Cortland Specialty Co. v. Commissioner

CORTLAND SPECIALTY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. MRS. H. R. SARGENT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. H. R. SARGENT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Cortland Specialty Co. v. Commissioner Docket Nos. 39403, 40353, 40354. United States Board of Tax Appeals 22 B.T.A. 808; 1931 BTA LEXIS 2054; March 19, 1931, Promulgated *2054 1. A transaction whereby one corporation "agrees to sell, transfer and convey * * *" certain fixed tangible assets for a sum certain, payable in cash and promissory notes, is a sale and not a reorganization within the meaning of section 203(h)(1)(A) of the Revenue Act of 1926. 2. Where a vendor receives more than one-half of the purchase price of certain property during a taxable period, the income realized from such a sale can not be reported on the installment basis. M. Manning Marcus, Esq., for the petitioners. H. B. Hunt, Esq., and L. A. Luce, Esq., for the respondent. MORRIS *808 These proceedings, consolidated for hearing and decision, are for the redetermination of a deficiency in income tax of $13,412.82 for disolved, and of liabilities in the same amount against its two stockholders, Mr. and Mrs. H. R. Sargent, as transferees under the provisions of section 280 of said act. *809 The respondent is alleged to have erred in each of the following particulars: 1. His failure to recognize the transfer of the property of the Cortland Specialty Company, a corporation, to another corporation and complete liquidation of*2055 said company as a reorganization contemplated under section 203(h)(1)(A) of the Revenue Act of 1926; and 2. In the event that it be determined that the transaction in question was not a reorganization, as alleged, the respondent nevertheless erred in not holding the transaction as constituting an installment sale within the meaning of sections 232 and 212(d) of the Revenue Act of 1926. At the hearing the parties stipulated that the individuals "are transferees of the Cortland Specialty Company, within the meaning of section 280 of the Revenue Act of 1926, and are each liable for the taxes if any due from said Cortland Specialty Company for the year 1925." FINDINGS OF FACT. During 1925 the Cortland Specialty Company, hereinafter referred to as the company, was, prior to its dissolution on June 30, 1926, a corporation, engaged in the distribution of petroleum products in Cortland, N.Y., and the vicinity thereof, where its principal office was located. In September, 1925, the stockholders of the said company were H. R. Sargent and his wife, joint petitioners herein. Sargent was the president and treasurer of the company, his wife was secretary, and they were two of the*2056 three directors of the company. During 1925 the company entered into certain negotiations with the Deyo Oil Company, Inc., of New York, and on September 15, 1925, the directors of the company, at a special meeting, attended by all, adopted the following resolution with respect thereto: On motion of Mrs. Sargent, seconded by Mr. Bucklin and carried, all voting aye: "Resolved that this corporation sell all of its real property, leases and fixed and tangible property of every name and nature to the Deyo Oil Company, Inc., for the sum of Two Hundred Thirteen Thousand Dollars ($213,000.00) plus the inventory value of the stock of merchandise on hand on October 1st, 1925, all according to the terms of a proposed contract submitted at this meeting, and that the President and the Secretary be and they hereby are authorized to execute said contract on behalf of this corporation and attach the corporate seal thereto. "And be it further resolved that the President be and he hereby is authorized to execute any further necessary instruments to convey the title to the property sold under said contract to the Deyo Oil Company, Inc., and to attach the corporate seal thereto. "And be it*2057 further resolved that the President be and he hereby is authorized to call a special meeting of the stock holders of this corporation at the *810 office of the company on the 30th day of September, 1925 at 10 o'clock in the forenoon to take action upon the proposition of making such sale." On September 16, 1925, the following duly executed contract was entered into between the company and Deyo Oil Company, Inc., in consummation of the aforestated negotiations: MEMORANDUM AGREEMENT Between CORTLAND SPECIALTY COMPANY, a domestic corporation, having its principial office in Cortland, New York, first party, and DEYO OIL COMPANY, INC., a domestic corporation, having its principal office in Binghamton, New York, second party. WHEREAS first party has been, and now is, engaged in the business of buying, selling and dealing in gasoline, oils and other petroleum products at Cortland, and at other points in the State of New York, and has determined to discontinue such business, and to sell and dispose of all its physical and tangible assets connected therewith, and WHEREAS second party has determined to purchase such assets on the terms and conditions hereinafter stated, *2058 Now, THEREFORE, this agreement WITNESSETH: FIRST: First party hereby agrees to sell, transfer and convey to second party, all and singular its real property, interests in real property, leases of real property and privileges occupied by first party under lease, switches, and switching privileges, storage tanks, office furniture and equipment, machinery, tools, utensils, horses, harnesses, tank wagons, sleighs, motor trucks and equipment, gasoline, kerosene and lubricating oil pumps and outfits, drums and all other physical assets of first party, used in connection with its business as heretofore and now conducted by it, situate at Cortland, Marathon, Tully, Cazenovia, Auburn, Seneca Falls, Geneva, Newark or elsewhere, except merchandise on hand, cash on hand and in bank, books of account, record books, accounts receivable and bills receivable, for the sum of Two Hundred Thirteen Thousand Dollars ($213,000.00) which second party agrees to pay at the time, and in the manner hereinafter stated. SECOND: First party agrees to furnish as soon as possible, Abstracts showing a merchantable title to the real property occupied by it at Cortland, Marathon, Tully, Seneca Falls and Geneva, *2059 and house and lot at Cazenovia, and to convey the same to second party free and clear from all liens and encumbrances, by deeds containing usual covenants of warranty. First party also agrees to assign to second party by proper instruments, the lease for premises on which storage tanks belonging to first party, are located, at Cazenovia, Auburn and Newark, also to assign all leases covering loaned equipment, and to execute and deliver such other instruments as may be necessary to transfer and convey to second party, a good and valid title to all the property and assets to be transferred under this agreement. All papers to be submitted to second party for examination as soon as possible. Deeds and other instruments of transfer to be delivered to second party at the office of the attorney for first party at Cortland, New York, October 1st, 1925, and transfers to be made as of that date. THIRD: Second party agrees to pay said purchase price of $213,000.00 at the office of the attorney of first party in Cortland, New York, October 1st, 1925, on execution and delivery of proper conveyances and transfers, as follows: - October 1st, 1925 $53,250.00 November 1st, 1925 35,500.00 December 1st, 1925 21,300.00 March 1st, 1926 26,625.00 June 1st, 1926 26,625.00 September 1st, 1926 26,625.00 December 1st, 1926 23,075.00 Total $213,000.00 *2060 *811 The payment of October 1st, 1925 is to be made in cash. Subsequent payments are to be made in six negotiable promissory notes of first party, each dated October 1st, 1925, and payable on or before the time when such deferred payments fall due respectively, as above provided, with interest. FOURTH: It is further agreed that first party shall sell to, and second party shall purchase, all of the merchantable gasoline, kerosene, oils and other petroleum products belonging to first party on hand at the opening of business October 1st, 1925; the amount, value and purchase price of such merchandise, shall be determined by an inventory taken at prevailing cost prices on that day. Second party shall pay the purchase price as so determined, the same to be paid by two promissory notes of second party, each for one-half the purchase price, notes to be dated October 1st, 1925, one maturing November 1st, 1925, and the other maturing December 1st, 1925, with interest. FIFTH: In consideration of the premises, first party covenants and agrees that it will not engage in the business of buying, selling or dealing in, gasoline, kerosene or other petroleum products from and after*2061 October 1st, 1925. Although the aforesaid agreement specifies $213,000, the actual selling price of the assets transferred by the petitioner to the Deyo Company was $212,820, exclusive of the merchandise inventory, separately provided for, and the depreciated cost of said assets was $111,644.42. The foregoing transaction received the official sanction of the stockholders of the Company by the following resolution of September 30, 1925: Upon motion duly made, seconded and unanimously carried. RESOLVED that the action of the Board of Directors in authorizing the sale of all the fixed assets of this corporation to the Deyo Oil Company, Inc. as set forth in a resolution adopted on the 15th day of September, 1925, be and the same is hereby ratified and confirmed and the Directors and officers be and they hereby are authorized to complete the transfer of said property according to the terms of said resolution and the contract made pursuant thereto. On October 1, 1925, the company received from the Deyo Company, under the above agreement, the initial cash payment of $53,250, and six promissory notes dated October 1, 1925, maturing on the dates set forth in the said agreement, *2062 the said notes aggregating $159,750. Shortly after October 1, 1925, the company distributed the said $53,250 and promissory notes to its two stockholders, hereinbefore mentioned, as a liquidating dividend. Immediately after receiving the notes Sargent discounted some of them, but none of them was discounted by the company. The first of the six notes, *812 maturing on November 1, 1925, in the sum of $35,500, was paid to the company on its due date by the Deyo Company and the second, maturing on December 1, 1925, in the sum of $21,300, was paid at maturity to H. R. Sargent, individually. The remaining four notes were paid at maturity during 1926, either to H. R. Sargent or his wife, none of the proceeds thereof being received by the company. Instead of paying for the merchandise inventory by promissory notes, as provided in the fourth paragraph of the contract of sale of September 16, 1925, the Deyo Company paid the company $23,803.82 by check on or about October 9, 1925, which sum was used as part payment of its outstanding indebtedness of the Texas Company. That amount was in addition to the other payments received in 1925 under said contract hereinbefore mentioned. *2063 The accounts receivable, excepted from the sale by paragraph two of said contract, at or about the effective date of the transfer, amounted to about $60,000, most of which were subsequently collected. The bills payable outstanding at that time, not assumed by the Deyo Company, aggregated $56,000, all of which were subsequently paid by the company. At the same time, that is, on September 16, 1925, Sargent entered into an employment agreement with the Deyo Company providing for his employment as general manager of the business of the said Deyo Company at Cortland and in the vicinity thereof for the term of one year, beginning October 1, 1925, at a salary of $10,000 per annum, with option in the company to renew from year to year. Without that agreement Sargent would not have entered into the memorandum agreement of sale for his company. The company's return for the calendar year 1925 shows that its total assets at the beginning and at the end of that year, were as follows: Beginning of taxable year End of taxable year ASSETS Amount Total Amount Total Cash $14,426.35 $10,568.90 Notes receivable 2,761.99 9,357.30 Accounts receivable $39,489.19 $23,273.16 Less reserve for bad debts 3,354.85 6,351.48 36,134.34 16,921.68 Inventories: Merchandise 18,761.62 18,761.62 Capital assets: Land 7,150.00 Buildings 23,033.73 Marchinery and equipment 1,768.99 Furniture and fixtures 1,727.12 Delivery equipment - auto trucks 31,711.80 Horses, wagons, sleighs, etc 1,969.14 Tanks and pumps 63,686.38 123.897.16 Less reserves for depreciation and depletion 41,276.43 82,620.73 Other assets: Pfd. stock - D. D. Newton Garage Co 4,000.00 4,000.00 4,000.00 4,000.00 Total assets 165,855.03 40,847.88 *2064 *813 Its total liabilities at the beginning and end of 1925, as shown in said return, exclusive of capital and surplus and an amount shown as a liability for a liquidating dividend at the end of that period, were $19,144.95 and $3,572.20, respectively. Between January 1, 1925, and September 30, 1925, the company acquired additional equipment for the distribution of its petroleum products. The respondent determined that the transfer in question resulted in taxable net income to the company in the amount of $101,175.58, and he increased the company's net income for 1925 in that amount. OPINION. MORRIS: The first question to be determined is whether the transaction between the Cortland Specialty Company, the stock of which the other petitioners herein owned, and the Deyo Oil Company, Inc., was a reorganization within the meaning of section 203(h)(1) of the Revenue Act of 1926, or whether it constituted nothing more than a sale of corporate assets at a taxable profit. That section provides that: (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*2065 of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected. (2) The term "a party to a reorganization" includes a corporation resulting from a reorganization and includes both corporations in the case of an acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation. The petitioners have made no attempt to bring the present facts within (B), (C), or (D), of the above statutory definition, but they do contend that substantially all of the Cortland Specialty Company's properties were acquired by the Deyo Company, and that under (A) above, the transaction was a reorganization. *2066 There is no question whatsoever but that substantially all of the Company's properties were acquired by the Deyo Company, but we are unable to concede that a "reorganization" was thereby effected within the meaning of the Act. A reorganization, etymologically speaking, "signifies nothing more than 'the act or process of organizing anew.'" Fletcher *814 Cyclopedia Corporations, vol. 7, p. 8465. "The term * * * has no very definite meaning in the law of corporations, but is applied indifferently to various proceedings and transactions by which succession of corporations is brought about, and also to proceedings by which existing corporations are continued under a different organization without the creation of a new corporation." Id. In , the Court quoted with approval the following definition taken from Morawetz in his work on Private Corporations, sec. 812: The term "reorganization" is commonly applied to the formation of a new corporation by the creditors and shareholders of a corporation which is in financial difficulties, for the purpose of purchasing the company's works and other property, *2067 after the foreclosure of a mortgage or judicial sale. The result of a transaction of this kind is to form a new corporation to carry on the business of the old company upon a new basis, free from its debts and obligations, except to the extent that they have been expressly assumed. In discussing the terms "reorganization," "consolidation," and "merger," Fletcher's Cyclopedia Corporation states that: Reorganization is clearly distinguishable from consolidation or merger. Sometimes, however, the term reorganization is loosely used as synonymous with consolidation or merger, but in reality there is a clear line of demarcation in that in the former case there are always two or more existing corporations which combine together, while in the latter case there is in effect but one corporation which merely changes its form and ordinarily dies upon the creation of the new corporation which is its successor. In other words, in case of reorganizations there ordinarily are at no time two or more going corporations in existence, while in case of consolidation or merger there must always be two or more existing corporations before there can be any consolidation or merger. [Vol. 7, p. 8467.] *2068 In , the Court defines mergers and consolidations as follows: The results of a merger are entirely different from those of a consolidation. Ordinarily, when corporations of two or more states "consolidate", in the technical sense of the term, the old corporations are dissolved and a new corporation comes into being in each state. Note to ; 2 Elliott on Railroads, § 335. However, when two corporations unite by way of merger, the result is not the same as in case of consolidation. In the case of merger the one is absorbed by the other, and when we come to apply the true test as to whether, under a given statement of facts, there has been a merger, it becomes necessary to ascertain whether the existence of one of the corporations, as such, has been preserved, and the other has ceased to exist. In the case of , the court, in discussing the question as to the difference between a merger and a consolidation, among other things, said: *2069 "That generally the effect of consolidation, as distinguished from a union by merger of one company into another, is to work a dissolution of the companies consolidating, and to create a new corporation out of the elements of the former, is asserted in many cases, and it seems to be a necessary result." *815 Also in the case of , it is said: "There seems to be a great confusion as to the difference between consolidation and merger and sale. Rightly understood, there never can be a consolidation of corporations, except where all the constituent companies cease to exist as separate corporations, and a new corporation, to wit, the consolidated corporation, comes into being. A merger, rightly understood, is not the equivalent of consolidation at all, but exists where one of the constitutent companies remains in being, absorbing or merging in itself all the other constituent corporations." Thompson on Corp. § 396, states the law as follows: "It has been seen that consolidations frequently take the form of one company purchasing the capital stock*2070 of another. In such cases, and in others that may be imagined, the terms of the union may be such that one corporation, without any change of name, merely absorbs or annexes the other. In such a case the absorbing corporation continues unaffected, and the other is dissolved. Railway consolidations, for instance, often take the form of the absorption by one railway of others, as where branches are united with a trunk line, or short lines are united with longer lines, so as to form one continuous line, in which case the absorbing company proceeds without any change of name, and succeeds to the rights possessed by the absorbed company." The facts in this case fail in our opinion to satisfy any one of the above definitions of reorganization, consolidation, or merger. What actually transpired was that, after certain preliminary negotiations between the two companies, they entered into an agreement of bargain and sale whereby certain specified assets were transferred in consideration of a sum certain in cash and promissory notes. Our determination is borne out by the resolutions of the board of directors and stockholders and by the provisions appearing in the agreement itself. The*2071 resolution adopted by the board of directors on September 15 indicates that their intention was to sell all the fixed and tangible property of the company. Following a statement of their purpose the said directors' resolution authorized the president of the company to execute the "* * * necessary instruments to convey the title to the property sold under said contract * * *," and still later therein it referred to the transaction as a sale. Nowhere in said resolution does there appear the slightest hint of an intention to reorganize the company, or to merge or consolidate it with another or other corporations. The agreement itself states that the company "* * * has determined to discontinue such business, and to sell and dispose of all its physical and tangible assets connected therewith, and Whereas second party has determined to purchase such assets * * *," etc., which shows that the transaction as between the parties was one of purchase and sale. The resolution adopted at the stockholders meeting on September 30, was one ratifying and confirming the action of the directors "* * * in authorizing the sale of *816 all the fixed assets of this corporation to the Deyo Oil*2072 Company, Inc. * * *." The alternative issue is whether the transaction constituted an installment sale. Section 232 of the Revenue Act of 1926 provides that the net income of a corporation "shall be computed on the same basis as is provided in subdivisions (b) and (d) of section 212 or in section 226." Section 212 provides that: (d) Under regulations prescribed by the Commissioner with the approval of the Secretary, a person who regularly sells or otherwise disposes of personal property on the installment plan may return as income therefrom in any taxable year that proportion of the installment payments actually received in that year which the total profit realized or to be realized when the payment is completed, bears to the total contract price. In the case (1) of a casual sale or other casual disposition of personal property for a price exceeding $1,000, or (2) of a sale or other disposition of real property, if in either case the initial payments do not exceed one-fourth of the purchase price, the income may, under regulations prescribed by the Commissioner with the approval of the Secretary, be returned on the basis and in the manner above prescribed in this subdivision. *2073 As used in this subdivision the term "initial payments" means the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable period in which the sale or other disposition is made. The petitioner corporation was clearly not "regularly" engaged in the sale or disposition of personal property on the installment plan in respect to this transaction; consequently, if it is entitled to the benefits of the above section it is by virtue of a "casual sale" of personal property or the sale of real property the "initial payments" from which "do not exceed one-fourth of the purchase price." A simple statement of the terms of payment obviously precludes the application of the installment provisions of the Act. The total "purchase price" to the Deyo Company was $212,820, plus an amount equal to the value of the merchandise inventory on hand at October 1, 1925, separately provided for in the contract of sale of September 16, 1925, which was found to be $23,803.82, making a total consideration or "purchase price" of $236,623.82. The initial cash payment of $53,250, provided for in said contract, was received by the company on October 1, 1925, which*2074 sum was augmented by the receipt of $23,803.82 on October 9, 1925, representing the purchase price of the inventory, $35,500 on November 1, 1925, and $21,300 on December 1, 1925, making the total payments received in cash during the taxable period $133,853.82, or more than 50 per cent of said purchase price. Decision will be entered for the respondent.