Hope v. CIR

• Decision Date: 09 January 1973
• Docket Number: No. 71-1993 to 71-1995.,71-1993 to 71-1995.
• Citation: 471 F.2d 738
• Parties: Karl and Hilda HOPE, Appellants in Nos. 71-1993, 71-1994, v. COMMISSIONER OF INTERNAL REVENUE, Appellant in No. 71-1995.
• Court: U.S. Court of Appeals — Third Circuit

471 F.2d 738 (1973)

Karl and Hilda HOPE, Appellants in Nos. 71-1993, 71-1994, v. COMMISSIONER OF INTERNAL REVENUE, Appellant in No. 71-1995.

Nos. 71-1993 to 71-1995.

United States Court of Appeals, Third Circuit.

Argued October 16, 1972.

Decided January 9, 1973.

Jules I. Whitman, Dilworth, Paxson, Kalish, Levy & Coleman, Philadelphia, Pa., for appellants in Nos. 71-1993, 71-1994 and appellees in No. 71-1995.

Elmer J. Kelsey, Department of Justice-Tax Division, Washington, D. C., for appellant in No. 71-1995 and appellees in Nos. 71-1993 and 71-1994.

Before GIBBONS and JAMES ROSEN,^* Circuit Judges, and LAYTON, District Judge.

OPINION OF THE COURT

GIBBONS, Circuit Judge.

The taxpayers, Karl and Hilda Hope, appeal from a decision of the United States Tax Court, 55 T.C. 1020, determining a deficiency in income tax for the taxable year 1960 in the amount of $985,459.00. The Commissioner has filed a protective appeal from the Tax Court decision determining an overpayment of $137,775.00 in the year 1961. Taxpayer has filed a cross appeal with respect to the year 1961.

The taxpayers have filed calendar year tax returns on the cash receipts and disbursements method of accounting. Prior to the years in issue Karl Hope was the sole stockholder of Perfect Photo, Inc. In 1959 a public offering of 150,000 shares of Perfect Photo stock was made at $14.00 a share. Of these shares 90,000 were sold by Karl Hope, and 60,000 by the corporation. This left 210,000 shares in Hope's hands. He sold 3,600 shares in January, 1960, at $37.11 a share, and during 1960 he expressed an interest in selling his remaining 206,400 shares. At that time Perfect Photo employed Karl Hope's brother, Henry Hope, as a vice-president in charge of technical aspects of the business. It also employed Warren G. Grabb, a management engineer, and Henry J. Sentiff, a certified public accountant, both of whom were engaged in the company's financial affairs. The company stock was then traded on the American Stock Exchange.

Sentiff approached Harriman Ripley and Company, Inc. of New York, (Harriman Ripley) an underwriter of securities, about financing the purchase of Karl Hope's 206,400 shares. He then obtained from Karl Hope an agreement granting Sentiff and Grabb the right, for a period of thirty days from June 15, 1960, to purchase the 206,400 shares for $4,000,000.00. However, Sentiff was then advised by Harriman Ripley that Federal Reserve Board margin regulations, limiting loans for purchase of securities, would prevent its financing of the purchase by Sentiff and Grabb. As an alternative Harriman Ripley proposed that it purchase the 206,400 shares, at a price of $19.38 per share, for a total of $4,000,032.00, and that it give Sentiff and Grabb options until December 31, 1961, to purchase 75% of the acquired stock at the same price. Sentiff told Karl Hope that Harriman Ripley would purchase his stock, but at that time did not mention the options.

On June 25, 1960, the details of the purchase arrangement including the options to Sentiff and Grabb, were made known by Harriman Ripley to the attorney for Karl Hope, who was also general counsel, secretary, and a director of Perfect Photo. The attorney was informed that Karl Hope could not be included as an optionee without risking violation of the Federal Reserve Board margin regulations. A meeting then took place between Karl Hope, his brother Henry, Sentiff and Grabb, during which Karl Hope learned that Sentiff and Grabb were to benefit from the transaction by virtue of their options, and that he could not share in those benefits because of the margin regulations. At the meeting it was agreed that Henry Hope would be included as an optionee for 77,400 shares.

On July 15, 1960, Karl Hope, in the presence of his attorney, executed a contract to sell to Harriman Ripley, for its own account and as agent for other purchasers, 206,400 shares of Perfect Photo stock for $19.38 a share. Karl Hope's obligation to complete the sale was conditioned upon the delivery by Harriman Ripley of options and proxies to Henry Hope for 77,400 shares, to Sentiff for 38,700 shares and to Grabb for 38,700 shares, all at $19.38 a share. Karl Hope attended the closing on July 27, 1960, with his attorney. All the conditions of sale having been met, including the delivery of the options and proxies to Henry Hope, Sentiff and Grabb, Karl Hope transferred 206,000 shares of Perfect Photo stock to Harriman Ripley and received checks totaling $4,000,032.00.

During June and July, 1960, Perfect Photo stock traded on the American Stock Exchange between a low of $40 ½ and a high of $66 7/8 per share. In September, 1960, an article appeared in Business Week stating that Karl Hope had sold his Perfect Photo stock for $20 a share when it was trading at over $50 a share. He then became dissatisfied with the transaction, and consulted a new attorney. On that attorney's advice he maintained the proceeds of sale in liquid position, as cash in the bank, $2,369,000.00, tax exempt municipal bonds, $1,575,000.00, and marketable common stock, $429,000.00. On his behalf his attorney attempted unsucessfully to negotiate a rescission of the sale. On December 21, 1960, Karl Hope filed a complaint in the United States District Court for the Eastern District of Pennsylvania against Harriman Ripley, Sentiff and Grabb, alleging a conspiracy to defraud him and seeking rescission. The complaint alleged that Henry Hope had acquiesced in a rescission and would perform such acts and execute any documents necessary to effectuate it.

The December 21, 1960 lawsuit resulted in a settlement on March 24, 1961, on these terms:

(1) Karl Hope paid $350,000.00 to Sentiff and Grabb in consideration of their assignment to him of their options to purchase a total of 77,400 shares of Perfect Photo from Harriman Ripley. (Sentiff and Grabb had resigned as officers and directors of Perfect Photo on March 3, 1961.)

(2) Henry Hope assigned to Karl his option to purchase 77,400 shares of Perfect Photo without receiving any consideration.

(3) Henry Hope, Sentiff and Grabb returned the proxies for 154,800 shares of Perfect Photo stock to Harriman Ripley.

(4) Harriman Ripley confirmed to Karl Hope that the options assigned to him by Henry Hope, Sentiff and Grabb were valid and binding instruments, and delivered to Karl proxies to vote the 154,800 shares subject to the options.

(5) The lawsuit was dismissed with prejudice and without costs.

Thus on March 24, 1961, Karl Hope held options to repurchase 75% of the stock he had sold to Harriman Ripley on July 27, 1960, for the same price per share at which he had sold it. The options ran until December 31, 1961. During the week of the settlement, Perfect Photo stock traded at a low of $44 5/8 and at a high of $48 7/8. Hope's new attorney explored the possibility of a resale of the 154,800 shares at a lower price, but Harriman Ripley declined any discount off the option price. Karl Hope therefore concluded that he would hold the $3,000,024.00, the option price, until December. On December 18, 1961, he gave notice of the exercise of the options, and on December 29, 1961, in exchange for the agreed option price, received from Harriman Ripley the option stock.¹

During 1961 Karl Hope paid his new attorney $85,000.00 in counsel fees for conducting and settling the litigation against Sentiff, Grabb and Harriman Ripley and for effectuating the delivery of the option stock on December 29, 1961.

In his 1960 tax return Karl Hope disclosed the July 27, 1960 transfer of 206,400 shares of Perfect Photo stock for $4,001,632.00 ($19.38 per share, plus $1,600.00 stock transfer tax paid by Harriman Ripley). He did not, however, include any gain in income for 1960 on the theory that the transfer was not a completed sale on which gain was "recognized" in 1960. In his 1961 tax return Karl Hope reported a sale of 51,600 shares of Perfect Photo stock and showed net proceeds from that sale of $651,578.00. The net proceeds were computed by deducting from the $4,001,632.00 received in 1960 the $3,000,054.00 paid to Harriman Ripley on the exercise of the options on December 29, 1961, and the $350,000.00 paid to Sentiff and Grabb for assignment of their options on March 24, 1961. Thus only the 51,600 shares retained by Harriman Ripley were treated as having been sold, and that sale was treated as having taken place in 1961. In computing the gain on that sale Karl Hope used his original cost basis on the 51,600 shares, increased by the counsel fee of $85,000.00 paid in 1961.

In his notice of deficiency for 1960 the Commissioner determined that the petitioner realized a taxable gain in 1960 on the entire 206,400 shares transferred on July 27, 1960, amounting to $3,939,712.00; and assessed a deficiency of $985,459.00. In his notice of deficiency for 1961 the Commissioner determined, as an alternative to his determination with respect to 1960, that if the sale took place in 1961 petitioner had realized a taxable gain of $986,098.00 on the sale of 51,600 shares of Perfect Photo stock.

In 1962 there occurred a severe decline in the stock market. Following that decline, during 1962 and 1963, Karl Hope sold a total of 464,340 of the option shares (154,780 shares prior to the stock split) for an average per share price of approximately $4.65 ($13.95 per share on a pre-stock split basis).²

In the Tax Court Karl Hope made these contentions:

1. That his tender of rescission in 1960 and an actual partial rescission in 1961 postponed the realization of gain on the sale of his stock until 1961.

2. That his tender of rescission should permit him to deduct in 1961, pursuant to Int.Rev.Code of 1954, § 1341, the amount included in his 1960 income under a claim of right because it was established after the close of the 1960 tax year that he did not have an unrestricted right to the proceeds of sale.

3. Alternatively, that there was an actual rescission in 1960 of a part

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