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Thompson v. Commissioner of Internal Revenue. Couse

decided: June 8, 1953.


Author: Kalodner

Before KALODNER, STALEY and HASTIE, Circuit Judges.

KALODNER, Circuit Judge.

These appeals involve certain government contracts, awarded to a corporation which later dissolved and whose principal stockholder paid a capital gains tax on the value of the contracts (estimated profits) in excess of his basis in the assets of the corporation and then contributed his interest to a partnership later formed. The question presented is whether the partnership may use the value of the contracts as thus determined as a basis for amortization deductions. The Tax Court held that it could not. 1952, 18 T.C. 361. Taxpayers petitioned this Court for a review of that decision.

The detailed facts are found in the Tax Court decision, supra, and may be summarized as follows:

Couse Laboratories, Inc., until its dissolution on October 31, 1942, was engaged in the manufacture of mobile machine shops and portable signal towers.*fn1 Couse, one of the two petitioning taxpayers, owned 1900 shares of stock and one Maud Dale owned or controlled the remaining 100 shares. Prior to its dissolution, the corporation had been awarded government contracts of $11,000,000 for the manufacture of its products for the Signal Corps and the Engineer Corps. The Engineer Corps contracts were made directly with the government. The Signal Corps, as a matter of expediency, placed its orders with Westinghouse Electric and Manufacturing Company, which manufactured the radar equipment, and required Westinghouse to buy the towers from Couse Laboratories, Inc.

The contracts held by the corporation reserved to the government and Westinghouse the right to terminate the contracts, subject to certain conditions.*fn2 They were awarded to the corporation because of the manufacturing "know-how" of Couse, who had personally developed and patented many of the features of his products. It was estimated as of October 31, 1942, that the completion of these contracts would result in a profit of $1,314,506.21.

Upon dissolution of the corporation, the contracts were not yet completed, and Couse paid a capital gains tax on his portion of the anticipated profits,*fn3 and contributed his 95 per cent interest in the contracts to a partnership subsequently formed by him and Thompson. Thompson was the son of Maud Dale, who, after dissolution, sold her interest to him,*fn4 and he in turn transferred it to the partnership*fn5 in consideration of a 5 per cent interest in the latter.

The partnership treated the estimate of the profits to be realized as the cost of the contracts to it. In computing its net income for the period ending November 30, 1942, $11,388.75 was deducted for the amortization of this cost; the balance of $1,303,117.46 was taken as a deduction for the fiscal year ending November 30, 1943. The Commissioner disallowed both deductions. This had the effect of decreasing the loss sustained by the partnership for the earlier period from $15,152.44 to $4,902.45 and increasing its income for the later period from $91,000.52 to $933,303.31. Couse's share of the latter amount was $869,328.14 and Thompson's $63,975.17. On the basis of these figures the Commissioner determined a tax deficiency against Couse of $502,027.12 and against Thompson of $38,276.98.

The Commissioner contends that the taxpayers herein received nothing of value from the corporation, because of the statutory interdiction against the transfer of government contracts, R.S. § 3737, 41 U.S. C.A. § 15, and the parallel restriction found in the contract between the corporation and Westinghouse. Having received nothing of value, says the Commissioner, taxpayers had no basis to recover through depreciation. This, in sum, was the decision of the Tax Court.

If the government had a right to annul these contracts under section 3737, such a right would of course have an effect on their fair market value, but in our view the transfer here involved does not come within the prohibition of section 3737 and the government therefore had no such right. That section states:

"No contract or order, or any interest therein, shall be transferred by the party to whom such contract or order is given to any other party, and any such transfer shall cause the annulment of the contract or order transferred, so far as the United States are concerned. All rights of action, however, for any breach of such contract by the contracting parties, are reserved to the United States."

Preliminarily, it should be noted that although the language of the section is broad, many limitations have been engrafted upon it. It has never been applied blindly, but rather, in each case, the Court has looked to the ratio legis to see whether the assignment involved was "within the mischief which congress intended to prevent." Freedman's Savings & Trust Co. v. Shepherd, 1888, 127 U.S. 494, 505, 8 S. Ct. 1250, 1255, 32 L. Ed. 163.

The rationale of sections 3737 and 3477, 41 U.S.C.A. § 15, 31 U.S.C.A. § 203 (the prohibition against assignments of claims against the government) was judicially declared in Hobbs v. McLean, 1886, 117 U.S. 567, 576, 6 S. Ct. 870, 874, 29 L. Ed. 940 where the Court said:

"They were passed in order that the government might not be harassed by multiplying the number of persons with whom it had to deal, and might always know with whom it was dealing until ...

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