Commissioner of Internal Revenue v. South Lake Farms, Inc., Commissioner of Internal Revenue v. South Lake Farms

324 F.2d 837, 12 A.F.T.R.2d (RIA) 6054, 1963 U.S. App. LEXIS 3608

• Court: Court of Appeals for the Ninth Circuit
• Decided: November 22, 1963
• Docket: 18019_1
• Status: Published

Opinions

DUNIWAY, Circuit Judge.

The Commissioner of Internal Revenue seeks review of a decision of the Tax Court. That decision is reported at 36 T.C. 1027 (1961). The underlying facts are not disputed; most of them were stipulated. They are fully set forth in the findings of the Tax Court and are not attacked by the Commissioner, and we therefore do not repeat them here. We are of the opinion that the decision of the Tax Court is correct for the reasons stated by it. We consider only those contentions made by the Commissioner before us. It is undisputed that the purchase by the new corporation of the stock of the old was an arm’s length transaction between unrelated parties.

The Commissioner asserts here, as he did in the Tax Court, that the fair market value of the unharvested cotton crop planted and cultivated by the old corporation, but harvested by the new corporation, and the fair market value of the barley crop, which was both planted and harvested by the new corporation, were properly included by him in the income of the old corporation for its last taxable period which ended with its complete liquidation on October 3, 1956. He asserts authority to so include these items as income under the provisions of section 446(b) of the Internal Revenue Code of 1954 which states in part: “if the method [of accounting] used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary or his delegate, does clearly reflect income.” The old corporation, which had been engaged for some years in the farming business, used the accrual method of accounting, as permitted under section 446(c) (2) of the Internal Revenue Code. At the time of its liquidation, on October 3, the cotton crop had not completely matured. Harvesting started on October 4 and continued into December. It is customary to start harvesting when % to y3 of the bolls have not yet opened. The barley crop had not even been planted, although considerable sums, which the Commissioner attempts to include in the corporation’s income, as the fair market value of the not yet planted crop, had been spent by the old corporation in preparing land for the raising of barley.

The .Commissioner is unable to point to any method of accounting which would require the inclusion of the items here involved in the old corporation’s income. Indeed, he does not try. It is clear that the method of accounting that the old corporation had been using, namely, the accrual method, did not require their inclusion ; a fortiori, the cash method would not do so. Under the published rulings of the Commissioner, not all of the events which fix the right to receive the income from the crops had occurred by the time of liquidation. (See Treas. Reg. (1954 Code) § 1.446-1 (c) (1) (ii)) The crops could not be included in the inventory of the old corporation. (See Treas.Reg. (1954 Code) § 1.61-4(b)) In I.T. 1368, 1-1 Cum.Bull. 72 (1922), the Commissioner ruled that: “While farmers may report their gross income upon the accrual basis (in which an inventory to determine profits is used), they are not permitted to inventory growing crops for the reason that the amount and value of such crops on hand at the beginning and end of the taxable year cannot be accurately determined.” Nor can the only other method, authorized by the Commissioner, the so-called “crop method,” be used. It applies only to “crops which take more than a year from the time of planting to the time of gathering and disposing” (Treas.Reg. (1954 Code) § 1.61-4(c)), and the crops here involved are not of that type.

None of the cases on which the Commissioner relies is in point. In most of them the liquidation of a corporation which was on a cash basis occurred at a time when income was fully earned, and the Commissioner, in order truly to reflect income, required that the corporation accrue these items in the year of dissolution. Idaho First Nat’l Bank v. United States, 9 Cir., 1959, 265 F.2d 6, involved interest earned but not yet payable at the time certain notes were distributed in liquidation. Commissioner of Internal Revenue v. Kuckenberg, 9 Cir., 1962, 309 F.2d 202, and Family Record Plan, Inc. v. Commissioner, 9 Cir., 1962, 309 F.2d 208, both involved moneys fully earned, some actually paid and some not yet payable at the time of liquidation. United States v. Lynch, 9 Cir., 1951, 192 F.2d 718, 721-22; Standard Paving Co. v. Commissioner, 10 Cir., 1951, 190 F.2d 330; Jud Plumbing & Heating, Inc. v. Commissioner, 5 Cir., 1946, 153 F.2d 681; and Williamson v. United States, Ct.Cl., 1961, 292 F.2d 524, are similar. Here, on the other hand, no income had been earned at the time of the dissolution, and the growing cotton crops, which were harvested thereafter over a period of two and a half months, cannot fairly be said to represent accrued or accruable income. The case of the lands prepared for planting barley is even stronger, as the barley had not even been planted, much less begun to grow.

This is not a case in which the old corporation converted ordinary income to capital gain simply by selling growing crops before harvest as in the following cases: Watson v. Commissioner, 1953, 345 U.S. 544, 73 S.Ct. 848, 97 L.Ed. 1232; Bidart Bros. v. United States, 9 Cir., 1959, 262 F.2d 607. Here there was no sale by the old corporation; it was completely liquidated and its assets transferred to the new corporation, which owned all of its stock, and therefore section 336 of the Internal Revenue Code applies. Section 334 makes the new corporation, for tax purposes, in effect, the purchaser of the assets of the old, even though the new corporation bought stock. But section 336 makes it clear that the old corporation is not the seller of those assets for tax purposes. The tax falls on the actual sellers, the stockholders of the old corporation. Section 336 prevents the imposition of the tax on the old corporation. We need not decide, because the question is not before us, whether the result would have been the same if the old corporation had in fact sold the same lands and sought to escape tax under section 337.

Before the Tax Court, the Commissioner also claimed, alternatively, that he was entitled, under section 482 of the Internal Revenue Code, to disallow to the old corporation its expenses in producing the cotton crop and in preparing the barley lands for planting. In this proceeding he has abandoned that position and relies entirely upon section 446(b) to support the same result. We are of the opinion that section 446(b) cannot be so used. Just what “method of accounting” the Commissioner is requiring the old corporation to use for this purpose, he does not state. We can think of none that would apply. To use section 446(b) in this case as proposed would, we think, circumvent the provisions and purposes of sections 334 and 336 of the Code. Essentially, the Commissioner’s position is that the old corporation got a “tax benefit” by deducting these expenses, all of which had been incurred or paid before liquidation. Such deduction was proper when taken. The contention is that because the price of the stock of the old corporation, which was sold to the new corporation, was fixed in part on the basis of the value of the cotton crop, and of the preparation of the land for a barley crop, and because an actual allocation of a portion of that price was made to those items, for the purpose of fixing the new corporation’s basis under section 334, the old corporation received an amount equivalent to, and sufficient to offset, the expenses that it had • incurred, and hence was no longer entitled to the “tax benefit" of the deduction of those expenses.

One immediate difficulty with this contention is that the old corporation received nothing. It was the stock of the old corporation that was sold, and the stockholders who got the money. The price that they got was higher because of the values added to the old corporation’s assets by the expenditures that were made in preparing the barley lands and in preparing, planting, and growing the cotton crop. No doubt they paid tax on the increased gain. Nowhere in the Code do we find an intent that gains of the stockholders were to be attributed to the corporation, much less that they were to be treated as ordinary income to the corporation. The corporation is to be taxed only on its own income. (Cf. Family Record Plan, Inc. v. Commissioner, supra, at 210 of 309 F.2d)

Here again, the cases on which the Commissioner relies do not support him. Three of them (Citizens Fed.Sav. & Loan Ass’n v. United States, Ct.Cl., 1961, 290 F.2d 932; West Seattle Nat’l Bank v. Commissioner, 9 Cir., 1961, 288 F.2d 47; and Commissioner of Internal Revenue v. First State Bank, 5 Cir., 1948; 168 F.2d 1004, 7 A.L.R.2d 738) involve deduction •of bad debt reserves or write-offs. These •differ from the expenses here involved, which are based upon out-of-pocket payments or fully incurred liabilities to third persons, whereas the reserves are based upon expectations rather than actual losses. In the case of bad debt reserves, the recovery of the deduction can fairly be said to occur at the time when the debts regain their full value, but in the ease of actual expenses, the recovery requires that the taxpayer shall have received or become entitled to receive money or property equal to the amount previously spent and deducted. Here, the taxpayer, as we have already pointed out, received nothing. Section 446(b) was not relied upon in any of them. There is a special section (§ 111) relating to bad debts, which was cited in each of them, and includes a statutory “tax benefit” rule. No similar provision applies here.

Dobson v. Commissioner, 1943, 320 U.S. 489, 64 S.Ct. 239, 88 L.Ed. 248, seems to us even less in point. It and its companion cases involved actual recoveries, in later years, of losses taken in earlier years, on sales of stock. We do not see any theory on which it can be fairly said that the old corporation has recovered the expenses which it deducted.

The result in this case is something of a tax windfall to the stockholders of the old corporation. They got a price for their stock that was enhanced by their corporation’s expenditures, which were deducted from its income, thereby reducing its income taxes, even though it never got the income that the expenditures were expected to produce. It may be that if Congress had considered the problem now before us when it enacted sections 334, 336, and 337 of the Internal Revenue Code, it would have inserted language designed to reach one or the other of the results here sought by the Commissioner. But it did not do so. Moreover, it was aware of the problem of how to treat the proceeds of the disposition of lands having growing crops upon them in another context, namely, a sale. (See Internal Revenue Code §§ 268, 1231(b) (4)) Yet the Commissioner disclaimed reliance on section 268 before the Tax Court, and does not rely on it here, presumably because, as we have already pointed out, there was no sale of the unharvested crop in this ease. If the result here is undesirable, the remedy is for Congress, not the courts.

The decision of the Tax Court is affirmed.