Bonham v. Commissioner

LUTHER BONHAM, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Bonham v. Commissioner Docket No. 66799. United States Board of Tax Appeals 33 B.T.A. 1100; 1936 BTA LEXIS 778; February 14, 1936, Promulgated *778 1. The petitioner, owning the majority of stock in a banking corporation, transferred the stock to a second corporation for cash and stock of the latter. Held, that the provisions of section 112(c)(1) of the Revenue Act of 1928 are applicable and the gain from the transaction is recognized, but only in an amount which does not exceed the cash payment. 2. The petitioner acquired by inheritance a portion of the bank stock so transferred. The fair market value of the stock, on the date acquired, determined. 3. The fair market value of the stock received in exchange, as of the date of such exchange, also determined. Peter S. Rask, Esq., and P. J. Coffey, Esq., for the petitioner. E. L. Corbin, Esq., for the respondent. TURNER *1100 This proceeding involves a determination by the respondent of a deficiency in income tax for the year 1929, in the amount of $4,545.54. The question submitted for our decision is whether or not the respondent erred in computing the taxable profit realized by the petitioner from the sale or exchange of shares of bank stock for cash and stock in a holding corporation. The respondent's determination*779 of the disputed deficiency was based upon the theory that but for the item of cash received the petitioner's stock transactions would have been made pursuant to a plan of corporate reorganization and under section 112(c)(1) of the Revenue Act of 1928 gain was limited to the amount of cash received. All the hearing, however, an amended answer was filed denying that the transaction would have been a reorganization even *1101 if the item of cash had not been involved and claiming that the stock should be included with the cash in computing the petitioner's taxable gain from the transaction. FINDINGS OF FACT. The petitioner is a resident of Fairbury, Nebraska. His income tax return for the year 1929 was made on a cash basis and was also the joint return of himself and wife. For more than twenty-five years the petitioner has been engaged in the banking business, in the city of his residence. On September 30, 1912, he acquired 10 shares of capital stock of the First National Bank of Fairbury, hereinafter referred to as the bank, at a cost of $100 per share. On December 2 of the same year, he acquired 40 additional shares, at $160 per share. From 1913 to 1920, inclusive, *780 the petitioner was cashier of the bank and since 1920 has been its president. On January 29, 1920, he acquired, through inheritance from his father's estate, 520 shares of the bank's stock, the fair market value of which, on that date, was $175 per share. In April of the same year he sold 50 shares of the stock to his mother, at a price of $175 per share. On September 1, 1920, he purchased 173 shares of stock at $175 per share, and nine days later, 33 additional shares at the same price. Thereafter, from time to time, he purchased more stock as follows: 12 shares on January 27, 1921; 5 shares on July 5, 1921; 3 shares on April 2, 1922; 10 shares on December 2, 1923; and 5 shares on February 11, 1924. In making these purchases the petitioner paid a cash price of $175 per share for the stock involved. The petitioner transferred 50 shares of stock to his wife. On October 30, 1929, the petitioner, as a shareholder of the bank, entered into a contract with the Northwest Bancorporation, a holding corporation, hereinafter referred to as the company. The company was described in the contract as party of the first part and "such shareholders of First National Bank of Fairbury, Nebraska, *781 as shall become parties hereto" as parties of the second part. Under the contract the holders of bank stock were to exchange their stock for company stock, or company stock and cash, on terms set forth in the contract as follows: Each of the Shareholders agrees that he will exchange the shares of stock in the Bank, which he owns, hereinafter set opposite his name for four (4) shares of stock of the Company or Three Hundred Sixty Dollars ($360.00) in cash for each share of stock of the First National Bank of Fairbury, Nebraska provided, however, that no Shareholder shall be entitled to receive from the Company more than one-fourth of the total purchase or sales price in cash but shall in each instance accept at least three-fourths of the consideration in stock of the Company. *1102 The shareholders of the bank represented, among other things, that on October 1, 1929, the bank had an unimpaired capital of $100,000, unimpaired surplus account of $50,000, undivided profits account of $16,000 and $5,000 in its current net earnings account, together with acceptable assets to the amount of its outstanding liabilities. In determining the capital, surplus, and undivided profits, *782 as set forth in the contract, the bank building and the land on which it was situated were included at a sum of $75,000. The company questioned certain assets of the bank, and in Exhibit "A" to the contract, listed loans to be eliminated in the amount of $13,700. In Exhibit "B" were listed cerain loans designated as conditioned paper in the amount of $80,423, and one loan designated as placed paper in the amount of $4,000. With reference to the items listed in these exhibits, the contract provided as follows: * * * The Company has caused to be made an examination of the assets and affairs of the First National Bank of Fairbury, Nebraska, and has objected to those certain assets described in Exhibits "A" and "B" hereto attached. The Shareholders agree that the First National Bank of Fairbury, Nebraska, had undivided profits, as of October 1st, 1929, in excess of Sixteen Thousand Dollars ($16,000) and that all of the assets described in Exhibit "A" shall be charged off the books of the said Bank, thereby reducing the undivided profits account of the said Bank, but in no event shall such undivided profits be reduced below Sixteen Thousand Dollars ($16,000) as aforesaid, and if*783 such account is reduced below Sixteen Thousand Dollars ($16,000) the Shareholders shall make up the deficit in cash. The Shareholders further agree that they will see that the conditions to be complied with, in connection with the assets described in Exhibit "B" hereto attached, will be fulfilled in the manner and at the times stated in said Exhibit "B". As a guarantee for the performance of the covenants of this paragraph of the contract, the Shareholders agree that they will deposit with the Company Seven Hundred Fifty (750) shares of stock of the Company which they are to receive under the terms of this agreement, to be held by the Company until all the requirements of said Exhibit "B" have been fulfilled and that, in the event of the failure of the Shareholders to comply with any of said requirements, the Company may sell said stock, or so much thereof as is necessary, on the market without notice to the Shareholders and use the proceeds to reimburse the bank for any loss resulting to the Bank by reason of the failure of the Shareholders to fulfill such requirements. * * * At the time the contract was entered into, the bank had outstanding 1,000 shares of capital stock, *784 950 of which were represented in the contract with the company. Of the 950 so represented, 700 shares belonged to the petitioner and 50 shares to his wife. The Northwest Bancorporation is a Delaware corporation, with its principal office in Minneapolis, Minnesota. Its outstanding capital *1103 stock in 1929 consisted of approximately 1,500,000 shares having a par value of $50 per share. It was a group banking organization and was engaged in the business of owning and operating banks. The fair market value of its stock on October 30, 1929, was $70 per share. Pursuant to the terms of the contract, a stock certificate was issued on November 4, 1929, transferring the 750 shares of bank stock belonging to the petitioner and his wife to the company. In return therefor the company issued and delivered to the petitioner and his wife certificates for 1,500 shares of stock and paid to them $67,500 in cash. The remaining 750 shares of company stock were issued to the petitioner on the books of the company, but were retained by the company under the provisions previously quoted from the contract. Of the stock so retained, 250 shares were delivered to the petitioner in April*785 1931 and the remaining 500 shares were delivered in November 1932. OPINION. TURNER: In his determination as originally made the respondent applied the provisions of subsection (c)(1) 1 of section 112 of the Revenue Act of 1928, thereby limiting the petitioner's taxable gain from the transaction in question to $67,500, the amount of cash received. The petitioner does not dispute the application of this provision of the statute to the facts in this case, but alleges that if the proper basis for the bank stock, and the fair market value of the company stock received therefor are used in the computation, it is apparent that no taxable gain was realized. *786 By amended answer the respondent now contends that subsection (c)(1), supra, is inapplicable, and that the petitioner realized taxable gain to the extent of the difference between the basis of the bank stock and the cash plus the fair market value of the company stock received. From an examination of the statute, it is apparent that in this case the applicability of subsection (c)(1) is dependent upon subsection (b)(3) 2 of the same section of the act. It is necessary *1104 therefore to determine whether or not the exchange of bank stock for company stock would be within the provisions of subsection (b)(3) if the item of cash had been omitted and only company stock had been received in exchange for bank stock. To make subsection (b)(3) applicable the exchange must have been in pursuance of a plan of reorganization and both the bank*787 and the company must have been parties to that reorganization. Subsection (i)(1) of section 112 of the Revenue Act of 1928 defines the term "reorganization" as "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, * * *)." Subsection (i)(2) of the same section provides that the term "a party to a reorganization" 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." Giving careful consideration to the meaning of the term "reorganization" quoted above from the statute and the facts in this case after omitting from consideration, in accordance with the provisions of subsection (c)(1), the cash payment received by the stockholders of the bank, we can find nothing of substance which would distinguish this case from that of *788 . Under authority of that decision, we accordingly hold that but for the fact that cash was received in the instant transaction, the exchange would be within subsection (b)(3) of section 112, supra, and under subsection (c)(1) of the same section the gain to the petitioner may not be recognized in an amount in excess of $67,500. So far as the record shows, the parties have accepted cost as the basis for computing the gain on all of the bank stock transferred except the 520 shares which the petitioner acquired by inheritance, and with reference to the 520 shares they are in apparent agreement that the basis is the fair market value of the stock on January 29, 1920. The petitioner contends that the stock had a fair market value of $279.64 on that date, while the respondent takes the position that the fair market value of the stock was $175 per share, as reflected by sales made soon thereafter and over a period of several years. The petitioner claims that the fair market value of the bank assets on the date in question was $204,635.36, or approximately $204 for each share of stock outstanding and relies on the testimony*789 of several witnesses, called in his behalf, who were of the opinion that the fair market value of the stock was between $250 and $270 per share. On the other hand it is noted that the book value of the capital stock on January 29, 1920, was only $128,059.36, or approximately *1105 $128 per share. Further, it appears, from the statement of earnings and dividends introduced in evidence by the petitioner, that net earnings adjusted to reflect losses on loans and bonds, and all recoveries for the years 1915 to 1920, inclusive, were $9,429.26, $11,919.79, $5,643.80, $8,094.31, $10,971.65, and $15,016.50, respectively, and that the net earnings so adjusted did not again reach the high of 1920 until the year 1928. It is also noted that all sales or purchases of the stock in 1920, or near that time, were made at $175 per share. After considering all of the evidence before us, we have decided and have found as a fact that the fair market value of the bank stock on January 29, 1920, was $175 per share. The next question for determination is the fair market value of the stock of the Northwest Bancorporation on October 30, 1929. While it might be argued that this stock was valued*790 at $90 per share under the contract, it is apparent that that figure was used as the basis of exchange and not as an indication of fair market value at a given date. The contract did not give the petitioner the privilege of receiving $360 per share for his bank stock, but required him to accept a minimum of three shares of Northwest Bancorporation stock and a maximum of cash in the sum of $90. Such a provision in the contract could not be held to establish the fair market value for the stock on the date of exchange in the face of evidence introduced by the petitioner showing sales of 2,883 shares of the stock on that date of the St. Paul Stock Exchange, at prices ranging from a low of 66 1/2 to a high of 71 and a closing price of 70. The petitioner has alleged in his petition that the stock on that date had a fair market value of $70 per share and we have so found as a fact. The only remaining question to be determined is whether or not the petitioner, being on a cash receipts and disbursements basis, received in the taxable year the 750 shares of the Northwest Bancorporation stock covered by paragraph 4 of the contract. If so, this stock, at $70 per share, must also be included*791 in computing the gain recognized for the year 1929. The petitioner contends that never at any moment until this stock was released to him in 1931 and 1932 did he receive it or have a right to receive it, and that under no circumstances did it constitute income to him in any prior year. The contract between the parties best reflects the actual transaction. By its terms the petitioner and his wife disposed of 750 shares of bank stock and received therefor 2,250 shares of stock of the Northwest Bancorporation and $67,500 in cash. In section 4 *1106 of the contract, it appears that the company had questioned certain paper carried in the assets of the bank, and the 750 shares of stock were deposited with the company and were to be held by it until the actual work-out of these assets had been determined. According to the terms of the contract the petitioner and his wife received the entire amount of the stock in the year 1929 and posted the 750 shares as security for the representations made by them with reference to the assets of the bank. Cf. *792 , and ; affd., . See also , and , reversing . In the last two cases cited stock was sold for cash and it was pointed out in the opinions that the sellers did not receive in the taxable year the full amount of the purchase price, nor did they have the right to receive it. Payment of this balance was conditional and it was held that such balance did not constitute income until the events on which payment was conditioned were fulfilled. This case is different. Here the contract contained no condition whatever with reference to the payment of the full amount of the stock agreed upon. Even though the assets of the bank did not work out as represented, there was no right on the part of the seller to reduce the number or to take back any of the shares exchanged under the contract, but only a right to sell collateral to the extent required to make good the representations as to the bank assets. Ownership of this stock*793 had passed to the petitioner and he was exactly in the same situation as if other securities had been deposited in the place of the 750 shares of company stock. On this point the petitioner relies on , affirming a decision of the Board reported at . There the facts are quite different from the facts here. In that case the petitioner was selling a sawmill and the price to be received was conditioned on the amount of timber available. The purchasers had offered a fixed price for the mill provided a definite amount of timber should be guaranteed, but the petitioner refused such a contract and the contract entered into postponed both the determination of and final settlement on the purchase price of the mill until the actual work-out of the timber was known. In the instant case the amount of cash and number of shares to be transferred were fixed, and the transfers made, and in this respect the transaction was not thereafter to be disturbed, the company having only the right to sell company stock, held by it as collateral, to the extent necessary to make itself whole in respect of the representations*794 of the shareholders of the bank. *1107 On this point the respondent is sustained and the 750 shares of stock in question should be included in computing petitioner's taxable income for the year 1929. Reviewed by the Board. Decision will be under Rule 50. ARUNDELL ARUNDELL, dissenting: I disagree with the holding in the majority report to the effect that petitioner received in 1929 750 shares of stock of the Northwest Bancorporation. As a matter of fact, the shares were not received by the taxpayer within that year, either actually or constructively. He had no right within the year to demand their delivery and indeed did not receive them until the years 1931 and 1932. In 1929 it was not definitely known if he would ever receive the shares in question. Under such circumstances it seems to me that the conclusion reached in the majority opinion on this point is wrong. Commissinoner v. Cleveland Trinidad Paving Co., 62 Fed.(2d) 85; Stoner v. Commissioner, 79 Fed.(2d) 75; Preston R. Bassett,33 B.T.A. 182. Mead Construction Co.,3 B.T.A. 438, treats of a deduction and is not*795 in point. TRAMMELL agrees with this dissent. Footnotes 1. Sec. 112. (c) Gain from exchanges not solely in kind. - (1) If an exchange would be within the provisions of subsection (b) (1), (2), (3), or (5) of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property. ↩ 2. Sec. 112. (b)(3) STOCK FOR STOCK ON REORGANIZATION. - 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. ↩