The opinion of the court was delivered by: LANE
The facts in this case have been stipulated by the parties. On January 11, 1952, Damar Products, Inc. (hereinafter Damar) was organized - with the Bankrupt as its president and sole stockholder. The business conducted by Damar was that of a wholesale supplier of household items. The Bankrupt, in addition to his activities with Damar, also operated a mail-order business as a sole proprietorship. In connection with the mail-order business the Bankrupt purchased on credit large quantities of household items from Damar.
Some time prior to 1957 the Bankrupt discontinued the mail-order operation and transferred it, including mailing lists, to Damar. The indebtedness of the Bankrupt to Damar arising out of the credit purchases remained on Damar's books. Subsequent to the transfer Damar carried on both its wholesale supply business and the mail-order business.
On May 1, 1957, two agreements were entered into. By the terms of a "sale and leaseback" arrangement Damar "sold" its mailing lists to a group represented by a William Manowitz (hereinafter Group) for $45,000. The Group then "leased back" the lists to Damar for a period of 32 months (to December 31, 1959) at a "rental" of $1,350 per month. By the terms of a second agreement the Bankrupt agreed to purchase the lists from the Group for $15,000 at any time during the year following the expiration of the lease that the Group desired to consummate the sale.
On February 24, 1959, just under twenty-two months after the "sale and leaseback" arrangement and prior to the maturity of his repurchase obligation, the Bankrupt purchased the lists from the Group for $15,000. Seven months later, on September 25, 1959, the Bankrupt transferred the lists to Damar. At that time the lists had a fair market value of $15,000 but the "sale" to Damar was stated at the inflated price of $150,000. At this time, Damar's books still showed an indebtedness owing to it from the Bankrupt of $134,972 arising out of the credit purchases he had made prior to 1957 while in the mail-order business. The September 25, 1959 "purchase" was reflected on Damar's books by crediting the indebtedness due from the Bankrupt with $150,000, thereby eliminating the debit balance and leaving a net credit balance of $15,028 due the Bankrupt.
In his 1959 income tax return the Bankrupt reported the transaction as a sale resulting in a long-term capital gain of $135,000 - claiming a $15,000 basis for the mailing lists. The Bankrupt had never engaged in the trade or business of buying or selling mailing lists.
On April 22, 1963, a jeopardy assessment was made against the Bankrupt by the Commissioner of Internal Revenue in the amount of $67,217.81, including interest. On June 21, 1963, a notice of deficiency was mailed to the Bankrupt. On June 29, 1963, the Bankrupt filed a petition in bankruptcy. Subsequently, but within the statutory period, he filed a petition in the Tax Court for redetermination of the deficiency but the petition was denied for lack of jurisdiction.
The District Director of Internal Revenue on behalf of the United States of America filed a claim in the bankruptcy proceedings. That claim, as amended, included amounts owing by virtue of the Government's disallowance of the Bankrupt's treatment of the transfer of the lists to Damar for $150,000 and for 1960 estimated tax. The Trustee objected to these claims and the Referee by an Opinion dated November 29, 1966, and an Order entered on December 30, 1966, dismissed the objections. The Trustee has appealed from the Referee's Opinion and Order.
The parties have stipulated that the amount of the estimated tax liability for 1960 should be reduced to $790.18, and the Government has abandoned its contention that the Bankrupt had a zero basis for the mailing lists. Thus the only question before us is whether the $135,000 realized by the Bankrupt upon the transfer of the mailing lists to Damar should be taxed as capital gain or as ordinary income.
The Bankrupt contends that the $135,000 gain should be taxed as a long-term capital gain, asserting two theories in support of this contention. The first is the one set out in his 1959 income tax return, i.e., the gain is the result of the sale of a capital asset held for more than six months. As an alternative, he argues that the transaction should be treated as a section 301(a) corporate distribution, and, since Damar had no earnings and profits and the Bankrupt had a zero basis for his stock, the corporate distribution would be taxed as a capital gain under section 301(c).
The Government, on the other hand, contends that the $135,000 should be taxed as ordinary income. In support of this it argues that the Bankrupt should not be allowed to redesignate the transaction as a corporate distribution under section 301(a) and hence should not be taxed under section 301(c). The Government then argues that because of the gross disparity between the fair market value of the mailing lists and the price for which they were sold, the transaction amounted to a fraud on the revenue, and capital gain treatment should be disallowed.
We will first deal with the Bankrupt's claim that the cancellation of his indebtedness should be treated as a corporate distribution. Section 301(a) provides:
In general. - Except as otherwise provided in this chapter, a distribution of property (as defined in section 317(a)) made by a corporation to a shareholder with respect to its stock shall be treated in the manner provided in subsection (c).
In order for this section to come into operation it is necessary that the value received by the shareholder be in his capacity as a ...