Six Seam Co., Inc. v. U.S., s. 73-2169

• Decision Date: 06 November 1975
• Docket Number: 73-2170,Nos. 73-2169,s. 73-2169
• Citation: 524 F.2d 347
• Parties: 75-2 USTC P 9765 SIX SEAM COMPANY, INC., Plaintiff-Appellee (73-2169), Plaintiff-Cross-Appellant (73-2170), v. UNITED STATES of America, Defendant-Appellant (73-2169), Defendant-Cross-Appellee (73-2170).
• Court: U.S. Court of Appeals — Sixth Circuit

Page 347

524 F.2d 347

75-2 USTC P 9765

SIX SEAM COMPANY, INC., Plaintiff-Appellee (73-2169), Plaintiff-Cross-Appellant (73-2170), v. UNITED STATES of America, Defendant-Appellant (73-2169),

Defendant-Cross-Appellee (73-2170).

Nos. 73-2169, 73-2170.

United States Court of Appeals, Sixth Circuit.

Argued Feb. 12, 1975.

Decided Oct. 17, 1975.

As Amended Nov. 6, 1975.

George J. Long, U. S. Atty., Louisville, Ky., Scott P. Crampton, Meyer Rothwacks, Ernest J. Brown, Gilbert Andrews, Richard Perkins, Stephen M. Gelber, Tax Div., Dept. of Justice, Washington, D. C., for defendant-appellant in No. 73-2169 and defendant-cross-appellee in No. 73-2170.

James E. Shafer, Wood, Pedley, Stansbury, Rice & Warner, Charles F. Wood, Louisville, Ky., for plaintiff-appellee in No. 73-2169 and plaintiff-cross-appellant in No. 73-2170.

Before EDWARDS and ENGEL, Circuit Judges, and RUBIN, District Judge ^*.

ENGEL, Circuit Judge.

This suit was commenced in the district court by Six Seam Co., for a refund of federal corporate income taxes for the years 1963, 1964 and 1965. Six Seam appeals from a district court grant of summary judgment in favor of the government denying it the right to deduct certain net operating losses incurred in the fiscal years 1960 and 1961, from its profits in 1963 and 1964. In its cross-appeal, the government challenges the district court's holding that the sale of certain mining equipment from Coiltown Mining Company to taxpayer Six Seam was a bona fide sale and that, therefore, Six Seam upon disposition of the assets to a third party, was not required under Section 1245 of the Internal Revenue Code to restore to its income the depreciation which Coiltown had claimed prior to the date of sale.

Six Seam was incorporated in 1959 and until April, 1961, its business consisted solely of operating a tipple used in the preparation of coal for commercial sale. The tipple crushed, sorted and washed coal. At no time during this period did Six Seam itself engage in the business of actually mining coal. Rather, it purchased raw coal from various local mines and merely processed the coal through its tipple. The coal tipple itself was leased by Six Seam from a third party, the Kington family. Taxpayer incurred net operating losses of $73,017 and $24,437 during fiscal years of 1960 and 1961 respectively. In March, 1961, Six Seam, heavily in debt, ceased operating the tipple. In April, 1961 it sub-leased the use of the tipple to one of its suppliers, Walnut Grove Mining. Initially, Six Seam had attempted to sell the tipple rights to Walnut Grove, but the latter was not in a position to purchase the facility. The sub-lease to Walnut Grove was not exclusive since Six Seam reserved the opportunity to process any of its coal through the tipple. The record indicates that Six Seam never subsequently availed itself of this reserved right. When Six Seam executed the lease, it notified various governmental agencies that it was terminating its business.

The Board of Directors of Six Seam on March 20, 1961, authorized the acceptance for surrender and cancellation of the stock of any shareholder who desired to tender his shares to the corporation. The resolution provided no consideration for the surrendered shares, but relieved the shareholder of his personal guarantee on a $75,000 note executed by Six Seam to a Kentucky bank. In May, 1961, the shareholders of Six Seam agreed to sell their stock to Coiltown Mining Company, Inc. for a total of $100 plus the full assumption by the latter of Six Seam's corporate liabilities. Coiltown was a coal mining company which for many years had been engaged in extracting coal from the Klondike Mine in Kentucky under contracts for the sale of coal to the Tennessee Valley Authority. During the remainder of 1961 and throughout 1962, Six Seam, now a wholly owned subsidiary of Coiltown, did not engage in any active business except to receive rental income from the lease of the tipple to Walnut Grove.

In 1961 and prior years Coiltown had encountered increasing difficulty in completing a coal supply contract with the Tennessee Valley Authority. The shareholders were concerned that potential liabilities in contractual damages would be incurred by the corporation if Coiltown defaulted on its contract with TVA. Since Coiltown had been accumulating liquid reserves in preparation for liquidation of the corporation and distribution to the shareholders, the specific fear was that a large contractual liability would deplete the "nest egg" of over $1,000,000 in cash and marketable securities. Therefore, to insulate the liquid assets of Coiltown from potentially ruinous liability on the TVA contract, the shareholders of Coiltown decided, as found by the district court,

". . . to reactivate Six Seam, a wholly-owned, but dormant, subsidiary of Coiltown, and endeavor to persuade TVA to substitute it for Coiltown on the T-4 Contract and to release Coiltown and the surety on its $325,000.00 performance bond from that contract . . . .

"The plan adopted and authorized by the Coiltown directors at a special meeting held on February 19, 1963, was for Coiltown to purchase for cash additional Six Seam stock 'in an amount sufficient to allow that company . . . to be able to perform the TVA contract' and 'thereby induce TVA to release Coiltown Mining Company from its contract' . . . . This plan also contemplated that Six Seam would purchase all of Coiltown's mining assets at a fair price with the cash thus received and that Six Seam would pay all of its outstanding obligations and have enough cash working capital left over to commence mining operations, thereby enabling Six Seam to present a balance sheet showing a net worth sufficient to satisfy both TVA and the bonding company that would be needed to write the necessary $325,000 performance bond on Six Seam in favor of TVA."

Pursuant to the plan, Six Seam on April 1, 1963, issued and Coiltown purchased an additional 3,030 shares of Six Seam stock for $303,000. On the same date Six Seam purchased all of Coiltown's mining equipment for $145,000 and all of its mining supplies for $41,291. Out of the remaining cash, Six Seam paid all of its outstanding debts and obligations, including an account payable to Coiltown of $66,000. When these transactions were completed, Six Seam owned all of Coiltown's mining assets and in addition had approximately $50,000 working capital to begin mining operations. Concerning this transaction, the district court found that

"The sole purpose and intent underlying the transfer by Coiltown of its mining and other operating assets to Six Seam on April 1, 1963, was to enable Coiltown's shareholders to get out of the coal mining business at the minimum possible risk of loss. And that those assets were not transferred to Six Seam pursuant to any plan to reorganize Coiltown so that its shareholders could continue in the coal mining business in modified corporate form to Six Seam. . . . Similarly, there is credible testimony in the record, which is not inherently improbable and which is not disputed or contradicted, that the $145,000 Six Seam paid to Coiltown for its mining equipment and other depreciable assets was a fair price, inasmuch as the sale was for cash and the assets were to remain in place. . . . Accordingly, this court finds as a fact that the sale by Coiltown of its mining and other depreciable assets to Six Seam on April 1, 1963, was a bona fide sale of those assets and, for the reasons heretofore given, was made for the legitimate purpose of protecting Coiltown's liquid assets in the event of a default on the T-4 contract . . . ."

By September 1964, the earlier production difficulties had been resolved and Six Seam was able successfully to complete performance under the TVA contract. Six Seam subsequently leased the mining equipment it had obtained from Coiltown to Pyro Mining Company. Pyro exercised the option under the lease and in January, 1965, purchased the mining equipment for $320,000.

I. The Loss Carryover

On its 1963 corporate income tax return, Six Seam claimed a net operating loss deduction of $48,219 against its mining income from the TVA contract, leaving a balance of $53,316 in loss carryover which it claimed as a net operating loss deduction on its 1964 return. The Commissioner of Internal Revenue disallowed the net operating losses for both 1963 and 1964 pursuant to Sections 269 and 382(a) of the Internal Revenue Code of 1954. In the district court, summary judgment was rendered in favor of the government on the ground that the deductions were disallowed by Section 382(a). ¹ The court did not pass upon the Section 269 issue.

Section 172 of the Internal Revenue Code of 1954, 26 U.S.C. § 172, in providing for the carryover of net operating losses in a given tax year to offset income which may be earned later, is the current statutory expression of a Congressional belief that "the allowance of a net operating business loss carry-over will greatly aid business and stimulate new enterprises". H.R.Rep. No. 855, 76th Cong. 1st Sess. 9. While its decisional authority may have been superseded by the 1954 amendments to the Internal Revenue Code, the following observation in Libson Shops, Inc. v. Koehler, 353 U.S. 382, 386, 77 S.Ct. 990, 993, 1 L.Ed.2d 924 (1957), still has validity:

"Those provisions were enacted to ameliorate the unduly drastic consequences of taxing income strictly on an annual basis. They were designed to permit a taxpayer to set off its lean years against its lush years, and to strike something like an average taxable income computed over a period longer than one year."

Prior to the 1954 amendments to the Internal Revenue Code, the only statutory vehicle to avoid potential abuse of the loss carryover provision was found in Section 269 which authorized the Commissioner of Internal Revenue to disallow a deduction, credit or allowance not otherwise available, in cases where the control of a...