Hempt Bros., Inc. v. United States

• Decision Date: 14 January 1974
• Docket Number: No. 73-1296.,73-1296.
• Citation: 490 F.2d 1172
• Parties: HEMPT BROS., INC., Appellant, v. UNITED STATES of America.
• Court: U.S. Court of Appeals — Third Circuit

490 F.2d 1172 (1974)

HEMPT BROS., INC., Appellant, v. UNITED STATES of America.

No. 73-1296.

United States Court of Appeals, Third Circuit.

Argued November 2, 1973.

Decided January 14, 1974.

Sheldon M. Bonovitz, John F. Fansmith, Jr., Duane, Morris & Heckscher, Philadelphia, Pa., for appellant.

Scott P. Crampton, Asst. Atty. Gen., Meyer Rothwacks, Ernest J. Brown, Attys., Tax Div., Dept. of Justice, Washington, D. C., for appellee.

Before ALDISERT and WEIS, Circuit Judges, and LATCHUM, District Judge.

OPINION OF THE COURT

ALDISERT, Circuit Judge.

In this appeal by a corporate taxpayer from a grant of summary judgment in favor of the government in a claim for refund, we are called upon to decide the proper treatment of accounts receivable and of inventory transferred from a cash basis partnership to a corporation organized to continue the business under 26 U.S.C. § 351(a).¹ This appeal illustrates the conflict between the statutory purpose of Section 351, postponement of recognition of gain or loss, and the assignment of income and tax benefit doctrines.

The facts were wholly stipulated; therefore, they may be summarized as set forth by the government in its brief:

The taxpayer is a Pennsylvania corporation with its principal place of business in Camp Hill, Pennsylvania. It files its federal income tax returns for a fiscal year beginning March 1.

From 1942 until February 28, 1957, a partnership comprised of Loy T. Hempt, J. F. Hempt, Max C. Hempt, and the George L. Hempt Estate was engaged in the business of quarrying and selling stone, sand, gravel, and slag; manufacturing and selling ready-mix concrete and bituminous material; constructing roads, highways, and streets, primarily for the Pennsylvania Department of Highways and various political subdivisions of Pennsylvania, and constructing driveways, parking lots, street and water lines, and related accessories.

The partnership maintained its books and records, and filed its partnership income tax returns, on the basis of a calendar year and on the cash method of accounting, so that no income was reported until actually received in cash. Accordingly, in computing its income for federal income tax purposes, the partnership did not take uncollected receivables into income, and inventories were not used in the calculation of its taxable income, although both accounts receivable reflecting sales already made and physical inventories existed to a substantial extent at the end of each of the partnership\'s taxable years. Rather than using the inventory method of accounting, the partnership deducted the costs of its physical inventories of sand, gravel, and stone as incurred.

On March 1, 1957, the partnership business and most of its assets were transferred to the taxpayer solely in exchange for taxpayer\'s capital stock, the 12,000 shares of which were issued to the four members of the partnership. These shares constituted 100% of the issued and outstanding shares of the taxpayer. This transfer was made pursuant to Section 351(a) of the Internal Revenue Code of 1954; . . . . Thereafter, the taxpayer conducted the business formerly conducted by the partnership.

Among the assets transferred by the partnership to the taxpayer for taxpayer\'s shares of stock were accounts receivable in the amount of $662,824.40 arising from performance of construction projects, sales of stone, sand, gravel, etc., and rental of equipment prior to March 1, 1957. Also among the assets transferred were physical inventories of sand, gravel, and stone, with respect to which the partnership had deducted costs of $351,266.05 and the value of which was no less than $351,266.05.

Commencing with its initial fiscal year which ended February 28, 1958, taxpayer maintained its books and filed its corporation income tax returns on the cash method of accounting and, accordingly, did not take uncollected receivables into income and did not use inventories in the calculation of its taxable income. In its taxable years ending in 1958, 1959, and 1960, taxpayer collected the respective amounts of $533,247.87, $125,326.71 and $4,249.72 of the accounts receivable in the aggregate amount of $662,824.40 (sic) that transferred to it, and included those amounts in income in computing its income for its federal income tax returns for those years, respectively.

As a result of an examination extending over a period of years, it was determined by the Commissioner of Internal Revenue, and agreed to by the taxpayer, that the use of the cash receipts and disbursements method of accounting with regard to purchases and sales, without taking into account merchandise on hand at the beginning and end of the taxable year, did not clearly reflect taxpayer\'s income. Accordingly, taxpayer\'s income was adjusted as set forth in an examination report of August 24, 1964 . . . to accrue unreported sales accounts receivable made during the taxable years in question and to take into account inventories in computing its cost of goods sold. In computing taxpayer\'s cost of goods sold under the inventory method, for the fiscal year ended February 28, 1958, the Commissioner of Internal Revenue, in conjunction with his accrual method treatment, fixed the beginning inventory of stone, sand, and gravel, which had been transferred to the taxpayer by the partnership, at zero, and the ending inventory at $258,201.35. The result was an increase in taxpayer\'s taxable income for the fiscal year ended February 28, 1958, in the amount of $258,201.35.

The Commissioner of Internal Revenue assessed deficiencies in taxpayer's federal income taxes for its fiscal years ending February 28, 1958, and 1959. The taxpayer paid the amounts in 1964, and in 1965 filed claims for refund of $621,218.09 plus assessed interest.² The claims were disallowed in full on September 24, 1968, and the district court action was timely instituted on December 5, 1968.

The district court held: (1) taxpayer was properly taxable upon collections made with respect to accounts receivable which were transferred to it in conjunction with the Section 351 incorporation, and (2) the court lacked jurisdiction to entertain taxpayer's contention that the tax-benefit theory of recovery entitled it to an opening inventory of not less than $351,266.05, since that theory of recovery was not presented in taxpayer's claim for refund. Hempt Bros., Inc. v. United States, 354 F.Supp. 1172 (M.D.Pa.1973).

I.

Taxpayer argues here, as it did in the district court, that because the term "property" as used in Section 351 does not embrace accounts receivable, the Commissioner lacked statutory authority to apply principles associated with Section 351. The district court properly rejected the legal interpretation urged by the taxpayer.

The definition of Section 351 "property" has been extensively treated by the Court of Claims in E. I. Du Pont de Nemours and Co. v. United States, 471 F.2d 1211, 1218-1219 (Ct.Cl.1973), describing the transfer of a non-exclusive license to make, use and sell area herbicides under French patents:

Unless there is some special reason intrinsic to . . . Section 351 . . . the general word "property" has a broad reach in tax law. . . . For section 351, in particular, courts have advocated a generous definition of "property," . . . and it has been suggested in one capital gains case that nonexclusive licenses can be viewed as property though not as capital assets. . . .

We see no adequate reason for refusing to follow these leads.

We fail to perceive any special reason why a restrictive meaning should be applied to accounts receivables so as to exclude them from the general meaning of "property." Receivables possess the usual capabilities and attributes associated with jurisprudential concepts of property law. They may be identified, valued, and transferred. Moreover, their role in an ongoing business must be viewed in the context of Section 351 application. The presence of accounts receivable is a normal, rather than an exceptional accoutrement of the type of business included by Congress in the transfer to a corporate form. They are "commonly thought of in the commercial world as a positive business asset." Du Pont v. United States, supra, at 1218. As aptly put by the district court: "There is a compelling reason to construe `property' to include . . . accounts receivable: a new corporation needs working capital, and accounts receivable can be an important source of liquidity." Hempt Bros., Inc. v. United States, supra, at 1176.³ In any event, this court had no difficulty in characterizing a sale of receivables as "property" within the purview of the "no gain or loss" provision of Section 337 as a "qualified sale of property within a 12-month period." Citizens Acceptance Corp. v. United States, 462 F.2d 751, 756 (3d Cir. 1972).

The taxpayer next makes a strenuous argument that "the government is seeking to tax the wrong person."⁴ It contends that the assignment of income doctrine as developed by the Supreme Court applies to a Section 351 transfer of accounts receivable so that the transferor, not the transferee-corporation, bears the corresponding tax liability. It argues that the assignment of income doctrine dictates that where the right to receive income is transferred to another person in a transaction not giving rise to tax at the time of transfer, the transferor is taxed on the income when it is collected by the transferee; that the only requirement for its application is a transfer of a right to receive ordinary income; and that since the transferred accounts receivable are a present right to future income, the sole requirement for the application of the doctrine is squarely met. In essence, this is a contention that the nonrecognition provision of Section 351 is in conflict with the assignment of income doctrine and that Section 351 should be subordinated thereto. Taxpayer relies on the seminal case of Lucas v. Earl, 281 U.S. 111, 50 S.Ct. 16, 74...