27 T.C. 547">*548 The respondent has determined deficiencies, and by affirmative allegations has claimed additional deficiencies by an amended answer, in income taxes due from the Nashville Corporation (hereinafter referred to as Nashville), as follows:

In his deficiency notice addressed to Avco Manufacturing Corporation the respondent states, among other things, as follows:

The amount of the deficiency stated, plus interest as provided by law, constituting your liability as transferee of assets of The Nashville Corporation, will be assessed against you.

The petitioner, Avco Manufacturing Corporation (hereinafter referred to as Avco), admits liability as transferee if any deficiencies are due.

The deficiencies arise from the respondent's determination that the assets paid into Nashville by Consolidated Vultee1956 U.S. Tax Ct. LEXIS 11">*14 Aircraft Corporation (hereinafter referred to as Convair) in exchange for the entire capital stock of Nashville were acquired in a taxable transaction and that those assets, which had a book value of about $ 20,000,000, acquired 27 T.C. 547">*549 a cost basis of $ 13,526,440.63. This basis was allocated to the various assets, according to what he contends was relative value, by the respondent. When certain of the assets, principally accounts receivable and inventories, were disposed of during the taxable years, the respondent contends that Nashville realized a profit.

The petitioner contends that the assets acquired by Nashville had a basis of not less than their book value which, when adjusted to include the restored basis of "emergency facilities," was $ 20,760,880.81, or that the assets were acquired in a nontaxable exchange and thereby acquired the basis of their transferor, Convair. Petitioner presses this latter contention only in the alternative that we should reject its contention as to the actual cost basis of the assets transferred by Convair to Nashville.

The issues raised by the pleadings are as follows:

1. Did the sale of certain assets to Nashville by Convair result in a 1956 U.S. Tax Ct. LEXIS 11">*15 taxable exchange as the Commissioner has determined?

2. Was the cost basis to Nashville of the assets it acquired from Convair $ 13,526,440.63, as the Commissioner has determined, or was it $ 20,760,880.81, as the petitioner contends?

3. Is respondent's allocation of Nashville's total cost basis among the various classes of assets acquired from Convair reasonable and proper, assuming that we sustain his determination that the cost basis was $ 13,526,440.63?

4. Is Nashville entitled to net operating loss deductions for the taxable periods ended November 30, 1948, and April 20, 1949?

The following concessions were made by the parties in the stipulation of facts filed at the trial of this proceeding:

Respondent concedes that adjustments made by the Commissioner relative to "Construction in Progress" on November 6, 1947 -- such adjustments increasing income to Nashville in the amounts of $ 1,021.83 and $ 19,242.03 for the taxable periods ending November 30, 1947 and November 30, 1948, respectively, are erroneous in their entirety.

Petitioner admits that adjustment (a) appearing on page 6 of the revenue agent's report, Exhibit 3-C is correct.

Petitioner admits that it is the transferee 1956 U.S. Tax Ct. LEXIS 11">*16 of the assets of Nashville and is liable as transferee for the amount of any Federal income taxes due from Nashville for the taxable period September 26, 1947 to November 30, 1947, the fiscal year ended November 30, 1948 and the taxable period ending April 20, 1949, * * *

FINDINGS OF FACT.

A stipulation of facts has been filed and is incorporated herein by reference.

The petitioner, Avco, is a corporation with its principal office in New York City. Avco is the transferee of Nashville and admits liability for any deficiency found to be due from Nashville. Nashville was a corporation and it filed income tax returns for the periods involved 27 T.C. 547">*550 herein with the collector of internal revenue for the district of Tennessee.

Avco owned 410,417 shares of Convair's stock, or about 26 per cent thereof, and controlled Convair by reason of having designated a majority of the board of directors. The next largest stockholder of Convair was Atlas Corporation (hereinafter referred to as Atlas) with about 7 per cent of Convair's stock.

After the termination of World War II and the cancellation of many contracts for military aircraft, Convair decided to use its excess working capital to diversify1956 U.S. Tax Ct. LEXIS 11">*17 its activities. It purchased about 48 per cent of the outstanding voting stock of ACF-Brill Motor Co. (hereinafter referred to as ACF-Brill) and about 14 per cent of the stock of Eastern Massachusetts Street Railway Co. (hereinafter referred to as Eastern). Furthermore, in order to utilize the plants and facilities at Nashville, Tennessee, Convair entered into contracts with the Crosley Corporation (hereinafter referred to as Crosley), a subsidiary and later a division of Avco, to produce the latter's entire requirement for ranges and frozen food storage cabinets. Convair also entered into cost-plus contracts with its subsidiary, ACF-Brill, to produce buses and parts for ACF-Brill. In pursuance of this program Convair expended about $ 2,500,000 to July 31, 1947, to acquire the necessary equipment and facilities to convert its Nashville, Tennessee, Division to the production of such products.

Convair suffered unanticipated losses in its postwar aircraft business. It also suffered losses at its Nashville Division due mainly to the shortage of steel and the numerous "starting up" expenses. Convair's working capital was depleted to a great extent so it decided to dispose of its 1956 U.S. Tax Ct. LEXIS 11">*18 nonaircraft assets.

Avco learned that Atlas would not be adverse to the sale under fair and reasonable conditions and it was contemplated that after the proposed sale Atlas would own about 10 per cent of Convair's stock and would control Convair by being allowed to designate a majority of the board of directors.

Nashville was then organized as a Delaware corporation on September 26, 1947, with 820,834 shares of $ 1-par-value common stock. Convair, Avco, and Nashville, on October 3, 1947, executed an agreement of sale which provided: (1) That all of the 820,834 shares of Nashville's stock would be issued to Convair for the assets of its Nashville Division, plus the securities of ACF-Brill and Eastern held by Convair and not included in the assets of the Nashville Division. Nashville would assume the liabilities of the Nashville Division and Convair would transfer cash to Nashville to the extent that the net book value of the Nashville Division (not including the securities of ACF-Brill and Eastern held by Convair) was less than $ 11,302,506. 27 T.C. 547">*551 If the net book value exceeded $ 11,302,506, Nashville would transfer cash to Convair in the amount of the excess. This provision1956 U.S. Tax Ct. LEXIS 11">*19 of the agreement of sale reads as follows:

(e) An amount of cash in addition to the cash on hand and in banks of Nashville Division at date of closing hereunder equal to the amount by which the net book value of the Nashville Division as of the closing date hereunder is less than $ 11,302,506. For the purposes of this computation net book value shall mean the net book value of the assets, less applicable reserves and less liabilities, as determined by Arthur Young & Company, Independent Public Accountants, from the books of the Nashville Division, in accordance with generally accepted principles of accounting. In such determination no value is to be placed upon the fully amortized Emergency Plant Facilities owned by Nashville Division, but said Emergency Plant Facilities are included in the assets transferred under this Article 1.

(2) Convair would issue to all of its stockholders subscription warrants good for 21 days entitling them to purchase Nashville's stock from them at the rate of 2 shares of Nashville for each 4 shares of Convair held by them at the price of 1 share of Convair plus $ 18 for 2 shares of Nashville. (3) Avco would purchase its pro rata share of Nashville's1956 U.S. Tax Ct. LEXIS 11">*20 stock and, in addition, would purchase all other shares of Nashville not purchased by other Convair shareholders. (4) Avco would dispose of any shares of Convair that it still held after the transfer was completed, market conditions permitting, and provided a reasonable price could be obtained therefor. Avco would also deliver the resignation of the majority of the board of directors that it had designated and would actively participate in the management of Nashville and ACF-Brill.

Atlas agreed not to exercise its right to purchase its proportionate share of the Nashville stock. The shareholders of Convair approved the sale on November 6, 1947, and the transfer between Nashville and Convair took place that day. The warrants were issued and were good until November 28, 1947. Also on that day (November 6, 1947) the majority of the board of directors of Convair, that had been designated by Avco, resigned; the Atlas nominees were then elected to take their place.

As per the terms of the agreement the sale of Nashville's stock was restricted to the Convair shareholders. Pursuant to that agreement Avco acquired 813,202 shares of Nashville's stock on November 28, 1947, and 241 other1956 U.S. Tax Ct. LEXIS 11">*21 Convair stockholders acquired 7,632 shares of Nashville's stock during the period November 6, 1947, to November 28, 1947, inclusive. For the Nashville stock thus acquired by it, Avco, as provided in the contract, transferred to Convair 406,601 shares of Convair's stock and paid Convair $ 7,318,818 cash. Convair had approximately 7,900 shareholders. Convair owned no shares of Nashville's stock at the end of the transaction.

27 T.C. 547">*552 The Nashville stocks or warrants were never listed or traded on any stock exchange. The record indicates that the only transfers of Nashville's stock were those mentioned above.

The closing price of Convair's common stock on the New York Stock Exchange on November 6, 1947, was 11.875 and the mean of highest and lowest prices was 11.75. Eight hundred shares were traded on that day. During the period November 6 to November 28, 1947, 40,900 shares were traded on the New York Stock Exchange with a mean price of 11.875. During the month of October 1947, 67,300 shares were traded with prices ranging between 15.25 and 11.75.

A list of the assets transferred by Convair to Nashville for all its capital stock and the book value thereof to Convair on November1956 U.S. Tax Ct. LEXIS 11">*22 6, 1947, were as follows:

1956 U.S. Tax Ct. LEXIS 11">*23 All of the assets acquired by Nashville were entered on Nashville's books at their book value per Convair's books on November 6, 1947, except that the stock and warrants of ACF-Brill and the stock of Eastern were set up at a total value of $ 4,169,556 (quoted market value).

27 T.C. 547">*553 The respondent determined the fair market value of Nashville's stock on November 6, 1947, by using the following method:

The respondent determined the cost of the assets Nashville received in the exchange as follows:

Respondent allocated the $ 13,526,440.63 among the various assets received by Nashville as follows:

When Nashville disposed of or depreciated the assets that it received on November 6, 1947, it did so on the basis of the book value, and recorded any gain, loss, or depreciation on that basis. The respondent's notice of deficiencies and amended answer recomputed Nashville's income using the allocated net cost as determined by him as the basis.

27 T.C. 547">*554 The book value of the accounts receivable was stated net (reserve for bad debts deducted). Substantially all of the accounts receivable were due from affiliated companies (Crosley and ACF-Brill). Both of those companies were solvent and substantially all of the receivables were collected at book value in the due course of business, as follows:

The book value1956 U.S. Tax Ct. LEXIS 11">*26 of the inventory was the lower of cost or market. The inventory included raw material, work in process, and finished goods. They were disposed of at at least book value in fulfilling the contracts with the affiliated companies as follows:

Nashville acquired as part of the assets transferred the following accounts from Convair. The amounts listed are the book values of the accounts on Convair's books.

The construction in progress account was closed to the machinery and equipment account as follows:

The balances in the other deferred charges accounts were disposed of in the normal course of business during the periods involved herein.

The emergency plant facilities were acquired between 1940 and 1942. The majority of the facilities were being used in the postwar business. According to the Building Cost Index for that area the 1956 U.S. Tax Ct. LEXIS 11">*27 cost of construction of that type building had risen from an average of about 100.3 in the 1940-1942 period to 157.7 in 1947.

About $ 2,221,000 of the fixed assets other than emergency plant facilities was acquired in the 2 years preceding November 6, 1947, in converting the Nashville plant to peacetime activities. Most of the machinery and equipment was general purpose machinery.

27 T.C. 547">*555 The real estate (building and interest in land) could have been sold for about $ 4,000,000. The machinery and equipment that could be removed could have been sold "under the hammer" for about $ 1,100,000. No realization value was included in the latter amount for machinery that was considered as scrap because of the manner of installation. This machinery had considerable value while it was being used in the plant, as it actually was.

The fair market value of the assets acquired by Nashville on November 6, 1947, was as follows:

1956 U.S. Tax Ct. LEXIS 11">*28 The fair market value of the stock (820,834 shares) Nashville issued for the above assets on November 6, 1947, was $ 19,495,648.06 (market value of assets less liabilities assumed).

OPINION.

We shall take up and discuss the issues in the same order as they appear in our preliminary statement, except issue 1 will be passed over until issue 2 has been decided. Respondent has determined in his deficiency notice that the transfer from Convair to Nashville was a taxable transaction and petitioner does not dispute this, except in the alternative.

Issue 2.

The deficiencies involved herein arise from the respondent's determination that the basis of assets acquired by Nashville in exchange for its capital stock was $ 13,526,440.63. The respondent contends that Nashville acquired the assets in a taxable transaction and therefore did not acquire its predecessor's basis; that their basis was cost; that the cost of the assets was the fair market value of Nashville's stock that was given in exchange for the assets, plus liabilities assumed; and that the fair market value of Nashville's stock was the price that Convair's shareholders paid Convair for it pursuant to the agreement of sale. 1956 U.S. Tax Ct. LEXIS 11">*29 He then contends that the cost thus arrived at should 27 T.C. 547">*556 be allocated among the various assets according to their relative value and that the basis so determined should be used in determining profit or loss upon disposition of any of the assets and in determining depreciation.

The petitioner contends that the sale of Nashville's stock to Convair's shareholders pursuant to the agreement of sale did not reflect the fair market value of that stock because it was not an arm's-length transaction but, on the contrary, was between parties of interrelated interests; that the fair market value of Nashville's stock was the fair market value of the assets received by Nashville in exchange for the stock; that the fair market value of the assets was not less than their book value; and that, assuming the respondent's determination as to the basis (cost) of the group of assets is correct, his allocation among the various assets, namely, the current assets, is incorrect. In the alternative, it contends that Nashville acquired the assets in a nontaxable exchange and therefore it acquired its predecessor's (Convair's) basis. Petitioner, in its brief, states that it only presses this alternative1956 U.S. Tax Ct. LEXIS 11">*30 contention in the event that the Tax Court fails to support its contention as to the fair market value of the assets at the time they were transferred and that that was their cost basis to petitioner.

Assuming that the transfer from Convair to Nashville was a taxable exchange, as we do for the purpose of this discussion, the basis of the assets received by Nashville is cost, sec. 113 (a), I. R. C. 1939, and cost is the fair market value of the stock that Nashville gave in exchange for those assets. Ambassador Petroleum Co., 28 B. T. A. 868, 873 (1933), reversed on another issue 81 F.2d 474 (C. A. 9, 1936); but cf. Philadelphia Park Amusement Co. v. United States, (Ct. Cl., 1954) 126 F. Supp. 184">126 F. Supp. 184, 126 F. Supp. 184">187-189. The determination of fair market value is one of fact. Estate of Leonard B. McKitterick, 42 B. T. A. 130, 136 (1940).

Sales on the open market are usually reliable as evidence of fair market value of the stock. John J. Newberry, 39 B. T. A. 1123, 1129 (1939). However, in the case of a newly formed corporation, where there are1956 U.S. Tax Ct. LEXIS 11">*31 no such sales, the fair market value of the assets received in exchange for the stock is usually considered to be the best evidence of the fair market value of the stock. Gillette Rubber Co., 31 B. T. A. 483 (1934), and cases cited therein. The crux of the respondent's position is that the sale of Nashville's stock by Convair to Convair's shareholders pursuant to the agreement of sale was an arm's-length transaction and that there is no need to look to the value of the assets received by Nashville because that sale reflects the fair market value of the stock.

We are convinced that the agreement of sale did not reflect the fair market value of the Nashville stock. The sale was restricted to the Convair stockholders. That is plain from the facts in the record. 27 T.C. 547">*557 The stock was offered to them so that they could maintain their relative interest in the assets that were transferred to Nashville. The subscription warrants given to the Convair shareholders were only good for 21 days and were probably difficult to sell because they would be valueless to anyone who did not own Convair's stock. (Convair's stock was part of the purchase price of Nashville's1956 U.S. Tax Ct. LEXIS 11">*32 stock.) A sale so restricted cannot be said to be the best evidence of the fair market value of Nashville's stock. Cf. Gillette Rubber Co., supra.

Undoubtedly the sale was fair to the stockholders inter se but it would have been fair to them regardless of the price paid by them so long as they all had equal rights. The fact that Atlas agreed not to subscribe does not indicate that the purchase price equaled fair market value. As a consequence of the sale, Atlas's interest in Convair increased to 10 per cent and it came into control of Convair as Avco bowed out. That was in accordance with the agreement and understanding of the parties. Unquestionably its action in agreeing to the sale and refraining from exercising its subscription warrants was motivated by its desire to gain control of Convair despite its relatively small holdings. The fact that very few of the other shareholders exercised their warrants is likewise not an indication that the purchase price was indicative of fair market value. They were required to put up cash plus some of their Convair shares in order to obtain the shares of Nashville. Those factors doubtless acted as a1956 U.S. Tax Ct. LEXIS 11">*33 deterrent to their purchasing the Nashville stock. At any rate, the facts show that Avco purchased its quota of Nashville's stock and also purchased the remainder, while most of the other stockholders of Convair did not exercise their rights under the warrants which they received.

Since the contract purchase price for Nashville's stock did not reflect the fair market value of that stock we should look to the fair market value of the assets received by Nashville as evidencing the fair market value of the stock. Gillette Rubber Co., supra;C. D. Johnson Lumber Corporation, 12 T.C. 348, 363 (1949). The petitioner contends that the fair market value of those assets is not less than their book value. We think the evidence regarding those assets sustains the petitioner's contention.

We think that under the evidence the current assets were clearly worth their book value. Substantially all of the accounts receivable were due from affiliated solvent corporations whose stock was listed on the New York Stock Exchange. The inventories were valued at the lower of cost or market and were to be used in fulfilling firm contracts (some1956 U.S. Tax Ct. LEXIS 11">*34 of which were cost-plus contracts) with those same affiliated corporations. See Newberry Lumber & Chemical Co., 33 B. T. A. 150, 155 (1935). Some of the contracts were in technical default but the parties favored waiving the existing defaults and settling the claims on a fair and equitable basis. Also, the fact that the accounts receivable 27 T.C. 547">*558 and inventories were later disposed of at face value in the normal course of business is not without significance. Cf. Frischkorn Development Co., 30 B. T. A. 8, 13 (1934), affd. 88 F.2d 1009 (C. A. 6, 1937).

The fixed assets were recorded on the books at cost less depreciation. The reproduction cost of the plant had risen over 50 per cent between the early 1940's, when the plant was built, and 1947. A substantial portion of the machinery was installed in the 2 years prior to the closing date of the sale. These facts, plus the opinion evidence, are good indications that the fair market value of these assets was not less than their book value (cost less depreciation).

The securities of ACF-Brill and Eastern were recorded on the books of Nashville1956 U.S. Tax Ct. LEXIS 11">*35 at the quoted market value at the closing date of the sale. Also the securities of ACF-Brill represented control of that corporation.

The fact that the stock of some of the affiliated corporations involved was selling at less than book value on the various stock exchanges does not require a finding that the fair market value of the Nashville stock was less than book value. In this instance Avco was gaining control of Nashville in addition to the fact that Nashville had assets with a fair market value equal to book value.

As to issue 2, we sustain the petitioner.

Having found for the petitioner on the valuation question there is no need to consider its alternative contention embodied in issue 1.

Also it becomes unnecessary to consider issue 3, which deals with the Commissioner's allocation of $ 13,526,440.63 alleged costs between the different assets which Convair conveyed to Nashville.

As to issue 4, dealing with net operating losses for the taxable periods ending November 30, 1948, and April 20, 1949, the parties seem to agree that the amount of the net operating losses, if any, to which Nashville is entitled will be determined by our Court's decision on the main issue as to the1956 U.S. Tax Ct. LEXIS 11">*36 cost basis of the assets which Nashville acquired from Convair.

Decision will be entered under Rule 50.