Schlumberger Technology Corp. v. United States

• Decision Date: 15 September 1971
• Docket Number: No. 29400.,29400.
• Citation: 443 F.2d 1115
• Parties: SCHLUMBERGER TECHNOLOGY CORPORATION, Plaintiff-Appellee-Cross Appellant, v. UNITED STATES of America, Defendant-Appellant-Cross Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

443 F.2d 1115 (1971)

SCHLUMBERGER TECHNOLOGY CORPORATION, Plaintiff-Appellee-Cross Appellant, v. UNITED STATES of America, Defendant-Appellant-Cross Appellee.

No. 29400.

United States Court of Appeals, Fifth Circuit.

June 11, 1971.

Rehearing Denied September 15, 1971.

Johnnie M. Walters, Asst. Atty. Gen., Lee A. Jackson, Paul M. Ginsburg, Attys., Tax Div., U. S. Dept. of Justice, Washington, D. C., Ben A. Douglas, Atty., Tax Div., Dept. of Justice, Fort Worth, Tex., Anthony J. P. Farris, U. S. Atty., James R. Gough, Asst. U. S. Atty., Houston, Tex., Meyer Rothwacks, Thomas L. Stapleton, Gilbert E. Andrews, Janet R. Spragens, Attys., Dept. of Justice, Washington, D. C., George R. Pain, Asst. U. S. Atty., Houston, Tex., for the United States.

George H. Jewell, Jr., William C. Griffith, Houston, Tex., for taxpayer; Baker, Botts, Shepherd & Coates, Houston, Tex., of counsel.

Before WISDOM, THORNBERRY and DYER, Circuit Judges.

THORNBERRY, Circuit Judge:

The instant matter represents another skirmish in the constant taxpayer-Government struggle over the definition of the term "capital asset," a struggle generated by the advantages to taxpayers of capital gains and the corollary disadvantages of capital losses. The participants in the case at bar call upon us to determine whether taxpayer's loss on unrepaid short term advances, evidenced by promissory notes, to subsidiary corporations were, in light of Corn Products Company v. Commissioner of Internal Revenue, 350 U.S. 46, 76 S.Ct. 20, 100 L.Ed. 29 (1955), deductible as a bad debt loss under Section 166(a)¹ of the Internal Revenue Code of 1954 or deductible only as a capital loss under Section 1232 (a) (1),² and whether taxpayer's loss realized upon the disposition of its stock in a subsidiary corporation is to be treated as an ordinary business expense or as a loss from the sale of a capital asset.

Taxpayer, Schlumberger Well Surveying Corporation (SWSC),³ is involved in the business of measuring physical phenomena, principally in the earth but also in the atmosphere, primarily for aid in the discovery of oil, gas, and other minerals, but also for scientific, space exploration, and other purposes. At all times material to this case Electro-Mechanical Research, Incorporated (EMR), a wholly owned subsidiary of SWSC, was also engaged in the measurement business, using taxpayer's and its own expertise and research to develop telemetry devices and related measurement components for use by military and space agencies in above ground measurement problems. EMR was formed during World War II by SWSC personnel to use SWSC's induction logging principles and techniques in the development of a mine detector for use by the allied forces. Because SWSC was owned principally by French nationals, it was necessary for EMR, in order to obtain a United States security clearance, to be formed as a corporation separate from SWSC with voting control in United States citizens. After the War the EMR stock was transferred to the Schlumberger Foundation, a charitable organization owned by taxpayer's parent, Schlumberger, Limited. To qualify EMR for security clearance in connection with military and defense work, the EMR stock was transferred in 1957 to a voting trust with voting control in United States citizens. Subsequently, SWSC reacquired the stock.

Because of the very specialized nature of its operations and the high degree of reliability that must be built into the equipment to enable it to operate under the extreme conditions of temperature, humidity, transportation and rough handling to which it is subjected, taxpayer has found it necessary to design and manufacture its own equipment. For this reason SWSC maintains research and development facilities in Houston, Texas and Ridgefield, Connecticut. Research conducted at these facilities has produced equipment used in the well logging and telemetry business as well as measurement equipment susceptible of use in other fields.

During the 1950's data obtained from taxpayer's sensing and transmitting equipment was being analyzed by engineers at the well site. However, the tremendous increase in the amount of data being obtained and the increasingly complex computations necessary to analyze it was making manual analysis less and less satisfactory. It soon became apparent to taxpayer that it must integrate computer analysis into its measurement system or lose its position in the measurement field. Consequently, taxpayer plunged into efforts to develop two types of logging devices embodying computer techniques: the dip meter log and the analog to digital computer. When the endeavors proved unproductive, taxpayer, convinced that SWSC's and EMR's scientific personnel lacked sufficient depth in computer technology to fulfill its needs, looked elsewhere for assistance. It found Computer Systems, Incorporated (CSI), a corporation primarily engaged in the development, manufacture, and sale of analog computers and in analog and digital computer research. Although CSI, which had just undergone bankruptcy organization, had not developed a commercially acceptable computer, it possessed highly experienced scientific and technical teams that were abreast or ahead of the field in computer technology. Taxpayer, believing that CSI was the answer to its need for computer expertise, subscribed in 1959 to 80%⁴ of the common stock of that company for $1,521,000. Because CSI was involved in matters requiring a security clearance, taxpayer contributed the CSI stock to EMR, enabling voting control of CSI to reside in United States citizens through the voting trust. Immediately after it was acquired by SWSC, CSI required funds for operating expenses. To meet the need taxpayer in 1960 contributed $1,000,000 to EMR to permit it in turn to make a contribution in that amount to CSI's capital stock. In addition, taxpayer made a series of short term loans totalling $3,200,000 to CSI.⁵ To evidence the existence, the interest rate, and the due date of the loans, CSI gave simple notes to SWSC at the time or shortly after each loan was made. CSI defaulted on each note, although it did pay all interest through January of 1962.

For two reasons, CSI proved to be of marginal value to taxpayer: (1) CSI was unable to develop an acceptable analog computer, and (2) scientific developments subsequent to SWSC's acquisition of CSI indicated that the need for computer analysis in the measurement systems of SWSC and EMR could better be fulfilled by digital, as opposed to analog, computers. Consequently, in late 1961, taxpayer, believing it had obtained sufficient digital expertise for its purposes, decided to sell CSI. At that time CSI was insolvent, its stock was worthless, and its debt to SWSC was for all practical purposes worthless. In February 1962 taxpayer accepted one Robert Haskins' offer to acquire the CSI stock for $10 and to contribute $150,000 to CSI to keep it in operation for at least six months. As part of the arrangement taxpayer agreed to compromise the $3,200,000 debt owed it by CSI for $150,000. On its 1962 federal income tax return taxpayer claimed the unrepaid balance on its advances to CSI $3,200,000 less $150,000=$3,050,000 as a bad debt deduction under Section 166(a) of the Code. The Commissioner disallowed the deduction, treating the unrepaid balance as a capital loss under Section 1232(a) (1).

In March 1960 taxpayer acquired American Systems, Incorporated (ASI), a company organized by former Hughes Aircraft Company employees in 1959 for the purpose of designing, developing, manufacturing, and programming electronic systems, equipment and components for military use. In their previous positions with Hughes Aircraft, the men had met with considerable success in obtaining systems contracts. Taxpayer, believing the personnel in question could aid it in obtaining markets for the electronic business in which it and its subsidiaries engaged, desired to avail itself of the men's talents. However, the men refused to enter taxpayer's employ unless they were given stock options. To satisfy that criterion, taxpayer assisted the personnel in forming and organizing ASI, in which the research personnel were given stock options. Taxpayer then purchased for $1,505,000 cash 250,000 shares of Class A common stock of ASI and 15,000 shares of its preferred stock. Subsequently, taxpayer paid $1,253,750 for additional shares. To meet security clearance requirements taxpayer registered the ASI stock in the name of EMR.

Because of unexpected adverse business conditions and ASI's failure to obtain governmental systems contracts, ASI was on the verge of bankruptcy by February, 1962. It was indebted to SWSC in the net amount of $610,778, the result of a series of short-term loans in the amount of $750,000 made to it by taxpayer for operating expenses, reduced to the balance of $610,778 by mutual offsets for services rendered and property leased. ASI had given notes to SWSC to evidence the existence, the interest rate and the ninety-day maturity date of the loans. On March 2 SWSC sold its ASI stock to Teledyne, Incorporated for $500, sustaining a loss of $2,768,250. Shortly thereafter ASI offered to pay $300,000 to taxpayer if it in turn would cancel and write off the remaining debt of $310,778. SWSC accepted the offer. On its 1962 federal income tax return taxpayer claimed the unrepaid balance on its advances to ASI $610,778 less 300,000=$310,778 as a bad debt deduction under Section 166(a) of the Code, and it treated the $2,768,250 loss on the ASI stock as an ordinary loss. The Commissioner allowed $3,184 of the ASI debt as a bad debt but determined that the $307,594 balance was a loss realized in a transaction qualifying under Section 1232 of the Code and was, therefore, a capital loss. Furthermore, the Commissioner determined that the loss on the ASI stock was a loss from the sale of a capital asset and thus was a capital loss.

Taxpayer attacked the correctness of the...