Kamborian v. Commissioner

*847 The Commissioner determined deficiencies in petitioners' income tax as follows: *848

The *95 cases relate to petitioners' transfer of certain securities to International Shoe Machine Corp. in exchange for its common stock. Specifically in question is whether gain realized by petitioners as a result of that transaction qualifies for nonrecognition under section 351, I.R.C. 1954; if it does not so qualify, a further question is raised as to the amount of such gain, and the answer depends upon the fair market value of the International Shoe Machine Corp. stock received by petitioners in the exchange. Also in issue in docket No. 5832-69 is whether petitioners Jacob S. and Elizabeth Kamborian are entitled to a deduction for a short-term capital loss in the amount of $ 50,000 in 1966.

FINDINGS OF FACT

The parties have stipulated certain facts which are incorporated herein by this reference.

Petitioners Jacob S. and Elizabeth Kamborian were husband and wife at the time of the trial herein. They filed joint Federal income tax returns for the calendar years 1965 and 1966 with the district director of internal revenue at Boston, Mass., and resided in West Newton, Mass., at the time their petition herein was filed. Petitioners Jacob S., Jr., and Nancy M. Kamborian filed a joint Federal *96 income tax return for the calendar year 1965 with the district director of internal revenue at Boston, Mass., and resided in Duxbury, Mass., at the time their petition herein was filed. Petitioners Gene E. and Lisbeth K. Godley filed a joint Federal income tax return for the calendar year 1965 with the district director of internal revenue at Baltimore, Md., and resided in Washington, D.C., at the time their petition herein was filed. Petitioner Michael M. Becka filed an individual Federal income tax return for the calendar year 1965 with the district director of internal revenue at Boston, Mass., and resided in Watertown, Mass., at the time his petition herein was filed.

1. International Shoe Machine Corp. (International) was incorporated in Massachusetts in 1938 and at the time of the trial herein was engaged in the business of manufacturing and leasing shoe machinery *849 and the sale of related supplies. On April 1, 1964, International's articles of organization were amended to provide for a 20 for 1 split of its common stock into two classes of common stock: Class A, $ 1 par, voting stock, and class B, $ 1 par, nonvoting stock. Following an exchange of the preexisting stock for *97 the newly created common stock. International's authorized and issued stock was as follows as of April 1, 1964:

At all times relevant herein, prior to July 10, 1969, International's stock was subject to the following restrictions:

No share of the common stock of the Company hereafter issued shall be sold or transferred by the registered holder thereof until such holder shall have first offered such shares for sale to the Company at the book value of such shares as shown by the Company's statement of assets and liabilities at the end of the Company's fiscal year next preceding the date of such offer. Such book value shall be adjusted to reflect any changes in the capital stock of the Company subsequent to the end of such preceding fiscal year but shall not be adjusted for any other reason. If within sixty days after the date of such offer the Board of Directors shall elect to purchase any or all of such shares, the holder thereof shall thereupon forthwith transfer and assign to the Company the shares so purchased and the Company shall at the same time make payment of the purchase price thereof. If the Board of Directors*98 shall vote not to purchase any or all of such shares or shall fail to elect to make such purchase within said sixty days, the registered holder of such shares within ninety days after the date of such vote or after the expiration of said sixty days, as the case may be, may transfer such shares by sale or otherwise. Said shares shall again become subject to the above restriction after the transfer by the holder thereof as above permitted or after the expiration of said ninety days if not transferred prior thereto. These restrictions shall not be deemed to restrict the transfer of shares to the executor, administrator, legatees or heirs of a deceased shareholder (including as legatee a testamentary trustee and any person entitled to the distribution of assets of a testamentary trust) but except as above provided all shares so transferred shall be subject in the hands of the transferee to the restrictions on transfer herein provided. Notwithstanding the foregoing, any shares of common stock, $ 1 par value, as to which the holders of two-thirds of the shares outstanding and entitled to vote thereon have authorized or ratified the waiving of any or all of the foregoing restrictions on *99 the transfer thereof, shall be transferable by the holder thereof from time to time free of the restrictions so waived. Such waiver and any transfer pursuant to any such waiver may be upon any terms and conditions specified by the shareholders in their authorization or ratification.

On September 1, 1965, prior to the transaction here in question, International's capital stock was held as follows: *850

Jacob S. Kamborian (Jacob) founded International and served as its president at all times relevant herein. Jacob S. Kamborian, Jr., and Lisbeth Kamborian Godley are the children of Jacob and his wife, Elizabeth. Michael Becka (Becka) is not related to the members of the Kamborian family. At the time of the trial herein he had been employed by International or an affiliate since at least 1943 and had served as International's executive vice president and general manager since approximately 1960. As such he was responsible for the operations of *100 all International's departments and reported directly to Jacob, the president of the corporation.

Jacob established the Jacob S. Kamborian Revocable Trust on April 13, 1965. Article I of the "Declaration of Trust" (which identified Jacob as "SETTLOR") set forth the trust's purposes:

ARTICLE I. The SETTLOR has executed this Trust to arrange for the continued management of his equity interests in INTERNATIONAL SHOE MACHINE CORPORATION and its affiliated companies and to create a family protective fund which will provide for the maintenance and comfort of the SETTLOR during his life, and after his death for the benefit of his children and their issue, all in the manner hereafter provided.

Under the trust instrument, Jacob as settlor retained the following powers over trust corpus and income:

ARTICLE VI.

A. During the SETTLOR'S life, except during any period of adjudicated incompetency, the SETTLOR shall have the full right, to be exercised from time to time by a writing or writings signed by him, to be effective when delivered to any trustee in office other than the SETTLOR and if for any reason there shall be no trustee in office other than the SETTLOR, to any beneficiary entitled to receive *101 income or principal under the terms of this trust:

1. To revoke this instrument entirely and to receive from the Trustees all of the trust property remaining after making payment or provision for payment of all expenses connected with the administration of this trust.

2. From time to time to alter or amend this instrument in any and every particular.

3. From time to time to change the identity or number, or both, of the Trustee or Trustees hereunder.

*851 4. From time to time to withdraw from the operation of this Trust any part or all of the trust property.

B. With respect to all policies of insurance at any time deposited hereunder by the SETTLOR and made subject to the terms of this Trust, he reserves full right and authority, to be exercised by him in the manner and during the periods hereinabove in Section A of this ARTICLE VI specified:

1. To sell, assign or hypothecate any or all of said policies.

2. To exercise any option or privilege granted by said policies including the right to change the beneficiaries of any policy.

3. To borrow any sum from the insurer or any individual, partnership, corporation or association.

4. To receive all payments, dividends, surrender values, benefits or privileges *102 of any kind which may accrue on account of said policies.

5. To freely inspect; and to withdraw from this instrument any or all of said policies.

C. At all times during the life and legal competency of the SETTLOR, the Trustees shall distribute to him, or to his written order, whatever part or parts or all of the income and of the principal of the trust fund he shall direct in writing from time to time.

On April 12, 1965, International's board of directors voted to waive the restrictions on the transfer of the corporation's class A and class B common stock to permit Jacob to transfer 20,324 shares of class A common stock and 182,916 shares of class B common stock to the trustees of the Jacob S. Kamborian Revocable Trust. Both at that time and as of September 1, 1965, the trustees of the revocable trust were Jacob, Becka, and Joseph E. Fiore.

The Elizabeth Kamborian Trust (Elizabeth's trust) was established by Jacob in 1949. At about that time Jacob and Elizabeth experienced domestic difficulties; they separated for a time; and the trust was established on their reconciliation in order to provide financial security for Mrs. Kamborian. The initial trust corpus consisted of 2,500 shares *103 of International stock. The trust instrument, dated September 27, 1949, provided for the disposition of trust principal and income in part as follows:

FIRST: To pay over the entire net income of the Trust Fund to my wife, Elizabeth Kamborian, so long as she shall live and upon her death to pay over the principal of this Fund discharged of any trust in equal shares to my son, Jacob L. Kamborian, and to my daughter, Lizbeth N. Kamborian, and to their issue taking by right of representation. If either of my said children shall have died leaving no issue then all of the Trust Fund shall be distributed to the surviving child or to his or her issue if he shall have died leaving issue then surviving. If both of my children shall have died leaving no issue then surviving the Trust Fund shall be distributed four-tenths to my nephew, Luther Kamborian, and to his issue taking by right of representation, three-tenths to the issue taking by right of representation of my step-daughter, Eunice Weisz, and three-tenths to the issue taking by right of representation of my stepdaughter, Venus Yardume. The share of any person or group of persons named in the previous sentence who shall have predeceased *104 my said wife shall be added *852 pro rata to the shares of the other persons or group of persons hereinabove named. If none of the persons named in this Article shall survive my said wife then the trust fund shall be distributed to those persons who would be my heirs-at-law if I had died intestate a resident of Massachusetts on the date of my wife's death.

* * * *

I direct that no part of the principal of the trust fund herein established nor of the income accruing thereon shall be assignable by the beneficiaries hereunder or payable by anticipation and that the interest of every such beneficiary hereunder shall be free from interference and attachment or control of creditors.

The trust instrument granted the trustees the following powers:

SECOND: In addition to any and all powers otherwise conferred on my said Trustees hereunder or by law and without in any way intending to limit the same said Trustees shall have the following powers to be exercised by them in their absolute and final discretion.

(a) Power to sell any and all of the property constituting the trust fund whether real or personal at public auction or private sale without the necessity of applying to any court for leave so to *105 do and to execute and deliver all instruments of transfer which may legally be necessary or proper therefor no purchaser from said trustees to be bound to see to the application of the purchase money.

(b) Power to invest and reinvest from time to time any money or property in such manner and at such time as may be deemed expedient and to purchase at any time or hold any securities or property of any kind even though the same be unproductive of income or be of a kind not usually considered suitable for trustees to select or hold in the absence of express authority and to purchase at any time or hold a larger proportion in any one investment than trustees should ordinarily purchase or hold including power to purchase or hold securities which excepting for the provisions of this paragraph would be considered unsuitable for two or more of the reasons above enumerated.

(c) Power to sell or transfer any securities or property constituting the trust fund to any corporation partnership or association in exchange for all or any part of the stock bonds notes shares or certificates of beneficial interest of such corporation partnership or association and to become party to or under plans of reorganization *106 or consolidation of any one or more corporations or other enterprises in which the trust fund or any portion of it may be invested and to buy or sell and/or exercise rights of subscription to stock or other securities of any corporation partnership or association and power to do any one or more of these acts whether or not said trustees are or may be interested as officers stockholders partners or otherwise in any such corporation partnership or association.

(d) Power to vote in person or by proxy upon any stock or shares for any purpose whatsoever including the purpose of electing any one or more of said trustees or of the beneficiaries herein named to any office or offices in any corporation partnership or association.

(e) Power to enter into any and all contracts guarantees and obligations which in their opinion may be expedient and power to deal with the trust fund and to manage control and conduct the affairs of the trust as fully and as *853 freely as if said trustees were the absolute owners of the securities and property constituting said fund.

The trustees were also expressly authorized to cooperate with the other stockholders of International in providing for its management and *107 continued operation:

THIRD: In creating the trust herein provided for I expressly contemplate that my interest in the manufacturing enterprises with which I am associated will constitute the major portion of the trust property and that my Trustees may find it necessary in cooperation with other stockholders to provide for the management and continued operation of some or all of these enterprises. I expressly authorize my Trustees or any one or more of them to become officers of such enterprises to participate in their management and to receive from such enterprises compensation for their services as officers in addition to any compensation to which they may be entitled as trustees of this trust.

I further contemplate that my son Jacob L. Kamborian may wish to become associated with some or all of said enterprises. It is my wish that my Trustees shall cooperate in giving him every opportunity to so associate himself as soon as they deem it appropriate for him to do so and to assume increasing responsibility and authority in the management of said enterprises as rapidly as he shows ability so to do.

I further expressly authorize my trustees in their discretion to sell to my said son at *108 any time or from time to time any part or all of the securities representing the ownership of the trust in any of said enterprises and to accept in whole or in part payment therefor promissory notes or other obligations of my said son with or without security and upon such other terms and conditions as my trustees in their sole judgment shall deem appropriate.

In addition, Jacob was authorized to appoint a successor trustee if any trustee should die or resign. As of September 1, 1965, Becka and Lisbeth K. Godley were the trustees. Jacob had appointed them as successor trustees in 1963 and 1964, respectively. At all times relevant herein, Becka served as the managing trustee; Mrs. Godley did not live in Boston during this period; and periodically Becka informed her of the trust's activities. As of September 1, 1965, the only assets of the trust were 5,000 shares of International's class A common stock and 45,000 shares of its class B common stock.

As of September 1, 1965, International's board of directors consisted of Jacob, Jacob, Jr., Albert Kamborian (Jacob's brother), Becka, Paul Hirsch II, Harold V. Daniels, and Roy S. Flewelling.

Campex Research & Trading Corp. (Campex), a Swiss *109 corporation with its principal place of business in Zug, Switzerland, was a patent holding and licensing company. It held primarily foreign shoe machine patents (i.e., patents not issued by the United States) and granted and administered licenses under them in a number of European countries and in Mexico. On September 1, 1965, and prior to the transaction here in question, the outstanding stock of Campex was held as follows: *854

On September 1, 1965, the board of directors of International authorized Jacob to enter into an agreement under which (a) the owners of all of the issued and outstanding shares of Campex would exchange their stock for common stock of International and (b) "certain stockholders" of International would purchase for cash additional shares of International's common stock. The vote of the board of directors declared in part as follows:

VOTED: That this corporation approved and adopt the proposed agreement between this corporation, the owners of all of the issued and outstanding shares of Campex Research and Trading Corporation, a Swiss corporation, and *110 certain of this corporation's stockholders, a copy of which agreement was presented and read to the meeting and was ordered to be appended to the minutes of this meeting pursuant to which all of the issued and outstanding shares of Campex Research and Trading Corporation would be contributed by the owners thereof to this corporation and certain stockholders of this corporation would purchase for cash additional shares of this corporation's common stock;

As part of the transaction it was contemplated that the Elizabeth Kamborian Trust would purchase additional shares of theretofore unissued International stock for about $ 5,000, so that the former owners of the Campex stock and the Elizabeth Kamborian Trust, when considered collectively and treated as transferors under section 351 (a), I.R.C. 1954, would own at least 80 percent of International's stock immediately after the transaction in an attempt to comply with the requirements of section 368 (c), I.R.C. 1954. If the Elizabeth Kamborian Trust were not taken into account, the International stock held by the former owners of Campex immediately after the transaction amounted to 77.3 percent of each class of outstanding stock of International *111 -- an amount that was insufficient to satisfy the requirements of section 368 (c).

The agreement authorized by International's board of directors was executed on September 1, 1965, and provided in part as follows:

AGREEMENT made this first day of September, 1965, by and between INTERNATIONAL SHOE MACHINE CORPORATION, a Massachusetts corporation, having an usual place of business in Boston, Suffolk County, Massachusetts, (hereinafter referred to as ISMC) and Jacob S. Kamborian, Michael M. Becka, Joseph Kazarosian and Joseph E. Fiore as they are Trustees of the Jacob S. Kamborian Revocable Stock Trust under a Declaration of Trust dated April 13, 1965 (hereinafter referred to as the Trustees) and Jacob S. Kamborian, Jr. of Duxbury, Plymouth County, Massachusetts (hereinafter referred to as Kamborian, Jr.) and Lisbeth M. Godley of Washington, District of Columbia (hereinafter referred to as Godley) and Michael M. Becka of Cambridge, Middlesex County, Massachusetts (hereinafter referred to as *855 Becka) and Lisbeth M. Godley and Michael M. Becka as Trustees under an Indenture of Trust established for the benefit of Elizabeth Kamborian dated September 27, 1949 (hereinafter referred to as the *112 Elizabeth Kamborian Trustees)

WITNESSETH:

* * * *

Whereas the Trustees, Kamborian, Jr., Godley and Becka collectively are the owners of the entire and issued outstanding stock of Campex and are collectively the owners of approximately 75.6 percent of I.S.M.C.; and

Whereas the Elizabeth Kamborian Trustees are the owners of approximately 13.4 percent of I.S.M.C.; and

Whereas the Trustees, Kamborian, Jr., Godley and Becka desire to contribute their shares of Campex to I.S.M.C. in exchange for shares of the common stock of I.S.M.C.; and

Whereas the Elizabeth Kamborian Trustees desire to purchase additional shares of the common stock of I.S.M.C.; and

Whereas I.S.M.C. is willing to exchange shares of its common stock for the shares of Campex and is also willing to sell additional shares of I.S.M.C. to the Elizabeth Kamborian Trustees;

Nowtherefor, in consideration of the mutual promises and convenants herein contained, and on either parties part to be performed, the parties hereto hereby agree as follows:

1. The Trustees, Kamborian, Jr., Godley and Becka agree to contribute the aggregate of fifty (50) shares of Campex owned by them to I.S.M.C., and I.S.M.C. agrees to accept the same and to issue *113 in exchange therefor shares of its common stock as hereinafter set forth. * * * It is further agreed that the value of said fifty (50) shares of Campex as of the date of this Agreement is Two Hundred Seventy-Four Thousand Four Hundred Fifty-Three ($ 274,453.00) Dollars or Five Thousand Four Hundred Eighty-Nine and 06/100 ($ 5,489.06) Dollars per share and further the value of the common stock of I.S.M.C. for purposes of this exchange twelve ($ 12.00) per share. Based upon the foregoing valuations, it is agreed that the contribution of the shares of Campex to I.S.M.C. and the exchange of I.S.M.C. shares will be made on the basis of 45.74 shares of Class A common Stock and 411.68 shares of Class B stock for each share of stock of Campex contributed hereunder.

Using this ratio, I.S.M.C. hereby agrees to issue to the Trustees, Kamborian, Jr., Godley and Becka, the following number of shares of its common stock upon receipt by I.S.M.C. of said fifty (50) shares of Campex.

2. Elizabeth *114 Kamborian Trustees simultaneously with the contributions of the shares of Campex as described in Paragraph 1 agree to purchase 42 shares of Class A stock of I.S.M.C. and 376 shares of the Class B stock of I.S.M.C., and I.S.M.C. agrees to sell the same to said Trustees at a purchase price of twelve ($ 12.00) dollars per share, i.e. for Five Thousand Sixteen ($ 5,016.00) dollars.

3. I.S.M.C., the Trustees, Kamborian, Jr., Godley and Becka hereby agree that *856 the contribution and exchange described in Paragraph 1 hereof shall be made simultaneously with the purchase by the Elizabeth Kamborian Trustees of the shares of I.S.M.C. as set forth in Paragraph 2 hereof.

4. It is contemplated that immediately after consummation of the exchanges and purchases specified herein that the individuals and Trustees who are a party to this agreement shall be the owners of at least eighty (80%) percent of the then issued and outstanding common stock of I.S.M.C. as reflected in the following table:

International acquired Campex stock as part of its program of preparing for a public issue of its stock. On the advice of underwriters and other specialists, it was thought that ownership of foreign patents would enable International to display worldwide activities which would be of value in establishing the price of the public issue. If the contemplated public offering had been made, it would also have been necessary to remove existing restrictions on the sale of International's stock. As of September 1, 1965, no date had been set for the offering and at the time of the trial herein the public offering had not yet been made.

As vice president and general manager of International, Becka participated from the beginning in the planning of the acquisition of the Campex stock. Moreover, during 1964 and 1965, Jacob was seriously ill for an extended period of time, underwent a number of operations, and *116 was hospitalized for a number of months. For approximately 9 months he was on his back and for a year thereafter he was "very *857 limited" in what he could do. During this period Becka was in charge of International's affairs, and it was at about this time that International acquired the Campex stock. During the course of planning for the transaction, International received legal advice with regard to qualifying the acquisition as a tax-free exchange, and the "variations of tax free exchange of stocks were discussed at some length."

As trustee of Elizabeth's trust, Becka borrowed approximately $ 5,000 at an interest rate of 6 percent in order to finance the trust's purchase of the total of 418 shares of International stock on September 1, 1965. The corpus of the trust consisted exclusively of International stock, and Becka anticipated that the loan would be repaid out of dividends paid on the stock. In deciding to acquire additional International stock, Becka also anticipated that International would make a public offering which might enhance the value of the stock.

Prior to the purchase of the International stock on behalf of the trust, Becka discussed his plans with both Jacob and *117 Elizabeth. Jacob, personally and as grantor of the Jacob S. Kamborian Revocable Trust, held a sufficient number of International shares to control the corporation and thus to determine whether it would issue additional shares. In his discussions with Elizabeth, Becka explained that because the $ 5,000 loan would have to be repaid out of dividends paid on the International stock held by the trust, her income from the trust would be diminished until the loan was repaid. Elizabeth told Becka to go ahead with the transaction.

During 1964 and 1965 Jacob maintained a residence for himself, his wife, and her two daughters (by a previous marriage) in West Newton, Mass. Also, during this period International paid Elizabeth $ 1,000 per month. Such amounts were charged to Jacob's salary.

During the years 1959 through 1964 International declared and paid dividends as follows:

During the same period International's *118 annual gross income and earnings per share (based on 372,000 shares of common stock), its net worth, and its cash and securities were as follows. Comparable figures for the first 6 months of 1965 are also listed below. *858