Sun Properties v. United States

• Decision Date: 02 March 1955
• Docket Number: No. 15052.,15052.
• Citation: 220 F.2d 171
• Parties: SUN PROPERTIES, Inc., Appellant, v. UNITED STATES of America, Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

220 F.2d 171 (1955)

SUN PROPERTIES, Inc., Appellant, v. UNITED STATES of America, Appellee.

No. 15052.

United States Court of Appeals, Fifth Circuit.

March 2, 1955.

C. B. Kniskern, Jr., and Douglas D. Felix, Miami, Fla., for appellant.

Louise Foster and Ellis N. Slack, Sp. Assts. to Atty. Gen., H. Brian Holland, Asst. Atty. Gen., E. David Rosen, Asst. U. S. Atty., Miami, Fla., Carolyn R. Just, Sp. Asst. to Atty. Gen., James L. Guilmartin, U. S. Atty., Miami, Fla., for appellee.

Before HUTCHESON, Chief Judge, and RIVES and TUTTLE, Circuit Judges.

TUTTLE, Circuit Judge.

The sole question here is whether the district court erred in holding that the conveyance of a warehouse property to the taxpayer corporation by its sole stockholder, in form a sale, was in substance a contribution to capital. We deem it appropriate here to set forth verbatim the findings of fact and conclusions of law of the district court, 54-2 U. S. Tax Cases ¶ 9528:

"1. The Court has jurisdiction of the parties and subject matter.

"2. The taxpayer corporation was formed by Henry Peacock, Jr., on August 25, 1947, and the certificate of incorporation was filed on August 27, 1947. On August 29, 1947, three shares of stock were issued, one to Henry Peacock, Jr., and two shares to nominees in exchange for one dollar paid by each to the capital of the corporation.

"3. On August 30, 1947, Mr. Peacock purchased the two shares of stock from the nominees. On September 1, 1947, he deeded two lots to the corporation in return for the remaining seven shares of stock. These lots were listed on the taxpayer's books at a cost of $400.00.

"4. On September 15, 1947, Mr. Peacock transferred to the corporation a warehouse building for an alleged consideration of approximately $125,000.00, which represented the fair market value of the buildings and the land. The agreement under which the transfer was made provided that the alleged consideration of approximately $125,000.00 was to be paid off at the rate of $4,000.00 semi-annually, the first payment to be made on or before December 15, 1947. No interest or down payment was provided, and the purchase price was not secured by a mortgage.

"5. It was customary in the Miami area to charge interest and to provide for a down payment and mortgage on such transactions.

"6. The corporation had only nominal assets other than the warehouse, and the alleged purchase payments were paid out of the rentals received. The current rentals were sufficient to meet the installment payments, pay all expenses, and provide a sizeable profit.

"7. At the time the alleged sale was entered into the warehouse property was very profitable. The net profits in 1947 were in excess of $21,000.00.

"8. The transaction was not the type which would have taken place between parties at arm's length.

"9. In auditing the income tax returns of the corporation for the fiscal years ending August 31, 1948, August 31, 1949, and August 31, 1950, the Commissioner disallowed certain depreciation deductions claimed on the buildings on the ground that the corporation should use the same basis for depreciation as had been used by Mr. Peacock before the transfer. The Commissioner also determined that certain administrative expenses which had been claimed by Mr. Peacock on his individual return should be allotted to various business entities owned by Mr. Peacock, including the taxpayer corporation. The adjustments were as follows:

                                                   1948       1949       1950
                  Depreciation claimed          $8,007.75  $8,471.95  $8,471.95
                  Depreciation disallowed        5,296.03   5,600.76   5,600.76
                  Depreciation allowed           2,711.72   2,871.19   2,871.19
                  Administrative expenses        2,166.30   1,941.81   1,945.23
                  New adjustment allowed         3,129.73   3,658.95   3,655.53
                  Tax Deficiency                   719.83     841.55     853.19
                    Total deficiency $2,414.57
                

"10. As a result of these adjustments deficiencies in tax were assessed and were paid as follows: $719.83 in tax and $149.57 interest for fiscal 1948; $841.55 in tax and $124.37 interest for fiscal 1949; and $853.19 in tax and $74.95 interest for fiscal 1950. The payments, totalling $2,763.46, were received by the Collector on May 19, 1952. Claims for refund were filed and were denied by the Commissioner.

"11. It appears that Mr. Peacock would not have entered into the transaction in question except for tax purposes.

"12. The transaction between Sun Properties, Inc., and its sole stockholder achieved no legitimate business purpose, but was made to reduce taxes.

"13. The transaction is not to be recognized as a sale for Federal tax purposes, but represents a transfer of property by the sole stockholder to his corporation as a contribution to capital.

"Conclusions of Law:

"1. The purported sale represented a contribution by Mr. Peacock of the warehouse property to the capital of the corporation, and in accordance with the provisions of Section 113(a)(8)(B) of the Internal Revenue Code, 26 U.S.C.A., the basis for depreciation of the property in the hands of the corporation is the same as it was in the hands of Mr. Peacock, the transferor.

"2. The plaintiff takes nothing by its action, and the defendant recovers its costs herein."

The taxpayer does not deny findings 1 through 11, but contends vigorously that findings 12 and 13, as well as the conclusions of law, are in error. Since the findings numbered 12 and 13 are really legal conclusions, we may assume as a true statement of the facts, the findings number 1 through 11; and thus we may consider the matter in hand purely as a question of law, whether those facts authorize the legal conclusion that the taxpayer took deductions for depreciation not permitted by law. The holding below is based on the general principle of tax law that the substance of a transaction rather than its mere form controls tax liability related thereto. To be more precise, its rationale is that this was not a customary or usual sort of sale nor the type which would have taken place between parties at arm's length; the decisive consideration motivating the transaction was the minimizing of taxes; and, in fact, that was the only business purpose of the transaction.¹ Therefore, the court reasoned, it was not a sale at all; and since the increase in assets of the corporation, if not offset by a corresponding increase in liabilities or debts of the corporation, represents an increase in capital, the transaction was in substance an increase in capital. One other consideration which undoubtedly influenced the holding was that this was a "thin" corporation; that is, one with an unusually high ratio of debts to capital on its books.

This rationale is perilously plausible. It is in effect saying to the taxpayer, "You did this under suspicious circumstances; therefore, you did not do it at all, and you are not entitled to any tax advantages." For all of the circumstances relied upon by the Government are consistent both logically and empirically, we think, with the opposite conclusion that the transaction was a sale in fact as well as in form; these are good reasons to scrutinize the transaction carefully, but they are not rational proof that it was something other than what it purported to be.

Let us consider first the argument that the transaction was not of the arm's-length sort. We think the law is as it is stated in Prentice-Hall, Federal Taxes ¶ 28,205:

"One of the circumstances which may cause the test of substance v. form to be applied is that the transaction involved was not an arm\'s length transaction * * *. The fact that a transaction was not at arm\'s length has apparently not of itself been a basis for disregarding the transaction but it does raise the question of whether the substance is the same as the form."

Indeed, we think it may be stated as a general rule that a transaction must not be disregarded simply because it was not at arm's length. Staab, 20 T.C. 834. And we think it would be judicial legislation of the most inexcusable kind for a court to create such a rule.

Likewise, the argument that the transaction was not done in the customary manner must go by the board. We know of no general requirement that transactions be entered into in a conventional way for them to be recognized as having the usual tax result. At most, this is only another reason to view the transaction closely for indicia of a different sort of transaction; it is not itself an indicium here of a capital transfer or of a sale, for we may take judicial notice that there are many kinds of capital transactions as well as many debtor-creditor transactions and sales which are highly unconventional. See Stevens, Corporations (2d Ed.) 414-418.

What about the fact, which we may assume to be true, that Peacock's predominant motive was to minimize taxes? In Gregory v. Helvering, 293 U. S. 465, 469, 55 S.Ct. 266, 79 L.Ed. 596, 97 A.L.R. 1355, the Supreme Court said that a motive of tax avoidance will not establish liability if the transaction does not do so without it. It may fairly be said that a tax avoidance motive must not be considered as evidence that a transaction is something different from what it purports to be. 8th Ann. N. Y. U. Institute on Federal Taxation 990, 1003:

"Transactions are properly subject to careful scrutiny when the only ascertainable motive is tax avoidance, just as they are subject to scrutiny when between the members of a family. The error into which

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