CAPITAL EXPENDITURES-continued
did not purchase stock in his trade or business, or as ordinary and
necessary expense incurred to protect his business reputation, since his
concern for his business reputation could not be separated from claim for
monetary damages; and contrary to petitioner's alternative argument,
even though legal expenses were capital expenditures, tax for year he sold
stock could not be recomputed under sec. 1341 to reflect resulting loss,
since regs. specifically exclude legal fees and other expenses incurred with
respect to item previously included in income from such adjustment.
John L. Locke
CAPITAL GAINS AND LOSSES
See also BASIS, DAMAGES, and INCOME.
Sale of Stock-Collapsible Corporation-Capital or Income.-
Where petitioner owned 20% of stock of subch. S corporation, which built
and operated cable TV system, and sold stock at substantial gain before
corporation realized substantial part of taxable income, even though
corporation was collapsible corporation under sec. 341(b) because
petitioner had requisite "view" to effect sale which was formed during
corporation's continuous production as provided under regs., Court deter-
mined that gain was long-term capital gain and was not converted to
ordinary income, since petitioner came within relief from sec. 341(a) pro-
vided in sec. 341(e), on facts showing petitioner was not in another TV or
other business which would have caused corporate assets to be ordinary
income assets in his hands, and net unrealized appreciation in corpora-
tion's subsection (e) assets (subscription contracts) amounted to less than
15% of corporation's net worth. Estate of C. A. Diecks___.
Termination Payments-Agreement as Lease or Employment
Contract-Capital or Income.-Where petitioner A in 1962 took over
operation of cardroom on B's premises under agreement providing for
fixed monthly payments from A to B but excluding formal assignment of
B's license to operate cardroom, which would have resulted in revocation
of license, and in 1965 county officials suspended license on deter-
mination that 1962 agreement was in fact assignment of license and
therefore contrary to law, whereupon A and B terminated operating
agreement by settlement agreement under which A was to receive lump-
sum payment plus percentage of gross profits each year until 1977, Court
determined on facts that 1962 agreement constituted lease rather than
employment contract, termination of which was sec. 1231 sale or
exchange of property, so that, contrary to Commissioner's contentions,
payments A received under settlement agreement were capital gains
subject to sec. 1245 recapture of depreciation previously taken on
leasehold, and hence were not subject to self-employment tax. Howard
G. Kingsbury
Worthless Stock-Acquired for Business and Investment
Reasons-Capital or Ordinary Loss or Business Expense.-
Corporation X, engaged in processing and selling raw woolen stock and
other woolen materials, which organized corporation Y in 1961 to
operate woolen textile mill and acquired 72% of its common stock with
predominant motive of having captive customer for its processed wool and
secondary motive of making profitable investment, was not entitled to
either ordinary loss deduction under sec. 165(a) or ordinary and necessary
expense deduction under sec. 162(a) when stock became worthless in
1970, since Court declined to extend Corn Products doctrine and refused
to expand statutory exceptions to "capital assets" in mixed-motive case
where both investment and business motives existed for purchase of stock.
W. W. Windle Co ____
COMMISSIONER OF INTERNAL REVENUE
See INSURANCE COMPANIES.
See ADDITIONS TO TAX and NONRESIDENT ALIENS.
CONSOLIDATED RETURNS
Insolvent Subsidiary-Investment Adjustment and Excess
Losses-Validity of Regs.-Where petitioner corporation X filed con-
solidated tax returns for 1967 and 1968 with subsidiary Y, whose net
operating losses were used to reduce consolidated income or were carried
back to prior taxable years in amounts exceeding X's basis in Y stock, and
X further filed purported consolidated return with Y for 1969, after Y's
insolvency in 1968, reducing consolidated income by net operating loss
carryover attributable to Y, Court upheld validity of (1) reg. 1.1502-32
whereby X's basis in Y stock was reduced below zero for losses in excess of
basis, resulting in excess loss account, and (2) reg. 1.1502-19 whereby Y
stock, concededly worthless in 1968, was deemed "disposed of" and excess
loss account was included in X's taxable income as ordinary income upon
such disposition, since regs. reflected permissible exercise of rulemaking
power granted by sec. 1502 and, under facts of case, demonstrated
reasonableness in limiting tax deduction to group's economic loss. Covil
Insulation Co
Penalty on Multiple Surtax Exemption Election-Controlled
Group of Corporations-Excluded Stock.-Court determined that
petitioners, parent corporation X and its 11 subsidiary corporations, were
controlled group of corporations under 1563(a)(1) subject to surtax
penalty provided in sec. 1562, since stock of subsidiaries which was owned
by their employees and was subject to option to repurchase by corporation
Z, which X created to acquire and dispose of stock, was "excluded stock"
under sec. 1563(c)(2)(A)(iii) for computation of 80% ownership by
parent, on facts showing parties stipulated that repurchase option sub-
stantially restricted employees' disposition of stock, X retained control of
Z and had same benefits of control over employees' stock as if it were out-
right owner, and, although options directly favored Z, they indirectly
favored X. Crow-Burlingame Co--
CONTRIBUTIONS
See also ESTATES AND TRUSTS.
Charitable-Invention Transferred From Grantor Trust to
University-Charitable or Business Transaction.- Where
petitioners claimed charitable deduction for cigarette filter invention
transferred to trust, herein determined to be grantor trust, which trans-
ferred invention to Columbia University in July 1967 under negotiated
agreement obligating university to prosecute patents, to protect them
from infringement, and to enter into licensing agreements with cigarette
industry, and in February 1968 petitioners terminated agreement because
university was not satisfactorily carrying out its obligations under agree-
ment, Court denied deduction and determined true nature of transaction
was not charitable within meaning of sec. 170, since on evidence transfer
was business transaction for profitable commercial exploitation of filter
for petitioner's benefit, and although petitioners intended that university
would receive economic benefit to further cancer research, intended
benefit was identical to that conferred on any person chosen to render
such services for compensation and was insufficient to characterize
transfer as charitable contribution. Irving I. Rusoff
CORPORATIONS
Acquisition to Avoid Tax-Net Operating Losses and Loss in
Sale and Leaseback-Bona Fide Business Purpose.-Where peti-
tioner corporation X in single transaction acquired 56% of stock in Y
corporation which owned hotel sustaining operating losses, Y sold hotel to
X's subsidiary Z at loss and leased back property, and X, after acquiring
80% of Y's stock, liquidated Y and claimed Y's net operating losses and
Y's loss on sale of hotel on its consolidated income tax return, Court
determined X was not precluded from deducting (1) net operating losses,
since on facts X's principal purpose in acquiring Y was not tax avoidance
contemplated by sec. 269(a), (2) loss carryovers, since on facts Y did not
substantially change its business after acquisition by X, so that sec.
382(a) was not applicable, and (3) losses on sale of hotel, since, contrary to
Commissioner's alternative contentions that sale was lacking in substance
or was exchange of like-kind property, facts showed sale had valid business
purpose. Capri, Inc
Liquidation-Distribution of Expensed Equipment-
Recognition of Income Under Tax Benefit Rule.-Corporation
engaged in motor freight transportation was required to include in gross
income under tax benefit rule previously expensed tires and tubes,
distributed in liquidation before their useful life had been exhausted, at
lesser of fair market value or portion of cost attributable to useful life
remaining at distribution, since for tax purposes tires and tubes were
deemed consumed when expensed, their subsequent treatment by
corporation on distribution as property having value, even though it
neither received nor was entitled to receive money or property for tires
and tubes, resulted in corporation being deemed to have received
immediately before distribution tires and tubes equal in value to those
expensed, and such receipt had independent tax sígnificance which was
not subject to sec. 336. Tennessee Carolina Transportation, Inc
Liquidation-Income from Distributed Assets-How and to
Whom Taxable.-(1) Commissioner's determination under sec. 446(b)
that cash basis corporation, which liquidated May 23, 1970, was taxable
on income from motion picture and television rights distributed to
petitioner shareholders was sustained as to payments to which
corporation had "fixed and determinable right" and only ministerial act
of computation remained, but not as to payments based on net proceeds
subject to significant contingencies before close of relevant accounting
periods, and (2) contrary to petitioners' contention, their 1970 taxable
income, which included gain on liquidation distribution, could not be
adjusted for their liability as transferees for corporate tax deficiencies,
but under case law taxes paid as result of transferee liability could be
deducted as loss for year in which paid. Judith Schneider
Sale or Nontaxable Exchange-Requisite Control of Stock-
Basis for Depreciation.-Court sustained contention of petitioner
corporations X and Y which filed consolidated returns for taxable years
that transfer of assets to X by incorporator A in exchange for X stock was
taxable sale and not tax-free exchange under sec. 351, since, on record,
sales agreement required A, as part of incorporation transaction, to sell
almost half of stock outstanding to incorporator B over period of time,
thereby depriving A of requisite percentage of stock within meaning of
sec. 368(c) necessary for "control" of X immediately after exchange, so
that X and Y, which subsequently purchased all X stock from its
incorporators, were entitled to depreciate X assets on higher fair market
value of assets at time of incorporation rather than on lower
incorporators' basis. Intermountain Lumber Co
Surtax Exemptions-Brother-Sister Controlled Group-
Common Control and Ownership Requirement.-Corporation X,
whose stock was entirely owned by A, and corporation Y, whose stock was
owned 55% by A and balance by B, did not constitute brother-sister
controlled group of corporations because, under sec. 1563(a)(2), B's stock
could not be taken into account to determine if the 80% ownership test
was satisfied, since, considering legislative history and statutory purpose
and language, each person must own stock in each member of controlled
group; furthermore, reg. 1.1563-1(a)(3)(ii) is invalid to extent it extends
statutory language of sec. 1563(a)(2) by providing that same persons
within ownership group need not own 80% of each member corporation,
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since underlying congressional intent was that statutory provisions reach
only multiple corporations characterized by common control and
ownership. Fairfax Auto Parts of Northern Virginia, Inc
See also CONSOLIDATED RETURNS, CORPORATIONS, and
LIMITATIONS.
Investment Credit-Basis of Self-Constructed New Sec. 38
Property-Includability of Depreciation on Constructing
Assets.-Petitioner's subsidiaries, which constructed their own
telephone and power plant properties which qualified as new sec. 38
property as defined by sec. 48(b), for purposes of determining qualified
investment under sec. 46(c)(1)(A), were permitted to include in basis
depreciation sustained with respect to constructing asset on which no
credit was allowed, but not as to property on which credit was allowed,
since reg. 1.46-3(c)(1) was invalid, as plainly inconsistent with statute
and congressional intent to deny double credit, to limited extent that it
excluded from basis depreciation attributable to constructing property on
which no investment credit was allowed. United Telecommunications,
Inc
Investment Credit-Recapture-Sale of Stock After Termi-
nation of Subch. S Election.-Court determined that investment
credit claimed by petitioner, who owned 20% stock of cable TV system
which terminated its subch. S election day before petitioner sold his
stock, was subject to recapture by petitioner, since under reg.
1.47-4(a)(2), as given retroactive effect consistent with prior case law,
stock was sold before end of estimated useful life of investment credit
property, mere termination of subch. S election is not disposition of prop-
erty, and it is corporation's status in year assets were acquired that
governs who is entitled to investment credit. Estate of C. A. Diecks___
Investment Credit-Recapture in Year of Disposition-Invalid
Amended Return.-Petitioners, who in 1967 properly claimed $1,400
investment credit under sec. 38 for property purchased and transferred to
corporation which disposed of property in 1970, were required to recap-
ture investment credit on their 1970 tax return under express terms of
sec. 47(a)(1) and were not entitled to amend their 1967 return to delete
investment credit for that year, since to permit taxpayers to change
method of tax treatment of credit would result in uncertainty in
administration of sec. 47 and would bear on taxpayers' liability in sub-
sequent year. Jack R. Goldstone
Investment Credit-Sec. 38 Property-Coin-operated Laundry
Equipment. (1) Subch. S corporation's coin-operated laundry equip-
ment leased for use in apartment buildings and available to public on
same basis available to tenants was eligible for investment credit under
sec. 38, since sec. 48(a)(3)(A) includes as "sec. 38 property" nonlodging
commercial facilities which are available to persons not using lodging
facilities on same basis as persons using lodging facilities; and (2) under
sec. 46(b)(1) petitioners were allowed investment credit carryovers from
1962-65 to 1966-68. Sydney Mandler
Investment Credit-Sec. 38 Property-Outdoor Advertising
Signs. Outdoor advertising signs, placed along highways to provide
petitioner's customers with advertisement, constituted tangible personal
property within meaning of sec. 48(a)(1)(A), and therefore, qualified for
sec. 38 credit, under case law and on evidence showing they were readily
and easily removable, were not constructed to last or remain permanently
in place, and were not permanently damaged on removal; moreover,
Court rejected Commissioner's contention that language in House
committee report specifically excluding "advertising displays" from sec.
38 credit was intended to apply to advertising signs, since there was no
CREDITS AND EXEMPTIONS continued
indication that display signs of temporary nature installed by one in
advertising business were within exclusion. Whiteco Industries, Inc --
Investment Credit-Used Oil Field Completion Equipment—
Used by Same Parties Before and After Acquisition.-Commis-
sioner's determination under reg. 1.48-3(a)(2)(i), that joint venture could
not claim investment credit under sec. 38 with respect to used oil field
completion equipment purchased in 1968, was sustained, since petitioner
failed to prove that equipment was not used by same parties before and
after it was purchased. Lawrence Ocrant
Investment Credit Recapture-Triggered by Subch. S Elec-
tion-Timeliness of Assumption Agreement.-Where petitioner,
which elected subch. S status effective Jan. 1, 1969, failed to file assump-
tion agreement under reg. 1.47-4(b)(2) until Apr. 17, 1970, when its
accountants notified it of potential liability on subch. S election for
investment credit recapture tax on sec. 38 property for period ended Dec.
31, 1968, unless agreement was filed, and IRS retained agreement with-
out questioning its effectiveness until amended answer was filed in this
proceeding on Mar. 28, 1975, alleging petitioner's liability for recapture
tax, Court determined on facts that late filing of agreement was for "good
cause" and that it relieved petitioner of alleged liability for recapture tax,
since (1) late filing did not cause Commissioner prejudice or incon-
venience, (2) petitioner acted in good faith, reasonably relied on advice of
tax counsel, and immediately complied with requirements of reg. upon
discovery of need for agreement, and (3) reg. was intended to provide
flexibility of deadlines to avoid undue hardship. Bell Fibre Products
Corp --
Settlement Proceeds Allocable to Loss on Sec. 1231 Property
Sale-Arrowsmith Doctrine-Capital or Income.-39% shareholder
of electing small business corporation, who deducted from ordinary
income in 1964 his portion of corporation's net operating loss, major part
of which resulted from loss on sale of sec. 1231 property, was required to
report his portion of proceeds from antitrust suit settlement in 1967 attri-
butable thereto as ordinary income and not as long-term capital gain,
since Arrowsmith, which concededly applied, required that gain realized
in 1967 be treated in same manner as if it had been received in 1964
when it would have resulted in ordinary income as it was merely adjust-
ment of sale price; $5,000 of net settlement was allocated as capital gain
under Cohan rule to injury of capital invested in corporation and good-
will, which Court was satisfied resulted from failure of business, since
petitioner's allocation of damages in complaint was insufficient proof
upon which to base allocation; and remaining proceeds were ordinary
income. David Bresler
Addition to Tax-Imposed for Failure to Timely Pay Proper
Tax Liability-Deductibility as Interest or Business Expense.-
Sec. 6651(a)(2) addition to tax imposed for failure to timely pay proper
tax liability was not deductible as interest under sec. 163, considering
that amount imposed by sec. 6651(a)(2) is clearly labeled addition to tax
and serves as penalty, which unlike interest is avoidable on showing that
failure to pay tax was due to reasonable cause and not willful neglect; that
interest under sec. 6601(a) may run on addition to tax not paid within
prescribed period; that recent legislation affecting interest rate left
penalty rate unaltered; and that penalty is subject to aggregate limit of
25%; moreover, deduction of addition to tax as penalty is prohibited by
sec. 162(f) and regs., and even assuming trade or business connection
which petitioner did not argue, under case law deduction was disallowed.
Frances J. May --
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