Riss v. CIR

• Decision Date: 19 April 1973
• Docket Number: No. 72-1342.,72-1342.
• Citation: 478 F.2d 1160
• Parties: Richard R. RISS, Sr., Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.
• Court: U.S. Court of Appeals — Eighth Circuit

478 F.2d 1160 (1973)

Richard R. RISS, Sr., Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

No. 72-1342.

United States Court of Appeals, Eighth Circuit.

Submitted February 12, 1973.

Decided April 19, 1973.

James K. Logan, and Edward M. Boyle, Olathe, Kan., for appellant.

Michael L. Paup, Atty., Tax Div., Dept. of Justice, Washington, D. C., for appellee.

Before GIBSON and ROSS, Circuit Judges, and BENSON,^* District Judge.

GIBSON, Circuit Judge.

This appeal¹ is another episode in the tax difficulties that has engulfed the appellant Richard R. Riss, Sr. and several related corporations that he controlled during the time the tax problems arose. This particular appeal concerns (1) the holding of the Tax Court that the appellant-taxpayer received a dividend of $96,000 in 1958 in consummating a bargain purchase from a controlled corporation, and (2) the disallowance of a bad debt deduction taken in 1963 on appellant's personal income tax and a related issue of a net operating loss carryback from the year 1963 to the year 1960, which turns on the resolution of the bad debt issue.²

CONSTRUCTIVE DIVIDEND ISSUE

We first consider the older of the tax problems originating in the taxpayer's purchase of a 50 per cent stock interest in the Niles and Moser group of corporations and a $215,000 note of that group from Transport Mfg. & Equipment Company (T.M.E.), a corporation controlled by taxpayer. Riss purchased the stock for $150,000 and the note for its face value of $215,000.

The Niles and Moser group was engaged in merchandising cigars. Without repeating the total background of Riss's difficulties in the operation of his controlled trucking company, Riss & Co., and its affiliate T.M.E., utilized for the purpose of purchasing capital equipment for Riss & Co.'s operations, suffice it to say that Riss & Co. enjoyed a high degree of prosperity in the hauling of explosives in the early 1950's, when its operating revenues exceeded $30 million and then entered into a period of precipitous decline so that it sustained operating losses from 1956 through the pertinent period of these tax difficulties. Riss & Co.'s problems were compounded by major law suits from suppliers of equipment, state governments seeking fines or sanctions for violating state operating laws, and jeopardy assessments by the United States government of $4.9 million against Riss & Co. and $2.3 million against T.M.E. During this period of travail Riss & Co. and T.M.E., in order to get the jeopardy assessments lifted, agreed with the then District Director of Internal Revenue that T.M.E. would not make any major transfer or sale of its assets without written notice to the Director.

T.M.E. had held since 1955 a 50 per cent stock interest in six corporations, known as Niles and Moser group and engaged in the merchandising of cigars. The total acquisition cost of the Niles and Moser group asset was about $2,-700,000, which was financed in part by a 50 per cent stock purchase for $150,000 and $215,000 loan from T.M.E. together with a like loan of $215,000 and 50 per cent stock purchase from R. O. Stenzel & Company. The balance of the $2.7 million was obtained from a commercial lending institution. The loans made by T.M.E. and Stenzel were subordinate to the bank loan.

In 1958 T.M.E. needed $400,000 cash to pay a bank loan. T.M.E. decided to sell some of its non-productive assets, and the 50 per cent stock interest in the Niles and Moser group was sold to appellant Riss at the figure these assets had on T.M.E.'s books, namely $150,000 for the stock and $215,000 for the note. Appellant testified he offered this stock to Mr. Stenzel, the other 50 per cent owner, but he was not interested. The record, however, is silent as to what price was placed on the stock or the stock and note in the offer to Stenzel. Stenzel was the active operator of the business, and under the agreement of purchase with the appellant, Stenzel could control the business as he had the right to name three of the five members of the Board of Directors of the company.

The Niles and Moser group experienced, since its acquisition by T.M.E. and Stenzel in 1955, a successful financial operation, increasing its earned surplus from zero in 1955 to over $446,000 in 1958 and $687,000 in February 1959.³ No dividends had been paid on this stock because of the large bank debt. The average annual after tax income of the group was also substantial.⁴

The sale to the taxpayer Riss was, after proper notice to the District Director of Revenue, made on September 9, 1958. The District Director interposed no objection to the proposed sale. The taxpayer apparently borrowed money on other assets to make this purchase, and the $365,000 received by T.M.E. was applied to a $400,000 obligation then due to a bank. The remaining $35,000 was paid by way of a 90-day note.

The Commissioner determined that the taxpayer's purchase of the Niles and Moser stock constituted a bargain purchase and treated the difference between $342,000, the amount which the Commissioner determined to be the fair market value of the shares, and the sale price of $150,000, as a dividend distribution to taxpayer. Palmer v. Commissioner, 302 U.S. 63, 69, 58 S.Ct. 67, 82 L.Ed. 50 (1937); Southern Ford Tractor Corp., 29 T.C. 833, 840-841 (1958). The Commissioner arrived at his valuation by multiplying the average annual earnings for the period by the factor of four, in other words, a capitalization of earnings at the rate of 25 per cent. He also arrived at a net worth liquidation valuation in the same amount of $342,000.

In contesting the Commissioner's fair market value, the taxpayer contends that no outside party would have been interested in buying the stock in a closely held corporate group that was managed by the owner of the other 50 per cent interest and subject to the direction of a board of directors controlled by the other owner. Also, adverse to the shares' market value were the sizeable jeopardy income tax assessments and the dependency of the business upon the operating knowledge and skill of the other 50 per cent holder, R. O. Stenzel. Further, the companies were totally dependent upon suppliers who could cancel for any reason upon 90 days notice, and the suppliers required the taxpayer's personal guarantee with every purchase made by the corporate group. Balancing and possibly outweighing the adverse factors were the excellent operating results and the increase in net worth. Obviously the shares in question had appreciably increased in value.

The notice of deficiency for 1958 was issued to the taxpayer on June 29, 1962. Taxpayer filed his petition in the Tax Court on September 19, 1962, which the Commissioner answered on November 15, 1962. The Commissioner, however, raised the constructive dividend issue for the first time in an amended answer on October 7, 1964. Ordinarily the burden of proof is on the taxpayer to disprove a valuation set by the Commissioner. However, since the Commissioner was late in raising the issue of a constructive dividend, he has the burden of proving that the transaction was in substance a dividend. Riss & Co. v. Commissioner, 56 T.C. 388, 429 (1971); Rule 32, Rules of the United States Tax Court.

The Tax Court did not accept in full the Commissioner's valuation but did find that the Commissioner carried his burden of proof in showing that a constructive dividend had in fact been received in the amount of $96,000. It held that "where corporate property is sold to a stockholder at less than its fair market value, the transaction may be regarded as a bargain purchase with the `bargain' element being taxed to a shareholder as a dividend. Southern Ford Tractor Corporation, 29 T.C. 833 (1958); and Stanley V. Waldheim, 25 T.C. 839 (1956), aff'd. 244 F.2d 1 (C.A. 7, 1957)." 56 T.C. 388, 429. After discussing and weighing the significant factors that would apply in setting a valuation on closed corporation stock⁵ and giving proper regard to the fact that Commissioner had the burden of proof on this issue, the Tax Court found the fair market value of the shares purchased by taxpayer to be $246,000.

The Tax Court in effect weighed the negative and positive factors and found that the positive factors of liquidation value and satisfactory after tax income, together with the capitalized value of past earnings based on a factor of four, clearly indicated a fair market valuation in excess of that paid by the taxpayer, setting the amount of $246,000. No doubt the adverse factors mentioned were depressants on fair market value and were properly considered by the Tax Court. The capitalization factor of four was certainly fair and objective under the circumstances, and this valuation in turn was diminished by an assessment of the adverse factors.

Our review of the Tax Court proceeding is confined to a determination of whether there is substantial evidence upon the record as a whole to support that court's finding or, as sometimes stated, whether or not the determination is against the clear weight of the evidence or is induced by an erroneous view of the law. C.I.R. v. Riss, 374 F.2d 161, 166 (8th Cir. 1967); Arc Realty Company v. C.I.R., 295 F.2d 98, 102 (8th Cir. 1961). As pointed out in Wilmington Co. v. Helvering, 316 U.S. 164, 62 S.Ct. 984, 86 L.Ed. 1352 (1942), our appellate review is confined to an examination of whether there is substantial evidence to support the findings. Therefore, this court may not substitute its view of the facts for that of the Tax Court, and thus its findings when supported by substantial evidence are conclusive. The Tax Court's finding on the valuation of the stock was clearly within the limits of the fair market value evidence disclosed in this case.

The Tax Court, however, did not address itself to the total valuation of the stock and the subordinated note. The taxpayer contends, and we think rightly so, that the accommodation purchase of the stock and the...