Court Opinion

ID: 4482196
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:15:22.217906+00
Date Added: 2024-06-11T13:32:56.346146
License: Public Domain

Scott, J., dissenting: I respectfully disagree with the conclusion of the majority in tMs case since in my view petitioner and his associates were merely owners of an equity or stock interest in the various corporations. Gofee, /., agrees with this dissent. Quealy, /., dissenting: If compelled to travel the same route taken by the majority, I would nevertheless reach a different conclusion. My disagreement with the majority, however, goes deeper than that. As Appellate Judge Eives aptly observed in Davant v. Commissioner, 366 F. 2d 874, 879 (C.A. 5, 1966), our decision should be compatible with the statute as a whole. He said: We stand now at the threshold of our travel through the detailed and complex Code provisions that must govern our determination. Before we embark upon that journey it is well to restate the general principle that rules prescribed by Congress in the Code are often wholly reasonable and appropriate when taken in isolation, but that fact alone should not and must not prevent a court from harmonizing these apparently divergent elements of specific policy so that they may continue to cohabit the same body of general law which Congress has directed shall be viewed as a single plan. As Mr. Justice Frankfurter so aptly stated [Universal Camera Corp. v. NLRB, 340 U.S. 474, 71 S.Ct. 456, 95 L.Ed. 456, 489 (1951)], “There are no talismanie words that can avoid the process of judgment.” [Fn. omitted.] We should not be diverted by “mere formalities” designed to make a transaction appear to be other than what it was in order to achieve a tax result. Commissioner v. Court Holding Co., 324 U.S. 331 (1945). Eather than be concerned with the separate steps in the “paper jungle,” I would look to the position of the parties when the transaction has been completed. I would thus be guided by a long line of cases following Helvering v. Alabama Asphaltic Limestone Co., 315 U.S. 179 (1942), holding that a connected series of acts must be construed as a single transaction and so judged under the internal revenue laws. Applying these principles to the facts in this case, it is my opinion that when all of the so-called paper work is considered, the interests acquired by the petitioner and his associates must be deemed to constitute an equity or stock interest in a taxable association. The transactions which are involved in this proceeding followed a common pattern. The petitioner would contact a commercial or manufacturing corporation which either had or was in the process of acquiring a facility. Petitioner would thereupon negotiate the terms of an agreement whereby the user of the facility would sell the property and lease it back under a long-term lease at a rental adequate to support the financing of the full amount of the purchase price. The petitioner would then cause to be organized a “financing corporation” which would take title to the property, enter into the lease with the user, and issue its notes to a lending institution, secured by a mortgage on the property and assignment of the lease, in order to obtain the funds for the purchase. As security for its notes, the financing corporation would convey to a trustee all its right, title, and interest in and to the property, including all rents and income therefrom. The financing corporation further covenanted to preserve its existence as a corporation and to keep in full force and effect its right to own such property and to transact business for so long as the notes were outstanding. As an integral part of the transaction, the petitioner simultaneously had the financing corporation execute a deed purporting to transfer the property to the petitioner and his associates. The petitioner and his associates then entered into an assumption agreement whereby they agreed to be bound by the terms and conditions of the deed of trust, the lease and its assignment, together with any other obligations imposed on the financing corporation except that they assumed no obligation for the payment of principal and interest on the notes or any monetary judgment resulting therefrom.1  The use of the financing corporation enabled the petitioner inter alia (1) to obtain from institutional lenders a loan for the full amount of the purchase price, (2) to avoid any personal liability on account of such financing, (3) to increase the marketability of the financing, and (4) to avoid any restrictions applicable under State laws in the case of individual borrowers. In addition, the holding of title and the execution of the lease in the name of the financing corporation enabled the petitioner to create subordinated fractional interests which could be transferred without affecting the continuity of the mortgage, deed of trust, lease, and the like. In the internal revenue laws, the term “corporation” is not limited to what might be considered a corporation organized under State law. Sec. 301.7701-1, Proced. & Admin. Kegs. Section 7701 (a) (3) provides: “CORPORATION. — The term ‘corporation’ includes associations, joint-stock companies, and insurance companies.” In his regulations, the respondent has enumerated the major characteristics of an entity taxable as a corporation under section 7701(a) (3), as follows: Sec. 301.7701-2 Associations, including organizations labeled “corporations.”— (a) Characteristics of corporations. (1) Tbe term “association” refers to an organization whose characteristics require it to be classified for purposes of taxation as a corporation rather than as another type of organization such as a partnership or a trust. There are a number of major characteristics ordinarily found in a pure corporation which, taken together, distinguish it from other organizations. These are: (i) Associates, (ii) an objective to carry on business and divide the gains therefrom, (iii) continuity of life, (iv) centralization of management, (v) liability for corporate debts limited to corporate property, and (vi) free transferability of interests. Whether a particular organization is to be classified as an association must be determined by taking into account the presence or absence of each of these corporate characteristics. The presence or absence of these characteristics will depend upon the facts in each individual case. In addition to the major characteristics set forth in this subparagraph, other factors may be found in some cases which may be significant in classifying an ogranization as an association, a partnership, or a trust. An organization will be treated as an association if the corporate characteristics are such that the organization more nearly resembles a corporation than a partnership or trust. See Morrissey et al. v. Commissioner (1935) 296 U.S. 344. In Morrissey v. Commissioner, 296 U.S. 344 (1935), the Supreme Court not only confirmed the authority of the respondent to issue such regulations, but approved the enumerated characteristics as appropriate criteria in determining whether a business entity or association, whether incorporated or otherwise, is to be treated as a taxable entity under section 7701(a) (3), separate and apart from its shareholders or participants. It thus becomes a question whether taking the enterprise as a whole, and looking to the characteristics enumerated, it more closely resembles a corporation than a partnership, trust, or proprietorship. If so, the interests acquired by the petitioner and his associates would be that of “stockholders” as distinguished from owners of the property. Morrissey v. Commissioner, supra; Bloomfield Ranch v. Commissioner, 167 F. 2d 586 (C.A. 9, 1948). The mechanics were such that the petitioner had provided continuity in the form of a corporation organized to take title to the property, limited liability on the part of the participants who held an undivided interest in the property, centralized management in that as the principal officer of the corporation petitioner conducted all negotiations and made all decisions; and, transferability of interest on the part of participants without affecting the obligations with respect to the property all of which had been undertaken in the name of the corporation. These objectives could only be achieved through an entity which would provide the continuity of ownership, centralization of control, and limitation of liability that are characteristic of the corporate form. Contrary to the opinion of the majority, fractional interests were not necessarily issued upon the basis of formal ownership of the stock in the financing corporation. Under the opinion of the majority, the corporation was immediately stripped of all its assets. The stockholders of record owned mere pieces of paper. The real equity in the financing corporation was represented by the deeds transferring fractional interests to the petitioner and his associates, not by the shares of stock. Thus, when we look to the transaction as a whole, there are present all of tlie characteristics enumerated by the respondent in section 301.7701-2, Proced. & Admin. Regs. Such entity must be recognized under the internal revenue laws as a “taxpayer” distinct and apart from the petitioner and his associates. Both the income and deductions reflected by the petitioner in his individual returns were chargeable to that “taxpayer.” Morrissey v. Commissioner, supra; Kurzner v. United States, 413 F. 2d 97 (C.A. 5, 1969). I must also disagree with the opinion of the majority in its application of the law to the separate components of the transactions presented here. While Crane v. Commissioner, 331 U.S. 1 (1947), holds that a taxpayer is entitled to include in his basis for purposes of depreciation a bona fide indebtedness encumbering the property at the time acquired, it is axiomatic for the application of this rulé that the indebtedness is discharged by the taxpayer either directly with his own funds or out of taxpayer’s interest in the income from the property. Where a taxpayer neither puts up his own funds nor is chargeable with the income used to discharge the indebtedness, such taxpayer never acquires a basis in the property. The identity and continued role of the financing corporation as mortgagor and lessor of the property was essential. Under the terms of the loan agreements, the mortgage notes were required to be maintained as the direct obligation of the issuing corporation. Any income designated to the payment thereof would necessarily be chargeable in the first instance, at least, to such corporation. If the deeds granting the petitioner and his associates fractional interests in the properties effectively transferred ownership thereof from the financing corporations, those corporations would be stripped of all of their assets. The financing corporation would be an empty shell. "While the majority thus purports to recognize that such corporations were at all times viable entities for tax purposes, the ultimate decision of the majority is incompatible with that principle. To put the matter simply, having transferred its entire interest in the leasehold to a trustee to collect the rents and pay its indebtedness, I would regard the documents purporting to transfer the property to the petitioner and his associates as carrying no present interest. The petitioner had no present interest in the property which was subject to depreciation. M. DeMatteo Construction Co. v. United States, 433 F. 2d 1263 (C.A. 1, 1970).2  The position of the petitioner and his associates was no different than that of an owner of land who leases it to another under an agreement whereby the lessee will cause a building to be erected on the land. The lessee goes out and obtains a loan secured by a mortgage on his leasehold interest, including the building. The income or rents from the property are then applied, in part, to amortize this loan. When the ground lease expires, the owner of the land will get back his land, together with the building. Some day, the landowner will get it all. The petitioner has the same expectations. During the intervening period, however, the rents are not taxable to him merely because of their application to the discharge of an indebtedness which encumbers the property. Neither has sustained any depreciation. For example, see Schubert v. Commissioner, 286 F. 2d 573 (C.A. 4, 1961), affirming 33 T.C. 1048 (1960); Reisinger v. Commissioner, 144 F. 2d 475 (C.A. 2, 1944); Albert L. Rowan, 22 T.C. 865 (1954). Gorfe, Jagrees with this dissent. Goffe, /., dissenting: As indicated, I agree with the views of Judge Quealy expressed in his dissenting opinion. I feel, however, that some additional comment is warranted as to the substance of the steps comprising the pattern utilized by petitioners. In order to make the pattern work from a business standpoint, the corporate form had to be adopted; it was indispensable. Not only did the corporation have to be organized; it had to continue in existence until the indebtedness was extinguished. After title was transferred to the individuals, the corporation continued to own the most valuable present right in the property, the right to the income which would extinguish the indebtedness. Because of this I feel that attention should be focused on the transfer of title from the corporation to the individuals. The transfer of title served no business purpose; it transferred the only revenue-producing asset of the corporation but was not even supported by action of the board of directors in order to give the transfer an aura of respectability. It was nothing more than an integrated step in the “paper work.” Assuming that the parties intended the transfer of title to be a dividend, they did not even carry out the necessary steps to make it look like a dividend. After the transfer of title the corporation continued to be liable on the debt and the individuals were not monetarily liable. I conclude that the transfer of title was for the sole purpose of passing on to the individuals a deduction for accelerated depreciation in excess of the income from the property. Furthermore, I do not see how the reporting of income by the individuals adds any strength to petitioners’ case. In my view both the income and the deductions belong to the corporation. I conclude that the transfer of title was nothing more than a device to secure for the petitioners the benefits of subchapter S status which they could not otherwise enjoy. Gregory v. Helvering, 293 U.S. 465 (1935). I do not believe petitioners should be able to accomplish by indirect means what they could not do directly. I would, therefore, disallow the deduction for depreciation to the individuals. Wiles, J., agrees with this dissent.   In reality the so-called assumption agreements were little more than- “window dressing,” since the participants were not subject to any monetary liability. It is questionable whether such agreements served any useful purpose other than to bind petitioner and his associates together in a common business enterprise.    In this respect, the facts are distinguishable from World Publishing Co. v. Commissioner, 299 F.2d 614 (C.A. 8, 1962). In that case, the taxpayer acquired by purchase the entire interest of the lessor. Since that interest included both the land and a building erected thereon by the lessee, it was held that the taxpayer acquired a depreciable Interest In the building.