Ohio Cent. Tel. Co. v. Commissioner

OHIO CENTRAL TELEPHONE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT Ohio Cent. Tel. Co. v. Commissioner Docket No. 52723. United States Board of Tax Appeals 28 B.T.A. 96; 1933 BTA LEXIS 1180; May 16, 1933, Promulgated *1180 1. Where the nontaxable profit resulting from the sale of the stock of a subsidiary corporation is included in a lump sum received for such stock and the bonds of the same subsidiary, and there are no facts establishing the separate cost of the stock, the claim for the noninclusion of such profit in income is not sustained by evidence and the determination of the Commissioner that the entire profit is taxable must be approved. 2. Where a taxpayer corporation sells the bonds of an affiliate, the whole amount of gain realized is taxable. United States v. Kirby Lumber Co.,284 U.S. 1, followed. Laurence Graves, Esq., for the petitioner. J. M. Leinenkugel, Esq., for the respondent. LANSDON *96 The respondent has determined a deficiency in income tax for the year 1927 in the amount of $12,401.62. The only issue is whether the petitioner realized profit in the amount of $163,090.86 from the sale of bonds and stock of a subsidiary corporation. The parties have filed a stipulation which the Board accepts and adopts as its findings of fact. FINDINGS OF FACT. The petitioner is a corporation, organized in September 1926*1181 under the laws of the State of Delaware, with principal office and place of business at 208 South La Salle Street, Chicago, Illinois. The Ohio Central Telephone Corporation was incorporated under the laws of the State of Ohio on December 11, 1926. Prior to July 29, 1927, the petitioner acquired all of the issued and outstanding capital stock of the following corporations at a cost of $1,661,909.14: The Millersburg, Wooster and Orrville Telephone Company The Licking Telephone Company The Caledonia Telephone Company The Morrow County Telephone Company The Valley Telephone Company The Mount Sterling Telephone Company *97 Under authority of orders of the Public Utilities Commission of Ohio, and on or about July 29, 1927, the Ohio Central Telephone Corporation acquired, in pursuance of a plan of reorganization and in a nontaxable exchange, all of the assets and properties of the corporations listed in the preceding paragraph, in exchange for $1,600,000 par value first mortgage 6 percent bonds, $500,000 par value nonvoting 7 percent preferred stock, and 5,675 shares no par value common stock of said Ohio Central Telephone Corporation. The above stocks and bonds*1182 were issued by the Ohio Central Telephone Corporation, the Public Utilities Commission of Ohio having valued the assets and properties received from the six companies as having a total value of $2,193,468.38 at the time of the reorganization. The 5,675 shares of common stock constituted all of the issued and outstanding common stock of said Ohio Central Telephone Corporation. The six corporations receiving the bonds, preferred stock and common stock of Ohio Central Telephone Corporation immediately distributed the securities to the petitioner, in pursuance of the plan of reorganization. Thereafter, and in the year 1927, the petitioner sold to outside interests the $1,600,000 par value first mortgage 6 percent bonds so received for $1,400,000 and the $500,000 par value 7 percent preferred stock so received for $425,000, a total consideration of $1,825,000. A consolidated return was filed by the petitioner and the Ohio Central Telephone Corporation for the taxable year ended December 31, 1927, with the collector of internal revenue for the first district of Illinois, at Chicago, Illinois. The respondent has determined that the petitioner and the Ohio Central Telephone Corporation*1183 were affiliated within the meaning of the provisions of section 240 of the Revenue Act of 1926 for the taxable year ended December 31, 1927, and permitted to file a consolidated return of gross income and deductions, and the respondent has determined the petitioner's tax liability upon the basis of the consolidated return filed by it and the Ohio Central Telephone Corporation for the taxable year 1927. The respondent has also determined that the petitioner realized a taxable profit as the result of the sale of the bonds and preferred stock of the Ohio Central Telephone Corporation of $163,090.86 and has included this amount in the petitioner's gross income in the determination of the deficiency in tax here in controversy. Said amount of $163,090.86 is the difference between the total cash received by the petitioner from the sale of the bonds and preferred stock of the Ohio Central Telephone Corporation; namely, $1,825,000, and the cost to the petitioner of the stock of the corporations *98 from which the bonds and stock were received by the petitioner in liquidation; namely, $1,661,909.14. OPINION. LANSDON: The facts material to the proceeding have been stipulated. *1184 The only question is whether petitioner realized a profit of $163,090.86 when it sold the bonds and stock of its subsidiary corporation, the Ohio Central Telephone Corporation, in the taxable year. Petitioner contends that the result of the transaction is nontaxable, since the property sold consisted entirely of the securities of an affiliated corporation and was in effect the sale of its own bonds and stock. In support of its position it relies on our decisions in ; ; ; ; ; and ; and that of the Circuit Court of Appeals in . In each of the cases above cited the controversy arose over the sale of the stock of one affiliated corporation by another member of the same group. In our opinion all support the contention of the petitioner as to that part of the income in question which it realized from*1185 the sale of the stock of its affiliate. This rule is also applicable to transactions in preferred stock, as we decided in , where the income which respondent attempted to tax resulted from the sale of shares of preferred stock and it was not disclosed whether such stock had voting rights. Notwithstanding our conclusion that the settled law sustains the claim of the petitioner as to sales of preferred stock, the stipulated facts provide no basis upon which we can compute and determine what proportion of the cost of the stocks and bonds should be regarded as the cost of the stock. It follows, therefore, that unless profit resulting from the sale of the bonds is nontaxable, the amount as a whole must be included in taxable income for the year in question. While it is well established that a taxpayer realizes no taxable gain or deductible loss from the sales of its own stock or that of an affiliate, it does not necessarily fllow that the same rule is applicable to gains resulting from the sale of bonds of an affiliate. There is, of course, a fundamental distinction between the two classes of securities. Stock evidences the amount of*1186 capital invested by shareholders in and at risk in the business. Bonds represent money borrowed. It is now well settled that a corporation may realize gain or sustain loss from transactions in its own bonds. This rule is *99 embodied in Regulations 69, article 545, and is conclusively sustained in , and . If a corporation can realize taxable income in the purchase of its own bonds at a discount it would seem to follow that the profits resulting from a sale are likewise taxable, and if this rule is sound in transactions in which a corporation buys and sells its own bonds, then for even stronger reasons it should apply to the sale of the bonds of an affiliate. On this question the determination of the respondent is affirmed. Decision will be entered for the respondent.