Gage Bros. & Co. v. Comm'r of Internal Revenue

• Decision Date: 30 September 1949
• Docket Number: Docket No. 17273.
• Citation: 13 T.C. 472
• Parties: GAGE BROTHERS AND COMPANY, AN ILLINOIS CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

13 T.C. 472

GAGE BROTHERS AND COMPANY, AN ILLINOIS CORPORATION, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 17273.

Tax Court of the United States.

Promulgated September 30, 1949.

1. Merger under Illinois statute held not to entitle resulting corporation to its predecessor's equity invested capital for purposes of excess profits tax.

2. Arm's length transaction between creditors and debtor corporation's stockholder which resulted in settlement of obligation and transfer of the business to the petitioner, a new corporation in which creditors and old stockholders had control and the interests of the parties were substantially unaltered, held to have constituted a nontaxable exchange under Internal Revenue Code, section 112(b)(5), Alexander R. Duncan, 9 T.C. 468, followed; and held, further, that pursuant to Internal Revenue Code, sections 718, 728, 729, and 113(a)(8), petitioner's equity invested capital was the basis of petitioner's property to its transferors.

3. A majority of petitioner's stock being owned by a creditor of the old company, held the creditor was not a ‘shareholder‘ as required by section 718(c)(5), depriving petitioner of the right to inherit its predecessor's earned surplus deficit under section 718(a)(7), Internal Revenue Code.

4. No income tax deficiency having been determined, held respondent's motion to dismiss proceedings as to income tax must be granted. Richard H. Tyrrell, Esq., and Patrick W. Cotter, Esq., for the petitioner.

H. H. Hart, Esq., for the respondent.

This proceeding is brought for the redetermination of deficiencies in petitioner's excess profits tax for the taxable years ended November 30, 1942 and 1943, in the amounts of $4,534.17 and $6,466.92, respectively. Petitioner claims an overpayment of $50,063.72. Respondent, in his notice of deficiency, also determined overpayment in Federal income tax for the years ended November 30, 1942 and 1943, in the amounts of $39.28 and $3,315.62, respectively. As to the latter, respondent now urges that this Court has no jurisdiction in these proceedings to redetermine the income tax liability for the years in question.

The primary issue is to determine petitioner's equity invested capital under Internal Revenue Code, section 718. This issue is dependent upon successive subissues of whether petitioner is a continuation of Gage Brothers & Co., hereinafter referred to as ‘Old Gage‘; whether a 1936 reorganization was a tax-free exchange under the Revenue Act of 1936; whether petitioner is entitled to a credit representing the deficit in earnings and profits of Old Gage under Internal Revenue Code, section 718(a)(7); and whether it is entitled to a credit for good will of Old Gage under section 718(a)(2). Depending upon the existence of jurisdiction, the income tax issue is whether liquidating dividends on capital stock received by petitioner during the period in question represent a long term capital gain or loss.

The case was submitted upon a stipulation of facts and evidence adduced at the hearing. Those facts hereinafter appearing which are not from the stipulation are otherwise found from the record.

FINDINGS OF FACT.

The stipulated facts are hereby found accordingly.

Petitioner filed the tax returns here involved with the collector of internal revenue at Chicago for the first district of Illinois.

Old Gage was incorporated under the laws of the State of Illinois on February 18, 1887. It was a continuation of an unincorporated business of similar character established in 1856. Old Gage, throughout its existence, engaged in the business of manufacturing, distributing, and selling women's hats of medium and high grade quality. It has been continuously a leading distributor of women's hats of that quality. It had occupied a building at 18 South Michigan Avenue, Chicago, Illinois, since 1896, and for many years a floor at 417 Fifth Avenue, New York, New York. Until the depression of the 1930's it maintained offices in most of the largest cities of the United States, and served approximately 10,000 account throughout the United States, China, Australia, Mexico, Hawaii, and South Africa. From 1930 to 1936 it had approximately 6,000 accounts.

Extensive national advertising was done by Old Gage throughout its existence in leading national fashion magazines such as Vogue and Harpers Bazaar, in newspapers and rotogravures. From 1920 to 1936 its expenditures for advertising totaled $777,370.75. It owned many registered trade names incorporating the name Gage, and its label was an outstanding individual identification in its field.

For some years prior to July 1, 1936, Old Gage purchased a substantial part of its hat merchandise from Slocum Straw Works, a Wisconsin corporation of Milwaukee. Old Gage constituted the principal outlet for the products of Slocum. During the depression years following the business collapse of 1929, Old Gage operated at severe losses and Slocum continued to extend large credits to it.

From 1931 to 1936 intensive efforts were made by the stockholders and directors of Old Gage to effect a financial reorganization and a series of negotiations was conducted between the stockholders of Old Gage (from time to time represented by special committees appointed for that purpose) and Slocum to bring about credit arrangements for the continued operation of the business. During this period of negotiation Slocum was given minority representation on Old Gage's board of directors. This was in consideration of Slocum's extension of credit and to protect Slocum's interest as a creditor. Slocum named three out of nine directors. Everett Slocum became vice president and A. L. Slocum treasurer of Old Gage.

During the period from 1932 to 1936 the amount of Old Gage's indebtedness to Slocum aggregated each year more than $200,000, part of which was secured by assignment of Old Gage's receivables. Between 1931 and 1936, the amount due from Old Gage to Slocum ranged as high as $276,980.50.

On July 9, 1935, at a special meeting of the stockholders of Old Gage, further consideration was given to the company's financial position and to the possibility of liquidation in the absence of a working agreement with Slocum. A committee representing the stockholders was appointed to consider the company's condition and report its recommendations. The committee was ‘to keep informed of the operations and progress under * * * (a plan for restricted operations that fall) and be in a position to report and offer recommendations to the balance of the stockholders at the next general meeting.‘

On June 9, 1936, Slocum, being unwilling to carry its credit accounts with Old Gage any longer, made the following proposition:

(a) A new corporation, hereinafter called ‘New Gage,‘ was to be organized to acquire all the assets of Old Gage.

(b) New Gage was to buy from Old Gage all of its assets and to pay therefor by issuing and delivering to Old Gage 15,000 shares of its class A stock and 30,000 shares of its class B stock, and by assuming all debts of Old Gage, except that as to the debts owing to Slocum, New Gage would assume only $75,000 and the current amount.

(c) Slocum was to accept from Old Gage 30,000 shares of New Gage class B stock, and from New Gage its promissory note for $75,000, dated July 15, 1936, payable in three years with interest at 4 per cent per annum, together with a promise to pay the current accounts due it from Old Gage, which as of May 31, 1936, totaled $14,850.15. Slocum agreed that in consideration of the above it would make no further claim on account of the indebtedness owing by Old Gage, and would release all security held for such indebtedness in the form of assignments of accounts receivable which it then held in the face amount of $82,456.46.

(d) Old Gage would immediately distribute 15,000 shares of class A stock to its stockholders, of which 7,500 shares were to go to holders of its common stock and 7,500 shares to its preferred stockholders. The old common stock and preferred stock were to be surrendered at the time of such distribution.

(e) Slocum was to pay legal expenses incurred in the organization of the new corporation.

(f) Old Gage was to take all corporate action to effect the reorganization and sale of its assets to the new corporation.

(g) Slocum offered to agree with New Gage that in the event the net profits of the new corporation in any year were not sufficient to meet the sinking fund requirements of $7,500 for the retirement of class A stock and the consolidated net profits of the new corporation and of Slocum equaled or exceeded $7,500, then Slocum would contribute $7,500 to the surplus of the new company for its sinking fund or such part thereof as might be required to make up the $7,500. It further agreed that if the consolidated net profits of Slocum and the new company should exceed $50,000 net a year, and the net profits of the new company should be less than the consolidated net profits, Slocum would contribute to the surplus of the new company to provide for the retirement of class A stock 20 per cent of the excess of consolidated net profits over $50,000. The foregoing was conditioned on the consolidated net profits statement of Slocum and the new company showing net profits for the current fiscal year.

At a special meeting of the stockholders of Old Gage held June 9, 1936, upon favorable recommendation of the stockholders' reorganization committee appointed on June 9, 1935, to negotiate with Slocum, the plan was approved by the stockholders and the matter was referred to the directors for action.

At a special meeting of the board of directors of Old Gage held June 23, 1936, the president stated that reorganization could be best effected by the merger of Old Gage and New Gage, to be called Galo Hat Co., temporarily, ‘which was in accordance with the action of the stockholders, under which the mechanics of the reorganization was left to subsequent...