Opinion
Docket Nos. 53878 53879.
1957-03-11
MARC D. LEH AND L. WAIVE LEH, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.DAVID E. BROWN AND CHRISTABEL H. BROWN, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
James L. Wood, Esq., and Barton B. Beek, Esq., for the petitioners in Docket No. 53878. David E. Brown, pro se, in Docket No. 53879.
James L. Wood, Esq., and Barton B. Beek, Esq., for the petitioners in Docket No. 53878. David E. Brown, pro se, in Docket No. 53879.
George E. Constable, Esq., for the respondent.
In 1948 a partnership entered into a contract which gave it the right to purchase from a corporation 2,250,000 gallons of gasoline per month. In 1950, when gasoline was in short supply, the corporation paid the partnership the amount of $183,330.50 to cancel and terminate the contract. Held, the respondent correctly determined that the gain resulting from this transaction was taxable as ordinary income and not as capital gain.
The respondent determined the following deficiencies in the income tax of petitioners for the year 1950:
+---------------------------------------------------+ ¦ ¦Deficiency ¦ +--------------------------------------+------------¦ ¦Marc D. Leh and L. Waive Leh ¦$24,669.86 ¦ +--------------------------------------+------------¦ ¦David E. Brown and Christabel H. Brown¦25,377.04 ¦ +---------------------------------------------------+
In each of the proceedings the petitioners claim an overpayment of tax.
The sole issue is whether the amount of $183,330.50 received in 1950 by a partnership from the Olympic Refining Company is taxable as capital gain or ordinary income.
Other issues raised by the pleadings have been settled by stipulations of the parties.
FINDINGS OF FACT.
Some of the facts have been stipulated and are incorporated herein by this reference.
The petitioners in each proceeding are husband and wife and residents of Los Angeles, California. They filed their income tax returns for the year 1950 with the collector of internal revenue for the sixth district of California. Marc D. Leh and David E. Brown will hereinafter be referred to as the petitioners.
The Progress Company (hereinafter referred to as Progress) was a general partnership. The members of this partnership were Marc D. Leh and David E. Brown and they shared equally its profits and losses.
Progress was formed in 1940 and thereafter engaged in various businesses, particularly businesses connected with the petroleum industry. Progress engaged in marketing petroleum products during 1947, 1948, 1949, and 1950.
Olympic Refining Company (hereinafter referred to as Olympic) is a corporation engaged in marketing petroleum products.
On November 19, 1945, Olympic entered into a supply contract with General Petroleum Corporation (hereinafter referred to as General) under the terms of which General was obligated to supply Olympic's requirements of gasoline and other petroleum products up to a maximum of 3,500,000 gallons of gasoline each month, and Olympic was obligated to purchase its entire requirements of gasoline from General without restriction as to quantity. The expiration date of the contract was January 1, 1951, but it contained a clause providing for automatic extension from year to year, subject to termination upon 6 months' notice by either party. This contract will hereinafter be referred to as the General-Olympic contract.
During the years 1946 and 1947 Olympic's purchases from General averaged 1,000,000 to 1,250,000 gallons of gasoline monthly.
On January 28, 1948, Progress entered into a contract with Olympic (hereinafter referred to as the Progress-Olympic contract). This contract was set forth in two letters bearing that date. One letter addressed to Progress by Olympic was as follows:
We are pleased to submit below our proposal to serve you with your requirements of our gasoline.
Your signature of acceptance acknowledges that you have read and are familiar with the terms and conditions of that certain agreement between Olympic Refining Company and the General Petroleum Corporation of California, dated November 19, 1945, and that the terms, amendments, conditions and provisions are incorporated herein by reference and made a part hereof to all intents and purposes as though the same were set forth in full, except that:
(1) The quantity of gasoline will be two and one-quarter million gallons, 10% more or less, subject to our option;
(2) The prices you will pay us will be one-half cent per gallon greater than the prices which are set forth in said agreement; and,
(3) Gasolines purchased hereunder will not be resold for delivery into the States of Washington and Oregon nor within the territory in the State of California which is embraced within exclusive distributor contracts with the Olympic Refining Company as follows: San Francisco, San Jose, Glendale, Pasadena, and San Diego.
The other letter addressed to Olympic by Progress was as follows:
In consideration of the gasoline contract which we have entered into with your company as of this date, it is understood that, in the event the Olympic Refining Company extends and/or makes a contract for gasolines with the General Petroleum Corporation of California and/or any other supplier of petroleum products, The Progress Co. shall have an extension of its agreement on the same terms and conditions, with the exceptions noted in our agreement of this date.
Likewise, if The Progress Co. should negotiate a contract for gasolines similar to the above referred to type of contract with the General Petroleum Corporation of California and/or any other supplier of petroleum products, The Progress Co. will pay to the Olympic Refining Company one-half (1/2¢) cent per gallon during the life of said contract.
Prior to the execution of the Progress-Olympic contract, Progress and Olympic had entered into a ‘Distributor's Agreement’ by the terms of which Progress was entitled to 350,000 gallons of gasoline per month. The distributor's agreement was assigned by Progress early in 1948 to Olympic-Progress Oil Co., a corporation controlled by petitioners Marc D. Leh and David E. Brown.
Between 1948, when the Progress-Olympic contract was executed, and 1950, the gasoline market expanded; and, by 1950, gasoline was in short supply in the Southern California area. General, as part of its policy of reducing its supply commitments, entered into negotiations with Olympic in 1950 seeking a reduction of its commitment under the General-Olympic contract, and Olympic, in turn, sought reduction or elimination of its commitment under the Progress-Olympic contract.
On July 26, 1950, an agreement, bearing the caption ‘Mutual Termination Agreement,‘ was entered into by Progress, as first party, Olympic-Progress Oil Co., as second party, and Olympic, as third party. Therein, after referring to prior agreements of the parties, including the Progress-Olympic contract and the distributor's agreement, it was agreed, in part as follows:
(1) Each and all of said agreements above described are hereby mutually declared to be cancelled and terminated as of the close of business on the 31st day of July, 1950 and declared to be of no further force or effect.
(2) First Party and Second Party hereby release and discharge Third Party and General Petroleum Corporation of and from any and all duties, claims, liabilities or obligations arising out of or in connection with said agreements above described or otherwise.
(3) Third Party releases and discharges First Party of and from any and all duties, claims, liabilities or obligations arising out of or in connection with said agreements above described or otherwise; excepting however, that Third Party does not release First Party of or from the following indebtednesses:
(a) The indebtedness in the sum of $255,277.80 owed by First Party to Third Party as of the close of business on the 24th day of July, 1950, for petroleum products theretofore sold and delivered by Third Party to First Party; and
(b) Any indebtedness of First Party to Third Party for petroleum products sold and delivered by Third Party to First Party up to and including the 31st day of July, 1950, computed at the same prices used in the computation of said existing indebtedness described in subparagraph (a) above;
First Party agrees to pay said indebtedness or any remaining balance thereof to Third Party on or before the 3rd day of August, 1950.
5. In consideration of the termination of said agreements, as provided in paragraph 1 hereinabove, and in consideration of the releases herein provided for, Third Party shall pay to First Party the sum of $183,330.50, and to Second Party the sum of $31,669.50; which said sums may, at the election of Third Party, be paid in cash to Second and Third Parties respectively, or be paid by crediting the said sums respectively against the respective indebtednesses of First and Second Parties described in paragraphs 3 and 4 hereinabove, which election shall be made by Third Party on or before July 31st.
The amount of $183,330.50 was paid to Progress during 1950 by crediting this amount to its account with Olympic for gasoline theretofore purchased under the Progress-Olympic contract.
On July 31, 1950, General and Olympic entered into an agreement which provided for the termination of the General-Olympic contract, and on August 1, 1950, they executed a new contract under the terms of which Olympic was entitled to purchase 1,750,000 gallons of gasoline per month. Olympic received from General approximately $235,000 at the time these agreements were executed.
In the partnership return filed by Progress for 1950, the $183,330.50 received by it from Olympic was reported as a long-term capital gain and treated as such on returns filed by petitioners. The respondent determined that this amount constituted ordinary income and that one-half should have been included in the taxable income for 1950 of each petitioner.
OPINION.
RAUM, Judge:
Section 117(j) of the Internal Revenue Code of 1939
accords capital gains treatment to gains from the sale or exchange of certain ‘property used in the trade or business' of a taxpayer. Petitioners contend that the right to purchase 2,250,000 gallons of gasoline per month, which Progress acquired from Olympic under the Progress-Olympic contract, was ‘property used in the trade or business' of Progress; that the transaction of July 26, 1950, constituted a ‘sale or exchange’ of this property; and that gain of $183,330.50 realized was taxable as capital gain and not as ordinary income.
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, or (C) a copyright, a literary, musical, or artistic composition, or similar property, held by a taxpayer described is subsection (a)(1)(C). * * *(2) GENERAL RULE.— If, during the taxable year, the recognized gains upon sales or exchanges of property used in the trade or business, plus the recognized gains from the compulsory or involuntary conversion (as a result of destruction in whole or in part, theft or seizure, or an exercise of the power of requisition or condemnation or the threat or imminence thereof) of property used in the trade or business and capital assets held for more than 6 months into other property or money, exceed the recognized losses from such sales, exchanges, and conversions, such gains and losses shall be considered as gains and losses from sales or exchanges of capital assets held for more than 6 months. If such gains do not exceed such losses, such gains and losses shall not be considered as gains and losses from sales or exchanges of capital assets. * * *
We agree with petitioners that the right of Progress to purchase 2,250,000 gallons of gasoline per month which it acquired under the Progress-Olympic contract falls within the definition of ‘property used in the trade or business' contained in section 117(j). We do not agree that the transaction of July 26, 1950, constituted a ‘sale or exchange’ of this property right to Olympic.
The petitioners argue that the rights of Progress under the Progress-Olympic contract were essentially the same as the rights of Olympic under the General-Olympic contract; that the Progress-Olympic contract was, in substance, an assignment from Olympic to Progress of a portion of Olympic's rights under the General-Olympic contract; that the transaction of July 26, 1950, was, in substance, a transfer from Progress to Olympic of the right to purchase 2,250,000 gallons of gasoline per month from General; and that Olympic paid Progress $183,330.50 for the transfer of this right. We do not agree with this argument, because Progress never acquired the right, by assignment or otherwise, to purchase gasoline from General under the Progress-Olympic contract. That contract gave Progress the right to have its gasoline requirements supplied by Olympic, and the evidence indicates that its purchases were made from Olympic. The General-Olympic contract was a separate and distinct transaction which gave Olympic the right to purchase gasoline from General, and which provided Olympic with a source of supply which enabled it to enter into contracts to sell gasoline to Progress and others. In the circumstances we cannot agree that the substance of the transaction of July 26, 1950, was a transfer from Progress to Olympic of the right of Progress to purchase 2,250,000 gallons of gasoline per month from General.
On July 26, 1950, Progress had the right under the Progress-Olympic contract to purchase 2,250,000 gallons of gasoline per month from Olympic. Because of a shortage in the supply of gasoline at that time, this right had a substantial value. It was property which was susceptible of transfer for a valuable consideration, and such a transfer would constitute a ‘sale or exchange.’ It was also susceptible of being canceled or terminated for a valuable consideration, in which event one of the essential elements of a ‘sale or exchange,‘ a transfer of property, would be lacking.
Progress and Olympic were parties to an agreement entered into on July 26, 1950, which was denominated a mutual termination agreement. After reciting the prior agreements previously entered into by the parties, including the Progress-Olympic contract, this agreement provided in part for the cancellation and termination of the prior agreements, for the release and discharge of Olympic from any duties or obligations arising out of or in connection with the prior agreements, and for the payment of $183,330.50 by Olympic to Progress in ‘consideration of the termination of said agreements * * * and in consideration of the releases herein provided for * * * .’
The petitioners urge that the fact that the July 26, 1950, agreement was denominated a mutual termination agreement and that the words ‘cancellation’ and ‘termination’ were used therein is not necessarily determinative of the nature of the transaction. We agree, and have carefully considered not only the provisions of the agreement but also the attendant facts and circumstances shown by the evidence. They disclose to our satisfaction that the transaction was not intended to effect a sale by Progress of its rights under the Progress-Olympic contract to Olympic; that Olympic was desirous of canceling and terminating those rights; and that the amount of $183,330.50 was paid to Progress in consideration for their cancellation and termination. In return for this payment Progress released Olympic from the obligation to sell it 2,250,000 gallons of gasoline per month. This release not only ended Olympic's duty to supply this gasoline but also destroyed Progress's rights under the Progress-Olympic contract. They were not transferred to Olympic; they ‘merely came to an end, and vanished.’ Cf. Commissioner v. Starr Brothers, Inc., 204 F.2d 673, 674 (C.A. 2).
We recognize that controversies in this field have resulted in some rather fine distinctions. Thus, the receipt of money in consideration of the relinquishment of contractual rights which had the consequence of enlarging rights in specific property of the other contracting party has been treated as a ‘sale or exchange.’ Cf Isadore Golonsky, 16 T.C. 1450, affirmed 200 F.2d 72 (C.A. 3), certiorari denied 345 U.S. 939; Louis W. Ray, 18 T.C. 438, affirmed 210 F.2d 390 (C.A. 5), certiorari denied 348 U.S. 829; McCue Bros. & Drummond, Inc., 19 T.C. 667, affirmed 210 F.2d 752 (C.A. 2), certiorari denied 348 U.S. 829; Henrietta B. Goff, 20 T.C. 561, affirmed 212 F.2d 875 (C.A. 3), certiorari denied 348 U.S. 829. Judge A. N. Hand undertook in the McCue Bros. & Drummond case to distinguish the two lines of cases; in cases such as Starr Brothers, supra, and General Artists Corp. v. Commissioner, 205 F.2d 360 (C.A. 2), certiorari denied 346 U.S. 866, there was a mere release of a contractual right which ‘vanished,‘ whereas in the other line of cases, ‘the right of possession under a lease or otherwise, is a more substantial property right which does not lose its existence when transferred.’ 210 F.2d at p. 753. And we attempted to apply the principles of these cases in Pittston Co., 26 T.C. 967, where the relinquishment of contractual obligations resulted in enlarged rights in the other party to dispose of specific coal produced at its mines. We felt that the facts there presented were comparable to the ones in the Golonsky and Goff line of cases. In the instant case, however, we cannot find such a transfer of rights in property as we presented in those cases.
If these distinctions are not wholly satisfying, it should be remembered that the Supreme Court was requested to issue writs of certiorari in a number of these cases in order to clarify the situation, but it refused to do so. In the circumstances, we must do the best we can with the precedents at hand, and, applying those precedents here, we conclude that the cancellation of the contract rights herein did not constitute a ‘sale or exchange.’
Decisions will be entered under Rule 50.