Hollywood Baseball Ass'n v. Commissioner

*234 Respondent has determined deficiencies of $ 25,502.07, $ 20,004.38, and $ 8,760.08 for the taxable years ending October 31, 1955, October 31, 1956, and October 31, 1958, ¹ respectively. The three remaining issues before us are as follows:

(1) Whether gain realized from the sale of certain baseball player contracts is within the purview of*116 section 337;

(2) Whether an amount realized pursuant to the transfer of two major league baseball teams to the Pacific coast area is taxable as ordinary income to petitioner; and

(3) Whether the petitioner is entitled to a claimed deduction for organizational expenses.

*235 GENERAL FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

Petitioner, Hollywood Baseball Association, was a corporation organized under the laws of the State of California on December 8, 1938. From December 8, 1938, to December 13, 1946, petitioner was known as Hollywood Baseball Investment Co. (hereinafter sometimes called Investment).

Another corporation, Hollywood Baseball Association, a California corporation (not the petitioner herein, and hereinafter sometimes called Association), *117 was organized on December 18, 1937. This corporation was formed for the purpose of acquiring, owning, and operating a professional baseball team in the Pacific Coast Baseball League (hereinafter called P.C.L.). All of the stock of this corporation was owned, from its inception, by Mission Baseball Association, a California corporation.

As of December 1, 1938, Investment purchased all of the stock of Association from Mission Baseball Association for $ 40,000.

On June 13, 1946, Association filed a certificate of election to dissolve with the secretary of state of California. On December 16, 1946, it filed a certificate of dissolution with the secretary of state of California. Pursuant to the certificate of election to dissolve, all of its assets and liabilities were transferred to petitioner, its sole stockholder, on December 11, 1946. On December 13, 1946, there was filed with the secretary of state of California, a consent of the shareholders of petitioner to change petitioner's name from Hollywood Baseball Investment Co. to Hollywood Baseball Association. On and after December 13, 1946, petitioner was known as Hollywood Baseball Association.

During and prior to the fiscal years*118 here in issue, petitioner operated under the name of the Hollywood Stars as a member club of the P.C.L.

On December 17, 1957, petitioner's stockholders adopted and assented to a plan of complete liquidation.

On its tax return for the fiscal period ended October 31, 1958, petitioner reported the following as items of nontaxable income:

By documents entitled "Uniform Agreement for the Assignment of a Player's Contract to or by a Major League Club" *119 and dated October 1, 1957, petitioner assigned the contracts of two baseball players to the Pittsburgh Athletic Co., Inc. (hereinafter called Pittsburgh). The following stated conditions were contained in each of the two agreements:

Conditionally: For and in consideration of the sum of $ 70,000.00 (Seventy Thousand Dollars) of which $ 25,000.00 (Twenty-Five Thousand Dollars) is payable upon execution of this agreement and the balance of $ 45,000.00 (Forty-Five Thousand Dollars) is payable if player is retained by Pittsburgh on April 1, 1958.

Petitioner received $ 25,000 for each player contract and included this total sum of $ 50,000 in its income tax return for the fiscal period ended October 31, 1957. The cost of the two player contracts to petitioner was $ 4,500, which amount had been previously deducted by petitioner as an item of current expense offsetting current income for Federal income tax reporting purposes. The remaining $ 90,000, or $ 45,000 per contract, was reported by petitioner on its Federal income tax return for the period ended October 31, 1958, as nontaxable income under section 337.

By documents entitled "Official Agreement for Outright or Conditional*120 Assignment" and dated January 3, 10, and 11, 1958, petitioner assigned the contracts of six baseball players to the Columbus Baseball Club of the International League. These have been treated as sales to Pittsburgh, which was connected with the stated buyer. The three agreements, each involving two player contracts, involved the assignment of other player contracts to petitioner and also a total of $ 27,000 as consideration flowing to petitioner. The cost of the six player contracts to petitioner was $ 17,650, which amount had been previously deducted by petitioner as an item of current expense offsetting current income for Federal income tax reporting purposes. The $ 27,000 was reported by petitioner on its Federal income tax return for the period ended October 31, 1958, as nontaxable income under section 337.

The world of professional baseball, made up of major and minor professional baseball leagues and their constituent clubs, is governed by a detailed set of agreements, rules, and regulations, most or all of which are codified in an annual publication entitled "The Baseball Blue Book." The parties stipulated relevant portions of the Baseball Blue Book for 1957. These provisions*121 may be summarized in the following manner:

*237 (a) Major league agreement -- An agreement between the National and American Leagues of professional baseball (hereinafter sometimes called the major leagues) and their [then] 16 constituent clubs;

(b) Major league rules -- A set of rules formulated pursuant to the major league agreement covering the operation of and relations between the National and American major leagues;

(c) Professional baseball agreement -- An agreement between the National and American major leagues and the National Association of Professional Baseball Leagues (hereinafter sometimes called the minor leagues);

(d) Major League-National Association rules (hereinafter sometimes called M.L.-N.A. rules) -- A set of rules formulated pursuant to the professional baseball agreement covering operations and relations between the major and minor leagues.

(e) National association agreement -- An agreement and rules covering the operations of and relations between the various minor leagues and their minor league member clubs.

Under the rules of organized professional baseball, the purchase and sale of player contracts was regulated and controlled by a series of agreements*122 and regulations governing the operations of and relations between the major and minor leagues. As a party to these agreements the P.C.L. was subject to the rules governing a category known as open classification.

The rules of organized professional baseball established a procedure whereby players of minor league teams could be selected by major league teams (hereinafter sometimes called the "player draft"). The consideration required under these rules for the selection of a player from an open classification league was $ 15,000. The rules provided, inter alia, that:

For the purpose of enabling players to advance in their profession, the contracts of National Association players shall be subject to selection from clubs holding title thereto by Major League clubs and by National Association clubs of higher classification upon the following conditions:

(a) Players whose contracts have been or hereafter are assigned outright to National Association clubs by Major League clubs shall be subject to selection without restrictions other than the following:

(1) One player's contract only may be selected each year from each Open Classification * * * club, except as hereinafter set forth*123 in (4) below.

* * * ^*

(4) Any club may designate a player's contract as being subject to unrestricted selection. Selection of any such player's contract shall not preclude selection of the contract of any one other player as set forth in (1) * * * hereof.

(5) Contracts of players who have as Veteran Major League players * * * given written consent to the assignment of their contract to a National Association club, shall be subject to unrestricted selection at any and all selection meetings following such assignment * * *

(b) The contracts of all other players shall be subject to selection of Major League * * * clubs after such players have had the following experience with *238 a club or clubs of the National Association; service during each of five seasons if reserved by an Open Classification club; * * *

(c) A player shall be considered as having had a "season's service" for the purpose of this rule during any season in which he has been on the active list or otherwise under control of a National Association club or clubs 30 days or more * * *.

(d) Nothing in this rule shall make subject to selection the contract of a player who has waived selection rights under the Professional*124 Baseball Agreement or Rules pursuant to contract with an Open Classification club.

Players on open classification teams had the right to exempt themselves from the player draft. The record does not disclose any player who so acted.

The M.L.-N.A. rules imposed a limit upon the number of players to which major and minor league clubs could hold title. The limitations upon open classification leagues were as follows:

Open Classification * * * clubs shall not have title to more than thirty-eight (38) player contracts at any time, including the contracts of players on the Active List, under reservation, and on optional assignment to other clubs, but excluding the contracts of players on the Voluntarily Retired, Disqualified, Restricted, Ineligible and National Defense Service Lists, which number must be reduced to twenty-four (24) active players by the opening date of the Major League season or of the particular league's own season, whichever is the later; and further reduced to twenty-one (21) active players from the 31st day of the playing season to twenty (20) days before the close of season each year, both inclusive.

The reason for this limitation was stated as follows:

Since the*125 supply of skilled players is not equal to the demand, the Major Leagues shall strictly observe their own rule imposing a limitation upon the number of players on their clubs and the National Association clubs shall likewise be limited * * *.

The Major League-National Association rules provided that a uniform baseball player contract must be used within organized baseball. The relevant rule stated the following:

Uniform Contract. To preserve morale and to produce the similarity of conditions necessary to keen competition, the contracts between all clubs and their players in the Major Leagues shall be in a single form which shall be prescribed by the Major League Executive Council: and the contract between all clubs and players in the National Association shall be in a single form which shall be prescribed by the President of the National Association. No club shall make a contract different from the uniform contract, and no club shall make a contract containing a non-reserve clause except permission be first secured from the Commissioner in case of a Major League player, or from the President of the National Association in case of a National Association player. The making of*126 any agreement between a club and a player not embodied in the contract shall subject both parties to discipline; and no such agreement, whether written or verbal, shall be recognized or enforced.

The uniform baseball player contract usually contained a "reserve clause" which reserved to the employing team the right to renew the employment for a succeeding year, subject to salary renegotiation. *239 Successive agreement to contracts containing reserve clauses would effect continued control over a player during his playing life. The parties stipulated a copy of a document entitled "Uniform Player Contract" and stipulated that it is representative of the player contract form used by the minor leagues. The following is contained in the uniform player contract:

On or before March 1 * * * of the year next following the playing season covered by this contract, the Club may notify the Player of its intention to renew this contract, by tendering him a contract for the term of such year, except that the compensation rate shall be such as the parties may then agree upon. * * * In the absence of agreement by the parties, the compensation rate shall be determined as provided * * * [below], *127 but pending such determination the Player will accept the compensation rate fixed by the Club or else will not play otherwise than for the Club.

The Club's right to renew this contract * * * and all covenants, promises and representations of the Player have been taken into consideration in determining the amount payable * * *.

In case of dispute between the Player and the Club * * *, the same shall be referred to * * * [arbitration].

Major and minor league teams sometimes entered into an arrangement called a "working agreement." The M.L.-N.A. rules defined working agreement as follows:

A club may convey by written agreement to a club of higher classification the right to select the contract, or contracts, of one or more players for a specified consideration which in no event shall be less than $ 100.00 per contract selected. Such agreements shall be known as "working agreements" and shall be subject to approval by the Commissioner if between a Major League Club and a National Association club and by the President of the National Association if between National Association clubs.

* * * *

Any selection made under working agreements granting the right to make selections of players' *128 contracts must be made on or before October 1st of each year, * * *.

* * * *

Working Agreements which contemplate the selection of player contracts from clubs of Class A or higher, * * * may be entered into upon terms and conditions satisfactory to the clubs concerned, provided that no provision of such agreement shall conflict with * * * [the above].

For the years ended 1949 and 1950, petitioner had a working agreement with the Brooklyn National League Baseball Club, Inc., for which it received $ 20,000 per year. For the years ended 1951 and 1952, petitioner had a working agreement with Pittsburgh of the national league, for which it received $ 27,500 per year. For the years ended 1955, 1956, and 1957, petitioner had a working agreement with Pittsburgh for which it received $ 20,000 per year.

The working agreement dated April 1, 1957, gave Pittsburgh the right to select, under certain conditions, the contracts of any and all players belonging to petitioner. It provided, inter alia, the following:

*240 Working Agreement

I

For and in consideration of the payment of the sum of $ 20,000.00 (Twenty Thousand Dollars) by Pittsburgh to Hollywood, Hollywood gives to Pittsburgh *129 the right to select, subject to conditions set forth below, the contracts of any and all players (including the manager, if a player) now under contract or reservation to Hollywood or whose contracts may become the property of Hollywood during the term of this agreement and also the contracts of all players which now are or may become the property of Hollywood-affiliated clubs during the term of this agreement and thereby become selectable or otherwise subject to acquisition by Hollywood, and the consideration for this agreement is at the same time consideration for contracts selected under its provisions except as otherwise specified herein.

* * * *

(a) In the event of the termination of this agreement, Hollywood will retain title to the contracts of eight (8) players mutually agreeable to both parties or in lieu thereof the sum of ($ 15,000.00) Fifteen Thousand Dollars shall be paid to Hollywood by Pittsburgh.

(b) As to selections made by Pittsburgh under this agreement, Pittsburgh shall reimburse Hollywood at the time of selection for payments made by Hollywood in originally acquiring the selected players' contracts as free agents (bonuses) or by purchase or selection (draft) from*130 clubs not affiliated with Pittsburgh independent of recommendation by authorized representative of Pittsburgh or other Pittsburgh-affiliated clubs.

(c) If during the term of this agreement authorized representatives of Pittsburgh or other Pittsburgh-affiliated clubs on behalf of Hollywood shall negotiate contracts with free agents providing for the payment of bonuses to such players, it is understood and agreed that Pittsburgh shall promptly reimburse Hollywood for such bonus payments provided that such payments, when payable on a contingent basis, have first been approved by Pittsburgh.

(d) Hollywood during the term of this agreement may not unconditionally release any player or assign outright the contract of any player without first giving Pittsburgh ten (10) days' written or telegraphic notice of its intention to release or assign such player's contract, within which ten (10) day period Pittsburgh may elect to exercise its right to select such contract or waive all right thereto.

II

The right of selection provided for in "I" above is to be exercisable by Pittsburgh on or before October 1, 1957, except as otherwise provided herein, and Hollywood upon receipt of notice of selection*131 immediately shall assign outright to Pittsburgh the contracts of selected players. All players, whose contracts are selected under this agreement, however, shall remain with Hollywood until the close of its current season, -- including all official post-season games, if any, unless otherwise agreed upon.

III

If during the term of this agreement Hollywood with Pittsburgh's approval shall enter into working agreements with clubs of lower classification, Pittsburgh shall reimburse Hollywood for all expenses incurred by Hollywood under such agreements.

*241 IV

The selection of Hollywood's field manager shall be subject to approval by Pittsburgh (but Hollywood solely shall be responsible for payment of said manager's salary).

V

Hollywood shall train at a site of its own choosing and shall be responsible for all expenses incurred in connection therewith.

VI

This agreement for the 1957 season shall be extended automatically for 1958 on the same conditions and terms as are set forth herein unless notice is given by either party of a desire to terminate this agreement as of October 1, 1957. Notice of such desire to terminate on the part of Hollywood shall be given to Pittsburgh on or*132 before August 1, 1957. Should Pittsburgh desire to terminate the agreement it must notify Hollywood to that effect on or before September 1, 1957.

VII

Pittsburgh agrees not to hold Hollywood liable for damages for failure to operate a baseball team at any time during the life of this agreement.

Although under the stated terms of the working agreement petitioner was only entitled to reimbursement for various costs of acquiring a player's contract, the general practice was that petitioner would be paid the fair market value for the sale of player contracts. ² During at least 1957, the chairman of the board of directors of Pittsburgh and the chairman of petitioner's board of directors was the same man, Branch Rickey, and Pittsburgh owned approximately 25 percent of petitioner's voting stock. The Baseball Blue Book listed petitioner as "Connected with Pittsburgh."

*133 Petitioner sold a total of 224 player contracts for a total consideration of approximately $ 799,800 from the year ended 1948 through the *242 year ended 1957. During this same period the petitioner purchased a total of 175 player contracts at a total cost of $ 561,450.

The following schedule reflects, in round figures, for the year ended 1948 through the year ended 1957, the receipts from the sale of player contracts, the number of sales and purchases, and certain expenses, such as the purchase price of player contracts, payments to free agents which were not reimbursed by major league teams holding working agreements with petitioner, net cost of player contract options and National Association commissions: ³

*134 Petitioner derived receipts from the sale of admissions to baseball games, concession items, advertising, radio and television broadcasting rights, as well as from the sale of baseball player contracts. The following schedule reflects (round figures) for the year ended 1948 through the year ended 1957, the revenues realized from the operations of the petitioner, exclusive of the receipts from player contracts, and the operation's expenses, exclusive of the purchase price of player contracts, net payments to free agents, net cost of player contract options, and National Association commissions:

*243 From at least the year ended 1948 through the year ended October 31, 1957, it had been the consistent accounting procedure of petitioner to return for Federal income tax reporting purposes the revenue realized from player contract sales as either a part of its gross*135 receipts or as other income from business operations. During these years it was petitioner's consistent accounting practice to deduct as an annual expense for Federal income tax purposes the entire cost of player contracts purchased in each year.

The player contracts at issue were held primarily for sale to customers in the ordinary course of petitioner's business.

For at least the period here in issue, organized professional baseball (hereinafter sometimes called entity, establishment, or monopoly baseball) was composed of two major leagues and several minor leagues. These leagues contained a varying number of teams and were under the jurisdiction of a commissioner of baseball, who presided at a "government of organized professional baseball office." The minor leagues were also under the jurisdiction of a president of the National Association.

Most or all of the basic agreements, rules, and regulations of entity baseball were codified in an annual publication entitled "The Baseball Blue Book." One such document was*136 the "Professional Baseball Agreement" between the major and minor leagues which contained a provision subjecting the minor leagues to the jurisdiction of the commissioner of baseball to a specified extent. It stated that the commissioner of baseball had power:

To investigate * * * any * * * practice * * * suspected to be detrimental to the best interests of the national game of baseball * * * [and] * * *

To determine * * * what * * * action is appropriate * * * and to take such action against any party hereto, any Major League, or club connected with any Major League, or any National Association League or club connected with the National Association, or any individual, as the case may be.

and it noted that:

The Major and National Association Leagues severally agree to be bound by the decisions of the Commissioner, rendered in accordance with the provisions of this Agreement.

All contracts between Major Leagues, Major League clubs, National Association Leagues and National Association clubs and their officers. players and employees shall contain a clause by which the parties agree to submit themselves to the discipline of the Commissioner and to his decisions rendered in accordance*137 with this Agreement.

The governing documents of monopoly baseball, including the "Professional Baseball Agreement," "Major League Rules," and "Major *244 League-National Association Rules," contained numerous provisions which were binding upon both the major and minor leagues. These included, among others, rules regarding uniform player contracts and the necessity of inclusion of reserve clauses, contract tender dates, disqualification of players from monopoly baseball in the event of failure of contract agreement with the reserving club, gifts for securing employment, the signing of high school students and American Legion junior baseball players, returning military personnel, the signing of free agents, the player draft and the return of selected players, the assignment of player contracts, optional assignments, restricted, disqualified, and ineligible player lists whereby the ineligible player would be barred from playing anywhere within establishment baseball, and uniform rules regarding the actual playing of baseball. Penalties for breach of some of these rules included the voiding of contracts, fines, and other action within the stated powers of the commissioner of baseball.

*138 A "professional baseball executive council" was provided for in the professional baseball agreement. This council had assured major league voting control and was empowered to adopt and amend the rules, regulations, and agreements regarding contacts between the major and minor leagues.

The P.C.L. had the exclusive right to play monopoly baseball in certain areas of the west coast of the United States, including Los Angeles and San Francisco. This exclusive right to play establishment baseball in the relevant areas was inherent in the P.C.L.'s membership in the general system of organized professional baseball.

The member teams of the P.C.L. had derivative rights from the league under the general entity scheme of organized baseball. A franchise membership in the P.C.L. entitled the holder to operate a P.C.L. team within the territory controlled by the league and granted the right to play P.C.L. baseball as a member of the league. It afforded the franchise holder the right to play baseball, inter alia, in Los Angeles and San Francisco, which areas were the most profitable in the league. It bestowed on the member an equal share of the P.C.L. exclusive territorial rights within*139 the baseball monopoly, including allocable rights to televise and radiocast games played against home teams in the P.C.L. area. It entitled the franchise holder to the privilege of being an equal partner in the league, including all league assets and property rights.

Separate, distinct, and divisible from rights derived from the P.C.L. franchise ownership were so-called territorial rights. The league territorial right was the right to play exclusive entity baseball in several areas. A team territorial right was the right to play home *245 games within a certain area, usually a city. Team territorial rights were recognized in the P.C.L. constitution.

The P.C.L. constitution provided that some of the teams were granted "exclusive territorial rights" over the city in which they were located. The Los Angeles Baseball Club had the "exclusive territorial right" for the vicinity of Los Angeles, Calif. The right of petitioner to play P.C.L. baseball in this area was recognized and limited under the P.C.L. constitution. Relevant portions of said constitution were as follows:

Article III. Membership

Section 1. This League shall consist of eight (8) clubs, and the membership shall*140 not voluntarily be increased or decreased except by unanimous vote of all the members of the League. The clubs forming the League shall be located in the following cities, to-wit: Portland, Oregon; Seattle, Washington; Los Angeles, San Francisco, Oakland, * Sacramento and San Diego, California; but the location of any of the eight (8) clubs forming the League may be changed by a three-quarters vote of the directors of the League, provided that the resolution to change such location is offered by the director representing the club affected.

Section 2. For the purpose of providing continuous baseball in the City of Los Angeles, the Hollywood Club shall be located in the City of Los Angeles, and the Los Angeles Club for such purpose, shall have the right to enter into a lease with the Hollywood Club under such terms and for such times as the Los Angeles Club may elect, with the right to renew such lease from time to time. Such lease shall not convey any territorial rights, whatsoever, and shall not change, alter or abridge the exclusive territorial or other rights of the Los Angeles Club.

* * * *

Article IV. Admissions to and Changes of*141 Membership

Section 1. Any club member of the League may ask the League for permission to dispose of its rights and franchise as a member of the League in that city in which its baseball club is operating, * * * Without the consent of the League such transfer cannot be made. * * *

* * * *

Section 4. A three-quarters affirmative vote of the members of this Pacific Coast Baseball League shall be required for admission to membership or for the approval of the transfer of a franchise or of the transfer of a majority of stock or ownership or interest of a member with the involved club having the right to vote. * * *

The following resolution was adopted at meeting of August 15, 1955:

Be it, and it hereby is, resolved:

1. That if any club of this league moves from a city mentioned in Sec. 1, Art. III, of the PCL Constitution, in which its franchise is now operated, to another city, the city from which the club moved shall continue to be regarded as PCL territory as far as the PCL is concerned, and the PCL may allow any club of this league to move into such territory. * * *

2. That the club which vacated such territory shall have, for three years thereafter, the first right and option to*142 reoccupy such territory, and thereby recover such territorial rights as it had therein prior to vacating same * * *.

* * * *

*246 Article V. Terminating Membership

Section 1. This League may terminate the membership of any member and forfeit to this League such member's franchise, certificate of membership and players' contracts and reservations upon the affirmative vote of seven (7) members for the following causes: * * *

* * * *

Article VIII. Jurisdiction of Board of Directors

Section 1. (a) The Board of Directors shall have final jurisdiction within the League, subject only to such right of appeal to other baseball authority as may exist under any agreement to which this League then may be a party.

* * * *

Article XIII. Club Territorial Rights

Section 1. Every Club in the League shall have exclusive territorial rights in the city in which it is located, and for a distance of ten (10) miles in every direction from the corporate limits of said city into the territory adjacent to it; provided, however, that the Hollywood Club, its successors and assigns, shall have no territorial rights in the City of Los Angeles but shall operate therein solely to the extent and subject *143 at all times to the terms and provisions of its lease agreement with the Los Angeles Club; and provided further, that the Oakland Club shall have no jurisdiction west of the westerly boundary line of the City of Oakland, and the San Francisco Club shall have no jurisdiction east of the easterly boundary line of the City of San Francisco.

Section 2. No visiting League Club, or any player under contract or reservation by a League Club, shall, under any circumstances, be allowed to play exhibition game, or any Club in such territory other than the League Club therein located, without the consent of the said local League Club, which, in the City of Los Angeles, shall for all times be the resident Los Angeles Club.

The Los Angeles Baseball Club and the petitioner's predecessor entered into an agreement dated July 29, 1938, which provided, inter alia, the following:

Whereas, the First Party owns and controls the franchise and territorial rights in said League in Los Angeles and adjacent territory, as specified and described in the Constitution of said League; and * * *

* * * *

1. In order to provide for the playing of continuous baseball in the City of Los Angeles and adjacent territory*144 (including the area therein known as the Hollywood area) as defined in said Constitution of said League, during the scheduled seasons provided by said League, the First Party hereby grants unto Second Party, upon the terms and conditions hereinafter set forth, for the period of twenty (20) years from the date of the commencement of the 1938 sch