Court Opinion

ID: 4612972
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:52:24.132068+00
Date Added: 2024-06-11T07:54:31.944263
License: Public Domain

WALLACE GROVES, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Groves v. CommissionerDocket No. 77324.United States Board of Tax Appeals36 B.T.A. 14; 1937 BTA LEXIS 785; June 4, 1937, Promulgated 1937 BTA LEXIS 785">*785  An individual who owns all the shares of a newly created corporation (F) and is under contract with an existing corporation (M) for his services in exchange for shares of M stock, makes a contract of employment with F, which assigns it to another corporation (W), which in turn assigns it to M for the said shares of M stock, held, under the circumstances, properly taxable upon the value of the M shares when received by W from M.  Hugh Satterlee, Esq., Albert S. Lisenby, Esq., and Philip Zimet, Esq., for the petitioner.  John E. Marshall, Esq., and Allen T. Aikin, Esq., for the respondent.  STERNHAGEN 36 B.T.A. 14">*14  The respondent determined a deficiency of $173,699.57 in petitioner's income tax for 1930, by (1) including in his income $713,000 as the value of shares said to have been received by him in that year, and (2) disallowing an interest deduction of $7,000.  By amended answer, the respondent alleges, in the alternative, that the shares were subject to petitioner's unfettered command and enjoyment during 1930, and, as new matter, that the petitioner in that year acquired shares in another corporation, the value of which ($510,000) was within1937 BTA LEXIS 785">*786  his income.  FINDINGS OF FACT.  Petitioner, now a resident of New York, was in 1931 a resident of Baltimore, where he filed his income tax return for 1930.  In 1929 and into 1930 he was employed by First Industrial Bankers, Inc., engaged in the small loan business, at an annual salary of $12,000.  That corporation had been organized January 9, 1929, and its outstanding shares in 1930 were 54,000 common and 46,296 preferred.  36 B.T.A. 14">*15  Of the 54,000 common, 18,000 were owned in equal shares by Belmont & Co., C. T. Williams & Co., and the Bankers Bond & Share Co., and 36,000 were owned by the First Industrial Holding Corporation, of which petitioner was an officer and director. 1 Petitioner "controlled" the 36,000 shares held by the First Industrial Holding Corporation.  In June 1930 Arthur M. Greene, president of the Merchants & Manufacturers Securities Co., informally began conversations and negotiations with petitioner1937 BTA LEXIS 785">*787  looking to the acquisition of an interest in First Industrial Bankers, inc., which resulted in an understanding that the Securities Co. should acquire the 54,000 common shares for $1,000,000 and that First Industrial Bankers, Inc., should be merged with the Domestic Finance Corporation, a subsidiary of the Securities Co.  This understanding was then to be embodied in a written agreement, the "mechanics" and details of which were to be "left entirely with the attorneys and accountants" of Greene.  On June 20, 1930, petitioner caused the Firinbank Corporation to be organized, with an authorized capital stock of 5,000 shares of $10 par value.  On June 21, 1930, the Wagegro Corporation was organized with an authorized capital stock of $1,000,000, consisting of 5,000 class A and 5,000 class B shares, and petitioner and his brother immediately became directors.  On June 26, 1930, petitioner acquired options to purchase the 18,000 shares of First Industrial Bankers, Inc., from Belmont & Co., C. T. Williams & Co., and the Bankers Bond & Share Co. for $191,146.14.  The written agreement between Greene, representing the Securities Co., and Groves, is dated June 27, 1930.  It provided1937 BTA LEXIS 785">*788  for the efforts of both to accomplish the merger of Domestic Finance and First Industrial Bankers, Inc., and set forth the details of the contemplated method of accomplishing such merger, among which was the acquisition by Domestic Finance of the 54,000 common shares of First Industrial Bankers, Inc., in exchange for 18,000 common shares of Domestic Finance.  It provided that upon such merger Groves would cause the said 18,000 common shares of Domestic Finance to be delivered to the Securities Co. and that he would: ARTICLE III 1.  * * * (f) * * * * * * (bb) cause to be assigned to the Securities Company or such corporation as it shall designate the employer interest in said employment contract, upon the Securities Company causing to be delivered to Groves or such person, firm or 36 B.T.A. 14">*16  corporation as he shall designate (whichever shall have transferred said securities and employment contract) (i) as payment for said 18,000 shares of common capital stock of Domestic Finance Corporation (Consolidated) the sum of $425,000 in cash, and (ii) as payment for the assignment of said employment contract 23,000 shares of Class "A" stock of the Securities Company accompanied by the1937 BTA LEXIS 785">*789  valid enforcible commitment of some person, firm or corporation to purchase from the holder thereof said 23,000 shares of Class "A" stock of Securities Company for the sum of $575,000, it being understood that the Securities Company guarantees the performance of the obligations of said commitment.  The "said employment contract" referred to in the above quoted paragraph (bb) was that covered by the following paragraph: ARTICLE IV * * * * * * 3.  Groves agrees that on or prior to the date of closing he will enter into an Employment Contract with the Securities Company or such other corporation as shall have authority to engage in the small loan business either directly or through subsidiary or affiliated companies under the terms of which Groves agrees to devote his entire time and services to such corporation and its subsidiary and affiliated companies for a period beginning on the date of closing and ending January 1, 1933, for an annual salary of $18,000 per year payable in equal monthly installments, and binds himself not to engage directly or indirectly in any business in competition with such corporation or its subsidiary or affiliated companies or in the so-called small1937 BTA LEXIS 785">*790  loan business for a period of two (2) years from and after the date of termination of such Employment Contract; and Groves agrees that on the date of closing, and upon the payment of the consideration provided by this agreement to be paid, he will cause the employer interest in said contract to be vested in such corporation as the Securities Company shall designate.  Such Employment Contract shall be in substantially the words and figures of the draft of Employment Contract marked "Exhibit B" and annexed to and by reference incorporated herein and made a part hereof.  On August 8, 1930, petitioner made an offer to the Firinbank Corporation of an option to purchase 36,000 shares of First Industrial Bankers, Inc., for $300,000, an assignment of options held by him for the purchase of 18,000 such shares, and $5,000 in cash, in exchange for the issuance to him by the Firinbank Corporation of its 5,000 shares of capital stock.  On the same date, this offer was accepted and the option covering 36,000 shares "controlled by" Groves was executed, and those covering the 18,000 shares were assigned.  On the same date, petitioner and the Firinbank Corporation agreed that petitioner would be1937 BTA LEXIS 785">*791  employed by the corporation for the period August 15, 1930, to January 1, 1933, and would receive compensation of $1,500 a month, and would refrain from the small loan business, except in New Mexico and Arizona, for two years after termination of the employment.  At the first meeting of the directors of Wagegro, on August 8, 1930, petitioner was elected president and treasurer.  At the meeting, consideration was given to an offer dated August 8, 1930, of Arthur 36 B.T.A. 14">*17  Greene to purchase from the corporation 5,000 of its class A shares for $500,000 in cash, the shares to be issued in Greene's name.  The offer was accepted.  Thereupon the directors immediately resigned, and Greene, Dallstream, and Dixon were elected in their places.  Dallstream and Dixon were associates of Greene.  Greene was now the Wagegro Corporation's sole shareholder.  On August 11, 1930, the charter of the Wagegro Corporation was amended as the result of a stockholders' meeting at which Groves voted all the shares under a proxy from Greene.  On August 12, 1930, the Firinbank Corporation made a written offer to the Wagegro Corporation, which was accepted by the Wagegro Corporation on August 13, 1930, to1937 BTA LEXIS 785">*792  assign to Wagegro the four options for the purchase of 54,000 shares of First Industrial Bankers, Inc., and its employment contract with Groves, in exchange for 5,000 class B shares of Wagegro to be issued to it.  On August 13, 1930, the four options and the employment contract were assigned by the Firinbank Corporation to the Wagegro Corporation, and the Wagegro Corporation resolved to exercise the options to purchase the 54,000 shares of First Industrial Bankers, Inc., for approximately $500,000.  The options were exercised and the 54,000 shares purchased by the Wagegro Corporation. 2 At the same meeting, an offer was received from the Securities Co. to issue to the Wagegro Corporation 23,000 shares of its class A stock "having a present fair market value of $575,000", in exchange for an assignment of the Firinbank-Groves employment contract; this offer was accepted, and the employment contract was assigned by the Wagegro Corporation to the Domestic Finance Corporation by direction of the Securities Co.  The fair market value of the 23,000 class A shares of Securities Co. was $575,000.  1937 BTA LEXIS 785">*793  On August 15, 1930, Greene made an offer to Wagegro, which Wagegro accepted, to purchase 23,000 class A shares of the Securities Co. for $575,000, payable $75,000 in cash and $500,000 by the surrender for retirement of 5,000 class A shares of the Wagegro Corporation.  On the same date, August 15, 1930, the Securities Co. made an offer to the Wagegro Corporation, which the Wagegro Corporation on that date accepted, to purchase the 54,000 common shares of First Industrial Bankers, Inc., for $425,000 cash.  Thereupon all the directors and officers, viz,. Greene, Dallstream, and Dixon, resigned and Groves, Sommerwerck, and Taylor were elected to their places.  Sommerwerck and Taylor were associates of Groves.  In January 1931 the employment contract, which was then still held by Domestic Finance Corporation, was substantially modified 36 B.T.A. 14">*18  by the parties by a reduction in the amount of compensation, a change in the services to be rendered by Groves, and in the extent of the restriction against engaging in the small loan business.  Petitioner at no time received the 23,000 class A shares of the Securities Co. which were, as above found, issued to the Wagegro Corporation on August 15, 1930. 1937 BTA LEXIS 785">*794  The 54,000 shares of First Industrial Bankers, Inc., were not transferred to or acquired by the Securities Co. in exchange for 18,000 shares of Domestic Finance Corporation as provided by the contract of June 27, 1930, between the Securities Co. and Groves.  The Firinbank Corporation is still in existence and operates as a holding company.  It still holds the Wagegro shares.  The Wagegro Corporation is still in existence, having the same capital, and has been active "as a finance company", buying securities, selling securities, and buying notes.  The Securities Co., on its income tax return for the fiscal year ended March 31, 1931, took a deduction of $151,315.80 as amortization of the Firinbank-Groves employment contract, computed upon a cost basis of $575,000 amortized over the period August 15, 1930, to January 1, 1933.  2.  Beginning in August 1930 petitioner borrowed money from time to time from the Wagegro Corporation, and all such loans have since been paid by petitioner in full.  In September 1930 he paid $7,000 to the Wagegro Corporation as interest on his indebtedness to that corporation.  OPINION.  STERNHAGEN: 1.  The Commissioner added $713,000 to the petitioner's1937 BTA LEXIS 785">*795  income as "value of stock distribution", and explained this determination as follows: 1.  Information on file in this office indicates that in 1930 you received from the Wagegro Corporation and/or the Firinbank Corporation 23,000 shares of Class A common stock of the Merchants and Manufacturers Securities Company without cost to you.  It is held that the fair market value of this stock at the date of receipt was $31.00 per share, and your net income has accordingly been increased by $713,000.00, representing the fair market value of 23,000 shares of stock received.  This determination the petitioner assails, alleging that he did not receive the said shares and that their value was no more than $25 each, or $272,000.  The value of the shares has been found from the only evidence to have been $575,000; and this the respondent no longer disputes, but expressly accepts.  At the trial, respondent fild an amended answer adding an affirmative allegation: * * * (in the alternative to his determination as set forth in the notice of deficiency) that the 23,000 shares * * * were subject to petitioner's 36 B.T.A. 14">*19  unfettered command on or about August 15, 1930 and he was then free to enjoy1937 BTA LEXIS 785">*796  them at his own option, * * *.  Petitioner denies this in his reply.  The evidence seems to set forth all that occurred, and there is no substantial dispute as to the facts.  The argument turns upon whether Groves must in the circumstances be regarded as realizing income of $575,000 in 1930 upon which he may lawfully be taxed.  If so, it is of minor consequence whether he be said to have received the shares, or to have been free to enjoy them, or to have had unfettered command over them.  Nor is it determinative that substance is more important than form or that corporate entities may not be disregarded or confused with their shareholders.  The matter which is difficult to treat as having jural significance is not the legal existence of any of the corporations, but the Firinbank-Groves employment contract and its assignments.  When Groves, in June, made his agreement with the Securities Co. he was not under a contract of employment with Firinbank, and was individually free to contract at once with the Securities Co. to serve that corporation.  By the June agreement, Article IV * * * 3, he bound himself to do this either by a direct employment contract or by procuring the assignment1937 BTA LEXIS 785">*797  of an employment contract made with another corporation.  Being so bound, he was then in no position to make a bona fide contract at arm's length to serve another corporation.  Such a bona fide contract could only be made subject to a duty of the employer corporation to assign it, and this would have been an anomaly, for the corporation would have purported to gain the right to Groves' services and at the same time agree to assign the right.  It is impossible to imagine such a contract being knowingly made by an independent corporation.  But Groves did not make a contract at arm's length.  The contract which he purports to have made is with a corporation (Firinbank), of which he owned all shares and was president and which he completely controlled.  While the existence of this corporation as a legal entity may not be ignored, the ownership by one person of all its shares and his resulting control is a circumstance affecting the reality or intendment of a contract between the two.  Their relation makes it necessary that the contract be subjected to the most careful scrutiny.  Groves' knowledge of the existing commitment to the Securities Co. must be imputed as well to the1937 BTA LEXIS 785">*798  corporation, for his was the only mind it had; and it is too much to require the Government to treat the employment contract as a real and substantial creation of new rights and obligations merely because it was stated in writing and contained no provision for the specifically contemplated assignment 36 B.T.A. 14">*20  to the Securities Co.  If Groves had insisted upon the Securities Co. making an employment contract directly with him, his right to it and to the 23,000 shares or their value was clear.  He chose instead to make a contract with Firinbank and to have Firinbank make a contract with him, well knowing that both the contracting parties were aware of the Securities contract and indeed the whole plan.  In this employment contract it is impossible to find substance, irrespective of the legal existence of the Firinbank Corporation.  Cf. ; ; certiorari denied, . The assignment of the employment contract to the Wagegro Corporation is in no better case.  Greene was the shareholder and Groves held the proxy. 1937 BTA LEXIS 785">*799  Both knew of the Securities Co. contract, and Wagegro must, through either or both of them, have known of it when it took the assignment and turned it over to the Securities Co. for the 23,000 shares.  Groves was at that time free to contract to serve the Securities Co., and receive the 23,000 shares, or have them go to such corporation as he might designate.  Their going to the Wagegro Corporation must be regarded as one of those anticipatory arrangements, whereby the fruit is attributed to a different tree from that on which it grew.  . Therefore it was proper, despite the issuance of the shares to Wagegro, to tax Groves as if he had received them.  ; ; see . There is no occasion to discuss the part of the plan by which the 54,000 shares in First Industrial Bankers reached the Securities Co., and were paid for, for all the Commissioner seeks is that the $575,000 value of the 23,000 shares shall be taxed to Groves, and in this he is sustained.  It maight1937 BTA LEXIS 785">*800  be that, looking at the entire transaction from the time of Greene's first conversation with Groves, the $575,000 should be attributed to Groves upon still other theories.  But it seems sufficient, after studying the events in their entirety, to consider petitioner's case at the point where it is most vulnerable.  For the reason stated, the Commissioner's determination is sustained.  2.  The Commissioner disallowed a deduction of $7,000 interest, saying: 2.  The deduction of $7,000.00, representing interest paid to the Wagegro Corporation, does not appear to be a proper deduction from income and has therefore been disallowed.  The evidence is all one way to support the finding that petitioner paid the amount to Wagegro as interest on an existing indebtedness, which has since been discharged.  The Commissioner's determination must be reversed.  36 B.T.A. 14">*21  3.  In the amended answer, the respondent sets up as new matter that in consideration of petitioner's entering into a contract of employment with the Firinbank Corporation he received 5,000 shares of that corporation having a fair market value of $510,000.  This the petitioner denies.  The issue is not pressed in argument. 1937 BTA LEXIS 785">*801  As appears from the findings, the 5,000 shares were not the consideration in the employment contract, but were issued for the options and $5,000 cash.  There is, therefore, no ground for respondent's contention, and it must fail.  Reviewed by the Board.  Judgment will be entered under Rule 50.Footnotes1. It was stated by petitioner's counsel at the bar that petitioner or his brother was the principal holder of the common shares of the First Industrial Holding Corporation, and this has not been disputed, although there is no evidence of the exact ownership. ↩2. Although this fact does not directly appear in the evidence, it is an inescapable inference and there is no reason in the argument to believe that it is disputed. ↩