Barker v. Commissioner

FRED BARKER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. EDWARD W. THOMPSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. W. L. THOMPSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Barker v. Commissioner Docket Nos. 51102, 51103, 51104. United States Board of Tax Appeals 28 B.T.A. 657; 1933 BTA LEXIS 1089; July 11, 1933, Promulgated *1089 1. Upon the record, held, that the transfer by the Columbia River Packers Association of its assets to the Columbia River Packers Association, Inc., for $1,578,600 and 17,540 shares of no par common stock of the Columbia River Packers Association, Inc., constituted a "reorganization" within the provisions of section 203 of the Revenue Act of 1924. 2. The fair market value of the no par value common stock of the Columbia River Packers Association, Inc., as of the date of issuance to the Columbia River Packers Association, determined. Robert T. Jacob, Esq., for the petitioners. William E. Davis, Esq., for the respondent. MARQUETTE *657 In these proceedings, which have been consolidated, the petitioners seek a redetermination of their income tax liabilities for the year *658 1924, for which year the respondent in his deficiency letters has proposed the following deficiencies: Petitioner Deficiency Penalty Fred Barker $952.58 Edward W. Thompson 16,228.34 $4,057.09 W. L. Thompson 276,658.01 The deficiencies result entirely from the action of the respondent in declaring a transfer of the assets of the*1090 Columbia River Packers Association (hereinafter referred to as the old company) in exchange for $1,578,600 in cash and 17,540 shares of the capital stock of the Columbia River Packers Association, Inc. (hereinafter referred to as the new company) to be a reorganization resulting in a taxable transaction. In his amended answer the respondent affimatively pleaded that the transfer of the assets of the old company to the new company constituted a sale rather than a reorganization, and consequently the gain to the petitioners, if any, was subject to both normal and surtaxes. FINDINGS OF FACT. During July 1924 W. A. Tyler approached petitioner W. L. Thompson with a proposition to acquire control of the old company, Tyler having learned that A. B. Hammond, representing control of the company, desired to sell. After considering methods of financing the deal, Tyler went to San Francisco, where he procured from Hammond an agreement to give a 60-day option upon the stock held by himself and associates upon the basis of $98.50 per share. In the meantime, certain bond houses of Portland, Oregon, had tentatively agreed to underwrite a bond issue of $1,250,000. Thereupon a 60-day option*1091 for the sale and delivery of 11,232 of the outstanding 17,540 shares of stock of the old company was executed by Hammond to W. L. Thompson and W. A. Tyler. Upon the expiration of this option an extension for 30 days was procured. After further negotiations the underwriters agreed to underwrite the bond issue. W. L. Thompson proceeded to San Francisco and completed the arrangements for the acquisition of the stock of the old company. Hammond and his associates were paid from the proceeds of a note given by W. L. Thompson to the Mercantile Trust Co. of San Francisco, which was secured by the stock of the old company acquired from Hammond and his associates. Later the Mercantile Trust Co. forwarded the stock to the First National Bank*659 of Portland, to be held in trust pending the reorganization of the company. The old company was incorporated in 1899 under the laws of the State of Oregon, for the purpose of engaging in the salmon-packing industry on the Columbia River and in Alaska. All of its original stock, consisting of 17,250 shares having a par value of $100 each, was issued for cash or its equivalent. The stock of the corporation was at all times closely held. *1092 The original number of shares was later increased to a total of 17,540, which during the early part of 1924 were held by less than 40 persons. On October 1, 1924, Tyler and Thompson exercised their option and acquired from Hammond and his associates 11,601 out of the total of 17,540 outstanding shares, at a cost of $95.50 per share. In order to comply with both an agreement made with Hammond and with the provisions of the Oregon laws, which required the approval of two thirds of the outstanding stock to make certain corporate changes, they made additional purchases of stock so that by October 31, 1924, they had acquired 14,694 1/2 shares, at a total cost of $1,469,276.34 or an average cost of $99.988 per share. On October 18, 1924, Tyler and Thompson entered into an agreement with two finance corporations of Portland, Oregon, for the purpose of Floating a bond issue and organizing a new corporation, to be called the Columbia River Packers Association, Inc. The new company was incorporated under the laws of the State of Oregon on or about October 31, 1924, with 17,540 shares of no par value stock, for the purpose of taking over the assets and business of the old company. The*1093 new corporation issued bonds in the amount of $1,250,000, at a cost of $100,000. By a resolution dated November 6, 1924, the board of directors of the old company authorized the sale to the new company of all the assets, real, personal and mixed, including all plants, merchandise, supplies, cash on hand, bonds, securities and accounts receivable for $1,578,600 and 17,540 shares of no par value common stock of the new company. By authorization of its board of directors, the new company agreed to purchase all of the assets of the old company for the sum of $1,578,600 and 17,540 shares of no par value common stock. The board of directors of the old comapny, by resolution, after stating that the sale of all its assets and equipment had been made to the new company and that the new company had paid to the old company $1,578,600 in cash and 17,540 shares of no par value common stock, voted "That a liquidating dividend in distribution of all of the assets of the corporation to the extent of $90 in cash and one share of no par value common stock of the Columbia River Packers Association, *660 Inc., to each share of stock of this corporation and the same is hereby declared." The liquidating*1094 dividend, so far as the petitioners W. L. Thompson and Edward W. Thompson are concerned, was paid to the banks which held the collateral for the loans which W. L. Thompson had given to make the payment on the stock acquired from Hammond, his associates, and others, the difference between the $90 per share dividend and the sale price of the stock being made up by notes given by Thompson and Tyler. In connection with the formation of the new corporation, an appraisal of the properties of the old company was made, which appraisal was the basis for recording the assets upon the books of the new company. The book value of the stock of the new corporation on the basis of this appraisal, exclusive of any value for good will, trade marks, or registered brands, which were separately valued at $415,000, which good will had not been destroyed prior to the formation of the new company and was not carried in the balance sheet of the new corporation, amounted to $148.32 per share. The products of the Columbia River Packers Association and its predecessor companies were marketed with great success under long established brands which were widely and favorably known to the trade throughout the*1095 United States and Europe. In the appraisal the existence of a value for good will was recognized, as well as a substantial increase in the market value of the real estate owned by the old corporation. The real estate and buildings of the old company on October 31, 1924, had a book value of $1,878,709.70. The value of the real estate and buildings acquired by the new corporation was placed at $2,884,988.74 by the appraisal, thus involving an appreciation of $1,006,279.04. By recording the value of the real estate and buildings on the basis of the appraisal figures, the new corporation was enabled to show a net worth in excess of two and one half million dollars, without including in its balance sheet any valuation for the old company's good will. The book value of the stock of the old corporation immediately prior to the sale on October 31, 1924, was $182.11 per share, as reflected by the book value of the tangibles only. During the 12-month period subsequent to October 31, 1924, there were isolated sales of the new company stock at prices ranging from $50 to $62.50 per share. The stock of the new company was closely held and was not listed on any exchange. The testimony of*1096 four expert witnesses was introduced to show that the no par value common stock of the new corporation was valueless at the time of its issue. The petitioner W. L. Thompson, who had had some 30 years' experience as a banker, *661 testified that the new company stock had no market value. Fred Barker, who had been the manager of the old company for 14 years, and who was thoroughly familiar with the properties and business of the company, testified: "I considered the new stock had no value. It was saddled with too big a debt." Hammond, who had had no previous business dealings with Thompson and Tyler testified as follows: Q. So far as you are concerned, this was a sale by sellers willing but not compelled to sell? A. Certainly not compelled to sell. That was a very good price. The best offer that I had received before I met Thompson and Tyler was $80 per share. Fred Barker, the petitioner in Docket No. 51102, is a resident of San Diego, California. Prior to 1924 he purchased 160 shares of the common stock of the old company for $100 per share. On or about October 31, 1924, he received from the old company a complete liquidating dividend of $14,400 in cash, which*1097 was at the rate of $90 per share for the stock of the old company, and 160 shares of no par value common stock of the new company. Edward W. Thompson, the petitioner in Docket No. 51103, is a resident of Portland, Oregon, with his principal office in Astoria, Oregon, with the Columbia River Packers Association, Inc. In 1924 he acquired 1,000 shares of the common stock of the old company as a gift from his father, W. L. Thompson. On or about October 31, 1924, he received from the old company a complete liquidating dividend of $90,000 in cash, the latter being at the rate of $90 per share for the stock of the old company, and 1,000 shares of no par value stock of the new company. W. L. Thompson, the petitioner in Docket No. 51104, is a resident of Portland, Oregon. In 1924 he purchased 7,770 1/2 shares of the common stock of the old company for $776,956.74. On or about October 31, 1924, he received from the old company a complete liquidating dividend of $699,345 in cash, the latter being at the rate of $90 per share for the old stock, which amount was immediately applied on the purchase notes, and 7,770 1/2 shares of the no par value common stock of the new company. The liquidation*1098 of the old company was effected coincidentally with the taking over by the new company of all its business properties on or about October 31, 1924. The surplus of the old corporation accumulated after February 28, 1913, amounted to 44.29 percent of the total distribution of $1,578,600, made on October 31, 1924. The respondent applied this same percentage to the amounts received by the petitioners as liquidating dividends and treated it as an ordinary taxable dividend. The balance of 55.71 percent of the cash distribution has been treated as ordinary income. *662 OPINION. MARGUETTE: The petitioners contend that the principal transaction, the organization of the Columbia River Packers Association, Inc., and the transfer to it of all the assets of the Columbia River Packers Association, in exchange for cash and all of its capital stock, constituted a reorganization; that the purchase of more than two thirds of the outstanding stock of the old company at an average price of $99.98 per share established the fair market value, and that the fair market value of the shares of stock of the new company was no greater than the value of the shares of the old, less the cash distributed. *1099 The respondent takes the position that the disposition of the assets of the old company to the new company for $1,578,600 and 17,540 shares of no par value common stock of the new company constituted a sale by the old company of its assets to the new company, and also that the fair market value of the no par common stock of the new company, as of the date of incorporation, was not less than $148.32 per share. The pertinent provisions of the Revenue Act of 1924 are section 203(a), which reads as follows: "Upon the sale or exchange of property the entire amount of gain or loss determined under section 202 shall be recognized, except as hereinafter provided in this section", and the following subdivisions of section 203: (b)(3); (d)(1); (e)(1) and (2); (f); (g); and (h)(1) and (2). In Pinellas Ice & Cold Storage Co.,21 B.T.A. 425; affd., 57 Fed.(2d) 188; 287 U.S. 462, we considered the reorganization sections under the Revenue Act of 1926, the provisions of which are the same as in the 1924 Act, and we there said: Section 203(a) provides that when there is a sale or exchange of property th entire amount of the gain or loss shall be*1100 recognized, with certain exceptions mentioned in the other subdivisions of that section. The question for decision is whether the transaction here comes within any of those exceptions. Generally, upon the sale or exchange of property taxable gain or loss is recognized. This is true unless the transaction comes within an exception contained in the statute. So far as the provisions of the statute pertinent here are concerned, section 203(b)(3) and 203(e), the exception relates to exchanges and not to sales. Section 203(b)(3) provides that no gain or loss shall be recognized, if a corporation a party to a reorganization exchanges property, under the circumstances therein provided, and section 203(e) provides that if an exchange would be within the provision of paragraph (3) subdivision (b) if it were not for the fact that money or other property were included in the transaction as a consideration. In other words, in order to come within the exception to the general provisions contained in section 203(e) there must in the first place clearly be an exchange. This essential requirement *663 must be met in any event, regardless of whether otherwise there might be a reorganization*1101 within the meaning of the statute or whether the other provisions of the statute have been met. We think it is clear that if property is sold the transaction would not come within the exchange provisions. A sale does not come within either the words or the reason of section 203(b)(3) or 203(e). There is a clear legal distinction between a sale and an exchange, and section 203(b)(3) and 203(e) relate only to exchanges, and not to sales. The United States Supreme Court has laid down a rule long recognized and well established in law as to what constitutes a sale. That court, in the case of Williamson v. Berry,8 How. 495, 543, stated as follows: * * * We remark that sale is a word of precise legal import, both at law and in equity. It means at all times, a contract between parties, to give and to pass rights of property for money, - which the buyer pays or promises to pay to the seller for the thing bought. Noy's Max. ch. 42; Shep. Touch., 244. The transaction before us may be summarized as follows: Thompson and Tyler learned that a large part of the stock of the old company could be purchased. They conferred with a bond house in Portland, *1102 Oregon, and were advised that a bond issue, secured by the old company's assets in the possession of a new company, could be sold to the investing public. Through such a bond issue a substantial part of the cost of the old company stock could be raised, thus leaving Thompson and Tyler in control of the stock in the new company, with comparatively small expenditure of money. Through arrangements made with the Portland bond houses, Thompson and Tyler proceeded to buy the stock of the old company. The necessary cash was temporarily advanced by banks which held the old company stock as collateral. The new company was organized, and resolutions were passed by both companies which in their formal wording would indicate a sale and purchase of the assets. The assets were transferred, the bonds issued, and the old company was paid for its assets at the rate of $90 cash and one share of stock in the new company for each share of stock in the old company. The old company then distributed the cash and stock as a liquidating dividend. The first question for us to decide is whether this transaction was a sale or an exchange. In discussing section 203 of the Revenue Act of 1926, which is*1103 the same as the similar section of the Revenue Act of 1924, the Circuit Court of Appeals, Second Circuit, in Cortland Specialty Co. v. Commissioner, 60 Fed.(2d) 937, said: When describing the kind of change in corporate structure that permits exemption from these taxes, section 203 does not disregard the necessity of continuity of interests under modified corporate forms. Such is the purpose of the word "reorganization" in section 203(b)(3) of the act, 26 USCA § 934(b)(3), where a corporation exchanges its property "solely for stock or *664 securities". Such also is the nature of the "merger or consolidation" described in subdivision (h)(1)(A) where a corporation acquires a majority of the stock of another, and such is the nature of the "reorganization" described in subdivision (h)(1)(B) of section 203, 26 USCA § 934 (h)(1)(B), where a corporation transfers assets to another corporation, and the transferor, or its stockholders, immediately thereafter are in control of the transferee. The words "A recapitalization", in subdivision (h)(1)(C) of section 203, 26 USCA § 934(h)(1)(C), and*1104 "A mere change in * * * form * * * of organization, however, effected," in subdivision (h)(1)(D) of section 203, 26 USCA § 934(h)(1)(D), involve the same idea. When subdivision (h)(1)(A) included in its definition of "merger or consolidation" the "acquisition by one corporation of * * * substantially all the properties of another," it did this so that the receipt of property by the corporation surviving the merger might serve to effect a reorganization as does an acquisition of stock. Each transaction presupposed a continuance of interest on the part of the transferor in the properties transferred. Such a limitation inheres in the conventional meaning of "merger and consolidation", and is implicit in almost every line of section 203 which we have quoted. In Pinellas Ice & Cold Storage Co. v. Commissioner, 57 Fed.(2d) 188, the Court of Appeals of the Fifth Circuit decided that a transaction almost exactly like the present was not a "merger or consolidation," but a mere sale carrying no exemption. Judge Groner's opinion in *1105 Corbett v. Burnet,60 App.D.C. 202, 50 F (2d) 492, is in accord. In defining "reorganization," section 203 of the Revenue Act gives the widest room for all kinds of changes in corporate structure, but does not abandon the primary requisite that there must be some continuity of interest on the part of the transferor corporation or its stockholders in order to secure exemption. Reorganization presupposes continuance of business under modified corporate forms. In discussing the meaning of the words "merger" and "consolidation" as used in the statute, the Supreme Court, in the Pinellas case, supra, said: The paragraph in question directs - "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)." The words within the parenthesis may not be disregarded. They expand the meaning of "merger" or "consolidation" so as to include some things which partake of the nature of a merger or consolidation*1106 but are beyond the ordinary and commonly accepted meaning of those words - so as to embrace circumstances difficult to delimit but which in strictness cannot be designated as either merger or consolidation. Since in the instant case we have the acquistition of all the assets of the old company by the new company and the same interests immediately thereafter are in control of the transferee, we are of the opinion that the transaction falls within the statutory meaning of a reorganization and the respondent's claim that it was a sale of assets should be denied. *665 The remaining question is, What was the fair market value, if any, of the no par value shares of the new company stock on October 31, 1924, the date on which it was received by the petitioners? It is undisputed that the cost of the old company stock to Barker was $100 per share, and that the cost of the stock to W. L. and Edward W. Thompson was $99.98 per share. The respondent in his deficiency notice determined the new company stock to have a fair market value of $148.32 per share. This value reflects the book value of the new company stock after the assets had been transferred. These same assets reflected*1107 on the books of the old company immediately before the transfer show a book value of $183.32 per share. The respondent contends that the book value of the stock of the new company more correctly reflects the value of the stock than did the sale of the stock of the old company immediately before the transfer of the assets. We are confronted with a situation where a group who had been in control of a corporation for a great many years sell about two thirds of the stock at an average price of $99.98 per share. The selling group were experienced in the industry and thought that they were getting an adequate price for their stock. The purchasing group were bankers, unfamiliar with the salmon-packing industry. Their first corporate step was to negotiate a $1,250,000 bond issue. An appraisal of the assets was made. We cannot help but feel that the appraisal was made primarily to support the sale of the bonds. All the assets were transferred directly from one corporation to another corporation, specifically organized for the sole purpose of taking over the properties, the business and the operations of the expiring company. There was no interruption in the continuity of existence, *1108 and no essential change in the corporate structure, except as was reflected by the flotation of a bond issue and the distribution of a cash dividend. There was a sale of the old company stock at $99.98 per share when its book value was $183.32. The same assets burdened with a bond issue of $1,250,000 on the books of the new company show a value of $148.32 per share. A few random sales of stock were made several months after the basic date at an average price of $60 per share, but we do not think they are representative of the fair market value of the stock at the time of this transaction. We are of the opinion that the sale of the old company stock is more determinative of the fair market value than either the book value or the subsequent sales, and from a consideration of all the evidence we think that the fair market value of the stock of the new company at the time it was received was $10 per share, and we so hold. Decision will be entered under Rule 50.