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Resorts International, Inc., Petitioner v. Commissioner of Internal Revenue, RespondentResorts International, Inc. v. CommissionerDocket No. 145-68August 27, 1973, Filed
United States Tax Court *76Decision will be entered under Rule 50 .1. The petitioner acquired the stock of certain corporations operating retail paint stores through a statutory merger with the parent corporation. Subsequently, but in a related transaction, the petitioner acquired all the assets of the subsidiary corporations in exchange for such stock.
Held : For purposes of the net operating loss carryover provisions of secs. 381 and 382, the statutory merger and subsequent liquidations must be considered together. The assets of the subsidiary corporations were acquired pursuant to a reorganization as defined in sec. 368(a)(1)(C) and the net operating loss carryovers are subject to the limitations of sec. 382(b)(1) and (2).2. The petitioner acquired all of the stock of several corporations operating roadside restaurants in exchange for the stock of the petitioner. Subsequently, but in a related transaction, the petitioner acquired all the assets of the subsidiary corporations in exchange for such stock.
Held , the assets of the subsidiary corporations were acquired pursuant to a reorganization as defined in sec. 368(a)(1)(C) and the net operating loss carryovers are subject to the limitations of sec. 382(b)(1) *77 and (2).3. The petitioner transferred the assets and business of each of several of the paint stores to individual operators, together with the right to use the manufacturer's name and to take over the leaseholds for a stated consideration. The agreements ran from year to year and did not differ materially from the customary dealer-distributor agreement.
Held : the transfer of the paint stores to the various individual operators constituted the sale of a going business, including both fixed assets, inventories, and goodwill. The resulting gain is taxable as a long-term capital gain.4. The petitioner sold the assets and subleased the premises of the various roadside restaurants to independent operators pursuant to a so-called franchise agreement. The operator was given the right to operate a roadside restaurant under the designated trade name and within a specific locality for a period of 15 years. The premises were sublet by the petitioner to the operator. The petitioner maintained control of the hours of operation and the products sold and received a percentage of the gross sales.
Held , the gain realized by the petitioner on account of such agreements was attributable to the licensing *78 of the operators and was taxable as ordinary income.John K. Antholis , for the petitioner.Agatha L. Vorsanger andAlfred C. Bishop, Jr ., for the respondent.Quealy,Judge .QUEALY*779 The respondent determined deficiencies in the income tax of petitioner as follows:
Year Deficiency 1962 $ 44,885 1963 53,764 1964 987 1965 25,288 The principal questions involved relate to the characterization of certain transactions whereby the petitioner acquired the stock of various subsidiary corporations which were thereupon liquidated and the businesses thereof taken over by the petitioner. The questions presented as a result of said transactions are:
(1) Whether the net operating loss carryovers of the former subsidiaries of the Victor Paint Co., otherwise available to the petitioner under section 381, are limited by reason of the application of section 382(b)(1) and (2); *79 to the foregoing, there is involved the characterization of the gain realized by the petitioner (a) on account of the sale of certain paint stores formerly operated as subsidiaries of Victor Paint Co. and (b) on account of the sale of certain Biff-Burger restaurants formerly operated by the Biff-Burger corporations.
*780 FINDINGS OF FACT
Some of the facts have been stipulated. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.
The petitioner was incorporated under the laws of the State of Delaware in 1958. At the time of its incorporation and at all times material herein, it operated under the corporate name of Mary Carter Paint Co. Petitioner filed its corporate tax returns for the taxable years 1962 to 1965, inclusive, with the district director of internal revenue, Jacksonville, Fla. At the time of the filing of the petition herein, its principal place of business was Tampa, Fla.
Victor Paint Co. was incorporated under the laws of the State of Michigan in 1946. It manufactured and sold paint through retail stores, some of which were separately incorporated. As of December 31, 1961, Victor Paint Co. had 53 of such retail stores, of which *80 47 were operated as wholly owned subsidiaries. Of the 47 subsidiaries, 33 operated stores in the State of Michigan and 14 operated stores in the State of Ohio.
Victor Building Co. was a corporation organized under the laws of the State of Michigan in January 1962. Its only asset consisted of improved real property located in Detroit, Mich., which was utilized by Victor Paint Co.
During the years involved herein, the business of the petitioner consisted of manufacturing, distributing, and selling paint both through company-owned stores and through independent dealers. The stock of the petitioner was publicly held, and beginning on or before April 9, 1962, was traded on the American Stock Exchange.
As of January 26, 1962, a memorandum of understanding for merger was entered into by the petitioner, Victor Paint Co., and Victor Building Co., pursuant to authority granted by the board of directors of the respective corporations, which set forth the basis upon which petitioner, Victor Paint Co., and Victor Building Co., would effect a statutory merger under the laws of the State of Delaware and of the State of Michigan.
On January 31, 1962, the petitioner, Victor Paint Co., and Victor Building *81 Co., entered into an agreement of merger pursuant to which the latter corporations would be merged into the petitioner, it being the surviving corporation. Said agreement of merger was conditioned, in part, upon obtaining the requisite statutory vote of the stockholders of the corporations parties thereto. Such approval was obtained at meetings of the stockholders of the respective corporations, each held on April 3, 1962.
On April 9, 1962, the agreement of merger was duly filed with the offices of the secretary of state of the States of Delaware and Michigan. Thereupon, the petitioner issued 185,187 shares of its class A common *781 stock in exchange for all of the shares of Victor Paint Co. and Victor Building Co. Said 185,187 shares represented 10 percent of the fair market value of all outstanding stock of petitioner.
At a meeting of the board of directors of the petitioner, likewise held on April 3, 1962, there was adopted the following resolution:
Resolved, That upon the effective date of the Agreement of Merger of Victor Paint Company and Victor Building Co. into Mary Carter Paint Co. the President or any Vice President and the Secretary or any Assistant Secretary of this Corporation *82 be and they hereby are authorized and directed to execute such documents and take such steps, with the advice of counsel for the Corporation, to liquidate and dissolve such of the wholly-owned subsidiaries of Victor Paint Company as the Chairman of the Board of this Corporation in his discretion may deem to be in the best interests of this Corporation.
On or about May 14, 1962, pursuant to the foregoing resolution, the petitioner filed certificates of dissolution dated May 9, 1962, for the 33 Michigan corporations which were formerly subsidiaries of Victor Paint Co. with the secretary of state of the State of Michigan pursuant to section 73, Act 327, Michigan Public Acts of 1931, as amended. The 33 Michigan corporations were thereupon liquidated and dissolved, the assets thereof being acquired by the petitioner as sole stockholder.
At various times between December 21 and December 29, 1962, certificates of dissolution of 10 of the Ohio corporations, which were formerly subsidiaries of Victor Paint Co., were filed with the secretary of state of the State of Ohio pursuant to
section 1701.86 of the Ohio Revised Code . The 10 Ohio corporations were thereupon liquidated and dissolved, the *83 assets thereof being acquired by the petitioner as sole stockholder. The other 4 Ohio corporations were maintained in existence as corporate shells in order to avoid any liability on the part of the petitioner on account of long-term leases under which said corporations were lessees.Prior to the merger between the petitioner and Victor Paint Co., the Internal Revenue Service had completed an examination of the tax returns of Victor Paint Co. and its subsidiaries for the calendar years 1957 and 1958 and for the fiscal years ended November 30, 1959 and 1960. In the course of such examination, the Internal Revenue Service proposed to disallow the surtax exemption claimed by each of said subsidiaries. On October 29, 1962, the proposed disallowance, together with other adjustments resulting from said examination, were disposed of by agreement with the Appellate Division of the Internal Revenue Service.
In the negotiations preceding the agreement of merger with Victor Paint Co., the officers and directors of the petitioner were informed with respect to the fact that operating losses had been or would be incurred by certain subsidiary corporations and that the allowance of the surtax exemption *84 to each of the subsidiaries of Victor Paint Co. had been challenged by the Internal Revenue Service.
*782 On or before April 3, 1962, the representatives of the petitioner who participated in, or were entrusted with, negotiations for the merger with Victor Paint Co. had knowledge of all of the facts upon which there was predicated the decision to dissolve the former subsidiaries of Victor Paint Co. In the case of the Michigan corporations, the decision to proceed with such dissolution on or before May 14, 1962, was attributable to the fact that the State of Michigan imposes a franchise tax on corporations in existence on May 15 of each year. Therefore, the imposition of such tax would be avoided with the filing of certificates of dissolution prior to that date. There were no compelling reasons to expedite the dissolution of the Ohio corporations.
For several years prior to the year 1961, petitioner had conducted its retail sales operations through 15 separately incorporated subsidiaries. At a meeting of petitioner's board of directors held on March 28, 1961, authorization was given to dissolve these subsidiary corporations as soon as possible. The corporations were subsequently in fact *85 dissolved.
On its corporate income tax return for the year ended December 31, 1962, the petitioner claimed a net operating loss deduction on account of net operating loss carryforwards of 26 of the former Michigan subsidiaries of Victor Paint Co. in the aggregate amount of $ 172,636.47 as follows:
Taxable period Corporate name Year ended Dec. 1 to May 14, Total Nov. 30, 1961 1962 (date of liquidation) Victor Paint East Dearborn Corp $ 19,422.34 $ 6,943.99 $ 26,366.33 Victor Paint Pontiac Corp 4,146.15 4,146.15 Victor Paint North Woodward Corp 1,587.82 5,042.29 6,630.11 Victor Paint Grand River Corp 2,004.96 5,471.58 7,476.54 Victor Paint Plymouth Corp 4,914.74 5,108.25 10,022.99 Victor Paint Oakland, Inc 5,076.69 5,076.69 Victor Paint Wayne, Inc 11,712.59 5,911.10 17,623.69 Victor Paint East, Inc 4,951.40 3,285.09 8,236.49 Victor Paint West, Inc 6,132.25 3,675.25 9,807.50 Victor Paint Van Dyke, Inc 4,323.07 4,119.49 8,442.56 Victor Paint Mack, Inc 1,223.95 760.64 1,984.59 Victor Paint Rouge, Inc 3,027.05 561.90 3,588.95 Victor Paint Northfield, Inc 5,965.95 565.70 6,531.65 Victor Paint Turney, Inc 6,985.97 5,589.49 12,575.46 Victor Paint Fulton, Inc 2,876.17 1,021.37 3,897.54 Victor Paint Goldengate, Inc 5,975.37 51.00 6,026.37 Victor Paint Shoregate, Inc 4,182.06 51.00 4,233.06 Victor Paint Euclid, Inc 4,739.37 51.00 4,790.37 Victor Paint Pearl, Inc 5,320.22 51.00 5,371.22 Victor Paint Harvard, Inc 636.73 4,592.34 5,229.07 Victor Paint Monroe, Inc 1,107.42 3,208.58 4,316.00 Victor Paint Broadway, Inc 844.50 3,452.08 4,296.58 Victor Paint Starr, Inc 941.37 941.37 Victor Paint Charles, Inc 36.15 36.15 Victor Paint Superior, Inc 2,225.30 2,225.30 Victor Paint Centers, Inc 2,577.22 186.52 2,763.74 Total 100,511.15 72,125.32 172,636.47 *86 In his notice of deficiency for the taxable year 1962, the respondent disallowed $ 86,318 (or 50 percent) of the net operating loss deduction claimed by the petitioner on account of said subsidiaries, relying on section 382(b)(1) and (2).
*783 Prior to November 9, 1962, Earl P. Brane and Bruce E. Brane owned all of the stock of the following corporations:
National Biff-Burger System, Inc.
B&B Distributing Corp.
Biff-Burger of South St. Petersburg, Inc.
Biff-Burger of St. Petersburg, Inc.
Biff-Burger of Clearwater, Inc.
Biff-Burger of West Tampa, Inc.
Biff-Burger of Tampa, Inc.
On October 3, 1962, an agreement of reorganization was entered into by and between petitioner, Earl and Bruce Brane, and the Biff-Burger corporations. Pursuant to this agreement, on November 9, 1962, petitioner acquired all the stock of these corporations solely in exchange for 50,000 shares of its voting class A common stock, representing 1 percent of the fair market value of petitioner's then outstanding stock.
In acquiring the stock of the *87 Biff-Burger corporations, it was the intent of the petitioner to acquire ownership or control over the businesses of each and to grant so-called franchises to individuals who would operate "Biff-Burger" restaurants under a so-called franchise agreement.
On December 20, 1962, the board of directors of each of the Biff-Burger corporations authorized the dissolution and liquidation of each corporation. Pursuant to said authorization, certificates of dissolution were filed with the secretary of state of Florida on February 27, 1963, for all corporations except National Biff-Burger System, Inc. A certificate of dissolution for this corporation was filed on April 3, 1963.
On its corporate income tax return for the year 1963, petitioner deducted $ 38,346 as a net operating loss carryforward of certain of the Biff-Burger corporations, as follows:
Feb. 28, Biff-Burger of St. Petersburg, Inc. Corporate name Dec. 31, Biff-Burger of Clearwater, Inc. 1958 1959 1960 1961 National Biff-Burger System, Inc Biff-Burger of St. Petersburg, Inc $ 145 $ 2,164 $ 6,174 $ 3,169 Biff-Burger of Clearwater, Inc 3,097 4,935 4,348 1,145 Total 3,242 7,099 10,522 4,314 Taxable period ended Corporate name Dec. 31, 1962 Total (date of liquidation) National Biff-Burger System, Inc $ 10,955 $ 10,955 Biff-Burger of St. Petersburg, Inc 1,546 13,198 Biff-Burger of Clearwater, Inc 668 14,193 Total 13,169 38,346 In *88 his notice of deficiency for the taxable year 1963, the respondent disallowed $ 36,429 (or 95 percent) of the net operating loss deduction *784 claimed by the petitioner on account of said subsidiaries, relying on section 382(b)(1) and (2).
During the taxable year 1963, the petitioner entered into contracts to transfer to independent dealers certain paint stores in Detroit, Mich., which had been acquired in the merger with Victor Paint Co. The terms and conditions pursuant to which the petitioner transferred each of said stores to the respective dealers were embodied in a set of documents entitled "franchise agreement," "promissory note," and "addendum to franchise agreement." In accordance therewith, the parties agreed,
inter alia , as follows:(1) The dealer would enter into a lease of the premises in which the business was operated.
(2) The petitioner would supply its products to the dealer at the same price and upon the same terms at which it sold to all other dealers.
(3) The dealer agreed not to sell below minimum prices established by the petitioner, to use such sales material as were supplied by the petitioner, to participate in the cooperative advertising programs of the petitioner, *89 and to keep its premises clean and neat and in a condition to attract customers. The dealer could not assign any right to use the petitioner's name without the petitioner's consent.
(4) The dealer gave the petitioner a note for the amount of the purchase price payable over a period of 3 years. During this period, the petitioner would add 7 percent to the normal price on all shipments to the dealer, which would be credited against the note. After the note had been paid in full, such addition would be continued until the balance owing for inventory had been paid in full. Upon payment of the purchase price and inventory in full, the dealer would be charged the normal price for shipments.
(5) In the event of default, the dealer would be released from any further liability upon assignment and delivery to the petitioner of the inventory and related products and the assignment of all fixtures and equipment located on the premises.
(6) The term of the agreement was to run for a period of 12 months from the date thereof, renewable automatically from year to year thereafter unless either party gave written notice at least 30 days prior to the expiration of the term. Upon termination thereof, *90 the petitioner would reacquire any inventory from the dealer.
On its corporate income tax return for the taxable year 1963, the petitioner reported a long-term capital gain in the amount of $ 128,965 attributable to the sale of so-called goodwill as a result of the transfer of the seven Detroit paint stores to the various dealers, computed as follows: *785
Dealer and location Sales price Sales price of fixtures of inventory Marshall Abramson and Jack Goyer, 24790 W. Seven Mile Rd., Detroit, Mich $ 1,957.58 $ 27,243.97 Marshall Abramson and Jack Goyer, 5601 Michigan, Detroit, Mich 1,607.63 17,775.54 Marshall Abramson and Jack Goyer, 24424 W. Michigan, Dearborn, Mich 2,835.64 35,224.32 Clarence Jellerson -- Victor Paint -- 8 Mile, 5330 E. Eight Mile Road, Detroit, Mich 1,270.95 31,583.89 Kenneth Hey, 26350 Eastgate Blvd., Roseville, Mich 2,752.09 39,411.58 Leonard Lyczynski -- Victor Paint & Wallpaper Co., 10300 Woodward Avenue, Detroit, Mich 908.01 19,839.73 Leonard Lyczynski -- Victor Paint & Wallpaper Co., 11330 Joseph Campau, Hamtramack, Mich 2,765.42 29,196.27 Total 14,097.32 200,275.30 Dealer and location Sales price Total sales of goodwill price Marshall Abramson and Jack Goyer, 24790 W. Seven Mile Rd., Detroit, Mich $ 19,204 $ 48,405.5 Marshall Abramson and Jack Goyer, 5601 Mich igan, Detroit, Mich 18,500 37,883.1 Marshall Abramson and Jack Goyer, 24424 W. Michigan, Dearborn, Mich 19,298 57,357.9 Clarence Jellerson -- Victor Paint -- 8 Mile, 5330 E. Eight Mile Road, Detroit, Mich 19,502 52,356.8 Kenneth Hey, 26350 Eastgate Blvd., Roseville, Mich 18,880 61,043.6 Leonard Lyczynski -- Victor Paint & Wallpaper Co., 10300 Woodward Avenue, Detroit, Mich 15,160 35,907.74 Leonard Lyczynski -- Victor Paint & Wallpaper Co., 11330 Joseph Campau, Hamtramack, Mich 18,421 50,382.6 Total 128,965 343,337.6 The *91 sale price of fixtures was equal to the depreciated book value of the fixtures and equipment which was located in each store. This depreciated book value had taken into account the depreciation on the fixtures and equipment to the date of sale.
The sales price of the inventory was determined at dealer's cost, which was equivalent to the prices at which the petitioner would sell such inventory, and any resulting gain was thus reflected as ordinary income.
To the amounts determined above was added an amount which was designated as "goodwill." This amount was determined by making an analysis of sales and profits of each particular store that was being sold. Based on such analysis, an amount was determined which was equivalent to 1 year's net profits for each of the stores being sold and this amount was designated as "goodwill."
In his notice of deficiency for the taxable year 1963, the respondent determined that the gain of $ 128,965 realized by petitioner from the sale of the seven Detroit paint stores was taxable as ordinary income rather than as a capital gain.
During the taxable years 1964 and 1965, petitioner entered into certain agreements for the transfer of the businesses of eight *92 roadside retaurants acquired in the liquidation of the Biff-Burger corporations pursuant to a so-called franchise agreement, which was similar in all cases. The agreement provided for the following: *786 15 years from the date of completion of the installation. This right or privilege could not be transferred without the consent of the petitioner.
(2) The petitioner agreed to assist in the training of the employees of the transferee and in the operation of the restaurant during the initial period after it opened for business, and to provide such other assistance as would aid the transferee in the continued operation of the restaurant, including advertising and promotional materials, recipes, food handling and portion control, recordkeeping, and administration.
(3) Transferee *93 agreed to operate the restaurant during such hours as were recommended by the petitioner and to sell only such items and at such prices as were approved by the petitioner. All supplies used were subject to the petitioner's approval.
(4) The transferee agreed to pay the petitioner a specified percentage of monthly gross sales, and the petitioner reserved the right to check the books and records in order to ascertain the amount due. The transferee could not operate any other roadside restaurant without the consent of the petitioner.
(5) Upon termination of the agreement, the transferee could not own or operate a drive-in restaurant within a 10-mile radius of any Biff-Burger restaurant. The transferee further agreed to discontinue all trade names, signs, or other advertising indicative of the Biff-Burger restaurant and to paint the restaurant so as to distinguish it in form and appearance from other Biff-Burger restaurants.
As part of the agreement, the *94 petitioner executed a "bill of sale and conveyance" pursuant to which the petitioner sold the transferee a "Biff-Burger Porter-Unit and Equipment." The transferee simultaneously executed a "chattel mortgage" securing the payment of the purchase price owing to the petitioner.
Also as a part of the agreement, the petitioner entered into a "sublease" of the business premises pursuant to which the transferee became entitled to all the rights and privileges which the petitioner held as original lessee of the premises and assumed the obligations and duties of the petitioner as such lessee. The terms of the subleases as to rent and duration of occupancy, as compared to the original leases, were as follows:
*95Location and sublessee Term of sublease Term of main lease Baton Rouge -- William H. Reinhardt 2/1/64-2/1/69 2/1/64-2/1/69 Tampa -- Bobby P. Smith, et ux 7/1/63-6/30/66 7/1/63-6/30/66 Kenneth City -- Albani J. Doucet, et ux 8/10/60-8/9/70 3/10/60-3/9/70 Warner Robbins -- John A. Sweat 7/1/65-7/14/68 7/15/63-7/14/68 Fayetteville -- O.S.D.B. Inc 8/1/65-10/15/67 10/15/62-10/15/67 Gulfport -- Lawrence Mahalak, et ux 10/1/65-9/30/68 9/1/63-9/30/68 Jacksonville -- Paul F. Dicken 10/1/65-5/30/68 7/1/63-5/30/68 Tampa -- John W. Barrett, Jr 7/1/65-3/12/68 3/13/63-3/12/68
