1929 BTA LEXIS 2105">*2105 The petitioner purchased the assets of a department store business for a price payable in cash, notes, and preferred stock of a corporation organized by himself and other department heads; these assets he then transferred to the corporation in consideration of its discharge of his obligations in cash and preferred stock to the original vendor and the issuance to him of preferred and common stock of the par value of $5,000 and $30,000, respectively, above the value of property exchanged therefor. The sale of common stock was limited, by by-law, to corporation's employees and, by incorporators' agreement, to department heads. One sale at par was made to department head after incorporation; an offer to purchase from an outsider was rejected. The department heads and other employees had purchased to their capacity and further efforts of the corporation to dispose of stock were unsuccessful. Held, since restrictions on disposition, whether or not enforceable, did in fact limit sales to exhausted market, the common stock acquired by petitioner had no readily realizable market value within the meaning of section 202, Revenue Act of 1921.
18 B.T.A. 194">*194 This proceeding involves income taxes in the sum of $5,270.81 for the calendar year 1923. The question involved is whether or not stocks received by petitioner in exchange for property had readily realizable market value, from which taxable gain can be computed.
FINDINGS OF FACT.
The petitioner is an individual residing at South Bend, Ind.
In 1898 the petitioner entered the employ of George Wyman & Co., a long established individual proprietorship conducting a department store in South Bend, Ind. Petitioner was employed in the capacity of general manager, at a salary of $1,000 a year plus a percentage of the net profits of the business, with the understanding that if his services were satisfactory he would be permitted to succeed to the business by purchase. In 1913 negotiations were in progress to carry this agreement into effect when the proprietor, George Wyman, died.
Clara L. Wyman, the widow and heir of George Wyman, having knowledge of her husband's intention to permit the petitioner to acquire said business, entered into a written contract1929 BTA LEXIS 2105">*2107 with him under date of December 16, 1916, whereby she granted the petitioner an option to purchase said business, which contract fixed the amount of the purchase price in the event the option was exercised at "capital 18 B.T.A. 194">*195 stock value," which on December 31, 1922, was $142,500; and which fixed the term and rentals to be paid under a lease covering the real estate and buildings owned by her and occupied by the said business for period of nineteen years from and after January 1, 1923, which she agreed to execute to the petitioner in the event he determined to acquire the business under said agreement; the terms and provisions of the lease were to be personally guaranteed by the petitioner. The option was to remain in force until January 1, 1922. On September 26, 1921, by mutual agreement of the contracting parties, the contract of December 16, 1916, was modified and the period within which petitioner could exercise his option to purchase was extended to January 1, 1925. In 1922 petitioner determined to exercise the option, and in August of that year he discussed this determination with his son. For financial reasons it was necessary that petitioner take others into the venture, 1929 BTA LEXIS 2105">*2108 and it was decided between him and his son that a corporation be formed to take over the business and certain department heads of the store be offered some of the stock.
Pursuant to this decision petitioner, during the year 1922, held numerous conferences with six of the department heads, in which they definitely agreed with the petitioner to organize a corporation; that they would each purchase a specified amount of common stock in the said corporation; that when said corporation started to transact business, ownership of common stock would be restricted to the department managers of the store; that thereafter no common stock of the corporation at any time be offered to or held by any person not a department head in the business, and then only to such department heads as said group should thereafter from time to time unanimously consent to. It was further agreed that petitioner was to be in control of the business, and in the event of his death or retirement his stock could be taken over by his sons if they were then active in the business. The original subscribers to the stock were materially influenced by these agreements and petitioner's oral promise that he would retain control. 1929 BTA LEXIS 2105">*2109 These agreements have been strictly observed, although never reduced to writing nor entered on the books of the corporation.
Two other employees, both active department heads, were also allowed to purchase common stock by the unanimous agreement of the aforesaid group in December, 1922.
When petitioner accepted his original position with Wyman upon a percentage basis of compensation it was understood that 10 per cent of the fixtures account should be written off each year. Later 25 per cent and 33 1/3 per cent were written off, and in 1917 the account was written off altogether. Petitioner protested against this practice, since it resulted in a reduced compensation for him, but 18 B.T.A. 194">*196 was told by Wyman that the fixtures would be his when he got the business. Since 1917, 25 per cent has been deducted from the fixtures account at the suggestion of the revenue agent. In the conferences held with the above department managers petitioner pointed out that his income had been reduced by about $35,000 as a result of the excessive depreciation taken on fixtures, and it was orally agreed that the business should pay him this sum in some way.
Petitioner caused to be formed1929 BTA LEXIS 2105">*2110 a corporation bearing the name George Wyman & Co., which was incorporated on December 12, 1922, under the laws of the State of Indiana, with an authorized capital stock of $350,000, divided into 2,000 shares of common and 1,500 shares of preferred stock, each having a par value of $100 a share. Petitioner and the above-mentioned department heads of the business were the incorporators.
The first meeting of the subscribers to the capital stock of George Wyman & Co. was held on December 14, 1922, at which meeting said subscribers recognized as the directors of said corporation, who were to serve until its first annual meeting, the persons named as such in the articles of incorporation, and also adopted a code of by-laws.
Pursuant to the agreement of September 26, 1921, between Clara L. Wyman and petitioner, a bill of sale covering the assets of said business and a lease in the form agreed upon were delivered to petitioner on January 2, 1923. By the terms of this bill petitioner agreed to pay Clara L. Wyman therefor as follows:
| Cash | $67,500 |
| 500 shares preferred stock of George Wyman & Co. (a corporation) | 50,000 |
| 5 promissory notes of $5,000 each | 25,000 |
| Total purchase price | 142,500 |
1929 BTA LEXIS 2105">*2111 The bill of sale and lease were to be effective at 11.59 p.m., December 30, 1922.
When the company began business January 2, 1923, it had a surplus of $13,000.
At a special meeting of the board of directors of George Wyman & Co. on January 2, 1923, the corporation accepted a proposition from the petitioner, wherein he offered to assign and turn over to said corporation the said lease and property covered by the bill of sale previously acquired by him from Clara L. Wyman. The consideration for such assignment was as follows:
| Payment in cash by the said corporation to Clara L. Wyman | $67,500 |
| Issuance to Clara L. Wyman of 500 shares of preferred stock of | |
| the par value of | 50,000 |
| Issuance to petitioner of common stock of a par value of | 55,000 |
| Issuance to petitioner of preferred stock of a par value of | 5,000 |
| Total | 177,500 |
18 B.T.A. 194">*197 Thirty thousand dollars was the amount of the excess in actual value of trade fixtures involved in the transaction over the book value thereof. In addition to the $55,000 in common stock issued to petitioner as aforesaid, petitioner purchased for $55,000 cash an additional 550 shares.
At the beginning of its business1929 BTA LEXIS 2105">*2112 $190,000 of the corporation's authorized common stock of $200,000 was taken. Of this amount petitioner held 1,100 shares of the par value of $100 a share; John J. Gehring, 100 shares; David M. Gemberling, 50 shares; F. A. Stevens, 100 shares; Frank W. Fritzer, 100 shares; Charles E. Speth, 200 shares; Donald H. Eldredge, 200 shares; Inez Case, 25 shares; and J. F. Stuller, 25 shares. Only one department head was not interested in purchasing any common stock, although it was offered to her. All the foregoing common stockholders, with the exception of Frank W. Fritzer and F. A. Stevens, borrowed money to make their purchases, and bought to the limit of their ability. It was known to all that there remained in the treasury available for purchase 100 shares of the common stock of the par value of $100. This stock remained there until 1925, when 25 shares were sold to J. J. Gehring, 25 to D. M. Gemberling, and 50 to F. A. Stevens. Prior to the disposition of these 100 shares the corporation was anxious to sell them, requiring the money in its business. An offer from its attorney to purchase, which was favored by petitioner, was rejected by the board of directors because the attorney1929 BTA LEXIS 2105">*2113 was not a department head of the corporation.
In May, 1923, Inez Case left the employ of the corporation, which thereupon exercised its right to repurchase the 25 shares of common stock which she held, paying her therefor $2,500, its book value. Thereafter it resold said stock, upon unanimous vote of the board of directors, to another department head at the same price. There were no other sales of or offers to buy common stock in 1923.
In January, 1925, Stuller left the employ of the company, returning his stock to the company for the price originally paid for it.
Charles E. Speth, the corporation's treasurer, has, since its issuance, held all the common stock in his possession in a safe-deposit box to which he has access. Subscribers for the stock were given by the treasurer a receipt for the certificates issued in their respective names and assigned by them in blank, the actual stock certificates never going into the owner's possession. This receipt provided that the stock certificate for which it was issued should remain at all times in the possession of the corporation's treasurer, and the wording of it was duly approved by the board of directors. A provision of the1929 BTA LEXIS 2105">*2114 by-laws, written on the face of the certificate, 18 B.T.A. 194">*198 made surrender of the certificate duly endorsed necessary to effect a transfer of the stock.
Article III of the articles of incorporation of the Wyman Company provided that the business to be carried on was merchandising, and article VI provided that the property to be taken over by the corporation was to be the individually owned business known as George Wyman & Co. Article II, section 1, of the code of by-laws adopted on December 14, 1922, provides that:
* * * All of said common stock shall at all times be the sole property of persons actively engaged in, or employed by the corporation and it is an express condition of the issuance and ownership of said stock, that should the owners thereof from any cause whatever, cease to be employed by the corporation, or shall die, or said stock shall be pledged, hypothecated or attached, garnished or levied upon to satisfy an execution against the owner, that the corporation shall have the absolute right to buy and reacquire said stock by paying therefor the book value thereof. Such stock so acquired or reacquired may be again issued by the corporation.
There was no provision, 1929 BTA LEXIS 2105">*2115 however, obliging the corporation to repurchase.
The corporation was authorized to issue $15,000 of 7 per cent cumulative preferred stock, preferred both as to assets and dividends over the common, redeemable only at 105 per cent of par and accumulated dividends, with the provision that the assets of the corporation could not be mortgaged or sold, and that other preferred stock of an equal ranking could not be issued without the consent of the preferred stockholders. In addition to the preferred stock there was authorized the $200,000 of common stock which alone had voting power. In pursuance of the said agreement which the petitioner had with the department heads, the incorporators, and directors of the company, the articles of incorporation, by-laws, common stock certificates and receipts therefor provided that such common stock could be owned only by persons employed by George Wyman & Co., with the right on the part of the company to reacquire the stock at book value whenever the holder died or withdrew from the business or did not give satisfactory service.
Efforts were made by the corporation to sell to its employees to preferred stock, upon the disposition of which there1929 BTA LEXIS 2105">*2116 was no restriction. Bulletins announcing a reorganization of the business were circulated among the employees prior to incorporation, urging them to purchase the preferred stock. Purchases were made by some to the aggregate value of $13,900, all of which was paid by the middle of January, 1923; no common stock was offered employees other than department heads in 1922 and 1923, nor did any volunteer to purchase it.
18 B.T.A. 194">*199 In 1921 the volume of the company's sales amounted to $1,000,000. It paid in 1923 a 6 per cent common stock dividend, but in 1924 or 1925 none was paid. The employees numbered between 150 and 160 and included managers, sales people, delivery men, elevator boys, etc. Their turnover was rapid, only forty-six in 1923 having been with the company over a year. The average wage paid was $18 a week; some received as low as $9 a week.
The aforesaid stock received by petitioner in 1923 in exchange for his property interest in the business assets and lease aforesaid did not have a readily realizable market value when received.
OPINION.
STERNHAGEN: In 1923 the petitioner exchanged the property, consisting of the business assets and leasehold interest, which1929 BTA LEXIS 2105">*2117 he had received from Mrs. Wyman in fulfillment of the preexisting contract, for, among other things, stock in the new corporation. By section 202(c), Revenue Act of 1921, no gain is recognized "unless the property received has a readily realizable market value." The respondent determined that the stock received by petitioner had a readily realizable market value equal to its par value, and raised the income by $30,000. In our opinion, the evidence of petitioner comprehended in the foregoing findings of fact clearly establishes that the value of the stock was not in fact a readily realizable market value, and hence under section 202(c) no gain shall be recognized. It is not necessary to analyze the legal effect of the agreement for the restricted ownership and disposition of the stock, for the question whether property has a readily realizable market value is primarily one of fact to be determined from a practical consideration of all the circumstances; and whether the restriction be enforceable or not, its existence with whatever it economically entails can not be ignored. Even if wholly unenforceable, or for some other reason beyond consideration, there is, in our opinion, ample1929 BTA LEXIS 2105">*2118 evidence otherwise that the value could not be readily realized. Nor is it important that the receipt by petitioner of the supplemental shares has an historical explanation in the earlier treatment of the depreciation account.
The respondent was in error in including $30,000 in petitioner's income as gain from the exchange, and the deficiency should be redetermined accordingly.
Reviewed by the Board.
Judgment will be entered under Rule 50.