Zerillo v. Commissioner, Docket No. 50014
| Decision Date | 31 July 1956 |
| Docket Number | 50015.,Docket No. 50014 |
| Citation | 15 TCM (CCH) 947,1956 TC Memo 180 |
| Parties | Lorenzo Zerillo v. Commissioner. Frances G. Zerillo v. Commissioner. |
| Court | U.S. Tax Court |
Joseph L. Alioto, Esq., 111 Sutter Street, San Francisco, Calif., for the petitioners. Charles W. Nyquist, Esq., for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined deficiencies in income tax for each of petitioners in these consolidated proceedings, as follows:
Year Ended Tax Deficiency
March 31, 1944 Income and Victory
Tax ............ $21,109.83
March 31, 1946 Income Tax ....... 2,780.92
March 31, 1947 Income Tax ....... 1,121.57
By amended answer respondent seeks to increase the deficiencies determined for the year ended March 31, 1944 by $26,844.74. The principal issue raised by the petition is whether respondent erred in reallocating the proceeds of sale of a winery between wine inventory, gain on which is concededly taxable as ordinary income, and the winery plant and equipment, gain on which is taxable only as capital gain. For the year ended March 31, 1947, respondent's disallowance of a bad debt loss is also in issue. Other issues were settled by oral stipulation necessitating a Rule 50 computation. By amended answer an issue is raised whether the sale occurred during the year ended March 31, 1944, or the year ended March 31, 1943, as reported.
Some facts were stipulated and are found accordingly.
Lorenzo, hereafter referred to as petitioner, and Frances G. Zerillo were husband and wife during the years in controversy. All transactions involve petitioner, and Frances G. Zerillo is here solely because their returns were filed on the community property basis. All income was community income. They filed separate returns for each fiscal year ended March 31 on an accrual basis with the collector of internal revenue for the first district of California.
The Riverbank Canning Company, sometimes herein referred to as the Canning Co., of which petitioner was president and controlling stockholder, packed large quantities of tomato and other vegetable products. It shipped its products on the Santa Fe Railway. Petitioner held all of the stock, except 15 or 16 per cent which he had given to his sons. He made all decisions without consulting anyone. He also engaged in other business ventures relating to growing, packing, and shipping of produce.
Petitioner had been in the wine business since childhood, and had continuously operated his own winery since the year prior to repeal of Prohibition. He employed Victor Luisi to manage the winery. The winery books were also kept on an accrual basis. After 1936 the winery was located in a brick building leased from the Riverbank Canning Company for $500 including the equipment therein.
After repeal petitioner purchased new winery equipment piecemeal. To secure a loan, on January 15, 1942 he transferred the equipment to the Canning Co. He made one payment of $2,600 on March 27, 1943, and three payments totaling 15,938.58 during May and June of 1943. Loans between petitioner and the Canning Co. occurred frequently. At a meeting of the Canning Co's directors on July 6, 1943, attended by petitioner, it was explained that he had paid the corporation the full purchase price under the contract, and since the equipment was subject to a mortgage lien, it should be released from the lien. The directors resolved that the Canning Co. give petitioner a bill of sale and take any necessary steps to have the equipment released from the lien. Under date of September 2, 1942, petitioner had notified the Alcohol Tax Unit that the Canning Co. owned the equipment which it had leased to himself personally. Petitioner never transferred his winery bond and license to the Canning Co. The Canning Co. carried the equipment on its books at $18,538.58.
Petitioner bought a building, hereafter referred to as the ice plant, from the Santa Fe Railway. The ice plant was a cork-insulated, brick building located on a siding near the Canning Co. which the railroad used for storing ice. Although the ice plant originally cost $600,000, petitioner contracted to pay only $55,000. Petitioner bought it to use for his winery, but never moved the winery into the building. The Canning Co. used it as a warehouse for its heavy wartime production.
In 1934, the year after repeal, the wine industry experienced mild prosperity. Steadily rising demand marked the following years. Because the wine supply exceeded demand from 1935 through 1941, the industry suffered from a poor financial situation, with 1938 being a more desperate year.
In 1938 several efforts were made to save the industry. The State of California originated a program to manufacture 45 per cent of the wine grapes into brandy. The United States Department of Agriculture purchased raisins for the relief and school lunch programs. It also established a marketing agreement for Tokay grapes.
Wine companies formed three groups: major wineries, including Roma, Italian Swiss Colony, Petri and other nationally-advertised companies, co-op wineries, and smaller wineries. Some of the latter two groups formed the Central California wineries, or C. C. W., which attempted to restore market order by controlling marketing and pricing. The Justice Department and congressional committees investigated alleged collaboration between C. C. W., the major wineries, and the Bank of America. Due to the investigations and improved market conditions, C. C. W. disintegrated and disappeared in 1941 or 1942.
In 1941 and 1942 large national distillers purchased major California wineries for comparatively high prices, although they were somewhat run-down physically. Little capital had been invested from 1938 through 1941. The distillers bought wineries primarily to retain or broaden their sales bases, there being the possibility of a continuing shortage of spirits. The influx of eastern capital tended to create, at least temporarily, a scarcity of good large operating wineries. All but one distiller later left the wine industry.
The wine industry is seasonal, the crushing period averaging 90 days beginning in late August or September. The 1941 crush was the largest on record: 1,120,000 tons. The 1942 crush was among the smallest: 610,000. The decrease was attributable to a War Food Administration order that all raisin variety grapes, a substantial tonnage of which are normally crushed, be converted into raisins. At the same time demand increased greatly due to increased expendable consumer income and scarcity of distilled spirits.
In May 1942 the Office of Price Administration established ceiling prices for sales of bulk and bottled wines based on the highest market price in March 1942. It never placed ceilings on sales of wineries. The first ceilings on bulk red sweet wine averaged 32 cents a gallon. In the fall of 1942, the ceiling was raised to range from 39 to 51 cents a gallon. The maximum ceiling on dry red or white wine varied from 24 to 27 cents a gallon. Ceilings on bottled wines varied more, some brands selling for as much as 50 cents a gallon more than others.
Some wineries arranged to have their wine bottled under brand names with higher ceilings by bottling it themselves or shipping it to a bottler to pack for them. The minimum price for sales of any volume late in 1942 was 75 to 80 cents. As the war continued, the reflected return for bulk wine ranged up to $3. Very little wine was sold at bulk ceilings. The ceiling on unfinished wine was removed from November 25, 1942 to February 15, 1943, when sweet wine sold for about 75 cents a gallon.
Most bottlers were located outside of California. Faced with diminishing supplies of bulk wine, bottlers communicated with California wineries by mail, telegraph, telephone, and in person to secure wine. They were, generally, unsuccessful because of the low ceilings.
Other bottlers obtained wine by purchasing wineries with their inventories. They purchased fifty or sixty wineries, representing more than half the volume of the industry, beginning in late 1942.
During this period new winery buildings and equipment were unobtainable. Some sales of wineries were made to bottlers and others not based entirely on a need for wine. Some purchasers retained the purchased facilities, either because they could not sell or did not want to sell.
In March 1943 Edward Bragno approached petitioner to purchase his winery. He was later joined by Joseph Gentile. Bragno primarily was trying to locate a supply of wine. Petitioner engaged an attorney to handle the negotiations, who held several conferences at his office and at the office of the attorney for the buyers. Besides the attorney, petitioner, Bragno, and Gentile, a representative of the Santa Fe Railway was sometimes present. The same attorney did not represent petitioner before the Alcohol Tax Unit.
Petitioner made only the down payment on the purchase of the ice plant. On January 31, 1943 he owed the railroad $50,000 principal and $2,000 interest, but had never been pressed for overdue payments. Since the railroad contracted to sell the ice plant at a bargain price to secure his extensive cannery shipping business, petitioner felt obliged to inform them of the impending sale. The railroad agreed to the assignment of the purchase contract to Bragno as of April 1, 1943. Petitioner did not condition his payments to the railroad on its acceptance of the assignment.
During the negotiations, questions of price and allocation arose. The attorney informed the buyers that petitioner would not sell above the applicable ceiling prices. He refused to look at an allocation prepared by the attorney for the buyer. After such conversations the agreement was executed. The attorney advised petitioner on April 2, 1943 to write to Bragno to confirm the allocation based...
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