Court Opinion

ID: 9452121
Source: CourtListenerOpinion
Date Created: 2023-08-04 17:30:36.19666+00
Date Added: 2024-06-11T17:33:04.521141
License: Public Domain

SWYGERT, Circuit Judge
(dissenting in part).
Both the Tax Court and the majority recognize the Tax Court’s own rule that when a taxpayer buys a mixed aggregate of assets for a lump sum, the allocation of the purchase price to the separate items should be based upon the relative value of each item to the value of the whole. This rule requires that the fair market value of each item be established and then that the proportion which the fair market value of each item bears to the total fair market value of the aggregate be applied to the lump-sum purchase price, in order to determine the portion of the purchase price to be allocated to each item. The Tax Court and the majority having recognized the rule, conclude that the petitioner failed to introduce any evidence of the fair market value of the inventory purchased and that therefore the rule cannot be applied in this case. The majority adds “nor could the Commissioner be required to follow it.” I do not agree with either of these conclusions.
In the Tax Court proceeding, the petitioner submitted the following evidence bearing upon the fair market value of the inventory: (1) the inventory was *42purchased only after a physical audit conducted by independent auditors which priced the inventory items at the lower of cost or market value; (2) at the date of purchase there was a backlog of orders totaling $523,500; (3) inventory turnover was two to four times per year; (4) the inventory was sold in normal trade channels at a normal profit;1 and (5) the finished goods included in the inventory were used as collateral for a loan equal to ninety per cent of their book value. Certainly the first of these items alone is some evidence of fair market value, and in any event the evidence introduced shows that the value of the inventory was greater than that assigned by the Commissioner.
The Commissioner admittedly produced no evidence relating to the fair market value of the inventory items. His method was merely to spread the $300,000 reduction from book value (the purchase price) proportionally over the items listed in the inventory and fixed assets, relating the book value of each item to the total book value of all the assets. The Tax Court and the majority adopted the Commissioner’s reallocation without requiring any justification for it in terms of the “relative fair market values” rule, solely on the strength of the Commissioner’s presumption of correctness. I cannot agree that the Commissioner’s allocation should be so excused. Since the Commissioner’s allocation is admittedly unrelated to the established formula, it cannot be, in the words of the majority opinion, “as reasonable as can be expected.” The arbitrary nature of his arithmetic formula is obvious. Its artificiality can hardly be doubted. In these circumstances the presumption ought not to have been used as a substitute for evidentiary proof. The Tax Court should either have made a determination on the basis of the evidence submitted or have required the Commissioner to support his allocation in accord with the applicable rule. It did neither, but relied upon a discredited presumption.
A similar problem was before the Sixth Circuit in Bryant Heater Co. v. Commissioner of Internal Revenue, 231 F.2d 938 (6th Cir. 1956). There the taxpayer realized a profit of $250,000 in the sale of certain assets, which profit was necessarily attributable to either the inventory or the capital assets, or both. The taxpayer allocated the entire gain to the capital assets. The Commissioner rejected this allocation and asserted a deficiency based upon an allocation made in the same manner as in the instant case. The Commissioner simply related the book value of inventory and capital assets separately to the total book value of these two groups of assets in proportioning the gain attributable to each. The Tax Court accepted the Commissioner’s allocation even though no evidence relating his computations to fair market value was offered.
In reversing the decision of the Tax Court, the court stated:
The petitioners offered testimony by representatives of both the buyer and the seller showing that at the time of the sale it was understood by each of them that the inventories were being sold at approximately their book value and that a substantial premium over book value was being paid for the capital assets. The effect of this evidence in our opinion was to overcome the presumption of correctness attaching to the Commissioner’s determination by demonstrating the arbitrary nature of the formula upon which it was based, invitingly convenient though that formula undoubtedly was * * * [However,] the petitioners’ evidence was not sufficiently exact to establish their contention that no part of the gain was properly attributable to the sale of the *43inventories. It follows that the ease should be remanded to the Tax Court for a redetermination of the amount of gain attributable to each group of assets, based upon evidence as to the fair market value of each at the time of the sale. 231 F.2d at 939-940.
In the recent decision of Fulton Container Co. v. United States, 355 F.2d 319 (9th Cir. 1966), the Tax Court’s adherence to a similar “book value” allocation by the Commissioner was also rejected. There the taxpayer sold certain assets, realizing a substantial gain attributable to either fixed assets or a covenant not to compete, or both. The taxpayer allocated the entire gain to the fixed assets and reported a long term capital gain. The Commissioner, however, determined that the portion of the sales price which exceeded the book value of the fixed assets was attributable to the covenant not to compete, and made a reallocation on that basis. The Ninth Circuit reversed the Tax Court’s acceptance of this reallocation and remanded the case for a redetermination, to be based upon evidence of the value of the fixed assets and the value placed upon the covenant not to compete by the parties to the sale of the assets. In the course of its discussion, the court made the following observation :
This case shows that what is euphemistically called a “presumption” becomes an absolute to sustain the Commissioner’s implied finding in the deficiency determination. In practical effect it puts the imprimatur of law on the unassailable character of a figure plucked out of the air by the Commissioner. 355 F.2d at 324, quoting from David v. Phinney, 350 F.2d 371 (5th Cir. 1965) (dissenting opinion).
I would remand this proceeding to the Tax Court for a rede termination in accordance with the foregoing views.
I concur in that portion of Judge Hastings’ opinion relating to the Commissioner’s disallowance of the claimed deduction for accrued contributions to the pension plans.

. In eight months of active operation the sales of the petitioner amounted to $2,-070,580. The gross profit realized was $500,560, a gross profit margin of 24.17 per cent. This margin is closely comparable to the profit margin experienced by South Bend Toy No. 1 for the years 1952 through 1956. The effect of the Commissioner’s allocation is to exaggerate the gross profit margin on sales made by the petitioner from the normal level to 33.20 per cent.