Opinion
Docket No. 5455-67.
1969-09-10
VICTOR MEAT CO., INC., PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Gregg M. Anderson, for the petitioner. Jeffrey E. Boly and Edward B. Simpson, for the respondent.
Gregg M. Anderson, for the petitioner. Jeffrey E. Boly and Edward B. Simpson, for the respondent.
Petitioner purchased for a lump sum a mixed aggregate of current and fixed assets. The current assets were comprised of cash, trade and employee receivables, inventory, supplies, and prepaid expenses, including prepaid insurance. Petitioner treated the aforementioned current assets as ‘equivalent to cash’ in allocating the lump-sum purchase price. Held, only the prepaid expenses, including the prepaid insurance, are ‘equivalent to cash’ in allocating the lump-sum purchase price among the assets under sec. 1012, I.R.C. 1954.
FAY, Judge:
Respondent has determined a deficiency of $60,564.11 in petitioner's Federal income tax for the fiscal year ended July 31, 1964.
The sole issue concerns the proper basis of assets which petitioner acquired in June 1964.
FINDINGS OF FACT
Some of the facts were stipulated, and the stipulation of facts and exhibits attached thereto are found accordingly.
Petitioner is a fiscal year taxpayer. It filed its Federal corporate income tax return for the fiscal year ended July 31, 1964, on an accrual method of accounting with the district director of internal revenue, San Francisco, Calif. Petitioner's principal place of business at the time its petition was filed was Oakland, Calif.
Petitioner purchased the business assets of Miller Packing Co. (hereinafter referred to only as Miller) as of the close of business on June 27, 1964. Petitioner paid $250,000 cash to Miller, and also paid closing costs of $1,324.30. It assumed liabilities of Miller totaling $168,656.53. Thus, the total purchase price of the assets to petitioner was $419,980.83.
The parties did not allocate in any documents relating to the transaction the total purchase price among the various assets which petitioner acquired. At the date of the transaction the fair market value of the assets, as stipulated by the parties, was:
+-------------------------------------+ ¦ ¦Agreed fair ¦ +----------------------+--------------¦ ¦Assets ¦market value ¦ +----------------------+--------------¦ ¦Cash ¦$10,158.53 ¦ +----------------------+--------------¦ ¦Trade receivables ¦1 169,156.55¦ +----------------------+--------------¦ ¦Employee receivables ¦276.92 ¦ +----------------------+--------------¦ ¦Inventory ¦128,032.20 ¦ +----------------------+--------------¦ ¦Supplies ¦32,519.98 ¦ +----------------------+--------------¦ ¦Prepaid insurance ¦4,175.38 ¦ +----------------------+--------------¦ ¦Prepaid other ¦1,248.75 ¦ +----------------------+--------------¦ ¦Land ¦70,000.00 ¦ +----------------------+--------------¦ ¦Buildings ¦130,000.00 ¦ +----------------------+--------------¦ ¦Machinery ¦83,210.00 ¦ +----------------------+--------------¦ ¦Autos ¦12,850.00 ¦ +----------------------+--------------¦ ¦Furniture and fixtures¦3,940.00 ¦ +----------------------+--------------¦ ¦Total assets ¦645,568.31 ¦ +----------------------+--------------¦ ¦ ¦ ¦ +-------------------------------------+
1 This represents book value as of the close of business June 27, 1964.
The inventory referred to above was comprised of various types of fresh meat. The meat was to be processed into hams, sausages, bacon, and other ground-meat products. The usual turnover of petitioner's inventories was in excess of 43 times per year. This rapid turnover was due to the fact that the time period required for processing the raw meat to the completed product was only 48 hours. As of the close of business on June 27, 1964, the items in inventory were at different stages of processing. Some of the inventory was completely unprocessed raw meat. The remaining portions consisted of work-in-process and fully processed products ready for sale to customers. Although a product was ready for sale, there would be incurred additional expenses for selling and shipping. Upon sale to a customer an entry was made on the books crediting the inventory and debiting the accounts receivable. Petitioner converted all inventory purchased on June 27, 1964, to accounts receivable within the next 30 days.
Of the $169,156.55 in accounts receivable purchased by petitioner on June 27, 1964, $135,777.91 was collected within 30 days, an additional $8,764.55 was collected within 45 days, an additional $7,657.70 was collected within 60 days, an additional $7,509.46 was collected within 90 days, an additional $3,573.04 was collected after 90 days, $4,423.11 remains open on the books, and.$1,450.78 was written off as a bad debt.
Petitioner purchased Miller Packing Co. as of the close of business on June 27, 1964, which was a Saturday. Payments on accounts receivable which were physically picked up at a Post Office on Monday, June 29, 1964, were posted in the cash receipts journal of Miller to the business for Friday, June 26, 1964. Payments on accounts receivable which were physically picked up at a Post Office on Tuesday, June 30, 1964, were posted in the cash receipts journal of Miller to the business for Monday, June 29, 1964. Payments on accounts receivable which were physically picked up at a Post Office on Wednesday, July 1, 1964, were posted in the cash receipts journal of Miller to the business for Tuesday, June 30, 1964.
On its Federal income tax return for the fiscal year ended July 31, 1964, petitioner allocated the total purchase price among the various assets acquired as follows:
+--------------------------------------+ ¦Assets ¦Claimed basis ¦ +----------------------+---------------¦ ¦Cash ¦$10,158.53 ¦ +----------------------+---------------¦ ¦Trade receivables ¦169,156.55 ¦ +----------------------+---------------¦ ¦Employee receivables ¦276.92 ¦ +----------------------+---------------¦ ¦Inventory ¦[2] 119,010.05 ¦ +----------------------+---------------¦ ¦Supplies ¦[2] 30,228.37 ¦ +----------------------+---------------¦ ¦Prepaid insurance ¦4,175.38 ¦ +----------------------+---------------¦ ¦Prepaid other ¦1,248.75 ¦ +----------------------+---------------¦ ¦Land ¦15,500.71 ¦ +----------------------+---------------¦ ¦Buildings ¦65,972.59 ¦ +----------------------+---------------¦ ¦Machinery ¦20,977.87 ¦ +----------------------+---------------¦ ¦Autos ¦3,261.49 ¦ +----------------------+---------------¦ ¦Furniture and fixtures¦993.43 ¦ +----------------------+---------------¦ ¦ ¦ ¦ +--------------------------------------+ FN2 The record is silent as to why the claimed bases of the inventory and supplies are not the same as their stipulated fair market value. Perhaps, the figures above represent the lower of cost or fair market value.
In the statement attached to his notice of deficiency respondent increased petitioner's gross income by decreasing the bases allocated to some of these assets:
+--------------------------------------+ ¦Assets ¦Allowed basis ¦ +----------------------+---------------¦ ¦Trade receivables ¦$105,716.26 ¦ +----------------------+---------------¦ ¦Employee receivables ¦174.26 ¦ +----------------------+---------------¦ ¦Inventory ¦74,253.08 ¦ +----------------------+---------------¦ ¦Supplies ¦18,248.64 ¦ +----------------------+---------------¦ ¦Prepaid insurance ¦2,627.41 ¦ +----------------------+---------------¦ ¦Other prepaid expenses¦785.79 ¦ +----------------------+---------------¦ ¦Total ¦201,805.44 ¦ +--------------------------------------+
As a complement respondent increased the cost basis of the other assets which petitioner had acquired, thereby increasing petitioner's depreciation deduction.
OPINION
The sole issue concerns the proper basis of assets which petitioner acquired in June 1964.
The parties are in agreement as to the legal principles involved herein. Their dispute reaches only to the application of those principles to the facts of the instant case.
Section 1012
of the Code and section 1.1012-1 of the regulations thereunder provide that the basis of property is generally the cost of such property. Neither the Code nor the regulations provide any additional assistance in determining what is the cost of the separate items of a lump-sum purchase of an integral business. It is established, however, that when a taxpayer buys a mixed aggregate of assets for a lump sum, an allocation of the purchase price will be made to the separate items upon the relative value of each item to the value of the whole. Nathan Blum, 5 T.C. 702 (1945); C. D. Johnson Lumber Corporation, 12 T.C. 348, 363 (1949). As a further refinement of this method, it is equally established that the purchaser should eliminate from the allocation whatever cash and its equivalents he acquires. A sufficient amount of the purchase price is apportioned to these assets so that their bases are their face or book values. The balance of the purchase price is allocated to the remaining assets. F. & D. Rentals, Inc., 44 T.C. 335 (1965), affd. 365 F.2d 34 (C.A. 7, 1966), certiorari denied 385 U.S. 1004 (1967); 3A Mertens, Law of Federal Income Taxation, sec. 21.32, p. 99.
All section references are to the Internal Revenue Code of 1954.
The dispute between the parties centers on what assets should be considered the equivalent of cash. Petitioner contends that its receivables, inventory, supplies, and various prepaid expenses, including prepaid insurance, are cash equivalents and as such their bases should be their fair market values. If petitioner's argument prevails and these assets are not treated in the same manner as the other assets, their bases will be greater than if they received only an allocated portion of the total purchase price.
Let us examine each of the assets in question separately. The receivables were of two types, trade and employee. Although the employee receivables are relatively small in amount, petitioner might have offered some evidence with respect to them. Since petitioner did not, our only alternative is to hold that the employee receivables were not equivalent to cash.
We have decided that the trade receivables were not cash equivalent notwithstanding that most of them were collected within 30 days of their purchase by petitioner. From the fact that petitioner has already written off almost $1,500 as a bad debt and another $4,400 remains uncollected, we must conclude that petitioner encountered difficulty in attempting to collect these trade receivables. The trade receivables were open accounts, payment of which was completely dependent upon the unsecured credit of Miller's customers.
Petitioner offers an additional reason why we should specifically consider $38,329.42 of the total trade receivables as the equivalent of cash. The purchase of Miller's assets occurred as of the close of business on Saturday, June 27, 1964. At the trial the accountant for petitioner testified that some of Miller's customers customarily issued their checks on Saturday or Sunday. Petitioner thus reasons that the amount of $38,329.42 which it collected on or before Thursday, July 2, 1964, had been already mailed when the contract of purchase was entered into and should be treated as cash. Such testimony of the accountant as to the usual practice of Miller's customers was not persuasive. His testimony was too general and lacked specificity regarding individual customers. For instance, petitioner might have established that certain designated payments received on Tuesday, Wednesday, or Thursday following the sale were actually in transit during the weekend. In this regard we note that an employee of Miller or petitioner picked up certain payments at the post office on Monday, June 29, 1964. These payments were posted in the cash receipts journal of Miller for Friday, the day preceding the sale. Thus, the amounts collected on that Monday already appear as cash on the closing balance sheet of Miller and cannot be also included in the disputed amounts alleged by petitioner to have been in transit over the weekend.
We next consider the inventory, which turned as rapidly as 43 times per year. Despite such rapid turnover, we still do not consider the inventory equivalent to cash. The inventory was in varying stages of process, ranging from raw meat to completed products. Petitioner did not produce evidence as to the fair market value of any of the three elements of inventory— raw materials, work-in-process, and finished goods. See F. & D. Rentals, Inc., supra at 346-347. Therefore, we need not speculate what our position would be if such evidence had been submitted regarding the completed products.
Petitioner has not submitted any argument why the supplies having a fair market value of $32,519.98 should be treated as cash. There is nothing in the record indicating the nature of these supplies. Petitioner has therefore failed to satisfy its burden of proof as to this item.
We have carefully considered the prepaid insurance as well as other prepaid expenses. Looking solely to the facts presented, we have decided to treat these items as the equivalent of cash.
See F. & D. Rentals, Inc., and Nathan Blum, both supra. Respondent's reliance on the holding in Boise Cascade Corporation v. United States, 288 F.Supp. 770 (S.D. Idaho 1968) is misplaced. That case rested on the statutory language of section 334(b)(2) rather than on a factual footing. In the case at bar, we have no specific statutory language for guidance.
The parties have stipulated that the lump-sum purchase price was $419,980.33. The total of petitioner's allocated bases amounts to $440,960.64. The difference in these amounts is not explained in the record. The matter can be reconciled under Rule 50, if necessary.
Before we ever reached the question whether any of the acquired assets were equivalent to cash, we carefully considered and then rejected petitioner's exhortation that we should adhere to its method of allocating the purchase price among all the assets acquired. Petitioner insists that its president agreed to the final purchase price only after he had assigned the same values to the various assets as petitioner now claims for their bases.
Petitioner's argument is too implausible in the face of what appears in the stipulation of facts. The parties have stipulated to the fair market values of the assets purchased. We have compared the stipulated values of fixed assets to petitioner's claimed bases in such assets:
+-----------------------------------------------------+ ¦ ¦Agreed fair ¦ ¦ +----------------------+--------------+---------------¦ ¦Assets ¦market value ¦Claimed basis ¦ +----------------------+--------------+---------------¦ ¦Land ¦$70,000 ¦$15,500.71 ¦ +----------------------+--------------+---------------¦ ¦Buildings ¦130,000 ¦65,972.59 ¦ +----------------------+--------------+---------------¦ ¦Machinery ¦83,210 ¦20,977.87 ¦ +----------------------+--------------+---------------¦ ¦Autos ¦12,850 ¦3,261.49 ¦ +----------------------+--------------+---------------¦ ¦Furniture and fixtures¦3,940 ¦993.43 ¦ +-----------------------------------------------------+
The above table suggests that this reasoning is without merit. The disparity between the claimed bases and the stipulated values of the fixed assets is too great for us to accept the veracity of petitioner's allegations.
Decision will be entered under Rule 50. 1. This represents book value as of the close of business June 27, 1964.
2. The record is silent as to why the claimed bases of the inventory and supplies are not the same as their stipulated fair market values. Perhaps, the figures above represent the lower of cost or fair market value.