Opinion
Docket Nos. 71150 71151.
1961-01-31
ARMY TIMES SALES COMPANY, FORMER NAME ARMY AND NAVY BULLETIN, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.MELVIN RYDER AND FLORENCE RYDER, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Temple W. Seay, Esq., for the petitioners. Neil J. O'Brien, Esq., for the respondent.
SEC. 129, I.R.C. 1939, AND SEC. 269, I.R.C. 1954: (1) CORPORATE TAXPAYER'S CLAIMED DEDUCTIONS FOR LOSS CARRYOVERS AND FOR INTEREST ON DEBENTURE BONDS ISSUED IN SUBSTITUTION FOR WORTHLESS PROMISSORY NOTES DENIED; (2) INDIVIDUAL TAXPAYER'S CLAIMED CAPITAL GAINS TREATMENT OF DISTRIBUTION IN REDEMPTION OF DEBENTURE BONDS DENIED.— Corporate petitioner was organized in 1945 and engaged in publishing a magazine for servicemen, sustained net operating losses for each fiscal year 1946 through 1952, and in 1952 had a deficit of approximately $500,000 in earned surplus and an outstanding worthless promissory note for $207,787.88 for advances for current operating expenses. In 1952 Melvin Ryder acquired control of corporate petitioner in a ‘package deal’ purchase of all its stock and its note. Shortly thereafter the publication was terminated; the note was converted into debenture bonds; the corporate name was changed to reflect its new sales activity; and under a contract with another corporation controlled by Ryder, corporate petitioner engaged in selling activities theretofore successfully conducted by such other corporation. Held, Melvin Ryder's principal purpose for acquiring control of corporate petitioner and its worthless note was to evade or avoid Federal income tax by securing to himself, as sole stockholder and possessor of the note, the benefit of deductions, credits, or other allowances which he would not otherwise have enjoyed and, further, section 129, I.R.C. 1939, and section 269, I.R.C. 1954, prohibit the allowance of corporate petitioner's claimed deductions for interest and net loss carryovers and individual petitioners' claimed capital gains treatment of distributions received in redemption of the corporation's debenture bonds. Temple W. Seay, Esq., for the petitioners. Neil J. O'Brien, Esq., for the respondent.
In these consolidated proceedings the respondent determined deficiencies in income and excess profits taxes against the corporate petitioner in Docket No. 71150 and a deficiency in income tax against the individual petitioners in Docket No. 71151 in the amounts and for the taxable year as follows:
+-------------------------------------+ ¦Docket¦Taxable year ended—¦Deficiency¦ +------+-------------------+----------¦ ¦No. ¦ ¦ ¦ +------+-------------------+----------¦ ¦ ¦(July 31, 1953 ¦$15,231.77¦ +------+-------------------+----------¦ ¦71150 ¦(July 31, 1954 ¦26,662.28 ¦ +------+-------------------+----------¦ ¦ ¦(July 31, 1955 ¦2,347.82 ¦ +------+-------------------+----------¦ ¦71151 ¦Dec. 31, 1953 ¦3,049.32 ¦ +-------------------------------------+
The issues presented are whether the respondent erred in determining that, under section 129 of the Internal Revenue Code of 1939, because the principal purpose of the acquisition of control of the corporate petitioner was the evasion or avoidance of Federal income or excess profits tax by securing the benefit of a deduction, credit, or other allowance which would not otherwise be enjoyed, (1) the corporate petitioner is not entitled to claimed deductions for (a) net operating loss carryovers for the years ended July 31, 1953 and 1954, and (b) alleged interest on debenture bonds for the years ended July 31, 1953, 1954, and 1955, and, further, (2) the individual petitioners are not entitled to the benefits of long-term capital gains provisions relative to the distribution by the corporate petitioner allegedly in retirement and redemption of its debenture bonds and that such distribution constituted ordinary income for the year 1953.
FINDINGS OF FACT.
Some of the facts have been stipulated by the parties. We find them to be as stipulated and incorporate herein by this reference the stipulation together with the exhibits attached thereto.
The petitioner Army Times Sales Company is a corporation with its principal place of business at 2020 M Street NW., Washington, D.C. It filed its Federal tax returns for the fiscal years ended July 31, 1953, 1954, and 1955, on an accrual basis, with the district director of internal revenue, Baltimore, Maryland. This petitioner was incorporated under the name of Army and Navy Bulletin, Inc., and engaged in the publishing business under that name until its present name was adopted in November 1952, shortly after all of its outstanding capital stock was acquired by Melvin Ryder.
The petitioners Melvin Ryder and Florence Ryder are individuals, husband and wife, residing in Washington, D.C. They filed a joint Federal income tax return for the year 1953 with the district director of internal revenue, Baltimore, Maryland.
Melvin Ryder (hereinafter referred to as Ryder) participated in the circulation department of the military newspaper Stars and Stripes during World War I, and since that time he has been interested in publications for military personnel. Since 1933 Ryder has been engaged in the publishing business in Washington, D.C. In 1933 the Civilian Conservation Corps authorized Ryder to publish a newspaper for that organization and he incorporated the Happy Days Publishing Company (hereinafter referred to as Happy Days) with its principal office located in Washington, D.C. That company published the newspaper Happy Days for the CCC from 1933 to 1940. From date of incorporation and at all times material herein Ryder has owned 100 percent of the voting stock of Happy Days.
In 1940 Ryder organized the Army Times Publishing Company (hereinafter referred to as Publishing Company), a Delaware corporation with principal offices in Washington, D.C. Since the organization of Publishing Company the majority of its outstanding common stock has been owned by Happy Days and Ryder has been its president and has managed its affairs. In 1940 Publishing Company started publication of Army Times a weekly tabloid newspaper which sought to serve as a listening post in reporting news from military headquarters in Washington and other areas, and also transfers, directives, regulations, various features, etc., of particular interest to military personnel. At various times subsequent to 1940 Publishing Company published additional similar newspapers for the different branches of the armed services. Those publications were sustained through paid advertising and circulation revenue derived from annual subscriptions costing about $5 and sales of individual copies at 10 cents a copy.
In 1952 Publishing Company had approximately 7,800 shares of common stock issued and outstanding of which 6,000 shares were owned by Happy Days. The balance of such shares were held in varying amounts by Raymond Hunsehe, Larry Lynch, Isaac Aronoff, Ferne H. Hunsehe, Allan S. Waldo, Frederick Kerby, Tom Streit, and Robert La Roux. Except for Aronoff, all of those persons were full-time employees of Publishing Company. The minor shareholdings of Streit and La Roux were subsequently retired.
In 1952 Publishing Company was publishing several weekly newspapers including Army Times, Air Force Times, Veterans Edition started at the end of World War II, and Navy Times started in 1951. It also published Military Market a military trade publication having less than 3,000 paid subscriptions among businesses interested in selling merchandise to military post exchanges and commissary stores, and having a total circulation of about 15,000 including the personnel who operated such exchanges and commissaries. In 1952 the approximate number of subscribers to the above-mentioned weekly publications was 110,000 for Army Times, 60,000 for Air Force Times, 100,000 for Veterans Edition, and 40,000 for Navy Times. Those publications were sold to both officers and enlisted men. A large part of the circulation was obtained through military unit subscriptions and after the men left the service individual subscriptions were obtained directly through the mail and also through independent catalog agencies which were paid a commission of from 20 to 30 percent depending on the number of subscriptions, and such agencies paid their own expenses. After the war newsstand sales were started and grew to substantial numbers. In 1952 the general offices of Publishing Company were located at 3132 M Street NW., Washington, D.C., and it had branch offices in the cities of New York, Chicago, Detroit, San Francisco, Los Angeles, London, and Paris. The branch offices handled subscriptions, advertising, and editorial work. The publications were printed in various places, namely, Pacific editions in Tokyo, Japan; European editions in Frankfurt, Germany; West Coast editions in San Diego, California; and other editions in Philadelphia, Pennsylvania. In 1952 Publishing Company had several hundred employees including about 10 salesmen.
The petitioner which now has the name of Army Times Sales Company was incorporated in Maryland on July 26, 1945, under the name of Army and Navy Bulletin, Inc. (hereinafter sometimes referred to as Bulletin and sometimes as Sales Company), to conduct, inter alia, a general printing and publishing business. It had an authorized capital stock of 10,000 shares without nominal or par value. The original stock issue embraced 3,100 shares for which $31,000 cash was paid in during September and October 1945, and such shares were issued in the amounts of 1,400 shares to Thurmond Chatham, 1,000 to Lewis L. Straus, 500 shares to W. W. Rapley, 100 shares to Arthur L. Rubin, and 100 shares to charles G. Moore. Subsequently during July and August 1946 and for a total of $46,880 cash paid in, as hereinafter mentioned, Bulletin issued an additional 4,688 shares to Thurmond Chatham, making a total of 7,788 shares which thereafter remained issued and outstanding at all times material herein.
Bulletin established offices in Washington, D.C., and continuously engaged in the business of publishing a weekly military news magazine until the latter part of 1952. Its publication was named Army and Navy Bulletin until about 1947 and thereafter Armed Force. It was sold to members of the Armed Forces, primarily reserve officers, and the subscription rate was about $5 a year. In February 1946 John A. Killick (hereinafter sometimes referred to as Killick) was employed by Bulletin as assistant editor because of his background service during World War II. Killick rendered editorial services to Bulletin from 1946 until the latter part of 1952.
Thurmond Chatham (hereinafter sometimes referred to as Chatham), who was chairman of the board of the Chatham Manufacturing Company of North Carolina and a member of the Congress of the United States, was the principal organizer of Bulletin and its financial backer over a period of years. Bulletin's revenue was derived from advertising and from subscriptions which fluctuated anywhere from 4,000 to a maximum of about 20,000. Bulletin's current revenues were insufficient to meet its operating expenses and it sustained a substantial operating net loss for each of the fiscal years ended July 31, 1946, to July 31, 1952, inclusive. During the period from Bulletin's first year of operation until Chatham disposed of his interest in the corporation Chatham regularly made substantial advances of funds with which Bulletin met its current operating expenses and was able to continue in business.
Bulletin's operating net losses, according to its original and/or amended tax returns, and Chatham's total advances to Bulletin for each of the indicated fiscal years were as follows:
+---------------------------------------------+ ¦Fiscal year ended¦Net loss per¦Advances by ¦ +-----------------+------------+--------------¦ ¦July 31- ¦return ¦Chatham ¦ +-----------------+------------+--------------¦ ¦1946 ¦$74,104.03 ¦1 $31,881.51¦ +-----------------+------------+--------------¦ ¦1947 ¦84,881.97 ¦80,000.00 ¦ +-----------------+------------+--------------¦ ¦1948 ¦110,347.30 ¦114,000.00 ¦ +-----------------+------------+--------------¦ ¦1949 ¦80,627.02 ¦70,000.00 ¦ +-----------------+------------+--------------¦ ¦1950 ¦94,411.66 ¦90,000.00 ¦ +-----------------+------------+--------------¦ ¦1951 ¦25,559.74 ¦20,000.00 ¦ +-----------------+------------+--------------¦ ¦1952 ¦19,647.76 ¦0 ¦ +---------------------------------------------+
On July 31, 1946, pursuant to a resolution of the board of directors, Bulletin issued 3,188 shares of its stock at $10 per share to Chatham in cancellation of his advances totaling $31,880 during the fiscal year ended July 31, 1946, which amount was transferred to Bulletin's capital stock amount. On August 6, 1946, Bulletin issued 1,500 shares of its stock to Chatham for $15,000 cash paid in by him, making a total of 6,088 shares issued to Chatham as of that date.
From September 10, 1946, to June 1, 1948, inclusive, Chatham made 17 separate advances totaling $184,000 to Bulletin for which the latter gave its 30-day promissory notes bearing 3 percent interest. No interest was paid on such notes. On June 7, 1948, Chatham returned to Bulletin its notes in the amount of $184,000 for cancellation of the debt as a contribution to capital and thereupon such amount was treated as paid-in capital surplus, bringing the total equity capital of Bulletin to $261,880 at that time.
On June 7, 1948, Chatham returned to Bulletin 4,000 of his 6,088 shares of stock as a contribution to the corporation for reissuance as an incentive to certain officers to remain with the company. On June 23, 1948, such 4,000 shares were reissued in the amounts of 1,500 shares to John A. Killick, vice president; 1,500 shares to Raleigh Hansl, Jr., secretary; and 1,000 shares to J. Milton Cooper, vice president and treasurer. Those three men were also directors of Bulletin at that time.
From July 1, 1948, to September 22, 1950, Chatham made 18 separate advances totaling $190,000 to Bulletin for which the latter gave its 30-day promissory notes bearing 3 percent interest. No interest was paid to Chatham on such notes, and he never made demand for payment of those notes.
In 1950 Chatham announced his intention to discontinue the publication of the magazine Armed Force. Thereupon Killick acquired all of Chatham's 2,088 shares of Bulletin stock together with the notes of Bulletin in the face amount of $190,000 held by Chatham for the nominal sum of $200 to cover the cost of transferring the stock. At that time Bulletin was operating at a loss, it had a deficit of approximately $500,000 in earned surplus, and its notes for $190,000 were worthless. At his request Killick purchased the notes with the stock in a ‘package deal,‘ with the hope that if Bulletin succeeded in operating at a profit he would benefit as a stockholder and also as possessor of the notes which he regarded as valid obligations of Bulletin. Chatham was willing to transfer the Bulletin stock and notes to Killick for a nominal sum in order to wind up his connection with Bulletin and thus avoid trouble, embarrassment, and prospective lawsuits. Upon acquisition of Chatham's stock, Killick held the controlling interest in Bulletin consisting of 3,588 shares of the issued and outstanding stock.
After acquiring control of Bulletin in 1950 Killick ran the business and continued publication of the magazine Armed Force for about 2 years. During that time there were periods when Bulletin broke even, but on its fiscal year basis Bulletin's revenues were insufficient to meet current expenses, and it continued to operate at a loss. Trade creditors were paid as regularly as possible. No interest was paid on Bulletin's notes in the face amount of $190,000 held by Killick. Subscriptions at $5 a year were obtained principally through direct mail solicitation and to some extent through post exchange stores and through subscription agencies. Advertising was obtained through direct solicitation. Sometime during 1951 the magazine Armed Force was printed on cheaper paper resembling newsprint. Both subscriptions and advertising declined steadily toward the latter part of 1952. By September 1952 Bulletin's financial situation was such that it had to obtain additional operating funds or go into bankruptcy.
In September 1952 Killick went to Ryder and stated that he was in financial difficulties and proposed that Ryder acquire Bulletin. Killick approached Ryder in that regard because the latter had sought to buy Bulletin during 1951, and also because of Ryder's standing in the field of military publications. Killick had put a great deal of time and effort into the publication of Armed Force and he was interested in the publication being continued and his staff being saved from abruptly losing their jobs. However, at that juncture Killick was not as much interested in what Ryder might accomplish in continuing the publication as he was in getting out from under his situation of being faced with failure and bankruptcy. Killick knew that he was in no position to bargain on the proposed sale. Ryder was fully aware that Chatham had previously financed Bulletin and that, after Killick took over control in 1950, Bulletin had insufficient financing, its publication had gone downhill, and its advertising had steadily declined. Killick fully advised Ryder as to Bulletin's operating net losses and its current financial situation. Ryder was interested solely in acquiring Bulletin's stock and notes as a ‘package deal’ and never made any offer to acquire only the assets of Bulletin. During the negotiations Ryder evidenced an interest in continuing the publication Armed Force, at least to the extent necessary to fulfill Bulletin's subscription and other contract obligations.
Sometime in September 1952 Ryder's accountant examined the books and records of Bulletin and found that no entries had been made therein since March 1952. Thereupon the accountant's staff started the work of bringing the entries up to date and getting the books in shape to determine accurately Bulletin's financial situation and particularly its current liabilities.
On October 13, 1952, in consideration of $1, Killick granted Ryder a 10-day option to purchase Bulletin's entire outstanding capital stock and its notes payable in the face amount of $190,000 with interest due thereon. On October 21, 1952, the parties mutually agreed to extend the option 1 day to include October 24. Ryder agreed that if the option was exercised he would pay the sum of $1 for Bulletin's stock and notes and as further consideration he agreed to advance funds to satisfy Bulletin's current liabilities and to cause Bulletin to enter into employment contracts with its personnel and to fulfill its subscription obligations.
In June 1951 Killick had acquired the 100 shares of Bulletin stock originally issued to Charles G. Moore, and during the negotiations with Ryder in 1952 Killick acquired the balance of Bulletin's stock then outstanding in the hands of other persons. On October 15, 1952, a certificate for 7,788 shares of Bulletin stock was issued to Killick.
Ryder's accountant and his staff brought the posting of entries in Bulletin's books up to date as of October 16, 1952, and for Ryder's information prepared a detailed schedule showing Bulletin's current liabilities in the total amount of $25,480.66 on that date. At that time Ryder was particularly interested in the current liabilities which had to be met to maintain Bulletin as a going concern. The schedule of current liabilities embraced numerous items listed under the designations ‘Accounts Payable,’ ‘Texas,‘ and ‘Commissions, Etc.’ The latter designation included amounts due various persons for commissions, advertising representation, editorial and art work, and also a liability of $6,096.08 to Killick. That schedule of current liabilities did not include any item of notes payable or accrued interest thereon. A separate item showed ‘Notes To Stockholders $190,000.00.’ The accountant's work on Bulletin's books was continued and a balance sheet made as of October 31, 1952. During the audit Bulletin's operating losses were ascertained and a statement was furnished to Ryder. Also during the audit Ryder discussed with his accountant the matter of whether Bulletin's notes in the face amount of $190,000 should be turned in or converted into 10-year debenture bonds as a basis for possible future capital gains upon the redemption thereof if and when the corporation made money. Ryder was desirous of obtaining capital gains on a future redemption of the notes. During that audit no check was made by Ryder's accountant or anyone else in regard to the circulation of Bulletin's publication Armed Force.
On October 16, 1952, at the suggestion of his tax counsel, caused Bulletin's board of directors to adopt a resolution which confirmed and ratified the company's issuance of the series of original notes for the principal amount of $190,000 as evidence of indebtedness to Thurmond Chatham and, further, adopted a resolution that Bulletin issue to the holder of such notes a new note for such principal amount plus accrued but unpaid interest thereon as a debt obligation of Bulletin. Pursuant thereto Bulletin issued its 30-day promissory note, dated October 16, 1952, payable to John A. Killick in the principal sum of $207,787.88 with interest at 3 percent per annum. Killick had no reason for converting the series of old notes into a single note payable to himself other than for the purpose of facilitating the sale to Ryder. The new note was uncollectible and worthless upon its issuance, but Ryder viewed it as an obligation of the corporation which would be payable in the future if Bulletin operated as a profit.
On October 24, 1952, Killick and Ryder entered into an agreement whereby, in consideration of $1, Killick transferred to Ryder all his right, title, and interest in 7,788 shares of stock of Bulletin and the latter's promissory note for $207,787.88. On the same date a certificate for 7,788 shares of Bulletin stock was issued to Melvin Ryder and the said note was endorsed by Killick payable to the order of Melvin Ryder without recourse.
On October 24, 1952, Ryder and Killick entered into a second agreement whereby, based solely upon Killick's representations that in addition to the original notes in the face amount of $190,000 Bulletin's ‘Current Liabilities' as shown by its books and records amounted to the total sum of $25,480.66 and based upon Killick's further assurance that some of those liabilities as shown by the schedule of October 16, 1952 (made a part of the agreement), were in fact not liabilities and others would be compromised, Ryder agreed to undertake (a) to provide as loan or capital contribution sufficient funds to enable Bulletin to compromise or otherwise satisfy such ‘Current Liabilities,’ (b) to cause Bulletin to enter into suitable employment contracts with its present personnel, and (c) to cause Bulletin to fulfill its present subscription obligations to the subscribers of its publication. It was understood that Killick neither assumed nor agreed to become liable for any obligation of Bulletin. Further, it was understood that, in the event obligations or claims against Bulletin were asserted in addition to those detailed in the agreement, the undertakings of Ryder expressed in such agreement would cease and terminate forthwith.
Sometime during the option period Killick told Ryder that he might not be able to get out even one more issue of Armed Force. Ryder found that the printers, engravers, and other creditors were not willing to extend further credit and that the payroll was overdue. Stoppage of publication was threatened and such event would have been a detriment to Bulletin and subjected it to lawsuits. Ryder went to the principal creditors, told them that he was interested in Bulletin, and gave his guarantee for the extension of further credit to publish the next issue. Ryder also advanced some money to meet Bulletin's payroll, rent, and other obligations. After Ryder's acquisition of Bulletin on October 24, 1952, and with Killick's assistance, he proceeded to compromise and settle the liabilities of Bulletin outstanding as of October 16, 1952, in the amount of $25,480.66 at a saving of $10,814.31. In connection with such settlements Killick, as a creditor, received $4,000 in compromise of his $6,096.08 claim.
During October 1952 and in addition to posting Bulletin's books Ryder's accountant prepared and filed Bulletin's payroll tax returns and its income tax return for the fiscal year ended July 31, 1952. A statement of Bulletin's assets and liabilities at October 31, 1952, as prepared by Ryder's accountant and which did not list the publication Armed Force as an asset, was as follows:
+-----------------------------------------------------------+ ¦ASSETS ¦ ¦¦ +------------------------------------------------+---------+¦ ¦Current assets: ¦ ¦ ¦¦ +---------------------------------------+--------+---------+¦ ¦Cash on deposit—Riggs National Bank ¦$358.47 ¦ ¦¦ +---------------------------------------+--------+---------+¦ ¦Petty cash fund ¦18.01 ¦ ¦¦ +---------------------------------------+--------+---------+¦ ¦Accounts receivable—advertising ¦1,430.00¦ ¦¦ +---------------------------------------+--------+---------+¦ ¦Accounts receivable—circulation ¦136.68 ¦ ¦¦ +---------------------------------------+--------+---------+¦ ¦Total current assets ¦ ¦$1,943.16¦¦ +---------------------------------------+--------+---------+¦ ¦Fixed assets: ¦ ¦ ¦¦ +---------------------------------------+--------+---------+¦ ¦Furniture and fixtures ¦4,077.67¦ ¦¦ +---------------------------------------+--------+---------+¦ ¦Less reserve for depreciation ¦2,132.81¦ ¦¦ +---------------------------------------+--------+---------+¦ ¦Total fixed assets ¦ ¦1,944.86 ¦¦ +---------------------------------------+--------+---------+¦ ¦Other assets and deferred charges: ¦ ¦ ¦¦ +---------------------------------------+--------+---------+¦ ¦Deposits with postmaster ¦72.48 ¦ ¦¦ +---------------------------------------+--------+---------+¦ ¦Prepaid insurance ¦25.72 ¦ ¦¦ +---------------------------------------+--------+---------+¦ ¦Deferred taxes ¦36.24 ¦ ¦¦ +---------------------------------------+--------+---------+¦ ¦Total other assets and deferred charges¦ ¦134.44 ¦¦ +---------------------------------------+--------+---------+¦ ¦Total assets ¦ ¦4,022.46 ¦¦ +-----------------------------------------------------------+
LIABILITIES AND NET WORTH (DEFICIT) Current liabilities: Loans payable $5,000.00 Accounts payable 7,342.79 Accrued interest 259.85 Accrued salaries 427.00 Accrued commissions 301.96 Accrued taxes and wage deductions 245.27 Total current liabilities $13,576.87 Other liabilities: Notes payable to stockholders 207,787.88 Deferred income: Subscription liability 13,930.98 Prepaid advertising 880.00 Total deferred income 14,810.98 Net worth (deficit): Capital stock—no par value—10,000 shares authorized—7,788 shares outstanding 77,880.00 Surplus arising from contribution of notes payable 184,000.00 Surplus arising from compromise of accounts payable 10,814.31 Surplus arising from change of accounting method of handling bad debts 1,854.97 Deficit from operations to 7-31-52 (504,828.01) Deficit from operations 8-1-52 to 10-31-52 (1,874.54) Total net worth (deficit) ($232,153.27) Total liabilities and net worth (deficit) 4,022.46
For some time prior to September 1952 the officers of Publishing Company had discussed plans for organizing a sales company to handle the sales of Publishing Company's publications but no action had been taken in that regard. Bulletin was not acquired specifically for the purpose of making it a sales company, but sometime around November 3 or 4 it was determined that the publication of Armed Force would be discontinued and, further, that the corporate structure of Bulletin should be used in setting up a sales company.
On November 6, 1952, the board of directors of Bulletin adopted a resolution authorizing its officers to file such notices and documents as required to amend its articles of incorporation to change Bulletin's name to Army Times Sales Company. It was further resolved that a special meeting of the stockholders of Bulletin be called and held on November 20, 1952, to take action on such change of name. The proposed change of Bulletin's name was for the purpose of reflecting the proposed new line of business activity.
On November 7, 1952, the board of directors of Bulletin adopted a resolution the preambles of which set forth that the corporation was indebted to Ryder as the holder in due course of its 30-day promissory note to the order of John A. Killick in the principal amount of $207,787.88 dated October 16, 1952, with interest at 3 percent; that as of November 15, 1952, there would be $208,307.35 including interest due Ryder; that the corporation was insolvent as shown by its balance sheet of October 31, 1952; that the corporation desired an extension of time for payment under conditions which would permit its continued operation without undue financial hardship; and that Ryder had offered to surrender the note with interest thereon in exchange for 10-year, 3 percent debentures in the aggregate amount of $208,307.35. It was thereupon resolved that the corporation issue its 10-year, 3 percent debentures due November 15, 1962, in the aggregate amount of $208,307.35, and deliver the same to Ryder in exchange for the above-mentioned promissory note held by him.
The last issue of Armed Force was dated November 8, 1952, and was published on or about that date. Killick wrote the editorial which stated, inter alia, that it was the final issue, that thereafter it would be combined with ‘Navy Times,’ and that each subscriber would be given the opportunity to take a substitute subscription to Navy Times, Army Times, or Air Force Times from Publishing Company or take a refund on his unexpired subscription. Most of such subscribers elected to receive one of those three publications and Armed Force has not been published since.
Sometime in the latter part of October 1952 Killick advised Ryder that he would not remain with Bulletin as had been contemplated during the negotiations and that he had accepted another position, but Killick did stay on with Bulletin until its last issue was published. After the final issue of Armed Force some of Bulletin's seven employees went to work for Publishing Company and the others quit.
After the cessation of Armed Force publication the first succeeding issue on November 15, 1952, of Navy Times included in its masthead the name Armed Force. That issue carried an announcement that the newspaper Armed Force had been combined with Navy Times and, further, that former Armed Force subscribers could receive Navy Times, Army Times, or Air Force Times as they preferred.
On November 15, 1952, Bulletin issued its 10-year, 3 percent debentures due November 15, 1962, in a series aggregating $208,307.35 to Ryder, pursuant to the above-mentioned corporate resolution of November 7, 1952. On November 15, 1952, Ryder gave a total of $55,000 face amount of the debentures in varying amounts to Aronoff, Ferne Hunsehe, R. W. Hunsehe, Kerby, Lynch, and Waldo, hereinabove mentioned as minority stockholders and also employees (except for Aronoff) of Publishing Company. With each such gift Ryder sent an accompanying letter stating: ‘Here are some debentures that I hope some day will be worth something. They are not worth anything now as far as being able to collect on them, but if things work out all right, I feel sure that they will some day be worth money.’
On November 20, 1952, the certificate of incorporation of Bulletin was amended to change its name to Army Times Sales Company and to change its resident agent and his address.
On Thanksgiving Day 1952 the furniture and fixtures of Sales Company were moved to the offices of Publishing Company. On November 28, 1952, Publishing Company and Sales Company executed a contract whereby the former acquired all of the latter's right, title, and interest in the publication Armed Force including copyrights, trade name, circulation rights, subscription agreements, renewals, and also advertising agreements.
On November 28, 1952, Publishing Company and Sales Company entered into an agreement which provided that Publishing would pay Sales 4o percent of subscriptions obtained by Sales to the publications of Publishing to the extent paid or collected. In addition thereto Publishing agreed (a) to pay as additional commissions to service post exchanges an additional 5 percent of subscriptions obtained by Sales through employees of post exchanges; (b) to provide Sales without cost to it all subscription receipt books, booklets, literature, and sample copies of publications of Publishing; (c) to advance or otherwise finance the expenses of subscription salesmen employed by Sales, such amounts to be considered as advances on amounts due Sales as commissions; and (d) to provide postage, shipping, telephone, and office space to Sales, such costs and expenses to be considered as advances on amounts due Sales as commissions. The agreement provided that Sales agreed to secure and transfer to Publishing a minimum of 5,000 subscriptions per month to the publications of Publishing, commencing not later than 90 days after the date of the agreement. Thereafter the offices of Sales were at the same location as those of Publishing. Publishing Company had a large number of employees and after about November 28, 1952, a number of its employees, particularly salesmen, have transferred back and forth between Sales and Publishing to suit their convenience.
With respect to the above-mentioned 10-year, 3 percent debenture bonds in the aggregate face amount of $208,307.35 originally issued by Bulletin on November 15, 1952, to Ryder and on the same date reissued to Ryder and six other persons, Sales Company made payments in retirement thereof during the indicated fiscal years ended July 31 as follows:
+-----+ ¦¦¦¦¦¦¦ +-----+
As reissued Paid during Paid during Paid during Total Name on 11-15-52 fiscal year fiscal year fiscal year payments 7-31-53 7-31-54 7-31-55 M. Ryder $153,307.35 $8,307.35 $5,000 $10,000 $23,307.35 I. Aronoff 12,000.00 2,000.00 10,000 12,000.00 F. H. Hunsehe 1,000.00 1,000.00 1,000.00 R. W. Hunsehe 36,000.00 4,000.00 12,000 10,000 26,000.00 F. Kerby 1,000.00 1,000.00 1,000.00 L. Lynch 4,000.00 3,000.00 1,000 4,000.00 A. S. Waldo 1,000.00 1,000.00 1,000.00
208,307.35 20,307.35 18,000 30,000 68,307.35
On its tax returns for the fiscal years ended July 31, 1953, 1954, and 1955 Sales Company claimed deductions as accrued interest on debenture bonds in the amounts of $6,374.36, $5,295, and $4,515.04, respectively.
On its tax returns for the fiscal years ended July 31, 1953 and 1954 Sales Company reported its net income (before net operating loss deduction), net operating losses incurred by Bulletin claimed as net loss carryovers, net income after net loss carryovers, income tax, and excess profits tax; and, further, on its tax return for the fiscal year ended July 31, 1955, reported net income and income tax as follows:
+-----+ ¦¦¦¦¦¦¦ +-----+
Net income Claimed Net income Fiscal year (before net net loss after loss Income Excess July 31— loss deductions) carryover carryover tax profits tax 1953 $32,040.97 $139,619.16 0 0 0 1954 52,999.04 45,207.50 $7,791.54 $2,337.46 0 1955 27,468.59 8,783.67
The claimed net operating loss carryover of $139,619.16 for the fiscal year ended July 31, 1953, consisted of Bulletin's prior fiscal year net operating losses in the amounts of $94,411.66 for 1950, $25,559.74 for 1951, and $19,647.76 for 1952. The claimed net operating loss carryover of $45,207.50 for the fiscal year ended July 31, 1954, consisted of the said net operating losses for the fiscal years 1951 and 1952.
Sales Company has never paid a formal dividend.
In determining the deficiencies involved herein with respect to the corporate petitioner, respondent determined that under the provisions of section 129 of the Internal Revenue Code of 1939 the corporate petitioner is not entitled to the claimed deductions (a) for net operating loss carryovers for the fiscal years ended July 31, 1953 and 1954, and (b) for interest on debenture bonds for the fiscal years ended July 31, 1953, 1954, and 1955.
On July 15, 1953, Melvin Ryder received $8,307.35 distributed by Army Times Sales Company in retirement and redemption of its debenture bonds in that face amount. On the joint income tax return of Melvin and Florence Ryder for the calendar year 1953 the redemption of such bonds was reported as a sale of capital assets having no cost basis and entitled to the benefit of the long-term capital gains provisions. In determining the deficiency involved herein with respect to the individual petitioners, respondent determined that under the provisions of section 129 of the Internal Revenue Code of 1939 petitioners are not entitled to the benefits of the long-term capital gains provisions and that such distribution of $8,307.35 constituted ordinary income in 1953.
On October 24, 1952, Melvin Ryder acquired by purchase from John A. Killick in a ‘package deal’ for a consideration of $1 all of the 7,788 shares of outstanding capital stock, and the $207,787.88 principal amount promissory note of petitioner corporation then named Army and Navy Bulletin, Inc., and subsequently named Army Times Sales Company. Melvin Ryder thereby directly acquired after October 8, 1940, control of petitioner corporation. Prior to and at the time of such acquisition petitioner corporation was insolvent and on the verge of bankruptcy, and its promissory note was uncollectible and worthless.
The principal purpose of Melvin Ryder for acquiring control of the corporate petitioner was to evade or avoid Federal income tax by securing to himself, both as sole shareholder and possessor of a note, the benefit of deductions, credits, and other allowances which he would not otherwise enjoy, namely, the benefit of deductions for net operating losses incurred by the corporate petitioner in fiscal years prior to such acquisition and deductions for interest on the corporate petitioner's note which had become worthless prior to such acquisition and was thereafter converted into the form of debenture bonds and, further, the benefit of long-term capital gains treatment of the corporate petitioner's distributions in retirement and redemption of such debenture bonds.
OPINION.
KERN, Judge:
Respondent contends that the provisions of section 129(a) of the Internal Revenue Code of 1939
and the similar provisions of section 269 of the Internal Revenue Code of 1954 prohibit the allowance of the net operating loss deductions and interest deductions claimed by Army Times Sales Company, and also the allowance of capital gains treatment of income derived from redemption of that company's debenture bonds as claimed by Melvin Ryder, because his primary purpose for acquisition of control of Sales Company was the avoidance of Federal income tax by securing the benefit of such deductions and allowances which he would not otherwise enjoy.
Decisions will be entered for the respondent. SEC. 129. ACQUISITIONS MADE TO EVADE OR AVOID INCOME OR EXCESS PROFITS TAX.(a) DISALLOWANCE OF DEDUCTION, CREDIT, OR ALLOWANCE.— If (1) any person or persons acquire, on or after October 8, 1940, directly or indirectly, control of a corporation, or (2) any corporation acquires, on or after October 8, 1940, directly or indirectly, property of another corporation, not controlled, directly or indirectly, immediately prior to such acquisition, by such acquiring corporation or its stockholders, the basis of which property, in the hands of the acquiring corporation, is determined by reference to the basis in the hands of the transferor corporation, and the principal purpose for which such acquisition was made is evasion or avoidance of Federal income or excess profits tax by securing the benefit of a deduction, credit, or other allowance which such person or corporation would not otherwise enjoy, then such deduction, credit, or other allowance shall not be allowed. For the purposes of clauses (1) and (2), control means the ownership of stock possessing at least 50 per centum of the total combined voting power of all classes of stock entitled to vote or at least 50 per centum of the total value of shares of all classes of stock of the corporation. (So far as here applicable, section 269 of the 1954 Code contains no substantial change.) -------- Notes:
$1.51 of this amount was repaid to Chatham in cash.
In the alternative, with respect to the corporate petitioner, respondent contends that the net operating losses are not allowable deductions because the business which produced the income against which the losses are claimed as an offset was not the business which produced the losses and therefore Sales Company is not the taxpayer that incurred the losses. Further, in the alternative, with respect to both the Sales Company and Melvin Ryder, respondent contends that the debenture bonds were not a bona fide indebtedness or even if so the debt had been extinguished and accordingly interest thereon is not deductible by Sales Company and the distributions by that company in redemption of the debentures held by Melvin Ryder constituted dividends taxable to him as ordinary income.
The primary contentions of petitioners are: (1) That Ryder's acquisition of control of the corporate petitioner was not for the interdicted purpose mentioned in the cited Code sections but instead was principally for the business purpose of continuing the publication of Armed Force, and (2) that the subsequent decision to discontinue the publication and change the operating function of the corporation was predicated upon discovery of the hopeless condition of the circulation of Armed Force, the lack of sufficient advertising revenue, and other adverse circumstances, and when the discontinuance of the publication was decided the corporate organization merely became available for use as the selling agent of Army Times Publishing Company. Petitioners further contend that in any event Sales Company is not an acquiring corporation within the statute involved but instead is the same taxpayer which earned income in the taxable years involved and is entitled to the allowance of its own interest and net operating loss deductions, and also that Ryder, the individual acquirer of control of Sales Company, is not the taxpayer seeking the benefit of such deductions.
The petitioner Ryder contends that, as an owner in due course of valid debenture bonds of Sales Company, the amount received by him in 1953 in retirement and redemption thereof constituted an exchange under section 117(b) of the Internal Revenue Code of 1939, and accordingly is taxable as a capital gain.
In Thomas E. Snyder Sons Co., 34 T.C. 400, and Urban Redevelopment Corporation, 34 T.C. 845, this Court decided that section 129, I.R.C. 1939, and section 269, I.R.C. 1954, are applicable to deny the benefit of a net operating loss deduction even though the person acquiring control of a corporation was not the taxpayer directly claiming the corporation's loss carryovers, where it was found that the principal purpose for the acquisition was tax avoidance by securing the benefit of a deduction which such person would not otherwise enjoy. In the instant proceedings, if the acquisition of control was made for the purpose of tax avoidance, the cited cases are direct authority for disallowing the corporate petitioner's claimed deductions for net operating losses incurred prior to the acquisition. Further, assuming the requisite intent or purpose and assuming that the promissory note represented a valid outstanding indebtedness at the time of Ryder's acquisition of the note and control of the corporate petitioner, we are of the opinion that the cited cases are authority for disallowing Sales Company's claimed deductions for interest on debenture bonds issued in substitution for such note, for the reason that they fall into the same category as the net operating losses in serving as the basis for securing the benefit of a deduction which the acquiring person would not otherwise enjoy but for such acquisition.
The judicial ascertainment of someone's subjective interest or purpose motivating actions on his part is frequently difficult. One method by which such ascertainment may be made is to consider what the immediate, proximate, and reasonably to be anticipated consequences of such actions are and to reason that the person who takes such actions intends to accomplish their consequences. This reasoning is implicit in the Late maxim ‘acta exteriora indicant interiora secreta’, and in the more homely English adage ‘actions speak louder than words.’
In the instant case the immediate, proximate, and admittedly anticipated results of the acquisition of Sales Company by Ryder were the securing to him of definite and valuable tax advantages.
Petitioners rely upon oral testimony to substantiate their primary contentions that Ryder's acquisition was motivated principally by a bona fide business purpose, that he gave little or no consideration to securing any tax benefits which he would not otherwise enjoy although he was fully aware of the acquired corporation's net losses and outstanding note, and that the changes in name and business activity of the acquired corporation were due to decisions reached after the acquisition. We have given careful consideration to the oral testimony so relied upon. In the light of the facts established by the record and what actually transpired, we are not persuaded by this testimony that the respondent has erred in his determination, which is of course presumed to be correct. It does not seem plausible that Ryder, a successful publisher of several service publications having substantial domestic and foreign circulation, made the acquisition principally as a business venture and for the principal purpose of pumping new financial life into the then insolvent corporation faced with bankruptcy so as to continue the publication of the magazine Armed Force which he knew had been a financial failure from its inception. The basic facts and circumstances surrounding Ryder's ‘package deal’ acquisition of the stock of the so-called ‘loss' corporation and its worthless note, the pattern of the various steps taken, and the sequence of events in connection with the entire transaction embracing the negotiations, acquisition, conversion of the note to bonds, and shifting of a part of Publishing Company's business to the acquired corporation compel a different conclusion from that sought by petitioners herein. We have set forth detailed findings of the factual circumstances involved and it would serve no useful purpose to here review or summarize those facts.
We conclude that Ryder's principal purpose for acquiring control of the corporate petitioner was to avoid Federal income tax by securing to himself, as sole stockholder, the benefit of deductions of the corporation's net operating losses and interest as a note, which deductions he would not otherwise have enjoyed. We further conclude that, as part and parcel of such acquisition of control, Ryder's acquisition of the note and the conversion thereof into debenture bonds were for the principal purpose of avoiding Federal income tax by securing to himself individually the benefit of the allowance of capital gains treatment of the corporation's payments or distributions in redemption of such debenture bonds. Having so found, section 129, I.R.C. 1939, and section 269, I.R.C. 1954, require the disallowance of the corporate petitioner's claimed deductions for interest and net loss carryovers and the disallowance of the individual petitioner's claim for capital gains treatment of income derived from redemption of that company's debenture bonds.
In view of the above conclusions, it is not necessary to discuss the various alternative contentions of the parties herein.