*67 Decisions will be entered under Rule 50.
1. Petitioner corporation acquired assets from a partnership pursuant to an installment sales contract under the terms of which the consideration was to be paid in 10 equal annual installments. Title to the assets was reserved in the partners until the full purchase price was paid. Held, the sales contract was not stock or securities within the meaning of
2. Held, further, the basis to the transferee corporation of the assets acquired by it is the cost of the assets.
3. Useful lives and salvage values of certain items of equipment used in logging and sawmilling business determined.
*27 The respondent has determined deficiencies in petitioners' income tax for the years and in the amounts as follows:
| Name | Docket No. | Year | Deficiency |
| Warren H. Brown | 50179 | 1947 | $ 2,024.20 |
| Jayne J. Brown | 50183 | 1947 | 2,024.20 |
| Warren H. Brown and Jayne J. Brown | 50179 | 1948 | 4,419.82 |
| 50183 | 1949 | 10,811.69 | |
| Carl E. Brown | 50180 | 1947 | 1,980.66 |
| 1948 | 1,873.67 | ||
| Ida H. Brown | 50182 | 1947 | 1,980.66 |
| 1948 | 1,910.17 | ||
| Carl E. Brown and Ida H. Brown | 50180 | 1949 | 10,653.14 |
| 50182 | |||
| Brown's Tie & Lumber Co | 50181 | 1947 | 26,805.56 |
| 1948 | 25,049.84 | ||
| 1949 | 30,095.41 |
In addition to the foregoing, respondent in amended answers has claimed increased deficiencies against petitioners for 1947 and 1948 as follows:
| Name | Year | Increase in |
| deficiency | ||
| Warren H. Brown | 1947 | $ 3,732.91 |
| 1948 | 7,494.92 | |
| Carl E. Brown | 1947 | 3,674.96 |
| 1948 | 3,455.78 | |
| Ida H. Brown | 1947 | 3,672.95 |
| 1948 | 3,494.92 | |
| Jayne J. Brown | 1947 | 3,732.91 |
| 1948 | 7,494.92 | |
| Brown's Tie & Lumber Co | 1947 | 9,198.10 |
| 1948 | 8,278.30 |
*69 *28 The issues presented for our determination are the correctness of the respondent's action (1) in determining that the assets acquired by petitioner Brown's Tie & Lumber Company retained the same basis as they had in the hands of the partners prior to the transfer; (2) in determining that the installment agreement executed by Brown's Tie & Lumber Company on January 2, 1947, was without substance and in the nature of stock or securities within the meaning of
FINDINGS OF FACT.
Some of the facts have been stipulated and are found accordingly.
Petitioners filed their income tax returns for 1947, 1948, and 1949 with the then collector of internal revenue for the district of Idaho. In addition, a partnership information return was filed on behalf of Brown's Tie & Lumber Company, a partnership, for each of the foregoing years.
Brown's Tie & Lumber Company, a copartnership, hereinafter referred to as the partnership, was formed on January 1, 1938, to*70 engage in the business of logging, milling, and marketing of lumber and other wood products. The partners were Carl E. Brown and Ida H. Brown who owned a one-half interest in the partnership as their community property, Warren H. Brown and Jayne J. Brown who owned a one-eighth interest as their community property, and Dorothy C. Brown, Margaret J. Brown, and Elizabeth Brown Harwood, the children of Carl and Ida Brown, each of whom also owned a one-eighth interest. On December 31, 1945, Warren acquired the one-eighth interest of each of the other children and thereby became the owner of a one-half interest. Carl was designated manager and Warren assistant manager of the partnership.
During 1946 there developed a serious disagreement between Carl and his son, Warren, as to the management of their business. The basis for the disagreement between the two was insistence by Warren upon the extensive expansion of their business, while Carl, fearful that adverse economic variations in business generally might and probably would endanger the continued existence of the business, especially since it was conducted largely upon the basis of borrowed funds, was consistently insistent that no*71 expansion program be adopted. As a result of the friction, they attempted to sell their lumber business and conducted negotiations with two prospective purchasers during the latter part of 1946. In connection with the foregoing negotiations, Warren and Patrick J. Hayes, the office manager *29 of the partnership, appraised the assets of the business and prepared an itemized list showing the market value of each asset.
During 1946 the partnership frequently borrowed from the First Security Bank of Idaho amounts ranging from $ 50,000 to $ 160,000. Such loans for the most part were unsecured, short-term obligations maturing in not more than 90 days. J. L. Driscoll, president of the First Security Bank of Idaho, had advised and assisted Carl and Warren in business matters for many years. In the fall of 1946, Driscoll urged the Browns to incorporate their partnership business. Driscoll was particularly concerned with possible difficulty in the collecting of loans of the bank in the event of the death of either of the partners or their wives since the partnership interests would then become involved in probate and inheritance tax proceedings.
Driscoll recommended to the partners*72 that they consult J. L. Eberle, an attorney practicing in Boise, Idaho, with respect to the incorporation of their partnership business. The Browns authorized Driscoll to contact Eberle and to authorize him on their behalf to incorporate their business. The articles of incorporation subsequently were prepared and executed and were filed at Boise, Idaho, on December 30, 1946.
Brown's Tie & Lumber Company, hereinafter referred to as the corporation, is a corporation organized under the laws of Idaho with its principal place of business at McCall, Idaho. The authorized capital of the corporation is $ 500,000, divided into 5,000 shares of common stock of $ 100 par value per share. The two principal stockholders, officers, and directors of the corporation at the time of its formation and at all times here material were Carl, president, and Warren, secretary.
The first meeting of the shareholders and officers of the corporation was held on December 31, 1946, and at that time the proposed transfer of the partnership assets was considered. Carl then refused to consent to the conveyance of the logging and milling equipment to the corporation for additional stock because he feared that*73 he would by so doing jeopardize his investment by subjecting all of the assets of the partnership to the risk of an expansion program to which he was bitterly opposed.
Upon the refusal of Carl on December 31, 1946, to consent to the transfer of all of the partnership assets to the corporation, the petitioners, Carl and Warren, on behalf of the partnership, transferred current assets, including cash, accounts receivable, and inventory, and certain land and timber of the partnership, to the corporation. The assets which were transferred were sufficient to enable the corporation to conduct a lumber sales and marketing business had the directors desired to lease or contract the logging and milling operations, as was the general practice among timber operators in Idaho at that time.
*30 The total book value of the foregoing assets on the date of transfer was $ 358,448.96. The fair market value of the assets transferred on December 31, 1946, was $ 451,228.44, the difference of $ 92,779.48 representing appreciation in the value of the timber. The corporation assumed all of the partnership liabilities as of December 31, 1946, totaling $ 181,067.75, set up an open account payable to*74 the partnership for $ 181.21, and issued to the partners jointly a stock certificate for 1,772 shares of its common stock having a par value of $ 177,200. Thus, valuing the timber and other assets at their fair market value, the corporation issued stock for assets having a net worth of approximately $ 270,000. The stock received by the partners in exchange for the assets conveyed to the corporation on December 31, 1946, was in proportion to their interests in the property prior to the exchange.
Immediately following the first meeting of the shareholders of the corporation, Carl consulted J. L. Eberle regarding possible methods of arranging for the use of the remaining assets. Carl was advised that the partnership might contract with another party to handle the logging and milling operations and let the corporation market the lumber, or lease the logging and milling equipment to another logger and sawmill operator to cut and process the timber on behalf of the corporation. He was advised, as a third alternative, that the partners might sell the logging and milling equipment on a retaining contract, reserving title to themselves until the purchase price was paid.
On January 2, 1947, *75 Carl informed J. L. Eberle that he would be willing to arrange for the transfer of the remaining partnership assets to the corporation on an installment sales contract. Thereupon, on behalf of the corporation, an installment agreement was executed bearing the date of January 2, 1947, and providing for the sale of the remaining assets of the partnership to the corporation for $ 605,138.75, payable in 10 equal annual installments, with interest at the rate of 4 per cent per annum. Payments were to be made to the partners without regard to the earnings of the corporation. No agreement was made by the partners not to enforce collection of the foregoing payments and interest. Title to the property transferred thereunder was reserved in the partners as seller. The corporation was given the right to anticipate the payments and to discharge its outstanding obligation at any time. Further, the corporation was required to keep the transferred assets insured for the benefit of both the buyer and seller as their interest might appear.
On January 2, 1947, under the installment contract the partnership transferred to the corporation its remaining assets, including the millsite, sawmill and*76 equipment for the logging and milling of timber, trucks, automobiles, and other assets formerly used by the partnership. The book value to the partnership of the assets so transferred was $ 270,480.73. The adjusted basis of the foregoing assets was *31 $ 279,602.60. The difference, in the amount of $ 9,121.87, between the book value of the foregoing assets to the partnership and their adjusted basis represents an adjustment by the respondent for depreciation taken for prior years. The fair market value of these assets on January 2, 1947, was $ 605,138.75. The valuation figures assigned to the assets sold to the corporation were the same figures as determined in the appraisal made by Warren H. Brown and Patrick J. Hayes in the summer of 1946 when the partners were contemplating a sale of their partnership business to another lumber company.
All of the installment payments with interest provided in the installment agreement executed January 2, 1947, which became due during the years in issue have been paid.
The sale of the assets by the partnership to the corporation which was contracted on January 2, 1947, has been consistently treated as a sale by the parties thereto, and*77 the proceeds received under the installment sales contract executed on that date have been reported by the partners on their income tax returns as long-term capital gains.
After the incorporation of the partnership business, the First Security Bank of Idaho extended additional credit to the corporation by raising its borrowing limits to approximately $ 300,000. This extension of bank credit enabled the corporation to purchase additional equipment and timberland which it had previously been unable to obtain. Accordingly, the business activities of the corporation subsequently were expanded. More than $ 600,000 was invested by the corporation in equipment during the period 1947 through 1949. During those years the corporation realized an average net profit of approximately $ 170,000 annually.
The useful life of the logging equipment, including trucks, tractors, and automobiles used by the corporation in its logging and sawmill operations, was 4 years. The life of a 45-ton equipment trailer used in the operations was 3 1/3 years. The useful life of mixers, teletalk devices, electric hammers, and boilers was 5 years. The life of bus bodies, lumber carriers, and sundry equipment*78 was 4 years. The useful life of office equipment was 7 1/2 years and of camp equipment was 5 years. The sawmill and sawmilling equipment and the automotive and logging equipment used by the corporation in its logging operations had no salvage value because of their distance from market at the time of the expiration of their useful life.
OPINION.
Petitioners contend that the execution of the installment contract on January 2, 1947, constituted a sales transaction, separate and distinct from the exchange of December 31, 1946, and created a valid debtor-creditor relationship between the partners and *32 the corporation. Petitioners therefore maintain that the gain realized on the transaction should be recognized, and that the corporation is entitled to utilize the fair market value of the assets at the time of the transfer as its basis for depreciation pursuant to
*79 The respondent has taken the position that the exchange of assets for stock which took place on December 31, 1946, and the execution of the installment sales contract on January 2, 1947, together with the transfer of assets pursuant thereto, should be regarded as steps in a single transaction; that the installment contract between the partners and the newly formed corporation was without substance and, in fact, represented equity capital; and that the entire transaction in substance was an exchange of property for stock or stock and securities of a corporation controlled by the transferors. Consequently, the respondent contends that no gain is recognized in the transaction pursuant to the provisions of
In support of his position, respondent relies on our decisions in
In
In the instant case, however, the petitioners invested assets worth $ 270,000 in capital stock, whereas the installment sales contract created a corporate obligation in the amount of $ 605,138.75. Thus, the corporation was adequately capitalized, there being a debt-stock ratio of approximately 2 to 1. The obvious business reason for the execution of the installment sales contract here in question, and the transfer of the rights to the use and possession of a portion of the partnership assets to the corporation pursuant thereto, reserving title in the transferors, was the categorical refusal of Carl Brown to accept the risks attendant upon a further capital investment in the new corporation.
Under Idaho law, the reservation in the transferors of title to personal property sold under an installment sales contract gives the transferor a right to possession and ownership superior to the rights of all other creditors of the transferee.
The Gooding Amusement Co. case, supra, is similarly distinguishable. There, as in
Respondent insists that the corporation here, as in the two foregoing decisions, could not have operated without all of the partnership assets. The record discloses, however, that Carl E. Brown was advised of the possibility of contracting the partnership logging and milling operations, as was the practice among timber operators in central Idaho at that time, and operating the newly formed corporation as a sales and marketing outlet. The assets transferred to the corporation on December 31, 1946, in exchange for stock were sufficient to enable the corporation to conduct a sales and marketing business. The partnership assets which the partners at that time refused to *85 convey to the corporation in exchange for stock were the logging and milling equipment. Thus, by separating the harvesting and processing operations from the marketing activities, the corporation could have continued to operate as a sales outlet without acquiring the assets purchased by it on January 2, 1947.
For the foregoing reasons, we are of the opinion that neither
Respondent contends that the installment payments and interest received by the partners and treated by them as the proceeds of a sale actually constitute distributions in the nature of dividends. In support of his argument on this point, respondent calls to our attention the fact that no formal dividends had been declared by the corporation although the corporation had earnings and profits during the years in issue. Accordingly, respondent suggests that, inasmuch as each partner received more than $ 16,000 in payments and interest *35 from the corporation during each of the years in question, no formal dividend declaration was necessary. *86 The record discloses, however, that the corporation invested substantial amounts in additional equipment and timberland, thereby expanding its activities during the years in question, leaving little or no cash available for the payment of dividends.
The courts have recognized that the consecutive steps involved in the incorporation of a business, occurring in immediate sequence, may nevertheless be entirely different in nature and therefore separate and distinct legal transactions, although closely related in time and purpose.
The facts apparent from the record before us would seem to require a similar conclusion here. In view of the apparent intention of the parties, the form of contract here in question, the reservation of title in the transferors until the full purchase price is paid, the obvious business considerations motivating the partners to cast the transaction in the adopted form, the*88 substantial investment by the transferors in stock of the corporation, the superior position of the transferors' claims to the claims of the other corporate creditors, the fact that the contract price was equal to the stipulated fair market value of the assets transferred thereunder, the contract provision calling for fixed payments to the partners without regard to corporate earnings, the provision requiring the payment of interest to the transferors at a reasonable rate, *36 the absence of an agreement not to enforce collection, and the subsequent payment of all installments which became due under the contract during the years in issue, we are persuaded that the transaction which was consummated on January 2, 1947, was a bona fide sale as petitioners contend.
Respondent contends in the alternative that the installment sales contract represents a security under
In view of the foregoing, we hold that the execution of the installment sales contract on January 2, 1947, was a transaction separate and distinct from the exchange which was consummated on December 31, 1946, and created a valid debtor-creditor relationship between the transferors and the corporation. Consequently, under
Our findings of fact as to the useful lives of various items of equipment used by the corporation during the years in issue and our findings with respect to salvage value as to a portion of such equipment dispose of all matters involved in the issue relating to depreciation.
Decisions will be entered under Rule 50.
Footnotes
1. Proceedings of the following petitioners are consolidated herewith: Carl E. Brown, Docket No. 50180; Brown's Tie & Lumber Company, Docket No. 50181; Ida H. Brown, Docket No. 50182; and Jayne J. Brown, Docket No. 50183.↩
2.
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; * * *↩
3.
SEC. 112 . RECOGNITION OF GAIN OR LOSS.(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. Where the transferee assumes a liability of a transferor, or where the property of a transferor is transferred subject to a liability, then for the purpose only of determining whether the amount of stock or securities received by each of the transferors is in the proportion required by this paragraph, the amount of such liability (if under subsection (k) it is not to be considered as "other property or money") shall be considered as stock or securities received by such transferor.↩
4.
SEC. 113 (a) . Basis (Unadjusted) of Property. -- The basis of property shall be the cost of such property; except that --* * * *
(8) Property acquired by issuance of stock or as paid-in surplus. -- If the property was acquired after December 31, 1920, by a corporation --
(A) 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), or(B) as paid-in surplus or as a contribution to capital, 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.↩