Independent Oil Co. v. Commissioner

Independent Oil Co., Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent Independent Oil Co. v. Commissioner Docket No. 5981 United States Tax Court 6 T.C. 194; 1946 U.S. Tax Ct. LEXIS 301; February 6, 1946, Promulgated *301 Decision will be entered under Rule 50. X Co. in 1930 transferred substantially all of its assets to petitioner, a newly organized corporation, in exchange for all of petitioner's capital stock, which had a stipulated fair market value. Seventy-five percent of this stock was immediately transferred by X Co. to Vacuum Oil Co. and the remaining 25 percent was placed in escrow where it was available to Vacuum at the latter's option. Vacuum then issued 22,978 shares of its stock to X Co. in exchange for the 75 percent of petitioner's stock. X Co. distributed the Vacuum stock to its shareholders and was dissolved shortly thereafter. These transactions all took place pursuant to an agreement between Vacuum and the stockholders of X Co.Held, that the basis (unadjusted) to the petitioner of the property acquired from X Co. is petitioner's cost, i. e., the fair market value of petitioner's stock, since petitioner did not acquire the property in a transaction described in section 113 (a) (7) and ( 8) of the Internal Revenue Code; held, further, that, in determining "property paid in for stock" in the computation of equity invested capital under the invested capital method for*302 excess profits tax purposes in 1940, petitioner is entitled to include the property paid in by X Co. for petitioner's stock at the cost of said property to the petitioner. William W. Landis, Esq., and Homer Hendricks, Esq., for the petitioner. William D. Harris, Esq., and Brooks Fullerton, Esq., for the respondent. Kern, Judge. KERN *194 The respondent has determined a deficiency against the petitioner in excess profits tax for the taxable year ended December *303 31, 1940, in the amount of $ 41,562.25. The question at issue is whether, in computing the petitioner's excess profits credit by the invested capital method, the amount to be included in equity invested capital for "property paid in for stock" is (a) the cost of said property, or (b) the basis of that property in the hands of the petitioner's transferor. FINDINGS OF FACT. Most of the facts have been stipulated by the parties and are found by us to be as stipulated. *195 Petitioner, Independent Oil Co., of Pennsylvania, is a corporation organized and doing business under the laws of the State of Delaware, with its principal office and place of business in Altoona, Pennsylvania; the date of its incorporation was March 15, 1930. An excess profits tax return was filed for the petitioner with the collector of internal revenue, Philadelphia, Pennsylvania, for the taxable year ended December 31, 1940. The petitioner acquired the properties which are involved in this proceeding from the Independent Oil Co., hereinafter referred to as the "old company." The old company was a corporation organized in 1924 to take over the business theretofore operated by Benjamin Cohn as an individual*304 since 1910 or 1911. The old company was a distributor of petroleum products, principally gasoline and lubricating oil, operating as a middleman between manufacturers and retail dealers, and it operated a few retail stations of its own. It did not manufacture its own products and had no fixed source of supply, but bought from various manufacturers and refiners at specifications furnished to them. The petitioner came into existence as a corporation pursuant to negotiations which were begun between the Vacuum Oil Co. and the stockholders of the old company with a view to Vacuum's obtaining an interest in a corporation (petitioner) to be organized for the purpose of taking over most of the assets of the old corporation. The negotiations were carried on by agents of the Vacuum Investing Co., a subsidiary of Vacuum Oil Co. This resulted in a contract dated January 31, 1930, the parties to which were Vacuum Oil Co. and Vacuum Investing Co., on the one hand, and all the stockholders of the old company, on the other hand. On February 3, 1930, the stockholders and directors of the old company approved the contract. Briefly, the contract 1 provided that a new company (the petitioner) should*305 be organized by Vacuum, with capital stock to be represented by 35,000 shares of common stock without par value. The stockholders of the old company agreed that they would acquire or cause the old company to acquire all of this capital stock and also certain income certificates, which, in general, would provide that the holders would be entitled to an amount not in excess of $ 500,000 if the new company made an average income in excess of 8 percent on its invested capital (capital stock of $ 3,500,000 plus surplus) over the next 10 years. In exchange for this stock and income certificates the old company would transfer to the new company all of its assets which were used in the oil business and working capital not in excess of $ 485,000, free and clear of all liabilities, mortgages, liens, and encumbrances except a $ 15,000 mortgage liability. *306 *196 The stockholders agreed that the old company would deliver to the Vacuum Oil Co. and Vacuum agreed to take from the old company 26,250 shares of the capital stock of the new company and a 10-year option on the remaining 8,750 shares, which were to be put in escrow under conditions detailed in the contract. In exchange for the 26,250 shares Vacuum agreed to deliver to the old company on the date of closing enough shares of its stock to equal $ 1,312,500, based upon the agreed valuation of the average stock market price of Vacuum stock for the 30 days preceding the date of closing, and, in addition, enough shares of its stock at the agreed valuation to equal $ 812,500, which stock should be placed in escrow to be sold as directed by Vacuum over a period of 5 years, but at least one-fifth of the stock to be sold each year. The proceeds of this stock were to be paid over to the old company as the stock should be sold, and Vacuum obligated itself to pay at the end of 5 years whatever difference there might be, if any, between such proceeds and the sum of $ 1,312,500. This difference was referred to as the "unpaid balance" and at the time of closing was stated nominally as *307 $ 500,000; upon sales of stock in excess of the value at which they were escrowed this "unpaid balance" was to be correspondingly reduced; on sales below the escrowed value the "unpaid balance" was to be correspondingly increased. The contract further provided for the payment of cash dividends upon the escrowed stock to the old company or its designees. It was also stipulated in the contract that the stockholders of the old company would cause the old company to discontinue all operations which might compete or interfere with the new company, immediately after the date of closing, and to dissolve as soon thereafter as practicable. The contract likewise provided that the new corporation at the time of organization should have a board of directors of seven members, including three who had been officers and stockholders of the old company. Two of these officers and stockholders also agreed that they would enter the service of the new company as executives for a fixed period. On April 4, 1930, pursuant to the contract, the petitioner acquired from the old company all of the assets of the latter except certain securities, a small amount of cash, accounts receivable, and a small piece*308 of real estate valued at approximately $ 4,000, to which satisfactory title could not be furnished, the assets so acquired constituting approximately 86 percent in value of the total assets of the old company. Pursuant to the contract the petitioner, on April 4, 1930, issued to the old company in exchange for these assets all of the capital stock of the petitioner, namely, 35,000 shares of common stock of no par value, and $ 500,000 of its income certificates. On April 4, 1930, upon receipt of the 35,000 shares of petitioner's no par common stock, the old company, pursuant to the contract, placed in escrow, 8,750 shares (25 percent) of petitioner's stock under *197 a 10-year option to Vacuum, and the remaining 26,250 shares (75 percent) of petitioner's stock were transferred by the old company outright to Vacuum Oil Co. Under the valuation formula prescribed by the contract the old company, on the date stated, received in exchange 22,978 shares of Vacuum stock, of which 8,786 shares were immediately placed in escrow to be sold as provided in the contract and set forth above. All the escrowed stock was sold during 1932, and Vacuum's obligation was discharged in that year. On*309 April 4, 1930, the 35,000 shares of petitioner's no par common stock had a fair market value of $ 3,156,558.67. The adjusted basis to the old company for determining loss upon sale or exchange in respect of the assets acquired by the petitioner from the old company was $ 1,223,225.35. The $ 500,000 of income certificates had no fair market value. The 22,978 shares of Vacuum stock received by the old company as set forth above had a fair market value as of the time of receipt of $ 2,125,000. On April 4, 1930, the outstanding capitalization of Vacuum Oil Co. consisted solely of 5,202,723 shares of common stock of a par value of $ 25 per share. The form of the contract and plan fulfilled the demands of the Vacuum Oil Co.'s business policy. Vacuum required that petitioner should be organized so that it would be free from undisclosed liabilities of the old company; also petitioner was to start out with no substantial liabilities and with adequate working capital. By the contract and plan, Vacuum retained the old management and gave them sufficient interest in petitioner to furnish an incentive for successful operation. The $ 812,500 of Vacuum stock was put in escrow because it was*310 considered that its value would so increase before its sale that a material part of the purchase price would be saved. The 25 percent of petitioner's stock was optioned to Vacuum so that Vacuum might acquire the entire interest in petitioner if it so desired. A resolution of the board of directors of the old company dated July 2, 1930, "authorized, empowered and directed" its officers, pursuant to the contract and plan, to distribute to the stockholders of the old company pro rata the assets received in the exchanges. By further resolutions of July 23 and September 4, 1930, the assets received in the exchanges were made available to the stockholders of the old company on request in accordance with an agreement on the part of said stockholders, dated September 2, 1930. The old company, on April 4, 1930, ceased to transact business and the petitioner thereafter conducted the business formerly operated by the old company. The old company was dissolved by court decree on December 28, 1930. Subsequent to the consummation of these transactions, the Commissioner of Internal Revenue proposed deficiencies in income tax for the year 1930 against the old company and against its stockholders, *311 *198 based on gains alleged to have been realized as a result of the transactions. The decision of the Board of Tax Appeals in the case involving the old company, Independent Oil Co. v. Commissioner, 35 B. T. A. 32, held in the favor of the taxpayer. The Commissioner appealed from this decision to the Circuit Court of Appeals for the Third Circuit, which reversed the Board and remanded the cause for redetermination of the taxes. The Third Circuit's decision is reported sub nom. Commissioner v. First National Bank of Altoona (1939), 104 Fed. (2) 865. Petitions for writs of certiorari in the case of the old company and for the individual stockholders involved were filed with the United States Supreme Court, but were later dismissed on motion of the taxpayer. 2 While the petitions were pending, the old company and its stockholders reached a settlement agreement with the Government, under which the amount of the income tax of the old company for 1930 in respect of the transaction herein described was determined to be $ 174,000, plus interest, representing a recognizable gain to the old company of $ 1,450,000. *312 OPINION. In computing its excess profits tax for 1940 petitioner used the invested capital method in determining its excess profits credit. The petitioner was entitled to use either the income or the invested capital method in computing this credit, whichever resulted in the larger credit. In the computation of equity invested capital under the invested capital method, petitioner included "property paid in for stock" at cost, viz., the fair market value of the petitioner's stock paid for the old company's property, namely $ 3,156,558.67. 3 *313 Respondent asserts that under the invested capital method the petitioner should not have included "property paid in for stock" at cost, but rather at the basis of the property to the petitioner's transferor. Using the latter basis, the resulting excess profits credit is less than the credit which would have been obtained under the income method. Therefore, the respondent used the income method in determining the deficiency, and he urges that petitioner should also be required to do so. Section 718 (a) (2) of the Internal Revenue Code provides that, in determining equity invested capital, "property paid in for stock" shall be included in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange. 4*314 According to section 113 (a) of the *199 code, the basis (unadjusted) of property for determining loss shall be the cost of such property, unless it comes within one of the exceptions specified in section 113 (a). Only two exceptions, (7) and (8), listed in 113 (a) could be applicable to the case under consideration, and our task is to ascertain whether this matter comes within one of those exceptions. 5 The applicable provisions of section 113 (a) of the Internal Revenue Code are: SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS. (a) Basis (Unadjusted) of Property. -- The basis of property shall be the cost of such property; except that -- * * * * (7) Transfers to corporation. -- If the property was acquired -- (A) after December 31, 1917, and in a taxable year beginning before January 1, 1936, by a corporation in connection with a reorganization, and immediately after the transfer an interest or control in such property of 50 per centum or more remained in the same persons or any of them, or (B) in a taxable year beginning after December 31, 1935, by a corporation in connection with a reorganization, then the basis shall be the same as it would be in the hands of*315 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 * * * [Emphasis supplied.] (8) Property acquired by issuance of stock or as paid in surplus. -- If the property was acquired after December 31, 1920, by a corporation -- (A) by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5) * * * 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. The respondent urges that the "property paid in for stock" was acquired in a transaction described in section 112 (b) (5) and that under section 113 (a) (8) the petitioner's basis for computing loss should be the same as the basis to the petitioner's transferor (the old company). Section 112 (b) (5), Internal Revenue Code, provides: (5) No gain or loss shall be recognized if property is transferred to a corporation by one or more persons*316 solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation * * *. [Emphasis supplied.] *200 "Control" as used in section 112 (b) (5) is defined in section 112 (h) of the code to mean the ownership of stock possessing at least 80 per centum of the total combined voting power of all classes of stock entitled to vote and at least 80 per centum of the total number of shares of all other classes of stock of the corporation. The problem at hand may be stated as follows: Was the old company or its shareholders immediately after the exchange of property for the petitioner's stock, in control of the petitioner within the meaning of the statutory provisions quoted? Let us review the essential facts. On January 31, 1930, a contract was entered into between Vacuum and the stockholders of the old company which provided that certain transactions should take place. Pursuant to that contract and all on the same date, April 4, 1930, the following steps were taken: (a) The old company transferred substantially all of its assets to the petitioner for all of the latter's stock; (b) then the old*317 company transferred 75 percent of petitioner's stock outright to Vacuum and placed the remaining 25 percent in escrow where it was available to Vacuum at Vacuum's option; and (c) Vacuum transferred 22,978 shares of its stock, 8,786 shares of it in escrow, and the so-called "obligation" to the old company in exchange for the 75 percent of petitioner's stock. Can it be said that under these facts the old company or its shareholders were in control of the petitioner immediately after the exchange of the property for petitioner's stock? We think not. The entire operation was in accordance with a prearranged plan. The separate transfers were but component steps of a single transaction. It is well settled that the transaction must be viewed as a whole. Diescher v. Commissioner, 110 Fed. (2d) 90; certiorari denied; Budd International Corporation v. Commissioner, 143 Fed. (2d) 784; certiorari denied, 323 U.S. 802; Halliburton v. Commissioner, 78 Fed. (2d) 265; and Spang, Chalfant & Co., 31 B. T. A. 721. Here, the old company*318 held a majority of petitioner's stock only momentarily at the most. In fulfillment of the preexisting contractual obligation, 75 percent of petitioner's stock was transferred outright to Vacuum immediately after being received by the old company. Obviously, the old company did not acquire "control" of the petitioner within the meaning of sections 113 (a) (8) and 112 (b) (5), and we so hold. Budd International Corporation v. Commissioner, supra; Halliburton v. Commissioner supra; Bassick v. Commissioner, 85 Fed. (2d) 8; certiorari denied, 299 U.S. 592; Diescher v. Commissioner, supra;Heberlein Patent Corporation v. United States, 105 Fed. (2d) 965. It must likewise be held that the case at hand does not come within the exception expressed in section 113 (a) (7). In view of the express language of this section, it is immaterial that there was a reorganization as between the old company and the new company (petitioner *201 here), since immediately after the transfer of the property an interest*319 or control in such property of 50 percent or more did not remain in the old company as required by section 113 (a) (7) if petitioner is to be required to take the basis of the old corporation. See Commissioner v. Schumacher Wall Board Corporation, 93 Fed. (2d) 79, 81; Hazeltine Corporation v. Commissioner, 89 Fed. (2d) 513; and Spang, Chalfant & Co., supra.Cf. Bickford v. Helvering, 98 Fed. (2d) 568. Respondent relies upon the decision of the Circuit Court of Appeals in the case of Commissioner v. First National Bank of Altoona, 104 Fed. (2d) 865. It is apparent that this case does not make the instant case res judicata, since different parties and different issues were there involved. However, in view of respondent's contentions and our respect for the court deciding it, we have examined the decision therein with care. It is our opinion that that case is not authority either expressly or by implication for the proposition that under all the facts present the old corporation or its stockholders retained such*320 control over petitioner as to constitute the transfer of property to petitioner one covered by section 113 (a) (7) or ( 8) of the Internal Revenue Code. Since the instant case involves a question of basis only, it is section 113 which is controlling; and, as we have already pointed out, the question of whether there was a reorganization under section 112 is material only as it is made so by section 113 (a) (7) or (8). Respondent in his opening statement advanced the view that sections 750 and 751 of the Internal Revenue Code, added by section 201 of the Second Revenue Act of 1940 and repealed by section 229 (b) of the Revenue Act of 1942 (see sec. 760, I. R. C.) are applicable to the situation here present. In his brief he makes no such contention and we assume therefore that he has abandoned this position. We conclude that the petitioner was correct in its computation of equity invested capital in including "property paid in for stock" at the cost of said property, viz., the fair market value of petitioner's stock paid for this property, namely $ 3,156,558.67. Decision will be entered under Rule 50. Footnotes 1. The contract is described in considerable detail in a decision previously promulgated by the Board of Tax Appeals and involving the old company as the petitioner, Independent Oil Co. (1936), 35 B. T. A. 32↩. 2. 309 U.S. 691↩. 3. Regulations 109 provides, inter alia: "Sec. 30.718-1. * * * For the purpose of determining equity invested capital, the amount of any property paid in is the unadjusted basis to the taxpayer for determining loss upon a sale or exchange under the law applicable to the taxable year for which the invested capital is being computed. * * * "If the basis to the taxpayer is cost and stock was issued for the property, the cost is the fair market value of such stock at the time of its issuance * * *."↩ 4. SEC. 718. [I. R. C.]. EQUITY INVESTED CAPITAL. [As amended by the Second Revenue Act of 1940.] (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. * * *↩ 5. Section 113 (a) (12), Internal Revenue Code, which preserves the rules of basis established by the Revenue Act of 1932, and section 113 (a) (16), preserving the rules in the Revenue Act of 1934, are to the same effect as section 113 (a) (7) and (8)↩, insofar as applicable here, and need not be considered separately.