Haberman Farms, Inc. v. United States

• Decision Date: 16 July 1962
• Docket Number: No. 16760-16762.,16760-16762.
• Citation: 305 F.2d 787
• Parties: HABERMAN FARMS, INC., Appellant, v. UNITED STATES of America, Appellee. George HABERMAN and Fannie H. Haberman, Appellants, v. UNITED STATES of America, Appellee. Rex HABERMAN and Phyllis Haberman, Appellants, v. UNITED STATES of America, Appellee.
• Court: U.S. Court of Appeals — Eighth Circuit

305 F.2d 787 (1962)

HABERMAN FARMS, INC., Appellant, v. UNITED STATES of America, Appellee.

George HABERMAN and Fannie H. Haberman, Appellants, v. UNITED STATES of America, Appellee.

Rex HABERMAN and Phyllis Haberman, Appellants, v. UNITED STATES of America, Appellee.

Nos. 16760-16762.

United States Court of Appeals Eighth Circuit.

July 16, 1962.

Flavel A. Wright, of Cline, Williams, Wright, Johnson, Oldfather & Thompson, and Flavel A. Wright, Lincoln, Neb., for appellants.

Harold C. Wilkenfeld, Tax Division, Dept. of Justice, Washington, D. C., Louis F. Oberdorfer, Asst. Atty. Gen., Washington, D. C., Lee A. Jackson, Harry Baum, Norman H. Wolfe, Attorneys, Dept. of Justice, Washington, D. C., Theodore Richling, U. S. Atty., Omaha, Neb., and Bernard Sprague, Asst. U. S. Atty., on the brief, for appellee.

Before VOGEL, BLACKMUN and RIDGE, Circuit Judges.

BLACKMUN, Circuit Judge.

These three cases, consolidated for trial, concern the propriety of the Internal Revenue Service's allocation of income of a corporation to the plaintiff taxpayers. The resulting income tax deficiencies were paid. By these actions the taxpayers now seek to recover those payments.

The individuals involved in the controversy are George Haberman, his son Rex, their respective wives who filed joint returns with them, and George's son Hubert. The corporations concerned are Haberman Farms, Inc. ("Farms") and Haberman Industries, Inc. ("Industries"). Hubert and his wife own all the stock of Farms in equal shares. George, Rex and Hubert own all the stock of Industries in equal shares. It is the net income received by Industries during its fiscal years ended September 30 of 1952, 1953 and 1954 from property leased or transferred to it by Farms, George and his wife, and Rex and his wife, respectively, which is in issue and which, for income tax purposes, was allocated back to those taxpayers. The allocation produced no tax change for Industries because its returns for the three years, both as filed and as adjusted on audit, showed no tax; this was due to Industries' assertion, under § 122(b) (2) (B) of the 1939 Code, 26 U.S.C.A. § 122(b) (2) (B), of a net operating loss carry over from fiscal 1951 arising out of manufacturing operations. The allocation did, however, produce the additional taxes in question for George and Rex and their wives for their taxable calendar years 1952, 1953 and 1954 and for Farms for its taxable fiscal years ending September 30 of 1952, 1953 and 1954.

The cases were tried to the court. Judgment in each was rendered for the United States. The trial court's findings and conclusions are reported at 182 F. Supp. 829. The taxpayers have appealed.

The government's position here is that this income received by Industries was in reality the income of the taxpayers, that Industries was employed only as a device for tax avoidance, that it possessed no legitimate business purpose during the years in question, and that, as an alternative ground, the allocation was properly made under § 45 of the 1939 Code, 26 U.S.C.A. § 45.^* The taxpayers' position is that business purpose is not the determinative test for income allocation; that the true test is that of economic effect upon the taxpayers themselves; that, in any event, there were genuine and valid business purposes in Industries' operation and status; and that the allocation is not to be supported under § 45.

The background facts are set forth in detail in the trial court's findings at pp. 830-831 of 182 F.Supp. and need not all be repeated here. We mention only the following as of particular importance:

1. Industries, incorporated in Nebraska in June 1950, was originally concerned with the manufacture of an insect spray device. Its initial operations were extensive and genuine. For a while Rex devoted his full time to the corporation. The device, however, proved defective and its production was discontinued in 1951. By September 30 of that year Industries' assets aggregated only $5,415.21 and it had built up a deficit of almost $75,000. The book liabilities creating this deficit consisted of $62,200 in advances made by the taxpayers, their capital stock investment of $18,000, and a small bank overdraft. To the extent of the advances Industries was indebted to the taxpayers.

2. Discussions took place about that time between the Habermans, their lawyer and their accountant as to what should be done with the corporation, as to the various income tax aspects of the entire situation, and as to the possibility of breathing new life into the corporation and making it solvent.

3. As a result of these meetings, the following steps were taken:

(a) In October 1951, January 1952, and March 1952, respectively, Farms, George and his wife, and Rex and his wife executed with Industries formal leases of farm lands in Nebraska and Colorado for 5-year terms. Industries agreed to maintain all improvements. Except for one of George\'s farms on which machinery was located, the rental specified in each lease was the same. There was testimony that the parties considered this to be a reasonable rental.

(b) In October 1951, when Farms\' lease was executed, Farms, by formal bill of sale, sold Industries grain, hay, an interest in growing wheat, and an interest in a farm partnership. The stated consideration was approximately $7,300 but no cash was paid. At the same time Hubert, also by bill of sale, sold Industries wheat on one of the properties Farms had leased. The consideration for this was $900.

(c) In January 1952, when George\'s lease was executed, he and his wife, by bill of sale, sold Industries wheat and standing grain on some of the properties they leased. The consideration was in excess of $13,000.

(d) In March 1952, when Rex\'s lease was executed, he and his wife, by bill of sale, sold Industries grains, hay, and an interest in growing wheat. The consideration was in excess of $3,500.

(e) In October 1951 Farms, by unrecorded warranty deed delivered to Industries\' attorney-director, conveyed to Industries for approximately $17,000 certain real estate in Hastings, Nebraska, improved with a cold storage house. Rex testified that this deed was not recorded "because of some liabilities and one thing and another".

(f) In March and April 1952 three separate checking accounts were opened in Industries\' name in a Hastings, Nebraska, bank. These were designated as Farm No. 1, Farm No. 2 and Farm No. 3 accounts and were under the respective "direction and management", as Rex testified, of George, Hubert and Rex. Receipts from the farms leased from George and his wife flowed into Account No. 1; those from the properties leased from Farms and the rent from the cold storage building flowed into Account No. 2; and those from farms leased from Rex and his wife flowed into Account No. 3. Although these accounts were all in Industries\' name, it was so arranged, at least, that George could effect withdrawals from Account No. 1, that Hubert and his wife could effect withdrawals from Account No. 2, and that Rex could effect withdrawals from Account No. 3. These withdrawal powers were not limited to amounts equal to the rentals specified in the respective leases. Withdrawals in excess of those rental amounts in fact were made. The corporation\'s book account for each taxpayer reflected these withdrawals, the rentals, the expenses attributable to the property, and the amount for which Industries was indebted to the taxpayer. The indebtedness included both the pre-October 1951 advances and the stated considerations, for which no cash was paid, for the properties transferred or conveyed to Industries.

4. Industries collected the rentals from the leased and conveyed properties. Except for wages paid to hands hired for such custom farming as was performed, the corporation paid no salaries after the end of its fiscal year 1951.

5. Industries' own books were kept separate from those of the respective taxpayers and from those of Hubert and his wife.

6. Following the execution of the leases and the property sales and conveyance, George, Rex and Hubert met at least once a month to discuss operations. They, as stated, were the sole stockholders of Industries and were officers of the corporation. In general, the management of the properties was continued in the same manner after the leases and transfers as before.

7. In 1953, 135 acres of the Nebraska land which George had leased to Industries were sold at auction for about $16,000. The warranty deed from George and his wife for this acreage made no reference to the lease to Industries. It reserved to the grantors an undivided interest in growing wheat. Several persons had expressed interest in this land and George and his sons had discussed the possibility of its sale. George did not recall whether he told the purchaser that the land was under lease to Industries. He testified:

"* * * I don\'t know how — why I should tell him that because when he bought the land Haberman Industries wouldn\'t have anything to do with it. I didn\'t tell him that the — I don\'t recall. I could have told him that the land was leased to Haberman Industries."

The amount received from this sale was evidently employed in connection with an irrigation system on a school section among the lands leased by George and his wife to Industries. The corporation's rental under the lease from George was thereafter reduced to the extent of the acreage sold. There was no evidence introduced as to any written release of this land by Industries or as to any other formal approval of the transaction on the corporation's part.

8. In February 1958 Industries purchased other Nebraska farm land for $37,500.

We thus have the situation where (a) a corporation possessed a substantial deficit which had been built up by losses from a then abandoned manufacturing operation; (b) the corporation's stockholders were its creditors; (c) the stockholders transferred and leased income producing assets to...