Opinion
Docket Nos. 86991, 93525, 93526.
Filed January 30, 1962.
Payments made in subsequent years under a contract of sale of corporate stock calling for a total specified maximum payment but not to exceed a stipulated percentage of the corporation's income for the following 5 years, held to be proceeds of the sale and thus taxable to the sellers notwithstanding that the unfulfilled portion of the sales contract had in the meantime been made the subject of a gift.
Anthony B. Diepenbrock, Esq., for the petitioners.
Richard G. Worden, Esq., for the respondent.
In these consolidated proceedings respondent determined deficiencies in petitioners' income taxes as follows:
Year Petitioners Amount
1956 ............ Stephen S. and Margery B. Townsend ......... $599.44 1957 ............ Stephen S. Townsend ........................ 402.03 1957 ............ Margery B. Townsend ........................ 419.67 The issues are whether petitioners made a valid gift prior to 1956 or 1957 of a right to receive an indeterminate amount of moneys in the future and, if so, whether the subject matter of the gift is such that it would prevent the shifting from the donors to the donees of the incidence of income tax upon subsequent receipts. Some of the facts have been stipulated.FINDINGS OF FACT.
The stipulated facts are hereby found.
Petitioners Stephen S. Townsend, a patent attorney, and Margery B. Townsend are husband and wife and reside at Piedmont, California. Their income tax returns for the years 1956 and 1957 were filed with the district director of internal revenue, San Francisco, California. A joint return was filed for the year 1956 and separate returns were filed for the year 1957.
Prior to August 31, 1955, petitioners were the owners of 100 shares of $10-par-value common stock of Rolley, Inc. (hereinafter referred to as Rolley). The stock was held in the name of petitioner Stephen S. Townsend (hereinafter sometimes referred to as petitioner) but was community property of petitioners.
On August 31, 1955, petitioner and other shareholders of Rolley entered into an agreement (hereinafter referred to as the agreement) with Botany Mills, Inc. (hereinafter referred to as Botany), for the sale of their Rolley stock to Botany. The agreement in pertinent part provided as follows:
THIS AGREEMENT made this 31st day of August, 1955, between Charles A. Rolley, * * * Stephen Townsend [sellers], * * * parties of the first part, [and] Botany * * *, party of the second part, * * *:
* * * * * * *
III. Agreement of Sale and Payment
* * * Botany agrees to buy from Sellers, who agree to sell to Botany, the said 8,250 shares of common stock of Rolley, and to pay therefore * * * a purchase price as follows:
(1) A down payment at the time of closing of 75,000 shares of the common stock of Botany to Sellers by Botany. Botany shall deliver at the time of closing to CROCKER FIRST NATIONAL BANK, San Francisco, California (hereinafter called "Crocker"), for the account of Sellers, stock certificates * * * evidencing the ownership of 75,000 shares of Botany common stock * * *
(2) The balance of the purchase price to be the sum of One Million Seven Hundred Thousand Dollars ($1,700,000) without interest, provided, however, that the obligation to pay such balance of said purchase price shall be an obligation to pay only such portion of said $1,700,000 as is equal to seventy-five per cent of the net income of Rolley, from October 1, 1955, to and including December 31, 1960 * * * but in no event shall said balance be an amount in excess of One Million Seven Hundred Thousand Dollars ($1,700,000). * * * Payments hereunder shall be made by certified check by Botany to Crocker for the account of Sellers * * *. The failure to make any payment hereunder when due shall constitute a default by Botany.
(3) All payments received by Crocker for the account of Sellers * * * shall be paid over immediately to Sellers * * *. Notwithstanding anything to the contrary herein contained, such payments shall be made in the following manner, to-wit: Dividends from Rolley to Botany shall be delivered by certified check to Crocker and Crocker shall hold such dividends and deliver them to Botany upon receipt by Crocker of a certified check from Botany for the account of Sellers in the amount due Sellers as provided for in Paragraph III(2) of this Agreement.
* * * * * * *
V. Closing
The closing shall take place at 1 o'clock P.M. on October 3, 1955, at the offices of Crocker; and time is hereby made of the essence.
* * * * * * *
The said shares of common stock of Rolley thereupon shall be transferred to the name of Botany, endorsed by Botany in blank, and deposited with Crocker as pledge holder to secure the performance of Botany of its obligations under this Agreement.
* * * * * * *
VII. Operation of Rolley
From and after the closing date * * * and until all payments to Sellers have been made:
(1) Botany shall have full voting rights as to the stock of Rolley sold hereunder but shall vote the stock to elect a board of four directors, two of whom shall be selected by Botany and two of whom shall be selected by Sellers. * * *
* * * * * * *
VIII. Commission of Broker
Sellers each agree to assume liability for payment of commission to Broker * * * in the amount of five per cent of any payments received by Sellers respectively. * * *
IX. Appointment of Agent
* * * Sellers irrevocably constitute [Charles A. Rolley] their agent * * * to modify, amend or otherwise change this Agreement and any of its terms or provisions; to instruct the escrow holder, to declare or waive any default, and to act in all manner as they themselves could do * * *
* * * * * * *
XI. General Provisions
(1) * * * In event of any default, Sellers' sole remedy shall be by sale of the security turned over to the escrow holder, and from the proceeds of such sale, Sellers shall be entitled to not exceeding the then unpaid balance of $1,700,000.
* * * * * * *
(4) This Agreement shall bind and inure to the benefit of the parties, their successors, legal representatives and assigns.
* * * * * * *
XII. Arbitration
* * * every * * * dispute, difference or question shall be determined by arbitration, one arbitrator to be appointed by Botany, one arbitrator to be appointed by Sellers, and a third arbitrator to be appointed by said two arbitrators. * * * Costs of arbitration shall be borne equally between Botany and Sellers.
Pursuant to the provisions of the agreement, petitioners' Rolley stock, along with that of Rolley's other shareholders, was endorsed to Crocker First National Bank (now Crocker-Anglo National Bank, and hereinafter called Crocker) as escrow and pledge holder to secure the performance of the agreement and the shares of Botany stock were delivered to the former Rolley shareholders. Petitioners received 863.6215 shares of Botany common stock.
As of December 30, 1955, petitioners had four minor children, the oldest being 14 years old, and a fifth child in esse but not yet born (hereinafter collectively referred to as the children). Upon birth, the children received property from petitioners and others and had separate bank accounts opened in each of their names wherein petitioner deposited dividends received upon stock owned by the children.
Petitioner intended to make a gift to the children and on December 30, 1955, petitioner sent to Crocker the following:
Reference is made to [the agreement].
Please record the fact that I have undertaken to act as custodian for each of my children, minors, under the California Gifts of Securities to Minors Act. From this day forth I am custodian of five equal shares of my share of income to be derived and paid under and pursuant to Paragraphs III (2) and (3) of said evidence of indebtedness dated August 31, 1955.
As donor I have registered Stephen S. Townsend as custodian for Suzanne Townsend, Stephen S. Townsend, Jr., James B. Townsend, Lawrence G. Townsend, and a child in esse, all minors, under the California Gifts of Securities to Minors Act and, as said custodian, I hold a one-fifth undivided interest for each of said donees of my said income to be derived and paid as aforesaid.
/s/ Stephen S. Townsend STEPHEN S. TOWNSEND
Received and filed for donee, December 30, 1955.
/s/ Stephen S. Townsend STEPHEN S. TOWNSEND, as custodian for * * *, a minor, under the California Gifts of Securities to Minors Act
At the time the above letter was sent, petitioner put copies of it in files which he kept for the children. Petitioner also informed others, including his wife, of the subject matter contained in this letter.
On January 5, 1956, Crocker, by letter, advised petitioner as to his letter of December 30, 1955, in pertinent part as follows:
As you know, under this contract, the securities which you own were sold and transferred to [Botany] by this agreement. The stock which we hold as pledge-holder is merely as security for the performance of the agreement. In view of these facts, our attorneys have advised us that your interest under this contract is not such as would fall within the definition of "securities" under the California Gifts of Securities to Minors Act, and therefore not such an interest as may be transferred to you as custodian under this Act. In view of this fact, we are unable to make any notation on our records of any transfer of an undivided interest in your share of the net income to be paid pursuant to the aforesaid agreement.
On or about January 8, 1956, petitioner received from the attorneys for Crocker a declaration of trust form referring to "IRC Sec. 2503(c) 1954 Code," which the above-mentioned attorneys suggested be used by petitioner to effect a transfer of his interest in the contract proceeds to his children. Petitioner used this form to prepare declarations of trust for each of his five minor children (the fifth child having by that time been born), which he mailed to Crocker on May 31, 1956. All the declarations of trust were identical except for the name of the beneficiary and provided as follows:
I, STEPHEN S. TOWNSEND * * * do hereby make the following declaration of trust:
I do hereby transfer to myself, as Trustee, for the use and benefit of * * *, a minor * * * the property listed on Exhibit "A" attached hereto.
I hereby authorize the Trustee of this Trust to collect the income from this Trust, and, in * * * [his] sole discretion, to pay to the said Beneficiary, without the necessity of the appointment of a guardian, or to apply for the use, welfare, comfort or benefit of said Beneficiary during his minority, such amounts from the principal or income of this Trust as the Trustee, in * * * [his] absolute discretion, may determine and to accumulate any income not so applied.
The Trustee shall have the power, in * * * [his] uncontrolled discretion:
(a) To receive additional property as a part of the trust estate from any person or persons, including Trustor;
(b) To invest and reinvest the trust estate in any property without being limited in any way by any law restricting the investment of trust funds;
(c) To vote any corporate stock held in the trust estate and to execute proxies;
(d) To exercise options or privileges to convert or subscribe, and to consent to mergers, dissolutions or liquidations of any corporation in connection with securities held by the trust estate;
(e) To sell upon such terms and conditions, for cash or upon terms, any property of the trust estate; * * *
* * * * * * *
In the event the said Beneficiary shall die prior to his attaining the age of twenty-one (21) years, this trust shall terminate and the Trustee shall deliver the principal and any accumulated income * * * to such person or persons, including his estate, his creditors, or the creditors of his estate, as the Beneficiary may appoint * * * and in default of such appointment, then to his estate.
This trust shall terminate upon said Beneficiary * * * attaining the age of twenty-one (21) years, and the Trustee shall thereupon pay, transfer and deliver to the said Beneficiary all of the principal and accumulated income * * *.
The Trustee may at any time appoint a successor Trustee, to be designated by a written instrument executed by the Trustee, and resign as Trustee by transferring the trust estate to said successor Trustee upon the trust herein set forth.
Dated at San Francisco, California, this __________ day of May, 1956.
* * * * * * *
EXHIBIT "A"
One-fifth (1/5) of my share and interest in income to be derived and paid under and pursuant to Paragraphs III (2) and (3) of [the agreement].
In subsequent years, petitioner wrote letters to the children pertaining to paragraphs III (2) and (3) of the agreement, in which he referred to these rights as being their property. Copies of these letters were put in their files.
During the years 1956 and 1957, payments were made by Botany to Crocker in the respective amounts of $2,224.88 and $1,979.62 in accordance with the original rights of petitioner under the agreement. These payments were deposited in the bank accounts maintained for the children and were not applied other than for their use.
No fiduciary returns were filed by petitioner for the taxable years 1956 and 1957. For the taxable years 1958 and 1959 he filed separate fiduciary returns for each of the five trusts purportedly created for the children. In each return, he reported the amounts received under the agreement as capital gains income of the purported trusts.
Subsequent to the mailing of respondent's notices of deficiency, petitioner requested attorney Gilbert D. Calden (hereinafter referred to as Calden), a personal friend of petitioners, to represent petitioners' children in an action to quiet title to the rights under the agreement, paragraphs III (2) and (3). Calden instituted such action in the Superior Court of the State of California in and for the County of Alameda and prepared the complaint, the answer of the defendants (petitioners herein), the judgment quieting title, and all other pleadings and documents in connection with the case. No legal fees were charged in connection with the action and Calden was reimbursed for court costs by petitioner.
It is stipulated that the pleadings and other documents in the quiet title action were filed by Calden on the dates and at the times as follows:
Document Date and time filed
Petition for appointment of guardian ad litem .................. May 20, 1960, 10:32 a.m. Petition for appointment of guardian ad litem ................. May 20, 1960, 10:33 a.m. Order appointing guardian ad litem .............................. May 20, 1960, 10:34 a.m. Order appointing guardian ad litem ............................. May 20, 1960, 10:34 a.m. Complaint to quiet title ............. May 20, 1960, 10:34 a.m. Answer ............................... May 20, 1960, 10:37 a.m. Stipulation .......................... May 20, 1960, 10:39 a.m. Judgment quieting title .............. June 6, 1960
The repetition is unexplained.
The parties have stipulated that the payments made by Botany pursuant to the agreement, paragraphs III (2) and (3), for the account of petitioner for 1956 were $2,224.88. The $200 difference is unexplained.
Trial of the quiet title action was held on June 6, 1960, and consumed approximately 30 minutes. Petitioner was the only witness to testify and was questioned by Calden and by the court. No case was put in on behalf of the defendants, no oral argument was made, and no briefs were filed on behalf of either of the parties. Petitioner wanted to obtain a judgment quieting title to the rights under the agreement, paragraphs III (2) and (3), in the children.
Calden prepared the judgment in advance of the trial and submitted it to the court for signature immediately thereafter.
In the judgment quieting title, the State court found that the agreement, paragraphs III (2) and (3), was an evidence of indebtedness within the meaning of the California Gifts of Securities to Minors Act; that petitioner on December 30, 1955, made irrevocable gifts to his children under said Act of all the benefits and properties to be derived under the aforementioned sections of the agreement; and that title to all of the properties and benefits to be derived thereunder had been since December 30, 1955, and then was the sole and separate property of the children.
Respondent, in his deficiency notice, determined that the payments made by Botany for the account of petitioner in 1956 and 1957 were proceeds from petitioners' 1955 sale of their Rolley stock and included them as long-term capital gain in petitioners' returns as follows:
Respondent stated in his opening statement at the trial that "these proceeds should be included in the income of the Petitioners for our two years under the cost recovery or return * * * [of] capital method of reporting long-term capital gain."
On or about August 31, 1955 petitioners exchanged the securities in question for certain income-producing property.
* * * * * * *
This gift operated to totally divest petitioners of all right, title and interest in and to said property and the income derived therefrom.
OPINION.
It is difficult to subscribe to petitioner's theory that the gains in controversy were income generated by income-producing property. The parties are evidently in agreement that the income is capital gain and it seems to us inescapable that this must have arisen out of the sale made by petitioners before they transferred its proceeds. Ordinarily, the gain would then have been taxable to them, cf. John W. Chamberlin, 32 T.C. 1098 (1959), affd. 286 F.2d 850 (C.A. 7, 1961), certiorari denied 368 U.S. 820 (1961), but if for some reason, as is agreed by the parties here, the tax can be postponed,fn1 as, for example, because of the absence of an ascertainable fair market value for the property received, see Burnet v. Logan, 283 U.S. 404 (1931), that does no more than postpone the time and perhaps fix the amount. It should not change the taxpayer whose activity created the profit, Lucas v. Earl, 281 U.S. 111 (1930); Helvering v. Eubank, 311 U.S. 122 (1940); Commissioner v. First State Bank, 168 F.2d 1004 (C.A. 5, 1948), certiorari denied 335 U.S. 867, and to whom the profit is consequently taxable. United States v. Joliet Chicago R. Co., 315 U.S. 44 (1942); Commissioner v. Court Holding Co., 324 U.S. 331 (1945); Griffith v. Commissioner, 308 U.S. 355 (1939); F. E. McGillick Co., 30 T.C. 1130, 1148 (1958), reversed other grounds 278 F.2d 643 (C.A. 3, 1960).
Congress also recognized this basic tax concept in enacting the relief provisions embodied in section 337 of the 1954 Code which, under certain limited conditions, relieves the seller from paying a tax on the gain resulting from a sale. Henry A. Kuckenberg, 35 T.C. 473 (1960), on appeal (C.A. 9, 1961).
In Cold Metal Process Co., 25 T.C. 1333 (1956), affirmed this issue 247 F.2d 864 (C.A. 6, 1957), we pointed out the factor distinguishing this case from ostensibly similar cases which look solely to the subject matter transferred and not to the transaction giving rise to it.
The case of Commissioner v. Court Holding Co., 324 U.S. 331 (1945), cited by respondent, is clearly distinguishable. Here there was no sale of anything, and hence there were no proceeds of a sale arranged by Cold Metal to be attributable to that corporation.
Cold Metal Process Co., supra at 1352. A sale is again lacking in the case of Blair v. Commissioner, 300 U.S. 5 (1937), also cited by petitioners.
The parties characterized their own transaction as a sale, paragraphs III (2) and (3) of the agreement constituting part of the sale proceeds. This is illustrated by the following extract from those paragraphs:
(2) The balance of the purchase price to be the sum of One Million Seven Hundred Thousand Dollars ($1,700,000) without interest, provided, however, that the obligation to pay such balance of said purchase price shall be an obligation to pay only such portion of said $1,700,000 as is equal to seventy-five per cent of the net income of Rolley, from October 1, 1955, to and including December 31, 1960 * * * but in no event shall said balance be an amount in excess of One Million Seven Hundred Thousand Dollars ($1,700,000). * * *
(3) All payments received by Crocker for the account of Sellers * * * shall be paid over immediately to Sellers * * *. [S]uch payments shall be made in the following manner, to-wit: Dividends from Rolley to Botany shall be delivered * * * to Crocker and Crocker shall hold such dividends and deliver them to Botany upon receipt by Crocker of a certified check from Botany for the account of Sellers in the amount due Sellers as provided for in Paragraph III(2) of this Agreement.
[Emphasis added.]
Following the sale, petitioners did not have a right to Rolley's subsequent income. See Gray Process Corporation, 43 B.T.A. 624, 633-634 (1941), affirmed per curiam 122 F.2d 1021 (C.A. 3, 1941). They had a right to collect from Botany an amount up to $1,700,000 to be measured by and limited to a number of dollars equaling 75 percent of Rolley's income for the next 5 years. See Estate of Raymond T. Marshall, 20 T.C. 979 (1953). This is not an income interest in Rolley but a claim against Botany, indefinite only as to amount.
With many of the foregoing propositions petitioners apparently agree. They say in their brief, for example:
In respect to respondent's analogy of the fruit and tree, petitioners agree that the payments in 1956 and 1957 made pursuant to Paragraphs III(2) and (3) * * * were the product (the fruit). However they disagree that the Rolley stock was the tree which produced the fruit. Petitioners had parted with all right, title and interest to the Rolley stock prior to the 1956 and 1957 payments. The fact is that said payments were the fruit of another tree * * *
That other tree seems to us inescapably to have been the sale made by petitioners in 1955. The remaining unpaid portions of the purchase price were purely the balance originally due to petitioners for the transaction they had already completed. That to our mind was the tree and it could no more be transferred after the crystallizing of its tax effects than could the subject matter of the litigation in Helvering v. Eubank, Lucas v. Earl, Commissioner v. Court Holding Co., and Griffith v. Commissioner, all supra, and authorities to the same effect.
To be contrasted with this arrangement is the situation presented in Commissioner v. Reece, 233 F.2d 30 (C.A. 1, 1956), affirming 24 T.C. 187 (1955), and similar cases cited by petitioners, where the court concluded that:
In this case Reece was originally the owner of a patentable invention. This capital asset had merely the potentiality of producing income, that is, if the invention were profitably exploited. But he sold his patent rights * * * and thereby received in substitution a new kind of property interest, a chose in action, a contract right to receive "royalty" payments in the future * * *. [Emphasis added.]
Here we have no "substitution" of income-producing property for other income-producing property, but a sale for a sum of money which became the subject of an anticipatory assignment. T. J. Rogers, 15 B.T.A. 638, 640 (1929); Floyd v. Scofield, 193 F.2d 594, 595 (C.A. 5, 1952); Mrs. Len Langston, 23 B.T.A. 991 (1931).
The deed ran to the purchaser and title was conveyed to him. Simultaneously with the passing of the title arose the obligation of the vendee to pay. This obligation ran to the vendor, to whom the * * * [first] payment was made. At the instant of the consummation of the sale the obligation of the vendor to pay a tax on any profit derived became fixed. The fact that the vendor directed that the notes * * * be made payable to a third party is immaterial and could not affect or lessen the obligation of the vendor to account for all profits on the transaction. It follows that what was conveyed to the * * * [donees] was a right to collect and retain the deferred payments, but the obligation of the vendor to pay tax on all profits, being fixed at the time of sale, was not reduced by this gift of the unpaid proceeds. [Emphasis added.]
T.J. Rogers, supra at 640-641.
Having concluded that an assignment of the proceeds of the agreement would not shift to the donees the incidence of taxation upon subsequent receipts, we need not consider the effect of Margery B. Townsend's power to reinstate the agreement as community property, resulting from the fact that prior to the receipts in question she had not consented in writing to the gift of community property made by petitioner nor waived that requirement. See Roy P. Harper, 6 T.C. 230 (1946). Nor need we consider the effect of the assignment of only a part of the agreement — the right to receive future payments. See Helvering v. Horst, 311 U.S. 112, 119, 120 (1940); Helvering v. Eubank, supra. And, of course, the State court decree, however persuasive as to the passage of title, could not on the present facts affect the incidence of Federal taxation. Kathryn S. Fuller, 37 T.C. 147 (1961); Roy P. Harper, supra.
"The husband has the management and control of the community personal property, with like absolute power of disposition * * * as he has of his separate estate; provided, however, that he can not make a gift of such community personal property * * * without the written consent of the wife." Cal. Civ. Code sec. 172.
To take account of a clerical error,
Decisions will be entered under Rule 50.