Commissioner of Internal Rev. v. Ashland Oil & R. Co.

• Decision Date: 18 November 1938
• Docket Number: 7542.,No. 7541,7541
• Citation: 99 F.2d 588
• Parties: COMMISSIONER OF INTERNAL REVENUE v. ASHLAND OIL & REFINING CO. ASHLAND OIL & REFINING CO. v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Sixth Circuit

99 F.2d 588 (1938)

COMMISSIONER OF INTERNAL REVENUE v. ASHLAND OIL & REFINING CO.

ASHLAND OIL & REFINING CO. v. COMMISSIONER OF INTERNAL REVENUE.

Nos. 7541, 7542.

Circuit Court of Appeals, Sixth Circuit.

November 18, 1938.

A. F. Prescott, of Washington, D. C. (James W. Morris, Sewall Key, and A. F. Prescott, all of Washington, D. C., on the brief), for Commissioner of Internal Revenue.

John W. Davis, of New York City, and John E. McClure, of Washington, D. C. (John W. Davis, of New York City, Weston Vernon, Jr., Robert N. Miller, and John E. McClure, all of Washington, D. C., Davis, Polk, Wardwell, Gardiner & Reed, of New York City, and Miller & Chevalier, of Washington, D. C., on the brief), for Ashland Oil & Refining Co.

Before HICKS, SIMONS, and HAMILTON, Circuit Judges.

SIMONS, Circuit Judge.

Upon the petition of the taxpayer, Swiss Oil Corporation, now merged with others under the name Ashland Oil & Refining Company, we have two principal questions to decide. The first is whether the taxpayer in 1926 by liquidating another corporation, the stock of which it wholly owned, realized gain, notwithstanding an original purpose to acquire the liquidated corporation's properties, and not its stock. The second involves the correctness of the Board of Tax Appeals' determination of cost of the stock as a base for computing depletion. Upon the Commissioner's petition, and depending upon our answer to the principal questions involved, subsidiary questions are presented relating to amortization of discount allowed on notes given for the stock affecting taxes for the years 1926 to 1930, inclusive. Issues involving an alleged estoppel and errors in procedure will become important only if we conclude that the Board was right in deciding the principal issues against the taxpayer.

The Swiss Company was in the oil producing business in Eastern Kentucky. Prior to 1925 its business was unprofitable and it determined to procure more productive properties. For several years its directors discussed the purchase of lands or leases belonging to the Union Gas & Oil Company in Kentucky. For reasons with which we are not here concerned, the Union Company refused to sell its properties, but on July 29, 1924, Combs, President of Swiss, and Thraves, a stockholder, acting for Swiss, secured an option to purchase all of the Union stock for Five Million Dollars, of which a first payment of $1,500,000 was to be made upon its exercise. By the terms of the option the Union stock was then to be placed in escrow, Union was to continue to operate the property until the net proceeds from operations should equal the sum of $1,000,000, when this amount was to be paid to the Union stockholders as a second payment. The balance of the purchase price was to be evidenced by promissory notes secured by a mortgage upon the oil and gas leases. Upon completion of the second payment and the delivery of the mortgage and notes for $2,500,000 the Union stock was to be delivered to Swiss by the escrow agent. It was agreed that the sale of the stock should not carry with it any oil, money, notes, accounts, credits or securities belonging to Union on the day of the delivery of the stock, but that they should belong to the Union stockholders in proportion to their stock holdings. Unused material and equipment on hand and in storage upon the properties were likewise reserved from the sale, with the provision that they were to be purchased by Swiss at a price not exceeding original cost. The Union stockholders were to pay all taxes and other obligations of the company incurred prior to the exercise of the option, and were to indemnify Swiss against any claims, either in tort or upon contract, that might accrue prior to the date of the initial payment.

Thereafter Thraves assigned his interest in the option to Combs, and Combs later assigned to Swiss. For a consideration, several extensions were granted by Union, the last being until January 12, 1925. Swiss made strenuous efforts to raise funds to meet the initial payment. They were unsuccessful, and finally Combs was authorized to dispose of the option on the best possible terms, and if this could not be done to allow it to lapse. Before its expiration, however, an agreement was made on behalf of Swiss with the securities firm of Pynchon & Company of New York and Chicago. By its terms Pynchon, to whom the option was first assigned and on whose behalf it had been exercised, agreed to reconvey the option to Swiss, together with $1,750,000 in cash, in consideration of the delivery to Pynchon of $2,000,000 of Swiss three year 7% notes and Swiss capital stock of a par value of $2,000,000. Swiss was to apply $1,500,000 to the payment of the first installment upon the purchase price of the Union stock and to assume Pynchon's obligation for the balance.

The Swiss agreements with Pynchon and with Union were carried out. During 1925 the oil and gas leases were operated under Union's supervision, and out of net earnings the second payment on the purchase price of the stock, plus interest, was paid by declaring dividends on the Union stock held by the escrow agent and paying them to the Union stockholders. The last payment was made on December 30, 1925, and thereafter the notes and mortgages to secure the remaining portion of the purchase price were executed and delivered. The Union stock was delivered to Swiss by the escrow agent, and on January 2, 1926, Union was liquidated and its properties assigned to Swiss.

It is agreed that the properties of Union when taken over by Swiss had a fair value of $7,906,043.32. The Commissioner, however, in his 1926 deficiency note determined the base for the taxpayer's depletion deduction on properties formerly owned by Union to be the same as when in the hands of Union, namely, $2,800,000. The Commissioner's determination was that Swiss had acquired the properties by virtue of a nontaxable reorganization. He also determined that the $2,000,000 par value of capital stock and the $2,000,000 of notes paid to Pynchon & Company formed part of the cost of acquiring the Union stock and that Swiss was therefore not entitled to any deduction for amortization of discount on the notes. Swiss appealed to the Board of Tax Appeals, asserting that its base for depletion was the cost to it of the properties acquired from Union, $7,906,043.32, and in the alternative, if the capital stock and notes were not part of its cost, it was entitled to deduction for amortization of expense and discount on the notes.

Shortly before the hearing upon the Swiss petition for review, the Commissioner abandoned the position that the taxpayer had acquired the properties through reorganization, and in an amended answer alleged that the taxpayer had realized a taxable gain of $2,906,043.32 at their acquisition in 1926. He contended that the liquidation of Union was to be treated as wholly independent of the purchase of its stock. In arriving at the alleged profits the Commissioner asserted the taxpayer's cost to be $5,000,000, disregarding the notes and stock issued in the process of acquiring the Union stock, and the profit the difference between that amount and the admitted value of the properties. The position of the taxpayer was that the acquisition of Union stock and the liquidation of that company were merely steps in a unitary plan to acquire the Union oil producing properties, and that no taxable gain was realized since the properties were still owned by it, that even if the Commissioner's theory is accepted and the liquidation of Union treated as a separate transaction, the gain alleged to have been realized was erroneous because of the exclusion of the notes and stock as elements of cost.

A division of the Board sustained the Commissioner. (The decision was not reviewed by the full Board.) It was held that while Combs was originally authorized to negotiate for the purchase of either the assets or stock of Union, the contract actually entered into was with the stockholders for the purchase of stock. Union was not a party to this transaction, and its dissolution was not immediately contemplated since its existence was to continue until an amount called for by the contract should be paid out of earnings, whereupon its property was to be mortgaged and its notes to be delivered to its old stockholders. Moreover, it did hold and operate its properties for almost a year, during which the taxpayer as sole stockholder received all benefit and dividends from its earnings. Besides, Union was a separate taxpayer during 1925 and joined with Swiss in a consolidated return for part of that year. It was therefore concluded that Swiss purchased the stock of Union and in a separate transaction acquired its assets upon dissolution, and that these circumstances might not be disregarded for tax purposes.

It is now conceded that the acquisition of Union stock by Swiss was not, as originally determined by the Commissioner, in pursuance of a "reorganization," for it is settled that the statutory definition of reorganization cannot be stretched to exempt from taxation gains resulting from a sale of properties for cash. Pinellas Ice Co. v. Commissioner, 287 U.S. 462, 53 S.Ct. 257, 77 L.Ed. 428; Cortland Speciality Co. v. Commissioner, 2 Cir., 60 F.2d 937, 939; Sarther Grocery Co. v. Commissioner, 7 Cir., 63 F.2d 68.

The question remains, however, whether if the entire transaction, whatever its form, was essentially in intent, purpose and result, a purchase by Swiss of property, its several steps may be treated separately and each be given an effect for tax purposes as though each constituted a distinct transaction. It is true that Swiss acquired all of the stock of Union. But this is not decisive, for a transitory ownership of stock is not necessarily of legal significance. Helvering v. Bashford, 302 U.S. 454, 458, 58 S.Ct. 307, 309, 82 L.Ed. 367. It has been said too often to warrant citation that taxation is an intensely...