1930 BTA LEXIS 2144">*2144 A certain transaction held to be taxable and the amount of profit resulting therefrom determined.
20 B.T.A. 334">*334 These proceedings which were consolidated are for the redetermination of deficiencies in income taxes for the calendar year 1925 in the amounts of $1,081.40, $1,081.40, $2,117.82, and $1,849.07, respectively.
The errors alleged in each petition are identical and result from the same transaction. The primary issue is whether the sale by J. C. Clemmons and Sol E. Gordon of one-half of the capital stock of the Jefferson Amusement Co. to the Saenger Amusement Co. gave rise to taxable income. If held to be taxable, a second issue is presented in the alternative, namely, the determination of the amount of the profit resulting therefrom.
FINDINGS OF FACT.
Petitioners are husbands and wives residing at Beaumont, Tex. For the calendar year 1925 each petitioner filed a separate incometax return on the community property basis, which basis was allowed by the respondent in his determination of the deficiencies.
On January 1, 1925, petitioners1930 BTA LEXIS 2144">*2145 J. C. Clemmons and Sol E. Gordon, hereafter referred to as Clemmons and Gordon, respectively, were equal owners of all the capital stock of the Jefferson Amusement Co., a Texas corporation engaged in operating motion-picture theatres in Beaumont. The outstanding capital stock of the Jefferson Amusement Co. consisted of 500 shares of common stock of the par value of $50,000. Prior to the taxable year under consideration, petitioners received notice through the daily press that the Saenger Amusement Co., the owner of an estensive chain of theatres throughout the South, was planning to invade Beaumont and erect in that city a de luxe theatre. It was Gordon's opinion that competition 20 B.T.A. 334">*335 from this source would prove disastrous to the Jefferson Amusement Co., and, accordingly, it occurred to him to approach the representatives of the Saenger Amusement Co. and ascertain if it were not possible for both companies to pool their resources and operate as equal joint owners of the proposed enterprise, and not operate independently as competitors. Acting on this idea, Gordon approached one Richards, a representative of the Saenger Amusement Co., and found him in a very receptive mood. 1930 BTA LEXIS 2144">*2146 Richards wanted Gordon to name a price for the assets of the Jefferson Amusement Co. at that first meeting, but Gordon said he was not prepared to fix a price without discussing it with Clemmons, whereupon a subsequent meeting was arranged for and held at Beaumont on February 17, 1925, at which meeting Clemmons and Gordon represented the Jefferson Amusement Co. and L. M. Ash and one Clarke represented the Saenger Amusement Co. At this meeting the principal thing discussed was the valuation to be placed upon the assets of the Jefferson Amusement Co. Clemmons and Gordon were trying to secure as high a valuation as possible, while Ash and Clarke were working to keep it as low as they could. After an all-day discussion both parties finally agreed upon a basis of $175,000, which agreement was reduced to writing under date of February 17, 1925. The written agreement recited that Gordon and Clemmons, as parties of the first part, were the owners of all the capital stock of the Jefferson Amusement Co., and that the Saenger Amusement Co., as party of the second part, acting through its treasurer, L.M. Ash, was desirous of acquiring 250 shares or an equal undivided one-half interest in1930 BTA LEXIS 2144">*2147 and to the stock of the Jefferson Amusement Co. The agreement then provided:
Now, THEREFORE, said parties of the first part, for and in consideration of the sum of Eighty seven thousand five hundred ($87,500.00) Dollars agreed to be paid to them by said Saenger Amusement Company, have transferred, assigned, endorsed and delivered, and by these presents, do transfer, assign, endorse and deliver unto the said Saenger Amusement Company, two hundred fifty (250) shares, or an equal undivided one-half of the capital stock of the Jefferson Amusement Company.
The agreement then provided that "the consideration for said stock has not yet been paid by said Saenger Amusement Co. to first parties, and the mode and manner of payment therefor shall be agreed upon subsequently between the parties, in New Orleans, Louisiana"; that "the transfer of the two hundred fifty (250) shares of the stock of the Jefferson Amusement Company, referred to in this contract, shall become effective as of date March 1, 1925, and the interest of the Saenger Amusement Company in the earnings of the Jefferson Amusement Company shall become effective as of date March 1, 1925"; and that the first parties should immediately1930 BTA LEXIS 2144">*2148 20 B.T.A. 334">*336 negotiate with the owners of the Liberty Theatre for a ten-year lease on the Liberty Theatre property.
On February 28, 1925, a three-party contract and agreement was made and entered into between the Saenger Amusement Co., the Jefferson Amusement Co., and Gordon and Clemmons, individually. The agreement recited that:
On the 17th day of February, 1925, Sol E. Gordon and J. C. Clemmons and the Saenger Amusement Company, Inc., made and entered into a certain contract of purchase and sale under the terms of which the said Gordon and Clemmons agreed to sell and deliver to the said Saenger Amusement Company, Inc., Two hundred and fifty (250) shares, being an equal one-half of the capital stock of the Jefferson Amusement Company, for an agreed consideration of Eighty seven thousand five hundred Dollars ($87,500.00).
In pursuance of said contract said Sol E. Gordon and J. C. Clemmons do now sell and convey and deliver unto said Saenger Amusement Company, Inc., said two hundred fifty (250) shares of the capital stock of the said Jefferson Amusement Company, represented by * * * receipt of which is hereby acknowledged by said Saenger Amusement Company, Inc.
The agreement1930 BTA LEXIS 2144">*2149 continued with certain warranties made by Gordon and Clemmons with respect to the stock in question and that the Jefferson Amusement Co. was a valid and legal corporation in every respect. In paragraph 2, the Saenger Amusement Co. agreed that the stated consideration of $87,500 was to be paid to Gordon and Clemmons, as follows:
The sum of Ten Thousand Dollars ($10,000.00) cash in hand paid to Sol E. Gordon and J. C. Clemmons, receipt of which is hereby acknowledged and confessed, and the balance evidenced by eight (8) certain promissory notes in writing, executed by the Saenger Amusement Company, Inc., and payable to Sol E. Gordon and J. C. Clemmons. Notes numbered One to Seven, inclusive, being for the principal sum of Ten Thousand Dollars ($10,000.00) each, and Note Number Eight being for the principal sum of Seven thousand five hundred Dollars ($7,500.00); each of said notes bear even date herewith, Note Number One is due and payable on or before ninety (90) days after its date, and each successive note is due on or before each successive ninety (90) days thereafter until each of said promissory notes, principal and interest, are fully paid off and discharged.
The notes bore1930 BTA LEXIS 2144">*2150 interest at 7 per cent and contained the usual provisions regarding the payment of attorney's fees in case of default. Paragraph 3 of the agreement provided that:
It is further understood and agreed that no amusement enterprise of any kind or character will be conducted, maintained, established, or operated in the city of Beaumont, Texas by the Saenger Amusement Company, Inc., or the Jefferson Amusement Company, directly or indirectly, or by any of their respective officers, agents or representatives, except on an equal basis, that is, an undivided one-half in the Saenger Amusement Company, Inc., or its designee, and the other undivided one-half to Sol E. Gordon and J. C. Clemmons, jointly, and the said Sol E. Gordon and J. C. Clemmons, in furtherance of such understanding, personally and individually agree, contract, bind and obligate themselves 20 B.T.A. 334">*337 not to engage in or be connected with, directly or indirectly, any amusement enterprises in the city of Beaumont, Texas, unless the Saenger Amusement Company, Inc., or someone by them designated, shall participate therein on an equal basis.
Paragraph 5 recited that the parties to the agreement were contemplating the construction1930 BTA LEXIS 2144">*2151 of a theatre in the city of Beaumont, the cost of the land and building not to exceed the sum of $400,000 without the unanimous consent of all parties thereto; that "for the purpose of financing said cost of $400,000 the said Saenger Amusement Company, Inc., hereby binds and obligates itself to furnish as required up to the sum of one hundred thousand dollars ($100,000.00) cash, and the said Sol E. Gordon and J. C. Clemmons hereby bind and obligate themselves to furnish up to the sum of One hundred thousand dollars ($100,000.00) cash"; and that "the balance of the cost of said enterprise shall be furnished by the said Jefferson Amusement Company." The last paragraph of the agreement entered into on February 28, 1925, is as follows:
The vendors, Sol E. Gordon and J. C. Clemmons, hereby warrant that such liabilities that may be due and owing by the Jefferson Amusement Company as of date March 1, 1925, will be paid off and discharged by the said Sol E. Gordon and J. C. Clemmons.
Contemporaneous with the written agreement of February 28, 1925, Gordon and Clemmons had an oral understanding with the Saenger Amusement Co., that as the payments were made by the latter on the notes given1930 BTA LEXIS 2144">*2152 in part payment for one-half of the Jefferson Amusement Co. stock, such payments would be held in a special account by Gordon and Clemmons to be used by them in making their payments to the Jefferson Amusement Co. provided for in the fifth paragraph of the February 28, 1925, agreement.
On January 9, 1926, paragraph 5 of the February 28, 1925, agreement was modified to the extent that the cost of the land and building could not exceed $500,000 without the unanimous consent of all parties and each party was to be obligated to the extent of $120,000 instead of $100,000 as previously agreed upon, except that the Jefferson Amusement Co. was to furnish the balance of $260,000.
The notes referred to above were paid promptly at maturity, with $30,000 principal being paid in the year 1925.
Gordon did his individual banking at the First National Bank, while Clemmons and the Jefferson Amusement Co. dealt with the City National Bank. Up until February 27, 1926, the payments made to Gordon and Clemmons by the Saenger Amusement Co. were deposited in the old accounts of Gordon and Clemmons. On February 27, 1926, a special account was opened at the Texas National Bank and all subsequent1930 BTA LEXIS 2144">*2153 payments were deposited in that account.
20 B.T.A. 334">*338 The first money received by Gordon and Clemmons from the Saenger Amusement Co. was used to pay off the liabilities of the Jefferson Amusement Co. existing as of March 1, 1925, in the amount of $11,846.97, and expenses of the Jefferson Amusement Co. prior to March 1, 1925, in the amount of $499.82. These two payments were made in accordance with the last paragraph of the February 28, 1925, agreement set forth above. As additional payments were made to Gordon and Clemmons by the Saenger Amusement Co. on the notes totaling $77,500, part of the money was paid in to the Jefferson Amusement Co. as it was needed to build the new theatre and part was invested by Gordon and Clemmons in stock of the Home Building & Loan Co. Although Gordon and Clemmons had obligated themselves jointly to contribute $120,000 towards the new theatre, it was only necessary for them to pay in the amount of $40,540.39. A like amount was paid in to the Jefferson Amusement Co. by the Saenger Amusement Co. A recapitulation of all the receipts and disbursements received and made by Gordon and Clemmons in connection with their agreements heretofore referred1930 BTA LEXIS 2144">*2154 to with the Saenger Amusement Co. from March 8, 1925, to November 3, 1928, inclusive, is as follows:
| 1925 | 1926 | 1927 | |
| RECEIPTS | |||
| Borrowed from bank | $11,075.00 | ||
| Income from Jefferson Amuse. | |||
| Co. to Mar. 1, 1925 | 1,786.02 | ||
| Initial cash payment from | |||
| Saenger Amuse. Co. (Inc.) | 10,000.00 | ||
| Payments on notes by Saenger | |||
| Amuse. Co. (Inc.) | 30,000.00 | $40,000.00 | $7,500.00 |
| Interest on notes | 1,050.00 | 3,850.00 | 1,050.00 |
| Sam Pertitta repaid loan | 3,570.00 | ||
| Div. Home Bldg. & Loan Co | 466.66 | 2,233.40 | 4,377.59 |
| Pro. from sale of stock in | |||
| Home Bldg. & Loan Co | 10,056.67 | 20,172.24 | |
| Total | 54,377.68 | 49,653.40 | 22,984.26 |
| DISBURSEMENTS | |||
| Liabilities J.A. Co. to Mar. | |||
| 1, 1925 | 11,846.97 | ||
| Expenses J.A. Co. to Mar. 1, | |||
| 1925 | 499.82 | ||
| Repaid loan from bank | 11,075.00 | ||
| Paid J.A. Co. for theatre | 7,547.25 | 7,993.14 | 12,500.00 |
| Investments Home Bldg. & Loan | |||
| Co | 20,100.00 | 39,366.67 | 10,500.00 |
| Withdrawals by Gordon & | |||
| Clemmons | 1,516.66 | ||
| Loaned to Sam Pertitta | 3,500.00 | ||
| Loaned to Clemmons | 300.00 | ||
| Copy of papers from U.S. | |||
| court | |||
| Total | 52,585.70 | 51,159.81 | 23,000.00 |
| 1928 | Total | |
| RECEIPTS | ||
| Borrowed from bank | $11,075.00 | |
| Income from Jefferson Amuse. | ||
| Co. to Mar. 1, 1925 | 1,786.02 | |
| Initial cash payment from | ||
| Saenger Amuse. Co. (Inc.) | 10,000.00 | |
| Payments on notes by Saenger | ||
| Amuse. Co. (Inc.) | 77,500.00 | |
| Interest on notes | 5,950.00 | |
| Sam Pertitta repaid loan | 3,570.00 | |
| Div. Home Bldg. & Loan Co | $1,010.67 | 8,088.32 |
| Pro. from sale of stock in | ||
| Home Bldg. & Loan Co | 30,223.91 | |
| Total | 21,182.91 | 148.198.25 |
| DISBURSEMENTS | ||
| Liabilities J.A. Co. to Mar. | ||
| 1, 1925 | 11,846.97 | |
| Expenses J.A. Co. to Mar. 1, | ||
| 1925 | 499.82 | |
| Repaid loan from bank | 11,075.00 | |
| Paid J.A. Co. for theatre | 12,500.00 | 40,540.39 |
| Investments Home Bldg. & Loan | ||
| Co | 69,966.67 | |
| Withdrawals by Gordon & | ||
| Clemmons | 8,948.04 | 10,464.70 |
| Loaned to Sam Pertitta | 3,500.00 | |
| Loaned to Clemmons | 300.00 | |
| Copy of papers from U.S. | ||
| court | 4.70 | 4.70 |
| Total | 21,452.74 | 148,198.25 |
The new theatre was opened on November 14, 1927.
On July 19, 1926, the charter of the Jefferson Amusement Co. was amended to increase the capital stock to $750,000, represented by 7,500 shares. Of this new issue 3,750 shares1930 BTA LEXIS 2144">*2156 were issued to Gordon and Clemmons and 3,750 shares were issued to the Saenger Amusement Co.
20 B.T.A. 334">*339 The respondent determined that the acquisition in 1925 of one-half of the capital stock of the Jefferson Amusement Co. by the Saenger Amusement Co. was a sale of such stock by Gordon and Clemmons on which a taxable gain was realized in the amount of $76,255.86, computed as follows:
| Selling price (250 shares) | $87,500.00 | |
| Income from Jefferson Amusement Co. to | ||
| March 1, 1925, collected by Gordon and | ||
| Clemmons | 1,786.02 | |
| Total | 89,286.02 | |
| Deduct: | ||
| Cost of 500 shares in 1923 | $13,713.54 | |
| Liabilities of Jefferson Amusement Co. | ||
| to 3/1/25 paid by Gordon and Clemmons | 11,846.97 | |
| Expenses of Jefferson Amusement Co. to | ||
| 3/1/25 paid by Gordon and Clemmons | 499.82 | |
| Total cost of 500 shares | 26,060.33 | |
| Cost of 250 shares (1/2 of $26,060.33) | 13,030.16 | |
| Taxable profit as determined by | ||
| respondent | 76,255.86 |
The respondent further determined that on the community property basis each petitioner was taxable on one-fourth of the total profit of $76,255.86, or $19,063.97.
OPINION.
LOVE: Petitioners contend that the disposition by them in 1925 of one-half1930 BTA LEXIS 2144">*2157 of the capital stock of the Jefferson Amusement Co., as set out in our findings, was not a taxable transaction for the reason that, under the oral agreement they had with the Saenger Amusement Co. they did not have the unrestricted use of the consideration received for such stock, since they were obligated to keep such funds in a separate account and pay into the Jefferson Amusement Co. such sums as might be required as the building program progressed. As an alternative they contend that the full amount of the liabilities ($11,846.97) and expenses ($499.82) of the Jefferson Amusement Co. which petitioners paid in accordance with the last paragraph of the written agreement executed February 28, 1925, should be deducted from the total consideration received, instead of only one-half thereof as was done by the respondent.
We are of the opinion that respondent's determination should be sustained on both points. Section 213 of the Revenue Act of 1926 provides in part that the term "gross income" includes "gains, profits, and income derived from * * * sales, or dealings in property, whether real or personal, growing out of the ownership or use or interest in such property * * * or gains1930 BTA LEXIS 2144">*2158 or profits and income derived from any source whatever * * *." The agreements which we 20 B.T.A. 334">*340 have set out in our findings clearly indicate that Gordon and Clemmons sold one-half of their stock in the Jefferson Amusement Co. for a certain stated consideration which was greater than the cost of the stock sold. The stock was originally acquired by petitioners in 1923. The excess of the consideration received over the cost is gain and should be included in gross income under the statute. The oral agreement relied upon by petitioners did not place such restrictions upon the use of the quid pro quo received as would prevent such consideration from becoming the absolute property of petitioners. As shown under the heading of "Disbursements" in our findings, by far the greater portion ($69,966.67) of the payments received from the Saenger Amusement Co. were invested by Gordon and Clemmons in stock of the Home Building & Loan Co. They loaned Sam Pertitta $3,500, Clemmons $300, and withdrew $10,464.70 for their own personal use. The fact that petitioners simultaneously agreed to invest additional funds in the Jefferson Amusement Co. is not material from the standpoint of determining1930 BTA LEXIS 2144">*2159 whether petitioners made a profit or sustained a loss from the previous sale. Such investments constitute new transactions and form the basis for a subsequent determination of either gain or loss upon the subsequent sale or disposition of the new property acquired.
Petitioners point out in their brief that, instead of Gordon and Clemmons selling half of their stock to the Saenger Amusement Co., it would have been possible for the Jefferson Amusement Co. to have had its authorized capital stock increased to $100,000 par value and to have issued the additional $50,000 par value to the Saenger Amusement Co. for assets equal in value to those then owned by the Jefferson Amusement Co. They argue that had the transaction taken this form, no taxable income could have resulted to them. Petitioners further argue that in substance the result is the same as if the transaction had taken that form, and "that in applying the provisions of the Sixteenth Amendment and the Income Tax Laws enacted thereunder, the courts, both in justice to the Government, as well as in justice to the taxpayer, will disregard matters of form for the purpose of giving effect to matters of substance," citing 1930 BTA LEXIS 2144">*2160 Lynch v. Turrish,247 U.S. 221">247 U.S. 221; Southern Pacific Co. v. Lowe,247 U.S. 330">247 U.S. 330; Gulf Oil Corporation v. Lewellyn,248 U.S. 71">248 U.S. 71; United States v. Phellis,257 U.S. 156">257 U.S. 156; and Weiss v. Stearn,265 U.S. 242">265 U.S. 242. We do not think the principle contended for by petitioners is applicable to the facts in the instant case. The substance of the transaction before us was a sale of stock by petitioners to the Saenger Amusement Co., which coincides with the form the parties employed. In Anna M. Harkness,1 B.T.A. 127">1 B.T.A. 127, we said:
It seems to us to be fundamentally unsound to determine income tax liability by what might have taken place rather than by what actually occurred. Even 20 B.T.A. 334">*341 though the practical effect may be the same in either case, the resulting tax liability may be quite different. United States v. Isham,17 Wall. 496.
To the same effect see R. V. Board,14 B.T.A. 374">14 B.T.A. 374, 14 B.T.A. 374">390; 1930 BTA LEXIS 2144">*2161 William H. Mullins,14 B.T.A. 426">14 B.T.A. 426, 14 B.T.A. 426">433; Hans Pederson,14 B.T.A. 1089">14 B.T.A. 1089. 1115; and Margaret B. Sparrow et al.,18 B.T.A. 1">18 B.T.A. 1, 18 B.T.A. 1">13. Petitioners' contentions on this point are denied.
In connection with petitioners' alternative, they contend that if a profit is to be determined upon the disposition by them of one-half the stock of the Jefferson Amusement Co., such profit should be the amount of $70,082.46, instead of $76,255.86, as determined by the respondent. We have included in our findings the details showing how the respondent arrived at the amount of $76,255.86. Petitioners arrive at the amount contended for by them as follows:
| Selling price (same as respondent) | $87,500.00 | |
| Income Jefferson Amusement Co. (same | ||
| as respondent) | 1,786.02 | |
| Total (same as respondent) | 89,286.02 | |
| Deduct: | ||
| One-half cost of 500 shares in 1923 | ||
| (same as respondent) | $6,856.77 | |
| Liabilities of Jefferson Amusement Co. | ||
| to Mar. 1, 1925, paid by Gordon & | ||
| Clemmons | 11,846.97 | |
| Expenses of Jefferson Amusement Co. to | ||
| Mar. 1, 1925, paid by Gordon & | ||
| Clemmons | 499.82 | |
| 19,203.56 | ||
| Profit as contended for by petitioners | 70,082.46 |
1930 BTA LEXIS 2144">*2162 The difference between the two computations is $6,173.40, or one-half the amount of the liabilities and expenses of the Jefferson Amusement Co. to March 1, 1925, which were paid by Gordon and Clemmons in fulfillment of the last paragraph of the written agreement dated February 28, 1925. Respondent contends that the amounts paid thereunder are part of the cost of the full 500 shares of the Jefferson Amusement Co. Petitioners contend that the amounts so paid are part of the cost of only the 250 shares sold. We agree with the respondent. The price of $87,500 was arrived at on the condition that petitioners would pay the liabilities and expenses of the business up to March 1, 1925, so that the net assets of the business on that date would have a value of $175,000. If the amounts totaling $12,346.79 had not been paid by petitioners, the net assets would have been reduced to the amount of $162,653.21. Since the Saenger Amusement Co. based their purchase price upon one-half the value of the net assets, it is clear that if the liabilities and expenses in question had not been paid the Saenger Co. would have only paid $81,326.60 for the 250 shares of Jefferson Amusement Co. stock. The1930 BTA LEXIS 2144">*2163 result of petitioners' agreement is therefore that by investing $12,346.79 more in the Jefferson Amusement Co. they 20 B.T.A. 334">*342 were only able to obtain $6,173.40 more for the 250 shares sold than if they had not made the investment. The conclusion which follows is that $6,173.39 of the $12,346.79 invested represents a part of the cost of the 250 shares retained.
Judgment will be entered for the respondent.