Opinion
Docket Nos. 12704 12705.
1949-03-9
CHARLES E. McCARTNEY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.EVELYN McCARTNEY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Austin H. Peck, Jr., Esq., for the petitioners. Earl C. Crouter, Esq., for the respondent.
Petitioner Charles E. McCartney received a payment from Lomita Gasoline Co. in 1944 upon release to that company of its contract made in 1935 to pay him monthly sums based upon sales of gas to Petrolane, Ltd., a corporation owned by Lomita and McCartney. The 1935 contract was made to induce McCartney to agree to modify a prior contract and require Petrolane to pay an increased price to Lomita for gas. Held, the payment received in 1944 was ordinary income to petitioners. Austin H. Peck, Jr., Esq., for the petitioners. Earl C. Crouter, Esq., for the respondent.
The respondent determined deficiencies in income tax for 1944 against Charles E. McCartney in the amount of $14,734.42 and against Evelyn McCartney in the amount of $14,859.42. The sole issue is whether an amount received by Charles E. McCartney in 1944 upon release of a certain contract was capital gain or ordinary income to the petitioners.
FINDINGS OF FACT.
The petitioners are husband and wife. They reside in Long Beach, California, and resided in California during the years mentioned herein. They filed separate income tax returns for the calendar year 1944 with the collector of internal revenue at Los Angeles, California, reporting their respective shares of the community income.
Charles E. McCartney (for convenience sometimes hereinafter referred to as ‘petitioner‘) is an engineer. He developed a process whereby what had been a waste product of a gasoline plant could be put to commercial use as ‘liquefied petroleum gas,‘ and prior to 1930 he was engaged in the business of distributing it to customers. His source of supply was the Standard Oil Co. of California. In 1929 this company increased the price to petitioner and entered into competition with him.
Petitioner sought another source of supply and in 1929 entered into a contract with Lomita Gasoline Co. (hereinafter referred to as Lomita). This company made certain equipment available to petitioner and agreed to allow him to draw his requirements of gas at a stipulated price. Petitioner and Lomita agreed to form a corporation to take over petitioner's business. Pursuant to the 1929 agreement, a corporation was formed under the name of Petrolane, Ltd., (hereinafter referred to as Petrolane). Lomita transferred to it certain equipment and petitioner transferred his business to it and assigned to it his 1929 contract with Lomita. Petitioner received 30 per cent of its stock and was its president and one of the three directors. Lomita received 70 per cent of the stock and named two directors.
The price charged Petrolane by Lomita was much lower than petitioner had previously been charged by the Standard Oil Co. of California. Petrolane carried on the business theretofore conducted by petitioner. Petitioner received a salary as president of Petrolane, starting at $500 per month, which was increased later, and also received fees as a director of Petrolane. Petitioner owned no stock in Lomita prior to January 3, 1944, and he has never been an officer or director of Lomita.
In 1935 Lomita sought an increase in the price to be paid it under the 1929 agreement. The current market price charged by other gasoline companies was then in excess of the price being paid by Petrolane. On June 24, 1935, an agreement was entered into by Lomita and Petrolane providing for an increased price to be paid Lomita. On the same date Lomita, as first party, entered into an agreement with petitioner, as second party, reciting the facts and providing as follows:
WHEREAS, First Party now feels that in view of the large market which is now developing for such products, and the retail price now obtainable therefor, that the price provided to be paid by Second Party to First Party for said gases is inadequate, and is now desirous of modifying said contract so as to provide for the payment to First Party by Second Party's assignee, Petrolane, Ltd, of a sum in excess of twenty Cents (20 cents) per thousand (1000) cu. ft. provided for in said contract, and so assigned by Second Party, as aforesaid; and
WHEREAS, any modification of said contract which would increase the amount to be paid to First Party for such gases would reduce the amount of profits to be paid to Second Party pursuant to the agreements as hereinabove outlined; and
WHEREAS, it is the desire of both of the parties hereto to make such an arrangement as will not work any injustice upon Second Party by reason of the modification of said contract, as aforesaid; and
WHEREAS, Second Party is willing to permit a modification of said contract provided that his proportionate part of the profits shall not be affected thereby;
NOW, THEREFORE, for and in consideration of the premises and of the mutual covenants and agreements hereinafter contained, it is agreed:
1. FIRST PARTY hereby agrees to pay to SECOND PARTY an amount equal to fifteen per cent (15%) of the total sales price received by First Party from Petrolane, Ltd., a corporation, for all liquified petroleum gases sold by First Party and purchased by the said Petrolane, Ltd., a corporation, under the proposed new contract basis, which said new contract under date of June 24, 1935, is hereby referred to and made a part hereof by this reference; it being understood that said new contract shall be executed, simultaneously and as a condition precedent to the execution of this agreement.
2. The commission provided to be paid by First Party herein shall be paid to Second Party on or before the 20th day of each calendar month hereafter during the period hereof for all liquefied petrolane gases sold and delivered by First Party to Petrolane, Ltd., and paid for by Petrolane, Ltd., during the preceding calendar month.
3. The period of this contract shall be for the entire period that Petrolane, Ltd, or its successors or assigns, shall purchase liquefied petroleum gases from First Party, or its successors or assigns.
4. It is understood and agreed by the execution of this agreement that the parties hereto, being the sole stockholders of Petrolane, Ltd., do hereby ratify and confirm the same as such stockholders.
5. This contract shall be binding upon and inure to the benefit of the heirs, administrators, successors or assigns of the respective parties hereto.
After the execution of the two agreements of 1935, Petrolane purchased its gas from Lomita at the higher price specified, and petitioner received periodic payments from Lomita. Petitioner also received dividends on his 30 per cent of Petrolane stock. The amounts of these dividends from Petrolane and the amounts petitioner received from Lomita under their 1935 agreement were as follows:
+-------------------------------------------------+ ¦ ¦Dividends¦Payments ¦ ¦Dividends¦Payments ¦ +----+---------+---------+----+---------+---------¦ ¦Year¦from ¦from ¦Year¦from ¦from ¦ +----+---------+---------+----+---------+---------¦ ¦ ¦Petrolane¦Lomita ¦ ¦Petrolane¦Lomita ¦ +----+---------+---------+----+---------+---------¦ ¦1933¦$2,700 ¦ ¦1940¦$12,000 ¦$8,543.61¦ +----+---------+---------+----+---------+---------¦ ¦1934¦2,700 ¦ ¦1941¦6,000 ¦11,202.94¦ +----+---------+---------+----+---------+---------¦ ¦1935¦None ¦$1,456.81¦1942¦9,000 ¦17,529.78¦ +----+---------+---------+----+---------+---------¦ ¦1936¦9,900 ¦6,204.96 ¦1943¦9,600 ¦33,650.52¦ +----+---------+---------+----+---------+---------¦ ¦1937¦9,000 ¦6,074.59 ¦1944¦14,400 ¦ ¦ +----+---------+---------+----+---------+---------¦ ¦1938¦6,000 ¦8,684.52 ¦1945¦14,400 ¦ ¦ +----+---------+---------+----+---------+---------¦ ¦1939¦4,500 ¦7,455.69 ¦ ¦ ¦ ¦ +-------------------------------------------------+
On January 3, 1944, both petitioners executed an instrument reciting that McCartney, in consideration of the sum of $69,300, ‘does by these presents sell, assign, and transfer unto the LOMITA GASOLINE COMPANY, all of his right, title, claim, and interest of every kind or character whatsoever in or to that certain Contract or Agreement dated the 24th day of June, 1935, by and between the Lomita Gasoline Company, as First Party, and the undersigned as Second Party, * * * together with and including all benefits and obligation of the undersigned under or by virtue thereof.‘
Each petitioner reported one-half of $69,300 as long term capital gain for 1944, claiming no basis for the asset.
OPINION.
ARNOLD, Judge:
The respondent determined that the $69,300 received by the petitioners in 1944 upon the release of Charles E. McCartney's contract of June 24, 1935, with Lomita was ordinary income. The petitioners allege error in this determination. Their contention is that in 1936 McCartney owned, in addition to his 30 per cent stock interest, a property interest in Petrolane, the quantum and value of which were fixed by the price relationship between Petrolane and Lomita, and that such interest was a capital asset and all payments received by him under the 1935 contract, including the amount received in 1944, were for the sale or exchange of this interest in Petrolane not represented by his stock.
Petitioners' premise is false. McCartney had no property right in Petrolane separate and apart from his stock. His 1929 contract with Lomita had been transferred to Petrolane and he retained no rights in it. When McCartney consented to the modification of the 1929 contract price there may have been a reduction in the value of his stock consequent upon the reduction of profits reasonably to be expected from the change in price. This reduction, if we assume it occurred, was not a disposition of a capital asset. McCartney still retained his stock and any change in its value would ultimately enter into his capital gain or loss upon its disposition. A payment for a loss in value of an asset, where the asset is retained, does not involve a sale or exchange of a capital asset and is ordinary income. Levinson v. Commissioner, 154 Fed. (2d) 60.
The 1935 contract provides in part:
WHEREAS, any modification of said contract (the 1929 contract) which would increase the amount to be paid to First Party (Lomita) for such gases would reduce the amount of profits to be paid to Second Party (McCartney) * * * and;
WHEREAS, Second Party is willing to permit a modification of said contract provided that his proportionate part of the profits shall not be affected thereby * * *
The 1935 contract does not purport to sell or transfer a property interest, as is now contended by petitioners. The parties expected that the increased price Petrolane would pay Lomita for gas would result in a reduction in the profits of Petrolane. The agreement provided a substitute to McCartney for the part of such profits he would lose. The payments provided by the contract, being a substitute for profits, which are income, were ordinary income and not capital gain. The payment of $69,300 in 1944, in settlement of Lomita's obligation to pay this income to McCartney in the future, likewise was ordinary income. Hort v. Commissioner, 313 U.S. 28.
The petitioners contend, in the alternative, that the transaction in 1944 was the sale of a capital asset, namely, the 1935 contract, which was valuable to the petitioner, as he received substantial amounts under it and was required to perform no services of any kind in return. We have concluded, as stated above, that the 1944 payment was ordinary income; but, assuming, arguendo, that the contract was a capital asset, the 1944 transaction was not a sale thereof. A taxpayer seeking the benefits of section 117 of the code must show that there has been a sale or exchange and that he has disposed of a capital asset. A sale is a contract whereby one acquires a property in the thing sold and the other parts with it for a valuable consideration. Words and Phrases, PermanentEd.,v.38,p.58. Where a note is surrendered to the maker on payment of all or a part of the debt, there is no acquisition of property by the maker and no transfer of property to him. Hale v. Helvering, 85 Fed.(2d) 819. The surrender to the maker for cash is not a sale to him and any property in the note vanishes. Bingham v. Commissioner, 105 Fed.(2d) 971. The contract here was not sold, it was extinguished. Lomita acquired no exchangeable asset. The transaction, although in form a sale, was a release of the obligation. This transaction did not involve the disposition of a beneficial interest in a trust, considered a capital transaction Blair v. Commissioner, 300 U.S. 5; McAllister v. Commissioner, 157 Fed.(2d) 236; certiorari denied, 330 U.S. 826, reversing 5 T.C. 714; Bell v. Commissioner, 137 Fed.(2d) 454, reversing 46 B.T.A. 484, nor was it the transfer of a right, as in Ranier Brewing Co., 7 T.C. 162.
Since there was no ‘sale or exchange‘ of a capital asset, section 117 is not applicable and the entire payment constituted ordinary income to the petitioners.
Decisions will be entered for the respondent.