Long Island Water Corp. v. Comm'r of Internal Revenue, Docket No. 65960.

• Decision Date: 25 May 1961
• Docket Number: Docket No. 65960.
• Citation: 36 T.C. 377
• Parties: LONG ISLAND WATER CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

36 T.C. 377

LONG ISLAND WATER CORPORATION, PETITIONER,
v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 65960.

Tax Court of the United States.

Filed May 25, 1961.

[36 T.C. 378]

J. Marvin Haynes, Esq., N. Barr Miller, Esq., and Arthur H. Adams, Esq., for the petitioner.

Anthony S. Del Giudice, Esq., for the respondent.

1. A, a public utility holding company, and M, an investment banking firm, agreed that M should acquire all of the capital stock of Q, an operating water company, and transfer it to petitioner, a newly organized corporation, in exchange for petitioner's stock and bonds. When these transactions were completed Q was merged into petitioner. M then exchanged the stock it held in petitioner for an agreed number of A's shares which were subsequently sold on the open market. Prior to these steps taking place the stockholders of Q were in control of its assets. Afterwards A owned all of petitioner's stock and was in control of the assets. The stockholders of A and Q were unrelated. Held: That the steps which began with the agreement between A and M and ended with the merger of Q into petitioner were interdependent steps of an integrated transaction. No tax-free reorganization occurred, and the petitioner's basis for the assets acquired from Q is its cost, which is determined to be. $4,583,556.03. Held, further, that the later transactions consisting of the petitioner's purchase of the stock of R and B, water companies operating in territory adjacent to petitioner, and the subsequent merger of those corporations into petitioner were not integral parts of the above-mentioned transaction but resulted in statutory reorganizations, and the petitioner's basis for the assets acquired from R and B, respectively, is the basis of each of its transferors. Held, further, that none of the above transactions constituted or was equivalent for tax purposes to the direct acquisition of assets by petitioner under any principle exemplified by Kimbell-Diamond Milling Co., 14 T.C. 74, affd. 187, F.2d 718.

2. The petitioner's basis for depreciable and nondepreciable assets acquired from Q and R must be allocated between such assets. On the basis of allocations made by the Court held that the petitioner sustained a loss on the sale of certain land in 1951. Held, further, that the respondent's reductions in the petitioner's basis, resulting from the sale of certain depreciable assets in 1929 and 1931, were excessive and resulted in an inadequate deduction for depreciation in each of the years involved.

Respondent determined deficiencies in the petitioner's income taxes as follows:

+--------------------+
                ¦Year ¦Deficiency ¦
                +------+-------------¦
                ¦1949 ¦$19,494.42 ¦
                +------+-------------¦
                ¦1950 ¦24,317.46 ¦
                +------+-------------¦
                ¦1951 ¦26,429.34 ¦
                +------+-------------¦
                ¦1952 ¦22,977.22 ¦
                +--------------------+
                

By amendment to his answer to the amended petition respondent has asked that the deficiencies set forth above be increased by certain amounts in the event we decide the major question presented herein adversely to the petitioner.

The primary issue in this proceeding is whether the petitioner's basis as to certain depreciable properties should be their cost (and, if so, the amount thereof and its proper allocation) or should be the cost of such properties to corporations merged into petitioner. Related questions have to do with the amount of gain or loss realized upon the sale of a part of such properties and with the amounts by which petitioner's depreciation base should be reduced by reason of certain dispositions of parts of such properties.

Findings OF FACT.

Some of the facts have been stipulated. The stipulated facts are so found and the stipulation of facts, together with the exhibits attached thereto, is incorporated herein by this reference.

The petitioner is the Long Island Water Corporation, a New York corporation with its principal office located at Lynbrook, New York. Since its incorporation in 1925 petitioner has been engaged in the distribution and sale of water to communities located on Long Island, New York. The petitioner has kept its books and filed its income tax returns according to a calendar year accrual method of accounting. The returns for the years in issue were filed with the then collector of internal revenue at Brooklyn, New York.

In February or March of 1925 a large public utility holding company, the Associated Gas and Electric Company (hereinafter referred to as Associated), asked a public utility engineer to make an investigation and submit a preliminary appraisal of the property of

[36 T.C. 379]

the Queens County Water Company of Long Island (hereinafter referred to as Queens), a firm which had engaged in the distribution and sale of water to communities located in or adjacent to Queens and Nassau counties, Long Island, New York, since its incorporation on March 27, 1884.

On April 1, 1925, pursuant to an understanding with Associated, the investment banking firm of Marshall Field, Glore, Ward & Company (hereinafter referred to as Marshall Field) contracted with Queens' president for the cash purchase of the outstanding capital stock of Queens.

On April 6, 1925, Marshall Field and Associated entered into a written agreement evidenced by the following proposal by Marshall Field and acceptance by Associated:

RE THE QUEENS COUNTY WATER COMPANY

ASSOCIATED GAS AND ELECTRIC COMPANY,

61 Broadway, New York City.

GENTLEMEN: We enclose herewith a copy of our contract for the purchase, at $280.50 per share, of not less than 90% of the outstanding capital stock of The Queens County Water Company, evidenced by our letter of April 1, 1925, to Mr. Henry De Forest Baldwin and his acceptance noted thereon under the same date. Mr. Baldwin is very confident that 100% of the stock will be delivered although some shares may not come in until the first of May. We are writing this letter to confirm the understanding which has been reached between your Company and ourselves in the matter.

1. We have made the purchase on behalf of your Company and ourselves, you to have 51% interest therein and the undersigned the remaining 49%. The total purchase price (assuming the acquisition of 100% of the outstanding Stock) will be $2,945,250 for the 10,500 shares outstanding. To this must be added the cost (exclusive of accrued interest) of calling the outstanding $702,000 of bonds at 105, or $737,100, making the total purchase price, on the basis mentioned $3,682,350. We shall provide the entire funds requisite to make the purchase and to carry the transaction, pledging, in order to raise the requisite funds, the entire stock to be purchased; it being the intent of our understanding that the entire transaction is to be worked out without your raising or providing any cash funds whatever.

2. The debt and stock of the Company will be re-adjusted so that the Company, or a new company to be formed for the purpose in succession to the present company, will create an issue of First Mortgage Bonds, unlimited in aggregate principal amount and issuable in series, and issues of First Preferred, Second Preferred and Common Stock, all without nominal or par value. The total number of authorized shares of each class of stock shall be worked out between us except that the Common Stock shall be divided into such number of shares as shall be fixed solely by your Company.

3. The First Preferred Stock shall be entitled to dividends at the rate of either $6.50 or $7 (as you shall determine) per/share per annum. The Second Preferred Stock shall be entitled to dividends at the rate of $8 per share per annum. Both classes of Preferred Stock shall be non voting and shall be redeemable at $105 per share and accrued dividends, and in the event of dissolution shall be entitled to $100 per share and accrued dividends, the First Preferred in preference to the Second Preferred and Common, and the Second Preferred

[36 T.C. 380]

in preference to the Common. If your Company so decides, the First Preferred shall be convertible, at the option of the holders after such date as your Company shall fix and/or (except while held by us) at any time at the option of the Queens Company, share for share, into the proposed new $7 Preferred Stock of your Company. If you so elect, it may be so convertible at the option of the Queens Company, but not at the option of the holders. This new Preferred Stock, we understand, is to be entitled to cumulative preferred dividends at $7 per share per annum, and is to be on a parity with your present outstanding Preferred Stock (Original Series, entitled to cumulative preferred dividends at $3.50 per share per annum) and your present outstanding Preferred Stock ($6 Series, entitled to cumulative preferred dividends at $6 per share per annum).

4. The following securities, in addition to the entire amount of no par value common stock, shall be issued in the manner provided in Paragraph 5 hereof, unless a different manner is agreed upon between us, and the same shall be taken by us at the following prices (plus accrued interest or dividends, as the case may be), producing the following proceeds (exclusive of accrued interest and dividends) to be applied as follows:

+--------------------------------------------------------------------+
                ¦ ¦Price ¦Cost ¦
                +-------------------------------------------------+-------+----------¦
                ¦$3,000,000 Thirty-Year 5 1/2% First Mortgage Gold¦ ¦ ¦
                +-------------------------------------------------+-------+----------¦
                ¦Bonds ¦92 1/2 ¦2,775,000 ¦
                +-------------------------------------------------+-------+----------¦
                ¦$532,000 (preference value) First Preferred Stock¦95 ¦505,400 ¦
                +-------------------------------------------------+-------+----------¦
                ¦$437,000 (preference value) Second Preferred ¦ ¦ ¦
                +-------------------------------------------------+-------+----------¦
                ¦Stock ¦92 ¦402,040 ¦
                +-------------------------------------------------+-------+----------¦
                ¦Total ¦ ¦$3,682,440¦

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