Universal Oil Products Co. v. Campbell

Decision Date06 April 1950
Docket NumberNo. 9902-9905.,9902-9905.
Citation181 F.2d 451
PartiesUNIVERSAL OIL PRODUCTS CO. v. CAMPBELL (UNITED STATES, intervenor) (two cases).
CourtU.S. Court of Appeals — Seventh Circuit

Ralph S. Harris, William W. Owens, New York City, Adam M. Byrd, Chicago, Ill., Lee J. Gary, Chicago, Ill., Loren C. Berry, H. Allen Lochner, New York City, of counsel, for Universal Oil Products Co.

Theron Lamar Caudle, Assistant Attorney General, Ellis N. Slack, Frank J. Ready, Ruppert Bingham, George R. Parsons, Special Assistants to the Attorney General, Otto Kerner, Jr., United States Attorney, John A. Looby, Jr., Assistant United States Attorney, Chicago, Ill., for Nigel D. Campbell and the United States.

Before DUFFY, LINDLEY and SWAIM, Circuit Judges.

SWAIM, Circuit Judge.

These are appeals by the defendant, the former Collector of Internal Revenue for the First District of Illinois, and the intervenor, the United States of America, from judgments of the District Court in numbers 9902, 9903 and 9904 on appeal, and an appeal by the plaintiff, Universal Oil Products Company, from a portion of the judgment in number 9905 on appeal.

The plaintiff brought three actions to recover a total of $1,576,808.42 of income and excess profits taxes, which it had paid on the income it reported for the years 1944 to 1946, inclusive, on the ground that it had been a tax exempt corporation under § 101(6) of the Internal Revenue Code, 26 U.S.C.A. § 101(6), from and after November 29, 1944. The intervenor, United States of America, in these three actions sought to recover from the plaintiff a total of $1,582,886.29 on alleged tax deficiencies for the three years.

The three cases were consolidated for trial in the Court below and, by order of this Court, were consolidated here for the purpose of briefing and argument.

In these appeals the parties have presented six principal questions for our consideration:

1. Whether the plaintiff is exempt from income and excess profits taxes as a scientific and educational corporation under § 101(6) of the Internal Revenue Code from and after November 29, 1944, on which date all of its capital stock and notes were acquired by a trust which was admittedly exempt from taxes on its income under said section?

2. Did the plaintiff, which used the accrual basis for its accounting and for reporting income and deductions, earn income in the year 1945 in the amount of $1,035,205.50 under its agreement with the Tide Water Associated Oil Company, or did it earn only one-fourth of that amount in each of the years 1945 and 1946?

3. Was the plaintiff entitled under § 23 (a) of the Internal Revenue Code, 26 U.S. C.A. § 23(a) to deduct in the years of 1942-1946, inclusive, certain expenditures made by it in connection with the prosecution of an action by Universal Oil Products Company of South Dakota against the Skelly Oil Company?

4. Did the plaintiff realize income of $75,000 in 1942 by the receipt from a debtor, on the Kanotex settlement, of one of its notes having a face value of $75,000 when the note at that time had a market value of only $60,000?

5. Was the plaintiff in the 1944 tax case entitled under § 23(a) of the Internal Revenue Code to a deduction of $356,867.47 for unpaid royalties owed by Root Refining Company which the plaintiff released in July, 1944?

6. Should overpayments of taxes which were credited under § 3806 of the Internal Revenue Code, 26 U.S.C.A. § 3806, in part payment of claims of the United States against plaintiff growing out of re-negotiations of excess profits under plaintiff's war contracts for the years 1944 and 1945 be taken into account in computing any refunds allowable to the plaintiff or tax deficiencies collectible from the plaintiff for these two tax years?

We shall consider these questions in the above order.

Exemption under Section 101(6).

The principal question presented by these appeals is the question of whether the plaintiff taxpayer from and after November 29, 1944, was, as the District Court held, exempt under the provisions of § 101(6).

The basic facts concerning this question are not in dispute. The plaintiff taxpayer was organized in 1932 as a Delaware business corporation with its principal place of business in Chicago, Illinois. Upon its organization the plaintiff succeeded to the bulk of the business and took over most of the assets and liabilities of a South Dakota corporation of the same name, hereinafter referred to as "South Dakota".

In 1931 South Dakota was a party to, or was defending on behalf of its licensees, many suits for infringement and was engaged in more than one hundred pending patent interference and opposition proceedings. As a part of the settlement of all this litigation the stock of South Dakota was indirectly acquired by several of the major oil companies through a series of reorganizations which resulted in the organization of the plaintiff and in the acquisition of its stock and other securities by these major oil companies.

The plaintiff's charter, like that of South Dakota, authorized it to engage in research work in chemistry, engineering, and other scientific fields; to acquire, own and license patented processes; to render engineering and other services; and to design chemical plants. The plaintiff at all times here in question was, and now is, engaged in the business of conducting research in the field of chemistry and physio-chemistry, particularly in the crude oil field; of devising processes, particularly those having to do with the crude oil field; of reducing such processes to commercial uses; of obtaining patents for such processes; of designing refineries and parts thereof to refine crude oil; and of licensing its patents and processes to others engaged in the refining of crude oil. The main objective of the plaintiff is to develop and acquire processes on units that can be used by the refining industry. It attempts to obtain patents covering such processes so that it can have a monopoly on the processes in connection with its business as an architect engineer for petroleum refineries. The plaintiff also manufactures and sells certain chemicals called catalysts and inhibitors to refineries. Plaintiff's revenue producing customers are principally small and independent refiners who do not have adequate research and engineering facilities to keep abreast of the major oil companies.

The capitalization of the plaintiff, since 1934, has consisted of 250,000 shares of non-voting A stock, 100 shares of voting C stock and 100 shares of voting S stock, all classes of the par value of $1 per share. As of October, 1944, all of the above was issued and outstanding with the exception of 130,000 shares of A stock. Plaintiff also had outstanding in 1944 C and D income "Notes" in the aggregate principal amount of $8,500,000; and prior to November, 1949 also had outstanding A "Notes" payable only from net income. No dividends have ever been paid on any of this stock since the recapitalization of the company in December, 1934, but prior thereto it paid dividends of a little more than $1,000,000 per year on its stock.

Prior to October 26, 1944, all of the outstanding shares of common stock and the outstanding income notes of the taxpayer were owned by the following oil companies:

Shell Oil Company, Inc.

Standard Oil Company of California

Standard Oil Company (Indiana)

Standard Oil Company (New Jersey)

The Texas Company

Phillips Petroleum Company, hereinafter referred to as "Phillips".

N. V. deBataafsche Petroleum Maatschappij.

On October 26, 1944, all of the owners of the stock and notes of the plaintiff, except Phillips, entered into a trust agreement creating the Petroleum Research Fund, and transferring to the Guaranty Trust Company of New York as trustee all of their stock and notes of the plaintiff as the corpus of said trust fund. This agreement provided that said trust should continue in perpetuity and that the recipient of funds distributed by the trustee should use such funds "exclusively" for advanced scientific education and fundamental research in the "petroleum field", which might include any field of pure science which in the judgment of the recipient might afford a basis for subsequent research directly connected with the "petroleum field". The agreement also provided that comprehensive reports of the research carried on by the recipient should be made available at least once each year to the public at large; that copies of such reports should be made available by the recipient to the donors of the trust; and that all publications of the results of such research should give credit to the donors of the trust.

The trust agreement then provided that the recipient or beneficiary of the trust fund should be the American Chemical Society, or a qualified successor.

The trust agreement stated that the plaintiff was a corporation engaged in the business of research and development work in the petroleum field, the ownership and licensing of processes, patents, and patent rights relating to the petroleum field; that the donors believed that the carrying on of such business was in the public welfare; and that, unless and until it should be authorized by a court of competent jurisdiction, the trustees should not sell or otherwise dispose of any of the securities of the plaintiff, nor should they "cause or permit the plaintiff to discontinue research and development work in the petroleum field, and the ownership and licensing of processes, patents and patent rights relating to the petroleum field." (Emphasis supplied.)

The trust agreement also provided that the donors, by the execution and delivery of the agreement, completely surrendered all interest in, and rights of supervision of any kind whatsoever over, the trust fund and should not be deemed to have any rights by way of reverter or otherwise.

Thereafter, Phillips transferred all of its stock and notes in the plaintiff corporation to the American Chemical...

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