Nelson Weaver Realty Company v. CIR

• Decision Date: 12 September 1962
• Docket Number: No. 19226.,19226.
• Citation: 307 F.2d 897
• Parties: NELSON WEAVER REALTY COMPANY, and Nelson Weaver Mortgage Company, Inc., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Fifth Circuit

307 F.2d 897 (1962)

NELSON WEAVER REALTY COMPANY, and Nelson Weaver Mortgage Company, Inc., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 19226.

United States Court of Appeals Fifth Circuit.

September 12, 1962.

Alfred M. Naff, Birmingham, Ala., Deramus & Johnston, Birmingham, Ala., of counsel, for petitioners.

Crane C. Hauser, Chief Counsel, I. R. S., John M. Morawski, Atty., I. R. S., John B. Jones, Jr., Acting Asst. Atty. Gen., Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, David O. Walter, Meyer Rothwacks, Attys., Dept. of Justice, Washington, D. C., for respondent.

Before RIVES, CAMERON and GEWIN, Circuit Judges.

CAMERON, Circuit Judge.

These consolidated cases involve deficiencies in federal income tax for 1955, as determined by the Commissioner, in the amount of $3,666.02 in the case of Nelson Weaver Realty Company, and $54,192.89 in the case of Nelson Weaver Mortgage Company. The decisions of the Tax Court we are called upon to review under § 7482 of the Internal Revenue Code of 1954, 26 U.S.C.A. § 7482 were entered March 17, 1961 and are reported at 35 T.C. 937, where the terms of the contracts and the detailed facts may be found.

The questions presented are whether the Tax Court erred in deciding the amount of $121,841.11 received by petitioner Nelson Weaver Mortgage Company, pursuant to an agreement with Cobbs, Allen and Hall Mortgage Company, was taxable as ordinary income rather than as capital gain; and whether the Tax Court erred in deciding that the amount of $8,000.00 paid to Nelson Weaver Realty Company by Cobbs, Allen and Hall, a partnership, was taxable as ordinary income from a covenant not to compete rather than as a gain from the sale of a capital asset. The Commissioner ruled that each transaction was taxable as ordinary income. He determined a deficiency against Mortgage Company for the fiscal year ending September 30, 1955 in the amount of $54,192.89 and a deficiency for the calendar year ending December 31, 1955 to the Realty Company in the amount of $3,666.02. The Tax Court sustained the actions of the Commissioner. These petitions for review by the Mortgage Company and the Realty Company were consolidated for hearing in this Court. The case of the Mortgage Company will be taken up first.

Mortgage Company is a corporation under the laws of Alabama and has, since 1946, been engaged in the business of procuring, selling, brokering and servicing mortgage loans, and in renting and holding real estate for investment purposes and other related activities. Nelson Weaver is its president and owner of controlling stock in the corporation. It keeps its books and records and reports its income on the accrual method of accounting.

Mortgage Company¹ and New York Life Insurance Company entered into a mortgage sales and service agreement (sometimes called a correspondence contract or agency contract) during the year 1947. On May 5, 1953, a new contract was entered into whereby Mortgage Company became the mortgage sales and servicing agent for New York Life in the cities of Birmingham, Gadsden, Anniston, Decatur, Huntsville, Tuscaloosa, Montgomery, Demopolis, Florence, Sheffield and Tuscumbia, all in Alabama.

January 29, 1955, Mortgage Company entered into a purchase and sale agreement with Cobbs, Allen and Hall Mortgage Company, Inc. by which it sold "all of the rights, title, obligations, and benefits pertaining to the servicing contract of all of the mortgages now being serviced by the Birmingham office of Nelson Weaver Mortgage Company, Inc. for the New York Life Insurance Company, subject to the approval of New York Life Insurance Company." Mortgage Company received, as of January 29, 1955, $35,241.11 of the total purchase price of $121,841.11. It received notes, one due November 1, 1955 in the sum of $43,300.00, and the second for the same amount due November 1, 1956. Each of the payments was due in a separate fiscal year of Mortgage Company, and its tax returns were made accordingly. § 432, Internal Revenue Code of 1954 and Rev. Rul. 55-374. New York Life Insurance Company having given its approval to said sale, Mortgage Company delivered to Cobbs-Allen its complete files, ledger cards and all papers pertaining to the mortgages described in the agreement and a current tabulation of the balances then due. It reported a taxable income for the calendar year 1955 of $39,067.23 and paid the tax shown to be due thereon, claiming that the transaction with Cobbs-Allen was a sale of capital assets.²

The Commissioner held with the approval of the Tax Court and the Government now argues, that the income derived from the deal between Mortgage Company and Cobbs-Allen was not subject to capital gains treatment. The gist of its argument is that what Mortgage Company really received "was consideration for the transfer of the contingent right to earn future compensation," so that the total payment called for in the sales contract to Cobbs-Allen has the taxable character of the income for which it is a substitute." We think that the transaction before us represents clearly a sale of a capital asset and that the Commissioner and the Tax Court erroneously held otherwise.

The Commissioner's argument centers around his contention that the taxpayer erroneously assumes that the term "property" has a broad meaning, and that a broad construction should be applied in interpreting the tax laws with respect to what constitutes "property," when the opposite is true. We have no quarrel with the Commissioner's position in that regard; but we think that the realities of the situation with which we are dealing, based upon the writings and facts and circumstances about which there is no real dispute, compel the conclusion that the subject of this sale was a capital asset of Mortgage Company. There is no contention by the Commissioner that the transaction is infected with any deception or the use of any devious scheme to convert into capital gains what would normally be ordinary income.

It is undisputed that the taxpayer here was in the business of a mortgage loan company whose activities embraced the preparation and making of mortgage loans, the sale of such loans to permanent investors, and the servicing of the loans after sale. Cf. Abbott Mortgage Co., 17 C.C.H., T.C.Mem. 542 (1958). The relationship between Mortgage Company and the New York Life was the one normally attending such an arrangement. The Insurance Company had a great volume of money which it desired to lend; Mortgage Company had the facilities for seeking out and making loans, but it did not have the vast amount of capital necessary to carry the loans to their maturities. Mortgage Company, therefore, made arrangements with New York Life and other lending agencies to purchase loans made by it, inter alia, in the cities named supra. It was paid brokerage fees on all loans initiated and completed by it and sold to New York Life, this forming an important item of its income.

New York Life was without ready facilities for servicing the loans, i. e., collecting the payments over a term of years, seeing that insurance and tax payments were promptly made, etc.; but Mortgage Company did have an organization equipped to perform such services. The contacts between Mortgage Company and the mortgagors gave it access to a large field of customers for other dealings, such as writing of hazard insurance, automobile liability insurance, purchase and sale of real estate, renewal of mortgages, and the like. The testimony on this subject is explicit and is not contradicted. The relationship between Mortgage Company and New York Life in the areas covered by their contract was, therefore, one of value to both.

Cobbs-Allen was in a similar business and had a similar (but not competitive with Mortgage Company) arrangement with New York Life. It was natural that it should be interested in purchasing from Mortgage Company the congeries of rights inhering in the relationship founded upon contract and upon years of satisfactory dealings which had exsited between Mortgage Company and New York Life. It made an offer to Mortgage Company and Mortgage Company accepted that offer at an agreed price to be paid in three installments. The bundle of rights belonging to Mortgage Company as the result of its long standing relationship with New York Life, constituted property which was undoubtedly the proper subject of sale.³

The Commissioner's contention that Mortgage Company had nothing to sell, because its contract with New York Life was subject to short term cancellation and that it was salable only upon New York Life's approval is, in our opinion, without merit. The Commissioner argues that no one would purchase a contractual relationship subject to such right of termination. He argues further that what Mortgage Company owned was salable only with the consent of New York Life. The short answer to these contentions is that they deal only with possibilities and not with actualities. The fact is that New York Life had maintained the relationship with Mortgage Company for eight years, during which time Mortgage Company sold to New York Life about fifty-five percent of its total number of loans running into millions of dollars. (The figure at the time of the sale was approximately $15,000,000.00.) Mortgage Company had built up a large organization dependent in great part upon the permanence of the arrangement existing between it and New York Life. Maybe it took a risk, but risk lies at the basis of all dealings in property and business and constitutes one of the realities of business life and of taxation. Adopting the essence of a statement by Mr. Justice Holmes in Compania General, etc. v. Collector, 1927, 275 U.S. 87, 100, 48 S.Ct. 100, 72 L.Ed. 177, we said, in Texas Trailercoach, Inc. v. Commissioner, 1958, 5 Cir., 251 F.2d 395, 403: "The closer a tax comes to giving effect to the economic realities, the more bearable it is as the price of...