1946 U.S. Tax Ct. LEXIS 284">*284 Decision will be entered under Rule 50.
W, an individual, acting as "trustee" for the holders of all claims and judgments against a mining corporation in receivership and for the subscribers of new money, successfully bid in the property of the corporation at the receiver's sale. W then transferred the property to petitioner, a newly organized corporation. In exchange for the property petitioner issued its "prior lien notes" to the holders of said claims and judgments and to the subscribers of new money in the face amount of the claims and judgments and new money subscribed, said persons thereby becoming 100 percent of the creditors of the petitioner. Petitioner also issued to said persons a bonus of one-half share of its common stock for each dollar of face value of prior lien notes, the stock so issued being not more than 7.98 percent of its total issued shares. 78.91 percent of petitioner's stock was issued to W for his promotional services and the balance to other persons for unrevealed considerations. Held:
(1) Immediately after the transfer of the property to petitioner an interest or control in such property of 50 percent or more did not remain in the same persons, 1946 U.S. Tax Ct. LEXIS 284">*285 as required by section 113 (a) (7) of the Revenue Act of 1938; and,
(2) The prior lien notes did not give their holders any "interest or control" in petitioner within the meaning of section 113 (a) (7) of the Revenue Act of 1938, and, therefore, petitioner's basis for determining depreciation and depletion of the property acquired by it is the cost of the property to petitioner.
6 T.C. 313">*314 The Commissioner determined deficiencies in petitioner's income and declared value excess profits taxes for the taxable years 1938, 1939, and 1940 as follows:
| Declared | ||
| Year | Income tax | value excess |
| deficiency | profits tax | |
| deficiency | ||
| 1938 | $ 2,578.19 | $ 2,158.14 |
| 1939 | 3,146.93 | 579.66 |
| 1940 | 3,256.41 | 202.53 |
| Total | 8,981.53 | 2,940.33 |
1946 U.S. Tax Ct. LEXIS 284">*286 These deficiencies resulted from the action of the Commissioner in reducing certain deductions taken by the petitioner for depreciation and depletion of certain mining equipment and properties on the ground that the basis for the determination of depreciation and depletion of these assets is petitioner's cost rather than the cost of the assets to petitioner's alleged transferor.
FINDINGS OF FACT.
The facts have been stipulated and are found to be as stipulated. Only the facts material to an understanding of the issues here involved are set forth.
The Lehigh Metals Co., hereinafter referred to as petitioner, is a 6 T.C. 313">*315 corporation organized under the laws of the State of Delaware on October 15, 1928. It is duly licensed to do business in New Mexico and is engaged in mining and leasing gold and silver mines located in New Mexico.
The Socorro Mining & Milling Co. was organized in 1909 and incorporated in 1913. This corporation was a consolidation of approximately 46 mining claims and interests, located in and around the Cooney Mining District, Mogollon, New Mexico, then known as the "Socorro Mines." In 1920 the Socorro Mining & Milling Co. changed its name to the American Silver1946 U.S. Tax Ct. LEXIS 284">*287 Corporation and revised its capital structure.
On May 3, 1922, the United States District Court for the District of New Mexico appointed a receiver of the property of the American Silver Corporation, hereinafter referred to as American. A stockholders' protective committee was promptly organized and a plan of reorganization prepared, but the committee was unable to fulfill its purpose and was disbanded and terminated in May 1923. By order of the court and over the objections of the stockholders' committee the properties of American were leased to the Mogollon Mines Co. for a period of three years beginning March 22, 1923.
From 1926 and including 1928, William J. Weatherby, a mining engineer, who was conversant with the Cooney Mining District and the owner of 400 shares of stock of American, attempted to work out a plan to acquire, as trustee, the assets of American from the receiver. The stockholders of American were solicited by Weatherby to subscribe $ 50,000 in new money, the new money to be secured by "prior lien notes" of a new corporation in the face amount of the money subscribed together with a bonus of one-half share of common stock of the new company for each $ 1 of new1946 U.S. Tax Ct. LEXIS 284">*288 capital subscribed. Being unsuccessful in raising this amount from the stockholders of American, Weatherby then solicited other persons for that sum, again offering the same rights in return. It is stipulated that between August 3 and October 15, 1927, Weatherby thus "secured as trustee subscriptions for new money" aggregating $ 46,000. It is further stipulated that prior to April 23, 1928, "Weatherby secured increased subscriptions and other subscriptions for new money" in the total amount of $ 49,459.12. 1
Prior to March 19, 1928, Weatherby secured, as "Trustee" (the term again being undefined) assignments of $ 97,559.76 of approved claims1946 U.S. Tax Ct. LEXIS 284">*289 in the bankruptcy proceeding against American, these assignments including all claims allowed by the court in the proceeding. The form 6 T.C. 313">*316 of the assignment agreement which Weatherby obtained from the creditors of American is as follows:
January 20, 1928.
Mr. William J. Weatherby,
Scranton, Pennsylvania.
Dear Sir:
We understand you and your associates are interested in acquiring the property of the American Silver Corporation at Mogollon, New Mexico, at the Receiver's Sale to be held on or about March 19th, 1928, and in forming a new company to operate the American Silver and other properties.
We understand further that you and your associates agree to raise Fifty thousand dollars ($ 50,000) cash to be used at the sale provided the larger creditors will co-operate in your plans by accepting for the American Silver Corporation judgments and credits which they now hold:
(a) 6% Three Year Prior Lien Notes of the new company in amount equal to the principal of such judgments and credits, with accrued interest to the date of sale, irrespective of any reduced price at which the property may be sold, and
(b) Stock in the new company of a par value equal to one-half of such prior1946 U.S. Tax Ct. LEXIS 284">*290 lien notes -- the Company's capitalization not to exceed that of the American Silver Corporation.
And we understand further that you and your associates agree that within ninety days after the acquirement of the American Silver Corporation property -- if acquired -- your company will be prepared to enter upon the property and proceed with the development thereof.
In consideration of the fulfillment of your part of the agreement, we do severally and irrevocably agree to take the amount of prior lien notes in the proposed new company set opposite our respective names; and we agree to assign our judgments and credits to Messrs. Barber, Fackenthal & Giddings, Agents, to be used by them in conjunction with your cash resources for the purpose of bidding on the American Silver Corporation property at said sale.
Name of Creditor
Amount
The entire property of American was offered for sale by the receiver on March 19, 1928, and Weatherby, as "Trustee," entered a bid of $ 120,000. He was the successful bidder, making payment with $ 97,559.76 in approved claims and $ 22,440.24 in cash. The receiver thereupon executed his deed to the property, in which the grantee was "William J. Weatherby, 1946 U.S. Tax Ct. LEXIS 284">*291 Trustee."
Petitioner was incorporated with an authorized capital of 1,970,000 shares of class A common, par $ 1 per share, 1,000,000 shares of class B common, par $ 1 per share, and 300 shares of 6 percent noncumulative preferred capital stock, par $ 100 per share. The class A and class B common stock had the same rights, except that class B had the right to elect the majority of the board of directors of the company. The 6 percent preferred stock had no voting rights. The 3 persons named in petitioner's certificate of incorporation as "subscribers of the capital stock" were persons from whom Weatherby had secured subscriptions "for new money."
6 T.C. 313">*317 On October 24, 1928, William J. Weatherby, as trustee, wrote a letter to the petitioner offering to convey to it all of the property conveyed to him by the receiver's deed of April 23, 1928. The letter stipulated that in consideration of the conveyance, the petitioner was to issue to Weatherby or his assigns, 108,750 shares of class A common stock, all of the class B common stock of the corporation (1,000,000 shares), and 6 percent "lien notes" in the total sum of $ 151,000, payable in 3 years. This offer was accepted by the 1946 U.S. Tax Ct. LEXIS 284">*292 unanimous vote of the then stockholders of the petitioner on the same day as received. On October 30, 1928, the board of directors of the petitioner held its first meeting and ratified the purchase from William J. Weatherby, trustee, of the properties in question. The directors consisted of Weatherby and all of the subscribers of "new money" (except one).
Weatherby, as trustee, on March 21, 1929, deeded to the petitioner all of the American property which he had acquired from the receiver of American. The contract between Weatherby, trustee, and petitioner was amended by agreement on August 15, 1929, so as to set forth in detail the consideration to be paid by the petitioner for the property. This agreement, which was in the form of a letter from Weatherby, trustee, to the petitioner provided, in part, as follows:
Art. 1st. There shall be issued to me or my assigns certificates for ninety three thousand seven hundred fifty (93,750) shares of Class A common stock or warrants of your corporation of the par value of one Dollar ($ 1.00) per share fully paid and non-assessable.
Art. 2nd. There shall be issued to me or to my assigns all of the Class B common stock or warrants of your1946 U.S. Tax Ct. LEXIS 284">*293 corporation; consisting of one million (1,000,000) shares of the par value of one dollar ($ 1.00) per share, fully paid and non-assessable.
Art. 3rd. There shall be issued to me or my assigns certificates for one hundred fifty (150) shares of 6% non cumulative preferred stock of your corporation, of the par value of one hundred dollars ($ 100.00) per share, fully paid and non-assessable.
Art. 4th. That you will caused [sic] to be duly authorized executed and issued Prior Lien Notes of your corporation, secured by Deed of Trust for the total sum of one hundred forty-nine thousand nine hundred forty-three and eighty-two one hundredths dollars ($ 149,943.82). Said notes to bear interest at rate of 6% (six per cent) per annum from October 24, 1928 and to be payable in three years, and to be secured by a Prior Lien against all property described in my letter of October 24, 1928.
This letter of August 15, 1929, also listed the names of the individuals and firms to whom the petitioner should issue prior lien notes of $ 149,943.82 face value and $ 1,108,750 worth of stock at par value.
There is no document in evidence delineating Weatherby's "Trustee" capacity. The District Court which1946 U.S. Tax Ct. LEXIS 284">*294 had the receivership proceeding before it dealt with him as trustee; the receiver's deed named as grantee, Weatherby, trustee, the court order confirming the sale referred to him as such, and a letter from the district judge to 6 T.C. 313">*318 Weatherby stated that he was approving the sale to Weatherby as trustee and that he appreciated the protection given the creditors by Weatherby's purchase. In a receipt given to the receiver by Weatherby, acknowledging receipt from the receiver of $ 97,559.76 in claims against American and releasing the receiver and American from all liability on such claims, Weatherby certified that in the purchase of the American properties he was acting as trustee for all of the owners and holders of these claims, and that he would hold the properties as such trustee "in accordance with the agreement and understanding" between himself and the owners of the claims. This receipt was made of record in the receivership proceedings.
From these evidentiary facts we conclude, and so find, that Weatherby was acting in the transactions above set out not only for himself and those persons subscribing "new money," but also as trustee for all the owners and holders of creditor1946 U.S. Tax Ct. LEXIS 284">*295 claims against American.
According to the court order approving the receiver's sale to Weatherby, the total outstanding approved claims against American amounted to $ 97,559.76. Prior to the distribution of petitioner's notes and stock a number of these claims were assigned to other persons, some of the assignees having original approved claims of their own and some being newcomers to the venture. Various members of the group of original approved creditors also owned a total of 531,587 shares of American stock out of the 1,486,006 shares then outstanding.
Pursuant to the agreement with Weatherby, petitioner on May 25, 1929, issued 6 percent prior lien notes totaling $ 149,943.82 in face value on the following basis:
| To original holders of judgments or claims against American | $ 44,797.92 |
| To assignees of judgments or claims against American | 52,761.84 |
| To subscribers of new money | 49,459.12 |
| 147,018.88 | |
| Interest due on claims | 2,924.94 |
| Total notes issued | 149,943.82 |
On August 12, 1929, petitioner issued 53,750 shares of class A stock and 1,040,000 shares of class B. 21946 U.S. Tax Ct. LEXIS 284">*297 Of the class B shares, 875,000 went to Weatherby alone for his services in this transaction. The holders1946 U.S. Tax Ct. LEXIS 284">*296 of the notes were entitled to a "bonus" of one-half share of common 6 T.C. 313">*319 stock for each dollar of face value of prior lien notes held, except that no stock was issued on notes received for interest due on claims. In so far as we are able to determine, and using this formula, approximately 73,509 shares of A and B stock were issued as such bonus to note holders. 3 The balance of approximately 145,241 shares of A and B stock was distributed to persons other than Weatherby for unrevealed considerations such as promotional services. 4 Petitioner also issued 150 shares of its $ 100 par value preferred stock to one of American's creditors, Montague, in partial settlement of his claim. 5
The1946 U.S. Tax Ct. LEXIS 284">*298 American properties were appraised by independent appraisers as having a value of $ 1,106,882.42 as of January 1, 1929. When the books of the petitioner were opened on March 27, 1929, these properties were set up on the books at a total value of $ 756,256.20, which value was approved by the board of directors. The respondent determined an original "cost value" of these assets to the petitioner of $ 149,943.82. For the taxable years 1938, 1939, and 1940, the respondent allowed depletion and depreciation based on this "cost value" of $ 149,943.82.
OPINION.
The respondent contends that petitioner's basis for determining depreciation and depletion of the properties acquired from Weatherby is the cost of the properties to the petitioner. In support of this contention, respondent argues that the acquisition by Weatherby of the properties of American and their subsequent transfer to the petitioner constituted a transaction of bargain and sale and was not a "reorganization" within the meaning of section 112 (i) (1) (A) of the Revenue Act of 1928.
Respondent asserts further that, even though it should be found that petitioner acquired the properties in connection with a reorganization, 1946 U.S. Tax Ct. LEXIS 284">*299 petitioner's basis should still be its cost because immediately after the transfer an interest or control in such property of 80 percent or more did not remain in the same persons (or any of them) who had an interest or control in American, so as to bring the transaction within the exception provided by section 113 (a) (7) of the Revenue Act of 1928.
6 T.C. 313">*320 Petitioner, on the other hand, urges that it is entitled to use the cost of the properties to its transferor, American, namely $ 2,013,285.45, as its basis for determining depreciation and depletion. 6 In support of this argument, petitioner asserts that it acquired the properties in connection with a "reorganization" within the meaning of section 112 (i) (1) (A) of the Revenue Act of 1928, and that immediately after the transfer an "interest or control" of 50 per centum or more in such properties remained in the same persons who had had "interest or control" in its transferor as required by section 113 (a) (7) of the Revenue Act of 1938, which section petitioner contends is applicable here rather than the corresponding section of the 1928 Act.
1946 U.S. Tax Ct. LEXIS 284">*300 Section 114 of the Revenue Act of 1938 provides that the basis for depletion and depreciation of any property shall be the adjusted basis provided in section 113 (b) for determining the gain upon the sale of such property. 7 Section 113 (b) of the 1938 Act refers us back to subsection (a) of 113, which provides that the basis of property shall be the cost of such property, unless the matter comes within one of eighteen well-defined exceptions. Subparagraph (7) of 113 (a), which is the only exception which could be applicable to the case at hand, provides: 8
(7) Transfers to corporation. -- If the property was acquired --
(A) after December 31, 1917, and in a taxable year beginning before January 1, 1936, by a corporation in connection with a reorganization, and immediately after the transfer an interest or control in such property of 50 per centum or more remained in the same persons or any of them, or
(B) in a taxable year beginning after December 31, 1935, by a corporation in connection with a reorganization, 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 transferor1946 U.S. Tax Ct. LEXIS 284">*301 upon such transfer under the law applicable to the year in which the transfer was made. * * *
1946 U.S. Tax Ct. LEXIS 284">*302 It is our opinion that immediately after the transfer an interest or control in such property of 50 percent or more did not remain in the same persons or any of them; and that, consequently, petitioner is not entitled to use the basis of its transferor as to the property here involved under the provisions of section 113 (a) (7) of the Revenue Act of 1938.
6 T.C. 313">*321 Therefore, we need not consider the arguments of the parties upon the question of whether the petitioner acquired its property in connection with a reorganization as that word is defined by section 112 (i) (1) (A) of the Revenue Act of 1928, for even if we assume arguendo that petitioner is correct in his contention that the transaction leading to the acquisition of its property constituted such a reorganization, it is impossible for us to conclude that the other prerequisite to the applicability of section 113 (a) (7) exists, i. e., that "immediately after the transfer an interest or control in such property of 50 per centum or more remained in the same persons or any of them."
We agree with petitioner's argument that the statute does not demand that the interest or control remain in identically the same persons, that1946 U.S. Tax Ct. LEXIS 284">*303 is, in all of them; its terms are met if the statutory quantum of interest or control remains in any of them. Muskegon Motor Specialties Co. v. Commissioner, 134 Fed. (2d) 904; Commissioner v. Bankers Farm Mortgage Co., 145 Fed. (2d) 772.
However, as a matter of simple arithmetic we can not agree that in the case here under consideration an interest or control in the American properties of 50 percent or more remained in the same persons or any of them.
The petitioner issued prior lien notes totaling $ 149,943.82, including $ 2,924.94 in notes issued for interest allowed on the claims. These notes were issued to the original owners of claims against American or to their assignees and to the subscribers of new money. Petitioner also issued as a bonus to these same persons approximately 73,509 shares of class A and B common stock. The total amount of stock issued by petitioner was 1,093,750 shares of class A and class B common stock, 875,000 shares of class B going to Weatherby alone. 73,509 shares represent but 6.72 percent of 1,093,750 shares. If, to give the petitioner the benefit of all possible doubt, we1946 U.S. Tax Ct. LEXIS 284">*304 include the 150 shares of preferred stock in our computations as being equal to 15,000 shares of common stock, we find that at the most 7.98 percent of the total stock issued went to the creditors or their assignees and to subscribers of new money. 9 On the same basis, we find that out of 1,108,750 shares of stock, Weatherby received 875,000 or 78.91 percent. Certain substantial blocks of stock, not precisely determinable from the facts before us, were also issued to other individuals for services in the reorganization and other considerations. In any event, the amount of stock received by former creditors or their assignees falls far short of the 50 percent interest or control required by section 113 (a) (7) of the 1938 Act, or the 80 percent required by the similar provision of the 1928 Act.
In support of its argument that an interest or control in the American property of 50 percent or more remained in the same 6 T.C. 313">*322 persons, 1946 U.S. Tax Ct. LEXIS 284">*305 petitioner places great stress on the fact that 100 percent of the creditors of American, or their assignees, became 100 percent of the creditors of the petitioner, i. e., received all of the prior lien notes. We do not consider that the notes gave the recipients thereof any "interest or control" in the petitioner within the meaning of the statute. The term "interest" in the statute is used to designate a right in the nature of ownership, and not the limited rights of creditors. 10 The prior lien notes did not give their holders any such rights, since they merely vested the holders with creditors' rights. Therefore the acquisition by creditors of American of these prior lien notes of petitioner gave them no interest or control in or of petitioner within the meaning of section 113 (a) (7).
1946 U.S. Tax Ct. LEXIS 284">*306 The fact that the creditors of American or their assigns owned 531,587 shares of American stock out of the 1,486,006 shares outstanding is without significance in determining "interest or control" remaining in the same persons. Nor is the fact that Weatherby owned 400 shares of American stock in any way material on this point. Any rights of beneficial ownership which holders of this stock had in the properties of American were wiped out by the receivership and the receiver's sale, and were superseded by the rights of creditors. See Helvering v. Alabama Asphaltic Limestone Co., 315 U.S. 179">315 U.S. 179. The stockholders of American who did receive prior lien notes or stock of the petitioner did not receive such notes or stock by virtue of any holdings of American stock, but whatever interests they received were in return for either new capital or for a claim or judgment which they held against American, or as in the case of Weatherby and his promotional associates, for services to the petitioner.
Nor can the 875,000 shares of Weatherby be merged with the shares issued to creditors of American or their assignees to fill the requirement of 50 percent interest1946 U.S. Tax Ct. LEXIS 284">*307 or control. Before the receivership sale, these creditors or their assignees had 100 percent "interest or control" in the American properties. Weatherby, a mere stockholder, had no part in such "interest or control" as to American, and yet after the transaction here in question Weatherby had an "interest or control" as to petitioner of over 50 percent.
Decision will be entered under Rule 50.
Footnotes
1. We have set out the stipulation on this point practically verbatim, since it leaves us in doubt as to whether the total amount of new money secured by Weatherby was $ 49,459.12 or $ 95,459.12 ($ 49,459.12 plus $ 46,000). However, an exhibit attached to the stipulation indicates that petitioner issued its prior lien notes for new money in the total amount of $ 49,459.12.↩
2. These figures are stipulated by the parties (par. 48, p. 9, of the stipulation). It is noted that there is an unexplained discrepancy between these figures and those contained in the letter of August 15, 1929, set out above. It is also noted that the figure of 1,040,000 shares of class B common stock is in excess of the amount of such stock authorized in petitioner's corporate charter. We make no attempt to reconcile these discrepancies in the stipulation because, as we shall demonstrate in our opinion, it is immaterial which of the discrepant figures is used.↩
3. Both parties hereto have furnished the court with varying figures as to the amount of stock issued as "bonus." We find it necessary to make our own approximation of the amount issued as bonus, this figure resolving all doubts in favor of the petitioner and being actually considerably in excess of the amount alleged in the petition to have been issued as "bonus." See footnote 2.↩
4. In his petition, petitioner alleges that 35,183 shares of "A" common and 125,000 shares of "B" common were issued to "promoters" other than Weatherby. The stipulated facts indicate that the amount of stock issued for promotional services to persons other than Weatherby may actually have been somewhat smaller than this 160,183 share total. See footnote 2.↩
5. Montague also received $ 15,000 in cash from Weatherby and his associates for the balance of his claim and, in exchange for the preferred stock and cash, assigned his entire claim to various individuals. When petitioner issued its prior lien notes and bonus stock these individuals received notes and stock covering the full amount of Montague's claim.↩
6. This figure of $ 2,013,285.45 is taken from a reconcilement of net worth of American filed by the receiver in the District Court in May 1922.↩
7. SEC. 114. BASIS FOR DEPRECIATION AND DEPLETION.
(a) Basis for Depreciation. -- The basis upon which exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the adjusted basis provided in section 113 (b) for the purpose of determining the gain upon the sale or other disposition of such property.
(b) Basis for Depletion. -- The basis upon which depletion is to be allowed in respect of any property shall be the adjusted basis provided in section 113 (b) for the purpose of determining the gain upon the sale or other disposition of such property * * *.↩
8. 113 (a) (7) of the 1928 Act, which respondent contends should control here, is substantially the same as 113 (a) (7) of the 1938 Act, except that 80 per centum interest or control is required. In view of our conclusions hereinafter expressed, it is unnecessary for us to decide whether the 1928 Act or the 1938 Act is applicable.↩
9. See Nelson Co. v. Helvering (1935), 296 U.S. 374">296 U.S. 374↩.
10. See Mertens, Law of Federal Income Taxation (1942), vol. 3, p. 507 footnote: "The word 'interest' probably does not include the defeasible interest of a bondholder as mortgagee of the property so transferred. The meaning of that word is probably confined, as used in GCM 7472↩, CB IX-1, p. 191, to a direct interest and to only such an indirect interest as is represented by 'the ultimate or beneficial species of rights, in the nature of ownership, which the individual shareholder has in property the direct ownership of and the beneficial and legal title to which is in the corporation of which the individual is a shareholder.'"