Nassau Lens Co.
Comm'r of Internal Revenue

Tax Court of the United States.Nov 14, 1960
35 T.C. 268 (U.S.T.C. 1960)
35 T.C. 268T.C.

Docket Nos. 70474 72132.



Bernard Jaffe, Esq., for the petitioners. Clarence P. Brazill, Jr., Esq., for the respondent.

T corporation, successor to sole proprietorship, issued all its stock and debenture notes to the sole proprietor, who arbitrarily allocated certain of the transferred assets as consideration for the debenture notes. Held, T is not entitled to amortization deductions with respect to discount allegedly attributable to the debenture notes. Bernard Jaffe, Esq., for the petitioners. Clarence P. Brazill, Jr., Esq., for the respondent.

In these consolidated cases the Commissioner determined deficiencies in income tax for the taxable year 1954 as follows: Nassau Lens Co., Inc., $3,071.43; Harry and Sarah Pildes, $3,240.

Petitioners in both cases have conceded all of the Commissioner's adjustments except those relating to certain debenture notes of Nassau Lens Co., Inc., held by its sole shareholder, Harry Pildes. The principal question presented is whether Nassau Lens Co., Inc., is entitled to amortization deduction with respect to discount allegedly attributable to debenture notes issued by it. If this question is answered in the affirmative, the Commissioner presents an alternative issue as to whether Harry Pildes must include the increase in the redemption value of these debenture notes as a part of his taxable income for 1954.


Some of the facts have been stipulated and are hereby incorporated by this reference.

For a number of years prior to 1954 petitioner Harry Pildes operated two businesses as sole proprietorships: One known as Pildes Company was a retail dispensing optician, and the other known as Nassau Lens Company was a wholesale dealer in lenses and optical equipment. Sarah Pildes is the wife of Harry Pildes; they reside in Brooklyn, New York.

Petitioner Nassau Lens Co., Inc., hereinafter referred to as Nassau, is a New York corporation organized on January 3, 1954, to take over the business of the second of the foregoing proprietorships. Harry Pildes became the sole stockholder of Nassau, as hereinafter set forth.

Nassau filed its corporate income tax return for 1954, on an accrual basis, with the district director of internal revenue for the Lower Manhattan District of New York; the individual petitioners filed their joint income tax return for 1954, also on an accrual basis, with the district director in Brooklyn.

The transfer of all the assets of the predecessor proprietorship to Nassau and the acquisition of all of its securities (stock and debenture notes) by Harry Pildes were based formally upon a written offer to the corporation by Harry dated January 6, 1954, which was promptly accepted by Nassau's board of directors. The transaction was thereupon finally consummated by the actual transfer of the assets to Nassau, which in turn issued its stock and debenture notes to Harry in accordance with the foregoing offer.

The balance sheet of the predecessor proprietorship as of December 31, 1953, was as follows:

+--------------------------------------------------------+ ¦ASSETS ¦ +--------------------------------------------------------¦ ¦ ¦ ¦ ¦ +-----------------------------------+---------+----------¦ ¦Cash on Hand ¦ ¦$10.00 ¦ +-----------------------------------+---------+----------¦ ¦Cash—Marine Midland Bank ¦ ¦18,517.54 ¦ +-----------------------------------+---------+----------¦ ¦Cash—Corn Exchange Bank ¦ ¦3,612.22 ¦ +-----------------------------------+---------+----------¦ ¦Accounts receivable ¦ ¦40,173.40 ¦ +-----------------------------------+---------+----------¦ ¦Security and deposits ¦ ¦10.00 ¦ +-----------------------------------+---------+----------¦ ¦Merchandise inventory—Dec. 31, 1953¦ ¦160,752.74¦ +-----------------------------------+---------+----------¦ ¦Auto equipment ¦$2,767.55¦ ¦ +-----------------------------------+---------+----------¦ ¦Reserve for depreciation ¦230.63 ¦ ¦ +-----------------------------------+---------+----------¦ ¦ ¦ ¦2,536.92 ¦ +-----------------------------------+---------+----------¦ ¦ ¦ ¦ ¦ +-----------------------------------+---------+----------¦ ¦Furniture and fixtures ¦7,069.38 ¦ ¦ +-----------------------------------+---------+----------¦ ¦Reserve for depreciation ¦1,943.14 ¦ ¦ +-----------------------------------+---------+----------¦ ¦ ¦ ¦ ¦ +-----------------------------------+---------+----------¦ ¦ ¦ ¦5,126.24 ¦ +-----------------------------------+---------+----------¦ ¦Total assets ¦ ¦230,739.06¦ +--------------------------------------------------------+

LIABILITIES AND CAPITAL Accounts payable $35,318.92 Sales taxes accrued 1,788.80 Taxes and expenses accrued 532.28 Total liabilities 37,640.00 Net worth—Dec. 31, 1953 193,099.06 Total liabilities and capital 230,739.06

There is no evidence that there was any change in any item of the foregoing balance sheet prior to the transfer of assets to the corporation, and all of such assets were in fact so transferred.

The inventory item was based upon a physical count and accurately reflected fair market value.

Harry's formal offer of January 6, 1954, undertook to divide the foregoing assets into three parts and to allocate consideration for each part as follows:

(a) I hereby offer to purchase all of the authorized stock of your corporation consisting of fifty (50) shares of Class A and one hundred fifty (150) shares of Class B, for a total consideration of $70,000.00. The said consideration of $70,000.00 shall be made up by transferring to you all of the assets of the Nassau Lens Co., listed on the attached balance sheet, except for the item of merchandise inventory. The total of the items so to be transferred is $69,986.32; the balance of $13.68 of the purchase price, I agree to contribute to the corporation in cash.

(b) I hereby offer to sell to the corporation, at cost, the inventory shown on the annexed balance sheet to the extent of $100,000.00 thereof, and offer to accept in payment, in lieu of cash, one hundred (100) registered debenture notes issued by your corporation, each with an issuance value of $1,000.00, and providing that on January 7th, 1964, your corporation shall pay to the registered holder thereof upon its presentation, the sum of $15,000.00. Said debenture notes shall further provide that your corporation shall have the right to redeem the same at any time upon thirty (30) days written notice to the registered holder thereof upon payment of the following amounts if redeemed within

+---------------------------------+ ¦First Year ¦after¦Issue¦¦$1,040¦ +-------------+-----+-----++------¦ ¦Second Year ¦after¦Issue¦¦$1,080¦ +-------------+-----+-----++------¦ ¦Third Year ¦after¦Issue¦¦$1,125¦ +-------------+-----+-----++------¦ ¦Fourth Year ¦after¦Issue¦¦$1,170¦ +-------------+-----+-----++------¦ ¦Fifth Year ¦after¦Issue¦¦$1,220¦ +-------------+-----+-----++------¦ ¦Sixth Year ¦after¦Issue¦¦$1,270¦ +-------------+-----+-----++------¦ ¦Seventh Year ¦after¦Issue¦¦$1,325¦ +-------------+-----+-----++------¦ ¦Eighth Year ¦after¦Issue¦¦$1,380¦ +-------------+-----+-----++------¦ ¦Ninth Year ¦after¦Issue¦¦$1,440¦ +---------------------------------+

Tenth Year after Issue To Maturity $1,500

In addition, said debenture notes shall further contain the usual provisions stated in instruments of that kind and nature.

(c) I offer to transfer to your corporation the balance of the said inventory shown on the annexed statement (amounting to $60,752.74) upon your agreement to assume and pay all of the obligations and liabilities now remaining outstanding, incurred by me in the operation of the said Nassau Lens, Co., except liability for my own income taxes, and to fulfill all commitments incurred to date in the regular course of business in Nassau Lens Co. Your obligations hereunder shall include assumption of all liabilities reflected in the annexed balance sheet, liability on the lease for the premises now occupied by the business, and any other liabilities which may be imposed upon the said business, provided, however, that the total obligations assumed by you under this paragraph shall in no case exceed the amount of $60,752.74. Any excess of the $60,752,74 in inventory transferred pursuant to this paragraph over liabilities assumed by you, shall be retained by your cooperation as paid in surplus.

The various steps spelled out in the offer were formally carried out. All the assets on the balance sheet were transferred to Nassau, which assumed the liabilities of the proprietorship and issued its stock and debenture notes to Harry Pildes. The liabilities were stated to be $37,640, and $23,112.74 of the transferred assets not allocated to any other item was treated as paid-in surplus by Nassau on its balance sheet. The 100 registered debenture notes were issued to Harry on January 7, 1954. By their terms these notes were transferable on the books of the corporation only, and Nassau was required to pay the registered holder the sum of $1,500 for each note (i.e., an aggregate of $150,000) on January 7, 1964. The notes were redeemable prior to maturity at Nassau's election in accordance with the schedule in the offer. The registered holder possessed no right to call for redemption. No interest payments were provided for in the notes.

Nassau did not redeem any of the debenture notes during the taxable year 1954 nor did Harry receive cash during the taxable year by reason of the ownership of any of the debenture notes.

On its 1954 corporate return, Nassau deducted the sum of $4,904.10 which it claimed for the period of January 7, 1954, to December 31, 1954, as the amortization of the original issue discount on the debenture notes. This discount was based on the difference between the value of the debenture notes at maturity and the alleged purchase price thereof. The Commissioner has disallowed this deduction.

The individual petitioners did not include any income based on ownership of the debenture notes in their 1954 joint return. The Commissioner determined a deficiency against them for failure to include $4,000 of taxable income based on the increase in the redemption value of the 100 debenture notes.

Harry was the sole stockholder of Nassau during all of 1954. He served as its president and his sister-in-law, Doris Philipson Press, was secretary-treasurer. The board of directors consisted of Harry, Doris, and Doris' husband, Lewis Press.


RAUM, Judge:

The principal question for decision is whether Nassau is entitled to a deduction in 1954 for amortization of discount with respect to its debenture notes in accordance with Regulations 118, section 39.22(a)-17(c). A subsidiary issue, presented in the alternative by the Commissioner in the event that he should be unsuccessful on the main issue, is whether the individual petitioners are required to include in their 1954 income the amount by which the redemption value of the debenture notes increased during that year. Since we have concluded that Nassau is not entitled to the amortization deduction, it becomes unnecessary to consider the Commissioner's alternative position.

Regs. 118, sec. 39.22(a)-17. Sale and purchase by corporation of its bonds.—(c) If bonds are issued by a corporation at a discount, the net amount of such discount is deductible and should be prorated or amortized over the life of the bonds * * *

We encounter at the outset a sharp conflict between the parties as to the fair market value of the merchandise inventory which Harry Pildes transferred to Nassau. Upon review of the evidence we agree with petitioners that the fair market value of the merchandise was equal to the amount appearing for that item on the balance sheet. However, we do not agree with petitioners that the transaction in question resulted in the creation of any amortizable discount.

The entire transaction whereby Harry transferred the assets of his wholly owned wholesale lens business to his wholly owned corporation was entirely lacking in arm's-length dealing. The allocations of (1) the noninventory assets as consideration for Nassau's stock, (2) a portion of inventory as consideration for the debenture notes, and;() the remaining inventory as consideration for Nassau's assumption of liabilities with the excess ($23,112.74) to be treated as paid-in surplus— all these were simply arbitrary component steps in a single transaction whereby Harry merely exchanged his wholesale lens business for 100 per cent ownership and control of the corporation that was thereafter to carry on that business. No business reasons appear for the artificial division and allocation of the assets in question. We cannot say on this record that $100,000 of inventory was the true consideration for the $150,000 debenture notes, nor can we say on this record that such notes represented a bona fide indebtedness of Nassau.

In Judge Kalodner's concurring views (joined by Judges Staley and Hastie) in Montana Power Company v. United States, 232 F.2d 541, 549-550 (C.A. 3), the opinion was expressed that where there is no arm's-length dealing between the seller and the purchasing corporation, no deduction is available in respect of discount allegedly inhering in the obligations of the purchasing corporation issued for assets transferred to it. We do not find it necessary to decide whether we should follow so sweeping a rule, for in the present case, not only was there an absence of arm's-length dealing, but the record is lacking in convincing evidence that $100,000 in inventory was in fact the consideration for the debenture notes. The issuance of the notes was merely part of a more comprehensive transaction and the allocation of $100,000 in inventory therefor appears to be completely artificial. Why, for example, was $23,112.74 treated as paid-in surplus? And what business reasons, if any, dictated a division of business assets already wholly owned by Harry so that a portion thereof would be allocated to invested capital (stock) while another portion would be charged to borrowed capital (debenture notes)? Further, assuming that some such allocation was proper, what business reasons if any justified the allocations in the amounts which Harry undertook to make? The answers to these and other pertinent questions are not to be found in the record before us, and we cannot find that there was in fact any bona fide amortizable discount. Cf. Dodge Brothers v. United States, 118 F.2d 95 (C.A. 4); Arkansas-Missouri Power Corporation v. Paschal, 144 F.Supp. 272 (E.D. Ark.), affirmed 243 F.2d 584 (C.A. 8), certiorari denied 355 U.S. 835. Accordingly, we hold that the deficiency against Nassau was properly determined. In view of this conclusion, it is unnecessary for us to consider other contentions advanced by respondent to the effect that an amortization deduction for bond discount is never available where the obligations are issued for property, or that section 267 of the 1954 Code in any event precludes the deduction.

Decision will be entered in Docket No. 70474 for the respondent. Decision will be entered in Docket No. 72132 under Rule 50.