Opinion
No. 45664.
May 7, 1945.
Harry Friedman, of Washington, D.C., for plaintiff.
John A. Rees, of Washington, D.C., and Samuel O. Clark, Jr., Asst. Atty. Gen. (Fred K. Dyar, of Washington, D.C., on the brief), for defendant.
Before WHALEY, Chief Justice, and LITTLETON, WHITAKER, JONES, and MADDEN, Judges.
Suit by Edwin L. Wiegand Company against the United States to recover alleged overpayment of income tax for the fiscal year ending June 30, 1937.
Judgment for defendant dismissing the petition.
Plaintiff seeks to recover $803.43, with interest, alleged overpayment of income tax for the fiscal year ending June 30, 1937, on the ground that defendant erroneously and illegally included as taxable income or profit the amount of $2,100, representing the difference between the amount of $3,600, for which plaintiff issued and sold (not as an original issue) twenty shares of its own capital stock during the taxable year, and the amount of $1,500 at which it had purchased such twenty shares of stock in 1933. Plaintiff's position is in substance that this was a capital transaction and since plaintiff was not engaged in dealing in its own shares as it might in the shares of other corporations the acquisition of these twenty shares in 1933 and the resale thereof in 1936 did not give rise to a taxable gain under section 22, Revenue Act of 1936, 49 Stat. 1648, 26 U.S.C.A. Int.Rev. Acts, page 825 — the provisions of which section are the same as the corresponding sections of all prior and subsequent income tax statutes.
Special Findings of Fact
1. September 18, 1937, plaintiff, a Pennsylvania corporation with principal office at Pittsburgh, filed a tentative income and excess profits tax return for the fiscal year ending June 30, 1937 (hereinafter referred to as 1937), and on December 15 filed its completed return showing an excess profits tax of $12,302.12 and a normal and surtax of $83,243.88. Subsequently, in December 1938 it prepared and filed in connection with a claim for refund an amended return for 1937 showing a profits tax of $11,509.27 and a total normal and surtax of $81,358.60. Plaintiff attached to this return a statement in which it asserted that an item of $7,000 in line 10, page 2, of the original completed return was erroneous and should not have appeared thereon; also, that an item of $44,282.18 in line 20, page 20, of that return was overstated by $392.89; and further stated that as a result of these two errors the tax for 1937 had been overpaid in the amount of $2,678.13. The total tax of $95,546 shown on the original return was paid in five installments, the last installment payment of $23,886.50 being June 18, 1938.
2. December 17, 1938, plaintiff filed a formal claim for refund of $2,678.13 for 1937, and set forth therein, as grounds, a statement that the claimed refund resulted from the erroneous inclusion upon plaintiff's return of an item of $7,000 as income collected under a royalty agreement which had been in effect over a period of years, first believed to include the taxable year but later discovered not to have been in effect during the fiscal year 1937.
September 5, 1940, the Commissioner notified plaintiff that its claim for refund had been allowed in part and disallowed to the extent not previously allowed. The overpayment so allowed in August was $1,874.70, and this sum, together with accrued interest thereon of $236.19, was paid plaintiff August 21, 1940.
In arriving at this overpayment of $1,875.70 the Commissioner first increased the net income originally reported by $2,100 which he determined to represent a taxable gain or profit to plaintiff on the sale in the taxable year of twenty shares of its own capital stock, as hereinafter mentioned. This had the effect of reducing the amount which would otherwise have been refundable as an overpayment by $803.43.
3. August 30, 1940, plaintiff filed another claim which it called an amended claim for refund for $803.43 for 1937. This claim contained the following statement:
"Under date of December 17, 1938, your petitioner corporation filed a claim for refund of overpayment of income tax for the fiscal year ended June 30, 1937, in amount of $2,678.13 based upon overstatement of royalty income for that year. The Commissioner upon examination of the claim proposes to allow only $1,874.70, contending that there should be offset as additional taxable income the sum of $2,100.00, representing alleged gain on the sale of treasury stock. Your petitioner corporation contends that such gain does not constitute taxable income under the applicable law and regulations and respectfully requests that refund be made not only of the $1,874.70 now proposed but also of the additional $803.43 which is being denied by reason of the treasury stock transaction."
December 16, 1941, the Commissioner notified plaintiff that its claim for $803.43 "is considered an application for reconsideration of the original claim in the amount of $2,678.13, which was partially disallowed, registered notice having been mailed to the taxpayer on September 5, 1940. * * * In view of the foregoing, the Form 843 will not be formally rejected, and no official rejection notice will be issued."
4. The alleged gain on the sale of Treasury stock arose under the following circumstances:
W.H. Snead, an employee of plaintiff, became one of its stockholders in 1929, holding twenty shares of $100 per stock (hereinafter referred to as par stock) and eighty shares of no par stock. At that time there were outstanding 1,000 shares of par stock and 4,000 shares of no par stock. The majority stockholder was Edwin L. Wiegand, founder and president and general manager of the company. Prior to October 19, 1936, all stock was held by those directly connected with the company, the company's policy being to have employees participate by holding shares of stock. The stock was closely held and was not traded or quoted on any exchange.
The stockholders had their holdings each in the ratio of four shares of no par stock to one share of par stock, except in isolated instances not here material.
Snead's connection with the company was severed in 1933, and at the time of severance the company bought his holding of twenty shares of par stock, Snead disposing of his no par stock to Wiegand.
At the time of his purchase Snead paid the company par for the twenty shares, a total of $2,000. They were transferred back to the company May 26, 1933, and the consideration paid therefor was $1,500. The transaction was treated as the acquisition of Treasury stock and so recorded on the company's books.
The transaction in which the stock was acquired from Snead was the only transaction by plaintiff in its own stock from the date of incorporation in 1924 to the date of the hearing in 1943.
5. The taxpayer from time to time invested its surplus funds in marketable securities and had an account on its books for such investments. The twenty shares of stock acquired from Snead was not carried in the investment account, but in a separate Treasury stock account. On the financial statements the Treasury stock was shown as a reduction from capital stock rather than as an investment. This accounting treatment of the transaction accords with good accounting practice.
Plaintiff did not purchase the stock from Snead because it was engaged in the business of dealing in its own stock, but such stock was acquired because Snead was leaving the employ of the company.
No attempt was ever made to resell the stock acquired from Snead to outsiders.
6. In preparation for a plan for recapitalization which later took place October 20, 1936, plaintiff on October 19, transferred to Edwin L. Wiegand the twenty shares of Treasury stock so held, and the consideration paid by Wiegand for this transfer was $3,600 in cash. This placed Wiegand's holdings as to par stock and no par stock in the same relative proportion as the other stockholders, that is to say, one share of par stock to four shares of no par stock.
The difference of $2,100 between the price at which the stock was sold by Snead to plaintiff and the price at which sold by the company to Wiegand, was included by the Commissioner of Internal Revenue as taxable profit for the fiscal year 1937, and if that sum be eliminated as taxable income plaintiff's tax for that year would be diminished by $803.43.
7. On the company's books this difference of $2,100 was treated as an appreciation in value of the shares from the time they were acquired by the company from Snead to the time they were sold to Wiegand.
The amount of $3,600 received from Wiegand was disposed of on the company's books by crediting $2,000 to the Treasury stock account and crediting $1,600 to the capital surplus account. The company's cash account was charged with the full $3,600.
The consideration of $1,500 to Snead had been handled on the books by debiting $2,000 to the Treasury stock account, crediting $1,500 to the cash and/or note account, and crediting $500 to the capital surplus account.
By the two accounting transactions the capital surplus account was credited with a total of $2,100, and the book profit was unaffected.
The values represented by the stock transactions were those placed by the company on its own stock on May 26, 1933, and October 19, 1936, and there is no evidence of other values.
When a certificate of stock was turned in to the company it was canceled, and any reissue was covered by a new certificate.
The question presented in this case is whether under the provisions of sec. 22 of the Revenue Act of 1936, 49 Stat. 1648, 1657, 26 U.S.C.A. Int.Rev. Acts, page 825, continued unchanged in all subsequent taxing acts and in Regulations 94, art. 22(a)-16, first adopted and promulgated May 2, 1934 in T.D. 4430 (XIII-1 C.B. 36), a gain of $2,100 derived by a corporation on the transfer or sale by it for $3,600 of certain shares of its own stock (not as an original issue) which it had previously acquired or purchased at $1,500, should be regarded as taxable income, or whether such a purchase and sale should be treated as a capital transaction giving rise to neither taxable gain nor deductible loss.
The Commissioner of Internal Revenue held that the excess of the sale price over the purchase price was taxable income to plaintiff in 1927, and defendant insists that this decision was correct and legal. Plaintiff takes the position that this excess of $2,100 represented capital paid in for stock and was not, therefore, taxable income within the meaning of the Sixteenth Amendment to the Constitution and sec. 22, supra; that art. 22(a)-16, Regs. 94, does not apply because plaintiff was not engaged in "dealing in its own shares as it might in the shares of another corporation," and that, if the regulation does apply to a single transaction, it is invalid.
The pertinent provisions of sec. 22, Revenue Act of 1936, applicable to the case, have been in effect unchanged under all revenue acts since the adoption of the Sixteenth Amendment, and are in effect at the present time. These provisions are as follows:
"(a) General Definition. `Gross income' includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * *"
The Treasury regulations in effect from 1920, made under the Revenue Act of 1918, 40 Stat. 1057, until May 2, 1934, provided (art. 542, Reg. 45) that: "If, * * * for any * * * purpose, the stockholders donate or return to the corporation to be resold by it certain shares of stock of the company previously issued to them, or if the corporation purchases any of its stock and holds it as treasury stock, the sale of such stock will be considered a capital transaction and the proceeds of such sale will be treated as capital and will not constitute income of the corporation. A corporation realizes no gain or loss from the purchase of its own stock. See articles 563, 861, and 862." The last-quoted sentence was changed in 1924 by art. 543, Reg. 65, to read: "A corporation realizes no gain or loss from the purchase or sale of its own stock."
The amended regulation of the Commissioner of Internal Revenue, approved by the Secretary of the Treasury, promulgated May 2, 1934, and ever since continued (art. 22(a)-16, Reg. 94, supra), provides as follows:
"Art. 22. (a)-16. Acquisition or disposition by a corporation of its own capital stock. — Whether the acquisition or disposition by a corporation of shares of its own capital stock gives rise to taxable gain or deductible loss depends upon the real nature of the transaction, which is to be ascertained from all its facts and circumstances. The receipt by a corporation of the subscription price of shares of its capital stock upon their original issuance gives rise to neither taxable gain nor deductible loss, whether the subscription or issue price be in excess of, or less than, the par or stated value of such stock.
"But if a corporation deals in its own shares as it might in the shares of another corporation, the resulting gain or loss is to be computed in the same manner as though the corporation were dealing in the shares of another. So also if the corporation receives its own stock as consideration upon the sale of property by it, or in satisfaction of indebtedness to it, the gain or loss resulting is to be computed in the same manner as though the payment had been made in any other property. Any gain derived from such transactions is subject to tax, and any loss sustained is allowable as a deduction where permitted by the provisions of the Act."
The occasion for the adoption of the above-quoted regulation modifying the regulations previously existing, and as contained in art. 543, Reg. 65, supra, and corresponding articles in Regs. 69, 74, and 77, appears to have been the opinion of the court in Commissioner of Internal Revenue v. S.A. Woods Machine Co., 1 Cir., 57 F.2d 635, 636, certiorari denied 287 U.S. 613, 53 S.Ct. 15, 77 L.Ed. 532. In that case the Woods Company had obtained a decree of patent infringement against the Yates Machine Company, which owned stock in the Woods Company. The parties settled the controversy as to damages and in connection therewith the Yates Company transferred to the Woods Company, with other considerations, 1,022 shares of the stock of the Woods Co., for $433,200.04. For these considerations the Woods Company acknowledged satisfaction of its rights under the decree of infringement. After the receipt of the stock the Woods Company, by corporate action, retired it, thereby reducing its capital stock from 3,000 to 1,978 shares. The Treasury held that the value of the stock so received by the Woods Company was taxable income to it, and the Board of Tax Appeals, now the Tax Court, reversed the decision and held in accordance with its prior decisions that a "corporation realizes no gain or loss from the purchase or sale of its own stock." The Court of Appeals reversed the Board and, after quoting art. 543, Reg. 65, said, at page 636 of 57 F.2d that: "Whether the acquisition or sale by a corporation of shares of its own capital stock gives rise to taxable gain or deductible loss depends upon the real nature of the transaction involved. * * * If it was in fact a capital transaction, i.e., if the shares were acquired or parted with in connection with a readjustment of the capital structure of the corporation, the Board rule applies. * * * But where the transaction is not of that character, and a corporation has legally dealt in its own stock as it might in the shares of another corporation, and in so doing has made a gain or suffered a loss, we perceive no sufficient reason why the gain or loss should not be taken into account in computing the taxable income. The view taken by the Board of Tax Appeals (see Houston Brothers Co. v. Commissioner [of Internal Revenue], 21 B.T.A. 804) presses accounting theory too far in disregard of plain facts. * * * In Knickerbocker Importation Co. v. [State] Board of Assessors, 74 N.J.L. 583, 585, 65 A. 913, 915, 7 L.R.A., N.S., 885, the plaintiff corporation was held liable for the franchise tax on its own stock which it had bought and held in its treasury. The court said: `Stock once issued is and remains outstanding until retired and canceled by the method provided by statute for the retirement and cancellation of capital stock.'"
After the promulgation in 1934 of the new regulation above quoted, the Commissioner of Internal Revenue applied it not only prospectively but sought to apply it in the decision of cases involving such transactions concluded in taxable years prior to its adoption and promulgation. Two of such cases were Helvering v. R.J. Reynolds Tobacco Co., 306 U.S. 110, 59 S.Ct. 423, 83 L.Ed. 536, involving 1929, and First Chrold Corporation v. Commissioner of Internal Revenue, 306 U.S. 117, 59 S.Ct. 427, 83 L.Ed. 542, involving 1933. The court in the opinion in the Reynolds Co. case refused to permit a retroactive application of the changed or amended regulation to a sale by the corporation of treasury stock in 1929 at a profit, and after holding ( 306 U.S. 114, 59 S.Ct. 425, 83 L.Ed. 536), that the language of the statute defining gross income was "so general in its terms as to render an interpretative regulation appropriate," said, 306 U.S. 114, 115, 59 S.Ct. 425, 83 L.Ed. 536:
"The administrative construction embodied in the regulation has, since at least 1920, been uniform with respect to each of the revenue acts from that of 1913 to that of 1932, as evidenced by Treasury rulings and regulations and decisions of the Board of Tax Appeals. In the meantime successive revenue acts have reenacted, without alteration, the definition of gross income as it stood in the Acts of 1913, 1916, and 1918. Under the established rule Congress must be taken to have approved the administrative construction and thereby to have given it the force of law."
Accordingly the court held that the "tax liability for the year 1929 is to be determined in conformity with the regulation then in force." The court, however, refused to decide the question as to whether the amended and changed regulation might properly be applied to a similar sale consummated after the amended regulation became effective and, at pages 116 and 117 of 306 U.S., at page. 426 of 59 S.Ct., 83 L.Ed. 536, said:
"Since the legislative approval of existing regulations by reenactment of the statutory provision to which they appertain gives such regulations the force of law, we think that Congress did not intend to authorize the Treasury to repeal the rule of law that existed during the period for which the tax is imposed. We need not now determine whether, as has been suggested, the alteration of the existing rule, even for the future, requires a legislative declaration or may be shown by reenactment of the statutory provision unaltered after a change in the applicable regulation. As the petitioner [Helvering] points out, Congress has, in the Revenue Acts of 1936 and 1938, retained Section 22(a) of the 1928 Act in haec verba. [26 U.S.C.A. Int.Rev. Code, § 22(a)]. From this it is argued that Congress has approved the amended regulation. It may be that by the passage of the Revenue Act of 1936 the Treasury was authorized thereafter to apply the regulation in its amended form. But we have no occasion to decide this question since we are of opinion that the reenactment of the section, without more, does not amount to sanction of retroactive enforcement of the amendment, in the teeth of the former regulation which received Congressional approval, by the passage of successive Revenue Acts including that of 1928."
Since, as the Supreme Court held, the language of the statutes defining taxable gross income is "so general in its terms as to render an interpretative regulation appropriate," the rule of reasonableness and Congressional approval by ratification of administrative interpretation and application, as applied in the Reynolds Co. case, gives equal support to the validity of the amended regulation, applied prospectively, as a modification or reversal of the prior regulation as to cases such as we have here. Although the court in the Reynolds case declined to pass upon the question here presented, because it was not there involved, it apparently recognized the force of the argument here made as to Congressional approval of the amended regulation as applied to stock sales made after its adoption in the statement that: "It may be that by the passage of the Revenue Act of 1936 the Treasury was authorized thereafter to apply the regulation in its amended form." The Revenue Act of 1938, effective May 28, 1938, 52 Stat. 447, also reenacted without change sec. 22 defining gross income, and the provisions of that section remained unchanged in the enactments of the amendatory Revenue Act of 1939, 53 Stat. 862, the first and second Revenue Acts of 1940, 54 Stat. 516 and 54 Stat. 974, the Revenue Act of 1941, 55 Stat. 687, the Revenue Act of 1942, 56 Stat. 798, and the Revenue Act of 1943, 57 Stat. 126, 26 U.S.C.A. Int.Rev. Code, § 22.
In view of this apparent Congressional acquiescence and approval of the interpretation of Section 22 by the amended regulation that a gain derived by a corporation from the purchase and sale of its stock constitutes taxable income, and in view of the decisions of the courts in cases decided under this regulation subsequent to the decision in the Reynolds Tobacco Co. case, supra, we are of opinion that defendant properly taxed plaintiff on the gain of $2,100 derived from the sale of the twenty shares of its own stock in 1936. The amended regulation of May 2, 1934, has been upheld and applied, in cases like the one here under consideration, in Commissioner of Internal Revenue v. Air Reduction Co., Inc., 2 Cir., 130 F.2d 145; Helvering v. Edison Bros. Stores, Inc., 8 Cir., 133 F.2d 575; Brown Shoe Co., Inc. v. Commissioner of Internal Revenue, 8 Cir., 133 F.2d 582; United States v. Stern Bros. Co., 8 Cir., 136 F.2d 488; Allen v. National Manufacture Stores Corporation, 5 Cir., 125 F.2d 239; Trinity Corporation v. Commissioner of Internal Revenue, 5 Cir., 127 F.2d 604; Dow Chemical Co. v. Kavanagh, 6 Cir.; 139 F.2d 42; Superheater Co. v. Commissioner, 1943 Tax Court Memorandum Decisions and Aviation Capital, Inc., v. William J. Pedrick, 2 Cir., 148 F.2d 165. See also, American Chicle Co. v. United States, 41 F. Supp. 537, 94 Ct.Cl. 699, 710-711, affirmed 316 U.S. 450, 454, 455, 62 S.Ct. 1144, 86 L.Ed. 1591.
The other arguments made by plaintiff that the regulation does not apply to the instant case because plaintiff was not engaged in dealing in its own stock; that if the gain of $2,100 is taxable the taxable portion must be limited to the difference, if any, between the selling price of $3,600 and the fair market value of the stock on October 19, 1936, and that the amended regulation applied prospectively is invalid because it changes without statutory authority an interpretation of long standing, were considered and rejected in certain of the cases above cited. See, also, Helvering v. Wilshire Oil Co., 308 U.S. 90, 99-103, 60 S.Ct. 18, 84 L.Ed. 101, and Helvering v. Reynolds, 313 U.S. 428, 431, 432, 61 S.Ct. 971, 85 L.Ed. 1438, 134 A.L.R. 1155, as to the last-mentioned argument that the Commissioner was not authorized to change the regulation.
Plaintiff is not entitled to recover and the petition is therefore dismissed. It is so ordered.
WHALEY, Chief Justice, and MADDEN, and WHITAKER, Judges, concur.
JONES, Judge, took no part in the decision of this case.