Evans Prods. Co. v. Commissioner

THE EVANS PRODUCTS COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Evans Prods. Co. v. Commissioner Docket No. 43044. United States Board of Tax Appeals 29 B.T.A. 992; 1934 BTA LEXIS 1442; February 2, 1934, Promulgated *1442 A, who owned all the stock of X, agreed to sell a 51 percent interest therein to B. In order to escape income tax A thereupon caused corporations Y and Z to be organized. He then exchanged his stock in X for the capital stock of Y. Y thereupon exchanged the capital stock of X for the capital stock of Z. Z thereupon liquidated X. All these transactions took place within three days. On the last day, but subsequent to these transactions, Y sold to B 51 percent of the stock of Z. Held, under section 204(a)(7) of the Revenue Acts of 1924 and 1926, A was in control of Z prior to the sale to B. Briggs Simpich, Esq., for the petitioner. James K. Polk, Esq., for the respondent. MARQUETTE *992 The respondent has determined the following deficiencies in income tax: [1924] $1,165.22 [1925] 73.33 [1926] 5,219.28 *993 The petitioner asserts that the respondent has erred (1) in using as a basis for the computation of depreciation on patents acquired by the petitioner on December 31, 1923, an amount less than their actual cost; (2) in not allowing depreciation for 1925 on patents acquired subsequent to December 31, 1923; *1443 and (3) in using as a basis for the computation of depreciation on buildings an amount less than their actual cost to it. Two other issues were made the subject of stipulations. FINDINGS OF FACT. The petitioner is a corporation, organized December 26, 1923, under the name of "E. S. Evans & Company, Inc.", but its name was subsequently changed to "Evans Auto Loading Company" and then changed to "The Evans Products Company." E. S. Evans, being interested in devices for loading automobiles on railroad cars, sought and obtained from the Studebaker Corporation a license under Patent No. 1237154, issued August 14, 1917, and known as the Baus patent, but in attempting to use this license he came into competition with a device manufactured under Patent No. 1254312, issued January 22, 1918, and known as the Copony patent. There had been expensive litigation between the owners of these patents and there was prospect of further costly litigation. In this situation Evans brought the contending parties together, with the result that the Studebaker Corporation, Copony Auto Loading Co. (owner of the Copony patent), and E. S. Evans & Co. (a Michigan corporation whose outstanding stock consisted*1444 of 120 shares of a par value of $10 each, all of which was owned by E. S. Evans) entered into a contract dated March 1, 1922, by which the Studebaker Corporation and Copony Co. granted to E. S. Evans & Co., in consideration of certain royalties and certain outstanding licenses, a "non-exclusive and non-transferable" license for the term of such patents to manufacture and sell and to license others to manufacture inventions covered by the two patents and which contract provided that during the existence of the agreement neither would grant any license except to E. S. Evans & Co. It was agreed that E. S. Evans & Co. was not to assign the license therein granted except to the successor to, or assignee of, its whole business. The owners of the patents reserved the right to terminate the contract if E. S. Evans & Co. did not comply with certain covenants made by it. Largely as a result of this contract, the sale of E. S. Evans & Co. increased from $445,071.30 in 1922 to $1,591,159.19 in 1923, and the net profits before deduction for Federal income tax increased from $34,903.88 in 1922 to $352,025.22 in 1923. *994 In 1923 E. S. Evans was approached by E. W. Bassick, the president*1445 of the Bassick-Alemite Corporation and allied companies, who desired to buy a half interest in E. S. Evans & Co. After offers and counter offers had been made Bassick agreed to purchase a 51 percent interest in E. S. Evans & Co. for $500,000. This offer was accepted by Evans, it being understood that the offer was subject to an audit and survey by Sanderson and Porter. Such audit and survey were made and resulted in adjustments on the books of E. S. Evans & Co. As of November 30, 1923, and before the entries hereinafter set forth were made, the books of E. S. Evans & Co. showed a debit balance in the account of E. S. Evans of $267,116.04. Thereafter, or as of November 30, 1923, there was credited to the account of E. S. Evans the sum of $28,000 on account of certain land transferred to the company by Evans which had a cost basis to him of $17,500, and there was also credited to him the sum of $51,436 on account of factory buildings transferred by him to the company which had a cost basis to him of $36,510.02. The land had a fair market value of $28,000 in December 1923 and the buildings had a fair replacement value of $51,436. As of November 30, 1923, the account of E. S. Evans*1446 was credited by the sum of $70,000, representing the capital stock of the Lumber Products Corporation turned over to the company by him. This stock cost him $70,000 and had on said date a fair market value of the same amount. On the same date the account of E. S. Evans was credited by the amount of $4,958.50 on account of a railway siding transferred by him to the company. The company assumed an obligation of $7,700 with respect to the land above referred to and the account of E. S. Evans was debited by the same amount. His account was also debited in the amount of $14,111.35 on account of commissions due Evans and by him assigned to the company. After the foregoing entries hd been made the account of E. S. Evans had a debit balance of $134,532.89. This account was credited, as of November 30, 1923, with the sum of $796,363.08 on account of certain patents transferred to the company by E. S. Evans. These patents had no cash basis to him and were minor improvements on the basic patents. Thereafter, and before December 20, 1923, the remaining credit balance to the account of E. S. Evans was charged off by a credit to surplus. In order to protect himself from income tax which*1447 might result from his sale to Bassick, E. S. Evans caused two corporations to be organized under the laws of Delaware - the Evans Corporation, hereinafter referred to as The Corporation, with an authorized capital stock of 1,500 shares of no par value, and E. S. Evans & Co., Inc., the petitioner herein, with an authorized capital stock of 10,000 shares of no par value. The first meeting of the board of directors of both corporations was held December 28, 1923, at 10 a.m. The directors *995 of The Corporation adopted resolutions accepting an offer of E. S. Evans to sell and transfer to it the 120 shares of stock of E. S. Evans & Co., being all the outstanding stock of that company, in consideration of the issue to him, or to his nominees, of 1,000 shares of The Corporation's stock. They also adopted a resolution authorizing the president to propose to the petitioner to transfer to the latter the 120 shares of stock of E. S. Evans & Co., when acquired, in consideration of 10,000 shares of the petitioner's stock. The directors of the petitioner at their meeting adopted a resolution accepting the offer of The Corporation to exchange the 120 shares of stock of E. S. Evans & Co.*1448 for 10,000 shares of the petitioner's stock. They further resolved to exchange the 120 shares of stock when acquired for all the assets of E. S. Evans & Co. and to take over such assets, subject to that company's liabilities except those owing E. S. Evans. At a meeting of the directors of the petitioner held at 11 a.m. December 31, 1923, the president reported that, pursuant to the resolutions previously adopted, the petitioner had acquired the 120 shares of the capital stock of E. S. Evans & Co., and that a proposal had been made to that company to purchase all its assets in consideration of the transfer to it of 120 shares of its own stock. The president further reported that the proposal authorized to be made had been accepted and that the transfers, assignments, and guarantees had been duly made and the accepted proposal complied with. The directors of The Corporation met on the same day and at the same hour. The president reported that the Bassick-Alemite Corporation had, on December 29, 1923, offered to purchase from it 5,100 shares of the stock of the petitioner at a price of $500,000, payable $100,000 on acceptance of the offer and delivery of the stock and the balance*1449 in installments of $100,000 each, payable six months apart with interest. Upon the acceptance of the offer the purchaser was to have an option until December 31, 1924, to purchase 2,500 additional shares for $250,000 cash, the option to be extended during the year 1925 for a price to be based on earnings. By resolution this offer was accepted. The transactions recited to have occurred in the resolutions of the boards of directors of both corporations took place in the manner set forth in the resolutions. In compliance with the above resolutions the corporations issued their certificates of stock as follows: The Corporation under date of December 28, 1923, issued its certificate No. 7 to E. S. Evans for 1,000 shares of its stock. Under date of December 29, 1923, the petitioner issued its certificate No. 6 to The Corporation for 10,000 shares of its stock. Under date of December 31, 1923, E. S. Evans & Co. issued its certificate No. 5 to The Corporation for 120 shares of its stock and on the same date issued its certificate No. 6 to the petitioner for the same number of *996 shares. Under date of December 31, 1923, the petitioner issued its certificate No. 7 to The*1450 Corporation for 4,900 shares of its stock, and on the same date issued its certificate No. 8 to the Bassick-Alemite Corporation for 5,100 shares. On December 31, 1923, the Bassick-Alemite Corporation made its initial payment of $100,000. Its final payment, including interest, was made on December 30, 1924. The sales and net profits of the petitioner and its subsidiary, the Lumber Products Corporation, for the years shown were as follows: Year Sales Net profit before taxes Lumber Products Corporation [1923] Intercompany $356.16 The petitioner [1924] $1,727,336.24 321,256.49 Lumber Products Corporation [1924] Intercompany 3,795.83 The petitioner [1925] $3,471,410.52 409,256.87 Lumber Products Corporation [1925] Intercompany 126,387.22 The petitioner [1926] $3,025,549.87 498,222.95 Lumber Products Corporation [1926] Intercompany 127,859.47 The petitioner [1927] $3,626,452.55 679,569.43 Lumber Products Corporation [1927] Intercompany 75,879.00 The petitioner [1928] $4,279,319.27 807,202.13 Lumber Products Corporation [1928] Intercompany 66,182.56 Following is a statement of the assets and liabilities of E. S. Evans & Co. which*1451 were transferred on December 31, 1923, to the petitioner, as shown on the books of the latter: ASSETS Cash $53,758.60 Notes receivable 40,000.00 Accounts receivable 103,014.34 Inventories 16,942.96 Capital stock Lumber Products Corporation 70,000.00 Investment Memphis mill 3,500.00 Prepaid interest 223.34 Land 28,000.00 Buildings 59,513.73 Machinery and equipment 1,370.87 Furniture 1,532.40 Railway siding 4,958.50 Patents and licenses 797,563.08 Total assets 1,180,387.82 LIABILITIES Notes payable $50,000.00 Accounts payable 86,056.96 Federal tax reserve 44,003.15 Reserve for depreciation (Dec. 1923 accrual) 327.71 Total liabilities 180,387.82 Net assets 1,000,000.00 *997 The fair market value on December 31, 1923, of the above patents and licenses was $781,620. OPINION. MARQUETTE: The first issue presented for decision is whether the petitioner is entitled to have depreciation on the patents and buildings which it acquired from E. S. Evans & Co. computed on cost to it, or on the same basis as when owned by the transferor. It is entitled to use the basis of cost to it (section 204(a) and (c) of the Revenue*1452 Acts of 1924 and 1926) unless section 204(a)(7) of these acts applies. Both parties concede that the transfers and transactions between E. S. Evans & Co., The Corporation, and the petitioner constituted a reorganization within the meaning of section 203(h) of these revenue acts. It is clear that the petitioner acquired the property of E. S. Evans & Co. after December 31, 1917, and that it acquired the property in connection with a reorganization. Piedmont Financial Co.,26 B.T.A. 1221. The question then is whether E. S. Evans remained in control of the petitioner immediately after the transfer of the property from E. S. Evans & Co. to it. It is not essential that Evans should retain control for any legth of time. It is sufficient that he was momentarily in control. Federal Grain Corp.,18 B.T.A. 242. As shown by our findings, every act involved in reorganization had been completed before 11 a.m. on December 31, 1923. All the transfers had then been made. Evans owned all the stock of The Corporation, which owned all the stock of the petitioner, which, in turn, had already acquired the property of E. S. Evans & Co. Up to this point neither*1453 E. W. Bassick nor the Bassick-Alemite Corporation had any contractual relations with any one of the three corporations. Neither was in any way a party to the reorganization or concerned therewith. The only contract was for the purchase of stock which belonged to Evans. So far as the record discloses Bassick was concerned only with the purchase of the 51 percent interest in the business. Evans would have been unable to complete his contract with Bassick if he had not retained wither ownership or control of the stock which he had contracted to sell. After reorganization was complete, Evans was able to deliver under his personal contract because, and only because, he had, through his ownership of The Corporation, control of the stock of the petitioner, which owned the business which was, in fact, the subject matter of the sale. In our opinion immediately after the transfer of the property of E. S. Evans & Co. to petitioner, E. S. Evans, who owned all the stock of the transferor, was in control of the petitioner, and the determination of the respondent in this respect is approved. *998 (*1454 Schmieg, Hungate & Kotzian, Inc.,27 B.T.A. 337.) West ,Texas Refining & Development Co.,25 B.T.A. 1254, on which the petitioner relies, is not in point. There the corporations involved were parties to the reorganization. We have found that the factory buildings transferred by E. S. Evans & Co. resulted in the crediting to his account of the sum of $51,436, thereby reducing his indebtedness to the company by that amount, and we have found that these buildings had a fair replacement value of the same amount. Under these facts we are of the opinion that the factory buildings cost the company $51,436, and that the petitioner is entitled to depreciation on the buildings at that cost. A question is raised as to the cost of patents transferred by E. S. Evans to E. S. Evans & Co. It is evident from the testimony that by far the larger part of the value we have found to adhere to the patents and licenses is to be attributed to the contract between the Studebaker Corporation and the Copony Auto Loading Co. on the one hand, and E. S. Evans & Co. on the other. This contract cost the company nothing. Evans himself testified that the patents which he transferred*1455 to E. S. Evans & Co. just prior to the reorganization were minor improvements on the basic patents covered by the contract. Under these circumstances it is impossible for us to find what part, if any, of the indebtedness of Evans which was released to him had any relation to the patents transferred by him to the company. It is evident that the credits made to Evans' account with respect to the patents were mere bookkeeping entries which had no relation whatever to the value or cost of the patents. In the absence of any evidence as to the cost of such patents we are unable to determine a proper basis for depreciation. Certain adjustments to income have been stipulated between counsel for the respective parties and these adjustments will be taken into consideration on final settlement. Reviewed by the Board. Judgment will be entered under Rule 50.