Schuh Trading Co. v. Commissioner of Internal Revenue

• Citation: 95 F.2d 404
• Decision Date: 08 March 1938
• Docket Number: No. 6389-6392.,6389-6392.
• Parties: SCHUH TRADING CO. et al. v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Seventh Circuit

95 F.2d 404 (1938)

SCHUH TRADING CO. et al. v. COMMISSIONER OF INTERNAL REVENUE.

Nos. 6389-6392.

Circuit Court of Appeals, Seventh Circuit,

March 8, 1938.

COPYRIGHT MATERIAL OMITTED

David S. Lansden, and David V. Lansden, both of Cairo, Ill., for petitioners.

James W. Morris, Asst. Atty. Gen., Sewall Key, and Ellis N. Slack, Special Assts. to Atty. Gen. Helen R. Carloss, of Washington, D. C., for respondent.

Before SPARKS and MAJOR, Circuit Judges, and LINDLEY, District Judge.

LINDLEY, District Judge.

These causes were consolidated in one appeal, argued as one, and grow out of the same facts. The petitioners seek to reverse decisions of the United States Board of Tax Appeals in which it was determined that there were deficiencies in the federal income tax of each of them for the calendar year 1929.

The Schuh Trading Company was formerly the Schuh Drug Company, under which name it was incorporated in 1893 and conducted its corporate business until the transactions here involved. Upon its organization, the corporation acquired and continued an established business, conducted for more than forty years by individuals, predecessors of petitioners, extending into six different states, and, having at the time of the execution of the contract involved, some 240 retail customers.

On March 9, 1929, the corporation and all its stockholders entered into a contract with McKesson & Robbins, Inc., a Maryland Corporation, entitled "Transfer Agreement Reorganization of the Schuh Drug Company of Cairo, Illinois, with McKesson & Robbins, Inc." This document provided for the transfer of the drug business and property of the Schuh Drug Company to McKesson & Robbins, or its nominee, in exchange for $562.19 in cash, and 3,877 shares of the common stock and 2,131 shares of the preference stock of McKesson & Robbins. The parties agreed that the assets to be transferred, considering certain agreed prices applied to specific items, amounted to $315,745.07, and that the liabilities to be assumed amounted to $49,290.88; the net assets to be transferred over liabilities to be assumed being $266,454.19.

On April 25, 1929, McKesson & Robbins having designated as its nominee its fully-owned subsidiary, Fuller-Morrison Company, the assets were transferred to the latter company, and on April 29, the stockholders of the Schuh Trading Company received from McKesson & Robbins the shares of stock specified in the agreement in proportions identical with the holdings of such stockholders in the transferring corporation. Obviously, the small amount of cash involved was paid to avoid the issuance of fractional shares. The reorganization contract provided that none of the shares of McKesson & Robbins received should be disposed of for six months, after receipt thereof, except with the prior written consent of McKesson & Robbins.

The four principal stockholders of Schuh Drug Company agreed to guarantee the payment of $37,042.32 of notes receivable transferred to McKesson & Robbins, and the board of directors of Schuh adopted a resolution agreeing to save and keep harmless the guaranteeing stockholders from liability upon the guaranty. This action was approved, likewise, by the stockholders. Upon completion of the transfer, the Schuh Drug Company changed its name to Schuh Trading Company, as it was provided in the reorganization agreement that the transferor should cease doing a drug business, and that the right to use its name should pass to the transferee. The stockholders of Schuh Trading Company surrendered 80 per cent. of their stock. This was canceled and the capital stock reduced thereby from $250,000 to $50,000.

The reorganization contract provided, among other things, that the Schuh Company should transfer all of its assets, business, properties, real and personal, tangible and intangible, rights, privileges, interests, licenses, patents, formulæ, tradenames, trade-marks, good will and franchises of all kinds, at the date of closing the contract, excepting only its corporate franchise, certain real estate, securities and investments, notes and accounts receivable due from officers and employees, insurance on the life of Herman Schuh, and certain claims for tax refunds. The parties entered into no agreement concerning the valuation of the intangible property, including good will or trade contracts. In their agreement they valued the preferred stock at $52 per share and the common stock at $40 per share.

Promptly, upon the completion of the transaction, the transferee, through its nominee, went into possession of the wholesale drug business, and has since conducted it; one of the petitioners being retained as manager, and serving also as director of both the transferee and its nominee.

During the year 1929, partly before but largely after these transactions, McKesson & Robbins acquired upon similar plans the assets and property or capital stock of many other corporations engaged in wholesale drug business throughout the United States, so that at the end of the year it had taken over the business and assets of some sixty-six different companies in various parts of the country.

Eventually $16,300, representing stock investments, reserved by the Schuh Company, proved to be wholly worthless; and the transferor was compelled to pay out some $21,000 on its guaranty of notes receivable transferred.

Petitioner Julius Schuh was indebted to a bank in Cairo to the extent of $42,000, for which he pledged McKesson & Robbins Stock as collateral security. During the year he requested McKesson & Robbins to remove the restriction and allow him to sell the stock, but that company refused.

The Schuh Trading Company, in its income tax return for 1929, made no report of the transaction, upon the theory that it amounted to a reorganization and was, therefore, nontaxable under the acts of Congress. The Commissioner decided that it was not a reorganization, and that a taxable gain resulted. In his calculation he valued the preferred stock received from McKesson & Robbins at $57.50 and the common at $51.50. The Board of Tax Appeals affirmed his action.

It is contended that the Board erred: (1) In finding that there was no reorganization; (2) if there was in fact no reorganization, in finding that the transaction resulted in gain to the petitioners; and (3) in refusing to receive competent and material evidence. The first two raise the issue of whether the ultimate findings of the Board were supported by the evidence or were contrary to all the evidence. This question we must determine, for such ultimate findings are subject to judicial review, and upon such review the court must substitute its judgment for that of the Board. Helvering, Commissioner, v. Tex-Penn Oil Co., 300 U.S. 481, 57 S.Ct. 569, 81 L.Ed. 755. If the evidence before the Board as the trier of the facts ought to be convincing, it may not say that it is not, because it may not arbitrarily discredit the testimony of witnesses so far as they testify to facts; the facts must be fairly and judicially weighed and determination reached thereon. Chicago Ry. Equipment Co. v. Blair, Commissioner, 7 Cir., 20 F.2d 10; Blackmer v. Commissioner, 2 Cir., 70 F.2d 255, 92 A.L.R. 982; Elkins v. Commissioner, 3 Cir., 91 F.2d 534.

Under section 112 (i) of the Revenue Act of 1928, 26 U.S.C.A. § 112(g) note, the term "reorganization" includes the acquisition by one corporation of substantially all the property of another corporation. This definition is not an all-inclusive one, but simply mentions certain cases with respect to which doubt might arise. It enlarges the connotation of the term, "a party to reorganization," to embrace corporations whose relation to the transaction would not in common usage be so denominated or as to whose status doubt might otherwise arise. Groman v. Commissioner, 302 U.S. 82, 58 S.Ct. 108, 82 L.Ed. ___. Consequently, whether a certain transaction is a reorganization within the statute is a question to be determined from the facts peculiar to each case.

In its opinion the Board relied upon three cases: Nelson Co. v. Helvering, 28 B.T.A. 529; Minnesota Tea v. Helvering, Commissioner, 28 B.T.A. 591 and G. & K. Mfg. Co. v. Commissioner, decided by the Board. Each has since been reversed by the Supreme Court of the United States; the first in Nelson Co. v. Helvering, 296 U.S. 374, 56 S.Ct. 273, 80 L.Ed. 281; the second, in Helvering, Commissioner, v. Minnesota Tea, 296 U.S. 378, 56 S.Ct. 269, 80 L.Ed. 284; and the third, in G. & K. Mfg. Co. v. Commissioner, 296 U.S. 389, 56 S.Ct. 276, 80 L.Ed. 291. Consequently, we must approach the issue with the knowledge that the authorities upon which the Board relied have been determined by the Supreme Court to have been erroneous.

The first immediate question is whether the facts support the ultimate finding of no reorganization. It will be observed that the Schuh Company under its contract changed its name, abandoned the name of Schuh Drug Company and all drug business, and agreed to remain out of that business in the state of Illinois for a definite period; that it reduced its capital stock, and delivered to the transferee all elements of the wholesale drug business of whatsoever character conducted by it for a long period of years. It rented to the nominee its real estate, valued by the parties at $27,000, but by the uncontradicted parol evidence submitted to the Board, really worth $25,000. It reserved certain stock investments amounting to $16,300 later found to be utterly worthless. It repaid to McKesson & Robbins some $21,000 on its guaranty of assets transferred.

According to the undisputed evidence the values of specific property transferred were as follows: (1) Cash in bank, notes and accounts receivable, less reserves for doubtful items and discounts, and inventory at cost or market, "whichever is lower," $260,731.02; (2) advances to customers and installment notes receivable, less reserve for doubtful items, $35,542.32; (3)...