DocketNumber： Docket Nos. 50167, 50168
Citation Numbers： 1955 U.S. Tax Ct. LEXIS 64, 25 T.C. 132
Judges： Rice
Filed Date： 10/27/1955
Status： Precedential
Modified Date： 11/14/2024
*64
Petitioners organized Jack & Heintz, Inc., in 1940, and thereafter held all its outstanding common stock. Such stock had a basis to them of $ 112,000 in 1946. The corporation achieved remarkable growth and earnings, but in 1945, petitioners became apprehensive about their ability to successfully convert its activities to peacetime production. They decided to sell their entire interest in the company. They negotiated with B. C. Milner, Jr., with respect to an $ 8,000,000 cash deal. When Milner and his associates were unable to raise the total purchase price in cash, petitioners accepted an offer from the purchasing group to sell for $ 5,000,000 in cash plus 60,000 shares of preferred stock in a corporation which would be organized to make the purchase. Petitioners accepted this arrangement only after receiving a promise from Milner and one of his associates that the preferred shares which they would receive as part of the consideration would thereafter be sold on their behalf together with a public offering of the stock of the new corporation. As part of the terms of sale, petitioners agreed to help effectuate a plan of the purchasing*65 group to merge Jack & Heintz, Inc., after its acquisition, into the purchasing corporation. The sale of petitioners' shares in Jack & Heintz, Inc., was consummated on March 5, 1946, and that corporation was merged into the purchasing corporation on the following day. Petitioners sold 50,000 of their preferred shares in the purchasing corporation during 1946, the remaining 10,000 shares being held in escrow at that time pending the resolution of certain contingencies. Respondent determined that petitioners had participated in a statutory reorganization, receiving preferred stock in the continuing corporation plus approximately $ 5,000,000 "boot" taxable as ordinary income.
*132 These consolidated proceedings involve deficiencies determined against the petitioners, and refunds claimed by them, as follows: *133
| Petitioner | Docket | Year | Deficiency | Refund |
| No. | determined | claimed | ||
| Ralph M. Heintz | 50167 | 1946 | $ 818,752.79 | |
| 50167 | 1947 | 2,011.02 | $ 17,187.50 | |
| William S. Jack | 50168 | 1946 | 2,482,645.92 | |
| 50168 | 1947 | 18,811.68 | 51,562.50 |
The issues to be decided are: (1) Whether the exchange of petitioners' common stock in Jack & Heintz, Inc., on March 5, 1946, for a total aggregate consideration of $ 5,157,404.33 in cash and 60,000 shares of $ *67 50 par value convertible preferred stock of Precision Products Corporation was a sale or whether it was made in pursuance of a plan of reorganization which resulted in the statutory merger of Jack & Heintz, Inc., into Precision Products Corporation on March 6, 1946, within the meaning of
Certain other issues raised by the pleadings have been conceded and will be taken into account under a Rule 50 computation.
Some of the facts were stipulated.
FINDINGS OF FACT.
The stipulated facts are so found and are incorporated herein by this reference.
Petitioner William S. Jack (hereinafter referred to as Jack) and petitioner Ralph M. Heintz (hereinafter referred to as Heintz) are, at present, residents of California. They each filed individual income tax returns for the calendar years 1946 and 1947 with the collector of internal revenue for the eighteenth district of Ohio.
Petitioners organized Jack & Heintz, Inc., an Ohio corporation, in November 1940, taking back*68 all of its outstanding stock. Such stock had a cost basis, as of March 5, 1946, of $ 87,000 to Jack and $ 25,000 to Heintz. Jack served as president and Heintz served as vice president and secretary-treasurer of the corporation throughout its corporate life; in addition, each of the petitioners was a member of the corporation's board of directors.
From its organization in 1940 through its fiscal year ended October 31, 1945, Jack & Heintz, Inc., achieved remarkable growth and earnings. It had extensive Government contracts for the production of aircraft starters, automatic pilots, and other items for the Armed Forces, and its annual volume of sales reached a peak of $ 90,405,610 in its fiscal year ended October 31, 1944. The corporation paid no dividends during the years 1940 through 1944. In its fiscal year ended October 31, 1945, dividends in the amount of $ 264,780 were paid, none *134 of which, however, were paid to petitioners. By March 4, 1946, accumulated undistributed earnings and profits of Jack & Heintz, Inc., amounted to $ 5,368,322.06. During the period from November 1940 to March 4, 1946, petitioners received compensation from the corporation in the aggregate*69 amounts of $ 664,880.07 each.
Toward the close of World War II, it became apparent that the corporation was not prepared for the production of non-military products and that, in connection with its conversion to peacetime production, it needed a large amount of additional working capital. Petitioners realized this but they were determined at that time to have no "outsiders" as stockholders of the corporation. They, therefore, decided to permit their employees, whom they considered and called "associates," to subscribe to class A stock. Accordingly, in June 1944, the corporation accepted subscriptions from such "associates" for 150,000 shares of its class A stock at an issue price of $ 100 per share. This stock was deposited in a voting trust, together with the common stock owned by Jack and Heintz themselves. The voting trustees were Jack, Heintz, and Jack's son, William R. Jack.
In 1945, petitioners became apprehensive about their ability to successfully convert the corporation's activities to peacetime production. Substantially all of its contracts had been terminated following the cessation of hostilities with Japan. Furthermore, Jack's health had badly deteriorated. They*70 decided to sell their stock in Jack & Heintz, Inc., and, upon making this decision, they caused the corporation to offer to repurchase all class A stock owned by the "associates." Over $ 10,000,000 had been paid to the corporation for its class A stock and, by March 4, 1946, all but 2,792 shares of such stock were repurchased.
Petitioners instructed one of their agents to attempt to sell their stock in Jack & Heintz, Inc., for $ 10,000,000 in cash. After fruitless negotiations with several prospective purchasers, this agent discussed an $ 8,000,000 cash deal with one B. C. Milner, Jr. (hereinafter referred to as Milner), an industrial consultant, promoter, and investor. However, Milner found that he was unable to raise $ 8,000,000 in cash and, on January 12, 1946, he submitted the following written offer to petitioners:
I offer to purchase all the issued and outstanding Common Stock of Jack & Heintz, Inc. for $ 8,000,000., payable $ 5,500,000. in cash, and $ 2,500,000. in Preferred Stock, carrying 4% cumulative dividends, redeemable to par, and having such other customary privileges and rights as will be satisfactory to you.
Petitioners negotiated without success in an attempt*71 to obtain $ 8,000,000 in cash for their stock. On January 19, 1946, they accepted Milner's offer after receiving an oral promise both from him and a representative of Harriman Ripley & Co., Inc., one of Milner's associates, *135 that the preferred stock which they were to receive in the corporation to be organized by the purchasing group would carry the same provisions as additional preferred stock to be issued by the new corporation in a public offering; and that their shares of preferred stock would be disposed of in the public offering at which the new corporation's shares would be sold. Petitioners were assured that this public issue would be on the market within 30 days and they regarded the preferred stock which they were to receive as a 30-day deferred payment.
The members of the purchasing group which had been organized by Milner caused Precision Products Corporation (hereinafter referred to as Precision) to be incorporated under Delaware law on February 26, 1946. That corporation had an authorized capital of 1,500,000 common shares having a par value of $ 5 each and 250,000 cumulative 4 per cent convertible preferred shares having a par value of $ 50 each. At the*72 corporation's first directors' meeting, held on February 27, 1946, subscriptions were accepted for 180,000 common shares at $ 10 per share from members and associates of the purchasing group. The purchase of petitioners' stock in Jack & Heintz, Inc., was then authorized. The purchasing group planned that the cash part of the consideration to be paid to petitioners for their Jack & Heintz, Inc., stock would be provided by the $ 1,800,000 proceeds of the original stock subscription and a $ 3,250,000 demand loan to be obtained from The National City Bank of New York. It was also planned that Jack & Heintz, Inc., would be immediately merged into Precision and that the demand loan would then be repaid from the proceeds of the sale of $ 10,000,000 in Government bonds owned by Jack & Heintz, Inc. These bonds were held by Jack & Heintz, Inc., as a reserve for tax and renegotiation liabilities. *73 When petitioners were informed of the contemplated merger, they raised the objection that this would have the effect of cutting short the corporate life of Jack & Heintz, Inc., and therefore limit the carryback of net operating losses suffered during the reconversion period to those losses experienced up to the date of the merger. However, petitioners were assured by the purchasing group that Jack & Heintz, Inc., would derive compensating tax advantages from the merger. Subsequently, in a registration statement filed with the S. E. C., Precision stated that, in addition to tax advantages, the merger would permit the reclassification of the capital stock of Jack & Heintz, Inc., and the simplification of that corporation's regulations and procedure.
*136 Petitioners agreed to take the steps necessary to prepare Jack & Heintz, Inc., for the merger into the purchasing corporation. At the request of counsel for the purchasing group, minutes relating a meeting of the board of directors of Jack & Heintz, Inc., on March 1, 1946, were drafted. These minutes, signed by petitioners, recite that "negotiations are in progress regarding the merger of the company with Precision" and that*74 Precision had indicated that it would not enter into the merger unless the profit-sharing plan of Jack & Heintz, Inc., was amended. The minutes contain a resolution amending the profit-sharing plan "in order to obtain the consent of Precision" to the merger, but it was further provided that such amendment was not to be effective unless the merger was consummated.
A 35-page printed draft of the agreement to merge Jack & Heintz, Inc., into Precision, entitled "Agreement of Merger" and bearing the date March 5, 1946, was prepared and submitted to the board of directors of each company. This draft was adopted and ratified by Precision on February 27, 1946, and by Jack & Heintz, Inc., on March 2, 1946. The minutes of the board of directors of Jack & Heintz, Inc., for March 2, 1946, also drafted at the direction and pursuant to the suggestions of counsel for the purchasing group, state that:
the Directors deem it desirable for the best interests of this Corporation * * * that this Corporation be merged into said Precision Products Corporation, a Delaware corporation, pursuant to and upon the terms and conditions of said Agreement of Merger;
Now Therefore, be it
Resolved, that the above*75 described Agreement of Merger be, and it is hereby approved, adopted and consented to; and be it
* * * *
Further Resolved, that the officers of this Corporation be, and they hereby are, authorized to do and perform any and all acts and to execute and deliver any and all other instruments that may be required, permitted or convenient in connection with carrying out said Agreement of Merger pursuant to the terms and conditions thereof
On March 4, 1946, petitioners signed an agreement with Precision for the sale to that corporation of their stock in Jack & Heintz, Inc. Said agreement was signed by Milner, acting on behalf of Precision, and stated that it superseded the original agreement which petitioners had made with him.
The agreement commenced with the following declaration:
This Memorandum of Agreement relates to the acquisition by PRECISION PRODUCTS CORPORATION, a new Delaware corporation * * * of the Common Stock of Jack & Heintz, Inc., the merger of Jack & Heintz, Inc. into the Delaware Corporation, * * * and the ultimate merger of Eisemann Corporation into the Delaware Corporation.
It provided that petitioners were to sell their 50,000 shares of common stock in Jack & Heintz, *76 Inc., to Precision for $ 5,000,000 in cash and *137 60,000 shares of Precision's preferred stock, having a $ 50 par value and convertible into common stock of Precision. It was further provided that the consideration payable to the petitioners was subject to later adjustment pending the favorable or adverse financial effect of certain war contracts renegotiation proceedings to which Jack & Heintz, Inc., was a party. To this end, "part of the purchase price of the 50,000 shares of Common Stock sold by Jack & Heintz," namely, 10,000 shares ($ 500,000 par value) of the preferred stock of Precision, were to be held in escrow. To the extent that the result of the renegotiation proceedings was adverse (as defined) the number of escrowed shares released to the petitioners would be less than 10,000. To the extent that the result was more favorable than anticipated, petitioners were to receive the 10,000 escrowed shares plus additional cash. The agreement stated that said "Preferred Stock will be substantially the same as that which it is expected will shortly be offered to the public by underwriters." No provision appears in the agreement to implement the oral promise of Milner *77 and the representative of Harriman Ripley & Co., Inc., that petitioners' preferred stock in Precision would be sold together with the public offering.
The agreement required that both petitioners accept employment with Precision for a period of 5 years at an annual salary of $ 40,000 each, Jack as chairman of the board and Heintz as an operational vice president. Both men were also to be directors of Precision.
It was further provided that Precision had the right to terminate the entire agreement on the closing date, March 5, 1946, if the approval of the Treasury Department to the changes in the Jack & Heintz, Inc., profit-sharing plan had not been secured. The approval of the Treasury Department was obtained prior to such date.
*79 On the following day, March 5, 1946, a formal closing was held at which all the essential provisions of the March 4 agreement between petitioners and Precision were carried out. The first order of business was the exchange of petitioners' common stock in Jack & Heintz, Inc., for cash and preferred stock in Precision. Petitioners each gave written representations to Precision that its preferred stock was being acquired by them for investment and not for distribution. Such representations were given in order to comply with S. E. C. regulations and, on the advice of petitioners' counsel, that the stock could subsequently be sold at the public offering without violating such regulations. Following this, various other documents were signed and delivered relating to the escrow arrangement for 10,000 shares of petitioners' preferred stock in Precision, the amendment of the Jack & Heintz, Inc., profit-sharing plan, and petitioners' employment contracts with Precision.
There were then delivered by the petitioners to the representatives of Precision various documents proving that Jack & Heintz, Inc., had adopted and approved the terms of the merger with Precision as set forth in the printed*80 document entitled "Agreement of Merger" and that the voting trustees for all the stock of Jack & Heintz, Inc., had also consented to the merger. The Agreement of Merger was then executed and signed by petitioners, by two other members of the board of directors of Jack & Heintz, Inc., and by the representatives of Precision. Immediately thereafter, petitioners delivered a document terminating the voting trust arrangement under which that stock had previously been held. All business at the closing was transacted uninterruptedly from beginning to end.
The terms of the March 5 "Agreement of Merger" were carried out on March 6, 1946, Precision merging its newly acquired subsidiary, Jack & Heintz, Inc., into itself pursuant to Delaware statutes. The surviving corporation, Precision Products Corporation, then changed its name to Jack & Heintz Precision Industries, Inc. (the surviving corporation will continue to be hereinafter referred to as Precision). On March 20, 1946, petitioners' certificates of preferred stock in Precision, including those held for them in escrow, were canceled and exchanged for new certificates in like amounts, bearing the name Jack & Heintz Precision Industries, *81 Inc. Each share of such *139 preferred stock was convertible prior to April 1, 1956, into 2 common shares of the same corporation.
During the period March 12 to June 15, 1946, Precision sold the $ 10,000,000 Government bonds, which it had acquired in the merger with Jack & Heintz, Inc., at an aggregate price of $ 10,546,884.35. Part of the proceeds so realized was used to repay the $ 3,250,000 bank loan, which together with the $ 1,800,000 proceeds of the common stock subscriptions, had furnished the $ 5,000,000 cash payment to petitioners.
On April 18, 1946, the Eisemann Corporation was merged into Precision, the latter company issuing 120,000 shares of its common stock to the stockholders and certain creditors of the Eisemann Corporation.
A public issue of the common stock of Precision was sold and on July 25, 1946, Precision received $ 8,525,000 therefor from the underwriters. However, due to unanticipated delays, Precision had not filed its preliminary registration statement with the S. E. C. until May 31, 1946. By that time, the market for new issues of preferred stock had deteriorated and, because of the underwriter's reluctance to offer Precision's preferred shares*82 concurrently with its common stock, the preliminary registration statement indicated that only 20,000 of the petitioners' preferred shares were being offered in the public sale. Prior to the approval of the final registration statement on July 19, 1946, the market for preferred shares deteriorated still further and, at the underwriter's insistence, no preferred stock of Precision was included in the public offering either on behalf of petitioners or Precision. Pursuant to the promises given petitioners by Milner and Harriman Ripley & Co., Inc., the purchasing group arranged for the private sale during the next month of the 50,000 shares of $ 50 par value preferred stock in Precision which were then held by petitioners. These shares had a fair market value of $ 50 each when acquired by petitioners on March 5, 1946. They were sold by petitioners to three or four individuals at approximately $ 30 per share on August 30, 1946. In addition, petitioners gave an option to some of such purchasers to purchase the 10,000 shares of preferred stock then held in escrow when and if such shares were released to them.
On August 30, 1946, after the private sales by petitioners of their 50,000*83 shares of preferred stock in Precision, the outstanding stock of that company consisted of 850,000 common shares and 69,772 preferred shares. Petitioners possessed at that time a contingent interest in 10,000 preferred shares held in escrow. On September 26, 1947, petitioners received out of escrow the 10,000 shares of preferred stock previously held there pending the resolution of certain contingencies, plus a total of $ 157,404.33 in cash. Such shares had a fair *140 market value of $ 27.50 each when delivered to petitioners. The receipt of such cash and stock was the final consideration given by Precision to petitioners for their stock in Jack & Heintz, Inc. The options previously given by petitioners with respect to the purchase of the escrowed shares were not exercised and petitioners sold such shares in 1949 and 1950 at prices ranging from $ 12.50 to $ 40 per share.
On their returns for 1946, petitioners reported that they had realized long-term capital gains on March 5, 1946, on the disposition of their stock in Jack & Heintz, Inc. Such gains were computed by determining the excess of the $ 7,500,000 ($ 5,000,000 cash plus the $ 2,500,000 fair market value of the*84 50,000 preferred shares in Precision) which petitioners had received over the basis for their Jack & Heintz, Inc., stock. They also reported on these returns the realization of short-term capital losses on August 30, 1946, arising out of the sales of the 50,000 shares of preferred stock in Precision for approximately $ 1,500,000. Petitioners reported on their 1947 returns that they had realized additional long-term capital gains, aggregating $ 432,404.33, from the March 5 disposition of their Jack & Heintz, Inc., stock by reason of the release to them on September 26, 1947, of the 10,000 shares of preferred stock in Precision previously held in escrow plus the additional payment of $ 157,404.33 in cash.
Respondent determined that petitioners' exchange of their stock in Jack & Heintz, Inc., for cash plus preferred stock in Precision constituted a statutory reorganization under
OPINION.
The tax consequences of this transaction, or series of transactions, depend upon whether they are characterized as a sale or as a "reorganization." Petitioners contend that we must regard the sequence of events as initially comprising two completely independent transactions. The first would be the sale of their stock in Jack & Heintz, Inc., for cash plus securities of the purchasing corporation, a transaction fully taxable at capital gains rates. The second transaction, in petitioners' view, was the statutory merger of Precision's 1-day-old operating subsidiary, Jack & Heintz, Inc., *141 into itself. Petitioners argue that although this merger may satisfy the formal requirements of *88 The basic facts herein are that petitioners, after unsuccessfully attempting to sell their stock in Jack & Heintz, Inc., in an all cash deal, finally settled for approximately $ 5,000,000 in cash plus 60,000 shares of preferred stock in the corporation which was organized by the purchasing group to make the purchase. Essential to this arrangement was the promise made to petitioners by members of the purchasing group that the preferred stock being paid to petitioners as part of the consideration would shortly thereafter be sold on their behalf *142 together with a public offering of the purchasing corporation's own preferred stock. Pursuant to the plan conceived by the purchasing group, petitioners caused their corporation to amend its profit-sharing plan and had its board of directors give its approval to the purchasing group's plan to merge Jack & Heintz, Inc., into Precision. On the day following the exchange of petitioners' stock in Jack & Heintz, Inc., for cash plus stock in Precision, the former company was merged into the latter. Then, according to the original plan, still another corporation was merged into Precision. This was followed by a public offering of Precision's*89 common stock through which Precision obtained $ 8,525,000 of additional capital. However, due to the underwriter's insistence that the market for preferred stock was too weak at that time, the promoters of Precision were unable to fulfill their oral promise to petitioners that petitioners' preferred shares in Precision would be included at public offering. Private sales were, therefore, arranged by the promoters of Precision and, on August 30, 1946, petitioners sold all their preferred shares in Precision, except the 10,000 then held in escrow. We think it clear that petitioners did not dispose of their stock in Jack & Heintz, Inc., pursuant to a "plan of reorganization." The term "reorganization," as used in *92 It does not help us to characterize the March 5 transaction as an "exchange" rather than as a sale for, in a technical sense, every sale may be referred to as an exchange. The essential element which must be shown if this transaction is to be termed a statutory reorganization is that the exchange took place "pursuant to a plan of reorganization" as that phrase is used in
1. The balance sheet of Jack & Heintz, Inc., as of March 6, 1946, included the following amounts among the current liabilities:
| Provision for renegotiation refunds | $ 6,749,564.81 |
| Provision for Federal taxes on income | 8,060,666.94 |
2. The March 4 agreement was signed by Jack's son, William R. Jack, in his capacity as voting trustee.↩
3.
(g) Definition of Reorganization. -- As used in this section (other than subsection (b) (10) and subsection (1)) and in (1) The term "reorganization" means (A) a statutory merger or consolidation. * * *↩
4.
(b) Exchanges Solely in Kind. -- * * * * (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.↩
5.
(c) Gain From Exchanges Not Solely in Kind. -- (1) If an exchange would be within the provisions of subsection (b) (1), (2), (3), or (5), or within the provisions of subsection (1), 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 or by subsection (1) to be received without 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. (2) If a distribution made in pursuance of a plan of reorganization is within the provisions of paragraph (1) of this subsection but has the effect of the distribution of a taxable dividend, then there shall be taxed as a dividend to each distributee such an amount of the gain recognized under paragraph (1) as is not in excess of his ratable share of the undistributed earnings and profits of the corporation accumulated after February 28, 1913. The remainder, if any, of the gain recognized under paragraph (1) shall be taxed as a gain from the exchange of property.↩
6. Regulations 111.
Sec. 29.112 (g)-1. Purpose and Scope of Exception of Reorganization Exchanges. --