1941 BTA LEXIS 1288">*1288 1. During the taxable year two North Carolina corporations entered into a written agreement of merger and consolidation to form a new corporation, the petitioner. The assets of both old corporations were to become the property of the new corporation and the stock of the new corporation was to be issued in agreed proportions to stockholders of the old corporations. At about the same time as the execution of the foregoing agreement but prior thereto, stockholders of both old corporations agreed that if the new corporation would pay and discharge a certain amount of indebtedness which one of the corporations owed to its stockholders, then no stock of the new corporation would be issued to the stockholders of the debtor corporation. The latter alternative was the one which was actually carried out. Held, the transfer of the assets of the debtor corporation to the new corporation was a sale and not a reorganization and petitioner is not entitled to use as a basis for depreciation the transferor's cost of the assets thus acquired. Prairie Oil & Gas Co. v. Motter, 66 Fed.(2d) 309.
2. A provision restricting the payment of dividends contained in an application1941 BTA LEXIS 1288">*1289 to the Reconstruction Finance Corporation for a loan which was to become effective and binding upon the parties when the loan was made available to the petitioner, held, not a written contract restricting the payment of dividends executed prior to May 1, 1936, within the meaning of section 26(c)(1) of the Revenue Act of 1936, since the application was not approved and the funds made available to the petitioner until July 6, 1936. Florence Cotton Mills,44 B.T.A. 436">44 B.T.A. 436.
44 B.T.A. 691">*692 The Commissioner has determined a deficiency of $5,844.14 in petitioner's income tax for the year 1936 and a deficiency of $509.97 in excess profits tax for the same year.
These deficiencies result from certain adjustments made by the Commissioner to the net income of petitioner as disclosed by its income tax return filed for the year 1936. One of these adjustments was the disallowance by the Commissioner of $10,078 depreciation claimed by petitioner. In explaining his action in making this adjustment the Commissioner stated in his deficiency notice as follows:
1941 BTA LEXIS 1288">*1290 The transaction whereby the taxpayer acquired the assets of the Dimension Manufacturing Company was not a reorganization within the meaning of sections 112(b) and (g) of the Revenue Act of 1936. Therefore, the basis for depreciation is the cost of the assets acquired on June 15, 1936.
The other adjustment made by the Commissioner was to disallow petitioner a credit under section 26(c)(1) of the Revenue Act of 1936, which it claimed because of a certain loan contract which it had made with the Reconstruction Finance Corporation. The Commissioner, in explaining his action taken in this adjustment, stated in his deficiency notice as follows:
The loan agreement with the Reconstruction Finance Corporation by its terms was not effective until after May 1, 1936, and therefore, no dividend paid credit is allowable under section 26(c)(1) of the Revenue Act of 1936 and I.T. 3051, C.B. 1937-1, page 88.
The petitioner by appropriate assignments of error contests the Commissioner's action in making each of the foregoing adjustments.
FINDINGS OF FACT.
The facts have been stipulated and we adopt those facts as our findings of fact. The following of those facts are stated for the1941 BTA LEXIS 1288">*1291 purpose of making clear the issues to be decided.
The Morgan Manufacturing Co., hereinafter referred to as the Morgan Co., was organized under the laws of the State of North Carolina November 23, 1933, with an authorized capital stock of 100 shares of the par value of $100 each. Its principal office and place of business was near the town of Black Mountain, in Buncombe County, North Carolina. On December 13, 1933, it leased from the Dimension Manufacturing Co., hereinafter referred to as the Dimension Co., certain assets consisting of lands, buildings, and equipment, with an option to purchase such assets at any time before December 1, 1934. A resolution extending this lease and option agreement to December 1, 1935, was adopted by the board of directors 44 B.T.A. 691">*693 of the Dimension Co. on October 31, 1934. The extension of the lease and option agreement was not submitted to the stockholders for approval and no renewal contract was executed by the officers of the Dimension Co., though the Morgan Co., with the consent of the Dimension Co., continued in possession and use of the property until and after June 16, 1936.
Prior to June 15, 1936, and within the year 1936, it was1941 BTA LEXIS 1288">*1292 orally agreed between the stockholders of the Dimension Co. and the stockholders of the Morgan Co. that if the Morgan Co., as it was to be constituted subsequent to June 16, 1936, should pay off the then existing notes payable of the Dimension Co. in the amount of $62,500, secured by a first mortgage on the latter's property, the stockholders of the Dimension Co. would release their rights, if any, in the stock of the Morgan Co. as constituted subsequent to June 16, 1936.
The aforesaid mortgage notes were held by certain stockholders of the Dimension Co. as follows:
| O. W. Slane Estate | $23,437.50 |
| B. S. Colburn | 15,625.00 |
| J. T. West | 11,718.75 |
| W. H. West | 11,718.75 |
| Total | 62,500.00 |
On June 15, 1936, the board of directors of the Dimension Co. adopted a resolution authorizing a consolidation of that company with the Morgan Co. Resolutions approving the consolidation were adopted on the same day by the board of directors of the Morgan Co. and by the stockholders of both companies. An agreement bearing date June 15, 1936, was executed by the officers and directors of both companies and was filed in the office of the Secretary of State of the State of North Carolina1941 BTA LEXIS 1288">*1293 on June 16, 1936. The agreement was entitled: "AGREEMENT OF MERGER CONSOLIDATING DIMENSION MANUFACTURING CO. and MORGAN MANUFACTURING CO. INTO MORGAN MANUFACTURING COMPANY", and provided in part as follows:
* * * IT IS AGREED BETWEEN THE PARTIES HERETO, acting in pursuance of the provisions of said Chapter 22 of the Consolidated Statutes of North Carolina, and of all acts supplemental thereto and amendatory thereof, that the Constituent Corporations shall be and the same are hereby merged and consolidated with each other into a new corporation to be formed by means of such merger and consolidation; * * *
* * *
EIGHTH: The manner and basis of converting the shares of stock of each of the Constituent Corporations into stock of the Corporation shall be as follows:
I. Immediately upon this Agreement becoming effective as the agreement and act of merger and consolidation of the Constituent Corporations, that is to say, immediately upon the filing of this Agreement in the office of the Secretary of State of the State of North Carolina the outstanding shares of 44 B.T.A. 691">*694 the capital stock of each of the Constituent Corporations shall, ipso facto, and without any other action on1941 BTA LEXIS 1288">*1294 the part of the respective holders thereof, become and be converted into shares of stock of the Corporation as follows:
(a) Each share of the Preferred Stock of the Dimension Manufacturing Company shall become one share of the stock of the Corporation;
(b) Each share of the Common stock of the Dimension Manufacturing Company shall become one third of a share of the stock of the Corporation;
(c) Each share of stock of the Morgan Manufacturing Company shall become one and seventy-one one-hundredths shares of the stock of the Corporation.
II. Certificates for shares of stock of each of the respective Constituent Corporations so converted into shares of stock of the Corporation shall be surrendered for cancellation by the respective holders thereof, at the office of the Morgan Manufacturing Company, near the Town of Black Mountain, North Carolina, and there shall be delivered to such respective holders, certificates for the corresponding number of shares into which the shares represented by the surrendered certificates have been so converted as follows:(a) Upon surrender and cancellation of certificates evidencing shares of Preferred Stock of the Dimension Manufacturing Company, 1941 BTA LEXIS 1288">*1295 the respective holders thereof shall receive certificates evidencing one share of the stock of the Corporation with respect to each share of the present existing Preferred stock of the Dimension Manufacturing Company, evidenced by the certificates so surrendered;
(b) Upon surrender and cancellation of certificates evidencing shares of Common stock of the Dimension Manufacturing Company, the respective holders thereof shall receive certificates evidencing one-third of a share of stock of the Corporation with respect to each share of the present existing stock of the Dimension Manufacturing Company, evidenced by the certificates so surrendered; and
(c) Upon surrender and cancellation of certificates evidencing shares of stock of the Morgan Manufacturing Company, the respective holders thereof shall receive certificates evidencing one share of the stock of the Corporation with respect to each share of the present existing stock of the Morgan Manufacturing Company, evidenced by the certificates so surrendered.
The new corporation resulting from the alleged consolidation or merger was to be known as the "Morgan Manufacturing Company." Its authorized capital stock was to consist of1941 BTA LEXIS 1288">*1296 1,000 shares of no par value. The agreement further provided:
The amount of stock with which the Corporation will commence business is not less than Seven Hundred and Fifty (750) Shares, or a book value of not less than One Hundred Thousand ($100,000.00) Dollars.
At the time of the execution of the agreement the Morgan Co. had outstanding 100 shares of stock, held as follows:
| D. B. Morgan, Sr | 45 shares |
| D. B. Morgan, Jr | 10 shares |
| Kent Swift | 45 shares |
All of those shares had been issued for cash in 1933. The Dimension Co. had outstanding 1,611 1/2 shares of common stock, held as follows:
| B. S. Colburn | 250 shares |
| J. T. West | 187 shares |
| J. G. Adams | 187 1/2 shares |
| W. H. West | 187 shares |
| O. W. Slane Estate | 250 shares |
| D. B. Morgan | 550 shares |
44 B.T.A. 691">*695 It also had outstanding 250 shares of preferred stock, all of which was held by B. S. Colburn.
On or about June 16, 1936, the following entries were made in petitioner's books:
| Account | Debit | Credit |
| Real estate, machinery and buildings | $308,099.15 | |
| Reserve for depreciation | $153,398.06 | |
| Accounts payable | 52.75 | |
| Notes payable | 62,500.00 | |
| Paid-in surplus | 2,148.34 | |
| Capital stock | 90,000.00 | |
| Total | 308,099.15 | 308,099.15 |
1941 BTA LEXIS 1288">*1297 The petitioner paid off the notes of the Dimension Co. referred to above on or about July 7, 1936, and the rights, if any, of the stockholders of the Dimension Co. in the stock of the Morgan Co. were then released. On or about the same date 900 additional shares of petitioner's stock were issued to the former stockholders of the Morgan Co., D. B. Morgan, Sr., and Kent Swift each receiving 405 shares, D. B. Morgan, Jr., 89 shares, and William McCants, 1 share. No new consideration was paid to the petitioner for such shares. The 900 additional shares were the same capital stock as the item of $90,000 shown in the column headed "credit" above. These 900 shares were issued to the above named individuals without the payment of cash or property to the Morgan Co. in addition to the sums paid by them for the 100 shares of stock issued originally at the time of incorporation in 1933.
On and after July 7, 1936, the petitioner had outstanding 1,000 shares of the capital stock of a book value of $100,000, held as follows:
| D. B. Morgan, Sr | 450 shares |
| D. B. Morgan, Jr | 99 shares |
| Kent Swift | 450 shares |
| William McCants | 1 share |
Contract Restricting Payment of Dividends.1941 BTA LEXIS 1288">*1298
On December 28, 1935, the petitioner made written application to the Reconstruction Finance Corporation for a loan of $65,000. It was stated in the application that the petitioner would not declare or pay any dividend or make any distribution upon its capital stock so long as it was indebted to the Reconstruction Finance Corporation, without the latter's written consent. It further provided that:
(16) This application as hereafter amended or supplemented, together with all conditions imposed by and all agreements required by or entered into with or for the benefit of R.F.C. in connection with the making of the loan hereby 44 B.T.A. 691">*696 applied for and the note or notes of applicant evidencing such l8an (all of which are incorporated herein and made a part hereof), shall constitute a contract between applicant and R.F.C. * * * Such contract shall become binding upon the parties therto only when all or any part of the loan applied is paid for the applicant by check or draft or otherwise, or is unconditionally credited to or for the account of applicant, and only with respect to the amount so paid or credited. * * *
The loan was approved by the board of directors of the Reconstruction1941 BTA LEXIS 1288">*1299 Finance Corporation on January 29, 1936, conditioned, among other things, upon the petitioner's delivery to the Charlotte branch of the Federal Reserve Bank of Richmond of its promissory note for the amount of the loan, secured by a first mortgage on all of its assets. The petitioner executed and delivered such promissory note to the Reconstruction Finance Corporation on June 30, 1936. The mortgage securing the note was executed June 30, 1936, and recorded on July 1, 1936. The amount of the loan was paid to the petitioner on or about July 6, 1936. The note and mortgage contained no reference to the payment of dividends by the petitioner.
OPINION.
BLACK: The first issue relates to the correct amount of depreciation which should be allowed petitioner as a deduction from 1936 income. There is no dispute as to the life of the property or the rate of depreciation which is to be used. The question at issue is the cost basis of the assets upon which depreciation is to be computed.
Petitioner contends that it is entitled to use the cost basis of the Dimension Co., adjusted by the amount of depreciation which had accrued to it at the time the property was transferred to petitioner. 1941 BTA LEXIS 1288">*1300 Respondent contends that the basis which should be used is $62,500, which represents the cost of the assets to petitioner. The statutes upon which petitioner relies are printed in the margin. 1
1941 BTA LEXIS 1288">*1301 Petitioner's contention is that there was a merger of the Dimension Co. with the old Morgan Co. and that immediately upon the completion 44 B.T.A. 691">*697 of the merger the new Morgan Co. owned all the assets of the Dimension Co. and the Morgan Co. and had assumed all of their liabilities and the stockholders of the two old companies had become stockholders in the new Morgan Co. In support of this contention, petitioner says in its brief:
So therefore on the effective date of the merger, namely, June 16, 1936, and immediately thereafter, that is to say until July 7, 1936, the former stockholers of the constituent Dimension Manufacturing Company were the owners of 829 1/6 shares (or 82.9%) and the former stockholders of the constituent original Morgan Manufacturing Company were the owners of 171 (or 17.1%) of the outstanding capital stock of the consolidated corporation.
The difficulty with petitioner's contention in this respect, it seems to us, is that petitioner would treat as entirely separate transactions the formal merger agreement which is in evidence and an oral agreement between the stockholders of both corporations entered into prior 44 B.T.A. 691">*698 to June 15, 1936, and within1941 BTA LEXIS 1288">*1302 the year 1936, by which it was agreed that:
* * * if the Morgan Co. as it was to be constituted subsequent to June 16, 1936, should pay off the then existing notes payable of the Dimension Co. in the amount of $62,500, the stockholders of the Dimension Co. would release their rights if any in the Morgan Co. as constituted subsequent to June 16, 1936.
We do not think it is permissible to treat these two steps as separate transactions but that the transaction as a whole determines its legal consequences. See Prairie Oil & Gas Co. v. Motter, 66 Fed.(2d) 309.
When the whole transaction as disclosed by the stipulated facts is viewed, we think it shows an acquisition by the Morgan Co. of all the properties of the Dimension Co. in consideration of the payment in cash by the Morgan Co. of $62,500 indebtedness which Dimension Co. owed to its stockholders. This was a sale by one corporation of its assets to another corporation for a consideration of $62,500 in cash. Neither the Dimension Co. nor any of its stockholders ever received any stock of the Morgan Co. in consideration of the sale of the Dimension Co.'s assets. There was, therefore, not that continuing1941 BTA LEXIS 1288">*1303 interest remaining in the old corporation or its stockholders which is required before there is a statutory reorganization. Cf. Cortland Specialty Co. v. Commissioner, 60 Fed.(2d) 937.
We, therefore, hold that petitioner did not acquire the assets in question in a statutory reorganization in which no gain or loss was recognized, but acquired them in a purchase for $62,500, and this latter amount represents the cost of such assets to petitioner and is the correct basis for depreciation. On this issue we sustain the Commissioner.
The second issue relates to petitioner's claim for a credit under section 26(c)(1) of the Revenue Act of 1936, printed in the margin. 2 The respondent has determined that the petitioner was not under any written contract restricting the payment of dividends prior to May 1, 1936; that petitioner's contract with the Reconstruction Finance Corporation by its expressed terms did not become effective and binding upon the parties until the funds had been paid to or made available to the petitioner, which did not occur until on or about July 6, 1936.
1941 BTA LEXIS 1288">*1304 44 B.T.A. 691">*699 On the facts of record the respondent's determination in this respect must be sustained. See Florence Cotton Mills,44 B.T.A. 436">44 B.T.A. 436; Bethlehem Silk Co.,43 B.T.A. 515">43 B.T.A. 515.
Reviewed by the Board.
Decision will be entered for respondent.
LEECH dissents on the second point.
SMITH, dissenting: I can not agree with the conclusion reached in the majority opinion that there was not a reorganization of the Morgan Manufacturing Co. and the Dimension Manufacturing Co. A reorganization is defined by the statute (section 112(g)(1) of the Revenue Act of 1936) as "(A) a statutory merger or consolidation." The majority opinion recognizes that there was a valid merger or consolidation of the corporations involved under the laws of the State of North Carolina, but takes the position, nevertheless, that this merger or consolidation was not a statutory reorganization; that, in effect, there was a sale by the Dimension Manufacturing Co. of all of its assets to the Morgan Manufacturing Co. for the amount of the indebtedness of the vendor company to its stockholders.
I do not think that this conclusion is justified. Obviously, 1941 BTA LEXIS 1288">*1305 the agreement of the Dimension Manufacturing Co.'s creditor stockholders to release their interest in the new corporation, if the merger should take place and if the indebtedness should be paid off by the new corporation, was not a part of the merger, or reorganization, plan. It was to take place, if at all, after the merger was completed. It was not a condition of the merger agreement. Neither the new corporation nor its stockholders were in any way bound ever to pay off the indebtedness. If they had failed to do so, could it still be said that there was no reorganization?
The North Carolina statutes provide a complete procedure for the merger or consolidation of corporations. See sec. 1224(a) to (i). The statutes make no distinction between a merger and a consolidation, the terms being used interchangeably. Carolina Coach Co. v. Hartness,198 N.C. 524">198 N.C. 524; 152 S.E. 489">152 S.E. 489. The merger or consolidation takes place "When the agreement [of merger or consolidation] is signed, acknowledged, filed and recorded," and thereupon the separate existence of the constituent corporations ceases and all of the assets and all of the debts and liabilities of1941 BTA LEXIS 1288">*1306 the constituent corporations become the assets, debts, and liabilities of the new corporation. (Sec. 1224(b).)
Speaking for the Supreme Court of North Carolina, Judge Adams said in 198 N.C. 524">Carolina Coach Co. v. Hartness, supra:
* * * but the instant the agreement is signed, acknowledged, filed, and recorded the separate existence of the constituent corporations ceases and the 44 B.T.A. 691">*700 consolidating corporations become a single corporation in accordance with the agreement. Section 1224-b. When the separate existence of the constituent corporations comes to an end, the new corporation acquires not only the property, but the powers, privileges, and franchises of the old corporations, which thereafter have neither property nor franchise. It is provided that all interests of the old corporations shall thereafter be the property of the consolidated corporations as effectually as they had previously been the property of the constituent corporations. Section 1224-b.
If, then, the assets of the Dimension Manufacturing Co. became the assets of the petitioner (new corporation) by operation of law under the North Carolina statute, how can it be said that the petitioner1941 BTA LEXIS 1288">*1307 purchased those assets from the Dimension Manufacturing Co. for the amount of that company's indebtedness to its stockholders? How, either, can it be said that the debt of the Dimension Manufacturing Co. to its stockholders did not, through the merger, become the debt of the petitioner?
It is my view, which I think is clearly supported by the facts and the law, that there was, first, a completed merger or consolidation of the Morgan Manufacturing Co. and the Dimension Manufacturing Co. under the laws of the State of North Carolina, and therefore a statutory reorganization; that the stockholders of both old corporations became stockholders of the new corporation and the assets and debts of the old corporation became the assets and debts of the new corporation; and that, subsequently, and as a separate transaction, the former creditor stockholders of the Dimension Manufacturing Co., who had become creditor stockholders of the new corporation, sold their interests in the stock of the new corporation in consideration for the payment by the new corporation of its indebtedness to them. I think that the former stockholders of the Dimension Manufacturing Co. continued as bona fide stockholders1941 BTA LEXIS 1288">*1308 of the new corporation from the effective date of the merger or consolidation, June 16, 1936, to July 7, 1936, the date on which they sold or relinquished their right to the stock in the new corporation.
Prairie Oil & Gas Co. v. Motter, 66 Fed.(2d) 309, is strongly relied upon in the majority opinion. That case, however, involves a different factual situation and is not controlling in the instant case. Cf. also Pinellas Ice & Cold Storage Co. v. Commissioner,287 U.S. 462">287 U.S. 462; West Texas Refining & Development Co. v. Commissioner, 68 Fed.(2d) 77.
There being a reorganization, it follows that under the provisions of section 113(a)(7) the basis of the assets in question for depreciation purposes is the same in the hands of the petitioner as it was in the hands of the Dimension Manufacturing Co. See Fairbanks Court Wholesale Grocery Co. v. Commissioner, 84 Fed.(2d) 18.
Footnotes
1. Revenue Act of 1936 -
SEC. 112. RECOGNITION OF GAIN OR LOSS.
* * *
(g) DEFINITION OF REORGANIZATION. - As used in this section and section 113 -
(1) The term "reorganization" means (A) a statutory merger or consolidation * * *.
* * *
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 -
* * *
(7) TRANSFERS TO CORPORATION. - If the property was acquired after December 31, 1917, 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 transferor upon such transfer under the law applicable to the year in which the transfer was made. This paragraph shall not apply if the property acquired consists of stock or securities in a corporation a party to the reorganization, unless acquired by the issuance of stock or securities of the transferee as the consideration in whole or in part for the transfer.
* * *
(b) ADJUSTED BASIS. - The adjusted basis for determining the gain or loss from the sale or other disposition of property, whenever acquired, shall be the basis determined under subsection (a) * * *.
* * *
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.
* * *
North Carolina statutes -
Sec. 1224(a). Merger, proceedings for. - Any two or more corporations organized under the provisions of this chapter, or existing under the laws of this State, for the purpose of carrying on any kind of business, may consolidate into a single corporation which may be either one of said consolidated corporations or a new corporation to be formed by means of such consolidation; the directors, or a majority of them, of such corporations as desire to consolidate, may enter into an agreement signed by them and under the corporate seals of the respective corporations, prescribing the terms and conditions of consolidation, the mode of carrying the same into effect, and stating such other facts as are necessary to be set out in the certificate of incorporation, as provided in this chapter, as well as the manner and basis of converting the shares of each of the old corporations into stock of the new corporation, with such other details and provisions as are deemed necessary or desirable.
* * * and the agreement so certified and acknowledged shall be filed in the office of the Secretary of State, and shall thence be taken and deemed to be the agreement and act of consolidation of the said corporation; * * *
Sec. 1224(b). Merger, status of old and new corporations.↩ - When the agreement is signed, acknowledged, filed and recorded, as in the preceding section is required, the separate existence of the constituent corporations shall cease, and the consolidating corporations shall become a single corporation in accordance with the said agreement, possessing all the rights, privileges, powers and franchises, as well of a public as of a private nature and all and singular the rights, privileges, powers and franchises of each of said corporations, and all property, real, personal and mixed and all debts due on whatever account, and all other things in action or belonging to each of such corporations, shall be vested in the consolidated corporation; and all property, rights, privileges, powers and franchises, and all and every other interest shall be thereafter as effectually the property of the consolidated corporation as they were of the several and respective former corporations, and the title to any real estate, whether by deed or otherwise, under the laws of this State, vested in either of such corporations, shall not revert or be in any way impaired by reason of this article; * * *
2. SEC. 26. CREDITS OF CORPORATIONS.
In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax -
* * *
(c) CONTRACTS RESTRICTING PAYMENT OF DIVIDENDS. -
(1) PROHIBITION ON PAYMENT OF DIVIDENDS. - An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. * * * ↩