Opinion
Docket Nos. 1632-68, 1633-68.
Filed February 12, 1970.
As of Jan. 31, 1962, Land Co., transferor, a corporation wholly owned and controlled by petitioners, was insolvent, and was indebted to petitioners, transferees, for an amount exceeding $100,000. This was a valid indebtedness, reflected on Land Co.'s books, and was secured by a mortgage on all of Land Co.'s real estate, recorded on Apr. 28, 1959. On Mar. 27, 1962, Land Co. entered into an agreement to sell all of its real estate to Bing Wong Farms in exchange for cash plus an 80-acre parcel of land. In order to clear Land Co.'s title to its real estate, on Apr. 3, 1962, petitioners released their mortgage, intending Land Co., which they controlled, to pay off its other known creditors with the cash and to transfer the 80-acre parcel to them as partial payment of its debt to the extent of the actual value of the land at the time of transfer. Bing Wong Farms transferred the 80-acre parcel into escrow on Apr. 3, 1962, as of which time Land Co. made an entry on its books to reflect its acquisition of the parcel, valued at $44,444. On June 26, 1962, the escrowee transferred title to the parcel, the fair market value of which was $100,000, to petitioners. During its fiscal year ended Jan. 31, 1963, Land Co.'s accountant made no entry on its books indicating either the transfer of the parcel to petitioners or satisfaction of its indebtedness to them. Land Co.'s accountant, on its income tax return for its fiscal year ended Jan. 31, 1963, listed the parcel as an asset as of the end of such year. Land Co. had a deficiency in its Federal income tax for its fiscal year ended Jan. 31, 1963, of more than $100,000, for which the Commissioner determined under sec. 6901, I.R.C. 1954, petitioners are liable for $100,000 as transferees of the 80-acre parcel. Held, Land Co.'s transfer of the parcel to petitioners was not a fraudulent transfer under the applicable State law; petitioners are not liable under sec. 6901 as transferees of property of Land Co.
William M. Waldrom and Norman D. Hall, Jr., for the petitioners.
Richard Rink and Roger Rhodes, for the respondent.
The Commissioner has asserted transferee liability against each of the petitioners in these consolidated proceedings as follows: Jack O. Nutter, $100,000; Jane E. Nutter, $100,000.
The Commissioner has determined that petitioners, each as transferee of an undivided one-half interest in a parcel of land worth $100,000 at the time of transfer, are liable under section 6901, I.R.C. 1954, for $100,000 of the unpaid Federal income taxes assessed against Pinal County Land Co., transferor. The only issue we must decide is whether this transfer was a fraudulent conveyance under sections 44-1004, 44-1005, or 44-1007 of the Arizona Revised Statutes, giving rise to transferee liability under the applicable State law. If it was, the petitioners are liable as transferees of property within the meaning of section 6901.
All statutory references are to the Internal Revenue Code of 1954 unless otherwise specified.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation and the exhibits attached thereto are incorporated herein by this reference. Our fact findings are limited to those facts which pertain to the question whether the transfer was fraudulent under Arizona law, the only question in dispute. If the transfer was fraudulent the petitioners are liable as transferees, the other facts necessary to establish such liability having been stipulated.
Jack O. Nutter (Jack) and Jane E. Nutter (Jane), husband and wife, resided in Phoenix, Ariz., at the time they filed their respective petitions to this Court.
In 1953 the petitioners sold a ranch then owned by them individually to Illinois Wesleyan University. As part of the purchase price the university contracted to pay petitioners $350,000. In 1954 or 1955 Pinal County Land Co. (Land Co.), a corporation wholly owned and controlled by the petitioners, bought the ranch from the university, assuming its obligation in favor of petitioners in the amount of $350,000. A $350,000 credit on the ledger account designated "Mortgage Payable, Jack O. Nutter" represents the placing on the corporate books of this liability to the petitioners. On September 30, 1958, the ledger account reflected a balance due and owing to the petitioners in the amount of $271,437.81. The amount represented a valid indebtedness at that time. No further entries have been made to this account and, as of the date of the trial of this case, the balance in this account was still $271,437.81. As security for this debt the petitioners owned a mortgage on all the corporation's real estate. This mortgage was recorded April 28, 1959, as of which time Land Co. was solvent.
As of January 31, 1962, Land Co. was insolvent. It has been insolvent ever since.
On March 27, 1962, Land Co. entered into an agreement to sell all its land to Bing Wong Farms, Inc. (Farms, Inc.). As part of the purchase price on April 3, 1962, Farms, Inc., transferred an 80-acre parcel of land to Surety Title Trust Co. (Surety Title) pursuant to an escrow arrangement between the parties to the sale. The following entry, dated April 3, 1962, was made on the books of Land Co. to reflect its acquisition of the 80 acres: Debit Credit
Fixed assets — land ............ $44,444 Fixed assets — sold ............ $44,444 Also on April 3, in order to clear title to the land being sold to Farms, Inc., petitioners released their mortgage.With the proceeds from the sale (except the 80 acres), Land Co. paid off all its debts with the exception of its debt to petitioners and the subsequently determined deficiency in its Federal income tax for the fiscal year ended January 31, 1963, liability for which is being asserted against the petitioners. On June 26, 1962, Surety Title transferred the 80-acre parcel to the petitioners. As of that date the parcel had a fair market value of $100,000. Land Co. was indebted to petitioners in an amount exceeding $100,000 at the time of this transfer. The petitioners intended the transfer of this land to them to be in consideration for their release of their mortgage and to constitute part payment by Land Co. of its debt to them to the extent of the actual value of the land.
As the 80 acres had been received in exchange for other land, its actual fair market value had not been established by bargain and sale. Bing Wong, the principal of Farms, Inc., had told Jack that he, Bing Wong, had purchased the property for $500 an acre, or $40,000 for the entire parcel. Jack was also advised that he could mortgage the land for $44,444. Based on these facts, and because the actual value of the land had not been conclusively shown to be greater, Land Co. valued the land on its books at $44,444.
Land Co.'s sale of property to Bing Wong was recorded on its Federal income tax return for its fiscal year ended January 31, 1963, as follows:
Sale price of farm ............................ $767,595.56 Cost — 1956 .................................. $477,477.64 Less — allowable depreciation ................ 237,306.48 Selling expense................................ 14,038.95 254,210.11 ----------- ---------- Gain on sale................................... 513,385.45 In determining the $767,595.56 sale price of the farm, the 80-acre parcel was valued at $44,444. The return also reflected the 80-acre parcel as an asset of the corporation on January 31, 1963.At the time the parcel was transferred to him, Jack knew that its fair market value was substantially in excess of $44,000. He did not make any good-faith effort to reflect its actual value on either the corporation's records or on its tax return for the fiscal year ended January 31, 1963. He did not report his receipt of the land on his 1962 tax return although it constituted taxable income to him in that year to the extent of its fair market value. The deficiency in Land Co.'s Federal income tax, for which transferee liability is being asserted herein, resulted in part from Land Co.'s undervaluation of the 80-acre parcel in reporting its gain realized upon the sale of its land to Farms, Inc.
After this sale to Farms, Inc., Land Co. was a defunct corporation, having no other operating assets of material value. It did not continue to maintain a formal set of books and records. Rather the corporate activities and its financial position were recorded in journals and summarized at the end of the year on "workpapers." The failure of Land Co.'s accountant to reflect the transfer of land to petitioners as being in partial satisfaction of Land Co.'s debt to them was inadvertent.
During 1964 petitioners sold the 80-acre parcel for $100,000. Land Co.'s accountant discovered during 1964 that Land Co. did not continue to own this land. In order to reflect its transfer to petitioners, the following entry was made dated January 31, 1964: Debit Credit
J.O.N. ...................................... $44,444 Land ........................................ $44,444 The "J.O.N." account is a "clearing account" used to record transactions between Land Co. and petitioners. A withdrawal of property from the corporation would be recorded in this account by a debit. A contribution would be recorded by a credit. This account was used to reflect current transactions between petitioners and the corporation rather than continually making entries in the "Mortgage Payable, Jack O. Nutter" account. The following entry was also made dated January 31, 1964: Debit Credit Mortgage payable — J.O.N. ................. $13,394.08 Account — J.O.N. to apply account to mortgage $13,394.08 The Commissioner determined that each of the petitioners is liable as transferee for the deficiency in Land Co.'s 1963 income tax.OPINION
Section 6901 of the Internal Revenue Code of 1954 provides in part:
(a) METHOD OF COLLECTION. — The amounts of the following liabilities shall, except as hereinafter in this section provided, be assessed, paid, and collected in the same manner and subject to the same provisions and limitations as in the case of the taxes with respect to which the liabilities were incurred:
(1) INCOME, ESTATE, AND GIFT TAXES. —
(A) Transferees. — The liability, at law or in equity, of a transferee of property —
(i) of a taxpayer in the case of a tax imposed by subtitle A (relating to income taxes),
* * * * * * *
(b) LIABILITY. — Any liability referred to in subsection (a) may be either as to the amount of tax shown on a return or as to any deficiency or underpayment of any tax.
This section neither creates nor defines any substantive transferee liability. Instead it provides an administrative procedure whereby the Commissioner may collect from a transferee or transferees the unpaid taxes of the transferor, for which, under the applicable State law, i.e., Arizona law, the transferees are liable. Commissioner v. Stern, 357 U.S. 39 (1958). The Government's substantive rights vis-a-vis either of the petitioners are precisely those which Land Co.'s other creditors would have under Arizona law. Commissioner v. Stern, supra.
The Commissioner contends that petitioners' liability as transferees is established by any or all of the following provisions of the Arizona Revised Statutes:
Sec. 44-1004. Conveyances by insolvent
Every conveyance made and every obligation incurred by a person who is or will be thereby rendered insolvent is fraudulent as to creditors without regard to his actual intent if the conveyance is made or the obligation is incurred without a fair consideration.
Sec. 44-1005. Conveyances by persons in business
Every conveyance made without fair consideration when the person making it is engaged or is about to engage in a business or transaction for which the property remaining in his hands after the conveyance is an unreasonably small capital, is fraudulent as to creditors and as to other persons who become creditors during the continuance of such business or transaction without regard to his actual intent.
Sec. 44-1007. Conveyance made with intent to defraud
Every conveyance made and every obligation incurred with actual intent, as distinguished from intent presumed in law, to hinder, delay, or defraud either present or future creditors, is fraudulent as to both present and future creditors.
Liability under either section 44-1004 or 44-1005 is predicated upon the absence of "fair consideration." That term is defined in section 44-1003 of the Arizona Revised Statutes:
Fair consideration is given for property, or obligation:
1. When in exchange for such property, or obligation, as a fair equivalent therefore, and in good faith, property is conveyed or an antecedent debt is satisfied, or
We consider first the question whether petitioners gave "fair consideration" for the property transferred to them. If they did there can be no liability under either section 44-1004 or 44-1005.
The stipulated facts show that Land Co. was indebted to the petitioners in the amount of $271,437.81 on September 30, 1958. The parties also stipulate that this amount represented "a valid indebtedness at that time." We find that the corporation remained indebted to petitioners for more than $100,000 when they released their mortgage of record on April 3, 1962. It was the intent of the petitioners when they released their mortgage that Land Co. would shortly convey to them the 80-acre parcel, representing their "equity" in Land Co.'s assets after payment of all its other known creditors, as consideration therefore and that the conveyance was to constitute part payment of Land Co.'s debt to them to the extent of the actual value of the parcel. We think the substance of the transaction was in accord with this stated intention, and that petitioners gave the corporation "fair equivalent" value in exchange for the parcel. And we think the exchange was made "in good faith" and without any intention on the part of petitioners to secure for themselves any preference over Land Co.'s other creditors all of whom, with the exception of the Commissioner, were paid in full: as secured creditors they already enjoyed priority over the Commissioner's claim for taxes. United States v. Guaranty Trust Co., 33 F.2d 533 (C.A. 8, 1929), affirmed on other grounds 280 U.S. 478. The Commissioner does not question the validity of Land Co.'s debt to petitioners nor the effectiveness of their mortgage as securing the priority of their claim over the claims of Land Co.'s unsecured creditors, including the Commissioner. Accordingly, we hold that petitioners gave "fair consideration" for the transfer.
There remains to be considered whether petitioners' liability as transferees of property is established by section 44-1007 of the Arizona Revised Statutes. The Commissioner must prove that the parcel was transferred " with actual intent * * * to hinder, delay, or defraud either present or future creditors." (Emphasis supplied.) Ariz. Rev. Stat. Ann. sec. 44-1007 (1956). The burden of proof is upon the Commissioner to show such intent. Sec. 6902. We do not think he has done so.
Decisions will be entered for the petitioners.