Cont'l Illinois Nat'l Bank & Trust Co. of Chicago v. Comm'r of Internal Revenue
| Decision Date | 05 December 1977 |
| Docket Number | Docket No. 4473-73. |
| Citation | 69 T.C. 357 |
| Parties | CONTINENTAL ILLINOIS NATIONAL BANK & TRUST COMPANY of CHICAGO, PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
In 1963 petitioner purchased an interest in conditional sales contracts and chattel mortgages guaranteed by corporations A, B, and C. During 1963, A, B, and C all filed petitions in bankruptcy under ch. XI, and petitioner filed claims therein with respect to the guarantees. Pursuant to the plan of arrangement, as confirmed, petitioner received in complete satisfaction of the contingent liability of A, B, and C, inter alia, two 10-year subordinated debentures of A and common stock of A. Petitioner nominally valued these assets at $1 each, writing off (after accounting for recoveries on the contracts involved) a net bad debt of $593,972.30, resulting in a tax benefit. In 1968 petitioner exchanged the debentures for additional stock of A, and later that year donated all of its A corporation stock, then valued at $660,435.75, to a charitable foundation and claimed a charitable contributions deduction in that amount.
CBCC was a corporation providing credit information to petitioner and many other Cook County businesses. Petitioner purchased 892.5 shares of CBCC for $490,875. Stock ownership was not a prerequisite to obtaining CBCC's services and acquisition of its shares had no appreciable effect on petitioner's methods of seeking credit information. In 1968, due to a divergence of shareholder objectives, petitioner sold its shares of CBCC stock for $782,567.08. Held: The substitution of A corporation stock and debentures for the original guarantees pursuant to the ch. XI proceedings closed the transaction. Any subsequent gain or loss must be accounted for as a separate transaction, and the tax benefit rule is therefore inapplicable. Allen v. Trust Co. of Georgia, 180 F.2d 527 (5th Cir. 1950), cert. denied340 U.S. 814 (1950), followed. Held, further, petitioner had a substantial investment motive in purchasing CBCC stock, therefore the Corn Products doctrine is inapplicable and the stock constituted a capital asset. W. W. Windle Co. v. Commissioner, 65 T.C. 694 (1976), appeal dismissed550 F.2d 43 (1st Cir. 1977), cert. denied431 U.S. 966 (1977). Edward C. Rustigan and Sean T. Crimmins, for the petitioner.
Seymour I. Sherman, for the respondent.
Respondent determined a deficiency in petitioner's Federal income tax for the taxable year 1968 in the amount of $376,950.59.1
Certain issues having been settled by the parties, the following issues remain for our decision:
(1) Whether the donation of appreciated Tastee Freez common stock to a charitable foundation resulted in the recovery of a previously deducted item which must be returned to income under the tax benefit rule; and
(2) Whether in the light of the Corn Products doctrine, the gain realized by petitioner on the sale of its stock in the Credit Bureau of Cook County, Inc., is reportable as ordinary income or capital gain.
Petitioner is a national banking association chartered under the laws of the United States, with its principal office and place of business in Chicago, Ill. It filed its Federal income tax return (Form 1120) for the calendar year 1968 with the District Director of Internal Revenue at Chicago, Ill.
By agreement dated April 4, 1963, the LaSalle National Bank of Chicago (LaSalle) entered into a financing arrangement with Allied Business Credit Corp. (Allied), and its parent company, Tastee Freez Industries, Inc. (Tastee Freez), relating to certain deferred payment paper issued in connection with the sale of mobile trucks by Tastee Freez or its predecessor. Tastee Freez and its subsidiaries sold these units to Tastee Freez franchise holders and operators and other interested parties. These mobile units were “stores on wheels” equipped to dispense Tastee Freez ice cream products and, in some cases, food products as well. The mobile units were sold on conditional sales contracts or chattel mortgages. The financing was handled by Allied and the contracts were then sold to banks and other lending institutions.
The agreement between LaSalle and Allied provided with regard to the deferred payment paper that:
Allied may offer Contracts to the Bank for purchase hereunder from time to time with full recourse as hereinafter set forth. The Bank shall be entitled to purchase such Contracts as it in its sole discretion shall determine to purchase. The purchase price to be paid by the Bank for each Contract so purchased shall be an amount equal to the unpaid balance thereof (including all finance charges or interest thereon).
The agreement specifically described the contracts involved which were sold by Allied with full recourse, as follows:
The term “Contracts” as used herein shall mean all valid conditional sales contracts, chattel mortgages and other title retaining or lien giving instruments and notes, if any, issued in connection with the sale by Tastee Freez or its predecessor of both mobile trucks and store equipment, which Contracts were acquired by Allied in the normal course of its business.
The agreement also contained provisions relating to the custody of the specific contracts sold and the ledger sheets recording payments by each obligor on the contract, and preserved certain remedies for failure to perform on the part of the obligor. Additionally, both Allied and Tastee Freez unconditionally guaranteed payments of all principal, finance charges, and interest due on each contract sold and agreed to repurchase any specific contract on which the obligor defaulted. Tastee Freez also unconditionally guaranteed the performance of Allied's obligations under the agreement.
In a separate agreement between LaSalle and petitioner, petitioner undertook to purchase, upon request by LaSalle, participations in the amount of 66 2/3 percent (rounded off to the nearest thousand dollars) in all the deferred payment paper purchased by LaSalle from Allied. Since LaSalle's agreement to purchase deferred payment paper under the April 4 agreement was limited to $3 million, petitioner was committed to purchase up to $2 million of such paper.
On September 4, 1963, Tastee Freez and Allied, and on September 5, 1963, Carrols, Inc. (a wholly owned subsidiary of Tastee Freez), which had also guaranteed some of the paper purchased by petitioner, filed petitions for an arrangement under chapter XI of the Bankruptcy Act. Petitioner filed and was allowed unsecured claims in the three chapter XI proceedings as follows:
+------------------------------------------------------------+
¦Proceeding ¦Date filed ¦Amount of claim ¦Amount allowed ¦
+------------+------------+-----------------+----------------¦
¦ ¦ ¦ ¦ ¦
+------------+------------+-----------------+----------------¦
¦Tastee Freez¦12/22/63 ¦$995,011.99 ¦$995,011.99 ¦
+------------+------------+-----------------+----------------¦
¦Allied ¦1/27/64 ¦995,011.99 ¦995,011.99 ¦
+------------+------------+-----------------+----------------¦
¦Carrols, Inc¦7/22/64 ¦139,918.66 ¦135,799.83 ¦
+------------------------------------------------------------+
Each of the companies filed plans of arrangement with the appropriate Federal district court. Orders confirming these plans were filed on September 21, 1964, in the Tastee Freez case; May 5, 1965, in the Allied case; and April 2, 1965, in the Carrols, Inc., case. Pursuant to the plans, petitioner received the following:
(i) A 10-year subordinated debenture in the amount of $398,004.80 payable by Tastee Freez on or before September 21, 1974, issued under the plan of arrangement of Tastee Freez.
(ii) A 10-year subordinated debenture in the amount of $9,931.75 payable by Tastee Freez on or before September 21, 1974, issued under the plan of arrangement of Carrols, Inc.
(iii) A 10-year subordinated debenture in the amount of $79,600.96 payable by Allied on or before May 5, 1975, issued under the plan of arrangement of Allied.
(iv) Ten thousand eight hundred ninety-two shares of Tastee Freez common stock, distributed under the plan of arrangement of Tastee Freez.
Petitioner determined that these subordinated debentures and shares of common stock were worthless. For book purposes, it placed a nominal value of $1 on each debenture and a nominal value of $1 on the total of 10,892 shares of Tastee Freez common stock, crediting a total amount of $4 to its bad debt reserve.
On May 15, 1964, petitioner charged $400,000 to its bad debt reserve as a loss with respect to the underlying debt, as directed by the national bank examiner. On December 15, 1964, petitioner charged an additional $431,381.63 to its bad debt reserve as a loss with respect to that debt, also at the direction of the national bank examiner. Subsequently, petitioner realized recoveries with respect to the debt of Allied in the amount of $237,409.33 from sales of trucks which had been pledged as collateral security. Petitioner credited the recoveries to its reserve for bad debts, leaving a net charge to the reserve for bad debts with respect to the debt of Allied, as of July 1968, in the amount of $593,972.30. This net charge of $593,972.30 resulted in a tax benefit.
In late 1967, Tastee Freez developed a plan seeking to induce the debenture holders to exchange their debentures for Tastee Freez common stock,2 options on Tastee Freez common stock, or cash. Pursuant to this plan, petitioner and Tastee Freez entered into an agreement dated December 13, 1967, and petitioner under an instrument bearing the same date, granted Tastee Freez an option to exchange stock for the debentures held by petitioner in the total face amount of $407,936.55. Tastee Freez exercised this option by letter dated April 2, 1968. As a result of the exercise, petitioner surrendered the two Tastee Freez...
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