United States v. Hess

• Decision Date: 16 February 1965
• Docket Number: No. 7797.,7797.
• Citation: 341 F.2d 444
• Parties: UNITED STATES of America, Appellant, v. John C. HESS and Faye L. Hess, John C. Hess as Executor of the Estate of C. L. Hess, deceased, and Stella B. Hess, E. H. Rights and Amelia A. Rights, Charles H. Widdifield and Laberta Widdifield, Appellees.
• Court: U.S. Court of Appeals — Tenth Circuit

341 F.2d 444 (1965)

UNITED STATES of America, Appellant, v. John C. HESS and Faye L. Hess, John C. Hess as Executor of the Estate of C. L. Hess, deceased, and Stella B. Hess, E. H. Rights and Amelia A. Rights, Charles H. Widdifield and Laberta Widdifield, Appellees.

No. 7797.

United States Court of Appeals Tenth Circuit.

February 16, 1965.

Robert A. Bernstein, Washington, D. C. (Louis F. Oberdorfer, Lee A. Jackson and Harold C. Wilkenfeld, Washington, D. C., were with him on brief), for appellant.

Ellis J. Sobol, Denver, Colo., for appellees.

Before MURRAH, Chief Judge, HILL, Circuit Judge, and DAUGHERTY, District Judge.

MURRAH, Chief Judge.

In this suit for refund of income taxes for the taxable years 1958 and 1959, the sole issue is whether gain realized by the taxpayers was capital gain as reported under Sections 1221 and 1231 of the Internal Revenue Code, or ordinary income as determined and assessed by the Commissioner.¹ The Government has appealed from a judgment on a jury verdict for the taxpayers, contending that the court should have sustained its motion for a directed verdict or judgment n. o. v., and ruled as a matter of law that the reported gain was ordinary income.

To sustain their burden of the case, the taxpayers showed that during the taxable years in question, and for a number of years previously, they were members of a partnership, Acetylene Service Company, engaged in the sale of compressed gases and other welding supplies and equipment. The compressed gases were sold in returnable steel cylinder-containers. Certain small cylinders (10-foot capacity) were sold with the gas contained in them. These cylinders were normally returned to the Company when empty in exchange for a full cylinder of gas. The Company reported gains from these sales as ordinary income, and that treatment is not now in issue.

Other large cylinders were ordinarily loaned to customers with each sale of their gas content, on the condition that the cylinders were to be returned within 30 days. Under these conditions the customer was not charged for the cylinder or for its use. If, however, the cylinder was not returned within the specified 30-day period, a rental (demurrage) of four cents a day in excess of 30 days was charged. After 120 days, the customer became obligated to pay for the cylinder at replacement cost, plus a few dollars for handling and paper work. The sales price ranged from $35 for the 100-foot capacity size to $45 for the largest cylinders, while gas contained therein was sold for approximately $5. The containers were given a 20-year life and were depreciated accordingly with the knowledge and consent of the Commissioner.

As a result of a shortage of supply of cylinders, the Company in 1958 mailed a form letter to customers who had held cylinders for more than 120 days, pointing out that the customer had agreed to return the cylinders within 120 days or purchase them. This letter was sent only one time with moderate success. During the taxable period in question, all letters and invoices which the Company sent out contained the words "PLEASE RETURN EMPTY CYLINDERS TODAY", prominently printed thereon.

To avoid penalties for failure to return the cylinders, some customers asked to purchase them. While the Company did not encourage their sale, if requested, it "would agree to sell it to him." This business policy and practice resulted in the sale of 588 cylinders in 1958 and 1,808 in 1959, accounting for 20 and 46 per cent respectively of the Company's net profits.²

The jury was instructed that in resolving the ultimate issue of capital gain or ordinary income, they must determine whether the cylinders used by the taxpayers in connection with their sales of acetylene and other gases "were held by Acetylene Service Company primarily for sale to customers in the ordinary course of trade or business;" and that the taxpayers had the burden to show that they were not held primarily for sale to customers in the ordinary course of trade or business. The jury was further told that in resolving that issue, they must consider "First, the purpose for which the cylinders were acquired and held by the Acetylene Service Company; Second, the activities of the Acetylene Service Company with respect to its cylinders, such as whether or not such cylinders were advertised for sale or whether customers were solicited; Third, the volume of sales and frequency and continuity of sales and the extent of income from sales of cylinders as contrasted with income from other activities of the Acetylene Service Company; Fourth, all the facts and circumstances surrounding these sales which tend to indicate whether or not the cylinders were held primarily for sale to customers in the ordinary course of the trade or business of Acetylene Service Company;" And that "no one or more of the factors which I have given you are conclusive, nor are the absence or presence of any one or more of the factors determinative, but in making your decision you must weigh all of the factors. If, from your consideration of all the factors, you find that the cylinders were held primarily for sale to customers in the ordinary course of trade or business of Acetylene Service Company, then your verdict should be for the defendants. On the other hand, if, from a consideration of all the factors, you find that the cylinders were not held primarily for sale to customers in the ordinary course of the trade or business of Acetylene Service Company, then your verdict should be for the plaintiffs. In the phrases `primarily held for sale' the term `primarily' means essentially or substantially, rather than principally or chiefly."

These instructions are commendably clear and understandable, and undoubtedly read upon the applicable law of this Circuit and elsewhere. See Coffey v. United States, 10 Cir., 333 F.2d 945, and cases cited; Ackerman v. United States, 5 Cir., 335 F.2d 521; Carlson v. C. I. R., 7 Cir., 288 F.2d 228; Annot. 46 A.L.R.2d 615.

Invoking Corn Products Refining Co. v. Commissioner, 350 U.S. 46, 76 S.Ct. 20, 100 L.Ed. 29, the Commissioner contends that the classification of the cylinders as capital or non-capital may be governed by something other than the literal statutory definition of Section 1221, if the facts indicate that the cylinders were acquired not as an investment but to per-the taxpayers' business income. In Corn petuate and benefit the mainstream of Products, the taxpayer was engaged in the business of manufacturing and selling corn products. It purchased corn future contracts to protect its profit margin against the possible increase in the price of corn. The taxpayer did not deny that the futures transactions were an integral part of its trade or business. However, it did insist that the futures contracts were capital assets as defined in Section 1221 because they did not come within any clause excluding property held by the taxpayer as a capital asset. The result of the court's decision is to essentially broaden the provisions of Section 1221 to include the sale of products purchased by the taxpayer, not as an investment, but as an integral and necessary act in the conduct of his business. E. I. Du Pont De Nemours & Co. v. United States, Ct.Cl., 288 F.2d 904; Booth Newspapers, Inc. v. United States, 303 F.2d 916, 157 Ct.Cl. 886. See: Judicial Treatment of "Capital" Assets Acquired for Business; The New Criterion, 65 Yale L.J. 401.

If the sale of the cylinders in our case can be said to be essentially or in substantial furtherance of the taxpayers' business of selling gas, we would then have a Corn Products case. And, a factual basis for saying so may be assumed. Indeed, the Court undoubtedly had Corn Products in mind when it instructed the jury "If the cylinder sales were a substantial or essential part of the taxpayers' business activities, then they are a source of ordinary income." By its verdict, the jury has resolved...