Court Opinion

ID: 4483453
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:16:06.865954+00
Date Added: 2024-06-11T15:04:27.352002
License: Public Domain

Fay, J., dissenting: I cannot agree with the majority’s reasoning and therefore respectfully dissent from its conclusion that the entire loss realized by petitioner as a result of the transactions which occurred in this case is a capital loss. As the path charted by the majority is not a model of clarity, I believe it appropriate at this juncture to retrace its steps in order to point out where I believe the majority stumbled on its journey. Under the majority’s view, the proper conclusion or destination in this case, is that a sale or exchange of a capital asset (petitioner’s Gulf stock) occurred, and the only loss involved was attributable to that sale or exchange. To reach this preordained destination, the majority begins by finding that petitioner’s Gulf stock constituted a capital asset in its hands. Next, it reasons that the execution of the March 1970 contract constituted a sales agreement in which petitioner agreed to transfer its Gulf stock in consideration for certain benefits.1 Finally, the majority interprets the subsequent transfer by petitioner of its Gulf stock in satisfaction of a warranty contained in the March 1970 contract as merely the delivery of the stock contemplated by the purported sales agreement. In other words, the majority broadly views these steps: the finding that petitioner’s Gulf stock constituted a capital asset in its hands, a finding of consideration for petitioner’s alleged promise to transfer its Gulf stock, and the actual transfer of such stock, as constituting a single integrated capital transaction in which petitioner sustained only a capital loss. In my opinion, the majority’s path to decision is no path at all. Rather, it merely represents an unrealistic attempt to oversimplify what is in fact a very complex factual situation. While the majority correctly characterizes petitioner’s Gulf stock as a capital asset, I believe its finding that the March 1970 contract should be considered as an agreement by petitioner to transfer its Gulf stock in exchange for certain benefits is untenable. First, as the trial judge in this case, having had the opportunity to consider the demeanor and credibility of the witnesses who testified, I am firmly convinced that the execution of the March 1970 contract was not contemplated by petitioner as a step in a master plan to dispose of its Gulf stock. To the contrary, I think the parties to the contract believed that Gulf would be a successful venture and that petitioner would retain its Gulf stock. Secondly, the March 1970 contract contained no requirement that petitioner transfer its Gulf stock either to Associated or Gulf in any event. The only relevant obligation imposed upon petitioner under the contract was that if, as of June 30,1970, the net worth of Gulf was less than $2,500,000, then petitioner was required to contribute one-half of such deficiency to Gulf. With respect to the mode of payment, petitioner had the option of contributing cash or Gulf stock at book value. This obligation was nonrecourse and secured by a pledge of petitioner’s Gulf stock as collateral. Thus, on the date the March 1970 contract was executed, petitioner neither intended nor was obligated to transfer its Gulf stock.2  My third difficulty with the majority’s finding that a sale or exchange of petitioner’s Gulf stock is embodied in the March 1970 contract, concerns the majority’s theory of consideration. Absent a foreclosure or other such “sale,” consideration is a necessary element of a sale or exchange. Smith v. Commissioner, 66 T.C. 622 (1976); compare Helvering v. Hammel, 311 U.S. 504 (1941); Russo v. Commissioner, 68 T.C. 135 (1977). The majority’s theory of consideration is that “petitioner bargained for benefits for its undertakings to transfer its shares in Gulf, both initially and by way of implementation of the warranty which it gave, and that it should be considered as having agreed to transfer its Gulf stock in exchange for such benefits.” The benefits alluded to by the majority concern petitioner’s sale of its Texas property to Gulf and certain contingent stock rights granted petitioner under the contract. However, a more careful analysis of the particular points upon which the majority relies, reveals that petitioner had no intention of transferring its Gulf stock in consideration for these benefits. To begin, pursuant to the March 1970 contract, petitioner sold its Texas plant facilities to Gulf for $610,000. The majority would view the $610,000 not only as consideration to petitioner for the transfer of the Texas property, but also as consideration for an agreement by petitioner to transfer its Gulf stock. In support of this conclusion the majority relies on the fact that petitioner reported a profit of $33,700 from the sale of its Texas property on its Federal income tax return. This view is not only illogical but is contrary to the evidence presented. Clearly, the $610,000 paid to petitioner represents consideration for the transfer of its Texas plant to Gulf. The relevant inquiry, however, is not whether petitioner made a profit on this sale, but whether any portion of the $610,000 paid for the property was in excess of the fair market value of the property on the date it was transferred. If, for example, the fair market value of the property was $500,000, the $110,000 excess ($610,000 minus $500,000) could be said to represent consideration for petitioner’s transfer of its Gulf stock. However, there is no direct or indirect evidence to indicate that such is the case.3 Absent such evidence, the $610,000 paid for the property should be presumed to equal its fair market value. See Philadelphia Park Amusement Co. v. United States, 126 F. Supp. 184 (Ct. Cl. 1954); cf. United States v. Davis, 370 U.S. 65 (1962). Since the $610,000 amount cannot be shown to have exceeded the fair market value of the Texas property, I believe it error for the majority to designate some portion of this amount as consideration for petitioner’s alleged promise to transfer its Gulf stock. Next, the majority purports to find consideration for the exchange from petitioner’s contingent right to the return of 2,000 of the 4,000 shares of Gulf stock that petitioner transferred to Gulf under the March contract, and from petitioner’s contingent right to acquire an additional 1,000-4,000 shares of Gulf stock at $50 per share. I find this most confusing. It is true that petitioner transferred 4,000 shares to Gulf in March 1970 and could reacquire up to 6,000 shares of Gulf stock upon the occurrence of certain contingencies and the payment of up to $200,000. Under the majority’s theory of consideration, however, petitioner transferred, under the March 1970 contract, its remaining 18,000 shares of Gulf stock in exchange for contingent rights to acquire 6,000 shares of the same stock at a cost of $200,000.4 As such, the majority’s theory simply makes no sense. Nor does it credit petitioner’s officers or board of directors as having any business sense whatsoever. In fact, one officer-director of petitioner, who took part in the negotiation of the March 1970 contract, testified at trial and was found by the Court to be an astute businessman. Furthermore, the majority’s theory of consideration is inconsistent with its own result. There is no dispute between the parties that the aggregate amount of petitioner’s loss was $254,518. Petitioner’s basis in its Gulf stock was also $254,518. The majority indicates (on p. 627 of its opinion) that the consideration petitioner received for its 18,000 shares of Gulf stock was equal in value to such stock. Assuming, for purposes of illustration only, that the fair market value of petitioner’s 18,000 shares of Gulf stock was $125,000, petitioner’s loss on the disposition of such stock, under the majority’s approach, would have been $129,518 ($254,518 basis minus $125,000 fair market value of consideration received) with no other loss being sustained. Of course, this is contrary to the majority opinion which indicates that petitioner’s realized loss was $254,518, as agreed by the parties.5  Based on the foregoing, I submit the majority’s view of the March 1970 contract as an agreement by petitioner to sell or exchange its Gulf stock is erroneous, and its conclusion based on such view therefore wrong.6  In lieu of the majority’s approach, I would view the payment by petitioner of its warranty obligation and the disposition of its Gulf stock as two transactions, each having its own tax consequences. While both transactions arise from the same contract, viewing them separately is not unusual. In many instances what appears to be one transaction is actually two separate transactions which happen to occur at the same time. For example, suppose a corporation, C, engages the services of an individual, I, as an employee for 1 week and pays I for his services with 10 shares of XYZ stock having a fair market value of $650 and a basis of $600 to C. Two transactions have occurred. First, C has made an exchange of its XYZ stock for I’s services. Thus, C has realized a capital gain of $50 on the disposition of its XYZ stock. Secondly, C has incurred an ordinary and necessary business expense for I’s salary and is entitled to a deduction equal to the fair market value of the stock ($650). The symmetry of this is illustrated by the fact that C began with a $600 investment, and as a result of the foregoing transactions, realized a $50 gain and is entitled to a $650 deduction. This approach is also in accordance with the decided cases. See, e.g., Santa Anita Consolidated, Inc. v. Commissioner, 50 T.C. 536 (1968). As a further illustration of this principle, assume (for the purpose of this example only) that Lenway, as the result of a valid business transaction, became obligated under the warranty provisions of a contract between itself and Associated to pay Gulf $100,000. Assume further that the Gulf stock held by Lenway had a fair market value of $100,000 and a basis of $250,000 in Lenway’s hands. Now, if Lenway sold its Gulf stock to an unrelated third party, X, for $100,000 and used the money to pay its warranty obligation, what should the result be? As in the first example, two transactions have occurred. First, Lenway has realized a $150,000 capital loss on the sale of its Gulf stock to X ($250,000 basis — $100,000 amount realized). Secondly, when Lenway pays the $100,000 to Gulf in satisfaction of its obligation to Associated, Lenway has realized an ordinary loss of $100,000 — the amount of money paid. Thus, Lenway began with a $250,000 investment, realized a $150,000 capital loss on the sale of its Gulf stock to X, and an ordinary loss of $100,000 on payment of an obligation. The only difference in the facts as they actually occurred in the case as opposed to the preceding illustration is that rather than selling its Gulf stock to a third party and paying Gulf with the proceeds, Lenway merely transferred the stock directly to Gulf. Admittedly it is conceptually more difficult to separate the two transactions where the identity of the transferee of the stock and the recipient of the warranty payment are one in the same. Nevertheless, the fact remains that two transactions have occurred and should be treated accordingly. With respect to the loss realized by petitioner on the disposition of its Gulf stock, I too believe this constituted a sale or exchange resulting in a capital loss to petitioner, but for reasons which differ from the majority opinion. The majority holds that petitioner received consideration for a transfer of its Gulf stock in March via certain benefits under the contract. I believe that petitioner transferred its Gulf stock for consideration in September 1970, the consideration being the extinguishment of a nonrecourse debt obligation created by the March 1970 contract. It is well established that if a taxpayer is personally liable on a debt and transfers property to the creditor in satisfaction of that debt, the consideration that flows to the taxpayer is the cancellation of the debt and the transaction constitutes a sale or exchange. E.g., Kaufman v. Commissioner, 119 F.2d 901 (9th Cir. 1941), affg. a Memorandum Opinion of this Court; Rogers v. Commissioner, 103 F.2d 790 (9th Cir. 1939), affg. 37 B.T.A. 897 (1938), cert. denied 308 U.S. 580 (1939); Unique Art Manufacturing Co. v. Commissioner, 8 T.C. 1341 (1947); Peninsula Properties Co. v. Commissioner, 47 B.T.A. 84 (1942). However, where the obligation is nonrecourse and the taxpayer abandons the underlying secured property or transfers it to the creditor (or to a third party at the direction of the creditor) in satisfaction of the obligation, it has not been clear, for the limited purpose of determining the presence of a sale or exchange, whether the taxpayer has received any consideration solely by virture of the satisfaction of the debt, since he was never personally obligated thereon. In Jamison v. Commissioner, 8 T.C. 173 (1947), we held that a conveyance of land to the local municipalities involved for the delinquent real estate taxes thereon, which were not the personal obligation of the owner under the applicable State law, was not a sale or exchange. We based our decision on the premise that since the taxpayer was not personally liable for the real estate taxes, no consideration flowed to the taxpayer on the conveyance of the property. At the time, our decision was in accord with the view of other courts. See Commissioner v. Crane, 153 F.2d 504 (2d Cir. 1945), affd. on other grounds 331 U.S. 1 (1947); Stokes v. Commissioner, 124 F.2d 335 (3d Cir. 1941); Polin v. Commissioner, 114 F.2d 174 (3d Cir. 1940). Shortly after our decision in Jamison, however, the Supreme Court handed down its landmark decision in Crane v. Commissioner, 331 U.S. 1 (1947). In Crane, the taxpayer by bequest, acquired an apartment building subject to an unassumed mortgage. Subsequently, the taxpayer sold the property to a third party, still encumbered, for a small amount of cash. The taxpayer contended that the small amount of cash was all she realized from the sale. In rejecting this contention and including the amount of the mortgage in the taxpayer’s amount realized under the predecessor to what is now section 1001, the Court observed: we think that a mortgagor, not personally liable on the debt, who sells the property subject to the mortgage and for additional consideration, realizes a benefit in the amount of the mortgage as well as the boot. If a purchaser pays boot, it is immaterial as to our problem whether the mortgagor is also to receive money from the purchaser to discharge the mortgage prior to sale, or whether he is merely to transfer subject to the mortgage — it may make a difference to the purchaser and to the mortgagee, but not to the mortgagor. Or put in another way, we are no more concerned with whether the mortgagor is, strictly speaking, a debtor on the mortgage, than we are with whether the benefit to him is, strictly speaking, a receipt of money or property. We are rather concerned with the reality that an owner of property, mortgaged at a figure less than that at which the property will sell, must and will treat the conditions of the mortgage exactly as if they were his personal obligations. If he transfers subject to the mortgage, the benefit to him is as real and substantial as if the mortgage were discharged, or as if a personal debt in an equal amount had been assumed by another. [331 U.S. at 14; fn. refs, omitted.] Subsequent cases dealing with the concept of “amount realized” under section 1001(b) have broadly construed this language in Crane to require inclusion of such indebtedness in the taxpayer’s amount realized on the disposition of encumbered property. See, e.g., Johnson v. Commissioner, 495 F.2d 1079 (6th Cir. 1974), affg. 59 T.C. 791 (1973), cert. denied 419 U.S. 1040 (1974); Teitelbaum v. Commissioner, 346 F.2d 266 (7th Cir. 1965), affg. a Memorandum Opinion of this Court; Parker v. Delaney, 186 F.2d 455 (1st Cir. 1950), cert. denied 341 U.S. 926 (1951); Millar v. Commissioner, 67 T.C. 656 (1977); Woodsam Associates, Inc. v. Commissioner, 16 T.C. 649 (1951), affd. 198 F.2d 357 (2d Cir. 1952). Nevertheless, the foregoing language utilized by the Supreme Court in Crane has not been interpreted until now as also establishing that a sale or exchange occurs solely upon the abandonment or transfer to the creditor of property pledged as security for a nonrecourse obligation. See Fox v. Commissioner, 61 T.C. 704, 715 (1974);7 cf. Parker v. Delaney, supra. In fact, the opinion by the Second Circuit Court of Appeals in Crane, contains language to the contrary. See Commissioner v. Crane, supra. In the present case, petitioner transferred a capital asset in satisfaction of a nonrecourse obligation. The amount of such obligation became fixed at an amount equal to the fair market value of petitioner’s Gulf stock on the date petitioner notified Associated of its election not to transfer cash to Gulf.8 It seems anomalous to me in light of the Supreme Court’s decision in Crane, as subsequently applied by the courts, that such amount constitutes petitioner’s “amount realized” under section 1001(b) on the disposition of its Gulf stock, but does not constitute consideration received by petitioner for purposes of the sale or exchange requirement of sections 1211 and 1222. Indeed, I find the distinction, if any, is without substance.9  Thus, in view of the foregoing and upon my reexamination of the basis of our decision in Jamison, I would conclude that the disposition of petitioner’s Gulf stock in satisfaction of its warrantly obligation to Associated was not without consideration and it therefore constituted a sale or exchange of such stock. Accordingly, I would no longer adhere to our opinion in Jamison to the extent that it is inconsistent with the views expressed herein. Apparently, the majority shares this view as it has effectively overruled Jamison on p. 628 of its opinion at n. 9. The matter does not end here, however. With respect to the loss also sustained by petitioner on the satisfaction of its warranty obligation, respondent argued on brief that petitioner was not entitled to deduct such loss because it failed to establish a business relationship between itself and Gulf sufficient to entitle it to a deduction under section 165(a). Section 165(a) provides, in general, for the deductibility of “any loss sustained during the taxable year and not compensated for by insurance or otherwise.” Petitioner realized a loss on the satisfaction of its warranty obligation to Associated under the relevant terms of the contract. The evidence clearly indicates that the contract creating such obligation arose in the course of petitioner’s business as a transaction entered into by petitioner for profit. Petitioner had no right to compensation for its loss by insurance or otherwise. Furthermore, the presence or absence of a business relationship between petitioner and Gulf has no bearing on the deductibility of its loss, as petitioner incurred the obligation on its own behalf and not as a guarantor of an obligation to Gulf. Thus, petitioner has met the requirements of section 165(a) regarding its warranty loss. Accordingly, I would hold that the loss realized by petitioner ($254,518 minus fair market value of stock transferred), due to the transfer of a capital asset in payment of an obligation, constitutes a capital loss and petitioner’s loss attributable solely to the satisfaction of its warranty obligation (the amount of that obligation — which in this case is the same as the fair market value of the stock transferred), constitutes an ordinary loss, deductible under section 165(a). Drennen, Dawson, and Goffe, JJ., agree with this dissent.  See p. 627 of the majority opinion.   I am cognizant that the substance of a transaction rather than its form is determinative for Federal income tax purposes. Gregory v. Helvering, 293 U.S. 465 (1935); Commissioner v. Court Holding Co.,324 U.S. 331 (1945). In the present case, however, the execution of the contract and petitioner’s mode of satisfaction of an obligation thereunder by the disposition of its Gulf stock, were each transactions of economic substance affecting the rights of both petitioner and Associated. Since the purpose of the contract was not the disposition of petitioner’s Gulf stock, to be achieved through a series of closely related steps executed for tax avoidance purposes, it would be inappropriate to ignore the form adopted by the taxpayer. Federal Bulk Carriers, Inc. v. Commissioner, 558 F.2d 128 (2d Cir. 1977), affg. 66 T.C. 283 (1976).   Indeed, two appraisals received into evidence for the purpose of establishing the fact that they were considered during the negotiations between the parties to the March 1970 contract indicate a fair market value of the Texas plant facility of $3,832,700 in 1966 and $4,696,980 in 1968. The record also indicates that pursuant to a 1969 lease agreement between Gulf and petitioner, Gulf had an option to purchase the Texas property for $1 million in cash. In short, the best that can be gleaned from the record is that the fair market value of the Texas property exceeded $610,000 on the date it was sold to Gulf.   Neither party views the execution of the contract involved and the disposition of petitioner’s Gulf stock as one overall transaction whereby the consideration received by petitioner upon the execution of the contract would also serve as consideration flowing to petitioner on the disposition of its Gulf stock.   The only circumstance in which the majority’s approach would be consistent with its own result would be to assign a fair market value of zero to petitioner’s Gulf stock. This, of course, would be inconsistent with the record and would render the contract meaningless. If the majority opinion had also discussed petitioner’s warranty or guarantee loss, it might have at least reached a result consistent with its own reasoning.   I would also point out that the record in this case plainly demonstrates that neither the execution of the March 1970 contract, petitioner’s warranty obligation thereunder, nor Associated’s purchase of Gulf stock had anything whatsoever to do with petitioner’s original acquisition of its Gulf stock. Therefore, United States v. Keeler, 308 F.2d 424 (9th Cir. 1962) and Siple v. Commissioner, 54 T.C. 1 (1970), heavily relied upon by the majority to support its finding of a single capital transaction, are inapposite. See Rietzke v. Commissioner, 40 T.C. 443 (1963); Shea v. Commissioner, 36 T.C. 577 (1961), affd. per curiam 327 F.2d 1002 (5th Cir. 1964); Condit v. Commissioner, 40 T.C. 24 (1963), affd. 333 F.2d 585 (10th Cir. 1964). In addition, I submit that the majority’s reliance upon Federal Bulk Carriers, Inc. v. Commissioner, 588 F.2d 128 (2d Cir. 1977), affg. 66 T.C. 283 (1976), and Downer v. Commissioner, 48 T.C. 86 (1967), is likewise misplaced. In Federal Bulk Carriers, X purchased all the stock of Y from Z. The purchase price for the Y stock was to be adjusted subsequent to its sale by reference to the profitability of the underlying business sold. When the business subsequently failed to produce the anticipated profits, Z became obligated to make certain payments to X. The resulting loss was held to be a capital loss. In the present case, Associated purchased its Gulf stock from Gulf, not petitioner. Furthermore, any payments by petitioner under the warranty were to be made to Gulf, not Associated, and the warranty was given in conjunction with Associated’s purchase of Gulf stock, not petitioner’s sale of its Gulf stock. In Downer, we dealt with the question of whether an employee’s continuation of his employment was consideration for a shareholder’s transfer of stock in the corporation to the employee. I find these cases unhelpful in the present context.   In Fox v. Commissioner, 61 T.C. 704, 715 (1974), we recently noted that generally the cases hold that no sale or exchange occurs under such circumstances. However, our holding in Fox was not predicated upon the continued validity of the cases cited for that general proposition. Rather, it was alternatively based on the fact that the taxpayer received no consideration on the disposition of certain stock as the obligation in that case was not canceled and no other consideration was received.   As of June 30,19Y0, petitioner had the option of transferring its Gulf stock or paying $437,010 in eash.'In other words, the petitioner in this instance had the option of selecting the amount of its warranty obligation as $437,010 or a lesser amount equal to the fair market value of its Gulf stock. The amount of its obligation to Associated thus became fixed at an amount equal to the then fair market value of the stock when it elected to transfer such stock rather than become obligated to pay money and notified Associated accordingly. Therefore, the amount of petitioner’s loss attributable to the disposition of its stock would be an amount equal to the difference between petitioner’s adjusted basis in the Gulf stock and its fair market value on the date of disposition. See United States v. General Shoe Corp., 282 F.2d 9 (6th Cir. 1960), cert denied 365 U.S. 843 (1961); Santa Anita Consolidated, Inc. v. Commissioner, 50 T.C. 536 (1968); cf. Woodsam Associates, Inc. v. Commissioner, 16 T.C. 649 (1951), affd. 198 F.2d 357 (2d Cir. 1952); Parker v. Delaney, 186 F.2d 455 (1st Cir. 1950), cert. denied 341 U.S. 926 (1951); Rev. Rui. 76-111, 1976-1 C.B. 214.   Commentators have also questioned the validity of such a distinction. See M. Ginsburg, “The Leaky Tax Shelter,” 53 Taxes 719, 723 (1975); R. Handler, “Tax Consequences of Mortgage Foreclosures and Transfers of Real Property to the Mortgagee,” 31 Tax L. Rev. 193, 244 (1976). Respondent has apparently adopted this position. See Rev. Rui. 76-111, 1976-1 C.B. 214.