1931 BTA LEXIS 1967">*1967 The petitioner in 1919 issued to certain of its stockholders shares of its capital stock of the par value, and actual value, of $71,000, as a consideration of their guaranteeing the payment, both of principal and interest, of an issue of the petitioner's bonds. Held, that the value of said shares of stock represented an expense of the sale of said bonds which should be amortized and deducted from income ratably over the life of the bonds.
22 B.T.A. 1298">*1298 These proceedings, which were duly consolidated for hearing and decision, are for the redetermination of deficiencies in income tax asserted by the respondent in the amounts of $494.04 for the year 1922, and $2,740.91 for 1923. The petitioner alleges that the respondent erred in allowing only a part, instead of the entire amount, of deductions taken by the petitioner in its returns for 1922 and 1923, which it claims represented expenses, applicable to those years, incurred in connection with a certain issue of its bonds. At the hearing the respondent amended his answer and alleged that he erred in allowing1931 BTA LEXIS 1967">*1968 for 1922 any part of said claimed deduction, and asked that the said claimed deduction be disallowed in its entirety, and that the deficiency for 1922 be increased accordingly.
22 B.T.A. 1298">*1299 FINDINGS OF FACT.
The petitioner is a California corporation with its principal office and place of business at San Francisco.
On January 28, 1919, the Liberty Farm Company made to the petitioner a written offer, as follows:
SAN FRANCISCO, CALIFORNIA, January 28, 1919.
LIBERTY FARMS COMPANY,
San Francisco, California.
DEAR SIRS: We hereby offer to transfer and convey to you all of the assets of this corporation, in consideration of the issuance to this company of 950 fully paid shares of the capital sotck of your company, and the assumption by your company of all of the liabilities of this company. In order that said liabilities may be paid off, it is understood that you will immediately take steps to authorize an issue of $250,000 in bonds of your company, to bear interest at the rate of 6 per cent. per annum, payable semi-annually, and to be secured by a first mortgage upon all of your properties. Said bonds shall be payable as follows:
$25,000 two years from the date1931 BTA LEXIS 1967">*1969 of said issue;
$30,000 three years from said date;
$30,000 four years from said date;
$30,000 five years from said date;
$35,000 six years from said date;
$35,000 seven years from said date;
$65,000 eight years from said date.
Said bonds or such part thereof as may be required to pay off said liabilities, shall be sold by you at a figure to net your not less than 95 per cent. If necessary for effecting such sale, the principal and interest of said issue will be secured by the guaranty of the following stockholders of this company, who in that event shall receive, in consideration of said guaranty, the number of fully paid shares of stock of your company set opposite their respective names:
J. H. Rossiter and R. K. Malcolm, 670; G. E. Bryan, 20; G. B. LaMontague, 20.This offer is subject to the permission of the Commissioner of Corporations of California being given to the issuance of the above-mentioned securities.
We remain,
Yours very truly,
(Signed) LIBERTY FARM CO.
By R. K. MALCOLM,
President.
Said offer was accepted by the petitioner pursuant to a resolution duly adopted by its board of directors on February 8, 1919, as follows:
RESOLVED, 1931 BTA LEXIS 1967">*1970 that said offer by and is hereby accepted; and that if and when the Commissioner of Corporations of California shall give his permission to the issuance of said stock, the president and secretary of this corporation be and are authorized to issue and deliver to said Liberty Farm Co., 950 shares of its fully paid stock, and also to execute and deliver to the said Liberty Farm 22 B.T.A. 1298">*1300 Co., an instrument assuming all of its liabilities, and to receive from it conveyances and transfers to this corporation of all of the properties of the said Liberty Farm Co.
All of the assets of the Liberty Farm Company were thereupon transferred to the petitioner, and the petitioner issued and delivered to the Liberty Farm Company 950 shares of its, the petitioner's, capital stock, which thereupon became and continued to be until on or after April 1, 1919, the only shares outstanding. The Liberty Farm Company immediately distributed said 950 shares of the petitioner's capital stock to its stockholders and then dissolved. From that date until April 1, 1919, or thereafter, the stockholders of the petitioner and the number of shares owned by each, were as follows:
| R. K. Malcolm | 162 |
| J. B. Coleman | 251 |
| G. E. Bryan | 187 |
| G. B. LaMontague | 187 |
| J. H. Rossiter | 162 |
| Hiram Deckerman | 1 |
| Total | 950 |
1931 BTA LEXIS 1967">*1971 The petitioner, after having negotiations with a number of investment bankers, issued its bonds in the amount of $250,000 and sold them at 95. In order to obtain that price for the bonds it was necessary to have them guaranteed as to payments of principal and interest. It was a custom of the investment bankers with whom the petitioner was in position to deal, to require guaranties for bond issues of this kind, and in the absence of said guaranties they could not handle the bond issues. The petitioner's said issue of bonds was guaranteed by four of its stockholders, namely, R. K. Malcolm, J. H. Rossiter, G. E. Bryan, and G. B. LaMontague, and on or about April 1, 1919, the petitioner issued to them 710 shares of its capital stock of the par value of $100 each, pursuant to a resolution duly adopted by the board of directors on April 1, 1919, as follows:
WHEREAS, J. H. Rossiter, R. K. Malcolm, G. E. Bryan, and G. B. LaMontague, stockholders of this corporation, have executed a guaranty of the principal and interest of the bonded indebtedness of this corporation, which guaranty bears date the first day of March, 1919;
And, whereas, the Commissioner of Corporations of California, 1931 BTA LEXIS 1967">*1972 by an order dated February 13, 1919, has authorized the issuance of the shares of stock of this corporation hereinbelow mentioned, in consideration of the execution of said guaranty; it is
RESOLVED, that in consideration of the execution of the said guaranty, fully paid shares of stock of this corporation be issued as follows:
To the said J. H. Rossiter and R. K. Malcolm, 670 shares;
To the said G. E. Bryan, 20 shares; and
To the said G. B. LaMontague, 20 shares.
22 B.T.A. 1298">*1301 Among the assets acquired by the petitioner from the Liberty Farm Company were 5,238 acres of land located in Salina County, California, about sixty miles from San Francisco. This land was of alluvial formation and was very rich and fertile. At the time said bonds were issued by the petitioner the fair market value of said land was $392,850. At that time the petitioner had other assets, including cash on hand, accounts and notes receivable, inventories and equipment, and Liberty bonds of the value of $121,206.74, making a total value of $514,056.73. Its liabilities at that time, exclusive of the 950 shares of capital stock then outstanding, were $321,642.42, and its net worth was $192,414.31. Immediately1931 BTA LEXIS 1967">*1973 after the said bonds had been sold, the petitioner's assets were of the value of $751,566.73, its liabilities, exclusive of capital stock, amounted to $571,642.42, and its net worth was $179,914.31. Immediately after said 710 shares were issued to Malcolm, Rossiter, Bryan, and LaMontague, the petitioner's outstanding capital stock was 1,660 shares of the par value of $100 each. No other shares of stock were issued by the petitioner in March or April, 1919, but later in that year and in 1920, sales of stock were made by the petitioner to certain of its then stockholders in order to secure additional capital. Part of said additional stock was sold at $100 per share, and the remainder at $125 per share. In 1920 the petitioner also sold 13 1/2 shares of its capital stock to the Sierra Securities Company, a company entirely independent of, and not connected with the petitioner, for $125 per share.
The petitioner treated the par value of the 710 shares of its capital stock that were issued to Malcolm, Rossiter, Bryan, and LaMontague for their guaranty of said bond issue of the petitioner, as an expense of issuing said bonds, and amortized that amount, $71,000, over the life of said1931 BTA LEXIS 1967">*1974 bonds, which was eight years, and deducted one-eighth thereof in computing its net income for 1922. In 1923 the petitioner called said bonds and in its return for that year it deducted from gross income that part of said $71,000 that had not been deducted in 1922, or prior thereto. The respondent allowed $2,512.81 of the deduction taken for 1922, and disallowed the entire deduction taken for 1923.
OPINION.
MARQUETTE: It is the contention of the petitioner that it issued to certain of its stockholders 710 shares of its capital stock of the par value, and actual value, of $71,000, as compensation to them for their personal guaranty of the interest and principal of an issue of the petitioner's bonds, and that the value of the stock is and should be 22 B.T.A. 1298">*1302 considered as an expense of the sale of the bonds and amortized and deducted ratably over the period of their life. The respondent takes the position that the petitioner is not entitled to any deduction at any time on account of the shares of stock in question, for the reason that (1) it acquired no asset therefor and had nothing to amortize, and (2) that the stock had no value.
1931 BTA LEXIS 1967">*1975 This Board has held, in , that the expense incurred subsequent to March 1, 1913, in connection with the flotation of a bond issue should be amortized and deducted ratably over the life of the bonds. In this case the evidence establishes that the four stockholders rendered services to the petitioner and the respondent does not question that these services were reasonably worth what the petitioner claims to have paid for them, that is, $71,000. If the payment to the stockholders had been made in money it clearly would have been an expense of the issue and sale of the bonds, and under , would have to be amortized over the life of the bonds. The issue, then, is narrowed to the question of whether the fact that the petitioner paid for the guaranty of its bonds in stock instead of in money precludes it from treating the value of the stock as an expense of the bond issue and amortizing it and deducting it accordingly.
In our opinion this is a transaction in which we should look through form to substance, and the substance is: (1) as if the petitioner1931 BTA LEXIS 1967">*1976 paid to the stockholders $71,000 in money and they immediately invested that amount in the petitioner's stock at par, or (2) as if it sold the stock at par and paid the stockholders in money. The latter view was adopted by the Commissioner in article 33 of Regulation 45, and has been continued in article 33 of Regulations 62, 65, and 69 and is still in force and effect. These regulations were promulgated by the respondent pursuant to authority vested in him by statute, and the position therein adopted, and so long maintained, is not to be lightly ignored. See .
We are satisfied that the 710 shares of stock issued by the petitioner to its stockholders, as set forth in the findings of fact, had a value of $71,000, which should be treated as an expense of the bond issue herein involved, and amortized and deducted ratably over the life of the bonds. It follows that the respondent erred in disallowing the deduction taken by the petitioner in its returns for 1922 and 1923 on account of said expense.
Reviewed by the Board.
Judgment will be entered under Rule 50.
22 B.T.A. 1298">*1303 BLACK, dissenting: I dissent1931 BTA LEXIS 1967">*1977 from the views expressed in the majority opinion. If the corporation had paid out $71,000 in cash in consideration of these stockholders guaranteeing payment of its bonds, I agree that it should be allowed to amortize such amount over the life of the bonds. But it did not pay out cash, but issued its stock in payment of such guaranty and it is my opinion that in issuing its stock, it has nothing to amortize.
In the instant case, when the Liberty Farms Company parted with 710 shares of its capital stock of the par value of $100 per share, it parted with no property. It still remained the owner of all the corporation's property just as it was prior to the issuance of the stock. The only difference in the situation was that whatever equity there was in the owners of common stock before the new stock was issued was divided among 950 shares, whereas, after the issuance of such stock this equity was divided among 1,660 shares. I fail to see where the corporation has anything which it may amortize as a result of the transaction.
STERNHAGEN agrees with this dissent.