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Commissioner of Internal Revenue v. Spaulding Bakeries Inc.

decided: February 26, 1958.


Author: Galston

Before MEDINA and MOORE, Circuit Judges, and GALSTON, District Judge.

GALSTON, District Judge.

The question involved is substantially one of law, and of law only, for the facts have been stipulated. Basically, the question presented involves an interpretation of Section 112(b)(6) of the Internal Revenue Code of 1939, 26 U.S.C.A. § 112(b) (6). The problem presented hinges upon an investment which the respondent made in the purchase over a period of years of shares of the capital stock of Hazleton Bakeries, Inc.

Hazleton Bakeries, Inc. (herein referred to as "Hazleton") was organized in 1927 in Delaware, and its certificate of incorporation authorized the issuance of 3,000 shares of common stock without par value, and 7,000 shares of preferred stock, each share of the par value of $100. On liquidation or dissolution, the holders of the preferred stock were entitled to receive the full par value of their stock and all unpaid dividends accrued thereon before any payment whatever was to be made on the common stock. The voting power was vested exclusively in the common stock. None of the common or preferred stock was issued originally to the respondent.

In April 1930, respondent purchased 1,650 shares of the common stock of Hazleton, and later acquired the balance of the 3,000 shares of common stock by purchases in January 1931 and January 1933. The cost to the respondent of the entire common stock of Hazleton aggregated $335,592.69.

Respondent purchased 5,977 shares of preferred stock, which was the entire number of outstanding shares of said stock, during the years from 1933 through 1946 at an aggregate cost of $293,651.82.

On September 18, 1949, the Board of Directors of Hazleton resolved that the company be dissolved on December 1, 1950, and the officers of Hazleton were authorized to convey any real and personal property of Hazleton to the respondent in connection with this dissolution. There is no evidence in the record that the transfer of assets to the respondent on the dissolution was to be in complete cancellation or redemption of all of Hazleton's stock then outstanding.

Hazleton was formally dissolved on December 1, 1950, and on dissolution all of its assets were transferred to the respondent. These assets had a net book value of $267,677.31. The stipulation of facts recites that the fair market value of these assets was not greater than the book value.

Since the preferred stock outstanding and held by the respondent had a par value of $597,700, it is clear that the holders of the preferred stock, who were entitled to be paid the aforesaid value of assets of $267,677.31, found the par value not met.

The common stock certificates bear the notation written across their face in ink: "Corporation dissolved - December 1, 1950 - W.W. Schmitt," whereas in contrast, thirteen of the fifteen preferred stock certificates bear the notation: "Cancelled - December 1, 1950 - W.W. Schmitt."

Hazleton was a corporation affiliated with the respondent, though it must be understood that there was no merger or consolidation effected at any time between the respondent and Hazleton. In the respondent's income tax return respondent took a deduction from its gross income in the amount of $320,919.07 due to the fact that the common stock investment in Hazleton was a total loss. This deduction was taken pursuant to the provisions of Section 23(f)*fn1 and 23(g)(4)*fn2 of the Internal Revenue Code of 1939, 26 U.S.C.A. § 23(f), (g)(4). This deduction resulted in a net operating loss for 1950 and a net operating loss carryback to the calendar year 1949. The Commissioner disallowed this deduction on the ground that such loss was not to be recognized under the provisions of Section 112(b)(6)*fn3 of the Internal Revenue Code of 1939.

The question presented to the Tax Court was whether Section 112(b)(6) prevented respondent from taking a loss deduction under Section 23(f) and Section 23(g)(4) due to the worthlessness of its common stock investment in Hazleton. Clearly, respondent would be entitled to this deduction if Section 112(b)(6) is inapplicable.

Respondent, before the Tax Court, asserted that the Commissioner, in applying Section 112(b)(6) had made no distinction between the preferred and the common stock. The Tax Court, in agreeing with respondent, stated:

"Here there was no payment or distribution to the parent after the payment of the preferred stock claim in liquidation. The preferred stock claim captured all of the assets. There was nothing left to distribute to the parent as a common stockholder in the subsidiary. We hold the parent received no distribution in liquidation on its common stock within the intendment of the statute. Petitioner merely received in liquidation, ...

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