Opinion
Docket Nos. 75197-75199.
Filed December 30, 1960.
1. Held, petitioners are liable as transferees of a corporation of which they were stockholders and which was dissolved in 1955 and which, under the resolution of dissolution, distributed all of its assets to petitioners and was left with no assets with which to pay the tax liabilities determined by the Commissioner against the corporation for taxable years prior to the distribution of its assets. Held, further, it was not necessary for the Commissioner to first issue a deficiency notice to the transferor corporation before issuing notices of liability to the transferees, the transferor corporation having been dissolved and left with no assets.
2. The transferor corporation was the owner of three contracts on which the work which it was required to perform had been completed but upon which settlement had not been made at the time its board of directors decided to dissolve the corporation. These contracts were sold to a purchaser for an agreed price and assigned to him during the process of liquidation. Held, profits realized by the corporation from such sale are excluded from the transferor's taxable income under section 337, I.R.C. 1954.
3. The transferor corporation in 1955, in liquidation, transferred one of its construction contracts to petitioners. It had performed certain work on the contracts both in 1954 and 1955 prior to its transfer and had charged the cost of the work performed to expenses and showed a loss on the contract for each of the taxable years. The contract turned out to be a profitable one. Held, the Commissioner is sustained in allocating a portion of the profits of the contract realized by the transferees to the transferor corporation.
4. The Commissioner made certain adjustments to the income of the transferor corporation for its taxable year 1954 and for the period January 1 to December 7, 1955, by the disallowance of a portion of the depreciation claimed by the transferor corporation on its returns. Held, the Commissioner is sustained in these depreciation adjustments.
William H. Kinsey, Esq., and James R. Moore, Esq., for the petitioners.
John D. Picco, Esq., for the respondent.
These proceedings involve the transferee liability of petitioners for deficiencies due and unpaid in income tax and additions thereto of Kuckenberg Construction Co., a dissolved corporation, in the amounts and for the taxable years as follows:
Year Deficiency Addition to tax, sec. 6653(a) 1954 .............................. $280,658.62 $14,032.93 1955 .............................. 183,123.71 9,156.19 In the statutory notices mailed to the respective petitioners, respondent determined the extent of each petitioner's transferee liability to be as follows: Docket Petitioner Transferee No. liability 75197 Henry A. Kuckenberg ....................... $486,971.45 75198 Harriet Kuckenberg ........................ 273,395.90 75199 Lawrence W. Kuckenberg .................... 272,281.99 These proceedings have been consolidated.In the transferee notice mailed to Henry A. Kuckenberg, Transferee, Docket No. 75197, it is stated in part as follows:
The above-mentioned amount represents your liability as a transferee of assets of Kuckenberg Construction Co., Portland, Oregon, for deficiencies in income tax due from Kuckenberg Construction Co. for the taxable years 1954 and January 1 to December 7, 1955.
It is determined that part of the corporation's underpayment in income tax is due to negligence or intentional disregard of rules and regulations (but without intent to defraud). The 5 percent penalty as provided by section 6653(a) of the Internal Revenue Code of 1954 has therefore been asserted.
* * * * * * *
The deficiencies in income tax and penalties due from Kuckenberg Construction Co. have been determined as follows:
[Here follows in detail an explanation of the adjustments which the Commissioner made to the net income as disclosed by the returns of the Kuckenberg Construction Co.]
Similar statements and adjustments were made in the transferee notices mailed to the other two petitioners.
At issue is petitioners' liability as transferees. Petitioners have denied any and all transferee liability. Also at issue is the liability of Kuckenberg Construction Co. for the asserted deficiencies against it. Redetermination of the Kuckenberg Construction Co. deficiencies is pertinent only if the transferee issue is decided adversely to petitioners. Kuckenberg Construction Co. is not a party to any of these consolidated proceedings. It was dissolved and completely liquidated in December 1955.
At the beginning of the hearings on March 12, 1960, in Portland, Oregon, petitioners filed a "Motion for Judgment on the Pleadings." After arguments were heard at the hearing, the Court granted permission for respondent to file opposition to the motion and respondent filed such opposition on March 25, 1960. The parties were directed to file briefs covering their respective positions with respect to petitioners' motion for judgment on the pleadings, as well as to all other issues raised by the pleadings. This has been done. After a careful consideration of the motion and respondent's opposition thereto, it is believed that such motion should be denied.
The issues raised by the pleadings will be decided on their merit.
The issues which remain for us to decide may be stated as follows:
Transferee issue. — Are petitioners liable as transferees for the asserted income tax deficiencies of Kuckenberg Construction Co.?
The issues raised by the pleadings as to the tax liability of the transferor, the Kuckenberg Construction Co., are as follows:
(1) Whether proceeds of $100,000 and $227,000, received by the corporation from the sale of three construction contracts in 1954 after its dissolution and liquidation had been determined upon were includible in corporate income for 1954 and 1955, respectively, or were nontaxable by reason of section 337 of the 1954 Code.
(2) Whether the corporation realized taxable income from a contract known as the Booth Ranch contract of $41,091.88 in 1954 and of $7,454.09 in its last taxable period in 1955 in lieu of reported losses of $50,019.05 and $11,365.25, respectively, requiring adjustments to corporate income in those years aggregating $109,930.27.
(3) Whether the corporation claimed excessive depreciation deductions of $68,898.74 and $1,927.38 in 1955.
FINDINGS OF FACT.
An extensive stipulation of facts, together with many exhibits thereto, was filed at the hearing. These are incorporated herein by this reference.
Petitioners are individuals residing in Portland, Oregon. During the periods herein involved, petitioners Henry A. Kuckenberg and Harriet Kuckenberg, husband and wife, and petitioner Lawrence W. Kuckenberg and his wife, Edna Kuckenberg, filed joint income tax returns with the district director of internal revenue for the district of Oregon.
During the periods involved, Kuckenberg Construction Co., hereinafter also referred to as the corporation or transferor, was an Oregon corporation, incorporated under the laws of Oregon on December 6, 1949, with principal office and place of business in Portland, Oregon. Petitioners were the officers and directors of the corporation.
From its incorporation in 1949 until January 14, 1955, the corporation was engaged in the heavy construction business, consisting primarily of roadbuilding and related work.
The corporation employed the cash basis method of accounting and its Federal tax returns were filed on the cash basis. Such returns were filed on the basis of calendar years, except the final return of the corporation which covered the period January 1, 1955, through December 7, 1955.
Issue of Transferee Liability.
On December 17, 1954, the board of directors of the corporation adopted, and the stockholders approved, a plan of complete liquidation of the corporation, which plan provided in part, as follows:
WHEREAS, it has been considered desirable that this corporation, Kuckenberg Construction Co. * * * shall be dissolved and completely liquidated pursuant to this plan of complete liquidation.
NOW THEREFORE, the corporation shall be dissolved and completely liquidated in accordance with the provisions hereof * * *.
1. The below-identified construction contracts of this corporation shall be sold for such price and to such purchaser as may be determined by the officers of this corporation:
Oregon State Highway Contract No. 3984, Section Clatskanie to Delena, Columbia River Highway, Columbia County, consisting of grading and bridge construction.
Contract with the City of Portland, dated April 8, 1952 providing for the construction of Bull Run Conduit No. 4.
Contract with Multnomah County Drainage District and Sandy Drainage District (Reynolds Metals Company) for the construction of earth dike near Reynolds Troutdale plant.
* * * * * * *
3. After the contracts referred to in Paragraph 1 have been sold and the full purchase price for the contracts has been paid to the corporation or satisfactory arrangements for such payment have been made, the officers shall report same to board of directors and as soon as practicable thereafter the board of directors shall authorize liquidating distributions whereunder all of the assets of the corporation (except the right to receive the balance of the purchase price for the construction contracts identified in Paragraph 1 in the event that all of such purchase price has not been received at the time of any distribution), subject to all of the liabilities of the corporation, shall be distributed pro rata to the stockholders of the corporation. Upon receipt of the final liquidating distribution of the corporation, the stockholders shall surrender to the corporation all of the capital stock of the corporation which stock shall be cancelled * * *
Following the adoption of the plan of complete liquidation, the corporation executed and duly filed with the corporation commissioner of Oregon a statement of intent to dissolve, pursuant to the provisions of the Oregon Revised Statutes, section 57.536. The Oregon Revised Statutes will hereinafter be referred to as O.R.S. On January 25, 1955, the corporation filed with the Commissioner the return of information required under section 6043 of the 1954 Code.
The liquidation of the corporation was accomplished through two liquidating distributions. The first liquidating distribution occurred on January 14, 1955; the second and final liquidating distribution occurred on November 30, 1955. The assets comprising the liquidating distributions were distributed pro rata to petitioners Henry A. Kuckenberg, Harriet Kuckenberg, and Lawrence W. Kuckenberg, according to their stock ownership, except for a Cadillac automobile having a fair market value of $1,113.92, transferred to Harriet.
The assets comprising the liquidating distributions constituted all of the property and rights to property of the corporation, including the assets set up in the balance sheet and ledger accounts of the corporation; proceeds from the sale of the three construction contracts described in paragraph 1 of the plan of complete liquidation; and a construction contract in process known as the Booth Ranch contract.
The fixed and other operating assets used in the corporate business were appraised upon dissolution of the corporation and distributed to the petitioners on the basis of their fair market value.
The assets received by the petitioners upon liquidation of the corporation were transferred by them to the Kuckenberg partnership, which continued operation of the business previously carried on by the corporation.
On the partnership's books the assets transferred by the petitioners on January 14, 1955, and November 30, 1955, were recorded as an additional contribution to capital and reflected in the partnership's net worth on December 31, 1955.
The value of the assets distributed in liquidation of the corporation is stipulated as follows:
The aggregate value of the January 14, 1955 liquidating distribution was not less than $1,110,413.37. No liabilities were taken over or assumed by the distributees in connection with such liquidating distribution. All liabilities shown on the books of the corporation in the year 1955 were paid prior to the November 30, 1955 distribution. The assets comprising the November 30, 1955 liquidating distribution had a fair market value at the time of the distribution equal to the aggregate book value thereof. No assets were retained by the corporation after the final liquidating distribution on November 30, 1955. * * *
It is agreed by the parties that of the value of the assets distributed in liquidation, 60 per cent should be attributed to Henry A. Kuckenberg, 20 per cent to Harriet Kuckenberg, and 20 per cent to Lawrence W. Kuckenberg. The Cadillac automobile having a value of $1,113.92 which was distributed to Harriet should be attributed to her alone.
The liquidating distributions made to the petitioners were without consideration and left the corporation without any assets after December 7, 1955. On December 7, 1955, the corporation filed articles of dissolution with the Oregon Corporation Commissioner pursuant to the provisions of O.R.S., section 57.575. On the same date the corporation commissioner issued its certificate of dissolution.
Issues as to Tax Liability of Transferor Corporation.
1. Sale of contracts. — The three construction contracts identified in paragraph 1 of the plan of complete liquidation, hereinafter collectively referred to as the three construction contracts, involved the following:
Oregon State Highway Contract. No. 3984, Section Clatskanie to Delena, Columbia River Highway, Columbia County, consisting of grading and bridge construction.
Bull Run Contract. Contract with the City of Portland, dated April 8, 1952, providing for the construction of Bull Run Conduit No. 4.
Drainage District Contract. Contract with Multnomah County Drainage District and Sandy Drainage District (Reynolds Metals Company) for the construction of an earth dike near Reynolds Troutdale plant.
On December 27, 1954, pursuant to the plan of complete liquidation, the corporation sold and assigned the three construction contracts to David B. Simpson for $327,000, payable in installments. Simpson, the purchaser of the three construction contracts, was not in the construction business; he was a real estate agent and operator.
The first installment payment of $100,000 was received by the corporation on December 30, 1954. The payment was recorded on the corporate books as a debit to cash and as a credit to a ledger account styled "Sale of Contracts." The second and final installment payments in the amounts of $100,000 and $127,000, respectively, were received by the corporation on January 17, 1955, and January 24, 1955. The installment payments, aggregating $327,000 were journalized on the corporate books and reported on the income tax returns as received in a nontaxable transaction, with the following explanation: "Gain from sale of property which gain is not recognized because of the applicability of section 337."
2. Booth Ranch contract. — In addition to the three construction contracts sold to Simpson described above, the corporation, at the time of its planned liquidation, was working on a contract known as the Booth Ranch contract, involving grading, oiling, and bridge construction in Columbia County, Oregon.
The corporation commenced work on the Booth Ranch contract on or about October 7, 1954, and performed work thereunder until January 14, 1955. By November 10, 1954, the corporation had finished 20 per cent of the clearing and grubbing, and other work done by that date, including 10 cubic yards of drainage excavations, 10 cubic yards of concrete, and 4,800 pounds of metal reinforcement. The corporation continued to work on the project until January 14, 1955.
The corporate costs incurred on the Booth Ranch contract aggregated $74,018.05. Of this amount, $62,652.80 was incurred in 1954 and $11,365.25 in 1955. On January 14, 1955, the contract was assigned to the partnership of petitioners for completion. The partnership paid no consideration for the contract. Thereafter the work was performed by the partnership. The project was completed in 1957.
In his notices of transferee liability the respondent determined, because of the liquidation of the corporation and in order clearly to reflect the corporate income, that the profits from the Booth Ranch contract should be allocated between corporation and partnership, based upon a percentage of completion method of computation.
Respondent further determined, upon applying the percentage-of-completion method of computation which he used to the incomplete information available at the time, that the contract profits of $216,720.38 which he arrived at were taxable to the corporation and the partnership in the following amounts:
Year Corporation Partnership 1954 ........................... $36,203.14 1955 ........................... 6,566.63 $173,950.61 ---------- ----------- 42,769.77 173,950.61The Booth Ranch contract was completed in 1957 and the profits therefrom aggregated $361,722.42, reported by the corporation and the partnership as follows:
Year Receipts Expenses Profit (loss) Corporation 1954 ................... $12,633,75 $62,652.80 ($50,019.05) 1955 ................... None 11,365.25 (11,365.25) Partnership 1955 ................... 579,133.76 301,029.08 278,104.68 1956 ................... 316,125.71 168,435.45 147,690.26 1957 ................... 5,347.50 8,035.72 (2,688.22) ---------- ---------- ---------- Total ............ 913,240.72 551,518.30 361,722.42 Respondent's percentage-of-completion method of computation, when applied to all of the receipts and expenses of the contract completed in 1957, discloses that the profits from the Booth Ranch contract in the amount of $361,722.42 were as between the corporation and the partnership as follows: Year Corporation Partnership Total 1954 .................... $41,091.88 $41,091.88 1955 .................... 7,454.09 $205,848.38 213,302.47 1956 .................... 109,317.81 109,317.81 1957 .................... (1,989.74) (1,989.74) ---------- ----------- ---------- 48,545.97 313,176.45 361,722.42 3. Depreciation. — The corporation claimed depreciation deductions of $155,726.74 and $5,478.08 in its income tax returns for 1954 and the taxable period from January 1, 1955, to December 7, 1955. In his notices to the transferees respondent determined that the depreciation taken by the corporation was excessive and disallowed $68,898.74 and $1,927.38, respectively, of the amounts claimed in the returns for 1954 and the last taxable period in 1955. These adjustments were explained in detail in schedules attached to the notices of transferee liability.The depreciable assets for which the depreciation adjustment was made by respondent consisted primarily of the assets included in the liquidating distribution to the petitioners on January 14, 1955, and transferred by them to the partnership on the same date. The depreciable assets consisted largely of used equipment and machinery and other operating assets. On January 14, 1955, they had a depreciated cost basis of approximately $377,000, and a value in excess of $1 million. The corporation employed in the periods here involved the straight line method of depreciation on its assets. This method was consistent with that used in prior years. The useful life of the assets as used in these depreciation computations was generally estimated from 3 to 4 years.
In his transferee notices respondent determined that the depreciable assets had a remaining useful life of 4 to 5 years, depending on the particular asset involved. When the assets were transferred by petitioners to the partnership on January 14, 1955, they were reappraised by petitioners and the life of each asset redetermined and extended for an additional 3 or 4 years commencing from January 14, 1955. Thereafter, the assets were depreciated by the partnership on that basis.
At the time of preparing the income tax returns of the corporation for 1954 and its last taxable period in 1955, its president, Henry A. Kuckenberg, and its accountant had knowledge of the reappraisal made of the depreciable assets on January 14, 1955. Although the corporation's president and its accountant knew that the depreciable assets had a longer useful life than originally estimated on the returns of the corporation for 1954 and 1955, no adjustment was made on the corporate books or on the returns of the corporation to reflect the extended life of the assets.
OPINION.
The petitioners contend that they are not liable as transferees of the corporation. Both parties are in agreement that the burden of proof is on respondent to prove transferee liability of petitioners. Respondent contends that he has met that burden of proof and petitioners contend that he has not done so.
Petitioners contend that under the law as interpreted by the Supreme Court in Commissioner v. Stern, 357 U.S. 39, whether one is liable as a transferee is determined under State law. Respondent concedes the force of the Stern decision and makes no contention but that Oregon State law governs as to whether petitioners are liable as transferees. Respondent contends that under the facts in these consolidated proceedings petitioners are liable as transferees both at law and in equity under Oregon State law. Respondent's contention that petitioners are liable at law is based upon the fact that the plan of complete liquidation of the corporation provided that the assets of the corporation should be distributed to the stockholders "subject to all of the liabilities of the corporation, shall be distributed pro rata to the stockholders of the corporation." Respondent argues that because of this language used in the resolution of liquidation, when petitioners accepted the assets transferred to them, they therefore assumed and agreed to pay all the liabilities of the corporation, including its tax liabilities to the Federal Government. It is doubtless true that if under the language above quoted petitioners assumed and agreed to pay all the liabilities of the corporation, including the tax deficiencies here involved, they would be liable at law as transferees. But we need not decide whether, under the language above quoted, petitioners became liable at law as transferees for it seems clear to us that under the facts herein the petitioners are liable in equity as transferees.
The corporation was dissolved in 1955 and distributed all of its assets to petitioners without consideration. The value of these assets was far in excess of the deficiencies which the Commissioner is claiming in these proceedings as unpaid by the corporation. It is true that those deficiencies were not known at the time of the distribution of the assets. But that fact makes no difference. If petitioners are transferees in equity they are liable for the deficiencies in tax due by the corporation for periods prior to the distribution even though unknown at that time. Petitioners, in their brief, argue that a transferee liability in equity is secondary and that because of that fact the Commissioner must first proceed against the corporation. That is undoubtedly true as a principle of equity. If the corporation here had been still in business and possessed of assets of its own, the Commissioner would first have had to proceed against the corporation and exhaust his remedies there before proceeding against petitioners as transferees. It seems unnecessary to further discuss that point because we do not understand that the Commissioner contends otherwise. But the corporation was not in business. It had ceased business in 1955 and had distributed all of its assets to its stockholders (petitioners) and had been dissolved. It is true that under Oregon law it could, for a period of time, in winding up its affairs still sue and be sued, but we think that makes no difference here. Of what avail would a suit be against a corporation which had been dissolved and left with no assets? Equity does not require a futile thing and if a corporation has been dissolved and left without any assets equity does not require a proceeding against the corporation before the creditor can proceed against the transferee. In United States v. Fairall, 16 F.2d 328, the court, among other things, said:
The rule that you must get judgment and issue execution against a debtor as a condition precedent to following his assets into the hands of transferees is not absolute. If it is impossible to get judgment, or if, when you get it, it is manifestly useless, equity does not insist upon such an idle formality. [Citing cases.]
Both parties cite and comment on several Oregon cases which deal with transferee liability in equity. We find it unnecessary to discuss and comment upon these Oregon cases. Suffice it to say that we have examined them and from such examination we are convinced that the trust fund doctrine exists in Oregon and has been recognized by the Supreme Court of that State in numerous cases. The trust fund doctrine in Oregon has been interpreted by the Supreme Court of that State, as we understand its decisions, in much the same manner as the Second Circuit interpreted it in United States v. Fairall, supra. Notwithstanding that fact, one of the points which petitioners strongly press in their brief is that the Commissioner cannot enforce transferee liability under section 6901(a) of the 1954 Code until he has first issued a deficiency notice to the dissolved corporation under section 6212 of the 1954 Code. Petitioners, in their brief, give the names of a long line of cases where the question of transferee liability was involved and point out that in each of those cases a deficiency notice had been mailed to the transferor prior to the mailing of a liability notice to the transferee. But the fact that that was done in those cases does not establish the principle that, in a situation where the transferor corporation has been dissolved and all of its assets distributed to its stockholders, the Commissioner must first issue a deficiency notice to the transferor before issuing a liability notice to the transferee.
We decided to the contrary in W. W. Cleveland, 28 B.T.A. 578 (1933), affd. 77 F.2d 184 (C.A. 5). In that case the Board of Tax Appeals rejected this argument and concluded that the issuance of a notice of deficiency against the corporate taxpayer was unnecessary. It held that the Government could enforce the liability of the transferee-stockholders directly and at once. In so holding the Board stated as follows:
In our opinion the first point in petitioners' contention, as above set out, is without merit. A deficiency is not created by any act of the respondent, but by the facts and the legal significance thereof as set out in the taxpayer's income tax return. The so-called "60-day letter" [the present 90-day letter] is no more than notice to the taxpayer that the amount of a deficiency disclosed by its return has been determined under the applicable statute. In our opinion no assessment, notice, or other act of the respondent is necessary to establish liability for income taxes. We think that any deficiency existing at the date of a transfer of assets is a liability against such assets under the trust fund theory. United States v. Garfunkel, 52 F.2d 727; Helen Dean Wright, 28 B.T.A. 543.
The question here raised by the petitioners is material only as to whether the respondent exhausted all means to collect the unpaid taxes from the taxpayer before he proceeded against its stockholders as transferees of assets impressed with a trust in favor of the revenue. * * * At March 4, 1932, the date at which respondent determined the liabilities of petitioner under section 311 of the Revenue Act of 1928, the taxpayer had no assets, and the respondent was without any means to enforce the collection of the deficiencies in question. In these circumstances it is clear that liabilities against the petitioners were properly determined * * *
We hold against petitioners as to this contention. Of course, it goes without saying that when the Commissioner does mail to a transferee a notice of liability under section 6901, 1954 Code, he must inform the transferee of the extent and nature of the tax deficiency which he is claiming against the transferor. This the Commissioner has done in the instant case.
In his notice of transferee liability to Henry A. Kuckenberg, Docket No. 75197, the Commissioner stated, among other things, as follows:
You are advised that the determination of the income tax liability of Kuckenberg Construction Co., * * * Transferor, for the taxable years 1954 and January 1 to December 7, 1955, discloses deficiencies in the respective amounts of $280,658.62 and $183,123.71 and section 6653(a) penalties in the respective amounts of $14,032.93 and $9,156.19, as shown in the statement attached. The total of the deficiencies in income tax and penalties, plus interest as provided by law, represents your liability as a transferee of assets of said corporation.
In accordance with the provisions of existing internal revenue laws, notice is hereby given of the deficiencies mentioned.
There is attached to this notice of transferee liability a detailed statement of the unpaid tax deficiencies which the Commissioner claims is owing and unpaid by the transferor corporation for the year 1954 and the period January 1 to December 7, 1955. The same facts as stated above in the case of Henry A. Kuckenberg, Transferee, are present in the cases of the other two petitioners.
When the transferee appeals from the notice of transferee liability asserted by the Commissioner against him, the burden of proof is on the Commissioner to establish transferee liability and the burden of proof is on the transferee to show error in the determination of the deficiency against the transferor. It is clear to us, because of the facts stated in our Findings of Fact, that the Commissioner has met his burden of proof in showing that petitioners are liable as transferees. As to this issue of transferee liability, we decide in favor of the Commissioner.
In view of this decision as to transferee liability, we shall now take up the issues which have been raised by the pleadings with respect to the tax liability of the transferor corporation during the taxable years involved.
1. Sale of contracts. — In each of the taxable periods of the transferor corporation the Commissioner has added to the net income disclosed by the returns of the transferor corporation, the following "(a) Construction contract income $359,446.42." The above adjustment is explained by the Commissioner in his notice to each of the transferees, as follows:
(a) It is determined, because of the liquidation of Kuckenberg Construction Co., that there should be taxed to the corporation, in its last taxable periods, earnings of $359,446.42 on three certain construction contracts, under the provisions of section 446(b) of the Internal Revenue Code of 1954. As there now exists an uncertainty as to the proper allocation of such additional income between the years 1954 and January 1 to December 7, 1955, it has been found necessary, in order to protect the Government's interest, to increase the taxable income of the corporation for both the years 1954 and January 1 to December 7, 1955 by the total $359,446.42.
There is now no longer any issue in these proceedings concerning the amount of the gain from the sale by the corporation of three of its construction contracts to David B. Simpson or as to the time when such amounts were received. The Commissioner in his brief states:
Because under the evidence adduced in these proceedings it would appear that the transfer of the contracts to Simpson represented an arm's length transaction, respondent no longer presses the argument that the amount of ordinary income taxable to the corporation was $359,446.42. Instead respondent now urges, for the reasons stated forthwith, that the amount of ordinary income taxable to the corporation with respect to the transaction in question is limited to the proceeds of sale in the aggregate amount of $327,000, taxable as received by the corporation, that is, $100,000 in 1954 and the balance of $227,000 in 1955.
Petitioners, although they concede that $327,000 gain was realized by the corporation from the sale of the three contracts to Simpson, nevertheless contend that such gain is not to be recognized for tax purposes to the transferor corporation in process of liquidation because of the provisions of section 337, 1954 Code. That portion of section 337 upon which petitioners rely is printed in the margin. With reference to the sale by the transferor corporation of these three contracts to Simpson it has been stipulated as follows:
SEC. 337. GAIN OR LOSS ON SALES OR EXCHANGES IN CONNECTION WITH CERTAIN LIQUIDATIONS.
(a) GENERAL RULE. — If —
(1) a corporation adopts a plan of complete liquidation on or after June 22, 1954, and
(2) within the 12-month period beginning on the date of the adoption of such plan, all of the assets of the corporation are distributed in complete liquidation, less assets retained to meet claims.
then no gain or loss shall be recognized to such corporation from the sale or exchange by it of property within such 12-month period.
(b) PROPERTY DEFINED. —
(1) IN GENERAL. — For purposes of subsection (a), the term "property" does not include —
(A) stock in trade of the corporation, or other property of a kind which would properly be included in the inventory of the corporation if on hand at the close of the taxable year, and property held by the corporation primarily for sale to customers in the ordinary course of its trade or business,
(B) installment obligations acquired in respect of the sale or exchange (without regard to whether such sale or exchange occurred before, on, or after the date of the adoption of the plan referred to in subsection (a)) of stock in trade or other property described in subparagraph (A) of this paragraph, and
(C) installment obligations acquired in respect of property (other than property described in subparagraph (A)) sold or exchanged before the date of the adoption of such plan of liquidation.
On December 27, 1954, pursuant to the plan of complete liquidation, the corporation sold, transferred and assigned the three construction contracts to a third party (David B. Simpson) for the total purchase price of $327,000. Said purchase price was received by the corporation in installments of: $100,000 on December 30, 1954, $100,000 on January 17, 1955, and $127,000 on January 24, 1955. Such amounts received by the corporation as consideration for the sale, transfer and assignment of the three construction contracts, were entered on the books of the corporation.
It seems to us that these facts, coupled with other facts stated in our findings, bring the gain realized from the sale of the three contracts within the nonrecognition provisions of section 337 of the 1954 Code. It certainly cannot be contended, we think, that contracts such as these sold to Simpson do not constitute property. Simpson certainly must have purchased them as property from which he expected to make a profit. The uncontradicted evidence is that Simpson realized a profit of $32,446.42 from the transaction. This profit would, of course, be taxable to him and not to the corporation. The property which these contracts represented, it seems to us, is not excluded from the nonrecognition of gain or loss provisions of section 337(b), printed in the margin.
Of the several cases cited by respondent in his brief in support of his position, we find only one which deals with section 337. The other cases cited by respondent seem to us to have no relevancy to the question we have here to decide. That one case which deals with section 337 is Central Building Loan Association, 34 T.C. 447. We do not think that case is controlling here. In the Central Building Loan Association case we had a finding of fact which reads:
On the date of sale of its assets to Guaranty, interest had been earned in the amount of $30,138.03, but was not then due and payable, upon outstanding note obligations issued to petitioner. The earned, but uncollected, interest was not separately reported as taxable income by petitioner in its 1956 return, but was included in the amount of $171,351.59, which was shown as nontaxable gain in a schedule attached to its return.
The respondent has recomputed petitioner's income by adding the earned, but uncollected, interest to taxable income.
In the course of our opinion denying taxpayer's claim that the $30,138.03 in interest fell within the nonrecognition provisions of section 337, we said:
The parties are in agreement that the amount of $171,351.59 shown by petitioner in its return as nontaxable gain upon the sale of its assets includes the interest item in controversy in the amount of $30,138.03. We find therefore that on the date of its receipt of the former figure it was actually paid interest in the latter amount. In lieu of a "sale of the right to receive interest," there was effectuated at that time an actual collection of interest by petitioner. Respondent was not compelled to treat the interest as accrued for it was actually received. Because the nonrecognition of gain or loss under section 337(a) is with respect only to the sale or exchange of property, it can have no application to the transaction here at issue for no sale took place and it is not contended that the receipt and collection of interest represented an exchange of property. [Emphasis supplied.]
It seems manifest to us that the facts of the instant case with respect to the sale of the three contracts to Simpson are distinguishable from the collection of interest which was involved in the Central Building Loan Association case. We hold in favor of petitioners on this issue with respect to the sale of the three contracts.
2. Booth Ranch contract. — In the liability notices to petitioners as transferees the Commissioner added to the net income as disclosed on the return of the transferor corporation "(b) Booth ranch contract $86,222.19." This adjustment was explained by the Commissioner in his notice as follows:
(b) It is also determined, because of the liquidation of the Kuckenberg Construction Co., that there should be taxed to the corporation in 1954 accruable earnings of $86,222.19 from a certain Booth ranch contract, based upon a percentage of completion method of computation.
The transferor corporation adopted its plan of liquidation on December 17, 1954. It was then performing work on the Booth Ranch contract. On January 14, 1955, it distributed to the petitioners most of the corporate assets, including the operating assets of the business. These assets were immediately transferred to petitioners' partnership which continued operation of the construction business. At the same time the Booth Ranch contract was assigned through petitioners to the partnership for completion. Thereafter the work was performed by the partnership. The project was completed in 1957.
The Booth Ranch contract was profitable. The gross receipts came to $913,240.72 and the expenses were $551,518.30, leaving a net profit of $361,722.42. The corporation incurred costs of $74,018.05 on work performed by it on the contract, but only received $12,633.75 of the total gross receipts. This amount it reported on its 1955 return. The partnership expended $477,500.25 but in turn received $900,606.97 of the gross receipts. Despite the substantial profits ultimately made on the contract the corporation reported losses therefrom of $50,019.05 and $11,365.25, respectively, for 1954 and the last taxable period in 1955.
The Commissioner determined on these facts that the losses reported by the corporation did not truly reflect its income from the contract. In his notices to petitioners the Commissioner allocated the profits from the contract between corporation and partnership in proportion to the work done by them. Profits were allocated to the corporation by computing the ratio of the costs incurred to January 14, 1955, the date of liquidation, to the total contract costs, and then applying that ratio to the total profits from the contract.
In determining the deficiencies of the transferor corporation in the notices to petitioners as transferees, respondent included in corporate income $36,203.14 and $6,566.63 for 1954 and the last taxable period in 1955, respectively, as income earned by the corporation from the contract. Respondent's position is that the strict application of the cash basis method of accounting in these cases does not clearly reflect the income realized by the corporation from the Booth Ranch contract, and that he had the right under section 446 of the 1954 Code to use a method which would properly reflect that income. The right to do this is the primary question presented here. Section 446 upon which respondent relies is printed in the margin.
SEC. 446. GENERAL RULE FOR METHODS OF ACCOUNTING.
(a) GENERAL RULE. — Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.
(b) EXCEPTIONS. — If no method of accounting has been regularly used by the taxpayer, or if the method used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary or his delegate, does clearly reflect income.
(c) PERMISSIBLE METHODS. — Subject to the provisions of subsections (a) and (b), a taxpayer may compute taxable income under any of the following methods of accounting —
(1) the cash receipts and disbursements method;
(2) an accrual method;
(3) any other method permitted by this chapter; or
(4) any combination of the foregoing methods permitted under regulations prescribed by the Secretary or his delegate.
Respondent cites as authority for his allocation of a portion of the profits from the Booth Ranch contract to the transferor corporation, Jud Plumbing Heating, Inc., 5 T.C. 127, affd. 153 F.2d 681 (C.A. 5), and Standard Paving Co., 13 T.C. 425, affd. 190 F.2d 330 (C.A. 10). While the facts in the instant case are not the same as in the two above-cited cases, we think they do support in principle the allocation which respondent has made.
In determining the deficiencies, respondent included in corporate income $36,203.14 and $6,566.63 for 1954 and the last taxable period in 1955, respectively, as income earned by the corporation from the contract, based upon the theory that the contract had been completed in 1955. The larger amounts of $41,091.88 and $7,454.09 now being asserted by respondent as the income allocable to the corporation are based upon evidence produced at the hearing showing that the contract was completed in 1957. According to the revised allocation now urged by respondent, the total profits from the Booth Ranch contract in the amount of $361,722.42 are taxable in the amount of $48,545.97 to the corporation and $313,176.45 to the partnership. We think the facts in the record justify respondent's revised allocation.
On this issue we sustain respondent.
3. Depreciation. — In his determination of the deficiencies of the transferor corporation as made in his notices to the transferees, the Commissioner has added to the net income as reported on the return filed by the transferor corporation for the year 1954 "(d) Excessive depreciation $68,898.74." This determination is explained in the notices as follows:
(d) It is determined that the depreciation deduction claimed by the corporation in the year 1954 was overstated by $68,898.74. See the attached depreciation schedule for details of this computation.
He made the same kind of adjustment for the taxable period of the corporation, January 1 to December 7, 1955, except the amount for that period was $1,927.38 and the adjustment was explained in the notices in the same manner as for 1954.
With respect to this issue, the depreciable assets consisted primarily of the assets included in the liquidating distribution to the petitioners and simultaneously transferred by them to the partnership on January 14, 1955. Both the corporation and the partnership employed the straight line method of depreciation. On January 14, 1955, the assets were reappraised by the partnership to which the petitioners assigned them and the life of each asset redetermined and extended for an additional 3 years for some of the assets and 4 years as to other of the assets, commencing from January 14, 1955.
The corporation filed its tax return for 1954 on May 20, 1955, 4 months after the transfer of the assets to the petitioners and their simultaneous transfer to the partnership. The final return of the corporation and the information return of the partnership for 1955 were filed simultaneously on July 12, 1956. The assets were shown in the depreciation schedules attached to the corporate returns as expiring in 1954 and 1955. At the time of preparing the corporate returns the petitioners and the corporation's accountant had knowledge of the reappraisal made of the assets on January 14, 1955. Although the petitioners and the accountant knew that the assets had a longer useful life than originally estimated in the corporate returns, no adjustment was made to reflect the extended life of the assets.
Respondent contends that, on the basis of the record, it would be unreasonable to conclude that the Commissioner erred in determining that the depreciable property had a remaining useful life in 1954 and 1955 to the extent which he has determined. So far as we can see there is no evidence to show error in such a determination. Petitioners offered no evidence as to the remaining useful life of the assets.
Petitioners' principal contention with respect to this issue of depreciation is that since the corporation had used the straight line method of depreciation in prior years and used it in the taxable periods here involved, the Commissioner had no right to change it. Undoubtedly the straight line method of taking depreciation is one of the methods which section 167(b) of the 1954 Code recognizes as proper for a taxpayer to use. That does not mean, however, that the Commissioner is bound to recognize in any one year the same amount as the taxpayer was permitted to deduct in a prior year. Section 1.167(a)-1, Income Tax Regs., reads as follows:
DEPRECIATION IN GENERAL. — (a) Reasonable allowance. — Section 167((a) provides that a reasonable allowance for the exhaustion, wear and tear, and obsolescence of property used in the trade or business or of property held by the taxpayer for the production of income shall be allowed as a depreciation deduction. The allowance is that amount which should be set aside for the taxable year in accordance with a reasonably consistent plan ( not necessarily at a uniform rate), so that the aggregate of the amounts set aside, plus the salvage value, will, at the end of the estimated useful life of the depreciable property, equal the cost or other basis of the property as provided in section 167(f) and § 1.167(f)-1. * * * [Emphasis supplied.]
We think under the above-quoted regulation, which we think is a valid regulation, the Commissioner had the authority to make the changes which he did make in the depreciation deductions which the transferor corporation took on its returns. We find nothing in the record which would justify us in holding that he erred in so doing.
We sustain respondent as to the depreciation issue.
In the stipulation of facts filed by the parties it was agreed by the parties that,
The travel expenses of $16,416.67 specified in Item (c) of the statutory notices as an unallowable deduction for 1954 constitutes an allowable deduction to the extent of $5,916.67, and the $10,500.00 balance is an unallowable deduction for 1954 or for any other period.
The negligence penalty under section 6653(a) of the 1954 Code is not applicable against the corporation for 1954 or for the period from January 1 through December 7, 1955.
Effect will be given to these agreements in a computation under Rule 50.
Decisions will be entered under Rule 50.