*2984 1. Certain promissory notes held to have been bona fide paid in to the petitioner for shares of its capital stock and to have been of the actual cash value of $350,000, which amount should be included in invested capital for 1920 and 1921.
2. Rate of depreciation of the petitioner's factory, determined.
*1156 This proceeding is for the redetermination of deficiencies in income and profits taxes asserted by the respondent in the amounts of $11,297.38 for the period beginning June 1 and ending December 31, 1920, and $16,916.95 for the year 1921. The deficiencies arise from the reduction by the respondent of the petitioner's invested capital, and the disallowance of a loss claimed by the petitioner to have been sustained on the sale of certain of its assets.
FINDINGS OF FACT.
For a number of years prior to 1920, the Citrus Soap Co., a corporation, hereinafter called the Old Corporation, was engaged in business in the State of California. Its original capital stock consisted of 361 shares of the par value of $100 each, but early*2985 in 1920 it declared a stock dividend of 1000 per cent, which increased its capital stock to 3,971 shares. All of the capital stock, except a nominal amount held by one Fulton, as a director, was owned by Robert P. Franck, Richard H. Franck, Elizabeth Franck, and George T. Franck. They were also officers and directors of the corporation and managed the business.
The Citrus Soap Co. of California, the petitioner herein, was organized under the laws of California some time prior to May 21, 1920, with an authorized capital stock of 7,500 shares of common stock and 7,500 shares of 7 per cent preferred stock, of the par value of $100 per share. Both classes of stock had voting rights.
On May 21, 1920, the petitioner, by resolution duly adopted by its board of directors, decided to purchase all of the assets of the Old Corporation. On May 24, 1920, the Commissioner of Corporations of the State of California gave the petitioner a written permit to issue 3,971 shares of its common stock to the Old Corporation in exchange for all of the property and assets of that company, and to sell 4,000 shares of its preferred stock to Stephens & Co. for cash at a price to net the petitioner not*2986 less than $87.50 per share.
On June 1, 1920, an amended permit was issued to the petitioner by the Commissioner of Corporations of the State of California, which is in part as follows:
Pursuant to its application, CITRUS SOAP COMPANY OF CALIFORNIA is permitted to sell and issue shares of its capital stock as follows:
1st. 3,971 shares of its common stock to Citrus Soap Company, in exchange for all of the property and assets of said Citrus Soap Company, first to be transferred to applicant, subject only to the liens and indebtedness recited in said application; and thereafter and not otherwise;
2nd. 4,000 shares of its preferred stock to Stephens & Company, in exchange for the 7 promissory notes of said Stephens & Company, for the aggregate *1157 principal sum of $350,000, and in the form of notes filed herein with said application.
This permit is issued upon each of the following conditions:
(a) That all certificates representing any of said 4,000 shares herein permitted to be sold for notes, shall be retained by said applicant company as a pledge for and until full payment of the note or notes for which they were sold and issued.
On the same date the*2987 petitioner issued 3,971 shares of its common stock to the Old Corporation in exchange for all of the assets of that company subject to its liabilities. The stock so issued was distributed among the stockholders of the Old Corporation in proportion to their stockholdings therein. The petitioner on June 1, 1920, also issued to Stephens & Co., 4,000 shares of its preferred stock. This stock was represented by certificates Nos. 1 to 7, as follows:
| Shares | |
| Certificate No. 1 | 250 |
| Certificate No. 2 | 250 |
| Certificate No. 3 | 500 |
| Certificate No. 4 | 500 |
| Certificate No. 5 | 500 |
| Certificate No. 6 | 500 |
| Certificate No. 7 | 1500 |
In exchange for said 4,000 shares of preferred stock the petitioner received from Stephens & Co. seven promissory notes of that company, as follows:
Note No. 1 for $70,000 due June 5, 1920.
Note No. 2 for 23,750 due July 1, 1920.
Note No. 3 for 43,750 due Sept. 1, 1920.
Note No. 4 for 43,750 due Oct. 1, 1920.
Note No. 5 for 43,750 due Dec. 1, 1920.
Note No. 6 for 43,750 due Jan. 1, 1921.
Note No. 7 for 131,250 due Mar. 1, 1922.
These notes bore interest at the rate of 7 per cent per annum. When said preferred stock was issued*2988 to Stephens & Co. the certificates therefor were immediately endorsed in blank by that company and left with the petitioner as collateral security for the payment of said notes.
Stephens & Co. sold said preferred stock to its customers as opportunity occurred. Upon the payment of each note the stock was released, and so much thereof as Stephens & Co. had sold went to the purchasers and the balance went to Stephens & Co.
Note No. 1 was canceled when it became due upon the payment by Stephens & Co. of $20,000, the balance being settled by a discount given to Stephens & Co. in order to make the net price of the stock $87.50 per share. All of the other notes were paid, except Note No. 7. About two years after it became due, it and the stock certificate securing it were canceled by mutual agreement between the petitioner and Stephens & Co. This was done because the petitioner needed no further funds.
*1158 Stephens & Co. was financially responsible and the said notes were bona fide paid to the petitioner for shares of its capital stock and were of the fair market value of $350,000.
The value of the net tangible assets of the Old Corporation and its net income before*2989 payment of Federal taxes for the years 1915 to 1919, inclusive, and for the period January 1 to May 31, 1920, as shown by its books, were as follows:
| Year | Income before tax paid | Tangibles | Federal taxes |
| 1915 | $59,995.84 | $76,450.16 | $599.96 |
| 1916 | 40,452.90 | 91,575.66 | 809.06 |
| 1917 | 29,895.08 | 105,690.08 | 7,788.45 |
| 1918 | 32,740.00 | 124,977.00 | 14,647.73 |
| 1919 | 101,691.19 | 147,215.02 | 38,612.47 |
| 5 months, 1920, | 55,199.41 | 271,408.01 | 21,549.43 |
| Total | 319,974.42 | 817,315.93 |
The petitioner constructed a new factory in the year 1920 at a cost of $138,583.31, divided as follows:
| Excavation | $259.94 |
| Foundations | 16,987.65 |
| Brick construction | 19,529.78 |
| Wood construction | 50,419.87 |
| Steel and iron work | 7,289.39 |
| Metal sash and doors | 7,470.03 |
| Roofing | $2,186.99 |
| Elevators | 4,315.73 |
| Electrical equipment | 5,732.80 |
| Sprinkler system | 17,776.91 |
| Plumbing | 3,799.71 |
| Miscellaneous | 2,812.51 |
The useful life of the building is 25 years. In its return for 1921 the petitioner claimed and was allowed depreciation on said building computed at the rate of 3.063 per cent.
Among the assets acquired by the petitioner from the Old Corporation was a factory*2990 building which had been in use for a number of years. About the end of the year 1920 the petitioner disposed of this building and machinery therein, they being no longer needed, for $2,220.60, and in its return for that year it claimed a loss of $13,474.74 thereon.
The petitioner, in its income and profits-tax return for the period beginning June 1, and ending December 31, 1920, computed its invested capital at $850,616.65, as follows:
| Capital stock | $397,100.00 |
| Capital stock, preferred | 400,000.00 |
| Reserve for taxes | 53,516.65 |
The respondent eliminated from invested capital good will in the amount of $129,938.04 and $64,109.94 of the value of tangibles claimed to have been acquired from the Old Corporation, and the *1159 reserve for taxes, and disallowed in part the loss claimed on the disposition of its old factory.
The respondent included in invested capital on account of the notes received by the petitioner from Stephens & Co. only the amount of said notes actually paid within the taxable year prorated to the dates of payment, and determined a deficiency in tax for the period June 1 to December 31, 1920, in the amount of $11,297.38. For the year*2991 1921 the respondent eliminated from invested capital as computed by the petitioner the amount of $129,938.04 claimed as good will acquired from the Old Corporation and $51,377.14 of the claimed value of tangibles acquired from that company, and included in invested capital on account of the notes of Stephens & Co. only the amount of such notes that had actually been paid, and determined a deficiency in tax in the amount of $16,916.95.
OPINION.
MARQUETTE: The issues raised by the pleadings in this case are: (1) What amount is the petitioner entitled to include in its invested capital for the years 1920 and 1921 on account of the assets acquired by it from the Old Corporation? (2) What amount is it entitled to include in invested capital on account of the seven promissory notes received from Stephens & Co. in payment for its preferred stock? (3) Whether the petitioner is entitled to additional depreciation for the year 1921 on its newly constructed factory. (4) Whether it is entitled to a further deduction from gross income for 1920 on account of the loss on the sale of its old factory building, machinery and equipment.
It is the contention of the petitioner that in exchange*2992 for its common stock it acquired from the Old Corporation assets of the value of $397,100, including good will; that the notes of Stephens & Co. were bona fide paid in for shares of the petitioner's preferred stock and were of the value of $350,000, which should be included in invested capital; that it is entitled to depreciation on its newly constructed factory and equipment for 1921, computed at the rate of 4.269 per cent, and that it is entitled to a further deduction of $11,718.02 as a loss sustained on the sale of its old factory building.
The respondent contends that more than 50 per cent of the ownership or control of the petitioner remained in the same interests that owned or controlled the Old Corporation, and that under section 331 of the Revenue Act of 1918, and section 331 of the Revenue Act of 1921, the petitioner is not entitled to include in its invested capital the assets acquired from the Old Corporation at more than their cost to that company; that the notes of Stephens & Co. were not bona fide *1160 paid in for stock of the petitioner, and that only the amounts actually paid on such notes in 1920 and 1921 should be included in invested capital for those*2993 years, and that the petitioner is not entitled to any greater allowance for depreciation on its new factory building or a greater loss on the sale of its old factory, than has heretofore been allowed.
The first two issues are so closely related that they will be discussed together.
We are of opinion that the restrictions on invested capital imposed by section 331 of the Revenue Acts of 1918 and 1921 do not apply to the transaction under consideration. The evidence shows that on June 1, 1920, the petitioner issued to Stephens & Co. certificates for 4,000 shares of its capital stock, and on the same day it issued 3,971 shares of its capital stock for the assets of the Old Corporation, and that the shares issued to the Old Corporation were promptly distributed among the stockholders of that company. The proportions of the stock so issued then stood:
| Per cent | |
| To Stephens & Co | 50.2 |
| To the Franck family | 49.8 |
But the respondent urges that the issue to Stephens & Co. was not a bona fide sale because that stock was later sold to various customers of Stephens & Co., and that while it was in form a sale it was in reality merely a contract under which Stephens & *2994 Co. undertook, for a commission, to sell the stock for the petitioner. We do not so regard it. The 4,000 shares of preferred stock were issued to Stephens & Co., who became the owners, entitled to vote it at stockholders' meetings and to the dividends which it earned. It is true that the certificates were endorsed in blank and placed with the petitioner as collateral security for the payment of the purchase money notes given by Stephens & Co., but this did not divest Stephens & Co. of its rights as a stockholder either as to voting or as to dividends. Stephens & Co. purchased the stock in question from the petitioner with the approval of the Commissioner of Corporations of the State of California, and it paid for the stock with notes. Stephens & Co. was a responsible, solvent concern, and the notes had a fair market value of $350,000 and were enforceable to that extent. We do not attach any importance to the fact that the last note and the stock for which it was given were canceled. That was done because at that time the petitioner no longer needed additional funds, and the cancellation of the note and the stock amounted in fact to a retirement of the stock. When the 4,000*2995 shares of preferred stock and 3,971 shares of common stock were issued by the petitioner as described in the findings of fact, the legal ownership of more than 50 per cent, and *1161 with it the control of the company, was in the hands of others than those who owned and controlled the Old Corporation. The petitioner is entitled to include the notes of Stephens & Co. in its invested capital at the amount of $350,000, and it is not restricted, in determining the amount at which the assets acquired from the Old Corporation may be included in invested capital, to the value at which they could have been included in the invested capital of that company.
The petitioner acquired all the property of the Old Corporation, and since section 331 of the Revenue Acts of 1918 and 1921 does not apply here, it may, under section 326(a)(2) and (5) of the Revenue Acts of 1918 and 1921, include in its invested capital the actual cash value of such property, subject to certain limitations on intangibles, provided such value is capable of ascertainment. As to this issue, however, the petitioner has failed to produce any evidence that would warrant us in disturbing the determination of values*2996 made by the respondent.
We have before us evidence as to the amounts at which the tangible assets were carried on the books of the Old Corporation and the earnings of that company over a period of years. There is also evidence that an appraisal was made of these assets about 1920, which appraisal is not before us. The book entries of the Old Corporation are not sufficient to prove that the values they purport to give the assets in question are correct, and they are not supported by other evidence. On this issue we must decline to disturb the determination of the respondent.
We are of opinion that the petitioner's new factory building had a useful life of 25 years and that it should be allowed depreciation thereon computed at the rate of 4 per cent at a cost of $138,583.31.
For the reasons heretofore stated we are unable to determine the cost to the petitioner of the old factory building and we can not, therefore, disturb the respondent's determination as to the amount of the loss sustained in 1920 on the sale thereof.
At the hearing it was stipulated that the reverve for taxes which the respondent eliminated from the petitioner's invested capital for 1920 consisted of*2997 certain taxes of the Old Corporation, the payment of which the petitioner assumed; that an equal amount of cash was turned over to the petitioner for that purpose, and that the respondent erred in eliminating the reserve from invested capital.
Judgment will be entered under Rule 50.