Swenson v. CIR

• Decision Date: 26 October 1962
• Docket Number: No. 16988.,16988.
• Citation: 309 F.2d 672
• Parties: George W. S. SWENSON and Ruth E. Swenson, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Eighth Circuit

309 F.2d 672 (1962)

George W. S. SWENSON and Ruth E. Swenson, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 16988.

United States Court of Appeals Eighth Circuit.

October 26, 1962.

J. Neil Morton, St. Paul, Minn., made argument for the petitioners and filed brief.

Arthur E. Strout, Atty., Dept. of Justice, Washington, D. C., made argument for respondent and Louis F. Oberdorfer, Asst. Atty. Gen., Washington, D. C., Lee A. Jackson, Robert N. Anderson, Arthur E. Strout, Attys., Dept. of Justice, Washington, D. C., were on the brief.

Before VOGEL and VAN OOSTERHOUT, Circuit Judges, and VAN PELT, District Judge.

VAN OOSTERHOUT, Circuit Judge.

This case is before us upon a timely petition for review of the decision of the Tax Court (opinion reported 37 T.C. 124) upholding the Commissioner's determination of a deficiency in income tax for the year 1957 as to petitioners George W. S. Swenson and Ruth E. Swenson, husband and wife, who filed a joint income tax return. The asserted deficiency arose out of Mr. Swenson's transactions and so for convenience we shall treat him as the sole petitioner and refer to him as taxpayer.

There is no dispute as to the basic facts which are stipulated for the most part. Such facts will be summarized to the extent necessary hereinafter.

The deficiency was based upon a determination that the taxpayer had disposed of stock he acquired from Minnesota Mining and Manufacturing Company, hereinafter called M.M.M., upon the exercise of an option granted him by said company's Executive Restricted Stock Option Plan within six months of the date of transfer of such stock to the taxpayer, and that hence such disposal required: (a) recognition of compensation income under § 421(a), Internal Revenue Code of 1954,¹ measured by the difference between the fair market value of the stock on the date of acquisition and the amount paid for the stock; and (b) recognition of short term capital gain under § 1222(1) measured by the difference between the net selling price and the fair market value of the stock on the date of acquisition.

The parties agree that the minimum holding periods of six months set out in § 421(a) relating to restricted stock options and § 1222(3) relating to long term capital gains are identical and are governed by the same principles.

The Tax Court held that the holding period of the stock commenced on January 16, 1957, and ended on July 16, 1957. Taxpayer concedes that if such dates are correctly determined the holding period would be exactly six months and not more than six months as required by the statutes, and that the deficiency determination would be correct. Thus, the vital issue presented is whether the Tax Court erred in its determination as to the commencement or the termination of the holding period.

Taxpayer urgently contends that the holding period of the stock under §§ 421 (a) and 1222 commences as soon as substantial contract rights accrue; that the taxpayer became the owner or substantial owner of the stock when he exercised his stock purchase option in strict conformity with its terms on January 10, 1957; that his holding period began on January 10, 1957, or in any event prior to January 16, 1957, and ended no earlier than July 16, 1957.

Sections 421 and 1222 and the Internal Revenue Code of 1954 as a whole contain no express statement regarding the prerequisites to the initiation or termination of the holding period of corporate stock.²

The cases considering the holding period have not required the actual issuance of stock or the transfer thereof upon the corporate books to start or end the holding period. It has been held frequently that the holding period of corporate stock begins or ends when a purchaser acquires substantial contractual rights which will ripen into full ownership unless defeated by a breach of contract by the other contracting party. Philip J. Lo Bue, 28 T.C. 1317, aff'd, 3 Cir., 256 F.2d 735; Mayer v. Donnelly, 5 Cir., 247 F.2d 322; C.A. Sporl & Co. v. Commissioner, 40 B.T.A. 829, aff'd, 5 Cir., 118 F.2d 283; Commissioner v. Robinson, 6 Cir., 103 F.2d 1009; Commissioner v. Dashiell, 7 Cir., 100 F.2d 625; Huntington Nat'l Bank v. Commissioner, 6 Cir., 90 F.2d 876; Ruml v. Commissioner, 2 Cir., 83 F.2d 257; Estate of James S. Ogsbury, 28 T.C. 93; W. F. Marsh, 12 T.C. 1083.

Taxpayer, to support his contention that the actual transfer of stock is not necessary to start the holding period, and the Commissioner, to support his claim that the holding period ends on the day of sale, cite and rely upon 3B Mertens, Law of Federal Income Taxation, § 22.104, and particularly the language thereof found at pages 446-47, reading:

"Where stock is sold on a stock exchange, delivery by the seller and payment by the buyer may not be required until the fourth full business day after the date on which the sale is executed; yet the seller\'s holding period ends on the day on which the selling order is executed on the exchange, and the buyer\'s holding period begins on the following day. The holding period of stock was decided to have begun when its ownership was acquired and not at a later date when the stock certificates were issued."

While it is true that the taxpayer acquired the stock here involved directly from the corporation rather than through a stock exchange, the foregoing language, which is generally accepted as stating the proper law, indicates that normally the issuance of the certificate is not a prerequisite to the acquisition of ownership sufficient to initiate the commencement of the holding period.

The words "nor within 6 months after the transfer of such share to him" appear in § 421(a). Treasury Regulations on Income Tax (1954 Code), § 1.421-1, defines the meaning and use of certain terms, including the following:

"(f) Transfer. For the purpose of section 421, the term `transfer\', when used in reference to the transfer of an individual of a share of stock pursuant to his exercise of a restricted stock option, means the transfer of ownership of such share, or the transfer of substantially all the rights of ownership. Such transfer must, within a reasonable time, be evidenced on the books of the corporation."

It is obvious upon a reading of the regulation that a transfer can occur prior to the issuance of the stock and that a transfer of substantially all rights of ownership is sufficient to start the holding period. This is made plain by the last sentence appearing in the excerpt from the regulation.

Revenue Ruling 59-418, 1959-2 Cum. Bull. 184 holds:

"A loss upon the sale of stock is sustained by a taxpayer on the date a contract for the sale of such stock was entered into and not at a later date when he delivers the stock to the purchaser."

Such ruling is supported by the statement contained therein that the taxpayer's obligation was fixed when he entered into the binding contract of sale by which he transferred his equitable interest in the stock. Supporting cases are cited, including Dashiell and Ruml, supra.

The Commissioner in his brief does not question the validity of the authorities cited, but contends that the situation here is distinguishable, stating:

"Those cases did not involve situations where the agreement between the parties specifically provided that the buyer should have no rights in the stock until the certificates were issued to him. Since in the above cases the intent of the parties as to the time of the transfer of ownership was not expressed in the contract, it was necessary for the courts to apply other rules of construction in order to determine when the transfer took place. These `stopgap\' rules are employed to fill the void that is left by the contracting parties."

In oral argument, counsel for the Commissioner conceded that were it not for the contractual provisions in the Restricted Option Plan and the contract thereunder between petitioner and M.M. M. to the effect "the participant shall have no interest in shares covered by this option until certificates for said shares are issued", the Commissioner would concede that the holding period would have commenced before January 16.

The rights of the taxpayer and other executives to stock options are fixed by the Executive Restricted Plan legally adopted by M.M.M. and a contract...