Opinion
Docket No. 92949.
1964-04-8
FREDERICK STEEL CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
William R. Seaman and William K. Hoskins, for the petitioner. Gerald W. Fuller, for the respondent.
William R. Seaman and William K. Hoskins, for the petitioner. Gerald W. Fuller, for the respondent.
1. Losses incurred by corporation in beer and ice businesses, which were discontinued in 1952, and in carrying idle real estate previously used in those businesses, may not be used as carryovers for purposes of deductions in 1954 and later years against income realized from entirely different enterprise that was transferred to the corporation in 1954.
2. B, the sole stockholder in D and controlling stockholder
in F, caused the D stock to be transferred to F, which shortly thereafter liquidated D, and then sold some of the assets received in the liquidation. Held: In computing the holding period for those assets in F's hands there must be added the time that they were held by D. Sec. 1223(2), I.R.C. 1954. Rule of Kimbell-Diamond Milling Co., 14 T.C. 74,affirmed187 F.2d 718 (C.A. 5), inapplicable.
3. Payments in nature of commercial bribes by petitioner to purchasing agent of its largest customer held not deductible as ‘ordinary and necessary’ business expenses. There was no convincing evidence that such payments were normal, usual, or customary in the industry.
Respondent determined deficiencies in petitioners income tax as follows:
+--------------------+ ¦Year ¦Deficiency ¦ +------+-------------¦ ¦1954 ¦$109,678.11 ¦ +------+-------------¦ ¦1955 ¦13,189.63 ¦ +------+-------------¦ ¦1956 ¦52,580.73 ¦ +------+-------------¦ ¦1957 ¦39,468.99 ¦ +--------------------+
The issues are:
(1) Whether losses incurred in beer and ice business, discontinued in 1952, and in carrying idle real estate previously used in that business, may be used as carryovers to 1954 and later years in determining net operating losses to be deducted from income of entirely different enterprise that was transferred to the corporation in 1954.
(2) Whether petitioner's holding period of assets acquired upon liquidation of subsidiary must be computed by taking into account the time that such assets were in the hands of the subsidiary.
(3) Whether payments in the nature of commercial bribes made by petitioner to the purchasing agent of its largest customer are deductible as ordinary and necessary business expenses under section 162 of the Internal Revenue Code of 1954.
FINDINGS OF FACT
Some of the facts and exhibits have been stipulated by the parties and are incorporated herein by this reference.
Loss Carryover Issue
Petitioner, a corporation organized under the laws of Ohio, with its principal place of business in Cincinnati, Ohio, filed its income tax returns for the years in question (1954-57) with the district director of internal revenue at Cincinnati. Its business is that of a ‘finished steel jobber.’ Abe Byer of Cincinnati owns 17,917 of its 18,000 outstanding shares of stock, most of which he acquired in 1952, as hereinafter set forth.
Petitioner's former name was Cleveland Home Brewing Co. Prior to 1952 it was engaged in Cleveland, Ohio, in the business of brewing and selling beer and, to a considerably lesser extent, manufacturing and selling ice. Its beer business had resulted in large operating losses and was discontinued in January 1952. Its 18,000 outstanding shares of stock were then owned by a number of persons, prominent among them being its president, A. L. DeMaioribus, his brother, and other members of his family. Disharmony existed among the stockholders.
At some time prior to March 10, 1952, the corporation entered into a contract with the Effron Auction Co. of Cincinnati, hereinafter referred to as Effron, whereby the latter agreed to auction the corporation's assets, except the iceplant. These assets consisted of: Approximately 3 1/2 acres of land, in a mediocre to poor section of east side Cleveland; 97,000 to 100,000 square feet of single-story, single-purpose, and multistory buildings, ranging from 5 years to 35 years in age; and equipment, the general status of which was good. The real estate consisted of the main plant (brewery), a bottle house, a garage building, an office building, and the iceplant.
Harold K. Hirschberg, a vice president of Effron, participated in the negotiations for the auction contract. He was an acquaintance of many years of Abe Byer, a Cincinnati businessman who owned substantially all of the stock of at least several corporations which were engaged in various businesses. Shortly after Effron had obtained the contract to sell the assets of Cleveland Home Brewing Co., Hirschberg called Byer's attention to the possibility of buying the stock in that corporation for less than $300,000, and, based upon his appraisal of its assets, he told Byer that he felt that ‘if the deal could be purchased for approximately $300,000 or less,‘ Byer could make a quick $200,000 or $250,000 profit.
The corporation had net operating losses from prior years in excess of $400,000, and Byer learned of the possibility of a net loss carryover.
On March 10, 1952, Sidney C. Brant, acting as trustee for Byer, entered into an agreement with A. L. DeMaioribus and another stockholder whereby Brant agreed to purchase, through an escrow agent, the stock of Cleveland Home Brewing Co. at a price of $15 per share. The remaining stockholders were to be notified of the proposed purchase, and any of them similarly desiring to sell their stock could deposit their certificates with the same escrow agent. The purchaser reserved the right to rescind the agreement if he could not purchase at least 90 percent of the outstanding stock. This agreement provided, in part, as follows:
The stockholders further warrant that the corporation has good title to all assets listed on the balance sheet of said corporation, and that the real estate is free, clear, and unincumbered, except for current taxes as shown on the balance sheet, and that the corporation may continue to use the real property of said corporation for its present uses, and that proceedings are not in effect to limit the rights of the corporation to its present use of real estate or to change zoning of the real estate to a more restricted use than presently authorized.
The purchaser understands that the corporation has an outstanding contract with Effron Auction Company to auction assets of the company as provided in said contract, and officers and directors agree that in all matters in the conduct of said sale wherein the corporation has discretionary rights that no decisions will be made without the concurrence of purchaser. The stockholders agree that the purchaser may send a representative to remain at the company until this transaction is concluded, which said representative shall exercise joint control with the stockholders.
An understanding existed between DeMaioribus and Byer that after March 10, 1952, Byer was to be in control of Cleveland Home Brewing Co. Hirschberg, after March 10, 1952, considered himself as working for Byer. The auction was held thereafter, in March or Paril 1952.
The machinery and equipment sold at the auction was reported by the auctioneer as sold for a gross price of $188,094.25. Against this amount the auctioneer charged commissions and expenses of $20,309.43. The gross selling price of $188,094.25 included sales of $23,766.38 which were bids on behalf of the corporation itself in respect of steel beer storage tanks, lines, cooperage, and office equipment, The reported net proceeds of the sale were $144,018.44, but these proceeds appear on the corporation's cash journal as receipts of $142,244.27. The iceplant was withheld from the auction sale.
None of petitioner's real estate was sold at the auction. However, offers totaling $142,000 were received for various pieces of this property; approximately $20,000, $90,000, and $32,000 were offered for the garage, bottle shop, and office building, respectively. These offers were rejected under orders of Byer because he felt they were too low and because he felt the properties should be sold in their entirety. There was no bid on the main plant and the iceplant was not open for bidding. The sale of the real estate at the auction had been hampered by the appearance of a Cleveland city official, who circulated among the prospective bidders stating that there might be clouds or encumbrances on the property and indicating that the city was going to acquire the property. Hirschberg had been apprised of the problems involved in selling the real estate prior to the auction.
On May 9, 1952, Byer acquired 17,615 of the 18,000 outstanding shares of the Cleveland Home Brewing Co. at the agreed price of $15 per share, the total consideration being $265,605.75. Between the date of purchase of these shares and December 31, 1955, Byer acquired an additional 302 shares for a total consideration of $7,856.50. In May and July of 1952 the corporation advanced $125,000 to Byer; these advances were used to repay part of Byer's indebtedness to the Atlas National Bank of Cincinnati. Byer had incurred this indebtedness in order to obtain funds for the purchase of the Cleveland Home Brewing Co. stock.
After the auction, the corporation continued to operate its ice business; however, in August 1952, this business was discontinued. The book value of the iceplant on December 31, 1952, was $5,217.37.
The balance sheets of Cleveland Home Brewing Co. as of December 31, 1951, and December 31, 1952, reflected the following:
+-----------------------------------------------------------------------------+ ¦ASSETS ¦Dec. 31, 1951 ¦ ¦Dec. 31, 1952 ¦ +---------------------------------+---------------+-----------+---------------¦ ¦Cash ¦ ¦$14,528.43 ¦ ¦$7,488.98 ¦ +---------------------+-----------+---------------+-----------+---------------¦ ¦Notes and accounts ¦ ¦287.08 ¦ ¦125,000.00 ¦ ¦receivable ¦ ¦ ¦ ¦ ¦ +---------------------+-----------+---------------+-----------+---------------¦ ¦Inventories ¦ ¦54,427.22 ¦ ¦ ¦ +---------------------+-----------+---------------+-----------+---------------¦ ¦Other investments ¦ ¦ ¦ ¦ ¦ +---------------------+-----------+---------------+-----------+---------------¦ ¦Treasury stock ¦ ¦55,200.00 ¦ ¦55,200.00 ¦ +---------------------+-----------+---------------+-----------+---------------¦ ¦Capital assets ¦ ¦ ¦ ¦ ¦ +---------------------+-----------+---------------+-----------+---------------¦ ¦Total depreciable ¦$712,949.02¦ ¦$423,122.89¦ ¦ ¦assets ¦ ¦ ¦ ¦ ¦ +---------------------+-----------+---------------+-----------+---------------¦ ¦Less: Reserve for ¦359,720.30 ¦ ¦227,242.74 ¦ ¦ ¦depreciation ¦ ¦ ¦ ¦ ¦ +---------------------+-----------+---------------+-----------+---------------¦ ¦ ¦ ¦353,228.72 ¦ ¦195,880.15 ¦ +---------------------+-----------+---------------+-----------+---------------¦ ¦Land (plant and ¦ ¦42,771.20 ¦ ¦42,771.20 ¦ ¦outside property) ¦ ¦ ¦ ¦ ¦ +---------------------+-----------+---------------+-----------+---------------¦ ¦Other assets ¦ ¦19,100.72 ¦ ¦2,484.19 ¦ +---------------------+-----------+---------------+-----------+---------------¦ ¦Total assets ¦ ¦539,543.37 ¦ ¦428,824.52 ¦ +---------------------+-----------+---------------+-----------+---------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+
LIABILITIES Accounts payable $10,528.86 $1,800.00 Accrued expenses Payroll, etc., taxes, etc. 11,091.44 9,786.73 Other liabilities Customers' deposits on containers 12,414.75 Capital stock Common stock 200,000.00 200,000.00 Paid-in or capital surplus 83,699.21 83,699.21 Earned surplus and undivided profits 221,809.11 133,538.58 Total liabilities 539,543.37 428,824.52
Inability to make profitable use of the corporation's real estate together with many acts of vandalism in respect thereof resulted in progressive deterioration of the property. The real estate valuations for Ohio real property tax purposes on the corporation's land and plant in Cleveland for the years 1952-59 were:
+--------------+ ¦1952¦$219,640 ¦ +----+---------¦ ¦1953¦219,640 ¦ +----+---------¦ ¦1954¦219,640 ¦ +----+---------¦ ¦1955¦138,570 ¦ +----+---------¦ ¦1956¦138,570 ¦ +----+---------¦ ¦1957¦84,840 ¦ +----+---------¦ ¦1958¦44,990 ¦ +----+---------¦ ¦1959¦44,990 ¦ +--------------+
Cleveland Home Brewing Co. incurred net operating losses in the conduct of its brewing business during the years 1950 and 1951 in the amounts of $174,728.53 and $237,851.13, respectively, and incurred net operating losses in the years 1952 and 1953 in the amounts of $88,270.33 and $18,915.01, respectively. At least $36,696.73 of the 1952 loss was incurred after Byer's acquisition of petitioner's stock on May 9, 1952.
With respect to the computation of net income for the years 1951, 1952, and 1953, the corporation's tax returns, in part, reflected the following:
+------------------------------------------------------+ ¦ ¦1951 ¦1952 ¦1953 ¦ +-----------------------+-----------+----------+-------¦ ¦Gross income ¦ ¦ ¦ ¦ +-----------------------+-----------+----------+-------¦ ¦Gross sales ¦$615,105.52¦$46,662.18¦$124.50¦ +-----------------------+-----------+----------+-------¦ ¦Less cost of goods sold¦245,206.47 ¦35,885.74 ¦ ¦ +-----------------------+-----------+----------+-------¦ ¦Gross profit from sales¦369,899.05 ¦10,776.44 ¦124.50 ¦ +-----------------------+-----------+----------+-------¦ ¦ ¦ ¦ ¦ ¦ +------------------------------------------------------+
Deductions Compensation of officers 41,000.16 24,583.34 Salaries and wages 107,669.63 17,885.37 2,000.00 Repairs 20,667.18 15.00 Bad debts 37.05 Taxes 267,969.00 25,789.21 7,661.27 Depreciation 56,049.34 25,592.07 12,413.01 Advertising 51,879.86 Other deductions 64,554.33 32,470.90 2,218.61
Byer is, and was as far back as at least 1952, the sole stockholder of American Compressed Steel Corp., an Ohio corporation engaged in the scrap iron or steel business. Of the various corporate enterprises that he dominated he considered American Compressed Steel as his ‘primary operating company.’ In October 1952, American Compressed Steel acquired the assets and inventory of Frederick Steel Co., a partnership engaged in the business of a finished steel jobber. American Compressed Steel continued to operate Frederick Steel Co. as a division until on or about July 12, 1954, when the Frederick Steel Co. division of American Compressed Steel was acquired by petitioner, Cleveland Home Brewing Co. The books of American Compressed Steel, as audited by Ernst & Ernst, show that the Frederick Steel Co. division had net earnings of $41,606.17 for the fiscal year ended October 31, 1953, and a net operating loss of $3,584.13 for the 8 months ended June 30, 1954.
Petitioner ‘purchased’ the Frederick Steel Co. for $735,326.30; payment was made by canceling receivables due to petitioner from American Compressed Steel in the amount of.$392,486.56 and by petitioner's promissory note for $342,839.74. With respect to the receivables due to petitioner from American Compressed Steel, receivables in the amount of $317,907.07 were acquired by petitioner from liquidation of its subsidiary, Donal, Inc., the stock of which had been acquired by petitioner on April 10, 1954, as more fully hereinafter set forth; the remainder of the receivables was acquired subsequent to that liquidation.
On or about July 14, 1954, petitioner changed its name from Cleveland Home Brewing Co. to Frederick Steel Co. and thereafter engaged in the business of a finished steel jobber in Cincinnati, the business formerly conducted by the Frederick Steel Division of American Compressed Steel.
With respect to petitioner's computation of taxable income for 1954, its tax return reflected, in part, the following:
+-----------------------------------+ ¦Gross income ¦1954 ¦ +-----------------------+-----------¦ ¦Gross sales ¦$345,582.96¦ +-----------------------+-----------¦ ¦Less cost of goods sold¦261,576.58 ¦ +-----------------------+-----------¦ ¦Gross profit from sales¦84,006.38 ¦ +-----------------------------------¦ ¦* * * * * ¦ +-----------------------------------+
Deductions Compensation of officers: Salaries and wages $29,958.66 Rent 225.00 Repairs 172.79 Interest 5,716.49 Taxes 10.010.31 Depreciation 14,479.21 Advertising 631.00 Other deductions 27,996.77
During the period 1954-58, petitioner's reported taxable income, before net operating loss deductions and special deductions, was as follows:
+-----------------------+ ¦Year ¦Amount ¦ +------+----------------¦ ¦1954 ¦1 $221,496.37 ¦ +------+----------------¦ ¦1955 ¦89,568.01 ¦ +------+----------------¦ ¦1956 ¦111,693.72 ¦ +------+----------------¦ ¦1957 ¦81,562.47 ¦ +------+----------------¦ ¦1958 ¦(49,407.03) ¦ +------+----------------¦ ¦ ¦ ¦ +-----------------------+
1 Includes capital gain from the sale of former assets of Donal, Inc., in the amount of $201,055.74
The operating income shown on petitioner's returns for these years was derived from petitioner's business of finished steel jobber.
On September 2, 1952, petitioner's Cleveland real estate was included in the city of Cleveland's Urban Redevelopment project; or May 24, 1954, a resolution was passed by the City Council of Cleveland declaring an intent to appropriate petitioner's land and buildings. The city of Cleveland did not, during the years 1954 through 1962 appropriate this land and buildings. Petitioner has been unsuccessful in its attempts to rent or sell the real estate and has continuously held it; parts of the buildings have been destroyed by fire, and the buildings have otherwise been looted and severely damaged by vandals. Some of the buildings have been demolished by petitioner pursuant to a request of the city of Cleveland.
Capital Gain Issue
In May 1951 Byer acquired all the stock of United States Electrical Tool Co., an Ohio corporation, which, prior to 1952, was engaged in the manufacture and sale of electrical tools. On or about October 31, 1952, United States Electrical Tool Co. leased, with an option to purchase, its real estate and the bulk of its machinery to Emerson Electric Manufacturing Co. In 1953 United States Electrical Tool Co. changed its name to Donal, Inc.
On or about April 10, 1954, petitioner ‘purchased’ all of the stock of Donal, Inc., from Byer for a price of $429,000; the terms of payment were $120,000 in cash and petitioner's promissory note for the remaining $309,000. The $120,000 payment was made by offsetting or canceling a like amount due from Byer to petitioner for prior advances.
On April 12, 1954, at a ‘Special Meeting of Stockholders' of Donal, Inc., it was resolved that Donal, Inc. be dissolved and its assets distributed to ‘its stockholders.’
On or about April 22, 1954, the assets and liabilities of Donal were distributed to petitioner pursuant to the April 12, 1954, resolution to liquidate; these assets included receivables in the amount of $90,540 due from Byer. Donal's assets were placed on petitioner's books at their book value of $430,623.06. Shortly thereafter the $90,540 receivable from Byer was extinguished by applying it against petitioner's note in the amount of $309,000 which was held by Byer.
On May 11, 1954, Emerson Electric Manufacturing Co. and petitioner entered into an agreement whereby Emerson exercised its ‘right, option and privilege to purchase the real estate and appurtenances thereto,‘ for the sum of $115,000. The parties also agreed to auction the Donal machinery and equipment; this auction was to be conducted on or before July 1, 1954. The assets thus sold by petitioner had been acquired by Donal more than 6 months prior to June 1954. The sales were completed in June 1954.
In its 1954 income tax return petitioner reported short-term capital gains in the aggregate amount of $201,055.74 on the foregoing sales of land, buildings,
and equipment, as follows:
+------------------------------------------------------------------------------+ ¦Short-Term Capital Gains and Losses—Assets Held for Not More Than 6 Months ¦ +------------------------------------------------------------------------------¦ ¦ ¦ ¦ ¦ ¦Depreciation¦ ¦ ¦ +---------------+--------+-----+-----------+------------+----------+-----------¦ ¦ ¦ ¦ ¦Gross sales¦allowed (or ¦Cost or ¦ ¦ +---------------+--------+-----+-----------+------------+----------+-----------¦ ¦ ¦ ¦ ¦price ¦allowable) ¦other ¦Gain or ¦ +---------------+--------+-----+-----------+------------+----------+-----------¦ ¦Description of ¦Date ¦Date ¦(contract ¦since ¦basis ¦loss ¦ ¦D property ¦ ¦sold ¦ ¦ ¦ ¦ ¦ +---------------+--------+-----+-----------+------------+----------+-----------¦ ¦ ¦acquired¦ ¦price) ¦acquisition ¦et al. ¦ ¦ +---------------+--------+-----+-----------+------------+----------+-----------¦ ¦ ¦ ¦ ¦ ¦or Mar. 1, ¦ ¦ ¦ +---------------+--------+-----+-----------+------------+----------+-----------¦ ¦ ¦ ¦ ¦ ¦1913 ¦ ¦ ¦ +---------------+--------+-----+-----------+------------+----------+-----------¦ ¦Land and ¦Apr. 10,¦June ¦$116,905.40¦$83,082.85 ¦$83,655.61¦$116,332.64¦ ¦buildings— ¦1954 ¦1954 ¦ ¦ ¦ ¦ ¦ +---------------+--------+-----+-----------+------------+----------+-----------¦ ¦Findlay St., ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦Cinti. ¦ ¦ ¦ ¦ ¦ ¦ ¦ +---------------+--------+-----+-----------+------------+----------+-----------¦ ¦Machinery and ¦Apr. 10,¦June ¦102,198.05 ¦118,686.23 ¦136,161.18¦84,723.10 ¦ ¦equipment— ¦1954 ¦1954 ¦ ¦ ¦ ¦ ¦ +---------------+--------+-----+-----------+------------+----------+-----------¦ ¦Findlay St., ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦Cinti. ¦ ¦ ¦ ¦ ¦ ¦ ¦ +------------------------------------------------------------------+-----------¦ ¦Total of short-term capital gains or losses or difference ¦ ¦ +------------------------------------------------------------------+-----------¦ ¦between short-term capital gains and losses ¦201,055.74 ¦ +------------------------------------------------------------------------------+
‘Commissions' Issue
Prior to the acquisition of the Frederick Steel Co. by American Compressed Steel in October 1942, that company had an arrangement with the purchasing agent of one of its largest customers, the American Can Co., whereby the purchasing agent was given approximately a 2-percent ‘commission’ on sales by Frederick Steel Co. to American Can. This arrangement was continued throughout the period when Frederick Steel Co. was a division of American Compressed Steel and also continued subsequent to its transfer to petitioner. American Can was petitioner's largest customer and it was Byer's understanding that petitioner could not have obtained American Can's business without making these payments to the purchasing agent. In 1957 and 1958 petitioner thus made payments to the purchasing agent of American Can, Herschel A. Streit, as measured by petitioner's sales to American Can, in the amounts of $4,916.37 and $4,010.12, respectively.
OPINION
RAUM, Judge:
1. Loss carry-over.— Prior to July 14, 1954, petitioner was known as Cleveland Home Brewing Co. It had sustained heavy losses in the operation of its beer business which it discontinued early in 1952. It disposed of a considerable amount of its personal property in the spring of 1952 and continued to operate its ice business until about August of 1952 when that too was discontinued. Thereafter, throughout the remainder of 1952 and 1953, it does not appear to have engaged in any activity other than attempting unsuccessfully to make some sort of profitable use or disposition of the idle real estate remaining from the beer and ice business, and it incurred net losses during both of those years. The principal question before us is whether the net losses thus incurred, both prior to 1952 and up through 1953, may be used as carryovers in computing net operating loss deductions for 1954 and later years pursuant to section 122 of the 1939 Code and section 172 of the 1954 Code. The Government argues that such carryovers are not available (a) by reason of section 269 of the 1954 Code dealing with acquisitions of corporate control made to evade or avoid income tax, and (b) because they are foreclosed by the so-called doctrine of Libson Shops, Inc. v. Koehler, 353 U.S. 382.
The evidence indicates a genuine business purpose in Byer's acquisition of the Cleveland Home Brewing Co. stock, and although he was aware of the corporation's net operating losses we cannot find on the record before us that he purchased the stock in order to take advantage of the losses. Rather, the evidence persuade us that Byer was interested primarily in making a ‘quick’ and substantial profit on the transaction, which, contrary to expectations, did not materialize. Accordingly, we reject the Government's position based upon section 269. However, we agree that the deductions must be disallowed on the other ground.
The Libson Shops case and a number of decisions following it in a wide variety of situations have spelled out a requirement of continuity of business enterprise— that losses growing out of one business may not be carried forward to be applied in later years against income derived from an entirely different business. The Court in Libson Shops noted that the statutory provisions were enacted so as to allow a business to avoid the harsh consequences of taxing income on an annual basis; ‘(they were) designed to permit a taxpayer to set off its lean years against its lush years, and to strike something like an average taxable income computed over a period longer than one year.’ 353 U.S. at 388. Thus, if the business producing the income was not the same business which incurred the losses, it was not the ‘taxpayer’ within the meaning of the statute. 353 U.S. at 388. J.G. Dudley Co., 36 T.C. 1122, affirmed 298 F.2d 750 (C.A. 4); Commissioner v. Virginia Metal Products, Inc., 290 F.2d 675 (C.A. 3), reversing 33 T.C. 788, certiorari denied 368 U.S, 889; Huyler's, 38 T.C. 773, affirmed 281 F.2d 174 (C.A. 7); Norden-Ketay Corporation v. Commissioner, 319 F.2d 902 (C.A. 2), affirming a Memorandum Opinion of this Court; Julius Garfinckel & Co., 40 T.C. 870; Arthur T. Beckett, 41 T.C. 386. Cf. Mill Ridge Coal Co. v. Patterson, 264 F.2d 713 (C.A. 5); Bookwalter v. Hutchens Metal Products, Inc., 281 F.2d 174 (C.A. 8).
The tax years before us are 1954-57, and the only operating income realized by petitioner during those years was derived from its business as a finished steel jobber, a business which petitioner acquired in 1954 and which was entirely unrelated to the beer and ice business. The only other income of petitioner during the period 1954-57 was the $201,055.74 profit upon its sale of the former Donal assets in 1954; these assets related to an electrical tool business theretofore carried on by another corporation and had no connection whatever with the beer and ice business. The rationale of the foregoing decisions requires us to hold that the pre-1954 losses which grew out of an entirely different enterprise may not be carried over in computing net operating loss deductions in the circumstances before use.
If the Frederick Steel Co. had been a wholly owned corporation of Byer instead of a division of American Compressed Steel, and if Byer had caused it to merge with petitioner, the case would be identical with or perhaps even weaker than Libson Shops. We cannot believe that Congress intended a different result merely because the finished steel jobbing business was a ‘division’ of another wholly owned corporation of Byer which petitioner, a related taxpayer, acquired directly by ‘purchase’ instead of by merger.
Petitioner has earnestly urged various factual distinctions upon us, but they do not go to the heart of the case. This issue must be decided against it.
] The answer depends upon whether the holding period of these assets in the hands of Donal, conceded to be more than 6 months, may be added to the comparatively short period during which they were held by petitioner.
The April 22, 1954, liquidation of Donal was literally within the terms of section 112(b)(6) of the 1939 Code, which provides that ‘No gain or loss shall be recognized upon the receipt by a corporation of property distributed in complete liquidation of another corporation.'
And the basis of assets received in a section 112(b)(6), liquidation is ‘the same as it would be in the hands of the transferor.’ Sec. (a)(15). Accordingly, if the liquidation were governed by section 112(b)(6), the time during which the assets were held by Donal would have to be taken into account in determining the holding period, because section 1223(2) of the 1954 Code
Like provisions are contained in sec. 332 of the 1954 Code, but sec. 392 of the 1954 Code states that except as otherwise provided, part II, dealing with corporate liquidations, shall apply only where the first distribution in liquidation occurs on or after June 22, 1954. 3. Except as otherwise provided, the 1954 Code applies to taxable years beginning after Dec. 31, 1953, sec. 7851, and there are no provisions which provide ‘otherwise’ in respect of the holding period involved herein.
specifically provides:
SEC. 1223. HOLDING PERIOD OF PROPERTY.
For purposes of this subtitle
(2) In determining the period for which the taxpayer has held property however acquired there shall be included the period for which such property was held by any other person, if under this chapter such property has, for the purpose of determining gain or loss from a sale or exchange, the same basis in whole or in part in his hands as it would have in the hands of such other person.
Sec. 1223(9) provides:(9) Any reference in this section to a provision of this title shall, where applicable, be deemed a reference to the corresponding provision of the Internal Revenue Code of 1939, or prior internal revenue laws.
The Government seeks to avoid the effect of these provisions by relying upon the so-called Kimbell-Diamond doctrine. Kimbell Diamond Milling Co., 14 T.C. 74, affirmed 187 F.2d 718 (C.A. 5), certiorari denied 342 U.S. 827. That case and its numerous progeny hold that where the stock of a corporation is purchased for the purpose of liquidating the corporation and obtaining its assets, the transaction is in substance merely a purchase of those assets, and the statutory provisions dealing with nonrecognizable corporate liquidations are inapplicable. Cf., e.g., United States v. M.O.J. Corporation, 274 F.2d 713 (C.A. 5); Georgia-Pacific Corporation v. United States, 264 F.2d 161 (C.A. 5); H. B. Snively, 19 T.C. 859, affirmed 219 F.2d 266 (C.A. 5); North American Service Co., 33 T.C. 677; Orr Mills, 30 T.C. 150; Estate of James F. Suter, 29 T.C. 244; Montana-Dakota Utilities Co., 25 T.C. 408.
However, the rule applied in these cases has its limitations. John Simmons, 25 T.C. 635, 651-642; Long Island Water Corporation, 36 T.C. 377, 389-390. In commenting upon situations in which the Kimbell-Diamond rule has been deemed inapplicable, the Court in North American Service Co., 33 T.C. 677, stated (p. 692): the facts disclose that there was a significant relationship between the interests who controlled and operated the acquired corporation and the interests who controlled and operated the acquiring corporation, a continuity of interest entirely absent from the instant case.
Again in announcing its acquiescence in United States v. M.O.J. Corporation, 274 F.2d 713, the Internal Revenue Service was careful to note (1960-2 C.B. 462):
The acquisition of assets through the purchase-liquidation method in the instant case was by a corporation owned by an entirely different group of stockholders from the group which owned the acquired corporation.
The present case is certainly not the typical one for application of the Kimbell-Diamond rule. This is not a situation where petitioner, unable to buy desired assets of a corporation, purchased the stock of the corporation and liquidated it. Both petitioner and Donal were controlled by Byer at the time of the transaction and for about several years prior thereto. The distinction noted in the acquiescence in the M.O.J. case is present here. The assets in question had been under common control for a substantial period of time, and indeed the evidence reveals that the very gain on sale that is here involved was measured from the basis of the assets in the hands of Donal. For, as our findings disclose, by far the greatest component of that gain was attributable to reduction in basis of the assets through depreciation, and depreciation in such large amounts could have occurred only during the comparatively long period that such assets were held by Donal.
In view of the particular circumstances in this case, we hold that the provisions of sections 112(b)(6) and 113(a)(15) of the 1939 Code and section 1223(2) of the 1954 Code, which apply literally here, are not rendered inapplicable by the Kimbell-Diamond rule. Petitioner is entitled to compute the holding period of the assets in question by taking into account the period during which they were held by Donal, and the capital gain in question must therefore be classified as long term.
3. ‘Commissions' to purchasing agent of American Can.— American Can Co. was petitioner's largest customer, and petitioner had an arrangement with one of American Can's employees, its purchasing agent, whereby petitioner would pay ‘commissions' to this person in an amount equal to approximately 2 percent of petitioner's sales to American Can. Thus, it paid him $4,916.37 in 1957 and $4,010.12 in 1958. The sole question presented in respect of this item is whether such payments were ‘ordinary and necessary’ business expenses under section 162(a) of the 1954 Code.
Whether the payments were both ordinary and necessary is a question upon which petitioner has the burden of proof. Welch v. Helvering, 290 U.S. 111, 115. Assuming that petitioner's payments were ‘necessary,‘ we are satisfied that petitioner has failed to meet its burden of proving that the payments were ‘ordinary.’ The word ‘ordinary’ means normal, usual, or customary; consequently, the payments in issue must be of the type which are common to, or frequently occur in, the type of business in which petitioner is engaged. Deputy v. Dupont, 308 U.S. 488, 495; cf. Welch v. Helvering, 290 U.S. at 114.
The payments which petitioner euphemistically described as ‘commissions' were not in reality commissions; rather, they appear to be of the type more commonly referred to as graft or commercial bribes. To prevail on this issue petitioner has the burden of proving that it was the normal, usual, or customary practice for finished steel jobbers such as petitioner to make payments of this nature to purchasing agents of their customers. The only evidence with respect to this matter was testimony by petitioner's owner, Abe Byer, who, when asked if he knew of ‘any other similar arrangements in the industry,‘ replied: ‘Yes, sir; lots of such arrangements are made in the industry.’
We heard that testimony and the short answer is that we have no confidence in it. There is no convincing evidence whatever that Byer was in fact familiar with any other similar arrangements or practice in the industry, and he appeared only too ready to give a broad, sweeping answer that did not ring true. Such self-serving, unconvincing testimony falls far short of establishing that payments in the nature of commercial bribes were common in this segment of the steel industry.
This case is to be sharply distinguished from Lilly v. Commissioner, 343 U.S. 90, relied on by petitioner, where the Court concluded that the payments were ‘ordinary.’ The Court stated, at page 93, that the facts were ‘not in dispute’ and that under the ‘long-established practice in the optical industry in the localities where petitioner did business, (the payments) * * * were normal, usual and customary in size and character. The transactions from which they arose were of common or frequent occurrence in the type of business involved. They reflected a nationwide practice.'
We cannot make any such a finding in this case. The payments herein were not deductible. Cf. United Draperies, Inc., 41 T.C. 457.
In Frank J. Valetti, 28 T.C. 692, reversed on other grounds 260 F.2d 185 (C.A. 3); Kirtz v. United States, 304 F.2d 460 (Ct. Cl.); and Fiambolis v. United States, 152 F.Supp. 10 (E.D. S.C.), there were findings that the payments involved were customary, or reflected common practice. Such payments were therefore ‘ordinary.’
Because of our disposition of this issue, we need not decide whether the payments frustrated sharply defined national or State policies within the meaning of such cases as Tank Track Rentals, Inc. v. Commissioner, 356 U.S. 30; Commissioner v. Heininger, 320 U.S. 467, 473; Dixie Machine Welding & Metal Works, Inc. v. United States, 315 F.2d 439 (C.A. 5), certiorari denied 373 U.S. 950, and Boyle, Flagg & Seaman, Inc., 25 T.C. 43.
Decision will be entered under Rule 50. 1. Although it is true that petitioner reported the profit as ‘short-term’ gain in its 1954 return, apparently this was a matter of no consequence to petitioner at that time in view of its position that the net operating losses of prior years could be used as carry-overs and thus eliminate any tax for 1954. In view of our decision as to the unavailability of the carryovers, however, it now becomes important to determine whether the gain should be classified as long-term or short-term.