Dennis v. CIR, 72-1813.
| Decision Date | 17 January 1973 |
| Docket Number | No. 72-1813.,72-1813. |
| Citation | 473 F.2d 274 |
| Court | U.S. Court of Appeals — Fifth Circuit |
| Parties | Clement O. DENNIS and Genia Lee Dennis, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. |
COPYRIGHT MATERIAL OMITTED
William A. Burnham, Louis Regenstein, Atlanta, Ga., Charles M. Cork, Macon, Ga., for petitioners-appellants.
Scott P. Crampton, Asst. Atty. Gen., Meyer Rothwacks, Atty., Tax Div., Dept. of Justice, Lee H. Henkel, Jr., Acting Chief Counsel, Internal Revenue Service, Raymond W. Sifly, John A. Townsend, Attys., Tax Div., Dept. of Justice, Washington, D.C., for respondent-appellee.
Before RIVES, THORNBERRY and GOLDBERG, Circuit Judges.
This is an appeal from a decision of the United States Tax Court holding that collections upon a corporate note received by taxpayer-appellant in a transaction made nontaxable by Section 351 of the 1954 Code must be reported as ordinary income in the year of receipt. We hold, in affirming the Tax Court, that its factual findings are not clearly erroneous and that taxpayer was not entitled to capital gain treatment on the amounts collected on the corporate note.
The factual context out of which this appeal arises is fully set forth in the Tax Court's opinion, reported at 57 T.C. 352, 352-360 (1971). Accordingly, we set forth only those facts necessary to understand our disposition of the issues raised on this appeal.
In 1939 taxpayer, Clement O. Dennis, entered the tire recapping business in Macon, Georgia, with his partner A.L. Jarvis. The Dennis-Jarvis Tire Co. used steam operated tire recapping equipment to mold tires by applying heat. In 1943, taxpayer met J.W. Napier, a retired engineer who had invented two electric tire recapping devices hereinafter the "original inventions". Napier had previously filed for Letters Patent for the original inventions in 1942.1 Taxpayer was convinced that Napier's original inventions would be commercially feasible if they were improved by adding certain features. In April of 1943 taxpayer and Napier discussed the possibility of Napier granting taxpayer exclusive rights and license to manufacture, use, and sell electric recapping molds of the design specified in Napier's 1942 patent application for the original inventions, subject only to a prior agreement covering ten Southern States. This understanding was reduced to writing but was signed only by Napier.
On January 31, 1944, Napier granted taxpayer a ninety day written option to an assignment of Napier's rights in the original inventions.2 Taxpayer agreed that if the rights in the original inventions were assigned to him, he would "diligently and promptly enter upon the manufacture and sale or lease of the apparatus and the practice of the method described in said applications and/or letters patent for the original inventions...." Taxpayer exercised this option within the prescribed time. He and Jarvis then formed another partnership in May of 1944, the Den-Nap Electric Mold Co. hereinafter "Den-Nap", and began manufacturing molds for the recapping of automobile tires.
In the meantime, Napier at taxpayer's suggestion, had been working throughout this period refining and improving the original inventions. On May 12, 1944 Napier and taxpayer consulted with a firm of patent attorneys in Washington, D.C. concerning the advisability of filing further patent applications.
During the middle or latter part of July 1944, Den-Nap made final tests on the Napier tire recapping apparatus hereinafter the "recapping apparatus" and the Napier separate section ring abutment mold component for tire recapping apparatus hereinafter the "mold component", both of which were refinements of Napier's original inventions. The recapping apparatus and the mold component together are hereinafter referred to as the "improved inventions." Den-Nap then entered into a written agreement with Napier on August 11, 1944. This agreement included an assignment by Napier to Den-Nap of all of his existing inventions and applications for patents relative to the manufacture and use of electric molds in the recapping of tires subject only to existing assignments.
On September 6, 1944, Napier applied for a patent for the mold component. This application had been assigned to taxpayer on August 29, 1944.3 On April 15, 1945, Napier applied for a patent for the recapping apparatus. This application had been assigned to taxpayer on March 27, 1945. A continuation application was substituted for the April 15, 1945 application on December 5, 1946.4 Napier died in 1949 and his widow subsequently released all claims that she might have both to the two Letters Patent that had been issued for the improved inventions as a result of the aforementioned applications and to any rights arising out of the August 11, 1944 agreement between Napier and Den-Nap.
After a number of corporate transactions, which are irrelevant for the purposes of this appeal, taxpayer assigned a one-half undivided interest in the Letters Patent for the improved inventions to Zeb Mattox. In order to enable both taxpayer and Mattox to receive payments on these patents, they were assigned on October 1, 1953, jointly with certain patent applications owned by Mattox, to Precision Recapping Equipment Co. hereinafter "Precision", a corporation formed under the laws of the State of Georgia for the purpose of (1) licensing the patents to Den-Nap and Retreading Equipment Co. of Charlotte, North Carolina and (2) acting as their sales agency. Taxpayer and Mattox owned eighty percent of the stock of Precision and served as its president and vice president respectively. The new corporation was initially capitalized with $10,000 cash and the patents and patent applications transferred to Precision were valued at $3,000,000. Taxpayer and Mattox each received a promissory note in the face amount of $1,500,000, with each note providing for 150 monthly installments of $10,000 each with interest at 2 1/2 percent per annum hereinafter "the note". The note was not issued in registered form and did not bear interest coupons.
Taxpayer reported payments he received between 1955 and 1962 on the note as long term capital gain received on an installment obligation. He claimed a basis of $1,000 and determined that the note had a gross profit percentage of 99.93%. Taxpayer reported the following amounts received and gross profit percentage on his Federal Income Tax return for the years in question:
Amount Gross profit
Year received percentage reported
1955 ....... $97,143.30 $97,075.30
1956 ....... 76,013.91 75,960.70
1957 ....... 114,089.08 114,009.22
1958 ....... 86,333.49 86,273.06
1959 ....... 72,104.39 72,053.92
1960 ....... 71,110.39 71,060.61
1961 ....... 4,624.62 4,621.38
1962 ....... None None
57 T.C. at 360. Reasoning that the amounts received were ordinary income and did not qualify for capital gain treatment, the Commissioner of Internal Revenue determined that taxpayer's returns were deficient.
Taxpayer petitioned the Tax Court for a redetermination of the deficiencies asserted by the Commissioner. He argued that at the time of the transfer of the patents and patent applications to Precision he was a qualified holder of these patent rights and that he was thus entitled to capital gain treatment upon the transfer to Precision under the provisions of section 1235 of the 1954 Code.5 He also contended that because the note was an evidence of an installment obligation, payments received on it were entitled to capital gain treatment. Finally, he argued in the alternative, that because of the speculative nature of the venture, the note that he received at the time of the transfer to Precision had no reasonably ascertainable value, and that therefore the transaction remained "open" until the note was sold, exchanged, or collected. Payments on the note would, under this theory, be entitled to capital gain treatment provided by Burnet v. Logan, 1931, 283 U.S. 404, 51 S.Ct. 550, 75 L.Ed. 1143, because they would be viewed as having been collected pursuant to the sale of a capital asset.
The Tax Court held: (1) that Dennis was not a "holder" as defined by Section 1235, (2) that the note he received from Precision was a security received in a tax free exchange of property under section 351 of the 1954 Code,6 (3) that even if taxpayer was a holder under section 1235, the capital gain treatment accorded by section 1235 is not applicable in a section 351 transfer, and finally (4) that amounts collected in payment of a note received in a section 351 transfer do not receive capital gain treatment unless that note independently qualifies for capital gain treatment under section 1232.
Taxpayer and the Commissioner have entwined this Court in a rather uneasy dialectic. They do not agree on the correctness of the Tax Court's fact findings, on its interpretation of applicable sections of the Internal Revenue Code, or on its application of the law to its fact findings.7 They do agree, however, that their conflict can be resolved only by this Court's determining whether the amounts received by taxpayer on the note were taxable to him as ordinary income or as capital gain. Out of this Hegelian struggle arises a result that we trust will be intellectually, if not financially, satisfying to taxpayer.
Taxpayer is cognizant of the general proposition that, absent special statutory authorization, collection on a note does not qualify for capital gain treatment. Fairbanks v. United States, 1939, 306 U.S. 436, 59 S.Ct. 607, 83 L.Ed. 855; Pounds v. United States, 5 Cir.1967, 372 F.2d 342, 349; Riddell v. Scales, 9 Cir.1969, 406 F.2d 210, 212. He therefore posits three different propositions that he contends authorize capital gain treatment for the amounts he...
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