Nevada Oil Co. v. Commissioner

Nevada Oil Co., Petitioner, v. Commissioner of Internal Revenue, Respondent

Nevada Oil Co. v. Commissioner

Docket No. 43588

United States Tax Court

22 T.C. 630; 1954 U.S. Tax Ct. LEXIS 173;

June 22, 1954, Filed. June 22, 1954, Filed

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Decision will be entered under Rule 50.

Income -- Ordinary Income or Return of Capital. -- Minority stockholders sued the Corporation and its majority stockholder for mismanagement, etc. They recovered a money judgment. The minority stockholders fearing appeal, a settlement was reached and an amended judgment entered thereon. Petitioner corporation was formed by the minority stockholders and substituted for them in the amended judgment. Oil leases and a money judgment were decreed in the amended judgment for the benefit of the minority stockholders and entered in the name of petitioner. The minority stockholders surrendered their stock to the Corporation and received in return, under the decree, a proportionate stock interest in petitioner. Held, amounts received by petitioner in payment of the money judgment were not taxable to it as ordinary income.

Sam G. Winstead, Esq., for the petitioner.

J. Marvin Kelley, Esq., and James F. Hoge, Jr., Esq., for the respondent.

Tietjens, Judge.

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TIETJENS

Respondent determined deficiencies in income tax as follows:

Year	Deficiency
1947	$ 8,641.26
1948	6,563.32

The only question for decision is whether amounts received by petitioner as installment payments on a judgment entered in its favor in 1944, nunc pro tunc October 6, 1943, were taxable as ordinary income in the taxable years.

Other issues have been conceded.

FINDINGS OF FACT.

Most of the facts have been stipulated. The stipulation is incorporated herein by reference and the stipulated facts are found accordingly.

Petitioner was organized under the laws of Nevada in July 1944. It received a permit to do business in Texas on April 18, 1945. Its tax returns for the years in question were filed with the collector of internal revenue at Dallas, Texas.

Prior to October 6, 1943, the W. C. Turnbow Petroleum Corporation, a Colorado corporation (hereafter called the Corporation), and W. C. Turnbow, individually, were involved in litigation with 49.5 per cent of its stockholders. These stockholder suits were styled "George A. Cox, et al v. W. C. Turnbow, et al, Docket No. 347, Civil," and "Romer Bullington, Trustee v. W. C. Turnbow, et al., Docket No. 387, Civil."

On February 21, 1940, the Corporation filed a petition in the District Court of the United States for the Eastern District of Texas for reorganization under section 77B of the Bankruptcy Act. The petition was dismissed on September 28, 1944. On October 6, 1943, the District Court of the United States for the Eastern District of Texas entered a final judgment in Civil Actions 347 and 387 and on September 29, 1944, entered a final amended judgment.

The "Final Judgment" of October 6, 1943, found, among other things, that the plaintiffs were entitled to recover from W. C. Turnbow, as follows:

1. For excess salary withdrawn by the said W. C. Turnbow to the amount of $ 4,000.00 per year for the period from January 1, 1931, to February 20, 1940, inclusive, in the total sum of $ 36,555.55.

2. For excess promotion fees withdrawn by the said W. C. Turnbow, prior to January 1, 1934, the sum of $ 26,873.45, with interest from January 1, 1934, to February 20, 1940, at 6% per annum, said interest being the sum of $ 9,898.37; the total of principal and interest to February 20, 1940, being the sum of $ 36,771.82.

3. Personal overdraft of moneys withdrawn by said W. C. Turnbow in the sum of $ 86,207.81, with interest thereon at the rate of 6% from January 1, 1937, to February 20, 1940, in the sum of $ 16,235.75, being a total overdraft with interest to February 20, 1940, in the sum of $ 102,443.56.

4. For personal income tax paid by said Defendant with corporate funds, the sum of $ 4,877.12.

5. For cost of water well drilled by said Defendant for domestic use and paid for with corporate funds, the sum of $ 3,216.36.

6. For excess oil for which no accounting or payment for same was made by said Defendant to said Corporation the sum of $ 200,000.00, with interest at 6% on $ 70,000.00 of said amount from December 28, 1936, to February 20, 1940, in the sum of $ 13,183.33, being a total for excess oil in the sum of $ 213,183.33.

7. $ 7,454.29, being moneys charged on the corporation books as having been paid by said W. C. Turnbow to Texas Pipe and Supply Company but which he did not, in fact, pay; the further sum of $ 3,000.00, charged to the Corporation for additional pipeline, which was not acquired for said Corporation; the further sum of $ 3,000.00 charged to said Corporation for additional labor which was not expended therefor; and cash in the sum of $ 9,593.22 received by said Turnbow from cash sales of oil but not accounted for by the said W. C. Turnbow; all of said items having accrued in the year 1934, interest is allowed on same at 6% from January 1, 1935, to February 20, 1940, in the sum of $ 7,106.30, aggregating the total sum of $ 30,153.81.

8. On account of payments out of corporate moneys to State officials to enable the running of hot oil in the sum of $ 30,000.00.

9. For legal and auditing expenses illegally charged to said Corporation in the sum of $ 48,663.06.

10. For amounts illegally paid out of corporate funds to the Defendant, W. C. Linden, in the sum of $ 19,134.13.

11. To items collected from the Solvex Company during the year 1937 by W. C. Turnbow in the sum of $ 5,240.00, with interest on same at 6% from January 1, 1938, to February 20, 1940, in the sum of $ 672.46, the total principal and interest found to be due by the said W. C. Turnbow to the W. C. Turnbow Petroleum Corporation on the items above set forth on the date of the filing of the petition for reorganization in bankruptcy on February 20, 1940, being the sum of $ 5,912.46.

The court further found that 50.5 per cent of the stock of the Corporation was owned by W. C. Turnbow and that the plaintiffs in the proceeding owned 49.5 per cent of such stock. The court further found that the Corporation was then solvent and that the payment of the sums found to be due in the judgment entered on October 6, 1943, should properly be paid in the nature of a dividend to the shareholders, other than W. C. Turnbow and Julia Ruth Brower, and in the proportion of the respective ownerships of such stock.

The court ordered, adjudged, and decreed that the plaintiffs

do have and recover for the use and benefit of the shareholders of the W. C. Turnbow Petroleum Corporation, other than W. C. Turnbow and Julia Ruth Brower, as their interests may appear in the proportion of their respective ownership of such shares, of and from W. C. Turnbow the sum of $ 262,801.02, with interest thereon at the rate of 6 per cent per annum from date hereof until paid * * *

Following the entry of the foregoing judgment, W. C. Turnbow filed a motion for rehearing and to correct certain items of said judgment, and the cases were reopened by order of the court for further consideration. The minority stockholders of the Corporation were numerous and it was considered feasible to organize a corporation to take over their interests. Nevada Oil Company, petitioner herein, was created for that purpose in July 1944 and was permitted to intervene in the two civil suits heretofore mentioned and was substituted as the plaintiff at interest therein, as successor to the original parties plaintiff, the minority stockholders in such suits. Subsequent to the reopening of said cases numerous conferences were had between the attorneys of W. C. Turnbow and the plaintiffs in said suits, and a compromise was reached between the parties that resulted in the final amended judgment dated September 28, 1944.

Among other things, the final amended judgment provided as follows:

1. * * * it appearing that the parties have in writing agreed to the amendment of said judgment as hereinafter set forth, and it further appearing to the Court that since the rendition of said judgment, the class of stockholders of the W. C. Turnbow Petroleum Corporation, being all of said stockholders, other than W. C. Turnbow and Julia Ruth Brower, have caused to be incorporated a corporation to-wit: Nevada Oil Company of Nevada, which has intervened herein and asked to be substituted as plaintiff herein as successor to and representative of all such class of stockholders, its stockholders being the said stockholders of said class, its directors for the first year being the Protective Committee of such stockholders, representing the majority of such stock, and it having appointed J. T. Griffin, Chairman, as trustee and treasurer thereof he being required to give and file with said corporation a good and sufficient surety company, [sic] and its stockholders, same being the former stockholders of the W. C. Turnbow Petroleum Corporation, represented herein as a class by plaintiffs, as their interests appear, and conditioned on the faithful discharge of his duties, the proper exchange of stock in said corporation for the lawful stock of said W. C. Turnbow Petroleum Corporation, and for the secure keeping and proper disbursement of all sums of money coming into his hands as such treasurer and trustee, and said corporation is permitted to intervene herein and is hereby substituted as the plaintiff at interest herein, as successor to the original parties plaintiff; a photostat copy of said bond being filed herein.

2. It further appearing to the Court that the parties have agreed to a partition of the properties of the W. C. Turnbow Petroleum Corporation, in the proportion of the stockholdings of each, as decreed herein, to-wit, 50.5 per cent to the said W. C. Turnbow and 49.5 per cent to the class of stockholders represented by the plaintiffs being all of the stockholders of the said W. C. Turnbow Petroleum Corporation, other than the said W. C. Turnbow and Julia Ruth Brower, and it appearing that no rights of creditors are involved, and that there are no matters in controversy, save and except those involved in this suit, all of which have been settled by said agreement and this judgment, which is herewith entered, in the place of and as an amendment of the said judgment as heretofore entered herein, so that same shall hereafter read as herein set forth, and, except as herein specifically stated, shall be a complete and final settlement between and among the parties, so that none shall have or hereafter assert any character of claim against the other, except as herein specificially reserved.

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5. It therefore appearing that of the total stock of the said W. C. Turnbow Petroleum Corporation the said W. C. Turnbow will have and hold 50 1/2 per cent thereof, and the shareholders other than W. C. Turnbow and Julia Ruth Brower will have and hold 49 1/2 per cent thereof, and it further appearing to the Court that the parties hereto have agreed to a partition of the properties of the said W. C. Turnbow Petroleum Corporation, and have asked the court to decree such partition in this proceeding in the proportion of the aforesaid stock ownership, and that all parties at interest, including the stockholders of the said W. C. Turnbow Petroleum Corporation, the trustee in bankruptcy, the creditors of said Corporation, and the United States Securities and Exchange Commission have been given due notice of said proposed compromise agreement and a hearing had thereon, at which no one opposed same except the said United States Securities & Exchange Commission which filed no pleading, but presented a legal brief in opposition thereto and said brief and all matters of fact and law being fully considered by the Court, the court finds such a settlement agreed to, is fair, just and equitable, and same is approved.

6. It is therefore ordered, adjudged and decreeed by the court that the defendant W. C. Turnbow Petroleum Corporation and W. C. Turnbow have and recover, as full value of said Turnbow's 50.5% stock ownership, the following properties, to-wit:

[Certain described leases]

7. It is further ordered, adjudged and decreed that the said Nevada Oil Company a corporation, duly incorporated under the laws of the State of Nevada as substituted plaintiff in lieu of the original plaintiffs herein, for the use and benefit of all the stockholders of the class represented by the plaintiffs, being all the stockholders of the said W. C. Turnbow Petroleum Corporation, other than the said W. C. Turnbow and Julia Ruth Brower, do have and recover, in lieu of their said 49.5 per cent of the stock of said W. C. Turnbow Petroleum Corporation, title and possession of the following properties, to-wit;

[Certain described leases]

8. It is further ordered, adjudged and decreed that the said substituted plaintiff, Nevada Oil Company, for the use and benefit of all of the stockholders of the said W. C. Turnbow Petroleum Corporation of the class herein represented by the plaintiffs, do have of and recover from the said W. C. Turnbow Petroleum Corporation and said W. C. Turnbow the sum of One Hundred Fifty Thousand ($ 150,000.00) Dollars with interest thereon at the rate of 3% per annum from October 6, 1943, which judgment shall be paid, including interest in 180 equal payments of $ 1058.50 each, the first payment being due the 20th day of February 1945, and one such payment to become due on the 20th day of each month thereafter until said 180 payments have been made.

9. It is decreed that this judgment shall be in full settlement and satisfaction of all claims and demands of the plaintiffs and stockholders of the class represented by them, save and except that the claims of said parties for hot oil or excess oil, claimed to have been sold by the said W. C. Turnbow during the period of his management of the W. C. Turnbow Petroleum Corporation, other than the amount embraced in the judgment and findings of the court, in the case of C. H. Lamb et al, vs. W. C. Turnbow et al, are not put in issue in this suit by the plaintiffs, but are expressly reserved by them and this judgment is without prejudice to the rights of the plaintiffs or their successors in interest, to sue for any and all sums claimed to be due from the sale of such hot oil or excess oil against the said Turnbow and any and all purchasers thereof, in any suit or suits now pending therefor, or hereafter instituted.

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14. It is further ordered by the Court that said Nevada Oil Company shall make the exchange of stock of the said class of stockholders represented by the plaintiffs herein for the stock of said Nevada Oil Company, in accordance with the rights of the parties at interest therein, and to receive and disburse any money payable hereunder.

* * * *

The stockholders of petitioner were all former stockholders of the Corporation and such stockholders owned 49.5 per cent of all of the outstanding capital stock of the Corporation. This 49.5 per cent of the Corporation stock was returned to the Corporation pursuant to the final amended judgment.

Also, pursuant to the final amended judgment, the Corporation transferred to petitioner as of January 1, 1945, the leases specified therein. Petitioner also received a judgment against the Corporation and W. C. Turnbow for the sum of $ 150,000 with interest at 3 per cent per annum from October 6, 1943, payable as specified in the final amended judgment.

The properties and the money judgment transferred to petitioner pursuant to the court decrees quoted above were, on the advice of a certified public accountant, set up on petitioner's books on the basis of their fair market value on January 1, 1945. The parties have agreed on that valuation and it is stipulated that the judgment had a fair market value of $ 150,000 at January 1, 1945.

For the taxable year 1947 petitioner received $ 9,999.96 as a payment on the judgment, of which $ 1,178.47 represented interest. The same amount was received in 1948, of which $ 1,116 represented interest. The full amounts received were not reported as income. The interest received was so reported.

On its returns for 1947 and 1948 petitioner claimed certain amounts for depreciation for lease equipment and for depletion of the leases received from the Corporation pursuant to the final amended judgment. These amounts were disallowed with the explanation that the fair market value of the leases and equipment lacked substantiation and because the basis of the properties was zero, since they "were acquired through a reorganization."

The amounts of $ 9,999.96 received by petitioner in each taxable year were added by the Commissioner to income with the explanation that such amounts were "taxable as ordinary income."

OPINION.

In opening statements of counsel the main issue was emphasized to be whether or not the transactions here involved amounted to a reorganization under section 112 (g) (1) (D) of the Internal Revenue Code. If they did, counsel explained, then petitioner would be required to take the basis of the transferor, the Corporation, in the properties transferred for purposes of depreciation and depletion, and the determination of this issue would in turn affect the question of whether or not recoveries on the money judgment constituted a return of capital or taxable income.

On brief, counsel for respondent state that "The reorganization issue under Section 112 (g) (1) (D) of the Internal Revenue Code is being conceded by respondent."

Nevertheless, respondent presses his contention that payments received in 1947 and 1948 by petitioner on the money judgment were taxable as ordinary income in those years. His argument goes as follows: Although the money judgment was originally entered in favor of the original plaintiffs -- the minority stockholders -- petitioner was created by them and substituted for them and finally itself recovered the judgment. Further, examination of the items for which the judgment was given discloses that the recovery was for lost profits of the Corporation, and so any payments received by petitioner should be treated as ordinary income, citing W. W. Sly Manufacturing Co., 24 B. T. A. 65, and Herman J. Sternberg, 32 B. T. A. 1039.

We do not disagree with the results reached in the cited cases, but we do not believe the facts of the case before us bring it within the ambit of those decisions.

Here, if any taxable transaction took place, it was at the time the original judgment was obtained by the minority stockholders. Whatever took place afterwards in the nunc pro tunc final amended judgment was simply a refinement of the original judgment based on agreement of the parties which shortcut needless formalities in order to reach the agreed result. In our view, what happened was this: The minority stockholders originally recovered a cash judgment. It was property in their hands and conceivably represented taxable income to them. Some doubt was entertained as to whether it could be upset on appeal. So the parties got together and settled their differences, nunc pro tunc in an agreed final amended judgment. The minority stockholders turned in their stock in the Corporation in exchange for certain corporate leases plus the money judgment which they were to receive under the amended decree. For convenience they formed petitioner corporation to which the leases and judgment were directly transferred. Thus, instead of the minority stockholders first receiving the leases and judgment in exchange for their stock in the Corporation and then transferring the leases and judgment to petitioner in exchange for its stock, these transactions were telescoped in the final amended judgment. If tax consequences flowed from these telescoped transactions, we think, though we need not decide, that the minority stockholders, as such, realized gain or loss when they surrendered their stock in the Corporation in return for the leases and the money judgment. Thereafter, on the transfer of the leases and judgment in exchange for stock in petitioner the leases and judgment became capital in the hands of petitioner and collections of the principal of the judgment by petitioner was tantamount to a return of capital and was not ordinary income.

Though not conclusive, we note in passing that the Federal District Court characterized the transaction as a "partition of the properties" of the Corporation and decreed that the minority stockholders recover the leases and judgment "in lieu of their said 49.5 per cent of the stock" in the Corporation. Further, the court, in the original judgment recited that the money judgment there decreed "should properly be paid in the nature of a dividend to the stockholders." All of these things indicate that the transactions amounted either to an exchange or sale by the minority stockholders of their stock in the Corporation for the leases and judgment, or a liquidating dividend by the Corporation to the minority stockholders. Whatever the true nature of the transactions, at the time petitioner received the leases and money judgment they became capital in its hands. So far as the leases and lease equipment are concerned, this seems to be admitted by respondent in his concession that the proper basis for depreciation and depletion of those properties to petitioner is their fair market value on January 1, 1945. We perceive no reason why the money judgment in the hands of petitioner should not be similarily treated, it being stipulated that the judgment had a fair market value of $ 150,000 (its face) on January 1, 1945.

We conclude that principal payments on the judgment received by petitioner are not to be taxed as ordinary income.

Decision will be entered under Rule 50.