Prudential Loan Co. v. Commissioner

PRUDENTIAL LOAN COMPANY, A MINNESOTA CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Prudential Loan Co. v. Commissioner Docket No. 78869. United States Board of Tax Appeals 37 B.T.A. 975; 1938 BTA LEXIS 958; June 1, 1938, Promulgated *958 1. Petitioner, succeeding to assets of predecessor corporation in a nontaxable reorganization under section 112, Revenue Act of 1928, held, on the facts to be entitled to offset against its income a loss on the sale of transferred property computed by using predecessor's basis, where the evidence sufficiently demonstrates ownership of the property by predecessor and transfer to petitioner prior to consummation of the sale, which had been previously contracted for by predecessor's principal stockholders. 2. Property (shares of stock) found not to have been worthless in or prior to year of sale. 3. Loss on sale held attributable to petitioner's regular business and therefore allowable in the computation of a net loss carry-over. Walter H. Newton, Esq., and L. A. Gravelle, Esq., for the petitioner. G. W. Brooks, Esq., and Alvin Pierson, Esq., for the respondent. OPPER *976 The respondent determined a deficiency in income taxes for the year 1930 in the amount of $11,961.84. It results from his disallowance of a claimed net loss of $98,387.59 for the year 1929, which was deducted by the petitioner on its income tax return*959 for the year 1930. The principal item which results in the claimed net loss is an alleged loss of $128,842.73 on the sale of 1,339 shares of Western Bond & Mortgage Co. stock by the petitioner. The validity of this stock loss is the only issue. The parties have stipulated that the net income for 1929 which is to be offset against the stock loss, if any, in computing any net loss for 1929 is $35,136.06. FINDINGS OF FACT. From a stipulation of facts by the parties and from oral testimony the following are found as facts: 1. The petitioner, a Minnesota corporation, was organized on January 21, 1929, to take over the remaining assets of an Oregon corporation of the same name (hereinafter referred to as Prudential), and to carry on the business of trading in securities. The petitioner engaged in the business of trading in securities in the years 1929 and 1930. 2. Petitioner was organized pursuant to a plan between J. R. Ridgeway of Minneapolis, Minnesota, and C. H. Farrington of Portland, Oregon, to segregate their stockholdings in two corporations, the Investors Syndicate and Western Bond & Mortgage Co., the latter an Oregon corporation hereinafter referred to as Western*960 Bond. 3. Ridgeway and his wife and Farrington and his wife owned in equal shares all of the stock of the petitioner's predecessor, Prudential. Prudential owned the controlling interest (4,300 out of 5,000 shares) in the Investors Syndicate and 1,339 shares of Western Bond. In addition Ridgeway and Farrington (and their respective wives) individually owned in equal amounts sufficient shares to give them control of Western Bond. 4. Ridgeway desired to segregate the Investors Syndicate from Western Bond, to withdraw from the latter, but to retain his (and his wife's) share of the Investors Syndicate stock held by Prudential. He also wanted additional capital contributed to Western Bond because *977 he feared a failure of that company, which might have a bad effect on the Investors Syndicate, due to their close connection. In addition to being controlled by the same individuals, Western Bond was a loaning agent of the Investors Syndicate. 5. Ridgeway and Farrington reached an agreement for the segregation of their interests which was embodied in an instrument designated "General Contract", executed on January 16, 1929. This contract recited the desire of the*961 parties to segregate their interests and contained the following: 1. The parties hereto agree to take such steps as may be necessary so as to divide the holdings of the said Prudential Loan Co., one-half for the benefit of the first party and his wife, and the other one-half for the benefit of the second party and his wife; the exact method of such segregation to be in accordance with the opinion of income tax advisors; provided that the first party [Farrington] and his wife shall receive all capital stock of the Western Bond & Mortgage Co. Ridgeway agreed to transfer to Farrington or his nominees forthwith all of the Western Bond stock owned by Ridgeway and his wife directly or indirectly, to the end that they might "no longer have any further interest in the Western Bond & Mortgage Co." It was added that: * * * Provided, however, the second party [Ridgeway] and his wife may retain to the extent necessary and in the manner deemed proper by the income tax advisors sufficient of the stock of the Western Bond & Mortgage Co. which they hold, indirectly, through the Prudential Loan Co., to offset earnings for the purposes of income tax, but any disposition of the stock made*962 to determine loss shall be made to first party or his order. It was agreed further that the affairs of Prudential "will be forthwith liquidated in conformity with the plan by [sic] the income tax advisors." Farrington agreed to assume the obligation of Ridgeway on their joint note in favor of one Mildred Farrington, shown by other evidence to be in the amount of $10,000. 6. On the same day as the foregoing Ridgeway entered into a further contract with Farrington and wife, designated "Sales Agreement", whereby Ridgeway obligated himself to use his best efforts to sell the Farringtons' share of the Investors Syndicate stock (2,150 shares, one-half of the 4,300 shares) held by Prudential, upon its transfer to a trustee for that purpose. Ridgeway agreed to obtain $250 a share for the stock. The Farringtons agreed to contribute to the capital of Western Bond one-half of the proceeds from the sale of this stock up to $200,000. 7. As a result of these agreements the 2,150 shares of Investors Syndicate, and a large part (2,188 shares) of the Western Bond stock owned by Prudential and by Ridgeway, were transferred to separate trustees pending the consummation of the agreements. *963 *978 8. The income tax advisors having worked out a plan of procedure, several transfers were made pursuant thereto shortly after February 6, 1929, as of January 17-21, 1929: (a) The Farringtons assigned part of their Prudential stock to Western Bond. (b) All of the remaining Prudential stock held by the Farringtons and all held by Western Bond were surrendered to Prudential in exchange for 2,150 shares of Investors Syndicate and one-half of the cash, notes, and other net assets of Prudential except the 1,339 shares of Western Bond owned by Prudential. The surrendered stock in Prudential was canceled and the Ridgeways remained its sole stockholders. (c) Prudential transferred all of its remaining assets, which included the 1,339 shares of Western Bond, to the petitioner, pursuant to a plan of reorganization, in exchange for all of the outstanding stock of the petitioner except three qualifying shares. Petitioner's stock was then distributed pursuant to the plan of reorganization to the Ridgeways as sole stockholders of Prudential. Prudential was thereupon declared dissolved except for liquidation purposes. 9. A dividend of $283.50 on the preferred stock of*964 Western Bond was paid on July 10, 1929, by mistake to Prudential, which was then in liquidation, rather than to the petitioner corporation, which was the owner of the Western Bond stock. This dividend was included by mistake in the dividends reported by Prudential in its 1929 income tax return. 10. Several letters were written from March 22 through September 14, 1929, by Ridgeway or his office, urging the completion of the segregation transactions by the sale of Western Bond stock to Farrington, and the discharge of the Mildred Farrington note. 11. On October 1, 1929, a check from Farrington for $4,000 in payment for the stock sold was received and deposited by the petitioner. On the same day Ridgeway withdrew $4,000 from the petitioner which was charged to accounts receivable on the books of petitioner as an advance to Ridgeway. This $4,000 was used by Ridgeway, together with the $6,000 received for the stock referred to in finding No. 14, to discharge the $10,000 Ridgeway-Farrington note owing to Mildred Farrington, which was paid on October 4, 1929. 12. Of the 3,360 shares of Western Bond stock held by petitioner and Ridgeway, 2,188 shares were held by a trustee and*965 the rest was in the vault of Western Bond. All of the stock was delivered to Farrington, the 2,188 shares being delivered on October 7, 1929. 13. The sale by petitioner to C. H. Farrington of all of its holdings in Western Bond, consisting of 1,339 shares, for the sum of $4,000, was a bona fide sale. The basis of the stock to the petitioner was $132,842.73. *979 14. At about the same time Ridgeway and his wife as individuals sold to Farrington all of their holdings of Western Bond stock, consisting of 2,021 shares, for $6,000. 15. During 1929 Ridgeway succeeded in selling all of the 2,150 shares of Investors Syndicate pursuant to the "Sales Agreement." Out of the total amount realized, $200,000, the proceeds of 800 shares previously transferred to Western Bond by Prudential, was retained by Western Bond as a contribution to capital pursuant to the "Sales Agreement." OPINION. OPPER: Respondent urges three grounds for sustaining his determination: First, that the sale of Western Bond stock by petitioner was in fact not what it appears to be, and should be treated as a nullity and entirely disregarded; second, that this stock became worthless in a prior year*966 and no loss is allowable for the year 1929; and, third, that the loss if otherwise proper is not deductible since it was not attributable to the petitioner's regular business. It is not entirely clear upon what ground respondent urges that the transaction was not in fact a sale. There is some intimation that the original contract, being designed to "segregate" the individual and corporate assets, could not at the same time be a contract to sell by the respective parties. No authority is cited for this proposition and we are unable to reach that result upon an analysis of the actual agreement. The parties were dealing with four items of property in arranging for segregation - the Western Bond and Investors Syndicate stock owned by or attributable to the Farringtons, and the corresponding stock controlled by the Ridgeways. As to two of the four items the arrangement was merely to leave the situation undisturbed; the Farringtons were to retain their Western Bond holdings, the Ridgeways to keep their Investors Syndicate stock. As to the Investors Syndicate stock of the Farringtons, the full cash value was to be paid to them by or through Ridgeway. *967 There thus remained the Ridgeway share of Western Bond, which had to pass to Farrington. And the only remaining consideration - which moved from Farrington to Ridgeway - was the agreement to relieve Ridgeway of liability on the $10,000 note. It seems to us that this was similar in legal effect to an agreement to sell the Western Bond stock in consideration of the worth of Ridgeway's release. "In a general and popular sense, the sale of an article signifies the transfer of property from one person to another, for a consideration of value, without reference to the particular mode in which the consideration is paid." Howard v. Harris, 8 Allen, (Mass.) 297, 299; . *980 We are the more fortified in this result by the circumstance that when these same facts were before the Board in connection with Farrington's tax liability arising out of the identical transactions, we found that the transfer of the Western Bond stock to him was in fact a sale. 1 No claim is made that the organization of petitioner lacked a true business purpose nor that*968 for any other reason the provisions of section 112 of the Revenue Act of 1928 are inapplicable. Cf. . In our consideration of these questions we are therefore justified in accepting as a premise that the organization of petitioner and the transfer to it of all of the assets of Prudential constituted a "tax free" reorganization. This much appears to be conceded by respondent. Petitioner was thus, for purposes of determining basis and depreciation of transferred assets, in the same position from a tax standpoint as its predecessor. ; ; . The remaining question under this contention accordingly appears to be whether the Western Bond stock was in fact among the assets transferred by Prudential to petitioner, for if it was, and, except for respondent's third contention, it seems to follow that petitioner must be entitled to deduct the same loss that Prudential could otherwise have deducted. To resolve this question we may consider, first, whether at*969 the time Ridgeway and Farrington entered into their contracts the stock was in reality the property of Prudential; and, second, if it was, whether in reality it ceased to be an asset of Prudential before the transfer to petitioner. There can be no dispute that in all outward aspects the Western Bond stock had been consistently treated as belonging to Prudential. The latter was the record owner. It received the dividends. It carried the stock on its books. Nor is it suggested that the corporation was a mere shall and not an actively functioning entity. We find no evidence that its apparent ownership was not real. True, the original contract for the sale of the stock was made by Ridgeway and not by Prudential; and the benefit of the sale as originally contemplated, that is, the liquidation of the Mildred Farrington note, was obviously to be derived by Ridgeway and not by Prudential, since the former and not the latter was the obligor on the note. But it seems to us this demonstrates no more than a recognition by the parties that their control of Prudential made its technical concurrence a foregone conclusion. We are not justified for this reason alone in assuming that the*970 property did not belong to Prudential. . *981 Although not specifically so stated, respondent's position may be that title to the stock passed from Prudential to Farrington by virtue of the contract, and hence that no transfer to petitioner or sale by it could have taken place later. With this position we should be unable to concur. That title to ascertained personal property may pass without delivery must be conceded. ; . But whether in any such circumstances title actually passes is a question of intent. ;. And, in the absence of evidence to the contrary, it will be presumed that title was not to pass until consummation of the contract. Here, if anything, the intention not to pass title is emphasized. Provision for escrow of other stock dealt with by the parties is specifically included in the "Sales Agreement. *971 " No such specific provision was made for the Western Bond stock, but, as respondent states in his brief, "Isaacs [one of the attorneys] was to hold the stock pending performance of the Contract", and two certificates representing part of the stock "were given by Ridgeway to Isaacs on January 19, 1929, immediately following the conference between Ridgeway and Farrington in Minneapolis when the General Contract was signed." This was rather an indication that the stock was to be withheld from Farrington in the meantime than that title had passed. See ; . Farrington delayed action on the Mildred Farrington note, and, pending this, the stock was not delivered. On August 20, 1929, Ridgeway wrote to Jacob, another attorney: "The Prudential Loan Co. of Minnesota nor I have received check from Mr. C. H. Farrington for Western Bond and Mortgage Co. stock. Please advise when this deal will be definitely consummated." Correspondence and action of the parties are consistent with an intention that passage of title to the stock was conditioned upon prior or simultaneous*972 payment, and cast serious doubt upon any other interpretation. Certainly there is no evidence that immediate passage of title was intended. Cf. And payment was not made until October, so that the actual sale took place many months after the February transfer of the stock from Prudential to petitioner. It follows from this that the further provision for retention of the stock by Ridgeway "to offset earnings for the purpose of income tax" was inconsequential. Its only effect could have been to prevent a passage of title which would otherwise have taken place. For that purpose, as we have seen, it was unnecessary, for the result was reached by other factors, and would have been, in any case. What the conclusion would be if the arrangement had been a mere colorable attempt *982 to disguise a contrary situation we are not called upon to decide. Cf. ; . It is true that, although insufficient to pass title, the contract created an unqualified obligation to sell the stock to Farrington, and no one else. But that is what*973 made it a contract to sell, rather than a mere legal nullity. It may also be assumed that Ridgeway's agreement that the stock would be sold was binding on Prudential, even in the absence of specific corporate action, see ; ; ; and that, the stock having been acquired by petitioner under the circumstances before us, petitioner in turn became bound to perform. See ; ; ; . This situation gives point to respondent's suggestion that Farrington's offer in September to buy the stock from petitioner was an empty formality. But this would be so not because such a transaction would do violence to the facts, *974 but, on the contrary, because it was so much in accord with them that petitioner was effectively disabled from refusing to perform. If we are correct in this, the delivery of the July dividend check to Prudential instead of to petitioner is of no importance. It could have been nothing more than an immaterial oversight. And the fact that the petitioner at the time it received the stock was contractually bound to make the sale would not permit us to disregard the sale and relieve petitioner of the consequences of any ensuing profit. No more does it require disallowance of the loss. ; . As to the claim that the stock was worthless, Farrington, who of all men was in a position to know, dealing voluntarily and at arm's length with Ridgeway, suffered a detriment by undertaking the full responsibility on the Mildred Farrington note. This liability was assumed in exchange for nothing, unless it was the Western Bond stock and unless that stock had some value. The company was a going concern; it showed a book surplus; and it stood, through the operation of the very transaction before us, to receive*975 $200,000 in cash and notes as a contribution to its capital. Under these circumstances we can not find that the stock had no value. It may be that the precise "market value" of these securities in 1929 was difficult to estimate, or indeed that sales were so infrequent that they had no "fair market value." But this is not to say, in the face of the record, that they were "worthless." *983 "Such shares may have intrinsic value, but * * * no 'fair market value.'" . It should be emphasized that here is not an instance of a private sale asserted by respondent to be at an unduly low figure, thus enabling the vendor to establish an excessive tax loss. Respondent's contention is that the valuation here was too high, since the stock was worthless. We can not agree that it was entirely worthless, and if it was in fact not worth quite as much as Farrington agreed to pay, an assumption it is difficult to make, the only tax result is that petitioner has taken a smaller loss than that to which it might otherwise have been entitled. Nor has petitioner attempted to escape its fair share of the consideration paid for the stock, *976 and thus to increase its loss. That proportion of the $10,000 payment which is a apparently to be ascribed to the stock owned by petitioner was in fact received by it and deducted from its basis. Had the parties followed the precise terms of the original contract and canceled the note, thus leaving Ridgeway with the proceeds of petitioner's asset, it might have been necessary to conclude that part of "the money belongs to the petitioner and is held in trust for it by its stockholders", ; and to charge petitioner with constructive receipt of part of Ridgeway's benefit, since "the fact that petitioner did not take action to recover the proceeds from its stockholder does not relieve it of liability for the tax." . That this was avoided by the ultimate form of the transaction, with the result of a direct payment to petitioner of the value of its stock, seems to us to enhance, not diminish, the reality of its loss. Nor can we agree that the disputed sale was not attributable to the operation of the petitioner's regular business. Its "Articles*977 of Incorporation" authorized it to deal in securities and it did in fact engage in other securities transactions. It does not appear to be contested that petitioner was organized to continue the business of Prudential and that it did so. Had Prudential sold the Western Bond stock, which it was created, in part, to hold, we do not see how it could be doubted that it would thereby be engaging in its regular business. We think the same conclusion follows as to petitioner. Finally, we can not refrain from an expression of our belief that characterization of the facts before us as "tax avoidance" is not peculiarly fortunate. The actuality of the economic loss sustained can not in fairness be disputed. Nor, it seems to us, is there justification for regarding the organization of petitioner, the transfer of assets, and the dissolution of Prudential, as actuated primarily, if at all, by tax motives. Cf. . Had Prudential continued to exist it could have sold the stock and offset the loss against its income with virtually identical tax results. Clearly, *984 then, no consequential tax advantage was to be anticipated from the proceedings*978 regarded as a whole. That petitioner should derive the benefit of Prudential's potential deduction, having succeeded to its property and income, is the essential justification for invoking the protection of section 112 "in order that ordinary business transactions will not be prevented on account of the provisions of the tax law." H.R. Report No. 179, 68th Cong., 1st sess., p. 13. And if the parties took pains to make the actual transaction apparent by its ultimate form they are no more to be penalized than, in the converse situation, a taxpayer is to be protected when he attempts to conceal the true facts by a misleading disguise. "To hold otherwise would be to exalt artifice above reality * * *." Decision will be entered under Rule 50. Footnotes 1. C. H. Farrington,↩ Docket No. 76847 (memorandum opinion, Feb. 5, 1936).