T. T. Word Supply Co. v. Commissioner , 41 B.T.A. 965 ( 1940 )

T. T. WORD SUPPLY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

T. T. WORD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

ANNA WORD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

T. T. Word Supply Co. v. Commissioner

Docket Nos. 90997, 93542, 93543, 93544.

United States Board of Tax Appeals

41 B.T.A. 965; 1940 BTA LEXIS 1118;

April 26, 1940, Promulgated

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1. AFFILIATION. - Upon the evidence it is held that the T. T. Word Supply Co. was not the owner of the stock of the Lucey Manufacturing Corporation of Texas, and, therefore, was not entitled to make a consolidated return with that corporation and the Word Specialty Manufacturing Corporation for the year 1931.

2. LIQUIDATING DIVIDENDS. - Upon the evidence it is held that the petitioner, T. T. Word, was the owner of the stock and obligations of the liquidating corporation, and the distribution of its assets to him in exchange for the stock and cancellation of the obligations was a distribution in complete liquidation, within section 115(c), Revenue Act of 1934, upon which he realized a taxable gain.

3. BAD DEBTS. - Evidence held insufficient to establish that debts were ascertained to be worthless in the taxable year.

J. L. Lockett, Esq., and Homer E. Mabry, Esq., for the petitioners.

J. L. Backstrom, Esq., for the respondent.

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ARNOLD

The Commissioner determined deficiencies in income and excess profits taxes as follows:

			Deficiency
Petitioner	Docket No.	Year	Income tax	Excess profits tax
T. T. Word Supply Co	90997	1931	$4,304.42
T. T. Word	93542	1934	37,084.49
Anna Word	93543	1934	37,084.49
T. T. Word Supply Co	93544	1934	24,478.35	$7,521.59

The proceedings were consolidated for hearing. The issues for determination in Docket No. 90997 are (1) whether the T. T. Word Supply Co. is entitled to have its tax liability for the year 1931 computed on the basis of a consolidated return with the Lucey Manufacturing Corporation of Texas and the Word Specialty Manufacturing Corporation; and (2) whether it is entitled to a deduction in that year of $10,424.55 for bad debts. The issues for determination in the three other proceedings are whether T. T. Word and Anna Word or the T. T. Word Supply Co. realized taxable gain in the year 1934 upon the surrender of the stock and certain claims in exchange for the assets of the Lucey Manufacturing Corporation of Texas, and, if so, the amount of such gain.

FINDINGS OF FACT.

The petitioner, T. T. Word Supply Co. (hereinafter referred to as the Supply Co.) is a Texas corporation engaged in the oil and gas well supply business. It was organized in December 1925, with a capital stock of $10,000, which was paid in cash. T. T. Word has owned all of the stock and has been president of that corporation at all times since its organization. The petitioners, T. T. Word and Anna Word, are husband and wife, and residents of Houston, Texas. The returns of all of the petitioners for the taxable years were filed with the collector of internal revenue for the first district of Texas. Those of T. T. Word and Anna Word were made on the community property basis.

T. T. Word was the president and a director of the Lucey Manufacturing Corporation of Texas (hereinafter referred to as the Texas corporation) which was engaged in 1926 in the manufacture and sale of oil and gas well supplies. The Lucey Manufacturing Corporation of Tennessee (hereinafter referred to as the Tennessee corporation) owned all of the stock of the Texas corporation, and the Lucey Manufacturing Corporation of New York (hereinafter referred to as the New York corporation) owned all of the stock of the Tennessee corporation. The New York corporation in 1926 was in the hands of receivers in New York and an ancillary receiver in Texas.

The New York corporation in 1926 owned mortgage notes of the Texas corporation and all of the capital stock of the North Texas Supply Co., and it owned unsecured claims against both corporations. T. T. Word had for some time carried on negotiations with the receivers for the acquisition of those assets from the New York corporation and for the acquisition of the stock of the Texas corporation from the Tennessee corporation, which finally resulted in a contract of sale of the assets and a transfer of the stock of the Texas corporation in March 1926.

The contract of sale, dated March 10, 1926, was signed by the receivers and the New York corporation, and by T. T. Word, the Supply Co., and the Texas corporation. The contract recited that the mortgage notes of the Texas corporation, on which there was an unpaid balance of principal of $141,086.14, had been delivered to the Supply Co., and that 298,500 shares of the stock of the North Texas Supply Co. had been delivered to T. T. Word; and they were delivered as stated. It further provided that the receivers "hereby sell, assign, transfer and set over" to the Supply Co. all their title and interest in unsecured claims of the New York corporation against the Texas corporation, amounting to $759,274.02, and to the Texas corporation all their title and interest in claims of the New York corporation against the North Texas Supply Co., amounting to about $75,000. The receivers and the New York corporation agreed, upon the request of T. T. Word, the Supply Co., or the Texas corporation, to execute such further instruments of transfer and assurance as may be desired for the purpose of vesting in them the interest of the receivers and the New York corporation in the "property hereby transferred to them respectively." The contract provided for payment of a consideration of $190,000, of which $160,000 was to be paid in cash and $30,000 was to be paid by delivery of three promissory notes of the Supply Co., endorsed by T. T. Word, for $10,000 each, payable to the ancillary receiver one, two, and three years after date. The Supply Co., on March 17, 1926, issued its checks to the receivers in the amount of $160,000, and executed and delivered to the ancillary receiver three promissory notes for $10,000 each, endorsed by T. T. Word, payable one, two, and three years after date. At that time the total assets of the Supply Co. did not exceed $19,000. $130,000 of the cash paid to the receivers was borrowed from the Union National Bank of Houston, and the remaining $30,000 was obtained from the Texas corporation, which then had about $39,000 of cash on hand.

In January 1926 the Texas corporation decided to discontinue manufacturing operations and consigned the manufactured products, supplies, and materials then on hand to the Supply Co. for sale by the latter on a commission basis. The Supply Co. had also made an arrangement with the Tennessee corporation to sell its products, and the latter proposed to continue the manufacturing operations theretofore carried on by the Texas corporation. A few days before the contract of March 10, 1926, was signed, the stock of the Texas corporation owned by the Tennessee corporation was issued in the name of and delivered to T. T. Word, and the Texas corporation turned over to the Tennessee corporation certain patterns, Jigs, dies, and raw materials of the value of $38,000.

The directors of the Texas corporation adopted a resolution on March 13, 1926, wherein they acknowledged indebtedness to the Supply Co. for the claims "recently purchased by it from the receivers", and authorized the execution of a promissory note therefor secured by a deed of trust. Pursuant thereto, the Texas corporation executed and delivered its demand promissory note, dated March 15, 1926, for $759,274.02, payable to the Supply Co., together with a deed of trust transferring various notes receivable and open accounts receivable of the aggregate face value of $220,391.40, as security for payment of the note. The note was renewed on March 15, 1930, for the same amount.

The mortgage notes of $141,086.14 were secured by a deed of trust and mortgage exeucted to C. S. E. Holland, trustee, in 1924. The Texas corporation on February 15, 1931, executed a renewal and extension of this instrument, and on April 4, 1931, it executed a chattel mortgage to the Supply Co., covering personal property described in the original deed of trust, as further security for the payment of the notes. Both instruments contain provisions acknowledging ownership of the notes by the Supply Co.

T. T. Word did not use any of his personal funds in connection with the acquisition of the property from the receivers and the Tennessee corporation. The Supply Co. continued to hold the mortgage notes and the claims against the Texas corporation, and T. T. Word continued to hold the stock of the Texas corporation in his name until they were canceled and surrendered.

The loan of $130,000 by the Union National Bank was made on the promissory note of the Supply Co., dated March 15, 1926, payable 90 days after date, and endorsed by T. T. Word. All of the assets of the Texas corporation were pledged to the bank as security for the loan. The loan was negotiated by T. T. Word, who submitted to the bank a balance sheet of the Texas corporation as of March 13, 1926, showing the note payable to the Supply Co. in the amount of $759,274.02 as a liability. The balance sheet contained a statement to the effect that the Supply Co. had acquired the Texas corporation and that the note represented the amount formerly owing to the receivers, "and in purchasing all of the capital stock, business and assets of the Lucey Co., the T. T. Word Supply Company also purchased the said note", and that "As the assets so acquired are liquidated, the proceeds will be applied in liquidation of the $130,000.00 * * * and thereafter the note for $759,274.02 will be cancelled out by the T. T. Word Supply Company, absorbing the then remaining assets and liabilities."

The Supply Co. and the Texas corporation made payments from time to time on the note to the Union National Bank and the notes of $30,000 to the receivers. The Supply Co. was engaged in selling the assets of the Texas corporation for a commission of 20 percent, and as sales were made the proceeds were credited, less the commission, to the Texas corporation, and all payments on the notes made through the Supply Co. were charged against the amount due the Texas corporation.

The Supply Co. set up on its ledger an account entitled "Investment Account, Lucey Mfg. Corp. of Texas", which it debited on March 31, 1926, in the amounts of $160,000 and $30,000, representing the $130,000 borrowed from the bank, the $30,000 acquired from the Texas corporation, and the $30,000 of notes due the receivers. The Investment Account was credited at various times up to August 31, 1932, with amounts aggregating $190,000. The total amounts credited in each year were as follows:

1926	$92,000
1927	34,000
1928	19,000
1929	14,000
1930	12,000
1931	$11,000
1932	8,000
	$190,000

During that period the Supply Co. paid to the Union National Bank by its own checks amounts totaling $60,055.88.

The Texas corporation credited the indebtedness of $759,274.02 on its books to an account entitled "T. T. Word Personal, Notes Payable." Two items aggregating $12,219.84 were debited to that account in 1931 and 1932. It set up a "Liquidation Account", to which it charged scrap and merchandise from one of its plants which was being disposed of. The debit balances therein were $64,097.49 at the end of 1926 and $69,026.88 at the end of 1929. The amounts paid by the Texas corporation on the notes held by the Union National Bank and the receivers were charged to an account designated "T. T. Word Loan Account."

The bookkeeper employed by T. T. Word opened a set of personal books in which he made entries pertaining to the transaction of March 1926. The notes of the Texas corporation were charged at a cost of $190,000. The Texas corporation was credited with $30,000 paid to the receivers in March 1926, $30,000 paid on the three notes to the receivers of $10,000 each, and $122,000 paid from March 1926 to December 31, 1931, to the Union National Bank on the $130,000 note; and the Supply Co. was credited with the $130,000 paid to the receivers and debited with $122,000 paid by the Texas corporation on the note to the Union National Bank. The books also show that interest payments of $14,807.25 were paid by the Texas corporation to the Union National Bank on the loan and credited to it and that that amount was charged as part of the cost of the notes. The $190,000 and $14,807.25 were carried as liabilities of T. T. Word.

The Supply Co. filed consolidated income tex returns for itself and the Texas corporation for the years 1926 to 1934, inclusive. The Word Specialty Manufacturing Corporation (hereinafter referred to as the Specialty Co.) was also included in the returns for the years 1928 to 1934. The returns were signed by T. T. Word, as president of the parent company. In the returns for 1926, 1927, and 1928 he stated in the affiliations schedules that he individually owned over 99 percent of the stock of the two subsidiaries, and in the returns for 1929 to 1934 he stated that over 99 percent of the stock of the two subsidiaries was owned by the Supply Co. or that the Supply Co. was the parent corporation.

In balance sheets filed as part of the 1926, 1927, and 1928 consolidated returns, there is included in the assets listed therein the item "T. T. Word Personal, Liquidation Account $64,097.49; Investment Account $190,000."

T. T. Word and his wife claimed deductions for interest paid in their income tax returns for the years 1926 to 1932, inclusive, as follows:

1926	$4,640.71
1927	3,319.21
1928	2,370.83
1929	2,749.30
1930	$2,021.64
1931	1,275.72
1932	368.26

The said amounts were interest paid to the Union National Bank in each year on the note of the Supply Co. for $130,000.00.

The consolidated return filed by the Supply Co. for 1931 reported a consolidated net loss of $9,482.00. There were included therein net losses of the Specialty Co. and the Texas corporation amounting to $34,927.61. The respondent increased the net income of the Supply Co. by the amount of $34,927.61. His action was based on the ground, as stated in the notice of deficiency, that the Supply Co. did not own the stock of those corporations and was not entitled to make a consolidated return.

The mortgage notes and the promissory note of the Texas corporation were unpaid on May 8, 1934. On that date its stockholders authorized the transfer to the Supply Co. of all of its real and personal property, subject to subsisting claims and liens, in exchange for the discharge of its liability on the note for $747,054.18 and the surrender of all of its stock "owned or held by the Supply Co." Pursuant to such authorization, the Texas corporation executed and delivered to the Supply Co. a deed of conveyance and a bill of sale of all of its real and personal property on June 5, 1934, and a few days later the Supply Co. executed a release of all liens under the deed of trust of 1924 and the extensions thereof. The notes of March 15, 1926, and March 15, 1930, for $759,274.02 were marked "Paid T. T. Word Supply Co., May 8, 1934", and the Texas corporation was thereafter dissolved. On May 8, 1934, the account "T. T. Word Personal, Notes Payable", and the "Liquidation Account" on the books of the Texas corporation showed debit balances of $747,054.18 and $69,026.88, respectively. Those accounts were closed by credits of those amounts under date of March 31, 1934.

The Supply Co. set up the assets and liabilities of the Texas corporation on its journal under date of March 31, 1934, substantially as follows:

Cash and prepaid items		$2,852.39
Real estate, less depreciation and mortgage		32,666.37
Finished goods		28,117.86
Accounts and notes receivable	$75,889.82
Less reserve for bad accounts and credits	67,188.14
		8,701.68
Furniture and fixtures, less depreciation		9,283.39
		81,621.69
Accounts payable assumed	$15,589.07
Reserve for taxes	738.81
		16,327.88
		65,293.81

There were further entries debiting the amounts of $65,293.81 and $109,420.99 to the Texas corporation and crediting them to surplus. The amount of $109,420.99 was the balance owing by the Supply Co. out of the proceeds of sales of the Texas corporation's supplies made over the period from 1926 to 1934. The journal entry contains the following explanation of both items:

Merger of Lucey Mfg. Corpn. of Texas with T. T. Word Supply Company as of March 31, 1934. Taking into accounts assets and liabilities of Lucey Mfg. Corpn. of Texas acquired through surrender of notes and stock of that company owned by this company but held in the name of T. T. Word. * * * Being the amount of this company's liability to Lucey Mfg. Corp. or Texas, which by reason of notes and stock surrendered are now being satisfied. The stock and notes which are being surrendered were not taken up on the books of this company at the time of acquisition because of doubtful value and are now regarded as a contribution to capital by Mr. T. T. Word.

The respondent held that the transaction of May 8, 1934, constituted a complete liquidation, and, since the Board had determined, in Word Specialty Manufacturing Corporation,34 B.T.A. 974, that T. T. Word was the owner of the stock of the Texas corporation, the resulting gain was taxable to the community estate of T. T. Word and Anna Word. He determined the net value of the assets acquired to be $393,518.63, and deducted from that amount the purchase price of the stock, of $38,000, and the purchase price of the notes, $190,000, less recoveries of $12,219.84, or $177,780.16, which resulted in a gain of $177,738.47. The net value of assets was computed by him as follows:

Cash and prepaid items	$2,852.39
Real estate	32,666.37
Finished goods	250.00
Receivables, less reserve for bad debts	8,701.68
Furniture and fixtures, less depreciation	9,283.39
Supply Co. accounts receivable	109,420.99
Supply Co. current operating accounts	3,035.63
T. T. Word interest account	14,897.25
T. T. Word purchase obligations for notes	190,000.00
T. T. Word purchase obligations for stock	38,000.00
	409,107.70
Less liabilities assumed	15,589.07
	393,518.63

The item of $8,701.68 was the aggregate of accounts and notes receivable after allowance of a reserve for bad debts. The accounts were principally accounts which had been carried on the Texas corporation's books since 1926. The reserve for bad debts in the amount of $67,188.14 had been carried on the books of the Texas corporation. When the accounts were transferred to the Supply Co.'s books, T. T. Word determined that $8,701.68 would probably be collected on said accounts. However, not more than $1,300 was eventually collected. The depreciated value of the furniture and fixtures was $2,000 on May 8, 1934. The item of $3,035.63 was similar to the item of $109,420.99, referred to above, except that it covered operations from January 1 to March 31, 1934.

T. T. Word owned the stock of the Texas corporation and was the beneficial owner of the obligations at all times from March 1926 to May 8, 1934; the Texas corporation was in process of complete liquidation throughout that period; and T. T. Word realized a taxable gain of $170,455.08 in 1934 upon the acquisition of the assets of the Texas corporation in exchange for the cancellation of the claims against it and the surrender of the stock.

The Supply Co. charged off its books, as of December 31, 1931, the amount of $10,424.55, representing accounts of the following oil operators and drilling contractors which it regarded as worthless at that time:

Geo. S. Anderson	$5,212.52
Ball Oil Corporation	434.94
Lloyd Oil Co	1,485.00
R. G. McIntyre	580.70
J. C. McCormick	452.92
Rusco Oil Co	862.35
Schubert Drilling Co	398.28
Sedberry & Thomas	$75.00
Sour Lake Machine & Supply Co	362.78
H. T. Taylor	560.06
	10,424.55

It deducted the amount of $10,424.55 on its income tax return for 1931 as bad debts. The respondent disallowed the deduction on the ground that the accounts were active and that the collections made in 1932 indicated that they were not worthless at the close of 1931.

The Supply Co. collected all of the above amounts during the year 1932, except $335 of the Lloyd account and an unknown portion of the Schubert and Sour Lake accounts. It restored the amounts so collected to its books and included them in its income on its income tax return for the year 1932.

Anderson made a payment on his account of $882.27 in February 1932. In order to obtain payment of the balance, T. T. Word negotiated a sale of two oil wells owned by Anderson, and Anderson paid the balance from the proceeds in March 1932. A payment of $1,150 was made by the Lloyd Oil Co. in February 1932 and the account of the Rusco Oil Co. was paid in full in June 1932. Substantial payments were made on the remaining accounts at various times during the year 1932, some of them as early as January and April.

The accounts above listed were not properly ascertained to be worthless as of the close of the year 1931.

OPINION.

ARNOLD: The Supply Co. filed a consolidated return for the year 1931, in which it deducted net losses of the Specialty Co. and the Texas corporation of $34,927.61. The respondent denied the right to make a consolidated return on the ground that the three corporations were not an ffiliated group", as defined in section 141 of the Revenue Act of 1928. ¹ In determining the tax liability of T. T. Word and Anna Word for the year 1934, the respondent held that T. T. Word acquired all of the assets of the Texas corporation in exchange for the surrender of all of its stock and the cancellation of certain of its obligations, and realized a gain of $177,738.47, which was taxable to him and Anna Word on the community property basis. He found that the Supply Co. did not own the stock of the Texas corporation and the Specialty Co. in 1931, and that T. T. Word and not the Supply Co. owned the stock and obligations of the Texas corporation in 1934. In order to protect the interests of the Government, the respondent also notified the Supply Co. of his determination of a deficiency against it for the year 1934, which resulted from inclusion of the gain of $177,738.47 in its income. However, he here insists upon liability of the Supply Co. for the tax on such gain only in the event that we should hold that T. T. Word was not the owner of the stock and obligations of the Texas corporation in 1934.

A question for determination, common to these proceedings, is whether T. T. Word or the Supply Co. owned the stock of the texas corporation. The issue in the proceeding of the Supply Co. involving the year 1931 turns upon ownership of the stock in that year and the issues in the proceedings of the Supply Co. and T. T. Word and Anna Word involving the year 1934 turn upon ownership in that year. in Word Specialty Manufacturing Corporation, Docket No. 68856, and T. T. Word Supply Co., Docket No. 68857 (34 B.T.A. 974) we found as a fact that during the years 1929 and 1930 T. t. Word woned directly in excess of 95 percent of the stock of the Texas corporation, and that such stock issued to him had not been transferred by him somce its acquisition. The evidence in the present proceeding shows that no change in ownership of the stock of the Texas corporation occurred from the time of its acquisition from the Tennessee corporation in 1926 to the time of its surrender in 1934. The respondent has pleaded and here argues that the question of ownership of the stock of the Texas corporation has been adjudicated in the former proceedings and that our decision therein is res judicata. At the hearing the respondent introduced in evidence the pleadings, decision, and orders of the Board in the former proceedings, and the petitioners were permitted to introduce evidence bearing on the ownership of the stock, over an objection that it was incompetent to the extent that it should be found to be inconsistent with our former decision. The petitioners rely upon such evidence to establish that the stock was owned by the Supply Co. in 1931 and 1934 and that it was not owned by T. T. Word.

The evidence shows, and the petitioners do not deny, that legal title to the stock was taken in the name of T. T. Word upon its acquisition in 1926 from the Tennessee corporation. T. T. Word testified that he acquired the stock for and on behalf of the Supply Co., that he held it as trustee for its benefit, and that the only reason for taking title in his own name was that his counsel, who advised him throughout the negotiations, directed that this be done so as not to offend the antitrust law of Texas. His counsel is now deceased, but another witness has corroborated his statement that such advice was given. We considered testimony to the same effect in the former proceedings, but were not convinced by it for the reason that other evidence indicated that T. T. Word owned the stock in his individual capacity, and for the further reason that no authority prohibiting a Texas corporation from owning stock of another corporation had been brought to our attention. In their brief the petitioners refer to provisions of the Texas statutes, civil and penal, relating to monopolies and combinations in restraint of trade. Vernon's Ann. Civil Stats., art 7427; Vernon's Ann. Penal Stats., art. 1633. Both articles define a monopoly as a combination or consolidation of two or more corporations, when effected by the following method, among others:

Where any corporation acquires the shares or certificates of stock * * * or the physical properties or any part thereof, of any other corporation * * * for the purpose of preventing or lessening, or where the effect of such acquisition tends to affect or lessen competition, whether such acquisition is accomplished directly or through the instrumentality of trustees or otherwise.

The statute is aimed at situations where there is an intent to lessen, or an acquisition has a tendency to effect a lessening of, competition. The evidence here is not directed to proof of intent or the effect of the transaction. However, it is sufficient to show that a direct acquisition of the stock by the Supply Co. could not have been intended, and would not have tended, to lessen competition between the Supply Co. and the Texas corporation. The two corporations were engaged in the same business - the sale of oil and gas well supplies. The Supply Co. was a selling company organized in 1926, and at that time or soon thereafter, the manufacturing branch of the Texas corporation's business was taken over by the Tennessee corporation. In January 1926 the Texas corporation consigned all manufactured products, supplies, materials, and implements then owned by it to the Supply Co. for sale by the latter on a commission basis. The contract of consignment states that the Texas corporation is discontinuing its business generally. Thus, the acquisition of the stock by the Supply Co. would not fall within the statute. If a transfer of the stock to the Supply Co. would be under the ban of the antimonopoly statute of Texas, transfer in the name of T. T. Word in trust for the Supply Co. would likewise be. The statute applies whether the acquisition of the stock is accomplished directly or through the instrumentality of a trustee. The reasons assigned for taking title in T. T. Word's name are therefore unconvincing. There is no evidence that any express trust was created, nor is there any evidence that a trust resulted by reason of the payment by the Supply Co. of any part of the consideration for the stock.

There is, so far as the evidence shows, no written contract covering the purchase of the stock. The contract of March 10, 1926, does not purport to sell the stock. The evidence merely shows that in the negotiations with the receivers T. T. Word also sought to acquire the stock and that several days before the contract of March 10, 1926, was executed the stock was delivered to him, and at the same time assets of the Texas corporation of the value of $38,000 were delivered to the Tennessee corporation. We regard the holding of the stock by T. T. Word and his subsequent acts as more persuasive of his ownership than his mere assertion of trusteeship. Consolidated income tax returns for the years 1926, 1927, and 1928 were filed on behalf of the Supply Co. and the Texas corporation. They were signed by Word as president of the Supply Co. and in them he definitely set forth that he owned the stock and certified that there were no equitable owners. Such allegations of ownership, as stated in our former decision:

* * * represent * * * a conclusion reached within a short time after completion of the transactions by one chiefly concerned with the result, and adhered to without change of position for a long period of time. It would require strong evidence to overcome the facts so consistently represented by the person primarily concerned with the outcome of these proceedings.

The above returns were filed under the Revenue Act of 1926, which permitted affiliation if 95 percent of the stock of two or more corporations was owned by the same interests. Sec. 240(d). Beginning with the taxable year 1929, affiliation was limited to chains of corporations connected through stock ownership with a common parent, if at least 95 percent of the stock of each corporation, except the common parent, was owned directly by one or more of the other corporations, or if the common parent owned directly at least 95 percent of the stock of at least one of the other corporations. Revenue Act of 1928, sec. 141(d). T. T. Word promptly accommodated his interests to this change, in so far as his dealings with the Government were concerned, by filing consolidated returns for 1929 and subsequent years in which he represented that the Supply Co. was the owner of the stock of the Texas corporation. This shift of position took place four years after the transaction of purchase, and was intended to secure the benefits of affiliation under the new statute, but in his dealings with his wholly-owned corporation he did not change his status with respect to the stock. He made no sale or donation of the stock to the Supply Co. His conduct is strong evidence that he intended to and did retain ownership of the stock in himself.

In his dealings with the Government with respect to his individual tax liability, T. T. Word made further representations which are inconsistent with the position now taken by him. As hereinafter shown, all of the consideration paid for the stock and obligations was derived from the assets of the Texas corporation. The consideration included $130,000 in cash which was borrowed from the Union National Bank on a note which T. T. Word was required to endorse. Consistently, in each of the years 1926 to 1932, T. T. Word deducted substantial amounts of interest on his income tax returns, which the record shows was the interest paid to the Union National Bank on the note. This was a representation that the indebtedness was his own, and, therefore, if any of the consideration paid for the obligations was in fact consideration in part for the stock, it was paid with money borrowed by T. T. Word for the purpose.

This evidence and the uncontradicted testimony that no change in the ownership of the Texas stock took place from the time it was originally acquired from the Tennessee corporation in 1926 until the surrender of the stock in 1934, together with all the other facts and circumstances shown by this record, warrants the conclusion that the stock was owned by T. T. Word at all times between March 1926 and May 8, 1934, and we so hold. Our conclusion is in accord with that reached in the former proceedings on substantially the same evidence, and our former conclusion is quite persuasive, since the petitioners have here proven no other facts or circumstances tending to show that T. T. Word did not own the stock.

Since the conclusion thus reached is adverse to the contentions of the petitioners, it is unnecessary to pass upon the question whether, under the doctrine of res judicata, our former adjudication of ownership of the stock is conclusive upon either the Supply Co. or T. T. Word and Anna Word. It may be noted, in conclusion, that the petitioner has produced no evidence whatever respecting the ownership of the stock of the Specialty Co. during the year 1931. For this reason, even if we should hold that the Supply Co. owned all of the Texas stock in that year, we would not be justified in disturbing the respondent's action in rejecting the consolidated return on which the aggregate net loss of both subsidiaries was deducted.

The ownership of the obligations, consisting of $141,086.14 of mortgage notes and $759,274.02 of unsecured claims, had its origin in the contract with the receivers of March 10, 1926. That contract expressly recites that the mortgage notes have been delivered to the Supply Co. and in terms sells, transfers, and assigns the unsecured claims to the Supply Co. In addition other assets, apparently of doubtful value, are transferred to other parties. Thus the legal title to the notes and claims clearly was placed in the Supply Co. All of the documents thereafter executed recognize the Supply Co. as the owner of these obligations. Such evidence would be quite convincing were it not for the fact that in the field of taxation we "are concerned with substance and realities, and formal written documents are not rigidly binding." Helvering v. Lazarus & Co.,308 U.S. 252, and Higgins v. Smith,308 U.S. 473. All of the stock of the Texas corporation was acquired by T. T. Word, and he also was the owner of all of the stock of the Supply Co. The evidence of the entire dealings between T. T. Word and these corporations must be closely scrutinized, and we proceed to examine it for the purpose of determining whether T. T. Word was the beneficial owner of the obligations. The entries on the books of the two corporations and T. T. Word are no more than evidential and, in case of conflict, must give way before the true facts. Doyle v. Mitchell Brothers Co.,247 U.S. 179; Watson-Moore Co.,30 B.T.A. 1197.

In March 1926 the Supply Co. was a newly organized corporation with a paid-in capital of $10,000. It had some earnings over a period of two months. The Texas corporation had assets which were represented to the Union National Bank as having an appraised net value of almost $500,000. That value did not take into account the $900,000 which it owed the New York corporation on the mortgage notes and unsecured claims. The contract with the receivers provided for a payment of $160,000 in cash. The Supply Co. neither had the cash with which to make the purchase nor financial standing by which it could borrow the money. The $160,000 was raised by withdrawing $30,000 from the cash funds of the Texas corporation and borrowing $130,000 from the Union National Bank on Word's endorsement. It was placed in the Supply Co.'s bank account, and paid by check to the receivers. The remainder of the consideration consisted of promissory notes of the Supply Co. for $30,000, which were executed and endorsed by T. T. Word as required by the contract. The bank took a promissory note of the Supply Co. for the $130,000. It not only required the endorsement of the note by T. T. Word, but it also insisted that the note of $759,274.02 payable to the Supply Co. and secured by some $220,000 of bills receivable of the Texas corporation be pledged as security for the note for $130,000. T. T. Word testified that all of the assets of the Texas corporation were pledged to the bank. Payments made from time to time on the notes to the bank and to the receivers were made from assets of the Texas corporation, except about $60,000. The latter amount was paid by the Supply Co. While the evidence does not show any reimbursement of the Supply Co. through direct cash payments, it does show that the Supply Co. credited the Texas corporation with 80 percent of the proceeds collected on all sales made on its behalf, and charged against such credits the payments made by it on the notes. When the Texas corporation was dissolved in 1934, the Supply Co. was indebted to it on that account to the extent of $109,420.99. Thus all of the consideration paid, both for the stock and the obligations, in the amount $228,000, was as a matter of fact paid through withdrawal of funds or assets of the Texas corporation. The Supply Co. did not use any of its own funds or its own credit.

The book entries relating to the transaction are set forth in detail in our findings of fact. The petitioners oppose their consideration on the ground that they are not proof of the actual facts, and, with respect to the entries on the personal books of T. T. Word, the latter in his testimony disclaims responsibility for such books and says that he did not know of their existence until they were shown to him for the first time in 1933 by a revenue agent. We think the personal books are what they purport to be and are competent to corroborate facts otherwise established. At the time the stock and obligations were acquired in 1926, T. T. Word employed an accountant for the purpose of guiding his bookkeeper in setting up accounts reflecting the entire transaction. The accountant had a personal conference with T. T. Word, in which the details of the transaction were discussed, and thereafter he gave written bookkeeping instructions based on the facts supplied by T. T. Word. The accountant advised, among other things, that the books of the Texas corporation should not recognize the personal dealings of T. T. Word and the books of the Supply Co. should record only such matters as involved it, but that the personal books of T. T. Word should contain a complete history of all transactions and a record of his dealings in the securities of the Texas corporation. On the personal books the notes were set up as assets of T. T. Word at a cost of $190,000, and the interest paid from year to year on the loan from the bank was charged as additional cost, in the amount of $14,807.35. Both of these amounts were carried on his books as liabilities. The Texas corporation set up on its books an account entitled "T. T. Word, Personal, Notes Payable", which was credited with $759,274.02. It set up a "T. T. Word Loan Account", to which it charged amounts paid by it to the receivers and the bank from time to time on their notes. The Supply Co. set up on its books an "investment account" with the Texas corporation, in which it charged $190,000, representing cash acquired from Texas corporation and the bank. Over the period 1926 to 1932, this account was credited with payments aggregating $190,000, including about $60,000 paid by the Supply Co. directly to the bank. We think the entries on the Supply Co. books were made to reflect the passing of the money through it and not an investment on its own account. In addition to the books, the consolidated income tax returns of the Supply Co. and the Texas corporation for the years 1926, 1927, and 1928 contain balance sheets wherein, under the heading of "other assets", the items of "Investment Account $190,000" and "Liquidation Account $64,097.49" are listed with the designation "T. T. Word Personal." These records, in connection with other facts and circumstances, indicate quite clearly that the obligations received under the contract of March 10, 1926, were acquired for the account of T. T. Word.

We are of the opinion and find that at all times from March 1926 to May 8, 1934, T. T. Word was the beneficial owner of the obligations of the Texas corporation.

Having determined that T. T. Word was the owner of the stock and the beneficial owner of the claims, the question remains whether he realized a taxable gain upon the surrender of the stock and cancellation of the claims in exchange for the assets of the Texas corporation in 1934. The respondent held that the transaction resulted in a complete liquidation, and that, since T. T. Word owned the stock, the gain resulting from the exchange was taxable income of the community estate under section 115(c) of the Revenue Act of 1934. In computing the amount of the gain, he included in the Assets acquired, as obligations owing by T. T. Word, the amounts of $190,000 and $38,000, and interest payments of $14,897.25, which as the evidence shows, are amounts which were withdrawn from the Texas corporation and used to pay for the stock and claims. He allowed a basis of $38,000 for the stock, and $190,000 (less recoveries of $12,219.84) for the claims. The contention made in his brief is that, since T. T. Word owned the stock and claims, and since he had recovered the entire cost thereof through disposal of the assets of the Texas corporation, the receipt of the remaining assets in liquidation resulted in a closed transaction, and the fact that the assets were transferred direct to the Supply Co. is immaterial. The petitioners contend that, even if the stock and claims were in fact owned by T. T. Word, the transaction of 1934 was a merger or consolidation of the Supply Co. and the Texas corporation, and that, since T. T. Word owned no more after the consolidation than he did before, and, by reason of the cancellation of the claims, he in fact owned less - he realized no taxable gain.

Section 115(c) of the statute provides that "amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock", and that the "gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112." Section 115(i) provides that "the term 'amounts distributed in partial liquidation' means a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock." The liquidation of a corporation is the process of winding up its affairs by realizing upon its assets, paying its debts, and appropriating the amount of its profit and loss. It differs from normal operation for current profit in that it ordinarily results in the winding up of the corporation's affairs, and there must be a manifest intention to liquidate, a continuing purpose to terminate its affairs and dissolve the corporation, and its activities must be directed and confined thereto. A mere declaration is not enough, and the question whether a corporation is in liquidation is one of fact. W. E. Guild,19 B.T.A. 1186; Fred T. Wood,27 B.T.A. 162. In the present case, the first formal declaration to dissolve was made in the resolution of May 8, 1934. Pursuant to that resolution the Texas corporation transferred its assets in exchange for the surrender of its stock and the cancellation of its principal obligations, and shortly thereafter was dissolved. Prior to the acquisition of the stock and claims and while the negotiations were pending with the receivers, T. T. Word organized the Supply Co. as a selling corporation, with a comparatively small paid-in capital. On January 6, 1926, the Supply Co. entered into a contract with the Texas corporation, under which the Supply Co. took over all of a large quantity of manufactured products, materials, supplies, and implements which the Texas corporation had on hand, for sale on a commission basis. The facilities theretofore used by the Texas corporation in the manufacturing branch of its business were transferred to the Tennessee corporation, which thereafter was to carry on that branch of the business, and the Supply Co. arranged to secure its future supply of manufactured products from the Tennessee corporation and sell them on consignment. The contract of January 6, 1926, recites that the business of the Texas corporation has proven unprofitable and that "it is understood and agreed that Lucey Manufacturing Corporation of Texas is discontinuing its business generally", and it authorizes the use of its facilities by the Supply Co. "until sold and disposed of." In connection with the loan of $130,000 from the Union National Bank, T. T. Word pledged all the assets of the Texas corporation as security, and represented that the Supply Co. was acquiring the stock, business, and assets of the Texas corporation and the note for $759,274.02, and that as the assets so acquired were liquidated the proceeds would be applied in liquidation of the $130,000, and thereafter the note for $759,274.02 would be canceled out by the Supply Co. absorbing the then remaining assets and liabilities. This evidence shows not only that there was a complete liquidation in 1934, but that the Texas corporation was in process of complete liquidation beginning in 1926 and in the intervening years up to and including 1934, and the withdrawals during the period 1926 to 1932 must therefore be regarded as a series of distributions intended to be in complete liquidation of the corporation. James P. Gossett,22 B.T.A. 1279; affd., 59 Fed.(2d) 365; 60 Fed.(2d) 484; Rollestone Corporation,38 B.T.A. 1093; Kent Oil Co.,38 B.T.A. 528; Gaston & Co.,39 B.T.A. 640. In such cases the stockholder is entitled to have the amounts distributed applied against the aggregate basis of all his shares, and he realizes no taxable income until the distributions exceed the basis. Florence M. Quinn,35 B.T.A. 412; Alvina Ludorff et al., Executrices,40 B.T.A. 32; Norman Cooledge,40 B.T.A. 110, 115. In the present case, the acquisition of the claims and the acquisition of the stock were integral parts of a single plan, and it was contemplated that, after all the liabilities incurred in the purchase had been satisfied out of the assets of the Texas corporation, the claims would be canceled with the surrender of the stock and the corporation would be liquidated. We think, therefore, that the petitioners are entitled to have the distributions applied against the cost of both the stock and the claims, and, as the distributions were equal to the cost, no gain was realized until the remaining assets were distributed in 1934. All amounts distributed in excess of the aggregate cost of the stock and claims constituted gain from the liquidation in 1934.

In view of our conclusion that T. T. Word was the owner of the stock, and that he was the beneficial owner of the claims, the facts that the Texas corporation in the resolution authorizing the exchange referred to the stock and claims as property owned by the Supply Co., that it conveyed the assets direct to the Supply Co., and that the latter released the lien of the mortgage notes and canceled the note for $759,274.02, are insufficient to show that he did not receive the assets in liquidation. As sole stockholder and owner of the claims, he was the only person entitled to the assets upon dissolution of the corporation. The Supply Co. had no interest in the Texas corporation, either as stockholder or creditor. It merely held the legal title to the claims for the benefit of T. T. Word. In receiving the assets and in canceling the liens and claims, it acted solely as the nominee or agent of T. T. Word. The assets could only pass to the Supply Co. through T. T. Word. The fact that the Supply Co. issued no stock or other thing of value for them indicates quite clearly that it acquired them as a donation or contribution of additional capital from him. The transfer of assets in complete liquidation to the wholly owned corporation of T. T. Word without consideration is analogous to those cases in which it has been held that a transfer of corporate assets to a partnership composed of the former stockholders is a distribution in the form of a liquidating dividend. See E. C. Huffman,1 B.T.A. 52; Joseph Joseph,6 B.T.A. 595; affd., 26 Fed.(2d) 532; John F. Prindible,16 B.T.A. 187; Commonwealth Improvement Co.,20 B.T.A. 1189; affd., 287 U.S. 415.

The fact that in the complete liquidation T. T. Word, as creditor, surrendered claims of the face value of about $900,000 does not warrant the conclusion that nothing was distributed to him in liquidation. The evidence does not show that the claims were worth their face amount. They were purchased, along with some assets of the North Texas Supply Co., from outside creditors for $190,000. They were not exchanged solely for the assets, but, as the resolution of the stockholders shows, the consideration for the assets consisted of cancelation of the claims and surrender of the stock. We are of the opinion that the assets of the Texas corporation were distributed to T. T. Word in complete liquidation, and that the value of such assets, to the extent that they exceeded the basis of the stock and claims, constituted taxable income for the year 1934.

The contention of the petitioners that the transaction was a merger or consolidation and no taxable gain was realized is without merit. Whether any gain realized from the distribution is not to be recognized depends upon whether the transaction falls within any of the exceptions contained in section 112. Sec. 115(c). The provisions of section 112 are exceptions to the rule taxing gains, and may not be availed of by a taxpayer unless he establishes a transaction coming clearly within their terms. Warner Co.,26 B.T.A. 1225; Dolomite, Inc.,28 B.T.A. 1271; John C. Shaffer,28 B.T.A. 1294; Charles Hall,31 B.T.A. 125. We need not decide whether there was a merger or consolidation, or a statutory reorganization. That of itself is not sufficient for nonrecognition of any gain under section 112. The taxpayer must further bring the transaction within one of the specific provisions of that section. See Cortland Specialty Co. v. Commissioner, 60 Fed.(2d) 937. The only provisions which can have any possible application are subdivisions (b)(3) and (b)(5). The former provides that no gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization. The transaction does not fall within this language, since the stock of the Texas corporation was not exchanged solely for stock of the Supply Co. Subdivision (b)(5) provides that 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. Here, there was a transfer of property by T. T. Word to the Supply Co., but it was not transferred solely for stock of the transferee. The Supply Co. issued no stock whatever, and, as indicated above, the assets passed to the Supply Co. as a contribution of additional capital. Since the petitioners have failed to point out any provision of section 112 which would exempt from taxation the gain derived from the distribution, it follows that, under the express provisions of section 115(c) and 112(a), the gain realized is subject to tax. Coxe v. Handy, 103 Fed.(2d) 873.

The amount of gain realized, as computed by the respondent, is shown in our findings of fact. The cash, prepaid items, real estate, and finished goods, amounting to $35,668.76, are not disputed, nor is the item of liabilities assumed, amounting to $15,589.07, questioned by either party. The item of furniture and fixtures should be reduced to $2,000, since the evidence shows, and the respondent concedes, that to be the proper value. We find no reason to disturb the respondent's valuation of the receivables at $8,701.68. The receivables on the books of the Texas corporation amounted to something over $75,000 and a reserve was set up for doubtful notes and accounts amounting to about $67,000, and in 1934 the accounts and reserve were transferred at the same figures to the Supply Co.'s books. T. T. Word determined at that time that $8,701.68 of the accounts would probably be collected. The petitioners now contend that this figure should be reduced to $1,500, and rely upon the testimony of T. T. Word that they were not worth more than that amount. He further testified that only $1,300 has since been collected. We agree with the respondent that the witness' estimate made at the time of taking over the accounts is a better indication of their value at that time than one made by him several years later.

The Supply Co. accounts of $109,420.99 and $3,035.63 represent the balance in a current account due by the Supply Co. to the Texas corporation out of the proceeds of supplies sold on consignment. There is no evidence that this was not a valid claim or that the Supply Co. was unable to pay it. The only argument advanced by the petitioners is that these accounts were never transferred to T. T. Word in the so-called merger or consolidation of the two companies. From what has been said above, they clearly were assets of the Texas corporation, which passed to T. T. Word along with the other assets and to the Supply Co. by way of a capital contribution.

We have found as a fact that the gain realized by T. T. Word was $170,455.08. That amount should be included in computing the net income of T. T. Word and Anna Word on the community property basis. In accordance with the concession of the respondent, this conclusion requires the elimination of gain in the amount of $177,738.47 from the taxable income of the Supply Co. for the year 1934.

The final question is whether the Supply Co. is entitled to a deduction of $10,424.55 for bad debts on its return for the year 1931. Deductions for bad debts are allowable only in the year in which two things occur - ascertainment of worthlessness and charge-off. Paul Pryibil,31 B.T.A. 164. The accounts were charged off during 1931, and the question for determination is whether they were ascertained to be worthless in that year. The ascertainment need not be absolute, but the taxpayer must make some reasonable and intelligent investigation of the facts concerning the claim, and the circumstances disclosed must be such as reasonably to generate the belief that it is in fact worthless. American Trust Co. v. Commissioner, 31 Fed.(2d) 47; Sherman & Bryan, Inc. v. Blair, 35 Fed.(2d) 713; Clark v. Commissioner, 85 Fed.(2d) 622; Kahn v. Commissioner, 108 Fed.(2d) 748; Eastern New Jersey Power Co.,37 B.T.A. 1037. We can not rest our determination upon the conclusions of witnesses alone, in the absence of facts upon which their conclusions are based. Merrill Trust Co.,21 B.T.A. 1395; Higginbotham-Bailey-Logan Co.,8 B.T.A. 566; Avery v. Commissioner, 22 Fed.(2d) 6. The facts presented fail to show that the petitioner was justified in concluding in 1931 that the accounts were worthless. T. T. Word testified that in the latter part of 1931 he ascertained that they could not be collected. In support of his conclusion he stated that the debtors were operators and contractors in the East Texas Oil Field, that, as a result of overproduction in 1931, the oil industry fell into a chaotic condition, the price of oil declined to 10 cents per barrel, and the State authorities finally shut in the wells. He also stated that he attempted to make collections, but that none of the debtors could pay anything. He did not disclose, however, what facts, if any, he ascertained concerning the financial condition of the debtors. The failure of a debtor to pay on demand or to pay promptly does not justify determination that the debt is worthless, in the absence of any investigation of the debtor's solvency. Joseph Kahn,38 B.T.A. 1417; affd., Kahn v. Commissioner, 108 Fed.(2d) 748; Prescott State Bank,11 B.T.A. 147. Cf. Clark v. Commissioner, supra.In the case of the Anderson account, it appears that the debtor was able to pay, and the petitioner testified that he was willing to do so. Anderson owned two oil wells which he sold two months after his account was charged off. The proceeds of that sale were used to discharge the balance of his debt. The collection of all of these accounts was undoubtedly delayed because of the unusual conditions, but there is no proof that they were worthless; and that they were not worthless is corroborated by the fact that, as soon as the condition of the oil industry improved, the accounts were paid. Joseph Kahn, supra;Richards & Hirschfeld, Inc.,24 B.T.A. 1289. The respondent's disallowance of the deductions is approved.

Reviewed by the Board.

Decision will be entered for the respondent in Docket No. 90997, and under Rule 50 in Docket Nos. 93542, 93543, and 93544.

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Footnotes

• 1. Sec. 141(d) * * * an "affiliated group" means one or more chains of corporations connected through stock ownership with a common parent corporation if -

  (1) At least 95 percentum of the stock of each of the corporations (except the common parent corporation) is owned directly by one or more of the other corporations; and

  (2) The common parent corporation owns directly at least 95 per centum of the stock of at least one of the other corporations. ↩