Motor Mart Trust v. Commissioner

Motor Mart Trust, Samuel L. Lowe, Charles M. Storey, Stanley R. Miller, Ernest Henderson, Trustees, Petitioner, v. Commissioner of Internal Revenue, Respondent Motor Mart Trust v. Commissioner Docket No. 2412 United States Tax Court 4 T.C. 931; 1945 U.S. Tax Ct. LEXIS 209; March 5, 1945, Promulgated *209 Decision will be entered for the petitioner. A trust, taxable as a corporation, being insolvent, was reorganized at the behest of its bondholders under section 77 B of the Bankruptcy Act, the former bondholders becoming its stockholders. Assuming but not deciding that section 270 of chapter X of the Chandler Act may, by section 276 (c)-3 of the same act, be applicable, it is held, following Alcazar Hotel, Inc., 1 T. C. 872, and other extant decisions of the Tax Court and of the Board of Tax Appeals, that there had not been, in the reorganization proceeding a cancellation or reduction of the debtor's indebtedness within the purview of the applicable acts, and therefore the basis of the property owned by the trust is not to be reduced. Stanley R. Miller, Esq., for the petitioner. J. T. Haslam, Esq., for the respondent. Mellott, Judge. MELLOTT *931 The Commissioner determined the following deficiencies in tax: Excess profits Year Income tax tax [1939] $ 2,893.54 $ 2,870.91 [1940] 2,511.26 2,400.70 The sole question is the basis for depreciation of a building erected in 1926. Respondent has held that it is "fair market value on June 21, 1938, the date of reorganization." Petitioner contends it is cost in 1926. In other words the issue is whether a reorganization under 77 B had the effect, under the facts, of reducing the basis of the building. FINDINGS OF FACT. Motor Mart Trust (hereinafter*211 referred to as the trust or petitioner) is a Massachusetts trust treated as a corporation under the Internal Revenue Code. The individuals named in the caption are, and at least since 1938 have been, the duly qualified trustees. Its books are kept on an accrual basis and its returns for the taxable years were filed with the collector of internal revenue for the district of Massachusetts. The trust, when organized in 1926, acquired a leasehold interest in land in Park Square, Boston. It issued 5,000 class B common shares for the leasehold interest, which it set up on its balance sheet at $ 500,000. A building was erected thereon at a cost of $ 2,046,469.35. It was financed by the sale of first mortgage bonds, second mortgage bonds, and preferred shares. It had an estimated life of 42.95 years from January 1, 1927. *932 From the date of the completion of the building an amortization charge was annually made by the trust, amounting to $ 47,649.97, on account of the building and (up to 1938) $ 11,420.76 on account of the leasehold. These amounts would have been just sufficient to reduce to zero at the end of 42.95 years the cost figures shown on the books. On April 1, 1937, *212 the trustee under the indenture securing the first mortgage bonds served notice indicating an intention to foreclose. On April 30, 1937, petitioner filed a petition for reorganization under section 77 B of the Bankruptcy Act in the District Court of the United States for the District of Massachusetts. At that time its outstanding liabilities were: First mortgage bonds $ 1,193,500.00 Interest on first mortgage bonds 298,375.00 Second mortgage bonds 282,000.00 Interest on second mortgage bonds 101,900.00 Trustees' compensation, unpaid 68,651.77 Scrip certificates (int. on first mtg. bonds) 60,750.00 8% preferred shares (par value $ 100) shares 1,250 Class B common, no par value shares 5,000 A substitute plan of reorganization was proposed by the debtor, dated September 13, 1937, and presented to the court on September 30, 1937. It was confirmed by the court on June 21, 1938, and the final decree was entered on January 16, 1939. In the order of June 21, 1938, confirming the substitute plan of reorganization the court approved claims aggregating $ 2,055,171.80. It stated that, inasmuch as it had previously found the debtor to be insolvent, no acceptance of the*213 plan by the shareholders was requisite to its confirmation; that the plan had been accepted by 71.3 percent of the first mortgage bondholders and 73 percent of the second mortgage bondholders; that it was fair and equitable and in all respects complied with the provisions of 77 B; and that there was no reason why it should not be confirmed. The court accordingly ordered, adjudged, and decreed that the plan be confirmed and made binding and effective in all respects as provided in section 77 B. The order also contained appropriate instructions with reference to the release and discharge of the indentures, cremation of the bonds, and distribution of the preferred and common stock to the owners of the bonds in accordance with the plan. All questions not thereby or theretofore disposed of were reserved for future adjudication, including determination of the amounts to be paid by the debtor to committees or reorganization managers and also approval so far as the court should deem appropriate of the form of any documents necessary in the carrying out of the plan. Under the substitute plan all of the existing securities were to be and were retired and canceled. 9,548 convertible preferred*214 shares of the *933 par value of $ 50 per share and 6,437 shares of the common of the par value of $ 5 per share were to be and were issued as follows: To holders of first mtg. bonds: 9,548 shares pref. at $ 50 $ 477,400 4,774 shares common at $ 5 23,870 $ 501,270 To holders of 2d mtg. bonds: 1,410 shares common at $ 5 7,050 To trustees under the bonds in satisfaction of their claims for compensation: 253 shares common at $ 5 1,265 $ 4,050 in cash was paid to the holders of the scrip certificates. While the substitute plan of reorganization was pending in the court and before confirmation thereof an attorney for petitioner formally requested a ruling by the Commissioner whether it would incur any income tax liability by reason of the proposed reorganization. Under date of May 13, 1938, a letter was transmitted to the attorney, reciting in extenso the details of the plan and stating inter alia: Under the facts presented, and as above outlined, it does not appear that there is involved in the plan any question of the cancellation of indebtedness. In each instance with the exception hereinafter noted where an indebtedness of the*215 corporation is involved and is being extinguished it is to be effected through an exchange and a payment of the indebtedness rather than through cancellation of the indebtedness, the consideration being the exchange of its new convertible preferred shares and common shares for its first and second mortgage bonds, and the accrued interest thereon. The same situation exists with respect to the satisfaction of the unpaid compensation due trustees which had accrued prior to January 1, 1933. The trustees accept the common stock in payment and discharge of their claim. It is, therefore, the opinion of this office that no taxable income will be realized by the taxpayer by reason of these transactions. The exception referred to in the latter part of the letter concerned the purchase of the scrip certificates, in connection with which it was stated that no tax liability "should be asserted * * * unless the taxpayer has had the benefit in prior years of a reduction of its tax liability" by reason of the accrual of the interest for which the scrip had been issued. The debtor's final report and petition for final decree came on for hearing before the court on January 16, 1939. It appearing*216 to the court: * * * that the substitute plan of reorganization proposed by debtor dated September 13, 1937, heretofore duly proposed herein and confirmed by this court, has been substantially carried out and consummated and that all things required to be done by said plan and by order of this court relative thereto have been or will be done and that there is no reason why a final decree should not be entered * * * the court approved the debtor's final report, found, ordered, adjudged, *934 and decreed that the substitute plan had been substantially carried out in accordance with its terms, and: * * * that in all other respects also the proceedings in this cause have conformed with requirements of section 77 B of Chapter VIII of the acts of Congress relating to bankruptcy, and that it is not practicable to apply to these proceedings any part or portion of Chapter X of the Act of June 22, 1938, known as the "Chandler Act". The rights and interests of the former shareholders of Motor Mart Trust were "terminated and ended." The fair market value of the building at June 21, 1938, was $ 404,719.54 and its unexpired life as of that date was 30 1/2 years. In its income tax return*217 for each of the taxable years petitioner claimed a deduction for depreciation of $ 47,649.97 ($ 2,046,469.35/42.95). The Commissioner determined that it was entitled to depreciation of $ 13,269.49 ($ 404,719.54/30.5), saying: The reorganization under Section 77 B of the Bankruptcy Act on June 21, 1938, is not deemed to have resulted in the creation of a new trust on that date. However, under the provisions of Section 270 of the Bankruptcy Act of 1938, as amended by the Act of June 22, 1938 (Public No. 696, 75th Congress) and the Act of July 1, 1940 (Public No. 699, 76th Congress, Third Session) the basis for the allowance of depreciation or amortization in connection with the building erected in 1926 on land leased by the trust is the fair market value of the building on June 21, 1938, the date of reorganization. * * * OPINION. The history and purpose of the provisions of the Bankruptcy Act, authorizing what are commonly referred to as 77 B reorganizations, and the amendment of the law by chapter X of the Chandler Act in 1938, are too well known to require any extended discussion. The sections of the latter act, the applicability and effect of which are in issue here, are the ones*218 recently -- and since the filing of briefs herein -- discussed by the Supreme Court in Claridge Apartments Co. v. Commissioner, 323 U.S. 141. In that case the Commissioner contended that the effect of section 276 (c) -3 was to require an adjustment to the basis of the property of the reorganized taxpayer (debtor) as provided in section 270. His theory was that such adjustment was required "for all tax years forward as to transactions in all proceedings in which a plan had been or should be confirmed, regardless of whether the proceedings were pending or had been closed on September 22, 1938 [the effective date of the Chandler Act]." Claridge Apartments Co. v. Commissioner, supra. The Court rejected this contention, limiting the application of the sections (268 and 270) "to proceedings pending when the Chandler Act became effective." The Commissioner makes the same contention here, notwithstanding the fact that the instant case is governed, partially at least, by section 276 (c) -2, the judge having found that it was "not practicable" to *935 apply any portion of the Chandler Act provisions in the reorganization proceeding referred *219 to in our findings. For present purposes it will be assumed, although not decided, that this circumstance is unimportant. Cf. United Gas Improvement Co. v. Commissioner, 142 Fed. (2d) 216. We pass at once, therefore, to the principal question discussed by the parties upon brief, i. e., Was there a cancellation or reduction of indebtedness of the debtor within the purview of sections 268 and 270 of the Chandler Act? The latter section, as the Court pointed out in the Claridge case, is complementary to the former. The history of the two "stems basically from United States v. Kirby Lumber Co., 284 U.S. 1, and subsequent decisions which have applied the principle of that case." As we pointed out when the case was before us (1 T. C. 173), "Section 268 is an obvious legislative effort to release 77 B reorganizations from the tax burden of the Kirby case," while section 270 is the reasonable correlative under which a new basis is provided to protect the revenue. In other words, without repeating what the Supreme Court so carefully and fully outlined as the history and effect of the*220 two sections, section 268 relieves the reorganizing debtor from tax upon the profit, actual or apparent, resulting from "the adjustment of * * * [its] indebtedness in a" reorganization under the Bankruptcy Act or the Chandler Act, specifically providing that no income shall be deemed to have accrued to it (except as provided in section 269, where the principal purpose was the avoidance of taxes) "by reason of a modification in or cancellation in whole or in part of any of the indebtedness of the debtor" in the proceeding, while section 270 provides for an adjustment in basis to the extent that "the indebtedness of the debtor * * * has been canceled or reduced" in such proceeding. Respondent admits "that the plan did not involve a cancellation of indebtedness" 1 and adheres to the view expressed in the letter, shown in part in our findings, "that payment of indebtedness by stock issue was not a cancellation giving rise to taxable income * * *." 1 He suggests, however, that petitioner places more reliance upon the letter than is justified and points out that the ruling is not now in issue, but, if it were, that he is "not bound by the opinion of a prior incumbent." 1 Cf. James Couzens, 11 B. T. A. 1040.*221 These questions need not detain us. His argument in support of his determination really boils down to this: "Petitioner's basis must be decreased if the indebtedness was either canceled or reduced. Petitioner's indebtedness was reduced to zero." 1 Petitioner's argument to the effect that "indebtedness of the debtor * * *, canceled or reduced" in a reorganization proceeding, as used in section 270, means, under the doctrine ejusdem generis, a "modification in or cancellation of * * * indebtedness" as used in section *936 268, is not without substance. Decision, however, need not be rested solely on that ground. The question which really evolves is: Did the substitution of shares of common stock for bonds of the debtor effect a cancellation or reduction of its indebtedness? We think this question, with all due deference to the Circuit Court of Appeals for the Seventh Circuit, which expressed a contrary view in Claridge Apartments Co. v. Commissioner, 138 Fed. (2d) 962,*222 must be answered in the negative. In Capento Securities Corporation, 47 B. T. A. 691; affd., 140 Fed. (2d) 382, Capento had acquired $ 500,000 face value bonds of a corporation, all of the stock of which was owned by the same corporation that owned the Capento stock. The cost of the bonds to Capento was $ 15,160. The corporation which had issued the bonds -- Production -- needed working capital and borrowed $ 200,000 from a bank upon Capento's agreement that the obligation of the bonds was subordinated to the new loan. Later, when Production needed more money, it, by a transaction which the Board construed to be a recapitalization and hence a nontaxable reorganization, substituted preferred shares having a value of $ 50,000 for the $ 500,000 bonds. The Commissioner argued that Production had realized a gain of $ 450,000. In the opinion it was said, inter alia: * * * The corporation had a liability of $ 500,000 on the bonds, having presumably borrowed that amount. While it discharged that liability, it created a new stock interest which became a balance sheet liability called capital stock. This is plainly different*223 from the discharge of its indebtedness by the payment of money in a less amount than the indebtedness, as in Kirby Lumber Co. v. United States, 284 U.S. 1, and the cases which have followed it. To substitute a capital stock liability for a bonded indebtedness may have its advantages, as this case illustrates, but it can not be called a present realization of gain. The assets are not thereby freed from obligation. They become a subscription price contributed by the shareholder. * * * While the bond loan has been terminated, the amount borrowed is now committed to capital stock liability instead of to the liability of a fixed indebtedness. The Circuit Court of Appeals for the First Circuit, after quoting the paragraph of which the above is a part, expressed the opinion that our decision seemed to be "only a question of proper tax accounting" and hence binding upon it, but added: "However that may be, the Board's reasoning seems to us persuasive and its conclusion right." In Alcazar Hotel, Inc., 1 T. C. 872, 879 (on appeal, C. C. A., 6th Cir.), stock of a reorganized debtor having a value of approximately $ 32,500 *224 had been accepted by holders of bonds aggregating $ 249,000. The Commissioner made the same contention there that he makes here, viz., that there should be a reduction of the taxpayer's basis under section 270 of the Chandler Act to the fair market value of the property on the date of the exchange. We disposed of that contention on *937 the authority of Claridge Apartments Co., 1 T. C. 163, and Capento Securities Corporation, supra, saying: Following Capento Securities Corporation, 47 B. T. A. 691, we held [in the Claridge case] that the substitution of common stock for bonds did not effect a cancellation or reduction of indebtedness, but rather amounted to a continuation of the obligation in another form. The reversal by the Supreme Court in the Claridge case had no effect upon the portion of our decision dealing with the cancellation of indebtedness. In the view which it took there was no necessity to approve or disapprove our action in that respect. We had held, following The Commodore, Inc., 46 B. T. A. 718; affd., 135 Fed. (2d) 89,*225 that no year earlier than 1938 would be affected by the Chandler Act. The Circuit Court of Appeals for the Seventh Circuit held (138 Fed. (2d) 962) that the years from 1935 to 1937, as well as 1938, were all affected. The Supreme Court held that none was; hence, it reversed both judgments. Our decision of the principal issue on the merits in favor of the taxpayer was not criticized. On the contrary, the Court cited, apparently with approval, the Capento Securities Corporation case, supra, upon which we had relied. Under the present facts, as in the Alcazar Hotel Co. case, there was no cancellation of indebtedness within the rule of the Kirby Lumber Co. case. There was a mere substitution of common stock for bonds in a reorganization proceeding. As pointed out by the Commissioner in his letter of May 13, 1933, there was an "exchange of its new convertible preferred shares and common stock for its first and second mortgage bonds and the accrued interest thereon." The obligation to make payment to the ones who had advanced the money for the construction of the building was continued in another form. It is therefore relatively unimportant*226 that the balance sheet may have shown a reduction in indebtedness after the reorganization. Moreover, the view which we have taken seems to be in accord with that of the responsible officers of the Treasury Department when T. D. 4871, 1938 -- 2 C. B., p. 130, was promulgated, modifying the regulations with reference to "Cancellation of Indebtedness." Therein the whole emphasis was placed upon the rule of the Kirby Lumber Co. case and cases stemming from it; and apparently no reason was thought to exist, justifying or requiring adjustment of basis in any other type of case. But however that may be, the position taken by us in the Alcazar Hotel Co. case requires that the present deficiency be set aside. Therefore, Decision will be entered for the petitioner. Footnotes 1. The quotations are from respondent's brief.↩