Baker Commodities, Inc. v. Comm'r of Internal Revenue

• Decision Date: 23 June 1967
• Docket Number: Docket Nos. 1371-65,5416-65,5418-65,5420-65.
• Citation: 48 T.C. 374
• Parties: BAKER COMMODITIES, INC., ET AL.,1 PETITIONERS V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

48 T.C. 374

BAKER COMMODITIES, INC., ET AL.,1 PETITIONERS V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket Nos. 1371-65

5416-65

5418-65

5420-65.

Tax Court of the United States.

Filed June 23, 1967.

Carl A. Stutsman, Jr., Jack R. White, and Glenn M. Alperstein, for the petitioners.

Arthur P. Generaux, Jr., for the respondent.

In 1961, three brothers transferred their partnership business, consisting of stock in four corporations and real estate, to a corporation owned partly by them and partly by seven employees of the partnership business. In consideration for the partnership assets thus acquired, the corporation assumed partnership indebtedness of $62,000 and issued a $3,150,000, 15-year promissory note to the partnership which required the corporation to make annual payments of interest and principal in the amounts of $80,000 and $200,000, respectively. Immediately after the transfer, the corporation liquidated two of the four corporate subsidiaries acquired thereby and took a stepped-up basis on the assets received from the liquidation corporations. In 1962, the corporation acquired stock in a Panamanian corporation from the three brothers and immediately liquidated it, taking a stepped-up basis on the assets thereby acquired, including an exclusive marketing agreement. Held:

1. The 15-year promissory note constituted a bona fide indebtedness rather than equity capital investments by the three brothers, and the corporation was entitled to deduct its annual interest payments made on the note.

2. The stock in the two subsidiary corporations which were liquidated in 1961 was acquired by the corporation in an exchange to which sec. 351, I.R.C. 1954, applied and pursuant to sec. 334(b)(2) and (b)(3)(B) the corporation was not entitled to take a stepped-up basis on the assets received upon liquidation of those two corporations.

3. The three brothers were entitled to report as long-term capital gain the gain received on their distributive share of the annual principal payments made by Baker Commodities, Inc., to their partnership.

4. At the time the corporation acquired stock in the panamanian corporation in 1962, it was the constructive owner of that stock under the attribution rules of sec. 318(a) and pursuant to sec. 334(b)(2) and (b)(3)(C), the corporation was not entitled to take a stepped-up basis on the assets received upon liquidation of the Panamanian corporation, including the exclusive marketing agreement.

WITHEY, Judge:

Respondent determined deficiencies in petitioners' income tax for the years and in the amounts as follows:

+-------------------------------------------------------+
                ¦Petitioner            ¦Docket ¦Taxable year ¦Deficiency¦
                +----------------------+-------+-------------+----------¦
                ¦                      ¦No.    ¦ended—       ¦          ¦
                +----------------------+-------+-------------+----------¦
                ¦                      ¦       ¦             ¦          ¦
                +----------------------+-------+-------------+----------¦
                ¦Baker Commodities, Inc¦1371-65¦June 30, 1961¦$57,324.26¦
                +-------------------------------------------------------+
                

                               July 31, 1961 6,946.27
                                               June 30, 1962 341,322.69
                                               June 30, 1963 182,156.18
                Frank and Helen Jerome 5416-65 Dec. 31, 1961 25,760.93
                

                              Dec. 31, 1962 305,694.99
                                              Dec. 31, 1963 17,774.89
                Varney and Iva Jerome 5418-65 Dec. 31, 1961 25,841.22
                

                                 Dec. 31, 1962 309,388.10
                                                 Dec. 31, 1963 18,085.06
                Paul and Angelina Jerome 5420-65 Dec. 31, 1961 23,962.26
                

  Dec. 31, 1962  309,169.92
                  Dec. 31, 1963  12,695.28
                

The cases have been consolidated and will be decided together. Numerous issues raised by the pleadings have been disposed of by the parties, leaving the following issues to be decided:

(1) Whether the promissory note in the amount of $3,150,000 given to the Jerome Bros. partnership by Baker Commodities, Inc., constituted a bona fide indebtedness, or was rather in the nature of preferred stock evidencing a risk capital investment by the partners.

(2) Whether Baker Commodities, Inc., obtained a stepped-up basis on the assets it acquired upon the complete liquidation in 1961 of two wholly owned subsidiaries.

(3) Whether the three Jerome brothers were entitled to report as long-term capital gain the gain they realized from their distributive share of the principal payments received from Baker Commodities, Inc., on the $3,150,000 promissory note.

(4) Whether Baker Commodities, Inc., obtained a stepped-up basis on the assets it acquired upon the complete liquidation in 1962 of a wholly owned subsidiary.

FINDINGS OF FACT

Some of the facts have been stipulated and are found accordingly.

All statutory references hereinafter are to the Internal Revenue Code of 1954 unless otherwise indicated.

Petitioner Baker Commodities, Inc., was duly organized and existed as a California corporation with its principal office in Los Angeles, Calif. For the tax years in question it filed its corporate income tax returns with the district director at Los Angeles, Calif.

The petitioners Frank and Helen Jerome are, and were at all times material herein, husband and wife residing in Downey, Calif. They filed their Federal income tax returns for all years in question with the district director at Los Angeles, Calif.

The petitioners Varney and Iva Jerome are, and were at all times material herein, husband and wife residing in Phoenix, Ariz. They filed their federal income tax returns with the district director at Los Angeles, Calif., for the years 1961 and 1962 and with the district director at Phoenix, Ariz., for the year 1963.

The petitioners Paul and Angelina Jerome are, and were at all times material herein, husband and wife residing in Albuquerque, N. Mex. They filed their Federal income tax returns for all years in question with the district director at Albuquerque, N. Mex.

Since the wives of the individual petitioners are joined here only by virtue of their filing of joint returns with their respective husbands, use of the word ‘petitioners,‘ when referring to the individual petitioners as distinguished from the corporate petitioner, will be used only in reference to the respective husbands.

Frank, Paul, and Varney Jerome are brothers who have been equal business partners since 1929 under the name of Jerome Bros. (hereinafter sometimes referred to as the Jerome Bros. partnership or the partnership). Their partnership agreement, although originally oral, was reduced to writing on or about January 1, 1951, and has continued in existence at all times up to and including the time of trial. In its early years, the partnership engaged in the fertilizer business. After discontinuing its fertilizer operations in 1937, it entered the business of rendering animal meat byproducts into animal feeding fats and inedible tallow. One of the most essential aspects of the tallow business is the procurement of raw materials such as meat scraps, fat, and bones. The raw material is obtained from various sources including retail markets, wholesale meat outlets, and packing houses. Since the partnership had no contracts with its sources of supply, procurement of needed raw materials was largely dependent upon personal contacts with its suppliers. While the company had many supplier accounts which were of longstanding duration, and although the company generally enjoyed a good reputation in the industry, it was still required to compete with four or five other companies in the acquisition of its raw materials. No part of the tallow business owned by the partnership was of a retail nature nor was the company's tallow marketed under any brand name. Approximately 60 percent of the tallow manufactured by the partnership competed in the world market where the price was determined by the market forces of supply and demand.

In 1940, the partnership expanded its tallow and rendering business to Phoenix, Ariz. The business in Phoenix was conducted in the partnership's name until 1946 when it was incorporated under the name of Phoenix Tallow Co. (hereinafter Phoenix Tallow). Thereafter, until June of 1961, the partnership owned all of the issued and outstanding stock of Phoenix Tallow. In 1947, the partnership began construction of a plant at Norwalk, Calif., a suburb of Los Angeles, and from 1947 until June 1961, the partnership engaged in the tallow and rendering business in and around the area of Los Angeles. In 1950, the partnership expanded its business to Kerman, Calif., where it acquired an interest in two California corporations, Kerman Tallow Works (hereinafter Kerman Tallow) and San Joaquin Packing Co. (hereinafter San Joaquin Packing). Until March of 1961, one-third of the stock of Kerman Tallow and San Joaquin Packing was owned by Harold Wardlaw (hereinafter Wardlaw), one-third by the partnership, and the remaining third by the R. S. Wilson Co. (hereinafter the Wilson Co.), a California corporation wholly owned by Robert S. Wilson. Wilson has been a business acquaintance of the three Jerome brothers since 1947 when, as a broker, he first solicited the partnership's rendering business in the Los Angeles area. In March 1961, Wardlaw's one-third interest in the two corporations was redeemed, leaving the outstanding stock divided equally between the Jerome Brothers partnership and the Wilson Co.

In addition to the foregoing businesses, the partnership owned all of the issued and outstanding stock of Baker Commodities, Inc. (hereinafter Old Baker), a California corporation. Thus, at the beginning of June 1961, the partnership owned 100 percent of the stock in Old Baker and Phoenix Tallow, and 50 percent of the stock in Kerman Tallow and San Joaquin Packing, all of which were principally engaged in the business of rendering animal meat byproducts into animal feeding fats and inedible tallow....