Docket No. 4595.
John C. Ristine, Esq., for the petitioner. Francis X. Gallagher, Esq., for the respondent.
Petitioner corporation was reorganized under chapter X of the National Bankruptcy Act in 1940, the plan of reorganization being approved by the court on the last business day of November. A considerable reduction of petitioner's indebtedness was provided by the plan of reorganization. New books of the corporation were set up on December 1, in which the basis for depreciation of the corporation's property was increased from that formerly used by it to an amount equivalent, so petitioner contends, to its then fair market value, and the inventory account was also increased to an amount representing what petitioner contends is the fair market value of the inventory. Respondent disallowed depreciation on excess of new basis over old, and adjusted petitioner's income by an amount equal to increase in inventory account. Held, section 270 of National Bankruptcy Act does not authorize an increase in basis or inventory. John C. Ristine, Esq., for the petitioner. Francis X. Gallagher, Esq., for the respondent.
The Commissioner determined deficiencies in petitioner's income tax for the calendar years 1940 and 1941 in the amounts of $2,570.85 and $1,185.10, respectively. By stipulation, the parties agreed that if the respondent's determination is sustained the amount of the deficiency for 1941 is $1,860, in lieu of the amount of $1,185.10 set forth in the notice of deficiency. The deficiencies arose out of the disallowance of certain claimed deductions for depreciation and adjustments of inventory valuation, claimed by petitioner to be authorized by section 270 of the Bankruptcy Act of 1938.
FINDINGS OF FACT.
Petitioner is a corporation organized under the laws of New Jersey, with its principal place of business in Trenton. It filed its original and amended income tax returns for the calendar years 1940 and 1941, on an accrual basis, with the collector of internal revenue at Camden, New Jersey.
On January 16, 1940, a petition was filed on behalf of petitioner with the United States District Court for the District of New Jersey, under the provisions of chapter X of the National Bankruptcy Act. The court referred the cause to a referee, who filed his report, and on November 29, 1940, the court entered its order approving and confirming a plan of reorganization. The plan of reorganization provided, briefly, (a) that the owners of the ten outstanding preferred and common stock of the corporation should have no interest in the reorganized corporation, their stock to be completed canceled; (b) that the certificate of incorporation of the debtor corporation should be amended to provide for an authorized issue of 2,500 shares of common stock of no par value, all of which was to be purchased by Harry R. Stover, president and general manager of the debtor corporation, for $25,000 in cash; and (c) that the plan contemplated that he should acquire and hold all the stock of the reorganized corporation. The plan of reorganization also provided for the following reduction or cancellation of indebtedness: The claim of the Broad Street National Bank of Trenton, evidenced by promissory notes in the amount of $61,745, some of which were endorsed by Harry R. Stover and others, and secured by a second mortgage on real estate of the debtor in the sum of $50,000, was settled for $31,000, a reduction of $30,745; claims of general creditors in the total amount of $131,839.99, evidenced by promissory notes, were compromised and reduced to an amount equivalent to 25 percent of the original indebtedness, effecting a reduction of approximately $98,879.92. The interests of the holders of stock, preferred, class A and B, and common, aggregating $265,002 were canceled.
The reorganization was carried out as decreed by the court on November 29, 1940, and on December 1, 1940, the first business day thereafter, the petitioner set up the assets on its books at determined fair market values and adjusted its inventory valuation to the market values.
In its return for 1940 petitioner computed depreciation on depreciable assets on a basis totaling $54,623.56 for the first eleven months, and, for the last month on the same assets, on a basis totaling $85,333.52 which petitioner contends is their fair market value. In its return for 1941 depreciation was computed on the increased basis. Petitioner in its 1940 return also reported an inventory valuation of $119,822.91 on January 1, 1940, a closing inventory as of November 30, 1940, of $138,518.96, and an opening inventory for the next day of $148,409.24, an increase of $9,890.28, which, petitioner contends, adjusts the inventory account to reflect fair market values. Its December 30, 1940, inventory valuation was $142,418.55.
Respondent disallowed the depreciation claimed on the increased basis used in petitioner's books for the last month of 1940 and for the year 1941, and has also adjusted petitioner's net income for 1940 by ignoring the increase in the inventory account made by petitioner on December 1, 1940. This action of respondent is due to his refusal to accept the increase in basis and in inventory account made by petitioner in order to make both basis and inventory conform to what petitioner contends was the fair market value of the depreciable property and the inventory items. These are the adjustments how in issue.
Petitioner relies, for its authority to make the inventory adjustments and to increase the basis of its depreciable assets to the fair market value from a lower basis used by it prior to the reorganization, on section 270 of the Bankruptcy Act of 1938, as amended, which reads as follows:
SEC. 270 (as amended by Public No. 699, 76th Cong., 3d sess., approved July 1, 1940). In determining the basis of property for any purposes of any law of the United States or of a State imposing a tax upon income, the basis of the debtor's property (other than money) or of such property (other than money) as is transferred to any person required to use the debtor's basis in whole or in part shall be decreased by an amount equal to the amount by which the indebtedness of the debtor, not including accrued interest unpaid and not resulting in a tax benefit on any income tax return, has been canceled or reduced in a proceeding under this chapter, but the basis of any particular property shall be not decreased to an amount less than the fair market value of such property as of the date of entry of the order confirming the plan. Any determination of value in a proceeding under this chapter shall not be deemed a determination of fair market value for the purposes of this section. The Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, shall prescribe such regulations as he may deem necessary in order to reflect such decrease in basis for Federal income tax purposes and otherwise carry into effect the purposes of this section.
The respondent argues that section 270 does not authorize an increase in basis or inventory, but is merely a limitation upon any decrease resulting from a reduction or cancellation of indebtedness.
A brief glance at that section in connection with section 268, without which it can not be properly interpreted, and in the light of its legislative history, services to emphasize the correctness of the respondent's position.
By section 268, Congress intended to and did provide that the cancellation or reduction of indebtedness of debtor corporations should not be deemed to result in the receipt by the reorganized corporation of taxable income. The passage of the Act was clearly traceable to the decision of the Supreme Court in United States v. Kirby Lumber Co., 284 U.S. 1, holding that the cancellation or reduction of indebtedness does, under some circumstances, result in taxable income to the debtor. It evidenced the desire of Congress to relieve insolvent corporations resorting to bankruptcy reorganization from the crippling effect of that rule. It was then felt that it would be unfair to allow such corporations to recover, by way of deduction for depreciation or otherwise, a capital outlay which they had thus been relieved of paying, and section 270, as it was first adopted, provided for the reduction of the basis of the debtor's property by the amount by which the indebtedness was reduced or canceled. The practical application of section 270, as it then stood, was found to result, in many cases, in the reduction of bases to zero or to figures so low as to lead to hardships in later tax years to such severity as almost to nullify the immediate remedial effect of the statute. To correct this situation, section 270 was amended, and made retroactive to the effective date of the Chandler Act, to provide that the basis which was reduced by the amount of the canceled indebtedness should not be decreased to an amount less than the fair market value of such property as of the date of the entry of the order confirming the plan of reorganization.
The purpose of this amendment was described by the report of the Committee to the House of Representatives (Report No. 2372, 76th Cong., 3d sess., C.B. 1940-2, p. 598), as providing ‘a fair market value ‘floor‘ below which the basis shall not be reduced.‘
The Supreme Court, in Claridge Apartments Co. v. Commissioner, 323 U.S. 141, described it also as placing ‘a floor to the amount of reduction required.‘
The whole context of the act clearly indicates the limited purpose and scope of section 270: That of providing for a reduction of basis, where indebtedness has been reduced or canceled, but limiting the reduction so required, where made, to an amount not less than the fair market value of the property. The statute provides ‘the basis * * * shall not be decreased to an amount less than the fair market value * * * ‘. If the basis of the property is already less than the fair market value, the statute, in effect, provides that it can not be decreased at all, since any decrease would be to an amount less than the fair market value. This is far different, however, from a provision that, in any event, the basis shall be fair market value. There is nothing in the language of the statute requiring an increase of basis or inventory account because of a reduction or cancellation of indebtedness, and we are confident that Congress did not intend such an increase to result from the statute before us.
We conclude that there was no error in respondent's determination. It is not necessary to consider the questions of valuation, or the questions of evidence relating thereto.
Decision will be entered for the respondent.