Redfield v. Commissioner

WILLIAM H. REDFIELD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. JAMES D. BIGGS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. GEORGE F. GREEN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Redfield v. Commissioner Docket No. 78860, 79122, 79321. United States Board of Tax Appeals 34 B.T.A. 967; 1936 BTA LEXIS 619; August 25, 1936, Promulgated *619 1. On the facts, held, that petitioners sustained losses in 1932 representing their investments in the capital stock of corporation A by reason of such stock becoming worthless in that year. 2. In 1930 corporation A acquired all the assets of corporation B in exchange for shares of A's capital stock, which stock was thereupon distributed pro rata among the stockholders of B, pursuant to a plan of reorganization. Held, said transaction constituted a reorganization within the meaning of section 112(i)(1)(A), Revenue Act of 1928, whether or not corporation B was thereafter dissolved, and the basis for computing the losses suffered by petitioners in 1932, under section 112(b)(3) or (g) of the Revenue Act of 1928 and section 113 of the Revenue Act of 1932, is cost to petitioners of their stock in corporation B. Emil J. Monde, Esq., and George E. H. Goodner, Esq., for the petitioners. Paul A. Sebastian, Esq., and Wilford H. Payne, Esq., for the respondent. HILL *967 These are consolidated proceedings for the redetermination of deficiencies in income tax for the year 1932 as follows: Petitioner Docket No. Deficiency William H. Redfield 78860 $168.13 James D. Biggs 79122 328.98 George F. Green 79321 91.13 *620 The issues are, (1) (involved in all three proceedings) whether each of the petitioners sustained a deductible loss in 1932 by reason of the alleged worthlessness of their investments in capital stock of the Caro Process Corporation; and, if so, what is the proper basis for computing the amount of such loss; (2) whether petitioner William H. Redfield sustained a deductible loss in 1932 in the amount of $1,100 by reason of the alleged worthlessness of his investment in capital stock of the Danbury Unbreakable Tool Corporation; and (3) whether petitioner William H. Redfield sustanined a deductible loss in 1932 by reason of the worthlessness of a debt due from the Danbury Unbreakable Tool Corporation in the amount of $135. The last two issues are involved only in the proceeding under Docket No. 78860. *968 FINDINGS OF FACT. Issue (1). - In January 1930 the Connecticut Caro Corporation, hereinafter called the Connecticut Corporation, was organized by a group of individuals, including petitioners herein, of Danbury, Connecticut, for the purpose of acquiring a machine for the manufacture of cloth under a license agreement with the Caro Cloth Co. The Connecticut Corporation*621 had an authorized capital stock of 1,000 shares of preferred and 20,000 shares of common. The common stock was issued as a bonus to the subscribers to the preferred stock. The preferred stock was sold at par for $100,000 paid in cash or notes. Some of the subscribers gave installment notes, the balance was paid in cash. Early in January of 1930 capital stock of the Connecticut Corporation was acquired by petitioners in amounts and at costs as follows: Petitioner Shares preferred stock Shares common stock Cost William H. Redfield [500] $5,000 George F. Green [750] 7,500 James D. Biggs [150] 2,000 15,000 In January 1930 the Caro Process Corporation, hereinafter called the Process Corporation, was organized with an authorized capital stock of 1,000,000 shares, all common stock. At that time it took over the total assets of the Connecticut Corporation, for which it paid 45,000 shares of its own capital stock. At the same time the Process Corporation issued 105,000 additional shares of its capital stock to other parties not stockholders of the Connecticut Corporation. These 150,000 shares of capital stock of the Process Corporation remained*622 issued and outstanding throughout all periods material hereto. The petitioner, George F. Green, subsequent to the issue to the Connecticut Corporation of said 45,000 shares, purchased additional shares of stock of the Process Corporation at a cost of $2,500. These three petitioners never at any time disposed of any of their stock in the Process Corporation. After its organization, the Connecticut Corporation entered into a contract with the Caro Cloth Co. for the purchase of one of its machines for the manufacture of cloth. However, before the machine was completed and delivered steps were taken to consolidate the Connecticut Corporation with the Process Corporation of New York, as hereinabove indicated. The stock exchanged by the Process Corporation for the assets of the Connecticut Corporation was distributed *969 pro rata among the stockholders of the latter corporation. The contract entered into between the Connecticut Corporation and the Caro Cloth Co. was turned over to the Process Corporation, which had theretofore entered into a contract to acquire one of said machines. A new contract was then executed by the Process Corporation and the Caro Cloth Co. *623 for two machines. These contracts granted a license to use the machine upon payment of $75,000 and a royalty on the cloth manufactured. The Process Co. had made total payments on its contract of about $40,000 when a controversy arose between this corporation and the Caro Cloth Co. as to the quality of the machine, the cloth manufactured, and other matters. As a result of this controversy the Process Corporation instituted suit against the Caro Cloth Co. in 1930 to recover the payments made on the machine or to correct the alleged imperfection in the machine which affected the quality of the cloth manufactured by it. This suit was dismissed for lack of prosecution in 1931. The capital stock of the Process Corporation was owned by two factions, who were in disagreement as to the policies of the corporation. These factions consisted of the Danbury group and the New York group of stockholders. The officers of the corporation were affiliated with the latter faction, which controlled the administration of the corporate affairs. The groups were not in agreement as to the institution of the suit against the Cloth Co. Petitioner James D. Biggs was secretary of the Connecticut Corporation*624 until the assets of that corporation were taken over by the Process Corporation, but he had no connection with the latter corporation, other than as a stockholder, until in 1931, when he was elected a director of the Process Corporation and as such attended on or two directors' meetings. Upon dismissal of the suit against the Caro Cloth Co. in 1931, Biggs, together with another stockholder of the Process Corporation, visited one Gates, president of the Caro Cloth Co., on behalf of the Danbury group in an attempt to recover something, particularly on the money invested by that group, and also for the benefit of all the stockholders of the Process Corporation. Negotiations were carried on with a view to obtaining a machine such as was originally contracted for, or in lieu thereof for capital stock in the Caro Cloth Co. Several visits were made to Gates with this object in view. Gates was at all times friendly and expressed a desire that the matter might be so worked out that the stockholders could recover something for the $40,000 already paid into the Cloth Co. for the machine. The last conference with Gates was had in the fall of 1932, and at that time he informed Biggs there*625 was no chance for a settlement of any kind because of the then financial condition of the Caro Cloth Co. Biggs *970 had personal knowledge of the bad financial condition of the Cloth Co. in 1932, and he thereupon abandoned hope of salvaging any part of the investment of the Process Corporation in the machine. He so informed the other stockholders. The stock of the Process Corporation became worthless in 1932. Issues (2) and (3). - During the year 1928 petitioner William H. Redfield acquired 110 shares of capital stock in the Danbury Unbreakable Tool Corporation, hereinafter called the Tool Corporation, at a cost of $1,100. During the same year he loaned the corporation $135 in cash. The Tool Corporation owned patents and patent rights on a special drill for boring long holes in bobbins used in woolen mills, in axe handles, golf clubs, and other things. The drill was patented in the United States and foreign countries. In 1930 the Tool Corporation went into receivership, and petitioner Redfield was appointed receiver. As receiver he endeavored to collect the accounts receivable and to sell the plant, including the patents. He also endeavored unsuccessfully*626 to bring about the organization of another company to take over the plant and patents. The patents were considered to be valuable assets. Royalties were received from foreign countries during the receivership. The receiver was unable to effect any organization or to make a public sale of the assets, and in 1932, by order of the court, he sold all the assets at private sale for $600. The proceeds of sale were used to pay preferred claims and nothing remained for the general creditors or stockholders. The corporation was then left without assets of any kind, and ceased to do business. Petitioner received nothing from the corporation, either on his stock, the debt owed to him, or for his services as receiver. Petitioner kept no individual books of account, but in 1932 he ascertained that his claim against the Tool Corporation for $135 was worthless, and took a deduction for that amount in his tax account and in his income tax return. The debt owing to the petitioner by the Tool Corporation became worthless in 1932, and also petitioner's investment in the stock of said corporation became worthless in 1932. OPINION. HILL: Issue (1). - Each of the petitioners herein deducted*627 in his income tax return for 1932 the cost of his stock in the Connecticut Corporation on the theory that the stock of the Process Corporation became worthless in 1932, and that the transaction by which the Process Corporation acquired all the assets of the Connecticut Corporation for shares of stock in 1930 was a reorganization in connection with which no profit or loss was recognizable for tax purposes. Hence, *971 the measure of the loss was the cost of the stock in the Connecticut Corporation. Respondent disallowed the claimed deductions on the grounds (1) that the losses were sustained in 1931 and not in 1932; (2) that there was no statutory reorganization; (3) that in any event, the stock received by the Connecticut Corporation in exchange for its assets was not distributed to its stockholders pursuant to any plan of reorganization; and (4) that no basis for the computation of the losses is disclosed by the record. That each of the petitioners has sustained a loss is not in controversy, but the parties are in disagreement as to the year in which the respective losses were sustained and whether or not the record establishes the amount. *628 The first question under this issue, therefore, is, In what year did the losses occur? The year of loss is the year in which occurred some identifiable event which fixed with reasonable certainty the fact of loss. The law does not require a taxpayer to be an incorrigible optimist to the extent of deferring a deduction until the most remote possibility of recovery is exhausted; nor may a taxpayer at his option take the deduction in a subsequent year if it reasonably appears that the loss was sustained in a prior year. United States v. White Dental Manufacturing Co.,274 U.S. 398. The respondent contends that the identifiable event which fixed the date of the losses in controversy here occurred in 1931, when the suit instituted by the Process Corporation against the Caro Cloth Co. was dismissed for lack of prosecution. Petitioners argue that the losses could not be said to have been sustained at that time for the reason that thereafter there was reasonable expectation of effecting recovery of a substantial amount of their investments through friendly negotiations with the president of the Caro Cloth Co. These negotiations were concluded late in 1932, at which*629 time all hope of recovery was abandoned. From a careful consideration of the evidence, we are of the opinion that the contention of the petitioners on this point must be sustained. At the end of 1931 it could not be said that the losses of these petitioners were complete. The circumstances as they existed at that time undoubtedly indicated a strong probability that there would be some loss, but negotiations were being actively carried on with a view to the recovery in one form or another of at least a portion of the petitioners' investments. Apparently petitioners believed in good faith that something would be recovered, and the situation, we think, reasonably supported such belief. Except for the financial difficulties encountered by the Caro Cloth Co. in 1932, the negotiations conducted by Biggs would have probably resulted in saving a substantial amount of the petitioners' investments. When those negotiations definitely failed during the taxable year solely because of the bad *972 financial condition of the Cloth Co., the stock in the Process Corporation became worthless, and this event fixed the date of the petitioners' losses. The next question which arises under*630 issue (1) concerns the proper basis for computing the amounts of the losses sustained by the petitioners in 1932. Respondent determined that the acquisition of the assets of the Connecticut Corporation by the Process Corporation did not constitute a statutory reorganization, and that in any event the subsequent distribution of the stock to the stockholders of the Connecticut Corporation was not made in pursuance of a plan of reorganization, as required by section 112(g) of the Revenue Act of 1928. Respondent urges, therefore, that the basis ofr computing the losses is the value of the stock of the Process Corporation at the date received by the stockholders of the Connecticut Corporation, or the value of the assets of the Connecticut Corporation at the time transferred. The undisputed evidence establishes that early in 1930 the Process Corporation acquired all the assets of the Connecticut Corporation in exchange for 45,000 shares of its capital stock, which stock was distributed pro rata among the stockholders of the Connecticut Corporation. The latter corporation thereupon ceased to do business. The record does not disclose whether or not this corporation was dissolved, but, *631 irrespective of dissolution, the transaction constituted a reorganization within the meaning of section 112(i)(1)(A) of the Revenue Act of 1928. Helvering v. Minnesota Tea Co.,296 U.S. 378; Nelson Co. v. Helvering,296 U.S.374; Western Industries Co. v. Helvering, 82 Fed.(2d) 461. Also, the record does not disclose whether the stockholders of the Connecticut Corporation surrendered their shares of stock in that corporation at the time of the distribution to them of the stock of the Process Corporation. If they did in fact surrender or exchange their shares of stock in the Connecticut Corporation for stock in the Process Corporation, both corporations being parties to the reorganization, no gain or loss was recognizable under the provisions of section 112(b)(3) of the Revenue Act of 1928, 1 if such exchange was "in pursuance of the plan of reorganization." On the other *973 hand, if the stock of the Process Corporation was distributed to the stockholders of the Connecticut Corporation without the surrender of their stock in that corporation, no gain to the distributees from the receipt of such stock was recognizable under*632 section 112(g) of the 1928 Act, 2 if the distribution was "in pursuance of a plan of reorganization." To come within the provisions of either subdivision of the statute referred to, the distribution or exchange of stock must be made in pursuance of a plan of reorganization. National Pipe & Foundry Co.,19 B.T.A. 242; Arctic Ice Machine Co.,23 B.T.A. 1223; J. M. Harrison, Inc.,30 B.T.A. 455. *633 It is not necessary, however, that such a plan of reorganization be evidenced by a formal written document, such as a contract or corporate minutes. It is sufficient if the circumstances indicate that the various steps taken were pursuant to a definite plan of reorganization. Western Industries Co. v. Helvering, supra. In the instant case, we do not know whether a formal plan of reorganization was embodied in the minutes of the Connecticut Corporation or other record, since it was testified that the records of that corporation, including its minute books, are out of existence, but the facts and circumstances, we think, clearly indicate a plan of reorganization. It follows that, under section 113 of the Revenue Act of 1932 the basis for determining the losses sustained by petitioners is the cost to them of their stock in the Connecticut Corporation. These amounts are set out in our findings of fact. In addition to the losses so computed, petitioner George F. Green (Docet No. 79321) is entitled to a deduction in the amount of $2,500 representing the cost of the additional shares of stock in the Process Corporation purchased by him subsequent to the issue*634 to the Connecticut Corporation of the 45,000 shares of stock in exchange for assets. Sec. 113, supra. On the first issue, respondent's action is reversed. Issues (2) and (3). - These issues are involved only in the case of petitioner William H. Redfield. In 1928 this petitioner acquired 110 shares of stock in the Tool Corporation, referred to in our findings of fact, at a cost of $1,100, and in the same year loaned the corporation $135 in cash. Petitioner contends he is entitled to deduct these amounts from gross income for 1932 for the reason that both the stock and the debt became worthless in that year. Respondent takes the position that the losses were sustained prior to 1932, and therefore do not constitute allowable deductions for the taxable year. Thus the year of loss is the sole question presented for decision. The Tool Corporation went into receivership in 1930, petitioner being appointed receiver. It is not shown that the corporation was then wholly insolvent. Whether or not it was insolvent depended *974 upon the realizable value of certain patents and other assets owned by the corporation. The assets were sold by the receiver under order of the*635 court in 1932, and the proceeds applied to the payment of preferred claims. Nothing remained for the general creditors or stockholders. The corporation was left without assets of any kind and its stock and unpaid obligations thereupon became worthless. We think it can not be said, under the facts here, that the corporation was so clearly insolvent that its stock and debts owed by it became wholly worthless prior to the sale of the assets in 1932. The mere fact of the corporation being in receivership alone is not enough to establish worthlessness of its stock. P. J. Quealy,6 B.T.A. 419; Henning Bruhn,11 B.T.A. 809. While there may have been some probability prior to the taxable year that the stock of the corporation would prove worthless, this fact was not definitely established until the assets were sold. William E. Metzger,21 B.T.A. 1271; Peter Doelger Brewing Co.,22 B.T.A. 1176; Royal Packing Co. v. Lucas, 38 Fed.(2d) 180, affirming *636 13 B.T.A. 773; Burnet v. Imperial Elevator Co., 66 Fed.(2d) 643, affirming 25 B.T.A. 234. Petitioner is entitled to deduct the amount of his investment in the stock of the Tool Corporation as a loss sustained in 1932. The facts referred to above which establish that the stock of the corporation became worthless in 1932 also support the conclusion that the debt owing to petitioner by the corporation became worthless in the same year. The statute requires not only that a debt, in order to be deductible, must be ascertained to be worthless, but also must be charged off within the taxable year. Sec. 23(j), Revenue Act of 1932. But petitioner kept no individual books of account, and could not therefore charge off the debt in the ordinary way. He claimed a deduction of the amount in his return for 1932, and respondent raises no question on this point. Petitioner is entitled ot the deduction claimed on account of the worthless debt. Merritt J. Corbett,15 B.T.A. 698; affd., *637 50 Fed.(2d) 492. Judgment will be entered under Rule 50. Footnotes 1. SEC. 112. RECOGNITION OF GAIN OR LOSS. * * * (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. ↩ 2. SEC. 112. (g) Distribution of stock on reorganization.↩ - If there is distributed, in pursuance of a plan of reorganization, to a shareholder in a corporation a party to the reorganization, stock or securities in such corporation or in another corporation a party to the reorganization, without the surrender by such shareholder of stock or securities in such a corporation, no gain to the distributee from the receipt of such stock or securities shall be recognized.