Opinion
Docket No. 1271-62.
1964-04-23
CHARLES SWAN AND JOSEPHINE SWAN, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Charles F. Hartsock, for the petitioners. W. Dean Short, for the respondent.
Charles F. Hartsock, for the petitioners. W. Dean Short, for the respondent.
On August 17, 1955, petitioners received $39,800 from Swan, Inc., their wholly owned corporation, except for qualifying shares, which was designated as payment for the stock of Charles, Inc., which was also wholly owned by petitioners, except for qualifying shares. Over a period of years Swan, Inc., had made numerous loans to Charles, Inc. Held: Petitioners have failed to meet their burden of proving that what was in form a redemption under section 304, I.R.C. 1954, was in substance repayment of a loan to one of the petitioners, as alleged by them. The distribution of $39,800 to petitioners was essentially equivalent to a dividend under section 302 and hence taxable as a dividend under section 301.
The Commissioner determined a deficiency in petitioners' income tax for the taxable year ended December 31, 1955, in the amount of $24,437.40; of this amount, $1,163.69 constituted an addition for negligence under section 6653(a) of the Internal Revenue Code of 1954.
At issue is whether $39,800 received by petitioners in 1955 from a corporation, substantially all of the stock of which was owned by them, in redemption of stock of another corporation was taxable as a distribution essentially equivalent to a dividend under the provisions of sections 301, 302, and 304 of the Internal Revenue Code of 1954. Petitioners have not contested the section 6653(a) addition to tax.
FINDINGS OF FACT
Some of the facts have been stipulated; the stipulation and accompanying exhibits are incorporated herein by this reference.
Petitioners, husband and wife, residing in Sarasota, Fla., timely filed their joint income tax return with the district director of internal revenue, Jacksonville, Fla., for the calendar year ended December 31, 1955.
Prior to 1955 petitioners resided in the Cincinnati, Ohio, area, in nearby Kentucky. During 1955, and for a number of years prior thereto, they owned all of the outstanding capital stock, except qualifying shares, of Swan Construction, Inc., referred to hereinafter as Swan, Inc., an Ohio corporation engaged in the heavy construction business. Charles Swan, hereinafter referred to as petitioner, was the president and a member of the board of directors of Swan, Inc. He actively participated in the management of Swan, Inc., and was primarily responsible for its success.
During the period May 31, 1952, to January 15, 1954, Swan, Inc., issued salary checks to petitioner as compensation for his services as president in the aggregate net amount of $39,377.80, after withholding for taxes. Although petitioner reported such compensation in his returns for the years in which the checks were received, and paid tax thereon, he did not cash or otherwise use them prior to January 25, 1954.
Around the early part of 1954, or prior thereto, petitioner became interested in a possible real estate development venture on property in the vicinity of Alexandria, Va. He made several trips to Alexandria and conferred with a lawyer who advised him to form a Virginia corporation for this purpose rather than to undertake the project through Swan, Inc. Accordingly, Charles Associates, Inc., hereinafter referred to as Charles, Inc., was incorporated for that venture under the laws of Virginia on February 2, 1954. Its total 400 shares of stock were issued pursuant to subscriptions received March 29, 1954, at a stated price of $100 per share as follows: 200 shares to Josephine Swan, 198 shares to Charles Swan, 1 share to Ann Brooks (bookkeeper for the project), and 1 share to Gilbert Frazee (associated with petitioner in the construction business). With the exception of the two qualifying shares, all of the stock of Charles, Inc., was owned continuously by petitioners up to August 17, 1955.
The funds required for the acquisition of the Charles, Inc., stock were supplied in the following manner: On January 25, 1954, petitioner went to the First National Bank of Cincinnati, Ohio, with his aforementioned theretofore uncashed salary checks in the aggregate amount of $39,377.80; he then cashed these checks, and used the proceeds together with a personal check and a small amount of additional cash, to purchase a $40,000 cashier's check at that bank; shortly thereafter he deposited this cashier's check in a Washington, D.C., bank for use in connection with the Virginia project; and subsequently transferred the funds in that account to an account in another Washington bank in the name of Charles Associates, Inc.
On January 26, 1954, petitioner entered into a contract for the purchase of 46.2983 acres of land in Fairfax County, Va., the land that was subsequently to be developed by Charles, Inc. The record does not disclose what portion, if any, of the foregoing $40,000 was used by petitioner in connection with this contract. He subsequently assigned this contract to Charles, Inc., for ‘One Dollar ($1.00) and other valuable consideration.‘
At some time, not clearly fixed in the record, a document on a printed form, dated February 3, 1954, was executed, reading as follows:
+-----------------------------------------------------------------------------+ ¦$40,000 ¦Cincinnati, Ohio, February 3, 1954 ¦ +---------------------------+-------------------------------------------------¦ ¦------- ¦---------------- ¦ +-----------------------------------------------------------------------------¦ ¦Josephine On Demand or Chas Swan after date,I,WE, OR EITHER OF US, ¦ ¦promise to pay to the order of XXXXXXXXXX the sum of --- ¦ ¦Forty Thousand and ----- 00/100 --- Dollars, Payable at XXXXXXXXXX with ¦ ¦interest at the rate of ___ per cent per annum from date/maturity. ¦ +-----------------------------------------------------------------------------¦ ¦The makers and endorsers hereof severally waive presentment, demand for ¦ ¦payment, notice of dishonor, protest and notice of nonpayment and protest of ¦ ¦this instrument, and agree and consent to all extensions and/or renewals ¦ ¦which the holder hereof may grant. ¦ +-----------------------------------------------------------------------------¦ ¦ ¦(signed) Chas Swan ¦ +---------------------------+-------------------------------------------------¦ ¦VALUE RECEIVED. ¦Swan Construction Inc. ¦ +---------------------------+-------------------------------------------------¦ ¦ ¦---------------------- ¦ +---------------------------+-------------------------------------------------¦ ¦ ¦(signed) G.J. Frazee, Treasurer ¦ +---------------------------+-------------------------------------------------¦ ¦ ¦---------------------- ¦ +-----------------------------------------------------------------------------+
The makers and endorsers hereof severally waive presentment, demand for payment, notice of dishonor, protest and notice of nonpayment and protest of this instrument, and agree and consent to all extensions and/or renewals which the holder hereof may grant.
(signed) Chas Swan
VALUE RECEIVED. Swan Construction Inc.
(signed) G. J. Frazee, Treasurer
The words ‘Josephine‘ and ‘or Charles Swan‘ were inserted by hand in the note in the places appearing above; they were in the handwriting of Charles Swan. The X's appearing above deleted the words, ‘THE FIRST NATIONAL BANK OF CINCINNATI, OHIO’ in the two places where the X's appear.
The books of account of Swan, Inc., which were submitted in evidence do not reflect any liability on a note relating to the foregoing document, nor is there any mention of such a loan in the corporate minutes of Swan, Inc., placed in evidence.
An entry, bearing the date ‘Apr’ 1954, was made in the cash receipts journal of Charles, Inc., to indicate the receipt of cash from Swan, Inc., in the amount of $40,000 and a corresponding credit was made to ‘Notes Pay.‘ The words ‘Notes Pay‘ were subsequently crossed out and the words ‘Capital Stock‘ inserted in their place.
In the early part of April 1954, petitioner received two checks totaling $35,000 from Swan, Inc., which he loaned to Charles, Inc. A note was later issued by Charles, Inc., to Swan, Inc., and petitioner was given credit for a loan to Swan, Inc., on its books.
The real estate venture in Virginia conducted by Charles, Inc., required substantial amounts of capital for labor, material, and equipment. During the period May 1, 1954, through March 10, 1955, Swan, Inc., made interest bearing loans for such purposes to Charles, Inc., upon promissory notes in the following amounts:
+------------------------------------+ ¦Date: ¦1954 ¦Amount of note ¦ +------------+------+----------------¦ ¦May 1 ¦ ¦$5,978.55 ¦ +------------+------+----------------¦ ¦May 13 ¦ ¦2,401.51 ¦ +------------+------+----------------¦ ¦June 3 ¦ ¦20,000.00 ¦ +------------+------+----------------¦ ¦June 8 ¦ ¦5,000.00 ¦ +------------+------+----------------¦ ¦June 14 ¦ ¦12,423.59 ¦ +------------+------+----------------¦ ¦June 23 ¦ ¦5,000.00 ¦ +------------+------+----------------¦ ¦June 28 ¦ ¦5,000.00 ¦ +------------+------+----------------¦ ¦July 10 ¦ ¦4,225.42 ¦ +------------+------+----------------¦ ¦July 21 ¦ ¦15,000.00 ¦ +------------+------+----------------¦ ¦August 5 ¦ ¦25,000.00 ¦ +------------+------+----------------¦ ¦August 7 ¦ ¦25,000.00 ¦ +------------+------+----------------¦ ¦August 10 ¦ ¦1,782.43 ¦ +------------+------+----------------¦ ¦September 1 ¦ ¦100,000.00 ¦ +------------+------+----------------¦ ¦September 8 ¦ ¦50,000.00 ¦ +------------+------+----------------¦ ¦September 21¦ ¦14,530.38 ¦ +------------+------+----------------¦ ¦October 20 ¦ ¦8,541.72 ¦ +------------+------+----------------¦ ¦October 30 ¦ ¦20,000.00 ¦ +------------+------+----------------¦ ¦November 22 ¦ ¦6,398.12 ¦ +------------+------+----------------¦ ¦December 13 ¦ ¦10,000.00 ¦ +------------+------+----------------¦ ¦ ¦ ¦ ¦ +------------------------------------+
1955 January 5 5,000.00 January 8 10,000.00 February 12 9,363.90 March 10 5,000.00 365,645.62
The balance sheets of Charles, Inc., as of December 31, 1954, 1955, and 1956 reflected the following:
+-----------------------------------------------------------------------------+ ¦ ¦1954 ¦1955 ¦1956 ¦ +------------------------------------------+----------+-----------+-----------¦ ¦ASSETS ¦ ¦ ¦ ¦ +------------------------------------------+----------+-----------+-----------¦ ¦Cash ¦$3,117.75 ¦ ¦ ¦ +------------------------------------------+----------+-----------+-----------¦ ¦Notes and accounts receivable (less ¦ ¦$159,987.05¦$159,000.00¦ ¦reserve for bad debts) ¦ ¦ ¦ ¦ +------------------------------------------+----------+-----------+-----------¦ ¦Other assets—real estate ¦302,076.66¦152,000.00 ¦ ¦ +------------------------------------------+----------+-----------+-----------¦ ¦Total assets ¦305,194.41¦311,987.05 ¦159,000.00 ¦ +-----------------------------------------------------------------------------+
LIABILITIES AND CAPITAL Accounts payable 36,349.76 Bonds, notes, and mortgages payable (maturing 265,000.00 less than one year from date of balance sheet) Accrued expenses—taxes 2,305.65 1,099.99 Bonds, notes, and mortgages payable (maturing 228,754.76 111,139.37 more than one year from date of balance sheet) Other liabilities— P/R taxes 194.41 Capital stock: Common stock 40,000.00 40,000.00 40,000.00 Earned surplus and undivided profits 4,576.88 6,760.44 Total liabilities and capital 305,194.41 311,987.05 159,000.00
A ‘Special Meeting of the Board of Directors of’ Swan, Inc., held on August 16, 1955, reflected the following:
The President stated that in view of the fact that this corporation has advanced the sum of approximately $365,000 to Charles Associates, Incorporated, which sum is secured by notes and a mortgage of Charles Associates, Incorporated, it would seem to be to the best interests of this corporation to purchase all of the outstanding stock of Charles Associates, Incorporated, in order to better secure the indebtedness.
The President stated further that the stockholders of Charles Associates, Incorporated have offered to sell their stock in the corporation at their cost, to-wit: a total of $40,000.
After a lengthy discussion, it was moved, seconded and unanimously carried that this corporation purchase all of the outstanding stock of Charles Associates, Incorporated from the shareholders of said corporation at a total purchase price of $40,000, and that the President be authorized to issue checks of this corporation to the respective shareholders of Charles Associates, Incorporated for such stock.
Swan, Inc., purchased the stock of Charles, Inc., from Josephine Swan, Charles Swan, Gilbert Frazee, and Ann Brooks by checks dated August 17, 1955, in the following amounts:
+-----------------------+ ¦Josephine Swan ¦$20,000¦ +---------------+-------¦ ¦Charles Swan ¦19,800 ¦ +---------------+-------¦ ¦Gilbert Frazee ¦100 ¦ +---------------+-------¦ ¦Ann Brooks ¦100 ¦ +-----------------------+
On each of the four checks there was a notation that the check was for the purchase of stock.
Swan, Inc., had earned surplus and undivided profits in the amounts of $145,245.04, $197,452.99, and $200,672.14 as of December 31, 1954, 1955, and 1956, respectively.
The balance sheets of Swan, Inc., as of December 31, 1954, 1955, and 1956 reflected the following:
+---+ ¦¦¦¦¦ +---+
1954 1955 1956
ASSETS Cash $5,393.11 $58,066.51 $150.00 Notes and accounts receivable (less reserve for bad debts) 304,380.93 228,754.76 194,339.57 Prepaid expenses and supplies 510.00 425.00 Other investments 40,000.00 112,450.00 Buildings and other fixed depreciable assets (less accumulated amortization and depreciation) 81,144.46 3,602.90 1,539.13 Other assets 510.00 Total assets 391,428.50 330,934.17 308,903.70
LIABILITIES AND CAPITAL Accounts payable 97,161.52 200.49 5,459.10 Accrued expenses 49,021.94 33,280.69 2,772.46 Capital stock: Common stock 100,000.00 100,000.00 100,000.00 Earned surplus and undivided profits 145,245.04 197,452.99 200,672.14 Total liabilities and capital 391,428.50 330,934.17 308,903.70
The balance sheet of Swan, Inc., as of December 31, 1953, shows cash on hand in the amount of $2,980 and notes and accounts receivable in the amount of $350,782.18. The cash receipts ledger sheet for the month of January 1954 shows cash receipts of $171,335.80 during the period January 1, 1954, to January 25, 1954, inclusive, all of which, with the exception of $117.25, were received from the Detroit Steel Co. and the U.S. Engineers. The cash disbursements ledger sheet of Swan, Inc., for the month of January 1954 shows that the cash disbursements made during that month were not in excess of $34,100.08. No evidence was submitted showing any other cash outlays during that month.
During the year 1952 petitioner's right side and right arm became paralyzed and in 1954 he underwent an operation to correct this condition. In 1952 he decided to discontinue the heavy construction and contracting business of Swan, Inc., and it was completely terminated on or about May 25, 1955, when most of the equipment used in that business was sold at auction for approximately $71,000. Equipment retained by the corporation after the sale included a pump, a bulldozer, a trailer, a tractor, and various tools which were being used by Charles, Inc., in connection with the Virginia real estate venture. Upon termination of the heavy construction business Swan, Inc., engaged in the loan and investment business, which it had commenced in 1954 or 1955, and it is presently in that business.
In 1957 Swan, Inc., liquidated its subsidiary, Charles, Inc., acquiring all of its assets and assuming its liabilities.
OPINION
RAUM, Judge:
The Commissioner determined that ‘your receipt of $40,000.00 in cash from the Swan Construction Company in exchange for the stock of Charles Associates, Inc., constitutes a taxable dividend in accordance with the provisions of Section 301, 302, 304, 316 and 318 of the Internal Revenue Code of 1954.'
The record shows that petitioners received $39,800 rather than $40,000 in exchange for their stock, and the Commissioner concedes on brief that the deficiency should be revised downward to reflect the difference.
There is no dispute between the parties that the purchase of petitioners' Charles, Inc., stock by Swan, Inc., falls literally within the words of section 304 of the 1954 Code, so that the distribution by Swan, Inc., is to be treated as though it were redeeming its own stock.
There is also no dispute that such redemption is covered by section 302(d)
SEC. 304. REDEMPTION THROUGH USE OF RELATED CORPORATIONS.(a) TREATMENT OF CERTAIN STOCK PURCHASES.—(1) ACQUISITION BY RELATED CORPORATION (OTHER THAN SUBSIDIARY).— For purposes of sections 302 * * *, if—(A) one or more persons are in control of each of two corporations, and(B) in return for property, one of the corporations acquires stock in the other corporation from the person (or persons) so in control,then * * * such property shall be treated as a distribution in redemption of the stock of the corporation acquiring such stock. * * *
and hence is taxable as a dividend under section 301
Sec. 302(d) is applicable only if the redemption does not fall within sec. 302(a). Sec. 302 provides in part as follows:SEC. 302. DISTRIBUTIONS IN REDEMPTION OF STOCK.(a) GENERAL RULE.— If a corporation redeems its stock (within the meaning of section 317(b)), and if paragraph (1), (2), (3), or (4) of subsection (b) applies, such redemption shall be treated as a distribution in part or full payment in exchange for the stock.(b) REDEMPTIONS TREATED AS EXCHANGES.—(1) REDEMPTIONS NOT EQUIVALENT TO DIVIDENDS.— Subsection (a) shall apply if the redemption is not essentially equivalent to a dividend.(2) SUBSTANTIALLY DISPROPORTIONATE REDEMPTION OF STOCK.—(3) TERMINATION OF SHAREHOLDER'S INTEREST.— * * *(4) STOCK ISSUED BY RAILROAD CORPORATION IN CERTAIN REORGANIZATIONS.— * * *(5) APPLICATION OF PARAGRAPHS.— In determining whether a redemption meets the requirements of paragraph (1), the fact that such redemption fails to meet the requirements of paragraph (2), (3), or (4) shall not be taken into account. * * *(c) CONSTRUCTIVE OWNERSHIP OF STOCK.—(1) IN GENERAL.— Except as provided in paragraph (2) of this subsection, section 318(a) shall apply in determining the ownership of stock for purposes of this section.(d) REDEMPTIONS TREATED AS DISTRIBUTIONS OF PROPERTY.— Except as otherwise provided in this subchapter, if a corporation redeems its stock (within the meaning of section 317(b)), and if subsection (a) of this section does not apply, such redemption shall be treated as a distribution of property to which section 301 applies.
unless the redemption ‘is not essentially equivalent to a dividend’ under section 302(b)(1).
SEC. 301. DISTRIBUTIONS OF PROPERTY.(a) IN GENERAL.— Except as otherwise provided in this chapter, a distribution of property (as defined in section 317(a) made by a corporation to a shareholder with respect to its stock shall be treated in the manner provided in subsection (c).(c) AMOUNT TAXABLE.— In the case of a distribution to which subsection (a) applies—(1) AMOUNT CONSTITUTING DIVIDEND.— That portion of the distribution which is a dividend (as defined in section 316) shall be included in gross income.
Petitioners concede that the redemption is not within sec. 302(b)(2), (3), or (4).
Petitioners' primary position seeks to cut across these exasperatingly complex provisions, cf. Thomas G. Lewis, 35 T.C. 71, 76. They contend that they never in fact owned any Charles, Inc., stock, that they never sold any such stock to Swan, Inc., and that therefore the foregoing statutory provisions have no application at all to this case. They argue that Swan, Inc., was the real owner of the Charles, Inc., stock from the beginning, that petitioner had lend $40,000 to Swan, Inc., to buy that stock, that the stock was issued in petitioners' names merely to secure that loan, and that the redemption of the Charles, Inc., stock was nothing more than the repayment of that debt. We cannot agree. The burden of proof is upon petitioners. The record that they made before us is highly confusing, the evidence upon which they rely is unconvincing and at time contradictory, and their position conflicts in important respects with the stipulation of facts filed by the parties. We hold that they have failed to carry their burden of proof.
Petitioners make a related argument that the August 17, 1955, redemption of the Charles, Inc., stock was in substance only a ‘final settlement of salary due‘ to petitioner Charles Swan on which income taxes had already been paid, citing Estate of Henry A. Golwynne, 26 T.C. 1209. This contention is spurious. True, petitioner held uncashed salary checks of Swan, Inc., in the aggregate amount of $39,377.80 upon which he had paid taxes. But he cashed those checks on January 25, 1954, and on that date used the proceeds, together with some other funds, to purchase a $40,000 cashier's check which subsequently found its way into the Virginia real estate development venture. The canceled salary checks are in evidence, and the word ‘Paid’ is perforated on each one of them, as is also the date ‘1-25-54.’ The fact that he invested the proceeds of the salary checks shortly thereafter in the Virginia real estate development hardly justifies characterizing the August 17, 1955, redemption as a ‘final settlement’ of the salary due to petitioner. He in fact received that salary long before the redemption. The Golwynne case is clearly distinguishable.
In Golwynne, 26 T.C. 1209, 1212, the petitioner successfully contended that ‘* * * when the corporation eventually redeemed the stock, it was merely completing the initial transaction of repaying the notes, ‘ whereas here we have found as a fact that petitioners transferred, as owners, stock of Charles, Inc., to Swan, Inc. Petitioner's use of the uncashed salary checks of Swan, Inc., to acquire the stock of Charles, Inc., does not place this case on any different footing than if he had used other funds to acquire the stock. Sec. 304 is in point and the net effect of this transaction was that of a redemption.
Contrary to petitioners' position, section 302(b)(1) is squarely involved, and the Commissioner's determination must be sustained unless the redemption was ‘not essentially equivalent to a dividend.’ Swan, Inc., had a large surplus at the time of its purchase of the Charles, Inc., stock from petitioners, and petitioners in no realistic way parted with their control over or their actual interest or investment in the Charles, Inc., enterprise, for, apart from qualifying shares, they were the sole stockholders of Swan, Inc.
In substance, the redemption was nothing more than a distribution of cash to them by Swan, Inc., out of its accumulated earnings and profits. Nor are we satisfied on the record that there was a bona fide business reason for the redemption. And in any event, the existence of a business purpose will not, of itself, require that the transaction be classified as ‘not essentially equivalent to a dividend.’ Cf. United States v. Fewell, 255 F.2d 496, 500 (C.A. 5); Bradbury v. Commissioner, 298 F.2d 111, 118 (C.A. 1), affirming a Memorandum Opinion of this Court; Thomas Kerr, 38 T.C. 723, 732, affirmed 326 F.2d 225 (C.A. 9).
See SEC. 318. CONSTRUCTIVE OWNERSHIP OF STOCK.(a) GENERAL RULE.— For purposes of those provisions of this subchapter to which the rules contained in this section are expressly made applicable—(2) PARTNERSHIPS, ESTATES, TRUSTS, AND CORPORATIONS.—(C) CORPORATIONS.— If 50 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, then—(i) such person shall be considered as owning the stock owned, directly or indirectly, by or for that corporation, in that proportion which the value of the stock which such person so owns bears to the value of all the stock in such corporation; and(ii) such corporation shall be considered as owning the stock owned, directly or indirectly, by or for that person.
In arguing that the distribution was not essentially equivalent to a dividend, petitioners refer to the contraction of the heavy construction business of Swan, Inc., thereby seeking to establish that the distribution was in liquidation or partial liquidation of Swan, Inc. While it is true that Swan, Inc., began to discontinue its heavy construction business as early as 1952, it subsequently entered the mortgage loan business and by absorbing Charles, Inc., it also continued the latter's venture. And there is no showing that its need for capital in its new activities was materially less than in the heavy construction business. Cf. Estate of Charles Chandler, 22 T.C. 1158, 1166, affirmed 228 F.2d 909 (C.A. 6). Moreover, there is no convincing evidence that the August 1955 redemption was in any way related to the termination of the heavy construction business. We hold that petitioners have failed to establish that the redemption was not essentially equivalent to a taxable dividend. Cf. United States v. Fewell, 255 F.2d 496, 499-500 (C.A. 5); Ferro v. Commissioner, 242 F.2d 838, 841 (C.A. 3); Flanagan v. Commissioner, 116 F.2d 937, 939 (C.A.D.C.); Jones v. Griffin, 216 F.2d 885, 887 (C.A. 10); Thomas Kerr, 38 T.C. 723, 729-730, affirmed 326 F.2d 225 (C.A. 9); Genevra Heman, 32 T.C. 479, 487, affirmed 283 F.2d (C.A. 8). We have viewed all the evidence before us in the light of the various criteria regarded as pertinent in the foregoing cases and have concluded that the redemption distribution herein must be regarded as essentially equivalent to a taxable dividend.
Decision will be entered under Rule 50.