Court Opinion

ID: 4615361
Source: CourtListenerOpinion
Date Created: 2020-11-21 02:32:12.29731+00
Date Added: 2024-06-11T07:54:56.263239
License: Public Domain

MECHANICS BANK & TRUST CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Mechanics Bank & Trust Co. v. CommissionerDocket No. 29974.United States Board of Tax Appeals18 B.T.A. 237; 1929 BTA LEXIS 2094; November 18, 1929, Promulgated *2094  Transaction involved here in held to be an exchange of property for property, and the property received having no readily realizable market value, no loss can be recognized under the provisions of section 202 of the Revenue Act of 1921.  H. H. Shelton, Esq., for the petitioner.  Hartford Allen, Esq., and Hugh Brewster, Esq., for the respondent.  MORRIS*237  This proceeding is for the redetermination of a deficiency in income come tax of $5,149.83 for the calendar year 1922, and the error assigned by the petitioner is the failure of the respondent to allow a deduction of $97,000 in the computation of its net loss for 1921 to be deducted from its net income for the taxable year.  FINDINGS OF FACT.  The petitioner is a banking corporation, organized and chartered under the laws of the State of Tennessee in 1907, which during the *238  period in controversy engaged in the purchase and sale of securities under the supervision of the banking department of that State in conjunction with its regular banking business.  In July, 1914, the petitioner purchased 97 K.S. & E. Railroad Co. first mortgage bonds, par value, $1,000 each, for*2095  which it paid $97,000 in cash.  In 1921 the said K.S. & E. Railroad was in financial difficulties and the first and second mortgage bondholders petitioned the court for the appointment of a receiver, whereupon a receiver was appointed, vested with authority to operate the road.  On July 23, 1921, the road was ordered to be sold by the court because of the inability of the receivers to operate it profitably.  The first bid submitted to the court on July 23, 1921, was rejected.  On November 1, 1921, S. B. Luttrell, T. A. Wright, W. B. Townsend, and L.C. Gunter, directors, and also stockholders of the petitioner to the extent of $72,650 of the total outstanding par value of stock of $300,000, purchased the assets of the K.S. & E. Railroad in the name of L. C. Gunter, trustee, for and in consideration of the payment of $50,000.  The entire sum of $50,000 paid for the properties of said railroad was consumed in the payment of losses sustained in operation and receivers' and attorneys' fees.  Nothing whatsoever was paid to the petitioner out of said sale toward liquidation of the $97,000 of securities which it held.  The said directors and stockholders thereupon organized the Knoxville*2096  & Carolina Railroad Co. for the purpose of taking over and operating the defunct K.S. & E. Railroad properties.  At a meeting of the board of directors of the petitioner on November 12, 1921, which was attended by the said Luttrell, Wright, Townsend, and Gunter, the following minutes were recorded: W. B. Townsend made a report of the Committee in buying of the K.S. & E. Ry., stating that it had been bought in the name of L. C. Gunter, Trustee, for $50,000.00.  The matter as to how the total should be handled and what securities, the bank would receive was discussed at length and on motion of E. R. Oates, seconded by C. A. Perkins, the Chairman was authorized to appoint a committee of five to go into the matter thoroughly and agree on the amount of stock and bonds the Mechanics Bank & Trust Company should get from the proposed re-organization.  The Chairman then appointed Howell J. Davis, L. C. Gunter, W. B. Townsend, C. A. Perkins and S. B. Luttrell.  The Committee met and made the following recommendation.  "At your meeting held November 12, 1921, Messrs. Gunter, Townsend, Perkins and Davis were appointed a Committee to agree on the amount of stocks and bonds the Mechanics*2097  Bank & Trust Company should get from the proposed re-organization of the Knoxville, Sevierville & Eastern Railway Co.; it being understood that the bank was not to put up any cash for these securities, but was to get them gratis in return for surrendering its first mortgage bonds of the old Knoxville, Sevierville & Eastern Railway Company.  *239  All members of the Committee were present.  L. C. Gunter was elected Chairman and Howell J. Davis, Secretary.  On motion, duly made, seconded and carried, it was decided that the Mechanics Bank & Trust Company should have $50,000.00 of First Mortgage bonds and $25,000.00 in stock of the re-organized Knoxville, Sevierville & Eastern Railway by whatever name the company will be called.  In accordance with the above, this Committee advised the new owners of the Knoxville, Sevierville & Eastern Railway Company to that effect." The minutes of the board of directors' meeting of January 12, 1922, contain the following recitals and resolution with respect to the K.S & E. Railroad transaction: WHEREAS the Mechanics Bank & Trust Company was the holder of $97,000.00 par value of bonds in the Knoxville, Sevierville & Eastern Railway Co. *2098  , which has been sold in the Chancery Court of Knox County and purchased by L. C. Gunter, as Trustee, for $50,000.00; the said L. C. Gunter acting as Trustee for Mechanics Bank & Trust Company, S. B. Luttrell and T. A. Wright, the said S. B. Luttrell being the owner of $43,000.00 par value of the said Knoxville, Sevierville & Eastern First Mortgage bonds, and T. A. Wright $24,000.00 of said Knoxville, Sevierville & Eastern Ry. Company bonds, and WHEREAS, the said L. C. Gunter conveyed his said purchase and said property to the Knoxville & Carolina Railroad Company, a corporation organized with an authorized capital stock of $400,000.00 and the stock all to be issued to the said Gunter, as such Trustee, in payment for said transfer, and WHEREAS, it is contemplated that the Knoxville & Carolina Railroad Company shall obtain authority to issue $300,000.00 par value of 6% mortgage bonds, and that the said Gunter, acting for the parties for whom he is acting as Trustee, shall return back into the treasury of the Railroad Company $375,000.00 of the Capital Stock, and that there shall be issued to the said Mechanics Bank & Trust Company, S. B. Luttrell and T. A. Wright, $82,000.00 of said*2099  First Mortgage bonds; and that the $25,000.00 of Capital Stock and the $82,000.00 of First Mortgage bonds shall be given to the said Mechanics Bank & Trust Company, S. B. Luttrell and T. A. Wright, in consideration of their interest in the property thus conveyed to the Knoxville & Carolina Railroad Company, and WHEREAS, it is contemplated that the Knoxville & Carolina Railroad Company shall sell for par $100,000.00 of its First Mortgage bonds and give to each purchaser of said bonds, stock in the Road two for one covering said $100,000.00 First Mortgage bonds, so that when the Knoxville & Carolina Railroad is thus fully organized, it will have outstanding $182,000.00 of First Mortgage bonds and $225,000.00 of Capital Stock, and will still have in the Treasury $118,000.00 of its First Mortgage bonds and $175,000.00 of its Capital Stock, and WHEREAS it is understood that $75,000.00 out of the $100,000.00 First Mortgage bonds have already been tentatively subscribed for by S. B. Luttrell, W. B. Townsend, L. C. Gunter and T. A. Wright, it being contemplated that the Mechanics Bank & Trust Company should not make any other or further investment in said Knoxville & Carolina Railroad*2100  Company.  NOW THEREFORE, be it resolved that the Mechanics Bank & Trust Company accept from the K. & C. Ry. Co. $50,000.00 of said $82,000.00 of said First Mortgage bonds, and $25,000.00 par value of the stock in payment of its interest in the purchase of the said Knoxville & Sevierville & Eastern Ry. Co., and of its interest in the Knoxville & Carolina Railroad Company under the organization *240  hereinbefore outlined, all to be effected so soon as the Interstate Commerce Commission shall give its authority for the issuance of the stock and bonds of the Knoxville & Carolina Railroad Company.  Said resolution was seconded and duly carried.  Although the petitioner supplied none of the funds for the purchase of the K.S. & E. Railroad, it was understood between the petitioner and the purchasers of the Knoxville & Carolina Railroad Co. in November, 1921, that it, the petitioner, would receive $5,000 first mortgage bonds and $25,000 capital stock.  The organizers turned over to the petitioner securities of said road to the extent of only $66,200, however, being $50,000 in bonds and $16,200 in stock.  Those securities had no marketable value.  The securities of the K.S. *2101  & E. Railroad had no value in 1921 after it was in receivership.  In fact it is questionable if they ever had any value.  However, the directors of the petitioner were optimistic in January, 1922, as in indicated by the minutes of the board of directors of January 12, 1922, in which it is said: The next item we wish to call to your attention is a Profit and Loss Account.  We have charged to this account to cover losses which include the K.S. & E. Ry. Co., McDowell Constr. Co., Bales Motor Co., and others approximately $32,000.  We believe the K.S. & E. Ry. Company matter to be in the best condition that it has been for years as we own over half the assets, whereas under the old organization we owned not quite one third.  A fuller report as to the Railroad matter will be made later.  In its return for the calendar year 1921 the petitioner deducted $22,000, representing a loss on K.S. & E. Railroad bonds, which the respondent allowed.  In its return for 1922 an additional amount of $25,000 was deducted and described therein as bad debts growing out of the said K.S. & E. Railroad bonds, and in 1923, a further amount of $30,000 was deducted, both of which amounts, however, were disallowed*2102  by the respondent.  In 1922 the petitioner commenced liquidation and in 1923 the securities of the Knoxville & Carolina Railroad were sold for $20,000.  OPINION.  MORRIS: The petitioner contends that it suffered a complete loss of its investment in the K.S. & E. Railroad Co. in 1921 and that the respondent erred in refusing to allow such loss which, if allowed, would result in a net loss to be carried forward to 1922, the taxable year, and eliminate the deficiency for that year.  The respondent contends, on the other hand, that it was an exchange of securities, either directly or indirectly, within the purview of section 202 of the Revenue Act of 1921, consequently no loss occurred until the year 1923, when the securities of the Knoxville & Carolina Railroad were *241  sold, for the reason that the transaction which occurred during the year 1921 was not closed and completed.  The respondent contends further that, should we hold that the receipt of new certificates did not bring the transaction within the provisions of the sections of the Act relied upon, the loss sustained on the bonds of the K.S. & E. Railroad Co. occurred prior to the year 1921.  Section 202(c)(2) of*2103  the Act aforesaid provides, insofar as applicable: (c) For the purposes of this title, on an exchange of property, real, personal or mixed, for any other such property, no gain or loss shall be recognized unless the property received in exchange has a readily realizable market value; but even if the property received in exchange has a readily realizable market value, no gain or loss shall be recognized - * * * (2) When in the reorganization of one or more corporations a person receives in place of any stock or securities owned by him, stock or securities in a corporation a party to or resulting from such reorganization.  The word "reorganization," as used in this paragraph, includes a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or of substantially all the properties of another corporation), recapitalization, or mere change in identity, form, or place of organization of a corporation, (however effected).  If the transaction whereby the petitioner received securities of the Knoxville & Carolina Railroad*2104  Co. was an "exchange" within the meaning of section 202(c), supra, then no loss "shall be recognized" unless the securities of the said road so received had a "readily realizable market value." The matter of the purchasing the said K.S. & E. Railroad was discussed at the meeting of the board of directors of the petitioner on November 12, 1921, and definite plans were laid for issuing certain of the securities of the Knoxville & Carolina Railroad Co. to the petitioner.  A committee was appointed to agree upon the amount of stock and bonds which the petitioner should receive from what was termed therein as a "reorganization." The said committee met and made its recommendations on the same date aforesaid, at which time the committee stated that the petitioner was not to advance any cash but was to receive the said securities "gratis," adding, however, "in return for surrendering its First Mortgage bonds of the old Knoxville, Sevierville and Eastern Railway Company." What the parties had in mind when they required the surrender of the bonds of the K.S. & E. Railroad for the securities of the Knoxville & Carolina Railroad, we do not know.  It is certain, however, they they regarded*2105  the surrender as a part of the transaction.  Therefore, we believe no violence is done to *242  the word "exchange" to say that there was an exchange of property for property within the meaning of section 202(c), supra.Did the securities of the Knoxville & Carolina Railroad Co. which the petitioner received in exchange for the surrender of its bonds of the K.S. & E. Railroad Co. have a "readily realizable market value"?  One of the petitioner's witnesses said they did not.  That witness was asked on direct examination whether the securities of the Knoxville & Carolina Railroad had any marketable value and he replied, "There was no marketable value." While he does not use the words as they are used in the statute, his statement can have only one meaning, and that is that they had no readily realizable market value.  This, we believe, is borne out by other testimony of record.  We are of the opinion, therefore, that the respondent's findings should be approved.  Judgment will be entered for the respondent.