Johnson-McReynolds Chevrolet Corp. v. Commissioner

Johnson-McReynolds Chevrolet Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent Johnson-McReynolds Chevrolet Corp. v. Commissioner Docket No. 53100 United States Tax Court 27 T.C. 300; 1956 U.S. Tax Ct. LEXIS 41; November 19, 1956, Filed *41 Decision will be entered under Rule 50. 1. In 1949, petitioner transferred an incompleted building, which the contractor agreed would have a total cost value of $ 175,000, to one of its two principal stockholders in exchange for shares of its stock having a value of approximately $ 125,000, together with cash in the amount of approximately $ 50,000. Several months after the transfer, the contractor submitted an additional bill, which claim petitioner compromised and paid in the amount of $ 7,663.50. Held, petitioner's exchange of its incompleted building for shares of its stock and cash was a sale of property used in its trade or business on which it sustained a fully deductible loss in the amount of $ 7,663.50. 2. Petitioner, a Chevrolet automobile dealer, assigned a certain number of new cars which it received each year to salesmen and company officials for their personal use. The automobiles were used to some extent in its business and for demonstration purposes. The cars were held for a year or less and were then sold. Held, the cars were property held by petitioner for sale to customers in the ordinary course of its business, and gain realized on their sale was*42 properly determined by respondent to be taxable as ordinary income. J. J. Fairbank, Jr., Esq., for the petitioner. James A. Scott, Esq., for the respondent. Rice, Judge. RICE *301 This proceeding involves the following deficiencies in income tax: Year Deficiency [1949] $ 4,817.28 [1950] 2,987.34 [1951] 2,398.79 The issues are: (1) Whether the respondent erred in disallowing an expense deduction of an amount which petitioner paid in 1949 in settlement of a claim; and (2) whether the petitioner realized capital gains or ordinary income from the sale of certain automobiles during each of the years in issue. *43 Concessions made with respect to other issues will be taken into account in a Rule 50 computation. FINDINGS OF FACT. Petitioner is a Virginia corporation with its principal place of business in the city of Roanoke. It kept its books and filed its returns on an accrual basis for each of the calendar years here in issue with the former collector of internal revenue for the district of Virginia. Petitioner was engaged in the operation of a Chevrolet automobile dealership during the years in issue. Prior to 1949, it had outstanding 2,000 shares of stock of which one Lucius C. Johnson owned 914 and Harry D. McReynolds owned 914. The remaining shares were held by two other stockholders. Johnson died on September 18, 1948. Petitioner operated the Chevrolet dealership under a franchise granted by General Motors to McReynolds and Johnson personally. After Johnson's death, General Motors at first insisted that McReynolds own at least 60 per cent of petitioner's stock. Pursuant to that requirement, McReynolds purchased sufficient shares of petitioner's stock from Johnson's estate to give him a 60 per cent interest in petitioner. Thereafter, General Motors decided that it was unwilling*44 for an estate to hold any of petitioner's stock and insisted that McReynolds buy the remaining shares. McReynolds had insufficient funds to purchase additional shares of petitioner's stock from Johnson's estate, but to satisfy General Motors' requirements the following plan was devised and carried out: Late in 1948 and early in 1949, petitioner had under construction a large building which it intended to use in its business. The *302 land on which the building was being erected had cost $ 15,300. Sometime prior to March 10, 1949, petitioner secured a letter from the contractor who was constructing the building to the effect that the final cost thereof would be $ 159,700. Petitioner agreed to transfer the land and building to Johnson's estate at its cost value, $ 175,000, and in exchange therefor, to take the shares of its stock held by the estate, which shares had an agreed-upon book value of $ 123,621.80, which value was also their fair market value. The difference in the book value of the stock and the cost of the building of $ 51,378.20 was paid to petitioner by the estate in cash. By a deed executed on March 10, 1949, petitioner transferred its then incompleted building*45 and land to the estate for the aforementioned consideration. It received all of the shares of its stock owned by Johnson's estate and held such shares in its treasury until the end of the year. At that time, 6 were sold to E. R. Johnson and 2 were sold to its sales manager at book value. The remaining shares were then canceled. Several months after petitioner conveyed the building to Johnson's estate, the contractor submitted a bill in the amount of $ 15,327 in excess of the previously agreed-upon price of $ 159,700. Petitioner was advised by counsel that it was not liable for the additional amount claimed by the contractor. For various reasons, among which was a desire to avoid litigation with the contractor and a wish to avoid unfavorable publicity arising out of a lawsuit, it agreed to compromise the claim for one-half of the amount, $ 7,663.50. It paid such sum to the contractor in 1949. On its income tax return for that year, petitioner claimed such payment as a fully deductible loss "On settlement of claim." In determining the deficiency for that year, respondent disallowed the deduction so claimed. In the operation of its business, petitioner assigned a number of new*46 cars each year to various company officials and employees, including its sales managers and salesmen. Such cars, when received from General Motors, were first entered on petitioner's books in its new car inventory account and were then transferred, when assigned to an employee, to the company car account. The cars so assigned were never thereafter transferred back to the new car account. The cars were assigned to the employees for their personal use at all times and were used, to some extent, for company business, and, to some extent, as demonstrators. Petitioner carried insurance on the cars and titled them in its name. Most of the cars were held for a year or less (but more than 6 months) and then sold. 1 At the time of sale they had had between 7,000 and 13,000 miles of usage. In reporting its income for each of the years in issue, petitioner claimed deductible *303 depreciation on the cars and reported the gain on their sales as capital gains. In determining the deficiencies herein, respondent disallowed the depreciation deductions and determined that the gain realized was taxable as ordinary income. *47 Such cars were held by petitioner primarily for sale in the ordinary course of its business. OPINION. In support of his determination disallowing the deduction taken by petitioner because of its payment of a claim in 1949, respondent contends that the amount paid was directly related to the exchange of the building for the stock owned by Johnson's estate; that such exchange was clearly a partial liquidation, as defined by section 115 (i)2 of the 1939 Code; and that, therefore, no gain or loss may be recognized on the transaction. The petitioner, on the other hand, contends that the payment which it made to the contractor was only an ordinary compromise of a claim which arose in the normal course of its business and that it is entitled to a deduction of the full amount paid, as an ordinary and necessary business expense. *48 We think neither argument presents the correct solution to this problem. Petitioner's argument is wrong because it fails to take cognizance of the whole factual background to which the payment in question was directly related. We think the respondent, on the other hand, has misconstrued the statutory meaning of partial liquidation and is pressing an argument here which is contrary to his own regulations. Petitioner's business activities were in no way reduced and it continued to operate as a Chevrolet automobile dealer on at least as full a scale as ever before, subsequent to the transfer. The transaction possesses some of the characteristics of both a sale and a partial liquidation. However, we think that the transfer by petitioner of its incompleted building for which it received its own stock, together with an amount of cash, should be treated as a sale of its property for income tax purposes. Regulations 111, section 29.22 (a)-15, provide that: if the corporation receives its own stock as consideration upon the sale of property by it, or in satisfaction of indebtedness to it, the gain or loss resulting is to be computed in the same manner as though the payment had been *49 made in any other property. * * * We think that is what happened here. The payment which petitioner made was directly related to the building and was clearly an additional cost thereof. All of the transactions *304 occurred in 1949. The net result of the whole transaction, therefore, was that it sold its building, which had a cost basis to it of $ 182,663.50, for cash and shares of its stock which had a value of $ 175,000. Hence, it sustained a loss in the amount of $ 7,663.50 on such sale. Country Club Estates, Inc., 22 T. C. 1283 (1954); C. M. Menzies, Inc., 34 B. T. A. 163 (1936); Dorsey Co. v. Commissioner, 76 F. 2d 339 (C. A. 5, 1935), affirming a Memorandum Opinion of this Court dated June 16, 1934, certiorari denied 296 U.S. 589 (1935). The real property which petitioner sold was property used in its trade or business within the meaning of section 117 (a) (1), 3 and the loss on its sale is a fully deductible loss which the petitioner is entitled to claim in computing its taxable income for 1949. Carter-Colton Cigar Co., 9 T. C. 219 (1947).*50 Petitioner contends that the sale of the cars was the sale of property used in its trade or business within the meaning of section 117 (j), 4 and that the gains therefrom are taxable as capital gains. The respondent, on the other hand, contends, in support of his determination that such gains were ordinary income, that the cars were the stock-in-trade of petitioner's business, held for sale to its customers, within the meaning of section 117 (j). *51 The respondent's determination that the automobiles in question were the stock-in-trade of petitioner's business is presumptively correct, and we think on this record that the petitioner has failed to overcome that presumption. The issue is entirely one of fact, and the two essential facts which petitioner failed to establish are: (1) That the automobiles were not property of a kind includible in inventory if on hand at the close of the taxable year; and (2) that the automobiles were not held by it primarily for sale to customers in the ordinary course of its trade or business. Petitioner relies heavily on Latimer-Looney Chevrolet, Inc., 19 T. C. 120 (1952). The respondent, on the other hand, relies on W. R. Stephens Co. v. Commissioner, 199 F. 2d 665 (C. A. 8, 1952), affirming *305 a Memorandum Opinion of this Court dated August 8, 1951. Each of those cases involved the sale by automobile dealers of so-called company cars or demonstrators. In Latimer-Looney Chevrolet, Inc., supra, the taxpayer established to our satisfaction that the automobiles there in question were truly used*52 in its business and were not held for sale to customers within the meaning of the statute. In W. R. Stephens Co. v. Commissioner, supra, the taxpayer failed to show that the automobiles in question, or a majority of them, were so held. We think the petitioner here has likewise failed. The automobiles here in issue were acquired by it originally as new cars and entered on its books in the new car inventory account. They were thereafter transferred to the so-called company car account when assigned to officials and salesmen. Clearly, the cars were initially acquired from General Motors for sale to customers. We think that the best that can be said on this record is that for a period of approximately a year or less the automobiles in question were temporarily assigned to salesmen and company officials for their use, but that the essential purpose for which they were originally acquired was never changed. Moreover, the position which the petitioner takes, on this record, seems to us contrary to the basic congressional purpose in providing for a capital gains tax. As the Supreme Court noted in Corn Products Co. v. Commissioner, 350 U.S. 46 (1955),*53 at page 52: the capital-asset provision of § 117 must not be so broadly applied as to defeat rather than further the purpose of Congress. Burnet v. Harmel, 287 U.S. 103, 108. Congress intended that profits and losses arising from the everyday operation of a business be considered as ordinary income or loss rather than capital gain or loss. The preferential treatment provided by § 117 applies to transactions in property which are not the normal source of business income. It was intended "to relieve the taxpayer from * * * excessive tax burdens on gains resulting from a conversion of capital investments, and to remove the deterrent effect of those burdens on such conversions." Burnet v. Harmel, 287 U.S., at 106. Since this section is an exception from the normal tax requirements of the Internal Revenue Code, the definition of a capital asset must be narrowly applied and its exclusions interpreted broadly. This is necessary to effectuate the basic congressional purpose. * * * We conclude that the gains which petitioner realized from the sale of the automobiles in question were taxable as ordinary income. Petitioner*54 conceded at the hearing that if we held the gains from the sale of the automobiles were taxable as ordinary income, the respondent's disallowance of deductions for depreciation on such automobiles was correct. Decision will be entered under Rule 50. Footnotes 1. One car was held for 14 months and one for 15 months before sale.↩ 2. SEC. 115. DISTRIBUTIONS BY CORPORATIONS. (i) Definition of Partial Liquidation. -- As used in this section the term "amounts distributed in partial liquidation" means a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock.↩ 3. SEC. 117. CAPITAL GAINS AND LOSSES. (a) Definitions. -- As used in this chapter -- (1) Capital assets. -- The term "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include * * * real property used in the trade or business of the taxpayer;↩ 4. SEC. 117. CAPITAL GAINS AND LOSSES. (j) Gains and Losses From Involuntary Conversion and From the Sale or Exchange of Certain Property Used in the Trade or Business. -- (1) Definition of property used in the trade or business. -- For the purposes of this subsection, the term "property used in the trade or business" means property used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 23 (l), held for more than 6 months, and real property used in the trade or business, held for more than 6 months, which is not (A) property of a kind which would properly be includible in the inventory of the taxpayer if on hand at the close of the taxable year, or (B) property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, * * *↩