Cohu v. Commissioner , 8 T.C. 796 ( 1947 )

La Motte T. Cohu, Petitioner, et al., ¹ v. Commissioner of Internal Revenue, Respondent

Cohu v. Commissioner

Docket Nos. 5039, 5040, 5041, 5042, 5043, 5044, 5045, 5046

United States Tax Court

8 T.C. 796; 1947 U.S. Tax Ct. LEXIS 233;

April 9, 1947, Promulgated

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Decisions will be entered under Rule 50.

1. On the facts, held, that petitioners realized income in 1940 rather than 1939 on account of certain promotional stock issued to them.

2. Value of promotional stock determined.

3. Promotional stock issued to petitioner La Motte T. Cohu, held to be community property.

Sidney H. Wall, Esq., and George F. Elmendorf, Esq., for the petitioners in Docket Nos. 5039 to 5045, inclusive.

Wesley G. LaFever, Esq., for the petitioners in Docket No. 5046.

R. E. Maiden, Jr., Esq., for the respondent.

Hill, Judge.

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HILL

Respondent determined deficiencies in petitioners' income taxes for the calendar year 1940 as follows:

Petitioner	Docket No.	Deficiency
La Motte T. Cohu	5039	$ 60,490.65
Didi M. Cohu	5040	22,047.92
John K. Northrop	5041	99,479.05
Inez H. Northrop	5042	99,479.04
Gage H. Irving	5043	15,694.14
Eleanor Salisbury Irving	5044	16,381.31
Edward A. Bellande and Molly Lamont Bellande	5045	5,833.34
Moye W. Stephens and Inez B. Stephens	5046	4,455.93

The principal question, common to all the cases here involved, is whether certain stock received by petitioners primarily for their promotional work constituted realization by them of income in 1939 or 1940 and, if in the latter year, the amount thereof. With respect to Docket Nos. 5039 and 5040, there is the question of whether the stock received by La Motte T. Cohu is his separate property or constitutes community property. The returns of the petitioners for 1940 were filed on a cash and calendar year basis with the collector of internal revenue for the sixth district of California at Los Angeles. The cases were consolidated at the hearing. The facts which were stipulated are so found.

FINDINGS OF FACT.

Petitioners John K. Northrop, Inez H. Northrop, Gage H. Irving, Eleanor Salisbury Irving, Edward A. Bellande, Molly Lamont Bellande, Moye W. Stephens, and Inez B. Stephens are now and at all times material hereto were individuals residing in Los Angeles County, California.

Petitioners Inez H. Northrop, Eleanor Salisbury Irving, Molly Lamont Bellande, and Inez B. Stephens are now and at all times material hereto were the respective wives of petitioners John K. Northrop, Gage H. Irving, Edward A. Bellande and Moye W. Stephens.

Petitioners La Motte T. Cohu and Didi M. Cohu are now and at all times material hereto were husband and wife, and are now residents of Los Angeles, California.

Petitioners John K. Northrop, La Motte T. Cohu, Gage H. Irving, Edward A. Bellande, and Moye W. Stephens, together with T. T. Ellsworth, were the promoters of Northrop Aircraft, Inc., a California corporation, hereinafter referred to as the company. As used hereinafter the word petitioners, unless otherwise indicated, will refer to the above promoters, excepting T. T. Ellsworth.

The company was incorporated under California law March 7, 1939, and was authorized to issue two classes of stock, to be designated class A common and class B common. By separate contracts between the company and petitioners, dated June 17, 1939, the company agreed to issue certain class A and class B stock to petitioners. These contracts provided in substance as follows:

(a) Shares agreed to be issued. -- Under each of the contracts the company agreed to issue to the promoter concerned class A and class B common shares not in excess of specified amounts, the number of shares to be issued to each to be determined upon the basis of a specified ratio to the number of class A common shares thereafter sold to the public. The maximum numbers of class A and class B common shares issuable to the respective promoters under the contracts and the ratios between the number of class A shares sold to the public and the numbers of class A and class B shares to be issued to the respective promoters, were as follows:

	Class A shares		Class B shares
Promoter
	Maximum	Ratio to A shares	Maximum	Ratio to A shares
		sold to public		sold to public
Northrop	24,615	1 to 16.25	61,538	1 to 6.5
Cohu	12,308	1 to 32.5	18,462	1 to 21.667
Irving	7,385	1 to 54.165	17,231	1 to 23.214
Bellande	2,462	1 to 162.5	3,692	1 to 108.33
Stephens	2,462	1 to 162.5	3,692	1 to 108.33
Ellsworth	2,462	1 to 162.5	3,692	1 to 108.33

(b) Time of issuance. -- Each of the contracts provided that as of the date the company first received cash proceeds from the sale of its shares, and thereafter if and as the company should issue shares for money or other specified considerations, the company should issue to the promoter concerned class A and class B common shares in the ratios specified above to the number of class A common shares so issued to the public for cash or such other specified considerations. Each of the contracts provided that the promoter's "rights to shares hereunder shall be deemed to have accrued as of the date of sale of the shares which shall have determined his right thereto, * * * notwithstanding the date of actual issuance thereof to" the promoter.

(c) Consideration. -- Under the Northrop contract the company agreed to issue the shares to Northrop in consideration for the use of his name, his past promotional services, and his agreement to be employed by the company to take charge of engineering and designing for a period of five years at annual salary of $ 9,000. The consideration under the Cohu and Irving contracts was past promotional services and agreements to be employed by the company, in Cohu's case as general manager for five years at an annual salary of $ 9,000, and in Irving's case as assistant general manager in charge of production for five years at an annual salary of $ 6,750. In the contracts with Bellande, Stephens, and Ellsworth, the consideration was past promotional services.

(d) Options. -- Under each of the contracts with Northrop, Cohu, and Irving the company was granted an option to purchase 60 per cent of the class B shares issued thereunder upon the happening of certain events at the cash price of 25 cents per share. The Northrop and Irving contracts provided that the option should be exercisable in the event of the death of the employee or in the event of the termination of his employment contract by reason of his default. The Cohu contract provided that the option should be exercisable in the event of his death or in the event of the termination of his employment contract by the company either by reason of his default or at the company's option without default. Under each of these three contracts 60 per cent of the class B common shares were to remain subject to the option for a period of two years after a date determined to be August 1, 1939, after which period the shares were to be gradually released from the option over the succeeding three-year period.

On June 15, 1939, the California Commissioner of Corporations issued a permit to the company to sell and issue securities. Paragraph 4 of this permit authorized the company as follows:

4. To sell and issue an aggregate of 51,694 of its Class A Common shares and 108,307 of its Class B Common shares to John K. Northrop, Lamotte [sic] T. Cohu, Gage H. Irving, Moye W. Stephens, Edward A. Bellande, and T. T. Ellsworth, in the manner and form, for the considerations, and in the proportions as related to the shares sold under paragraphs 1 and 2 hereof, as set forth in the application.

The permit conditioned the issuance of promotional shares as follows:

(b) That none of the shares authorized by paragraph 4 hereof shall be sold or issued unless and until the applicant first shall have selected an escrow holder and said escrow holder shall have been first approved in writing by the Commissioner of Corporations; that, when issued, all certificates evidencing any of said shares shall be forthwith deposited with said escrow holder, to be held as an escrow pending the further written order of the said Commissioner; that the receipt of said escrow holder for said certificates shall be filed with said Commissioner; and that the owner or persons entitled to said shares shall not consummate a sale or transfer of said shares, or any interest therein, until the written consent of said Commissioner shall have been obtained so to do.

(c) That none of the shares authorized by paragraph 4 hereof shall be sold or issued unless and until John K. Northrop, Lamotte [sic] T. Cohu, Gage H. Irving, Moye W. Stephens, Edward A. Bellande, and T. T. Ellsworth shall have executed an agreement in writing with said applicant, and filed a copy thereof with the Commissioner of Corporations, whereby they shall in effect agree for themselves, their successors, administrators, and assigns, as owners of the Class A Common shares and the Class B Common shares herein authorized to be issued to them under paragraph 4 hereof, to waive their right to participate in any distribution of assets of the applicant (excepting dividends payable according to law), while said shares shall be required to be held in escrow, until all stockholders who have paid cash or its equivalent for their shares shall have received the return of the full amount of the issuance price.

(d) That none of the shares authorized by paragraph 4 hereof shall be sold or issued unless and until John K. Northrop, Lamotte T. Cohu, Gage H. Irving, Moye W. Stephens, Edward A. Bellande, and T. T. Ellsworth shall have executed a written waiver, and filed a copy thereof with the Commissioner of Corporations, for and on behalf of themselves, their successors, administrators, and assigns, wherein they waive, as owners of the Class A Common shares and the Class B Common shares herein authorized to be issued to them under paragraph 4 hereof, their right to the payment or accrual of any dividends while said shares shall be required to be held in escrow.

On or about January 4, 1940, petitioners entered into a written agreement with the company dated as of November 30, 1939, by which the petitioners waived their respective rights to participate in any distribution of assets of the company while the promotional shares were required to be held in escrow and for the same period of time waived their rights to the payment or accrual of any dividends. An executed counterpart of such agreement was filed by the company with the Commissioner of Corporations on or about January 22, 1940. On January 25, 1940, the Commissioner of Corporations approved the agreement of and acceptance by the Bank of America National Trust & Savings Association as escrow agent.

Pursuant to the provisions of the agreements dated June 17, 1939, and pursuant to the provisions of the Corporation Commissioner's permit dated June 15, 1939, the company on March 4, 1940, issued certificates for class A common shares and class B common shares of the company in the following names and in the following respective amounts:

Name	Class A	Class B
	shares	shares
John K. Northrop	15,384	38,461
La Motte T. Cohu	7,692	11,538
Gage H. Irving	4,615	10,769
Edward A. Bellande	1,538	2,307
Moye W. Stephens	1,538	2,307
A. H. Smith	1,538	2,307

All of these certificates were on the same day placed in escrow with the Bank of America National Trust & Savings Association, Los Angeles, California.

On November 28, 1939, the following transaction was consummated through White, Wyeth & Co., a Los Angeles securities firm, acting as a principal: T. T. Ellsworth assigned to A. H. Smith, a resident of Houston, Texas, his contract with the company dated June 17, 1939; A. H. Smith delivered to White, Wyeth & Co. 2,500 shares of Duval Texas Sulphur Co., of which 2,200 shares were transferred to T. T. Ellsworth in exchange for his contract, and 300 shares were retained by White, Wyeth & Co. as its profit on the transaction.

On November 28, 1939, T. T. Ellsworth sold 600 of such shares of Duval Texas Sulphur Co. at a price of 7 1/8, for which he received $ 4,251 on November 29, 1939.

Ellsworth had made written application dated November 16, 1939, to the Commissioner of Corporations requesting written consent to the sale and transfer to Smith of all Ellsworth's right, title, and interest in and to the shares of stock to which he was entitled under the employment contract of June 17, 1939. This manner of accomplishing the transfer was apparently abandoned and on November 21, 1939, the company requested the Commissioner of Corporations to amend their permit by substituting Smith for Ellsworth as one of the promoters to whom applicant might issue shares. Such amendment was granted November 28, 1939.

By application dated July 26, 1940, La Motte T. Cohu requested the Commissioner of Corporations to issue an order consenting to the assignment by way of gift to the applicant's wife, Didi M. Cohu, of 5,769 class B common shares of the company and to each of applicant's three daughters, Anne T. Cohu, Renee Cohu, and Marit Cohu, respectively, of 1,923 of the shares, all of such shares being then held in escrow pursuant to the Corporation Commissioner's permit dated June 15, 1939. The Corporation Commissioner, by order dated July 31, 1940, consented to the transfer of the shares in accordance with the application upon the condition that the new certificates evidencing such shares be deposited with Bank of America National Trust & Savings Association and held in escrow in accordance with the conditions of the Corporation Commissioner's permit dated June 15, 1939, and upon the further condition that the old certificate or certificates be immediately canceled.

By an order dated November 19, 1940, the Commissioner of Corporations ordered 11,000 of the class A shares then held in escrow to be released from escrow to the following named persons and in the following respective amounts:

	Class A shares
	released
John K. Northrop	5,240
La Motte T. Cohu	2,620
Gage H. Irving	1,580
Edward A. Bellande	520
Moye W. Stephens	520
A. H. Smith	520

The stock to which the petitioners became entitled, except for the 11,000 shares just mentioned above, was released from escrow by order of the Commissioner of Corporations on October 26, 1942.

Under the provisions of article five of the articles of incorporation of the company, as amended June 14, 1939, the class B common shares of the company were subject to the following limitations and conversion rights:

(a) Class B shares were not entitled to participate in dividends declared or paid prior to July 1, 1942 (that date and other dates hereinafter mentioned being determined under the provisions of the Articles in relation to the actual date when the Company first received cash proceeds from the sale of its Class A shares), and were entitled to participate in dividends declared and paid thereafter only in the event that specified earnings requirements per Class A share had been met.

(b) In the event of liquidation, dissolution or winding up of the Company, the holders of Class B shares were not entitled to receive any distribution unless and until the holders of all Class A shares then outstanding should have received an amount equal to the consideration received by the Company upon the original issuance thereof.

(c) The Class B shares were to become void if no adjusted net profits, as therein defined, were earned by the Company either during the five year period commencing August 1, 1939, or during the three year period commencing August 1, 1941.

(d) Class B shares were convertible, share for share, into Class A shares on August 1, 1944, if adjusted net profits, as therein defined, had then amounted to 50 cents per Class A share per annum for the five year period commencing August 1, 1939, based on a computation of such adjusted net profits either for the entire five year period or for the three year period commencing August 1, 1941. If such earnings per Class A share amounted to less than 50 cents per annum for such five year period, then the Class B shares were convertible into a proportionately smaller number of Class A shares. Class B shares were further convertible, share for share, into Class A shares at any time prior to August 1, 1944, when the adjusted net profits, as therein defined, computed either from August 1, 1939, or from August 1, 1941, amounted in total to $ 1,000,000.

None of the company's class B shares became convertible into class A shares prior to August 1, 1942, nor were any of the class B shares converted into class A shares prior to August 1, 1942. On August 1, 1942, pursuant to the provisions of article five (c) (1) of the articles of incorporation, all class B shares became convertible, share for share, into class A shares, by reason of the fact that the company's adjusted net profits, as defined in article five (a) (4), computed from August 1, 1941, amounted to more than $ 1,000,000.

The company and certain underwriters made and entered into an underwriting agreement dated June 17, 1939, pursuant to which the several underwriters named in the agreement agreed to purchase and the company agreed to sell 200,000 of its class A common shares in units of 5 shares and 1 public warrant at the price of $ 25 per unit. Such agreement further provided for the employment of the several underwriters as exclusive agents of the company for the offering and sale of an additional 200,000 of the company's class A common shares in units of 5 shares and 1 public warrant, and for the payment by the company to each underwriter of a commission of $ 1 per share on all shares of such stock sold by such underwriter as agent. The initial public offering price for the 200,000 underwritten shares and the 200,000 additional agency shares was specified in the underwriting agreement as $ 30 per unit of 5 shares and 1 public warrant. As additional consideration to the underwriters, the agreement provided for the delivery by the company to the underwriters of "underwriters' warrants" for the purchase of an aggregate of 53,333 shares of the class A common stock, exercisable during the period of 5 years at the price of $ 7 per share or 80 per cent of book value, whichever was higher.

Before the public offering of the company's class A stock was commenced, two members of the original underwriting group withdrew and Lester & Co. was requested to and did become a member of the underwriting group. At least one other securities firm, Bateman, Eichler & Co., was approached with a proposition that it become a member of the underwriting group, but that firm declined to participate in the underwriting or sale of the class A stock to the public because it considered the stock too speculative to sell to its clients.

The company first received cash proceeds from the sale of its shares on July 21, 1939, when the underwriters accepted and paid for in cash the first block of the underwritten class A common shares which were offered to the public.

Difficulty in marketing the class A stock to the public was encountered shortly after the public offering was commenced, and the shares were not well received by the public, with the result that only a very small amount of stock had been sold or subscribed for after 10 days or 2 weeks of trading. In an effort to bolster public confidence in the stock by having an initiated investor take a substantial interest therein, the underwriters persuaded Floyd B. Odlum, president of Atlas Corporation and a personal friend of John K. Northrop, to subscribe in August 1939, on behalf of Atlas Corporation, for 30,000 shares of class A stock and 6,000 public warrants (6,000 underwritten units). The units were purchased by Atlas Corporation and sold by the underwriters at the underwriters' cost of $ 25 per unit, in order to stimulate the sale of shares to the public.

After the underwriters had disposed of between 200,000 and 225,000 shares of class A common stock to the public, it became apparent that it would be very difficult, if not impossible, to distribute more than a total of 250,000 shares to the public. As a result of conferences between the underwriters and the promoters, the company's initial program, which had called for the expenditure of approximately $ 2,000,000, was reduced in scope, it being determined that $ 1,250,000 would enable the company to start operations on a smaller scale. Accordingly, the underwriting agreement was amended as of August 15, 1939, to reduce from 200,000 to 50,000 the number of shares to be sold the public on an agency basis. The total number of class A common shares to be sold to the public was thus reduced from 400,000 to 250,000.

A total of 250,000 of the company's class A common shares (together with warrants for the purchase of 103,333 class A common shares) were issued by the company and were accepted and paid for in cash by the underwriters during the period beginning July 21, 1939, and ending November 28, 1939.

On or about February 15, 1940, the company completed its factory at Hawthorne, California. On March 1, 1940, the company had 142 employees, which number rose to 192 by the end of the month. On March 4, 1940, the company had unfilled orders in the amount of $ 760,249.16, consisting solely of one contract dated December 1939 with Consolidated Aircraft Corporation for the manufacture of seats, cowls, and empennages for the United States Army and Navy airplanes. On March 12, 1940, the company got an order from the Norwegian Government for 24 Navy planes, the total contract price being $ 1,558,582.62. Prior to October 22, 1940, the company had entered into contracts totaling $ 24,000,000.

On March 4, 1940, the company faced substantial competition, including that offered by Douglas Aircraft Co., North American Aviation Co., Lockheed Aircraft Corporation, Consolidated Aircraft Corporation, Boeing Aircraft Co., and Vultee Aircraft Corporation, all of which were established aircraft manufacturing companies having operating plant facilities on the west coast and having proven products ready for sale.

As of February 29, 1940, the book value of the company's then outstanding 282,305 class A shares and 67,689 class B shares was $ 1,309,436.38. As of July 31, 1940, the book value of the company's then outstanding 282,305 class A shares and 67,689 class B shares was $ 1,199,174.93. As of July 31, 1941, the book value of the company's then outstanding 282,305 class A shares and the 74,637 class B shares was $ 156,331.54. ² The company had no earnings prior to March 4, 1940, nor had it paid any dividends on its stock. The company suffered a loss in the fiscal year ended July 31, 1940, which was capitalized. In the fiscal year ended July 31, 1941, the company suffered a net loss in the amount of $ 848,778.33. The company first showed earnings in the fiscal year ended July 31, 1942, and it first declared and paid dividends on its stock in November 1943.

The class A common shares of the company that were sold to the public, and upon which there were no restrictions or limitations as to sale, dividends, or right to participate in distributions of assets (hereinafter called unrestricted class A common shares), were never, during 1939 or 1940, traded or listed on any securities exchange, but were traded on an over-the-counter basis through securities dealers.

The unrestricted class A common shares were traded in for the most part in relatively small blocks of 100 or less, at prices ranging from a low of 5 to a high of 6 7/8 during the period beginning November 9, 1939, and ending March 8, 1940. On March 1, 1940, 100 such shares were traded at 5 7/8, 50 at 6 1/8, and 100 at 6 1/4. On March 5, 1940, 100 were traded at 5 7/8, and 100 at 6 3/8.

During November 1940 the unrestricted class A common shares were traded on an over-the-counter basis at prices ranging from 6 1/8 to 7 1/4.

During 1940 the highest price at which any such unrestricted class A common shares were purchased or sold by Lester & Co. was $ 8 in April 1940, and the lowest price at which any such shares were purchased or sold by Lester & Co. was $ 5 in May 1940.

During the period commencing November 9, 1939, and continuing through the year 1940, there was trading by securities dealers in warrants for the purchase of unrestricted class A common shares. Each of the warrants entitled the holder thereof to purchase one class A common share at any time on or before December 1, 1944, at the higher of the following prices: (a) $ 7 per share, or (b) an amount equal to 80 per cent of the book value of one share of such stock at the end of the quarterly period next preceding the date of exercise.

During the period from November 9, 1939, to and including March 10, 1940, Lester & Co. purchased 196 such warrants and sold 150 such warrants at prices ranging from $ 2 1/8 to $ 3 1/4 per warrant, the average price per warrant being $ 2.175.

During the period from March 11, 1940, to and including December 31, 1940, Lester & Co. purchased 3,290 such warrants and sold 3,283 such warrants at prices ranging from $ 2 to $ 4 per warrant, the average price per warrant being $ 3.43.

The class A and class B promotional shares were worth $ 4 a share as of March 4, 1940.

Prior to 1939 petitioners La Motte T. and Didi Cohu had never lived outside the State of New York. In January 1939 La Motte went to Los Angeles in the hope of making an investment for his New York company, Air Investors, Inc. He came in contact with petitioner Northrop and became involved in the organization and financing of the company, the details of which appear above. La Motte went to New York early in 1939 in connection with financing the California company and returned to California. He assisted in the organization of the company, which was incorporated March 7, 1939. At that time La Motte intended to take a position with the new company and make California his home if the financial arrangements for the company were adequately made. By early June 1939 adequate financial arrangements had been made and the final underwriting agreement was executed June 17, 1939. Early in June La Motte definitely and finally decided to remain in California and make it his home. He then telephoned Didi, informed her of this decision, and told her to close the New York house and come to California. Didi arrived in Los Angeles on or about July 1, 1939. The New York house was later sold. La Motte, on or about June 20, 1939, resigned from Air Investors, Inc., resigned from his various eastern clubs, and otherwise severed his business and social connections in New York. La Motte and Didi bought a house in California and the children entered school there in September 1939.

OPINION.

The first question is whether by virtue of the promotional shares petitioners realized income in 1939 rather than 1940. Since the instant proceeding involves only 1940 a determination that the income, if any, was realized in 1939 would dispose of the cases.

Petitioners earnestly contend that they acquired a proprietary interest in the company in 1939 which rendered them taxable, if at all, in 1939 rather than in 1940. Petitioners argue that the public sales which determined the amount of their interests were made in 1939 and that by the terms of their contracts with the company their rights to shares accrued as of the date of such public sales, notwithstanding the date of actual issuance to them. Petitioners further argue, in effect, that at the end of 1939 merely the formality of the Corporation Commissioner's approval of the escrow agent and the execution of the waivers by petitioners required accomplishment before the issuance of shares to them.

We have carefully considered this argument and have concluded that petitioners did not acquire a proprietary interest in the company in 1939. The permit authorizing the company's stock issue provided that no promotional shares "shall be sold or issued unless and until the applicant [the company] shall have selected an escrow holder and said escrow holder shall have been first approved in writing by the Commissioner of Corporations * * *." The permit further provided that no promotional shares "shall be sold or issued unless and until * * *" the petitioners "shall have executed an agreement in writing with said applicant and filed a copy thereof with the Commissioner of Corporations" waiving their rights to dividends and distributions of assets. In 1939 the Commissioner of Corporations had not approved in writing the appointment of the escrow agent nor had petitioners executed their waivers. These requirements were clearly conditions precedent to the company's authority to issue shares. The company's authority to issue shares or create proprietary interests derives from the state and is not an inherent corporate power which can be exercised by contract independently of sovereign control. Therefore the company could only bestow proprietary interests on petitioners when and as authorized by the Commissioner of Corporations. Live Oak Cemetery Assn. v. Adamson, 288 Pac. 29. See also Fletcher Cyclopedia Corporations, sec. 5158. A recognition of the distinction between the issuance of certificates and the issuance of shares does not affect our conclusion. Nor does the fact that original subscribers to stock are sometimes regarded as stockholders, even absent an issuance of shares, have application here. We are satisfied that petitioners did not acquire any stock or other proprietary interest in the company in 1939.

Petitioners alternatively argue that they constructively received a stock or proprietary interest in 1939. From what we have already said, it is apparent that the theory of constructive receipt can have no application in the instant situation.

Although not explicitly argued, it seems to us that petitioners' position perhaps unconsciously involves a reliance upon the equivalent of cash theory. We have therefore considered the possible application of this theory to the instant situation and have rejected it. It is undoubtedly true that petitioners had a contract right of value. They had fully rendered their considerations, i. e., past promotional services, entering employment contracts, and so on. The company was obliged to issue certain shares to petitioners, subject, of course, to the limitations and requirements imposed by the Commissioner of Corporations. The company was at least impliedly required under its contracts with petitioners to comply with these limitations and requirements. That these obligations or duties of the company or the correlative contract rights of the petitioners had value is witnessed by the Ellsworth-Smith transfer described in the facts. Nevertheless, we do not think that petitioners accepted these contract rights as payment. The written contracts were merely evidence of the company's undertaking and, while undoubtedly valuable and transferable with the Corporation Commissioner's permission, they were not given or accepted as payment. Unless the company's obligation as evidenced by the written contracts with petitioners was accepted by them as payment, we do not think such evidenced obligations can be considered the equivalent of cash, even though valuable in the hands of a cash-basis taxpayer. San Jacinto Life Insurance Co., 34 B. T. A. 186; Frank Kuhn, 34 B. T. A. 274; Great Southern Life Insurance Co., 33 B. T. A. 512; affd., 89 Fed. (2d) 54; certiorari denied, 302 U.S. 698">302 U.S. 698; Schlemmer v. United States, 94 Fed. (2d) 77. It is pertinent in this connection to note that section 22 (a), Internal Revenue Code, defines as gross income, inter alia, "compensation for personal services * * * of whatever kind and in whatever form paid * * *." (Italics supplied.) While contract rights under certain circumstances can be considered the equivalent of cash, we do not think the instant situation is properly susceptible to such treatment. Nor, as indicated above, do we think such contract right should be confused with a proprietary interest in the company. We therefore conclude that petitioners did not realize income in 1939 by virtue of their situation with respect to the promotional shares in question.

Having determined that any income realized on account of the promotional shares was not realized in 1939, it becomes necessary to determine the value of the promotional shares as of March 4, 1940. The petitioners concede on brief that, if 1939 is not the income year, then March 4, 1940, becomes the crucial date, being the date when the promotional shares were issued to petitioners and the certificates therefor placed in escrow.

Respondent has determined that each share of promotional stock, classes A and B alike, was worth $ 6.25. This value was apparently based largely on the price for which the unrestricted class A shares sold for in 1940. Petitioners, on the other hand, contend that the promotional stock had no value as of March 4, 1940. We have found as a fact that each share of promotional stock, classes A and B alike, was worth $ 4 as of March 4, 1940.

We have treated class A and class B promotional shares as equivalents in making our evaluation. We have done this for convenience and simplicity, because the parties approach the problem in this manner and because as a practical matter the limitations imposed on the promotional stock virtually eliminated any distinction between the two classes of stock. The company's option to repurchase the promotional class B stock for 25 cents a share seems to us to have little significance for evaluation purposes, because the petitioners were the directors of the company and, further, had they exercised such an option for the company the result would have been to increase the value of the class A shares. Nor does the junior position of the class B shares have significance with respect to the promotional shares, since petitioners had to waive all their rights to any dividends and distributions of assets. Nor does the provision calling for the cancellation of class B shares at the end of the 5-year period, if they failed to become convertible, have significance with respect to the promotional shares, because if they failed to become convertible it would mean that there had been no adjusted net profits and therefore the promotional class A shares would have remained in escrow, subject to the waivers. In other words, it seems to us that with respect to the promotional shares the distinction between class A and class B was essentially eliminated by the restrictions imposed and, in practical operation, if the class A shares had any value the class B shares directly or indirectly acquired an equivalent value. For these reasons we feel warranted in treating them for evaluation purposes as equivalents.

We do not think respondent's evaluation can be sustained. The unrestricted class A stock sold during 1940 at a high of $ 8 and a low of $ 5, or at a mean average of $ 6.50. Respondent's determination of $ 6.25 for the promotional shares, we think, too closely approximates the value of the unrestricted shares and fails to give sufficient recognition to the restrictions imposed on the promotional shares in question. We think that the Ellsworth-Smith transfer furnishes the best available indication of the approximate value of the promotional shares, and this transfer indicates an approximate value of $ 4.50 a share. It is true, as petitioners suggest, that this transfer was a somewhat isolated transaction, but, nonetheless, we think it offers a reliable approximation of value. We have found a value slightly less than the value indicated by the Ellsworth-Smith transaction. In so doing we have given consideration and effect to such factors as the managerial relationship of petitioners to the company, the large block represented by the shares in question, and the unproven position of the company as compared with its more seasoned competitors. After a very careful consideration of these factors, in addition to all the other pertinent evidence bearing on value, we have concluded that $ 4 a share represents the fair value of the promotional stock as of March 4, 1940, the crucial date.

The remaining question is whether the promotional shares received by petitioner La Motte T. Cohu constituted his separate property or was community property. The answer depends on whether La Motte was domiciled in California when he acquired the shares. We have found as a fact that La Motte decided to make California his home early in June 1939, and this fact, coupled with his presence in California and the other attendant circumstances of the situation, satisfies us that he became domiciled in California at that time. We think that, for the purpose of determining the community or separate character of the shares, June 17, 1939, is the earliest possible determinative date, being the date La Motte entered the written contract with the company by which the company undertook to issue the promotional shares to him. Since La Motte was domiciled in California prior to this date, it follows that the shares became the community property of La Motte and Didi, and we so hold.

Decisions will be entered under Rule 50.

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Footnotes

• 1. Proceedings of the following petitioners are consolidated herewith: Didi M. Cohu; John K. Northrop; Inez H. Northrop; Gage H. Irving; Eleanor Salisbury Irving; Edward A. Bellande and Molly Lamont Bellande; and Moye W. Stephens and Inez B. Stephens.↩

• 2. The sharp decrease in book value as of July 31, 1941, as compared with the prior year, is principally due to a very substantial increase in the latter year of current liabilities. This increase in current liabilities consisted principally of advances received on contracts in excess of expenditures thereon.↩