Opinion
Docket Nos. 38971 38972.
1953-05-14
JOSEPH P. SCHMITT AND RUTH B. SCHMITT, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.JAMES S. LEHREN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Norman D. Keller, Esq., for the petitioners. Roy E. Graham, Esq., for the respondent.
In the taxable year 1947 petitioners, stockholders of Wolverine Supply & Manufacturing Company, received a proportionate distribution of 1,486 shares of its capital stock acquired by purchase out of undivided profits. Held, that such distribution constituted a taxable dividend to the extent of the fair market value of the shares received by each petitioner. Norman D. Keller, Esq., for the petitioners. Roy E. Graham, Esq., for the respondent.
These consolidated proceedings involve deficiencies in income taxes for 1947, as follows:
+-------------------------------------------------+ ¦Joseph P. Schmitt and Ruth B. Schmitt¦$138,495.17¦ +-------------------------------------+-----------¦ ¦James S. Lehren ¦167,076.99 ¦ +-------------------------------------------------+
The sole issue is whether a distribution of capital stock of the Wolverine Supply & Manufacturing Company to the petitioners in 1947 is essentially equivalent to a taxable dividend.
The case was submitted upon a stipulation of facts, exhibits, and oral testimony. The facts as stipulated are found accordingly.
FINDINGS OF FACT.
Petitioners Joseph P. Schmitt and Ruth B. Schmitt are husband and wife, residing in Mt. Lebanon Township, Allegheny County, Pennsylvania. They filed a joint return for the calendar year 1947 with the collector of internal revenue for the twenty-third district of Pennsylvania, at Pittsburgh.
Petitioner James S. Lehren is an individual with principal office in New York, New York. His return for the calendar year 1947 was filed with the collector of internal revenue for the third district of New York, at New York City.
During the year 1947 and for a number of years immediately prior thereto, James S. Lehren was president and Joseph P. Schmitt, vice president, of Wolverine Supply & Manufacturing Company, hereinafter referred to as ‘Wolverine.‘
Wolverine is a Pennsylvania corporation organized on or about September 6, 1906, and since its organization has engaged in the manufacture of children's toys and games. Its principal office is located in Pittsburgh, Pennsylvania.
Benjamin F. Bain, prior to his death in 1925, owned substantially all of the stock of Wolverine and also three factory buildings which were leased to Wolverine. His widow, now Dora Elliott Green, inherited the majority of his Wolverine stock and the factory buildings.
In 1926 James S. Lehren, Joseph P. Schmitt, and Carl C. Bain signed a contract with Dora Elliott Green to purchase 1,596 shares of the capital stock of Wolverine. This contract was canceled for nonpayment by the vendees under the terms of the agreement.
In 1929 Lehren and Schmitt entered into another agreement with Dora Elliott Green to purchase 1,438 shares of the capital stock of Wolverine. The prescribed payments became in default and the agreement was canceled on April 16, 1932.
In 1935 Lehren and Schmitt entered into another written contract with Dora Elliott Green to purchase, 1486 shares of the stock of Wolverine. The amount of the purchase price was $270,560.76 plus interest of $49,847.68, which was payable in designated annual installments over a period of 12 years ending April 15, 1947, with annual interest of designated amounts upon the unpaid balance of the purchase price. The agreement provided that it was contemplated by the parties that the payment of the annual installments of principal and interest would primarily be made out of dividends declared on the stock owned by Dora Elliott Green. None of the stock was to be delivered until the whole had been fully paid for. It was further provided that after the stock had been transferred to the purchasers it should be held in escrow by a trustee as collateral security to a lease between Wolverine and Dora Elliott Green until all of the terms of the lease had been carried out. In pursuance of the agreement, the 1,486 shares involved were deposited in escrow with The Citizens National Bank of Washington, Pennsylvania. The agreement was canceled on April 30, 1937, by oral agreement of the parties.
On September 16, 1937, Lehren and Schmitt, as president and vice president of Wolverine, and pursuant to resolutions duly adopted by the stockholders and directors, executed a contract with Dora Elliott Green to purchase 1,486 shares of the capital stock of Wolverine and 40 shares of the capital stock of Ulca Camera Corporation. The purchase price was $345,784.74, payable in designated annual installments over a period of 11 years ending in 1947, together with designated annual amounts of interest upon unpaid balances, with the right of the purchaser to anticipate payment of principal at any time. The agreement also provided that it was contemplated that payments under it should be paid out of current net earnings for the then fiscal year, and/or out of earnings carried in surplus in the discretion of the board of directors, which should in no manner impair the working capital. The agreement further provided that the stock should be placed in escrow, and that annually, following the payment of the designated principal with interest as provided, Wolverine should be entitled to demand and have transferred to its name 40 per cent of that portion of the stock as paid for at the rate of $300 per share, the remaining 60 per cent to remain in escrow with the right of Dora Elliott Green to vote the stock held in escrow. On June 20, 1940, the parties entered into a written amendatory agreement, in several particulars, including the correction of the unit price of the stock to the amount of $232.60 from the amount of $300, which was recited to have been a typographical error. The Citizens National Bank of Washington, Pennsylvania, pursuant to oral understanding, retained the 1,486 shares as trustee under the terms of the 1937 agreement.
During the years 1937 to 1944, inclusive, under the agreement of September 16, 1937, Wolverine paid to Dora Elliott Green from earnings of the corporation the aggregate amount of $278,991.07. The balance due for the years 1945, 1946, and 1947 was $153,301.05. Wolverine desired to pay the balance in full in 1945, so approximately $41,000 was taken out of earnings and the corporation borrowed $110,000 from two banks and the money was used to pay Dora Elliott Green. In 1946 the corporation took $45,000 out of earnings which was applies against the $110,000 indebtedness. In 1947 the balance of $65,000 was paid out of earnings to discharge the remainder of such indebtedness.
Prior to September 16, 1937, Wolverine had purchased from other stockholders 210 shares which it held in its treasury. Of such shares, 15 were held by Frank J. Goriup and 3 shares were held by Allan J. Ratz, employees of Wolverine, Goriup and Ratz were induced by petitioners to sell their shares to the corporation on the understanding that after the 1,486 shares had been acquired from Dora Elliott Green they could repurchase such shares at the price at which they had sold them. On September 10, 1947, after the distribution of the 1,486 shares to the petitioners, Wolverine sold to Goriup 22 shares and to Ratz 3 shares of the treasury stock, leaving 185 shares remaining in the treasury.
Wolverine paid no cash dividends during the period 1937 to 1947. Its net earnings after taxes were as follows:
+------------------+ ¦1937 ¦$ 4,998.08 ¦ +-----+------------¦ ¦1938 ¦(165.37) ¦ +-----+------------¦ ¦1939 ¦34,403.35 ¦ +-----+------------¦ ¦1940 ¦67,383.61 ¦ +-----+------------¦ ¦1941 ¦31,859.29 ¦ +-----+------------¦ ¦1942 ¦32,107.03 ¦ +-----+------------¦ ¦1943 ¦27,478.72 ¦ +-----+------------¦ ¦1944 ¦30,548.31 ¦ +-----+------------¦ ¦1945 ¦29,046.86 ¦ +-----+------------¦ ¦1946 ¦146,610.96 ¦ +-----+------------¦ ¦1947 ¦225,414.64 ¦ +-----+------------¦ ¦Total¦$629,685.48 ¦ +------------------+
The balance sheets of Wolverine as of December 31 for the years 1937 to 1947, inclusive, show, inter alia, the following.
+--------------------------------------------------------------+ ¦ ¦Assets ¦Liabilities ¦ +----+---------------------------------+-----------------------¦ ¦Year¦ ¦Premiums ¦ ¦ ¦ ¦ +----+-----------+----------+----------+-----------+-----------¦ ¦ ¦Cash ¦paid on ¦Treasury ¦Common ¦Surplus ¦ +----+-----------+----------+----------+-----------+-----------¦ ¦ ¦ ¦treasury ¦stock ¦stock ¦ ¦ +----+-----------+----------+----------+-----------+-----------¦ ¦ ¦ ¦stock ¦ ¦ ¦ ¦ +----+-----------+----------+----------+-----------+-----------¦ ¦1937¦$126,201.89¦$51,154.50¦$13,850.00¦$103,150.00¦$437,087.70¦ +----+-----------+----------+----------+-----------+-----------¦ ¦1938¦112,786.38 ¦75,379.01 ¦17,650.00 ¦103,150.00 ¦436,095.96 ¦ +----+-----------+----------+----------+-----------+-----------¦ ¦1939¦123,315.11 ¦101,403.52¦22,050.00 ¦103,150.00 ¦468,680.15 ¦ +----+-----------+----------+----------+-----------+-----------¦ ¦1940¦169,631.04 ¦129,048.03¦27,050.00 ¦103,150.00 ¦536,008.26 ¦ +----+-----------+----------+----------+-----------+-----------¦ ¦1941¦138,260.51 ¦158,832.54¦32,950.00 ¦103,150.00 ¦567,857.30 ¦ +----+-----------+----------+----------+-----------+-----------¦ ¦1942¦318,335.83 ¦192,967.05¦38,300.00 ¦103,150.00 ¦600,158.35 ¦ +----+-----------+----------+----------+-----------+-----------¦ ¦1943¦118,634.89 ¦228,096.56¦44,750.00 ¦103,150.00 ¦619,175.21 ¦ +----+-----------+----------+----------+-----------+-----------¦ ¦1944¦185,071.35 ¦265,241.07¦52,250.00 ¦103,150.00 ¦640,684.05 ¦ +----+-----------+----------+----------+-----------+-----------¦ ¦1945¦245,845.28 ¦385,992.12¦84,800.00 ¦103,150.00 ¦669,753.37 ¦ +----+-----------+----------+----------+-----------+-----------¦ ¦1946¦283,976.57 ¦ ¦84,800.00 ¦103,150.00 ¦405,177.29 ¦ +----+-----------+----------+----------+-----------+-----------¦ ¦1947¦469,998.36 ¦ ¦9,250.00 ¦103,150.00 ¦526,828.16 ¦ +--------------------------------------------------------------+
On December 31, 1946, the authorized capital stock of Wolverine consisted of 2,500 shares of common stock of the par value of $50 per share, of which 2,063 shares had been issued. On said date, 168 shares were owned by Schmitt and 199 by Lehren. A certificate in the name of Wolverine for 892 shares was held by The Citizens National Bank of Washington, Pennsylvania, in escrow, under the 1937 purchase agreement; 804 shares of reacquired stock were not evidenced by any certificate; and the remaining 437 shares of authorized capital had never been issued.
On April 21, 1947, the escrow agent returned the certificate for 892 shares to Wolverine, and on April 23, 1947, the certificate was marked ‘Cancelled.‘
On June 13, 1947, at a special meeting of the board of directors of Wolverine, the following resolution was unanimously adopted:
WHEREAS, there is now in the Treasury of the company, 1,486 shares of its capital stock which was acquired by purchase from Dora Elliott Green, and represents undivided profits invested in said security and,
WHEREAS, it is deemed advisable to divide said stock as a dividend among the stockholders of record at the close of business, July 1, 1947, be it therefore
RESOLVED: that the President and the Secretary be and they hereby are authorized and directed to distribute the said 1,486 shares of the capital stock of this company new held in the Treasury of the company to the stockholders of record at the close of business July 1, 1947, in proportion (sic) to their holdings as of said date.
On July 18, 1947, a certificate for 680 shares of the capital stock of Wolverine was issued and delivered to Schmitt and a certificate for 806 shares was issued and delivered to Lehren. On that date, prior to the delivery of the above-mentioned certificates, Schmitt owned 168 shares and Lehren owned 199 of the issued and outstanding capital stock of Wolverine. No further distributions of common stock of Wolverine were made during the year 1947.
In determining the deficiencies against the petitioners, the respondent increased the gross income of Joseph P. and Ruth B. Schmitt by $170,000 and that of James S. Lehren by $201,500, as dividends received from Wolverine in the taxable year 1947.
The distribution of the 1,486 shares of capital stock of Wolverine to the petitioners in 1947 was a taxable dividend.
OPINION.
LEMIRE, Judge:
The respondent determined that the petitioners, in the taxable year 1947, received a taxable distribution equal to the fair market value of 1,486 shares of the capital stock of Wolverine.
Petitioners contend that the distribution of such shares was a nontaxable stock dividend within the ambit of Eisner v. Macomber, 252 U.S. 189, and our decisions in the cases of James Kay, 28 B.T.A. 331, and David Bruckheimer, 46 B.T.A. 234.
The authorized capital of Wolverine was 2,500 shares of common stock of the par value of $50 per share, and 2,063 shares had been issued. Prior to September 16, 1937, the corporation had reacquired by purchase 210 shares, which were held in its treasury. Of the remaining 1,853 shares, Dora Elliott Green held 1,486 shares, Joseph P. Schmitt 168 shares, and James S. Lehren 199 shares. From 1937 to 1945, Wolverine paid to Dora Elliott Green sums totaling $432,292.12 to acquire her 1,486 shares. The 210 shares previously purchased and the 1,486 shares acquired from Dora Elliott Green was not retired, but were carried on Wolverine's balance sheets as assets.
On June 13, 1947, Wolverine's board of directors adopted a resolution in substance as follows:
WHEREAS, there is now in the Treasury of the company, 1,486 shares of its capital stock which was acquired by purchase from Dora Elliott Green, and represents undivided profits invested in said security and,
WHEREAS, it is deemed advisable to divide said stock as a dividend among the stockholders of record at the close of business, July 1, 1947, be it therefore
RESOLVED: that the President and the Secretary be and they hereby are authorized and directed to distribute the said 1,486 shares of the capital stock of this company now held in the Treasury of the company to the stockholders of record at the close of business July 1, 1947, in proportion (sic) to their holdings as of said date.
This record discloses that during the period 1937 to 1947, inclusive, the balance sheets of Wolverine stated its capital stock liability to be $103,150, representing the 2,063 shares it had previously issued at the par value of $50 per share. As of December 31, 1946, the 1,486 shares acquired from Dora Elliott Green under the contract of September 16, 1937, plus the 210 shares repurchased by the corporation during the period when petitioners were attempting to acquire the shares held by Dora Elliott Green, were carried as corporate assets at cost. At the time of the distribution there was no conversion of surplus into capital stock.
In Bass v. Commissioner, 129 F.2d 300, in discussing a true stock dividend, the United States Court of Appeals for the First Circuit said:
‘A stock dividend always involves a transfer of surplus (or profit) to capital stock.‘ Graham and Katz, Accounting in Law Practice, 2d ed. 1938 Sec. 80. As the court said in United States v. Siegel, 8 Cir., 1931, 52 F.2d 63, 65, 78 A.L.R. 672: ‘A stock dividend is a conversion of surplus or undivided profits into capital stock, which is distributed to stockholders in lieu of a cash dividend.‘ Congress itself had defined the term ‘dividend‘ in Sec. 115(a) of the Act as meaning any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits. In Eisner v. Macomber, 1920, 252 U.S. 189, 40 S.Ct. 189, 64 L.Ed. 521, 9 A.L.R. 1570, both the prevailing and the dissenting opinions recognized that within the meaning of the revenue acts the essence of a stock dividend was the segregation out of surplus account of a definite portion of the corporate earnings or profits theretofore available for dividends, the freezing of such segregated earnings as part of the permanent capital resources of the corporation by the device of capitalizing the same, and the issuance to the stockholders of additional shares of stock representing the profits so capitalized. * * *
The respondent argues that the purchase by Wolverine of the holdings of Dora Elliott Green, constituting the majority of the issued and outstanding capital stock, was, in substance, a purchase for the sole benefit of petitioners and served no corporate purpose.
The record establishes that the petitioners were desirous of acquiring the shares held by Dora Elliott Green and made three vain attempts to purchase them, by the application of cash dividends to be declared. However, Dora Elliott Green was also desirous of having the corporation continued by the petitioners, because she was vitally interested in having the corporation maintain its manufacturing plant on her property which the corporation was then occupying under a lease arrangement. Apparently, it was thought that if the majority interest was sold to outsiders they might not continue to occupy her property. This is clearly indicated by the fact that in each of the contracts of purchase entered into by the petitioners and the corporation the execution of a 10- or 12-year lease of the premises was required as part of the consideration. The end result to be achieved was a continuation of the corporation with the petitioners owning the controlling interest.
Other pertinent facts are presented by this record which we think have a bearing on the bona fides of the entire transaction. Prior to the execution of the contract by the corporation to repurchase the shares of Dora Elliott Green, and during the period when the petitioners were endeavoring to purchase such shares, several other stockholders, some of whom were employees, owned small blocks of the capital stock of Wolverine. Since the dividends were to be applied to the purchase price of the Dora Elliott Green shares, it was apparently deemed advisable to eliminate such minor stockholders. The petitioners were instrumental in having the corporation repurchase the shares of such minor stockholders. Two of the employee stockholders holding 3 and 15 shares, respectively, were reluctant to sell, but were persuaded to do so on the promise of the petitioners to permit them to repurchase the same number of shares at the price they received for them, after the holdings of Dora Elliott Green were acquired. After the corporation had consummated the purchase of the 1,486 shares from Dora Elliott Green, the agreement with the two employee stockholders to resell to them the shares previously purchased by the corporation was not given immediate effect, but was postponed until after the adoption of the resolution in question. On September 14, 1947, a total of 25 shares were sold to the two employee stockholders. If the petitioners had fulfilled their promise to the two employee stockholders, the resolution in question could not have been adopted. The method pursued prevented the two employees from participating in the so-called stock dividend.
We think the resolution distributing the specific shares may not be viewed as an isolated transaction. The effect and final result of the various acts of the parties was a purchase of the shares owned by Dora Elliott Green by the corporation out of its own funds, not with the intention of retaining or retiring them but for the purpose of transferring them to petitioners. This transaction was not completed and there was no taxable distribution to petitioners until the final consummation by the actual transfer of the shares in 1947, which revealed for the first time the real purpose behind the several steps. When viewed in the light of the over-all picture revealed by this record we are convinced that, in substance, the transaction was a distribution of a taxable dividend and not a bona fide stock dividend within the rationale of Eisner v. Macomber, supra, and kindred authorities. In our opinion, to reach any other conclusion on the facts here presented would permit the tactics employed here to be used as a means of tax evasion where corporate shares are closely held.
We think the cases of James Kay, supra, and David Bruckheimer, supra, relied upon by the petitioners are clearly distinguishable. The facts and circumstances there involved are not comparable to those presented in the instant case. There the form and substance of the transaction were thought to coincide and the rationale of Eisner v. Macomber, supra, was held to be controlling.
The respondent determined the petitioners received taxable income in 1947 to the extent of the fair market value of the 1,486 shares at the time of the distribution. The petitioners offered no evidence of the value of such shares and, therefore, the determination of the respondent is sustained.
Reviewed by the Court.
Decisions will be entered for the respondent.