Opinion
Docket No. 3757.
1947-02-12
PULLMAN, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
W. J. Butler, Esq., and L. M. Greenlaw, Esq., for the petitioner. Harold H. Hart, Esq., for the respondent.
Held, surrender by sole stockholder of small part of subsidiary's stock and payment from latter of amount of stockholders' cost basis as to such stock, which amount was considerably less than subsidiary's accumulated earnings and profits, constituted a transaction essentially equivalent to the distribution of a taxable dividend under section 115(g) of the Internal Revenue Code. W. J. Butler, Esq., and L. M. Greenlaw, Esq., for the petitioner. Harold H. Hart, Esq., for the respondent.
The Commissioner determined a deficiency in petitioner's income tax for the calendar year 1941 in the amount of $249,961.29 and a penalty in the amount of $12,498.06.
The principal question at issue is whether the Pullman Co. canceled or redeemed 50,000 shares of its stock owned by petitioner in such a manner as to make the distribution of $5,042,500 essentially equivalent to a taxable dividend.
The penalty was asserted by reason of respondent's contention that the deficiency was due to petitioner's negligence, or intentional (but nonfraudulent) regard of rules and regulations.
FINDINGS OF FACT.
A partial stipulation of facts has been filed. We find the facts therein set out to be as stipulated.
Petitioner is a holding company, organized under the laws of the State of Delaware in 1927. Its principal office is at 100 West 10th Street, Wilmington, Delaware. Petitioner filed its income tax return for the calendar year 1941 with the collector of internal revenue at Wilmington.
In 1941 petitioner's principal subsidiaries were as follows:
(a) Petitioner owned more than 99 percent of the capital stock of The Pullman Co., an Illinois Corporation, engaged in the sleeping car business, furnishing berths and other accommodations to railroad passengers. Subsequent to 1941, petitioner became the owner of 100 percent of this stock.
(b) Petitioner, in 1941, owned, and still owns, 100 percent of the capital stock of Pullman Standard Car Mfg. Co., a Delaware corporation, engaged in the manufacture and sale of railroad freight and passenger cars and Pullman cars.
(c) Petitioner, in 1941, owned, and still owns, 100 percent of the capital stock of Pullman Car & Mfg. Corporation, an Alabama corporation, which, in 1941, owned, and still owns, a manufacturing plant in Alabama leased to and operated by Pullman Standard Car Mfg. Co., the Delaware corporation.
The capitalization of the Pullman Co. from its organization in 1867 down through 1941 consisted of one class of stock, namely, common stock of a par value of $100 per share. The total authorized capital of the Pullman Co. as of September 17, 1941, was 1,081,350 shares, all of which were issued and outstanding.
None of the 1,081,350 shares represented a capitalization of earnings of the Pullman Co. accrued since 1913, and no stock dividend was issued by the Pullman Co. after 1910.
Petitioner owned 1,081,290 of the outstanding shares of the Pullman Co., and carried them on its books at a value of $100.85 per share. For the purposes of this proceeding only, the parties have stipulated the petitioner's adjusted basis for this stock was not less than $100.85 per share.
During 1941 the boards of directors of petitioner and of the Pullman Co. consisted of fifteen directors. Fourteen of the directors of petitioner were also directors of the Pullman Co. The president of petitioner was also president of the Pullman Co.
During 1941 petitioner's authorized capital was 3,875,000 shares of common stock of no par value, of which 3,302,897 shares were outstanding at the close of 1941. They were held by approximately 34,100 stockholders.
At a meeting of petitioner's board of directors held September 17, 1941, it was resolved that petitioner tender for sale to the Pullman Co., at the close of business on that day, 50,000 shares of capital stock of the Pullman Co. at a price of $100.85 per share, the value at which it was carried on petitioner's books.
At a meeting held later on the same date, the board of directors of the Pullman Co. accepted petitioner's offer, and directed its officers to take all necessary steps to effect the purchase of the stock, which, it was stated, would be held in the treasury of the Pullman Co., subject to the further order of the board. It has been stipulated, for the purpose only of the issue arising herein under section 115(g) of the Internal Revenue Code, that it was not the intention of the Pullman Co. to hold the shares so purchased for investment or resale, but that it was the intention of the Pullman Co. and of petitioner on September 17, 1941, to proceed in due course with retirement and cancellation of the 50,000 shares by appropriate corporate action in Illinois.
Pursuant to the action taken at the meetings on September 17, 1941, petitioner endorsed and delivered to the Pullman Co. certificates for 50,000 shares of stock of the Pullman Co. Federal stock transfer stamps in the amount of $3,000 were affixed to the certificates and canceled. On September 19, 1941, the Pullman Co. paid to petitioner $5,042,500 as the purchase price of the 50,000 shares. Transfer of the shares was made on the stock records of the Pullman Co., and a new stock certificate for 50,000 shares was issued to the Pullman Co. At that time there were 1,031,350 shares of the Pullman Co. in the hands of persons other than the Pullman Co. Of these, petitioner owned 99.99418 per cent. Prior to the transaction petitioner owned 99.99444 per cent of the outstanding stock of the Pullman Co.
On March 11, 1942, the board of directors of the Pullman Co. adopted a resolution recommending to the stockholders that the corporate charter be amended by reducing its authorized shares from 1,081,350 to 1,031,350 shares, and reducing its stated capital from $108,135,000 to $103,135,000, such reduction to be effected by canceling and retiring the 50,000 shares purchased from petitioner.
This recommendation was adopted by stockholders at the annual meeting on March 25, 1942, and the amendment to the charter was thereupon filed with the Secretary of State of Illinois.
During the period 1906 through 1942 the Pullman Co. had amended its charter to effect the changes in its capital stock indicated below:
+-----------------------------------------------+ ¦Nov. 20, 1906¦capital increased to $100,000,000¦ +-------------+---------------------------------¦ ¦Mar. 24, 1910¦capital increased to $120,000,000¦ +-------------+---------------------------------¦ ¦Dec. 22, 1921¦capital increased to $135,000,000¦ +-------------+---------------------------------¦ ¦Feb. 5, 1930 ¦capital decreased to $120,150,000¦ +-------------+---------------------------------¦ ¦Aug. 10, 1934¦capital decreased to $108,135,000¦ +-------------+---------------------------------¦ ¦Mar. 27, 1942¦capital decreased to $103,135,000¦ +-----------------------------------------------+
The 150,000 shares of increased stock resulting from the charter amendment filed December 22, 1921, were issued as part of the purchase price of the assets and property of a company which owned a freight car building plant at Michigan City, Indiana, and did not represent a stock dividend.
Subsequent to the retirement of the 50,000 shares here in question in March 1942, the Pullman Co. effected these further changes in its capitalization by filing appropriate charter amendments:
+-----------------------------------------------------------------------------+ ¦Nov. 10,¦capital decreased to $83,135,000 ¦ ¦1942 ¦ ¦ +--------+--------------------------------------------------------------------¦ ¦June 9, ¦capital decreased to $73,135,000 ¦ ¦1944 ¦ ¦ +--------+--------------------------------------------------------------------¦ ¦Dec. 15,¦par value of shares decreased ¦ ¦1945 ¦ ¦ +--------+--------------------------------------------------------------------¦ ¦ ¦to $10 per share, thereby decreasing stated capital to $7,313,300 ¦ ¦ ¦and creating paid-in surplus of $65,821,500 ¦ +-----------------------------------------------------------------------------+
Because it had not acquired any new equipment during the depressed years of 1930-1935, and only a relatively small number of cars from 1935-1940, the cash and liquid assets of the Pullman Co. were substantially increased by reason of depreciation allowances. Its reluctance to invest in new equipment was due not only to the low earnings experience of the depression, but also because it could foresee the necessity in the future of severing the operating company from the manufacturing activities of the group. Such investments as were made between 1935 and 1940 were made pursuant to special contracts with the railroads to purchase the new cars at the expiration of the operating agreements. In 1940 the Government instituted an anti-trust suit which was strenuously contested by the Pullman Co., as a result of which in 1943 the court ordered the separation of the Pullman Co. from the manufacturing company, effective in 1944.
In 1941, and thereafter, when the greatly increased business activity growing out of the defense program and the war created a desperate need for new cars, the Government caused to be built at its own expense about 2,400 new cars, and the schedule set out below, so far as it relates to 1943, includes 626 Government owned cars, and for 1944, 1,238 Government owned cars. The Pullman Co. during this period operated the Government owned cars, and also reactivated 800 old cars which had been retired and would have been scrapped but for the emergency.
The average number of cars owned and operated by the Pullman Co. from 1921 through 1944, the car miles operated, the number of revenue passengers, and gross operating revenues, are set forth below:
+-----------------------------------------------------------------------------+ ¦Calendar¦Average number¦Average number ¦Car miles ¦Revenue ¦Gross ¦ ¦year ¦of cars owned ¦of cars operated¦operated ¦passengers¦operating ¦ ¦ ¦ ¦ ¦ ¦ ¦revenue ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1921 ¦7,826 ¦6,754 ¦799,572,465 ¦31,225,324¦$65,662,882¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1922 ¦7,764 ¦6,847 ¦820,827,020 ¦31,748,385¦66,747,754 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1923 ¦7,562 ¦7,267 ¦890,719,336 ¦34,249,445¦73,736,161 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1924 ¦7,999 ¦7,600 ¦943,334,475 ¦34,085,756¦74,065,180 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1925 ¦8,814 ¦8,238 ¦1,043,663,099¦35,525,803¦81,749,537 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1926 ¦8,952 ¦8,639 ¦1,112,967,022¦36,073,211¦83,272,533 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1927 ¦9,068 ¦8,688 ¦1,140,476,049¦35,197,178¦82,270,061 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1928 ¦9,248 ¦8,631 ¦1,153,889,647¦33,923,920¦82,391,514 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1929 ¦9,529 ¦8,842 ¦1,206,767,059¦33,434,268¦84,144,961 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1930 ¦9,860 ¦8,559 ¦1,183,668,557¦29,360,186¦77,985,085 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1931 ¦9,483 ¦7,402 ¦1,025,164,501¦22,984,921¦63,854,286 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1932 ¦9,279 ¦5,693 ¦799,484,608 ¦15,749,507¦44,321,191 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1933 ¦8,478 ¦4,944 ¦710,747,267 ¦13,716,538¦39,371,841 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1934 ¦8,473 ¦5,029 ¦737,167,857 ¦15,105,349¦45,541,188 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1935 ¦8,027 ¦5,057 ¦758,554,032 ¦15,478,708¦50,135,369 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1936 ¦8,004 ¦5,355 ¦825,945,721 ¦17,197,736¦58,334,826 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1937 ¦7,763 ¦5,500 ¦872,598,392 ¦17,744,568¦64,287,199 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1938 ¦7,578 ¦5,124 ¦818,481,116 ¦15,539,849¦58,924,968 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1939 ¦7,052 ¦5,100 ¦825,745,133 ¦15,655,135¦60,664,266 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1940 ¦6,901 ¦4,990 ¦820,386,700 ¦14,765,316¦60,143,649 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1941 ¦7,048 ¦5,303 ¦878,057,274 ¦16,910,721¦67,040,587 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1942 ¦7,121 ¦6,368 ¦1,071,254,181¦26,062,549¦99,722,785 ¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1943 ¦7,747 ¦7,096 ¦1,222,676,452¦32,631,899¦124,960,365¦ +--------+--------------+----------------+-------------+----------+-----------¦ ¦1944 ¦8,336 ¦7,485 ¦1,326,580,210¦35,837,908¦146,613,094¦ +-----------------------------------------------------------------------------+
The Pullman Co. paid dividends in the amounts indicated for the various years in the following table, which also sets out the net earnings based on income tax returns for the years 1913 to 1937, which have been settled and closed, and on income tax returns as filed for the years 1938 to 1944:
+-----------------------------------------------------------------------------+ ¦Year¦Net earnings ¦Regularly declared¦Year¦Net earnings ¦Regularly declared¦ ¦ ¦ ¦dividends ¦ ¦ ¦dividends ¦ +----+--------------+------------------+----+--------------+------------------¦ ¦1913¦$12,515,921.24¦$9,328,348.00 ¦1929¦$12,369,892.64¦$40,473,796.50 ¦ +----+--------------+------------------+----+--------------+------------------¦ ¦1914¦10,662,117.01 ¦9,328,352.66 ¦1930¦6,537,823.59 ¦10,121,272.50 ¦ +----+--------------+------------------+----+--------------+------------------¦ ¦1915¦13,569,049.72 ¦9,328,420.68 ¦1931¦4,513,746.86 ¦ ¦ +----+--------------+------------------+----+--------------+------------------¦ ¦1916¦13,563,300.50 ¦9,368,429.32 ¦1932¦(180,295.18) ¦6,006,410.00 ¦ +----+--------------+------------------+----+--------------+------------------¦ ¦1917¦16,553,675.76 ¦9,368,278.68 ¦1933¦919,604.16 ¦ ¦ +----+--------------+------------------+----+--------------+------------------¦ ¦1918¦11,816,767.72 ¦9,368,280.00 ¦1934¦2,720,805.76 ¦ ¦ +----+--------------+------------------+----+--------------+------------------¦ ¦1919¦13,033,597.48 ¦9,368,282.00 ¦1935¦508,251.73 ¦ ¦ +----+--------------+------------------+----+--------------+------------------¦ ¦1920¦11,677,465.57 ¦9,368,288.00 ¦1936¦4,098,087.92 ¦3,243,783.00 ¦ +----+--------------+------------------+----+--------------+------------------¦ ¦1921¦11,154,128.58 ¦9,455,888.00 ¦1937¦3,251,794.33 ¦3,243,846.00 ¦ +----+--------------+------------------+----+--------------+------------------¦ ¦1922¦11,906,258.32 ¦10,728,238.00 ¦1938¦3,371,668.89 ¦ ¦ +----+--------------+------------------+----+--------------+------------------¦ ¦1923¦16,300,807.76 ¦10,737,483.50 ¦1939¦2,941,343.56 ¦2,162,620.00 ¦ +----+--------------+------------------+----+--------------+------------------¦ ¦1924¦12,597,788.56 ¦10,721,572.00 ¦1940¦2,439,540.61 ¦1,621,968.00 ¦ +----+--------------+------------------+----+--------------+------------------¦ ¦1925¦19,349,174.17 ¦10,705,158.00 ¦1941¦2,131,682.05 ¦3,243,942.00 ¦ +----+--------------+------------------+----+--------------+------------------¦ ¦1926¦15,198,130.56 ¦10,725,382.00 ¦1942¦12,459,869.11 ¦5,156,570.00 ¦ +----+--------------+------------------+----+--------------+------------------¦ ¦1927¦33,221,464.24 ¦12,116,169.63 ¦1943¦8,975,295.59 ¦3,093,942.00 ¦ +----+--------------+------------------+----+--------------+------------------¦ ¦1928¦13,984,656.35 ¦8,078,634.00 ¦1944¦7,017,003.05 ¦4,687,974.00 ¦ +-----------------------------------------------------------------------------+
As of January 1, 1941, the accumulated earnings and profits of the Pullman Co. after February 28, 1913, were not less than $17,829,000.
The payment of $5,042,500 by the Pullman Co. to petitioner in the taxable year constituted a transaction essentially equivalent to the distribution of a taxable dividend.
The receipt of the sum of $5,042,500 in dispute here was not reported for taxation by petitioner in its 1941 income and excess profits tax return, since it was and is petitioner's belief that it was a capital transaction resulting in no gain or loss. The transaction was reflected in the balance sheet attached to the return. No part of the deficiency is due to petitioner's negligence or intentional disregard of rules and regulations.
OPINION.
KERN, Judge:
The primary question for consideration here is whether the distribution to petitioner by a subsidiary corporation of $5,042,500 in exchange for 50,000 shares of the subsidiary's stock, which were canceled, was essentially equivalent to a taxable dividend within the meaning of section 115(g) of the Internal Revenue Code.
Since the shares were redeemed at the figure which represented petitioner's basis for the stock, and not at book or fair market value, there is no question involved of capital gain or loss. The same facts indicate that the tax effects of the transaction were carefully weighed and so arranged as to relieve petitioner from tax liability.
The parties agree that the distributing corporation had an earned surplus approximating $17,000,000.
Section 115(a) of the code defines a dividend as ‘any distribution made by a corporation to its shareholders * * * out of its earnings and profits accumulated after February 28, 1913 * * * .‘
Section 115(b) says ever- distribution is made out of earnings and profits to the extent thereof. As we have seen, this distribution was in an amount less than accumulated earnings and profits.
Section 115(g) provides that if a corporation cancels or redeems its stock at such time and in such manner as to make the distribution and cancellation or redemption essentially equivalent to the distribution of a taxable dividend, it shall be treated as such to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913.
A dividend ordinarily results in the distribution of earnings and profits to stockholders and does not affect the proportionate ownership and control of the corporation by its stockholders.
This was the net effect of the distribution presently before us. A payment was made to petitioner by the Pullman Co. out of its accumulated earnings and profits, and the proportionate interest and control of petitioner through its ownership of the stock of the Pullman Co. was reduced by .00026 per cent. The realities of the transaction clearly demand that it be treated as a dividend rather than a purchase of stock, which it purported to be. In a purchase of stock the parties would normally attempt to arrive at a purchase price which would reflect the ideas of buyer and seller with regard to its fair market value at the time of the sale, and this price thus arrived at would normally result in either a gain or a loss to the owner. Here, there was paid an amount which did not purport to reflect the fair market value, nor even the book value of the stock, but was arrived at only by reference to the stockholder's actual tax basis for the stock. The same reasoning militates against a conclusion that the transaction constituted, in effect, a partial liquidation. A complete redemption of a part of the stock of a corporation would normally imply the return to the stockholder of the full amount of the capital contribution evidenced by the shares redeemed adjusted by the proportion of the corporation's subsequent gain or loss allocable to the shares involved, i.e., the book value of the stock redeemed. It might be the par value of the stock redeemed. It would not normally be the cost basis of the stock redeemed to the individual stockholder.
The situation presented by the instant case seems to be a fair example of the type of situation which Congress appears to have had in mind when it enacted the applicable sections of the statute. See S. Rept. No. 52, 69th Cong., 1st sess., p. 15.
Petitioner earnestly contends that the redemption of the stock was not a step in a plan to distribute earnings and profits to it as a stockholder and thus subject to the provisions of section 115(g), but was dictated by the reasonable needs of the corporate business and was thus a partial liquidation within the definition of section 115(i). See Samuel A. Upham, 4 T.C. 1120, 1127.
For a discussion of some of the cases in which the doctrine of ‘the reasonable needs of the corporate business‘ as a criterion for the application of section 115(g) to distributions purportedly in redemption of capital stock was evolved and applied, see J. Natwick, 36 B.T.A. 866.
The force of this doctrine has been considerably weakened by the recent pronouncements of several of the Circuit Courts of Appeal and of the Supreme Court in analogous cases. See Commissioner v. Bedford's Estate, 325 U.S. 283; A. J. Long, Jr., 5 T.C. 327; affd., 155 Fed.(2d) 847; Kirschenbaum v. Commissioner, 155 Fed.(2d) 23; Bazley v. Commissioner, 155 Fed.(2d) 237. See also Flanagan v. Helvering, 116 Fed.(2) 937, 939, 940, where the present Chief Justice of the United States, then a member of the Court of Appeals for the District of Columbia, said on behalf of the latter court: ‘But the net effect of the distribution, rather than the motives and plans of the taxpayer or his corporation, is the fundamental question in administering section 115(g).‘
It is not necessary for us to decide the extent to which this doctrine has thus been weakened, or to await the opinion of the Supreme Court in the Bazley case, which is now before it for certiorari, since, even though we accept the doctrine, we do not believe that the facts of the instant case make it applicable.
It is axiomatic that ‘the question of whether a distribution in connection with the retirement of a portion of corporate stock is a taxable dividend or a distribution in partial liquidation depends upon the particular facts of each individual case.‘ Samuel A. Upham, supra, p. 1125.
We conceive the controlling facts of the instant case to be as follows: In the taxable year the Pullman Co. was conducting the same types of business which it had conducted during the period 1930-1940, and it had no intention to liquidate any part thereof. During that period the volume of its business declined, but in 1941 events occurred which indicated that the volume of its business would increase. During the period in which the volume of its business declined there was a considerable increase in its cash and liquid assets by reason of its depreciation of equipment then in use and its decision (doubtless a reasonable one) not to manufacture during a large part of that period as much new equipment as had been formerly manufactured. In 1941 the Pullman Co. had more cash and liquid assets than it deemed necessary in that year in the operation of its business, and petitioner, which was for all practical purposes the sole stockholder of the Pullman Co., wished to obtain cash and initiated the transaction whereby it surrendered a part of its stock in the Pullman Co. and obtained the amount of cash which it needed. The amount of the accumulated earnings and profits of the Pullman Co. was approximately three times the amount of the cash thus obtained by petitioner. It should be added that the transaction here involved was given the fictitious form of a sale in which the purported purchase price reflected neither the fair market value nor the book value of the stock ‘sold,‘ but the basis of the stock in the hands of the petitioner.
This being our view of the facts here presented, we are unable to conclude that the distribution was dictated by the reasonable needs of the corporate business of the Pullman Co. In our opinion the distribution was not a partial liquidation within the meaning of section 115(i) and section 115(c), but was a distribution essentially equivalent to the distribution of a taxable dividend within the meaning of section 115(g), read in the light of sections 115(a) and 115(b).
It would be unprofitable to distinguish the instant case from the fact presented by all of the cases cited by petitioner, or the cases discussed by us in J. Natwick, supra, since, as we have already pointed out, and as petitioner admits, the conclusion in each class depends on the special facts presented. We content ourselves with distinguishing the facts of the instant case from those present in the latest case cited by petitioner, Samuel A. Upham, supra (1945). In that case liquidation of the corporation was contemplated and, consequently, an expansion of plant facilities for which a part of the capital of the corporation was set aside was abandoned. Here there was no proposed liquidation on the part of the corporation, and none of its capital had been set aside for physical expansion the abandonment of which made the capital thus set aside unnecessary.
The fact that the Pullman Co. treated the distribution on its books as from capital rather than from earnings and profits, and showed no change in its surplus account, is not controlling. Adams v. Commissioner, 155 Fed.(2d) 246.
The assessment of the 5 per cent penalty for negligent disregard of rules and regulations does not seem to be justified under the present facts. Petitioner did not report receipt of the amount involved here because of a bona fide belief that it was not taxable. It did not make a specific report to the Commissioner of the facts and circumstances surrounding the distribution, as advised by section 19.115-9 of the regulations, but sufficient information was contained in the return, or more specifically, in the balance sheet attached to the return, to apprise the Commissioner of the fact that the transaction had occurred. This seems indicated by the fact that the controversy which eventually gave rise to this proceeding was begun within three months after the filing of the return. We can not sustain the respondent's action in this respect.
Reviewed by the Court.
Decision will be entered under Rule 50.