Court Opinion

ID: 4479953
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:13:57.590957+00
Date Added: 2024-06-11T12:59:40.002708
License: Public Domain

Opper, J., dissenting: It seems to be recognized by all concerned that some quarter million dollars of income taxable under section 61 is being permitted to escape tax altogether. This can only be justified if it is unavoidable. I do not think it is. Beneath the superficial complications of consolidated reporting, this situation seems to me to present a comparatively simple problem with which we have been called upon to deal frequently in the past. That the real issue is not explicitly developed by the parties can be at most an occasion for rehearing or reargument. It does not justify an incorrect result in a reasonably obvious context. First, consolidated returns are, of course, not a method of accounting but a method of reporting, conferred as a privilege, Carboloy Co., 18 T.C. 1028, 1030 (1952), affirmed per curiam 207 F. 2d 777 (C.A. 6, 1953), and not a requirement, upon a family of affiliated corporations for the purpose of simplifying tlieir tax obligations.1 It was clearly intended that, if elected, the method should not be the means of eliminating otherwise taxable income.2  Simply stated, the theory was that for tax-computing purposes the corporate entities were to be ignored and intercorporate dealings eliminated as mere bookkeeping detail until a transaction outside the family was consummated. This is the only reasonable explanation of “unrealized” as employed in the regulation,3 which is obviously the reverse of the “Intercompany profits and losses which have been realized l>y the group through -final transactions with persons other than members of the group? (Emphasis added.) Sec. 1.1502-31(b)(1), Income Tax Regs. Of course, the taxing of the separate corporate identities can be preserved by merely failing to take advantage of the optional privilege of consolidated reporting. But where consolidated returns are elected the concept must be that the whole group is treated as one taxable entity, owning the assets and owing the external obligations of the entire group.4  Second, this is not a case, like those cited in the Court’s opinion, where income earned and realized in one year is sought to be placed in another. The “profit” appearing on the books in 1953 was not “realized” nor earned, nor reportable in that year for two reasons.5 Only when in 1957 there was a “final transaction” with a nonmember of the group — that is, when the Homes stock was sold — was there a realization, and hence an earning, of any gain which could be reported. And, in that year, the gain should have been reported because under the “other law applicable thereto” referred to in the regulations 6 the group for the first time realized a gain. Third, when, in 1953, Homes secured an apparent profit through a mortgage greater than the cost of construction and passed this on to Management, there was no gain to the group. This was, it is true, a transaction “with persons other than members of the group.” But the existence of the encumbrance represented by the mortgage offset any benefit resulting from the excess cash, and accordingly suspended its “finality.” At that time, Realization of gain was therefore postponed for taxation until there was a final disposition of the property * * *. See Lutz & Schramm Co., 1 T.C. 682; Mendham Corp., 9 T.C. 320. * * * [Emphasis added.] [Woodsam Associates v. Commissioner, 198 F. 2d 357, 359 (C.A. 2, 1952), affirming 16 T.C. 649 (1951).7] But when the obligation of the group was satisfied and liquidated— in this instance by eliminating Homes as a group member — the gain measured by the amount collected earlier from the mortgage was, for the first time, a free asset and includable in computing gain as part of the “money received” 8 for the property previously owned by the group. Since at least as early as 1943, the rule has been clearly established that when the owner of property borrows an amount in excess of his basis the borrowing constitutes a part of the amount received when the property is disposed of and the obligation of the mortgage is extinguished. The borrowing does not constitute gain when it occurs, because any receipt is offset by the accompanying liability. Thus, in Lutz & Schramm Co., 1 T.C. 682, 688, 689 (1943), court-reviewed without dissent on this issue, we said: The net result of the transaction was that the petitioner received $300,000 for its property. The $300,000 was received by the petitioner in 1925 [when the mortgage in that amount was placed on the property], but the taxable transaction took place in 1937 when the petitioner transferred the property to the creditor in discharge of a debt of $300,000. ******* The fact remains that the taxable transaction took place in 1937, and the net result of it was that the petitioner, over a period of years, had enjoyed the full benefit from the receipt of $300,000 by transferring a property which had a [lower] basis in its hands for gain or loss * * *. In R. O'Dell & Sons Co., 8 T.C. 1165, 1167 (1947), affd., 169 F. 2d 247 (C.A. 3, 1948), we stated the rule as follows: So where an owner pledges its property for a loan, the proceeds of which are greater than its basis, and subsequently succeeds in transferring the property for a cancellation of the debt, the excess of what is received over the basis of the property is gain, taxable in the year in which the property is disposed of and the debt discharged. Lutz & Schramm Co. [supra] * * * And in Mendham Corporation, 9 T.C. 320, 323, 325 (1947), as here, the loan was obtained by one member of a corporate group and subsequently eliminated by the transfer by another member. We said: it was not petitioner, but its transferor in a nontaxable exchange, which made the original borrowing, and hence the opening move toward that final profit. * * * [Bjecause the whole operation was within the corporate family, no tax consequence attached * * *. Nevertheless, it is petitioner’s disposition of the property, and its elimination of the mortgage debt, which concludes the operation instituted by its predecessor and furnishes the occasion for a survey of the results of the entire transaction. Unless the transferee’s situation be thought of as including the consequences of the original borrowing, that phase of the calculation will never be taken into account * * *. ******* It seems to us to• follow that petitioner must he treated here exactly as though it had itself placed the mortgage on the property and benefited by the cash so acquired.3 [Footnote omitted; emphasis added.] And see Woodsam Associates v. Commissioner, supra. Lest it be suggested that these cases are different because there the property and the indebtedness were disposed of together, it needs only to be observed that under consolidated reporting that is precisely what happened here. When the Homes stock was sold, all contact of the group with the project and the mortgage was severed — and for the first time. For tax purposes, property of the group was disposed of and indebtedness of the group was simultaneously satisfied.9  Of course, this means capital gain treatment and not ordinary income. The collapsible corporation section,10 being inapplicable because one of its conditions11 was, perhaps purposely, avoided, the transaction was capital in nature. But what was realized here was in an amount which must include the gain from the proceeds of the mortgage. That the presentation on behalf of petitioners is as skillful and able as one would expect from their eminent counsel may be a reason but is scarcely an excuse for the result which the Court reaches here. I think it is incorrect. Tietjens, Withey, and Pierce, JJ., agree with this dissent.   “* * * consolidated statements of income have been tbe rule for ordinary business purposes, and for 16 years the income tax law has provided for consolidated returns. The administration of the income tax law is simpler with the consolidated return since it conforms to ordinary business procedures; enables the Treasury to deal with a single taxpayer instead of many subsidiaries; and eliminates the necessity of examining the bona lides of thousands of intercompany transactions.” H. Kept. No. 704, 73d Cong., 2d Sess. (1934), p. 17.    Sec. 1502, I.R.C. 1954. American Water Works Co. v. Commissioner, 243 F. 2d 550 (C.A. 2, 1957), affirming on this issue 25 T.C. 903 (1956).    Sec. 1.1502-31(b)(1)(i), Income Tax Regs.    Petitioners appear to agree with this. They say: “If the affiliated group is viewed as a single entity, which respondent suggests is proper » * * as do all of the authorities he cites and with which we heartily agree, clearly the income was not earned upon completion of the housing project, for all that had occurred at that time was the construction of the project by the affiliated group for itself and the financing thereof * *    Again, petitioners appear to agree: “Viewed from the standpoint of substance, all that occurred here [in 1953] was a transfer of borrowed funds from one corporate division to another, and the designation of a portion of the amount transferred as “construction profit" is meaningless for taw purposes. The very reason for eliminating intercompany transactions is because income cannot be considered earned as a result of self-dealing. * * *” (Emphasis added.)    Sec. 1.1502-3, Income Tax Regs.    This ease is cited and relied on by petitioners.    See. 1001, I.R.C. 1954.    See footnote 4, supra, and see Burnet v. Aluminum Goods Co., 287 U.S. 544, 547 (1938).    See. 341, I.R.C. 1954.    Sec. 341(b)(3) and (d)(3), I.R.C. 1954.