GEESEMAN v. COMMISSIONER

DELBERT B. GEESEMAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. GEESEMAN v. COMMISSIONER Docket No. 81736. United States Board of Tax Appeals 38 B.T.A. 258; 1938 BTA LEXIS 892; August 4, 1938, Promulgated *892 In March 1931, the petitioner was given an option by a corporation by which he was employed to purchase a stated number of shares of stock in the corporation at a price below the current market. According to the terms of the offer the shares could be purchased in stated amounts on and after specified dates extending over a period of more than four years. Prior to the purchase of any shares by petitioner the current market price declined below the option price and the corporation reduced the option price to an amount below the then market price. Thereafter, in 1933, when the market price for the shares had increased to an amount almost double the option price, petitioner purchased a number of shares according to the terms of the option. Held, on the facts, that such acquisition of stock by the petitioner did not constitute the receipt of compensation in an amount equal to the difference between the price paid and the fair market value of the stock at the date of purchase, or in any amount. J. Garfield Houston, Esq., and H. V. Blaxter, Esq., for the petitioner. L. W. Creason, Esq., for the respondent. TURNER *258 This proceeding involves*893 a deficiency in income tax determined by the respondent in the amount of $6,349.77 for the year 1933. The issue presented is whether the respondent erred in including in petitioner's taxable income, as additional compensation, the amount of $26,690 representing the difference between the amount paid and the fair market value of stock purchased by the petitioner in 1933 pursuant to an option granted by his employer in 1931. FINDINGS OF FACT. The petitioner is an individual, residing at Houston, Washington County, Pennsylvania. He filed his Federal income tax return for the year 1933 with the collector of internal revenue at Pittsburgh, Pennsylvania. Some time prior to March 11, 1931, the petitioner entered the employ of the Continental Can Co., a New York corporation, sometimes referred to as Continental Can, and continued in that employment throughout the calendar year 1933. In August 1930 the executive committee of the board of directors of the Continental Can Co. initiated a plan to set aside a block of its common stock upon which options to purchase would be granted to certain officials and employees. On March 10, 1931, the stockholders approved the plan and authorized*894 the setting aside of 85,000 *259 shares upon which options to purchase in varying amounts would be granted to approximately 150 officials and employees. Pursuant to the plan so authorized, a letter signed by the president of the company was sent to petitioner under date of March 11, 1931. The body of the letter reads as follows: The Board of Directors has set aside a block of stock of our Company, on which the management or key man have an option to purchase the same at $40.00 per share. You have been awarded an option on 800 shares on the terms and conditions shown on the enclosed form, which you will please retain for your record. This is by far the most substantial thing the Company has ever been able to do for those who are most responsible for its progress. On account of the attractive price and the period of years the option covers, the Board of Directors and the Management feel you are placed in a most favorable position to materially add to your worth or estate. The prospects of the Company are brighter today than at any time in its history, and with every man doing his level best, we feel reasonably certain you are going to have a very handsome profit*895 on this stock in a few years. As this proposition is being extended only to those in the most important positions, we request that you consider this confidential. If there should be anything about the terms of the option not clear to you, I will be glad to hear from you. The statement enclosed, showing the terms and conditions under which the petitioner might acquire the 800 shares of Continental Can Co. stock, reads as follows: CONTINENTAL CAN COMPANY, INC. EMPLOYEE'S STOCK OPTION CONTRACT 1. CONTINENTAL CAN COMPANY, INC., a New York corporation (herein called the "Company"), recognizing the value to it of the continuance of the services of D. B. GEESEMAN (herein called the "Employee"), who is an officer or employee of the Company, and desiring the continuance of such services, grants to the Employee the option to purchase, at any time on or after the dates hereinafter mentioned and prior to the expiration date of this contract, at Forty Dollars ( $40) per share, all or any part of the following amounts of the Company's common stock: On or after September 1, 1931 160 shares On or after September 2, 1931, an additional 160 shares On or after September 2, 1932, an additional 160 shares On or after September 2, 1933, an additional 160 shares On or after September 2, 1934, an additional 160 shares *896 The number of shares which the Employee shall be privileged to purchase after each of said dates shall at all times include any shares theretofore purchasable under this paragraph 1 but not purchased. 2. The shares deliverable hereunder, at the election of the Company, may be shares of its authorized but unissued common stock or shares of common stock reacquired by the Company and held in its treasury. The Company agrees that if, at the time any shares of stock are purchased hereunder by the Employee, its common stock is listed on the New York Stock Exchange, the stock delivered to *260 the Employee hereunder shall be listed stock. If the Company elects to deliver authorized but unissued stock, the Company shall have a reasonable time within which to procure the listing of such stock. 3. If the Employee is discharged or resigned or dies prior to the expiration date of this contract, the only right which he or his estate shall have hereunder will be to take up, within six months thereafter and prior to the expiration date of this contract, the shares which at the date of such discharge, resignation or death were immediately purchasable hereunder; except, however, *897 if he shall die during the first year of this contract his estate may within said six months take up the full amount of the first installment. 4. It is the intent of this contract that the stock deliverable hereunder shall be common stock of the Company of the kind and character now outstanding or its equivalent, and, in the event of a readjustment of the Company's capital structure, of a merger or consolidation of the Company with any other company or in any other event whereby the character of the present common stock of the Company shall be changed, the Company agrees that the stock to be purchased hereunder shall be the equivalent of the present common stock of the Company, whether in the new or increased stock of the Company after such readjustment, or in stock of the consolidated company or of the company with which the Company shall have been merged. The stock to be purchased hereunder shall carry with it all stock dividends paid on an equivalent number of shares between the date of this agreement and the date on which the stock shall be purchased hereunder; but this provision shall not apply to stock dividends paid at rates not in excess of 5% per annum and charged to*898 the net earnings of, or surplus earned in, any year subsequent to 1930. If during the life of this contract the Company shall offer to the holders of any class of its stock the right to subscribe for additional shares of its common stock, the Employee, at the time of taking up any stock under any installments of his option maturing thereafter, may subscribe for as many additional shares as he would have been entitled to subscribe for had he been the owner of the stock so taken up under the installments at the time of the offering of the additional stock to stockholders; and the price at which he may subscribe for such additional stock shall be the same as that at which the additional shares were offered to stockholders. 5. The Executive Committee of the Board of Directors of the Company shall have power to construe this contract in good faith. 6. This contract will expire September 2, 1935. The above statement was signed for the company by its president and attested by its secretary. There is nothing to indicate that any acknowledgment or acceptance by petitioner was expected or received. The common stock of the Continental Can Co. was listed on the New York Stock Exchange*899 and was traded in throughout the period from March 11, 1931, to the end of the calendar year 1933, at the following highs and lows: Date High Low Mar. 11, 1931 58 1/2 57 1/8 Sept. 1, 1931 [48] 47 3/4 Sept. 2, 1931 [48] 47 3/8 Oct. 14, 1931 36 1/8 34 3/4 Mar. 8, 1932 [41] 40 1/2 Sept. 2, 1932 34 3/4 [33] Sept. 1, 1933 [66] Sept. 2, 3, and 4, 1933 were holidays Sept. 5, 1933 [66] Nov. 1, 1933 63 1/4 [61] Nov. 25, 1933 72 1/8 [71] *261 At a meeting of the executive committee of the company, held on October 14, 1931, the price of $40 per share stipulated in the option was reduced to $30 per share, subject to ratification by the stockholders. At this meeting the chairman, in recommending the reduction, stated that: The purpose of the Company's * * * option plans was to afford the personnel of the Company an incentive by which their loyal support of the organization could be secured both as employees and as stockholders through the advantage of being able to purchase stock of the Company at a price below that at which it could be purchased in the open market. This reduction was ratified by the stockholders at a meeting held on March 8, 1932. *900 Pursuant to the terms and conditions of the option, as amended, the petitioner purchased on November 1, 1933, 100 shares of stock of the Continental Can Co., at a rate of $30 per share, for the total amount of $3,000. The fair market value of those 100 shares on the date of acquisition was $6,212.50. On November 25, 1933, the petitioner purchased 540 additional shares at a rate of $30 per share, for the total amount of $16,200. The fair market value of those 540 shares on the date of acquisition was $38,677.50. Under options granted other employees of the Continental Can Co., which options were identical with that of petitioner except for the number of shares allotted, the employees purchased 440 shares in 1931, 6,060 shares in 1932, and 47,291 shares in 1933. On April 18, 1934, a firm of attorneys representing the Continental Can Co. directed a letter to the Commissioner of Internal Revenue requesting a ruling with respect to the proper way of treating, for income tax purposes, the plan whereby officers and employees of the company were given the right to purchase designated amounts of the company's stock. On May 1, 1934, the Commissioner replied to the company in effect*901 that the options were contracts of employment and the difference between cost of the shares and their fair market value constituted additional compensation to the employee, which the company could deduct from gross income and the employee should report as additional compensation. In its income tax returns for the years 1931 and 1932 the Continental Can Co. did not deduct, as additional compensation paid to employees who acquired shares in those years, the difference between their market value and the price paid under the options. In its income tax return for the year 1933 it did deduct, as additional compensation paid to employees who acquired shares in that year, the difference between their market value and the price paid under the option. On his income tax returns for the years 1931 and 1932, the petitioner reported no gain or additional compensation received on *262 account of the shares of common stock of the company which he was privileged to acquire during those years, nor did he report any taxable income as a result of the acquisition of the 640 shares in 1933. The respondent made no change in respect of the petitioner's returns for the years 1931 and 1932, but*902 for the year 1933 he has determined that the petitioner received additional compensation taxable as income in the amount of $26,690, representing the difference between the fair market value and the price paid by the petitioner for the 640 shares. The respondent was not advised of the existence of the stock options granted to the petitioner by the company until he received the above mentioned letter dated April 18, 1934, wherein the attorneys for the company requested the respondent's ruling. The petitioner was not advised of the respondent's ruling on the subject until June 4, 1934. The petitioner filed his income tax returns for the years 1931, 1932, and 1933 upon the cash receipts and disbursements basis, while the Continental Can Co. filed returns for those years upon the accrual basis. The petitioner's returns for the years 1931 and 1932 were filed on March 1, 1932, and March 7, 1933, respectively, and no waiver extending the time for assessments and collection of additional taxes has been executed by the petitioner, and the time for making assessents and collection of additional taxes for those years expired prior to the mailing of the deficiency notice or the filing*903 of the petition in this proceeding. OPINION. TURNER: The respondent contends that the option granted the petitioner "by its terms was strictly an employment of service contract" and that the difference between the price paid for the shares of stock and their fair market value on the date of purchase was additional compensation received by him as an employee of Continental Can Co. The petitioner contends that his purchase of stock was a "bargain" purchase and that such acquisition does not result in the realization of gain until the shares are sold or otherwise disposed of at a profit. In the alternative, he contends that if the transaction did constitute the payment of compensation, such compensation was received either then the option was originally granted or on the respective dates when the right to acquire the various allotments of stock matured. Numerous cases which resemble the instant case in many respects have been decided and the results in many of them can not be reconciled as to conclusions of fact or conclusions of law. The disposition of such cases has become increasingly difficult because of the effort to *263 spell out some set rule or formula whereby*904 transactions of the type here involved may be automatically classified either as "bargain" purchases having no dependency on a contract of employment and which in the absence of sale or other disposition of the shares are said not to result in the present realization of gain, or classified as the payment of compensation which, to the extent that the fair market value of the shares on the date of acquisition exceeds the purchase price, must be returned by the employee as income in the year of the purchase. To hold that a transaction of the character here involved is a "bargain" purchase having nothing to do with the employer-employee relationship, or, to the contrary, that it is not a purchase but constitutes the receipt of compensation having nothing to do with the purchase of property, to the extent that the fair market value exceeds the purchase price, is to ignore obvious facts and to assume a case substantially different from the one before us. In the first place, it may not be said that the acquisition of the stock of Continental Can Co. was not a purchase merely because the price paid was substantially lower than the price at which the same stock was then selling on the market, *905 and, in the second place, obvious facts are ignored it is be said that the stock transaction was separate and apart from, or was not based upon, the employer-employee relationship, or that it had no relation to services rendered or to be rendered. In practically all such cases both elements are present and decision is impossible if the absence of one of the other is essential thereto. Normally the purchase of property does not result in the realization of taxable gain, but rather in the acquisition of an asset with a view to the later realization of gain or profit through its use or subsequent sale, and upon sale the general rule is that no taxable gain is realized until the seller has recovered his cost or capital. . Certainly the above principle is applicable in the instant case in so far as the stock acquired by the petitioner under the option granted to him by his employer was acquired at a cost to him of $30 per share in cash. It is also equally obvious that the petitioner did not at the time of or in the year of purchase recover any part of such cost. Our question then is whether on the facts presented it must be said that*906 some undivided part of the 640 shares of Continental Can acquired by the petitioner was acquired by purchase and in respect of that part no taxable gain is realized until the stock in sold or otherwise disposed of and the petitioner has recovered his cost, while saying that the remaining undivided part of the said shares was received as the payment of compensation and must be reported as income in the year received to the extent of the fair market value of such undivided part. If so, it must be because of the fact that the price paid was lower than the price at which the same stock *264 was selling on the market either at the time of purchase or at the time the offer was extended or became effective; otherwise, there would be no basis for holding that any portion of the stock was acquired other than by purchase, even though the sale to petitioner was based on an employer-employee relationship. . Furthermore it is not at all unusual that the purchaser of property may through his ability and shrewdness as a buyer, or by reason of other influences or forces, be able to purchase property at a price substantially*907 lower than the price at which it may be immediately sold, but it does not fllow that gain is presently realized through such a purchase. ; ; ; affd., ; ; ; and . Accordingly it is our opinion that as a prerequisite to the conclusion sought by the respondent it should definitely and clearly appear that a transaction, which in form is nothing more than a purchase and to an obvious and substantial extent is unquestionably a purchase, is in fact to some extent the payment of compensation for services rendered or to be rendered. If the agreement between an employer and employee shows that the amount of money which is to be paid by the employee in connection with the acquisition of stock in the employer is fixed or controlled by services rendered or to be rendered and further shows that the employee agrees to receive payment of his compensation*908 in the form of stock, the parties should not be heard to say that the excess of the fair market value of the stock over the cash paid by the employee should not be treated for income tax purposes as compensation paid. . Cf. . It is also possible that even in the absence of such a definite understanding or expressed declaration in the agreement between the employer and employee, the circumstances surrounding the agreement may be such as to render unreasonable and absured any conclusion that the acquisition of the stock at the price named did not constitute the payment of compensation to the extent of the difference between the amount paid and the fair market value of the stock. Such, however, is not the case before us. It is true that the prospective purchasers were selected solely because they were valued employees of Continental Can Co., and there is no doubt that the added interest of these employees and the proprietary attitude toward the company which would result from their ownership of the stock constituted one of the motives for the granting of the option. It is equally*909 obvious, however, that the continued employment of the petitioner was not dependent upon the receipt by him *265 of the right to purchase the stock at less than the market price. The terms and conditions of his employment and the compensation he was receiving were in no way changed by the receipt of the privilege of purchasing the stock. Accordingly the rule stated in the Erskine and Ritter Lumber Co. cases is not applicable here. Furthermore the price to be paid by petitioner for the stock was substantial and, if consideration be given to the language of the offer, the margin of difference between the option price and the current market price at the time the option price was fixed, and to the fluctuation of prices on the stock market during the period in which the offer was made, we do not believe that it can be said that the margin of difference between the offering price and the fair market value of the stock was so great as to require the conclusion that the transaction here constituted the payment of compensation. Cf. *910 ; ; and . Accordingly we are unable to find in the instant case the elements which would indicate that the transaction was not what its form indicates, that is, a purchase of stock by the petitioner with a view to the subsequent realization of profit through dividends or sale or other disposition of the property. The conclusion stated makes it unnecessary to consider the petitioner's alternative contentions. Decision will be entered for the petitioner.