Knapp King-Size Corp. v. United States

• Decision Date: 17 December 1975
• Docket Number: No. 9-73 and 203-73.,9-73 and 203-73.
• Citation: 527 F.2d 1392
• Parties: KNAPP KING-SIZE CORP. and Knapp Brothers Shoe Manufacturing Corp. v. The UNITED STATES.
• Court: U.S. Claims Court

527 F.2d 1392

KNAPP KING-SIZE CORP. and Knapp Brothers Shoe Manufacturing Corp. v. The UNITED STATES.

Nos. 9-73 and 203-73.

United States Court of Claims.

December 17, 1975.

Chester M. Howe, Boston, Mass., attorney of record, for plaintiff.

Allan C. Lewis, Washington, D. C., with whom was Asst. Atty. Gen. Scott P. Crampton, for defendant; Theodore D. Peyser, Jr., Washington, D. C., of counsel.

Before COWEN, Chief Judge, and SKELTON and BENNETT, Judges.

OPINION

PER CURIAM:

These cases come before the court on plaintiffs' motion, filed September 25, 1975, requesting that the court adopt, as the basis for its judgment in these cases, the recommended decision of Trial Judge Philip R. Miller, filed May 9, 1975, as modified by the Supplemental Opinion, filed August 13, 1975, pursuant to Rule 134(h). Both opinions have now been consolidated in one opinion and defendant has filed no notice of intention to except thereto. Upon consideration thereof, without oral argument, since the court agrees with the recommended decision as hereinafter set forth, it hereby adopts the basis for its judgment in this case.

It is therefore ordered and concluded, as a matter of law, that the court has jurisdiction of these cases and that plaintiffs are entitled to recover. Judgments are entered for plaintiffs to that effect with the amount of their recoveries to be determined in further proceedings pursuant to Rule 131(c); and

It is further ordered that the order issued November 21, 1975, is, in view of the issuance of this opinion per curiam, hereby withdrawn.

OPINION OF TRIAL JUDGE

MILLER, Trial Judge:

These are suits for refund of federal corporate income taxes and interest paid by Knapp Brothers Shoe Manufacturing Corp. (Knapp Bros.) and its successor in interest, Knapp King-Size Corp. (Knapp), of Brockton, Massachusetts, in the sums of $779,460 and $58,773, for the years 1967 and 1968. The only question at issue is the determination of the portion of the purchase price paid for an entire business which may be attributed to the inventory.

On December 20, 1966, Knapp Bros. purchased all of the outstanding stock of King-Size Inc. (King-Size) from its stockholders. Ten months later, on October 31, 1967, Knapp Bros. liquidated King-Size and took over all of its assets in its own name. For the calendar year 1967, Knapp Bros. filed a consolidated income tax return with King-Size, including therein all income and deducting all costs and expenses from the operation of King-Size prior to its liquidation.

Section 334(b)(2) of the Internal Revenue Code of 1954 treats such an acquisition and liquidation as a purchase of the assets at the price which the acquiring company paid for the stock, with adjustments for the intervening financial results of operations during the 10-month period. The adjusted basis as of October 31, 1967, is agreed to be $5,347,725. The parties have also agreed that the proper allocation of basis to the assets other than the inventory and goodwill is $755,761. This leaves for determination only the relative portions of the remaining $4,591,964 to be attributed to the inventory and goodwill. The parties have further agreed that whatever value is determined for the inventory the residue is allocable to goodwill. The portion attributed to inventory represents the cost of goods sold for purposes of determining Knapp Bros.' income from the sale of merchandise for the years at issue.

Prior to December 20, 1966, Knapp Bros. was exclusively in the shoe business, both as a manufacturer and distributor, selling through a chain of retail stores, at wholesale and by mail order. King-Size was also located in Brockton and was exclusively a retail distributor of men's apparel and accessories, 92 percent of its sales being by mail order. It was the sole national mail-order distributor dealing exclusively in wearing apparel and accessories for men who were above average in height and weight. Its customers for the most part were over 6 feet 2 inches in height and weighed in excess of 200 pounds. It did no manufacturing but purchased all of its merchandise from standard manufacturers, modifying their specifications, however, to suit the needs of its unusual clientele. King-Size had a 600,000 name customer list which it had amassed by soliciting applicants for its catalogs through advertising in national periodicals at an average cost of about $3 per name. The executives of Knapp Bros. were of the view that King-Size's mail-order trade for large sized men's apparel could be used to complement Knapp Bros. own mail order shoe business.

The negotiations for the purchase of the King-Size stock began in January 1966 and culminated in a verbal agreement by September 1966. There were no negotiations with respect to the price of specific assets nor any attempt to put values on such assets. The price was essentially arrived at by capitalizing King-Size's earnings at a 10 percent rate. A basic $3,700,000 price represented 10 times the earnings for King-Size's fiscal year ending October 31, 1966; but it was subject to increases up to $4,500,000 if in any of the 3 ensuing years the earnings increased to levels that would warrant such price upon application of the same multiple. In fact the earnings did increase and the aggregate purchase price did become $4,500,000. The kinds of adjustments which increased the basis to $5,347,725 are explained in the discussion of the statute, infra.

King-Size customarily acquired its inventory from approximately 50 to 100 manufacturers of men's apparel and accessories. Its principal selling vehicles were its fall and spring catalogs, which required extensive preparation. Each of these catalogs had five different editions. For example, the original fall catalog, the October issue, was mailed out in the latter part of September, but variations thereof with different emphasis on the same merchandise were mailed out in the last weeks of October, November, December and January. The latter two also contained price reductions necessary to sell slower moving seasonal and fashion merchandise.

Because of the special requirements of its customers as to size, weight and durability and because of the long lead time required for catalog sales, King-Size's preparations for each season began many months prior to the publications. It would solicit new resources up to 15 months in advance to ascertain their willingness and capability to manufacture the required merchandise at acceptable prices. In December it would contact acceptable manufacturers for selection of fabrics and styles for the following October catalog. In January it would select the specific items for presentation in the fall catalogs. In January and February it would advise the resources of the models and piece goods selected and the desired specifications. The manufacturers would then make up and submit pilot samples for approval. In February and March King-Size would place orders for all of the fashion items and 75 to 80 percent of the basic items for the fall season. The manufacturers would produce the merchandise from March through September and make deliveries to King-Size's warehouse from August through October and as needed. The end of October represented King-Size's peak inventory accumulation period.

Preparation of the fall catalogs began in February or March upon receipt of the pilot samples and models. The catalogs required illustrations, photographs and artwork, editorial work, composition and other preparations over 5 to 6 months prior to publication.

King-Size uniformly did not pay its suppliers for the inventory on hand on October 31 until November 10. On the other hand, its customers paid cash in advance for their orders.

King-Size's cost for its October 31, 1967 inventory was $1,473,978. Its aggregate retail catalog price for the same merchandise was $3,096,000. In view of the manner in which it accumulated its inventory it is clear that substantially all of it was purchased well after December 20, 1966, when Knapp Bros. acquired the stock of King-Size.

Both parties tried the case on the assumption that the sole issue was the fair market value of the King-Size inventory on October 31, 1967. However, the statutory scheme and purpose raise a reasonable question as to the correctness of that assumption. Section 334(b)(2) provides that if a corporation purchases 80 percent of the total number of shares of stock of another corporation during a 12-month period and if the purchasing corporation receives the property of the acquired corporation in a complete liquidation pursuant to a plan adopted not more than 2 years after the purchase, then the basis of the property in the hands of the distributee shall be the adjusted basis of the stock with respect to which the distribution was made. The statute further provides that under regulations prescribed by the Secretary of the Treasury or his delegate proper adjustment in the adjusted basis of any stock shall be made for any distribution made to the distributee before the adoption of the plan of liquidation, for any money received, for any liabilities assumed or subject to which the property was received, and for other items.

Section 334(b)(2) was adopted for the first time in the Internal Revenue Code of 1954. Senate Report No. 1622, 83d Congress, 2d Session, page 48 (3 U.S. Code Cong. & Admin.News, p. 4679 (1954)) stated the purpose of the section.¹

Under the House bill, a shareholder would in all cases be permitted to receive the purchase price for his stock as his basis for the assets distributed to him regardless of the assets' cost to the corporation. In this respect the principle of Kimbell-Diamond Milling Company (187 F.2d 718) was effectuated. Since the application of the rule of this case is primarily in the area of liquidations by a parent corporation of its subsidiary, the rule has been limited by your committee to liquidations of this type. Accordingly, your committee has

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