Evans v. Commissioner

A. T. EVANS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

M. RUIZ, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

W. E. STEEGE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Evans v. Commissioner

Docket Nos. 64397, 67097, 67098.

United States Board of Tax Appeals

30 B.T.A. 746; 1934 BTA LEXIS 1273;

May 17, 1934, Promulgated

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The Union Co. in December 1928 entered into a contract with the stockholders of the Miller Co. to purchase from them all of the stock of the latter company in exchange for cash and the stock of the purchaser, the latter to be delivered as soon as a permit could be secured from the Corporation Commissioner of California. Thirty-nine percent was to be paid in cash on the signing of the contract and the remaining cash was to be paid in 1929. The cash payment for 1928 was made. The Union Co. secured a permit to issue its stock in January 1929 and the stock was then delivered and the remaining part of the cash paid. In July 1929 the Union Co. took over all the assets of the Miller Co. except $500. Held, that there was no reorganization in 1928 within the meaning of section 112(i)(1) of the Revenue Act of 1928, and following National Iron Works,22 B.T.A. 382">22 B.T.A. 382, the selling stockholders were not in receipt of the stock of the Union Co. in 1928.

A. W. Helvern, Esq., for the petitioners.

D. P. Kimball, Esq., for the respondent.

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MARQUETTE

These proceedings were consolidated. The respondent has determined the following deficiencies in income tax for the year 1928:

A. T. Evans	$1,084.56
M. Ruiz	830.31
W. E. Steege	1,025.93

The respondent has determined an overassessment against each of the petitioners for the year 1929, and for that reason each of the above proceedings, in so far as it affects that year, is dismissed for lack of jurisdiction. The issues are whether, under the facts hereinafter set forth, a reorganization occurred within the meaning of section 112(i)(1) of the Revenue Act of 1928, and, if so, whether the recognized gain of the petitioners arising from the transfers of stock may be returned under section 44 of the same revenue act. At the hearing respondent's counsel asserted that the respondent erred in determining that there had been a reorganization and thereupon claimed any increase in deficiency which might result therefrom.

FINDINGS OF FACT.

On December 11, 1928, the Union Lithograph Co., Inc., a corporation (hereinafter referred to as the Union Co.) organized under the laws of the State of California, as party of the first part, and the petitioners and two others, as parties of the second part, entered into a contract which recites that the parties of the second part owned between them 129 shares of preferred stock and 655 shares of common stock of the Miller Lithograph Co. (hereinafter referred to as the Miller Co.), which had outstanding 209 shares of preferred stock and 708 shares of common stock; that the Union Co. desired to acquire all the outstanding stock of the Miller Co., and that the Union Co. had at that time outstanding only common stock. The Union Co. agreed forthwith to create a 7 percent participating cumulative preferred stock having shares of the par value of $100 each. The contract then provides:

2. Second parties agree to sell to first party, and first party agrees to purchase from second parties, all of the shares of stock of Miller Company owned by second parties at a price as follows, to-wit:

$100.00 per share cash for the preferred stock of said Miller Company and $325.00 per share for common stock of said Miller Company, of which said $325.00 one-half thereof shall be payable in cash and the balance in said seven per cent cumulative participating preferred stock of Union Company. Thirty-nine per cent of the total purchase price due second parties hereunder, as hereinabove provided, shall be paid in cash upon the execution hereof and the transfer to first party on the books of the Miller Company of the stock of said second parties and the delivery to said first party of the stock of said Miller Company in the name of first party. The balance of the cash to be paid to second parties, as hereinabove provided, is to be paid on January 4, 1929, and the stock of Union Company to be issued to second parties, as hereinabove provided, is to be issued immediately following the granting of permit by the Corporation Commissioner of the State of California authorizing the issuance by first party to second parties of the said stock as a part of the purchase price hereinabove provided for.

Second parties agree to deliver to said first party, coincident with the execution hereof by both parties, the said shares of stock of Miller Company to be sold by second parties and purchased by first party, it being agreed and understood, however, that notwithstanding the delivery of said stock to first party and transfer thereof into the name of first party on the books of Miller Company, title to said stock is reserved by second parties until the payment of the final installment of the cash purchase price hereinabove provided to be paid on January 4, 1929.

Second parties furthermore agree to procure the sale and transfer to first party, not later than January 4, 1929, of all of the outstanding common stock of Miller Company not owned by second parties, and of all of the preferred stock of Miller Company not owned by second parties, with the possible exception of 20 shares of said preferred stock. Second parties agree to purchase said additional common stock and said additional preferred stock (including the said 20 shares of preferred stock hereinabove excepted, if the same be procurable) at the price of $105.00 per share cash for the preferred stock and $325.00 per share cash for the common stock. All of the stock hereinabove provided to be sold to first party, whether by second parties or by other stockholders, is to be free and clear of liens and incumbrances of any sort whatsoever.

In the event that second parties are not able to procure the transfer to first party of all of the outstanding common stock of Miller Company not owned by second parties and all of the said preferred stock not owned by second parties (with the exception of said 20 shares), then second parties shall, not later than January 10, 1929, procure the legal transfer to first party of the assets of said Miller Company, and first party agrees to pay for such assets the same consideration as said first party has agreed to pay for the stock in lieu of the transfer of which said assets are so transferred. In the event of such transfer of assets, at the request of second parties first party will vote any shares of stock of Miller Company theretofore transferred to it for and in favor of such transfer.

3. First party shall with due diligence apply to the Corporation Commissioner of the State of California for a permit to issue said seven per cent preferred stock to second parties as a part of the purchase price hereinabove. In the event, however, that the said permit be not issued on or before February 1, 1929, then in lieu of delivering to second parties the said preferred stock of said Union Company, second parties shall pay to first party an additional sum of $162.50 for each share of common stock of said Miller Company owned by said second parties and sold to first party, said payment to be made in four equal annual installments commencing with January 1, 1931. First party agrees to pay to second parties interest on said deferred payments at the rate of seven per cent per annum, payable quarterly commencing with April 1, 1929.

The Union Co. then agreed to procure and deliver to the second parties a written guarantee of H. S. Crocker, Inc., and contracted on its own part to pay such 7 percent dividends; if such dividends were not earned, then to pay the second parties a bonus which, together with earnings, would equal the 7 percent dividend. The second parties warranted that the attached balance sheet as of October 31, 1928, was true and correct and that the net worth of the Miller Co. as of that date was at least equal to the net worth on its balance sheet. The balance sheet is incorporated herein by reference.

The above contract was carried out according to its terms and the Union Co. acquired all the stock of the Miller Co. The Union Co. applied to the Commissioner of Corporations of the State of California for a certificate permitting it to increase its authorized capital stock from $750,000 to $1,000,000, to be divided into 10,000 shares of the par value of $100 each, of which 2,500 shares should be 7 percent cumulative participating preferred stock and 7,500 shares should be common stock. On January 12, 1929, the Commissioner of Corporations issued to the Union Co. a certificate permitting it to issue and sell the stock for which it had applied.

The Miller Co. possessed good will. At a meeting of the board of directors of the Miller Co. held July 1, 1929, the following resolution, among others, was adopted:

RESOLVED, That this corporation pursuant to its plan of reorganization, liquidate by withdrawing, paying and distributing to its stockholders all of its assets and property other than the sum of $500 in cash, subject to the existing liabilities and obligations of this corporation, in consideration of said stockholders assuming and agreeing to pay all of the existing liabilities and obligations of this corporation;

FURTHER RESOLVED, That upon the filing with the Secretary of the corporation of the written consent of the holders of at least two-thirds of the subscribed capital stock of the corporation agreeing and consenting to the afore resolved withdrawal, payment and distribution of its assets and property to its stockholders, the President and Secretary, or a majority of the Board of the corporation, be and they hereby are authorized, empowered and directed to make application to the Commissioner of Corporations of the State of California for his permit authorizing this corporation to so withdraw, pay and distribute to its stockholders its assets and property;

FURTHER RESOLVED, That the President and/or Secretary of the corporation be and is hereby authorized, empowered and directed to execute any and all agreements or other instruments deemed necessary or proper for the purpose of liquidating the corporation and/or carrying into effect any of the purposes set forth in the foregoing resolutions in accordance with said plan of reorganization.

Each of the petitioners in his income tax return for 1928 treated the transaction as a separate sale of the common stock of the Miller Co. and of the preferred stock of the same company, and the transfers were treated in the same way. The following is taken from the return of the petitioner, Evans:

Description	Am't Rec'd	Cost	Net Profit
42 Shares Pfd. stock Miller Lithograph Co	4,200.00	4,200.00
159 Shares Com. stock Miller Lithograph Co * Installment sale			$10,076.63
			$10,076.63

Total profit limited to cash received, viz., $25,837.50

This was an installment sale. Only 39 percent of consideration was received in 1928 by taxpayer. Cost of shares sold and taxable profit realized is shown below:

Selling price:

Cash, one half of 159 shares at $325.00 per share (1/2 times $325.00 times 159)	$25,837.50
Preferred stock of Union Lithograph Co., Inc., shares at $100.00 per share	$25,837.50
	$51,675.00
Cost of common shares sold	12,605.00
Total Profit	$39,070,00
Taxable profit (not to exceed cash to be received as per Sec. 112(c)(1))	25,837.50
Profit to be reported in 1928 income tax return on installment basis (39 per cent of $25,837.50)	$10,076.63

The respondent determined in each case that there was but one sale, that there had been a reorganization, and that the recognizable gain could not be reported on the installment basis.

OPINION.

MARQUETTE: In each petition it is asserted that the respondent erred in not determining that the profits derived from the exchanges of stock of the Miller Co. for cash and stock of the Union Co. were the income of the marital community under the laws of California. No evidence was introduced on this issue, nor was it referred to by counsel on either side. This issue was abandoned.

Petitioners insist that their common stock was sold for cash and their preferred stock was exchanged for cash and stock, thus resulting in separate transactions. They further contend that there was a reorganization within the meaning of section 112(i)(1) of the Revenue Act of 1928, and also that they had the right to return so much of their gross gain as was recognized under section 112(c)(1) on the installment basis, as provided in section 44 of the same act. The respondent determined that there had been a reorganization, but computed the gain as on a single transaction. He denied that the petitioners were entitled to the benefits of section 44. At the hearing respondent's counsel stated that the respondent had erred in determining that there had been a reorganization and insisted that there had been a straight-out exchange of stock for stock and cash, all the gain on which was subject to income tax. He claimed a larger deficiency on the ground that the petitioners should be held to have been in receipt in 1928 of all the stock of the Union Co. which that company had agreed to exchange for Miller Co. stock and cash.

We see no merit in the contention that there were two separate transactions. The Union Co. desired to purchase and in fact did acquire all the stock of the Miller Co. The contract further provided that if the contracting stockholders could not acquire all the stock of the Miller Co. (except perhaps 20 shares of preferred stock), then they agreed to have that company take such action as would result in the transfer of all its assets to the Union Co., for which the latter agreed to pay the same consideration which it had agreed to pay for the stock. It is clear that the contract called for the purchase and exchange of all the stock except perhaps 20 shares, and not for the purchase of the preferred stock separately. Furthermore, the consideration which was at once to be paid in cash was 39 percent "of the total purchase price" and not that percentage of the price to be paid for the preferred stock alone.

Whether the whole gain of the petitioners arising from their transfers of Miller stock for cash and stock of the Union Co. should be recognized for income tax purposes, or should be recognized only to the extent of the cash paid and to be paid, depends on the application of section 112 of the Revenue Act of 1928, the pertinent parts of which read:

(a) General rule. - Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.

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(b) (3) STOCK FOR STOCK ON REORGANIZATION. - No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.

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(c) (1) If an exchange would be within the provisions of subsection (b)(1), (2), (3), or (5) of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received within the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.

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(i) (1) The term "reorganization" means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected.

We find it unnecessary to decide whether a reorganization occurred, when in July 1929 the Union Co. as sole stockholder of the Miller Co. acquired all the assets of the latter, except $500, the Miller Co. still surviving. Conceding, however, that the answer should be in the affirmative, there still remains the question of whether the petitioners are entitled to participate in the benefits arising from such reorganization. All the petitioners made their returns on the calendar year basis. We have before us only the calendar year 1928. Petitioners' claims must stand or fall by what was done in that year. . All that the record discloses that was done in that year was the execution of the agreement, the transfer by the stockholders of the Miller Co. of all their stock in that company to the Union Co., and the payment by the latter in cash of 39 percent of the contract price. The acquisition by the Union Co. of all the stock of the Miller Co. in exchange for cash and the Union Co. stock, standing alone, did not constitute a reorganization as that term is used in section 112. . Of course, it is not necessary that all the steps essential to a complete reorganization must be taken in the taxable year, but if the words used in section 112(b)(3) as modified by section 112(c)(1) mean anything, it is that an exchange made in a taxable year to be effective under section 112 must have been made in pursuance of a plan of reorganization. In the first place, the Miller Co. was not a party to the agreement of December 11, 1928, and no covenants were made in its behalf except that the stockholders who were parties to the agreement agreed that if they could not be January 10, 1929, secure all the stock of the Miller Co. except 20 shares, then they agreed to procure the transfer of all the Miller Co.'s assets to the Union Co. for the same consideration which the latter had agreed to pay for the stock. There is nothing in the agreement which even remotely refers to what was to occur to the Miller Co. after the transfer of the stock. Much less does the agreement contemplate such action as was taken by the directors of that company on July 1, 1929, when all its stock was owned by the Union Co. As we see it, the contract was one of sale and exchange and nothing else. In fact, the words of the contract are: "Second parties agree to sell to first party, and first party agrees to purchase from second parties, all of the shares of stock of Miller Company owned by second parties at a price as follows, to-wit: * * *."

It is true that the resolution of the directors of the Miller Co. of July 1, 1929, states that their action was taken "pursuant to its plan of reorganization." But when that plan was adopted and what its provisons were are not disclosed. It is pertinent to point out that in July 1929 the Union Co. was, and for several months ahd been, the owner of all of the Miller Co.'s stock. Neither the petitioners nor any of the old stockholders then had any connection whatever with that company. In the absence of any evidence that a plan of reorganization was adopted in 1928, and at a time when the old stockholders were in control, we are compelled to find that the petitioners should be taxed as on a straight sale and exchange and that they are entitled to the benefits of section 44 of the Revenue Act of 1928.

The claim of the respondent that in 1928 the petitioners were in receipt of all the stock of the Union Co. must be denied. The agreement of the Miller Co. was that its preferred stock should be delivered to the petitioners and the other stockholders of the Miller Co. immediately following the granting of the permit by the Corporation Commissioner of the State of California. That permit was granted January 12, 1929. Under the laws of California there was no stock in existence and none could exist until the permit was granted. . In that case, after referring to the fact that one may be a stockholder even though no certificate has been issued to him and after setting forth all the pertinent provisions of the California Securities Act of 1917, the Board said:

Under the provisions of this act it was held by the California District Court of Appeals in , that not only was stock issued without a permit void, but a contract to sell such stock was also void and could not be ratified. In , the same court held that where one had purchased stock so issued without a permit from another holder the stock was void, the sale was void, and "in reality the plaintiff and her assignor never became stockholders in the corporation." In each of the above cases hearing was denied by the Supreme Court of California.

Judgment will be entered under Rule 50.

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Footnotes

• *. 159 Shares of common stock Miller Lithograph Co. exchanged in reorganization for 258.375 shares of stock of Union Lithograph Co. with cash "boot" of $25,837.50. Other property received, viz., shares in Union Lithograph Co., received without recognition of gain under Sec. 112(b)(3) Revenue Act of 1928. ↩