Hoult v. Commissioner

J. HAMPTON HOULT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. MARTIN J. DREGGE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Hoult v. Commissioner Docket Nos. 45782, 45783. United States Board of Tax Appeals 24 B.T.A. 79; 1931 BTA LEXIS 1700; September 21, 1931, Promulgated *1700 During the years 1922 to 1924 each petitioner purchased over 600 shares of stock in the Morton Hotel Company, a Michigan corporation, at a price exceeding $130 a share. During the taxable year 1927 one Joseph H. Brewer organized the Grand Rapids Hotel Company, a Michigan corporation. Petitioners agreed with Brewer to sell him their stock in the Morton Hotel Company for $50 a share and buy stock in the new company with the proceeds, which was done. Held, petitioners did not in substance exchange old stock for new within the meaning of section 203(b)(2) of the Revenue Act of 1926, but actually and in substance sold old stock and purchased new; held, further, petitioners sustained a capital net loss on the sale of the old stock. F. E. Seidman, C.P.A., and J. S. Seidman, Esq., for the petitioners. B. M. Coon, Esq., for the respondent. LOVE *79 These proceedings, which were consolidated for hearing and decision, are for the redetermination of deficiencies in income taxes for the calendar year 1927 in the amounts of $4,332.71 and $6,734.38, respectively. The assignment of error in the petitions is that the respondent erred in disallowing*1701 a capital net loss claimed by petitioners in connection with the sale of stock in the Morton Hotel Company. At the hearing petitioners obtained leave to amend their petitions by assigning in the alternative an additional error, that should the Board sustain the respondent in connection with the error first assigned, "then the Commissioner erred in failing to deduct the loss sustained on the subsequent sale in 1927 of part of the securities involved in the transaction." The respondent concedes the error alleged in the alternative. The facts were stipulated. FINDINGS OF FACT. Petitioners are individuals residing in Grand Rapids, Mich. During the years 1922 to 1924, inclusive, petitioners purchased for cash stock in the Morton Hotel Company, a Michigan corporation, which owned and operated the Morton Hotel in Grand Rapids, Mich. Petitioner Hoult purchased 672 1/2 shares of common stock of a par value of $100 per share, paying therefor $90,000, and petitioner Dregge purchased 622 1/2 shares, paying therefor $85,000. *80 On March 1, 1927, the capitalization of the Morton Hotel Company consisted of 7,315 shares of common stock of a par value of $100 per share, $550,000*1702 of first mortgage bonds, and an authorized issue of $200,000 of second mortgage bonds, of which $138,500 was outstanding. The hotel had been operating at a loss, and under date of March 17, 1927, petitioners, along with other stockholders of the corporation, entered into an agreement with Joseph H. Brewer, a then owner of 10 shares (less than 1/2 of 1 per cent) of common stock in the Morton Hotel Company. In this agreement it was proposed by Brewer and accepted by the stockholders of the Morton Hotel Company (hereafter called the old company) that Brewer would "organize a new corporation to be known as the Grand Rapids Hotel Company" (hereafter called the new company); that the new company would issue 7,315 shares of preferred stock of the par value of $50 per share and a certain amount of no par value stock; that Brewer would purchase from petitioners and the other stockholders of the old company their old company stock "at the price of fifty (50%) per cent of the par value thereof"; and that: Said proposal is upon the condition, however, that the stockholders of the Morton Hotel Company so selling their stock shall subscribe for stock in said new corporation to be formed, as*1703 follows, viz.: For each share of common stock of said Morton Hotel Company owned by them one (1) share of the preferred stock of said new corporation and one-half (1/2) share of no par value stock of said new corporation, and shall pay for such stock upon the basis of Fifty ( $50) Dollars for one (1) share of preferred and one-half (1/2) share of no par value stock together. The proposal, which as stated above, was accepted by the stockholders of the old company, further provided that the stockholders of the old company would grant Brewer an option to purchase the no par value stock of the new company subscribed for by them at any time within three years at a certain specified price per share; that the old company would issue and sell the remaining $61,500 of its authorized bond issue; that the new corporation would "ultimately, by consolidation, merger or otherwise, acquire the assets and properties" of the old company; that the new company "shall assume all debts, obligations, contracts and engagements of every kind" of the old company; and that: * * * upon any such consolidation or merger the subscribers to this agreement shall have the same relative holdings in preferred and*1704 no par value or common stock (whichever shall be issued) of the corporation resulting from such consolidation or merger as are subscribed for by this agreement. Said proposal of Joseph H. Brewer is conditioned, however, upon his receiving fifty-one (51%) per cent of the no par value stock of said new company * * * [italics supplied] *81 The said proposal further provided that, subject to the approval of the Michigan Securities Commission, the new company would authorize a second mortgage bond issue of $500,000; that $200,000 of such issue would be exchanged for the second mortgage bonds of the old company; and that Brewer and others would purchase $8,500 of the new bonds. The said proposal further provided that Brewer would subscribe for 3,807 shares of the no par value stock of the new corporation and pay for such stock a price of $1 per share. On the same day, namely, March 17, 1927, the second mortgage bondholders of the old company agreed to exchange their bonds in the old company for new second mortgage bonds of the new company. On March 25, 1927, the new company was organized as a Michigan corporation, with an authorized capital stock of 7,320 shares*1705 of preferred stock of a par value of $50 each, and 183,000 shares of common stock of no par value, but having a declared value of $25 per share. A total of 3,807 shares of no par value common stock was initially subscribed for, of which 3,795 shares were subscribed for by Brewer at $1 per share. On April 7, 1927, at separate meetings of the stockholders and board of directors of the new company, the following resolution was passed: RESOLVED, That the officers of this Company be and they hereby are authorized to issue 7,320 shares of the preferred stock of this Company of the aggregate par value of $366,000, and 3,660 shares of the no par value stock of this Company, and to sell the preferred stock at par and as a premium to the purchaser of said preferred stock to give for each share of preferred stock purchased one-half share of no-par common stock; and with the proceeds from the sale of such preferred stock to purchase all of the outstanding common stock of the Morton Hotel Company of the par value of $732,000, being 7,320 shares at $50 a share. The stock authorized to be issued in the aforegoing resolution was issued and the stock certificates were dated April 1, 1927. *1706 On April 7, 1927, petitioners and the other stockholders of the old company executed the following power of attorney: We, the undersigned stockholders of the MORTON HOTEL COMPANY, hereby authorize GRAND RAPIDS TRUST COMPANY as TRUSTEE in our behalf to carry out the contract dated March 17, 1927, made between us and Joseph H. Brewer for the sale of stock of the Morton Hotel Company to him and the purchase of stock in the Grand Rapids Notel Company by us. We hereby ratify the acts of said GRAND RAPIDS TRUST COMPANY heretofore taken in the performance of said contract. The Grand Rapids Trust Company accepted the trust and acted in behalf of petitioners and other stockholders of the old company in accordance therewith. *82 On April 27, 1927, Brewer issued a check on the Grand Rapids Savings Bank to the "Grand Rapids Trust Company as Trustee for Stockholders of Morton Hotel Company" for $362,650. This remittance was deposited in the Grand Rapids Trust Company for the credit of the account called "Grand Rapids Trust Company, Trustee for Stockholders of Morton Hotel Company." On April 28, 1927, the said trustee issued a check on the Grand Rapids Savings Bank to "Grand*1707 Rapids Hotel Company" for $362,650. This remittance was deposited by the new company in its account at the Kent State Bank. On April 28, 1927, the new company issued a check on the Kent State Bank to "Joseph H. Brewer" in the amount of $362,650. This remittance was deposited in the Grand Rapids Savings Bank for the account of Brewer. Concurrently Brewer turned over to the new company 7,253 shares of the common stock of the old company. Up to April 28, 1927, holders of 62 shares of common stock of the old company had not consented to the sale of their stock under the terms of the March 17, 1927, contract. On June 9, however, substantially the same transactions as outlined in the three preceding paragraphs transpired with respect to the 62 shares, involving $3,100. In August, 1927, petitioner Hoult and petitioner Dregge, respectively, sold to Brewer 336 1/4 shares and 311 1/4 shares of the new company no par value common stock at a price of $10 a share. Petitioners in preparing their 1927 returns deducted a loss on the sale of stock in the old company. Petitioner Hoult deducted a loss of $56,375 based on the difference between a cost of $90,000 and a selling price of*1708 $33,625. Petitioner Dregge deducted a loss of $53,875 based on the difference between a cost of $85,000 and a selling price of $31,125. The respondent disallowed the deductions in their entirety, and did not allow petitioners any deduction as losses on account of the sale of new company stock in August, 1927. The parties have stipulated that should the Board approve the deficiency as determined by the respondent with respect to the disallowance of the loss claimed by petitioners in connection with their stock in the old company, "then the petitioners are entitled to a loss on the sale of Grand Rapids Hotel Company stock in the amount of $4,818.50 in the case of J. Hampton Hoult and $4,460.24 in the case of Martin J. Dregge." OPINION. LOVE: The principal question in these proceedings is whether under the contract with Brewer petitioners in substance exchanged their stock in the old company solely for stock in the new, or, whether the actual sale by petitioners to Brewer of their stock in the old company *83 and the investment by them of the proceeds in the stock of the new company constituted the substance as well as the form of the transactions set out in our findings. *1709 The respondent contends that these proceedings are governed by the following provisions of section 203 of the Revenue Act of 1926: SEC. 203. (b)(2) No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization. SEC. 203. (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 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" *1710 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. There can be no question as to what was actually done. The facts were stipulated. Petitioners actually sold their stock in the old company to Brewer, and with the proceeds purchased preferred and no par value common stock in the new company. But, since petitioners were contractually bound to subscribe for the new stock, should we disregard the sale and say that was a mere matter of form and an act entirely unnecessary to bring about the ultimate result? The respondent urges us to do so and to hold that the substance of the execution of the contract with Brewer was that of exchanging old stock solely for new. We can not so disregard the real and actual things that occurred and hold the petitioners to have done something which in fact they did not do. They actually sold their stock in the old company and with the proceeds purchased stock in the New. True, it may be that the same ultimate result*1711 might have been accomplished if petitioners had exchanged directly their stock in the old company solely for stock in the new. But this is not what actually occurred. Income-tax liability must be determined by what actually takes place, rather than by what might have taken place. In , we held that where three individuals transferred certain assets to a newly organized corporation and received the corporation's check, which they immediately indorsed and turned back to the corporation in payment for its capital *84 stock, the transaction was a sale resulting in profit at the time the check was received, rather than in substance a transfer of assets to the corporation for stock, which would have been nontaxable under section 202(c)(3) of the 1921 Act. The Seventh Circuit affirmed our decision in this case from the bench and without opinion. In the course of our opinion in the Ray case we said: It is contended that the substance of the whole transaction was that assets were issued for stock, and that substance should control over the form. The Supreme Court has frequently said that it would look to substance and not form. *1712 . But we do not believe in a case such as this that what a person actually does should be ignored, and that one be held to do one thing when another thing was done. What is actually done fixed the tax liability and not what might have been done, even though the same result in the end might have been reached in another way or by another process. To the same effect see our holdings in ; affirmed by the Eighth Circuit at ; ; ; ; affirmed by the Court of Appeals of the District of Columbia at 36 Fed.(2d) 546; and . In , the Supreme Court, inter alia, said: "In such matters, what was done, rather than the design and purpose of the participants, should be the test." It is, therefore, our opinion that petitioners are entitled to the capital net losses of $56,375 and $53,875 referred to*1713 in our findings. It thus becomes unnecessary to consider petitioners' alternative assignment of error. Judgment will be entered under Rule 50.