                      110 T.C. No. 18



                UNITED STATES TAX COURT



        MARTIN ICE CREAM COMPANY, Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 1477-93.                Filed March 17, 1998.



     A and his son M were shareholders of MIC, an S
corporation that distributed ice cream products to
supermarket chains, independent grocery stores, and
food service accounts. MIC's supermarket business was
largely attributable to the close personal relation-
ships that A had developed and maintained for decades,
beginning before the creation of MIC in 1971, with the
owners and managers of the supermarket chains. Since
1974, MIC had distributed the ice cream products of HD,
pursuant to an oral agreement entered into between A
and the founder of HD. In 1987 and 1988, following the
acquisition of HD by a public company, HD initiated
negotiations with MIC to acquire MIC's rights to
distribute HD ice cream products to MIC's customers.
After some but not all terms of the acquisition had
been negotiated in the 1988 negotiations, A and M
caused SIC, a wholly owned subsidiary of MIC, to be
created, and HD was notified that SIC would be the
seller of the assets that HD wished to acquire. MIC
then transferred to SIC all of MIC's rights to
distribute HD ice cream products to the supermarket
                         - 2 -

chains and food service accounts, and business records
relating thereto, in exchange for all the stock of SIC,
and immediately distributed the SIC stock to A in
exchange for all of A's stock in MIC. Following
further negotiations, A and SIC, 3 weeks thereafter,
entered into a contract to sell HD all their intangible
assets relating to distribution of HD ice cream
products. Two weeks thereafter, following the
determination of a purchase price adjustment provided
for in the final version of the contract, the sale
closed and SIC received the proceeds of sale, which it
distributed to A.

     1. Held: The benefits of the personal relation-
ships developed by A with the supermarket chains and
A's oral agreement with the founder of HD were not
assets of MIC that were transferred by MIC to SIC and
thereafter sold by SIC to HD; A was the owner and
seller of those assets.

     2. Held, further, respondent's attempt to apply
Commissioner v. Court Holding Co., 324 U.S. 331 (1945),
to regard MIC as the seller of assets to HD is rejected
because the final sale to HD was on terms that were
negotiated with HD by A and SIC that were significantly
different from the terms of the earlier proposed
transaction under negotiation between MIC and HD.

     3. Held, further, MIC's distribution of SIC stock
to A was not entitled to nonrecognition of gain under
sec. 355, I.R.C., because SIC was not engaged in the
active conduct of a trade or business after the
distribution of SIC stock to A.

     4. Held, further, although MIC's transfer of
intangible assets to SIC in exchange for SIC stock was
entitled to nonrecognition of gain under sec. 351,
I.R.C., the immediate distribution of SIC stock in
redemption of A's stock in MIC was a distribution of
appreciated property under secs. 311(b) and 317(b),
I.R.C., on which recognized gain in the amount of
$141,000 is taxable to MIC under sec. 1374, I.R.C.

     5. Held, further, MIC is not liable for a
negligence addition to tax under sec. 6653(a), I.R.C.,
but is liable for a substantial understatement addition
under sec. 6661, I.R.C.
                               - 3 -

     Frank Agostino, Alan G. Merkin, Mary Ann Perrone, and

Susan M. Flynn, for petitioner.

     Patricia Y. Taylor and Clare W. Darcy, for respondent.

     BEGHE, Judge:   Respondent determined the following

deficiency and additions to tax:

                                           Additions to Tax
   Year         Deficiency         Sec. 6653(a)(1)       Sec. 6661
   1988          $477,816              $23,891             $119,454

In so doing, respondent determined that Martin Ice Cream Co. (MIC

or petitioner) recognized taxable gain of $1,430,340 on the

distribution of stock of its newly created subsidiary, Strassberg

Ice Cream Distributors, Inc. (SIC), to one of petitioner’s two

shareholders, Arnold Strassberg (Arnold), in redemption of his

51-percent stock interest in petitioner.    Shortly before trial,

we granted respondent's motion for leave to amend answer to

allege that a subsequent sale of assets to the Häagen-Dazs Co.,

Inc. (Häagen-Dazs), by Arnold and SIC should be attributed to

petitioner under Commissioner v. Court Holding Co., 324 U.S. 331

(1945).

     We reject respondent’s attempt to apply Court Holding,

although we uphold respondent’s original determination that

petitioner recognized gain on the redemption of Arnold’s stock in

petitioner.   We find that petitioner’s gain is substantially less

than the gain determined by respondent.    We reject respondent’s

imposition of an addition to tax under section 6653(a)(1) but
                                 - 4 -

uphold the addition to tax for substantial understatement under

section 6661.1

                           FINDINGS OF FACT

     Some of the facts are stipulated and are so found.    MIC is a

New Jersey corporation whose principal place of business was

Bloomfield, New Jersey, when it filed its petition.

     MIC was incorporated in 1971 as a wholesale ice cream

distributor, with Martin Strassberg (Martin) as its sole

shareholder.     MIC was a C corporation from 1971 through 1986.   On

December 30, 1986, MIC filed with the Internal Revenue Service a

Form 2553, Election by a Small Business Corporation, which took

effect on November 1, 1987.     As a result of the election, the

accounting period of MIC was changed, commencing January 1, 1988,

from an October 31 fiscal year to the calendar year.

     Soon after World War II, Arnold, Martin’s father, a high

school mathematics teacher, began a part-time business after

school hours, selling ice cream products wholesale to stores in

Newark, New Jersey.    During summer vacations, Arnold expanded his

coverage to small stores and ice cream parlors on the Jersey

Shore.   By 1960, Arnold had incorporated his own company,

Arnold’s Ice Cream, and was engaging full time in the wholesale

distribution of ice cream.     In the 1960's, Arnold began to



     1
       All section references are to the Internal Revenue Code in
effect for the year in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
                                - 5 -

develop relationships with the owners and managers of several

supermarket chains when he conceived an innovative packaging and

sales campaign that used bright colors and catchy slogans to

market ice cream products to supermarkets for resale to

consumers.   Ice cream had hitherto been sold by supermarkets to

consumers as an undifferentiated product in large containers and

multiserving packages with plain brown wrappers.    Arnold

subsequently developed other packaging ideas for ice cream

products that helped supermarkets sell ice cream products under

their private labels.    Even with different kinds of packaging,

supermarkets marketed ice cream to consumers mainly on the basis

of price.    In the late 1960's, Arnold had a falling-out with his

major supplier, Eastern Ice Cream, which forced Arnold’s Ice

Cream into bankruptcy.

     In 1971, Martin and Arnold organized MIC as a part-time

business, with one delivery truck, distributing ice cream to

small grocery stores and food service accounts (restaurants,

hotels, and clubs) in northern New Jersey.    Martin joined the

business after having completed virtually all requirements for a

Ph.D. in statistics and after spending several years doing

operations research and statistical analysis as an employee of

large corporations.   In 1975, Martin began working in the ice

cream distribution business full time.    During most of the

1970's, Arnold owned no stock in MIC because he wished to avoid

the claims of creditors of Arnold’s Ice Cream.    In 1979, Arnold
                                 - 6 -

became a 51-percent shareholder in MIC, and Martin’s interest was

reduced to 49 percent.   At no time did Arnold or Martin have an

employment agreement with MIC.

     In 1974, Ruben Mattus (Mr. Mattus), the founder of Häagen-

Dazs, asked Arnold to use his ice cream marketing expertise and

relationships with supermarket owners and managers to introduce

Häagen-Dazs ice cream products into supermarkets.    Häagen-Dazs

manufactured an entirely new range of “super-premium” ice cream

products that were differentiated from the competition by both

higher quality and higher price.    Häagen-Dazs had initially

marketed its products to small stores and restaurants for single-

serving on-premises consumption.    Häagen-Dazs had made only

minimal inroads into the supermarkets, and now Mr. Mattus wanted

to intensify his marketing efforts in that sector.    Mr. Mattus

asked for Arnold’s help because he had been unable to convince

the supermarkets to carry his products; they saw super-premium

ice cream as too expensive for a retail setting designed for off-

premises consumption.

     Arnold, as the first distributor of Häagen-Dazs ice cream to

supermarkets, sparked a revolution in the retail sale of ice

cream.   Arnold and Häagen-Dazs tapped a hitherto hidden demand

for a super-premium ice cream in supermarkets by consumers who

were willing to pay higher prices for higher quality.    By the

late 1970's, MIC was distributing ice cream products, including

Häagen-Dazs ice cream, to four major supermarket chains,
                                 - 7 -

Pathmark, Shop Rite, Foodtown, and Acme in New York, New Jersey,

Connecticut, and Pennsylvania (the supermarkets) and to smaller

grocery stores.    However, neither Arnold nor MIC ever entered

into a written distribution agreement with Häagen-Dazs or

Mr. Mattus.

     Arnold was so successful that in the late 1970's or early

1980's Mr. Mattus invited Arnold to become his partner in a

planned expansion of Häagen-Dazs’ supermarket sales to the West

Coast.     Arnold declined the offer and continued to use MIC as his

corporate vehicle to distribute Häagen-Dazs products in New

Jersey and adjacent areas.

     Martin did not support or participate in Arnold’s efforts to

expand ice cream distribution to the supermarkets.    Martin

disliked the social activities necessary to developing and

sustaining personal relationships with supermarket owners and

managers--activities that Arnold thrived on.    Martin preferred to

manage day-to-day operations at the MIC warehouse, arriving at

work as early as 3 to 4 a.m. to supervise the loading of MIC’s

delivery trucks for delivery to the supermarkets and the small

stores.2    Martin employed route salesmen to expand and maintain

wholesale distribution of ice cream, primarily Häagen-Dazs, to

small independent grocery stores and food service accounts in New



     2
       Häagen-Dazs delivered its products to the MIC warehouse,
where they were transferred to MIC trucks for delivery to both
the supermarkets and the small grocery stores and food service
accounts.
                               - 8 -

Jersey and New York.   Martin did little or no solicitation

himself.   Arnold did not participate in Martin’s development of

the business of wholesale ice cream distribution to small grocery

stores and food service accounts, focusing instead on the

supermarkets.

     In 1985, the Borden Co. (Borden) retained Arnold to use his

contacts with the supermarkets to put Borden’s ice cream products

into supermarket freezers.   Arnold worked as a broker for Borden,

personally earning commissions on Borden’s sales of ice cream

products to supermarkets, rather than as a distributor buying

from the manufacturer and reselling to retailers.   MIC did not

participate in Arnold's work for Borden.   Arnold had the ability

to--and did--put Borden’s ice cream products into supermarket

freezers at a time when many of his original contacts from the

1960's and earlier had passed from the scene.    By 1988, Arnold no

longer had a business relationship with Borden.

     At some time in the early to mid-1980's, Ben and Jerry’s, a

competitor of Häagen-Dazs in the manufacture and marketing of

super-premium ice cream, asked Arnold to help obtain supermarket

freezer space for its products.   Häagen-Dazs had not objected to

Arnold’s work for Borden but told him that he could not continue

to distribute Häagen-Dazs ice cream products if he were to

distribute Ben and Jerry’s ice cream products.    Arnold thereupon

terminated further contact with Ben and Jerry’s.

       In 1983, the Pillsbury Co. (Pillsbury) purchased Häagen-
                               - 9 -

Dazs from Mr. Mattus.   Pillsbury promptly initiated a business

plan to consolidate the distribution of Häagen-Dazs ice cream

products into its own distribution centers, with the goal of

delivering directly to retail stores, especially large

supermarket chains.   Pillsbury believed it could deliver a

uniformly higher quality product to supermarkets at lower cost

than independent distributors whose refrigeration equipment was

not as reliable.   Pillsbury believed that ensuring high quality

was vital to its basic corporate strategy of continuing to

differentiate Häagen-Dazs products from those of its competitors.

     Another important component of the Häagen-Dazs corporate

strategy was to enter into written distribution contracts,

explicitly terminable at will by Häagen-Dazs on short notice,

with distributors that it was not ready to buy out.   Since 1974,

MIC, like other regional distributors, had distributed Häagen-

Dazs products on the basis of Arnold’s original oral agreement

with Mr. Mattus.   After its acquisition by Pillsbury, Häagen-Dazs

always maintained that distributors such as MIC did not have

enforceable rights to continue to distribute Häagen-Dazs ice

cream.   In June 1988, the U.S. District Court, Northern District

of California, MDL docket No. 682, ordered summary judgment in

favor of Häagen-Dazs against a terminated distributor who had

distributed ice cream products for a direct competitor.3   The


     3
       In re Super Premium Ice Cream Distribution Antitrust
Litig., 691 F. Supp. 1262 (N.D. Cal. 1988), affd. without
                                                   (continued...)
                              - 10 -

grounds were that the termination did not violate antitrust laws

and that the oral agreement with the distributor did not prevent

termination at will.4

     In late 1985 or early 1986, representatives of Häagen-Dazs

first approached the Strassbergs about acquiring direct access to

Arnold’s relationships with the supermarkets and removing him as

a middleman in the chain of distribution.   Häagen-Dazs also

wanted to forestall competitors, such as Ben and Jerry’s, from

using Arnold’s contacts and knowledge to gain access to the

supermarkets.   Häagen-Dazs also did not want to leave

distributors like Arnold, who had been with Häagen-Dazs since the

early days of Mr. Mattus, without adequate reward for the role

they had played in bringing Häagen-Dazs to prominence.   Also,

because Arnold was a high-profile, well-respected ice cream

distributor, Häagen-Dazs did not wish to alienate Arnold and risk

having him stir up the other independent distributors before

Häagen-Dazs was ready to take similar steps against them.

Häagen-Dazs believed that these various relationships, personal



     3
      (...continued)
published opinion sub nom. Häagen-Dazs Co. v. Double Rainbow
Gourmet Ice Creams, Inc., 895 F.2d 1417 (9th Cir. 1990).
     4
       During the negotiations with Arnold, attorneys for
Pillsbury sent Russell L. Hewit (Mr. Hewit), attorney for Arnold,
Martin, and MIC, a copy of applicable sections of two treatises
on franchising, Rosenfield, The Law of Franchising, and Brown,
Franchising Realities and Remedies (1982 rev.), in support of its
contention that MIC, SIC, Arnold, and Martin had no enforceable
rights to distribute Häagen-Dazs ice cream products that could
not be terminated at will.
                                - 11 -

to Arnold, had value for which it was willing to pay.    At the

same time, Häagen-Dazs wished to terminate any residual rights to

distribute Häagen-Dazs ice cream that its distributors might have

acquired over the years, even as it maintained that neither

Arnold nor MIC, or later, SIC, had any enforceable “distribution

rights” as such.    Häagen-Dazs was not interested in acquiring MIC

as an ongoing distributor to either the supermarkets or the small

grocery stores and food service accounts or in acquiring its

physical assets.

       During the early to mid-1980's, Arnold and Martin had

increasingly vocal disagreements over the future direction of

MIC.    Arnold wished to expand the supermarket business, and

Martin wished to expand the small store business.    They were

unable to agree on which course to take or otherwise to agree on

coordinating their different business objectives.

       Martin was concerned about MIC’s overdependence on a small

number of large supermarket accounts.    He felt that a diversified

customer base of small independent stores with higher gross

profits carried less risk.    Martin was concerned about the

smaller profit margins of the supermarket business and also felt

that the small stores had a better record of paying MIC’s

invoices in full and on time.

       Arnold attributed Martin’s disparagement of the supermarket

business to his dislike of the process of developing and

maintaining the personal relationships with the managers and
                              - 12 -

owners of the supermarkets that was needed to maintain access to

supermarket freezer space.   Arnold believed that the small volume

of sales generated by each of the independent stores did not

justify the effort to acquire and service their accounts.

     Arnold and Martin each blamed the other’s approach to

management of his own line of the business for MIC's not being

more profitable during the mid-1980's.

     From 1985 through 1988, Arnold’s and Martin’s disagreements

intensified, especially in the aftermath of Arnold’s promotion of

MIC’s failed investment in a warehouse facility in central Newark

that would have substantially expanded MIC’s capability to

distribute ice cream to the supermarkets, just as Häagen-Dazs was

building its own large distribution facility in the Bronx.   MIC’s

share of the total cost of the Newark facility would have been

about $2.5 million.   In 1987 or early 1988, Arnold and Martin

ultimately abandoned the project after MIC had invested

approximately $100,000.

     By 1988, Martin no longer wanted to work with Arnold, and

Arnold felt that Martin was pushing him to retire.   They were

looking for a way to end their constant strife over the future

direction of petitioner.   Their disagreement had made them both

receptive to the first overture from Häagen-Dazs in May 1986.    At

that time, Arnold and Martin began consulting with their

attorney, Russell L. Hewit (Mr. Hewit), concerning the
                              - 13 -

negotiations with Häagen-Dazs.5   Arnold was the primary

negotiator in the talks with Häagen-Dazs.   To that end, Arnold

executed a series of confidentiality agreements.    In March 1987,

the initial talks broke down because the parties could not agree

on the price for the business with the supermarkets.

     To memorialize the termination of discussions, Mr. Hewit

sent Häagen-Dazs a letter dated April 7, 1987, stating that he

understood Häagen-Dazs to have made an initial offer of $3

million for “the Haagen-Dazs portion of the business”.     In a

letter dated April 16, 1987, Häagen-Dazs replied that it had not

offered $3 million, and that the distribution rights under

discussion were worth approximately $1 million.    Despite the

breakdown in formal negotiations, the parties remained in

contact.   On January 8, 1988, Arnold signed a new confidentiality

agreement.

     On May 4, 1988, the MIC board of directors, consisting of

Martin, Arnold, and Mr. Hewit, and Arnold and Martin as MIC’s

shareholders, adopted and approved resolutions to form a

subsidiary of MIC, to be called SIC.   Later that month,

negotiations resumed between Häagen-Dazs and Arnold and Martin

regarding the possible sale of Arnold’s supermarket distribution

rights.


     5
       There is no evidence in the record that it ever occurred
to Mr. Hewit, Martin, or Arnold that Martin and MIC should obtain
separate legal representation, independent from Arnold, in
negotiating and effectuating the split-off and the transactions
with Häagen-Dazs.
                              - 14 -

     As with the earlier negotiations, Arnold took the lead in

the negotiations with Häagen-Dazs.     Between May 13 and May 23,

1988, Arnold and Martin met at least three times with Häagen-Dazs

representatives.   On May 16, 1988, Hewit wrote a letter to

Charles McGill, vice president--acquisitions, for Pillsbury,

stating that, on May 13, proposals for Häagen-Dazs to buy MIC’s

“supermarket and food service business only” for up to $2.5

million had been rejected and that one of the obstacles was the

possible sale of the remaining business to another distributor

acceptable to Häagen-Dazs.   However, neither Martin nor MIC

thereafter pursued the possibility of such a sale, and the

subject was never raised in subsequent negotiations with Häagen-

Dazs.

     On May 19, 1988, the parties discussed the outlines of an

agreement to sell the supermarket and food service distribution

business to Häagen-Dazs.   On May 23, 1988, Mr. Hewit wrote

another letter to Mr. McGill detailing the terms discussed in the

meetings, including an overall price of $1.5 million for that

business, $350,000 in additional contingent payments payable over

3 years, and annual payments of $150,000 to Arnold for 3 years,

and of $50,000 to Martin for 5 years in return for consulting

services and covenants not to compete in the retail super-premium

ice cream distribution business, except as MIC and Martin would

continue to distribute ice cream to stores other than the

supermarket chains.   Mr. Hewit’s letter did not refer to any
                               - 15 -

allocation of the total price between distribution rights as such

and the business records related to those rights, or even refer

to any such records.   Häagen-Dazs had derived the total price it

was willing to pay from a formula based upon MIC’s annual sales

of Häagen-Dazs products to the supermarkets.

     On May 31, 1988, SIC’s certificate of incorporation was

filed with the New Jersey secretary of state, and SIC was

organized as a wholly owned subsidiary of MIC.   On June 2, 1988,

Stan Oleson of Pillsbury sent Mr. Hewit a draft “Agreement for

Purchase and Sale of Assets” and other associated draft

documents.   The Agreement documents listed Arnold, Martin, MIC,

and SIC collectively as “Sellers” and provided for the purchase

of any and all of Sellers’ distribution rights, “including but

not limited to supermarket and food service distribution rights,

if any” and their cancellation by the “Buyer”.   On June 6, 1988,

Mr. Hewit replied to Mr. Oleson with a letter containing a number

of modifications to the proposed agreements, chief among which

was elimination of all references to Martin and MIC as parties to

the proposed sale so as not “to increase the risk that the 355

Exchange will be collapsed”.   During the negotiations that

culminated in the signing on July 8 of a sale agreement between

Arnold and SIC as sellers and Häagen-Dazs as buyer, Mr. Hewit did

not draft his own version of the sale agreement; he made mark-ups

of his suggested changes and sent copies of the marked-up drafts

back to Häagen-Dazs.
                                - 16 -

     On June 14, 1988, Beth L. Bronner, vice president for

strategic and business development for Häagen-Dazs, replied to

Mr. Hewit’s letter of June 6, stating that Häagen-Dazs had

“incorporated, where possible, the suggested changes in your

redraft and letter of June 6.    However, many of the points in

your letter reflected a transaction materially different from

the one we believed we had negotiated with your clients”.

Ms. Bronner’s letter stated that Häagen-Dazs had incorporated

“your proposed exclusion of Martin Strassberg and * * * [MIC]

from the Purchase Agreement,” although it created “an important

issue with which we must deal” in light of Häagen-Dazs’ main

objective of obtaining “any and all distribution rights” of both

Arnold and Martin and their respective companies.    Ms. Bronner

proposed to resolve this issue through a separate “side

agreement” in which Martin and MIC “would clearly acknowledge”

that all rights to distribute “Häagen-Dazs products have been

transferred to * * * [SIC] and that he * * * [Martin] claims no

rights to distribute Häagen-Dazs.”6



     6
       The record includes an “Agreement”, signed by Martin and
Ms. Bronner on behalf of MIC and Häagen-Dazs, respectively, on
July 8, 1988, that appears to be the contemplated “side
agreement” referred to by Ms. Bronner in her June 14 letter.
This agreement states that Häagen-Dazs and MIC would enter into
three distribution agreements upon the closing of the Häagen-Dazs
agreement with Arnold and SIC. The three distribution
agreements, which were signed July 22, 1988, provide MIC with
various rights to distribute certain Häagen-Dazs ice cream
products in specified convenience stores, delis, places where ice
cream is consumed on the premises, and other small independent
grocery stores in New Jersey and parts of New York.
                                - 17 -

     Mr. Hewit sought advice from two tax attorneys, Charles E.

Falk, an attorney-C.P.A. with an LL.M. in taxation from New York

University School of Law, and Martin’s brother-in-law, Jan

Neiman, an attorney practicing tax law in Miami Beach, Florida,

on the tax structuring of the transactions creating SIC and

distributing its stock to Arnold.7       Mr. Hewit sought their advice

to ensure that he properly drafted all documents necessary to

effect the separation of Martin and MIC from Arnold and SIC.

There is no evidence in the record that Mr. Hewit considered

trying to obtain a private letter ruling from the Internal

Revenue Service, or that he rendered a written opinion to

petitioner or Martin or Arnold regarding the tax consequences of

the transactions at issue, or that Mr. Hewit or any of the

parties in interest received a written tax opinion from

Mr. Neiman or Mr. Falk.

     On June 15, 1988, Arnold, Martin, and Mr. Hewit executed

documents providing for the transfer of MIC’s interests in the

supermarket business and associated customer and pricing lists

from MIC to SIC and the exchange of Arnold’s stock in MIC for the

stock of SIC (the split-off).    The first of these documents,

entitled “Agreement”, provided for the transfer of



     7
       Martin also consulted with Mr. Neiman, who told him that
“this is the way you should do it”, referring to a distribution
of stock under sec. 355 as a means of dissociating Arnold from
MIC. It is unclear from the record whether Mr. Falk and
Mr. Neiman were aware of the ongoing negotiations with Häagen-
Dazs.
                               - 18 -

       All of the Corporation’s [MIC’s] rights to distribute
       Haagen-Dazs Ice Cream products to supermarket chains
       (Pathmark, Shop Rite, Foodtown and Acme) and food
       service accounts (restaurants, hotels and clubs), and
       the business records of said distributorship, including
       but not limited to customer lists and pricing lists, to
       the Subsidiary * * * for the purpose of transferring to
       Arnold all of the outstanding shares of the Subsidiary
       in exchange for the surrender by Arnold of all of his
       shares of the Corporation, in a transaction intended to
       qualify as a tax-free split-off under Internal Revenue
       Code Section 355, as amended * * *

       A second document, dated June 15, 1988, also entitled

“Agreement”, stated that Martin and Arnold were operating

separate businesses that were formerly jointly operated by MIC,

and that both Arnold and Martin “wish to assure a smooth

transition so that neither party loses customers or employees as

a result of * * * misunderstanding”.     The document further stated

that

            Following the Exchange, * * * [MIC] shall
       cooperate with * * * [SIC] and provide such assistance
       that is reasonably necessary for * * * [SIC] to conduct
       its business, provided that the rendering of such
       services does not unduly interfere with the conduct of
       * * * [MIC]’s business.

               *     *     *     *      *    *     *

       [SIC] shall pay to and reimburse * * * [MIC] for all
       costs incurred by * * * [MIC] in providing such
       services.

This agreement provided, among other things, that MIC would

continue to deliver ice cream from its warehouse to SIC’s

supermarket accounts after the June 15 transactions separating

MIC and SIC.    MIC did continue to do so until the closing of

Arnold’s and SIC’s sale of assets to Häagen-Dazs on July 22.
                               - 19 -

       On June 15, 1988, the MIC board of directors, consisting of

Arnold, Martin, and Mr. Hewit, adopted a resolution, which was

approved by Arnold and Martin as shareholders, declaring that MIC

was in two separate businesses of equal fair market value, one

distributing ice cream to supermarket chains and food service

accounts and another distributing ice cream to small independent

grocery stores.    The resolutions stated that MIC undertook the

transaction to split into two corporations in order to resolve

the dispute between Arnold and Martin over the future direction

of MIC and whether it would focus on distribution to supermarkets

or to food service accounts and small stores and that Martin

wished to operate the business of distribution of Häagen-Dazs ice

cream products to nonsupermarket stores.    Martin and Arnold each

submitted his written resignation as a director, officer, and

employee of the other company, Martin from SIC, and Arnold from

MIC.    Each of these documents bore the typed date “June 3, 1988”,

which was crossed out and amended by hand to read “June 15,

1988”.    None of the resolutions, agreements, or resignations

contain any guaranty or indemnification from SIC or Arnold that

would protect MIC or Martin from any tax liabilities arising from

the split-off or the contemplated sale to Häagen-Dazs.

       On June 20, 1988, Arnold and Mr. Hewit signed a directors’

resolution of SIC, submitting to Arnold, as sole shareholder of

SIC, an offer by Häagen-Dazs to “purchase all of the rights of

the Corporation [SIC] to distribute Haagen-Dazs ice cream
                              - 20 -

products”.   Arnold then signed a shareholder’s resolution to

authorize SIC to enter into negotiations with Häagen-Dazs.    In an

undated memorandum, Arnold disclosed his customer list to Häagen-

Dazs, most likely in response to a June 30 letter from

Ms. Bronner.

     In a letter to Mr. Hewit, dated July 1, 1988, Richard

Wegener, a Pillsbury attorney, summarized changes made “to the

various distributor agreements” pursuant to negotiations that had

taken place the previous week.    Mr. Wegener stated that, in the

wake of those negotiations, Häagen-Dazs “clearly * * * [had its]

work cut out concerning the financial issues raised by Section

4.5 of the proposed agreement.”   Mr. Wegener exhorted Arnold “to

get out * * * on the table” all relevant information required to

complete that section, which was a warranty and representation by

Arnold and SIC concerning sales of Häagen-Dazs ice cream products

to supermarkets by MIC and SIC for the period of June 1, 1987, to

May 31, 1988.   On July 5, 1988, Mr. Hewit sent Ms. Bronner

documentation of the sales to supermarkets for the 12-month

period ending May 31, 1988.   On July 7, 1988, Mr. Oleson wrote

Mr. Hewit a letter asking whether Häagen-Dazs’ refusal to agree

to deposit money in escrow on signing the purchase agreement

would be a “deal breaker” that would require cancellation of this

planned July 8 meeting to sign the agreeement.   He also expressed

optimism that the deal would be signed.

     On July 8, 1988, Arnold, individually, and as president of
                               - 21 -

SIC, and Ms. Bronner, on behalf of Häagen-Dazs, signed an

“Agreement For Purchase and Sale of Assets” by Arnold and SIC, as

“Sellers”, in which the parties agreed to the terms of the sale

and related documents.    Notwithstanding that the documents

effectuating the split-off provided only for the transfer of

supermarket and food service distribution rights and records to

SIC, the Arnold-SIC-Häagen-Dazs agreement recited that SIC “owns

all of the rights to distribute Häagen-Dazs product which were or

may have been owned by Martin Strassberg and [MIC],” and

purported to provide, consistent with the Häagen-Dazs first

draft, for the purchase of all distribution rights including but

not limited to supermarket rights.8     This agreement specifically

stated that “Buyer is not purchasing assets relating to the ‘non-

banner’ business of * * * [MIC], the former parent of [SIC],”9


     8
         The Agreement enumerated the “Sellers’ Rights” as

     Any and all of Seller’s rights and the rights of any
     corporations or entities owned or controlled by Sellers
     obtained from Buyer, its predecessors, its customers or
     others to distribute the products of Buyer within the
     states of New York, New Jersey, Pennsylvania,
     Massachusetts, Delaware, Connecticut and elsewhere
     including but not limited to supermarket and food
     service distribution rights, if any (the “Sellers’
     Rights”) * * *. Upon Closing of the transactions
     contemplated herein, any and all of such Sellers’
     Rights obtained by Sellers from Buyer or its
     predecessors shall be cancelled.
     9
       “Non-banner” business was defined by the Agreement as
“independent convenience stores and delis that have no more than
two cash registers * * * `independent’ shall mean a firm which
                                                   (continued...)
                               - 22 -

and allocated the stated $1.5 million price to be paid at the

closing, $300,000 to “Records” and $1,200,000 to “Sellers’

Rights”.   There is no evidence in the record of any negotiation

over this allocation or of any of the considerations that led

Häagen-Dazs to allocate the purchase price in this fashion.

     Unlike prior drafts of the purchase agreement in the record,

the agreement as executed on July 8, 1988, between Häagen-Dazs

and SIC and Arnold contains an Article 2.4 that makes the closing

contingent on an audit by a “`Big-8’ auditing firm” of the

documentation of the sales to supermarket chains, independent

supermarkets, and food service accounts for the 12-month period

ending May 31, 1988.   The audit was required to ascertain the

actual sales figures in order to set the purchase price under

Article 2.4 in accordance with a purchase price reduction clause

that applied to both the payment to be made at the closing and

the contingent annual payments to be made over the following 3

years.10   Article 2.4 also provided that Häagen-Dazs would have


     9
      (...continued)
operates from one to ten stores”.
     10
       The Agreement provided that if the audited supermarket
sales were greater than $4 million but less than $4,700,000, then
there would be a downward adjustment to the purchase price equal
to:

     [1 - (audited sales figures/$4,700,000)] x $2,350,000.

The Agreement allocated 81 percent of the downward adjustment to
the purchase price to be paid at closing and 19 percent to the
                                                   (continued...)
                                - 23 -

no obligation to close if the audited sales were less than $4

million for the period under audit.

     On July 20, 1988, Touche Ross & Co. submitted an audit

report to Häagen-Dazs, stating that the audited sales were less

than represented by Arnold and SIC.      As late as July 21,

Mr. Hewit was still negotiating with Häagen-Dazs on behalf of

petitioner concerning the list of accounts that MIC would

continue to service after the sale.

     On July 22, 1988, Arnold and representatives of Häagen-Dazs

closed the sale to Häagen-Dazs.     The employees of MIC who had

reported to Arnold before June 15 continued to do so until that

date.     Arnold thereupon notified MIC in writing that SIC no

longer required the services of MIC in delivering ice cream

products to the supermarkets or in otherwise servicing their

accounts.11    SIC then paid MIC for services rendered.   MIC’s

customers had not been notified of any changes in its business

until they were notified of the sale of the supermarket

distribution business to Häagen-Dazs.

     The closing documents contained an amendment to the purchase

agreement--signed July 22 after receipt of the Touche Ross & Co.


     10
      (...continued)
contingent annual payments payable to Arnold over the following
3 years.
     11
       Martin testified that MIC and SIC delayed changing how
product was delivered to the supermarket customers in order to
get through the busy summer season.
                              - 24 -

audit of the supermarket sales figures--stating that during the

12-month period ending May 31, 1988, the sales of Häagen-Dazs

products to the four supermarket chains, food service accounts,

and independent supermarkets had totaled $4,528,000.   Pursuant to

the purchase price reduction clause of the Agreement, that sales

figure resulted in a downward price adjustment of $86,000, of

which $69,660 reduced the purchase price paid by Häagen-Dazs at

the closing, and $16,340 of which reduced the amount of

contingent additional payments payable to Arnold over 3 years.

Consequently, the first closing document, entitled "Closing

Statement", reduced the agreed sale price of $1.5 million to

$1,430,340, and reduced the maximum amount of contingent annual

payments of $350,000 to $333,660.

     The bill of sale, signed by Arnold individually and as

president of SIC, listed the items acquired from SIC as all

existing customer lists, price lists, historical sales records,

promotional allowance and rebate records, “and other business

records as requested by Buyer, and the goodwill associated

therewith”.

     Arnold also signed an “Assignment of Rights”, which

referenced--and transferred to Häagen-Dazs--the rights described

supra, in two capacities:   first, as president of SIC, and

second, as an individual; there was no allocation of the
                              - 25 -

consideration paid for the rights as between Arnold and SIC.12

Ms. Bronner also signed the Assignment of Rights on behalf of

Häagen-Dazs.   Arnold signed a “Consulting and Non-Competition

Agreement” with Häagen-Dazs, for which he was to be paid $150,000

annually for a period of 3 years.   Martin also signed a

“Consulting and Non-Competition Agreement” with Häagen-Dazs, for

which he was to be paid $50,000 annually for a period of 5 years.

Finally, Häagen-Dazs entered into three nonexclusive distribution

agreements with petitioner for its continued distribution of

Häagen-Dazs ice cream products to specified small independent

stores and food service accounts in a limited geographical area.

     On March 3, 1989, petitioner filed a Form 1120S for 1988,

reporting gross sales of $6,021,394 and an ordinary loss of $278.

Rudolph Bergwerk signed the return as preparer.   MIC’s 1988 Form

1120S contained no reference to the creation of SIC, the transfer

to it of assets, or their basis, or the distribution of SIC stock

to Arnold in redemption of his stock in MIC.   Nor did the return

refer to SIC’s and Arnold’s subsequent sale of assets to Häagen-


     12
       Subsequent to trial, respondent submitted to the Court a
facsimile of the face of a Häagen-Dazs check to SIC in the amount
of $1,430,340, accompanied by an affidavit that Häagen-Dazs
issued the check to SIC as payment due at the closing of the sale
of assets purportedly sold by SIC to Häagen-Dazs. We do not
admit the facsimile and affidavit into evidence; there is
sufficient evidence in the record to support a finding that SIC
received the entire payment from Häagen-Dazs. However, because
we decide this case as we do, initial receipt of payment by SIC
instead of Arnold does not determine the Federal tax treatment to
petitioner of the transactions at issue.
                                - 26 -

Dazs, contain any of the other information required by the

regulations under sections 351, 355, or 368, or allocate earnings

and profits between petitioner and SIC as required by section

312(h) and associated regulations with respect to a transaction

governed by sections 355 and 368(a)(1)(D).

     On April 10, 1989, SIC filed Form 1120S for its tax year

1988, which included a statement disclosing the sale of assets by

SIC, including records and goodwill for $286,068 and the “right

to distribute the product of buyer for $1,144,272”.13   The

statement also disclosed that Arnold, as sole stockholder

distributee, would report the gain on his personal income tax

return for taxable year 1988.    On July 14, 1989, Arnold caused

SIC to be dissolved under New Jersey law.

     For each tax year thereafter through 1995, MIC reported the

following losses and gross sales as compared with 1988 and

earlier years:




     13
       This statement attached to the SIC Form 1120S indicates
that the downward adjustment of $69,660 to the purchase price
paid by Häagen-Dazs at closing was allocated between the
distribution rights and business records of SIC in the same
proportions as the relative amounts of the preadjustment
allocation of the purchase price to be paid at the closing--80
percent, or $55,728, to the distribution rights, and 20 percent,
or $13,932, to the business records. The closing documents do
not set forth or otherwise contain any reference to the
allocation between distribution rights and business records of
the reduction in the price paid at closing.
                                       - 27 -

       Year            Gross Sales         Taxable Income        Retained Earnings
       19861            $8,488,491             $68,728               $551,383
       19872            1,137,298                 284                 551,676
              3
       1988             6,021,394                (278)                551,398
       1989             4,718,087            (316,793)                238,541
       1990             5,532,675             (58,153)                180,388
       1991             5,882,632            (122,534)                 59,654
       1992             5,518,248             (75,726)                (16,072)
       1993             6,032,463             (69,622)                (85,694)
       1994             5,619,756            (201,778)               (287,472)
       1995             5,472,912             (49,396)               (336,868)

1
    Tax year Nov. 1, 1986-Oct. 31, 1987.
2
    Tax year Nov. 1, 1987-Dec. 31, 1987.
3
    Supermarket distribution rights and records sold to Häagen-Dazs July 22, 1988.


                              ULTIMATE FINDINGS OF FACT

        1.        The intangible assets embodied in Arnold’s oral

agreement with Mr. Mattus and personal relationships with the

supermarket owners and managers were never corporate assets of

petitioner.           Until the sale to Häagen-Dazs on July 22, 1988,

Arnold was the sole owner of those assets, whose use he had

hitherto made available to petitioner.                   Accordingly, neither any

transfer of rights in those assets to SIC nor their sale or other

disposition to Häagen-Dazs is attributed to petitioner.

        2.        The fair market value of the SIC stock distributed by

petitioner to Arnold in redemption of his stock in petitioner was

$141,000.

        3.        Immediately after the distribution of the stock of SIC
                              - 28 -

to Arnold, and thereafter, SIC did not engage in the active

conduct of a trade or business.

                              OPINION

1.   Assets Transferred by MIC

     Respondent advances two alternative grounds in support of

the original determination that the $1,430,340 consideration

received by Arnold and SIC measures the gain realized and

recognized by petitioner:   First, Arnold negotiated the sale of

assets on behalf of MIC, and MIC should therefore be regarded as

the true seller of the assets under the principle of Commissioner

v. Court Holding Co., 324 U.S. 331 (1945); alternatively, the

amount paid by Häagen-Dazs to SIC and Arnold measures the gain

realized and recognized by petitioner on the redemption of

Arnold’s stock in petitioner, a split-off that fails to qualify

for nonrecognition of corporate gain under section 355.

     We disagree with respondent's overall position, insofar as

it is predicated on the assumption or conclusion that petitioner

owned assets with a value of $1,430,340 that were sold to Häagen-

Dazs.   Petitioner never owned all the assets sold to Häagen-Dazs.

The record shows, and we have found as facts, that Arnold, acting

on his own behalf and as agent for SIC, of which he was the sole

shareholder, entered into a contract to sell Häagen-Dazs two

distinctly different types of assets:   The first, and much more

valuable, was the intangible assets of Arnold’s rights under his

oral agreement with Mr. Mattus and his relationships with the
                               - 29 -

owners and managers of the supermarkets, which formed the basis

of his ability to direct the wholesale distribution of super-

premium ice cream to the supermarkets; the second, and much less

valuable, was the business records that had been created by

petitioner during Arnold’s development of the supermarket

business, and transferred by petitioner to SIC.

     Arnold built the business of wholesale distribution of

super-premium ice cream to supermarkets on the twin foundations

of his personal relationships with the supermarket owners, the

development of which preceded the creation of petitioner by

some years, and his personal, handshake understanding with

Mr. Mattus, which continued with Häagen-Dazs after its sale to

Pillsbury.    In developing his supermarket distribution business,

Arnold changed the way ice cream was marketed to customers in

supermarkets.   The success of the venture depended entirely upon

Arnold.   Mr. Mattus’ offer to go into business with Arnold

distributing Häagen-Dazs ice cream products on the West Coast

attests to the value that Mr. Mattus, Häagen-Dazs, and later,

Pillsbury, placed on Arnold’s position in the market, which

retained considerable value as late as June 1988, when petitioner

distributed the SIC stock to Arnold in redemption of his stock in

petitioner.

     Ownership of these intangible assets cannot be attributed to

petitioner because Arnold never entered into a covenant not to

compete with petitioner or any other agreement--not even an
                              - 30 -

employment agreement--by which any of Arnold’s distribution

agreements with Mr. Mattus, Arnold’s relationships with the

supermarkets, and Arnold’s ice cream distribution expertise

became the property of petitioner.     This Court has long

recognized that personal relationships of a shareholder-employee

are not corporate assets when the employee has no employment

contract with the corporation.   Those personal assets are

entirely distinct from the intangible corporate asset of

corporate goodwill.   See, e.g., Estate of Taracido v.

Commissioner, 72 T.C. 1014, 1023 (1979) (where sole shareholder

was sine qua non of corporation's success, corporation's goodwill

did not include the personal qualities of its sole shareholder);

Cullen v. Commissioner, 14 T.C. 368, 372 (1950) (personal

ability, personality, and reputation of sole active shareholder

not a corporate intangible asset where there is no contractual

obligation to continue shareholder's services); MacDonald v.

Commissioner, 3 T.C. 720, 727 (1944) (“We find no authority which

holds that an individual’s personal ability is part of the assets

of a corporation by which he is employed where * * * the

corporation does not have a right by contract or otherwise to the

future services of that individual.”); Providence Mill Supply Co.

v. Commissioner, 2 B.T.A. 791, 793 (1925).

     In the case at hand, as in MacDonald v. Commissioner, supra,

petitioner never obtained exclusive rights to either Arnold’s

future services or a continuing call on the business generated by

Arnold’s personal relationships with the supermarket owners and
                              - 31 -

the rights under his agreement with Mr. Mattus; petitioner never

had an agreement with Arnold that would have caused those

relationships and rights to become petitioner’s property.   Even

if there had been such an agreement, and the record shows that

there was none, the value of these relationships and rights would

not have become petitioner’s property in toto.   In 1974, Mr.

Mattus sought Arnold as his agent to create a substantial

presence for Häagen-Dazs ice cream in supermarkets after Mr.

Mattus had been able to achieve only minimal market penetration

through his own efforts.   Mr. Mattus wanted what Arnold had

already created in the 1960's when he operated Arnold’s Ice

Cream--the critical relationships with key supermarket owners and

managers and the marketing know-how necessary to put ice cream

products in supermarket freezers.   See, e.g., Coskey’s Television

& Radio Sales & Serv., Inc. v. Foti, 602 A.2d 789, 795 (N.J.

Super. Ct. App. Div. 1992) (“What * * * [the employee] brought to

his employer, he should be able to take away.”).   The record

shows that, at most, petitioner had only the benefit of the use

of these assets while Arnold was associated with petitioner--

which contributed heavily to the profitability of petitioner

during the years before the split-off.

     Our conclusion that the rights under the oral agreement with

Mr. Mattus, the personal relationships with supermarket owners

and managers and the ice cream distribution expertise, belonged

to Arnold rather than petitioner is confirmed by the disparity
                              - 32 -

between the sales price paid by Häagen-Dazs to Arnold and SIC and

the value of petitioner as an ongoing business just before the

split-off.   The sales figures from petitioner’s tax returns show

that the supermarket business generated slightly more than one-

half of the pre-split-off sales.   Were petitioner to have been

the owner of the rights sold to Häagen-Dazs, then the $1,430,340

paid to Arnold and SIC would have been approximately half the

value of petitioner, and petitioner would presumably have had an

overall fair market value approaching $3 million, a conclusion

that would logically follow from respondent’s arguments.    For

reasons discussed infra, $3 million far exceeds any possible fair

market value that petitioner, as a corporation with less than

$8.5 million in gross sales and $70,000 net income in its best

year, fiscal 1987, might have had immediately before the

transactions in issue.

     Our conclusion is not impaired by the fact that the

corporate documents created by Mr. Hewit to accomplish the

transfer of some of petitioner’s assets to SIC and the

distribution of SIC stock to Arnold purported to transfer

supermarket distribution rights owned by petitioner.14   We have

     14
       We note that the record contains no documents that
actually transfer assets from MIC to SIC in exchange for SIC
stock. The record contains only the MIC corporate resolutions
stating the intention to make such transfer. However, we are
satisfied by those corporate resolutions and testimony by Arnold,
Martin, and Mr. Hewit that such a transfer did occur, in the
sense that petitioner transferred to SIC the records of the
                                                   (continued...)
                              - 33 -

already found that petitioner never owned the rights under

Arnold’s oral agreement with Mr. Mattus, nor his personal

relationships with the supermarkets or his ice cream distribution

expertise; petitioner merely had the benefits of the use of those

assets during the years up to the split-off.   What petitioner did

not own, petitioner could not transfer; these documents

transferred only that which belonged to MIC--the business records

generated by the supermarket business that were subsequently

transferred by petitioner to SIC in exchange for its stock.15

Accordingly, we find that the sale to Häagen-Dazs of Arnold’s

supermarket relationships and distribution rights cannot be

attributed to petitioner.   All that is at stake in this case is

the value of Arnold’s remaining stock interest in petitioner,

shorn of his supermarket relationships and distribution rights

under his agreement with Mr. Mattus.


     14
      (...continued)
supermarket business and whatever rights petitioner had in that
business.
     15
       Petitioner may have had some residual rights to
distribute Häagen-Dazs ice cream, but they were independent of
Arnold’s supermarket relationships and his value as a middleman.
To the extent that they existed at all, they were in relationship
to Häagen-Dazs’ ability to terminate petitioner as a distributor.
Häagen-Dazs was certainly interested in acquiring those rights as
it rationalized and consolidated its wholesale distribution
network as one of the assets it was buying from Arnold and SIC.
However, in light of the summary judgment by the District Court,
Northern District of California, in favor of Häagen-Dazs against
a similarly situated distributor, the value of those rights in
the event of termination by Häagen-Dazs was highly speculative at
best.
                              - 34 -

2.   MIC Is Not the Deemed Seller of Assets to Häagen-Dazs Under
     Court Holding

     Respondent argues that Arnold began and completed the

negotiations with Häagen-Dazs for the sale of distribution rights

on behalf of petitioner.   Respondent would have us believe that

all essential terms fixed by the negotiations had been settled

before Mr. Hewit informed Häagen-Dazs that SIC and Arnold would

be the named sellers of the assets in the purchase agreement and

instructed Häagen-Dazs to omit all references to Martin and

petitioner from the purchase agreements.   Respondent urges the

Court to apply the principle of Commissioner v. Court Holding,

 Co., 324 U.S. 331 (1945),16 to find that petitioner is the true

seller of the assets, and that SIC is a mere conduit whose

     16
       Shortly after issuance of Rev. Rul. 96-30, 1996-1 C.B.
36, respondent first raised this theory with petitioner in a
stipulation conference held on June 19, 1996, and was given leave
to incorporate it in an amended answer filed less than 3 weeks
before trial. Generally, when the Commissioner makes allegations
in an amended answer requiring the presentation of different
evidence, then the Commissioner “has introduced a new matter” or
a new issue that requires the shifting of the burden of proof to
the Commissioner as to the new matter or issue. Achiro v.
Commissioner, 77 T.C. 881, 890 (1981); see also Seagate Tech.
Inc. & Consol. Subs. v. Commissioner, 102 T.C. 149, 169 (1994).

     Because the determination of the applicability of
Commissioner v. Court Holding Co., 324 U.S. 331 (1945), required
respondent to present evidence of the events leading up to the
sale of assets which is different from the evidence showing that
the requirements of sec. 355 were not met, we issued an order
shifting the burden of proof to respondent on the Court Holding
issue. However, we decide the issue on a preponderance of the
evidence; therefore, the allocation of the burden of proof does
not determine the outcome. See Kean v. Commissioner, 91 T.C.
575, 601 n.40 (1988) (citing Deskins v. Commissioner, 87 T.C.
305, 323 n.17 (1986)).
                              - 35 -

existence and participation in the sale to Häagen-Dazs should be

ignored for Federal income tax purposes.   Respondent's argument

implies that petitioner constructively received the proceeds from

the sale of assets to Häagen-Dazs, and then constructively

distributed those proceeds to Arnold in redemption of his stock

in petitioner.17

     In Commissioner v. Court Holding Co., supra, a corporation

with two shareholders, husband and wife, owned an apartment

building as its only asset.   Negotiating on behalf of the

corporation, the husband entered into an oral agreement with the

lessee that fixed all the terms and conditions for the sale of

the apartment building and received a payment on account from the

purchaser.   After the negotiations had been completed, the

husband was informed of the adverse tax consequences of a sale by

the corporation.   He thereupon caused shareholder resolutions to

be adopted under which the corporation declared and distributed

the apartment building to the shareholders as a "liquidating


     17
       Implicit in respondent's Court Holding argument is the
view that SIC's ownership of the assets transferred to it by MIC,
and Arnold's ownership of SIC stock were too transitory to be
recognized for tax purposes. However, we need not grapple with
the transitory nature of SIC and the tax consequences of such a
designation on the transactions in the case at hand. Respondent
acknowledges that if we decide that Court Holding does not apply
to attribute the sale to petitioner, then the transaction should
be regarded as a sec. 351 transfer from MIC to SIC, followed by a
taxable redemption of Arnold's shares in petitioner, thereby
acknowledging the existence of SIC for Federal income tax
purposes under respondent's alternative argument. See infra pp.
46-49.
                                - 36 -

dividend".    The shareholders then sold the apartment building on

the same conditions and terms previously agreed upon to the same

purchaser, and the prior payment received by the corporation was

applied in part payment of the purchase price.    The Supreme Court

affirmed the finding of the Tax Court that the transaction, in

substance, was a sale by the corporation, and that the

shareholders were mere conduits whose formal participation in the

closing with the buyer was to be ignored for Federal income tax

purposes.    The corporation was therefore liable for a corporate

level tax on the gain recognized on the sale of the apartment

building.

     Any analysis of Court Holding would be incomplete without an

examination of United States v. Cumberland Pub. Serv. Co., 338

U.S. 451, 455 (1950).    In Cumberland Pub. Serv., corporate assets

were distributed in liquidation and thereafter sold by the

corporation's shareholders.    Unlike Court Holding, the

corporation at no time entered into negotiations to make the sale

itself.     Instead the shareholders first offered to sell the buyer

their stock; after the buyer rejected their offer, they conducted

on their own behalf all the negotiations to sell the assets to

the buyer.    The Supreme Court concluded that the shareholders

were the sellers of the assets and refused to find that, in

substance, the corporation was the actual seller.

     Court Holding and Cumberland Pub. Serv. together support a

narrow rule or holding on the genuineness of corporate
                               - 37 -

liquidations.    In Court Holding, the Supreme Court upheld this

Court's factual finding that the liquidation of the corporation

was not genuine and never occurred for Federal income tax

purposes.    Therefore, the corporation continued to own the

apartment building for tax purposes, and the shareholders were

mere conduits used to pass title.   In contrast, the Supreme Court

in Cumberland Pub. Serv. upheld the factual finding of the Court

of Claims that a genuine liquidation had occurred, and therefore

the subsequent sale of assets by the shareholders was respected.

     Court Holding and Cumberland Pub. Serv. also provide a

broader principle that helps to explain why a corporate

liquidation is respected in one setting and disregarded in

another.18   The substance of a transaction can be found in the

negotiations leading up to the closing.    Where the negotiations

have culminated in an understanding that is inconsistent with the

form of the final transaction, that form is said to be

inconsistent with the substance, and the substance must prevail.

Such is the case when a corporation negotiates all the terms and

conditions of a sale of its assets, and then, at the last minute,

distributes assets to its shareholders and the shareholders'

names are conveniently inserted as sellers; the substance of the

negotiations will prevail, and the corporation will be regarded

as the seller for Federal income tax purposes.

     18
       See Isenbergh, “Musings on Form and Substance in
Taxation”, 49 U. Chi. L. Rev. 859, 871-874 (1982), for a
discussion of the narrow and broad interpretations.
                                 - 38 -

     This Court and others have acknowledged this broader principle of

what Court Holding and Cumberland Pub. Serv. stand for.19     Where

shareholders are found to have negotiated the sale of corporate assets

independently, on their own behalf, the form of the transaction is

respected, and the corporation is not recast as the seller,

notwithstanding that some negotiations were carried on by the

shareholders before the liquidation.   See, e.g., Bolker v.

Commissioner, 81 T.C. 782 (1983), affd. 760 F.2d 1039 (9th Cir. 1985);

Doyle Hosiery Corp. v. Commissioner, 17 T.C. 641 (1951); Amos L. Beaty

& Co. v. Commissioner, 14 T.C. 52 (1950).20   Where a corporation is

found to have negotiated a transaction, and at the last minute, the

shareholders are substituted for the corporation as sellers, Court

Holding has been applied to regard the corporation as the seller for

Federal income tax purposes.   See, e.g., Waltham Netoco Theatres, Inc.

v. Commissioner, 401 F.2d 333 (1st Cir. 1968), affg. 49 T.C. 399, 405

(1968); Kaufmann v. Commissioner, 175 F.2d 28 (3d Cir. 1949), affg. 11


     19
       The Supreme Court noted in Central Tablet Manufacturing
Co. v. United States, 417 U.S. 673, 680 (1974), that its earlier
decisions in Court Holding and United States v. Cumberland Pub.
Serv. Co., 338 U.S. 451, 455 (1950), "created a situation where
the tax consequences were dependent upon the resolution of often
indistinct facts as to whether the negotiations leading to the
sale had been conducted by the corporation or by the
shareholders." See also Bolker v. Commissioner, 81 T.C. 782, 799
(1983), affd. 760 F.2d 1039 (9th Cir. 1985).
     20
       There is some discussion in the above-cited cases
concerning whether shareholders who are corporate officers or
directors can negotiate a sale of assets in corporate solution
on their own behalf, rather than on the corporation's behalf,
especially when the negotiations take place before the
corporation resolves to liquidate the assets that are to be sold.
                                 - 39 -

T.C. 483 (1948).21

     Arnold, on behalf of himself as well as petitioner, began

negotiations with Häagen-Dazs with respect to the sale of distribution

rights in January 1988.   On May 4, 1988, MIC adopted corporate

resolutions authorizing the creation of a wholly owned subsidiary to

be called SIC.   Over the following weeks, Arnold, Mr. Hewit, and

representatives of Häagen-Dazs continued to negotiate the price and

terms of a sale of distribution rights by MIC to Häagen-Dazs.     On May

31, 1988, SIC was organized as a wholly owned subsidiary of MIC.     On

June 6, 1988, in response to the Häagen-Dazs first draft of purchase

agreement, which provided for the sale of all distribution rights, Mr.

Hewit informed Häagen-Dazs that Martin and MIC would not be parties to

the sale transaction.   In a letter sent to Mr. Hewit dated June 14,


     21
       Although Commissioner v. Court Holding Co., supra, deals
with corporations that distribute assets to their shareholders in
complete liquidation, the Commissioner has recently applied its
conduit theory to sec. 355 distributions. In Rev. Rul. 96-30,
1996-1 C.B. 36, D, a publicly traded corporation, distributes the
stock of C, its wholly owned subsidiary, to its shareholders in a
spin-off. C then enters into negotiations with Y, an unrelated
corporation, and is merged into Y, after a vote to do so by C’s
shareholders, under a plan that meets all the requirements of
sec. 368(a)(1)(A). Rev. Rul. 96-30, supra, specifically cites
the complete lack of negotiations regarding the acquisition of C
by Y before the spin-off as the determining factor in respecting
the form of the transactions under Commissioner v. Court Holding
Co., supra, in addition to the shareholder vote cited in Rev.
Rul. 75-406, 1975-2 C.B. 125. Although respondent did not cite
Rev. Rul. 96-30, supra, on brief, see supra note 16.

     While Rev. Rul. 96-30, supra, indicates that a complete lack
of negotiations before the spin-off will prevent the recasting of
transactions under Court Holding, situations where there have
been some, or even substantial, negotiations are not addressed.
Nor does Rev. Rul. 96-30, supra, deal with a non pro rata
distribution such as a split-off, as in the case at hand.
                                  - 40 -

1988, Ms. Bronner stated that Häagen-Dazs, as requested by Mr. Hewit,

would eliminate references to Martin and MIC from the purchase

agreement, but she insisted that Häagen-Dazs had to acquire "any and

all" of the 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 business records related thereto, from MIC to

SIC.    Thereafter, Arnold continued to negotiate with Häagen-Dazs on

behalf of himself and SIC until the purchase agreement was signed on

July 8.    The purchase agreement, as finally negotiated and amended at

the closing on July 22, provided that Häagen-Dazs could walk away from

the deal if an audit by a "Big-8" accounting firm disclosed ice cream

sales by petitioner of less than $4 million for the 12-month period

ended May 31, 1988, and for a reduction in both the fixed and deferred

contingent portions of the purchase price if such sales amounted to

less than $4.7 million.   On July 22, following the Touche-Ross sales

audit and the parties' agreement that ice cream sales amounted to

$4,528,000, the sales price paid at the closing was reduced to

$1,430,340 and the maximum deferred contingent payments were reduced

to $333,660.

       The facts of this case are distinguishable from those of Court

Holding.   In Court Holding and other cases applying its holding, such

as Waltham Netoco Theaters, Inc. v. Commissioner, supra, the change in

the identity of the sellers took place at the last minute.   In such

cases, the only difference in whether the corporation or all its

shareholders are regarded as the seller(s) lies in whether the
                                 - 41 -

proceeds of the sale to which the shareholders become entitled will be

decreased by the amount of the corporate level tax imposed.    In the

present case, the change in the identity of the sellers, namely the

removal of Martin and MIC, resulted in a significant economic change

that was independent of any change in tax consequences.    Once SIC,

wholly owned by Arnold, was designated as the seller, along with

Arnold, a situation was created in which all proceeds of the sale

would come under the control of Arnold, to the exclusion of Martin and

MIC.22

     The change in the identity of the sellers was not a "last minute"

change in a deal that had already been consummated, or whose terms had

been completely negotiated.   Rather, it signaled the birth of a new

deal significantly different from its predecessor, both in terms of

what would be sold and who would receive the proceeds.    Stated

differently, having Arnold and SIC, rather than petitioner, sell

assets to Häagen-Dazs was not a mechanism to give effect to a

transaction that had already been negotiated by, or on behalf of,

petitioner.   See Kaufmann v. Commissioner, 11 T.C. at 490-491 (Kern,



     22
       Compare the ownership position of the single shareholder,
which remained unchanged, in Idol v. Commissioner, 38 T.C. 444
(1962), affd. 319 F.2d 647 (8th Cir. 1963), with Standard Linen
Serv., Inc. v. Commissioner, 33 T.C. 1 (1959), and Esmark, Inc. &
Affiliated Cos. v. Commissioner, 90 T.C. 171 (1988), affd.
without published opinion 886 F.2d 1318 (7th Cir. 1989), where
redemptions accomplished a substantial change in the ownership of
the stock of the taxpayer corporation. Similar to Standard Linen
and Esmark, MIC's redemption of Arnold's stock substantially
changed the proportionate ownership of MIC by eliminating one of
the two shareholders and assured that Arnold would receive the
entire consideration paid by Häagen-Dazs for acquisition of the
distribution rights.
                                  - 42 -

J., concurring).

     Not only are the facts of this case distinguishable from those of

Court Holding, but they also fall under the rubric of Cumberland Pub.

Serv., where the taxpayer corporation did not negotiate a sale of

assets.   As in Cumberland Pub. Serv., we focus on the "negotiation

substance" of the transaction to determine whether it is consistent

with its form.   This requires us to first identify the transaction,

whose negotiations we examine.   Where, as here, a change in the

identity of a seller occurs during the negotiation process, and that

change has business purposes and economic effects that are independent

of any tax consequences, then the transaction is transformed and a new

transaction arises.   In then determining whether the form of the new

transaction is consistent with its substance, the only negotiations

that are relevant are those that occur after the identity of the

seller has changed.

     After SIC became a party to the sale transaction, replacing

petitioner, the transaction was transformed.   In determining whether

the form of the transaction is consistent with its substance, we focus

on the negotiations that occurred once SIC became the named seller in

the proposed new transaction.    Petitioner took no part in these

subsequent negotiations for the sale of distribution rights, and

therefore the final form of the transaction is consistent with its

substance.   We accordingly deny respondent's attempt to apply Court

Holding to treat petitioner as a seller of assets to Häagen-Dazs.
                                  - 43 -

3.   Split-Off Did Not Qualify Under Section 355

      Section 355 generally allows a corporation to make a tax-free

distribution of an amount of stock constituting control of a

corporation (control being defined in section 355(a)(1)(D)(ii) for

purposes of section 355 by reference to section 368(c))23 to its

shareholders, provided the active business requirement of section

355(b) is satisfied, and the transaction is not deemed a "device" to

make a tax-free distribution of earnings and profits, which otherwise

would be taxable as a dividend.   The section 355 regulations impose

other requirements, which we need not address.

     Respondent determined that petitioner failed to satisfy several

of the requirements for nonrecognition of gain under section 355 when

it distributed SIC stock to Arnold in redemption of Arnold’s stock in

petitioner.   We need consider only whether SIC was actively engaged in

a trade or business immediately after the split-off within the meaning

of section 355(a)(1)(C) and (b)(1)(A), which requires that the

distributing corporation and the subsidiary corporation both be

“engaged immediately after the distribution in the active conduct of a

trade or business”.   Sec. 355(b)(1)(A).

     The determination of whether a trade or business is actively

engaged in is a factual question requiring an examination of all the

facts and circumstances.   Under section 1.355-(1)(c), Income Tax




      23
       The corporation must also be in control of the
corporation whose stock is being distributed immediately before
the distribution. Sec. 355(a).
                                 - 44 -

Regs., a corporation is treated as engaged in a trade or business

immediately after the distribution if it

     consists of a specific existing group of activities being
     carried on for the purpose of earning income or profit from
     only such group of activities, and the activities included
     in such group must include every operation which forms part
     of, or a step in, the process of earning income or profit
     from such group. * * *

By requiring that a trade or business be actively conducted, section

355 envisions a corporation with substantial management and

operational activities directly carried on by the corporation itself.

See sec. 1.355-3(b)(2)(iii), Proposed Income Tax Regs., 42 Fed. Reg.

3870 (Jan. 21, 1977);24 see also Rev. Rul. 73-236, 1973-1 C.B. 183.

     Petitioner's distribution of SIC stock does not qualify for

nonrecognition of gain under section 355(c) because SIC was not

engaged in the active conduct of a trade or business immediately after

the distribution.   SIC received no operating assets from petitioner on

the transfer of intangible assets by petitioner to SIC in exchange for

SIC stock.   During the 6-week period from the time of the split-off

until the sale of all of the assets of SIC to Häagen-Dazs, SIC did not

directly carry on any operational activities.   SIC had neither the

assets nor the employees required to engage in the active conduct of

an ice cream distributorship.


     24
       The proposed regulations were finalized by T.D. 8238,
1989-1 C.B. 92. The final regulations, however, are effective
for transactions occurring after Feb. 6, 1989. In response to
several comments received by practitioners requesting guidance,
the final regulations also state that in determining whether a
corporation is actively conducting a trade or business,
activities performed by independent contractors will generally
not be taken into account. See sec. 1.355-3(b)(2)(iii), Income
Tax Regs.
                                  - 45 -

       SIC used petitioner's employees in all of its operational

activities.    Petitioner was retained as an independent contractor by

SIC.    Petitioner and Martin’s agreement with SIC and Arnold stated

that MIC would provide all services “reasonably necessary” for SIC to

carry on during an interim period while it made alternative

arrangements.    Pursuant to that agreement, drivers employed by MIC

made all the deliveries to SIC's supermarket accounts during the

interim 6-week period.    Other than perhaps Arnold, its sole

shareholder, SIC had no employees.

       SIC used petitioner's tangible assets in all of its operational

activities.    After the distribution, petitioner continued to own all

the refrigerated trucks and storage facilities required to operate

both the small store and supermarket businesses.    During the period

between the split-off and the sale to Häagen-Dazs, trucks owned by MIC

made all the deliveries to the supermarkets, and the MIC warehouse and

refrigeration facilities were used to store the Häagen-Dazs ice cream

products until they could be delivered to the supermarkets.     The

supermarket customers themselves were largely unaware until the

closing of the transactions with Häagen-Dazs on July 22 that Martin

and MIC had parted company from Arnold and SIC.

4.     Petitioner’s Gain Recognized on Distribution of SIC Stock

       Because petitioner’s transfer of assets to SIC and distribution

of SIC stock to Arnold do not qualify for nonrecognition of gain under

section 355, we must determine the Federal income tax consequences of

these transactions under other provisions of the Code.
                                 - 46 -

     Respondent acknowledges that petitioner was entitled to

nonrecognition of gain under section 351 upon the transfer of assets

to SIC in exchange for its stock25 but argues that petitioner

recognized gain under section 311(b) on the immediately following

distribution of the SIC stock to Arnold in redemption of his stock in

petitioner.   We agree with respondent.

     a.   MIC's Transfer of Assets to SIC

     Under section 351(a), a transfer of property to a corporation

solely in exchange for its stock does not trigger a recognition event,

provided that immediately after the transfer the transferor or

transferors “are in control (as defined in section 368(c))” of the

transferee.   Section 351(c) modifies the controlling interest

requirement, providing that, in determining control for this purpose,

the fact that a corporate transferor distributes to its shareholders

all or part of the stock of the transferee “shall not be taken into

account.”

     The June 15, 1988, transfer of assets by MIC to SIC, solely in

exchange for the stock of SIC, is a nonrecognition event under section

351(a).   Immediately after the transfer, MIC received all the stock of

SIC, which it thereupon distributed to one of its shareholders,

Arnold.   By reason of section 351(c), the distribution of SIC stock to

     25
       The record is not clear whether petitioner received the
stock of SIC on May 31, 1988, the date of its incorporation, or
June 15, 1988, the effective date of the transfer of assets from
petitioner to SIC. Because respondent acknowledges on brief that
petitioner’s basis in SIC stock is determined under secs. 351 and
358, we treat the operative events as having occurred
simultaneously.
                                - 47 -

Arnold does not adversely affect the conclusion that MIC had a

controlling interest in SIC immediately after the transfer.

     In Rev. Rul. 68-298, 1968-1 C.B. 139, a corporation transferred

property to a newly created subsidiary in exchange for all the stock

of the subsidiary, whereupon the transferor distributed 25 percent of

the transferee corporation’s stock to a shareholder in complete

redemption of the shareholder’s stock in the transferor.   The

Commissioner ruled that the transferor had maintained its controlling

interest under section 351(a) and (c), notwithstanding that the

transferor’s remaining interest in the transferee was less than 80-

percent control as defined in section 368(c).

     We agree with the conclusion of Rev. Rul. 68-298, supra, which is

consistent with the statutory language of section 351.   Section 351(c)

provides that a transferor corporation's subsequent distribution of

transferee stock to its shareholders “shall not be taken into

account”; this means that the transferor will not be deemed to have

relinquished control immediately after the transfer by reason of

having distributed to one or more of its shareholders all or part of

the stock of the transferee, even though the distribution effects a

termination of the shareholder’s interest in the transferor.

     b.   Distribution of SIC Stock to Arnold in Redemption of
His Stock in Petitioner

     While the transfer of assets by MIC to SIC was a nonrecognition

event for Federal income tax purposes, the subsequent distribution of

SIC stock to Arnold by MIC was not.   The rules of subchapter C

determine whether and to what extent an S corporation recognizes gain
                                   - 48 -

on the distribution of property in redemption of its stock.    S. Rept.

100-445, at 66 (1988); see also Eustice & Kuntz, Federal Income

Taxation of S Corporations, par. 8.02[1][a], at 8-24, par. 13.06[2],

at 13-40 (3d ed. 1993).

     The distribution of SIC stock to Arnold in exchange for his stock

in petitioner was a distribution of property under section 317(a),

amounting to a redemption by petitioner of its stock held by Arnold.26

Sec. 317(b).27    Section 311(a), as enacted by the 1954 Code, codified

the rule of General Utils. & Operating Co. v. Helvering, 296 U.S. 200

(1935), by providing that a distributing corporation generally

recognizes no gain or loss on distributions of property with respect

to its stock.    However, section 631(c) of the Tax Reform Act of 1986

(TRA), Pub. L. 99-514, 100 Stat. 2272, amended section 311(b) so as to

effectively repeal the rule of General Utilities where there is a gain

on distributions of property with respect to stock.    Section 311(b)

now provides that a corporation recognizes gain to the extent that the

fair market value of the distributed property exceeds its adjusted

basis in the hands of the distributing corporation.    Petitioner


     26
       Stock redemptions by S corporations are governed by the
provisions of subch. C. Sec. 1371(a)(1); S. Rept. 100-445, at 66
(1988); see also Eustice & Kuntz, Federal Income Taxation of S
Corporations, par. 8.02[1][a], at 8-24, par. 13.06[2], at 13-40
(3d ed. 1993) .
     27
          Sec. 317(b) provides:

     For purposes of this part, stock shall be treated as
     redeemed by a corporation if the corporation acquires
     its stock from a shareholder in exchange for property,
     whether or not the stock so acquired is cancelled,
     retired, or held as treasury stock.
                                   - 49 -

therefore recognized the gain that it realized on the distribution of

SIC stock in redemption of Arnold’s stock in petitioner, measured by

the excess of fair market value over the basis of the SIC stock

distributed.

     Petitioner presented no evidence to establish the adjusted basis

of assets transferred to SIC in the section 351 exchange.    Inasmuch as

petitioner has the burden of proof with respect to this issue and

presented no evidence, we accept respondent’s determination of the

adjusted basis of the SIC stock, which is zero, the same as the

adjusted basis of the assets that petitioner transferred to SIC in the

section 351 exchange.    Sec. 358(a)(1).

     c.     Amount Realized on Distribution of SIC Stock

     We next determine the fair market value of the appreciated

property that petitioner distributed to Arnold--the SIC stock.    To

ascertain the fair market value of property, whether for income tax

purposes or for estate tax purposes, Champion v. Commissioner, 303

F.2d 887, 892-893 (5th Cir. 1962), revg. and remanding on other

grounds T.C. Memo. 1960-51, we must determine “the price at which the

property would change hands between a willing buyer and a willing

seller, neither being under any compulsion to buy or to sell and both

having reasonable knowledge of relevant facts.”    United States v.

Cartwright, 411 U.S. 546, 551 (1973); sec. 20.2031-1(b), Estate Tax

Regs.     This determination presents a question of fact, Estate of

Andrews v. Commissioner, 79 T.C. 938, 940 (1982), based on all the

evidence in the record, Helvering v. Safe Deposit & Trust Co., 316
                                - 50 -

U.S. 56, 66-67 (1942); Silverman v. Commissioner, 538 F.2d 927, 933

(2d Cir. 1976), affg. T.C. Memo. 1974-285.

     Our task is made all the more difficult by the lack of any direct

evidence in the record of the market value of the SIC stock.   However,

we may approximate the value of the SIC stock by determining the fair

market value of Arnold’s previously held stock in MIC, inasmuch as the

taxable event at issue is the distribution by MIC of SIC stock in

redemption of Arnold’s stock in MIC.   See United States v. Davis, 370

U.S. 65, 72 (1962); Philadelphia Park Amusement Co. v. United States,

130 Ct. Cl. 166, 126 F. Supp. 184, 189 (1954); Spruance v.

Commissioner, 60 T.C. 141, 157 (1973), affd. without published opinion

505 F.2d 731 (3d Cir. 1974); Williams v. Commissioner, T.C. Memo.

1997-326.

     Respondent did not submit an expert’s report valuing the SIC

stock, arguing that this is not a valuation case.    In respondent’s

view, the intervening transfer of property by MIC to SIC and exchange

of SIC stock for Arnold’s MIC stock are to be disregarded, and

petitioner held, under the Court Holding theory, to be the

constructive seller of all property sold to Häagen-Dazs, having a fair

market value of $1,430,340, as established by the price paid by

Häagen-Dazs for assets purchased less than 6 weeks later.    Similarly,

respondent argues, even if respondent loses on the Court Holding

theory, that the price paid in the Häagen-Dazs sale is the best

evidence of the value of the assets transferred from MIC to SIC and of

the value of Arnold’s MIC stock that was redeemed.   For reasons

previously discussed, we have rejected respondent’s overall position
                                   - 51 -

equating petitioner’s gain with the total amount of the consideration

paid by Häagen-Dazs in the purchase and sale transaction.

     Petitioner submitted an expert witness report that valued

Arnold’s share of MIC as an ongoing business prior to the June 15

transfer at $141,000.   Rudolph Bergwerk, a certified public

accountant, prepared the report for petitioner.    Expert opinions can

aid the Court in understanding an area of specialized training,

knowledge, or judgment, such as valuation.    Perdue v. Commissioner,

T.C. Memo. 1991-478.    While we may accept an expert’s opinion in its

entirety, Buffalo Tool & Die Manufacturing Co. v. Commissioner, 74

T.C. 441, 452 (1980), we are not bound to do so, Silverman v.

Commissioner, supra, and may selectively use any portion of the report

and testimony in determining fair market value of property, IT&S of

Iowa, Inc. v. Commissioner, 97 T.C. 496, 508 (1991); Parker v.

Commissioner, 86 T.C. 547, 562 (1986).

     Respondent urges the Court to reject Mr. Bergwerk’s report in its

entirety on the ground that he was a “hired gun”.    Cf. Estate of

Mueller v. Commissioner, T.C. Memo. 1992-284.     Experts are not

supposed to be “hired guns”; they lose their usefulness and

credibility to the extent to which they become mere advocates for the

side that hired them.    Estate of Halas v. Commissioner, 94 T.C. 570,

577 (1990); Buffalo Tool & Die Manufacturing Co. v. Commissioner,

supra at 452.

     Mr. Bergwerk is a certified public accountant who had an ongoing

professional relationship with petitioner as petitioner’s tax return

preparer from 1982 through 1985.    Mr. Bergwerk prepared personal
                                  - 52 -

income tax returns for Martin and Arnold during this same period.    He

also represented petitioner before the IRS in the audit that preceded

the issuance of the deficiency notice at issue in this case.

Respondent argues that these prior relationships so infect Mr.

Bergwerk’s report with bias that we should completely disregard it.

The mere existence of the relationships does not automatically

disqualify Mr. Bergwerk as petitioner’s expert.   See, e.g., Estate of

Bennett v. Commissioner, T.C. Memo. 1993-34 (appraiser was a longtime

family adviser and was a coexecutor of the estate).   Nor is Mr.

Bergwerk automatically disqualified by his lack of formal

qualifications as an appraiser.    Id. (citing Fed. R. Evid. 702; Grain

Dealers Mut. Ins. Co. v. Farmers Union Coop. Elevator & Shipping

Association, 377 F.2d 672, 679 (10th Cir. 1967)).

     In Estate of Halas v. Commissioner, supra at 578, we stated that

an “appraiser’s duty closely corresponds to the public duty of an

auditor or certified public accountant.”   On the basis of the nature

of the report, which we discuss infra, Mr. Bergwerk’s professional

qualifications as a certified public accountant, and the testimony of

Mr. Bergwerk, we are satisfied that Mr. Bergwerk was not acting as a

mere advocate for petitioner, but as an appraiser with a duty to the

Court.   Id. at 577.   However, we do not ignore or disregard this prior

and continuing relationship between Mr. Bergwerk and petitioner,

Arnold, and Martin and weigh it in the balance of whether--and the

degree to which--to accept Mr. Bergwerk’s expert opinion.

     Mr. Bergwerk stated that he had based his report on the

methodology set forth in Rev. Rul. 59-60, 1959-1 C.B. 237, modified by
                                 - 53 -

Rev. Rul. 65-193, 1965-2 C.B. 370, and Rev. Rul. 68-609, 1968-2 C.B.

327, and amplified by Rev. Rul. 77-287, 1977-2 C.B. 319, Rev. Rul.

80-213, 1980-2 C.B. 101, and Rev. Rul. 83-120, 1983-2 C.B. 170.     We

follow the principles set forth in Rev. Rul. 59-60, supra, which we

recognize as having been “widely accepted as setting forth the

appropriate criteria to consider in determining fair market value”,

Estate of Newhouse v. Commissioner, 94 T.C. 193, 217 (1990), to the

extent they represent a correct approach to the valuation of closely

held corporations, see Stark v. Commissioner, 86 T.C. 243, 250-251

(1986).

     Mr. Bergwerk’s report characterized petitioner as an

undiversified company engaged in a single line of business, the

wholesale distribution of ice cream products, which was highly

dependent on weather and time of year.    Petitioner also had “an

unhealthy concentration” of its business in Häagen-Dazs products.

Despite such drawbacks, the company had expanded its gross sales

substantially in the 5 years before the distribution of SIC stock.

Mr. Bergwerk opined that the potential for further growth was limited

because of the ability of supermarkets and ice cream manufacturers to

eliminate independent wholesale distributors from business.28

      Mr. Bergwerk expressly considered each of the factors set forth

in Rev. Rul. 59-60, 1959-1 C.B. at 238-239, as a basis for valuation

of closely held corporations.   In arriving at his valuation of MIC as



     28
       The evidence in the record strongly supports Mr.
Bergwerk’s opinion concerning petitioner’s market position and
relative vulnerability to outside forces.
                                - 54 -

an ongoing business, Mr. Bergwerk assigned relative weights to the

three valuation factors that he found persuasive--50 percent to

capitalized earnings, 30 percent to petitioner’s dividend-paying

capacity, and 20 percent to petitioner’s book value--and then averaged

the factors in accordance with those relative weights.   In so doing,

he appropriately gave primary consideration to petitioner’s earnings

history, as recommended by Rev. Rul. 59-60, sec. 5, 1959-1 C.B. at

242, and estimated petitioner’s fair market value as an ongoing

business prior to the separation of the business lines to be $276,509,

and Arnold’s 51-percent share, which was redeemed upon distribution of

SIC stock, to be $141,000.

     Mr. Bergwerk used the same three factors and approach used in

Bader v. United States, 172 F. Supp. 833 (S.D. Ill. 1959), a case

decided prior to the issuance of Rev. Rul. 59-60, supra, which also

averaged the results of the factors.   Mr. Bergwerk did not discount

his valuation on account of lack of marketability, as did the court in

Bader, nor did he provide an explanation of why he used the particular

weights he used, or of why he had disregarded the admonishment of Rev.

Rul. 59-60, 1959-1 C.B. at 243, that “no useful purpose is served by

taking an average of several factors * * * and basing the valuation on

the result.”

     Despite the problems we have with Mr. Bergwerk’s report, we find

that Mr. Bergwerk’s estimate of the fair market value of petitioner

just prior to the transactions in issue provides a reasonable upper

limit on the value of petitioner as of June 1988; we adopt Mr.

Bergwerk’s figure, in the absence of countervailing expert opinion and
                                 - 55 -

testimony from respondent.

     Of the three valuation factors used by Mr. Bergwerk, the highest

amount was book value as of October 31, 1987, $552,061.29   In

calculating the capitalized earnings of petitioner at $331,394, Mr.

Bergwerk estimated the earning capacity of petitioner as $53,023 per

year after taxes, based on a weighted average of the 5 years of

operations ending on October 31, 1987,30 and a price-earnings ratio of

6.25:1, the same as used by this Court in Estate of Little v.

Commissioner, T.C. Memo. 1982-26, to determine the value of a closely

held, diversified corporation engaged in light manufacturing.    Mr.

Bergwerk discounted the price-earnings ratio because of the corporate

shortcomings noted above, the dependence of the business on Arnold’s

personal relationships with the supermarkets, and the lack of a second

tier of management.

     Mr. Bergwerk opined that the corporation had no goodwill because

the rate of return on tangible assets did not exceed 10 percent, a

rate of return on tangible assets suggested by Rev. Rul. 68-609, 1968-

2 C.B. 327.   Under the approach of Rev. Rul. 68-609, supra, any return

in excess of 10 percent would be attributable to goodwill or other

intangibles for tax purposes.   See also Financial Valuation:

Businesses and Business Interests, par. 16.4[7], at 16-10 (Zukin ed.


     29
       Mr. Bergwerk estimated the book value as $554,061 in the
text of his report and $552,061 in the exhibit. The exhibit
corresponded to the book net worth shown in the tax balance sheet
in petitioner’s 1987 tax return.
     30
       Petitioner’s net income rose from $40,873, or 0.0081
percent of gross sales, in 1983, to $55,914, or 0.0066 percent of
gross sales, in 1987.
                                 - 56 -

1990).   However, petitioner did have some intangibles in the form of

customer lists and pricing lists.   Petitioner transferred those

business records pertaining to the supermarket distribution business

to SIC in the initial tax-free exchange for SIC stock.   Petitioner

retained other proprietary information pertaining to the independent

grocery store business that Martin continued to conduct in the years

subsequent to the transactions at issue.

     Mr. Bergwerk determined that petitioner had no dividend-paying

capacity, using the methodology that this Court used in Bardahl

Manufacturing Corp. v. Commissioner, T.C. Memo. 1965-200, to determine

reasonable business needs for retained earnings.   He therefore

assigned a fair market value of zero to MIC as an ongoing business on

the basis of this lack of dividend-paying capacity.   In so doing, Mr.

Bergwerk disregarded an explicit instruction in Rev. Rul. 59-60, 1959-

1 C.B. at 241, which points out that, where

     an actual or effective controlling interest in a corporation
     is to be valued, the dividend factor is not a material
     element, since the payment of such dividends is
     discretionary with the controlling stockholders. The
     individual or group in control can substitute salaries and
     bonuses for dividends, thus reducing net income and
     understating the dividend-paying capacity of the company.
     It follows, therefore, that dividends are less reliable
     criteria of fair market value than other applicable factors.


Even though a valuation derived from dividend-paying capacity is an

inappropriate factor in this case, the relative lack of dividend-

paying capacity cannot be entirely ignored in that it shows the extent

to which petitioner was undercapitalized in those years--a factor that
                                 - 57 -

negatively affects petitioner’s fair market value.31

     Under the circumstances of this case, use of book value would

tend to overvalue petitioner, especially in light of the effect of the

relatively low--and dropping--ratio of net income to sales during the

mid-1980's on the value of petitioner and the relative lack of

dividend-paying capacity, which shows the precarious nature of

petitioner’s financial health.   Capitalized earnings at a 6.25:1

price/earnings ratio, $331,394, also over- values petitioner to the

extent that it does not sufficiently take into account a number of

other factors not fully considered by Mr. Bergwerk.

     Although Mr. Bergwerk discussed petitioner’s overreliance on

Häagen-Dazs as its major supplier, he did not expressly take into

account the negative effect on marketability--and hence fair market

value--of Häagen-Dazs’ effective veto over any sale to an unrelated

third party.   Because of the tenuous nature of petitioner’s

distribution rights--if any--to Häagen-Dazs products, Häagen-Dazs

could effectively stop a sale of petitioner, if it did not approve of

the buyer, by threatening to stop supplying petitioner with its

product.   The withdrawal of Häagen-Dazs as a supplier would leave



     31
       Using the formula used in Bardahl Manufacturing Corp. v.
Commissioner, T.C. Memo. 1965-200, which calculates the amount
available for dividends as the working capital at year’s end less
necessary working capital and capital expenditures actually made
in the following year, petitioner was insufficiently capitalized
in the years immediately preceding the separation of the business
lines. Necessary working capital was determined as a function of
working capital requirements for the year and the length of
petitioner’s operating cycle, which is determined by inventory
and accounts receivable turnover and the credit period extended
by suppliers--primarily Häagen-Dazs.
                                 - 58 -

petitioner as little more than a collection of physical assets and a

distribution network with nothing to distribute.   Häagen-Dazs’ cold

shoulder to Mr. Hewit’s overture in his May 16, 1988, letter

concerning the possible sale of the nonbanner business to an unrelated

third party, and the abandonment of any further effort to sell by

Martin, is probative, not only of the effect of Häagen-Dazs’ veto on

petitioner’s marketability--and its market value--but also of the

likelihood that Häagen-Dazs would have used such a veto.

     Another factor having a depressing effect on fair market value is

the lack of value that Häagen-Dazs attached to petitioner as an

ongoing business concern.   This is demonstrated by the refusal of

Häagen-Dazs to consider buying any of petitioner’s assets beyond a few

business records that documented the sales to the supermarkets.

Despite petitioner’s investment in refrigerated trucks and warehouse

facilities during the mid-1980's--which contributed to the anemic

position of its net current assets and its inability to pay dividends-

-Häagen-Dazs still considered petitioner’s physical plant and

equipment to be substandard for purposes of distributing Häagen-Dazs

ice cream.

     We must also consider the effect of petitioner’s being a small,

family-owned business on the sale by either Arnold or Martin of his

interest in petitioner without the sale of the other interest.    While

we do not assign a precise value to this discount factor, the closely

held nature of petitioner and the reluctance of a third party to buy

into a family-owned business, especially one with the handicaps we
                                 - 59 -

have just recited, could serve only to decrease the market value of

the interest for sale.

     Also important is that the conditions under which petitioner had

operated during the 1970's had changed in the 1980's, when Pillsbury

acquired Häagen-Dazs, with the avowed goal of distributing ice cream

to supermarkets itself rather than relying on independent distributors

such as petitioner--a fact well known at the time of the redemption of

Arnold’s stock in MIC.   These changed conditions render suspect any

fair market value based on past earnings.

     Most importantly, petitioner’s earnings in the years preceding

the split-off were substantially attributable to Arnold’s oral

agreement with Mr. Mattus and his relationship with the supermarkets.

As we have found, the supermarket distribution rights were personal to

Arnold and did not belong to petitioner.    The assumption underlying a

capitalization of earnings approach is that, barring adverse

developments, the historical earnings will continue.   Therefore, in

valuing petitioner as of the time of the split-off, which marks the

parting of the ways between petitioner and Arnold, an adverse

development indeed, it makes no sense to assume that petitioner’s

earnings would continue at the same level in the future, or even that

there would be no more than a pro rata reduction of such earnings by

reason of Arnold’s departure.

     Under the circumstances of this case, where there was a heavy

investment in physical assets during a period when the corporation had

been unable to pay dividends, an absence of a second tier of
                                 - 60 -

management, a lack of diversification in business, an overdependence

on one supplier, Häagen-Dazs, and on one primary “rainmaker”, Arnold,

who was leaving, the risk of petitioner’s being completely eliminated

from business as an independent wholesale distributor, the effective

veto Häagen-Dazs had over any sale to a third party, the fact that

petitioner is a closely held, family-owned business, and the declining

ratio of net income to sales, we find that a value of $276,509 is the

upper limit to a fair estimate of the value of petitioner immediately

prior to the transactions at issue.

     Respondent's determination of the value of assets sold to Häagen-

Dazs by SIC, and the corresponding value of SIC stock distributed to

Arnold, is presumptively correct, and the burden of proving a lower

value rests on petitioner.   Rule 142(a); Frazee v. Commissioner, 98

T.C. 554, 562 (1992); Pessin v. Commissioner, 59 T.C. 473, 480 (1972).

In the present case, respondent did not present the testimony or

report of an expert upon which to consider an alternative valuation.

Petitioner, on the other hand, did present the report and testimony of

Mr. Bergwerk, and has thereby effectively rebutted respondent's

original determination.   Although Mr. Bergwerk's methodology was

flawed, his conclusion is only erroneous insofar as his $276,509

value for petitioner results in an overstatement of the fair market

value of the SIC stock distributed to Arnold.   Petitioner has carried

its burden of reducing respondent's determination of $1,430,340 to

$141,000 (51 percent of the value of petitioner) but has not carried

the burden of reducing the value any further.   See Hess v.

Commissioner, 24 B.T.A. 475, 478 (1931) (Court adopted taxpayer's
                                  - 61 -

asserted value where the Commissioner introduced no evidence to rebut

taxpayer's expert testimony, citing Baldwin v. Commissioner, 10 B.T.A.

1198 (1928)); cf. Anselmo v. Commissioner, 80 T.C. 872, 886 (1983),

affd. 757 F.2d 1208 (11th Cir. 1985); Estate of Trompeter v.

Commissioner, T.C. Memo. 1998-35.   Taking into account Mr. Bergwerk’s

valuation conclusion, we find that the fair market value of Arnold’s

51-percent interest in petitioner, which petitioner redeemed for all

of SIC’s stock, was $141,000.32

     32
       Respondent argues that petitioner, under the rule of
Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967), vacating
and remanding 44 T.C. 549 (1965), cannot unilaterally vary the
terms of a contract for tax purposes and must therefore abide by
the terms of the sale to Häagen-Dazs in determining the value of
assets distributed to SIC and, in turn, the value of SIC stock
distributed to Arnold.

     As we stated in Hospital Corp. of Am. v. Commissioner, T.C.
Memo. 1996-559:

           As we understand the Danielson rule, it is not
     applicable where the parties have not established the
     fair market value of the property at the time agreement
     is adopted because, under those circumstances, there is
     no agreement to which a party may be held. See
     Campbell v. United States, 228 Ct. Cl. [661,] 675-677
     (1981); * * * see also Commissioner v. Danielson, 378
     F.2d 771, 778 [(3d Cir. 1967)] ("it would be unfair to
     assess taxes on the basis of an agreement the taxpayer
     did not make”). Furthermore, the Danielson rule is not
     applicable if the contract is ambiguous. See North
     American Rayon Corp. v. Commissioner, 12 F.3d [583,]
     589 [(6th Cir. 1993), affg. T.C. Memo. 1992-610] ("the
     Danielson rule does not apply if there is no contract
     between the parties or if the contract is ambiguous").
     * * *

     The allocation by the sale agreement of the $1,430,340 sales
price paid by Häagen-Dazs to SIC and Arnold between “Sellers’
Rights”, $1,144,272, and the records, $286,068, is not an
agreement made by petitioner as to the value of SIC stock. At
                                                         (continued...)
                                  - 62 -

     d.   Petitioner’s Tax Liability Under Section 1374

     Section 1363(a) provides that, generally, S corporations are not

subject to income tax.    However, when a former C corporation such as

MIC elects S corporation status and then distributes or sells

appreciated property, it may be liable for tax under section 1374 if

the S corporation election was made prior to January 1, 1987.    TRA

sec. 633(b), 100 Stat. 2277; H. Conf. Rept. 99-841 (Vol. II), at II-

203 (1986), 1986-3 C.B. (Vol. 4) 1, 203.   Petitioner is a former C

corporation that elected S status prior to January 1, 1987.

     Section 1374, as applicable to petitioner for the year in issue,

reads in pertinent part:

          SEC. 1374(a).    General Rule.--If for a taxable year of
     an S corporation--

                (1) the net capital gain of such corporation
           exceeds $25,000, and exceeds 50 percent of its taxable
           income for such year, and

                (2) the taxable income of such corporation for
           such year exceeds $25,000,

     There is hereby imposed a tax (computed under subsection (b)) on
     the income of such corporation.

     32
      (...continued)
best it is an ambiguous indication. Furthermore, because
petitioner was not a party to the transaction with Häagen-Dazs,
the Danielson rule does not apply.

     MIC cannot be held to an allocation that it did not bargain
for with a party with opposing interests in an arm’s-length
negotiation. Neither MIC, SIC, nor Arnold actively negotiated
the allocation with Häagen-Dazs. It remained unchanged from the
June 2 draft agreement through the closing of the sale on July
22. See Particelli v. Commissioner, 212 F.2d 498, 501 (9th Cir.
1954), affg. a Memorandum Opinion of this Court dated Feb. 20,
1952; Berry Petroleum Co. & Subs. v. Commissioner, 104 T.C. 584,
615 (1995).
                                 - 63 -

                 *     *     *     *      *     *     *

          (d) Determination of Taxable Income.--For purposes of
     this section, taxable income of the corporation shall be
     determined under section 63(a) without regard to--

                (1) the deduction allowed by section 172 (relating
           to net operating loss deduction), and

                (2) the deductions allowed by part VIII of
           subchapter B (other than the deduction allowed by
           section 248, relating to organization expenditures).

     In order for section 1374 to apply, petitioner must have

recognized "net capital gain", which means the excess of net long-term

capital gain over net short-term capital loss, as defined in section

1222.   Given that petitioner reported no capital gains or losses on

its 1988 income tax return, in order for section 1374 to apply,

petitioner's distribution of SIC stock to Arnold must have resulted in

a long-term capital gain, exceeding $25,000.   This, in turn, requires

that SIC stock be a capital asset in the hands of petitioner and that

petitioner be deemed to have held the SIC stock longer than 1 year.

See sec. 1222(3), as amended by sec. 1402(a), Tax Reform Act of 1976,

Pub. L. 94-455, 90 Stat. 1520, 1731.

     The SIC stock was a capital asset in the hands of petitioner.

Arkansas Best Corp. v. Commissioner, 485 U.S. 212, 222-223 (1988).

Petitioner relies on section 1221(3) to argue that the business

records of MIC, which were subsequently transferred to SIC, are not

capital assets, and that the SIC stock received in exchange is

consequently also not a capital asset.    Section 1221(3) provides that

the term "capital asset" does not include "a copyright, a literary,

musical, or artistic composition, a letter or memorandum, or similar
                                  - 64 -

property, held by --(A) a taxpayer whose personal efforts created such

property".   Section 1253(c) extends the exception to property whose

basis is determined by reference to the basis of such property in the

hands of a taxpayer as described in subparagraph (A) of section

1221(3).   We do not agree with petitioner.   The legislative history of

section 117(a)(1)(C) of the 1939 Internal Revenue Code, the

predecessor to section 1221(3), states that the exception was intended

to deal with the writing of books and other artistic works in a very

narrow sense.   See S. Rept. 2375, 81st Cong., 2d Sess. 43-44 (1950),

1950-2 C.B. 483, 543-544; S. Rept. 91-552, at 198-199 (1969), 1969-3

C.B. 423, 549-550 (discussing the addition of "letters, memorandums,

papers, etc." to section 1221(3) under the Tax Reform Act of 1969,

Pub. L. 91-172, sec. 514(a), 83 Stat. 643); see also Commissioner v.

Ferrer, 304 F.2d 125, 132 (2d Cir. 1962), revg. in part and remanding

35 T.C. 617 (1961).   MIC's business records do not fall under the

narrow category of assets described in section 1221(3).

     Second, petitioner is deemed to have held the SIC stock for more

than 1 year.    Respondent acknowledged that petitioner's transfer of

assets in exchange for the stock of SIC qualified for nonrecognition

under section 351.    See supra p. 46.   Under sections 1223 and 358,

where a taxpayer has transferred property in a transaction that

qualifies for nonrecognition under section 351, the taxpayer's holding

period in the stock received in the transaction includes the period

for which the taxpayer has held the property transferred in the

transaction.    Petitioner's holding period in SIC stock therefore
                                   - 65 -

includes the period it held the assets transferred to SIC.       Petitioner

presented no evidence to establish that its holding period of the

assets, or any part of the assets, transferred to SIC was less than 1

year.     Inasmuch as petitioner has the burden of proof on this issue

and has presented no evidence, we accept respondent's determination

that the gain realized by petitioner was a long-term capital gain.

     Petitioner’s long-term capital gain of $141,000, resulting from

petitioner’s distribution of SIC stock in redemption of Arnold’s stock

in petitioner, is petitioner’s only capital gain in 1988.

Accordingly, petitioner had "net capital gain" (as defined in section

1222) for purposes of section 1374.    When the $141,000 of capital gain

is included, petitioner’s net capital gain exceeds $25,000 and also

exceeds 50 percent of petitioner's taxable income for 1988, as defined

in section 1374(d).33    Accordingly, petitioner satisfies the

requirements of section 1374(a) and is liable for tax imposed by

section 1374(b) on its recognized gain of $141,000.

5.   Additions to Tax

     a.    Negligence

     For taxable year 1988, section 6653(a)(1) adds to tax an amount

equal to 5 percent of an underpayment of tax required to be shown on

the return that is due to negligence or disregard of rules or

regulations.    Sections 6653(c)(1) and 6212 essentially define an

     33
       Petitioner reported an ordinary loss of $278 on its Form
1120S filed for the 1988 taxable year. Petitioner's 1988 taxable
income did not include any net operating loss deductions pursuant
to sec. 172, nor any deduction for organization expenditures
allowed by sec. 248.
                                  - 66 -

underpayment for purposes of this section as the equivalent of a

deficiency.

     Section 6653(a)(3) provides that negligence includes “any failure

to make a reasonable attempt to comply with the provisions of this

title, and the term ‘disregard’ includes any careless, reckless, or

intentional disregard.”    Courts have defined negligence as the lack of

due care or failure to do what an ordinarily prudent person would do

under the circumstances.    Bassett v. Commissioner, 67 F.3d 29, 31 (2d

Cir. 1995), affg. 100 T.C. 650 (1993); Marcello v. Commissioner, 380

F.2d 499, 506 (5th Cir. 1967), affg. in part and remanding in part 43

T.C. 168 (1964).   Petitioner bears the burden of showing that it was

not negligent.   Rule 142(a); Goldman v. Commissioner, 39 F.3d 402, 407

(2d Cir. 1994), affg. T.C. Memo. 1993-480.

     In United States v. Boyle, 469 U.S. 241, 251 (1985), the Supreme

Court held that “When an accountant or attorney advises a taxpayer on

a matter of tax law, such as whether a liability exists, it is

reasonable for the taxpayer to rely on that advice.”   Ordinary

business prudence or due care does not demand that a taxpayer seek a

second opinion, id., so long as such advice is reasonable under the

circumstances and is based on full disclosure by the taxpayer, see,

e.g., Sim-Air, USA, Ltd. v. Commissioner, 98 T.C. 187, 201 (1992)

(reliance on tax professional’s advice was reasonable when a corporate

subsidiary failed to qualify as a DISC when the advice turned out to

be erroneous, especially in light of the complexity of section 992 and

associated regulations).
                                  - 67 -

     In this case, Martin, as president of petitioner, and Arnold both

relied on legal advice from Mr. Hewit throughout the protracted

negotiations with Häagen-Dazs.    Even though Mr. Hewit never gave a

written tax opinion to petitioner or Arnold or Martin, Martin and

petitioner were entitled to rely and proceed on the assumption that

the transactions at issue were nontaxable to petitioner because of the

way Mr. Hewit had structured the transactions and drafted the

documents effecting the transactions that separated the two business

lines.    Mr. Hewit, in turn, sought advice from third-party tax

professionals on how to structure a tax-efficient solution to resolve

the growing dispute between Martin and Arnold over the future

direction of petitioner as an ice cream distributor.    Like the advice

sought by the taxpayer in Sim-Air, USA, Ltd. v. Commissioner, supra at

201, the advice that petitioner sought from Mr. Hewit, who in turn

also sought expert advice, was subject to section 355, a complex

section of the Code.34   We find that Martin and petitioner acted as

ordinarily prudent business persons would under the circumstances and

that petitioner is not liable for an addition to tax under section

6653(a)(1).

     b.   Substantial Understatement

     For tax year 1988, section 6661(a) provides for an addition to

tax of “25 percent of the amount of any underpayment attributable” to

“a substantial understatement of income tax for any taxable year”, for

     34
       We note the recent debate over the amendment to sec. 355
enacted in sec. 1012, Taxpayer Relief Act of 1997, Pub. L. 105-
34, 111 Stat. 788, 914.
                                - 68 -

penalties assessed after October 21, 1986.   Section 6661(b)(1) defines

a substantial understatement as any understatement that exceeds the

greater of $10,000 in the case of corporations, sec. 6661(b)(1)(B), or

10 percent of the tax required to be shown on the return for the

taxable year, sec. 6661(b)(1)(A)(i).   An understatement of income tax

occurs when the tax actually shown on the return is less than the

amount required to be shown on the return.   Sec. 6662(b)(2); Woods v.

Commissioner, 91 T.C. 88, 95 (1988).   Petitioner bears the burden of

proving that respondent’s determination of the deficiency, the

understatement with respect to the deficiency, and the addition to tax

based on the understatement are erroneous.   Rule 142(a); Conti v.

Commissioner, 39 F.3d 658, 664 (6th Cir. 1994), affg. on this issue

and remanding 99 T.C. 370 (1992).

     Section 6661(b)(2)(B) provides a means to reduce the amount of

the addition to tax, stating that

     The amount of the understatement * * * shall be reduced by
     that portion of the understatement which is attributable to-
     -

               (i) the tax treatment of any item by the taxpayer
          if there is or was substantial authority * * *, or

               (ii) any item with respect to which the relevant
          facts affecting the item’s tax treatment are adequately
          disclosed in the return or in a statement attached to
          the return.

Petitioner failed to disclose on its 1988 return or in a statement

attached to the return, as required by section 1.6661-4, Income Tax

Regs., the existence of its transfer of assets to SIC and its

distribution of SIC stock to Arnold in redemption of his stock in
                                 - 69 -

petitioner.   We note that sections 1.368-3(a), 1.355-5(a), and 1.351-

3(a), Income Tax Regs., also require disclosure of all plans of

reorganization, distributions of stock of a controlled subsidiary, and

transfers to controlled corporations, respectively.   Because

petitioner failed to disclose the transactions at issue on its 1988

income tax return, the understatement may not be reduced on the ground

of adequate disclosure.   Sec. 6661(b)(2)(B)(ii); sec. 1.6661-4, Income

Tax Regs.

     Substantial authority is defined in section 1.6661-3(a)(2),

Income Tax Regs., as

     less stringent than a “more likely than not” standard (that
     is, a greater than 50-percent likelihood of being upheld in
     litigation), but stricter than a reasonable basis standard
     (the standard which, in general, will prevent imposition of
     the penalty under section 6653(a), relating to negligence or
     intentional disregard of rules and regulations). Thus, a
     position with respect to the tax treatment of an item that
     is arguable but fairly unlikely to prevail in court would
     satisfy a reasonable basis standard, but not the substantial
     authority standard.

With respect to the issue of whether Commissioner v. Court Holding

Co., 324 U.S. 331 (1945), controls the transactions in question,

petitioner has prevailed and thus had substantial authority for its

position with respect to the form of the transactions.   Sec. 1.6661-

3(a)(2), Income Tax Regs.

     Petitioner has not prevailed on the issue of whether section 355

confers nonrecognition of gain realized in the split-off.   Petitioner

must therefore demonstrate that substantial authority supports the

positions taken on the income tax return with respect to those

transactions.   Gallade v. Commissioner, 106 T.C. 355, 367 (1996); sec.
                                   - 70 -

1.6661-3(b)(1), Income Tax Regs.    Petitioner cited no case law or

regulations in support of its position.     Petitioner has cited as

substantial authority only the advice given by its hired

professionals.   Advice of hired professionals, even when reasonable

under the circumstances--and regardless of the form in which it is

rendered--does not constitute substantial authority.     Gallade v.

Commissioner, supra at 367; sec. 1.6661-3(b)(2), Income Tax Regs.

Indeed, in light of the facts in this case, the weight of authority

directly supported respondent on the issue of “active conduct of a

trade or business”.   Sec. 355(a)(1)(C) and (b).   Petitioner did not

have substantial authority for taking a position that the split-off

qualified for nonrecognition of gain under section 355.

     Section 6661(c) authorizes the Commissioner to waive “all or any

part of the addition to tax * * * on a showing by the taxpayer that

there was reasonable cause for the understatement (or part thereof)

and that the taxpayer acted in good faith.”    While the authority to

waive the section 6661(a) addition to tax rests with the Commissioner

and not with this Court, we review a denial of waiver by the

Commissioner under the abuse of discretion standard.     Gallade v.

Commissioner, supra at 367-368; Mailman v. Commissioner, 91 T.C. 1079,

1084 (1988).

     We find no evidence in the record that petitioner ever requested

a waiver.   Accordingly, as we noted in Alondra Indus., Ltd. v.

Commissioner, T.C. Memo. 1996-32, and Brown v. Commissioner, T.C.

Memo. 1992-15, “we cannot find that respondent abused his discretion
                                 - 71 -

when the petitioner never requested respondent to exercise it.”    See

also McCoy Enters., Inc. & Subs. v. Commissioner, 58 F.3d 557, 563

(10th Cir. 1995), affg. T.C. Memo. 1992-693; Estate of Reinke v.

Commissioner, 46 F.3d 760, 765-766 (8th Cir. 1995), affg. T.C. Memo.

1993-197; Mailman v. Commissioner, supra at 1082-1084; Dugow v.

Commissioner, T.C. Memo. 1993-401, affd. without published opinion 64

F.3d 666 (9th Cir. 1995); Klieger v. Commissioner, T.C. Memo.

1992-734; sec. 1.6661-6, Income Tax Regs.; cf. Gallade v.

Commissioner, supra at 369 (citing Estate of Reinke v. Commissioner,

supra at 765, for the proposition that, while the existence of “a

taxpayer’s request for a waiver can establish the Commissioner’s

degree of fault for failing to waive, it [Estate of Reinke] does not

hold that a request is a requirement or prerequisite for a waiver.”).35

     Even if petitioner had requested a waiver, we would hold that

petitioner has not established that respondent would have committed an

abuse of discretion in refusing the request.   In this case, petitioner

would have been required to show that reliance on the professional

advice of Mr. Hewit was reasonable and that petitioner acted in good

faith under the circumstances.   Sec. 1.6661-6(b), Income Tax Regs.

While we have held that petitioner has established, by the

preponderance of the evidence, that it was not negligent for purposes

     35
       Under sec. 6664(c) of the current law, the Omnibus Budget
Reconciliation Act of 1989, Pub. L. 101-239, sec. 7721(a), 103
Stat. 2398, effective for returns with a due date after Dec. 31,
1989, the Commissioner no longer has this discretion, and no
penalty may be imposed for understatements if the taxpayer can
show that it had reasonable cause for the understatement and that
it acted in good faith.
                                 - 72 -

of section 6653(a), the evidence before us on that issue was not

completely uncontroverted, especially in light of petitioner’s failure

to disclose the split-off on its 1988 income tax return.   We therefore

cannot say that reasonable cause and good faith were so clear that any

refusal by respondent to waive the addition to tax would have amounted

to an abuse of discretion as being without sound basis in fact.    See,

e.g., Vandeyacht v. Commissioner, T.C. Memo. 1994-148; Klavan v.

Commissioner, T.C. Memo. 1993-299.

     Accordingly, we sustain respondent’s determination that

petitioner is liable for the section 6661(a) addition to tax on the

underpayment.

     To reflect the foregoing,


                                          Decision will be entered

                                     under Rule 155.
