Lakeland Grocery Co. v. Commissioner

LAKELAND GROCERY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Lakeland Grocery Co. v. Commissioner Docket No. 83392. United States Board of Tax Appeals 36 B.T.A. 289; 1937 BTA LEXIS 736; July 13, 1937, Promulgated *736 The petitioner was insolvent but under a composition with creditors received from them a cancellation of their claims, after which the petitioner was solvent with net assets of $39,596.93 over and above all liabilities to creditors. Held, that the petitioner realized gain in the amount of the assets thereby freed from claims of creditors. Robert Ash, Esq., for the petitioner. C. A. Gwinn, Esq., for the respondent. HARRON *289 This is a proceeding for the redetermination of a deficiency in income tax of $12,139.12 and excess profits tax of $4,257.97, a total of $16,397.09 for the taxable year 1933. The petitioner's tax return showed a net loss of $29,900.18 and the respondent made adjustments which resulted in a net income of $88,284.49. The only adjustment in issue is his addition of $89,237.55 as income realized from a composition settlement by the petitioner with its creditors. FINDINGS OF FACT. The petitioner, a corporation, with its principal office in Lakeland, Florida, was forced into receivership on December 26, 1930, as the result of a suit filed in the United States District Court for the Southern District of Florida, *737 two receivers being appointed, from which it was discharged on March 29, 1933, after having effected a composition settlement with its creditors as hereinafter shown. On March 3, 1933, the petitioner filed a voluntary petition in bankruptcy in the said United States District Court with the usual allegations, i.e., inability to pay its debts and offering to give up all of its assets in settlement thereof, listing an excess of debts over assets. After filing such petition, and prior to action thereon by *290 the court, the petitioner, because of the pendency of a plan of composition then under consideration, requested the court to delay action upon the petition for adjudication until a decision by the creditors with respect thereto. This request was granted and the petition in bankruptcy was not acted upon. In order to permit petitioner to remain in business, the creditors accepted a composition plan resulting in the cancellation and forgiveness of the petitioner's indebtedness to the extent of $104,710.16, in consideration of payments to the creditors in the sum of $15,472.61, or a net cancellation of $89,237.55 of debts. The petitioner was permitted to retain assets*738 in the net amount of $39,596.93 which might have been applied against its indebtedness had it been adjudicated a bankrupt. The United States District Court confirmed this composition on March 29, 1933. Immediately prior to this composition settlement the petitioner was insolvent, having an excess of liabilities over assets. Immediately thereafter, on April 1, 1933, the petitioner as a result of the composition had net assets of $39,596.93. A summary of its balance sheet on that date is as follows: Assets Liabilities Current assets $54,064.80 Current liabilities $14,092.17 Fixed assets 12,347.00 Note payable 15,000.00 Other assets 2,277.30 Capital: Capital stock $38,600.00 Total 68,689.10 Surplus 996.93 Total capital 1 39,596.93 Total liabilities and capital 68,689.10 OPINION. HARRON: The respondent made several adjustments of the taxpayer's income for the taxable year 1933, but the only one in issue is his addition to the petitioner's income of $89,237.55 as "Profit arising from composition settlement. *739 " This amount was determined by subtracting the total payment to creditors made in comsideration of the composition, $15,472.61, from the total of debts which were canceled, $104,710.16. The petitioner claims that no "income" whatever was realized from the cancellation of indebtedness and the respondent, while contending that "income" was realized, concedes on brief that the "income" should be limited to the total of the petitioner's net assets immediately following the composition, namely, $39,596.93, which were made available to the petitioner free from the claims of creditors as a result of the composition. *291 Both parties are agreed on the fact that prior to the composition settlement petitioner was insolvent, having an excess of liabilities over assets. The parties are also agreed that immediately after the composition the petitioner had net assets of $39,596.93 which were freed from the claims of creditors as a result of the composition settlement. The statute so far as applicable here merely provides that "'Gross income' includes gains, profits and income derived from * * * trades, businesses, commerce or sales, or dealings in property, or use of or interest*740 in such property; also from * * * the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever." (Sec. 22(a), Revenue Act of 1932.) The question here is whether the cancellation of indebtedness under the circumstances of this case resulted in "gains", "profits", or "income" within the meaning of the statute. The cases which the petitioner claims are controlling on the facts are: Meyer Jewelry Co,3 B.T.A. 1319; Burnet v. Compbell Co., 50 Fed.(2d) 487; Dallas Transfer & Terminal Co. v. Commissioner, 70 Fed.(2d) 95; and Porte F. Quinn,31 B.T.A. 142. As we read these cases none of them appear to involve the facts we have before us. Although the reports in some of them are not clear as to the facts involved, it seems to us a fair conclusion that in all of them the petitioner was assumed to be insolvent before the forgiveness of indebtedness and to have remained in a state of insolvency or at least with no excess of assets over liabilities after the cancellation of indebtedness. On such facts it was properly held that no gain was realized, and*741 a long line of cases reaches this result. Simmons Gin Co.,16 B.T.A. 793; affd., 43 Fed.(2d) 327; Eastside Manufacturing Co.,18 B.T.A. 461; Progress Paper Co.,20 B.T.A. 234; E. B. Higley & Co.,25 B.T.A. 127; Towers & Sullivan Manufacturing Co.,25 B.T.A. 922. However, in the case at bar the distinguishing factor is that although the petitioner was insolvent immediately before the composition it emerged from that settlement with free assets of $39,596.93. The respondent rightly, it seems to us, perceives this to be a case of first impression on the particular facts present. He points out that the line of cases cited are applicable where the debtor is insolvent both before and after the cancellation of debts. He cites the other line of cases holding that gain is realized from forgiveness of indebtedness where the debtor is solvent both before and after the cancellation of indebtedness. B. F. Avery & Sons, Inc.,26 B.T.A. 1393; *742 Knowles D. White,34 B.T.A. 424; affd., sub nom Walker v. Commissioner, 88 Fed.(2d) 170, and he points out that this is an intermediate case where the debtor was insolvent before the cancellation *292 but solvent immediately after it with an excess of assets over liabilities of $39,596.93. In this situation he contends that the rationale of United States v. Kirby Lumber Co.,284 U.S. 1, should apply and that gain is realized to the extent of the value of the assets freed from the claims of creditors by the composition in the amount of $39,596.93. This we believe is the correct result. The petitioner's net assets were increased from zero to $39,596.93 as a result of the cancellation of indebtedness by its creditors, and to that extent it had assets which ceased to be offset by any liability. The decisions that the increase in clear assets so brought about constitutes taxable "gain" or "income" (United States v. Kirby Lumber Co., supra, and *743 Helvering v. American Chicle Co.,291 U.S. 426) are applicable to the facts of the instant case, as the cancellation of the petitioner's debts had the effect of making its assets greater than they were before that transaction occurred. It is true that "gain" or "profit" is essential to the existence of taxable "income" (cf. Dallas Transfer & Terminal Warehouse Co., supra), and we believe that "gain", as commonly understood, was realized here when the petitioner, who was hopelessly insolvent, received by the action of its creditors an increment to its assets clear and free of any claims of the creditors. We are not certain under the facts in the case of Dallas Transfer & Terminal Co. v. Commissioner, 70 Fed.(2d) 95, reversing 27 B.T.A. 651, whether the taxpayer had assets in excess of liabilities after the forgiveness of indebtedness involved there. It appears that this proceeding is distinguishable from the Dallas Transfer & Terminal case. The facts of the Dallas case show that the taxpayer conveyed its chief asset, a piece of realty, and for this conveyance the taxpayer's indebtedness was discharged. The Circuit*744 Court stated, in reversing the Board, supra, and in distinguishing the Kirby Lumber Co. case, that in the Kirby case the taxpayer had greater "clear" or net assets than it had before the discharge of its obligations, whereas in the Dallas case, having thus parted with assets, it did not. In this proceeding the petitioner's financial statement shows that it obtained assets clear of liabilities after the composition of creditors. From the balance sheet and testimony respecting the nature of petitioner's business, we conclude that the assets freed to the petitioner by the composition of creditors had an exchange value. Under such facts and as stated above, we believe that this petitioner realized taxable gain and that the rationale of the Kirby Lumber Co. case, supra, applies. Reviewed by the Board. Decision will be entered under Rule 50. STERNHAGEN *293 STERNHAGEN, concurring: Both Meyer Jewelry Co.,3 B.T.A. 1319, and Burnet v. Campbell Co., 50 Fed.(2d) 487, were decided before United States v. Kirby Lumber Co.,284 U.S. 1, and in my opinion are incompatible with the*745 decision and were overruled by it. Dallas Transfer & Terminal Co. v. Commissioner, 70 Fed.(2d) 95, while different from the present case in its facts, contains reasoning with which I can not agree, and I do not, therefore, think its effect should be spread to cases where (short of a proceeding in bankruptcy) the debtor is saved from insolvency by the forgiveness of a debt or enabled thereby to carry on his business and recover his solvency. In such cases his gain may be just as real and substantial as where the forgiveness or composition occurs before insolvency. MURDOCK agrees with the above. MORRIS MORRIS, dissenting: I disagree with the majority in holding that the petitioner realized taxable income of $39,596.93 as a result of the composition settlement. I am unable to distinguish the facts in this proceeding from those in Dallas Transfer & Terminal Co. v. Commissioner, 70 Fed.(2d) 95, reversing 27 B.T.A. 651. The Board, in its opinion in that case, at page 657, pointed out that the taxpayer was solvent after the cancellation; therefore, in both cases the taxpayers were insolvent prior to the forgiveness*746 and solvent thereafter. Under such circumstances the taxpayer does not always realize taxable income, a conclusion which, necessarily, follows from the majority opinion, but the facts of each case must be analyzed to ascertain whether there has been a gain or a profit. In the Dallas case the Board held, treating the transaction as a partial forgiveness of indebtedness, although deciding the case primarily on another theory, that taxable income was realized to the extent of the amount forgiven as assets were left cleared of debts to that extent. The reasoning of the court in reversing the Board and the distinction made by it between that case and United States v. Kirby Lumber Co.,284 U.S. 1, are equally applicable to the facts in this proceeding and make it unnecessary to extend this opinion. Based thereon, it is my opinion that the taxpayer did not realize any income as a result of the composition settlement. See also Commissioner v. Rail Joint Co., 61 Fed.(2d) 751; Burnet v. Campbell Co., 50 Fed.(2d) 487. SMITH, VAN FOSSAN, and DISNEY agree with this dissent. Footnotes 1. Representing the excess of assets over liabilities resulting from the composition settlement. ↩