Republic Steel Corporation v. United States, (1941)

Full title: REPUBLIC STEEL CORPORATION v. UNITED STATES

Court: United States Court of Federal Claims

Date published: Oct 6, 1941

40 F. Supp. 1017 (Fed. Cl. 1941)

Opinion

No. 44577.

October 6, 1941.

Thomas F. Patton and Luther Day, of Cleveland, Ohio (Jones, Day, Cockley Reavis, of Cleveland, Ohio, on the brief), for plaintiff.

S.E. Blackhain and Francis T. Donahoe, both of Washington, D.C., and Samuel O. Clark, Jr., Asst. Atty. Gen. (Robert N. Anderson and Fred K. Dyar, Sp. Assts. to Atty. Gen., on the brief), for defendant.

Before WHALEY, Chief Justice, and LITTLETON, WHITAKER, JONES, and MADDEN, Judges.

Suit by the Republic Steel Corporation against the United States to recover income taxes paid by the plaintiff.

Judgment for the plaintiff.

This case having been heard by the Court of Claims, the Court, upon the report of a commissioner and the evidence, makes the following

Special Findings of Fact.

1. Plaintiff is, and for some time prior to January 1, 1928, has been, a corporation organized and existing under the laws of the State of New Jersey and engaged in the manufacture of iron and steel products. Its original corporate name, Republic Iron and Steel Company, was on April 8, 1930, changed according to law to its present corporate name. Its principal office and place of business were formerly in Youngstown, Ohio, but since 1936 have been in Cleveland, Ohio.

2. Steel and Tubes, Incorporated, hereinafter referred to as Steel and Tubes No. 1, from the time of its incorporation on August 7, 1902, until abandonment of its charter on October 15, 1928, was a corporation organized and existing under the laws of the State of Ohio. Its original corporate name, the Elyria Iron and Steel Company, was on October 13, 1927, changed to Steel and Tubes, Incorporated. Its principal office and place of business were at Elyria, Ohio.

3. Steel and Tubes, Inc., hereinafter referred to as Steel and Tubes No. 2, from the time of its incorporation on September 17, 1928, until it was dissolved on October 13, 1939, was a corporation organized and existing under the laws of the State of Ohio. Its principal office and place of business were at Elyria, Ohio. It was caused to be incorporated by, and at all times during its corporate existence was an affiliate of, plaintiff. At the time of its dissolution on October 13, 1939, all its assets were acquired by plaintiff in exchange for its outstanding stock and securities, all of which were then owned by plaintiff.

4. A consolidated Federal income tax return was filed within due time on behalf of plaintiff and certain of its affiliates, not including Steel and Tubes No. 2, for the entire calendar year 1928. A Federal income tax return was filed within due time on behalf of Steel and Tubes No. 2 for the period commencing October 1, 1928, and ending December 31, 1928. By reason of plaintiff's affiliation with Steel and Tubes No 2 through ownership by the former of all of the common stock of the latter, and pursuant to agreement between them, plaintiff paid to the Collector the amount of $360,155.72, being the aggregate of the amounts of the taxes so reported to be due under these returns as follows:

March 18, 1929 ........................... $125,000.00 June 15, 1929 ............................ 55,077.86 September 16, 1929 ....................... 90,038.93 December 16, 1929 ........................ 90,038.93 ___________ Total ................................. $360,155.72

5. The Commissioner of Internal Revenue treated these returns as though the two returns constituted a single return for plaintiff and certain of its affiliates, including Steel and Tubes No. 2, and for assessment purposes consolidated the accounts of plaintiff and Steel and Tubes No. 2 for the year 1928, and thereafter on May 10, 1933, assessed against plaintiff as Federal income taxes for the year 1928 respecting income of plaintiff and its affiliates, including Steel and Tubes No. 2, an additional amount in the principal sum of $106,123.75 and interest of $24,530.58.

6. For the year 1929 a consolidated Federal income tax return was filed within due time on behalf of plaintiff and its affiliates, including Steel and Tubes No. 2, and plaintiff paid to the Collector the amount of $964,675.73 being the amount of the taxes so reported to be due under this return, as follows:

March 15, 1930 ........................... $207,337.87 June 10, 1930 ............................ 275,000.00 September 16, 1930 ....................... 241,168.93 December 15, 1930 ........................ 241,168.93 ___________ Total ................................. $964,675.73

Thereafter, on May 10, 1933, the Commissioner of Internal Revenue assessed against plaintiff and its affiliates additional income taxes in the principal amount of $104,128.75 and interest of $17,821.71.

7. On August 26, 1933, the additional assessments for 1928 and 1929, as above set out, were paid by the plaintiff through a credit by the Collector of Internal Revenue of the amount thereof against overpayments by plaintiff for other years.

8. On September 12, 1932, plaintiff filed with the Collector of Internal Revenue for the Eighteenth District of Ohio a claim for refund in which plaintiff asserted, inter alia, that there had not been allowed a proper amount for depreciation to Steel and Tubes No. 2 respecting the patents hereinafter referred to, and requested a refund of $144,258.23 income taxes assessed against plaintiff and paid as aforesaid for the calendar year 1929. On August 25, 1933, the Commissioner of Internal Revenue disallowed this claim for refund.

9. On April 24, 1934, plaintiff filed with the Collector of Internal Revenue for the Eighteenth District of Ohio two claims for refund in each of which plaintiff asserted, inter alia, that there had not been allowed a proper amount for depreciation to Steel and Tubes No. 2 respecting the patents hereinafter referred to. In one of the claims for refund plaintiff requested a refund of $38,657.53 respecting Federal income taxes assessed against plaintiff and paid as aforesaid for the calendar year 1928, and in the other plaintiff requested a refund of $141,744.27 respecting Federal income taxes assessed against plaintiff and paid as aforesaid for the calendar year 1929. On January 22, 1937, the Commissioner of Internal Revenue disallowed each of these claims for refund and ruled, inter alia, that the basis allowable to Steel and Tubes No. 2 for depreciation respecting the patents should be the cost thereof to Steel and Tubes No. 1, and not the cost thereof to Steel and Tubes No. 2, as is contended by plaintiff.

10. Steel and Tubes No. 2 in its income-tax return for the last three months of the year 1928 claimed as a deduction from income depreciation on the above-mentioned patents in the amount of $325,326.40, based upon a cost to Steel and Tubes No. 2 of $12,919,015.72 for such patents and an unexpired life for such patents of 11.123 years. The Commissioner disallowed the depreciation so claimed to the extent of $322,146.09, and allowed depreciation only in the amount of $3,180.31, based upon the then actual remaining undepreciated cost of such patents to Steel and Tubes No. 1 of $171,397.45 and an unexpired life for such patents of 11.123 years.

11. In the consolidated income-tax return for the year 1929 depreciation was claimed on the above-mentioned patents on behalf of Steel and Tubes No. 2 in the amount of $1,301,413.96, based upon a cost to Steel and Tubes No. 2 of $12,919,015.72 for such patents and an unexpired life for such patents of 11.123 years. The Commissioner disallowed the depreciation so claimed to the extent of $1,288,584.36, and allowed depreciation only in the amount of $12,829.60, based upon the then actual remaining undepreciated cost of such patents to Steel and Tubes No. 1 of $140,554.17 and an unexpired life for such patents of 11.123 years.

12. Plaintiff's subsidiary Steel and Tubes No. 2 acquired the patents, the proper basis for depreciation on which is the issue involved, under the following circumstances:

Plaintiff was a manufacturer of steel pipes in about the year 1925. An improvement over plaintiff's method of manufacture thereof was developed which decreased the cost of its manufacture and made possible the manufacture of an improved article. In order to offset the consequent competitive disadvantage, plaintiff sought to purchase from Steel and Tubes No. 1 certain of its patents known as the Johnston patents. Steel and Tubes No. 1 were unwilling to sell its patents unless at the same time all of its assets were purchased, and for all of its assets it demanded a price of between nineteen and twenty million dollars. As the result of considerable negotiations the plaintiff entered into an agreement with it, under the terms of which plaintiff agreed to organize a new corporation known in the record as Steel and Tubes No. 2, which was to have an authorized capital of 117,000 common shares, 72,000 Class A preferred shares, 45,000 Class B preferred shares, and 117,000 Class C preferred shares.

It was agreed that Steel and Tubes No 1 should transfer to Steel and Tubes No. 2 all of its assets in consideration of the debentures of the new company of $4,500,000, all of its 72,000 shares of Class A preferred stock, and all of its 45,000 shares of Class B preferred stock, and 31,500 shares of the common stock of the plaintiff. In addition, the new corporation was to assume all the liabilities of Steel and Tubes No. 1, and was to deposit with it sufficient cash to enable it to redeem all of its outstanding 3,578 shares of preferred stock, and to enable it to discharge specified obligations of two of its subsidiaries. So long as the Class A and Class B preferred stock was outstanding, it was agreed that none of the Class C preferred stock should be issued, except upon the retirement of shares of the Class A and Class B preferred stock, when an equal number of shares of the Class C preferred stock might be issued. It was agreed that plaintiff should furnish the new corporation the necessary cash and the required amount of its common stock to enable it to carry out the agreement. In consideration thereof the new corporation issued to plaintiff its entire common stock of 117,000 shares. In addition, as part of the consideration the plaintiff agreed to purchase 11,799 shares of the total outstanding common stock of 101,799 shares of Steel and Tubes No. 1, and upon the consummation of the reorganization to surrender to it these shares for cancellation without further consideration.

At the same time, and as a part of the entire transaction, it was agreed that Steel and Tubes No. 2 should issue to plaintiff a nonexclusive license for the use of the Johnston patents for the manufacture of so-called "patented pipe", which was defined to mean "heavy wall pipe or tubing intended to take the place and be used in lieu of lap welded or butt welded merchant pipe and seamless tube. * * *" The royalty to be paid therefor was $1 per ton. The license was cancellable if the licensee should be declared a bankrupt, or if it should be in default in the payment of royalties. Also as a part of the same transaction the plaintiff agreed to sell to Steel and Tubes No. 2, and Steel and Tubes No. 2 agreed to buy from plaintiff, all of the strip steel required by it in the manufacture of light wall electrically welded tubing at a price equal to 5 per cent less than the average base market price thereof as shown by the Iron Trade Review and Iron Age for the previous quarter year, with certain qualifications This agreement was cancellable on certain conditions

The agreements were carried out in accordance with their terms.

The purchase by plaintiff of the 11,799 shares of the common stock of Steel and Tubes No. 1 was in part consideration for the transfer of the assets to Steel and Tubes No. 2, and were purchased by plaintiff only in order to acquire the assets of Steel and Tubes No. 1.

13. The fair market value of each item of the total consideration paid by Steel and Tubes No. 2 to Steel and Tubes No. 1 for the assets of the latter on October 1, 1928, was as follows:

72,000 shares Class A Stock ............. $ 6,853,846.15 45,000 shares Class B Stock ............. 3,375,000.00 31,500 shares R.I. and S. Company common stock ................................. 2,598,750.00 4,500,000 — 6% debenture ................. 4,275,000.00 Indebtedness of Steel and Tubes, Incorporated, retired as part of consideration: Preferred stock ........... $357,800.00 Dividend .................. 24,151.50 ___________ 381,951.50 Bonds of Elyria Iron and Steel Realty Company: Principal ................. 360,000.00 Premium ................... 7,200.00 ___________ 367,200.00 Mortgage of Steel and Tubes, Incorporated of New York: Principal ................ $355,000.00 Interest ................. 3,550.00 ___________ 358,550.00 11,799 common shares of Steel and Tubes, Incorporated, owned by Republic, surrendered for cancellation as part of consideration .............. 1,346,694.78 ______________ Total ............................... $19,556,992.43

14. The assets and liabilities of Steel and Tubes No. 1, as shown by the balance sheet of September 30, 1928, were as follows:

ASSETS Current: Cash ....................................... $ 598,090.90 Marketable securities ...................... 101,575.77 Notes and accounts receivable .............. 45,893.33 Accounts receivable ......... $577,362.35 Less: Reserve for doubtful accounts ................... 31,167.01 ______________ 546,195.34 Miscellaneous accounts receivable .......... 18,858.56 Inventories ................................ 867,155.52 Prepaid expense ............................ 23,980.13 Other assets: Due from Tube Investments, Ltd. ............ 112,588.94 Employees notes and accounts receivable .......................................... 2,978.58 Cash surrender value of life insurance 58,150.50 Investments in other companies ............. 1,866.00 Investments in subsidiaries: Ohio Tubular Products Company .............. 7,500.00 Elyria Iron, Steel, and Realty Company .......................................... 20,000.00 Steel and Tubes, Incorporated, New York ..................................... 1,309,636.80 Canadian Metal Products Company ............ 49,100.00 Due from subsidiary companies .............. 812,811.45 Notes of subsidiary companies .............. 82,779.85 Fixed assets: Land ....................................... 280,324.43 Buildings .................... $1,285,839.09 Machinery and equipment ...... 1,984,302.99 Furniture and fixtures ....... 158,198.41 Automobiles .................. 9,760.67 Rolls and annealing boxes .... 56,885.50 Construction in progress ..... 121,359.30 Less: Reserve for depreciation ............................ (1,463,500.34) ______________ 2,152,845.62 Organization expense ........................ 2,000.32 Intangibles: Patents ..................................... 171,397.45 Good will ................................... None _____________ Total assets ............................. $7,265,729.49

LIABILITIES

Current: Accounts payable ............................ $ 219,833.32 Accrued liabilities ......................... 45,723.78 Other liabilities ........................... 1,133,529.83 Reserves .................................... 261,307.16 Capital stock: Common ...................................... 2,544,982.50 Surplus: Earned ...................................... 2,149,186.18 Capital ..................................... 911,166.72 _____________ Total liabilities ........................ $7,265,729.49

15. Among the patents acquired from Steel and Tubes No. 1 were the following:

------------------------------------------------------------------------------------------------------- Patent | | | Elapsed life to | Remaining No. | Date granted | Description | Sept. 30, 1928 | life from Oct. | | | | 1, 1928 ------------|---------------|-------------------------------------|--------------------|--------------- 1,388,434 | Aug. 23, 1921 | G.V. Johnston process for electric | 7,107 years ...... | 9,893 years. | | welding of tubing. | | 1,435,306 | Nov. 14, 1922 | Improvement which made the | 5,877 years ...... | 11.123 years. | | Johnston patent practical. | | ------------------------------------------------------------------------------------------------------- In addition to the foregoing patents, Steel and Tubes No. 1 also owned other patents, only two of which had any value, the value thereof being $50,000.

In arriving at the price to be paid for the assets of Steel and Tubes No. 1, the plaintiff, on the one hand, and Steel and Tubes No. 1, on the other, agreed that the fixed assets of Steel and Tubes No. 1 had the value at which they were carried on the books of that company, and that the patents were worth the sum of $12,462,660.39, and Steel and Tubes No. 2 paid to Steel and Tubes No. 1 said amount for their tangible assets and for these patents. The cost to Steel and Tubes No. 2 of the two Johnston patents was $12,412,660.39.

16. No gain or loss was recognized by the Commissioner of Internal Revenue on the transaction whereby Steel and Tubes No. 2 acquired the assets of Steel and Tubes No. 1.

WHITAKER, Judge.

The question in this case is the proper basis for depreciation of certain patents acquired by plaintiff's subsidiary through a reorganization from a corporation known in the record as Steel and Tubes No. 1. The plaintiff contends that the cost to its subsidiary is the proper basis for depreciation, but the defendant says that its proper basis is the cost to the person from whom plaintiff's subsidiary acquired it, because after the reorganization an 80 per cent interest or control in the patents remained in the hands of the same persons. Whether or not an 80 per cent interest or control remained in the hands of the same persons is the first question presented.

The basis for determining depreciation of property acquired after February 28, 1913, is the cost of the property, except in those instances set out in section 113 of the Revenue Act of 1928, 45 Stat. 791, 819, 26 U.S.C.A. Int.Rev. Acts, page 382. The defendant alleges that the acquisition of these assets by the plaintiff comes within exception 7. This exception reads:

"(7) Transfers to Corporation Where Control of Property remains in same Persons. — If the property was acquired after December 31, 1917, by a corporation in connection with a reorganization, and immediately after the transfer an interest or control in such property of 80 per centum or more remained in the same persons or any of them, 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. * * *"

For some years prior to 1925 the plaintiff was the manufacturer of steel piping. In that year, or shortly prior thereto, a new process for its manufacture was discovered by plaintiff's competitors, by the use of which the cost of the manufacture thereof was greatly decreased and a superior article manufactured. In order to offset this competitive disadvantage the plaintiff sought to acquire certain patents of Steel and Tubes No. 1. In order to do so, it was necessary for plaintiff to acquire all the assets of this corporation. In order to bring this about plaintiff, under agreement with those in control of this corporation, agreed to organize a new corporation known in the record as Steel and Tubes No. 2. This new corporation had an authorized capital of 117,000 common shares, 72,000 Class A preferred, 45,000 Class B preferred and 117,000 Class C preferred shares. It was agreed that Steel and Tubes No. 1 should transfer to Steel and Tubes No. 2 all of its assets in consideration of the debentures of the new company of $4,500,000, all of its 72,000 shares of Class A preferred stock, and all of its 45,000 shares of Class B preferred stock, and 31,500 shares of the common stock of the plaintiff. In addition, the new corporation was to assume all the liabilities of Steel and Tubes No. 1, and was to deposit with it sufficient cash to enable it to redeem all of its outstanding 3,578 shares of preferred stock, and to enable it to discharge specified obligations of two of its subsidiaries. So long as the Class A and Class B preferred stock were outstanding, it was agreed that none of the Class C preferred stock should be issued, except upon the retirement of shares of the Class A and Class B preferred stock when an equal number of shares of the Class C preferred stock might be issued. It was agreed that plaintiff should furnish the new corporation the necessary cash and the required amount of its common stock to enable it to carry out the agreement. In consideration thereof the new corporation issued to plaintiff its entire common stock of 117,000 shares.

In addition, as part of the consideration for the assets of Steel and Tubes No. 1, the plaintiff agreed to purchase 11,799 shares of the total outstanding common stock of 101,799 shares of Steel and Tubes No. 1, and upon the consummation of the reorganization to surrender to it these shares for cancellation without further consideration.

The agreement was carried out according to its terms. After the reorganization had been completed the plaintiff had complete control of the new corporation and the stockholders of Steel and Tubes No. 1 had an interest in the corporation represented by 117,000 shares of Classes A and B preferred stock. Since the interest of the stockholders of Steel and Tubes No. 1 in the new corporation was less than 80 percent, and since they had no control over the new corporation, an 80 percent interest or control of the new corporation did not remain in the hands of the same persons, unless we treat the plaintiff as one who had an interest or control in the old corporation by reason of its ownership of the 11,799 shares, which by agreement it purchased and surrendered for cancellation. If by virtue of the ownership of these shares plaintiff can be considered as one of the persons who had an interest in or control of the old corporation, then an 80 percent interest or control in the new corporation did remain in the hands of the same persons.

However, plaintiff purchased and surrendered these 11,799 shares in the old corporation as a part of the consideration to the old corporation for a transfer of its assets to the new. It was a part of the purchase price. Its purchase of them and subsequent surrender of them was equivalent to its paying into the treasury of the old company the amount required to purchase them, as part consideration for the purchase of the old company's assets. Had this been done, it would hardly be contended that plaintiff had had an interest or control in the old company. These shares were purchased only as part of the consideration for the acquisition of the old company's assets. The plaintiff's interest in the old company was transitory only. It was acquired only as a step in bringing about the reorganization, as a result of which plaintiff acquired what it wanted, to wit, the old company's patents.

Under such circumstances, we are of the opinion that the statute does not require us to consider plaintiff as one who had an interest or control in the assets of the old corporation prior to the reorganization.

The purpose of the statute was to prevent those interested in property from stepping up its basis by a change in the form of ownership, when there had been no change in fact. The underlying motive of this reorganization was not a continuance of ownership by the same persons in a different form, but was a change in ownership. The motive was plaintiff's desire to acquire these patents owned by a corporation in which it had previously had no interest. When the plaintiff set out to acquire these patents it had no interest or control whatsoever in the company that owned them. After the reorganization was completed it had complete control of the company that owned them, and a substantial interest in it. In order to acquire this control or interest it purchased for temporary holding these 11,799 shares in the old company. Its acquisition of them was merely a means by which it ultimately acquired complete control of the desired patents. For this reason we think that it cannot be said that plaintiff was one of those who had an interest or control in the old company prior to the initiation of the reorganization. It is the situation at the beginning and end of the reorganization at which we must look. National Rubber Machinery Co. v. United States, 38 F. Supp. 260, 93 Ct.Cl. 340; Helvering v. Bashford, 302 U.S. 454, 58 S.Ct. 307, 82 L.Ed. 367; Commissioner of Internal Revenue v. Schumacher Wall Board Corp., 9 Cir., 93 F.2d 79; Commissioner v. Ashland Oil Refining Co., 6 Cir., 99 F.2d 588; and Banner Machine Co. v. Routzahn, 6 Cir., 107 F.2d 147, certiorari denied, 309 U.S. 676, 60 S.Ct. 713, 84 L.Ed. 1021; Hazeltine Corp. v. Commissioner, 3 Cir., 89 F.2d 513; Heberlein Patent Corp. v. United States, 2 Cir., 105 F.2d 965; Bassick v. Commissioner, 2 Cir., 85 F.2d 8; West Texas Refining D. Co. v. Commissioner, 10 Cir., 68 F.2d 77.

Plaintiff, therefore, is entitled to deduct depreciation upon the basis of the cost of these patents to its subsidiary.

The next question is the cost of the patents to plaintiff's subsidiary. When plaintiff approached Steel and Tubes No. 1 to buy its Johnston patents, it refused to sell them unless plaintiff would agree to purchase also its other assets, and for all its assets it demanded a price that would net its stockholders approximately $200 a share. It justified the price demanded by representing that its fixed assets were worth their book value and that its patents were worth something in excess of $12,000,000. The valuation of its patents it justified by the savings effected in the manufacture of small pipe and what could be effected by the use of the patents in the manufacture of large pipe. Plaintiff's representatives made careful investigations and various calculations and reached the conclusion that the patents it sought were in fact worth the price demanded. An agreement was accordingly reached to buy the entire assets of Steel and Tubes No. 1 at a price of $19,556,992.43. The tangible assets were carried on the books of Steel and Tubes No. 1 at $7,094,332.04, leaving $12,462,660.39 as the price to be paid for the patents. Apparently Steel and Tubes No. 1 did not consider that it had any good will separate and apart from its patents; in other words, if it disposed of its patents, it would not have any good will. Its president so testified, and it gave no value to it on its books. The plaintiff says it placed no value on it in determining whether or not to pay the price demanded.

But the defendant says the parties over-valued the patents, that they were not worth the sum at which the parties valued them, and it argues at length in support of this proposition. This may or may not be true; they may not have been worth what the parties thought they were. But the fact remains that they were purchased on the parties' valuation of them, and not on their actual value. The amount of $19,556, 992.43 was paid for all the assets, the tangible assets were worth $7,091,332.04, leaving $12,462,660.39 as the price paid for the intangible assets. The only intangible assets regarded by the parties as of any value were the patents, so, it must follow that this sum was paid for the patents. It may be that the seller's good will really did have a value, but if the parties did not think so and, in computing the price to be paid, gave it no value, it must be eliminated from consideration in computing the amount paid for the other assets.

The plaintiff admits that Steel and Tubes No. 1 had two patents other than the Johnston patents which were worth $50,000. This leaves $12,412,660.39 as the cost to plaintiff's subsidiary of the Johnston patents, on which depreciation is to be computed.

The entry of judgment will be deferred until the filing of a stipulation by the parties, or, in the absence of a stipulation, until the incoming of a report by a commissioner as to the correct amount due plaintiff computed in accordance with this opinion. It is so ordered.