Haserot v. Comm'r of Internal Revenue, Docket No. 93774.

• Decision Date: 27 January 1964
• Docket Number: Docket No. 93774.
• Citation: Haserot v. Comm'r of Internal Revenue, 41 T.C. 562 (T.C. 1964)
• Parties: HENRY McK. HASEROT AND BONNIE C. HASEROT, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

41 T.C. 562

HENRY McK. HASEROT AND BONNIE C. HASEROT, PETITIONERS,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 93774.

Tax Court of the United States.

Filed January 27, 1964.

Warren E. Hacker, for the petitioners.

Eugene S. Linett, for the respondent.

Petitioners controlled corporations H, N, and G. Petitioners transferred to H all of their N and G stock and received in return $64,850 cash and H stock worth $48,640. Held, since section 351, I.R.C. 1954, applies, the language of sections 302(d) and 301(a) precludes dividend treatment despite the fact that section 304 also applies.

TRAIN, Judge, Respondent determined a deficiency of $82,224.86 in petitioners' income tax liability for 1958.

Some of the issues have been settled. The issue remaining for decision is whether stock and $64,850 received by Henry McK. Haserot from his controlled corporation in return for stock in two other controlled corporations are taxable as a dividend or are to be treated as payment for stock and taxed as long-term capital gain.

FINDINGS OF FACT

Some of the facts have been stipulated.

The petitioners are husband and wife and reside in Cleveland, Ohio. Their cash basis joint Federal income tax return for the calendar year 1958 was filed with the district director of internal revenue at Cleveland, Ohio. Petitioner Henry McK. Haserot will hereinafter sometimes be referred to as petitioner.

Northport Cherry Factory, Inc. (hereinafter sometimes referred to as Northport), was incorporated in Michigan on February 25, 1930. Since then, Northport has been engaged in the business of owning and operating cherry orchards and a fruit canning and packing plant in Northport, Mich. Its office is at Port Clinton, Ohio. Northport's products are principally cherries and apple juice, a large part of which are canned or packed under the brand name ‘Northport,‘ a registered trademark. At all material times, Northport had outstanding 4,562 shares of stock of the only class authorized.

The Gypsum Canning Co. (hereinafter sometimes referred to as Gypsum) was incorporated in Ohio on June 16, 1900. At all material times Gypsum was engaged in the business of owning and operating cherry orchards and a fruit and vegetable canning and packing plant at Port Clinton. Its office is at Port Clinton. Gypsum's products were principally cherry, tomato, and pumpkin food products, a large part of which were canned or packed under the brand names ‘Ottawa Chief,’ ‘Lake Shore,‘ and ‘Bellevue,‘ all registered trademarks. At all material times, Gypsum had outstanding 6,582 shares of stock of the only class authorized.

The Haserot Co. (hereinafter sometimes referred to as Company) was incorporated in Ohio on March 7, 1894. Its principal office and place of business are in Cleveland, Ohio. Since its incorporation, Company has been engaged in the business of importing, blending, and roasting coffee; importing spices, condiments, and other food products; purchasing canned and preserved fruits and vegetables and other food products from Northport, Gypsum, and others; and marketing those goods to wholesalers, distributors, and large consumers. Company markets products under its own brand names which are registered trademarks and under the brand names of Northport, Gypsum, and others.

Northport and Gypsum sold the entire output of their canning and packing plants, except for damaged and rusted cans sold for salvage and casual sales to local purchasers, to Company for resale through the latter's sales and distributing organization. Northport and Gypsum had no sales or distributing organizations of their own.

Company furnished the principal management for Northport and Gypsum and provided the seasonal financing necessary for their crops and canning operations. This financing was provided in party by substantial cash advances, evidenced by negotiable interest-bearing notes, and in part by Company's guaranty of the accounts of Northport and Gypsum to their suppliers. The cash advances to each company averaged about $445,000 per year.

The food purchased annually by Company from Northport and Gypsum has varied in the 10 years 1952 through 1961 from a low of $649,745 in 1952 to a height of $1,420,860 in 1959. This has constituted approximately 10 percent of Company's overall food purchases each year. The food purchased from Northport and Gypsum was important to Company beyond the dollar amounts directly involved, since it permitted Company to furnish a wider range of food products to its customers. This enabled Company's salesmen to have initial access to more purchasers, which was beneficial to the entire line of products. Also, by increasing the number of items sold per sales call, it reduced the sales expense for each particular item.

Although the food products obtained from Northport and Gypsum might have been obtained from other sources, had control of Northport and Gypsum been lost, there were many business advantages to obtaining the products from Northport and Gypsum and to having control over these canneries, some of which are as follows:

(1) Independent and competing canneries are not reliable sources of supply. In bad crop seasons they provide for their own brands first and a small independent company such as Company would be the first to go short. Even in good seasons, the particular types of packaging available may not meet Company's particular needs.

(2) The brand names of the Northport and Gypsum products are not national known and advertised. However, they are well and favorably known to Company's customers. The loss of these brand names would result in an immediate loss of business and customer goodwill. It is a long and difficult process for a small company to develop new brand names.

(3) The development and maintenance of goodwill for a small company and its brand names require constant attention to quality control. Such control cannot be assured where canned goods are bought from an independent source for resale under the company's labels.

(4) The locations of the Northport and Gypsum canneries are very favorable, both in geographical proximity to Company's markets, and in the quality of the surrounding growing areas.

(5) A middleman, such as Company, cannot change its prices to meet market fluctuations except in conjunction with the packer which is its source. Control of the packer permits the decisions for both companies to be made together, with a resulting advantage in speed and flexibility.

Company was founded by petitioner's uncle and his father, Francis H. Haserot, hereinafter sometimes referred to as Francis H. Prior to 1942, Francis H. was the president of Company, Northport, and Gypsum. In 1942, petitioner became president of Company; however, Francis H. continued as president of Northport and Gypsum until 1951.

During the period from 1942 to 1951 there was a lack of common control over Company and the canneries, resulting in costly, inefficient production practices at the canneries, morale and communication problems, and related difficulties. These problems stemmed in part from the fact that management of Company did not always know what orders had been given to the canneries by Francis H., and coordination with him became very difficult. In part, the problems stemmed from the afflictions of age, Francis H. then being in his late 80's.

In 1951, Francis H. resigned as president of Northport and Gypsum; at the same time he gave his stock in those companies to petitioner, who thereby became the controlling shareholder and president of both companies.

At various times beginning after his acquisition of the Northport and Gypsum stock in 1951, petitioner informally discussed with the other directors the advisability of transferring that stock to Company. The other directors favored such a transfer.

The directors' reasons for preferring direct stock ownership by company were:

(1) The loss of Northport and Gypsum as suppliers would have been extremely serious.

(2) Divided control, even within the Haserot family and without loss of Northport and Gypsum as suppliers, had proved inefficient, unpleasant, and costly.

(3) As long as the Northport and Gypsum stock was held by an individual there was a danger that those shares would become separated from the shares of Company, either by voluntary transfer (which had been responsible for the prior division of control), by involuntary transfer, by inheritance, or by other events after the death of the individual.

(4) In early 1958, petitioner was 68 years old.

(5) In assessing the changes of such an inter vivos or testamentary division of the stock all parties involved were deeply influenced by the lack of judgment displayed by Francis H. in his late years, and in particular by the latter's actual decision in 1942 to divide control.

Francis H. died on February 14, 1954. His will was admitted to probate by the Probate Court of Cuyahoga County, Ohio. The Cleveland Trust Co. was appointed executor of the estate. At the time of his death, Francis H. owned 10,293 shares of Company, all of which was bequeathed to petitioner. The bequest was conditioned, however, upon the payment by petitioner to the estate of certain amounts the total of which was ultimately computed to be $80,984.28. Any stock not passing under the bequest, due to failure to make such payment, would have fallen into the residue, which was to be divided equally between Francis S. Haserot (hereinafter sometimes referred to as Francis S.) and Margaret Haserot (hereinafter sometimes referred to as Margaret), petitioner's brother and sister.

Francis S. had worked for Company for 1 month during a school vacation many years earlier. He had had not other connection with Company, Northport, or Gypsum, as officer, shareholder, director, or employee. He had formerly been a college professor of philosophy but by 1958 had retired to Florida. In February 1958, Francis S. was 63 years old.

Margaret also had never been an officer, shareholder,...