Jack Daniel Distillery v. United States
| Decision Date | 09 June 1967 |
| Docket Number | No. 302-63.,302-63. |
| Citation | 379 F.2d 569 |
| Parties | JACK DANIEL DISTILLERY, Lem Motlow, Prop., Inc., v. The UNITED STATES. |
| Court | U.S. Claims Court |
N. Barr Miller, Washington, D. C., for plaintiff. J. Marvin Haynes, Washington, D. C., attorney of record. Joseph H. Sheppard, Jerome D. Meeker, Robert S. Bersch, Walter D. Haynes, and Haynes & Miller, Washington, D. C., of counsel.
Theodore D. Peyser, Washington, D. C., with whom was Asst. Atty. Gen., Mitchell Rogovin, for defendant.
Before COWEN, Chief Judge, and LARAMORE, DURFEE, DAVIS, COLLINS, SKELTON, and NICHOLS, Judges.
This is a suit for refund of corporation income tax and assessed interest in the total sum of $4,274,803.73 for the fiscal years ended April 30, 1958 through 1962. While plaintiff does not claim a refund for the fiscal year ended April 30, 1957, it claims entitlement to a carryover of a net operating loss from such year to the fiscal year ended April 30, 1959. Defendant by counterclaim seeks a judgment for income tax and interest previously refunded in the sum of $559.99 for the fiscal years 1958 through 1960, and for unpaid assessments of income tax and interest in the sum of $211,838.02 for the fiscal years 1961 and 1962.
With the approval of the trial commissioner, the trial has been limited by agreement of the parties to the issues of law and fact relating to the right of each party to recover, reserving the determination of the amounts of recovery, if any, for further proceedings.
Plaintiff, a newly-formed Tennessee corporation, acquired the stock of a predecessor Tennessee corporation of the same name (hereinafter called Old Jack Daniel) on August 29, 1956, for a total purchase price of $18 million, with a down payment of $5.4 million in cash and the balance of $12.6 million in negotiable promissory notes. On September 17, 1956, plaintiff liquidated Old Jack Daniel and thereby acquired all its assets and assumed its liabilities, and thereafter carried on the whiskey distillery business previously operated by Old Jack Daniel at Lynchburg, Tennessee. Plaintiff had been incorporated by its parent, Brown-Forman Distillers Corporation, on August 25, 1956, for the specific purpose of acquiring the Old Jack Daniel stock and then liquidating Old Jack Daniel. There are two issues in this case:
1. The fair market value of the inventory of barreled whiskey, the tax-paid whiskey in bottling tanks, and the goodwill acquired by plaintiff from Old Jack Daniel for purposes of section 334 of the Internal Revenue Code of 1954; and
2. Whether the amount of $3.5 million paid to plaintiff by its parent, Brown-Forman Distillers Corporation, on August 28, 1956, was a loan or a contribution to capital.
The point of beginning for the valuation issue is section 334(b) (2) of the Internal Revenue Code of 1954, 26 U.S.C. § 334(b) (2) (1964). It provides that if property is received in complete liquidation of a subsidiary under section 332(b) and certain other criteria are met (all of which occurred in the instant case), the basis of the property received shall be the adjusted basis of the stock with respect to which the distribution was made. Treasury Regulations § 1.334-1(c) (4) (viii) (1954 Code), 26 C.F.R. § 1.334-1 (c) (4) (viii) (1961) provides, for the purposes of this case, that the adjusted basis of the stock shall be allocated among the tangible and intangible assets received in proportion to the net fair market value of the assets received.1 The parties have stipulated the value of all items other than the three in dispute. The undisputed assets acquired by plaintiff in the liquidation of Old Jack Daniel including the distillery plant, buildings and equipment, land, cash, accounts receivable, raw materials and supplies, and others, and as to these defendant has accepted as fair market value the amounts shown on plaintiff's books. The valuations of the parties concerning the disputed items, and the cost basis of such assets on the books of Old Jack Daniel, are as follows:
______________________________________________________________________________
| Defendant | Plaintiff | Cost to Old
| | | Jack Daniel
________________________________|_____________|________________|______________
Whiskey in barrels ____________ | $3,788,000 | $11,571,381.51 | $3,249,294.87
Whiskey in bottling tanks _____ | 17,200 | 26,248.86 | 16,256.55
Goodwill ______________________ | 6,706,000 | 2,507,998.30 | 0
________________________________|_____________|________________|______________
The wide gap between the valuations given by the parties results in part from a use of two completely different methods of valuation and in part from a difference as to what incidents of ownership are part of fair market value.
Jack Daniel whiskey is and was what is known in the distilling industry as an irreplaceable whiskey, that is, it is a unique whiskey which has gained a reputation for its distinctive taste. Jack Daniel, being considered irreplaceable, was not sold on the bulk whiskey market. Examples of irreplaceable whiskeys were such bourbons as Old Grand-Dad, Old Forester, and Old Fitzgerald. Jack Daniel was even more distinctive than such irreplaceable bourbons, because the unique method by which it was produced gave it a taste distinct from both rye and bourbon, and it was unlike any other whiskey on the market in 1956. It was also, at that time, the highest priced domestic whiskey.
Some years prior to 1956, the distilling industry, believing that the market price for bulk whiskey did not adequately reflect the value of irreplaceable whiskeys, entered into an agreement with insurance underwriters to use a new method of valuing irreplaceable whiskey for insurance purposes. The method used was to take the case price of the whiskey in glass and subtract from this, excise taxes, bottling costs, and other charges as yet unincurred with respect to the bulk inventory. The resulting figure was considered to be the value of the matured whiskey in barrels and bottling tanks. The value of freshly distilled whiskey was established on the basis of production cost. The intermediate age whiskey was valued by prorating, according to age, the difference between the values of the mature whiskey and the fresh whiskey.
When sale negotiations began between the Old Jack Daniel stockholders and the representatives of Brown-Forman, the sellers' asking price for the Old Jack Daniel stock was placed at $20 million. This amount was arrived at by two methods. First, the anticipated combined earnings for Old Jack Daniel and its sales affiliate, Nashville Sales Company, for the fiscal year 1956 were $2 million. The Old Jack Daniel stockholders considered that a sales price of 10 times earnings, or $20 million, was reasonable. The second method was that the net tangible assets of Old Jack Daniel were valued at $15 million, and to this was added $5 million as the value of goodwill. In determining the net tangible asset value of Old Jack Daniel, the bulk inventory was valued by the same method as that used for insurance valuation.
After the initial negotiating session, Brown-Forman verified to its satisfaction the valuation given the tangible assets. In order to determine whether, for tax purposes, it could write up the unbottled inventory to the insurance value, it consulted its regular outside auditors, Lybrand, Ross Bros. & Montgomery. The auditors reviewed the projected income and cash flow, and determined that the valuation given the inventory would yield an extraordinary gross profit. They then advised Brown-Forman that they considered the proposed valuation a correct accounting method for determining basis under § 334(b) (2) of the Internal Revenue Code of 1954.
After further negotiations, Brown-Forman and the Old Jack Daniel stockholders agreed on a purchase price of $18 million, and the sale of the Old Jack Daniel stock was consummated on August 29, 1956, with the subsequent liquidation of Old Jack Daniel on September 17, 1956.
In accordance with the market value insurance formula, plaintiff valued (as did Old Jack Daniel) the transferred inventory of barreled whiskey (3,125,277.06 original proof gallons) at $11,571,381.51, and the transferred inventory of whiskey in bottling tanks (1,350 regauged proof gallons) at $26,248.56, for a total valuation of $11,597,630.37, all in the manner detailed in findings 42 through 45.
In comparing its income tax liability for the fiscal period August 25, 1956 to April 30, 1957, and the fiscal years ended April 30, 1958-1962, plaintiff used as its basis for computing the cost of the unbottled inventory acquired by the liquidation of Old Jack Daniel the aforementioned valuation used for determining insurance values. These values were entered on its books on September 17, 1956. Plaintiff filed timely income tax returns for the fiscal period ended April 30, 1957, and the fiscal years 1958-62, showing taxable income or loss and tax paid, as follows:
______________________________________________________________
| Taxable |
Taxable Year | Income | Tax Paid Per
| (or Loss) | Return
______________________________|________________|______________
1957 ________________________ | ($377,667.55) | None
1958 ________________________ | (1,080.17) | None
1959 ________________________ | 348,478.49 | $ 175,708.81
1960 ________________________ | 2,318,166.67 | 1,199,946.67
1961 ________________________ | 3,940,388.52 | 2,043,502.03
1962 ________________________ | 5,874,356.32 | 3,049,165.29
|________________|______________
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