Petition for Review of Decision of the United States Board of Tax Appeals.
Before SPARKS and KERNER, Circuit Judges, and LINDLEY, District Judge.
This petition for review of a decision of the Board of Tax Appeals presents the question of the correctness of (1) the determination by the Board that a certain series of transactions whereby the taxpayer acquired title to certain assets formerly the property of the Royal Cloak Company did not constitute a non-taxable statutory reorganization under the provisions of §§ 112(i)(1)(B) and 113(a)(7) of the Revenue Act of 1932 [26 U.S.C.A. Int. Rev. Acts, pages 513, 514], and (2) the computation of the tax which followed that decision.
Three corporations, including petitioner, were involved in the alleged non-taxable reorganization: The Royal Cloak Company, an Iowa corporation, organized in 1916 to sell wearing apparel; the Klein Clothing Company, an Illinois corporation all of whose stock except two qualifying shares belonged to the Royal Company; and petitioner, the D. W. Klein Company, organized in 1932 pursuant to the plan here involved. The outstanding common stock of the Royal Company all belonged to five brothers, and the 450 shares of Class A preferred stock outstanding which carried no voting rights, belonged to Mrs. Klein, wife of one of the brothers. The company operated stores in eleven cities in Iowa and Illinios. Its subsidiary was engaged in the men's clothing business in Peoria, operating in the store occupied by the Royal Company.
In 1930, following operating losses, the Royal Company closed two of its stores and sold a third, and in 1931 it closed another. It was desirous of closing four other stores but was unable to do so because of its liability under leases which it was unable to have cancelled. It therefore determined upon a plan of reorganization, and acting on advice of counsel it executed a common law assignment of its assets for the benefit of creditors, to Harry Frankel as trustee. Shortly thereafter it was learned that some of its creditors planned to file a petition in bankruptcy against it in Iowa.
Being anxious that the affairs of the company be administered in Peoria, Illinois, its principal place of business, its officers filed a voluntary petition in bankruptcy there, and Frankel, the assignee for benefit of creditors, was appointed receiver to take charge of the assets and continue operation of the stores. He later became trustee. Schedules filed by the bankrupt showed assets of $341,571 as against liabilities of $220,596. Frankel closed all but two stores, located at Peoria and Burlington, prior to January 25 and sold all the assets of the closed stores except some of their accounts receivable. On January 25 and 26, he offered for sale at public auction the assets of the Royal Company consisting of these accounts receivable and those of the Peoria and Burlington stores, along with the merchandise, stock and fixtures of those two stores.They were bid in by an agent of Mrs. Klein for $45,625. On January 27, the trustee offered for sale the balance of the Royal assets consisting of the 348 shares of stock of the Klein Company, and these also were bid in by Mrs. Klein's agent, for $6,500. Both of these bids were approved by the court. On January 31, the agent assigned to Mrs. Klein all his interest in the bids, whereupon she assumed liability for payment thereon, paying the trustee $20,000 in cash and giving him her notes for the balance of $32,125.
The D. W. Klein Company, taxpayer and petitioner here, was organized in February, 1932, and on February 25, Mrs. Klein executed to it a bill of sale of all the assets purchased at the bankruptcy sale. In consideration, she received its stock of the par value of $52,125, and petitioner agreed to pay the balance due on the purchase price of the assets, $32,125. Thereafter, petitioner paid her the amount due on her notes, and she in turn paid it over to the bankruptcy trustee.
The taxpayer contends that this series of transactions whereby the preferred stockholder of the bankrupt acquired all the assets of the bankrupt at a public sale and thereafter transferred all those assets to it, a newly organized corporation, in exchange for all of its capital stock and its assumption of liability on her notes for the balance due on the bankruptcy assets, constituted a non-taxable reorganization under the purview of § 112 of the Revenue Act, hence that the cost basis for computing gain or loss and depreciation should be the same as it was in the hands of the bankrupt rather than the price paid at the bankruptcy sale. It vigorously urges the intent of the parties and points to the testimony of their counsel that he advised them to proceed as they did in order to continue the business as a going concern, retaining the good will and making it easier to collect outstanding accounts receivable; he also testified that all that was done in connection with the organization of the taxpayer was pursuant to the plan of reorganization of the Royal Cloak Company.
this court has held that a reorganization, non-taxable under the provisions of section 112, may be effected through the medium of a foreclosure sale or proceedings in bankruptcy. Such was our conclusion in the cases, Commissioner v. Kitselman, 7 Cir., 89 F.2d 458, certiorari denied, 302 U.S. 709, 58 S. Ct. 29, 82 L. Ed. 548; Rex Mfg. Co. v. Commissioner, 7 Cir., 102 F.2d 325, upon both of which petitioner relies. However, to say that a non-taxable reorganization may be so effected is not to say that every reorganization brought about by means of such proceedings is nontaxable.
In the Kitselman case, the corporation was insolvent, and the bondholders were, therefore, held by this court to supersede the stockholders under the doctrine of In re 620 Church Street Bldg. Corp., 299 U.S. 24, 57 S. Ct. 88, 81 L. Ed. 16. Hence it was held that a reorganization resulted from the carrying out of a plan whereby those bondholders, upon surrender of their bonds, became the holders of stock and bonds of a new corporation to which the assets of the old corporation had been transferred after a judicial sale as contemplated by the plan. Accordingly the taxpayer, one of the bondholders, was not permitted to deduct from his gross income the loss sustained in the exchange of his bonds for the securities of the new corporation.
In the Rex case, the stockholders of a corporation having assets considerably in excess of its liabilities, but which assets were mostly frozen, determined upon a plan of reorganization whereby creditors of the corporation received 25% of their claims in cash and the balance in bonds of a new corporation organized to take over the assets which were transferred by a nominee who purchased them at a bankruptcy sale. Stockholders of the old became the holders of 77.78% of the stock of the new. The Rex case involved the construction and applicability of subsection (1)(A) of section 112(i) of the Revenue Act of 1928 which defines the term reorganization as " * * * a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation) * * * ". 26 U.S.C.A. Int.Rev. Acts, page 379. It held that there was sufficient continuity of interest on the part of stockholders of the old corporation in the new corporation to satisfy the definition.
In the Kitselman case, the court did not state whether the situation defined in Clause A or B of section 112(i)(1) was involved, calling attention to the fact that the two might overlap a bit, as indicated by Helvering v. Minnesota Tea Co., 296 U.S. 378, 56 S. Ct. 269, 80 L. Ed. 284. It held, however, that since "the essence of the corporate life - all its assets - were transferred by its bondholders to a new corporation in exchange for that corporation's stocks and bonds" [89 F.2d 461], a statutory reorganization had occurred, regardless of the total lack of participation on the part of stockholders of the transferor corporation.
In the case at bar we have squarely presented, the question whether the facts fall within the definition of reorganization provided by clause B: "a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred * * * ." It seems clear that the transfer here was not one by a corporation to a corporation. On the contrary, what occurred was a conveyance by the trustee in bankruptcy of the old corporation of all the ssets to an individual who was the highest bidder at a public sale. The bankrupt corporation at the time of the sale no longer was in a position to determine to whom its assets should be transferred, or what disposition should be made of the proceeds of the sale. We agree with the statement of the ...