Smith v. Comm'r of Internal Revenue (In re Estate of Smith), Docket Nos. 7378-71
| Decision Date | 27 March 1975 |
| Docket Number | Docket Nos. 7378-71,5746-73. |
| Citation | 63 T.C. 722 |
| Parties | ESTATE OF CHARLES A. SMITH, DECEASED, DONALD C. SMITH, EXECUTOR, ET AL., PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENTESTATE OF CHARLES A. SMITH, DECEASED, DONALD C. SMITH, ET AL., EXECUTORS, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
George M. Zimmermann and Ralph J. Gregg, for the petitioner
John D. Steele, Jr., for the respondent
Held, that the decedent's estate, having elected the alternate valuation method permitted by sec. 2032, I.R.C. 1954, for valuing the gross estate, did not realize gain when its stock in Consolidated Cigar Corp. was exchanged for stock, purchase warrants, and cash in Gulf & Western Industries, Inc., in a reorganization of the type described in sec. 368(a)(1)(A), I.R.C. 1954. Held, further, that the Gulf & Western Industries, Inc., warrants received in the exchange are to be valued as of the date of the merger rather than as of the date 1 year after the decedent's death for the purpose of computing the decedent's gross estate for estate tax purposes.
Respondent determined a deficiency in the amount of $38,145.91 in petitioner's Federal estate tax (docket No. 7378-71) and a deficiency of $170,717.58 in petitioner's Federal income tax for the taxable period August 13, 1967, to July 31, 1968 (docket No. 5746-73).
The issues presented for decision are:
1. Whether the value of stock purchase warrants of Gulf & Western Industries, Inc., received by the Estate of Charles A. Smith, deceased, in connection with a reorganization falling under section 368(a)(1)(A)1 is taxable to the estate, and if so, whether the value of the warrants is taxable as long-term capital gain or as a divided; and
2. Whether the warrants of Gulf & Western Industries, Inc., received . by the estate in the reorganization should be valued under section 2032 for estate tax purposes as of the date of the reorganization-exchange or as of the date 1 year after the decedent's death.
Donald C. Smith, co-executor of the Estate of Charles A. Smith, deceased (hereinafter referred to as the estate), was a legal resident of Buffalo, N.Y., at the time the petitions herein were filed. The estate timely filed an estate tax return. It also filed a fiduciary income tax return for the taxable period August 13, 1967, through July 31, 1968.
At the time of his death on August 13, 1967, Charles A. Smith (hereinafter referred to as decedent) owned 41,738 shares of Consolidated Cigar Corp. (hereinafter Consolidated) common stock which had a value at that time of $1,022,581. On January 11, 1968, Consolidated was merged into Gulf & Western Industries, Inc. (hereinafter G&W), in a statutory merger of the type described in section 368(a). As a result of the merger, the estate received in exchange for its 41,738 shares of Consolidated common stock the following: (1) 4,637 shares of G&W series B preferred stock (hereinafter sometimes referred to as G& W preferred), (2) 8,347 warrants to purchase G&W common stock at $55 per share (hereinafter referred to as the warrants), and (3) money in the amount of $121.65 in lieu of fractional shares. This money was received from the sale of fractional interests in the open market; it did not come from either Consolidated or G&W. The G&W preferred gave its owners equal voting rights with all other classes of G&W stock.
A proxy statement issued to G&W shareholders describes the warrants as follows:
The Warrants which will be issued to holders of Consolidated Common Stock will entitle the holders to purchase shares of G&W Common Stock for $55 per share during a ten-year term commencing on the Effective Date of the Consolidated Merger. The purchase price and the total number of shares of G&W Common Stock issuable upon exercise are subject to adjustment in case of a split, reverse split or other reclassification of G&W Common Stock; or if rights or warrants are issued to all holders of shares of G&W Common Stock entitling them for a period of 45 days to purchase shares of G&W Common Stock at a price per share less than the current market price; or if any other securities (other than G&W Common Stock) or assets (other than cash payable out of consolidated earnings or earned surplus) are distributed to all holders of G&W Common Stock. An adjustment will also be made in case of dividends payable in shares of G&W Common Stock to the extent that such dividends in any fiscal year exceed five per cent of the outstanding Common Stock. No adjustment will be required if G& W otherwise issues, in exchange for cash, property or services, shares of G&W Common Stock or any security carrying rights to acquire G&W Common Stock. No adjustment will be required unless such adjustment will require an increase or decrease of at least $1 in the purchase price, but any adjustments not made by reason of this provision will be carried forward and taken into account at the time of any subsequent adjustment.
If G&W consolidates with or merges into or sells its assets to another corporation, and G&W is not the continuing corporation in such consolidation, merger or sale of assets, a holder of a Warrant will be entitled to receive the securities or property to which a holder of the number of shares of Common Stock then deliverable upon the exercise of such Warrant would have been entitled to receive upon such consolidation or merger.
Fractional shares of Common Stock will not be issued on exercises of Warrants, but G&W shall, in lieu thereof, either make a payment in cash based on the purchase price of the Common Stock purchasable upon the exercise of the Warrants, or issue scrip certificates (of such duration as determined by the Board of Directors) evidencing such fractional interests, which certificates may be combined and exchanged for whole shares of Common Stock of the Company.
Until a Warrant is exercised, its holder will not be entitled to any of the rights of a stockholder of G&W.
The proxy statement also states:
Consolidated has requested the Internal Revenue Service to issue rulings to the effect that: (a) the merger of Consolidated into G&W will constitute a reorganization within the meaning of the Internal Revenue Code; (b) no gain or loss will be recognized by G&W, Consolidated or New Consolidated as a result of such merger or the transactions contemplated thereby; (c) gain (but not loss) will be recognized by the stockholders of Consolidated upon the conversion and exchange of their Consolidated Common Stock for G&W Series B Preferred Stock and Warrants (including fractional interest), limited to the fair market value of the Warrants; (d) the basis of the G&W Series B Preferred Stock will be the basis of the Consolidated Common Stock exchanged therefor, increased by the gain, if any, recognized upon the exchange and decreased by the fair market value of the Warrants; (e) the holding period of stockholders of Consolidated Common Stock of the Series B Preferred Stock received in exchange therefor, including fractional interests, will include the holding period during which such Consolidated Common Stock was held or deemed to be held by stockholders of Consolidated; (f) the basis of the Warrants received in exchange for the Consolidated Common Stock will be the fair market value thereof on date from said Effective Date; (g) holders of Consolidated Common Stock selling fractional interests in shares of G&W Series B Preferred Stock received on the merger will realize gain or loss on such sale, which gain or loss will constitute capital gain or loss provided that the Consolidated Common Stock is a capital asset in the hands of the stockholders; * * *
The shares of Consolidated which were owned by the estate prior to the merger constituted approximately .0082 percent of the total outstanding voting stock of Consolidated. The Consolidated stock earned dividends of 60 cents per share in the first 6 months of 1967. The shares which the estate owned in G&W after the merger represented approximately .0003 percent of the total outstanding voting stock of G&W. The affirmative vote of two-thirds of Consolidated stockholders was sufficient to approve the merger. Due to its limited ownership of voting stock in Consolidated, the estate could not have prevented the merger from taking place.
On August 13, 1968, l year after decedent's death (hereinafter sometimes referred to as the anniversary date), the estate continued to hold the G&W preferred and the warrants which it received in the merger.
The G&W preferred was traded on the New York Stock Exchange prior to and following the merger. The warrants were traded on the New York Stock Exchange after completion of the merger. The market values of the G&W preferred and the warrants on January 11, 1968— the date of the merger, and August 13, 1968— 1 year after the date of decedent's death, are as follows:
+---------------------------------------------------------------+
¦ ¦Jan. 11, 1968 ¦Aug. 13, 1968 ¦
+-------------------------------+---------------+---------------¦
¦ ¦ ¦ ¦
+-------------------------------+---------------+---------------¦
¦4,637 shares G&W, $3.50 ¦ ¦ ¦
+-------------------------------+---------------+---------------¦
¦convertible preferred, series B¦$1,156,351.88 ¦$756,990.25 ¦
+-------------------------------+---------------+---------------¦
¦8,347 G&W warrants ¦238,932.88 ¦131,465.25 ¦
+---------------------------------------------------------------+
The financial data of G&W and Consolidated as of the date of the merger do not reflect a distribution of any earnings and profits by either corporation. Neither the paid-in surplus nor the shareholders' equity of either corporation was adjusted as a result of the issuance of the G&W warrants to the Consolidated...
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