Georgia-Pacific Corp. v. U.S., GEORGIA-PACIFIC

• Decision Date: 18 June 1981
• Docket Number: GEORGIA-PACIFIC,No. 79-4039,79-4039
• Parties: 81-2 USTC P 9515 CORPORATION, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 653

648 F.2d 653

81-2 USTC P 9515

GEORGIA-PACIFIC CORPORATION, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.

No. 79-4039.

United States Court of Appeals, Ninth Circuit.

Argued Nov. 5, 1981.

Submitted March 19, 1981.

Decided June 18, 1981.

Maurice O. Georges (argued), David C. Culpepper, Portland, Or., on brief, for plaintiff-appellant.

David E. Carmack, Washington, D. C., for defendant-appellee; John F. Murray, Acting Asst. Atty. Gen., Gilbert E. Andrews, Washington, D. C., on brief.

Appeal from the United States District Court for the District of Oregon.

Before HUG and REINHARDT, Circuit Judges, and TAYLOR, ^* District Judge.

HUG, Circuit Judge:

Georgia-Pacific Corp. appeals from the dismissal of its tax refund suit. Georgia-Pacific claimed that it was entitled under Int.Rev.Code § 631(b) to long-term capital gains treatment on the sale of standing timber. The district court held that under Treas.Reg. § 1.1502-13(c)(4), governing affiliated corporations filing consolidated tax returns, Georgia-Pacific was required to treat the gain as ordinary income. Georgia-Pacific contends on appeal that the regulation is not applicable because the transaction was not a "deferred intercompany transaction" and the purchaser was not entitled to claim depletion when the timber was cut. We affirm.

I. Facts

In 1973, Georgia-Pacific Corp. entered into a timber-cutting contract with its wholly-owned subsidiary, Timber, Inc. (Timber), under which Timber agreed to cut a fixed amount of standing timber on certain lands owned by Georgia-Pacific for $150 per thousand board feet. The contract refers to Georgia-Pacific as the "seller" and Timber as the "buyer." Payment is required upon removal of the timber and title passes from seller to buyer upon payment. The contract does not specify which party bears the risk of loss prior to payment, except that the buyer is liable for trees injured by its own negligence. The contract prohibits assignment of the buyer's rights. Georgia-Pacific also entered into a similar contract with another wholly-owned subsidiary, Rex Timber Corp. (Rex), whereby Georgia-Pacific agreed to cut timber on land owned by Rex. This contract is identical to the Georgia-Pacific/Timber contract except that it expressly specifies that the seller bears the risk of loss and provides that the price per board foot is to be readjusted annually to reflect market value. Because the contracts are virtually identical, in our discussion of the case we will refer to the Georgia-Pacific/Timber contract with the understanding that the same logic applies to the Rex/Georgia-Pacific contract.

Georgia-Pacific, Timber, and Rex filed a consolidated tax return for 1973 in which they claimed capital gains treatment under Int.Rev.Code § 631(b) for the payments received under the contracts. The IRS issued a notice of deficiency for $332,472 on the theory that the gain must be treated as ordinary income under Treas.Reg. § 1.1502-13(c)(4). Georgia-Pacific paid the disputed tax and sued for a refund in the district court. The district court dismissed for failure to state a claim upon which relief could be granted.

II. Statutory Framework

Int.Rev.Code § 631(b) provides that the disposition of standing timber held for a specified period pursuant to a contract under which the owner retains an economic interest in the timber shall be treated for tax purposes as a gain or loss. ¹ Under Int.Rev.Code § 1231(b) the gain on such a transaction is treated as a long-term capital gain. Treas.Reg. § 1.631-2(a)(2). The IRS does not dispute that the transaction between Georgia-Pacific and Timber qualifies under § 631(b).

Int.Rev.Code § 1501 provides that an "affiliated group" ² of corporations may file a consolidated return. Such a return allows the losses of one corporation to be offset against the income of the other affiliated corporations. It is not disputed that the corporations here are an affiliated group entitled to file a consolidated return.

Section 1502 authorizes the Commissioner to promulgate regulations for corporations using consolidated returns "to prevent avoidance of tax liability." The regulations under section 1502 provide that transactions between affiliated corporations filing consolidated returns are generally to be treated as if they were between unrelated taxpayers. Treas.Reg. § 1.1502-13(b) (1). Calculation and payment of tax is deferred, however, where the transaction is a sale or exchange of property or is an expenditure that must be capitalized. Treas.Reg. § 1.1502-13(a)(2). This transaction is called a "deferred intercompany transaction." The gain or loss on such a transaction is generally deferred until the asset is sold outside the affiliated group or the purchasing corporation leaves the affiliated group. ³ Treas.Reg. § 1.1502-13(c).

Section 1502 regulations also provide, however, that where property acquired by an affiliated corporation in a deferred intercompany transaction is subject to depreciation, depletion, or amortization, the gain is immediately taxable, Treas.Reg. § 1.1502-13(d)-(f), and is treated as ordinary income, Treas.Reg. § 1.1502-13(c)(4). ⁴ Georgia-Pacific concedes that Treas.Reg. § 1.1502-13(c) (4) is valid and that, where applicable, it mandates ordinary income treatment of transactions otherwise qualifying for capital gains treatment under Int.Rev.Code § 631(b).

Section 611 of the Internal Revenue Code and the applicable regulations provide that owners of standing timber may deduct from their income a proportion of their basis in the timber to reflect depletion of their capital resource as the timber is cut. Because several parties are often involved in the purchase and cutting of standing timber, the regulations provide that only a party with an "economic interest" in the timber may take depletion as it is cut. Treas.Reg. § 1.611-1(b)(1).

III. Deferred Intercompany Transaction

Georgia-Pacific first argues that the ordinary income provision of Treas.Reg. § 1.1502-13(c)(4) does not apply because the timber contracts do not qualify as deferred intercompany transactions. We do not agree.

A transaction between affiliated corporations will be deemed a deferred intercompany transaction if it constitutes:

(i) The sale or exchange of property,

(ii) The performance of services in a case where the amount of the expenditure for such services is capitalized (for example, a builder's fee, architect's fee, or other similar cost which is included in the basis of property), or

(iii) Any other expenditure in a case where the amount of the expenditure is capitalized (for example, prepaid rent, or interest which is included in the basis of property)(.)

Treas.Reg. § 1.1502-13(a)(2).

We hold that the transactions in the present case were "sales" under the above-quoted regulation. ⁵ The timber contracts refer to the transaction as a "sale" and refer to the parties as the "buyer" and "seller." We are not inclined to ignore the taxpayer's characterization of the contracts. We hold infra that each of the purchasers acquired an "economic interest" in standing timber through the contracts that entitled it to claim depletion as the timber was cut. It is therefore appropriate to deem the transfer of this economic interest a "sale." ⁶

Georgia-Pacific contends that a disposition of rights in standing timber that qualifies for capital gains treatment under Int.Rev.Code § 631(b) can never be deemed a sale. It first notes that the Supreme Court held that receipts from a mineral lease do not constitute the sale of mineral rights and are not entitled to capital gains treatment. Burnet v. Harmel, 287 U.S. 103, 53 S.Ct. 74 77 L.Ed. 199 (1932). Georgia-Pacific argues that, by analogy to Burnet, the disposition of rights in standing timber does not constitute a "sale" and that it is afforded capital gains treatment solely by virtue of Int.Rev.Code § 631(b). This argument is unpersuasive.

Assuming arguendo that the logic of Burnet also applies to the disposition of standing timber, we note that the Court held only that the lease did not constitute a sale of a capital asset, in that case the mineral rights in the land. The Court acknowledged that the lease did constitute a transfer of ownership of the minerals removed. Id. at 110-11, 53 S.Ct. at 77. Moreover, contracts for the sale of standing timber are more like a traditional sale than a mineral lease.

(T)he typical contract for the exploitation of an oil and gas deposit does not have the characteristics of a sale of the owner's capital interest in the underlying oil and gas; its dominant purpose is to fix the terms under which the land will be explored and under which any deposit of oil and gas that may be found will be produced. The exploration, drilling, and production contemplated by such a contract resembles a manufacturing operation to which the passage of title to the oil and gas produced is only an incident, rather than a sale of an interest in the oil and gas in place

By contrast, the dominant purpose of the Timber Sale Agreement in the present case was not the lease of lands for exploration, discovery, and exploitation of a concealed resource over an extended term, but rather the immediate conveyance of a visible, measurable, readily accessible timber crop, to be paid for, cut, and removed within a short period of time.

United States v. Giustina, 313 F.2d 710, 714 (9th Cir. 1962).

Georgia-Pacific also argues that a transfer qualifying under section 631(b) can never be a "sale" because the disposing party retains an economic interest in the timber. This argument is also unpersuasive. The intent of Congress in enacting section 631 was to prevent application of the Burnet rationale to the sale of standing timber and to allow the owner of timber land capital gains treatment whether he sold the timber and the land or just the standing timber. Dyalwood, Inc. v. United States, 588 F.2d 467 (5th Cir. 1979); United States v....