Grove v. CIR

• Decision Date: 27 July 1973
• Docket Number: Docket 73-1037.,No. 847,847
• Citation: 490 F.2d 241
• Parties: Philip GROVE and Harriet Grove, Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Appellant.
• Court: U.S. Court of Appeals — Second Circuit

490 F.2d 241 (1973)

Philip GROVE and Harriet Grove, Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Appellant.

No. 847, Docket 73-1037.

United States Court of Appeals, Second Circuit.

Argued May 24, 1973.

Decided July 27, 1973.

Wesley J. Filer, Atty., Tax Div., Dept. of Justice, Washington, D.C. (Scott P. Crampton, Asst. Atty. Gen., Meyer Rothwacks, Elmer J. Kelsey, Attys., Tax Div., Dept. of Justice, Washington, D.C., on the brief), for appellant.

Mason G. Kassel, New York City (R. Palmer Baker, Jr., and Lord, Day & Lord, New York City, on the brief), for appellees.

Before KAUFMAN, Chief Judge, and KILKENNY^* and OAKES, Circuit Judges.

KAUFMAN, Chief Judge:

We are called upon, once again, to wrestle with the tangled web that is the Internal Revenue Code and decipher the often intricate and ingenious strategies devised by taxpayers to minimize their tax burdens. We undertake this effort mindful that taxpayer ingenuity, although channelled into an effort to reduce or eliminate the incidence of taxation, is ground for neither legal nor moral opprobrium. As Learned Hand so eloquently stated, "any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes . . . ." Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934), aff'd, 293 U.S. 465, 55 S.Ct. 266, 79 L.Ed. 596 (1935).

The case before us involves charitable contributions to an educational institution. It is becoming increasingly apparent that colleges and universities must engage in extensive fund-raising if they are to continue to exist and provide quality education. In their efforts to induce alumni to make substantial contributions, these institutions have devised interesting gift plans which offer attractive, and legal, tax advantages to the donor. Philip Grove,¹ a successful engineer, was one who responded to the needs of his alma mater, Rensselaer Polytechnic Institute ("RPI"). Thus, in 1954, he began making annual donations to RPI of 165 to 250 shares of Grove Shepherd Wilson & Kruge, Inc. ("the Corporation"), a closely held corporation of which he is majority shareholder, vice-president, and a director. In each instance, Grove retained a life interest in any income earned from his gift and limited his charitable contribution deduction to the value of the remainder interest received by RPI. Despite the absence of any prearranged agreement between Grove and RPI, each year between 1954 and 1964 RPI successfully offered individual groups of shares to the Corporation for redemption. RPI then invested the redemption proceeds in income-producing securities and made quarterly disbursements to Grove of any income received. Grove reported any federally-taxed items on his personal income tax returns for the year of receipt.

The Commissioner of Internal Revenue refused to approve these arrangements. Instead, he assessed deficiencies in Grove's income taxes for the years 1963 and 1964, contending that Grove had employed RPI as a tax-free conduit for withdrawing funds from the Corporation and that redemption payments by the Corporation to RPI were in reality constructive dividend payments to Grove. Grove successfully challenged the deficiency determinations in the Tax Court, and the Commissioner appealed. We affirm.

I.

A full recitation of the undisputed facts underlying this controversy will aid in placing the legal issues raised on appeal in their proper context.

Philip Grove received an engineering degree in 1924 from Rensselaer Polytechnic Institute, a private, tax-exempt educational institution. During the Depression, he founded what is now Grove Shepherd Wilson & Kruge, Inc. and at all times since has controlled a majority of its shares.² The balance of the Corporation's shares, with the exception of those held by RPI, are owned by officers and employees of the Corporation or their relatives.

The Corporation's business is building airfields, highways, tunnels, canals, and other similar heavy construction projects in both the United States and foreign countries. These projects usually involve the investment of large sums of money over an extended period of time and involve a high degree of risk. Since, in this industry, contract payments normally are made only after specified levels of progress are achieved, a firm must always commit substantial amounts of its own funds, whether borrowed or internally generated, to a project. Moreover, a company can determine an acceptable contract price based only on its best estimate of the cost to complete the project. A bad "guess" or unforeseen contingency may require a firm to complete a project while incurring a loss. Not surprisingly, the mortality rate in this industry is high. To protect against such adverse developments, successful firms seek to maintain liquidity by holding ample cash or other assets easily converted to cash. One method of conserving cash, adopted by the Corporation, is to retain all earnings and refrain from paying dividends.

As we have noted, RPI, like all universities and colleges, pursued its alumni with a wide variety of contribution plans. One plan employed "life income funds," and its terms were simple. An alumnus would make a gift of securities to RPI and retain a life interest in the income from the donated securities. Whatever dividends and interest were paid during the donor's life would belong to the donor, while any capital appreciation would inure to RPI. Upon the death of the donor, RPI would obtain full title to the securities.

In 1954, Dr. Livingston Houston, RPI's president, suggested to Grove that he make a gift under the "life income funds" plan. Grove explained that his only significant holdings were shares of his own corporation, but expressed a willingness to donate some of these shares under the plan, with certain qualifications. The Corporation, he stated, could not agree to any obligation or understanding to redeem shares held by RPI. This condition, of course, stemmed from a fear that RPI might seek redemption at a time when the Corporation was hard pressed for cash, which, as we have noted, was an asset crucial to a company in the heavy construction business. Moreover, since Grove at that time was unsure of RPI's money-management qualifications, he further conditioned his gift on a requirement that if RPI disposed of the shares, any proceeds would be invested and managed by an established professional firm.

RPI found these terms acceptable and on December 30, 1954, Grove made an initial gift of 200 shares, valued at $25,560. A letter accompanying the donation set forth the conditions we have recited. Moreover, in addition to retaining an interest in the income from the gift for his life, Grove specified that in the event he should predecease his wife Harriet, she would receive the income until her death.

On the same day, the Corporation and RPI signed a minority shareholder agreement. RPI agreed not to "sell, transfer, give, pledge or hypothecate, or in any way dispose of the whole or any part of the common stock of the Corporation now or hereafter owned . . . until RPI shall have first offered the Corporation the opportunity to purchase said shares upon the terms and conditions hereinafter provided." The redemtion price was established at book value of the shares as noted on the Corporation's most recent certified financial statement prior to the offer. Pursuant to the contract, the Corporation was "entitled (but not obligated) to purchase all or any part of the shares of stock so offered." If the Corporation did not exercise its option to purchase within sixty days, RPI could transfer the shares to any other party and the Corporation's right of first refusal would not subsequently attach to such transferred shares.³

The 1954 gift was the first in a series of annual contributions to RPI by Grove. From 1954 to 1968,⁴ Grove donated to RPI between 165 and 250 shares of the Corporation each year, reaching a cumulative total of 2,652 shares, subject to terms substantially similar to those noted earlier.⁵

Generally, RPI offered donated shares to the Corporation for redemption, between one and two years after they were donated by Grove.⁶ The transactions followed a similar pattern. On each occasion, the Finance Committee of RPI's Board of Trustees first authorized the sale of specific shares of the Corporation. RPI's treasurer or controller would then write to Sidney Houck, the Corporation's treasurer, informing him of RPI's desire to dispose of the shares. Upon receipt of this letter, Houck would call a special meeting of the Corporation's board of directors to consider whether or not to exercise the Corporation's right of first refusal. The Board would adopt a resolution authorizing redemption and Houck would so inform RPI's financial officer, enclosing a company check for the amount due. By return mail, RPI would forward the appropriate stock certificate to the Corporation for cancellation.

At the time of the first redemption, in December, 1955, RPI opened an investment account at the Albany, New York, office of Merrill Lynch, Pierce, Fenner & Beane ("Merrill Lynch"). The account was captioned "Rensselaer Polytechnic Institute (Philip H. Grove Fund) Account." In accordance with Grove's wishes concerning the management of disposition proceeds, RPI authorized Merrill Lynch to act directly upon investment recommendations made by Scudder, Stevens, & Clark, Grove's personal investment adviser. RPI deposited the proceeds of each redemption transaction into this account which, pursuant to Scudder, Stevens & Clark's instructions, were generally invested in securities of large corporations whose shares traded on organized stock exchanges. Merrill Lynch paid the income from these investments to RPI on a monthly basis. RPI, in turn, made quarterly remittances to Grove, accompanied by an analysis of all account...