*171 Decision will be entered under Rule 50.
In each of the taxable years petitioner sold certain properties which it had acquired in 1937 in exchange for its capital stock. The petitioner was created and its stock was issued in order to facilitate the distribution of an estate's assets to decedent's four sons and to certain attorneys. During the period of the administration of the estate two of the sons had entered into a contingent fee agreement under which the attorneys were to receive 35 percent of whatever was recovered from the estate by the two sons. During this period, also, certain of the sons received advancements from the estate in varying amounts. Held, that the transaction in 1937 whereby petitioner acquired the properties was a nontaxable exchange under section 112 (b) (5) of the Internal Revenue Code, and that petitioner's basis for determining gain or loss on the sale of the properties is the same as it would have been in the hands of its transferors. Sec. 113 (a) (8) of the code.
*1 The respondent determined deficiencies in income tax and declared value excess profits tax for the years 1939 and 1941, as follows:
| Declared value | ||
| Year | Income tax | excess profits |
| tax | ||
| 1939 | $ 295.98 | |
| 1941 | 7,125.33 | $ 415.01 |
The issue involves the question of determining the correct basis of certain properties sold by petitioner in the taxable years, for the purpose of computing petitioner's gain or loss in each taxable year.
Petitioner filed its returns for the taxable years with the collector for the first district of Texas.
Most of the facts have been stipulated.
*2 FINDINGS OF FACT.
We adopt the stipulation of facts filed by the parties and such stipulated facts are incorporated herein by reference. However, only those stipulated facts necessary to an understanding of the issue are hereinafter specifically set forth.
Petitioner is a Texas corporation, *173 with its office located at Houston, Texas. Its corporate charter was filed on June 18, 1937, the incorporators being Frank S. Roberts, George H. Roberts, and Charles A. Perlitz, Jr. The capital stock of the corporation consisted of 10,000 shares of no par value, all of which was subscribed and paid in the amount of $ 78,162 by the sale and conveyance to the corporation of several tracts of land, aggregating approximately 7,816 acres in 4 counties in Texas, under circumstances which will be described hereinafter.
Martha E. Roberts died on April 30, 1933, leaving a last will and testament which was duly probated in Harris County, Texas. In her will, after a direction for the payment of her debts, she bequeathed all the rest and residue of her estate, both real and personal, to her four sons, Frank S. Roberts, Benjamin G. Roberts, John R. Roberts, and George H. Roberts, share and share alike. The estate of Martha E. Roberts consisted principally of four kinds of assets: Jewelry, stocks and other securities, lands in Georgia, and lands in Texas aggregating approximately 7,816 acres which were valued for estate tax purposes in her estate at $ 5 per acre.
The First National Bank of Houston*174 and Frank S. Roberts qualified as executors of the estate on May 23, 1933. On July 11, 1933, the First National Bank of Houston resigned as one of the executors of the estate, and thereafter Frank S. Roberts continued as sole independent executor and acted as such at all times material herein.
Various claims, disputes, and litigations arose in connection with estate properties and in connection with these John R. Roberts and Benjamin G. Roberts, two of the sons of the decedent, on or about July 6, 1936, made a contingent fee agreement with the law firm of Jones, Fuller & Clapp of Atlanta, Georgia, wherein they agreed to pay such attorneys an aggregate of 35 percent of whatever was recovered from the Martha E. Roberts estate by the two sons. At the time this contingent fee agreement was entered into, the estate of Martha E. Roberts had direct and contingent claims against it totaling $ 186,000, and if those claims were collected the estate might be rendered insolvent. By letter dated August 7, 1936, Jones, Fuller & Clapp agreed to pay the law firm of Fulbright, Crooker & Freeman, of Houston, Texas, one-half of whatever fees they might receive under their agreement with John R. Roberts*175 and Benjamin G. Roberts. George *3 H. Roberts, another of decedent's sons paid attorneys' fees of $ 5,000 in cash to another attorney on account of the same matters. All claims, disputes, and litigation concerning the estate were concluded by the late spring of 1937, and at that time all debts of the estate had been satisfied and the administration thereof had been completed.
During the period from the death of the decedent to the spring of 1937 there had been various advancements or loans from the estate to the several sons, but in unequal amounts, so that adjustments were necessary as between them to equalize the advances or loans which some had received in larger amounts than others.
Following the settlement of the claims and disputes and the completion of the administration, Frank S. Roberts, Benjamin G. Roberts, John R. Roberts, and George H. Roberts, being the four residuary beneficiaries under the decedent's will, entered into an agreement, dated May 10, 1937, which provided in part as follows:
That, whereas, there is now pending in the District Court of Harris County, Texas, 80th Judicial District, the case of John R. Roberts, et al., vs. First National Bank of Houston*176 et al., No. 230,592, the same being a petition for partition of the estate of Mrs. Martha E. Roberts; and whereas a provision has been made for the immediate payment of all debts of said estate; and whereas all issues in said matter have been disposed of except only that relating to the actual partition of the assets of said estate; and whereas it is desired by the parties hereto, who are all of the children and legatees under the will of Mrs. Martha E. Roberts, that a partition of said estate be made by agreement and consent of said parties; due consideration and allowance being given to advances made and properties already distributed; --
Therefore, the undersigned contract and agree that the assets of the estate of said Mrs. Martha E. Roberts be divided and partitioned among them in the following manner and proportions, to wit:
1. The lands owned by said estate in the State of Texas comprising 7816 acres, more or less, are to be conveyed by the executor to a corporation to be organized under the laws of the State of Texas, under the name and style of Roberts Realty Corporation (or if such name shall conflict with any name now being used, some other name is to be agreed upon by *177 the parties hereto), in exchange for the entire capital stock of said corporation.
2. Of the property now owned by the estate, Frank S. Roberts is to receive 189 shares of the stock of the First National Bank of Houston, 6.98 per cent of the capital stock of the corporation hereinabove provided for and called herein Roberts Realty Corporation, 1/4th of the jewelry now owned by the estate, the parties hereto to agree upon some fair method of dividing the said jewelry into four equal parts.
3. Benjamin G. Roberts is to receive 890 shares of the stock of First National Bank of Houston, 32.92 per cent of the stock of Roberts Realty Corporation, an undivided 1/3rd interest in the lands of the estate located in Atlanta, Georgia, consisting of one tract of fifteen (15) acres, more or less, and a small triangular tract at Fair and Formwalt Streets, and 1/4th of the jewelry now owned by the estate.
4. George H. Roberts is to receive 720 shares of the stock of the First National Bank of Houston, 26.74 per cent of the stock of the Roberts Realty Corporation, *4 an undivided 1/3rd interest in the lands located in Atlanta, Georgia owned by the estate and 1/4th of the jewelry now owned by the*178 estate.
5. John R. Roberts is to receive 901 shares of the stock of the First National Bank of Houston, 33.36 per cent of the stock of Roberts Realty Corporation, an undivided 1/3rd interest in the lands owned by the estate in Atlanta, Georgia, and 1/4th of the jewelry owned by the estate.
* * * *
13. The parties hereto do further agree that as soon as this instrument is executed by all four parties, that Frank S. Roberts will prepare and execute deeds to the land in Texas to the corporation herein provided for, to wit: Roberts Realty Corporation, and such other instruments as may be necessary to completely effectuate the purposes of this instrument.
The organization meeting of petitioner's board of directors was held on July 13, 1937. At that meeting it was made known that Frank S. Roberts, George H. Roberts, and Charles A. Perlitz, Jr., who had subscribed for the capital stock of the corporation, had done so for themselves and various other persons and that the stock of the corporation should be issued to the following named parties for the shares shown:
| Shares | |
| Frank S. Roberts | 698 |
| Benjamin G. Roberts | 2,140 |
| George H. Roberts | 720 |
| Carrie Munson Roberts | 1,954 |
| John R. Roberts | 2,168 |
| Briterman Holding | |
| Corporation of Texas | 1,160 |
| Robert H. Jones, Jr | 340 |
| Wm. A. Fuller | 340 |
| A. W. Clapp | 340 |
| Jones, Fuller and Clapp | 140 |
| Total | 10,000 |
*179 Carrie Munson Roberts was the wife of George H. Roberts, who by instrument dated July 2, 1937, instructed that 1,954 shares of petitioner's stock be issued to her as her separate property. The Briterman Holding Corporation of Texas was a corporation owned by the law firm of Fulbright, Crooker & Freeman.
The authorized capital stock of petitioner was 10,000 shares without par value, which were issued in certificates dated July 16, 1937, as follows:
| Certificate | ||
| No. | Issued to | Shares |
| 1 | Frank S. Roberts | 698 |
| 2 | Benjamin G. Roberts | 1,880 |
| 3 | Benjamin G. Roberts | 260 |
| 4 | Carrie M. Roberts | 1,954 |
| 5 | George H. Roberts | 400 |
| 6 | George H. Roberts | 320 |
| 7 | John R. Roberts | 1,908 |
| 8 | John R. Roberts | 260 |
| 9 | Charles A. Perlitz, Jr | 1,020 |
| 10 | Charles A. Perlitz, Jr | 140 |
| 11 | Robert H. Jones, Jr | 340 |
| 12 | Wm. A. Fuller | 340 |
| 13 | A. W. Clapp | 340 |
| 14 | Jones, Fuller & Clapp | 140 |
| Total issue | 10,000 |
*5 No additional certificates were issued until September 1, 1937, when certificate No. 9, issued to Charles A. Perlitz, Jr., for 1,020 shares, was surrendered and reissued in certificates numbered from 15 to 24, inclusive, aggregating 1,020 shares, distributing such shares among the*180 various lawyers composing the partnership of Fulbright, Crooker & Freeman, in which partnership Charles A. Perlitz, Jr., was a member.
The 2,320 shares of stock of petitioner issued to Charles A. Perlitz, Jr., Robert H. Jones, Jr., Wm. A. Fuller, and A. W. Clapp, as set out in the above list, were so issued pursuant to the contingent fee contract with John R. Roberts and Benjamin G. Roberts. Charles A. Perlitz, Jr., was at all times material herein a member of the firm of Fulbright, Crooker & Freeman, and the stock issued to him was for the account of that firm. Robert H. Jones, Jr., Wm. A. Fuller, and A. W. Clapp were the members of the firm of Jones, Fuller & Clapp.
On July 29, 1937, pursuant to the partition agreement of May 10, 1937, Frank S. Roberts, as independent executor of the estate of Martha E. Roberts, conveyed to petitioner by four deeds approximately 7,816 acres of land situated in 4 counties in Texas. The consideration for these conveyances was the issuance of all of petitioner's capital stock to the persons previously described herein. No other conveyances were made to petitioner and no consideration was paid by petitioner for such lands other than the issuance*181 of its stock as heretofore set forth. Throughout the year 1937 the fair market value of the said Texas lands was $ 10 per acre, and they were taken by petitioner at that value and were so recorded on its books, and its stock was issued in consideration therefor.
In the year 1939 petitioner sold the surface and one-eighth of the minerals in the tract of land so acquired by petitioner in the Bailey McFadden Survey in Montgomery County, Texas, receiving therefor a net consideration of $ 6,582.50. In the year 1941 petitioner sold the surface and one thirty-second of the minerals in the tracts of land so acquired by petitioner, known as the J. F. de Rumayor Surveys in Liberty County and Polk County, Texas, receiving therefor a net consideration of $ 42,080.20.
In determining its profit on the sale of these lands, petitioner used as its basis the cost to it of $ 10 per acre. In the notice of deficiency, the respondent determined that petitioner's basis was $ 5 per acre. The explanation of the adjustment was set forth in the deficiency notice, as follows:
It is held that an additional gain of $ 2,114.13 was realized in 1939 and $ 22,521.09 in 1941 from the sale of property for the reason*182 that the property was acquired in a tax free transaction as provided in Section 112 (b) (5) of the Internal Revenue Code which requires that the property sold take the same basis as in the hands of the transferors.
*6 OPINION.
The controversy in this proceeding arises over the proper basis to be used by petitioner in computing the gain realized by it from the sale of certain properties in each of the taxable years. Respondent has determined that the transaction under which petitioner acquired the properties in 1937 was a nontaxable exchange under section 112 (b) (5) of the Internal Revenue Code, and that, under section 113 (a) (8) of the code, petitioner's basis is the same as it would have been in the hands of its transferors, which, in the deficiency notice, respondent determined to be $ 5 per acre. Petitioner on the other hand contends that the transaction in 1937 was a taxable exchange, and that its basis was the cost of the properties, which it claims was $ 10 per acre.
Section 112 (b) (5) provides that "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, *183 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. * * *" Section 112 (h) defines control as meaning "the ownership of stock possessing at least 80 per centum of the total combined voting power of all classes of stock entitled to vote and at least 80 per centum of the total number of shares of all other classes of stock of the corporation." Petitioner takes the position that section 112 (b) (5) is inapplicable for two reasons: First, that the transferors were not in control of petitioner immediately after the exchange; and, secondly, that each transferor did not receive stock substantially in proportion to his interest in the property prior to the exchange. The major premise for these contentions is that the four Roberts brothers were the only transferors of the properties to the petitioner. Petitioner argues that, under Texas law, upon the death of a decedent title to real estate descends to the heirs or devisees, *184 subject only to being divested by conveyance of the administrator or executor pursuant to law to pay debts or to accomplish other proper purposes of administration. Revised Civil Statutes of Texas (1925), art. 3314. It claims that in 1937 each of the four brothers owned a 25 percent interest in the properties transferred, or a total interest of 100 percent, and that immediately after the exchange they owned only an aggregate of 5,726 shares out of a total of 10,000 shares, or only 57.26 percent of the total shares issued. Thus, it is argued that they were not in control of the corporation immediately after the exchange. Petitioner also points out that Frank received only 6.98 percent of the stock for his alleged 25 percent interest in the property *7 transferred and that George received only 7.2 percent of the stock for his interest. Respondent contends that the amount of capital stock received by each of the four brothers was in exact proportion to his interest in the property prior to the exchange. He argues that the brothers, although owning the entire legal title to the properties, were not the only transferors, since the attorneys, who owned an interest of 35 percent*185 of whatever John and Benjamin recovered, were also transferring their equitable interests in the properties in exchange for some of petitioner's stock. The issue, therefore, turns upon the meaning of the word "property" as used in section 112 (b) (5).
We have heretofore held that the word "property" as used in what is now section 112 (b) (5) comprehends those interests which a court of equity would recognize as equitable assignments. F. L. G. Straubel, 29 B. T. A. 516. In that case, although the legal title to the property transferred was vested in one individual, we held that a valid oral assignment of equitable interests had been made by that individual to his brother and son, which could be recognized under section 112 (b) (5). Here, by parity of reasoning, if the contingent fee agreement between the two Roberts brothers and their attorneys amounted to a valid equitable assignment of an interest in the Texas lands, then the principle of the Straubel case, supra, would apply. Neither of the parties has briefed the question, but independent research indicates that, under Texas law, such an agreement does amount to an equitable assignment*186 upon successful completion of the litigation. A summary of the applicable Texas law is set forth in Northern Texas Traction Co. v. Clark & Sweeton (Tex. Civ. App.), 272 S.W. 564">272 S. W. 564, as follows:
It is within the fixed rule that an agreement between client and attorney, by which the attorney is to have for his services a fixed portion of whatever amount of money shall be realized or received, whether on settlement or without settlement, on account of such claim as shall be put in suit, whether of tort or contract, constitutes an equitable assignment pro tanto. The doctrine is fully laid down in Story, Eq. Jur. § 1040, and in 3 Pomeroy Eq. Jur. § 1280. The rule is followed in this state. Harris Co. v. Campbell, 68 Tex. 22">68 Tex. 22, 3 S. W. 243, 2 Am. St. Rep. 467">2 Am. St. Rep. 467; Clark v. Gillespie, 70 Tex. 513">70 Tex. 513, 8 S. W. 121; Railway Co. v. Vaughan, 16 Tex. Civ. App. 403">16 Tex. Civ. App. 403, 40 S. W. 1065; Railway Co. v. Miller, 21 Tex. Civ. App. 609">21 Tex. Civ. App. 609, 53 S. W. 709; Railway Co. v. Stubbs (Tex. Civ. App.) 166 S.W. 699">166 S. W. 699;*187 Railway Co. v. Wood (Tex. Civ. App.) 152 S. W. 487; Electric Co. v. Chancellor & Bro. (Tex. Civ. App.) 229 S. W. 649; Wheeler v. Frouhoff (Tex. Civ. App.) 270 S.W. 887">270 S. W. 887. Being, as it is, an "equitable assignment pro tanto" of the particular sum of money, the interest therein is not merely a lien or charge, but in the nature of property vesting absolutely in the assignee attorneys.
At the time the contingent fee agreement between John and Benjamin Roberts and their attorneys was entered into, the estate of Martha E. Roberts had direct and contingent claims against it totaling $ 186,000, and if those claims were collected the estate might be rendered *8 insolvent. It was against this background that John and Benjamin agreed to pay the attorneys 35 percent of whatever was recovered from the estate by the two sons. As a result of the efforts of the attorneys, all claims against the estate were disposed of by the late spring of 1937, and by then all debts of the estate and the administration thereof had been completed. All that was left was to distribute the assets of the estate. *188 By decedent's will, each of the four sons was entitled to 25 percent of those assets. However, Frank Roberts, the executor, had apparently advanced to himself, during the period of administration, substantial amounts against his share of the estate, so that at the time of distribution John and Benjamin were together entitled to 66.28 percent of the Texas lands. This percentage represented the recovery by John and Benjamin, and their attorneys owned, in equity, 35 percent of 66.28 percent of the Texas lands, or a total of 23.198 percent of those lands. When John and Benjamin transferred their legal interest in the Texas lands, they were conveying in behalf of the attorneys and themselves. In exchange for the conveyance of the attorneys' interest to petitioner, the attorneys received 2,320 shares of petitioner's stock, or 23.20 percent of the total issued stock. When that percentage is added to the 57.26 percent owned by the four brothers, it is apparent that more than 80 percent of petitioner's stock was issued to the transferors, and the control requirement of the statute is met.
The rationale of this holding disposes of petitioner's second contention, namely, that each transferor*189 did not receive stock substantially in proportion to his interest in the property prior to the exchange. At the time the partition agreement was executed, Frank did not own a 25 percent interest in the Texas lands, as petitioner contends. The amounts which he had previously advanced to himself were merely applied against his one-fourth interest in the assets of the estate, which included the Texas lands, and that one-fourth interest in the Texas lands had diminished to an interest of only 6.98 percent. The facts do not show the amounts which Frank had previously advanced to himself nor the method whereby the four brothers agreed upon the allocation of the assets of the estate. Under the circumstances, the reasonable inference is that Frank's advancements in the prior years had so reduced his interest in the Texas lands that at the time of the transfer to petitioner that interest amounted to only 6.98 percent. The reduction of Frank's interest necessarily increased the interests of the other brothers. In any event, the burden of proving that Frank owned more than a 6.98 percent interest in the Texas lands at the time of the exchange was upon petitioner, and it has not sustained*190 that burden. This also applies to the interests of the other brothers.
The only other question remaining pertains to the interest of George H. Roberts. Prior to the exchange he owned a 26.74 percent interest *9 in the Texas lands and was entitled to receive 26.74 percent of petitioner's stock, or 2,674 shares. The partition agreement under which George was entitled to receive these shares of petitioner's stock was executed on May 10, 1937. On July 2, 1937, he instructed that 1,954 shares of the stock which he was to receive should be issued to his wife, Carrie Munson Roberts, as her separate property. He had not, however, conveyed or assigned to his wife any interest in the lands which were the subject of the exchange. She was not entitled to any of petitioner's stock by virtue of the agreement of May 10, 1937. The 1,954 shares of stock which she received came to her as a gift from her husband. Under these facts, the transaction must be viewed as if the 1,954 shares of stock first came to the husband, who then gave them to his wife. The effect of section 112 (b) (5) can not be evaded by an anticipatory device of this nature. See Mertens, Law of Federal Income Taxation, *191 vol. 3, § 20.43, pp. 163, 164. The case of Heberlein Patent Corporation v. United States, 105 Fed. (2d) 965, is distinguishable, for there the instructions relating to the gifts of stock in the new corporation were given prior to the execution of the agreement under which the new corporation was to be organized.
Petitioner also makes the alternative contention that, even if the transaction in 1937 were a nontaxable exchange under section 112 (b) (5), nevertheless, the basis of the property to it would be higher than the $ 5 per acre used by respondent. On brief, the respondent concedes this to be true, and he agrees that 23.20 percent of the land sold during each of the taxable years should be valued at $ 10 per acre, which was the fair market value of the land throughout 1937. This percentage represents the interests of the attorneys in the land, and was a capital expenditure made by John and Benjamin Roberts. By the same token, the $ 5,000 paid by George H. Roberts to his attorney is a capital expenditure and represents additional cost of George H. Roberts' interest in the land.
At the hearing petitioner attempted to establish by the witness*192 Perlitz that the four sons in arriving at a division of the estate properties placed a valuation of $ 10 per acre on the Texas lands. Apparently it was intended to use this testimony as a basis for an argument that Frank, who received only a 6.98 percent interest in the land, sold the difference between that amount and the 25 percent interest he was entitled to receive under his mother's will to his three brothers at a price of $ 10 per acre. This testimony, however, was rejected because Perlitz was unable to testify as to the facts concerning the indebtedness of each brother and the values they ascribed to different assets in the estate. Perlitz represented only two of the brothers and he did not participate in all of the negotiations with respect to the partition agreement. He had no notes or other records of the meetings in which the brothers participated. Even if this testimony had been *10 admitted, however, petitioner's argument would have availed it nothing, because there was no sale from Frank to the other brothers. All that was done was to divide the assets, and, because Frank in the past had withdrawn larger amounts from the estate, his share of the distribution*193 was considerably less than the shares of the other brothers.
Accordingly,
Decision will be entered under Rule 50.