Douty v. Commissioner

F. A. DOUTY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Douty v. Commissioner

Docket No. 7477.

United States Board of Tax Appeals

9 B.T.A. 398; 1927 BTA LEXIS 2608;

Nov. 28, 1927, Promulgated

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1. Petitioner held to have been the purchaser of certain stock as principal and not an agent for the Multnomah Lumber & Box Co.

2. Evidence held insufficient to show error on the part of respondent in determining gain realized on the surrender of stock for the cancellation of an indebtedness.

John A. Collier, Esq., for the petitioner.

George G. Witter, Esq., for the respondent.

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ARUNDELL

This is a proceeding for the redetermination of a deficiency in income tax in the amount of $50,749.07 for the calendar year 1921. Petitioner alleges that the Commissioner erred in holding that a transaction involving stock of the Multnomah Lumber & Box Co. was a personal transaction, and if it was a personal transaction, that error was committed in determining the amount of petitioner's liability and in auditing and determining the distribution of certain amounts.

FINDINGS OF FACT.

Petitioner is an individual residing at Portland, Oreg.

In 1918 he was president and manager of the Multnomah Lumber & Box Co. (hereinafter called the Box Company) and of the American Export Lumber Co. (hereinafter called the Export Company), both Oregon corporations. Both companies were capitalized at $90,000, the stock in each case consisting of 900 shares. Petitioner was the largest individual stockholder in both companies. He owned a fraction less than one-third of the stock of the Box Company, the remaining stock being owned by the heirs of the Cook Estate and one Dooley.

A disagreement arose between petitioner and the Cooks over the question of cutting timber on two tracts owned by the companies, whereupon a contract was entered into, the material parts of which are set forth herewith:

THIS AGREEMENT, made this 28th day of February, 1918, between A. W. Cook, J. H. Cook, HATTIE J. ROSS, and A. W. COOK, Administrator of the estate of Rebecca A. Cook, deceased, hereinafter referred to as the "COOKS," parties of the first part, F. A. DOUTY, and ESSIE GRACE DOUTY, his wife, parties of the second part, MULTNOMAH LUMBER & BOX COMPANY, and Oregon corporation, hereinafter referred to as the "BOX COMPANY" party of the third part, AMERICAN EXPORT LUMBER COMPANY, an Oregon Corporation, hereinafter referred to as the "EXPORT COMPANY," party of the fourth part, and PORTLAND TRUST COMPANY OF OREGON, a corporation, hereinafter referred to as the "TRUST COMPANY," party of the fifth part.

WITNESSETH:

First. That the Cooks own in the aggregate 450 2/7 shares of the capital stock of the Box Company, being a majority of the capital stock thereof, and they own respectively an equal number of shares of the capital stock in the Export Company; that their respective ownerships in the capital stock of each of said corporations are as follows:

S. W. COOK	85 5/7
J. H. COOK	193 1/7
HATTIE J. ROSS	85 5/7
A. W. COOK, Administrator of the estate of Rebecca A. Cook, deceased	85 5/7

* * *

Fourth. That the said F. A. Douty is the largest individual holder of capital stock on both the Box Company and the Export Company and has been for a number of years last past the Manager of said Box Company. That the said Cooks desire to dispose of their capital stock in said corporation, that said Douty desires to purchase the capital stock holdings of the said forth [sic] and it is deemed to be for the best interests of said Box Company that said proposed sale be consummated on the terms and in the manner hereinafter provided.

NOW, THEREFORE, in consideration of the premises and of the promises and covenants made by the parties hereto as hereinafter provided, and for other good and valuable considerations, the parties hereto agree:

1. The Cooks agree to sell their said capital stock holdings in said Box Company and said Export Company for the sum of Two Hundred Twenty-five Thousand One Hundred Forty-two and 85/100 ($225,142.85) dollars, and the said F. A. Douty agrees to purchase same at said price upon the terms and conditions hereinafter set forth. That contemporaneous with the execution of this agreement the said Douty has paid to the said Cooks on said purchase price the sum of One Hundred Thousand ($100,000.00) Dollars, receipt of which by said Cooks is hereby acknowledged. That the balance of said purchase is evidenced by sixteen (16) promissory notes, executed by said F. A. Douty, all of even date herewith, aggregating One Hundred Twenty-five Thousand One Hundred Forty-two and 75/100 ($125,142.75) Dollars; that said notes are with respect to amounts and dates of maturity in sets of fours, to-wit:

[Here follows a description of the notes as to amounts, payees, and due dates.]

* * *

Except as to amounts, dates of maturity, and names of payee, said notes are of the same tenor, and the following is a copy of one thereof:

PORTLANDOREGON, February 28, 1918.

$13,419.49

"On or before October 1st, 1918, I promise to pay to the order of J. H. Cook, THIRTEEN THOUSAND FOUR HUNDRED NINETEEN AND FORTY-NINE HUNDREDTHS DOLLARS, for value received, with interest from date, payable quarterly, at the rate of seven per cent per annum until paid, and if interest is not so paid the whole sum of both principal and interest to become due immediately and collectible at the option of the holder of this note. Principal and interest payable in Gold Coin at the office of the PORTLAND TRUST COMPANY OF OREGON, in Portland, Oregon.

And in case suit or action is instituted to collect this note or any portion thereof, I promise to pay such additional sum as the Court may adjudge reasonable as attorney's fees in such suit or action.

This is one of the sixteen notes, all of even date, aggregating One Hundred Twenty-Five Thousand One Hundred Forty-Two Dollars and Seventy-five cents ($125,142.75) and all equally and ratable secured by 450-2/7 shares of the capital stock of Multnomah Lumber Box Company pledged with and standing in the name of the Portland Trust Company of Oregon, as Trustee, and further secured by a Trust Indenture bearing even date herewith, executed by the undersigned and wife to said Trust Company, said Indenture being recorded in Wahkiakum and Cowlitz Counties in Washington, and in Columbia County in Oregon.

Said sixteen notes comprise four for $13,419.49 each payable on or before October 1st, 1918, February 1st, 1919, August 1st, 1919, and February 1st, 1920, respectively, and twelve for $5,955.40 each, four of which are payable on or before October 1st, 1918, four on or before February 1st, 1919, four on or before August 1st, 1919, and four on or before February 1st, 1920. No one of said sixteen notes has any preference over any other note by reason of priority of maturity or otherwise, but each is equally and ratably secured by said pledged capital stock and under said Trust Indenture.

(Signed) F. A. DOUTY."

2. That said Box Company agrees to and will contemporaneous with the execution of this agreement guarantee the payment of said notes according to the tenor thereof, by endorsement on the back of each thereof subscribed to and executed by said Box Company in the following language, to-wit:

"For and in consideration of One Dollar to be paid by , receipt of which is hereby acknowledged, the undersigned, Multnomah Lumber & Box Company does hereby guarantee the payment of the within note, and consents to any extension of time granted the maker, and waives protest, demand and notice of non-payment thereof, and in case suit or action is instituted upon this guaranty for the collection of within note, it, the said Multnomah Lumber Box Company promises to pay such sum as the court may adjudge reasonable as attorney's fees in such suit or action.

MULTNOMAH LUMBER & BOX COMPANY, By F. A. DOUTY, President.

Attest: H. G. PLATT, Secretary.

3. That the said Cooks shall forthwith surrender to the officers of said Box Company and said Export Company respectively said shares of capital stock in said respective corporations, and said Box Company and said Export Company by their proper officers shall forthwith execute certificates of stock corresponding in amount of shares to those surrendered in favor of the Portland Trust Company of Oregon, Trustee, and said Trustee shall receive and hold the same as collateral security for the payment of said notes according to their tenor until all of said notes have been paid in full, and the obligations assumed by said Douty and said Box Company in this agreement have been performed.

4. That from the date of the depositing of said stock with said Trust Company and until the said Douty or the said Box Company have defaulted in the payments called for by said notes, or breached any of the terms or obligations assumed by them in this agreement, the said F. A. Douty shall have and enjoy the voting power upon all of said capital stock so held by said Trustees. In case of default or breach by said Douty or said Box Company in the payment of said notes or any installments of interest thereon, or in case of the breach by said Box Company or said Douty of any promise, obligation or covenant made by them or either of them in this agreement, then and thereupon the voting power upon said capital stock shall be no longer enjoyed by said Douty, but shall be exercised by said Trustee for the benefit of the holders of said notes or any portion thereof remaining unpaid, and the voting of said stock in such or any of said contingencies shall be done by said Trustee pursuant to the written instructions of a majority in amount of the holders of said outstanding and unpaid notes.

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6. That the Export Company shall forthwith convey to said F. A. Douty all and singular the premises and property real, personal and mixed, rights, franchises and appurtenances described in Paragraph Third of this agreement, and the latter shall enter into the possession thereof, subject, however, to the lien of the mortgage or deed of trust hereinafter provided for, and the Box Company grants to the said Douty the right to enter into and upon the premises described in Paragraph Second hereof (except the property of the said Box Company located in the City of Portland, Oregon), and to assume possession and control subject to the terms of this agreement, of the logging railroad and spurs, equipment, rolling stock, engines, motive power, machinery, fixtures and appurtenances upon said premises; and he, the said Douty, shall thereupon proceed by modern logging methods to cut, log and remove all of the timber standing, fallen or being upon said properties described in Paragraphs Second and Third of this agreement as aforesaid, and to cut the timber in question in a clean workmanlike manner, and to mark the logs as cut with a distinguishing mark to enable identification thereof, to-wit; "L" in circle on logs from property described in Paragraph Second of this agreement, and "G.M." on logs from property described in Paragraph Third in this agreement, and he, the said Douty, shall maintain said railroad, logging outfit, equipment, motive power, machinery and supplies in good order and condtion until the logging of said premises contemplated and called for by this agreement is completed.

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7. That said logs shall at all times until paid for as hereinafter provided, be and continue to be subject to the lien of the mortgage or deed of trust hereinafter provided for; that the logs hereinbefore referred to shall be scaled as assembled at said respective boom sites by the Columbia River Log Scaling Bureau, and the triplicate of said scale shall be made and same shall be transmitted by said Bureau as follows: One copy thereof to F. A. Douty, Portland, Oregon, one copy thereof to the Portland Trust Company of Oregon, Portland, Oregon, and another copy to A. W. Cook, Cooksburg, Pa. That the said Douty shall on or before the 15th day of each month submit to the Box Company a statement of the cost of conducting said logging operations as aforesaid, including in said expenses all the items involved in the operations hereinbefore called for, and the Box Company shall within fifteen (15) days thereafter pay to the said Douty said cost of conducting said logging operations incurred during the preceding calendar month, and it, the Box Company, shall, in addition thereto, within said fifteen (15) day period pay to the said Trust Company Three Dollars ($3.00) per thousand feet for all logs delivered or tendered to it at said boom sites, as aforesaid, by the said Douty during the said preceding month, * * * said sum of ($3.00) Dollars per thousand shall be applied as received by said Trustee monthly pro-rate on the note or notes next thereafter maturing, unless the holders of said note or notes agree upon the application of said proceeds in a different order.

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11. The said Box Company and the said Douty further covenant and agree that no stock dividends shall be declared by the former, nor shall any increase or increases be authorized or made of the capital stock of the Box Company while said notes or any thereof remain unpaid, and any cash dividends declared by the Box Company, while said notes or any thereof remain unpaid, shall, to the extent of the capital stock pledged with the Trust Company as aforesaid, be paid to the Trust Company and applied pro rata upon the notes remaining unpaid at the time of such cash dividend.

12. Upon the written request of any holder of any unpaid note or notes the Trust Company shall promptly demand of the Box Company a financial statement reflecting the conditions of its business and affairs at such time, and the Box Company shall promptly furnish same, and upon similar request and the furnishing of the necessary funds to the Trust Company by such holder or holders, the Trust Company shall cause and the Box Company shall permit to be made an audit of the books of the Box Company to ascertain the financial condition of said corporation.

13. It is agreed by all parties hereto that the payment already made by said Douty nor the payments made from time to time as herein provided for, shall not operate to release any of the stock of the Box Company pledged with the Trustee as aforesaid, but all of said pledged stock shall remain and continue as security for said notes until all of them have been fully paid.

14. If the said Douty and/or the said Box Company fail to pay any note or notes when due then and in such event the holder of any such note or notes shall have the option upon the expiration of fifteen (15) days after the maturing date of such note or notes to require the Trustee in writing to declare all of the remaining unpaid notes to be immediately due and payable, and said declaration shall be promptly made by said Trustee to said Douty and to said Box Company in writing and when made shall operate to cause all of the remaining unpaid notes immediately due and payable.

15. The said Box Company and the said F. A. Douty shall secure the release of the said Cooks and each of them from any obligation as security for either of said parties, or otherwise, and the said Box Company hereby releases and acquits the said Cooks and each and all of them from any and all liability of whatsoever character to it, the said Box Company, or to anyone for its account or benefit.

16. All Trustee's fees, recording fees, taxes, revenue charges for United States documentary stamps, and other incidental expenses incurred called for by this agreement shall be borne and paid by the said F. A. Douty.

17. To the end that the management of and business affairs of the Box Company may be vested in and enjoyed by the said F. A. Douty during the time that he and the Box Company comply with the covenants, promises, undertakings, and obligations assumed by them in this agreement, and to permit of the transfers and transactions contemplated by this agreement, the said A. W. Cook and J. H. Cook agree to retire from the Board of Directors of said Box Company, and the said Douty agrees to qualify men of his selection to take their places upon the Board of Directors, and to cause said men to be elected Directors, all to the end that the agreements and stipulations herein contained may be accomplished and carried out.

18. If the said F. A. Douty default or fail in the making of any of the payments called for by said notes or by this contract, or in any other manner default or fail and comply with any of the covenants, promises or agreements herein contained, and undertaken to be by him performed or complied with, and such default or failure continue for a period of fifteen (15) days after demand by the Trustee upon said Douty for performance thereof, then and in every of such cases the Trustee shall upon the written request of a holder of any of said unpaid and outstanding note or notes hereinbefore described, by notice in writing delivered to the said F. A. Douty, or mailed to his principal address or place of business (1) declare the said F. A. Douty to be in default hereunder, (2) declare the principal and interest of the then outstanding and unpaid notes immediately due and payable, anything in this contract or in said notes to the contrary notwithstanding. In case of such default and declaration the Trustee shall be authorized and upon being secured for necessary costs and expenses by the holder or holders of said notes, shall proceed to sell or cause to be sold the said 450-2/7 shares of the capital stock of the said Box Company, and the same number of shares in the said Export Company in the manner provided by the Laws of the State of Oregon for the sale of personal property upon execution, and shall apply the proceeds as follows:

(a) In the payment of costs and expenses of said sale: (b) in the payment of any moneys advanced for taxes or for the protection of the security described in this contract; (c) in payment of the said unpaid notes, interest and attorney's fees.

IN WITNESS WHEREOF, the Cooks and said F. A. Douty and wife have executed this agreement, and the said Box Company, Export Company and Trust Company have caused the same to be executed by their proper officers thereunto duly authorized, the day and year first herein written.

A. W. COOK. [SEAL.] J. H. COOK. [SEAL.] A. W. COOK. [SEAL.]

Adm. Estate Rebecca Cook.

HATTIE J. ROSS. [SEAL.]

By A. W. COOK.

Witnesses as to the Cooks:

T. H. WARD, A. C. SPENCER. F. A. DOUTY. [SEAL.]

ESSIE GRACE DOUTY. [SEAL.]

Witnesses as to the Doutys:

T. H. WARD, A. C. SPENCER.

Of the consideration for the stock of the Cooks, petitioner paid about $17,000 from his own funds and the balance was paid by the Multnomah Lumber & Box Co. on behalf of petitioner. Dooley's stock in the Box Company, amounting to about 150 shares, was transferred in consideration of the cancellation by the Box Company of an indebtedness to the extent of $75,000 of a company in which Dooley had an interest.

Two accounts were carried with petitioner on the books of the Box Company, one of which was known as his personal account, and the other was denominated "F. A. Douty Special A/c." Payments made by the Box Company on petitioner's notes were charged against him in the special account. Interest on the notes to December 31, 1918, in the amount of $7,591.17 was charged against petitioner in the special account under date of February 28, 1919. Credits on the special account consisted mostly of amounts representing petitioner's monthly salary.

After the notes were retired the escrow holder, the Portland Trust Co., delivered the stock of both the Box Company and the Export Company to petitioner, who was then the owner of all stock of the Box Company except the qualifying shares.

Thereafter the Box Company increased its capital stock and issued to petitioner as a stock dividend 15,120.4667 shares. The issue of the stock dividend was entered on the company's books on June 30, 1921, as of March 31, 1921. Petitioner surrendered back to the company 1,020.4667 shares of its stock and turned in to it 900 shares of stock of the Export Company, and there was credited to the special account under date of June 30, 1921, the amount of $214,791.15. The credit was given by reason of petitioner's surrender of the stock, and the amount thereof, together with the other credit entries balanced the total of the debits entered in the special account to and including August 31, 1921.

At the time the entries above described were made the Box Company held a personal note of petitioner in the amount of $17,804.07, which amount was included in the indebtedness canceled.

OPINION.

ARUNDELL: The petitioner alleges that the purchase of the Box Company stock and the Export Company stock from the Cooks and Dooley was not a personal transaction, but was for and in behalf of the Box Company. The contract for the purchase of the stock, which we have set out at some length, does not sustain the petitioner's claim. It clearly sets forth the fact that the petitioner is the purchaser. He signed the contract as principal, and not as agent for the Box Company; he was the maker and principal obligor of the notes given for the balance of the purchase price and the Box Company was merely a guarantor and hence only secondarily liable. In asking us to find that the Box Company was the purchaser of the stock, the petitioner is asking that we read into the agreement something that will vary its terms which plainly name the petitioner as purchaser.

We do not have in evidence the method of computing gain which respondent used in determining the deficiency involved. His counsel stated at the hearing that the amount of the gain was arrived at by deducting from $317,087.88, the amount of petitioner's indebtedness which was canceled, the cost of the stock turned in, $192,551.49, resulting in a gain of $124,536.39. The evidence is insufficient to permit of a check of the figures used by the respondent. Among the elements missing are the cost to petitioner of his original holdings of stock in the two companies and the cost of the Export Company stock subsequently acquired. Copies of both petitioner's personal and special accounts carried on the Box Company ledger were introduced in evidence, but both accounts contain many items that are unexplained, so that we are unable to find from them whether or not the Commissioner erred in his determination of the amount of indebtedness canceled. If, as a matter of law, a taxable gain might result from a transaction such as is here involved, we must, in view of the state of the record, assume that whatever the Commissioner's computation was, it was correct.

The transaction, in brief, was that petitioner purchased outstanding stock of the Export Company and the Box Company, paying therefor with funds advanced by the latter. After the stock was thus paid for, the Box Company issued a stock dividend to petitioner, who thereupon turned in to the Box Company his stock in the Export Company and surrendered to the Box Company a part of his stock in it, which company then canceled his indebtedness to it.

The effect of the transaction was, as we see it, the same as if the Box Company had paid petitioner $317,087.88 for stock which cost him $192,551.49. The fact that a part of the $317,087.88 was advanced to petitioner to pay for the stock makes it none the less a part of the price received on its sale to the Box Company. In short, he received more than he paid for the stock and the amount of such excess constitutes income.

Judgment will be entered for the respondent.

Considered by STERNHAGEN and GREEN.