United States v. Mills, 25439.

• Decision Date: 02 August 1968
• Docket Number: No. 25439.,25439.
• Citation: 399 F.2d 944
• Parties: UNITED STATES of America, Appellant, v. John A. MILLS, Jr. and Evelyn H. Mills, Appellees.
• Court: U.S. Court of Appeals — Fifth Circuit

399 F.2d 944 (1968)

UNITED STATES of America, Appellant, v. John A. MILLS, Jr. and Evelyn H. Mills, Appellees.

No. 25439.

United States Court of Appeals Fifth Circuit.

August 2, 1968.

Mitchell Rogovin, Asst. Atty. Gen., Lee A. Jackson, Meyer Rothwacks, Melva M. Graney, Attys., Dept. of Justice, Washington, D. C., Donald H. Fraser, U. S. Atty., Savannah, Ga., W. Reeves Lewis, Asst. U. S. Atty., Richard C. Pugh, Acting Asst. Atty. Gen., for appellant.

Thomas H. Adams, Julian Friedman, Adams, Adams & Brennan, Savannah, Ga., for appellees.

Before BELL, AINSWORTH and GODBOLD, Circuit Judges.

AINSWORTH, Circuit Judge:

In this taxpayer's¹ suit for refund of income taxes paid for the year 1959, the verdict of the jury was in his favor. The District Judge denied motions by the United States for judgment notwithstanding the verdict and, alternatively, for a new trial, and the Government has appealed.

Taxpayer Mills, a retired banker, on December 16, 1958, formed a corporation under the law of Georgia known as John Mills and Sons, Inc., with an authorized capital of 2,500 shares of common stock of a par value of $100 per share. The purpose of the corporation was to consolidate all of the business and investment assets of Mr. Mills and to simplify the transmission of his assets to his heirs in the event of his death. Taxpayer sought the advice of his accountant concerning the formation of the corporation and its tax consequences and was informed there would be no income tax liability in the exchange of his assets or stock of the corporation. Accordingly, on January 1, 1959, the following transfers were made between the taxpayer and the corporation:

                Transferred to the Transferred to
                corporation by taxpayer by the
                taxpayer: corporation
                  Various assets consisting      Stock of the
                  of cash,                       corporation           $249,800.00
                  accounts receivable,           Promissory
                  notes receivable,              note                   197,879.55
                  stocks, cattle
                  real estate  $955,351.89
                  (The corporation
                  assumed payments
                  due on certain
                  notes in the sum
                  of:           507,672.34)
                                ___________                            ___________
                  Net           $447,679.55                            $447,679.55
                

Taxpayer received for the transfer 2,498 shares of the corporation's authorized stock of a par value of $249,800 and an unsecured promissory note for $197,879.55 due one year thereafter, bearing interest at 5 per cent per annum — a total of $447,679.55, the net value of the assets transferred by him to the corporation.

The fair market value of the transferred assets at the date of transfer was $1,163,534.97 according to the stipulation entered into between the parties and received in evidence at the trial.²

Section 351 of the Internal Revenue Code of 1954 (26 U.S.C. § 351) is the pertinent statutory provision which governs taxability of transfers to a corporation controlled by transferor. It reads in pertinent part as follows:

SEC. 351. TRANSFER TO CORPORATION CONTROLLED BY TRANSFEROR.

(a) General Rule. — No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation. For purposes of this section, stock or securities issued for services shall not be considered as issued in return for property.

(b) Receipt of Property. — If subsection (a) would apply to an exchange but for the fact that there is received, in addition to the stock or securities permitted to be received under sub-section (a), other property or money, then —

(1) gain (if any) to such recipient shall be recognized, but not in excess of —

(A) the amount of money received, plus

(B) the fair market value of such other property received; and

(2) no loss to such recipient shall be recognized.

Applying this section, the Commissioner determined a deficiency in income tax. It was conceded that since taxpayer owned all but two of the corporation's authorized shares, he was in control of the corporation immediately after the exchange, as Section 351 requires. However, the Commissioner determined that the unsecured one-year promissory note in the amount of $197,879.55 was "other property" within the meaning of sub-section (b) of Section 351 and that the exchange was therefore taxable to the extent of the fair market value of the note conceded to be the sum of $197,879.55. If, however, the Commissioner had determined, as taxpayer contends he should have, that the one-year note represented a "security" within the meaning of Section 351(a), the exchange would have been wholly tax free under the provisions of the section.

The question, therefore, whether the one-year promissory note was a "security" was submitted to the jury and it found for the taxpayer.

As authority for the meaning of the undefined term "security," both the Government and taxpayer rely on this Court's decisions in Camp Wolters Enterprises v. Commissioner of Int. Rev., 5 Cir., 1956, 230 F.2d 555; Aqualane Shores, Inc. v. C.I.R., 5 Cir., 1959, 269 F.2d 116; and Parkland Place Company v. United States, 5 Cir., 1966, 354 F.2d 916, and both parties quote the following identical excerpt from the Camp Wolters decision, which was restated in Aqualane Shores and applied in Parkland Place Company:

"The test as to whether notes are securities is not a mechanical determination of the time period of the note. Though time is an important factor, the controlling consideration is an overall evaluation of the nature of the debt, degree of participation and continuing interest in the business, the extent of proprietary interest compared with the similarity of the note to a cash payment, the purpose of the advances, etc. It is not necessary for the debt obligation to be the equivalent of stock since Sec. 112(b) (5) specifically includes both `stock\' and `securities\'."

In applying this test in Camp Wolters, this Court found the following factors to be indicative that a note was a "security": The notes "were an integral part of the scheme of its the corporation's forming and financing" (230 F.2d at 559); the rights created by the note "constituted permanent contributions to petitioner's business, not merely temporary advances of rights to be used for current needs" and the "noteholders were assuming a substantial risk of petitioner's enterprise, and on the date of issuance were inextricably and indefinitely tied up with the success of the venture, in some respects similar to stockholders" (Id. at 560, quoting with approval from the Tax Court decision); the giving of the notes was "an integral part of the pot luck no pay no cure plan, formed before incorporation, of launching petitioner with cash and securities in note form" (Id. at 559); the notes and stock were "different forms of the assured participation in the pot luck of the enterprise" or "evidence of participation" (Id. at 560).

The Government contends that since the promissory note on its face is payable in...