Jeffers v. United States

• Decision Date: 18 May 1977
• Docket Number: No. 432-73.,432-73.
• Citation: 556 F.2d 986
• Parties: Lewis F. JEFFERS and Minnie B. Jeffers v. The UNITED STATES.
• Court: U.S. Claims Court

556 F.2d 986

Lewis F. JEFFERS and Minnie B. Jeffers v. The UNITED STATES.

No. 432-73.

United States Court of Claims.

May 18, 1977.

COPYRIGHT MATERIAL OMITTED

John S. Nolan, Washington, D.C., atty. of record, for plaintiffs. Robert L. Moore, II, and Miller & Chevalier, Washington, D.C., of counsel.

Kenneth R. Boiarsky, Washington, D.C., with whom was Acting Asst. Atty. Gen. Myron C. Baum, Washington, D.C., for defendant. Theodore D. Peyser, Jr., and Donald H. Olson, Washington, D.C., of counsel.

Before COWEN, Senior Judge, DAVIS, Judge, SKELTON, Senior Judge, NICHOLS, KASHIWA, KUNZIG and BENNETT, Judges, en banc.

ON DEFENDANT'S MOTION FOR PARTIAL SUMMARY JUDGMENT AND PLAINTIFFS' CROSS MOTION FOR PARTIAL SUMMARY JUDGMENT

KASHIWA, Judge:

Plaintiffs initiated this action to recover for the calendar year 1971 taxes allegedly overpaid in the amount of $25,995, together with interest thereon as provided by law. Since the facts essential to the resolution of the issues in this case are not in dispute, the parties cross move for partial summary judgment with respect to all issues raised by the pleadings except for the counterclaim asserted by defendant in its first amended answer. Although we are confronted with ancillary issues, the ultimate issue with which we are faced is whether contingent payments of stock in a tax-free reorganization under I.R.C. § 368(a)(1)(A) are considered deferred payments to which I.R.C. § 483 would apply.¹

For the reasons set forth below, we agree with the defendant that § 483² applies to the instant transaction; and we remand the case to the trial division for further proceedings with respect to the defendant's counterclaim raised by its first amended answer.

The plaintiffs³ are individuals, husband and wife, who prior to March 1967 owned 81,035 shares of the 743,109 outstanding shares of common stock of Hayes International Corporation ("Hayes"). Hayes was engaged in the government contracting business, doing work for various agencies of the United States Government in the air and aerospace fields. Hayes, interested in expanding its business to its full potential in the aerospace industry, sought to acquire financial strength through a merger with another corporate entity.

The representatives of Hayes discussed the possibility of merger with the officers of City Investing Company ("City"). In discussing the proposed merger of Hayes and City, the boards of directors of Hayes and City agreed that in the event that the merger was consummated, the business operations of Hayes should continue in the form of a separate corporation which would operate as a subsidiary of City. However, the representatives of Hayes and City could not reach an agreement as to the value of the Hayes' assets and business. Accordingly, the representatives negotiated an agreement which provided that, in addition to City common stock, the Hayes shareholders would receive from City nontransferable certificates of contingent interest which would entitle them to additional shares of City stock based upon the earnings performance of Hayes, operating as a subsidiary of City, over a five-year period.

The merger of City and Hayes was executed pursuant to a merger agreement dated October 6, 1966. The plan provided that upon completion of the merger the shareholders of Hayes would receive, in exchange for their shares of Hayes, shares of common stock of City and certificates of contingent interest entitling them to additional shares of common stock of City upon certain conditions. The merger plan, as well as the certificates of contingent interest, specified the aggregate dollar value of the maximum number of contingent shares that could be issued to the certificate holders. The additional shares were to be issued if the cumulative earnings of the business formerly carried on by Hayes reached $7,500,000 during a five-year earnings period commencing at the effective date of the merger. However, prior to the issuance of the additional shares, the Hayes shareholders would have no voting or dividend rights with respect to those shares.

In order to determine the tax consequences of the proposed merger, tax counsel for Hayes filed a private ruling request with the Internal Revenue Service ("IRS") by letter dated October 12, 1966. With respect to the tax consequences of the proposed merger and the exchange by the shareholders of Hayes of their common stock and certificates of contingent interest, tax counsel requested rulings under §§ 368(a)(1)(A), 316, 354, 356 and 362.

By letter dated December 15, 1966, the IRS issued the ruling requested by Hayes' tax counsel. With respect to the tax treatment of the Hayes shareholders, the ruling stated as follows:

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(4) In accordance with the provisions of section 354(a)(1), no gain or loss will be recognized to the shareholders of Hayes on the receipt by them of shares of City stock (including City stock issuable by reason of the certificates of contingent interest and any fractional share interests to which they may be entitled) in exchange for their shares of Hayes stock. The certificates of contingent interest received by the shareholders of Hayes will not constitute the receipt of additional consideration within the meaning of section 356.

(5) The basis of the stock of City received by the shareholders of Hayes (including City stock issuable by reason of the certificates of contingent interest and any fractional share interests to which they may be entitled) will be the same as the basis of the stock surrendered therefor (section 358(a)(1)). Until the additional shares are issued by reason of the certificates of contingent interest, the basis will be determined as though the maximum number of shares issuable were received.

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No opinion is expressed as to the tax treatment of the transaction under the provisions of any of the other sections of the Code and Regulations which may also be applicable thereto or to the tax treatment of any conditions existing at the time of, or effects resulting from, the transaction which are not specifically covered by the above rulings.

After receipt of the private letter ruling from the IRS, the board of directors of Hayes consummated the merger with City in March 1967. As a result of the merger, plaintiffs, who held 81,035 shares of the 743,109 shares of common stock of Hayes outstanding at the time of the merger, received 23,151 shares of the common stock of City and 81,035 certificates of contingent interest in exchange for their Hayes stock.

The agreement of merger and related documents did not specify that any part of the additional City stock to be issued to the holders of the certificates of contingent interest was issuable as or in lieu of interest, nor did those documents specify that any interest was to be paid in this connection.

The earnings goal of $7,500,000, which under the merger plan would trigger the issuance of additional shares of City common stock in exchange for the certificates of contingent interest was reached in 1971; thereupon, in 1971, plaintiffs received 28,079 shares of City stock in exchange for their certificates.

Plaintiffs timely filed a joint federal income tax return for the year 1971. In that return plaintiffs computed an interest element on their receipt of the additional City shares received in 1971 and reported that amount as ordinary income on their 1971 federal income tax return.⁴ On June 26, 1973, plaintiffs timely filed a claim for refund for 1971 in the amount of $25,995, claiming that the sum of $97,565 was erroneously reported on their income tax return, under the heading "Dividend Income," as interest income. Plaintiffs' claim was formally disallowed by the IRS by notice dated July 19, 1973. On November 15, 1973, plaintiffs filed a petition in this court based upon the grounds set forth in the July 19, 1973, claim for refund. During the course of litigation in this court, the plaintiffs raised an additional ground for recovery which was not set forth in the July 1973 claim; accordingly, on August 19, 1974, the plaintiffs timely filed an amended claim for refund with the IRS, submitting that additional ground for recovery.

In contending that § 483 does not apply to the City stock in question, plaintiffs pose alternative arguments that they are entitled to a refund of overpaid 1971 federal income taxes. Initially, plaintiffs contend that they reasonably relied upon the private letter ruling issued by the IRS with respect to the merger of Hayes into City; it is plaintiffs' position that the ruling precludes the application of § 483 to the City shares in issue. Alternatively, plaintiffs argue that the regulation which applies § 483 to "tax-free" corporate reorganizations is invalid, being contrary to the intention of Congress in enacting § 483 as well as contrary to statutory provisions applicable to corporate reorganizations.

Of course, defendant argues the opposite. With relation to the private letter ruling, defendant asserts that the plaintiffs cannot be said to have reasonably relied upon the ruling to support their conclusion because no ruling was requested or issued with respect to § 483. With relation to the regulations, defendant directs our attention to the statutory language and legislative history of § 483 which to defendant emphasize the "paramount application of Section 483 `for all purposes of the Code.'" We agree with the defendant, which is unfortunate for plaintiffs.

Both parties aptly direct the court to the legislative history of § 483.⁵ However, each party when interpreting that history attributes a different intention to Congress for enacting the section. Both the plaintiff and the defendant agree that Congress was aware of a problem that certain deferred sales transactions could be structured so as to permit the buyer to convert ordinary income—interest—into capital gain merely by including the interest element in the purchase price.⁶ To remedy the...