Opinion
Docket No. 21075.
1950-05-16
A. B. & CONTAINER CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Nathan Wald, Esq., for the petitioner. Sheldon V. Ekman, Esq., for the respondent.
EXCESS PROFITS TAX— DEDUCTIONS— CREDITS— CORPORATE IDENTITY.— The Commissioner can not disregard the ta- consequences of an unsuccessful business, regularly carried on by a corporation for several years, merely because it acquired and also carried on during the taxable year an additional unrelated profitable business formerly carried on by its present stockholders as partners. Nathan Wald, Esq., for the petitioner. Sheldon V. Ekman, Esq., for the respondent.
The Commissioner determined for the fiscal year ended October 31, 1943, a deficiency of $2,231.90 in declared value excess profits tax and a deficiency of $22,008.03 in excess profits tax of the petitioner. The issues for decision are whether the Commissioner erred in (1) disallowing the loss of $6,352.44 incurred in the operation of the book business department of the petitioner during the taxable year; (2) disallowing the net loss carry-over of $14,809.44 sustained in the two preceding fiscal years; and (3) disallowing the benefits of an unused excess profits credit carry-over in the amount of $6,800.98 in the computation of its excess profits credit.
FINDINGS OF FACT.
The return for the taxable year was filed with the collector of internal revenue for the third district of New York.
The petitioner was organized on September 11, 1937, under the name of American Book Exchange, Inc. It was engaged in the business of buying and selling college and law school textbooks in a large room on the second floor of a building in Brooklyn. Some of its business was done through lists furnished students at various colleges and universities and through student salesmen.
Zola Harvey was the owner of all of the capital stock of the petitioner in 1942.
It kept its books and filed its returns upon an accrual basis of accounting and on a fiscal year ended October 31. It had sustained losses for a number of years after deducting officers' salaries. Harvey's salary for the fiscal year ended October 31, 1941, was $3,975 and had been $3,900 for each of the two preceding years.
Harvey, in the summer of 1942, had received notice to report for a physical examination preparatory to going into the Army and was worried about what would happen to his business in case he had to go into the Army. He felt that a forced sale of the assets might result in insufficient funds with which to pay the liabilities of the corporation, although the book value of the assets was in excess of the liabilities, excluding capital stock. He discussed the situation with Saul Kramer, his brother-in-law. Kramer had had no experience in the book business.
Kramer was at that time engaged in the business of selling paper containers at wholesale through a partnership consisting of himself, his father, Joseph, and his mother, Rose Kramer. That was a profitable business.
Kramer, after investigation, found that he could purchase accounts payable of the petitioner in the amount of $50,755.34 for 25 cents on the dollar, or $13,549.04. He purchased those accounts payable for that amount of money after discussion with his father. He then notified Harvey that he would take over the business and Harvey transferred all of the capital stock of the petitioner to the three Kramers on December 29, 1942. Harvey received nothing for the stock.
A certificate of change of name to A. B. & Container Corporation was filed by the petitioner with the Secretary of State of New York on January 21, 1943.
The Kramers terminated their partnership on January 31, 1943, and transferred its assets and liabilities to the petitioner, which reflected them on its books as of February 1, 1943.
The Kramers, on February 4, 1943, assigned to the petitioner its accounts payable in the amount of $50,755.34 which they had previously purchased.
The petitioner increased its capital stock, and on March 9, 1943, issued to the Kramers 50 shares of its capital stock. The following journal entry was made on its books:
+------------------------------------------------------------+ ¦Accounts Payable ¦$50,755.34 ¦ ¦ +----------------------------------+------------+------------¦ ¦Capital stock issued ¦ ¦$50,000.00 ¦ +----------------------------------+------------+------------¦ ¦Capital surplus ¦ ¦755.34 ¦ +------------------------------------------------------------¦ ¦To record the issuance of 50 shares of no par value stock in¦ +------------------------------------------------------------¦ ¦payment of accounts payable. ¦ ¦ ¦ +------------------------------------------------------------+
Harvey was not inducted into the Army because of a 4-F rating. He was employed by the petitioner on a salary for all or a part of the taxable year.
The petitioner reported for the taxable year a net profit of $66,492.98, consisting of a profit of $87,654.86 from its container business, a net operating loss deduction of $14,809.44 carried over from prior years, and a loss of $6,352.44 from its book business. The latter loss was computed as follows:
+-----------------------------------------------------------------------+ ¦Sales of books for fiscal year ended Oct. 31, 1943¦ ¦$13,563.41¦ +--------------------------------------------------+---------+----------¦ ¦Purchases ¦$8,487.14¦ ¦ +--------------------------------------------------+---------+----------¦ ¦Add opening inventory, 10/31/42 ¦43,483.90¦ ¦ +--------------------------------------------------+---------+----------¦ ¦Total ¦51,971.04¦ ¦ +--------------------------------------------------+---------+----------¦ ¦Less closing inventory, 10/31/43 ¦39,720.00¦12,251.04 ¦ +--------------------------------------------------+---------+----------¦ ¦Gross profit ¦ ¦1,312.37 ¦ +--------------------------------------------------+---------+----------¦ ¦Less expense ¦ ¦7,664.81 ¦ +--------------------------------------------------+---------+----------¦ ¦Net loss ¦ ¦6,352.44 ¦ +-----------------------------------------------------------------------+
The petitioner at or about the close of the taxable year transferred its book business from Brooklyn to smaller quarters in a loft in Manhattan, and during the next fiscal year sold its entire inventory of books for scrap and liquidated the book business. It reported for that year a net profit of $46,294.70, consisting of a profit of $86,316.85 from the container business and a loss of $40,022.15 from the book business, computed as follows:
+------------------------------------------------------------+ ¦Sales ¦$2,987.97¦ ¦ +---------------------------------------+---------+----------¦ ¦Cost of goods sold (inventory 10/31/43)¦39,720.00¦ ¦ +---------------------------------------+---------+----------¦ ¦Gross loss ¦36,732.03¦ ¦ +---------------------------------------+---------+----------¦ ¦Other income ¦5.96 ¦ ¦ +---------------------------------------+---------+----------¦ ¦Loss on sales ¦ ¦$36,726.07¦ +---------------------------------------+---------+----------¦ ¦Bad debts ¦2,663.18 ¦ ¦ +---------------------------------------+---------+----------¦ ¦Depreciation ¦617.90 ¦ ¦ +---------------------------------------+---------+----------¦ ¦Other deductions ¦15.00 ¦3,296.08 ¦ +---------------------------------------+---------+----------¦ ¦Total loss ¦ ¦40,022.15 ¦ +------------------------------------------------------------+
The Kramers bought the accounts payable of the petitioner and acquired its capital stock for business purposes and not for the purpose of reducing taxes. The book business declined because the war took so many of the students out of the law schools. The decision to discontinue the book business was reached because the books on hand would be out of date after the war and there were no immediate prospects of profits.
The Commissioner, in determining the deficiency, held that the petitioner was ‘not entitled to any portion of the net operating loss of $6,352.44 incurred in the operation of the book business as an offset against your income derived from the corrugated container business for the fiscal year ended October 31, 1943,‘ and also that it was not entitled ‘to any portion of the net operating losses aggregating $14,809.44 sustained by the American Book Exchange, Inc. for the two preceding fiscal years ending October 31, 1941 and October 31, 1942 as a deduction in computing your net income for the fiscal year ended October 31, 1943.‘ He further held in connection with the computation of the excess profits credit:
The money paid in for stock has been limited to $13,549.04, the amount paid in cancellation of the indebtedness of American Book Exchange, Inc.
It is held that in computing your excess profits credit for the fiscal year ended October 31, 1943, you are not entitled to the benefits of an excess profits credit carryover in the amount of $6,800.98 attributable to the American Book Exchange, Inc.
The stipulation of facts is incorporated herein by this reference.
OPINION.
MURDOCK, Judge:
The Commissioner has referred to no provision of the Internal Revenue Code or to any decided case which would support the strange position which he has taken in this case. The following is the way he described his position in his brief:
* * * The situation in this case is unique in that the Commissioner is not seeking to tax an individual or a corporation by reason of the acquisition or control of another corporation but seeks, upon the same basic legal reasons peculiar to that type of case, to deny a corporation the right to benefits of deductions and credits of a predecessor business where the transactions involved are done to evade Federal taxes.
While the technical form of the old corporation, American Book Exchange, Inc. has been retained, what happened in substance was that a new corporation for Federal taxing purposes came into existence and the alleged net operating losses and credits attributable to the old corporation should not be recognized. The corporate veil should be pierced, or rather the old structure be disregarded just as is done when a closely owned corporation buys another corporation for a similar tax evasion objective.
He apparently finds some similarity between the facts in this case and cases in which a corporation doing a profitable business has found another which could be obtained cheaply and would bring great tax benefits into the group if the two could be parties to a statutory reorganization. Cf. Ericsson Screw Machine Products Co., 14 T.C. 757. But the similarity between the present situation and such a situation is not clear at any point. Here there was but one corporation. It existed without interruption, without going through any statutory reorganization, and without its assets being combined with those of any other corporation. The Commissioner makes no point and can make nothing of the change in name. The Kramers had formerly carried on their paper box business as a partnership, to which the excess profits taxes did not apply. The partnership assets were transferred to the petitioner and thereby the corporate taxes were greatly increased. The Commissioner is not attempting to ignore the petitioner and tax the Kramers on their paper box business income as if it did not belong to the petitioner, but is attempting to tax the income of that business which the petitioner had always carried on and continued to carry on through the taxable year. Of course, the Commissioner's method would increase the taxes of the petitioner over what they would be if the losses of the book business, both current and prior, and its unused excess profits credit carry-over are to be considered. However, the Commissioner has adopted a scheme to increase taxes without authority and has erred as alleged by the petitioner.
No issue was raised in regard to the amount paid in for stock of the petitioner and no decision on any such point will be made. However, it would appear that the value of the accounts payable was the amount which the Kramers had just paid for them.
Decision will be entered under Rule 50.