Chenango Textile Corp. v. Commissioner , 1 T.C. 147 ( 1942 )

OppeR, J.,

dissenting: It seems to me totally lacking in realism to conclude that this petitioner was in receipt of income of any kind by reason of the cancellation of the agreement obligating it to pay its preferred stockholder the originally agreed purchase price of the securities she had delivered. If this had been a transaction between strangers and the property remained in the vendee’s possession, it might be permissible to regard the renegotiation as an adjustment of. purchase price, even though that is not the theory upon which the proceeding was heard, nor the issue presented by the pleadings or arguments. See Hirsch v. Commissioner (C. C. A., 7th Cir.), 115 Fed. (2d) 656; cf. Frank v. United States (Dist. Ct., E. Dist. Pa.), 44 Fed. Supp. 729. But the difficulty with treating the income here as arising from the sale of the securities is that -this was not a short sale nor a borrowing of securities nor anything of that nature and the property which petitioner originally sold was unquestionably its own and never considered nor treated otherwise. The cancellation of the note was not a true rescission, since the sale ivas in no respect any longer executory and-it'was impossible to restore the vendor to her original position. Furthermore, there was not, as in the case of a short sale, a covering purchase, or other similar dealing with the property in the tax year. Cf. Estate of George II. Flinn, 45 B. T. A. 874.

That, however, is a difficulty which does not seem to me to confront us, for the transaction was not between strangers but had its inception solely because of the stockholder-corporate relationship. The substance of it was that the stockholder loaned petitioner the money with which to buy her securities. This was done solely to benefit the corporation and she so testified. When this indebtedness was forgiven in the tax year before us it presented a familiar and usual situation. It need not be confused or complicated by considering the purchase and sale as the source of income, but can and it seems to me should be decided from the viewpoint of what it actually was — a gratuitous contribution to capital even though under some species of compulsion. This is a type of transaction specifically and satisfactorily disposed of by respondent’s regulations which provide:

* * * 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. * * * Regulations 86, Art. 22(a)-14.

No' consideration whatever flowed from the corporation to petitioner for her renunciation of the claim she held against it. Since the litigation instituted by the minority stockholders was for the corporation’s benefit, it may justifiably be inferred that the settlement of the litigation with its accompanying cancellation of the debt resulted in an advantage to petitioner, but this does not prevent the act from being gratuitous, for, to borrow the language of Carroll-McCreary Co. v. Commissioner (C. C. A., 2d Cir.), 124 Fed. (2d) 303, “such a construction of the regulation deprives it of any function whatever; for an indirect benefit of this character always results to the shareholder from a gift to his corporation.” Cf. Robert H. Scanlon, 42 B. T. A. 997.

And to add that the stockholder received the further benefit of a settlement of the litigation is to say.no more than that the minority stockholders were satisfied to discontinue that proceeding upon the indirect consideration of the benefit which the stockholder was conferring upon petitioner by canceling the obligation. The termination of the litigation was thus a consequence of the gratuitous contribution by the stockholder; it did not prevent that contribution from being gratuitous in the sense that the stockholder received nothing from petitioner, in exchange. “In our opinion the phrase ‘gratuitously forgives the debt’ means simply that no consideration is paid by the corporation for release of the debt.” Carroll-McCreary Co. v. Commissioner, supra. Nor is there anything to the contention that what the stockholder received was a prepayment and hence worth more than what she was entitled to a number of years later. The obligation was in default and under its terms payment could have been enforced at any time.

No support for the conclusion reached here is to be derived from such cases as Helvering v. Jane Holding Corporation (C.C.A., 8th Cir.), 109 Fed. (2d) 933, certiorari denied, 310 U. S. 653. Release of an indebtedness which has led in prior years to a tax benefit may well cause a subsequent readjustment to create taxable income on the familiar theory that recovery of items once deducted is the equivalent of the receipt of income. In that case the court was evidently influenced by this view, “the controlling factors being the previous deductions offsetting income otherwise taxable and the subsequent release of the indebtedness before payment.” Under the facts we are considering here, in every year between the creation of the debt and its partial cancellation — except the year 1930 in which there were no security losses and the interest due was paid in cash-petitioner had a net loss without resorting to any deduction connected with the debt. Neither the capital losses’ attending disposition of the securities for which the debt was incurred nor the interest accrued in favor of the creditor was needed to compute its net loss in any year. Citizens State Bank, 46 B. T. A. 964. And see Revenue Act of 1942, sec. 116.

Finally, it seems inescapable that if the stockholder had made a cash contribution to the paid-in surplus of petitioner and petitioner had used those funds to pay off the obligation in full no material aspect of the entire situation would have been different. The litigation could clearly as well have been settled in that manner and the minority stockholders would have been exactly as well off. But there would then have been no excuse lor resorting to the short-sale concept upon which the decision here is rested nor any factual basis for it. The use of petitioner’s outstanding obligation instead of cash to pay for such a capital contribution was merely a short cut to the same end and can not, it seems to me, justify the result reached. It is a familiar doctrine that the offsetting of an obligation has tax effects no different from what would be the case if one who was not a creditor attained a similar result by a cash outlay. See Helvering v. Midland Mutual Life Insurance Co., 300 U. S. 216. That is the vital distinction from the cases relied upon in the prevailing opinion, none of which presented the stockholder-corporation relationship nor the problem of capital contribution.

I have no quarrel with the treatment accorded by the majority opinion to the forgiven interest or to the claimed deductions for attorney fees.

Smith, and Mellott, JJ., agree with the above.