Depew v. Commissioner , 27 B.T.A. 515 ( 1933 )

GANSON DEPEW, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Depew v. Commissioner

Docket No. 50860.

United States Board of Tax Appeals

27 B.T.A. 515; 1933 BTA LEXIS 1352;

January 6, 1933, Promulgated

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Held, that the transaction relating to the sale of petitioner's stock was consummated in the year 1926 and loss suffered thereby was deductible in that year.

Ralph M. Andrews, Esq., and W. W. Grimes, Esq., for the petitioner.

George D. Brabson, Esq., for the respondent.

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VAN FOSSAN

This proceeding was brought to redetermine a deficiency in the income tax of the petitioner for the year 1926 in the sum of $2,750.92.

The issue presented by the petitioner is whether or not a loss sustained by him from the sale of certain common and preferred stock of the Rogers-Brown Iron Company should be deducted from his gross income for the calendar year 1926. He asserts that it should. The respondent contends that the transaction from which the alleged loss arose was fully consummated in 1925, and, further, that the worthlessness of the Rogers-Brown Iron Company's stock was not established and the consideration for its sale was nominal and not actual.

The facts were stipulated and, so far as material, are as follows:

FINDINGS OF FACT.

Prior to March 1, 1913, the petitioner acquired 250 shares of the common stock of Rogers-Brown IronCompany, a New York corporation, with its principal office in the City of Buffalo, New York, paying for said stock $100 per share. Thereafter, and on May 19, 1922, the petitioner acquired 50 shares of the preferred stock of said Rogers-Brown Iron Company, paying therefor $100 per share.

The said Rogers-Brown Iron Company was engaged in the manufacture of pig iron. Prior to 1920, it was a prosperous corporation. Beginning with the years 1920 and 1921, increased taxes and freight rates, a protracted period of depression in the industry, coupled with the constantly increasing competition from other furnaces in the Buffalo area which were able to lower pig iron costs through the sale of by-product coke and gas, resulted in a sharp drop in business and sales. The company's large ore property at Hibbing, Minnesota, known as the Susquehanna mine, could not be profitably operated except at a capacity operation unwarranted by the company's reduced pig iron production. The excessive charges incident to the operation and maintenance of this property produced a heavy drain on the resources of the company. Accordingly, the company's earnings declined and its surplus was rapidly reduced. When in 1925 a default in the payment of an installment of bond interest impended, a plan for refinancing Rogers-Brown Iron Company was evolved.

The M. A. Hanna Company, an iron company, of Cleveland, Ohio, became interested in the company's affairs by reason of the fact that the former was desirous of obtaining possession of the Susquehanna mine. Overtures were made by the M. A. Hanna Company to stockholders of the Rogers-Brown Company which resulted in the adoption of a refinancing agreement dated September 24, 1925, which plan was embodied in a contract designated the "Principal Agreement" to which the following were parties: Rogers-Brown Iron Company; certain of the stockholders of Rogers-Brown Iron Company, including the petitioner; the M. A. Hanna Company, an Ohio corporation; Central Trust Company of Illinois, an Illinois corporation; Central Securities Company, an Illinois corporation; and a group of banks to which Rogers-Brown Iron Company was currently indebted in amounts aggregating $1,500,000, consisting of The Marine Trust Company of Buffalo, Buffalo Trust Company, Liberty Bank of Buffalo, The Chemical National Bank of New York and The Chase National Bank of the City of New York. The contract was not under seal and was executed and delivered by the parties thereto in the City of Buffalo, New York.

Central Securities Company, hereinabove mentioned, the purchaser of the petitioner's common and preferred stock of Rogers-Brown Iron Company, at all times material herein, was an investment affiliate of Central Trust Company of Illinois and conducted a general underwriting and investment distributing business. The petitioner at no time has been connected with the Central Securities Company by stock ownership or otherwise. The Securities Company was acting largely in the interests of the M. A. Hanna Company, which, under the terms of the refinancing agreement, acquired control of the Susquehanna mine. Under the terms of the agreement, a new corporation, the Susquehanna Ore Company, was organized by the M. A. Hanna Company, which new corporation acquired ownership of the Susquehanna mine and assumed existing mortgages of the Rogers-Brown Iron Company thereon of approximately $4,000,000.

In accordance with the terms of the "Principal Agreement" a general plan of refinancing was agreed upon, which provided that the Central Securities Company should aid in the marketing of $1,000,000 of par value of an issue of $2,000,000 of so-called gold notes of the Rogers-Brown Iron Company.

The pertinent provisions of the "Principal Agreement" covering the issuance of the gold notes and the sale of the 80 per cent of the stock in question are set forth in paragraphs 5 and 6 of the "Principal Agreement" as follows:

5. The Rogers Stockholders, severally owning or controlling the number of shares of preferred and common stock of the Rogers Company set opposite their respective names, collectively amounting to more than 80 per cent. (80%) of the outstanding common and preferred stock of the Rogers Company, severally agree to sell to the Securities Company, and the Securities Company agrees to purchase from the Rogers Stockholders, said $1,000,000 of gold notes and (in proportion to their aggregate holdings of stock) $2,040,000 par value of the present outstanding preferred stock and $4,000,000 par value of the present outstanding common stock of the Rogers Company at and for the price of $1,000,604. plus any accrued and unpaid interest on such notes.

Each of the Rogers Stockholders, within five (5) days after the execution of this Agreement by him, shall deposit with The Marine Trust Company of Buffalo certificates duly endorsed in blank for the number of shares of preferred and common stock of the Rogers Company agreed by him to be sold to the Securities Company as provided in this paragraph 5, in escrow, to be delivered by said Trust Company to the Securities Company upon the consummation of this contract, and to be returned to said respective stock holders if, without default on the part of the Rogers Stockholders or the Rogers Company, the transactions provided for in this Agreement shall not be consummated on or before February 1, 1926.

6. The gold notes hereinbefore referred to shall be dated January 1, 1926, and mature at the times set forth in paragraphs numbered 3 and 4 hereof and be for the aggregate amount of $2,000,000, shall bear interest at the rate of six per centum (6%) per annum, payable semi-annually on January 1 and July 1 of each year, without deduction for Federal income taxes except that portion thereof in excess of two per cent. of such interest, shall be subject to redemption on any interest date at par and accrued interest, and shall be issued under an appropriate note agreement with some trust company, as Trustee, to be approved by counsel for the respective parties hereto, drawn in such manner as to provide for the equal benefit and security of all said notes.

The consideration $1,000,604 was computed as follows:

$1,000,000	for gold notes
604	for the common and preferred stock
$1,000,604

The "Principal Agreement" further provided that the aforesaid transactions should be consummated simultaneously on or before February 1, 1926, but irrespective of the date "when so consummated the transactions shall be deemed to be closed and all adjustments made as of January 1, 1926."

The balance sheet of the Rogers-Brown Iron Company shows that the refinancing agreement was effective on its books of account as of January 1, 1926.

Subsequent to the execution of the "Principal Agreement" and on or about October 15, 1925, duly authorized representatives of the stockholders of Rogers-Brown Iron Company and of Central Securities Company met in the City of Buffalo, New York, to agree among other things upon the details and manner of carrying out the "Principal Agreement." At the meeting it was orally agreed between the parties that all of the common and preferred stock of Rogers-Brown Iron Company which the stockholders were obligated to sell to Central Securities Company, together with the checks of the Central Securities Company in payment of the purchase price thereof, should be deposited with The Marine Trust Company of Buffalo on or before the close of business on December 30, 1925. It was further agreed, however, that certain of said stock, including petitioner's stock, should not be delivered or the checks of the Central Securities Company delivered until January 2, 1926, but certificates representing the stock, endorsed in blank, and the checks of Central Securities Company in payment therefor, dated January 2, 1926, and payable to the respective selling stockholders, should, nevertheless, be deposited in escrow on or before December 30, 1925, with The Marine Trust Company of Buffalo as above stated.

Pursuant to the "Principal Agreement" and the supplemental agreement referred to above the petitioner deposited with The Marine Trust Company of Buffalo, as depositary, on December 28, 1925, certificates duly endorsed in blank for 200 shares of the common stock and 40 shares of the preferred stock of Rogers-Brown Iron Company, being 80 per cent of the petitioner's total holdings thereof. Contemporaneously therewith, the petitioner also deposited with said The Marine Trust Company of Buffalo, as depositary, his check, dated January 2, 1926, payable to Rogers-Brown Iron Company, in the sum of $3,973.51, representing the purchase price of his pro rata share of the $1,000,000 of Gold Notes of Rogers-Brown Iron Company allocated to and agreed to be purchased by the stockholders of said company pursuant to the "Principal Agreement" above mentioned. These certificates of stock were deposited with the depositary under instructions of the petitioner that they be held in escrow by the depositary for delivery to Central Securities Company, or its nominees, on January 2, 1926, against the check of Central Securities Company, payable to the petitioner in the sum of $3,975.91, being the aggregate face value of the petitioner's pro rata share of Rogers-Brown Iron Company notes, plus one cent a share for the petitioner's stock so deposited. The petitioner's check for $3,973.51 was cashed by Rogers-Brown Iron Company and charged to the petitioner's account on January 2, 1926.

On December 30, 1925, Central Securities Company, pursuant to paragraph 5 of the "Principal Agreement," delivered to The Marine Trust Company of Buffalo, its check, payable to the petitioner, dated January 2, 1926, in the sum of $3,975.91. The check, payable to the petitioner, was one of numerous such checks aggregating $1,000,604, payable to various stockholders of Rogers-Brown Iron Company, who were parties to the "Principal Agreement." Some of the said checks were dated December 30, 1925; others were dated January 2, 1926. All of the checks, including the check made payable to the petitioner, were delivered to The Marine Trust Company of Buffalo on December 30, 1925, with a letter dated December 30, 1925, instructing The Marine Trust Company of Buffalo to deliver the checks on their respective dates to the payees thereof, provided the payee stockholders had theretofore deposited their stocks with the Trust Company as escrow agent. The Trust Company consented to such instructions in writing. The letter of the Central Securities Company to The Marine Trust Company dated December 30, 1925, reads as follows:

We have contracted to purchase from certain stockholders of the Rogers-Brown Iron Company $1,000,000 principal amount of its Five Year 6%, Series "B" Gold Notes and 40,000 shares of Common Stock and 20,400 shares of Preferred Stock of Rogers-Brown Iron Company for a total consideration of $1,000,604.00, represented by our checks therefor delivered to you herewith.

You will deliver today to The M. A. Hanna Company of Cleveland, Ohio, $500,000 principal amount of such notes, 20,000 shares of such common stock and 10,200 shares of such preferred stock. The remainder of the notes and stock have been or are to be delivered to you in such proportions as the stockholders of the Rogers-Brown Iron Company, supplying the same, may determine, a part on this date and a part on January 2, 1926, and when so delivered to you, you are authorized to pay therefor, as above provided, and to hold such stock subject to our order and ship such notes to us at 125 W. Monroe Street, Chicago.

It is our understanding that although a portion of said notes and stock is not to be delivered to us until January 2, 1926, it nevertheless has been deposited with you in escrow for delivery on such date.

Please deliver the stock to us in one or more certificates in the name of James G. Alexander, william S. Rogers and E. L. Ives, Syndicate Managers.

Kindly indicate your acquiescence in this communication at the foot hereof.

The following endorsement was placed on the above quoted letter of December 30, 1925, by The Marine Trust Company as escrow agent before the close of the year 1925: "We assent to the foregoing and will be bound by the instructions therein contained."

Checks of the Central Securities Company, payable to the several stockholders of the Rogers-Brown Iron Company and aggregating $1,000,604, accompanied the above letter.

On January 4, 1926, the petitioner received from The Marine Trust Company of Buffalo, as depositary the check of Central Securities Company, dated January 2, 1926, in the sum of $3,975.91. This check was cashed by the petitioner and credited to his account on January 4, 1926.

On January 23, 1926, The Marine Trust Company of Buffalo, as depositary, pursuant to instructions of Central Securities Company, forwarded to nominees of Central Securities Company, by registered mail, certificates representing in part, the petitioner's said 200 shares of common stock and 40 shares of preferred stock of Rogers-Brown Iron Company.

Since the sale of said 200 shares of common stock and 40 shares of preferred stock of Rogers-Brown Iron Company, the petitioner has never reacquired any part of the stock or acquired any other stock or interest whatsoever in said company.

At all times material herein, the petitioner kept his accounts and filed his returns on a cash receipts and disbursements basis.

The comparative balance sheets for the Rogers-Brown Iron Company, as of January 1, 1925, January 1, 1926, and January 1, 1927, are as follows:

	Jan. 1, 1925	Jan. 1, 1926	Jan. 1, 1927
ASSETS
Cost of properties	$18,839,200	$10,908,621.27	$11,043,995.00
Depreciation reserve, etc		3,656,484.18	3,975,841.40
Net value		7,252,137.09	7,068,153.60
Liberty Bonds, etc	67,698	67,698.00	67,698.00
Inventories	2,570,006	1,851,368.60	2,665,972.36
Bills and accounts receivable	1,358,205	816,280.99	647,297.71
Cash	557,235	225,193.61	244,233.53
Cash for coupons	100,756	46,396.00	79,992.00
Deferred charges	828,794	606,346.40	572,183.09
Deficit	665,567	3,702,156.59	483,174.32
Total	24,987,461	14,567,577.28	11,828,704.61
LIABILITIES
Preferred stock	$2,550,000	$2,550,000.00	$2,550,000.00
Common stock	5,000,000	5,000,000.00	1,297,843.41
Bonded debt	8,301,900	3,987,300.00	3,987,300.00
6% Gold notes		1,614,841.12	2,000,000.00
Accounts payable	922,836	760,620.86	720,029.87
Notes payable	1,924,445	157,683.34	773,999.53
Accrued liabilities	434,803	170,310.66	190,613.42
Ore advances	50,429	27,608.52	11,057.45
Bond coupon interest	100,756	46,396.00	79,992.00
Reserves for depreciation, etc	5,702,292	252,816.78	217,868.93
Total	24,987,461	14,567,577.28	11,828,704.61

OPINION.

VAN FOSSAN: The primary issue in this proceeding is whether or not the transaction relating to the sale of the petitioner's stock in the Rogers-Brown Iron Company (hereinafter called the company) to the Central Securities Company was consummated in 1925 or 1926. The petitioner contends that such transaction resulted in a loss and that the loss was sustained in 1926. After challenging the fact that a loss actually occurred, the respondent asserts that the terms of the contract by which the petitioner disposed of his stock were performed within the year 1925.

In order to arrive at a proper conclusion as to both issues it is pertinent to review briefly the circumstances giving rise to the sale of the petitioner's stock. Prior to 1920 the Rogers-Brown Iron Company was a prosperous manufacturer of pig iron. Beginning with that year, however, the industry suffered a serious depression. The company's outlook was further limited by increased freight rates and taxes. It owned a large Minnesota ore property, the capacity of which far exceeded the reduced demand of the company's business. The operating and carrying charges of the mine rapidly absorbed the company's earnings and made inroads on its surplus, so that in 1925 the company was confronted with its inability to pay interest on its bonded indebtedness. Under such threatening circumstances it became imperative that the company should be refinanced.

The M. A. Hanna Company, an iron company of Cleveland, Ohio, desired to secure the mine property and made certain proposals to the company's stockholders which resulted in a multilateral agreement dated September 24, 1925, and executed by the holders of more than 80 per cent of the outstanding stock of the company; by the company itself; by the Hanna Company; by certain banks to which the company was indebted; by The Marine Trust Company as escrow agent of the stockholders and the Central Trust Company; and by the last named company and the Central Securities Company, the corporations through which the refinancing was to be accomplished. By the terms of that agreement the stockholders were to deposit with the escrow agent their duly endorsed certificates of stock in the company, to be delivered to the Securities Company upon payment of the purchase price therefor and also upon the fulfillment of certain other provisions of the contract, but such stock was "to be returned to said respective stockholders if, without default on the part of the Rogers stockholders or the Rogers Company, the transactions provided for in this Agreement shall not be consummated on or before February 1, 1926."

About October 15, 1925, the stockholders and the Securities Company, through their representatives, agreed to advance the date of closing the transaction as to certain stockholders, including the petitioner, from February 1, 1926, to January 2, 1926, and to that end all stock of the company subject to the agreement was to be deposited with the escrow agent on or before the close of business on December 30, 1925, and likewise the checks dated January 2, 1926, issued by the Securities Company in payment for certain of the stock, including that of the petitioner, were also to be so deposited. Pursuant to the agreement the petitioner deposited his stock certificates with the escrow agent on December 28, 1925. On December 30, 1925, the Securities Company notified the escrow agent to deliver the former's checks to the stockholders, a part on that date and a part on January 2, 1926. On January 4, 1926, the petitioner received the check of the Securities Company from the escrow agent.

If the petitioner did not receive payment for his stock either actually or constructively during the year 1925, it is obvious that he is not subject to tax for that year. It is stipulated that he did not receive it actually. The question then arises whether or not delivery of the check to the escrow agent under the conditions set forth constituted constructive receipt by the petitioner. We think not.

An escrow agent is not a general agent. His powers and duties are limited strictly by the terms of the escrow agreement. . Thus delivery to The Marine Trust Company of the Securities Company check was delivery to its principal, the petitioner, only when all the terms and conditions of that agreement were completely and explicitly fulfilled. In that portion of the "Principal Agreement" relating to escrow, it was specifically agreed that no delivery of either the stock certificates or check should be made until January 2, 1926. Thus, in so far as the petitioner was concerned, the escrow agent was prohibited from completing the transaction before that date.

It is entirely conceivable that something might have happened in the interval between December 30, 1925, and January 2, 1926, that would have prevented final consummation of the transaction.

The facts in this case do not bring it within the rule of constructive receipt as defined by the respondent in article 51 of Regulations 65 and 69, which is as follows:

ART. 51. Income not reduced to possession. - Income which is credited to the account of or set apart for a taxpayer and which may be drawn upon by him at any time is subject to tax for the year during which so credited or set apart, although not then actually reduced to possession. To constitute receipt in such a case the income must be credited to the taxpayer without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made. A book entry, if made, should indicate an absolute transfer from one account to another. If the income is not credited, but is set apart, such income must be unqualifiedly subject to the demand of the taxpayer. * * *

The case at bar is clearly distinguishable from , upon which the respondent relies. There the sale in question was completed in 1919, and the purchase price was on deposit in the bank and available to the petitioner in that year. We said in that case:

* * * It was only because of instructions which had been issued to the bank at the instance of the petitioner that it was not paid. Had such instructions been a part of the contract there might have been some basis for a determination that the money was not received in 1919 by the petitioner, who reported his income upon a cash receipts basis. As to this we express no opinion. Here, however, was no contract or enforceable modification of the original contract; nothing more than an instruction (without consideration) at the request of the petitioner that payment be withheld.

In the above case the terms of the escrow agreement were performed in 1919. The instructions to defer payment until January 1, 1920, were given subsequent to the completion of the contract.

Here the authority to pay to the petitioner was contained in the contract itself dated September 24, 1925, and modified October 15, 1925. The consummation date of the original contract was set at February 1, 1926. As to the petitioner that date was advanced to January 2, 1926, under the supplemental agreement. We are not concerned with those stockholders who received their checks from the escrow agent on December 30, 1925. But in the case of all stockholders the escrow agent was directed not to deliver either the certificates of stock or the checks in payment thereof until all the transactions covered by the contract had been completed. In the Holden case, supra; , and in other cases cited by the respondent, the attempt to avoid or evade taxation was obvious. In the case at bar there is no such suggestion or suspicion. If the conditions of the agreement had not been met by January 2, 1926, the date fixed, it was the duty of the escrow agent to retain both the certificates of stock and the checks until the contract was complied with or to return them to their respective owners upon the demand of either party. By reason of the actual delivery on January 2, 1926, of the stock certificates and the check dated that day, we may assume that all conditions imposed in the contract had been fulfilled and the transactions therein provided for had been consummated, but we have no ground for concluding that such a situation existed prior to January 2, 1926.

The respondent contends further that the petitioner was not entitled to a deduction for a loss because there is no evidence that his stock became worthless in 1926. Petitioner's claim is not based on an alleged worthlessness of the stock. On the contrary, it is shown that it had a considerable book value during 1925 and 1926. However, if heroic measures were not taken, the condition of the industry, and the business outlook of the Rogers-Brown Company, made it exceedingly doubtful that any of the stock would long continue to possess a value. The impending foreclosure of mortgages and the consequent liquidation of the corporation would soon have consumed the remaining surplus and dissipated any value, actual or potential, which the stock might have. Not infrequently the owners of the majority holdings in a corporation are compelled to sacrifice part of their holdings and relinquish majority control to save the balance of their investment. That is what was done here. The refinancing of the Rogers-Brown Iron Company was an emergency measure undertaken in order to save the company from bankruptcy and to salvage some value from the remaining 20 per cent of the stock still held by the petitioner and other stockholders. Respondent suggests in his brief that the sale was nominal and not actual. The evidence fails to support this position. The stipulated facts show that the 240 shares of stock in controversy were sold for one cent a share and that they cost the petitioner $24,000 prior to March 1, 1913. The petitioner never reacquired any part of the stock so sold and acquired no other stock or interest in the Rogers-Brown Iron Company. There is no evidence of lack of good faith. The fact that can not be gainsaid is that upon the completion of the transaction on January 2, 1926, the petitioner had suffered a loss. The amount of this loss was $23,997.60 and, as we have held, that loss is deductible from his gross income for 1926.

Decision will be entered under Rule 50.