author: PíiiLLirs:

text:
    Appeals of A. J. SIEGEL et al.
    Docket No. 5255.

    Submitted December 23, 1925.
    Decided June 23, 1926.
    1. Under tlie 1918 amendment to tbe National Banking Act, three banking associations agreed to unite their business and assets and to continue the business under the charter of one of such associations, in accordance with the provisions of the statute. Held, that no new corporate entity was created, the effect of the statute being to merge the identity of two of such associations in the third, whose corporate existence continued.
    2. Under the terms of the agreement under which such merger took place, stockholders of the bank which continued its corporate existence received stock of a par value in excess of the par value of the stock held prior to such merger. Held, that under the Revenue Act of 1918 the amount of the excess in par value should be treated as a gain to the extent provided in section 202 (b) of that Act.
    3. Where, as a result of a merger, the interests of the stockholders are substantially different from their interests prior to such merger, the transaction may result in a taxable gain, even though the corporate identity of the corporation in which the taxpayer is a stockholder continues. Weiss v. Steam, 265 ü. S. 242; ilarr v. United States, 268 U. S. 536.

      George T. Weitzel, Esq., for tbe petitioners.

      Edward C. Lake, Esq., for tbe Commissioner.
    Before GkatjpNer, Trammell, and Phillips.
    Taxpayers appeal from the determination of deficiencies in income tax for 1919, arising from the decision of the Commissioner that a taxable gain arose out of a merger or consolidation of three national banks.
    FINDINGS OF FACT.
    In 1919 the taxpayer, A. J. Siegel, was the owner of 255 shares of stock of the Third National Bank in St. Louis. During that year the Third National Bank, the Mechanics-American National Bank and the St. Louis Union National Bank, all located in the City of St. Louis, Mo., entered into an agreement of consolidation in terms and figures as follows, to-wit:
    This agreement, made between the Third National Bank o-f St. Louis and the Mechanics-American National Bank of St. Louis and the St. Louis Union National Bank, all- located in the City of St. Louis, State of Missouri, and each acting pursuant to a resolution of its Board of Directors and by a majority of said Boards, pursuant to the authority given by, and in accordance with the provisions of, an Act of the Congress of the United States entitled “An Act to provide for the consolidation of national banking associations,” approved on the 7th day of November, 1918, witnesseth as follows:
    1. The Third National Bank of St. Louis (hereafter referred to as the Third National Bank), the Mechanics-American National Bank of St. Louis (hereafter referred to as the Mechanics Bank) and the St. Louis Union National Bank (hereafter referred to as the St. Louis Union Bank) are hereby consolidated under the charter of the said first named association as hereby modified.
    2. The name of the consolidated association shall be “ First National Bank in St. Louis.”
    3. The amount of capital stock of the consolidated association shall be ten million dollars ($10,000,000.90) divided into one hundred thousand (100,000) shares of one hundred dollars ($100.00) each, subject to the right to change the amount of said capital hereafter as is now, or shall hereafter be, authorized by law. On the date of consolidation its surplus shall be five million dollars ($5,000,000.00), and its undivided profits shall be five hundred thousand dollars ($500,000.00). Said capital, surplus and undivided profits at the date of consolidation shall then aggregate fifteen million five hundred thousand dollars ($15,500,000.00). Of this capital stock thirty-three thousand three hundred and thirty three and one-third (33,333%) shares shall be allotted to the then shareholders of each of said banks, being one and one-third (1%) shares for each share now held by them.
    To create such capital, surplus and undivided profits and the special fund of two hundred fifty thousand dollars ($250,000.00) for the stockholders of the Third National Bank hereinafter provided for in paragraph 7 hereof, each of the three banks shall furnish net assets, over and above all of its liabilities of five million two hundred and fifty thousand dollars ($5,250,000.00) and additional assets in an amount sufficient to cover all state and city taxes assessed against it up to and including May 31, 1919, and all assessed and estimated federal taxes up to said date.
    If the amount contributed by any of the three banks to provide for estimated federal taxes up to said date be made sufficient to pay said taxes when finally assessed and determined, any additional amount for that purpose shall be paid by the consolidated bank, in which event an equal amount shall be paid by the consolidated bank on account of the taxes of the other two hanks. If the amount so contributed by any of the three banks is in excess of the amount of said taxes so finally assessed and determined, then such excess amount shall he added to and held hy the consolidated bank as a part of the trust fund provided for in paragraph 8 hereof.
    4. The assets contributed by each of the banks shall, upon the effective date of the consolidation, be passed upon and be acceptable to a committee of nine (9), three (3) to be appointed by the Board of Directors of each of the banks, which committee shall examine the assets of each of the banks and select therefrom sufficient assets in excess of the total liabilities of said banks to other than stockholders to make up said sum of five million two hundred and fifty thousand dollars ($5,250,000.00) and taxes as hereinbefore provided and certify to such valuation. And the assets so selected by said committee shall constitute the assets t<5 be contributed by each of the three banks to the consolidated bank.
    Said committee shall accept and treat all real estate owned by said banks as of its present book value and shall accept and treat the furniture and fixtures of the Mechanics Bank as of a value of one hundred thousand dollars ($100,-000.00) and shall determine the value of all other assets selected and accepted by it.
    5. In the event said committee does not accept assets of any of said banks up to the required amount, then the shareholders of such bank not having sufficient assets to make good its proportion shall pay the difference in cash.
    6. In the event that the committee finds assets belonging to any of the three consolidating banks in excess of the said amount to be contributed by each of them, then such excess assets, if any, shall be by such 'bank transferred and delivered to the consolidated bank, to be held by said bank in a special trust account for liquidation and distribution among the stockholders, as of the date of consolidation, of the respective banks contributing the same. The directors of the consolidated bank shall have full and absolute discretion in the liquidation and distribution of the same, and neither they nor the bank shall be in anywise liable for any act of theirs in relation thereto, except for their wilful misconduct. Such excess assets may be held for a period of six (6) months after the consolidation by the consolidated bank as a guarantee against any undisclosed liabilities of the contributing- banks, and if any such liabilities are asserted within six (6) months after the consolidation, said excess assets, or such part thereof as the directors of the consolidated bank shall deem advisable, shall be held by the consolidated bank until such liabilities are discharged, and said assets may be used in the absolute discretion of the directors of the consolidated bank to liquidate and discharge any such liabilities.
    7. Out of the assets aggregating fifteen million seven hundred and fifty thousand dollars ($15,750,000.00) and taxes as aforesaid, contributed by the three banks, fifteen million five hundred thousand dollars ($15,500,000.00) shall constitute the capital, surplus and undivided profits of the consolidated bank, and the remaining two hundred and fifty thousand dollars ($250,000.00) which amount represents the agreed excess value of the business of the Third National Bank over the business of each of the other banks, shall be set aside and held by the consolidated bank as a special fund for the account of the stockholders of record of the Third National Bank on the date of the consolidation and as a guarantee against loss on the real estate of the Third National Bank upon the following conditions, to wit:
    If the real estate now owned by the Third National Bank is occupied as the permanent place of business - of the consolidated bank, under resolution of its Board of Directors, then, when so occupied, said sum shall be distributed among the persons, or their legal representatives, who were stockholders of the Third National Bank on the date of the consolidation.

      If said real estate be sold prior to July 1, 1922, at its present book value, then said sum shall likewise be so distributed when said real estate is sold. If said real estate is sold prior to said date for less than its present book value, then the difference between the sale price and said book value shall be deducted from said sum and shall become the property of the consolidated bank, and the remainder only, if any, of said sum shall be so distributed to said stockholders.
    If said real estate is not so occupied by the consolidated bank and is not sold prior to July 1, 1922, then said sum shall become the property of the consolidated bank.
    8. The Board of Directors of the consolidated bank shall be not less than five (5) nor more than fifty-five (55) in number.
    These directors shall continue in office until new directors are elected and qualify. The stockholders shall, at each annual meeting, have the right to determine the number of directors to be elected for the ensuing year, and, in the absence of any change, the same number of directors shall be elected as were elected the preceding year.
    9. The above mentioned Board of Directors shall meet at the office of the above-mentioned consolidated bank on July 7, 1919, at the hour of 10 o’clock a. m., for the purpose of electing officers of the consolidated bank, adopting by-laws and transacting such other business as may come before said meeting. These officers shall serve until their successors shall have been chosen and qualified.
    If such consolidation has not become effective on July 7, 1919, then such first meeting of the Board of Directors shall be held at the hour of 10 o’clock a. m. on the effective date of such consolidation.
    10. On July 5, 1919, or on the date the consolidation takes effect, each of the stockholders of the three banks shall, on delivery of his certificates of stock in the consolidating banks, duly endorsed for cancellation, receive, on demand, on or after the day succeeding the effective date of consolidation, one and one-third (1%) shares of stock in the consolidated bank for each share of the stock formerly owned by him in the respective consolidating banks.
    11. The consolidation herein provided for shall become effective as of the close of business on July 5, 1919, if the consolidation shall then have been ratified and confirmed by the affirmative vote of the shareholders of each of the said three banks holding at least two-thirds (%) of their capital stock outstanding, at meetings to be called and held as provided in the National Banking Act, and shall have been approved by the Comptroller of the Currency of the United States. And if not so ratified and approved on or before said July 5, 1919, then the consolidation shall become effective when so ratified and approved.
    Witness the signature and seals of said associations, this - day of -, 1919, each hereunto set by the president and attested by its cashier, pursuant to a resolution of its Board of Directors, acting by a majority thereof, and witness the signatures hereto of a majority of each of said Board of Directors.
    At the time of the execution of this contract between the three banks, the capital stock of the Third National Bank was $2,000,000, the surplus $2,000,000 and the undivided profits $350,000, or a total of assets of $4,350,000. It was therefore necessary, in order for the Third National Bank to be able to contribute its $5,250,000 of assets contemplated by the agreement of consolidation, that its assets be increased by the sum of $1,000,000. In order to produce this additional $1,000,000, the capital stock of the Third National Bank was increased $500,000 and the additional shares of stock were offered and sold to the then existing stockholders of the Third National Bank at the price of $200 per share. There was thus added $500,000 to the capital and $500,000 to the surplus of the Third National Bank. At the time of this increase, each then shareholder of the Third National Bank was allowed to subscribe for one share of the new stock for each four shares of stock then held. The capital stock of the Third National Bank was so increased, and certificate of such increase was issued on June 28, 1919.
    The capital and surplus of the Third National Bank having, in this manner, been increased and the capital and surplus of the Mechanics-American National Bank having, in like manner, been increased, thereafter, in pursuance of the agreement of consolidation above set out, the name of the Third National Bank was changed to First National Bank in St. Louis and the business of the three banks was continued under the charter of the Third National Bank. Meetings of the stockholders of the three banks were held and the agreement of consolidation approved, which consolidation became effective as of July 5, 1919, and certificate was issued by the Comptroller of the Currency on July 7,1919, approving the consolidation.
    In carrying out the consolidation and in pursuance of the provisions of paragraph i of the contract of consolidation, a committee of nine was appointed, which committee examined the assets proposed to be contributed by each of the three banks, and such of the assets of the three banks as were in excess of the amount of $5,250,000 to be contributed by each of them were, by each of sucli banks, delivered to the consolidated bank to be held, and they have since been held, as a special trust fund to be liquidated and distributed among the stockholders as of the date of consolidation. The committee selected assets of each bank of a value of $5,250,000, which were accepted under the agreement as the contribution of each bank, as provided in the contract. There was no other or further division or separation of any portion of the assets of any of the three banks from any other portion of its assets for distribution among the stockholders except for the distribution, through the consolidated bank, of the assets of any of the consolidated banks in excess of $5,250,000.
    The certificate of the Comptroller of the Currency approving the consolidation was issued on July 7, 1919, in terms as follows:
    Whereas, by satisfactory evidence presented to the undersigned, it has been made to appear that the directors and shareholders of the Third National Bank of St. Louis, Missouri, The Mechanies-American National Bank of St. Louis, Missouri, and The St. Louis Union National Bank, St. Louis, Missouri, have complied with all the provisions of an Act of Congress approved November 7, 1018, entitled “An Act to provide for the consolidation of National Banking Associations.”
    Now, therefore, I, Thomas P. ICane, Acting Comptroller of the Currency, do hereby certify that the Third National Bank of St. Louis, The Mechanies-Ameriean National Bank of St. Louis, and the St. Louis Union National Bank have been consolidated under the charter of the Third National Bank of St. Louis and under the corporate title of “ First National Bank in St. Louis,” with capital stock of ten million dollars ($10,000,000), and that the said consolidation is approved.
    In testimony whereof witness my hand and seal of office this seventh day of July, 1919.
    (Signed) T. P. Kane,

      Acting Comptroller of the Currency.

    Charter No. 170. Consolidation No. 16.
    Charter No. TT0 is the charter number of the First National Bank in St. Louis and is the same charter number held by the Third National Bank of St. Louis.
    After the certificate of consolidation had been issued, each former stockholder of the Third National Bank, and of the Mechanics-American National Bank, and the St. Louis Union National Bank, received one and one-third shares of stock of the consolidated bank for each share formerly held.
    None of the taxpayers reported any gain or loss from the transaction. The number of shares of stock in each of these banks held by each of the taxpaj^ers, the amount of the gain as determined by the Commissioner and the deficiencies in income tax for 1919 determined by him are as follows:

       The following appeals were consolidated for hearing, involve the same question, and are decided herewith: Appeals of A. J. Siegel, No. 5255; George L. Allen, No. 137; Joseph D. Bascom, No. 5260; Mississippi Valley Trust Co., Trustees, Jessie K. Lindley Trust, No. 4010 ; Mississippi Valley Trust Co.. Trustees. Rachel D. Cuendet Trust. No. 5259 : Estate of Charles W. Whitelaw, No. 5262; Ada Johnson Forgan, No. 5388 ; F. O. watts, No. 5256; Ambler F. wilson, No. 5506 ; W. R. Wright, No. 378; Eugene D. Nims, No. 5257; Justina G. Catlin, No. 634; Daniel IC Catlin, No. 032; Theron E. Catlin, No. 631; Irene C. Allen, No. 624; Cora B. Boynton, No. 640; Andrew W. Johnson, No. 132; Jaclcson Johnson, No. 326; Clement W, Nelson, No. 5258; Florence J. Shinlcle, No. 5261; and Joseph S. Calfee, No. 2286.
      The Appeal of St. Louis Trust Co., Trustee for Mrs. C. O. Vaughn, No. 6189, was submitted January 26, 1926, upon the pleadings and the record in the Appeal of A. J. Siegel, and is decided herewith. M. N. Mslier, Esq., for the Commissioner.

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

   OPINION.

PíiiLLirs:

The sole question involved is whether any taxable gain resulted from the transaction set out in the findings. There are no differences between the parties as to the correctness of the computation of the gain, if any taxable gain resulted.

The appeal arises out of the same transaction which was involved in Appeal of R. D. Musser, 2 B. T. A. 1031. Counsel for the taxpayers contends that the Board erred in that case when it reached the conclusion that a new corporation was created. Counsel takes the position that the opinion (1) does not give weight to the provisions of the statute which provide that the consolidation is to take place under the charter of one of the existing banks, (2) relies upon decisions interpreting the National Banking Act which were rendered under other provisions of the Act and not under the provisions of the 1918 amendment, which amendment was passed for the purpose of changing the law under which the decisions referred to were made, and (3) does not give consideration to those provisions of the National Banking Act which provide that no new corporation shall engage in banking without first having procured from the Comptroller of the Currency a certificate authorizing the bank to commence business and which prohibit payment for stock in property.

After reciting provisions of the agreement and quoting the Act, the opinion of the Board in the Musser appeal quotes Y Corpus Juris, 851, to the effect that the National Banking Act has been construed as authorizing the consolidation of national banks and as stating further that where consolidation is effected by one bank taking over all the assets and assuming all the liabilities of the other, the former becomes a new corporation whose stockholders are the stockholders of each of the old corporations before consolidation. For this proposition Corpus Juris cites Bonnet v. First National Bank of Eagle Pass, 60 S. W. 325, decided by the Court of Civil Appeals of Texas in 1900.

That was an action in which a stockholder sought to recover damages for the action of the corporation in depriving him of his right to acquire his quota of newly issued shares of stock, such stock having been issued to the stockholders of another bank whose assets had been taken and liabilities assumed by the defendant under authority of the National Banking Act then in force. The principal question was whether there had been a mere purchase of the assets of the bank whose assets were taken. The court, just prior to the extract from the opinion which is set out in the Musser appeal, asks: “Was the consolidation (for it is treated by appellant as a consolidation) or amalgamation of the banks ultra vires, and therefore void?” It appears that the court had itself some doubt whether there was a consolidation or amalgamation (merger) but in its opinion it followed the theory of the appellant. Whether there was a consolidation or a merger, the result would be the same, and while the opinion contains a statement concerning the effect of a consolidation, and a further statement that, in effect, a new corporation existed, it can not be considered authority for the proposition that a consolidation, rather than a merger, resulted, or that a new legal entity came into being. We must also bear in mind that the consolidation or merger in that case did not take place under the provisions of the law which is here involved.

The opinion in Bonnet v. First National Bank of Eagle Pass relies upon Adams v. Yazoo & M. V. R. R. Co., 77 Miss. 194; 24 So. 200 (which was subsequently appealed to the United States Supreme Court and is discussed below) and upon Railway Co. v. Ashling, 160 Ill. 373; 43 N. E. 373. The question involved in the latter case was whether an award of damages for personal injuries against one corporation could be recovered from a successor corporation. The decision does not differentiate between a merger and a consolidation, nor was it necessary in that case to do so. During the course of its opinion the court says:

The general rule that the consolidation of two or more corporations into one creates a new company, and works a dissolution of the original corporations forming the consolidated company, is subject to exceptions, and depends upon the statute under which the consolidation is effected. * * *
We see no reason why, under the statutes in question, one corporation may not he consolidated with another, under the name of such other, which is continued in existence with enlarged powers, franchises, and property rights. It is, in substance, so provided, and such consolidations are frequently made.

The court then proceeds to determine that one of the “ consolidated ” companies remained in existence. Surely this case can not be cited as authority for the proposition that in all consolidations each of the consolidating companies goes out of existence and a new legal entity comes into existence.

This case was discussed in Collinsville National Bank v. Esau, 74 Okla. 45; 176 Pac. 514, where the court said:

Á “ consolidation ” takes place where two or more existing corporations are united into a single corporation, and the existence of the uniting corporation is terminated, and the organization succeeds in a general way to the franchise and acquires the property and assets and assumes the debts and obligations of the constituent companies.
In ordinary legal phraseology, the term “ consolidation ” is generally used to indicate the act and result of uniting two or ■ more corporations into one under a new name. A “ merger ” takes place where one of the constituent corporations remains in existence absorbing or merging in itself all the other companies. In a merger of two or more companies, one of the merging corporations continues to survive and succeeds to the franchise and acquires the property and assets of the other constituent corporations; that is, the merger consists from the uniting of two or more corporations by the transfer of the property to some one of the existing corporations, which continues its existence while the others are swallowed up or consumed by the one that survives. It differs from a consolidation ” wherein all the corporations cease to exist and unite in the interest of a new one. Rightly understood, there never can be a consolidation of corporations except where the constituent corporations cease to exist as separate entities, and a new corporation with the property and assets of the old one comes into being. Thus it will be seen that a “ merger ” is not the equivalent of a “ consolidation ” at all. Whether a particular transaction is in reality a sale, conversion, consolidation, or merger, to a great extent depends on the circumstances surrounding each particular case.
In the ease of C., S. F. & Cal. Ry. Co. v. Ashling, 160 Ill. 373, 43 N. E. 373, it is held that, where one corporation takes over all of the property and assets and succeeds to the franchise of another corporation and issues stock in the new corporation to the stockholders of the old corporation in exchange for an equal amount held by them in the old company, and the officers of the old corporation are made officers in the new, it amounted to a consolidation of the two entities. While we do not agree with the Illinois court that such transaction amounted to a consolidation, nevertheless we do believe it was a merger, and the same conclusion and result must follow as to the rights of creditors of the old corporation to assert their claims against the new organization.

The opinion in the Musser appeal then goes on to say that the legal eifect of a consolidation is to extinguish the constituent companies and create a new corporation with appropriate liabilities and stockholders derived from those then passing out of existence, and cites Adams v. Yazoo & M. V. R. R. Co., supra. That case was subsequently appealed to the Supreme Court of the United States and is reported as Yazoo & M. V. Ry. Co. v. Adams, 180 U. S. 1. In that case the statute under which the companies were consolidated provided :

All of the companies so consolidating shall be merged into and become one company, and the companies so formed by such consolidation shall be deemed and held to be a corporation created by the laws of this State.

The Supreme Court held that under the statute there was a grant of corporate power creating a new corporation, and affirmed the decision of the Supreme Court of Mississippi holding that a new corporation was created. In the course of its opinion the Supreme Court says: :

But if, as was the case in Tomlinson v. Branch [15 Wall. 460], one road loses its identity and is merged in another, the latter preserving its identity, and issuing new stock in favor of the stockholders of the former, it is not the creation of a new corporation but an enlargement of the old one. In such case it was held that where the company which had preserved its identity held as to its own property a perpetual exemption from taxation, it would not be extended to the property of the merged company without express words to that effect.
* * * * # * *
In Central Railroad & Banking Company v. Georgia, 92 U. S. 665, 670, an act of the legislature authorized the Central Railroad and the Macon Railroad to unite and consolidate their stock, and all their rights, privileges, immunities and franchises, under the name and charter of the Central Railroad, in such manner that each owner of shares of stock of the Macon Road should be entitled to receive an equal number of shares of the stock of the consolidated companies. “ Whether,” said Mr. Justice Strong, “ such be the effect [consolidation or amalgamation] or not, must depend upon the statute under which the consolidation takes place, and of the intention therein manifested. If, in the statute, there be no words of grant of corporate powers, it is difficult to see how a new corporation is created.” It was held that the act did not work a dissolution of the existing corporátions and the creation of a new company, since there was no provision for a surrender of the stock of the shareholders of the Central, and none for the issue of other certificates to them. In that case, the road, whose charter contained the exemption from taxation, was preserved intact by the consolidation, and it was held that its exemption continued, while the other road was to go out of existence. * * *
Other cases to the same effect, holding that the consolidation did not operate as a dissolution of the constituent companies, are Chesapeake & Ohio Railroad v. Virginia, 94 U. S. 718; Greene County v. Conness, 109 U. S. 104, and Tennessee v. Whitworth, 117 U. S. 139.
* * * In Railroad Company v. Georgia, 98 U. S. 359, two railroad companies were consolidated by an act of the legislature, which authorized the consolidation of their stocks, conferred upon the consolidated company full corporate powers, and continued to it the franchises, privileges and immunities which the companies had held by their original charters. We held in that case that a new corporation was created, which became subject to the provisions of a statutory code, adopted January 1, 1863, permitting the charters of private corporations to be changed, modified or destroyed at the will of the legislature. The case was distinguished from Railroad Company v. Georgia, 92 U. S. 665, as being a consolidation instead of a merger. “ Nor was it,” said Mr. Justice Strong, “ a mere alliance or confederation of the two. If it had been, each would have preserved its separate existence as well as its corporate name; but the act authorized the consolidation of the stocks of the two companies, thus making them one company in place of two. It contemplated, therefore, that the separate capital of each company should go out of existence as the capital of that company.” To the same effect is St. Louis, Iron Mountain &c. Railway v. Berry, 113 U. S. 465. (Italics ours.)

The distinction between a consolidation and a merger has been laid down in a number of cases in addition to those quoted above.

In State v. Atlantic Coast Line R. R. Co., 202 Ala. 558; 81 So. 60, the court says:

Accurate logicians very properly distinguish between the meanings of “ consolidation ” and “ merger.” Strictly speaking, a consolidation means the unifying of two or more corporations into a single new corporation, having the combined capital, franchises, and powers of all of its constituents. And, strictly speaking, a merger means the absorption of one corporation by another, which retains its name and corporate identity, with the added capital, franchises, and powers of the merged corporation. * * * For most purposes, however, and apart from mere questions of identity, the result is in each case practically the same; and so it is that courts and text-writers have usually used the terms “ consolidation ” and “ merger ” interchangeably, and, in cases of doubt, conjunctively, to express the idea of complete corporate union, whether a new corporation nominally results or whether a constituent corporation is nominally preserved.

To the same effect, see Alabama, T. & N. Railway v. Tolman, 200 Ala. 449; 76 So. 381; and Chicago Title & Trust Co. v. Doyle, 259 Ill. 489; 102 N. E. 790.

In Keokuk & Western R. R. Co. v. Missouri, 152 U. S. 301, the court said:

In the numerous cases .which have arisen in this court as to the effect of a consolidation upon the existence and status of the constituent corporations, it has been held that the question of the dissolution of such corporations depended upon the language of the statute under which the consolidation took place.

In Chicago Title & Trust Co. v. Doyle, supra, the court said:

The question of 1he effect of the consolidation must be answered by a consideration of the terms of the statute under which the consolidation took place, and not what the parties resolved or did not resolve as to such effect.

In Central Railroad and Banking Co. v. Georgia, 92 U. S. 665, the act in question provided:

Be it enacted by the general assembly of the State of Georgia, that the Macon and Western Railroad Company, and the Central Railroad and Banking Company of Georgia, be, and they are hereby, authorized and empowered to unite and consolidate the stocks of the said two companies, and all the rights, privileges, immunities, property, and franchises belonging or attaching to said companies, under the name and charter of the said “The Central Railroad and Banking Company of Georgia,” in such manner that each and every owner and holder of shares of the capital stock of the Macon and Western Railroad Company shall be entitled to and receive an equal number of shares of the capital stock of the consolidated companies: Provided, that nothing herein contained shall relieve or discharge either of said companies from any contract heretofore entered into, but that all such contracts shall be assumed by, and be binding on, the Central Railroad and Banking Company of Georgia, and all benefits and rights under the same shall accrue to, and vest in, the said last-mentioned company: And provided further, that, upon such union and consolidation, the capital stock of the Central Railroad and Banking Comp -ny of Georgia shall not exceed the amount of the authorized capital thereof, and the present authorized capital of the Macon and Western Railroad Company added thereto.
‡ s*c >|: sj« ‡ # sfc
Be it further enacted, that upon the union and consolidation herein provided for, each stockholder in the Macon and Western Railroad Company shall be entitled to receive a certificate of stock as a shareholder in the Central Railroad and Banking Company of Georgia for a like number of shares, upon the surrender of his certificate of stock in the former company, which new certificate shall entitle the holder thereof to the same rights, privileges, and benefits as attach to the holders of stock now held by the shareholders in said companies, or either of them.

The question involved was whether certain exemptions contained in the charter of the Central Railroad and Banking Co. survived.

The court, in the course of its opinion, says:

It may be that the consolidation of two corporations, or amalgamation, as it is called in England, if full and complete, may work a dissolution of them both, and its effect may be the creation of a new corporation. Whether such be the effect or not must depend upon the statute under which the consolidation takes place, and of the intention therein manifested. If, in the statute, there be no words of grant of corporate powers, it is difficult to see how a new corporation is created. If it is, it must be by implication; and it is an unbending rule that a grant of corporate existence is never implied. In the construction of a statute, every presumption is against it. * * * We are not called upon, however, now to determine whether a consolidation, effected under a statute making no express grant of new corporate existence, may not, in some cases, work a dissolution of the existing corporations, and at the same time the creation of a new company; for, in the present ease, we think the act of 1872 plainly contemplated no such thing. It is true, the act speaks of union and consolidation. It authorizes the two companies to unite and consolidate their stock, and all their rights, privileges, immunities, property, and franchises; but it prescribes the manner in which this may be done, and its effect. It is to be done under the name and charter of the Central Railroad and Banking Company; that is, the union is to be under that charter, not under a new charter of a company bearing that name. The union is also to be in such a manner that every holder of the shares of the capital stock of the Macon and Western Railroad Company shall be entitled to, and shall, on the surrender of their certificates, receive, an equal number of shares of the capital stock, as a shareholder in the Central Railroad and Banking ‘Company of Georgia, as declared in the fourth section. But there is no provision for a surrender of the certificates of stock of the shareholders of the Central, and none for the issue of other certificates to them. Their rights, whatever they may be after the union, are evidenced only by certificates of stock of the company chartered in 1835. If that charter has gone out of existence, they are stockholders in no company. Again: the act declared that all contracts of either of the companies should be assumed by and binding on the Central Railroad and Banking Company, and all benefits and rights under the same— that is, under the contracts — should vest in that company, not in a new corporation then springing into life. Nowhere in the act is there an intimation ojE any legislative purpose that the Central Railroad Company should cease to exist. The Macon and Western Railroad Company was undoubtedly intended to go out of existence; for provision was made for the surrender of all the shares of its capital stock; and without stockholders it could not exist. The existence of such a provision in regard to the one company, and its absence in regard to the other, is a strong argument in support of the conclusion that it was not intended the Central Railroad and Banking Company should surrender its charter, or dissolve. And still more, that company was authorized to increase its capital, plainly for the purpose of making room for the new shareholders entitled to come in by virtue of their ownership of shares of the dissolved company’s stock. The language of this provision is significant. It is, that, upon the union and consolidation, the capital stock of the Central Railroad and Banking Company “ shall not exceed the amount of the authorized capital thereof, and the present authorized capital of the Macon and Western Railroad Company added thereto.” This refers plainly to the corporation which it was contemplated should exist after the union and consolidation of the two companies. What, then, was intended by the expression “ authorized capital thereofthat is, authorized capital of the Central Company? Had this reference to a new company? Certainly not; for no new company had any authorized capital. It must have referred,- therefore, to the old Central Railroad and Banking Company, in existence when the act was passed; and that was the company the amount of whose stock-was to be limited after the union had taken place. That company was to continue in existence, and its capital was restricted to the amount of what had been previously authorized, augmented by a sum equal to the capital of the absorbed company. * * *
* * * It- is of no importance to the inquiry, * * * that the Central acquired under the act new and enlarged powers as well as new stockholders. It was authorized to own and operate a railroad from Macon to Atlanta; to operate it as its own. It was also authorized to increase its capital stock. But the gift of new powers to a corporation has never been thought to destroy its identity, much less to change it into- a new being. * * *
Our opinion, therefore, is, that the charter granted to the Central Railroad and Banking Company of Georgia, by the act of 1835, was not surrendered by its action under the later act of 1872; that it still has all the rights that were originally conferred upon it, holding them under the charter originally granted to it; and, consequently, that it is not in the power of the legislature to impose upon it a greater tax than one-half of one per centum of its net annual income. * * * * * * *
* * * The obvious purpose of the act was to vest in the Central Company the rights, privileges, immunities, property, and franchises which had belonged to the Macon and Western Company; not to enlarge those rights, or to bestow new immunities. If, therefore, the Macon and Western held its franchises and property subject to taxation, the Central, succeeding to the franchises and property, holds them alike subject. It took them just as they were, acquiring no additional or enlarged rights as against the State.

In Railroad Co. v. Georgia, 98 U. S. 359, it appeared that in April, 1863, the legislature of the State of Georgia passed an act whereby two railroad companies were empowered to consolidate their stocks upon such terms as might be agreed upon by the directors and ratified by a majority of the stockholders; and the act provided that, when so consolidated, they should be known as “The Atlantic and Gulf Railroad Company,” Avith a proviso that nothing therein .contained. should relieve or discharge either of them from any contract theretofore entered into by eitljer, but that this company should be liable on the same. By the second section it was enacted that the stockholders of said consolidated railroad companies, by such corporate name, and in such corporate capacity, should be capable in law io have, purchase, and enjoy such real and personal estate, goods, and effects as might be necessary and ptoper to carry out the objects therein specified, and to secure the full enjoyment of all the rights therein and thereby granted, and by said name to sue and be sued, plead and be impleaded, in any court of competent jurisdiction; to have and use a common seal, and the same to alter at pleasure; to make and establish by-laAvs, and generally to exercise corporate poAvers.

The third section of the act declared that the several immunities, franchises, and privileges granted to the said Savannah, Albany and Gulf Railroad Company, and the Atlantic and Gulf Railroad Company, by their original charters and the amendments thereof, and the liabilities therein imposed, should continue in force, except so far as they might be inconsistent with the act of consolidation.

The court said:

It is conceded that under this act a consolidation took place. It is, therefore, a vital question, What Avas its effect? Did the consolidated companies become a neAV corporation, holding its powers and privileges as such under the act of 1863? Or Avas the consolidation a mere alliance between two pre-existing corporations, in Avhich each preserved its identity and distinctive existence? Or, still further, \Aras‘it an absorption of one by another, whereby the former was dissolved, AA-liile the latter continued to exist? The • answer tó these inquiries must be found in the intention of the legislature as expressed in the consolidating act. We think that intention was the creation of a new corporation out of the stockholders of the two previously existing companies. The consolidation provided for was clearly not a merger of one into the other, as was the case of Central Railroad & Banking Co. v. Georgia, 92 U. S. 665. Nor was it a mere alliance or confederation of the two. If it had been, each would have preserved its separate existence, as well as its corporate name. But the act authorized the consolidation of the stocks of the two companies,, thus making one capital in place of two. It contemplated, therefore, that the separate capital of each company should go out of existence as the capital of that company; and, if so, how could either have a continued separate being? True, the proviso to the first section declared that nothing therein contained should relieve or discharge either of the companies from any contract theretofore entered into by either, adding; “ But this company [that is, the company created by the act] shall be liable on. the same.”1 It is thus distinguished between the two original companies and the one contemplated to be formed by their consolidation. And the proviso would have been quite unnecessary, had it not been thought by the legislature that the consolidation would Avork a dissolution of the amalgamated companies. Hence it was considered necessary to preserve the rights of parties who might have contracted with them. Only their contracts were mentioned in the proviso, and that in order to authorize a novation. The third section continued in force the several immunities, franchises, and privileges granted by the original charters and the amendments thereof, and the liabilities therein imposed, but plainly for the benefit of the consolidated companies. Why speak of original charters, if a later charter was not intended by the act? That such was the intention appears still more clearly in the third section. That conferred upon the consolidated stockholders complete corporate powers. It granted to them, when consolidated, not only a corporate name, but the right under that name to acquire and hold property, to sue and be sued, to have a common seal, to make by-laws, and generally to do every thing that appertains to corporations of like character. This full grant of corporate power must have been intended for some purpose. What was it, if not to create a corporation? For that purpose it was amply sufficient. For any other it was unmeaning. If the two original companies were to continue in being, if it was not contemplated that they should be dissolved by consolidation, a new grant of corporate power and existence was unnecessary. They had it already.
Looking thus at the legislative intent appearing in the consolidation act, we are constrained to the conclusion that a new corporation was created by the consolidation effected thereunder in the place and in lieu of the two companies previously existing, and that whatever franchises,. immunities, or privileges it possesses, it holds them solely by virtue of the grant that act made. That generally the effect of consolidation, as distinguished from a union by merger of one company into another, is to work a dissolution of the companies consolidating, and to create a new corporation out of the elements of the former, is asserted in many cases, and it seems to be a necessary result.

These are the two leading cases upon the subject: When does a corporate charter continue in existence ? In the one it was held that the act of consolidation worked a merger under which one of the corporations continued its existence with the additional rights, privileges, franchises, and liabilities of the merging corporation. In the other it is found that a new corporation came into existence. Under which of these two cases does the present situation fall?

The act which we must consider, which is set out in full in the opinion in the Musser appeal, provides that any two or more national banking associations may consolidate into one wider the charter of either existing baoilc, on terms to be agreed upon, subject to certain limitations. Section 2 provides that associations consolidating with another association shall not be required to deposit money for their outstanding circulation, but that their assets and liabilities shall be reported by the association with which they have consolidated, and further provides that all property rights of the national bank so consolidated shall be deemed transferred to the bank into which it is consolidated. There is here the plain expression of an intention that one or more existing corporations shall be merged into another existing corporation under the charter of the latter, which is to acquire the assets and assume the liabilities of the former. The statute uses the word “ consolidate ” and not “ merge ”, but this was likewise true in tbe case of Central Railroad & Banking Co. v. Georgia, supra, and biost, if not all, of the other cases cited above.

It will also be noted that nowhere in the statute is there any grant of corporate power to any new corporation, one of the principal distinctions drawn by the Supreme Court between the cases of Central Railroad & Banking Co. v. Georgia, supra, and Railroad Co. v. Georgia, supra. In our opinion the present situation falls squarely within the decision of the Supreme Court in the first of these cases. We must conclude that the Mechanics-American and St. Louis Union National banks were merged into The Third National Bank, the corporate existence of which continued under its new name.

But it does not follow, because the corporation which merged was the same legal entity as the corporation in which taxpayer held stock before the merger, that no taxable gain results. Section 202 (b) of the Revenue Act of 1918 provides as follows:

When property is exchanged for other property, the property received in exchange shall for the purpose of determining gain or loss be treated as the equivalent of cash to the amount of its fair market value, if any; but when in connection with the reorganization, merger, or consolidation of a corporation a person receives in place of stock or securities owned by him new stock or securities of no greater aggregate par or face value, no gain or loss shall be deemed to occur from the exchange, and the new stock or securities received shall be treated as taking the place of the stock, securities, or property exchanged.
When in the case of any such reorganization, merger, or consolidation the aggregate par or face value of the new stock or securities received is in excess of the aggregate par or face value of the stock or securities exchanged, a like amount in par or face value of the new stock or securities received shall be treated as taking the place of the stock or securities exchanged, and the amount of the excess in par or face value shall be treated as a gain to the extent that the fair market value of the new stock or securities is greater than the cost (or if acquired prior to March 1, 1913, the fair market value as of that date) of the stock or securities exchanged.

Under the statute the same result follows a merger as follows a consolidation, and it remains only to determine whether there was an exchange of property for other property so that a taxable gain resulted.

It is contended that, since the corporate identity is preserved, the new stock is the equivalent of a stock dividend and is not subject to tax under the decision of the Supreme Court in Eisner v. Macomber, 252 U. S. 189. On first impression this reasoning appears sound. However, an examination of the decisions dealing with the effect of mergers convinces us that the transaction differs from a stock dividend, both in legal theory and in substance.

Under the agreement the taxpayer received 340 shares of stock in place of 255 shares previously owned. The shares received and the shares surrendered evidenced interests in different properties, Instead of owning 255/25,000ths, he now owns 340/100,OOOths, or 85/25,OOOths, reducing his pro rata voting interest from approximately 1 per cent to approximately one-third of 1 per cent. This is not the result which follows a stock dividend.

It is said that the increase in the property of the corporation and the decrease in the pro rata holdings arise from what is, in effect, a purchase of additional property for stock, and that an increase in the assets of a corporation is not a transaction which subjects the stockholders to tax. The effect of the merger is more than a purchase of assets. The assets are not taken as-they would be by a purchaser for value, but are subject to all infirmities in title and all liabilities of the merging corporation, whether or not made known to the corporation which acquires these assets. People’s National Bank v. Board, 103 Pac. 682; Collinsville National Bank v. Esau, 74 Okla. 45; 176 Pac. 514. The stockholder has no right to subscribe for the additional shares to be issued, as would ordinarily be the case, but, On the other hand, a stockholder who does not consent to the merger ' has the right to have his stock appraised and to receive its value in cash. None of these results follows from the purchase of assets or from the declaration of a stock dividend. They follow from the fact that, while in legal contemplation the corporation continues its existence, it has, in effect, taken a step not authorized by its charter whereby its stock, stockholders, assets, liabilities, and powers are enlarged. When it emerges, the rights of the original stockholders have been changed in material respects and it is because this is so that a taxable transaction results.

The two most recent decisions of the Supreme Court which appear to have a bearing upon the case are Weiss v. Stearn, 265 U. S. 242, and Marr v. United States, 268 U. S. 536. Both of these arose out of reorganizations by which the assets of a corporation were transferred intact to a new corporation. In Weiss v. Steam, it was held that no taxable transaction took place, in the course of its opinion the court says:

We cannot conclude that mere change for purposes of reorganization in the technical ownership of an enterprise, under circumstances like those here disclosed, followed by issuance of new certificates, constitutes gain separated from the original capital interest. Something more is necessary — something which gives the stockholder a thing really different from what he theretofore had.

In Marr v. United States, the court, holding that a taxable transaction resulted from the reorganization under consideration, said:

In Weiss v. Stearn, as in Eisner v. Macomber, the transaction was considered, in essence, an exchange of certificates representing the same interest, not an exchange of interests.
In the case at bar the new corporation is essentially different from the old.

Considering these two decisions, it appears that the determining point is not whether the corporate existence continues, but whether the interest of the stockholder changes.- In the instant case the interests of the stockholder before the merger and after the merger differed more radically than did the interests of the stockholders in Marr v. United States. What the taxpayer now has is essentially different from that which he had and an exchange has taken place which is properly subject to tax.

The deficiencies are redetermined to be the amounts determined by the Commissioner, which amounts are set forth in the findings of fact above. Orders of redetermination will be entered accordingly.


source: Caselaw Access Project

author: Tkammell

license: Public Domain

text:
    Appeal of TRIMOUNT THEATRES, INC.
    Docket No. 4132.
    Submitted March 6, 1926.
    Decided June 23, 1926.
    A certain leasehold held, to have had no value, at the time acquired, for invested capital purposes.

      Harry F. B. Dolan, Esq., for the petitioner.

      W. Frank Gibbs, Esq., for the Commissioner.
    Before QRaupnek  and Tkammell.
    This is an appeal from the determination of a deficiency for 1919 in the amount of $1,077.62. The taxpayer assigns error on the part of the Commissioner in refusing to allow, for invested capital purposes, any value for a certain leasehold which the taxpayer claims had a value of $100,000.
    FINDINGS OP PACT.
    The taxpayer is a Massachusetts corporation, organized June 14, 1918. During the taxable year it was engaged in the business of operating the St. James Theatre of Boston. On June 15, 1918, it acquired a lease from one Moses H. Gulesian on the St. James Theatre Building for a term of five years, commencing September 1, 1918, with the privilege of a renewal for an additional five years. The lease provided for an annual rental of $37,500 payable in 40 equal installments of $937.50 for the first five years and an annual rental of $42,500 for the second five-year period. The circumstances leading up to the lease were as follows:

      In 1913 the said theatre was leased to the Loew interests for a five-year period at an annual rental of $32,000, with the privilege of renewal for another five-year period at $31,500 per year. The first five-year period expired September 1, 1918. In the early part of 1918 the .Loew interests were dissatisfied with certain of the provisions of the lease and there was some doubt whether they would exercise the right of renewal at $37,500. The provisions objected to related to the reservation of a part of the building to Gulesian, the lessor, for office purposes, a theatre box for the lessor and family, and the extension of certain other privileges which led to personal disputes between the lessor and employees of the lessee. Feeling that the Loew interests might not accept a renewal of the lease, Gulesian obtained the services of a broker who specialized in negotiating theatre leases to obtain a tenant for him. This broker interested one George A. Giles in the lease. Giles was a real estate man who specialized in the building and managing of theatres and in buying and selling leases of theatres. Upon the refusal of the Loew interests to accept a renewal of the lease at $37,500 with the objectionable provisions above referred to, Gulesian agreed to lease the premises to Giles for five years at $37,500 and a five-year extension for $42,500, the lease, however, to retain certain provisions objected to by the Loew interests. Giles, not desiring personally to undertake the lease, formed the taxpayer corporation, with himself, his wife and two brothers as stockholders. Gulesian for some time refused toi make the lease to the taxpayer, and it was only after considerable' negotiations and the agreement of the taxpayer to pay $5,000 advance rent and to deposit certain securities, that he consented to do so.. After the lease was made, 198 shares of the par value of $100 each were issued to Giles, 116 shares to his wife, 400 shares to each of his brothers, and a few qualifying shares to others. His wife and brothers were instrumental in securing the cash and securities required to obtain the lease, viz, $5,000 advance rent and $15,000 in securities to be deposited as security, and $8,500 required to purchase the personal property left in the premises by the former lessee.
    The taxpayer commenced to operate the theatre as a moving picture and vaudeville house on September 1, 1918. Being a newcomer in this field, it experienced difficulty in getting suitable vaudeville acts and was put to much additional expense in getting the business started on a profitable basis. From September 1, 1918, to December 31, 1918, it suffered a loss of $41.55. In 1919, however, the taxpayer came to be recognized by the booking houses and was able to get suitable vaudeville and other attractions. In that year it made a net profit of $11,613.61, and in 1920 made a net operating profit of $53,735.23.

      On December 28, 1920, the taxpayer sold its lease to George A. Giles Co., a corporation, receiving $40,000 par value of its capital stock. On June 1, 1921, the taxpayer purchased the interest of the said Gulesian in the property, including store rooms on the first floor, for $150,000, and thereafter continued only as a holding company. The George A. Giles Co., after September 21,1921, commenced to operate a theatre with a stock company and abandoned the moving-picture and vaudeville business for the reason that the Loew interests had erected a new and larger theatre in the same block. The George A. Giles Co. during 1921 made a profit of about $40,000; in 1922, $29,000; and in 1923, $27,000; and for the remainder of the term about $25,000 to $30,000 per year.
    In August, 1925, the taxpayer leased the theatre to the Keith interests for seventeen years, at an annual rental of $50,000 for the first eight years and $52,000 for the balance of the term. The new lessee was also required to pay for other items, amounting to $2,000 or $3,000 per year, that the taxpayer did not have to pay under the original lease of Gulesian to the taxpayer.
    The St. James Theatre -was located near the junction of Massachusetts Avenue and Huntington Avenue, the two principal thoroughfares of Boston, in a rapidly growing section of the city. It was in the center of a densely populated district. In the vicinity was the Horticultural Hall, the Mechanics Building, the Boston Opera House, the Y. M. C. A., and several schools and colleges. Numerous lodging houses, a large student population and people of moderate means were located in this district.

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

   OPINION.

Tkammell

: The taxpayer contends that the leasehold in question was paid in for stock and was worth $100,000, and that that sum should be included in invested capital. The Commissioner contends that (1) the leasehold was not in fact paid in for stock of the taxpayer ; (2) if it was paid in for stock the value, for invested capital purposes, could not exceed the cost to the previous owner under the provisions of section 331 of the Revenue Act of 1918; and (3) it had no value in excess of the stipulated rentals at the time acquired.

We will discuss the last contention first. The taxpayer, in support of its valuation, presented the evidence of several witnesses whose training and experience in dealing in such properties qualified them to express their opinions with respect to values. They expressed opinions that the value of the leasehold at the time of acquisition was from $100,000 to $125,000. We believe, however, that these witnesses did not take into consideration all of the actual condi-tioils and circumstances existing which would reflect the actual cash value of the lease, but if they did, we must bear in mind that it is only the actual cash value of the leasehold at the time it was alleged to have been paid in for stock that is material. In other words, the amount that a willing purchaser would give and a willing seller would take. In this appeal we find an experienced buyer and seller dealing at arm’s length, negotiating back and forth, who finally, after considerable negotiations, agreed upon the terms and conditions that another theatrical organization (former lessee), although well able financially to pay the rental and although it desired to have a theatre in that locality, refused to accept. From the evidence it appears that Mr. Gulesian built the theatre in 1911 on property held by him under a long-term lease. In 1913 he leased it to the Loew interests for $32,000 for five years, with a renewal privilege for five years more at $37,500. He retained his private office in the theatre; he had a box reserved for his exclusive use and required weekly payments of the rent. He was in daily contact with the business and must have known what business the theatre was doing or was capable of doing. In fact his close personal contact was such that it was objectionable to the Loew interests. It being doubtful whether the Loew interests would renew at $37,500 under the terms of tne lease, we find Gulesian, early in 1918, searching for another tenant. He employed an experienced theatrical broker to obtain a tenant. This broker put him in touch with Giles, who was also an experienced theatrical man. Their negotiations resulted in a lease at $37,500, containing practically as stringent terms as those objected to by the Loew interests. Gulesian required the taxpayer to pay $5,000 advance rent and to deposit $15,000 collateral as security for future rentals. The Loew interests must have been familiar with the future possibilities of this location for a theatre, as they had been operating there for five years. They refused to renew at $37,500. -A representative of the Loew interests testified that he was surprised that Gulesian could get another tenant at the same terms. So we have a situation where former lessees refused a renewal on substantially the same terms accepted by the taxpayer; where the lessor being fully advised of the conditions voluntarily made the lease; where an experienced theatrical broker, acting for the lesser, sought the best terms for his client; and where the taxpayer, under the management of an experienced theatrical man, accepted the lease and on the terms mentioned. All parties were dealing at arm’s length. How, under such conditions, can we hold that the actual cash or market value at that time was in excess of the amount arrived at by the parties ? This evidence of the actual transactions at the time, under the circumstances, to our mind, has greater weight than the opinions of witnesses as to value. At the time the lease was executed we are not convinced that it had an actual cash value in excess of the annual rentals. See Appeal of Saenger Amusement Co., 1 B. T. A. 96.

If it be conceded, however, that the lease had in fact the value claimed by the taxpayer, it is not shown to have been acquired for stock. The stock was issued to Giles, his wife and two brothers. These individuals did not have the lease, nor did Giles have it. The corporation was the lessee from Gulesian and it issued no stock to him. The most that can be said is that Giles had a verbal agreement for the lease and he desired to have the lease made to the corporation instead of to himself. It was only after considerable negotiations and. additional consideration, in the way of advance rent and collateral, that the landlord finally consented to make the lease to the corporation. There is no evidence that any option to lease was assigned to the corporation, and if it was it is not shown to have had any value as the landlord did not feel himself bound and did not make the lease to the corporation based on any option, but made an entirely new arrangement on different terms.

On either of the above propositions, the determination of the Commissioner must be approved, and it is not necessary to discuss the contention of the Commissioner as to the applicability of section 331 of the Revenue Act of 1918.

The deficiency is $1,077.62. Order will he entered accordingly.


author: Geaupner:

text:
    Appeal of THE PRECISION MACHINE CO., INC.
    Docket No. 3104.
    Submitted February 23, 1926.
    Decided June 23, 1926.
    Proof insufficient to determine debt to be worthless.

      Otto E. Koegel, Esq., for the petitioner.

      Arthur II. Murray, Esq., for the Commissioner.
    Before Graupner and Trammell.
    This is an appeal from the determination of a deficiency in income tax for the calendar year 1919 in the amount of $14,171.85. The deficiency arose from the disallowance by the Commissioner of a deduction for an alleged worthless debt.
    FINDINGS OF FACT.
    The petitioner is a New York corporation with its principal office at 317 East Thirty-fourth Street, New York. Its business is the manufacture and sale of motion-picture machines.

      The C. & H. Manufacturing Co., hereinafter referred to as the C. & H. Co., is a New York corporation organized April 21, 1913, for the development and manufacture of a high speed motion-picture camera.
    Frank C. Cannock, the secretary of the taxpayer company, was the inventor of a motion-picture machine which the C. & H. Co. was endeavoring to develop. He was the owner of the majority of stock in and the moving spirit of the latter company. The experimental room of the C. & H. Co. was located on the premises occupied by the taxpayer.
    The C. & H. Co. had no funds of its own and, from time to time, as money was needed to meet the expenses of- development and to pay bills, the taxpayer advanced the amounts required. The advances made during a period from some time in 1913 to November 30, 1919, totaled $37,265.24. Of this amount $1,729.57 was advanced after Cannock’s death on January 9, 1919.
    Prior to Cannock’s death, efforts were made to sell the motion-picture machine. In 1918, a Mr. Evans, with whom some negotiations were had for a sale, put a price of $50,000 on the camera, which at that time was still to a great extent incomplete. These negotiations did not result in a sale.
    After the death of Cannock, various parts, dies, tools and equipment, which were in the custody of the C. & H. Co., Avere taken over by the taxpayer. Their value was appraised by the superintendent of the taxpayer company at $2,265.24 and they were placed in the stock of the taxpayer. The amount of the appraisal was credited to the C. & H. Co. on the books of the taxpayer. The manager and cashier of the taxpayer, after some investigation of the camera and its prospects, decided they were not sufficiently familiar with that field and advised the company to abandon the matter.
    At a conference between the manager and the bookkeeper and a Mr. Friedman, who was one of the attorneys for the taxpayer, it was decided to charge off the balance remaining after crediting the original indebtedness of $37,265.24 with the appraised value of the inventory taken over. The amount of $35,000 was charged off the books of the taxpayer in December, 1919.
    The C. & H. Co. is still in existence.

       This decision -was prepared by Mr. Graupner during Ms term of office.

   OPINION.

Geaupner:

It is contended in substance that the taxpayer relied for repayment mainly on the inventive genius of Cannock, and that after his death nothing remained except possibly the parts and tools which were taken over, and that there was nothing out of which the debt could be satisfied. If this had been established the taxpayer might be entitled to prevail.

It was shown that the last advance was made November 30, 1919, almost eleven months after Cannock’s death, so it may reasonably be presumed that the taxpayer had expectations of collecting the amount due it without recourse to Cannock. Yet the debt was charged off some time in the following month, the exact date not being shown. There is evidence to the effect that “all manner of means ” to collect the debt were attempted, but of what these attempts consisted or when they were made we have no knowledge. As we held in the Appeal of Valdosta Grocery Co., 2 B. T. A. 727, evidence of efforts made to collect a debt, unaccompanied by a showing of what those efforts were or why they failed, is insufficient.

There is also the fact to be considered that the C. & H. Co. is still in existence. While one of the witnesses testified the company was “ dormant,” in the same breath he stated he did not know whether the'company was doing any business. Apparently no steps were ever taken by the taxpayer to liquidate the company. While a creditor is not required to resort to legal remedies to establish the worthlessness of a debt, the fact that he did not, with no facts establishing a reason for not doing so, is matter for consideration.

Upon the whole evidence, we are of the opinion that the worthlessness of the debt has not been established.

The deficiency is $14-,.171.85. Order will be entered accordingly.


author: Trammell:

text:
    Appeal of BOB H. McGINNIS.
    Docket No. 6647.
    Submitted February 23, 1926.
    Decided June 23, 1926.
    Under the facts, held, that merchandise actually purchased, whether the price was fully paid or not, and sold during a taxable year, should be added to purchases during the year, even if the taxpayer was on the cash receipts and disbursements basis.

      Paul E. iShorb, Esq., and Harold G. Anderson, O. P. A., for the petitioner.

      F. O. Granes, Esq., for the Commissioner.
    Before GeattpNer  and Trammell.
    This appeal involves a deficiency in income tax for 1919 in the amount of $1,446.89. The deficiency arises on account of the inclusion by the Commissioner, in the closing inventory of 1919, of cotton in the amount of $8,688, and on account of the exclusion, from the cost of cotton sold, of 14 bales which cost $2,074.09, upon the ground that that amount of cotton Avas not purchased during 1919.
    FINDINGS OF FACT.
    The taxpayer was an individual residing at Cartersville, Ga. He was engaged in the business of buying and selling cotton. He had a large quantity of cotton stored in a warehouse at Taylorsville, Ga. He also had cotton stored in warehouses at Cartersville, Calhoun, Rockmount and Stilesboro, in the same State. The inventory of cotton on hand at the end of the year 1919 was increased by the Commissioner in the amount of $8,688 over that reported by the taxpayer. Some cotton during 1919 was transferred by the taxpayer from the Taylorsville warehouse to the Cartersville warehouse.
    The taxpayer acquired by purchase 14 bales of cotton during 1919, which he sold during that year. The cotton cost $2,074.09. It was purchased from a person who ivas indebted to the taxpayer and it was not known at the time of the purchase exactly how the account stood between them — whether the purchase of the cotton would balance the account or Iioav much Avould be owing over the amount of the indebtedness. A part of the purchase price of these 14 bales of cotton was paid in 1920, when an agreement Avas reached on the account betAveen the parties.
    Inventories were taken by taxpayer on the basis of cost. The cost of this cotton should be added to purchases during the year 1919.

       This decision was prepared daring Mr. Graupner’s term of office.

   OPINION.

Trammell:

In the absence of convincing evidence that the action of the Commissioner was erroneous in increasing the closing inventory by $8,688, we must approA^e his action. There was testimony that the inventory representing cotton at the Taylorsville warehouse wTas included in the inventory taken at the Cartersville warehouse. The evidence introduced by the taxpayer, however, was not definite and posit^e. Neither of the Avitnesses testified positively of his oaaui knoAvledge that the cotton at the Taylorsville Avarehouse was in fact included in the inventory.

With respect to the 14 bales of cotton acquired by the taxpayer and sold by him during 1919, we have found as a fact that it was actually purchased during that year. The fact that a part of the payment was not made until 1920 is not sufficient to hold that it should not be included in the 1919 purchase, although the taxpayer was on the cash receipts and disbursements basis. The cotton was purchased and actually sold during 1919. The fact that a part of the purchase price was not paid until '1920 might be evidence that the goods were not jiurchased until that year, since there was testimony that the taxpayer Avas on a cash basis. But the other facts overcame this evidence. Goods actually bought and sold during a year should be added to purchases made during the year in order to reflect the income properly attributable to the year. It is not necessary to decide whether the taxpayer was on the cash basis or the accrual basis, as in any event the above rule is correct with respect to goods actually purchased and sold during a year.

Order of redetermination will be entered on 10 days' notice, under Rule 50.


author: James:

text:
    Appeal of S. J. HARRY CO.
    Docket No. 1644.
    Submitted May 10, 1925.
    Decided June 25, 1926.
    1. Salaries paid or credited to a corporation’s officers under authority of resolutions duly adopted by its board of directors, held to have been reasonable compensation for services of such officers.
    2. The taxpayer was a subcontractor on the construction of the Shandaken Tunnel for the New York City water supply system. During the taxable years the city retained a percentage of the contract price from the principal contractor, and the principal contractor from the taxpayer, the amount retained to be released upon the satisfactory completion of the entire contract. The principal contractor defaulted, and in 1920 the taxpayer and other contractors continued the work, taking over all the liabilities and assets of the principal contractor, and organizing a new corporation for that purpose. Held, that the taxpayer did not derive taxable income as to the amounts retained by the city during the years here in question, and on the reorganization completed a closed transaction whereby it exchanged its contingent claims for capital stock in the new company, at that time the stock having no “ fair market value.”

      Arthur B. Foye, O. P. A., and Arthur J. Farber, O. P. A., for the petitioner.

      Willis D. Nance, Esq., for the Commissioner.
    Before James, Smith, and TRUssell.
    This is an appeal from the determination of deficiencies for the years 1919 and 1920, in the amounts, respectively, of $8,969.05 and $356.74, offset by an overassessment for the year 1918 in the amount of $704.70, — a net deficiency of $8,621.09.
    The taxpayer alleges error in the determination of the Commissioner in the disallowance of certain salaries incurred and paid, which are alleged to have been excessive, and from the determination of a profit arising from the acquisition by the taxpayer of $175,000 par value of stock of the Shandaken Tunnel Corporation under circumstances more fully set forth below.

      FINDINGS OF FACT.
    The taxpayer is a Pennsylvania corporation with its principal office at Connellsville. It is engaged in the business of general contracting, with particular reference to the sinking of shafts, driving of tunnels, and like work.
    Prior to May 22, 1918, the Degnon Contracting Co. of New York City had a contract for the construction of eight shafts for the Shan-daken- Tunnel of the Schoharie Water-Shed Development for the water supply of New York City. On that date the taxpayer entered into a contract with the Degnon Co. whereby it undertook to carry out the work of sinking the said shafts, at rates of compensation therein provided. As one of the conditions of the contract held by the Degnon Co. the Board of Water Supply of the City of New York retained a certain percentage of payments provided to be made as the contract progressed, the ultimate payment of such retained percentages being contingent upon the final acceptance of the work by the Board of Water Supply. In conformity with that provision of the principal contract, the contract between the Degnon Co. and the taxpayer, among other provisions, stipulated:

      Ninth: The said contractor shall pay to the subcontractor monthly payments on or about the 20th day oí each month which said payments shall be for ninety (90) per cent of the labor performed during' the preceding month. Full and final payment shall be made thirty (30) days after the completion of said work, and acceptance by the Board of Water Supply of the city of New York.

      Tenth: In the event the said contractor shall default in the payment of any monthly installments due and owing to the subcontractor, under the terms of this agreement, for the period of thirty (30) days, upon ten (10) days’ notice in writing to the contractor then and in that event the subcontractor may, at its option, terminate this agreement, and shall not be obligated to perform any further work hereunder.
    The taxpayer proceeded with the construction work and during the years 1918, 1919, and 1920 earned the amounts and was subjected to the retained percentages under its contract as set forth below:

      Prior to July 20, 1920, the Degnon Co. found itself financially unable to continue with its principal contract and unable to meet its obligations to the taxpayer and other creditors. Thereupon, substantially all the creditors interested in the so-called Shandaken tunnel project met and determined upon a plan of reorganization whereby the work might be completed and they might be enabled to realize from it as much of the anticipated profits as possible, or minimize the losses to the greatest possible extent. S. J. Harry, president of the taxpayer, was chairman of the creditors’ committee.
    As a result of the work of this committee, a plan of reorganization was outlined, which involved the furnishing of $750,000 additional capital, to be secured by the sale of 7,500 shares of class A preferred stock. As a second step, the creditors of the then Degnon Co. were to receive class B preferred stock to the full amount of their claims, which claims were to be transferred to the Shandaken Tunnel Corporation, the name of the proposed new company.
    Common stock was provided to be issued by the Shandaken Tunnel Corporation — 75 per cent to the holders of class A stock and 25 per cent to the Degnon Contracting Co.
    As a result of the above-mentioned reorganization, the taxpayer received $175,000 par value of the class B stock of the Shandaken Tunnel Corporation during the year 1920, and the Shandaken Tunnel Corporation received a transfer of the assets of the Degnon Contracting Co. and the claims of the taxpayer and the other participating creditors against that company. The Shandaken Co. thereupon proceeded with its work and the taxpayer proceeded under its subcontract.
    Under the reorganization plan as adopted, provision was made that a fee of $500,000 be paid to the Ulen Contracting Corporation, which had participated by contributing one-third of the payment for class A stock; that class A stock should be retired, and thereafter that class B stock, in which the taxpayer participated, was to receive payments pro rata until also retired. This was subsequently modified whereby the fee to the Ulen Contracting Corporation was reduced to $250,000, except that, as to the remaining $250,000, it participated with the class B stock in a distribution in which each shared equally until both should be paid.
    The operations of the Shandaken Tunnel Corporation under the contract as assigned to it were continued and completed in the latter part of the year 1924. In January, 1925, the taxpayer received from the Shandaken Tunnel Corporation a liquidating dividend on its class B stock in the sum of $41,431.78. • The Shandaken Tunnel Corporation at that time, and at the time of the hearing of this appeal, did not have assets sufficient to pay the full par value of the taxpayer’s stock on liquidation, and the best estimate of its officers was to the effect that its total distribution would not exceed $51,000.
    On May 1, 1918, at a special meeting of the board of directors of the taxpayer company, held at its offices at Connellsville, Pa., the following resolutions were adopted and entered upon the record of such meeting:

      Resolved, That the president and secretary of the S. J. Harry Oo. are hereby authorized to enter into an agreement with the Degnon Contracting Co. of New York, N. Y., for the sinking and concreting of 8 shafts, driving a tunnel, and any other work that might be specified in said agreement.

      Resolved, That the president’s salary from July 1, 1918, to January 1, 1919, be at the rate of $15,000 per annum and from January 1, 1919, at the rate of $20,000 per annum; the salary of Mary E. Harry to be $2,400 per annum from January 1, 1919. * * * The secretary-treasurer’s salary from July 1, 1918, to January 1, 1919, to be at the rate of $7,200 per annum, and from January 1, 1919, at the rate of $15,000 per annum. * * *
    During the years 1919 and 1920 the taxpayer corporation charged itself upon its books and records, and in its income and profits-tax returns for such years claimed deductions, for salaries of its officers as follows:

    The taxpayer, in making its returns in the first instance, undertook to return its income from the Shandaken Tunnel operation upon the basis of completed work, and included therein all of the retained percentage. When it became apparent that the retained percentage would not be fully realized, it undertook to file amended returns for those years prior to the year 1920 in which the reorganization took place. The Commissioner refused to compute the tax liability upon the basis of sucb amended returns, adhered to the basis upon which the taxpayer’s original returns had been made, and treated the reorganization in 1920, wherein the taxpayer received $175,000 par value of stock in the Shandaken Tunnel Corporation, as a closed transaction in which the taxpayer realized the full $175,000 at that time from the reorganization.
    The Commissioner, in determining the tax liability of the taxpayer for the years 1919 and 1920, disallowed deductions of $17,000 and $12,000, respectively, in the determination of reasonable salaries.
    The taxpayer kept its accounts and made its returns upon the accrual basis.

       Tills decision was prepared by Mr. James during his term of office.

   OPINION.

James:

The salaries paid by the taxpayer as compensation to its officers during the years 1919 and 1920 have been reduced by the Commissioner and net taxable income increased by the amount of such reduction. It appears that in May, 1918, at about the time the taxpayer was preparing to begin operations under the contract for constructing a portion of the work required for increasing the water supply of New York City, the taxpayer’s board of directors held a meeting, and then agreed upon, and spread upon the corporate records, the amounts of officers’ salaries which the taxpayer company should pay during the period that work under the above-mentioned contract should continue. The president was voted a salary of $20,000 per year beginning January 1, 1919, and the secretary-treasurer $15,000 per year beginning on the same date. According to the record of this appeal, the work undertaken by the taxpayer in carrying out its contract involved expenditures for labor and material during the year 1919 in the amount of $571,364.28 and, had the work continued throughout the year 1920, there is no reason to doubt that the volume of disbursements for the latter period might have been equal to or in excess of the amount for the year 1919. We are of the opinion that, in view of the volume of the work and the duties and responsibilities of the managing officers of the taxpayer company then undertaken, that work was of such a character that the salaries provided for were not unreasonable, and that, in recomputing the tax liability of this taxpayer for the years 1919 and 1920, the deductions on account of compensation of officers claimed by the taxpayer should not be disturbed.

Operations under the contract between the taxpayer and the Degnon Contracting Co. continued over a period from May, 1918, to some time in the spring or early summer of 1920, when they were terminated by the insolvency of the Degnon Contracting Co. The terms of this contract appear to have been such that the taxpayer was able each month to compute the amount of compensation for which it had performed labor and furnished material; and it was also able to compute the cost of the labor and material entering into that part of the work performed, and for each of such months advances were made to the taxpayer, presumably equivalent to 90 per cent of the contract price on work completed at that time. Based on these monthly accounts the taxpayer appears to have estimated that during the year 1918 it had earned a profit of $3,521.95 and for the j^ear 1919, $69,004.79, and in making its income and profits-tax returns for those years it included the last-mentioned amounts of apparent gains fropi operations under this contract. It paid the full amount computed as tax for the year 1918 and one-fourth of the amount computed as tax for the year 1919. In the spring of 1920, and prior to the time when the second-installment of the 1919 tax was due to be paid, the insolvency of the Degnon Contracting Co. had become known, and active operations under the contract apparently had ceased. The taxpayer thereupon filed a claim for abatement of the amount of the three unpaid installments of the tax as computed by it for the year 1919. At this time there was still due and owing to the taxpayer retained percentages under its contract aggregating $175,000, and this taxpayer, together with all the other creditors of the Degnon Contracting Co., faced the possibility of the cancellation of the contract between the Board of Water Supply of the City of New York and the Degnon Contracting Co., and the consequent entire loss of all amounts owing to the creditors from the Degnon Contracting Co. If such cancellation had occurred the taxpayer, instead of having an apparent gain, would have suffered a loss of $90,831.71. While facing this situation the creditors of the Degnon Contracting Co. succeeded in formulating a plan by means of which the contract between the Board of Water Supply of the City of New York and the Degnon Contracting Co. could be completed. In carrying out such plan the taxpayer exchanged its claim of $175,000 against the Degnon Contracting Co. for $175,000 of the class B preferred stock of the succeeding Shandaken Tunnel Corporation.

The Commissioner has taken the position that, when the taxpayer exchanged its claim against the Degnon Contracting Co. for stock of the Shandaken Tunnel Corporation, the taxpayer received final settlement on its contract, and, assuming that the class B preferred stock of the Shandaken Tunnel Corporation had a fair market value equal to its par, the Commissioner has asserted that the taxpayer realized its gain from operations under the Degnon contract and that it is therefore indebted to the United States for income and profits-taxes in the amount not only of the three unpaid installments for which a claim for abatement was made, but also for additional deficiencies aggregating $9,325.79 for the two years 1919 and 1920.

The first question here involved is whether the taxpayer, during the years 1918 and 1919 when it was performing work under the original Degnon contract, was in receipt of taxable income. This question in turn hinges upon the treatment of the retained percentages of the contract price, which percentages corresponded to those retained by the City of New York from the Degnon Co., and were contingent so far as payment to the taxpayer was concerned, upon the ultimate completion of the work, not only by the taxpayer, but by all other subcontractors and the principal contractor itself. Articles ninth and tenth of the contract between the Degnon Co. and-the taxpayer are significant upon this point, and read as follows:

Ninth: The said contractor shall pay to the subcontractor monthly payments on or about the 20th day of each month which said payments shall be for ninety (90) per cent of the labor performed during the preceding month. Full and final payment shall be made thirty (-30) days after the completion of said work, and acceptance by the Board of Water Supply of the city of New York.
Tenth: In the event the said contractor shall default in the payment of any monthly installments due and owing to the subcontractor, under the terms of this agreement, for the period of thirty (30) days, and upon ten (10) days notice in writing to the contractor then and in that event the subcontractor may, at its option, terminate this agreement, and shall not be obligated to perform any further work hereunder.

In its estimate of accrued income for tbe taxable years 1918 and 1919 the taxpayer included in gross income the amounts withheld under the foregoing provision. This we believe was erroneous. These amounts were neither paid to the taxpayer nor placed at its disposal, nor did they accrue to it in the sense of becoming due and payable. Whether these amounts would ever be received depended upon circumstances over which the taxpayer had no control. We express no opinion as to the significance of such items in respect of a principal contractor, but as respects the taxpayer here, it must be clear that the amounts retained by the City of New York and also by the principal contractor from the subcontractor taxpayer could not, in any respect, represent accrued income to it. In 1918 and 1919, therefore, we must find that the net income of the taxpayer has been overestimated in the amounts, respectively, of $24,168.58 and $109,574.05. The deficiency for those years should be recomputed in accordance with the foregoing.

This brings us to a consideration of the year 1920. During that year there was retained an additional amount 'of $41,257.87. It does not appear whether all of this represented retained percentage or whether some portion of it represented a claim due from the Degnon Contracting Co. prior to the collapse of that company. Since this amount was retained and the settlement was made in 1920, in the view we take of the matter, this is immaterial.

In connection with the plan of reorganization, the taxpayer here accepted class B preferred stock in exchange for its claim against the Degnon Contracting Co., if any there were, for amounts accrued but not paid, and, in addition thereto, for its contingent claim to that portion of the retained percentage held by the City of New York to which it would become entitled upon the satisfactory completion of the entire contract. This amounted to $175,000 of face or par value. In our opinion the computation of gain or loss under this exchange is controlled by section 202(b) of the Revenue Act of 1918, which reads as follows:

When property is exchanged for other property, the property received in exchange shall for the purpose of determining gain or loss be treated as the equivalent of cash to the amount of its fair market value, if any; but when in connection with the reorganization, merger, or consolidation of a corporation a person receives in place of stock or securities owned by him new stock or securities of no greater aggregate par or face value, no gain or loss shall be deemed to occur from the exchange, and the new stock or securities received shall be treated as taking the place of the stock, securities, or property excl.anged.
When in the case of any such reorganization, merger or consolidation the aggregate par or face value of the new stock or securities received is in excess of the aggregate par or face value of the stock or securities exchanged, a like amount in par or face value of the new stock or securities received shall be treated as taking the place of the stock or securities exchanged, and the amount of the excess in par or face value shall be treated as a gain to the extent that the fair market value of the new stock or securities is greater than the cost (or if acquired prior to March 1, 1913, the fair market value as of that date) of the stock or securities exchanged.

It is apparent that that portion of the above-quoted section of the statute which deals with reorganizations has no application here. Tbe Sliandalten Tunnel Corporation was a new corporation organized to complete the contract of tbe Degnon Contracting Co. and had no relation to that company other than the fact that it grew out of the operations in which that company had failed. We have, then, the simple case of the exchange by tbe taxpayer in 1920 of a claim against the Degnon Contracting Co., for the most part contingent, and the cost of which is not disclosed, for a par value of stock representing its hope and expectancy to receive upon its completion of its contract the total contract price which the Degnon Contracting Co. had theretofore agreed to pay. This was the property received in exchange under the above-mentioned section. It is to be treated as income to the taxpayer to tbe amount of tbe difference between the cost of the claim and the fair market value, if any, of the stock received in exchange therefor. It may be deducted as a loss by the taxpayer in 1920, in accordance with the difference between the cost of the claim and the fair market value, if any, of the stock received in exchange therefor if actually less than cost. Whatever value is determined forms the basis of a determination of profit when and if the Shandaken Tunnel Corporation is ever liquidated and a final distribution of its assets is bad. The ultimate value of this class B stock depended entirely upon the future performance, both of this taxpayer and of others associated with it in the venture after the collapse of the Degnon Contracting Co. In our opinion, the stock had no fair market value at the time it was exchanged for the claim of the taxpayer against the Degnon Contracting Co. and the taxpayer carried forward the class B stock at the then unliquidated cost of its completed work included in the unpaid claim for $175,000, final computation of gain or loss upon such stock to be determined upon the liquidation of that stock at the difference between the amount received in such liquidation and the cost of its completed work included in the claim against the Degnon Co.

Order of redetermination will be entered on 15 days' notice, under Bule 50.

SterNhageN dissents.

Phillips concurs in the result only.