State v. Johnson

• Decision Date: 29 February 1960
• Docket Number: No. 41250,41250
• Citation: 238 Miss. 211,118 So.2d 308
• Parties: STATE of Mississippi, and Noel Monaghan, Paul Ford and Arny Rhoden, Members of the Mississippi State Tax Commission, v. Walter G. JOHNSON, Jr.
• Court: Mississippi Supreme Court

Page 308

118 So.2d 308

238 Miss. 211

STATE of Mississippi, and Noel Monaghan, Paul Ford and Arny Rhoden, Members of the Mississippi State Tax Commission, v. Walter G. JOHNSON, Jr.

No. 41250.

Supreme Court of Mississippi.

Feb. 29, 1960.

James E. Brown, Jackson, for appellant.

Watkins & Eager, Jackson, for appellee.

ETHRIDGE, Justice.

The Mississippi Income Tax Act permits gains from certain types of installment sales to be returned on a deferred basis, authorizing the spreading of the income tax over the period of the installment payments. Miss. Code 1942, Sec. 9220-08(a). The taxpayer, Walter G. Johnson, Jr., appellee, received ten installment promissory notes representing part of the purchase price from him of certain shares of stock. He exercised his option under the statute to pay the Mississippi income tax on gains received in the years in which the deferred payments were received by him. Subsequently, he transferred these notes in a bona fide transaction to a merchandising corporation in which he owned the majority of stock, for the principal purpose of enabling the endorsee to use the notes as collateral in its business. In return, and as consideration for the transfer, he received substantially identical notes of the corporation payable to him in installments. The question is whether under Code Sec. 9220-08(a) the sale by taxpayer of these installment obligations, and the receipt by him as payment therefor of similar installment notes executed to him by the transferee, terminated the statutory privilege of paying his income tax on the installment payments when received; or whether taxpayer may continue to report his taxable gain under the new installment notes on the deferred payment basis. We conclude that the taxpayer retains that privilege.

The statute defines gross income as including gains and income from sales, and income derived from any source whatever. Sec. 9220-08(a) then states: 'The amount of all such items shall be included in the gross income for the taxable year in which received by the taxpayer; provided, when property is sold upon what is known as the instalment or deferred payment plan, and the initial payment is thirty per cent (30%) or less, (and the initial payment shall include the total sum paid, including assumption of mortgage or other indebtedness, during the taxable period in which such sale occurs) the net income realized may be included for taxation in that portion of any instalment payment representing gain or profit in the year in which such payment is received.'

I.

The case involves an additional assessment for 1955 Mississippi income taxes.

On August 7, 1954 appellee Johnson sold to Mississippi Publishers Corporation 350 shares of stock in that corporation for a total consideration of $962,500. The purchaser paid him $250,000 in cash, and gave notes for the balance of $712,500, the notes being payable annually over a ten-year period, at $71,250 a year, at five per cent interest. The State Tax Commission, appellant, admits this was a valid installment payment sale under the above statute. There is no dispute between appellee and the Commission as to the amount of profits from the sale. Johnson paid the 1954 income tax due on the profit of $205,189.50 realized from the cash received by him in 1954 of $250,000.

On January 17, 1955 appellee organized a corporation known as Giles, Inc. Its principal purpose was to own, carry on and conduct a clothing, department or other type of store for the purpose of sale at retail of merchandise and articles of various types. It is undisputed, and the chancery court found, that this corporation was not organized with any tax purposes in mind, and without any thought by appellee at that time of selling the notes of Mississippi Publishers Corporation, owned by him, to Giles, Inc; and that Giles, Inc. was organized for a bona fide purpose of establishing a high quality retail mercantile establishment in the City of Jackson.

On January 28, 1955, Johnson established an irrevocable trust for his children, with his wife as trustee, placing $48,000 in the trust. At the organizational meeting of Giles, Inc., Johnson purchased 52 per cent of the stock for a cash payment of $52,000, and Mrs. Johnson, as trustee, purchased 48 per cent of the stock by investing $48,000 of the trust funds.

Johnson made a detailed study of the need in Jackson of an additional department store. He discussed his plans with merchants in several cities of the nation, and with his attorneys, local merchants and bankers. In order to open the store in the early fall of 1955, work was begun on renovating a building on Capitol Street. It was later found that the old structure was insufficient for the purposes, so it was demolished and work began on a new four story building. The anticipated cost of the building, the store's equipment and operating expenses gradually began to increase considerably. The amount of cash which Giles, Inc. needed was not available. In order for Giles to secure the necessary financing, it had to have a better financial statement. Johnson concluded that this could be done only by a transfer to Giles, Inc. of the liquid and well-established notes of Mississippi Publishers Corporation. Giles could then use them as security for loans, and they would buttress its financial statement.

For these reasons, on February 15, 1955, Johnson transferred to Giles, Inc. the ten installment notes of Mississippi Publishers Corporation, for their face amount of $712,500. The consideration for the transfer was ten notes of Giles, Inc., executed by Johnson as President thereof, payable to Johnson individually, in identical amounts of those of the Mississippi Publishers Corporation and payable on the same dates. Hence there was no profit or taxable gain from this transaction, nor was there any loss from it. This was an outright sale and transfer of Mississippi Publishers notes by Johnson to Giles, Inc. Johnson retained no individual rights in them. The consideration paid him was the ten installment notes of Giles, Inc. payable to him. A certified public accountant testified for appellee that it is usual and customary in business for stockholders in a corporation to sell valuable property to it for a long-term consideration. This gives the corporation the necessary credit with which to operate its business and meet its obligations. He said that in his opinion the transfer of the Mississippi Publishers notes to Giles, Inc. greatly increased its financial responsibility and enabled it to operate in the money market as an established business.

However, between February 15 and April 7, 1955, there was a change in the financial condition of Giles, Inc. During this period it was discovered that the old building was not suitable for renovation, and it was going to cost approximately $600,000 to build and equip a new building; that Giles, Inc. needed about $1,000,000 for construction of the building and operating capital. Upon advice of counsel, bankers and accountants, inquiry was made of Mississippi Publishers Corporation as to whether it would be interested in prepaying the notes. Mississippi Publishers accepted this offer, and paid the full face amount of the notes to Giles, Inc. Johnson individually received none of this money. It was used by Giles, Inc. in financing construction of the building, securing inventory, and preparing for opening of the store. When Giles, Inc. opened, it had actual physical assets of approximately $1,000,000, not including the value of its eighteen-year lease.

The tax year involved is 1955. In that year Giles, Inc. paid appellee $85,000 on its indebtedness to him under the installment notes. Appellee considered this a receipt attributable to and including profits from his sale of stock, so in his 1955 income tax return he reported this $85,000 from Giles, Inc. as a portion of the profits of his sale of stock to Mississippi Publishers Corporation. He paid income tax on the part constituting realized net income from the sale. However, the commissioner of the income tax division, State Tax Commission, made an additional assessment against Johnson for 1955 taxes. He decided that the disposition by Johnson of the Mississippi Publishers notes to Giles, Inc. terminated the deferred payment privilege under the statute; that the statute refers to the sale of tangible personal property rather than intangible; and that the transaction with Giles, Inc. was not an arms-length deal.

The full Commission affirmed this additional assessment for 1955 of the full amount of the profits on the sale of the stock to Mississippi Publishers Corporation, the assessed remainder being $584,790.50. In other words, the Commission took the position that upon the disposition by sale of these installment obligations, there was a termination of the installment contract privilege, and the remaining taxable gain, resulting from the initial sale, must be reported in the year in which the installment obligations are sold. This resulted in an additional 1955 tax of $34,152.85, plus interest. Johnson appealed to the chancery court. Code Sec. 9220-31. After a hearing at which Johnson and a certified public accountant testified, the chancery court reversed the order of the State Tax Commission and vacated the additional assessment for the year 1955. It found that the transfer of the Mississippi Publishers notes to Giles, Inc. was for the purpose of giving financial stature to the transferee and to assist it in financing its obligations. Giles, Inc. was organized as a legitimate business venture. There is no prohibition in the tax statute of a subsequent sale of installment notes. The second sale, from Johnson to Giles, Inc., was a bona fide transaction, and payment of income tax can continue to be made on an installment sale basis when the profits are actually received.

II.

The quoted part of Code Sec. 9220-08(a) was incorporated in the Mississippi Income...