Leh v. Commissioner of Internal Revenue

• Decision Date: 17 October 1958
• Docket Number: No. 15797.,15797.
• Parties: Marc D. LEH and L. Waive Leh, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. David E. BROWN and Christobel H. Brown, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

260 F.2d 489 (1958)

Marc D. LEH and L. Waive Leh, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

David E. BROWN and Christobel H. Brown, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 15797.

United States Court of Appeals Ninth Circuit.

October 17, 1958.

James L. Wood, Los Angeles, Cal., for petitioner.

Charles K. Rice, Asst. Atty. Gen., Melvin L. Lebow, Lee A. Jackson, Harry Baum, Myron C. Baum, Attys., Department of Justice, Washington, D. C., for respondent.

Before STEPHENS, Chief Judge, and FEE and BARNES, Circuit Judges.

BARNES, Circuit Judge.

These are petitions to review two decisions of the Tax Court. Int. Rev. Code of 1954, § 7482, 26 U.S.C.A. § 7482. The sole question presented is whether the Tax Court was correct in refusing to find that the transaction herein involved constituted a "sale or exchange" of property within the meaning of section 117 (a) (4) and (j) of the Internal Revenue Code of 1939, 26 U.S.C.A. § 117(a) (4), (j). If there was such a "sale or exchange" then taxpayers were entitled to treat the consideration received by them for the cancellation of a contract as capital gain¹ rather than ordinary income.²

The facts, as found by the Tax Court are not disputed and many were stipulated. They are set forth in the margin.³

These facts deal with the distribution of gasoline under a "master" supply contract between General Petroleum Corporation (hereinafter referred to as General) and Olympic Refining Company (hereinafter referred to as Olympic).

On the facts found, the Tax Court held that the agreement of July 26, 1950, was not intended to, and did not effect a sale or exchange by The Progress Co., a partnership (hereinafter called Progress), to Olympic of the former's rights under the Progress-Olympic contract, but was intended to terminate and cancel those rights. It held that under that contract, the rights of Progress "came to an end and vanished," and that there existed no sale or exchange essential as a basis for capital gain. Hence, the Tax Court affirmed the Commissioner's opinion that the amount received under this contract of July 26, 1950, was ordinary income, taxable as such.

If this contract be considered merely as an agreement whereby Olympic paid Progress (the partnership) and Olympic-Progress Oil Co., a second and separate corporation (hereinafter called Olympic-Progress), in advance, the estimated value of future income from the existing purchase and supply contracts between them, then tax on ordinary income was clearly payable.

"* * * If one, entitled to receive at a future date interest on a bond or compensation for services, makes a grant of it by anticipatory assignment, he realizes taxable income as if he had collected the interest or received the salary and then paid it over. That is the teaching of Helvering v. Horst, 311 U.S. 112, 61 S.Ct. 144, 85 L.Ed. 75, and Harrison v. Schaffner, supra 312 U.S. 579, 61 S.Ct. 759, 85 L.Ed. 1055; and it is applicable here. As we stated in Helvering v. Horst, supra, 311 U.S. 117, 61 S.Ct. 147, `The taxpayer has equally enjoyed the fruits of his labor or investment and obtained the satisfaction of his desires whether he collects and uses the income to procure those satisfactions, or whether he disposes of his right to collect it as the means of procuring them.\' There the taxpayer detached interest coupons from negotiable bonds and presented them as a gift to his son. The interest when paid was held taxable to the father. Here, even more clearly than there, the taxpayer is converting future income into present income." Commissioner of Internal Revenue v. P. G. Lake, Inc., 1958, 356 U.S. 260, 267, 78 S.Ct. 691, 695, 2 L.Ed. 743.

The Tax Court found, with respect to the essentials listed in § 117(j) of the Internal Revenue Code of 1939, that the subject of the contract of July 26, 1950, was "property," that such property, was "used in the trade or business"; and has been held "more than 6 months." The sole remaining question: Was this a "sale or exchange"? The Tax Court found it was not.⁴

It may well be, as argued by appellant, that there is a conflict in the different circuits as to what constitutes "ordinary income," on the one hand; and what constitutes capital gain from "the sale or exchange" of property within the meaning of § 117(a) (4) and (j), on the other. Respondent concedes it cannot distinguish Jones v. Corbyn, 10 Cir., 1950, 186 F.2d 450, but urges it was erroneously determined, and points out the strong dissent to it written by Judge Phillips, and the subsequent statement by Judge Swan of the Second Circuit in Commissioner of Internal Revenue v. Starr Bros., 1953, 204 F.2d 673, at 674: "With due deference to the majority opinion, we respectfully agree with Judge Phillips' dissent."

All other cases which are apparently in conflict with the result here reached in the Tax Court are sought to be differentiated by respondent on their facts; that they are cases involving the transfer, not of a mere or "naked" contractual right, but of an interest in property; "a more substantial property right which does not lose its existence when it is transferred." Commissioner of Internal Revenue v. McCue Bros. & Drummond, Inc., 2 Cir., 1954, 210 F.2d 752, 753. In other words, it is urged that certain rights continue to exist as property of the transferee-payor in those cases which find an exchange. Typical examples seem to be those cases involving a lease, i. e., the surrender by lessee of leased premises to lessor before the lease expires (Commissioner of Internal Revenue v. McCue Bros. & Drummond, Inc., supra; Commissioner of Internal Revenue v. Golonsky, 3 Cir., 1952, 200 F.2d 72); or a release from a lease's covenant restricting the lessor (Commissioner of Internal Revenue v. Ray, 5 Cir., 1954, 210 F.2d 390); or Commissioner of Internal Revenue v. Goff, 3 Cir., 1954, 212 F.2d 875, where the taxpayer had title to four hosiery manufacturing machines placed in a manufacturing plant, as well as the exclusive right to buy the output of those machines, and transferred both title and exclusive right to the manufacturer.

The government first points out that by its terms, the agreement of July 26, 1950, between Progress Co., a partnership, Olympic-Progress Oil Co., a corporation, and Olympic Refining Co., a corporation, was denominated a "Mutual Termination Agreement" — and it released all rights and claims between the parties, terminated all contract obligations, and wiped out all differences. But this alone is not controlling.⁵

What property could Olympic be said to "acquire" by reason of the July 26, 1950 contract? The right to purchase from General Petroleum a maximum quantity of 3½ million gallons of gasoline a month? Olympic already had this right by reason of its contract of November 19, 1945, with General, as extended. That purchase and supply contract between General and Olympic was not affected in any way by the Mutual Termination Agreement. The purchase and supply contract existed as it always had, until terminated by General and Olympic five days later on July 31st, 1950.

The Mutual Termination Agreement was just that; it terminated not only Olympic's contractual obligation to Progress and to Progress-Olympic; it settled all claims, including those of Progress against Olympic arising out of past deliveries of gasoline. Thus it was more than a sale, it was a clearing up of various disputes, and, we think, falls aptly within the language of the court in Commissioner v. Starr Bros., supra, relied upon by the government:

"Undoubtedly the taxpayer\'s rights under the 1903 contract were property; and we will assume arguendo, as does the Commissioner, that they were a capital asset. The decisive issue is whether there was a `sale or exchange\' of such capital asset when the contract was terminated in 1943. To refer to the contract as a grant of a `franchise\' tends, we think, to becloud analysis of the legal relations. What the taxpayer gave in return for the cash payment was a release of United\'s contract obligations, chief of which was its promise not to sell its products to other dealers in New London. Such release not only ended the promisor\'s previously existing duty but also destroyed the promisee\'s rights. They were not transferred to the promisor; they merely came to an end and vanished." Emphasis added. Id. 204 F.2d at page 674.

The Mutual Termination Agreement did actually terminate the rights of Progress and Olympic-Progress to obtain certain gallonage monthly from Olympic. It cancelled out other disputes and claims as well, but its principal object, result, and "effect" was to terminate rights, not continue them, nor transfer them — nor sell them — nor exchange them. By the terms of the contract of July 26, 1950, no title, right of possession or interest in any gasoline was acquired by the Olympic Refining Co. It had precisely what it had had before, a contractual right to enforce its purchase and supply contract of October 19, 1945, previously entered into with General and it no longer was required to sell to Progress. As the Tax Court said, the Termination Agreement was not an assignment of Progress' right to purchase from General,

"* * * because Progress never acquired the right, by assignment or otherwise, to purchase gasoline from General under the Progress-Olympic contract. That contract gave Progress the right to have its gasoline requirements supplied by Olympic, and the evidence indicates that its purchases were made from Olympic. The General-Olympic contract was a separate and distinct transaction which gave Olympic the right to purchase gasoline from General, and which provided Olympic with a source of supply which enabled it to enter into contracts to sell gasoline to Progress and others. In the circumstances we cannot agree that the substance of the transaction of July 26, 1950, was a transfer from Progress to Olympic of the right of Progress to

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