Commissioner of Internal Rev. v. Pittston Company, 32

• Decision Date: 11 February 1958
• Docket Number: No. 32,Docket 24531.,32
• Citation: 252 F.2d 344
• Parties: COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. The PITTSTON COMPANY, Respondent.
• Court: U.S. Court of Appeals — Second Circuit

252 F.2d 344 (1958)

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. The PITTSTON COMPANY, Respondent.

No. 32, Docket 24531.

United States Court of Appeals Second Circuit.

Argued December 6, 1957.

Decided February 11, 1958.

Davis W. Morton, Jr., Atty., Dept. of Justice, Washington, D. C. (Charles K. Rice, Asst. Atty. Gen., Ellis N. Slack, Harry Baum, Attys., Dept. of Justice, Washington, D. C., on the brief), for petitioner.

Rollin Browne, New York City (Joseph J. Pugh, and Satterlee, Browne & Cherbonnier, New York City, on the brief), for respondent.

Before CLARK, Chief Judge, MOORE, Circuit Judge, and SMITH, District Judge.

SMITH, District Judge.

This is a petition by the Commissioner of Internal Revenue for review of a decision of the Tax Court of the United States reported in 26 T.C. 967, holding the taxpayer The Pittston Company entitled to treat the sum of $500,000 received in 1949 as consideration for the termination of an exclusive contract to purchase the output of Russell Fork Coal Company's leased Pike County coal mines, as long term capital gain, derived from a sale or exchange within the meaning of Section 117(a) (4) of the Internal Revenue Code of 1939. The pertinent sections of the statutes are as follows:

"§ 22. Gross Income. (26 U.S. C.1952 ed., Sec. 22)

"(a) General Definition. — `Gross income\' includes gains, profits, and income derived from salaries, wages, or compensation for personal service of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * *

* * * * * *

"§ 117. Capital Gains and Losses. (26 U.S.C. 1952 ed., Sec. 117)

"(a) Definitions. — As used in this chapter —

"(1) (As amended by Sec. 115 (b), Revenue Act of 1941, c. 412, 55 Stat. 687, and Sec. 151(a), Revenue Act of 1942, c. 619, 56 Stat. 798) Capital Assets. — The term `capital assets\' means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or property, used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 23 (l), or an obligation of the United States, or any of its possessions, or a State or Territory, or any political subdivision thereof, or of the District of Columbia, issued on or after March 1, 1941, on a discount basis and payable without interest at a fixed maturity date not exceeding one year from the date of issue, or real property used in the trade or business of the taxpayer;

* * * * * *

"(4) (As amended by Sec. 150(a) (1), Revenue Act of 1942, supra) Long-term capital gain. The term `long-term capital gain\' means gain from the sale or exchange of a capital asset held for more than 6 months, if and to the extent such gain is taken into account in computing gross income; * * *".

The Pittston Company and its wholly owned subsidiary, Pattison & Bowns, Inc., filed consolidated returns for the taxable year 1949. The subsidiary, which was the contracting party with Russell Fork Coal Company (hereinafter called Russell) and the recipient of the amount in question, will be referred to as the taxpayer.

On January 25, 1944, taxpayer (as buyer) and Russell (as seller) entered into a written contract, which provided, in part, as follows:

"That in consideration of the mutual covenants and conditions herein set forth and of an agreement executed and delivered simultaneously with the execution and delivery of this agreement, it is agreed as follows:

"(1) Subject to the provisions of Paragraph 2 of this agreement the Seller (Russell Fork) agrees to sell to the Buyer (Pattison & Bowns), and any other affiliated person, partnership or corporation whom and which the Buyer may from time to time designate in writing, F.O.B. the mine, all of the coal which shall be mined and sold for resale from the mining plant or plants which the Seller expects to install or does install upon its leased property in Pike County, Kentucky, as set forth in the agreement executed simultaneously herewith.

* * * * * *

"(3) The title to all coal sold to the Buyer hereunder shall pass to the Buyer at the time said coal is loaded into cars or trucks at the mines for transportation and before transportation begins.

"(4) The Buyer shall be entitled to and is hereby authorized to deduct a discount of 8% of the gross selling price on all coal purchased by it, which amount shall include all expenses and compensation of every kind of the Buyer and its designees and under no circumstances shall any affiliate of the Buyer be entitled as a wholesaler, jobber or otherwise to any additional discount, compensation and expenses all of which shall be included in the foregoing 8%, * * *.

* * * * * *

"(6) The Buyer agrees for itself and its designees and binds itself and each of them that it and each of them will at all times have and maintain proper facilities and employees so as to be able efficiently to resell the said coal and agrees to endeavor with diligence and in every proper manner to resell the largest available amount of said coal at prices specified from time to time by the Seller, and further agrees to comply with all laws that are now in force, or may hereafter be enacted, and all valid rules and regulations thereunder relating to the selling of coal or all other related or incidental matters. * * * if the Buyer and its designees, as the case may be, complies with the obligations binding upon it and them, then this agreement shall be irrevocable for a period of ten (10) years from this date and for such additional period of extensions as is provided in Paragraph 3 of the agreement executed and delivered simultaneously with the execution and delivery of this agreement. * * *"

On the same date, January 25, 1944, taxpayer and Russell entered into another contract, under the terms of which taxpayer agreed to loan Russell $250,000, which loan was to be repaid in periodic installments over a period of 10 years and was to bear interest at 4 per cent per annum. During the period January 25, 1944 to October 14, 1949, taxpayer purchased from Russell 1,959,563.15 tons of coal for $9,855,089.64 which it resold at a gross profit of $273,411.14. Taxpayer carried out its agreement to loan Russell $250,000 and it also made various additional advances on open account; these loans were finally liquidated by Russell during 1948. On October 14, 1949, Russell paid $500,000 to taxpayer in consideration of taxpayer's surrender of all of its rights under the coal agreement of January 25, 1944. The transaction was reflected in a letter agreement dated October 14, 1949; the letter was sent to Russell by taxpayer, and read as follows:

"In consideration of the payment by you to us of the sum of Five Hundred Thousand Dollars ($500,000), receipt of which is hereby acknowledged, it is understood that you have as of this day acquired all of our right and interest in and to the agreement dated January 25, 1944 between us, which agreement provides for the exclusive right by Pattison & Bowns, Inc. to purchase all of the coal produced by you at your Russell Fork Mine, said contract expiring by its terms on January 25, 1954."

In its income tax return for the year 1949, taxpayer reported the $500,000 as long-term capital gain. In his notice of deficiency, the Commissioner determined that this amount "was not received as the result of a sale or exchange and therefore is reportable as ordinary income." The Tax Court held that the $500,000 was taxable as long-term capital gain, not as ordinary income, and accordingly overruled the Commissioner.

The courts have not been entirely consistent in their treatment of lump sum payments received by a taxpayer for the termination of jural relations between the taxpayer and another as falling within or without the area entitled to more favored treatment as long-term capital gains rather than ordinary income.¹ This circuit has steered a middle course. In McAllister v. C. I. R., 2 Cir., 157 F.2d 235, payment received for transfer by a taxpayer of a life interest in a trust to a remainderman was held a capital gain, Judge Frank dissenting. The McAllister holding and its possible consequences were criticized in Judge Frank's dissent and in comments on the problem in law journals (see 56 Yale L.J. 570-574 and 14 U. of Chic.L.Rev. 484-493). The court thereafter held in C. I. R. v. Starr Bros., 2 Cir., 204 F.2d 673, that payment received by a taxpayer, a New London retail druggist, for relinquishing its rights under a provision in a contract with a manufacturer, binding the manufacturer not to sell drugs to taxpayer's competitors in New London, was ordinary income and not a capital gain. In the same year, consistently with Starr, the court in General Artists Corp. v. C. I. R., 2 Cir., 205 F.2d 360, certiorari denied 346 U.S. 866, 74 S.Ct. 105, 98 L.Ed. 376, held that payments received by a taxpayer for transfer of its contracts with a singer as his exclusive booking agent to another such agent by an agreement providing for cancellation of the contracts and execution of new contracts with the singer by the transferee were ordinary income and not capital gains received as gain from sale of a capital asset. However, in C. I. R. v. McCue Bros. & Drummond, Inc., 2 Cir., 210 F.2d 752, the court held a payment received by a taxpayer lessee from a landlord for vacating premises where the taxpayer had a...