Peeler Hardware Co. v. Commissioner

Peeler Hardware Company, Petitioner, v. Commissioner of Internal Revenue, Respondent Peeler Hardware Co. v. Commissioner Docket No. 5849 United States Tax Court 5 T.C. 518; 1945 U.S. Tax Ct. LEXIS 114; July 28, 1945, Promulgated *114 Decision will be entered under Rule 50. 1. Petitioner contended that in computing its equity invested capital for excess profits tax purposes it had acquired certain assets in a tax-free reorganization and that the base of its investment therein should be determined accordingly. Respondent contended contra. Held, that the assets in question were not so acquired. 2. Petitioner contended that certain salaries which it paid and deducted in its tax returns, which were in part disallowed as deductions by respondent, were reasonable. Held, that such salaries were reasonable and were deductible in full. C. Baxter Jones, Esq., and L. D. Baggs, Jr., C. P. A., for the petitioner. Edward L. Potter, Esq., for respondent. Hill, Judge. HILL *518 The Commissioner determined deficiencies as follows: Declared Fiscal year ended -- Income tax value excess Excess profits tax profits tax May 31, 1940 $ 2,605.87 $ 72.74 May 31, 1941 1,016.35 May 31, 1942 224.41 $ 13,757.19 *115 The first issue is whether petitioner's equity invested capital for the fiscal year ended May 31, 1942, should be reduced by the amount of $ 109,508.77. This involves the question of whether petitioner acquired certain assets in a tax-free reorganization. The second issue is whether petitioner is entitled to deductions for salary paid to T. B. Peeler in the following amounts: [1940] $ 11,625.00 [1941] 10,091.49 [1942] 10,225.00 Other items entering into the composition of the deficiencies have been conceded by petitioner. *519 Issue I. FINDINGS OF FACT. Petitioner is a Georgia corporation, with its principal office at Macon, Georgia. It filed its income tax returns for the years in question with the collector of internal revenue for the district of Georgia. In 1930 A. M. Peeler was the sole stockholder of the petitioner, with the exception of 4 qualifying shares in the hands of the directors. The Dunlap sisters were the sole stockholders of the Dunlap Hardware Co., hereinafter referred to as Dunlap, a competitor of the petitioner. Desiring to retire, the Dunlap sisters offered to sell the business to A. M. Peeler and the offer was accepted. By a contract of *116 sale entered into May 23, 1930, A. M. Peeler agreed to purchase from the Dunlap sisters all of the outstanding stock of Dunlap, consisting of 800 shares, for the purchase price of $ 180,000. A. M. Peeler personally borrowed $ 100,000 which he placed in a Macon bank as escrow for ultimate payment to the Dunlap sisters for their stock pursuant to the contract. The 800 shares of Dunlap were then issued in the name of A. M. Peeler and were deposited in the bank in escrow, the Dunlap sisters retaining a security interest therein until the purchase price was paid in full. Thereupon the $ 100,000 was paid over to the Dunlap sisters. Pursuant to the contract A. M. Peeler exercised an optional method of paying the remaining $ 80,000 of the purchase price. He caused the petitioner to issue $ 80,000 par value preferred stock in the name of the Dunlap sisters within 60 days, as required by the contract. Under this optional method Peeler Hardware Co. amended its charter by changing its name to Dunlap-Peeler Hardware Co. The name was subsequently changed back to Peeler Hardware Co. At a stockholders' meeting of petitioner on June 25, 1930, the following resolutions were adopted: The following*117 resolution was unanimously adopted: Resolved that the corporation accept the amendment to its charter granted by the Superior Court of Bibb County on the 25th day of June, 1930, changing the name of the corporation from Peeler Hardware Company to Dunlap-Peeler Hardware Company. On motion the following resolution was unanimously adopted: Resolved that the common capital stock of the company be increased from $ 150,000.00 to $ 200,000.00 and that 500 additional shares of common stock of the par value of $ 100.00 per share be issued. On motion the following resolution was unanimously adopted: Resolved that an issue of preferred stock in the amount of $ 80,000.00 par value be authorized, such stock to be first preferred 7% cumulative stock and to be issued in shares of the par value of $ 100.00. Such stock shall be issued upon the terms and conditions set forth and contained in the specimen stock certificate hereto attached and by reference made a part of this resolution. *520 Such specimen stock certificate as prepared and as submitted to this meeting is hereby approved as to all its terms and conditions. On Motion the following resolution was unanimously adopted: *118 Whereas, A. M. Peeler, the President of Peeler Hardware Company and the sole stockholder of Peeler Hardware Company, except for four qualifying shares issued to directors of said company, has acquired all of the assets of Dunlap Hardware Company subject to the liabilities of said company, and Whereas, said A. M. Peeler has proposed to turn said assets of said Dunlap Hardware Company over to this corporation, subject to the liabilities so assumed by him, and Whereas, it appears that the assets of Dunlap Hardware Company, after deducting the liabilities of said company, are reasonably worth an amount equal to or in excess of the value of the common and preferred stock heretofore authorized by resolution of the stockholders at this meeting, and Whereas, it is to the best interests of this company to acquire the assets of Dunlap Hardware Company subject to its liabilities. Now, Therefore, be it resolved that the said assets be accepted and that the liabilities of Dunlap Hardware Company be assumed and that the additional shares of common stock and all of the preferred stock to be issued in accordance with the resolution heretofore adopted by the stockholders of this company be issued*119 and delivered to said A. M. Peeler or his nominee or nominees in exchange for the assets of said Dunlap Hardware Company. By this resolution A. M. Peeler was recognized by petitioner as personally being the owner of the assets formerly belonging to Dunlap. These assets were carried forward on the books of the petitioner at the same value that they had had on the books of Dunlap. Dunlap took no action in transferring its assets. It took no formal corporate action of any sort after the issuance of its stock in the name of A. M. Peeler. In addition to issuing $ 80,000 par value of preferred stock to the Dunlap sisters as the nominees of A. M. Peeler, the petitioner issued an additional $ 50,000 par value common stock to Peeler in return for the assets so conveyed to it. The preferred shares were redeemed by petitioner at a discount on December 15, 1930. A. M. Peeler caused Dunlap to be liquidated and personally took over the assets prior to conveying them to the petitioner. The fair market value of these assets, subject to Dunlap's liabilities at the date of liquidation, was $ 180,000. OPINION. The issue is as to the proper valuation of the assets originally belonging to Dunlap*120 in determining petitioner's equity invested capital for the fiscal year ended May 31, 1942. Petitioner seeks to have the value carried as it would have been in the hands of Dunlap. Respondent reduced that amount by $ 109,508.77 so as to carry the assets at a valuation of $ 180,000, the purchase price paid by A. M. Peeler for the stock of Dunlap. Section 718 of the Internal Revenue Code provides that, in the determination of the equity invested capital for the excess profits credit, property paid in for stock or as paid-in *521 surplus or as a contribution to capital shall be included in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange. 1 *121 It is petitioner's contention that once A. M. Peeler had purchased the entire stock of Dunlap he caused a tax-free reorganization between the petitioner and Dunlap. If we were to consider the various steps as a part of one plan of reorganization, we could not begin the consideration of those steps after the acquisition by A. M. Peeler of the Dunlap stock as urged by petitioner. The conveyance of the assets to petitioner was required by the Dunlap interests in the contract of sale in the event that A. M. Peeler should decide to cause the balance of the purchase price for their stock to be met by causing petitioner to issue preferred stock to them. Thus, if there were a reorganization, it would have to commence with the Dunlap sisters having the sole proprietary interest in Dunlap. Their requisite proprietary capacity did not continue into the reorganized company. The Commissioner determined that the assets were acquired by petitioner from A. M. Peeler as an individual and that A. M. Peeler acquired the assets in the complete liquidation of Dunlap. The evidence tends to support the Commissioner's determination. It would appear that at the time of the transaction in 1930 A. *122 M. Peeler and the petitioner had no interest in bringing about a tax-free reorganization. On brief the petitioner states that the Dunlap sisters had no such interest. In short, there is no showing that there was any plan of reorganization to which petitioner and Dunlap were parties or that what was done was pursuant to a plan of reorganization. On the contrary, Peeler simply liquidated Dunlap. Then, in his capacity as sole stockholder and director, he caused the petitioner to recognize him as the individual owner of the assets and to take over the assets from him personally. This may be seen from the resolution of the petitioner in accepting the assets: *522 Whereas, A. M. Peeler, the President of Peeler Hardware Company and the sole stockholder of Peeler Hardware Company, except for four qualifying shares issued to directors of said company, has acquired all of the assets of Dunlap Hardware Company subject to the liabilities of said company, and Whereas, said A. M. Peeler has proposed to turn said assets of said Dunlap Hardware Company over to this corporation, subject to the liabilities so assumed by him, and * * * * Now, Therefore, be it resolved that the said assets be*123 accepted and that the liabilities of Dunlap Hardware Company be assumed and that the additional shares of common stock and all of the preferred stock to be issued in accordance with the resolution heretofore adopted by the stockholders of this company be issued and delivered to said A. M. Peeler or his nominee or nominees in exchange for the assets of said Dunlap Hardware Company. A further indication that A. M. Peeler considered Dunlap as liquidated may be seen in his statement at the trial that the shares of Dunlap were canceled. He was questioned further as to this by his counsel as follows: Q. When you made the statement a few minutes ago that they were cancelled, I take it you were not referring to any active cancellation. A. No. That was just a slip -- I mean, you say a thing was cancelled, and given back to you. Something like that. Peeler considered the situation to be the same as though there had been such a cancellation. Thus, with no reason to bring about a tax-free reorganization at the time, A. M. Peeler did not seek to do so. Although there was no formal cancellation of the shares of Dunlap, his testimony and the resolutions of the petitioner made under his*124 guidance indicates that Dunlap was liquidated, and that A. M. Peeler personally became the owner of the assets and thereafter conveyed those assets to petitioner. The taking of formal action to liquidate the corporation was not essential. Kennemer v. Commissioner, 96 Fed. (2d) 177, 178; Tootle v. Commissioner, 58 Fed. (2d) 576. It is only now, 12 years later, when the equity invested capital credit of the excess profits tax makes it tax wise for the earlier transaction to have been carried out by means of a tax-free reorganization that petitioner seeks to force the steps there taken into conformity with the requirements of section 112 of the Revenue Act of 1928. The petitioner may not reconstruct now what was done 12 years earlier in order to gain a tax benefit. No formal corporate action of any sort was taken by Dunlap. The fact that the petitioner corporation took the proper formal action in its resolution to take over the assets of Dunlap indicates that A. M. Peeler knew the proper method of having Dunlap convey its assets to petitioner had he desired to effect the transaction in that way. Instead, he caused*125 petitioner, through its resolutions, to recognize him as the individual owner of the assets formerly belonging to Dunlap. *523 The Dunlap sisters wanted to sell their business. When they set a price of $ 180,000, the purchaser assuming all liabilities of that company, it was immaterial to them whether it be the assets themselves that were sold for that price or whether the sale be of the shares of stock. When A. M. Peeler liquidated Dunlap and received the assets, they took on a basis in his hands of $ 180,000, their fair market value at that date. Gloyd v. Commissioner, 63 Fed. (2d) 649; certiorari denied, 290 U.S. 633; Anna L. Dirkson, Executrix, 24 B. T. A. 1152; Benjamin H. Read, 6 B. T. A. 407. When A. M. Peeler then conveyed these assets to petitioner in return for the issuance of stock to himself and to his nominees, the transaction came within the provisions of section 113 (a) (8) of the Revenue Act of 1928. 2 The petitioner's basis for the assets became $ 180,000. We accordingly hold for the respondent on this issue. *126 Issue II. Petitioner paid T. B. Peeler, its vice president and secretary-treasurer, salaries of $ 11,625, $ 10,091.49, and $ 10,225, respectively, for its fiscal years 1940, 1941, and 1942. Respondent has disallowed any deductions for this item over $ 6,120.60 for 1940, $ 6,387.60 for 1941, and $ 7,444.80 for 1942. T. B. Peeler is the son of A. M. Peeler, the president and only other executive officer of petitioner. Petitioner has been allowed deductions of $ 25,000 for each of the three years in question for salary paid to A. M. Peeler. T. B. Peeler owns 259 of the outstanding 1,625 shares of capital stock of petitioner. The remaining shares, except qualifying shares in the hands of the directors, are owned by his father. Since completion of his education in 1933, at the age of 21, T. B. Peeler has devoted his entire time to the business. Prior to that time and since childhood he had been working in the business during his vacations. Starting at a salary of $ 10 a week in 1933, he was transferred from one department to another in order that he might learn the business, both wholesale and retail, and be prepared eventually to take over its management. As he moved from one*127 department to another *524 he retained supervision over each of the departments in which he had worked. In 1935 he was made a director of the company and in 1936 its vice president. In 1936 he revised the operating methods in petitioner's retail store, putting in many new lines of merchandise, which resulted in an increase in sales volume, and instructed the salesmen in the best method of demonstrating and selling the new lines. He improved the company's relationship with its customers by repricing all the merchandise and eliminating the earlier practice of permitting the salesmen to compete with each other for customers by setting lower prices. In 1940 he was given the additional duty of assigning priority ratings to all priority merchandise, this constituting a majority of all goods handled. It was also his function to allocate scarce merchandise between the wholesale and retail departments and between particular customers. Since 1938 he has been in charge of all of petitioner's advertising. In addition to supervising all of petitioner's buying, both wholesale and retail, he directly made 25 percent of the purchases. The secretary-treasurer was unable to perform his *128 designated functions during 1940 due to ill health. These duties were taken over at that time by T. B. Peeler, who was elected to the office in 1941 and for the subsequent years in question. Since 1934 the total annual compensations paid T. B. Peeler by the petitioner have been as follows: [1934] $ 1,068.30 [1935] 3,782.00 [1936] 4,570.00 [1937] 11,765.00 [1938] 11,600.00 [1939] $ 11,625.00 [1940] 11,625.00 [1941] 10,091.49 [1942] 10,225.00 [1943] 10,225.00 During the years in question petitioner paid five of its salesmen the following amounts: [1942] A. P. Tucker $ 7,175.68 $ 8,158.31 $ 11,036.88 A. J. Johnson 8,090.89 8,541.78 12,022.84 W. C. Slocumb 10,267.97 11,984.89 15,545.75 C. E. Hermitage 6,239.99 7,629.72 11,531.43 G. M. Yates 13,117.73 14,266.84 19,889.14 These were gross amounts, out of which the salesmen paid their own expenses. The net pay of the salesmen was not more than 20 percent below these figures. T. B. Peeler was capable of earning more as a salesman than he was actually paid, but his services were more valuable to petitioner in relieving A. M. Peeler of managerial responsibility and so he was not permitted to go out on *129 the road. *525 The growth in petitioner's business and the comparative growth in the retail department following the improvements made therein by T. B. Peeler may be seen from the following: Percent Year Gross Retail Wholesale of retail to total [1936] $ 734,189.45 $ 226,416.33 $ 507,773.12 30.8 [1937] 987,887.09 285,172.88 702,714.21 28.9 [1938] 771,209.40 262,889.41 508,319.99 34.1 [1939] 711,349.45 272,131.30 439,218.15 38.3 [1940] 866,633.34 303,988.81 562,644.53 35.1 [1941] 1,004,324.32 377,901.40 626,422.92 37.6 [1942] 1,423,810.45 543,697.93 880,112.52 38.2 [1943] 1,501,310.35 559,334.61 941,975.74 37.3 The net income before officers' salaries and officers' salaries during the years in question was as follows: Officers' Year Net income salaries [1940] $ 64,909.05 $ 42,010.00 [1941] 59,620.87 35,283.12 [1942] 101,398.23 35,200.00 Total 225,928.15 112,493.12 The growth in surplus was as follows: Year ended -- Surplus May 31, 1939 $ 248,260.87 May 31, 1940 267,941.11 May 31, 1941 286,497.94 May 31, 1942 329,171.59 For the last two years under consideration, T. B. Peeler's compensation*130 was fixed by the board of directors of the corporation. We find that the salaries paid to T. B. Peeler for the years in question were reasonable. Decision will be entered under Rule 50. Footnotes 1. SEC. 717. DAILY INVESTED CAPITAL. The daily invested capital for any day of the taxable year shall be the sum of the equity invested capital for such day plus the borrowed invested capital for such day determined under section 719. SEC. 718. EQUITY INVESTED CAPITAL. (a) Definition. -- The equity invested capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following amounts, reduced as provided in subsection (b) -- * * * * (2) Property paid in. -- Property (other than money) previously paid in (regardless of the time paid in) for stock, or as paid-in surplus, or as a contribution to capital. Such property shall be included in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange. If the property was disposed of before such taxable year, such basis shall be determined in the same manner as if the property were still held at the beginning of such taxable year. If such unadjusted basis is a substituted basis it shall be adjusted, with respect to the period before the property was paid in, in the manner provided in section 113 (b) (2):↩ 2. SEC. 113. BASIS FOR DETERMINING GAIN OR LOSS. (a) Property Acquired After February 28, 1913. -- The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; except that -- * * * * (8) Same -- corporation controlled by transferor. -- If the property was acquired after December 31, 1920, by a corporation by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5) (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money, in addition to such stock or securities), then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.↩