OPINION.
Murdock :
Issue I. — Sale by W. <& K. of Securities Acquired from Its Stockholders in Exchange for Preferred Stock.
The petitioner, W. & K., contends that it is entitled to use as its basis for gain or loss on the disposition of the securities the cost of those securities to its stockholders because the property was acquired in an exchange of the kind described in section 112 (b) (5) of the Eevenue Act of 1932. The statutory provision is as follows:
SEC. 112. RECOGNITION OP GAIN OR LOSS.
(b) Exchanges Solely in Kind.—
<t
(5) Transfer to corporation controlled by transferor.- — No gain or loss shall bo recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior, to the exchange.
Every element necessary under the above provision is present here. See also section 112 (j) as to control.
The Commissioner argues, however, that since this transaction was carried out for the purpose of minimizing taxes, since it had no real business purpose, and since it was followed by a redemption of the preferred stock, it should be treated as a taxable transaction giving the property a new basis in the hands of W. & K., citing Gregory v. Helvering, 293 U. S. 465. The question in the Gregory case was whether or not there was a nontaxable reorganization. No such question is involved in this issue. This was an exchange, not a reorganization. The Gregory case does not support the Commissioner's contention. Cf. George W. Griffiths, 37 B. T. A. 314.
Here there was an exchange and no substantial change occurred in the beneficial ownership and control of the property beyond the change from individual to corporate ownership. Snead v. Jackson Securities Co., 77 Fed. (2d) 19. The loss of the stockholders was therefore postponed under the statute. The transaction was not a sale with payment deferred. The transferors had no right to any purchase price. Their rights were those of stockholders. Cf. Newman, Saumders & Co. v. United States, 36 Fed. (2d) 1009; certiorari denied, 281 U. S. 760; Osbum California Co. v. Welch, 39 Fed. (2d) 41; certiorari denied, 282 17. S. 850; American Compress & Warehouse Co. v. Bender, 10 Fed. (2d) 655; T. W. Phillips, Jr., Inc., 23 B. T. A. 1272; affd., 63 Fed. (2d) 101. The expectation of redemption is the only new circumstance. But it was a mere expectation, not an agreement. There was no debt due from the corporation to the preferred stockholders and no obligation to retire the preferred stock. The redemption was subject to claims of all creditors. The stock was actually retired in the next fiscal year, but the exchange is not dependent upon what happened that long afterward.
The exchange was within the provisions of section 112 (b) (5). Therefore, 113 (a) (8) applies and the basis for W. & K. was the same as that of the transferors. Section 101 (c) (8) (B) also applies and makes the loss a capital loss. That being so, section 23 (r) does not apply. The Commissioner erred as the petitioner contends.
Issue II. — Redemption of Common Stock "by W. <⅛ K.
. The Commissioner has held, as to each individual petitioner, that the retirement of the common stock was "at such time and in such manner as to make the distribution and redemption in whole essentially equivalent to the distribution of a taxable dividend." Six hundred and fourteen of the 1,000 shares outstanding were retired at $300 per share. The total amount distributed was $184,200, consisting of $173,100 paid on January 3 and $11,100 paid on October 7,1933.
That these amounts were actually paid from earnings or profits accumulated after February 28, 1913, can not be seriously controverted on this record. The corporation was not formed until long after February 28, 1913. All of its earnings or profits were accumulated after that date. Its books showed an operating surplus of $31,411.52 at August 1,1932. That was increased to $189,374.68 upon the sale of the real estate in November 1932. There was also on the books in January 1933 a "capital surplus" of $30,860.59. The amount of accumulated earnings on January 3, 1933, and on October 7,1933, is not shown. The petitioners had the burden of proof. However, it is clear that the accumulated earnings exceeded the total amounts distributed. The excess was more than sufficient to take care of all uncertainties in this record, as well as all liabilities and losses shown by the record. The loss on the securities allowed under issue I has no effect upon the distribution of January 3, 1933, because the sales were made after that date. Furthermore, that loss and the loss of $12,104.70 involved in issue VI, the date of which is not shown, do not affect earnings available for distribution because they are not, actually and for dividend purposes, losses of the corporation, since they resulted entirely from the fact that the corporation was merely permitted to use a basis in excess of cost to it for the purpose of computing its taxable income. Earnings available for dividends are computed upon actual gains and losses of the corporation as of the date of the distribution. Charles F. Ayer, 12 B. T. A. 284; B. M. Weyerhaeuser, 88 B. T. A. 594; Susan T. Freshman, 33 B. T. A. 394; F. J. Young Corporation, 35 B. T. A. 860.
The petitioners contend that the surplus should be reduced by a reserve of $35,000 for taxes for the fiscal year ended July 31, 1933. The taxes owed for that period were much less than $35,000 and can only be accrued ratably to the distribution date. Commissioner v. James, 49 Fed. (2d) 707, affirming 13 B. T. A. 764. Due allowance has been made for Federal taxes in our finding that earnings were available. Another contention of the petitioners, that the surplus had to be allocated to all of the 1,000 shares outstanding, is contrary to the clear provision of section 115 (b) which requires only the existence of earnings. Some testimony about depreciation in value of two assets was unimportant because, even if it were convincing, ,it would account for a reduction of excess surplus only.
The evidence not only fails to show error in the Commissioner's determination as to the effect of this distribution but supports his conclusion. The corporation had an extraordinarily large profit which it desired to distribute to its stockholders. It could have declared a dividend for that purpose. Instead, it distributed its excess funds by redeeming a large block of its stock. The distribution was made in that way so that the stockholders might avoid tax. Cf. J. Natwick, 36 B. T. A. 866, as to motive. There was no intention to liquidate. A dividend need not be in direct proportion to stock-holdings. However, the relative stock interests of the principal stockholders were not materially changed by the redemption. It is not essential that there be any connection between the issuance and the retirement of the stock or that the stock be canceled instead of held in the treasury. Annie Watts Hill, 27 B. T. A. 73; affd., 66 Fed. (2d) 45; James D. Robinson, 27 B. T. A. 1018; J. Natwioh, swpra. Since the facts show that this distribution was essentially equivalent to the distribution of a taxable dividend, it follows that the Commissioner did not err.
The transaction was not in liquidation, neither was it a sale, as the petitioners contend. Nor was any reasonable business need accomplished by making the distribution in the form of a retirement rather than as a dividend. Section 115(g) is not unconstitutional merely because it incorporates the presumption of section 115(b) that all distributions are made out of earnings to the extent thereof and from those most recently accumulated. The presumption of (b) has been held constitutional, Leland v. Commissioner, 50 Fed. (2d) 523, and (g) adds no unconstitutional effect.
Issue III. — Redemption of Preferred Stock by W. <& K.
The Commissioner gave the preferred shares a basis equal to the fair market value of the property given in exchange for them instead of the cost of that property to the transferors. Since the exchange was a nontaxable one, as held under issue I, it follows that the Commissioner erred. Section 113(a) (6) allows the use of the cost of the property as the basis for the property received in exchange. Even if this gives a double deduction, one to the stockholder and another to the corporation, Congress alone can correct the law.
Issue IV. — Alleged Loss of Sewat from Disposition of Securities and Alleged Loss of Peace from Exchange of his W. <& K. Stack for Flushing Mortgage.
Sewat claims the right to use, as its basis for gain or loss on the securities acquired from Peace on January 10, $51,171.62, the cost of those securities to Peace. It makes this contention on the ground that the exchange was within section 112(b) (5) and, therefore, section 113(a)(8) applies. This argument is unsound, since the exchange was not within section 112 (b)(5). Peace transferred the securities to Sewat as part of an integral plan. Although he momentarily held the stock of Sewat, he was never in control of that corporation. He had to transfer that stock immediately to W. & K. Thus, W. & K., not Peace, was in control of Sewat immediately after the exchange. Control depends upon the situation as it exists upon completion of the plan, not upon the situation existing after one of the intermediate steps. Wilbur F. Burns, 30 B. T. A. 163, 172; affd., 85 Fed. (2d) 8; Charles Hall, 31 B. T. A. 125.
Sewat was not entitled to use cost to Peace as its basis for gain or loss on the securities, but was entitled to use only the value of those securities at the time of the transfer. That value was $11,154.62. Those securities were exchanged by Sewat for the Flushing mortgage. The principal amount of the mortgage was $10,000. Its fair market value is not shown, although Herman Knobloch acquired it and another mortgage as set forth in the findings. It was worth at least $4,000 and the loss of Sewat could not exceed $7,154.62 ($11,154.62— $4,000). The Commissioner has held that this exchange did not result in any deductible loss. He argues that this particular transaction was but a part of a larger one, the consideration for the whole was divided among the various parts to suit the convenience of the parties and to avoid income taxes, and there was other consideration for the transfer by Sewat of assets worth $11,154.62 for a mortgage worth much less. The evidence strongly supports this contention of the Commissioner and it fails to show that Sewat sustained any loss which would entitle it to a deduction for income tax purposes. The statute does not mean that parties may obtain deductions in this way through maneuvering puppets. Sewat held the mortgage only long enough to transfer it pursuant to the general plan. This consideration was not the result of dealing at arm's length. The loss was not genuine and real. Cf. Seymour H. Knox, 33 B. T. A. 972; Labrot v. Burnet, 57 Fed. (2d) 413, affirming 18 B. T. A. 332; Commissioner v. Ehrhart, 82 Fed. (2d) 338; Shoenberg v. Commissioner, 77 Fed. (2d) 446; certiorari denied, 296 U. S. 586.
Peace claims the right to use $51,154.62, the cost of his securities, as his basis for gain or loss on the 38 shares of W. & K. preferred stock which he received in exchange for those shares. But since the exchange was not within section 112 (b) (5), as previously explained, he can not use that old basis. It follows, however, that he sustained a loss of $40,027.46 on January 10, 1933. He owned on that morning securities which had cost him $51,154.62. He exchanged them and held in their place at the end of the day 38 shares of preferred stock of W. & K-, redeemable for $11,127.16. A part of that loss was a capital loss. Proper adjustment may be made under Rule 50.
The 38 shares of W. & K. preferred then had a basis in his hands of $11,127.16. Peace exchanged them, together with 12 shares of common which had cost him $1,550, for the Flushing mortgage, which he valued at $10,000. The Commissioner has held that that transaction was not entered into for profit. The obvious inadequacy of the consideration supports the determination. An individual is allowed such a loss only in case the transaction was entered into for profit. Sec. 23 (e). The "Commissioner contends, in addition, that this transaction was only a part of the larger transaction and here, again, there was no real loss. We agree with the Commissioner. Peace had to reduce the bank loan. He could have sold his W. & K. stock, but the Knoblochs did not want outsiders to get that stock and they wanted Sewat to have a loss. The plan was then formed whereby the Knoblochs would satisfy the bank and Peace would transfer his W. & K. stock to Sewat, which was in turn owned by W. & K. Herman Knobloch transferred the Flushing mortgage to Archie Peace without any stated consideration. Archie transferred it to Sewat for assets worth much more than the mortgage. These were family transactions and invite careful scrutiny. The net result was that each family, the Knoblochs and the Peaces, received assets worth substantially the same as those surrendered. No real loss resulted to either, and on this record the action of the Commissioner can not be changed except as already stated. Cf. Shoenberg v. Commissioner, supra; Commissioner v. Ehrhart, supra.
Issue V. — Loss on Sale of Amsterdam Avenue Mortgage by W. & K.
The parties have stipulated that the cost of this mortgage to the stockholders was $13,104.70. The stockholders donated the mortgage to W. & K. in November 1932. The mortgage then had a basis for gain or loss to W. & K. of $13,104.70. Sec. 113 (a) (2). The evidence is reasonably clear that the fair market value of the mortgage thereafter was about $1,000. It was sold by W. & K. to Archie Peace, a minority stockholder, for $1,000 during the fiscal year ended July 81, 1933. The evidence indicates that the sale was absolute and an isolated transaction. There is no suggestion that W. & K. ever reacquired the mortgage. W. & K. is entitled to deduct a loss of $12,104.70 on the sale.
Issue VI. — Constitutionality of Excess Profits Tax.
W. & K. alleges that "the law under which the respondent attempts to impose an excess profits tax amounting to $3,764.37 is unconstitutional." Sections 215 (a) and (f) and 216 (a), National Industrial Recovery Act of June 16, 1933, 48 Stat. 195, impose a capital stock tax and an excess profits tax on domestic corporations. The capital stock provisions apply only to the year ended June 30, 1933. The profits tax provisions do not apply to any year ending after June 30, 1934. Sec. 703, Revenue Act of 1934. Substantially the same provisions (except as to years) were reenacted in sections 701 and 702 of the Revenue Act of 1934, effective beginning with the year ending June 30, 1934.
Section 215 (a) imposes for each year ending June 30 an excise tax of $1 for each $1,000 of the adjusted declared value of the capital stock. Section 215 (f) provides that for the first year ending June 30 "the adjusted declared value shall be the value, as declared by the corporation in its first return under this section (which declaration of value can not be amended), as of the close of its last income tax taxable year ending at or prior to the close of the year for which the tax is imposed by this section (or as of the date of organization in the case of a corporation having no income tax taxable year purling at or prior to the close of the year for which the tax is imposed by this section.)" There are provisions for increases and reductions of the original declared value for subsequent years, on account of additions and reductions of capital, earnings, distributions, etc., which are similar to the old invested capital provisions of earlier acts, not here material.
Section 216 (a) imposes "upon the net income of every corporation, for each income-tax taxable year ending after the close of the first year in respect of which it is taxable under section 215, an excess- profits tax equivalent to 5 per centum of such portion of its net income for such income-tax taxable year as is in excess of 12⅜ per centum of the adjusted declared value of its capital stock as of the close of the preceding income-tax taxable year determined as provided in section 215. " The tax imposed by section 216 (a) is subject to the same provisions of law as taxes imposed by Title I, Eevenue Act of 1932. The plan of the statute is to permit the taxpayer to declare the value of the capital stock, and, if it makes a low valuation and thereby pays a small capital stock tax, the 12½ percent credited against its net income will be smaller and will result in an increase of the excess profits tax. A high valuation will operate conversely. The statute was designed to avoid administrative difficulty and controversy in valuing the stock. The profits tax permits a reasonable valuation, and the primary purpose was to induce corporations to declare a fair value. William A. Webster Co., 37 B. T. A. 800; Senate Eeport 114, 73d Cong., 1st sess. p. 6.
Wesley Knobloch testified that the income tax return was made up first, and, as he knew the amount of net income to be $48,244.22, he arbitrarily declared the value of the capital stock of W. & K. at $386,000, so as to escape the profits tax. In other words, he declared it at 8 times the net income. He was familar with the assets and liabilities and the market value of the assets, and expressed the opinion that the fair market value of the stock was $115,000. He does not state how he arrived at this figure.
The amended petition alleges that the profits tax is based upon $397,154.62, an arbitrary and unsound value which petitioners were compelled by section 215 to place on their stock; that amount did not reflect the actual value on June 30, 1933; the law denied to them the right to file an amended return correcting that value; the law does not provide any method by which the value may be computed but delegates to the taxpayer the right arbitrarily to fix it without any basis in fact, an invalid delegation of the lawmaking power; and the law requires doing an act in terms so vague that men must guess at its meaning and differ as to its application, all in violation of the Fifth Amendment. The petitioner argues that section 215 is invalid under the Fifth and Fourteenth Amendments in that it compels payment of a tax based upon an arbitrary and unreasonable amount not easily or accurately ascertainable nor defined within the law itself, not based upon actual facts, but upon a basis prejudicial to taxpayers by reason of its effect upon the tax imposed under section 216. The petitioner relies on Oertel Co. v. Glenn, 13 Fed. Supp. 651, wherein the United States District Court of Western Kentucky sustained the right to file an amended return. The Commissioner contends that this case supports the validity of the statute, since the right of amendment is not here involved.
Since the briefs were filed, tbe Board, the Court of Claims, and the Circuit Court for the Sixth Circuit have considered these provisions. The cases are: Glenn v. Oertel Co., 97 Fed. (2d) 495; Chicago Telephone Supply Co. v. United States (Ct. Cls.), 23 Fed. Supp. 471; William A. Webster Co., 37 B. T. A. 800.
It is to be noted that the Commissioner determined an excess profits tax and we are not here concerned with the validity of, nor have we jurisdiction over, capital stock taxes. The Court of Claims in the Ghicago Telephone case sustained the statute, but stated its validity is not free from doubt. In the Oertel case, the District Court held that where the original declared value is understated the taxpayer may file an amended capital stock tax return before the liability for the profits tax accrues. The reasoning of the court is that the capital stock tax is based on the value of the stock, the value must be determined according to the underlying facts, and declared value means actual value. The court further observed that if the tax were levied on a value declared by the taxpayer regardless of actual value, it would be void for uncertainty and would offend the Fifth Amendment. The latter statement is pure dicta, since the court held that the statute was not to be so construed. The case is, therefore, no authority for holding the statute invalid. The Circuit Court of Appeals on June 8, 1938, affirmed the District Court. In construing the statute it held that Congress did not intend that an incorrect invalid return springing from an honest mistake could not be corrected, particularly where the correction was sought within the period for which an extension had been granted. It reasoned that to lay a tax upon the taxpayer's error rather than its income was inconsistent with the purpose to induce declaration of fair and reasonable values. It did not pass on the validity of the law.
The Board in the Webster case reached an opposite conclusion from the District Court in the Oertel case. The original capital stock tax return was filed and, within the time for filing as extended by the Treasury, the taxpayer sought to file an amended return increasing the value from $395,000 to $800,000. The Board held the statute prohibited amendment in plain terms and refused to accept the reasoning of the Oertel case. There is nothing in the facts there to show the reason for the change or that the first return was due to mistake. The constitutionality of the law was not raised.
The Chicago Telephone case is the only one in which the constitutional question was decided. The court followed the Board in holding that the statute does not permit amendment. The decision of the court is that the real value was known to and was readily ascertainable by the taxpayer, and the resulting profits tax was not due to arbitrary features of the law, but to the taxpayer's fault in electing to state a fictitious value which it had full opportunity to avoid. ^Referring to the statement in the Oertel case that the statute, if construed to deny amendment to show real value, would raise a conclusive presumption that an incorrect value shall be used as a measure of the tax, the court held that for the first year the declaration is made, no question of presumption arises, as the taxpayer has an opportunity to ascertain the value and can not be said to have fixed it without evidence or an opportunity to be heard. The court further held that the statute did not involve a delegation by Congress of its lawmaking authority, since a declaration of value is a mere statement of fact; and it answered the objection, that no guide or method was prescribed for making the declaration of value, by saying that there is no necessity for a guide in making a statement of fact. The court seemed to think that, if a declaration for a previous year were used in a later year, it might be arbitrary to make the declaration conclusive, but that case, like the present one, involved use of the declaration only in the first year.
The decision of the Court of Claims is a complete answer to the petitioner's contentions. The petitioner here is in a less favorable position than the taxpayer in that case. Here, with full knowledge of the facts as to value and of its net income, the petitioner made what is now claimed to be a grossly excessive declaration expressly intended to wipe out any profits tax. The effect of its action is that it has secured the benefit of a lower tax than it would have had to pay if it had made a lower valuation. Its claim is not now directed to the right to amend to show the actual value, but it seeks to strike down the whole taxing statute as void for failure to set a guide for the declaration of value.
There is nothing in the statute which prohibits a taxpayer from declaring the actual value. Congress did not intend that a corporation should declare a value sufficiently high to wipe out all profits taxes, for the purpose is to tax profits in excess of the credit of 12½ percent. One of the objects is to tax at higher rates abnormal profits which are out of proportion to the capital. In the case of the Sewat Co., the declared value was based on the value of assets acquired for stock.
If the District and Circuit Court in the Oertel case are right in holding that the statute contemplates a tax only on actual value of the capital stock, that construction gives taxpayers a standard or guide. It would then follow in this case that if the capital stock tax was invalid as being based on an excessive value (it is not here involved), the profits tax was less than what it would have been if computed on actual value. Hence, the petitioner suffered no injury or damage when the Government applied the tax on the basis of its excessive valuation. The petitioner in such case could not attack the constitutionality of the profits tax. The rule is that "one who invokes the power to declare a statute unconstitutional must show not only that the statute is invalid but that he has sustained or is immediately in danger of sustaining some direct injury as the result of its enforcement, and not merely that he suffers in some indefinite way in common with people generally." Massachusetts v. Mellon, 262 U. S. 447, 488. See also Heald v. District of Columbia, 259 U. S. 114, 124.
On the facts in this case a claim of the right to file an amended return would avail the petitioner nothing. The petitioner's contention is without merit.
Beviewed by the Board.
Decision will be entered wider Bule 50.