Opinion
Docket Nos. 110260 110275.
1946-03-26
CHARLES H. THORNTON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
J. E. Hughes, Esq., for the petitioner. Charles Munz, Esq., for the respondent.
In 1932 the X company acquired the assets of a Joint Stock Land Bank for the purpose of liquidating them and distributing the proceeds to its stockholders, who had been bondholders of the bank. Petitioner was a stockholder of X. During the years 1932 to 1938 liquidating distributions were made by X to its stockholders, not from earnings and profits, but from the proceeds of its assets sold. During those years X intended to liquidate its assets and engaged in no business which was not incident to such liquidation. The petitioner did not surrender any of his stock to X when the distributions were made, and no endorsements were made on his stock certificates to record these distributions. In 1945 X made loans on real estate and intended to continue in this business. Held, distributions made to petitioner by X during the taxable years were distributions in partial liquidation, includible in income in their full amounts under section 115(c) of the appropriate revenue acts. J. E. Hughes, Esq., for the petitioner. Charles Munz, Esq., for the respondent.
These proceedings involve deficiencies determined by respondent in the income tax of petitioner for the years 1935 to 1939, together with a penalty for one of the years, in the following amounts:
+-----------------------------------+ ¦No. ¦Year ¦Deficiency¦25% penalty¦ +------+-----+----------+-----------¦ ¦ ¦(1935¦$10,997.34¦$2,749.34 ¦ +------+-----+----------+-----------¦ ¦110260¦(1936¦6,918.71 ¦ ¦ +------+-----+----------+-----------¦ ¦ ¦(1937¦4,003.30 ¦ ¦ +------+-----+----------+-----------¦ ¦110275¦(1938¦3,594.94 ¦ ¦ +------+-----+----------+-----------¦ ¦ ¦(1939¦6.48 ¦ ¦ +------+-----+----------+-----------¦ ¦Total ¦ ¦25,520.77 ¦2,749.34 ¦ +-----------------------------------+
In the stipulation of facts and in a supplemental stipulation in Docket No. 110260 all issues raised by the pleadings have been agreed upon with the exception of the one issue common to both dockets relative to the taxable status of distributions made by the Bankers Farm Mortgage Co. to the petitioner during the years 1935 to 1938, inclusive. The stipulations setting forth the agreements of the parties on these issues will be given effect under Rule 50.
The question remaining for decision is whether certain distributions received by the petitioner from the Bankers Farm Mortgage Co. during the taxable years 1935 to 1938, inclusive, were includible in petitioner's income in the full amounts under section 115(c) of the Revenue Acts of 1934, 1936, and 1938 as being ‘amounts distributed in partial liquidation‘ within the meaning of section 115(i) of those acts.
FINDINGS OF FACT.
Most of the facts have been stipulated by the parties. From the stipulated facts and evidence adduced at the hearing we find the facts to be as follows:
The petitioner is an individual, with his principal office at Fond du Lac, Wisconsin. He filed his Federal income tax returns for the years 1935 to 1939, inclusive, with the collector for the district of Wisconsin.
The Bankers Farm Mortgage Co. (hereinafter referred to as the company) was incorporated under the laws of the State of Wisconsin on April 15, 1931. The petitioner was one of the three incorporators of the company who signed the articles of incorporation and various amendments thereto. The articles, as amended, provided that the capital stock of the company was to be 50,000 shares of common stock without nominal or par value. The business purposes of the company stated in the articles of incorporation are:
Article II.
The business and purpose of the corporation shall be as follows:
To acquire, by purchase or otherwise, the outstanding bonds and assets of the Bankers Joint Stock Land Bank of Milwaukee, Wisconsin, and to liquidate the same.
To purchase, own, improve, equip, operate, and manage farms and engage in any agricultural pursuit or undertaking.
To acquire, by purchase, exchange, lease or otherwise, and generally to deal with and in real estate and property, improved and unimproved, tenements, hereditaments, chattels, real or personal, or any interest or right therein; to construct, erect, improve, enlarge, alter, rebuild, equip, maintain, manage, operate, control and lease houses and all kinds of buildings for dwelling, farm or other purposes; to own, hold, sell, exchange, manage, improve, develop, assign, transfer, convey, lease, sublet or otherwise alienate or dispose of, or to mortgage, pledge, or otherwise incumber the real property, lands, buildings, chattels, and other property real and personal, of the company, and any and all rights therein.
To acquire by purchase, subscription, or otherwise, and to hold for investment or for any other lawful purpose, and to use, sell, assign, transfer, mortgage, pledge or otherwise deal with or dispose of the stocks, bonds, notes, certificates of beneficial interest, or any other obligations or securities of any person or persons or other corporation or corporations; to aid in any manner any person or persons, or any corporation whose stock, bonds, notes, certificates of beneficial interest or other obligations or securities are held, sold, pledged, or in any manner guaranteed by this company or in which this company is in any way interested, or any corporation which is affiliated with this company by reason of the ownership of the stock of any such corporation by the stockholders of this company; to do any other acts or things for the preservation, protection, improvement or enhancement of the value of any such stocks, bonds, notes, certificates of beneficial interest, or other obligations or securities, or to do any acts or things designed for any such purpose; while the owner of any such stocks, bonds, notes or certificates of beneficial interest or other obligations or securities, to exercise all rights, powers and privileges of ownership thereof, and to exercise any or all voting power thereon; and to guarantee the payment of dividends upon any stock or the principal or interest, or equivalent thereof, of any bonds, notes, certificates of beneficial interest, or other obligations and the performance of the contracts of any such corporation.
To issue bonds, notes, debentures or obligations of this corporation from time to time, for any of the objects or purposes of the corporation, and to secure the same by mortgage, pledge, deed of trust, or otherwise.
To purchase, hold, sell and transfer the shares of its own capital stock; provided it shall not use its funds or property for the purchase of its own shares of capital stock when such use would cause any impairment of its capital; and provided further that shares of its own capital stock belonging to it should not be voted upon directly or indirectly.
In general, to carry on any other business in connection with the foregoing, which the stockholders of the company may deem proper to enhance the value of its property or rights, and to have and to exercise all the powers conferred by the laws of Wisconsin upon corporations formed under the statute hereinbefore referred to, and to do any and all of the things hereinbefore set forth to the same extent as natural persons might or could do.
The foregoing clauses shall be construed both as objects and powers; and it is hereby expressly provided that the foregoing enumeration of specific powers shall not be held to limit or restrict in any manner the powers of this corporation.
The Bankers Joint Stock Land Bank of Milwaukee, Wisconsin (hereinafter referred to as the bank), was a Joint Stock Land Bank which for some years operated under a receivership. The issued stock and bonds of the bank were privately owned. On or about October 15, 1931, the company submitted a proposal to the bondholders' committee of the bank, whereby the company offered to exchange one share of its stock for each $100 principal face value of the outstanding bonds of the bank, or, in the alternative, to purchase said bonds at 40 percent of face value from the holders thereof who did not elect to take the stock offer. The bondholders' committee submitted the proposal to the bondholders as a plan for the disposition of the bonds and for the reorganization of the affairs of the bank. The plan was to become operative upon the assent of the holders of 95 percent of the bonds of the bank. A prospectus of the company describing its capitalization, organization, and purposes was distributed with the plan.
The prospectus provided, inter alia, that until all borrowings were paid off and all stockholders had received in cash $50 per share on their stock, the voting power of the company should be lodged in seven trustees, under a voting trust. The petitioner here was listed in the prospectus as a director of the company and chairman of its board of directors, and as one of the seven trustees.
The prospectus stated in conclusion:
It will be the policy of the Company to pay as liberal dividends as may be consistent, in the opinion of the Directors, with sound business policy. The proceeds of liquidation will be applied first to the retirement of the financing and thereafter as distributions to the stockholders.
It is believed that the offer of the Bankers Farm Mortgage Company is eminently fair as it offers the bondholders an opportunity of taking cash considerably in excess of the market price of their bonds or to exchange them for its stock and afford them an opportunity of participating in the proceeds of liquidation if the Company acquires the assets of the Bank.
The requisite percentage of bondholders assented to the plan and the company acquired their bonds for stock and cash, and used these bonds in connection with successfully bidding in the assets of the bank at the receiver's sale. The receiver on August 6, 1932, transferred to the company the assets, which consisted of securities, mortgage loans, real estate, land contracts, and purchase money mortgages and had a total value of about thirteen million dollars.
The common stock of the company was issued at no par value, but had a stated value of $85. Throughout the period during which the distributions here involved were made, the total number of issued shares was 45,262, of which 45,196 were issued to the 7 voting trustees (petitioner being one of them) under a voting trust agreement dated February 5, 1932. The company also issued to each stockholder, a voting trust certificate certifying that it had deposited the number of shares of stock owned by that stockholder with the trustees for the benefit of the stockholder.
Petitioner was a member of the board of directors and a member of the executive committee of the board throughout the period material to this proceeding. He apparently was also chairman of the board and an officer of the company.
From time to time during 1934 to 1937, inclusive, the executive committee or board of directors met and directed the payment of ‘liquidating dividends‘ of designated amounts per share. In each case where the executive committee directed the payment it was subsequently ratified by the board. The payments were authorized by resolutions of the board, of which the following, adopted at a meeting held on December 18, 1935, is typical:
Resolved, that a liquidating dividend of $7.50 per share on the company's outstanding capital stock, be and the same is hereby declared, payable directly to the Voting Trust Certificate Holders of record, as shown by the Company's books, at the close of business on December 21, 1935.
The only resolution authorizing a distribution of corporate funds which varied in any material respect from the resolution quoted above is one adopted at a board meeting held on December 23, 1936, which provided:
Be it resolved, that a dividend of $7.50 per share be, and the same is hereby declared, payable December 24 to holders of its voting trust certificates of record at the close of business December 23, said dividend to be paid out of income to the extent payable and the balance out of the realization of capital assets.
The last such ‘liquidating dividend,‘ amounting to $2.50 per share, was declared on December 21, 1937, payable January 6, 1938. The resolutions of the executive committee of the board authorizing these payments were in each instance unanimously passed and petitioner participated in all the meetings where such resolutions were adopted, except the board meetings of November 2, 1934, March 5, 1935, and December 23, 1936.
The number of shares of common stock of the Bankers Farm Mortgage Co. owned by the petitioner, dates of acquisition, and cost basis to him were as follows:
+-------------------------+ ¦Date ¦Shares¦Cost basis ¦ +------+------+-----------¦ ¦4-1-31¦2,880 ¦$84,267.88 ¦ +------+------+-----------¦ ¦4-1-34¦700 ¦21,000.00 ¦ +------+------+-----------¦ ¦4-1-36¦10 ¦none ¦ +------+------+-----------¦ ¦4-1-37¦183 ¦none ¦ +------+------+-----------¦ ¦Total ¦3,773 ¦105,267.88 ¦ +-------------------------+
The petitioner received distributions from the Bankers Farm Mortgage Co. during the years 1935 to 1938, inclusive, upon his 3,773 shares of stock as follows:
+------------------------------------------------------------------------+ ¦Distributions ¦2,880 shares¦700 shares¦10 Shares¦183 shares¦Total 3,773¦ +---------------+------------+----------+---------+----------+-----------¦ ¦ ¦ ¦ ¦ ¦ ¦shares ¦ +---------------+------------+----------+---------+----------+-----------¦ ¦1935 ¦ ¦ ¦ ¦ ¦ ¦ +---------------+------------+----------+---------+----------+-----------¦ ¦$25 per share ¦$72,000 ¦$17,500 ¦ ¦ ¦$89,500.00 ¦ +---------------+------------+----------+---------+----------+-----------¦ ¦1936 ¦ ¦ ¦ ¦ ¦ ¦ +---------------+------------+----------+---------+----------+-----------¦ ¦$15 per share ¦43,200 ¦10,500 ¦$150 ¦ ¦53,850.00 ¦ +---------------+------------+----------+---------+----------+-----------¦ ¦1937 ¦ ¦ ¦ ¦ ¦ ¦ +---------------+------------+----------+---------+----------+-----------¦ ¦$5 per share ¦14,400 ¦3,500 ¦50 ¦$915.00 ¦18,865.00 ¦ +---------------+------------+----------+---------+----------+-----------¦ ¦1938 ¦ ¦ ¦ ¦ ¦ ¦ +---------------+------------+----------+---------+----------+-----------¦ ¦$2.50 per share¦7,200 ¦1,750 ¦25 ¦457.50 ¦9,432.50 ¦ +------------------------------------------------------------------------+
The distribution made to petitioner in 1938 was payable to him on January 6, 1938.
Petitioner concedes that prior to 1935 the distributions received on his stock were in excess of the cost basis of said stock to him.
At the time of these distributions by the company, it had no accumulated earnings and profits and had no earnings and profits for the taxable years in which the distributions were made. Furthermore, the distributions were not made out of earnings and profits, and were not out of increase in value of property accrued before March 1, 1913.
During the years in which the distributions here involved were made, the petitioner never surrendered any of his stock to the company and no endorsements of these distributions were made on his stock certificates.
On about May 12, 1938, control of the company passed into the hands of new interests, which had acquired voting trust certificates evidencing 36,456 2/3 shares of the company's stock. Petitioner was associated with these new interests in obtaining control of the company and became president of the company, which office he still holds. The voting trust was terminated on May 12, 1938, and the shares of stock were distributed to the holders of voting trust certificates.
The company started business in 1932 with assets received from the bank amounting to approximately thirteen million dollars in value. From 1932 on the company continuously disposed of assets and converted them into cash, which it distributed in the form of dividends to its stockholders, so that by May 12, 1938, when petitioner and his new associates obtained control of the company, its total assets amounted to only about $4,500,000.
At the time of the hearing the company was engaged in the business of owning real estate and making loans on the security of real estate, mostly farm lands, and it intended to continue in this business. During the taxable years the company intended to liquidate its assets and did not intend to, nor did it, engage in any business not incident to this liquidation.
Petitioner, as president of the company, on May 13, 1939, signed the corporation income and excess profits tax return of the company for the calendar year 1938. This return stated that the business of the company was ‘liquidating assets of the Bankers Joint Stock Land Bank, Milwaukee, Insolvent. ‘ In signing this return, petitioner, as president of the company, executed the usual form of affidavit that he had examined the return and that, to the best of his knowledge and belief, it was a true, correct, and complete return.
In his Federal income tax returns for the taxable years 1935 to 1938, inclusive, the petitioner reported as long term capital gains a portion of the distributions received from the company on the shares of common stock owned by him, and the respondent included all the distributions so received as short term capital gains in the notice of deficiency as set forth below:
+---------------------------------------------------+ ¦ ¦Distributions¦ ¦Amount included¦ +----+-------------+----------------+---------------¦ ¦Year¦received ¦Amounts reported¦indeficiency ¦ +----+-------------+----------------+---------------¦ ¦ ¦ ¦in returns ¦notice ¦ +----+-------------+----------------+---------------¦ ¦1935¦$72,000.00 ¦$28,800.00 (40%)¦$72,000.00 ¦ +----+-------------+----------------+---------------¦ ¦ ¦17,500.00 ¦13,800.00 (80%) ¦17,500.00 ¦ +----+-------------+----------------+---------------¦ ¦ ¦89,500.00 ¦42,600.00 ¦89,500.00 ¦ +----+-------------+----------------+---------------¦ ¦1936¦43,200.00 ¦17,280.00 (40%) ¦43,200.00 ¦ +----+-------------+----------------+---------------¦ ¦ ¦10,500.00 ¦6,300.00 (60%) ¦10,500.00 ¦ +----+-------------+----------------+---------------¦ ¦ ¦150.00 ¦60.00 (40%) ¦150.00 ¦ +----+-------------+----------------+---------------¦ ¦ ¦53,850.00 ¦23,640.00 ¦53,850.00 ¦ +----+-------------+----------------+---------------¦ ¦1937¦14,400.00 ¦6,760.00 (40%) ¦14,400.00 ¦ +----+-------------+----------------+---------------¦ ¦ ¦3,500.00 ¦1,400.00 (40%) ¦3,500.00 ¦ +----+-------------+----------------+---------------¦ ¦ ¦50.00 ¦20.00 (40%) ¦50.00 ¦ +----+-------------+----------------+---------------¦ ¦ ¦915.00 ¦366.00 (40%) ¦915.00 ¦ +----+-------------+----------------+---------------¦ ¦ ¦18,865.00 ¦8,546.00 ¦18,865.00 ¦ +----+-------------+----------------+---------------¦ ¦1938¦7,200.00 ¦3,600.00 (50%) ¦7,200.00 ¦ +----+-------------+----------------+---------------¦ ¦ ¦1,750.00 ¦875.00 (50%) ¦1,750.00 ¦ +----+-------------+----------------+---------------¦ ¦ ¦25.00 ¦12.50 (50%) ¦25.00 ¦ +----+-------------+----------------+---------------¦ ¦ ¦427.50 ¦228.75 (50%) ¦457.50 ¦ +----+-------------+----------------+---------------¦ ¦ ¦9,432.50 ¦4,716.25 ¦9,432.50 ¦ +---------------------------------------------------+
Each of the distributions here in question was intended to be one of a series of distributions intended by the company to be in complete liquidation of all of its stock when the series was completed.
OPINION.
KERN, Judge:
The petitioner contends that the distributions which he received from the company during the taxable years 1935 to 1938, inclusive, are within the ambit of section 115(d) of the Revenue Acts of 1934, 1936, and 1938.
Respondent, on the other hand, urges that each of these distributions was ‘one of a series of distributions in complete cancellation or redemption of all or a portion‘ of the company's stock within the meaning of the definition of ‘amounts distributed in partial liquidation‘ in section 115(i) of said acts and, therefore, fall within the exception provided in 115(d), rendering 115(d) inapplicable in the premises. Respondent further urges that these distributions were fully includible in the income of the petitioner when received, under the provisions of section 115(c) of said acts, as amounts distributed in partial liquidation.
SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
(d) OTHER DISTRIBUTIONS FROM CAPITAL.— If any distribution (not in partial or complete liquidation) made by a corporation to its shareholders is not out of increase in value of property accrued before March 1, 1913, and is not a dividend, then the amount of such distribution shall be applied against and reduce the adjusted basis of the stock provided in section 113, and if in excess of such basis, such excess shall be taxable in the same manner as a gain from the sale or exchange of property.
The question for decision, therefore, is whether these distributions were distributions in partial liquidation within the meaning of section 115(i) of the Revenue Acts of 1934, 1936, and 1938 and includible in petitioner's income in the full amounts under section 115(c) of those acts.
Section 115(c) of the Revenue Acts of 1934, 1936, and 1938 provides, inter alia, that amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock and that the gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. Section 115(c) of the 1934 and 1936 Acts also provides that, despite the provisions of section 117(a), 100 per centum of the gain so recognized shall be taken into account in computing net income, whereas section 115(c) of the 1938 Act provides that, despite the provisions of section 117, the gain so recognized shall be considered as a short term capital gain.
Section 115(i) of these three acts defines the term ‘amounts distributed in partial liquidation‘ as meaning ‘a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock.‘
Revenue Acts of 1934 and 1936:
‘SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
‘(c) DISTRIBUTIONS IN LIQUIDATION.— Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributees resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. Despite the provisions of section 117(a), 100 per centum of the gain so recognized shall be taken into account in computing net income. * * * ‘
Revenue Act of 1938:
‘SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
‘(c) DISTRIBUTIONS IN LIQUIDATION.— Amounts distributed in complete liquidation of a corporation shall be treated as in full payments in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or in full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. Despite the provisions of section 117, the gain so recognized shall be considered as a short term capital gain. * * * ‘
Respondent relies upon the last clause of 115(i).
Revenue Acts of 1934, 1936, and 1938:
‘SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
(i) DEFINITION OF PARTIAL LIQUIDATION.— As used in this section the term ‘amounts distributed in partial liquidation‘ means a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock.‘
It appears clear to us that each of the distributions here in question was ‘one of a series of distributions in complete cancellation or redemption‘ of the company's stock, and thus in partial liquidation.
There is ample evidence in the record of this case to justify the conclusion that the company was in process of liquidation during the period in which these distributions were made. The first corporate purpose stated in article II of the company's articles of incorporation is ‘to acquire * * * the outstanding bonds and assets of the Bankers Joint Stock Land Bank of Milwaukee, Wisconsin, and to liquidate the same.‘ There is no evidence indicating that during the period here material the company had any assets other than those acquired from the bank. From 1932 to 1938 the company continuously pursued its purpose of disposing of these assets and converting them into cash, which it distributed to its stockholders. This program resulted in the reduction of its assets from some thirteen million dollars in 1932 to approximately four and one-half million dollars in 1938, the amount of reduction for each year being annually entered on the company's books.
This Court stated in T.T. Word Supply Co., 41 B.T.A. 965, 980:
The liquidation of a corporation is the process of winding up its affairs by realizing upon its assets, paying its debts, and appropriating the amount of its profit and loss. It differs from normal operation for current profit in that it ordinarily results in the winding up of the corporation's affairs, and there must be a manifest intention to liquidate, a continuing purpose to terminate its affairs and dissolve the corporation, and its activities must be directed and confined thereto. A mere declaration is not enough, and the question whether a corporation is in liquidation is one of fact.
See also Fred T. Wood, 27 B.T.A. 162, 166, and R.D. Merrill Co., 4 T.C. 955, 968. We think that the facts of this case clearly meet the requirements laid down in this statement. The fact that the process of liquidation extended over a period of some years is not fatal to our conclusion. R.D. Merrill Co., supra.
Furthermore, the company made current distributions of the sums realized from the conversion of its assets into cash. These distributions, with one exception, were designated by the company as ‘liquidating dividends.‘ The exception is the distribution declared on December 23, 1936, but since this distribution was clearly but one of the series, we do not consider it material that it was not designated as a ‘liquidating dividend.‘ See Rollestone Corporation, 38 B.T.A. 1093, 1105.
As this Court has repeatedly held, it is immaterial that when these distributions were made no shares were surrendered or canceled in whole or in part or that there was no endorsement of these distributions on the stock certificates. James P. Gossett, 22 B.T.A. 1279, 1286; affd., Gossett v. Commissioner, 59 Fed.(2d) 365; Edward S. Bacharach, 29 B.T.A. 282, 287; Florence M. Quinn, 35 B.T.A. 412, 414; Rollestone Corporation, supra. See also Henry E. Mills, 4 T.C. 820; Holmby Corporation, 28 B.T.A. 1092; affd., 83 Fed.(2d) 548; and Tyson v. White, U.S. Dist. Ct. Mass., 1933.
Nor is it material that after the company came under new management on May 12, 1938, it deviated from or abandoned its purpose of liquidating its assets. The character of the distributions must be determined in the light of the circumstances when made. ‘Each of the distributions here in question seems to have been one of a series of distributions intended to be in complete cancellation or redemption of all of the stock of the corporation when the series was completed.‘ See Rollestone Corporation, supra, at page 1105. The disruption or termination of the series or the departure from the program of liquidation by reason of the subsequent injection of new life into the veins of the dying corporation will not change the character of the distributions previously made in liquidation. W. E. Guild, 19 B.T.A. 1186, is distinguishable on the grounds set forth in James P. Gossett, supra, at page 1285, i.e., that the distributions in that case were made after the purpose to liquidate was discontinued.
We, therefore, conclude that these distributions were distributions in partial liquidation within the meaning of section 115(i) of the Revenue Acts of 1934, 1936, and 1938 and are includible in petitioner's income in their full amounts under section 115(c) of those acts.
Reviewed by the Court.
Decision will be entered under Rule 50.