Wener v. Commissioner of Internal Revenue

• Decision Date: 25 March 1957
• Docket Number: No. 15025.,15025.
• Citation: 242 F.2d 938
• Parties: Harold WENER, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Molly WENER, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

242 F.2d 938 (1957)

Harold WENER, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Molly WENER, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 15025.

United States Court of Appeals Ninth Circuit.

March 25, 1957.

Franklin K. Lane, III, Robinson & Powers, Los Angeles, Cal., for appellant.

Charles K. Rice, Acting Atty. Gen., Robert N. Anderson, Helen A. Buckley and Lee A. Jackson, Attys., Washington, D. C., and John Potts Barnes, Chief Counsel, Washington, D. C., for appellee.

Before CHAMBERS and BARNES, Circuit Judges, and YANKWICH, District Judge.

YANKWICH, District Judge.

The facts in the controversy are, in the main, not in dispute.

I. The Facts in the Controversy

On September 7, 1943, the petitioners (to be referred to as "the taxpayers"), husband and wife, entered into a limited partnership agreement with two other couples, Leon A. and Dorothy Jane Smoller and Alan A. and Margaret M. Joseph (to be referred to as "the remaining partners"), which was to be known as the "Boreva Sportswear Co." The partnership engaged in the manufacture of women's sportswear, and was conducted at Chicago, Ill., where it had a sales office and Stoughton, Wis., where it had a manufacturing plant. The husbands became general partners and the wives limited partners.

On September 6, 1946, an agreement was entered into dissolving the partnership as to the taxpayers by allowing their withdrawal from it as of January 31, 1947, the remaining partners being given the option of acquiring the interests of the taxpayers. The agreement contained a formula for determining the full value of the interests of the taxpayers, — the determination to be made by a designated certified public accountant. It also obligated Harold Wener and his wife not to engage in the business of manufacturing women's sportswear for five years from and after the severance date within a radius of fifty miles from any manufacturing plant of the partnership.

On February 1, 1947, the taxpayers executed a Bill of Sale transferring their interests in the assets of the partnership. The purchase price stated in the Agreement of Dissolution was approximately $75,131.12, as computed by the accountant. Partial payments of $10,428.20 to the husband and $5,265.14 to the wife were made at the time of the purchase. These and certain withdrawals left a balance of $38,713.80 due to the husband and $19,564.27 to the wife, to be paid in three installments, computed on a percentage basis, due, respectively, on January 31, 1948, when forty per cent was to be paid, on April 15, 1948, when thirty per cent was to be paid and April 15, 1950, when the final installment of thirty per cent was to be paid. All deferred installments bore interest at the rate of four per cent per annum. The taxpayers reported the sale of their partnership interest as a "long-term capital loss" for 1947, fifty per cent of which amount, $391.25 in the case of the husband, and $197.53 for the wife, was taken into account. The claimed loss was based on the contention that the sale price of each partnership interest was less than the cost of the interest equivalent to capital account January 31, 1947.

After receiving the first installments of the purchase price the taxpayers moved to California, and established at Westminister a women's sportswear manufacturing plant. The first year's operation resulted in a loss, $20,000 being borrowed from the Bank of America, using as collateral the indebtedness due from the remaining partners. The need for additional cash became pressing. After failing to secure it, Wener began corresponding with his former partners in an endeavor to receive from them a prepayment of the entire balance. After offers and counteroffers were exchanged, the remaining partners finally offered to pay $35,000 in cash for the unmatured balance due under the Dissolution Agreement and sale. An agreement entitled "Mutual Release" was entered into on August 25, 1947, in which the remaining partners agreed to pay to the taxpayers the sum of $35,000 in cash in lieu of the three installments totaling $59,260.13. The money was paid and was used by the taxpayers in their business, $10,000 going to the Bank of America as a balance payment on the loan. Of the $35,000 received, Wener's share was $23,257.50, his wife's share was $11,742.50.

In their income tax returns for 1947, the taxpayers claimed the difference between the balance due on the sale and the amount settled for as ordinary losses, the loss claimed by the husband being $15,456.46, and that of the wife being $7,803.77. These claimed losses were disallowed by the Commissioner on December 21, 1951, and income tax deficiencies were assessed against the taxpayers. They then petitioned the Tax Court for a redetermination of the deficiency as determined by the Commissioner in his Notice dated December 21, 1951. The Tax Court sustained the Commissioner, its Findings and Opinion being filed on June 29, 1955.¹ The parties having filed an agreed computation of the tax, the Tax Court filed its decision in each case on September 2, 1955, finding a deficiency against the husband for the year 1947 in the sum of $5,279.53, and against the wife in the sum of $238.59.

Before us are petitions to review these decisions.

II. Was There an Ordinary Loss?

At the bottom of this controversy is the question whether the taxpayers suffered an ordinary loss in the course of business under Section 23(e) (1) and (2) of the Internal Revenue Code of 1939, — as they contend, or whether their loss, if any, was a "long-term capital loss" as defined in Section 117(a) (5) of the same Code, as the Commissioner and Tax Court found.²

The last named Section defines "long-term capital loss" in this manner:

"(5) Long-term capital loss.

"The term `long-term capital loss\' means loss from the sale or exchange of a capital asset held for more than 6 months, if and to the extent such loss is taken into account in computing net income."³

The taxpayers concede that the debt owed them on January 31, 1947, when they retired from the partnership and sold their interests to the remaining partners, was a capital asset. They insist, however that the subsequent transaction of August 25, 1947, whereby, in consideration for advancing the time of its payment, they accepted a sum less than was owed to them by the remaining partners was a distinct and separate transaction which resulted in a loss during the taxable year which was totally deductible as a loss incurred by individuals "in trade or business"⁴ or "in any transaction entered into for profit, though not connected with the trade or business."⁵

While the tendency of courts is to interpret the word "business" in taxing statutes in a broad sense,⁶ nevertheless, in passing on claimed business losses, Courts are very strict in relating them to the actual business in which the taxpayer is engaged.⁷ In the case before us, this problem is subordinated to the main problem which is (a) whether there was "a sale or exchange" of property and (b) when it took place.

This Court has held repeatedly that upon the dissolution of a partnership and transfers of interest in it to co-owning partners or others, the interests received by the continuing partners or transferees give rise to a gain or loss upon the sale of a capital asset within the meaning of Section 117(a) (1-3) of the Internal Revenue Code of 1939, and similar ones under prior Acts.⁸

And generally, courts have refused to expand the meaning of the words "sale" and "exchange" and have ruled that these words refer only to such transactions as would be considered sales and exchanges in the business world.⁹ In speaking of liquidation of debts, the Supreme Court has stated that

"Payment and discharge * * * is neither sale nor exchange within the commonly accepted meaning of the words."¹⁰

While the language just quoted was used in conjunction with the redemption of a bond, it is applicable to the payment of any debt. So we find that it is generally held that where, through a valid transaction, the amount of an indebtedness is reduced, the reduction may be income to the debtor in the year in which the adjustment is made. This is true whether we are dealing with an individual debt or the debt of a corporation represented by bonds, debentures or other obligations.¹¹ By the same reasoning, when a creditor, in consideration of immediate cash payment, agrees to accept less than the amount of the debt owed to him, but payable in the future, the loss, if any, is not on a "sale" or "exchange." The principle has been well summed up by the Tax Court in another case:

"But it is now too well settled to require extended discussion that the compromise of an indebtedness, whether it be based on inability to collect or by reason of anticipating the payment of the indebtedness, is not a sale or exchange within the meaning of the statute, and, therefore, is not a transaction that falls under Section 117."¹²

In the case from which this excerpt is quoted, the Tax Court adopted the reasoning of a case relied on by taxpayers here.¹³ In that case, the maker had declined to pay the balance of $22,418.84 due on promissory notes which were part of the purchase price of real property. After suit was instituted by the creditors, they settled by accepting a smaller amount, although the debtor was solvent and the promissory notes were secured by a first mortgage on real property. The Court held that the transaction was not a sale, saying:

"Accepting the definitions relied upon by the petitioner as constituting the ordinary meaning of the words in question, such definitions do not include the disposition of the notes under the facts here. There was no acquisition of property by the debtor, no transfer of property to him. Neither business men nor lawyers call the compromise of a note a sale to the maker. In point of law and in legal parlance property in the notes as capital assets was

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