*1330 1. In April, 1924, a partnership, consisting of three members owning equal shares, purchased a business and immediately transferred the same to this petitioner, the stock of petitioner being issued to the three partners in equal proportions. Held, that the Revenue Acts of 1924 and 1926 are applicable and that thereunder the basis to be used in the determination of gain or loss upon the sale of the merchandise and the basis to be used in computing depreciation deductions upon the fixtures transferred to petitioner is the cost of such merchandise and fixtures to the partnership.
2. Held that petitioner has not met the burden of proof in respect to the inclusion in income of an item placed to petitioner's credit.
*304 This is a proceeding for the redetermination of asserted deficiencies in income taxes for the 8-month period ended December 31, 1924, in the amount of $3,746.10, the year 1925 in the amount of $1,000.78, and the year 1926 in the amount of $338.68.
It is alleged that the respondent erred (1) in deducting from the opening*1331 inventory for the period the sum of $32,191.13; (2) in disallowing depreciation on the fixtures, the cost of which was disallowed in the opening inventory; and (3) in setting up an item of $714.29 as additional income to the petitioner in the year 1924.
FINDINGS OF FACT.
The Baron brothers, Louis, Abraham and Isaac, in 1924 were equal partners in a partnership known as Baron Brothers, engaged in operating department stores in Mitchell, South Dakota.
Upon the recommendation of a representative of a Chicago wholesale house, Louis Baron and one of his brothers went to Madison, Wisconsin, in the latter part of March, 1924, for the purpose of investigating or with the idea of buying the business located there *305 known as Loken Bros., Inc., which had made an assignment of its assets to J. H. Coe, trustee, for the benefit of its creditors. Louis Baron spent about three days checking over the merchandise and the prospects. He obtained as many facts pertaining to the history of the business as he could from Coe and from the auditor of Loken Brothers, Inc. The Baron brothers also talked with the office personnel and the bookkeeper of Loken Brothers, Inc. They had two or*1332 three informal discussions with Coe and then the partnership made him an offer to buy the business.
On April 10, 1924, J. H. Coe, as trustee, party of the first part, and Abraham, Louis and Isaac Baron, copartners, parties of the second part, entered into an agreement which provided in part as follows:
1. Party of the first part agrees to sell, transfer and assign to parties of the second part, and the parties of the second part agree to buy, all of the stock in trade, furniture and fixtures, supplies, equipment and attachments thereunto belonging and appertaining, formerly owned by Loken Bros., Inc., a corporation, (excepting goods upon which deposit has been made and which are not included in inventory) and located in, upon or about the store occupied by said Loken Bros., Inc., a corporation, at Nos. 12-18 West Mifflin St. in the city of Madison, Dane County, Wisconsin, and party of the first part shall secure from Shirley Fuller Hobbins and Jessica Fuller, lessors, an assignment of a certain lease dated the 11th day of September, 1922, heretofore entered into with H. O. Loken and George C. Loken and duly assigned to said Loken Bros., Inc., a corporation, and being the lease*1333 covering the said premises at Nos. 12-18 West Mifflin Str. in said city of Madison, formerly occupied by Loken Bros. Inc., a corporation. All of the property, including the leasehold aforesaid for the unexpired term thereof, so sold to be transferred free and clear of all liens and encumbrances to parties of the second part, or their assigns, by proper bill of sale in usual form. Any and all liens or encumbrances upon any of said property shall be paid by party of first part or his successor in trust out of the proceeds realized from the sale of said property. It is distinctly agreed and understood that the furniture and fixtures and stock which may be owned by the sublessees of said Loken Bros. Inc., to-wit, H. C. Netherwood Printing Co., Mrs. W. Wengel, Walter C. Hanna, and Mary C. Graham, are not to be transferred by the party of the first part, and he is not to be responsible for the transfer of either the stock or fixtures owned by any of said parties. Party of the first part further agrees as part of the consideration to assign by proper instruments of assignment all insurance policies now held by party of the first part.
2. Party of the second part agrees to pay, and*1334 party of the first part agrees to accept for the transfer of said property as above set forth the following sum of money: Party of the first part shall transfer all goods, wares, merchandise, supplies and sundries contained in the inventory made as of the close of business March 22, 1924, and also all furniture, fixtures, equipment and attachments and appurtenances thereunto belonging. The proceeds derived from all sales made from the date of the opening of business on the 24th of March, 1924, to the date of this agreement to be paid by the party of the first part to the party of the second part on the basis of sale price, after deducting twenty-six (26) per cent of said sale price for operating expense. All goods in the *306 store and being merchandise on hand which was not included in said inventory, and being new stock, to be paid for by the parties of the second part to the party of the first part at invoice price. The amount thereof is hereby fixed at approximately Four Thousand Five Hundred Ninety and four-one hundreths Dollars ($4590.04).
3. Price for the transfer of the stock, fixtures and all other property hereinbefore specified so agreed by the party of the*1335 first part to be transferred to be One Hundred Six Thousand One Hundred Sixty-seven Dollars ($106,167.00) subject to the payment to be made for goods sold, and subject to the payment of the additional amount for the goods not inventoried, as hereinbefore provided.
4. It is mutually agreed that the lease between Loken Bros. Inc., and Mrs. W. Wengel for the Bobber Ship on the second floor may be continued and that party of the first part assumes no liability for the cancellation of said lease; that party of the second part recognizes that there is an oral agreement that the Netherwood Printing Company shall have certain space in said premises, and that party of the first part assumes no liability in connection therewith; that party of the second part has made agreements with said Walter C. Hanna and Mary C. Graham and that party of the first part assumes no obligation with reference thereto so far as the cancellation of the lease or turning over of their stock or fixtures is concerned.
5. It is further mutually agreed that all provisions with reference to sales of stock in bulk, and particularly the provisions of Section 2317 c, Wisconsin Statutes, 1923, shall be fully complied*1336 with by the parties hereto, and that possession of said store and of the stock and fixtures contained therein shall not be given until the 24th day of April, 1924, more than ten (10) days subsequent to the mailing of notices to creditors, as provided in said Statutes. That during the period from the date of the making of this agreement party of the second part shall have the right to have a representative in said store and shall have the right to direct the sales of stock therein; that all proceeds from the sale of said stock shall be deposited daily in a separate and distinct account, and that all expenses during said period shall be paid from said account, said expenses to consist of the running expenses of the said business, and that upon the consummation of this agreement on the date hereinbefore specified, and the delivery of said store and contents, as above provided, that the net moneys resulting from operation as aforesaid be turned over by party of the first part to party of the second part as the property of said party of the second part; said account to stand in the name of J. H. Coe as trustee and said party of the second part to have no right or claim therein, and no*1337 right or cleaim as against said moneys in the event that this agreement shall not be consummated.
6. It is further mutually agreed that in the event that litigation shall be instituted, or that bankruptcy proceedings shall be instituted against said Loken Bros. Inc., so that title to said property so to be transferred may not be given by party of the first part, or the agreements between Walter C. Hanna or Mary C. Graham and parties of the second part shall not be fully consummated, that this agreement shall be void and of no effect; otherwise this agreement shall be binding upon the respective parties hereto and their respective heirs, executors, administrators and assigns.
* * *
Thereafter J. H. Coe continued in charge of the business and business was conducted in the regular manner. Louis Baron continued on the premises representing Baron Brothers, copartners.
*307 On April 24, 1924, J. H. Coe executed a bill of sale to Abraham, Louis and Isaac Baron, as copartners, for all of the stock in trade, furniture and fixtures, supplies and attachments, formerly owned by Loken Bros., Inc.
In the settlement between J. H. Coe, trustee, and the partnership, the date*1338 of which is not shown, the partnership agreed that the amount due from it to Coe was $81,576.46. Therein, among the items of actual expenses from April 10 to April 23, 1924, agreed to be paid by the partnership, was included an item of "Taxes, $714.29." A part of the amount agreed upon was paid by check of Baron Brothers. This money was paid on April 24, 1924.
In addition to the amount paid to Coe, Baron Brothers made settlements with the various lessees in the building in an amount ranging between $8,000 and $9,000.
The Baron brothers thereafter organized a corporation, the petitioner herein, to take over the business.
On April 24, 1924, Baron Brothers, the partnership, made the following offer to the petitioner:
Baron Brothers, Inc.,
Madison, Wisconsin.
Gentlemen: -
We will sell your company all of the assets, purchased by us, and which were formerly owned by Loken Brothers, Inc., a corporation of Madison, Wisconsin, said assets consisting of merchandise, furniture, fixture, supplies, equipment, lease and leasehold interest to the property located at number 12 to 18 Miflin Street, Madison, Wisconsin, the above described assets having been purchased by us from*1339 J. H. Coe, Trustee of Loken Brothers, Inc., under an agreement of purchase dated April 10th, 1924, for One Hundred twenty nine thousand dollars ($129,000.00) and the further consideration that your company assume and agree to pay all expense items now owned by Baron Brothers, a co-partnership, in connection with the operation and organization of the above described business, also a certain note for twenty-five thousand dollars ($25,000.00) given by the co-partnership, Baron Brothers, to the First National Bank of Madison, Wisconsin, which money was used by the co-partnership to pay for merchandise added to assets described above.
The following balance sheet to be accepted by you as a statement of what you purchase,
| Assets | |
| Cash | $585.44 |
| Merchandise | 99,866.65 |
| Fixtures | 53,547.91 |
| Total | $154,000.00 |
| Bills pay | 25,000.00 |
| Cost to you | $129,000.00 |
If the above proposition is accepted, we Baron Brothers, a co-partnership, agree to accept as payment of the One Hundred Twenty Nine Thousand Dollars ($129,000.00) the purchase price, one thousand two hundred ninety, (1290) *308 shares of your corporation stock, same to be fully paid up and nonassessable, said*1340 stock to be issued as follows:
| Abraham Baron | 430 one hundred dollar ($100.00) shares, |
| Louis Baron | 430 one hundred dollar ($100.00) shares, |
| Isaac Baron | 430 one hundred dollar ($100.00) shares. |
Yours respectfully,
(Signed) BARON BROTHERS, a co-partnership.
ABRAHAM BARON
LOUIS BARON
ISAAC BARON
All members of the partnership.
The petitioner accepted the offer above set forth, and 1,290 shares of $129,000 par vlaue of its capital stock were issued to the partnership. Three stock certificates in the amount of 430 shares each were issued to each of the Baron brothers. The authorized capital stock of the petitioner was $200,000 par value, but only $129,000 par value was issued.
The above merchandise sold by the partnership to the petitioner included not only the assets purchased from Coe, but also the property purchased from the other lessees who were in the store at the time.
When the books of the corporation were opened on April 25, 1924, the assets were listed thereon in the amounts as set forth in the offer hereinabove set forth.
The figure of $53,547.91 for fixtures represented the cost thereof to Loken Bros., Inc., less the first*1341 year's depreciation deduction as taken by Loken Bros., Inc.Loken Bros., Inc., had been in business a little over a year prior to its assignment for the benefit of creditors. The fixtures and merchandise of Loken Bros., Inc., were excellent stock. They were a little over a year old.
The basis which was used by the petitioner for sales in the store was the price at which the merchandise was sold to the corporation, and not the basis at which the partnership purchased the goods from Coe. By using the amount at which the merchandise was sold to petitioner as a base for the computation of the sale price thereof, the petitioner made a satisfactory amount of profit at the end of the first year of operation.
In the year 1924 the merchandise levels were normal. There were no wide fluctuations.
In computing the deficiency for the eight-month period ending December 31, 1924, the respondent added to income as reported by petitioner the amount of $714.29 as "deposit for taxes."
In the deficiency letter the respondent explained his treatment of the $714.29 item as follows:
*309 In the settlement with the trustee $714.29 for taxes was deposited in a bank to the credit of*1342 the taxpayer. Taxpayer recognized the excess balance but was unable to account for same. The amount was credited equally to each of the three stockholders' accounts. It is included in taxable income. Article 21, Regulations 65.
For the eight-month period ending December 31, 1924, the respondent added to income as reported by the petitioner the amount of $32,191.13 as "appreciation of opening inventory," with the following explanation in the deficiency letter:
This amount represents appreciation of merchandise which is disallowed. The method of determining appreciation is shown in detail in the revenue agent's report, a copy of which was furnished you. Article 1612, Regulations 65.
The respondent held that the proper value to be used for the petitioner's opening inventory of merchandise is the cost of such merchandise to Baron Brothers, the partnership.
In the deficiency letter, the respondent added to income reported by the petitioner for each of the taxable periods in controversy amounts representing "excess depreciation," and stated in regard thereto:
Your contention that you should be allowed to compute depreciation on furniture and fixtures on the basis of the*1343 value of said assets at the time they were turned over by the partnership to you has also been denied. The Revenue Act of 1924 provides that the basis for determining depreciation shall be the cost in the hands of the transferors increased by any gain or decreased by any loss recognized under the Act in force at the time of transfer.
OPINION.
MCMAHON: In the petition it is alleged that some of the taxes in controversy are for the month of January, 1927, but in the deficiency letter the Commissioner did not determine any deficiency for that month and, therefore, the petition, in so far as it purports to relate to that month, is hereby dismissed for lack of jurisdiction.
The petitioner contends that for the eight-month period ended December 31, 1924, the respondent erred in deducting from the opening inventory for the period the sum of $32,191.13. In this regard the petitioner contends that the Revenue Act of 1921 is governing and that the basis to be used in the computation of gain derived upon the sale of the merchandise received from the partnership is the fair market value of such merchandise on April 25, 1924, the date it was acquired by the petitioner. The respondent, *1344 on the other hand, contends that the Revenue Act of 1924 is applicable and that the basis to be used for the inventory is the cost of the merchandise to the partnership.
*310 There are set forth in the margin the applicable provisions of the Revenue Act of 1924. 1
*1345 The Revenue Act of 1924, which was enacted June 2, 1924, in section 1100(a) specifically repealed Title II (called "Income Tax") of the Revenue Act of 1921, as of January 1, 1924. By the provisions of section 200(a) of the Revenue Act of 1924, such act applies in determining tax liabilities for the calendar year 1924 or any fiscal year ending during such calendar year.
In the instant proceeding the partnership exchanged the merchandise and fixtures to the petitioner for stock of petitioner, the amount of stock which each partner received was exactly in proportion to his interest in the property prior to the exchange, and after the exchange the partners were in control of the petitioner. Thus the transaction in question answers the description in section 203(b)(4) and under the provisions of section 204(a)(8), the basis to be used for the determination of gain or loss upon the sale of such property is the same as it would be in the hands of the partnership, increased in the amount of gain or decreased in the amount of loss recognized to them under the law applicable to the year in which the transfer was made. We have already shown that the Revenue Act of 1924 is applicable to*1346 the year 1924 and under section 203(b)(4) of that act no gain or loss is recognized upon the transaction in question. Thus the basis in the hands of the petitioner is the same as it would be in the hands of the partnership, which is the cost to the partnership. *311 Section 204(a) of the Revenue Act of 1924. Thus the petitioner should include the merchandise in question in its inventory at cost to Baron Brothers, the partnership. The respondent's determination in this regard is approved.
The petitioner also contends that for the eight-month period ended December 31, 1924, the year 1925, and the year 1926, the respondent erred in disallowing a portion of the claimed depreciation on fixtures which petitioner had acquired from the partnership, it being the position of the petitioner that the proper basis for depreciation is the fair market value of such fixtures on April 25, 1924, the date petitioner acquired the assets. The respondent contends that the 1924 Act is governing and that the proper basis for depreciation is the cost of the assets to the partnership.
By the specific provisions of section 204(c) of the Revenue Act of 1924, the basis for the allowance for depreciation*1347 is the same as the basis for determination of gain or loss. The fixtures were acquired in the same manner and at the same time as the merchandise above referred to and since the basis for determining gain or loss upon their disposition would be the cost to Baron Brothers, as explained above in regard to the merchandise, the basis for the allowance of deductions for depreciation thereon for the period ended December 31, 1924, is also the cost to Baron Brothers. With regard to depreciation allowance for the years 1925 and 1926, we are governed by the Revenue Act of 1926. Section 200 of the Revenue Act of 1926. That revenue act in like numbered sections contains provisions identical with those of the Revenue Act of 1924 with which we have above dealt, and consequently the basis for the allowance of depreciation deductions in the years 1925 and 1926 is the cost of the fixtures to Baron Brothers. The respondent's determination of the depreciation deductions to which petitioner is entitled is approved.
For the eight-month period ended December 31, 1924, the respondent added to the income as reported by the petitioner an amount of $714.29, with the statement in the deficiency letter*1348 that this amount had been deposited in a bank to the credit of the taxpayer, and that it had been credited equally to each of the three stockholders' accounts. Louis Baron, one of the three stockholders, testified at the hearing that it was his recollection that the amount represented what was left of a deposit made by the partnership with Coe to take care of bills for merchandise that were coming in during the period that Coe continued to run the business in conjunction with the partnership prior to the time the business was acquired by the petitioner. He testified that this balance was evidently returned to the partnership and that it has no relation whatever to the petitioner's income.
*312 The burden is upon the petitioner to show that the item of $714.29 is not income to it. While an item of "Taxes, $714.29," appears in the settlement between Coe and the partnership, we have no evidence as to how it came into the hands of the petitioner. The testimony of Louis Baron was not positive and does not serve to throw any light upon the nature of the payment to the petitioner. In the contract between Coe and Baron Brothers there was no provision that Baron Brothers should*1349 pay or put up a deposit to care for any bills occurring during the period that the sale was being considered by the creditors. On the contrary, the contract provided that "all proceeds from the sale of said stock shall be deposited daily in a separate and distinct account, and that all expenses during said period shall be paid from said account."
In this situation we hold that petitioner has not met its burden of proving error in the respondent's determination and such determination is approved.
The proceeding in so far as it purports to relate to the month of January, 1927, is dismissed for lack of jurisdiction. As to the eight-month period ended December 31, 1924, and the years 1925 and 1926, judgment will be entered for the respondent.
Footnotes
1. SEC. 1100. (a) The following parts of the Revenue Act of 1921 are repealed, to take effect (except as otherwise provided in this Act) upon the enactment of this Act, subject to the limitations provided in subdivision (b) and (c):
Title II (called "Income Tax") as of January 1, 1924;
* * *
SEC. 200. (a) * * * The first taxable year, to be called the taxable year 1924, shall be the calendar year 1924 or any fiscal year ending during the calendar year.
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 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.
SEC. 204. (a) The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; except that -
* * *
(8) If the property (other than stock or securities in a corporation a party to a reorganization) was acquired after December 31, 1920, by a corporation by the issuance of its stock or securities in connection with a transaction described in paragraph (4) of subdivision (b) of section 203 (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), 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.
SEC. 204. (c) The basis upon which depletion, exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the same as is provided in subdivision (a) or (b) for the purpose of determining the gain or loss upon the sale or other disposition of such property * * *. ↩