Hoagland Corp. v. Commissioner

THE HOAGLAND CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Hoagland Corp. v. Commissioner

Docket No. 95920.

United States Board of Tax Appeals

42 B.T.A. 13; 1940 BTA LEXIS 1066;

June 7, 1940, Promulgated

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DEDUCTIONS - LOSSES - REORGANIZATION. - The petitioner owned 2,500 shares of $100 par value stock, being all of the capital stock of a corporation. The corporation also owed a large debt to the petitioner on a promissory note. A large bond issue secured by a mortgage on the property of the corporation was also outstanding. The corporation, in 1935, went through a reorganization under section 77(b) of the Bankruptcy Act. Its capital stock was changed to 13,355 shares of $1 par value. Sixty percent of those new shares was issued to the petitioner in exchange for all of its old shares and the cancellation of the debt due on the note. The remaining 40 percent of the new shares was issued pro rata to the bondholders who agreed to a reduction of the interest rate and an extension of the mortgage. Held, that there was a recapitalization of the corporation and, therefore, a reorganization under section 112(g)(1)(D) of the Revenue Act of 1934, and, since the exchange made by the petitioner comes within section 112(b)(3), its loss, if any, is not recognized.

Clark H. Hebner, Esq., for the petitioner.

Walt Mandry, Esq., for the respondent.

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MURDOCK

The Commissioner determined the following deficiencies for the calendar year 1935:

Income tax	$1,765.23
Excess profits tax	127.75
Personal holding company surtax	11,778.59

There is only one issue for decision, another having been waived. The assignment is as follows:

In determining the taxable income of the petitioner for the year 1935, the Commissioner erroneously refused to allow the deduction from gross income of a loss sustained by petitioner through the reorganization under Section 77B of the Federal Bankruptcy Act of said subsidiary, Seven Eleven Fifth Avenue, Inc., in the amount of $662,440.00, (which amount includes the accrued interest item of $116,110.00, above referred to), as a loss sustained during the taxable year not compensated for by insurance or otherwise.

FINDINGS OF FACT.

The petitioner is a corporation, organized under the laws of Delaware. Its address, for the purposes of Federal tax for the year 1935, was 1 Park Avenue, Borough of Manhattan, City and State of New York.

The petitioner had been the owner for some time of all of the outstanding capital stock of a New York corporation known as Seven ElevenFifth Avenue, Inc. The stock consisted of 2,500 shares, each share having a par value of $100. The cost or basis of the stock has not been established in the record.

Seven Eleven Fifth Avenue, Inc., was indebted to the petitioner on a demand promissory note on which there were due in 1935 $1,290,000 of principal and accrued unpaid interest in the amount of $116,100.

Seven Eleven Fifth Avenue, Inc., owned and continued to own as its only asset the leasehold on the premises at 711 Fifth Avenue, New York City. Its leasehold was subject to a bond issue in the amount of $1,800,000 secured by a mortgage on the leasehold. The principal of the mortgage had been reduced to $1,335,500 up to June 1, 1935.

The petitioner and Seven Eleven Fifth Avenue, Inc., filed consolidated income tax returns for the years 1929 through 1935, and during the latter part of that period Seven Eleven Fifth Avenue, Inc., had losses from its operations which were deducted upon those returns.

Most of the building was rented under leases which expired cotemporaneously with the leasehold on the building held by Seven Eleven Fifth Avenue, Inc. The tenants, most of whom had excellent credit rating prior to 1932, became unable to pay their rent and one after another became in default beginning in 1932 and 1933. The building was only about half occupied in 1934 and Seven Eleven Fifth Avenue, Inc., was unable to meet its obligations, including interest, taxes, and sinking fund payments. The bankers who had underwritten the mortgage suggested the formation of a bondholders' protective committee in 1934 and such a committee was formed. It became apparent that if Seven Eleven Fifth Avenue, Inc., was to retain any of its equity in the property, a reorganization of Seven Eleven Fifth Avenue, Inc., under section 77(b) of the Federal Bankruptcy Act would be necessary.

A petition under section 77(b) was filed on May 31, 1935. A plan of reorganization under that provision was formulated, was approved by the court, and was consummated. The plan provided that the interests of the petitioner be modified as follows:

The debt of the Company to the Hoagland Corporation which amounts to $1,290,000 (with interest thereon now amounting to $116,100) and the entire present stock of the Company are to be retired upon consummation of the Plan, through the issuance by the Company of its entire authorized Class B stock in exchange therefor and as part consideration for the making of the Reorganization Loan * * *.

The following things, among others, were done pursuant to the plan. The entire debt with accrued interest thereon due to the petitioner from Seven Eleven Fifth Avenue, Inc., and secured by the demand promissory note was canceled. The stock of Seven Eleven Fifth Avenue, Inc., was reclassified and changed from 2,500 shares, each having a par value of $100, to 13,355 shares, each having a par value of $1. These shares were divided into class A and class B. The class A consisted of 5,342 shares, which were distributed to the bondholders in the ratio of four shares for each $1,000 bond held. The remaining 8,013 shares, called class B stock, were issued to the petitioner on August 8, 1935. The class A stock could elect two directors and the class B stock could elect three. The interest on the mortgage was reduced and the mortgage was extended for an additional period of time. The ground rent was also reduced.

The Commissioner, in determining the deficiency, refused to allow a deduction on account of the cancellation of the debt due to the petitioner and on account of the surrender of 40 percent of its stock. He explained:

The surrender of accounts receivable (including the aforesaid interest of $116,100.00) and old capital stock, in exchange for new capital stock in the reorganized Seven Fifth Avenue, Inc.[sic] results in no gain or loss under the provisions of Sections 112(b)(3), 112(b)(4), 112(b)(5) and 112(g)(1)(D) of the Revenue Act of 1934.

OPINION.

MURDOCK: The petitioner concedes that there was a reorganization of Seven Eleven Fifth Avenue, Inc., within the meaning of that term as defined in section 112(g)(1)(D) of the Revenue Act of 1934, in that there was a recapitalization. Section 112(b)(3) provides that "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." That provision exactly covers the transactions participated in by the present petitioner. It held before the reorganization all of the capital stock and a demand promissory note of the reorganized corporation. The petitioner does not contend that the promissory note was not "securities" within the meaning of that term as used in the above provision. It surrendered the stock and the notes, pursuant to the plan of reorganization, and received in exchange new stock of the reorganized corporation. The conclusion, that no gain or loss shall be recognized to the petitioner on the transaction, seems inevitable.

The petitioner contends that the surrender by it of one-fourth of the stock and the amount due on the note was not an "exchange", since the petitioner was required to make that surrender in order to induce others to assist the corporation through financial difficulties and since it received no tangible consideration of determinable value for the surrender. It argues that the reorganization through recapitalization was an incident which necessarily took place prior to the surrender of one-fourth of the stock and, therefore, the loss does not come within the nonrecognition provisions of section 112. A reorganization under section 77(b) of the Federal Bankruptcy Act may differ materially from a reorganization through recapitalization within the meaning of section 112(g)(1)(D). Here, however, the distribution of the new stock, 40 percent to the bondholders and 60 percent to the petitioner, was an essential part of the plan of reorganization through recapitalization, within the meaning of section 112. The reclassification of the stock can not be separated from its distribution. The evidence shows that the petitioner exchanged its old stock and the debt due it for 60 percent of the new stock. These steps bring the transaction squarely within the provisions of section 112(b)(3). . The cases which the petitioner cites are all right, as far as they go, but they do not go far enough for the petitioner's purpose.

The petitioner argues that its loss was not a capital loss and, therefore, was not limited to a deduction of $2,000. The respondent does not mention that point in his brief, but he does contend that the petitioner would not be entitled to any deduction on the showing which it has made, even if there were no reorganization and nonrecognition provisions in the revenue act. The petitioner has failed to prove its basis for gain or loss on the shares. It has failed to prove that the debt in question had any value at the beginning of the taxable year. There is evidence which raises serious doubt as to whether or not it had any value at the beginning of the year. The respondent argues that 60 percent of the new stock represents the amount realized from the exchange and the value of that stock, an essential element in the computation of any gain or loss, has not been shown. He contends also that any loss would be subject to adjustments, in amounts not disclosed in the record, since consolidated returns were filed in which losses of the subsidiary were offset against income of the petitioner. See Regulations 89, arts. 39 and 40. These questions, which would otherwise be important, are not so here, where the petitioner is not entitled to any loss by reason of section 112(b)(3).

Decision will be entered for the respondent.