Commissioner of Int. Rev. v. Transport Mfg. & Equip. Co.

• Decision Date: 20 April 1973
• Docket Number: No. 72-1321,72-1493.,72-1321
• Citation: 478 F.2d 731
• Parties: COMMISSIONER OF INTERNAL REVENUE, Appellant, v. TRANSPORT MANUFACTURING AND EQUIPMENT COMPANY, Appellee. TRANSPORT MANUFACTURING AND EQUIPMENT COMPANY, Cross-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Cross-Appellee.
• Court: U.S. Court of Appeals — Eighth Circuit

478 F.2d 731 (1973)

COMMISSIONER OF INTERNAL REVENUE, Appellant, v. TRANSPORT MANUFACTURING AND EQUIPMENT COMPANY, Appellee.

TRANSPORT MANUFACTURING AND EQUIPMENT COMPANY, Cross-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Cross-Appellee.

Nos. 72-1321, 72-1493.

United States Court of Appeals, Eighth Circuit.

Submitted February 12, 1973.

Decided April 20, 1973.

James K. Logan, Olathe, Kan., and Guy A. Magruder, Kansas City, Mo., for Transport Mfg. Co.

Michael L. Paup, Atty., Tax Div., Dept. of Justice, Washington, D. C., for Commissioner.

Before GIBSON and ROSS, Circuit Judges, and BENSON,^* District Judge.

GIBSON, Circuit Judge.

Both the Commissioner and taxpayer, Transport Manufacturing & Equipment Company (T.M.E.), appeal from adverse holdings rendered on two different issues by the Honorable Leo H. Irwin, United States Tax Court.¹ This Court has jurisdiction pursuant to 26 U.S.C. § 7482(a) to review Tax Court decisions "in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury." We affirm the Tax Court on both issues.

Two questions are presented in this appeal: (1) Did the taxpayer realize a capital gain on the sale of certain equipment in 1957? and (2) Was the Tax Court correct in holding that the taxpayer was not entitled to a net operating loss carryback for a bad debt deduction allegedly occurring in 1960? These questions will be discussed seriatim.

TAXPAYER'S 1957 SALE OF TRAILERS

A. Factual Discussion. T.M.E., owned and controlled by the Riss family, leased non-refrigerated and refrigerated vans and tank trailers to Riss & Co., Inc. (Riss & Co.), an interstate motor carrier also founded and controlled by Richard Riss, Sr. Riss & Co., subject to the rules and regulations of the Interstate Commerce Commission, founded T.M.E. to avoid an ICC regulation requiring a hearing whenever a carrier with more than $500,000 in debt sought to incur further indebtedness.² T.M.E. was organized as an independent corporation to buy the carrier's (Riss & Co.'s) equipment and to lease that equipment to the carrier on a "net lease" basis. Riss & Co. paid T.M.E. a monthly rental on each item of equipment, which was determined by a depreciation method employed by T.M.E., plus a monthly charge to cover T.M.E.'s overhead and interest expense. At the end of the leasehold agreement, Riss & Co. was usually given the option of purchasing the rental equipment at the original book value less the accumulated depreciation. The Tax Court said that "T.M. E. was designed merely to serve as a conduit for equipment needed for Riss" and "it was never intended that T.M.E. would reap a profit of any significance from its dealings with Riss."³

In 1954, T.M.E. purchased 1,216 vans and trailers from Fruehauf Trailer Co. for $8,471,294. By leasehold agreements dated April 1, 1954, T.M.E. leased all of this equipment to Riss & Co. for a six-year term. T.M.E. assigned the leases to Fruehauf as additional security for the purchase mortgage executed to Fruehauf on the purchase of the trailers and vans. Of the 1,216 trailers and vans, 899 were designed experimentally with aluminum components replacing the traditional steel sections. During three years of use by Riss & Co., the trailers required extensive repairs. Riss & Co. estimated that these repairs due to the faulty design and the lost time of the use of the equipment cost it between $700,000 and $800,000.

By agreements dated January 16 and July 16, 1957, Fruehauf contracted to repurchase 814 of the 1,216 trailers and vans sold to T.M.E. in 1954. The agreed repurchase price was $3,904,000. T.M. E. also purchased 850 improved trailers and vans from Fruehauf to be used in Riss & Co.'s expanding frozen food shipping. From 1954 until the time of the sale in 1957, T.M.E. had depreciated the 814 trailers in the amount of $3,683,756.43, which left a date-of-sale basis (book value) in the trailers sold of $1,688,756.47. The difference between the amount received from Fruehauf ($3,904,000) and the taxpayer's basis ($1,688,756.47) was $2,215,243.53. T. M.E. credited this amount to a receivable account marked "A/C Rec. Riss & Co.," on the basis of the following agreement entered into by Riss & Co. and T.M.E. on January 16, 1957:

"AGREEMENT

"WHEREAS, Transport Manufacturing & Equipment Co. owns and has under long term lease to Riss & Company, Inc. certain 1954 Fruehauf semi-trailers, which leases will expire on various dates following January, 1960.

"WHEREAS, Transport Manufacturing & Equipment Co. now has an offer to purchase certain of these units which would require that Riss & Company, Inc. agree to cancel the existing leases on the units sold, and

"WHEREAS, the existing leases on these units are on a declining rental basis calling for higher rentals in the early years and lower rentals in the later years, and the cancellation of the leases would result in a sacrifice by Riss & Company, Inc. of the low rentals during the last months of the aforementioned leases.

"NOW THEREFORE BE IT UNDERSTOOD, that Riss & Company, Inc. does hereby agree to the cancellation of the leases on the units which Transport Manufacturing & Equipment Co. desires to sell and that in consideration for the agreement by Riss & Company, Inc., to cancel the leases on the units sold that Transport Manufacturing & Equipment Co. does hereby agree to pay Riss & Company, Inc. an amount equal to the sale price above Transport Manufacturing & Equipment Co.\'s book value on the sale of these units."

The above agreement had the effect of transferring the entire profit on the repurchase sale from T.M.E. to Riss & Co. The Tax Court stated that the price for the used trailers "was above market" and appeared to compensate Riss & Co. for the damages suffered due to the defectively designed trailers. 56 T.C. 388, 397 (1971). The Tax Court also noted that Riss & Co. had been experiencing steady losses in revenue at this same time. 56 T.C. 388, 397 (1971). Obviously, it was to T.M.E.'s benefit to pass the gain on the sale of the trailers through to Riss & Co., which was experiencing heavy losses.

The Commissioner sent T.M.E. a notice of deficiency, which assessed, as capital gain, the excess of the amount received by the taxpayer from Fruehauf over T.M.E.'s basis. The notice of deficiency did not inform the taxpayer, in any manner, of the reason for the deficiency.

The Tax Court, in its first opinion, held that the Commissioner failed to apprise the taxpayer of his intent to employ 26 U.S.C. § 482's⁴ "arm's-length" theory to sustain the deficiency, and, therefore, the issue was raised too late to be considered by the Tax Court. 56 T.C. 388, 401 (1971). However, the Tax Court went on "to examine the financial consequences" of the lease cancellation agreement and under an "adequacy of consideration" theory found that $217,413.03 of the $2,215,243.53 gain remained with T.M.E. 56 T.C. 388, 405 (1971). However, in a supplemental opinion, the Tax Court upon reconsideration held that this assessment of $217,413.03 was actually based on an "adequacy of consideration" theory (also derived from § 482), which was also presented by brief after trial and too late to be considered by the Tax Court. 57 T.C. 469, 472 (1971). The Tax Court, therefore, finally held that T.M. E. had not realized any gain on the sale of the trailers, because the Commissioner failed to inform the taxpayer T.M.E. "either in the statutory notice, in his answer, or at trial of his intended theory for sustaining the deficiency." 57 T.C. 469, 474 (1971).

B. Legal Discussion. In reviewing Tax Court decisions, we apply the clearly erroneous standard. Findings supported by substantial evidence on the record as a whole which are not against the clear weight of evidence or induced by an erroneous view of the law will not be disturbed on appeal. Wilmington Co. v. Helvering, 316 U.S. 164, 62 S.Ct. 984, 86 L.Ed. 1193 (1942); C. I.R. v. Riss, 374 F.2d 161, 166 (8th Cir. 1967); Lessmann v. C.I.R., 327 F.2d 990, 993-994 (8th Cir. 1964); Schoenberg v. C.I.R., 302 F.2d 416, 419 (8th Cir. 1962).

It is uncontested that the notice of deficiency, Commissioner's answer, and trial statements and testimony did not expressly refer to § 482 and the theories based on that section to sustain the Commissioner's assessment. The Commissioner, however, argues that the taxpayer was sufficiently apprised of the intended use of § 482, because the pleadings and evidence introduced at trial "centered around the economic basis for the cancellation payment" and, therefore, inferentially indicated that the taxpayer knew of the Commissioner's intended use of § 482's arm's-length and adequacy of consideration theories. The Commissioner cites many instances concerning statements made in pleadings by both parties and at trial "pertaining to the economic realities of the lease cancellation payment—e. g. . . . whether, in fact, Riss so badly wanted new equipment that it would have voluntarily relinquished its rights under the lease."

The Tax Court held on these arguments that:

". . . the issue framed by the pleadings and presented at trial was whether T.M.E. realized the gain at all and was not whether T.M.E., after having realized the gain, could deflect part of it to Riss as compensation for loss of an advantageous lease." 57 T. C. 469, 473 (1971).

In the first place, the questions of whether T.M.E. realized a gain or whether T.M.E. deflected a gain after realizing it are closely related and would involve use of much of the same evidence. We see this case as an attempt on T.M.E.'s part to present in its pleadings and prove at trial the validity of the lease cancellation agreement. On the other hand, the Commissioner, in order to sustain the deficiency, was attempting to prove the invalidity of the same agreement. Of course, in attempting to prove this invalidity, the Commissioner, at the time of the trial, could well have been inferentially...