Northern Coal & Dock Co. v. Commissioner

The Northern Coal & Dock Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. The Youghiogheny & Ohio Coal Company, Petitioner, v. Commissioner of Internal Revenue, Respondent Northern Coal & Dock Co. v. Commissioner Docket Nos. 12746, 12747 United States Tax Court 12 T.C. 42; 1949 U.S. Tax Ct. LEXIS 296; January 26, 1949, Promulgated *296 Decisions will be entered under Rule 50. Where insolvent, wholly owned subsidiary corporation transferred all its assets to its creditor parent for credit on its indebtedness, leaving an unpaid balance of indebtedness, held, that the provisions of section 112 (b) (6) of the Internal Revenue Code do not apply and that the subsidiary may claim a deductible loss on the assets transferred, provided that fair market value was given to transferred assets as a basis for credit on a genuine indebtedness. I. W. Sharp, Esq., for the petitioners. Clarence E. Price, Esq., for the respondent. LeMire, Judge. LeMIRE *42 The proceeding under Docket No. 12746 involves the liability of the Northern Coal & Dock Co., hereinafter called the petitioner, for income taxes and declared value excess profits taxes for the fiscal years ended April 30, 1943, 1944, and 1945, as follows: Tax [1945] Income tax $ 3,758.69 $ 2,189.42 $ 8,077.31 Declared value excess profits tax 832.38 *43 The proceeding under Docket No. 12747 involves the liability of the Youghiogheny & Ohio Coal Co., hereinafter called the Y & O, as transferee of the assets of the petitioner. It has been stipulated that the Y & O is liable for any deficiencies that may be finally determined to be due from the petitioner for the years*298 in question. The proceedings have been consolidated for hearing and decision. The petitioner alleges that the respondent erred as follows: (a) the disallowance of a deductible loss for the fiscal year ended April 30, 1945, in the amount of $ 102,028.21, resulting from the transfer of its dock properties to its parent company, the Y & O; (b) the disallowance of a deductible loss for the fiscal year ended April 30, 1945, in the amount of $ 1,633.68, from the transfer of certain equipment to its parent company, the Y & O; (c) the disallowance of a net operating loss for the fiscal year ended April 30, 1945, which may be carried back to the fiscal years ended April 30, 1943, and April 30, 1944. Most of the facts have been stipulated and the stipulation filed is incorporated herein by reference. FINDINGS OF FACT. The Northern Coal & Dock Co. and the Youghiogheny & Ohio Coal Co. are both corporations of the State of Ohio. The petitioner is a wholly owned subsidiary of the Y & O and both corporations have their principal offices and books of account in the same offices in Cleveland, Ohio. The petitioner's Federal tax returns for the fiscal years here involved were filed with the collector*299 of internal revenue for the eighteenth district of Ohio. All of the outstanding capital stock of the petitioner, in the amount of $ 1,000,000, divided into 10,000 shares of $ 100 each, at all times here material, was owned by the Y & O. The petitioner acted as a selling agent for the Y & O of coal produced from the mines of the Y & O and of coal procured by the Y & O from other sources, buying the coal at wholesale prices and distributing it in the area contiguous to its coal dock facilities at Superior and Milwaukee, Wisconsin. The petitioner derived its revenues from the sale of the coal at a profit above the prices paid the Y & O, plus its cost for freight and handling the coal through its facilities. The petitioner's balance sheet, as of November 30, 1944, showed total assets of approximately $ 2,382,000 and total liabilities of approximately *44 $ 2,554,000, or a deficit of approximately $ 172,000. 1 The current liabilities consisted of coal accounts payable to the Y & O of $ 955,539.68 and $ 63,669.89 payable to others. Petitioner was also indebted to the Y & O for $ 500,000 face amount of its debenture notes. These notes were issued in 1927 as a funding of a part of*300 the then existing open account indebtedness of petitioner to the Y & O. *301 On recommendation of the president of the Y & O, the board of directors, on December 19, 1944, resolved to take over the assets of petitioner. In so doing the Y & O made a formal demand on petitioner for payment of the debenture notes. On petitioner's failure to pay the notes according to their terms it was agreed that petitioner's assets be transferred to the Y & O for application on the indebtedness. Under the agreement the assets were applied first to the current indebtedness and then to the notes. *45 The assets were credited at their book values, except for certain dock properties and equipment. Although the book value carried on the dock properties was $ 1,226,207.52, the value placed on them by an independent appraisal on September 1, 1944, ordered by the Y & O was $ 299,800. The appraisal included all of the physical property and equipment located at the sites at the time the appraisal was made. The equipment items, on which the petitioner claims a separate loss of $ 1,633.68, were in use as a part of the dock equipment at that time and their value was included in the total appraisal value given to the properties. These dock properties were all applied against *302 the indebtedness at their appraised values. In its return the petitioner claimed a loss on the dock properties of $ 102,028.21, that amount being the difference between the appraised value and the agreed tax basis of $ 401,828.21. No separate credit was allowed for the equipment items. They had been charged to expense by petitioner and so had no book value. Respondent had required them to be capitalized and had allowed depreciation on them. The capitalized cost, less the depreciation, amounting to $ 1,633.68, is the tax basis of the equipment and the amount claimed as a separate loss in this proceeding. The fair market value of the dock properties, including the $ 1,633.68 of equipment last mentioned, was $ 299,800. Petitioner's assets included a large inventory of coal, which was credited against the indebtedness at its book value, amounting to $ 971,410. The petitioner bought its supplies of coal at wholesale prices similar to those paid by other wholesale customers of the Y & O, and carried the coal on its books at its wholesale cost, plus its freight and other handling costs. The book value of the coal was its fair market value for sale to a wholesaler of coal in a single*303 transaction at the location of the coal at that time of the year. All of petitioner's other assets were credited at their book value of $ 184,932.47, which respondent does not dispute as being their fair value. After credits were given for the transferred assets, a balance of $ 98,078.95 remained of petitioner's indebtedness to the Y & O. The Y & O charged this amount off as an uncollectible bad debt. After the transfer of all the assets of petitioner to the Y & O, the petitioner retained its corporate charter and its right to do business in Ohio, but gave up its rights to do business in Wisconsin and Minnesota, where its principal operations had previously been. Petitioner then had no assets and carried on no business activity, but did continue to carry the remaining indebtedness on its books as a liability. The officers and directors of petitioner, most of whom held similar positions with the Y & O, continued to hold their positions in both corporations. *46 The board of directors of the Y & O wrote off the stock the company held in petitioner as worthless, but continued to hold it and did not mark it canceled. The parties agree that $ 74.20 which was erroneously allowed*304 as a deduction for depreciation in the fiscal year ended April 30, 1945, should be included in petitioner's taxable income for that year. This adjustment will be made under Rule 50. OPINION. The principal issue in this case is whether the petitioner incurred deductible losses in the fiscal year ended April 30, 1945, on the transfer of its assets to its parent company for credit on its current and funded indebtedness to the parent at amounts less than the agreed tax bases at which the properties were carried by petitioner. The petitioner claims that the transfers amounted, in legal effect, to sales at less than cost basis to petitioner, adjusted for depreciation, on which the petitioner sustained deductible losses just as if it had sold the properties to a third party for cash. Respondent claims that the transfers were transfers "in liquidation" of the petitioner to the parent corporation on which no loss can be recognized under the provisions of section 112 (b) (6) of the Internal Revenue Code. Since the properties involved consist entirely of land and depreciable buildings and equipment, all used in the business of petitioner, the properties are not capital assets and any gain or*305 loss resulting from their sale or exchange would be recognized as ordinary gain or loss. Section 112 (b) (6) of the Internal Revenue Code provides that "No gain or loss shall be recognized upon the receipt by a corporation of property distributed in complete liquidation of another corporation." That section then states certain qualifications which must be met to bring the transfer within this provision. We are of the opinion that section 112 (b) (6) of the code does not apply to this case for the reason that it is applicable to the receipt of assets distributed in liquidation by a corporation and not to the transfer of them. This petitioner was the transferor of the assets involved and not the recipient thereof. Moreover, we are of the opinion that it does not apply for the reasons hereinafter discussed. The respondent argues that the transfer of petitioner's assets to the Y & O for credit on its indebtedness was not an arm's length transaction amounting to an actual sale or exchange. He claims that it was only a step in the plan of both corporations to wind up the affairs of an unprofitable subsidiary and to consolidate it with the parent corporation in the hope that operating*306 economies could be effected. The evidence is that the petitioner was hopelessly insolvent and had long been in default on the payment of its debentures and its current *47 indebtedness to the Y & O. In view of the circumstances, it seems a reasonable course of action for the directors of the Y & O to have decided to discontinue the operations of petitioner. The Y & O accepted the petitioner's inventories of coal at their book value, which consisted of the wholesale price paid to the Y & O, plus freight and handling cost. The respondent argues that the Y & O should have accepted the coal at a higher value than book value, stating that the coal could have been sold at a higher price than cost and that the profit from the sale of the coal would have at least partially made up the losses. However, the book value was the wholesale value of the coal in that amount at that time and place for the single wholesale disposition of the coal to a wholesaler of coal. The Y & O, itself a producer and wholesaler of coal, was not in the market for coal at a higher than wholesale price, which was the equivalent of the allowance given to the petitioner. The Y & O, as a creditor seeking to *307 collect the amount due it from an insolvent debtor, could not be required to allow the debtor more for coal than either the debtor or the creditor would have to pay for it elsewhere. Petitioner, as an insolvent debtor, was in no position to bargain for a profit upon its wholesale price from its wholesaler creditor. The respondent further argues that Y & O should have accepted the coal dock properties at petitioner's book value, instead of appraisal value, as it accepted the other assets of petitioner. We do not see that respondent has any grounds for complaint because these dock properties were transferred at appraisal, rather than at book value. The evidence is that the appraisal fairly represented the market value of the properties at the time of the transfer to the Y & O. We find no basis in the evidence for any doubt that the indebtedness of petitioner to the Y & O was genuine, nor is there any basis for doubt that the allowances made for all of the assets transferred were reasonable and represented their fair market value. Respondent's principal argument is that section 112 (b) (6) of the Internal Revenue Code controls this case. He argues that for all intents and purposes*308 the transaction here involved amounted to a winding up of the petitioner as a corporate entity and a complete liquidation within the meaning of section 112 (b) (6). The transaction did leave the petitioner with no assets, no income, and no business. For all practical purposes the petitioner was liquidated. The facts that the Y & O continued to hold the stock of the petitioner without formal cancellation and that there was no formal dissolution of petitioner as a corporation are not obstacles to the transfer being a distribution in liquidation. Frelmort Realty Corporation, 29 B. T. A. 181; Wilmington Steamboat Co. v. Sturgess, 52 Fed. (2d) 210; affd., 55 Fed. (2d) 831; Commissioner v. Court Holding Co., 324 U.S. 331. *48 Section 112 (a) of the code states the general rule for recognition of gain or loss when it provides that upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized except as thereinafter provided in the section. The exception in section 112 (b) (6), which respondent*309 is attempting to apply here, is effective only "upon the receipt by a corporation of property distributed in complete liquidation of another corporation" (emphasis supplied), provided that certain other qualifications are satisfied. Assuming that the respondent is correct in his argument that this transaction amounted in final effect to a liquidation of the petitioner, it is still necessary to decide whether the transfer of assets to the Y & O was a "distribution in liquidation," such as is meant by section 112 (b) 6. The term "distribution in liquidation" has been defined by the courts as a distribution of assets to stockholders in cancellation and redemption of the stock; that is, a return to them in whole or in part of their capital investment in the corporation. A distribution made to a creditor against an indebtedness does not come within the statute. H. G. Hill Stores, Inc., 44 B. T. A. 1182; Glenmore Distilleries Co., 47 B. T. A. 213; B. F. Sturtevant Co., 47 B. T. A. 464; Iron Fireman Manufacturing Co., 5 T. C. 452; Houston Natural Gas Corporation, 9 T. C. 570.*310 We said in the Houston Natural Gas Corporation case, supra, that: * * * a subsidiary's transfer of all assets to a creditor parent is first applicable to a discharge of its indebtedness to the parent, and it [the principle of the cited decisions] operates with equal force to require the recognition of any gain realized by the parent from a full collection of such indebtedness. It is the excess of the assets' value above indebtedness that constitutes a liquidating distribution * * * All of petitioner's assets were consumed by the indebtedness against which they were applied, leaving nothing for the Y & O to receive as a distribution on its stock. If here there had been a liquidating distribution of petitioner's assets to the Y & O, we would have a situation like that in J. T. S. Brown's Son Co., 10 T. C. 840, where we held that under the provisions of section 29.22 (a)-20, Regulations 111, no gain resulted to the distributor. However, as pointed out above, we are not dealing here with a liquidating distribution, but with a transfer of assets in satisfaction of an indebtedness. We conclude that the petitioner realized deductible losses on the*311 transfer of its assets to the Y & O in the amounts claimed. The determination of this issue controls the other issues in this case. Decisions will be entered under Rule 50. Footnotes 1. Joint exhibit 4-D. -- The Northern Coal & Dock Company balance sheet as at November 30, 1944, before transfer of assets and liabilities to the Youghiogheny & Ohio Coal Company and before adjustment of book values of dock properties to conform to appraised values: ↩ Assets Current Assets Cash on Hand and Deposit $ 21,676.36 Accounts Receivable -- Customers 138,152.06 Miscellaneous Accounts Receivable 725.00 Inventories -- Coal 971,410.00 Total Current Assets $ 1,131,963.42 Property, Plant & Equipment Superior Dock Property $ 1,806,241.51 Less: Depreciation 982,690.32 $ 823,551.19 Milwaukee Dock Property 663,441.05 Less: Depreciation 260,784.72 402,656.33 Nicolett Island Yard 14,913.99 Automobiles 9,330.64 Less: Depreciation 5,243.26 4,087.38 Office Furniture 500.00 Total Property, Plant & Equipment $ 1,245,708.89 Deferred 4,877.68 Total 2,382,549.99 Liabilities, Capital Stock & Surplus Current Liabilities Accounts Payable to The Youghiogheny & Ohio Coal Company $ 955,539.68 Accounts Payable to Others 63,669.89 Total Current Liabilities $ 1,019,209.57 Reserves Taxes $ 32,271.08 Deferred Income 2,740.77 35,011.85 Debenture Notes Payable 500,000.00 Capital Stock 1,000,000.00 Surplus -- Deficit (171,671.43) Total 2,382,549.99