Hadley v. Commissioner

Harold F. Hadley, Petitioner, v. Commissioner of Internal Revenue, Respondent Hadley v. Commissioner Docket No. 110063 United States Tax Court 1 T.C. 496; 1943 U.S. Tax Ct. LEXIS 249; January 26, 1943, Promulgated *249 Decision will be entered under Rule 50. Petitioner transferred to a corporation a minor portion of the stock which it had issued. A part was transferred for cash prior to any decision by the corporation as to disposition of the stock. Transfer tax stamps were attached. After the transfer the corporation decided to, and did, hold the stock in its treasury for a few days. A few days later the officers decided to retire the stock, retirement was approved by the stockholders about two weeks later, and the stock was then retired, a certificate of retirement being filed with the secretary of state. Other stock was later, from time to time, delivered under contracts made at the same time as that for the stock above referred to, and corporate action was taken to retire it after full payment for, and delivery of, the stock finally delivered. Transfer tax stamps were affixed to some of such shares at delivery, to others at a later date. The corporation continued in business and its business increased. Held, there was sale of stock and not distribution in partial liquidation. Frank M. Cobourn, Esq., for the petitioner. W. W. Kerr, Esq., for the respondent. Disney, Judge*250 . DISNEY *496 This proceeding involves deficiencies in income tax determined by the Commissioner for the years 1938 and 1939 in the respective amounts of $ 2,489.24 and $ 957.88. A minor portion of the deficiency is admitted by the petitioner. The sole question at issue is whether certain gains realized by the petitioner on transfers of shares of stock owned by him to the issuing corporation are taxable to him as distributions in partial liquidation, or as gains realized on sales of capital assets. Some of the facts are stipulated. We adopt the stipulation filed by the parties and incorporate the same herein by reference. Such parts thereof as are necessary to an understanding of the issues are included in our findings of fact made from evidence submitted at the hearing. FINDINGS OF FACT. The petitioner is an individual, residing in Defiance, Ohio. His income tax returns for the years 1938 and 1939 were filed with the collector for the eleventh district of Ohio. In 1938, and for some years prior thereto, petitioner was president of The A P Parts Corporation, hereinafter referred to as A P, an Ohio corporation having its office in the city of Toledo. A P had issued and outstanding*251 an undisclosed number of shares of preferred stock and 600 shares of common stock. Petitioner owned 150 shares of the common stock, represented by certificates numbered 3, 5, 7, 12, *497 and 14, for an aggregate of 55 shares, 18 for 45 shares, 24 for 25 shares, and 28 for 25 shares. On November 8, 1938, he had held certificates 3, 5, 7, 12, 14, and 18 for more than 24 months. On July 1, 1939, he had held certificate 24 for more than 24 months and had held certificate 28 for more than 18 months, but not more than 24 months. During or prior to 1936 petitioner had become interested in the Defiance Pressed Steel Corporation, of Marion, Ohio. He moved to Marion in that year, and in 1938 held the office of vice president of that corporation. He was then no longer actively engaged in carrying out his duties as A P's president, except to the extent of affixing his signature to documents requiring the president's signature and of performing such formal acts as the office required. Being desirous of obtaining funds with which to increase his holdings in the Defiance Pressed Steel Corporation, he offered, on November 2, 1938, to sell his A P stock to John Goerlich, who owned or controlled*252 the majority of A P's issued and outstanding shares. Goerlich agreed to buy or to procure a purchaser willing to buy at a price equal to the then book value of the stock. As the result of discussion among Goerlich, Frank M. Cobourn, a stockholder and director of and the attorney for A P, and Ralph G. Rule, its secretary and treasurer, it was determined that the corporation itself should purchase the petitioner's shares. Thereafter, Cobourn discussed the terms of sale with petitioner, and drew four contracts embodying their agreement. These were approved on behalf of the corporation by Rule, and on November 8, 1938, were executed by him for the corporation and by petitioner. The first contract provided for immediate sale and delivery of 90 shares, being the 55 shares represented by certificates 3, 5, 7, 12, and 14, and 35 of the 45 shares represented by certificate 18, for the price of $ 33,750 payable in cash forthwith upon the delivery of the certificates properly endorsed and stamped for transfer. The second provided for sale of 10 of the 45 shares represented by certificate 18 for $ 3,800 payable on or before February 8, 1939. Petitioner agreed to endorse and deliver certificate*253 18 and to receive a new certificate for 10 shares to be held by him as security for the full payment of the purchase price. The third provided for sale of the 25 shares represented by certificate 24 for $ 9,500, payable $ 3,800 on or before May 8, 1939, $ 3,800 on or before August 8, 1939, and $ 1,900 on or before November 8, 1939. The fourth provided for sale of the 25 shares, represented by certificate 28 for $ 9,500 payable $ 1,900 on or before November 8, 1939, $ 3,800 on or before February 8, 1940, and $ 3,800 on or before May 8, 1940. Both the third and fourth contracts provided that petitioner should hold certificates 24 and 28 as security for payment in full of the aggregate purchase price of the shares *498 represented by those certificates. The fourth further provided that in the event the purchase price for certificates 24 and 28 should be fully paid on or before July 1, 1939, then the price for certificate 28 should be reduced from $ 9,500 to $ 8,000. Under the second, third, and fourth contracts, A P agreed to pay interest at the rate of 5 percent per annum on the amount of all installments on purchase price from the date of execution until payment. All four*254 contracts contained agreements by petitioner not to engage in the manufacture, handling, or sale of certain specified automobile parts and accessories in the United States or Canada, for a term of five years, except with the permission of A P. On November 12, 1938, petitioner endorsed and delivered certificates 3, 5, 7, 12, 14 and 18, and received payment of $ 33,750 and a new certificate for 10 shares, in accordance with the provisions of the first and second contracts. Transfer tax stamps in appropriate amounts were affixed to the old certificates and were canceled, and a new certificate for 90 shares was issued to A P. Paragraph seventh of A P's articles of incorporation provided: This corporation may purchase shares of any class issued by it at any time and for any reason, when authorized by its Board of Directors, without notice to or consent of any of its shareholders. At a meeting of the directors held November 15, 1938, a resolution was adopted by which the four contracts of November 8, and the action of Rule in executing the same for the corporation, making payment of the $ 33,750, and receiving the 90 shares from petitioner, were ratified and approved. Prior to November*255 12 there had been no discussion of the question of what should be done with petitioner's shares when they were acquired. After the transfer, Cobourn and Rule agreed that the transaction should be treated presently as a purchase of stock to be held in the treasury, and book entries debiting treasury stock account and crediting cash, both in the amount of $ 33,750, were accordingly made. The question of whether the stock should be so held permanently, sold, or retired was also discussed, but no decision was then reached. It was raised again after the close of the directors' meeting on November 15. Cobourn then advised that it be retired in order to avoid the possibility of disadvantageous tax consequences in the event of its subsequent sale, and also advised that the power to retire stock lay with the stockholders. Rule favored its retirement so that its reflection as treasury stock on the corporation's balance sheet might be avoided. Subsequently, at a special meeting of the stockholders held on November 30, it was resolved that the 90 shares be retired, that authorized common stock be reduced from 1,000 shares to 910 shares, and that, in connection with the retirement, stated*256 capital be reduced from $ 88,000 to $ 80,000. A certificate of amendment retiring *499 the shares in pursuance of the resolution was filed in the office of the Secretary of State of the State of Ohio on December 8. Under that date, journal entries debiting common capital stock and surplus accounts in the respective amounts of $ 8,000 and $ 25,750, and crediting treasury stock account in the amount of $ 33,750, were made in A P's books to record the retirement. The petitioner was not present either on November 12 or on November 15, 1938, when the questions of the immediate and ultimate dispositions to be made of his stock by A P were discussed. He had no discussion with regard to the sale with any officer or representative of A P other than Goerlich, Rule, and Cobourn, none of whom at any time mentioned to him the possibility that his stock might be retired. His only knowledge that such action might be taken was acquired from a waiver of notice of a directors' or stockholders' meeting, called to consider retirement, which he received and signed about November 20, 1938. Payments were made to petitioner by AP during 1939 in accordance with the terms of the second, third, and*257 fourth contracts. In each instance debit entries reflecting the payments were made in its treasury stock or interest accounts, as the case might be, and offsetting credits were entered in its cash account. By July 1 the corporation had acquired and paid for all of the remaining 60 shares. Certificates 24 and 28 were transferred on that day, and the latter was paid for at the reduced price of $ 8,000, as provided in the fourth contract. Payments made on account of purchase price during 1939 aggregated $ 21,300. On July 3, 1939, the stockholders resolved that the 60 shares be retired, that authorized common stock be reduced from 910 to 850 shares, and that, in connection with the retirement, stated capital be reduced from $ 80,000 to $ 75,000. A certificate of amendment retiring the shares in pursuance of the resolution was filed in the office of the Secretary of State of the State of Ohio on July 12. Under date of July 3, journal entries debiting capital stock and surplus accounts in the respective amounts of $ 5,000 and $ 16,300 and crediting treasury stock account in the amount of $ 21,300 were made in the corporation's books to record the retirement. Transfer tax stamps were*258 not affixed to some of the certificates delivered during 1939 at the time of their delivery, but such stamps in appropriate amounts were affixed at some subsequent time. In November 1938 AP had a substantial cash balance. Its surplus was sufficient for the purchase of all of petitioner's shares, and neither the payments made at that time nor those made during 1939 impaired its working capital to an extent requiring it to curtail its business. Computed on the basis of net sales, the volume of its 1939 and 1940 business exceeded that of 1938 by about 30 percent and more than 90 percent, respectively. *500 The petitioner realized gains on the sale in 1938 in the amount of $ 25,710, and during 1939 in the aggregate amount of $ 9,800. Of the latter amount, $ 3,500 was attributable to the sale of the 25 shares represented by certificate 28. On his income tax return for 1938 petitioner reported $ 12,855 as long term capital gain realized on the sale of his stock, and on his 1939 return he reported short term capital gains in the amount of $ 1,946.97. Respondent increased reported net long term gain for 1938 by $ 12,855 and net short term gain for 1939 by $ 9,800, made other adjustments*259 to net income not here in issue, and determined the deficiencies. OPINION. We have here to decide whether the transactions through which the petitioner disposed of the corporate stock here involved constitute a sale resulting in capital gain, taxed according to the time of holding under section 117 of the Revenue Act of 1938, or whether on the other hand such transactions constituted a distribution in partial liquidation under section 115 (c) and (i), Revenue Act of 1938, in which case the entire gain would be taxable. No disagreement appears as to the amount of the gain or as to the length of time petitioner had held the stock. On the record before us there can be no doubt that the transaction to be considered took the form of a sale; and it is equally clear that after the stock was held in the treasury for a short time, it was retired. That the transaction was in the form of a sale is not conclusive. (414); . Nevertheless, that fact is to be considered with all of the other circumstances in determining whether there was the distribution *260 in partial liquidation which the Commissioner determined it to be. After considering all of such circumstances, we have come to the conclusion that it was a sale and not a distribution in partial liquidation, within the meaning of section 115 (c) and (i) of the Revenue Act of 1938. 1 Those subsections, so far as here pertinent, are shown *501 in the margin. Although, as the respondent stresses, there was actual retirement of the stock very shortly after the purchase, it is beyond question, under the record here, that at the time of the purchase and sale of the 90 shares of stock on November 12, 1938, there had been no determination as to what the corporation would do with the stock when purchased. This is emphasized by the fact that a question arose in that respect after the transfer, and only between the officers of the corporation, the petitioner not participating; also, by the fact that at that time the only thing decided was that the stock should be held for the present in the treasury and that no decision was reached as to permanent holding, sale, or retirement of the stock. It was not until November 15 that it was decided to retire the stock, and this decision on the*261 part of some of the officers was not effectuated until November 30, at which time the stockholders authorized retirement and reduction of capital. Although the fact that there was such retirement after the purchase of the 90 shares of stock certainly is not to be disregarded, we think it clear that the fact that such course was not even suggested or decided upon until November 15 makes it impossible to regard the sale of the stock by the petitioner as part of any plan or course of action resulting in retirement of stock; for, even after the petitioner had disposed of his stock to the corporation, the direction of events might have turned either towards retirement or towards mere holding as treasury stock. *262 The statutory expression is, "amounts distributed in partial liquidation," and it here means "a distribution by a corporation in complete cancellation or redemption of a part of its stock." Though not holding that the word "distribution" is altogether inapplicable to a transfer of stock by but one stockholder, nevertheless in such a case as here, we think it not amiss to recall that the word "distribution" is defined by Webster's International Dictionary as "division or apportionment among several or many," and that there is no lack of difficulty in applying logically the word to a mere sale by one minor stockholder. It is not easy, moreover, to see where the cash payment for stock delivered prior to any suggestion of, or decision upon, cancellation or retirement is a part of any cancellation or redemption, that is "in" a "cancellation or redemption" which later arose. The parties agree that whether there was liquidation is a question of fact, and here it is plain there was no history of failing business, no intent to go out of business, in whole or in part, and in fact the corporate business very substantially increased in later years. The ordinary concept of liquidation as*263 involved in a dissolution of business, in whole or in part, is here altogether absent. The stock involved is common stock, and cases involving various methods of retiring preferred stock, more or less in pursuance of plans made at *502 the time of its issuance, are not fully here applicable. Considering the acquisition of the stock prior to decision either to hold in the treasury or to retire it, we think that the conclusion herein is largely controlled by that in . There the court says: * * * The character of the transaction must be judged by what occurred when the petitioner surrendered his certificate in exchange for payment. It is stipulated that his shares were transferred to the corporation but we can see nothing to indicate that when it acquired them it had then the intention to retire them. * * * The intent to retire at the time of acquisition of the 90 shares is equally absent in the present case. That the facts there involved were largely similar to those here considered is shown by the following further quotation: * * * The idea of retirement was first suggested by an accountant's advice*264 to the company's bookkeeper at some unspecified date after its acquisition of the shares. We do not think that a subsequently formed intention to retire stock purchased by a corporation can convert its payment of the purchase price into "a distribution by the corporation in complete cancellation or redemption of a part of its stock" so as to effect the tax liability of the shareholder who sold, even on the assumption that formal compliance with the state law as to retirement is unnecessary. It is true that in the Alpers case there was no certificate of redemption of shares filed with the secretary of state and no corporate action taken to ratify the transaction, but the court considered the fact, here involved, that transfer taxes were paid, and, as above seen, the fact that the retirement was under a decision arrived at after the purchase. A decision to show retirement upon the corporate books and to file a certificate with the secretary of state, arrived at after and unconnected with the acquisition of the stock seems to us to leave such acquisition no part of liquidation proceedings. It has not been suggested that the situation was any different with respect to the other*265 stock paid for up to July 1, 1939, and though the retirement of the earlier purchase may be some indication that the later purchase was also to be retired, no corporate action towards retirement of the stock was taken until after final delivery and payment for all stock, that is after July 1, 1939, and prior to that time the 60 shares of stock were carried in the treasury, some of them for several months. We conclude that there is no essential difference in the treatment of the 90 shares and the 60 shares, and that the purchase price received by the petitioner was not received by way of "distribution by a corporation in complete cancellation or redemption of a part of its stock." Decision will be entered under Rule 50. Footnotes 1. 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 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, except in the case of amounts distributed in complete liquidation. * * * * * * * (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.↩