Opinion
No. 46963.
May 2, 1949.
Cornelius W. Grafton, of Louisville, Ky. (Henry H. Mathis, and Wyatt, Grafton Grafton, all of Louisville, Ky., on the brief), for plaintiff.
J.H. Sheppard, of Washington, D.C. and Theron Lamar Caudle, Asst. Atty. Gen. (Robert N. Anderson and Andrew D. Sharpe, both of Washington, D.C. on the brief), for defendant.
Before JONES, Chief Judge, and LITTLETON, WHITAKER, MADDEN and HOWELL, Judges.
Action by the Cumberland Public Service Company against the United States to recover back the amount of a tax deficiency assessment after the tax had been paid and a claim for refund had been disallowed.
Judgment for plaintiff.
This case having been heard by the Court of Claims, the court, upon the evidence and the report of a commissioner, makes the following
Special Findings of Fact.
1. Cumberland Public Service Company (herein sometimes called "Cumberland"), a Kentucky corporation, was organized in 1929 to engage in the business of generating electricity and distributing it at retail in an area comprising three counties in Southern Kentucky. It had an authorized capital stock of 500 shares, of which only 400 were ever issued. These were issued as follows:
Shares W.L. McComas .................................. 200 E.S. Mayes .................................... 197 W.F. Grigsby .................................. 3
2. In 1937, W.L. McComas transferred 40 shares to himself as trustee for his daughter, Elizabeth O. McComas, and 40 shares each to himself as trustee for his three sons, D. Keith McComas, W. Leslie McComas, Jr., and Jack D. McComas, retaining 40 shares in his own name. In 1937, Finley M. Mayes acquired the three shares theretofore standing in the name of W.F. Grigsby. At the same time E.S. Mayes transferred to Finley M. Mayes 47 shares, to Zana M. Mayes 50 shares, and to KatherineT. Mayes 50 shares. As a result of the above transfers, late in 1937, the stockholdings were as follows:
Shares E.S. Mayes ............................................ 50 Zana M. Mayes (wife of E.S. Mayes) .................... 50 Finley M. Mayes (son of E.S. Mayes) ................... 50 Katherine T. Mayes (wife of Finley) ................... 50 W.L. McComas .......................................... 40 W.L. McComas, Trustee for Elizabeth O. McComas, (daughter) ........................................... 40 W.L. McComas, Trustee for D. Keith McComas (son) ................................................ 40 W.L. McComas, Trustee for W. Leslie McComas, Jr. (son) ............................................ 40 W.L. McComas, Trustee for Jack D. McComas (son) ................................................ 40 --- Total shares outstanding ........................... 400
3. On or about March 17, 1941, the plaintiff corporation filed with the appropriate Collector of Internal Revenue its final corporation income tax, declared value, excess profits tax and defense tax return for the calendar year 1940 and reported therein a loss of $7,602.49 and no tax liability. In the computation of such loss, the plaintiff disclosed the various transactions here involved with regard to the sale of the transmission and distribution lines and equipment to Tri-County Electric Membership Corporation (herein sometimes called "Tri-County") and alleged in the return that such sale had been made by the stockholders and not by the corporation. The return further disclosed the sale to Messrs. McComas and Mayes of the real estate at Burkesville and Tomkinsville, Kentucky, and the machinery and equipment referred to hereinbefore. In the return the plaintiff claimed a deduction from gross income, as a loss, the difference between the depreciated book values of such property and the prices at which the property was sold to Messrs. McComas and Mayes. In the computation of the loss the plaintiff disclosed in the return the transactions by which the transmission and distribution lines and equipment were sold to Tri-County and claimed that the sale had been made by the stockholders after a distribution of the assets to the stockholders. The return further disclosed as contributing to the loss the sales by the corporation of certain real estate and machinery and equipment to two of the stockholders at less than the book value thereof.
The Commissioner of Internal Revenue, in his audit of the return, made adjustments which resulted in a deficiency in tax. The Commissioner determined that the property had been sold by the corporation rather than by the stockholders and also disallowed the losses claimed from the sales of the other property to the stockholders. The asserted deficiency of $17,054.70 was duly assessed and, together with interest thereon, was paid by the plaintiff as follows:
Deficiency .................. $17,054.70. Paid Oct. 15, 1943. Interest .................... $ 2,643.48. Paid Dec. 16, 1943.
The said sum of $19,698.18 was procured by plaintiff by pro rata assessments against its former stockholders, since all of the assets of the corporation had theretofore been distributed in liquidation.
4. On July 26, 1944, the plaintiff filed a claim for refund with the Commissioner of Internal Revenue seeking a refund of taxes for the year 1940 in the amount of $19,698.18 paid as aforesaid. In such claim the plaintiff alleged that the Commissioner of Internal Revenue had erred in his determinations that the sale to Tri-County of plaintiff's transmission and distribution lines and facilities had been made by the corporation rather than its stockholders and that the plaintiff was not entitled to the losses claimed in its return of the difference between the depreciated book values of the property sold to Messrs. McComas and Mayes and the amounts for which such property was so sold.
By registered letter dated August 18, 1945, the Commissioner of Internal Revenue rejected plaintiff's claim for refund in full.
Sale of Distribution Properties.
5. Tri-County Electric Membership Corporation is a cooperative corporation which was organized under the laws of Tennessee in 1936. Tri-County obtained electrical energy from Tennessee Valley Authority and distributed it in an area comprising six counties in Tennessee and six counties in Kentucky, including three Kentucky counties served also by Cumberland. From its organization, it was the plan and purpose of the manager of Tri-County to acquire the transmission and distribution system owned and operated by Cumberland. Tri-County did not have any substantial funds of its own. Whenever it considered the acquisition of substantial additions to its electric distribution systems, it turned to the Rural Electrification Administration, Washington, D.C. (sometimes called "REA") for a loan sufficient to pay the purchase price. REA was accustomed to making such loans to local cooperatives if the REA engineers considered the price to be satisfactory and the investment sound. Soon after Tri-County began operating, it became evident to the officers of Cumberland that Cumberland would have either to acquire power from Tennessee Valley Authority or sell its properties to Tri-County, and negotiations to that end continued more or less regularly thereafter. In October 1939, W.L. McComas called upon J.A. Krug, Chief Power Engineer, Tennessee Valley Authority, for the purpose of ascertaining whether power could be secured from the Tennessee Valley Authority, or, if not, if a sale of plaintiff's properties could be effected. The price asked for the properties by Mr. McComas was $156,000 which was based on an appraisal made in July 1939, a copy of which had been previously furnished to Mr. Krug and which indicated the following values for the property named:
Generation:
A. Burkesville:
I. Land ........................ $2,000.00
II. Buidings:
a. Generating Plant ........ 3,500.00 b. Storage ................. 500.00
III. Equipment:
a. Diesel Power Units Alter. Exciters, Sw. Bd. Misc Aux. Equipment ......... 28,955.51
B. Tomkinsville:
I. Land ........................ 750.00 II. Buidings .................... 1,000.00
III. Equipment:
a. Obsolete equipment ...... 300.00 --------- 37,005.51 Transmission and Distribution Lines and equipment .............................. 80,547.92 Refrigeration Equipment ................. 5,854.70 Trucks .................................. 900.00 Construction Expense and Going Concern Value .................................. 32,229.27
6. On February 16, 1940, representatives of plaintiff met with representatives of the REA at Murfreesboro, Tennessee, and for several days discussed the possibility of the acquisition by Tri-County of the transmission and distribution lines of the plaintiff. The officers of the plaintiff desired to sell the entire plant as a going concern and offered to sell all the stock of the corporation to Tri-County for the sum of $156,000, which was the value determined for its facilities in an appraisal which had previously been made. However, plaintiff's officers were advised that Tri-County was not interested in acquiring either the generating plants of plaintiff or an ice plant which it operated and that Tri-County desired to purchase only plaintiff's transmission and distribution lines. This was because Tri-County had an adequate source of energy supplied by Tennessee Valley Authority. Thereupon, plaintiff's officers offered to sell the stock of the company for the sum of $115,000 with the understanding that the generating plants and the ice plant would be disposed of prior to the sale. The difference between the original price suggested of $156,000 and the reduced figure of $115,000 represented the approximate appraised value of the generating equipment and the ice plant.
Prior to this meeting Mr. McComas and his counsel had discussed the method of making the sale and had agreed that it should be made by a sale of the stock by the stockholders, and not by a sale of the physical properties by the corporation. Representatives of the REA expressed some doubt as to whether or not that organization could finance a purchase of the stock of the company, but the determination of this question was deferred until the legal representatives of the REA in Washington could be consulted.
7. On April 2, 1940, William Parker, president of Tri-County, addressed a letter to the Deputy Administrator of the REA containing the following:
* * * * * *
"We have been negotiating with the owners of the Cumberland Public Service Company, a small independently owned utility, which can be bought, we believe, at a figure of around $100,000. The Cumberland Public Service Company last year grossed about $40,000. It incorporates in its territory one of the richest agricultural areas in either Tennessee or Kentucky; the farmers of this section have repeatedly petitioned us to serve them. There are now between eight hundred (800) and nine hundred (900) customers served by the Cumberland Public Service Company with over two hundred (200) additional farmers living along the transmission lines now connecting their towns. The economic conditions in this area and of the customers are unusually good.
"We would greatly appreciate your help in our acquisition of this property as we believe that it is of greatest importance to this cooperative."
8. On April 11, 1940, Mr. W.E. Herring, consulting engineer of the REA, addressed a letter to W.L. McComas reading as follows:
"A thorough study of the Cumberland Public Service Company's lines which we discussed while I was in Murfreesboro, Tennessee, discloses that we would not be warranted in approving a purchase price in excess of $86,750 for the property. This would mean that for this price you would turn over to the Tri-County Electric Membership Corporation a deed for the Cumberland Public Service Company's property exclusive of the generating plant at Burkesville and the ice plant. We would also require that the ice plant sign a three-year contract with the cooperative for its energy requirements. If this price is satisfactory to you, we can have the necessary papers prepared covering the sale of the property. In the event that the sale is consummated, we would require certain additional information, of which I am writing you in a separate letter.
"You will recall that I told you that there would be no money available for this purchase until July 1, the beginning of the next fiscal year and then only, of course, if Congress made appropriations for us. You seemed to feel that there would be no difficulty in working out some kind of a plan for the purchase to go through at present and payment to be made on or after July 1 provided funds were made available to us by Congress."
9. Mr. McComas, after consultation with Mr. Mayes, declined to accept the offer set out in finding 8. On May 15, 1940, they sent Mr. Arthur Grafton to Washington to consult with the REA. At that conference the legal department of the REA definitely advised Mr. Grafton that the REA could not lawfully advance money to Tri-County for the acquisition of the stock of plaintiff, but could advance money for the purchase of the properties themselves.
Mr. Herring, representing REA, then made an offer of $104,000 for the physical properties desired. This offer was communicated to McComas and Mayes by Grafton. McComas and Mayes then directed Grafton to write to Herring the following letter:
"Upon my return from Washington I reported our conversation to Messrs. McComas and Mayes, who felt that prior to making a commitment they should seek to ascertain what the taxes would run. We immediately employed a certified public accountant who is at Burkesville today getting certain information from the books and we are exploring two or three methods of handling the matter with possible taxes involved in each method. It will probably be the end of the week before we are able to say with any degree of assurance what the taxes will be, and until that time I am afraid my clients will be unable to make up their minds."
* * * * * *
10. Plaintiff's officers employed a firm of certified public accountants to prepare computations of the taxes which would be incurred in various ways of making the sale of the properties desired by Tri-County, that is, either by a sale of these properties by the plaintiff corporation, or by a sale of the stock in the company by the stockholders, or by dissolution of the company and a distribution of the assets to the stockholders, and a subsequent sale of the assets by the stockholders. After receiving the computations, plaintiff's officers and counsel had a conference for the purpose of considering the tax liability resulting from various ways in which the properties could be sold to Tri-County.
11. As a result of the above conference plaintiff's counsel, on May 31, 1940, addressed the following letter to W.E. Herring:
"Since my conversation with you on May 15, 1940, I have consulted with Messrs. McComas and Mayes and have in their behalf now completed a survey of the problems which would be involved in a sale to you. After considering the net result to the corporation, the directors of Cumberland, Public Service Company have determined that the corporation will not accept an offer of $104,000.00 for the transmission and distribution lines.
"Mr. McComas and Mr. Mayes individually, however, are willing to enter into a contract with the cooperative in such form as will be acceptable to your administration under the following terms and conditions.
"(1) Messrs. McComas and Mayes as individuals will acquire the transmission and distribution lines of Cumberland Public Service Company and will agree to deed the same to the cooperative for a consideration of $104,000.00, such delivery and such payment to be made as soon as practicable after September 1, 1940, and in any event within thirty days thereafter.
"(2) The cooperative will immediately and in any event, on or before June 10, 1940, without expense to my clients, procure whatever permission is necessary and make whatever connections are necessary to furnish to Cumberland Public Service Company or to Messrs. McComas and Mayes, if they are then the owners of the transmission and distribution lines, such power at standard TVA rates as they may need to supply that system.
"(3) From and after the acceptance of this proposal, if accepted, Messrs. McComas and Mayes will cause the same service to be made available to the customers of Cumberland Public Service Company and at the same rates until the date of the delivery of the deed as set out in paragraph (1) so that you will be assured of a going concern being conveyed to you. During this period the cooperative is to have the right to either (a) make any additions or extensions or improvements on the transmission and distribution lines at the expense of such cooperative or (b) upon the specific order and direction of the cooperative, Messrs. McComas and Mayes will cause such extensions, improvements and additions to be made and the actual cost thereof will be added to the purchase price.
"(4) On or before the date of the delivery of the deed, Messrs. McComas and Mayes will pay or cause to be paid all state, county, city, school district or other ad valorem taxes on said transmission and distribution lines then payable, but subject to such ad valorem taxes as may be by law then a lien against the property but not yet due and payable.
"The reason for postponing delivery of the deed to September 1st or thereafter is because that I have now ascertained that the mortgage securing the outstanding bonds of the company provides that the bonds are callable on interest payment dates only and the next interest payment date is September 1st. As I told you in Washington a substantial part of the bonds are held by friends of Messrs. McComas and Mayes but some of the bonds are otherwise held and we find that we can not count on being able to get them in and so release the mortgage prior to September 1st.
"As I explained to you in Washington, the power situation is an acute problem and while it is entirely agreeable to my clients to enter into an agreement looking to a delivery of the property in the future they can only do so in the event they are assured there will be no breakdown in the meantime. You advised me that you thought you could get from TVA permission for temporarily supplying such current where there was an actual contract under which the cooperative was to acquire the property and I assume that you have not found TVA's attitude to the contrary.
"The foregoing conditions have been discussed informally by Mr. McComas with Mr. Sullivan in an attempt to find some way in which to make the deal. It will probably take not less than two or three months in any event to complete the corporate transactions necessary to the delivery of the property in such form as is desired by your legal staff, and Mr. Sullivan expressed the view that it was to the advantage of the cooperative to have some two or three months in which to get the improvements made before actually taking over the property, as he anticipated a rush of new customers at that time.
"I am sending copies of this letter to Mr. McComas who will doubtless furnish one to Mr. Sullivan or to Mr. Parker. As soon as you have consulted with these gentlemen and can advise me whether our suggestions are practical, I will be delighted to have my clients meet you at such time and place as is convenient for a more formal agreement to work it out."
12. After arrangements had been completed for the furnishing of power by Tennessee Valley Authority, the offer of May 31 was accepted by Tri-County. By an instrument dated June 10, 1940, W.L. McComas and E.S. Mayes agreed to sell, and Tri-County agreed to purchase the facilities of plaintiff desired by Tri-County. Such instrument contained the following provisions:
"* * * Whereas, Vendors expect to acquire all of such electric transmission and distribution lines and facilities of Cumberland and, in the event of such acquisition, desire to sell to Tri-County the electric transmission and distribution lines and facilities so acquired immediately upon such acquisition, and Tri-County is willing to purchase such electric transmission and distribution lines and facilities upon the terms and conditions herein set forth;
"Now, therefore, for and in consideration of the mutual agreements herein contained, the parties hereto covenant, promise and agree as follows:
"Section 1. Vendors shall grant, bargain, sell, alien, enfeoff, remise, release, convey, confirm, transfer and deliver to Tri-County the property more particularly described in the Deed and Bill of Sale, marked `Exhibit A,' attached hereto and by this reference made a part hereof, with such additions and betterments as may be made to the existing system of Cumberland between the date of this contract and the Closing Date hereinafter provided for, all with covenants of warranty as set forth in such Exhibit A, free and clear of all liens and encumbrances of every kind and nature whatsoever, except ad valorem taxes which are to be prorated and provided for as set forth in Section 5 hereof. Such properties shall be conveyed as a going electric system with the exclusive right as between the parties hereto and parties in privity with them to serve the consumers being served through such properties at the time of such conveyance. The Deed and Bill of Sale shall be executed and delivered in a sufficient number of counterparts to permit Tri-County to record such instruments simultaneously in the three counties in which the property to be acquired is located.
"Section 2. In consideration of such sale, conveyance and delivery, Tri-County shall pay to Vendors on the Closing Date the sum of One Hundred Four Thousand Dollars ($104,000) * * *."
The effective date of this sales agreement was June 10, 1940, but the signatures of the parties were actually affixed thereto at a later date.
13. On or about August 9, 1940, D. Keith McComas, W. Leslie McComas, Jr., Jack D. McComas, and Elizabeth O. McComas entered into a written contract with W.L. McComas by which they appointed W.L. McComas their agent to assist in the liquidation of Cumberland and to receive for them their distributable portion of the assets of the corporation. The stock theretofore standing in the name of W.L. McComas as Trustee for each of them was then transferred on the records of the corporation to W.L. McComas individually.
14. Under date of August 9, 1940, Zana M. Mayes and Katherine T. Mayes executed a similar written contract with E.S. Mayes, and they then transferred to E.S. Mayes on the records of Cumberland the 50 shares of stock theretofore standing in the name of each of them.
Finley M. Mayes did not transfer his 50 shares to E.S. Mayes at that time because they were advised that Kentucky law required a corporation to have three directors, and that only stockholders could serve as directors.
The stock of the corporation was transferred on the records of plaintiff, and from August 10, 1940, such records showed the ownership of the stock as follows:
Shares W.L. McComas .............................. 200 E.S. Mayes ................................ 150 Finley M. Mayes ........................... 60
15. At a special meeting of the plaintiff's stockholders on August 13, 1940, at 2 p. m., the following resolution was adopted:
"Whereas, it is considered that the best interests of the stockholders of this corporation will be served by an immediate dissolution of said corporation and a liquidation of its properties,
"Be it resolved that this corporation be dissolved in accordance with the laws of the State of Kentucky and the Board of Directors and the persons selected by them be and they are empowered, authorized, and directed to take all steps which shall be necessary or desirable to effect the dissolution of this corporation, the liquidation of its assets and liabilities, and the distribution to its stockholders in cash or in kind of all of its assets which shall not be required to pay all of its outstanding indebtedness."
16. At 2:30 p. m. on August 13, 1940, the Board of Directors of the plaintiff corporation held a special meeting for the purpose of transacting the business disclosed by the following minutes of the meeting:
"Special Meeting of Board of Directors of Cumberland Public Service Company.
"At a meeting of the Board of Directors of Cumberland Public Service Company, held at the office of Grafton Grafton, Kentucky Home Life Building, Louisville, Kentucky, on the 13th day of August, 1940, at two-thirty p. m., all of the directors of this corporation being present, there was produced before and examined by said meeting a resolution of the stockholders of this corporation authorizing a dissolution of said corporation and authorizing and directing the Board of Directors to take such action as might be necessary or desirable to effect the dissolution of the corporation, the payment of its debts, and the distribution of its remaining assets to the stockholders, and said resolution having been discussed at this meeting, the following resolution was offered:
"Resolved first, that W.L. McComas and E.S. Mayes be and they are hereby constituted a committee for liquidation and said committee be and is hereby authorized and directed to take such action as shall be necessary or desirable for the purpose of realizing upon the assets of the corporation the payment of its debts and the distribution to the stockholders of the assets of the corporation which shall remain after provision for the payment of said debts shall have been made.
"Resolved further, that said liquidation committee be and they are hereby authorized and directed to set aside from the assets of the corporation a fund sufficient to pay all of the debts of said corporation.
"Resolved further, that W.L. McComas as President, and F.M. Mayes, as Secretary, be and they are hereby authorized and directed to forthwith convey to the stockholders of this corporation of record at the date of such conveyance all of the electric transmission and distribution facilities of this corporation located in the counties of Cumberland, Metcalfe, and Monroe in the Commonwealth of Kentucky, together with all services and connecting lines, fixtures and equipment used in connection therewith, and together with all easements, rights of way, or other interests in lands used in connection with such transmission and distribution lines, and all other rights, licenses, franchises, privileges, or permits used in connection with said lines, and that said officers be and they are hereby authorized and directed to execute, acknowledge, and deliver for and on behalf of this corporation such instruments or documents as may be necessary or desirable to effect such conveyance and to affix the seal of this corporation to any or all of such instruments or documents.
"Upon motion duly made and seconded the foregoing resolution was unanimously adopted."
17. As the plaintiff was in the utility business, it was subject to the jurisdiction of the Public Service Commission of Kentucky. Therefore, all contemplated transactions affecting its business were required to have the approval of that Commission.
On or about September 4, 1940, a document was filed before the above-named commission entitled: "In the Matter of the Joint Application of Cumberland Public Service Company, W.L. McComas, E.S. Mayes, and Tri-County Electric Membership Corporation for the Sale and Purchase of Utility Properties".
This application represented that W.L. McComas and E.S. Mayes were the principal stockholders of the Cumberland Public Service Company; that the corporation was taking the necessary steps under Kentucky law to dissolve and terminate its corporate existence; that as a part of this plan its electric transmission and distribution system would be conveyed to W.L. McComas and E.S. Mayes as a liquidating dividend; that W.L. McComas and E.S. Mayes desired to sell such property to the Tri-County Electric Membership Corporation and that Tri-County desired to purchase such property; that upon the conveyance of the property by the corporation to McComas and Mayes, the corporation would cease the operation thereof and such operation would be continued by McComas and Mayes until the bill of sale and transfer of title to Tri-County; and that Tri-County desired to begin the operation of the properties immediately upon delivery to it of the deed from McComas and Mayes. The application concluded with a prayer for an order by the Public Service Commission authorizing the consummation of the proposed dissolution, operation, sale and purchase of the utility properties therein described. All parties interested in the consummation of the plan affixed their signatures to the application.
By order dated September 27, 1940, the Public Service Commission of Kentucky granted the aforesaid application on the condition that the transactions therein set out be consummated without any interruption of or impairment to the service being rendered to the customers of the Cumberland Public Service Company.
Notice of the dissolution of the Cumberland Public Service Company was duly published in appropriate newspapers and all other formalities required by law to complete the dissolution of the plaintiff corporation were duly complied with.
18. On October 21, 1940, Finley M. Mayes endorsed and surrendered to E.S. Mayes the certificates representing his stock in the plaintiff corporation in the amount of 50 shares. This was done pursuant to a previous oral agreement between the parties.
19. On or about October 31, 1940, plaintiff corporation filed with the Collector of Internal Revenue a "Return of Information under Section 148(d) of the Internal Revenue Code to be filed by Corporations within 30 Days after Adoption of Resolution or Plan of Dissolution or Complete or Partial Liquidation" in which it set forth certain information relative to its corporate existence and that the adoption of the resolution or plan of dissolution or complete or partial liquidation had occurred on August 13, 1940.
20. On October 22, 1940, the plaintiff corporation, by its president, W.L. McComas, executed a deed and bill of sale to W.L. McComas and E.S. Mayes, under the terms of which the grantor conveyed to the grantees the transmission and distribution lines and facilities which Tri-County desired to purchase.
21. By instrument dated October 24, 1940, W.L. McComas, and Agnes O. McComas (his wife) and E.S. Mayes and Zana McElroy Mayes (his wife) as vendors conveyed the above properties to Tri-County Electric Membership Corporation. At the time of the delivery of the aforesaid instrument, the consideration of $104,000 was paid with appropriate adjustments to the effective date of the sale.
Losses on Sale of Other Properties.
22. After the transfer by plaintiff to W.L. McComas and E.S. Mayes of its transmission and distribution lines, which in turn were transferred to Tri-County as aforesaid, the plaintiff continued to own an electric light plant, an ice plant, certain property in Burkesville and Tomkinsville, Kentucky, a Ford truck, certain accounts receivable and two life insurance policies, one covering W.L. McComas and the other E.S. Mayes. The plaintiff also continued to own certain notes of the Horse Cave Water Company aggregating $37,000.
23. In the return filed by the corporation there was a claimed loss resulting from the sale of machinery and equipment. The book value of this property was $8,164.99 and the indicated sale price was $1,950, showing a loss of $6,214.99. The return also disclosed a loss of $1,290.12 resulting from the sale for $1,550 of real estate of a book value of $2,840.12.
24. Between August 19, 1940, and November 16, 1940, some attempts were made by the company to dispose of the machinery and equipment constituting the generating plant and ice plant which the company had been operating but which were not acquired by Tri-County. Some possible purchasers investigated the properties but no offer was received. The generating equipment was heavy, weighing between 50,000 and 100,000 pounds, and it was installed on deep concrete foundations in buildings on the real estate owned by the company. One of the generators was 20 years old, and the others were about 30 years old. These models were no longer manufactured and it was difficult to obtain spare parts when necessary. On November 16, 1940, Mr. W.L. McComas and Mr. E.S. Mayes, acting as a liquidation committee, held a meeting, at which time Mr. E.S. Mayes offered $1,950 for all the machinery and equipment, including one 1-ton Ford truck, located on the property at Burkesville and Tomkinsville, subject to the condition that he be permitted to leave the machinery and equipment upon the property for a period of two years without charge. At the same meeting Mr. W.L. McComas offered $1,550 for the real estate at Burkesville and Tomkinsville, subject to the condition of the storage of the machinery. Mr. Mayes was the owner of other similar plants and he expected to find some use for the machinery in connection with the other plants. Mr. McComas was interested in a garage located adjacent to the real property at Burkesville and he expected that the real estate with its improvements would be useful in the operation of the garage. Each of the two stockholders attending this meeting was at liberty to make a higher offer than that offered by the other, but at the time of the meeting it had been agreed that no further offers would be made. The liquidation committee thereupon accepted the offers and authorized the sale of the properties to these stockholders by the company.
25. Certain other remaining assets of the company were also disposed of by the liquidation committee as follows: Mr. McComas and Mr. Mayes each reimbursed the company for premium payments on life insurance policies which were transferred to them. The accounts receivable in the amount of $4,850.50 were bought by Mr. McComas and Mr. Mayes for $4,850.50. $37,000 of first-mortgage notes of the Horse Cave Water Company were endorsed and delivered to W.L. McComas and E.S. Mayes pro rata in proportion to their ownership of the capital stock of the corporation. The sales authorized by the committee produced the sum of $28,685, and this sum was directed to be distributed in cash, one-half to W.L. McComas and one-half to E.S. Mayes.
26. The machinery and equipment sold to Mr. Mayes by direction of the liquidation committee were as follows:
1 1-ton 1937 Ford truck. 1 60 H. P. } Fairbanks-Morse Diesel engine, 1 120 H. P.} directly connected to 1 200 H. P.} generator.
1 5-ton York Ice Plant, together with switchboard equipment and engine auxiliaries.
The 60- and 120-horsepower engines were comparatively new in 1929 when the plant in which they were installed was acquired by or for the plaintiff company. The 200-horsepower engine was acquired second-hand in 1934 or 1935, it having previously been installed in 1920. This equipment was in regular use by the company up to August 1940.
The appraisal made in 1937 listed this equipment, exclusive of the Ford truck, as having a value of $34,710.21 as a part of a going concern. The depreciated book value was $8,164.99.
In 1941 or 1942 Mr. Mayes sold the three engines and the York Ice Plant for $8,300. The Ford truck was also sold but the selling price is not disclosed.
27. The real property sold to Mr. McComas by order of the liquidation committee consisted of the following: in Burkesville, a lot adjoining the Burkesville Garage upon which the ice plant and generating plant were located, together with the improvements; in Tomkinsville, a tract of land containing about three-eighths of an acre, together with a power plant and other improvements. About two years later he sold the real estate in Tomkinsville for $400. He still owns the real property in Burkesville. The real property was shown in the appraisal of 1937 as having cost $7,750 and as having a value of that amount as a part of a going concern. Its depreciated book value was $2,840.12. For state tax purposes, the real property, including the generating and ice plants, was appraised at $22,500 as a part of a going concern.
The value of the real property was impaired to some extent by the right to have the machinery stored without charge for two years, and also by the fact that after removal of the machinery it would be necessary to remove the concrete engine foundation before the buildings could be fully used.
Conclusion of Law.
Upon the foregoing special findings of fact, which are made a part of the judgment herein, the court concludes as a matter of law that the plaintiff is entitled to recover, and it is therefore adjudged and ordered that plaintiff is entitled to recover of and from the United States the sum of $19,698.18, plus interest according to law on $17,054.70 from October 15, 1943, and interest on $2,643.48 from December 16, 1943.
W.L. McComas and E.S. Mayes and their families owned all of the stock of the Cumberland Public Service Company, an electric light company, located in Kentucky. On June 10, 1940, McComas and Mayes entered into an agreement with the Tri-County Electric Membership Corporation to sell to it certain of the physical properties of the plaintiff company, the Cumberland Public Service Company, as soon as this company was liquidated and the properties were received by them as a liquidating dividend. The sale was later consummated.
Subsequently the plaintiff company filed its income tax return for 1940 reporting a loss on the year's operation and no tax liability. It disclosed the sale of some of its properties to the Tri-County Electric Membership Corporation, but stated that this sale had been made by the stockholders, and not by the corporation. On an audit of this return the Commissioner of Internal Revenue determined that the property had been sold by the corporation, at a profit, and a tax on this profit was assessed against the corporation.
The return of the plaintiff company also claimed a loss on the sale of certain real estate of the company to one of the stockholders and a loss on the sale of machinery and equipment to another stockholder. These claimed losses were disallowed by the Commissioner. A total deficiency in tax and interest of $19,698.18 was assessed against the company. This deficiency was paid and a claim for refund was duly filed. Upon its disallowance this suit was brought.
The first issue presented is whether or not the assets sold to Tri-County Electric Membership Corporation were sold by the corporation or whether the sale was made by the stockholders.
It is clear from the testimony that from the beginning of negotiations for the purchase of the plaintiff company's assets the stockholders of the plaintiff were desirous of selling their stock in the plaintiff company, instead of causing the plaintiff company to sell the physical properties desired by Tri-County Electric Membership Corporation (referred to hereafter as Tri-County). Tri-County, however, did not desire all of the assets of the plaintiff company, and the stockholders thereupon agreed to reduce the price asked for their stock from $156,000 to $115,000, with the understanding that plaintiff company in the meantime should dispose of the assets which Tri-County did not want.
The original conference between representatives of Tri-County and the stockholders of the plaintiff company was at Murfreesboro, Tennessee, on February 16, 1940. There was present at this meeting a representative of the Rural Electrification Administration, hereinafter referred to as REA, which Administration was considering advancing to Tri-County the money for the purchase of these properties. This representative expressed doubt as to whether or not the REA could lawfully advance money to Tri-County for the purchase of the stock of the plaintiff corporation, but no final determination of this question was had until May 15, 1940, at a conference in Washington between the representatives of the REA and an attorney who represented both the stockholders of the plaintiff company and the plaintiff company itself. At this meeting this attorney was definitely advised that the REA could not advance money for the purchase of the stock of the plaintiff company.
The REA then advised this attorney that it was willing to advance to Tri-County the sum of $104,000 for the purchase of the physical properties desired. This attorney communicated this offer to the stockholders of the plaintiff company, who then directed the attorney to write the REA in part as follows: "Upon my return from Washington I reported our conversation to Messrs. McComas and Mayes, who felt that prior to making a commitment they should seek to ascertain what the taxes would run. We immediately employed a certified public accountant who is at Burkesville today getting certain information from the books and we are exploring two or three methods of handling the matter with possible taxes involved in each method. It will probably be the end of the week before we are able to say with any degree of assurance what the taxes will be, and until that time I am afraid my clients will be unable to make up their minds."
This accountant made computations of what the taxes would be if the corporation should sell the physical properties to Tri-County; what they would be if the stockholders sold their stock; and what they would be if the corporation dissolved and distributed its assets to the stockholders and then the stockholders made the sale of the desired properties to Tri-County. After these computations had been made it was determined that the least tax liability would be incurred by dissolving the corporation, distributing the assets to the stockholders, and letting the stockholders make the sale of the desired properties.
Thereupon, the stockholders of the plaintiff company determined to accept the offer and entered into a contract with Tri-County, agreeing to transfer to it certain properties upon receipt of them through liquidation of the plaintiff company. Later, the company was liquidated, its assets were distributed to its stockholders, and the stockholders made the sale to Tri-County of the properties desired.
It is evident that the transaction was handled in the way it was handled for the purpose of incurring the least tax liability. The purpose of the stockholders in the beginning, in undertaking to sell their stock in the plaintiff company rather than to cause this company to sell the physical assets, was to reduce tax liability as much as possible, and this purpose continued throughout the negotiations and determined the way the transaction was finally handled. There was never at any time an intention on the part of the plaintiff company or of its stockholders to cause this company to make the sale of its physical properties, because it was thought from the beginning that this would result in the greatest tax liability.
Under such facts we do not think it is tenable to say that, although the sale in form was made by the stockholders, it was in fact made by the corporation.
Although the avowed purpose of the stockholders of the plaintiff company was to reduce taxes, nevertheless, every step they took in the matter was entirely legal; there is not a suspicion of fraud or evasion involved; it was an open and above-board effort to carry out the transaction in the way that would result in the least taxes. This they had the undoubted right to do.
In Gregory v. Helvering, 293 U.S. 465, 469, 55 S.Ct. 266, 267, 79 L.Ed. 596, 97 A.L.R. 1355, the Supreme Court said: "The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted."
The court cited as authority for this statement United States v. Isham, 17 Wall. 496, 506, 21 L.Ed. 728; Superior Oil Co. v. State of Mississippi, 280 U.S. 390, 395-396, 50 S.Ct. 169, 74 L.Ed. 504; and Jones v. Helvering, 63 App.D.C. 204; 71 F.2d 214, 217. In the Isham case the Supreme Court said:
"* * * To this objection there are two answers:
"1st. That if the device is carried out by the means of legal forms, it is subject to no legal censure. To illustrate. The Stamp Act of 1862 imposed a duty of two cents upon a bank check, when drawn for an amount not less than twenty dollars. A careful individual, having the amount of twenty dollars to pay, pays the same by handing to his creditor two checks of ten dollars each. He thus draws checks in payment of his debt to the amount of twenty dollars, and yet pays no stamp duty. This practice and this system he pursues habitually and persistently. While his operations deprive the government of the duties it might reasonably expect to receive, it is not perceived that the practice is open to the charge of fraud. He resorts to devices to avoid the payment of duties, but they are not illegal. He has the legal right to split up his evidences of payment, and thus to avoid the tax. The device we are considering is of the same nature."
The Government contends that this well established and sensible doctrine has been overturned by the Supreme Court in Commissioner v. Court Holding Co., 324 U.S. 331, 65 S.Ct. 707, 89 L.Ed. 981. We cannot impute to the Supreme Court an intention to so hold. In the Court Holding Company case the corporation had initiated the negotiations for the sale, but when it was realized that this would result in more taxes than from a sale by the stockholders, after a liquidating dividend, the sale by the corporation was ostensibly dropped (as found by the Tax Court) and the sale was nominally made by the stockholders. The Court held that the corporation had actually made the sale. But the Court did not hold that the stockholders could not have initiated negotiations for the sale in the first instance, and could not have carried it through themselves without resulting liability on the corporation for any profit derived from the sale. The Court was of opinion that the corporation, having initiated the sale, in effect consummated it. Its decision was based expressly on the finding of the Tax Court 2 T.C. 531 that "despite the declaration of a `liquidating dividend' followed by the transfers of legal title, the corporation had not abandoned the sales negotiations; that these were mere formalities designed `to make the transaction appear to be other than what it was' in order to avoid tax liability." [Italics ours.] It called attention to the fact that the Circuit Court of Appeals, 5 Cir., 143 F.2d 823 had held, instead, that "the corporation had `called off' the sale," but held that "there was evidence to support the findings of the Tax Court, and its findings must therefore be accepted by the courts." [ 324 U.S. 331, 65 S.Ct. 708] It said: "On the basis of these findings, the Tax Court was justified in attributing the gain from the sale to respondent corporation."
These are not the facts here. From the very beginning it was the stockholders who were negotiating for the sale of their stock. There was never any intention that the corporation should make the sale, and even when the REA determined that they could not furnish the money to Tri-County to buy the stock, the stockholders still persisted in their purpose of making the sale themselves, and for this reason they caused a dissolution of the plaintiff company, and the stockholders then in fact made the sale of the physical properties received by them as a liquidating dividend.
We are of the opinion that the principle first laid down by the Supreme Court in the Isham case, 17 Wall. 496, 21 L.Ed. 728, and reiterated in Superior Oil Co. v. State of Mississippi, 280 U.S. 390, 50 S.Ct. 169, 74 L.Ed. 504, and in Gregory v. Helvering, 293 U.S. 465, 55 S.Ct. 266, 79 L.Ed. 596, 97 A.L.R. 1355, is still the law. If this principle be applied to the facts of this case, we think it is altogether untenable to say that, although the sale in this case was ostensibly made by the stockholders, it was in fact made by the corporation.
The view we have taken is the same as that taken by the 5th Circuit Court of Appeals in the case of Howell Turpentine Co. v. Commissioner, 162 F.2d 319, in which opinions were written by Judge Sibley, and by Judges Hutcheson and Lee, all of whom expressed the opinion that although the avowed purpose is to reduce taxation, nevertheless the stockholders of a corporation may validly contract to dissolve the corporation and to sell the physical assets themselves. See also Commissioner v. Falcon Co., 5 Cir., 127 F.2d 277; United States v. Cummins Distilleries Corp., 6 Cir., 166 F.2d 17; Acampo Winery Distilleries, Inc. v. Commissioner, 7 T.C. 629.
It is unnecessary for us to determine whether or not the plaintiff is entitled to the loss they claim upon the sale to McComas and Mayes of its remaining machinery and its real estate, since, if the sale of its transmission lines to Tri-County was not made by the corporation, it had no taxable income. Since we are of the opinion that it was not made by the plaintiff company, but by the stockholders, we do not consider whether or not the company is entitled to the deduction claimed for these losses.
Judgment will be entered for the plaintiff in the sum of $19,698.18, plus interest, according to law, on $17,054.70 from October 15, 1943, and interest on $2,643.48 from December 16, 1943.
JONES, Chief Judge, and HOWELL and LITTLETON, Judges, concur.
I am unable to agree with the court's decision. The object of the parties here, as in the case of Commissioner of Internal Revenue v. Court Holding Co., 324 U.S. 331, 65 S.Ct. 707, 89 L.Ed. 981, was to transfer certain tangible property from the plaintiff corporation, its owner, to the Tri-County Electric Membership Corporation. In the Court Holding Company case, the tax consequences of a direct sale were not at first known to the selling corporation, hence it proceeded, up to a point, with the negotiation, but, upon learning that taxes would be reduced by first dissolving the corporation and distributing the assets to the stockholders, who, in turn, would transfer them to the intended purchaser, it followed that course. The court held that the fact that the transfer was made by two steps instead of one, did not, in the circumstances, reduce the tax liability. The instant case involves the same two steps, taken for the same reason. The factual difference that here the plaintiff corporation knew from the outset what the tax consequences of a direct sale would be, instead of, as in Court Holding, learning them later, cannot be important. The corporation had not, in that case, proceeded to the point of making a binding agreement of sale before it discovered the tax problem and changed the form of the transaction. Hence it could be said in that case, as well as in our case, that perhaps the corporation, or the stockholders who controlled it, would not have been willing to sell at all, unless they could keep the taxes which would result from the sale down to the level at which the form of the transaction was directed.
My views as to how this and similar questions of taxation should be treated are expressed in the case of Benjamin Guinness v. United States, 73 F. Supp. 119, 109 Ct.Cl. 84, 106, certiorari denied, 334 U.S. 819, 68 S.Ct. 1083, 92 L.Ed. 1749.
I do not discuss the plaintiff's claim for losses upon the sale of its remaining machinery and real estate, in view of the court's decision that there were no profits against which these losses could be set off.