Opinion
Docket No. 57120.
1958-01-27
LODI IRON WORKS, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Frank C. Scott, C.P.A., for the petitioner. Leslie Jones, Esq., for the respondent.
Frank C. Scott, C.P.A., for the petitioner. Leslie Jones, Esq., for the respondent.
1. A taxpayer cannot rely upon its alleged failure to comply with its own State law to avoid the effect of a Federal tax statute.
2. Assets received by the petitioner in exchange for stock were assets received in a nontaxable exchange within the meaning of section 112(b)(5), I.R.C. 1939, and thus should be awarded the same basis for computing depreciation as they would have in the hands of the transferor.
3. Estoppel must be specially pleaded.
Respondent determined a deficiency of $2,268.32 in petitioner's income tax return for the fiscal year ended May 31, 1951.
The question here presented is whether assets received by the petitioner in exchange for stock should be awarded the same basis for computing depreciation as they would have in the hands of the transferor.
FINDINGS OF FACT.
Most of the facts are stipulated, the stipulation being incorporated herein by this reference.
Petitioner, Lodi Iron Works, Inc., a California corporation, computes its income under an accrual method of accounting and does business on the basis of a fiscal year ending May 31. Petitioner filed its income tax returns with the collector of internal revenue for the first district of California in San Francisco, California, for all taxable years involved in this proceeding.
Petitioner was incorporated under the general corporation laws of the State of California on August 2, 1946, and commenced active conduct of business on September 16, 1946.
On September 13, 1946, petitioner was granted a permit by the California corporation commissioner to issue 15,000 shares of capital stock. Each share was to be issued at a par or stated value of $10. 12,000 shares were to be issued free of restrictions. 3,000 shares were to be issued subject to restrictions. No other stock of any class was authorized or issued by petitioner.
Petitioner issued 12,900 shares of stock in the following manner: In September 1946, 7,000 shares were given in exchange for the assets of the Lodi Iron Works, a partnership, 3,500 shares being issued to each of two equal partners and owners of the assets of Lodi Iron Works, Henry H. Kaiser and Walter O. Crosby. At that time it was believed and represented to the California corporation commissioner that the assets of the Lodi Iron Works partnership had a value of approximately $70,000. This figure was reflected by the financial statement incorporated in the permit to issue stock. In September 1946, 3,000 shares of petitioner's stock were placed in escrow for the benefit, equally, of Walter O. Crosby and Henry H. Kaiser upon satisfaction of the terms of the escrow. The conditions and restrictions of the escrow are not material here. In various transactions occurring between September 16, 1946, and February 21, 1947, petitioner issued 2,900 shares of its stock to members of the public at $10 per share.
On or about January 27, 1947, petitioner distributed a stock dividend of 60 cents per share totaling $5,990.40.
In July 1947 it was learned that the net value of the assets received by petitioner from the Lodi Iron Works partnership had been overstated at the time acquired by the petitioner by reason of the fact that certain outstanding liabilities of the partnership had not been taken into account when valuing the assets. The corrected value given to the partnership assets was approximately $49,000. Because of the error it was the opinion of petitioner's counsel that the issued stock was void.
On September 18, 1947, petitioner obtained an amendment of its permit of September 13, 1946, from the California corporation commissioner. The amended permit authorized petitioner to issue 12,815 shares of capital stock at a par or stated value of $10 per share in exchange for the stock it had previously issued.
The new issue was distributed subsequent to October 15, 1947. 4,900 shares were issued to Henry H. Kaiser and Walter O. Crosby, one-half to each, and assigns, in exchange for the 7,000 shares which previously had been issued to these parties in acquiring the assets of the Lodi Iron Works partnership. 3,000 shares were placed in escrow to be divided between Walter O. Crosby and Henry H. Kaiser, and assigns, upon completion of the terms of the escrow. Petitioner obtained 3,000 shares of previously issued stock in return for these shares. 4,915 shares were issued to members of the public in return for previously issued stock. This exchange was 1 new share for 1 old share.
Petitioner's income tax return for the period ended May 31, 1947, included a statement that the Lodi Iron Works, Inc., was using as its basis the value its stock for the assets of the Lodi Iron Works partnership did not meet the requirements of section 112(b)(5) of the Internal Revenue Code of 1939.
An internal revenue agent making an audit of petitioner's books and records for the fiscal years ended May 31, 1947, and 1948, held that petitioner's assets were acquired in a nontaxable exchange within the provisions of section 112(b)(5). Accordingly, he depreciated the assets at the basis in the hands of the predecessor and reduced the depreciation deductions claimed by petitioner.
For the taxable years ended May 31, 1949, and 1950, petitioner computed its taxable income by valuing its assets received from the Lodi Iron Works partnership at the adjusted basis such assets had in the hands of the partnership.
On August 10, 1951, petitioner filed an income tax return for the fiscal year ended May 31, 1951, reporting net income of $24,834.64 and a tax liability of $6,167.56. Petitioner remitted $1,850.27 to the collector to apply on its tax liability.
On March 14, 1952, petitioner filed another income tax return for the fiscal year ended May 31, 1951, reporting a net income of $6,063.39 and a tax liability of $1,548.33.
On or about June 20, 1952, petitioner filed with the collector a verified claim for refund of tax paid for the taxable year ended May 31, 1951, in the amount of $301.94, the difference between $1,850.27 and $1,548.33. This claim has been neither paid nor rejected.
On its second return for the taxable year ended May 31, 1951, petitioner included a computation of its net operating loss deduction, as follows:
+-----------------------------------------------------------------------------+ ¦Net operating loss for F. Y. May 31, 1948, per Form 1120 return ¦$21,842.98¦ +------------------------------------------------------------------+----------¦ ¦Less: Carryback to F. Y. May 31, 1947 ¦850.05 ¦ +------------------------------------------------------------------+----------¦ ¦Balance: Carryover to F. Y. May 31, 1950 ¦20,992.93 ¦ +------------------------------------------------------------------+----------¦ ¦Net income for F. Y. May 31, 1950, per return ¦$7,889.60 ¦ ¦ +---------------------------------------------------+--------------+----------¦ ¦Less: Depreciation and losses added back ¦ ¦ ¦ +---------------------------------------------------+--------------+----------¦ ¦in error ¦$2,788.14 ¦ ¦ ¦ +-------------------------------------+-------------+--------------+----------¦ ¦California franchise tax ¦25.00 ¦2,813.14 ¦5,076.46 ¦ +------------------------------------------------------------------+----------¦ ¦Balance: Carryover to F. Y. May 31, 1951 ¦15,916.47 ¦ +------------------------------------------------------------------+----------¦ ¦Net income for F. Y. May 31, 1949, per return ¦15.64 ¦ ¦ +---------------------------------------------------+--------------+----------¦ ¦Less: Depreciation and losses added back in error ¦2,554.84 ¦ ¦ +------------------------------------------------------------------+----------¦ ¦Corrected net operating loss, carryover to F. Y. May 30 [ sic ], ¦2,539.20 ¦ ¦1951 ¦ ¦ +------------------------------------------------------------------+----------¦ ¦Total: Operating loss deduction for income tax and excess profits ¦ ¦ +------------------------------------------------------------------+----------¦ ¦tax ¦18,455.67 ¦ +-----------------------------------------------------------------------------+
Petitioner then deducted the net operating loss carryover of $18,455.67 and arrived at a net income of $6,063.39 for the taxable year.
Respondent recalculated petitioner's net income and net operating loss carryover or carryback for each of the fiscal years 1947 through 1951, computing depreciation upon the basis of the assets in the hands of the transferor. Respondent then reduced the net operating loss carryover for fiscal year 1951 to $9,619.59 and determined a deficiency in income tax for the fiscal year ended May 31, 1951, of $2,268.32.
OPINION.
VAN FOSSAN, Judge:
The sole question presented is whether respondent correctly determined that the assets received by petitioner from the Lodi Iron Works partnership in return for stock were assets received in a nontaxable exchange within the meaning of section 112(b)(5), I.R.C. 1939,
and thus should be awarded the same basis for computing depreciation as they would have in the hands of the transferor partnership.
SEC. 112. RECOGNITION OF GAIN OR LOSS.(b) EXCHANGE SOLELY IN KIND.—(5) TRANSFER TO CORPORATION CONTROLLED BY TRANSFEROR.— No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange. Where the transferee assumes a liability of a transferor, or where the property of a transferor is transferred subject to a liability, then for the purpose only of determining whether the amount of stock or securities received by each of the transferors is in the proportion required by this paragraph, the amount of such liability (if under subsection (k) it is not to be considered as ‘other property or money’) shall be considered as stock or securities by such transferor.
SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.(a) BASIS (UNADJUSTED) OF PROPERTY.— The basis of property shall be the cost of such property; except that—(8) PROPERTY ACQUIRED BY ISSUANCE OF STOCK OR AS PAID-IN SURPLUS.— If the property was acquired after December 31, 1920, by a corporation—(A) by the issuance of its stock or securities in connection with a transaction described in section 112(b)(5) (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money, in addition to such stock or securities), or(B) as paid-in surplus or as a contribution to capital, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.
To fall within the provisions of section 112(b)(5) the property must be transferred solely in exchange for stock or securities, the transferor or transferors must be in control of the corporation immediately after the exchange, and, in the case of an exchange by two or more persons, the amount of stock and securities received by each must be substantially in proportion to his interest in the property prior to the exchange.
Sec. 112(b)(5), I.R.C. 1939, supra footnote 1.
For the purposes of this section, ‘control’ is defined as
the ownership of stock possessing at least 80 per centum of the total combined voting power of all classes of stock entitled to vote and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.
Sec. 112(h), I.R.C. 1939.
It was represented to the California corporation commissioner that the net value of the assets transferred from the Lodi Iron Works partnership to petitioner was approximately $70,000. This figure was reflected on the financial statement incorporated in the permit to issue stock granted by the corporation commissioner. It was later learned that the net value of these assets had been overstated and they were given a corrected value of approximately $49,000.
The California Corporate Securities Law provides, inter alia, that
Every security of its own issue sold or issued by a company with the authorization of the commissioner but which has been sold or issued in nonconformity with any provision in the permit authorizing the issuance or sale of the security is void.
Cal. Corp. Code, sec. 26100.
Petitioner contends that since the permit granted by the California corporation commissioner did not reflect the true value of the assets acquired from the Lodi Iron Works partnership, stock issued by the petitioner was not issued in conformity with the permit and was void. Consequently, petitioner contends the transaction between the partnership and petitioner was not an exchange of stock or securities for assets, control of petitioner was not vested in the transferor partnership, and therefore section 112(b)(5) does not apply.
We find this argument to be without merit. The petitioner may not rely upon its self-asserted failure to comply with its own State law to avoid the effect of a Federal tax statute. Angelus Building & Investment Co., 20 B.T.A. 667 (1930), affd. 57 F.2d 130 (C.A. 9), certiorari denied 286 U.S. 562; Osburn California Corporation v. Welch, 39 F.2d 41 (C.A. 9, 1930), certiorari denied 282 U.S. 850; California Iron Yards Co. v. Commissioner, 47 F.2d 514 (C.A. 9, 1931).
We must consider the stock as of the time it was issued— 7,000 shares of capital stock, 3,500 shares to each of two equal partners— at a stated par value of $10 per share issued during September 1946 in exchange for the assets of the Lodi Iron Works partnership. Angelus Building & Investment Co., supra. 3,000 additional shares were placed in escrow for the benefit of the transferor partners.
It is obvious that at the time of or immediately after this transaction the block of stock transferred to the partners amounted to more than 80 per cent of be total issued. The burden of proof of error rests upon the petitioner. On the record it must be concluded that immediately after the exchange the transferor partners were in control of petitioner as defined in section 112(h), supra. For purposes of determining control, only stock actually issued as of the basic date is considered, and the statutory words ‘immediately after the exchange’ require control for no extended period; in fact, momentary control is sufficient. American Bantam Car Co., 11 T.C. 397 (1948). affd. 177 F.2d 513 (C.A. 3, 1949), certiorari denied 339 U.S. 920. The fact that subsequently additional stock was issued to the public for cash does not affect this conclusion. Likewise, the fact that subsequently new stock was issued in exchange for the above stock did not revoke or rescind the original issue for which the assets were actually exchanged.
The transfer of the assets of the Lodi Iron Works partnership to petitioner qualifies as an exchange of stock for assets under the provisions of section 112(b)(5), I.R.C. 1939. Therefore, the basis of the assets received by petitioner from the transferor partnership is the same as it would be in the
We find this argument to be without merit. The petitioner may not rely
Petitioner argues on brief that respondent, by failing to alter petitioner's deductions for depreciation on the return for the fiscal year ended May 31, 1951, has waived his right to object to the same basis for the other years involved in his determination. This is in essence an argument by estoppel and as such must fail. No evidence was produced of petitioner's reliance upon respondent's act, nor was estoppel specially pleaded. Estate of Thomas E. Steere, 22 T.C. 79 (1954), affirmed sub nom. Rhode Island Hosp. Tr. Co. v. Commissioner, 219 F.2d 923 (C.A. 1, 1955).
Decision will be entered for the respondent. 6. Sec. 113(a)(8), I.R.C. 1939, supra footnote 2.