National Pipe & Foundry Co. v. Commissioner

NATIONAL PIPE & FOUNDRY CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. National Pipe & Foundry Co. v. Commissioner Docket No. 32997. United States Board of Tax Appeals 19 B.T.A. 242; 1930 BTA LEXIS 2442; March 11, 1930, Promulgated *2442 Held, that the transaction by which the petitioner transferred its assets to a newly organized corporation for cash and preferred stock of such new corporation was a reorganization. Needham W. Graham, Esq., and Otto H. Schultz, C.P.A., for the petitioner. W. Frank Gibbs, Esq., for the respondent. TRAMMELL *242 The petition in this proceeding was filed against the respondent's notice advising the petitioner of a determination of deficiencies in *243 income tax for 1923 and 1925 of $311.23 and $15,068.28, respectively, which have been assessed. The petitioner admits its liability for the full amount of the deficiency for 1923 and for $151.67 of the deficiency for 1925. There is therefore in controversy only the remaining amount of the deficiency for 1925, or $14,916.61. The matters in controversy are (1) whether the exchange in 1925 by the petitioner of certain of its assets for cash and stock of another corporation constituted a sale or a reorganization, and (2) if the transaction is held to be a sale, what the fair market value of the stock received by the petitioner in such sale was. FINDINGS OF FACT. The petitioner*2443 is an Alabama corporation, organized in April, 1916, and had its manufacturing plant and principal office at Attalla. In 1925 it was engaged in the manufacture of soil pipe and fittings. On June 30, 1925, the outstanding capital stock consisted of 250 shares of 7 per cent cumulative preferred stock, of the par value of $25,000 and 1,050 shares of common stock of the par value of $105,000. On that date the petitioner had undivided profits of $179,704.24 and the book value of its fixed physical properties was $337,677.11. On March 8, 1925, the petitioner, through its president and treasurer, Wiley Alford, entertained a proposition from the Walworth Manufacturing Co., a Massachusetts corporation, with its principal office at Boston, and also engaged in the manufacture of soil pipe and fittings, for the purchase of all of the properties and assets of the petitioner at the price and on the terms set out in the following agreement which was entered into by the parties on the same date: WALWORTH MFG. CO. agrees to buy and NATIONAL PIPE & FOUNDRY CO. agrees to sell all the assets of the latter company including its good will, as well as the assets of the National Land Co. [all of*2444 whose stock being owned by National Pipe & Foundry Co.] on the following basis: The value of all assets of the seller company including land, buildings, equipment, patterns and tools shall be set at Four Hundred and Fifty Thousand Dollars ($450,000.00). Inventory of raw materials and supplies of work-in-process and finished stock shall be valued at cost. Accounts Receivable shall be accepted at book value with losses beyond such book value guaranteed by seller. Against the above assets shall be set up the liabilities of all kinds, the equity balance so arrived at shall be paid for by the purchaser in the following way: A new corporation shall be formed under the name of WALWORTH ALABAMA CO. or some similar title. Bonds shall be sold upon this company to yield sufficient to pay one-half the purchase price in cash or as near one-half as the position of the new company will permit. No further bonds shall be placed except by consent of 75% *244 of the preferred stock referred to hereafter. The balance of the purchase price shall be paid for in 7% cumulative preferred stock of the new company, non-voting unless the dividends remain unpaid over a period of 18 months, *2445 when the preferred stock shall have voting power equal to the common stock share for share. After the purchase price has been provided for the preferred issue shall be closed. Dividends shall be payable January 1st and July 1st. The preferred stock shall be callable at 105 and accrued dividends, in part by lot, or as a whole, on any dividend date by giving 60 days notice in writing. The Walworth Mfg. Co. agrees, at the time of transfer, to subscribe not less than One Hundred Thousand Dollars ($100,000.00) in cash to the common stock of the new company. The National Pipe & Foundry Co. agrees not to go into a competing line of business for a period of 5 years. The transfer shall be effective as of July 1st, 1925. The present organization agrees to continue in charge of operations of the new company under the supervision and following the instructions of the Walworth Mfg. Co. Up to and including June 30th, 1925, the National Pipe & Foundry Co. shall continue to operate as at present and shall seek orders from its customers for shipment up to Oct. 1, 1925 except as specifically instructed by Walworth Mfg. Co. It is understood what the liabilities of the National Pipe*2446 & Foundry Co. as of Dec. 31, 1924 are approximately $150,000.00 and the equity value using $450,000.00 as the value of all fixed assets is approximately $475,000.00. At a meeting of the board of directors of the petitioner held on March 17, 1925, and at a subsequent meeting of its stockholders held on April 3, 1925, by resolution unanimously carried, the votes of all the holders of the capital stock of the petitioner corporation being cast therefor, the proposed sale of the petitioner's properties and assets as previously negotiated was approved, and the board of directors was authorized and directed to take all such action and do all things necessary to effectuate and consummate said sale, the same to be effective as of July 1, 1925. At a special meeting of the stockholders of the petitioner held on June 23, 1925, a resolution which reads in part as follows, was adopted: WHEREAS, This, the National Pipe & Foundry Company, pursuant to a plan of reorganization, has entered into an agreement with the Walworth Manufacturing Company for the sale of the entire properties and assets of the said National Pipe & Foundry Company to a new corporation which the said Walworth Manufacturing*2447 Company agrees to cause to be organized and incorporated under the Laws of Alabama, at the price and on the terms in said agreement set forth, said agreement being evidenced by an instrument in writing dated the 8th day of March, 1925, executed by National Pipe & Foundry Company and Walworth Manufacturing Company, * * * and, WHEREAS, It is desirable that the affairs of this the National Pipe & Foundry Company be liquidated and distributed among its stockholders and this corporation dissolved as promptly after the completion of the said sale, transfer and conveyance of all its properties and assets to said new corporation to be organized as aforesaid, as practicable; *245 Now, THEREFORE, BE IT RESOLVED BY the stockholders of this, the National Pipe & Foundry Company, in meeting duly and regularly assembled, as follows: FIRST: That the Directors of this the National Pipe & Foundry Company be requested and directed promptly upon the completion of said sale, transfer and conveyance of the entire properties and assets of this corporation to said new corporation to be organized as aforesaid, and receipt of the consideration therefor, and as said consideration is received, if*2448 it be not all received at once, to make application and distribution of said proceeds of said sale as follows: That they retain in their hands a sufficient sum, not exceeding $25,000.00 for the payment of costs and expenses of such sale and paying, satisfying and discharging all contingent liabilities, such as Federal Tax liabilities, and any and all other debts or liabilities owing by this Company which are not assumed by said new corporation purchaser, and for the payment of the necessary costs and expenses of the liquidation and dissolution of this corporation. That they pay to the Preferred stockholders of this corporation, respectively, the par value of the shares of Preferred Stock held by them, respectively, and all accrued and unpaid dividends thereon to the date of such distribution; That they distribute among the holders of the Common Stock of this Corporation the shares of Preferred Stock in said new corporation so issued and delivered to this, the National Pipe & Foundry Company as part of the purchase price of said properties and assets so sold and conveyed, giving to each holder of Common Stock in this corporation his proportionate share of the preferred stock*2449 in said new corporation according to the number of shares held by such holder of the Common Stock in this corporation at the time of such distribution; That they distribute the remainder of the purchase price or proceeds of the sale of said property and assets among the holders of the Common Stock of this corporation, to each holder of Common Stock his proportionate share thereof according to the number of shares of Common Stock held by such stockholder in this corporation at the time of such distribution; SECOND: RESOLVED Further that all necessary and proper steps be taken to legally dissolve this corporation and terminate its existence, and that the directors as Trustees under the Statute, proceed as promptly as possible to settle the affairs of this corporation, and when all debts and liabilities of this corporation have been fully paid, satisfied and discharged, that they distribute the remainder of said sum so retained by them and not consumed in the payment, satisfaction and discharge of said expenses, debts and liabilities, among the holders of the Common Stock of this corporation, to each such stockholder his proportionate share thereof according to the number of shares*2450 of Common Stock held by him in this corporation. On June 26, 1925, by resolution of the board of directors of the petitioner the time for the performance on the part of the Walworth Manufacturing Co. of the agreement of March 8, 1925, was extended until August 1, 1925, the sale and transfer of the properties and assets to be made as of July 1, 1925. On July 28, 1925, the directors again extended the time of performance until September 1, 1925, but to be effective as of July 1, 1925. At the same meeting the directors also authorized Wiley Alford, the president and treasurer of the petitioner, to vote the shares of the preferred stock of the new corporation, to be issued, in order that the issuance of bonds and *246 the execution of a mortgage or deed of trust might be legally authorized as contemplated in the agreement of March 8, 1925. On July 29, 1925, the new corporation known as the Walworth Alabama Co. was incorporated under the laws of Alabama in Etowah County, Alabama. The authorized capital stock consisted of 5,000 shares of common stock without nominal or par value and 2,250 shares of 7 per cent cumulative preferred stock of the par value of $100 per share. *2451 The charter of the Walworth Alabama Co. provided that after the corporation began business the 2,250 shares or the entire amount of the preferred stock should be sold at their par value to the petitioner and the National Land Co. (all of whose capital stock was owned by the petitioner) in part payment of the properties and assets of the two corporations and issued to them or their nominees. The Walworth Manufacturing Co. of Boston purchased the 5,000 shares or the entire amount of the common stock of the new corporation and paid therefor $20 a share, or $100,000. None of the common stock of the new company was issued to the petitioner or to any of its stockholders. Pursuant to action previously taken by the stockholders of the petitioner and in accordance with the provisions of the Alabama Code respecting the dissolution of corporations there was filed with the probate judge of Etowah County, Alabama, on August 16, 1925, the required agreement and certificate thereby dissolving the petitioner. Upon an audit of the books and records of the petitioner by a firm of public accountants, the accounts and notes receivable were classified as "Good Receivables" in the amount of $138,156.19*2452 and "Doubtful Receivables" in the amount of $16,564.66. With the exception of the "Doubtful Receivables" all of the property and assets of the petitioner and the lands of the National Land Co. were transferred and conveyed by the petitioner and the National Land Co. to the Walworth Alabama Co. on August 17, 1925. The property and assets so transferred to the new corporation had a net book value of $337,677.11. After the sale by the new company of its capital stock and the transfer to it of the above-mentioned property and assets, the total of the book value of its assets and cash was $437,677.11. The Walworth Alabama Co. issued and sold its bonds in the amount of $250,000 face value secured by a mortgage or deed of trust on the property conveyed to it by the petitioner and the National Land Co. The bonds were sold at a discount of 10 per cent, the new company realizing $225,000 in cash therefor. *247 In consideration of the transfer and conveyance of the above mentioned property and assets the Walworth Alabama Co. paid to the petitioner for its fixed physical property $225,000 in money and 2,250 shares or the entire authorized issue of the Walworth Alabama Co.'s 7*2453 per cent cumulative preferred stock having a par value of $225,000. For the petitioner's inventories of raw materials, supplies, work in process, and finished stock which were accepted at cost, and for the accounts and notes receivable classified as "Good Receivables" which were accepted at book value all having a total value of $195,093.36, the Walworth Alabama Co. assumed and paid a like amount of the petitioner's liabilities totaling $246,188.90. The remainder of the liabilities the petitioner paid from the proceeds of the sale of its properties. The Walworth Alabama Co. also undertook to collect for the petitioner the "Doubtful Receivables" and to pay to the petitioner the amounts collected when and as collected. Pursuant to resolutions previously adopted and immediately upon receipt of the $225,000, the petitioner in 1925 retired its outstanding preferred stock paying the holders of such stock the par value thereof, $25,000 and the accumulated dividends thereon of $8,650 and made cash distributions to the holders of the common stock of 25 per cent and 100 per cent, or $26,250 and $105,000 respectively On or about October 22, 1925, and at some time subsequent to their receipt, *2454 the 2,250 shares of the preferred stock of the Walworth Alabama Co. were distributed to the common stockholders of the petitioner on the basis of the amount of common stock each held in petitioner. The common stock of the petitioner was canceled and so was that of the National Land Co. After making provision for other liabilities the petitioner's president and treasurer and its secretary, who were acting as agents of the board of directors and trustees in settling the affairs of the corporation, retained in their hands from the proceeds of the petitioner's property the amount of $32,217.13, out of which to pay the expenses of the dissolution and liquidation of the petitioner and to provide for any unpaid liabilities not assumed by the Walworth Alabama Co. and for any contingent liabilities that might arise. Out of the above-mentioned amount of $32,217.13 retained by the liquidating agents the costs and expenses of the sale of the property and of the liquidation and dissolution of the petitioner and of the National Land Co. have been paid except the tax liability here involved and a few minor unliquidated claims. Immediately after its incorporation, the sale of its common stock*2455 for $100,000 and the transfer to it by the petitioner of assets having a net book value of $337,677.11, the Walworth Alabama Co. had assets totaling $437,677.11. Reducing this amount by $25,000, the *248 amount of discount at which it sold its bonds, there is left an amount of $412,677.11. Deducting from that amount $225,000 representing the amount paid to the petitioner for property and assets, there remains $187,677.11, which represents the amount of net assets not including any value for good will against which the preferred stock of a par value of $225,000 was issued. In some years of its existence the petitioner had made "good" profits while in others it had sustained losses. The Walworth Manufacturing Co., which brought about the organization of the Walworth Alabama Co. and took all of its common stock, had an established reputation and was an excellent company. The preferred stock of the Walworth Alabama Co. was not listed on any stock exchange and up to July 1, 1929, none of it had been sold by any of the petitioner's stockholders. Dividends on the stock have been paid regularly with the exception of the first or second dividend, when there was a delay of a*2456 month or so. Wiley Alford, who was president of the petitioner and who became vice president of the Walworth Alabama Co. and continued in that capacity until July 1, 1926, received, in distribution from the petitioner, $52,500 par value of the preferred stock of the Walworth Alabama Co. Shortly after acquiring the stock he attempted to sell it to or obtain a loan on it from Ward, Sterne & Co., investment bankers of Birmingham, Ala., who were regularly engaged in buying and selling stocks and bonds. After communicating with the banks in the vicinity of the plant of the Walworth Alabama Co. and others in the same vicinity who were likely to be familiar with the Walworth Alabama Co. and who were likely to be in the market for such stocks, as well as communicating with the bankers who put out the bond issue of the company and the officials of the Walworth Co. at their New England headquarters, Ward, Sterne & Co. were unable to get any bid for the stock. Being unable to get any bid for the stock and being unwilling to create a market for the stock, Ward, Sterne & Co. refused to purchase the stock or to make a loan on it. M. H. Sterne, a member of the firm, told Alford that in view*2457 of the efforts of Ward, Sterne & Co. to sell the stock without success and with a knowledge of the properties which the Walworth Alabama Co. had and which were heavily bonded already he did not think the stock could be sold except at an amount far below its par value of $100 per share. Alford was also told that if he cared to have Ward, Sterne & Co. attempt to sell the stock at $50 or $60 a share, it could probably be sold for him at that price. Alford decided, however, to keep the stock rather than sell at that price. This was the only attempt made by Alford to sell the stock. Two *249 other holders of the preferred stock of the Walworth Alabama Co. shortly after they acquired it in the dissolution of the petitioner, sought to have Ward, Sterne & Co. sell it for them or make a loan on it, but they were no more successful than Alford. In determining the deficiency here involved, the respondent determined that the market value of the preferred stock of the Walworth Alabama Co. at the time of its receipt by the petitioner was equal to par, or $225,000. The difference between this amount plus $225,000 representing the cash received by the petitioner for assets, or $450,000, *2458 and $337,677.11, the book value of the petitioner's assets at the time of the transfer, or $112,322.89, the respondent determined to be the profit realized by the petitioner from the sale. The respondent accordingly increased the petitioner's income by $112,322.89. He further increased the petitioner's income by $2,420.24 also representing profit determined by him from the sale of capital assets. The preferred stock of the Walworth Alabama Co. at the time of its receipt by the petitioner in 1925 had a fair market value of $70 per share or a total value of $157,500. OPINION. TRAMMELL: The petitioner contends that the transaction set out in our findings of fact by which it disposed of its assets and acquired therefor money and preferred stock of the Walworth Alabama Co. was a reorganization resulting in no taxable income under the statute. The respondent contends that it was a sale resulting in taxable income. The pertinent provisions of the Revenue Act of 1926 are as follows: SEC. 203. (a) Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 202, shall be recognized, except as hereinafter provided in this section. *2459 * * * (b) (3) No gain or loss shall be recognized if a corporation a party to a reorganization exchanges property, in pursuance of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization. * * * (e) If an exchange would be within the provisions of paragraph (3) of subdivision (b) if it were not for the fact that the property received in exchange consists not only of stock or securities permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then - (1) If the corporation receiving such other property or money distributes it in pursuance of the plan of reorganization, no gain to the corporation shall be recognized from the exchange, * * * * * * (h) As used in this section and sections 201 and 204 - (1) The term "reorganization" means (A) a merger or consolidation (including the acquisition by one corporation of * * * substantially all the properties of another corporation), * * * *250 (2) The term "a party to a reorganization" includes a corporation resulting from a reorganization * * *. Section 286 of the Revenue Act of 1926 provides: "This title*2460 (The Income Tax), shall take effect as of January 1, 1925, * * *." The evidence discloses that the Walworth Alabama Co., the new corporation created under the laws of Alabama acquired "substantially all the properties of another corporation" that is, of the petitioner, and this fact brings the transaction within the plain language of the definition of a reorganization as contained in paragraph 203(h)(1). The transaction, however, did not come within the provisions of section 203(b)(3) above quoted for the reason that the petitioner exchanged its property for cash and securities and not solely for stock or securities in another corporation, a party to the reorganization. However, section 203(e) provides that if an exchange would be within the provisions of paragraph (3) of subdivision (b) if it were not for the fact that the property received in exchange consists not only of stock or securities permitted by such paragraph to be received without the recognition of gain, but also other property or money, then if the corporation receiving such other property or money distributes it in pursuance of a plan of reorganization, no gain to the corporation shall be recognized from the exchange. *2461 In this case, previous to the consummation of the exchange of the assets of the petitioner for securities and money, there was a plan evidenced by minutes of the corporation indicating a purpose to immediately distribute the money received for the assets. This money was distributed in pursuance of such plan. Under the definition of a reorganization as contained in paragraph 203(h)(1)(A) the acquisition of substantially all the property of one corporation by another is a reorganization. The plan to distribute the money which was received in part payment for the assets was a part of the plan of reorganization as defined by the statute. In the case of the , we said: "The test (of whether it was a reorganization) is not identity of stock ownership in the two companies, but whether some interest of the stockholders in the old is preserved to them in the new." This may well be true where the statute does not specifically define a reorganization to include something else. Under the 1926 Act the statute specifically states that a reorganization shall include the acquisition of substantially all the assets of another corporation. *2462 Definitions of a reorganization or what a reorganization might be in the absence of the definition in the statute do not have the effect of changing what the statute specifically provides shall be included in a reorganization. *251 Considering the definition of a reorganization and the other provisions contained in section 203 of the Revenue Act of 1926, it is our opinion that the transaction here involved comes within the plain language of the statute and does not give rise to taxable gain. In view of the foregoing, it is our opinion that the Commissioner erred in holding that the transaction resulted in tax liability to the petitioner. Reviewed by the Board. Judgment will be entered under Rule 50.