Mountain Wholesale Co. v. Commissioner

Mountain Wholesale Co., Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent Mountain Wholesale Co. v. Commissioner Docket No. 9170 United States Tax Court 17 T.C. 870; 1951 U.S. Tax Ct. LEXIS 28; November 28, 1951, Promulgated *28 Decision will be entered for the respondent. 1. Petitioner was organized by the stockholders of a corporation which had been unsuccessful and was in liquidation. This latter corporation possessed a piece of improved real estate and certain old and uncollectible accounts receivable. Petitioner acquired this property, the improved real estate, at a stated figure equal to its depreciated cost to the former owner and the uncollectible assets at a stated consideration of 100 cents on the dollar. The value of the property acquired was manifestly far less than the consideration entered upon petitioner's books. The former owner of this property not being in operation had no income against which to charge off the accounts as bad debts or a loss resulting from a sale of the improved real estate. It is found petitioner's purpose in acquiring this property at the consideration stated was, in addition to securing the property, to obtain a deduction against income resulting from its operations, and it is held that under such circumstances its cost for determining loss upon sale of the improved real estate and upon charge-off of the worthless accounts was the fair market value of the*29 property at the time acquired and not its stated cost to the petitioner. 2. No evidence having been introduced to show the delinquent filing of its returns for 1942 by the petitioner to have been due to reasonable cause and not to negligence, the imposition of a delinquency penalty by respondent is approved. Geo. E. H. Goodner, Esq., and Scott P. Crampton, Esq., for the petitioner. Lester M. Ponder, Esq., and Roy A. Wentz, Esq., for the respondent. Leech, Judge. LEECH *871 Respondent has asserted deficiencies in income and excess profits taxes for the taxable year ended September 30, 1942, and the taxable period ended April 30, 1943, and penalties for the taxable year ended September 30, 1942, as follows: Period Tax Deficiency Penalty Income tax $ 1,672.17 $ 83.60 Year ended Sept. 30, 1942 Excess profits tax 3,259.38 162.97 Income tax 5.20 None Period Oct. 1, 1942 to Apr. 30, 1943 Excess profits tax 1,836.25 None The contested errors assigned are: (a) Did petitioner sustain a loss in the claimed amount of $ 15,524.92 upon the sale of real property in the taxable year ended September 30, 1942, or in the amount of $ 6,714.95, as determined*30 by the respondent? (b) Is petitioner entitled to deduct the claimed amounts of $ 1,665.64 and $ 2,286.21 as bad debts for the taxable year ended September 30, 1942, and the taxable period ended April 30, 1943, respectively? And, in the alternative, is petitioner entitled to deduct the total of these claimed amounts as a loss for the taxable period ended April 30, 1943? (c) Is a penalty of 5 per cent, in addition to deficiencies in income and excess profits taxes, due from petitioner for the taxable year ended September 30, 1942? Other issues raised by the petition were abandoned by petitioner at the hearing. FINDINGS OF FACT. The petitioner is a Kentucky corporation organized on February 9, 1939, and dissolved on April 30, 1943. Under the laws of Kentucky it retains its legal corporate existence for the winding up of its affairs. Petitioner was organized to carry on a wholesale grocery business at Lothair, Kentucky, and its income and excess profits tax returns for the periods here in question were filed with the collector of internal revenue for the district of Kentucky. The Appalachia Grocery Co., Inc., (hereinafter referred to as "A") *872 was incorporated on June 16, 1926, *31 under the laws of the State of Virginia, with its principal place of business at Appalachia, Virginia, for the purpose of conducting a wholesale grocery business. Appalachia, Virginia, is a small town with a population of about 3,500. In 1927 "A" constructed a concrete and brick warehouse building for use in its business. This building was two stories high, with a railroad siding in the rear and fronting on the highway going into Appalachia, Virginia. It was designed and constructed exclusively for use as a warehouse building and could not be used in a retail business because of its size, location and construction. Prior to 1939 the stockholders and directors of "A" realized that the business could not be profitably operated, due to local competition. Its main competitor in the wholesale grocery business was owned by a coal mining corporation which in turn controlled the retail outlets in the territory available to "A." It was thereupon decided to cease business and liquidate the affairs of "A" and secure another location for the carrying on of a wholesale grocery business. The individuals owning and operating "A" therefore organized the petitioner corporation. Upon the organization*32 of the petitioner corporation, "A" ceased carrying on a wholesale grocery business and disposed of its inventory between February and July 1939. Petitioner was organized to carry on, and thereafter did carry on, a wholesale grocery business with authorized and issued preferred stock in the sum of $ 20,000 and common stock in the sum of $ 40,000. Of this common stock of the petitioner, "A" acquired $ 39,500. Five shares of common stock of the par value of $ 100 per share were issued to directors of petitioner, who were the directors of the liquidating "A." The sum of $ 39,500 used by "A" for the acquisition of the stock of petitioner was secured on loans from various banks and individuals on notes of "A" personally endorsed by one or more of the officers or stockholders of "A" and of petitioner. After the disposition by "A" of its inventory, it was left with assets represented by its warehouse, certain old accounts and notes receivable from its transactions during its operations, and 395 shares of the common stock of petitioner of a par value of $ 100 per share. "A" was dissolved on or about December 31, 1941, and on March 16, 1942, filed its final tax return for the year ended *33 December 31, 1941. Prior to this time it had made unsuccessful attempts through its president, S. A. Mars, to sell its building in Appalachia. Failing to find a purchaser, it transferred this property to petitioner in October 1939 for a stated consideration of $ 23,000, paid by petitioner through assumption of liability in that amount of notes due by "A" to certain banks and individuals. The sum of $ 23,000 was the cost basis to "A" of this property. The total of $ 23,000 in obligations so assumed by the petitioner included notes as follows: $ 5,000 from "A" to Ethel *873 Mars, a note of $ 3,500 to Mrs. W. L. Sharp, a note of $ 1,000 to Mrs. L. A. Sharp, and one of $ 2,100 to Mrs. L. C. Mullins. Ethel Mars is the wife of S. A. Mars, president of "A" and of petitioner; Mrs. W. L. Sharp is the mother of R. L. Sharp, the secretary of "A" and of petitioner; Mrs. L. A. Sharp is the sister-in-law of R. L. Sharp; and Mrs. L. C. Mullins is the aunt of R. L. Sharp. Petitioner had no intention of conducting a wholesale grocery business in Virginia subsequent to the acquisition of "A's" building. It was able to rent the building for only a short time after its acquisition, and at a*34 rental of $ 50 per month. It listed the building for sale with a real estate agent in Appalachia, made unsuccessful efforts to find a purchaser, and finally sold the building at public auction, after advertising it for sale in the local newspapers and distributing handbills within an area of 50 miles of Appalachia, for the sum of $ 6,500. In determining the deficiency the respondent determined that the fair market value of the building and its equipment when acquired by petitioner from "A" was $ 13,800, and used such fair market value instead of cost in determining the loss to petitioner upon the sale. On December 31, 1941, "A" transferred to the petitioner accounts and notes receivable and cash in the sum of $ 9,900, and the petitioner entered on its books an assumption of liability of "A" in that total amount as represented by notes of "A" to various banks and individuals. The accounts and notes receivable so transferred by "A" to petitioner were delinquent accounts arising through the operations of "A" in prior years. These had been delinquent for from one to eight years. These notes and accounts receivable were entered on petitioner's books as acquired at face value. "A," *35 for the taxable year 1939, claimed no bad debt deductions on its return, and for the year 1940 it claimed the amount of $ 1,064.78. On its 1941 return, designated as its final return, no bad debt deductions were claimed. Sometime after December 1941, "A" distributed ratably to its stockholders the stock held by it in petitioner, then in the amount of 500 shares of common stock, the original 395 shares acquired by it having been increased to this amount by a stock dividend. Upon the liquidation of "A" and distribution to its stockholders of the stock of the petitioner corporation, the petitioner's stock was owned as follows: Shares R. L. Sharp [153] Jess D. (wife of R. L. Sharp) [10] S. A. Mars [23] Ethel M. (wife of S. A. Mars) [150] R. W. Gibson (manager of both corporations [105] Total [441] shares of 600 shares outstanding. *874 Of the 200 shares of preferred stock of a par value of $ 20,000 issued by petitioner, 100 shares of $ 10,000 face value were retired shortly after the organization of petitioner; the balance of the preferred stock was soon thereafter retired. Immediately prior to the petitioner's dissolution, on or about April 30, 1943, its outstanding*36 common stock was owned as follows: Shares S. A. Mars [25] Ethel M. Mars [200] R. L. Sharp [25] Jess D. Sharp [200] R. W. Gibson [150] Total [600] On its Federal income tax return for the taxable year ended September 30, 1942, petitioner claimed as a deduction the amount of $ 15,524.92 as a loss on the sale of the building and equipment acquired under circumstances heretofore detailed, and for the same period claimed as a bad debt deduction the amount of $ 1,830. On its Federal income tax return for the tax period October 1, 1942, to April 30, 1943, petitioner claimed as a bad debt deduction the amount of $ 7,194.87. In determining the deficiencies herein the respondent determined that of the amount of $ 15,524.92 claimed as a loss, only $ 6,714.95 was allowable as a deduction. Of the $ 1,830 claimed as a bad debt deduction by petitioner for the taxable year 1942, respondent allowed only $ 164.36, disallowing the sum of $ 1,665.64. Of the sum of $ 7,194.87 claimed as a bad debt deduction for the taxable year 1943, respondent disallowed the amount of $ 2,286.21. The amounts so disallowed for the two taxable years by the respondent, of the total bad debt deduction for*37 those two years, represented old accounts acquired from "A" and entered on its books at face value under the circumstances given in full detail. In the notice of deficiency respondent asserted a 5 per cent penalty against petitioner, in addition to the income and excess profits tax deficiencies, for its failure to file timely income and excess profits tax returns for the taxable year ended September 30, 1942. OPINION. In determining the pending deficiencies, respondent has refused to accept the transaction under which petitioner acquired from "A," at a consideration stated to be its book value, the warehouse building formerly used by it at Appalachia, Virginia, and certain old accounts and notes receivable at a stated purchase price of 100 cents on the dollar, as bona fide, arm's length transactions. It is his contention that the assets thus acquired by petitioner were so manifestly less in value than the value of the consideration claimed to have *875 been paid therefor that such consideration must be presumed to have been paid for something more than the mere assets received. Under such conditions he contends that the property acquired does not take a basis of the stated*38 consideration but rather the basis of its fair market value at date of acquisition. We agree with respondent that this is the rule where property is acquired in a transaction not at arm's length for a sum manifestly in excess of its fair market value. Pierre S. Du Pont, 37 B.T.A. 1198, affd. 118 F.2d 544, certiorari denied 314 U.S. 623. It is well established that cost is not always the amount actually paid in acquisition of property. Amounts in excess of market value may have been paid for other purposes rather than the acquisition of the property. We think that the action of respondent was correct in his application of the rule in view of the circumstances established by the record. Here "A," unsuccessful in its operations and moribund, was to be liquidated. This action was taken and the owners of that corporation organized the petitioner corporation at Lothair, Kentucky, to carry on a wholesale grocery business at that point, which business was thereafter carried on by petitioner to the date of its dissolution in April 1943. "A" owned a warehouse building at Appalachia, Virginia, which*39 it was abandoning and which it was unable to sell at a price approaching its book value. It also had on its books certain old accounts. The active operations of the corporation had ceased, and if these old accounts were charged off, no tax benefit to "A" could be secured. Likewise, if the building were sold by "A" it would necessarily be at a loss, the benefit of which could not be secured. Under these conditions the parties interested in "A," which were the same parties interested in petitioner, caused "A" to borrow on its notes, personally endorsed by one or more of these individuals, the amount of cash necessary to acquire all the issued common stock of petitioner. The warehouse of "A" and worthless accounts of that corporation were transferred to petitioner ostensibly at book value by the assumption of the note indebtedness of "A." The latter corporation was then dissolved and the common stock of petitioner distributed in liquidation to its stockholders. The evidence establishes that the fair market value of the warehouse at Appalachia, Virginia, was far below the amount ostensibly paid in its acquisition by petitioner; in fact the fair market value determined by respondent*40 in computing the allowable cost appears to us to have been most generous. As for the accounts receivable transferred at an ostensible purchase price to petitioner of 100 cents on the dollar, the evidence convinces us this transfer was a sham and lacked good faith. No ordinary business man in his right mind would buy even a first class account for a sum which merely gave him the legal right to collect that amount from another. These were delinquent accounts, many of which were years overdue and manifestly *876 uncollectible. We think the reason for the acquisition in this form was to secure, if possible, their deduction by petitioner as bad debts from its income resulting from its operations after its organization. As to the issue pertaining to the assertion of a 5 per cent penalty for failure by petitioner to file timely returns for the taxable year ended September 30, 1942, the action of respondent is approved. No evidence upon this issue was presented by the petitioner to show that the tardy filing was due to reasonable cause and not to willful neglect. Decision will be entered for the respondent.