text:
    Sisto Financial Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105982.
    Promulgated August 4, 1942.

      Robert O. Vincent, Esq., and Albert E. Radio ch, Jr., Esq., for the petitioner.

      J. G. Maddox, Esq., for the respondent.
   OPINION.

Leech:

In its income tax return for 1936, the petitioner treated the transaction in which it received Stainless stock from Barium in satisfaction of Barium notes held by the taxpayer, as an exchange of securities for stock in a nontaxable reorganization under section 112 (b) (3) of the Revenue Act of 1936. Consistent with this treatment it then reported capital gain on its disposition of that Stainless stock in 1936, using as a basis its cost of the Barium, notes. Respondent, in his deficiency notice, determined that the Stainless stock disposed of by petitioner in 1936 was not received by it in a nontaxable reorganization but in a taxable exchange of property, in the form of Barium notes for Stainless stock, under section 112 (a) of the same act. He then valued the Stainless stock at $3 per share when received by the petitioner, and computed the taxable gain to petitioner on such exchange in the amount of the difference between the cost to petitioner of the notes and the aggregate value, at $3 per share, of the Stainless stock received by the petitioner in satisfaction thereof. Thus computed, this gain was $237,308. Accordingly, he then used the basis of $3 per share for the Stainless stock in computing petitioner’s gain on the disposition of part of such stock in the taxable year, and reduced the returned gain accordingly.

Here both parties maintain their original positions except that petitioner alternatively contends that the fair market value of the Stainless stock when received by it was not $3 per share, as determined by respondent, but was no greater than its cost of the satisfied Barium notes.

The principal argument of respondent is that the notes of Barium owned by petitioner were not “securities” within the meaning of section 112 (b) (3), supra. He says Barium’s financing evidenced by these demand and short term promissory notes “was current, not permanent. * * * Petitioner’s ownership of the notes gave it no interest in the assets of Barium. * * * It [Barium] thus used the medium of the common stock of the new company [Stainless] to collect a debt never intended as anything other than current financing of an enterprise to be paid immediately when that enterprise was in receipt of funds. * * * They [the short term and demand promissory notes of Barium] were evidence of indebtedness but they were hardly securities.”

We agree. Admittedly petitioner was a stockholder in Barium. Nevertheless, its position here must rest alone on the character of the notes of Barium which it held. Marjorie Fleming Lloyd-Smith, 40 B. T. A. 214; affd., 116 Fed. (2d) 642; certiorari denied, 313 U. S. 588. Cf. Helvering v. Alabama Asphaltic Limestone Co., 315 U. S. 179; E. M. Wilson, 46 B. T. A. 673. The six-month promissory note of $50,000 secured by a second mortgage and other collateral, as well as the demand notes of Barium owned by petitioner, were evidences only of current financing for operating expenses. The loans evidenced by these notes gave petitioner no proprietary interest in Barium. By virtue of such loans petitioner became a mere creditor of Barium and the evidencing notes are not “securities” within the meaning of section 112 (b) (3), supra. Marjorie Fleming Lloyd-Smith, supra. See also Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462; Cortland Speciality Co. v. Commissioner, 60 Fed. (2d) 937; certiorari denied, 288 U. S. 599; LeTulle v. Scofield, 308 U. S. 415.

Petitioner relies heavily on Burnham v. Commissioner, 86 Fed. (2d) 776; certiorari denied, 300 U. S. 683. In that case, however, the notes involved were for 10 years and were issued under such circumstances as to be characteristically equivalent to bonds which were refinanced with the notes. The other cases cited by petitioner are even more readily distinguishable.

Bespondent also argues that section 112 (b) (3) does not apply here for another reason. He says there was no exchange of the Barium notes for stock and securities since Barium merely satisfied its own indebtedness to petitioner. Nevertheless, in spite of this position, respondent’s conclusion is that the satisfaction of Barium’s notes to petitioner by Barium’s transfer of its Stainless stock to petitioner, constituted an exchange taxable under section 112 (a), supra. We think this conclusion is an obvious non sequitur.

J. A. Sisto in fact dominated and controlled the affairs of the partnership of J. A. Sisto & Co., Barium, Stainless, and petitioner. Nevertheless, as was specifically provided in the negotiations leading up to the transaction, it was actually Barium and not Stainless which contracted to and did satisfy Barium’s notes by the transfer of its Stainless stock received by Barium for its assets. Bespondent, in effect, concedes this on brief.

We have held that the Barium notes were not “securities” but were mere evidences of Barium’s indebtedness to petitioner. When Barium transferred its Stainless stock to petitioner in satisfaction of that indebtedness, it simply paid its own debts. There was therefore no more of an exchange within section 112 (a) than there was withm section 112 (b) (3). Barium received nothing. Bingham v. Commissioner, 105 Fed. (2d) 971; Commissioner v. Spreckels, 120 Fed. (2d) 517; Hale v. Helvering, 85 Fed. (2d) 819. Barium simply sold its Stainless stock to petitioner for an amount equal to the indebtedness thus satisfied. Betty Rogers, 37 B. T. A. 897; affd., 103 Fed. (2d) 790. Petitioner purchased that stock at a price equal to the amount evidenced by the notes due it from the seller. As was said in our recent decision in Peninsula Properties Co., Ltd., 47 B. T. A. 84, in a comparable situation:

* * ⅜ jn eacj1 cage transaction is treated as if the transferor had sold the assets for cash equivalent to the amount of the debt and had applied the cash to the payment of the debt. * ⅜ ⅜

Bee also E. F. Simms, 28 B. T. A. 988; Carlisle Packing Co., 29 B. T. A. 514; Hagan Corporation, 21 B. T. A. 41. In view of this conclusion the question of fair market value of the Stainless stock when received by the taxpayer from Barium has not been considered.

Petitioner in returning its net income for 1936 reported gain on three of its transfers in that year of Stainless stock thus received. It claimed a loss on the other transfer. In the computation of that gain and loss petitioner used $1,516 as its basis per share. This amount was the cost to petitioner of the Barium notes plus accrued unpaid interest, allocated equally to the Stainless shares thus received. That basis was correct. But we have held that petitioner did not receive these shares in a nontaxable exchange in August 1936 under section 112 (b) (3) of the Revenue Act of 1936, as it contends, but that petitioner purchased them at that time. Therefore all, instead of part of the gain, is taxable since the stock sold had been held for less than a year.

In reference to the secondary issue, petitioner sold 1,000 shares of its Stainless stock received in connection with the satisfaction of the Barium notes in the taxable year at $1 per share, which was then below its fair market value and $546.29 below its cost to petitioner. Petitioner made this sale at this price to an individual in compensation for valuable business services rendered to the petitioner. On its Federal income tax return for 1936 petitioner deducted as a loss the difference between its cost and the selling price of this stock under section 23 (f) of the Revenue Act of 1936. In the determination of the deficiency respondent denied the deduction of this loss. In its petition initiating this proceeding petitioner not only assigns error in that action, but alternatively claims the right to deduct this amount as a business expense under section 23 (a) of that act. Obviously, it is not deductible as a loss because it was paid for services. Brandeis v. Allen, 60 Fed. (2d) 1004; E. A. Roberts, 36 B. T. A. 549; Hawke v. Commissioner, 109 Fed. (2d) 946; Lelia S. Kirby, 35 B. T. A. 578. But, since no question has been raised as to its reasonableness, we think it is deductible as compensation under the same statutory provision.

Decision will Toe entered wider Bule 50.


source: Caselaw Access Project

author: Arnold:

license: Public Domain

text:
    Leonard A. Yerkes, Petitioner, v. Commissioner of Internal Reveune, Respondent.
    Docket No. 106189.
    Promulgated August 4, 1942.

      Floyd F. Toomey, Esq., for the petitioner

      Charles Olifhant, Esq., for the' respondent.
   OPINION.

Arnold:

This case involves a deficiency in gift taxes for the year 1937 in the sum of $2,347.73. Two questions are presented: (1) whether income paid to a life beneficiary under a trust, revocable as to income by the donor, is a gift of such income in the year paid, and (2) the number of $5,000 exclusions, if any, to which petitioner is entitled. By an amended answer respondent claimed an increased deficiency in that he allowed two $5,000 exclusions when he should have allowed but one, since the gifts in trust for the benefit of petitioner’s children were gifts of future interests.

The case was submitted on an agreed statement of facts, which are incorporated herein by reference, and the return and amended return.

Petitioner is an individual residing at Greenville, Delaware. His Federal gift tax return for the calendar year 1937 was filed with the collector of internal revenue for the first district of Delaware at Wilmington, Delaware.

On August 20, 1929, petitioner created a trust for the benefit of his wife and children. All the income from the trust was payable annually in quarterly installments to his wife during her life. Upon her death the principal was to be divided into as many equal shares as there were children of the donor then living, and issue, collectively, of any then deceased child, each child to receive the income from his or her share for life, the principal then to go to such child’s heirs. Petitioner expressly reserved to himself the power to amend the trust or trusts from time to time by instruments in writing, but could not make himself, either directly or indirectly, a beneficiary nor add additional beneficiaries. Such power to amend:

* * * shall solely be confined to rearranging among the beneficiaries originally named herein the proportions or proportionate benefits, whether of principal or income which they are entitled to receive hereunder, even to the extent of depriving one or more of them of any participation. The power of amendment of the party of the first part as above expressed shall extend to changing, amending, adding to or subtracting from the power and authority of the Trustee or Trustees, and to the substitution of new or different Trustees and the revocation of the power and authority of any trustee or trustees, at any time serving.

• On September 29, 1937, pursuant to the power retained by him, petitioner, by amendment, canceled and terminated the right reserved to him under the original trust indenture, in so far as it applied to the principal of the trust. The parties are not in disagreement that this amendment gave rise to a taxable gift of principal. Petitioner’s power and control over the income of the trust in the original agreement remained unchanged.

Other provisions of the stipulation are as follows:

Pursuant to the terms of the Trust Agreement of August 20, 1929, there was paid from the net income of said trust to Helen J. Yerkes, wife of the petitioner, from June 6, 1932, to December 31, 1937, the following amounts:
Year Amount
1932 (subsequent to June 6)_$4,585.87
1933_ 7, 373. 35
1934_ 7, 683. 58
1935_ 14, 688.45
1936_10, 781. 76
1937_ 12,268.59
On September 29, 1937, tbe value of tbe principal of tbe trust, discounted for tbe then life of tbe petitioner’s wife Helen J. Yerkes, was $112,578.38.'^"* “In^Tompíitiñg Tbe^tótál' gif ts”for' 1937, ” tbe Commissioner included tbe sum of $12,268.59 paid to Helen J. Yerkes in that year, pursuant to tbe terms of the Trust Agreement of August 20,1929, as amended.
The amount of tbe net gifts for preceding years, in tbe sum of $19,382.43, as shown in the notice of deficiency, was computed by the Commissioner as follows:

In his amended answer filed at the hearing respondent alleges that in computing petitioner’s gift tax liability for the calendar year 1937. in addition to allowing one exclusion of $5,000 for the life beneficiary, he erroneously allowed an additional exclusion of $5,000 with respect to the gifts in trust for the benefit of petitioner’s children, and asserts such gifts were of future interests and no exclusion was allowable to the trust or to the children.

At the hearing counsel for petitioner conceded respondent’s position as set forth in his amended answer. We therefore hold that, by reason of the gifts to the trust for the benefit of the children being gifts of future interests, no exclusion on account thereof is allowable.

This leaves for consideration the question of whether the income of the trust paid to the wife is a gift of income in the year paid. The Commissioner so treated it in his deficiency notice and in his amended answer which claimed an increased deficiency. Petitioner filed no brief, but his counsel stated at the hearing that he relied upon the case of Estate of Giles W. Mead, 41 B. T. A. 424, and Jack L. Warner, 42 B. T. A. 954, as determinative of the question of law involved.

Both of these cases were appealed to the United States Circuit Court of Appeals for the Ninth Circuit. The Mead case was dismissed, Commissioner v. Mead, 116 Fed. (2d) 278. The court, on May 2, 19-12, on the authority of Burnet v. Guggenheim, 288 U. S. 280; Estate of Sanford v. Commissioner, 308 U. S. 39; and Rasquin v. Humphreys, 308 U. S. 54, reversed the Board in the Warner case, 127 Fed. (2d) 913.

The court there held that, where the power to revoke had not been relinquished or terminated, the payments of income by the trust to the settlor’s wife and children were transfers by the settlor of the trust of such income by gift.

In the case before us, in the original trust indenture of August 20, 1929, petitioner expressly reserved the right to rearrange among the named beneficiaries proportions or proportionate benefits they were entitled to receive, whether of principal or income, even to the extent of depriving any one or more of them of any participation in either principal or income. By the amendment of September 29, 1987, this right was canceled and extinguished as to principal. The power to control the income of the trust remained in petitioner as reserved by him in the original trust agreement. He had the right to apportion the income among the beneficiaries named in any manner he saw fit. He could exclude any one or more of them from any participation therein. He had the power to divest his wife of any right to receive income by directing its payment to other beneficiaries named. This retained control over the income made the recipient subject to petitioner’s bounty from year to year and the payment of the income by the trust to petitioner’s wife, we think, constituted gifts by petitioner in the year paid by the trust and received by petitioner’s wife.

In so far as the case of Giles W. Mead, supra, is in conflict with the conclusions here reached, it will no longer be followed.

In view of petitioner’s concession that only one $5,000 exclusion is allowable, respondent is entitled to an increase in the deficiency as claimed in his amended answer.

Reviewed by the Board.

Decision will be entered u/nder Bule 50.

Leech and KeRN dissent.


author: Disney:

text:
    Central Electric & Telephone Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99731.
    Promulgated August 4, 1942.

      Clarence H. Boss, Esq., and Melvin A. Hardies, Esq., for the petitioner.

      Angus Boy Shannon, Jr., Esq., for the respondent.
   OPINION.

Disney:

This proceeding involves income taxes for the years 1934, 1935, and 1936 and excess profits taxes for 1934 and 1935, also penalties. Deficiencies were determined against the Central West Public Service Co. as follows:

Notice was given by the Commissioner to the petitioner of its liability for the above amounts as transferee of the assets of that company. Due to elimination by stipulation of issues which will be reflected in decision under Rule 50, and concessions upon brief, the only issues remaining for determination are: (1) Was the petitioner’s transferor entitled to deduct interest which was accrued in the amount of $394,-716.24 .upon bonds for the period April 12 to December 31, 1934, and accrued in the amount of $550,575 for 1935? As more particularly stated below, only amounts considerably less than the above are actually put in issue by the petitioner upon brief, since it argues only as to amounts sufficient to offset the taxable income determined. (2) Did the petitioner’s transferor suffer a deductible loss in 1935 because of abandonment of certain ice storage properties? (3) Was the petitioner’s transferor liable for a penalty for the year 1938 for failure to file timely return? Upon the first and major issue all pertinent facts were stipulated, and we adopt the stipulation by reference and find the facts therein agreed upon. They will be recited herein only so far as necessary to discussion.

Summarized, the stipulated facts, so far as left material after the stipulations and concessions, are as follows:

The petitioner, a Delaware corporation, filed its income and excess profits tax returns for the taxable years with the collector for the District of Iowa.

The petitioner is admittedly transferee from and liable as such transferee for any deficiency in income or excess profits tax determined against the Central West Public Service Co., hereinafter sometimes called the company. The company was at all times on an accrual basis of keeping its books and making its Federal tax returns. It had outstanding on January 1, 1934, large amounts of bonds, also debentures and notes. Interest had been in arrears since 1932. On all of these interest was accrued on the company’s books for 1934 and 1935. From April 12 until June 8, 1934, the company was in voluntary receivership and from that date was in the hands of trustees in section 77-B proceedings in the United States District Court. A special master appointed by the court found that the company was insolvent on June 8, 1934, and at date of report on December 24, 1935. The court, on January 20, 1936, in its order confirming in general the master’s report, specifically left the question of insolvency open in case of rehearing due to failure of the court to confirm the plan, or due to failure of consummation of the plan. A plan of reorganization was confirmed by the court on February 21, 1936, and the properties of the company were transferred as of February 29, 1936, to the petitioner, and another corporation, the Central West Public Service Co., both as successors to the company.

The receivers and trustees continued the company’s practice of keeping books and filing income tax returns on the accrual basis. Interest was accrued on the company’s bonds in the amount of $156,074.17 from January 1 to April 12, 1934, in the amount of $894,716.24 from April 12 to the end of the year 1934, and in the amount of $550,575 for the year 1935. The payment of the bonds and interest thereon was secured by properties mortgaged and pledged thereunder, and although the bonds were in default as to payment of interest from the year 1932, no payment of interest on such bonds was made during the trustee proceedings. The court approved the claims for the amount of the bonds and interest accrued thereon as being claims secured by fixed properties and securities. Prior to January 1, 1934, $275,425 had been deposited in trust by the company for the payment of coupons maturing in 1932 on the bonds. This cash remained in trust and was paid to the petitioner about June 10, 1936, pursuant to the plan of reorganization. At that time Chicago banks held $449,311.28 in trust for the holders of the bonds and included that amount in $1,109,576.61 paid to the trustees and by them to the petitioner. The balance paid to petitioner represented all earnings of the properties during the trusteeship, plus certain .earnings from February 29, 1936, to June 10, 1936.

Under the plan of reorganization as confirmed the holder of each $1,000 principal amount of bonds received $350 principal amount of new mortgage bonds dated January 1, 1935, with semiannual interest coupons; $300 par value of preferred stock dated January 1, 1935, with provision for 6 percent cumulative dividends; and 35 shares of $1 par value common stock, all issued by the petitioner; also voting trust certificates for 10 shares of $5 par value common stock of the Central West Public Service Co. and $5.50 in cash. Pursuant to the plan of reorganization properties consisting of cash and securities of a total market value of $7,128,612.40 were delivered to the holders of the company’s bonds as of February 21, 1936.

The earnings of the company for 1935 were $202,417.38 after payment of interest on the new bonds and before deduction for Federal income taxes. With the approval of the court the petitioner paid $179,637.50 interest on the new bonds, for 1935, and paid dividends on the cumulative preferred stock. The amount of such payments for 1935 to the holder of each $1,000 principal amount of old bonds was $35.50.

The holders of the old bonds, by virtue of the pledge of all bonds and stock of the company’s subsidiaries, were entitled during the period of trusteeship, from April 12, 1934, to February 29, 1936, to all interest accruing on the bonds so pledged, also to all earnings of the physical properties subject to the lien of the bonds; and the unsecured creditors were entitled to the earnings from unpledged assets. The pledged assets constituted 93.7 percent- of the company’s earning assets, so that the holders of the old bonds were entitled to 93.7 percent of the operating earnings of the company for the period under consideration, and to all interest accrued on pledged bonds of the company’s subsidiaries and all earnings available for dividends on the pledged stock of subsidiaries. Such earnings to which the holders of old bonds were entitled amounted to $334,399.55, for the-period from April 12, 1934, to the end of that year, and for the year 1935 they amounted to $473,247.31. Of the earnings for 1934, $185,-680.86, and of earnings for 1935, $110,412.22, was held by Chicago banks in trust for the bondholders and paid over by the banks to the trustees after confirmation of the reorganization, and then was paid to the petitioner.

The return filed for 1934 showed a net loss of $226,153.48. In determining deficiency the Commissioner added $493,616.29 to income, resulting in a taxable net income of $267,462.81. For 1935 the return showed a net loss of $219,799.15. In determining the deficiency the Commissioner added to income $486,962.32, with the result of $267,-163.17 taxable net income. The additions to income consisted in part of interest on the funded debt of the company to the extent of $716,-334.13 for 1934 and $714,410 for 1935.

On the ground that the amount of taxable income of the company for the years 1934 and 1935, as determined by the Commissioner, is less than the interest accrued from April 12, 1934, to December 31, 1935, on the bonds alone, the petitioner offers no argument as to notes and debentures. It is apparent that if the company was entitled to deduction of such interest on the bonds, to the extent of $267,462.81 in 1934, after April 12, and $267,163.17 in 1935, there is no tax due, since the allowance of such amounts would offset the taxable income asserted.

The accrued bond interest from April 12, 1934, to the end of that year was $394,716.24. For the year 1935 it was $550,575. The bonds were secured by certain assets and the earnings thereon. Such assets produced earnings in 1934, after April 12, of $334,399.55, and during 1935 such earnings were $473,247.31. These amounts are much larger than the taxable income asserted by the Commissioner. In our opinion the position of the petitioner should be sustained. It is a cardinal principle of bankruptcy law that secured claims are entitled, to the extent of the agreed interest accruing during the period of bankruptcy, to the earnings for that period from the pledged assets. The same applies to receiverships. Rohrer v. Deatherage, 168 N. E. 266; In re Wakey, 50 Fed. (2d) 869; American Iron & Steel Mfg. Co. v. Seaboard Airline Railway Co., 233 U. S. 261; Mortgage Loan Co. v. Livingston, 45 Fed. (2d) 28; Ticonic Bank. v. Sprague, 303 U. S. 406. The interest is entitled to the same priority as the principal; Consolidated Rock Co. v. Du Bois, 312 U. S. 510; and the current earnings of the secured assets are applicable to the interest accruing upon the secured obligation. Sexton v. D'reyfus, 219 U. S. 339.

It follows that, since the earnings upon the assets hypothecated as security for the bonds, for the periods here in question, exceeded the taxable income determined, and were applicable upon the interest accruing, there can remain no question because of insolvency under such cases as Zimmerman Steel Co., 45 B. T. A. 1041, for under such circumstances it can not reasonably be said that that situation precluded any reasonable certainty that the interest would be paid. The secured bondholders had a claim in rem against the pledged assets, and their earnings, not limited by the general status of the obligor company as to solvency or insolvency. Not only was there no lack of reasonable certainty of payment of interest, as upon an unsecured claim against an insolvent, but there was under the pledgees’ legal position certainty of payment to the extent of the earnings upon the pledged property; and that such earnings were in fact more than the net taxable income here involved only serves to accentuate the negative of the uncertainty discerned in the Zimmerman Steel Co. case. We conclude that there was error in disallowing the deduction for accrued interest claimed, at least to the extent of the earnings from pledged assets.

In addition to the above, we think that Hummel-Ross Fibre Corporation., 40 B. T. A. 821, and Shamrock Oil & Gas Co., 42 B. T. A. 1016, are applicable. It is true, as the respondent points out, that insolvency does not affirmatively appear in either of those cases, but it is equally true that insolvency does not affirmatively appear in the facts involved in this proceeding. Although the special master found insolvency on June 8, 1934, and at the date of his report, December 24, 1935, the court, although in its order it approved in general most of the matters in the report, specifically left the question of insolvency open, and we make no finding of insolvency. Section 77-B does not require, as a prerequisite to a reorganization thereunder, that the corporate debtor be insolvent, but only requires allegation and proof either of insolvency or of inability to meet debts as they mature. Inability to meet debts as they matured appears in the Hummel-Ross Fibre Corporation and Shamrock Oil & Gas Co. matters, as well as here, for there was in all three cases approximately the same period of arrearages in interest. In both of those cases and here there were reorganization and the issuance of new securities for old securities. We there held that the interest accruing upon the old secured claims was properly deducted. In our opinion the whole story of the situation here involved indicates that there was no uncertainty as to payment of the interest more than in the two cases above referred to, that the consideration for exchange of securities and interest thereon for other securities was the same here, and that they may not logically be distinguished. The right to the accrued interest was, as provided by subsection (b) of section TT-B of the Bankruptcy Act, modified or altered through the issuance of new securities, and in effect upon the final confirmation of the plan of reorganization the old claims, including the claim to accrued interest, were thereby discharged or paid. We think the rationale of Hummel-Ross Fibre Corporation and Shamrock Oil & Gas Co. can not be avoided in this proceeding.

Although the petitioner urges other arguments in support of de-ductibility of the accrued interest, the conclusions to which we come above render unnecessary of consideration such additional points as well as the other issues presented as to loss by abandonment and penalty; as to which issues, therefore, we have not considered it necessary to find facts.

Decision will be entered under Bule 50.


author: Harron:

text:
    Paris & Mt. Pleasant Railroad Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.

    Docket No. 103578.
    Promulgated August 4, 1942.

      T. D. Gresham, Esq., for the petitioner.

      Donald, P. Moyers, Esq., for the respondent.

       The report in this proceeding which was promulgated on June 23, 1942, 47 B. T. A. 144, was vacated by order of the Board.' This report supersedes the earlier report, supra.

   OPINION.

Harron:

The respondent determined a deficiency in income tax for the year 1937 in the amount of $13,540.88. The deficiency results from the respondent’s determination that petitioner is liable for surtax on undistributed profits in the amount of $14,038.97, which is computed by applying the provisions of section 14(b) of the Bevenue Act of 1936 to undistributed adjusted net income in the amount of $68,482.78. Petitioner agrees on the amounts of its taxable net income and its adjusted net income.

Petitioner contends, first, that it is not a corporation which comes within the terms of section 14 (b), because under the provisions of the Interstate Commerce Act, as amended by the Transportation Act of 1920, it was prohibited from paying any dividends in the taxable year because it had a capital deficit. During the taxable year petitioner’s deficit amounted to in excess of $400,000. Petitioner argues, in effect, that before it could pay dividends out of current earnings it was required to accumulate earnings until the capital deficit was extinguished. Petitioner has not cited us to any other provisions of the Interstate Commerce Act which prescribe what funds are “properly includable in the capital account.” Assuming, arguendo and without deciding the point, that provisions of the Interstate Commerce Act prevented the petitioner from paying any dividends out of earnings in the taxable year, there is nothing in this case to take it out of the rule of Crane Johnson Co., 38 B. T. A. 1355; affd., 311 U. S. 54; and Helvering v. Northwest Steel Rolling Mills, Inc., 311 U. S. 46. In both cases the corporations had existing deficits and they were prohibited by state statutes from paying dividends except out of surplus. Section 26 (c) (1) allows a credit if dividends can not be distributed without violating the terms of a written contract executed prior to May 1, 1936, which expressly deals with the payment of dividends. “The language used in section 26 (c) (1) does not authorize a credit for statutorily prohibited dividends.” (Italics added.) Northwest Steel Rolling Mills, Inc., supra. It provides no distinction here that the statute which, presumably, prohibited petitioner from paying dividends, was a Federal statute. The provisions of the Interstate Commerce Act are not a “contract” within the meaning of section 26 (c) (1). The Crane Johnson Co. and Northwest Steel Rolling Mills, Inc., cases, supra, are controlling. Furthermore, petitioner is not a corporation within the classes of corporation specifically exempted from the surtax on undistributed profits by section 14 (d). Section 14 (b) makes the surtax applicable to “every corporation”, which means, upon reading section 14 in its entirety, every corporation except those specifically exempted.

For the above reasons, it is held that petitioner is not entitled to a credit in the amount of its adjusted net income, or $68,482.78.

In the alternative, petitioner claims that it is entitled to a credit under section 26 (c) (2) of the Eevenue Act of 1936, in the sum of $14,000, which amount was irrevocably set aside in the taxable year out of earnings and profits in discharge of a debt. Petitioner contends that the above amount was set aside pursuant to the terms of a written contract executed prior to May 1, 1936, which terms expressly dealt with the disposition of earnings and profits of the taxable year, so that the amount in question squarely comes within the provisions of section 26 (c) (2). The respondent agrees that petitioner irrevocably set aside in 1937 $14,000 of its earnings and profits of the taxable year for the discharge of a debt by paying that amount to the Farmers & Merchants National Bank of Abilene.

The question is whether or not the $14,000 was paid in accordance with the requirements of a written contract executed prior to May 1, 1936. The deed of trust executed July 1, 1912, was continued in effect in all of its terms on February 7, 1935. Under the facts it must be concluded that the deed of trust in all its terms was in effect in 1937. When the holders of eight bonds held back their consent to the appointment of a successor trustee, for which paragraph seventeenth of the trust deed provided, until it was agreed that petitioner would redeem their bonds, there was no modification of any of the terms of the trust deed, or of paragraph thirteenth, relating to the payment of 5 percent of the gross earnings of each year into a sinking fund. The arrangement made with them, to which Jones consented, did not constitute the making of a new agreement in 1937. Jones’ consent simply constituted a waiver of his right, under the default, to have all of the moneys in the sinking fund applied fro rata for the benefit of each bondholder.

Under the terms of the sinking fund provision petitioner is required to make sinking fund payments until all of its bonds are paid. It was required to deposit $22,657.14 in the sinking fund in 1937, or 5 percent of its gross earnings. Petitioner set aside $14,000. Under the facts there can be no serious contention that the $14,000 irrevocably set aside to redeem the eight bonds was not a sinking fund payment. It is immaterial that it was less than the required 5 percent of gross earnings of the year. It is concluded that the above amount was a sinking fund payment.

Respondent argues that paragraph thirteenth of the trust deed did not require “the retirement of any specific bonds in the manner here employed”; that the retirement of the eight bonds was undertaken only to afford a change in the trustees; and that, therefore, the setting aside of the $14,000 was not in pursuance of a requirement of a written contract. This argument is without merit. First, petitioner was required by the terms of the deed of trust to set aside during each year certain amounts as a sinking fund out of the current earnings of each year, and, second, out of the sinking fund the corporate trustee could, at the option of petitioner, use money in the sin hirin' fund for the purchase or redemption of bonds at 105 percent of par value plus accrued interest. Furthermore, in the event of default, any sinking fund moneys held by the corporate trustee had to be applied for the use and benefit of the holders of bonds and interest coupons secured by the sinking fund. The fact that Jones waived his right, under the terms of the last part of paragraph thirteenth of the trust deed, to have all of the sinking fund moneys applied pro rata to all outstanding bonds, including the bonds held by him, did not invalidate, amend, or change the other requirement of paragraph thirteenth relating to the setting aside of moneys in the taxable year out of gross earnings of the taxable year for the sinking fund.

It must be concluded that the $14,000 was irrevocably set aside in 1931 out of the earnings of 1937, pursuant to the terms of a written contract expressly dealing with earnings of the taxable year, and that the written agreement was one which was executed prior to May 1, 1936. The payment comes within the provisions of section 26 (c) (2), and petitioner is entitled to a credit in the amount of $14,000. Cf. Brockway Glass Co., 43 B. T. A. 267, 270, 271, where the taxpayer deposited in a sinking fund more than it was required to set aside out of earnings in the taxable year, as contrasted with petitioner’s setting aside less than was required. See also Michigan Silica Co., 41 B. T. A. 511; affd., 124 Fed. (2d) 397; Strong Manufacturing Co., 41 B. T. A. 1273; affd., 124 Fed. (2d) 360; certiorari granted, 316 U. S. 651; Saginaw & Manistee Lumber Co., 45 B. T. A. 780.

Decision will be entered under Bule 50.

       The Interstate Commerce Act, as amended by the Transportation Act of 1920, U. S. C. A., Title 49, sec. 20 (a) (12), pp. 292-293, provides in substance that it shall be unlawful for the director of any carrier to participate in the paying of any dividends from any funds properly includable in the capital account.

       SEC. 26. CREDITS OF CORPORATIONS.
      *******
      (c) Contracts Restricting Payment of Dividends.—
      *******
      (2) DISPOSITION OF PROFITS of taxablh yeae. — An amount equal to the portion of the earnings and profits of the taxable year which is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings'and profits of the taxable year) to be paid within the taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt; to the extent that such amount has been so paid or set aside. For the purposes of this paragraph, a requirement to pay or set aside an amount equal to a percentage of earnings and profits shall be considered a requirement to pay or set aside such percentage of earnings and profits. As used in this paragraph, the word “debt” does not include a debt incurred after April 30,1936.


author: Mellott:

text:
    Edith G. Goldwasser, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103309.
    Promulgated August 5, 1942.

      Roswell Magill, Esq., and Clifford H. Domhe, Esq., for the petitioner.

      Thomas EE Lewis, Jr., Esq., for the respondent.
   OPINION.

Mellott:

The contract of September 18, 1936, embodied a “plan of reorganization” under the terms of which C. I. T. acquired all the stock of B. E. in exchange for 30,700 shares of its common stock. The plan was carried out and petitioner received common stock of C. I. T. in exchange for her common stock in B. E.

In her income tax return for 1936 petitioner treated the C. I. T. stock as received in a tax-free exchange under section 112 (b) (3) of the Revenue Act of 1936. Respondent determined that C. I. T. was not a “party to a reorganization.” He therefore treated the exchange as a transaction giving rise to gain or loss and the stock received by petitioner as “other property” within the meaning of the statute.

Petitioner contends that there was in fact a reorganization within the meaning of section 112 (g) (1) (B) of the Revenue Act of 1936 in pursuance of the plan of reorganization included in the contract •of September 18, 1936; that this reorganization was complete within itself and duly carried out according to its terms; that C. I. T. was a party to it; and that the exchange of stock for stock is within section 112 (b) (3), and hence no gain or loss is to be recognized.

Respondent contends that the plan of reorganization embodied in the contract of September 18, 1936, was not, in fact, the whole plan of reorganization; that the entire plan of reorganization included not only the exchange of all the stock of B. E. for common stock of C. I. T., but the transfer of the assets of B. E. to Emmerich for the common stock of Emmerich and the dissolution of B. E. within the year 1936; that this plan was carried out and C. I. T. surrendered for cancellation all the B. E. stock which it had received in exchange for 30,700 shares of its common stock and received, upon the dissolution of B. E. the Emmerich stock which B. E. had received in exchange for its assets; that under these facts C. I. T. was not “a party to a reorganization”; and that the transaction under which petitioner acquired the common stock of C. I. T. was not a tax-free exchange. Both parties cite and discuss upon brief Groman v. Commissioner, 302 U. S. 82; Helvering v. Bashford, 302 U. S. 454; Anheuser-Busch, Inc. v. Helvering, 115 Fed. (2d) 662, affirming 40 B. T. A. 1100; certiorari denied, 312 U. S. 679; and Gertrude B. Chase, 44 B. T. A. 39; affirmed per curiam June 19, 1942.

The facts and the basic principles of the Groman and Bashford cases need be examined only briefly. In each there was a transfer of stock or assets by one or more corporations to a subsidiary of another corporation in exchange for stock of the subsidiary, stock of its parent, and cash. It was held that the stock of the parent was “other property” because the parent was not “a party to a reorganization.” The Court emphasized that the required continuity of interest was lacking and that the parent corporation in each instance was but a mere instrumentality through which a corporate reorganization was effectuated. These cases and others were discussed by the court and the Board in the Anheuser-Busch case, supra, and conclusion was reached that, since the sole object and accomplishment of the plan there under consideration required the transfer of the assets and business of a subsidiary of the taxpayer to a subsidiary of the other party, the other party was not “a party to a reorganization” and hence the realized gain must be recognized.

The plan which was before the court and the Board in the Anheuser-Busch case was in writing and contemplated that a subsidiary of Borden, the other corporation, would be organized to take over the assets of the taxpayer’s subsidiary and the taxpayer was required to co-operate in carrying out this plan. The contract, said the court, “negatived any purpose to retain that continued interest required in a merger.” The precise question now before us was not directly in issue. It was suggested in the Board’s opinion, however, (l.c. 1107) that if the transfer to the subsidiary had occurred after “a significant interval”, the question “might then arise as an issue of fact whether the subsequent transfer was part of the effectuation of the plan of reorganization or independent of it.” Subsequently, in Gertrude B. Chase, supra, we were called upon to determine substantially the same question as that suggest'd above, although the situation was “reversed as to the order of the transfers.” The transfer had been made to a subsidiary in the first instance; but looking at the whole plan we decided that it'“contemplated a merger of the two enterprises rather than the conduct of the acquired business by the vanishing subsidiary, and that it envisaged a continuity of interest in the merged enterprise on the part of those in receipt of its securities.” The Circuit Court of Appeals for the Second Circuit affirmed per curiam on the authority of the Groman and Bashford cases.

The cited cases indicate and counsel seem to agree that our question is largely one of fact. If, as petitioner contends, the “plan” was limited to the acquisition of the C. I. T. stock by B. E.’s stockholders and the acquisition of B. E. stock by C. I. T., then petitioner must prevail. But if the plan contemplated the liquidation of B. E., following a temporary holding of the B. E. stock by C. I. T., then respondent’s determination must be upheld.

The evidence indicates and we think it must be found that prior to- the execution of the agreement of September 18, 1936, it was contemplated that C. I. T., as the sole stockholder of B. E., would cause B. E. to transfer all of its assets, subject to its liabilities, to Emmerich, a subsidiary of its wholly owned subsidiary, Factors, and would then dissolve B. E. This plan is evidenced by several circumstances, among others the “guarantee” letter written by C. I. T. and confirmed by Louis Bachmann, which refers to the agreement of September 18,1936, as “our proposed agreement with the stockholders of B. E. which we will execute in consideration of your executing this agreement, to be dated September 18, 1936.” This letter states: “Subsequent to our acquisition of the stock of B. E. under The Agreement * * * We will cause B. E. to transfer in 1936 its assets (excluding dividends described above), subject to its liabilities, to Emmerich, the latter being a subsidiary of Factors, one of oúr subsidiaries, and to issue stock of Emmerich in exchange for the net assets. We may, if we so desire, dissolve B. E. prior to December 31, 1936.” The resolutions of the board of directors of C. I. T., adopted October 22, 1936, at the first meeting of the board following the acquisition of the B. E. stock providing for the immediate liquidation of B. E., support the view that this was an integral part of the whole plan. Finally, the steps which were taken indicate quite clearly a plan existed from the beginning under which they were to be taken. These steps were: first, the exchange of all the stock of B. E. for 30,700 shares of C. I. T.; second, the transfer of the assets of B. E. to Emmerich in exchange for its common stock; third, the surrender for cancellation of all the shares of B. E. by its sole stockholder, C. I. T.; and, fourth, the receipt by C. I. T. of the remaining property of B. E., consisting of common stock of Emmerich.

Petitioner argues that there is no evidence the two letters or the corporate resolutions were any part of the plan of reorganization; that the latter show the transfer of the B. E. assets was made three months after the reorganization of C. I. T. and B. E. and the exchange of petitioner’s stock; that both she and her husband testified they understood B. E. was to continue in existence and Goldwasser was to remain its president; that this was petitioner’s “main concern” and it is inconceivable she would have consented to a plan of reorganization which embodied the dissolution of her husband’s company and the transfer of its assets; and that the record bears out her contention the whole plan of reorganization was contained in the signed document bearing that label. This argument has been considered, but we do not believe that the ultimate finding requested can be made. No attempt will be made to set out all of the evidence which, it is felt, impels the opposite conclusion. Suffice it to point out that the letters were obviously deemed to be a prerequisite to C. I. T.’s participation in the plan, and that the corporate resolutions liquidating B. E. were promptly adopted and carried out during the taxable year, that Goldwasser carried on all the negotiations leading up to the exchange as petitioner’s agent and also represented B. E. as its president, that he, as president and a director of B. E., joined in the adoption of the necessary resolution to liquidate B. E., that in spite of the testimony referred to Goldwasser did not sign the proposed contract of employment but waited until B. E. was liquidated and then entered into a contract with Factors, and that the whole record clearly indicates the plan embraced all of the steps precisely as they were carried out. We hold that the exchange of petitioner’s B. E. stock for stock in C. I. T. was not made in pursuance of a plan of reorganization in which C. I. T. was a party and the respondent did not err in holding that the realized gain must be recognized.

The next question is the fair market value of the property received by petitioner. Bespondent requests that we find petitioner acquired, on September 80, 1936, a “right” to receive 5,864 shares of C. I. T. stock, that this “right” had a fair market value of $482,314 when received, and that the 5,864 shares, when received on December 31, 1936, had a fair market value of $445,000. The requested findings can not be made. For reasons which will be set out later, conclusion has been reached that petitioner received only 5,163 shares and that she never had any right to receive more. These shares have been found to have had a fair market value of $68 per share on December 31, 1936, or a total value of $351,084. Finding has also been made that the fair market value on September 30, 1936, of the right to receive the shares was not in excess of the fair market value of the shares on December 31, 1936. This finding accords with the testimony of respondent’s principal witness. He expressed the opinion that “there was no important difference between the two dates, the vital difference being that the market for the stock declined somewhat during the three months period” and that the right to receive the stock should be evaluated by applying “a discount of about 7½% to the quoted market price of the stock as of September 30, 1936.” This resulted in a figure of $445,000, as the value on each date, which is approximately equal to the price at which the stock was selling on the latter date.

In view of the conclusion which has been reached, that the value of the stock and the right to receive it were the same, we deem it unnecessary to decide which date is applicable, since they are both within the taxable period. We pass, then, to a brief discussion of the value found by us.

The evidence of value consists of market quotations and the testimony of two witnesses called by the respondent as experts. The quotations cover the period from August 1936 to the end of the year 1938. Those particularly relied upon by the petitioner — and this is the sole evidence introduced by her on this phase of the controversy— are September 30, 1937, and December 31, 1937. Respondent relies chiefly on those of September 30, 1936, and December 31, 1936. Petitioner’s theory is that the provision of the contract of September 18, 1936, prevented her from making a sale of the stock earlier than December 31, 1937 — in the alternative September 30, 1937— and that therefore the fair market value of the stock on tha,t date, equivalent to the mean of the high and low quotations, should be used in computing her gain, if any. Respondent contends that the fair market value of the stock on December 31, 1936, or of the right to receive it on September 30, 1936, must be used in computing petitioner’s gain— a view which we share — and that this must be determined either upon the market quotations of those dates or upon the testimony of his witnesses. Complete rationalization of the value determined by us of $68 per share can not be made. “In matters so practical as the administration of tax laws and in the decision of problems connected with them, a high degree of precision is often impossible to achieve.” Sometimes “an approximation derived from the evaluation of elements not easily measured” must be made. Helvering v. Safe Deposit & Trust Co. of Baltimore, 316 U. S. 56; cf. Cohan v. Commissioner, 39 Fed. (2d) 540; Gloyd v. Commissioner, 63 Fed. (2d) 649; Fidelity Title & Trust Co. v. Commissioner, 64 Fed. (2d) 52. Some of the evidence upon which the finding has been based may, however, be alluded to briefly.

The quotations during the last five months of 1936 range from a high of 91⅝ to a low of 74½, the average being around 82 or 83. The low is reached near the end of the year. The value requested by the respondent of the right to receive the stock is equivalent to the mean of the high and low on September 30, 1936, or 82¾. His witnesses refused to accept this as the true value and he presents no convincing argument why we should do so. Their estimate of the value of the shares on December 31, 1936, is, of course, a circumstance to be considered by us, though it is not controlling. The record clearly indicates it was bottomed very largely upon the market quotations. Indeed the witness who testified at length (one merely gave his conclusion as to value) stated under cross-examination that the value fixed by him had been “based on the New York Stock Exchange quotations merely rounding off the New York Stock Exchange to a round sum of money.” While the price at which shares of stock are bought and sold on the open market is frequently the best evidence of their value, it is not always the sole criterion to be used.

The evidence indicates that C. I. T. compared very favorably with companies doing a similar business. Its earnings were high, its dividend record good even throughout the depression, and its business had so increased during 1936 that it was able to pay a stock dividend of 20 percent. Those facts, together with the quotations and the testimony of respondent’s witnesses, would seem to dictate that a value closely approximating the one requested by the respondent should be found. There are other facts, however, which materially affect the question. One is the provision of the contract requiring that petitioner make no public offering of the stock but hold it “as an investment.” In considering the effect of this provision reference must also be made to the fact that most of petitioner’s certificates were for 1,000 shares each and were in the form of “less than 100 share certificates”, surcharged to show a larger size unit, which, under a ruling of the stock exchange, could not be transferred merely by delivery.

Petitioner contends that the effect of the provision referred to was \/to restrict her in the sale of the stock. She cites Helvering v. Tex-Penn Oil Co., 300 U. S. 481; Prosper v. Commissioner, 89 Fed. (2d) 617, and other cases holding that stock subject to a restrictive agreement preventing its sale has no fair market value. She does not contend that the stock received by her had no fair market value, but only that the fair market value was not in excess of the price at which the stock was quoted on the New York Stock Exchange at the end of the restrictive period, citing Schuh Trading Co. v. Commissioner, 95 Fed. (2d) 404.

Eespondent argues that, since the evidence clearly indicates that the provision was inserted in the contract for the purpose of eliminating the necessity for registration under the Securities Act of 1933, it should be construed in the light of the requirements of that act. This, he insists, justifies a holding that the whole phrase describes a mere present intention of petitioner and does not in anywise circumscribe her future course of conduct. He argues that the provision prohibiting petitioner from making a public offering would not restrict her right to sell it at a. private sale, to give it away, to use it to pay her debts, or to put it up as collateral for a loan. Pie also contends that her right to sell to the public, through brokers or on the stock exchange, depended only “upon the honesty of the intent with which she received it and an honest change in that intent.” He concludes: “The most that can be said is that had she attempted to make a public offer, she might have had some difficulty in persuading others of her honesty; and that thus her freedom of disposition was somewhat narrowed.”

Petitioner insists that she would have violated her contract with C. I. T. if she had sold the shares and that C. I. T. was in a position to take effective action either against her or against her husband if she had attempted to do so. In this connection she points out that an attempted sale by her would immediately have come to the knowledge of C. I. T. because of the fact that the certificates were surcharged and, unless she lived up to her agreement, that the relations between her husband and C. I. T. “would have been seriously prejudiced, perhaps even to the extent of a termination of the employment.”

While we are of the opinion that the provision did not constitute a restrictive covenant preventing petitioner from disposing of the stock if she had seen fit to do so, we think it did have the effect of depressing the market for her particular shares. This can only be approximated; for it is an “element not easily measured.” Considering the fact that the shares could have been disposed of in the manner suggested by the respondent, including a private sale, we have concluded that their actual fair market value was somewhat less than the price at which they could have been sold on the open market on the date actually received. This amount is not greatly in excess of the price at which they could have been disposed of on September 30, 1937, one year after the right to receive them under the contract of September 18, 1936, became vested.

The next question requires determination of the holding period of the 3,436 shares of B. E. stock received by petitioner as a gift from her husband in June of 1936.

Finding has been made that Goldwasser received the certificates for the 3,346 shares “toward the end of the year 1931.” The evidence shows he accepted the offer to become an officer of B. E. in July 1931, but did not resign his position with Factors until October 15, 1931, on which date he became president of B. E. Petitioner contends that Goldwasser acquired the shares in July 1981, at the time the offer was accepted. She argues that the stock “constituted compensation constructively received in July, 1931.” We do not agree. Gold-wrasser continued in the employ of Factors until October 15, 1931. His compensation as president of B. E. began at that time. To hold that he was constructively in receipt of compensation prior to that date would be carrying the doctrine of constructive receipt too far. The stock was thought to have, and evidently did have, no value. Goldwasser, testifying as a witness, stated that Bachmann wanted to give him as much of the common stock as he wished and that he should take whatever he wanted and whenever he wanted it. Apparently he took none until toward the end of the year 1931, the precise date not being shown in the evidence.

Respondent determined that the 3,436 shares had been held for more than two years but for less than five years. Petitioner undertook to show that it had been held for more than five years. In our judgment she has not sustained her burden of proof. Respondent’s determination upon this issue therefore must be, and it is, upheld.

The fourth question is Avhether, in computing petitioner’s gain, the value of the 701 shares of C. I. T. stock, which petitioner immediately transferred to Haiblum and Goldblatt, should be included in her gross income. We have found that it should not be.

Respondent’s contention is that petitioner either used some of her stock to pay an obligation of herself or of another, or disposed of it by gift. If this were true then the value of such stock must be included in her gross income. Eisner v. Macomber, 252 U. S. 189; Helvering v. Horst, 311 U. S. 112; cf. Schermerhorn Oil Corporation, 46 B. T. A. 151; H. Lewis Brown, 40 B. T. A. 565; affd., 115 Fed. (2d) 337; Leonard Marx, 39 B. T. A. 537.

The question is one of fact. The evidence is to the effect that the stock in question was given to Haiblum and Goldblatt for services rendered to Bachmann Co. and B. E. in working out certain details of the reorganization; that they performed no services for petitioner personally; that both she and her husband, who represented her in the negotiations with C. I. T., understood that, she was to receive a number of shares less than the number allocated to her B. E. stock and that Haiblum and Goldblatt were to receive the difference as compensation for their services; and that this agreement was carried out.

It is true, as respondent points out, that there is nothing in the record to explain why the 701 shares were not issued directly to Haiblum and Goldblatt. Obviously, however, it was to the interest of C. I. T. that these gentlemen be paid; for it was assuming all of B. E.’s liabilities. Since a substantial portion of the B. E. stock owned by petitioner had been a gift from B. E. to her husband, it is-readily understandable that an agreement should have been reached to reduce the shares of C. I. T. which she would receive on the exchange rather than to deduct a part of the 701 shares from the shares to be received by other stockholders. That, in effect, was the testimony. The circumstances pointed out above and the fact that the value of the 701 shares of stock was approximately $47,000 incline us to the opinion that petitioner was not discharging a personal obligation when she transferred the 701 shares to Haiblum and Goldblatt, nor was she paying the obligation of another or making a gift. The transfer to them was a part of the whole plan, though not specifically set out therein. In other words, petitioner was a mere conduit, through which the 701 shares passed to Haiblum and Goldblatt for services rendered to Bachmann Co. and B. E. We have therefore concluded and now hold that the only stock petitioner received over which she could exercise absolute dominion and control was 5,163 shares. Only the fair market value of these shares constituted income to her. Cf. George G. Moore, 19 B. T. A. 364; George W. Mason, 41 B. T. A. 1287; affd., 125 Fed. (2d) 540.

The last question is whether the December 1936 dividend of $751.25 on the 701 shares of C. I. T. stock turned over to Haiblum and Gold-blatt constituted gross income to petitioner. In view of the conclusion reached upon the preceding issue it is unnecessary to discuss this at any length. The dividends belonged to the owners of the shares. Kespondent erred in including them in petitioner’s gross income.

Upon brief respondent contends that if the value of the 701 shares is not to be included in petitioner’s gross income then holding should be made that those shares came out of the ones received by petitioner in exchange for the 3,436 shares. He bases this upon the assumption that petitioner, in effect, had given Haiblum and Goldblatt a portion of her B. E. stock, that they had caused it to be transferred in exchange for C. I. T. stock, and, since no actual designation had been made by her of the shares given up, “her transfer to the attorneys and accountant was out of her first receipts.” We have concluded that petitioner became the owner of only 5,163 C. I. T. shares as a result of the exchange of her B. E. shares and that she was a mere conduit through which the 701 shares were delivered in payment of an obligation of B. E. This, we believe, is justified under the evidence. It follows, therefore, that an allocation of petitioner’s profit on the exchange should be made in substantially the manner set out in the notice of deficiency.

Decision will Toe entered under Rule 50.

       SEC. 112. RECOGNITION OP GAIN OR LOSS.
      *******
      (b) Exchanges Solely in Kind.—
      *******
      (3) Stock urn stock on reorganization. — No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.

       SEC. 111. DETERMINATION op amount OP, AND RECOGNITION OP, GAIN OR LOSS.
      *******
      (b) Amount Realized. — The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received.
      SEC. 112. RECOGNITION OP GAIN OR LOSS.
      *******
      (c) Gain from Exchanges Not Solely in kind.—
      (1) If an exchange would be within the provisions of subsection (b) (1), (2), (3), or (5) of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but an amount not in excess of the sum of such mony and the fair market value of such other property.

       * * * The term “reorganization” means * * * (B) the acquisition by one corporation in exchange solely for all or a part of its voting stock : of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of another corporation; or of substantially all the properties of another corporation * * *.


author: Sternhagen:

text:
    Clarence J. Schoo, Petitioner, v. Commissioner of Internal Revenue, Respondent. Grace Harwood Schoo, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 109203, 109307.
    Promulgated August 5, 1942.

      George E. Cleary, Esq., for the petitioners.

      Charles P. Reilly, Esq., for the respondent.
   OPINION.

Sternhagen:

The Commissioner determined deficiencies in income tax for 1939 of $130,296.18 as to Clarence J. Schoo and $15,091.97 as to Grace Harwood Schoo, his wife, holding that an exchange of preferred shares for debenture bonds of the same corporation was a partial liquidation resulting in gain. The petitioners contend that the exchange was pursuant to a plan of reorganization, gain from which is not recognized.

The facts are all stipulated and it is only necessary to recite those in the husband’s case. The petitioners resided in Springfield, Massachusetts, and filed their returns with the collector at Boston.

Before September 5, 1939, petitioner owned some common shares and 2,400 shares of 7 percent preferred, $100 par, of the Longview Fibre Co. Pursuant to a plan of reorganization, he exchanged the preferred for newly issued 7 percent debenture bonds of the same face value, the fair market value being the same. He received no cash.

The plan of reorganization wyas not occasioned by a prospective transaction which would involve gain to its shareholders or the corporation, but was borne of a genuine desire and intent to reform the capital structure of the corporation. Instead of 36,000 outstanding 7 percent preferred (50,000 authorized) and 68,000 outstanding, no par common (100,000 authorized), the plan was to authorize 200,000 $25 par value 5 percent preferred and 400,000 $7.50 par value common; to substitute 4 new 5 percent preferred shares for each outstanding old 7 percent preferred share, and to substitute four new $25 par common shares for each outstanding old no par common share, and to exchange a newly authorized 25-year debenture bond ($3,600,000 authorized) for each outstanding old 7 percent preferred share or for each four outstanding new 5 percent preferred shares. As stated by the president to the shareholders:

Tour Board of Directors believes that the effecting of the proposed reorganization of the corporation will be advantageous to the corporation and its shareholders. It is believed that splitting the shares will facilitate negotiability, particularly if the same be at any time listed. The change of the shares of Common Stock from shares without par value to shares of a par value of $7.50 will reduce the transfer taxes which will be exacted upon the transfer of shares of Common Stock and is in line with the present practice of other corporations. The purpose of the change in the Preferred Stock is to make available to the corporation a 5% Preferred Stock of low par value which may be used, if deemed advisable, for the payment of dividends on the Common Stock.
The issue of 25-year Income Debenture Bonds will result in a tax saving to the corporation. It has been deemed advisable to issue these securities to the holders of the Preferred Stock of the corporation (solely in exchange for shares of Preferred Stock) rather than to have outstanding two different classes of Preferred Stock. Preferred stockholders who do not exchange their shares for the new 25-year Income Debenture Bonds will have four times the number of shares of Preferred Stock previously held, although the dividend rate thereon will be cut from 7% to 5% per annum, and the said shares will be in accordance with the terms of the proposed amendment to the Certificate of Incorporation, copy of which is attached.

88.88 percent of tbe 7 percent preferred shares was held by persons who owned 71.54 percent of the common shares. All the holders of old 7 percent preferred shares, including petitioner, made the exchange for debentures.

It can hardly be disputed that the readjustment of the corporation’s common and preferred shares was a recapitalization, Helvering v. Southwest Consolidated Corporation, 315 U. S. 194, or that the exchange of the debentures for the preferred was an integral part of the plan. There is no reason to considA it as if it stood separately. The 25'-year debentures were “securities”, Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462. Stated, therefore, in terms of section 112 (b) (3), stock in a corporation was, in pursuance of a plan of recapitalization, exchanged solely for securities in such corporation.

The respondent contends that the statutory word “recapitalization” may not be read as meaning a type of statutory “reorganization” unless through it persists a continuation of the same proprietary interest; and that a substitution of bonds for shares breaks the proprietary interest and substitutes a creditor interest. To support this argument, reliance is principally placed on LeTulle v. Scofield, 308 U. S. 415. This, however, is to take the LeTulle case out of its setting in the consideration of a “merger or consolidation” of two corporations under subdivision (A), and to apply it to a recapitalization of a single corporation. As a contemplated result of the “merger or consolidation” of two corporations, the individual taxpayer, for his shares in one of the corporations and other properties, received cash and bonds of the other corporation. This was something substantially different from what he gave up. It was not a mere reshaping of his interest in the same corporation through a recapitalization. In the present case, the substitution of the debentures for the preferred shares was in substance not so much of a change as the words imply. In both, the holder was entitled only to dividends or interest out of income, and had no greater rights than unsecured creditors.

The respondent argues that the petitioner’s receipt of the bonds was a liquidation distribution, as defined in section 115 (i), so that the value of the bonds is to be treated as in full payment for the preferred shares, with resulting gain, citing section 115 (c). This, however, would be in disregard of the sentence in that subsection that the gain to the distributee .shall be recognized only to the extent provided in section 112, and section 112 (b) (3) forbids the recognition of any gain in a recapitalization exchange of stock solely for securities.

There is nothing in the circumstances to invite the doctrine of Gregory v. Helvering, 293 U. S. 465. No transaction was impending which threatened a tax on any of the participants. The recapitalization is not a sham or an artificial detour around a taxable event. There is nothing to indicate that a devious form of corporate maneuvering was masquerading as a recapitalization in order to avoid a tax which would have been assessed if the transaction had been permitted to take its direct course.

Decision will be entered, for the petitioners.


text:
    Edgar M. Docherty, Petitioner, v. Commissioner of Internal Revenue, Respondent. Frank R. Budlong, Petitioner, v. Commissioner of Internal Revenue, Respondent. John A. Straight, Petitioner, v. Commissioner of Internal Revenue, Respondent. George A. Armstrong, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 109238, 109239, 109240, 109241.
    Promulgated August 5, 1942.

      Stuart II. Tucker, Esq., for the petitioners.

      Martin E. Lore, Esq., for the respondent.
   OPINION.

Sternhagen:

The Commissioner determined the following deficiencies in income tax for 1939:

Edgar M. Docherty_$3, 680. 49
Prank R. Budlong__ 3, 649. 64
John A. Straight_ 226. 24
George A. Armstrong- 2, 985. 88

Petitioners contend that the receipt by them of debenture bonds was in pursuance of a plan of reorganization and was not a taxable dividend. The salient facts are all stipulated, and some testimony was taken; but there is no conflict in the evidence.

Petitioners are individuals residing in Rhode Island, and filed their income tax returns for 1939 in Providence. Since 1928 they have been the sole shareholders of the William C. Green Co., a manufacturer of gold jewelry. It was organized in 1917 with an authorized capital stock of 500 common shares of $100 par value, and issued 499 shares. In 1939 Edgar M. Docherty, its treasurer, owned 167 shares; Frank R. Budlong, its president, 167 shares; John A. Straight, a former director, 20 shares; and George A. Armstrong, its secretary, 145 shares. Docherty, Budlong, and Armstrong were directors.

For many years the corporation has carried a $50,000 insurance policy on the life of each of the three officers, with the intention of retiring the stock of any one who should die and also to aid its credit. During 1939 the value of its stock was $600 a share and, while dividends of $10 to $30 a share have been regularly declared since 1935, its accumulated earnings and profits exceeded $49,900. On June 10, 1939, a plan of recapitalization was adopted to change the authorized capital stock to 500 common shares of no par value and issue $75,000 debenture certificates of $100 face value. These certificates bore 5 percent interest, payable quarterly, and were to mature on February 25, 1959, or sooner at the corporation’s option; they were subordinated to claims of all other creditors.

In pursuance of this plan, petitioners surrendered their stock certificates to the corporation and received in exchange for each share one share of the no par value stock and a $100 debenture, worth par. The corporation’s capital stock account was written down from $49,900 to $998. The $48,902 remaining in capital account and $998 from surplus account were transferred to the debenture account. Thereafter one share of stock was sold for cash, and “debenture certificates were issued in satisfaction of notes of the corporation which were held by the officers.” At the close of the corporation’s taxable year ended February 28, 1940, there were outstanding all of the corporation’s shares, the $49,900 face value debentures issued for the surrendered old shares, and $23,500 face value debentures “issued in satisfaction of notes of the corporation which were held by the officers.” Petitioners still hold the debentures, except that Docherty made a gift to his family of $4,000 issued to him in satisfaction of notes.

On June 10, 1939, petitioners deposited their stock certificates and the corporation deposited the insurance policies on its' officers’ lives in trust with a national bank of Providence as trustee to collect the proceeds upon an insured’s death and purchase his shares and also Straight’s shares. The plan to recapitalize and issue debentures was adopted to facilitate this arrangement, and was intended to avoid the possibility of unfriendly shareholders and of litigation.

Debenture bonds were issued to petitioners for their old shares as follows: Doclierty $16,700, Budlong $16,700, Straight $2,000, Armstrong $14,500. The Commissioner included these amounts in their respective incomes as an ordinary taxable dividend.

However uncertain may be the boundaries of the term “recapitalization” as used in the definition of reorganization, section 112~⅛), we think it must be read to comprise a reduction or other change in the par value of capital stock. The change here involved was a reduction from par value of $100 per share to no par and a stated value of $2 per share, thus changing the aggregate par value of $50,000 to a stated value of $1,000, and leaving the number of shares (500) unchanged. The purpose of this is explained as a means, in this smal I closely held corporation, of facilitating the purchase of the shares held by any of the four shareholders in the event of his death, and thus to assure the continuance of harmonious ownership and control.. As a part of this plan of recapitalization, the shareholders exchanged their common shares, not alone for shares of no par value, but also for 30-year debentures. The recapitalization plan involved both the shares and the debentures and there is no ground for treating the debentures as if they were the subject of a separate and unrelated transaction. The debentures were “securities”, and as to each petitioner the transaction was literally an exchange of his shares in the corporation, in pursuance of a plan of reorganization (recapitalization), for shares and securities in the corporation. This is precisely within the terms of section 112 (b) (3), which provides that in such transaction no gain or loss shall be recognized. This is what the petitioner claims, and we see no ground for denying it.

There is nothing to arouse the application of the doctrine of Gregory v. Helvering, 293 U. S. 465, for the recapitalization was a bona fide readjustment of the corporation’s financial structure for a legitimate business purpose. The evidence to that effect is entirely credible and there is neither fact nor circumstance to throw it in doubt.

The Commissioner’s determination is reversed.

Decision will be entered under Rule BO.


text:
    B. F. Sturtevant Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 106742.
    Promulgated August 5, 1942.

      Philip Nichols, Esq., for the petitioner.

      Davis EasJdn, Esq., for the respondent.
   OPINION.

Sternhagen:

The Commissioner determined a deficiency of $23,257.01 in petitioner’s 1937 income tax. He disallowed (1) a deduction of $177,521.25 bad debts of the Cooling & Air Conditioning Corporation, of which petitioner owned all the shares, and (2) a deduction of $71,500 loss attributed to the worthlessness of the shares, both disallowances being based on section 112 (b) (6), Revenue Act of 1936.

The essential facts are stipulated and there is no conflicting evidence. The petitioner is a Massachusetts corporation and filed its 1937 income tax return with the collector for Massachusetts.

Before the taxable year, the petitioner, at a cost of $71,500, acquired all the shares of the Cooling & Air Conditioning Corporation. For years it had sold material to the Cooling Corporation, and on December 31, 1937, the indebtedness on this account was $268,679.40. The Cooling Corporation had, since 1931, continuously suffered losses, and on December 31,1937, its liabilities far exceeded its assets, the balance sheet deficit being $237,521.25. It had no plant or similar tangible assets, the largest asset items being accounts receivable, $179,629.94, and contract work in process, $267,448.42. The largest liability items were the account payable to petitioner, $268,679.40, reserve for uncompleted contracts, $350,735.98, and capital stock, $60,000. The failure of the Cooling Corporation’s business to “make profitable headway” in 1937, despite a considerable volume of business done and despite a general improvement in business, indicated before the end of 1937 that its debt to petitioner could not be paid. For the express purpose of discharging its debts, it transferred all its assets to petitioner, including its contracts, and petitioner assumed the $44,856.30 debts to others in order to assure the supply of the materials which such creditors were furnishing for the existing contracts. The net value of the assets thus acquired from the Cooling Corporation was $91,158.13, leaving $177,521.25 of the debt to petitioner wholly worthless and uncollectible. This amount petitioner ascertained to be worthless and charged off before closing its books for the year 1937. The Cooling Corporation did not dissolve, but it has done no business since, and has had no assets. Its shares became worthless in 1937.

The Commissioner’s principal justification for the disallowance is that the closing out of the debt was in reality a liquidation of the Cooling Corporation whereby the petitioner, as a shareholder, received that corporation’s property. If this were the fact, section 112 (b) (6) would preclude the recognition of any loss. But it is not shown to be the fact; and, upon the evidence, it can not be said that what was done in the guise of closing out a bad account was in substance a liquidation distribution. There was no difference between the substance and the form of the transaction. In truth, the debt arose from the purchase and sale of merchandise on open account, and nothing indicates that in reality petitioner was, as a shareholder, making capital contributions in enhancement of the value of its shares of stock. It had already paid more for the shares than their par value, and it sold materials to the Cooling Corporation not because it was a shareholder, but in the ordinary course of business. So, too, when the account was settled it was not as a liquidation of petitioner’s shareholder interest but as a discharge of its creditor rights. Both corporations passed resolutions that the net value of the assets should be transferred to petitioner as a credit on the indebtedness and that no action be taken toward dissolution. While this expression by two affiliated corporations is not controlling, and the Government has a right to be skeptical to prevent unwarranted deductions, it is entirely reasonable to believe that the resolutions fit the fact; for the Cooling Corporation had a large deficit, and there was no property with Avhich to make a liquidation distribution and therefore no way to bring section 112 (b) (G) into operation.

The Government is not bound to adopt the style in Avhich a taxpayer clothes its transactions as determinatiA’e of their true character for tax purposes; but there is no more reason to act upo'n an artificial designation when used by the Government than when used by the taxpayer. Here the Government argues that there was a liquidation; that in such liquidation, property was received by petitioner; that there was in truth no debt but a capital contribution; and that if there was a debt, its worthlessness was but a form of loss and its deduction may not be taken as a bad debt deduction but as a loss deduction, with the statutory limitation on such deductions. This argument, we think, is not founded in substance and can not be adopted as the ground of the decision.

The indebtedness at the end of 1937 amounted to $268,679.40. The net assets, apart from the petitioner’s credit account, were $91,158.13. Petitioner took the assets, consisting mostly of contracts in process, assumed the $44,856.30 liabilities to others, and charged off the remaining $177,521.25, as a debt ascertained to be worthless. This, we think, it had the right to deduct.

By the same circumstances as demonstrated the worthlessness of the account in 1937, the shares were shown to be worthless and petitioner’s investment of $71,500 shown to be lost. Nothing remained in the Cooling Corporation to give value or hope of value to the shares. Although it had not given up its charter, it had nothing else and its business had proven to be unprofitable. The failure of profit in 1937 may be taken to be the “identifiable event” which supports the deduction in 1937.

The Commissioner’s disallowance of the deductions of $177,521.25 bad debts and $71,500 loss on shares is reversed. Other items of adjustment are not contested.

Decision will be entered under Bule 50.