Eaton v. Commissioner of Internal Revenue
| Decision Date | 15 April 1938 |
| Docket Number | Docket No. 86942. |
| Parties | CYRUS S. EATON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Board of Tax Appeals |
Richard Inglis, Esq., I. W. Sharp, Esq., H. A. Mihills, C. P. A., and L. C. Weiss, C. P. A., for the petitioner.
T. M. Mather, Esq., for the respondent.
The Commissioner made several additions to the net income shown by petitioner's return for the year 1929 and determined a deficiency in his income tax for said year in the amount of $157,882.69. Some of the additions are conceded to have been made properly. The petition alleges that the respondent (Commissioner) erred: (1) in increasing petitioner's taxable income by the addition of $427,343.75 representing the market value on December 3, 1929, of 12,500 shares of Central Alloy Steel Corporation common stock acquired by petitioner under the circumstances hereinafter related; (2) in disallowing the deduction from gross income, as a loss, of $1,287,536.15 claimed to have been sustained by the petitioner on the sale of certain securities on December 30, 1929; and (3) in disallowing $279,338.80 of a loss of $456,923.56 sustained by a partnership of which petitioner was a member, as a result of which he was prevented from taking his proportionate amount of the loss, or $117,322.30, as a deduction from his gross income.
All of the facts were stipulated. A resume of them will be sufficient for present purposes.
Petitioner was a member of the partnership of Otis & Co., which was a dealer in securities with its principal office in Cleveland, Ohio. The partnership kept its books and made its returns of income on a calendar year basis.
During the latter part of the year 1929 the Central Alloy Steel Corporation, hereinafter called Alloy, acquired the property and assets of the Interstate Iron & Steel Co., hereinafter called Interstate, in exchange for shares of stock of Alloy, which Interstate then distributed among its stockholders. Alloy had entered into an agreement with Interstate on October 2, 1929, that it would "procure some firm or individual to enter into a binding agreement" with Interstate to purchase any shares of Alloy which the stockholders of Interstate should receive. Pursuant thereto Alloy entered into an agreement with Otis & Co. under which Otis & Co. agreed to purchase the Alloy stock, at $60 per share, if offered within two weeks after the ratification of the agreement by the stockholders of Interstate.
The contract between Otis & Co. and Alloy provided that Alloy, "as full compensation to the Dealer for undertaking and carrying out the purchase * * * and when the Dealer shall have fully performed its obligations to purchase stock offered to it" as provided by the agreement, should "issue to the Dealer Twelve Thousand Five Hundred (12,500) shares" of Alloy stock, fully paid and nonassessable.
Otis & Co. had been unwilling to assume on its own behalf and at its own risk the obligations involved in the above agreement and had executed it only at the request of petitioner and upon his written agreement, contained in a letter dated October 2, 1929, reading as follows:
You will agree to purchase at 60 Central Alloy stock from the Interstate stockholders offered you during the two weeks subsequent to the ratification of the merger, and scrip (if issued) at market until Jan. 1 next, all for my account, I to receive the compensation for this indemnity from Central Alloy.
The market value of Alloy stock at the time the agreement was made was approximately $54 per share. Pursuant to the agreement petitioner, through Otis & Co., purchased 79,687 shares of Alloy at $60 per share which, together with the 12,500 shares, made a total of 92,187 shares acquired by petitioner under the agreement.
The respondent treated the receipt of the 12,500 shares as a fee to petitioner for purchasing the 79,687 shares, the fee being computed upon the basis that the shares received had a fair market value of $34.1875 per share, or a total value of $427,343.75. Petitioner maintains that the sum paid out in acquiring the 79,687 shares — $4,781,220 — should be treated as the cost of the entire 92,187 shares.
Respondent argues that "in view of the plain and unambiguous terms of the agreement * * * that the stock was full compensation * * * for undertaking and carrying out the purchase" the fair market value of such stock must be held to be "compensation for personal service" and hence income to petitioner under section 22 (a) of the Revenue Act of 1928. Petitioner contends that the 12,500 shares "average down" his cost per share to an amount about equal to the actual value of the shares and that it is obvious that the agreement to purchase the shares at 60 would not have been made but for the fact that the contemporaneous agreement had been made under which he would receive more shares than those actually purchased. He contends that there is no difference in principle between the transaction before us and one in which a purchaser of preferred stock receives a "bonus" of common stock, in which case the total purchase price is, in the language of article 58 of Regulations 74, "* * * fairly apportioned between such common stock and the securities purchased for the purpose of determining the portion of the cost attributable to each class of stock or securities * * *." Cf. C. H. Mead Coal Co., 28 B. T. A. 599.
It is, of course, well settled that compensation for personal service, though paid in the form of stock or securities, must be included in gross income to the extent of the fair market value of such property when received. Marshall Field, Glore, Ward & Co., 16 B. T. A. 1299; affd., 47 Fed. (2d) 541; Benedict Crowell, 21 B. T. A. 849; affd., 62 Fed. (2d) 51; Old Colony Trust Co. et al., Administrators, 22 B. T. A. 1062; affd., 59 Fed. (2d) 168; J. Kemp Bartlett, 28 B. T. A. 285; affd., 71 Fed. (2d) 598; and Adam H. Davidson, 34 B. T. A. 479 affd., 91 Fed. (2d) 516. But is this rule applicable here?
In James Brown, 10 B. T. A. 1036, 1054, the petitioner was paid certain amounts to induce him to purchase some stock which the majority stockholder desired should be purchased by one friendly to the company. The Board held that the amount paid to the petitioner did not constitute income, but was a reduction of the cost of the stock. It was said that the two contracts — the agreement under which the additional amounts were paid and the purchase by him of the stock at a price which he considered too high — were to be "considered together upon the basis of the intent of the parties when made and in the light of the results reached in their final consummation", and that the amount so paid could not be "considered as taxable income."
The rule applied in the above case is not unlike the rule frequently applied in cases somewhat analogous. Thus, where different classes of securities are acquired in consideration of a lump sum, the profit is computed by allocating the cost between, or among, the securities purchased in the proportion that the fair market value of each class bears to the total fair market value of all classes. Cf. Clifford Hemphill, 25 B. T. A. 1351. In the case of stock dividends the cost of the original shares is allocated to the stock received and the original shares. Silas H. Burnham, 29 B. T. A. 605. In the sale of rights to subscribe to new issues of stock, such rights being "essentially analogous to a stock dividend", and in the case of the sale of stock acquired through the exercise of such rights, the gain or loss is to be computed by, or after, an allocation of cost. Miles v. Safe Deposit & Trust Co., 259 U. S. 247. While the facts in the cited cases are not entirely analogous to the facts in the instant proceeding, there is in our opinion sufficient similarity to justify the application of the same rule. It is therefore held that the respondent erred in treating the fair market value of the 12,500 shares of Alloy stock as income to the petitioner when they were received. Upon this issue petitioner is sustained.
Industrial Shares, Inc., is a corporation organized under the laws of the State of Delaware by a certificate of incorporation filed December 23, 1929, with an authorized capital stock of 1,000 shares of preferred stock of the par value of $100 each, with no voting rights, and 10,000 shares of common stock of the par value of $10 each, with full voting rights. One hundred shares of the common stock of said corporation were subscribed for by the incorporators. At a meeting of the incorporators held December 23, 1929, a board of directors consisting of three persons was elected. At a meeting of the board of directors held December 26, 1929, officers were elected and the treasurer of the corporation was authorized to accept subscriptions for, and to sell, the preferred shares of the corporation at their par value of $100 per share. The treasurer of the corporation, on December 28, 1929, in accordance with the authority previously given to him by the board of directors, received subscriptions from seven individuals for an aggregate of 250 shares of the preferred stock of the corporation at $100 per share and the cash received, or $25,000, was deposited to the credit of the corporation.
At a meeting of the board of directors of Industrial Shares, Inc., held December 30, 1929, the treasurer reported the sales of the preferred stock and the deposit of the sum of $25,000. Immediately following the report of the treasurer there was presented to the board of directors an offer from petitioner, contained in a letter dated December 30, 1929, addressed to the corporation and signed by petitioner, reading as follows:
I am the owner of the following shares of stock held by Otis & Co. of Cleveland, for me, which I am willing to sell at the respective prices set opposite the different items:
1,000 shares of Central Alloy Steel Corporation common at
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