*908 The petitioner acquired certain assets by the issue of its stock to three prior owners thereof in exact proportions to their interests therein. Held, that the basis for determining gain or loss on the subsequent sale of all its assets is cost to such prior owners, plus any capital addition after acquisition.
*628 The respondent has determined a deficiency in income tax for the year 1928 in the amount of $23,456.23, to which he has added $1,173.26 as a negligence penalty. The only issue pleaded by the petitioner is that in computing the profit from the sale of certain assets in the taxable year the respondent has erroneously reduced the cost thereof.
FINDINGS OF FACT.
The petitioner is a Delaware corporation, with its principal office in New Orleans, Louisiana. It was organized in April 1923, and at that time its stock was issued to J. E. Pottharst, George Jones, and R. N. Morgan, in the respective amounts of 300, 300, and 100 shares. Subsequent to organization Morgan acquired 200 additional shares from the corporation for $20,000 in*909 cash.
On March 22, 1923, Pottharst entered into a written contract with the town of Poplarville, Mississippi, in which the town agreed to lease its electric light and power plant and water plant, together with equipment, for a period of 20 years and to sell the same to the lessee if legislative authority could be obtained. In consideration for such lease Pottharst agreed to furnish the town with not more than 50 electric lights and with water service as required, and to supply the inhabitants of the town with power, light, and water at rates specified therein.
Pottharst was obligated under the contract as an individual, but his intention was to form a corporation and transfer his rights and obligations to it. Accordingly the petitioner was incorporated and the contract was assigned to it. As the organization of the petitioner and its operation would require working capital, Pottharst looked about for someone who would be willing to furnish the necessary cash in exchange for an interest in the project. He consulted with Jones, who agreed to secure the necessary capital from Morgan. On *629 April 7, 1923, he delivered the following letter to the petitioner, which was*910 organized on that day:
This will acknowledge that the contract of lease entered between myself and the Town of Poplarville, Miss. on March 22nd, 1923 for the lease of the said Town's Electric Light and Water Plant was entered into in my name alone for the purpose of convenience and that the said contract is in fact owned by the following named persons in the proportions set opposite their names:
| J. George Jones | 3/7ths |
| J. E. Pottharst | 3/7ths |
| R. N. Morgan | 1/7th |
The minutes of the first meeting of petitioner's board of directors, held April 7, 1923, contain the following:
The communication of Mr. J. E. Pottharst, dated April 7, 1923, addressed to this company wherein he acknowledges that the contract entered into by him with the Town of Poplarville, Miss. dated March 22nd, 1923, relative to the lease of the electric light and water plant of that Town, was executed in his name for the purpose of convenience only and in reality that the said contract was owned by the following persons in the proportions set opposite their names:
| J. George Jones | 3/7ths |
| J. E. Pottharst | 3/7ths |
| R. N. Morgan | 100 shares |
was received and read by the Secretary.
*911 It was thereupon moved by J. George Jones, seconded by J. E. Pottharst that the that the corporation purchase the contract from the respective owners for 700 shares of the capital stock of the corporation, the owners to be paid in stock of this corporation as follows:
| To J. George Jones | 300 shares |
| J. E. Pottharst | 300 shares |
| R. N. Morgan | 100 shares |
It was also moved by Mr. Jones and seconded by Mr. Pottharst that the physical assets of the corporation, together with said lease, franchise, and street lighting contract with the Town of Poplarville, Miss., be appraised at the following values, which are the true net values thereof, towit:
| Franchise and street lighting contract | $75,000 |
| Real estate | 5,500 |
| Buildings | 16,500 |
| Water well | 10,000 |
| Reservoir | 4,500 |
| Tank and tower | 6,500 |
| Water and distribution system | 42,000 |
| Electric distribution system | 26,000 |
| Power Equipment, engines, etc | 4,500 |
| Water works, pumps, etc | 2,500 |
| Meters and Duc, etc | 2,000 |
| 195,000 |
There being no objections the motion was duly carried and the Secretary ordered to prepare certificates of stock accordingly for delivery to the above persons, and to set forth in*912 the minutes the value of the assets as appraised.
*630 It was then moved by Mr. Pottharst and seconded by Mr. Jones that it be
RESOLVED, that while the corporation and the Board of Directors thereof, believed that the values set forth above as the appraised values of the above and foregoing assets was a conservative [sic] and represented the Board's opinion of the true value thereof, it was the sense of the Board that an even more conservative value be placed thereon and that the mass of said assets be and carried on the books of the corporation at an amount equal to the par value of the stock issued therefor.
On June 7, 1924, as authorized by an act of the Legislature of Mississippi, effective February 29, 1924, the town of Poplarville executed its warranty deed to Pottharst in conformity with the terms of the contract of March 22, 1923. On August 16, 1928, Pottharst executed a quitclaim deed conveying the assets involved in the contract to petitioner. On August 16, 1928, the petitioner sold all its physical properties to the Mississippi Power Co. for $275,000.
In its income tax return for 1928 the petitioner included $61,582.68 in its gross income as profits*913 from the sale of capital assets, computed by the deduction of cost in the amount of $263,526.29 from $275,000, and adding depreciation in the amount of $50,108.97. The cost claimed is made up of $200,000 alleged to be the value of the assets acquired under the contract of March 23, 1923, plus $63,776.29 representing additional capital investments between that date and the date of sale and attorney fees of $4,750 incurred in connection with incorporation. Upon audit of such return the respondent held that the assets in question were acquired by the incorporators without cost, reduced the basis for computing profit in the amount of $200,000, made other minor adjustment not in controversy, and determined the deficiency and penalty under review.
OPINION.
LANSDON: The basis for the deficiency determined by the respondent is that the profit realized by the petitioner in the sale of its capital assets must be computed under the provisions of section 112(b)(5) and section 113(a)(8) of the Revenue Act of 1928 1 which he asserts are applicable to the facts established in the record. The petitioner contends that such provisions do not apply and the computation of profit must be governed*914 by the exception in section 112(b)(5), and that if such exception applies it is entitled to a basis for *631 computing profit from the sale equal to the fair market value of the assets acquired.
*915 The exception relied on by petitioner is as follows:
* * * but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.
The property in question is the lease of March 22, 1923. Petitioner contends that at the date of its exchange for stock such contract was the sole property of Pottharst. To support this contention Jones, Pottharst, and Morgan all testified orally at the hearing that prior to Arpil 7, 1923, the contract was the sole property of Pottharst and that prior to that date neither Jones nor Morgan had any interest therein. If the record contained no other evidence such oral testimony would seem to establish the claim of the petitioner.
In rebuttal of the oral testimony of Jones, Pottharst, and Morgan, the respondent adduced in evidence the letter or April 7, 1923, which Pottharst wrote to petitioner and the minutes of the corporation of that date. In that letter Pottharst expressly states that "* * * the contract of lease * * * was entered into in my name alone for the purpose of convenince and*916 that the said contract is in fact owned by the following named persons in the proportions set opposite their names: J. George Jones, 3/7ths; J. E. Pottharst, 3/7ths; and R. N. Morgan, 1/7th." At the meeting of the directors of the petitioner on the same day, the statement of the letter was accepted and on that basis stock was issued to the three incorporators. In this direct conflict of evidence we must accept that which is the more reasonable and convincing. In our opinion the contemporary documents must be taken in preference to oral testimony of interested witnesses ten years after the event in question. The general rule is that the properly proved records of a corporation establish the facts set out therein. . The real facts seem to us to be that in order to secure working capital Pottharst, Jones, and Morgan entered into the deal prior to the organization of the petitioner, with interests therein as set out in *632 Pottharst's letter to the petitioner. We conclude, therefore, that upon incorporation the petitioner issued its stock to the three incorporators in exact proportion to their interests*917 in the contract and that the exception relied on by the petitioner is not applicable.
In the light of our conclusion above the value of the assets in question at the date they were acquired by the petitioner is not material, since the basis for determining gain or loss on the subsequent disposition thereof is cost to the prior owners, plus any capital addition thereafter. There was no cost to such prior owners and the capital additions subsequent to acquisition have been allowed by the respondent, whose determination must be affirmed. ; ; ; .
No evidence was offered in explanation of the negligence for which penalty is asserted and so the determination of the respondent in regard thereto must be affirmed.
Decision will be entered for the respondent.
Footnotes
1. SEC. 112. (b) Exchanges solely in kind. - * * *
* * *
(5) TRANSFER TO CORPORATION CONTROLLED BY TRANSFEROR. - No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.
SEC. 113. (a) Property acquired after February 28, 1913. - The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; except that -
* * *
(8) SAME - CORPORATION CONTROLLED BY TRANSFEROR. - If the property was acquired after December 31, 1920, by a corporation by the issuance of its stock or securities in connection with a transaction described in section 112(b)(5) (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money, in addition to such stock or securities), then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made; * * * ↩