1935 BTA LEXIS 823">*823 1. An individual owning certain clay and coal properties in 1925 made an offer to a newly formed corporation to exchange those properties for all of the stock of the corporation, conditioned upon the purchase by the corporation of the current assets, connected with the operation of the properties, for cash. The offer was accepted and the transaction was carried out in accordance with the terms of the offer. Held, that the transfer by the individual of the assets, both current and fixed, and their acquisition by the corporation constituted one transaction and, further, that section 203(d)(1) of the Revenue Act of 1926 is applicable in computing the gain to the individual.
2. The fair market value of the stock received determined.
32 B.T.A. 1283">*1283 This proceeding involves a deficiency in income tax for the year 1925 in the amount of $303,152.75. The respondent has included in income as capital gain the sum of $2,423,944.48 derived by the petitioner's 32 B.T.A. 1283">*1284 decedent, Walter S. Dickey, from the transfer of certain assets and properties to1935 BTA LEXIS 823">*824 the W. S. Dickey Clay Manufacturing Co. It is alleged that there were two separate and distinct transactions, one being a transfer of fixed assets to a corporation for all of its stock, and the other a sale of current assets at cost, from neither of which Dickey realized a taxable gain; and, further, it is claimed that even though the transfer of properties to the W. S. Dickey Clay Manufacturing Co. was a taxable transaction, a determination of the fair market value of the stock received will show that no gain was realized. All other allegations of error contained in the petition have been abandoned.
The case was submited on written stipulation with attached exhibits, from which we make the following findings of fact.
FINDINGS OF FACT.
In June 1925, and prior thereto, the decedent, W. S. Dickey, was the owner of certain clay and coal lands, together with the plants, equipment, and assets used in their operation. These clay and coal lands were located in Missouri, Illinois, Kansas, Alabama, Georgia, Tennessee, Texas, and Arkansas. Title to some of the properties was held by trustees under agreements and declarations of trust, but in each case Dickey was the sole beneficiary.
1935 BTA LEXIS 823">*825 On June 6, 1925, Dickey entered into a written contract with the Commerce Trust Co. of Kansas City, Missouri, and the Harris Trust & Savings Bank, of Chicago, Illinois, whereby the banks agreed to purchase $4,500,000 of first mortgage 6 percent gold bonds from a company to be organized to acquire the clay and coal lands, properties, and equipment previously mentioned. These bonds were to constitute a first mortgage lien against the properties, and were to mature in specified amounts on January 1 and July 1 of each year, beginning January 1, 1928, and ending July 1, 1940. The trust indenture was to provide that current assets should be maintained at least equal to 200 percent of current liabilities and at all times in a minimum amount of $1,000,000. Dickey agreed that until $2,500,000 of the bonds were retired no sale of his controlling interest in the company would be made outside of his family without the consent of the trustees under the indenture.
On or about June 30, 1925, the W. S. Dickey Clay Manufacturing Co. was organized under the laws of the State of Delaware. The charter thereof was amended on or about July 6, 1925.
On July 11, 1925, a proposal was made by Dickey1935 BTA LEXIS 823">*826 and the trustees who held title to certain of his properties offering to exchange the fixed assets described in the proposal, subject to an indebtedness of $2,000,000 evidenced by notes of the trustees, for all of the capital 32 B.T.A. 1283">*1285 stock of the W. S. Dickey Clay Manufacturing Co., and providing that in the event the offer should be accepted the company should bind itself to purchase the current assets of the trust estates and pay for the same in cash on demand. On the same date the company accepted the proposal without change.
The proposal made by Dickey and the trustees contained, inter alia, the following conditions:
In case this offer is accepted the corporation shall agree and bind itself by such acceptance to purchase all of the current assets of each of said trust estates, including without prejudice to the general description of such assets their cash on hand, bills and accounts receivable, merchandise on hand, finished and unfinished product, raw materials and supplies, investments and such other assets as are usually included by correct accounting in the term "current assets", and pay for the same in cash or by notes made payable on demand to Walter S. Dickey. 1935 BTA LEXIS 823">*827 The amount of the purchase price of said assets shall be the amount of the net current assets belonging to said estate at invoice price and book value, as shown by the books of the Trustees as at the opening of business on July 1st, 1925, the same to be finally determined by an invoice and audit and by deducting from the current assets, as shown by such invoice and audit, the amount of the current liabilities all as of the opening of business on July 1st, 1925. For the purpose of this agreement, the amount of said net current assets is estimated at $2,600,000.00, for which the corporation shall pay cash or give demand notes to Walter S. Dickey, as above provided, bearing interest at the rate of six (6%) per cent per annum from July 1st, 1925, and in the event an invoice and audit shows that the correct amount of said net current assets is more or less than $2,600,000.00, then proper adjustment shall be made in cash upon such determination.
At the conclusion of the proposal the offer of Dickey and the trustees is summarized as follows:
In case the corporation accepts this offer, upon delivery to Walter S. Dickey, or upon his order, of cash or a demand note or notes in the amount1935 BTA LEXIS 823">*828 above named for said net current assets, and of stock certificates representing 25,000 shares of first preferred stock, 25,000 shares of second preferred stock, all of the par value of $100 per share, and 50,000 shares of common stock, without any nominal, or par value, for which he has offered to subscribe (the same to be issued in such name or names and in such amounts as shall be directed by Walter S. Dickey), and upon the execution by the corporation of an instrument agreeing to assume the obligations of the trustees herein mentioned to be assumed by the corporation, including the notes of the trustees above mentioned, amounting in the aggregate to $2,000,000, together with the interest thereon, we agree to transfer and convey all of the above described properties, rights, privileges and assets to the corporation.
The indebtedness of $2,000,000 represented by notes of the trustees was the obligation of the trustees under the declarations of trust, which provided that there should be no personal liability on their part, but that the obligations should be a charge against the assets in their hands.
In accordance with the proposal of July 11, 1925, Dickey transferred all of1935 BTA LEXIS 823">*829 the assets, both fixed and current, to the W. S. Dickey 32 B.T.A. 1283">*1286 Clay Manufacturing Co., which in return assumed the $2,000,000 indebtedness of the trustees, issued all of its capital stock to Dickey, and gave him its notes in the amount of $2,600,000. Subsequently an adjustment was made in the inventory of current assets and a credit of $176,055.52 was entered on one of the notes, thereby reducing the principal of the notes to $2,423,944.48. The cost to Dickey of the current assets, as finally determined by inventory and audit, was the said sum of $2,423,944.48, while the cost to him of the fixed assets was $5,740,346.25.
On July 11, 1925, the W. S. Dickey Clay Manufacturing Co., by proper and appropriate action of its stockholders and directors, authorized a bond issue and the execution of an indenture to secure the same, under which bonds of the company to the amount of $4,500,000 were duly issued and sold to the Harris Trust & Savings Bank of Chicago and the Commerce Trust Co. of Kansas City, in accordance with the contract of June 6, 1925, between these two banks and Dickey.
The indebtedness of $2,000,000 represented by notes of the trustees, which were assumed by1935 BTA LEXIS 823">*830 the company, was promptly paid. The notes given by the company to the decedent for the current assets, with accrued interest, were paid as follows:
| July 23, 1925 | $2,007,666.67 |
| July 23, 1925 | 100,383.33 |
| Sept. 14, 1925 | 150,000.00 |
| Sept. 30, 1925 | 50,000.00 |
| Oct. 7, 1925 | $25,000.00 |
| Nov. 5, 1925 | 40,000.00 |
| Nov. 6, 1925 | 64,090.24 |
Previously, under date of May 8, 1925, the American Appraisal Co. had made an appraisal as of December 31, 1924, of the fixed assets, which, according to the offer and acceptance of July 11, 1925, were paid in to the W. S. Dickey Clay Manufacturing Co. for its capital stock. The appraisal certified the "sound value of the property to a going concern, as of December 31, 1924" as being $9,406,641.55. It was stated that the land was appraised in accordance with its utility and market conditions. The value placed on the deposits was based upon a capitalization of the saving which resulted from the absence of royalty obligations. Plants, equipment, and other assets were appraised on the basis of reproduction costs, with due allowance for depletion and expectancy of serviceable life of the properties to a going concern. Raw materials, 1935 BTA LEXIS 823">*831 supplies, accounts and bills receivable, and other items included in the current assets which formed the basis for the subsequent cash payment of $2,423,944.48 by the W. S. Dickey Clay Manufacturing Co., were not covered by the appraisal.
The fixed assets were carried into the books of the W. S. Dickey Clay Manufacturing Co. at a value of $9,163,055.07. This amount represented the value placed on them by the American Appraisal 32 B.T.A. 1283">*1287 Co. after adjustments for properties included in the appraisal but not transferred to the company, depletion for the period from December 31, 1924, to June 30, 1925, and additions at cost between the same dates. Making allowance for the notes of the trustees in the amount of $2,000,000 which were assumed and paid by the company, the value of the stock received by Dickey was shown on the books of the company as follows:
| 25,000 shares first preferred stock | $2,500,000.00 |
| 25,000 shares second preferred stock | 2,500,000.00 |
| 50,000 shares common stock, non par, book value | 2,163,055.07 |
| 7,163,055.07 |
In computing the deficiency herein the respondent has accepted the $7,163,055.07 book value of the stock as its fair market value1935 BTA LEXIS 823">*832 when received by Dickey.
There were no sales of the stock and none of it was ever offered for sale nor were any bids for it received.
The earnings from the properties paid in to the company for the years 1920 to 1924, inclusive, and January 1 to June 30, 1925, after making adjustments that would have been necessary under corporate operation and after providing for annual bond interest of $270,000 on the outstanding first mortgage bonds of $4,500,000, were as follows:
| 1920 | $64,479.92 |
| 1921 | 196,160.19 |
| 1922 | 207,178.53 |
| 1923 | 583,748.62 |
| 1924 | 540,999.27 |
| Jan. 1 to June 30, 1925 | 197,361.27 |
The stock of the W. S. Dickey Clay Manufacturing Co. received by Dickey in the transfer of his clay properties to that company had a fair market value on the date received of $5,000,000.
OPINION.
TURNER: The petitioners contend that the disposition by Dickey of the fixed assets and current assets and their acquisition by the W. S. Dickey Clay Manufacturing Co. were two separate transactions and that no gain or loss was realized in either case, on the ground that the exchange of fixed assets for capital stock falls within the provisions of section 203(b)(4) 1 of the1935 BTA LEXIS 823">*833 Revenue Act of 1926, while the current assets were sold at cost.
32 B.T.A. 1283">*1288 The respondent argues that Dickey exchanged property for stock and cash, thereby bringing the transaction within the provisions of section 203(d)(1) of that act, 2 and, applying the provisions of that section, the gain, if any, is taxable to the extent of the cash received.
1935 BTA LEXIS 823">*834 The petitioners' theory of the case completely ignores certain terms of the contracts entered into between Dickey and the banks, on the one hand, and Dickey and the company, on the other. The agreement of june 6, 1925, with the banks contemplated that the corporation to be organized would acquire "assets of every nature" relative to Dickey's clay properties. It specified that current assets would always be maintained in a minimum amount of $1,000,000 and that the current assets would at least equal 200 percent of current liabilities. In the proposal of June 11, 1925, Dickey conditioned the transfer of his fixed assets for stock upon the company's binding itself to purchase his current assets. In its acceptance the company specifically agreed to assume and perform all the obligations and conditions set up in the offer, and the agreements were carried out according to their terms.
Considering what was actually done, and not what the parties might have designed or proposed to do, , we must hold that the steps in this transaction were but parts of the whole whereby Dickey exchanged all his assets for cash and stock. 1935 BTA LEXIS 823">*835 , and , cited and relied on by petitioners, turn upon their own particular facts, which are different from those here existing. The exchange of property here was not solely for stock, but for stock and cash. The necessity for several related steps can not alter the ultimate results. Dickey's intent, ascertained from a fair construction of his contracts, points to the related steps as parts of one transaction. ; affd., . Section 203(d)(1), supra, is accordingly applicable and the gain, if any, from the transaction is taxable to the extent of the cash received.
Section 202(a) of the Revenue Act of 1926 provides that "gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis provided in subdivision (a) or (b) of section 204 * * *." In this case there is no dispute as to the basis for determining the gain from the property so exchanged. It has been stipulated that the cost to Dickey of the fixed assets was $5,740,346.25, 1935 BTA LEXIS 823">*836 while the cost of the current assets was 32 B.T.A. 1283">*1289 $2,423,944.48, or a total of $8,164,290.73. In section 202(c) of the same act it is stated that "the amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received." It is thus apparent that the amount realized by Dickey is the sum of the $2,423,944.48 in cash, the $2,000,000 liability which was assumed and paid by the W. S. Dickey Clay Manufacturing Co., and the fair market value of the capital stock received. The first two items are definite and fixed, leaving for determination the fair market value of the stock.
In valuing the stock of a closely owned corporation, no particular method of valuation of reasoning is controlling, but the value of stock in such cases must be arrived at by consideration of the facts and circumstances in each particular case. ; ; affd., .
In this case there were no sales of stock on which a valuation might be based. The facts also show that the stock was never offered1935 BTA LEXIS 823">*837 for sale and that no bids for it were received. The respondent has determined that the fair market value of the stock on the date received was $7,163,055.07, which amount was also its book value, which in turn was the net appraised value of the fixed assets as of December 31, 1924, shown by the appraisal of the American Appraisal Co. dated May 4, 1925, with adjustments to June 30, 1925. The petitioners call attention to the fact that the amount shown by the appraisal referred to was not the fair market value of the assets in question, but was termed the sound value of the property to a going concern. It is also pointed out that the valuation of the plants and equipment was based on reproduction costs. Our attention is also called to the fact that the respondent's valuation rests solely on the appraised value of the fixed assets without regard to other assets of the company or the increase from $2,000,000 to $4,500,000 in the indebtedness which constituted a first lien against those assets. It is also contended that the average earnings from the operation of the properties by Dickey for the 5-year period preceding their transfer to the W. S. Dickey Clay Manufacturing Co. will not1935 BTA LEXIS 823">*838 support the value arrived at by the respondent. It is pointed out that a capitalization of average net earnings, after making allowance for an increase of the bonded indebtedness to $4,500,000, for a 2 1/2-year period at 8 percent, would reflect a value of $6,330,083.88; that capitalization of average earnings for a 4-year period, subject to the same conditions and at the same rate, would reflect a value of $5,085,524.37; while a similar capitalization of the average net earnings for a 5-year period would reflect a value of $4,394,169.63, and if a capitalization 32 B.T.A. 1283">*1290 rate of 10 percent for the 5-year period should be used, the value reflected would be $3,515,335.70. It is further suggested that these computations, indicating a value so much lower than that determined by the respondent, are based on average net earnings from operations, which utilized not only the fixed assets but the current assets as well.
Considering all of the facts presented, including the appraised value of the fixed assets, the cost of these assets to Dickey, the average net earnings from his operations for a period of five years prior to the organization of the W. S. Dickey Clay Manufacturing Co. 1935 BTA LEXIS 823">*839 , the bonded indebtedness against the assets of the corporation, the restriction on the sale of Dickey's stock, and the fact that there were no sales of stock or offers of or bids therefor, we are of the opinion that the value determined by the respondent is excessive and have found as a fact that the fair market value of the stock received by Dickey in connection with the transfer of his assets to the W. S. Dickey Clay Manufacturing Co. was $5,000,000.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 203. (b) (4) No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange. ↩
2. SEC. 203. (d) (1) If an exchange would be within the provisions of paragraph (1), (2), or (4) of subdivision (b) if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property. ↩