Court Opinion

ID: 4478501
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:13:07.452195+00
Date Added: 2024-06-11T14:53:31.491391
License: Public Domain

PieRce, J., concurring in part and dissenting in part: Notwithstanding that I concur in the Court’s ultimate holding on each of the three issues stated in its Opinion (i. e., that the royalty payments involved in said issues are taxable as ordinary income, and not as capital gain), I am impelled to dissent from the Opinion in respect of issues 1 and 2 which pertain to the royalties which petitioners received under the intercorporate patent license agreement between Laundri-Matic Corporation and Hydraulic Brake Company (which license agreement was later taken over by Bendix Home Appliances, Inc.). I think that in deciding these two issues, the Court has begged the basic legal froblem presented, which is: Whether the Laundri-Matic transactions of July 17, 1936, and December 4, 1937, through which Chamberlin obtained the rights to the royalties involved (part of which rights he transferred to his wife), did as a matter of lato qualify as “exchanges of capital assets.” The Court has assumed or concluded, without statement of reasons (and I believe erroneously), that the transactions did so qualify; and then, based on such assumption, has arrived at its ultimate holdings through consideration of various other factual and legal problems (which I think should not have been reached or decided), such as: Whether the proceeds of such assumed “exchanges” were susceptible of valuation in 1936 and 1937; whether the petitioners bore their burden of proving that such proceeds were not susceptible of valuation; whether the case falls within “an exception to the usual tax treatment of such an exchange”; and whether a deemed rationale of the decisions in Burnet v. Logan, 283 U.S. 404, and certain other cited cases, is here applicable. I think that in making said basic assumption, the Court has viewed the 1936 and 1937 transactions too narrowly, as though they were isolated deals between Laundri-Matic and Chamberlin alone (which was not so); has failed to give effect to all the evidence; and has placed too much emphasis on mere forms and formalisms, as distinguished from what actually was done. 1. Whether a particular transaction qualifies as an “exchange of capital assets,” is a question of law; and, when presented by the pleadings (as it was presented here as the starting point in a capital gains problem) it should be resolved by applying the law to all the material facts and surrounding circumstances disclosed by the record. In the instant case the record, including more particularly Chamberlin’s own pleadings and testimony and also both instruments of “assignment” that were obtained by him, clearly discloses the history, character, purpose, and effect of said 1936 and 1937 transactions; and, in my view, definitely shows that they were not “exchanges of capital assets.” Rather their true character and effect was as follows: Neither of the transactions of July 17, 1936, and December 4, 1937, was an isolated transaction between Laundri-Matic and Cham-berlin alone; rather, each was part of a prearranged plan worked out by all the stockholders of Laundri-Matic including Chamberlin, at a meeting held on or shortly before July 17, 1936, under which most of the anticipated future income of said corporation from its patent license agreement with Hydraulic was “assigned” by Laundri-Matic to its stockholders, in shares proportionate to their respective equity interests in the corporation, solely for the stockholders’ own personal benefit and for no business purpose. Another feature of said plan was, that the corporation would not be dissolved or be either partially or wholly liquidated; and the reason for this was that the continued existence of Laundri-Matic was necessary for the continued protection of the “assignees,” because the corporation was the licensor under the patent license agreement, the royalties were payable to it under the terms of the agreement, and only by reason of its direction and request were such royalties to be withheld at their source and be paid directly to the holders of the instruments of “assignment.” The principal effects of said 1936 and 1937 transactions were, that the corporation’s anticipated income which normally would be available for dividend distributions, was earmarked in advance for distribution to the then stockholders, by name and in fixed proportions, rather than being left for distribution in respect to the shareholdings at the time when such income was realized; and that, as before stated, such future income of the corporation was, in accordance with its prearranged direction and request, withheld at its source and paid directly to the holders of the “assignments.” Each instrument of “assignment” obtained by a stockholder, evidenced an interest in the corporation’s future income, which was proportionate to such stockholder’s equity interest in the corporation; and, under the original plan, as each “assignment” was delivered to a stockholder, the number of shares of stock which he then held was to be correspondingly decreased. Also, each instrument of “assignment” was transferable, in the same manner as the certificates of stock; and, unlike assignments of accounts receivable which would gradually decrease in value as payments thereon were received, these instruments of “assignment” would, like the shares of stock, increase in value as the flow of royalties thereunder increased or gave prospect of increasing. Also the holders thereof, like the holders of shares of stock, carried the risks of the Laundri-Matic business fortunes, which in turn depended upon the success of the management, advertising, and sales activities of Hydraulic and Bendix. Viewing actualities, as distinguished from the prearranged forms and formalisms employed, these instruments of “assignment” were merely substituted evidences of the same proportionate equity interests in Laundri-Matic Corporation. It is true that the “assignments” apparently carried no voting rights. But this would appear to be a matter of lesser importance; for Laundri-Matic, at the time when the instruments of “assignment” were delivered, had subjected its patents to an exclusive patent license agreement that was to operate in perpetuity so long as the licensee continued to manufacture and sell thereunder; its operations had been reduced to little else than holding the long-term patent license agreement, accruing the income therefrom, and seeing that such income was paid directly to holders of the instruments of “assignment,” in accordance with its directions. Thus no active participation by the equity holders was necessary. The fact that the corporation remained in existence only to maintain a stock transfer book and the license agreement, is immaterial; for the relationship between it and its equity holders continued, and any distributions of income to the equity holders would be in performance of the obligation owed by the corporation to them. United States v. Joliet & C. R. Co., 315 U.S. 44. Also, in considering dealings between a corporation and its equity holders, neither the name nor the form of the instruments by which the equity interests are evidenced is a controlling factor; nor is it important whether such instruments carry all the privileges normally attributable to shares of stock. See Emanuel N. (Manny) Kolkey, 27 T.C. 37, 57-58, affd. (C.A. 7) 254 F. 2d 51.1  2. As regards the transactions on July 17, 1936, there is another and even more cogent reason why these cannot qualify as an “exchange of capital assets.” Such reason is that, in said transactions, neither Chamberlin nor any of the other stockholders except Scott, actually surrendered, transferred, or caused to be canceled, any of their shares of stock as had originally been planned. The exception with respect to Scott, who was not one of the four original stockholders of Laundri-Matic and who enjoyed only a temporary in-and-out participation in the corporation, was due to special circumstances described in Chamberlin’s testimony, which are not here pertinent and need not here be reviewed. In said 1936 transactions, 82 per cent of the anticipated future royalty income of Laundri-Matic was “assigned” by it to its stockholders, as is stated by Chamberlin in his pleadings; and Chamberlin obtained an instrument of “assignment” evidencing his right to receive 20 per cent of the same. It is this “assignment” upon which he here relies to obtain capital gains treatment for the royalties which he received in 1947, 1948, and 1949. But, notwithstanding the original plan that Chamberlin and the other three original stockholders would surrender corresponding portions of their shareholdings, none of them did so. To the contrary, each of these original stockholders including Chamberlin, continued to retain all his shares. And about iy2 years later, when another meeting of the Laundri-Matic stockholders was held and additional “assignments” of anticipated income of that corporation were authorized, all these original stockholders continued to act in the capacity of stockholders; and they then executed a written endorsement appearing on the additional instrument of “assignment” which Chamberlin obtained, wherein they represented that they held all the shares of the corporation’s stock, in the identical share amounts, which they had held prior to the earlier 1936 transactions. Even if said stockholders had carried out their original plan of surrendering part but not all their shares, this would not have effected an “exchange of capital assets”; for they would still have continued to hold substantially the same equity interests as stockholders, even though the same would have been evidenced by fewer shares. There would simply have been a bookkeeping revision of the corporation’s capital accounts (a reduction of outstanding shares, as distinguished from a stock split), with the stockholders continuing to hold the same proportionate equity interests. But in the 1936 transaction as it actually was carried out, there was no adjustment whatever of the shares of the original stockholders, including Chamberlin. Thus I think there can be no possible justification for concluding that there was an “exchange of capital assets” by Chamberlin; and that the Court’s contrary assumption in its Opinion is unwarranted. 3. As regards the later transactions on December 4,1937, these likewise were not isolated dealings between Laundri-Matic and Cham-berlin alone. Bather, as revealed by Chamberlin’s pleadings, an additional 12 per cent of Laundri-Matic’s anticipated future income was at that time “assigned” by it to its stockholders, pursuant to a meeting of the stockholders held on that date; and Chamberlin thereby obtained an additional 6 per cent interest in such income. Neither the minutes of said stockholders meeting, nor the stock record books, nor any of the corporation’s accounts were offered or received in evidence; and also there is little or no testimony, other than legal conclusions that there was an “exchange,” which bears on what actually took place at that meeting. Chamberlin stated in his pleadings that “a further distribution in liquidation” was there authorized; but the corporation was not dissolved, and it was not either partially or wholly liquidated. To the contrary it continued to operate in accordance with the plan agreed upon at the meeting of the stockholders which preceded the prior assignments in 1936; and it retained the right to the unassigned portion of its future income. The new instruments of “assignment” were in form identical to the previous ones; they operated in the same manner; and they evidenced merely a repeat transaction under the original prearranged plan. There is evidence that, about 3 days after the new “assignments” were delivered, Chamberlin endorsed (and presumably delivered) to Laundri-Matic, his certificate for all his 26 shares of stock, which had been issued to him through certificate No. 1 on December 14, 1935. But, again looking to substance as distinguished from mere formalisms, this had little substantial effect. By that time, 94 per cent of the corporation’s anticipated income for an indefinite future period, had been drained off by the “assignments”; the corporation had no active business operations, other than to hold the license agreement which was to operate in perpetuity so long as the licensee or its successors continued to manufacture and sell thereunder; and the holders of the instruments of “assignment” had already made arrangements, satisfactory to them, for continuing the existence of the corporation, primarily for their benefit. Thereafter, as before suggested, the holders of such “assignments” were the ones who carried the risks of the corporation’s fortunes; they were entitled to receive substantially all the royalty income which Laundri-Matic thereafter realized; and actually, they were the true equity owners. In such circumstance, it made little practical difference how their equity interests were evidenced.2  Moreover, at the time when these additional instruments of “assignment” were delivered, “the umbilical cord between it [the corporation] and the stockholders * * * [had] not been cut” (quotation from United States v. Joliet & C. R. Co., supra); for these additional instruments of “assignment” were authorized by Chamberlin and the three other original stockholders, in the capacity of stockholders, at the stockholders meeting on December 4, 1937; and the “assignments” as before noted, bore endorsements of consent signed by said individuals as stockholders, in which they represented that they were all the stockholders of said corporation at the time the instruments were delivered. Such delivery did truly represent “a further distribution” to the stockholders; but it was not “in liquidation,” as pleaded. I think the subsequent surrender of shares under the circumstances here present, cannot as a matter of law qualify as an “exchange of capital assets” within the meaning of the Internal Revenue Code. The decisions in Burnet v. Logan, supra, and the other cases cited in the Court’s Opinion, are not apposite in a situation like the present. The more pertinent legal principles are those which were stated and applied in United States v. Joliet & C. R. Co., supra; Helvering v. Horst, 311 U.S. 112; Burnet v. Wells, 289 U.S. 670; Gregory v. Helvering, 293 U.S. 465; and Emanuel N. (Manny) Kolkey, supra. Both Chamberlin and his wife, in the separate income tax returns which they filed for the year 1947 (which is the first year here involved), reported the Laundri-Matic royalties which they received in said year, as ordinary income. The Commissioner thereafter, in his notices of deficiency for all years involved, determined that such royalties were ordinary income. Similarly, this Count has now held that they were ordinary income — with which holding I agree, except that I believe it should have been based on the more basic reason above mentioned, that such royalties were not received pursuant to any “exchange of capital assets.” The importance of determining the true character of the transactions of 1936 and 1937 is, that the question of whether these transactions did as a matter of law qualify as “exchanges of capital assets,” is a continuing one. Five stockholders participated in these transactions ; the various instruments of “assignment” which they obtained therein are transferable, as is shown by the transfer to Chamberlin’s wife; and the period during which the “assignments” are to remain operative is continuous, so long as the licensee of the patent license agreement (or its successors) manufactures and sells machines thereunder. Since the Court has decided the present case largely on a burden-of-proof basis, after having assumed, that the 1936 and 1937 transactions qualify as “exchanges of capital assets,” a continuance of litigation directed toward a curing of such procedural defect (but with the above-mentioned basic legal problem still lurking and unsettled), can be anticipated. I think the Court could and should have here decided such basic problem; and thereby have quieted this area of further controversy.   It is doubtful whether, as a matter of law, the present instruments of “assignment” can have any validity, except as substituted evidences of the holders’ equity interests in Laundri-Matic; or whether such “assignments” can, as a matter of law, provide the “consideration” for any exchange of capital assets. The income of all corporations is subject to claims for taxes and claims of creditors— both of which have priority over the interests of the equity owners. Anticipatory assignments of income by a corporation, which are not made pursuant to a plan for liquidation, do not eliminate the corporation’s liability for income taxes on such income. United States v. Joliet & C. R. Co., 315 U.S. 44. Nor do they eliminate the potential secondary liability for such taxes, in those who received the income without adequate consideration. I believe that in situations like the present, where stockholders acting in their capacities as stockholders cause the corporation to assign to them its income for an indefinite future period (in this case 94 per cent of such income), such stockholders cannot avoid the above-mentioned principles of corporation law and tax law, merely by their subsequent surrender to the corporation (by agreement or otherwise) of their shares of stock from which the income potential has been shorn (or indeed by the surrender of any other property), as purported “consideration” for the anticipatory assignments. Such “assignments,” if they have any validity at all, are distributed by the corporation pursuant to the obligation owed by it to its stockholders, under the corporation-stockholder relationship ; and they cannot properly be deemed or regarded to be the quid pro quo for any sale or exchange of property. If this were not so, the stockholders of any close corporation could, after authorizing “assignments” to themselves of substantially all the corporation’s income for an indefinite future period, surrender to the corporation some property of uncertain value; thereby establish an “exchange” of capital assets which are considered to have “no ascertainable values”; and thereafter, not only escape all the priorities and obligations attaching to equity ownership, but also obtain capital gains treatment on the income which flows to them from the corporation’s continued operation.    See footnote 1 supra.