Clydе Brown, Jr. appeals from the district court’s judgment entered December 1, 1987, which denies in part his claim for a refund of taxes paid filed pursuant to 28 U.S.C. § 1346(a)(1). For the following reasons, we affirm the district court’s judgment in part, vacate the district court’s judgment in part, reverse the district court’s judgment in part, and remand this case for further proceedings.
I.
Appellant Clyde Brown, Jr. began mining and investing in coal in the early 1950’s. He had conducted coal extraction activities in his own name as a proprietor in the 1950’s and as late as 1966, but not thereafter. Nonetheless, he is an experienced coal operator with great knowledge of the coal propensities of the counties in western Kentucky.
During the years 1970-1977, Brown entered into the following six different coal mining leases, collection of leases, or subleases in his individual capacity or in cooperation with Brown Badgett, Inc., a corporation in which Brown holds a substantial interest. First, on June 10, 1970, Brown and Brown Badgett acquired as lessees a coal mining lease from Harrison and Pearl Cross (the Cross lease). Second, beginning on November 4, 1970, Brown acquired as lessee six lignite mining leases from Jackson Lignite Company, covering lignite deposits in Alabama, and acquired four leases from other individuals relating to these deposits (the Alabama lignite leases). Third, on October 7, 1973, Brown acquired as lessee a coal mining lease from Hayward Spinks, Jackie R. Spinks, and others (the Spinks lease). Fourth, on July 30, 1976, Brown and Brown Badgett acquired as lessees a coal mining lease from Henry Case-bier and his wife (the Casebier lease). Fifth, on October 26, 1976, Brown and Brown Bаdgett acquired as lessees a coal mining lease from E.R. Wickliffe and his wife (the Wickliffe lease). Finally, on March 8, 1977, Brown entered into a coal mining sublease with Old Ben Coal Company (the Old Ben sublease). 1
In each transaction, Brown acquired the mineral rights to particular tracts of land in exchange for a certain sum of money per month in advanced minimum coal royalties. These royalty payments were to be credited against future earned royalties.
This tax dispute arises out of Brown’s treatment of the advanced minimum royalty payments made to his lessors in 1976. In that year, Brown deducted these payments, totalling $41,118.63, as trade or business expenses pursuant to I.R.C. § 162(a)(3). 2 Section 162(a)(3) permits a taxpayer to deduct “rentals or other payments required to be made as a condition to the continued use or possession, for purposes of trade or business, of property to which the taxpayer has not taken or is not taking title in or in which he has no equity-”
After 1976, but before he had begun mining the tracts of land, Brown assigned or subleased each of the coal mining leases to various parties. The Commissioner of Internal Revenue audited Brown’s return and assessed a deficiency of $57,397.86 plus statutоry interest. Among other things, the Commissioner claimed that the proper treatment of Brown’s 1976 advanced minimum royalty payments is gov
Brown paid the assеssed income tax deficiency. He then filed timely claim for refund for the year 1976 in the amount of $26,624.31. The Commissioner disallowed Brown’s claim for a refund.
Thereafter, on March 25, 1982, Brown filed a complaint in the United States District Court for the Western District of Kentucky for recovery of taxes and interest. In
Brown v. United States,
This court vacated the district court's judgment in
Brown I,
relying on
Davis v. Commissioner,
Application of the step transaction doctrine is necessary to a holding that § 631(c) governs the tax treatment of the royalties paid by Brown as a lessee. If the step transaction doctrine applies, Brown will be considered a lessee who is also a sublessor and, pursuant to Treas. Reg. § 1.631-3(b)(3)(ii)(a), he will be subject to the terms of § 631(c) requiring the royalties paid to be offset against royalty income to compute capital gain. If the doctrine does not apply, the execution of the leases and subsequent execution of subleases shоuld be viewed as separate transactions for the purposes of taxation. Under this view, Brown’s original treatment of his royalty payments as deductible business expenses would be allowable, since § 631(c) by its own terms does not apply to a taxpayer who is solely a lessee.
Brown I,
After remand, the district court made the following relevant conclusions of law:
The advanced royalty paymеnts made by the plaintiff for the Wickliffe, Casebier, Cross and Spinks leases during 1976 must be offset by the royalty payments received thereafter with respect to each property, inasmuch as the royalty payments received constituted component parts of overall plans to sublease those properties.
... The advanced royalty payments made by the plaintiff for the Old Ben and Alabama Lignite leases were properly claimed as deductions by the plaintiff on his 1976 federal income tax return inasmuch as he had no settled intention which would constitute plans to sublease those properties.
... The payment by the plaintiff of $10,-000.00 for the Old Ben Option Agreement on June 18, 1976, was payment for the purchase of an option which may not be treated as an ordinary business expense under 26 U.S.C. § 162 during the calendar year 1976.
Brown v. United States,
Brown appealed and the government cross-appealed from the district court’s judgment. In accordance with the stipulation of the parties, this court dismissed the government’s cross-appeal in an order filed
II.
A.
A business transaction, like the rest of life, has no clearly defined beginning or end, but it is necessary in рractice to cut it, usually chronologically, into segments for tax purposes. If the segment is too thin, however, the tax results may be unfair to the taxpayer or to the government, or to both. In viewing a dynamic whole, the courts often say that an integrated transaction must not be broken into independent steps or, conversely, that the separate steps must be taken together in attaching tax consequences.
B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders ¶ 1.05 (5th ed. 1987).
As the Supreme Court has recognized, “[a] transaction must be viewed as a whole, and each step, from the commencement of negotiations to the consumation ..., is relevant_ To permit the true nature of a transaction to be disguised by mere formalisms, which exist solely to alter tax liabilities, would seriously impair the effective administration of the tax policies of Congress.”
Commissioner v. Court Holding Co.,
“The step transaction doctrine is a ‘ “judicial device expressing the familiar principle that in applying the income tax laws, the substance rather than the form of the transaction is controlling.” ’ ”
Brown v. United States,
The problem of deciding whether to accord the separate steps of a complex transaction independent significance, or to treat them as related steps in a unified transaction is a recurring problem in the field of tax law. The principle that even extended business transactions have determinate limits for tax purposes is based on a strоng preference for ‘closed transactions’ upon which to impose tax consequences. This preference is tempered, however, with respect for the integrity of an entire transaction. Accordingly, the essence of the step transaction doctrine is that an ‘integrated transaction must not be broken into independent steps or, conversely, that the separate steps must be taken together in attaching tax consequences’. The mere recitation of the doctrine, however, does not clarify the necessary relationship between the steps requisite to characterization as an integrated transaction.
King Enters., Inc. v. United States,
“Although ‘there is no universal test applicable to step transaction situations,’ the courts and commentators have artiсulated several tests to be used in determining when the [step transaction] doctrine applies.”
Brown I,
In
Davis v. Commissioner,
Brown argues that in order for the step transaction doctrine to apply he must have intended to sublease at the time he entered into the original leases. The government argues that it was sufficient that Brown intended to sublease at the time the advanced royalty payments at issue were made. We agree with Brown that his intention tо sublease at the time the advanced royalty payments at issue were made does not trigger application of the step transaction doctrine.
The effect of applying the step transaction doctrine to a case such as this is that the taxpayer’s acquisition of leases and subsequent subleases are treated as one transaction.
See Davis,
[b]y treating Cumberland’s acquisition of leases and subsequent subleases as one transaction, the Tax Court was applying the step transaction doctrine, which requires for income tax purposes that component steps of a single transaction are not to be treated separately, so as to assure that tax consеquences turn on the substance of a transaction rather than on its form. On appeal, the taxpayers do not challenge the Tax Court’s finding that ‘Cumberland never intended to nor did it ever engage in any mining operations’ and that ‘Cumberland’s leases were held only for sublease to Webster Coal.’ Therefore, based on the undisputed facts of this case, we agree with the Tax Court that because Cumberland never intended to be other than a sublessor, the advanced royalty payments made by Cumberland before it subleased the mining rights to Webster must also be included in adjusted depletion basis under section 631(c).
Id. Accord Brown I,
In the instant case, the district court made no finding with respect to any of the four leases involved in this issue on appeal that at the time the original lease was entered into Brown intended to sublease. With respect to the Spinks lease, the district court found that Brown kept the leаsed property a couple of years, i.e., two or three years, before reaching a decision to sublease. With respect to the Cross lease, the district court found that Brown reached a decision to sublease the property within four or five years after acquiring his leasehold interest. With respect to the Casebier lease, although the district court found that Brown could not remember his intentions at the time he acquired his interest in this property or when he decided to assign the lease, the court made no independent finding concerning Brown’s intentions. Likewise, the district court made no finding with respect to Brown’s original intentions concerning the Wickliffe lease.
Thus, the facts in the instant case are easily distinguishable from
Davis.
In
Davis,
Joe C. Davis was a partner in Cumberland Land Company, a jоint venture involved in the leasing of coal mining rights. The joint venture leased coal mining rights from land owners in Kentucky and then in every instance subleased those rights to Webster Coal Corporation, which was wholly owned by partners in the original joint venture. In every instance, Webster Coal, not the joint venture, mined the coal covered by the leases.
Davis,
The facts in the instant case do not support such a finding with respect to any of the leases at issue. In fact, with respect to the Spinks and Cross leases the district court made contrary findings. Therefore, the district court’s application of the step transaction doctrine was in error.
The government argues, however, that Brown is precluded from making the argument that in order for the step transaction doctrine to apply Brown must have intended to sublease at the time he entered into the original leases. The government asserts that, in light of the parties’ stipulation of issues, it was sufficiеnt that Brown intended to sublease at the time the advanced royalty payments were made. We reject this argument. “A stipulation of law is not binding upon an appellate court.”
Avila v. Immigration & Naturalization Serv.,
Having held that taxpayer’s intent for the purposеs of the step transaction doctrine must be evaluated at the outset, i.e., the time he entered into the original leases, we note that respondent alludes to no other doctrine which makes intent at the time taxpayer made advanced minimum royalty payments relevant. Nor do we think that he properly could. Particularly in light of the strong preference for closed transactions,
King Enters., Inc.,
For the foregoing reasons, we reverse the district court’s judgment as it relates to the advanced royalty payments on the Spinks and Cross leases. We vacate the district court’s judgment as it relates to the advanced royalty payments on the Casebier and Wickliffe leases and remand this case for further findings on Brown’s intent at the time he entered into these latter two leases.
B.
The district court’s finding that Brown’s June 18, 1976 payment of $10,000 for an option on the Old Ben sublease was payment for the purchase of an option which may not be treated as an ordinary business expense under I.R.C. § 162 during the calander year 1976, may not be upset unless it is clearly erroneous.
Anderson v. City of Bessemer City,
[A] finding is ‘clearly erroneous’ when although there is evidence to support it, the reviewing court on the entire evidence is left with the definite and firm conviction that a mistake has been committed.’ ... ‘In applying the clearly erroneous standard to the findings of a [trial] court sitting without a jury, appellate courts must constantly have in mind that their function is not to decide factual issues de novo.’ If the [trial] court’saccount of the evidence is plausible in light of the record viewed in its entirety, the court of appeals may not reverse it even though convinced that had it been sitting as the trier of fact, it would have weighed the evidence differently. Where there are two permissible views of the evidence, the factfinder’s choice between them cannot be clearly erroneous.
Id.
In the instant case, the transcript reveals that taxpayer explained his reasoning in taking the option on the lease in question as follows:
A. To take and look at it and do whatever I could do with it at the time. I went and looked at the records, and they had some drilling on it, and I'd done some drilling on it; and after the nine months, I had enough time to get into it and figure out if I wanted to go ahead and work with it; and I did.
Q. What were you going to do when— let’s go back to June of 1976, what did you intend to do if yоu went and you had your orders, look at the title on those leases, and they proved to be bad title, what would you — what would you — what did you intend to do then?
A. If the title had been bad, I wouldn’t take it.
Q. You would not have executed ... A. If the title was — if I wasn’t getting nothing for my money, I wouldn’t.
Under these circumstances, the district court’s finding that Brown’s January 18, 1976 payment of $10,000 was payment for pujóse of an option was not clearly erroneous, and its holding with regard to this payment’s tax treatment is not in error.
For the foregoing reasons, the district court’s judgment is AFFIRMED in part, VACATED in part, REVERSED in part, and this case is REMANDED for further proceedings.
Notes
. On June 18, 1976, Brown executed a nine-month option to acquire the Old Ben sublease and paid to Old Ben Coal Company $10,000 as required by the option agreement. On February 26, 1977, Brown notified Old Ben Coal Company of his intention to exercise the option.
. Following is a breakdown of the payments deducted by each lease:
LEASE PAYMENTS DEDUCTED
Cross $ 3,000.00
Alabama lignite 7,818.63
Spinks 12,000.00
Casebier 800.00
Wickliffe 7,500.00
Old Ben 10,000.00
TOTAL $41,118.63