author: SteRNhagen : Leech,

text:
    West Town State Bank, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 59060.
    Promulgated April 30, 1935.

      Willis D. Nance, Esq., for the petitioner.

      Olaude B. Marshall, Esq., for the respondent.
   OPINION.

SteRNhagen :

The Commissioner determined a deficiency of $10,984.64 in petitioner’s income tax for 1928. He disallowed deductions for donations and obsolescence. In its petition, the bank assailed the disallowance of the obsolescence deduction and the refusal to recognize a resulting net loss. The Commissioner, by an amended answer, set up an additional profit of the petitioner in 1928 from a condemnation award, and claimed an increase in the deficiency. No reply was filed, and hence the allegations of new matter must be taken as admitted, F. O. Statler, 27 B. T. A. 342. When the case came on for trial, petitioner’s attorney called attention to section 22, Act of March 1, 1879, 20 Stat. 351; 12 U. S. Code Annotated 570, stated that the bank was closed by order of the State Auditor of Illinois after the petition was filed in this proceeding and that its assets were held by a receiver, and offered in evidence an affidavit of the receiver, which, there being no objection, was received in evidence. The affidavit is in the margin. This constitutes the record in the case. The Commissioner, after the case was submitted, assessed the deficiency, and notified the Board in accordance with Bevenue Act of 1928, section 274.

Normally there would be no doubt that the petitioner’s lack of evidence would entitle the Government to a judgment for the deficiency originally determined, Avery v. Commissioner, 22 Fed. (2d) 6; Bishoff v. Commissioner, 27 Fed. (2d) 91, and the amount of increase affirmatively pleaded in the answer and admitted by the failure of reply, F. O. Statler, supra.

But petitioner’s position seems to be (although no argument has been submitted in its behalf), that, no matter what the deficiency, the Act of March 1, 1879, requires the Board to render a judgment of no deficiency. The respondent argues that that act is not within the Board’s jurisdiction to consider, and that even though facts appear in the record before the Board showing that the 1879 Act is squarely applicable to prohibit assessment and collection or require abatement, the Board must nevertheless enter a judgment for the full amount of the claimed deficiency as if no such statute were in existence. The Board, it is said, is confined to a consideration alone of the revenue statutes.

Although, as will appear, the decision must stand upon another ground, we must reject the Commissioner’s argument. It would restrict the Board to a merely academic function having no regard for substantial rights and liabilities. We may not so far close our eyes to the law as to adjudicate as a deficiency or a transferee liability an amount which by the Constitution or a supervening statute or decision may not legally be imposed or exacted. This was held at the beginning of the Board’s existence and has since been consistently adhered to, National Refining Co. of Ohio, 1 B. T. A. 236; New York, Ontario & Western Railway Co., 1 B. T. A. 1172, 1182; Leah Brunt, Executrix, 5 B. T. A. 134; Independent Life Insurance Co. of America, 17 B. T. A. 757; American Security & Trust Co. et al., Executors, 24 B. T. A. 334, 346. See W. P. Brown & Sons Lumber Co. v. Burnet, 282 U. S. 283; Helvering v. Independent Life Insurance Co., 292 U. S. 371. For the Board to pass upon a computation of a hypothetical amount which is without substance and which may not be assessed or collected is analogous to the determination by the Court of Claims of nominal damages; and it has been held by the Supreme Court, with no more express statutory support than is here, that the Court of Claims has no such jurisdiction. Nortz v. United States, 295 U. S. 317; Grant v. United States, 7 Wall. 311, 338; Marion & Rye Valley Ry. Co. v. United States, 270 U. S. 280.

We, therefore, shall consider whether, in view of the Act of 1879, the deficiency, otherwise admittedly correct, must be set aside. We find that the terms of that statute have not been met. The receiver’s affidavit is a mere estimate that what in his opinion may reasonably be expected to be realized from the liquidation of the bank’s assets and the assessments against stockholders will not be sufficient to pay depositors in full. The statute, however, is conditioned upon the fact of insolvency and the fact, not an estimate by the receiver, that the tax shall diminish the bank’s assets below the amount necessary for the full payment of all its depositors; and the abatement is conditioned upon the facts appearing to the Commissioner of Internal Revenue. In all likelihood the Commissioner may not arbitrarily ignore the facts which properly are made to appear to him, but there is no indication in this case that he has done so. The receiver has merely stated that the bank is insolvent and its assets and stockholders’ assessments will not, in his opinion, be sufficient to pay depositors in full. This is not sufficient to bring the Act of 1879 into operation, cf. Johnston v. United States, 17 Ct. Cls. 157; Jackson v. United States, 20 Ct. Cls. 298.

The respondent may have judgment for the amount of the deficiency as increased.

Beviewed by the Board.

Judgment will be entered under Bule 50.

Leech,

concurring: In my judgment, the provision of the Act of 1879, quoted in the majority opinion, has to do with an administrative function of Federal tax collection, outside the statutory jurisdiction of this Board. I agree, therefore, only, with the result reached in that opinion.

As the majority opinion indicates, if we have jurisdiction here on any ground, to adjudicate petitioner’s rights under the quoted provision, then, that adjudication is conclusive unless reversed upon review. A finding of fact, possible, in my opinion, even upon the present record, that the petitioner was entitled to the benefit of the quoted act, would require a decision of no deficiency upon that finding. In such circumstances, if the bank in receivership were to become able to pay the disputed tax without loss to its depositors, within the statutory period for assessment and collection of the disputed tax, a practical possibility, no part of the pending deficiency could be collected. On the other hand, assuming the correctness of the conclusion of fact upon which the majority opinion is based, as soon as the decision entered upon that opinion becomes final, the taxpayer bank, and, a fortiori, its depositors, can not have the relief provided for them in the act even though the fact, upon which, alone, the benefit of the statute depends, admittedly arose later during the receivership — a similar possibility. I think those results obviously repugnant to the expressed statutory intendment, which is limited to the relief of depositors in such banks. The basis for or bar to that relief is not necessarily permanent, but exists, only, concurrently with the factual premise supporting it. The legislative intention is merely to constitute the depositors in such banks, preferred creditors as to the Government’s tax claims under the circumstances provided in the act. To permit the conclusive adjudication of a right to that preference before satisfaction of the depositors or final liquidation of the pending receivership, is wholly irreconcilable with that intention.

AruNdell agrees with the above.

Smith dissents from the majority opinion.

       § 570. Insolvent VanJcs as exempt from tax. whenever and after any bank . has ceased to do business by reason of insolvency or bankruptcy, no tax shall be assessed or collected, or paid into the Treasury of the united States, on account of such bank, which shall diminish the assets thereof necessary for the full payment of all its depositors ; and such tax shall be abated from such national hanks as are found by the Comptroller of the Currency to be insolvent; and the Commissioner of Internal Revenue, when the facts shall so appear to him, is authorized to remit so much of said tax against insolvent State and savings banks as shall be found to affect the claims of their depositors. (Mar. 1, 1879, c. 125, § 22, 20 Stat. 351; Mar. 3, 1883, c. 121, § 1, 22 Stat. 488).

       Thomas B. Roberts being duly sworn on his oath states he is in possession of West Town State Bank, 2400 West Madison Street, Chicago, Illinois, having been appointed Receiver by the Auditor of Public Accounts of the State of Illinois on the 21st day of July, 1931, and that certified copy of his certificate of appointment is now on file with the Commissioner of Internal Revenue, same having been lodged with the Public Relations Division of the Bureau of Internal Revenue.
      Deponent further states that the above named bank ceased to do business by reason of insolvency on or about the 11th day of June, 1931.
      Deponent further states that the amount which may reasonable [sic] be expected to be realized from the liquidation of the assets of the bank together with the amounts which may reasonable [sic] be expected to be realized from assessments against stockholders, will not in the aggregate be sufficient to pay depositors in full, and it is respectfully requested that proper application be made to this taxpayer of the benefits ot the Act of March 1, 1879, Title 12 U. S. Code (annotated) Section 570;
      Particular reference is made to any unpaid taxes of record or proposed to be assessed, and in addition to any taxes imposed by the Revenue Act of 1932, including taxes on checks and stamp taxes on stocks, bonds, mortgages, etc.
      Further deponent sayeth not.


source: Caselaw Access Project

author: McMahon:

license: Public Domain

text:
    North American Coal Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 51712, 52492.
    Promulgated April 30, 1935.

      G. F. Taflin, Esq., for the petitioner.

      Allin H. Pierce, Esq., for the respondent.
   OPINION.

McMahon:

At the hearing counsel for respondent stated as follows:

Our theory of the case is that the statute gives the privilege to the Commissioner to check the books of the taxpayer and see whether they did reflect income, and if they did not, then make adjustments that do reflect income.
*******
* * * I think we can agree with him [counsel for petitioner] that we could not set up the statute of limitations in this connection. But, there comes a time when it is unreasonable to carry these longer. There are various factors to be taken into consideration in determining whether they are or are not accounts payable.
*******
The Commissioner has been liberal in its dealings and [has] not attempted to set them up or set up the statute of limitations and throw them into income, but has allowed them to run along until 1927 for the first time. He challenged these items, and said not only are your creditors unknown, or the nature of their claims uncertain, but the statute has now run. Now, what are we going to do, where are we going to draw the line when we are going to throw them into income.
He sees it [He seized] upon this particular year because of the accumulation of all these items and the running of the statute of limitations.
Now, all that he is doing is challenging the fact that they are no longer true accounts payable.

As conceded above by counsel for respondent, the tolling of the statutory period does not ipso facto change a deductible liability into taxable income. In G. M. Standifer Construction Corporation, 30 B. T. A. 184, the Board stated:

* * * Local statutes are not decisive of what constitutes income, Burnet v. Harmel, 287 U. S. 103, nor what deductions may be taken. Weiss v. Wiener, 279 U. S. 333. We are of course bound to follow established state rules of property, Warburton v. White, 176 U. S. 484, but there is no property right in a statute of limitations which affects the remedy alone and not the obligation. Campbell v. Holt, 115 U. S. 620. So it has been held that local statutes of limitations barring collection of debts are not sufficient to constitute ascertainment of worthlessness. Leo Stein, 4 B. T. A. 1016; Ralph H. Cross, 20 B. T. A. 929; affd., 54 Fed. (2d) 781.

This disposes, adversely to petitioner, of its contention that if the statutory period of limitations is invoked to restore accounts payable to income, it must be limited to accounts which are exactly six years old, which is the statutory period of limitation of Ohio, and not to balances which include items more than six years old.

Upon brief the respondent states, and correctly so, that the rule to be drawn from Great Northern Railway Co. v. Lynch, 292 Fed. 903, and T. D. 3147, 4 C. B. 277 based thereon; Chicago, Rock Island & Pacific Railway Co., 13 B. T. A. 988; affd., 47 Fed. (2d) 990; and Charleston & Western Carolina Railway Co., 17 B. T. A. 569; affd., 59 Fed. (2d) 342, is that “ when a reserve or liability account, properly created in an earlier year, has ceased to be a true liability or reserve in a later year, it should be reversed and the amount thereof should be added to the income of the year when reversed.”

In this proceeding the petitioner did not reverse the items on its books of account until 1931. However, in that year when it reversed the items it does not appear that the petitioner determined that such accounts should be reversed because prevailing conditions disclosed that they had ceased to be liabilities in 1931, but, as stated by its counsel, this was done by the petitioner, after the notices of deficiency herein had been received, at his suggestion made to petitioner and the Bureau in an attempt to “ settle this question with the Department in view of the fact that four different years involved the same question.” Presumably, without such suggestion the petitioner would not have reversed the items even in 1931. However, assuming that it had of its own volition reversed the items on its books either in 1931 or in any year prior thereto, such entries on its books would not have been controlling here. The United States Supreme Court, in Doyle v. Mitchell Bros. Co., 247 U. S. ,179, stated that books of account “ are no more than evidential, being neither indispensable nor conclusive. The decision must rest upon the actual facts.” The Board stated in Daily Record Co., 13 B. T. A. 458, that “ It is well settled that the income of the petitioner is to be determined by actual facts as to which the books of account are only evidential. Doyle v. Mitchell, 235 Fed. 686; Southern Pacific Co. v. Muenter, 260 Fed. 837.” To the same effect are James William Everhart, 26 B. T. A. 318, and cases cited therein.

Nor does the failure of the petitioner to reverse in 1927 and 1928 the items involved, without other evidence showing that the petitioner was in 1927 and 1928 obligated to pay such accounts, establish that such items represented valid and subsisting liabilities in 1927 and 1928. A “ failure to record an item as income [does not] permit it to escape taxation when the time arrives that it represents income.” G. M. Standifer Construction Corporation, supra.

The petitioner emphasizes the fact that it never set up the bar of the statute of limitations against any claim made in respect to any of the items involved herein and this apparently is the only ground upon which rests the petitioner’s contention that the items were liabilities in 1927 and 1928. However, this policy alone does not justify indefinitely postponing the restoration of such items to income. While it was testified that petitioner never set up the statute of limitations as a bar to any claim in- connection with these accounts, there is no evidence that claims were ever made as to these accounts after the expiration of the statutory period. There is no evidence showing that the petitioner carried out this policy to the extent of expressly acknowledging to any creditor, after the tolling of the statutory period, its liability for any items set up in these accounts. There is no evidence that any item so set up was ever paid after the tolling of the statutory period. There is no evidence indicating that this policy was ever made known to creditors generally and that they relied thereon. All the burden of establishing any claim against the petitioner, as between it and its creditors, for items so set up as liabilities rested upon petitioner’s creditors, although these liabilities were set up and retained on its books as liabilities. The petitioner, so far as the record shows, made no effort to establish the identity of those to whom it owed the items so set up or to correct or reverse the entries made, but remained passive in the matter and waited for claims to be made. No claims were made as to the balances involved herein and they were permitted to remain upon the books as liabilities until 1931, when reversed at the suggestion of counsel as heretofore stated. There is no evidence showing that the petitioner was obligated in 1927 and 1928 to pay the items involved in whole or in part or that there were any creditors asserting claims for any of these items.

The evidence presented by the petitioner pertains chiefly to the reasons for the creation of the accounts involved, the nature thereof, the amounts of the entries and the years in which such entries were made. The respondent does not claim that any of the items involved were improperly created or set up as liabilities.

The burden of proof is upon the petitioner to show that the respondent erred in his determination that petitioner’s books of account did not clearly reflect income for the reason that the liability accounts involved did not, in 1927 and 1928, represent true liabilities and therefore should be restored to income. The failure of petitioner to sustain this burden requires approval of the respondent’s determination in these respects.

The petitioner on brief suggests the question whether the returns for earlier years should not be amended and the income increased therein on the theory that excessive deductions were taken, either erroneously or by virtue of the fact that such deductions never became real through payment. Ordinarily errors should be corrected in the year made. However, while it appears from the evidence that some errors may have been made in earlier years, we are unable to determine what amount or amounts, if any, were set up in error. Furthermore we have before us only the years 1927 and 1928 for redetermination of the deficiencies asserted by the respondent for those years; and hence our jurisdiction herein is limited to those years, to which we here confine ourselves.

The determination of the respondent is therefore approved with an exception as follows: The petitioner, in its returns for the years involved, did not claim depreciation on the Johnson Eiver tipple. However, upon reaudit of such returns, the respondent allowed $10,571.30 in 1927 and $5,285.65 in 1928. It was stipulated by counsel of the parties that petitioner is not entitled to depreciation on the Johnson Eiver tipple as such tipple had been fully depreciated prior to the taxable years here involved. See North American Coal Corporation, 28 B. T. A. 807, 848. Effect will be given to this stipulation upon recomputation of the deficiencies under Eule 50.

Reviewed by the Board.

Decision will he entered wider Rule 50.


author: MoMahon:

text:
    MacCallum Gauge Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 70437.
    Promulgated April 30, 1935.

      Stanley S. Waite, Esq., for the petitioner.

      T. M. Mather, Esq., for the respondent.
   OPINION.

MoMahon:

This is a proceeding for the redetermination of a deficiency in income tax for the calendar year 1930 in the amount of $485.48. It is alleged that the respondent erred in determining that the basis for the exhaustion or depreciation of a patent secured by James MacCallum, Jr., on a liquid measuring device and assigned by him to petitioner on April 30, 1930, was the cost thereof to the assignor, instead of determining that the proper basis is the value of the patent on the date when it was assigned to the petitioner, which value, it is alleged, was $119,587.58.

The petitioner is a corporation, with principal office in St. Louis, Missouri.

The parties entered into a stipulation of facts, which we incorporate herein by reference, setting forth, however, only such portions as are necessary to an understanding of the proceeding. The stipulation discloses that James MacCallum, Jr., perfected a liquid measuring device; that he agreed to pay E. B. Powell, who assisted him, one third of all the amount received in the event of the sale of the invention, and one third of all royalties received, and withheld from Powell any other interest in any patents or application for patents therein; that thereafter MacCallum agreed to pay O. F. McKnight, in consideration of his promotion of the invention, certain stock of a proposed company to be incorporated, to which company the rights to manufacture the said measuring device were to be conveyed, and one sixth of the net royalties received; that thereafter the Gaso-Scope Corporation of America was organized, to which MacCallum, in exchange for stock, transferred the rights to manufacture the measuring device for which application for letters patent had been made; that in the agreement between MacCallum and the Gaso-Scope Corporation of America, dated October 12, 1922, it was provided that in case the Gaso-Scope Corporation of America should become insolvent or be adjudged a bankrupt, then all rights conferred should revert to MacCallum; that MacCallum then transferred some of the stock to others; that on February 20,1923, MacCallum, Paul J. Bier-man, and the Gaso-Scope Corporation of America entered into an agreement under which Bierman agreed to invest $25,000 in the corporation in exchange for 2,500 shares of preferred stock and 36,550 shares of the common stock; that the contract of February 20, 1923, also provided for the organization of a new Missouri corporation, the stock thereafter to be distributed on the same basis as the common stock of the Gaso-Scope Corporation of America was then held or to be held, and that MacCallum should transfer the invention to the new Missouri corporation; that in the meantime Bierman had secured an option to purchase from Powell whatever interest he had in an undivided one-third interest in 60,000 shares of the common stock of Gaso-Scope Corporation of America issued in the name of MacCallum, the consideration being $5,000; that Bierman failed to fulfill his part of the contract of February 20, 1923, became dissatisfied, and was instrumental in involving the Gaso-Scope Corporation of America in receivership proceedings, and then in bankruptcy; that subsequently the Gaso-Scope Corporation of America was adjudicated a bankrupt and thereby lost its right to manufacture the measuring device; that during 1925 MacCallum entered into an agreement with the King-Seeley Corporation under which he granted that corporation the exclusive right to manufacture the measuring device in consideration of the payment to him of royalties; that on June 12, 1928, patent No. 1673753 was issued to James MacCallum, Jr., by the United States covering this measuring device; that sometime in 1929 or 1930 Bierman caused to be organized the Gage-Kite Corporation; and that such corporation and Bierman instituted suit against MacCallum and the King-Seeley Corporation to compel the transfer of patents or applications therefor to the Gage-Kite Corporation in pursuance of the agreement of February 20, 1923, and for an accounting of the amount of money paid by the King-Seeley Corporation to MacCallum under the license agreement. The stipulation then states as follows:

15. In order to settle all litigation between the parties, and prevent the loss of other patents perfecting said measuring device, for which applications wore pending, by failure to prove said patents before the Patent Office due to the tying up of the money by impounding under court order, Bierman and MacCallum entered into a contract in 1930 under which they agreed to organize a new corporation to be named the MacCallum Gauge Company, and MacCallum agreed to transfer his patent to said company, said company to have a capital of 1,200 shares of stock, 840 shares of which were to be issued to MacCallum and 360 shares to Bierman. The agreement provided for the payment of $5,000.00 from MacCallum to Bierman to reimburse Bierman for the money he paid to Powell for his stock in the Gaso-Scope Corporation of America. Said agreement also provided that the outstanding license agreement between MacCallum and King-Seeley Corporation, covering the domestic manufacture of said measuring devices under said patent, should be issued to said new corporation, contemporaneously with the execution of said agreement.
16. In pursuance to [sic] said agreement, the MacCallum Gauge Company was organized April 28, 1930, under the laws of the State of Missouri, with a capital stock of 1,200 shares and 840 shares of the stock of said corporation were issued to MacCallum, and 360 shares were issued to Bierman. On April 30, 1930, MacCallum assigned to said company the patent for said measuring device and the license agreement existing between him and the King-Seeley Corporation.
17. On April 30, 1930, when said patent was transferred to the MacCallum Gauge Company, its fair market value was $100,000.00. The cost of said patent to MacCallum is $18,780.56.
18. It is petitioner’s contention that the basis for the annual deduction for exhaustion of said patent is $100,000.00, the value thereof when transferred to petitioner, which contention is denied by respondent. Respondent’s contention is that said basis is the cost of said patent to MacCallum. and the cost, $18,780.56, has been allowed by respondent as the basis for the annual deduction for exhaustion of said patent.

The question presented for determination is whether the basis, in the hands of the petitioner, for the determination of the exhaustion allowance upon the patent transferred to the petitioner on April 30, 1930, is the value of the patent at the date of such transfer to the petitioner, $100,000, as contended by the petitioner, or the cost of the patent to MacCallum, $18,780.56, as held by the respondent.

Section 114 (a) of the Revenue Act of 1928 provides that the basis upon which exhaustion is to be allowed in respect of any property shall be the same as is provided in section 113 for the purpose of determining the gain or loss upon the sale or other disposition of such property. Section 113 provides that the basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property, with certain exceptions. One of such exceptions is contained in subdivision (8) of section 113 (a). Such subdivision provides that if the property was acquired after December 31,1920, by a corporation by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5), then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made. Section 112 (b) (5), referred to in section 113 (a) (8), provides that no gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation, but in the case of an exchange of property by two or more persons this provision shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange. Section 112 (j) provides that the term “ control ” means the ownership of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.

The respondent contends that the patent and the license agreement between MacCallum and the King-Seeley Corporation were transferred to the petitioner by MacCallum and Bierman, that the stock and securities received by each were substantially in proportion to his interest in the property prior to the exchange, and that, therefore, the basis for exhaustion allowance is the cost thereof to MacCallum in the amount of $18,780.50. Petitioner, on the other hand, contends that MacCallum was the sole owner of the patent, that he alone transferred it to the petitioner, and that since immediately after the exchange MacCallum was not in control of the petitioner, there is no exception to the general provision that the basis is cost to the petitioner.

We agree with petitioner that MacCallum was the sole owner of the patent. The stipulated facts show that MacCallum, by agreement entered into February 20, 1923, agreed to transfer his interest in the patent to a new Missouri corporation to be organized, but that this contract was never performed. Even if this had been done it would not have been tantamount to transferring an interest therein to Bierman, who was to be a stockholder of the new corporation. So far as we can determine from the stipulated facts MacCallum did not, at any time prior to April 30, 1930, ever transfer any right, title, or interest in his invention, patent application, or patent to Bierman or anyone else, with the exception that by the license agreement in 1925 he granted the King-Seeley Corporation the right to manufacture the device. The suit instituted by Bierman against MacCallum did not result in any decision of the court that anyone other than MacCallum owned an interest in the patent, but was settled out of court. The stipulated facts relative to the agreement of settlement entered into between Bierman and MacCallum in 1930 do not disclose that Bierman was thereby given any interest in the patent, as contended by the respondent. Such stipulated facts show that this settlement agreement was entered into for the purpose of putting an end to the litigation and preventing the loss of other patents perfecting the measuring device for which applications were pending, by failure to prove such patent before the Patent Office due to the tying up of the money by impounding under court order As the evidence shows, $5,000 was paid by MacCallum to Bierman to reimburse Bierman for the money he paid Powell for stock in the Gaso-Scope Corporation. This is the only consideration that passed from MacCallum to Bierman. No patent rights passed from Mac-Callum to Bierman. That MacCallum was the sole owner of the patent and that it was he alone who transferred it to the petitioner is shown by the stipulated facts as follows:

* * * MacCallum agreed to transfer his patent to said company [the petitioner] * * *. Said agreement also provided that the outstanding license agreement between MacCallum and King-Seeley Corporation, covering the domestic manufacture of said measuring device under said patent, should be issued to said' corporation, contemporaneously with the execution of said agreement.
* * * On April 30, 1980, MacCallum assigned to said company [the petitioner] the patent for said measuring device and the license agreement existing between him and the King-Seeley Corporation.

To find or hold that MacCallum was not the sole owner of the patent would be contrary to the stipulations of the parties, and would be in violation of them.

The stipulated facts show that MacCallum received 840 shares of the petitioner’s capital stock and that Bierman received 360 shares of such stock at that time. The facts upon this point are stipulated in the following words: “ In pursuance to [sic] said agreement the MacCallum Gauge Company was organized April 28, 1930, * * * and 840 shares of the stock of said corporation were issued to Mac-Callum, and 360 shares were issued to Bierman.”

It will be seen that immediately after the transfer of the patent and the license agreement by MacCallum to the petitioner, Mac-Callum was not in control of the petitioner, owning only 70 percent of the petitioner’s stock, whereas “ control ” under the statute requires a holding of 80 percent of the stock. This proceeding comes within no exception to the general provision and the basis for exhaustion of this patent in the hands of the petitioner is its cost to the petitioner.

The fair market value of the stock issued by a corporation for a patent or other property is the measure of the cost of the patent or other property to the corporation. Fifth Street Building, 24 B. T. A. 876; Hazeltine Corporation, 32 B. T. A. 4; Ida I. McKinney, 32 B. T. A. 450; Pierce Oil Corporation, 32 B. T. A. 403, and cases cited therein. The net result of the transaction was that petitioner transferred 840 shares of its capital stock to MacCallum, receiving therefor the patent and all of MacCallum’s rights under the license agreement between him and the King-Seeley Corporation. It is our opinion that the rights under the license agreement should be considered as inhering in the patent. The parties have stipulated that the fair market value of the patent on April 30, 1930, the time it was transferred to the petitioner, was $100,000. The only thing shown to have been paid in to the petitioner was this patent valued at $100,000. So far as the record shows, the patent and the rights that inhered in it constituted all of the assets of petitioner immediately after the transfer thereof and the issuance of its 1,200 shares of stock. In such a situation as is presented here, where there is no other method of measuring the fair market value of the stock of a corporation, the fair market value of the stock may be measured by the fair market value of the assets. Ida I. McKinney, supra; and Fifth Street Building, supra. In the former case, we stated in part:

It is well settled that the cost to a corporation of the property acquired through the issuance of its capital stock is the fair market value of such capital stock on the date issued, and where all of the capital stock of a corporation is issued for property and there is no other method of measuring the fair market value of the stock so issued, such fair market value on that date may properly be determined to be the equivalent of the fair market value of the property received. Reliance Investment Co., 22 B. T. A. 1287; Mead Realty Co., 21 B. T. A. 1062; L. H. Philo Corporation, 16 B. T. A. 130; John Glackner Realty Corporation, 11 B. T. A. 151; Realty Sales Co., 10 B. T. A. 1217.

In the latter case we stated in part:

* * * the cost as determined from the fair market value of the property acquired for its stock may be used as a basis for computing deductions for exhaustion over the term thereof for the years 1921 and 1923. Ben T. Wright, Inc., 12 B. T. A. 1149.

It is true that, in the two cases just cited and quoted from, all or substantially all the stock of the corporation involved was issued for one particular asset, and, as pointed out in Pierce Oil Co., supra, if all the outstanding shares of a corporation are not issued for a particular asset the value of such asset is not to be taken as the cost thereof to the corporation. However, the fair market value of the asset may properly be taken as the measure of the fair market value of all of the outstanding stock of the corporation under such circumstances as are present here. The value of all of petitioner’s outstanding shares is reflected by the value of the patent. Here the 1,200 shares of stock of the petitioner had a fair market value of $100,000, which is the stipulated value of the patent. As pointed out above 840 of the 1,200 outstanding shares were issued to MacCallum for the patent. These 840 shares had a fair market value of 840/1200 of $100,000 or $70,000. The cost of the patent to the petitioner was, therefore, $70,000; and upon the recomputation the petitioner may take, as a deduction, an allowance for exhaustion thereof based upon such cost. The exhaustion of a patent is computed upon a life for the patent of 17 years from the date of its issuance. Hazeltme Corporation, supra. The patent was acquired by the petitioner on April 30, 1930, and for the remainder of such calendar year the petitioner is entitled to deduct as exhaustion an aliquot part of $70,000, the cost of such patent to the petitioner, based upon the remaining life of the patent in the hands of the petitioner of 15 years, 1 month and 12 days.

Reviewed by the Board.

Decision will be entered under Rule SO.


author: Smith :

text:
    Bradley W. Palmer, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 62652.
    Promulgated April 30, 1935.

      A. Mitchell Palmer, Esq., William D. Harris, Esq., and Francis V. Bar stow, Esq., for tbe petitioner.

      F. R. Shearer, Esq., and E. L. Updike, Esq., for the respondent.
   OPINION.

Smith :

This is a proceeding for the redetermination of a deficiency in income tax for 1929 in the amount of $33,381.03. The allegations of error stated in the petition are as follows:

(a) The Commissioner erroneously disallowed as a capital net gain the amount received from the sale of stock rights received in respect of stock held by him more than two years, because the Petitioner included in his return the entire proceeds from the sale of the said rights and did not prorate the cost of the basic stock between the said stock and the said rights.
(b) The Commissioner erred in adding to the amount of taxable dividends reported by the Petitioner the sum of $160,115.50 on account of the issue to him by The American Superpower Corporation of Purchase Certificates or rights to purchase shares in The United Corporation and of The Commonwealth & Southern Corporation.
(c) The Commissioner also erred in adding to the amount of taxable dividends reported by the petitioner the sum of $135,115.50 on account of the issue to the petitioner by the American Superpower Corporation of Purchase Certificates or rights to purchase shares of The United Corporation.

In his answer the respondent—

* * * avers that in the event it be held and determined that the Commissioner did err in any respect as set forth in subparagraphs (b) and (c) of paragraph IY of the amended petition, then the Commissioner further erred in favor of the petitioner in the following respects:
(1) If said tz-ansaetions did not i'epresent corporate distributions, the Commissioner erred by overstating the cost or other basis to the petitioner of the stock of The United Corporation so acquired, and thereby understated the correct profit from the sale of 3,800 rights issued to the petitioner by The United Corporation subsequent to the transactions in question.
(2) If said transactions represented distributions, but the Commissioner erred in selecting the proper dates for valuing such distributions, then the Commissioner erred through understating the amount of petitioner’s taxable dividends from those sources to the extent that the fair market value of such rights on dates other than those selected by the Commissioner exceeded the respective amounts determined by the Commissioner.
(3) If said transactions represented distributions, but the amounts thereof as determined by the Commissioner exceeded the accumulated earnings and profits of The American Superpower Corporation, then the Commissioner erred through failing to apply the provisions of subdivision (d) of Sec. 115 of the Revenue Act of 1928.
(4) If said transactions pertaining to stock of The United Corporation represented distributions governed by the provisions of Sec. 112 (g) of the Revenue Act of 1928, then the Commissioner erred through failing to apply the provisions of See. 113 (a) (9) of that Act to petitioner’s holdings of Superpower and United stock, and particularly in overstating the basis of 100 shares of Superpower stock and 3,800 United rights sold by petitioner later in the year 1929.

The respondent has accordingly moved to increase the deficiency, if any, which may arise from a redetermination of the tax liability in accordance with the Board’s opinion.

The material facts have all been stipulated and, together with the exhibits referred to in the stipulation and filed at the hearing, are adopted as our findings by reference.

1. The petitioner as a stockholder of International Telephone & Telegraph Co. and of Electric Bond & Share Co. received from those corporations during 1929 rights to subscribe to additional shares of their stock. He sold such rights for $27,360 and reported the entire proceeds as income pursuant to the option contained in article 58 of Regulations 74, which, so far as pertinent, provides:

Tbe taxpayer may at his option include the entire proceeds from the sale of stock rights in gross income, in which case the basis for determining gain or loss from the subsequent sale of the stock in respect of which the rights were issued shaU be the same as though the rights had not been issued.

The respondent treated the entire sum as ordinary income, stating in his deficiency notice that “ inasmuch as the cost of the basic stock was not prorated, the total selling price should be taxed at ordinary rates.” The.petitioner had held the shares of stock in respect of which the rights were issued for more than two years prior to the respective dates on which the rights were sold, and claims that the amount of $27,360 is a capital gain under section 101 of the Revenue Act of 1928.

Section 101 of the Revenue Act of 1928 deals with “ capital net gains and losses.” It defines a “ capital gain ” as the “ taxable gain from the sale or exchange of capital assets consummated after December 31, 1921 ”, and “ capital assets ” as “ property held by the taxpayer for more than two years.” The stipulated facts here show that the shares of stock in respect of which the rights in question were issued were owned and held by the petitioner for a period of more than two years at the date the rights were issued. Therefore, they constituted capital assets.

Were the rights issued on those shares of stock and received by the petitioner likewise capital assets ?

In Miles v. Safe Deposit & Trust Co. of Baltimore, 259 U. S. 247, a stock subscription right was regarded as representative of a portion of the stockholder’s original investment in the corporate enterprise. The Court stated:

The stockholder’s right to take his part of the new shares therefore — assuming their intrinsic value to have exceeded the issuing price — was essentially analogous to a stock dividend. * * *

In General Counsel Memorandum 12942, Cumulative Bulletin XIII-1, p. 13, it was stated:

* * * where stock rights are sold, in determining the period for which the taxpayer held the property there shall be included the period for which he held the stock in respect of which the rights were issued. That position not only finds support in the theory underlying Miles v. Safe Deposit & Trust Co. of Baltimore, supra, but also in section 101 (c) 8 (O), supra, as the issuance of stock rights may be said to effect (certainly in some, if not in all, cases) a recapitalization of a corporation, and thus the rights may be regarded as securities in the reorganized distributing corporation received without the surrender of the stock in respect of which distributed. In that event tacking is, of course, specifically authorized. However, while these considerations support the treatment of rights as capital assets, they do not justify such treatment of stock acquired through the exercise of rights, unless-it is held for the'period prescribed by the statute. * * *

In Lee v. Commissioner, 76 Fed. (2d) 203, it was held that the date of acquisition of rights to subscribe to stock dates back to the date of acquisition of the stock and that where the stock was acquired more than two years from the date of the sale of the rights the gain must be treated as capital gain.

We think it clear from the stipulated facts that the issuance of the subscription warrants by the International Telephone & Telegraph Co. and the Electric Bond & Share Co. constituted a division among the stockholders of their capital interests in the corporations and that they stand on the same footing as stock dividends. See article 501 of Regulations 74. Since the shares of stock in respect of which the stock rights were issued had been held by the petitioner for a period of more than two years at the date of sale of the stock rights, the rights themselves constituted “ capital assets.” The contention of the petitioner that the net proceeds from the sale of the rights here in question amounting to $27,360 is taxable as capital net gain is sustained.

2. The principal question presented by this proceeding is whether the petitioner, a stockholder of the American Superpower Corporation (hereinafter called Superpower), derived any taxable income from the receipt of certain rights issued by Superpower to its stockholders entitling them to purchase from it shares of common stock in the United Corporation (hereinafter called! United), and in the Commonwealth & Southern Corporation (hereinafter called Commonwealth), which were exercised by the petitioner. The respondent contends that the value of these rights received by the petitioner in the form of purchase certificates constituted taxable dividends within the meaning of the Revenue Act of 1928. The facts bearing upon this question are all covered in a lengthy stipulation of facts filed with the Board.

Superpower acquired 2,210,853 shares of common stock, 344,187 shares of $3 cumulative preference stock, and 1,000,000 option warrants (entitling the holder to purchase 1,000,000 shares of common stock at any time, without limit, at $27.50 per share), of United upon its organization in January 1929. United was organized for the purpose of bringing into a common ownership large holdings of public utility companies, principally the Public Service Corporation of New Jersey and United Gas Improvement Co. Superpower, J. P. Morgan & Co., Drexel & Co., and Bonbright & Co., were instrumental in its organization. For the United securities acquired by Superpower, Superpower turned over to United shares of stock of the Public Service Corporation of New Jersey and of the United Gas Improvement Co., and $25 cash. The fair market value of these shares thus contributed to United was $72,480,000 as determined by the respondent. The respondent likewise determined the fair market value of United securities received by Superpower to be the same amount, $72,480,000. He found the fair market value of United common stock received by Superpower to be $25 per share. J. P. Morgan & Co. and Bonbright & Co. each agreed to purchase and did purchase from United 400,000 shares of its common stock for cash at $22.50 per share.

At the time of the organization of United, Superpower contemplated selling a portion of the United common shares to be acquired by it to its stockholders. This was for the purpose of building up its cash position and of creating a wide market for the United stock. Soon after it received United common stock it offered to sell pro rata to the holders of its class A and class B common stock a one-half share of United common stock for each of its common shares outstanding, at $25 per share.

There proved to be a great demand on the part of the public for United common stock. The first series of rights issued by Superpower to its stockholders to purchase United common stock at $25 per share was actively dealt in on the New York Curb Exchange and ranged from a low of 11% to. a high of 21 from January 1, 1925, to February 15, 1929, when the rights expired. Superpower issued 1,642,944 rights on its 1,642,944 shares of class A and class B common stock, all of which rights were exercised on or before January 15, 1929, and Superpower thus disposed of 821,472 shares of its United common stock.

In May 1929 Superpower again offered to sell pro rata to its stockholders United common shares at $30 per share. These rights likewise found a ready sale. Practically all of them were exercised and Superpower disposed of more than 400,000 additional shares of United Common stock.

In May or June 1929 Superpower acquired, partly by purchase and partly in a nontaxable exchange, certain shares of common stock of Commonwealth. On June 5, 1929, the directors of Superpower took action in reference to a portion of its holdings in Commonwealth similar to that taken in January and in May with respect to United common stock. By resolutions then adopted the holders of its common stock of record on June 18, 1929, were granted the right to acquire shares of Commonwealth common stock at $15 per share and at the rate of one share of Commonwealth stock for every 10 shares of Superpower common stock (Superpower common stock having a little earlier been split five for one). These rights were likewise valuable. Under the resolution of June 5, 1929, Superpower issued 8,242,310 rights for the purchase of Commonwealth common stock, of which 8,231,480 were exercised on or before July 2, 1929.

At the beginning of 1929, the petitioner was the owner of 3,796 shares of class A and 2,600 shares of class B common stock of Superpower. During the year 1929 the petitioner received purchase certificates from Superpower as follows:

1. On February 1, 1929, purchase certificates entitling the petitioner to purchase on or before February 15, 1929, 3,198 shares of common stock of United at a price of $25 per share.

2. On May 15, 1929, purchase certificates entitling petitioner to purchase on or before May 24, 1929,1,599 shares of common stock of United at a price of $30 per share.

3. On June 24,1929, purchase certificates entitling the petitioner to purchase on or before July 2, 1929, 3,200 shares of common stock of Commonwealth at a price of $15 per share.

On February 15,1929, the petitioner exercised his option under the first purchase certificates and purchased from Superpower 3,198 shares of United common stock and paid therefor in cash $79,950, or at the rate, of $25 per share, concurrently surrendering his first purchase certificates. The cost to Superpower of the 3,198 shares of United common as determined by the respondent was $8,949 plus per share and Superpower received from the sale a profit of $16.05 plus per share, total $51,327.90.

On May 24, 1929, petitioner exercised his option under the second purchase certificates and received from Superpower 1,599 shares of United common stock and paid therefor in cash $47,970, or at the rate of $30 per share, concurrently surrendering his second purchase certificates, Superpower realized a profit from the sale of approximately $20 per share, total $33,578.95.

On July 2,1929, the petitioner exercised his option under the third set of purchase certificates and acquired from Superpower 3,200 shares of Commonwealth common, paying therefor in cash $48,000, or at the rate of $15 per share, concurrently surrendering the third set of purchase certificates. Superpower received a profit from the sale of $2,912.

In his income tax return for 1929 the petitioner did not include the receipt of the purchase certificates as income. The respondent has held, however, that the petitioner received taxable dividends represented by the value of the purchase certificates received from Superpower entitling him to purchase shares of common stock of United and Commonwealth at what the respondent contends were bargain prices.

Section 115 of the Revenue Act of 1928 provides in part:

(a) Definition of dividend. — The term “dividend” when used in this title * * * means any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913.
(b) Source of distributions. — For the purposes of this Act every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits. Any earnings or profits accumulated, or increase in value of property accrued, before March 1, 1913, may be distributed exempt from tax, after the earnings and profits accumulated after February 28, 1913, have been distributed, but any such tax-free distribution shall be applied against and reduce the basis of the stock provided in section 113.
(c) Distributions in liquidation. — Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part' or full payment in exchange for the stock. * * *
(d) Other distributions from capital. — If any distribution (not in partial or complete liquidation) made by a corporation to its shareholders is not out of increase in value of property accrued before March 1, 1913, and is not out of earnings or profits, then the amount of such distribution shall be applied against and reduce the basis of the stock provided in section 113, and if in excess of such basis, such excess shall be taxable in the same manner as a gain from the sale or exchange of property. The provisions of this subsection shall also apply to distributions from depletion reserves based on the discovery value of mines.
*******
(f) Stock dividends. — A stock dividend shall not be subject to tax.

The stipulated facts negative the idea that Superpower had any intention of distributing to its stockholders any of its earnings or any of its assets by the sale of certain shares of common stock of United and of Commonwealth to its stockholders. The resolutions of the board of directors of Superpower relating to these sales do not refer to them as dividends or as distributions of its assets. In its books of account the sales are treated as sales of assets and not otherwise. It is stipulated that “ on its books of account The American Superpower Corporation made no charge against nor deduction from its profits and loss or earnings account, its earned surplus account, or its paid-in surplus account, in connection with or as a result of the issuance of the {Purchase Certificates ’ pursuant to the provisions of the aforesaid resolutions of January 23, 1929, May 1, 1929, and June 5, 1929.”

As above indicated, the stipulated facts show that the respondent determined the “total fair market value” of all the securities received by Superpower from United in January 1929 to be $72,480,000. He allocated this value to the three classes of securities received and determined the fair market value of the common shares to be $25 per share. This is the exact price at which Superpower offered the first block of 821,472 shares of common stock of United to its stockholders. No valid argument can be made that Superpower intended to distribute to its stockholders any portion of its assets by selling 821,472 common shares of United to them at a fair market value. Upon the sale of the stock at $25 per share Superpower realized a profit of $16.05 on each share.

That $25 was a fair market price for the stock in January 1929 is further evidenced by the fact that J. P. Morgan & Co. and Bon-bright & Co., pursuant to the agreement made between the interested parties, each subscribed for and purchased from United 400,000 shares of its common stock at $22.50 per share.

The stipulated facts do not show the fair market value of United common stock in May 1929, or of Commonwealth common stock in June and July 1929. The sales of United common in May 1929 were made at $30 per share, or at $5 per share more than the price at which the stock was offered to Superpower’s stockholders in January. The Commonwealth stock was acquired by Superpower just before it was offered for sale by Superpower to its stockholders. In selling it at $15 per share Superpower made a profit on each share sold.

The decided weight of legal authority is to the effect that where a corporation issues to its stockholders rights to purchase shares of its own stock or of its bonds, or, indeed, to purchase assets owned by it, the stockholders do not receive taxable income either from the receipt of the rights or from the exercise thereof. In Miles v. Safe Deposit & Trust Co. of Baltimore, supra, the Supreme Court held that the distribution to its stockholders by a corporation of rights entitling them to subscribe for new shares of its own stock “ in and of itself constituted no division of any part of the accumulated profits or surplus of the company, or even of its capital ”, and that the privilege to subscribe to the new stock “ of itself was not a fruit of stock ownership in the nature of a profit; nor was it a division of any part of the assets of the company.” The Court further stated:

* * * What would have happened had defendant in error decided to accept the new shares and pay the issuing price instead of selling the rights is of no consequence; in that event there would have been no realized profit, hence no taxable income. * * *

This Board has held that a stockholder who receives a valuable right for the purchase of bonds of the corporation of which he is a stockholder and exercises the right does not thereby realize taxable income. T. I. Hare Powel, 27 B. T. A. 55; Robert C. Cooley, 27 B. T. A. 986; affirmed on another issue, 75 Fed. (2d) 188; Edward S. Harkness, 31 B. T. A. 1100. The Board has also held that where a stockholder has received rights to purchase shares of stock in the issuing corporation and those rights became worthless in his hands, the stockholder does not have a legal claim of loss of the value of the rights as of the date of receipt by him. St. Louis Union Trust Co. et al., Co-trustees, 30 B. T. A. 370. It has been held further that, where a stockholder of a corporation receives from the corporation valuable rights to purchase shares of stock subscribed for by such corporation • and the stockholder exercises such rights, he does not receive taxable income; J. Kemp Bartlett, 28 B. T. A. 285; affd., Helvering v. Bartlett (C. C. A., 4th Cir.), 71 Fed. (2d) 598; also, that where a corporation gives a stockholder a right to purchase property at less than its market value and such right is exercised by the stockholder, the stockholder has not realized taxable income. Taplin v. Commissioner, 41 Fed. (2d) 454; Commissioner v. Van Vorst, 59 Fed. (2d) 677, affirming George W. Van Vorst, Executor, 22 B. T. A. 632. Cf. Samuel A. Salvage v. Commissioner, 76 Fed. (2d) 112.

Article 51 of Regulations 74, promulgated under the provisions of the Revenue Act of 1928, provides in part:

Where property is sold by a corporation to a shareholder, or by an employer to an employee, for an amount substantially less than its fair market value, such shareholder of the corporation or such employee shall include in gross income the difference between the amount paid for the property and the amount of its fair market value. In computing the gain or loss from the subsequent sale of such property its cost shall be deemed to be its fair market value at the date of acquisition by the shareholder or the employee. This paragraph does not apply, however, to the issuance by a corporation to its shareholders of the right to subscribe to its stock, as to which see article 58.

In Irving D. Rossheim, 31 B. T. A. 857, 865, we stated:

* * * Article 51 is the successor to, and is identical with, article 31 of Regulations 65 and 69, interpreting corresponding provisions of the 1924 and 1926 Acts, respectively. It should also be noted that article 31 of Regulations 65 and 69 and article 51 of Regulations 74 were first promulgated by the Treasury Department as Treasury Decision 3435, and thereafter appeared as a part of Regulations 65, 69, and 74.
Treasury Decision 3435 has been carefully considered by the courts in Taplin v. Commissioner, 41 Fed. (2d) 454; and Commissioner v. Van Vorst, 59 Fed. (2d) 677, affirming George W. Van Vorst, Executor, 22 B. T. A. 632, and by the Board in the latter case and in James William Everhart, 26 B. T. A. 318. These cases and authorities therein cited adequately support the view that article 51 of Regulations 74 cannot create income where none, in fact, exists when measured by the statutory definition of gross income. * * *

This observation is equally applicable to this proceeding.

In support of his contention that the issuance of the purchase certificates by Superpower constituted a dividend the respondent cites Metcalf's Estate v. Commissioner (C. C. A., 2d Cir.), 32 Fed. (2d) 192, affirming 13 B. T. A. 236. The court stated in that case: “ The question presented is whether, by the selling of these rights, the petitioner received taxable income, under section 211 of the Revenue Act of 1921.” In the course of its opinion the court stated:

Thus, where a stockholder receives a distribution of the assets of a corporation in cash or in stock of a different enterprise, such distribution is for taxing purposes a dividend. No sound distinction can be drawn between a distribution of stock of another corporation and one of valuable rights to purchase such stock. Each may be sold at its selling price. The rights this petitioner sold netted §18 per right. They amounted to a distribution of assets of the company of which it was a stockholder, just as much as an actual distribution of stock of the Baltimore & Ohio Railroad by the Union Pacific Company did in the Pea-tody Case. There was a distribution in specie of a portion of the assets of the Southern Pacific Company. A distribution of earnings or assets of a corporation is a distribution, whether or not so determined.

The facts in that case were in short that the Southern Pacific Co., which owned valuable oil lands, deemed it expedient to dispose of them. As a means of so doing it organized Pacific Oil Co., to which it transferred the oil lands and cash, and then distributed the stock to its stockholders share for share upon the payment by each stockholder of $15 to reimburse it for advances which it had made to the Pacific Oil Co. This Board and the court held that the distribution of the Pacific Oil Co. stock in such circumstances constituted a distribution of property and that the petitioner realized taxable income from the sale of the rights equal to the net proceeds from the sale.

In Helvering v. Bartlett, supra, the question before the court was whether rights issued by a corporation entitling it to purchase shares of stock in another corporation constituted dividends to the amount of the fair market value of the rights received by the stockholder. The Board held that the taxpayer had realized no taxable profit or dividend because of the allotment to him of the rights in question. The court in its opinion stated:

We tbink that this holciing of the Board was clearly right. We are not dealing with a case where a stockholder who has received rights to purchase stock sells the rights and thus realizes a profit. If the taxpayer here had sold the rights allotted him, the amount received on such sale would, of course, have been taxable as income. Miles v. Safe Deposit Co., 259 U. S. 247; Metcalf’s Estate v. Commissioner, (C. C. A. 2nd) 32 Fed. (2d) 192. But he did not sell the rights. He exercised the option which they conferred upon him to purchase stock in the fire company; and he has as yet realized no profit upon this transaction. The rights were nothing but options to purchase stock, and the fact that they were allotted to stockholders of the Guaranty Company did not make them in any sense dividends. An option is but a continuing offer; and, when the offer is accepted, it is merged in the contract which results. We have, then, nothing upon which to predicate an assessment of the tax but a purchase of stock by the taxpayer; and it is well settled that s,ueh a transaction does not give rise to taxable income until a profit is realized by the sale of the stock purchased. The taxing statutes are not based upon the theory that a man can “ buy himself rich.”
* # Jit * * * *
* * * All that the Guaranty Company did was to acquire in behalf of its stockholders options to subscribe to stock in the Pire Company and to allot these options to them in accordance with their holdings; and it seems clear that one is not to be taxed as upon income merely because he acquires an option which he might sell for value. * * *
* * * No profit is realized upon a purchase; and the mere according of a right to purchase is not to be treated as a dividend or distribution of assets, unless these are in fact involved and the right to purchase is a mere cloak for a transaction which is essentially something else.
* * * A different situation would, of course, be presented if the Guaranty Company had transferred assets to the Pire Company and a preferential right to purchase stock at less than its real value had been accorded the stockholders of the former; for this would amount to a distribution of assets by the Guaranty Company to the stockholders who exercised the right to purchase. But that is not the situation here, and there is nothing to indicate that the formation of the Pire Company was in any sense a oloalc for the payment of a dividend or the distribution of assets. [Italics supplied.]

Was the issuance of purchase certificates by Superpower “ a cloak for the payment of a dividend”? For reasons set forth above we are of the opinion that it was not.

The normal application of the statute to the facts of this case is that the stockholder derives no taxable income either from the receipt 'of rights to purchase stock at a fair price or from the exercise of those rights. It is only when the circumstances are such that the issuance of the rights is tantamount to the payment of a dividend or a distribution of assets in the form of a property dividend that the value of the rights may be regarded as a dividend. See Metcalf's Estate, supra; Nanaline H. Duke, 18 B. T. A. 874.

If a stockholder receives rights and sells them he may have income from the sale of the rights — not from the receipt of them. If, on the other hand, he exercises the rights and later sells the stock or other assets acquired by the exercise of such rights he has a gain or loss from the sale measured by the difference between the selling price and the cost or other basis to him of the property sold.

Upon the entire record we are of the opinion that the petitioner realized no taxable income from the receipt of the purchase certificates involved in this proceeding or from the exercise of them in the purchase of shares of stock of United and Commonwealth. There is no reason to give to the transaction a different interpretation from that placed upon it by both Superpower and the petitioner. Superpower treated the transaction solely as a sale of a portion of its assets and accounted for the profit realized therefrom. The petitioner likewise treated the transaction as a purchase of shares of stock for cash. If and when he shall sell the shares acquired by him the profit or loss must be predicated upon the basis of the price that he paid for them.

Upon this disposition of the case it is unnecessary to consider the third question presented by this proceeding.

The respondent is entitled to a redetermination of the profit realized by the petitioner from the sale of 3,800 of United stock rights. Safe Deposit & Trust Co. of Baltimore, supra. It was stipulated at the hearing of this proceeding that this matter could be settled from the stipulated facts under Rule 50 of the Boards Rules of Practice.

Reviewed by the Board.

Judgment will he entered under Rule 50.


text:
    Ramapo, Inc., petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 60517.
    Promulgated April 30, 1935.

      D. A. Embury, Esq., for the petitioner.

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

Smith :

This proceeding is for the redetermination of a deficiency in income tax for 1929 in the amount of $10,789.73. By an amended answer the respondent claims an increased deficiency.

The principal question in issue is the basis for computing gains and losses from sales of rights and shares of stock acquired through the exercise of rights issued by the American Superpower Corporation, of which the petitioner was a stockholder, for the purchase of shares of stock of the United Corporation and of the Commonwealth & Southern Corporation owned by the American Superpower Corporation. The petitioner exercised some of the rights and sold some. Upon its books of account the petitioner accounted for the value of the purchase certificates at the dates they were received, namely, February 1, May 13, and June 24, 1929, as dividends received by it from the American Superpower Corporation. In the determination of the deficiency the respondent has likewise treated the value of the purchase certificates as dividends received from the American Superpower Corporation, but as of the dates fixed by corporate resolutions for identifying the stockholders entitled to receive them, namely, January 23, May 1, and June 5, 1929. By an amended answer the respondent has moved to increase the deficiencv determined by him if as a result of any errors which he may have made in the determination of the deficiency the amount thereof should be increased.

The material facts have all been stipulated and, together with the exhibits referred to in the stipulation and filed at the hearing, are adopted as our findings by reference.

The petitioner is a Delaware corporation and keeps its books and makes its Federal income tax returns on a cash receipts and disbursements basis.

At the beginning of 1929 it was the owner of 8,659 shares of class A and 21,000 shares of class B, or an aggregate of 29,659 shares of the common stock of the American Superpower Corporation (hereinafter sometimes called Superpower). In 1929 Superpower issued to each of its stockholders certain “ Purchase Certificates ” entitling each stockholder to purchase from it certain shares of stock which it held of the United Corporation and of the Commonwealth & Southern Corporation.

In 1928 a group of persons and corporations who were the owners of shares of stock in three utility companies (Mohawk Hudson Power Corporation, Public Service Corporation of New Jersey, and United Gas Improvement Co.) entered into agreements which led to the organization of the United Corporation (hereinafter sometimes referred to as United), which was incorporated on January 7, 1929, at the instance of J. P. Morgan & Co., Drexel & Co., and Bon-bright & Co. Other parties to the agreements above referred to were the Koppers Co., Day & Zimmerman, S. T. Bodine, and S. Z. Mitchell. They agreed to- organize United as a holding company and to contribute to it certain specified shares in the three utility companies mentioned in payment or exchange for a certain number of the $3 preference stock, common stock, and option warrants (for the purchase of common stock) of United. Also- J. P. Morgan & Co. and the Bonbrig-ht Electric Corporation (nominee of Bonbright & Co.) each agreed to buy from United 400,000 shares of its common stock at a price of $22.50 per share and option warrants covering the right to purchase 1,000,000 shares of common stock at $1 per warrant.

It was agreed that the contribution of 800,000 shares of the Public Service Corporation of New Jersey and 53,000 shares of United Gas Improvement Co. owned by Superpower should be made by the Public Electric Holding Corporation, its subsidiary. These agreements were not reduced to writing prior to January 2, 1929, but were carried out thereafter in the manner specified in the stipulation of facts filed in this proceeding.

As a result of these transactions Superpower received the following stock and option warrants of United: 344,181 shares of $3 cumulative preference stock; 2,210,853 shares of common stock; and option warrants entitling holder to purchase 1,000,000 shares of common stock at $27 per share.

Superpower is a Delaware corporation engaged primarily in acquiring, holding, and selling stocks of public utility corporations and holding companies thereof. At the time of the organization of United, or shortly thereafter, the officers of Superpower contemplated selling shares of stock of United to its own stockholders. The minutes of a meeting of its board of directors held on January 23, 1929, provide in part as follows:

Tile Chairman presented to the Board, for its consideration, a proposal to offer to Common Stockholders of this Corporation the privilege of purchasing Common Stock of The United Corporation owned by this Corporation — thus securing a wide distribution of the Common Stock of The United Corporation and, at the same time, materially improving the cash position of The American Superpower Corporation. Tie suggested that the offering price of the Common Stock of The United Corporation be Twenty-five ($25) Dollars per share, and that the holders of Class A and Class B Common Stock of this Corporation be entitled to purchase one-half (%) a share of the Common Stock of The United Corporation for every share of Class A and Class B Common Stock held in this Corporation. He presented to the meeting forms of a Purchase Certificate and Fractional Purchase Certificate to be sent to Class A and Class B Common Stockholders of this Corporation.

On January 31,1929, purchase certificates dated February 1, 1929, in the form authorized as aforesaid, were mailed to the holders of class A and class B common stock of Superpower of record as of January 26, 1929, and petitioner received, on February 1, 1929, certificates certifying that it was entitled to acquire, pursuant to the aforesaid resolutions, a total of 14,829% shares of United common at $25 per share.

Subsequent to the receipt on February 1, 1929, of the certificates above referred to petitioner purchased at a cost of $14 a further right to acquire a one-half share of said stock. On February 15, it surrendered its certificates, paid the sum of $370,750 in cash, and received 14,830 shares of United common.

On May 1, 1929, directors of Superpower adopted further resolutions offering to the holders of its class A and class B common stock at the close of business May 8, 1929, the privilege of purchasing additional shares of common stock of United owned by Superpower at $30 per share and at the rate of one share of United for each four shares of class A and class B Superpower common owned by each stockholder.

On May 12, 1929, purchase certificates dated May 8, 1929, in the form authorized at the directors’ meeting, were mailed to the Superpower stockholders and on May 13, 1929, petitioner received a communication from Superpower together with certificates certifying that it was entitled to acquire, pursuant to the aforesaid resolutions and on or before May 24, 1929, a total of 7,414% shares of United common at $30 per share. On May 24, 1929, the petitioner sold the 29,659 rights entitling it to purchase 7,414% shares of United common at $30 per share for $227,407.28 and claimed a loss of $69,713.62 in connection with such sale, which loss the Commissioner in his notice of deficiency reduced to $28,401.5,9.

On June 5, 1929, the directors of Superpower adopted resolutions offering the holders of its common stock at the close of business June 18, 1929, the privilege of purchasing on or before July 2, 1929, common stock of the Commonwealth & Southern Corporation (hereinafter sometimes referred to as Commonwealth) at $15 per share and at the rate of one share of Commonwealth for each 10 shares of - the new Superpower common (which prior to this date had been split five for one), subject to the acquisition by Superpower of such Commonwealth stock under a certain agreement then pending. Commonwealth was a Delaware corporation organized May 23, 1929. It was organized as a holding company to hold shares of stock in other public utility companies.

On June 22, 1929, purchase certificates dated June 22, 1929, were mailed to the Superpower stockholders and on June 24, 1929, the petitioner received a communication from Superpower together with certificates certifying that it was entitled to acquire, pursuant to the aforesaid resolutions, a total of 14,829% shares of Commonwealth common. Subsequent to that date the petitioner purchased five additional rights at a total cost of $5.94. It then was possessed of rights to purchase 14,830 shares of Commonwealth common at $15 per share, which rights it exercised on July 2, 1929, and acquired that number of shares of Commonwealth common at a cost of $222,450.

All of the purchase certificates issued by Superpower pursuant to the resolutions of January 23, 1929, were utilized by its stockholders or assignees in the purchase of 821,472 shares of United common from the petitioner. Substantially all of the purchase certificates issued to stockholders as of May 8, 1929, and as of June 18, 1929, were likewise utilized. On the purchase certificates issued by Superpower to stockholders of record as of May 8,1929, Superpower sold 410,504 shares of United common, and on the purchase certificates issued to stockholders as of June 18, 1929, Superpower sold approximately 828,748 shares of Commonwealth common to its stockholders at $15 per share, which amount was only a fractional part of its total holdings in that company.

There was an active market for United common stock from the time that it was admitted to trading on January 29, 80, and 31,1929. Superpower sold 9,279 shares out of its total holdings of 2,210,853 shares of common stock of United at prices ranging from $56.96 to $63.46. There was likewise an active market for the sale of the rights issued by Superpower in the form of “ Purchase Certificates.” The first series of rights was admitted to dealings on the New York Curb Exchange on a when, as, and if issued ” basis on January 25, 1929. These rights sold from the date admitted to trading until they expired by limitation from a low of 11% to a high of 21.

The second lot of rights was admitted to trading on the New York Curb Exchange on a “ when, as, and if issued ” basis. On May 2, 1929, these rights sold for prices ranging from 6% to 11%.

The third lot of rights relating to the purchase of the Commonwealth common stock sold at prices ranging from % to 1¶%.

Upon receipt of the respective purchase certificates issued by Superpower the petitioner, pursuant to the several sets of resolutions, entered on its books as dividends amounts representing the weighted average thereof on the basis of sales effected on the New York Curb Exchange on the respective dates of such receipt, namely, February 1, May 13, and June 24, and reported them on its income tax return as dividends from Superpower. The respondent in the notice of deficiency treated the rights so received as dividends, but valued them on the basis of the mean between high and low prices on the respective record dates as of which stockholders entitled to receive such rights were determined, namely, January 26, May 8, and June 18, 1929.

The respective values so claimed by the petitioner and determined by the respondent are as follows:

On or about July 10, 1929, United issued to its stockholders, including petitioner, rights to subscribe to its own stock. The petitioner received 16,830 such rights, which it sold for a total consideration of $68,859.81. In connection with this sale petitioner deducted on its income tax return a loss of $3,280.11. The respondent in the notice of deficiency disallowed this loss and included in gross income the sum of $7,171.51 as a profit realized on such sale.

Section 115 of the Revenue Act of 1928 provides in material part as follows:

{a) Definition of dividend. — The term “ dividend ” when used in this title '(except in section 203 (a) (4) and section 208 (c) (1), relating to insurance companies) means any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913.

For reasons fully set forth in Bradley W. Palmer, 32 B. T. A. 550, argued together with this case, the purchase certificates issued by Superpower did not constitute dividends under section 115 of the Revenue Act of 1928.

By section 113 (a) of the Revenue Act of 1928 it is provided that:

* * * The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; * * *

The petitioner argues that since the purchase certificates received by it from Superpower had a market value at the dates received by it, the basis for computing gain or loss upon the sale thereof, and upon the sales of shares of stock acquired through the exercise of the rights represented by the purchase certificates, is the fair market value of such certificates at the date of receipt plus, in the case of sales of stock acquired through the exercise of the certificates, the amount paid for such shares.

We are of opinion that this contention of the petitioner can not be sustained. The purchase certificates issued by Superpower did not represent the distribution to its stockholders of any part of its assets. They represented on the part of Superpower nothing but an offer to sell certain assets pro rata to its stockholders at an attractive price to them, but at a price which would return to Superpower a large profit. If the petitioner had not exercised the rights represented by the purchase certificates or the purchase certificates through decline in the market had become valueless in its hands, it would not have sustained any deductible loss. St. Louis Union Trust Co. et al., Co-trustees, 30 B. T. A. 370. The purchase certificates did not represent rights to make an additional investment in the shares of Superpower; hence, the method of computing taxable gains received from the sale of the rights approved by the Supreme Court in Miles v. Safe Deposit & Trust Co. of Baltimore, 259 U. S. 247, is not available to the petitioner.

The rights represented by the purchase certificates cost the petitioner nothing; hence, the entire amount received by the petitioner from the sale of the rights constituted taxable income. The basis for computing the gain on the sale of shares of stock acquired through the exercise of the rights is the amount paid by the petitioner for such shares.

The respondent’s claim for an additional deficiency made in its amended answer is hereby granted. All of the data for the computation of the correct liabilities are contained in the lengthy stipulation of facts filed in this proceeding.

Reviewed by the Board.

Judgment will be entered under Bule 50.


author: Smith:

text:
    Samuel Insull, Jr., Petitioner, v. Commissioner of Internal Revenue, Respondent. Margaret A. Insull, Petitioner, v. Commissioner of Internal Revenue, Respondent. Samuel Insull, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 68001-68003, 68503-68505.
    Promulgated April 30, 1935.

      Laurence Graves, Esq., and E. J. Quinn, Esq., for the petitioners.

      Allin H. Pierce, Esq., and Irving M. Tullar, Esq., for the respondent.
   supplemental opinion.

Smith:

In our opinion promulgated in the above entitled proceedings February 14,1935, 32 B. T. A. 47, we held that the proceeds received by petitioners from the sale of rights received by the petitioners in August 1930 to subscribe for additional shares of the common capital stock of Insull Utility Investments, Inc., constituted ordinary gains and not capital net gains.

The facts bearing upon this point are fully covered in the stipulation of the parties. Insull Utility Investments, Inc., issued rights to the holders of its common and preferred stock of record on August 30, 1930, to subscribe for its common stock at $50 per share on and prior to September 15,1930. In accordance with this action the petitioners herein received rights on stock held in most instances for a period of more than two years prior to the date of the issuance of the rights. The petitioners did not exercise the rights, but on September 13, 1930, exchanged them for common stock of the Corporation Securities Co., which at that date had a stipulated value of $23 per share. The petitioners and the respondent have treated this exchange as the equivalent of a sale. The question for decision by the Board was whether the proceeds from the exchange or sale of the rights constituted capital gain or ordinary income.

In our opinion we sustained the contention of the respondent that the gains were ordinary income. Our opinion was rested upon the fact that the stipulation did not show the value of the rights at the time they were received by the petitioner.

For reasons fully set out in Bradley W. Palmer, 32 B. T. A. 550, we are of opinion that our holding upon this point was in error. The contention of the petitioners that the proceeds from the sale of rights upon shares of stock owned and held by the petitioners for a period of more than two years from the date of the sale of the rights is sustained.

This opinion modifies our opinion promulgated February 14, 1935, 32 B. T. A. 47.

Reviewed by the Board.

Judgment will be entered wider Bule 50.