Opinion
Judgment in favor of the plaintiffs.
WHALEY, Judge, dissenting.
James McCormick Mitchell, of Buffalo, N. Y. (John L. Kenefick, Ralph M. Andrews, and Kenefick, Cooke, Mitchell, Bass & Letchworth, all of Buffalo, N. Y., on the brief), for plaintiffs.
Erwin N. Griswold, of Washington, D. C., and Charles B. Rugg, Asst. Atty. Gen. (Ralph C. Williamson, of Washington, D. C., on the brief), for the United States.
Before GREEN, LITTLETON, WILLIAMS, and WHALEY, Judges.
This suit is for the recovery of $85,232.17, income tax for 1918, with interest. The question concerns a sale in 1917 by the Schoellkopf Aniline & Chemical Works, Inc., of all its business, properties, and assets to the National Aniline & Chemical Company, Inc., for stock and cash. Cash to the extent of $713,558.10 was not received by the vendor until 1918, and the specific question for decision is whether this amount should be included in income for 1917 or 1918. Plaintiffs contend that this amount represented a part of the consideration received in the sale which was consummated in 1917, and, since the Schoellkopf Aniline & Chemical Works, Inc., was on the accrual basis, the amount so received was not income for 1918.
Special findings of fact:
1. The Schoellkopf Aniline & Chemical Works, Inc. (hereinafter referred to as the Schoellkopf Company), a New York corporation with its principal office at Buffalo, had been engaged in the manufacture and sale of dyes and chemicals for many years prior to July 23, 1917, when it was dissolved as shown below.
2. April 5, 1917, the Schoellkopf Company entered into a written agreement with certain parties for the sale of all its assets to a corporation to be thereafter organized. The agreement was approved by the board of directors of the Schoellkopf Company April 27, 1917, and confirmed by its stockholders May 26, 1917.
3. Pursuant to the agreement, the National Aniline & Chemical Co., Inc. (hereinafter referred to as the National Company), was incorporated May 26, 1917, as a New York corporation and by an instrument duly executed and delivered May 28, 1917, became a party to the agreement of April 5, 1917. June 6, 1917, the Schoellkopf Company, pursuant to the same agreement, sold all of its assets, business, and properties to the National Company and executed and delivered deeds covering the real property which were duly recorded.
4. July 23, 1917, the Schoellkopf Company was dissolved under article 10 of the General Corporation Law of New York (Consol. Laws, c. 23 [section 220 et seq.]), its directors becoming trustees for its creditors and stockholders, and, in so far as they survive, they brought this suit as such trustees.
5. The agreement of April 5, 1917, provided for the sale to the National Company of not only the properties of the Schoellkopf Company but also those of four other vendors, effective 'as of the opening of business on January 2, 1917.' The agreement further provided that 'In full consideration for each vendor's business and properties above described and to be transferred to the Company aforesaid, the company shall pay to such vendor (or to its stockholders pro rata) the value of such business and properties at the opening of business on January 2, 1917, determined as hereinafter provided.' The tangible assets, after adjustment in a certain manner on account of the liabilities which were assumed by the National Company, were to be paid for with preferred stock of the National Company. The intangibles were to be paid for partly in cash, or preferred stock at par, and partly in common stock. In so far as the Schoellkopf Company was concerned, the value of its intangibles was to be determined in the following manner:
'The relative values of the intangibles of the respective vendors, at the opening of business on January 2, 1917, to be transferred as aforesaid, have already been determined and are hereby finally agreed upon as follows: (i) partly in terms of shares of the company's common stock and (ii) partly in terms of percentages of the amount (if any) by which the company's net profits during the calendar year 1917 (to be determined as hereinafter provided, including profits accrued prior to, and to be embraced in, said transfers of businesses and properties, as aforesaid) shall exceed the sum of $3,723,600 (such excess being hereinafter sometimes called 'excess net profits'), viz.:
'(a) Such value of Schoellkopf's said intangibles is: 180,468 shares of the company's common stock and, in addition thereto, 59.892 percent of such excess net profits.'
The same agreement made the following provision with respect to the determination of, and payment for, 1917 excess not profits.
'(a) Determination: For the purpose of this agreement, the company's said net profits during 1917 shall be the balance obtained by deducting from gross profits (including those of subsidiaries) all expenses and charges of every character relating thereto, including a depreciation charge at the rate of ten percent per annum on the value of all buildings, laboratories, plant, machinery, tracks, cars, fixtures, furniture, equipment, implements and apparatus, as such gross profits, expenses, and charges shall be determined in the manner hereinafter provided in Clause X. [Clause X provided for an appraisal committee explained below.]
'(b) Payment: The said respective percentages of excess net profits shall be determined quarterly as of April 1, July 1, October 1, 1917, and January 1, 1918, and shall be paid accordingly in four quarterly installments on July 1, October 1, 1917, January 1 and April 1, 1918, respectively, or as soon as practicable thereafter. If not paid on said respective dates, said respective amounts shall bear interest from said respective dates at the rate of six percent per annum until paid. All such quarterly settlements shall be based on the total amount of net profits accrued from and after January 2, 1917, in excess of that proportion (or the whole) of $3,723,600, corresponding to the period so under settlement; previous payments being credited against the amounts so settled. All payments of said amounts of excess net profits shall be made in cash, except (i) that the company may, at its option, pay any part thereof, not exceeding thirty percent, in its preferred stock at par (with adjustment of dividends to the date of payment), provided that all payments for each respective quarter (other than payments on account of Beckers' said percentage) shall be made in substantially the same proportions of cash and stock, and except (ii) that the company shall pay Beckers' said percentage up to $1,500,000 in the company's preferred stock as aforesaid.'
Clause X of the agreement provided for an appraisal committee which would have the power to verify, harmonize, and correct various schedules to be furnished by the vendors; to identify and determine the properties to be transferred and liabilities to be assumed; to ascertain and value the tangible property to be transferred; and to determine the quarterly excess net profits and percentages thereof applicable to each vendor. It was provided that the unanimous agreement of such committee would be binding on all parties concerned, but in case of disagreement provision was made for the appointment by them of an umpire who would decide the matter.
6. The agreement of April 5, 1917, was amended in certain particulars by three instruments dated May 28, 1917, and by other instruments dated August 14, 1917, September 26, 1917, and by two instruments dated December 31, 1917.
7. One of the amendments of May 28, 1917, increased the percentage of excess net profits applicable to the Schoellkopf Company from 59.892 per cent. to 60.166 per cent. and substituted the amount of $3,681,900 for the base amount of $3,723,600, referred to in connection therewith.
8. The amendment of August 14, 1917, was executed because of a controversy which arose as to what constituted excess net profits under the portions of the agreement of April 5, 1917, quoted in finding 5. This controversy was whether, in determining excess net profits during 1917, federal income and profits tax for that year should be deducted from gross profits in determining such net profits. The amendment or agreement of August 14, 1917, provided that pending final adjustment of the dispute payments should be made to the Schoellkopf Company after the deduction of such taxes from the gross profits. This controversy was finally settled by one of the amendments dated December 31, 1917, though not formally acknowledged until January 28, 1918, in which it was provided and agreed that in such determination 74.074 per cent. of the taxes on 1917 income should be deducted; such taxes being tentatively determined at $12,500,000. The amount which the Schoellkopf Company would be entitled to receive on account of 1917 excess net profits was fixed at an amount not in excess of $6,685,100.
9. The foregoing agreements were carried out through the transfer of properties on the part of the Schoellkopf Company and the payment of the consideration, including the assumption of liabilities, on the part of the National Company. All assets and properties of the Schoellkopf Company were transferred to the National Company on or about June 6, 1917, and the National Company thereafter operated such properties. The greater part of both preferred and common stock contemplated by the agreement as part of the consideration was issued to the Schoellkopf Company in 1917 and the balance in 1918 after the appraisal committee had submitted its report and after certain adjustments on account of cash subscriptions. Likewise, cash to the extent of at least $6,000,000 on account of excess net profits or intangibles was paid to the Schoellkopf Company in 1917. A further payment of $713,558.10 on account of such excess net profits was paid to the Schoellkopf Company May 24, 1918. The last-mentioned item is the one in controversy in this case.
10. April 29, 1918, the liquidating trustees filed an income and profits tax return on behalf of the Schoellkopf Company for 1917. The return showed a total net income of $4,917.522.11 which was arrived at by deducting from gross income, among other items, an alleged loss of $4,682,422.45 an account of the sale of the Schoellkopf Company's assets to the National Company. The foregoing loss was determined in the following manner:
Value as of March 1, 1913.....................................
$ 3,675,712.59
Subsequent additions..............................................
6,149,766.62
----------------
9,825,479.21
Profit for 6 months to June 30, 1917.......................
$12,039,669.79
Less depreciation...................................................
375,516.15
----------------
11,664,153.64
----------------
21,489,632.85
Received therefor:
138,105 preferred shares at $70............................
9,667,350.00
136,980 common shares at $5...............................
684,940.00
Interest on purchase price.......................................
483,367.50
Cash......................................................................
5,971,552.90
----------------
16,807,210.40
----------------
Total loss...............................................................
$ 4,682,422.45
The item of cash, in the amount of $713,558.10, received May 24, 1918, although disclosed by plaintiffs, was not included in the foregoing computation nor was it included in the Commissioner's determination hereafter referred to in finding 13.
11. March 15, 1919, the liquidating trustees filed a return on behalf of the Schoellkopf Company for 1918 showing a total net income of $765,737.79, including therein as income for that year the amount of $713,558.10 referred to in finding 9 as having been received by the company May 24, 1918. This return disclosed a tax of $91,372.54, $85,626.97 of which was due to the inclusion of the said sum of $713,558.10 as income for 1918. The tax shown on this return was paid March 15, June 16, September 15, and December 15, 1919, in the respective amounts of $10,227.09, $35,459.18, $22,843.19, and $22,843.08. The inclusion of the item of $713,558.10 in the return for 1918 was on the advice of counsel to the effect that since a loss had been claimed as a deduction for 1917 on account of the sale in question, future collection on account thereof should be returned as income when received.
12. The Schoellkopf Company and the liquidating trustees, on its behalf, kept their books and rendered their returns on the accrual basis. On such basis, whatever gain or loss was realized on account of the sale heretofore referred to accrued in 1917.
13. December 11, 1919, the Commissioner of Internal Revenue determined a deficiency in respect of the tax paid by the Schoellkopf Company for 1917 of $7,881,822.50 in large part on the ground that it had realized a profit of $6,720,488.67 on the sale of its assets to the National Company instead of sustaining a loss of $4,682,422.45 as claimed in its return. The foregoing profit was determined on the basis of the following consideration received:
Preferred stock:
134,258 shares National Aniline & ChemicalCompany stock par value $100.00 per share.............................
$13,425,800.00
Common stock:
145,889 shares National Aniline & ChemicalCompany stock at $10.52243301 per share...................
1,535,107.23
Securities...........................................
384,700.00
Cash..................................................
6,486,117.03
Income and excess-profits tax liability as of June 6,1917, assumed by new company, per schedule 3....................
5,816,969.84
--------------
Total consideration received ...............
$27,648,694.10
14. May 3, 1920, the Commissioner advised the liquidating trustees that 'After due consideration of the information furnished by your representatives, the bureau is of the opinion that the sale of the assets of your company to the National Aniline & Chemical Company, Inc., on June 6, 1917, did not result in a determinable profit or loss to your company as of that date.' In reliance on this decision, the trustees, having paid all liabilities of the Schoellkopf Company, distributed to the stockholders of said corporation in proportion to their respective interests, the funds and securities remaining in their hands as liquidating trustees, except a contingent reserve of $18,221.58. They distributed cash in the amount of $3,116,843.04 and $1,315,700 in Liberty bonds.
15. The stockholders of the Schoellkopf Company made returns showing the cost or March 1, 1913, value of the stock interest of each in the corporation and the liquidating dividends received thereon from said trustees. The Commissioner assessed taxes, amounting in the aggregate to more than $2,000,000, against said stockholders on the basis of the gains or profits disclosed in the returns, and the taxes so assessed were paid.
16. March 15, 1924, the liquidating trustees filed a claim for refund of $85,232.17 for 1918 on behalf of the Schoellkopf Company and assigned as a basis therefor the alleged erroneous inclusion in income for that year of the item of $713,558.10 referred to in finding 9, contending that the same accrued in 1917 and should have been included in determining gain or loss for that year. The claim was rejected by the Commissioner September 15, 1926.
Conclusion of law:
Upon the foregoing special findings of fact, which are made a part of the judgment herein, the court decides as a conclusion of law that the plaintiffs are entitled to recover $85,232.17, with interest as provided by law.
It is therefore adjudged and ordered that the plaintiffs recover of and from the United States the sum of $85,232.17 with interest on $4,086.72 from March 15, 1919, $35,459.18 from June 16, 1919, $22,843.19 from September 15, 1919, and $22,843.08 from December 15, 1919, to such date as the Commissioner of Internal Revenue may determine in accordance with the provisions of section 177(b) of the Judicial Code, as amended by section 615(a) of the Revenue Act of 1928 (28 USCA § 284(b).
LITTLETON, Judge.
The question in this case is whether plaintiffs are entitled to recover a tax assessed and collected for 1918 on an item of $713,558.10 received in that year from a sale which was consummated in 1917. Extended evidence, both oral and documentary, was submitted making the matter seem somewhat complicated, but, when reduced to the basic facts, the question is simply whether the item accrued in 1917 or 1918.
April 5, 1917, the Schoellkopf Company entered into an agreement with certain parties to sell its assets, effective at the opening of business January 2, 1917, to a corporation thereafter to be organized. The agreement contemplated not only the sale to the same corporation of the assets of the Schoellkopf Company, but also those of four other corporations. The proposed corporation, the National Company, was organized May 26, 1917, and on May 28, 1917, became the necessary party to the agreement of April 5, 1917. June 6, 1917, the Schoellkopf Company executed an agreement of transfer of all its properties and business to the National Company, and July 20, 1917, executed and delivered deeds covering the real property which were duly recorded. Thereafter the National Company operated the properties.
The price to be paid to the Schoellkopf Company was the 'value of such [its] business and properties at the opening of business on January 2, 1917,' and the agreement set out in detail how such value should be determined. Among other things, the agreement provided for an appraisal committee whose duty it was to identify and determine the properties to be transferred as well as their value on the basic date. Such committee was also to determine excess net profits in the operation of the business for 1917 on account of which cash payments were to be made quarterly to the Schoellkopf Company.
Apparently the appraisal committee did not finish its work until about December 31, 1917, but prior to that time cash in the amount of approximately $6,000,000 had been paid to the Schoellkopf Company and a substantial amount of the preferred and common stock, representing the remainder of the consideration, had been issued to it. While some preferred and common stock was issued in 1918, there has been no inclusion in income for 1918 on account of such consideration, nor is there any suggestion on the part of defendant that it should be so included. The record does not definitely show what part of the consideration was represented by the common and preferred stock; however, the record shows that it was very substantial, having been tentatively determined at one time by the Commissioner at approximately $15,000,000 and shown on the return for 1917 at approximately $10,000,000. We are not advised of the exact amount of cash paid in 1917, but the facts show that it was at least $6,000,000. The exact amount of consideration paid in 1917 is not material, since we are not here seeking to determine the gain or loss on the 1917 sale, but we do consider important the fact that the greater part of the consideration passed to the Schoellkopf Company in 1917, and the further fact that the assets were transferred in 1917 and the Schoellkopf Company thereafter operated the properties.
In addition to the consideration referred to above, there was paid to the Schoellkopf Company, or rather to its liquidating trustees who acted for it after dissolution, $713,558.10 on May 24, 1918, as part of the consideration of the sale referred to above, and the questions is, Was this item taxable income for 1918? The return for 1917 was filed prior to the receipt of the foregoing amount, although it had been fixed, and such amount was not included in the consideration used in determining gain or loss for 1917 from the sale. The return, however, claimed a loss on the transaction of $4,682,422.45 which was determined by assigning a March 1, 1913, value, plus certain additions and less depreciation, to the assets sold of $21,489,632.82 and deducting therefrom consideration received in the amount of $16,807,210.40, which was made up principally of preferred stock at a value of $9,667,350, common stock at $684,940, and cash of $5,971,552.90. Prior to the disallowance by the Commissioner of the foregoing loss as a deduction, the return for 1918 had been filed, which, upon advice of counsel, included the controverted item of $713,558.10 as income, on the theory that since a loss had been claimed on the sale for 1917, any other payments should be reported as income. This, however, was erroneous, and, if the item of $713,558.10 had been included in the consideration shown in the return, there would still have been a claimed loss. Subsequently, the Commissioner determined that there was neither a determinable gain nor loss on the transaction in 1917, thus denying the claimed loss. Thereafter, in 1923, an agent of the Commissioner made an examination and audit of the 1918 return and recommended the exclusion of the item of $713,558.10 from 1918 income for the reason that it was accrued income for 1917, but the Commissioner did not approve this recommendation and this suit followed in due course.
The defendant suggests that the liquidating trustees who filed the 1917 and 1918 returns on behalf of the Schoellkopf Company were on the cash basis, though admitting that the books of the corporation were kept on the accrual basis. We cannot sustain this contention, and have found as a fact to the contrary. We are satisfied from the record that income for both 1917 and 1918 should be reported on the accrual basis. It may well be that the liquidating trustees kept only memorandum accounts, but they were only acting in the final liquidation of the Schoellkopf Company, and for such purposes the Schoellkopf Company remained in existence under section 221 of the General Corporation Law of the state of New York. We are convinced that pending final dissolution the same method of accounting for income to such company was followed subsequent to July 23, 1917, as was used prior to that time, namely, the accrual basis.
Under all revenue acts which have been enacted since the adoption of the Sixteenth Amendment, a return of income has been required on an annual basis, showing the result of transactions occurring during a fixed accounting period, either calendar year or fiscal year, at the option of the taxpayer. Under the statutes and regulations in force for 1917 and 1918, a taxpayer could report his income on the accrual basis. Burnet v. Sanford & Brooks Co., 282 U.S. 359, 51 S.Ct. 150, 75 L.Ed. 383. The Schoellkopf Company was on a calendar year basis and reported its income under the accrual method of accounting. The only question in this case, therefore, is whether the controverted item in question accrued in 1917. In other words, Was the 1917 sale a transaction from which gain or loss could be said to have accrued in 1917? We have no doubt that it was. An item accrues when all events have occurred necessary to fix the liabilities of the parties concerned therewith and to determine the amount of such liabilities. United States v. Anderson et al., 269 U.S. 422, 46 S.Ct. 131, 70 L.Ed. 347; American National Co. v. United States, 274 U.S. 99, 47 S.Ct. 520, 71 L.Ed. 946; Lucas v. North Texas Lumber Co., 281 U.S. 11, 50 S.Ct. 184, 74 L.Ed. 668, and Lucas v. American Code Co., 280 U.S. 445, 50 S.Ct. 202, 74 L.Ed. 538. There must not only be admitted liability arising on account of the transaction, but also the events necessary to fix the amount of the liability must have occurred. An examination of the 1917 sale in the light of the foregoing principle leads us to the conclusion that whatever gain or loss accrued on account of such sale accrued in 1917. It is clear that the liability under the contract of April 5, 1917, which was accepted by the National Company May 28, 1917, arose at that time. By such agreement the Schoellkopf Company became obligated to transfer its assets to the National Company and this was carried out in 1917. By the same agreement the National Company became obligated to pay certain consideration to the Schoellkopf Company, namely, stock and cash, and the greater part of such consideration passed in accordance with the agreement in 1917. The assets to be transferred were in existence in 1917 and the contract set out in detail the consideration to be paid, namely, the value at January 2, 1917, and the manner in which such valuation should be determined. No question is raised as to the existence in 1917 of the factors necessary to a determination of the price to be paid for the tangible assets, but the defendant insists that the factors necessary to determine the amount to be paid on account of excess net profits for 1917 were not only not determinable in 1917, but also were not determined until 1918. The controverted item of $713,558.10 consisted of a payment on account of excess net profits. Much of the defendant's argument on this point is based upon the changes which were made in the contract on account of this item. It will be noted, however, that the original contract specifically provided that which should be paid on account of excess profits; there can therefore be no question that there was a liability to make payment on that account and that the contract provided how such amounts should be determined. It is true that a dispute arose as to how the amount of such profits would be computed, but we do not think that changes the situation. The controversy was whether federal income and profits tax for 1917 should be deducted from gross profits in determining excess net profits. The original contract provided that the excess net profits should be determined by deducting 'from gross profits * * * all expenses and charges of every character relating thereto.' The dispute was finally settled by agreeing, apparently by a compromise, that only a part of such taxes should be deducted. But all the events necessary to a determination of income and tax thereon occurred in 1917, and certainly the contract is not so indefinite or so uncertain that it would not have been possible to have determined at the end of 1917 the amount of liability under the contract. We are of opinion that the case comes within the rule laid down in Uncasville Mfg. Co. v. Commissioner of Internal Revenue (C. C. A.) 55 F. (2d) 893, 895, where, in dealing with a somewhat similar situation, the court said: 'We think that the case falls within U. S. v. Anderson, 269 U.S. 422, 46 S.Ct. 131, 70 L.Ed. 347, not Lucas v. American Code Co., 280 U.S. 445, 50 S.Ct. 202, 74 L.Ed. 538. All the facts upon which the calculation depended had been fixed before the expiration of the year 1918. Differences could arise, and did, as to the amount of the company's income for that year, but they were due to the proper appraisal of its property, and possible disputes as to the meaning of the law. The computation was uncertain, but its basis was unchangeable; it was unknown, not unknowable on December 31, 1918.' See, also, Acme Coal Co. v. United States, 44 F. (2d) 95, 70 Ct. Cl. 696. As the court stated in Lucas v. American Code Co., supra, 'since the company kept its books on the accrual basis, the mere fact that the exact amount of the liability had not been definitely fixed in 1919 would not prevent the deduction, as a loss of that year, of the amount later paid.'
The payment in question of $713,558.10 was admittedly a part of the consideration received on account of the 1917 sale, and, as indicated above, we are of opinion that it accrued in 1917. It was therefore an item to be considered in arriving at gain or loss in 1917 on account of the 1917 sale. It therefore follows that it was improper to include such amount as income for 1918, and the Commissioner of Internal Revenue erred in rejecting the claim for refund.
Judgment will be entered in favor of plaintiffs for $85,232.17, with interest as provided by law. It is so ordered.
WILLIAMS and GREEN, Judges, concur.
WHALEY, Judge, dissents.
BOOTH, Chief Justice, took no part in the decision of this case on account of illness.