Jeanese, Inc. v. United States

• Decision Date: 03 March 1964
• Docket Number: No. 39236.,39236.
• Citation: 227 F. Supp. 304
• Parties: JEANESE, INC., a corporation, et al., Plaintiffs, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Northern District of California

227 F. Supp. 304

JEANESE, INC., a corporation, et al., Plaintiffs, v. UNITED STATES of America, Defendant.

No. 39236.

United States District Court N. D. California, S. D.

March 3, 1964.

W. A. Lahanier, San Francisco, Cal., for plaintiffs.

Cecil F. Poole, U. S. Atty., Richard L. Carico, Asst. U. S. Atty., San Francisco, Cal., for defendant.

OLIVER J. CARTER, District Judge.

This is an action for refund of an alleged overpayment of Federal income taxes, paid on behalf of the now dissolved taxpayer, Jeanese, Inc. ("Jeanese"), for the fiscal period commencing February 1, 1957, and ending January 16, 1958. The amount of overpayment is alleged to be the sum of $28,667.04.

The facts have been largely stipulated to between the parties.

In 1953, Frank Crist and three other individuals formed a partnership and acquired King Ranch, a parcel of land of approximately 90 acres near Los Altos, California. The partnership, later increased to thirteen individuals, intended to subdivide the entire parcel, to sell the resultant lots, and to acquire and subdivide additional land in the area. To permit gradual development of King Ranch, it was divided into four arbitrary units, known as Mentone 1, Mentone 2, Mentone 3, and Mentone 4. Mentone 1 and 2 were the first two units subdivided, and the partnership sold a total of 62 of the 108 lots in those units prior to incorporation of Jeanese.¹

Early in 1955, the partnership filed a tentative subdivision map with the Santa Clara County Engineer, showing the development of Mentone 3 and 4 as a single unit. The plan was never submitted for approval to the County of Santa Clara or to the City of Los Altos and was abandoned prior to commencement of any work thereon.²

In October, 1954, Jeanese was incorporated for the purpose of land development.³ In February, 1955, Jeanese took over the assets of the partnership and continued development of King Ranch. Jeanese sold the lots remaining in Mentone 1 and 2 prior to commencement of the fiscal period in question.⁴

In November, 1955, a final subdivision map for Mentone 3 was submitted to, and approved by, the City of Los Altos. No on-site improvements—streets, sewers, etc.—had been completed, and Jeanese was required to, and did, deposit funds in escrow to guarantee completion. The improvements were not completed until the summer of 1957 and were accepted by the City of Los Altos in October, 1957.⁵

Jeanese sold thirteen of the Mentone 3 lots prior to May 23, 1956. On that date a deposit receipt pertaining to 36 of the 50 lots then remaining in Mentone 3 was executed by and between Jeanese, Builders Associates, Inc. ("Builders"), and R. V. Jones and Co. ("Jones Co."), as real estate agent.⁶ Between the time of execution of the deposit receipt and the time of commencement of the fiscal period in question, Jeanese conveyed nine Mentone 3 lots. During the fiscal period Jeanese conveyed the remaining twenty-seven lots. Each of the twenty-seven lots was sold for $4,600, the price called for in the deposit receipt, for a total price of $124,200.⁷

On January 19, 1957, Jeanese's board of directors passed a resolution to dissolve and to liquidate, which was consented to in writing by the stockholders holding a majority of the voting power. That same day, January 19, the board also accepted an offer for the purchase of all of Mentone 4 for $208,000 in cash. The offer was later accepted by a majority of the stockholders. Jeanese received the purchase price on February 5, 1957, and reported the amount received on the income tax return it filed for the fiscal period in question. Claiming the nonrecognition of gain or loss provision of section 337 of the Internal Revenue Code of 1954, 26 U.S.C. § 337, infra, the gain of $96,010.05 was not included as part of Jeanese's taxable income.⁸

On January 13, 1958, the stockholders executed an agreement transferring all of Jeanese's remaining assets to Frank Crist and two other individuals as a liquidating dividend, in trust, for Jeanese's stockholders.⁹ No question as to the propriety of the use of trustees has been raised by the government, thus no issue is presented as to whether Jeanese was liquidated within the 12-month statutory period.

The fiscal period in question began February 1, 1957, and ended with the liquidation of Jeanese on January 16, 1958. After audit, the Internal Revenue Service determined that the gain on the sale of Mentone 4 was not subject to the nonrecognition provision of section 337, infra, and assessed a deficiency in Jeanese's federal income taxes in the amount of $38,667.04, based in part upon the inclusion of the gain from the sale of Mentone 4. Plaintiffs paid the assessed deficiency and interest and filed a claim for refund, which was denied by the Commissioner. The instant action for refund of taxes was then commenced.

The relevant portions of section 337 of the Internal Revenue Code of 1954 are subsections (a) and (b):

"Gain or loss on sales or exchanges in connection with certain liquidations

"(a) General rule. —If—

"(1) a corporation adopts a plan of complete liquidation on or after June 22, 1954, and

"(2) within the 12-month period beginning on the date of the adoption of such plan, all of the assets of the corporation are distributed in complete liquidation, less assets retained to meet claims, then no gain or loss shall be recognized to such corporation from the sale or exchange by it of property within such 12-month period.

"(b) Property defined. —

"(1) In general. — For purposes of subsection (a), the term `property' does not include —

"(A) stock in trade of the corporation, or other property of a kind which would properly be included in the inventory of the corporation if on hand at the close of the taxable year, and property held by the corporation primarily for sale to customers in the ordinary course of its trade or business,

* * * * *

"(2) Nonrecognition with respect to inventory in certain cases. — Notwithstanding paragraph (1) of this subsection, if substantially all of the property described in subparagraph (A) of such paragraph (1) which is attributable to a trade or business of the corporation is, in accordance with this section, sold or exchanged to one person in one transaction, then for purposes of subsection (a) the term `property' includes —

"(A) such property so sold or exchanged, and

"(B) installment obligations acquired in respect of such sale or exchange."

In order for Jeanese to prevail, it must show that Mentone 4 was not a section 337(b) (1) (A) asset, or if it was, that the bulk sale exception of section 337(b) (2) applies.

A. Was Mentone 4 a Section 337 (b) (1) Asset?

Not all assets of a liquidating corporation come within the nonrecognition of gain or loss provision of section 337(a). To reap the benefits of nonrecognition of gain, a corporate asset must be "property" as defined by section 337(b). Subsection (b) excludes from the definition of "property", with respect to which no gain or loss on a sale or exchange is to be recognized to the selling corporation, assets which are defined in its paragraph (1), subparagraph (A). Since The Congress clearly meant to exclude from nonrecognition of gain or loss upon any (1) sale of an inventory-type asset, or (2) sale of property held primarily for sale in the ordinary course of business, it is incumbent upon the Court to determine the proper construction to be placed upon the definition found in subparagraph (A).

Neither section 337 nor the Treasury Regulations promulgated thereunder define stock in trade or inventory, or property held by the corporation primarily for sale to customers in the ordinary course of its trade or business, and no case has been found by the Court defining such property as applied to real estate sold by a liquidating corporation.

In H.Rep. No. 1337, 83d Cong., 2d Sess., 1954 U.S.C.Cong. and Adm.News, pp. 4017-4619, the House Ways and Means Committee placed the tax consequences of a corporate liquidation in sections 331-336. With regard to those sections, the Committee reported that:

"* * * In order to eliminate questions resulting only from formalities, your committee has provided that if a corporation in process of liquidation sells assets there will be no tax at the corporate level, but any gain realized will be taxed to the distributee-shareholder, as ordinary income or capital gain depending on the character of the asset sold." p. 4064

Proposed section 333 (which became section 337 of the Code), incorporated the rules relating to gain from the sale of property in a corporate liquidation, and made clear that the purpose of characterizing a particular asset in liquidation as either a "capital" asset or an "ordinary" or "inventory" asset was to maintain the tax on doing business as ordinary income at the two traditional levels—first to the corporation and then to the shareholder. In its discussion of the section, the Committee said that, "Subsection (a) does not apply to any sale which is (1) a sale in the ordinary course of business or (2) a sale of an inventory asset (as defined in sec. 336 (d)) where the amount received for such asset exceeds 120 percent of the adjusted basis of such asset." 1954 U.S.C. Cong. and Adm.News, at page 4244.

The Senate, in S.Rep. No. 1622, 83d Cong., 2d Sess., 1954 U.S.C.Cong. and Adm.News, pp. 4621-5279, renumbered proposed section 333 as section 337, and said:

"Your committee provides that if a corporation adopts a plan of liquidation and liquidates within 12 months thereafter, sales of assets during this 12-month period will not result in tax at the corporate level. The House bill provides an exception to this rule where sales were made of so-called appreciated inventory. Your committee allows the nonrecognition of gain at the corporate level even if inventory is sold but requires that the inventory must be sold in bulk. This more nearly corresponds to the results that would follow a sale of all the corporate assets

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