Penney & Long, Inc. v. Commissioner , 15 B.T.A. 232 ( 1929 )

PENNEY & LONG, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Penney & Long, Inc. v. Commissioner

Docket No. 17908.

United States Board of Tax Appeals

15 B.T.A. 232; 1929 BTA LEXIS 2896;

February 6, 1929, Promulgated

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">*2896 The Commissioner's determination in respect of the value of a distributor's contract approved for lack of sufficient evidence to show error.

E. S. Parker, Esq., and Jesse I. Miller, Esq., for the petitioner.

H. LeRoy Jones, Esq., for the respondent.

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LITTLETON

">*232 The Commissioner determined a deficiency of $23,934.94 for the year 1920. Petitioner assigns as errors the Commissioner's action (1) in holding that it realized a profit of $50,125 upon the sale of a certain contract; and (2) in excluding the contract referred to in the first assignment from invested capital.

FINDINGS OF FACT.

Petitioner is a North Carolina corporation with its principal office at Greensboro.

In May, 1919, a partnership, composed of C. B. Penney, Ralph Long., R. J. Mebane, and J. E. Rossell, was organized, under the firm name of Penney and Long, for the purpose of acting as a distributor for the American Motors Corporation of Plainfield, N.J. Each of the four partners contributed $3,000 cash to the capital of the partnership. A contract was secured, without any cost to the partnership, from the American Motors Corporation, under which the partnership">*2897 was granted the exclusive agency rights in several southern States, for the distribution and sale of automobiles manufactured by that corporation, under the trade-name "American Balanced Six." This contract has since passed successively into the ownership of two succeeding corporations and its whereabouts at the present time is unknown. The American Motors Corporation became defunct in 1921. All of the petitioner's endeavors to locate and obtain a copy of this contract have been without avail.

The contract provided for the allowance to the partnership of a discount of 28 per cent from list price. Under its terms, the partnership was required to establish a suitable distributing and sales organization for the development of sales within its territory. The contract was noncancelable so long as the partnership continued to take the number of cars allotted to it under its terms.

About 15 or 16 automobiles were sold by the partnership prior to the transfer of the business to the petitioner.

">*233 Petitioner corporation was organized on September 12, 1919, for the purpose of taking over the partnership assets and business. The minutes of a special meeting of its board">*2898 of directors, held on September 16, 1919, contain the following:

The action of the stockholders in their meeting this day held in regard to the proposition of C. B. Penney, Ralph Long, and R. J. Mebane to transfer and convey to the Company the entire business of the co-partnership of Penney & Long, as represented in their letter, at the price of $50,125, to be paid in 500 fully paid and non-assessable shares of "Class A" Common Stock of this Corporation and 2500 shares of "Class B" Common Stock of this Corporation, was then taken up and considered.

On motion of C. A. Mebane, the following resolution was unanimously adopted, all of the Directors being present and voting:

RESOLVED, that in the judgment of this Board of Directors the business of the co-partnership of Penney & Long, which is proposed to be conveyed to this Corporation, in accordance with the written proposition of C. B. Penney, Ralph Long and R. J. Mebane, is fully worth the sum of $50,125, and that it is highly advantageous for the Company to secure and become the owner of said business at the price named, and to pay therefor in the fully paid and non-assessable shares of the capital stock of the Company;

RESOLVED">*2899 FURTHER, that the President and Secretary and Treasurer, or either of them, be and they are hereby authorized and directed to issue and deliver to said C. B. Penney, Ralph Long and R. J. Mebane, 500 fully paid and non-assessable shares of "Class A" Common Stock of the Corporation and 2500 shares of fully paid and non-assessable shares of "Class B" Common Stock of the Corporation upon the consummation of said transfer.

In accordance with the foregoing resolution, the petitioner took over the assets, including the distributor's contract, and business of the partnership, issuing in exchange therefor, to each of the four partners, "Class A" common stock of a par value of $12,500 and "Class B" common stock of a par value of $31.25, each share of "Class A" stock having a par value of $100 and each share of "Class B" stock having a par value of 5 cents. The partnership assets taken over by the petitioner, in addition to the distributor's contract, consisted of cash in bank, accounts receivable, notes receivable, inventory of used cars, and furniture and fixtures. No appraisal was made of, nor any specific value placed upon, the distributor's contract for the purpose of the exchange. ">*2900 But of the $50,125 par value of capital stock issued for the partnership assets, the partners considered that $12,000 was in payment for the tangible assets and a return of their original contributions, of $3,000 each, to the partnership capital, and that the balance was in payment for the distributor's contract. The actual cash value of the tangible assets conveyed by the partnership to the petitioner is unknown. All efforts to locate the records and books of account of the partnership and of the petitioner have been without avail.

After the transfer of the partnership assets to the petitioner, the former partners, through their stockholdings in petitioner company, ">*234 continued to own or control an interest therein of 50 per centum or more.

Between September 18, 1919, and March 16, 1920, the petitioner sold shares of its "Class A" common stock, of a total par value of $48,250, for cash and notes, at par, and of the total amount so disposed of, shares of a total par value of $27,500 were sold within the first 30 days after organization. All of this stock was sold to relatives, friends, and business associates of the former partners, and upon the solicitations of">*2901 the latter. None of petitioner's capital stock was offered for sale to the general public. Purchasers of this stock were made acquainted with all of the details of the distributor's contract which the petitioner had acquired; and though, in soliciting their subscriptions for stock, no specific value was placed upon the contract, representations were made to them that, because of its favorable discount terms, the excellent territory allotted, and the shortage of automobiles within that territory, the contract offered very great possibilities of making large profits.

Shortly after the petitioner acquired the business, the American Motors Corporation made a change in the model of cars they were producing. The new model proved very unsatisfactory mechanically and resulted in the bankruptcy of the manufacturers early in 1921.

In July, 1920, the petitioner assigned the distributor's contract to the American Southern Motors Corporation in exchange for $50,125 par value of that company's capital stock. This stock was sold by the petitioner in 1920 for $50,125 cash.

In the deficiency notice, the Commissioner has treated the entire proceeds from the sale of the contract to the American">*2902 Southern Motors Corporation, as profit, and added the sum of $50,125 to income.

OPINION.

LITTLETON: There is no dispute between the parties as to the consideration received in the sale of the distributor's contract to the American Southern Motors Corporation. The parties agree that the fair market value of the stock was $50,125. The petitioner contends that the contract had an actual cash value at the date it was acquired from the predecessor partnership of $38,000, and that the profit realized upon the sale of this contract to the American Southern Motors Corporation did not exceed $12,125. It contends also, that it is entitled to have this contract included in invested capital at a value of $38,000, subject to the limitations applicable to intangible properties paid in for stock. The Commissioner argues that petitioner has failed to show that the contract had any value at the date it was acquired by the petitioner and, consequently, the entire consideration ">*235 received in the sale to the American Southern Motors Corporation must be treated as profit. He argues further, that whether the contract had any value or not when acquired by the petitioner, the provisions">*2903 of section 331 of the Revenue Act of 1918 preclude the inclusion in invested capital of any value whatever for the contract, because it was acquired without cost to the same persons who, after the transfer of the contract to the petitioner, continued to own or control an interest therein of 50 per centum or more.

In the submission of its appeal, the petitioner, for proof as to the actual cash value of the contract at the date of acquisition, relied entirely upon sales of the same class of stock as that which was issued for the contract, and the judgment of its board of directors as expressed in the resolution authorizing the purchase of the assets of the predecessor partnership. The petitioner contends that the sale of a substantial block of its "Class A" stock for cash, at par, establishes the value of the "Class A" stock issued for the contract and other assets of the predecessor partnership and, a fortiori, the value of those assets; and that the judgment of its directors, in the absence of proof of fraud, in declaring the assets of the partnership to be worth $50,125, and in issuing fully paid and nonassessable shares of stock of a like par value in payment therefor, should">*2904 be accepted as conclusive of the value of the assets acquired from the partnership.

There are several reasons why we believe the petitioner's contentions must fail. In the first place, assuming the stock issued by petitioner for the partnership assets had a fair market value equal to par, how are we to determine what part of this stock was issued in payment for the contract in question? The evidence discloses that the partnership assets, in addition to the contract, included cash in bank, accounts receivable, notes receivable, inventory of used cars, and furniture and fixtures, and there is not one iota of evidence as to their value. And we would be confronted with the same problem if we accepted the directors' declaration as to value since the value declared is the directors' judgment as to the value of all the assets, and not the contract alone. One of the members of the partnership testified that the partners "considered" that $12,000 of the total of $50,125 par value of stock issued to them by the petitioner for the partnership assets was in pahment for the tangible assets and a return of their contributions to the partnership capital, and that $38,125 was in payment for">*2905 the contract. He admitted, however, that there was no discussion or appraisal of the contract value by the partners, who were acting in the dual role of vendors and agents for the vendee. The statement is a vague self-serving declaration without the least support whatever. So, if the contention of the petitioner as to the fair market value of the stock issued for the partnership assets could be granted, and that value fixed as the fair value of the assets, not ">*236 knowing what part of the total stock issued was in payment for the distributor's contract, we still would be unable to determine the cost or cash value of the contract when acquired.

Furthermore, we do not believe that the sales of "Class A" stock for cash, at par, though substantial in the aggregate, establish in the circumstances of this case, the fair market value of stock, of the same class, which was issued for the partnership assets. The evidence discloses that the purchasers of this stock were relatives, intimate friends and business associates of the former partners. It appears that none of them made any independent personal investigation as to the wisdom of their investments, and that they were guided">*2906 entirely in their actions by the representations made to them by the former partners and organizers of petitioner company, in whose reputation, sagacity, and business abilities they had the utmost confidence. The witness, Bush, testified that he bought some of this stock "largely on the personal reputation of the managers of the company and hopes for the future of the industry in Greensboro" and "the representations satisfied me it was a good investment." The witness, Brawley, stated: "Of course I know a lot more about buying stocks than I did then, but if I was going to buy stock to-day the first thing I would want done was to have it analyzed by a man who knew his business, but I did not do it at the time. I had only invested in foreign stocks; and I did this more on the personality of the people behind it and good business and things of that kind." The witness, Kelly, testified that he formed no opinion of the value of the contract, but "relied on the reputation of Mr. R. J. Mebane;" that he purchased the stock "solely on the personality of Mr. R. J. Mebane and his representations as to future prospects." The witness Brooks stated that he made no investigation of petitioner's">*2907 affairs or its assets before he made a purchase of petitioner's stock, and that "I think I relied on the statement of Jess Mebane and Long." Not a share of this stock was offered for sale on the general market; all sales were entirely private in character, and in them filial and friendly relationships and personalities appear to have been the dominating factors motivating the transactions. The facts given to us present no plausible reason for believing that had the entire issue of "Class A" stock been thrown on the general market, a price would have been realized equivalent to par. In the light of the circumstances surrounding these sales, we are not convinced that they establish a fair market value for the stock given in exchange for the partnership assets. Cf. ; .

It appears that the contract, or a copy thereof, is not now availabel, and we have been given but the most meagre details, and then, only those favorable to the petitioner. Perhaps it contained no disadvantageous ">*237 provisions, but contracts are based upon the mutual promises and undertakings of">*2908 the parties. What obligations did the petitioner assume under the contract, and was their nature such as to impose no hardship? Was the petitioner so situated as to be enabled to carry out its undertakings? What were the prospects of reasonable performance on the part of the American Motors Corporation? All of these it would appear could be answered without the presence of the contract.

The most favorable statement of the evidence from the petitioner's standpoint which can be made is that the petitioner considered the contract a most favorable one and, based upon the knowledge of the success of distributors of other makes of automobiles doing business under somewhat similar contracts, hoped for a like success of its own venture, and that its organizers were sufficiently enabled to impress their ideas and personalities upon close associates as to induce the latter to purchase a part of petitioner's stock at par. The testimony of two of the former partners leaves no doubt as to the enthusiasm or degree of confidence with which they embarked upon the venture made possible by this contract. But what were the reasons for their great optimism? We were told that the territory allotted">*2909 under the contract was excellent, that the discount of 28 per cent off list price was an exceptionally favorable one, and that there was a shortage of cars, and there the story ends. We know very little about the American Motors Corporation, and the prospects as to its ability to carry on its part under the contract. That someone told one of the witnesses that it was in good condition, but needed a little capital, and that a change in model of car which proved to be mechanically unsatisfactory brought about a condition which resulted in the company "going broke," is substantially all that was told to us about that company. We know nothing whatever about the car it produced. Certainly the name "American Balanced Six" is not so established in the public mind, or the general characteristics of the car produced under that name so well known that, for quality and utility, we can accord it a place of favorable comparison with other well known makes of cars.

From the time the partnership acquired this contract until it disposed of it to the petitioner, 14 or 16 cars were sold in the allotted territory of 6 or 7 southern States. We know nothing whatever as to what the petitioner accomplished">*2910 or realized under the contract from the time it was acquired from the partnership until disposed of to the American Southern Motors Corporation.

We are unable to determine from the evidence the value of the contract at date of acquisition, and, consequently, we may not disturbe the Commissioner's determination as to the profit realized upon the sale of the contract.

">*238 In addition to our inability to determine the actual cash value of the contract, at date of acquisition, there is the further consideration that any revision of Commissioner's determination as to invested capital is precluded by the provisions of section 331 of the Revenue Act of 1918. It is clear that this contract was acquired by the partnership without cost, and that after it was transferred to petitioner, in 1919, the former members of the partnership, through their holdings of stock in the petitioner company, continued to own or control an interest in the contract of 50 per centum or more. Under these circumstances, the contract may not be included in petitioner's invested capital at any value.

Judgment will be entered for the respondent.