Opinion
No. 62.
November 16, 1944.
Petition by taxpayer for review of a decision of the Tax Court of the United States.
Petition by W.H. Grunlocke Chair Company for review of a decision of the Tax Court of the United States redetermining deficiencies in income and excess profits taxes assessed by Commissioner of Internal Revenue.
Decision affirmed.
This is an appeal from a decision of the Tax Court sustaining the Commissioner's determination of deficiencies in income and excess profits taxes, for the taxable year ended June 30, 1939, pursuant to § 102 of the Revenue Act of 1938, 26 U.S.C.A. Int. Rev. Code, § 102.
That section provides in part:
"Sec. 102. Surtax on corporations improperly accumulating surplus. (a) Imposition of tax. There shall be levied, collected, and paid for each taxable year (in addition to other taxes imposed by this title) upon the net income of every corporation (other than a personal holding company as defined in Title IA or a foreign personal holding company as defined in Supplement P) if such corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders or the shareholders of any other corporation, through the medium of permitting earnings or profits to accumulate instead of being divided or distributed, a surtax equal to the sum of the following: 25 per centum of the amount of the undistributed section 102 net income not in excess of $100,000 plus; 35 per centum of the undistributed section 102 net income in excess of $100,000 * * * (c) Evidence determinative of purpose. The fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid surtax upon shareholders unless the corporation by the clear preponderance of the evidence shall prove to the contrary."
The facts as found by the Tax Court, and which are not in dispute, are as follows:
"Petitioner was incorporated on October 21, 1902, under the laws of New York for the purpose of engaging in the manufacture and sale of chairs, furniture and fittings of all kinds. Its office and manufacturing plant are at Wayland, New York, a small town about forty miles south of Rochester. During the taxable year and for some years before petitioner's principal business was the manufacture and sale of chairs for office use. During the taxable year from 11 to 15 percent of its products consisted of upholstered furniture for offices. The office furniture which petitioner manufactures is of high grade.
"Petitioner's original capital, as provided in the certificate of incorporation, was $50,000, consisting of 500 shares of the par value of $100 per share. On August 14, 1919 petitioner, with the unanimous consent of all its stockholders, amended its certificate of incorporation so as to authorize it to have capital stock of $400,000, divided into 2,000 shares of preferred stock with a par of $100 per share, redeemable at $105 the share, and 2,000 shares of common stock of a par value of $100 the share, the preferred stock being entitled to a cumulative dividend of $8 the share per annum.
"In 1925 petitioner again amended its certificate of incorporation so as to authorize it to issue 2,000 shares of new preferred stock of a par value of $100 the share, the new stock to be entitled to a cumulative dividend of $6 the share per annum. Thereupon all the previously outstanding preferred stock was retired either by payment of its redemption price in cash or by exchange for the new six percent preferred stock. A certificate of reduction of capital stock was then filed with the Secretary of State of New York so that petitioner's authorized capital thereafter consisted of 2,000 shares of common and 2,000 shares of six percent preferred stock, each of a par value of $100 the share. The six percent preferred stock was cumulative as to dividends and in the event of liquidation its holders were entitled to $100 the share plus any accrued dividends before distributions could be made on the common stock. All or any part of this preferred stock could at the option of the board of directors and upon two months' notice be redeemed at any time after five years from March 1, 1925 by paying $105 the share plus any accrued dividends, but in the event of such redemption the stock was to be cancelled and the capital stock reduced by appropriate statutory proceedings. The six percent preferred stock had no voting power unless and until dividends thereon should be in default for a period of two years, after which it had equal voting power, share for share, with the common stock. If after default the arrears in dividends were paid the common stock again regained exclusive voting power. From 1923 until the beginning of the taxable year there were outstanding 1,242-1/2 shares of common stock.
"On December 8, 1938, and during the taxable year, petitioner purchased 325-1/2 shares of its common stock from the estate of Charles Scales for $20,000 and retired these shares. Scales was one of the founders of petitioner and his estate was in need of cash.
"At the close of the taxable year the common stock outstanding was 917 shares which were all held by petitioner's officers, who were also its directors, as follows:
No. of Shares Percent
H.G. O'Connor, President 107.1 11.7 Ernest Child, Vice-President 87.5 9.5 John Stahle, Secretary 35.7 3.9 Howard W. Gunlocke, Treasurer 686.7 74.9 _____ _____ Total outstanding common stock at June 30, 1939 ..................... 917. 100.
With the exception of Howard W. Gunlocke, the above officers had held the stated amounts of shares for a number of years. For several years before 1939 Howard W. Gunlocke had owned 150 shares of the common stock.
"On October 10, 1938 he received 534.7 shares as a distribution from the principal of a trust created under the will of his mother, Anne H. Gunlocke. The income of this trust had been distributable to him since 1932 when he became of age. The principal of the trust was distributable to him at any time in the discretion of the trustees but not later than 1946. The president, H.G. O'Connor, resided in Philadelphia, Pa., and John Stahle in New York City. Ernest Child, vice-president and Howard W. Gunlocke, treasurer, resided in Wayland, New York. Howard W. Gunlocke became actively engaged in the business in 1935. His father, W.H. Gunlocke, had been treasurer for a number of years before his death in 1937. From 1935 on Howard W. Gunlocke was quite familiar with the petitioner's manufacturing operations and finances. At the close of the taxable year there were 1,215 shares of preferred stock outstanding, of which Howard W. Gunlocke owned 149 shares. Most of the remaining preferred stock at that time, and since its issuance, was owned in small lots by a substantial number of individuals who resided in or near Wayland, New York, and who were for the most part friends of petitioner's officers or employees of petitioner.
"On June 30, 1932 the par of the outstanding preferred stock was $189,500. The par of the preferred stock purchased or retired by petitioner thereafter was as follows:
For the year ended June 30, 1933 ........ $ 12,850.00 1934 ........ 1,000.00 1935 ........ 1,400.00 1936 ........ 500.00 1937 ........ 5,100.00 1938 ........ 22,650.00 1939 ........ 24,500.00 1940 ........ 36,400.00 1941 ........ 36,500.00 1942 ........ 48,600.00 ___________ Total ................... $189,500.00
There was no legal obligation on the part of petitioner to make the above purchases. During the two or three depression years and up to 1936 or 1937 most of the preferred stock purchased was acquired at a discount from individuals who desired the money for their stock because dividends had not been paid or whose circumstances necessitated the raising of money.
"For a period of two or three years, beginning in 1932, petitioner's plant was operating only part-time. During the year ended June 30, 1932 and again in 1933 petitioner paid only a portion of the preferred stock dividends, and no dividends in 1934; but the dividend arrears were paid in full by the year ended June 30, 1937. By 1937 conditions were much better and petitioner was then glad to buy up any preferred stock it could obtain. The purchases in 1938 and 1939 and thereafter were for the most part not occasioned by any particular desire of the officers and common stockholders, to avoid in the future the risk of losing control of the company which had faced them during the depression years. The purchases during the taxable year in the par amount of $24,500 were mostly in small amounts throughout the year and the aggregate purchase price was $21,770. The same is true of the year ended June 30, 1940, when the amount purchased was $36,400 par value and the aggregate purchase price was $36,377.50.
"Upon the death of W.H. Gunlocke in 1937 petitioner collected $50,000 insurance on his life.
"During the years 1914 to 1918, inclusive, petitioner paid dividends of approximately $10,000 the year on its common stock. There was no preferred stock outstanding during those years. In 1921 petitioner paid a stock dividend of common on common in the amount of $11,000. A similar stock dividend in the amount of $53,250 was paid in 1923. The amounts of such stock dividends were charged to the surplus account on petitioner's books." Here the Tax Court set forth tables of annual net sales, book income, cash dividends paid, current assets, current liabilities, cash and securities and surplus annually, balancesheets and analyses of the taxpayer's financial condition. The findings continued as follows:
"During the taxable year the biggest share of petitioner's business went to the commercial trade, which included dealings with several large customers. Petitioner had approximately ten competitors who manufactured wooden office furniture. Petitioner uses oak, walnut, birch and maple wood and until its importation was prohibited by the United States Government some mahogany. Petitioner purchases the lumber which it uses in the manufacture of its furniture. This lumber comes from logs having a 45 to 50 percent moisture content, and it takes a little over a year to dry and cure the larger pieces and about seven months for the smaller pieces. After the lumber is cured and taken from the kiln it takes about ten weeks to manufacture the furniture for an order and to deliver it to the customer. For a great number of years petitioner has had on hand a more or less constant supply of lumber.
"During the period 1936 to 1939 petitioner, in addition to its so-called commercial business, manufactured considerable furniture for use in new centralized schools which were being built through the instrumentality of one of the Federal Government agencies. Such business was of a more or less temporary character. During these years petitioner had to meet increased competition in its commercial trade occasioned by the introduction and manufacture by other concerns of metal office equipment which resulted in a decline in its commercial business. On account of this increasing competition petitioner began to concentrate its attention on obtaining contracts with the United States Government. Petitioner also considered the possibility of manufacturing metal chairs.
"At informal conferences of petitioner's directors, consideration was given to putting in a steel or aluminum division. This would have meant the installation of new machinery and dies, and either the erection of an addition to its plant or the conversion of a part of its existing plant. This would have entailed a considerable expense. Consideration was also given to meeting the increased competition on the part of the makers of steel office furniture by manufacturing and selling wooden desks to match the office chairs which it produced and sold. Accordingly petitioner attempted to buy a desk company in the middle west but a satisfactory agreement as to price was not reached and the negotiations lapsed. After the taxable year the advent of the war caused a prohibition of the use of metal in the manufacture of metal furniture, and therefore the solution of this problem of competition is no longer immediately imperative.
"Petitioner now manufactures chairs for sale to the United States Government. This business was begun in 1935 and is obtained by competitive bidding invited periodically by the Procurement Division of the Treasury Department.
"At all times throughout the taxable year and during the following year petitioner had ample cash on hand. During these years approximately $30,000 of petitioner's cash was represented by certificates of deposit in two different banks. Its remaining cash was carried in regular accounts in three different banks.
"No business policies for the taxable year or for future years were recorded in the petitioner's minute book.
"Petitioner's accumulated earnings and profits at the close of the taxable year amounted to $367,589.95. The net income of petitioner for the taxable year available for dividends, after deduction of $27,892.04 for current Federal income and excess-profits taxes, was $95,652.44. After deduction of $7,674 for dividends on preferred stock, the earnings available for distribution on the common stock amounted to $87,978.44.
"The surtaxes avoided by the common stockholders for the calendar year 1939 by failure of petitioner to distribute the earnings of $87,978.44 available for distribution on such stock were as follows:
Howard W. Gunlocke ......... $15,418.19 Henry G. O'Connor .......... 801.09 Ernest Child ............... 632.17 John Stahle ................ 52.44 __________ Total ................... $16,903.89
The total taxes (income tax and surtax) reported by the above stockholders on their returns and the additional taxes which would be payable by them if petitioner had distributed the $87,978.44 are as follows:
Add. Reported income on return and surtax
Howard W. Gunlock $243.82 $18,013.98 Henry G. O'Connor 373.26 1,210.78 Ernest Child .... 444.06 963.93 John Stahle ..... 57.65 250.43 _______ __________ Total .................. $20,439.12
"Petitioner's earnings and profits were permitted to accumulate beyond the reasonable needs of the business.
"Petitioner was availed of in the taxable year for the purpose of preventing the imposition of a surtax upon its shareholders."
The taxpayer's summary of the facts shown in the tables incorporated in the Tax Court's findings is as follows:
"Petitioner's profits (after provision for federal income taxes) in each of its fiscal years from 1919 to 1930, excepting 1921 and 1928, ranged from $20,693.89 (1927) to $75,147.70 (1919). In 1921 and 1928 losses of $44,332.83 and $3,153.76, respectively, were sustained. In the years 1931 to 1933, petitioner's operations resulted in quite substantial losses amounting in the aggregate for the three-year period to $146,498.06. For the year 1934, a small profit (after provision for federal income taxes) of $7,425.64 resulted, and in succeeding years to 1939, profits of various amounts for each of the years were made. The largest profit during the period following 1933 through the taxable year was the profit of $95,652.44 in the taxable year. At the end of 1920, petitioner's surplus amounted to $257,018.46. During the interval of nine and one-half years of June 30, 1930, the increase in surplus and accumulated profits amounted to $29,407.88. On the latter date there was a balance of $286,426.34 in the surplus account after adding back the stock dividends of $11,000 and $53,250 paid in 1921 and 1923 respectively. In the next three years to June 30, 1933, petitioner suffered large losses from operations each year, and, notwithstanding the severe drain of such losses upon its resources, paid $38,628.25 in dividends upon its preferred and common stock. By June 30, 1933, petitioner's surplus and accumulated profits dropped from $222,176.34 to $19,540.74, or a total reduction of $202,634.60 during the comparatively short interval of three years. This was accounted for principally by the losses of $146,498.06 suffered during the period and the $38,628.25 of dividends paid. During the six years following June 30, 1933 petitioner's surplus and accumulated profits increased $283,799.21 from $19,540.74 at June 30, 1933 to $303,339.95 at June 30, 1939. This increase was composed mainly of profits of $203,391.21 remaining after provision for federal income taxes and payment of dividends on preferred stock. The balance of $80,408 of the net increase in surplus resulted from discount on common and preferred stock purchased, the excess received by petitioner over the cash surrender value of life insurance upon one of its deceased officers, revaluation due to adjustments of depreciation, and other similar non-recurring items. The profits of $203,319.21 retained in the business during the six-year period from 1933 to 1939 recouped by an excess of only $755.61 the drain of $202,635.60 made in petitioners' surplus and accumulated profits during the previous three-year period * * *. The discount on preferred and common stock amounting to $17,960.78 resulted from purchase by petitioner of some of its outstanding shares for less than their par value. The revaluation of the depreciation reserve amounting to $27,032.43 was merely a decrease in such reserve with a corresponding increase in the surplus. * * * In the findings of the Tax Court it is stated that at the close of the taxable year petitioner's accumulated earnings amounted to $367,589.95. That figure is composed of the surplus on hand at the end of the year of $303,339.95, plus the stock dividends paid in 1921 and 1923 aggregating $64,250."
Goodwin, Nixon, Hargrave, Middleton Devans, of Rochester, N Y (Scott Stewart, Jr., of Rochester, N.Y., of counsel), for petitioner.
Samuel O. Clark, Jr., Asst. Atty. Gen., Sewald Key, J. Louis Monarch, and Robert Koerner, Sp. Assts. to Atty. Gen., for respondent.
Before SWAN, AUGUSTUS N. HAND, and FRANK, Circuit Judges.
The Tax Court found that taxpayer's earnings or profits were permitted to accumulate beyond the reasonable needs of the business. Under the express terms of § 102(c), this finding, if valid, created a presumption that the purpose of the accumulation was to avoid surtax upon the shareholders unless the taxpayer proved the contrary by a clear preponderance of the evidence. The Tax Court found that taxpayer had not done so. Both those findings constitute determinations of fact which, under the narrowest interpretation of Dobson v. Commissioner, 320 U.S. 489, 64 S.Ct. 239, we cannot disturb unless we consider them, as we do not, unsupported by substantial evidence. See Helvering v. National Grocery Co., 304 U.S. 282, 294, 58 S.Ct. 932, 82 L.Ed. 1346; Helvering v. Chicago Stockyards Co., 318 U.S. 693, 702, 63 S.Ct. 843, 87 L.Ed. 1086; Trico Products Corp. v. Commissioner, 2 Cir., 137 F.2d 424, 426, certiorari denied 320 U.S. 799, 64 S.Ct. 369.
Affirmed.