Respondent Brown, members of his family and three others, who
owned substantially all the stock of a lumber milling company, of
which Brown was president, sold their stock to a tax-exempt
charitable organization (Institute) for $1,300,000. Institute paid
$5,000 down from the company's assets. Concomitantly with the
transfer, Institute liquidated the company and leased its assets
for five years to a new corporation (Fortuna), formed and wholly
owned by respondents' attorneys, which agreed to pay Institute 80%
of the operating profits before taxes and depreciation, Institute
to apply 90% of such payments (amounting to 72% of the net profits
of the business) to a $1,300,000 noninterest-bearing note Institute
gave the respondents which was secured by mortgages and assignments
of the assets leased to Fortuna. The entire balance of the note was
payable if payments thereon failed to total $250,000 over any
consecutive two years. The foregoing transaction, consummated in
February, 1953, was effected pursuant to agreement between
respondents, Institute, and other interested parties. Fortuna
operated the business with practically the same personnel
(including Brown as general manager up to his resignation over a
year and a half later) until 1957, when Fortuna's operations ended
with a severe decline in the lumber market. Respondents did not
repossess under their mortgages, but agreed that the properties be
sold, with Institute receiving 10% of the $300,000 proceeds and the
respondents the balance. In their federal income tax returns,
respondents showed the payments remitted to them out of the profits
of the business as capital gains. Petitioner asserted that such
payments were taxable as ordinary income under the Internal Revenue
Code. The Tax Court upheld respondents' position, concluding that
the transfer to the Institute of respondents' stock was a bona
sale. The Court of Appeals affirmed.
1. The transaction constituted a bona fide
local law, the Institute having acquired title to the company
stock, and, by
Page 380 U. S. 564
liquidation, to all the assets in return for its promise to pay
over money from the operating profits. P. 380 U. S.
2. The transaction also constituted a sale within the meaning of
§1222 (3) of the Internal Revenue Code, defining a capital gain as
gain from the sale of a capital asset. Pp. 380 U. S.
(a) The fact that payment was made from business earnings did
not divest the transaction of its status as a sale, which is a
transfer of property for a fixed monetary price or its equivalent.
Pp. 380 U. S.
(b) The sales price in the arm's length transaction between
respondents and the Institute, as the Tax Court found, was within a
reasonable range in light of the company's earnings history and the
adjusted net worth of its assets. P. 380 U. S.
(c) There had been an appreciation in value of the company's
property accruing over a period of years which respondents could
have realized at capital gains rates on a cash sale of their stock.
Pp. 380 U. S.
3. It does not follow from the fact that there was no
risk-shifting from seller to buyer that the transaction constituted
not a sale, but a device to collect future earnings at capital
gains rates for which the price set was excessive. Pp. 380 U. S.
(a) The Tax Court did not find the price excessive. P.
380 U. S.
(b) The petitioner offered no evidence to show that an excessive
price resulted from the lack of risk-shifting. Pp. 380 U. S.
(c) Accelerated payment of the purchase price resulted from the
deductibility of the rents payable by Fortuna which were not
taxable to the Institute, thus constituting an advantage to the
seller desiring the balance of the purchase price paid off rapidly.
P. 380 U. S.
(d) Risk-shifting has not previously been deemed essential to
the concept of sale for tax purposes. Pp. 380 U. S.
(e) The transaction here is not analogous to cases involving a
transfer of mineral deposits in exchange for a royalty from the
minerals produced, the mineral-extracting business being viewed as
an income-producing operation, and not as a conversion of capital
investment. Thomas v. Perkins, 301 U.
, distinguished. Pp. 380 U. S.
4. The Treasury Department itself has noted the availability of
capital gains treatment on the sale of capital assets where the
Page 380 U. S. 565
retained an interest in the income produced by the assets. Pp.
380 U. S.
325 F.2d 313 affirmed.
MR. JUSTICE WHITE delivered the opinion of the Court.
In 1950, when Congress addressed itself to the problem of the
direct or indirect acquisition and operation of going businesses by
charities or other tax-exempt entities, it was recognized that, in
many of the typical sale and lease-back transactions, the exempt
organization was trading on, and perhaps selling part of, its
exemption. H.R.Rep. No. 2319, 81st Cong., 2d Sess., pp. 38-39;
S.Rep. No. 2375, 81st Cong., 2d Sess., pp. 31-32. For this and
other reasons, the Internal Revenue Code was accordingly amended in
several respects, of principal importance for our purposes by
taxing as "unrelated business income" the profits earned by a
charity in the operation of a business, as well as the income from
long-term leases of the business. [Footnote 1
] The short-term lease, however, of five years
Page 380 U. S. 566
less, was not affected, and this fact has moulded many of the
transactions in this field since that time, including the one
involved in this case. [Footnote
The Commissioner, however, in 1954, announced that, when an
exempt organization purchased a business and leased it for five
years to another corporation, not investing its own funds but
paying off the purchase price with rental income, the purchasing
organization was in danger of losing its exemption; that, in any
event, the rental income would be taxable income; that the charity
might be unreasonably accumulating income; and, finally and most
important for this case, that the payments received by the seller
would not be entitled to capital gains treatment. Rev.Rul. 54-420,
1954-2 Cum.Bull. 128.
This case is one of the many in the course of which the
Commissioner has questioned the sale of a business concern to an
exempt organization. [Footnote
] The basic facts are undisputed.
Page 380 U. S. 567
Clay Brown, members of his family and three other persons owned
substantially all of the stock in Clay Brown & Company, with
sawmills and lumber interests near Fortuna, California. Clay Brown,
the president of the company and spokesman for the group, was
approached by a representative of California Institute for Cancer
Research in 1952, and, after considerable negotiation, the
stockholders agreed to sell their stock to the Institute for
$1,300,000, payable $5,000 down from the assets of the company and
the balance within 10 years from the earnings of the company's
assets. It was provided that, simultaneously with the transfer of
the stock, the Institute would liquidate the company and lease its
assets for five years to a new corporation, Fortuna Sawmills, Inc.,
formed and wholly owned by the attorneys for the sellers. [Footnote 4
] Fortuna would pay to the
Institute 80% of its operating profit without allowance for
depreciation or taxes, and 90% of such payments would be paid over
by the Institute to the selling stockholders to apply on the
$1,300,000 note. This note was noninterest bearing, the Institute
had no obligation to pay it except from the rental income, and it
was secured by mortgages and assignments of the assets transferred
or leased to Fortuna. If the payments on the note failed to total
$250,000 over any two consecutive years, the sellers could declare
the entire balance of the note due and payable. The sellers were
neither stockholders nor directors of Fortuna, but it was provided
that Clay Brown was to have a management contract
Page 380 U. S. 568
with Fortuna at an annual salary and the right to name any
successor manager if he himself resigned. [Footnote 5
The transaction was closed on February 4, 1953. Fortuna
immediately took over operations of the business under its lease,
on the same premises and with practically the same personnel which
had been employed by Clay Brown & Company. Effective October
31, 1954, Clay Brown resigned as general manager of Fortuna and
waived his right to name his successor. In 1957, because of a
rapidly declining lumber market, Fortuna suffered severe reverses,
and its operations were terminated. Respondent sellers did not
repossess the properties under their mortgages, but agreed they
should be sold by the Institute, with the latter retaining 10% of
the proceeds. Accordingly, the property was sold by the Institute
for $300,000. The payments on the note from rentals and from the
sale of the properties totaled $936,131.85. Respondents returned
the payments received from rentals as the gain from the sale of
capital assets. The Commissioner, however, asserted the payments
were taxable as ordinary income, and were not capital gain within
the meaning of I.R.C.1939, § 117(a)(4) and I.R.C.1954, § 1222(3).
These sections provide that "[t]he term long-term capital gain'
means gain from the sale or exchange of a capital asset held for
more than 6 months. . . ."
In the Tax Court, the Commissioner asserted that the transaction
was a sham, and that, in any event, respondents retained such an
economic interest in and control over the property sold that the
transaction could not be treated as a sale resulting in a long-term
capital gain. A divided Tax Court, 37 T.C. 461, found that there
Page 380 U. S. 569
been considerable good faith bargaining at arm's length between
the Brown family and the Institute, that the price agreed upon was
within a reasonable range in the light of the earnings history of
the corporation and the adjusted net worth of its assets, that the
primary motivation for the Institute was the prospect of ending up
with the assets of the business free and clear after the purchase
price had been fully paid, which would then permit the Institute to
convert the property and the money for use in cancer research, and
that there had been a real change of economic benefit in the
transaction. [Footnote 6
conclusion was that the transfer of respondents' stock in Clay
Brown & Company to the Institute was a bona fide
arrived at in an arm's length transaction, and that the amounts
received by respondents were proceeds from the sale of stock, and
entitled to long-term capital gains treatment under the Internal
Revenue Code. The Court of Appeals affirmed, 325 F.2d 313, and we
granted certiorari, 377 U.S. 962.
Having abandoned in the Court of Appeals the argument that this
transaction was a sham, the Commissioner now admits that there was
real substance in what occurred between the Institute and the Brown
family. The transaction was a sale under local law. The Institute
acquired title to the stock of Clay Brown & Company and, by
liquidation, to all of the assets of that company, in return for
its promise to pay over money from the operating profits of the
company. If the stipulated price was paid, the Brown family would
forever lose all rights to the income and properties of the
company. Prior to the transfer, these respondents had access to all
of the income of the company; after the transfer, 28% of the income
remained with Fortuna and the Institute. Respondents
Page 380 U. S. 570
had no interest in the Institute, nor were they stockholders or
directors of the operating company. Any rights to control the
management were limited to the management contract between Clay
Brown and Fortuna, which was relinquished in 1954.
Whatever substance the transaction might have had, however, the
Commissioner claims that it did not have the substance of a sale
within the meaning of § 1222(3). His argument is that, since the
Institute invested nothing, assumed no independent liability for
the purchase price, and promised only to pay over a percentage of
the earnings of the company, the entire risk of the transaction
remained on the sellers. Apparently, to qualify as a sale, a
transfer of property for money or the promise of money must be to a
financially responsible buyer who undertakes to pay the purchase
price other than from the earnings or the assets themselves, or
there must be a substantial down payment which shifts at least part
of the risk to the buyer and furnishes some cushion against loss to
To say that there is no sale because there is no risk-shifting,
and that there is no risk-shifting because the price to be paid is
payable only from the income produced by the business sold, is very
little different from saying that, because business earnings are
usually taxable as ordinary income, they are subject to the same
tax when paid over as the purchase price of property. This argument
has rationality, but it places an unwarranted construction on the
term "sale," is contrary to the policy of the capital gains
provisions of the Internal Revenue Code, and has no support in the
cases. We reject it.
"Capital gain" and "capital asset" are creatures of the tax law,
and the Court has been inclined to give these terms a narrow,
rather than a broad, construction. Corn Products Co. v.
Commissioner, 350 U. S. 46
350 U. S. 52
"sale," however, is a common event in the non-tax world, and
Page 380 U. S. 571
since it is used in the Code without limiting definition and
without legislative history indicating a contrary result, its
common and ordinary meaning should at least be persuasive of its
meaning as used in the Internal Revenue Code.
"Generally speaking, the language in the Revenue Act, just as in
any statute, is to be given its ordinary meaning, and the words
'sale' and 'exchange' are not to be read any differently."
Helvering v. William Flaccus Oak Leather Co.,
313 U. S. 247
313 U. S. 249
Hanover Bank v. Commissioner, 369 U.
, 369 U. S. 687
Commissioner v. Korell, 339 U. S. 619
339 U. S.
-628; Crane v. Commissioner, 331 U. S.
, 331 U. S. 6
Lang v. Commissioner, 289 U. S. 109
289 U. S. 111
Old Colony R. Co. v. Commissioner, 284 U.
, 284 U. S.
"A sale, in the ordinary sense of the word, is a transfer of
property for a fixed price in money or its equivalent," Iowa v.
McFarland, 110 U. S. 471
110 U. S. 478
it is a contract "to pass rights of property for money -- which the
buyer pays or promises to pay to the seller . . . ,"
8 How. 495, 49 U. S. 544
the definition of "sale" in § 1(2) of the Uniform
Sales Act and in § 2-106(1) of the Uniform Commercial Code. The
transaction which occurred in this case was obviously a transfer of
property for a fixed price payable in money.
Unquestionably, the courts, in interpreting a statute, have
"scope for adopting a restricted, rather than a literal or
usual, meaning of its words where acceptance of that meaning would
lead to absurd results . . . or would thwart the obvious purpose of
Helvering v. Hammel, 311 U. S. 504
311 U. S.
-511; cf. Commissioner v. Gillette Motor
Transport, Inc., 364 U. S. 130
364 U. S. 134
and Commissioner v. P. G. Lake, Inc., 356 U.
, 356 U. S. 265
But it is otherwise "where no such consequences [would] follow and
where . . . it appears to be consonant with the purposes of the
Act. . . ." Helvering v. Hammel, supra,
at 311 U. S. 511
Takao Ozawa v. United States, 260 U.
, 260 U. S. 194
We find nothing in this case indicating that the Tax Court or
Page 380 U. S. 572
Court of Appeals construed the term "sale" too broadly or in a
manner contrary to the purpose or policy of capital gains
provisions of the Code.
Congress intended to afford capital gains treatment only in
"typically involving the realization of appreciation in value
accrued over a substantial period of time, and thus to ameliorate
the hardship of taxation of the entire gain in one year."
Commissioner v. Gillette Motor Transport, Inc.,
364 U. S. 130
364 U. S. 134
It was to "relieve the taxpayer from . . . excessive tax burdens on
gains resulting from a conversion of capital investments" that
capital gains were taxed differently by Congress. Burnet v.
Harmel, 287 U. S. 103
287 U. S. 106
Commissioner v. P. G. Lake, Inc., 356 U.
, 356 U. S.
As of January 31, 1953, the adjusted net worth of Clay Brown
& Company as revealed by its books was $619,457.63. This figure
included accumulated earnings of $448,471.63, paid in surplus,
capital stock, and notes payable to the Brown family. The appraised
value as of that date, however, relied upon by the Institute and
the sellers, was.$1,064,877, without figuring interest on deferred
balances. Under a deferred payment plan with a 6% interest figure,
the sale value was placed at $1,301,989. The Tax Court found the
sale price agreed upon was arrived at in an arm's length
transaction, was the result of real negotiating, and was "within a
reasonable range in light of the earnings history of the
corporation and the adjusted net worth of the corporate assets." 37
T.C. 461, 486.
Obviously, on these facts, there had been an appreciation in
value accruing over a period of years, Commissioner v. Gillette
Motor Transport, Inc., supra,
and an "increase in the value of
the income-producing property." Commissioner v. P. G. Lake,
at 356 U. S. 266
This increase taxpayers were entitled to realize at capital gains
rates on a cash sale of their stock; and likewise if they sold on a
Page 380 U. S. 573
plan taking an installment note and a mortgage as security.
Further, if the down payment was less than 30% (the 1954 Code
requires no down payment at all) and the transaction otherwise
satisfied I.R.C.1939, § 44, the gain itself could be reported on
the installment basis.
In the actual transaction, the stock was transferred for a price
payable on the installment basis, but payable from the earnings of
the company. Eventually, $936,131.85 was realized by respondents.
This transaction, we think, is a sale, and so treating it is wholly
consistent with the purposes of the Code to allow capital gains
treatment for realization upon the enhanced value of a capital
The Commissioner, however, embellishes his risk-shifting
argument. Purporting to probe the economic realities of the
transaction, he reasons that, if the seller continues to bear all
the risk and the buyer none, the seller must be collecting a price
for his risk-bearing in the form of an interest in future earnings
over and above what would be a fair market value of the property.
Since the seller bears the risk, the so-called purchase price must
be excessive, and must be simply a device to collect future
earnings at capital gains rates.
We would hesitate to discount unduly the power of pure reason,
and the argument is not without force. But it does present
difficulties. In the first place, it denies what the tax court
expressly found -- that the price paid was within reasonable limits
based on the earnings and net worth of the company; and there is
evidence in the record to support this finding. We do not have,
therefore, a case where the price has been found excessive.
Secondly, if an excessive price is such an inevitable result of
the lack of risk-shifting, it would seem that it would not be an
impossible task for the Commissioner to demonstrate the fact.
However, in this case, he offered no evidence whatsoever to this
effect; and in a good many other cases involving similar
transactions, in some of which
Page 380 U. S. 574
the reasonableness of the price paid by a charity was actually
contested, the Tax Court has found the sale price to be within
reasonable limits, as it did in this case. [Footnote 7
Thirdly, the Commissioner ignores as well the fact that, if the
rents payable by Fortuna were deductible by it, and not taxable to
the Institute, the Institute could pay off the purchase price at a
considerably faster rate than the ordinary corporate buyer subject
to income taxes, a matter of considerable importance to a seller
who wants the balance of his purchase price paid as rapidly as he
can get it. The fact is that, by April 30, 1955, a little over two
years after closing this transaction, $412,595.77 had been paid on
the note, and, within another year, the sellers had collected
another $238,498.80, for a total of $651,094.57.
Furthermore, risk-shifting of the kind insisted on by the
Commissioner has not heretofore been considered an essential
ingredient of a sale for tax purposes. In LeTulle v.
Scofield, 308 U. S. 415
corporation transferred properties to another for cash and bonds
secured by the properties transferred. The Court held that there
"a sale or exchange upon which gain or loss must be reckoned in
accordance with the provisions of the revenue act dealing with the
recognition of gain or loss upon a sale or exchange,"
at 308 U. S. 421
since the seller retained only
Page 380 U. S. 575
a creditor's interest, rather than a proprietary one.
"[T]hat the bonds were secured solely by the assets transferred
and that upon default, the bondholder would retake only the
property sold [did not change] his status from that of a creditor
to one having a proprietary stake."
Ibid. Compare Marr v. United States,
268 U. S. 536
require a sale for tax purposes to be to a financially responsible
buyer who undertakes to pay the purchase price from sources other
than the earnings of the assets sold or to make a substantial down
payment seems to us at odds with commercial practice and common
understanding of what constitutes a sale. The term "sale" is used a
great many times in the Internal Revenue Code, and a wide variety
of tax results hinge on the occurrence of a "sale." To accept the
Commissioner's definition of sale would have wide ramifications
which we are not prepared to visit upon taxpayers absent
congressional guidance in this direction.
The Commissioner relies heavily upon the cases involving a
transfer of mineral interests, the transferor receiving a bonus and
retaining a royalty or other interest in the mineral production.
Burnet v. Harmel, 287 U. S. 103
Palmer v. Bender, 287 U. S. 551
Thomas v. Perkins, 301 U. S. 655
Kirby Petroleum Co. v. Commissioner, 326 U.
; Burton-Sutton Oil Co. v. Commissioner,
328 U. S. 25
Commissioner v. Southwest Exploration Co., 350 U.
. Thomas v. Perkins
particularly pertinent. There, a leasehold interest was transferred
for a sum certain payable in oil as produced and it was held that
the amounts paid to the transferor were not includable in the
income of the transferee, but were income of the transferor. We do
not, however, deem either Thomas v. Perkins
or the other
First, "Congress . . . has recognized the peculiar character of
the business of extracting natural resources," Burton-Sutton
Oil Co. v. Commissioner, 328 U. S. 25
328 U. S.
Page 380 U. S. 576
see Stratton's Independence Ltd. v. Howbert,
231 U. S. 399
231 U. S.
-414, which is viewed as an income-producing
operation, and not as a conversion of capital investment,
Anderson v. Helvering, 310 U. S. 404
301 U. S. 407
but one which has its own built-in method of allowing through
depletion "a tax-free return of the capital consumed in the
production of gross income through severance," Anderson v.
at 310 U. S. 408
which is independent of cost and depends solely on production,
328 U. S. 34
. Percentage depletion allows an arbitrary
deduction to compensate for exhaustion of the asset, regardless of
cost incurred or any investment which the taxpayer may have made.
The Commissioner, however, would assess to respondents as ordinary
income the entire amount of all rental payments made by the
Institute, regardless of the accumulated values in the corporation
which the payments reflected and without regard for the present
policy of the tax law to allow the taxpayer to realize on
appreciated values at the capital gains rates.
Second, Thomas v. Perkins
does not have unlimited
sweep. The Court in Anderson v. Helvering, supra,
out that it was still possible for the owner of a working interest
to divest himself finally and completely of his mineral interest by
effecting a sale. In that case, the owner of royalty interest, fee
interest and deferred oil payments contracted to convey them for
$160,000 payable $50,000 down and the balance from one-half the
proceeds which might be derived from the oil and gas produced and
from the sale of the fee title to any of the lands conveyed. The
Court refused to extend Thomas v. Perkins
beyond the oil
payment transaction involved in that case. Since the transferor in
had provided for payment of the purchase price
from the sale of fee interest as well as from the production of oil
"the reservation of this additional type of security for the
deferred payments serve[d] to distinguish this case from
Page 380 U. S. 577
Thomas v. Perkins.
It is similar to the reservation in
a lease of oil payment rights together with a personal guarantee by
the lessee that such payments shall at all events equal the
Anderson v. Helvering, supra,
at 310 U. S.
-413. Hence, there was held to be an outright sale of
the properties, all of the oil income therefrom being taxable to
the transferee notwithstanding the fact of payment of part of it to
the seller. The respondents in this case, of course, not only had
rights against income, but, if the income failed to amount to
$250,000 in any two consecutive years, the entire amount could be
declared due, which was secured by a lien on the real and personal
properties of the company. [Footnote 8
Page 380 U. S. 578
There is another reason for us not to disturb the ruling of the
Tax Court and the Court of Appeals. In 1963, the Treasury
Department, in the course of hearings before the Congress, noted
the availability of capital gains treatment on the sale of capital
assets even though the seller retained an interest in the income
produced by the assets. The Department proposed a change in the law
which would have taxed as ordinary income the payments on the sale
of a capital asset which were deferred over more than five years
and were contingent on future income. Payments, though contingent
on income, required to be made within five years would not have
lost capital gains status nor would payments not contingent on
income even though accompanied by payments which were. Hearings
before the House Committee on Ways and Means, 88th Cong., 1st
Sess., Feb. 6, 7, 8 and 18, 1963, Pt. I (rev.), on the President's
1963 Tax Message, pp. 154-156.
Congress did not adopt the suggested change, [Footnote 9
] but it is significant for our
purposes that the proposed amendment did not deny the fact or
occurrence of a sale, but would have taxed as ordinary income those
Page 380 U. S. 579
payments deferred for more than five years. If a purchaser could
pay the purchase price out of a earnings within five years the
seller would have capital gain, rather than ordinary income. The
approach was consistent with allowing appreciated values to be
treated as capital gain but with appropriate safeguards against
reserving additional rights to future income. In comparison, the
Commissioner's position here is a clear case of "overkill" if aimed
at preventing the involvement of tax-exempt entities in the
purchase and operation of business enterprises. There are more
precise approaches to this problem as well as to the question of
the possibly excessive price paid by the charity or foundation. And
if the Commissioner's approach is intended as a limitation upon the
tax treatment of sales generally, it represents a considerable
invasion of current capital gains policy, a matter which we think
is the business of Congress, not ours.
The problems involved in the purchase of a going business by a
tax-exempt organization have been considered and dealt with by the
Congress. Likewise, it was given its attention to various kinds of
transactions involving the payment of the agreed purchase price for
property from the future earnings of the property itself. In both
situations, it has responded, if at all, with precise provisions of
narrow application. We consequently deem it wise to "leave to the
Congress the fashioning of a rule which, in any event, must have
wide ramifications." American Automobile Ass'n v. United
States, 367 U. S. 687
367 U. S.
The Revenue Act of 1950, c. 994, 64 Stat. 906, amended § 101 of
the Internal Revenue Code of 1939 and added §§ 421 through 424,
3813 and 3814. These sections are now §§ 501 through 504 and 511
through 515 of the Internal Revenue Code of 1954.
The sale and leaseback transaction has been much examined.
Lanning, Tax Erosion and the "Bootstrap Sale" of a Business-I, 108
U.Pa.L.Rev. 623 (1960); Moore and Dohan, Sales, Churches, and
Monkeyshines, 11 Tax L.Rev. 87 (1956); MacCracken, Selling a
Business to a Charitable Foundation, 1954 U.So.Cal.Tax Inst. 205;
Comment, The Three-Party Sale and Lease-Back, 61 Mich.L.Rev. 1140
(1963); Alexander, The Use of Foundations in Business, 15 N.Y.U.Tax
Inst. 591 (1957); New Developments in Tax-exempt Institutions, 19
J.Taxation 302(1963). See also
Stern, The Great Treasury
Raid, p. 245 (1964).
Union Bank v. United States,
285 F.2d 126, 152 Ct.Cl.
426; Commissioner v. Johnson,
267 F.2d 382, aff'g
Estate of Howes v. Commissioner,
30 T.C. 909; Kolkey v.
254 F.2d 51; Knapp Bros. Shoe Mfg. Corp. v.
142 F. Supp. 899, 135 Ct.Cl. 797; Oscar C.
P-H 1963 T.C.Mem.Dec. � 63,201; Isis Windows,
P-H 1963 T.C.Mem.Dec. � 63,176; Ralph M.
P-H 1963 T.C.Mem.Dec. � 63,158; Brekke v.
40 T.C. 789; Royal Farms Dairy Co. v.
40 T.C. 172; Anderson Dairy, Inc. v.
39 T.C. 1027; Estate of Hawthorne,
1960 T.C.Mem.Dec. � 60,146; Estate of Hawley,
T.C.Mem.Dec. � 61,038; Ohio Furnace Co. v. Commissioner,
25 T.C. 179; Truschel v. Commissioner,
29 T.C. 433. Some
of these cases are now pending on appeal in one or more of the
courts of appeals.
The net current assets subject to liabilities were sold by the
Institute to Fortuna for a promissory note which was assigned to
sellers. The lease covered the remaining assets of Clay Brown &
Company. Fortuna was capitalized at $25,000, its capital being paid
in by its stockholders from their own funds.
Clay Brown's personal liability for some of the indebtedness of
Clay Brown & Company, assumed by Fortuna, was continued. He
also personally guaranteed some additional indebtedness incurred by
The Tax Court found nothing to indicate that the arrangement
between the stockholders and the Institute contemplated the Brown
family's being free at any time to take back and operate the
In all but four of the cases listed in note 3 supra,
there was a finding that the
price was within permissible limits. The exceptions are: Kolkey
where the price was considered grossly
excessive and the transaction a sham; Union Bank v. United
in which the Court of Claims referred to the evidence
of excessive price but nevertheless held a sale had taken place;
Brekke v. Commissioner,
where the seller was not before
the court, the price was said to be twice the fair market value,
and the issue was the deductibility of the rent paid by the
operating company to the exempt organization; and Estate of
in which there was no express treatment of the sale
price, but the transaction was found to be a bona fide
Respondents place considerable reliance on the rule applicable
where patents are sold or assigned, the seller or assignor
reserving an income interest. In Rev.Rul. 58-353, 1958-2 Cum.Bull.
408, the Service announced its acquiescence in various Tax Court
cases holding that the consideration received by the owner of a
patent for the assignment of a patent or the granting of an
exclusive license to such patent may be treated as the proceeds of
a sale of property for income tax purposes, even though the
consideration received by the transferor is measured by production,
use, or sale of the patented article. The Government now says that
the Revenue Ruling amounts only to a decision to cease litigating
the question at least temporarily, and that the cases on which the
rule is based are wrong in principle and inconsistent with the
cases dealing with the taxation of mineral interests. We note,
however, that in Rev.Rul. 60-226, 1960-1 Cum.Bull. 26, the Service
extended the same treatment to the copyright field. Furthermore,
the Secretary of the Treasury in 1963 recognized the present law to
the that "the sale of a patent by the inventor may be treated as
the sale of a capital asset," Hearings before the House Committee
on Ways and Means, 88th Cong., 1st Sess., Feb. 6, 7, 8 and 18,
1963, Pt. I (rev.), on the President's 1963 Tax Message, p. 150,
and the Congress failed to enact the changes in the law which the
These developments in the patent field obviously do not help the
position of the Commissioner. Nor does I.R.C.1954, § 1235, which
expressly permits specified patent sales to be treated as sales of
capital assets entitled to capital gains treatment. We need not,
however, decide here whether the extraction and patent cases are
irreconcilable or whether, instead, each situation has its own
peculiar characteristics justifying discrete treatment under the
sale and exchange language of § 1222. Whether the patent cases are
correct or not, absent § 1235, the fact remains that this case
involves the transfer of corporate stock which has substantially
appreciated in value and a purchase price payable from income which
has been held to reflect the fair market value of the assets which
the stock represents.
It did, however, accept and enact another suggestion made by the
Treasury Department. Section 483, which was added to the Code,
provided for treating a part of the purchase price as interest in
installment sales transactions where no interest was specified. The
provision was to apply as well when the payments provided for were
indefinite as to their size, as for example "where the payments are
in part at least dependent upon future income derived from the
property." S.Rep. No. 830, 88th Cong., 2d Sess., p. 103, U.S.Code
Congressional and Administrative News 1964, p. 1776. This section
would apparently now apply to a transaction such as occurred in
MR. JUSTICE HARLAN, concurring.
Were it not for the tax laws, the respondents' transaction with
the Institute would make no sense, except as one arising from a
charitable impulse. However, the tax laws exist as an economic
reality in the businessman's world, much like the existence of a
Page 380 U. S. 580
plan their affairs around both, and a tax dollar is just as real
as one derived from any other source. The Code gives the Institute
a tax exemption which makes it capable of taking a greater
after-tax return from a business than could a non-tax-exempt
individual or corporation. Respondents traded a residual interest
in their business for a faster payout apparently made possible by
the Institute's exemption. The respondents gave something up; they
received something substantially different in return. If words are
to have meaning, there was a "sale or exchange."
Obviously the Institute traded on its tax exemption. The
Government would deny that there was an exchange, essentially on
the theory that the Institute did not put anything at risk; since
its exemption is unlimited, like the magic purse that always
contains another penny, the Institute gave up nothing by trading on
One may observe preliminarily that the Government's remedy for
the so-called "bootstrap" sale -- defining sale or exchange so as
to require the shifting of some business risks -- would accomplish
little by way of closing off such sales in the future. It would be
neither difficult nor burdensome for future users of the bootstrap
technique to arrange for some shift of risks. If such sales are
considered a serious abuse, ineffective judicial correctives will
only postpone the day when Congress is moved to deal with the
problem comprehensively. Furthermore, one may ask why, if the
Government does not like the tax consequences of such sales, the
proper course is not to attack the exemption, rather than to deny
the existence of a "real" sale or exchange.
The force underlying the Government's position is that the
respondents did clearly retain some risk-bearing interest in the
business. Instead of leaping from this premise to the conclusion
that there was no sale or exchange, the Government might more
Page 380 U. S. 581
broken the transaction into components and attempted to
distinguish between the interest which respondents retained and the
interest which they exchanged. The worth of a business depends upon
its ability to produce income over time. What respondents gave up
was not the entire business, but only their interest in the
business' ability to produce income in excess of that which was
necessary to pay them off under the terms of the transaction. The
value of such a residual interest is a function of the risk element
of the business and the amount of income it is capable of producing
per year, and will necessarily be substantially less than the value
of the total business. Had the Government argued that it was that
interest which respondents exchanged, and only to that extent
should they have received capital gains treatment, we would perhaps
have had a different case.
I mean neither to accept nor reject this approach, or any other
which falls short of the all-or-nothing theory specifically argued
by the petitioner, specifically opposed by the respondents, and
accepted by the Court as the premise for its decision. On a highly
complex issue with as wide ramifications as the one before us, it
is vitally important to have had the illumination provided by
briefing and argument directly on point before any particular path
is irrevocably taken. Where the definition of "sale or exchange" is
concerned, the Court can afford to proceed slowly and by stages.
The illumination which has been provided in the present case
convinces me that the position taken by the Government is unsound,
and does not warrant reversal of the judgment below. Therefore, I
concur in the judgment to affirm.
MR. JUSTICE GOLDBERG, with whom THE CHIEF JUSTICE and MR.
JUSTICE BLACK join, dissenting.
The essential facts of this case, which are undisputed,
illuminate the basic nature of the transaction at issue.
Page 380 U. S. 582
Respondents conveyed their stock in Clay Brown & Co., a
corporation owned almost entirely by Clay Brown and the members of
his immediate family, to the California Institute for Cancer
Research, a tax-exempt foundation. The Institute liquidated the
corporation and transferred its assets under a five-year lease to a
new corporation, Fortuna, which was managed by respondent Clay
Brown, and the shares of which were in the name of Clay Brown's
attorneys, who also served as Fortuna's directors. The business
thus continued under a new name with no essential change in control
of its operations. Fortuna agreed to pay 80% of its pretax profits
to the Institute as rent under the lease, and the Institute agreed
to pay 90% of this amount to respondents in payment for their
shares until the respondents received $1,300,000 at which time
their interest would terminate and the Institute would own the
complete beneficial interest, as well as all legal interest, in the
business. If remittances to respondents were less than $250,000 in
any two consecutive years or any other provision in the agreements
was violated, they could recover the property. The Institute had no
personal liability. In essence, respondents conveyed their interest
in the business to the Institute in return for 72% of the profits
of the business and the right to recover the business assets if
payments fell behind schedule.
At first glance, it might appear odd that the sellers would
enter into this transaction, for, prior to the sale, they had a
right to 100% of the corporation's income, but, after the sale,
they had a right to only 72% of that income and would lose the
business after 10 years, to boot. This transaction, however,
afforded the sellers several advantages. The principal advantage
sought by the sellers was capital gain, rather than ordinary
income, treatment for that share of the business profits which they
received. Further, because of the Tax Code's charitable exemption
Page 380 U. S. 583
and the lease arrangement with Fortuna, [Footnote 2/2
] the Institute believed that neither it nor
Fortuna would have to pay income tax on the earnings of the
business. Thus, the sellers would receive free of corporate
taxation, and subject only to personal taxation at capital gains
rates, 72% of the business earnings until they were paid
$1,300,000. Without the sale, they would receive only 48% of the
business earnings, the rest going to the Government in corporate
taxes, and this 48% would be subject to personal taxation at
ordinary rates. In effect, the Institute sold the respondents the
use of its tax exemption, enabling the respondents to collect
$1,300,000 from the business more quickly than they otherwise
could, and to pay taxes on this amount at capital gains rates. In
return, the Institute received a nominal amount of the profits
while the $1,300,000 was being paid, and it was to receive the
whole business after this debt had been paid off. In any realistic
sense, the Government's grant of a tax exemption was used by the
Institute as part of an arrangement that allowed it to buy a
business that, in fact, cost it nothing. I cannot believe that
Congress intended such a result.
The Court today legitimates this bootstrap transaction and
permits respondents the tax advantage which the parties sought. The
fact that respondent Brown, as a
Page 380 U. S. 584
result of the Court's holding, escapes payment of about $60,000
in taxes may not seem intrinsically important -- although every
failure to pay the proper amount of taxes under a progressive
income tax system impairs the integrity of that system. But this
case in fact has very broad implications. We are told by the
parties and by interested amici
that this is a test case.
The outcome of this case will determine whether this bootstrap
scheme for the conversion of ordinary income into capital gain,
which has already been employed on a number of occasions, will
become even more widespread. [Footnote
] It is quite clear that the Court's decision approving this
tax device will give additional momentum to its speedy
proliferation. In my view, Congress did not sanction the use of
this scheme under the present revenue laws to obtain the tax
advantages which the Court authorizes. Moreover, I believe that the
Court's holding not only deviates from the intent of Congress, but
also departs from this Court's prior decisions.
The purpose of the capital gains provisions of the Internal
Revenue Code of 1954, § 1201 et seq.,
is to prevent gains
which accrue over a long period of time from being taxed in the
year of their realization through a sale at high rates resulting
from their inclusion in the higher tax brackets. Burnet v.
Harmel, 287 U. S. 103
287 U. S. 106
These provisions are not designed, however, to allow capital gains
treatment for the recurrent receipt of commercial or business
income. In light of these purposes, this Court has held that a
"sale" for capital gains purposes is not produced by the mere
transfer of legal title. Burnet v. Harmel, supra; Palmer v.
Bender, 287 U. S. 551
Rather at the very least, there must be a meaningful economic
transfer in addition to a change in legal title. See Corliss v.
Bowers, 281 U. S. 376
Thus, the question posed here is not whether this transaction
constitutes a sale within the
Page 380 U. S. 585
terms of the Uniform Commercial Code or the Uniform Sales Act --
we may assume it does -- but, rather, the question is whether at
the time legal title was transferred, there was also an economic
transfer sufficient to convert ordinary income into capital gain by
treating this transaction as a "sale" within the terms of I.R.C. §
In dealing with what constitutes a sale for capital gains
purposes, this Court has been careful to look through formal legal
arrangements to the underlying economic realities. Income produced
in the mineral extraction business, which "resemble[s] a
manufacturing business carried on by the use of the soil,"
Burnet v. Harmel, supra,
at 287 U. S. 107
is taxed to the person who retains an economic interest in the oil.
Thus, while an outright sale of mineral interests qualifies for
capital gains treatment, a purported sale of mineral interests in
exchange for a royalty from the minerals produced is treated only
as a transfer with a retained economic interest, and the royalty
payments are fully taxable as ordinary income. Burnet v.
Harmel, supra. See Palmer v. Bender, supra.
In Thomas v. Perkins, 301 U. S. 655
owner of oil interests transferred them in return for an "oil
production payment," an amount which is payable only out of the
proceeds of later commercial sales of the oil transferred. The
Court held that this transfer, which constituted a sale under state
law, did not constitute a sale for tax purposes because there was
not a sufficient shift of economic risk. The transferor would be
paid only if oil was later produced and sold; if it was not
produced, he would not be paid. The risks run by the transferor of
making or losing money from the oil were shifted so slightly by the
transfer that no § 1222(3) sale existed, notwithstanding the fact
that the transaction conveyed title as a matter of state law, and,
once the payout was complete, full ownership of the minerals was to
vest in the purchaser.
Page 380 U. S. 586
I believe that the sellers here retained an economic interest in
the business fully as great as that retained by the seller of oil
interests in Thomas v. Perkins.
The sellers were to be
paid only out of the proceeds of the business. If the business made
money, they would be paid; if it did not, they would not be paid.
In the latter event, of course, they could recover the business,
but a secured interest in a business which was losing money would
be of dubious value. There was no other security. The Institute was
not bound to pay any sum whatsoever. The Institute, in fact,
promised only to channel to the sellers a portion of the income it
received from Fortuna.
Moreover, in numerous cases, this Court has refused to transfer
the incidents of taxation along with a transfer of legal title when
the transferor retains considerable control over the
income-producing asset transferred. See, e.g., Commissioner v.
Sunnen, 333 U. S. 591
Helvering v. Clifford, 309 U. S. 331
Corliss v. Bowers, supra.
Control of the business did not,
in fact, shift in the transaction here considered. Clay Brown, by
the terms of the purchase agreement and the lease was to manage
Fortuna. Clay Brown was given power to hire and arrange for the
terms of employment of all other employees of the corporation. The
lease provided that
"if for any reason Clay Brown is unable or unwilling to so act,
the person or persons holding a majority interest in the principal
note described in the Purchase Agreement shall have the right to
approve his successor to act as general manager of Lessee
Thus, the shareholders of Clay Brown & Co. assured
themselves of effective control over the management of Fortuna.
Furthermore, Brown's attorneys were the named shareholders of
Fortuna and its Board of Directors. The Institute had no control
over the business.
I would conclude that, on these facts, there was not a
sufficient shift of economic risk or control of the business
Page 380 U. S. 587
to warrant treating this transaction as a "sale" for tax
purposes. Brown retained full control over the operations of the
business; the risk of loss and the opportunity to profit from gain
during the normal operation of the business shifted but slightly.
If the operation lost money, Brown stood to lose; if it gained
money, Brown stood to gain, for he would be paid off faster.
Moreover, the entire purchase price was to be paid out of the
ordinary income of the corporation, which was to be received by
Brown on a recurrent basis as he had received it during the period
he owned the corporation. I do not believe that Congress intended
this recurrent receipt of ordinary business income to be taxed at
capital gains rates merely because the business was to be
transferred to a tax-exempt entity at some future date. For this
reason, I would apply here the established rule that, despite
formal legal arrangements, a sale does not take place until there
has been a significant economic change such as a shift in risk or
in control of the business. [Footnote
To hold, as the Court does, that this transaction constitutes a
"sale" within the terms of I.R.C. § 1222(3), thereby giving rise to
capital gain for the income received, legitimates considerable tax
evasion. Even if the Court restricts its holding, allowing only
those transactions to be § 1222(3) sales in which the price is not
excessive, its decision allows considerable latitude for the
unwarranted conversion of ordinary income into capital gain.
Valuation of a closed corporation is notoriously difficult. The Tax
Court in the present case did not determine that the price for
which the corporation was sold represented its true value; it
simply stated that the price "was the result
Page 380 U. S. 588
of real negotiating" and "within a reasonable range in light of
the earnings history of the corporation and the adjusted net worth
of the corporate assets." 37 T.C. at 486. The Tax Court, however,
also said that
"[i]t may be . . . that petitioner [Clay Brown] would have been
unable to sell the stock at as favorable a price to anyone other
than a tax-exempt organization."
37 T.C. at 485. Indeed, this latter supposition is highly
likely, for the Institute was selling its tax exemption, and this
is not the sort of asset which is limited in quantity. Though the
Institute might have negotiated in order to receive beneficial
ownership of the corporation as soon as possible, the Institute, at
no cost to itself, could increase the price to produce an offer too
attractive for the seller to decline. Thus, it is natural to
anticipate sales such as this taking place at prices on the upper
boundary of what courts will hold to be a reasonable price -- at
prices which will often be considerably greater than what the
owners of a closed corporation could have received in a sale to
buyers who were not selling their tax exemptions. Unless Congress
repairs the damage done by the Court's holding, I should think that
charities will soon own a considerable number of closed
corporations, the owners of which will see no good reason to
continue paying taxes at ordinary income rates. It should not be
necessary, however, for Congress to address itself to this
loophole, for I believe that, under the present laws, it is clear
that Congress did not intend to accord capital gains treatment to
the proceeds of the type of sale present here.
Although the Court implies that it will hold to be "sales" only
those transactions in which the price is reasonable, I do not
believe that the logic of the Court's opinion will justify so
restricting its holding. If this transaction is a sale under the
Internal Revenue Code, entitling its proceeds to capital gains
treatment because it was arrived at after hard negotiating, title
in a conveyancing
Page 380 U. S. 589
sense passed, and the beneficial ownership was expected to pass
at a later date, then the question recurs, which the Court does not
answer, why a similar transaction would cease to be a sale if hard
negotiating produced a purchase price much greater than actual
value. The Court relies upon Kolkey v. Commissioner,
F.2d 51 (C.A.7th Cir.), as authority holding that a bootstrap
transaction will be struck down where the price is excessive. In
however, the price to be paid was so much greater
than the worth of the corporation in terms of its anticipated
income that it was highly unlikely that the price would in fact
ever be paid; consequently it was improbable that the sellers'
interest in the business would ever be extinguished. Therefore, in
the court, viewing the case as one involving "thin
capitalization," treated the notes held by the sellers as equity in
the new corporation and payments on them as dividends. Those who
fashion "bootstrap" purchases have become considerably more
sophisticated since Kolkey;
vastly excessive prices are
unlikely to be found, and transactions are fashioned so that the
"thin capitalization" argument is conceptually inapplicable. Thus,
I do not see what rationale the Court might use to strike down
price transactions which, though excessive, do not reach
dimensions, when it upholds the one here under
consideration. Such transactions would have the same degree of
risk-shifting, there would be no less a transfer of ownership, and
consideration supplied by the buyer need be no less than here.
Further, a bootstrap tax avoidance scheme can easily be
structured under which the holder of any income-earning asset
"sells" his asset to a tax-exempt buyer for a promise to pay him
the income produced for a period of years. The buyer in such a
transaction would do nothing whatsoever; the seller would be
delighted to lose his asset at the end of, say, 30 years in return
for capital gains treatment
Page 380 U. S. 590
of all income earned during that period. It is difficult to see,
on the Court's rationale, why such a scheme is not a sale. And, if
I am wrong in my reading of the Court's opinion, and if the Court
would strike down such a scheme on the ground that there is no
economic shifting of risk or control, it is difficult to see why
the Court upholds the sale presently before it, in which control
does not change and any shifting of risk is nominal.
I believe that the Court's overly conceptual approach has led to
a holding which will produce serious erosion of our progressive
taxing system, resulting in greater tax burdens upon all taxpayers.
The tax avoidance routes opened by the Court's opinion will surely
be used to advantage by the owners of closed corporations and other
income-producing assets in order to evade ordinary income taxes and
pay at capital gains rates, with a resultant large-scale ownership
of private businesses by tax-exempt organizations. [Footnote 2/5
] While the Court justifies its result
in the name of conceptual purity, [Footnote 2/6
] it simultaneously violates longstanding
congressional tax policies that capital gains treatment is to be
given to significant economic transfers of investment-type assets,
but not to ordinary commercial or business income, and that
transactions are to be judged on their entire substance, rather
than their naked form. Though turning tax consequences on form
alone might produce greater certainty of the tax results of any
transaction, this stability exacts as its price the certainty that
tax evasion will be produced. In Commissioner v.
Page 380 U. S. 591
Lake, Inc., 356 U. S. 260
356 U. S. 265
this Court recognized that the purpose of the capital gains
provisions of the Internal Revenue Code is
"'to relieve the taxpayer from . . . excessive tax burdens on
gains resulting from a conversion of capital investments, and to
remove the deterrent effect of those burdens on such conversions.'
. . . And this exception has always been narrowly construed so as
to protect the revenue against artful devices."
I would hold in keeping with this purpose and in order to
prevent serious erosion of the ordinary income tax provisions of
the Code, that the bootstrap transaction revealed by the facts here
considered is not a "sale" within the meaning of the capital gains
provisions of the Code, but that it obviously is an "artful
device," which this Court ought not to legitimate. The Court
justifies the untoward result of this case as permitted tax
avoidance; I believe it to be a plain and simple case of
unwarranted tax evasion.
I.R.C.1954, § 501(c)(3).
This lease arrangement was designed to permit the Institute to
take advantage of its charitable exemption to avoid taxes on
payment of Fortuna's profits to it, with Fortuna receiving a
deduction for the rental payments as an ordinary and necessary
business expense, thus avoiding taxes to both. Though unrelated
business income is usually taxable when received by charities, an
exception is made for income received from the lease of real and
personal property of less than five years. See
514; Lanning, Tax Erosion and the "Bootstrap Sale" of a Business --
I, 108 Pa.L.Rev. 623, 684-689. Though denial of the charity's tax
exemption on rent received from Fortuna would also remove the
economic incentive underlying this bootstrap transaction, there is
no indication in the Court's opinion that such income is not tax
the Court's opinion, ante
380 U. S.
the articles cited in the majority opinion,
at 380 U. S. 566
The fact that respondents were to lose complete control of the
business after the payments were complete was taken into account by
the Commissioner, for he treated the business in respondents' hands
as a wasting asset, see
I.R.C.1954, § 167, and allowed
them to offset their basis in the stock against the payments
Attorneys for amici
have pointed out that tax-exempt
charities which they represent have bought numerous closed
It should be noted, however, that the Court's holding produces
some rather unusual conceptual results. For example, after the
payout is complete, the Institute presumably would have a basis of
$1,300,000 in a business that, in reality, cost it nothing. If
anyone deserves such a basis, it is the Government, whose grant of
tax exemption is being used by the Institute to acquire the