Court Opinion

ID: 4482476
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:15:30.75553+00
Date Added: 2024-06-11T15:03:44.442662
License: Public Domain

Deennen, /., dissenting: I respectfully dissent for the following reasons. As stated by the majority, there remains for decision only the question whether the losses incurred by petitioners are ordinary or capital in nature. Section 165(a) provides generally a deduction for losses sustained during the taxable years and not compensated for by insurance or otherwise. The deduction provided in subsection (a) is limited, however, in the case of individuals, by subsection (c), to (1) losses incurred in a trade or business, or (2) losses incurred in a transaction entered into for profit though not connected with a trade or business, and (3) casualty losses. Such losses are deductible in full unless limited by some other provision of the Code. Subsection (f) does limit the deduction for losses from sales or exchanges of capital assets to that allowed in sections 1211 and 1212. Also subsection (g) provides that if a security, as therein defined, which is a capital asset becomes worthless during the taxable year the loss resulting therefrom will be treated as a loss from the sale or exchange of a capital asset. And finally section 1234 provides that a loss attributable to the sale or exchange of, or from the failure to exercise, a privilege or option to buy or sell property shall be considered a loss from the sale or exchange of property which has the same character as the property to which the option or privilege relates. It is within the above statutory framework that we must decide the issue before us. Petitioners contend that the losses they admittedly incurred in 1965 were losses incurred in a transaction entered into for profit, deductible in full, and that none of the other provisions which would require treatment of those losses as capital losses are applicable. Respondent, on the other hand, contends that the losses were attributable to petitioners’ failure to exercise a privilege or option to acquire stock in Las Delicias or their failure to perform a unilateral contract, either of which he claims would result in capital loss treatment under section 1234; or in the alternative, that the losses resulted from a security which became worthless which would be deductible as a loss on the sale or exchange of a capital asset under section 165(g). There can be little question that petitioners’ losses were incurred in a transaction entered into for profit, in one way or another. Respondent makes a rather feeble argument that petitioners did not expect to make their profit from renovating the sugar mill but rather from acquiring stock in the corporation. I find this argument to be in-apposite for petitioners were obviously interested in making money and whether they achieved their goal through a capital transaction or a noncapital transaction is completely irrelevant for purposes of section 165(c) (2). The evidence is quite clear that had the transaction run its intended course petitioners would have become the controlling stockholders of a profitable sugar mill operation from which they expected to make a profit. Plainly this brings them within the provisions of 165(c) (2) and consequently 165(a). We are thus left with the question of whether the losses were attributable to a failure to exercise an option, so that section 1284 would be controlling, or resulted from a security becoming worthless within the meaning of section 165(g). Respondent’s principal contention is that under the somewhat nebulous agreement between the parties, petitioners were given the option to meet the production standards demanded by the Nielsen group and if they did so, they were entitled to 55 percent of the stock of Las Delicias; and that the election to take the stock after the production quotas had been met was illusory and nothing more than a formality. Contrarily, petitioners contend that they were obligated under the agreement to try to meet the production quotas and until they did so they had no option at all. While it is quite probable that had the production quotas been met petitioners would have taken the stock, this cannot be said to be a foregone conclusion and hence a mere formality. On the other hand, the entire agreement failed to give petitioners any rights which would qualify as an option that would warrant capital gains treatment .under section 1234 unless and until they met the production quotas. Like the majority, I am reluctant to delve into the unilateral versus bilateral concepts that permeate some of the cases involving the applicability of section 1234 because it is difficult for me to fit a unilateral agreement into the statutory language of section 1234 unless it is tantamount to an option. Nevertheless, respondent presses the argument and in light of the conclusion I reach I feel I should discuss it. The record clearly discloses that the agreement between the Washington group and the Nielsen group imposes duties on both parties. The Nielsen group was anxious to make the mill profitable and thereby regain their funds invested in the business principally as loans but also as capital. Furthermore, they believed it was necessary that the mill be revitalized in the 1965 cutting and grinding season or all would be lost. Given these considerations, certainly they would not have given the Washington group carte blanche to undertake the renovation of the sugar mill without some commitment on the part of the Washington group that it would make a bona fide attempt to make the operation successful. I think petitioners’ obligation was rather explicit in the exchange of correspondence and the conversations upon which the agreement was consummated, and was also inherent in the form in which the arrangements were cast. The fact that the Nielsen group apparently had other groups interested in making advances to the sugar mill also indicates that it exacted some promise from petitioners, for, being reasonable businessmen, the members of the group clearly would have wanted some commitment from petitioners before abandoning their other alternatives. Another aspect of the transaction which confirms the bilateral nature of the agreement is the protracted negotiations between the parties in which the Nielsen group was obviously attempting to maximize the commitment of the Washington group. The Nielsen group was successful to the extent of a $105,000 contribution which was unrefundable. Finally, I think that the Washington group was quite aware of its obligation as indicated by its continued support of the sugar mill operation during the entire 1965 cutting and grinding season despite the unfavorable report brought back from Costa Rica by Myers in January 1965, only halfway through the season. For these reasons I am unable to find that the agreement between the Washington group and the Nielsen group was unilateral, as respondent urges us to do. Therefore, the line of cases relied upon by respondent such as Lawler v. Commissioner, 78 F. 2d 567 (C.A. 9,1935), reversing sub nom. Estate of Erskine M. Ross, 29 B.T.A. 227 (1933); W. A. Drake, Inc., 3 T.C. 33 (1944), affd. 145 F. 2d 365 (C.A. 10, 1944); and Morris R. DeWoskin, 35 T.C. 356 (1960), which appear to recognize that unilateral agreements are transactions which fall within the ambit of section 1234, are not controlling. Nor can I find that petitioners had an option within the meaning of section 1234 under any other standard. In normal parlance an option is something which the optionee has the right to exercise at or during the times prescribed in the option. Here petitioners were never in a position to exercise any option because they were unable to meet the production quotas, and even had the quotas been met, exercise of the option was not a foregone conclusion. Petitioners’ failure to meet the production quotas therefore does not equate with a failure to exercise an option. Petitioners had no unqualified contract right to a capital asset as a result of their agreement with the Nielsen group. Section 1234, as do all of the capital gains and loss provisions, plainly contemplates the existence of a capital asset which normally can be bought or sold. Petitioners have never had anything they could buy or sell. They were not entitled to an interest in the company unless they first met the production quotas; nor had they any apparent right to sell or assign the opportunity to try to achieve those quotas and thus become entitled to an interest in the company. Moreover, my interpretation of the evidence convinces me that though the remuneration for petitioners’ undertaking was to be a capital asset, i.e., 55-percent ownership in Las Delicias, the basic tenor of the transaction was not capital but ordinary. I believe petitioners undertook to get the Las Delicias sugar mill on its feet contributing their money and financial management skills in return for the promised stock if they were successful. It was a deal wherein they would render a performance which, if successful, would entitle them to a capital asset in lieu of some other type of remuneration. In short, they clearly set out to acquire controlling ownership of the plant, a capital asset, but the means they chose to expedite their plan did not take the form of a capital transaction. Additionally, it is quite possible that had the venture succeeded and petitioners received the stock, they might have been subject to income tax on the difference between their advances and the fair market value of the stock, as ordinary income. Admittedly, this was an unusual and extraordinarily aleatory-type arrangement where petitioners were willing to risk their own capital in someone else’s business upon the contingency that until the operations were made successful they would get no return on their contributions. Petitioners undoubtedly had reasons of their own for fashioning the arrangements in this manner, which quite likely included consideration of the U.S. tax structure and the Costa Rican corporation and labor laws. But, unusual as it may be, the fact remains that here petitioners did not possess anything which could be considered a capital asset under the Internal Revenue Code. Because of the uncommon nature of petitioners’ agreement with the Nielsen group, I have found very few cases factually similar which direct the way to the correct characterization of these losses. While primarily concerned with whether the expenditures there involved were made in a transaction or a mere investigation, I find the cases of Harris W. Seed, 52 T.C. 880 (1969), and Charles T. Parker, 1 T.C. 709 (1943), helpful to some degree. In those cases as here a successful conclusion of the ventures would have resulted in taxpayers acquiring capital assets, but the ventures failed and the capital assets were never acquired. Nevertheless, this did not prevent this Court from recognizing that the losses were incurred in transactions entered into for profit and consequently deductible in full. The Commissioner acquiesced in the Parker case and subsequently issued Rev. Rul. 57-418, 1957-2 C.B. 143, explaining Ms position, wHcli supports the conclusion I would reach here. The revenue ruling— held, that a loss * * * sustained during a taxable year with respect to expenditures incurred in search of a business or investment is deductible only where the activities are more than investigatory and the taxpayer has actually entered into a transaction for profit and the project is later abandoned. The loss is allowable [under section 165(e) (2)] only in the taxable year in which the project is abandoned. There can be no question that petitioners had actually entered into a transaction for profit here. The majority opinion bases its conclusion on respondent’s alternative argument that petitioners’ losses must be treated as capital losses because of section 165(g). Under that section, if a security which is a capital asset becomes worthless, the loss resulting therefrom is treated as a capital loss. The definition of a “security” for purposes of that section includes “a right to subscribe for, or to receive, a share of stock in a corporation.” Respondent argues and the majority concludes that because petitioners would have had a right to receive stock of the corporation if their attempt to meet the production quotas had been successful, tins somehow gave them a security within the meaning of section 165 (g). The conclusion of the majority is based on the assumption that petitioners had a right to receive stock. However, the argument defeats itself since petitioners never had a right to subscribe for or right to receive stock due to their failure to meet the production quotas. In James C. Hamrick, 43 T.C. 21 (1964), cited by the majority, the two inventors transferred all of their interest in their patent to a newly formed corporation in exchange for 190 shares each of the corporation’s stock and the right to have issued to them by the corporation additional shares of stock when the net earnings of the corporation exceeded 10 percent of the par value of the outstanding and issued capital stock. This was stated to be the consideration for the assignment and agreement in the written assignment agreement. There the right to receive additional stock was a contract right that came into existence when the assignment was made. That it was considered an existing asset freely transferable is evidenced by the fact that one of the inventors did sell both his stock and his right to receive additional shares of stock; and by the fact that the directors of the corporation later found it necessary to first acquire the rights and then retire them rather than simply to retire the rights, in order to resolve a conflict between the stockholders. Likewise, in Carlberg v. United States, 281 F. 2d 507 (C.A. 8, 1960), also cited by the majority, the rights there involved were evidenced by certificates of contingent interest in certain reserved shares of stock. The above two cases are the only cases cited by the majority as support for its conclusion that the “right to receive” stock, as used in the definition in section 165(g), need not be unconditional. Of course, those two cases involved entirely different provisions of the Code but in my opinion they do emphasize that a security, or right to receive stock, which can be classified as a capital asset as required by section 165 (g), must be something in hand that can be transferred for a consideration. In this case the petitioners never had anything in hand that they could have transferred, and hence in my opinion they did not have a security within the meaning of section 165 (g). The statement made in the majority opinion in attempting to distinguish Harris W. Seed, supra, points up the fallacy in the reasoning which I believe leads to the majority’s erroneous conclusion in this case. In referring to Seed the majority says— There the taxpayer’s right to obtain stock was subject to further action on Ms part, namely, the furnishing of the cash necessary to pay for the shares. Here, at the time ithe claimed loss was sustained, no further cash was needed. The right to receive the shares of Las Delicias was totally independent of any further action on petitioners’ part. I submit that this reflects a clear misunderstanding of the situation. Petitioners’ right to receive the shares of Las Delicias was at all times dependent on action or further action on their part. Plaving failed to perform as required by the agreement and having decided to take no further action, petitioners never acquired the right to receive stock. The attempted distinction of Seed is not valid. My conclusion is bolstered, I believe, by analysis of the character and posture of subsection (g) in section 165. Subsection (g) itself does not limit the amount of the loss allowable. It simply treats the loss from a security which is a capital asset becoming worthless as a loss from the sale or exchange of a capital asset. One must turn to the preceding subsection (f) to determine the effect of this treatment. Subsection (f) limits the losses from sales or exchanges of capital assets. If the “right to receive” stock cannot be sold or exchanged, it would not seem to have any place in subsection (g). Furthermore, if one analyzes the meaning of “right to receive” in the context of the entire paragraph (2)1 in which it appears, it becomes clear that what is intended to qualify as a “security” under subsection (g) is a- specific documented and existing right, probably one issued by the corporation itself, such as. stock warrants and stock rights. Definition (A) refers to a share of stock in a corporation, which is tangible evidence of an interest in the corporation. Definition (C) refers to a bond, debenture, note, or certificate, or other evidence of indebtedness, issued by a corporation. Definition (B) refers to “a right to subscribe for, or to receive, a share of stock in a corporation.” A right to subscribe for stock in a corporation is a tangible right issued by the corporation itself. It is only reasonable to believe that Congress had reference to the same sort of corporate issue when it included the words “or to receive” in this sentence of the definition. If this analysis holds water, then I do not believe petitioners held a “security” the becoming worthless of which produced their losses. Viewing the transaction as a whole, I cannot find that petitioners’ losses resulted from or were attributable to the sale or exchange of capital assets as defined in any of the provisions of the Internal Revenue Code brought to our attention. Since I read section 165 (a) and (c) to be inclusive, except for statutory exceptions, I believe that any deductible loss not limited by the other provisions of the Code shall be deductible in full as an ordinary loss. There is agreement between the parties that the losses are deductible and it, therefore, follows that the losses suffered by petitioners in 1965 were losses incurred in a transaction entered into for profit deductible in full in that year under section 165 (c) (2). Dawson, Fat, and Featherston, JJ., agree with this dissent.   (2) Security defined. — For purposes of this subsection, the term “security” means— (A) a share of stock in a corporation ; (B) a right to subscribe for, or to receive, a sh,aTe of stock in a corporation; or (C) a bond, debenture, note, or certificate, or other evidence of indebtedness, issued by a corporation or by a government or political subdivision thereof, with interest coupons or in registered form.