H.B. Zachry Co. v. Comm'r of Internal Revenue
| Decision Date | 02 November 1967 |
| Docket Number | Docket No. 903-66. |
| Parties | H. B. ZACHRY COMPANY, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Robert J. Bird, Chester H. Johnson, O. D. Hite, and Edmund M. Gregorie, Jr., for the petitioner.
Harold Friedman, for the respondent.
Held, a carved-out oil payment transferred from petitioner to a subsidiary in exchange for common stock constituted ‘property’ within the meaning of sec. 351(a), I.R.C. 1954. Held, further, this transfer was separate from petitioner's subsequent sale of preferred stock to such subsidiary for cash, and therefore qualified as a nontaxable exchange under sec. 351(a).
Respondent determined income tax deficiencies against petitioner for the taxable years 1961 and 1962 in the amounts of $327,940.14 and $692,528.21, respectively.
Petitioner has apparently abandoned the argument made at trial that respondent has the burden of proof with respect to allegations contained in the amended answer. The parties have resolved the issues pertaining to the year 1962 and have agreed upon the deficiency, subject to the Court's disposition of the main issue in controversy. Likewise, several issues pertaining to the year 1961 have been conceded or settled by the parties, leaving for our decision the single issue of whether petitioner realized taxable income through a series of transactions with its subsidiary, Zachry Minerals, Inc. In order to resolve this issue, several questions are presented by the parties, namely:
1. Did a carved-out oil payment from petitioner to Zachry Minerals, Inc., constitute ‘property’ within the meaning of section 351,1 I.R.C. 1954, so that its transfer to a newly organized subsidiary for all of the subsidiary's stock results in a nontaxable exchange under section 351(a)?
2. If the carved-out oil payment was ‘property’ within the meaning of section 351, were certain transactions in June 1961 all part of a single integrated transaction, thereby resulting in a section 351 exchange with ‘boot’ of $649,000 to petitioner?
3. Is the taxable income, if any, resulting from and recognized in such transactions taxable as ordinary income or as long-term capital gain?
4. If gain is recognized to petitioner on the assignment of the carved-out oil payment, is the income recognized immediately on the exchange or is the petitioner taxable on the income from the oil produced only as the oil is produced?
Some of the facts have been stipulated by the parties. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference.
H. B. Zachry Co. (hereinafter called petitioner) is a Delaware corporation with its office and principal place of business in San Antonio, Tex., at all times relevant to this case, and particularly as of the time of filing the petition herein. Petitioner filed its Federal corporation income tax returns for the taxable years 1961 and 1962 with the district director of internal revenue at Austin, Tex. It maintains its books and filed its income tax returns on the basis of the accrual and completed-contract method of accounting.
Petitioner has been engaged in the business of general contracting for many years. As part of its business activities, it bids on various types and sizes of local, State, and Federal construction projects. Its bidding capacity or strength is based on its bonding capacity, and its bonding capacity is based on a multiple times the net current assets.2 Depending on the project, a construction company's bonding capacity varies from 10 to 15 times the company's net current assets.
H. B. Zachry (hereinafter called Zachry) is an individual who owned substantially all of petitioner's common stock during the years 1961 and 1962.
Gasoline Production Corp. (hereinafter called Gasoline Production) was merged into petitioner on or about June 30, 1959. As a result of this merger, petitioner owned various types of interests in oil, gas, and mineral properties situated in Texas and Louisiana at the beginning of 1961.
Gasoline Production was operated as a division of petitioner during 1961 and 1962. Among the assets and liabilities acquired by petitioner as a result of its merger with Gasoline Production was a note in the amount of $750,000 which was due to the First City National Bank of Houston, Tex., on January 30, 1962. This note became a current liability on petitioner's books on January 31, 1961; and as of that date it affected petitioner's bonding and bidding capacity.
Petitioner's officers held discussions with regard to improving its bidding strength. Pursuant to these discussions, Zachry Minerals, Inc. (hereinafter called Minerals), was organized on June 20, 1961, under the laws of the State of Texas. The purpose of Mineral's organization was ‘to take care of (petitioner's) needs from a current position angle.’
On June 26, 1961, petitioner's board of directors held a special meeting to discuss the advisability of acquiring all of the authorized shares of stock of Minerals and, if deemed advisable, ‘to determine the best method and manner in which to acquire same.’ Zachry presided at the meeting.
On June 28, 1961, the board of directors of Minerals held a special meeting, Zachry presiding. The directors approved a motion making the First City National Bank a depository for funds of Minerals. Authority was given for funds to be withdrawn from said depository on the signature of any two of six named persons or on the signature of Zachry alone. The directors also approved ‘the exchange of all the authorized shares of the corporation for certain property’ of petitioner and authorized Zachry ‘to borrow money and obtain loans and to sell, lease, mortgage or otherwise dispose of the corporation's real or personal property or any interest therein.’
On June 28, 1961, an agreement was executed between Minerals and petitioner which provided for the exchange of all 10 authorized shares of Minerals' stock in return for certain property. This property was the assignment of a carved-out oil payment, payable out of one-eighth of the interest which Gasoline Production had in several specifically listed oil and gas properties. This assignment was to remain in effect until Minerals received $650,000 plus an amount equivalent to 6-percent interest on the unliquidated balance. be effective as of June 30, 1961, and 10 shares of Minerals' stock were issued to petitioner on June 28, 1961. At the time of transfer, petitioner's tax basis in the property transferred to Minerals was $17,992.12. The 10 shares of Minerals' common stock had a value of $452,800 as of June 28, 1961, while the oil production payment had a fair market value of $470,000 on that date.
On June 28, 1961, petitioner issued 6,328 shares of preferred stock to Minerals; 5,493 shares were original issue stock and 835 shares were treasury stock. The stock certificate was executed by Zachry as president. This transaction was recorded in petitioner's journal voucher as follows:
+------------------------------------------------------------------------------+
¦ ¦Sub. acct. ¦ ¦ ¦ ¦ ¦
+---------+------------+---------------------------+--------+--------+---------¦
¦ ¦or ¦ ¦ ¦ ¦ ¦
+---------+------------+---------------------------+--------+--------+---------¦
¦Account ¦job No. ¦Description ¦Detail ¦Debits ¦Credits ¦
+---------+------------+---------------------------+--------+--------+---------¦
¦152 ¦205 ¦Zachry Minerals, Inc ¦ ¦$649,000¦ ¦
+---------+------------+---------------------------+--------+--------+---------¦
¦291 ¦001 ¦Preferred capital stock ¦ ¦ ¦ ¦
+---------+------------+---------------------------+--------+--------+---------¦
¦ ¦ ¦issued ¦ ¦ ¦$549,300 ¦
+---------+------------+---------------------------+--------+--------+---------¦
¦292 ¦001 ¦Preferred stock in ¦ ¦ ¦ ¦
+---------+------------+---------------------------+--------+--------+---------¦
¦ ¦ ¦Treasury ¦ ¦ ¦83,500 ¦
+---------+------------+---------------------------+--------+--------+---------¦
¦296 ¦002 ¦Gain on sale of Treasury ¦ ¦ ¦ ¦
+---------+------------+---------------------------+--------+--------+---------¦
¦ ¦ ¦stock ¦ ¦ ¦16,200 ¦
+---------+------------+---------------------------+--------+--------+---------¦
¦ ¦ ¦To record the issue of ¦ ¦ ¦ ¦
¦ ¦ ¦6,328 ¦ ¦ ¦ ¦
+---------+------------+---------------------------+--------+--------+---------¦
¦ ¦ ¦shares of H. B. Zachry ¦ ¦ ¦ ¦
+---------+------------+---------------------------+--------+--------+---------¦
¦ ¦ ¦Company preferred ¦ ¦ ¦ ¦
+---------+------------+---------------------------+--------+--------+---------¦
¦ ¦ ¦stock to Zachry ¦ ¦ ¦ ¦
+---------+------------+---------------------------+--------+--------+---------¦
¦ ¦ ¦Minerals, Inc. at ¦ ¦ ¦ ¦
+---------+------------+---------------------------+--------+--------+---------¦
¦ ¦ ¦$102.56 per share, ¦ ¦ ¦ ¦
+---------+------------+---------------------------+--------+--------+---------¦
¦ ¦ ¦certificate No. 355 ¦ ¦ ¦ ¦
+---------+------------+---------------------------+--------+--------+---------¦
¦ ¦ ¦dated...To continue reading
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