Opinion
Docket No. 8930.
1947-09-19
RANSOHOFFS INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Lawrence Livingston, Esq., and H. W. S. Leeker, Esq., for the petitioner. R. E. Maiden, Jr., Esq., for the respondent.
In about 1902 the father of Robert, James, and Howard Ransohoff established the business of Ransohoffs. Later Robert and James and their father formed a partnership to conduct the business. The father died and in the early 1920's Howard joined the firm. In 1930 a written partnership agreement was executed by the three brothers. On May 20, 1938, they executed a further partnership agreement, providing for the continuation of the partnership after the death of a partner. On October 9, 1938, Howard died. Upon his death no liquidation of the firm occurred, its assets were not distributed, and it was continued in operation exactly as it had been prior thereto. Robert and James owned the partnership equally. In 1940 petitioner was incorporated, with Robert and James as owners of an equal amount of its stock. Held, that under section 740, Internal Revenue Code, petitioner is entitled to compute its excess profits tax credit by the income method as provided in section 713. Lawrence Livingston, Esq., and H. W. S. Leeker, Esq., for the petitioner. R. E. Maiden, Jr., Esq., for the respondent.
The respondent determined a deficiency of $5,341.68 in the petitioner's excess profits tax liability for its taxable year ended July 31, 1942.
The single issue is whether or not the petitioner is entitled to compute its excess profits tax credit by the use of the income method, pursuant to the provisions of Supplement A of subchapter E, chapter 2, of the Internal Revenue Code.
FINDINGS OF FACT.
Certain facts were stipulated. The portions thereof material to the issue are as follows:
The petitioner is a corporation, organized by the surviving partners of Ransohoffs on April 23, 1940, under the laws of the State of California, with its principal place of business in San Francisco. It is known as Ransohoffs Inc. It filed its original and amended income tax returns for the taxable year with the collector of internal revenue for the first district of California. The petitioner filed its returns on the income method, under the provisions of Supplement A, subchapter E, chapter 2, of the Internal Revenue Code.
On May 20, 1938, Robert Ransohoff, James B. Ransohoff, and Howard J. Ransohoff formed a partnership, doing business under the firm name and style of Ransohoffs. The three persons were brothers. Each brother owned a one-third interest in the partnership. The partnership was a continuation of a partnership among the same brothers as copartners, established by an agreement of partnership executed April 29, 1930. The partnership which was established in 1930 continued from the date of its inception until the formation of the partnership under the agreement of May 20, 1938. The business of the partnership was the purchasing and selling of women's apparel of all kinds and kindred merchandise.
Howard J. Ransohoff died on October 9, 1938. At the time of his death the partnership was operating under the terms of the agreement of May 20, 1938, which had never been terminated, amended, or modified. At the time of the death of Howard, each brother owned a one-third interest in the partnership. Immediately upon his death the surviving partners, Robert and James, took possession of all of the property of the partnership and assumed liability for all its obligations. They continued the partnership and continued the operation of the partnership business under the terms and provisions of the agreement of May 20, 1938.
After the death of Howard, the surviving partners, Robert and James, paid to the estate of the deceased partner an amount equal to one-third of the book value of the partnership as shown on its books as of the last day of the month immediately preceding the date of the death of the deceased partner, plus or minus appropriate credits to or charges against the deceased partner, as shown by the books of the partnership. The payments have heretofore been made by the surviving partners without awaiting the full ten years allowed them by the agreement of May 20, 1938. (The contract provided for ten annual payments.)
On July 31, 1940, the partners, Robert and James, transferred all of the assets of the partnership to the petitioner in exchange for all its capital stock, each brother receiving 50 per cent of such stock. The corporation continued the operation of the business of the predecessor partnership without change or interruption.
The articles of partnership of May 20, 1938, provided, among other things, as follows:
The partnership shall continue in existence until the death of two of the parties hereto, unless sooner terminated by the parties hereto or the survivors of them, and the partnership may, notwithstanding the foregoing, continue in existence after the death of two of the parties hereto if prior to such time the parties, or the survivors thereof, shall so provide. For the purposes of this paragraph, the withdrawal of a partner pursuant to the provisions of this agreement shall have the same force and effect as the death of a partner.
In the event of the death of any partner, the two survivors shall continue as partners under the same firm name and subject to the terms, covenants, and conditions of this agreement as then existing, or as hereafter amended or modified, and the interest of the deceased partner shall be compensated for in the manner hereinafter provided.
Upon the death of the partner first to die, the surviving partners shall thereupon and immediately become the sole owners of all of the assets of the partnership and liable for all liabilities thereof, and said survivors agree to protect and save harmless the successors of such deceased partner against any and all such liabilities, whether presently then existing or future or contingent.
No successor of a deceased partner shall have any interest, right or title in or to the business or management of said partnership or the assets thereof.
The record discloses the following additional facts:
The business of Ransohoffs was started by the father of Robert, James, and Howard Ransohoff and has been maintained under that name to the present time. Robert and James were associated with their father as partners in the venture until their father's death. In the early 1920's Howard joined the firm as a partner. No written partnership agreement was executed until 1930, but verbally the partners agreed to share the profits and losses. The written agreement was made with the understanding that the partners were to continue the business and, if one should die, the other two would succeed him, take over his interest and duties, and carry on the business just as theretofore.
After the death of Howard, the surviving partners, Robert and James, continued the partnership and its operation under the terms of the agreement of May 20, 1938. The conduct of the business was not altered in any manner, its assets were not distributed; it was not dissolved; its affairs were not terminated or wound up; there was no distribution of assets or profits; there was no liquidation of the firm; and the partnership continued in every respect exactly as it had prior to the death of Howard, except that the surviving brothers, Robert and James, owned the assets of the partnership in equal shares, with the obligation to compensate the heirs or successors of a deceased partner.
It was stipulated at the hearing that the petitioner did not make the elections required by section 228(f) of the Revenue Act of 1942 in order to have the provisions of section 740(f) of the Internal Revenue Code made applicable retroactively to all taxable years beginning after December 31, 1939.
OPINION.
VAN FOSSAN, Judge:
It is unnecessary to enter into any extended discussion of sections 740 and 744 of the Internal Revenue Code, under which the controversy in the case at bar arises. The precise issue is whether the petitioner is entitled thereunder to compute its excess profits credit by the income method, as provided in section 713, or by the invested capital method, as provided in section 714. The petitioner contends that it is entitled to use the income method. In order to do so the preceding partnership must be regarded as a ‘qualified component corporation‘ as defined in section 740
and it must have been in existence on the date of the beginning of the petitioner's base period, August 1, 1936.
SEC. 740. DEFINITIONS.For the purposes of this Supplement—(a) ACQUIRING CORPORATION.— The term ‘acquiring corporation‘ means—(1) A corporation which has acquired—(D) Substantially all the properties of a partnership in an exchange to which section 112(b)(5), or so much of section 112(c) or (e) as refers to section 112(b)(5), or to which a corresponding provision of a prior revenue law, is or was applicable.(b) COMPONENT CORPORATION.— The term ‘component corporation‘ means—(5) In the case of a transaction specified in subsection (a)(1)(D), the partnership whose properties were acquired.(c) Qualified Component Corporation.— The term ‘qualified component corporation‘ means a component corporation which was in existence on the date of the beginning of the taxpayer's base period.
The petitioner and the respondent agree that the partnership composed of Robert and James was a component corporation as defined by the statute. The respondent argues that the partnership was not a ‘qualified component corporation‘ because it was not in existence on August 1, 1936, due to the fact that the death of Howard in October 1938 terminated the prior partnership of Robert, James, and Howard, and that the partnership of Robert and James became a new entity.
Therefore, the issue before us is narrowed to one of law— Did the death of Howard dissolve the partnership composed of himself, Robert, and James and thus interrupt the continuity of the component corporation extending from the petitioner's taxable year to the beginning of its base period, as required by the statute?
In his brief respondent expresses his position in the following language:
The whole issue on appeal now hinges on the one point of whether the partnership, composed of Robert and James, was actually in existence on August 1, 1936. This presents on the facts of the case a cold question of law— the law of partnerships, governed by the law of the State of California.
He then cites section 2425 of the California Civil Code,
covering the dissolution of a partnership, and asserts that there is no provision of the California law which permits, by agreement or otherwise, the avoidance of a dissolution of a partnership upon the death of a partner. He seeks to distinguish the continuance of the partnership itself. He construes the partnership agreement of May 20, 1938, as providing for the continuation of the business, but not of the partnership.
Section 2425: Causes of dissolution: Dissolution is caused:(4) By the death of any partner.
The petitioner contends that, under the California decisions and under a proper interpretation of the Federal taxing statutes, a partnership may, by agreement, be continued after the death of one of the partners, that the continuity of the petitioner as the acquiring corporation and of its predecessors, the ‘component corporation,‘ was thus preserved during the petitioner's base period, and that hence it has complied strictly with the requirements of the statute.
The first question is whether or not after the death of Howard the partnership contract of May 20, 1938, continued the partnership, or merely the business being conducted by it. From a study of the history and background of Ransohoffs and of the stated intent and purpose to continue their family partnership as expressed in the contract, we conclude that after Howard's death the partnership was intended to, and did, continue in existence. The agreement provided that ‘the partnership shall continue in existence until the death of two of the parties hereto * * * ‘ and ‘In the event of the death of any partner, the two survivors shall continue as partners under the same firm name and subject to the terms, covenants, and conditions of this agreement as then existing, or as hereafter amended or modified, and the interest of the deceased partner shall be compensated for in the manner hereinafter provided. ‘ From this language it is plain that the fundamental intent was to carry on the family partnership, not merely to carry on the business enterprise. The collateral record lends ample support to this view.
Addressing himself to the question of whether the partnership was actually continued after Howard's death and thus in existence on August 1, 1936, the respondent argues that, even though the agreement contemplated and provided for such continuance, it was ineffectual in the face of the California statute. In Robert E. Ford, 6 T.C. 499, we had a comparable question arising in Minnesota and relating to a proposed adjustment of the cost basis of the partnership for the capital asset it sold. The same basic principle of law was involved as is now before us. There we said:
* * * The respondent suggests that the withdrawal of the partner whose interest was purchased on November 26, 1938, constituted a dissolution or termination of the partnership and the commencement of a new partnership. By the general rule of law, death or withdrawal of a partner dissolves the partnership, but it is competent for the parties to provide otherwise. As stated by Rowley in his work on Modern Law of Partnership (sec. 550):
‘ * * * Whatever in the absence of express agreement of all partners may be the technical effect of the admission of a new member or retirement of an old member these conditions are ordinarily cared for by agreement, either under provisions in partnership articles authorizing a retirement, or arrangements made by the partners at the time of retirement. * * * ‘
Cf. Burwell v. Mandeville's Executors, 2 How. 560, 576.
In the instant proceeding, the offer to purchase the partnership interest specifically provided for the continuation of the partnership without interruption. The partners having legally contracted for the continuation of the partnership and having actually continued it, those facts should be recognized and effect thereto given, unless prohibited by some provision of the taxing act. We are not aware of any such prohibition. Moreover, under section 27 of the Uniform Partnership Act, which has been adopted by the State of Minnesota, it is specifically provided that a transfer of a partnership interest does not of itself dissolve the partnership.
See also Allan S. Lehman, 7 T.C. 1088, in which he said:
* * * the old partnership of Lehman Brothers continued to be carried on by the surviving partners, notwithstanding the death of Arthur Lehman, and that no new partnership came into existence as would start a new period of holding of the partnership interests of the surviving partners who continued to carry on the partnership business. * * *
The general provision of the California statute to the effect that the death of a partner causes dissolution of the partnership relied on by respondent does not render ineffective a specific agreement to continue the partnership thereafter. See section 2496 of the California Civil Code, which provides specifically:
The * * * , death * * * of a general partner dissolves the partnership, unless the business is continued by the remaining general partners.
(a) Under a right so to do stated in the certificate, or
(b) With the consent of all members.
In Allan S. Lehman, supra, which arose in the State of New York, the statute of which governing the dissolution of partnerships is the same as that of California, we so held. The petitioner has cited several California cases which directly and indirectly conform to our conclusions.
Thompson v. Gibb, 1 Cal.U. 173; California Employment Commission v. Walters, 64 Cal.A.(2d) 554.
We have found no prohibition in the Federal taxing statutes against the continuance of a partnership for tax purposes after the death of a partner. Moreover, the basic purposes of section 740 must not be overlooked. It is a remedial measure and, as such, it is axiomatic that it be construed liberally. It was intended to give to the petitioner the benefit of the business experience of its predecessors.
In Faigle Tool & Die Corporation, 7 T.C. 236, we said:
However, Supplement A to the excess profits tax provisions of the Internal Revenue Code recognizes that even though a corporation may not actually have been in existence during any of the years 1936-1939, it may have acquired, in a tax-free reorganization, the properties of a corporation or another type of business organization which was in existence during those years. If so, the acquiring corporation may compute its excess profits credit under the income method, using as its average base period net income the history of earnings of the business organization it acquired. * * *
There is no doubt that the petitioner corporation acquired and succeeded to the business organization of the Ransohoff partnership. We have held that the preceding partnership had a continuous existence. The history of the earnings of that partnership, whether composed of Robert, James, and Howard, or of Robert and James, is a proper measure of the average base period net income of the petitioner for excess profits tax purposes. Therefore, the petitioner is entitled to compute its excess profits tax credit upon the income method, as provided in section 713.
Reviewed by the Court.
Decision will be entered under Rule 50.