Michael Carpenter Co. v. Commissioner

MICHAEL CARPENTER COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Michael Carpenter Co. v. Commissioner Docket No. 105718. United States Board of Tax Appeals 47 B.T.A. 626; 1942 BTA LEXIS 670; August 21, 1942, Promulgated *670 Petitioner, a corporation, pursuant to a tax-free reorganization on December 23, 1936, acquired in exchange for its capital stock the business and assets of a Wisconsin corporation. Among the assets acquired were claims for reimbursement against certain milling companies for processing taxes included in the 1935 flour prices paid by the Wisconsin corporation. Negotiations led to settlements of the claims in a subsequent year, conditioned upon a full and complete release and discharge of the milling companies of any and all liability thereunder upon payment of agreed amounts. Held, the amounts received by petitioner in settlement of such claims constituted income to it in the year of receipt. George D. Spohn, Esq., and John S. Best, Esq., for the petitioner. S. U. Hiken, Esq., for the respondent. ARNOLD *627 This proceeding involves deficiencies in income and excess profits taxes for 1936 and 1937. Petitioner admits liability as to a portion of each deficiency, but denies liability as to the remainder thereof. The deficiencies determined and the amounts thereof disputed are as follows: Income tax Excess profits tax Deficiency Amount disputed Deficiency Amount disputed [1936] $612.93 $72.60 [1937] 3,503.68 2,107.72 $518.26 $240.51 *671 The issue, briefly stated, is whether certain sums representing processing taxes, received from various milling companies, amounting to $660 in 1936 and $11,246.50 in 1937, constituted taxable income to petitioner for those years. By an amended answer respondent alleged that he erred in including the $660 item in petitioner's income for 1936, inasmuch as it is taxable to the M. Carpenter Baking Co., which was a separate entity for the period January 1 to December 22, 1936. FINDINGS OF FACT. The M. Carpenter Baking Co. was organized under the laws of Wisconsin in 1901 and is hereinafter referred to as the Wisconsin corporation. Petitioner was organized under the laws of Delaware on or about December 17, 1936, and was authorized to transact business in Wisconsin on or about December 22, 1936. On January 9, 1940, its name was changed to amendment to its charter. It will hereinafter be referred to as petitioner, unless otherwise indicated. All income tax returns of the above corporations material hereto were on the accrual basis and were filed with the collector of internal revenue for the district of Wisconsin. On December 23, 1936, pursuant to a plan of reorganization*672 under section 112:b):4) of the Revenue Act of 1936, petitioner acquired all of the assets of the Wisconsin corporation for 840 shares of its capital stock. The transfer was effected by a bill of sale which, after *628 specifically describing certain of the properties, concludes by transferring tangible or intangible, which the grantor now owns or in which it has any interest whatever, wherever situated * * *. the general baking business was conducted by petitioner at the same address and with the same officers and employees that formerly operated the business of the Wisconsin corporation. During the course of its dealings in 1935 the Wisconsin corporation purchased flour under written contracts from various milling companies. Part of the price which it paid in 1935 for such flour was $1.38 per barrel on account of processing taxes imposed by the Agricultural Adjustment Act of 1933. The entire amounts paid to the milling companies, including the processing taxes, were treated by the Wisconsin corporation as cost of materials purchased and as such were entered upon its accounting records and reflected in its income tax returns. No provision was contained in any of said*673 contracts providing for reimbursement of the processing tax if found to be undonstitutional. On January 6, 1936, the United States Supreme Court held the Agricultural Adjustment Act of 1933 unconstitutional. On or about November 23, 1936, the Wisconsin corporation received from the International Milling Co. $660 representing a portion of the processing taxes which had been included in its invoices and paid as part of the cost of the flour. During 1937 the petitioner received directly or through the Wisconsin corporation $11,246.50 from six milling companies because their 1935 flour sales to the Wisconsin corporation had included an amount representing processing taxes. The companies making the payments, the payees, and the amounts thereof, are as follows: Millers Payee Amount Hubbard Milling Co M. Carpenter Baking Co $660.00 Washburn-Crosby Co Carpenter Baking Co 1,500.00 Pillsbury Flour Mills Co M. Carpenter Baking Co 3,186.50 Rodney Milling Co M. Carpenter Baking Co 2,240.00 Royal Milling Co 1,000.00 Midland Flour Milling Co M. Carpenter Baking Co 2,660.00 Total 11,246.50 Voucher checks with attached release agreements were used*674 by the milling companies in making their refunds. 1 Payment thereof was conditioned upon execution of the release, whereby claimant released all claims against the milling company because the latter had included in its 1935 flour prices an amount representing processing taxes, which *629 taxes had not been paid by the milling company. 2 The endorsements on the checks did not always correspond with the payee named therein, nor did the party named in the release agreement always conform with the party executing the same. *675 A portion of the $11,246.50, supra, namely, $2,888.50, represented refunds by the milling companies upon flour which was included in the inventory of the Wisconsin corporation on January 1, 1936. The balance of the $11,246.50, or $8,358, represented payments in 1937 on account of processing taxes paid by the Wisconsin corporation to its vendors upon flour which had been consumed by the Wisconsin company in its baking operations in the year 1935. No account receivable was carried on the books of the Wisconsin corporation in connection with any of the above payments, nor were such payments reflected in the inventory of assets transferred by the Wisconsin corporation to the petitioner. No accounts receivable in connection with such payments were carried on the books of the petitioner prior to the receipt of the payments. The income tax return of the Wisconsin corporation for 1935 showed a loss of $27,768.29. Subsequent to the receipt of the payments above mentioned, and on or about March 14, 1939, an amended return was filed in the name of the Wisconsin corporation by its former officers which reduced the loss shown on the original return by $11,906.50, explained as and*676 fixed the Wisconsin corporation's loss for 1935 as $15,861.79. The income tax return for 1936 was filed by the petitioner. The return reflects the results of the bakery business for the entire year, without regard to the reorganization which occurred on December 23, 1936. It reflects the $669 received from the International Milling Co. in the total of return. The income tax return of petitioner for 1937 did not reflect as income the $11,246.50 received from milling companies during that year. The books and records of the Wisconsin corporation and petitioner were closed at the end of every four-week period, which gives 13 *630 periods or returns of the Wisconsin corporation for 1935, original and amended, while purportedly covering the calendar year 1935, actually covered the 52 weeks from December 15, 1934, to December 14, 1935. The 1936 return filed by the petitioner covered the period December 14, 1935, to December 12, 1936, a period of 52 weeks, although purportedly covering the calendar year 1936. The 1937 return actually reflected operations from December 13, 1936, to December 11, 1937, a period of 52 weeks, although the return as filed purported to cover the*677 calendar year 1937. In computing the deficiencies herein respondent adjusted the 1936 and 1937 returns to the calendar year basis, and added to 1937 income the $11,246.50 received by the petitioner from the milling companies. OPINION. ARNOLD: Petitioner asserts that the $660 item received from the International Milling Co. was erroneously reported as income in its 1936 return. Respondent in his amended answer alleges he erroneously included it in 1936 income. Thus both parties are in agreement that it should not be included in 1936 income, and we so hold. Our findings show that in 1937 petitioner received $11,246.50 no part of which was reported as income in its 1937 return, but all of which was included as income by the respondent in determining the 1937 deficiencies. Petitioner now admits that $2,888.50 thereof was properly determined to be 1937 income as a tax benefit was derived by its predecessor to this extent because of flour included in the January 1, 1936, inventory. The issue with respect to 1937, therefore, relates only to whether the amount of $8,358 constituted taxable income. Briefly, petitioner contends that, since the Wisconsin corporation's assets*678 were acquired pursuant to a tax-free reorganization, all property received by it has the same basis in its hands as the property had in the hands of the transferor, section 113:a):7), Revenue Act of 1936; that the contract rights had a basis of $1.38 per barrel in the transferor's hands, and had the same basis in petitioner's hands; and that it received only $1 per barrel by virtue of the payments by the millers, and, therefore, realized no taxable income. As an alternative, petitioner contends that, even if the payments were not tax free under section 112:b):4), or if it is held that the basis thereof to petitioner is zero under section 113:a):7), nevertheless they are not taxable to it because the contract rights were capital assets and the mere liquidation of such assets gave rise to no taxable income. McLaughlin v. Harr, 99 Fed.:2d) 638; Merchants Bank Building Co. v. Helvering, 84 Fed.:2d) 478. Finally, petitioner contends that, if the payments *631 were not received in settlement of contract rights, they were gifts which are excluded from gross income by section 22:b):3) of the Revenue Act of 1936. By the bill of sale the Wisconsin corporation transferred*679 certain properties, specified therein, plus all other property of whatever nature, real or personal, tangible or intangible, that it owned or in which it had capital stock. The language in the bill of sale is broad enough to cover any claims, demands, or rights that the transferor had against its vendors. As between the Wisconsin corporation and the petitioner, the latter acquired any claims or rights that its transferor had, and, since such claims were acquired for stock along with the other capital assets of the transferor, each claim represented one of the capital assets involved in the reorganization. McLaughlin v. Harr, supra. Whether said claims were legally enforceable or not is immaterial here. The evidence shows that the claims were the subject matter of negotiations which led to settlements of at least a portion of the amounts claimed and that payment of the amounts agreed upon was conditioned upon a full and complete release and discharge from any and all liability on account thereof. Section 113(a)(7) of the Revenue Act of 1936 provides that where property is acquired after December 31, 1917, by a corporation in connection with a reorganization, the basis*680 for determining gain or loss upon disposition of the property 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 at the time the transfer was made. Petitioner contends that section 113:a):7), supra, applies to the exchange of December 23, 1936, and that under that section the or claims acquired from the Wisconsin corporation had the same basis in its hands that said claims had in the hands of the transferor. While we agree that section 113:a):7) applies, we can not agree that the basis of the claims in the transferor's hands was $1.38 per barrel at the time of exchange, or that any basis it may have had is available to petitioner. In our opinion any such basis had already been exhausted by the transferor, and the basis of such claims in the transferor's hands at the time of the exchange was zero. National Bank of Commerce of Seattle v. Commissioner, 115 Fed.:2d) 875, affirming 40 B.T.A. 72. In the last cited case, as here, there was a reorganization, and petitioner admits that the same question would be presented except that there the reorganization*681 was a taxable transaction, while here the reorganization is agreed to be tax free. We can attribute but little weight to the suggested distinction. Section 113:a):7) of the Revenue Act of 1936 used the term *632 whether the reorganization is tax free or not. Muskegon Motor Specialties Co.,45 B.T.A. 551, 559. This proceeding and the National Bank of Commerce of Seattle case, supra, are similar in several important aspects. In the cited case the transferors charged off certain debts ascertained to be worthless, and took such debts into account in determining their taxable income for the year deducted. In this proceeding the transferor included the $1.38 per barrel in the cost of materials entering into its finished products and took said sum into account in determining the results of its 1935 operations. Here the transferor's tax return for 1935 showed a net loss in excess of the amount of the processing tax included in the price of flour. Similarly, in the National Bank of Commerce of Seattle case five of the transferors sustained net losses in an amount greater than the debts charged off and claimed as deductions, *682 40 B.T.A. 72, 74; and yet, the Circuit Court, in affirming the Board, held that the debts at the time of the transfer had a zero basis in the transferor's hands for the reason that they had been ascertained to be worthless and charged off in a prior year and deducted from income by the transferor banks in such prior year. Having used up its cost basis, the transferor here had no cost basis that it could independently ascribe to more than the transferor banks had because of debts charged off prior to their transfer in the National Bank of Commerce of Seattle case. As to each proceeding the cost basis had been accounted for prior to the exchange and cost could not again be taken into account in determining the taxable income of either corporation. As an alternative, petitioner contends that, since the transferor derived no benefit tax-wise from thus taking the cost basis into account in 1935, it should be allowed the benefit which but for the reorganization would be available to the transferor. We think the answer to this contention is to be found in the Supreme Court's decision in New Colonial Ice Co.v. Helvering, 292 U.S. The facts there show that a*683 new corporation, organized for the purpose, took over the assets and business of another corporation in exchange for a portion of the new corporation's stock. The old company had sustained a statutory net loss prior to the transfer which the new corporation sought to deduct under section 204:b) of the Revenue Act of 1921. In denying the deduction the Court pointed out that losses to the taxpayer sustaining them, i.e., to treat them as personal to him and not transferable to or usable by another." (P. 440.) While we do not have here a question involving the deduction of a statutory net loss by an entity separate and distinct from the corporation sustaining the loss, we do have a comparable situation in that petioner, in reliance upon the rule announced in Central Loan & Investment*633 Co.,39 B.T.A. 981, seeks to offset $8,358 of its 1937 income by an equivalent amount of the 1935 net loss of its transferor. In the cited case the taxpayer was formed for the purpose of liquidating its predecessor corporation, which had been in the hands of a receiver for almost three years. Actually, the taxpayer there was the liquidating agent of its transferor, and*684 the case was tried and decided upon the theory that the reorganization resulted in no change in corporate identity. Just the opposite is true here; and the separate identity of the transferor and transferee must be recognized, as it was in the New Colonial Ice Co., supra. Believing as we do that the situation here is governed by the rule announced in the latter case, we hold that the 1935 loss of the Wisconsin corporation was not transferable to or usable by petitioner, either directly or indirectly, and that the personal defense available to the transferor did not survive the transfer to petitioner. Having determined that the claims petitioner acquired from the transferor constituted capital assets, and that said claims had a zero basis in the transferor's hands at the time of the exchange, it is apparent under sections 113:a):7) and 111:a) that anything realized thereon by petitioner in 1937 constituted taxable income. As pointed out in the National Bank of Commerce of Seattle case, supra, when an asset with a zero basis is liquidated the taxpayer realizes a gain to the extent of the amount received. *685 Suffolk Co., Ltd.,42 B.T.A. 994, 996 :on appeal, C.C.A., 4th Cir.). Petitioner's final contention is that, if the payments were not received in settlement of contract rights, they were gifts to be excluded from gross income under section 22:b):3) of the Revenue Act of 1936. A similar argument was advanced by the vendee-taxpayer in Sportwear Hosiery Mills v. Commissioner :C.C.A., 3d Cir.), 129 Fed.:2d) 376, affirming 44 B.T.A. 1026. We find the opinion of the court very pertinent to the issues here. It points out that the Board found no evidence of a donative intent and that it agreed with this finding. The court stated that the payments were income to the taxpayer, that the taxpayer and its vendor were involved in continuous business dealings, that it was not unreasonable to consider the payments or credits as made for maintaining good will and encouraging future business, and finally that, while the vendors sought a possible intangible benefit, the taxpayer realized a real profit. The court further stated that the refunds reduced the price paid by the taxpayer for the goods it had recently sold, thereby increasing the gain*686 realized on those sales. Specifically, the court said: gain that the Unjust Enrichment Act was aimed. This additional profit constituted taxable income. Robertson (C.C.A., 4th Cir.), 89 Fed.(2d) 775, and Ben Bimberg &*634 Co. v. Commissioner :C.C.A., 2d Cir.), 126 Fed.:2d) 412, 424. Houbigant, Inc.,31 B.T.A. 954; affd., 80 Fed.:2d) 1012; certiorari denied, 298 U.S. 669. In accordance with the foregoing discussion and authorities, we hold that the payments received from the milling companies during 1937 constituted taxable incom of this petitioner for that year. Decision will be entered that there is no deficiency for 1936. Decision will be entered for the respondent as to the year 1937. Footnotes 1. Record fails to disclose method of payment used by Royal Milling Co., or whether release was secured. ↩ 2. The release agreement of the Pillsbury Flour Mills Co. is typical of the release agreements accompanying the voucher checks. The pertinent portions thereof read as follows: £ Pillsbury Flour Mills Company] * * * is liable to the undersigned for certain amounts, on account of Federal excise taxes imposed under the Agricultural Adjustment Act * * * but not paid, that were included in or added to the price of articles which were sold or contracted to be sold * * * to the undersigned under a written contract or contracts of sale * * * by £ Pillsbury] the receipt whereof is hereby acknowledged, the undersigned does hereby acknowledge full payment and satisfaction of all claims which the undersigned ever had, now has, or may hereafter have against £ Pillsbury], by reson of all amounts on account of Federal excise taxes imposed under the Agricultural Adjustment Act. * * *@ Other paragraphs provided for the release and discharge of Pillsbury from any and all liability to the undersigned vendee. ↩