Opinion
Docket No. 4788-66.
1970-06-17
ARNOLD MALKAN AND AUDREY MALKAN, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Whitfield J. Collins and Allan Howeth, for the petitioners. Harry H. Ellis, for the respondent.
Whitfield J. Collins and Allan Howeth, for the petitioners. Harry H. Ellis, for the respondent.
1. Held, shares of corporate stock were sold by petitioner rather than trusts of which he was the settlor-trustee, where he and the purchasers had agreed upon all the terms of the sale prior to the creation of the trusts and he participated in the closing in his individual capacity.
2. Held, further, for the purpose of determining the basis of the shares sold, petitioner's assignment of 16,000 GTC shares under an escrow agreement, executed prior to the closing of the sale, constituted the first transfer under the ‘first-in, first-out’ rule of sec. 1.1012-1(c). Income Tax Regs.
FEATHERSTON, Judge:
Respondent determined a deficiency in petitioners' Federal income tax for 1958 in the amount of $51,469.07. Certain issues have been settled by the parties. The issues remaining for decision are as follows:
(1) Whether the sale of 10,500 shares of stock was made by petitioner Arnold Malkan or by four trusts of which he was the settlor-trustee.
(2) What was the proper basis of the shares which were sold.
FINDINGS OF FACT
Petitioners Arnold Malkan (hereinafter referred to as petitioner) and Audrey Malkan, husband and wife, were legal residents of Fort Worth, Tex., at the time their petition was filed. They filed a joint Federal income tax return for 1958 with the district director of internal revenue for the Manhattan District, New York, N.Y.
From 1955 to 1957 petitioner, an attorney acquired 89,888 shares of stock, approximately 29 percent of the 315,000 shares outstanding, in General Transistor Corp. (hereinafter GTC), and became chairman of the board of directors, secretary, and general counsel of that corporation. The other principal shareholders were Herman Fialkov, the president of GTC; his brother Max, GTC's treasurer; Bernard Cohen; and Frank Pennucci.
During the first part of 1958 disagreements arose between petitioner and Fialkov over the management policies of GTC. These differences culminated in petitioner's decision, after a meeting of the board of directors of GTC on April 28, 1958, to sell his GTC stock.
Prior to these disputes, in the summer of 1967, petitioner and Audrey had discussed the possible creation of trusts for members of their family. In early June 1958 Petitioner spoke with his attorney about establishing four trusts, with petitioner as trustee and his mother, wife, son, and an unborn child as beneficiaries.
The outstanding shares of GTC stock were not registered with the Securities and Exchange Commission (hereinafter the SEC) and, therefore, could not be offered for public sale. At some time prior to June 10, 1958, GTC and petitioner retained the New York City law firm of Blackwell, McMahon & McMahon to secure the registration of 100,000 shares held by petitioner and others, in order that a public offering of the shares could be made— 73,888 shares to be offered for the account of petitioner, and 26,112 shares to be offered for the account of GTC.
In the latter part of June 1958 petitioner met with Fialkov and GTC's management and requested their cooperation in securing the registration and their approval of joint payment by GTC and himself of any expenses incurred in the registration, underwriting, and sale of the offered shares. The GTC board of directors held a special meeting on June 25, at which time it approved the proof form of the registration statement, including a prospectus, for the public offering of the 100,000 shares through a syndicate of underwriters headed by Hayden, Stone & Co. (hereinafter Hayden-Stone). The board also authorized and directed the proper officers of GTC to execute the registration statement and to take the necessary steps to qualify the shares for public sale. As consideration for GTC's filing the registration statement, petitioner agreed on June 26: (1) To place 16,000 shares of his GTC stock in escrow, granting GTC an option for 3 years to purchase them at a price of $21 per share; (2) to contribute his proportionate share of the expenses of registration, underwriting, and sale; (3) to provide for indemnification of certain officers and directors in connection with statements made in the registration statement and prospectus; (4) to covenant not to compete with GTC for a period of 3 years; and (5) to resign as an officer and director of GTC.
Also on June 26, Blackwell, McMahon & McMahon transmitted to the SEC a registration statement (Form S-1), with exhibits and a certified check. The preliminary prospectus, dated June 27, contained the following information:
PRINCIPAL HOLDERS OF SECURITIES
The following table sets forth the shares of Common Stock of the Company owned by all persons owning of record and known by the Company to own beneficially more than 10% of such Common Stock, and the number of shares beneficially owned by the Company's directors and officers as a group, as of June 16, 1958, and after giving effect as of such date to the present offering.
+-----------------------------------------------------------------------------+ ¦ ¦ ¦ ¦ ¦ ¦After completion ¦ ¦ ¦ ¦ ¦ ¦ ¦of ¦ +---------------+----------+-----------+-------------------+------------------¦ ¦ ¦ ¦Type of ¦As of June 26, 1958¦offering ¦ +---------------+----------+-----------+-------------------+------------------¦ ¦Name ¦Title of ¦ownership ¦ ¦ ¦ ¦ ¦class ¦ ¦ ¦ ¦ +---------------+----------+-----------+-------------------+------------------¦ ¦ ¦ ¦ ¦Shares ¦Percentage¦Shares ¦Percentage¦ +---------------+----------+-----------+--------+----------+-------+----------¦ ¦ ¦ ¦ ¦owned ¦ ¦owned ¦ ¦ +---------------+----------+-----------+--------+----------+-------+----------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +---------------+----------+-----------+--------+----------+-------+----------¦ ¦Arnold Malkan ¦Common ¦Record and ¦1 ¦28.5 ¦2 ¦4.7 ¦ ¦ ¦stock ¦ ¦89,888 ¦ ¦16,000 ¦ ¦ +---------------+----------+-----------+--------+----------+-------+----------¦ ¦ ¦ ¦beneficial.¦ ¦ ¦ ¦ ¦ +---------------+----------+-----------+--------+----------+-------+----------¦ ¦Directors and ¦Common ¦Beneficial ¦3 ¦51.6 ¦3 ¦26.0 ¦ ¦Officers ¦stock ¦ ¦162,721 ¦ ¦88,833 ¦ ¦ +---------------+----------+-----------+--------+----------+-------+----------¦ ¦as a Group. ¦ ¦ ¦ ¦ ¦ ¦ ¦ +---------------+----------+-----------+--------+----------+-------+----------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+
At some time prior to July 1958 petitioner had pledged all of his GTC shares to the Franklin National Bank of Long Island, Mineola, N.Y. (hereinafter Franklin National Bank), to secure a $300,000 loan. No written agreement was made with Franklin National Bank prior to July 29 to release these shares.
On July 7 petitioner sent a letter to the SEC, requesting either that he be relieved of the necessity of completing the formal registration before selling his stock, or that the other GTC officers and directors be prevented from requiring enforcement of the above escrow-option agreement and other restrictions because he was not in control of GTC.
Chadbourne, Parke, Whiteside & Wolff, the attorneys for Hayden-Stone, sent a letter to the SEC on July 10 concerning the status of the GTC stock held by petitioner. The letter explained that at that time petitioner owned all of the 73,888 shares to be offered for his account, but that prior to the date of the offering he expected to transfer without consideration a substantial amount of his GTC holdings (but less than one-half) to members of his family or to trusts for their benefit.
On July 14 petitioner, Fialkov, and the Franklin National Bank (as escrow agent) entered into an escrow agreement, which provided in pertinent part as follows:
2. I (petitioner) hereby deposit with you (the Franklin National Bank), as escrow agent, certificates representing 16,000 shares of the Common Stock, 25 cents par value, of GTC. Such certificates are owned by me free and clear of all liens and encumbrances, are endorsed in blank for transfer and have the signatures thereon guaranteed.
3. At any time or from time to time, not later than the third anniversary of the first effective date of the registration statement, which effective date is anticipated to be on or about July 23, 1958, GTC may purchase all or any of the shares so deposited on payment to you of $21 per share. Any shares so purchased shall thereupon be transferred forthwith by you to GTC or its nominee.
4. Promptly after receipt of the certificates deposited by me, you shall cause the transfer thereof into your name or that of your nominee; provided that such transfer shall not be made until GTC shall have given you written notice by registered mail that the 73,888 shares of common stock of GTC to be sold by me and members of my family as indicated in the registration statement have been purchased and payment therefor has been made pursuant to the form of underwriting agreement filed as an exhibit to the registration statement. * * *
9. I hereby assign to GTC all of my right, title and interest
(a) in the securities or property which may at any time be deposited with you and
(b) in any dividend or purchase payment which may at any time be due and unpaid to me
under this escrow agreement, such assignment being for the purpose of securing my obligation to indemnify GTC, and its officers and directors who signed the registration statement * * *
On July 15 petitioner prepared instruments to establish four trusts for his family. The beneficiary of one trust was petitioner's mother; the beneficiary of another trust was Matthew Malkan, petitioner's son; and a third trust was for the benefit of Matthew, or in the alternative for an unborn child who should live at least 1 month. Each of these trusts was to have as its corpus 2,500 shares of GTC stock. The fourth trust was created for the benefit of Audrey, and its corpus was to consist of 3,000 shares of GTC stock. The instrument creating the trust for petitioner's mother (the other trust instruments being substantially the same provided in pertinent part as follows:
TRUST INSTRUMENT— NO. 1— BENNETT-MALKAN
I hereby transfer to myself as trustee two thousand five hundred (2,500) shares of General Transistor Corp. common stock, evidenced by certificate no. U-10861 in trust for my mother, E. R. Bennett, of 84 Howe Street, New Haven, Conn. and then, if she shall die before September 1, 1968, to my wife, Audrey Malkan of 196 Elm Road, Princeton, until that date. This trust shall be primarily liable for a debt of $37,500 to the Franklin National Bank; and shall be subject to any indemnity or obligation given or to be given by me to any Insurance Co. in connection with my lost stock certificate for 89,033 shares of General Transistor Corp.
The only initial asset of the trust is unregistered stock of General Transistor Corp., which probably cannot be lawfully sold to the public unless it is first registered with the S.E.C. and sold as part of a secondary offering. Consequently, special expenses must be incurred which will obviously reduce the net proceeds below the quoted market price of the stock. Nevertheless the trustee is authorized and directed to register and sell such stock as promptly as possible, incurring whatever special expenses and obligations and executing whatever documents may seem to him to be reasonable and necessary. Likewise, in the disposition of any other assets which the trust may acquire, the trustee shall be entitled to incur such special expenses and other charges as may in his sole discretion seem reasonable or necessary.
Although each trust bore the typewritten date on the first pages of July 15, 1958, they were notarized for the first time on July 18 and were executed by petitioner for the first time no later than that date.
An amendment to the registration statement was filed with the SEC on July 16. This document contained an amended prospectus, which stated that 73,888 shares of GTC stock were being offered for the account of petitioner and members of his family, and that ‘subsequent to June 26, 1958, Mr. Malkan transferred 10,300 shares to members of his family and trusts for their benefit.’ The final prospectus, which was filed with the SEC on July 19 along with a second amendment to the registration statement, corrected the latter figure to 10,500. The printed date on the final prospectus was July 21.
On July 18 petitioner entered into an agreement with GTC which was intended to protect GTC against liability arising from a stock certificate which petitioner had lost several years previously. Under the agreement petitioner obligated himself to give GTC a surety bond in the penal amount of $500,000.
On July 20 Lou Chessler indicated to petitioner and the other GTC shareholders that he was interested in purchasing all of the outstanding GTC stock. A meeting began on that afternoon at Chessler's estate in New York to discuss his proposal. Present at the meeting were all of GTC's principal shareholders and all but one of its directors. Chessler proposed that Universal Controls, a corporation which he controlled, purchase the shares of the five principal GTC shareholders. Negotiations continued until the early morning hours of July 21, but ultimately failed because Chessler declined personally to guarantee Universal Controls' performance under the proposed sales agreement. If an agreement had been reached with Universal Controls, the necessity for a public offering of the GTC stock would have been avoided.
After the discussions with Chessler ended, petitioner went to New York City, and at approximately 7 a.m. (on July 21) he arrived at the office of Hayden-Stone to attend a meeting concerning the public offering. In the early stages of the meeting petitioner again consulted with his attorney regarding the four trusts, and was advised that each trust instrument should have expressly provided that the situs of the trust was New Jersey. Thereupon petitioner had the last page of each instrument revised to provide that the trust ‘shall be construed according to the laws of the State of New Jersey, the undersigned being domiciled at 196 Elm Road, Princeton, New Jersey.’ Each instrument also provided on the retyped last page that the trust was irrevocable. These instruments were reexecuted and signed before a notary public early on the morning of July 21.
Petitioner left Hayden-Stone's office at approximately 2:30 that afternoon. Upon arriving at his home his wife informed him that word had been received that the SEC had allowed the registration statement, with the amendments, to become effective at 5:30 that evening.
The underwriting agreement, bearing the printed date of July 21, was signed on the morning of July 22 and become effective, pursuant to its terms, at 12 noon on that date. The agreement referred to the selling parties as GTC, ‘Arnold Malkan, and Arnold Malkan as trustee under four trust instruments dated July 18, 1958 for the benefit of members of his family,‘ and provided that:
The undersigned Arnold Malkan agrees that, unless prior to the delivery date he shall have either (i) found and returned to the Corporation for cancellation a certificate representing 89,888 shares of Common Stock for which a replacement certificate has heretofore been issued or (ii) furnished to the Corporation an indemnity bond in the face amount of $500,000 indemnifying the Corporation with respect to potential liability resulting from issuance to him of such replacement certificate, he will, at the delivery date, simultaneously with payment for and delivery to the Underwriters of certificates for the Stock pursuant to this Article 3, pay over the sum of $750,000 (by endorsement and delivery of checks received from the Underwriters in such aggregate amount) to a bank or trust company as escrow agent under an escrow agreement to secure Mr. Malkan's personal indemnification given to the Corporation with respect to the issuance of such replacement certificate, the escrowed funds to be released only upon the furnishing by Mr. Malkan of an indemnity bond as described above or otherwise in accordance with such escrow agreement; provided, however, that such surety company and the form and substance of such indemnity bond and of such escrow agreement shall be satisfactory to the Corporation and to the Chadbourne, Parke, Whiteside & Wolff, counsel for the several Underwriters.
GTC and its shareholders (including petitioner) also agreed to reimburse the underwriters if any party to the agreement elected not to go through with it. Petitioner signed this agreement, ‘Acting for himself and as trustee under four trust instruments dated July 18, 1958 for the benefit of E. R. Bennett et al. (Trust Instrument No. 1), Audrey Malkan (Trust Instrument No. 2), Matthew Malkan et al. (Trust Instrument No. 3) and Matthew Malkan et al. (Trust Instrument No. 4).’
On July 29 the closing took place at the office of Hayden-Stone. After an officer of the Franklin National Bank delivered the certificate for the shares petitioner had hypothecated at that bank the closing was completed.
Petitioner reported a gain of $1,101,229.25 from the sale of 63,388 shares of GTC stock on his joint return for 1958. Petitioner also prepared fiduciary income tax returns for the four trusts for the fiscal year beginning July 21, 1958, and ending June 30, 1959, in which the following items of income and tax were reported:
+---+ ¦¦¦¦¦ +---+
Beneficiary Ordinary Capital gain Income tax income Hope Malkan $381.41 $44,115.50 $8,580.11 Matthew Malkan 381.41 44,115.50 8,580.11 Audrey Malkan 381.41 52,938.60 11,205.44 E. R. Bennett 381.41 44,115.50 8,580.11 Total 1,525.64 185,285.10 36,945.77
The capital gain of $185,285.10 was derived from sale of 10,500 shares of GTC stock in the underwriting.
In the notice of deficiency respondent determined that petitioner sold all of the 73,888 shares, including the 10,500 shares reported to have been sold by the trusts.
The 73,888 shares sold by petitioner to the underwriters were not separated and identified from the total of 89,888 shares held by him. Petitioner computed the cost basis of the 73,888 shares by allocating a prorata part of the total cost of all his GTC shares to the 73,888 shares which he sold.
In the notice of deficiency respondent used the ‘first-in, first-out’ rule for arriving at the cost basis of the 73,888 shares which were sold. The actual cost of the first 73,888 shares acquired by petitioner was $8,190.50, of which amount $1,163.94 was allocable to the 10,500 shares reported as sold by the trusts. Respondent's adjustment of the basis for the GTC shares which were sold, and the additional income determined to be attributable thereto, are summarized as follows:
+---------------------------------------------------------------+ ¦Number of shares sold ¦73,888 ¦ +----------------------------------------------------+----------¦ ¦Basis per returns (average cost) ¦$22,447.17¦ +----------------------------------------------------+----------¦ ¦Basis per notice of deficiency (first-in, first-out)¦$8,190.50 ¦ +----------------------------------------------------+----------¦ ¦Additional income ¦$14,256.67¦ +---------------------------------------------------------------+
OPINION
The principal issue is a variation of the familiar problem of substance versus form. There is no dispute that gain was realized from the sale of the 10,500 shares of GTC stock; the question is, who realized the gain, the four trusts or petitioner? Emphasizing his long-term plans to create trusts and the signing of the trust instruments before the underwriting agreement, petitioner insists that the trusts made the sale and realized the gain therefrom. Respondent, on the other hand, urges that the substance of the transaction is that petitioner himself made the sale, and then placed the proceeds thereof in trust. We think respondent has the better of the argument.
Petitioner has shown that he has discussed creation of trusts for his family members several months before he signed the trust instruments on July 18, 1958; that the agreement with GTC of June 26, 1958, refers to the trusts to be created, as do the registration papers filed with the SEC; that in correspondence with the attorneys for the representatives of the underwriters petitioner explained that the creation of the trusts was a feature of the plan; and that he reexecuted the trust instruments on July 21, 1958, the day before he signed the contract with the underwriters. Asserting that this latter contract was ‘the first written agreement of any kind between a seller and a purchaser, and the petitioner could not have been bound to sell his shares to anyone prior to the execution of this agreement on July 22,‘ and relying principally on United States v. Cumberland Pub. Serv. Co. 338 U.S. 451 (1950); Preston R. Bassett, 33 B.T.A. 182 (1935), affirmed per curiam 90 F.2d 1004 (C.A. 2, 1937); and Martin v. Machiz, 251 F.Supp. 381 (D.Md. 1966), petitioner asks us to hold that the four trusts, not he, realized the gain on the sale of the 10,500 GTC shares.
The basic principle to be applied in cases such as this is that ‘A sale by one person cannot be transformed for tax purposes into a sale by another by using the latter as a conduit through which to pass title.’ Commissioner v. Court Holding Co., 324 U.S. 331, 334 (1945); Hindes v. United States, 326 F.2d 150 (C.A. 5, 1964), certiorari denied 377 U.S. 908 (1964); Harry C. Usher, Sr., 45 T.C. 205 (1965); Virginia W. Stettinius Dudley, 32 T.C. 564 (1959), affirmed per curiam 279 F.2d 219 (C.A. 2, 1960). Stated another way, ‘A given result at the end of a straight path is not made a different result because reached by following a devious path.’ Minnesota Tea Co. v. Helvering, 302 U.S. 609, 613 (1938).
Petitioner's heavy emphasis on the fact that he executed the trust instruments before he signed the contract with the underwriters misconceives the rule. Where the issue is whether an individual is acting for himself or for trusts of which he is trustee, the chronological sequence of the steps taken to accomplish a preconceived objective (here, a sale) may have little to do with determining who in truth and substance made the sale. Thus, by analogy, when a closely held corporation, ‘manipulated by its shareholders,‘ distributes properties ‘with the knowledge that they will immediately be sold as part of a scheme to avoid taxes and the corporation then plays an active role in the subsequent disposal, the sale in substance is made by the corporation.’ Estate of Henry A. Rosenberg, 36 T.C. 716, 727 (1961), citing United States v. Lynch, 192 F.2d 718 (C.A. 9, 1951), certiorari denied 343 U.S. 934 (1952). This doctrine also controls other stockholder-corporation transactions. See, e.g., Abbott v. Commissioner 342 F.2d 997 (C.A. 5, 1965), affirming per curiam a Memorandum Opinion of this Court; S. Nicholas Jacobs, 21 T.C. 165, 169 (1953), affd. 224 F.2d 412 (C.A. 9, 1955); cf. Kimbell-Diamond Milling Co. v. Commissioner, 187 F.2d 718 (C.A. 5, 1951), affirming 14 T.C. 74 (1950), certiorari denied 342 U.S. 827 (1951). We fail to see why this same principle should not apply to transactions involving trusts created by a taxpayer with a view to their serving as conduits of title in effectuating a sale to a third party.
Thus, we do not limit our inquiry to a determination of whether creation of the trusts preceded the execution of a binding contract with the underwriters. ‘Rather, the transaction must be viewed as a whole, and each step, from the commencement of negotiations to the consummation of the sale, is relevant.’ Commissioner v. Court Holding Co., supra at 334. Our examination must focus on the realities of the transaction rather than the refinements of legal title, the verbiage of written instruments, or the chronological order of formal events. So viewed, we think it plain that, in substance, petitioner rather than the trusts made the sale of the 10,500 shares of GTC stock to the underwriters.
By July 21, 1958, the date petitioner reexecuted the four trust instruments, the terms of the sale had been cast. As early as June 10, 1958, he and other GTC stockholders had agreed to sell 100,000 unregistered GTC shares, 73,888 of which were owned by him. A registration statement and two amendments thereto had been filed with the SEC to register the shares so that they could be sold at a public offering. The second amendment, bearing the printed date of July 21, 1958, be submitted to the SEC on July 19, specified the selling price of the shares. A contract also bearing the date of July 21 had been negotiated with the underwriters, in which they agreed to purchase the stock. Quite obviously, the details of these documents had been decided upon several days previously. Thus, prior to any transfer to the trusts petitioner had carried on negotiations and reached an understanding with the purchasers regarding the terms of the sale. See S. Nicholas Jacobs, supra. All of these negotiations were handled by petitioner in his individual capacity and not as trustee; indeed, the trusts were not even in existence.
Furthermore, at the time he created the trusts, petitioner contemplated that sale of the stock would be immediately completed, and in his individual capacity he played an active role in closing the sale. See Estate of Henry A. Rosenberg, supra.
Subsequent to June 26, 1958, Mr. Malkan transferred shares to members of his family and trusts for their benefit.
That petitioner felt free— even in the absence of a retained power to revoke, alter, or amend— to destroy the last page of the trust declarations signed on July 18, 1958, and to execute new instruments on July 21, 1958, similar in all respect except for a provision that New Jersey law was to control their interpretation, suggests that the very existence of the trusts may have been tentative in character, i.e., subject to revocation if the sale had not been completed. 2. The record is not entirely clear regarding the certificates evidencing petitioner's GTC shares. Petitioner had lost his original certificate— described in the trust instruments as representing 89,033 shares and in the underwriting agreement as representing 89,888 shares—and a replacement certificate was issued for 89,888 shares. Apparently this replacement was the certificate which had been pledged by petitioner to the Franklin National Bank and was later delivered at the closing. And although the trust declarations refer to separately numbered certificates, spaces were left for the certificate numbers, which were evidently inserted at a later date. But, regardless of which certificate or certificates the Franklin National Bank held, the important thing is that the 10,500 shares purportedly placed in trust were in that bank's possession until the closing. 3. The trust instruments provide that they ‘shall be construed according to the laws of the State of New Jersey.’ But New Jersey law holds that the question of whether a transfer of securities to an inter vivos trust has been made is governed by the law of the situs of such securities. See In re Damato 86 N.J.Super.107, 206 A.2d 171 (1965). Thus, since the securities were located in New York, GTC was a New York corporation, and all of the significant events occurred in New York, the law of that State is determinative. 4. On brief respondent raised an alternative argument that, even if the sale was made by the trusts, the income therefrom was or could have been applied at petitioner's discretion in discharge of a legal obligation of his, see sec. 1.677(a)-1(d), Income Tax Regs., that he therefore is to be treated under sec. 677, I.R.C. 1954, as the owner of the trust corpora, and that consequently, he is taxable on the gains realized by the trusts under sec. 671, I.R.C. 1954. Petitioner objects to this contention on the ground that no predicate for it is laid in the deficiency notice, pleadings, or opening statement of counsel for respondent, and that he has been prejudiced by a failure of proof arising from this new contention. Cf. Boe v. Commissioner, 307 F.2d 339, 342 (C.A. 9, 1962), affirming 35 T.C. 720 (1961). Our conclusion that the gain from the sale of the 10,500 shares is taxable to petitioner is in no respect based on this alternative position of respondent.
At no time prior to execution of the agreement with the underwriters on July 22 did petitioner, as trustee, have custody of the 10,500 shares. Even though petitioner had discussed creating the trusts for several months, he did not establish them until the parties had agreed upon the details of the sale. Thus, there was never any intention that the trusts would hold the shares themselves— only the proceeds of their sale. We think it clear that petitioner took care to execute the trust instruments before completing the sale only so that the trusts could serve as conduits for the transmission of title.
Finally, although not essential to our conclusion, we note that the purported gift of the 10,500 shares to the trusts was not completed prior to the sale, because the shares were never delivered to petitioner in his capacity as trustee. Indeed, it appears that on July 21, 1958, petitioner merely signed the declarations of trust, making no change in custody of his stock; the certificate for all of his GTC shares had been pledged to the Franklin National Bank and remained so until the sale was closed on July 29, 1958.
Mr. Malkan has agreed to grant to the Company upon completion of the present financing on option to purchase all or any part of such 16,000 shares at the price of $21 per share at any time within 3 years from the date hereof.
since the shares were held by that bank, actual delivery of them to the trusts was impractical, see Schwartzman v. Kimler, 53 Misc.2d 102, 275 N.Y.S.2d 330 (Civ. Ct. 1966); and although symbolic delivery would be sufficient in these circumstances, such delivery requires that there be at least a transfer of record on the corporate stock books. In re Szabo's Estate, 10 N.Y.2d 94, 176 N.E.2d 395 (1961). Petitioner has not shown that there was such a transfer prior to July 22 or even prior to the closing in July 29.
The officers also hold options to purchase 7,980 shares of common stock. See Management-Remuneration.
Turning now to the cases relied upon by petitioner, we find nothing in them to aid his cause. We note that each case in this area turns on its own facts. As to Cumberland, the obverse of Court Holding, this Court explained in Waltham Netoco Theatres, Inc., 49 T.C. 399, 405 (1968), affd. 401 F.2d 333 (C.A. 1, 1968), that ‘The presence of substantial negotiations on behalf of the shareholders, not to mention the fact that the corporation expressly refused to sell the asset at the corporate level, was the distinguishing feature in Cumberland.’ In the present case, none of the negotiations were conducted on the trusts' behalf, and petitioner did not condition the sale of his shares on creation of the trusts.
In Preston R. Bassett, supra, decided before Court Holding, the substance-versus-form dichotomy was given only minor consideration; the principal ground for decision was an interpretation of a section of the Revenue Act of 1928. But even the formal facts in that case are clearly distinguishable from those in the present one. There the taxpayer delivered the shares in question to his attorney on April 10, with instructions to place them in trust for his wife. Then, on April 12, the trust instrument was formally executed. On the same day an agreement for the sale of the stock to a third party was reached, and on the following day a contract embodying this agreement was executed. Therefore, as was pointed out in Harry C. Usher, Sr., supra at 216-217, ‘the taxpayer had not, prior to the transfer of certain stock in trust, reached an agreement for the sale of the stock to a third party.’ Here, in contrast, the terms of such an agreement— as reflected in the final prospectus and underwriting agreement, both bearing the printed date of July 21, 1958— had been agreed upon in advance of the creation of the trusts.
The third case relied on by petitioner, Martin v. Machiz, supra, involved a transfer of stock to a charitable trust followed by a sale. That it is distinguishable from the instant controversy is readily apparent from the following ultimate facts found by the District Court (251 F.Supp.at 390):
While there is some evidence to support defendant's position, the preponderance of the evidence establishes that the concept of a charitable trust originated before and independently of the sale, the deed of trust was executed before and independently of the sale, and at the time the deed of trust was executed no mutual understanding or meeting of the minds or contract existed between the parties. In short, the Court finds as an ultimate fact that the substance of the transaction was precisely in accordance with its form.
No similar findings as to the independence of the sale from the creation of the trusts can be made here. The sale of petitioner's shares was always an integral part of the plan to create the trusts for his family members; and the declarations of trust were executed only after all of the terms of the sale had been agreed upon and included in a contract which petitioner signed the next day.
The final issue involves a determination of the basis of the shares sold by petitioner. Section 1012 I.R.C. 1954, states that as a general rule the basis of property shall be the cost of such property. Section 1.1012-1(c)(1), Income Tax Regs.,
provides that if shares of stock acquired on different dates or at different prices are ‘sold or transferred,‘ and are identified as to the date and price at which purchased, their basis is the actual price of such shares; on the other hand, if the shares sold cannot be adequately identified, their basis is determined by application of a ‘first-in, first-out’ (Fifo) rule.
Sec. 1.1012-1 Basis of property.(c) Sale of stock— (1) In general. If shares of stock in a corporation are sold or transferred by a taxpayer who purchased or acquired lots of stock on different dates or at different prices, and the lot from which the stock was sold or transferred cannot be adequately identified, the stock sold or transferred shall be charged against the earliest of such lots purchased or acquired in order to determine the cost or other basis of such stock and in order to determine the holding period of such stock for purposes of subchapter P., chapter 1 of the Code. If, on the other hand, the lot from which the stock is sold or transferred can be adequately identified, the rule stated in the preceding sentence is not applicable. * * *
Both petitioner and respondent agree that the 73,888 shares sold to the underwriters were not singled out and identified by petitioner from the total of 89,888 shares held by him, and that he did not determine their actual cost basis. Accordingly, we must apply the Fifo rule. Respondent asserts that the first, and only, transfer of shares by petitioner was the delivery by the official of the Franklin National Bank of the single certificate for all of petitioner's shares at the closing on July 29, 1958. Petitioner, on the other hand, maintains that the letter agreement of June 26, 1958, subjecting 16,000 shares of his GTC stock to an escrow agreement granting GTC a 3-year option to purchase them, was the first transfer; that the second transfer was of the 10,500 shares to the four trusts; and that the 63,388 shares which he sold on July 29, 1958 were transferred last.
The phrase ‘sold or transferred’ is not defined in regulations section 1.1012-1(c). The regulations under the 1939 Code, in applying the Fifo rule, spoke only of the sale of stock. Sec. 39.22(a)-8(a), Regs. 118. It is clear, therefore, that the present regulation's reference to a sale or transfer contemplates certain dispositions other than sales. Since the Fifo rule applies only when the shares sold or transferred are not adequately identified, the rule creates a constructive identification; the meaning of the term ‘transfer’ must be measured against this purpose.
The letter agreement of June 26, 1959, provided that at or prior to the closing petitioner would deposit 16,000 shares of GTC stock with a bank designated by GTC as escrow agent, under an agreement which was to constitute an assignment to GTC of all petitioner's right, title, and interest in those securities. On July 14, 1958, petitioner, GTC, and the Franklin National Bank (which already held all of petitioner's GTC stock as security for a loan) as escrow agent entered into an agreement, the terms of which were identical to those set out in the June 26 letter. Petitioner thereby relinquished dominion and control over the 16,000 shares and could no longer use them to vary the basis of his remaining shares. We conclude therefore, that the assignment of petitioner's interest in the 16,000 shares under the escrow agreement constituted a transfer, within the meaning of the regulation, on July 14, 1958, i.e., prior to the closing.
Since we have concluded that petitioner in substance sold all of the 73,888 shares offered for his account and the account of his family trusts, we need not differentiate between the 10,500 shares purportedly sold by the trusts and the remaining 63,388 shares. Therefore, we hold that the sale by petitioner of the 73,888 GTC shares to the underwriters constituted the second sale or transfer for the purpose of determining the basis of the shares in question under the Fifo rule.
Decision will be entered under Rule 50.