Martin Ice Cream Co. v. Comm'r of Internal Revenue, 1477–93.

• Citation: 110 T.C. No. 18,110 T.C. 189
• Decision Date: 17 March 1998
• Docket Number: No. 1477–93.,1477–93.
• Parties: MARTIN ICE CREAM COMPANY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: United States Tax Court

110 T.C. 189
110 T.C. No. 18

MARTIN ICE CREAM COMPANY, Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 1477–93.

United States Tax Court.

March 17, 1998.

[110 T.C. 190]

Frank Agostino, Alan G. Merkin, Mary Ann Perrone, and Susan M. Flynn, for petitioner.

[110 T.C. 191]

Patricia Y. Taylor and Clare W. Darcy, for respondent.

BEGHE, Judge:

[110 T.C. 189]

A and his son M were shareholders of MIC, an S corporation that distributed ice cream products to supermarket chains, independent grocery stores, and food service accounts. MIC's supermarket business was largely attributable to the close personal relationships that A had developed and maintained for decades, beginning before the creation of MIC in 1971, with the owners and managers of the supermarket chains. Since 1974, MIC had distributed the ice cream products of HD, pursuant to an oral agreement entered into between A and the founder of HD. In 1987 and 1988, following the acquisition of HD by a public company, HD initiated negotiations with MIC to acquire MIC's rights to distribute HD ice cream products to MIC's customers. After some but not all terms of the acquisition had been negotiated in the 1988 negotiations, A and M caused SIC, a wholly owned subsidiary of MIC, to be created, and HD was notified that SIC would be the seller of the assets that HD wished to acquire. MIC then transferred to SIC all of MIC's rights to distribute HD ice cream products to the supermarket chains and food service accounts, and business records relating thereto, in exchange for all the stock of SIC, and immediately distributed the SIC stock to A in exchange for all of A's stock in MIC. Following further negotiations, A and SIC, 3 weeks thereafter, entered into a contract to sell HD all their intangible assets relating to distribution of HD ice cream products. Two weeks thereafter, following the determination of a purchase price adjustment provided for in the final version of the contract, the sale closed and SIC received the proceeds of sale, which it distributed to A.

1. Held: The benefits of the personal relationships developed by A with the supermarket chains and A's oral agreement with the founder of HD were not assets of MIC that were transferred by MIC to SIC and thereafter sold by SIC to HD; A was the owner and seller of those assets.

2. Held, further, respondent's attempt to apply Commissioner v. Court Holding Co., 324 U.S. 331, 65 S.Ct. 707, 89 L.Ed. 981 (1945), to regard MIC as the seller of assets to HD is rejected because the final sale to HD was on terms that were negotiated with HD by A and SIC that were significantly different from the terms of the earlier proposed transaction under negotiation between MIC and HD.

3. Held, further, MIC's distribution of SIC stock to A was not entitled to nonrecognition of gain under sec. 355, I.R.C., because SIC was not engaged in the active conduct of a trade or business after the distribution of SIC stock to A.

4. Held, further, although MIC's transfer of intangible assets to SIC in exchange for SIC stock was entitled to nonrecognition of gain under sec. 351, I.R.C., the immediate distribution of SIC stock in redemption of A's stock in MIC was a distribution of appreciated property under secs. 311(b) and 317(b), I.R.C., on which recognized gain in the amount of $141,000 is taxable to MIC under sec. 1374, I.R.C.

5. Held, further, MIC is not liable for a negligence addition to tax under sec. 6653(a), I.R.C., but is liable for a substantial understatement addition under sec. 6661, I.R.C.

Respondent determined the following deficiency and additions to tax:

+----------------------+
                ¦¦¦¦¦¦Additions to Tax ¦
                +----------------------+
                

 Year Deficiency Sec. 6653(a)(1) Sec. 6661
                 1988 $477,816 $23,891 $119,454
                

In so doing, respondent determined that Martin Ice Cream Co. (MIC or petitioner) recognized taxable gain of $1,430,340 on the distribution of stock of its newly created subsidiary, Strassberg Ice Cream Distributors, Inc. (SIC), to one of petitioner's two shareholders, Arnold Strassberg (Arnold), in redemption of his 51–percent stock interest in petitioner. Shortly before trial, we granted respondent's motion for leave to amend answer to allege that a subsequent sale of assets to the Häagen–Dazs Co., Inc. (HRagen–Dazs), by Arnold and SIC should be attributed to petitioner under Commissioner v. Court Holding Co., 324 U.S. 331, 65 S.Ct. 707, 89 L.Ed. 981 (1945).

We reject respondent's attempt to apply Court Holding, although we uphold respondent's original determination that petitioner recognized gain on the redemption of Arnold's stock in petitioner. We find that petitioner's gain is substantially less than the gain determined by respondent. We reject respondent's imposition of an addition to tax under section 6653(a)(1) but uphold the addition to tax for substantial understatement under section 6661.¹

FINDINGS OF FACT

Some of the facts are stipulated and are so found. MIC is a New Jersey corporation whose principal place of business was Bloomfield, New Jersey, when it filed its petition.

MIC was incorporated in 1971 as a wholesale ice cream distributor, with Martin Strassberg (Martin) as its sole shareholder. MIC was a C corporation from 1971 through 1986. On December 30, 1986, MIC filed with the Internal Revenue Service a Form 2553, Election by a Small Business Corporation, which took effect on November 1, 1987. As a

[110 T.C. 192]

result of the election, the accounting period of MIC was changed, commencing January 1, 1988, from an October 31 fiscal year to the calendar year.

Soon after World War II, Arnold, Martin's father, a high school mathematics teacher, began a part-time business after school hours, selling ice cream products wholesale to stores in Newark, New Jersey. During summer vacations, Arnold expanded his coverage to small stores and ice cream parlors on the Jersey Shore. By 1960, Arnold had incorporated his own company, Arnold's Ice Cream, and was engaging full time in the wholesale distribution of ice cream. In the 1960's, Arnold began to develop relationships with the owners and managers of several supermarket chains when he conceived an innovative packaging and sales campaign that used bright colors and catchy slogans to market ice cream products to supermarkets for resale to consumers. Ice cream had hitherto been sold by supermarkets to consumers as an undifferentiated product in large containers and multiserving packages with plain brown wrappers. Arnold subsequently developed other packaging ideas for ice cream products that helped supermarkets sell ice cream products under their private labels. Even with different kinds of packaging, supermarkets marketed ice cream to consumers mainly on the basis of price. In the late 1960's, Arnold had a falling-out with his major supplier, Eastern Ice Cream, which forced Arnold's Ice Cream into bankruptcy.

In 1971, Martin and Arnold organized MIC as a part-time business, with one delivery truck, distributing ice cream to small grocery stores and food service accounts (restaurants, hotels, and clubs) in northern New Jersey. Martin joined the business after having completed virtually all requirements for a Ph.D. in statistics and after spending several years doing operations research and statistical analysis as an employee of large corporations. In 1975, Martin began working in the ice cream distribution business full time. During most of the 1970's, Arnold owned no stock in MIC because he wished to avoid the claims of creditors of Arnold's Ice Cream. In 1979, Arnold became a 51–percent shareholder in MIC, and Martin's interest was reduced to 49 percent. At no time did Arnold or Martin have an employment agreement with MIC.

In 1974, Ruben Mattus (Mr. Mattus), the founder of HäagenDazs, asked Arnold to use his ice cream marketing

[110 T.C. 193]

expertise and relationships with supermarket owners and managers to introduce Häagen–Dazs ice cream products into supermarkets. Häagen–Dazs manufactured an entirely new range of “super-premium” ice cream products that were differentiated from the competition by both higher quality and higher price. Häagen–Dazs had initially marketed its products to small stores and restaurants for singleserving on-premises consumption. Häagen–Dazs had made only minimal inroads into the supermarkets, and now Mr. Mattus wanted to intensify his marketing efforts in that sector. Mr. Mattus asked for Arnold's help because he had been unable to convince the supermarkets to carry his products; they saw super-premium ice cream as too expensive for a retail setting designed for offpremises consumption.

Arnold, as the first distributor of Häagen–Dazs ice cream to supermarkets, sparked a revolution in the retail sale of ice cream. Arnold and Häagen–Dazs tapped a hitherto hidden demand for a super-premium ice cream in supermarkets by consumers who were willing to pay higher prices for higher quality. By the late 1970's, MIC was distributing ice cream products, including Häagen–Dazs ice cream, to four major supermarket chains, Pathmark, Shop Rite, Foodtown, and Acme in New York, New Jersey, Connecticut, and Pennsylvania (the supermarkets) and to smaller grocery stores. However, neither Arnold nor MIC ever entered into a written distribution agreement with Häagen–Dazs or Mr. Mattus.

Arnold was so successful that in the late 1970's or early 1980's Mr. Mattus invited Arnold to become his partner in a planned expansion of Häagen–Dazs' supermarket sales to the West Coast. Arnold declined the offer and continued to use MIC as his corporate vehicle to distribute Häagen–Dazs products in New Jersey and adjacent areas.

Martin did not support or participate in Arnold's efforts to expand ice cream distribution to the supermarkets. Martin disliked the social activities necessary to developing and sustaining personal relationships with supermarket owners and managers—activities that Arnold thrived on. Martin preferred to manage day-to-day operations at the MIC warehouse...