Hastings, Chief Judge, Swygert, Circuit Judge and Grant, District Judge. Swygert, Circuit Judge (dissenting in part).
Petitioner, F. & D. Rentals, Inc. (F & D), an Indiana corporation, appeals from an adverse decision of the Tax Court of the United States*fn1 which upheld the determination by the Commissioner of Internal Revenue of a $98,540.50 deficiency in F & D's income tax for the fiscal year ended April 30, 1958.
F & D was first organized in 1957 under the name of The South Bend Toy Manufacturing, Inc., for the purpose of engaging in the manufacture and sale of toys.*fn2 This was the same name as that of an Indiana corporation organized in 1882 for the purpose of engaging in the manufacture and sale of toys. (Hereafter referred to as South Bend No. 1 to distinguish it from petitioner's corporation, which will be referred to as South Bend No. 2.)
South Bend No. 1 was owned principally by a South Bend bank as trustee under two separate trusts. The bank, as trustee, sought to sell South Bend No. 1, but received no firm offer prior to March 15, 1957.
On that day, Benjamin F. Fohrman and John W. Dorgan, two Chicago attorneys who had no connection with either the bank or trusts involved, offered by letter to purchase the business.
The letter stated in part:
"We propose to buy all assets as disclosed on balance sheet dated December 31, 1956 excepting cash, government bonds and negotiable securities for a price of $300,000.00 less than the book value of said assets * * *."
This offer was accepted, and on May 13, 1957, the principal stockholder trustee-bank filed a petition in the St. Joseph Superior Court No. 1 in St. Joseph County, Indiana, seeking approval for the sale. The petition contained, inter alia, the following representations:
"5. That The South Bend Toy Manufacturing Company has received a proposal from Messrs. Benjamin F. Fohrman and John W. Dorgan of Chicago, Illinois to purchase all assets of The South Bend Toy Manufacturing Company as the same shall exist on May 31, 1957, excepting and excluding from such sale cash on hand and in banks, refund claims for taxes, if any there be, federal, state and local, whether or not arising from the contemplated transaction; * * * that said prospective purchasers have offered to pay the "book value" of the assets to be purchased as such book value is determined by the auditors of the company to be as at May 31, 1957 in accord with the normal accounting procedures employed by such company auditors in computing the book value thereof, less the sum of Three Hundred Thousand Dollars ($300,000.00), * * *.
"6. That it is anticipated that such sale will result in a corporate loss of Three Hundred Thousand Dollars ($300,000.00) which, together with the seasonal net operating loss for the current fiscal year of the corporation, is likely to result in a federal net income tax refund to The South Bend Toy Manufacturing Company of approximately One Hundred Ninety-two Thousand One Hundred Dollars ($192,100.00), dependent upon variables, including the variable of the exact seasonal loss to date of closing; that, therefore, the net realization to be experienced by the corporation on account of the transaction would be approximately One Hundred Forty-four Thousand Dollars ($144,000.00) less than the book value of the net worth of the corporation as at December 31, 1956 in the amount of One Million Five Hundred Fifty-eight Thousand Six Hundred Seventy-six Dollars ($1,558,676.00) and accordingly that the net realization anticipated to the corporation from the transaction is likely to approximate One Million Four Hundred Fourteen Thousand Six Hundred Seventy-six Dollars ($1,414,676.00), subject to Indiana gross income tax and costs incident to perfecting the transaction; that Messrs. Dorgan and Fohrman, as an incident to the transaction, have undertaken to enter a certain contract with the shareholders of the corporation whereby they will guarantee such anticipated tax refunds * * *."
On the same day, the Superior Court entered an order authorizing the trusteebank to vote, as majority stockholder, in favor of the sale to Fohrman and Dorgan.
On May 22, 1957, a formal purchase and sale agreement was entered into by South Bend No. 1 and Fohrman and Dorgan. This agreement provided in effect that South Bend No. 1 would sell to Fohrman and Dorgan, or their nominee, all the operating assets of South Bend No. 1 at a purchase price equal to the book value of the assets, reduced by $300,000. The assets thus sold were by agreement to be listed and priced to reflect the $300,000 reduction in book value. In the event the parties failed to agree upon the proper allocation of the $30,000 among the various assets, a neutral third party was to make a decision binding on the parties.
On May 24, 1957, South Bend No. 2 was organized by Fohrman and Dorgan, and received, as their nominee, all their right, title, and interest under the agreement of purchase and sale.
Fohrman and Dorgan made the allocation of the $300,000 reduction from book value, and the trustee-bank, as majority stockholder, agreed to it.
The book value of South Bend No. 1 and the allocation of reduction were as follows:
Value per of "reduced" Reduction
books of purchase price if
South Bend by Fohrman any, from
Toy No. 1 and Dorgan book value
Petty cash $750.00 $750.00 -0-
Cash in bank 100.00 100.00 -0-
Accounts receivable 252,060.39 252,060.39 -0-
Advances for material 29,014.83 29,014.83 -0-
Prepaid insurance 15,240.38 15,240.38 -0-
Airline deposit 425.00 425.00 -0-
Total Current Assets $297,590.60 $297,590.60 -0-
Raw materials $353,677.93 $353,677.93 -0-
Work in process 111,687.77 111,687.77 -0-
Finished goods 324.986.69 324,986.69 -0-
Total Inventory $790,352.39 $790,352.39 -0-
Factory supplies $5,003.87 ...