Daniel K. Ludwig and Gertrude V. Ludwig v. Commissioner

Daniel K. Ludwig (Ludwig) (plaintiff) entered into an agreement with Phillips Petroleum Co. (Phillips) in June 1963 under which Ludwig would purchase 1,340,517 shares of Union Oil Co. (Union Oil) stock from Phillips for $75 per share or a total of just over $100 million. Such a sale required consent of the Antitrust Division of the Department of Justice and court approval in a pending California suit against Phillips, both of which were obtained. Ludwig borrowed the purchase price from three banks, and the banks agreed to accept the pending shares of Union Oil stock as collateral for the purchase as well as 1,000 shares of Oceanic Tankships, S.A. (Oceanic). Oceanic was a Panamanian company, and the 1,000 shares were Oceanic’s full amount of outstanding stock. In 1963, Oceanic had accumulated earnings and profits of $5,092,318. The stock value was roughly $200 million, and much of the value lay in Oceanic holding all outstanding stock of Universe Tankships, Inc. (Universe), a Liberian entity. The three banks also required Ludwig to enter a negative covenant in which Ludwig agreed not to cause Oceanic or Universe to borrow money, pledge assets as collateral, guarantee or assume liability on the debts of others, merge or consolidate, sell or lease assets, transfer any shares of any controlled subsidiaries, or pay any money to Ludwig or as any other dividend. Ludwig completed the agreement and eventually sold the Union Oil Stock in 1965 for a gain of just over $45 million. Ludwig reported that gain on his income taxes, but the Commissioner of Internal Revenue (the commissioner) (defendant) found a deficiency of $4,438,086.75 on Ludwig’s tax returns. The concern was whether Oceanic, as wholly owned by Ludwig, a United States shareholder, was a guarantor of Ludwig’s obligations to the three banks. Ludwig argued that Oceanic was not a guarantor, as Oceanic had not made any promises on behalf of Ludwig or undertaken liability for his debt if Ludwig failed to make payment. The government argued that Oceanic’s assets would be available if Ludwig defaulted, so Ludwig had income by virtue of Oceanic essentially guaranteeing the loans in question.