In 1948, three taxpayers received a commitment from the Federal
Housing Administration to insure loans for the construction of a
multiple-dwelling apartment project. Two corporations were formed
to carry out the project, and each of the three taxpayers was
issued one-third of the stock in each corporation. After the costs
of the construction had been paid, each of the corporations had an
unused amount of mortgage loan funds remaining, and, in 1950, the
taxpayers sold their stock at a profit, receiving as part of the
sale transaction distributions from the corporations which included
the unused funds.
Held: Under § 117(m) of the Internal Revenue Code of
1939, the resulting gains to the taxpayers must be treated as
ordinary income, instead of long-term capital gains, since the
corporations were "collapsible" within the meaning of that section.
Pp.
374 U. S.
65-73.
305 F.2d 949, affirmed.
MR. JUSTICE HARLAN delivered the opinion of the Court.
This case involves the applicability of the "collapsible
corporation" provisions of the federal income tax laws which,
during the period relevant here, were set forth in
Page 374 U. S. 66
§ 117(m) of the Internal Revenue Code of 1939. [
Footnote 1] These provisions require that,
under certain circumstances, gain from the sale of stock which
would otherwise be considered as long-term capital gain, and
accordingly taxed at
Page 374 U. S. 67
a maximum rate of 25%, must be reported as ordinary income.
The three taxpayers who are petitioners here became associated
in 1938, and have since participated in a number of construction
projects, usually through corporations in which the stock was
equally divided. [
Footnote 2]
In 1948, the petitioners received a commitment from the Federal
Housing Administration to insure loans for the construction of a
multiple-dwelling apartment project in Queens County, New York. Two
corporations were formed to carry out this project, and each
petitioner was issued one-third of the stock in each corporation.
After the costs of construction had been paid, the corporations
each had an unused amount of mortgage loan funds remaining, and, in
1950, the petitioners sold their stock at a profit, receiving as
part of the sale transaction distributions from the corporations
which included the unused funds. The petitioners reported the
excess of the amounts received over their bases in the stock as
long-term capital gains of $313,854.17 each. [
Footnote 3]
Page 374 U. S. 68
The Commissioner asserted a deficiency, treating the gain as
ordinary income on the ground that the corporations were
"collapsible" within the meaning of § 117(m). The Tax Court
sustained the Commissioner, 36 T.C. 22, and the Court of Appeals
affirmed the Tax Court, 305 F.2d 949, holding that (1) the
taxpayers had the requisite "view" during construction of the
property (
see note 1
supra); (2) more than 70% of the gain realized by the
taxpayers was attributable to the constructed property
(
id.); and (3) § 117(m) applies even if the constructed
buildings would have produced capital gain on a sale by the
taxpayers had no corporations been formed. This last holding was in
response to an argument by the taxpayers based on a theory similar
to that adopted by the Court of Appeals for the Fifth Circuit in
United States v. Ivey, 294 F.2d 799. In view of the
conflict between the decision below and that in
Ivey on
this point, we granted certiorari,
371 U.
S. 933, stating that the grant was limited to the
following question:
"Whether Section 117(m) of the Internal Revenue Code of 1939,
which provides that gain 'from the sale or exchange . . . of stock
of a collapsible corporation' is taxable as ordinary income, rather
than capital gain, is inapplicable in circumstances where the
stockholders would have been entitled to capital gains treatment
had they conducted the enterprise in their individual capacities
without utilizing a corporation."
Briefly summarized, petitioners' argument runs as follows: as
the legislative history shows, the collapsible corporation
provisions of the code were designed to close a loophole through
which some persons had been able to convert ordinary income into
long-term capital gain by use of the corporate form. For example,
in the case of in individual who constructed a property which he
held
Page 374 U. S. 69
primarily for sale to customers in the ordinary course of his
trade or business, any gain from the sale of the asset would be
ordinary income; [
Footnote 4]
but if that same individual were to form a corporation to construct
the property, intending to sell his stock on the completion of
construction, it was at least arguable prior to the enactment of §
117(m) that the proceeds of the ultimate sale of the stock were
entitled to capital gains treatment. It was this and similar
devices that § 117(m) was designed to frustrate, but it was not
intended to have the inequitable effect of converting into ordinary
income what would properly have been a capital gain prior to its
enactment even in the absence of any corporate form. Thus, it is
argued, the phrase "gain attributable to such property," as used in
§ 117(m), must apply only to profit that would have constituted
ordinary income if a corporation had not been utilized, for only in
such cases is the corporation made to serve as a device for tax
avoidance. In the present case, neither the corporation nor the
individual petitioners were in the trade or business of selling
apartment buildings, and thus the corporations were not used to
convert ordinary income into capital gain, and the provisions of §
117(m) are inapplicable. [
Footnote
5]
We have concluded that petitioners' contentions must be
rejected. Their argument is wholly inconsistent with the plain
meaning of the language of § 117(m), and we find nothing in the
purpose of the statute, as indicated by its legislative history, to
warrant any departure from that meaning in this case.
Page 374 U. S. 70
I
As to the language used, § 117(m) defines a collapsible
corporation as embracing one formed or availed of principally for
the manufacture, construction, or production of property with a
view to (1) the sale or exchange of stock prior to the realization
by the corporation of a substantial part of the net income from the
property and (2) the realization "of gain attributable to such
property." The section is then expressly made inapplicable to gain
realized during any year "unless more than 70 percentum of such
gain is attributable to the property so manufactured, constructed,
or produced." If used in their ordinary meaning, the word "gain" in
these contexts simply refers to the excess of proceeds over cost or
basis, and the phrase "attributable to" merely confines
consideration to that gain caused or generated by the property in
question. With these definitions, the section makes eminent sense,
since the terms operate to limit its application to cases in which
the corporation was availed of with a view to profiting from the
constructed property by a sale or exchange of stock soon after
completion of construction, and in which a substantial part of the
profit from the sale or exchange of stock in a given year was, in
fact, generated by such property.
There is nothing in the language or structure of the section to
demand or even justify reading into these provisions the additional
requirement that the taxpayer must, in fact, have been using the
corporate form as a device to convert ordinary income into capital
gain. If a corporation owns but one asset, and the shareholders
sell their stock at a profit resulting from an increase in the
value of the asset, they have "gain attributable to" that asset in
the natural meaning of the phrase, regardless of their desire, or
lack of desire, to avoid the bite of federal income taxes.
Page 374 U. S. 71
II
Nor is there anything in the legislative history that would lead
us to depart from the plain meaning of the statute as petitioners
would have us do. There can, of course, be no question that the
purpose of § 117(m) was, as petitioners contend, to close a
loophole that Congress feared could be used to convert ordinary
income into capital gain.
See H.R.Rep.No.2319, 81st Cong.,
2d Sess.; S.Rep.No.2375, 81st Cong., 2d Sess.. But the crucial
point for present purposes is that the
method chosen to
close this loophole was to establish a carefully and elaborately
defined category of transactions in which what might otherwise be a
capital gain would have to be treated as ordinary income. There is
no indication whatever of any congressional desire to have the
Commissioner or the courts make a determination in each case as to
whether the use of the corporation was for tax avoidance. Indeed,
the drawing of certain arbitrary lines not here involved -- such as
making the section inapplicable to any shareholder owning 10% or
less of the stock or to any gain realized more than three years
after the completion of construction -- tends to refute any such
indication. It is our understanding, in other words, that Congress
intended to define what it believed to be a tax avoidance device,
rather than to leave the presence or absence of tax avoidance
elements for decision on a case-to-case basis.
We are reinforced in this conclusion by the practical
difficulties -- indeed, the impossibilities -- of considering
without more legislative guidance than is furnished by § 117(m)
whether there has in fact been "conversion" of ordinary income into
capital gains in a particular case. For example, if we were to
inquire whether or not the profit would have been ordinary income
had an enterprise been individually owned, would we treat each
taxpaying shareholder differently, and look only to
his
trade
Page 374 U. S. 72
or business, or would we consider the matter in terms of the
trade or business of
any, or at least a substantial
number, of the shareholders? There is simply no basis in the
statute for a judicial resolution of this question, and, indeed,
when Congress addressed itself to the problem in 1958, it approved
an intricate formulation falling between these two extremes.
[
Footnote 6]
As a further example, what if the individual in question is not
himself engaged in any trade or business, but owns stock in varying
amounts in a number of corporate ventures other than the one before
the court? Do we pierce
each of the corporate veils,
regardless of the extent and share of the individual's investment,
and charge him with being in the trade or business of each such
corporation? Again, there is no basis for a rational judicial
answer; the judgment is essentially a legislative one, and, in the
1958 amendments, Congress enacted a specific provision, designed to
deal with this matter, that is far too complex to be summarized
here. [
Footnote 7]
These examples should suffice to demonstrate the point: the
question whether there has in fact been a "conversion" of ordinary
income in a particular case is far easier to state than to answer,
and involves a number of thorny issues that may not appear on the
surface. [
Footnote 8] We find
no
Page 374 U. S. 73
basis in either the terms or the history of § 117(m) for
concluding that Congress intended the Commissioner and the courts
to enter this thicket and to arrive at
ad hoc
determinations for every taxpayer. Accordingly, the judgments below
must be affirmed.
Affirmed.
MR. JUSTICE DOUGLAS dissents.
[
Footnote 1]
Section 117(m) was added to the Internal Revenue Code of 1939 by
the Revenue Act of 1950, § 212(a), 64 Stat. 934. The section was
amended by the Revenue Act of 1951, § 326, 65 Stat. 502. It was
reenacted without substantial change as § 341 of the Internal
Revenue Code of 1954, 68A Stat. 107, and was amended by the
Technical Amendments Act of 1958, § 20(a), 72 Stat. 1615, and by
the Act of October 16, 1962, § 13(f)(4), 76 Stat. 1035. As
originally enacted, and during the period relevant here, it
provided:
"(1) TREATMENT OF GAIN TO SHAREHOLDERS. -- Gain from the sale or
exchange (whether in liquidation or otherwise) of stock of a
collapsible corporation, to the extent that it would be considered
(but for the provisions of this subsection) as gain from the sale
or exchange of a capital asset held for more than 6 months, shall,
except as provided in paragraph (3), be considered as gain from the
sale or exchange of property which is not a capital asset."
"(2) DEFINITIONS."
"(A) For the purposes of this subsection, the term 'collapsible
corporation' means a corporation formed or availed of principally
for the manufacture, construction, or production of property, or
for the holding of stock in a corporation so formed or availed of,
with a view to --"
"(i) the sale or exchange of stock by its shareholders (whether
in liquidation or otherwise), or a distribution to its
shareholders, prior to the realization by the corporation
manufacturing, constructing, or producing the property of a
substantial part of the net income to be derived from such
property, and"
"(ii) the realization by such shareholders of gain attributable
to such property."
"
* * * *"
"(3) LIMITATIONS ON APPLICATION OF SUBSECTION. In the case of
gain realized by a shareholder upon his stock in a collapsible
corporation --"
"(A) this subsection shall not apply unless at any time after
the commencement of the manufacture, construction, or production of
the property, such shareholder (i) owned (or was considered as
owning) more than 10 percentum in value of the outstanding stock of
the corporation, or (ii) owned stock which was considered as owned
at such time by another shareholder who then owned (or was
considered as owning) more than 10 percentum in value of the
outstanding stock of the corporation;"
"(B) this subsection shall not apply to the gain recognized
during a taxable year unless more than 70 percentum of such gain is
attributable to the property so manufactured, constructed, or
produced; and"
"(C) this subsection shall not apply to gain realized after the
expiration of three years following the completion of such
manufacture, construction, or production. . . ."
[
Footnote 2]
Petitioners Benjamin and Harry Neisloss are builders; petitioner
Braunstein, an architect. Their wives are parties only by virtue of
the filing of joint returns.
[
Footnote 3]
The parties have agreed that the distributions from the
corporations and the amounts received directly from the buyers of
the stock may be considered together, as if the entire amount had
been received from the buyers.
[
Footnote 4]
Int.Rev.Code, 1939, § 117(a)(1)(A).
[
Footnote 5]
The Government has assumed for purposes of its argument here,
but does not concede, that petitioners would have been entitled to
capital gains treatment had they conducted the enterprise without
utilizing a corporation.
[
Footnote 6]
Int.Rev.Code, 1954, § 341(e), added by the Technical Amendments
Act of 1958, § 20(a), 72 Stat. 1615.
[
Footnote 7]
Int.Rev.Code, 1954, § 341(e)(1)(C).
[
Footnote 8]
The Government has emphasized in its argument here that the
present case involves a particularly "blatant" conversion of
ordinary income because, by charging the corporations only for the
out-of-pocket costs of construction,
"petitioners contributed their services to create a valuable
property for the corporation[s], and then realized upon that value
by selling their stock."
Thus, the Government concludes the petitioners claim as capital
gain "what ought to have been (and, in an arm's-length transaction,
would have been) taxed as compensation for services."