Supreme Investment Corporation v. United States, 71-2819.

• Decision Date: 02 October 1972
• Docket Number: No. 71-2819.,71-2819.
• Citation: 468 F.2d 370
• Parties: SUPREME INVESTMENT CORPORATION, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

468 F.2d 370 (1972)

SUPREME INVESTMENT CORPORATION, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.

No. 71-2819.

United States Court of Appeals, Fifth Circuit.

October 2, 1972.

COPYRIGHT MATERIAL OMITTED

Jerome J. Reso, Jr., New Orleans, La., Robert L. Curry, III, Monroe, La., for plaintiff-appellant.

Donald E. Walter, U. S. Atty., Robert H. Shemwell, Shreveport, La., Fred B. Ugast, Acting Asst. Atty. Gen., Scott P. Crampton, Asst. Atty. Gen., Meyer Rothwacks, David E. Carmack, Attys., Tax Div., Dept. of Justice, Washington, D. C., for defendant-appellee.

Before WISDOM, GODBOLD and RONEY, Circuit Judges.

WISDOM, Circuit Judge:

In this action the taxpayer, Supreme Investment Corporation, sued for a refund of $852 in federal income taxes for the fiscal year ended November 30, 1965, allegedly erroneously and illegally assessed.¹ The case involves the interaction of § 269 and §§ 332, 334(b)(2) and 381(a)(1) of the 1954 Internal Revenue Code.² We hold that the Commissioner overstepped the bounds of § 269 in assessing the tax in this case, and accordingly we reverse the district court's holding in the Government's favor, 320 F.Supp. 1328.

Supreme Investment Corporation (Supreme), originally incorporated in 1959, is a Louisiana corporation domiciled and doing business in Ouachita Parish, Louisiana. Until February 17, 1965, Supreme's 87½ outstanding shares of stock were owned solely by R. D. Kellogg. On that date R. D. Kellogg sold to his attorneys, Thomas W. Leigh and Robert L. Curry, ten shares each of his Supreme stock at $250 per share. On February 22, 1965, Supreme redeemed 57½ shares of stock from R. D. Kellogg, so that its remaining thirty shares of stock were equally divided among Kellogg, Curry, and Leigh. Then, on February 26, 1965, Supreme purchased from Robert L. Kellogg, the son of R. D. Kellogg, all the shares of CKS Corporation (CKS). CKS was a Louisiana corporation, originally incorporated in 1953, which, like Supreme, was domiciled and doing business in Ouachita Parish.

Supreme elected to liquidate CKS, its wholly owned subsidiary, on April 19, 1965. Certain assets of CKS, including a promissory note dated July 31, 1956, and drawn by Star Motel, Inc. (the predecessor of CKS) to the order of CKS, were transferred under date of April 26, 1965 to Supreme in consideration for Supreme's surrender of its CKS stock and its assumption of certain liabilities due and owing by CKS. As part of this transaction, the taxpayer assumed a $125,000 note payable to R. D. Kellogg by his son, Robert Kellogg. CKS had been reporting its gain on the Star Motel note, which had a principal amount of $400,000 with 4 percent interest per annum until paid, on the installment method authorized by § 453 of the Internal Revenue Code, whereby the gain realized is recognized ratably over the period of collections upon the note.

At the heart of this controversy is a dispute over the basis Supreme should properly assign to the Star Motel installment obligation. Supreme determined its basis for the Star Motel note by reference to its allocable cost for the CKS stock, together with the liabilities which it assumed from CKS, arriving at a figure of $204,235.37. The Commissioner determined that, instead of using a cost basis, Supreme should have carried over the same basis for the note as it had in the hands of CKS. The basis of the note in the hands of CKS was $121,639.80. Consequently the Commissioner assessed a deficiency against Supreme in the amount of $852 for its taxable fiscal year ending November 30, 1965, representing the tax allegedly due on amounts Supreme received in part payment of the Star Motel note plus interest. After its claim for a refund was denied, Supreme brought suit in district court. The district court held in favor of the Commissioner, concluding that Supreme should have used a carryover rather than a cost basis.

On this appeal Supreme contends that it is compelled by §§ 332,³ 334(b)(2),⁴ and 381⁵ of the Internal Revenue Code to determine its basis in the installment obligation by reference to its allocable cost for CKS stock. The Government counters by asserting that the transaction in question was nothing more than a tax avoidance scheme and that § 269 therefore requires Supreme to use the lower basis, regardless of the rules laid down in other sections of the Code. Tax avoidance would result from the fact that under § 453(d)(4), as then applicable,⁶ CKS would not recognize any gain on distribution of the installment obligation in liquidation. If Supreme were permitted to use its cost basis, $83,000 higher than CKS's basis, that $83,000 of income would ultimately escape taxation altogether. The Government stresses the attorney-client and father-son relationships among the principals and the careful consideration given to tax consequences in structuring this transaction. The Government maintains that the principal purpose of the acquisition and liquidation of CKS was to obtain this tax benefit and that therefore § 269 operates to deny the claimed tax benefit. Even if § 269 does not apply, the Government further argues that the same result is mandated by § 1001(d) and by general principles of taxation. Supreme denies that the principal purpose of the transaction was tax avoidance, alleging instead that its principal purpose was to acquire a leasehold interest owned by CKS.⁷ Supreme further argues that § 269 is inapplicable on its face, regardless of the purpose of the transaction.

The district court held that § 269 was broad enough to apply to the facts of this case, and went on to find that Supreme's "principal purpose" in acquiring and liquidating CKS was tax avoidance. Since we hold that § 269 is inapplicable, we do not reach the district court's findings of fact.

I.

The predecessor to § 269 was § 129 of the 1939 Code, enacted in the Revenue Act of 1943, 58 Stat. 47 (1934). Its prime aim was to discourage corporations with large excess profits from the practice of trading in loss corporations or corporations with excess profits tax credits as a means of tax avoidance. See 7 Mertens, Law of Federal Income Taxation § 38.65 (1967); Rudick, Acquisitions to Avoid Income or Excess Profits Tax: Section 129 of the Internal Revenue Code, 58 Harv.L.Rev. 196 (1944); Peter Pan Seafoods, Inc. v. United States, 9 Cir.1969, 417 F.2d 670, 674; S.Rep. No. 627, 78th Cong., 1st Sess. 58 (1944), 1944 Cum.Bull. 1016; Zanesville Investment Co. v. Commissioner of Internal Revenue, 6 Cir.1964, 335 F.2d 507, 509. Both its language and legislative history suggest that it was intended to reach a wide variety of tax avoidance schemes. Section 269 was not designed to enumerate any one particular type of tax avoidance device, but rather was intended to condemn such devices "in whatever form they may appear." H.R.Rep. No. 871, 78th Cong., 1st Sess.(1943), 1944 Cum.Bull. 973, 1017. See Borge v. Commissioner of Internal Revenue, 2d Cir.1968, 405 F.2d 673, 678, cert. denied sub nom. Danica Enterprises, Inc. v. Commissioner of Internal Revenue, 1969, 395 U.S. 933, 89 S.Ct. 1994, 23 L.Ed.2d 448. The Commissioner has taken a broad view of the section's scope. Thus the Regulations define "allowance" under § 269 to include "anything in the internal revenue laws which has the effect of diminishing tax liability."⁸ Treas.Reg. § 1.269-1(a) (1962). See also 7 Mertens § 38.66; James Realty Co. v. United States, 8 Cir.1960, 280 F.2d 394.

In view of the apparently deliberate breadth of the language of § 269 we do not think that a mechanical reading of the section can resolve the issues before us. As this Court said in Bobsee Corp. v. United States, 5 Cir. 1969, 411 F.2d 231, 234: "Whatever else may be said of this provision, its applicability or inapplicability is certainly not revealed by a mere reading of the statutory language."⁹

Our rejection of a mechanical, literal approach to § 269 does not mean that we think that § 269 is broad enough to reach the facts of this case. Section 269 was not intended to condemn every acquisition resulting in a tax saving. Zanesville Investment Co. v. Commissioner of Internal Revenue, 6 Cir. 1964, 335 F.2d 507, 510. We think that § 269 must be read in light of the other provisions of the Internal Revenue Code which it was designed to supplement. The Senate Finance Committee Report accompanying § 129 of the 1939 Code made clear that the section was to be read with a view to Congressional policies embodied in specific deductions or exemptions. The test whether § 129 was applicable to a given transaction was that stated in Higgins v. Smith, 1940, 308 U.S. 473, 60 S.Ct. 355, 84 L. Ed. 406: "whether the transaction or a particular factor thereof `distorts the liability of the particular taxpayer' when the `essential nature' of the transaction or factor is examined in the light of the `legislative plan' which the deduction or credit is intended to effectuate." S.Rep. No. 627, 78th Cong., 1st Sess. (1943), 1944 Cum.Bull. 1016, 1017. A similar statement has been embodied in the Regulations. Treas.Reg. § 1.269-2(b) (1962). There is no tax avoidance, in other words, and no occasion for applying § 269, when a taxpayer determines its tax liability in accordance with the rules specified by Congress, and pays the tax Congress intended it should pay.

Thus § 269 has been held inapplicable to deny taxpayers certain tax benefits which Congress plainly intended that they should enjoy. The Commissioner ruled that creation of a "Western Hemisphere trade corporation" under § 109 of the 1939 Code¹⁰ was not tax avoidance within the meaning of § 129 of the 1939 Code, even though done for the principal purpose of obtaining tax savings, since the tax benefit was consistent with the Congressional plan. I.T. 3757, 1945 Cum.Bull. 200. In A. P. Green Export Co. v. United States, 1960, 284 F.2d 383, 151 Ct.Cl. 628, the Court of Claims reaffirmed the Commissioner's ruling. In Alinco Life Ins. Co. v. United...