Opinion
Docket No. 23928.
1951-05-7
ARTIS C. BRYAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
F. Robert Gilfoil, Jr., Esq., for the petitioner. Clay C. Holmes, Esq., for the respondent.
F. Robert Gilfoil, Jr., Esq., for the petitioner. Clay C. Holmes, Esq., for the respondent.
Petitioner, in his income tax return for 1944, reported the sale of certain shares of stock but reported no gain on such sale claiming such shares were a gift. Held, that petitioner acquired the shares of stock for an adequate consideration and their basis for tax purposes, as determined by respondent, will not be disturbed.
This case involves a deficiency in income tax for the year 1944 in the amount of $38,186.25. The issue to be decided is whether certain shares of stock, which were sold by the petitioner in 1944, were a gift to petitioner or whether they had been received by him for adequate consideration. If they were not a gift, a further issue is presented with respect to the basis of the stock for computing gain or loss thereon.
Some of the facts were stipulated.
FINDINGS OF FACT.
The stipulated facts are so found and are incorporated herein.
Petitioner is a resident of the City of Syracuse, New York. He filed his income tax return for the year 1944 with the collector of internal revenue for the twenty-first district of New York.
Petitioner moved to Syracuse in May of 1913 to begin employment with the LeFever Arms Company of Syracuse, New York, which company had a small factory engaged in the manufacture of double barrel shot guns and was owned and controlled by J. Frank Durston and his two sons, A. H. Durston and M. H. Durston.
The Durston, at that time, were losing interest in the manufacture and sale of shot guns and were becoming interested in the future possibilities of the manufacture and sale of units and parts for the automotive industry. Accordingly, petitioner was employed to supervise the designing and developing of a line of automotive units and parts such as transmissions, axles, gearing, etc., and to supervise the expansion, the equipping and the manufacturing operations of the factory to produce these automotive products.
Shortly thereafter the gun manufacturing part of the business was sold and the company devoted its activities and facilities exclusively to the manufacture and sale of automotive products. In a few years the company had become recognized in the trade as one of the leading automotive transmission and gear manufacturing companies in the country. After 1918, it operated under the name of DURSTON GEAR CORPORATION.
J. Frank Durston died in 1921 and A. H. Durston died in 1926. M. H. Durston then became president and the controlling stockholder of the corporation.
The corporation's business became highly competitive, and very hard hit in the general depression of the early 1930's. It lost heavily in 1930, 1931, and 1932, and at the end of 1932 was in serious financial condition. Its only working capital was that borrowed from the Syracuse Trust Company. At the end of 1932 the corporation had note indebtedness to the Syracuse Trust Company of $150,000 which note was endorsed by both petitioner and M. H. Durston, rendering both individually liable for this debt.
At the end of 1932, petitioner (in addition to his liability as endorser of the corporation's $150,000 note indebtedness) had personal note indebtedness to the Syracuse Trust Company totaling $46,484.48 against which personal note petitioner had pledges as collateral security, 570 shares of his Durston Gear Corporation capital stock and life insurance policies totaling $40,000. The personal note of petitioner was endorsed by M. H. Durston and covered the unpaid balance of money borrowed for the purchase of shares of the Durston Gear Corporation capital stock, by petitioner, from A. H. Durston estate, from M. H. Durston, and from R. M. Bean (a former officer and employee of the Durston Gear Company) for all of which stock petitioner paid $100 per share.
On or about December 31, 1932, M. H. Durston informed petitioner that he (Durston), as president of the corporation and its controlling stockholder, was closing the factory, abandoning the corporation's business and leaving the corporation in the hands of the Syracuse Trust Company. Durston thereupon discharged all employees including petitioner and proceeded forthwith to the Syracuse Trust Company, delivered the keys of the factory to C. H. Sanford, president of the bank, and told Sanford that he was abandoning the corporation and its business and turning it over to the bank.
In January 1933 petitioner took over the management of the Durston Gear Corporation under terms and conditions dictated solely by the Syracuse Trust Company. If petitioner had not been indebted to the bank in the amount of $196,484.48, he would not have taken over management of the corporation.
After Durston had closed the factory, abandoned the business, and turned the corporation and its affairs over to the bank at the end of December 1932, Durston took no further active part in the management of the business. Petitioner continued as manager of the corporation under the direction and control and financial support of the bank until 1940. He operated the business until the latter part of 1944.
On January 7, 1935, M. H. Durston executed the following document under the terms of which petitioner was to receive 2,540 shares of stock in the Durston Gear Corporation subject to certain conditions.
WHEREAS, I, the undersigned, MARSHALL H. DURSTON, am the owner of a majority of the capital stock of Durston Gear Corporation, a corporation organized and existing under the laws of the State of New York, having its office and principal place of business in the City of Syracuse, New York, and
WHEREAS, said corporation now has a bank indebtedness of One Hundred Fifty Thousand Dollars ($150,000) for which I am personally liable by reason of my endorsement of the notes representing said indebtedness, and
WHEREAS, during the past few years the business of said corporation has not been sufficient to pay its operating expenses and reduce said indebtedness, and
WHEREAS, for the past two years I have not been active in the management of said corporation and do not wish to be burdened with the management thereof, and
WHEREAS, it is my desire to be relieved from a part of my said obligation and as I believe the same can be accomplished by a reduction of said bank indebtedness by said corporation under the management of A. C. Bryan.
NOW, THEREFORE, in consideration of One Dollar )$1.00), lawful money of the United States of America, to me in hand paid by A. C. Bryan, the receipt whereof is hereby acknowledged, and of other valuable consideration, I hereby sell, assign, transfer and set over unto A. C. Bryan all my right title and interest in and to 2540 shares of the capital stock of the Durston Gear Corporation and I hereby constitute and appoint said A. C. Bryan my true and lawful attorney to transfer said shares upon the books of said corporation with full power of substitution in the premises, provided, however, that this agreement is given upon the following terms and conditions:
1. Annually on the 31st day of December, of each year beginning on the 3lst day of December, 1935, said Bryan shall furnish to me evidence of the amount said bank indebtedness shall have been reduced during the year ending on said date and thereupon that part of said 2540 shares as is in the same proportion as the amount of said reduction bears to $25,000.00 shall become the property of said A. C. Bryan free from any and all conditions whatsoever, and said Bryan shall become entitled to a certificate or certificates representing said shares without the endorsement thereon of the endorsement provided for by the clause hereof numbered ‘5‘. A copy of the evidence furnished to me, and proof of the delivery thereof to me shall be filed with the Secretary of said Durston Gear Corporation.
2. Said stock when the same shall have passed into the ownership of said Bryan shall be retained by him and shall not be assigned or pledged or otherwise disposed of until a certain note in the amount of $47,000.00 given by said Bryan to The Syracuse Trust Company and endorsed by me shall be paid in full or until I shall have been otherwise relieved of all obligation by reason of said endorsement, except that the same may be assigned or pledged at any time as security for the payment of said obligation or of any obligation of the Durston Gear Corporation or otherwise for the benefit of said corporation.
3. On the 1st day of January, 1940, if said bank indebtedness shall not have been reduced $25,000.00, from the present amount of $150,000.00 to $125,000.00, then that part of said 1540 shares which is in the same proportion as the amount of said deficiency bears to $25,000.00 shall be reassigned and transferred by said A. C. Bryan to me, Marshall H. Durston, or to my assigns.
4. In the event that the whole of said 1540 shares shall have passed into the unconditioned ownership of A. C. Bryan prior to the 1st day of January, 1940, and the said A. C. Bryan shall die prior to that date, then the estate of said Bryan, upon written notice given within 90 days after the appointment and qualification of the executor or administrator thereof, shall reassign and transfer to me or my assigns all the shares of said stock held by said Bryan at the time of his death which shall exceed 49% of the total issued and outstanding stock of said corporation.
5. Until all other conditions of this assignment shall be been fully satisfied said Durston Gear Corporation shall at all times keep its plant insured against loss or damage by fire in an amount not less than $150,000.00. and shall pay all real estate taxes and assessments taxed and assessed against the same, and its failure to do so shall prevent the operation of the other conditions hereof.
6. Upon the transfer of said 2540 shares to said A. C. Bryan the certificate or certificates representing the same shall bear the endorsement, ‘Subject to the conditions contained in an assignment executed by Marshall H. Durston, dated January 7, 1935‘, and a certificate or certificates representing said shares, or any part thereof shall not be issued to said Bryan without said endorsement except as provided in the clause hereof numbered ‘1‘ A copy of this assignment shall be filed with the Secretary of said Durston Gear Corporation.
And I agree that I will make no claim against said Durston Gear Corporation on account of any unpaid salary or any other items which now appear upon the books of said corporation as due and owing to me and I undertake that no claim will be made against said corporation by Harriet Francis Durston on account of any items now appearing to be due and owing to her and agree that I will give such satisfaction and release of all of said items as may be requested by said corporation.
On January 7, 1935, the books of the corporation showed an account owing M. H. Durston in the amount of $25,562.
The total (4,000) shares of the capital stock of the Durston Gear Corporation were owned by the following on January 7, 1935:
+----------------------------+ ¦Holder ¦Shares ¦ +-------------------+--------¦ ¦M. H. Durston ¦3080 ¦ +-------------------+--------¦ ¦A. C. Bryan ¦720 ¦ +-------------------+--------¦ ¦R. M. Bean ¦160 ¦ +-------------------+--------¦ ¦M. J. Jores ¦38 ¦ +-------------------+--------¦ ¦Mrs. M. H. Durston ¦1 ¦ +-------------------+--------¦ ¦C. H. Sanford ¦1 ¦ +----------------------------+
During the 2 years of 1933 and 1934 immediately preceeding January 7, 1935, the business of the corporation, operating under the direction and control of the bank, was sufficient to pay its operating expenses and while the corporation, during those 2 years, did not make a reduction on its $150,000 bank indebtedness, it was, nevertheless, making steady progress and making a continuous effort to carry on its operations so that reductions in the corporation's indebtedness could be made as promptly as possible.
M. H. Durston had, in December 1932, relieved himself of any future burden pertaining to the management of the corporation. The bank would not permit him to take any part, whatsoever, in the future management of the corporation or its functions or its business or in any of its operations.
At the end of December 1939, the corporation had reduced its $150,000 bank indebtedness a total of $20,000. At the end of December 1939, the corporation had sufficient cash in the bank to have reduced its indebtedness an additional $5,000 if the corporation had desired to apply this available cash to further reduction of its bank indebtedness. If the corporation had applied its available cash to the further reduction of its indebtedness to the bank, petitioner would have been entitled to receive the full 2540 shares of the Durston Gear Corporation capital stock under the terms of the document executed by Durston on January 7, 1935.
On January 20, 1940, Durston transferred to the petitioner 2032 shares of stock in the Durston Gear Corporation in accordance with the terms of the document of January 7, 1935. Since the corporation's indebtedness to the bank had been reduced by $20,000, petitioner was entitled to four-fifths of the 2540 shares mentioned in said document. On the same date petitioner wrote the following letter to Durston:
January 20, 1940
Mr. Marshall H. Durston
1646 James Street
Syracuse, New York
DEAR MR. DURSTON: It is understood in taking over 2032 shares of Durston Gear Corporation stock that I will retain this stock and shall not assign or pledge or otherwise dispose of it until a certain note in the amount of approximately $47,000.00 given by me to the Syracuse Trust Company and endorsed by you shall be paid in full or until you have been otherwise relieved of all obligations by reason of said endorsement except that said stock may be assigned or pledged at any time as security for the payment of said obligation or of any obligations of the Durston Gear Corporation or otherwise for the benefit of said corporation.
Very truly yours,
On December 15, 1943, the remaining personal indebtedness of Bryan was paid in full to the Syracuse Trust Company and on September 29, 1944, the remaining indebtedness of the corporation was paid in full to the Syracuse Trust Company.
On December 10, 1943, petitioner received the following letter from Durston:
Syracuse, New York December 20, 1943.
Mr. A. C. Bryan
213 Maltbie Street
Syracuse, New York
DEAR MR. BRYAN: Under the terms of the agreement dated January 7, 1935, by which I gave you an option upon certain of the Capital stock of Durston Gear Corporation, it was provided that when that stock passed to your ownership it was to be retained by you and not assigned, pledged or otherwise disposed of until a certain note given by you to The Syracuse Trust Company in the amount of forty-seven thousand ($47,000.00) dollars, and endorsed by me should be paid in full, or until I should have been relieved of all obligation by reason of my endorsement thereof. Subsequent to the option and on or about January 20, 1940, on which date I transferred and delivered to you certain capital stock of the Durston Gear Corporation pursuant to the terms of that option, you delivered to me a letter dated Jan. 20, 1940, in which you agreed in substance to retain the stock transferred to you under the conditions of the option. This letter I have been unable to find.
Inasmuch as the note to The Syracuse Trust Company has now been paid in full the conditions of the option and your letter of January 20, 1940, have been fulfilled and I hereby release you from all limitations upon the free ownership and use of the aforesaid stock.
Very truly yours,
On or about November 1, 1944, all stockholders of Durston Gear Corporation disposed of their stock receiving therefor $83 per share. At that time petitioner owned 2417 shares.
Petitioner, in his income tax return for 1944, reported the sale of the 1972
OPINION.
RICE, Judge:
The petitioner claims that the 1972 shares of stock which he received from Durston were a gift and that he is entitled to the donor's basis of $170,205; and that, since he sold them for less than that amount, no gain or loss is recognizable. Respondent, on the other hand, claims that said shares were not a gift because they were received by petitioner for an adequate consideration; that, consequently, the basis for computing gain or loss thereon was the fair market value of said shares when received; and that said shares were received for tax purposes on January 7, 1935, when Durston executed the document set out in our findings of fact.
Petitioner disposed of the 1972 shares at a price of $83 a share, or a total of $163,676, less $1,586.36 as the cost of the sale. Respondent therefore computed a gain of $158,145.64 on the sale, and took 50 per cent thereof, or $79,072.82, into account under section 117(b) of the Internal Revenue Code. In making such computation, respondent used a fair market value of $2 per share as set forth in petitioner's income tax return for 1944.
A study of the document executed by Durston on January 7, 1935, seems to us conclusively to dispose of the gift issue. The corporation had an indebtedness of $150,000 for which Durston was personally liable. The business of the corporation had not been sufficient to pay its operating expenses and reduce the said indebtedness. Durston had not been active in the management of the corporation and recited in the document that he wished to be relieved of the management thereof. He also desired to be relieved of his obligation on the note and he stated that he believed it could be accomplished under the management of petitioner. He then stated that in consideration of $1 and other valuable consideration ‘I hereby sell, assign, transfer and set over unto A. C. Bryan all my right title and interest in and to 2540 shares of the capital stock of the Durston Gear Corporation and I hereby constitute and appoint said A. C. Bryan my true and lawful attorney to transfer said shares upon the books of said corporation with full power of substitution in the premises, provided, however, that this assignment is given upon the following terms and conditions: * * * .‘
One of the conditions was that petitioner would not be entitled to any of such shares of stock unless and until the amount of the bank indebtedness was reduced. If it were reduced by $25,000, he was to get the whole 2540 shares. If it were reduced in a smaller amount, he would be entitled to receive a smaller number of shares.
Another condition was that when the stock passed into the ownership of petitioner he could not assign or pledge or otherwise dispose of it until a note given by petitioner to the Syracuse Trust Company and endorsed by Durston had been paid in full or until Durston had otherwise been relieved of all obligation thereon, with the exception that they could be assigned or pledged at any time as security for the payment of the note or of any obligation of the Durston Gear Corporation or otherwise for the benefit of said corporation.
At the end of 1939 the corporation had reduced its $150,000 bank indebtedness a total of $20,000, and on January 20, 1940, Durston transferred to the petitioner 2032 shares of stock in accordance with the terms of the document of January 7, 1935. The petitioner, in accepting said shares of stock, wrote to Durston that he would retain the stock and would not assign or pledge or otherwise dispose of it until his note, which had been endorsed by Durston, had been paid in full or until Durston would otherwise be relieved of all obligations thereunder by reason of said endorsement. On December 20, 1943, after petitioner's note had been paid in full, Durston wrote petitioner releasing him from all limitations ‘upon the free ownership and use of the aforesaid stock.‘
The petitioner testified that he did not give Durston the $1 consideration mentioned in the document of January 7, 1935, nor did he give him any other money or any property or render any services therefor. Neither party called Durston as a witness and the Court was not advised why he was not called. From the record made in this case, the document executed by Durston for all we know may have been executed at the insistence of the Trust Company. If that were so, Durston by no stretch of the imagination could be said to be making a gift to the petitioner. The testimony of petitioner that he gave no consideration to Durston for the stock was a mere conclusion of the witness. Even though oral testimony may be ‘undisputed,‘ it may not from all the evidence in the case constitute ‘indisputable evidence.‘ Slayton v. Commissioner (C.A. 1, 1935), 76 F.2d 497, 499, certiorari denied, 296 U.S. 586.
It seems clear that donative intent on the part of Durston was lacking. It also seems clear that he received an adequate consideration from petitioner in that his personal indebtedness was to be reduced, and was in fact reduced, through the services petitioner rendered to the corporation. We said in Estate of Monroe D. Anderson, 8 T.C. 706 (1947), at page 717:
It is quite true that in Wemyss the Supreme Court held that Congress in section 503 had dispensed with the subjective test of donative intent and substituted the more workable external or objective test of whether the consideration for the transfer is full and adequate in money or money's worth. It must not be overlooked, however, that at the same time the Court was careful to point out that genuine business transactions— ‘business transactions within the meaning of ordinary speech‘— are not within the scope of the gift tax. Citing Treasury Regulations 79 (1936 Ed.), art. 8, it said that:
* * * the Treasury Regulations make clear that no genuine business transaction comes within the purport of the gift tax by excluding ‘a sale, exchange, or other transfer of property made in the ordinary course of business (a transaction which is bona fide, at arm's length, and free from any donative intent).‘ * * * Thus on finding that a transfer in the circumstances of a particular case is not made in the ordinary course of business, the transfer becomes subject to the gift tax to the extent that it is not made ‘for an adequate and full consideration in money or money's worth.‘
We, therefore, conclude that the transaction here was a transfer of property made in the ordinary course of business, it was bona fide, at arm's length, and free from any donative intent. Petitioner acquired said shares of stock for an adequate consideration.
There remains for our consideration the basis of said shares of stock to be used in computing gain or loss. The 1935 agreement plus the two letters of January 20, 1940 and December 20, 1943, when read as a whole, show that petitioner was not entitled to the stock until some indebtedness of the corporation to the bank had been reduced. This first occurred at the end of 1939 and Durston handed over the stock on January 20, 1940. It is true that petitioner received the stock at that time subject to certain limitations and petitioners cites Fred C. Hall, 15 T.C. 195 (1950) for the proposition that, since such restrictions were not lifted until his personal indebtedness had been discharged and he had received the letter of December 20, 1943, from Durston removing such restrictions, he is entitled to use the fair market value of such stock as of December 20, 1943, when he received the free and unrestricted use thereof. In the Hall case, the taxpayer entered into an employment contract with a corporation in November of 1942. He agreed to render services to it during the years 1943 and 1944. As part of his compensation the corporation issued two certificates of stock in his name, each for 25 shares. He endorsed the certificates in blank and gave them to the treasurer of the corporation. Upon the satisfactory performance of the required services and pursuant to an order of the board of directors, the treasurer was to deliver one of the share certificates to the taxpayer at the end of each of the years 1943 and 1944. This Court held that the fair market value of the 25 shares was includible in the taxpayer's income for each of the years 1943 and 1944, in which years they were delivered to him without restriction in consideration of services performed. That is not this case. Here, the petitioner actually received the stock in 1940. Presumably, he was entitled to vote it, and, if any dividends had been earned and paid by the corporation in that year, he would have been entitled to his share. The only restrictions remaining, and which petitioner agreed to by his letter of January 20, 1940, were that he would not assign or pledge or otherwise dispose of the stock until his personal note to the bank had been paid in full or until Durston had otherwise been relieved of all obligation thereunder. Cf. Luther Bonham, 33 B.T.A. 1100 (1936), affd. (C.A. 8, 1937), 89 F.2d 725.
Since the shares of stock were not a gift to petitioner, their fair market value as of January 20, 1940, should have been included in petitioner's 1940 gross income. This is true no matter what the exact generating source of the income might have been. Section 22(a) of the Code defines gross income to include, among other things, ‘gains or profits and income derived from any source whatever.‘ If they had been so included in his 1940 income, such fair market value would have been the basis to be used in computing his gain or loss in 1944 when he sold them. Commissioner v. Farren (C.A. 10, 1936), 82 F.2d 141; Continental Oil Co. v. Jones (C.A. 10, 1949), 177 F.2d 508. Since respondent has predicated his deficiency upon the allowance of $2 per share market value on the stock, there is no occasion for the Court to reexamine its general rule that an item of income cannot be converted into a capital asset, having a cost basis, until it is first taken into income. See Ruth B. Rains, 38 B.T.A. 1189 (1938); and Cf. Ross v. Commissioner (C.A. 1, 1948), 169 F.2d 483, and Bennet v. Helvering (C.A. 2, 1943), 137 F.2d 537. We are without jurisdiction to determine a deficiency in excess of the amount determined by respondent.
Decision will be entered for respondent.