McDonald v. Commissioner of Internal Revenue

• Decision Date: 09 December 1954
• Docket Number: No. 12122-12128.,12122-12128.
• Citation: 217 F.2d 475
• Parties: R. H. McDONALD, et al., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Charles E. LOVELL, et al., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Hans P. LAURITZEN, et al., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. ESTATE of E. H. KELLER, etc., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Harris B. McLAREN, et al., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Herman J. SHEEDY, et al., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Charles B. McDONALD, et al., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Sixth Circuit

217 F.2d 475 (1954)

R. H. McDONALD, et al., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Charles E. LOVELL, et al., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Hans P. LAURITZEN, et al., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. ESTATE of E. H. KELLER, etc., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Harris B. McLAREN, et al., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Herman J. SHEEDY, et al., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Charles B. McDONALD, et al., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Nos. 12122-12128.

United States Court of Appeals, Sixth Circuit.

Decided December 9, 1954.

Herbert Bruce Griswold, Edwin G. Halter, Cleveland, Ohio (Kenneth Resseger, Cleveland, Ohio, on the brief), for petitioners.

S. Dee Hanson, Washington, D. C. (H. Brian Holland, Ellis N. Slack, and Howard P. Locke, Washington, D. C., on the brief), for respondent.

Before McALLISTER, MILLER, and STEWART, Circuit Judges.

McALLISTER, Circuit Judge.

The issue before us is whether a distribution of cash from a trustee, under a so-called land trust, to a taxpayer partnership¹ constituted ordinary income or a return of capital. The determination of the issue depends on whether the amounts which were distributed had accrued before purchase by the taxpayer of certificates of the land trust in November and December of 1946, and in January of 1947. If the amounts accrued before the purchase of the certificates, they are to be considered a return of capital. If they accrued after the purchase, they are ordinary income, in accordance with the so-called "flat purchase" rule. This rule is to the effect that if the owner acquires bonds or notes with defaulted interest payments due thereon at a flat rate, the interest which had accrued thereon up to the time of purchase constitutes a return of capital when collected; whereas if the interest accrued thereon after purchase, it constitutes ordinary income when collected. See National City Lines v. United States, 3 Cir., 197 F.2d 754, 756-757. The Tax Court held that the amounts distributed had not accrued prior to the purchase of the certificates and, therefore, constituted ordinary income. As far as this case is concerned, it appears and is apparently admitted that the so-called rental involved, which was payable on the certificates, stands upon the same basis as interest on a bond or note.

The background of the controversy is as follows: A corporation acquired by purchase lands and buildings comprising valuable hotel property in Cleveland, Ohio, at a cost of more than $4,600,000. The corporation raised most of the money for the purchase through a transfer of the hotel property to a trustee, and receiving from the trustee several million dollars, which was procured by the issuance and sale of a large number of trust certificates, entitling the holders thereof to certain payments and an increased price upon redemption. Concurrent with the transfer of the property to the trustee for the certificate holders, the trustee leased the property back to the corporation.

The project thereafter fell on bad times and, in 1936, pursuant to the Bankruptcy Act, reorganization proceedings were undertaken, under Title 11 U.S.C.A. § 501 et seq. On December 31. 1946, the Plan of Reorganization which had been submitted to the interested parties and the district court was consummated by order of the district court.

The Plan provided, first, for the payment by the lessee corporation of rentals to the trustee for the certificate holders in the amount of 5% of the face value of the certificate, as "ordinary rental," plus one-half of the annual net earnings of the lessee company as "additional rental," and also one-half of the annual net earnings of the lessee, to be used in redeeming the certificates. The Plan further provided that out of these moneys received from the lessee, the trustee would pay to the certificate holders the amount of 5% of the face value of the certificates as "ordinary rental," and one-half of the lessee's net profits as "additional rental." Prior to the order of consummation of the Plan of Reorganization, and during the entire period of litigation relative to the proposed Plan, all of the payments of the so-called "ordinary rentals" (5% annually of the face value of the certificates) were paid by the lessee to the trustee, and, presumably, in turn, paid by the trustee to the certificate holders. The so-called "additional rentals" (one-half of the annual net earnings of the lessee) were not paid by the lessee to the trustee during the period of litigation relating to the reorganization, for the reason that the lessee was required to withhold such payments until further order of the district court.

On January 2, 1947, immediately after the Plan of Reorganization had been consummated, the district court, which had control of both the trustee and the lessee company, entered an order determining the lessee company's net earnings for the period from July 1, 1942 through December 31, 1945, and directed that $630,000 of such net earnings be transferred to the trustee as "additional rent;" and such transfer was, accordingly, made prior to January 18, 1947. Later, on March 14, 1947, the district court entered another order determining the operating company's earnings for the calendar year 1946 and ordered that the sum of $93,690.44 of such net earnings be transferred to the trustee as "additional rent" for the calendar year of 1946; and such transfer was made to the trustee prior to April 1, 1947.

Appellant partnership, as above mentioned, had purchased its land trust certificates in November and December of 1946, and in January of 1947. The face value of each certificate was $500, for which appellant paid $575. After the sum of $630,000 was transferred to the trustee pursuant to the first order of the court above mentioned, the trustee, on January 18, 1947, by a letter, advised the certificate holders of its receipt of $630,000 as rent and stated that "The additional rent of $630,000 aforesaid together with such other funds (including quarterly rent to March 15, 1947) as are then in the hands of the Trustee available for distribution will be distributed on April 1, 1947 to certificate holders of record on March 15, 1947."

Subsequent to the second order of the district court entered on March 14, 1947, as above mentioned, the trustee, on April 1, 1947, by a letter, advised the certificate holders of record on March 15 as to the amounts of rent for the first quarter of 1947, the "additional rent" for the period July 1, 1942 through December 31, 1945, and the "additional rent" for 1946, all of which payments were received by the certificate holders on April 2, 1947, enclosed in the trustee's letter of April 1, 1947.

It is submitted by the Commissioner that the trustee for the certificate holders was first obligated and empowered, under the specific terms of the Trust Agreement, as amended by the Plan of Reorganization, to distribute the amounts of additional rent here involved on April 1, 1947; that these amounts had not been transferred from the lessee to the trustee until shortly before April 1, 1947, and, consequently, long after the purchase of the certificates by appellant: that the trustee was neither obligated, authorized, nor empowered to distribute any money representing such "additional rentals" in its possession until April 1, 1947; that payment of the additional rental in question was wholly contingent upon the order of the court subsequent to the adoption of the Plan of Reorganization; and that, accordingly, accrual of the "additional rental" payable to the certificate holders did not become fixed until after appellant's purchase of these certificates.

Appellant taxpayer, however, contends that the rental which was distributed to appellant subsequent to its purchase of the certificates accrued prior to its purchase, since accrual takes place when there is a present fixed right to earned income, even though such income is not payable until a future time. It is pointed out that appellant did not purchase the certificates until after the order of confirmation of the Plan of Reorganization had become final, in that it was, at that time, no longer subject to appeal or review; that appellant's right to payment of the rental was fixed by such final order of confirmation by the court; and that it was possible to ascertain with reasonable accuracy the amount that would be available for payment of interest, and which was afterward actually distributed, since the lessee, or operating company, had, during...