Koch v. Commissioner of Revenue

• Decision Date: 14 December 1993
• Citation: 624 N.E.2d 91,416 Mass. 540
• Parties: William I. KOCH v. COMMISSIONER OF REVENUE.
• Court: United States State Supreme Judicial Court of Massachusetts Supreme Court

Page 91

624 N.E.2d 91

416 Mass. 540

William I. KOCH v. COMMISSIONER OF REVENUE.

Supreme Judicial Court of Massachusetts Suffolk.

Argued May 5, 1993.

Decided Dec. 14, 1993.

Eric A. Smith, Asst. Atty. Gen., for the Commissioner of Revenue.

Arthur R. Miller, Cambridge (Edward F. Hines, Jr., Boston, with him), for the taxpayer.

Before LIACOS, C.J., and WILKINS, LYNCH and O'CONNOR, JJ.

O'CONNOR, Justice.

William I. Koch (taxpayer), a Massachusetts resident, reported on his Federal income tax return for 1983 a net long-term capital gain of $275,349,470 from 25 Subchapter S corporations which were incorporated in Delaware and did no business in Massachusetts. Internal Revenue Code § 1366, 26 U.S.C. § 1366 (1993), which in substance was also the provision in effect in 1983, allows gains or losses from a Subchapter S corporation to pass through a corporation and be attributed directly to its shareholders. In contrast, Massachusetts, in 1983, attributed Subchapter S income to the corporation. G.L. c. 62, § 2(a)(2)(B), as appearing in St.1973, c. 723, § 2. ¹ On schedule D of his 1983 Massachusetts income tax return, under the caption, "Differences, if any [between Federal and Massachusetts capital gains]," the taxpayer subtracted $275,332,555 in capital gains from Subchapter S corporations. The defendant Commissioner of Revenue (commissioner) assessed a Massachusetts tax on those gains, plus interest and penalties, to the taxpayer, who paid the total amount and then filed an application for abatement. The abatement was deemed denied due to the commissioner's inaction, G.L. c. 58A, § 6, and G.L. c. 62C, § 39, and the taxpayer appealed to the Appellate Tax Board (board). The board concluded that the commissioner had exceeded his authority in assessing the tax, and therefore ordered abatement. The commissioner appealed to the Appeals Court pursuant to G.L. c. 58A, § 13, and that court reversed the board's decision. 33 Mass.App.Ct. 707, 605 N.E.2d 301 (1992). We granted the taxpayer's application for further appellate review and, disagreeing with the Appeals Court, we now affirm the board's decision. ²

The board's findings are detailed and comprehensive, and our careful review of the administrative record satisfies us that those findings are supported by substantial evidence. Indeed, there is little dispute about the subsidiary facts, as distinguished from the inferences to be drawn from them. An abridged recitation of the board's findings follows. The capital gains in question were incurred as a result of the redemption by Koch Industries, Inc., of stock held by its minority shareholders in settlement of a long and bitter dispute over the operations, management, and control of that corporation. Koch Industries, Inc., was based in Wichita, Kansas, and was founded by the taxpayer's father, Fred C. Koch. Fred C. Koch had four sons, Frederick R., Charles G., David H., and the taxpayer, all of whom held stock in the corporation either directly or in trust. Other relatives also held corporate stock. The taxpayer was the beneficial owner of 2,309,160 shares of which about 40% was held in trusts established by his father. The trustees were the taxpayer and the First National Bank of Wichita. The bank was also cotrustee under similar trusts established for Charles and David. In the mid-1970's the taxpayer placed some of his stock in a family trust of which Charles and the bank were the trustees.

Charles was chairman and chief executive officer of the corporation from the time of his father's death in 1967. The taxpayer began working for the corporation out of his home in Wellesley, Massachusetts, in 1974, and in 1979 he became vice president for corporate development. He was also a director. After the taxpayer began working for the corporation in 1974, disagreements developed between him and Charles over the management of the corporation. By 1979, the disagreements had become serious. Directors' and shareholders' meetings became shorter and less frequent. The board of directors was not informed of management decisions and actions. The taxpayer, who was the only witness before the board besides his Wichita attorney, Robert Martin, testified that his brother was running the corporation as if it were a one-man business.

During 1979 and 1980, the taxpayer tried to persuade Charles to change his operation of the company and the treatment of minority shareholders. After the taxpayer authored a memorandum voicing his concerns, Charles attempted to fire the taxpayer at the next directors' meeting. In defense, the taxpayer formed a coalition of shareholders, which controlled about 52% of the voting stock, with a view to calling a special shareholders' meeting to elect additional members to an expanded board of directors or to elect new members by cumulative voting. When Charles refused to call the special shareholders' meeting, the taxpayer called it. However, before the date set for the meeting, Charles induced the First National Bank to revoke proxies it had given to the taxpayer and Frederick to vote the shares of which the bank was cotrustee. With the help of another, Charles also persuaded a minority shareholder to sell his shares to Charles and David. As a result, the coalition's control was reduced to no more than 48%, and the shareholders' meeting did not take place. At their next meeting, the directors fired the taxpayer as an officer and employee of the company.

In 1981, Koch Industries, Inc., had seven directors, four of whom supported Charles and management and three of whom represented the minority shareholders. Charles, David, and others allied with Charles placed all the shares they held outright into a voting trust to assure their continued control of the corporation. The members of the minority coalition also placed the shares they held outright into a voting trust in order to protect their continued representation on the board and ensure that none of them would weaken and sell out. The trustees for the minority coalition were the taxpayer and Frederick, with one vote each, and two others with one vote between them. The trust document required the consent of two thirds of the trustees to sell all the shares held by the trust, and the consent of all the trustees to sell a lesser number.

In 1982, Kansas law required a corporation to have cumulative voting and precluded exclusion of minority shareholders from representation on the board of directors. Although the taxpayer was therefore a director, he was excluded from meetings of an executive committee which was the effective governing body. He learned only through a newspaper that Koch Industries, Inc., was going to buy an oil refinery for $150,000,000 and was planning to sell all the assets of a division of the corporation for $198,000,000. Thereupon, he advised the corporation that, if it continued to conduct its business through an executive committee, ignoring the board of directors, the minority shareholders would bring suit. That suit was filed in the United States District Court for Kansas on October 12, 1982. The suit asserted both direct shareholder rights against the corporation and derivative rights on behalf of all shareholders, the latter being claims of the corporation against its officers for injuries done to the corporation. Among other things, the complaint charged the individual defendants with involving the corporation in a Federal oil and gas lease lottery scandal, diverting corporate funds to support political activities of Charles and David in the Libertarian party, involving the corporation in litigation and administrative proceedings relative to government claims of unpaid taxes and Department of Energy claims of improper pricing of oil products, and exposing the corporation to civil suits resulting in judgments for fraud. The defendants filed answers to the suit, and Charles and the corporation counterclaimed against the taxpayer alleging libel and slander and asserting damages in the sum of $160,000,000.

The parties engaged in extensive discovery and filed related motions to compel and for protection. According to the board's findings, attorney "Robert Martin, who represented the [taxpayer] at the hearings, testified that [the deposition of the taxpayer, which lasted five days in December, 1982] was the most acrimonious of thousands of deposition hearings which he had attended during his career." By early June, 1983, the court's order to the corporation to produce documents and a related contempt petition were pending, and depositions of two of Charles' supporters at Koch Industries, Inc., repeatedly rescheduled at their counsel's request, were scheduled for mid-June. During the last two weeks of May, the board found, "[T]he defendants surprised the plaintiffs' counsel with an offer of settlement."

In connection with the proposed settlement, a stock purchase and sale agreement was executed just before midnight on Saturday, June 4, 1983, by Koch Industries, Inc., as buyer, and the taxpayer and Rocket Oil Co., a plaintiff in the Federal court action, as principal sellers. Among other things, the agreement provided that, on the closing date, which would be September 6, 1983, "or earlier on 24 hours' written notice by the corporation," the principal sellers would deliver their shares to the corporation and the corporation would pay for them, that the corporation's duty to purchase depended on the sellers fulfilling certain warranties, and that the sellers' obligation depended on the corporation's fulfilment of its warranties. The sellers' warranties included a warranty that the trustees of their voting trust would approve the agreement, and the corporation's warranties included a warranty of the veracity of its balance sheets and the absence of material changes in its financial condition subsequent to December 31, 1982. The agreement also provided that the corporation's obligation to purchase was conditioned on the sellers...