Salvage v. Commissioner of Internal Revenue

• Decision Date: 18 March 1935
• Docket Number: No. 153.,153.
• Parties: SALVAGE v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Second Circuit

76 F.2d 112 (1935)

SALVAGE v. COMMISSIONER OF INTERNAL REVENUE.

No. 153.

Circuit Court of Appeals, Second Circuit.

March 18, 1935.

Jackson, Fuller, Nash & Brophy, of New York City (John G. Jackson and George B. Brooks, both of New York City, of counsel), for petitioner.

Frank J. Wideman, Asst. Atty. Gen., and Sewall Key and Helen R. Carloss, Sp. Assts. to Atty. Gen., for respondent.

Before L. HAND, SWAN, and AUGUSTUS N. HAND, Circuit Judges.

SWAN, Circuit Judge.

The Board decreed a deficiency of $12,005.38 in the petitioner's income tax for the year 1929. He contends that not only is there no deficiency, but that he is entitled to a refund of $63,750. The controversy arises out of the fact that in 1929 the petitioner received $671,000 upon the redemption of 6,100 shares of preferred stock of American Viscose Corporation. The question in dispute is what part of this sum represents capital net gain; and this involves a determination of the cost base properly attributable to the redeemed shares.

In December, 1922, the Viscose Company, of which the petitioner Salvage was an officer and employee, increased its capital stock by 4,000 shares and permitted Mr. Salvage to acquire 1,500 of them. They were sold to him at par, $100 per share, pursuant to a contract dated December 30, 1922, which recited that they were sold at less than their real value in consideration of the agreement of Salvage therein set forth. By the contract he agreed (1) that the corporation should have an option to repurchase at par five-sevenths of the 1,500 shares at any time during 1923, four-sevenths during 1924, three-sevenths during 1925, two-sevenths during 1926, and one-seventh during 1927; and (2) that he would not engage at any time throughout his life in any competing business without the company's consent. Another contract of the same date permitted him to exchange each of these 1,500 shares for four preferred shares and five common shares of American Viscose Corporation, and, with respect to the aforesaid option of repurchase, expressly substituted for each share of old stock subject to it an equivalent block of the new preferred and common. The option was never exercised in any year. In addition to the above-mentioned 1,500 shares of the Viscose Company, Mr. Salvage owned 25 shares which he had acquired in 1916 at a cost of $166.66 a share. These 25 shares he also exchanged for stock of American Viscose Corporation on the same basis of four preferred and five common for one share of the Viscose Company stock. Altogether he received 6,100 preferred and 7,625 common shares of American Viscose in exchange for his 1,525 shares of Viscose stock. In 1929 his preferred shares, which were callable at $110 per share, were redeemed at the aggregate sum of $671,000. In his income tax return for 1929 he reported as capital net gain the difference between $671,000 and the sum of $154,166.66 which he had paid for the 1,525 shares of Viscose stock. In auditing the return, the Commissioner apportioned 37.778 per cent. of the petitioner's cost to the preferred stock and 62.222 per cent. to the common stock. This resulted in ascribing to the 6,100 preferred shares a cost base of $58,123.47, and produced the deficiency in question.

Before the Board the petitioner contended, first, that he had made a "bargain purchase" of the 1,500 shares of the Viscose Company stock on December 30, 1922, that the fair market value of such stock on that date was $1,164.70 per share, and upon this basis no taxable gain was realized on redemption of the preferred shares but rather there had been an overpayment of taxes; and, second, that it was impracticable to apportion the cost of the Viscose stock between the preferred and common shares of American Viscose so that no taxable gain was realized until the entire cost ($154,166.66) was recovered. The Board rejected both contentions.

It is conceded that the real value of Viscose stock on December 30, 1922, was $1,164.70 per share. The petitioner paid only $100 per share in cash, and the Commissioner concedes that the difference of $1,064.70 per share, if it had represented compensation for services past or future, would have constituted taxable income to the petitioner in 1922, and that the market value of the stock when acquired would be the proper basis for determining gain upon the subsequent sale (or redemption) of any stock exchanged for it in a nontaxable exchange. T. D. 3435, later incorporated in article 31, Reg. 65. Said Treasury Decision, now part of the Regulations, reads as follows:

"Where property is sold by a corporation to a shareholder or member, or by an employer to an employee, for an amount substantially less than its fair market value, such shareholder or member of the corporation or such employee shall include in gross income the difference between the amount paid for the property and the amount of its fair market value. In computing the gain or loss from the subsequent sale of such property its cost shall be deemed to be its fair market value at the date of acquisition."

Although there is no suggestion in the language quoted that the property sold for less than its fair market value must be intended to be compensation to an employee for past or future services or in the nature of a dividend to a shareholder, the article, has properly been so limited. Commissioner v. Van Vorst, 59 F.(2d) 677 (C. C. A. 9); Taplin v. Commissioner, 41 F.(2d) 454 (C. C. A. 6). In the Van Vorst Case the stockholder purchased real estate from his corporation at less than its market value, and the taxing officials attempted to include in his gross income the sum by which the market value of the land exceeded the price paid by the purchaser. This was not permissible because such excess value was not "income" within the meaning of the applicable revenue act. The Taplin Case was a similar ruling where stock was purchased for less than its real value. But where the excess value is in the nature of compensation for services it does constitute taxable income when received. Robinson v. Commissioner, 59 F.(2d) 1008 (C. C. A. 6); Rodrigues v. Edwards, 40 F.(2d) 408 (C. C. A. 2). In the case at bar the Board found that the stock was not acquired by the petitioner as compensation for services. The correctness of this finding is disputed, but, as it was made upon conflicting evidence, some of which tends to support it, we must accept it as a finding of fact.

Nevertheless, the Commissioner is not aided thereby. The contract under which the petitioner purchased the 1,500 shares of Viscose stock stated that the consideration for selling it at less than its real value was the petitioner's covenants relating to the option and to his refraining from engaging in a competing business. Compensation paid for refraining from labor would seem to be taxable income no less than compensation for services to be performed. For example, a farmer who is paid for voluntarily refraining from raising hogs receives, in our opinion, income. Certainly it is neither a capital payment nor a gift. The statutory definition of gross income is...