North Jersey Quarry Co. v. Commissioner

North Jersey Quarry Co., Petitioner, v. Commissioner of Internal Revenue, Respondent North Jersey Quarry Co. v. Commissioner Docket No. 16182 United States Tax Court 13 T.C. 194; 1949 U.S. Tax Ct. LEXIS 111; August 11, 1949, Promulgated *111 Decision will be entered under Rule 50. 1. In computing equity invested capital for excess profits tax purposes, basis of property received by petitioner in 1930 liquidation of wholly owned subsidiary with which petitioner had filed a consolidated return held determinable under Internal Revenue Code, Supplement C. 2. Stock of subsidiary held to have a "cost basis" under Supplement C (Regulations 112, sec. 35.761-3), arrived at in part by valuation of petitioner's stock given in exchange when subsidiary's stock was acquired. Benjamin Harrow, C. P. A., for*112 the petitioner. Francis X. Gallagher, Esq., for the respondent. Opper, Judge. OPPER *194 This proceeding was brought for a redetermination of a deficiency of $ 41,302.26 in excess profits tax for 1942. The sole contested issue is the proper basis, for equity invested capital purposes, of property received in December 1930 by petitioner from a wholly owned subsidiary. The parties filed a stipulation of facts and evidence was adduced at the hearing. Those facts hereinafter appearing which are not from the stipulation are otherwise found from the record. FINDINGS OF FACT. The stipulated facts are hereby found accordingly. Petitioner, a New Jersey corporation organized in May 1904, has its principal office in Morristown, New Jersey. It filed its Federal income and excess profits tax return for 1942 with the collector of internal revenue for the fifth district of New Jersey. On or about May 23, 1895, a corporation known as Morris County Crushed Stone Co. was formed under the laws of the State of New Jersey. It was legally dissolved on or about December 30, 1930. On or about December 30, 1930, a new corporation known as Morris County Crushed Stone Co., hereinafter called*113 the "new company," was formed under the laws of the State of New Jersey. That corporation is still in existence. It is one of the group of subsidiaries of petitioner which it listed in its return for the period in question. *195 Prior to December 29, 1930, petitioner acquired 2,680 shares of stock of the old Morris County Crushed Stone Co. at an aggregate cost of $ 109,000. The following schedule shows the details of petitioner's acquisition of those shares: Payments Shares January 4, 1911: Petitioner purchased 100 shares of Morris County Crushed Stone Co. stock from F. W. Schmidt. This was paid for by issuing 200 shares of preferred stock of petitioner at $ 200 per share $ 20,000 [100] June 1912: Morris County Crushed Stone Co. declared a dividend payable in stock of petitioner. Petitioner received $ 10,000 of its own stock and reduced its investment in the Morris County Crushed Stone Co. by that amount. Deduct 10,000 December 31, 1916: Morris County Crushed Stone Co. owed petitioner $ 15,000 on account of royalties and paid this indebtedness by issuing its stock at par to petitioner 15,000 [150] December 1919: Petitioner purchased 250 shares of Morris County Crushed Stone Co. stock at $ 200 per share. This was paid as follows: Cash in the amount of $ 25,283.13, cancellation of indebtedness for royalties, $ 24,716.87 50,000 [250] December 1920: Petitioner purchased 150 shares of Morris County Crushed Stone Co. stock at $ 200 per share. This was paid as follows: $ 21,500 in cash and $ 8,500 by cancellation of indebtedness for royalties 30,000 [150] April 30, 1922: Petitioner purchased 20 shares of Morris County Crushed Stone Co. stock from Margaret Upton at $ 200 per share for cash 4,000 [20] February 8, 1928: On this date Morris County Crushed Stone Co. issued a stock dividend of 3 shares of its stock for each share held by its stockholders. Petitioner thus received 2,010 shares 2,010 Total 109,000 2,680 *114 This acquisition constituted 67 per cent of the 4,000 shares of the stock of Morris County Crushed Stone Co. then outstanding. Its stock was all of one class. On December 29, 1930, petitioner acquired all of the then remaining outstanding stock of the old Morris County Crushed Stone Co., consisting of 1,320 shares. In consideration of the acquisition of the 1,320 shares petitioner issued 2,640 shares of petitioner's theretofore unissued stock to the holders of the 1,320 shares of the capital stock of the old Morris County Crushed Stone Co. Stockholders of petitioner immediately prior to the acquisition of the 1,320 shares in the Morris County Crushed Stone Co. were as follows: Stockholder Shares held William H. Haelig [10] F. W. Schmidt, Inc 3,460 Julia L. Haelig [720] I. W. Wortman [675] Lucy Upton [277] National Iron Bank, trustee (Mrs. E. L. Schmidt) [240] Eleanor S. Upton [234] F. W. Schmidt [177] John H. Schmidt [176] Louise M. Wortman [132] C. W. Toye [69] N. Arrowsmith [66] L. C. Bonnell [44] Estate of F. W. Schmidt [25] Lottie F. Jones [25] Margaret Hoffman [10] Sarah J. Voorhees [10] Nancy R. King [10] Charles V. Higgins [10] William H. Spencer [10] William H. Hosking [10] Elsie L. Thompson [10] Total 6,400 *115 *196 Stockholders of the Morris County Crushed Stone Co. immediately prior to the acquisition of the 1,320 shares by petitioner were as follows: Shares held North Jersey Quarry Co. [petitioner] 2,680 Estate of F. W. Schmidt [620] I. W. Wortman [600] N. Arrowsmith [60] F. W. Schmidt [20] John H. Schmidt [20] Total 4,000 Stockholders of petitioner after the acquisition of 1,320 shares in the Morris County Crushed Stone Co. were as follows: Stockholder Shares held F. W. Schmidt, Inc 3,460 Julia L. Haelig [720] I. W. Wortman 1,875 Lucy Upton [277] National Iron Bank, trustee (Mrs. E. L. Schmidt) [240] Eleanor S. Upton [234] F. W. Schmidt [217] John H. Schmidt [216] Louise M. Wortman [132] C. W. Toye [69] N. Arrowsmith [186] L. C. Bonnell [44] Estate of F. W. Schmidt 1,265 Lottie F. Jones [25] Margaret Hoffman [10] Sarah J. Voorhees [10] Nancy R. King [10] William H. Haelig [10] Charles V. Higgins [10] Charles C. Spencer [10] William H. Hosking [10] Elsie L. Thompson [10] Total 9,040 On December 30, 1930, the net assets of the old Morris County Crushed Stone Co. were transferred to petitioner and on December 31, 1930, at a special meeting of the board of directors*116 of the old Morris County Crushed Stone Co., it was resolved that: * * * upon the surrender and delivery to this company by the holders of the 4,000 shares of capital stock of this company now issued and outstanding, the company convey to North Jersey Quarry Co., the actual owner of said 4,000 shares of stock, all of the assets, real and personal, of the company, subject to all of the liabilities of this company, the payment of which said liabilities are [sic] to be assumed by said North Jersey Quarry Co. And it further resolved that "this Morris County Crushed Stone Company thereupon be dissolved." As of the date of acquisition of at least 80 per cent of the stock of the Morris County Crushed Stone Co. by petitioner (December 29, 1930) and as at the date of liquidation (December 30, 1930), the balance sheet of the old Morris County Crushed Stone Co. appeared as follows: Assets Cash $ 215,810.13 Accounts receivable 43,836.49 Bills receivable 6,600.00 Inventory 65,248.47 Depreciable assets (net) 242,989.96 Total 574,485.05 Liabilities and capital Capital stock $ 400,000.00 Surplus 174,485.05 Total 574,485.05 *197 Petitioner's excess*117 profits tax return for 1942 was a consolidated excess profits tax return filed by petitioner as common parent corporation of an affiliated group. The consolidated average invested capital, exclusive of consolidated accumulated earnings and profits as disclosed by the return, was $ 2,428,341.89 and included petitioner's claimed value of the assets acquired from the old Morris County Crushed Stone Co. referred to above at the amount of $ 769,000, which petitioner claims represented the total amount of petitioner's investment in the old Morris County Crushed Stone Co. immediately prior to the transfer. Upon audit of petitioner's excess profits tax return for 1942, respondent determined that petitioner's invested capital should be reduced by a net adjustment of $ 208,205.34, which included a reduction of the assets acquired from the old Morris County Crushed Stone Co. of $ 194,514.95 constituting the difference between $ 769,000, the balance claimed in petitioner's investment account referred to above, and $ 574,485.05, the book value of the net assets of the old Morris County Crushed Stone Co. as above set forth. Between September 3, 1926, and November 2, 1929, there were three changes*118 in petitioner's capital structure. In 1929 the 1,000 shares of preferred stock then outstanding were converted into the same number of shares of common stock. About the same time the stockholders were given the right to subscribe to additional common stock and accordingly subscribed to 1,000 shares. In August 1929, after the two above mentioned increases in the common stock had taken place, the company purchased certain properties for $ 95,000 and issued 400 shares of common stock in payment therefor. The value thus placed on these 400 shares was equivalent to $ 237.50 per share. The difference between the purchase price of $ 95,000 and the total par value of the stock issued of $ 40,000 was credited to capital surplus. There were no changes in the capital structure of the company between November 2, 1929, and December 29, 1930. On March 13, 1931, petitioner filed a consolidated corporation income tax return for the year 1930 for itself and six affiliated companies, among the latter being the old Morris County Crushed Stone Co. which filed the necessary consent to the filing of the consolidated return. In his report dated December 22, 1932, the internal revenue agent eliminated*119 the Morris County Crushed Stone Co. from the consolidation, on the ground that it was not affiliated, and he made a separate report covering its operations. A valuation of $ 293 a share was placed upon petitioner's stock for estate tax purposes on September 3, 1926, on the death of Frederick W. Schmidt. *198 A valuation of $ 331 a share was placed upon petitioner's stock by respondent for estate tax purposes on November 2, 1929, on the death of Margaret Upton. When Morris County Crushed Stone Co. was liquidated, all of its assets were distributed to petitioner. Petitioner retained the plant and plant equipment. The new company was organized, to which rolling stock, including steamshovels, locomotive cranes, and trucks, were sold back at the same figure at which the old company had carried them on their books. The value of petitioner's stock at the time of the transaction in question was $ 200 per share. OPINION. Although asserting that its excess profits credit based on invested capital should be computed under the general provisions of section 718 of the code, rather than the limited terms of section 761, petitioner nevertheless contends that even under the latter section *120 its tax was correctly arrived at and the deficiency is unwarranted. We are compelled to consider both contentions. Section 761 is in terms designed to apply to "an intercorporate liquidation." The effort is reasonably manifest to reach such liquidations only if they were tax-free, 1 but word for word the statutory language applies here. There was "an intercorporate liquidation" because petitioner was in "receipt * * * of property in complete liquidation of another corporation * * * to which * * * a provision of law * * * [was] applicable prescribing the nonrecognition of gain or loss in whole or in part upon such receipt (including a provision of the regulations applicable to a consolidated income * * * tax return * * *)." 2 *121 As petitioner points out, no statutory counterpart of section 112 (b) (6) appears in the applicable 1928 Act. But petitioner could and did file with its subsidiary a consolidated return for the period including *199 the transfer, and this it was entitled to do at its option. Revenue Act of 1928, sec. 141; Regulations 75, art. 13 (f). No revenue agent or other administrative officer could deprive the two corporations of that right. Radiant Glass Co. v. Burnet (App. D. C.), 54 Fed. (2d) 718, affirming 16 B. T. A. 610. And once the consolidated return issue is settled, the remainder of the prerequisites of section 761 is supplied by the regulations then in effect denying the recognition of gain or loss in such an "intercompany transaction" 3*122 and by the provisions of section 141 (a), supra, constituting the filing of a consolidated return a consent to their acceptance by the taxpayers. See Charles Ilfeld Co. v. Hernandez, 292 U.S. 62. The applicability of section 761 thus seems to us inescapable. Sec. 718 (d). 4 The second phase of the controversy reduces in effect to the meaning of the phrase in section 761 (c) "a basis determined to be a cost basis" and its applicability to the assets acquired by petitioner. 5 The terms "cost basis" and "basis other than cost" are not defined in section 761, which is too extensive to set out here at length. But the legislative scheme appears to be to treat in separate classes the taxpayer's assets acquired through the ownership of shares for which its basis would be represented by what was paid for them, as opposed to other shares for which there would be an inherited, attributed, or substituted basis, typically one computed by reference to that of a transferor. See Maloney "Supplement C," 2 Tax Law Review 231 (Dec. 1946). On that approach there would seem no adequate reason for denying in this instance a "cost basis." *123 The omission in the statute is, moreover, supplied by the regulations. We note first that both subdivisions (1) and (2) of 761 (c) speak in terms of what is "determined" to be the basis. And section 761 (g), entitled "Determinations," provides for "Any determination which is *200 required to be made under this section" to be "made in accordance with regulations * * *." Regulations 112, section 35.761-3, deal with the present issue. They provide: * * * Cost Basis or Basis Other Than Cost. -- (a) Cost Basis. -- In all cases other than those in which the basis of stock is determined to be a basis other than cost under (b) or (c) of this section, the basis of stock shall be determined to be a cost basis. (b) Basis Other Than Cost. -- Stock in any corporation shall be determined to have a basis other than cost if, as a result of the transaction in which such stock was acquired -- (1) The basis of such stock is fixed by reference to the basis of other property previously held by the acquiring corporation * * * or (2) The basis of such stock is fixed by reference to its basis in the hands of a preceding owner * * *. (c) Statutory Merger Or Consolidation*124 * * *. The stipulation recites that, as to 2,680 shares of the transferor, petitioner's "aggregate cost" was $ 109,000. These shares clearly fall outside the exceptions described in the foregoing quotation. The remaining shares were acquired in exchange for petitioner's unissued stock. As to these, their cost would be arrived at by reference to petitioner's shares -- Estate of Isadore L. Myers, 1 T. C. 100 -- not either "by reference to the basis of other property previously held" by petitioner nor "by reference to its basis in the hands of a preceding owner." The general rule is consequently applicable that "the basis of stock shall be determined to be a cost basis." We can not, however, subscribe to the valuation placed by petitioner upon its shares for the purpose of arriving at cost. Granting that book values can be employed in the absence of more compelling evidence, B. F. Edwards, 39 B. T. A. 735, the best that can be made of this record is that prior to the transfer petitioner owned two-thirds of the stock of its transferor. All that it acquired by issuing 2,640 shares of its stock was the remaining one-third, *125 having a book value of only about $ 191,500. On the theory that value may, in the absence of better evidence, be gauged by what is received for stock, Estate of Isadore L. Myers, supra, this would put the figure at only $ 72 a share, which under all the circumstances appears to be too low. On the other hand, adding to the pre-transfer book value of petitioner's assets -- $ 1,637,317.28 -- the $ 191,500 of assets received, and dividing by the 9,040 shares then outstanding, results in a value for petitioner's shares of about $ 200. Bearing in mind that prior sales and valuations had been made before the advent of the depression of 1930, of which we may take notice -- Safe Deposit & Trust Co. of Baltimore, Executor, 35 B. T. A. 259, 263; affd. (C. C. A., 4th Cir.), 95 Fed. (2d) 806 -- this seems to us the most appropriate value to place on petitioner's stock, and we have so found. *201 Computations of petitioner's tax liability should be made by use of that figure multiplied by the 2,640 shares as the cost of one-third of the transferor's stock. For that purpose, Decision will be entered*126 under Rule 50. Footnotes 1. "SEC. 761. INVESTED CAPITAL ADJUSTMENT AT THE TIME OF TAX-FREE INTERCORPORATE LIQUIDATIONS."↩ 2. SEC. 761. * * * (a) Definition of Intercorporate Liquidation. -- As used in this section, the term "intercorporate liquidation" means the receipt (whether or not after December 31, 1941) by a corporation (hereinafter called the "transferee") of property in complete liquidation of another corporation (hereinafter called the "transferor") to which (1) the provisions of section 112 (b) (6), or the corresponding provision of a prior revenue law, is applicable or (2) a provision of law is applicable prescribing the non-recognition of gain or loss in whole or in part upon such receipt (including a provision of the regulations applicable to a consolidated income or excess profits tax return but not including section 112 (b) (7), (9), or (10) or a corresponding provision of a prior revenue law), but only if none of such property so received is a stock or a security in a corporation the stock or securities of which are specified in the law applicable to the receipt of such property as stock or securities permitted to be received (or which would be permitted to be received if they were the sole consideration) without the recognition of gain.↩ 3. Art. 37. [Regulations 75]. Dissolutions -- Recognition of Gain or Loss. (a) During Consolidated Return Period. Gain or loss shall not be recognized upon a distribution during a consolidated return period, by a member of an affiliated group to another member of such group, in cancellation or redemption of all or any portion of its stock; and any such distribution shall be considered an intercompany transaction.↩ 4. (d) For special rules affecting computation of property paid in for stock in connection with certain exchanges and liquidations, see Supplement C.↩ 5. SEC. 761. * * * * * * * (c) Rules for the Application of this section. -- (1) Stock having cost basis. -- The property received by a transferee in an intercorporate liquidation attributable to a share of stock having in the hands of the transferee a basis determined to be a cost basis, shall be considered to have, for the purposes of subsection (b), an adjusted basis at the time so received determined as follows: * * * * (2) Basis of stock not a cost basis. -- The property received by a transferee in an intercorporate liquidation attributable to a share of stock having in the hands of the transferee a basis determined to be a basis other than a cost basis shall, for the purposes of subsection (b), be considered to have, at the time of its receipt, the basis it would have had had the first sentence of section 113 (a) (15) been applicable.↩