*40 Decisions will be entered under Rule 50.
1. In 1943, Pat O'Brien and three others formed a corporation, Terneen Productions, Inc., all of whose stock they owned, to produce a motion picture in which O'Brien was the star. Terneen signed a distribution agreement with Columbia Pictures Corporation giving it exclusive distribution rights to the picture. Columbia provided part of the financing; the balance thereof was secured from the Bank of America. The picture, "Secret Command," was completed in July 1944. In August 1944, Terneen ceased doing business and assigned all of its right, title, and interest in the film to its stockholders, who, in 1945, 1946, and 1947, received payments from Columbia from the distribution of the film. The payments received in 1947 exceeded the fair market value of the film, as reported in 1944. On their returns for 1944, the stockholders estimated the fair market value of Terneen's rights and interest in the film at $ 150,000 and reported the difference in such amount and their stock investment as a long-term capital gain and paid the tax thereon. Respondent determined that Terneen was not a bona fide corporation and that all sums paid to its stockholders*41 were taxable to them as ordinary income. In the alternative, he determined that Terneen did not dissolve for Federal tax purposes in 1944 but continued in existence until and throughout 1947, and that all sums paid to its stockholders were its income and that the stockholders were liable as the transferees of its assets for the deficiencies determined against it. Held, Terneen was a bona fide corporation for Federal tax purposes. Held, further, it ceased doing business, liquidated, and commenced dissolution for Federal tax purposes in August 1944, and was not thereafter taxable on any profits realized from the picture which it produced. Held, further, the amounts received by petitioners from Columbia in 1947, which amounts were in excess of the fair market value of the film as reported in 1944, were ordinary income.
2. Pat O'Brien was paid a salary of $ 25,000 for starring in "Secret Command." The respondent determined that $ 40,000 of the amount which he received in 1945 from Columbia constituted additional compensation for his performance in the picture. Held, the respondent erred in determining that any amounts received by Pat O'Brien from Columbia constituted*42 compensation for his performance as the star of the picture.
3. On August 29, 1945, petitioner, Phil L. Ryan, sold to RKO Radio Pictures, Inc., his option on the story from which the motion picture "Fighting Father Dunn" was made. He received a 10 per cent interest in the net profits of the picture and a contract to produce the picture at a salary of $ 30,000. In July 1947, he sold one-half of his 10 per cent interest in the net profits to the director of the film and reported the profit thereon as a long-term capital gain. Held, Ryan's 10 per cent interest in the net profits of the film was a capital asset and gain realized on the sale of one-half of such interest was properly reported by him as a long-term capital gain.
*377 This proceeding involves deficiencies in taxes and additions thereto determined by the respondent under the provisions of the 1939 Code, as follows:
| Petitioner | Docket | Year | Kind of tax | Deficiency | Sec. 291 (a) |
| No. | addition | ||||
| Pat O'Brien | 46372 | 1945 | Income | $ 25,862.11 | |
| 1946 | Income | 7,049.12 | |||
| 1947 | Income | 679.03 | |||
| Eloise T. O'Brien | 46373 | 1945 | Income | 25,862.11 | |
| 1946 | Income | 7,034.87 | |||
| 1947 | Income | 679.02 | |||
| Pat O'Brien and Eloise T. | 46374 | 1944 | Income | 3,769.34 | |
| O'Brien, Transferees. | D. V. E. P. | 16,436.65 | |||
| E. P. | 74,427.63 | $ 18,606.91 | |||
| 1945 | Income | 2,769.07 | 692.27 | ||
| D. V. E. P. | 3,104.60 | 776.15 | |||
| E. P. | 8,369.55 | 2,092.39 | |||
| 1946 | Income | 2,113.91 | 528.48 | ||
| 1947 | Income | 4,283.34 | 1,070.84 | ||
| Phil L. Ryan | 46375 | 1945 | Income | 10,652.30 | |
| 1946 | Income | 2,188.26 | |||
| 1947 | Income | 2,530.21 | |||
| Gladys Ryan | 46376 | 1944 | Income | 396.58 | |
| 1945 | Income | 10,511.87 | |||
| 1946 | Income | 2,188.26 | |||
| 1947 | Income | 2,530.21 | |||
| Phil L. Ryan and Gladys | 46377 | 1944 | Income | 3,769.34 | |
| Ryan, Transferees. | D. V. E. P. | 16,436.65 | |||
| E. P. | 74,427.63 | 18,606.91 | |||
| 1945 | Income | 2,769.07 | 692.27 | ||
| D. V. E. P. | 3,104.60 | 776.15 | |||
| E. P. | 8,369.55 | 2,092.39 | |||
| 1946 | Income | 2,113.91 | 528.48 | ||
| 1947 | Income | 4,283.34 | 1,070.84 | ||
| Graydon B. Howe, | 46378 | 1944 | Income | $ 3,769.34 | |
| Transferee | D. V. E. P. | 16,436.65 | |||
| E. P. | 74,427.63 | $ 18,606.91 | |||
| 1945 | Income | 2,769.07 | 692.27 | ||
| D. V. E. P. | 3,104.60 | 776.15 | |||
| E. P. | 8,369.55 | 2,092.39 | |||
| 1946 | Income | 2,113.91 | 528.48 | ||
| 1947 | Income | 4,283.34 | 1,070.84 | ||
| Graydon B. Howe | 46379 | 1945 | Income | 5,080.03 | |
| 1946 | Income | 828.73 | |||
| Terneen Productions, Inc. | 46380 | 1944 | Income | 3,769.34 | |
| D. V. E. P. | 16,436.65 | ||||
| E. P. | 74,427.63 | 18,606.91 | |||
| 1945 | Income | 2,769.07 | 692.27 | ||
| D. V. E. P. | 3,104.60 | 776.15 | |||
| E. P. | 8,369.55 | 2,092.39 | |||
| 1946 | Income | 2,113.91 | 528.48 | ||
| 1947 | Income | 4,283.34 | 1,070.84 |
*44 *378 The respondent determined overassessments in income tax for petitioners Pat O'Brien, Eloise T. O'Brien, Phil L. Ryan, and Graydon B. Howe for the year 1944.
The respondent determined the deficiencies herein on alternative theories. He first determined that Terneen Productions, Inc., was not a bona fide corporation for Federal tax purposes and that all sums received by petitioners Pat and Eloise T. O'Brien, Phil L. and Gladys Ryan, and Graydon B. Howe from Columbia Pictures Corporation under a distribution contract between it and Terneen were taxable to such recipients as ordinary income rather than as capital gains. The first issue is, therefore, whether the respondent erred in that determination. If he did, he determined, in the alternative, that Terneen was a bona fide corporation but that its liquidation in August 1944, and its subsequent dissolution in November 1944, were without substance and should not be recognized for Federal tax purposes. On this theory, he determined that the sums which the O'Briens, Ryans, and Graydon B. Howe received from Columbia during the years in issue were income of Terneen, taxable to it, and that the above-named petitioners were liable*45 as its transferees for the deficiencies which he determined against Terneen for the years 1944 to 1947, inclusive. The second issue is whether he erred in this determination and in determining penalties for Terneen's failure to file tax returns for such years.
On their income tax returns for 1947, the O'Briens and the Ryans reported as ordinary income the sums received from Columbia during that year, which were in excess of the amount which they had reported in 1944 as the fair market value of all assets received by them as the stockholders of Terneen. They now claim that such sums should have been reported as additional capital gains and claim an overpayment of taxes for the year 1947. This issue is whether the sums which the petitioners received in excess of the reported fair market value of the *379 assets of Terneen upon its liquidation were properly reportable by them as ordinary income or as capital gains.
The remaining issues are: (4) Whether the respondent erred in adding $ 40,000 to the community income of Pat and Eloise T. O'Brien in 1945, which sum he determined was additional compensation to petitioner, Pat O'Brien, for his performance in the motion picture "Secret*46 Command"; and (5) whether the proceeds received by petitioner, Phil L. Ryan, from the sale of his one-half interest in the net profits of the motion picture "Fighting Father Dunn" were taxable as ordinary income or capital gains.
Concessions have been made with respect to other issues and will be taken into account under a Rule 50 computation.
Some of the facts were stipulated.
FINDINGS OF FACT.
The stipulated facts are so found and are incorporated herein by this reference.
Pat O'Brien and his wife, Eloise T. O'Brien, Phil L. Ryan and his wife, Gladys Ryan, and Graydon B. Howe were residents of Los Angeles County, California, during the years in issue. The returns of the O'Briens and Ryans were filed on the community property basis with the collector of internal revenue for the sixth district of California for such years. The individual returns of Graydon B. Howe were also filed with such collector.
Terneen Productions, Inc. (hereinafter referred to as Terneen), was a California corporation, incorporated on June 30, 1943. Its principal place of business was in Los Angeles County, California. It filed a timely corporation and declared value excess-profits tax return on the cash*47 basis for the fiscal period beginning January 1, 1944, and ending November 6, 1944, with the collector of internal revenue for the sixth district of California.
Early in 1943, Phil L. Ryan read a story in the Saturday Evening Post, entitled "Pile Buck," which he believed would make a good motion picture. He discussed the story with Pat O'Brien, who agreed that he would like to play the leading role in a motion picture based on the story. Ryan and O'Brien wanted to produce an independent motion picture and toward that end they, together with two attorneys, organized Terneen on June 30, 1943.
The first meeting of Terneen's incorporators was held on July 8, 1943. They elected themselves as the permanent directors of the corporation, and were also its officers. Ryan was president and O'Brien was vice-president. On July 28, 1943, the Commissioner of Corporations of California issued a permit to Terneen authorizing *380 it to sell 1,250 of its shares of stock at $ 10 per share. On August 9, 1943, Terneen issued 625 shares to Pat O'Brien, 500 shares to Phil Ryan, and 125 shares to Graydon B. Howe. The shareholders paid $ 10 per share for the stock and the proceeds in the amount*48 of $ 12,500 were deposited by Terneen in its bank account on August 23, 1943.
The independent production of motion pictures by actors and directors was common during the years here in issue. The financing of such productions was often handled by forming a corporation which entered into a distribution agreement with one of the major motion picture companies; that company agreed to provide its facilities for the production of the proposed picture and agreed to distribute it when completed; and on the strength of such agreements and with a mortgage on the completed film, banks would lend up to 60 per cent of the proposed budget of the picture. Terneen followed the above-described pattern in producing the picture here in question.
On July 1, 1943, it entered into a production distribution agreement with Columbia Pictures Corporation (hereinafter referred to as Columbia) whereby Terneen was to produce a motion picture based on the story "Pile Buck." Columbia had exclusive distribution rights to the picture and agreed to distribute the picture throughout the world upon its completion. The agreement specifically provided that Columbia was in no way acting in a fiduciary capacity with *49 respect to any moneys which it collected from the distribution of the picture and that it had the right to commingle such funds with its own moneys. The agreement provided that Columbia would make its facilities and credits available for the production of the proposed motion picture; that it would finance the proposed budget for the picture up to 40 per cent, or more, if bank financing was not available; and that it would repay any of Terneen's bank loans directly out of the proceeds realized from distribution of the motion picture. For the services which it agreed to perform, Columbia was to receive a distribution fee of 25 per cent of the gross revenue from the picture while being reimbursed for all cash advances and credits to Terneen; and Columbia, after it had recouped such advances and credits and repaid any bank loans, was to share equally with Terneen the remaining proceeds from the picture.
Terneen employed Phil Ryan as the producer of the motion picture at a salary of $ 25,000 and employed Pat O'Brien as the principal star for the sum of $ 25,000. Eddie Sutherland was employed as the director of the picture at a salary of $ 30,000. Between December 1943 and February 1944, *50 Terneen arranged for and signed contracts for the balance of the cast which consisted of 21 actors and actresses and 4 stand-ins. On February 7, 1944, Terneen borrowed $ 314,000 from the Bank of America to finance the production of the motion picture. The *381 loan was secured by a mortgage of its rights and properties in the picture. Terneen procured workmen's compensation insurance from Lumberman Mutual Casualty Company for its employees. It likewise applied for and received an employer's identification number from the United States Treasury. It withheld from the wages of its employees the amounts required under the Federal Contribution Act and withholding tax statutes and made returns and payment of the taxes so withheld. Unsecured personal property taxes were assessed against Terneen by the Los Angeles tax assessor. Terneen paid such taxes in the amount of $ 4,793.96 on July 18, 1944.
The motion picture was completed and released for distribution under the title of "Secret Command" late in July 1944. On August 4, 1944, Terneen borrowed $ 35,000 from Columbia; and, after deducting withholding taxes, paid the balance of such sum to Pat O'Brien and Phil Ryan for salary*51 due them.
On August 9, 1944, a special stockholders' meeting of Terneen was held, at which it was unanimously decided to wind up and dissolve the corporation. A resolution to that effect was passed and notice thereof given to Columbia and to the Bank of America on that date. A certificate of election to wind up and dissolve was filed with the secretary of state of California on August 11, 1944, and a copy thereof was certified by the secretary of state and filed in the office of the Los Angeles county clerk on August 14, 1944.
At the meeting on August 9th, the stockholders surrendered their certificates of stock for which they received Terneen's assignment of all of its right, title, and interest in the motion picture "Secret Command," in proportion to their stockholdings. Such assignment was subject to the Bank of America loan and to the claims of Columbia. On August 31, 1944, $ 6,238.46 remained in Terneen's bank account. On that date, such sum was distributed to the stockholders in proportion to their interest in the corporation. On October 25, 1944, the franchise tax commissioner of California issued a tax clearance for Terneen. On November 2, 1944, a certificate of dissolution*52 was filed in the office of the secretary of state, and a copy thereof, certified by the secretary of state, was filed on November 6, 1944, in the office of the Los Angeles county clerk, Los Angeles, California. On November 18, 1944, Terneen filed a final income tax return for the fiscal period January 1 to November 6, 1944.
On their income tax returns for 1944, the O'Briens, Phil L. Ryan, 2 and Graydon B. Howe reported the fair market value of Terneen's right, title, and interest in "Secret Command" to be $ 150,000 and reported the difference in such sum (plus cash received) and the cost *382 basis of their stock as a capital gain and paid the tax thereon. Ryan had many years experience in the sales and distribution of motion pictures. The estimate of the fair market value of Terneen's interest in "Secret Command" was made by him from detailed information of the receipts of the picture during its first weeks of showing and from other additional information from which an accurate appraisal of expected gross receipts of the picture could be made.
*53 On their returns for 1947, the O'Briens and Ryans reported the amounts received from Columbia in excess of the fair market value of Terneen's assets as ordinary income but now contend that such sums should have been reported as additional capital gains. They claimed a refund of taxes paid for that year.
Terneen ceased doing business, liquidated, and commenced dissolution on August 9, 1944. The fair market value of its right, title, and interest in the motion picture "Secret Command," on August 9, 1944, was $ 150,000.
In 1945, Ryan purchased an option on the story from which the motion picture "Fighting Father Dunn" was later produced. On August 29, 1946, he sold that option to RKO Radio Pictures, Inc. (hereinafter referred to as RKO), in consideration of a 10 per cent interest in the net profits of the film plus a contract of employment as the film's producer at a salary of $ 30,000. Upon completion of the film, Ryan, on July 17, 1947, sold one-half of his 10 per cent interest to the director of the picture for $ 20,000. On his return for that year, he reported the profit on the sale as a long-term capital gain. The respondent determined that the profit was ordinary income.
*54 OPINION.
The substance of the respondent's determination of deficiencies here is that Terneen was a "collapsible corporation" as that term is known in the law of Federal taxation. Had Terneen's shareholders realized the gains in question on or after January 1, 1950, the taxability of such gains as ordinary income or as capital gains would be determined pursuant to specific statutory standards. By section 212 of the Revenue Act of 1950, 3Congress added
*55 The reports of the House Ways and Means Committee 4 and the Senate Finance Committee 5 indicate that Congress was fully aware that so-called collapsible corporations were in widespread use in the motion picture industry. Congress further recognized that no such corporation had, at that time, been before the courts. Hence, section 212 (b) of the 1950 Act provided that the courts were free to decide, with no inference being drawn from the enactment of such subsection, whether the gains arising from the sale or exchange of stock of an alleged collapsible corporation prior to January 1, 1950, were taxable as ordinary income or as capital gains.
A case with facts almost identical to those here was decided by the United States District Court for the Southern District of California --
The respondent's determination of the deficiencies here is predicated on what he believes to be strong equitable considerations in his favor. While solicitude for the revenue may sometimes be an appealing basis on which to decide a particular tax case, it is often a treacherous one. And here, irrespective of what equitable arguments might be advanced in support of the respondent's position, we think it clear that his determination has no support in law.
The deficiencies in Docket Nos. 46372, 46373, 46375, 46376, and 46379 were determined on the theory that Terneen was not a bona fide corporation for Federal tax purposes. The respondent, however, did not argue that theory on brief, and we assume he now deems it to be without merit. *57 Nor need we belabor that question. Suffice it to say, that the facts as set forth in our findings show clearly that Terneen was a bona fide corporation until August 1944, when it ceased doing business, liquidated, and commenced dissolution. Cf.
The respondent's alternative determination that Terneen did not dissolve for Federal tax purposes in 1944 is based on two arguments. *384 His first argument is predicated on the holdings of such cases as:
The second argument which the respondent advances for disregarding Terneen's corporate dissolution in 1944 is predicated on the basis of the holding of
We think the respondent clearly erred in disregarding Terneen's liquidation in 1944 and in determining deficiencies in taxes and penalties against it for that and subsequent years, and in determining deficiencies against the individual petitioners here as its transferees.
The third issue is whether the sums which the O'Briens and the Ryans received from Columbia in 1947, which sums were in excess of the fair market value of Terneen's assets as reported by them in 1944, were taxable as ordinary income or as additional capital gains. On their returns for 1947, they reported such excess as ordinary income; but, upon the respondent's determination of the deficiencies herein, they claim such sums should have been reported as additional capital gains. In support*61 of their position they cite
The respondent argues that those cases are distinguishable on their facts from the one here; and, in support of his argument that the excess sums in question here were ordinary income, cites an unreported opinion of the United States District Court for the Southern District of California -- Lewin v. Westover, decided October 29, 1953. 6 On facts similar to those here, the District Court there concluded that the taxpayer should have reported similar excess sums as ordinary income.
We agree with the respondent that
Here, the interest in the film which Terneen's stockholders received had a readily ascertainable fair market value at the time Terneen dissolved. The distribution of the asset was a closed transaction for Federal tax purposes. Hence, the amounts in excess of such fair *386 market value, which the petitioners received in 1947, were properly reported by them as ordinary income, since their basis in the asset had been recovered by that time.
The fourth issue is whether the respondent erred in determining that $ 40,000 of the sums paid to petitioner, Pat O'Brien, by Columbia in 1945 was additional ordinary community*63 income of the O'Briens in that year on the theory that such amount should have been paid to Pat O'Brien as additional compensation for his performance as the star of "Secret Command." The respondent argues in support of his determination that O'Brien's normal salary for starring in a motion picture was $ 65,000 or more. We think the respondent was clearly in error in his determination. Here, a reasonable salary for O'Brien under the circumstances was agreed upon and there is insufficient reason for regarding a part of the 1945 payments from Columbia as additional salary to O'Brien. See
The fifth and final issue is whether the respondent erred in determining that the profit realized by Phil L. Ryan from the sale of one-half of his 10 per cent interest in "Fighting Father Dunn" constituted ordinary income rather than capital gain. We think the respondent's determination was erroneous.
The attorney for RKO, who testified at the hearing, made it very clear that RKO purchased the story by giving Ryan a 10 per cent interest in the net profits of the picture and by employing him as the producer of the picture at a salary*64 of $ 30,000. RKO paid $ 50,000 to the author of the story and gave him a 5 per cent interest in the net profits of the film.
The respondent argued on brief that the story, or the option thereon, could not be a capital asset in Ryan's hands since his previous activity in purchasing and selling stories indicated that he was in the business of doing so. That argument misses the point altogether. What Ryan sold in 1947 was not the story but an entirely different asset, namely, one-half of his 10 per cent interest in the net profits of the motion picture. The record as a whole indicates that Ryan was not in the business of buying and selling interests in motion pictures. Hence, his 10 per cent interest in "Fighting Father Dunn" was a capital asset which he had held for more than six months prior to the time when he sold one-half of it. The profit on such sale was a capital gain.
Decisions will be entered under Rule 50.
Footnotes
1. Proceedings of the following petitioners are consolidated herewith:
↩Petitioners Docket Nos. Pat O'Brien 46372 Eloise T. O'Brien 46373 Pat O'Brien and Eloise T. O'Brien, Transferees 46374 Phil L. Ryan 46375 Gladys Ryan 46376 Phil L. Ryan and Gladys Ryan, Transferees 46377 Graydon B. Howe, Transferee 46378 Graydon B. Howe 46379 Terneen Productions, Inc 46380 2. The Ryans reported their income on the community property basis in 1944, but Phil L. Ryan reported all of the gain from the distribution of Terneen's assets on his return.↩
3. 64 Stat. 934.↩
4. H. Rept. No. 2319, 81st Cong., 2d Sess. (1950), p. 56.↩
5. S. Rept. No. 2375, 81st Cong., 2d Sess. (1950), p. 45.↩
6. 53-2 U. S. T. C. par. 9619,
45 A. F. T. R. 944↩ .