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September 29, 1956

James W. JOHNSON, Collector of Internal Revenue, Defendant

The opinion of the court was delivered by: BICKS

Plaintiff claims to have overpaid income and excess profits taxes for its fiscal year ended June 30, 1943 by $ 143,069.79 and brings this suit to recover the alleged overpayment. Its right to prevail turns principally upon whether certain of its assets were acquired in a tax-free reorganization.

The Internal Revenue Code of 1939, section 710, 26 U.S.C.A. Excess Profits Taxes, § 710, imposed a tax on the 'adjusted excess-profits net income' of corporate taxpayers. Broadly speaking, this was the taxpayer's net income for the year, reduced by a credit deemed to represent the normal or non-excess earnings. Taxpayers were permitted a choice of basis of computing the credit, either on average earnings during the pre-war period 1936 to 1939, or on a return on the amount of capital invested in the enterprise. Plaintiff chose to employ the latter method in determining tis tax liability for the tax year under review. It asserts, however, that the credit was computed on what it erroneously conceived to be its 'invested capital' with the result that the credit to which it was entitled was grossly understated. For the fiscal year here involved plaintiff filed a consolidated income and excess profits tax return, covering the operations of itself and its twenty-two wholly-owned subsidiaries *fn1" which disclosed a liability for taxes in the following amounts, all of which were paid: Income Tax $57,712.73 Declared Value Excess Profits Tax 2,352.74 Excess Profits Tax 132,178.18 $192,243.65

 On December 6, 1946 plaintiff filed a claim for refund of $ 44,963.42. An amended claim increasing the amount of refund demanded to $ 142,999.79, *fn2" was filed on July 16, 1948.

 Section 718(a) of the Internal Revenue Code of 1939, 26 U.S.C.A. Excess Profits Taxes, § 718(a) provides that the invested capital credit is determined by referring to the property paid into the corporation 'for stock, or as paid-in-surplus, or as a contribution to capital', and including the same 'in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange.' Under Section 760 of the 1939 Code the basis to the transferee of property transferred in a tax-free exchange is determined by reference to the basis of such property in the hands of the transferror or predecessor corporation. *fn3" plaintiff paid $ 400,000 for the assets in question. The basis thereof in the hands of its vendor was upwards of $ 4,000,000. In the tax return as filed taxpayer treated the amount it paid for the assets as its invested capital. The claim for refund is predicated on an invested capital in an amount equal to the vendor's basis for said assets.

 Shubert Theatre Corporation (referred to herein as 'Shubert') was organized in 1924 for the purpose of taking over the theatrical enterprises which had been conducted for approximately twenty-five years by Messrs. Sam S., Lee and J. J. Shubert. It was one of the principal producers of so-called 'legitimate' theatrical attractions in the United States and the largest operator of 'legitimate' theatres. The business had been highly profitable and continued so through its fiscal year which ended June 30, 1929. The severe decline in the securities markets in the last quarter of 1929 and the general business depression which followed had a marked adverse effect on the theatrical industry, Shubert included. For the fiscal year ended June 30, 1930, it sustained a net loss of $ 1,231,000, for the succeeding fiscal year $ 1,672,000; and for the period July 1, 1931, to October 20, 1931, $ 1,187,000; a loss in the aggregate during this period of approximately twenty-eight months, of $ 4,090,000. Shubert then found itself unable to discharge its obligations as they matured with the result that on October 20, 1931, a bill of complaint in an equity receivership proceeding was filed in this court by a general creditor. Shubert's answer admitted the allegations of the complaint and joined in the prayers for relief contained therein. Irving Trust Company, a New York banking corporation, and Lee Shubert, were thereupon appointed receivers. *fn4"

 At the date the receivership proceedings were instituted Shubert's liabilities consisted of $ 6,360,000. 6% gold debentures due June 15, 1942; $ 323,000. accumulated interest on said debentures; $ 1,158,000. notes and accounts payable; Federal amusement taxes payable $ 9000; and $ 284,000. deferred credits. *fn5" The capital stock consisted of $ 218,160 shares without par value of which 210,360 were issued and outstanding and 7800 were held in the treasury. Messrs. Lee and J. J. Shubert owned, either directly or indirectly, 71,680 shares of Shubert stock (34% of the total outstanding shares); $ 619,000 principal amount of Shubert 6% gold debentures (9.7% of the total outstanding debentures); and $ 660,000 of other debt.

 During the operation of the business by the receivers the liquid assets continued to dwindle. In order to provide funds for payment of the expenses of administration and the continued operation of the business, the receivers were authorized in April 1932 to create a second issue *fn6" of interest bearing certificates of indebtedness or receiver's certificates in a principal amount not in excess of $ 400,000 maturing not later than March 1, 1933, and to sell all or any part thereof up to $ 300,000 in principal amount. The order provided, inter alia, that (i) the certificates shall not impose any personal liability on the receivers otherwise than as receivers of Shubert; (ii) the certificates shall be secured by (a) a direct charge upon the receivership estate, (b) a lien upon all the assets in the possession of the receivers, subject and subordinate to all valid liens on any part of the assets covered thereby existing at the date of the appointment of the receivers, but prior and superior to the 6% gold debentures due June 15, 1942, and all other unsecured debts, (c) such charge and lien shall rank equally with the charge or lien of all other obligations of the receivers incurred in the operation of the business, except administration expenses, which, by operation of law, may be entitled to priority thereto, (d) such charge or lien shall not, so long as the receiver shall not be in default in the payment of said certificates when due, limit or restrict the right of the receivers to dispose of any assets then in their hands or which may thereafter come in their hands in the conduct of the business, or to apply such assets or the proceeds thereof to the payment of expenses and indebtedness incurred by the receivers in the conduct of the business, (e) all the certificates, at the election of the holders thereof, shall become immediately due and payable upon any sale of the assets in satisfaction of any final decree and the termination of the receivership, or in the event that Shubert shall be adjudged bankrupt and (f) the receivers were authorized, by agreement with the holders of the certificates, to extend the maturity date for a period not exceeding three months from March 1, 1933.

 The entire issue of said receivers' certificates was sold to The Atel Co., Inc., hereinafter referred to as 'Atel'. Atel was organized on March 23, 1932 under the Laws of the State of New Jersey. At least from May 1932 all its outstanding stock was owned by Dorsar Enterprises, Inc., a New York corporation, which was 100% owned by the Shuberts individually. The funds employed by Atel for the purpose of purchasing the receivers' certificates came to it by loan from Dorsar Enterprises, Inc., the latter having previously borrowed a like sum from the Shuberts. Atel was neither a stockholder nor creditor of Shubert or any of its subsidiaries. *fn7"

 Efforts in the direction of effecting a reorganization met with no success. The amount of cash and the value of assets readily convertible into cash in the hands of the receivers continued to decline. In the opinion of the receivers further operation of the business might have resulted in further losses. Thus circumstanced, the receivers on January 4, 1933 recommended that the properties and assets in their hands be sold and the proceeds thereof distributed among those entitled thereto. Upon the petition of the receivers a decree was made under date of January 21, 1933, directing that, the assets be sold, either in bulk or in separate parcels, to the highest bidder or bidders (in case of a bulk sale an upset price of $ 400,000 was fixed); any creditor or any stockholder, director or officer of Shubert may purchase the assets in his own right, and Lee Shubert, one of the receivers, may likewise bid at such sale, or may be interested in any corporation that shall bid thereat and he or any such corporation may purchase the assets in his or in its own right provided that he shall have resigned as receiver prior to the date of the sale; and further, that

 'no sale of the * * * assets * * * shall be confirmed to any purchaser on behalf of, or for the benefit of, any corporation organized or to be organized with the intention that it shall become the owner of said * * * assets * * * pursuant to any plan or agreement of reorganization unless at or before the sale * * * such purchaser shall have filed with the Special Master a complete copy of such plan or arrangement * * * and no sale of any property * * * to any purchaser who is to purchase such property pursuant to any such plan or agreement shall be confirmed if the Court shall determine that the provisions of such plan * * * are inequitable * * *. So much of the purchase price as may not be required by the Court to be paid in cash may be paid in whole or in part by delivery to the Special Master, * * * outstanding Receivers' Certificates of Indebtedness and/or claims allowed * * *, including claims in respect of the 6% Gold Debentures * * *. The purchaser shall be credited on account of the purchase price with such sum * * * as would be payable in cash, out of the proceeds of the sale, in respect of said Receivers' Certificates of Indebtedness. Debentures, * * * and other claims, if the whole amount of the purchase price were paid in cash.'

 Lee Shubert removed any disqualification to become a bidder at the sale or interested in the purchaser by resigning as receiver. The sale pursuant to said decree originally scheduled for February 24, 1933 was adjourned from time to time to April 7, 1933. As a condition to the last adjournment Lee Shubert bound himself to bid or cause to be bid not less than $ 400,000 for the assets held in the receivership estate. At the sale the assets were struck down in bulk to the only bidder -- Select Theatres Corporation, the plaintiff herein, for $ 400,000. Upon the Special Master's report of sale and petition of the plaintiff herein a decree was entered confirming the sale. The petition recited that plaintiff intended to deliver the receivers' certificates to the Special Master on account of the purchase price and prayed that the Special Master be directed to credit on account of the purchase price such sums as would be payable out of the proceeds of sale in respect of said receivers' certificates if the whole amount of the purchase price were paid in cash. The confirmatory decree authorized the Special Master to accept said certificates as pro tanto payment of the purchase price. It recited further

 'it appearing to the Court that said Select Theatres Corporation has not been organized with the intention that it shall become the owner of the properties and assets of defendants, or any part thereof, or any beneficial interest therein, pursuant to any plan or agreement of reorganization, and does not propose to purchase said properties and assets, or any part thereof, on behalf of, or for the benefit of, any other corporation organized or to be organized with such intention.'

 Select Theatres Corporation, the successful bidder, was organized on April 5, 1933, two days before the sale. Its original authorized capital stock consisted of 200 shares of common stock without par value. At its first meeting the Board of Directors accepted an offer by Atel to purchase 101 shares of its common stock for $ 404,000 to be paid, $ 300,000 by delivery of the receivers' certificates and the balance, less accrued interest on said certificates in cash. On April 17, 1933, the subscription agreement was modified. Under the amended agreement Atel subscribed to 140 shares for $ 14,000 and agreed to loan to the company.$ 390,000 (in cash and the aforesaid receivers' certificates), against its one year note.

 The purchase at the Special Masters sale was consummated on April 25, 1933. Payment of the purchase price was made by delivery of the receivers' certificates duly endorsed, plus $ 90,009.52 in cash *fn8" representing the difference between the principal amount of the receivers' certificates plus accrued interest and the $ 400,000 purchase price. The cash proceeds of the sale were applied to the payment of expenses of administration by the estate in ...

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