Opinion
Docket No. 63331.
1959-10-13
WALTER L. AND HELEN MORGAN, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Andrew B.Young, Esq., and David P. Brown, Jr., Esq., for the petitioners. Edward L. Newberger, Esq., for the respondent.
Andrew B.Young, Esq., and David P. Brown, Jr., Esq., for the petitioners. Edward L. Newberger, Esq., for the respondent.
1. Held, an exchange of the type specified in paragraph (1) of section 112(c), I.R.C. 1939, is a prerequisite to the application of paragraph (2) thereof; held, further, the distributions in liquidation of petitioner husband's wholly owned corporation are not taxable as dividends under section 112(c)(2), 1939 Code, but are taxable to the extent the distributions exceed the cost basis of petitioner's stock as long-term capital gain.
2. Held, section 45 of the 1939 Code does not authorize respondent to treat distributions in complete liquidation of one corporation of which petitioners held 98.33 per cent of the stock as a taxable dividend by another corporation of which petitioner-husband owned 100 per cent of the stock; held, further, distributions made to the petitioners were in complete liquidation of their stock and were not taxable as dividends under section 115(g)(1), 1939 Code, but are taxable to the extent the distributions exceed the cost basis of petitioners' stock as long-term capital gain.
Respondent determined a deficiency in petitioners' income tax for the year 1952 in the amount of $168,442.85. Respondent has conceded that one adjustment was erroneously made. The two issues now before us arise out of the determination by the respondent as to the nature of certain corporate distributions, explained in the statutory notice as follows:
(a) Distributions to you by the following corporations as purported liquidating dividends are held to be essentially equivalent to the distribution of taxable dividends, taxable as ordinary income rather than as long-term capital gains:
+--------------------------------------------------+ ¦Distributing ¦Return in Excess of Bases ¦ +----------------------+---------------------------¦ ¦Corporation ¦Taxable as a Dividend ¦ +----------------------+---------------------------¦ ¦Wellington Corporation¦$212,150.99 ¦ +----------------------+---------------------------¦ ¦Fund Shares, Inc ¦56,425.88 ¦ +--------------------------------------------------+
Petitioners contest both of the foregoing adjustments.
The issues here presented are: (1) Were distributions made by the Wellington Corporation to petitioner Walter L. Morgan during 1952 in the amount of $214,150.99 in complete liquidation of his stock therein, $212,150.99 of which was in excess of the cost basis of his stock, taxable to petitioner as capital gain under the provisions of section 115(c), 1939 Code, as petitioner contends, or did the $212,150.99 in question represent distributions to petitioner essentially equivalent to dividends under section 112(c)(2), as the Commissioner contends? (2) Were distributions made by Fund Shares, Inc., to the petitioners during 1952 in complete liquidation of their stock therein, taxable to them as capital gains to the extent that the amounts received exceeded the cost basis of their stock, as petitioners contend, or was the $56,425.88 in question taxable to petitioners as dividends under section 115(g) (1), as the Commissioner contends?
GENERAL FINDINGS OF FACT.
Facts common and relevant to both issues herein are found under this heading, ‘General Findings of Fact.’ Facts peculiar to each particular issue are found under the subheadings, ‘Issue 1’ and ‘Issue 2.’
A stipulation of facts has been filed and is incorporated herein by reference.
Petitioners are individuals who were during the calendar year 1952, and continue to be, husband and wife, residing at Bryn Mawr, Pennsylvania. Hereinafter Walter L. Morgan is referred to as the petitioner.
Petitioners timely filed their joint income tax return for the calendar year 1952 with the district director of internal revenue, Philadelphia, Pennsylvania.
Wellington Fund, Inc., herein referred to as Fund, Inc., is a corporation organized in 1928 under the laws of the State of Delaware. Since its organization, Fund, Inc., has carried on the business of a balanced mutual fund in the form of an open-end investment company.
The Wellington Corporation, herein referred to as the Corporation, was organized in 1929 under the laws of the State of Delaware. For approximately 20 years prior to April 12, 1952, the Corporation's principal business was providing investment advisory service to Fund, Inc.
W. L. Morgan & Co., herein referred to as the Company, was organized in 1931 under the laws of the State of Delaware. It has, since its organization, served as national sponsor or underwriter, promoter, and distributor of the stock of Fund, Inc. On April 10, 1952, its name was changed to the Wellington Company, hereafter referred to as the Company, and since April 12, 1952, it has supplied investment advisory service to Fund, Inc., as well as continued to serve as national sponsor or underwriter, promoter, and distributor of the stock of Fund, Inc.
Fund Shares, Inc., herein referred to as Shares, was organized in 1948 under the laws of the State of Delaware. Its principal business was the promotion and wholesale distribution of stock of Fund, Inc., in the West and mid-West under a contract with the Wellington Company, formerly W. L. Morgan & Co.
At all times relevant herein, petitioner owned 100 per cent of the outstanding stock in the Corporation and in the Company. Petitioner held 53.33 per cent of the stock of Shares and petitioner's wife (the co-petitioner) held 45 per cent of the stock in Shares. Petitioner and members of his family held 13,500 shares of the approximately 10 million shares of the outstanding stock of Fund, Inc.
At all times relevant petitioner was president and chairman of the board of directors of Fund, Inc., the Corporation, the Company, and Shares.
The board of directors of Fund, Inc., on December 31, 1951, and December 31, 1952, consisted of 11 members whose names, relationships to petitioner, and the periods or relevant times of the existence of the relationships are as follows:
+-----------------------------------------------------------------------------+ ¦Director ¦Nature of relationship ¦Period ¦ +---------------------+---------------------------------------+---------------¦ ¦James S. Benn, Sr ¦Father of Morgan's wife who ¦(Not shown) to ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦died in 1941. ¦1941. ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦ ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦George B. Junkin ¦President of a company of ¦1928-1945 ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦which Morgan was treasurer. ¦(approx.) ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦ ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( Vice pres., the Fund ¦Feb. 27, 1952 ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( Vice pres. & dir. of Investment ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦A. Moyer Kulp ¦( Committee, the Company ¦Feb. 27, 1952 ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( Vice pres. & exec. dir. of Investment¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( Committee, the Corporation ¦Feb. 27, 1952 ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦ ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( Vice pres. & secy., the Fund ¦Feb. 27, 1952 ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( Vice pres. & dir. of Investment ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦Rawson Lloyd ¦( Research, the Company ¦Feb. 27, 1952 ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( Vice pres. & dir. of Investment ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( Research, the Corporation ¦Feb. 27, 1952 ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦ ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( Owner of several companies of ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( which Morgan was treasurer ¦1930 ¦ +---------------------+---------------------------------------+---------------¦ ¦Nicholas S. Ludington¦( Chairman of board of real ¦Prior to and on¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( estate firm through which ¦Feb. 27, 1952 ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( Morgan sometimes ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( purchased properties. ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦ ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦Howard. S. McClurken ¦Partner with Morgan in CPA ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦firm. ¦1926—1948 ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦ ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦Wallace M. McCurdy ¦(No relationship shown) ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦Walter M. Morgan ¦Petitioner—Chairman of board. ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦R. Sanford Saltus ¦(No relationship shown) ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦ ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( Exec. vice pres. & treas., the ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( Fund ¦Feb. 27, 1952 ¦ +---------------------+---------------------------------------+---------------¦ ¦Joseph E. Welch ¦( Secy. & dir., the Company ¦Feb. 27, 1952 ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( Exec. vice pres. & secy., the ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( Corporation ¦Feb. 27, 1952 ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦ ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( Vice pres., the Fund ¦Feb. 27, 1952 ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( Sales manager, W. L. Morgan ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦Alvin J. Wilkins ¦( & Co. ¦Feb. 27, 1952 ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( Vice pres. in charge of ¦ ¦ +---------------------+---------------------------------------+---------------¦ ¦ ¦( distribution, the Company ¦Feb. 27, 1952 ¦ +-----------------------------------------------------------------------------+
The total stockholdings in Fund, Inc., of all of the directors of Fund, Inc., and their families, petitioner excepted, were approximately 17,500 shares. The aggregate holdings of all of the directors and their families, petitioner and his family included, were approximately 0.003 per cent of the outstanding stock of Fund, Inc.
Section 10(a) of The Investment Companies Act of 1940,
which said act is administered by the Securities and Exchange Commission, requires that not more than 60 per cent of the board of directors of an investment company may be the investment advisors of such company, or affiliated persons of the investment advisor, or persons who are officers or employees of the investment company. Section 10b(2) of the same act
Investment Companies Act of 1940, Act of Aug. 22, 1940, ch. 686, title I, sec. 10, 54 Stat. 806.
further provides that if the principal sales underwriter of an investment company is either a director, officer, or employee of the investment company of an affiliated person, the majority of the board of directors must be persons who are neither the principal sales underwriter nor affiliated persons of such principal sales underwriter.
Ibid.
For the purpose of meeting the requirements of The Investment Companies Act of 1940, supra, and regulations of the Securities and Exchange Commission promulgated pursuant thereto,
the following directors of Fund, Inc., were deemed independent directors:
17 C.F.R. 210.6-01 to 210.6-10.
See also the following sections of The Investment Companies Act of 1940, supra, fn. 1:Sec. 2(a)(3), 54 Stat. 791, which defines ‘affiliated person.’Sec. 8(b)(3), 54 Stat. 804, which requires the filing with the Securities and Exchange Commission of the names of all affiliated persons, and of the names and business experience for the preceding 5 years of each officer and director of an investment company upon registration under the Act.Sec. 30(b)(1), 54 Stat. 836, which requires the filing of reports subsequent to registration, so as to keep the information submitted in the application for registration current.
+-----------------------------------------+ ¦James S. Benn, Sr. ¦Howard S. McClurken¦ +---------------------+-------------------¦ ¦George B. Junkin ¦Wallace M. McCurdy ¦ +---------------------+-------------------¦ ¦Nicholas S. Ludington¦R. Sanford Saltus ¦ +-----------------------------------------+
During the years 1943 to 1952 a pronounced trend toward single advisory-sales companies developed in the mutual investment fund industry. The reasons for this trend were:
1. Increased experience under Federal laws enacted in 1933
The Securities Act of 1933, Act of May 27, 1933, ch. 38, Title I, 48 Stat. 74 et seq., as amended; N.B. secs. 12 and 24.
to curb misrepresentation in the sale of stocks had decreased the fear of subjecting the income from performance of the advisory function to the possible liabilities arising from performance of the promotion and sales function. The application of these laws had become sufficiently predictable that during this period insurance against such liabilities became available.
The Securities Exchange Act of 1934, Act of June 6, 1934, ch. 404, 48 Stat. 881 et seq., as amended; N.B. secs. 9(a)(3), (4), and (5), 9(e), 18(a), and 32.
2. Single advisory-sales companies enjoy two sources of income, one based on a percentage of the sales of stock, the other based upon a percentage of the value of the assets of the mutual fund. A decline in one type of income is not necessarily reflected in the other. This combination or stabilization of income permits the continuance, at a sustained level, of either function despite a short-term decline in its income, and the mutual fund so served is benefited by continuity of advisory personnel and sustained sales effort.
3. By combining and stabilizing the income of a single advisory-sales company, its margin of profit can be reduced with a concomitant reduction in the per share management costs to the mutual fund. In the highly competitive mutual investment fund industry, low per share management costs are an incentive to continued shareholding and an inducement to new or increased shareholding.
On February 27, 1952, the board of directors of Fund, Inc., unanimously approved an investment advisory agreement with the Company and submitted the agreement for the approval of the stockholders of Fund, Inc., at their annual meeting on April 9, 1952. The agreement was approved by a majority of the stockholders and was entered into by Fund, Inc., and the Company on April 12, 1952.
As a result of the combination and stabilization of income from the advisory and the sales functions through consolidation of the two functions in the Company, the Company was able to spend more money on sales promotion, expand sales operations into additional markets, decrease its concessions on, and thereby stimulate, large sales of stock, and establish an installment purchase plan.
Issue 1. Wellington Corporation.
For the fiscal year ended May 31, 1951, the Corporation reported income of $305,175.96. No dividends were paid during the fiscal year. During late 1951 and early 1952, an internal revenue agent assigned to examine the Corporation's income tax return discussed the imposition of a surtax upon the accumulated earnings with several representatives of the Corporation. As a result of these meetings, a preliminary formal conference between representatives of the Corporation and the Government was held on February 11, 1952. No agreement was reached.
At a meeting of the board of directors of the Corporation held on March 3, 1952, it was determined that a study of the prospects of obtaining new business to replace the loss of the advisory contract with Fund, Inc., should be made to determine whether the Corporation should continue in business or liquidate. Subsequent to that meeting, several advisory accounts were obtained and petitioner and other officers and directors of the Corporation investigated its business prospects. On May 27, 1952, the board of directors of the Corporation upon written consent of petitioner, its only stockholder, resolved to liquidate because of the failure to obtain sufficient business to justify continued investment.
Subsequent to the adoption of the liquidating resolution, the Corporation sold its office furniture and equipment to the Company for a price set by the Company's firm of accountants as the fair market value thereof. We have no issue as to gain or loss on this sale. The Corporation also transferred to the Company possession of, access to, and the right to make use of certain investment statistical and research material, if not title thereto, without consideration of any kind.
Pursuant to the liquidating resolution of the Corporation's board of directors, which also authorized distribution of the corporate assets, there were made to petitioner distributions on the dates, in the form, and of the fair market value, as follows:
+-----------------------------------------------+ ¦May 27, 1952 ¦Cash ¦$100,000.00¦ +--------------+--------------------+-----------¦ ¦June 1, 1952 ¦U. S. Treasury bonds¦48,906.25 ¦ +--------------+--------------------+-----------¦ ¦Sept. 18, 1952¦Cash ¦65,244.74 ¦ +--------------+--------------------+-----------¦ ¦Total ¦ ¦214,150.99 ¦ +-----------------------------------------------+
The Corporation's accumulated earnings and profits at the time of the above distributions were at least $212,150.99. The distributions were all attributable to the stated liquidating preference of $250,000 for 2,500 shares of preferred stock owned by petitioner, and no part was attributable to the common shares which he owned.
Upon completion of the distributions, petitioner delivered his preferred and common shares to the Corporation for cancellation. Thereafter, the Corporation filed a return of information with respondent, and the State of Delaware, on September 24, 1952, issued a certificate of dissolution.
Petitioner had held all of his stock in the Corporation for more than 6 months preceding the first distribution to him; his cost basis for the stock was $2,000.
In their income tax return filed for the year 1952, petitioners reported the gain of $212,150.99 from the liquidation of petitioner's shares in the Wellington Corporation as long-term capital gains. The Commissioner, in his deficiency notice, determined that the distribution to the extent of $212,150.99 was ‘essentially equivalent to the distribution of taxable dividends.’
Issue 2. Fund Shares, Inc.
As a result of an examination of Shares' income tax returns for 1948 and 1949, Shares and the Company agreed to the allocation of Shares' income, deductions, credits, and allowances to the Company under section 45 for the period September 1, 1948, to April 30, 1950. The Company's returns for 1950 and 1951 reflected the inclusion of Shares' income and expenses in the returns filed by the Company. On these returns, the income, deductions, credits, and allowances of Shares were itemized separately from those of the Company, only the separately shown totals being consolidated and charged or credited to the Company.
Subsequent to the assumption by the independently owned Wellington Distributors, Inc., of the performance of the functions previously performed by Shares, and because Shares had no business prospects, its board of directors resolved on December 15, 1952, to liquidate Shares completely and authorized distribution of its assets to its stockholders, in the form, and of the fair market value, as follows:
+-----------------------------------------------------+ ¦Petitioner ¦Cash ¦$11,386.58¦ +-----------------+------------------------+----------¦ ¦Petitioner ¦1,400 shares of the Fund¦28,980.00 ¦ +-----------------+------------------------+----------¦ ¦ ¦Subtotal ¦40,366.58 ¦ +-----------------+------------------------+----------¦ ¦Petitioner wife ¦Cash ¦34,059.30 ¦ +-----------------+------------------------+----------¦ ¦T. J. Meaney, Inc¦Cash ¦1,261.47 ¦ +-----------------+------------------------+----------¦ ¦ ¦Total ¦75,687.35 ¦ +-----------------------------------------------------+
The stockholders of Shares executed a written consent to the dissolution. Prior to December 31, 1952, the distributions to Shares' stockholders as authorized in the liquidating resolution were made; the stockholders surrendered their shares for cancellation; a return of information was filed with respondent; and on January 19, 1953, a certificate of dissolution was issued by the State of Delaware.
The petitioners had held all their stock in Shares for more than 6 months preceding the first distributions to them. Petitioner's cost basis for his stock was $9,600; petitioner wife's cost basis for her stock was $8,100.
Petitioners reported their gain from the liquidation of the shares which they owned in Fund Shares, Inc., as long-term capital gains. The Commissioner, in his deficiency notice, determined that the distributions to petitioners to the extent of $56,425.88 were ‘essentially equivalent to the distribution of taxable dividends.’
OPINION.
BLACK, Judge:
There is no dispute between the parties as to the amounts of gain which petitioners received from the liquidation of their shares in Wellington Corporation and in Fund Shares, Inc. The dispute is as to how such gains should be treated for taxation.
Issue 1. Wellington Corporation.
The first issue presented is whether the distributions by the Corporation to petitioner in the amount of $214,150.99 were in liquidation of stock or had the effect of taxable dividends to the extent of petitioner's gain on the distribution. Petitioner contends that that portion of the payment in liquidation of his stock in the Corporation which is in excess of the cost basis of his stock is taxable as long-term capital gain under section 115(c).
Respondent contends that the excess is taxable as ordinary income under section 112(c)(2).
SEC. 115. DISTRIBUTIONS BY CORPORATIONS.(c) DISTRIBUTIONS IN LIQUIDATION.— Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. * * *
We agree with petitioner. It is clear from the record that the distributions by the Corporation to petitioner were in complete liquidation of the Corporation. They were made pursuant to a corporate resolution authorizing liquidation and directing distribution of corporate assets. The Corporation was in fact dissolved within 1 year of the distributions and the liquidation served the useful business purpose of dissolving a corporation with no business operations. Thus, literal compliance with section 115(c) has been established.
SEC. 112. RECOGNITION OF GAIN OR LOSS.(c) GAIN FROM EXCHANGES NOT SOLELY IN KIND.—(2) If a distribution made in pursuance of a plan of reorganization is within the provisions of paragraph (1) of this subsection but has the effect of the distribution of a taxable dividend, then there shall be taxed as a dividend to each distributee such share of the undistributed earnings and profits of the corporation accumulated after February 28, 1913. The remainder, if any, of the gain recognized under paragraph (1) shall be taxed as a gain from the exchange of property.
The respondent, however, asserts that the liquidation was but part of a reorganization, that the distribution had the effect of a taxable dividend, and that it must be taxed as ordinary income under section 112(c)(2). That portion of the statute requires that a distribution be taxed as a dividend rather than as capital gain if it (1) is in pursuance of a plan of reorganization, (2) has the effect of a taxable dividend, and (3) is within the provisions of section 112(c)(1).
If we assume, arguendo, that the first two conditions of section 112(c)(2) are met, we must still determine whether the distribution is within the provisions of section 112(c)(1). The distributions which are within the provisions of section 112(c)(1) are those distributions made (1) partly in exchanges solely in kind as set forth in section 112(b)(1), (2), (3), or (5);
(1) If an exchange would be within the provisions of subsection (b)(1), (2), (3), or (5), or within the provisions of subsection (1), of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph or by subsection (1) tobe received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.
and (2) partly in money or other property. The record clearly shows that petitioner received a distribution of money or other property in the liquidation, but we are unable to find any exchange solely in kind as set forth in section 112(b)(1), (2), (3), or (5). Petitioner received nothing other than $214,150.99 in cash and bonds of the United States upon the liquidation.
SEC. 112. RECOGNITION OF GAIN OR LOSS.(b) EXCHANGES SOLELY IN KIND.—(1) PROPERTY HELD FOR PRODUCTIVE USE OR INVESTMENT.— No gain or loss shall be recognized if property held for productive use in trade or business or for investment (not including stock in trade or other property held primarily for sale, nor stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest) is exchanged solely for property of a like kind to be held either for productive use in trade or business or for investment.(2) STOCK FOR STOCK OF SAME CORPORATION.— No gain or loss shall be recognized if common stock in a corporation is exchanged solely for common stock in the same corporation, or if preferred stock in a corporation is exchanged solely for preferred stock in the same corporation.(3) STOCK FOR STOCK ON REORGANIZATION.— No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.(5) TRANSFER TO CORPORATION CONTROLLED BY TRANSFEROR.— No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange. * * *
Respondent, on brief, has cited many cases for the proposition that we should ‘look through form to substance,‘ or see the ‘net effect’ of the transaction here involved. Survaunt v. Commissioner, 162 F.2d 753 (C.A. 8, 1947); Lewis v. Commissioner, 176 F.2d 646 (C.A. 1, 1949); Love v. Commissioner, 113 F.2d 235 (C.A. 3, 1940); Estate of Elise W. Hill, 10 T.C. 1090 (1948); Standard Realization Co., 10 T.C. 708 (1948); Becher v. Commissioner, 221 F.2d 252 (C.A. 2, 1955); and Liddon v. Commissioner, 230 F.2d 304 (C.A. 6, 1956), certiorari denied 352 U.S. 824 (1956). We do not think the cases cited and relied upon by respondent are applicable to the facts in the instant case. It is to be noted that in each cited case there was an exchange of like property plus a distribution of money or other property. The cited cases stated for the proposition that we may and should look carefully to determine the true nature of disputed transactions; they do not stand for the proposition that we may or can manufacture missing links or imagine the existence of operative facts which will either invoke or revoke the application of any statute.
It is undoubtedly true that ‘(t)he underlying purpose of the exemptions in Sec. 112 is to disregard corporate manipulations which do not substantially affect the shareholders' interest in the properties,‘ as the Second Circuit stated in Helvering v. Schoellkopf, 100 F.2d 415, 417, but it is equally true that Congress subjected to the provisions of section 112(c)(2) only those transactions encompassed within section 112(c)(1) and, by reference therein contained, possessing the nature of those transactions clearly and unambiguously set forth in section 112(b)(1), (2), (3), or (5). No matter how broadly or how piercingly we look, we can find no such transaction as is set forth in section 112(b)(1), (2),(3), or (5), whether with or without the ‘boot’ to which section 112(c) addresses itself. ‘In the interpretation of statutes levying taxes it is the established rule not to extend their provisions, by implication, beyond the clear import of the language used, or to enlarge their operations so as to embrace matters not specifically pointed out.’ Gould v. Gould, 245 U.S. 151. We are entitled to consider that the use of the word ‘exchanges' was confined to its ordinary sense, and cannot extend it by implication or enlarge it by construction so as to embrace matters not specifically pointed out in section 112(b)(1), (2), (3), or (5). Edward H. Ellis & Sons v. United States, 187 F.2d 698, 700;Mead Corporation v. Commissioner, 116 F.2d 187, 192.
Here there were no exchanges solely in kind as enumerated in section 112(b) (1), (2), (3), or (5). The shares were surrendered for cancellation in complete liquidation, and the only property received was money or other property. Section 112(c)(2) applies only where (c)(1) applies, and (c)(1) applies only where an exchange would be within one of the provisions expressly mentioned in (c)(1). None of the provisions mentioned in (c)(1) has even remote application. Section 112(c)(1) has no application, and section 112(c)(2) has no application. The situation comes precisely within section 115(c). The amount of the distribution in excess of petitioner's cost basis is not subject to taxation as dividends but is taxable as capital gain. As to this issue we sustain petitioners.
Issue 2. Fund Shares, Inc.
The second issue here presented is whether payments made in redemption of petitioners'stock in Fund Shares, Inc., were payments in liquidation of stock under section 115(c)
and taxable as capital gains, or ‘essentially equivalent to the distribution of a taxable dividend’ under section 115(g)(1)
Relevant portions quoted supra, footnote 8.
and taxable as ordinary income.
SEC. 115. DISTRIBUTIONS BY CORPORATIONS.(g) REDEMPTION OF STOCK.—(1) IN GENERAL.— If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend.
Petitioners contend that the amounts they received were ‘distributed in complete liquidation of a corporation’ and have established that the board of directors of Shares adopted a resolution authorizing the complete liquidation of the corporation and the distribution to petitioners in cancellation of their stock, that Shares was in fact completely liquidated and dissolved within 1 year after the distribution, and that the liquidation served the business purpose of dissolving a corporation with no business operations. Respondent does not contend that there was any reorganization of Shares as he contends there was of the Wellington Corporation. He contends, however, that the net assets of Shares belonged to the Wellington Company and that the distributions were but taxable dividends made by the Wellington Company out of accumulated earnings and profits. To support this contention respondent relied upon two facts: First, that Shares and the Company agreed with an agent of the Internal Revenue Service to treat, for tax purposes, the income of Shares as income of the Company under section 45;
and second, that petitioners held 98.33 per cent of the stock of Shares and that petitioner husband held 100 per cent of the stock in the Company. The respondent concludes from these two facts that Shares was but a sham, that its net assets were the property of the Wellington Company, and that the distributions were in reality a disguised dividend paid out of the Company's accumulated earnings and profits.
SEC. 45. ALLOCATION OF INCOME AND DEDUCTIONS.In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Commissioner is authorized to distribute, apportion, or allocate gross income, deductions, credits, or allowances, between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.
In so concluding, the respondent has exceeded the authority granted by section 45 and has broadened the scope and ignored the purpose of that statutory enactment as set forth in Regulations 118, section 39.45-1(b)(1).
The very fact of the statutory enactment establishes that disregard of corporate entities is an extraordinary legal technique. Acts performed by the respondent under color of authority granted by section 45 which in fact exceed that authority will not be sustained. General Industries Corporation, 35 B.T.A. 615; Chelsea Products, Inc., 16 T.C. 840, affd, 197 F.2d 620 (C.A. 3); T.V.D. Co., 27 T.C. 879. Section 45 authorizes the distribution, apportionment, or allocation of gross income deductions, credits, or allowances; it does not authorize the distribution, apportionment, or allocation of net assets, surplus, or accumulated earnings and profits either specifically or by necessary implication. The purpose of section 45 as set forth in Regulations 118, section 39.45-1(b), is the placing of ‘a controlled taxpayer on a tax parity with an uncontrolled taxpayer’ within the scope of a determination of ‘the true net income from the property and business of a controlled taxpayer.’ Respondent's action herein neither accomplishes such a purpose nor falls within such scope. Respondent's contention that because the income of Shares was taxed as that of the Company, the net assets of Shares which represented accumulated net income belonged to the Wellington Company is a contention that cannot be sustained. We think respondent's contention is wholly without merit. We, therefore, sustain petitioners under issue 2.
Sec. 39.45-1 Determination of the taxable net income of a controlled taxpayer— * * *(b) Scope and purpose. (1) The purpose of section 45 is to place a controlled taxpayer on a tax parity with an uncontrolled taxpayer, by determining, according to the standard of an uncontrolled taxpayer, the true net income from the property and business of a controlled taxpayer. The interests controlling a group of controlled taxpayers are assumed to have complete power to cause each controlled taxpayer so to conduct its affairs that its transactions and accounting records truly reflect the net income from the property and business of each of the controlled taxpayers. * * * The standard to be applied in every case is that of an uncontrolled taxpayer dealing at arm's length with another uncontrolled taxpayer.
Because there are other adjustments not contested,
Decision will be entered under Rule 50.