Court Opinion

ID: 4479280
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:13:34.779837+00
Date Added: 2024-06-11T07:57:16.341058
License: Public Domain

PiERCE, J., dissenting: The Supreme Court said in Griffiths v. Helvering, 308 U.S. 355: We cannot too often reiterate that “taxation is not so much concerned with the refinements of title as it is with actual command over the property taxed— the actual benefit for which the tax is paid.” Corliss v. Bowers, 281 U.S. 376, 378. And it makes no difference that such “command” may be exercised through specific retention of legal title or the creation of a new equitable hut controlled interest, or the maintenance of effective benefit through the interposition of a subservient agency. * * * I am impelled to dissent from the majority opinion herein, because I believe that inadequate effect was given to the foregoing principles, and that the case has been wrongly decided. /. The intricate series of transactions here involved is typical of a widely publicized tax avoidance plan, sometimes referred to as a “Bail-Out Plan” or a “Bootstrap Sale.”1 The objective of such a plan is to set up a procedure, whereby low-basis stockholders of a close corporation which has large accumulated earned surplus and prospects for good future earnings, might “bail out” these earnings and future profits at less than the normal tax cost, without disruption of the continued business operations, and with the “sellers” retaining their command and control over such operations while the bailout is in process. An indispensable feature of such a plan is a purported “installment sale” of the business to a tax-exempt charitable organization, through which the plan is operated and the future tax-free business profits are “channeled” back to the “sellers” — without the charity making any investment from its own assets or assuming any personal liability. Of course, the fact that the plan is devised for tax avoidance purposes is not alone sufficient to condemn it; but this factor does justify close scrutiny of what in reality has been done. As was recently said by the Court of Appeals for the Fifth Circuit in United States v. General Geophysical Co., 296 F. 2d 86: These tax avoidance implications do not constitute a license to courts to distort the laws or to write in new provisions; they do mean that we should guard against giving force to a purported transfer which gives off an unmistakably hollow sound when it is tapped. * * * II. What happened in the present case may be summarized as follows. The petitioners (consisting of Clay Brown, his wife and three children, and the two Booths — all of whom are herein referred to as the Brown group) owned all or substantially all the issued and outstanding shares of capital stock of Clay Brown & Company, which had certain lumber interests and operated a sawmill near Fortuna, California. The aggregate cost basis of the Brown group’s investment was only about $42,000; whereas the corporation had, as of January 31, 1953, an accumulated earned surplus of $448,472, and prospects for good future earnings as its timber was utilized and the lumber was sold. In the summer of 1952 Clay Brown, who was president of the company and also the representative of the Brown group, had a conference with a business promoter who supplied him with brochures pertaining to the bailout plan of procedure. These brochures pointed out the hazards of heavy tax penalties on the corporation for unreasonable accumulation of surplus, the “ruinous” possible effects of estate and income taxes if the Browns’ investment were retained in the business or current dividends were paid, and the advantages of using the bailout plan to relieve such situation. The upshot was that the Brown group decided to embark on such a plan; specific details for adapting the plan to the particular situation were worked out; a complicated set of interrelated legal instruments was drafted to give effect to the plan; and then, as of February 4,1953, the following steps were taken: (a) The Brown group endorsed and delivered all their shares of stock of Clay Brown & Company to the charitable organization here involved (called the institute), together with $125,000 face amount of promissory notes of said company that were then held by Clay Brown and his wife. The institute at the same time delivered to the Brown group, as purported consideration therefor, its “promissory note” in the face amount of $1,300,000, which was dated to mature about 10 years later, which was nonnegotiable and noninterest bearing; with respect to which the institute assumed no personal liability whatever for its payment; and on which payments were to be made solely out of so-called rentals derived from the future profits of the continuing business, in the manner more fully described. The institute invested none of its own assets in exchange for the stock; and indeed, it had no such assets available for investment, because its receipts came principally from donations made to it for charitable purposes. Clay Brown did not even inquire regarding its assets or its financial responsibility. (b) The institute as “buyer” of the stock, had no discretion whatever as to what disposition it might make of the property; for all details as to such disposition were specifically arranged and provided for in the various predrafted instruments of the plan. These included the following steps which were then followed: (1) The Clay Brown & Company was dissolved; (2) $5,000 of the underlying current assets were withdrawn and turned over to the Brown group as a “down payment,” in order to set up a purported “installment sale” for the transferred stock; (3) the remaining net current assets were “sold” for another promissory note to a new thinly capitalized corporation named Fortuna Saw Mills, Inc., which had theretofore been organized in the office of Clay Brown’s attorneys, for the specific purpose of taking over and continuing the operations of the former business of Clay Brown & Company; (4) all other assets of the business, both real and personal, were thereupon mortgaged back to the Brown group; and (5) these same assets were then “rented” by the institute to the new Fortuna company, under arrangements whereby 80 percent of the net profits of the business, before any allowances for depreciation or for State and Federal taxes, were to be distributed currently to the institute as “rentals,” and whereby 90 percent thereof were then to be paid over to the Brown group as purported “credits” on the above-mentioned $1,300,000 note. (c) Concurrently and as part of the plan, Clay Brown was employed as “general manager” for the new Fortuna company at an annual salary of $25,000; and further provision was made that, if for any reason he ceased to act as such, his successor would be selected by the Brown group. The powers given to Brown in such capacity were substantially the same as those which he had previously exercised as president of Clay Brown & Company. No property could be sold without his consent. When mortgage loans of the Clay Brown & Company were transferred into the name of the new company, Brown personally guaranteed them (for the entire capital stock of the new company was equal only to Brown’s first year’s salary). And Brown also, on another occasion, personally guaranteed a $50,000 bank loan to the ■ new company. The new Fortuna company took over and continued operation of the business, without interruption; and it thereafter continued to operate the same for about 4½ years on the same premises, with the same operating personnel, with both the control and management thereof in the hands of Clay Brown, and with no practical difference except as to name. During said period, it harvested over 20 million feet of timber from the interests which it had taken over from the Clay Brown & Company; and it currently paid out its profits, before depreciation and before taxes, in the manner above described. These operations continued until June 19,1957, when Fortuna Mills shut down its mill and permanently discontinued business. Thereupon, an appraisal was made of the remaining net assets of the business; and this revealed the salable value of the same to be about $300,000, as compared with the appraisal made prior to the purported “sale” of over $1 million. In July 1959, the entire remaining assets of the business were sold to a third party for $300,000; and out of the net proceeds, the Brown group then received 90 percent, and the institute received its familiar 10 percent. Thereafter, in accordance with a “settlement” between the Brown group and the institute, the $1,300,000 “promissory note” of the institute was canceled; and also all of the “mortgages,” “rental agreements,” “assignments,” and other instruments which had been employed under the plan, were likewise canceled. The net financial result of the plan’s operation was that the Brown group received out of its investment during the time that the plan was in operation, a total of $936,131.85; and the institute received nothing except its 10 percent withdrawals from the current distributions which passed through its hands. It is the above amount of over $900,000 which the Brown group has contended should be taxed at the preferred capital gains rates after spreading on the installment sale basis; and it is this amount also which the respondent determined should be taxed as ordinary income from the continued operation of the business, after adjustment for exhaustion of the Brown group’s original investment. III. When the foregoing intricate series of transactions are viewed in the light of their realities, when consideration is given to who had the command and control over the business, who bore the risks of its operation, and who was entitled to enjoy the substantial benefits therefrom — I believe the same will not support a conclusion that the business actually was “sold” to the institute, or that the Brown group received its share of the profits solely in the capacity of “creditors” of the institute. Moreover, it is doubtful whether there was any legally sufficient “consideration”2 delivered by the institute which would support a valid sale. It invested nothing out of its own assets; assumed no personal liability for payment of the $1,300,000 “promissory note”; and became entitled to receive only what was, in effect, a 10 percent “service fee” for its assistance in carrying out the plan. All acts done were for the primary benefit of the Brown group; and the institute was, in reality, merely an interposed subservient agency (see quotation from Griffiths v. Helvering, supra). In the leading case of Gregory v. Helvering, 293 U.S. 465, the Supreme Court refused to give effect to corporate transactions which complied precisely with the formal requirements for nontaxable corporate reorganizations, on the ground that the transactions had served no functions other than that of a contrivance to bail out corporate earnings to the sole shareholder at capital gains tax rates. In Commissioner v. Court Holding Co., 324 U.S. 331, the Supreme Court taxed a corporation on the gain from sale of an apartment house notwithstanding a transfer of the house to the corporation’s two shareholders before the sale, since it found that the transfer was made solely to set in a more favorable tax form, a sale which in reality was made by the corporation. Similarly, in Helvering v. Clifford, 309 U.S. 331, the Supreme Court taxed a trust grantor on the income of the trust property, since the formal transfer of the property by the grantor was lacking in substance. The Court found that the dilution of the grantor’s control seemed insignificant and immaterial, and that “since the husband retains control over the investment, he has rather complete assurance that the trust will not effect any substantial change in his economic position.” See also the recent case of Knetsch v. United States, 364 U.S. 361; Emanuel N. (Manny) Kolkey, 27 T.C. 37, 57-62, affd. 254 F. 2d 51 (C.A. 7); and the recent Fifth Circuit case of United States v. General Geophysical Co., supra. I would have held that the Brown group made no valid “sale” to the institute of their equity interests in the business. TURNER, Baum, Withex, Atkins, and Mulroney, JJ., agree with this dissent.   Moore and Dolían, “Sales, Churches, and Monkeyshines,” 11 Tax L. Rev., 87 (1956) ; Lanning, “Tax Erosion and the ‘Bootstrap Sale’ of a Business,” 108 TJ. P. L. Rev. 623 (I960) ; MacCracken, “Selling a Business to a Charitable Foundation,” U. of So. Calif., 1954 Tax Inst. 205, 209.    See in this connection, 1 Williston, Contracts, sec. 112, p. 445 (3d ed. 1957). There Wiliiston, in his discussion of consideration, gives the illustration of a man saying to a tramp : “If you go around the comer to the clothing shop there, you may purchase an overcoat on my credit.” fWilliston says that although the walk might be regarded as a legal detriment to the tramp, yet it is not “consideration” because, on a reasonable, interpretar tion, the walk was not requested as the price of the promise but merely as a condition of a gratuitous promise. See also Evans v. Rothensies, 114 F. 2d 958 (C.A. 3), wherein the taxpayer “sold” preferred stock to a penniless son-in-law, for a Joint-and-survivor annuity of slightly less than the dividends. .Nearly all the stock was held in escrow to secure the annuity, payments. The court held that the stock transfer was “hardly more than a gift,” with retention of a partial interest in the income from the stock for the lives of the “seller” and his wife.