Frederick Weisman Co. v. Comm'r of Internal Revenue
| Decision Date | 20 November 1991 |
| Docket Number | Docket No. 23934-89. |
| Citation | 97 T.C. No. 39,97 T.C. 563 |
| Parties | FREDERICK WEISMAN COMPANY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
As a condition for obtaining a 5-year automobile distributorship from TMS, P redeemed its outstanding shares from all but one shareholder. The distributorship was necessary for the survival of P. HELD, applying the “origin and nature” of the transaction test, neither the amount paid for the stock nor the incidental expenses incurred in connection with the redemption are deductible under sec. 162(a), I.R.C. HELD FURTHER, both the purchase price of the stock and the incidental expenses in connection with the redemption are nondeductible capital expenditures. Five Star Mfg. Co. v. Commissioner, 355 F.2d 724 (5th Cir. 1966), revg. 40 T.C. 379 (1963), not followed. Donald C. Alexander, Duane H. Pellervo and Michael Quigley, for the petitioner.
Richard H. Gannon, Ruth M. Spadaro and Eugene J. Wien, for the respondent.
Respondent determined the following deficiencies in petitioner's Federal corporate income taxes:
+---------------------------+
¦TYE ¦Deficiency ¦
+--------------+------------¦
¦Aug. 31, 1983 ¦$1,013,859 ¦
+--------------+------------¦
¦Aug. 31, 1984 ¦1,127,357 ¦
+--------------+------------¦
¦Aug. 31, 1985 ¦1,093,266 ¦
+---------------------------+
Unless otherwise indicated, all section references are to the Internal Revenue Code as amended and in effect for the taxable years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
The issue for decision is whether the amount paid by petitioner in redemption of its stock, when such redemption is brought about by an outside force and is necessary to the survival of petitioner's business, is an ordinary and necessary expense deductible under section 162(a) or a nondeductible capital expenditure.
This case is before the Court on respondent's Motion for Judgment on the Pleadings pursuant to Rule 120(a). For purposes of this motion, respondent assumes as true the factual allegations set forth in the petition. Respondent does not, however, accept the legal conclusions petitioner draws from these deemed-true facts.
Petitioner is a Delaware corporation with its principal place of business in Glen Burnie, Maryland. Petitioner's primary business is the operation of a Toyota distributorship for the mid-Atlantic region of the United States. It operates through Mid-Atlantic Toyota Distributors, Inc. (hereinafter MAT), its wholly owned subsidiary.
On March 17, 1970, MAT entered into an agreement with Toyota Motor Sales, U.S.A., Inc. (hereinafter TMS). This agreement authorized MAT to distribute new Toyota motor vehicles and other products in the mid-Atlantic region for a period of two years. On March 17, 1972, TMS agreed to extend the term of the agreement for six months.
On October 11, 1972, MAT entered into an agreement with TMS which authorized petitioner to continue to distribute new Toyota motor vehicles and other products in the mid-Atlantic region for a period of five years. On October 7, 1977, MAT entered into an agreement with TMS authorizing MAT to continue distribution for a further period of five years. By its terms this agreement terminated on October 11, 1982.
On August 27, 1982, petitioner and TMS entered into an agreement (hereinafter the 1982 Agreement) authorizing petitioner to continue distribution for a period of five years, beginning on October 12, 1982. Petitioner assigned the distributorship to MAT. By its terms, the 1982 Agreement expired on October 11, 1987.
The survival of petitioner's business depended upon its entering into the 1982 Agreement with TMS. As a condition to entering into the 1982 Agreement, TMS demanded that petitioner redeem the shares of all of its shareholders other than Frederick R. Weisman (Weisman). TMS was able to impose this requirement because of its superior bargaining position.
Weisman was the majority shareholder and sole director of petitioner. The stock that was redeemed was held by Marcia S. Weisman (Marcia), Richard L. Weisman (Richard), and Lerand, Inc.
Marcia held 5,000 shares of class A voting common stock and 31,365 shares of class B nonvoting stock. On or about July 31, 1982, petitioner redeemed all of Marcia's shares for $1,000,000 cash, title to certain works of art owned by petitioner valued at $540,783, and a secured promissory note in the principal amount of $5,870,000, payable without interest on or before January 3, 1983. Richard held 8,346 shares of class B nonvoting stock. On or about June 25, 1982, petitioner redeemed Richard's shares for $1,415,899 in cash. Lerand, Inc. held 18,835 shares of class B nonvoting stock. On or about June 25, 1982, petitioner redeemed Lerand Inc.'s shares for $3,195,358 in cash. Weisman has been the sole shareholder of petitioner since the 1982 stock redemption.
The total purchase price for the redeemed shares was $12,022,040. Petitioner also incurred $189,335 in legal expenses attributable to the stock redemption. Petitioner deducted these amounts ratably over the 5-year term of the 1982 Agreement. Respondent challenges those deductions, contending that all amounts paid in connection with petitioner's redemption of its stock are not deductible because of section 311(a), and are capital expenditures not deductible or amortizable under any provision of the Code.
The issue is whether the costs (purchase price and expenses) incurred in connection with a corporation's redemption of its own stock are deductible under section 162(a) or are amortizable despite the section 311(a) prohibition against the recognition of gain or loss on stock redemptions. Section 311(a) provides:
SEC. 311(a) GENERAL RULE. -- Except as provided in subsection (b), * * * no gain or loss shall be recognized to a corporation on the distribution, with respect to its stock, of --
(1) its stock (or rights to acquire its stock), or
(2) property.
Section 317 provides:
SEC. 317(a) PROPERTY. -- For purposes of this part, the term “property” means money, securities, and any other property; except that such term does not include stock in the corporation making the distribution (or rights to acquire such stock).
(b) REDEMPTION OF STOCK. -- For purposes of this part, stock shall be treated as redeemed by a corporation if the corporation acquires its stock from a shareholder in exchange for property, whether or not the stock so acquired is cancelled, retired, or held as treasury stock.
Petitioner relies on the Fifth Circuit's opinion in Five Star Mfg. Co. v. Commissioner, 355 F.2d 724 (5th Cir. 1966), revg. 40 T.C. 379 (1963), to support the proposition that stock redemption costs (purchase price and expenses) incurred in the face of an outside threat to the survival of the corporation are deductible as ordinary and necessary business expenses under section 162(a). Petitioner acknowledges that we are not bound by that Fifth Circuit opinion since the case before us is appealable to the United States Court of Appeals for the Fourth Circuit. Under the Golsen rule, we are not bound by the Fifth Circuit's holding in Five Star. Golsen v. Commissioner, 54 T.C. 742 (1970), affd. 445 F.2d 985 (10th Cir. 1971), cert. denied 404 U.S. 940 (1971). However, petitioner asks us to follow the Fifth Circuit's opinion. Respondent, for purposes of his motion for judgment on the pleadings, has accepted as true a statement of facts that brings the instant case squarely within the facts of Five Star. Thus, respondent asks us to decline to follow the Fifth Circuit's Five Star opinion and to adhere to our own opinion that such costs are nondeductible capital expenditures.
Five Star Mfg. Co. v. Commissioner, supra, addressed the deductibility of the amount paid by a corporation to terminate the interest of a 50-percent shareholder. W.S. Kincade and H.E. Smith, Jr., each owned 50 percent of the Five Star stock. Andrew Freeman held a patent on an automobile heater and through a patent license agreement had granted Kincade and Smith the exclusive right to manufacture, use, and sell the heater in the United States. Kincade and Smith in turn had transferred the right to manufacture the heater to Five Star. Smith thereafter borrowed substantial amounts of money from Five Star. In 1954, Freeman brought suit against the corporation and its two shareholders for nonpayment of royalties and attached most of Five Star's assets. Kincade paid part of the judgment and assured Freeman that the balance would be satisfied. As a result of subsequent litigation to recover amounts owed to Five Star by Smith, Five Star obtained a net money judgment of $56,715.43 against Smith. Five Star “purchased” Smith's stock for $56,000 at a judicial sale. 1 Five Star Mfg. Co. v. Commissioner, 355 F.2d at 724-725.
At the trial level in Five Star Mfg. Co. v. Commissioner, 40 T.C. 379, 391 (1963), this Court had found that “any benefit resulting from the purchase of the stock would extend over an indefinite number of years * * *” and hence denied Five Star a deduction under section 162 for an ordinary and necessary business expense. We prefaced our opinion with the following:
Apparently the parties are agreed that the instant case is not affected by section 311 of the Internal Revenue Code of 1954, which provides generally that no gain or loss shall be recognized to a corporation on distributions with respect to its stock. The regulations under section 311 make it clear that the section does not apply to transactions between a corporation and a shareholder in his capacity as a debtor. [Fn. ref. omitted.]
Five Star Mfg. Co. v. Commissioner, 40 T.C. at 387. The Tax Court footnoted section 1.311-1(e), Income Tax Regs., which provides:
(1) Section 311 is limited to distributions which are made by reason of the corporation-stockholder relationship. Section 311 does not apply to transactions between a...
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