Old Colony Trust Co. v. Commissioner , 12 B.T.A. 1334 ( 1928 )

OLD COLONY TRUST CO., EXECUTOR, ESTATE OF CLARENCE D. REED, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Old Colony Trust Co. v. Commissioner

Docket No. 6601.

United States Board of Tax Appeals

12 B.T.A. 1334; 1928 BTA LEXIS 3361;

July 13, 1928, Promulgated

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1. The Commissioner's determination that a contract to purchase stock had a readily realizable market value in the taxable year 1921, sustained.

2. Determination of the March 1, 1913, value of shares of stock of Commonwealth Shoe & Leather Co. sustained.

Hervey W. King, Esq., for the petitioner.

Thomas P. Dudley, Jr., Esq., for the respondent.

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LOVE

This proceeding is for the redetermination of a deficiency in income tax for the calendar year 1921 in the amount of $109,740.07, resulting from the action of the Commissioner in increasing gain derived from the sale by the decedent of the petitioner in 1921 of shares of stock of the Commonwealth Shoe & Leather Co. In determining the deficiency the Commissioner is alleged to have erred, (1) in valuing an obligation evidenced by the contract of sale of the stock at $350,000 and including that amount in gross income for the year 1921, and (2) in determining that the value of 564 shares of stock owned by decedent of petitioner on March 1, 1913, and sold in 1921, was $100 per share.

FINDINGS OF FACT.

Petitioner is a corporation organized under the laws of the State of Massachusetts and is the executor of the will of Clarence D. Reed, deceased. Prior to March 31, 1921, Clarence D. Reed and Charles H. Jones had each owned one-half or 4,500 shares of the capital stock of the Commonwealth Shoe & Leather Co., a corporation organized under the laws of Massachusetts. On that date Reed agreed to sell and Jones to buy the shares of the former for an aggregate price of $800,000, payable as follows: $300,000 in cash upon the execution of the agreement and the balance, $500,000, in cash in installments, with interest at the rate of 7 per cent per annum, in designated amounts, and at stated intervals over a period of five years, the buyer to be privileged to anticipate payment of any or all of the cash installments, or any part thereof, as he might desire. To secure the due performance of the buyer's undertaking, the agreement further provided (1) that he should transfer to the seller, by way of pledge, 6,000 shares of the stock of the Commonwealth Shoe & Leather Co., with a power upon default of the buyer after notice, to declare the unpaid balance of the purchase price due at once, and to sell all or any part of the stock at public sale and apply the proceeds thereof to the satisfaction of the indebtedness; (2) that, so long as any portion of the purchase price of the stock remained unpaid, an annual accounting and audit of the business of the Commonwealth Shoe & Leather Co. should be made by a designated agency for the purpose of determining whether the fair value of the 6,000 shares pledged did not exceed the unpaid balance of the purchase price, in which event the seller should have the right to demand of the buyer that he reduce such balance or deliver such additional security as would in the seller's judgment make the total value of all the security given exceed the amount of the unpaid balance by at least 100 per cent thereof, in default of which the seller should have the power mentioned above; (3) and that the seller should have the optional power, in case of default, to transfer all the shares pledged to his own name and thereafter to exercise the powers and privileges of the owner of such stock as to control, appointment of officers, liquidation, etc. Other provisions protected the interests of the buyer in the event of his faithful performance of the contract and in matters not material to the present controversy. No evidence of indebtedness other than the contract itself was given.

Concurrently with the execution of the agreement March 31, 1921, Reed transferred 4,500 shares of the stock of the Commonwealth Shoe & Leather Co. to Jones, who paid Reed $300,000 in cash and transferred 6,000 shares of the said stock as collateral security as agreed. No default in the performance of the terms and conditions of the contract ever occurred, and Jones in fact anticipated the deferred payments to such an extent that an additional payment of $150,000 was made in 1921, and the entire balance of the purchase price in 1922.

The facts material to a determination of the second issue briefly, are as follows: The Commonwealth Shoe & Leather Co. was organized in 1884, under the laws of the Commonwealth of Massachusetts. In 1902, a corporation was organized under the laws of the State of Maine, bearing the same name. Both corporations were owned by the same interests and were operated as a single enterprise. On March 1, 1913, Clarence D. Reed owned 564 shares of the Massachusetts company. This stock was held subject to a contract entered into by Reed and the Maine company on April 12, 1902, by which the Maine company within 10 days after demand in writing, agreed to exchange 564 shares of its own stock for the shares of the Massachusetts company owned by Reed. There was a further provision by which each party to the contract agreed to pay to the other the difference required to equalize the dividends received by him on his stock with those paid on the stock to which he would have been entitled had the exchange been consummated. The provisions of the contract as to the exchange of stock were never executed.

On the question of the March 1, 1913, value of the 564 shares of stock of the Massachusetts company which were sold by Reed in 1921, the evidence of record discloses that there were no sales of stock at that time to indicate a fair market value. The book values as of March 1, 1913, of the shares of the Maine and Massachusetts companies were $322.39 and $100, respectively.

OPINION.

LOVE: The first question to be determined in this case is whether or not the Commissioner erred in including in the taxable gross income of Reed, who was on a cash receipts and disbursements basis, for the year 1921, the amount of $350,000 which he found to be the readily realizable market value in that year of the written contract dated March 31, 1921, evidencing the obligation of Jones to pay the balance of the purchase price of stock sold by Reed to Jones. The term "gross income" includes gains, profits and income derived from dealings in property, whether real or personal, growing out of ownership or out of an interest in such property (section 203, Revenue Act of 1921), and computed according to the basis set forth in section 202(a) of the statute. In the case of an exchange of property, whether real, personal, or mixed, for any other property, the statute further provides that no gain or loss shall be recognized unless the property received in exchange has a readily realizable market value. Section 202(e), Revenue Act of 1921.

In support of its contention that no gain resulted from the exchange of stock for the buyer's written promise to pay the balance of the purchase price, the petitioner takes the position (1) that such written promise, not represented by notes or other forms of commercial paper, is not property within the meaning of the statute, and (2) that even though the written promise of the buyer of the stock be regarded as property, it had no readily realizable market value during the taxable year in question and can not, therefore, form the basis on which taxable gain is recognized. In order, therefore, to decide the general question raised by this appeal, two subordinate questions must be answered - (1) Was the written obligation of Jones to pay the balance of the purchase price property within the meaning of the statute? and, if so, (2) Did it have a readily realizable market value in 1921?

Concurrently with the signing of the contract each party performed his part according to its terms. Thereafter the only existing legal relation between the parties consisted of an unconditional duty of Jones to pay the balance of the purchase price of the stock and the correlative right of Reed to receive such payment. From the standpoint of a creditor in this situation, he is generally described as owning a chose in action, which for the purposes now under consideration can clearly be regarded as a form of property within the meaning of the statute. Accordingly, the first question must be answered in the affirmative.

The Commissioner found that the claim of Reed against Jones for the payment of the balance of the purchase price of the stock had a readily realizable market value in 1921 of $350,000. To sustain the burden of proof which this determination cast upon the petitioner, the testimony of two witnesses was offered; first, that of Kenneth E. Downs to the effect that he was an officer of the First National Bank of Boston (an institution having more shoe and leather business than any other bank in New England), whose personal banking experience extended over a period of 19 years, both in banks and trust companies, and who was familiar through his membership in an association of credit officers of banks, with the practice of other banks and financial institutions in Boston and vicinity, with respect to loans and discounts, and that in his opinion, based upon the nonnegotiable nature and form of the agreement, no bank or financial institution in Boston or vicinity would have purchased from Reed or discounted for him in 1921, regardless of his financial standing, his claim against Jones as established by the purchase and sale agreement in question; and second, that of Edward L. Prescott, an expert in the shoe and leather industry, particularly in the financial matters connected with reorganizations, to the effect that in view of the precarious situation of the industry in 1921, nobody would have purchased the agreement or loaned anything on it other than a nominal amount.

In our opinion the evidence offered does not overcome the presumption raised by the determination of the Commissioner. What course of action banks or other financial institutions might have pursued had Reed sought to discount his claim against Jones in 1921 belongs to the realm of conjecture. No evidence whatever was offered tending to impeach the financial responsibility of Jones and this omission, coupled with the fact that the claim was secured by collateral having a value in 1921 in excess of one million dollars, seems to us to justify the conclusion that the petitioner has not established error on the part of the Commissioner in reaching his determination. Accordingly, our decision must be for the Commissioner on this issue of the appeal.

The contention of the petitioner on the second issue is that the Commissioner erred in determining that the 564 shares of stock of the Massachusetts company acquired prior to March 1, 1913, had on that date a fair market value of $100 per share, on the ground that the agreement between the Maine corporation and Reed inevitably resulted in an equalization of the values of the stock of the two companies, i.e., that the stock of the Massachusetts company automatically acquired the value of the stock of the Maine company, into which it was convertible. That this conclusion does not follow, is obvious from the fact that had Reed exercised his option to convert his shares in the Massachusetts company into shares of the Maine company, on March 1, 1913, he would have received from the Maine company shares which it held in its treasury on that date, and that the effect of the transaction would have been to increase the outstanding shares of the Maine corporation with a corresponding reduction in the book value thereof, due to the fact that the shares of the Massachusetts company acquired had a book value of $100 per share only. In the absence of any evidence as to the actual value on March 1, 1913, of the stock of the Massachusetts company, we are of the opinion that the petitioner has failed to establish that the Commissioner erred in determining the March 1, 1913, value of the stock of the Massachusetts company at $100 per share. Accordingly, the appeal on this issue must be denied.

Judgment will be entered for the respondent.