Source: https://law.justia.com/cases/federal/appellate-courts/F2/260/489/428423/
Timestamp: 2019-04-19 16:43:40+00:00

Document:
James L. Wood, Los Angeles, Cal., for petitioner.
Charles K. Rice, Asst. Atty. Gen., Melvin L. Lebow, Lee A. Jackson, Harry Baum, Myron C. Baum, Attys., Department of Justice, Washington, D. C., for respondent.
These facts deal with the distribution of gasoline under a "master" supply contract between General Petroleum Corporation (hereinafter referred to as General) and Olympic Refining Company (hereinafter referred to as Olympic).
On the facts found, the Tax Court held that the agreement of July 26, 1950, was not intended to, and did not effect a sale or exchange by The Progress Co., a partnership (hereinafter called Progress), to Olympic of the former's rights under the Progress-Olympic contract, but was intended to terminate and cancel those rights. It held that under that contract, the rights of Progress "came to an end and vanished," and that there existed no sale or exchange essential as a basis for capital gain. Hence, the Tax Court affirmed the Commissioner's opinion that the amount received under this contract of July 26, 1950, was ordinary income, taxable as such.
If this contract be considered merely as an agreement whereby Olympic paid Progress (the partnership) and Olympic-Progress Oil Co., a second and separate corporation (hereinafter called Olympic-Progress), in advance, the estimated value of future income from the existing purchase and supply contracts between them, then tax on ordinary income was clearly payable.
"* * * [I]f one, entitled to receive at a future date interest on a bond or compensation for services, makes a grant of it by anticipatory assignment, he realizes taxable income as if he had collected the interest or received the salary and then paid it over. That is the teaching of Helvering v. Horst, 311 U.S. 112, 61 S. Ct. 144, 85 L. Ed. 75, and Harrison v. Schaffner, supra [312 U.S. 579, 61 S. Ct. 759, 85 L. Ed. 1055]; and it is applicable here. As we stated in Helvering v. Horst, supra, 311 U.S. 117, 61 S. Ct. 147, `The taxpayer has equally enjoyed the fruits of his labor or investment and obtained the satisfaction of his desires whether he collects and uses the income to procure those satisfactions, or whether he disposes of his right to collect it as the means of procuring them.' There the taxpayer detached interest coupons from negotiable bonds and presented them as a gift to his son. The interest when paid was held taxable to the father. Here, even more clearly than there, the taxpayer is converting future income into present income." Commissioner of Internal Revenue v. P. G. Lake, Inc., 1958, 356 U.S. 260, 267, 78 S. Ct. 691, 695, 2 L. Ed. 743.
It may well be, as argued by appellant, that there is a conflict in the different circuits as to what constitutes "ordinary income," on the one hand; and what constitutes capital gain from "the sale or exchange" of property within the meaning of § 117(a) (4) and (j), on the other. Respondent concedes it cannot distinguish Jones v. Corbyn, 10 Cir., 1950, 186 F.2d 450, but urges it was erroneously determined, and points out the strong dissent to it written by Judge Phillips, and the subsequent statement by Judge Swan of the Second Circuit in Commissioner of Internal Revenue v. Starr Bros., 1953, 204 F.2d 673, at 674: "With due deference to the majority opinion, we respectfully agree with Judge Phillips' dissent."
All other cases which are apparently in conflict with the result here reached in the Tax Court are sought to be differentiated by respondent on their facts; that they are cases involving the transfer, not of a mere or "naked" contractual right, but of an interest in property; "a more substantial property right which does not lose its existence when it is transferred." Commissioner of Internal Revenue v. McCue Bros. & Drummond, Inc., 2 Cir., 1954, 210 F.2d 752, 753. In other words, it is urged that certain rights continue to exist as property of the transferee-payor in those cases which find an exchange. Typical examples seem to be those cases involving a lease, i. e., the surrender by lessee of leased premises to lessor before the lease expires (Commissioner of Internal Revenue v. McCue Bros. & Drummond, Inc., supra; Commissioner of Internal Revenue v. Golonsky, 3 Cir., 1952, 200 F.2d 72); or a release from a lease's covenant restricting the lessor (Commissioner of Internal Revenue v. Ray, 5 Cir., 1954, 210 F.2d 390); or Commissioner of Internal Revenue v. Goff, 3 Cir., 1954, 212 F.2d 875, where the taxpayer had title to four hosiery manufacturing machines placed in a manufacturing plant, as well as the exclusive right to buy the output of those machines, and transferred both title and exclusive right to the manufacturer.
What property could Olympic be said to "acquire" by reason of the July 26, 1950 contract? The right to purchase from General Petroleum a maximum quantity of 3½ million gallons of gasoline a month? Olympic already had this right by reason of its contract of November 19, 1945, with General, as extended. That purchase and supply contract between General and Olympic was not affected in any way by the Mutual Termination Agreement. The purchase and supply contract existed as it always had, until terminated by General and Olympic five days later on July 31st, 1950.
"Undoubtedly the taxpayer's rights under the 1903 contract were property; and we will assume arguendo, as does the Commissioner, that they were a capital asset. The decisive issue is whether there was a `sale or exchange' of such capital asset when the contract was terminated in 1943. To refer to the contract as a grant of a `franchise' tends, we think, to becloud analysis of the legal relations. What the taxpayer gave in return for the cash payment was a release of United's contract obligations, chief of which was its promise not to sell its products to other dealers in New London. Such release not only ended the promisor's previously existing duty but also destroyed the promisee's rights. They were not transferred to the promisor; they merely came to an end and vanished." [Emphasis added.] Id. 204 F.2d at page 674.
"(j) Gains and losses from involuntary conversion and from the sale or exchange of certain property used in the trade or business.
"(1) Definition of property used in the trade or business. For the purposes of this subsection, the term `property used in the trade or business' means property used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 23 (l), held for more than 6 months, and real property used in the trade or business, held for more than 6 months, which is not (A) property of a kind which would properly be includible in the inventory of the taxpayer if on hand at the close of the taxable year, or (B) property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.
"(2) General rule. If, during the taxable year, the recognized gains upon sales or exchanges of property used in the trade or business, plus the recognized gains from the compulsory or involuntary conversion (as a result of destruction in whole or in part, theft or seizure, or an exercise of the power of requisition or condemnation or the threat of imminence thereof) of property used in the trade or business and capital assets held for more than 6 months into other property or money, exceed the recognized losses from such sales, exchanges, and conversions, such gains and losses shall be considered as gains and losses from sales or exchanges of capital assets held for more than 6 months. If such gains do not exceed such losses, such gains and losses shall not be considered as gains and losses from sales or exchanges of capital assets. * * *"
"The petitioners in each proceeding are husband and wife and residents of Los Angeles, California. They filed their income tax returns for the year 1950 with the collector of internal revenue for the sixth district of California. Marc D. Leh and David E. Brown will hereinafter be referred to as the petitioners.
"The Progress Company (hereinafter referred to as Progress) was a general partnership. The members of this partnership were Marc D. Leh and David E. Brown and they shared equally its profits and losses.
"Progress was formed in 1940 and thereafter engaged in various businesses, particularly businesses connected with the petroleum industry. Progress engaged in marketing petroleum products during 1947, 1948, 1949 and 1950.
"Olympic Refining Company (hereinafter referred to as Olympic) is a corporation engaged in marketing petroleum products.
"On November 19, 1945, Olympic entered into a supply contract with General Petroleum Corporation (hereinafter referred to as General) under the terms of which General was obligated to supply Olympic's requirements of gasoline and other petroleum products up to a maximum of 3,500,000 gallons of gasoline each month, and Olympic was obligated to purchase its entire requirements of gasoline from General without restriction as to quantity. The expiration date of the contract was January 1, 1951, but it contained a clause providing for automatic extension from year to year, subject to termination upon six months' notice by either party. This contract will hereinafter be referred to as the General-Olympic contract.
"During the years 1946 and 1947 Olympic's purchases from General averaged 1,000,000 to 1,250,000 gallons of gasoline monthly.
"`We are pleased to submit below our proposal to serve you with your requirements of our gasoline.
"`In consideration of the gasoline contract which we have entered into with your company as of this date, it is understood that, in the event the Olympic Refining Company extends and/or makes a contract for gasolines with the General Petroleum Corporation of California and/or any other supplier of petroleum products, The Progress Co. shall have an extension of its agreement on the same terms and conditions, with the exceptions noted in our agreement of this date.
"Prior to the execution of the Progress-Olympic contract, Progress and Olympic had entered into a `Distributor's Agreement' by the terms of which Progress was entitled to 350,000 gallons of gasoline per month. The `Distributor's Agreement' was assigned by Progress early in 1948 to Olympic-Progress Oil Co., a corporation controlled by petitioners Marc D. Leh and David E. Brown.
"Between 1948, when the Progress-Olympic contract was executed, and 1950, the gasoline market expanded, and by 1950, gasoline was in short supply in the Southern California area. General, as part of its policy of reducing its supply commitments, entered into negotiations with Olympic in 1950 seeking a reduction of its commitment under the General-Olympic contract, and Olympic, in turn, sought reduction or elimination of its commitment under the Progress-Olympic contract.
"`1. Each and all of said agreements above described are hereby mutually declared to be cancelled and terminated as of the close of business on the 31st day of July, 1950 and declared to be of no further force or effect.
"`2. First Party and Second Party hereby release and discharge Third Party and General Petroleum Corporation of and from any and all duties, claims, liabilities or obligations arising out of or in connection with said agreements above described or otherwise.
"`First Party agrees to pay said indebtedness or any remaining balance thereof to Third Party on or before the 3rd day of August, 1950.
"The amount of $183,330.50 was paid to Progress during 1950 by crediting this amount to its account with Olympic for gasoline theretofore purchased under the Progress-Olympic contract.
"On July 31, 1950, General and Olympic entered into an agreement which provided for the termination of the General-Olympic contract, and on August 1, 1950 they executed a new contract under the terms of which Olympic was entitled to purchase 1,750,000 gallons of gasoline per month. Olympic received from General approximately $235,000 at the time these agreements were executed.
It should be noted no exception is taken to the correctness of the Tax Court's Findings up to the point it found there was "no sale or exchange."
"Their forms do not control. Their essence is determined not by subleties of draftsmanship but by their total effect. See Helvering v. Clifford, 309 U.S. 331, 60 S. Ct. 554, 84 L. Ed. 788; Harrison v. Schaffner, 312 U.S. 579, 61 S. Ct. 759, 85 L. Ed. 1055;" Commissioner of Internal Revenue v. P. G. Lake, Inc., supra, 356 U.S. at page 267, 78 S. Ct. at page 695.
We incidentally call attention to the reasoning of Judge Swan (in Commissioner v. Starr Bros., supra) with respect to the effect of the absence of any specific statutory reference to contracts such as those here under consideration.
We also note as respectable authority the analogous line of cases holding that payment received for a covenant not to engage in competitive business was ordinary income, not gain realized on disposal of a capital asset. Helvering v. Salvage, 1936, 297 U.S. 106, 56 S. Ct. 375, 80 L. Ed. 511; Beals' Estate v. Comm'r, 2 Cir., 1936, 82 F.2d 268; Cox v. Helvering, D. C.Cir., 1934, 71 F.2d 987.
"* * * when the (reviewing) court cannot separate the elements of a decision so as to identify a clear-cut mistake of law, the decision of the Tax Court must stand. * * * The Tax Court is informed by experience and kept current with tax evolution and needs by the volume and variety of its work."

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