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April 25, 1963


The opinion of the court was delivered by: Will, District Judge.

This is an action to recover federal income and excess profits taxes for the calendar years 1955, 1956 and 1959, assessed and collected allegedly erroneously and illegally by the Commissioner of Internal Revenue. The Court's jurisdiction is based on section 1346 of Title 28, United States Code.

The parties have entered into a stipulation of facts with respect to the years 1956 and 1959 which they have submitted to the Court. Furthermore, they have agreed that, if the Court determines that plaintiff is entitled to judgment in its favor, the parties will attempt to resolve between themselves the amount of the refund to which plaintiff is entitled, referring the matter to the Court only if they are unable to reach an accord.*fn1

The facts, except where noted, are undisputed. Plaintiff, a Missouri corporation, has, since its incorporation in 1907, been engaged in the operation of restaurants and other eating establishments. Until 1956, all of these establishments were located in or adjacent to railroad stations. Noting a decline in revenue and profits commencing in 1953, apparently due to diminished railroad passenger traffic, plaintiff's directors began to consider diversification of its business activities within the restaurant industry.

In February, 1956, plaintiff learned that a roadside restaurant, cocktail lounge and bar, located in Palatine, Illinois, and known as the Evergreen Supper Club, was for sale. Negotiations for purchase of this supper club were had with its purported owner, Paul A. Peterson, and were substantially concluded when he first revealed that (1) the club was owned not by him but by a corporation, the Evergreen Supper Club, Inc. (henceforth sometimes referred to as the "Evergreen corporation") of which he was the sole stockholder, (2) the restaurant stood on premises leased to the Evergreen corporation,*fn2 and (3) the lessor was unlikely to consent outright to an assignment of the lease. However, Peterson advised plaintiff that obtaining of the lessor's consent was unnecessary if plaintiff purchased the corporation itself, rather than the assets of the supper club. Plaintiff took Peterson's suggestion and, in March, 1956, bought from him for $89,982.64 all of the stock of the Evergreen corporation. Prior to this purchase, plaintiff did not inquire of the lessor or his representative whether the lessor would in fact object to such an assignment. There is no evidence that plaintiff paid any more for the stock than it would have paid for the assets alone*fn3 for it appears that the Evergreen corporation owned no assets other than those directly related to the supper club's operation.

The lease is dated September 15, 1952. It was to run for 7½ years, and the lessee had an option to renew for an additional 2½ years without any increase in rent. Paragraph 7 of the lease provides, in pertinent part, as follows:

  "Lessee will not allow said premises to be occupied,
  in whole or in part, by any other person, and will
  not sublet the same, or any part thereof, except for
  the use of the upstairs apartment and rooms by the
  personnel employed in said business, nor assign this
  lease without the written consent in each case of the
  Lessors first had, and will not permit any

  transfer, by operation of law, of the interest in
  said premises acquired through this lease, * * *."

Upon taking possession, plaintiff changed the name of the club to the Grier Supper Club, but the type of food and service offered remained substantially the same. Although none of the employees of the Grier Club, including its resident manager, were taken from plaintiff's then existing personnel, all employees were paid directly by plaintiff. The latter's profit-sharing and hospitalization plans were amended to include employees of the Grier club. In addition to paying salaries of the club's employees, plaintiff paid directly all trade account and miscellaneous expenses incurred by the club. Gross receipts from the club were deposited in its accounts, but at regular intervals funds from these accounts were transferred to plaintiff's general account. Plaintiff appointed its vice-president, W.C. Darnell, Jr., to be responsible for the operation of the Grier club. On its books of account, plaintiff carried the cost of its purchase of the Evergreen stock as "investment, Grier's Supper Club * * *."

The Evergreen corporation filed separate federal income tax returns as follows:

                              Depreciation of   Amortization
                  Taxable     Restaurant and    of Leasehold
  Year Ending     Income      Bar Equipment     Facilities
  8/31/56       $6,518.54      $6,235.98        $4,097.30
  12/31/56        2,230.32       1,427.00           971.00
  12/31/57        6,342.70       4,710.00         3,317.00
  12/31/58      (11,968.49)      4,848.00         3,444.00
  12/31/59      (11,680.92)      4,848.00         3,444.00

Between August 31, 1956 and December 31, 1958, depreciable restaurant and bar equipment was increased by approximately $4,000 (cost) and leasehold equipment was increased by approximately $3,000 (cost).

In 1959, plaintiff sold the Evergreen stock to the lessor for $14,209.12, and in its 1959 federal income tax return plaintiff claimed as an ordinary loss deduction the sum of $75,773.52, the difference between what it paid for the stock initially and the proceeds of its sale. Plaintiff sought to carry this loss back in full to 1956, and thereby to reduce that year's tax, but the Commissioner determined that the loss arose from the sale of a capital asset, and consequently he disallowed the carryback. He assessed a deficiency of $7,437.09 in tax and $388.97 in interest for 1956, and $26,049.92 in tax and $1,042.00 in interest for 1959, or a total of $34,917.98. Plaintiff paid $34,826.49 of this sum and filed a timely claim for refund. It was disallowed in September, 1961, and this litigation ensued.

There is only one issue before the Court: did the sale by plaintiff of the Evergreen stock give rise to a capital or an ordinary loss, i.e., was this a sale of a capital or of a non-capital asset. A "capital asset" is defined in section 1221 of the Internal Revenue Code, 26 U.S.C. as "property held by the taxpayer (whether or not connected with his trade or business)" but excluding

  "property, used in his trade or business, of a
  character which is subject to the allowance for
  depreciation ...

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