United States v. General Geophysical Company

• Decision Date: 07 December 1961
• Docket Number: No. 18530.,18530.
• Citation: 296 F.2d 86
• Parties: UNITED STATES of America, Appellant, v. GENERAL GEOPHYSICAL COMPANY, Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

296 F.2d 86 (1961)

UNITED STATES of America, Appellant, v. GENERAL GEOPHYSICAL COMPANY, Appellee.

No. 18530.

United States Court of Appeals Fifth Circuit.

October 20, 1961.

Rehearing Denied December 7, 1961.

Charles K. Rice, Asst. Atty. Gen., Lee A. Jackson, Atty., Dept. of Justice, Washington, D. C., William B. Butler, U. S. Atty., Houston, Tex., Gilbert E. Andrews, Jr., Harry Baum, Attorneys, Department of Justice, Washington, D. C., R. F. Wheless, Jr., Asst. U. S. Atty., Houston, Tex., for appellant.

Homer L. Bruce, Houston, Tex., Baker, Botts, Andrews & Shepherd, Houston, Tex., of counsel, for appellee.

Before RIVES and WISDOM, Circuit Judges, and DAWKINS, Jr., District Judge.

WISDOM, Circuit Judge.

February 25, 1954 General Geophysical Company, the taxpayer, transferred certain depreciable assets having a tax basis of $169,290 and a market value of $746,525 to two of its major stockholders in the redemption of their stock. Later that day the taxpayer reacquired the same assets from the former stockholders in exchange for corporate notes in the amount of $746,525. In its 1954 income tax return the corporation claimed depreciation deductions using as the cost basis the market value of the assets at the time of the transaction.¹ The sole question this litigation presents is whether the corporation's reacquisition of the assets stepped up the basis. We hold that it did not and reverse the decision below.

Earl W. Johnson founded General Geophysical Company in 1933 to engage in oil exploration, and managed its operations until his sudden death in 1953. At his death his estate, his wife, his mother, and a friend Paul L. Davis owned 77% of the corporation's total stock and 94% of its voting shares. The major portion of the remaining shares was owned by Chester Sappington, T. O. Hall, and Albert B. Gruff, who were also officers in the corporation. The Johnson stock was community property: half belonged to the widow and the other half was held by the Second National Bank of Houston as executor and trustee for Johnson's estate. The testimony shows that the bank and Mrs. Johnson soon realized that neither of them could contribute anything of value to running the corporate business, and that they should not attempt it. They realized also that if the corporation were liquidated and its properties sold, they would receive less than the value of their stock in a going concern. Sappington, Hall, and Grubb believed that they could run the corporation successfully and if so, they should receive its future profits. Accordingly, the corporation agreed to retire the stock held by the bank, the two Mrs. Johnsons, and Davis. After long negotiations the parties settled on a valuation of the stock at $245 a share, payable partly in cash and partly in notes. The attorney for the retiring stockholders advised against this proposal for fear that it would leave the stockholders without sufficient protection in case the corporation should be forced into bankruptcy. He based this legitimate business fear on Robinson v. Wangemann, 5 Cir., 1935, 75 F.2d 756, 758, which holds that when a former shareholder owns notes of a bankrupt corporation, received in the redemption of his stock, he "cannot be permitted to share with the other unsecured creditors in the distribution of the assets of the bankrupt estate." To avoid exposure to this risk, the stockholders proposed that the Johnson stock be retired in exchange for cash and corporate property having a market value equal to that of the stock. The redemption was carried out in accordance with this proposal. A few hours later, the corporation repurchased the property for corporate notes, giving the former stockholders a mortgage on certain of its properties.

Witnesses for the taxpayer insisted that there was no agreement between the corporation and the stockholders to reexchange the corporate properties transferred to the stockholders in the redemption of their shares. The trial judge so found, and it seems clear that there was no legally binding agreement to that effect. The attorney for the stockholders did testify, however, that he had discussed the possibility of such a resale and before February 25, 1954 had prepared the documents for a resale in case that was decided upon after the initial transfer.

Under Section 1012 of the Internal Revenue Code of 1954, 26 U.S.C.A. § 1012, "the basis of property shall be the cost of such property." This requires a determination of when the taxpayer acquired the property and the price he paid for it. Our decision depends on whether or not the transactions in question created an interruption in the ownership of the property, producing a new basis on its reacquisition. The Government asserts that we should disregard the form of the transfer and recognize that the substance of the transactions was a redemption of the corporate stock for cash and notes, leaving the ownership and basis of the depreciable assets undisturbed. The taxpayer answers that there was no fraud or subterfuge in these transactions, that the stockholders acquired complete and unfettered ownership of the properties, and that the trial judge's finding of two separate and independent transactions cannot be overturned on appeal.

The solution of hard tax cases requires something more than the easy generalization that the substance rather than the form of a transaction is determinative of its tax effect, since in numerous situations the form by which a transaction is effected does influence or control its tax consequences. This generalization does, however, reflect the truth that courts will, on occasion, look beyond the superficial formalities of a transaction to determine the proper tax treatment.

In the landmark case of Gregory v. Helvering, 1935, 293 U.S. 465, 55 S.Ct. 266, 79 L.Ed. 596, the Supreme Court refused to give effect to corporate transactions which complied precisely with the formal requirements for nontaxable corporate reorganizations, on the ground that the transactions had served no function other than that of a contrivance to bail out corporate earnings to the sole shareholder at capital gains tax rates. In Commissioner v. Court Holding Co., 1945, 324 U.S. 331, 65 S.Ct. 707, 89 L.Ed. 981, the Supreme Court taxed a corporation on the gain from the sale of an apartment house notwithstanding a transfer of the house to the corporation's two shareholders before the sale, since it found that the transfer was made solely to set in a more favorable tax form a sale which in reality was made by the corporation. Similarly, in Helvering v. Clifford, 1940, 309 U.S. 331, 60 S.Ct. 554, 84 L.Ed. 788, the Supreme Court taxed a trust grantor on the income of the trust property since the formal transfer of the property by the grantor was lacking in substance. The Court found that the dilution in his control seemed insignificant and immaterial and that "since the husband retains control over the investment, he has rather complete assurance that the trust will not effect any substantial change in his economic position." 309 U.S. at pages 335-336, 60 S.Ct. at page 557. See also Estate of Weinert, etc. v. Commissioner of Internal Revenue, 5 Cir., 1961, 294 F.2d 750; Liston Zander Credit Co. v. U. S., 5 Cir., 1960, 276 F.2d 417; Campbell v. Fasken, 5 Cir., 1959, 267 F.2d 792; Rupe Investment Corp. v. Commissioner of Internal Revenue, 5 Cir., 1959, 266 F.2d 624; Georgia-Pacific Corp. v. U. S., 5 Cir., 1959, 264 F.2d 161. Each case must be decided on its own merits by examining the form and substance of the transactions and the purpose of the relevant tax provisions to determine whether recognition of the form of the transaction would defeat the statutory purpose.

The case at bar presents an unusual tax question created by the conjunction of two parts of the tax code not frequently brought together by a single transaction: the provisions governing basis and capital gains, and the rule that no gain is recognized by a corporation when it distributes property with respect to its stock. The basis of property is determined by its cost; when the property is sold the owner realizes a taxable gain equal to the difference between the basis and the proceeds received in the sale. There is no danger that a taxpayer could effect an artificial sale and repurchase to raise the basis of appreciated property, since such a transaction would subject him to a tax on the step-up in the basis. There are, therefore, no provisions to prevent tax avoidance by such a device, and the question whether a transfer and reacquisition should be recognized as independent transactions creating tax consequences would generally affect only the timing of the imposition of a tax rather than its amount. The twist here comes from the fact that the corporation did not incur a tax on the difference between basis and current market value when it transferred the assets to its shareholders in redemption of their stock. Section 311(a) of the Code, 26 U.S.C.A. § 311(a),...