Arrott v. Commissioner of Internal Revenue

• Decision Date: 09 June 1943
• Docket Number: No. 8230.,8230.
• Parties: ARROTT v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Third Circuit

136 F.2d 449 (1943)

ARROTT v. COMMISSIONER OF INTERNAL REVENUE.

No. 8230.

Circuit Court of Appeals, Third Circuit.

Argued March 1, 1943.

Decided June 9, 1943.

Drayton Heard, of Pittsburgh, Pa., for petitioner.

N. Barr Miller, of Washington, D. C. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key and Carolyn E. Agger, Sp. Assts. to the Atty. Gen., on the brief), for respondent.

Before MARIS and GOODRICH, Circuit Judges, and GANEY, District Judge.

GOODRICH, Circuit Judge.

The taxpayer was at one time the owner of four blocks of stock of a corporation known as Standard Sanitary Manufacturing Company, hereafter called Standard. She acquired them on four different occasions. The first came to her under the intestate laws of Pennsylvania from the estate of her husband in 1909 as to which value is fixed, of course, as of March 1, 1913. The second came under the intestate laws of Pennsylvania from the estate of her son who died in 1917. The third and fourth acquisitions were through purchases in open market in 1924 and 1926 respectively. The cost basis of each block of this stock was different from that of any other.

During the period of taxpayer's ownership of these Standard shares there were certain stock dividends, split-ups and exchanges none of which raised questions in this litigation. The total holdings in 1929 were 27,900 shares of Standard; the total cost of acquisition, $117,951.01.

In 1929, upon a non-taxable reorganization, the taxpayer surrendered all her Standard shares and received in exchange therefor 30,423 shares of American Radiator & Standard Sanitary Corporation (hereafter called Radiator) common stock. This was a non-taxable exchange under the Revenue Act of 1928, 26 U.S.C.A. Int. Rev.Acts, page 351 et seq.¹

From 1931 to 1936 inclusive, the taxpayer sold some of her Radiator shares in the open market. In 1938 she sold 5,500 shares. It is the cost basis of the latter shares which is the subject of this litigation. The Commissioner says it is to be computed by an equal allocation of the cost of all the Radiator shares.² Petitioner wants a basis allocated to the cost of her two market purchases of 1924 and 1926, plus so much of the cost of her 1917 inheritance from her son as may be required to fill out the number of Radiator shares sold in 1938. If average cost is to be used, she says, then the straight average cost should be adjusted in such manner as to take into account the earlier sales, as shown in the Commissioner's original notice of deficiency.³

We shall first discuss briefly the application of the average cost rule. When a shareholder buys, at different times and at different prices, shares in the same corporation, his $80 share is just as great an interest in the corporate enterprise as the one for which he pays $110. But if he sells each at $120 it is too clear to be talked about that his profit is $30 greater on the low cost purchase than the high cost acquisition. If he sells only part of his shares and can identify what he sold as the block purchased at any particular price, then he pays his tax upon the gain from that transaction. Many cases turn upon the sufficiency of such identification. For examples, see Curtis v. Helvering, 2 Cir., 1939, 101 F.2d 40; Fuller v. Commissioner of Internal Revenue, 1 Cir., 1936, 81 F.2d 176; Rule v. Commissioner of Internal Revenue, 10 Cir., 1942, 127 F.2d 979. If no identification is established, the first in-first out rule provides a working basis for the imposition of a tax upon the profits of a particular transaction and insures the shareholder that if he keeps on selling he will eventually have all of his capital allowed. Though it seems to be a favorite rule of the Commissioner there is little else to commend it. The taxpayer's preference would undoubtedly be for the most expensive purchase as the one to be used as the basis of calculating the tax on an individual sale. We think the average cost of all the shares is the fairest of the three.

At any rate the courts have refused to follow the Commissioner's first in-first out rule when the taxpayer had exchanged the various blocks of stock in one corporation for the shares of another in a tax free reorganization. In those instances the average cost rule finds such firm support both from the Tax Court and the various Circuits that it will take a Supreme Court decision or an act of Congress to change it. Commissioner of Internal Revenue v. Von Gunten, 6 Cir., 1935, 76 F.2d 670; Helvering v. Stifel, 4 Cir., 1935, 75 F.2d 583; Commissioner of Internal Revenue v. Oliver, 3 Cir., 1935, 78 F.2d 561; Commissioner of Internal Revenue v. Bolender, 7 Cir., 1936, 82 F.2d 591; Fleischmann v. Commissioner of Internal Revenue, 1939, 40 B.T.A. 672. That this result was established against the contentions of the Commissioner does not of course preclude him from using it in his favor in subsequent litigation, even though it gives the taxpayer a chance to make faces at the tax collecting authorities.

We think it is the only sound rule. The old shares all have the same exchange value for the new ones no matter what they cost the taxpayer. He gets as much new stock for the share for which he paid $80 as he does for the share for which he paid $120. The old shares lose their identity when traded for the new, just as the money with which one buys a war bond loses its identity in the certificate, though to the purchaser some of it may have been a gift, some won on a horse race and the remainder earned by the sweat of his brow. The old shares are gone; the new shares in what is at least nominally a new company take their place. Each new share costs the taxpayer the quotient of the sum of the cost of the old shares divided by the number of new...