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Crean Bros. Inc. v. Commissioner of Internal Revenue.

filed: March 17, 1952.

CREAN BROS., INC.
v.
COMMISSIONER OF INTERNAL REVENUE.



Author: Maris

Before MARIS, KALODNER and STALEY, Circuit Judges.

MARIS, Circuit Judge.

This petition by the taxpayer to review a decision of the Tax Court against it presents the question whether the taxpayer is entitled, under Section 718(a) (2)*fn1 of the Internal Revenue Code, to include the sum of $99,965.05 in its equity invested capital for the purpose of computing the tax on its excess profits for the year 1945. This sum represented an indebtedness owing from the taxpayer to Hudson Coal Company which that company had gratuitously cancelled in 1938. Hudson Coal Company was the majority stockholder of the taxpayer's principal stockholder.The facts are stated in the opinion of the Tax Court, 15 T.C. 889, and need not be detailed here. The Tax Court in banc, three judges dissenting, held that the amount of the cancelled indebtedness was not includible in the taxpayer's equity invested capital. We hold to the contrary.

Under the express terms of Section 718(a) (2) the cancelled indebtedness in question was required to be included in the taxpayer's equity invested capital if it was "Property (other than money) previously paid in * * * as a contribution to capital." The indebtedness clearly was property within the meaning of Section 718(a) (2)*fn2 Under the Treasury Regulations in force in 1938*fn3 as well as during the tax year involved*fn4 its gratuitous forgiveness, if it had been by a stockholder creditor, would have amounted to a contribution to the capital of the taxpayer.*fn5 It is also settled that one who is not a stockholder and who has no proprietary interest in a corporation may make a contribution to its capital within the meaning of Section 718(a).*fn6 Here the Hudson Coal Company, although not itself a stockholder of the taxpayer, was the majority stockholder of the taxpayer's own majority stockholder and thus a corporate grandparent, so to speak, with a proprietary interest which a contribution to capital would enhance.

The Tax Court nonetheless held that the cancelled indebtedness did not represent property paid in to the taxpayer since it was includible in equity invested capital under Section 718(a) (2) only "in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange" and upon cancellation ceased to exist and therefore could have no such basis in the hands of the debtor. But the Tax Court failed to give effect to Section 113(a) (8) (B) of the Internal Revenue Code which provides that such basis for gain or loss in the case of property acquired after December 31, 1920 as a contribution to capital shall be the same as it would be in the hands of the transferor.*fn7 The interdependence of the two provisions has been recognized by the Commissioner.*fn8 The basis of the indebtedness herein question in the hands of Hudson Coal Company, the creditor-transferor, was $99,965.05. It was therefore includible in the taxpayer's equity invested capital in that amount.

The respondent argues that the indebtedness was wholly uncollectible because of the taxpayer's insolvency and for that reason could not be regarded as property paid in to the taxpayer as a contribution to capital. It does appear that the taxpayer was insolvent prior to the cancellation of the debt but the only evidence on the point in the record is the taxpayer's income tax return for 1938 and that indicates that after the cancellation of the indebtedness of $99,965.05 the taxpayer had a net worth of $42,484.28. The Tax Court made no finding that the debt was worthless or wholly uncollectible and such a finding would clearly have been erroneous under the circumstances. For, assuming a pro rata distribution of the taxpayer's assets at their book value to the taxpayer's creditors before the cancellation of the Hudson Coal Company debt, that company and all the other creditors would have received a dividend of 84% of their claims. That the cancellation of the debt was of value to the taxpayer is obvious since it transformed an insolvency of $57,480.77 into a net worth of $42,484.28.

The respondent's final contention is that Section 718(a) (2) is not applicable here because Hudson Coal Company did not intend to make a contribution to the taxpayer's capital. While there are no findings by the Tax Court on the subject the facts were stipulated and it appears from them that the cancellation of the indebtedness by Hudson Coal Company was wholly gratuitous and motivated solely by its desire to aid the taxpayer in continuing in business.*fn9 This is sufficient evidence that the transaction was intended to be a contribution to capital.*fn10

The decision of the Tax Court will be reversed.

KALODNER, Circuit Judge (dissenting).

The crux of the majority's position is that (1) the cancelled indebtedness had a "basis" of $99,965.05 in the hands of the Hudson Coal Company within the meaning of Section 113(a) (8) (B) and (2) was "property" within the meaning of Section 718(a) (2). I disagree with that position.

First, as to the "basis": the record itself clearly establishes its non-existence. Since the majority in its opinion did not discuss what I deem to be the critical facts in the record on that score, it becomes necessary to do so here. The facts referred to are:

On December 29, 1938, the Hudson Coal Company ("Hudson") owned 51 per cent and the Foedisch Coal Company*fn1 ("Foedisch") owned 49 per cent of the capital stock of the Middle Atlantic Anthracite Corporation. The latter corporation in turn owned 77.3 per cent of the outstanding stock of the taxpayer. Hudson mined and produced coal. Foedisch sold coal at wholesale and the taxpayer sold coal at retail.

Shortly before December 29, 1938, Foedisch owed Hudson $303,151.15 for coal purchased and resold to the taxpayer; the latter owed $317,634.50 to Foedisch on account of its purchase of coal from it.

Orally, on December 28, 1938, and by letter on December 29, 1938, Foedisch advised Hudson that it was unable to make collections from the taxpayer, and proposed to Hudson that "an adjustment" be made of its obligation to Hudson and that of the taxpayer to it. Foedisch specifically proposed that it assign to Hudson $100,000 of the taxpayer's indebtedness to it in consideration of Hudson's cancellation of $100,000 of Foedisch's indebtedness to ...


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