Ah Pah Redwood Co. v. Commissioner

26 T.C. 1197 (1956).

Rev'd in part and remanded 251 F.2d 163;
58-1 USTC ¶9153; 1 AFTR 2d, 456 (9th Cir. 1957).
On remand 18 T.C.M. 202; P-H T.C. Memo ¶ 59,044 (1959).

Case Text

The respondent determined deficiencies in income tax of petitioner, and additions thereto, pursuant to section 291(a) of the Internal Revenue Code of 1939, for failure to file timely returns, for years and in amounts as follows:

Year	Deficiency	Addition to tax
1948	$2,654.84	$663.71
1949	35,649.37	8,912.35

Respondent's imposition of the additions to tax is not contested. Nor is error assigned with respect to various adjustments made by respondent in his determination. The issues framed by the pleadings and here to be resolved are:

(1) Whether the amounts received by petitioner in 1948 and 1949 from Coast Redwood Co. for timber cut by the latter from the property of petitioner are properly taxable as long-term capital gains.

(2) Whether petitioner's depletion allowance for the taxable years 1948 and 1949 is properly to be adjusted subsequent to the close thereof by revision of the estimated amount of units of timber standing on petitioner's property during such years.

The stipulation of facts filed by the parties, with exhibits attached, is adopted and, by this reference, made a part hereof.

The petitioner, Ah Pah Redwood Co., is a corporation organized under the laws of California, with its main office at Portland, Oregon. The returns for the periods here involved were filed with the then collector ¹ of internal revenue for the district of Oregon. Such returns were filed on a calendar year basis.

Upon its organization in October 1947, petitioner purchased all the right, title, and interest of "the buyer" in a certain purchase agreement (hereinafter called the Sage Agreement), and all the timber and land covered thereby, dated December 13, 1946, between Sage Land & Lumber Company, Inc. (hereinafter called Sage), as seller, and Union Bond & Trust Company (hereinafter called Union), as buyer. The timber and land involved are located in Humboldt County, California, and the purchase price paid by petitioner was $1,443,839,99. Shortly after the purchase of this tract (hereinafter called the Sage Tract), petitioner, in October 1947, under an oral or implied contract with Coast Redwood Co. (hereinafter called Coast), allowed the latter to begin cutting timber from the Sage Tract and pay therefor $5 per thousand feet as removed. On January 9, 1950, petitioner entered into a formal written agreement with Coast, pursuant to which petitioner agreed to sell all of the timber and land covered by the Sage Agreement to Coast.

In the years 1948 and 1949, petitioner reported its income on the sales of timber to Coast as long-term capital gains. In so reporting its income on the timber thus sold to Coast, petitioner used the basis for depletion of $3.941566 per thousand board feet. Respondent also used such basis in computing a portion of the deficiencies here in question. This basis for depletion was computed by both parties by dividing the amount of timber on the Sage Tract, as was shown on schedule A of the Sage Agreement per the French cruise, which amount petitioner assumed to be the correct quantity thereof, into the total purchase price paid by petitioner for such agreement. In 1952, petitioner first became aware of the fact that schedule A of the Sage Agreement erroneously overstated the quantity of timber on the Sage Tract by a substantial amount. Upon an actual cruise made shortly after logging operations ceased in November 1954, it was ascertained that such overstatement was approximately double the actual amount and that there was a "fall-down" of approximately 48 per cent.

In addition to other sales, petitioner sold 33,883,000 board feet of timber covered by the Sage Agreement to A. K. Wilson Lumber Company in 1950. This quantity of timber was assumed to be the above amount on the basis of the quantities shown in schedule A to the Sage Agreement. Prior to petitioner's acquisition of the Sage Agreement, International Pacific Pulp and Paper Co. sold 16,022,060 board feet of the timber covered thereby to Coast in the years 1946 and 1947.

VAN FOSSAN, Judge: The first issue is whether the amounts received by petitioner in 1948 and 1949 from Coast for timber cut in those years by the latter from the Sage Tract are properly taxable as capital gains, as urged by petitioner, or as ordinary income, as determined by respondent. The statutes involved are sections 117(j) (1) and 117(k)(2) of the Internal Revenue Code of 1939, as amended, the pertinent provisions of both of which are set forth below ² It is petitioner's position that the only question to be resolved under this issue is whether or not its oral arrangement with Coast, whereby Coast commenced logging operations on the Sage Tract, as indicated in our findings above, in October 1947, shortly after petitioner's acquisition thereof, from which logging operations the amounts in dispute were received, constituted a "disposal" by petitioner of all of the timber standing thereon within the meaning of section 117 (k) (2).

In line with this view, petitioner makes the argument on brief that such oral arrangement was ineffective to pass title to all of the standing timber in question in October 1947, the date the oral agreement was made, because of the California Statute of Frauds (Cal. Civ. Code Ann. sec. 1091 (West); Anderson v. Palladine, 178 P. 553; see, also, 34 Am. Jur. 498), and that it therefore could not and did not constitute a "disposal" of such timber within the ambit of the cited statute at any time prior to the execution of the written agreement in 1950. Further, petitioner advances the theory that while its oral agreement with Coast was not effective as a contract to sell standing timber, it did constitute a license to cut, which license ripened into a contract for the sale of logs upon the severance of each individual tree.

Whether or not petitioner's theory be valid, its application will not constitute a disposition of the issue framed in the pleadings. Thus to narrow the issue is to make the unwarranted assumption that the timber involved in the: transaction at issue constituted a capital asset to petitioner at the time of such transaction, Within the definition contained in section l17(a) (1) of the Internal Revenue Code of 1939, ³ or property used in petitioner's trade or business within the meaning of section l17(j)(1), supra. In this connection, respondent makes the point, which we feel to be well taken, that petitioner at no time engaged in any logging activities, but, rather, merely sold the Sage timber to others under arrangements whereby the vendees would do the logging; that these sales of timber were the only business activity entered into by petitioner; that it is thus to be considered as having been engaged in the trade or business of selling timber; and that the timber in dispute, whether or not it was standing, was held for sale to customers 'in the ordinary course of such business.

The facts found on this record lead to the conclusion that petitioner was engaged in the trade or business of selling timber and that the timber in controversy was held for sale to customers in the ordinary course thereof. Petitioner does not deny the nature of its business activity and the purpose for which the Sage timber was held. Nor does it claim that the timber comes within the definition of section 117(a) (1), supra. In fact, petitioner bases its entire case upon the applicability of section l17(j). In this connection, petitioner's position is summed up in its statement on brief that section 117(j) "includes timber to which Section 117(k)(2) is applicable and allows capital gain treatment of income therefrom without regard to the nature of the taxpayer's business or the purpose for which the timber is held." (Emphasis supplied.)

The view thus expressed is in direct conflict with the plain wording of the statute relied upon. Section l17(j), by its own language, specifically excludes from its operation all property held for sale to customers in the ordinary course of business. This being true, the gains derived from the sale of the Sage timber, regardless of the time of such sale, would not qualify for capital gains treatment under either section l17(a)(1) or section l17(j).

While there is no direct evidence of the precise terms of the oral cuffing contract entered into between petitioner and Coast, such contract, for aught that is shown, looked immediately to the severance and removal of all timber standing upon the Sage Tract. Under the provisions of the Uniform Sales Act which was enacted in California in 1931 (See title 1, Sales of Goods, Stats. 1931, ch. 1070, p. 2234, sec. 1; Cal. Civ. Code Ann. secs. 1721-1800 (West)), the sale of "things attached to or forming a part of the land," which category includes fructus naturales, or standing timber, pursuant to a contract according to the terms of which the trees are to be severed and removed as soon as possible, is a sale of goods, i.e., personalty, and not of an interest in land. See sec. 1796, supra; Brown, Personal Property sec. 164 (2d ed.). Thus it is, that, in our opinion, petitioner's cutting contract with Coast was fully enforceable by the latter in the California courts and not invalid for noncompliance with the Statute of Frauds. See sec. 1091, supra; see, also, secs. I723, 1724, supra. By being allowed access to the Sage Tract and by beginning its logging operations, Coast partly performed on its contract with petitioner and by such partial performance removed the contract from the application of the Statute of Frauds. McGinn v. Willey, 24 Cal. App. 303, 141 Pac. 49; cf. Forbes v. City of Los Angeles, 101 Cal. App. 781,282 Pac. 528; 101 A. L. R. 923; see sec. 1724, supra.

Accordingly, it is our view that petitioner's oral agreement with Coast, under either rationale, constituted a disposition of the Sage timber within 6 months of the acquisition thereof in direct opposition to the specific statutory language defining capital gains. See sec. 117 (k) (2), supra, and footnote 2.

The recent case, L. D. Wilson, 26 T.C. 474, is clearly distinguishable from that now before us. There the issues framed were whether the partnership, of which the petitioners therein were members, could be considered the "owner" of the timber in question within the intend-merit of section 117(k)(2), supra, and, if so, whether the timber cutting arrangement involved was sufficient to constitute a "disposal" of the timber within the scope of the statute involved. We answered both questions in the affirmative.

In the instant case, albeit the existing oral cutting arrangement between petitioner and Coast constitutes a valid cutting contract for the disposition of the Sage timber, such contract does not meet the prerequisites of a "disposal" within the statutory purview, in that at the time it was entered into, petitioner had been the owner of the Sage timber for a period of less than 6 months. Nor, contrary to the instant case, could the partnership in L. D. Wilson, supra, on the facts there present, be considered as having been in the trade or business of selling stumpage to customers in the ordinary course of such business.

In view of all the foregoing, respondent's determination on this point is affirmed.

The second issue involves petitioner's allegation that an erroneous basis for depletion was applied by both petitioner and the respondent to timber cut from its property in the taxable years.

The facts adduced herein show that the amount of recoverable units of timber standing on the Sage Tract was substantially less than the original estimate which was used in computing petitioner's depletion allowance at $3.941566 per thousand board feet. Petitioner first became aware of the error in 1952 and upon an actual cruise made shortly following the Cessation of logging activities in November 1954, the amount of fall down was ascertained to be approximately 48 per cent.

Petitioner here seeks revision of its depletion allowance for the years 1948 and 1949, citing section 23(m), Internal Revenue Code of 1939, ⁴ and our opinion in ,Marion A. Burr Beck, 15 T. C. 642, aff'd. 194 F. 2d 537, as authorizing such adjustment. Petitioner reasons that since the amount of fall-down in its timber resources was readily ascertainable at all times during the taxable years, a revision of its depletion allowance should be made effective for those years. We do not agree.

The Beck case does not stand for the proposition advanced by the petitioner. There the taxpayer was contesting a downward revision by respondent of her depletion allowance for the years there involved. However, the record made in that proceeding was adequate to warrant our finding as a fact that the taxpayer on the basis of facts known and reasonably ascertainable in the taxable years had discovered the discrepancy between the amount of units of ore actually recoverable and the prior estimates thereof. This being true, we sustained respondent's action, saying, in part:

The statute does not imply that the party to whom it would be ma immediate tax-wise advantage to suppress the information, of a need for adjustment, has any privilege not to come forward and make the necessary correction in the return. * * *

The evidence here affords us no basis for making any finding that petitioner at any time in the taxable years knew or even suspected that its prior estimate of standing timber was erroneous. Albeit such; error was readily ascertainable, it was not in fact ascertained at any time within either of the taxable years, In our view, therefore, the: revision sought by petitioner does not qualify under the statutory provision that the allowance "for subsequent taxable years shall be based upon such revised estimate." Cf. Petit Anse Co. v, Commissioner, 155 F. 2d 797, certiorari denied, 329 U. S. 732. Respondent's determination on this issue is approved.

Reviewed by the Court.

Decision will be entered/or the respondent.

MURDOCK, J., dissenting: The legislative history of section 117(k) indicates clearly that Congress was trying to give capital, gains treatment to timber owners when they disposed of their timber. See Helga Carlen, 20 T.C. 573. This taxpayer seems to come precisely within the terms of section l17(k) (2) and, therefore, is entitled to its benefits.

I also have doubt on the depletion issue, The facts in regard to the true content were reasonably ascertainable during the taxable year, and under such circumstances a reasonable allowance for depletion could be based on such ascertainable facts.

This proceeding involves Federal income taxes for the years 1948 and 1949 in the aggregate amount of $38,304.21.

In an opinion promulgated September 28, 1956, this Court, on the facts then before us, held that petitioner was not entitled to capital gains treatment under section 117(k)(2) of the Internal Revenue Code of 1939 ¹ on amounts received by petitioner in 1948 and 1949 from Coast Redwood Co. for timber cut by it from the property of petitioner. Ah Pah Redwood Co., 26 T. C. 1197 (1956).

Petitioner appealed, and on December 13, 1957, the Court of Appeals for the Ninth Circuit issued its opinion, affirming our holding as to allowable depletion and that petitioner was not entitled to capital gains treatment under section l17(k)(2). Ah Pah Redwood Co. v. Commissioner, 251 Fed. (2d) 163. The appellate court noted, however, that in second supplemental briefs, fried at the request of the court, both parties had called attention to the fact that capital gains treatment is available for absolute sales of timber under either section 117 (a) (1) or 117 (j)(1), provided, that the six-month-holding-period requirement is met, and that the timber was not held primarily for sale to customers in the ordinary course of trade or business. The court concluded that the only factor preventing the application of these last-mentioned Code sections to the case at bar was that petitioner may have held the timber primarily for sale to customers in the ordinary course of its trade or business. The court then remanded the case for further proceedings and a determination as to whether petitioner was entitled to capital gains treatment under section l17(a)(1) or (j)(1).

The only question presently before us is whether petitioner held the timber primarily for sale to customers in the ordinary course of its trade or business.

A new stipulation of facts with accompanying exhibits, filed by the parties pursuant to a motion granted by this Court on July 11, 1958, has clarified the facts in issue. In this situation a new or revised findings of fact is required.

The petitioner, a California corporation, was organized on June 23, 1947. The returns for the periods here involved were filed with the collector of internal revenue for the district of Oregon. Petitioner used the calendar year for reporting its income.

The articles of incorporation reveal that petitioner was formed; inter alia, to engage in the business of buying, selling, and owning timber and of carrying on a general logging and lumber business. This purpose included the manufacturing, selling, processing, and shipping of lumber and related products; the construction, ownership, and operation of sawmills, tanbark mills, and pulp mills, as well as tram-roads, railroads, and steamships; and the acquisition, holding, improving, encumbering, developing, and exchanging of real and personal property of every kind.

The capital stock of petitioner was originally owned by A. K. Wilson, who was its president from its inception and during the taxable years.

On September 29, 1947, all of petitioner's outstanding capital stock was acquired by International. Pacific Pulp & Paper Company, hereinafter referred to as International, an Oregon corporation which, during the years involved, was actively engaged in a substantial sawmill and lumber business. Its plant was located in Portland, Oregon.

Wilson owned one share of the common and five shares of the preferred stock of International. He was its president during the taxable years in question. The majority of International's stock was owned by Union Bond & Trust Company.

Coast Redwood Co., hereinafter called Coast, was incorporated under the laws of California in 1945 for the purpose of engaging in the business of logging and manufacturing lumber. During the years in question its sawmill was located in Arcata, Humboldt County, California. The capital stock of Coast was owned by Wilson and members of his family. Wilson has been its president since its inception.

Union Bond & Trust Company, hereinafter referred to as Union, is an Oregon corporation. Its stock is owned by Union Mortgage Company. Wilson has been its president since Union Mortgage Company acquired the capital stock of Union, a period which includes the tax years in question. Wilson owns 29 per cent of the capital stock of Union Mortgage Company.

On December 13, 1946, Sage Land & Lumber Company, Inc., as seller, and Union, as buyer, entered into a purchase agreement (hereinafter referred to as the Sage Agreement or Sage B Agreement) covering certain redwood timberlands in northern California. Subsequently, Union transferred its right, rifle, and interest under the Sage Agreement to International. On September 29, 1947, International reassigned its interest in the Sage Agreement to Union which in turn assigned and transferred it to petitioner.

The minutes of a special meeting of the board of directors of International called on September 29, 1947, include the following paragraph:

The President and Chairman of the Board, Mr. A. K. Wilson, announced that the Ah Pah Redwood Co. was ready, wining and able to purchase the Sage 'B' agreement dated December 13, 1946, between the Sage Land & Lumber Company, Inc., and Union Bond & Trust Company, which covers 6757.90 acres of land in Northern Humboldt County, California, for the sum of $446,840.99 for the equity of this Corporation in said Sage 'B' agreement. The purchase price of said equity is to be paid $99,500.00 cash as the down payment with a note of the Ah Pah Redwood CO. for the balance of $347,340.90. The Directors were reminded that as of this morning the Ah Pah Redwood Co. was a wholly owned subsidiary of this Corporation, and that .any profit realized from the Sage 'B' agreement would work to the benefit of this Corporation. A statement was made that the note referred to in this paragraph was not the type of note that was to be guaranteed by A. K. Wilson, and would not be guaranteed by A. K. Wilson, but would be the sole obligation of Ah Pah Redwood Co.

On the same day, September 29, 1947, petitioner agreed to allow Coast to cut timber on the Sage lands and pay $5 per thousand feet as removed. This arrangement was an oral or implied contract. The following schedule shows the monthly transactions between petitioner and Coast involving Sage B timber during the years 1948 and 1949:

1948	Board Feet of Timber Sold	Sales Price
January	796,232	$ 3,981.16
February	1,057,086	5,285.43
March	2,066,124	10,330.62
April	1,650,335	8,251.68
May	1,508,049	7,540.25
June	1,615,717	8,078.58
July	1,100,406	5,502.03
August	2,206,344	11,031.72
September	1,529,882	7,649.41
October	234,493	1,172.47
November	33,624	168.12
December	271,485	1,357.43
	14,069,777	$70,348.90
1949
January		0
February		$ 69.65
March	1,223,043	6,115.22
April	1,645,403	8,227.02
May	1,494,205	7,471.02
June	1,383,242	6,916.21
August	2,403,066	12,973.82
September	1,763,486	8,817.43
October	1,503,354	7,516.77
November	1,789,906	8,949.53
December	1,241,579	6,207.90
	16,584,453	$83,880.76

In the taxable years 1948 and 1949 petitioner reported its income from the sales of timber to Coast as long-term capital gain.

On February 19, 1948, petitioner sold 79,752,000 board feet of the Sage timber to Walter F. Foster at $5 per thousand feet. On May 17, 1948, petitioner sold an additional 91,247,000 board feet of the Sage timber to Foster. These sales were made pursuant to a deferred payment plan. Foster assigned his interest in the Sage timber to Big Tree Timber Company. Subsequently, the buyer, Big Tree Timber Company, defaulted in the payments, the contracts of sale were cancelled, and the timber was repossessed by petitioner.

On .January 9, 1950, petitioner entered into a formal-written agreement with Coast for the :sale of the Sage 'timber. Petitioner sold 18,575;000 board feet of Sage timber to A. K. Wilson Lumber Company in 1950 and 15,308,000 board feet in 1951." The latter company was a California corporation formed, for the" Purpose of manufacturing and selling lumber. The company mill is located at Los Angeles, California. Its capital stock is owned by Wilson and members of his family and Wilson was its president during the tax years in question.

On May 30, 1950, Coast sold its interest as buyer under the agreement of January 9, 1950, to Union, reserving the right to continue logging the Sage timber at the rate of $5 per thousand board feet.

In 1946 and 1947, .prior to the acquisition by the petitioner of the Sage timber, International sold 16,022,060 board feet of the Sage timber to Coast.

Petitioner did not advertise the Sage timber for sale. It did not employ salesmen and it did not solicit offers from buyers. Nor did petitioner log or mill the Sage timber. It had no logging equipment and no sawmill and did not log timber or manufacture lumber during the taxable years.

Throughout the years 1948 and 1949 petitioner did not .hold the Sage timber primarily for 'sale to customers in the ordinary course of its trade or business.

VAN FOSSAN, Judge: This case was remanded to us to determine whether petitioner is entitled to capital gains treatment Under section l17(a)(1) or (j)(1) of the Internal Revenue Code of' 1939. ² That question turns on whether' or not petitioner held the timber in the Sage B Agreement primarily for sale to customers in the ordinary course of its trade or business.

It will be noted that the question before us is purely a question of fact. It will be noted further that we have made the ultimate finding of fact that throughout the years in question petitioner did not hold the Sage timber primarily for sale to customers in the ordinary course of its trade or business. This holding represents our conclusion after consideration of the entire record and is dispositive of the case. It follows that petitioner is entitled to use the capital gains method of computing its taxable income as to income arising from timber sold during the taxable years 1948 and 1949 and after expiration of the statutory period.

Decision will be entered under Rule 50.

1 The stipulation, as well as the petition, reads "Director," but this is obviously erroneous inasmuch as such office did not come into being until after the taxable years.

2 SEC. 117. CAPITAL GAINS AND LOSSES.

(j) GAINS AND LOSSES FROM INVOLUNTARY CONVERSION AND FROM THE SALE OR EXCHANGE OF CERTAIN PROPERTY USED IN THE TRADE OR BUSINESS.-