Texas-Canadian Oil Corp. v. Commissioner , 44 B.T.A. 913 ( 1941 )

TEXAS-CANADIAN OIL CORPORATION, LTD. (CANADIAN COMPANY), PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

TEXAS-CANADIAN OIL CORPORATION (DELAWARE CORPORATION), PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Texas-Canadian Oil Corp. v. Commissioner

Docket Nos. 100183, 103852.

United States Board of Tax Appeals

44 B.T.A. 913; 1941 BTA LEXIS 1258;

July 8, 1941, Promulgated

---

Two foreign corporations, outside of the United States, exchanged oil and gas leases in Texas for stock in a transaction which, if between domestic corporations, would have constituted a nontaxable reorganization within section 112(b)(4), Revenue Act of 1934. The parties did not prior to the transaction comply with section 112(i), denying a foreign corporation the status of a corporation in such transaction unless prior thereto it has been established to the satisfaction of the Commissioner that the exchange is not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes. Held, that the transaction resulted in income from sources in the United States, under section 119(a)(5), and that section 112(i) was properly applied to require taxation thereof to the foreign corporation exchanging the leases for stock.

Henry Ravenel, Esq., and William A. Blakely, Esq., for the petitioners.

James H. Yeatman, Esq., for the respondent.

---

DISNEY

The above styled proceedings, duly consolidated for hearing, involve income tax in the amount of $35,124.50 and excess profits tax in the amount of $10,707.86, all for the taxable year ended April 30, 1936, which taxes were determined by the Commissioner against the Texas-Canadian Oil Corporation, a Delaware corporation, petitioner in proceeding No. 103852, as transferee of the Texas-Canadian Oil Corporation, Ltd., a Canadian corporation, petitioner in proceeding No. 100183. The facts were stipulated, and we find the facts to be as so stipulated. In addition, one exhibit was received in evidence without objection, being a certificate showing the assessments and payments of taxes by the Canadian corporation, which certificate we adopt as a part of our findings of fact.

As a part of the stipulation, it was agreed that the Texas-Canadian Oil Corporation, of Delaware, petitioner in Docket No. 103852, is liable at law and/or in equity under section 311 of the Revenue Act of 1934 for any deficiencies in income and excess profits tax which the Board may redetermine to be due from the Canadian corporation for the year ended April 30, 1936; and at the hearing it was further stipulated that the return of the Canadian corporation for the taxable year was filed with the collector at Dallas, Texas, and, further, that, if the Board decides the matter in favor of the respondent, the taxpayer's liability will be as follows: income tax deficiency, $29,555.75; excess profits tax liability, $8,682.86.

The question presented for our determination is whether the Canadian corporation realized taxable gain during the taxable year as the result of a contract of reorganization dated October 1, 1935.

THE FACTS.

The facts pertinent to consideration of the issues may be summarized as follows:

The Canadian corporation was organized in 1929 and was dissolved in 1937. On August 23, 1935, a corporation of the same name was formed under the law of the Islands of Bahama. A Delaware corporation, petitioner in Docket No. 103852, was organized in 1939 as successor to the Bahamas corporation. On October 1, 1935, within the taxable year here considered, the Canadian corporation conveyed its assets, pursuant to a written contract, to the Bahamas corporation. In consideration thereof, the Bahamas corporation issued to the stockholders of the Canadian corporation one share of its stock for each share held in the Canadian corporation, and assumed the liabilities of the Canadian corporation.

The agreement of October 1, 1935, the only document involved in the transaction, was signed and delivered in Canada, and all meetings of stockholders and directors necessary to the consummation by both corporations were held in Canada. Ninety-seven percent of the Canadian company's stock was held by residents of Canada and Great Britain, and 2 percent by a citizen of Canada temporarily residing in the United States. The certificates for the shares of stock of the Bahamas corporation were issued in Canada directly to the shareholders of the Canadian corporation, and no certificates were issued to, or in the name of, the Canadian corporation.

The agreement provides, in material part, that the Canadian corporation grees to, and "does hereby grant, bargain, sell, assign, transfer and set over" to the Bahamas corporation "its undertaking, property and assets, real and personal", also "all and singular its lands and interests in lands * * *, and its outstanding business and the good will thereof." It is further provided:

Consideration - The consideration for the aforegoing transfer shall be * * *

"(a) the issue to the holders of share certificates of this Company (the Dominion Company) of one fully paid share in the new Company (the Bahamas Company) in exchange for each share held by them, respectively in this Company, and

"(b) the assumption by the new Company of all the obligations, agreements, debts and liabilities of whatsoever nature or description of this Company."

The Canadian corporation also agreed:

3 Subscription - To subscribe for and it hereby on behalf of its individual Shareholders, as authorized by its said By-law Number 8, subscribes for 1,000,000 shares of the capital stock of the Bahamas Company of the par value of $1.00 per share; and it hereby requests the Bahamas Company to cause its Directors to allot the said shares in the Bahamas Company to the individual holders of shares in the Dominion Company in accordance with, or in proportion to their individual shareholdings in the Dominion Company on the date of this Agreement, upon surrender for exchange by them, and each of them, to the Bahamas Company, of their respective share certificates of the and be indemnified by that company accordingly. The contract was Dominion Company's shares.

The Bahamas corporation on its part agreed to accept the transfer of the assets, and to cause its board of directors to accept the subscription of the Canadian corporation "and to allot the shares for which it so subscribed to the individual shareholders of the Dominion Company" and to "issue to the respective holders of share certificates of the Dominion Company, certificates of one fully paid share in the Bahamas Company in exchange for each fully paid share so held by them in the Dominion Company"; also to assume the liabilities of the Canadian corporation. It was agreed that the effective date of transfer was October 1, 1935, and that so far as continuing business thereafter the Canadian corporation should be deemed to do so on behalf of the Bahamas corporation, and should account to carried out according to its provisions.

The assets conveyed by the petitioner to the Bahamas corporation consisted of cash, accounts receivable, inventory, oil and gas leases in Texas and the equipment thereof, prepaid interest, prepaid insurance, and deferred salaries, all totaling $778,916.94, of which leaseholds represented $461,576.91 at cost, and equipment at cost represented $277,457.34 (all as per closing balance sheet of the Canadian corporation after adjustment by the revenue agent. In computing deficiency respondent used adjusted cost of equipment at $249,009.65, with depreciation of $27,466.47.) After acquisition of the oil and gas leases the Bahamas corporation continued the operation thereof. None of the income-producing properties received from the Canadian corporation were removed from the United States.

Neither prior to nor at the time of the transfer of assets to the Bahamas corporation had anyone done anything to establish to the satisfaction of the respondent that the exchange was not made in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes; and he had no information or knowledge concerning the exchange until later. No one connected with either the Canadian or Bahamas corporation or the preparation and execution of the agreement of October 1, 1935, was aware of or familiar with section 112(i) of the Revenue Act of 1934, and the first notice that the Canadian corporation had that the transfer of assets would be basis of claim of taxable profit was in September 1937, as a result of a field audit of petitioner's books by a revenue agent. Thereafter and prior to deficiency notice, full information was furnished respondent as to the reorganization and transfer, including statements under oath that neither the transfer nor the reorganization was pursuant to a plan to avoid Federal income taxes, thus seeking to comply retroactively with the terms of section 112(i).

It is stipulated that in determining the deficiency respondent increased income by $257,700.03, resulting from his valuation of the Texas oil leaseholds owned and transferred by the petitioner to the Bahamas corporation at a sum $257,700.03 in excess of the depreciated and depleted cost of the leases to the petitioner. In arriving at this increase the value of equipment used on the leaseholds was considered to be its depreciated cost.

OPINION.

DISNEY: The respondent in the deficiency notice added to petitioner's income as reported $257,700.03 "profit on reorganization", explaining that the reorganization was held to result in realization of taxable gain under the provisions of article 112(i) - 1 of Regulations 86, ^{*1266 a profit on the reorganization by applying the provisions of the above regulation, based upon section 112(i) of the Revenue Act of 1934. *1267 The nature of the approach to the problem requires that we first resolve petitioner's last argument, since if it be sustained the other questions become immaterial.}

1. The petitioner urges that we hold that the agreement of reorganization did not have as one of its principal purposes the avoidance of Federal income taxes and therefore that the reorganization was not taxable, and that we reverse the Commissioner in holding that the reorganization was not tax free under section 112(i), which requires that prior to such reorganization a foreign corporation shall establish to the Commissioner's satisfaction that the exchange is not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes.

The situation here is not essentially different from that in , where, as herein, the taxpayer was not advised as to a statutory provision - requiring an election to be made in the "first return." When apprised of the provision, the taxpayer filed an amended return, much as the petitioner here furnished the information called for by section 112(i). The Court, is affirming the Circuit Court, which had affirmed this Board in holding that the amended return did not comply with the statute, said that "to require the administrative branch to extend the time for filing on a showing of cause for delay would be to vest in it discretion which the Congress did not see fit to delegate", and that "to extend the time beyond the limits prescribed in the Act is a ligislative not a judicial function." To the plea, which petitioner here also makes, that a hardship was imposed upon it, the Court further said: "That may be the basis for an appeal to Congress in amelioration of the strictness of that section. But it is no ground for relief by the courts from the rigors of the statutory choice which Congress has provided." Various other statutes require, in a manner analogous to that of section 112(i), affirmative action of the petitioner in order to have the benefits therein involved, e.g., consent prior to change of accounting method under section 46, and consent of affiliates prior to filing a consolidated return under section 141. The statute here involved provided for a determination by the Commissioner prior to the reorganization. It was not asked for at that time and was not made. In our opinion the Commissioner did not err in the view that he had no authority to make it upon application made after the reorganization. On this point we sustain the respondent and hold that he properly applied section 112(i).

2. The petitioner argues that it realized no profit in the transaction with the Bahamas corporation, urging that the contract, taken as a whole, did not represent an exchange of its assets for Bahamas' stock, since the stock was issued directly to petitioner's stockholders and not to it. Suggestion is made that either the petitioner, in legal effect, liquidated its assets to its stockholders, who in turn transferred them to the Bahamas corporation in satisfaction of the subscription to its stock made on their behalf; or that, in effect, the stockholders transferred their stock to the Bahamas corporation for its stock, thus empowering it, as owner of such stock, to take the assets of the Canadian corporation in place of the stock. Cases are cited where substance and not form was controlling. We find none decisive here. Thus , involved agency of one company for another. Equal distinction from the instant matter appears to us in the other citations. Herein a corporation transferred its assets in consideration of stock in another, and directed the issuance thereof to its stockholders. Only the petitioner could convey its assets, and they were never conveyed to its stockholders. The fact that the stockholders received the consideration does not control. ; ; ; . We hold that the petitioner realized a profit on the exchange.

3. The petitioner also argues that section 112(i) is not applicable to an exchange between two foreign corporation, that, assuming the Canadian corporation exchanged its assets for stock of the Bahamas corporation, there was reorganization under section 112(g), and nonrecognition of gain; and that no reason exists for applying the provisions of section 112(i) to foreign corporations and a transaction not affecting Federal income tax liability. Such contention requires us to ignore section 112(i). On its face, the statute expressly covers foreign corporations, and exchanges that are nontaxable when made between domestic corporations. It can not be ignored. That the transaction comes within the definition of reorganization under section 112(g) is only preliminary. If within section 112(b)(4), as here the transaction is, section 112(i) must be applied, with the result of recognized gain. We see no merit in petitioner's argument on this point.

4. There remains for consideration the question as to whether the profit from the exchange was from sources within the United States, or without the United States and nontaxable under the provisions of sections 231 and 119(e) of the Revenue Act of 1934, which in effect provide that a foreign corporation is taxable only upon profit from sources within the United States, and that if the profits is from sale or exchange of personal property, it is nontaxable if the sale or exchange takes place outside the United States. The petitioner points out, and we find, that the agreement was consummated outside the United States; but the respondent urges that the sale or exchange was of oil and gas leases, in Texas, and that, under the decisions of the courts of that state, such leases are real estate, so that under section 119(a)(5), Revenue Act of 1934, *1273 The courts of Texas have in various cases construed oil and gas leases to be real estate. As to that state this is a concept so well settled that citation of authorities seems unnecessary. . Section 119(a)(5) of the Revenue Act of 1934 does not define real property. In , the court said: "Since the Federal Statutes do not define the term 'property' or the rights attaching thereto, we must turn to the state law for their meaning. ." In , the court considered the question as to whether documentary stamp taxes need be affixed to assignments of oil and gas leases on lands in Texas, under section 800 and schedule A-8 of the Revenue Act of 1926, as amended, imposing tax with respect to any "Deed, instrument or right * * * whereby any lands, tenements or other realty sold shall be granted, assigned, transferred or otherwise conveyed * * *." Pointing out that the Texas decisions are uniform to the effect that mineral leasehold interests are interests in lands, tenements, or other realty, the court held that the statute required affixing of stamps. It was pointed out that , which the petitioner herein cites and relies upon, involved the question of whether a bonus received by the lessor for execution of an oil and gas lease was subject to capital gains provisions. The same question was involved in , extensively cited by the petitioner here. It was held that such bonus was not capital gain. Obviously, these cases do not involve the question here presented, which is whether the owner of an oil and gas lease on land in Texas, in exchanging it, exchanges real property, within the text of section 119(a)(5). In , it was held that the amounts received for the sale by the lessee of an oil and gas lease was return of capital invested - which serves to distinguish a sale or exchange of an oil and gas lease by the owner from the receipt of bonus by the lessor, in the above cases cited by the petitioner here.

We are impelled by the above decisions to the conclusion that the petitioner, in the exchange of oil and gas leases constituting real estate under Texas law, derived income from sources within the United States within the intendment of section 119(a)(5) of the Revenue Act of 1934.

Reviewed by the Board.

Decision will be entered for the respondent in Docket No. 100183, that there is a deficiency in income tax in the amount of $29,555.75 and in excess profits tax in the amount of $8,682.86, and that the Texas-Canadian Oil Corporation of Delaware, petitioner in Docket No. 103852, is liable for said amounts at law and/or in equity as transferee from the Texas-Canadian Oil Corporation, Ltd., petitioner in Docket No. 100183.

---

Footnotes

• 1. ART. 112(i) - 1. Reorganization with, or transfer of property to, a foreign corporation. - A foreign corporation will not be considered a corporation to which a tax-free transfer of property for stock or securities may be made, or a corporation a party to a reorganization with which a tax-free reorganization exchange may be made, unless, prior to the transfer or exchange, it has been established to the satisfaction of the Commissioner that such transfer or exchange is not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes. The term "Federal income taxes" includes the excess-profits tax on the net income of a corporation referred to in sections 702 and 703 of the Act.

  Whether any of the exchanges or distributions referred to in section 112(i), involving a foreign corporation, is in pursuance of a plan having as one of its principal purposes the avoidance of Federal income or excess-profits taxes, is a question to be determined from the facts and circumstances of each particular case. In any such case if a taxpayer desires to establish that the exchange or distribution is not in pursuance of such a plan, a statement under oath of the facts relating to the plan under which the exchange or distribution is to be made, together with a copy of the plan, shall be forwarded to the Commissioner of Internal Revenue, Washington, D.C., for a ruling. A letter setting forth the Commissioner's determination will be mailed to the taxpayer. If the Commissioner determined that the exchange or distribution is not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income or excess-profits taxes, the taxpayer should retain a copy of the Commissioner's letter as authority for treating the foreign corporation as a corporation in determining the extent to which gain is recognized from the exchange or distribution. If the reorganization or the transfer is not carried out in accordance with the plan aubmitted, the Commissioner's approval will not render the transaction tax free. ↩

• 2. SEC. 112. RECOGNITION OF GAIN OR LOSS.

  * * *

  (i) FOREIGN CORPORATIONS. - In determining the extent to which gain shall be recognized in the case of any of the exchanges (made after the date of the enactment of this Act) described in subsection (b)(3), (4), or (5), or described in so much of subsection (c) as refers to subsection (b)(3) or (5), or described in subsection (d), a foreign corporation shall not be considered as a corporation unless, prior to such exchange, it has been established to the satisfaction of the Commissioner that such exchange is not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes. ↩

• 3. SEC. 119. INCOME FROM SOURCES WITHIN UNITED STATES.

  (a) GROSS INCOME FROM SOURCES IN UNITED STATES. - The following items of gross income shall be treated as income from sources within the United States:

  * * *

  (5) SALE OF REAL PROPERTY. - Gains, profits and income from the sale of real property located in the United States. ↩