Drummond v. Commissioner

Memorandum Findings of Fact and Opinion

FISHER, Judge: Respondent determined deficiencies in petitioners' income taxes for the years and in the amounts as follows:

The only significant issue is whether the fair market value of Quality Foods Co-Operative, Incorporated, notes received by petitioners in 1957 and 1958 in exchange for revolving fund certificates issued by the Co-Operative was less than that determined by respondent.

Findings of Fact

The petitioners, William M. Drummond and Ruby B. Drummond, are husband and wife who reside in Amherst, Virginia. They filed timely joint income tax returns for the taxable years 1957 and 1958 with the district director of internal revenue at Richmond, Virginia.

Petitioners, during the years here involved, *240 owned and operated a retail grocery store in Amherst, Virginia, doing business in the name of "Drummond Cash Store." The petitioners maintained their books of account and reported income from this business on the accrual method of accounting.

From some time prior to 1950 and continuing through the taxable years 1957 and 1958, petitioners were stockholder members of Quality Foods Co-Operative, Incorporated, (hereinafter referred to as the Co-Operative), Lynchburg, Virginia. The Co-Operative conducts a wholesale grocery business for the sale of merchandise exclusively to its members.

Article XVII, section 4, of the bylaws of the Co-Operative provides as follows:

All profits received by the Co-Operative during each year over and above the cost of operating the said Co-Operative shall be placed in a revolving fund, which shall be rebated to the members of record at the end of the year, in cash or Revolving Fund Certificates in proportion to their purchases, as shall be determined by the Board of Directors.

Pursuant to the above quoted section of its bylaws, the Co-Operative issued to the petitioners Revolving Fund Certificates for 1957 and 1958 in the following amounts:

*241 Simultaneously with the issue of the Revolving Fund Certificates, the Co-Operative called the certificates for retirement and gave the petitioners its registered notes in exchange therefor. Each of the notes was made payable to the petitioners or their executors, administrators, successors, or assigns and bore interest at two percent per annum from date, payable at maturity.

The first note dated March 21, 1957, for $2,279.03, is payable March 15, 1965, and the second note dated March 31, 1958, for $2,135.50, is payable March 31, 1966. It is stated on the face of each note that the Co-Operative reserves the right to pay the note at any time prior to maturity with interest at two percent to date of payment. Each note also contains the following provision:

This note is and shall be junior and subordinate to all other debts of the Association, both secured and unsecured. Upon the winding up or liquidation of the Association in any manner, after full payment to all its other creditors, this note, if then outstanding, shall be retired in full, with interest as aforesaid, or on a pro-rata basis without priority. This note is non-negotiable.

The balance sheets of the Co-Operative for*242 the years 1952 through 1958 as of December 31 of each year are as follows:

QUALITY FOODS CO-OPERATIVE, INCORPORATED

Balance Sheets

As of December 31, 1952 through 1956, inclusive

*243 QUALITY FOODS CO-OPERATIVE, INCORPORATED

Balance Sheets

As of December 31, 1957 and 1958

*244 Profit and loss statements for the Co-Operative for the years 1952 through 1958 are as follows:

QUALITY FOODS CO-OPERATIVE, INCORPORATED

Condensed Profit and Loss Statement 1952 through 1958, inclusive

Opinion

Respondent, in*245 his statutory notice of deficiency for 1957, made the following explanation:

(a) It is held that the note received by you in 1957 from Quality Foods Co-Operative, Incorporated, representing purchase rebates or patronage dividends, is includible in taxable income in the year of receipt to the extent of its fair market value or $1,428.95 ($2,279.03 X.627).

Respondent's determination for 1958 contained substantially the same statement except for the amount and ratio applied which, for 1958, were as follows: Fair market value of $1,338.96 ($2,135.50 X.627).

Petitioners claim that the notes had no fair market value in the years in question. The burden lies with petitioners to demonstrate error in respondent's determination. Petitioners do not suggest any intermediate amount less than determined by respondent but more than zero.

There is no difference in the principles involved as between 1957 and 1958 and the two years will be considered together.

There are a multitude of authorities on the subject of fair market value, but each is based upon the circumstances involved in the particular case. Essentially, as here, the issue is one of fact, and a detailed analysis of the authorities*246 would be fruitless.

In projecting their position, petitioners take some pains to discuss the financial status of the Co-Operative. Balance sheets and condensed profit and loss statements for the years material are set forth in our Findings. The financial condition of the Co-Operative is, of course, a factor to be considered. In the instant case, the financial statements only serve to indicate that the notes had intrinsic value, and fail to demonstrate absence of fair market value.

Petitioners also urge that the conditions set forth in the notes eliminate the possibility of fair market value. These conditions, which are set forth in our Findings, are also factors to be considered but are not of themselves controlling in support of petitioners' claim of complete absence of fair market value.

Petitioners' greatest reliance was placed upon the testimony of a well-known banker, who was offered as an expert witness. He made a very favorable impression, and we have no doubt of his objectivity and credibility. However, it is clear from his testimony that he had no knowledge of or experience with the notes in question, and could go no further than to say that his bank would not have discounted*247 the paper. Moreover, he did not know, and was not advised, of the meaning of the term "fair market value" for the purposes of this case, and there was no basis on which he could offer an opinion. That a bank would not discount a note of the character of those here involved is not surprising, but falls short of demonstrating that there was no fair market value for the notes.

Finally, petitioners make a somewhat general statement concerning the possible application of the Sixteenth Amendment. We find neither facts nor law to support the contention as applied to this case.

In the light of the foregoing discussion, we must hold that petitioners have failed to sustain the burden of proof of error in respondent's determination.

Decision will be entered under Rule 50.