Commissioner of Internal Revenue v. Brown

Citation380 U.S. 563,14 L.Ed.2d 75,85 S.Ct. 1162
Decision Date27 April 1965
Docket NumberNo. 63,63
PartiesCOMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Clay B. BROWN et al
CourtU.S. Supreme Court

[Syllabus from pages 563-565 intentionally omitted] Wayne G. Barnett, Washington, D.C., for petitioner.

William H. Kinsey, Portland, Or., for respondents.

Mr. Justice WHITE delivered the opinion of the Court.

In 1950, when Congress addressed itself to the problem of the direct or indirect acquisition and operation of going businesses by charities or other taxexempt entities, it was recognized that in many of the typical sale and lease-back transactions, the exempt organization was trading on and perhaps selling part of its exemption. H.R.Rep. No. 2319, 81st Cong., 2d Sess., pp. 38—39; S.Rep. No. 2375, 81st Cong., 2d Sess., pp. 31—32, U.S.Code Congressional Service 1950, p. 3053. For this and other reasons the Internal Revenue Code was accordingly amended in several respects, of principal importance for our purposes by taxing as 'unrelated business income' the profits earned by a charity in the operation of a business, as well as the income from long-term leases of the business.1 The short-term lease, however, of five years or less, was not affected and this fact has moulded many of the transactions in this field since that time, including the one involved in this case.2

The Commissioner, however, in 1954, announced that when an exempt organization purchased a business and leased it for five years to another corporation, not investing its own funds but paying off the purchase price with rental income, the purchasing organization was in danger of losing its exemption; that in any event the rental income would be taxable income; that the charity might be unreasonably accumulating income; and finally, and most important for this case, that the payments received by the seller would not be entitled to capital gains treatment. Rev.Rul. 54—420, 1954—2 Cum.Bull. 128.

This case is one of the many in the course of which the Commissioner has questioned the sale of a business concern to an exempt organization.3 The basic facts are un- disputed. Clay Brown, members of his family and three other persons owned substantially all of the stock in Clay Brown & Company, with sawmills and lumber interests near Fortuna, California. Clay Brown, the president of the company and spokesman for the group, was approached by a representative of California Institute for Cancer Research in 1952, and after considerable negotiation the stockholders agreed to sell their stock to the Institute for $1,300,000, payable $5,000 down from the assets of the company and the balance within 10 years from the earnings of the company's assets. It was provided that simultaneously with the transfer of the stock, the Institute would liquidate the company and lease its assets for five years to a new corporation, Fortuna Sawmills, Inc., formed and wholly owned by the attorneys for the sellers.4 Fortuna would pay to the Institute 80% of its operating profit without allowance for depreciation or taxes, and 90% of such payments would be paid over by the Institute to the selling stockholders to apply on the $1,300,000 note. This note was noninterest bearing, the Institute had no obligation to pay it except from the rental income and it was secured by mortgages and assignments of the assets transferred or leased to Fortuna. If the payments on the note failed to total $250,000 over any two consecutive years, the sellers could declare the entire balance of the note due and payable. The sellers were neither stockholders nor directors of Fortuna but it was provided that Clay Brown was to have a management con- tract with Fortuna at an annual salary and the right to name any successor manager if he himself resigned.5

The transaction was closed on February 4, 1953. Fortuna immediately took over operations of the business under its lease, on the same premises and with practically the same personnel which had been employed by Clay Brown & Company. Effective October 31, 1954, Clay Brown resigned as general manager of Fortuna and waived his right to name his successor. In 1957, because of a rapidly declining lumber market, Fortuna suffered severe reverses and its operations were terminated. Respondent sellers did not repossess the properties under their mortgages but agreed they should be sold by the Institute with the latter retaining 10% of the proceeds. Accordingly, the property was sold by the Institute for $300,000. The payments on the note from rentals and from the sale of the properties totaled $936,131.85. Respondents returned the payments received from rentals as the gain from the sale of capital assets. The Commissioner, however, asserted the payments were taxable as ordinary income and were not capital gain within the meaning of I.R.C.1939, § 117(a)(4) and I.R.C.1954, § 1222(3). These sections provide that '(t)he term 'long-term capital gain' means gain from the sale or exchange of a capital asset held for more than 6 months * * *.'

In the Tax Court, the Commissioner asserted that the transaction was a sham and that in any event respondents retained such an economic interest in and control over the property sold that the transaction could not be treated as a sale resulting in a long-term capital gain. A divided Tax Court, 37 T.C. 461, found that there had been considerable goodfaith bargaining at arm's length between the Brown family and the Institute, that the price agreed upon was within a reasonable range in the light of the earnings history of the corporation and the adjusted net worth of its assets, that the primary motivation for the Institute was the prospect of ending up with the assets of the business free and clear after the purchase price had been fully paid, which would then permit the Institute to convert the property and the money for use in cancer research, and that there had been a real change of economic benefit in the transaction.6 Its conclusion was that the transfer of respondents' stock in Clay Brown & Company to the Institute was a bona fide sale arrived at in an arm's-length transaction and that the amounts received by respondents were proceeds from the sale of stock and entitled to long-term capital gains treatment under the Internal Revenue Code. The Court of Appeals affirmed, 9 Cir., 325 F.2d 313, and we granted certiorari, 377 U.S. 962, 84 S.Ct. 1647, 12 L.Ed.2d 734.

Having abandoned in the Court of Appeals the argument that this transaction was a sham, the Commissioner now admits that there was real substance in what occurred between the Institute and the Brown family. The transaction was a sale under local law. The Institute acquired title to the stock of Clay Brown & Company and, by liquidation, to all of the assets of that company, in return for its promise to pay over money from the operating profits of the company. If the stipulated price was paid, the Brown family would forever lose all rights to the income and properties of the company. Prior to the transfer, these respondents had access to all of the income of the company; after the transfer, 28% of the income remained with Fortuna and the Institute. Respondents had no interest in the Institute nor were they stockholders or directors of the operating company. Any rights to control the management were limited to the management contract between Clay Brown and Fortuna, which was relinquished in 1954.

Whatever substance the transaction might have had, however, the Commissioner claims that it did not have the substance of a sale within the meaning of § 1222(3). His argument is that since the Institute invested nothing, assumed no independent liability for the purchase price and promised only to pay over a percentage of the earnings of the company, the entire risk of the transaction remained on the sellers. Apparently, to qualify as a sale, a transfer of property for money or the promise of money must be to a financially responsible buyer who undertakes to pay the purchase price other than from the earnings or the assets themselves or there must be a substantial down payment which shifts at least part of the risk to the buyer and furnishes some cushion against loss to the seller.

To say that there is no sale because there is no risk-shifting and that there is no risk-shifting because the price to be paid is payable only from the income produced by the business sold, is very little different from saying that because business earnings are usually taxable as ordinary income, they are subject to the same tax when paid over as the purchase price of property. This argument has rationality but it places an unwarranted construction on the term 'sale,' is contrary to the policy of the capital gains provisions of the Internal Revenue Code, and has no support in the cases. We reject it.

'Capital gain' and 'capital asset' are creatures of the tax law and the Court has been inclined to give these terms a narrow, rather than a broad, construction. Corn Products Co. v. Commissioner, 350 U.S. 46, 52, 76 S.Ct. 20, 24, 100 L.Ed. 29. A 'sale,' however, is a common event in the non-tax world; and since it is used in the Code without limiting definition and without legislative history indicating a contrary result, its common and ordinary meaning should at least be persuasive of its meaning as used in the Internal Revenue Code. 'Generally speaking, the language in the Revenue Act, just as in any statute, is to be given its ordinary meaning, and the words 'sale' and 'exchange' are not to be read any differently.' Helvering v. William Flaccus Oak Leather Co., 313 U.S. 247, 249, 61 S.Ct. 878, 880, 85 L.Ed. 1310; Hanover Bank v. Commissioner, 369 U.S. 672, 687, 82 S.Ct. 1080, 1088, 8 L.Ed.2d 187; Commissioner v. Korell, 339 U.S. 619, 627—628, 70 S.Ct. 905, 909—910, 94 L.Ed. 1108; Crane v. Commissioner, 331 U.S. 1, 6, 67 S.Ct. 1047, 1050, 91 L.Ed. 1301; Lang v. Commissioner, 289 U.S. 109, 111, 53 S.Ct. 534, 535, 77 L.Ed. 1066; Old...

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