J. M. Turner & Co. v. Commissioner

J. M. Turner and Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent J. M. Turner & Co. v. Commissioner Docket No. 51719 United States Tax Court 26 T.C. 795; 1956 U.S. Tax Ct. LEXIS 137; June 29, 1956, Filed *137 Decision will be entered under Rule 50. Held, on the basis of the facts presented, that petitioner is neither an "acquiring corporation" nor a "purchasing corporation," within the meaning of sections 461 (a) and 474 (a), respectively, of the Internal Revenue Code (1939); and, hence, that it is not entitled to use the base period experience of a certain proprietorship, in computing its excess profits credit for the year 1951. Fortescue W. Hopkins, Esq., for the petitioner. Elmer E. Lyon, Esq., for the respondent. Pierce, Judge. PIERCE *138 *795 The respondent determined a deficiency in petitioner's income and excess profits tax liability for the year 1951 in the amount of $ 17,208.84. 1 The sole issue for decision is whether the petitioner corporation, in computing its excess profits credit for the year 1951, is entitled to use the base period experience of the business operated by James M. Turner as a sole proprietor, by reason of being an "acquiring corporation" within the meaning of section 461 (a) of the Internal Revenue Code (1939), or a "purchasing*139 corporation" within the meaning of section 474 (a). 2 FINDINGS OF FACT. Some of the facts have been stipulated, and the stipulation is incorporated herein by reference. The petitioner, J. M. Turner and Company, Inc., is a corporation organized under the laws of the Commonwealth of Virginia, with principal office in Roanoke, Virginia. Its income and excess profits tax returns for the calendar year 1951 were filed with the collector of internal revenue for the district of Virginia. Petitioner's president, J. M. Turner (hereinafter called Turner), operated, from about 1937 to 1941, a contracting business as a sole proprietor. From 1941 to 1945 he served as an officer in the United States Navy, where his duties involved the construction of naval facilities. After his release from active duty with the Navy in late 1945, he resumed his prior general contracting*140 business, as a sole proprietor. He operated under the name of J. M. Turner, contractor; and, as such, he constructed residential houses, industrial and commercial buildings, and roads. The results of his operations, on a completed contract basis, were as follows: *796 Year Total contracts Gross profit Net profit billed [1946] $ 199,332.94 $ 33,841.92 $ 25,239.30 [1947] 426,690.64 29,338.57 16,158.11 [1948] 711,270.39 82,728.31 62,121.87 [1949] 1,103,378.73 104,691.29 73,905.09 In the latter part of 1949, Turner decided to organize the petitioner, with a view to segregating the portion of his assets used in business, to limiting his personal liability, and to rewarding two faithful employees (his brother, A. Morris Turner, and his general superintendent, W. S. Boyd) by affording them an opportunity to become part owners through the acquisition of stock. Accordingly, the petitioner was incorporated on December 27, 1949. It had an authorized capital stock of not more than $ 250,000 and not less than $ 50,000, divided into shares of $ 100 par value. The officers of the corporation, who were also all of its directors, were: J. M. Turner, president and treasurer; *141 A. Morris Turner, vice president; and Florence Miller, secretary. On January 3, 1950, the corporation issued its first 600 shares of stock, for cash at par, as follows: Stockholder Shares Cost Date paid J. M. Turner [250] $ 25,000 Jan. 10, 1950 J. M. Turner [250] 25,000 Jan. 25, 1950 A. Morris Turner [50] 5,000 May 12, 1950 Dorothy J. Turner (wife of J. M. Turner) [50] 5,000 June 22, 1950 Total [600] $ 60,000 Turner paid for the shares issued to his wife. He filed no gift tax return respecting the same. The board of directors, at its first meeting on January 3, 1950, discussed and unanimously approved "the terms of a certain sale" from Turner to the corporation of a contract which Turner had with the Norfolk and Western Railway for the construction of a building. The corporation was directed to pay Turner, for an assignment of the contract, the sum of $ 24,143.80, being the book value of the completed portion of the job as of January 3, 1950. The corporation agreed to complete the contract; and its secretary was directed to cause "the sale" to be recorded in the minutes. At this same initial meeting of the board of directors, the board discussed and unanimously*142 approved the terms of "a certain sale" from Turner to the corporation of "the down town office equipment and certain items of construction equipment for the sum of $ 3,214.56, paid by the corporation to J. M. Turner, the sum aforesaid being the book value of the assets of J. M. Turner aforesaid * * *." *797 Petitioner's books recorded, as of January 3, 1950, the two above-mentioned purchases, and the setting up of an account payable to Turner for the purchase prices, as follows: Job control -- Esso station 1 $ 28.50 Job control -- N. & W. Railway Co 24,143.80 Account payable -- J. M. Turner $ 24,172.30 Equipment -- Hoist (net) 746.74 Pump (net) 76.90 Mortar mixer (net) 76.13 Batching plant 731.25 Autos -- Trucks (net) (Chevrolet truck) 522.50 Office equipment (net) 1,060.34 Account payable -- J. M. Turner 3,214.56 The aggregate of the purchase prices for the above property, totaling $ 27,386.86, was recorded on the books of Turner's proprietorship as a debit to notes*143 and accounts receivable. Subsequent to the above transactions, the corporation issued additional shares of its stock, for cash at par, as follows: Date issued Stockholder Shares Cost Date paid July 8, 1950 J. A. Turner (father of J. M. Turner) [10] $ 1,000 July 11, 1950 July 8, 1950 J. M. Turner [140] 14,000 July 11, 1950 Oct. 13, 1950 W. S. Boyd [200] 20,000 Oct. 13, 1950 Oct. 13, 1950 J. M. Turner [50] 5,000 Oct. 31, 1950 Total [400] $ 40,000 Following the issuance of these shares, and throughout the taxable year involved, there were 1,000 shares of stock outstanding, having an aggregate par value of $ 100,000, held as follows: Name Shares J. M. Turner [690] Dorothy J. Turner [50] A. Morris Turner [50] J. A. Turner [10] W. S. Boyd [200] The physical assets of the proprietorship as shown on its books as of December 31, 1949, the original cost thereof, the items transferred to the corporation on January 3, 1950, shown at book value on that date, and the items retained by Turner shown at book value on the same date, are as follows: *798 Cost when Transferred Retained Assets acquired to corporation by Turner (book value) (book value) Equipment: Dewalt saw $ 730.20 [1] Concrete mixer 1,774.00 [1] Hoist 1,644.20 $ 746.74 Pump 158.67 76.90 Mortar mixer 614.65 76.83 Shovel 12,336.20 $ 8,703.87 Batching plant 1,950.00 731.25 Total $ 19,207.92 $ 1,631.72 $ 8,703.87 Automobiles and trucks: Chevrolet dump truck $ 2,466.36 $ 184.98 Chrysler automobile 2,030.65 319.65 Chevrolet truck 1,254.00 $ 522.50 Total $ 5,751.01 $ 522.50 $ 504.63 Office equipment: Filing cabinet $ 49.50 $ 37.88 Speed-O-Print 59.00 45.86 Monroe calculator 424.00 346.27 Typewriter 151.05 137.21 Burroughs adding machine 265.00 251.75 Air-conditioning unit 249.69 241.37 Total $ 1,198.24 $ 1,060.34 Total $ 26,157.17 $ 3,214.56 $ 9,208.50 *144 The principal asset of the proprietorship on December 31, 1949, was 14 contracts in process of being completed. As before stated, Turner assigned 2 of these contracts to the corporation on January 3, 1950, for a consideration of $ 24,172.30, which represents only the book value of the completed portions of these jobs as of that date (being the difference between prior receipts of $ 17,654.75, and costs of $ 41,827.05). Neither the total contract prices, nor the value of the uncompleted portions of the contracts, has been established. Turner as a proprietor, on the other hand, retained the other 12 contracts, completed them in 1950, and derived profits as follows: Date of last Portion of Portion of Dates Contract payment gross profit gross profit of final to labor attributable attributable payment to 1949 to 1950 Acme Super Market 2/27/50 $ 54.73 3/18/50 Cates 2/10/50 $ 1,131.35 120.98 2/15/50 First Nat. Exch. Bank 8/1/50 9,412.50 1,133.72 9/16/50 Kroger Company 4/4/50 21,741.89 700.19 4/20/50 Magic City Motor 12/22/49 240.40 2/3/50 Mountcastle 11/3/49 21.96 2/3/50 Old Colony Box Co 4/10/50 3,491.43 2,510.68 4/7/50 Radford College 4/21/49 32,521.85 3,005.62 4/20/50 Roanoke Iron & Bridge 12/22/49 62.55 2/7/50 Shell Oil Co 3/7/50 3,558.88 2,731.85 6/10/50 Davis & Stephenson [1] Roanoke Animal Hospital [1] Total $ 72,187.31 $ 10,257.77 *145 *799 The total gross profit on the above retained contracts, taken into account upon their completion in 1950 through application of the completed contract method of accounting, was $ 82,445.08. The portion of the net profit attributable to the contracts as of December 31, 1949, is not established by the evidence. The total net profit of the proprietorship for the year 1950 (including certain miscellaneous income) was $ 59,185.10, before taxes; and the portion of Turner's individual income tax liability for 1950, attributable to such net profit, was approximately $ 22,000. None of this profit, either before or after taxes, was acquired by the corporation. The net profit of the proprietorship for 1949, derived from contracts completed in that year, was $ 73,905.09, before taxes; and the portion of Turner's individual income tax liability for said year, attributable to these profits, was approximately $ 27,000, of which some portion was unpaid on December 31, 1949. None of such profit, either before or after taxes, can be identified as part of the assets of the proprietorship shown on its books as of December 31, 1949, or as part of the assets acquired by *146 the corporation. The proprietorship also had the following miscellaneous business assets on December 31, 1949: Notes and accounts receivable $ 5,345.22 Account in Mountain Trust Bank 50.30 Deposits on plans 35.00 Insurance deposit 66.00 Total $ 5,496.52 None of these assets was acquired by the corporation. Turner had on December 31, 1949, a bank account with the First National Exchange Bank, which contained both business and personal funds. The balance in this account on said date was $ 94,929.15. The sources of the deposits in this account, and the nature of the withdrawals therefrom, are not identified; and there is no evidence as to what portion, if any, of said balance was an asset of the proprietorship. 3 *147 There is no indication in the books of either the petitioner or the proprietorship, or in the minutes of petitioner's board of directors, of the existence or acquisition by petitioner of any goodwill. The only liabilities of the proprietorship, shown on its books as of December 31, 1949, were -- Withholding taxes $ 2,176.70 Old age benefit deductions 396.69 $ 2,573.39 *800 None of these liabilities was assumed by the corporation. During the year 1950, following the transfer of certain assets to the corporation, Turner, as a sole proprietor, completed the 12 contracts which he had retained. Most of the work on these contracts was completed by the end of February 1950; but the last payment for labor in connection therewith was not made until August 1, 1950, due to the necessity of replacing certain work pursuant to guarantees in these contracts. Thereafter, Turner, as a proprietor, did not enter into any new contracts until about May 1, 1951. Thereafter, when the corporation had reached the limit of the work it could handle under its capacity to give bonds, Turner, as a sole proprietor, bid for in his own name and performed the following contracts: Date work Date of final Receipts Gross begun payment by profit owner First National Exchange Bank 6/9/51 9/10/51 $ 327.93 $ 99.91 Old Colony Box Corp 5/1/51 7/18/51 19,114.39 2,498.27 Radford High School 6/25/51 12/11/52 205,961.57 21,299.12 V. P. I. Processing Laboratory 6/26/51 7/10/52 146,341.60 16,079.34 V. P. I. Gymnasium 11/12/51 2/29/52 5,104.72 1,378.72 *148 During the year 1950, Turner used, in completing the contracts which he had retained, the power shovel and other equipment which he had retained; and he also rented the shovel to the petitioner corporation and to other parties. The rent which he received therefor in 1950, from the corporation, was $ 2,250. The petitioner corporation, in its excess profits tax return for 1951, claimed an excess profits credit of $ 81,195.65, based on the earnings experience of the Turner proprietorship. Respondent, in his notice of deficiency, determined that petitioner was not entitled to use the base period experience of the proprietorship, on the ground that it was neither an "acquiring corporation" within the meaning of section 461 (a), nor a "purchasing corporation" within the meaning of section 474 (a) of the 1939 Code. OPINION. The petitioner contends that, in computing its excess profits credit for the year 1951, it is entitled to use the base period experience of the business operated by J. M. Turner as a sole proprietor, on the ground that it is either an "acquiring corporation" or a "purchasing corporation," within the meaning of sections 461 (a) and 474 (a), respectively, of the Internal*149 Revenue Code (1939). 4 *150 *801 At the outset, it will be observed that one of the essential prerequisites to qualification of the petitioner under section 461 (a) or 474 (a), is that petitioner must have acquired "substantially all the properties" of Turner's proprietorship. Section 474 (a) limits the word "properties" as used therein, by the parenthetical phrase "(other than cash)"; whereas in section 461 (a), the word "properties" is not so limited, and is therefore construed to include both "cash" and other properties. Cf. Halliburton v. Commissioner, (C. A. 9) 78 F. 2d 265. Whether the properties transferred constitute "substantially all" is a matter to be determined from a consideration of all the facts and circumstances, rather than by the application of any particular percentage. Milton Smith, 34 B. T. A. 702, 705. It is our opinion that petitioner did not acquire "substantially all the properties" of Turner's proprietorship, irrespective of whether cash is included or excluded from consideration. As regards the cash assets of the proprietorship, the only cash which the corporation received from Turner was that delivered in payment*151 for the shares of stock which were issued at par, pursuant to direction of petitioner's board of directors. The identity of the account or source of funds from which Turner obtained this cash is not shown; and, *802 accordingly, the evidence does not establish what portion, if any, of the cash assets of the proprietorship (as distinguished from Turner's personal cash) was acquired by petitioner. As regards physical assets, our Findings of Fact show that on December 31, 1949, the total book value of all such assets carried on the books of the proprietorship was $ 12,423.06; that of these, only a portion, having a book value of $ 3,214.56, was acquired by petitioner, whereas the remainder (including a power saw, a cement mixer, and a valuable power shovel), having a book value of $ 9,208.50, was retained in the proprietorship. Although Turner claimed that miscellaneous other physical assets having a value of approximately $ 6,000 were transferred, there is no record of their transfer; and the books of neither petitioner nor the proprietorship reflect them. Turner testified also that the aggregate fair market value of the physical assets of the proprietorship exceeded their book*152 value; but the evidence contains neither an appraisal nor a sufficient description of the condition of such assets, to permit a determination of their fair market value. In this situation, we have no alternative to the use of book values. E. T. Renfro Drug Co., 11 T. C. 994; Hawaiian Freight Forwarders, Ltd., 15 T. C. 35. As regards contracts in process of completion on December 31, 1949, there were 14 of them held by the proprietorship; and these were its most important and valuable asset. Only 2 of these contracts were acquired by petitioner; whereas the other 12 were retained in the proprietorship. These contracts represented large potential profits, and the expenditure of substantial amounts for planning, labor, and materials. Upon completion of the 12 retained contracts, the proprietorship realized gross profits of $ 82,445.08, and net profits of $ 59,185.10; but no portion of such profits, either before or after taxes, was acquired by petitioner. The proprietorship also had certain miscellaneous assets on December 31, 1949, including notes and accounts receivable, which had an aggregate value of $ 5,496.52; but*153 no portion of such assets was acquired by petitioner. Turner testified that petitioner acquired goodwill of the proprietorship; and he estimated that this had a value of $ 350,000. There is no indication, either in the minutes of petitioner's board of directors or on the books of either petitioner or the proprietorship, of any such goodwill having been transferred, acquired, or held. To the contrary, there is evidence that the proprietorship had operated under Turner's name prior to the transactions here involved; that it continued to operate under such name in completing the 12 contracts which it retained; and that, after a lapse of about 1 year, it resumed operations under such name, in bidding for and performing 5 new contracts in 1951 and 1952. Also, Turner did not report, in his 1950 *803 income tax return, the sale of any goodwill of the proprietorship, which presumably would have had a zero basis. The mere fact that Turner organized a corporation bearing his name, and became the president thereof, is not sufficient to establish the sale or transfer of any goodwill from his proprietorship to petitioner. Moreover, there is no indication as to how Turner determined the*154 $ 350,000 value which he used; and we regard such value to be unsupported, unproved, and unacceptable. Finally, the only liabilities of the proprietorship shown on its books as of December 31, 1949, were withholding taxes and old age benefit deductions, in the aggregate amount of $ 2,573.39; and none of these was assumed by petitioner. It is argued by petitioner, however, that the amount of these liabilities should be increased by those portions of Turner's individual income tax liabilities for the years 1949 and 1950, which were attributable to the proprietorship profits of those years; and that such increased amount of liabilities should be offset against the value of the proprietorship assets which petitioner did not acquire. But, if such individual income tax liabilities are to be attributed to the proprietorship, then consistently, the net profits of the business for 1949 and 1950 (represented by cash and work in process, totaling $ 133,090.19), to which such taxes are attributable, should be regarded as assets of the proprietorship. And, if such profits are added to the assets of the proprietorship, it becomes even more apparent that petitioner did not acquire "substantially*155 all the properties" of the proprietorship. We think that the foregoing facts and conclusions are sufficient, in themselves, to establish that petitioner does not qualify, either as an "acquiring corporation" or as a "purchasing corporation," within the meaning of the applicable statutes. But there are still other reasons for denying such qualification. As before stated, section 461 (a) is applicable only to acquisitions of property through transactions which qualify as nontaxable exchanges under section 112 (b) (5) and its related sections. Here, petitioner did not acquire either cash or property in any transaction which falls within the ambit of these sections. The books and records of petitioner, and also the minutes of the first meeting of its board of directors, clearly establish that all of petitioner's stock was issued solely for cash at par; and there is no showing that any of this cash represented an asset of the proprietorship. Also, both of the two transferred contracts in process, and all of the other transferred assets, were purchased by petitioner for specific prices; and these prices were thereafter evidenced by the setting up of an account payable on the books of*156 the petitioner and an account receivable on the books of the proprietorship. It may well be, as suggested in petitioner's *804 brief, that Turner did not anticipate the enactment of the Excess Profits Tax Act of 1950; and it is possible that, if he had anticipated such statute, he might have cast the transactions differently. But, in deciding the present controversy, it is necessary for us to deal with the facts and transactions as they actually existed. With further regard to section 474 (a), its application is expressly limited to situations (1) where the seller did not continue any business activities, other than those incident to "complete liquidation"; and (2) where the seller, within a reasonable time thereafter, "ceased existence." Here, Turner's proprietorship not only continued active operations under the 12 contracts that it retained (which, in itself, might well be regarded as something more than mere liquidation activity); but also, it thereafter held and rented certain of the retained construction equipment; continued to carry a depreciation account at the end of the year 1950; and, beginning in about May 1951, bid for and performed work on 5 new contracts in 1951*157 and 1952. One of these new contracts, alone, produced receipts of $ 205,961.57 and gross profit of $ 21,299.12. So far as here shown, there was no agreement with the petitioner or anyone else, which would have prevented the proprietorship from operating continuously after 1949. Indeed, there is no evidence that the books of the proprietorship were ever closed, or that the proprietorship ever "ceased existence." The indication, to the contrary, is that there was merely a segregation of part of Turner's business assets, including only 2 of his contracts, in the petitioner corporation. We decide the issue here involved in favor of the respondent. Decision will be entered under Rule 50. Footnotes 1. The respondent, in the notice of deficiency, also determined an overassessment in respect of petitioner's income and excess profits tax liability for 1950. The present proceeding, insofar as it related to said year 1950, was dismissed for lack of jurisdiction.↩ 2. The parties agreed that, in the event such issue is decided in favor of the petitioner, the amount of the credit will be computed under Rule 50 of this Court.↩ 1. The purchase of this contract was not mentioned in the minutes of the board of director's meeting. It is stipulated, however, that such contract was assigned.↩ 1. These fully depreciated assets, together with the depreciation reserves therefor, were continued to be carried in the depreciation schedule as of December 31, 1950, shown on Turner's individual income tax return for 1950. Although Turner testified that these assets were acquired by the corporatlin, they are not included among the assets shown on the corporation's books, nor were they included among the assets purchased pursuant to the direction of the board of directors.↩ 1. Not shown.↩ 3. The only evidence which might have a bearing on this matter is an estimate of Turner that, "for the volume we had been doing the last few years, we could have operated the business with cash of $ 30,000." This does not appear to relate to the amount of cash in banks, which the proprietorship had on December 31, 1949.↩ 4. SEC. 461. DEFINITIONS. For the purposes of this Part -- (a) Acquiring Corporation. -- The term "acquiring corporation" means -- (1) A corporation which has acquired -- * * * * (D) substantially all the properties of a partnership in an exchange to which section 112 (b) (5), or so much of section 112 (c) or (e) as refers to section 112 (b) (5) is applicable. * * * * (b) Component Corporation. -- The term "component corporation" means -- * * * * (5) In the case of a transaction specified in subsection (a) (1) (D), the partnership whose properties were acquired. * * * * (f) Sole Proprietorship. -- For the purposes of sections 461 (a) (1) (D), 461 (b) (5), and 462 (k), a business owned by a sole proprietorship shall be considered a partnership. SEC. 474. EXCESS PROFITS CREDIT BASED ON INCOME -- CERTAIN TAXABLE ACQUISITIONS. (a) Definitions. -- For the purpose of this part -- (1) Purchasing corporation. -- The term "purchasing corporation" means a corporation which, before December 1, 1950, acquired -- (A) In a transaction other than a transaction described in section 461 (a), substantially all of the properties (other than cash) of another corporation, of a partnership, or of a business owned by a sole proprietorship; * * * * (2) Selling corporation. -- The term "selling corporation" means a corporation, a partnership, or a business owned by a sole proprietorship, as the case may be, properties of which were acquired by a purchasing corporation in a transaction described in paragraph (1). (3) Part IV transaction. -- The term "part IV transaction" means a transaction described in paragraph (1). * * * * (c) Limitations. -- This part shall apply only if each of the following conditions is satisfied: (1) The selling corporation (A) did not, after the part IV transaction (or the last transaction described in subsection (a) (1) (B)), continue any business activities other than those incident to its complete liquidation, and (B) within a reasonable time after ceasing business activities, completely liquidated in a transaction other than a transaction described in section 461 (a)↩, and ceased existence.