PEBBLE SPRINGS DISTILLING Co., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 40519. Filed October 29, 1954.

During the course of a liquidation which commenced in 1948, petitioner sold all of its noninventory assets to a corporation wholly owned by its controlling stockholders. The new corporation had broad powers to carry on the same business as petitioner as well as to conduct a real estate and other businesses. It rented the property to various tenants and was still in existence at the time of the hearing. The price at which the noninventory assets were sold was $551,428.54 less than their depreciated book value. Petitioner claimed a net operating loss on its return for the fiscal year ended March 31, 1949, and carried such loss back to its 2 preceding taxable years. Carry-back of the loss eliminated all taxes for those years.

Held, the purchase of petitioner's noninventory assets by a corporation wholly owned by petitioner's controlling stockholders was pursuant to a plan of reorganization within the meaning of section 112 (g) (1) (D) of the 1939 Code; hence, no loss is allowed on such sale.

Sidney U. Hiken, Esq., for the petitioner.

Robert R. Veach, Esq., for the respondent.

This proceeding involves deficiencies in income tax of $110,030.86 for the fiscal year ended March 31, 1947, and $34,128.81 for the fiscal year ended March 31, 1948.

The only issue is whether petitioner sustained a recognized loss on the sale of its plant and other noninventory assets during the taxable year ended March 31, 1949, which may be carried back as a net operating loss to its 2 previous taxable years.

Some of the facts were stipulated.

FINDINGS OF FACT.

The stipulated facts are so found, and are incorporated herein by this reference.

Petitioner, a whisky distiller, was incorporated under the laws of Illinois on July 25, 1945. Its offices and principal place of business were located at Peoria during the years here in issue. It began business in the spring of 1946, and kept its books and filed its returns for the fiscal years ended March 31, 1947, 1948, and 1949, on the accrual basis with the collector of internal revenue for the eighth district of Illinois.

Petitioner had 500,000 outstanding shares of stock owned by the following persons (hereinafter sometimes referred to as the controlling stockholders) who, as indicated, were its officers and directors and related to one another:

By the beginning of 1948, the whisky market was greatly oversupplied. Production had been substantially increased following the war, and distillers and dealers were overstocked; prices had declined drastically. Companies, such as petitioner, without an established label or a large supply of old whisky were faced with ruinous competition.

At a shareholders' meeting on January 5, 1948, petitioner's president reported the outlook facing the company and stated that its directors felt that operations could continue only if it were willing to expend substantial sums in advertising and for the purchase of older whiskies. He further reported that the necessary funds for such expenditures were not available and recommended, in behalf of the directors, that the company be dissolved. Petitioner's shareholders thereupon authorized its directors to dissolve the corporation and liquidate its assets. They further authorized the directors to sell petitioner's plant and other real property at public auction and to distribute the proceeds from such sale, together with other assets or their cash equivalent, pro rata to the stockholders. Petitioner's president also stated at the meeting that negotiations with two of the major distilleries looking toward a purchase by one of them of all of petitioner's outstanding stock had not been successful.

In January 1948, when dissolution was authorized, petitioner had a bulk whisky inventory of approximately 2,000,000 gallons. Such inventory had a cost or book value of approximately $1,700,000 and a fair market value of approximately $3,400,000. On April 9, 1948, petitioner's directors authorized a pro rata distribution of a part of its whisky inventory to its stockholders. Pursuant thereto, approximately 1,000,000 gallons of whisky were so distributed by the medium of warehouse receipts, and scrip where a stockholder held less than 200 shares. The inventory accounts on petitioner's books were credited with the cost value of the whisky, in the amount of $981,921.23. The fair market value of the whisky so distributed was approximately $2,010,000.

Also on April 9, 1948, petitioner's directors authorized the firm of Samuel L. Winternitz & Company to auction petitioner's plant, fixtures, machinery, goodwill, labels, and brand names, such auction to be held on petitioner's premises on May 20, 1948.

All of petitioner's stockholders were so notified, and advertisement of the auction appeared in several newspapers.

The brochure prepared by the auctioneer specified that the highest bidder would be required to deposit 10 per cent of the price bid, in cash or by certified check.

At a meeting on May 13, 1948, 1 week prior to the auction, petitioner's controlling stockholders, headed by Silberstein, its president, decided that they would purchase all of petitioner's assets at the auction for the sum of $242,080 if no bid of that amount or more was made by someone else. Also on that day, the controlling stockholders began organizing a corporation which they intended would purchase and receive title to such assets. Because the name chosen for the new corporation was not available, issuance of its charter was delayed. until June 5, 1948. On that date, the new corporation-Old Peoria Building Corporation-(hereinafter referred to as Old Peoria) was granted a perpetual charter by the State of Illinois and empowered to buy, sell, own, rent, lease, hold, convey, and mortgage real estate and any interest therein; to carry on any business commonly conducted by real estate developers; to acquire, hold, and dispose of patents and trade-marks; to buy and sell any and all equipment and merchandise used in manufacturing or commercial operations; and to manufacture, buy, sell, deal in, distribute, store, warehouse, and export whisky of all kinds, high wines, spirits, alcohol, and gins of all kinds and to do and perform all kinds of distilling, redistilling, and rectifying high wines, spirits, and alcohol and of compounding and blending of gins and whiskies of all kinds. Old Peoria's stock was wholly owned by petitioner's controlling stockholders at all times here material.

At the auction on May 20, 1948, the auctioneer divided the asets into four lots: (1) Goodwill, (2) rectifying and bottling plant, (3) distillery, and (4) entire plant and goodwill (lots 1, 2, and 3).

While persons other than the controlling stockholders were present at the auction, they made no bids. When lot 3 was offered, Silberstein bid $10,000; and when lot 4 was offered, he bid $242,080 as he and the other controlling stockholders had agreed. The auctioneer recited the customary first, second, and third call-"Going, going, gone"--and declared all of petitioner's assets "Sold" to Silberstein.

The auctioneer's memorandum of the sale showed that all of the property was bid for and sold for $242,080 to Silberstein, "his nominee or nominees." Silberstein, as petitioner's president, together with its other officers waived the 10 per cent deposit requirement.

On June 9, 1948, petitioner's board of directors ratified the May 20 auction sale of its assets, and on June 15 petitioner transferred such assets to Old Peoria upon payment by it of cash in the amount of $194,208.36 and the assumption of two mortgages and taxes. Old Peoria had previously secured a loan of $200,000 from three corporations owned by the Silberstein, Venezky, and Weimer families, respectively.

Subsequent to the purchase of the assets, Old Peoria rented parts of the plant to some 20 or 25 different tenants for dead storage. It was still in business at the time of the hearing.

Petitioner declared a second liquidating dividend of 40 cents per share on June 9, 1948; a third such dividend of 10 cents per share on April 6, 1949; a fourth, of 5 cents per share on September 2, 1949; and a final such dividend of 21 cents per share on May 5, 1950. It was finally dissolved on November 15, 1950.

On its income tax return for the fiscal year ended March 31, 1947, petitioner reported net taxable income of $289,328.83 and income tax liability thereon of $109,905.95. On its return for the fiscal year ended March 31, 1948, it reported net taxable income of $89,812.66 and income tax liability thereon of $34,128.81.

The depreciated book value of petitioner's noninventory assets sold by public auction on May 20, 1948, was $793,508.54. On its return for the fiscal year ended March 31, 1949, petitioner showed an operating profit of $10,376.33 and a net loss of $561,982.32. It claimed a loss of $551,428.54 from the auction sale of its assets and a net operating loss for the taxable year of $551,605.99 which it carried back to the 2 preceding taxable years. Petitioner therefore claimed, and received, a refund of taxes paid in 1947 and 1948 in the respective amounts of $109,905.95 and $34,128.81.

In his deficiency notice, respondent determined that:

no net operating loss deduction is allowable under the provisions of Sections 23 (8) and 122 of the Internal Revenue Code for the years ended March 31, 1947 and 1948, by reason of the sale or transfer of taxpayer's properties during the year ended March 31, 1949.

Petitioner's sale of its noninventory assets to Old Peoria was pursuant to a plan of reorganization within the provisions of section 112 (b) (3) and (g) (1) (D) of the Internal Revenue Code of 1939, and no loss is, therefore, recognized on such sale.

OPINION.

RICE, Judge: Respondent predicated his disallowance of the claimed net operating loss carry-back here on three grounds: (1) That the sale of petitioner's noninventory assets was, in fact, made to Silberstein as representative of the controlling stockholder group, and that any loss

thereon is barred by section 24 (b) (1) (B) of the 1939 Code;1 (2) that if the sale was, in fact, made to Old Peoria, petitioner's transfer of its assets was pursuant to a plan of reorganization within the provisions of section 112 (b) (3) and (g) (1) (D)2 and no loss is, therefore, recognized; and (3) that in any event, petitioners suffered no real economic loss sufficient to constitute a "net operating loss" within the meaning of section 122.

Whatever the merits of respondent's positions enumerated as (1) and (3) above, it is clear that the purchase of petitioner's noninventory assets by a corporation wholly owned by petitioner's controlling stockholders was pursuant to a plan of reorganization within the provisions of section 112 (b) (3) and (g) (1) (D). The substance of petitioner's argument is that the sale of its noninventory assets was incident only to its own liquidation, and not pursuant to any plan of reorganization, citing United States v. Arcade Co., 203 F. 2d 230 (C. A. 6, 1953) certiorari denied 346 U. S. 828, and Charles R. Mathis, Jr., 19 T. C. 1123 (1953).

Those cases are clearly distinguishable from the one before us here, as we shall presently indicate.

It cannot be denied that the literal requirements of section 112 (g) (1) (D) are satisfied by the bare facts of the sale here in question: petitioner sold its noninventory assets to Old Peoria, a corporation organized to purchase and receive title to those assets; a majority of petitioner's stockholders (both before and) immediately thereafter controlled Old Peoria. "Control" as defined by section 112 (h) means 80 per cent or more of the new corporation's stock. It is not necessary that 80 per cent of the shareholders of the old corporation be shareholders of the new company. Reilly Oil Co., 13 T. C. 919 (1949), affd. 189 F. 2d 382 (C. A. 5, 1951); Toklan Royalty Corporation v.

1 SEC. 24. ITEMS NOT DEDUCTIBLE.

(b) LOSSES FROM SALES OR EXCHANGES OF PROPERTY.—

(1) LOSSES DISALLOWED.-In computing net income no deduction shall in any case be allowed in respect of losses from sales or exchanges of property, directly or indirectly

(B) Except in the case of distributions in liquidation, between an individual and a corporation more than 50 per centum in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual;

'SEC. 112. RECOGNITION OF GAIN OR LOSS.

(b) EXCHANGES SOLELY IN KIND.

(3) STOCK FOR STOCK ON REORGANIZATION.-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.

(g) DEFINITION OF REORGANIZATION.

(D) a transfer by a corporation of

(1) The term "reorganization" means all or a part of its assets to another corporation if immediately after the transfer the transferor or its shareholders or both are in control of the corporation to which the assets are transferred,