*2657 In the circumstances, held that a purported sale of petitioner's assets to its president was not a bona fide sale thereof upon which a deductible loss may be claimed.
*133 This proceeding is for the redetermination of deficiencies in income and profits taxes duly asserted by the respondent for the fiscal years ended March 31, 1919, and March 31, 1920, in the amounts of $339,393.73 and $3,654.37, respectively.
The petitioner alleges that the respondent erred in determining the deficiencies herein in that he disallowed as a deduction from gross income the amount of $481,657.69, alleged to represent a loss sustained by reason of the transfer of petitioner's assets on April 10, 1919, under the circumstances and conditions hereinafter described.
FINDINGS OF FACT.
The petitioner was organized in May, 1916, under and by virtue of the laws of the State of Ohio, with an authorized capital of $5,000 *134 divided into 50 shares each of the par value of $100. A few days later, the capital stock*2658 of the petitioner was increased to $300,000, represented by shares of stock of the par value of $100.
Upon its organization the petitioner acquired the assets of Hutchcroft & Sons Co. of Cleveland, Ohio, and immediately engaged in the business of manufacturing bodies for pleasure automobiles. The White Motor Co. of Cleveland bought the entire output of the petitioner from the time of its incorporation until some time in March, 1918, at which time the White Motor Co. discontinued producing pleasure automobiles. Leon Rubay was the president of the petitioner and a body designer of some note.
In March, 1918, due to the war in which the United States was at that time engaged, the White Motor Co. turned its attention to the manufacture of trucks. Losing its sole customer for pleasure-car bodies, the petitioner, finding its plant suited for the manufacture of airplane spares and parts, secured contracts from the United States Government for the manufacture of such spares and parts for airplanes. It continued manufacturing airplane parts and spares until after the Armistice, and sometime in November, 1918, the contracts which it had with the Government were canceled.
Upon the*2659 cancellation of its contracts for the manufacture of airplane parts and spares, the petitioner found itself with a plant unsuited for the production of any article other than automobile bodies. However, the White Motor Co., its sole customer for pleasure bodies, did not reenter the field of pleasure cars. The petitioner attempted to continue its business but found that it was operating at a loss of about $25,000 a month.
On February 24, 1919, at a meeting of the directors of the petitioner, the advisability of winding up the affairs of the petitioner was discussed, and at another meeting of the directors held on March 26, 1919, Leon Rubay informed the other directors that he hoped to be able to work out a plan whereby the entire assets of the company could be sold for $270,000, partly in cash and partly in securities.
On April 10, 1919, the petitioner's books showed its net worth to be $733,725.16. A trial balance taken as of that day shows assets and liabilities as follows:
| Debit | Credit | ||
| 1A | Union Commerce National Bank | $283,861.12 | |
| B | Detroit Ave. Savgs. & Banking Co | 355.36 | |
| C | Petty Cash Fund | 915.00 | |
| D | City Savings & Loan Company | 440.00 | |
| 4A | Accounts Receivable - Customers | 8,320.59 | |
| B | Accounts Receivable - Employees | 5,283.34 | |
| C | Int. Rec. on Investment | 108.49 | |
| 1,711.51 | |||
| D | Transportation Claims | 2,189.92 | |
| E | Accts. Rec. Gov't. Contract De H #1 | ||
| F | Accts. Rec. Gov't. Contract De H #2 | ||
| 6A | Stockholders Notes Receivable | $11,000.00 | |
| 8A | Raw Materials | 30,424.99 | |
| B | Spec. Body Stock | 3,495.61 | |
| C | Stand Body Stock | 18,887.88 | |
| D | Lumber Stores | 24,519.20 | |
| E | Paint Stores | 2,413.55 | |
| F | Misc. Sup. Stores | 9,372.99 | |
| G | Rest. Kitchen Stores | 673.16 | |
| H | Rest. Show Case Stores | 119.52 | |
| I | Coal Stores | 4,284.55 | |
| 10A | Work in Process Production Orders | 42,671.05 | |
| B | Work in Process Equipment Orders | 94.80 | |
| 12A | Real Estate | 20,265.76 | |
| 13A | Buildings | 297,067.49 | |
| 14A | Factory Equipment | 96,267.31 | |
| 15A | Cash Sur. Value L. Rubay Insc | 2,730.61 | |
| C | Stocks & Bonds | 115,200.00 | |
| 17B | Prepaid Ins. Misc | 5,678.25 | |
| C | Prepaid Ins. Emp. Lia | $90.17 | |
| D | Prepaid Ins. L. Rubay | 586.84 | |
| F | Advances on Accounts Payable | 645.69 | |
| H | Advances on Trav. Exp. | 67.25 | |
| 19A | L. Rubay Contract | 9,861.07 | |
| 21A | Accts. Payable Misc | 22,844.00 | |
| C | Liberty Bond Collections | 77.50 | |
| D | Wages & Salaries Payable | 6,904.24 | |
| E | Wages & Salaries Unclaimed | 183.18 | |
| F | Deposits on Bodies | 1,335.00 | |
| G | L. Rubay Salary Withheld | 506.66 | |
| 23A | Accd. Interest | 683.45 | |
| B | Accd. Taxes Inc. & E. Profits - Federal | 182,000.00 | |
| D | Accd. Taxes Fed. Cap. Stock | 43.21 | |
| E | Accd. Taxes Real Estate | 833.33 | |
| F | Accrued Taxes County - Personal | 1,666.66 | |
| G | Accrued Taxes State Franchise | 12.50 | |
| H | Accrued Legal Expenses | 333.33 | |
| 23I | Accrued C.E. Ill. Co | 846.10 | |
| K | Accrued Water Rent | 13.94 | |
| M | Accrued Land Rental | ||
| 25C | Notes Payable Misc | 4,394.29 | |
| 26A | Res. for Depreciation - Bldgs | 23,720.99 | |
| B | Res. for Depreciation - Mchy, & Equipt | 17,318.67 | |
| 27C | Res. for Adjusting | 1,233.33 | |
| D | Res. for Traveling | 641.69 | |
| E | Res. for Advtg. Shows Catalogs | 213.57 | |
| 30A | Scrap Matl. sold J.N 4 | 222.02 | |
| 32A | Adj. of Profit & Preceding Year | 243.67 | |
| B | Profit & Loss Current | 72,574.32 | |
| C | Surplus | 361,150.84 | |
| D | P. & L. Sale of Cap. Assets to L. M. Henders, Tr. | ||
| 33 | Capital Stock | 300,000.00 | |
| $999,799.78 | $999,799.78 |
*2660 *135 However, certain adjustments were made so that the net worth was shown to be $751,657.69. The increase in net worth was produced by reducing petitioner's liability for accrued taxes from $182,000 to $164,045.82; by transferring the item, "scrap material $222.02" to profit and loss; and by treating the amount of $243.67 listed as "adjustment of profit and preceding year" as a deduction from income. *136 These adjustments of the books amounted to $17,922.53 and increased net worth by that amount.
On April 10, 1919, at a directors' meeting, Leon Rubay, president of the petitioner, read the following offer:
CLEVELAND, OHIO, April 10, 1919.
THE RUBAY COMPANY,
Cleveland, Ohio.
GENTLEMEN:
I understand that because of the cancellation of the Government contracts for airplanes, in the manufacture of which your company has of late exclusively been engaged, you desire to sell your entire assets.
I, therefore, make you the following proposition, subject to your acceptance:
If you will sell, assign, transfer and set over to me or my nominees, by deed, bill of sale, or other proper legal instrument satisfactory to my counsel, all of the assets of*2661 your company of every kind and description, whatever, subject to all of its liabilities, contingent or otherwise, including liability for income and excess profits taxes, I will pay or cause to be paid to you or your nominees, $135,000.00 in cash and $135,000.00 par value 6% notes or bonds secured to your satisfaction by a mortgage upon the plant and equipment of your company given by a new company to which I am planning to sell said plant and equipment.
The acceptance of the foregoing proposition by you will constitute a binding contract between us, subject, of course, to the approval of our respective counsel as to the details of the transaction.
Yours very truly,
L. M. HENDERS.On April 10, 1919, the foregoing proposition was considered by the board of directors, who were as follows:
Leon Rubay
L. M. Henders B. E. Robertson M. C. Byrnes C. M. Burke.On the same day at a recessed meeting the offer was accepted, and the following corporate action was taken:
THE RUBAY COMPANY,
RECESSED MEETING OF STOCKHOLDERS,
April 10, 1919.
Pursuant to resolution passed at the meeting of the stockholders held earlier in the day, the stockholders owning all of the*2662 capital stock of THE RUBAY COMPANY convened at 1009 American Trust Building, Cleveland, Ohio, at three o'clock, p.m., on April 10, 1919.
The Secretary, at the direction of the President, read the minutes of the Directors' meeting held at 2:30 o'clock p.m., including the proposition accepted by the Directors covering the sale of the entire assets of the Company.
After full consideration of the matter, on motion duly made, seconded and unanimously adopted bya vote of all the stockholders, represented at the meeting, the Secretary, under instruction, casting the unanimous ballot of all the stock, it was
*137 Resolved that said proposition marked "Exhibit A" to the minutes of the Directors be accepted and that the Directors and officers of the Company be authorized to take all steps deemed by them necessary and proper to carry out the transaction and to make, execute and deliver all necessary papers in connection therewith.
There being no further business, on motion duly made, seconded and unanimously adopted the meeting then adjourned.
(Signed) W. D. TURNER, Secretary.
On the same day, April 10, 1919, the following letter was received:
CLEVELAND, OHIO, *2663 April 10, 1919.
THE RUBAY COMPANY,
Cleveland, Ohio.
GENTLEMEN:
Referring to a certain proposition dated April 10, 1919, made by me, to purchase from you your entire assets, which proposition has been accepted by you, will you please execute deed to the Rubay Company of Delaware covering all of your real estate as described in "Exhibit A" to a certain proposition made by me to that company, under date of April 11, 1919, and will you also please make a Bill of Sale to that same Company for the property described in Exhibits "B" and "C" to that same proposition dated April 11, 1919.
Will you also please deliver to me the sum of One hundred and Eighty-two thousand Dollars ($182,000) in cash, being also part of your entire assets which I am to receive pursuant to my proposition to you under date of April 10, 1919.
Very truly yours,
L. M. HENDERS.On April 11, 1919, the following letter was received by the petitioner:
CLEVELAND, OHIO, April 11, 1919.
THE RUBAY COMPANY,
Cleveland, Ohio.
GENTLEMEN:
Referring to the proposition which I made to your company under date of April 10, 1919, and accepted by you under same date, and by which I took over*2664 all the assets of your Company, subject to all liabilities, inasmuch as it will be qu te inconvenient for me to pay various debts owing by your company, amounting approximately to ($35,000.00), Thirty Five Thousand Dollars, I hereby request that you retain from the money that would otherwise come to me, such sum of $35,000, Thirty Five Thousand Dollars, and that for and in my behalf you pay the obligations of your company approximating that amount.
You will, of course, pay to me or to my order any part of the amount above named which may not be necessary to pay such obligations.
Very truly yours,
L. M. HENDERSL. M. Henders was a stenographer in the law offices of M. B. and H. H. Johnson. She was the agent of Leon Rubay and he was her nominee in the above negotiations.
On April 10, 1919, the day on which the negotiations for the transfer of the assets of the petitioner were consummated, the following *138 minutes were recorded in the minute book of the petitioner, the material part of which is quoted below:
THE RUBAY COMPANY,
STOCKHOLDERS MEETING,
April 10, 1919.
Pursuant to informal notice, the holders of all of the stock of The Rubay Company, met*2665 at 1009 American Trust Building, Cleveland, Ohio, on Thursday, April 10, 1919, at two o'clock, p.m.
The stock represented at the meeting was held as follows:
| Leon Rubay | 2,996 shares |
| L. M. Henders | 1 share |
| B. E. Robertson | 1 share |
| M. C. Byrnes | 1 share |
| C. M. Burke | 1 share |
Leon Rubay acted as Chairman of the meeting and W. D. Turner acted as Secretary thereof.
The Chairman stated that all of the Directors, except himself, had disposed of their stock and were, therefore, not qualified to act any longer as directors and suggested that it was in order to elect an entire new Board of Directors.
On April 10, 1919, a warranty deed was executed by the Rubay Co., whereby it conveyed its real estate to the Rubay Co. of Delaware, which deed was duly recorded, and on the same day by bill of sale the Rubay Co. transferred its other property to the Rubay Co. of Delaware.
Immediately after the petitioner had transferred to the Rubay Co. of Delaware, all of its assets both personal and real, excepting such cash as was transferred to Leon Rubay pursuant to the request above set forth, it decreased its capital stock to $3,000, represented by 3,000 shares of a par value*2666 of $1 per share, and discontinued business.
Upon audit of the petitioner's returns, the Commissioner determined that for years subsequent to April 30, 1917, its returns should be made on the basis of a fiscal year ended March 31. The Commissioner further determined that by reason of the transfer of the assets on April 10, 1919, the petitioner did not sustain a loss in the amount of $481,657.69, or in any amount.
OPINION.
LOVE: The petitioner alleges that on April 10, 1919, it sold outright to Leon Rubay all of its capital assets, valued at $751,657.69 for the amount of $270,000, thereby suffering a loss in the amount of $481,657.69 which loss, it contends, is deductible from gross income. The respondent denies that the assets were sold outright to Rubay and further denies that a loss was suffered by reason of the transaction.
*139 It should be noted that while the petitioner did not challenge in its petition the respondent's determination with respect to the closing date of its fiscal year, it did contend at the hearing herein that the respondent had erred in that respect. The petitioner further contended that if we found that it had sustained a deductible loss*2667 by reason of the transaction in question, such loss should be allocated to a preceding fiscal year other than that in which the transaction was completed. This contention is, of course, without merit. The respondent's determination as to the closing date of the fiscal year, in the absence of affirmative evidence to the contrary, is approved.
The transfer of petitioner's assets to Rubay took place on April 10, 1919, and the loss, if any, was sustained in that fiscal year. It is apparent that if a bona fide sale of the capital assets was made, as alleged, and if the net worth thereof was in the amount disclosed by the books, a loss would result for the obvious reason that the net worth exceeded the selling price. The respondent contends that a loss did not result from the transaction because, in fact, a partial liquidation took place. We are, therefore, confronted with the question as to whether a bona fide sale occurred.
The evidence in this proceeding was presented in the form of depositions and at the time and place of the taking thereof, the respondent introduced evidence showing the stockholdings of the petitioner on the day of the alleged sale. The petitioner strenuously*2668 objected to the introduction of this evidence on the ground that it was irrelevant and immaterial to the issue as to whether a sale took place. The evidence was, we believe, competent for the reason that it reflects directly upon the bona fides of the sale in question.
In its brief the petitioner urges that we must confine our inquiry solely to the question as to whether a transfer of the assets took place, disregarding all other elements. In other words, we are adjured to follow the form and not the substance of the transaction, that is, look only to the formalities observed in carrying out the sale. This we decline to do. The principle that the form must be disregarded in such a transaction is too well established to call for the citation of authority.
Let us look, therefore, at the substance of the sale in question. On April 10, 1919, Rubay had standing in his name all but four shares of the petitioner's stock. On the same day he made a proposition to the petitioner through an agent for the purchase of its assets, which proposition was forthwith accepted.
We must not lose sight of the fact that for all intents and purposes, Rubay and the petitioner were one and*2669 the same, his act being the corporate act. If, through his agent, he had offered the petitioner $100 or $1,000 for all of its assets, he could have accepted that proposition *140 with the same alacrity. He could establish an apparent loss to the corporation in any amount he chose by the simple expedient of offering and accepting an amount necessary to produce the desired loss. After all, it mattered not to him because being the owner of all of the stock he would not suffer thereby. The net result of such a transaction is that to the corporation an apparent loss results but the owner of all the stock suffers not. For that reason, we must look through the corporate entity in such case.
An examination of the trial balance of petitioner's books as of April 10, 1919, discloses that exclusive of the amount set aside for taxes, petitioner had over $235,000, consisting of cash, stocks and bonds, among its assets. In addition it had buildings valued at $297,067.49, to say nothing of other assets of great value. Yet, on April 10, 1919, Rubay who was for all intents and purposes the corporation, sold to himself all of the assets for $135,000 in cash and $135,000 in bonds to be*2670 secured by the identical assets. An examination of the facts found discloses that the cash needed for the purchase was provided by the petitioner itself.
An impartial appraisement of the evidence leads irresistibly to the conclusion that the transaction in question would not be carried out by persons dealing at arms' length. Every element points to the fact that the sale was not bona fide, and we so hold.
We approve, therefore, the respondent's determination in regard thereto.
Judgment will be entered for the respondent.
Considered by TRUSSELL, SMITH, and LITTLETON.