*95 Decision will be entered under Rule 50.
1. Income -- Gain from Sale -- Who Was Seller. -- A sale of assets distributed in partial liquidation to trustees for stockholders was made for the stockholders and not for the corporation.
2. Inventories -- Addition to Income Based Upon a Reduction in Opening Inventory. -- No addition to income is proper where wines giving rise to a reduction in opening inventory were distributed in kind to stockholders during the year as a partial liquidation.
3. Deductions from Gross Income -- When Deductible. Distributions -- Mutual Associations -- Nonprofit. -- Amounts paid to obtain release of wine from warehouse were deductible in full when paid and no part thereof was deductible later as a charge-off of a receivable set up to represent the estimated amount which might be returned later through a distribution from a mutual financing association. Any amount returned later should be reported as income when received.
4. Deductions from Income -- "Carry-Backs" -- Net Operating Losses of Subsequent Years -- Sections 23 (s) and 122. -- Sections 23 (s) and 122 do not discriminate generally against corporations merely because they are in process of *96 liquidation and dissolution.
*630 The Commissioner determined deficiencies as follows for the petitioner's fiscal year ended March 31, 1943:
| Income tax | $ 23,435.82 |
| Declared value excess profits tax | 53,903.10 |
| Excess profits tax | 279,114.45 |
The principal error assigned by the*97 petitioner is the action of the Commissioner in holding that the petitioner sold certain assets on March 25, 1943, and realized a taxable profit. Another is the action of the Commissioner in adding $ 4,774.57 to reported income representing an understatement of the opening inventory on wine involved in the first issue. A third is the disallowance of deductions claimed for "step-up" and "overcosts" allegedly charged off in 1943 and the inclusion in income of a distribution from Central California Wineries, Inc. The fourth issue is a claimed deduction for carry-backs of 1944 and 1945 losses. The parties have agreed to adjust another item. Other issues are raised only as an alternative to the first and main issue.
FINDINGS OF FACT.
The petitioner is a California corporation. Its returns for 1943 were filed with the collector of internal revenue for the first district of California.
78,000 shares of stock of the petitioner were outstanding in the latter part of 1942 and in the early months of 1943. These shares were owned by 318 stockholders. There was dissatisfaction among the stockholders. Some of them had consulted an attorney to see if he could devise some way to get their*98 money out of the corporation.
The petitioner had a large inventory of wines in the early part of 1943. Such wines had been in great demand for a number of months. The officers and directors of the petitioner refused to consider offers to buy its assets because of the heavy taxes which would result. Some of the stockholders endeavored to find a purchaser for all of the stock of the petitioner, but no one interested in buying the wine was found who would buy the stock.
The attorney for the stockholders, mentioned above, then suggested to the stockholders that they dissolve the corporation, have the assets distributed to themselves in liquidation, and then sell them, thus avoiding the tax to the corporation upon a sale by it. His general plan was followed A majority of the stockholders filed a consent to dissolution on February 11, 1943. This was followed promptly by other appropriate steps leading towards dissolution. All stockholders were duly notified and a sufficient number assented. It was realized at the beginning of these steps that the stockholders could not personally act as sellers because of the inconvenience of dealing with 318 owners, *631 of whom some were in*99 the armed forces, some of Japanese descent were not free to move about, and some were representatives of estates. Therefore, the stockholders who instigated the plan proposed therein that the assets should be distributed to three trustees who would be named by the stockholders to act for them in receiving the assets from the petitioner, in caring for those assets until they could be sold, in promptly selling the assets, and in dividing the net proceeds of the sale among those owning beneficial interests in the trust thus established. Such a plan of dissolution of the petitioner was agreed upon by the stockholders and was carried out. The stockholders became owners of beneficial interests in the trust in proportion of their stockholdings. The three trustees elected by the stockholders were not officers or directors of the petitioner. It was expressly provided in the various instruments that those trustees were authorized to act only for the stockholders. They were not authorized in any way to act for the petitioner corporation.
The petitioner retained a small portion of its wine and a few other assets to meet some commitments, to pay some taxes and other obligations, and to pay*100 the expenses of winding up its affairs. All of the remainder of its assets, including wine, winery, real estate and other items, were distributed in liquidation to the trustees for the stockholders. Appropriate resolutions were adopted. The appropriate conveyances were made on or about February 26, 1943. Thereafter the petitioner never had any further dealings or connection with the assets distributed to the trustees. It ceased doing business and proceeded to wind up its affairs in complete liquidation and dissolution.
The assets were conveyed to the trustees, subject to certain stated liens of record which were amply secured by the assets.
No deal of any kind for the sale of the assets involved herein was pending on or about February 26, 1943. The trustees, on February 27, 1943, began to advertise those assets for sale and eventually found a purchaser as a result of their advertisements and efforts. They had many inquiries and offers. They sold all of the assets for $ 937,000 to R. H. Gibson of Covington, Kentucky, on March 25, 1943, after negotiations with him begun on that same day.
Gibson was a distributor of wine in eastern states. Distributors were buying wineries*101 in order to obtain bulk wines for their business. He had tried to buy the wines of the petitioner in January 1943, but had been told that the petitioner would not sell any of its wine or other assets. He made no offer to buy the stock. There were no further negotiations with him upon behalf of the petitioner. He read an advertisement of the trustees and contacted them as a result of that. Meanwhile the trustees had carried negotiations with other prospective purchasers almost to the point of a sale. The sale was made to *632 Gibson because he was the highest bidder and because he was agreeable to the terms of sale. An unsuccessful bidder sued the trustees to prevent the sale to Gibson and for specific performance of an alleged prior agreement to sell to him. The suit was decided against him in October 1943.
The purchase price was paid by Gibson as follows:
| Cash | $ 400,000.00 | ||
| Promissory note | 175,212.07 | ||
| Taken subject to liens: | |||
| Principal | $ 360,578.50 | ||
| Interest accrued | 1,209.43 | 361,787.93 | |
| 937,000.00 |
The trustees divided $ 351,000 among the owners of beneficial interests in August 1943. They have refrained from making further distributions of*102 the purchase price because the Commissioner has requested that they make no more pending final decision in this case.
The Commissioner has held that the "trustees effected the sale for and on behalf of the corporation which realized the proceeds and is, therefore, subject to tax on the net gain of $ 426,673.18 derived therefrom."
The petitioner used $ 360,668.53 as its opening inventory for 1943 in reporting its income for 1943. The Commissioner determined that the correct opening inventory for 1943 was $ 323,957.65 because certain wines included therein had not cost as much as was shown on the petitioner's books. The petitioner does not contest the correctness of that determination. The Commissioner, in determining the deficiency for 1943, added $ 36,710.98, the difference between the above amounts, to income as reported by the petitioner on its return for 1943. He made no change in the petitioner's closing inventory for 1943 shown on its books as $ 1,520.16.
The petitioner, in closing its books for 1943, used an inventory value of $ 355,833.56 for the wines which it transferred on February 26, 1943, to the trustees for the stockholders. The Commissioner, in determining the *103 deficiency, treated that transaction as a sale by the petitioner, computed the profit by using the book inventory figure of $ 355,833.56, and added the profit to the income reported by the petitioner.
Wines in the opening inventory for 1943 on which the book inventory figures were reduced $ 4,774.57 by the Commissioner's adjustment were a part of the wines transferred to the trustees for the stockholders on February 26, 1943.
Central California Wineries, Inc. (referred to herein as CCWI) was a nonprofit membership corporation organized in August 1939 under the laws of California. The purpose of CCWI was to aid in *633 financing wineries by stabilizing prices in the wine industry. It was discontinued in the spring of 1942 because of objections from the Department of Justice. One of the officers of the petitioner was designated a member of CCWI and the petitioner participated in its activities from August 1939 to May 1942 through contracts between the two corporations.
CCWI purchased grapes which were delivered to the wineries. The wineries produced wine from those grapes. The wine was stored in public warehouses against warehouse receipts in the name of CCWI. The latter borrowed*104 money from the bank by hypothecating the warehouse receipts. The loans were for fixed amounts per gallon of wine. CCWI used this money to buy grapes and advanced the rest of it to the wineries to pay their expenses. The wineries, as wine was sold, paid to CCWI from the purchase price an amount sufficient to obtain from the bank a release of the wine. The amount paid for a release was computed at so much per gallon to cover the costs of CCWI in purchasing the grapes and in advancing money to the wineries and also included a "step-up" to cover the costs of operating CCWI, including all charges made by the bank. The "step-up" was fixed at a cent or more per gallon. The release payment required by the bank was uniform for wine of a given type. It was based upon the average amount loaned to CCWI per gallon. If a winery produced its wine at less than average cost, CCWI credited the difference, called "undercosts," to its "Operating, Capital and Reserve" account. If one produced at higher than average it had to pay the difference to CCWI to obtain releases.
CCWI recorded all moneys received from member wineries in an account called "Operating, Capital and Reserve" account. CCWI*105 occasionally made distributions out of this fund whenever it contained more than CCWI deemed necessary to meet its obligations. Such distributions were made to the member wineries in proportion to the quantity of wine produced by each through CCWI.
The petitioner issued a check to CCWI for each release and recorded the amount, less the "step-up" and any "undercost," as a credit to an account payable to CCWI. The petitioner entered the amount of the "step-up" as a credit to an account receivable and against it charged an arbitrary amount per gallon of wine per month as expense. It made an adjusting entry in this account at the end of each fiscal year, after conferring with CCWI, in an effort to make the charges in the account approximate the petitioner's share of the estimated expenses of CCWI. The petitioner also carried the "overcosts" as an account receivable from CCWI.
CCWI and the petitioner entered into a final settlement on or about April 30, 1942, when CCWI discontinued operations.
*634 The Commissioner has held that all payments by the petitioner to CCWI for releases were deductible as ordinary and necessary expenses of the year in which they accrued or were paid, *106 and has held that all distributions from CCWI to the petitioner were income of the year in which made. The general explanation given by him in the notice of deficiency pertains to the year 1941 and is as follows:
(c), (d) and (e). In the fiscal year ended March 31, 1940 you became a member of the Central California Wineries, Incorporated, a cooperative corporation association of wine producers. This organization was formed to handle purchasing of grapes, production of wine and the financing of such operations on behalf of the members. The agreement provided that members would make payments of funds based on gallons of wines handled, to the association for the purpose of meeting the association's running expenses; and would make further payments to equalize costs of grape purchases between members. The former were called "step-up" payments; the latter were called "undercosts" or "overcosts". It was further provided that when the association had on hand funds in excess of its needs for running expenses or other possible charges, the excess would be distributed to the members in accordance with their respective interests in the association.
You made payments of both "step-up" and*107 "undercosts" to the association in the fiscal years from 1940 to 1943 inclusive and received back distributions from the association. As payments were made you charged a portion to operating expense on your books and part were charged to a deferred account receivable. Information as to the allocation of such payments between expense and deferred accounts receivable has not been supplied. On receipt of distributions, they were credited against deferred accounts receivable. In the fiscal year 1943, upon your withdrawal from the association the balance of charges to the account receivable was charged to profit and loss and claimed as a deduction in your return for the fiscal year 1943. Charges to deferred accounts receivable and credits thereto are summarized as follows:
| Balance | ||||
| Dr. | Cr. | (End of year) | ||
| 1940 F. Y. | Deferred step-up charges | $ 8,029.42 | ||
| Deferred undercosts | 14,653.01 | $ 22,682.43 | ||
| 1941 F. Y. | Deferred step-up | 23,486.57 | ||
| Deferred undercosts | 10,397.89 | |||
| Distribution from C. C. W. I. | $ 8,234.37 | 48,332.52 | ||
| 1942 F. Y. | Deferred step-up | 15,961.25 | ||
| Distribution from C. C. W. I. | 24,500.00 | 39,793.77 | ||
| 1943 F. Y. | Distribution from C. C. W. I. | 16,324.56 | ||
| Balance charged to P. & L. to | ||||
| adjust excess amounts | ||||
| deferred -- step-up | 2,189.24 | |||
| Balance charged to P. & L. to | ||||
| adjust excess amounts | ||||
| undercosts | 21,279.97 | 0 |
*108 It is held that all payments to the association for the latter's expenses either "step-up" or "undercosts" were allowable deductions from income at the time paid since the Central California Wineries, Incorporated had no liability to make repayments of such items to its members. And that when distributions were made to members the amounts constituted taxable income in the years received.
*635 The Commissioner made the following adjustments for 1943:
| (b) | Charge-off of deferred "step-up" payments to | |
| C. C. W. I. disallowed | $ 2,189.24 | |
| (c) | Charge-off of deferred "undercost" payments to | |
| C. C. W. I. disallowed | 21,279.97 | |
| (d) | Distribution from C. C. W. I. added to income | 16,324.56 |
He gave the following explanation:
(b), (c) and (d). In accordance with the explanation herein to adjustments (c), (d) and (e) for the fiscal year 1941, the charge-offs of the balances of deferred accounts receivable for "step-up" and "undercost" payments to the Central California Wineries, Inc. in the amounts of $ 2,189.24 and $ 21,279.97 respectively, are disallowed since the payments of amounts represented by such balances have been allowed herein as deductions in the years such payments*109 were made. Distributions of $ 16,324.56 received from the Central California Wineries, Inc. in the taxable year are included as taxable income when received.
All stipulated facts are incorporated herein by this reference.
OPINION.
The Commissioner has taken an untenable position upon the main issue in this case. It is contrary to the stipulated facts and, as a consequence, is not supported by the cases upon which he relies. He contends that the trustees were "trustees in dissolution," acting for and on behalf of the corporation to carry out its liquidation and dissolution, they effected the sale for the corporation, the latter realized the proceeds and is subject to the tax on the net gain. He states in support of this contention that the authority given the trustees was for the purpose of liquidating the properties, settling the debts of the corporation, and paying the remainder to the shareholders. He cites Mrs. Grant Smith, 26 B. T. A. 1178, and First National Bank of Wichita Falls, Trustee, 3 T. C. 203, which would be helpful if the facts here were as the respondent states them, but the stipulation and the testimony*110 are to the contrary.
The assets of the corporation in the Smith case were transferred to an agent for the directors, who were acting as trustees in liquidation. The agent was not chosen by the stockholders and was not representing them in receiving or selling the assets. The trustee in the Wichita Falls case also acted for the corporation under circumstances unlike those here present.
The negotiations which led to the sale in the present case were begun after the liquidating distribution, were carried on by trustees elected by and representing only stockholders, were not participated in by the corporation in any way, and had no important connection with any prior negotiations. These facts distinguish this case from Mrs. Grant Smith, supra;Fairfield Steamship Corporation, 5 T.C. 566">5 T. C. 566; affd., 157 *636 Fed. (2d) 321; *Meurer Steel Barrel Co. v. Commissioner, 144 Fed. (2d) 282; certiorari denied, 324 U.S. 860">324 U.S. 860; and Court Holding Co. v. Commissioner, 324 U.S. 331">324 U.S. 331, cited and relied upon by the*111 Commissioner, in which the negotiations leading to the sale were instituted and pushed to an advanced stage by representatives of the corporation. The case of Howell Turpentine Co., 6 T.C. 364">6 T. C. 364, is similarly distinguishable.
The trustees in the present case were not in form or in fact "trustees in liquidation." They were not named or authorized to carry out the liquidation of the corporation. The corporation was doing its own liquidating and dissolving. It retained assets needed in winding up its affairs and it was proceeding with its liquidation. If any further distribution in liquidation is permitted, it will make it. The trustees were not authorized to settle any debts of the corporation or to do anything else in its behalf. The assets distributed to the trustees were not in fact used to pay off any debts of the corporation. The proceeds of the sale did not go to or benefit the*112 corporation. The various instruments expressly provided that the trustees were to act solely for the stockholders in receiving the first liquidating distribution and in selling the assets thus received. The respondent may not distort the stipulated facts to support his determination.
It is frankly conceded that the petitioner did not want to sell any of its assets because of the heavy taxes which would follow such a step. It refused to sell. It is also conceded that the stockholders wanted to get their money out of the petitioner and they formulated a plan for that purpose which was adopted in preference to any other because they thought it would be acceptable to possible buyers and would have tax advantages. The respondent says "it would therefore be proper to disregard the trusteeship device in the computation of income tax liability under the rubric of Gregory v. Helvering, (1935) 293 U.S. 465">293 U.S. 465; Alice H. Bazley, (1945) 4 T.C. 897">4 T. C. 897, aff'd. (C. C. A. 3rd, 1946) 155 F. (2d) 237; and Court Holding Company (1945), 324 U.S. 331">324 U.S. 331." Form sometimes gives away to*113 substance in tax matters, but here the steps taken were real and genuine. Cf. Chisholm v. Commissioner, 79 Fed. (2d) 14. The cases cited are not authority for the proposition that the method resulting in most tax must be selected in preference to another, otherwise proper and permissible, which would result in less tax. The law is to the contrary. Gregory v. Helvering, supra.
The respondent also argues that the distribution was not in accordance with section 401 (a) of the Civil Code of California. He cites no decided case to support this argument. It is not too clear just how this contention, if sound, would help him. The part of the code upon which he relies is as follows:
*637 After determining that all the known debts and liabilities of a corporation in the process of winding up have been paid or adequately provided for, the directors shall distribute all the remaining corporate assets among the shareholders and owners of the shares according to their respective rights and preferences. * * *
The payment of a debt or liability shall be deemed to have been adequately provided for if the payment thereof*114 has been assumed or guaranteed in good faith by one or more financially responsible corporations or other persons, and such provision was determined in good faith and with reasonable care by the board of directors to be adequate at the time of any distribution of assets by the directors hereunder.
The respondent says that "payment of the corporate liabilities was not provided for until Gibson, the ultimate purchaser, assumed payment of the bank liabilities of $ 361,787.93 as part payment of the purchase price." The board of directors of the petitioner adopted a resolution approving a finding that the properties transferred which were subject to liens of record were adequate security for those debts. That finding was fully justified by the facts. The assets here in question were transferred to the trustees subject to the secured debts of record. Other assets, adequate in amount, were retained by the corporation to meet all other liabilities. Thus it does not appear that there was any failure to comply with the code. Furthermore, the liens of record, "the bank liabilities," were not "assumed" by Gibson. He merely bought "subject to" those debts. Thus, if there was any defect*115 in the distribution, it was not cured by the sale and it is not clear how this would help the respondent. Furthermore, the distribution would not be void in any event and the Commissioner would not be in position to complain or to make anything of any failure to provide adequately for the debts. Cf. section 402 of the code.
The sale was made for the stockholders, who owned the assets sold. It was not made by or on behalf of the petitioner. No sound reason for taxing the corporation with any gain from the sale has been suggested. Conservative Gas Co., 30 B. T. A. 552; Central National Bank, Trustee, 25 B. T. A. 1123. Cf. Falcon Co., 41 B. T. A. 1128; affd., 127 Fed. (2d) 277; Chisholm v. Commissioner, supra;George T. Williams, 3 T. C. 1002; Fruit Belt Telephone Co., 22 B. T. A. 440; Robert Jemison, Jr., 3 B. T. A. 780.
The Commissioner added $ 36,710.98 to the income reported by the petitioner. He did that because the petitioner's opening*116 inventory was overstated by that amount. The petitioner concedes that that adjustment was proper in so far as the wines giving rise to the overstatement of the opening inventory were sold during 1943. He points out, however, that wines giving rise to $ 4,774.57 of the overstatement of the opening inventory were not sold during 1943, as determined by the Commissioner, but were distributed to the trustees for the *638 stockholders. See the holding upon the first issue herein. The respondent does not contest the fact that the $ 4,774.57 figure is correct. The petitioner has made an assignment of error contesting the addition of the $ 4,774.57 to income as a part of the larger amount, $ 36,710.98.
The respondent's brief does not indicate that he has understood this issue and it does not contain any helpful discussion on the point. We, too, have had some difficulty in understanding the issue as presented by the petitioner. However, we are satisfied that the elimination of the $ 4,774.57 follows as a corollary of our holding, on the first issue, that the petitioner did not sell the wines to Gibson, but distributed them in kind to its stockholders in liquidation.
If the petitioner*117 had sold those wines, then its profit would have been computed properly upon the smaller correct inventory figure and the $ 4,774.57 would have been properly added to income as reported. But, since they were not sold, the petitioner did not realize anything from their disposition, did not recover any part of their inventory value, did not realize any gain in addition to that reported. It was immaterial from the standpoint of its 1943 taxable income whether they appeared in the opening inventory at one figure or at another, so long as they were taken out of the inventory account at the same figure at which they appeared therein. The Commissioner has stated in his notice of deficiencies that they were taken out at the same figure at which they appeared in that account. It follows that no adjustment to income was called for or proper. Apparently the Commissioner made the adjustment only because of his erroneous holding that these wines were sold to Gibson by the petitioner. He has advanced no other sound reason for his action.
The next issue is whether the Commissioner erred in disallowing the deductions for "step-up" and "overcosts" claimed for 1943 and in including the distribution*118 from CCWI in income for that year. The record does not support all of the findings which the petitioner requests and leaves something to be desired in showing just how the issue arises. However, the parties do not seem to be in disagreement as to any of the figures. They differ on general principles. The petitioner contends that the deductions which it claimed in prior years on account of "step-up" were all that it was entitled to, the Commissioner erred in allowing deductions in those years for the full amounts paid to CCWI on releases, and, consequently the deferred "step-up" receivable and the deferred "overcost" receivable which it charged off in 1943 after the settlement were properly deductible at that time and the distribution which it received was merely a return to it of an amount due from CCWI as an excess contribution by the petitioner to the expenses of CCWI. Apparently the petitioner *639 did not receive in the settlement the full total of the balances in its "step-up" and "overcost" receivable accounts as shown by its books and the first two items in controversy represent those differences.
The Commissioner contends that the petitioner had no right to recover*119 any part of the total amounts which it paid to CCWI for releases, regardless of whether they represented "step-up" or "overcost," except as the directors of CCWI might later determine that the balance in its "Operating, Capital and Reserve" account was more than it would require for its own use and distribute a part of that account ratably to all member wineries. Cf. Farmers Union State Exchange, 30 B. T. A. 1051, 1066. The record supports this contention. The total release payments were definite obligations of the petitioner when paid, fixed by events which had then occurred. The petitioner has not shown that lesser liabilities accrued or that there was any sound basis for accounting for less than the full amount paid for releases. They were properly allowed in full as deductions in those years. The Commissioner did not err in refusing to allow duplicating deductions for 1943. Furthermore, the distribution made by CCWI to the petitioner in 1943 was taxable income for that year. It was a partial return of amounts taken as deductions in prior years and was properly to be reported as income when returned. Estate of William H. Block, 39 B. T. A. 338*120 (affd., 111 Fed. (2d) 60; certiorari denied, 311 U.S. 658">311 U.S. 658) and cases cited therein. Cf. Security Flour Mills Co. v. Commissioner, 321 U.S. 281">321 U.S. 281.
The petitioner relies upon San Joaquin Valley Poultry Producers Association v. Commissioner, 136 Fed. (2d) 382, for the proposition that the balance in the "Operating, Capital and Reserve" account of CCWI belonged to the member wineries and did not represent taxable income when distributed, but represented a deductible item to the extent that it was not distributed to pay the balances in the petitioner's two deferred receivable accounts. The question in that case was whether a nonprofit organization had taxable income. It placed the items in question in a reserve account. The circumstances and the question in that case were so different from those involved herein that the case is not controlling here.
The petitioner also argues that the adjustments made by the Commissioner distort its income reported upon an annual basis. The facts used in this argument are not clear from the record but, aside from that, we could*121 not find error in the determination upon this theory.
The next point urged by the petitioner is that it is entitled to a deduction for 1943, under sections 23 (s) and 122 of the Internal Revenue Code, of net operating losses sustained in 1944 and 1945. The notice of deficiency was dated January 23, 1945. It contained no reference to a net operating loss deduction for 1943 based upon an operating *640 loss for the fiscal year ended March 31, 1944, and, of course, the next fiscal year had not yet ended. The parties have now stipulated facts from which the deduction sought can be computed. The respondent argues, however, that no deduction may be allowed because this petitioner was "substantially liquidated and marking time" during 1944 and 1945 and "was no more the taxpayer it was in previous years, in substance and in fact, than if it had legally changed its existence." He says that Congress intended this deduction only where the same taxpayer was continuing to carry on substantially the same business in the loss years that it had carried on in the taxable year. He cites no authority to show that this petitioner is not entitled to whatever deduction the stipulated facts*122 will show. The words of the statute are general in their application and something would have to be read into them which is not there to limit them so that they would not apply in this case.
The parties are to agree upon the effect of any change in California franchise tax liability. The petitioner raises other issues only in the alternative to an unfavorable decision on the first point decided herein. They need not be considered, since the main issue has been decided for the petitioner.
Decision will be entered under Rule 50.
Footnotes
*. The question on which the Circuit Court based its affirmance is not involved in the present case.↩