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Lark Sales Co. v. Commissioner of Internal Revenue

December 9, 1970


Hastings, Senior Circuit Judge, and Cummings and Pell, Circuit Judges.

Author: Pell

PELL, Circuit Judge.

Taxpayer, Lark Sales Company, an Illinois corporation, appeals from the decision of the Tax Court which sustained, in part, the determination of deficiencies against Lark by the Commissioner of Internal Revenue in the amounts of $109,791.04, $93,635.42, $69,875.71 and $52,118.70 for the respective years of 1955, 1956, 1957 and 1958.*fn1 The Tax Court redetermined the deficiencies in the amounts of $106,425.24, $57,410.80, $41,355.22 and $10,771.78. The decision of the Tax Court is reported at 27 T.C. M. 1224.

The issues on this appeal are almost purely factual. The record before us consists of 1148 pages of oral testimony, a voluminous number of exhibits, 2280 pages of briefs and appendices and a Tax Court opinion of 211 pages. The factual situation resulting in the determination of the deficiencies is a conglomerate mass of confusing and often inconsistent contractual arrangements between various individuals and corporations. Inasmuch as these instruments are fully referred to in the reported decision of the Tax Court, little purpose would be served by setting them forth in this decision. It seems unlikely that the precise factual morass involved in this case will again present itself. Accordingly, we are in this decision confining ourselves simply to the basic facts necessary for the purpose of the decision.

One Harry Oltz patented a soft ice cream freezer, which became the basis of the Dairy Queen ice cream business eventually established through the efforts of one H.A. McCullough. Oltz and his family primarily operated through Ar-Tik Systems, Inc., a corporation. McCullough, his family and his accountant, L.S. Murchie, operated through various corporations as well as individually. Oltz's patent expired in 1954 and apparently much of the machination arose from an effort to preserve royalty rights subsequent to the patent expiration.


Royalty payments under the so-called Eastern Agreement were to be collected and of this 2 cents, known as "2 cents East," was to be paid by Ar-Tik to McCulloughs Dairy Queen.

The first issue presented for our review concerns the ownership of, and thus the tax liability for, the 2 cents East income for the years 1956, 1957 and 1958. Both the Commissioner and the Tax Court found that Lark was the owner of the 2 cents East royalty right during these years.

In 1947 certain of the McCulloughs purported to assign 2 cents East to Ilco-Mac Venture which in turn, by a bill of sale dated December 30, 1950, transferred its rights to the Micro Manufacturing Company. Both of these entities were dominated by Murchie.

By an agreement dated April 2, 1954 the McCulloughs, in apparent disregard of the earlier assignment, transferred the ownership of 2 cents East to Lark. This transfer purported to be complete and absolute on its face.

The April 2, 1954 agreement was attached as an exhibit to yet another agreement, the so-called "Lark/Ar-Tik Agreement" dated December 31, 1954 but executed February 25, 1955. So far as here relevant, this agreement gave Lark the right to collect money due Ar -Tik under the Eastern Agreement and provided that Lark should remit such collections, after certain deductions, to Ar-Tik on a monthly basis.

Lark contends that the Tax Court erred in three respects in finding that it was the owner of 2 cents East.

Lark's first contention was that Micro was the owner of this royalty by virtue of the 1950 bill of sale. While we do not agree with the Tax Court's finding that it could not identify the 2 cents royalty referred to in the 1950 bill of sale with 2 cents East, we do not find persuasive evidence of Micro's ownership. Micro paid no consideration for the alleged transfer to it of 2 cents East. All the collections of 2 cents East made by Ar-Tik prior to the Lark/Ar-Tik Agreement were remitted directly to the McCulloughs and never to Ilco-Mac or Micro. In 1953, the McCulloughs, not Micro, signed a supplement to the Eastern Agreement. During the negotiations leading to the Lark/Ar-Tik Agreement, Murchie, who was conducting the negotiations and who owned and controlled Micro, never gave any indication that Micro, rather than the McCulloughs, was the owner of 2 cents East.

Lark next contends that the negotiations leading to the execution of the Lark/Ar-Tik Agreement show that 2 cents East was transferred to Lark only to provide Ar-Tik with security under that agreement. While it is true that an absolute transfer on the face of a document may under some circumstances be shown actually to be a security device, it does not necessarily follow that because Ar-Tik, for purposes of its own security, wished Lark to have "some substance" that Lark acquired only a security interest in 2 cents East.

It would seem more consistent with Ar-Tik's purposes that Lark be given absolute ownership of the asset rather than a mere security interest subject to the claims of the true owner. The record supports this as being the intent of the parties. At the time the negotiations were taking place between Lark and Ar-Tik, Ar-Tik's attorney prepared a memorandum letter to his co-counsel and his principal noting that "the substance in Lark is now to be created by the assignment of the 2 cents due on the Eastern Contract to Lark which would become Lark's property. * * *" In the Tax Court, he testified that the agreement reached was for the vesting of the ownership of 2 cents East in Lark and that this was "vital" to Ar-Tik.

Finally, Lark contends that the conduct of the various parties supports its interpretation of the above agreements. It is true that in years prior to the Lark/Ar-Tik Agreement, amounts remitted to the McCulloughs as 2 cents East income were reported as income on the returns of Ilco-Mac and Micro. However, the record also shows that the claimed income was never in fact paid over to Micro. Further, despite Lark's assertion that it was merely an agent to collect for both Micro and Ar-Tik, collections of 2 cents East were credited on its books to "Lark Accommodation Credits" and were retained by Lark as income. In contrast, Lark's collections of royalties due Ar-Tik were credited to "Ar -Tik Accommodation Credits" and were eventually remitted to Ar-Tik in one form or another. Thus, Lark's own conduct as revealed by the record indicates that it claimed greater rights to 2 cents East collections than it did to other royalty collections.

The question of the ownership of 2 cents East under the array of agreements and assignments which we have attempted to outline briefly is a purely factual one. Our review of the decision of the Tax Court is limited accordingly. It is well settled that factual findings of the Tax Court must stand unless shown to be clearly erroneous within the meaning of Rule 52(a), Fed. R. Civ. Proc. Commissioner of Internal Revenue v. Duberstein, 363 U.S. 278, 291, 80 S. Ct. 1190, 4 L. Ed. 2d 1218 (1960); Tripp v. Commissioner of Internal Revenue, 337 F.2d 432, 434 (7th Cir. 1964). This standard is also applicable to factual inferences drawn from undisputed basic facts. Duberstein, supra. Where the evidence would support either of two permissible conclusions, the choice of the Tax Court between them is not clearly erroneous. United States v. Yellow Cab Co., 338 U. S. 338, 342, 70 S. Ct. 177, 94 L. Ed. 150 (1949). A finding of fact is clearly erroneous only when, although there is evidence to support it, the reviewing court on the basis of all the evidence is left with the definite and firm conviction that a mistake has been committed. United States v. United States Gypsum Co., 333 U.S. 364, 395, 68 S. Ct. 525, 92 L. Ed. 746 (1948).

We have carefully reviewed the entire record pertaining to the ownership of 2 cents East and have attempted to summarize the most relevant aspects of it. The facts and circumstances revealed therein are at least as consistent with the findings of the Tax Court as with Lark's contrary position. In such a case, the decision of the Tax Court to draw one, rather than the other, permissible inference cannot be said to be clearly erroneous. Yellow Cab, supra, 338 U.S. at 342, 70 S. Ct. 177. This is particularly so here for "findings as to the design, motive and intent with which men act depend peculiarly upon the credit given to witnesses by those who see and hear them." Id. at 341, 70 S. Ct. at 179. Thus the Tax Court did not err in concluding that Micro did not own 2 cents East during 1956, 1957 and 1958, that Lark did own it during those years and that its ownership was complete and not confined to a security interest.


Under the Lark/Ar-Tik Agreement, Lark had the right to reimbursement from Ar-Tik for certain expenses. Paragraph 6 of the Agreement provided:

"6. Lark shall render to Ar-Tik a report of its costs of operations from time to time, which report shall show the areas occasioning such expenses and the amounts thereof, and Ar-Tik, within ten (10) days of receipt of such report, shall make payment to Lark of Ar-Tik's share of such expenses in the proportions to which Ar-Tik and Lark are sharing revenue from such area as set forth in Paragraph 5 above."

For the years 1955 through 1958, Lark kept its books and filed its federal tax returns on an accrual basis. During those four years it recorded on its books and reported in its returns the respective amounts of $93,053.34, $53,568.20,*fn2 $27,140.73 and $12,279.19 referred to as "Expense Allocations to Ar-Tik" and representing Lark's allocation to Ar-Tik of its alleged share of the costs of Lark's operations.

Lark subsequently sought to amend its returns for the years in question by deleting the above amounts from its income, contending that its right to receive such amounts was in dispute between it and Ar-Tik during the respective years and that such amounts were too contingent to be accrued as income until a settlement was reached with Ar -Tik in 1959. The Commissioner determined, and the Tax Court held, that the amounts were properly included in the returns as originally filed.

The following facts are discernible from the record. No part of the amounts accrued and claimed by Lark had been paid by Ar-Tik as of December 31, 1958. With one exception, Lark had not submitted to Ar-Tik the reports required of it by paragraph 6 of the agreement. On March 15, 1956, shortly over a year after Lark began collecting royalties for Ar-Tik under the Lark/Ar-Tik Agreement, Ar-Tik filed suit against Lark and Murchie in the Circuit Court of Rock Island County, Illinois, seeking an accounting for past collections, an injunction against future collections and damages for breach of contract. In April 1956, a temporary injunction was granted which was modified in June of the same year at Ar -Tik's request to permit Lark to make certain collections from operators who had signed territorial agreements with it. Lark was to be permitted to retain out of the amounts collected by it for Ar-Tik "authorized commitments for advertising and store services."

The only report of expenses pursuant to paragraph 6 which Lark submitted was on July 31, 1956 while the state court litigation was pending. Ar-Tik rejected this on several grounds. Included was the fact that the period prior to April 9, 1956 was before the state court and, as to the subsequent period, Ar-Tik was making its own collections and therefore was not responsible to Lark for any costs of collection. A partial accounting submitted to the state court by Lark was also objected to by Ar-Tik.

In October 1959, before any further accounting had been submitted, the parties settled the litigation. As part of the settlement agreement, Ar-Tik agreed to pay to Lark:

"(a) Ar-Tik's share of ex-

penses for the year

1955 $92,478.34

"(b) Ar-Tik's share ...

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