Lowndes v. United States

• Decision Date: 16 September 1966
• Docket Number: Civ. A. No. 15991.
• Citation: 258 F. Supp. 193
• Parties: W. Bladen LOWNDES and Anne W. Lowndes, Plaintiffs, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — District of Maryland

258 F. Supp. 193

W. Bladen LOWNDES and Anne W. Lowndes, Plaintiffs, v. UNITED STATES of America, Defendant.

Civ. A. No. 15991.

United States District Court D. Maryland.

September 16, 1966.

P. McEvoy Cromwell, Baltimore, Md., (John D. Wright, and Wright, Robertson & Dowell, Baltimore, Md., on brief), for plaintiffs.

Moshe Schuldinger, Atty., Dept. of Justice, Washington, D. C. (C. Moxley Featherston, Acting Asst. Atty. Gen., David A. Wilson, Jr., Atty. Dept. of Justice, Washington, D. C., Thomas J. Kenney, U. S. Atty., and Robert W. Kernan, First Asst. U. S. Atty., Baltimore, Md., on brief), for defendant.

WINTER, Circuit Judge (by designation):

This suit for refund of income taxes raises the questions of whether plaintiff Anne W. Lowndes received income taxable as long term capital gains or as ordinary income on the dates that four corporations, all of the issued and outstanding stock of which she had acquired, were liquidated and assets distributed, or whether she received income taxable as ordinary income on the dates that she acquired the stock of those corporations. Suit was filed by her and her husband because they filed joint income tax returns for the years in question. The transactions by which she acquired the stock were conducted in her name, but were negotiated by her husband; her only participation was to execute various documents to carry out the transactions which he arranged.

Concerned are the tax years 1957, 1959 and 1960. In 1957 Mrs. Lowndes acquired all of the outstanding stock of two corporations which were liquidated later in that year, but six months after the date of acquisition of stock. In 1959 Mrs. Lowndes acquired all of the outstanding stock of two more corporations, which were liquidated in 1960, again six months after the date of acquisition of stock. She and Mr. Lowndes treated the gains which she realized as long term capital gains, realized on the respective dates of liquidation. The Commissioner, however, treated the gains as ordinary income, realized on the dates of stock acquisition, or alternatively on the dates of liquidation, and assessed additional income taxes with interest thereon.¹ It is stipulated that all of the additional assessments have been paid in full, demand for repayment refused, and the jurisdiction of this Court under 28 U.S.C.A. § 1346(a) (1) properly invoked. The parties have further stipulated that if plaintiffs are entitled to judgment, they will agree upon the amount of judgment to be entered.²

The stock of all four corporations was acquired from subsidiaries of three subsidiaries of Bethlehem Steel Company, viz., Bethlehem Steel Company, Bethlehem-Cuba Iron Mines Company and Bethlehem Limestone Company (hereinafter individually as well as collectively called "Bethlehem"). The stock acquired in 1957 was that of American Well and Prospecting Company (hereinafter called "American Well") and Bethlehem Quarry Company (hereinafter called "Bethlehem Quarry"). The 1959 acquisitions were the stock of Indian Coal Company (hereinafter called "Indian Coal") and Maryland Century Coal Company (hereinafter called "Maryland Century"). The acquisitions came about when Bethlehem, which had theretofore acquired these companies but had ceased to operate them for a number of years,³ decided to dispose of them because they were no longer useful to Bethlehem and Bethlehem desired to simplify its corporate structure. Bethlehem caused all of their assets to be reduced to cash and paid all of their liabilities, including liabilities for taxes. Bethlehem had a loss in each of the companies but, by a quirk in the federal income tax laws, Bethlehem could gain no tax advantage from its loss if it undertook to dissolve the corporations and distribute the cash, which was in the form of bank accounts, to itself. Rather, Bethlehem was obliged, if it was to realize a loss for tax purposes, to sell the stock in an arm's length transaction to a third party. The only condition Bethlehem imposed on such sales was that they be for a price agreeable to it, payable in cash.

The sale of the stock of American Well is typical of each of the four transactions. By bill of sale dated April 17, 1957 Bethlehem sold all of the stock of American Well (1,000 shares) to Mrs. Lowndes at and for the price of $93,000.00. At the time of the sale American Well's sole net asset was a bank account in the amount of $100,000.00; it had no liabilities; and Bethlehem warranted that it had no tax or contingent liabilities. Immediately prior to the sale, American Well closed out its checking account theretofore existing and opened a new checking account at the Union Trust Company of Maryland (hereinafter called "Union Trust"). This was done in conformity with one of the conditions fixed by Union Trust for making a loan to Mrs. Lowndes. On April 17, 1957, Mrs. Lowndes borrowed $93,000.00 from Union Trust on her demand note bearing interest at 4½% and pledged as security for the loan the 1,000 shares of American Well. Simultaneously, the theretofore officers and directors of American Well resigned, Mr. and Mrs. Lowndes and another person were elected as directors, and Mr. and Mrs. Lowndes were elected officers of American Well, as well as two individuals who were also officers of Union Trust. American Well adopted bank resolutions which limited withdrawals from its checking account at Union Trust to checks signed by Mr. or Mrs. Lowndes and one of the two individuals who was an officer of Union Trust. On the same date American Well instructed Union Trust to convert the checking accounts to time deposit accounts for a six month period bearing interest at 2½%, representing that it would make no withdrawals for a period of six months.⁴

On October 22, 1957 Mrs. Lowndes, as the sole stockholder of American Well, instructed its board of directors to liquidate and dissolve the company and distribute its assets to her. A partial liquidating dividend of $99,000.00 was paid October 24, 1957. A final liquidating dividend was paid after November 1, 1957. Payment of the Union Trust loan was accomplished by use of the time deposit of American Well. For the year 1957 American Well reported and paid income tax on the interest earned on the time deposit and, for the same year, taxpayers claimed a tax deduction for the interest paid by Mrs. Lowndes to Union Trust on the loan.

The transactions in regard to the three other companies were identical. The stock of Bethlehem Quarry, consisting of 1,709 shares, was also acquired April 17, 1957. The purchase price was $169,789.15. Bethlehem Quarry had no liabilities, except a reserve for federal income tax in the amount of $2,534.00, and its sole asset was cash in bank in the amount of $179,346.00. Mrs. Lowndes borrowed $169,789.15 from Union Trust on a 4½% demand note, secured by a pledge of 1,709 shares of Bethlehem Quarry. New directors and officers were elected for Bethlehem Quarry. Shortly before settlement, Bethlehem Quarry had theretofore established a new demand account at Union Trust; it adopted new bank resolutions limiting the persons who could sign on the checking account to Mr. or Mrs. Lowndes and one of the bank officers; and on the date of settlement with Mrs. Lowndes converted the checking account to a time account bearing interest at 2½%, again representing that there would be no withdrawals for six months. On October 22, Mrs. Lowndes directed Bethlehem Quarry's board of directors to liquidate and dissolve that company and to distribute its assets to her. A partial liquidating dividend, in the amount of $179,000.00, was paid October 24, 1957 and, on November 1, 1957, a final liquidating dividend was authorized. Payment of Mrs. Lowndes' loan from Union Trust was made from funds from Bethlehem Quarry's time deposit. No additional distribution was made to Mrs. Lowndes, because there were insufficient funds to pay the expenses incident to liquidation and dissolution of Bethlehem Quarry, so that Mrs. Lowndes refunded $947.35 to Bethlehem Quarry, thus reducing the total net liquidating proceeds received by her to $178,052.65. For 1957 Bethlehem Quarry reported as taxable income the interest earned on its time deposit and paid the tax thereon. Taxpayers claimed as a tax deduction the interest Mrs. Lowndes paid on the loan from Union Trust.

From the standpoint of Bethlehem and the taxpayers these transactions were so satisfactory that, in 1959, when Bethlehem undertook to sell 1,000 shares of Indian Coal, which had no liabilities and a single asset of $100,000.00 cash in bank, and 3,000 shares of Maryland Century, which had no liabilities and a single asset of cash in bank of $300,000.00, Mrs. Lowndes undertook to buy them for $95,500.00 and $286,500.00, respectively. Again, prior to settlement, these companies closed their existing bank accounts, opened demand accounts at Union Trust and deposited all their funds therein; Mrs. Lowndes borrowed the purchase prices in full from Union Trust on demand notes bearing interest at 5%; new officers and directors were elected; new bank resolutions adopted restricting signatories on the account to Mr. or Mrs. Lowndes and a bank officer; and Indian Coal and Maryland Century gave Union Trust written instructions to convert the demand accounts to time accounts bearing interest at 3%, representing that no withdrawals would be made for six months. On May 26, 1960 Mrs. Lowndes, as the sole stockholder of Indian Coal and Maryland Century, instructed the directors thereof to liquidate the companies and distribute their assets to her. Liquidating dividends were paid her on May 26, 1960 and June 6, 1960. Mrs. Lowndes' loans from Union Trust were repaid from corporate funds. Mr. and Mrs. Lowndes claimed as tax deductions the interest paid by Mrs. Lowndes to Union Trust on the latter two loans, and both corporations paid income tax on their interest income.

Other than the testimony which established that the transactions between...