Court Opinion

ID: 4477115
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:12:22.375607+00
Date Added: 2024-06-11T14:53:54.691808
License: Public Domain

Bettce /., dissenting: Preliminarily I would like to point out, as was done by the.Supreme Court in Commissioner v. Wilcox, 327 U. S. 404, that “Moral turpitude is not a touchstone of taxability,” and that no “fall-out” from the “cloud” created by some of the questionable practices of petitioner’s officers should be allowed to permeate our thinking respecting the legal issues involved herein. I would also like to restate in more simple form the issues involved, as follows: 1. Whether the Commissioner correctly determined that petitioner could not capitalize the cost of settling a suit which represented a cloud on its title to certain real property. 2. Whether the Commissioner correctly determined that petitioner could not deduct a payment in satisfaction of its share of a tort judgment and related attorney’s fees. 3. Whether the Commissioner correctly determined that petitioner realized gain to the extent of the full sale price of certain stock which was acquired by gift from a donor whose basis is unknown. First Issue. The first issue involves petitioner’s right to capitalize the amount paid to settle an action brought to partially annul and rescind a conveyance by virtue of which petitioner claimed title to certain real property. The theory of the settled action was that the conveyance was a transfer in fraud of the grantor’s creditors. The conclusion seems inescapable, and the majority opinion does not hold otherwise, that the settled action represented a cloud on the petitioner’s title. It is well settled that the cost of defending and settling such an action “is a capital expenditure representing additional cost of the property.” Murphy Oil Co., 15 B. T. A. 1195, 1201, affirmed on this point (C. A. 9) 55 F. 2d 17. Cf Regs. 111, sec. 29.24-2; Agnes Pyne Coke, 17 T. C. 403, affd. (C. A. 5) 201 F. 2d 742; Levitt & Sons, Inc., 5 T. C. 913, 924-930, affd. (C. A. 2) 160 F. 2d 209. The majority opinion attempts to draw a distinction in the instant case on the ground that the settled action challenged the validity of -the original conveyance to petitioner. But the same can be said of virtually any suit representing a cloud on title whether it be predicated upon an alleged prior deed, mortgage, tax lien, or other right in the property attaching prior to the conveyance to the taxpayer. Unless the petition in the pending action alleges that the taxpayer’s grantor did not or could not convey a valid title, no cause of action would be stated. Furthermore, no reason appears for not allowing a taxpayer to capitalize the expense of removing a cloud on its title because of possible knowledge of the cloud at the time of the original conveyance. The majority opinion holds that petitioner acquired a basis in the entire property at the time of the original conveyance. This holding seems to ignore the entire rationale behind the rule allowing the capitalization of the expense of removing a cloud on title. The amount paid by a purchaser of property becomes the basis of only that interest in the property which is acquired.. An additional amount later paid to remove a cloud on the title is considered as payment for another outstanding interest in the property which increases both the purchaser’s total interest in the property and its cost basis. Here petitioner acquired Caldwell’s title to the property subject to the claims of Caldwell’s creditors. The amount paid or the value of the stock given in exchange for the property became the basis of only that interest in the property which was acquired. When petitioner compromised the creditor’s bill, it extinguished the creditor’s rights, thereby increasing its own interest in the property as well as its cost basis. The majority opinion states that petitioner is not entitled to a greater basis than that which reflected the entire property. No fault could be found with this statement if the entire basis is to be measured by the property acquired. Cf. Murphy Oil Co. v. Burnet, 55 F. 2d 17, cited in the majority opinion. Here, however, the proper basis is made up of petitioner’s cost. Except to the extent the value of the property received is considered in determining the value of the property given in exchange, a cost basis is in no way affected by the extent of the property interest acquired. Petitioner’s cost basis was the fair market value of the stock given for Caldwell’s interest (Hens & Kelly, Inc., 19 T. C. 305, 321), together with the amount paid the creditor for its interest. The basis of the property interest acquired from Caldwell was fixed by an agreement of the parties. The majority opinion evidently assumes that in agreeing to the basis of this interest respondent placed too high a value on the stock, which determined petitioner’s cost basis, because of a mistaken conception of the property interest acquired from Caldwell. If such were the case the fair market value of the stock should have been lowered and the basis adjusted downward ; but the fact that respondent has erroneously agreed to an excessive value for stock, representing the cost of one interest in property, is not a valid reason for disallowing the capitalization of the amount paid for another interest in property. Furthermore respondent has neither determined nor contended that the basis fixed by the agreement was erroneous but in fact has apparently conceded that it was correct. Under these circumstances it would seem highly improper for this Court to look behind that agreement and to assume that the basis agreed to was in error where the record does not even disclose the amount of the agreed basis or contain a scintilla of evidence indicating that it was erroneous. The holding in the majority opinion is apparently based upon the wholly unsupported fear that unbeknownst to the respondent he has made a mistake in agreeing to the cost of the interest acquired from Caldwell. The majority opinion attempts to counteract any such mistake by disallowing the capitalization of the cost of an additional interest in the property acquired 16 years later. This approach calls to mind the adage, “Two wrongs don’t make a right,” to which could be added the caveat, “especially where there is only an unfounded fear that the first wrong has been done.” The majority opinion states, as an alternative ground for its holding, that the settlement also benefited petitioner’s class B stockholders and that, in the absence of other evidence, no part of the settlement can be allocated to the settlement of the attack on petitioner’s title. Respondent has not raised this point, and the stipulation as well as the entire record indicates that petitioner was settling the action against it in order that it might remove the lis pendens and sell the property. Furthermore, the property or land was worth far more than the amount of the settlement. If the holding in the majority opinion is correct, that a compromise is a pro tanto confession of judgment, then by settling the action petitioner conceded that the land was subject to the creditor’s claim and this concession removed all challenge to the stock which the complaint prayed be sold only if the claim was not paid out of the proceeds from the sale of the land. For the sake of completeness I would also point out that respondent’s contention that the settlement was made in order to benefit James E. Caldwell by discharging his personal liability is manifestly untenable as James E. Caldwell had died 3 years prior to the settlement, leaving no assets and substantial liabilities. Likewise without merit is respondent’s contention that petitioner did not affirmatively disprove the allegations in the complaint filed by the First National Bank in St. Louis stating that the property was conveyed to petitioner in order to defraud the creditors of James E. Caldwell, and that petitioner should not be allowed to capitalize the cost of removing the cloud on its title arising out of a fraudulent transaction. Whether the allegations were true or false is in my opinion immaterial to the issue presented herein. I would hold that the petitioner clearly had the right to capitalize the expenditures as an addition to cost in the instant case. Second, Issue. The majority opinion holds that petitioner is not entitled to a deduction, under either section 23 (a) or section 23 (f) of the Internal Bevenue Code of 1939, for $123,116.81 paid in satisfaction of its share of a final judgment against it together with $1,500 in attorney fees. The basis for the holding appears to be that the transactions which gave rise to the judgment were not “in any way related to petitioner’s normal and legitimate [emphasis supplied] business operations.” Judgment was rendered against petitioner and other defendants in a case styled Dale v. Thomas H. Temple Co., 186 Tenn. 69, 208 S. W. 2d 344, in the approximate amount of $266,000. Subsequently, after negotiations with the other defendants known as the “Potter group,” the petitioner paid $123,116.81 as its share of the judgment and deducted the sum paid in its 1948 income tax return. Bespondent determined that the judgment represented a debt of individual stockholders of petitioner and for that reason disallowed the deduction. The facts, however, do not sustain respondent’s determination. It is undoubtedly true that the beneficial owners of a minority of petitioner’s stock were largely responsible for the perpetration of the fraud upon Apex and that petitioner’s role in the conspiracy was relatively minor. Nevertheless the Supreme Court of Tennessee held petitioner liable as a joint tort-feasor for the full amount of the judgment. As the owner of a substantial amount of property which could easily be subjected to execution and as the only solvent member of the Caldwell group, petitioner’s only alternative was to pay. It is not the petitioner’s culpability but his liability that determines his right to the deduction. North American Investment Co., 24 B. T. A. 419; Helvering v. Hampton, 79 F. 2d 358. Whether or not the transactions involved were legitimate is unimportant unless the allowance of the deduction would frustrate sharply defined national or State policies. The majority opinion has not found that to be, and in fact it is not, the case here. Even though the acts committed prior to the judgment were “nonmoral,” wrongful, or unethical, there would be no frustration of public policy in allowing deduction of the amount paid in satisfaction of a civil judgment making restitution for such acts. Commissioner v. Heininger, 320 U. S. 467; Helvering v. Hampton, supra. Section 23 (a) permits the deduction of “All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * *.” The argument that the expenditure was not incurred “in carrying on any trade or business” of petitioner because no corporate purpose was served by the diversion or misappropriation of the funds of Apex by the individual Caldwells is precluded by the findings and opinion of the Supreme Court of Tennessee in the case of Dale v. Thomas H. Temple Co., supra, holding that the petitioner was liable for the full amount of the judgment as a joint tort-feasor. Petitioner was organized to carry on a general investment business. The Supreme Court of Tennessee found that James E. Caldwell & Company was the parent corporation and the other “Caldwell Corporations” which were involved in the sale of the Apex stock were mere dummies wholly owned and completely dominated in the entire matter by the parent corporation. It further found that James E. Caldwell & Company “was incorporated to do the type of business that the sale of Apex stock represented.” The argument that the payment on the judgment by petitioner was not a “necessary” expense is likewise untenable. The judgment of the State court having become final, petitioner, being solvent, had no choice but to see that the judgment was paid or to suffer an execution to be levied against it. The majority has held that Helvering v. Hampton and Commissioner v. Heininger, both supra, are distinguishable on their facts, stating that there the liabilities were for “irregularities” in handling a lease and in conducting a sale, respectively, which were incidental to the normal business of the taxpayer. In my opinion both cases are particularly applicable under the facts presented in the instant case. As was said by the Supreme Court in the Heininger case, in holding as “ordinary and necessary” the expenses of unsuccessfully litigating a suit to set aside a fraud order of the Post Office Department, It is plain, that respondent’s legal expenses were both “ordinary and necessary” if those words be given their commonly accepted meaning. * * * Surely the expenses were no less ordinary or necessary than expenses resulting from the defense of a damage suit based on malpractice, or fraud, or breach of fiduciary duty. Yet in these latter eases legal expenses have been held deductible without regard to the success of the defense. [Emphasis supplied.] The circumstances of the instant case are more nearly comparable to those which existed in Helvering v. Hampton, supra, cited with approval by the Supreme Court in the Heininger case (320 U. S. 472, footnote 6). In that case the deduction claimed was for the amount paid in settlement of a judgment against the taxpayer-lessor and in favor of a lessee upon the cancellation of a lease, for fraud in negotiating for the lease. Tn the course of its opinion affirming an order of the Board of Tax Appeals allowing the deduction, the Ninth Circuit Court of Appeals said: Even if restitution for wrong in a private business transaction were regarded as infected by the wrong it seeks to cure, there are no decisions holding that a deduction for the amount restored should be denied. * * * ******* We cannot agree that private wrongdoing in the course of business is extraordinary within the meaning of the taxing statute allowing deductions for “ordinary and necessary expenses.” The statute itself makes no such exception, and since it is construable as we have interpreted it, that construction against the collector is required by the long-established rule of interpretation in taxing statutes. Miller v. Standard Nut Margarine Co., 284 U. S. 498, 508, 52 S. Ct. 260, 76 L. Ed. 422. In the instant case we hold that, even if unethical conduct in business were extraordinary, restitution therefor is ordinarily expected to be made from the person in the course of whose business the wrong was committed. It is therefore deductible under § 214 (a) (1). In my opinion Hales-Mullaly, Inc., 46 B. T. A. 25, affd. (C. A. 10, 1942) 131 F. 2d 509, upon which the majority relies is not in point. That case involved a suit arising out of acts committed prior to taxpayer’s organization. The Tenth Circuit Court of Appeals held that the amounts paid by the corporate taxpayer in settlement of pending litigation to recover damages sustained as a result of an alleged conspiracy of individuals related to the corporation were not deductible as ordinary and necessary business expenses because such a liability was not one reasonably to be anticipated in the taxpayer’s business. It will also be observed that the amounts there sought to be deducted were paid in settlement of pending litigation whereas the amounts here sought to be deducted were in payment of a judgment which had become final. In any event, on the question here presented, the Hales-Mullaly case is believed to be of dubious value as a precedent today, since on the main point decided similar reasoning therein relied upon was later rejected by the Supreme Court in Commissioner v. Heininger, (1943) supra. See also Kanne v. American Factors, 190 F. 2d 155, 160, footnote 2, criticizing the reasoning of the Hdles-Mullaly case as “without merit.” As stated above, the majority opinion also holds that section 23 (f), which allows the deduction by corporations of “losses sustained during the taxable year and not compensated for by insurance or otherwise,” does not apply because it was not shown that the transactions giving rise to the judgment were incident to the normal and ordinary conduct of petitioner’s business. Unlike section 23 (a) (1) (A), Congress has not made this a requirement of section 23 (f), and making it a prerequisite to a deduction under that section would appear wholly unwarranted. Cf. 1 Montgomery, Federal Taxes — Corporations and Partnerships 1948-1949, p. 638; Tye, “Bad Debts and Other Losses,” 6th Ann. FT. Y. U. Tax Inst. 695 (1947). See also North American Investment Co., supra; Champlain Coach Lines v. Commissioner, 138 F. 2d 904. The conclusion I have reached with reference to the treatment of the $123,116.81 makes unnecessary a determination of the question whether the sum paid was deductible as a loss under section 23 (f). See, however, William Zeigler, Jr., 5 T. C. 156; Robert S. Farrell, 44 B. T. A. 238; Charles R. Stuart, 38 B. T. A. 1147, including the administrative rulings cited therein; L. Heller & Son, Inc., 12 T. C. 1109. And compare this Court’s opinion in Adam, Meldrum & Anderson Co., 19 T. C. 1130, which was reversed (C. A. 2) 215 F. 2d 163, certiorari denied 348 U. S. 913, on the ground that the payment in that case should be capitalized and not for the reason that it would otherwise be erroneous to allow the deduction as a loss under section 23 (f). I would accordingly hold that the payment by petitioner of its share of the judgment awarded against it by the Supreme Court of Tennessee is deductible in full under the provisions of section 23 (a). For similar reasons I would hold that the $1,500 in legal fees expended by petitioner during the negotiations with the Potter group to determine what share of the judgment would be paid by each, is deductible as an ordinary and necessary business expense under section 23 (a). Helvering v. Hampton and Commissioner v. Heininger, both supra. Third Issue. The majority opinion has upheld respondent’s determination that petitioner realized gain to the full extent of the sale price of the Stock Yards stock. Section 111 (a) provides that “The gain from the sale or other disposition of property shall be the excess of the amount realized over the adjusted basis provided in section 113 (b) for determining gain * * Section 113 (b) refers to section 113 (a) which provides that in the circumstances here present the basis “shall be the fair market value of such property [the stock] as found by the Commissioner as of the date or approximate date at which according to the best information that the Commissioner is able to obtain, such property was acquired by such donor or last preceding owner.” (Emphasis supplied.) Therefore, under the pertinent statutory provisions a basis is a prerequisite for determining gain on the sale of property (cf. Burnet v. Houston, 283 U. S. 223), and the property or stock in question could not have a basis to exceed until the Commissioner made the proper finding. The majority opinion states that it was impossible for the Commissioner to find the fair market value of the stock, and therefore it was permissible for him to substitute a basis of zero for the basis provided in the statute. In Burnet v. Houston, supra, the Supreme Court said: We cannot agree that the impossibility of establishing a specific fact, made essential by statute as a prerequisite to the allowance of a loss, justifies a decision for the taxpayer based upon a consideration only of remaining factors which the statute contemplates. The definite requirement of section 202 (a) (1) of the act is not thus easily to be set aside. * * * Similarly, the impossibility of respondent finding a specific fact, made essential by the statute as a prerequisite to the determination of gain, which finding respondent alone is authorized to make, does not justify the respondent in substituting a basis of zero for the basis provided by statute. The definite requirement of section 113 (a) (2) of the 1939 Code is not that easily to be put aside. Where the taxpayer is unable to prove the amount of his statutory basis, he is not entitled to a loss; where the Commissioner is unable to make a finding which is necessary to establish the statutory basis, he is not justified in determining a gain. The holding in the majority opinion that the petitioner has the burden of proof is clearly correct, but its holding with regard to the factors petitioner must prove appears contrary to the terms of the statute. Petitioner has sustained its burden because the record shows that the Commissioner has not made the finding necessary to establish a basis without which there can be no gain. Petitioner is not required to prove the amount of a basis which, prior to a finding by the Commissioner, is nonexistent. A distinction must be made between an unknown basis and a basis which is nonexistent because the Commissioner has failed to perform his statutory duty. Moreover, there is nothing in the record which would indicate that it was impossible to find the fair market value of the stock around the time it was acquired by the donor or last preceding owner. One of petitioner’s officers testified on cross-examination that he had seen a record that the stock was acquired from the First Savings Bank and Trust Company. Whether the stock was acquired at that time by the donor or was acquired by the donor’s husband and later given the donor is immaterial. In either case the pertinent date is the time the stock was acquired from the bank. There is nothing in the record to indicate that the time of this transfer could not have been ascertained if the Commissioner had made any attempt to carry out the duty which the statute imposes upon him. If the Commissioner had attempted to carry out his duty, he probably would have found that there was no gain. The statement of petitioner’s counsel indicates that the stock was acquired sometime during the 1920’s and the testimony of one of petitioner’s officers would indicate that the stock was worth at least $10 per share throughout those years. If the Commissioner had found such to be the case, lie could have stopped there as the basis for determining gain would equal or exceed the sale price. Instead of attempting to make a iinding, the Commissioner arbitrarily treated the full amount of the sale price of $10 per share as gain. In no event could the gain have exceeded the difference between the sale price and the lowest fair market value of the stock between 1919, when the corporation was organized, and 1932, when the gift was made and, undoubtedly, the value of the stock was never lower than in 1932 when its fair market value Avas probably only slightly less than its book value of $3.40 per share. (See petitioner’s Exhibit 19.) In my opinion respondent’s determination of a deficiency herein, based upon the sale of the above stock, is without any foundation and is clearly arbitrary where it appears he made no finding of fair market value as of the pertinent date, the record contains no evidence whatever upon which such a finding could be predicated, and, in fact, contains no evidence whatever even as to what the pertinent date was, that is, the date the stock was acquired by the donor or last preceding owner by W'hom it was not acquired by gift. Neither party has called attention to any authority construing the pertinent language of section 113 (a) (2). The majority has referred' to none, and an extensive research has failed to reveal any. In my opinion, however, it is clear that where the statue places upon the Commissioner the duty of making a finding necessary to the establishment of a tax liability and his determination contains no such finding, the decision of the Commissioner cannot be regarded as making a prima facie case. See First National Bank of Boston v. Commissioner, (C. A. 1) 63 F. 2d 685, 693. The pertinent language of section 113 (a) (2) contemplates action by the Commissioner, not the taxpayer or the courts. Cf. Harden v. Commissioner, (C. A. 10, May 17, 1955) 223 F. 2d 418; Cornett-Lewis Coal Co. v. Commissioner, (C. A. 6) 141 F. 2d 1000, 1004. The petitioner is not required to show the correct amount of its gain. As was said in Helvering v. Taylor, 293 U. S. 507, “The fact that the Commissioner’s determination of a deficiency was arbitrarily made may reasonably be deemed sufficient to require the Board [Tax Court] to set it aside.” I would accordingly hold that the determination by respondent of a tax deficiency herein based upon the sale of the 2,081 shares of stock in the National Union Stockyards, Inc., was arbitrary and cannot be sustained. Helvering v. Taylor, supra; Durkee v. Commissioner, (C. A. 6) 163 F. 2d 184; Federal National Bank v. Commissioner, (C. A. 10) 180 F. 2d 494. For the foregoing reasons, I respectfully dissent from the opinion of the majority on all three of the issues presented. Ahundell and Johnson, JJ., agree with this dissent.