1947 U.S. Tax Ct. LEXIS 78">*78 Decision will be entered under Rule 50.
1. Corporation A, having acquired bonds of its subsidiaries at a discount, liquidated the subsidiaries, acquiring all their assets and assuming all their liabilities. The assets received exceeded in value the obligations assumed, including the bonds, which were not immediately retired. Held:
(a) Transfer of the subsidiaries' assets to the extent of the face value of the bonds was not a distribution in liquidation within the meaning of section 112 (b) (6), Internal Revenue Code.
(b) The difference between A's cost of acquisition and the face value of the bonds was taxable gain.
2. That part of the capital stock tax for the year ended June 30, 1940, attributable to the 10-cent increase in rate imposed by the Revenue Act of 1940, held, accrued and deductible in 1940. First National Bank in St. Louis, 1 T.C. 370.
9 T.C. 570">*570 The Commissioner determined petitioner liable for a deficiency of $ 75,201.08 in the 1940 income tax of a Delaware corporation which had transferred all1947 U.S. Tax Ct. LEXIS 78">*79 its assets to petitioner. In computing the deficiency, the Commissioner treated as taxable gain the difference between the cost of bonds which the Delaware corporation acquired from its subsidiaries and the face amount of such bonds which it still owned when the subsidiaries transferred all their assets to the parent and dissolved in 1940. The assets exceeded in value the amount of the subsidiaries' obligations. The Commissioner also disallowed the deduction of an amount accrued as capital stock tax for the year ended June 30, 1940.
Petitioner contends that no gain is recognizable on account of Delaware's purchase of the bonds at less than par and receipt of the subsidiaries' assets in excess thereof, because the transfers of assets by the subsidiaries were distributions in complete liquidation within the meaning of section 112 (a) (6), Internal Revenue Code. It contends further that the portion of the capital stock tax attributable to the increase in rate fixed by section 205, Revenue Act of 1940, did not accrue prior to 1940 and is deductible in that year.
FINDINGS OF FACT.
This case was submitted upon a stipulation and exhibits which are incorporated by reference as findings1947 U.S. Tax Ct. LEXIS 78">*80 of fact and from which it appears that:
9 T.C. 570">*571 Petitioner, a Texas corporation, with principal office at Houston, Texas, is successor to the Houston Natural Gas Corporation, a Delaware corporation (hereinafter called Delaware), having received all the assets and assumed all the liabilities of Delaware as of July 31, 1940. Petitioner was organized on May 29, 1940, for that purpose and to operate the businesses conducted by Delaware's four subsidiaries: the Houston Natural Gas Co., the Texas Natural Gas Utilities, the Gulf Cities Natural Gas Co., and the Tex-Mex Natural Gas Co. Delaware kept its books and prepared its income tax returns on an accrual basis of accounting, and it filed its income tax return for the calendar year 1940 with the collector of internal revenue for the district of Maryland. For the years 1929-1933 it and its subsidiaries filed consolidated returns. The subsidiaries were public utilities engaged in the purchase and retail sale of natural gas in certain counties of Texas. Delaware, a holding company, owned all of their stock and all of their bonds, which latter had been issued during the period 1928-1938 to finance their operations. On July 31, 1940, 1947 U.S. Tax Ct. LEXIS 78">*81 these bonds were outstanding in an aggregate face amount of $ 5,945,000. Delaware had acquired them at an aggregate discount of $ 310,918.80. They bore 6 1/2 per cent interest; those of the Houston Natural Gas Co. of a face amount of $ 4,066,000 were due and payable on December 1, 1941; the others on December 1, 1943.
All the stocks and bonds of the four subsidiaries were pledged by Delaware with the Maryland Trust Co., trustee, as security for its own bonds, pursuant to a trust indenture executed December 1, 1928. This indenture provided that Delaware was authorized to issue to the public $ 5,000,000 face amount of first mortgage collateral 6 per cent gold bonds due and payable December 1, 1943; that if Delaware should issue bonds in excess of $ 2,000,000, it should deposit with the trustee as additional security bonds of the subsidiaries having a face value equal to the excess; that it should pay to the trustee as a sinking fund for the trustee's purchase of its own bonds a minimum annual amount equal to $ 50,000 plus 2 1/2 per cent of the face amount of its bonds issued in excess of $ 2,000,000 and 10 per cent of its annual net earnings; that on the trustee's indication it should1947 U.S. Tax Ct. LEXIS 78">*82 cause the obligations and bonds of its subsidiaries to be converted into obligations secured by a mortgage on the subsidiary's property; and that it should not transfer ownership or title of the subsidiaries' shares. In the event of its failure to pay the principal of its bonds, the trustee was authorized to sell all or part of the pledged collateral. Of the $ 5,000,000 authorized, Delaware issued bonds of a face value of $ 4,891,500. Of this issue, the trustee on July 31, 1940, held in the sinking fund bonds of a face value of $ 2,086,500, and the public held bonds of a face value of $ 2,805,000.
9 T.C. 570">*572 Early in 1940 Delaware's shareholders adopted and caused to be carried out a comprehensive plan for the simplification of the corporate structure and the elimination of subsidiaries. Pursuant to this plan (which was approved by the Securities & Exchange Commission, with which Delaware was registered as a holding company), each of Delaware's subsidiaries as of July 31, 1940, conveyed to Delaware all of its properties, subject to a contract lien, a vendor's lien, and the liens previously created as security for its bonds in favor of the Maryland Trust Co., trustee, and in the1947 U.S. Tax Ct. LEXIS 78">*83 same instrument granted, assigned, transferred, and conveyed to the trustee:
* * * all and singular the contract lien, vendor's lien, and all other liens herein identified, and all rights and remedies securing the same, together with the superior title to the properties and assets aforesaid, which Grantor holds by virtue of being Grantor in this instrument, for the benefit of the holder or holders of said bonds * * *.
In consideration of these transfers, Delaware assumed liability for the payment of the bonds, debts, and obligations of each subsidiary, and, pursuant to agreement, obtained all the shares of each from the Maryland Trust Co., which held them as trustee. It then delivered the shares to the respective subsidiaries, which canceled them, and on September 10, 1940, the four subsidiaries were dissolved. As of July 31, 1940, Delaware sold and conveyed to petitioner (recently organized as contemplated by the plan), all of its properties, including those acquired from the subsidiaries and subject to the liens mentioned. In consideration therefor petitioner assumed liability for Delaware's bonds, debts, and other obligations, including those of the subsidiaries, and delivered1947 U.S. Tax Ct. LEXIS 78">*84 to Delaware 10,000 shares of its $ 50 par value 7 per cent preferred stock and 158,289 shares of its no par value common stock, which shares were identical in type and number with Delaware's outstanding shares and were exchanged share for share with Delaware's stockholders. Delaware was dissolved on November 27, 1940.
On August 1, 1940, petitioner began operating the physical properties which Delaware had received from its subsidiaries, which consisted of pipe lines, right of ways, franchises, lands, rights in lands, buildings, machinery, pumping stations, regulator stations, gas meters, and like items of distribution systems for the purchase, transportation, and sale of natural gas. When the subsidiaries transferred their assets to Delaware on July 31, 1940, the fair market value of the assets of each transferee was in excess of the then outstanding indebtedness of the transferor.
The subsidiaries' bonds remained on deposit with the Maryland Trust Co., trustee, after the subsidiaries had transferred their assets to Delaware, subject to the vendor's lien and other liens heretofore mentioned. By a trust indenture of July 29, 1940, supplementary to Delaware's indenture of December1947 U.S. Tax Ct. LEXIS 78">*85 1, 1928, and signed by petitioner, 9 T.C. 570">*573 Delaware, and the trustee, petitioner recognized its obligation to pay the bonds of the subsidiaries and of Delaware and to perform all covenants of the existing indenture, and further recognized the vendors' and other liens attaching to the subsidiaries' properties as of that date for the bondholders' benefit, and "in ratification of such liens" it transferred to the trustee all of its property and assets in trust to secure payment of Delaware's bonds. On December 1, 1940, petitioner caused the subsidiaries' bonds to be canceled, with the consent of the trustee.
In determining Delaware's income tax for 1940 the Commissioner added to income reported a gain of $ 310,918.80, representing "the difference between the purchase price of its subsidiaries' bonds and the face value of the same as of July 31, 1940, upon the liquidation of the subsidiaries."
2. In its corporation income, declared value excess profits and defense tax return for 1940, Delaware accrued and deducted $ 2,419 on account of a total capital stock tax of $ 4,675 for its capital stock tax year ended June 30, 1940. Of the $ 2,419, $ 475 was attributable to an increase in rate1947 U.S. Tax Ct. LEXIS 78">*86 of 10 cents per thousand imposed by section 205, Revenue Act of 1940.
The Commissioner disallowed deduction of the $ 2,419 claimed for 1940 on account of the capital stock tax for the year ended June 30, 1940.
The Commissioner determined petitioner liable for the deficiency resulting from adjustments in Delaware's income tax for 1940.
OPINION.
1. The Commissioner determined that in 1940 Delaware realized taxable income of $ 310,918.80, representing "the difference between the purchase price of its subsidiaries' bonds and the face value of the same as of July 31, 1940, upon the liquidation of the subsidiaries." The parties are in agreement that Delaware acquired the bonds at a cost which was $ 310,918.80 less than their face value, and that upon the liquidations in 1940 each subsidiary transferred to Delaware assets of a value in excess of the face amount of the bonds. Petitioner contends that no gain is taxable because all the assets were distributed "in complete liquidation" of the subsidiaries as contemplated by section 112 (b) (6), Internal Revenue Code, which provides that no gain or loss is to be recognized for tax purposes upon the receipt of property so distributed.
Respondent1947 U.S. Tax Ct. LEXIS 78">*87 agrees, as he must, that all the subsidiaries' assets were transferred to Delaware in the course of a complete liquidation and that under section 112 (b) (6) no gain is recognizable insofar as the assets transferred constituted a distribution in liquidation and cancellation 9 T.C. 570">*574 of the subsidiaries' stock, all of which was held by Delaware. But he argues that the amount available for this purpose must be reduced by the subsidiaries' obligations, which Delaware assumed, and among which were the subsidiaries' bonds, which Delaware held; that so much of the assets transferred as equaled the face value of the bonds must be considered as received by Delaware in satisfaction of the bonds, not in liquidation of the stock, and, since under this view the full face amount of the bonds was received, Delaware's gain in the amount of the discount of $ 310,918.80 is not precluded from recognition by section 112 (b) (6), and, hence, is taxable as income under the doctrine of Helvering v. American Chicle Co., 291 U.S. 426">291 U.S. 426.
In H. G. Hill Stores, Inc., 44 B. T. A. 1182, we held that "The provisions of section 112 (b) (6), * * * 1947 U.S. Tax Ct. LEXIS 78">*88 do not and were not intended to cover a sale or transfer of assets to a creditor." Adhering to that view, we are of opinion that the Commissioner's determination here must be sustained. In the Hill case an insolvent subsidiary had transferred all its assets to a creditor parent, which assumed its liabilities. As the subsidiary owed the parent an amount greater than the value of the assets, the parent asserted its right to deduct the excess as a bad debt. We sustained its contention against the Commissioner's argument there that no loss was recognizable under section 112 (b) (6) because the subsidiary's transfer of assets was in liquidation. Under similiar facts we have approved similar deductions in Glenmore Distilleries Co., 47 B. T. A. 213; B. F. Sturtevant Co., 47 B. T. A. 464; and Iron Fireman Manufacturing Co., 5 T.C. 452.
Delaware's subsidiaries were solvent and, hence, discharge of their obligations to the parent at par formed no basis for a deduction by the parent. But the principle of the cited decisions is not limited to transfers by insolvent subsidiaries; it supports 1947 U.S. Tax Ct. LEXIS 78">*89 the general proposition that a subsidiary's transfer of all assets to a creditor parent is first applicable to a discharge of its indebtedness to the parent, and it operates with equal force to require the recognition of any gain realized by the parent from a full collection of such indebtedness. It is the excess of the assets' value above indebtedness that constitutes a liquidating distribution, and the provisions of section 112 (b) (6) apply to that amount only.
Petitioner argues, to the contrary, that the cited cases are not applicable because the subsidiaries made no "sale" or transfer of their assets to Delaware in order to pay off the indebtedness due Delaware as holder of their bonds, and "such a payment or satisfaction did not occur in the liquidation of Delaware's subsidiaries." It stresses that "Delaware merely assumed payment of these bonds when due"; that the bonds were not canceled until December 1, 1940, and that the liquidation plan did not contemplate and did not involve any payment of them. Whatever color the literal form of the transactions may lend 9 T.C. 570">*575 to such views, the realities are to the contrary. Delaware could not acquire all the subsidiaries' assets1947 U.S. Tax Ct. LEXIS 78">*90 in derogation of their creditors; the excess of their assets above their obligations was the maximum available for a liquidating distribution. And this is here a fortiori true because Delaware received the assets impressed with liens in favor of the bondholders, fortified by an actual conveyance to the trustee for the bondholders and by Delaware's own assumption of liability for obligations, including the bonds. As a result, Delaware received assets securing full payment of bonds which it itself owned and for which it itself was liable. Its position was identical with that of a bond issuer which acquires its own bonds at a discount. The amount of such discount has been held taxable as income, 291 U.S. 426">Helvering v. American Chicle Co., supra;United States v. Kirby Lumber Co., 284 U.S. 1">284 U.S. 1, whether or not the bonds were canceled immediately or later. TennesseeConsolidated Coal Co. v. Commissioner (C. C. A., 6th Cir.), 145 Fed. (2d) 631; Garland Coal & Mining Co. v. Helvering (App. D. C.), 75 Fed. (2d) 663; Eastern Building Corporation, 45 B. T. A. 188.1947 U.S. Tax Ct. LEXIS 78">*91
Petitioner urges, further, that to treat the assets as received by Delaware partly in payment of the bonds and partly as a liquidating distribution is to make an unwarranted division of the liquidations for the application of section 112 (b) (6), and to create insuperable difficulties in determining Delaware's bases for the several assets under section 113 (a) (15). We are not impressed by these arguments. Section 112 (b) (6) applies only to distributions in liquidation, and such distributions can not comprise assets required for the discharge of obligations. As for bases, we fail to perceive that the difficulties of determination are any greater than would follow if the bonds had been owned by another and Delaware, pursuant to its assumption of liability, had satisfied them with cash from its general funds. We approve the determination that Delaware realized in 1940 taxable income of $ 310,918.80 representing the discount below par at which it acquired the bonds.
2. Petitioner contends that Delaware is entitled to deduct in 1940 $ 475 representing the part of its total capital stock tax for the year ended June 30, 1940, which is attributable to a 10-cent increase in rate imposed1947 U.S. Tax Ct. LEXIS 78">*92 by section 205, Revenue Act of 1940, approved June 25, 1940. While the capital stock tax accrued, as respondent argues, on July 1, 1939, that accrual was operative only in respect of the rate of $ 1 then imposed by section 1200, Internal Revenue Code. As the increase in rate to $ 1.10 was the subject of an amendment to the law enacted June 25, 1940, liability for such increase had accrued, and deduction of the $ 475 in 1940 is therefore approved. First National Bank in St. Louis, 1 T.C. 370.
Decision will be entered under Rule 50.