Lead Opinion
OPINION
The case is presently before us on cross-motions for partial summary judgment under Rule 121(b).
The Commissioner determined the following deficiencies in, and additions to, petitioner’s Federal income taxes:
TYE Deficiency Addition to tax Sec. 6661
July 2, 1977 $929,112
June 30, 1979 5,268,805
Jan. 3, 1981 16,138,544
Jan. 2, 1982 191,523
Jan. 1, 1983 15,959,638 $3,989,910
Petitioner Nestlé Holdings, Inc., is a corporation organized under the laws of the State of Delaware. It is the parent corporation of a consolidated group of corporations. During the years in issue, Libby, McNeill & Libby, Inc. (Libby), was a member of petitioner’s affiliated group of corporations and it was engaged in the manufacture and sale of canned food products. Libby maintained its books and records on the accrual method of accounting.
In 1981, Libby decided to discontinue certain lines of its canned fruit and vegetable businesses. On March 9, 1982, Libby sold a portion of its canned vegetable inventory to S.S. Pierce Co. (Pierce), a corporation organized under the laws of the State of New York, in exchange for a long-term promissory installment note of Pierce in the amount of $25 million, 1,500 shares of preferred stock of Pierce having a redemption price of $15 million, and a short-term promissory note of Pierce in the amount of $10,707,387. The combined face amounts of the notes and the redemption value of the preferred stock equaled the direct cost of Libby in the inventory that it sold.
The preferred stock had the following rights, preferences, and limitations:
1. Dividends. Dividends on the stock were to be paid when and as declared by the board of directors, but only out of surplus legally available for the payment of dividends, at the rate of $500 per share per annum, payable quarterly. The dividends were cumulative, in that if, for any quarter, they were not paid at the $500 per annum rate, the deficiency was to be fully paid before a dividend could be declared on any common stock, or on any other preferred stock of the same or junior parity. However, no dividends were payable on the stock unless dividends had been fully paid on certain other classes of preferred stock.
3. Mandatory Redemption. Pierce was obligated to redeem the preferred stock on the following terms:
a. As of the first day of each fiscal quarter of Pierce beginning on or after February 1, 1987, Pierce was to calculate and report to the preferred stockholders the ratio of its total shareholders’ equity to its average total assets for the preceding 4 fiscal quarters (asset ratio). To the extent that the asset ratio exceeded 30 percent, Pierce was to redeem the preferred stock at the rate of $10,000 per share up to a maximum of $1.5 million for any 4 consecutive quarters. Pierce was also to pay the holders of any redeemed preferred stock any dividends accumulated on it up to the date of redemption. Payments for the redemption and accumulated dividends were to be made within 15 days after the asset ratio reports were due to be mailed.
b. All preferred stock outstanding on March 8, 1992, was to be redeemed, and any dividends accumulated on the stock up to that date were to be paid, at that time.
4. Voting and Board Representation. Holders of the preferred stock were entitled to vote as a separate class with respect to:
a. the authorization or issuance of any class or series of stock of the same or senior parity with respect to dividends or liquidating distributions;
b. any change in the preferences and rights of the stock;
c. any change in the preferences and rights of any other class of preferred stock which would cause it to have the same or senior parity with respect to dividends or liquidating distributions; and
d. any merger or consolidation which would have a similar effect.
Whenever an amount equal to 6 full quarterly dividends was in arrears on the stock, its holders were entitled to appoint two extra directors to the board of Pierce.
In calculating its gain or loss from the sale, Libby reported the value of the short-term note at its face value of
Face/redemp tion price FMV determined by Libby Discount from face/redemp tion price used in reporting amount realized
Short-term note $10,707,387 $10,707,387
Long-term note 25,000,000 16,400,000 $8,600,000
Preferred stock 15,000,000 6,100,000 8,900,000
Totals 50,707,387 33,207,387 17,500,000
On its return for the taxable year ending January 1, 1983, petitioner claimed a loss in the amount of $17.5 million (basis, equal to the direct cost of its inventory $50,707,387, less amount realized of $33,207,387). The Commissioner disallowed the loss. Petitioner concedes that Libby should not have discounted the long-term note to fair market value; i.e., it should have included the note at its full face, or $25 million, in calculating the amount realized from the sale of the inventory.
Pierce included the full redemption price of the preferred stock which it issued in calculating its cost of the inventory purchased from Libby.
Later in 1982, Libby sold the long-term note and the preferred stock to petitioner for $22.5 million. In 1983, petitioner sold the note and the preferred stock back to Pierce for the same amount.
Petitioner argues that it should be required to include only the fair market value of the preferred stock of Pierce, rather than its redemption price, in calculating the amount realized from the sale of Libby’s inventory. This is so, contends petitioner, because section 1001(b) defines the amount realized from the sale or other disposition of property to be the sum of any money received plus the fair market value of property other than money received, and because preferred stock is property other than money.
Respondent concedes that the preferred stock is property other than money but maintains that, in the case of an accrual method taxpayer, section 1001(b) must be read in conjunction with section 451, which requires that income be
The pertinent portion of section 1001 provides:
SEC. 1001. DETERMINATION OF AMOUNT OF AND RECOGNITION OF GAIN OR LOSS.
(a) Computation of Gain OR Loss — The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 1011 for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining loss over the amount realized.
(b) Amount Realized. — The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received. * * *
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(c) Recognition of Gain OR Loss. — Except as otherwise provided in this subtitle, the entire amount of the gain or loss, determined under this section, on the sale or exchange of property shall be recognized. [Emphasis supplied.]
(d) Installment Sales. — Nothing in this section shall be construed to prevent (in the case of property sold under contract providing for payment in installments) the taxation of that portion of any installment payment representing gain or profit in the year in which such payment is received. * * *
On its face, the statute establishes a general rule for calculating the amount of gain or loss on the sale or other disposition of property and does not, by its terms, distinguish between taxpayers on different methods of accounting. The only reference in the statute to accounting methods is in subsection (d), relating to and approving the installment method of accounting for certain sales, see section 453 et seq. Nothing in the language of the statute requires an accrual method taxpayer to compute the amount realized any differently than a cash method taxpayer — both would appear to be required to add the amount of money and the fair market value of property other than money, received on the sale or other disposition in order to arrive at the amount realized.
Nevertheless, our cases applying section 1001 do differentiate results according to the accounting method employed by the selling taxpayer. In First Savings & Loan Association v. Commissioner,
We rejected this contention, however, stating that in spite of the above-quoted language of section 1001(b),
an accrual basis taxpayer does not treat an unconditional right to receive money as property received, but rather as money received to the full extent of the face value of the right. * * * The fact that there is always the possibility that a purchaser or debtor may default in his obligation is not sufficient to defer the accruing of income that has been earned. * * * [40 T.C. at 487 ; fn. ref. and citations omitted.]
However, we also observed:
In any event, the petitioner has not shown that the notes, which carried interest at 6 percent per annum, which were secured by first mortgages or first deeds of trust, and which were endorsed and guaranteed by State Guaranty, did not have a fair market value equal to their face amounts. [40 T.C. at 487 .]
Likewise, in Western Oaks Building Corp. v. Commissioner,
Keeping accounts and making returns on the accrual basis, as distinguished from the cash basis, import that it is the right to receive and not the actual receipt that determines the inclusion of the amount in gross income. When the right to receive an amount becomes fixed, the right accrues * * *
the accounts receivable arising from the sales, * * * less the cost of the goods sold, figure in the statement of gross income. If such accounts become uncollectible, * * * the question is one of the deduction which may be taken according to the applicable statute. * * * It is not altered by the fact that the claim of loss relates to an item of gross income which had accrued in the same year.
[292 U.S. at 184-185 . Emphasis in original and citations omitted.]
We pointed out that Spring City Foundry Co. dealt with the accruability of an account receivable arising from the sale of merchandise when the purchase price was immediately due and payable but the actual payment postponed. However, citing First Savings & Loan Association v. Commissioner, supra, we held that even when payment is not due until some time in the future, an accrual method taxpayer not using the installment method must include the amount of the payment in income at the time of the sale, when it acquires the right to receive it. We also held that the face amount of the right, rather than its fair market value, is the amount included in income.
We, nevertheless, held that the cash method taxpayers were not required to include any portion of the accounts in income at the time of sale, but only the amounts of the accounts which were released to them, when released. For such taxpayers, according to our opinion, the right to receive a future payment is not includable in the amount realized under section 1001(b) unless it is the equivalent of cash. To qualify, the right must be embodied in notes, mortgages, or other evidences of indebtedness which are like money in that they are freely and easily negotiable and thus readily change hands in commerce. The evidence showed that there were very few sales of accounts of this type and, with the restrictions placed on them, they did not qualify as negotiable instruments under the Uniform Commercial Code. They were thus not readily negotiable.
Petitioner argues that our opinions are in error in determining the amount realized from a sale based upon the accounting method of the selling taxpayer. According to petitioner’s line of reasoning (1) no such distinction appears in the statute — its language defines the amount realized similarly for all taxpayers; (2) reading section 451 in conjunction with section 1001 is mixing apples and oranges in that section 451, as an accounting provision, tells us when an item of income is to be included in gross income, whereas section 1001 tells us the amount of the item; (3) section 451 cannot apply until we know how much to include in income, which, in the case of a sale, is determined in large part by computing the amount realized; (4) Spring City Foundry Co. v. Commissioner, supra, is not inconsistent with this argument, because .the issue there was not the fair market value of the receivables at the time of the sales,' but the appropriate accrual accounting treatment
We find it unnecessary to pass upon this argument in order to resolve the instant case. Whether our prior cases were correctly decided or not, they do not apply on their
We also agree with petitioner that the position of respondent that the preferred stock must be treated as money received is inconsistent with the treatment of this type of stock in other contexts. For example, preferred stock satisfies the continuity of interest requirement of section 368, John A. Nelson Co. v. Helvering,
A final problem we have with extending the definition of “money received” in section 1001(b) to encompass preferred stock is its great dissimilarity to money in any practical sense. Assuming without deciding that the term includes
in order for an item to qualify as a cash “equivalent,” it must be in the nature of money; that is, it must be convertible into cash at face amount as. a matter of certainty. * * * [R.M. Smith, Inc. v. Commissioner,69 T.C. 317 , 329 (1977), affd.591 F.2d 248 (3d Cir. 1979), cert. denied444 U.S. 828 (1979)].
Certainly, preferred stock does not qualify under this practical definition. To be converted into money, it must be sold, and, even if traded on a national exchange, its market value can vary greatly over short periods of time. Indeed, respondent concedes that the preferred stock is not in fact money but property other than money.
Respondent’s argument concerning the administrative and judicial burdens resulting from having to value the preferred stock in order to calculate gain or loss is almost too disingenuous to require comment. As must be true of any market-based economy, the concept of fair market value has always been part of the warp and woof of our income, estate, and gift tax laws, and concomitantly the necessity of determining the fair market values of numerous assets for equally numerous purposes has always been a vital and unavoidable function of the tax administrative and judicial process. Further, respondent concedes that fair market value must at the very least be determined in every case of an exchange of property by a cash method taxpayer.
We, therefore, hold as a matter of law that redeemable preferred stock received on a sale or other disposition of property is “property (other than money)” for purposes of section 1001(b), regardless of the method of accounting used by the taxpayer, and is to be included in the “amount realized” at its fair market value. Respondent has not conceded that the fair market value of the preferred stock ascribed by Libby ($6,100,000) is correct. It will, therefore, be necessary for the parties to agree upon the fair market value of the preferred stock or submit that question of fact
To reflect the foregoing,
An appropriate order will be issued.
Notes
Unless otherwise indicated, all Rule references are to the Rules of Practice and Procedure of this Court, and all section numbers refer to the Internal Revenue Code in effect for the taxable years in issue.
This ruling holds in part:
The “cash method” tax treatment specified by section 1001(b) * * *, that is, amount realized from sale of property, is the sum of money received and the fair market value of property received, is appropriate unless the taxpayer’s use of a method other than the cash method, for example, accrual method, prescribes a different period or manner for the inclusion of gross income derived from the sale of property. This concept that the provisions of section 1001(b) are subject to the taxpayer’s method of accounting is a reiteration, although not specifically set forth in section 1001(b), of the general rule for the taxable year of gross income inclusion presented in section 451(a). The provisions of section 451(a) also require gross income inclusion for the taxable year of receipt “unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period.” [1979-2 C.B. at 288 ; emphasis in original.]
One issue was whether the taxpayer sold or merely financed the sale of the homes. We found that the taxpayer was the true seller and hence reached the issue discussed in the text. First Savings & Loan Association v. Commissioner,
Respondent did not determine nor did he argue that the preferred stock should be recharacterized as debt under sec. 385.
We do not treat this as a concession of the entire case; rather, we interpret respondent’s argument to be that even though the preferred stock is not in fact money, under sec. 451 and sec. 1.451-l(a), Income Tax Regs., an accrual method taxpayer should treat preferred stock with a mandatory redemption feature as the equivalent of money.