $500,000 which it had received from Mathieson on December 30, 1948. In its 1949 return, plaintiff treated the next Mathieson payment of $300,000 in the same way. However, on July 13, 1951, plaintiff filed an amended return for 1948 in which it included the entire amount paid and payable by Mathieson under the cancellation agreement as ordinary income. In a statement attached to the amended return, plaintiff explained that, by reason of a recent decision of the United States Court of Appeals for the Seventh Circuit in Universal Oil Products Co. v. Campbell, 181 F.2d 451 (7th Cir., 1950), cert. denied 340 U.S. 850, 71 S.Ct. 78, 95 L.Ed. 623 (1950), it had concluded that the full amount payable under the cancellation contract should have been accrued for Federal income tax purposes in the year 1948.

The amended return increased plaintiff's tax liability for 1948 by $798,000, which amount was paid with interest. Shortly thereafter, plaintiff filed its claim for refund of 1949 tax on the ground that it had erroneously included in 1949 income the $300,000 payment received from Mathieson on July 1, 1949. That claim for refund of 1949 income tax was allowed and appropriate refund was made. Thereafter, of course, plaintiff did not include in its tax returns for subsequent years any of the Mathieson installment payments.

On June 30, 1954, plaintiff filed a timely claim for refund of an alleged overpayment of 1948 tax on the ground that the $2.6 million received or receivable from Mathieson under the cancellation agreement represented proceeds from the sale of a capital asset and, therefore, should be taxed to it as capital gain. Following an unusually long administrative proceeding before the Internal Revenue Service, the claim for refund was formally rejected on December 18, 1961. Thereafter, on December 13, 1963, plaintiff filed its petition in this case asserted as its sole ground for recovery "that the amount of $2,600,000 receivable from Mathieson Chemical Corporation was not ordinary income but represented the proceeds from the sale of a capital asset."

Meanwhile, following an audit of plaintiff's tax returns for each of the years 1949-1956, the Commissioner of Internal Revenue asserted deficiencies in plaintiff's income taxes for four of those years, such deficiencies being unrelated to the issues here involved. Plaintiff contested those deficiencies in the Tax Court. Following the Tax Court's decision (42 T.C. 455) partially upholding the deficiencies, plaintiff appealed to the Second Circuit Court of Appeals. On May 26, 1965, the appeal was dismissed pursuant to a settlement by the parties. By virtue of the dismissal, no further deficiencies in plaintiff's taxes or the years 1951 and 1954-1956 could be asserted. At the time the settlement was reached, neither plaintiff's representatives, nor the Department of Justice, nor the Internal Revenue Service, knew that plaintiff would thereafter amend its petition in the instant action.

On September 13, 1965, plaintiff filed an amended petition in the pending action adding second and third causes of action, the effect of which was to challenge the propriety of reporting the entire gain in 1948. Prior to the time that the amended petition was filed, plaintiff's officers, employees, and representatives had made no statements or representations to the Internal Revenue Service indicating that plaintiff intended to, or did in fact, claim a refund of 1948 income tax on the grounds set forth in the second and third causes of action of its amended petition. At the time...