Peabody Hotel Co. v. Commissioner , 7 T.C. 600 ( 1946 )

Peabody Hotel Company, Petitioner, v. Commissioner of Internal Revenue, Respondent

Peabody Hotel Co. v. Commissioner

Docket No. 230

United States Tax Court

7 T.C. 600; 1946 U.S. Tax Ct. LEXIS 98;

August 19, 1946, Promulgated

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Decision will be entered under Rule 50.

Pursuant to a plan of reorganization adopted under a section 77-B Bankruptcy Act proceeding, the insolvent debtor corporation's property was transferred to two new corporations. Approximately 13 per cent of such property (as it existed prior to such transfers) was transferred to one new corporation in recognition of the full priority rights of one class of bondholders secured by such property. The other new corporation, petitioner, acquired all of the insolvent debtor's property to which the latter's general creditors and the other classes of bondholders could look for payment of their claims; and, further, petitioner acquired such property subject to various liabilities assumed by petitioner, pursuant to the plan and court decrees and in exchange for 69 per cent of petitioner's voting common stock issued to the debtor's creditors. In addition, petitioner issued 31 per cent of its common stock for $ 49,861 new working capital. Held, that the transaction was a nontaxable reorganization under section 112 (b) (4) and (g) (1) (B) of the 1934 Act, as amended, and that petitioner is entitled to the same basis as its properties would have in the hands of the transferor under section 113 (a) (7) of the 1934 Act.

J. S. Allen, Esq., Allan Davis, Esq., and M. O. Carter, C. P. A., for the petitioner.

Bernard D. Hathcock, Esq., for the respondent.

Tyson, Judge.

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TYSON

The respondent determined deficiencies in income tax and excess profits tax for the years and in the amounts as follows:

Year ended --	Income tax	Excess profits
	deficiency	tax deficiency
Aug. 31, 1935	$ 3,406.07	$ 854.73
Aug. 31, 1936	6,634.75
Aug. 31, 1937	4,958.04
Total	14,998.86	854.73

Petitioner seeks a redetermination that there are no deficiencies for the years ended August 31, 1935, and August 31, 1937, but, instead, that there are overpayments in the amounts of $ 1,362.22 and $ 365.23 for those years, respectively, and that there is a deficiency not in excess of the amount of $ 1,700.75 for the fiscal year ended August 31, 1936.

The issues are whether respondent erred in disallowing claimed deductions for each of the years involved (1) for depreciation and (2) for amortization of bond discount and expense. The primary question, answer to which is decisive of both issues, involves a determination of the petitioner's basis for the property acquired by it upon its organization in 1934, that is to say, whether the basis in the hands of petitioner is (a) the cost to it of such property as determined by respondent, or (b) as contended for by petitioner, the same basis for such property in petitioner's hands as it would have in the hands of its transferor under section 113 (a) (7) or (a) (8) of the Revenue Act of 1934, because, as claimed, the property was acquired either pursuant to a nontaxable "reorganization" within the meaning of section 112 (b) (4) and (g) (1) (B) of the Revenue Act of 1934 as amended by section 213 (g) of the Revenue Act of 1939, or pursuant to a nontaxable "exchange" within the meaning of section 112 (b) (5) of the Revenue Act of 1934.

At the hearing the parties stipulated the amounts of the deductions for depreciation and for amortization of bond discount and expense allowable to petitioner for each of the years in controversy, if it is determined herein that petitioner acquired its assets pursuant to a nontaxable reorganization or exchange. The parties also stipulated the amounts and dates of payments made by petitioner for income taxes for each of the years in controversy. Effect to the stipulations will be given under Rule 50 in accordance with our opinion herein. The petition was amended to conform to such stipulated facts, which are included herein by reference.

FINDINGS OF FACT.

The petition herein was filed on November 23, 1942.

The petitioner is a Tennessee corporation, with its principal office in Memphis, Tennessee. Its income tax returns for the years here involved were filed with the collector of internal revenue for the district of Tennessee at Nashville, Tennessee.

The petitioner was organized on July 26, 1934, pursuant to a plan of reorganization of the Memphis Hotel Co., a Tennessee corporation, under section 77-B of the Bankruptcy Act, as amended.

In March 1933 the Memphis Hotel Co. had an authorized capital stock of 50,000 shares, par value $ 50 each, which were owned by persons in various states. At that time it owned and operated the Peabody Hotel and the Gayoso Hotel, both located in Memphis, Tennessee, and it also owned and operated a farm known as the Gayoso farm, located in DeSoto County, Mississippi. The Memphis Hotel Co. also owned 50 per cent of the capital stock of the Chickasaw Hotel Co., consisting of 1,000 shares of common and 684 shares of preferred, and under an agreement operated the latter's hotel property known as the Chisca Hotel located in Memphis, Tennessee. At that time the Memphis Hotel Co.'s liabilities included, inter alia, three separate bond issues as follows: One hereinafter referred to as the "Peabody firsts," which were secured by Southern Hotel first mortgage 6 per cent gold bonds, dated July 1, 1923, constituting a first lien on all the Peabody Hotel real and personal property, which bonds had been assumed by the Memphis Hotel Co.; one hereinafter referred to as the "Gayoso firsts," which were secured by the Memphis Hotel Co.'s first mortgage 6 per cent gold bonds, dated March 1, 1924, constituting a first lien on all the Gayoso Hotel real and personal property; and one hereinafter referred to as the "Peabody seconds" which were secured by the Memphis Hotel Co.'s refunding mortgage and collateral trust 7 per cent gold bonds, dated November 2, 1925, constituting a second lien on the Peabody Hotel and Gayoso Hotel real and personal properties and further secured by a collateral trust agreement and pledge of 1,000 shares of the common stock of the Chickasaw Hotel Co.

On March 8, 1933, E. G. Taylor, a resident of Mississippi, as a bondholder and on behalf of all creditors, both secured and unsecured, and on behalf of the stockholders of the Memphis Hotel Co., filed against that company a bill of complaint, Equity No. 1182, in the District Court of the United States for the Western Division of the Western District of Tennessee. The bill of complaint alleged, inter alia, that during 1932 and 1933 the defendant, Memphis Hotel Co., had failed to make certain interest and sinking fund payments on its bonds and had defaulted on the principal of certain of those bonds which had matured; that demand for foreclosure on the mortgages would be made in the immediate future; that the filing of many suits would be precipitated; and that timely intervention of the court was necessary for the preservation of the assets and the going business of the defendant and for the avoidance of a multiplicity of suits. The bill of complaint prayed for an order appointing receivers with full power to take possession of all the defendant's properties and to operate its business in toto, and requiring all creditors to file claims in that proceeding. On March 8, 1933, and on consent of the defendant, the court entered its order appointing W. P. Armstrong and A. L. Parker as receivers for the defendant corporation, with powers and duties as prayed for. The bill of complaint did not allege insolvency of the defendant, but, on March 8, 1933, it was, in fact, insolvent.

On March 10, 1933, the Bank of Commerce & Trust Co. of Memphis, Tennessee, filed an intervening bill in the above mentioned proceeding, as the indenture trustee under each of the three deeds of trust securing the bond issues above mentioned, and also as trustee under the collateral trust agreement and pledge of stock constituting liens against the Memphis Hotel Co.'s Peabody Hotel, Gayoso Hotel, Gayoso Farms, and 1,000 shares of common stock of the Chickasaw Hotel Co. The intervening bill alleged, inter alia, defaults under each indenture, and asserted the respective lien rights of the interveners for foreclosure on those properties. The bill prayed that, pending foreclosure, the receivers theretofore appointed and then in possession of all the defendant's properties be also constituted receivers for the benefit of the holders of the respective secured debts, with full authority and powers to continue the operation of the various properties in the manner theretofore conducted by them and that they be required to impound, segregate, and hold in separate accounts the net rents, issues, and profits from the several mortgaged properties for the benefit of the respective classes of bondholders. On March 10, 1933, the court entered its order appointing W. P. Armstrong and A. L. Parker as receivers, with the powers and duties as prayed for.

Through the above mentioned proceedings in equity the creditors of the insolvent Memphis Hotel Co. took effective command and control over that company's properties, with the result that the equity ownership of such properties had shifted from the stockholders to such creditors. Subsequent to March 10, 1933, and pursuant to the court order of that date, the receivers, in accordance with the directions of the decree, continued operation of the business and properties of the Memphis Hotel Co. and the proceeds from the various properties were impounded and segregated for the benefit of creditors through the application of proper accounting methods.

At the time of the institution of the proceeding in Equity No. 1182, on March 8, 1933, the Memphis Hotel Co. was indebted to the Bank of Commerce & Trust Co. of Memphis on a collaterally secured loan and that bank immediately asserted its banker's lien against the Memphis Hotel Co.'s entire deposit in that bank. Later, by compromise agreement with the receivers and approval of the court, the bank applied a portion of the deposit in reduction of the debt and released the remaining portion of such deposit to the receivers. The Memphis Hotel Co. was thereafter indebted to the bank in the amount of $ 69,602.25, with interest, secured by the originally pledged securities. By proceedings had in both the District Court of the United States for the Western Division of the Western District of Tennessee and in the District Court of the United States for the Northern District of Mississippi, in which latter district the Gayoso farm was located, that farm was sold for $ 70,000 cash, and the sale was confirmed by the courts. Pursuant to an order of the court for the Western District of Tennessee, the receivers applied the cash proceeds of the sale to pay in full the Memphis Hotel Co.'s debt to the bank, which thereupon released the pledged collateral consisting of $ 250,000 principal amount of Peabody seconds and 684 shares of preferred stock, par value $ 100 each, of the Chickasaw Hotel Co. The Peabody seconds, so released, were canceled, thus reducing the outstanding bonds of that issue to the principal amount of $ 841,000, and the preferred stock of the Chickasaw Hotel Co., so released, was charged with liens as per the court's allocation between creditors, viz, a first lien of $ 10,799.83 in favor of general unsecured creditors of the Memphis Hotel Co. and a junior lien of $ 47,035.70 in favor of holders of Peabody seconds. The acts as recited in this paragraph were all done prior to March 1, 1934, the date of the promulgation of the plan hereinafter mentioned.

Due to the Memphis Hotel Co.'s defaults on its outstanding bond issues, the holders of each of the three respective bond issues executed protective agreements, of dates as follows: For Peabody seconds in November 1932, for Gayoso firsts in March 1933, and for Peabody firsts in June 1933; and pursuant to those agreements bondholders' protective committees were organized.

A reorganization committee composed of the chairman of each of the three bondholders' protective committees promulgated, as of March 1, 1934, a plan and agreement of reorganization of the Memphis Hotel Co. That plan was approved and adopted by each bondholders' protective committee, and was submitted to the court in the pending proceeding in Equity No. 1182 by petition of the receivers and intervening petitions of the several bondholders' protective committees. The court, by its order entered on May 5, 1934, adjudged such plan to be fair, timely, and equitable with respect to the interests of all parties concerned, ordered the consummation of the plan under the supervision of the court, and ordered the cause set for further hearing on July 7, 1934.

On June 25, 1934, the reorganization committee and the several bondholders' protective committees executed an amendment to the plan and agreement of reorganization of March 1, 1934, to make the same applicable and to enable its consummation through a corporate reorganization proceeding in bankruptcy under sections 77-A and 77-B of the Bankruptcy Act as amended on June 7, 1934. One of the primary purposes of the amended plan was to avoid foreclosure sales provided for in the original plan.

On June 28, 1934, the Memphis Hotel Co. filed in the District Court of the United States for the Western Division of the Western District of Tennessee a "Debtor's Original Petition" "In Proceedings for a Corporate Reorganization No. 11663," alleging insolvency and invoking the jurisdiction of the court under sections 77-A and 77-B of the Bankruptcy Act, as amended, for consideration and approval of the original plan and agreement of reorganization dated March 1, 1934, as amended by the amendment of June 25, 1934. The petition alleged, inter alia, the pertinent facts as to the Memphis Hotel Co.'s assets and liabilities, capital stock, and financial condition, and further alleged that continued operation of the business was impossible without effecting a plan of reorganization materially reducing the Memphis Hotel Co.'s capitalization and fixed charges and rearranging its indebtedness; that a bankruptcy reorganization could be consummated, without foreclosure, more expeditiously and at less expense than through the pending proceeding in Equity No. 1182; that the proposed plan as amended had been accepted by more than two-thirds in amount of the holders of secured and unsecured claims; and that by corporate resolution the Memphis Hotel Co. had approved and accepted the plan as amended and authorized the filing of its "Debtor's Original Petition." By court order entered June 28, 1934, the foregoing petition was approved as properly filed under sections 77-A and 77-B of the Bankruptcy Act, as amended, and A. L. Parker was appointed temporary trustee of the estate of the debtor, Memphis Hotel Co.

In the "Proceedings for a Corporate Reorganization No. 11663," upon notice to all creditors and stockholders and on hearing and consideration of certain premises, including the record in the prior receivership cause in Equity No. 1182, the court in entering its decree on August 1, 1934, found that the debtor was insolvent; that the plan was "fair and equitable" as to all classes of creditors and the stockholders and was "feasible"; that the plan complied in all respects with the requisites of section 77-B of the Bankruptcy Act as amended; and that the plan had been accepted by a majority of the stockholders and by or on behalf of holders in excess of two-thirds in amount of each class of allowed claims, including the outstanding $ 1,777,000 principal amount of "Peabody firsts," the outstanding $ 660,000 principal amount of "Gayoso firsts," and the outstanding $ 840,000 principal amount of "Peabody seconds." The court in its decree approved and confirmed in all respects the plan of reorganization, as amended (hereinafter referred to as the plan); made the plan binding on all stockholders and creditors of the debtor, whether they had accepted it or not; and granted the debtor and the corporations to be organized under the plan full authority to consummate and ordered the consummation of the plan. The court further ordered that the time within which the stockholders of the debtor could comply with the plan requiring deposit of stock of the Memphis Hotel Co. and payment of cash for stock in the Peabody Hotel Co. be extended to January 1, 1935. The decree made permanent the appointment of A. L. Parker as trustee of the estate of the debtor, and allowed established claims, both secured and unsecured.

The decree of August 1, 1934, also ordered cancellation of $ 3,000 principal amount of Peabody firsts and $ 1,000 principal amount of Peabody seconds theretofore acquired by the debtor for retirement and not included in the above amounts of outstanding bonds. The decree reserved for further action of the court the allowance of compensation and expenses of various parties in connection with the proceedings and the plan, including the expenses in the cause Equity No. 1182, whether payable by the trustee or made a charge upon the assets of the debtor.

Pursuant to the plan the petitioner in the case at bar, the Peabody Hotel Co., was incorporated on July 26, 1934, under the laws of Tennessee, with an authorized capitalization of 25,000 shares of no par value voting common stock, to take over all the properties of the Memphis Hotel Co. except the Gayoso Hotel property. Also, pursuant to the plan and at or about the same time, the Gayoso Hotel Co. was incorporated under the laws of Tennessee to take over the Gayoso Hotel property free of all liens except taxes, because the plan recognized the full priority rights of the holders of Gayoso firsts to that entire hotel property, including its impounded receipts from the receivership and trustee operations, and also because the plan recognized that such holders, to the extent of their deficits, had the status of general creditors of the Memphis Hotel Co.

On August 31, 1934, pursuant to the plan and with court approval of the substance and form of the conveyance, the bankruptcy trustee, the Memphis Hotel Co. and the Bank of Commerce & Trust Co. as indenture trustee under the trust deed of March 1, 1924, securing Gayoso firsts, jointly executed a transfer and conveyance to the Gayoso Hotel Co. of all the real property known as the Gayoso Hotel, together with all machinery, equipment, personal property, etc., used in connection therewith; the good will and use of the name Gayoso; the supplies, etc., located in or held for use of the Gayoso Hotel; the bills, notes and accounts receivable, the executory contracts, and the cash in the hands of A. L. Parker, trustee, consisting of two items of $ 1,154.53 and $ 10,462.25, arising from the receivership and trusteeship operation of the Gayoso Hotel; and also the sum of $ 10,799.83 in the hands of A. L. Parker, trustee, arising from the sale of the Gayoso farm and originally allocated for the benefit of general creditors of the Memphis Hotel Co. but subsequently directed by the court to be transferred to the Gayoso Hotel Co. in connection with Gayoso firsts becoming general creditors with respect to their deficits. The conveyance was in fee simple, free and clear of all claims of the Memphis Hotel Co. and its stockholders and creditors, except liens for taxes on the property transferred, which it was agreed would be paid out of the cash transferred to the Gayoso Hotel Co. For the transfer of such property and as required by the plan, the Gayoso Hotel Co. issued its entire capital stock, no par voting common, to Parker, trustee, who lodged the same with the transfer agent for distribution in exchange for Gayoso firsts. The August 31, 1934, book value of the properties so transferred amounted to $ 696,163.03, or approximately 13 per cent of the total properties of the Memphis Hotel Co. on that date and prior to the transfer. The properties so conveyed were subject only to the priority lien rights of the holders of Gayoso firsts bonds, and neither the holders of Peabody firsts and Peabody seconds nor the general creditors of the Memphis Hotel Co. had any equitable interest therein.

On August 31, 1934, pursuant to the plan, the Peabody Hotel Co. voting trust agreement was executed to secure a union of all interests in order to concentrate the responsibility for proper management of the Peabody Hotel Co. properties. The agreement provided for the issuance of the common capital stock of the Peabody Hotel Co. requisite to be issued to carry out the plan up to the amount of 23,481 shares, to the voting trustees for them to hold the legal title thereto upon active trust for a period of 10 years, unless sooner terminated. The agreement also provided that the stock represented by the voting trust certificates should be voted by the trustees as directed by the owners of such certificates at any meeting of the stockholders at which it was proposed:

(a) to amend its certificate of incorporation, (b) to reduce its capital, (c) to sell, lease or exchange all of its property and assets, including its good will and its corporate franchises, or such part of its property and assets as would substantially limit the corporate business, (d) to consolidate with any other corporation or corporations, or (e) to surrender its charter and dissolve itself, * * *

The agreement further provided for the voting trustees' issuance of voting certificates requisite under the plan and up to an amount representing the 23,481 shares of such stock, and for delivery of such voting certificates to the transfer agent of the trustee in bankruptcy for distribution to the stockholders in accordance with the plan. The agreement also provided for payment of all dividends on the stock of the Peabody Hotel Co. to the holders of the voting trust certificates.

On August 31, 1934, pursuant to the plan and court decree and with court approval of the conveyance, the bankruptcy trustee, the Memphis Hotel Co., and the Bank of Commerce & Trust Co. as indenture trustee under the deed of trust and collateral trust agreement, both dated November 2, 1925, jointly executed a transfer and conveyance of title in fee simple to the Peabody Hotel Co. of all the remaining properties of every kind and description of the Memphis Hotel Co. (the properties so conveyed being all its properties other than those properties transferred of even date to the Gayoso Hotel Co.) including all the real property, building and land, known as the Peabody Hotel, together with all machinery, fixtures, furniture, equipment, and personal property owned or used in connection with such property; the good will, business and name of Peabody; the merchandise, supplies, and personal property of every kind located in or held for use of the Peabody Hotel; the printing machinery, presses, equipment, and supplies comprising the print shop owned by the Memphis Hotel Co. and located in the Chisca Hotel; all the automobiles and trucks owned by the Memphis Hotel Co.; the 1,000 shares of common and 684 shares of preferred capital stock of the Chickasaw Hotel Co.; and all bills, notes, accounts receivable, intangibles, rights, and beneficial interests under executory contracts, and cash on hand arising from the operation of the Peabody Hotel and comprising assets of the Memphis Hotel Co. and its receivers from March 8, 1933, to June 28, 1934, in the proceeding in Equity No. 1182, and of the trustee of the estate of the Memphis Hotel Co. appointed on June 28, 1934, in the proceeding for corporate reorganization No. 11663. The conveyance was in fee simple and free and clear of all claims of the Memphis Hotel Co. and its stockholders and creditors, except that it was subject to the liens for taxes assessed against such property; the liens of the deeds of trust securing the Peabody firsts and the Peabody seconds bonds; the rights of lessees and licensees of space or privileges under certain specified existing executory leases and contracts; and also the court costs, expenses, and liabilities due to be paid by the bankruptcy trustee but not already paid by him on August 31, 1934. The August 31, 1934, book value of the properties so transferred amounted to $ 4,594,750.80, which (after eliminating the properties transferred to the Gayoso Hotel Co. in recognition of the full priority rights of the holders of Gayoso firsts) was 100 per cent of the Memphis Hotel Co.'s properties against which its general creditors and the holders of Peabody firsts and Peabody seconds had any equitable claim. On August 31, 1934, the Peabody Hotel Co. acquired substantially all of the properties of the Memphis Hotel Co.

Pursuant to the foregoing conveyance of August 31, 1934, the plan and court orders and decrees, and in consideration for such conveyance, the Peabody Hotel Co., petitioner, did the following:

Assumed the obligation of the "Peabody firsts" outstanding in the principal amount of $ 1,777,000 and the coupons attached thereto, including $ 17,770 interest accrued to September 1, 1934, and the deed of trust securing the same, except that the sinking fund requirements of the deed of trust then in default and to become due during a period of three years beginning January 1, 1934, which were waived;

Assumed the $ 840,000 principal amount of outstanding old "Peabody seconds" and unpaid coupons thereon, and issued to the bankruptcy trustee's transfer agent in exchange therefor an equal principal amount of new Peabody Hotel Co. second mortgage 10-year 5 per cent bonds, dated as of May 1, 1934, with accrued interest thereon amounting to $ 14,000 on September 1, 1934, secured by lien on the Peabody Hotel real and personal property junior to the lien of the Peabody firsts and further secured by collateral trust agreement and pledge of 1,000 shares of common stock of the Chickasaw Hotel Co.;

Issued, immediately, for the benefit of the holders of the old Peabody seconds a total of 10,080 shares of its stock to the voting trustees on the basis of 12 shares in exchange for each old Peabody seconds bond;

Issued, immediately, for the benefit of holders of old Gayoso firsts, a total of 3,960 of its shares to the voting trustees on the basis of three shares for each $ 500 principal amount of Gayoso firsts representing their participation as general creditors of the Memphis Hotel Co.;

Issued, immediately, for the benefit of general creditors of the Memphis Hotel Co., a total of 895 shares of its stock to the voting trustees on the basis of one share for each $ 25 of claim; and, to eliminate claims under $ 25 and the excess of other claims over the highest multiple of $ 25, such creditors were paid $ 2,790.81 out of the cash assets received from the bankruptcy trustee subject to such liability;

Issued, immediately, for the benefit of holders of lease claims against the Memphis Hotel Co. a total of 987 shares of its stock to the voting trustees on the basis of one share for each $ 25 of claim for rent reserved and unpaid since default to the end of 1934;

Issued, immediately, for the benefit of holders of commission claims against the Memphis Hotel Co. a total of 58 shares of its stock to the voting trustees on the basis of one share for each $ 25 of claim for claims for commissions unpaid and accrued to May 1, 1934;

Issued, pursuant to the plan and court decrees, a total of 7,123 shares of its stock to the voting trustees for the benefit of participating stockholders of the Memphis Hotel Co. and certain other persons, at the times and in the amounts hereinafter fully set out.

The petitioner, Peabody Hotel Co., also assumed the following liabilities to which the transferred property was subject: The accrued taxes amounting to $ 59,810.66 on August 31, 1934, on the property transferred to the Peabody Hotel Co.; the expenses and costs of the reorganization proceedings and of the receivership and bankruptcy proceedings; expenses and liabilities not already paid by the bankruptcy trustee at August 31, 1934, including three items totaling $ 13,136.41; an item of $ 904.96 to I. Samelson & Co. on its preferential right of reclamation claim for assets improperly taken over by the receivers from the Memphis Hotel Co. and subsequently adjudged to be a lien on the assets of the Memphis Hotel Co.; three items totaling $ 22,423.61 to be paid over to the Gayoso Hotel Co. by petitioner out of the cash funds received from the bankruptcy trustee and pursuant to the plan in connection with the settlement of accounts in the trustee's operation of the business and the amount due on account of claims of the holders of old Gayoso firsts as general creditors of the Memphis Hotel Co. In addition, petitioner assumed and agreed to pay the expenses of the voting trustees under the Peabody Hotel Co. voting trust agreement executed as a part of the plan.

On August 31, 1934, all of the properties of the Memphis Hotel Co. in the hands of the trustee in bankruptcy were delivered to the Gayoso Hotel Co. and the Peabody Hotel Co., respectively, pursuant to the above mentioned conveyances of even date, except for $ 2,500 retained by the trustee for payment of his fee and certain other expenses as ordered by the court. The court, by its order entered on September 29, 1934, approved and confirmed the transfers, conveyances, and other instruments and documents executed in carrying out the plan; approved appointment of the transfer agent of the trustee and the delivery to such agent of the securities for exchange in carrying out the plan; approved the trustee's statement of accounts to September 29, 1934; and approved all acts done and steps taken toward consummation of the plan. Also, the order approved the final allowance of compensation to the trustee in bankruptcy, but, after stating that all exchanges could not be completed for some time and certain adjustments could not be then finally determined, ordered that "the trusteeship of said Trustee is not at this time terminated, but said Trustee will continue to act until said Plan of Reorganization in all respects has been fully and finally consummated." The cause was retained by the court for further reports by the trustee and for such action on "other matters as may be appropriate or proper incident to, or in connection with this proceeding, to be finally and completely carried out and consummating said Plan of Reorganization or the orders of the Court relative thereto."

Pursuant to the plan and court decrees, the Peabody Hotel Co. earmarked 7,123 shares of its stock as the maximum number available to the stockholders of the Memphis Hotel Co. if all of them participated under the plan by depositing with the depositary one share of the latter company's stock accompanied by payment of $ 1, for which they were to receive one-seventh share of Peabody Hotel Co. stock, thereby providing a total of $ 49,861 cash to be paid in as new working capital. The August 1, 1934, court decree fixed January 1, 1935, as the time limit for making such exchange. Pursuant to the Peabody Hotel Co.'s intervening petition filed December 18, 1934, in proceedings for corporate reorganization No. 11663, for instructions and directions of the court on certain matters in connection with the consummation of the plan and the court's order entered on the same date, the Peabody Hotel Co. offered to participating stockholders of the Memphis Hotel Co. the right, expiring on January 1, 1935, to subscribe for sufficient fractional shares to complete whole shares on the basis of $ 7 per share; and further offered such stockholders the right, after January 1, 1935, to subscribe at $ 7 per share for an additional allotment out of the unutilized portion of the 7,123 shares of Peabody Hotel Co. stock set apart under the plan for the benefit of the participating Memphis Hotel Co. stockholders. Pursuant to the plan and also the court authorization to issue additional fractional shares, the Peabody Hotel Co. issued up to January 1, 1935, a total of 3,010 of its shares to the voting trustees for the benefit of participating stockholders of the Memphis Hotel Co. The Peabody Hotel Co. further issued, on January 18, 1935, a total of 1,542 of its shares to the voting trustees for the benefit of participating Memphis Hotel Co. stockholders who subscribed for additional allotments at $ 7 per share under the court order and offer of December 18, 1934. Pursuant to corporate resolution adopted January 18, 1935, the Peabody Hotel Co. filed a petition on January 22, 1935, in the proceedings for a corporate reorganization No. 11663, for directions and instructions with reference to the unutilized portion of the above mentioned 7,123 shares of its stock and on January 22, 1935, the court entered its order "That, pursuant to the Plan of Reorganization and in order to raise necessary working capital, Peabody Hotel Company be and it is hereby authorized and directed to offer the 2,571 shares of its stock unabsorbed by stockholders of Memphis Hotel Company" participating under the plan, to the voting trustees at $ 7 per share, with the understanding that they in turn notify holders of voting trust certificates of their preemptory right to subscribe to such shares until February 18, 1935, and further that after that date the Peabody Hotel Co. was authorized to accept the offer of H. T. Bunn and R. B. Snowden to purchase the remainder thereof, at $ 7 per share. In accordance with the order, the Peabody Hotel Co. issued in February 1935 a total of 16 of its shares at $ 7 per share to the voting trustees for the benefit of those exercising such preemptory rights and also in February 1935 issued to the voting trustees a total of 2,555 shares at $ 7 per share as subscribed for H. T. Bunn and R. B. Snowden. Prior to February 1935 Bunn had been a stockholder of the Memphis Hotel Co., but not a participating stockholder under the plan, and he held no shares of Peabody Hotel Co. stock other than the 1,500 shares so purchased. Snowden, as a holder of old Peabody seconds bonds, had been issued Peabody Hotel Co. stock under the plan prior to his purchase of 1,055 shares in February 1935.

In the matter of Memphis Hotel Co., "Debtor," "In Proceedings for a Corporate Reorganization No. 11663" (77-B proceedings), the court, on March 2, 1935, entered its final order and decree, in which it was found that all acts ordered done in consummation of the plan had been performed and that all exchanges of securities had been consummated, either by delivery to the parties or to the transfer agent for delivery to them. The decree approved final report of the trustee in bankruptcy and discharged the trustee of all further duty. Also the decree provided that the debtor, Memphis Hotel Co., was discharged of all debts and liabilities, and the rights of creditors, stockholders, and other interested persons were terminated, except as to the claim of I. Samelson & Co. which was finally determined subsequent to that date. The plan was consummated on March 2, 1935.

In consummation of the plan as above set out, the Peabody Hotel Co. issued a total of 23,103 shares of its voting no par common stock to the voting trustees, of which total 15,980 shares, or approximately 69 per cent, were, immediately after the transfer to it by the Memphis Hotel Co. of the properties in question, issued for the benefit of the secured and unsecured creditors of the debtor, Memphis Hotel Co., and 7,123 shares, or approximately 31 per cent of such total, were issued for the benefit of stockholders of the Memphis Hotel Co. participating under the plan and certain other persons as authorized by the court, upon payment therefor at $ 7 per share for a total of $ 49,861 cash paid in as new working capital.

The voting trust agreement was terminated on August 31, 1936, whereupon shares of stock of the Peabody Hotel Co. held in trust were exchanged for the voting trust certificates.

In December 1937 the Peabody Hotel Co. sold 1,098 shares of its stock to its stockholders at $ 26 per share and in February 1938 it sold its remaining 799 shares (making a total of 25,000 authorized shares outstanding), but neither of those sales had any connection with the plan of reorganization.

The properties of the Memphis Hotel Co. acquired by the Peabody Hotel Co. on August 31, 1934, pursuant to the plan of reorganization, had in the hands of the Memphis Hotel Co. on that date a depreciated cost and basis, as follows:

Land	$ 924,398.16
Buildings	2,532,870.67
Equipment, machinery, etc	823,307.43
1,000 shares common stock Chisca Hotel Co	110,000.00
684 shares preferred stock Chisca Hotel Co	68,400.00
Cash accounts, prepaid expense, inventories and notes receivable	128,405.39
Automobiles and trucks	1,369.15
Print shop equipment	6,000.00
Total	4,594,750.80

The opening book entries of the Peabody Hotel Co. were based on the books and records of the Memphis Hotel Co. and reflected the above listed assets on the same basis, except that unamortized bond discount was not brought forward from the Memphis Hotel Co.'s books to the Peabody Hotel Co.'s books. Also, the Peabody Hotel Co.'s books set up liabilities totaling $ 2,747,836.45 assumed pursuant to the plan.

OPINION.

The question presented involves primarily a redetermination of the petitioner's basis of the property acquired by it upon its organization in 1934. More specifically stated, the question is whether the basis in the hands of petitioner is (a) the cost to it of the property as determined by respondent, or, as contended by petitioner, (b) the same basis for such property in petitioner's hands as it would have in the hands of the Memphis Hotel Co. because acquired pursuant to a nontaxable reorganization or exchange. By stipulation the parties have concluded the issues originally raised as to the amounts of the deductions allowable for each of the years for depreciation and for amortization of bond discount and expense, if petitioner's contention as to the basis is sustained.

The petitioner contends, first, that the transfer of the Memphis Hotel Co. property to it on August 31, 1934, pursuant to the plan of reorganization, meets the requirements of a nontaxable reorganization under section 112 (b) (4) and the first clause of section 112 (g) (1) (B) of the Revenue Act of 1934, as amended by section 213 (g) of the Revenue Act of 1939, in that as a party to and in pursuance of a plan of reorganization, petitioner acquired substantially all of the properties of the Memphis Hotel Co. solely for petitioner's voting stock and its assumption of the transferor's liabilities; and/or, second, that the transfer meets the requirements of a nontaxable exchange under section 112 (b) (5) of the Revenue Act of 1934; and, third, that from either viewpoint petitioner's basis for the property so acquired is the same as it would be in the hands of the transferor, the Memphis Hotel Co., under either section 113 (a) (7) or section 113 (a) (8) of the 1934 Revenue Act, or both. The applicable sections of the revenue acts are set out in the margin. ¹

The respondent contends that petitioner did not acquire its properties either as the result of a reorganization of the Memphis Hotel Co. or as the result of any exchange, within the meaning of the applicable provisions of the revenue acts, and that therefore he has correctly used the petitioner's cost basis in determining its tax liability for the years in question.

The answer to the question presented by petitioner's first contention of whether there is here a nontaxable reorganization depends, in part, upon answers to other subsidiary questions arising out of the definition of "reorganization" made in section 112 (g) (1) (B) as amended, supra, those subsidiary questions being as follows: (a) Whether the Peabody Hotel Co. acquired "substantially all the properties" of the Memphis Hotel Co.; and, if so, (b) whether those properties were acquired "solely for all or a part of its voting stock"; and, if (a) and (b) are answered in the affirmative, (c) whether there was preserved the continuity of interest requisite to a reorganization. We shall consider the subsidiary questions in the order as stated.

Did the Peabody Hotel Co. acquire "substantially all the properties" of the Memphis Hotel Co., the subsidiary question presented in (a) above? We think the question requires an affirmative answer.

In , it was held that whether the assets acquired by the transferee constituted "substantially all the properties" of the transferor depends upon the facts and circumstances in each case rather than upon any particular percentage, and it is clear from that case and the authorities cited therein that the question must be resolved as an ultimate conclusion of fact. It is established that the receiver's sale of the Gayoso farm and the resulting elimination of certain liabilities of the Memphis Hotel Co. was prior to the promulgation of the plan of reorganization and formed no part thereof. The court, in approving the plan as being "fair and equitable" to all classes of creditors of the Memphis Hotel Co., determined, in accordance with the plan, that the holders of Gayoso firsts, outstanding in the principal amount of $ 660,000 as a liability of the Memphis Hotel Co., had full priority rights to the entire Gayoso properties, including the impounded receipts from the receivership and bankruptcy trustee operations, and further recognized that such bondholders, to the extent of their resulting deficits, took the status of general creditors of the Memphis Hotel Co. It would therefore seem apparent that, at the time of its conveyances to the petitioner and the Gayoso Hotel Co., the Memphis Hotel Co. had no equity and consequently no real substantial property interest in the assets conveyed to the Gayoso Hotel Co., and this because the property so conveyed was of lesser value than the amount of the mortgage thereon evidenced by Gayoso firsts. That it was of lesser value is clearly shown by the fact that the holders of Gayoso firsts were issued, as general creditors, 3,960 shares of stock in petitioner to cover their deficits remaining after conveyance of the properties to the Gayoso Hotel Co., in which the holders of Gayoso firsts become sole stockholders. Furthermore, by its transfer of the Gayoso Hotel properties to the Gayoso Hotel Co., the Memphis Hotel Co. was relieved of all liability on the Gayoso firsts bonds, except for the above mentioned deficits. On August 31, 1934, pursuant to the plan, petitioner acquired all the properties of the insolvent Memphis Hotel Co. to which the latter's general creditors and the holders of Peabody firsts and Peabody seconds could look for payment of their claims, and such creditors had become the equitable owners of such properties through the court proceedings initiated in March 1933. While, from the viewpoint of the total properties of the insolvent Memphis Hotel Co. as they existed at the time of the August 31, 1934, transfers, it may be said that 13 per cent thereof was transferred to the Gayoso Hotel Co. and 87 per cent was transferred to the petitioner, we think that such percentages are not determinative of this question. In its decree of August 1, 1934, the court, in approving the plan which recognized the full priority rights of the holders of Gayoso firsts, as above stated, thereby carved out the Gayoso Hotel properties for separate transfer in partial satisfaction of the Memphis Hotel Co.'s liability of $ 660,000 on Gayoso firsts bonds. The fact that the transfers to the Gayoso Hotel Co. and to petitioner occurred on the same date and pursuant to the same plan is immaterial. Under the factual circumstances here present we conclude, and have so found as a fact, that by the transfer of August 31, 1934, the petitioner acquired "substantially all the properties" of the Memphis Hotel Co. on that date. See also ; ; ; dismissed, ; and .

Were the properties in question acquired by petitioner "solely for all or a part of its voting stock," the subsidiary question presented in (b) above? In the consideration of this question, the liabilities to which the property acquired was subject and the liabilities assumed by petitioner as set out in our findings are to be "disregarded" under section 112 (g) (1) (B) as amended, supra. Included in these assumed liabilities are the outstanding Peabody seconds, in lieu of which petitioner issued new bonds in the same principal amount. , and .Also included in those assumed liabilities are the liabilities to which the property acquired was subject, such as the accrued real estate taxes; the various liabilities of the Memphis Hotel Co. and its bankruptcy trustee and the expenses and costs of the court proceedings not already paid by the trustee on August 31, 1934; and the I. Samelson & Co. preferential right of reclamation claim for certain assets. After thus disregarding the assumed liabilities, the facts clearly establish that no consideration passed from petitioner for the properties acquired other than the issuance of its voting common stock to various classes of creditors of the insolvent Memphis Hotel Co. Briefly stated, petitioner acquired properties having a total book value of $ 4,594,750.80, subject to assumed liabilities totaling $ 2,747,836.45, and immediately after the transfer to it of such properties it issued a total of 15,980 shares of its voting common stock to the transferor's creditors in consideration therefor. Petitioner also issued 7,123 shares of its voting common stock at $ 7 per share for a total $ 49,861 new working capital. We conclude that petitioner acquired the properties in question "solely" for "a part" of its "voting stock" within the meaning of section 112 (b) (4) and (g) (1) (B), supra. ;; and .

Was the continuity of interest requisite to a reorganization preserved, the subsidiary question presented in (c) above? This question must also be answered in the affirmative, for, pursuant to the plan and court orders, the Memphis Hotel Co.'s stockholders were eliminated as the equitable owners of the properties of that insolvent company and its creditors, to whom the stock in the Peabody Hotel Co. was issued, became such equitable owners instead, thus satisfying the required continuity of interest. ; .

Having concluded that petitioner acquired the properties in question pursuant to a "reorganization" as defined in section 112 (g) (1) (B) as amended, supra, and since it is clearly established that such acquisition was "in pursuance of the plan of reorganization" as to which, each, the petitioner and the Memphis Hotel Co. was a "party," we further hold that the transaction was a nontaxable reorganization under section 112 (b) (4), supra.

The next question presented is whether the transfer meets the requirements of section 113 (a) (7), supra, namely, that "immediately after the transfer an interest or control in such property of 50 per centum or more remained in the same persons or any of them." The creditors of the insolvent Memphis Hotel Co. became the equitable owners of that company's assets from the time they invoked legal processes to enforce their full priority rights over the stockholders of that company. Pursuant to the plan of reorganization the bankruptcy trustee, the trustee under the indentures securing the bonds, and the debtor, the Memphis Hotel Co., joined in a transfer of substantially all of the latter's properties to petitioner, and immediately thereafter those former creditors were entitled to receive and were issued, under the plan, 69 per cent of petitioner's voting common stock; that is, 15,980 shares out of the total of 23,103 shares which were to be issued pursuant to the plan, the remaining 31 per cent, or 7,123, being issued for cash at various times prior to the consummation of the plan on March 2, 1935, as evidenced by the court's final decree entered on that date. Accordingly, immediately after the transfer, those creditors had an "interest or control in such property of 50 per centum or more," thus satisfying the required continuity of interest or control. ;; and The fact that petitioner's voting stock was issued to the voting trustees instead of directly to the creditors is immaterial, for the voting trustees held legal title to the stock with the consent and for the holders of the voting trust certificates, who were the equitable owners, respectively, of specific numbers of shares of the stock of petitioner and entitled to receive the dividends thereon. .

Accordingly, we hold that petitioner's basis for the property in question is the same as it would be in the hands of its transferor, Memphis Hotel Co., under section 113 (a) (7) of the Revenue Act of 1934. Since the parties have stipulated the amounts of the deductions to which petitioner is entitled for depreciation and for bond discount and expense, they are also necessarily in agreement as to the correct "basis" which the properties would have had in the hands of the Memphis Hotel Co., petitioner's transferor.

In view of our conclusion as to the application of section 113 (a) (7), supra, it is unnecessary to consider or decide whether or not the transaction involved came within the provisions of section 112 (b) (5), supra.

The respondent erred in his determination.

Decision will be entered under Rule 50.

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Footnotes

• 1. SEC. 112 [1934 ACT] RECOGNITION OF GAIN OR LOSS.

  (a) General Rule. -- Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.

  (b) Exchanges Solely in Kind. --

  * * * *

  (4) Same -- gain of corporation. -- No gain or loss shall be recognized if a corporation a party to a reorganization exchanges property, in pursuance of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization.

  (5) Transfer to corporation controlled by transferor. -- No gain or loss shall be 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.

  * * * *

  (g) Definition of Reorganization. [1934 Act as amended by section 213 (g) Revenue Act of 1939.]

  (1) The term "reorganization" means * * * (B) the acquisition by one corporation, in exchange solely for all or part of its voting stock, of substantially all the properties of another corporation, but in determining whether the exchange is solely for voting stock the assumption by the acquiring corporation of a liability of the other, or the fact that property acquired is subject to a liability, shall be disregarded; * * *

  SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.

  (a) Basis (Unadjusted) of Property. -- The basis of property shall be the cost of such property; except that --

  * * * *

  (7) Transfers to corporation where control of property remains in same persons. -- If the property was acquired after December 31, 1917, by a corporation in connection with a reorganization, and immediately after the transfer an interest or control in such property of 50 per centum or more remained in the same persons or any of them, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made. * * *

  (8) Property acquired by issuance of stock or as paid-in surplus. -- If the property was acquired after December 31, 1920, by a corporation --

  (A) by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5) (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money, in addition to such stock or securities), or

  (B) as paid-in surplus or as a contribution to capital, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.↩