PEABODY HOTEL COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 230. Promulgated August 19, 1946.

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

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

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

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

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

The issues are whether respondent erred in disallowing claimed deductions for each of the years involved (1) for depreciation and (2) for amortization of bond discount and expense. The primary question, answer to which is decisive of both issues, involves a determination of the petitioner's basis for the property acquired by it

upon its organization in 1934, that is to say, whether the basis in the hands of petitioner is (a) the cost to it of such property as determined by respondent, or (b) as contended for by petitioner, the same basis for such property in petitioner's hands as it would have in the hands of its transferor under section 113 (a) (7) or (a) (8) of the Revenue Act of 1934, because, as claimed, the property was acquired either pursuant to a nontaxable "reorganization" within the meaning of section 112 (b) (4) and (g) (1) (B) of the Revenue Act of 1934 as amended by section 213 (g) of the Revenue Act of 1939, or pursuant to a nontaxable "exchange" within the meaning of section 112 (b) (5) of the Revenue Act of 1934.

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

FINDINGS OF FACT.

The petition herein was filed on November 23, 1942.

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

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

In March 1933 the Memphis Hotel Co. had an authorized capital stock of 50,000 shares, par value $50 each, which were owned by persons in various states. At that time it owned and operated the Peabody Hotel and the Gayoso Hotel, both located in Memphis, Tennessee, and it also owned and operated a farm known as the Gayoso farm, located in DeSoto County, Mississippi. The Memphis Hotel Co. also owned 50 per cent of the capital stock of the Chickasaw Hotel Co., consisting of 1,000 shares of common and 684 shares of preferred, and under an agreement operated the latter's hotel property known as the Chisca Hotel located in Memphis, Tennessee. At that time the Memphis Hotel Co.'s liabilities included, inter alia, three separate bond issues as follows: One hereinafter referred to as the "Peabody firsts," which were secured by Southern Hotel first mortgage 6 per

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cent gold bonds, dated July 1, 1923, constituting a first lien on all the Peabody Hotel real and personal property, which bonds had been assumed by the Memphis Hotel Co.; one hereinafter referred to as the "Gayoso firsts," which were secured by the Memphis Hotel Co.'s first mortgage 6 per cent gold bonds, dated March 1, 1924, constituting a first lien on all the Gayoso Hotel real and personal property; and one hereinafter referred to as the "Peabody seconds" which were secured by the Memphis Hotel Co.'s refunding mortgage and collateral trust 7 per cent gold bonds, dated November 2, 1925, constituting a second lien on the Peabody Hotel and Gayoso Hotel real and personal properties and further secured by a collateral trust agreement and pledge of 1,000 shares of the common stock of the Chickasaw Hotel Co. On March 8, 1933, E. G. Taylor, a resident of Mississippi, as a bondholder and on behalf of all creditors, both secured and unsecured, and on behalf of the stockholders of the Memphis Hotel Co., filed against that company a bill of complaint, Equity No. 1182, in the District Court of the United States for the Western Division of the Western District of Tennessee. The bill of complaint alleged, inter alia, that during 1932 and 1933 the defendant, Memphis Hotel Co., had failed to make certain interest and sinking fund payments on its bonds and had defaulted on the principal of certain of those bonds which had matured; that demand for foreclosure on the mortgages would be made in the immediate future; that the filing of many suits would be precipitated; and that timely intervention of the court was necessary for the preservation of the assets and the going business of the defendant and for the avoidance of a multiplicity of suits. The bill of complaint prayed for an order appointing receivers with full power to take possession of all the defendant's properties and to operate its business in toto, and requiring all creditors to file claims in that proceeding. On March 8, 1933, and on consent of the defendant, the court entered its order appointing W. P. Armstrong and A. L. Parker as receivers for the defendant corporation, with powers and duties as prayed for. The bill of complaint did not allege insolvency of the defendant, but, on March 8, 1933, it was, in fact, insolvent.

On March 10, 1933, the Bank of Commerce & Trust Co. of Memphis, Tennessee, filed an intervening bill in the above mentioned proceeding, as the indenture trustee under each of the three deeds of trust securing the bond issues above mentioned, and also as trustee under the collateral trust agreement and pledge of stock constituting liens against the Memphis Hotel Co.'s Peabody Hotel, Gayoso Hotel, Gayoso Farms, and 1,000 shares of common stock of the Chickasaw Hotel Co. intervening bill alleged, inter alia, defaults under each indenture, and asserted the respective lien rights of the interveners for foreclosure on those properties. The bill prayed that, pending foreclosure, the receivers theretofore appointed and then in possession of all the

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defendant's properties be also constituted receivers for the benefit of the holders of the respective secured debts, with full authority and powers to continue the operation of the various properties in the manner theretofore conducted by them and that they be required to impound, segregate, and hold in separate accounts the net rents, issues, and profits from the several mortgaged properties for the benefit of the respective classes of bondholders. On March 10, 1933, the court entered its order appointing W. P. Armstrong and A. L. Parker as receivers, with the powers and duties as prayed for.

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

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

$47,035.70 in favor of holders of Peabody seconds. The acts as recited in this paragraph were all done prior to March 1, 1934, the date of the promulgation of the plan hereinafter mentioned.

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

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

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

On June 28, 1934, the Memphis Hotel Co. filed in the District Court of the United States for the Western Division of the Western District of Tennessee a "Debtor's Original Petition" "In Proceedings for a Corporate Reorganization No. 11663," alleging insolvency and invoking the jurisdiction of the court under sections 77-A and 77-B of the Bankruptcy Act, as amended, for consideration and approval of the original plan and agreement of reorganization dated March 1, 1934, as amended by the amendment of June 25, 1934. The petition alleged, inter alia, the pertinent facts as to the Memphis Hotel Co.'s assets and liabilities, capital stock, and financial condition, and further alleged that continued operation of the business was impossible without effecting a plan of reorganization materially reducing the Memphis Hotel Co.'s capitalization and fixed charges and rearranging its indebtedness; that a bankruptcy reorganization could be consummated, without foreclosure, more expeditiously and at less expense than