DocketNumber： Docket No. 6095-73
Judges： Raum
Filed Date： 6/30/1975
Status： Precedential
Modified Date： 11/14/2024
*120
T Corp. entered into a contract under which J Co. had the right to remove sand and gravel from T Corp.'s property, and which, as construed herein, did not require it to remove all or any specified portion thereof. J Co. undertook to pay for the sand and gravel removed at a price per ton geared to the wholesale selling price of sand and gravel then prevailing in the local market during the month such sand and gravel was removed.
*511 The Commissioner determined deficiencies in petitioner's Federal income taxes in the following amounts:
| TYE Oct. 31 -- | Deficiency |
| 1967 | $ 23,570.73 |
| 1968 | 21,570.17 |
| 1969 | 26,133.00 |
*126 The ultimate issue in this case is whether petitioner is a personal holding company subject to the personal holding company tax imposed by
FINDINGS OF FACT
The parties have stipulated most of the facts, and their several stipulations, together with accompanying exhibits, are incorporated herein*127 by this reference.
Pleasanton Gravel Co. (petitioner) is a California corporation. At the time of filing its petition herein, its principal office was in Oakland, Calif.
Following its incorporation in 1956, petitioner issued 800 shares of $ 25 par stock to George W. Jamieson in return for $ 20,000. He has since remained petitioner's sole stockholder. Shortly thereafter petitioner acquired 173 acres of land (Pleasanton property) situated in the Livermore Valley near Pleasanton, Calif., from George W. Jamieson for $ 18,000. On January 1, 1959, petitioner entered into an agreement concerning the sand and gravel deposits on its property with Jamieson Co., a partnership consisting of George W. Jamieson and, for the years here in issue, his father, George G. Jamieson, as equal partners. *512 By that agreement petitioner purported to "sell and grant to Buyer [Jamieson Co.] forever, all the rock, sand and gravel deposits in, on and under" the therein described portion of the Pleasanton property. Pertinent terms and conditions of agreement were as follows:
1. Buyer shall have the right to operate upon the premises described in "Exhibit A" hereto such number of gravel pits and quarries*128 as may be proper under approved quarrying procedures and to excavate and remove from the said premises such rock, sand and gravel as may be proper and profitable under good quarrying practices. * * *
Buyer shall operate its gravel pits and quarries upon said premises in accordance with good quarrying practices and shall not abandon any gravel pit or refill the same with overburden or dirty water until Buyer in its judgment determines that all rock, sand and gravel that can profitably be recovered therefrom under good quarrying practices has been removed.
2. The Seller makes no warranty to Buyer as to the amount of rock, sand and gravel that may profitably be quarried in, on or under the lands * * *, however, if the water table should fall below one hundred (100) feet, Buyer may expect to profitably remove three million (3,000,000) tons of rock, sand and gravel from the deposits herein sold to Buyer.
3. The Buyer shall pay to Seller for every ton of rock, gravel or sand removed by Buyer, a specific amount for each ton so removed by Buyer. The price to be paid by Buyer for each ton so removed will depend on the average wholesale selling price in Pleasanton, California, during the month*129 of removal for the materials so removed. Attached hereto as "Exhibit B" is a schedule setting forth the price that will be payable by Buyer for each ton of rock, gravel or sand removed (Column II) based on the base wholesale price per ton in Pleasanton, California, for rock, gravel and sand (Column I).
Buyer shall deliver to Seller a report in writing showing the number of tons of gravel, rock and sand removed from said premises during the preceding month on or before the 15th day of the calendar month next succeeding the calendar month in which Buyer makes its first removal of gravel, rock or sand from said premises and shall deliver to Seller a like report on or before the 15th day of each calendar month thereafter that Buyer is conducting quarry operations on the premises, and Buyer shall pay to Seller a sum equal to the total purchase price for all gravel, rock and sand as shown in the report due on the 15th day of the preceding month.
4. If at any time during quarrying operations Buyer determines that rock, gravel and sand can no longer be profitably quarried and removed from the lands described in "Exhibit A" hereto, Buyer shall have the option to terminate this agreement upon*130 sixty (60) days notice to Seller.
* * *
6. Buyer may erect upon the lands particularly described in "Exhibit A" hereto such machinery, trackage and buildings roads [sic] as it may deem necessary or convenient for the proper and economical operation of the gravel pits and quarries upon said premises. * * *
* * *
*513 9. Buyer shall keep the lands * * * free from any liens arising out of any work performed for, materials furnished to or obligations incurred by Buyer.
10. Buyer shall, at its sole cost and expense, comply with all the requirements of all Municipal, State and Federal authorities now in force or which hereafter may be in force pertaining to its operations upon said premises, and shall faithfully observe in its operations on said premises all Municipal ordinances and State and Federal statutes now in force or which may hereafter be in force. * * *
The attached Schedule B referred to in paragraph 3 of the agreement provided that petitioner was to be paid a minimum of $ 0.05 per ton of rock, sand, and gravel removed plus an additional $ 0.01 per ton for each $ 0.30 (or part thereof) increment in the wholesale selling price above $ 1.50 per ton. Thus, for example, if *131 the per ton wholesale selling price of rock, sand, and gravel was $ 1.90 per ton, petitioner was entitled to receive $ 0.07 per ton from Jamieson Co.; if it were $ 2.20 per ton, petitioner would receive $ 0.08 per ton, and so on. This payment schedule was amended on January 1, 1962, to provide that --
In event [sic] and whenever one million (1,000,000) or more tons of Rock, Sand and Gravel is sold by Pleasanton Gravel Company to Jamieson Company in any one calendar year then the purchase price to be paid shall be reduced 20% as applied to Exhibit B * * *
Under this agreement, Jamieson Co. mined the sand and gravel which it then processed with machinery located on the same property. The processing consisted of washing, sizing, screening, crushing, and stockpiling the various materials mined. Jamieson Co. thereupon sold these materials to Rhodes-Jamieson, Ltd., a corporation which, for the years in issue, also was owned by George W. Jamieson and his father, 49 percent and 51 percent, respectively. Rhodes-Jamieson, Ltd., used the gravel and sand both for ready-mix concrete and for sales to third parties. Neither petitioner nor Jamieson Co. had any employees; instead, they each *132 paid a fee to Rhodes-Jamieson, Ltd., to perform their respective activities, including the operation of the processing machinery. In addition, Jamieson Co. leased the processing machinery from Rhodes-Jamieson, Ltd.
Petitioner's primary source of income since its incorporation has been the proceeds received from Jamieson Co., pursuant to their agreement. Despite their estimate in the agreement that Jamieson Co. would be able to remove a total of 3 million tons of material, Jamieson Co. in fact removed over 14 million tons by the close of petitioner's fiscal year which ended in 1969, and *514 more than an additional 4 million tons before exhausting the available supplies in 1973 (other than those beneath the area which Jamieson Co. used for processing). As a result of Jamieson Co.'s mining activity, the portion of the Pleasanton property from which deposits had been removed was left covered with water which, due to the high level of the water table, could not be drained away.
For each of its taxable years in issue, petitioner filed a Federal Corporation Income Tax Return, Form 1120. On none of those returns did it indicate in the space provided that it was a personal holding*133 company nor did it attach thereto a separate schedule showing its gross income, adjusted ordinary gross income, and the names and addresses of its stockholders. Petitioner stated on each return that its principal business activity was "Gravel Mining & Sales," and it reported income and expenses for the years in issue as follows:
| Description | |||
| Income | 10/31/67 | 10/31/68 | 10/31/69 |
| Gravel sales | $ 67,776.93 | $ 71,143.41 | $ 81,654 |
| Rental income | 1,000.00 | 1,000.00 | 1,000 |
| Interest income | 7,430.50 | 9,225.00 | 9,225 |
| Total income | 76,207.43 | 81,368.41 | 91,879 |
| Expenses | |||
| Repairs | 0 | 7,334.62 | 200 |
| Rents | 1,000.00 | 1,000.00 | 1,000 |
| California franchise taxes | 2,182.35 | 3,722.82 | 3,428 |
| Property taxes | 12,228.76 | 14,337.32 | 13,917 |
| Depreciation | 2,606.98 | 4,345.86 | 8,016 |
| Depletion | 3,388.85 | 3,557.17 | 4,083 |
| Professional services | 630.00 | 625.00 | 685 |
| Outside office services | 1,200.00 | 1,200.00 | 1,200 |
| Total expenses | 23,236.94 | 36,122.79 | 32,529 |
| Taxable income | 52,970.49 | 45,245.62 | 59,350 |
Pleasanton had adjusted gross income and adjusted gross income from gravel transfers for the years in issue as follows:
| TYE Oct. 31 -- | |||
| 1967 | 1968 | 1969 | |
| Adjusted gross income $ 54,800.49 | $ 54,405.24 | $ 61,435 | |
| Adjusted gross income | |||
| from gravel transfers | 47,369.99 | 45,180.24 | 52,210 |
*515 On its Federal income tax returns for these years, petitioner reported its income from the gravel transfers on the line entitled "Gross receipts or gross sales." In its returns for prior years, petitioner had at times reported such income as "royalties." In each of its taxable years ended in 1960 through 1969, petitioner deducted from its income a depletion allowance in an amount equal to 5 percent of its gross income from gravel transfers. In none of the years at issue or prior thereto did petitioner treat the gravel-related income as capital gains. Also, there is no evidence that petitioner paid any dividends during these years.
Petitioner filed its Federal income tax returns for the first 2 taxable years in issue with the District Director*135 of Internal Revenue at San Francisco, Calif.; for the remaining taxable year in issue it filed with the Western Service Center at Ogden, Utah. Payments or evidences of credits for prior payments were removed and proper credit made thereof. Each return was checked for mathematical accuracy and internal consistency. The return was then accepted as being filed and thereupon delivered to a classifying officer of the Internal Revenue Service. It would then be assigned to a revenue agent who worked in the classification section. He reviewed each of the returns, and, upon the basis of criteria not disclosed herein, made a determination and ordered a clerk to place the stamp "Closed on Survey" or "Field Audit" on the face of the returns. In accordance with this procedure the returns for the first 2 of the years here in issue were stamped "Closed on Survey" while the return for the taxable year ended in 1969 was marked with the imprint "Field Audit." For each of these taxable years, the Commissioner conducted only one actual inspection of petitioner's books and records kept at its home office.
By reason of three Forms 872, executed on behalf of petitioner, the period of limitation upon*136 assessment of income and profits tax for each of the years in issue was extended until June 30, 1973. In the deficiency notice, dated June 25, 1973, the Commissioner determined that --
Since over 60 percent of your adjusted ordinary gross income * * * [in each of the years in issue] consisted of personal holding company income as defined in
*516 In its amended petition herein, petitioner claimed refunds for each of the taxable years in issue on account of its alleged error in reporting the amounts received on the sale of gravel as ordinary income instead of capital gain.
OPINION
At issue is whether, for the taxable years before us, petitioner is subject to the personal holding company tax imposed by
"Personal holding company income" is, by definition, a specified portion of "adjusted ordinary gross income," *517 income,
(3) Mineral, oil, and gas royalties. -- The adjusted income from mineral, oil, and gas royalties; except that such adjusted income shall not be included if -- (A) such adjusted income constitutes 50 percent or more of the adjusted ordinary gross income, (B) the personal holding company income for the taxable year (computed without regard to this paragraph, and computed by including as personal holding company income copyright royalties and the adjusted income from rents) is not more than*140 10 percent of the ordinary gross income, and (C) the sum of the deductions which are allowable under section 162 (relating to trade or business expenses) other than -- (i) deductions for compensation for personal services rendered by the shareholders, and (ii) deductions which are specifically allowable under sections other than section 162, equals or exceeds 15 percent of the adjusted ordinary gross income.
Alternatively, petitioner takes the position that, for the taxable years ended in 1967 and 1969, even if the proceeds in question were mineral royalties, petitioner otherwise met the three conditions of
Whether a taxpayer is entitled to capital gains treatment upon the sale of sand, gravel, and the like is a familiar question with which the courts have wrestled seemingly all too often. From the plethora of opinions on this subject has emerged the now widely accepted principle by which the facts of each case are to be measured. Often referred to as the "economic interest" test, it was first propounded by the Supreme Court in
The extension of this criterion*145 to the taxation of proceeds from the extraction of hard minerals may be stated as follows: if the property owner disposes of his entire interest in the deposits "in place," unconditionally and without further interest in their removal, then his income therefrom is not disqualified from being regarded as capital gain by reason of the form of the transaction; however, where the terms of the agreement are tantamount to a lease for the exploitation of the land whereby the property owner must look to the extraction of the mineral in order to recover his capital, then the owner has retained an economic interest in the deposits and in their production which interest renders the gain reflected in the proceeds therefrom ordinary income in his hands.
Where, as here, it is not disputed that petitioner acquired an interest in the deposits through investment, the key consideration is the basis upon which it recouped that investment, or stated otherwise, did petitioner "look
The answer to the*147 question depends largely upon an evaluation of the particular facts involved. Moreover, as in tax matters of every sort, unless otherwise clearly provided by statute, we must *521 be guided by the substance of the underlying arrangement, not by its formal trappings.
The substance of *148 the arrangement between petitioner and Jamieson Co. convinces us that petitioner did retain an economic interest in its sand and gravel deposits for which reason the payments received from Jamieson Co. are royalties. Although the parties adopted the language of an outright sale in one portion of their agreement, this was nothing more than protective coloration, and was contradicted by other provisions therein. The heart of their arrangement was contained in the terms of paragraph 3, where they provided that Jamieson Co. was to pay petitioner a specified amount for each ton of rock, gravel, or sand removed. This was the only consideration for the sand and gravel. Moreover, the amount so specified was based on a sliding scale of prices per ton pegged to the average wholesale price during the month of removal. Accordingly, the agreed-upon payments to petitioner were
*522 Our conclusion in this respect is confirmed, we think, by the language of the 1962 addendum to the contract which provided that the "purchase price" would be reduced by 20 percent in any year in which petitioner "sold" more than a million tons of rock, sand, and gravel to Jamieson Co. By its agreement to this price reduction as an incentive for Jamieson Co.'s increased production, petitioner attested to the explicitly conditional nature of its recovery of its investment. Plainly, it was the parties' understanding that their arrangement involved continuing and repeated royalty payments in respect of the sand and gravel as they*150 were removed rather than a single, unconditional sale of the deposits "in place" to be paid for either in a lump sum or by installments.
Petitioner nonetheless argues that Jamieson Co.'s obligation under the contract to remove
This interpretation of the contract, however, fails to account for the percentage-of-market price arrangement and for the agreement to grant Jamieson Co. production discounts, both of which smack of a retained economic interest by petitioner. The broader response to petitioner's position, though, is that nowhere in the contract was Jamieson Co. obligated to remove any deposits. To be sure, it was contemplated that it would remove some deposits. The contract included an estimate of available deposits, qualified, however, by a specific disclaimer of any warranty in respect*151 thereof. But paragraph 1 spoke only of a "right" to quarry on the premises, and then only "as may be proper and profitable under good quarrying practices." Furthermore, paragraph 4 provided Jamieson Co. with an option to terminate the agreement if "at any time * * * Buyer determines that rock, gravel and sand can no longer be profitably quarried and removed from the lands." This is not the language of an unconditional obligation. Cf.
In this regard*152 it appears to us that petitioner's true role in this arrangement was that of a costakeholder with Jamieson Co. in the deposits, both of whom bore the risk of a poor market and shared the gains in a favorable market. The contingent nature of petitioner's compensation resembled the situation in
Where, as here, taxpayers [sic] only substantive return of capital is dependent upon a unit price payment for an undetermined amount of sand and gravel,
See also
By reason of the conditional payment arrangement here and the absence of an obligation of Jamieson Co. to remove all, or indeed any, of the sand and gravel deposits, we are fully persuaded that under the agreement petitioner looked solely*153 to the extraction of the deposits for a return of its investment in the land. Petitioner thus retained an economic interest in the property in the form of royalty payments, the fact of which belies the existence of a sale of the deposits "in place." This conclusion in respect of the form of the transaction relieves us of the necessity of deciding whether the sand and gravel deposits could properly be deemed a capital asset in the hands of petitioner, although the answer seems fairly clear since the corporation was engaged in the business of selling sand and gravel. Cf.
To repeat, under the pertinent statutory provision of
(3) Mineral, oil, and gas royalties. -- The adjusted income from mineral, oil, and gas royalties; except that such adjusted income shall not be included if -- (A) such adjusted income constitutes 50 percent or more of the adjusted ordinary gross income, (B) the personal holding company income for the taxable year (computed without regard to this paragraph, * * *) is not more than 10 percent of the ordinary gross income, and (C) the sum of the deductions which are allowable under section 162 (relating to trade or business expenses) (i) deductions for compensation for personal services rendered by the shareholders, and (ii) equals or exceeds 15 percent of the adjusted ordinary gross income. [Emphasis supplied.]
The parties agree that petitioner did not in any event comply with the 10-percent test of part (B) for the taxable year ended in 1968. Furthermore, *155 unless petitioner was entitled to include its California franchise and real property taxes in its computations under (C), it cannot avail itself of the exception for the remaining 2 years in issue. The California franchise tax is a tax levied on net income,
Petitioner's reliance on our decision in
*157 *158 The short answer to petitioner's position is that the applicability of *526 (f) Personal Holding Company Tax. -- If a corporation which is a personal holding company for any taxable year fails to file with its return under chapter 1 for such year a schedule setting forth -- (1) the items of gross income and adjusted ordinary gross income, described in (2) the names and addresses of the individuals who owned, within the meaning of section 544 (relating to rules for determining stock ownership), at any time during the last half of such year more than 50 percent in value of the outstanding capital stock of the corporation, In each of the years in issue petitioner filed a standard U.S. Corporation Income Tax Return, Form 1120, unaccompanied by the schedule of specific information referred*159 to in In the first place, nowhere did petitioner provide the Commissioner with its adjusted ordinary gross income or even all the information necessary for its computation. *161 Statutes which bar the collection of taxes otherwise due and unpaid are matters of congressional consent and are to be strictly construed in favor of the Government. 2. *163 Likewise, petitioner's reliance upon section 601.105(j), Proced. & Admin. Regs., *165 is misplaced. Those regulations are intended to govern the reopening of cases which are closed
is not alone to get tax information in some form but also to get it with such uniformity, completeness, and arrangement that the physical task of handling and verifying returns may be readily accomplished. * * *
Not only did petitioner fail to include this information in a readily usable fashion, it effectively disguised what information was reported by failing to check the box provided on its Forms 1120 identifying itself as a personal holding company. Cf.
1. Although the parties' stipulation referred to "Adjusted ordinary gross income," we assume this was inadvertent inasmuch as it is the essence of petitioner's case that its gross income from gravel transfers was
2.
In addition to other taxes imposed by this chapter, there is hereby imposed for each taxable year on the undistributed personal holding company income (as defined in section 545) of every personal holding company (as defined in
3. Cf.
4.
(a) General Rule. -- For purposes of this subtitle, the term "personal holding company" means any corporation (other than a corporation described in subsection (c)) if -- (1) Adjusted ordinary gross income requirement. -- At least 60 percent of its adjusted ordinary gross income (as defined in (2) Stock ownership requirement. -- At any time during the last half of the taxable year more than 50 percent in value of its outstanding stock is owned, directly or indirectly, by or for not more than 5 individuals. * * *↩
5.
(a) General Rule. -- For purposes of this subtitle, the term "personal holding company income" means the portion of the adjusted ordinary gross income which consists of * * *↩
6.
(b) Definitions. -- For purposes of this part -- (1) Ordinary gross income. -- The term "ordinary gross income" means the gross income determined by excluding -- (A) all gains from the sale or other disposition of capital assets, (B) all gains (other than those referred to in subparagraph (A)) from the sale or other disposition of property described in section 1231(b), and (C) in the case of a foreign corporation all of the outstanding stock of which during the last half of the taxable year is owned by nonresident alien individuals (whether directly or indirectly through foreign estates, foreign trusts, foreign partnerships, or other foreign corporations), all items of income which would, but for this subparagraph, constitute personal holding company income under any paragraph of subsection (a) other than paragraph (7) thereof.
7.
(b) Definitions. -- For purposes of this part -- * * * (2) Adjusted ordinary gross income. -- The term "adjusted ordinary gross income" means the ordinary gross income adjusted as follows: (A) Rents. -- From the gross income from rents (as defined in the second sentence of paragraph (3) of this subsection) subtract the amount allowable as deductions for -- (i) exhaustion, wear and tear, obsolescence, and amortization of property other than tangible personal property which is not customarily retained by any one lessee for more than three years, (ii) property taxes, (iii) interest, and (iv) rent, to the extent allocable, under regulations prescribed by the Secretary or his delegate, to such gross income from rents. The amount subtracted under this subparagraph shall not exceed such gross income from rents. (B) Mineral royalties, etc. -- From the gross income from mineral, oil, and gas royalties described in paragraph (4), and from the gross income from working interests in an oil or gas well, subtract the amount allowable as deductions for -- (i) exhaustion, wear and tear, obsolescence, amortization, and depletion, (ii) property and severance taxes, (iii) interest, and (iv) rent, to the extent allocable, under regulations prescribed by the Secretary or his delegate, to such gross income from royalties or such gross income from working interests in oil or gas wells. The amount subtracted under this subparagraph with respect to royalties shall not exceed the gross income from such royalties, and the amount subtracted under this subparagraph with respect to working interests shall not exceed the gross income from such working interests. (C) Interest. -- There shall be excluded -- (i) interest received on a direct obligation of the United States held for sale to customers in the ordinary course of trade or business by a regular dealer who is making a primary market in such obligations, and (ii) interest on a condemnation award, a judgment, and a tax refund. (D) Certain excluded rents. -- From the gross income consisting of compensation described in subparagraph (D) of paragraph (3) subtract the amount allowable as deductions for the items described in clauses (i), (ii), (iii), and (iv) of subparagraph (A) to the extent allocable, under regulations prescribed by the Secretary or his delegate, to such gross income. The amount subtracted under this subparagraph shall not exceed such gross income.↩
8. With respect to mineral royalties, the amount remaining after the exclusion of the enumerated deductions is defined as "adjusted income from mineral, oil, and gas royalties."
9. Since we find that there has been failure of compliance with condition (C) of
10.
(a) General Rule. -- Except as otherwise provided in this section, the amount of any tax imposed by this title shall be assessed within 3 years after the return was filed (whether or not such return was filed on or after the date prescribed) or, if the tax is payable by stamp, at any time after such tax became due and before the expiration of 3 years after the date on which any part of such tax was paid, and no proceeding in court without assessment for the collection of such tax shall be begun after the expiration of such period.↩
11. In computing the adjusted ordinary gross income, as defined in
12.
(b) Restrictions on Examination of Taxpayer. -- No taxpayer shall be subjected to unnecessary examination or investigations, and only one inspection of a taxpayer's books of account shall be made for each taxable year unless the taxpayer requests otherwise or unless the Secretary or his delegate, after investigation, notifies the taxpayer in writing that an additional inspection is necessary.↩
13. Sec. 601.105. Examination of returns and claims for refund, credit or abatement; determination of correct tax liability.
* * *
(j)
(i) There is evidence of fraud, malfeasance, collusion, concealment, or misrepresentation of a material fact; or
(ii) The prior closing involved a clearly defined substantial error based on an established Service position existing at the time of the previous examination; or
(iii) Other circumstances exist which indicate failure to reopen would be a serious administrative omission.
(2) All reopenings are approved by the Assistant Regional Commissioner (Audit), or by the Director of International Operations for cases under his jurisdiction. If an additional inspection of the taxpayer's books of account is necessary, the notice to the taxpayer required by Code
14. Sec. 601.103(b), Proced. & Admin. Regs., provides as follows:
Sec. 601.103. Summary of general tax procedure.
(b)
Sec. 601.105. Examination of returns and claims for refund, credit or abatement; determination of correct tax liability.
(a)
15. Cases closed after examination are to be distinguished from cases in respect of which the taxpayer and the Commissioner have executed a closing agreement the exclusive procedure for which is set forth in sec. 7121. That section envisages an agreement knowingly entered into by both parties.