Court Opinion

ID: 4632410
Source: CourtListenerOpinion
Date Created: 2020-11-21 03:11:44.755637+00
Date Added: 2024-06-11T07:57:53.561027
License: Public Domain

WILLIAM L. JAMES, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.  PEERLESS INVESTMENT COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.James v. CommissionerDocket Nos. 65302, 70278.United States Board of Tax Appeals30 B.T.A. 491; 1934 BTA LEXIS 1315; April 26, 1934, Promulgated *1315  1.  The deficiency notice in the case of petitioner William L. James was mailed more than two years after his return for the year 1928 was filed.  Respondent failed to prove fraud and it is held that assessment and collection of the proposed deficiency are barred.  2.  The evidence in the case of the Peerless Investment Co. does not establish that contracts acquired for stock had any greater value at the time of acquisition than that determined by respondent.  It is accordingly held that petitioner realized taxable gain upon liquidation of the contracts in an amount in excess of the value determined by the respondent.  M. M. Matthiessen, Esq., for the petitioners.  Warren F. Wattles, Esq., for the respondent.  ARUNDELL*492  The respondent determined a deficiency in income tax in the case of petitioner James for the year 1928 in the amount of $2,319.91, to which he has added a 50 percent fraud penalty of $1,159.96.  In the case of the Peerless Investment Co. the deficiency in income tax asserted is $2,728.92 for the 1929.  In the James case the questions are whether petitioner realized profit on the sale of stock and whether assessment*1316  and collection are barred by the statute of limitations.  The limitations question depends upon whether or not there was fraud.  In the Peerless Investment Co. case the issue is whether an amount received in 1929 was capital or income.  FINDINGS OF FACT.  William L. James - Docket No. 70278.In 1928 petitioner was a stockholder in Pacific Stages, Inc., an Oregon corporation, which owned and operated stage lines in competition with various common carriers, including the Southern Pacific Co., operating through its subsidiary, the Southern Pacific Motor Transport Co., hereinafter called the Transport Co. Pacific Stages, Inc., had an authorized capital of 2,000 shares of common stock of the par value of $100 each.  In 1928 there were 1,908 1/2 shares outstanding, of which petitioner owned 240 shares, which he had acquired at a cost of $10,434.78.  On September 17, 1928, James entered into a contract with the Transport Co. granting that company an option to purchase all the stock of Pacific Stages, Inc., for an initial consideration to be determined by appraisal of assets plus additional consideration in an amount equal to one half of the profits of Pacific Stages, Inc., for*1317  the three years following the consummation of the sale.  The contract provides that during that three-year period "the general plan of operations of Pacific Stages, Inc., shall be continued." In order to carry out the contract in the event the option was exercised, James procured the delivery to him, as escrow holder, of all the outstanding stock, with an agreement on his part to pay over to each stockholder his pro rata share of the purchase price.  On October 24, 1928, James and the Transport Co. entered into a supplemental agreement whereby the Transport Co. might elect to pay the sum of $90,000 in lieu of one half of the profits of Pacific Stages, Inc., designated in the original contract as additional consideration.  In December 1928 the Transport Co. exercised the option to purchase and paid as part of the initial consideration $106,131.27 and retained $10,356.24 to meet contingent claims.  After the receipt by James of $106,131.27 from the Transport Co., the vendors of 1,203 1/2 shares of Pacific Stages, Inc., stock *493  agreed with the vendors of the remaining 705 shares, including James, to surrender all rights in the remainder of the purchase price provided they*1318  were presently paid the sum of $80 per share.  The vendors of the 1,203 1/2 shares were thereupon paid at the rate of $80 per share, a total of $96,280, leaving in the hands of James $9,851.27 out of the part of the initial consideration received from the Transport Co.  The sum so remaining was disposed of as hereinafter related.  Petitioner James filed his income tax return for 1928 on March 15, 1929.  That return disclosed no item of profit on the sale of his stock in Pacific Stages, Inc.  The notice of deficiency was mailed by the respondent on January 9, 1933.  The deficiency asserted by the respondent is not due to fraud with intent to evade tax.  Peerless Investment Co. - Docket No. 65302.The group, including petitioner James, which had formerly owned 705 shares of stock of Pacific Stages, Inc., desired to continue in the motor transport business.  In order to carry out that purpose, in January 1929 it incorporated the petitioner, Peerless Investment Co., under the laws of Oregon with an authorized capital stock of 1,000 shares of common stock of the par value of $100 per share.  James and his associates subscribed for 705 shares of stock of the new corporation, *1319  which were issued to them in exchange for the transfer to the corporation of all rights under the contracts with the Transport Co., all rights under the contract with the former owners of the 1,203 1/2 shares of Pacific Stages, Inc., stock, and the payment to it of the $9,851.27 then remaining in the hands of James out of the part of the consideration paid by the Transport Co. in 1928.  The stock of Peerless Investment Co. was originally subscribed for as follows: SharesWilliam L. James240Claude Bettis72Eric Rendahl144H. Gall63W. J. Smith73L. Mackey50Clara A. Emerson63705This was precisely the number of shares each had owned in Pacific Stages, Inc., except L. Mackey, who had owned 72 shares and had sold 22 for $80 per share.  [The stipulation states that Mackey had owned 62 shares and sold 12, but from exhibits attached to the stipulation it appears that the correct figures are 72 shares owned and 22 sold for cash.] *494  By reason of the assignment of the aforesaid contract rights, the Transport Co. in May 1929 paid $5,000, and in August of that year paid $5,356.24, to the Peerless Investment Co., the sum of these*1320  two payments being the amount which had been retained in 1928 by the Transport Co. to indemnify it against possible contingent claims.  In December 1929 the Transport Co., in exercise of the option under the contract of October 24, 1928, paid the $90,000 therein provided for (in lieu of one half of the profits of Pacific Stages, Inc.) by then paying $30,000 in cash and giving its notes, one due February 26, 1930, for $15,000, one due June 26, 1930, for $30,000, and one due December 26, 1930, for $15,000.  OPINION.  ARUNDELL: In the case of petitioner James, the return was filed on March 15, 1929, and the deficiency notice was mailed on January 9, 1933.  The respondent alleges fraud to remove the case from the operation of the two-year limitation period prescribed by section 275 of the Revenue Act of 1928.  The evidence fails to convince us that there was fraud.  Petitioner James testified and explained fully his failure to report the sale of stock of Pacific Stages, Inc.  His testimony in part was as follows: My method of reasoning on that, whether right or wrong, was simply that we received the contract and a certain amount of money that was to be turned over for stock in*1321  another company, and all we were doing was trading stock for money in one case and getting stock back, and there was no income, as far as that was concerned.  That was my method of thinking of it, whether it was right or wrong.  The petitioner prepared his return himself, without assistance or advice from anyone versed in the tax law.  He received no cash for himself out of the transaction and considered that he had not realized any income.  We are unable to find in the evidence any indication of fraud with intent to evade tax, and we accordingly hold that respondent is barred from assessment and collection of the deficiency asserted against petitioner James.  This holding makes it unnecessary to decide whether the petitioner was right or wrong in his conclusion that he had realized no income from the sale of his stock.  In the case of the Peerless Investment Co. the respondent determined that gain was realized to the extent of the difference between the value of the contracts, plus cash, turned in for stock and the cash received plus the discounted value of the notes received in 1929.  He determined that the purchase contracts of the Transport Co.*495  when turned in to*1322  petitioner had a value of $36,192.49.  His computation, as explained by counsel at the hearing, is as follows: Amount realized on contracts:Cash paid in by James at organization$9,851.27Cash paid by Transport Co10,356.24Cash paid by Transport Co30,000.00Notes of Transport Co., discounted59,361.76109,569.27Less:Value of contracts$36,192.49Cash paid in -By James9,851.27By Transport Co10,356.2456,400.00Taxable gain53,169.27The petitioner reported a profit of $39,069.29 which it arrived at by the following method: Amount realized on contracts:Cash paid by Transport Co$10,356.24Cash paid by Transport Co30,000.00Notes of Transport Co., discounted59,361.7699,718.00Less:Value of contracts when received60,648.73Profit39,069.27Petitioner subsequently filed claim for refund of a portion of the tax paid, and it now claims that it realized no income from the transactions with James and the Transport Co.  We agree with petitioner in saying it is obvious that there was no gain to it in the original transaction with James and his associates who turned in their contracts and $9,851.27*1323  cash for stock of petitioner.  That was purely a capital transaction and respondent has not asserted a tax on it.  It is the next step, the liquidation of the contracts by the Transport Co., that the respondent asserts gave rise to gain.  Petitioner argues that this was not a sale or exchange, but a mere conversion of capital assets, and that even if it were a sale or exchange the contracts had a value of $90,000 when turned in to it, so that the receipt of that amount in cash and notes would give rise to no gain.  We are unable to agree with petitioner's argument that the conversion of capital assets may not give rise to gain or loss.  The disposition of capital assets for a sum in excess of their cost, or other basis, clearly results in income.  Had the petitioner in the present case sold its contracts to outside interests, undoubtedly gain or loss *496  would be recognized.  Looking at the other side of the ledger, outstanding capital stock is a capital item, yet the receipt of it by the issuing corporation in satisfaction of an indebtedness may result in gain or loss.  *1324 ; . Where upon disposition of an asset, whether it be through sale, exchange, or redemption by the obligor, the amount received is in excess of the basis, income is realized.  The result is an "accession to income" which is within the scope of the taxing act.  . The respondent has used as a basis in determining the amount of the gain a figure which he determined represented the value of the contract rights when turned in to petitioner for stock.  It is urged by petitioner that the contract rights had a value of $90,000, which was the amount that the Transport Co. was obligated to pay.  We assume that if the matter were seriously urged, petitioners would add to this the $10,356.24 which the Transport Co. withheld from the initial payment to meet contingent claims and released to petitioner in 1929.  At the time the contracts were turned in for stock the Transport Co. was not obligated to pay $90,000.  At that time it had an option to pay either that sum or one half of*1325  the profits from the operation of Pacific Stages, Inc., for a three-year period.  Obviously the Transport Co. would elect to pay the lower of the two amounts, and at the time of petitioner's receipt of the contract it was not known which election the Transport Co. would make.  It was not until December 1929 that the Transport Co. elected to pay $90,000.  The record contains no evidence directed toward establishing the value of the contracts.  The respondent has determined a value which is presumptively correct, and the petitioner has failed to meet the burden which is upon it of establishing error in the respondent's determination.  ; . Accordingly, decision in this case will be entered for the respondent.  Decision of no deficiency will be entered in Docket No. 70278.  Decision for the respondent will be entered in Docket No. 65302.