Muskegon Motor Specialties Co. v. Commissioner

MUSKEGON MOTOR SPECIALTIES COMPANY, A DELAWARE CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Muskegon Motor Specialties Co. v. Commissioner Docket No. 100097. United States Board of Tax Appeals 45 B.T.A. 551; 1941 BTA LEXIS 1105; November 4, 1941, Promulgated *1105 Assets acquired by petitioner in dissolution of two predecessor corporations the stock of which it had just obtained in exchange for its shares and other property, held, under Revenue Act of 1932, section 113(a)(7), to entitle petitioner to a basis for depreciation of no more than the basis to its transferors, the predecessor corporations, the assets having been acquired "in connection with a reorganization", and after the transfer more than a 50 percent control remaining in the old shareholders through ownership of petitioner's voting stock. Schweitzer & Conrad, Inc.,41 B.T.A. 533. L. A. Masselink, Esq., for the petitioner. Paul A. Sebastian, Esq., for the respondent. OPPER *552 Respondent asserted deficiencies for 1934 of $5,596.51 and $2,035.10 income and excess profits tax. Petitioner in its brief directs its argument to but one of the several issues making up the deficiency. All the issues save that must therefore be regarded as abandoned. The primary question to be determined under that issue is the proper basis for depreciation for certain assets acquired by petitioner from predecessor corporations. FINDINGS*1106 OF FACT. The facts are presented by stipulation, supplemental stipulation, and evidence adduced at the hearing. All of the stipulated facts are hereby found accordingly. Facts hereinafter appearing which are not from the stipulations are facts otherwise found from the record. In 1928 Muskegon Motor Specialties Co., a Michigan corporation, hereinafter referred to as "Muskegon Michigan", and the L. O. Grdon Manufacturing Co., a Michigan corporation, hereinafter referred to as the "Gordon Co.", were engaged in the business of manufacturing cam shafts. Muskegon Michigan had outstanding capital stock of 4,500.9 shares of no par value and the Gordon Co. had outstanding capital stock of 2,000 shares of a par value of $100. Under date of November 7, 1928, a circular letter was sent to the stockholders of Muskegon Michigan setting out a plan for the consolidation or merger of that company and the Gordon Co., stating that it had been "unanimously agreed upon by the officers and directors of both companies, by all the stockholders of L. O. Gordon Manufacturing Company, and by 96 percent of the stockholders of this Company, and is now submitted to the remaining stockholders of this*1107 Company for their approval." The plan, as set forth in the letter, called for the organization of a new corporation and provided: In exchange for the shares of no par value stock now held by the stockholders of this Company, there will be issued to said stockholders shares of Class B stock of said new or consolidated corporation on the basis of 16 2/3 shares of said Class B stock for each share of no par value stock now issued and outstanding and in addition to said stock there will be paid to the holders of the no par value stock of the present company in cash the sum of $171.30 per share. The letter solicited the deposit of their stock in escrow for the purpose of carrying out the plan. All of Muskegon Michigan's outstanding capital stock was deposited in escrow as called for in the letter. L. O. Gordon, president of the Gordon Co., obtained options to purchase 1,440 shares of that company's stock for cash at various prices ranging from $150 to $322.58 per share, and these shares, which constituted all the outstanding capital stock of the Gordon Co. not owned or controlled by *553 L. O. Gordon were, together with the L. O. Gordon stock, likewise deposited in escrow. *1108 Petitioner was incorporated on November 24, 1928, as a Delaware corporation with an authorized capital stock of 62,500 shares class A convertible preference stock and 187,500 shares of common stock, both classes being no par stock. The class A stock carried a $2 per share per annum cumulative dividend, and was entitled to substantial preferences in the event of liquidation of petitioner, by reason of article fourth (3) of petitioner's certificate of incorporation which provided: (3) In the event of any liquidation, dissolution or winding up of this Corporation, whether voluntary or involuntary, or any reduction of its capital stock resulting in the distribution of its assets to its stockholders, out of the net assets of the Corporation available for distribution to the stockholders of the Corporation the holders of the Class A stock shall be entitled to receive for each share thereof the amount of all dividends accrued or in arrears thereon before any further distribution of assets shall be made. After such payment shall be made, the remaining net assets shall be divided among the holders of the Class A stock and the holders of the common stock in such proportion that there*1109 shall be distributed upon and in respect of each share of Class A stock then outstanding an amount which shall be equal to four times the amount distributed upon and in respect of each share of common stock then outstanding. Nothing in this paragraph (3) shall be deemed to prevent the redemption of Class A stock in any manner permitted by paragraph (4) of this Article. A consolidation or merger of this Corporation with any other corporation or corporations shall not be regarded as a liquidation, dissolution or winding up of this Corporation within the meaning of this paragraph, provided that such consolidation or merger does not materially impair the rights and preferences of the Class A stock. The class A stock was callable at petitioner's option on any dividend payment date, in whole or in part at $35 per share, together with all accrued and unpaid dividends. It was also provided that each share of class A and each share of common stock entitled the holder thereof to one vote for all purposes. On November 27, 1928, petitioner entered into a financing agreement with a group of bankers whereby the bankers agreed to buy all of petitioner's class A stock and 15,000 shares of*1110 its common stock for a total consideration of $1,385,000 cash. The stock was purchased by the bankers named as follows: Shares purchased Class A Common Amount payable Burnham 20,833 5,000 $461,659.28 Davis 20,833 5,000 461,659.28 Murdock 20,834 5,000 461,681.44 Total 1,385,000.00 *554 In the financing agreement petitioner agreed to issue 110,000 shares of its common stock and to pay $1,445,004.17 to the holders of all the capital stock of Muskegon Michigan and the Gordon Co. The difference of $60,004.17 between the amount to be received from the bankers and the amount to be paid to the old stockholders was to be recouped by means of a dividend to be paid to petitioner by the Gordon Co. It was further agreed that the petitioner might at any time after acquiring the stock of Muskegon Michigan and the Gordon Co. acquire their assets upon surrender of the stock. It was contemplated that this would be done as soon as practicable. On the same date, November 27, 1928, petitioner organized two subsidiary holding companies under the laws of Delaware, viz., Midland Investors, Inc., and Norton Securities Co. Petitioner subscribed*1111 and paid for their entire authorized capital stock; 5,000 shares of Midland at $45 a share or $225,000, and 3,750 shares of Norton at $100 a share or $375,000. The Midland payment was $165,000 cash and an assignment on December 6, 1928, of $60,000 of the Gordon Co. dividend which was declared December 7, 1928. On December 6, 1928, the financing agreement was closed and petitioner issued to the bankers the 62,500 of its class A and 15,000 of its common stock for $1,385,000. On the same day petitioner acquired all of the shares of stock of the Gordon Co. as follows: From L. O. Gordon and his wife, 560 shares for $15,492.40 cash, 5,000 shares of Midland and 35,000 shares of petitioner's common; from the remaining stockholders, 1,440 shares for $433,507.60 cash, pursuant to the options thereon which L. O. Gordon assigned to petitioner on the same day (December 6, 1928). The fair market value of the 5,000 shares of Midland at this time was $225,000. On the same day petitioner acquired all the outstanding shares of Muskegon Michigan stock as follows: From Flanders Investment Co. (a personal holding company for Fred L. Flanders), 2,228 shares, paying therefor $6,652.23 cash, 3,750*1112 shares of the capital stock of Norton and 37,118 1/3 common shares of petitioner; from the remaining stockholders 2,272.9 shares, paying therefor $389,347.77 cash and 37,881 2/3 common shares of petitioner. The fair market value of the 3,750 shares of Norton stock at this time was $375,000. The total cost to petitioner of all the outstanding stock of the Gordon Co. and Muskegon Michigan was cash $845,000, 5,000 shares of Midland at a cost of $225,000, 3,750 shares of Norton at a cost of $375,000, together with 110,000 shares of petitioner's common stock. Upon the completion of the foregoing transactions petitioner owned the entire issued and outstanding capital stock of the Gordon Co.*555 and Muskegon Michigan, and had issued and outstanding 62,500 shares of its class A stock, being the total amount authorized by its charter, and 125,000 shares of no par value common stock out of a total of 187,500 shares of such stock authorized by its charter. The remaining 62,500 shares of petitioner's common stock were reserved for conversion of the class A stock. Prior to December 6, 1928, none of the former stockholders of the Gordon Co. owned any stock in Muskegon Michigan*1113 and none of the former stockholders of Muskegon Michigan owned any stock in the Gordon Co. Likewise, on December 6, 1928, and continuously thereafter, to and including January 24, 1929, none of the former stockholders of the Gordon Co. or Muskegon Michigan owned any of petitioner's class A stock or any of the 15,000 shares of petitioner's common stock which had been sold to the bankers; and during this entire period petitioner's outstanding capital stock consisted of 62,500 shares of class A and 125,000 shares of common. The holders of the 1,440 shares of Gordon stock acquired by petitioner as above mentioned were not informed as to the respective option prices which were to be paid for their stock or of the proposed creation of Midland. The financial arrangements, however, were known to two of the Gordon stockholders, Mr. and Mrs. A. V. Klise, L. O. Gordon's brother-in-law and sister. No stockholders' meetings of the Gordon Co. were held to vote upon any plan of merger or consolidation with Muskegon Michigan. It does not appear whether the stockholders' meeting called for November 15, 1928, by notice dated November 7, 1928, to Muskegon michigan's stockholders was ever held. *1114 One of the purposes stated in the notice was to change Muskegon Michigan's name to "The Cam Shaft Manufacturing Company." This was done at a stockholders' meeting held on November 26, 1928. On January 23, 1929, petitioner was the sole stockholder of the Gordon Co. and Muskegon Michigan, which companies at that time adopted resolutions authorizing their dissolution and the conveyance of their assets to petitioner in consideration of the latter's assumption of all their debts and liabilities. On the same day deeds and bills of sale to petitioner were executed by these companies. Notices of the dissolution dated January 23, 1929, were filed January 24, 1929, with the Michigan Secretary of State, respectively stating: * * * that the said corporation has been dissolved by the sale of all of its property and assets to Muskegon Motor Specialties Company, a Delaware corporation. Although the Gordon Co. and Muskegon Michigan were not legally dissolved until January 23, 1929, after petitioner's acquisition of their stock, they were inactive. *556 Fred L. Flanders was president of Muskegon Michigan and became treasurer and chairman of the board of petitioner. L. O. Gordon*1115 was president of the Gordon Co. and became president of petitioner. In bringing about the plan of reorganization of petitioner, Flanders spoke for the stockholders of Muskegon Michigan and Gordon represented the stockholders of the Gordon Co. The fair market value of the properties of the Gordon Co. at the date of acquisition was $377,362.85; the fair market value of the properties of Muskegon Michigan at the date of acquisition was $545,181.88, or a combined value of $922,544.73. The fair market value of the Gordon Co.'s depreciable assets at the date of acquisition by petitioner was $364,684.10 and the fair market value of the Muskegon Michigan's depreciable assets was at the date of acquisition $490,896.88. The cost basis to the Gordon Co., as of December 31, 1928, of such assets which had not been previously fully depreciated in prior years was determined by respondent to be $370,478.10 and the accrued depreciation as of December 31, 1928, on such assets was $155,802.59, leaving the net unrecovered cost of the Gordon Co.'s assets on said date at $214,675.51. The cost basis to Muskegon Michigan of such assets which had not been previously fully depreciated in prior years*1116 was determined by the respondent as of December 31, 1928, to be $79,647.58 and the accrued depreciation as of that date on such assets was determined to be $56,277.95, leaving the net unrecovered cost of Muskegon Michigan's assets at $23,369.63. L. O. Gordon derived taxable gain in 1928 in the amount of $159,369.30 on the transfer of 420 shares of Gordon Co. stock to petitioner, such amount being the difference between the $11,619.30 cash and $168,750 fair market value of the 3,750 shares of Midland, and the cost of the 420 shares of Gordon stock ($21,000). Margaret E. Gordon, by similar processes, derived taxable gain in the amount of $53,123.10 upon the transfer of 140 shares of Gordon Co.'s stock to petitioner. The total taxable gain recognized to all Muskegon Michigan's stockholders upon the transfer of their stock to petitioner was not less than $703,713.45. OPINION. OPPER: Petitioner succeeded to the business of two corporations, the Gordon Co. and Muskegon Michigan, whose stockholders transferred shares in the old companies in exchange for stock of petitioner. As part of this transaction, new money was furnished by a banking syndicate and in effect distributed*1117 to stockholders of the original corporations, partly by means of the formation of subsidiaries and the distribution of their stock. These securities were held in Flanders*557 , to be taxable to the recipients as "other property" received in the reorganization, since the two subsidiaries were held not to be parties thereto. The stock of the petitioner received by the shareholders of the predecessor corporations consisted of over 50 percent of petitioner's voting stock, the bankers receiving the balance. Shortly after petitioner became the sole stockholder of the two corporations it acquired their properties and caused their dissolution. We are required to determine the proper basis for depreciation 1 of the physical assets which petitioner thus acquired from the two predecessor corporations. This, in the ordinary case, would be petitioner's cost.2 2 But there are exceptions, and respondent contends that one of these governs the present case. Specifically he urges that section 113(a)(7) of the 1932 Act, 3 expressly made applicable to periods subsequent to January 1, 1934, by subsection (a)(12) of section 113, 4 requires*1118 us to find that the proper basis is not cost to petitioner, but that which prevailed in the hands of the transferor corporations. *1119 The first requisite for approval of this contention is that the physical properties involved were acquired by petitioner "in connection with a reorganization." The transfer took place in 1928. The Board has heretofore taken the position that: * * * Inasmuch as the acquisition in question occurred during the time the Revenue Act of 1928 was in effect, * * *. We therefore go to the Revenue *558 Act of 1928 for the purpose of determining whether or not there was a reorganization as defined in said section [113(a)(7), Revenue Act of 1932]. [.] Even, however, if it is the definition in the 1932 Act which controls, the result necessary would not be different; for the 1932 version of that definition is identical with the comparable provision of the prior act. Cf. . One of the statutory descriptions of a reorganization so appearing 5 is: * * * a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, *1120 or substantially all the properties of another corporation), * * * Petitioner acquired directly all of the stock of Gordon and Michigan and indirectly all of their properties, and gave in exchange a majority of its voting stock. This transfer was accordingly a reorganization. ; ; . There was no lack of the continuing interest in the common stockholders which is necessary to distinguish a reorganization from a sale. Cf. . Voting control of petitioner remained in the former shareholders after the transfer. And, as will more evidently appear from subsequent discussion, this control of petitioner was held by those who had previously constituted the entire shareholding group of both the old companies. An effort is made to convince us that the physical properties were transferred by the predecessor corporations in a separate distribution in liquidation and not as part*1121 of the reorganization. But petitioner concedes that "the liquidation [of the predecessors], although contemplated at the time petitioner was organized, was permissive." We regard it as now settled law that an optional procedure "will be treated as a part of the plan if it is a contemplated possibility under the plan and actually eventuates." ; affd. (C.C.A., 8th Cir.), ; certiorari denied, . * * * It is equally clear that a plan must be viewed as a whole and that if the transferred property, although designed to pass temporarily through one corporation, is intended to rest permanently in another, the holding by the first may be of such a transitory nature as to be without real substance. [ We can not agree that the physical properties were not acquired by petitioner "in connection with" the reorganization. And see . *559 Nor is it material that there may have been no "tax-free" reorganization, a question we need not decide. Petitioner advances*1122 , as controlling our decision here since it involved the same transaction. But, giving its argument the broadest possible scope, the most that can be said for it is that respondent, by conceding on his brief there that "respondent's position that the assets were acquired in a nontaxable reorganization can not be maintained," consented to a determination that this transaction did not constitute a reorganization which was "tax-free." Assuming, without deciding, that a similar conclusion is binding here under the doctrine of res judicata, it still leaves petitioner no better off. For in 113(a)(7), unlike 113(a)(6) the section relied upon in , the term used is "reorganization" without any reference to non-recognition of gain, and if there be a reorganization it is not necessary that it be "tax-free." In ; affd. (C.C.A., 9th Cir.), , the Board held that as to: * * * transfers * * * made in connection with a reorganization (even though not a tax-free reorganization) * * * section*1123 113(a)(7) of the Act of 1934 is applicable. If the Muskegon case is relevant here at all it is rather in an aspect detrimental to petitioner's position, for the Board there said: * * * Considering all the evidence, it is our opinion that the dissolution of the two companies and the acquisition of their assets by the petitioner were all a part of the original plan of consolidation * * *. However, we prefer to record no conclusion as to the binding quality of that decision, and to base our view in this aspect of the case on the strict ground that no "tax-free" reorganization is required to bring 113(a)(7) into play. The next question is whether, granting that the properties were acquired in connection with a reorganization, the requirement is met that "immediately after the transfer an interest or control in such property of 50 per centum or more remained in the same persons or any of them." It is not entirely clear whether this necessitates that the continuing interest be held by all of the same persons who previously held a majority interest or control since the language is "the same persons or any of them." But we can assume for present purposes the correctness of petitioner's*1124 contention that use of the word "remained" imports that premise. See ; reversed other grounds, . For even so, we think the facts show that not only a majority, but all of the previous shareholders retained stock ownership. In the instance of Michigan, that conclusion admits of no debate. All the stockholders of that company participated in the plan. As to Gordon, while some, *560 in fact a majority of the erstwhile owners had granted options for cash sales of their stock, these had in effect been exercised before the plan went into effect. L. O. Gordon, to whom the options ran, became thereby the owner of all the Gordon stock. His deposit of that stock in escrow under the plan was at once the necessary premise for the inception of the plan, and an act so inconsistent with any other ownership that we have no difficulty in ascribing to him the entire proprietorship of all of Gordon's stock. Only thus can be justified the statement in the proposal that it had been "unanimously agreed upon * * * by all the stockholders of L. O. Gordon Manufacturing Company." Nor are we impressed by the contention*1125 that after the transfer this group held less than the 50 percent interest or control specified in the statute. It is possible that taking the liquidating values of petitioner's assets and apportioning them between the Gordon and Michigan shareholders, on the one hand, and the new interests holding the class A stock with its partial preferences, on the other, the dollar value attributable to the latter might outweigh that of the common stock held by the former. It is also conceivable that the market value of the one might exceed that of the other. But such considerations, while perhaps relevant if the statute were limited to prescribing the value of merely an "interest", overlooks the significance of the word "control" which is coupled with "interest" in the disjunctive. We think it idle to suggest that those owning a majority of the voting stock of an enterprise do not control it. Cf. And that is all the provision requires. Finally, we are asked to hold that even if we find section 113(a)(7) to be applicable, as we do, the basis in petitioner's hands may nevertheless be computed by adding to the basis of its transferors so*1126 much of the gain on the transfer, received in the form of cash and "other property", as was contemporaneously taxable to the participating stockholders. This would necessitate the conclusion that the latter were "transferors", a result we find it impossible to reach in the face of On the authority of that case, disposition of this contention, as well as of any question of the retroactivity or constitutionality of section 113(a)(7) in its application to a prior reorganization, must be unfavorable to petitioner. , upon which petitioner relies, dealt with a different question. The facts as they there appear do not indicate that any gain of the old shareholders had been taxable. The present question was not and apparently could not have been raised by the taxpayer nor was it discussed or decided by the Board. Reviewed by the Board. Decision will be entered for the respondent. Footnotes 1. SEC. 114. BASIS FOR DEPRECIATION AND DEPLETION. [Revenue Act of 1934.] (a) BASIS FOR DEPRECIATION. - The basis upon which exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the adjusted basis provided in section 113(b) for the purpose of determining the gain upon the sale or other disposition of such property. SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS. * * * (b) ADJUSTED BASIS. - The adjusted basis for determining the gain or loss from the sale or other disposition of property, whenever acquired, shall be the basis determined under subsection (a), adjusted as hereinafter provided. ↩ 2. SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS. (a) BASIS (UNADJUSTED) OF PROPERTY. - The basis of property shall be the cost of such property; except that - * * * ↩ 3. (7) TRANSFERS TO CORPORATION WHERE CONTROL OF PROPERTY REMAINS IN SAME PERSONS. - If the property was acquired after December 31, 1917, by a corporation in connection with a reorganization, and immediately after the transfer an interest or control in such property of 50 per centum or more remained in the same persons or any of them, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made. This paragraph shall not apply if the property acquired consists of stock or securities in a corporation a party to the reorganization, unless acquired by the issuance of stock or securities of the transferee as the consideration in whole or in part for the transfer. ↩ 4. (12) BASIS ESTABLISHED BY REVENUE ACT OF 1932. - If the property was acquired, after February 28, 1913, in any taxable year beginning prior to January 1, 1934, and the basis thereof, for the purposes of the Revenue Act of 1932 was prescribed by section 113(a)(6), (7), or (9) of such Act, then for the purposes of this Act the basis shall be the same as the basis therein prescribed in the Revenue Act of 1932. ↩ 5. Revenue Acts of 1928 and 1932, sec. 112(i)(1)(A). ↩