1949 U.S. Tax Ct. LEXIS 72">*72 Decision will be entered under Rule 50.
1. Merger under Illinois statute held not to entitle resulting corporation to its predecessor's equity invested capital for purposes of excess profits tax.
2. Arm's length transaction between creditors and debtor corporation's stockholders which resulted in settlement of obligation and transfer of the business to petitioner, a new corporation in which creditors and old stockholders had control and the interests of the parties were substantially unaltered, held to have constituted a nontaxable exchange under Internal Revenue Code, section 112 (b) (5), Alexander R. Duncan, 9 T.C. 468, followed; and held, further, that pursuant to Internal Revenue Code, sections 718, 728, 729, and 113 (a) (8), petitioner's equity invested capital was the basis of petitioner's property to its transferors.
3. A majority of petitioner's stock being owned by a creditor of the old company, held the creditor was not a "shareholder" as required by section 718 (c) (5), depriving petitioner of the right to inherit its predecessor's earned surplus deficit under section 718 (a) (7), Internal Revenue Code.
4. No income tax1949 U.S. Tax Ct. LEXIS 72">*73 deficiency having been determined, held respondent's motion to dismiss proceedings as to income tax must be granted.
13 T.C. 472">*473 This proceeding is brought for the redetermination of deficiencies in petitioner's excess profits tax for the taxable years ended November 30, 1942 and 1943, in the amounts1949 U.S. Tax Ct. LEXIS 72">*74 of $ 4,534.17 and $ 6,466.92, respectively. Petitioner claims an overpayment of $ 50,063.72. Respondent, in his notice of deficiency, also determined overpayment in Federal income tax for the years ended November 30, 1942 and 1943, in the amounts of $ 39.28 and $ 3,315.62, respectively. As to the latter, respondent now urges that this Court has no jurisdiction in these proceedings to redetermine the income tax liability for the years in question.
The primary issue is to determine petitioner's equity invested capital under Internal Revenue Code, section 718. This issue is dependent upon successive subissues of whether petitioner is a continuation of Gage Brothers & Co., hereinafter referred to as "Old Gage"; whether a 1936 reorganization was a tax-free exchange under the Revenue Act of 1936; whether petitioner is entitled to a credit representing the deficit in earnings and profits of Old Gage under Internal Revenue Code, section 718 (a) (7); and whether it is entitled to a credit for good will of Old Gage under section 718 (a) (2). Depending upon the existence of jurisdiction, the income tax issue is whether liquidating dividends on capital stock received by petitioner during1949 U.S. Tax Ct. LEXIS 72">*75 the period in question represent a long term capital gain or loss.
The case was submitted upon a stipulation of facts and evidence adduced at the hearing. Those facts hereinafter appearing which are not from the stipulation are otherwise found from the record.
FINDINGS OF FACT.
The stipulated facts are hereby found accordingly.
Petitioner filed the tax returns here involved with the collector of internal revenue at Chicago for the first district of Illinois.
Old Gage was incorporated under the laws of the State of Illinois on February 18, 1887. It was a continuation of an unincorporated business of similar character established in 1856. Old Gage, throughout its existence, engaged in the business of manufacturing, distributing, and selling women's hats of medium and high grade quality. It has been continuously a leading distributor of women's hats of that quality. It had occupied a building at 18 South Michigan Avenue, Chicago, Illinois, since 1896, and for many years a floor at 417 Fifth Avenue, New York, New York. Until the depression of the 1930's it maintained offices in most of the largest cities of the United States, and served approximately 10,000 accounts throughout the1949 U.S. Tax Ct. LEXIS 72">*76 United States, China, Australia, Mexico, Hawaii, and South Africa. From 1930 to 1936 it had approximately 6,000 accounts.
Extensive national advertising was done by Old Gage throughout its existence in leading national fashion magazines such as Vogue and 13 T.C. 472">*474 Harpers Bazaar, in newspapers and rotogravures. From 1920 to 1936 its expenditures for advertising totaled $ 777,370.75. It owned many registered trade names incorporating the name Gage, and its label was an outstanding individual identification in its field.
For some years prior to July 1, 1936, Old Gage purchased a substantial part of its hat merchandise from Slocum Straw Works, a Wisconsin corporation of Milwaukee. Old Gage constituted the principal outlet for the products of Slocum. During the depression years following the business collapse of 1929, Old Gage operated at severe losses and Slocum continued to extend large credits to it.
From 1931 to 1936 intensive efforts were made by the stockholders and directors of Old Gage to effect a financial reorganization and a series of negotiations was conducted between the stockholders of Old Gage (from time to time represented by special committees appointed for that 1949 U.S. Tax Ct. LEXIS 72">*77 purpose) and Slocum to bring about credit arrangements for the continued operation of the business. During this period of negotiation Slocum was given minority representation on Old Gage's board of directors. This was in consideration of Slocum's extension of credit and to protect Slocum's interest as a creditor. Slocum named three out of nine directors. Everett Slocum became vice president and A. L. Slocum treasurer of Old Gage.
During the period from 1932 to 1936 the amount of Old Gage's indebtedness to Slocum aggregated each year more than $ 200,000, part of which was secured by assignment of Old Gage's receivables. Between 1931 and 1936, the amount due from Old Gage to Slocum ranged as high as $ 276,980.50.
On July 9, 1935, at a special meeting of the stockholders of Old Gage, further consideration was given to the company's financial position and to the possibility of liquidation in the absence of a working agreement with Slocum. A committee representing the stockholders was appointed to consider the company's condition and report its recommendations. The committee was "to keep informed of the operations and progress under * * * [a plan for restricted operations that fall] 1949 U.S. Tax Ct. LEXIS 72">*78 and be in a position to report and offer recommendations to the balance of the stockholders at the next general meeting."
On June 9, 1936, Slocum, being unwilling to carry its credit accounts with Old Gage any longer, made the following proposition:
(a) A new corporation, hereinafter called "New Gage," was to be organized to acquire all the assets of Old Gage.
(b) New Gage was to buy from Old Gage all of its assets and to pay therefor by issuing and delivering to Old Gage 15,000 shares of its class A stock and 30,000 shares of its class B stock, and by assuming all debts of Old Gage, except that as to the debts owing to Slocum, New Gage would assume only $ 75,000 and the current account.
13 T.C. 472">*475 (c) Slocum was to accept from Old Gage 30,000 shares of New Gage class B stock, and from New Gage its promissory note for $ 75,000, dated July 15, 1936, payable in three years with interest at 4 per cent per annum, together with a promise to pay the current accounts due it from Old Gage, which as of May 31, 1936, totaled $ 14,850.15. Slocum agreed that in consideration of the above it would make no further claim on account of the indebtedness owing by Old Gage, and would release all security1949 U.S. Tax Ct. LEXIS 72">*79 held for such indebtedness in the form of assignments of accounts receivable which it then held in the face amount of $ 82,456.46.
(d) Old Gage would immediately distribute 15,000 shares of class A stock to its stockholders, of which 7,500 shares were to go to holders of its common stock and 7,500 shares to its preferred stockholders. The old common stock and preferred stock were to be surrendered at the time of such distribution.
(e) Slocum was to pay legal expenses incurred in the organization of the new corporation.
(f) Old Gage was to take all corporate action to effect the reorganization and sale of its assets to the new corporation.
(g) Slocum offered to agree with New Gage that in the event the net profits of the new corporation in any year were not sufficient to meet the sinking fund requirements of $ 7,500 for the retirement of class A stock and the consolidated net profits of the new corporation and of Slocum equaled or exceeded $ 7,500, then Slocum would contribute $ 7,500 to the surplus of the new company for its sinking fund or such part thereof as might be required to make up the $ 7,500. It further agreed that if the consolidated net profits of Slocum and the new 1949 U.S. Tax Ct. LEXIS 72">*80 company should exceed $ 50,000 net a year, and the net profits of the new company should be less than the consolidated net profits, Slocum would contribute to the surplus of the new company to provide for the retirement of class A stock 20 per cent of the excess of consolidated net profits over $ 50,000. The foregoing was conditioned on the consolidated net profits statement of Slocum and the new company showing net profits for the current fiscal year.
At a special meeting of the stockholders of Old Gage held June 9, 1936, upon favorable recommendation of the stockholders' reorganization committee appointed on June 9, 1935, to negotiate with Slocum, the plan was approved by the stockholders and the matter was referred to the directors for action.
At a special meeting of the board of directors of Old Gage held June 23, 1936, the president stated that reorganization could be best effected by the merger of Old Gage and New Gage, to be called Galo Hat Co., temporarily, "which was in accordance with the action of the stockholders, under which the mechanics of the reorganization was left to subsequent determination." The president then presented a 13 T.C. 472">*476 statement of the plan of merger1949 U.S. Tax Ct. LEXIS 72">*81 proposed in accordance with Illinois statutes and presented a document received from Slocum consenting to the amendment of the reorganization plan by merger of Old Gage with Galo Hat Co. It was then resolved that the plan be carried out by adopting the mechanics of a merger; and that the plan of merger be submitted to the stockholders for vote at a special meeting to be called July 14, 1936.
A summary of the plan of reorganization was sent by Old Gage to its stockholders, which was as follows:
(a) Class A capital stock. The authorized class A stock to consist of 15,000 shares of $ 5 par value, which should (1) be entitled to 5 per cent noncumulative dividend after provision for sinking fund; (2) participate in corporate assets in liquidation with class B stock par for par; (3) be subject to retirement and redemption from sinking fund, and (4) have no preemptive rights in present or additional issue of class B stock. Each share of outstanding $ 100 par common stock of Old Gage was to be converted into one share of class A stock, and each share of outstanding preferred stock of Old Gage was to be converted into three shares of class A stock.
(b) Class B capital stock. The total 1949 U.S. Tax Ct. LEXIS 72">*82 authorized class B stock to be 30,000 shares, par value $ 2.50 per share, which was to receive 5 per cent noncumulative dividend only after provision for sinking fund requirements and after payment of 5 per cent on A stock, and thereafter class B and class A should share dividends ratably.
(c) The new corporation was to assume the current obligations of Old Gage for $ 14,850.15 and issue to Slocum its promissory note for $ 75,000, dated July 15, 1936, payable three years after date, with interest at 4 per cent per annum. The claim of Slocum in the sum of $ 214,692.04 as of June 30, 1936, was to be released and Slocum was to receive from the new company, in addition to the $ 75,000 note, 30,000 shares of B stock.
(d) Slocum was to contribute to the sinking fund of the new corporation, as outlined in its proposal of June 6, 1936.
The Galo Hat Co. was organized as a corporation on June 12, 1936, under the laws of Illinois. Its articles of incorporation were in accordance with the plan. They provided, inter alia:
In the event the net profits exceeded $ 50,000, then in addition to the $ 7,500, 20 per cent of the net profits in excess of $ 50,000 became part of the sinking fund. 1949 U.S. Tax Ct. LEXIS 72">*83 The sinking fund was to be available for distribution within 60 days after the close of each fiscal year, and the shares of class A stock to be redeemed were to be determined by law unless shares should be tendered for redemption at less than par. In the event of liquidation class A and class B stock participated 13 T.C. 472">*477 in proportion to the par value of the shares of each class of the stock outstanding. The number of shares issued by the corporation at the time of its incorporation was 400 class B shares.
On July 14, 1936, "Articles of Merger" were executed. They recited that Old Gage and Galo Hat Co. were to merge into Galo Hat Co., which was then "the surviving corporation" and which was to adopt the name Gage Brothers & Co. (petitioner); that all the assets of both companies would be merged as of June 30, 1936, subject to their liabilities; that the holders of the 400 class B shares of $ 2.50 par value of Galo Hat Co. should receive "the ten day promissory notes of the surviving corporation dated July 15, 1936, in amounts equal to $ 2.50 for each of said shares * * *", that each share of outstanding preferred stock of Old Gage was to be converted into three shares of class1949 U.S. Tax Ct. LEXIS 72">*84 A stock and each outstanding share of common stock of Old Gage was to be converted into one share of class A stock; that the indebtedness of Old Gage to Slocum (other than current account) of $ 214,692.04 was to be converted into the $ 75,000 note and 30,000 shares of class B stock.
The plan of reorganization, as carried out, was reached as a result of arm's length good faith negotiations between conflicting interests, and represented an agreement between the parties as to the value of their respective interests. As of June 30, 1936, the outstanding stock of Old Gage consisted of the following:
| Common stock | $ 743,900 |
| Preferred stock | 249,900 |
| Total | $ 993,800 |
As of the close of business June 30, 1936, the total value of money and property paid in for capital stock of Old Gage outstanding as of that date, was common stock, $ 90,650; and preferred stock, $ 172,179.
As of the close of business June 30, 1936, immediately prior to the reorganization, the deficit in earnings and profits of Old Gage was $ 338,311, all of which was accumulated subsequent to March 1, 1913.
As of the close of business June 30, 1936, immediately prior to the reorganization, Slocum had claims 1949 U.S. Tax Ct. LEXIS 72">*85 against Old Gage in the aggregate amount of $ 214,692.04, secured in part by assignment of accounts receivable then amounting to $ 82,456.46.
As of the close of business June 30, 1936, the cost basis to Old Gage of the assets of Old Gage was $ 155,023.81.
The cost basis of their stock to holders of the shares of stock of Old Gage as of the close of business June 30, 1936, was $ 87,952.
Adjustments were made on the corporate books at the time of reorganization respecting the amount of $ 214,692.04 owing by Old Gage to Slocum as follows: 13 T.C. 472">*478
| Debit | Credit | |
| Notes payable | $ 25,000.00 | |
| Accounts payable | 189,692.04 | |
| Notes payable | $ 75,000.00 | |
| Class B stock | 75,000.00 | |
| Capital surplus | 64,692.00 | |
| Reduction of indebtedness to Slocum Straw | ||
| Works and issuance of Class B stock. |
Condensed balance sheets of Old Gage as of June 30, 1936, and of petitioner as of July 1, 1936, the date of the opening entries are as follows:
| Old Gage Co., | Petitioner, | |
| June 30, 1936 | July 1, 1936 | |
| ASSETS | ||
| Cash, receivables, and inventory | $ 130,192.23 | $ 134,544.41 |
| Deferred charges | 4,717.90 | 9,717.90 |
| Fixed assets, less reserve for depreciation | 20,113.68 | 20,113.68 |
| Good will | 100,000.00 | |
| Total | 155,023.81 | 264,375.99 |
| LIABILITIES | ||
| Notes payable (Slocum Straw Works) | 25,000.00 | 75,000.00 |
| Accounts payable (Slocum Straw Works) | 189,692.04 | |
| Accounts payable, others | 8,648.52 | 8,648.52 |
| Accrued taxes and expenses | 7,165.68 | 12,554.42 |
| Preferred stock outstanding | 249,900.00 | |
| Common stock outstanding | 743,900.00 | |
| Class A stock outstanding | 74,680.00 | |
| Class B stock outstanding | 75,000.00 | |
| Capital surplus | 257,750.00 | 18,493.05 |
| Surplus (deficit) | (1,327,032.43) | |
| Total | 155,023.81 | 264,375.99 |
1949 U.S. Tax Ct. LEXIS 72">*86 Old Gage filed a Federal income and excess profits tax return for the period November 1, 1935, to June 30, 1936, with the collector of internal revenue at Chicago, wherein it stated: "Final return on June 30, 1936, the assets and liabilities of the company were transferred to a new corporation (corporation dissolved July 16, 1936)."
Petitioner (New Gage) filed its first Federal income and excess profits tax return for the period July 1 to November 30, 1936, with the collector of internal revenue at Chicago. It disclosed a net loss of $ 4,173.69, and stated: "On June 30, 1936 Gage Brothers and Company (old corporation) transferred its assets and liabilities to the new corporation."
Under the plan of reorganization, 14,936 shares of class A capital stock of petitioner of the par value of $ 5 per share, having an aggregate par value of $ 74,680, were issued to the stockholders of Old Gage; 30,000 shares of class B capital stock of petitioner of the par value of $ 2.50 per share, having an aggregate par value of $ 75,000, and a promissory note of petitioner, dated July 15, 1936, payable to Slocum 13 T.C. 472">*479 in the sum of $ 75,000 due 3 years after date with interest at the rate of 4 per1949 U.S. Tax Ct. LEXIS 72">*87 cent per annum, were issued and delivered to Slocum. Each share of each class of stock was entitled to one vote.
Pursuant to the plan of reorganization and prior to its consummation, the stockholders and directors of Old Gage caused to be set up on the books of Old Gage an asset item of $ 100,000 as the value of labels, trade names, and good will. These items had been valued in the reorganization proceedings and the prior negotiations at $ 150,000.
The actual value of the good will of Old Gage, as of June 30, 1936, was not less than $ 100,000.
In petitioner's Federal excess profits tax returns filed for the fiscal years ended November 30, 1942 and 1943, with the collector of internal revenue at Chicago, its excess profits credit was computed on the invested capital method and it claimed the amount of $ 168,173.05 as equity invested capital at the beginning of each fiscal year. Respondent determined in his notice of deficiency that the equity invested capital to which petitioner was entitled was $ 68,173.05, disallowing the sum of $ 100,000 which petitioner had included in equity invested capital as good will and denying petitioner's claim that it was entitled to use credits derived1949 U.S. Tax Ct. LEXIS 72">*88 from Old Gage which would give it an excess profits credit much greater than that claimed on its tax returns.
Under date of April 29, 1946, petitioner filed with respondent a claim for refund of $ 95,381.25 of excess profits tax paid by it for its fiscal year ended November 30, 1943.
Under date of December 31, 1947, petitioner filed claims for refund of $ 39.28 and $ 3,315.62 of normal income tax for its fiscal years 1942 and 1943, respectively, being the amounts of overpayment of income tax determined by respondent in his notice of deficiency dated November 18, 1947.
OPINION.
We are indebted to petitioner's counsel for a summary of the issues, which, as an aid to simplification of both the consideration and the discussion of the complicated questions involved, we quote in full:
In summary, the petitioner's argument presents the following solutions to the court:
1. The petitioner and Old Gage are in fact and under the express language of the Illinois statute, pursuant to which the merger was accomplished in 1936, a single entity and the equity invested capital of the petitioner in the computation of its excess profits tax liability in issue is $ 402,521.00. If the court so holds, 1949 U.S. Tax Ct. LEXIS 72">*89 the solutions presented in Parts III, [paragraph 2, infra] IV [paragraph 3, infra] and V [paragraph 4, infra] of the argument need not be considered.
2. If the court holds that the petitioner and Old Gage were not the same taxpayer and that the petitioner acquired its assets in the 1936 transaction, the petitioner maintains that that transaction was a tax-free exchange within 13 T.C. 472">*480 the provisions of Section 112 (b) (5) and that under Section 113 (a) (8) the basis of the property to the petitioner in determining the value of property paid in for stock is the basis thereof to the transferors, to-wit, the Old Gage stockholders and Slocum. If the court so holds, the equity invested capital of the petitioner is $ 227,644.04.
3. Regardless of the determination of the applicable basis in computing the value under Section 718 (a) (2) of property paid in to the petitioner, there must be included in petitioner's equity invested capital, under Section 718 (a) (7), the sum of $ 338,311.00 constituting the deficit in earnings and profits of Old Gage. If the court so holds, consideration of Part V of the argument is unnecessary.
4. If the court should reject all of the above solutions1949 U.S. Tax Ct. LEXIS 72">*90 advanced by the petitioner and sustain the theory of the Commissioner in using 1936 values, then the court must determine the value of Old Gage good will which was transferred to the petitioner in the 1936 reorganization. The petitioner submits that this value is $ 250,000.00 and that the equity invested capital allowed by the Commissioner at $ 68,173.05 should be increased to $ 318,173.05.
5. The Commissioner erred in disallowing the long-term capital loss sustained by the petitioner upon the receipt in 1942 of a final liquidating dividend on 140 shares of capital stock of Indiana-Illinois Coal Corporation.
We shall deal with the issues in that order.
I.Petitioner's contention that it is the same corporation as its predecessor and hence entitled to compute its equity invested capital as though it were itself the old company, requires rejection for a number of reasons.
First, the premise for this approach is confined to the language of the Illinois merger statute. We can not view as decisive the varying provisions of local corporate enactments when applying a Nationwide system of corporate taxation. See Burnet v. Harmel, 287 U.S. 103">287 U.S. 103. The very1949 U.S. Tax Ct. LEXIS 72">*91 argument made here that the essential continuance of the corporate existence should take no account of inconsequential changes in form is the legislative justification for such ameliorative provisions as sections 112, 718 (a) (2), and 740. See, e. g., LeTulle v. Scofield, 308 U.S. 415">308 U.S. 415; Sigmund Neustadt Trust, 43 B. T. A. 848; affd. (C. C. A., 2d Cir.), 131 Fed. (2d) 528. Section 112 (i) itself expressly includes a "statutory merger" in the description of corporate changes to which it is intended to apply. See also sections 718 (c) (4) and 761 (f). This must mean a merger under a state statute, and hence would either be unnecessary or applicable with varying effects from state to state if petitioner's contention were sound.
Secondly, the parties themselves treated the corporations as different, see Interstate Transit Lines v. Commissioner, 319 U.S. 590">319 U.S. 590, and for that reason if for no other we should reject the effort to do 13 T.C. 472">*481 otherwise now. See New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435. The contemporaneous1949 U.S. Tax Ct. LEXIS 72">*92 tax returns for the old and new companies show that for income tax purposes they were viewed as predecessor and successor. It is difficult to see why they should not be similarly treated for excess profits tax purposes, particularly when section 728 provides that "the terms used in this subchapter shall have the same meaning as when used in Chapter 1" and section 729 provides for all chapter 1 (income tax) provisions of law to be applicable to excess profits taxes. 1
Contrary to petitioner's present statement, these same tax returns indicate that the old company was "dissolved." It is even to be questioned whether, if a simple continuation of Old Gage had sufficed, the parties would have undertaken the tedious processes1949 U.S. Tax Ct. LEXIS 72">*93 of forming the new company, effectuating the merger, dissolving the old company, and then changing the new company's name. If these steps were necessary or even useful, we should not disregard them now. Moline Properties, Inc. v. Commissioner, 319 U.S. 436">319 U.S. 436. "* * * the mere fact that the corporate existence * * * was continued is not controlling. The gain [to a stockholder] * * * was represented by shares with essentially different characteristics in an essentially different corporation * * *." United States v. Siegel (C. C. A., 8th Cir.), 52 Fed. (2d) 63; certiorari denied, 284 U.S. 679">284 U.S. 679.
In the third place, we search the applicable provision (section 718) in vain for any suggestion that the equity invested capital of merged corporations is to be computed as though both corporations still exist. Assuming only one survived, we have no statutory guide as to which was the survivor and which the deceased. If the old company survived, there was no need for a change of name, which the parties took pains to accomplish. And if it was the new company, it is manifest its history had only begun. 1949 U.S. Tax Ct. LEXIS 72">*94 This consideration suffices to distinguish Stanton Brewery, Inc. v. Commissioner (C. A., 2d Cir.), 176 Fed. (2d) 573, reversing 11 T.C. 310, which deals with different statutory language and an altogether unrelated legislative device.
But we think the most cogent reason for disallowing petitioner's first claim is the demonstration that the excess profits tax provisions themselves spell out in detail how such a transaction as that now in question should be treated. Cf. North Jersey Quarry Co., 13 T.C. 194. Where there are such unmistakable directions by the Federal Legislature as to the effect of a transaction for Federal tax purposes, we need look no further in arriving at the correct result. 287 U.S. 103">Burnet v.13 T.C. 472">*482 ; see Alexander C. Yarnall, 9 T.C. 616; affirmed per curiam (C. A. 3d Cir.), 170 Fed. (2d) 272. This brings us to petitioner's second contention.
II.The only part of this issue in controversy is whether the reorganization of Old Gage constituted a transfer as to which under1949 U.S. Tax Ct. LEXIS 72">*95 section 112 (b) (5) no gain or loss would be recognized. 2 We think it clearly did. As was recently held in Alexander E. Duncan, 9 T.C. 468, 471: "Section 112 (b) (5) applies where holders of obligations (including notes) of a corporation surrender those obligations in exchange for stock of a new corporation organized to take over and continue the business of the original obligor. Miller & Paine," 42 B. T. A. 586. The Duncan opinion continues: "No satisfactory distinction between the present case and those cited * * * particularly those in which the old stockholders still had some equity, [e. g., Miller & Paine, supra] appears." (Emphasis added.)
1949 U.S. Tax Ct. LEXIS 72">*96 And the fact that the transfers here were the result of arm's length dealings between conflicting interests is, on this record, adequate to satisfy us that within the meaning of section 112 (b) (5) the securities received by each were substantially in proportion to his interest in the property prior to the exchange. Taylor-Wharton Iron & Steel Co., 5 T.C. 768; Montgomery Building Realty Co., 7 T.C. 417, 426; Alexander E. Duncan, supra.
There is a suggestion that the transaction does not qualify because Old Gage, rather than its stockholders and creditors, was the transferor. Section 112 (b) (3) or 112 (b) (4), where the corporation is the transferor, and section 112 (b) (5) may, to be sure, overlap in their application. See Helvering v. Cement Investors, 316 U.S. 527">316 U.S. 527. But no part of the transaction would be taxable on that account and the basis of the assets would not be altered by any such tax consequence. Cf. Richard H. Survaunt, 5 T.C. 665; affd. (C. C. A., 8th Cir.), 162 Fed. (2d) 753. We1949 U.S. Tax Ct. LEXIS 72">*97 do not break up for separate consideration the various phases of a section 112 transaction. Anheuser-Busch, Inc., 40 B. T. A. 1100; affd. (C. C. A., 8th Cir.), 115 Fed. (2d) 662; certiorari denied, 312 U.S. 699">312 U.S. 699. And, in fact, the stock and indebtedness were 13 T.C. 472">*483 unquestionably transferred to petitioner, which thereby acquired Old Gage's assets. In Hartford-Empire Co., 43 B. T. A. 113, 127; affd. (C. C. A., 2d Cir.), 137 Fed. (2d) 540; certiorari denied, 320 U.S. 787">320 U.S. 787, where stockholders and creditors of a predecessor, Hartford-Fairmont Co., transferred their stock and obligations to the taxpayer (pp. 118, 119) and likewise received its stock, the predecessor being immediately liquidated, respondent analyzed the transaction as petitioner does here: "that the recipients of all of the issued * * * stock of the petitioner were transferors; that they transferred assets to the petitioner for shares of stock of the petitioner; and that such transferors correctly claimed, in 1922, that they had exchanged such assets1949 U.S. Tax Ct. LEXIS 72">*98 for shares of stock of the petitioner in tax-free exchanges." This description of the transaction was sustained, section 112 (b) (5) held to be applicable to the original transaction, and section 113 (a) (8) to attribute to the taxpayer the basis of its transferors. We accordingly agree with petitioner that section 112 (b) (5) applies.
It remains to specify the effect of this conclusion upon the amount of petitioner's equity invested capital. Sec. 718 (a) (2) "Property Paid In," provides that "Such property shall be included in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange." Relying upon sections 728 and 729 (supra), we find that this basis to petitioner is set forth in section 113 (a) (8) as "the same as it would be in the hands of the transferor," 3 no gain or loss on the original transaction having been recognized under section 112 (b) (5), Revenue Act of 1936. 316 U.S. 527">Helvering v. Cement Investors, supra.That basis, as computed by petitioner, is $ 227,644.04, which we consider to be the correct figure for equity invested capital under the express provisions of section 718 and those incorporated in it by1949 U.S. Tax Ct. LEXIS 72">*99 reference. Montgomery Building Realty Co., supra.
III.Regardless 1949 U.S. Tax Ct. LEXIS 72">*100 of the disposition of its second contention, petitioner claims the benefit of section 718 (a) (7), Internal Revenue Code, reading as follows:
13 T.C. 472">*484 SEC. 718. EQUITY INVESTED CAPITAL.
(a) Definition. -- The equity invested capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following amounts, reduced as provided in subsection (b) --
* * * *
(7) Deficit in earnings and profits of another corporation. -- In the case of a transferee, as defined in subsection (c) (5), an amount, determined under such paragraph, equal to the portion of the deficit in earnings and profits of a transferor attributable to property received previously to such day.
In order to qualify as a "transferee" for this purpose petitioner must hence conform to the language of section 718 (c) (5), which provides:
SEC. 718. EQUITY INVESTED CAPITAL.
* * * *
(c) Rules for Application of Subsections (A) and (B). -- For the purposes of subsections (a) and (b) --
* * * *
(5) Deficit in earnings and profits -- Earnings and profits of transferor and transferee. -- If a corporation (hereinafter called "transferor") transfers substantially all its 1949 U.S. Tax Ct. LEXIS 72">*101 property to another corporation formed to acquire such property (hereinafter called "transferee"), if --
(A) the sole consideration for the transfer of such property is the transfer to the transferor or its shareholders of all the stock of all classes (except qualifying shares) of the transferee. (In determining whether the transfer is solely for stock, the assumption by the transferee of a liability of the transferor or the fact that the property acquired is subject to a liability shall be disregarded);
(B) the basis of the property, in the hands of the transferee, for the purposes of this subsection, is determined by reference to the basis of the property in the hands of the transferor;
(C) the transferor is forthwith completely liquidated in pursuance of the plan under which the acquisition of the property is made; and
(D) immediately after the liquidation the shareholders of the transferor own all such stock;
for the purposes of this subchapter, in computing the equity invested capital for any day after the date of the acquisition of the property, the earnings and profits or deficit in earnings and profits of the transferee and the transferor shall be computed as if, immediately1949 U.S. Tax Ct. LEXIS 72">*102 before the beginning of the taxable year in which such transfer occurs, the transferee had been in existence and sustained a recognized loss, and the transferor had realized a recognized gain, equal to the portion of the deficit in earnings and profits of the transferor attributable to such property.Passing the inconsistency of petitioner's assertion that the "transferor" was Old Gage rather than the stockholders, as it maintained under the second issue, and that Old Gage was liquidated after the merger contrary to its statement under the first, it suffices to consider the requirement of section 718 (c) (5) (D), since the characteristics of a "transferee" are stated in the conjunctive and all must be conformed with to fall within the definition.
A considerable portion, in fact a majority, of petitioner's stock was owned immediately after the transfer -- as well as after "the liquidation" 13 T.C. 472">*485 -- by Slocum, which had been a creditor, not a shareholder of Old Gage. Its interest in the property might constitute it a transferor for purposes of section 112 (b) (5), 316 U.S. 527">Helvering v. Cement Investors, supra;Alexander E. Duncan, supra;1949 U.S. Tax Ct. LEXIS 72">*103 or even be a proprietary interest under the continuity of interest test of a "reorganization." Helvering v. Alabama Asphaltic Limestone Co., 315 U.S. 179">315 U.S. 179. "But," to quote from Helvering v. Southwest Consolidated Corporation, 315 U.S. 194">315 U.S. 194, 315 U.S. 194">202, "it is one thing to say that the bondholders 'stepped into the shoes of the old stockholders' so as to acquire the proprietary interest in the insolvent company. It is quite another to say that they were the 'stockholders' of the old company within the purview of clause (C)" (of section 112 (g) (1)), which requires that immediately after the transfer the "transferor or its stockholders" or both be in control of the transferee. The opinion continues: "In the latter Congress was describing an existing, specified class of security holders of the transferor corporation * * *. Indeed clause (C) contemplates that the old corporation or its stockholders, rather than its creditors, shall be in the dominant position of 'control' * * * and not excluded or relegated to a minority position. * * *"
We have here no problem of control, since subdivision (D) requires that "all" of the1949 U.S. Tax Ct. LEXIS 72">*104 transferee's stock be held by shareholders of the transferor. Not only did the Old Gage stockholders not hold "all" of petitioner's stock, they did not even have control, but were clearly "relegated to a minority position." The holding, as well as the quoted language of the Southwest Consolidated case so aptly covers the present situation that we must deny petitioner's claim on the strength of it.
The assertion that the purpose, if not the language, of section 718 (a) (7) is applicable to petitioner does not withstand scrutiny. Section 718 (a) (7) was added by section 219, Revenue Act of 1942, adopted on October 21, 1942. The Southwest Consolidated case had been decided the 2d of February previous. We can not but assume that language already so authoritatively interpreted was employed by Congress with the same meaning.
This is borne out by the committee reports accompanying the measure. "This amendment incorporates a new section * * * providing that, under certain very limited circumstances, the equity invested capital of a 'transferee' corporation which receives property from another corporation pursuant to a tax-free exchange or reorganization shall be increased1949 U.S. Tax Ct. LEXIS 72">*105 * * *." H. Rept. 2586, 77th Cong., 2d sess., p. 61 (emphasis added). "* * * The rule increasing the invested capital of a corporation by the deficit of its transferor will apply only if * * * (a) the sole consideration for the transfer of such property is the transfer to the transferor or its shareholders of all the stock * * * 13 T.C. 472">*486 and (d) immediately after the liquidation, the stockholders of the transferor own all the stock of the transferee * * *." S. Rept. 1631, 77th Cong., 2d sess., pp. 193-194 (emphasis added). We hence take the view that respondent correctly denied to petitioner the benefits of section 718 (a) (7).
IV.Our disposition of the second issue removes the necessity of considering petitioner's fourth contention, relating to the undervaluation of good will, which, as the opening summary makes plain, is no more than an alternative to the first three. We have included in our findings a determination of its minimum value only for its effect upon the existence of potential equities on the part of the stockholders.
V.Respondent made no determination of income tax deficiencies against petitioner for either of the years in controversy. We are accordingly without1949 U.S. Tax Ct. LEXIS 72">*106 jurisdiction to consider that aspect of petitioner's claim. Respondent's motion to dismiss to this extent must accordingly be granted. Difco Laboratories, Inc., 10 T.C. 660. If the consequence of these proceedings is to create a deficiency in income tax which is subsequently determined, the groundwork for a cognizable petition may then have been laid. We can not anticipate it.
Decision will be entered under Rule 50.
Footnotes
1. That is one reason we are unable to agree with the proposition advanced by petitioner that "What may be required by the Federal Government on the matter of filing returns of income during the year of merger has no bearing upon the determination of equity invested capital under section 718 IRC.↩"
2. Section 112 (b) (5), Revenue Act of 1936, reads:
SEC. 112. RECOGNITION OF GAIN OR LOSS.
* * * *
"(b) Exchanges Solely in Kind. --
* * * *
"(5) Transfer to corporation controlled by transferor. -- 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 the 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."↩
3. SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.
(a) Basis (Unadjusted) of Property. -- The basis of property shall be the cost of such property; except that --
* * * *
(8) Property acquired by issuance of stock or as paid in surplus. -- If the property was acquired after December 31, 1920, by a corporation --
(A) by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5) (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money, in addition to such stock or securities), or
(B) as paid-in surplus or as a contribution to capital, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.↩