Opinion
Docket No. 33036.
1953-06-23
NATIONAL BELLAS HESS, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
George R. Sheriff, Esq., for the petitioner. Rigmor O. Carlsen, Esq., for the respondent.
1. In 1932 the petitioner acquired certain properties from its predecessor in a nontaxable exchange under section 112(b)(4) of the Revenue Act of 1932 pursuant to a reorganization as defined in section 112(i)(1)(B) of that Act. Held, the basis of the properties to the petitioner for equity invested capital purposes is the predecessor's basis. Section 718(a)(2), Internal Revenue Code, section 113(a)(7) and (8) of the Revenue Act of 1932.
2. The petitioner may deduct the fair market value of its capital stock distributed to its employees during the taxable years 1943 and 1944 as compensation for services. George R. Sheriff, Esq., for the petitioner. Rigmor O. Carlsen, Esq., for the respondent.
The respondent has determined the following deficiencies in the petitioner's income and excess profits tax liability:
+---------------------------------------------------------------------------+ ¦Fiscal year ended ¦Income tax deficiency ¦Excess profits tax deficiency ¦ +-------------------+-----------------------+-------------------------------¦ ¦July 31 ¦ ¦ ¦ +-------------------+-----------------------+-------------------------------¦ ¦1943 ¦$6,629.15 ¦ ¦ +-------------------+-----------------------+-------------------------------¦ ¦1944 ¦ ¦$297,495.16 ¦ +-------------------+-----------------------+-------------------------------¦ ¦1945 ¦ ¦509,418.75 ¦ +-------------------+-----------------------+-------------------------------¦ ¦ ¦6,629.15 ¦806,913.91 ¦ +---------------------------------------------------------------------------+
In contesting the deficiencies the petitioner raises two issues, first, whether the petitioner acquired its predecessor's assets in a nontaxable exchange with the result that for invested capital purposes those assets had the same basis to the petitioner as to its predecessor; second, whether the petitioner may deduct the fair market value of its capital stock issued as compensation for services, or only the par value. Other issues raised in the pleadings were abandoned at the hearing.
FINDINGS OF FACT.
The petitioner is a corporation organized under the laws of Delaware on July 19, 1932. It is engaged in the mail order business, distributing clothing and allied lines at retail.
Petitioner's books and records are kept and its income tax returns are filed upon the accrual basis for fiscal years ending July 31. The petitioner's income and declared value excess-profits tax returns and its excess profits tax returns for the fiscal years ended July 31, 1943, July 31, 1944, and July 31, 1945, here involved were filed with the collector of internal revenue for the sixth district of Missouri.
The petitioner's predecessor, National Bellas Hess Co., Inc., a New York corporation, was similarly engaged in the mail order business, selling principally wearing apparel upon orders received from customers throughout the United States. The orders were for merchandise selected from catalogs and pamphlets issued and disseminated by the predecessor to customers and others. Payment was made with the order, and the merchandise was thereafter delivered by mail or express to the customer. The mail order business had been previously conducted through plants of the predecessor at New York City and at Kansas City, Missouri.
Prior to the 1932 exchange here involved, the predecessor had a list of about 5,500,000 active mail order customers throughout the United States. The predecessor also engaged in the business of selling men's, women's and children's apparel and other items of merchandise of general dry goods, notions, supplies, etc., conducted through wholly owned subsidiaries with 48 retail stores located in various states. The mail order business composed approximately 80 per cent of the predecessor's business, and its retail stores approximately 20 per cent. Mail order business was solicited by circulation of catalogs and ‘flyers.‘
The petitioner's predecessor had transacted a substantial amount of business through its mail orders and retail stores. Its net sales in 1930 and 1931 were approximately $33,000,000 and $30,000,000, respectively, and its net losses for those years were $4,109,238 and $3,490,611, respectively. In 1931 the predecessor encountered difficulties due to a steady decline in the value of its average orders resulting from declining commodity prices and restricted consumer purchasing power. There was a general decrease in the number of orders received due to the general trade depression throughout the country.
The predecessor's inventory at the end of 1931 was 29.40 per cent below the inventory at the end of 1930, and 64.29 per cent below the inventory at the close of 1929. With the beginning of 1932, it was necessary to decrease drastically the mail order activities, and the inventories were converted into cash in order to liquidate debts. The losses eliminated the predecessor's reserve and surplus, and its working capital was reduced below that required for the normal operation of its business.
As a result of the lack of working capital and inability to borrow money, and depleted capital, the predecessor was unable to conduct its business upon the large scale to which it was accustomed. This resulted in expenses becoming out of proportion to the amount of the business transacted. In spite of the heavy losses, the predecessor was solvent and had sufficient net assets to pay all creditors.
In 1932 it became necessary to cease mail order operations. The predecessor also ceased publication and distribution of its catalog, which had cost several million dollars annually. The predecessor handled its entire mail order business from the two plants in New York and Kansas City. The real estate at New York and Kansas City was used almost entirely for carrying on the mail order business. As a result of discontinuance of the mail order business, the Kansas City and New York plants became practically useless. The predecessor wished to convert the real estate into revenue-producing assets, either through sale or rental.
The predecessor had wished to continue the mail order business if the necessary capital could be procured but could not continue to hold the real estate and operate the retail stores and mail order business without drastically depleting its assets. Being unable to obtain the necessary financing, the board of directors of the predecessor determined to make some advantageous disposition of the mail order business and assets.
By reason of the financial inability to continue business operations, it became necessary to place the affairs of the company under the jurisdiction of an equity court for the protection of the business and for the benefit of all interested parties, including stockholders. As of April 28, 1932, the predecessor (National Bellas Hess Co., Inc.) was capitalized as follows:
+---------------------------------------------------------------------+ ¦Preferred Stock ¦Common Stock ¦ +-------------------------------------+-------------------------------¦ ¦Authorized ¦Outstanding ¦Authorized ¦Outstanding ¦ +---------------------+---------------+----------------+--------------¦ ¦61,847 shares 7% ¦59,947 shares--¦1,000,000 shares¦721,897 shares¦ +---------------------+---------------+----------------+--------------¦ ¦cumulative (par $100)¦ ¦(non-par) ¦ ¦ +---------------------------------------------------------------------+
There were approximately 600 preferred stockholders and 6,000 common stockholders. On April 28, 1932, a stockholders' petition for receivership, on behalf of all stockholders, was filed against National Bellas Hess Co., Inc., the predecessor, in the United States District Court for the Southern District of New York. On the same day, April 28, 1932, the predecessor filed an answer to the complaint, admitting all allegations thereof and consenting to the appointment of a receiver as therein prayed. At the time of the petition for a receiver, the predecessor had no liabilities other than for current expenses and refunds due to mail order customers. The predecessor was solvent and able to pay these liabilities.
The purpose of application for receivership was to conserve the assets and business for the protection of stockholders so that the business and assets might be properly dealt with, as the predecessor was unable in its then financial condition to continue the business. It was the hope that the receivers could continue the business under direction of the court.
Shortly thereafter, the United States District Court, Southern District of New York, entered an order appointing permanent receivers. The receivers were authorized, among other things, to carry on the business, conserve the assets, and to borrow money for those purposes. Receivers also were appointed for all the wholly owned subsidiaries of the predecessor.
In order to dispose of the mail order business assets and good will to the best advantage of creditors and stockholders, the receivers had negotiations with various persons and companies seeking such acquisition, either as part of a reorganization of the predecessor or by outright sale.
On July 13, 1932, the court ordered the acceptance of an offer made by a group of employees of the predecessor. This offer was as follows:
In order to take over the mail order business, this group was to organize a new corporation, (the petitioner) having an authorized capital stock of 1,800,000 shares. The Receivers were offered 300,000 shares of this stock in return for the customer list, name and good-will, complete fixtures of the Kansas City Warehouse, and selected equipment and supplies from the New York Warehouse. The new corporation was to rent the Kansas City premises from the Receivers under a long term lease, with option to buy. Working capital was to be raised by the public sale of the greater remaining portion of the company's stock.
The court order of July 13, 1932, provided, in part, that the receivers were to accept the offer from the employee-organizers referred to in the order as the ‘purchasers.‘ The terms of the offer were set forth in the order and may be summarized, in part, as follows:
1. The purchasers will organize the petitioner to engage in the cash mail order business, with an authorized capital of 1,800,000 shares of the par value of $1 each, or of no par value.
2. The receivers will ‘sell, assign and convey‘ to the corporation the predecessor's mailing list and equipment used therewith; the exclusive right to the name ‘National Bellas Hess‘ and all its trademarks and trade names; all its personal property in Kansas City, Missouri; and all its personal property in New York, set forth in an attached schedule.
3. The purchasers will issue and deliver to the receivers 300,000 shares of the petitioner's capital stock and $100,000 to be paid within 5 years, evidenced by a bond or note secured by the property received.
4. The receivers will lease to the petitioner the real property located at Kansas City, Missouri.
6. The purchasers will provide a group of executives and employees to conduct the petitioner's business. The group shall include a ‘Management Group‘ which shall consist of a general manager, a financial executive, three merchandise managers, a sales promotion manager, a catalog production manager and an operating manager. Each member of the management group shall enter into an employment contract with the petitioner for a 5-year period commencing with the date of closing of title hereunder. In this connection, the plan further provided that:
For a period of five (5) years starting with the date of closing of title hereunder, no person shall receive from the corporation (petitioner) salary or other compensation in excess of Ten thousand ($10,000) Dollars per year, except with the approval of the receivers. The term ‘other compensation,‘ as used in the preceding sentence, does not include the employees' share in the profits, as hereinafter provided. The corporation may pay to the members of said Management Group and/or to any other officers or employees of the corporation percentages of its annual net profits, as hereinafter defined, provided that such percentages in the aggregate shall not exceed twenty-five (25%) percent, and provided further that the said percentages of profits will not be paid in cash to said employees or officers but will be applied by them to the purchase of stock in the corporation at the price of One ($1) Dollar per share, until the aggregate of stock thus purchased by said employees and officers will be Five hundred thousand (500,000) shares. No part of said Five hundred thousand (500,000) shares of stock shall be issued by the corporation unless and until the same shall have been paid for out of the said employees' percentages of profits. The corporation will, upon demand of each employee, reimburse to him the amount of Federal and State income taxes actually paid by him insofar as such taxes shall be applicable to his respective percentage of profit.
9. The receivers and the purchasers will enter into a voting trust agreement * * * . Said agreement will provide for five (5) voting trustees, one of whom shall be at all times an appointee of the committee of preferred stockholders of National Bellas Hess Co., Inc., (the predecessor) one of whom shall be at all times an appointee of the committee of common stockholders of National Bellas Hess Co., Inc., and three (3) of whom shall be at all times appointees of the purchasers. The said voting trustees shall be acting by a majority of not less than three (3) voting trustees; said agreement will further provide that the voting trustees shall at all times so vote their stock held by them as to elect as directors of the corporation first, two persons designated by said committee of preferred stockholders, second, one person designated by the said committee of common stockholders, and third persons designated by the purchasers, and it shall provide further that if the votes cast by the voting trustees shall not be sufficient to elect all such persons, then they shall be cast so as to elect said persons in the order hereinabove named. The receivers will deposit with such voting trustees all the Three hundred thousand (300,000) shares hereinabove provided to be issued to them, and the purchasers and employees will deposit with them any and all shares of stock issued to them pursuant to the provisions of paragraph ‘6‘ hereof. The term of said trust shall be for the maximum term permissible under the laws of the state under which the corporation will be organized but if, before the expiration of such term, there shall have been purchased Three hundred thousand (300,000) shares or more of stock by the employees pursuant to paragraph ‘6‘ hereof, then and in such event the said voting trust shall terminate forthwith. (On October 1, 1932, the voting trust agreement was modified to eliminate the provision for termination of the voting trust agreement upon purchase of the 300,000 shares by the employees.)
10. The receivers shall not distribute in kind or otherwise dispose of said Three hundred thousand (300,000) shares and/or the voting trust certificates issued by said voting trustees, for a period of one year from the date of closing hereof; during said period of one year, the purchasers shall have the option to buy said shares of stock and/or said voting trust certificates, all or none, at the price of Two ($2) Dollars per share.
13. The petitioner shall assume and pay all refund checks heretofore issued by the predecessor to its customers up to $180,000.
The petitioner was organized for the purpose of taking over and engaging in the mail order business previously conducted by the predecessor. As directed in the court order, the petitioner's authorized capital was 1,800,000 shares of common stock, having par value of $1 per share.
Pursuant to the court order, the petitioner was organized on July 19, 1932. Also, pursuant to the court order, 300,000 of the petitioner's authorized 1,800,000 shares of capital stock were, on or before July 30, 1932, issued to the receivers of the predecessor in exchange for the predecessor's mailing list and equipment used therewith, the exclusive right to the name ‘National Bellas Hess,‘ and all of the predecessor's trade-marks and trade names, and all of the predecessor's personal property in Kansas City, Missouri, and in New York. As additional consideration for the transfer of those properties, the petitioner executed a $100,000 note in favor of the receivers, payable within 5 years, without interest, secured by a chattel mortgage on the properties conveyed, and assumed liability for refund checks issued to customers by the predecessor which might be presented for redemption up to an aggregate of $180,000. Later, formal documents evidencing the transfer of title to the petitioner were executed and were approved by the court.
Also, in accordance with the court order, the predecessor's receivers granted to the employee-organizers an option expiring August 5, 1933, to purchase from the receivers the 300,000 shares of capital stock which they had received from the petitioner, ‘all or none,‘ at the price of $2 per share. The petitioner also leased the Kansas City real estate.
In the document transferring certain assets of the predecessor from its receivers to the petitioner, the receivers recited that they ‘do hereby bargain, sell, grant and convey‘ unto the petitioner the assets therein listed; and it was further recited therein that ‘This sale and conveyance‘ was made without any representations or warranty and without recourse to the receivers. A complete list of equipment, furniture, and fixtures then located at the plant of the predecessor in Kansas City, Missouri, was enumerated, as well as the equipment, records, and supplies located on the New York premises.
The 300,000 shares of the petitioner's capital stock issued to the predecessor's stock. The plan of reorganization or exchange did not require the issuance of additional capital stock. Immediately after the transfer of the predecessor's properties to the petitioner, the predecessor, through its receivers, was the owner of at least 80 per cent of the voting stock and at least 80 per cent of the total number of shares of all other classes of stock of the petitioner.
The 300,000 shares issued to the predecessor's receivers were to be deposited in a voting trust and voting trust certificates issued therefor. A voting trust agreement dated July 13, 1932, was entered into pursuant to the court order. On October 1, 1932, a new voting trust agreement was entered into to replace the voting trust agreement of July 13, 1932. The 300,000 shares were deposited with the voting trustees in exchange for voting trust certificates for the 300,000 shares on May 6, 1933.
Subsequent to the granting of the option to the employee-organizers to purchase the 300,000 shares of the petitioner's capital stock, proposals were made to the receivers by a group of bankers to whom the option had been assigned to revise the terms of the option. After extended negotiations, a modification thereof was effected, after a hearing before the court on June 9, 1933. In accordance with a court order entered June 12, 1933, the option was modified whereby options were granted to purchase 100,000 shares, of the 300,000 shares, on or before 60 days after the date of the entry of the order, at $1.50 per share; 100,000 shares at $1.75 per share on or before October 31, 1933; and 100,000 shares at $2.75 per share on or before April 30, 1935. Under such modification, the total aggregate consideration to be received for such stock amounted to $600,000, the same amount as under the prior option.
The occasion for the modification of the option agreement was the receipt by the new company of an offer from the bankers to underwrite some of the new company's previously authorized and unissued capital stock, in connection with which underwriting the bankers desired the 300,000 shares held by the receivers.
The 300,000 shares were subsequently sold to the public through those underwriters, and by January 7, 1936, $600,000 had been realized thereon by the receivers. None of the employee-organizers of petitioner at any time exercised the option on their own behalf. The employee-organizers purchased approximately 32,710 shares of petitioner's capital stock at $1 per share on July 31, 1932, and by September 30, 1932, an additional 345,695 shares had been sold to the public. The whole amount of 1,800,000 shares originally authorized had been issued by the end of the fiscal year 1944.
In 1938 the preferred stockholders of the predecessor received the last of four liquidating dividends, which per share of prior preferred aggregated:
(a) $5.85 per share in cash; (b) one share of the petitioner's common stock per share of the old preferred; (c) one-tenth of a $100 bond of National Holding Company convertible into common stock of the petitioner. (National Holding Company was the petitioner's wholly owned subsidiary which had been organized to and did acquire title in 1935 to the Kansas City real estate which previously had been leased to the petitioner.) The preferred stockholders of the predecessor were required to and did surrender their preferred stock for cancellation. No distribution was made to the common stockholders of the predecessor.
The receivers of the Predecessor company were finally discharged by court order of March 29, 1938.
The basis of the good will of the predecessor company for invested capital purposes was $5,040,000.
In accordance with the agreement providing for extra compensation, the petitioner issued to the individuals in the management group certain shares of its capital stock as hereinafter set forth, which respondent included as income to the recipients, at the market value in each of the respective years as follows:
+-----------------------------------------------------------------------------+ ¦Fiscal Year¦Number of shares ¦Par ¦Market ¦Total market value when ¦ ¦ ¦paid ¦value ¦value ¦paid ¦ +-----------+------------------+--------+-----------+-------------------------¦ ¦July 31, ¦46,000 ¦$1 ¦$1.328125 ¦$61,093.75 ¦ ¦1942 ¦ ¦ ¦ ¦ ¦ +-----------+------------------+--------+-----------+-------------------------¦ ¦July 31, ¦200,000 ¦1 ¦1.328125 ¦265,625.00 ¦ ¦1943 ¦ ¦ ¦ ¦ ¦ +-----------+------------------+--------+-----------+-------------------------¦ ¦July 31, ¦47,699 ¦1 ¦1.965625 ¦93,758.35 ¦ ¦1944 ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+
The respondent has allowed the petitioner deductions for such stock paid as compensation for services in each of the respective fiscal years, at the rate of $1 per share of stock, being the par value rather than the fair market value.
OPINION.
ARUNDELL, Judge:
The first question is the basis to the petitioner, for equity invested capital purposes, of certain properties acquired from its predecessor. The petitioner contends the properties were acquired in an exchange that was ‘non-taxable‘ under either section 112(b)(4) or (5) of the Revenue Act of 1932,
and therefore it takes its predecessor's basis for the properties. Sec. 718(a)(2) of the I.R.C., sec. 113(a)(7) and (8) of the Revenue Act of 1932, Regs. 77, art. 598.
SEC. 112. RECOGNITION OF GAIN OR LOSS. (Revenue Act of 1932.)(a) GENERAL RULE.— Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.(b) EXCHANGES SOLELY IN KIND.(4) SAME— GAIN OF CORPORATION.— No gain or loss shall be recognized if a corporation a party to a reorganization exchanges property, in pursuance of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization.(5) TRANSFER TO CORPORATION CONTROLLED BY TRANSFEROR.— No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.
The respondent denies that the transaction by which the petitioner acquired the properties was an exchange within the purview of section 112, supra. Accordingly, he contends the petitioner's basis is cost.
SEC. 718. EQUITY INVESTED CAPITAL. (Internal Revenue Code.)(a) DEFINITION.— The equity invested capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following amounts, reduced as provided in subsection (b)—(2) PROPERTY PAID IN.— Property (other than money) previously paid in (regardless of the time paid in) for stock, or as paid-in surplus, or as a contribution to capital. Such property shall be included in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange. If the property was disposed of before such taxable year, such basis shall be determined under the law applicable to the year of disposition, but without regard to the value of the property as of March 1, 1913. If the property was disposed of before March 1, 1913, its basis shall be considered to be its fair market value at the time paid in. If the unadjusted basis of the property is a substituted basis, such basis shall be adjusted, with respect to the period before the property was paid in, by an amount equal to the adjustments proper under section 115(1) for determining earnings and profits;SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS. (Revenue Act of 1932.)(a) BASIS (UNADJUSTED) OF PROPERTY.— The basis of property shall be the cost of such property; except that—(7) TRANSFERS TO CORPORATION WHERE CONTROL OF PROPERTY REMAIN IN SAME PERSONS.— If the property was acquired after December 31, 1917, by a corporation in connection with a reorganization, and immediately after the transfer an interest or control in such property of 50 per centum or more remained in the same persons or any of them, then the basis 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 upon such transfer under the law applicable to the year in which the transfer was made. This paragraph shall not apply if the property acquired consists of stock or securities in a corporation a party to the reorganization, unless acquired by the issuance of stock or securities of the transferee as the consideration in whole or in part for the transfer.(8) PROPERTY ACQUIRED BY ISSUANCE OF STOCK OR AS PAID-IN SURPLUS.— If the property was acquired after December 31, 1920, by a corporation—(A) by the issuance of its stock or securities in connection with a transaction described in section 112(b)(5) (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money, in addition to such stock or securities), or(B) as paid-in surplus or as a contribution to capital, then the basis 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 upon such transfer under the law applicable to the year in which the transfer was made.Regulations 77:Art. 598. Property acquired in reorganization after December 31, 1917.—In the case of property which was acquired after December 31, 1917, by a corporation in connection with a reorganization, if immediately after the transfer an interest or control in such property of 50 per cent or more remained in the same persons or in any of them, the basis 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 upon such transfer under the law which was applicable to the year in which the transfer was made.Example: The X Corporation owns property which it purchases in 1925 for $10,000. It causes the organization of the Y Corporation, transferring the property to the Y Corporation in exchange for its capital stock. No gain or loss from this transaction is recognized under section 112(b)(4). The basis of the property in the hands of the Y Corporation is $10,000, the basis which the property would have had in the hands of the X Corporation if the transfer had not been made.
The transaction may be summarized as follows: In 1932 the predecessor corporation, although solvent, was in voluntary receivership for the benefit of all interested parties, including stockholders. In 1932, pursuant to a plan set forth in a court order, the properties in question were transferred to the petitioner, a corporation then newly organized by a group of key employees of the predecessor. In return, the predecessor received 300,000 of the 1,800,000 authorized shares of common stock of $1 par value. The 300,000 shares were issued to the predecessor on or before July 30, 1932, and were the only shares outstanding at that time.
The petitioner also gave a $100,000 5-year promissory note secured by a chattel mortgage on the properties conveyed and assumed the predecessor's obligation to refund to its customers up to $180,000.
Pursuant to the court order, the predecessor's receivers granted to the key employees who organized the petitioner a 1-year option to purchase all or none of the 300,000 shares at $2 per share. Also, pursuant to the court order, a voting trust agreement was entered into.
In contending that this transaction came within the purview of section 112(b)(4), the petitioner argues that the property was transferred in pursuance of a plan of reorganization as defined in section 112(i)(1)(B), Revenue Act of 1932.
The respondent contends that the ‘control‘ required by section 112(i)(1)(B) was not present.
SEC. 112(i)(1). The term ‘reorganization‘ means * * * (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred * * * .
‘Control‘ is defined in section 112(j), Revenue Act of 1932, as ‘the ownership of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.‘ The respondent does not question the rule that control relates to equitable ownership and is not negated by the fact that under the court order the predecessor was required to deposit the stock in a voting trust. Federal Grain Corporation, 18 B.T.A. 242; cf. Griswold Co., 33 B.T.A. 547; Peabody Hotel Co., 7 T.C. 600; G.C.M. 2177, VI-2 C.B. 112. In contending that the required control was not present, the respondent relies on cases setting forth the general rule that if the transferor relinquishes the control as a step in the plan of reorganization, which step is inseparable from the others and essential in accomplishing the purpose of the plan, then the control requirement is not met. Banner Machine Co. v. Routzahn, 107 F.2d 147; certiorari denied 309 U.S. 676; West Texas Refining & Development Co. 25 B.T.A. 1254, affirmed on this point 68 F.2d 77; Ericsson Screw Machine Products Co., 14 T.C. 757; Charles Hall, 31 B.T.A. 125; Omaha Coca-Cola Bottling Co., 26 B.T.A. 1123.
It is clear from the facts as found that the conditions calling for the application of this general rule are not present here. The 300,000 shares were the only shares outstanding at the time they were issued to the predecessor's receivers and it was not until some time later that other additional shares were issued and the predecessor lost ‘control.‘
The predecessor's ownership or ‘control‘ was real and lasting; it was not a momentary formality, and its subsequent relinquishment was not part of the plan of reorganization or exchange. By virtue of this ownership of the petitioner's capital stock, the predecessor had a continuing interest in the mail order business and the property transferred and operated under the new corporate form of the petitioner.
The respondent points to the fact that from the beginning the predecessor was obligated to grant to the employee-organizers an option to purchase the 300,000 shares. We think it is significant that the predecessor was not obligated to do more than grant an option. It had not entered into a contract of sale or in any way divested itself of ownership. Cf. American Bantam Car Co., 11 T.C. 397, affd. 177 F.2d 513, certiorari denied 339 U.S. 920, and cases cited therein. Moreover, as explained in our Findings of Fact, the employee-organizers never exercised the option or acquired the shares. Cf. Scientific Instrument Co., 17 T.C. 1253, affirmed per curiam 202 F.2d 155. Instead, as a result of assignments and modifications, the receivers granted what in effect constituted a different option to different parties. This option was exercised and, as a result, the 300,000 shares were thereupon sold to the public. The fact that the receivers of the predecessor were able to grant and then modify the option and the further fact that the option was not exercised, even in part, for approximately a year emphasizes the real and substantial nature of the ownership and control in the predecessor through its receivers.
Nor is the requisite ownership and control negated by the fact that petitioner planned to sell its capital stock to general public. The public sale was not part of the plan of reorganization or exchange. Under these circumstances, we need not look to the time of consummation of the public sale to determine whether the predecessor possessed the requisite ‘control.‘ Scientific Instrument Co., supra; American Bantam Car Co., supra.
Finally, although admitting the transaction was pursuant to court order and for a bona fide business purpose, the respondent contends the predecessor's stockholders were interested in securing cash only and it was never contemplated that they would receive the petitioner's capital stock issued to the predecessor corporation or that the predecessor would retain it.
Even if accepted as true, this contention is of no moment here.
It is interesting to note that the preferred stockholders of the predecessor did in fact receive in liquidation some of the petitioner's capital stock. We have found this as a fact based on the stipulation filed by the parties.
The intention of the stockholders is not determinative in these circumstances. In fact, it is now well settled that if the transferor plans to and in fact does dispose of the capital stock shortly after receipt, the ownership or control requirement is nonetheless complied with if the disposition was not required as part of the plan of reorganization or exchange. American Bantam Car Co., supra; Evans Products Co., 29 B.T.A. 992, affirmed per curiam 84 F.2d 998, certiorari denied 298 U.S. 675; Samuel Insull, Jr., 32 B.T.A. 47, reversed on other issues 87 F.2d 648; Schmieg, Hungate & Kotzian, Inc., 27 B.T.A. 337. Moreover, the important fact here is that regardless of what may have been contemplated, the predecessor corporation which transferred the property to the petitioner received all of the petitioner's outstanding capital stock and through its receivers was in ‘control‘ of the petitioner as that term is defined in section 112(j), immediately and for some time after the transfer. The disposition which occurred after a period of approximately a year was not in pursuance of the plan of reorganization or exchange.
From what has been said above, we think it is clear that the predecessor possessed the ownership or control required for a section 112(i)(1)(B) exchange. For the reasons discussed, we conclude that the petitioner received the properties in question from its predecessor in a nontaxable exchange under section 112(b)(4) pursuant to a reorganization as defined in section 112(i)(1)(B). Therefore, the basis of the properties to the petitioner for equity invested capital purposes is the predecessor's basis. Sec. 718(a)(2), I.R.C.; sec. 113(a)(7) and (8) of the Revenue Act of 1932; Regs. 77, art. 598. The parties have stipulated that the basis of the good will of the predecessor company for equity invested capital purposes was $5,040,000.
The next issue is whether the petitioner may deduct the fair market value rather than the par value of its own capital stock distributed to its employees during the taxable years 1943 and 1944 as compensation. The stock was distributed in accordance with the plan in the court order which provided that the petitioner could pay its employees up to 25 per cent of its annual net profits, but provided further that the percentage of profits was not to be paid in cash. Instead it was to be applied to the purchase of capital stock of the petitioner corporation at the price of $1 per share (the par value).
This provision is similar to the corporate resolution pursuant to which stock was distributed to officers in Package Machinery Co., 28 B.T.A. 980, and the decision in that case is controlling here. In the instant case, as in Package Machinery Co., supra, the effect of the provision was not to authorize the payment of a specific monetary sum, but to authorize the payment of a number of shares of an aggregate par value equal to a certain percentage of profits. That is, the 25 per cent of profits was not the sum to be paid but merely the measure of the number of shares to be issued.
Of course, these shares must be translated into a monetary sum; and this translation must be based upon a fair market value of the stock when distributed. Package Machinery Co., supra, and cases cited therein. The total fair market value of the shares distributed to employees during the taxable years 1943 and 1944 is $265,625 and $93,758.35, respectively. The petitioner may deduct these sums for these years as compensation paid to its employees.
Decision will be entered under Rule 50.