VGS Corp. v. Comm'r of Internal Revenue

• Decision Date: 25 July 1977
• Docket Number: 6897—74,Docket Nos. 6896—74,9916—74.
• Citation: 68 T.C. 563
• Parties: VGS CORPORATION, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

68 T.C. 563

VGS CORPORATION, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket Nos. 6896—74

6897—74

9916—74.

United States Tax Court

Filed July 25, 1977.

The predecessor of VGS, New Southland, acquired all the stock of a corporation and certain assets of a partnership which operated together as a going concern. Subsequently, New Southland merged with Vermont Gas Systems, Inc., wherein Vermont survived and the name was changed to VGS. VGS claimed deductions for depreciation based on allocation of a substantial portion of the purchase price to depreciable assets. Held, no goodwill was acquired as a part of the acquisition of the stock of the corporation and partnership assets. Held, further, going-concern value was acquired in that acquisition and that element is not depreciable as an enhancement to the depreciable assets. Held, further, the principal purpose of the acquisition of Vermont Gas Systems, Inc., by New Southland was not the avoidance or evasion of Federal income tax under the provisions of sec. 269, I.R.C. 1954. Jack W. Brand, Justin L. Cox, and William S. Painter, for the petitioner.

Roy S. Fischbeck, for the respondent.

GOFFE, Judge:

The Commissioner determined deficiencies in petitioner's Federal income tax as follows:

+--------------------------------------+
                ¦            ¦Taxable     ¦            ¦
                +------------+------------+------------¦
                ¦Docket No.  ¦year ended  ¦Deficiency  ¦
                +------------+------------+------------¦
                ¦            ¦            ¦            ¦
                +------------+------------+------------¦
                ¦6897-74     ¦7/31/66     ¦$120,128.27 ¦
                +------------+------------+------------¦
                ¦            ¦7/31/67     ¦122,451.54  ¦
                +------------+------------+------------¦
                ¦            ¦12/31/67    ¦46,129.76   ¦
                +------------+------------+------------¦
                ¦6896-74     ¦12/31/68    ¦525,344.12  ¦
                +------------+------------+------------¦
                ¦9916-74     ¦12/31/69    ¦177,479.59  ¦
                +------------+------------+------------¦
                ¦            ¦12/31/70    ¦138,605.49  ¦
                +------------+------------+------------¦
                ¦            ¦12/31/71    ¦280,445.89  ¦
                +--------------------------------------+
                

Upon joint motion of the parties, these cases were consolidated dated for trial, briefing, and opinion. Concessions having been made, only the following issues remain for our consideration:

(1) Whether any part of the lump-sum purchase price paid by petitioner's predecessor in acquisition of all the capital stock of Southland Oil Co. and certain assets of the Southland Co., a partnership, is properly allocable to nondepreciable intangible assets;

(2) What was the fair market value of the Crupp Refinery at the time it was acquired; and

(3) Whether the principal purpose of the acquisition of Vermont Gas Systems, Inc., by Southland Oil Co. and its shareholders was the evasion or avoidance of Federal income tax under the provisions of section 269 of the Code.¹

FINDINGS OF FACT

Many of the facts have been stipulated. The stipulation of facts and the exhibits attached thereto are incorporated by reference.

VGS Corp., petitioner, is a Vermont corporation and the successor to a merger between the Southland Oil Co., a Mississippi corporation, and Vermont Gas Systems, Inc., a Vermont corporation, wherein Vermont Gas Systems, Inc., was the surviving corporation. Subsequently, Vermont Gas Systems changed its name to VGS Corp. At the time of filing its petitions herein, petitioner's principal office was located in Yazoo City, Miss.

Southland Oil Co. filed corporation income tax returns for the taxable years ended July 31, 1966, July 31, 1967, and December 31, 1967, with the District Director of Internal Revenue, Jackson, Miss. Vermont Gas Systems, Inc., filed its corporation income tax returns for the taxable years 1966 and 1967 with the District Director of Internal Revenue, Burlington, Vt. Vermont Gas Systems, Inc., filed corporate income tax returns for the taxable years 1968 and 1969 with the Internal Revenue Southeast Service Center, Chamblee, Ga. VGS Corp. filed corporation income tax returns for the taxable years 1970 and 1971 with the Internal Revenue Southeast Service Center, Chamblee, Ga.

Prior to July 31, 1965, the Southland Co. was a partnership composed of Mr. E. Constantin, Jr., Mr. Gilbert L. Bright, and Mr. Charles W. Else, whose ownership interests therein were 90 percent, 5 percent, and 5 percent, respectively. The partnership owned and operated the Rogerslacy Refinery located in Sandersville, Miss., from which petroleum products, principally asphalt, were refined and marketed. In addition to the refinery at Sandersville, Miss., the partnership owned a terminal at Vicksburg, Miss., several bulk plants, service stations, miscellaneous transport equipment and automobiles, timberland in Mississippi, and 90 percent of the stock of Delta Refining Co. of Memphis, Tenn. Delta Refining Co. owned a large refinery located in Memphis, Tenn. Prior to July 31, 1965, the Southland Oil Co. (Old Southland) was a Mississippi corporation, the stock of which was owned by Mr. Constantin, Mr. Else, and Mr. Bright in the amounts of 90 percent, 5 percent, and 5 percent, respectively. Old Southland owned and operated the Crupp Refinery at Yazoo City Miss., which produced asphalt as its principal product. In addition to other minor assets, Old Southland owned a pipeline from a gas plant located near Laurel, Miss., to the Rogerslacy Refinery.

In 1964 Mr. Constantin decided to sell Old Southland and the assets of the Southland Co. partnership (hereinafter sometimes referred to collectively as the Southland companies) in order to diversify his holdings and thereby reduce his business and investment risk. His decision to sell was based primarily on his desire to reduce his executive responsibilities in light of his advanced age. Mr. Constantin, whose net worth was approximately $6 million, was the principal officer of the Southland companies and actively participated in their day-to-day operations.

After Mr. Constantin decided to sell the Southland companies he directed Mr. Paul A. Lockhart, Jr., his attorney and personal adviser, to contact prospective buyers. Mr. Lockhart approached several prospective purchasers and discussed in general terms the proposed sale of the companies including the Delta Refinery operation. However, after preliminary negotiations, each prospective buyer either declined to make an offer or offered to buy the companies for little or no downpayment and extended installment terms. In the spring of 1965, Mr. Lockhart approached Mr. G. Scott Hammonds, a geologist and independent oil operator, with regard to the possible purchase of the Southland companies. Based on their conversations, Mr. Hammonds considered making the purchase. On April 23, 1965, Mr. Hammonds retained the firm of Purvin & Gertz, Consulting Engineers of Dallas, Tex., to conduct a study of the Southland Co. partnership and Old Southland. The results of this study were set forth in the firm's report entitled ‘Review of Operations, The Southland Company and Affiliated Companies.’ Specifically, Mr. Hammonds requested that Purvin & Gertz forecast the future profitability and cash flow of the Southland operations and ascertain the physical value of the fixed assets of the companies.

In the latter part of April 1965, Purvin & Gertz initiated their study of the Southland companies. Mr. Melvin H. Gertz was in overall charge of the study. He was assisted by Mr. John P. Marshall and Mr. James L. Walker. Purvin & Gertz had performed services for Mr. Constantin with regard to his business operations since 1950. Two of the engineers involved in the Hammonds' study Mr. Gertz and Mr. Walker, had performed services for Purvin & Gertz on prior occasions involving the Southland companies and were generally familiar with the companies' assets and operations. Mr. Gertz is an expert in the appraisal and evaluation of refining facilities. Mr. Walker is an expert in projecting the profitability and cash flow of refining facilities. Mr. Marshall, now deceased, was an evaluation engineer specializing in the physical appraisal of refineries and natural gas and oil processing properties.

In the Purvin & Gertz study, Mr. Marshall's function was to ascertain the replacement cost for new physical properties and then apply a judgment depreciation factor to this value to arrive at the physical or fair market value of the physical (depreciable) properties. Mr. Walker's primary function was to investigate the operations of the Southland companies and forecast the future profitability of the operations and prepare a 10-year forward cash flow projection. Mr. Gertz's function was to supervise the overall direction of the study, coordinate the team members, and help edit the final report. Mr. Marshall's appraisal of the physical assets was to be used to establish a depreciable base for the depreciable assets in order to ascertain the allowable deduction for depreciation under the Federal tax laws. This was necessary to enable Mr. Walker to ascertain the approximate Federal income tax liability of the operations and thereby accurately predict the net cash flow of the companies. This type of study and the procedures employed therein had been conducted by Purvin & Gertz for other companies on numerous occasions prior to the Hammonds' study.

In order to develop the appraised fair market values of the physical assets, Marshall first inventoried all existing assets. In making his inventory of the physical assets, Mr. Marshall utilized a full inventory or ‘nuts and bolts' appraisal prepared in 1957 by Mr. E. D. Martin, an evaluation engineer. From the Martin inventory Mr. Marshall deleted facilities no longer in operation and included new facilities added to the companies' plants since 1957. Mr. Marshall's valuation figures were not dependent upon the valuation figures in the Martin report. But rather, after ascertaining physical assets actually present in the Southland...