author: Van Fossan: Murdock,

text:
    The American Fork & Hoe Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 60681.
    Promulgated February 20, 1936.

      John H. Watson, Jr., Esg., John T. Scott, Esq., and Robert W. Wheeler, Esq., for the petitioner.

      Arthur Carndwff, Esq., and Curtis Risley, Esq., for the respondent.
   OPINION.

Van Fossan:

In this opinion we will discuss the contested issues in the order hereinabove set forth.

Issue I.

The petitioner contends that under section 141 (a), (d), and (e¡) of the Revenue Act of 1928, it is entitled to include the Cronk & Carrier Manufacturing Co. in its consolidated income tax return for the fiscal year ended June 80, 1929.

The petitioner bases its contention upon the statutory definition of an “affiliated group” which is “one or more chains of corporations connected through stock ownership with a common parent corporation.” The chain here begins with the petitioner as the parent owning all the stock except qualifying shares of the General Land & Industrial Co., Ltd., which in turn owned all the stock except qualifying shares of the Welland Yale Manufacturing Co., which in turn owned all the stock except qualifying shares of Cronk & Carrier Manufacturing Co., which completes the chain. All of these corporations, according to petitioner, were members of the affiliated group, and while the two intervening corporations were foreign, that fact does not exclude the Cronk & Carrier Manufacturing Co. from the consolidated return under section 141 (e), because the latter company is in fact a domestic corporation, organized and existing under the laws of the State of New York. In its brief the petitioner asserts that the only possible argument against including the Cronk & Carrier Manufacturing Co. in the consolidated return is the provision of section 238 of the Revenue Act of 1928 which provides that “a foreign corporation shall not be deemed to be affiliated with any other corporation within the meaning of sections 141 or 142.”

Petitioner, in its principal brief, relied on our decision in Manus-Muller & Co., 30 B. T. A. 1015, where it was held that foreign corporations may be included in the affiliated group, but are precluded from joining in a consolidated return made for the domestic corporations within the group. In that case a foreign corporation owned all of the stock of two domestic corporations. The Board held the three corporations constituted an affiliated group and allowed the two domestic corporations to file a consolidated return.

Since the hearing in this case, however, the Board’s decision in the cited case was reversed by the Circuit Court of Appeals for the Second Circuit (Commissioner v. Manus-Muller & Co., 79 Fed. (2d) 19), that court holding that the prohibition in section 238, supra, could not be ignored and that the express provisions of that section must prevail. The Supreme Court on January 6, 1936, denied certiorari, 296 U. S. 657. This decision by the Circuit Court of Appeals of the Second Circuit disposes of the arguments advanced by petitioner and, therefore, on this issue, the respondent must be affirmed.

Issue II.

During the period December 1, 1928, to June 30, 1929, the petitioner paid $70,392.89 of obligations assumed by the Investment Co. under its sublease dated August 13, 1923. During this same period the Investment Co. paid petitioner $29,000 on account, leaving a balance due petitioner at June 30, 1929, of $41,392.89. The petitioner contends that this balance should not be accrued as income because it was uncollectible, it being urged that the Investment Co. was insolvent and in all probability the account would never be collected.

The petitioner adduced evidence to show that there was a serious deflation in real estate values in Cleveland during 1926, 1927, and 1928, that every effort was made to operate the Union Building and the garage at a profit, but that despite every effort rentals and other income from the building and garage were insufficient to meet the obligations the Investment Co. had assumed. The financial condition of the latter company was established by a balance sheet as of December 31, 1928, which reveals book assets of over $731,000 and liabilities, exclusive of capital stock and reserves, of over $856,000. The principal book asset was leaseholds and buildings in the sum of over $678,000, which undoubtedly represented values prior to the deflation of 1926, 1927, and 1928. While an excess of liabilities over assets does not necessarily mean permanent insolvency, that fact, together with the known fact of receivership of the Investment Co., the $41,392.89 default in rental obligations during the taxable year, and the fixed yearly disbursements required under its sublease, discloses the serious financial situation that existed on June 30, 1929. Considering the facts known on June 30, 1929, we are of the opinion that petitioner is justified in its contention that in all probability the $41,392.89 of rentals due would never be received.

A taxpayer on the accrual basis can not be charged with income if there exists good reason for believing that the income can not be collected. Corn Exchange Bank v. United States, 37 Fed. (2d) 34; Oregon Terminals Co., 29 B. T. A. 1332; Emanuel Solomon Ullmann, 30 B. T. A. 764; Atlantic Coast Line Railroad Co., 31 B. T. A. 730, 749, and cases there cited. Here, when the ground rent, taxes, interest, and bond retirement obligations fell due the Investment Co. was unable to pay these obligations, which fact, with the other known factors at June 30, 1929, convinced petitioner that the unpaid balances thereof would never be collected. Subsequent events proved the correctness of this belief. The amount owed to petitioner steadily increased until August 1931, when the petitioner repossessed the leaseholds and buildings, at which time the Investment Co. was over $123,000 in arrears on its obligations under the lease agreement of August 13, 1923. It is our opinion that in the instant state of facts petitioner’s income should include only the cash actually received from the Investment Co. during the taxable year.

Issue III.

The final issue is whether petitioner is entitled to deduct a portion of the $186,000 advanced to the W. F. Tubbs Co. The petitioner has fixed the amount of its claimed deduction, $54,468.28, by taking the excess of the liabilities of the Tubbs Co. over its assets as shown by the balance sheet of that company at June 30, 1929.

The right to deduct a portion of a debt is provided for by section 23 (j) of the Revenue Act of 1928. The statutory requirements set forth therein are different from the statutory requirements for deducting the entire debt. The statute says that when the Commissioner is satisfied that a debt is recoverable only in part, he may allow such debt to be charged off in part. In deducting a portion of a debt the taxpayer is under no duty to make the charge-off, but must satisfy the Commissioner that he is entitled to the deduction claimed. Failure of the Commissioner to allow the deduction gives the taxpayer a right to have the Commissioner’s ruling reviewed to determine whether or not the deduction should have been allowed. Commissioner v. Liberty Bank & Trust Co., 59 Fed. (2d) 320; Allic M. Turbeville, 31 B. T. A. 283; Ross v. Commissioner, 72 Fed. (2d) 122, reversing Frank P. Ross, 27 B. T. A. 1062; Henry R. Huntting, 32 B. T. A. 495. See also Olympia Harbor Lumber Co. v. Commissioner, 79 Fed. (2d) 394, affirming 30 B. T. A. 114.

It is to be observed that petitioner could designate three of the Tubbs Co’s, five directors; that it had a first mortgage on all the property and assets of the Tubbs Co.; that it financed and promoted an expansion program for the Tubbs Co. which failed to produce the desired results; that it was the sole creditor of the Tubbs Co. on June 30, 1929; that the assets of the Tubbs Co. were not worth more than the values placed upon them in the balance sheet; that the liabilities exceeded the assets of the Tubbs Co. by $54,468.28; that for the years 1928 and 1929 the Tubbs Co. had net losses of $26,613.51 and $28,124.92, respectively, and we have the testimony of petitioner’s vice president that in his opinion the advances to the Tubbs Co. were 40 to 50 percent bad at June 30, 1929.

Subsequent to June 30, 1929, the evidence shows that petitioner acquired in August 1929, all the Tubbs Co’s, capital stock for $5,000, which was designated the “nuisance value” of the stock; that additional loans were made to the Tubbs Co. to the extent that on May 28, 1931, the Tubbs Co. owed petitioner $209,687.04; that on that date petitioner purchased all the property and assets of the Tubbs Co., except cash; that the assets so purchased were not worth more than the depreciated values appearing on the Tubbs Co’s, books; that the petitioner’s books reflect the charge-off in May 1931 of $113',-624.41, being the balance of the notes of the Tubbs Co. after crediting the amount owed with the depreciated value of the assets acquired; and that after May 28, 1931, the petitioner continued to operate the Tubbs Co. as a branch of the American Fork & Hoe Co.

From the foregoing summary of facts, we are of the opinion that the Commissioner should have been satisfied that only a portion of the $186,000 loaned by petitioner was recoverable, and that his failure to allow the deduction constituted error. It was apparent at June 30, 1929, that petitioner would never recover all the sums advanced to the Tubbs Co. The yardstick used to measure the portion of the aggregate loans that was worthless, is the difference between the assets and liabilities. The petitioner was the sole creditor of the Tubbs Co. and the assets were worth no more than the values carried on the Tubbs Co.’s books. The petitioner’s only opportunity to recoup its loans over and above the assets would be from the earnings of the Tubbs Co. It appears, however, that despite petitioner’s efforts to expand the business of the Tubbs Co. net losses resulted for 1928 and 1929 and the failure of the expansion program was conceded as early as 1928. The events occurring subsequent to June 80, 1929, corroborate the contention of the petitioner that this portion of its advances to the Tubbs Co. was worthless at June 30, 1929.

The present situation differs from that before us in Estate of James N. Gamble, 32 B. T. A. 892, in that here only a partial charge-off is claimed. Our observations in that case related to a claim of entire worthlessness of the advances in question.

On this issue, therefore, we sustain the contention of the petitioner.

Reviewed by the Board.

Decision will be entered wider Rule 50.

Murdock,

concurring: My views on the question of whether an affiliated group may contain a foreign corporation, and whether the domestic corporations within the group may join in a consolidated return, under section 141 of the Revenue Act of 1928, were fully set forth in Manus-Muller & Co., 30 B. T. A. 1015. The Circuit Court of Appeals for the Second Circuit considered the question and reversed the decision of the Board, 79 Fed. (2d) 19. The court there properly pointed out at the conclusion of its opinion that doubts on the question must be resolved against the taxpayer. The interpretation which I placed upon the provisions of the act, including section 238, was not entirely free from doubt. The question is a complicated one and probably has been settled for all practical purposes by the decision of the Appellate Court in Commissioner v. Manus-Muller & Co., supra.

       SEC. 141. CONSOLIDATED RETURNS OP CORPORATIONS — 1929 AND SUBSEQUENT TAXABLE TEARS.
      (a) Privilege to file consolidated returns. — An affiliates group of corporations shall, subject to the provisions of this section, have the privilege of making a consolidated return for the taxable year 1929 or any subsequent taxable year, in lieu of separate returns. The making of a consolidated return shall be upon thp condition that all the corporations which have been members of the affiliated group at any time during the taxable year for which the return is made consent to all the regulations under subsection (b) prescribed prior to the making of such return; and the making of a consolidated return shall be considered as such consent. In the case of a corporation which is a member of the affiliated group for a fractional part of the year the consolidated return shall include the income of such corporation for such part of the year as it is a member of the affiliated group.
      ‡ sf: * * # #
      (d) Definition of “affiliated group”. — As used in this section an “affiliated group’’ means one or more chains of corporations connected through stock ownership with a common parent corporation if—
      (1) At least 95 per centum of the stock of each of the. corporations (except the common parent corporation) is owned directly by one or more of the other corporations; and
      (2) The common parent corporation owns directly at least 95 per centum of the stock of at least one of the other corporations. As used in this subsection the term “stock” does not include nonvoting stock which is limited and preferred as to dividends.
      (e) A consolidated return shall be made only for the domestic corporations within the affiliated group. An insurance company subject to the tax imposed by section 201 or 204 shall not be included in the same consolidated return with a corporation subject to the tax imposed by section 13.

       SEC. 23. DEDUCTIONS FROM GROSS INCOME.
      In computing net income there shall be allowed as deductions:
      *******
      (j) Bad debts. — Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts) ; and when satisfied that a debt is recoverable only in part, the Commis* sioner may allow such a debt to be charged off in part.


source: Caselaw Access Project

author: Arundell : MuRdock,

license: Public Domain

text:
    Irving S. Merrell, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 70103.
    Promulgated February 20, 1936.

      Robert J. Heberle, Esq., for the petitioner.

      O. W. Swecker, Esq., for the respondent.
   OPINION.

Arundell :

On November 29, 1935, a division report in this proceeding was promulgated and is reported at 33 B. T. A. 625. Thereafter by orders of the Chairman the division report was reviewed by the Board and the decision entered was vacated.

The proceeding involves a deficiency in income tax for 1930 in the amount of $5,099.83. It was submitted on a stipulation of facts, without appearances.

The petition alleges error in the respondent’s determination of “excessive profit attributed to sales of Borden stock.” It appears that in the taxable year the petitioner sold 1,000.16 shares of Borden Co. stock for $67,045.05 and reported a profit thereon of $3,244.84, using as a basis the sum of $63,800.21. The respondent used as a basis a “cost” figure of $24,126.70. The 1,000.16 shares sold in 1930 are part of a larger number of shares of Borden stock issued to the petitioner in 1928 in exchange for all his stock, preferred and common, of the Merrell-Soule Co., in a reorganization effected by the Borden Co. The parties appear to be agreed that the basis applicable to the Merrell-Soule Co. shares is to be allocated proportionately to the Borden shares. At least there is no issue on this.

The parties have stipulated that they “are in agreement concerning the cost to the petitioner of all of said common and preferred shares of the Merrell-Soule Company, except 875 common shares which the petitioner acquired from the Estate of his father.” They further stipulate that “the question here concerns the cost to the petitioner of said common and preferred stock of the Merrell-Soule Company.” Viewed broadly, we take this to mean that the question in issue is the proper basis to be used in determining the profit on the sale of the Borden stock in 1930.

The 875 shares in question were acquired by the petitioner from the estate of his father. The father, G. Lewis Merrell, died testate on January 7, 1909. He owned at that time 2,625 shares of the common stock of the Merrell-Soule Co. Each share had a par value of $100. He placed his residuary estate, including these shares, in trust. The trustees were to pay $5,000 annually to his wife, Mary A. Merrell, during her lifetime. Each grandchild of the decedent was to receive $3,000 from the trustees when he reached his majority. The remainder of the income was to be divided equally among the testator’s three sons, Irving S. Merrell, Lewis C. Merrell, and Oliver Edward Merrell. The principal of the fund, except the Merrell-Soule Co. stock, was to be divided equally among the three sons upon the death of the testator’s wife. The Merrell-Soule Co. stock was to be held by the trustees during the lifetime of Oliver Edward Merrell and the income therefrom was to be equally divided among the three sons. The stock was to be divided into three equal parts upon the death of Oliver Edward Merrell and each son or his estate was to have one part. The thirteenth and fourteenth articles of the will were as follows:

ARticlb Thirteenth. I further will and direct that none of my said sons shall in any manner sell or dispose of any of said stock or any interest therein unless he shall have first offered it to both or either of the others of my said three sons at a price not to exceed the par value thereof, and given to each of the others an option to purchase the same at said valuation for a period of ninety (90) days, and that in case any one of my said sons shall desire to sell his interest in said stock, the other shall be given the privilege to purchase the same in equal amounts, except that I hereby will and direct my executors and trustees hereinafter named to convey to one of themselves enough stock of said Company to enable the holder thereof to qualify as a Director of said Merrell-Soule Company.
Article Fourteenth. I further will and direct that in ease it shall seem advisable to each and every one of my said three executors and trustees hereinafter named to dispose of said stock, they shall have the privilege of so doing, provided, however, that all three of them shall agree as to the advisability of such sale.

The three sons were named executors and trustees. Oliver Edward Merrell is still living. Mary A. Merrell, the testator’s widow, died on November 11, 1911, and the trustees then distributed practically all of the property in the estate except the 2,625 shares of Merrell-Soule Co. stock. The grandchildren were paid in accordance with the will.

The three sons, as executors, trustees, and individuals, entered into an agreement on December 20, 1919, wherein they agreed to sell to each of themselves, as individuals, at $100 per share, one third of the total shares which they held as executors and trustees. The agreement recited that they had determined that it was advisable to dispose of the 2,625 shares of Merrell-Soule Co. stock. It further provided:

* * * said shares of stock having been offered pursuant to Article Thirteenth of said will and testament, to said Irving S. Merrell, Lewis C. Merrell and Oliver E. Merrell, and they have each determined to purchase at par and acquire one-third of the said shares of stock constituting said trust estate as authorized by Article Thirteenth of said will and testament.

Each of the sons delivered to themselves as executors and trustees his individual demand promissory note for $87,500. The transfer agent for the stock refused to make the transfers called for by this agreement, whereupon Lewis C. Merrell instituted suit against the transfer agent, naming as codefendants the corporation and all of the other parties in interest, to compel the transfer agent to deliver to him a proper certificate for his part of the stock. The court gave judgment for the plaintiff and held that the sale of stock as provided in the contract of December 20, 1919, was valid and binding. The transfer agent thereafter issued the certificates in accordance with the contract and the decision of the court. The executors and trustees under the will of G. Lewis Merrell filed their final account in December 1927, and were discharged in April 1928. The three $87,500 notes were among the assets distributed to the three sons on their final accounting. The parties have stipulated that the fair market value of the Merrell-Soule Co. common stock was $333.91 per share on March 1, 1913, and $800 per share on December 20, 1919.

The father made a specific bequest of 875 shares of the Merrell-Soule Co. stock to the petitioner, to take effect in possession at the death of Oliver and subject to the contingency that the property might be sold before that time under articles thirteenth or fourteenth of the will. If the property had not been sold and if it had been distributed to the petitioner at the death of Oliver, the petitioner would have acquired the property by specific bequest, and the basis of the property for gain or loss in his hands would have been the fair market value of the property on March 1, 1913, since that was greater than its value at the death of the decedent. Sec. 113 (b), Revenue Act of 1928. Thus, if the petitioner had acquired the 875 shares in that way, his basis would have been $333.91 per share; the petitioner agrees with this view.

The respondent treated the acquisition as one by purchase at December 20, 1919, and the petitioner in his brief agrees that he acquired the shares at that date. Assuming this view of the parties to be correct, the basis to the petitioner would be cost. Sec. 113(a), Revenue Act of 1928. The money price that petitioner agreed to pay was $100 per share and that figure is taken by the respondent to represent the entire cost and the basis. The petitioner, citing a number of Board and court cases, contends for a basis of $800 per share. His theory is that under the decided cases the money cost is not the entire cost to him, but that, considering the intent of the parties and their relationship, the correct basis is market value at the time of acquisition. See Robinson v. Commissioner, 59 Fed. (2d) 1008; G. Wildy Gibbs, 28 B. T. A. 18; E. D. Knight, 28 B. T. A. 188. At first glance, the cited cases lend support to the petitioner’s contention. Typical of the cases is that of Robinson v. Commissioner, supra, in which an employee o.f a corporation was permitted to acquire stock of the corporation at less than its market value. The court said:

In each such case we think that the obvious intent of the parties, and their relationship as affecting intent, are the controlling considerations. * * * Whether regarded as a gift or as compensation, it is evident that the surplus value, over and above the actual price paid for the shares, must be taken into consideration in determining the capital base, and that such base is to be fixed at the true or market value at the time the stock was acquired.

However, the Robinson case and the others cited did not have the complication of title being derived through a will effective prior to March 1, 1913. There was no occasion in those cases to consider the effect of March 1,1913, value on the base, and so as far as the present proceeding is concerned, those cases stand only for the proposition that basis is not necessarily confined to money cost.

No argument or citation is needed to establish that the so-called sale of December 20, 1919, was not an arms’ length transaction. Stock worth $800 per share is not “sold” for one eighth of the value. Nor is any argument necessarj^ to show that the shares were acquired through the will of petitioner’s father who died January 7, 1909. As we read the agreement of December 20, 1919, between petitioner and his brothers, and the approval thereof by the local courts, it purported to be in accordance with the provisions of the will and not in contravention of them. The substance of the will was to bequeath to petitioner and each of his two brothers an equal interest in the Merrell-Soule Co. stock. The father attempted to discourage the sale of the stock by his sons, but he also recognized that a time might come when it would be desirable for them to sell, and so he provided in his will that they might sell if all three agreed, or if one alone desired to sell he must first offer his interest in the stock to his brothers at par before selling elsewhere.

As pointed out above, the transaction effected by the brothers in 1919 was not a genuine sale. Not only was the stated consideration inadequate, but no actual payment was made, the notes given being returned in the final distribution of the estate. The effect of the transaction was to enable each son to acquire individually the shares bequeathed to him by his father prior to the time he would have obtained them in ordinary course. So viewed, the substance of the transaction was a distribution of the stock from the trust to the beneficiaries. The value of the shares held in trust on March 1, 1913, has been agreed to as $331.91 per share, and in our opinion that value is the proper basis for determining gain or loss to the beneficiaries.

There is an additional reason why we think the March 1, 1913, value is the proper basis. Under the laws of New York there is a merger of legal and equitable estates where the trustees and beneficiaries are the same persons, L. 1909, ch. 52, § 92; and where a trust is merely passive, as here, legal title vests in the beneficiaries, id. § 93. In Greene v. Greene, 125 N. Y. 506; 26 N. E. 739, the testator nominated three of his sons trustees of the residue of bis estate to hold for a period of time and then distribute it to them equally. In a suit brought by a fourth son attacking this disposition of the estate, the court said:

* * * To the constitution of every express trust there are essential these elements, namely, a trustee, an estate devised to him, and a beneficiary. The trustee and the beneficiary must be distinct personalities, or otherwise there could be no trust, and the merger of interests in the same person would effect a legal estate in him of the same duration as the beneficial interest designed. 1 Rev. St. p. 727, §§ 47, 55; Woodward v. James, 115 N. Y. 346, 22 N. E. Rep. 150. That the legal and the beneficial estates can exist and be maintained separately in the same person is an inconceivable proposition. It is quite as much of an impossibility, legally considered, as it is physically. These three sons would have the actual possession of the land; they would be entitled to receive and to retain and enjoy the rents and profits; and they and their heirs would be subjected to no change of title or possession, nor other diminution of interest than what might be produced by an application of income, or of any proceeds of sales, to the payment of legacies. The result is that they have every estate and interest in possession, in remainder, and in reversion; or, in other words, the whole fee of the property. It was the design of the legislature, in the revision of the statute of uses, to abolish technical and useless distinctions between the title and the use, and to convert the estate of a beneficiary into a legal estate, commensurate with the beneficial interest intended, whenever the trust was of a passive or formal character, and the actual possession and fruits of possession were the beneficiary’s. Under section 47 of the article upon uses and trusts, if a person, by virtue of a devise, shall be entitled to the actual possession of lands, and the receipt of the rents and profits thereof, in law or in equity, he shall be deemed to have a legal estate of the same quality and duration, and subject to the same conditions, as his beneficial interest.

The above cited sections and case relate to real property, but the same rules apply to personal property. See L. 1909, ch. 45, § 11; In re Farmer’s Will, 99 Misc. 437; 163 N. Y. S. 1089; In re Scott’s Will, 204 N. Y. S. 478, 486. Consequently, it would appear that the petitioner acquired full right to his portion of the shares of stock at the death of his father in 1909, or not later than 1911 when the testator’s widow died and there was no longer any annuity charge upon the estate, and, upon acquisition at either of those dates, the March 1, 1913, value became the basis.

Eeviewed by the Board.

Decision will be entered under Rule 50.

Leech dissents.

MuRdock,

dissenting: I expressed my views on the proper disposition of this case in the report promulgated at 33 B. T. A. 625, and I need not repeat what appears there. The prevailing opinion is based upon the thought that the petitioner did not acquire the property by a “genuine sale” but, on the contrary, acquired it by a distribution under the will of his father. Yet there was no distribution of the shares and a sale actually took place and was recognized and approved by the court. The Commissioner determined that the stock was acquired by. purchase on December 20, 1919, and the petitioner in his brief agrees that he acquired the shares on that date. The sale may not be disregarded in order to grant the petitioner the use of a larger basis than the statute itself allows under the circumstances. Cf. Hugh M. Matheson, 31 B. T. A. 493. If he had paid the full fair market value for the stock, he would be entitled to use the purchase price as his basis for subsequent gain or loss upon the shares. Yet the reasoning of the prevailing opinion would apply just as appropriately to that situation and would require the use of the March 1, 1913, value.

The value of the shares on March 1, 1913, is immaterial to the determination of gain in this case under the statute. The petitioner on that date had but a contingent future undivided one-third interest in the 2,625 shares which would come into possession only upon the death of Oliver, then of unstated age. The value of the petitioner’s interest at that time was wholly speculative, has not been proven, and was certainly different from the value of one third of the shares on that date. Those shares were then in a trust. The petitioner does not contend that there was no trust. The trustees and the beneficiaries were not the same persons. The parties and the court regarded this particular trust as an existing trust. There seems to have been good reason for its continuance. Why then should the Board hold that there was no trust after the death of the mother ?

The petitioner was able to acquire these shares from the trustees at a cost of $100 each. The trustees were not in position to make and did not make any gift to the petitioner. Cf. Robinson v. Commissioner, 59 Fed. (2d) 1008. The petitioner had no right to use the shares prior to the purchase. Cf. Bradley W. Palmer, 32 B. T. A. 550. Therefore, unless this is such an extraordinary case as to warrant an exception to the use of the normal basis of cost and to justify the use of the greater value of the shares at the time of the purchase, my original opinion was correct. But in no event can I understand how the statute justifies the use, under the circumstances here present, of the value of the shares on March 1, 1913, as the petitioner’s basis for subsequent gain or loss upon the disposition of the shares.

SterNhagen, Smith, MoRRis, and Meluott agree with this dissent.


author: TiíamMell :

text:
    The Lorraine Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 61329.
    Promulgated February 20, 1936.

      George Bouchard, Esq., for the petitioner.

      Dewitt M. Evans, Esq., for the respondent.
   OPINION.

TiíamMell :

With respect to the issue involving limitations, the respondent concedes in his brief that unless we find for him on the question of fraud the deficiencies are barred.

On the question of .fraud, the respondent, who has the burden of proof, now relies on only two classes of items, namely, royalties from the Crowell license agreement and deductions for the expenditures for whiskey.

The testimony of Summers, who was the secretary and treasurer of the petitioner during the years in controversy, shows that all the net profit realized by the petitioner for each year from the manufacture and sale of the device covered by the license agreement entered into between the petitioner and Crowell was charged to profit and loss on the books of the petitioner as royalties paid to Lorraine, its president, and his personal account on the petitioner’s books was credited accordingly. The amounts of such charges and credits were stipulated by the parties and are not in controversy. The controversy is as to the deductibility of the amounts by the petitioner. The respondent contends that, since the license to manufacture and sell granted under the agreement with Crowell was granted to the petitioner, the profit realized by the petitioner from operations thereunder was profit belonging to the petitioner and was taxable to it. The petitioner contends that, after it entered into the agreement with Crowell and before any profit was realized from operations thereunder, it entered into an agreement with Lorraine whereby it was to manufacture the device covered by the Crowell patents, receiving therefor the cost of materials used plus $3 per hour for the time each of its employees was engaged in the manufacture of it, and that whatever profits were derived from the sale of the device were to belong to Lorraine and losses that resulted were to be borne by him. In support of this contention the petitioner relies on certain testimony of Lorraine which was substantially to this effect. Lorraine, however, further testified that the manufacture of the device by the petitioner, under these conditions, was taken up by him with the other stockholders of the petitioner, including William Lacy, and was agreed to by them, that such agreement was made at a meeting of the stockholders of the petitioner at which William Lacy among others was present, that such action of the stockholders was recorded in the minute book, that the directors of the petitioner authorized an assignment to him of the license agreement with Crowell, and that this action was also recorded in their minute book. Neither the minutes of the meeting of the petitioner’s stockholders respecting their action as testified to by Lorraine were offered in evidence nor was there offered in evidence the minutes oí a meeting of its board of directors showing their authorization of the assignment to Lorraine of the license agreement, as he testified.

William Lacy was a stockholder in the petitioner during 1926, 1927, and until some time in 1928 when he sold his stock to Lorraine. His holdings amounted to about 12% percent of the petitioner’s outstanding stock. Lacy was called as a witness by the respondent and testified that he knew nothing about the license agreement between Crowell and the petitioner, that he knew nothing about the manufacture of the device thereunder or that Lorraine was taking the profit therefrom for himself, that he never entered into any agreement with Lorraine respecting the profits and losses from the device, and that he had no recollection of ever discussing the license agreement with Lorraine or of ever being present at a meeting of the stockholders of the petitioner at which they agreed that Lorraine would receive the profit from the device and not the petitioner.

The license agreement, an executed copy of which was placed in evidence, clearly shows that it was one between the petitioner and Crowell and not one between Lorraine personally and Crowell. The agreement specifically provided against the petitioner’s assignment of its interest therein without the consent of Crowell. There is nothing in the record to indicate that Crowell was ever asked to or did give his consent to the petitioner’s assignment of it to Lorraine. While Lorraine testified that the petitioner’s board of directors authorized the assignment of the license agreement to him by the petitioner, his testimony is not supported by any minutes of the meeting of the directors substantiating his testimony, nor is there any showing that such assignment, if authorized by action of the directors, Avas ever made.

The only evidence in the record to support the existence of an agreement between the petitioner and Lorraine whereby the latter was to have the profits and bear the losses from the device is the testimony of Lorraine. Much of his testimony was contradicted by a stockholder of the petitioner who owned a substantial amount of its stock. In view7 of this and of the fact that Lorraine stated that the agreement was recorded in the minutes of a meeting of the petitioner’s stockholders, the question arises as to why such minutes were not offered in evidence. No explanation is offered by the petitioner for its failure in this respect. We think under the circumstances here presented the only logical conclusion to be reached from the petitioner’s failure in this respect is that there were not any minutes containing such an agreement. The revenue agent who made an examination of the petitioner’s books for the years in controversy testified that he was unable to find any basis for the petitioner’s action in charging the amounts here in question to royalties paid and crediting them to Lorraine’s personal account. From the record before us we are unable to find that the alleged agreement was ever entered into between the petitioner and Lorraine and therefore conclude that such agreement never existed. The profits realized by the petitioner from the device, therefore, were income taxable to it and were improperly taken as deductions.

The next question is whether the deduction of the amounts by the petitioner was due to fraud with intent to evade tax. Summers, who was secretary and treasurer of the petitioner during the years in question, testified that the amounts were entered on the petitioner’s books as royalties paid to Lorraine, pursuant to instructions given by Lorraine. Nowhere in the record is the correctness of this statement disputed or denied. To justify the deduction of the amounts the petitioner has relied on an alleged agreement between it and Lorraine. The evidence not only fails to establish the making of such agreement but tends to indicate that the allegation as to its having been made is a fabrication. The amount of $16,837.20 deducted for 1926 is approximately two and one-half times the amount of net income reported by the petitioner for that year. The amount of $26,152.83 deducted for 1927 is more than nine times the amount of net income reported by the petitioner for that year. The deduction of $24,272.03 taken for 1928 is approximately one third of the amount of the net income reported for that year.

In extenuation of this situation the petitioner relies on the testimony of Lorraine that he reported the amounts as income in his individual returns for the respective years, hence the Government has not been deprived of the tax thereon. This does not greatly help the petitioner’s position. In the hands of the corporation the amounts were subject to a normal tax at the rate of 13% percent for 1926 and 1927 and at 12 percent for 1928. If they had been the income of Lorraine as a result of the alleged agreement the highest rate of normal tax on them would have been only 5 percent for each of the years. Irrespective o.f whether the amounts came into Lorraine’s hands either by way of dividends from the petitioner or as a result of the alleged agreement they would have been subject to the same graduated rates of surtax. By the amounts having been treated as they were by the petitioner the Government was deprived of normal tax on them by at least the difference between the rates of 5 percent and 13% percent for the years 1926 and 1927, and by the difference between the rates of 5 percent and 12 percent for 1928. No agreement having existed between the petitioner and Lorraine during the years in controversy which warranted the deduction of the amounts by the petitioner, we think under the circumstances presented the action of the petitioner was fraudulent and with an intent to evade tax. The action of the respondent in determining the 50 percent penalties is accordingly sustained.

The pertinent portions of the applicable revenue acts provide that if any part of the deficiency is due to fraud with intent to evade tax then 50 percent of the total amount of the deficiency shall be assessed as a penalty. While our opinion as to fraud with respect to the issue above discussed would be sufficient on which to base the fraud penalty, there is in addition thereto the question of the deduction claimed as an ordinary and necessary expense of expenditures made for whiskey for beverage purposes. These expenditures for this purpose were disguised in the form of commissions and traveling and entertainment expenses. We do not think that such expenditures are allowable deductions even though the purpose was entertainment. The expenditures were for an illegal purpose, that is, to acquire possession of alcoholic liquor for beverage purposes contrary to Federal statute. It appears that a portion of the liquor was consumed by employees. While we think that the entire expenditures for illegal liquor are not allowable deductions as ordinary and necessary expenses of carrying on a trade or business, at least that portion of the expenditures for liquor which was consumed by employees and for which a deduction was claimed in the disguised form of commissions and traveling and entertainment expenses constituted fraud with intent to evade the tax.

Since we have found that the petitioner’s returns were fraudulent with intent to evade tax, the question of limitations is decided adversely to the petitioner.

The petitioner offered no evidence respecting the remaining assignments of error and makes no contention relative to' them in its brief. The action of the respondent with respect to them is sustained for lack of evidence.

Reviewed by the Board.

Decision will be entered under Bule 50.

       This decision was prepared during Mr. Trammell’s term of office.


author: Leech:

text:
    Retailers Credit Association of Alameda County, a Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 78008.
    Promulgated February 25, 1936.

      JolmL. Reith, Esq., and D. A. Sargent, O. P. A., for the petitioner.

      O. P. Reilly, Esq., for the respondent.

       This concurrence was noted during Mr. Trammell’s term of office.

   OPINION.

Leech:

The petitioner reported a net income of $6,878.61 for the calendar year 1931. It paid no tax on that income upon the ground that it was an exempt corporation under the Revenue Act of 1928, section 103 (7). The respondent denied petitioner the exempt status, as claimed, and accordingly determined the pending deficiency. The only issue presented is whether the respondent was correct in his denial of petitioner’s asserted exemption from income tax under the cited statutory provision.

The rule that a taxing act shall be construed strictly against the Government in the inclusion of income within its purview is reversed where the taxpayer seeks the benefit of an exemption from such tax. To secure such exemption, the taxpayer must not only carry whatever burden of proof the determination of the pending deficiency imposes (Helvering v. Taylor, 293 U. S. 507), but must proceed perceptibly further and bring itself strictly within the provisions of the act creating the exemption. Central Cooperative Oil Association, 32 B. T. A. 359, and cases therein cited.

Under the cited statutory provision, the protection of which petitioner seeks, the taxpayer, to prevail, must establish clearly the existence of three conditions. These are: (1) That no part of the net earnings of petitioner inured to the benefit of any individual during the year 1931; (2) that petitioner was not organized .for profit; and (3) that, during the year 1931, petitioner was either a business league, chamber of commerce, real estate board, or board of trade within the intendment of the quoted section.

As to the first condition, it is admitted here that no dividend in money or property has ever been paid to its members by petitioner. However, this fact is not conclusive of the existence of that condition. Profit can result to members in other ways than from the distribution of such dividends. Houston Belt & Terminal Railway Co. v. United States, 250 Fed. 1; Fort Worth Grain & Cotton Exchange, 27 B. T. A. 983. Obviously, the expenses of the many incidental services which petitioner was rendering its members and for which it made no charge were paid from its current income from those services for which a charge was made, or from its surplus, built up from those charges. It necessarily follows, we think, that petitioner’s profits, in that way, inured to the benefit of its members enjoying those services for which no charge was made. Northwestern Jobbers Credit Bureau v. Commissioner, 37 Fed. (2d) 880, affirming 14 B. T. A. 362.

With reference to the second condition, it is true that the enabling act of California, under which petitioner was incorporated, permitted the organization of petitioner as a nonprofit company. It is likewise true that there is testimony in the record that petitioner was not organized nor operated for profit. However, an examination of its purposes set out in its articles of incorporation, as well as the activities in which it was engaged, leads us unavoidably to the conclusion that the primary purpose for which the petitioner was organized and operated was the furnishing of credit reports and the collection of accounts for its members. In onr judgment, these activities are such as are ordinarily carried on for the purpose of making profit. Northwestern Jobbers Credit Bureau v. Commissioner, supra. It is true these profits were to be limited to the necessities of its expanding business. But, that petitioner contemplated earning a profit appears from its bylaw providing for the allocation of those profits and the discretionary payment of dividends. Rubber Co. v. Goodyear, 76 U. S. 788. In fact, petitioner, until the tax year, had made a profit of $32,587.53, and in 1931 undoubtedly derived a profit of $6,878.61, which the respondent here seeks to tax. We conclude the petitioner here was organized for profit. Northwestern Jobbers Credit Bureau v. Commissioner, supra; and Fort Worth Grain & Cotton Exchange, supra.

In connection with the third condition, it is obvious petitioner was neither a chamber of commerce, real estate board, or board of trade. Our inquiry then is limited to whether, during 1931, it was a “business league” within the intendment of the quoted section.

The regulations of the respondent, construing this term as it has appeared in each of the revenue acts since that of 1918, at least so far as here relevant, have remained substantially unchanged. These regulations have been approved as properly construing the controlling statutory provision. Uniform Printing & Supply Co. v. Commissioner, 33 Fed. (2d) 445; affirming 9 B. T. A. 251; certiorari denied, 280 U. S. 591. See margin for Regulations 74, article 528, construing the controlling statutory provision.

Aside from any other reason that precludes petitioner here from the essential designation of “business league” under that regulation, we think the conclusion is unescapable that the petitioner, during 1931, was “An organization whose purpose is to engage in a regular business of a kind ordinarily carried on for profit, even though the business is conducted on a cooperative basis or produces only sufficient income to be self-sustaining * * *.” The taxpayer’s primary purpose and business was the furnishing of credit reports and the collection of accounts for its members. These are the only real purposes appearing definitely in its articles of incorporation. Its income arises, at least principally, if not wholly, from those activities. During some years one of those activities may result in losses, and the other profit. In other years, the converse is true. But the profits always arise from one or both of those activities. It is true petitioner engaged in numerous other gratuitous activities, as advertising campaigns for the encouragement of prompt payment of accounts payable by the public, and other movements that are indeed laudable and of public benefit. But these activities were merely incidental to its primary purpose and business of furnishing credit reports to and collecting accounts for its members, from which its income and profits were derived. Northwestern Jobbers Credit Bureau v. Commissioner, supra; Fort Worth Grain & Cotton Exchange, supra. That regular business of supplying credit reports and collecting accounts, for members, was a business ordinarily carried on for profit. Uniform Printing & Supply Co. v. Commissioner, supra; Northwestern Jobbers Credit Bureau v. Commissioner, supra; Fort Worth Grain & Cotton Exchange, supra. The Court of Appeals for the Second Circuit, in construing the statutory provision controlling here, in the case of Produce Exchange Stock Clearing Association, Inc. v. Helvering, 71 Fed. (2d) 142, said:

* * * The numerous subdivisions of section 103 of the Revenue Act of 1928 (26 USCA § 2103), and the corresponding provisions in the earlier acts, specify organizations which, in the great majority of instances, are evidently granted exemption because of the benefit to be derived by the public from their activities. Cf. Trinidad v. Sagrada Orden 263 U. S. 578, 581. [Citations] There is reason why these should be favored, but none is apparent for exempting an association which merely serves each member as a convenience or economy in his business. This is the distinction which the Board of Tax Appeals and the courts have taken in applying the provision in question to somewhat analagous situations. [Citations.]

That expression seems pertinent here.

Though the petitioner was held by the Commissioner of Internal Revenue to be an exempt corporation within the ■ provisions of the presently applicable and above quoted provisions of the revenue law, in connection with capital stock tax, and although an administrative officer of the State of California may have held it to possess the qualifications necessary to its present asserted exemption, our jurisdiction is original and is controlled solely by the factual record presented here. Upon that record, the respondent’s denial of the disputed exemption is sustained.

Reviewed by the Board.

Judgment will be entered for the respondent.

Smith, Trammell , VaN FossaN, and Murdock concur in the result solely upon the ground that the petitioner is not a “business league.”

       SEC. 103. EXEMPTIONS FROM TAX ON CORPORATIONS.
      The following organizations shall be exempt from taxation under this title—
      *******
      (7) Business leagues, chambers of commerce, real estate boards, or boards of trade, not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual; * * *

       Art. 528. Buisiness leagues, chambers of commerce, real estate boards, and boards of trade. — A business league is an association of persons having some common business interest, the purpose of which is to promote such common interest and not to engage in a regular business of a kind ordinarily carried on for profit. It is an organization of the same general class as a chamber of commerce or board of trade. Thus its activities should be directed to the improvement of business conditions or to the promotion of the general objects of one or more lines of business as distinguished from the performance of par ticular services for individual persons. An organization whose purpose is to engage in a regular business of a kind ordinarily carried on for profit, even though the business is conducted on a cooperative basis or produces only sufficient income to be self-sustaining, is not a business league. An association engaged in furnishing information to prospective investors, to enable them to make sound investments, is not a business league, since its activities do not further common business interest, even though all of its income is devoted to the purpose stated. A stock exchange is not a business league, a chamber of commerce, or a board of trade within the meaning of the law and is not exempt from tax.


author: Leech :

text:
    The Liquidating Company (Formerly Standard Creameries, Inc.) v. Commissioner of Internal Revenue, Respondent.
    Docket No. 60850.
    Promulgated February 25, 1936.

      Stanley Redder, Esq., for the petitioner.

      F. R. Shearer, Esq., for the respondent.
   OPINION.

Leech :

The most important issue presented is whether petitioner’s transaction with Borden constituted a reorganization within the meaning of section 112 of the Revenue Act of 1928, the pertinent parts of which are set out in the margin.

In its contract with Borden, the petitioner agreed to transfer to the former all of its assets except its stock in its subsidiaries and all the assets of its subsidiaries, including, in each case, the business of the corporation as a going concern. The consideration to be received by the petitioner was the stock of Borden, its assumption of all the liabilities of the petitioner, and its agreement to provide funds to redeem, on September 1, 1929, all the then outstanding debenture bonds of the petitioner. Borden further agreed to transfer to the petitioner additional stock in case of the conversion of any of its debentures into its own common stock. The petitioner was required to retire its preferred stock (which in case of its dissolution became payable in cash), to distribute its remaining Borden stock to its stockholders, and then, with all reasonable dispatch, to dissolve itself and its subsidiaries. This contract was carried out. As the result of the transaction the petitioner became a stockholder in Borden and the rights of its creditors were retained as against that company or were paid off as agreed. The petitioner and its subsidiaries have been dissolved and are now doing no business except that of liquidating. All this was done pursuant to the plan of reorganization set out in the agreement of July 5, 1929.

Under these circumstances, we think that such transaction between the petitioner and Borden was a reorganization, within the meaning of section 112 (i) (1) (A) of the Revenue Act of 1928. Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462; Cortland Specialty Co. v. Commissioner, 60 Fed. (2d) 937; Watts v. Commissioner, 75 Fed. (2d) 981; affd., 296 U. S. 387; Minnesota Tea Co. v. Commissioner, 16 Fed. (2d) 191; affd., 296 U. S. 378. The fact that the petitioner may have received “other property or money” does not alter this conclusion. It merely limits the taxable gain to “the sum of such money and the fair market value of such other property so received, which is not so distributed.” Sec. 112 (d) (2), quoted in the margin.

In his original computation of the pending deficiency, respondent determined that the amount of $813,995 with which the debentures were paid was “money” within the meaning of subdivision (d) of section 112. He used that amount as a yardstick with which to measure the amount of the petitioner’s taxable gain on the whole transaction. On his assignment of error to that determination, petitioner argues: (1) That this was but a method of discharging a debt already assumed by Borden; (2) that the petitioner was never in receipt of this sum; (3) that it was distributed, within the meaning of section 112 (d) (1).

With respect to the first contention, it is pointed out that the respondent has not determined that the assumption of petitioner’s liabilities by Borden constituted “other property or money” and so it is immaterial whether petitioner’s obligation on its debenture bonds was assumed and afterwards paid, or a contract was made to furnish funds with which to pay that debt. The question whether an assumption of liabilities in such a case constitutes “other property” is not before us. We express no opinion with reference thereto, but confine ourselves to the issue presented by the pleadings. That issue is whether the money advanced to pay the debentures did or did not constitute “money” received by the petitioner and was not distributed within the meaning of section 112 (d) (2), supra. It is important to note that the obligation by which petitioner’s liabilities were assumed appears in one paragraph and the agreement to provide the funds for the payment of the debentures, which is another and distinct obligation, is found in a separate paragraph of the contract. But, more significant is the fact that Borden was not in a position to assume the payment of the debentures for the one reason, if for no other, that these debentures contained an agreement for conversion into stock of the petitioner with which it would have been impossible for Borden to comply. The petitioner in its return for the fiscal year ending September 30, 1929, claimed and was allowed deductions of premiums, accrued interest, and unamortized discount on these very debenture bonds. However, considering what was actually done under the contract and not what might have been done or the purpose which might have actuated the parties (E. F. Simms, 28 B. T. A. 988, 1011; William H. Mullins, 14 B. T. A. 426), we are of opinion that the cash advanced by Borden to pay the petitioner’s debt, and so used, was received by the petitioner (Old Colony Trust Co. v. Commissioner, 279 U. S. 716) in payment of part of the agreed consideration. There is thus no merit in the first or second contention.

This brings us to petitioner’s third argument.

Since it received the stock and cash, petitioner’s gain was taxable to the extent of the cash received unless it distributed the cash, as provided in section 112 (d) (1). Petitioner asserts that the cash was distributed. He contends that the word “distributes” as used in subsection (d) (1) should not be limited to distributions to stockholders. He apparently argues that the payment of the debt constituted a distribution.

The gain of a corporation incurred in a reorganization transaction is taxed only to the corporation or ultimately to its stockholders. There is nothing in section 112 or any of the related sections which indicates any purpose to transfer the tax due from a corporation to any other persons. Cf. Evert A. Bancker, 31 B. T. A. 14.

In West Texas Refining & Development Co. v. Commissioner, 68 Fed. (2d) 77, the court had before it similar sections contained in the Revenue Act of 1926. The court there said:

Assuming, but not deciding, that the transaction was a reorganization within the meaning of section 203 (b) (3), then the effect of section 203 (e) (2) must be considered. Where there is a corporate reorganization and a transfer of the assets of the old corporation to the new corporation and an exchange of the interests of the stockholders in the old corporation for like or substantially like interests in the new corporation, there is in substance no closed transaction and no gain. But where a consideration has been paid for such transfer of assets and not distributed to the stockholders of the old corporation and hence not reflected in their individual tax returns, but paid to the old corporation and used by it to pay debts, unless the gain realized to the extent not distributed to the stockholders of the old corporation is made taxable, a realized gain would escape taxation; hence the provisions of section 203 (e) (1 and 2).
Since the cash payment, not distributed to the stockholders of the West Texas Company, was more than the profit realized on the transaction, the whole profit was taxable as income to the West Texas Company under the provisions of section 203 (e) (2).

Such, it seems, was the concept of the Congress, which enacted the Revenue Act of 1924, the provisions of -which, on this subject, are similar to those before us for application. House Report No. 179, 68th Cong., 1st sess., p. 16.

We hold that the cash received from Borden was not distributed, within the meaning of section 112 (d) (1). Arctic Ice Machine Co., 23 B. T. A. 1223; mod., 67 Fed. (2d) 983.

In reference to the transfer by petitioner of shares of Borden stock to Shurtleff, Northon, and Wilson as “trustees” for its preferred stockholders, petitioner takes two positions. They are: First, that, by that transfer the petitioner divested itself of all interest in the stock transferred with the result that sales made by the trustees were not sales made by the petitioner and therefore no taxable gain could accrue to the latter; and second, that, since the transaction occurring under the contract between the petitioner and Borden resulted in a reorganization, a necessary part of which was the redemption of the preferred stock, no taxable gain arose from the sales.

In answer to the first, it may be doubted that petitioner parted with all rights and title to the Borden stock transferred to the trustees. If the trustees received more than sufficient to liquidate petitioner’s preferred stock, the excess was returnable to petitioner. In fact, the surplus money in the hands of the trustees after liquidation of the preferred stock was so returned. The trustees distributed or sold all the stock they received.

Certainly the trustees did not receive this Borden stock as a liquidation in kind for the preferred stockholders. Petitioner’s preferred shareholders were then creditors of petitioner. The trustees’ receipt of Borden stock did not satisfy petitioner’s obligation to those preferred stockholders. This record will sustain no other conclusion.

The petitioner, although dissolved, was continued as a body corporate for dissolution purposes. Section 40, General Corporation Law of the State of Delaware. One of these purposes was the liquidation of its outstanding stock including its preferred stock. This duty was performed in part by the three trustees as mere agents of petitioner for that purpose.

Article 71 of Regulations 74 reads:

Akt. 71. Gross income of corporation in liquidation. — When a corporation is dissolved, its affairs are usually wound up by a receiver or trustees in dissolution. The corporate existence is continued for the purpose of liquidating the assets and paying the debts, and such receiver or trustees stand in the stead of the corporation for such purposes. (See sections 274 and 298 and articles 1191 and 1192.) Any sales of property by them are to be treated as if made by the corporation for the purpose of ascertaining the gain or loss. No gain or loss is realized by a corporation from the mere distribution of its assets in kind in partial or complete liquidation, however they may have appreciated or depreciated in value since their acquisition. But see section 44 (d) and article 355. (See further article 392.)

That regulation has been found reasonable. It is applicable here to characterize petitioner as the seller. Taylor Oil & Gas Co. v. Commissioner, 47 Fed. (2d) 108; certiorari denied, 283 U. S. 862; Burnet v. Lexington Ice Coal Co., 62 Fed. (2d) 906; Hellebush v. Commissioner, 65 Fed. (2d) 902; and Northwest Utilities Securities Corporation v. Helvering, 67 Fed. (2d) 619; certiorari denied, 291 U. S. 684.

In applying the above regulation, it is immaterial whether a corporation attempts to vest trustees with title to all or only a part of its assets. In either case the trustees are vested with a liquidating function, a duty which pertained to the corporation and not to the stockholders, who were entitled only to receive. They were distributing or selling stock which in fact belonged to the corporation. Taylor Oil & Gas Co. v. Commissioner, supra.

Nor is it material that in following the course the petitioner pursued, it did not follow the ordinary methods of corporations in liquidation. Northwest Utilities Securities Corporation v. Helvering, supra.

Therefore, these sales, for tax purposes, are to be treated as having been made by petitioner.

But the petitioner argues these sales, as well as those by it, direct, from the proceeds of which dissolution expenses were paid, were in pursuance of the plan of reorganization, and the profits therefrom consequently exempt. However, we are convinced that the controlling statutory provision does not exempt from immediate tax gain received by the taxpayer upon a sale not essential to the consummation of a statutory reorganisation. Cf. Edison Securities Corporation, 29 B. T. A. 483; affirmed in part and reversed in part, 78 Fed. (2d) 85. Obviously, any other conclusion would be, at least, highly unreasonable, because of its consequences.

It may well be true that the present plan of reorganization included not only the exchange of stock and cash for assets, but the liquidation of petitioner’s preferred stock, and its dissolution. See West Texas Refining & Development Co. v. Commissioner, supra; First Seattle D. H. National Bank v. Commissioner, 77 Fed. (2d) 45; Samuel Insull, Jr., 32 B. T. A. 47. But, aside from the question whether these sales of the Borden stock by petitioner on the market, from the proceeds of which petitioner’s outstanding preferred stock was redeemed, were an essential part of that plan, neither the liquidation of the petitioner’s preferred stock nor its dissolution was necessary to constitute the contemplated and executed transaction as a reorganization within the applicable statute. Minnesota Tea Co. v. Commissioner, supra; Watts v. Commissioner, supra.

We therefore sustain the respondent’s determination of taxable gain to petitioner upon the sale of Borden stock by the trustees, Shurtleif, hi or th on, and Wilson, with the proceeds of which petitioner’s outstanding preferred stock was redeemed.

The expenses, to pay which petitioner, itself, made the other disputed sales of Borden stock, were undoubtedly necessary to petitioner’s dissolution. However, as stated, that dissolution was not essential to the completion of a statutory reorganization. Minnesota Tea Co. v. Commissioner, supra; Watts v. Commissioner, supra. And so, the gains on those sales, upon the same reasoning as applied to the sales last discussed, would also be taxable here to petitioner.

The petitioner contends that the items making up the total of the $27,978.99, which, it is stipulated, represents stock-selling expenses incurred and paid prior to the fiscal year 1929 by the petitioner’s subsidiaries, the Benham Ice Cream Co. and Gloria Ice Cream Co., constitute capital expenditures which are deductible upon the dissolution of these corporations in that year. It so treated them in its consolidated return. The respondent denied the deductions but included this amount as part of the cost of the assets transferred to Borden. The respondent does not attack his own determination on this point. In his answer to the petition, as amended, he asks that if we hold that this item or any part thereof is deductible from gross income for the year 1929, then the amount so allowed should be eliminated from the cost of assets transferred and the profit thereon increased accordingly. These presently disputed expenses were-not capital expenditures and were not deductible, as contended. Pacific Coast Biscuit Co., 32 B. T. A. 39; James I. Van Keuren, 28 B. T. A. 480. Upon this record we go no further but leave the parties on this issue as we found them.

The petitioner seeks to deduct from gross income for the fiscal year 1929 the organization expenses of itself and of its affiliates, Benham Ice Cream Co. and Gloria Ice Cream Co.

The so-called certificates of dissolution were issued by the Secretary of State of Delaware in the case of the petitioner on August 3, 1929, in the case of Gloria Ice Cream Co. on September 30, 1929, and in the case of the Benham Ice Cream Co. on October 4, 1929. The affidavits of the publishers of the newspapers containing the advertisements required by section 39 of the General Corporation Law of Delaware, as amended by the Act of 1929, were filed with the Secretary of State of Delaware on the following dates: the Liquidating Co., September 3, 1929; the Gloria Ice Cream Co., October 3, 1929; and the Benham Ice Cream Co., October 7, 1929.

Section 39 of the General Corporation Law of Delaware of 1929, effective March 22, 1929, provides such- affidavits

* * * shall be filed in the office of the Secretary of State, who, upon being satisfied by due proof that the requirements aforesaid have been complied with, shall issue a certificate that such consent has been filed, and the Secretary of State shall cause such certificate to be published in one issue in a newspaper published in the county wherein the principal office of the dissolved corporation was situated. The Secretary of State shall ascertain the charge for publishing the certificate of dissolution as aforesaid, and collect the amount from the corporation before the certificate of dissolution is issued; and upon the filing in the office of the Secretary of State of an affidavit of the manager or publisher of the said newspaper that said certificate has been published one time, in said newspaper, the corporation shall be dissolved.

Under the above provisions it is apparent that the petitioner was dissolved on September 3, 1929. It is equally clear that Benham Ice Cream Co. was not dissolved within the fiscal year ending September 30, 1929. Yfhile the so-called certificate of dissolution was issued to Gloria Ice Cream Co. on September 30, 1929, the affidavit of the publishers of the newspapers, as required by the above section, was not filed until October 3,1929. Therefore, the Gloria Ice Cream Co. was not dissolved within the fiscal year ending September 30, 1929. Since the two affiliates are not before us for the succeeding fiscal year, no relief can be afforded them. The material part of section 40 of the General Corporation Law of Delaware provides:

All corporations, whether they expire by their own limitation, or are otherwise dissolved, shall nevertheless be continued for the term of three years from such expiration or dissolution bodies corporate for the purpose of prosecuting and defending suits by or against them, and of enabling them gradually to settle and close their business, to dispose of and convey their property, and to divide their capital stock but not for the purpose of continuing the business for which said corporation shall have been established * * *.

When the petitioner was dissolved, it lost the right to continue the business for which it had been established. It retained its corporate life for the sole purpose of liquidation. It was not engaged in a business while liquidating. Trustees for Gonzolus Creek Oil Co., 12 B. T. A. 310; White v. Hornblower, 27 Fed. (2d) 777; Willis v. Commissioner, 58 Fed. (2d) 121. In our opinion when the petitioner was dissolved on September 3, 1929, and thereby lost the right to transact its regular business, it surrendered its charter in reality-then. For this reason the petitioner should be permitted to deduct organization expenses in the amount of $59,041.76. Pacific Coast Biscuit Co., supra; Malta Temple Association, 16 B. T. A. 409. In reaching this conclusion we have not overlooked our decisions in City & Suburban Mortgage Co., 26 B. T. A. 179, and Surety Finance Co. of Tacoma v. Commissioner, 77 Fed. (2d) 221. Neither of these decisions is in point for the reason in neither was the taxpayer corporation dissolved.

Judgment will be entered under Rule 50.

       SEC. 112. RECOGNITION OP GAIN OR LOSS.
      (a) General rule. — Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.
      (b) Exchanges solely in kind.—
      (4) Same — gain on corporation. — No gain or loss shall be recognized if a corporation a party to a reorganization exchanges property, in pursuance of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization.
      * « * « * a *
      (d) Same — Gain of corporation. — If an exchange would be within the provisions of subsection (b) (4) of this section if it were not for the fact that the property received in exchange consists not only of stock or securities permitted by such paragraph to bo received without the recognition of gain, but also of other property or money, then — •
      (1) If the corporation receiving such other property or money distributes it in pursuance of the plan of reorganization, no gain to the corporation shall be recognized from the exchange, but
      (2) If the corporation receiving such other property or money does not distribute it in pursuance of the plan of reorganization, the gain, if any, to the corporation shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property so received, which is not so distributed.
      ♦ * * * ÍI # *
      (i) Definition of reorganization. — As used in this section and sections 113 and 115—
      (1) The term “reorganization” means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected.

       Section 203 (e) : There is no provision of the existing law which corresponds to subdivision (e) of the bill, nor has the Treasury Department ever ruled officially on the type of case covered by that subdivision. The subdivision provides that if a corporation in connection with a reorganization transfers its assets to another corporation, a party to the reorganization, for stock and securities of the same corporation and cash, then no gain or loss to the transferor is recognized, if it distributes the cash to its stockholders. But if the selling corporation fails to distribute the cash to its stockholders then the gain or loss is to be recognized. In other words, if the corporation which sells its assets in connection with the reorganization acts merely as a conduit in passing the proceeds of the sale on to its stockholders, no gain io the corporation is to be recognized, but if it retains all or any of the proceeds with the result that the transaction is in substance a real sale, then all or a part of the gain shall be recognized. [Emphasis supplied.]


author: Tbammell :

text:
    Illinois Power & Light Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 56299, 59687.
    Promulgated February 25, 1936.

      Henry S. 'Wingate, Esq., R. B. Goodell, Esq., and Henry I. Green, Esq., for the petitioner.

      Elden McFarland, Esq., for the respondent.
   orisnoN.

Tbammell :

The first question presented here is whether petitioner is entitled to deduct from gross income for the year of retirement, the unamortized discount (and premium paid) upon the retirement of certain bonds issued by a corporation which subsequently, but prior to the retirement of the bonds, became merged or consolidated into petitioner corporation.

In the case of American Gas & Electric Co., 33 B. T. A. 471, we discussed at some length previous Board decisions and court decisions on the subject of the allowance of a deduction from gross income for the year of retirement of the unamortized discount and premium paid upon the retirement of bonds. It is not necessary to further discuss those cases here. That case involved the question of the deduction of unamortized discount of bonds retired by a corporation which succeeded to the assets and liabilities of the issuing company, and we held that such successor corporation was not entitled to a deduction. This case is materially different from that case in that in this case there was a statutory consolidation under the laws of Illinois, the pertinent provisions of which statute are quoted in the margin.

Under this statute the consolidated corporation becomes the owner of all the property and succeeds to all the liabilities of the component corporations by operation of law and not by purchase. See Oswego Falls Corporation, 26 B. T. A. 60; affd., 71 Fed. (2d) 673. In this case the bonds issued by the Southern Illinois Co. became by operation of law the obligations of the consolidated corporation, the petitioner herein, to the same extent as if the bonds had been issued by it. Petitioner stood in the place of the issuing corporation and it is therefore entitled to treat the unexhausted discount and premium paid upon retirement of the bonds in the same manner as like discount and premium in the case of its own bonds. We therefore hold that the petitioner is entitled to the deduction claimed for unamortized discount and premium paid on the bonds retired.

The second issue presents the question whether petitioner is entitled to deduct from gross income for the year of retirement un-exhausted bond discount, premium, and expenses incident to the retirement of its-own bond issue and that of another member of the affiliated group filing a consolidated return, where the funds used for such purposes were replaced by the proceeds o.f a new issue, or where the proceeds of the new issue were used directly to retire the prior issue.

This case does not involve the question whether a parent corporation is entitled to a deduction on account of unamortized discount on the retirement by the parent corporation of bonds issued by a subsidiary. Here, petitioner, the parent corporation, issued and redeemed its own bonds, and the subsidiary issued and redeemed its own bonds. Petitioner claims a deduction of the discount on the bonds issued and retired by it, and because of the fact that it filed a consolidated return for itself and the subsidiary, also claims a deduction for the subsidiary’s bond discount in determining the total tax liability on the basis of the consolidated return. The only point in controversy here is whether such deductions are allowable where the funds used for retirement of the bonds were replaced by proceeds from the sale of a new issue of bonds.

On brief respondent concedes that both the Board and the courts have taken a view contrary to his contention on this question, but, pending further judicial clarification, continues to urge his position.

In American Gas & Electric Co., supra, we held that a corporation which retires an outstanding issue of bonds at a callable price above par in accordance with the trust agreement is entitled to a deduction for the unexhausted discount and expense on the old bond issue and for the premium paid on retirement, even though it had borrowed money to retire the bonds and promptly repaid the amount borrowed from the proceeds of a new bond issue. And see also East Ninth Euclid Co., 26 B. T. A. 32; 27 B. T. A. 1289 (reconsideration); San Joaquin Light & Power Corporation v. McLaughlin (C. C. A., 9th Cir.), 65 Fed. (2d) 677; California-Oregon Power Co. v. Helvering (C. A. D. C.), 75 Fed. (2d) 644, affirming the Board’s memorandum opinion entered May 11, 1933; Public Service Co. v. Helvering (C. C. A., 8th Cir.), 75 Fed. (2d) 733, affirming the Board’s memorandum opinion entered October 25, 1933; and Central States Electric Corporation v. Commissioner (C. C. A., 2d Cir.), 76 Fed. (2d) 1011, affirming the Board’s memorandum opinion entered December 27, 1933.

On authority of the decisions above cited, respondent’s action on the second issue herein is revised.

Since we reach the conclusion that respondent erred in refusing to allow the deductions claimed by the petitioner, we hold, in accordance with the stipulations of the parties, that there is no deficiency due from the petitioner for either of the taxable years involved.

Reviewed' by the Board.

Judgment will be entered for petitioner.

MtiRdocK dissents.

       This decision was prepared during Mr. Trammell’s term of office.

       After setting forth the procedure for the merger or consolidation of two or more corporations into a single corporation, the statute provides:
      70. Such single corporation shall thereupon and thereafter possess all the rights, privileges, immunities, powers and franchises, as well of a public as of a private nature, and all property, real, personal and mixed, and all' debts due on whatever account, as well as for stock subscriptions and all other things in action of, or belonging to, each of such corporations, and be subject to all the restrictions, liabilities and duties of each of such corporations so merged or consolidated. All property, rights, privileges, immunities, powers and franchises and all and every other inlerest shall thereafter be as effectually the property of the single corporation as they were of the several and respective merging or consolidating corporations. The title to any real estate, whether by deed or otherwise, under the laws of this state, vested in any of such corporations, shall not revert or be in any way impaired by reason of such merger or consolidation.
      71. All rights of creditors and all liens upon the property of either of such merging or consolidating corporations shall be preserved unimpaired, and all debts, liabilities and duties of the respective corporations shall henceforth attach to such single corporation and may be enforced against it to the same extent as if such debts, liabilities and duties had been incurred or contracted by it. Any action by or, against one of the corporations merged or consolidated may be prosecuted to judgment as if such merger or consolidation had not taken place, or the merged or consolidated corporation may be substituted in its place. [Cahill’s Illinois Revised Statutes, Ch. 32, p. 677.]