Opinion
Docket Nos. 56785, 56789, 56790, 56791.
Filed November 18, 1957.
1. The individual petitioners first sought to purchase the assets, primarily a paper mill, of Rondout 1935, which corporation possessed no value to purchasers other than the assets. Kelly, the owner of all of the capital stock of Rondout 1935, refused to sell the assets but agreed to sell his stock. Petitioners, pursuant to a plan, purchased Kelly's stock; dissolved Rondout 1935 and distributed its assets to themselves; and then transferred the assets to a new corporation, Rondout 1945, whose stock was solely owned by them. Rondout 1945 in consideration thereof assumed the liabilities for the purchase price of the stock. Held, that the series of steps constitutes one transaction, viz, the purchase by Rondout 1945 of the assets of Rondout 1935. Therefore, the basis of the assets in the hands of Rondout 1945 is the purchase price of the stock. Held, further, the individual petitioners did not receive a dividend when Rondout 1945 assumed liabilities for the purchase price of the stock.
2. Under our holding in headnote 1 above, none of the individual petitioners omitted from his gross income an amount properly includible therein which is in excess of 25 per cent of the gross income stated in his return which was filed for the taxable year 1945. Held, the 5-year period of limitation provided in section 275 (c), I. R. C. 1939, is not applicable. The individual petitioners are sustained in their plea of the statute of limitations.
Charles Wilson, Esq., and Albert R. Dworkin, Esq., for the petitioners.
John F. Walsh, Esq., for the respondent.
The respondent has determined deficiencies in income tax as follows:
Docket No. Petitioner Year Deficiency 56785 ...... Estate of James F. Suter ..... 1945 $15,740.16 56789 ...... Helen M. Aal ................. 1945 12,990.85 56790 ...... Morris Hartman ............... 1945 17,534.59 56791 ...... Rondout Mills, Inc. .......... 1946 4,760.00The deficiency in Docket No. 56791, involving the corporate petitioner, is due in part to respondent's partial disallowance of the depreciation claimed, which disallowance is based on his determination that the basis of its assets is the same as in the hands of a prior corporation. One other adjustment of $2,000 is not in issue. Petitioner concedes that the Commissioner was correct in making the latter adjustment.
The deficiencies in the dockets involving the individual petitioners, who, at all times relevant, were the sole shareholders of the corporate petitioner, are due to respondent's determination that they each received a dividend of $29,427.57 when the corporate petitioner assumed their liabilities. The Commissioner explained this adjustment in his deficiency notice as follows:
(a) It has been determined that a dividend has been received from Rondout Paper Mills, Inc. in the amount of $29,427.57.
The issues involved are dependent upon the tax effect of a series of transactions whereby the individual petitioners purchased the stock of a prior corporation, dissolved it and distributed its assets to themselves, and then transferred the assets to the corporate petitioner. It is petitioners' contention that the sole and only purpose of the purchase by the said individuals of the capital stock of Rondout 1935 was one of the steps used to acquire the physical properties of the said corporation, which properties could not otherwise be acquired, and that all the transactions should be viewed together as a purchase of assets by the new corporation.
The individual petitioners have pleaded the 3-year period of limitations under section 275 (a), I. R. C. 1939.2 The respondent alleges that the 5-year period of limitations, as provided in section 275 (c), is applicable.
FINDINGS OF FACT.
A stipulation of facts has been filed and is incorporated herein by this reference.
Petitioners Frederick F. Suter and Shirley Cutaia are the duly qualified and acting administrators of the estate of James F. Suter, who was an individual residing at Ellenville, New York. The decedent, James F. Suter, hereinafter sometimes referred to as Suter, filed his Federal income tax return for the calendar year 1945 with the then collector of internal revenue for the fourteenth district of New York.
Petitioner Helen M. Aal, hereinafter sometimes referred to as Aal, an individual residing in New York City, filed her income tax return for the calendar year 1945 with the then collector of internal revenue for the third district of New York.
Petitioner Morris Hartman, hereinafter sometimes referred to as Hartman, an individual residing in New York City, filed his income tax return for the calendar year 1945 with the then collector of internal revenue for the third district of New York.
Suter, Aal, and Hartman are hereinafter sometimes referred to as the individual petitioners.
The petitioner Rondout Paper Mills, Inc., hereinafter sometimes referred to as Rondout 1945, is a corporation organized and existing under the laws of the State of New York with its principal place of business at Ellenville, New York. Rondout 1945 filed its corporation income tax returns for the period July 1 to December 31, 1945, and for the calendar year 1946 with the then collector of internal revenue for the fourteenth district of New York.
A prior corporation bearing the name of Rondout Paper Mills, Inc., hereinafter sometimes referred to as Rondout 1935, had been organized under the laws of the State of New York in 1935. During 1945, Rondout 1935 had a capitalization consisting of 1,000 shares of $100-par-value capital stock, all of which were outstanding and owned (prior to his sale of them) by William P. Kelly, hereinafter sometimes referred to as Kelly.
Rondout 1935 owned and operated a paper mill, which was located on Rondout Creek near Ellenville, New York.
Suter was employed by Rondout 1935 as manager of its mill. Prior to Kelly's ownership of the mill Bernard Aal, husband of petitioner Helen Aal, had been one of the owners of the mill and was acquainted with its facilities and capabilities. Hartman and Aal had been engaged in the paper products jobbing business for many years prior to 1945. During the war years 1941-1945, and in the period immediately following the war, the demand for paper products generally exceeded the supply and many large users of, and dealers in, paper acquired control of paper mills in order to insure their continued supply.
During a period commencing some time prior to, and through the early part of, 1945, Hartman and Aal were dominant interests in a paper-jobbing business in New York City which purchased some (not a substantial percentage) of its paper requirements from the mill owned by Rondout 1935. Mutual Paper Co. of New York, a competitor of the jobbing business of Hartman and Aal, was at this time receiving almost half of the production of the mill owned by Rondout 1935.
About February 1945, Suter, who wished to promote a purchasing group in which he would be a participant, advised Hartman and Aal that the competitor, Mutual Paper Co., was negotiating for the purchase of the Rondout mill. Hartman and Aal believed that they would no longer receive paper from the Rondout mill if control passed to this competitor.
Suter, Hartman, and Aal agreed to attempt to purchase the Rondout mill under an arrangement by which Suter would acquire a one-third stock interest in a new corporation to be formed but 50 per cent of the voting power, and Hartman and Aal would handle the distribution and sales of the mill and acquire a two-thirds stock interest in the new corporation to be formed but collectively 50 per cent of the voting power, and Hartman and Aal would advance substantially all the cash required in the purchase, but such advances were to be repaid to them from the venture. Suter had no money.
Hartman and Aal then went with Suter to Kelly in February 1945, to negotiate for the purchase of the operating assets of the mill. Bernard Aal represented petitioner Helen M. Aal in the negotiations. After several weeks of negotiations a tentative agreement was reached in March 1945, upon a purchase price of $500,000 for the mill. Hartman, Aal, and Suter then notified their attorneys to work out the legal arrangements and details, and Kelly did likewise with respect to his attorney.
About the end of March 1945, after the tentative agreement had been reached, Kelly permitted Hartman, Aal, and Suter to take over direction of the mill's operation and sales policies. They proceeded to carry out changes in products and in customers and thereafter only customers of Hartman's and Aal's jobbing business received any of the mill's output, except for unfulfilled prior commitments. Kelly allowed them to take over the mill's operations prior to entering into a contract of sale and prior to the consummation of the sale because he had confidence in the prospective purchasers, having employed Suter for about 22 years and having known Bernard Aal for about 37 years.
Early in April 1945, Kelly's attorney and accountant advised him that his tax situation required him to sell the capital stock of Rondout 1935 rather than the mill, i. e., the specific assets, for which Hartman, Aal, and Suter were negotiating. Kelly informed the purchasers that he would only sell the capital stock of Rondout 1935. The purchasers consulted with their attorneys, who strongly advised them not to purchase the stock for the reason, inter alia, that Rondout 1935 might be subject to certain undisclosed and unascertainable liabilities, especially under the then existing war regulations controlling prices and production.
Rondout 1935, aside from the mill and its production, possessed no value which interested the purchasers. The purchasers did not want the corporation's customers; they needed the mill's production for their own customers. It had no secret or special processes. The corporation had no sales organization, nor any key employees other than Suter, who was one of the purchasers. It had no contract arrangements with any of its employees, and with the exception of Suter there was only office help on a weekly basis and skilled labor on an hourly basis. The corporation had no brand names of any kind and produced only standard commercial grades which were sold unbranded. Rondout 1935 had no established or protected sources of supply of raw materials. The purchasers did not desire to continue the particular grades and types of paper theretofore manufactured by the corporation since they were of lower quality than the purchasers desired to continue.
Kelly, however, adamantly refused to sell anything except the capital stock of Rondout 1935. Seeing that Kelly would not change his position the purchasers agreed to purchase the capital stock of Rondout 1935. Under date of May 18, 1945, Kelly, as seller, and Suter, Hartman, and Aal, as purchasers, entered into a contract providing that Kelly would sell the capital stock of Rondout 1935 to Suter, Hartman, and Aal for the price of $500,000. The sum of $150,000 was to be paid immediately. The sum of $50,000 was to be paid by a series of seven notes (six $7,150 notes and one $7,100 note) payable monthly between July 1, 1945, and January 1, 1946, with interest at 4 per cent, on which Suter, Hartman, and Aal were to be jointly and severally liable. The balance of $300,000 was to be paid in equal quarter-annual installments at the rate of $15,000 per annum, the first of such installments to be paid on April 1, 1946. There was required to be paid with each installment interest at the rate of 4 per cent per annum on the unpaid balance. To secure the payment of the $300,000 balance, the purchasers agreed to take such steps as were necessary to effectuate a good and valid assignment to the seller of 75 per cent of the proceeds of the condemnation award from the City of New York (one of the assets of Rondout 1935 was a water right claim against the City of New York). As further security the purchasers were required to deposit the capital stock of Rondout 1935 with the seller until the debt of $300,000 was extinguished.
Simultaneously, the parties entered into a supplemental contract which provided that the purchasers could liquidate Rondout 1935 and transfer the assets to a new corporation to be formed by them. Kelly consented to such liquidation and transfer of assets and to release the capital stock of Rondout 1935, which he was to hold as security, in exchange for collateral security consisting of all the issued and outstanding capital stock of any new corporation to which the assets of Rondout 1935 were to be transferred.
Annexed to the contract of sale was a balance sheet of Rondout 1935 as of March 31, 1945, which showed the following: Assets Liabilities and capital
Current assets: Cash ................................. $30,834.51 United States Government securities ......................... 28,700.00 Accounts receivable .................. 41,221.91 Inventories .......................... 46,938.42 ---------- $147,694.84 Excess profits tax credit ........................... 368.47 Fixed assets: Land and water rights ................ 60,000.00 Building and equipment (less reserve for depreciation ................... 48,219.12 ---------- 108,219.12 Goodwill, trademark, tradenames, etc. ............... 1.00 Deferred charges .................................... 4,044.90 ----------- Total assets .................................... 260,328.33 Current liabilities: Accounts payable ..................... $19,740.64 Accrued salary, wages, and taxes ..... 10,756.19 ----------- $30,496.83 Due to William P. Kelly ............................. 65,915.73 Capital and surplus: Capital stock ........................ 100,000.00 Surplus, March 31, 1945 .............. 63,915.77 ----------- 163,915.77 ----------- Total liabilities and capital ................... 260,328.33 Kelly represented and warranted to the purchasers that the balance sheet was correct and accurate and that he (Kelly) agreed to indemnify the purchasers for any liabilities not set forth on the balance sheet which arose from any transaction entered into prior to April 1, 1945.Subsequent to March 31, 1945, and prior to May 24, 1945, Kelly caused Rondout 1935 to sell the United States bonds which were owned by the corporation at March 31, 1945. These proceeds, together with the greatest part of the cash balance, were applied at Kelly's direction to the liquidation of corporate indebtedness.
The sale was closed according to its terms on May 24, 1945, and the purchasers acquired legal control of Rondout 1935 on that day. Pursuant to their inter se agreement, Suter, Hartman, and Aal each received 333 1/3 shares of the stock of Rondout 1935 transferred by Kelly on May 24, 1945. At a special meeting of the board of directors of Rondout 1935 on May 24, 1945, the resignations of Kelly and Evelyn Smith (two of the corporation's then three directors) were presented and accepted. Hartman and Bernard Aal were elected as directors in their stead, and Suter, who had been a director, continued as such.
At a joint special meeting of the directors and stockholders of Rondout 1935 held on June 28, 1945, the directors and stockholders adopted a resolution to dissolve Rondout 1935 and to transfer the physical assets to the stockholders, pursuant to a plan of liquidation approved and agreed to by Suter, Aal, and Hartman.
On June 29, 1945, Rondout 1935 issued a deed to its real estate and a bill of sale for its personal property to Hartman, Suter, and Aal, who accepted the property pursuant to the plan of liquidation. A list of the property so transferred is as follows: Book value (on books of Fair market Assets Rondout 1935) value
None.
This is a "cash" account.
Notes payable ................................. $12,462.73 Accounts payable .............................. 22,280.17 Accrued wages, taxes, etc. .................... 10,882.39 ---------- Total...................................... 45,625.29
On June 29, 1945, a certificate was issued by the secretary of state of New York certifying that Rondout 1935 had been dissolved. The certificate of dissolution of the corporation was published in a newspaper as required by law. Rondout 1935 was dissolved completely and effectively in accordance with the laws of the State of New York.
Rondout 1945 was incorporated and formed by a certificate of incorporation dated June 29, 1945, which was filed in the office of the secretary of state of New York on July 2, 1945.
The authorized capital stock of Rondout 1945 consisted of 100 shares of class A voting stock, having the exclusive right to elect two of the four directors; 100 shares of class B voting stock, having the exclusive right to elect the other two directors; and 250 shares of nonvoting common stock. All of these shares were entitled to the same treatment with respect to dividends and distribution on liquidation, the sole distinction between the classes being the voting provisions. The total authorized capital of Rondout 1945 was 450 shares without par value. At all times relevant thereto, there was no change in such authorized capital.
Contemporaneously with the organization of petitioner Rondout 1945, its capital stock was issued as follows:
{ 100 shares of class A voting stock To James F. Suter ..... { 50 shares of nonvoting common stock
{ 50 shares of class B voting stock To Helen M. Aal ....... { 100 shares of nonvoting common stock
{ 50 shares of class B voting stock To Morris Hartman ..... { 100 shares of nonvoting common stock
Suter, Aal, and Hartman each paid in $300 to Rondout 1945 for the stock which was issued to them.
On July 2, 1945, Rondout 1945 accepted the offer of Suter, Hartman, and Aal to sell to petitioner the assets (as set out above) which they had received from Rondout 1935. The consideration was the assumption of the $50,000 in notes and the further amount of $300,000 payable by the offerors to Kelly; further assumption of the liabilities (as set out above) of Rondout 1935 assumed by Suter, Aal, and Hartman on the liquidation of that corporation; the issuance by petitioner Rondout 1945 of promissory notes to Hartman and Aal in the amount of $150,000; and the issuance of additional promissory notes in the amount of $4,742.05 to the individual stockholders. The conveyance of the assets to Rondout 1945 was effected on July 2, 1945. The opening entry on the books of Rondout 1945 was as follows:
Includes $767.06, shown as expense of sale.
The item "Fixed assets" represents the following assets which are shown at values placed upon them by Suter and Hartman, giving effect to additions to December 31, 1945:
Land and water rights ......................... $189,755.41 Buildings ..................................... 111,427.08 Machinery and equipment ....................... 149,219.72 Trucks ........................................ 275.00 ----------- 450,677.21 Less fixed assets additions July 1 to Dec. 31, 1945, included above ............. 10,678.21 ----------- Balance ..................................... 439,999.00 Unexplained difference ...................... 1.00 ----------- Fixed assets — as above ........................ 440,000.00
"WPK" signifies William P. Kelly.
Includes notes payable by Rondout 1935 assumed by Suter, Hartman, and Aal in connection with the distribution of assets by Rondout 1935 to its stockholder pursuant to the plan of liquidation.
Production records of the Rondout mill indicate the following:
First 3 Second 3 First 6 months, months, months, 1945 1945 1946 (Tons) (Tons) (Tons) #1 Wrapping tissue .......................... 37 0 0 #2 Wrapping tissue .......................... 372 400 1,021 #3 Wrapping tissue .......................... 165 0 0 Kraft wrapping tissue ....................... 54 0 0 Colored wrapping tissue ..................... 32 172 753 Screening wrapping tissue ................... 97 62 0 #2 Roll tissue .............................. 97 62 0 Crepe for toilet paper ...................... 33 42 96 Crepe for toilet paper ...................... 235 286 0 Crepe for pleating purposes (sold to garment trade) .................................... 0 0 237 ----- ----- ----- Total ................................... 1,025 962 2,107 Basic raw materials used by the mill for manufacture of paper consisted almost exclusively of woodpulp and wastepaper. The mill had no advantageous, controlled, or protected source of supply of either class of raw material. The War Production Board, hereinafter sometimes referred to as W. P. B., made allocations of woodpulp to the paper mills during the 1945 period in which the Rondout purchase occurred, and any mill having a capacity for producing paper (which was deemed an essential commodity) would have received an allocation of woodpulp by application to the W. P. B. The producers of woodpulp under W. P. B. orders were directed to furnish various quantities of woodpulp to the paper mills. Scrap paper was obtained from sources located by Hartman and Aal after acquisition of control by their group. Kelly controlled a wastepaper business which had been a supplier of wastepaper to the Rondout mill but the grades of wastepaper which he handled were not as suitable for the changed classes of product as the grades of wastepaper available from the sources found by Hartman and Aal.The customers served by the Rondout mill prior to the new group's acquisition of control purchased standard paper products (the standard being determined by specifications) and resold these products as unbranded standard products. The change in grades of product to items commanding higher prices was accompanied by a change in the customers. During the first 6 months of 1945, sales of products were made by the Rondout mill to a total of 101 customers. During the first 6 months of 1946, sales were made by the Rondout mill to 229 customers. In the case of customers sold during both the 1945 and 1946 periods, the nature of the products sold to such customers was in many cases substantially different in 1946 from the products which they had purchased in 1945. Mutual Paper Co. purchased $112,000 of products from the mill in the 1945 period but only $8,500 in the 1946 period. Other large customers in the 1945 period became relatively unimportant customers in the 1946 period. The total sales of the mill for the first 6 months of 1946 amounted to $390,000. Only $80,000 of this amount was sold to customers who had made purchases from the mill during the first 6 months of 1945.
On June 29, 1945, the basis for depreciation purposes in the hands of Rondout 1935 of the depreciable assets transferred by Rondout 1935 to Suter, Hartman, and Aal, and thereafter transferred by Suter, Hartman, and Aal to Rondout 1945, was as follows:
These figures have been stipulated. It appears, however, that no adjustment has been made for accumulated depreciation.
Machinery and equipment .................... $84,546.77 Buildings .................................. 61,244.24 Trucks ..................................... 1,285.00 ----------- Total .................................. 147,076.01
These assets were retained by Rondout 1945 during all of the year 1946.
During the year 1946, Rondout 1945 acquired additional depreciable assets, the basis for depreciation of which was as follows:
Machinery and equipment ...................... $14,385.39 Buildings .................................... 6,848.41 ---------- Total .................................... 21,233.80
The amount of depreciation deducted by Rondout 1945 in its return for 1946 was $19,579.88. The Commissioner, in his determination of the deficiency, disallowed $12,526.31 of this amount and explained this adjustment in his deficiency notice as follows:
(b) It has been determined that the proper basis to be used for the computation of depreciation is $168,309.81. The correct deduction for depreciation for 1946 is $7,053.57. Since the sum of $19,579.88 was claimed on the income tax return filed, the net income has been increased in the amount of $12,526.31.
It has been stipulated that —
The deductible depreciation for the year 1946 of Rondout (1945) would be properly computed in the amount of $19,579.88 if the basis of the depreciable property of Rondout (1945) is determined to be cost to Rondout (1945) rather than the basis in the hands of Rondout (1935).
The accumulated earnings and profits of Rondout 1935 at December 31, 1944, were in the amount of $67,392.94. Current earnings and profits for the period January 1 to June 30, 1945, were in the amount of $7,599.48. The parties have stipulated further that —
In the event that the Court should find for the petitioner on the depreciation issue in this case, the current earnings and profits for the period July 1, 1945 to December 31, 1945, were in the amount of $6,058.17. If the Court should find for the respondent on the depreciation issue, the current earnings and profits for the period July 1, 1945 to December 31, 1945 were in the amount of $13,289.29.
The individual petitioners, on their respective 1945 returns, reported one-third of the difference between the fair market value of the net assets distributed to them by Rondout 1935 and the purchase price of the stock as short-term capital gain. The Commissioner, in his determination of the deficiencies against the individual petitioners, has taxed them with a dividend of $29,427.57 each and has eliminated from their income the amount of capital gain reported by them as aforesaid.
Statute of Limitations.
Suter, Aal, and Hartman each filed his individual income tax return for the calendar year 1945 on or before March 15, 1946. Suter on January 9, 1951, Aal on January 22, 1951, and Hartman on January 9, 1951, each agreed in writing with the Commissioner to an extension of the period for assessment of income tax for the calendar year 1945 to and including June 30, 1952. Thereafter, the period so agreed upon was extended by subsequent agreements in writing made before the expiration of the period agreed upon, to and including June 30, 1955. The separate notices of deficiency were mailed to Suter, Aal, and Hartman by registered mail on December 14, 1954.
In his income tax return for the calendar year 1945, Suter stated his income as follows:
Salary (Rondout Paper Mills, Inc.) ............. $11,400.00 Net gain from sale or exchange of capital assets ............................... 1,488.14 ---------- Total ...................................... 12,888.14
In her income tax return for the calendar year 1945, Aal stated her income as follows: "Net gain from sale or exchange of capital assets, $1,998.42."
In his income tax return for the calendar year 1945, Hartman stated his income as follows:
Salaries ....................................... $12,601.18 Net gain from sale or exchange of capital assets ............................... 209.35 ---------- Total ...................................... 12,810.53
In schedule D attached to their respective income tax returns Suter, Aal, and Hartman showed the following:
Suter Aal Hartman Suter Aal Hartman fn1
Kind of property Date Date Gross acquired sold sales price Short-term capital gain 333 1/3 shares Rondout Paper Mills, Inc. ................. 4/1/45 6/30/45 $168,154.81 Short-term capital gain 33 1/3% Rondout Paper Mills, Inc. .............................. 4/1/45 6/30/45 $168,287.24 Long-term capital gain 3 1/3 shares Terrace Paper Corp. .... 7/19/44 3/31/45 $1,589.04 ------- ------- ----------- Net gain from sale or exchange of capital assets .................. Short-term capital gain or loss 33 1/3% Rondout Paper Mills, Inc. .... 4/1/45 6/30/45 $168,287.24 Less: Capital loss carryover ......... ------- ------- ----------- Net short-term capital loss .......... Long-term capital gain 3 1/3 shares Terrace Paper Corp. ..... 7/19/44 3/31/45 $1,589.04 -------- -------- ----------- Net gain from sale or exchange of capital assets ..................... Cost or Gain Kind of property other Gain taken into basis account Short-term capital gain 333 1/3 shares Rondout Paper Mills, Inc. ...................... $166,666.67 $1,488.14 $1,488.14 Short-term capital gain 33 1/3% Rondout Paper Mills, Inc. ............................. $166,666.67 $1,620.57 $1,620.57 Long-term capital gain 3 1/3 shares Terrace Paper Corp. ............................ $833.33 $755.71 $377.85 ----------- --------- --------- Net gain from sale or exchange of capital assets ................ 1,998.42 Short-term capital gain or loss 33 1/3% Rondout Paper Mills, Inc. ............................. $167,433.73 $853.51 $853.51 Less: Capital loss carryover ....... (1,022.02) ----------- --------- ---------- Net short-term capital loss ........ (168.51) Long-term capital gain 3 1/3 shares Terrace Paper Corp. ............................. $833.33 $755.71 $377.86 ----------- --------- ---------- Net gain from sale or exchange of capital assets .................... 209.35OPINION.
The determination of the issues involved herein is dependent upon the tax effect given to a transaction involving a series of steps: (1) Kelly, the owner of all the capital stock of Rondout 1935, at first tentatively agreed and then refused to sell the assets, primarily a paper mill, of Rondout 1935, which the individual petitioners, Suter, Aal, and Hartman, were seeking to purchase. The individual petitioners then agreed to purchase, and did purchase, Kelly's stock for $500,000, $150,000 in cash and $350,000 in notes, which was approximately equal to the fair market value of the net assets of Rondout 1935. (2) The individual petitioners shortly thereafter distributed the assets of Rondout 1935 to themselves and dissolved it. (3) Immediately thereafter they transferred the assets received upon liquidation of Rondout 1935 to a newly formed corporation, Rondout 1945, and Rondout 1945, in consideration therefor, assumed the $350,000 liability due to Kelly from the individual petitioners; issued its notes of $150,000 to the individual petitioners to cover the cash payment to Kelly; and issued additional notes in the amount of $4,742.05 to Suter, Aal, and Hartman. The individual petitioners paid in $900 for all of the capital stock of Rondout 1945, and they held the stock in equal shares as they had held the stock of Rondout 1935, except that under the new corporate structure Suter had a 50 per cent voting interest and Aal and Hartman combined had the other 50 per cent.
The Commissioner, in his determination of the deficiencies, treated the several transactions separately and, as stated in our preliminary statement, determined that the individual petitioners each received a dividend of $29,427.57 in 1945, and that the corporate petitioner, in its 1946 return, deducted $12,526.31 too much depreciation. The latter adjustment was based on the determination by the Commissioner that Rondout 1945 must take the same basis for depreciation as Rondout 1935.
We shall now take up and decide the issues raised by the pleadings.
Depreciation.
Rondout 1945 allocated its cost (the liabilities it assumed plus the notes it issued) among its assets and used that amount as a basis for depreciation. Respondent partially disallowed the depreciation claimed, determining that the basis of Rondout 1945's assets was the same as the basis in the hands of Rondout 1935.
There is no dispute over the depreciation rate used.
The basis for depreciation is as provided in section 114 (a). Sec. 23 (n). Section 114 (a) provides that the basis for depreciation shall be the adjusted basis provided in section 113 (b). Section 113 (b) provides that the basis shall be the basis determined under section 113 (a) with certain adjustments not applicable here. Section 113 (a) provides, with numerous exceptions, that "the basis of property shall be the cost of such property." The exception upon which the respondent relies is section 113 (a) (7).
Section 113 (a) (7) provides, in part, that if the property was acquired in a taxable year beginning after December 31, 1935, by a corporation in connection with a reorganization, then the basis shall be the same as it would be in the hands of the transferor. Respondent contends that the property was acquired in connection with a reorganization as defined in section 112 (g) (1) (D), "a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its shareholders or both are in control of the corporation to which the assets are transferred," or as defined in section 112 (g) (1) (F), "a mere change in identity, form, or place of organization, however effected." The petitioner, on the other hand, argues that the series of steps, i.e., the purchase of Rondout 1935 stock by Suter, Aal, and Hartman; the dissolution and liquidation of Rondout 1935 and the transfer of the assets of Rondout 1935 to Suter, Aal, and Hartman; and the transfer of those assets to Rondout 1945, constitute a purchase by Rondout 1945 of the assets of Rondout 1935.
Substance, rather than form, governs the tax effect of the transaction here involved. United States v. Phellis, 257 U.S. 156, 168 (1921). Prior to the transaction Kelly owned all the shares of Rondout 1935 which owned and operated a paper mill. After the transaction was completed, Suter, Aal, and Hartman owned all the shares of Rondout 1945 which owned and operated the same mill. The object sought to be accomplished by the transaction was the acquisition of the mill for the purpose of utilizing its productive capacity as a source of supply for the paper-jobbing business of Aal and Hartman. The means employed to achieve the object were the several steps heretofore mentioned. The steps were all part of a predetermined plan designed to effectuate the inter se agreement of the individual purchasers.
When the series of steps is viewed as one transaction, which the foregoing indicates that it is, it is clear that there was no reorganization under section 112 (g) (1) (D) since the transferor (Rondout 1935) or its shareholder (Kelly) was not in control of the transferee (Rondout 1945) immediately after the transfer, Prairie Oil Gas Co. v. Motter, (C. A. 10, 1933) 66 F.2d 309, or under section 112 (g) (1) (F) since "a transaction which shifts the ownership of the proprietary interest in a corporation is hardly 'a mere change in identity, form, or place of organization' * * *." Helvering v. Southwest Corp., 315 U.S. 194, 202-203 (1942).
The transfers of the assets to and from Suter, Aal, and Hartman can be disregarded since they acted as mere conduits for the delivery of the assets. Survaunt v. Commissioner, (C. A. 8, 1947) 162 F.2d 753, 755. Cf. Helvering v. Alabama Asphaltic Limestone Co., 315 U.S. 179, 184-185 (1942).
Petitioners rely on the rule of Commissioner v. Ashland Oil R. Co., (C. A. 6, 1938) 99 F.2d 588, certiorari denied 306 U.S. 661. That case "involved a taxpayer who was forced to purchase the stock of a corporation in order to reach the primary objective of acquiring the corporate property through liquidation and dissolution. * * * The court concluded that the two steps — the stock purchase and the liquidation — were to be taken as a single transaction despite their separation in time by a considerable period. The question was whether the taxpayer realized a gain on liquidation. It was held that though the transaction was, in form, a purchase of stock, in substance, it was a purchase of property and that since the taxpayer still held the property, no taxable gain was realized on the liquidation." H. B. Snively, 19 T.C. 850, 859 (1953). The basis of the properties in such a case is the cost of the stock. Koppers Coal Co., 6 T.C. 1209, 1217-1222 (1946); Prairie Oil Gas Co. v. Motter, supra. This principle has been applied in cases involving corporate purchasers, see Kimbell-Diamond Milling Co., 14 T.C. 74 (1950), affd. (C. A. 5, 1951) 187 F.2d 718; individual purchasers, see H. B. Snively, supra; and individual purchasers who transfer the stock to a newly formed corporation, see Georgia Properties Co. v. Henslee, (M. D. Tenn., 1955) 138 F. Supp. 587.
In John Simmons Co., 25 T.C. 635 (1955), a case relied upon by respondent, we held that the Ashland rule does not apply where the purpose was not to acquire assets but to acquire stock in a going business and to continue that business in a new corporate form. We think the Simmons case, supra, is distinguishable on its facts.
The record here shows that Aal and Hartman, who were advancing the necessary cash for the purchase, wanted the mill as a source of supply for their paper-distributing business; that the purchasers first negotiated for the assets — primarily the mill — and did enter into a tentative agreement to purchase the assets; that the corporation, aside from its physical assets, had nothing of value which interested the purchasers; and that the purchasers, after they took over the mill's operation, completely changed its products and sold only to customers of the paper-jobbing business of Aal and Hartman. These facts, we think, clearly indicate that the purpose of the stock acquisition was to acquire assets rather than stock in a going business.
It is true that Rondout 1935 owned assets other than the physical properties at the time of the stock purchase but that does not require a different result. The failure to "strip down," although an important circumstance in determining whether the intent and purpose were to purchase assets or to purchase stock, cannot be regarded as prohibiting a finding that the intent and purpose were to purchase assets, especially when other circumstances indicate otherwise.
Compare the assets held by the old corporation in Kimbell-Diamond Milling Co., 14 T.C. 74 (1950), and H. B. Snively, 19 T.C. 850 (1953) with the assets held by the old corporation in Commissioner v. Ashland Oil R. Co., (C. A. 6, 1938), 99 F.2d 588, and Koppers Coal Co., 6 T.C. 1209 (1946).
The record here compels a finding that, in substance, assets were purchased. And, again giving effect to substance, we think that the intermediate transactions should be disregarded and Rondout 1945 considered the purchaser. Therefore, the basis of the assets transferred to it on July 2, 1945, is the cost ($500,000) of the stock of Rondout 1935.
Respondent argues that the intent to purchase assets cannot be ascribed to Rondout 1945. This contention is apparently based on the fact that Rondout 1945 was formed subsequent to the stock purchase by its three individual shareholders. "The argument is purely technical," Georgia Properties Co. v. Henslee, (M. D. Tenn., 1955) 138 F. Supp. 587, 591.
There has been no argument regarding section 112 (b) (6), but it is clear that that section is inapplicable where, as here, assets were purchased. See Kimbell-Diamond Milling Co., supra.
The parties have agreed by stipulation on the amount of depreciation which is to be allowed as a deduction, depending on whether our decision sustains respondent that the transactions shall be treated separately, or whether we sustain petitioners' contention that the transactions shall be viewed as one, namely, a purchase by Rondout 1945 of the assets of the paper mill from Rondout 1935.
On this depreciation issue, we sustain petitioner Rondout Paper Mills, Inc. Therefore, in a recomputation under Rule 50, the corporate petitioner should be allowed a deduction for depreciation for the year 1946 in the amount of $19,579.88, which will be in accordance with the stipulation of the parties.
Dividends.
The issue with respect to the individual petitioners is whether they each received a dividend in the amount of $29,427.57 in the taxable year 1945 upon the issuance by Rondout 1945 of notes in the total amount of $150,000 to petitioners Aal and Hartman and the assumption by Rondout 1945 of the joint and several liability of Suter, Aal, and Hartman of $350,000 to Kelly. The respondent measured the alleged dividend attributable to each individual petitioner by one-third of the total of accumulated and current earnings and profits of Rondout 1935 and the current earnings and profits of Rondout 1945.
Since we hold that the transaction constituted a purchase by Rondout 1945 of the assets of Rondout 1935 for $500,000, which amount constituted its cost basis for the assets it purchased, the assumption of the liability for the purchase price by Rondout 1945 would not constitute a distribution of earnings and profits to the shareholders but would merely constitute Rondout 1945's payment for the assets it purchased and received. Also, of course, the earnings and profits of Rondout 1935 would not carry over to Rondout 1945 since there was no reorganization and since Rondout 1945 was a separate and distinct taxable entity.
On this issue of dividends of $29,427.57 to each individual petitioner, we hold in favor of petitioners.
Statute of Limitations.
It has been stipulated that each of the individual petitioners signed waivers in January 1951 and these waivers were later extended to and including June 30, 1955. The notices of deficiency were mailed December 14, 1954. Inasmuch as the waivers were signed in each case more than 3 years after the returns were filed, they are ineffective unless each petitioner omitted from his gross income an amount properly includible therein which is in excess of 25 per cent of the gross income stated in his original return so that the 5-year period of limitations under section 275 (c) applies.
Section 276 (b) provides:
(b) WAIVER. — Where before the expiration of the time prescribed in section 275 for the assessment of the tax, both the Commissioner and the taxpayer have consented in writing to its assessment after such time, the tax may be assessed at any time prior to the expiration of the period agreed upon. The period so agreed upon may be extended by subsequent agreements in writing made before the expiration of the period previously agreed upon. [Emphasis supplied.]
The time prescribed in section 275, as far as pertinent here, is 3 years under subsection (a) and 5 years under subsection (c). The waivers, having been consented to after 3 years and before 5 years, would not be valid if the time prescribed in subsection (a) (3 years) applied but would be valid if the time prescribed in subsection (c) (5 years) applied.
What respondent contends with respect to the statute of limitations is stated in his brief as follows:
As the result of failing to report the above-described dividend, Suter, Hartman and Aal omitted from the gross income reported in their income tax returns for the year 1945, an amount properly includible therein which is in excess of 25 per cent of their reported gross income.
We have held against respondent on this issue of dividends. The effect of our holding is that petitioners omitted no such dividends from their gross income reported in their 1945 returns. Therefore, it is clear that section 275 (c) has no application.
We sustain petitioners on the issue of the statute of limitations.
Reviewed by the Court.
Decisions will be entered under Rule 50.
The Findings of Fact and majority Opinion recognized that Kelly sold stock and refused to have Rondout 1935 sell its assets. Accepting that, then obviously no one ever sold the assets of Rondout 1935 and no one purchased assets of Rondout 1935. The Commissioner contends that the property was acquired by Rondout 1945 in connection with a section 112 (g) (1) (D) reorganization. The majority Opinion holds that there was no such reorganization because Kelly was a stockholder of Rondout 1935 in the beginning and held no stock in Rondout 1945 at the end. However, the reorganization did not start with Kelly as a stockholder. The individual petitioners had to be the owners of the stock of Rondout 1935 before they could carry out any plan of transferring its assets to Rondout 1945, and, starting with them as stockholders of Rondout 1935, there was a reorganization and no stepped-up basis for the assets.
PIERCE, J., agrees with this dissent.