Intangibles were shareholder's assets, not corporate property.

In 1945, the Supreme Court held that a sale by a shareholder of property that had been distributed to him in a liquidating distribution should be treated as a sale by the distributing corporation. The Court reasoned that the corporation had in fact conducted all the negotiations and the terms of the sale had been agreed on prior to the distribution of the property (Court Holding Co., 324 US 331 (1945)). Recently, in Martin Ice Cream Company, 110 TC No. 18 (1998), the Tax Court reminded the IRS of the narrow scope of the Court Holding decision.

Arnold Strassberg and his son Martin were the shareholders of Martin Ice Cream Co. (MIC), a corporation that distributed Haagen-Dazs products to supermarket chains, independent grocery stores and food-service establishments. The distribution rights were based on an oral agreement with the founder of Haagen-Dazs. Even before the incorporation of MIC, Arnold had developed and maintained close personal relationships with the owners and managers of supermarket chains, and these relationships were largely the reason for MIC's success.

Following the acquisition of Haagen-Dazs by Pillsbury, Haagen-Dazs approached the Strassbergs about acquiring direct access to Arnold's relationships with the supermarkets and removing him as the middleman in the chain of distribution. Arnold, on his own behalf as well as for MIC, began negotiations for the sale of distribution rights in January 1988. On May 4, 1988, MIC adopted corporate resolutions authorizing the creation of a wholly owned subsidiary, Strassberg Ice Cream (SIC). Over the following weeks, Arnold, his attorney (Hewit) and representatives of Haagen-Dazs continued to negotiate the price and sale of distribution rights by MIC to Haagen-Dazs. On May 31,1988, SIC was formed. On June 6, 1988, in response to the first draft of a purchase agreement prepared by Haagen-Dazs providing for the sale of the distribution rights, Hewit informed Haagen-Dazs that Martin and MIC would not be parties to the sale transaction. In a letter sent to Hewit, a Haagen-Dazs representative stated that Haagen-Dazs would eliminate any references to Martin and MIC from the purchase agreement, but insisted that Haagen-Dazs had to acquire any and all distribution rights owned by Martin, Arnold and their respective companies.

On June 15, 1988, MIC executed documents providing for the transfer of supermarket chain and food-service distribution rights (and related business records) from MIC to SIC. MIC then, transferred all of SIC's stock to Arnold in exchange for all of his MIC stock in what purported to be a Sec. 355 split-off. Thereafter, Arnold continued to negotiate with Haagen-Dazs on behalf of himself and SIC until an agreement was signed on July 8, 1988.

The IRS argued that the consideration received by Arnold and SIC measured the gain realized and recognized by MIC as the true seller of the assets. The Service's characterization of the transaction was that Arnold negotiated the sale of assets, on behalf of MIC, and that MIC should therefore be regarded as the true seller of the assets under Court Holding. The Tax Court, however, disagreed. It determined that MIC never owned the bulk of the assets sold to Haagen-Dazs, and that Arnold, acting on Ins own behalf and as an agent for SIC (of which he was the sole shareholder), entered into a contract to sell Haagen-Dazs two distinctly different types of assets. The first asset, by far the more valuable, was the intangible asset that consisted of Arnold's rights under his oral agreement with the founder of Haagen-Dazs and his relationships with the supermarket owners and managers. These relationships formed the basis of Arnold's ability to direct the wholesale distribution of Haagen-Dazs ice cream to the supermarkets, and the ultimate success of the business. The second asset sold was the business records that had been created by MIC during Arnold's development of the supermarket business, and transferred by MIC to SIC.

The Tax Court determined that the intangible assets could not be attributed to MIC; Arnold never entered into a covenant not to compete (or any other agreement) with MIC by which any of Arnold's distribution agreements, his relationships with the supermarkets or his ice-cream expertise became property of MIC. Because an employee-shareholder's personal relationships are not corporate assets when the employee has no employment contract with the corporation, those personal assets are entirely distinct from corporate goodwill.

The Tax Court distinguished this case from Court Holding Co., noting that the change in the identity of the sellers was not a last-minute alteration in a deal that had already been consummated or whose terms had been completely negotiated. Rather, the final agreement was a new deal significantly different from its predecessor, both in terms of what would be sold and who would receive the proceeds.

However, it agreed with the IRS's determination that the distribution of SIC stock to Arnold in redemption of his MIC stock did not qualify for non-recognition under Sec. 355. Rather, MIC had to recognize gain to the extent that the fair market value of the SIC stock exceeded MIC's adjusted basis in the SIC stock.

This case highlights a sole shareholder's opportunity and ability to avoid corporate-level gain on the disposition of self-created intangibles, by retaining the intangible business assets personally rather than transferring them to a corporation. Such intangibles could then be provided to the corporation for a fee, creating a potential deduction for the corporation that it would not otherwise be allowed if it made a dividend distribution of a similar amount to the shareholder.