Opinion
No. 45667.
May 7, 1945.
W.A. Sutherland, of Washington, D.C. (Charles B. Lowndes and Sutherland, Tuttle Brennan, of Washington, D.C., on the brief), for plaintiff.
J.W. Hussey, of Washington, D.C., and Samuel O. Clark, Jr., Asst. Atty. Gen. (Robert N. Anderson and Fred K. Dyar, both of Washington, D.C., on the brief), for defendant.
Before WHALEY, Chief Justice, and LITTLETON, WHITAKER, JONES, and MADDEN, Judges.
Action by Trust Company of Georgia and another, trustees for Charlotte Louise Woolford, against the United States, to recover alleged overpayment of taxes on corporate stock redeemed by corporation.
Judgment for plaintiffs.
This case having been heard by the Court of Claims, the court, upon the evidence and the report of a commissioner, makes the following special findings of fact:
1. Plaintiffs are the trustees for Charlotte Louise Woolford under a trust created by Cator Woolford dated August 20, 1935.
2. In the manner hereinafter set forth, plaintiffs, on January 14, 1937, disposed of 545 shares of Class A preferred stock of the Retail Credit Company to that company, which stock plaintiffs and their predecessor donor-grantor had held for more than ten years. The stock had a cost basis for tax purposes of $7,771.70 and the amount received for it was $57,225. The Commissioner of Internal Revenue in determining the plaintiffs' income tax for the year 1937 treated the transaction as a partial liquidation and therefore not subject to the 30 percent limitation provided in section 117(a) of the Revenue Act of 1936, 26 U.S.C.A. Int.Rev. Acts, page 873. The parties have stipulated that if the Commissioner was correct in his holding, plaintiffs are not entitled to recover any portion of the taxes paid, but that if plaintiffs are correct in their contention, their taxes were overpaid in the sum of $10,704.67, and that interest was paid by plaintiffs on that overpayment in the sum of $1,025.74.
3. The sums alleged to have been overpaid were paid to the Collector of Internal Revenue at Atlanta, Georgia, on October 19, 1939. A claim for refund based upon the grounds stated in this suit was filed by plaintiffs on June 30, 1941, and that claim was rejected by the Commissioner on August 5, 1942.
4. The Retail Credit Company is a Georgia corporation with its principal place of business at Atlanta, Georgia. The company was founded in March 1899 and incorporated in 1913. The business of the company is that of making reports to insurance companies concerning the advisability of accepting applications for insurance, the making of financial and personal reports on matters of concern to its patrons, such as credit reports, and the carrying on of a general reporting business.
5. The founders of the Retail Credit Company were anxious to keep the control of the company in the hands of those actively engaged in its management after the death or retirement of the founding group. In order to do this a plan was adopted in 1925 under which much of the common stock of the company was to be exchanged for a new type of stock known as "participating preferred." The new stock was identical with the common stock as far as sharing in the control and earnings of the company was concerned. However, it was callable at a price determined by a formula based upon book value and earnings over a period of years. The reason for issuing the new stock was to have stock which could be called upon the death of one of the founding group and resold to key employees of the company in order to keep control of the company in their hands. To help finance these anticipated purchases life insurance was taken out upon the lives of the principal stockholders. By December 31, 1930, this plan had progressed to a point where, of the 104,908 shares of stock outstanding upon that date, 89,738 were participating preferred and 15,170 were common. About that time it was discovered that the formula basis for calling the participating preferred stock had some serious defects. For example, if one of the principal stockholders died, his stock would be purchased at a certain price per share. If, however, his death was followed by that of another stockholder, the stock belonging to the latter would be purchased at a lower figure due to the depletion of the company's assets by the purchase of the stock of the first stockholder. In addition to this, it was felt that it was undesirable for the estates of the principal stockholders to have so much cash coming in at one time which would have to be reinvested. Accordingly, a better plan was sought to keep the control of the company within the active management group. The principal feature of the plan adopted was a recapitalization which provided for the issuance of a new Class A preferred stock to holders of common or participating preferred stock on the basis of one share of Class A preferred for each five shares of participating preferred, and the exchange of participating preferred stock for common stock. The outstanding participating preferred stock was 7 and 8 percent stock, whereas the new Class A preferred stock was 6 percent stock. Under the new arrangement it was planned that the Class A preferred stock would assure the founding group and their families, so long as they or their families retained their interest in the business, a stable income after their retirement from active management or their deaths, and would at the same time permit their common stock to be sold to the younger men in the company so as to keep control of the company in the hands of the active management. No tax motive was involved in providing for the foregoing recapitalization.
6. In order to carry out the plan referred to in the preceding finding a resolution was adopted at a meeting of the stockholders of the Retail Credit Company on April 27, 1931, authorizing an amendment of the charter of the company, and on May 25, 1931, the Superior Court of Fulton County, Georgia, approved the amended charter. The charter, as amended, authorized the issuance of 150,000 shares of no par value common stock and 50,000 shares of no par value Class A preferred, with a proviso that the total outstanding capital stock should at no time be less than 50,000 shares of no par value common stock. The Company was empowered to redeem and retire all capital stock in excess of that minimum. The board of directors was authorized to select for redemption and retirement any particular share or shares of the Class A preferred without any pro rata restrictions. Only the common stock had voting privileges.
7. On May 28, 1931, the board of directors of the Retail Credit Company adopted resolutions to make effective the amended charter and called for redemption as of July 1, 1931, all outstanding preferred stock which had been issued prior to the recapitalization. The board also ordered the issuance of a stock dividend of new Class A preferred stock to holders of record of common stock on July 1, 1931, at the ratio of one share of Class A preferred for each five shares of common stock. The Class A preferred stock was ascribed a value of $100 per share for purposes of the sale by or purchase by the company of fractions of shares. Pursuant to the foregoing action of the board of directors, 22,296 shares of Class A preferred stock were issued to 364 stockholders on July 1, 1931, as follows:
Shares
Issued to holders of participating preferred stock and as a stock dividend on the common stock ..................................... 20,940 3/5 Less: 101 fifths purchased by company at $100 per full share ....................... 20 1/5 __________ 20,920 2/5 Plus 68 fifths sold at $100 per full share .. 13 3/5 __________ 20,934 Shares sold at $100 per share ............... 1,362 __________ Total Class A preferred stock issued to 364 stockholders ........................ 22,296
On July 13, 1931, all of the common stockholders of the Retail Credit Company also owned shares of the Class A preferred stock.
8. Under the new charter provisions which were printed on the back of the Class A preferred stock certificates and which have remained unchanged since the recapitalization in 1931, it is provided that the Class A preferred stock is callable in whole or in part by the directors at $105 per share plus accrued dividends, and it is also provided that any issued stock redeemed, purchased, or otherwise acquired by the corporation may be sold by the corporation at such price as may be fixed by the board of directors and subject to no restriction upon the right, based upon the financial history of the company or otherwise.
As distinguished from Class A preferred stock which the corporation purchased from the stockholders and was authorized to resell without any limitations, the corporation was authorized to issue new Class A preferred stock only when certain conditions as to earnings were met. When these conditions were met, the quantity of such new stock which might be issued was limited by the past earnings. The charter of the company, as amended in 1931, specifically prohibited the reissuance of any stock purchased by the company from issues outstanding prior to the 1931 amendment to the charter.
As shown in finding 15, during the period from July 1, 1931, through 1937 the Retail Credit Company purchased or acquired 5,922 shares of Class A preferred stock. None of that stock was ever reissued and no additional shares of participating preferred nor any additional Class A preferred stock was issued during that period.
9. In July 1931 the Retail Credit Company arranged with DeKalb Securities Company to act as a sort of clearing-house or trading center for the Class A preferred stock and agreed to purchase from DeKalb Securities Company such stock as the Retail Credit Company might wish to retire at not more than $2 per share average price over the price paid by DeKalb Securities Company, an arrangement which with renewals thereof and changes therein remained in force until May 1935.
On January 27, 1932, the following resolution was adopted by the board of directors of the Retail Credit Company:
"Be It Resolved, That this Company do purchase from time to time all or any part of the shares of Class A Preferred stock of this Company not in excess of five hundred (500) shares, provided that the same may be purchased at not in excess of one hundred ($100.00) dollars per share and accrued dividends; said purchase to be made from those tendering the shares of stock.
"Be It Further Resolved, That the Treasurer of the Company is authorized to acquire all or any part of the above-mentioned five hundred (500) shares of Class A Preferred stock and to cancel the same and deliver the same to the Secretary.
"Be It Further Resolved, That the Secretary of the Company is authorized and directed to certify to the Transfer Agent of the Company the shares that have been so purchased and the number of the certificates evidencing the said shares; and is also authorized to deliver the canceled certificates for the said shares to the Transfer Agent. This shall be done by the Secretary from time to time as shares are acquired.
"Be It Further Resolved, That the shares so purchased shall be canceled, but that this shall be done without prejudice to the right of the Company to reissue the same in accordance with the provisions of the charter of this Company."
January 27, 1933, and January 24, 1934, similar resolutions were adopted, each of which authorized the purchase and retirement of not in excess of 500 shares of Class A preferred stock.
10. October 3, 1934, the board of directors of Retail Credit Company adopted a resolution reading as follows:
"Whereas this Company now has outstanding 19,551 shares of Class A Preferred stock; and
"Whereas the Treasurer's report shows, and he recommends, it to be desirable to reduce this outstanding number of shares to 18,000, and further reports that there are sufficient funds in undivided profits to purchase 1,551 shares at $100.00 a share; be it
"Resolved, That $136,750.00 be set aside in reserve for the purchase and retirement of 1,551 shares of Class A Preferred stock. This amount plus amounts already set aside, and to be set aside for the remainder of the year under previous resolutions, will amount to $155,100.00; and be it
"Further Resolved, That the President of this Company be requested to make such arrangements with the DeKalb Securities Company (which Company now has a contract with the Retail Credit Company) to assure present holders of Class A Preferred stock not less than $99.00 per share for said 1,551 shares; such arrangements to terminate within one year, or sooner, if the said 1,551 shares shall have been purchased. Also to include a cancellation clause that will provide that the Retail Credit Company will take off of the hands of the DeKalb Securities Company such shares as it may then have."
11. The foregoing arrangement continued in effect until May 8, 1935, when the following resolution was adopted by the board of directors of the Retail Credit Company:
"Whereas the Finance Committee has stated that our Class A Preferred stock is not being purchased for retirement in the number of shares needed to complete our program within the year; and whereas it was recommended that we offer to purchase 1,127 shares of Class A stock of the Retail Credit Company, offering to the holders of such shares the call price of $105.
"Resolved, That this Company offer to purchase direct, at the call price of $105 per share, a sufficient number of shares of its Class A stock to complete its financial program; therefore, be it
"Further Resolved, That the Treasurer is authorized and is hereby directed to notify all Class A Preferred stockholders of its desire to purchase for retirement said shares; and whereas it has been moved, seconded, and resolved that the Retail Credit Company offer to purchase direct and not through DeKalb Securities Company shares of Class A Preferred stock to complete its program; therefore, be it
"Resolved, That the Secretary write to DeKalb Securities Company requesting cancellation of the October 1, 1934, contract as of this date."
Pursuant to the directions contained in the above resolution, the treasurer of the Retail Credit Company sent a letter dated May 14, 1935, to all holders of Class A preferred stock, which read as follows:
"By Resolution of our Board of Directors, as of 5-8-35, I am directed to offer Holders of our Class A Preferred Stock $105 per share, for all, or any part, of their holdings of such stock. This offer to hold good until further notice is given.
"The Company wishes to retire the stock to be purchased under this offer. It could call, at $105 per share, such shares as it needs to complete its financial program, but by offering now the full call price those who wish to sell may take advantage of the offer.
"If you wish to sell any of your stock at $105 per share, date and endorse your stock certificate just as it was issued, have your signature witnessed and guaranteed by a bank or trust company, and send it by registered mail to Mr. C.D. Harrison, Assistant Treasurer, with instructions as to the number of shares you are selling.
"Immediately upon receipt of certificate properly endorsed, check will be mailed for the purchase price and any shares not desired sold returned to you."
12. During the years 1931 to 1935, inclusive, DeKalb Securities Company purchased from stockholders 3,701 shares of Retail Credit Company Class A preferred stock at prices ranging from $83.50 to $99 per share. Of the shares purchased, 492 were sold by DeKalb Securities Company to individuals and 3,209 were sold to the Retail Credit Company at prices ranging from $84.50 to $100 per share.
Following the resolution of May 8, 1935, the Retail Credit Company purchased the following Class A preferred stock from stockholders offering their stock for sale:
1935 ............................ 825 shares 1936 ............................ 492 shares _____ Total ....................... 1,317 shares
13. In January 1937, without prior authorization from the board of directors, officers of the Retail Credit Company purchased on behalf of that company from stockholders offering their stock for sale 1,111 shares of Class A preferred stock at $105 per share. The minutes of the board of directors for January 27, 1937, contained the following approval of that action:
"The Treasurer brought to the attention of the Directors that eleven hundred eleven shares of Class A Preferred shares of the Retail Credit Company has been offered for sale by some of the stockholders at $105 per share and had been purchased and retired by the Company since January 1, 1937, and that other shares would likely be offered during the year; whereupon it was moved, seconded, and unanimously
"Resolved that the purchase and retirement of eleven hundred eleven shares of Class A Preferred stock at $105.00 per share since January 1, 1937, is hereby ratified and confirmed; and be it
"Further Resolved that the Treasurer be, and he is hereby, authorized to purchase, if offered, for retirement up to five hundred additional shares of Class A Preferred stock at $105.00 per share during 1937."
14. All Class A preferred stock purchased by the Retail Credit Company through 1937, since it began to purchase direct from stockholders on May 8, 1935, may be classified as to the number of purchases as follows:
---------------------------------------------------- Purchased from — | 1935 | 1936 | 1937 -------------------------------|------|------|------ Stockholders owning 1 share .. | 20 | 11 | 5 Stockholders owning 2 shares . | 14 | 3 | 5 Stockholders owning 3 to 5 | | | shares ..................... | 19 | 5 | 9 Stockholders owning 6 to 15 | | | shares ..................... | 22 | 10 | 6 Stockholders owning 16 to 30 | | | shares ..................... | 13 | 2 | 1 Stockholders owning over 30 | | | shares ..................... | 1 | 3 | 5 |______|______|______ Total .................... | 89 | 35 | 31 ----------------------------------------------------
Stockholders who sold more than 30 shares were as follows:
-------------------------------------------------------------------------- | | Number | Number | Year | Name | of shares | of shares | Per Cent | | owned | sold | -----|----------------------------------|-----------|-----------|--------- 1935 | E.J. Hyde, retired ............. | 550 | 200 | 36+ 1936 | Trust Company of Ga., Trustee .. | 1,120 | 151 | 13+ " | James C. Malone ................ | 599 | 99 | 16+ " | H.L. Allen ..................... | 92 | 67 | 73+ 1937 | Trust Company of Ga., Trustee .. | 960 | 545 | 56+ " | Trust Company of Ga., Trustee .. | 1,090 | 545 | 50 " | E.J. Hardin .................... | 40 | 40 | 100 " | Walter C. Hill ................. | 74 | 74 | 100 " | Louis S. Brooke ................ | 200 | 50 | 25 --------------------------------------------------------------------------
15. The following tabulation shows the total Class A preferred stock issued July 1, 1931, by the Retail Credit Company and the purchases of that stock by that company from the date of issuance through and including December 31, 1937:
Shares
Class A stock issued July 1, 1931 ......... 22,296 Class A stock purchased through Decemcember 31, 1937:
From DeKalb Securities Co.: 1931 ............................ 300 1932 ............................ 975 1933 ............................ 1,105 1934 ............................ 502 1935 ............................ 327
From Individuals: 1935 ............................ 825 1936 ............................ 492 1937 ............................ 1,396 _____ Total ................................. 5,922 ______ Outstanding December 31, 1937 ............. 16,374
The Class A preferred stock of the Retail Credit Company purchased by that company during the period from July 1, 1931, to December 31, 1937, inclusive, was not in proportion to the holdings of common or preferred stock of the stockholders of that company, and had no relation to the comparative amounts of common or preferred stock held by the stockholders who sold such stock.
The only subsequent purchases by the Retail Credit Company of Class A preferred stock through December 31, 1943, were:
131 shares in 1938 at $100 per share 243 shares in 1939 at $100 per share 81 shares in 1943 at $100 per share
The Retail Credit Company's accumulated earnings and profits were sufficient at all times to cover all dividend distributions and redemptions of the Class A preferred stock without impairment of its capital or any reduction of its business activities.
16. From July 1, 1931, through the calendar year 1937, the Retail Credit Company redeemed no common stock and the 104,703 shares of common stock originally issued remained outstanding.
17. The Retail Credit Company was not reducing its business during the period 1931 to 1943, inclusive, and was not acquiring its Class A preferred stock for the purpose of reducing its activities or liquidating its business. The number of its employees was increasing yearly from 1,445 at the end of 1931 to 2,568 at the end of 1940, and its average sales increased from $6,238,612 in 1931 to $8,137,013 in 1940. Its total net earnings over the period from 1929 to 1938, inclusive, were $5,595,263.55, and it paid cash dividends during that period of $4,227,653.14. It had earnings in 1937 of approximately $599,000 and paid cash dividends in that year of approximately $570,000.
The capital stock, surplus, and undivided profits of the Retail Credit Company at December 31, 1930, June 30, 1931, December 31, 1936, and December 31, 1937, were as follows:
--------------------------------------------------------------------------------------------------- | Dec. 31, 1930 | June 30, 1931 | Dec. 31, 1936 | Dec. 31, 1937 ------------------------------------|---------------|---------------|---------------|-------------- Preferred Stock 7% and 8% (Ret. | | | | July 1, 1931) .................... | $192,700.00 | $196,500.00 | ............. | ............. Participating Pref. Stock (Ret. | | | | July 1, 1931) .................... | 897,380.00 | 895,630.00 | ............. | ............. Class A Preferred (Issued July 1, | | | | 1931) ............................ | ............. | ............. | $1,777,000.00 | $1,637,400.00 Common stock ...................... | 151,700.00 | 151,400.00 | 523,515.00 | 523,515.00 Surplus (including Capital Surplus) | | | | ................................. | 524,540.00 | 523,515.00 | 529,395.60 | 550,822.29 Undivided Profits ................. | 310,406.27 | 389,531.53 |.............. | ............. |_______________|_______________|_______________|______________ Total .......................... | 2,076,726.27 | 2,156,576.53 | 2,829,910.60 | 2,711,737.29 --------------------------------------------------------------------------------------------------- 18. On July 1, 1931, Cator Woolford owned 33,373 shares of common stock of the Retail Credit Company and on that date he received thereon as stock dividend 6,674 3/5 shares of the company's Class A preferred stock. On that date he purchased 2/5 ths of a share of the Class A preferred stock, making the total of such shares held by him 6,675. By the end of 1936 he had made gifts to his family of 6,900 shares of the common stock, and in the years 1932 to 1935, inclusive, he sold 16,600 shares of the common stock to employees of the company, retaining only 9,873 shares. By the end of 1939 he had made gifts of 2,600 shares of Class A preferred stock, and at the end of that year retained 4,075 shares.19. On August 20, 1935, Cator Woolford created the trust of which plaintiffs are trustees, the trust property consisting of 1,150 shares of Class A preferred stock, 3,450 shares of common stock of the Retail Credit Company, and $8,500 in cash. During the period from the creation of the trust until the end of 1940, plaintiffs sold all of that common stock to employees of the Retail Credit Company at prices ranging from $35 to $50 per share. In 1936 plaintiffs disposed of 60 shares of the Class A preferred stock to the Retail Credit Company and, on January 14, 1937, disposed of 545 shares of that stock to that company. On March 2, 1944, plaintiffs still retained the other 545 shares of Class A preferred stock.
Section 11 of the trust instrument reads as follows:
"11. A part of the corpus of this trust estate consists of shares of common and preferred capital stock of Retail Credit Company, a corporation under the laws of Georgia. It is not deemed by the grantor wise that this trust estate be largely interested in said shares from either its own or Retail Credit Company's standpoint. Grantor also recognizes that it may take a substantial period of time to market said shares of this stock, especially the shares of common stock which he is conveying to this trust estate. Grantor directs the trustee to dispose of said shares of common stock in one or more lots for cash or on terms and to cooperate with the Retail Credit Company in the disposition of the said shares of common stock and in the retirement of the shares of preferred stock.
"The powers as to the shares of stock of Retail Credit Company herein conferred shall apply to both the shares of common and preferred stock, though it is best that the common stock be disposed of first. The Trustees are authorized to await the retirement by the company of the shares of preferred stock if and to the extent it in the exercise of ordinary care shall deem it wise so to do."
20. Included in the purchases heretofore referred to as having been made by the Retail Credit Company directly from stockholders in 1937 were the 545 shares of Class A preferred stock which the Retail Credit Company purchased from plaintiffs on January 14, 1937. That stock had a basis for tax purposes of $7,771.70 — that is, $14.26 per share — and plaintiffs received therefor from the Retail Credit Company a total payment of $57,225 — that is, $105 per share. In making the transfer to the Retail Credit Company of that stock, plaintiffs endorsed stock certificate No. 1096, representing 816 shares of Class A preferred stock, as follows:
"For value received ____ hereby sell, assign, and transfer (to) for cancellation — 545 — for reissue in same name — 271 — shares of the stock represented by the within certificate and do hereby irrevocably constitute and appoint C.A. Allen to transfer the said stock upon the books of the within-named corporation with full power of substitution in the premises.
"(Signed) JAMES DICKEY, "TRUST COMPANY OF GEORGIA, "By WILLIAM HUNTER, "Vice President, "By JAMES C. SHELOR, "Trust Officer, as Trustees for Charlotte Louise Woolford u/a dated 8/20/35."
The Trust Company of Georgia, transfer agent for stock of Retail Credit Company, inserted certificate No. 1096 in the stock book, stamped it
"Cancelled
"January 16, 1937 "Trust Company of Georgia"
and issued to plaintiffs a certificate No. 1158 for 271 shares. No certificate was issued covering the 545 shares transferred to the Retail Credit Company.
The stamp appearing on the foregoing certificate is the regular stamp of the Trust Company of Georgia, as transfer agent, which it places on all certificates turned in to it, whether the stock represented by the certificate is to be reissued in other certificates to the holders, or no certificates representing the stock are to be issued.
The foregoing disposition of the 545 shares of Class A preferred stock was made by plaintiffs on their own volition in order to diversify the investment of the trust, and without any compulsion from the Retail Credit Company.
The question presented in this case is the extent of the taxability of the gain derived in 1937 from the redemption by the Retail Credit Company of 545 shares of its own Class A preferred stock held by plaintiffs. The taxpayers claim that the gain is taxable as a capital gain to the extent of 30 percent as an ordinary sale of stock held for more than 10 years. The Commissioner taxed it at normal and surtax rates to the extent of 100 percent, on the theory that the gain was an amount "distributed in partial liquidation."
The facts surrounding the transaction are as follows: Prior to May 25, 1931, the Retail Credit Company of Atlanta, Georgia had outstanding 89,738 participating preferred shares of stock and 15,170 shares of common stock, each with full voting rights. The company decided to rearrange its capital structure so as to permit those who were in active management of the business to retain control of the company through ownership of the common stock and to give to other stockholders not in active charge of the management preferred stock having no voting rights. Accordingly, a resolution was adopted on April 27, 1931 authorizing such an amendment of the charter of the company, which was approved by the Superior Court of Fulton County, Georgia on May 25, 1931.
The amended charter authorized the issuance of 150,000 shares of no par value common stock and 50,000 shares of no par value Class A preferred stock. One share of the Class A preferred stock was to be issued for every five shares of the old participating preferred stock.
The Board of Directors was authorized to redeem any particular shares of the Class A stock it desired without pro rata restrictions, and to resell it at such price as might be fixed by the Board of Directors.
By proper resolutions of the Board of Directors the provisions of the charter were put into effect. The participating preferred stock was redeemed and one share of Class A preferred stock was issued for each five shares thereof. The common stock remained as before except that there was declared thereon a stock dividend of one share of Class A preferred stock for each five shares of common.
After the amendment of the charter Cator Woolford was the owner of both common stock and Class A stock of the company. On August 20, 1935, he transferred to plaintiffs in trust 1,150 shares of the Class A stock and 3,450 shares of the common stock, with authority to sell it according to a stated plan. By 1940 plaintiffs had sold all the common stock to employees of the company. They sold to the company itself 60 shares of the Class A stock in 1936 and 545 shares in 1937. The extent of the taxability of the gain derived from the sale of the 545 shares in 1937 is the question presented.
On the first of the year following the year the recapitalization was put into effect the Board of Directors authorized the company treasurer to purchase from anyone wishing to sell not more than 500 of the 22,296 outstanding shares of Class A stock at not more than $100 a share plus accrued dividends. Similar resolutions were passed in the two succeeding years. On October 3, 1934, a resolution was passed offering stockholders who might wish to sell some or all their Class A stock not less than $99.00 per share therefor.
By May 8, 1935, a total of 3,701 shares had been purchased at prices ranging from $84.50 to $99.00 per share.
On May 8, 1935, the company, pursuant to resolution of its Board of Directors, wrote all its stockholders offering to purchase up to 1,127 shares of this stock at $105.00 per share, the call price. In 1935 and 1936 there were purchased 1,317 shares. In 1937 an additional 1,111 shares, including 545 of plaintiffs', were purchased without previous authorization from the Board of Directors, but this was ratified later.
By the end of 1937 a total of 5,922 shares had been purchased, leaving outstanding 16,374 shares.
The purchases were from anyone wishing to sell and the amount purchased had no relation to the amount of the stock held by the seller. Purchases from stockholders owning more than 30 shares ranged from 13 per cent of their holdings to 100 per cent, and the prices paid ranged from $84.50 to $105.00.
The question is whether the sale by plaintiffs of one-half of their stock in 1937 comes within any of the provisions of section 115 of the Revenue Act of 1936 dealing with distributions of corporate earnings by corporations. The Commissioner treated the sale as a partial liquidation as defined in subdivision (i) and, hence, taxable as provided in subdivision (c).
Section 115 of the Revenue Act of 1936, 49 Stat. 1648, 1687, 26 U.S.C.A. Int.Rev. Acts, page 868, deals with "distributions by corporations." Subsection (a) defines a "dividend" as follows:
"The term `dividend' when used in this title * * * means any distribution made by a corporation to its shareholders * * * (1) out of its earnings or profits accumulated after February 28, 1913 * * *."
By section 22 of the Act, 26 U.S.C.A. Int.Rev. Acts, page 825, the entire amount received as dividends is required to be included in gross income and is subject to both normal and surtax.
Subsection (c) deals with "distributions in liquidation." It provides:
Subsection (b) of section 115 is not material to our inquiry.
"* * * 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 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(a), 100 per centum of the gain so recognized shall be taken into account in computing net income, except in the case of amounts distributed in complete liquidation of a corporation. * * * In the case of amounts distributed * * * in partial liquidation * * * the part of such distribution which is properly chargeable to capital account shall not be considered a distribution of earnings or profits."
* * * * *
This made the gain derived on a partial liquidation taxable on the same basis as ordinary dividends.
Subsection (d) is concerned with "other distributions from capital." It provides that if the distribution is not in partial or complete liquidation and is not out of increase in value of property before March 1, 1913, and is not a dividend, then it is to be taxable, to the extent of the gain derived, as a gain from the sale or exchange of property, that is, as a capital gain. Such a distribution not being in the nature of a dividend is not taxable on the same basis as one.
Thus the statute recognizes that a corporation may acquire its own stock without the transaction being either a dividend or a partial liquidation.
Subsection (g) relates to "redemption of stock." It is quoted in full:
The intermediate subsections are not relevant.
"Redemption of stock. If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend."
Such a redemption, being essentially equivalent to a dividend, was made taxable as one.
Subsections (h) and (j) are not material.
"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."
From a reading of the section it seems to us that Congress' intention in the enactment of this whole section was to tax dividends at normal and surtax rates and to prevent tax avoidance by taxing as dividends any distribution of earnings or profits of a corporation which was the equivalent of a dividend, in whatever guise distributed.
Ordinarily a distribution of corporate earnings is in the form of a dividend, but Congress recognized that profits might be distributed in other forms, and so escape the tax on dividends, and thus in the various subsections Congress dealt with various transactions which were in the nature of dividends and provided that when the distribution took on that character it was taxable as such; otherwise, not.
One form in which earnings might be distributed in lieu of a dividend is by partial liquidation of the corporation, as in a case where the corporation has accumulated more assets than it needs to carry on its business, or where it wishes to curtail its activities. Where the corporation desires to liquidate in part, a certain proportion of the stockholdings of each stockholder is called in and in lieu thereof the assets of the corporation are "distributed" to them in proportion to the stock turned in. This contemplates, of course, a proportionate reduction in the stockholdings of each stockholder, either in one transaction or in a series of transactions. It contemplates equal treatment of all stockholders in proportion to their stockholdings. It contemplates a "distribution" among all the stockholders of the corporation's assets in proportion to their stockholdings. Indeed, the entire section 115 deals with "distributions" by corporations, that is, a division among the stockholders of corporate assets. It had in mind the taxation of a distribution of earnings as dividends and the taxation of schemes evolved to escape the tax on dividends.
If this is correct, then it is plain that a corporation's dealings with a lone stockholder, or any number of them less than all, does not come within the ambit of the section. This being the intention of Congress, it was accordingly provided in subsection (d) that if a distribution was made which was not in partial liquidation or was not a dividend, it was taxable only as is the gain from a sale or exchange of property. It was thus recognized that a corporation might acquire its stock in a transaction which did not amount to a distribution of earnings equivalent to a dividend. If so, it was not taxed as such.
This intention is further shown by subsection (g). This section provides for the taxation, on the same basis as dividends, of only those redemptions of stock which are "essentially equivalent to the distribution of a taxable dividend." The purchase of stock from a sole stockholder bears not the slightest resemblance to the distribution of a dividend.
If plaintiffs had sold the stock in question to anyone other than the corporation, the gain derived would have been taxable as a capital gain only to the extent of 30 percent thereof. For what reason would Congress have desired to tax the gain at normal and surtax rates to the extent of 100 percent if the sale was to the corporation itself? We can think of none, unless the gain was essentially equivalent to a dividend, which was so taxable. A gain derived by one stockholder only has none of the elements of a dividend.
It is true, of course, that if all the purchases by the corporation taken together accomplish the same result as the declaration of a dividend, the gain derived would be taxable as would a dividend; but that is not the case here. Some stockholders of the Retail Credit Company got $83.50 for their stock and others got prices ranging up to $105.00. Some stockholders sold all their stock, some one-half of it, and some much less, and presumably some sold none. The company's stockholders, therefore, did not share in the earnings of the company in proportion to their stockholdings, as they are entitled to do in the case of a distribution of a dividend or any distribution in the nature of a dividend.
That this is a correct interpretation of the intent of Congress is shown by the report of the Finance Committee of the Senate on the 1934 Act (Sen. Rep. No. 558, 73rd Cong. 2d Sess. p. 37), which first carried this provision. It reads in part:
"Under existing law a distribution in liquidation of a corporation is treated in the same manner as a sale of stock. This rule has serious objections, as it permits wealthy stockholders to escape surtax upon corporate earnings or profits distributed in the form of liquidating dividends * * *. Your Committee recognizes that liquidating dividends do contain some of the elements of a sale in that the shareholder is relinquishing in whole or in part his investment in the corporation. On the other hand, they also contain some of the elements of an ordinary dividend insofar as they represent a distribution of corporate earnings or profits. * * * The House bill retains the principle of the present law of taxing to the shareholder only the amount by which the liquidating dividend exceeds the basis of the stock with respect to which the dividend is paid. However, to prevent avoidance of surtax through liquidating dividends, the gain to the shareholder is made subject to both normal and surtax. This is accomplished by taxing the gain in the same manner as if it were a gain from the sale * * * of a capital asset held for not more than one year, even though the shareholder may have actually held the stock upon which the dividend is paid for a longer period." [ Italics supplied.]
This is further shown by the Senate Finance Committee Report on the 1942 Act (Sen. Rep. No. 1631, 77th Cong. 2d Sess. p. 116). This reads in part:
"Under existing law * * * the gain realized from a distribution in partial liquidation is treated, despite the provisions of Section 117, as a short-term capital gain. This treatment was occasioned by the facility with which ordinary dividends may be distributed under the guise of distributions in partial liquidation, although Section 115(g) makes explicit provision for the treatment of such distributions as ordinary dividends. Inequality results, however, under the existing law in the case of unquestionable bona fide redemptions of stock not equivalent in any way to the distribution of a taxable dividend. It is believed that the proper application of section 115(g) will prove adequate to prevent taxable dividends disguised as liquidations from receiving capital gain treatment. Accordingly, this section of the bill eliminates the provision requiring the gain from a partial liquidation to be treated as a short-term capital gain." [Italics supplied.]
Not only does the transaction in this case not come within the spirit of the section, neither does it come within the letter of it. Subsection (i) defines a partial liquidation as "a distribution by a corporation in complete cancellation or redemption of a part of its stock." When a corporation purchases and retires and completely cancels one share of its stock, it pro tanto liquidates, but there has been no "distribution" of its assets in liquidation. It is only a "distribution" in liquidation with which subsections (c) and (i) are concerned. Furthermore, subsection (i) defines "amounts distributed in partial liquidation" as a distribution in "complete" cancellation or redemption of a part of its stock. Not only was there no "distribution" of assets among all the stockholders of the Retail Credit Company, but also there was no "complete" cancellation or redemption of the stock. As plaintiffs say, it was the certificates of stock that were cancelled; the stock was not. Under the amended charter the directors had the right to resell the stock at any time, at any price, without limitation. This charter provision was never amended or repealed. So long as it was in effect, the stock was not cancelled. There could be no "complete" cancellation of this stock so long as this charter provision remained in effect. Knickerbocker Importation Co. v. State Board of Assessors, 74 N.J.L. 583, 65 A. 913, 7 L.R.A., N.S., 885.
The transaction, therefore, does not come within the letter of subdivision (i) and, for the reasons stated above, we do not think it comes within its spirit.
The Circuit Court of Appeals for the Fifth Circuit in Hill v. Commissioner of Internal Revenue, 5 Cir., 126 F.2d 570, held that the gain derived in a similar transaction was subject to tax at the normal and surtax rates. Its decision was based alone on the premise that the transaction came within the letter of subsection (i). For the reasons stated, we do not think it does.
Defendant also cites Cohen Trust v. Commissioner of Internal Revenue, 3 Cir., 121 F.2d 689. In that case the company offered to purchase 10,000 of the 11,116 shares of its outstanding preferred stock. A total of 8,705 shares were acquired, and then the balance of the stock was called and the charter of the company was amended so as to eliminate from its capital structure all of this class of stock. All of the stock was purchased and called at the same price. Here there was a "complete cancellation" of the stock. The facts of that case and in the one at bar are essentially different.
We are of opinion plaintiffs are entitled to recover the sum of $11,730.41 with interest as provided by law from October 19, 1939. Judgment for this amount will be entered. It is so ordered.
WHALEY, Chief Justice, concurs.
Defendant appears to rely upon the number of acquisitions by the Retail Credit Company of its Class A preferred stock in support of its position that the amounts paid for such stock were distributions in partial liquidation, but there is nothing in the record to show or indicate that there was any concerted action or intention on the part of the company and the stockholders or that there was any intention or scheme by the corporation, or by any stockholder, such as was contemplated by Congress in sec. 115, to enable any stockholder to escape normal and surtax on the profit derived from the sale of stock by using the capital gains provision of the taxing act on distributions in the nature of dividends. So far as the evidence shows, the Retail Credit Company simply decided to acquire some of its outstanding Class A preferred stock, not for the purpose of completely cancelling it, but subject to reissuance or sale. It had a right under the statute to do this without rendering the gain to the stockholder taxable one hundred percent as a dividend. Reissuance or sale of treasury stock so acquired gives rise to a taxable gain or a deductible loss to the corporation. Edwin L. Wiegand Co. v. United States, 60 F. Supp. 464, and cases therein cited.
There is a complete absence of any evidence to show that in purchasing the Class A stock from certain stockholders who were willing to sell it the Retail Credit Company did so for the purpose of completely canceling and retiring the stock. It must be assumed that Congress was aware of the fact disclosed by numerous published decisions relating to income taxes that corporations frequently acquire their own stock and hold it as treasury stock subject to reissue or resale; that, in so acquiring stock, they often cancel the certificates but do not completely cancel the stock as such; that corporations also frequently reissue or resell such stock. It must also be assumed that when Congress enacted the Revenue Act of 1936, in subsection (c) of which it inserted the provision relied upon by defendant which related to amounts distributed in partial liquidation, i.e., "despite the provisions of sec. 117(a), 100 percentum of the gains so recognized shall be taken into account in computing net income," it was aware of the Treasury Regulation, art. 543 regs. 65, in effect from May 2, 1934, that a resale by a corporation of its own stock results in a taxable gain or a deductible loss. From this it must be concluded that Congress did not intend that such acquisitions or bona fide redemptions of stock should, standing alone, be treated as distributions in partial liquidation, and that it was for this reason that sec. 115(i) defined a distribution in partial liquidation as being a distribution "in complete cancellation or redemption of part of its stock." The instant case is therefore, on its facts, excluded by sec. 115(i) from the provisions of 115(c) upon which the defendant relies.
The gain received by plaintiffs from the sale of the 545 shares of stock in question would, of course, be taxable 100 percentum under sec. 115(g), even though the stock was not completely cancelled, if defendant had been able to submit sufficient evidence to show that in acquiring the stock the Retail Credit Company cancelled or redeemed it at "such time and in such manner as to make the distribution and cancellation or redemption essentially equivalent to a taxable dividend," but we have no such evidence and there is no basis in the facts of record for the inference that, in so acquiring the stock, there was present a scheme to make distributions in partial liquidation in the guise of purchasers of stock, and thereby enable the stockholders to escape or avoid the full normal and surtax on amounts which were in effect "distributions."
We are not, therefore, justified in finding that the transaction in question was a distribution by the Retail Credit Company in partial liquidation within the meaning of sec. 115(c), (g), or (i). Plaintiffs are therefore entitled to the benefit of the capital gain provision of the taxing act.
Our question is whether the payment made in 1937 to the plaintiffs for their stock was, in the circumstances here present, a "distribution by a corporation in complete cancellation or redemption of a part of its stock * * *," which is the definition given in Section 115(i) to the words "amounts distributed in partial liquidation" which are used in subsection (c) of that section in the Revenue Act of 1936, which subsection required the profits included in amounts so "distributed" to be returned 100% for taxation no matter how long the stocks had been held.
The court holds that their transaction is not covered by the statutory language; that the transaction did not result in "complete cancellation or redemption of a part" of the corporation's stock, because of the provision of the amended charter that any issued stock redeemed, purchased, or otherwise acquired by the corporation might be sold by the corporation at whatever price the board of directors fixed. This provision, the court holds, made the stock purchased from the plaintiffs and others "treasury stock" not completely cancelled or redeemed. I do not agree. The board of directors, in its resolution of October 3, 1934, expressed its intention to reduce the number of shares of preferred stock to 18,000, and in its resolution of May 8, 1935, authorized its treasurer to notify all holders of Class A preferred stock of its offer to "purchase for retirement" a sufficient number of shares "to complete its financial program." That the directors intended to eliminate the purchased shares from the corporation's financial structure is plain. Stockholders who, like the plaintiffs, also owned common stock of the corporation might well have been willing to sell their preferred stock for retirement, when they would not have been willing to sell it for reissue to compete for the future earnings of the corporation, or to compete in the market with the shares of preferred stock which the stockholders retained. The officers of the corporation did "cancel" the stock as effectively as that could be done by physical acts. None of it was ever reissued.
If a taxing body had imposed a per share tax on the corporation's capital, surely it would not have been taxable on these shares. I think the provision in the amended charter authorizing the corporation to reissue acquired stock was intended only to remove any legal question as to whether the mere acquisition by the corporation of its own stock would, ipso facto, prevent its reissue, and was not intended to tie the corporation's hands so that it could not, if it so desired and intended, cancel some of its stock. The provision in the resolutions adopted in January of 1932, 1933, and 1934 that the shares purchased under those resolutions should be cancelled, but without prejudice to the right of the corporation to reissue them, was omitted from the resolution of October 3, 1934, and subsequent resolutions, and its omission, in connection with the language and conduct which followed, shows, I think, that the corporation intended to "completely cancel" the shares acquired thereafter.
The court holds that the statutory language of Section 115(c) and (i) does not fit the transaction here involved because the payment made to the plaintiffs was not a "distribution" but was the mere payment of a price for the purchase of some shares. In the statute, Congress was dealing with a number of different kinds of dispositions by a corporation of its accumulated earnings, and was attaching different consequences, in re taxability, to them. It was, it seems, seeking a neutral word which would not, in itself, connote that the disposition referred to was a dividend, or so like a dividend that it ought to be taxed as such, or was a mere payment of a purchase price, which ought to be taxed like the sale of a horse. Congress was devising a meticulous statutory scheme for dealing with the problem of the disposition by corporations of their accumulated profits to their stockholders, as distinguished from their spending those profits with outsiders. I can think of no generic word more suitable for the purpose than the word "distribution."
That Congress did not use the word "distribution" in the sense of the payment of a dividend is evident, since dividends ordinarily regarded as such, and by the statute taxed as such, are only one of many kinds of payments dealt with by Section 115, whose heading is "Distributions by Corporations." And Section 115(g), in providing for the special treatment of a "distribution" in cancellation of stock which, because of its time and manner, is essentially equivalent to the declaration of a taxable dividend, recognizes that many other "distributions" are not dividends or their equivalents. The only other meaning, narrower than "payment," which occurs to me for possible application to the word "distribution" in this connection, is "pro rata payment" among all holders of the stock in question. But that would mean that if a corporation had reserved the right to call for retirement a specified number of its shares, at one time, or at specified times, by lot, or by selection made by the board of directors, the payments would not be "amounts distributed in partial liquidation" nor taxable as such under Section 115(c). Yet I have no doubt that such payments would be so taxable. The final call which would bring in all the remaining outstanding shares of the kind subject to call would, by any possible meaning of the word "distribution," be taxable as a "partial liquidation" under Section 115(c). I see no reason why those stockholders should be taxed three times as much as the ones whose stock was called earlier.
The plaintiffs' stock was not called pro rata, or by lot, or by selection of the board of directors, or at all. It was purchased as a result of a general offer made by the corporation to its stockholders, which reminded them that it could call their stock, but that instead it was offering the call price to those willing to sell. It thus offered an opportunity for self-selection, and the plaintiffs sold a part of their stock. If after having purchased all the stock it could get from willing sellers, the corporation had needed more and had called it pro rata from all stockholders, that would have been a "distribution," but it would be hard to find a reason why the stockholders, including the plaintiffs, should pay three times as much taxes on their surrenders of stock in response to the call as on their earlier sales.
The court's decision really, it seems to me, is aimed at the equity and wisdom of Section 115(c) of the 1936 Act. That the criticism has validity is shown by the fact that Congress repealed the part of it here in litigation in 1942. Its apprehension, in 1936, that dispositions by corporations to their stockholders were so fraught with possibilities of evading taxes that so-called "partial liquidations" must be taxed substantially like ordinary income, yielded in 1942 to recognition that real evasions could be adequately taxed under Section 115(g), and that other partial liquidations belonged, in fairness, with completel liquidations, in the taxing scheme. But the nonretroactive repeal in 1942 of the provisions of the statute under which the plaintiffs were taxed in 1937 is not a reason why we should now give the former statute a narrower construction than we would have done before it was modified.
JONES, Judge, took no part in the decision of this case.