Mains v. U.S.

• Citation: 508 F.2d 1251
• Decision Date: 13 January 1975
• Docket Number: No. 74-1469,74-1469
• Parties: 75-1 USTC P 9167 Donald L. MAINS and Joyce G. Mains, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee. F. E. GOODING, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 1251

508 F.2d 1251

75-1 USTC P 9167

Donald L. MAINS and Joyce G. Mains, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.

F. E. GOODING, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.

No. 74-1469.

United States Court of Appeals, Sixth Circuit.

Jan. 13, 1975.

H. Thompson Nicholas, Jr., Cincinnati, Ohio, Bruce W. Powell, Powell & Powell, Columbus, Ohio, for plaintiffs-appellants.

William W. Milligan, U.S. Atty., Columbus, Ohio, Scott P. Crampton, Meyer Rothwacks, Gilbert Andrews, Gary R. Allen, Louis Bradbury, Chief, Appellate Section, Tax Div., Dept. of Justice, Washington, D.C., for defendant-appellee.

Before WEICK and ENGEL, Circuit Judges, and O'SULLIVAN, Senior circuit judge.

WEICK, Circuit Judge.

The suits in the District Court were for refund of federal income taxes paid for the year 1966 by taxpayers Donald L. and Joyce G. Mains, in the amount of $8,025.01, plus interest, and by taxpayer F. E. Gooding in the amount of $105,578.64, plus interest. Claims for refund had been timely filed and were disallowed.

The cases were consolidated for trial and were heard by the District Court without a jury. The District Court, in a written opinion, held that distribution of the entire proceeds of sale of a portion of the capital assets of Gooding Amusement Company, Inc. and Thrills Unlimited, Inc., amounting to $363,632, made to the shareholders of the corporations, was not entitled to capital gain treatment under 331 of Title 26 of the Internal Revenue Code as being made in partial liquidation of the corporations, but was dividends properly taxable as ordinary income. ¹ 372 F.Supp. 1093 (S.D.Ohio, 1974). Judgment was entered in favor of the Government, and taxpayers appealed. ²

Mr. Gooding owned 64.3% Of the stock of Gooding Amusement, 60% Of the stock of Thrills Unlimited, both Ohio corporations, and was the chief executive officer of said corporations. Mr. Gooding's daughter, Joyce G. Mains, owned 16.6% Of the stock of Gooding Amusement, and 35.7% Of the stock of Thrills Unlimited. Donald Mains is the husband of Joyce G. Mains.

Gooding Amusement was engaged in carnival business, contracting with fairs, trade shows, and expositions to provide rides and other forms of entertainment. Thrills Unlimited was incorporated to own certain large, dangerous rides, and to lease them to Gooding Amusement for a percentage of the gross receipts.

Gooding Amusement was divided into ten operating units, of which the most profitable was unit number three, called the 'Southern Route.' In the year ending July 31, 1966 the Southern Route provided 38% Of the gross income of Gooding Amusement, and 47.91% Of its expenses.

In contrast to the other units, the Southern Route had some equipment which was used exclusively by it; and its playing contracts remained almost the same from year to year. The Southern Route's general manager, Hal Eifort, controlled its day to day operation on the road, and was only lightly supervised by Gooding Amusement's home office in Columbus, Ohio.

Gooding Amusement kept its books and records at its home office and had its bank account there for all operations. It purchased all the equipment used by the Southern Route, paid any privilege deposits required by fair boards, and made most of the expenditures required for ticket printing and advertising. However, Mr. Eifort arranged and paid for newspaper advertising for the various playing dates.

During the 'off season' all of the rides and equipment were stored in one place on Gooding's property.

On April 5, 1966 Gooding Amusement and Thrills Unlimited adopted plans of complete liquidation pursuant to IRC 337. The following day Gooding Amusement contracted to sell the Southern Route's equipment, contracts, and trade name to a Delaware corporation for $350,000. Gooding Amusement also agreed not to compete with the purchaser for one year. Concurrently Thrills Unlimited contracted to sell a ride, called the 'Mad Mouse,' to the Delaware corporation for $25,000. The purchaser was given an option to buy the remaining assets of the two corporations within one year, but it did not exercise the option. The entire proceeds of sale, totaling $363,632, were distributed to the shareholders of the two corporations.

Both corporations filed information returns of said plans pursuant to IRC 337.

Gooding Amusement and Thrills Unlimited were unable to liquidate within one year and therefore could not avail themselves of the advantages of IRC 337. On March 24, 1967 they amended their plans of liquidation to plans of partial liquidation. The corporations filed information return forms 966 describing the plans as plans of partial liquidation under IRC 331(a)(2) and 346(a)(2).

The corporations had substantial accumulated earnings and profits and liquid assets. ³ Although their incomes were substantial, dividends were relatively small.

Because of the ill health of Mr. Gooding the corporations later entered into a management contract with an unrelated corporation, including an option to purchase the stock or assets. While this appeal was pending the option was exercised, according to statements in appellants' reply brief.

Distributions by a corporation to its shareholders receive ordinary income treatment under IRC 301 and 316, assuming adequate earnings and profits, unless the Internal Revenue Code provides otherwise. One of the exceptions is a distribution made in partial liquidation of a corporation. IRC 331(a)(2). 'Partial liquidation' is defined in IRC 346 which is set out in relevant part in footnote 4. ⁴ The District Court concluded that the distributions were not made in partial liquidation of the corporations pursuant to IRC 346(a)(2) and 346(b). The Court held that the pretrial order in the case precluded consideration of IRC 346(a)(1), but stated in a footnote that the distributions could not qualify under that subsection in that there had been no series of distributions in redemption of all of the stock of the two corporations. 372 F.Supp. 1093, 1104, n. 11.

There is no question as to this Court's standard of review. A District Court finding that a distribution was not made in partial liquidation, but was essentially equivalent to a dividend, is a finding of fact which cannot be disturbed unless it is clearly erroneous or was induced by an erroneous view of the law. United States v. Carey, 289 F.2d 531, 537 (8th Cir. 1961); Estate of Chandler v. Commissioner of Internal Revenue, 228 F.2d 909 (6th Cir. 1955).

We will now consider the sections of the Internal Revenue Code which taxpayers claim require capital gains treatment.

I

IRC 346(a)(2)

The only requirement of 346(a)(2) which is in issue is whether the distributions by the corporations were 'not essentially equivalent to a dividend.' According to the legislative history of the section, qualification under this subsection depends primarily on the existence of a bona fide corporate contraction. Such a corporate contraction qualifies to the same extent as under previous law. 3 1954 U.S.Code Cong. & Ad.News, p. 4680, 4899.

From the stockholder's point of view a pro rata distribution in partial liquidation of a corporation is similar to an ordinary dividend. Distributions in partial liquidation are 'characterized by what happens solely at the corporate level . . ..' 3 1954 U.S.Code Cong. & Ad.News, at 4680, although 331 and 346 are concerned with the tax treatment of the shareholder.

Because a distribution qualifying under 346(a)(2) possesses many of the characteristics of a dividend taxed at ordinary income rates, the sale or distribution of assets claimed to constitute a corporate contraction must be a significant event in the history of the corporation if sale or distribution of assets is not to become a convenient pretext for bail-out of earnings and profits at capital gain rates. ⁵ Bittker & Eustice, Fed. Income Taxation of Corporations & Shareholders, P9.52, 3d Ed.

The District Court held that the sale and distribution was not a 346(a)(2) contraction. The Court stated that a corporation must sell and distribute a significant percentage of its net worth, and that the percentages attributable to the sales of the Southern Route and the Mad Mouse, 5.19% And 1.41% Respectively, were not significant. In addition the Court stated that purchases of new equipment after the sale, by the two corporations, resulted in no real contraction at all, and that business activity, measured by the number of playing days, was not appreciably affected.

The taxpayers contend that this Court should not regard Thrills Unlimited as having a corporate existence separate from Gooding Amusement for purposes of determining the applicability of 346(a)(2) to distributions made by Thrills Unlimited. They argue that Thrills Unlimited's only business was to lease equipment to Gooding Amusement, and therefore its fortunes were tied closely to the fortunes of Gooding Amusement. However, the taxpayers offered no evidence that Thrills Unlimited and Gooding Amusement were not treated as two distinct corporations. Thrills Unlimited was not a subsidiary of Gooding Amusement, and Gooding Amusement had a number of shareholders who were not shareholders of Thrills Unlimited. Distributions from Thrills Unlimited must qualify independently, if they qualify at all.

The District Court found that Thrills Unlimited purchased new equipment in the year of the sale and during the following two years for amounts totaling approximately $149,000, about six times the sale price of the Mad Mouse, and that Thrills Unlimited was engaged in a plan of expansion. These findings are supported by the evidence. Doris Relyea testified concerning equipment purchases made by Thrills Unlimited, and admitted writing a letter to the Internal Revenue Service to justify the accumulation of earnings and profits in Thrills Unlimited, stating that Thrills had plans to expand.

It is clear that in the year of the...