On Petitions for Review of Decisions of United States Board of Tax Appeals.
Before BUFFINGTON and BIGGS, Circuit Judges, and MARIS, District Judge.
These are petitions by the Commissioner of Internal Revenue to review decisions of the Board of Tax Appeals determining that there was no deficiency in income tax for the year 1930 in the cases of J. de S. Freund and Lillian M. Freund, his wife (hereinafter called Mrs. Freund), respectively. The two cases were considered by the Board in one opinion and will be so considered here. The Board found the relevant facts to be substantially as follows:
In 1930 Freund was the owner of 154 shares of preferred stock and 770 shares of common stock of the American Cement Tile Manufacturing Company (hereinafter called the American Company). This stock was acquired by him in the two years prior to 1930 at an aggregate cost of $54,086.80. At the same time Mrs. Freund owned 279 shares of preferred stock and 1,395 shares of common stock of the American Company, part of which she had received in 1930 as a gift from I. L. Myers, who had owned and held it for more than two years prior to 1930, and the remainder she had owned and held for more than two years. Her cost basis was $74,956.26.
The American Company was a Pennsylvania corporation with its principal office in Pittsburgh. It was engaged in the manufacture and sale of cement tile and kindred products. In addition to Freund and Mrs. Freund there were only four other stockholders of the American Company. The capital stock was 1,000 shares of preferred and 5,000 shares of common - 6,000 shares in all. The Federal Cement Tile Company (hereinafter called the Federal Company) was an Illinois corporation with its principal office in Chicago and was also engaged in the cement tile business.
The Federal Company desired to take over the business of the American Company and the assets employed in that business, with certain exceptions. The stockholders of the American Company, including Freund and Mrs. Freund, entered into an agreement with the Federal Company under date of September 4, 1930, in order to effectuate such a transfer. The plan as set forth in this agreement may be briefly outlined as follows: A new corporation, the American Liquidation Company (hereinafter called the Delaware Company), was to be organized by the stockholders of the American Company. The American Company was to convey to the Delaware Company certain assets, hereinafter referred to as "fixed assets," consisting of lands, buildings, machinery, equipment, patents, etc., and also certain other assets, hereinafter referred to as "excepted assets," comprising some investments, a life insurance policy and some doubtful accounts receivable. In return for these "fixed assets" and "excepted assets" the American Company was to receive 1,900 shares of the capital stock of the Delaware Company. The inventories, accounts receivable and other assets, hereinafter refered to as the "current assets," were to be retained by the American Company.
The American Company and the Delaware Company then formulated what was designated as "a plan of reorganization." This plan provided that the American Company should reduce its capital stock from 6,000 shares to 3,000 shares, all common, having a par value of $100 per share. After this reduction the American Company was to distribute to the holders of its outstanding stock the 1,900 shares of the Delaware Company stock acquired in exchange for the assets transferred to that company. The capital stock of the American Company was then to be transferred to the Delaware Company in exchange for 950 shares of the latter's capital stock.
As soon as the foregoing steps had been consummated the Delaware Company was to transfer to the Federal Company the 3,000 shares of the capital stock of the American Company and the so-called "fixed assets" above mentioned. In consideration for the transfer, the Federal Company was to pay $292,000 in cash and $317,900 in bonds for the assets and $282,100 in bonds for the 3,000 shares of stock. This was the agreed consideration to be paid by the Federal Company under the agreement between it and the stockholders of the American Company. The Delaware Company was then to distribute forthwith to its stockholders the cash and bonds and other considerations received by it in pursuance of the plan.
The "plan of reorganization" between the American Company and the Delaware Company was ratified and approved by the stockholders and directors of both companies and during the month of October, 1930, all the transfers contemplated were made. The Federal Company became the owner of the "fixed assets" and all of the capital stock of the American Company. By reason of the ownership of this stock the Federal Company also became indirectly the owner of the "current assets." The Delaware Company received the $292,000 in cash and the $600,000 in bonds of the Federal Company. The bonds were dated October 10, 1930, bearing interest at the rate of 6% per annum, payable semi-annually to the bearer or registered owner. The bonds were payable serially as follows: $50,000 of the principal on October 10th of each of the years 1931, 1932, 1933, 1934, and 1935; and $350,000 on October 10, 1936. The Federal Company had the right to redeem or repay any or all of said bonds at various dates by payment of specified premiums thereon. The bonds were secured by a mortgage and deed of trust on all of the Federal Company's property given to the Foreman-State Trust and Savings Bank and Henry J. Carson, as trustees, who were given the right to enter and take possession of the mortgaged property in case of default in the payment of interest or principal or in the performance of other covenants of the mortgage.
On October 20, 1930 the Delaware Company distributed the bonds and cash to the stockholders. After the payment of certain expenses $265,970.29 in cash was divided among the stockholders. In the distribution Freund received $100,000, in bonds, and $40,378.35, in cash, totalling $140,378.35, and Mrs. Freund received $175,000 in bonds and $79,321.81 in cash, totalling $254,321.81.
The Delaware Company was formed for the purpose of receiving and liquidating the so-called "excepted assets" of the American Company which the Federal Company did not desire to acquire or which the stockholders of the American Company did not desire to transfer, and for the purpose of discharging the contingent and other liabilities assumed or retained by the stockholders of the American Company under the agreement of September 4, 1930 between those stockholders and the Federal Company. After the transactions hereinabove set forth the assets of the Delaware Company, which consisted solely of the so-called "excepted assets," were shown on its balance sheet to have a book value of $149,527.16. It had liabilities of $4,431.11, exclusive of its outstanding capital stock, which amounted to $2,850. The Delaware Company continued in existence and engaged in collecting, selling and otherwise disposing of or liquidating the so-called "excepted assets" acquired by it and in discharging certain of the liabilities of itself and of the former stockholders of the American Company. Its capital stock, all of which was distributed to the former stockholders of the American Company, including Freund and Mrs. Freund, had no fair market value at the time of its receipt.
In the agreement of September 4, 1930 between the stockholders of the American Company and the Federal Company, the stockholders, including Freund and Mrs. Freund, guaranteed and warranted that all accounts receivable, notes receivable, bills receivable and trade receivables of the American Company would be collected by October 31, 1931, and they agreed to repurchase any such receivables that were not fully collected by that time. They also covenanted to indemnify the Federal Company against all contingent liabilities of the American Company and against all liabilities not shown by an audit report made out by an accounting firm at that time.
Prior to the execution of the contract of September 4, 1930 the American Company had installed roofs with guarantees against defects in material and workmanship. Subsequent to the year 1930 the Federal Company made certain expenditures for repairs and replacements and made claim for reimbursement against the individual former stockholders of the American Company. In settlement of this claim, subsequent to the year 1930, three of the six stockholders of the American Company returned to the Federal Company $25,000 in par value of the bonds ...