Kenlin Industries, Inc. v. U.S., 89-1576

• Decision Date: 08 March 1991
• Docket Number: No. 89-1576,89-1576
• Citation: Kenlin Industries, Inc. v. U.S., 927 F.2d 782 (4th Cir. 1991)
• Parties: -623, 91-1 USTC P 50,122 KENLIN INDUSTRIES, INCORPORATED, Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant.
• Court: U.S. Court of Appeals — Fourth Circuit

Page 782

927 F.2d 782

67 A.F.T.R.2d 91-623, 91-1 USTC P 50,122

KENLIN INDUSTRIES, INCORPORATED, Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant.

No. 89-1576.

United States Court of Appeals Fourth Circuit.

Argued July 16, 1990.

Decided March 8, 1991.

Linda E. Mosakowski, argued (Shirley D. Peterson, Asst. Atty. Gen. Gary R. Allen, Gilbert S. Rothenberg, on brief), Tax Div., U.S. Dept. of Justice, Washington, D.C., for defendant-appellant.

Charles Ernst Pazar, argued, Stephenson, Kellogg, Krebs & Moran, Fairfax, Va. (Henry E. Hudson, U.S. Atty., Alexandria, Va., on brief), for plaintiff-appellee.

Before RUSSELL, WIDENER, and HALL, Circuit Judges.

DONALD RUSSELL, Circuit Judge:

This suit began on January 26, 1989, as one by Kenlin Industries, Inc. (the "taxpayer") against the Government to recover taxes paid for the tax years 1983, 1984, and 1985. It was alleged that the corporation R & D Urethanes, Inc. ("R & D") transferred in August 1982 its operating assets and business to the taxpayer effecting a reorganization qualifying for tax treatment under 26 U.S.C. Sec. 368, and that the taxpayer was entitled to use the losses of its predecessor company against its own tax liabilities in subsequent tax years under the terms of Section 368. The Government, in answer, pleaded lack of jurisdiction in connection with the refund for the years 1983 and 1985, asserting that the taxpayer paid no taxes for the tax year 1983 and had not fully paid its tax liability for the tax year 1985. It conceded jurisdiction of the action for recovery of taxes for the tax year 1984, but denied liability for various reasons. The Government deposed Kenneth Welk, who, with his wife, owned approximately 95 percent of both corporations and who had engineered the transfer from R & D to the taxpayer, on the terms and substance of the transfer. As a result of this examination of Welk and another officer of the two corporations, the Government decided to concede liability for the 1984 refund and so advised taxpayer's counsel by letter dated July 17, 1989. The taxpayer agreed to the dismissal of its claims relating to the 1983 and 1985 tax years. At this point, the parties agreed on an order dismissing the action, and the district court signed such order on July 19, 1989. The taxpayer thereupon filed a motion for attorney's fees and costs, contending that it was the prevailing party in the refund suit and that the Government had no reasonable or justified defense to the suit. The Government defended against the motion, arguing, among other reasons, that the taxpayer had failed to exhaust administrative remedies available to it under Internal Revenue Service procedures before filing suit and therefore was precluded from recovery of attorney's fees or costs. Without noticing or ruling on the Government's claim of failure to exhaust, the district court granted the taxpayer's motion and awarded costs and attorney's fees in favor of the taxpayer. The Government has appealed on, among other grounds, the failure of the taxpayer to exhaust administrative remedies. We reverse and remand the action to the district court for the entry of an order of dismissal for failure of the taxpayer to exhaust.

I.

The taxpayer is a corporation formed by Kenneth Welk in August 1982. Welk, who, with his wife, owned 95 percent of the stock of the new company, also was the owner, with his wife, of 95 percent of the stock of R & D Urethanes, Inc., which for some years had manufactured bomb carts for the United States Navy, gun plugs for NATO, and certain plastic specialty products. A short time before the taxpayer's incorporation, a grand jury instituted an investigation of the operations of R & D. Pursuant to a subpoena issued in the course of that grand jury investigation, the FBI seized the records of R & D. The investigation focused on R & D's bomb cart operations under contract with the United States Navy. Shortly after the FBI seized such records, Welk formed the corporation Kenlin Industries, Inc., with substantially the same stockholders as R & D. The plastic and gun plug businesses of R & D, neither of which was concerned with the grand jury investigation, were transferred with all their assets to the new corporation, and the taxpayer promptly began manufacturing specialty plastics and gun plugs. However, Kenneth Welk and R & D were indicted in the fall of 1985 in the United States District Court for the Eastern District of Virginia on multiple felony counts. Prior to trial, the charges against R & D were dismissed. Mr. Welk was convicted of multiple felony counts relating to improprieties stemming from the bomb cart contract.

R & D did not file a tax return for the year ending March 31, 1982, until June 16, 1986, several years after it had ceased to do business. On that return, R & D claimed losses of $1.3 million. Three days earlier, the taxpayer had filed claims for tax refunds for the tax years ending April 30, 1983, April 30, 1984, and April 30, 1985. The petition of the taxpayer based the refund claims on the losses reported on R & D's 1982 tax return. ¹ The taxpayer asserted that the transfer of assets from R & D to the taxpayer in August 1982 satisfied the requirements of a reorganization as provided in Section 368(a)(1)(D) of the Internal Revenue Code of 1954, entitling the taxpayer to avail itself of the losses shown on R & D's tax return for the year ending April 30, 1982, against its own tax liabilities for the tax years 1983, 1984, and 1985. ² Some disagreement developed between counsel for the taxpayer and Internal Revenue Service Agent Bamber over the propriety of the reorganization in the absence of any formal written plan of reorganization. The taxpayer's counsel submitted a list of cases, two of which were from the Fourth Circuit, ³ holding, as he contended, that a formal written plan of reorganization was not essential to a valid plan of reorganization under Section 368(a)(1)(D).

On January 6, 1989, Agent Bamber advised the taxpayer by letter, attaching Form 4549, that its claim for a refund of $16,320.06 for the year ending April 30, 1985, had been disallowed for failure to meet the reorganization requirements of Internal Revenue Code Section 368, "because there was no written plan and the corporate conduct did not approximate a reorganization." Prior to this statement, the letter said:

If you have any questions, please call me immediately. Otherwise, please sign and return both forms to me by January 18, 1989. If this date is not possible, please call me immediately to discuss the situation; otherwise, I will close the case unagreed on January 18, 1989.

The letter indicated just below this explanation the following:

Consent to Assessment and Collection--I do not wish to exercise my appeal rights with the Internal Revenue Service or to contest in the United States Tax Court the findings in this report. Therefore, I give my consent to the immediate assessment and collection of any increase in tax and penalties, and accept any decrease in tax and penalties shown above, plus any interest as provided by law. It is understood that this report is subject to acceptance by the District Director.

A little over two weeks after receiving Bamber's letter, the taxpayer filed this refund suit. The Government answered the taxpayer's suit by first denying jurisdiction over the refund claim for the tax year 1983, because the taxpayer had not paid any taxes for that tax year, even though the taxpayer alleged in its complaint that it "had paid all income tax, penalties, additions to tax, additional amounts, and interest assessed by defendant, if any." The Government also pleaded lack of jurisdiction over the refund claim for 1985 taxes since the taxpayer had not paid such tax in full. See Flora v. United States, 362 U.S. 145, 80 S.Ct. 630, 4 L.Ed.2d 623 (1960). It conceded jurisdiction of the 1984 tax year refund claim but joined issue on the claim of liability for refund for that year. Various requests for interrogatories were filed and depositions taken. In particular, the Government examined on deposition certain of taxpayer's officers on the circumstances related to the transaction between R & D and the taxpayer. After this examination, the Government seemed satisfied that a valid reorganization under Section 368 had been effected and conceded the taxpayer's claim for refund for the tax year 1984, and actually paid the taxpayer such refund. The taxpayer also agreed at that time to the dismissal of its claims for tax refund for the tax years 1983 and 1985, apparently for the reasons assigned by the Government. With these agreements, the parties submitted to the court their consented order of dismissal which the district judge signed.

Following this dismissal, the taxpayer filed its petition for the allowance of fees under Section 7430(b)(1) of the Internal Revenue Code of 1986. In a memorandum submitted in support of its fee petition, the taxpayer sought to excuse its failure to exhaust administrative remedies by alleging that "[e]ven if there were further avenues of [administrative] appeal available, plaintiff was unaware of them, since the IRS never informed the plaintiff of those rights." On this basis, it accordingly alleged that it had exhausted administrative remedies. The taxpayer then argued in this memorandum that it, the taxpayer, was the "prevailing party," since the Government was "not substantially justified in its defense" and the taxpayer had "prevailed in the most significant issue presented." The taxpayer identified the "most significant issue" as the "subsection D" reorganization treatment, or, more specifically "whether Kenlin Industries is the successor to R & D Urethanes." It further asked that the cap in fees allowed be raised in this case because, as it alleged, its counsel (Mr. Kellogg) "is an expert in tax law. He holds a Master's degree in Taxation from Georgetown University. He taught tax law for...