Unpublished Disposition, 920 F.2d 936 (9th Cir. 1989)

Annotate this Case
U.S. Court of Appeals for the Ninth Circuit - 920 F.2d 936 (9th Cir. 1989)

Lawrence R. PERRYMAN, Alice M. Perryman, Petitioners-Appellants,v.COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 89-70325.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted Dec. 13, 1990.Decided Dec. 17, 1990.

Before HUG, BEEZER and BRUNETTI, Circuit Judges.


MEMORANDUM* 

On October 28, 1985, the Commissioner of the Internal Revenue Service ("Commissioner") notified appellants Lawrence and Alice Perryman ("Perryman") of a deficiency in their taxes for the year ending December 31, 1981. The deficiency was based, among other grounds, upon the Commissioner's allocation to Perryman of the proceeds from the sale of two oil rigs rather than to Perryman's wholly owned corporation. Perryman filed a petition in United States Tax Court on January 24, 1986, for a redetermination of the deficiency. In an opinion filed on August 16, 1988, the tax court upheld the Commissioner's determination. The decision was entered on May 4, 1989. This appeal followed.

FACTS AND PROCEEDINGS

The facts in this case are not disputed. In August, 1981, Perryman became the sole proprietor of P & C Enterprises ("P & C"). P & C owned two oil rigs ("rig 1" and "rig 2"). Perryman was also the sole shareholder of Drilling Rigs, Inc. ("DRI") which owned a third drilling rig ("rig 3"). A fourth drilling rig ("rig 4") was built by Perryman in 1981 but had not been put into service at the time of the pertinent transactions. The tax treatment of transactions involving rigs 3 and 4 are not in dispute.

P & C and DRI leased rigs 1, 2, and 3 to Perryman Drilling Co., Inc. ("PDC"), a corporation wholly owned by Perryman.1  PDC was engaged in the business of contracting with oil companies to do the companies' drilling using the rigs leased from P & C and DRI. The lease agreements required PDC to provide property insurance for rig 1 and rig 2 and liability insurance for claims arising out of the leases of the rigs. Perryman never purchased property insurance for the rigs or personal liability insurance.

On July 30, 1981, Perryman met S. Edward Tomaso ("Tomaso") to discuss the potential sale of rig 4 by DRI to Tomaso. On August 17, 1981, Perryman indicated to Tomaso that he was interested in selling rigs 1, 2, and 3. The tax court found that " [o]n or before September 1, 1981, ... [Perryman] and Tomaso had reached agreement concerning the basics for the sale of all four rigs."

On September 1, 1981, Perryman, as sole shareholder of DRI, caused DRI to adopt a resolution by which Perryman would contribute rigs 1 and 2 to DRI in exchange for DRI's assumption of approximately $2,500,000 in debts secured by the rigs. The amount of assumed debt was the amount that Perryman believed would result in no recognized gain under the Internal Revenue Code.2  Perryman testified that he contributed the rigs to DRI to consolidate his operations and to protect him from liability. The assumed loans were held by First Interstate Bank. Perryman did not notify the bank of the September 1, 1981, change in ownership nor effect a change of ownership on the financing statement with the California Secretary of State.

On September 2, 1981, Perryman and Tomaso signed a "Letter Agreement" which "summarize [d] the verbal agreements between" Perryman and Tomaso. The letter agreement provided for the sale of rigs 1-4. Tomaso agreed to purchase rigs 1, 2, and 3 for $5,850,000. The agreement stated that it was "conditioned upon the buyers obtaining a loan in the amount of $6,450,000 ... by Oct. 31, 1981."

A single bookkeeper kept all records connected with DRI, PDC, and P & C. P & C billed PDC for the use of rigs 1 and 2, pursuant to the lease agreements, through December 1, 1981. DRI billed PDC for the use of the rigs for the period December 2, 1981 to December 28, 1981. PDC paid the bills to P & C and DRI according to the bills. Perryman's 1982 tax return (including income received as sole proprietor of P & C) included the payment received from PDC for the billed period before December 2, 1981. The relevant tax return for DRI reported income from the leases only for the period after December 1, 1981. The DRI return also listed deductions for interest payments made in connection with rigs 1 and 2 after December 1, 1981. Deductions for interest payments made prior to that time were listed on Perryman's return. Depreciation deductions for the rigs taken by Perryman and DRI also reflected the December 1, 1981, change in ownership date.

On October 28, 1981, DRI adopted a plan of complete liquidation. Under the plan, all corporate assets would be sold to Tomaso pursuant to the letter agreement and all proceeds from the sale would be distributed to Perryman as sole shareholder.

On November 12, 1981, Gardner Spring, a finance consultant hired by Tomaso, submitted a request to First Interstate Bank for term loan financing for the purchase of rigs 1 through 4. The request stated that "Perryman will convey all of this personal drilling rig interest in [DRI]." An addendum to the financing statement filed by Spring on December 21, 1981, stated that Perryman transferred the rigs to DRI on December 2, 1981. Spring testified that this date was provided to him by Tomaso.3 

On December 10, 1981, DRI and Tomaso entered into a final "Agreement to Purchase and Sale of Equipment." The agreement provided for the sale of rigs 1, 2, and 3 and equipment for $6,000,000. The closing date was December 28, 1981.4  On February 24, 1982, DRI distributed to Perryman, pursuant to the plan of complete liquidation, $2,899,741.

Subsequent to the sale, DRI reported a sale of rigs 1, 2, and 3 for a realized gain of $2,466,567. $644,164 of this gain was recognized as section 1245 recapture income. The remainder was not recognized by DRI pursuant to section 337 of the Code.5  The recognized gain was partially offset by net operating losses carried forward from the previous year. Perryman reported no gain on his 1981 tax return on the contribution of the rigs to DRI pursuant to section 351 and on his 1982 return reported the distribution in liquidation of DRI as capital gain income.

On October 28, 1985, the Commissioner sent Perryman a deficiency notice based on calculations that ignored the transfer of rigs 1 and 2 to DRI and treated the sale of the rigs as a sale by Perryman to Tomaso. The Commissioner also reallocated rental income, depreciation, and interest expenses on the rigs to December 28, 1981, to Perryman. Perryman filed a petition for a redetermination of the deficiency on January 24, 1986.

The tax court made ultimate findings of fact that (1) Perryman transferred rigs 1 and 2 to DRI on December 2, 1981; (2) prior to the transfer Perryman agreed to sell the rigs to Tomaso; and (3) Perryman, and not DRI, sold the rigs to Tomaso. The tax court concluded that

the technical corporate form of ownership of the rigs at the time of sale will be ignored, and that the income from the sale of rig 1 and rig 2 is attributable to petitioner pursuant to either section 482, or the substance-over-form doctrine.

On appeal, Perryman argues that the tax court erred in upholding the Commissioner's allocation of the gain from the sale of the rigs to Perryman rather than to DRI. We affirm.

ANALYSIS

The tax court found that the Commissioner's allocation of the gain from the sale of the rigs was proper under either section 482 of the Internal Revenue Code or the substance-over-form doctrine. Section 482 permits the Internal Revenue Service to allocate income and deductions among related businesses if it determines that the "allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such ... businesses." 26 U.S.C. § 482. The substance-over-form doctrine is applied by the Commissioner to deny legal effect to a transaction even though structured to satisfy the requirements of the Internal Revenue Code when the purpose of the transaction was to evade taxes. Stewart v. C.I.R., 714 F.2d 977, 987 (9th Cir. 1983). See also Comm'r v. Court Holding Co., 324 U.S. 331, 334 (1924) ("A sale by one person cannot be transformed for tax purposes into a sale by another by using the latter as a conduit through which to pass title.").

The analysis under both section 482 and the substance-over-form doctrine in the present case is essentially identical. See Stewart, 714 F.2d at 989. Under section 482 the tax court must determine if the proceeds from the sale of the rigs to Tomaso must be allocated to Perryman "in order to prevent evasion of taxes or clearly to reflect ... income." See id. Under the substance-over-form doctrine the tax court determines whether DRI was "merely a conduit for the sale of [the rigs] by [Perryman]." Id. Both theories "have been held to limit the extent to which a taxpayer may obtain nonrecognition treatment under section 351 for a transaction that appears formally to fall within the bounds of the provision." Id.

Section 482 provides the Commissioner with broad discretion in allocating income and deductions and " 'neither we nor the Tax Court will countermand his decision unless the taxpayer shows it to be unreasonable, arbitrary or capricious.' " Foster v. C.I.R., 756 F.2d 1430, 1432 (9th Cir. 1985) (citation omitted). The tax court's finding that Perryman, and not DRI, was in substance the seller of the rigs will not be reversed unless the finding was clearly erroneous. Stewart, 714 F.2d at 992. We will not set aside findings of fact made by the tax court unless they are clearly erroneous. Id. at 990 n. 17.

Perryman argues that the Tax Court's finding that rigs 1 and 2 were transferred on December 2, 1981, is clearly erroneous. We disagree. P & C billed PDC for use of the rigs through December 1, 1981. PDC paid P & C for this period. From December 2, 1981 to December 28, 1981, PDC paid DRI for use of the rigs. Perryman, as sole proprietor of P & C was allocated interest expense and depreciation deductions and rental income related to the rigs until December 1, 1981. Thereafter, until the rigs were sold to Tomaso, these tax items were allocated to DRI. Although DRI adopted a resolution that the rigs were contributed on September 1, 1981, Perryman nor anyone else filed a new financing statement reflecting any change of ownership on that date. A request for financing filed by Spring on behalf of Tomaso filed on November 12, 1981, stating that Perryman will convey the rigs to DRI indicates that the rigs had not yet been so conveyed. An addendum to the request stated that the rigs were transferred to DRI on December 2. Perryman argues, without citing to the record, that

[t]he tax allocation errors and Spring's use of the December 2, 1981, date were explained by the testimony at trial. The bookkeeper's lack of knowledge as to the transfer of the rigs was also explained at trial. The December 2, 1981, date was the result of confusion caused by inadvertent mistakes because of false assumptions, lack of communication, and the reliance on what Tomaso probably told Spring which was thereafter relied upon by [Perryman's accountant].

The trial court considered this testimony but found that "the witnesses' actions speak louder than their words." This court gives "special deference" to a trial court's determinations of witness credibility. S.E.C. v. Rogers, 790 F.2d 1450, 1455 (9th Cir. 1986). The Tax Court's finding that the rigs were contributed to DRI on December 2, 1981, and not on September 1, 1981, is not clearly erroneous.

Perryman contests the Tax Court's finding that he agreed, prior to the transfer of the rigs to DRI, to sell the rigs to Tomaso.6  Perryman argues that there was no agreement to sell the rigs until the final "Agreement to Purchase and Sale of Equipment" was entered into on December 10, 1981. On September 2, 1981, Perryman and Tomaso signed a "Letter Agreement" summarizing their verbal agreements providing for the sale of the rigs. Perryman argues that this was not an agreement to sell because it was incomplete and conditional upon Tomaso obtaining financing. Although the financing condition, if not fulfilled, may have prevented the sale from taking place, it does not preclude the finding that the Letter Agreement was an agreement to sell the rigs. The letter agreement stated that Perryman and Tomaso "agree to enter into formal agreements with respect to the ... Purchase [of] Drillings Rigs # 1, 2, and 3.... This Agreement shall bind and inure to the benefit of the respective heirs, personal representatives, successors, and assignees of the parties hereto." Perryman treated the letter agreement as a contract. The plan of liquidation adopted by DRI on October 28, 1981, referred to the sale of assets to Tomaso pursuant to the letter agreement as a "contract of sale." We conclude that the Tax Court's finding that there was an agreement prior to the December 2, 1981, transfer of the rigs to DRI is not clearly erroneous.

Notwithstanding the Tax Court's findings that Perryman agreed to sell the rigs prior to transferring them to DRI, the transfer may arguably be given legal effect if it was done for business purposes and not for purposes of tax evasion. " [T]ransactions are to be taken at face value for tax purposes only if they are imbued with a 'business purpose' or reflect 'economic reality'." Bittker, Pervasive Judicial Doctrines in the Construction of the Internal Revenue Code, 21 How. L.J. 693, 695 (1978) (quoted in Stewart, 714 F.2d at 988). At trial, Perryman justified the transfer on the grounds that it was done for the purpose of consolidating his leasing operations and to limit his liability from the risks of operation of the rigs. At the time the rigs were transferred to DRI, however, DRI had already adopted a plan of liquidation. The Tax Court found that although Perryman desired to consolidate the rigs into DRI, " [t]he consolidation was rather for purposes of the sale to Tomaso, and was the precise type of consolidation intended to be avoided by both section 482 and the substance-over-form doctrine." The Tax Court also dismissed Perryman's argument that he was attempting to limit his personal liability by placing the rigs in a corporate shell. PDC, the court noted, already provided full insurance for any liability Perryman may incur in connection with the rigs. On appeal, Perryman does not directly contest these findings stating only that "he had business reasons for contributing the rigs to DRI." Viewing the transaction as a whole, the Tax Court's finding that the purpose of the transfer was not motivated by business concerns but rather by Perryman's desire to evade taxes is not clearly erroneous.7  The Tax Court properly upheld the Commissioner's determination.

Perryman relies on Smalley v. Comm'r, 32 T.C.M. 373 (1973) and United States v. Cumberland Pub. Serv. Co., 338 U.S. 451 (1952). In Smalley, the taxpayer was the controlling shareholder of Smalley Corporation. The taxpayer had entered into negotiations to merge the corporation with a second corporation, Moxie Co. The controlling shareholder of Moxie expressed concern over the large debt obligations of Smalley Corporation. 32 T.C.M. at 375. A creditor of the corporation also expressed such concern. To reduce the debt, Smalley contributed certain stock to the corporation. The corporation later sold this stock and applied the proceeds to reduce in indebtedness. The Commissioner argued that the sale of stock was, in substance, a sale by the taxpayer.8  32 T.C.M. at 378-79. The taxpayer argued that the contribution and sale by the corporation of the stock were made for business reasons because of the corporation's creditor's strong advocation to reduce its liabilities and that reducing its liabilities were necessary for the success of the merger. The tax court concluded "that these reasons furnished a sufficient non-tax purpose for contributing the stock to the capital of Smalley Corporation." Id. at 379.

Perryman argues that Smalley is analogous. In both cases the taxpayer sold property to a controlled corporation which in turn sold it to others. Here the similarities end, however. Perryman makes no claim, nor could he, that the contribution and sale was made to reduce DRI's debt. Tomaso had no interest in buying the rigs from DRI rather than from Perryman. The transfer and sale were not advocated by anyone other than Perryman. As the Smalley court stated, " [e]ach case must be decided on its own merits." Id. (citing United States v. General Geophysical Co., 296 F.2d 86, 88 (5th Cir. 1961). The tax court in the present case considered the merits of Perryman's arguments and found, unlike the tax court in Smalley, no sufficient non-tax purpose for the transfer of the rigs to DRI. As discussed above, this finding was not clearly erroneous.

In Cumberland, a cooperative offered to buy certain assets from the taxpayer corporation. The corporation refused to sell them. The shareholders of the corporation then arranged to acquire the assets from the corporation in partial liquidation and sell them to the cooperative. The Commissioner argued that the transaction was in substance a sale of the assets from the corporation. 453 U.S. at 451. The tax court found that "at no time did the corporation plan to make the sale itself" and upheld the taxpayer's view of the transaction. Id. Unlike the corporation in Cumberland, there is no indication that Perryman would not have sold the rigs to Tomaso if the rigs were not first transferred to DRI. The Supreme Court also stated that " [i]t is for the trial court, upon consideration of an entire transaction, to determine the factual category in which a particular transaction belongs. Here as in the Court Holding Co. case we accept the ultimate findings of fact of the trial tribunal." Id. at 456. As in Cumberland, we also accept the tax court's findings of fact.

CONCLUSION

Perryman has not shown that the Commissioner's allocations were unreasonable, arbitrary, or capricious. Consequently, the tax court's finding that Perryman, and not DRI, was in substance the seller of the rigs was not clearly erroneous.

AFFIRMED.

 *

This disposition is not appropriate for publication and may not be cited to or by the courts of this circuit except as provided by Circuit Rule 36-3

 1

Perryman owned fifty percent of PDC until June, 1981. At that time Perryman became the sole shareholder of the corporation

 2

Section 351 of the Internal Revenue Code as in effect at the time of these transactions provided for the nonrecognition of gain when property is transferred to a corporation in exchange for stock or securities of the corporation and the transferor is a controlling shareholder of the corporation. 26 U.S.C. § 351. Section 357 permits the application of section 351 where the consideration received by the transferor is the assumption of a liability of the transferor by the corporation. 26 U.S.C. § 357

 3

When Perryman's accountant was asked why he used the December 2, 1981, date in allocating payments, interest, and depreciation he answered that the date was obtained from Spring. [RT 147-148]

 4

A separate agreement for the sale of rig 4 was also entered into. [ER 28]

 5

Section 337 of the Internal Revenue Code as in effect at this time provides:

If, within the 12 month period beginning on the date on which a corporation adopts a plan of complete liquidation, all of the assets of the corporation are distributed in complete liquidation ... then no gain or loss shall be recognized to such corporation from the sale or exchange by it of property within such 12-month period.

26 U.S.C. § 337.

 6

The finding that Perryman intended to sell the rigs prior to transferring them to DRI supports the Commissioner's arguments that DRI was merely a conduit for the sale of the rigs and allocation of the proceeds to Perryman is necessary to prevent tax evasion and to clearly reflect income to Perryman. There is nothing in section 482 or the doctrine of substance-over-form, however, which requires the showing of such an agreement

 7

Perryman is entitled, of course, to "arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury." Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934), aff'd, 293 U.S. 465 (1935). Although he may seek to limit his tax liability, he may not attempt to evade taxes through transactions which have no business purpose

 8

The Commissioner in Smalley did not rely on Section 482. 32 T.C.M. at 378

Some case metadata and case summaries were written with the help of AI, which can produce inaccuracies. You should read the full case before relying on it for legal research purposes.

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.