United States Board of Tax Appeals

1938-07

Segall v. Commissioner ( 1938 )

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KARL B. SEGALL, TRANSFEREE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

WALTER F. TANT, TRANSFEREE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Segall v. Commissioner

Docket Nos. 82397, 82434.

United States Board of Tax Appeals

38 B.T.A. 43; 1938 BTA LEXIS 925;

July 12, 1938, Promulgated

*925 Where, pursuant to a contract designated a plan "of merger, consolidation and reorganization", one company transferred its assets to a second corporation in consideration of cash and debenture notes of the acquiring corporation, which debentures were issued under an indenture which granted to the holders of the debentures a definite, material, and substantial continuity of interest in the property transferred, held, a statutory reorganization was effected, such debentures were securities under the terms of the statute, and, all cash and debentures having been distributed to the stockholders of the receiving corporation, pursuant to the plan of reorganization, the corporation incurred no tax on the transaction. Consequently the petitioners are not liable as transferees.

T. S. Forward, Esq., and Don M. Harlan, Esq., for the petitioners.

Chester A. Gwinn, Esq., for the respondent.

VAN FOSSAN

*43 These proceedings were brought to redetermine deficiencies in the income tax of each of the petitioners for the year 1932 in the sum of $113,091.43. This amount was proposed to be assessed against them as transferees of the assets of the Silent*926 Automatic Corporation.

The issues are: (1) Whether or not the transaction between the Silent Automatic Corporation and the Timken-Detroit Co. constituted a tax-free reorganization; and (2) whether the profit thereon, if any, was taxable in 1931 or 1932.

FINDINGS OF FACT.

Certain facts were stipulated substantially as follows:

On October 2, 1931, the Timken-Detroit Co. and the Silent Automatic Corporation and the petitioners entered into a contract the pertinent provisions of which are as follows:

THIS PLAN AND AGREEMENT (hereinafter referred to as the "Plan") of merger, consolidation and reorganization, made in triplicate as of the second day of October, A.D. 1931, between THE TIMKEN-DETROIT COMPANY, a Michigan corporation, of Detroit, Michigan, (hereinafter called "Timken"), party of the first part, SILENT AUTOMATIC CORPORATION, a Michigan corporation, of Detroit, Michigan, (hereinafter called "Silent Automatic"), party of the second part, WALTER F. TANT and KARL B. SEGALL, parties of the third part, and WALTER F. TANT, as Trustee for "Silent Automatic", party of the fourth part, -

WITNESSETH

(1) Pursuant to this plan and agreement of merger, consolidation and reorganization, *927 Silent Automatic agrees to transfer and Timken agrees to acquire *44 all of the assets, tangible and intangible, of Silent Automatic, as hereinafter set forth, in exchange for certain cash and securities of Timken.

* * *

(D) * * * The liabilities which Timken will assume include notes and accounts payable, as shown by consolidated balance sheet of Silent Automatic and Sales Corporation as of August 31, 1931, attached hereto as Exhibit "A", together with those currently accruing from August 31, 1931, to the effective date of delivery, current city, county and state taxes payable, Federal income taxes for the year 1931 upon the profits made by Silent Automatic and/or Sales Corporation up to December 31, 1931, except as excepted by item (3) above, contingent liabilities of Silent Automatic and/or Sales Corporation on customers' notes discounted prior to January 2, 1932, unexpired service contracts and service guaranties on new installations. * * *

(e) In exchange for all the assets of Silent Automatic and the assumption of its liabilities by Timken, as hereinbefore set forth, Timken agrees to give Silent Automatic cash and securities of Timken in the aggregate amount of*928 Two Million One Hundred Thousand Dollars ($2,100,000.00) in the manner and form hereinafter set forth.

The said aggregate sum of Two Million One Hundred Thousand Dollars ($2,100,000.00) shall consist of:

(1) Seven Hundred Sixty Thousand Dollars ($760,000.00) in cash to be paid by Timken to the party of the fourth part upon the execution of this agreement:

(2) A promissory note of Timken in the amount of One Hundred Thousand Dollars ($100,000.00) drawn to the order of Surprenant & Company, Incorporated, brokers of New York City, New York, said note to be dated October 2, 1931, and to mature January 2, 1933, and to bear interest at the rate of five (5) per centum per annum from October 2, 1931, payable semi-annually thereafter, which said note shall be delivered to said fourth party upon the execution of this agreement and by him thereupon delivered to said Surprenant & Company, Incorporated, in full payment of all services, expenses, and commissions as a broker in connection with this plan:

(3) One Million Two Hundred Forty Thousand Dollars ($1,240,000.00) in principal amount in the Five Per Cent Gold Debentures of Timken in such denominations as Silent Automatic may specify, *929 all dated January 2, 1932, bearing interest at the rate of five (5) per centum per annum from October 2, 1931, payable semi-annually on the second days of July and January and maturing as follows: -

$300,000.00 on or before January 2, 1933

300,000.00 on or before January 2, 1934

300,000.00 on or before January 2, 1935

300,000.00 on or before January 2, 1936

40,000.00 on or before January 2, 1937

Timken agrees to cause the payment of said debentures to be unconditionally guaranteed by the Timken-Detroit Axle Company, an Ohio corporation. Said debentures shall be delivered as hereinafter provided upon the transfer of the assets to Timken hereunder.

* * *

(i) The transfer of assets herein contracted for shall be consummated on

(I) The transfer of assets herein contracted for shall be consummated on

*45 i. The delivery of Silent Automatic to Timken of the bills of sale, assignments and other necessary conveyances hereinbefore specified, together with possession of the assets of Silent Automatic;

ii. The delivery by Timken to party of the fourth part of said Five Per Cent Gold Debentures in the principal amount of One Million Two Hundred Forty Thousand Dollars*930 ($1,240,000.00);

iii. The transfer by Silent Automatic or party of the fourth part to Ferris D. Stone and Joseph G. Hamblen, Jr., Attorneys of Detroit, Michigan, as Trustees, of the debentures aggregating Three Hundred Forty Thousand Dollars ($340,000.00) maturing (1) January 2, 1933, and (2) January 2, 1937, to be held as hereinafter specified;

iv. Silent Automatic or party of the fourth part will distribute, pursuant to the plan, to its stockholders the total avails of this transaction, including the interest of Silent Automatic in the debentures held in trust by Stone and Hamblen, after payment of such of its expenses as arise in connection therewith, and after retirement of the preferred stock of Silent Automatic with accrued dividends thereon.

As to the debentures to be held in escrow by said Stone and Hamblen, they shall deliver to party of the fourth part those maturing January 2, 1933, upon deposit with them of a certificate by Ernst & Ernst that Exhibit "A" is a correct consolidated balance sheet of Silent Automatic and Sales Corporation as of August 31, 1931. Should the certificate of Ernst & Ernst disclose a deficiency in assets and/or excess of liabilities, debentures*931 representing in principal amount the sum of such deficiency and excess shall be cancelled and delivered to Timken and the balance of said debentures maturing January 2, 1933, delivered to party of fourth part. The debentures maturing January 2, 1937, shall be cancelled in principal amount equal to the liability of Silent Automatic on customers' notes discounted as certified to by Ernst & Ernst as hereinabove provided. The balance of said debentures shall thereafter be delivered to the party of the fourth part.

(j) Silent Automatic agrees that it will from the date of the signing of this agreement until delivery to Timken diligently conduct its business in the usual manner and that it will not enter into any contract of employment running beyond December 31, 1931, or into any unusual contract or agreement; that it will not incur any liability except in the usual course of business; and that neither Silent Automatic nor Sales Corporation will, prior to delivery of assets to Timken, pay or declare any dividend or dividends.

* * *

On the same day stockholders of Silent Automatic representing the 81,646 shares of common stock out of a total of 116,033 such shares outstanding, *932 or over 70 percent thereof, by written agreement consented to the transfer of the assets of Silent Automatic to Timken as set forth in the foregoing agreement, "specifically assenting to any and all measures that may be deemed necessary and proper for the purpose of giving complete effect to said agreement." They further agreed to vote their shares in favor of the plan of merger and consolidation "contemplated to be held in January" and appointed the petitioner Tant as their attorney to vote their stock for the plan.

*46 On the same day the directors of Silent Automatic passed the following resolution:

RESOLVED that the proposed plan of merger, consolidation and reorganization, pursuant to which this Corporation will transfer and The Timken-Detroit Company, a Michigan corporation, will acquire all of the assets, tangible and intangible, of this Corporation (except the franchise to be a corporation) as the same exist on January 2nd, 1932, subject to the liabilities of this Company, in the manner and to the extent set forth in the draft of agreement heretofore presented and read to this meeting, be and the same is hereby declared to be expedient and for the best interests*933 of this Corporation and is hereby ratified, approved and adopted; and

* * *

The payment of $760,000 in cash and the delivery of a promissory note for $100,000 were made as noted in the following record of the directors' meeting:

Following a short adjournment, the meeting reconvened and the President reported that said plan and agreement of merger, consolidation and reorganization between this Corporation and the Timken-Detroit Company had been duly signed and sealed by all the parties thereto and delivered, and that there had been duly delivered in accordance with the terms of said agreement, to Walter F. Tant, as Trustee for this Corporation and/or its Stockholders, Seven Hundred Sixty Thousand Dollars ($760,000.00) in cash, together with a promissory note in the amount of One Hundred Thousand Dollars ($100,000.00) of the Timken-Detroit Company drawn to the order of Surprenant & Co., Incorporated, Brokers of New York City, and unconditionally guaranteed by the Timken-Detroit Axle Company.

On October 5, 1931, the stockholders of the Timken-Detroit Axle Co. were notified that "on October 2, 1931, an agreement was signed whereby Silent Automatic Corporation (manufacturers and*934 distributors of domestic oil burners) will merge with a subsidiary, The Timken-Detroit Company, on January 2, 1932", and that "until January 2, 1932, the two companies will continue to operate separately * * *." The stockholders were also told that just as soon after January 2, 1932, as the necessary legal steps could be taken, the name of Timken would be changed to the "Timken Silent Automatic Company."

On October 5, 1931, Silent Automatic notified its preferred stockholders that their stock would be called on April 1, 1932, due to the consolidation of Silent Automatic with Timken "which would be effective after January 1."

On October 10, 1931, the common stockholders of Silent Automatic were notified that an agreement had been entered into by consent of more than two-thirds of the outstanding capital stock, "pursuant to which a merger or reorganization will be effected by Timken's acquiring all of the assets of the Silent Automatic as of January 2, 1932, subject to its liabilities." The stockholders were also *47 notified that a meeting would be called about January 2, 1932, for the purpose of ratifying the agreement.

On October 15, 1931, the sales organizations of*935 Silent Automatic and Timken were notified by a joint statement signed by the presidents of both companies that the two corporations would be consolidated on January 1, 1932, and that all service obligations and other liabilities incurred by the two separate companies would be assumed by Timken after January 1, 1932.

The officers of Silent Automatic treated the transactions covered by the agreement of October 2, 1931, as a tax-free merger or consolidation and did not report it in its income tax return for 1931 or 1932.

The outstanding common stock of Silent Automatic on October 2, 1931, totaled 116,033 shares. A two-thirds vote was sufficient to dispose of the properties of Silent Automatic.

Pursuant to the agreement of October 2, 1931, after accounting for adjustments provided therein, Timken issued and delivered the following:

October 2, 1931	Cash	$760,000.00
October 2, 1931	Note to Surprenant & Co. due January 2, 1933	100,000.00
Jan. 2, 1932	Debenture notes due Jan. 2, 1933	121,700.00
Jan. 2, 1932	Debenture notes due Jan. 2, 1934	300,000.00
Jan. 2, 1932	Debenture notes due Jan. 2, 1935	300,000.00
Jan. 2, 1932	Debenture notes due Jan. 2, 1936	300,000.00
Apr. 10, 1935	Balance in cash after adjustments	4,682.93

*936 The debentures due January 2, 1933, 1934, 1935, and 1936 of a face value of $1,021,700 had a total fair market value of $920,000 as of January 2, 1932.

The debenture notes of Timken covering this transaction were accepted for filing by the Michigan Securities Commission on December 31, 1931.

The Timken-Detroit Co., with the consent of the Silent Automatic Corporation, changed its name to "The Timken Silent Automatic Company" by amendment to its articles of incorporation filed with the Secretary of State of Michigan on December 17, 1931.

The $1,021,700 in debenture notes of Timken heretofore described were part of an issue of $1,240,000 of 5 percent serial gold coupon debenture notes in denominations of $1,000, $500, and $100, due serially as follows: $300,000 payable on January 2 of each of the years 1933, 1934, 1935, and 1936, and $40,000 payable on January 2, 1937.

The issue was unconditionally guaranteed by the Timken-Detroit Axle Co., was payable as to both principal and interest at the Detroit Trust Co., the trustee named therein, and was secured by an elaborate, formal indenture containing many covenants and promises, *48 including Timken's agreement to maintain, *937 renew, and repair its buildings and keep them insured to 80 percent of insurable value; to pay all taxes, assessments and charges against it; to comply with all valid civic regulations; to furnish the trustee an annual audit by public accountants satisfactory to it; and to permit the trustee to inspect the property. In the event any of the above covenants were not performed or kept by the company the trustee had the right to perform such covenants and make advances to pay therefor, and the company agreed to reimburse the trustee, with interest.

The petitioner Tant, as trustee for Silent Automatic, distributed the proceeds of the transaction to its stockholders according to their respective interests. Each stockholder other than Tant and Segall received $1.02 cash and $5 par value debentures for each share of Silent Automatic common stock. Petitioner Tant received on the distribution $65,417.12 cash and $301,140 debentures and petitioner Segall received $62,653.94 cash and $287,595 par value debentures.

Silent Automatic kept its books on the accrual basis and filed its 1931 income tax return on that basis. Silent Automatic was organized under the laws of Michigan on February 28, 1925. *938 After the disposition of all its assets in accordance with the contract of October 2, 1931, it ceased to do business.

The record discloses the following additional facts:

On October 3, 1931, the president, the general manager, and the sales manager of Timken and the president of Silent Automatic held in Detroit a meeting of the combined sales organizations of both companies. The salesmen there were told that thereafter they were to be considered as working for the same company. During October similar conferences were held with the salesmen of the branch offices of both companies. After the last of these meetings Haldeman Finnie, vice president and general manager of Timken, devoted his time to planning the transfer of the Silent Automatic assets to Timken and to the consolidation and discharge of personnel. In October 1931 he brought to the Timken office the employee of Silent Automatic who had been in charge of dealers' sales for the latter company. In December 1931 Finnie and the sales manager of Timken ordered the Boston branch manager of Silent Automatic to Philadelphia to take charge of the Philadelphia office of Timken. At Finnie's request a number of employees of*939 Silent Automatic were discharged by Silent Automatic in the fall of 1931.

The purchase price of the Silent Automatic assets was based on the balance sheet of that company as of October 31, 1931.

OPINION.

VAN FOSSAN: Two issues are presented and argued by the parties: (1) Did the transactions pursuant to the agreement of October 2, *49 1931, between the Timken-Detroit Co. and Silent Automatic Corporation accomplish a tax-free reorganization as provided in section 112(b)(4) and (d)(1) of the Revenue Act of 1928 or 1932, ^{*940 The general principles governing reorganizations have been considered in many cases and need not be discussed at length. There must be a plan of reorganization. There must remain in the transferor or its stockholders a real, material, and substantial continuity of interest in the property transferred. It is necessary in certain cases also to determine whether the consideration paid consists of cash and "securities" or cash and "other property."}

The respondent's position here is that the transfer of the assets of Silent Automatic for cash of $760,000, a promissory note of $100,000 and gold debenture notes of a face value of $1,021,700 (fair market value $920,000) did not effect a reorganization because the debenture notes did not represent the retention of a definite and material continuity of interest in the property transferred. He further urges that the debenture notes were not "securities" within the meaning of section 112(b)(4), but are "other property" within the meaning of section 112(d).

The petitioners contend that the debenture notes evidenced a definite, substantial and continuing interest of the transferor in the property transferred and were "securities" under*941 the statute.

We disagree with both of respondent's contentions. The agreement of October 2, 1931, clearly contemplated a plan of reorganization. In exchange for the Silent Automatic assets Timken agreed to give to the former company "cash and securities" aggregating $2,100,000 (later reduced by adjustment). The cash and debenture notes were distributed to the stockholders as provided in section 112(d)(1). The vital question is whether or not the ownership of the debentures vested in the Silent Automatic or its stockholders a definite, *50 material and continuing interest in Timken and the property of Silent Automatic transferred to it.

On consideration of the nature of the debentures, the obligations assumed by Timken under the indenture creating them, and the rights conferred on the trustee for the benefit and in protection of the rights of the debenture holders, we are of the opinion that through the debentures the holders retained a definite, material, and continuing interest in the property transferred. Though they were for relatively short terms, the interest conferred by them on their holders was very real.

The debentures were created under a formal indenture. *942 They were unconditionally guaranteed by the Timken-Detroit Axle Co. Under the indenture Timken undertook to maintain the property in good repair; to make necessary renewals, replacements, and improvements; to keep it insured to full value permitted; to pay and discharge all taxes, assessments, and legal charges, or, if contesting such taxes or charges, to indemnify the trustee for ultimate payment; to furnish a complete annual audit by auditors approved by the trustee; to permit inspection by the trustee. In case of default by the company as to any of the maintenance or insurance provisions, or in the payment of charges or compliance with legal orders, the trustee was empowered to perform the same, make advances therefor, and collect the sums so expended with interest from the company. Furthermore, the company agreed to maintain its corporate life; to provide an office for the payment of principal and interest of the debentures; and to replace the same if any debentures were lost or mutilated.

Respondent emphasizes the fact that the debentures were what he calls "short-term" and from this argues that they fall within the decision of the Supreme Court in *943 , in which , was cited with approval. In each of these cases the Court held the facts did not spell a reorganization. The transactions involved were held to be sales of assets, not reorganizations. The part of the consideration in question consisted of short term purchase money notes, a very different type of obligation from that here involved.

Although the Supreme Court has never ruled on a transaction involving solely bonds, or bonds and cash, as consideration for the transfer of stock or assets, the Board has held such a transaction to constitute a reorganization. ; ; .

That bonds are "securities" was held in . In ; certiorari denied, *944 , the Court held that unsecured promissory notes *51 due on or before 10 years after date fall within the term "securities." We believe the debenture notes here involved should be likewise classified. The fact that they were accepted for filing by the Michigan Securities Commission is persuasive. They differed widely in character from the $100,000 note given at the same time, or the purchase money notes involved in the Pinellas and Cortland Specialty cases. The debentures were "securities" rather than "other property" referred to in the statute.

The conclusion we have indicated above is not in conflict with the holding of the Board in . Though the Board there characterized the debentures as "short-term of about six and one-half years," it is noted that the debentures were in fact called within a year. Moreover, as observed in the opinion, the debentures were not the securities of the company which acquired the assets but those of a third party not a party to the claimed reorganization. We have noted, supra, the many provisions of the indenture in the instant cases which created a continuing*945 interest in the property transferred. In the Graham case obviously no such condition existed.