Clock v. Commissioner

JOHN G. CLOCK, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. BLANCHE D. CLOCK, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. MAUDE H. CLOCK, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. RALPH H. CLOCK, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Clock v. Commissioner Docket Nos. 105848, 105849, 105850, 105851. United States Board of Tax Appeals 46 B.T.A. 1065; 1942 BTA LEXIS 777; May 6, 1942, Promulgated *777 1. The law partnership of which petitioners were members was retained by the Superintendent of Banks of California to perform legal services in connection with the liquidation of insolvent state banks. Held, that the petitioners were not officers or employees of the State of California and that the compensation received by the partnership in 1938 for services performed by its members constitutes taxable income. 2. Under a plan of reorganization under section 77B of the Bankruptcy Act, the acquiring corporation issued all of its stock and assumed all of the liabilities, including outstanding bonds, of another corporation. A portion of each bond of one issue of the old corporation was paid in cash; income notes and common stock of the acquiring corporation were issued in redemption of another issue of bonds; unsecured creditors received income notes and common stock or cash for their claims and preferred stockholders received common stock of the new corporation for their interests, common stockholders of the old corporation receiving nothing for their holdings. Held, that there was not a reorganization within the meaning of section 112(g)(1)(B) of the Revenue Act of*778 1938, as amended by section 213(g) of the Revenue Act of 1939. Helvering v. Southwest Consolidated Corporation,315 U.S. 194. William L. Kumler, Esq., and H. Benjamin Thompson, Esq., for the petitioners. Byron M. Coon, Esq., for the respondent. DISNEY *1065 These proceedings were consolidated for hearing and involve the redetermination of deficiencies in income tax for 1938, as follows: Docket No. 105848 $19.00 Docket No. 105849 19.01 Docket No. 105850 65.64 Docket No. 105851 65.63 The issue common to all of the proceedings is whether income re-received by a law partnership as compensation for services rendered to the Superintendent of Banks of the State of California is taxable. In Docket Nos. 105848 and 105849 an additional issue is whether loss was sustained or gain was realized in the sale of shares of stock *1066 of the Citizens Utilities Co. Other issues were abandoned at the hearing or conceded by respondent upon brief. The income tax returns of the petitioners were filed with the collector for the sixth district of California. FINDINGS OF FACT. The petitioners are individuals*779 residing in the State of California. Petitioners John G. Clock and Blanche D. Clock are husband and wife, and petitioner Ralph H. Clock is the husband of Maude H. Clock. Petitioners John G. Clock and Ralph H. Clock, hereinafter referred to as petitioners, were members of the law partnership of Clock, McWhinney & Clock, with offices in Long Beach, California. In December 1934 petitioner Ralph H. Clock was consulted by the Superintendent of Banks of the State of California, hereinafter referred to as "superintendent", as to whether his law firm would be interested in acting as counsel in connection with bank liquidation proceedings, about twenty in number, then being carried on in eight counties in southern California. The services were then being performed by a law firm with offices in San Francisco. On December 8, 1934, the superintendent wrote the following letter to the firm: It is my desire that you should act as attorneys in the liquidation of the banks in the eight southern counties of California. I have talked this matter over with Mr. Roche and Judge Sullivan, whose firm has heretofore been handling all of the business of the state. Judge Sullivan informed me today*780 that Mr. Roche would meet with you in Los Angeles on Monday at Mr. Childress' office, Title Insurance Building, and settle the details as to how the business can be transferred. Other than this communication, no written contract of employment was entered into between the partnership and the superintendent. The partnership was not employed for any definite period of time and its services were subject to termination at the discretion of the superintendent. Neither the partnership nor any of the members thereof furnished a bond for the faithful performance of services nor took an oath of office. The particular work to be performed under the provisions of the letter were decided upon at conferences held prior to January 1, 1935, when the law partnership assumed its duties. The compensation to be paid to the partnership for routine work was fixed by the superintendent at amounts ranging from $25 to about $250 per month per bank in liquidation, according to the volume of legal work each bank might have. As the volume of work of a bank decreased the superintendent reduced or discontinued the payment. It was agreed that the superintendent and his deputies would communicate with*781 the partnership regarding matters requiring the *1067 services of its members. The partnership had no discretion in the matter of filing suit or settling claims in favor of or against the banks. Such questions were decided by the superintendent or his deputies. The work of the partnership included preparation of necessary legal papers, much of which was done by its clerks on forms prepared and approved by the superintendent, and appearances in court on questions in litigation. The most common forms covered sales of real estate, compromises and refinancing. At times it was necessary to modify the forms to meet requirements of the particular case. The partnership rendered several opinions to the superintendent on questions not related to banks in liquidation. All of the legal work was performed by the petitioners and an attorney employed by the partnership. A special charge was made by the partnership on a quantum meruit basis for trial work of any consequence, and for preparing extraordinary formal documents. About one-half of the claims of the banks against stockholders for assessments and against debtors was compromised by the superintendent or his deputies without*782 consulting the partnership. At times the superintendent rejected compromises proposed by the partnership. Requests received by the partnership to compromise claims of the banks were referred to deputies of the superintendent. The partnership attended to the printing of briefs, but the superintendent designated the printer to do the work. The superintendent did not have a legal department in his office. A law firm with offices in San Francisco performed services for the superintendent in other parts of California similar to the work performed by the partnership in counties in the southern part of the state. The partnership had no authority to accept service on behalf of the superintendent or his deputies. At times the superintendent instructed the partnership to hold in abeyance matters in litigation pending further instructions from him. The superintendent was not bound to follow the legal advice of the partnership. Many of the cases pending at the time the partnership assumed its duties involved liability of stockholders of the banks for assessments on their stock. All agreements entered into for the settlement of claims of the banks required court approval. There were*783 hundreds of such cases each year. One or two foreclosure suits were conducted by the partnership. Members of the partnership frequently discussed with the superintendent and his deputies legal questions pertaining to the liability of stockholders and debtors and the ability of the latter to pay their obligations. Examinations of court and land records to ascertain the ability of stockholders and debtors to pay were made by deputies of the superintendent. The partnership had no authority to incur expense in obtaining witnesses to testify in proceedings without the approval of the superintendent. *1068 About one-half of the time of the partnership was devoted to rendering services to the superintendent. The superintendent did not provide the partnership with office space. The partnership used its own office and paid its own expenses without reimbursement therefor except indirectly through amounts it received for services rendered by its members. The superintendent had no attorneys performing services for him other than the partnership and the firm in San Francisco. During the taxable year the partnership received as compensation for its services amounts totaling $25,015, *784 all of which was paid out of assets of the banks in liquidation. The amount was included in the partnership return and the partnership profits reported by the respective petitioners in individual income tax returns filed on the community property basis. The petitioners were not officers or employees of the State of California. In 1928 John G. Clock and his wife purchased at a cost of $1,000, representing community property acquired after July 29, 1927, ten shares of preferred stock of the Public Utilities Consolidated Corporation, hereinafter referred to as Public Utilities. In 1936 the stock was exchanged for two shares of common stock of the Citizens Utilities Co., a Delaware corporation, under a plan of reorganization under section 77B of the Bankruptcy Act, approved by a United States District Court on November 30, 1935. Public Utilities had outstanding at the time of the reorganization the following securities and claims: 5 1/2% bonds $4,383,500.00 6 1/2% bonds 1,743,500.00 6% bonds 1,906,000.00 Unsecured adjudicated creditors' claims 418,692.64 7% preferred stock, par value $100 per share (shares) 89,597 Class A common stock, without par value (shares) 149,438 Class B common stock, without par value (shares) 342,250 *785 Under the plan of reorganization the Citizens Utilities Co. issued all of its 276,250 shares of common stock, par value $1 per share, and $1,937,482.21 of 3 percent income notes maturing in 20 years, and assumed all of the liabilities of Public Utilities in consideration of the transfer to it of all of the assets of Public Utilities. The plan also provided for the payment of $600 cash on each $1,000 face amount of 6 1/2 percent bonds and a reduction of the interest on the remaining $400 of face amount to 4 percent; the issuance of income notes of the face amount of $750 and 100 shares of common stock of Citizens Utilities Co. for each $1,000 of 6 percent bonds; the issuance of $75 par value of income notes and ten shares of common stock for each $100 of unsecured creditors' claims in excess of $100, the *1069 payment of cash to unsecured creditors having claims $100of or less, and the issuance of one share of common stock in exchange for each five shares of preferred stock of Public Utilities. The income notes and common stock were issued only in multiples of $75 and ten shares, respectively. Provision was made for issuing warrants for fractional interests and subsequent*786 exchange of the warrants, if exercised within three years, for income notes and stock. The common stockholders of Public Utilities received nothing for their stock under the plan of reorganization. The common stock of Citizens Utilities Co. had voting privileges at the rate of one vote per share. In 1938 petitioners John G. Clock and his wife sold to a broker for $3 the two shares of stock which they had received in 1936 in exchange for ten shares of preferred stock of Public Utilities. OPINION. DISNEY: The petitioners contend that the compensation received by the partnership for services rendered by its members to the superintendent is nontaxable under the Public Salary Tax Act of 1939 and that the amount of the taxes paid thereon, about which there is no dispute, is subject to credit or refund under the provisions of section 203 of that act. 1 *787 The purpose of the Act was to provide that where a taxpayer asserted immunity as a state employee as to taxes prior to the taxable year beginning January 1, 1939, such immunity would be allowed, under certain procedural circumstances here fulfilled, if the same result would have been reached prior to the O'Keefe decision. . See H.R. Rep. No. 26, 76th Cong., 1st Sess. (1939). The taxability of independent contractors with the State, or state employees of an agency considered not to be engaged in an essential governmental function had long been recognized and was in no wise changed by this Act. ; . See H.R. Rep. No. 26, supra. The immunity was to be no broader and no narrower than formerly. It seems incontrovertible that the words "officer or employee" as used in the Public Salary Tax Act were intended to have a meaning no broader than that formerly given to the same words in exemptive provisions of income tax statutes, e.g., Revenue Act of 1926, § 1211, 44 Stat. 130, 26 U.S.C.A. *788 Internal Revenue Acts, page 342. To secure *1070 the advantage of such an expressed exemption, it was always necessary to establish that the taxpayer was employed in an essential governmental agency and that he was an officer or employed and not an independent contractor. See, e.g., , affirmed, ; ; cf. . Similar showings must be made to come within the provisions of the Public Salary Tax Act. * * * [ See ; . Petitioners make no contention that they were officers of the State of California. They argue that they were state employees and cite *789 . They emphasize the right of control and the amount of control actually exercised by the superintendent of banks, a test applied in , to show that they were employees. The control exercised by the superintendent is set forth in our findings and needs no restatement. It is sufficient to point out that it was no greater than the control exercised by the state officer in the case of ; affirmed by the Supreme Court in , on authority of , and , which involved the taxability of amounts received by an attorney retained by the Commonwealth of Pennsylvania to represent it in specified matters, and in , a case involving attorneys retained by the insurance department of the State of Missouri to conduct fire insurance rate litigation. Petitioners took no oath of office. Their services for the state were performed in their own office with the assistance of their own*790 employees. No attempt was made to show whether or not the superintendent had first call upon the services of the members of the partnership. In the absence of such proof it may be assumed that he did not. If it could be said that petitioners were state employees, there would still be the question of whether taxation of the income would impose any actual or substantial burden on the functions of the state. . The compensation was paid out of assets of the banks in liquidation pursuant to a provision of the state statute authorizing the appointment of petitioners; none from the state treasury. Sec. 136, California Bank Act. Taxation of such income has been held not to impose a substantial burden upon the state. ; ; . The case of , and others decided in the same opinion do not require a different answer. Those cases involved the taxation of income of liquidators, and counsel employed *1071 to assist in the liquidation, *791 of insolvent state banks and of insurance companies. In holding that the compensation was not immune from tax, the Court said: "He [Commissioner] gave proper application to the rule which we must recognize as established. The compensation of the taxpayer was paid from corporate assets - not from funds belonging to the state. * * * The business about which they were employed was not one utilized by the state in the discharge of her essential governmental duties. The corporations in liquidation were private enterprises; their funds were the property of private individuals." The decision did not establish any new rule. On this issue we sustain the respondent. The parties agree that the amount of the loss sustained upon the sale of stock of the Citizens Utilities Co. depends upon whether the securities were acquired in a nontaxable reorganization under the provisions of section 112(g)(1)(B) of the Revenue Act of 1938, as amended by section 213(g) of the Revenue Act of 1939, reading as follows: The term "reorganization" means * * * (B) the acquisition by one corporation, in exchange solely for all or a part of its voting stock, of substantially all the properties of another*792 corporation, but in determining whether the exchange is solely for voting stock, the assumption by the acquiring corporation of a liability of the other, or the fact that property acquired is subject to a liability, shall be disregarded; * * *. The issue is controlled by the recent case of , involving a like provision of the Revenue Act of 1934. In that case the new corporation acquired the assets of the old corporation by paying nonparticipating bondholders cash borrowed from a bank; issuing most of its voting common stock to the remaining bondholders; issuing voting common stock and class A stock purchase warrants to unsecured creditors; and issuing class B warrants, also containing stock purchase rights, to old common and preferred stockholders. In holding that there was no reorganization the Court said that section 112(g)(1) of the Revenue Act of 1934 requires that the assets of the transferor corporation be acquired for voting stock only, not such stock plus some other consideration, or for consideration other than voting stock. The court says: * * * Congress has provided that the assets*793 of the transferor corporation must be acquired in exchange "solely" for "voting stock" of the transferee. "Solely" leaves no leeway. Voting stock plus some other consideration does not meet the statutory requirement. * * * So far as pertinent, the provision controlling herein, section 112(g)(1)(B), Revenue Act of 1938, as amended, is the same as that interpreted by the Court. Here, as part of the consideration paid for assets of Public Utilities, the new corporation paid off part of the *1072 bonds of one issue and small claims of unsecured creditors with cash, and redeemed another bond issue, and paid other unsecured creditors by issuing income notes and its common stock. Preferred stockholders received common stock for their interests and common shareholders did not participate in the plan. Thus the exchange was not solely for voting stock of the transferee corporation and the transaction was not a reorganization within the meaning of the statute. Decision will be entered under Rule 50. Footnotes 1. SEC. 203. Any amount of income tax (including interest, additions to tax, and additional amounts) collected on, before, or after the date of the enactment of this Act for any taxable year beginning prior to January 1, 1939, to the extent attributable to compensation for personal service as an officer or employee of a State, or any political subdivision thereof, or any agency or instrumentality of any one or more of the foregoing, shall be credited or refunded in the same manner as in the case of an income tax erroneously collected, if claim for refund with respect thereto is filed after January 18, 1939, and the Commissioner of Internal Revenue, under regulations prescribed by him with the approval of the Secretary of the Treasury, finds that disallowance of such claim would result in the application of the doctrines in the cases of Helvering against ), Helvering against ), and Graves et al. against New York ex rel. O'Keefe, decided March 27, 1939, extending the classes of officers and employees subject to Federal taxation. ↩