Crean Bros., Inc. v. Commissioner of Internal Revenue , 195 F.2d 257 ( 1952 )

MARIS, Circuit Judge.

This petition by the taxpayer to review a . decision of the Tax Court against it presents the question whether the taxpayer is entitled, under Section 718(a) (2) ¹ 2of the Internal Revenue Code, to include the sum of $99,965.05’ in its equity invested capital for the purpose of computing the tax on its excess profits for the year 1945. This sum represented an indebtedness owing from the taxpayer to Hudson Coal Company which that company had gratuitously cancelled in 1938. Hudson Coal Company was the majority stockholder of the taxpayer’s principal stockholder. The facts are stated in the opinion of the Tax Court, 15 T.C. 889, and need not be detailed here. The Tax Court in banc, three judges dissenting, held that the amount of the can-celled indebtedness was not includible in the taxpayer’s equity invested capital. We hold to the contrary.

Under the express terms of Section 718(a) (2) the cancelled indebtedness in question was required to be included in the taxpayer’s equity invested capital if it was "Property (other than money) previously paid in * * * as a contribution to capital.” The indebtedness clearly was property within the meaning of Section 718(a) (2) ². Under the Treasury Regulations in force in 1938³ as well as during the tax year involved⁴ its gratuitous forgiveness, if it had been by a stockholder creditor, would have amounted to a contribution to the capital of the taxpayer.⁵ It is also settled that one who is not a stockholder and who- has no proprietary interest in a corporation may make a contribution to its capital within the meaning of Section 718(a).⁶ Here the Hudson Coal Company, although not itself a stockholder of the taxpaj^er, was the majority stockholder of the taxpayer’s own majority stockholder and thus a corporate grandparent, so- to speak, with a proprietary interest which a contribution to capital would enhance.

The Tax Court nonetheless held that the cancelled indebtedness did not represent property paid in to' the taxpayer since it was includible in equity invested capital under Section 718(a) (2) only “in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange” and upon cancellation ceased to exist and therefore could have no such basis in the hands of the debtor. But the Tax Court failed to give effect to Section 113(a) (8) (B) of the Internal Revenue Code which provides that such basis for gain or loss in the case of property acquired after December 31, 1920 as a contribution to capital shall be the same as it would be in the hands of the transferor.⁷ The interdependence of the two provisions has been'recognized by the Commissioner.⁸ The basis of the indebtedness herein question in the hands of Hudson Coal Company, the creditor-transferor, was $99,965.05. It was therefore includible in the taxpayer’s equity invested capital in that amount.

The respondent argues that the indebtedness was wholly uncollectible because of the taxpayer’s insolvency and for that reason could not be regarded as property paid in to the taxpayer as a contribution to capital. It does appear that the taxpayer was insolvent prior to the cancellation of the debt but the only evidence on the point in the record is the taxpayer’s income tax return for 1938 and. that indicates that after the cancellation of the indebtedness of $99,965.05 the taxpayer had a net worth of $42,484.28. The Tax Court made no finding that the debt was worthless or wholly un-collectible and such a finding would clearly have been erroneous under the circumstances. For, assuming a pro rata distribution of the taxpayer’s assets at their book value to the taxpayer’s creditors before the cancellation of the Hudson Coal Company debt, that company and all the other creditors would have received a dividend of 84% of their claims. That the cancellation of the debt was of value to the taxpayer is obvious since it transformed an insolvency of $57,-480.77 into a net worth of $42,484.28.

The respondent’s final contention is that Section 718(a) (2) is not applicable here because Hudson Coal Company did not intend to make a contribution to the taxpayer’s capital." While there are no- findings by the Tax Court on the subject the facts were stipulated and it appears from them that the cancellation of the indebtedness by Hudson Coal Company was wholly gratuitous and motivated solely by its desire to aid the taxpayer in continuing in business.⁹ This is sufficient evidence that the transaction was intended to be a contribution to capital.¹⁰

The decision of the Tax 'Court will be reversed.

1 . Ҥ 718. Equity invested capital

“(a) Definition. The equity invested capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following amounts, reduced as provided in subsection (b)¹—

“(1) Money paid in. Money previously paid in for stock, or as paid-in surplus, or as a contribution to capital;

“(2) Property paid in. Property (other than money) previously paid in (regardless of the time paid in) for stock, or as paid-in surplus, or as a contribution to capital. Such property shall be included in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange. * * * * * * * *

“(4) Earnings and profits at beginning of year. The accumulated earnings and profits as of the beginning of such taxable year; * * 26 U.S.C.A. § 718.

2 . Walsh Holyoke Steam Boiler Works v. Commissioner of I. R., 1 Cir., 1947, 160 F.2d 185, 188.

3 . Regulations 94

“Art. 22(a)-14. Cancellation of indebtedness. — * * * If a shareholder in a corporation which is indebted to him gratuitously forgives the debt, the transaction amounts to a contribution to the capital of the corporation.”

4 . Regulations 111

“Sec. 29.22(a) — 13. * * * In general, if a shareholder in a corporation which is indebted to him gratuitously forgives the debt, the transaction amounts to a contribution to the capital of the corporation to the extent of the principal of the debt.”

The term “contribution to capital” means- the same thing under the excess profits tax provisions of the Internal Revenue Code as it does under the income tax provisions. Sec. 728, I.R.C., 26 U.S.C.A. § 728; Brown Shoe Co. v. Commissioner, 1950, 339 U.S. 583, 592, 70 S.Ct. 820, 94 L.Ed. 1081.

5 . Helvering v. American Dental Co., 1943, 318 U.S. 322, 328, 63 S.Ct. 577, 87 L.Ed. 785.

6 . Brown Shoe Co. v. Commissioner, 1950, 339 U.S. 583, 70 S.Ct. 820, 94 L.Ed. 1081; Commissioner of Internal Rev. v. McKay Products Corp., 3 Cir., 1949, 178 F.2d 639, overruling on this point Carlisle Tire & Rubber Co. v. Commissioner of Int,. Rev., 3 Cir., 1948, 108 F.2d 816.

7 . 26 U.S.C.A. § 113(a) (8) (B).

8 . Regulations 112

“Sec. 35.718-1 Determination of Daily Equity Invested Capital-Money and Property Paid In. * * *

“If the property was acquired after December 31, 1920, by a corporation from a shareholder as paid-in surplus or from any person as a contribution to capital, then the basis shall be the same as it would be in the hands of the trans-feror if the transfer had not been made. (See section 113(a) (8).) * * *”

9 . In a letter to the taxpayer dated December 29, 1938, Hudson Coal Company stated: “In view of the financial position of Crean Brothers, Incorporated, and to aid your Company in continuing in business on a reasonable basis, this is to advise that The Hudson Coal Company is cancelling the amount of this indebtedness, viz. $99,965.05.”

10 . United States v. Oregon-Washington R. & Nav. Co., 2 Cir., 1918, 251 F. 211, 213; Commissioner of Internal Revenue v. Auto Strop Safety Razor Co., 2 Cir., 1934, 74 F.2d 226; Carroll-McCreary Co. v. Commissioner of Internal Rev., 2 Cir., 1941, 124 F.2d 303; Chenango Textile Corp., v. Commissioner of Int. Rev., 2 Cir., 1945, 148 F.2d 296.