Pinkney Packing Co. v. Commissioner

*823 The respondent determined deficiencies of $7,503.80 in income tax and $2,728.65 in excess profits tax for the year 1934. The only question for determination is whether the petitioner realized taxable income as a result of a transaction whereby the original purchase price of its plant and equipment, which was evidenced by installment notes, was reduced and paid off in the taxable year by a cash payment in an amount less than the face value of the notes.

FINDINGS OF FACT.

Petitioner is a Texas corporation, with its principal place of business at Amarillo, Texas. It was organized in August 1930 by R. R. Pinkney and several of his associates for the purpose of receiving and holding title to a meat packing plant and for the purpose of operating a meat packing business.

In about 1926 the Western Packing Co. purchased 8 1/3 acres of land, with improvements thereon consisting of a meat packing plant, situated in Potter County, Texas. The sale was made by interests represented by H. E. Fuqua, who was president of the First National Bank, and for a consideration of $60,000. The*954 operation of the business was unsuccessful and by 1930 the Western Packing Co. was ready to turn the property back to Fuqua, or the interests which he represented. For several years prior thereto the operation of the business consisted of renting the facilities of the plant to 10 or 12 local butchers, *824 who killed their cattle there and used a few of the refrigerators. Most of the equipment had been idle for a number of years and was obsolete and in very bad condition. Fuqua was anxious to get some one to take the plant over and operate a meat packing business under some arrangement whereby those having an equity therein could realize something on their investment.

About February 1930, R. R. Pinkney, who at that time was connected with the Nuckles plant in Pueblo, Colorado, and Arthur G. Miller and Fred Miller, who were associated with him, began negotiations with Fuqua with the view of purchasing the plant. They had about $18,000 which they were willing to invest in the business and if they acquired the plant they desired and expected to make certain improvements, install new equipment, and operate a meat packing business. It was apparent that their capital was inadequate*955 for the undertaking and during the negotiations Fuqua told them that if they purchased the plant he would be willing to assist them financially in making improvements and buying new equipment and for that purpose he would advance them amounts equal to whatever investment they made in the business.

In August 1930 the negotiations culminated in an agreement that Pinkney and his associates would purchase the plant for $125,000, with interest and principal payable in quarterly installments of $3,750 each. During the negotiations Fuqua told them that if at any time in the future they were in a position to pay all or a substantial part of the purchase price in cash, he would give them a discount of $25,000 to $50,000. Pinkney was of the opinion that a new plant, a little smaller than this plant, could be built and equipped for approximately $75,000 and on the basis of a cash deal he would not have been willing to pay more than $50,000 for the property, with improvements.

The fair market value of the property, with improvements, on the date of the sale was not in excess of $75,000.

On or about August 22, 1930, Fuqua caused the Western Packing Co. to execute and deliver to the above*956 named individuals a deed to the said land and improvements, retaining a vendor's lien to secure payment of the purchase price. In consideration therefor the individuals executed and delivered to the Western Packing Co. their note for $125,000, with interest and principal payable in quarterly installments of $3,750 until September 1, 1940, at which time the balance then remaining would become due. The deed of conveyance contained the following paragraph:

But it is expressly agreed and stipulated that the Vendor's Lien is retained against the above described property, premises and improvements, until the above described note and all interest thereon is fully paid according to its face and tenor, effect and reading, when this deed shall become absolute.

*825 On the same date, August 22, 1930, Pinkney and his associates executed and delivered to Fuqua, as trustee, a deed of trust on the property to further secure payment of the note. Also on August 22, 1930, the Western Packing Co. assigned the note to the Western Stockyards Co., a Taxes corporation. The assignment of the note was made by a separate written instrument setting forth the terms of the sale of the packing plant*957 property in considerable detail. Among the provisions of the assignment were the following:

And WESTERN PACKING COMPANY also hereby Bargains, Sells and Conveys unto the said WESTERN STOCKYARDS COMPANY all of the right, title and interest owned or held by it in said land by virtue of said note herein conveyed and assigned.

Said land and note being fully set out and described in a deed duly executed by Western Packing Company to the said R. R. Pinkney, Arthur G. Miller and Fred V. Miller, dated August 22, 1930, and recorded in Volume , page , of the Deed Records of Potter County, Texas, which is referred to and made a part hereof for further description.

TO HAVE AND TO HOLD, unto the said WESTERN STOCKYARDS COMPANY, its successors and assigns, the above described note, together with all and singular the contract lien, vendor's lien, rights, equities, titles and interest in said land which WESTERN PACKING COMPANY has by virtue of being the vendor in said deed and payee in said note, and the legal holder and owner of said note.

Shortly thereafter the three purchasers, together with L. F. Fink, completed the incorporation of the petitioner, and on September 13, 1930, pursuant*958 to their plan, conveyed the property to petitioner, subject to the indebtedness above referred to. The conveyance contained the following paragraph:

This conveyance, however, is subject to the indebtedness described in a certain deed from The Western Packing Company to R. R. Pinkney, Arthur G. Miller and Fred V. Miller, dated August 22, 1930, recorded in Vol. , page , of the Deed Records of Potter County, Texas, and also subject to all of the terms and conditions of said deed, reference to which is here made for all purposes.

After acquiring the plant, petitioner proceeded to make certain improvements and to modernize the equipment. Pinkney invested about $18,000 in the business and from time to time petitioner borrowed certain amounts from Fuqua, or interests which he represented. By December 1934 it had borrowed from this source approximately $50,000, most of which had been expended for improvements and new equipment.

On January 1, 1933, the petitioner executed renewal notes, one in the amount of $71,691 to the Western Stockyards Co. and another in the amount of $53,309 to the West Texas Mortgage Loan Co., which latter company was an assignee of the Western Stockyards*959 Co. for that portion of the debt. Each of these notes provided for interest at the rate of 6 percent per annum, both principal and *826 interest payable at Amarillo, Texas. The note to the Western Stockyards Co. provided that principal and interest would be payable in installments as follows: Interest on July 1, 1933; interest and principal installment of $3,000 on October 1, 1933; $2,125 on January 1, 1934, and a like amount on the first day of each April, July, October, and January thereafter, up to and including July 1, 1940; and the balance unpaid would be due and payable on September 1, 1940. The note to the West Texas Mortgage Loan Co. provided that principal and interest would be payable in installments as follows: Interest on July 1, 1933; interest and principal installment of $2,000 on October 1, 1933; $1,000 on January 1, 1934, and a like amount on the first day of each April, July, October, and January thereafter, up to and including July 1, 1940; and the balance unpaid would be due and payable in full on September 1, 1940.

Also on January 1, 1933, petitioner executed and delivered to Fuqua, as trustee, a deed of trust on the property to secure payment of the*960 notes described in the preceding paragraph. Among other provisions contained in that instrument were the following:

The NOTES hereinabove described and hereby secured are given in RENEWAL and EXTENSION of one certain VENDOR'S LIEN NOTE in the principal sum of $125,000.00, dated AUGUST 22, 1930, executed by R. R. PINKNEY, ARTHUR G. MILLER and FRED V. MILLER, payable to the order of WESTERN PACKING COMPANY, described in a certain deed of conveyance from WESTERN PACKING COMPANY to said R. R. PINKNEY, ARTHUR G. MILLER and FRED V. MILLER, dated August 22, 1930, reference to which is here made for a more particular description of said NOTE, the indebtedness evidenced by said NOTE now being owned by WESTERN STOCKYARDS COMPANY and WEST TEXAS MORTGAGE LOAN COMPANY, in the respective amounts of the NOTES hereby secured, and the owners and holders of said NOTES hereby secured are subrogated to all the rights, equities, liens and security of the original holder of the said original NOTE in the principal sum of $125,000.00.

The property hereinbefore described is now owned by PINKNEY PACKING COMPANY, and said PINKNEY PACKING COMPANY hereby acknowledges the original lien securing such indebtedness*961 to be in full force and effect to secure the payment of the above extension NOTES, and hereby acknowledges and declares that said NOTES evidence a valid and subsisting debt.

The petitioner met the interest payments on the original note and the two renewal notes but made none of the payments on principal.

In December 1934 Pinkney, who was then president and general manager of petitioner, commenced negotiations with the owners of the notes with the view of making a cash payment for the plant and of being released from the obligation evidenced by the two notes. Pinkney requested and was granted a conference with the parties representing the owners of the notes which included Fuqua and the president and secretary of the West Texas Mortgage Loan Co. At this conference Pinkney called attention to the representation made by Fuqua during the negotiations for the purchase of the plant to *827 the effect that if at any time in the future they were in a position to pay for the plant in cash he would allow them a discount of from $25,000 to $50,000 on the purchase price. After some discussion, Pinkney, acting for petitioner, offered $75,000 in cash for the plant, provided petitioner*962 would be completely released from the obligation evidenced by the two notes. He told them that if they did not accept the offer petitioner was ready to turn the plant back to them and lose the investment it had made in the way of improvements and new equipment, which by that time amounted to approximately $75,000. At that time Pinkney was of the opinion that the financial position of petitioner was such that it would be unable to continue the operation of the plant unless the offer was accepted. Pinkney was requested and agreed to hold the offer open for 24 hours. The next day he was notified that they would accept the offer.

On December 27, 1934, petitioner paid $75,000 in cash to the Western Stockyards Co. and the West Texas Mortgage Loan Co. Of that amount $65,000 was raised through the sale of certain hides and other products which petitioner had on hand and the remaining $10,000 was obtained by a loan from an outside source. Upon receipt thereof those companies executed and delivered to petitioner a release from its obligation to pay the two notes in question. The release recited generally the terms of the original instrument of conveyance from the Western Packing Co. *963 to Pinkney and his associates, specifically noting that a vendor's lien on the property had been retained and that the notes to the Western Stockyards Co. and the West Texas Mortgage Loan Co. were in renewal and extension of the original note for $125,000. The release also contained the following provisions:

WHEREAS, at the time of the creation of the original indebtedness which is now an obligation of said Pinkney Packing Company, representations were made to R. R. Pinkney, Arthur G. Miller and Fred V. Miller to the effect that a substantial reduction would be made in the purchase price for said land and plant if and when the said purchasers, or their assigns, would be in position to pay off the indebtedness against the same; and,

WHEREAS, said plant has greatly depreciated, and the present obligor on said indebtedness is unable to pay the same in full, and has tendered back the land in question to the payees in said two deed of trust notes above described, which aggregate the sum of $125,000.00, and said obligees are not desirous of accepting the conveyance of said land from said Pinkney Packing Company, but in order to enable the refinancing and further operation of said plant*964 as a going concern are willing to compromise and settle the indebtedness owing to them by said Pinkney Packing Company.

Now, THEREFORE, KNOW ALL MEN BY THESE PRESENTS: That Western Stockyards Company, a corporation, and West Texas Mortgage Loan Company, a corporation, both of the County of Potter and State of Texas, in consideration of the premises and the sum of SEVENTY-FIVE THOUSAND ($75,000.00) DOLLARS to them in hand paid by Pinkney Packing Company, the receipt of which is hereby acknowledged, have this day and do by these presents remise, release *828 and quit-claim unto the said Pinkney Packing Company, its successors and assigns, the liens heretofore existing on said premises by virtue of the retention of the vendor's lien in the deed aforesaid and the execution of the deeds of trust hereinabove referred to, and do hereby declare the same fully released and satisfied.

At the beginning of the taxable year 1934 petitioner's balance sheet showed a deficit of $8,542. In its income tax return for that year it reported net income in the amount of $57,324.16 and a surplus at the end of the year of $32,364.72. The income reported resulted largely from the sale of hides*965 and other products above referred to and most of the proceeds thereof were used to make the $75,000 payment. During 1934 petitioner paid cash dividends in the amount of $4,370. It has continued operation of the plant up to the present time. It was not insolvent immediately before or after the time of making the $75,000 payment above referred to.

Certain additional facts have been stipulated by the parties and are found as stipulated. A statement of a few of those facts will suffice for the purposes here.

Upon acquisition of the packing plant property it was set up on petitioner's books in a total amount of $150,000. At December 31, 1934, the property appeared on petitioner's balance sheet in the total amount of $176,487.63, less depreciation in the amount of $49,785.97, showing a balance remaining of $126,701.66. On October 15, 1935, the plant was appraised for the purpose of determining its value as of that date "to a going concern utilizing its facilities for the purpose and to the capacity for which they were built and equipped." The value shown by the appraisal was $161,515.57.

Applying article 22(a)-14 of Regulations 86, respondent determined that the petitioner*966 realized taxable income in the amount of $50,000 "in the settlement of outstanding obligations of $125,000.00 for $75,000.00."

OPINION.

TURNER: The respondent's theory of the case, as stated on brief, is that petitioner, a solvent debtor, was under obligation to make payment for property purchased by it, that it satisfied this obligation (the notes) by paying less than the face value thereof, that the property remained in its possession and continued to be of a value sufficient to pay the obligation, and that it therefore realized taxable income in an amount equal to the difference between the face value of the obligation and the amount paid for its satisfaction, or $50,000. He states that his contention is fundamentally based on the decision of the Supreme Court in , and cites and discusses the line of cases applying that decision, with particular reliance on .

*829 The petitioner has presented argument on two points. First, it contends that the transaction was executory from the time the negotiations were carried on for the purchase of the plant*967 until petitioner paid $75,000 in cash and was released from the $125,000 indebtedness, that the cash payment and release from the indebtedness was in effect and substance a revision of the original "credit" purchase price of the property and the substitution of a "cash" price therefor, thereby reducing the cost basis or price of the plant to petitioner without resulting in any taxable gain; and, second, petitioner contends that it realized no taxable profit from the transaction for the reason that at the time the property was purchased it was not worth more than $50,000 and that when it procured absolute title to same by paying $75,000 cash in lieu of paying the two notes aggregating $125,000, it merely procured a reduction of the loss which it would have sustained if it had paid the face amount of the notes, or, in other words, there was merely a reduction of liability and a consequent diminution of loss.

In our opinion the petitioner's first contention is sound. The facts show that what took place in 1934 was an adjustment for cash in the purchase price of the packing plant property in accordance with the understanding of the parties at the time the original agreement was entered*968 into in 1930 and was not a transaction which falls within the rule laid down in , as the respondent contends. The respondent argues that, inasmuch as the understanding with Fuqua as to the cash consideration was oral and did not appear in any of the written instruments executed when the agreement was reached in 1930, it was not enforceable and can not therefore have any bearing on the issue here. Such an argument is, in our opinion, beside the point, for in 1934, when petitioner was in a position to make payment for the property in cash, the holders of the notes recognized the understanding reached with Fuqua as to the fixing of a cash price as distinguished from and in an amount substantially less than the time payment price of $125,000 and the actual purchase price was then negotiated and agreed upon. The conveyance of the property executed by the Western Packing Co. under date of August 22, 1930, recited the retention of the vendor's lien and provided that the deed should become absolute when the payments were made. The written assignment of the original note to the Western Stockyards Co. and the deeds of trust from*969 petitioner to Fuqua specifically recognized the original note and the renewal or extension notes as being supported by the vendor's lien. The facts of record, in our opinion, clearly indicate, as the petitioner contends, that the purchase of the packing plant property was not fully accomplished until the payment of the $75,000 in cash and the execution *830 of the release on December 27, 1934. Accordingly we do not have here the satisfaction of an indebtedness for a lesser amount as in , and , also strongly relied on by the respondent, but merely the payment of the purchase price for the property as finally agreed upon by the parties in interest, and petitioner realized no income therefrom. See .

By amended answer the respondent affirmatively alleged that, in the event the petitioner is sustained on the issue considered and disposed of above, the cost basis of the plant should be reduced for the purpose of computing the depreciation thereon. By stipulation the parties have agreed on the*970 facts necessary for making a proper adjustment thereon and effect will be given to the stipulation upon recomputation herein.

Respondent also alleged in his amended answer that a loss deduction in the amount of $1,833.33 claimed by the petitioner for an abandoned well should be disallowed in the amount of $833.34. He presented no evidence or argument as to this issue and it will be regarded as having been abandoned.

Another issue raised in the amended answer relating to the deduction of processing taxes paid by petitioner was waived by the respondent at the hearing.

Decision will be entered under Rule 50.