JM TURNER AND CO. v. Commissioner of Internal Rev.

• Decision Date: 17 July 1957
• Docket Number: No. 7365.,7365.
• Citation: 247 F.2d 370
• Parties: J. M. TURNER AND COMPANY, Incorporated, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Fourth Circuit

247 F.2d 370 (1957)

J. M. TURNER AND COMPANY, Incorporated, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 7365.

United States Court of Appeals Fourth Circuit.

Argued May 27, 1957.

Decided July 17, 1957.

William N. Pierce and Fortescue W. Hopkins, Roanoke, Va. (Hopkins & Pierce, Roanoke, Va., on the brief), for petitioner.

David O. Walter, Atty., Dept. of Justice, Washington, D. C. (Charles K. Rice, Asst. Atty. Gen., Ellis N. Slack and Lee A. Jackson, Attys., Dept. of Justice, Washington, D. C., on the brief), for respondent.

Before PARKER, Chief Judge, and SOPER and HAYNSWORTH, Circuit Judges.

HAYNSWORTH, Circuit Judge.

This case comes before us upon a petition to review a decision of the Tax Court (26 T.C. 795), in which the Tax Court held that certain deficiencies of excess profits tax were properly assessed. The Tax Court held that the taxpayer was neither an "acquiring corporation" within the meaning of § 461(a) nor a "purchasing corporation" within the meaning of § 474(a) of the Internal Revenue Code of 1939 (26 U.S.C.A. Excess Profits Taxes) and was, therefore, not entitled, in computing its excess profits tax credit, to use of the earnings experience in the base period years of a predecessor sole proprietorship. The principal basis of the conclusion of the Tax Court was that the taxpayer did not acquire "substantially all the properties," as required by § 461(a) (1) (D), nor "substantially all of the properties (other than cash)," as required by § 474(a) (1) (A), of the predecessor sole proprietorship.

The taxpayer, a corporation, was organized under the laws of Virginia for the purpose of engaging in a contracting business, which theretofore had been conducted by its president and principal stockholder as a sole proprietor.

Turner, operating as an individual, had developed a successful contracting business with substantial annual net profits. He had a staff of managerial and supervisory personnel, and in December 1949 was engaged in 14 construction projects. As of December 31, 1949, the book value of his mixed business and personal assets was over $300,000.00, of which the largest items were cash of $94,979.45, and contracts account receivables of $178,631.56.

Turner's books were kept on an accrual basis, but, for purposes of income taxes, he reported income on a completed contracts basis.

Late in 1949 Turner decided to organize a corporation. He was motivated by a desire to segregate business assets from personal assets, to limit his personal liability and to provide means of giving two of his employees a proprietary interest in the business. Accordingly, the taxpayer was incorporated on December 27, 1949, and on January 3, 1950, Turner paid into the corporation $55,000.00, against which 500 shares of common stock, of $100.00 par value each, were issued to him and 50 shares to his wife. At the same time his brother, one of his employees, paid in $5,000.00, against which 50 shares of stock were issued to him. On the same day Turner transferred to the taxpayer all of his office equipment, specified items of construction equipment, a Chevrolet truck and two of the fourteen contracts in process of construction. The transferred assets had a book value on Turner's individual books of $27,386.86 and they were set up on the books of the corporation upon that basis.

Expendable and small tools and similar items of equipment having an aggregate value, according to Turner, of approximately $6,000.00 were also turned over to the corporation. Since they were not capitalized on the books of the proprietorship, however, no entries respecting them were made on the books of the corporation.

The only physical assets used in the business which were not transferred to the taxpayer were a Lorain shovel having a book value of $8,703.87 and an automobile having a book value of $319.65.

Turner testified that the Lorain shovel was not suitable to the needs of a building contracting business. It had been purchased by him when he was in urgent need of excavating equipment,¹ but it did not have a boom of the type which would permit its use in setting steel or pouring concrete. Turner planned to have the new corporation purchase a more appropriate piece of equipment, and in the fall of 1950 it did purchase a Lima crane.

The newly formed corporation, with the assets thus transferred, conducted a general contracting business with substantial profits in 1950 and 1951. The evidence does not disclose that the physical and liquid assets transferred to it were insufficient for its business needs, except that in 1951 its volume of business was such that it exceeded its bonding limits. In May, June and November of that year, Turner, individually, took contracts which the corporation could not perform, because of its bonding limits, which gave him a gross profit of approximately $41,000.00. But the corporation was operating successfully and profitably at the same time. Indeed, its operations were so profitable that this claim for a deficiency of excess profits tax arose with respect to its income in 1951.

In reaching its conclusion that the assets transferred by Turner to the corporation were not substantially all of the properties of the proprietorship, the Tax Court was principally concerned with the fact that he did not transfer twelve of the contracts then in process of completion, and that he retained the major portion of his cash in the bank. The contracts in process of completion were said to have been the most valuable asset of the proprietorship, representing very large potential profits, while the bank account, though admittedly representing personal as well as business cash, was treated as being an asset of the contracting business. At the same time the Tax Court refused to allocate any value to good will of the proprietorship, because it found no evidence that it had been transferred to the corporation.

As to the twelve retained contracts, it is the apparent position of the Commissioner that they could, and should, have been transferred to the corporation, that the proprietorship, reporting on the completed contracts method, had derived no profit from them, that, transferred, the corporation would earn the profit and, presumptively, return it for taxation as its income. But these contracts were substantially completed at the time of the transfer. The last of them was completed in February of 1950 within two months following the transfer, except that Turner, upon the request of the owners and pursuant to his contracts, had to make minor adjustments, the last of which was accomplished in August 1950.

These contracts, being substantially completed at the time of the transfer, rather than representing large potential profits, represented profits actually accrued to Turner individually. The accrual was reflected in his balance sheet in the item of contracts accounts receivable and in his cash in bank. While the exact amount of that profit could not be finally ascertained with precision, because of unpredictable costs in winding up a construction project, it is clear that at the time of the transfer very substantial profits had already been earned and were accrued on those contracts.

The completed contracts method of reporting income for taxation is an equitable method of reporting widely used by contractors performing long term contracts or extensive construction work. Such work is subject to so many vicissitudes that it is difficult or impossible to reasonably determine what income has been earned when the end of the taxing period comes at a time when the work is not substantially completed. When reporting on a completed contracts basis, a contractor postpones reporting income until the completion of the contract, at which time his actual profit or loss can be determined accurately.

The completed contracts method of reporting, however, is not a device by which income can be transferred from one taxpayer to another. A change in the ownership of the contract during the course of construction would normally result in an accrual for tax purposes of income to the transferor, notwithstanding he had previously been reporting upon the completed contracts method. If Turner had transferred these twelve, substantially completed contracts to the corporation, particularly if the tax rate to the corporation was lower than the effective rate applicable to Turner's individual return, the Commissioner quite properly could have assessed tax on income, accrued to the date of the transfer, to Turner individually rather than to the corporation. Jud Plumbing & Heating Co. v. Commissioner, 5 Cir., 153 F.2d 681; Standard Paving Co. v. Commissioner, 10 Cir., 190 F.2d 330. It is quite apparent that any transfer of these contracts by Turner could have resulted in grave tax detriment to him and that the Commissioner, contrary to the theory of his position here, could have compelled him to treat the profit on such contracts, accrued to the date of transfer, as his individually even though he attempted to transfer it to the corporation. Under such circumstances it seems only reasonable to conclude, as Turner did, that the profits on these contracts, accrued to the date of the transfer, were his individual concern and not a part of the continuing contracting business to be conducted by the corporation. By retaining them and completing them himself, he avoided substantial tax questions and deprived the corporation of no substantial asset which was necessary or useful in its conduct of the general contracting business.

If it should be suggested that Turner could have transferred these contracts while retaining the obligation of paying income tax upon the profit accrued to the date of transfer, the result would have been to impose a substantial charge upon Turner's personal assets by putting into the corporation accrued profits, soon to be converted into cash, far in excess of the needs of the continuing business.

Turner...