Capri, Inc. v. Commissioner

Capri, Inc., Petitioner v. Commissioner of Internal Revenue, Respondent

Capri, Inc. v. Commissioner

Docket No. 6769-71

United States Tax Court

65 T.C. 162; 1975 U.S. Tax Ct. LEXIS 48;

October 28, 1975, Filed

---

Decision will be entered under Rule 155.

Petitioner, which, among other business activities, owned and operated a motel, purchased 56 percent of the stock of Hotel Florence Co. in a single transaction. Florence owned and operated a hotel which sustained operating losses. Florence immediately sold the hotel building to one of petitioner's subsidiary corporations at a loss and leased back the property. Two months following the acquisition, petitioner began attempts to acquire the remaining shares of Florence. Almost 2 years transpired from the original acquisition before petitioner owned 80 percent of the outstanding stock of Florence. Florence was liquidated 6 months later. Petitioner claimed the Florence net operating losses including the loss on the sale of the hotel building on its consolidated return with Florence. Held, the principal purpose of petitioner's acquisition of control of Florence was not tax avoidance contemplated by sec. 269(a), I.R.C. 1954, and petitioner is entitled to deduct the net operating losses of Florence on the consolidated return. Held, further, the loss carryovers are not disallowed under sec. 382(a), I.R.C. 1954, because Florence did not substantially change its business after the acquisition. Held, further, the sale of the hotel to petitioner's subsidiary is recognized and the resulting loss sustained by Florence is allowable.

Peter Meloy, John R. Kline, and David N. Niklas, for the petitioner.

David R. Brennan, for the respondent.

Goffe, Judge.

---

GOFFE

The Commissioner determined a deficiency of $ 62,642.28 in petitioner's Federal income tax for the taxable year ended June 30, 1970. The issues to be decided are:

(1) Whether petitioner is precluded from deducting on a consolidated return net operating losses of its subsidiary because it acquired control for the principal purpose of avoiding tax under section 269(a), ¹ I.R.C. 1954, or because there was a substantial change in the business of the subsidiary after an ownership acquisition within the meaning of section 382(a); and

(2) Whether the loss claimed by the subsidiary and carried over to the consolidated return with petitioner is not allowable because the sale of the principal asset of the subsidiary to a related corporation lacked substance or the sale was an exchange of property of like kind.

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulation of facts and attached exhibits are incorporated by reference.

Petitioner is a corporation organized under the laws of the State of Delaware in 1929. Its principal place of business at the time of filing its petition was in Helena, Mont. Its business activities have included, from time to time, investments in various corporate enterprises, stocks, bonds, operating a motel, and performing bookkeeping services for some of these corporations. Petitioner's U.S. corporation income tax return for the taxable year ended June 30, 1970, was filed with the Internal Revenue Service Center at Ogden, Utah.

Petitioner was organized by J. E. O'Connell (hereafter referred to as O'Connell). During the years involved, he was the principal and dominating officer of petitioner.

For the time period material here, petitioner's stock was owned by the following persons and entities in the percentages indicated:

Shareholder	Percentage
J. E. O'Connell	88.04
James O'Connell, son of J. E. O'Connell	3.90
Milcap, Inc.	.43
Treacy Co.2	7.62

Petitioner, for the period involved herein, owned all of the issued and outstanding stock of Milcap, Inc., and Capri Insurance Co., a life insurance company, and 75.38 percent of all the issued and outstanding stock of Glacier General Assurance Co. which sold casualty insurance and owned supermarkets, an office building, apartments, and rental houses. It also owned 75 percent of the voting stock of Intermountain Reinsurance Corp. and 50 percent of the voting stock of Riverside Development, Inc. All of the corporations were located in Missoula, Mont., except Milcap, Inc., which was located in Helena, Mont. Petitioner also owned less than 50 percent of the outstanding stock in 51 additional corporations.

Throughout petitioner's taxable years ended on June 30, 1964, through June 30, 1970, its investments in certificates of deposits, savings deposits, United States obligations, commercial paper, debentures, and tax-exempt bonds comprised an average of 63 percent of its total assets. Petitioner's taxable income and income taxes paid (or which would have been paid) without taking into consideration net operating loss deductions for the taxable years ended June 30, 1963, through June 30, 1970, were as follows:

		Year ended June 30 --
		1963	1964	1965	1966
Operating gross profit		$ 141,015	$ 186,582	$ 218,184	$ 231,489
Dividends		28,529	36,248	50,672	51,419
Interest		153,859	127,465	149,858	79,095
Rents		82,018	82,619	77,164	75,376
	Management fees from
	affiliated corporations	11,942	14,012	11,266	5,589
	Partnership income --
	Jamestown store	0	0	0	0
	Rebates -- Minnesota store	10,158	13,018	13,983	10,400
	Other income	1,210	35	1 7,255	0
Gains or (losses)		8,396	18,933	(2,736)	0
	Total income	437,127	478,912	525,646	453,368
Expenses		(329,752)	(309,722)	(340,058)	(342,942)
Special deductions		(23,546)	(29,750)	(41,864)	(43,025)
Taxable income		83,829	139,440	143,724	3 67,399
Municipal bond interest		13,228	13,155	12,922	47,800
Federal taxable income
plus municipal bond
interest		97,057	152,595	156,646	115,199
Tax paid before NOLD		35,735	60,569	71,429	26,743

		Year ended June 30 --
		1967	1968	1969
Operating gross profit		$ 304,415	$ 410,221	$ 446,808
Dividends		41,513	57,155	67,650
Interest		62,000	74,103	67,927
Rents		74,654	69,660	69,924
	Management fees from
	affiliated corporations	6,502	6,640	16,229
	Partnership income --
	Jamestown store	(41,949)	(40,279)	0
	Rebates -- Minnesota store	0	0	0
	Other income	0	18	2 4,486
Gains or (losses)		2,802	51,289	16,871
	Total income	449,937	628,807	689,895
Expenses		(462,711)	(614,614)	(690,012)
Special deductions		(35,063)	(31,403)	(60,365)
Taxable income		(47,837)	(17,210)	(60,482)
Municipal bond interest		77,634	65,077	51,324
Federal taxable income
plus municipal bond
interest		29,797	47,867	(9,158)
Tax paid before NOLD		0	21	1,268

		Year ended June 30 --
		1970
Operating gross profit		$ 1,030,365.27
Dividends		73,055.30
Interest		104,714.69
Rents		68,344.00
	Management fees from
	affiliated corporations	15,713.04
	Partnership income --
	Jamestown store	0
	Rebates -- Minnesota store	0
	Other income	0
Gains or (losses)		155,540.42
	Total income	1,447,732.72
Expenses		(1,201,034.96)
Special deductions		(64,045.20)
Taxable income		182,652.56
Municipal bond interest		9,812.60
Federal taxable income
plus municipal bond
interest		192,465.16
Tax paid before NOLD		81,173.22

In 1959, John Hayden organized Glacier General Assurance Co. (Glacier) and was its first president. He continued as president following its organization throughout the period involved here. Hayden was also a director of petitioner since 1955. Glacier in 1966 constructed for petitioner a motel in downtown Butte, Mont., under an agreement whereby petitioner became the owner and named it Capri Motel.

O'Connell expressed a desire to establish a chain of motels in Montana and requested Hayden to contact a property owner regarding purchase of a tract in Helena and to make a feasibility study of the construction costs for building a motel on that site. In October 1968, the Capri Motel was transferred to the Capri Insurance Co. as a contribution to the capital of that company and was leased back to petitioner.

In 1939, petitioner acquired at $ 100 per share 25 shares of stock of the Hotel Florence Co. (Hotel Florence), a Montana corporation which was incorporated in that year. A hotel was constructed by that corporation in Missoula, Mont., in 1941. During the period from 1957 through 1966, Hotel Florence earned the following amounts of taxable income and suffered losses as follows:

Year	Amount
1957	$ 51,726.00
1958	12,264.28
1959	9,838.86
1960	19,409.48
1961	(17,403.19)
1962	($ 7,417.12)
1963	(37,354.92)
1964	(14,640.36)
1965	(74,455.72)
1966	(61,712.79)

O'Connell indicated an interest for several years in purchasing Hotel Florence and on several occasions O'Connell discussed aspects of the operation of the hotel with a board member of Montana Mercantile (Mercantile), which was the majority shareholder of Hotel Florence.

Mercantile decided to dispose of its 56-percent stock interest in Hotel Florence in 1964. This decision was based upon the deterioration of the hotel's plant and equipment; the necessity for annual cash advancements of $ 60,000 to $ 70,000 a year to Hotel Florence by Mercantile; and the difficulty of establishing an overall policy as to expenditures among its shareholders, the expense of maintaining the adjoining Pigeonhole Garage, the increasing use of charge accounts by patrons, increased motel and restaurant competition in the area, and the drag racing on the street in front of the hotel.

In order to enhance the prospects for the sale of the hotel, Hotel Florence increased its mortgage by approximately $ 270,000 and completely refurbished its kitchen and guest rooms. In January 1967, Mercantile informed Hotel Florence that it would no longer advance operating capital to the hotel.

In February 1967, Hayden was asked by the president of both Mercantile and Hotel Florence, upon a chance encounter, whether Glacier was interested in purchasing Mercantile's 56-percent interest in Hotel Florence. Because Hayden was aware of O'Connell's interest in the hotel, Hayden, 10 days later, examined the operating statements from 1962 through 1966 which reflected the accounts receivable, loans, profits and losses, and taxes of the hotel. Although he was aware of the annual amounts of cash required by the hotel and the fact that the hotel was operating at a loss, Hayden concluded that if Glacier were to own the hotel, it could obtain a benefit by crediting Hotel Florence's real estate taxes against Glacier's State premium taxes and could also provide Glacier with a building for its offices. Hayden did not examine the Hotel Florence income tax returns. Glacier's State premium taxes and the credits taken against these taxes were as follows:

GLACIER GENERAL ASSURANCE CO.
		1965	1966	1967
Premium tax		$ 52,745.05	$ 74,366.35	$ 75,318.59
Fire marshal tax		1,208.50	1,778.33	1,793.15
Credits		(40,721.08)	(38,540.75)	(76,305.55)
Tax paid		13,232.47	37,603.93	806.19
Credit recap
	Florence Hotel	0	0	31,980.68
	Other real estate taxes	21,403.47	0	25,225.78
	Industrial accident tax	18,416.05	15,599.86	16,235.07
	Other taxes (primarily
	auto license taxes)	901.56	0	2,864.02
	Other payments -- not
	identifiable	0	22,940.89	0
		40,721.08	38,540.75	76,305.55
Type of property owned
by Glacier General
	Butte supermarket	X	X	X
	Havre supermarket	X	X	X
	Rental houses		X	X
	Rental apartments
	Florence Hotel			X
	Office building

GLACIER GENERAL ASSURANCE CO.
		1968	1969	1970
Premium tax		$ 71,873.02	$ 91,745.79	$ 78,949.86
Fire marshal tax		1,879.17	4,264.25	4,784.87
Credits		(84,979.86)	(142,163.96)	(94,903.30)
Tax paid		0	0	0
Credit recap
	Florence Hotel	33,860.03	33,487.59	37,581.97
	Other real estate taxes	30,718.62	86,072.04	0
	Industrial accident tax	14,475.59	15,812.11	0
	Other taxes (primarily
	auto license taxes)	5,925.62	6,792.22	0
	Other payments -- not
	identifiable	0	0	57,321.33
		84,979.86	142,163.96	94,903.30
Type of property owned
by Glacier General
	Butte supermarket	X	X	X
	Havre supermarket	X	X	X
	Rental houses	X
	Rental apartments	X	X
	Florence Hotel	X	X	X
	Office building		X	X

On March 3, 1967, Hayden discussed the proposed purchase of Hotel Florence stock with O'Connell and outlined to him his conclusions as to how Glacier could benefit by the acquisition. During the course of their discussion, Hayden pointed out to O'Connell the hotel's operating loss shown on its statement for the calendar year 1966. The two men agreed on a price which would be offered for Mercantile's stock in Hotel Florence. On March 4, Hayden informed O'Connell that the price of $ 12.50 per share was acceptable to Mercantile and O'Connell made the decision to purchase the stock after discussing the acquisition with Hayden and James O'Connell.

On March 6, 1967, petitioner purchased at $ 12.50 per share 2,800 shares of voting stock of Hotel Florence from Mercantile which represented 56 percent of the corporation's outstanding stock.

Prior to the acquisition of the stock, neither petitioner nor J. E. O'Connell received any tax advice with respect to the purchase. Between the dates of March 2 and March 8, 1967, petitioner did not retain a lawyer in an advisory capacity specifically for purposes of the acquisition.

At the annual meeting of the stockholders of Hotel Florence on March 6, 1967, the president of Hotel Florence stated that Mercantile could no longer shoulder the responsibility of maintaining the operation of the hotel and "that there are other business enterprises which are organized to operate a hotel and to receive tax benefits in its set up, and, with this in mind, Montana Mercantile has sold its stock interest to [Capri]."

At the meeting of the board of directors of Hotel Florence on March 6, 1967, James E. O'Connell was elected vice president and John Hayden was elected secretary-treasurer of the corporation. Hayden outlined to the board his plan for operating the hotel at a profit. He reviewed the losses experienced by the hotel from 1961 through 1966 and proposed that the hotel be sold to Glacier and leased back to Hotel Florence, a procedure which would remove depreciation, interest, and tax expenses of $ 122,002.31 from the Hotel Florence 1966 operating statement. The proposal was unanimously approved by the board of directors.

On March 6, 1967, Hotel Florence entered into an agreement with Glacier whereby the hotel, a garage, an adjoining office building, and all real and personal property owned by Hotel Florence were sold to Glacier for $ 633,000. Of the total consideration, $ 150,000 was payable upon execution of the contract and $ 21,200 was payable by March 6, 1967, on December 31, 1967, and at 6-month intervals thereafter. The $ 21,200 payments were equal to Hotel Florence payments on its outstanding mortgage. The payment due on January 1, 1967, was delinquent and the mortgagee attempted to secure payment. This payment was made by Glacier on March 3, 1967, and on July 1, 1967, Glacier made a second payment of $ 21,200 to the mortgagee. The mortgage loan was thereafter refinanced to provide for monthly payments of $ 3,495 by Glacier.

Of the $ 150,000 paid by Glacier to Hotel Florence upon execution of the contract, $ 80,000 was paid to Mercantile in satisfaction of shareholder advances; $ 60,000 was paid to Glacier for the 10th year's rental as a deposit; and $ 10,000 was retained for operating capital.

Hotel Florence recorded a loss of $ 330,526.19 on its books from the sale of its assets to Glacier. The loss was added to its 1967 operating loss ($ 72,111.31) to record a total net operating loss of $ 402,637.50 for 1967.

On March 6, 1967, Hotel Florence leased the hotel from Glacier for 10 years at a monthly rental of $ 5,000, the first payment being due on April 1, 1967. There was no provision in the lease agreement for renewal of the lease. The lessee agreed to maintain the property and pay all costs in connection with the operation of the building, including repairs. Glacier was obligated to pay for major remodeling, taxes, assessments, liquor license fees, and fire insurance. Hotel Florence paid the following amounts as rent to Glacier under the lease agreement:

Year	Amount
1967	0
1968	$ 55,000
1969	$ 59,200
1970	58,850

After petitioner acquired its 56-percent stock interest in Hotel Florence, the income tax returns, corporate minutes, and all the other corporate records were delivered to petitioner.

At the time of acquiring its stock interest in Hotel Florence, petitioner agreed to make a tender offer to purchase for $ 12.50 per share the stock owned by the other shareholders of the corporation. It was O'Connell's intent to have petitioner acquire 100 percent, or at least 80 percent of the stock of Hotel Florence, if possible, and petitioner purchased such stock from May 1967 through July 1969. Petitioner paid $ 12.50 per share until December 1968 when it increased the price to $ 15 per share.

In a letter to all the stockholders of Hotel Florence dated May 16, 1967, petitioner offered to purchase their shares of stock for $ 12.50 per share and petitioner recited the losses sustained by Hotel Florence from 1961 through 1966.

During 1967, petitioner purchased 622 shares of Hotel Florence stock in 20 separate transactions to bring its ownership at the end of the year to 68 percent.

Immediately after the acquisition of the Hotel Florence stock, Hayden analyzed the hotel's operations and its physical plant and concluded that a major modernization or major infusion of capital would be required to make the hotel profitable. He discussed his conclusions with O'Connell. Hayden approached owners of property adjoining the hotel with the view of expanding the hotel and found them willing to sell their property or participate with petitioner in a joint venture of constructing a motel west of the hotel. He also discovered that a $ 1,200,000 loan could be obtained for such purposes. O'Connell rejected such a proposal because he did not want petitioner to become that deeply involved with the hotel. In a letter to Hayden on June 12, 1967, O'Connell wrote as follows:

Jim and I have just been visiting about whether or not to increase our investment at the Florence Hotel corner in additional real estate, and it seems to us that maybe we should just graciously back away from the present owners of the gas station corner. Wait and see how near below or above we get to 80% of the Florence Hotel Company and how that will work out with Glacier General as property owners, and Capri, Inc., as operators of the Hotel.

On August 14, 1967, O'Connell advised the manager of the hotel that the bookkeeping for Hotel Florence (with the exception of the customer's ledger, payroll accounts, and disbursements) would be performed by petitioner in the same manner that petitioner handled the bookkeeping functions for many corporations in which it owned stock, thereby relieving the manager of such details.

After petitioner acquired the 56 percent of Hotel Florence stock, it requested the manager to collect accounts receivable. He collected some accounts and within a year reduced the accounts receivable from $ 50,000 to $ 25,000. In addition, petitioner required cuts in the Hotel Florence inventory. Nevertheless, Hotel Florence continued to experience working capital problems. Petitioner, unlike its predecessor, Mercantile, refused to advance working capital to Hotel Florence. Hotel Florence suffered the following operating losses:

Year	Amount
1967	$ 72,111.31
1968	31,486.54
1/1/69-7/31/69	42,444.45

In January 1968, O'Connell asked his attorney and Hayden if it would be possible to increase the number of shares of Hotel Florence stock outstanding so that petitioner would own 80 percent. Although unaware of the reason that O'Connell desired petitioner to own 80 percent of the stock, Hayden advised him that a new stock offering could be made at a price of $ 25 per share with the expectation that not all of the shareholders would purchase the number of shares they were entitled to so that petitioner could thereby obtain 80-percent ownership for $ 25,000. This investment was to be recouped thereafter by placing James O'Connell on Hotel Florence's payroll, charging Hotel Florence for petitioner's management services, or increasing the rental payable to Glacier.

On March 5, 1968, O'Connell solicited from the Hotel Florence shareholders their pro rata share of the $ 60,000 installment due on the hotel's promissory note due Northwestern Insurance Co. on May 1, 1968. Simultaneously, Hotel Florence offered to redeem the stock of certain of its shareholders for capital stock of their selection on a dollar-for-dollar basis with Hotel Florence stock valued at $ 12.50 per share.

In December 1968, O'Connell approached the owner of 5 shares of Hotel Florence stock and asked to redeem his shares. O'Connell informed him about the losses the corporation had experienced in the last 8 to 10 years and stated that the hotel could no longer continue to be operated "unless it could be used as a tax writeoff." O'Connell explained that he must acquire 80 percent of the stock in order to utilize the hotel as a tax writeoff. The shareholder agreed to have his stock redeemed and the transaction was completed on December 24, 1968.

O'Connell, after December 1968, sought advice from petitioner's comptroller as to the manner in which Hotel Florence could be absorbed into petitioner. Petitioner's officers had on two or three occasions previously considered combining the operations of the Hotel Florence and the Capri Motel. The comptroller advised him that the Hotel Florence corporation could be merged or liquidated or petitioner could file a consolidated income tax return with Hotel Florence. The comptroller explained to O'Connell that petitioner, in all three instances, would be required to own 80 percent of the Hotel Florence stock.

During 1968, petitioner purchased 518 shares of Hotel Florence stock in 19 separate transactions so that its percentage ownership at the end of the year was 79 percent.

On January 31, 1969, petitioner achieved the 80-percent stock ownership of Hotel Florence by the purchase of stock from five stockholders.

In December 1968, petitioner rejected an overture of a real estate firm in Spokane, Wash., to purchase the hotel. Petitioner received a second letter from the Spokane real estate firm on February 19, 1969, indicating a continued interest in purchasing the hotel, but the letter was not answered. O'Connell did not inform Hayden on either occasion of the firm's interest in acquiring the hotel. Petitioner thereafter purchased additional shares of Hotel Florence on the following dates:

	Number
Date	of shares
2/21/69	7
2/26/69	10
4/16/69	1
5/28/69	781
7/11/69	5

On June 25, 1969, Florence Hotel adopted a plan of liquidation and on July 31, 1969, it was liquidated and dissolved. Petitioner received $ 32,422.84 cash in liquidation and the other shareholders received $ 2,835.

The adjusted basis of Hotel Florence assets on March 7, 1967, on December 31, 1967 and 1968, and on the date of the liquidation of the corporation were as follows:

HOTEL FLORENCE
Adjusted Basis of Assets
	3/6/67		12/31/67
Assets
Cash		$ 14,847		$ 20,844.56
Accounts receivable	$ 94,531			52,602.66
Less: Accounts written off	(53,952)	40,579
Inventories		22,748		10,833.99
Land		103,000
Buildings	1,219,386		$ 28,888.33
Less: Depreciation	(538,014)	681,372	(2,030.41)	26,857.92
Furniture and equipment	325,522			32,064.71
Less: Depreciation	(116,585)	208,937
Prepaid expenses		19,440
Prepaid lease deposit				375.12
Total assets		1,090,923		143,578.96
Liabilities
Accrued payroll		8,571
Accounts payable		29,692		17,277.63
Accrued taxes		14,959
Accrued expenses		6,130
Notes payable and interest --
(Montana Mercantile)		78,615
Mortgage payable		483,911		19,737.52
Interest on mortgage payable		13,912
Contingent liability		22,125
Notes payable (other)		3,290
Total liabilities		661,205		37,015.15
Net assets (net worth)		429,718		106,563.81

HOTEL FLORENCE
Adjusted Basis of Assets
	12/31/68		6/30/69
Assets
Cash		$ 19,753.57		$ 11,433.67
Accounts receivable		36,406.62		38,715.15
Less: Accounts written off
Inventories		10,601.36		10,857.30
Land
Buildings	$ 51,591.42		$ 67,600.30
Less: Depreciation	(12,084.35)	39,507.07	(19,723.37)	47,876.93
Furniture and equipment		19,887.91		6,408.85
Less: Depreciation
Prepaid expenses
Prepaid lease deposit
Total assets		126,156.53		115,291.90
Liabilities
Accrued payroll
Accounts payable		30,729.14		65,348.56
Accrued taxes
Accrued expenses
Notes payable and
interest --
(Montana Mercantile)
Mortgage payable		17,725.00		17,520.50
Interest on mortgage payable
Contingent liability
Notes payable (other)
Total liabilities		48,454.14		82,869.06
Net assets (net worth)		77,702.39		32,422.84

After the liquidation of Hotel Florence, the hotel continued to suffer losses even though petitioner advanced funds for its operation. On November 24, 1969, O'Connell wrote to Hayden with the view to selling the hotel and enclosed certain operating statements. Hayden was not furnished with the 1967 operating statement. In the letter, O'Connell stated:

Enclosed are the operating statements and balance sheets for the Hotel Florence Co. for calendar year 1968 and the short period ending July 31, 1969 at which time the Hotel Florence Co. was dissolved. Also enclosed is the operating statement and balance sheet since Capri, Inc. has owned the business from Aug. 1, 1969 to Oct. 31, 1969.

We do not have the statements prior to 1967. We are not enclosing a statement for 1967 because the operating statement shows mining accounts charged off of $ 49,209.20 and a loss on the sale of property of $ 330,870.69, which are unusual items that would need an explanation to anyone analyzing the statements.

In view of the fact that Hotel Florence Company was dissolved by the then stockholders as of August 1, 1969, and absorbed into the operations of Capri, Inc., it will not be sold as a corporation, but will be sold only to a buyer who would inspect the hotel, buildings, town, location and be satisfied that they are getting a real bargain; that the hotel will go into the hands of people who understand the business and with their knowhow and understanding continue it as the nice hotel which can operate at a very nice profit. Its purchase would be on the bargain levels, but it needs to be purchased by people who understand the business, know a bargain when they see it. The hotel is in immaculate condition, beautifully furnished, located in one of the best towns in all the northwest and [I] speak without any reservation, but a lot of experience in the territory, extending from Minneapolis to Seattle.

It would be greatly to the advantage of the buyer to buy buildings, equipment, and land enabling them [sic] to set up their [sic] own figures as to depreciation, etc.

In December 1970, the hotel was transferred by Glacier to Milcap, Inc., petitioner's wholly owned subsidiary, in exchange for the building occupied by Glacier and leased from Milcap, Inc. Although architectural plans had been prepared for Glacier's new offices to be located in the hotel, Glacier never relocated in the hotel. The hotel was eventually sold to the Western Broadcasting Co. on February 4, 1972.

The taxable income of Hotel Florence, as stipulated by the parties, was $ 51,726 for its taxable year 1957, $ 12,264 for 1958, $ 9,839 for 1959, and $ 19,409 for 1960. Its taxable income (losses), net operating loss carrybacks, net operating loss carryforwards, and contribution carryovers for its taxable years 1961 through 1969 were as follows:

		1961	1962	1963
Taxable income 1		($ 17,403)	($ 7,417)	($ 37,355)
NOL carrybacks		17,403	7,417	17,776
Contributions -- Not
allowed for carryback
or carryover		(409)	(674)	(532)
NOL carryover
	1963			19,047
	1964
	1965
	1966
	1967
	1968
	1969
NOL available				19,047
Contribution carryover
	1961	409	409	409
	1962		674	674
	1963			532
	1964
	1965
	1966
	1967
	1969	409	1,083	1,615
	Total NOL carryover and
	contribution carryover	409	1,083	20,662

		1964	1965	1966
Taxable income 1		($ 14,640)	($ 74,456)	($ 61,713)
NOL carrybacks
Contributions -- Not
allowed for carryback
or carryover		(587)	(561)	(695)
NOL carryover
	1963	19,047	19,047	19,047
	1964	14,053	14,053	14,053
	1965	73,895	73,895	73,895
	1966	61,018	61,018	61,018
	1967
	1968
	1969
NOL available		33,100	106,995	168,013
Contribution carryover
	1961	409	409
	1962	674	674	674
	1963	532	532	532
	1964	587	587	587
	1965		561	561
	1966			695
	1967
	1969	2,202	2,763	3,049
	Total NOL carryover and
	contribution carryover	35,302	109,758	171,062

		1967	1968	1969
Taxable income 1		($ 402,638)	($ 31,487)	($ 42,444)
NOL carrybacks
Contributions -- Not
allowed for carryback
or carryover		(703)	0	0
NOL carryover
	1963	19,047
	1964	14,053	14,053
	1965	73,895	73,895	73,895
	1966	61,018	61,018	61,018
	1967	401,935	401,935	401,935
	1968		31,487	31,487
	1969			42,444
NOL available		569,948	582,388	610,779
Contribution carryover
	1961
	1962
	1963	532
	1964	587	587
	1965	561	561	561
	1966	695	695	695
	1967	703	703	703
	1969	3,049	2,546	1,959
	Total NOL carryover and
	contribution carryover	573,026	584,934	612,738

On its consolidated Federal income tax return for the taxable year ended June 30, 1970, petitioner and its related corporations claimed a net operating loss deduction for the carryover losses of Hotel Florence as follows:

Year	Amount
12/31/65	$ 74,455.72
12/31/66	61,712.79
12/31/67	402,637.50
12/31/68	31,486.94
7/31/69	42,444.45
Total	612,737.40
Allowable to Capri, Inc.,
taxable year ended
6/30/70	192,465.16
Carryover to taxable year
ended 6/30/71	420,272.24

In his statutory notice of deficiency, the Commissioner disallowed the net operating loss deduction for the net operating losses sustained by Hotel Florence under the provisions of sections 269(a), 382(a), and 482. In addition, he determined that the loss reported by Hotel Florence from the sale of the hotel to Glacier in 1967 was not allowable because the sale was without substance and that the sale was an exchange of property of like kind. He also adjusted the amount of the net operating loss deduction under section 381(c). The Commissioner has abandoned the theory that the net operating loss deduction was not allowable under section 482. Petitioner has conceded the correctness of the Commissioner's adjustment under section 381(c).

OPINION

Issue 1. Section 269(a)

The Commissioner disallowed petitioner's deduction for net operating losses sustained by its subsidiary, Hotel Florence, on the ground that petitioner acquired control of Hotel Florence for the purpose of avoiding tax by securing the benefit of the net operating loss deductions to which it would not otherwise be entitled. Section 269(a)³ defines the control which brings about disallowance of the deduction as 50 percent.

The issue is factual and our inquiry must be focused upon all the circumstances surrounding acquisition of control. Sec. 1.269-3(a), Income Tax Regs.; D'Arcy-MacManus & Masius, Inc., 63 T.C. 440">63 T.C. 440, 449 (1975).

In order for section 269(a) to be applicable, the tax-avoidance motive must be the principal purpose for the acquisition. S. Rept. No. 627, 78th Cong., 1st Sess. (1943), 1944 C.B. 1017">1944 C.B. 1017; Commodores Point Terminal Corp., 11 T.C. 411">11 T.C. 411, 416 (1948). ⁴ To prevail, petitioner need prove only that the avoidance of tax was not the principal purpose. Bush Hog Manufacturing Co., 42 T.C. 713">42 T.C. 713, 729 (1964). Nevertheless, petitioner must prove the Commissioner's determination to be wrong by a preponderance of the evidence. American Pipe & Steel Corp. v. Commissioner, 243 F.2d 125">243 F.2d 125 (9th Cir. 1957), affg. 25 T.C. 351">25 T.C. 351 (1955).

Petitioner acquired 56 percent of the stock of Hotel Florence from Mercantile in one transaction. This gave petitioner the control necessary for the application of section 269 but did not give petitioner sufficient control to file a consolidated income tax return with Hotel Florence and enjoy the benefit of the hotel's net operating loss carryovers. Respondent relies upon our holding in Swiss Colony, Inc., 52 T.C. 25">52 T.C. 25 (1969), affd. 428 F.2d 49">428 F.2d 49 (7th Cir. 1970), for the proposition that the facts and circumstances after acquisition of 50-percent control represent part of the integrated transaction of acquiring 80-percent control and should be considered as indicative of the motive to avoid tax. Petitioner counters by relying on Hawaiian Trust Co. v. United States, 291 F.2d 761">291 F.2d 761 (9th Cir. 1961). In the latter case, the Court of Appeals for the Ninth Circuit stated at page 768:

In effect, the Government is saying that even though, at the time of acquisition, Refiners had a business and not a tax evasion purpose, when it subsequently ascertained the tax consequences it revived or kept Hilo Gas alive in order to take advantage of a possible loss carryover. The determining factor, however, is the intention or purpose of Refiners at the time of acquisition. Refiners having acquired control of Hilo Gas for business reasons alone and without considering the tax aspects of the transaction, the intention or purpose "for which (such) acquisition was made" would not be changed from a business into a tax evasion purpose when it subsequently ascertained the tax consequences of the transaction.

Whether the rationale of Swiss Colony, Inc., supra, is harmonious with that of Hawaiian Trust Co. v. United States, supra, we need not decide. An appeal in the instant case would lie in the Ninth Circuit which decided Hawaiian Trust. Therefore, we are required to apply Hawaiian Trust to the facts here. Jack E. Golsen, 54 T.C. 742">54 T.C. 742 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971), cert. denied 404 U.S. 940">404 U.S. 940 (1971). Our inquiry here must be focused on the intent of petitioner when it acquired 56 percent of Hotel Florence stock from Mercantile.

Although the test is one of subjective intent, the inquiry is based upon objective facts which manifest the subjective intent. The testimony of the acquiring corporation's top management is of particular importance. D'Arcy-MacManus & Masius, Inc., supra at 450. Unfortunately, Mr. J. E. O'Connell, the dominant and controlling shareholder, director, and officer of petitioner, was deceased at the time of trial. His testimony would have been the most helpful of those who participated in the acquisition. We have carefully examined the testimony of John Hayden in particular because he recommended to J. E. O'Connell that petitioner acquire the Hotel Florence stock. He devised the plan whereby the hotel should make a profit instead of sustaining additional losses. He was connected with the construction and operation of the Capri Motel. His testimony reeks with business motives not tax motives. We recognize that Hayden was aware that Hotel Florence had sustained losses but he did not see the income tax returns reflecting the net operating loss carryovers until after petitioner had acquired 56 percent of the stock. When all of the evidence is considered, it is clear that petitioner has proved that the principal purpose for acquiring 56 percent of the outstanding stock of Hotel Florence was not tax avoidance. Petitioner has established valid, substantial business motives which were comparable to other business practices which it carried on. The Commissioner is not, therefore, sustained in his determination under section 269(a).

Issue 2. Section 382(a)

The limited issue presented under section 382(a) is whether Hotel Florence substantially changed its business after petitioner acquired the requisite ownership in March 1967. There is no dispute that there was the necessary change in ownership to cause the "change of ownership" requirement of section 382(a) to be applicable. Section 382(a)(1)(C)⁵ requires disallowance of the net operating loss carryovers in this case if Hotel Florence did not continue to carry on a trade or business substantially the same as that conducted prior to the change in ownership. Respondent contends that because petitioner refused to advance funds to operate the hotel as had Mercantile prior to petitioner's acquisition it somehow changed the business of the hotel. Further he argues that subsequent acquisitions of stock of Hotel Florence followed by the liquidation of the Florence Hotel corporation and sale of the hotel property represent the necessary change in the trade or business to apply section 382(a). Petitioner acquired 56-percent ownership in March 1967; it achieved 80-percent ownership in January 1969; the Hotel Florence corporation was liquidated on July 31, 1969; the hotel was sold by a subsidiary of petitioner in 1972. Throughout the period from March 1967 to 1972, the hotel was operated as a hotel.

Respondent complains that the net operating loss carryovers of the hotel are being used to offset petitioner's passive investment income and such offsets are prohibited by Libson Shops, Inc. v. Koehler, 353 U.S. 382">353 U.S. 382 (1957). The Ninth Circuit, to which an appeal in the instant case will lie, has held that Libson Shops does not apply to cases involving section 382(a). It held that when section 382(a) was enacted by Congress, the test of that section apply, not the Libson Shops rationale. Maxwell Hardware Co. v. Commissioner, 343 F.2d 713 (9th Cir. 1965). We are bound by that decision in this case. Jack E. Golsen, supra.

Factually we do not hold that Hotel Florence changed its business. There was nothing mysterious about the sale and leaseback of the hotel. It was done for valid business reasons developed by John Hayden. The Capri Motel was operated in like manner. The evidence does not support respondent's position that petitioner set out to strip Hotel Florence of its income-producing capacity and to benefit only from its net operating loss carryovers. After its acquisition of control, petitioner set out to reduce the hotel accounts receivable and inventory. Prior to acquisition, Hotel Florence sustained a loss of $ 74,455.72 in 1965 and a loss of $ 61,712.79 in 1966. After petitioner gained 56-percent ownership in March 1967, Hotel Florence sustained a loss for 1967 of $ 72,111.31 but in 1968, the first full year of operations under petitioner's control, the loss was only $ 31,486.54. Such statistics hardly support respondent's position.

Accordingly, we hold that the business of Hotel Florence did not substantially change after petitioner acquired 56-percent ownership, and section 382(a) does not apply to prevent the deductions of Hotel Florence's net operating losses.

Issue 3. Sale and Leaseback

Respondent challenges the deductibility of the loss of $ 330,526.19 claimed by Hotel Florence on the sale of its assets to Glacier. He contends that the sale and leaseback lacked substance. We disagree. There were valid business purposes explained by John Hayden. Glacier could offset the real estate taxes of the hotel against the premium tax it paid. The selling price and rentals paid were an integral part of John Hayden's effort to turn the losses of the hotel into profits. We conclude that the transaction, sale and leaseback, had substance and the loss was sustained by Hotel Florence.

Respondent argues, in the alternative, that the sale and leaseback was a nontaxable exchange of property of like kind under section 1031 and the loss should not be recognized. Although section 1.1031(a)-1(c), Income Tax Regs., requires a lease of real property to be 30 years in duration to constitute an interest in real property equivalent to a fee interest, respondent argues that the 10-year lease between Glacier and Hotel Florence, because they were related corporations, would be automatically renewable. We fail to see how respondent arrives at that conclusion with that line of reasoning. Whether Glacier entered into a lease with Hotel Florence at the end of the 10-year lease is mere conjecture on respondent's part. There was no provision in the lease agreement for renewal or extension at the end of the 10-year term.

We conclude that petitioner is entitled to deduct the portion of the net operating loss consisting of the loss sustained by Hotel Florence upon the sale and leaseback transactions with Glacier. Leslie Co., 64 T.C. 247 (1975).

Decision will be entered under Rule 155.

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Footnotes

• 1. All section references are to the Internal Revenue Code of 1954, as amended.↩

• 2. Treacy Co. is a tax-exempt foundation organized and directed by J. E. O'Connell.↩

• 1. Rebate utilities on Helena rental property.↩

• 3. This figure has been stipulated to by the parties.↩

• 2. Rebate legal fees of J. E. O'Connell.↩

• 1. This chart and the figures contained herein have been stipulated to by the parties.↩

• 3. SEC. 269. ACQUISITIONS MADE TO EVADE OR AVOID INCOME TAX.

  (a) In General. -- If --

  (1) any person or persons acquire, or acquired on or after October 8, 1940, directly or indirectly, control of a corporation, or

  (2) any corporation acquires, or acquired on or after October 8, 1940, directly or indirectly, property of another corporation, not controlled, directly or indirectly, immediately before such acquisition, by such acquiring corporation or its stockholders, the basis of which property, in the hands of the acquiring corporation, is determined by reference to the basis in the hands of the transferor corporation, and the principal purpose for which such acquisition was made is evasion or avoidance of Federal income tax by securing the benefit of a deduction, credit, or other allowance which such person or corporation would not otherwise enjoy, then the Secretary or his delegate may disallow such deduction, credit, or other allowance. For purposes of paragraphs (1) and (2), control means the ownership of stock possessing at least 50 percent of the total combined voting power of all classes of stock entitled to vote or at least 50 percent of the total value of shares of all classes of stock of the corporation.↩

• 4. Armais Arutunoff, T.C. Memo. 1963-192↩.

• 5. SEC. 382. SPECIAL LIMITATIONS ON NET OPERATING LOSS CARRYOVERS.

  (a) Purchase of a Corporation and Change in Its Trade or Business. --

  (1) In General. -- If, at the end of a taxable year of a corporation --

  * * *

  (C) such corporation has not continued to carry on a trade or business substantially the same as that conducted before any change in the percentage ownership of the fair market value of such stock,

  the net operating loss carryovers, if any, from prior taxable years of such corporation to such taxable year and subsequent taxable years shall not be included in the net operating loss deduction for such taxable year and subsequent taxable years.