1932 BTA LEXIS 1395">*1395 In 1923, a partnership, of which the taxpayers were members, and another brokerage firm purchased 125,000 shares of Class A stock (fair market value $25.50 per share) and 20,000 shares of common stock (fair market value $5 per share) of a corporation for $2,250,000. The Class A stock was sold in 1923 and the total cost allocated to it in computing the profit upon the sale. Held, the profit should be recomputed by allocating the cost between the Class A stock and the common stock in the proportion that the fair market value of each class bears to the total fair market value of both classes.
25 B.T.A. 1351">*1352 These consolidated proceedings are for the redetermination of deficiencies in the petitioners' income taxes for 1923 as follows:
| Petitioner | Docket No. | Deficiency |
| Clifford Hemphill | 38573 | $18,572.24 |
| Jansen Noyes | 38574 | 27,825.18 |
| Charles E. Gardner | 38575 | 18,190.02 |
| Harold C. Strong | 38576 | 1,194.88 |
| Stanton Griffis | 38577 | 15,361.36 |
| Walter S. Marvin | 38578 | 1,071.55 |
| Elizabeth E. Cook | 38579 | 662.37 |
1932 BTA LEXIS 1395">*1396 The petitioners allege that the Commissioner erred (a) in adding to net income an amount representing the fair market value of certain shares of common stock of the American Chain Company, and (b) in determining that this stock had a fair market value of $25 per share when received.
By amended answers, the Commissioner asserted increased deficiencies against the several petitioners in the following manner:
7. Respondent further alleges that, during the year 1923, petitioner received, through the partnership of Hemphill Noyes and Company, as a bonus, and in addition to the income set forth in the notice of deficiency hereinbefore referred to, certain securities having a fair market value as follows:
| [Docket No. 38573, Clifford Hemphill.] | ||
| Name of Company | Kind and Amt. of Security | Fair Market Value |
| Illinois Coal Company | 54 shares preferred stock | $5,130.00 |
| Illinois Coal Company | 272 shares common stock | 19,428.57 |
| American Furniture | 818 shares common stock | 4,090.00 |
| Mart Bldg. Corp. | ||
| Phoenix Silk Mfg. Co. | 764 shares common stock | 49,660.00 |
| McCrory Stores Corp. | 236 warrants to purchase | |
| preferred stock | 472.00 | |
| [Total | $78,780.57] |
| [Docket No. 38574, Jansen Noyes.] | ||
| Name of Company | Kind and Amt. of Security | Fair Market Value |
| Illinois Coal Company | 79 shares preferred stock | $7,505.00 |
| Illinois Coal Company | 396 shares common stock | 28,285.71 |
| American Furniture | 1190 shares common stock | 5,950.00 |
| Mart Bldg. Corp. | ||
| Phoenix Silk Mfg. Co. | 1111 shares common stock | 72,215.00 |
| McCrory Stores Corp. | 342 warrants to purchase | 684.00 |
| preferred stock | ||
| [Total | $114,639.71] |
| [Docket No. 38575, Charles E. Gardner.] | ||
| Name of Company | Kind and Amt. of Security | Fair Market Value |
| Illinois Coal Company | 54 shares preferred stock | $5,130.00 |
| Illinois Coal Company | 272 shares common stock | 19,428.57 |
| American Furniture | 818 shares common stock | 4,090.00 |
| Mart Bldg. Corp. | ||
| Phoenix Silk Mfg. Co. | 764 shares common stock | 49,660.00 |
| McCrory Stores Corp. | 236 warrants to purchase | 472.00 |
| preferred stock | ||
| [Total | $78,780.57] |
| [Docket No. 38576, Harold C. Strong.] | ||
| Name of Company | Kind and Amt. of Security | Fair Market Value |
| Illinois Coal Company | 10 shares preferred stock | $950.00 |
| Illinois Coal Company | 49 shares common stock | 3,500.00 |
| American Furniture | 150 shares common stock | 750.00 |
| Mart Bldg. Corp. | ||
| Phoenix Silk Mfg. Co. | 139 shares common stock | 9,035.00 |
| McCrory Stores Corp. | 43 warrants to purchase | 86.00 |
| preferred stock | ||
| [Total | $14,321.00] |
| [Docket No. 38577, Stanton Griffis.] | ||
| Name of Company | Kind and Amt. of Security | Fair Market Value |
| Illinois Coal Company | 50 shares preferred stock | $4,750.00 |
| Illinois Coal Company | 248 shares common stock | 17,714.29 |
| American Furniture | 744 shares common stock | 3,720.00 |
| Mart Bldg. Corp. | ||
| Phoenix Silk Mfg. Co. | 694 shares common stock | 45,110.00 |
| McCrory Stores Corp. | 214 warrants to purchase | 428.00 |
| preferred stock | ||
| [Total | $71,722.29] |
| [Docket No. 38578, Walter S. Marvin.] | ||
| Name of Company | Kind and Amt. of Security | Fair Market Value |
| Illinois Coal Company | 11 shares preferred stock | $1,045.00 |
| Illinois Coal Company | 53 shares common stock | 3,785.71 |
| American Furniture | 160 shares common stock | 800.00 |
| Mart Bldg. Corp. | ||
| McCrory Stores Corp. | 46 warrants to purchase | 92.00 |
| preferred stock | ||
| [Total | $5,722.71] |
| [Docket No. 38579, Elizabeth E. Cook.] | ||
| Name of Company | Kind and Amt. of Security | Fair Market Value |
| Illinois Coal Company | 5 shares preferred stock | $475.00 |
| Illinois Coal Company | 27 shares common stock | 1,928.57 |
| American Furniture | 80 shares common stock | 400.00 |
| Mart Bldg. Corp. | ||
| Phoenix Silk Mfg. Co | 74 shares common stock | 4,810.00 |
| McCrory Stores Corp. | 23 warrants to purchase | 46.00 |
| preferred stock | ||
| [Total | $7,659.57] |
25 B.T.A. 1351">*1354 and that these securities constitute additional taxable income to the petitioner for said year 1923 in the amounts of their fair market values as hereinabove set forth.
8. In the event the Board should find from the evidence that the securities set forth in the preceding paragraph, and the common stock1932 BTA LEXIS 1395">*1399 of the American Chain Company, Inc., referred to in the aforesaid notice of deficiency, were not received by the petitioner as a bonus, then respondent prays that the Board find that the aforesaid securities were purchased together with other securities by said partnership of Hemphill, Noyes & Company, and that the Board allocate the entire cost of said securities between all securities so acquired in order to determine the cost basis to said partnership of each of said securities, and that the Board thereafter redetermine the amounts of the profits received by said partnership upon the sale in 1923 of all or any of said securities, and the distributive share of the petitioner as a member of said partnership.
WHEREFORE, it is prayed that the appeal be denied, and that the Board redetermine the amount of the deficiency involved in this proceeding to be equal to the amount determined by the Commissioner, plus any additional amount which may arise from the correction of any error or errors that may have been committed by the Commissioner, and plus any additional amount which may arise from the failure of the Commissioner to take into consideration, in determining the amount of the1932 BTA LEXIS 1395">*1400 deficiency, any or all of the securities referred to in paragraph 7 hereof, or from the failure of the Commissioner to allocate the cost between securities sold in 1923 and the securities set forth in paragraph 7 hereof. Claim is hereby asserted for the increased deficiency, if any, resulting from such redetermination.
FINDINGS OF FACT.
The petitioners were, in 1923, members of the partnership of Hemphill, Noyes & Company, hereinafter referred to as the partnership.
On April 2, 1923, the partnership and the firm of Dillon, Read & Company jointly acquired, from Walter B. Lashar, 125,000 shares of the Class A stock and 20,000 shares of the common stock of the American Chain Company for a cash consideration of $2,250,000. Dillon, Read & Company acted as syndicate accountants, receiving and distributing the moneys. All of the Class A stock was sold to the public at $25.50 per share. The entire cost of both the Class A and common stock was allocated by the syndicate to the Class A stock. 25 B.T.A. 1351">*1355 Upon the syndicate's basis of computation, the partnership realized a profit of over $200,000 upon the sale of the Class A stock. Of the 20,000 shares of common stock (none of1932 BTA LEXIS 1395">*1401 which was sold), 9,000 shares were distributed by Dillon, Read & Company to the partnership. Petitioners, in 1923, received the following shares of the common stock:
| Petitioner | Shares received |
| Clifford Hemphill | 1,802 |
| Jansen Noyes | 2,622 |
| Charles E. Gardner | 1,802 |
| Harold C. Strong | 328 |
| Stanton Griffis | 1,639 |
| Walter S. Marvin | 345 |
| Elizabeth E. Cook | 176 |
Petitioners, in their income-tax returns for the calendar year 1923, did not report the receipt of the common stock of the American Chain Company as income. The Commissioner has included the stock received by each petitioner in his gross income at a valuation of $25 per share. The fair market value of the American Chain Company Class A stock was $25.50 per share and the fair market value of the common stock was $5 per share when acquired by Dillon, Read & Company and the partnership.
During 1923, the partnership paid $718,535.75 for the following securities of the Illinois Coal Company: $775,000 face value of first mortgage 7% bonds; 300 shares of preferred stock; and 1,500 shares of common stock. The partnership allocated the entire cost to the bonds in determining the profit on the sale of the bonds.
1932 BTA LEXIS 1395">*1402 During 1923 the partnership paid $667,500 for the following securities of the Phoenix Silk Manufacturing Company: $750,000 face value of first mortgage 7% bonds, and 4,500 shares of common stock. The partnership allocated the entire cost to the bonds in determining the profit on the sale of the bonds. In distributing the common stock among its partners, the partnership charged them $1 per share for the stock.
The partnership purchased preferred stock of the McCrory Stores Corporation, with warrants attached which authorized the purchase of common stock at $40 a share. A portion of the preferred stock was sold with warrants attached, and some shares were sold without warrants. Sales of shares with warrants were for $2 more per share than the sales of shares without warrants attached. The partnership retained 1,151 shares of the preferred stock and distributed some of the warrants among its partners. In connection with the above transactions (other than the American Chain Company transaction) in 1923, the petitioners received, through the partnership, securities as follows:
| Illinois Coal Co. stock | Phoenix Silk Mfg. Co. common stock | McCrory stores Corporation warrants to purchase preferred stock | ||
| Petitioner | Preferred | Common | ||
| Clifford Hemphill | 54 | 272 | 764 | 236 |
| Jansen Noyes | 79 | 396 | 1,111 | 342 |
| Charles E. Gardner | 54 | 272 | 764 | 236 |
| Harold C. Strong | 10 | 49 | 139 | 43 |
| Stanton Griffis | 50 | 248 | 694 | 214 |
| Walter S. Marvin | 11 | 53 | 46 | |
| Elizabeth E. Cook | 5 | 27 | 74 | 23 |
1932 BTA LEXIS 1395">*1403 25 B.T.A. 1351">*1356 OPINION.
SMITH: The deficiencies are based upon the respondent's determination that the petitioners received certain shares of the common stock of the American Chain Company as a bonus or compensation for services rendered by the partnership in underwriting the securities of the American Chain Company. By amended answers, the respondent makes affirmative allegations to the effect that petitioners received other securities in like manner. The evidence adduced does not support the respondent's position on this point, and we have found as a fact that all of these securities were purchased by the partnership. On brief, the respondent abandoned his original position and contends for a redetermination as set forth in his affirmative allegations, to wit, that the entire cost of the securities purchased be allocated between the several classes of securities purchased and that the profits realized by the partnership be redetermined accordingly. The petitioners would then be taxed upon their distributive share of such profits. Section 218(a) of the Revenue Act of 1921.
The respondent has the burden of proving facts necessary to maintain his affirmative allegations. 1932 BTA LEXIS 1395">*1404 Rule 30, Board's Rules of Practice. See . In these proceedings, it amounts to proving the proper basis for allocating the cost of the several classes of securities purchased by the partnership, some of which were sold to the public and some distributed to the petitioners. The petitioners argue that "to make an apportionment of cost among securities of different classes purchased for a lump sum, it is necessary to know the market value of the several classes of stock."
The matter of allocating the cost or other basis between the several classes of securities (bonds, preferred and common stock) and warrants for the purchase of stock is not one of simple mathematical computation. See . But the purchase price of the securities now under consideration may be "fairly apportioned" between the several classes in the "proportion 25 B.T.A. 1351">*1357 which the market value of the particular class bears to the market value of all securities" purchased. See articles 39 and 1567 of Regulations 62.
The evidence adduced related largely to the fair market value of the common stock of the1932 BTA LEXIS 1395">*1405 American Chain Company, which we have found was $5 per share. This finding is based upon the opinions of qualified experts that this stock had a speculative value of not to exceed $5 per share. Their reasoning is persuasive and their testimony was not weakened upon cross-examination. They were familiar with the market for such stock. These opinions are entitled to weight, and in the circumstances we believe that the prima facie correctness of the respondent's determination of value for this stock is overcome. Cf. ; . The Class A stock sold at $25.50 per share in 1923, and since there is nothing to indicate that these were not bona fide sales and since there is no contention that the fair market value of this stock was more or less, we have found that sum to be its fair market value. On brief, the petitioners concede that if the cost of the Class A and common stocks of the American Chain Company is to be allocated between these stocks, then the allocation should be in the proportion that the fair market value of each class bears to the total fair market value of1932 BTA LEXIS 1395">*1406 both classes. With this we agree, and so hold.
Applying the above principle to the purchase and sale of the 125,000 shares of Class A stock of the American Chain Company which, with 20,000 shares of the common stock, were purchased for $2,250,000, this cost being allocated to the Class A stock in determining in profit upon its sale, we find that the profit realized by the partnership has been understated. The fair market value of the Class A stock and the common stock is $25.50 and $5 per share, respectively. The cost to be allocated to the Class A stock is:
125,000 X 25.50/(125,000 X 25.50) + (20,000 X 5) of $2,250,000, or $2,181,558.93.
The profit realized by the partnership upon the sale of the Class A stock should be recomputed upon this cost basis and the petitioners' shares of such distributive profit taxed accordingly. The profits of the partnership were not affected by the distribution of the common stock to the petitioners and we need not further consider the common stock in our determination.
The evidence relating to the purchase of the other securities consists of the admissions by the petitioners that the securities set forth in our findings were acquired1932 BTA LEXIS 1395">*1407 by purchase and that they 25 B.T.A. 1351">*1358 received the securities indicated. The petitioners do not admit, and the respondent has not shown, that they received the stock of the American Furniture Mart Building Corporation as alleged by the respondent. The transactions respecting the McCrory Stores Corporation preferred stock and warrants for the purchase of common stock are unexplained and we have no evidence upon which to consider the issue as it relates to this stock and warrants. We have no evidence explaining the charge of $1 per share for the common stock of the Phoenix Silk Manufacturing Company when distributed by the partnership to the petitioners. The only evidence of the fair market value of the other securities in controversy is (1) respondent's Exhibit B, a prospectus regarding:
$3,500,000
ILLINOIS COAL CORPORATION
First Mortgage Sinking Fund Gold Bonds
Series A, 7%
in which the financial condition of that corporation is set forth; and (2) respondent's Exhibit C, a prospectus regarding:
$1,500,000
PHOENIX SILK MANUFACTURING COMPANY, INC.
First Mortgage Twenty-Year 7% Sinking
Fund Gold Bonds
in which the financial condition of that corporation is set1932 BTA LEXIS 1395">*1408 forth. Both prospectuses were issued in 1923, and, assuming that they correctly show the financial condition of those corporations at a certain time, we do not know the fair market value of the several classes when purchased, and can not make an allocation of the cost basis to each class.
Except for the American Chain Company stocks, the facts of record are not sufficient to enable us to make an allocation of the cost basis to the several securities involved in these proceedings. Cf. , reversed by the Court of Appeals, D.C., March 14, 1932; ; ;. The distributive profits of the partnership should be redetermined by recomputing the profit realized upon the sale of the Class A stock of the American Chain Company in accordance with this opinion, and the deficiencies redetermined accordingly.
Judgments will be entered under Rule 50.