G.C. Serv. Corp. v. Comm'r of Internal Revenue, Docket No. 11193-76.
| Decision Date | 03 December 1979 |
| Docket Number | Docket No. 11193-76. |
| Citation | 73 T.C. 406 |
| Parties | G.C. SERVICES CORP., PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
P purchased shares of its own stock from a shareholder, who at the time had several legal actions pending against P. As part of the transaction, the seller also released the legal actions. The written agreement between the parties primarily dealt with the sale of the stock and allocated the entire payment to the purchase of the stock, but the agreement did also provide for the release of the legal actions. Held, P failed to carry its burden of showing by “strong proof” that the written agreement did not reflect the intentions of the parties. Charles W. Hall, Kenneth W. Gideon, and Gerald W. Haddock, for the petitioners.
Daniel A. Taylor, Jr., for the respondent.
The Commissioner determined a deficiency of $168,000 in the petitioner's Federal income tax for 1972. The petitioner subsequently claimed an overpayment of $93,848 for the same year. The issues for decision are: (1) What portion, if any, of the payment which the petitioner made to purchase shares of its own stock and to settle claims of the seller of such stock is allocable to the settlement of such claims, and (2) if a portion is so allocable, whether it can be deducted as an ordinary and necessary business expense under section 162(a) of the Internal Revenue Code of 1954.
Some of the facts have been stipulated, and those facts are so found.
The petitioner, G C Services Corp., maintained its principal office at Houston, Tex., when it filed its petition in this case. It filed its Federal income tax return on the basis of a taxable year ending on September 30, and we shall identify each taxable year by the calendar year in which it ends. It filed its Federal corporate income tax return for its 1972 taxable year with the Internal Revenue Service Center, Austin, Tex.
The petitioner, which is a Texas corporation and which was formerly known as Gulf Coast Collection Agency Co., is engaged in the business of collecting delinquent accounts for many large U.S. corporations, including most of the major oil companies. To modernize its collection systems and procedures and improve its profitability, the petitioner hired Ely M. Zalta as its president on February 13, 1967. There was no written employment contract.
The petitioner customarily allowed its new officers to buy stock in the corporation. Hence, upon joining the petitioner, Mr. Zalta was permitted to purchase 25 of 100 shares of the petitioner's stock then issued and outstanding. From June 1967 through September 1968, he purchased such stock in four separate transactions for an aggregate price of $16,762.20. The sales prices in the several transactions were either equal to book value or were established by negotiations at less than book value.
On November 28, 1967, Mr. Zalta, Jerold B. Katz (Mr. Katz), Larry I. Fradkin, and Martin M. Katz, who were the officers and sole shareholders of the petitioner at the time, entered into a stock purchase agreement which gave the petitioner an option to purchase the stock of any shareholder upon the termination of the shareholder's employment with the petitioner. In early 1969, the petitioner terminated Mr. Zalta's employment; and in reliance on the stock purchase agreement, the petitioner, on March 25, 1969, exercised its option to purchase Mr. Zalta's stock for a price of $111,730.50. However, Mr. Zalta rejected the offer, contending that under the stock purchase agreement he was entitled to a higher price for his stock.
By September 15, 1969, the dispute between the petitioner and Mr. Zalta was still not settled; accordingly, on that day, he commenced the first civil action against the petitioner in the District Court of Harris County, Tex. In that action, there were three principal prayers for relief. In one of the principal prayers (the first prayer), he sought to recover $1,530,000 or, alternatively, $1 million for his stock in the petitioner. He believed that if the petitioner exercised its option, he was entitled either to the full value of his stock, which he considered to be $1,530,000, or at least to the amount which he had been offered for it by certain outside investors, $1 million. However, in November 1969, he and the petitioner agreed that the attempted exercise of the option was no longer effective.
In another of the principal prayers (the second prayer) of the first civil action, Mr. Zalta sought to enjoin the petitioner and its officers, directors, and managing agents from taking certain actions which might adversely affect the value of his stock or his interest in the corporation. Mr. Zalta feared that the petitioner would be able to obtain his stock certificate from the Texas National Bank of Commerce of Houston, where it was being held pursuant to the stock purchase agreement. His request for a temporary restraining order (the restraining order) with respect to the second prayer was granted on September 18, 1969. Among other provisions, such order enjoined the petitioner from authorizing or issuing any new shares which would dilute the percentage or value of Mr. Zalta's ownership, from effecting any merger or acquisition, from diverting any of the earnings of the petitioner to any other person or from otherwise disposing of Mr. Zalta's shares in any manner or form, and from making any changes in the capitalization of the petitioner or any of its wholly owned subsidiaries. Such order remained in effect until the settlement between Mr. Zalta and the petitioner in 1972.
In another of the principal prayers (the third prayer) of the first civil action, Mr. Zalta sought to recover 44 percent of the increase in retained earnings of the petitioner during the period of his employment. According to his computation, he was entitled to $176,000 plus interest, but had he prevailed, he would actually have been entitled only to approximately $172,000 including interest. Mr. Zalta's counsel considered such claim to have little merit.
In 1970, Mr. Zalta commenced the second civil action against the petitioner in the District Court of Harris County, Tex., in which he sought a writ of mandamus (the mandamus action). The court entered judgment against the petitioner and directed it to furnish to Mr. Zalta (1) monthly profit and loss statements for the petitioner and National Credit Control Inc. (NCCI) (a related inactive company in which Mr. Zalta owned a small amount of stock) from October 1, 1969, forward; (2) a monthly breakdown of expenses for the petitioner and NCCI for the same period set forth in the following categories: compensation to officers and directors, compensation to other employees, ordinary and usual overhead, and special overhead expenses; and (3) access to all stock books and minutes books of all meetings of shareholders and boards of directors of the petitioner and NCCI. Mr. Zalta was the sole nonemployee stockholder of the petitioner, and he commenced the mandamus action to obtain such information in order to protect his interest in the petitioner. Such order remained in effect until the settlement in 1972.
Later in 1970, Mr. Zalta commenced a third civil action against the petitioner in the District Court of Harris County, Tex., in which he requested an injunction against the adoption of an employee stock option plan by the petitioner (the stock option action). The court issued a temporary restraining order directing the petitioner not to adopt any such plan pending the action. In January 1971, the case was tried before a jury, and the jury found, among other things, that on the day of the adoption of the stock option plan, the fair market value of the petitioner's stock was $133 per share and that the action of the board of directors of the petitioner in offering to sell such stock under such plan to the employees at a price of $32 was fraudulent.
Mr. Zalta never took judgment on his verdict; instead, he agreed with Mr. Katz to forbear taking judgment while Mr. Katz attempted to resolve their differences and end all the litigation by finding a buyer either for Mr. Zalta's stock or for the entire company. By that time, the petitioner had spent more than $75,000 in legal and accounting fees as a result of the litigation.
Mr. Katz did not find a buyer for Mr. Zalta's stock. However, in December 1971, Mr. Zalta did receive an offer from investors in Killeen, Tex., to purchase all his stock in the petitioner for $1,250,000. Initially, he rejected the offer, and when, in January 1972, he sought to have it renewed, the Killeen investors refused to extend the offer.
Shortly thereafter, Mr. Katz, on behalf of the petitioner, offered Mr. Zalta $1,300,000 for his stock. Mr. Zalta also rejected such offer; whereupon, Mr. Katz increased the offer to $1,400,000, and Mr. Zalta accepted such offer. The agreement was subsequently reduced to writing (the settlement agreement) and was signed on May 8, 1972, by the parties thereto.
In part, the settlement agreement provided:
Zalta agrees to sell and Gulf Coast agrees to buy 9,624 shares of the common stock of Gulf Coast * * * and 250 shares of the common stock of * * * (NCCI), all of which are referred to hereinafter as the Stock, on the following terms and conditions:
(a) The purchase price for the Stock is One Million Four Hundred Thousand and no/100 Dollars ($1,400,000.00) * * *
(d) All parties hereto agree to execute at Closing a Mutual Release * * * 1
It is stipulated that the value of Mr. Zalta's 250 shares of NCCI did not exceed $2,470. There were pending criminal indictments against the officers of the petitioner for allegedly using the mails with the intent to extort money and a Federal Trade Commission (FTC) complaint against the petitioner and its officers for allegedly engaging in unfair and deceptive acts and practices in commerce. The settlement agreement provided that the closing...
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