Miller & Paine v. Commissioner

MILLER & PAINE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Miller & Paine v. Commissioner Docket No. 94968. United States Board of Tax Appeals 42 B.T.A. 586; 1940 BTA LEXIS 981; August 20, 1940, Promulgated *981 Petitioner was a stockholder and one of the creditors of a New Jersey corporation. The New Jersey corporation got into financial difficulties and a plan was formed by which it was agreed that a New York corporation would be organized and the New Jersey corporation would convey to it all of its assets in consideration of the New York corporation agreeing to issue one share of its stock for each four shares in the New Jersey corporation, and to issue one share of its stock for each $100 of indebtedness which the creditors held against the New Jersey corporation. The plan was carried out as agreed upon. Held, that section 112(b)(5), Revenue Act of 1934, is applicable; when the plan was completed the stockholders and creditors of the New Jersey corporation were in complete control of the New York corporation and no gain or loss is recognizable to the creditors who transferred their notes against the New Jersey corporation solely for stock in the New York corporation. H. A. Mihills, C.P.A., for the petitioner. Angus R. Shannon, Jr., Esq., for the respondent. BLACK *587 The Commissioner has determined a deficiency of $3,527.54 in petitioner's*982 income tax for the year 1934. This deficiency results in the main from the disallowance by the Commissioner of $25,490 which petitioner claimed on its income tax return as a deduction for a bad debt ascertained to be worthless and charged off in the taxable year. The Commissioner, in disallowing the claimed deduction, stated in his deficiency notice as follows: (c) The Bureau sustains its previous holding that under the authority of section 112(b)-5 of the Revenue Act of 1934, a deductible loss was not sustained in the transactions in 1934 between your corporation and the Syndicate Trading Company, Inc., (New Jersey) involving the receipt by your corporation of 301 shares of stock in a new corporation of the same name, organized under the laws of the State of New York, in exchange for 62 1/2 shares of capital stock and $28,500.00 notes receivable of the old (New Jersey) corporation. See also . The petitioner assigns error as to this action taken by the Commissioner in the following language: (a) The Commissioner has erroneously treated the compromise settlement of an amount due the petitioner by the Syndicate*983 Trading Company evidenced by short term unsecured promissory notes, as coming within the meaning of Section 112(b)-5 of the Revenue Act of 1934, and asserts that no taxable loss was sustained. FINDINGS OF FACT. The facts have all been stipulated, and are hereby found as stipulated. We will state herein such of the facts as we deem necessary to an understanding of the issue which is to be decided. The petitioner is a Nebraska corporation, with principal offices at 13th and O Streets, Lincoln, Nebraska. The corporation income and excess profits tax returns for the period here involved and for the calendar year 1936 were prepared upon the accrual basis and were filed with the collector for the State of Nebraska. The petitioner had made advances in cash in the aggregate amount of $30,000 to the Syndicate Trading Co. (a New Jersey corporation), hereinafter referred to as the New Jersey corporation, evidenced by *588 unsecured promissory notes due in 1932 and 1933. The loans were made on various dates, and from time to time the notes were renewed. During the year 1933 a cash payment of $1,500 was received by petitioner to apply on the indebtedness. At the beginning*984 of the taxable year 1934 the unpaid balance of the notes amounted to $28,500, represented by the following notes: Date Due date Amount unpaid 7/2/33 1/22/34 $10,000 10/13/33 2/13/34 5,000 11/2/33 3/2/34 10,000 11/9/33 3/9/34 3,500 Total 28,500 The New Jersey corporation had been organized by a number of department stores to conduct a cooperative merchandise purchasing service for its shareholders. The principal offices of the company were located in New York City. On or about September 30, 1934, the company had 22 shareholders, of which number 9 also held notes of the company which had been issued for cash advances made by them to the company. The notes of the company were held by 13 individuals and corporations, of whom 9 were shareholders of the company. During the taxable year 1934 the New Jersey corporation formed the "Syndicate Trading Company, Inc." (a New York corporation), hereinafter referred to as the New York corporation. The following are the resolvatory clauses appearing in the minutes of the special directors' meeting of the New Jersey corporation held September 7, 1934: On motion made, seconded and carried, it was *985 RESOLVED that this Board does declare it advisable and most for the benefit of the Syndicate Trading Co., that the property and assets of the corporation, including its good-will shall be transferred to a corporation to be formed under the laws of the State of New York, which shall have an authorized capital stock of 3000 shares of no par value, subject only to the assumption by such New York corporation of accrued and/or current payroll, rent, corporation income or franchise taxes, license fees and merchandise and expense purchases, credit balances against undelivered import merchandise and the agreement by said New York corporation to deliver one share of its stock to creditors of the corporation for each $100 of such loan or fraction thereof (interest excluded) and subject to the acceptance of such offer by 3/4 in amount of the creditors of the corporation similarly situated, whose loans to the Syndicate Trading Co. aggregate $191,192.98 and to deliver to every stockholder of this corporation one share of said no par value stock of the new corporation for every four shares of capital stock held by such stockholder in this corporation, and that the officers of the corporation be*986 empowered to make, execute and deliver any contracts or agreements to contain such terms and conditions as they deem advisable to carry this resolution into effect, and that a meeting of *589 the stockholders of the corporation be called for and held on the fourth day of October, 1934 at the office of the corporation to take action upon such resolution, and it was further RESOLVED that this Board declare it advisable and most for the benefit of the Syndicate Trading Co. that the same should be dissolved and that a meeting of the stockholders be called for and held on the aforesaid fourth day of October, 1934 at the office of the corporation in the City of New York to take action upon the question of dissolution of the said company and further that the secretary forthwith give notice of said meeting of stockholders and of the adoption of these resolutions. On September 20, 1934, an agreement was prepared in the form of a consent to be executed by each noteholder of the New Jersey corporation, a copy of which is here set forth: For Value Received, and in consideration of like consents by other creditors similarly situated, the undersigned, a creditor of the SYNDICATE TRADING*987 COMPANY, a New Jersey corporation having its principal place of business at 240 Madison Avenue, New York City, hereby consents to accept in full payment of the loans (the amount whereof is hereafter specified) due it from the Syndicate Trading Co., shares of no par value stock or stock of a par value as determined by the Directors at the rate of one share for each $100.00 of such loan or fraction thereof (interest excluded) of a corporation to be formed under the laws of the State of New York, to have an authorized capital stock of three thousand shares and to which New York corporation there shall be transferred all assets, including the name and good will of the Syndicate Trading Co. subject only to the assumption by such New York corporation of accrued and/or current payroll, rent, corporation income or franchise taxes, license fees and merchandise and expense purchases, credit balances against undelivered import merchandise, and such New York corporation agreeing to deliver to the stockholders of the Syndicate Trading Co. one share of said capital stock for every four shares of stock now held by such stockholders in said Syndicate Trading Co. on surrender of the present stock. *988 This consent is to be effective only when accepted by 75% in amount of the creditors similarly situated whose loans of the Syndicate Trading Co. aggregate $191,192.98 and when approved by two-thirds in number of the outstanding shares of stock of the Syndicate Trading Co. This consent and similar counterparts, when executed, shall constitute one agreement. Name of Creditor Address Amount of Loan Miller & Paine, by R. E. Campbell, Sec'y Sept. 20 1934 Lincoln, Nebraska $28,500.00 On October 48 1934, a somewhat similar agreement (shareholders' proxy) was prepared in reference to the exchange of stock of the New Jersey corporation for the stock of the newly formed New York corporation, a copy of which agreement is here set forth: KNOW ALL MEN BY THESE PRESENTS that the undersigned, a stockholder of the SYNDICATE TRADING COMPANY, a New Jersey Corp., having its principal place of business at 240 Madison Avenue, New York City, does hereby constitute and appoint. *590 WALDON D. SMITH and HENRY WOLF or any of them, our true and lawful attorneys and agents, for us in our name, place and stead, to vote upon all stock held by the undersigned in the*989 Syndicate Trading Co. at a special meeting of the stockholders of such corporation, to be held on the 4th day of October, 1934, and at any adjourned meeting thereof called for the purpose of acting upon a resolution to dissolve the corporation and to authorize the transfer of all its assets, including the name and good will of the Syndicate Trading Co. to a corporation to be formed under the laws of the State of New York and to have an authorized capital stock of three thousand (3,000) shares of no par value or stock of a par value as determined by the Directors, subject only to the assumption of such New York corporation of accrued and/or current payroll, rent, corporation income or franchise taxes, license fees and merchandise and expense purchases, credit balances against undelivered import merchandise and the agreement by such New York Corporation to deliver to every stockholder of the Syndicate Trading Co. one share of said capital stock for every four shares of capital stock held by such stockholder in the Syndicate Trading Co. giving to such attorneys herewith appointed full power of substitution and revocation in the premises and full power to agree to any modification of any*990 of the terms for the transfer of the assets as above set forth. IN WITNESS WHEREOF the undersigned has hereunto set his hand and seal this fourth day of October 1934. MILLER & PAINE, By R. E. CAMPBELL, Sec'y. Witness: MARY L. JEFFERY Miller & Paine, Inc. - 61 1/2 shares The consent and agreement (shareholders' proxy) were carried out in accordance with the resolution approved by the directors of the New Jersey corporation on September 7, 1934. The New Jersey corporation transferred its assets and liabilities to the New York corporation. The liabilities to be assumed by the New York corporation in the amount of $11,273.45, as disclosed by the indenture dated October 27, 1934, are shown in the same amount in the balance sheet of the New Jersey corporation at the close of business September 30, 1934, under the caption of "Current Liabilities." The note indebtedness of the New Jersey corporation for borrowed money in the aggregate amount of $191,192.98, as referred to in the minutes of September 7, 1934, and the October 27, 1934, indenture were recorded upon the books of the New Jersey corporation at September 30, 1934, under the caption "Other Liabilities", and*991 subdivided between members' loans $141,270.84, and a loan to the Scotch Realty Co. in the amount of $49,922.14. The opening balance sheet of the New York corporation shows the recording on its books of the liabilities assumed from the New Jersey corporation in the amount of $11,273.45, as hereinbefore referred to. This balance sheet also discloses that 1,866 shares of stock of $10 par value were issued by the New York corporation in lieu of the money borrowed by the New Jersey corporation. In *591 issuing its stock for each $100 of indebtedness of the New Jersey corporation, the New York corporation ignored the $4,500 indebtedness which the New Jersey corporation held against itself as a part of the Scotch Realty Co. loans. This balance sheet also discloses that 352 shares of stock of $10 par value were issued by the New York corporation in exchange for the 1,375 shares of stock of $100 par value of the New Jersey corporation, and that accordingly the New York corporation had total capital stock outstanding represented by 2,218 shares of $10 per share par value, aggregating $22,180. A list of the members' loans (New Jersey corporation stockholders) and the Scotch Realty*992 Co. loans, aggregating $190,970.84, for which the aforementioned 1,866 shares of stock of the New York corporation were issued, appears in the following schedules: Members' loans Amount due Shares issued Adam Meldrum & Anderson Co., Buffalo, N.Y $19,000.00 [190] Brown Thomson Inc., Hartford, Conn 21,125.00 [212] Callender McAuslan & Troup Co., Providence, R.I. 47,500.00 [475] Denholm & McKay Co., Worcester, Mass 9,500.00 [95] Miller & Paine Inc., Lincoln, Nebr 28,500.00 [285] Pomeroy's Inc., Reading, Pa 15,645.84 [157] Total 141,270.84 1,414 Scotch Realty Co. loans Amount due Shares issued Adam Meldrum & Anderson Co $5,000 [50] Almy Bigelow & Washburn Inc 5,000 [50] Callender McAuslan & Troup Co 5,000 [50] Denholm & McKay Co 5,000 [50] Dives, Arthur W [6] Dives, Mary Nolan, and Reading Trust Co., executors 2,100 [21] Donaldson Realty Co 5,000 [50] Forbes & Wallance, Inc 5,000 [50] Gay, George A 5,000 [50] Peck Co., George B 5,000 [50] Pomeroy's, Inc 2,500 [25] Syndicate Trading Co 4,500 None Total 49,700 [452] The shareholders of the Syndicate Trading Co. (New Jersey corporation) who exchanged their stock for 352*993 shares of the capital stock of the new company (New York corporation) were as follows: Syndicate Trading Co. stockholders Shares of old stock held New shares issued Adams Meldrum & Anderson Co 62 1/2 [16] Almy Bigelow & Washburn Inc. 62 1/2 [16] Brown Thomson Inc 62 1/2 [16] Callender McAuslan & Troup Co 62 1/2 [16] Cleland Simpson Co 62 1/2 [16] Crews Beggs Dry Goods Co 62 1/2 [16] Denholm & McKay Co 62 1/2 [16] Dunn-Taft Co 62 1/2 [16] Elder & Johnston Co 62 1/2 [16] Forbes & Wallace Inc 62 1/2 [16] Gable Co., William F 62 1/2 [16] Higbee Co 62 1/2 [16] Howland Dry Goods Co 62 1/2 [16] Kern Co., Ernst 62 1/2 [16] Killian Investment Co 62 1/2 [16] Miller & Paine Inc 62 1/2 [16] Peck Co., Geo. B 62 1/2 [16] Penn Traffic Co 62 1/2 [16] Pomeroy's Inc 62 1/2 [16] Stone & Thomas 62 1/2 [16] Vorhees, H. M. & Bro 62 1/2 [16] Zion's Co-Operative Mercantile Institution 62 1/2 [16] Total 1,375 [352] *592 The petitioner held 62 1/2 shares of the capital stock of the New Jersey corporation, in exchange for which 16 shares of the capital stock of the New York corporation were received. For the notes of the New Jersey corporation, aggregating*994 $28,500, the petitioner received 285 shares of capital stock of the New Jersey corporation. The fair market value of the 285 shares of capital stock was not in excess of the par value thereof, $10 per share. In computing the alleged loss sustained in 1934 as the result of the transaction heretofore mentioned the petitioner used the par value of the shares received, although the book value as reflected by the opening balance sheet of the New York corporation was slightly in excess of that amount. The shares were sold on January 16, 1936, at $10 per share. The amount of the loss claimed as a bad debt in the return filed by the petitioner for the calendar year 1934 was $25,490. Petitioner in figuring its loss on its return deducted from its debt of $28,500 the fair market value of the 285 shares which it received in consideration of the transfer by it of the notes which it held against the syndicate to the New York corporation, and also deducted the fair market value of the 16 shares which it received in exchange for its 62 1/2 shares in the Syndicate Trading Co. Petitioner now claims that it should not have reduced its bad debt by the fair market value of the latter 16 shares*995 of stock and therefore claims a bad debt deduction of $25,650 instead of the $25,490 which it took on its income tax return for the year 1934. OPINION. BLACK: As we understand the contention of petitioner, it is in substance that the transfer of stock in the New Jersey corporation for stock in the New York corporation was one in which no gain or loss was recognized because it was one which falls squarely within the provisions of section 112(b)(3) of the Revenue Act of 1934, which reads: (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. Petitioner further contends that the receipt by the creditors of the New Jersey corporation, petitioner being one of them, of stock in the New York corporation in exchange for the notes which these creditors held against the New Jersey corporation was a separate transaction and was not an exchange of property for stock within the meaning of section 112(b)(5), but was simply a paying*996 off by *593 the New York company of indebtedness which it had assumed of the New Jersey corporation, and that, inasmuch as only $10 was paid for each $100 indebtedness the balance of the debt was worthless, and petitioner had the right to charge off during the taxable year $25,650 of the indebtedness of the New Jersey corporation to petitioner, which it did not collect and to deduct it in determining net income. Among other authorities which petitioner cites in support of its contention are , affirming , and . We think these authorities do not support petitioner's contention. In the Hale case there was a compromise by the creditor of his debt for less than face value and the court held that this action of the creditor in accepting in cash a lesser amount than the full face value of his note was not a "sale or exchange" of his note, so as to bring the loss suffered by the creditor within the capital loss provisions of the statute. To somewhat the same effect is the Bingham case above cited. If there had been a paying off*997 of petitioner's debt in cash at 10 cents on the dollar, doubtless petitioner would be correct in its contentions under the authorities cited. It should be remembered, however, that section 112(b)(5), upon which the Commissioner relies in this proceeding, does not deal with the paying off of debts in cash. It deals with the "transfer to corporation controlled by transferor." In other words, it deals with a situation where the transferor instead of receiving cash retains an interest through stock ownership in the property which he has transferred. If that interest amounts to a control by the transferors of the transferee corporation as control is defined in the statute, then no gain or loss is to be recognized, assuming that the other conditions provided in the statute are met. In the instant case there can be no question but that the creditors of the New Jersey corporation, including petitioner, transferred their notes against that corporation to the New York corporation and received in exchange therefor solely stock in the New York corporation. In other words, they did not receive payment of their debts, but exchanged their debts for a continuing interest in the new corporation. *998 This is the sort of transaction where no gain or loss is recognized, provided the conditions required by section 112(b)(5) of the Revenue Act of 1934 are met. Cf. . While petitioner firmly contends that section 112(b)(5) is not applicable and that the facts simply show the compromise of a debt at less than face value and therefore , and , govern, nevertheless petitioner *594 contends that, even if section 112(b)(5) is held to be applicable, the conditions which it prescribes are not met with in the instant case. Petitioner points out that 112(b)(5) requires that "in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange." Certainly in the instant case each of the creditors fared the same. Each was given one share of stock in the New York corporation of the par value of $10 for each $100 of his indebtedness. But, says petitioner, the 352 shares of stock*999 of $10 par value in the new corporation which the stockholders of the old corporation received in exchange for their 1,375 shares of $100 par value must be considered in determining whether all who transferred their property to the New York corporation received stock of the new corporation in proportion to their interests in the property prior to the exchange. We agree with petitioner that this 352 shares of stock must be considered, but we do not agree with petitioner that there is anything in the facts which shows that these stockholders fared any better or any worse in the exchange than the creditors who exchanged their notes for stock. Petitioner in its argument points out that the noteholders exchanged $100 of indebtedness for $10 par value of stock, whereas each stockholder exchanged four shares of $100 par value in the New Jersey corporation for $10 par value of stock in the New York corporation. Petitioner cites, in support of its contention that there is a substantial disparity in this treatment, . Petitioner, in making its comparison to show disparity in the proportions of the stock received by the*1000 old stockholders and the creditors, uses cost basis of the property. It assumes that each share of stock costs $100, its par value, and that each $100 of indebtedness costs $100. Even if we assume that the record which we have before us shows these respective costs, which it does not, we point out that it is not the cost of property which is transferred to a transferee corporation in exchange for its stock that determines whether or not section 112(b)(5) is applicable. It is the value of the property at the time it is transferred to the corporation which is used in the comparison to determine whether or not each transferor has substantially received his correct proportion of stock. Cost of the assets transferred is not material in making that comparison. Value at the time of transfer is the important thing. An examination of , upon which petitioner relies, will show that the court reached its decision that section 112(b)(5) did not control by comparing the values of the respective properties at the time of transfer with the values of the shares *595 of stock in United Carbon Co. which each transferor received. *1001 The court, after making this comparison, reached the conclusion that there was a very substantial disparity as to the proportions received by the several transferors and therefore section 112(b)(5) was not controlling. Cf. ; . In the instant case we have no evidence whatever as to the value of the notes of the New Jersey corporation at the time they were transferred to the New York corporation. Likewise we have no evidence as to the value of the shares of stock of the New Jersey corporation which were transferred to the New York corporation. In the absence of such evidence we can only presume that each $100 of indebtedness at the time of transfer had a value of $10 when it was exchanged for a share of stock in the New York corporation having a fair market value of $10. Likewise we can only presume that each four shares of stock in the New Jersey corporation had a fair market value of $10 when they were exchanged for shares of the New York corporation on a basis of four shares of the New Jersey corporation for one share of the New York corporation of*1002 a fair market value of $10. If that be true, and in the absence of evidence as to value we have no right to assume that it is not true, then the proportion of stock in the new corporation which each transferor received was substantially the same proportion as the value of the property which he transferred to the new corporation. Certainly no one can successfully contend that the transferors of the property were not in control of the corporation after the transfers were made. They owned 100 percent of the stock of the New York corporation. It seems to us that the only possible contention as to why section 112(b)(5) does not control would be that the respective transferors did not receive stock in the new corporation which was substantially in proportion to the interest which they each owned in the property at the time it was transferred to the new corporation. As we have already pointed out, we think there is no evidence in the record from which we can conclude that the interests were not substantially proportionate. Therefore, we think section 112(b)(5) is controlling. Cf. *1003 . Petitioner can not be allowed the loss in 1934 which it claims. It will have to take its loss in the year 1936, when it sold the stock in the New York corporation at $10 per share. Respondent is sustained. Decision will be entered for respondent.