Boyle v. Commissioner

James F. Boyle, Petitioner, v. Commissioner of Internal Revenue, Respondent Boyle v. Commissioner Docket No. 21624 United States Tax Court 14 T.C. 1382; 1950 U.S. Tax Ct. LEXIS 135; June 30, 1950, Promulgated *135 Decision will be entered for the respondent. Petitioner's share of payments received from a corporation by him and the two other principal stockholders in exchange for a portion of the stock, being made for no corporate reason and not affecting petitioner's ultimate proportional interest in the company, held on facts essentially equivalent to the distribution of a taxable dividend. Section 115 (g), Internal Revenue Code. Llewelyn A. Luce, Esq., and Clyde D. Yeomans, C. P. A., for the petitioner. John E. Mahoney, Esq., and Francis X. Gallagher, Esq., for the respondent. Opper, Judge. OPPER *1382 A deficiency of $ 137,561.21 in income and victory tax for calendar year 1943 is challenged on the ground that respondent erred in treating as "essentially equivalent to the distribution of a taxable dividend," under section 115 (g), *136 Internal Revenue Code, amounts received by petitioner in exchange for stock and reported by him as long term capital gain. The case was heard on a stipulation of facts and other evidence. FINDINGS OF FACT. The stipulated facts are hereby found. Petitioner filed Federal income tax returns for 1942 and 1943 with the collector of internal revenue for the fifth district of New Jersey. *1383 Petitioner, an engineer, began manufacturing and selling airships and inflatable rubber products upon graduation from college, and invented several products which later proved useful to this country's war effort, including inflatable rubber boats, Mae West life jackets, a pontoon bridge, barrage balloons, and airplane emergency flotation gear. In 1929 he organized Air Cruisers, Inc., a Delaware corporation hereinafter called the company. Prior to his death in July, 1943, Earl F. Glover was the company's business manager and financial head, serving as president and treasurer. Thomas P. Vaughan succeeded Glover as treasurer. Petitioner was secretary, chief engineer, production manager, and sales engineer; and upon Glover's death he became president. Carter Tiffany, vice president, was active*137 principally in signing notes for the company. Gross sales rose from practically zero in 1939 to about $ 10,000,000 in 1942. In its returns for 1943 and 1944, the company reported gross sales of $ 10,746,221.31 and $ 7,037,067.71, respectively. During the years in question the company was engaged in manufacturing and selling the inflatable products already mentioned, and about 95 per cent of its sales were to the United States Government. The company's authorized capital stock was increased on June 27, 1929, from 10,000 to 15,000 shares of no par value common. The company has never declared cash or stock dividends. No more than 10,705 shares were ever issued and outstanding. The stock as of the dates indicated was held as follows: May 11, Dec. 13, Dec. 18, Prior 1943 to 1943 to 1943 to Stockholder to May Dec. 13, Dec. 18, May 16, 11, 1943 [1944] Petitioner 3,095 3,602 [300] Glover 2,995 3,501 3,501 3,501 Tiffany 2,995 3,502 [300] H. P. Morris [100] Pelham Bissell [710] Adrian Van Muffling [810] Treasury stock 6,504 6,504 Vaughan [50] Harry A. Gerrish [50] Total 10,705 10,705 10,705 10,705 *138 May 16 May 18, Stockholder 1944 to 1945 to After May 18, May 29, May 29, [1945] Petitioner [300] Glover 3,501 Tiffany H. P. Morris Pelham Bissell Adrian Van Muffling Treasury stock 6,504 10,005 9,805 Vaughan [300] Harry A. Gerrish [300] Total 10,705 10,705 10,705 Petitioner's original 3,095 shares were received in exchange for his inventions and services in organizing the company. By the transaction of May 11, 1943, which involved the first transfer of stock recorded on the company's books since 1939, Bissell and Muffling's aggregate of 1,520 shares were acquired by petitioner (507), Glover (506), and Tiffany (507), at $ 20 per share. Petitioner paid $ 10,140 for his 507 shares. The 1,520 shares were acquired because of the advantages in offering all the stock for sale. Due to disagreements with Glover on management policy, Tiffany had been trying to sell his stock since *1384 1941. In that year he offered to sell out to petitioner and Glover for $ 75,000. Subsequently he negotiated with two other individuals and one corporation, but all negotiations failed because the prospective purchasers wanted*139 100 per cent of the outstanding stock. Most of Tiffany's negotiations were based upon a sale of the entire stock. When the opportunity arose to buy the 1,520 shares from Bissell and Muffling, Tiffany was authorized to negotiate and buy the stock for the joint account of petitioner, Glover, and Tiffany. Petitioner, in directing the company's production, depended on Glover for efficient business management. Upon Glover's death on July 16, 1943, the company's financial management fell to Vaughan, who had been Glover's assistant. Tiffany disagreed with Vaughan as he had with Glover and continued his efforts to sell the stock. He offered 100 per cent of the stock in the company to Pharis Tire & Rubber Co. Glover's will appointed Harry A. Gerrish, the company's attorney, as executor. Caveats protesting probate of the will were filed by Glover's divorced wife and son on August 6, 1943, and September 7, 1943, respectively. The former filed a petition for appointment of an administrator pendente lite on August 12, 1943. Passaic County Surrogate's Court, New Jersey, on March 30, 1944, dismissed the caveats and authorized Gerrish to administer the estate. During the negotiations with*140 Pharis Tire & Rubber Co., in 1943, Gerrish took the position that because of the caveats, neither he nor anyone else could convey title to the Glover stock. Pharis refused to wait until the estate was settled, or to buy on condition that Gerrish qualify as executor. In October, 1943, an instrument was drafted providing for the sale of an undisclosed amount of stock to Pharis. At the last minute petitioner refused to sign because he was dissatisfied with the terms, and the deal fell through. Tiffany and petitioner proposed a transfer of some of their stock to the company. In late November, 1943, Gerrish informed Tiffany that, if offered for sale, the company would buy Tiffany's stock at its book value. Tiffany agreed to accept that figure. At a special meeting of stockholders on December 13, 1943, presided over by Tiffany and attended only by him and petitioner, Vaughan was elected director to succeed Glover. The minutes disclose the following action: * * * * The Chairman then stated that the further purpose of the meeting was to consider and take action upon a proposal made by Mr. Tiffany and Mr. Boyle, offering 6504 shares of their capital stock to the corporation for sale. *141 A general discussion was had during which the balance sheet of the corporation as of November 30, 1943, was analyzed and Mr. Clyde D. Yeomans, accountant for the corporation, stated that the book value of the stock was $ 62.67 per share. *1385 Upon motion, duly made, seconded and unanimously adopted, it was resolved as follows: -- WHEREAS, Mr. Carter Tiffany and Mr. James F. Boyle have offered 6504 shares of the capital stock of Air Cruisers, Inc., to the corporation at its book value and WHEREAS, the surplus of the corporation is larger than the sum required to purchase the said stock, NOW, THEREFORE, BE IT RESOLVED, that the Board of Directors be and it is hereby authorized and directed to accept said offer and to purchase said shares from the said Carter Tiffany and James F. Boyle, for the sum of $ 62.67 per share. * * * * At a special meeting of the Board of Directors on December 13, 1943, attended by petitioner, Tiffany, and Vaughan, comprising the entire board, it was * * * RESOLVED that the offer of Mr. Carter Tiffany and Mr. James F. Boyle be, and the same is hereby accepted and that this corporation purchase 6504 shares of its stock for the sum of $ 62.67 per share * *142 * *. At the same meeting of the Board of Directors, officers of the company were elected as follows: Officer Office Petitioner President and Secretary Vaughan Vice-President and Treasurer Tiffany Vice-President On December 13, 1943, petitioner and Tiffany endorsed to the company 3,302 and 3,202 shares, for which they received $ 206,936.34 and $ 200,669.34, respectively. The 6,504 shares were held by the company as treasury stock until its dissolution. Petitioner retained 300 shares. Gerrish expected to function as executor of Glover's estate, and believed that petitioner's technical knowledge was required for the company to complete work under its contracts. Tiffany executed an instrument which gave Gerrish a ten-year option to purchase 300 shares for 10 cents each, and a proxy and power of attorney to vote the stock during the option period. The instrument, which was dated December 1, 1943, recited that certificates evidencing ownership of the 300 shares were simultaneously deposited with a trustee who was directed to deliver them to Gerrish upon receipt of the purchase price. Gerrish exercised the option in 1944. Tiffany considered the 300 shares as compensation to*143 Gerrish for services in connection with disposing of the 3,202 shares to the company. Gerrish considered that the 300 shares were a gratuity from Tiffany. As of December 18, 1943, Vaughan and Gerrish each acquired half of the stock (50 shares) from the remaining minority stockholder, Morris. As of May 16, 1944, 150 of the 300 shares covered by the *1386 Tiffany option agreement were acquired by Vaughan, the remaining 150 shares being recorded in Gerrish's name. As disclosed by its income and declared value excess profits tax return for calendar year 1944, the company paid the following compensation to its officers during that year: Officer Title Compensation Glover, deceased $ 31,250.02 Petitioner President 45,000.00 Vaughan Vice-President 25,000.00 Gerrish Vice-President 20,000.00 After the Court order of March 30, 1944, confirming his appointment as executor of the Glover Estate, Gerrish attempted to work out a plan of distributing the 3,501 shares to the legatees, including himself, Vaughan, Glover's son, and several employees of the company. All of the legatees except Gerrish and Vaughan preferred cash to a distribution of stock. At the annual meeting*144 of stockholders on May 17, 1945, attended by petitioner (chairman), Vaughan and Gerrish, it was RESOLVED, that this Corporation through its Board of Directors, offer to purchase the 3501 shares of the capital stock of this Corporation, now held by the Estate of Earl F. Glover or so much thereof as may be necessary to liquidate said estate for the sum of $ 62.67 per share * * *. At the same meeting, at the instance of Gerrish, the legatees were given an option, extending until June 1, 1945, "to repurchase any portion of the stock so acquired by this Corporation, to the extent of their respective legacies, for the sum of $ 62.67 per share." Petitioner, Vaughan, and Gerrish were elected directors. The annual meeting of the board of directors on May 17, 1945, adopted resolutions similar to the above, and elected officers and fixed their salaries for 1945 as follows: Officer Office Salary Petitioner President $ 30,000 Vaughan Vice-President and Treasurer 25,000 Gerrish Vice-President and Secretary 20,000 As of May 18, 1945, the Glover Estate transferred its 3,501 shares to the company in exchange for $ 62.67 per share which it reported in its Federal income tax return *145 as a capital gain. Vaughan and Gerrish exercised their options as legatees, and as of May 29, 1945, each acquired 100 shares from the company. The remaining 3,301 Glover shares were held by the company as treasury stock until its dissolution. None of the shares formerly owned by petitioner, Tiffany, or Glover were ever formally canceled. Revenue stamps, provided for under the Stamp Tax Act, were affixed to each of the shares transferred to the company by petitioner and Tiffany on December 13, 1943, and by Glover's Estate on May 18, 1945. *1387 During the period in question, the company's operations were financed almost entirely by quick inventory turnover and advances on Government contracts. The company's cash on hand and surplus as of December 31, 1943, after the transfer on December 13, 1943, of 6,504 shares from petitioner and Tiffany, were $ 476,294.05 and $ 221,711.56, respectively. The adjusted balance in surplus prior to the transfer was $ 629,317.24, being the $ 221,711.56 plus $ 407,605.68 paid to petitioner and Tiffany. If the company had not made the payments its cash on hand as of December 31, 1943, would have been greater by $ 407,605.68. In 1943 a revenue agent*146 audited the company's books for 1942, and considered its liability under section 102, Internal Revenue Code. In a written waiver of restriction of assessment for 1942, signed by the company's accountant, the revenue agent stated: "Taxpayer is engaged at lighter than aircraft, and surplus is needed for the expansion of business." In the spring of 1943 the company's war contracts were renegotiated, and during 1943 it paid a renegotiation liability for 1942 of $ 1,700,000. In Tiffany's negotiations with Pharis Tire & Rubber Co. in the fall of 1943, Pharis required as a condition to its purchase of stock that $ 200,000 be held in escrow to take care of possible renegotiation liability for 1943. Renegotiation proceedings were carried on for every year until the end of the war. The company was dissolved on November 7, 1949. In his income and victory tax return for 1943, petitioner reported the $ 206,936.34 received for the December 13 transfer of his stock to the company as a long term capital gain. He used a basis of $ 10,140, being the amount paid for the 507 shares purchased from Bissell and Muffling, resulting in a gain of $ 196,796.34 and a "Gain * * * to be taken into account" *147 of $ 98,398.17. In his notice of deficiency, respondent increased petitioner's income by $ 108,538.17, being the $ 206,936.34 less the $ 98,398.17, determining -- that the amount of $ 206,936.34 distributed to the taxpayer in redemption of 3,302 shares of capital stock of Air Cruisers, Inc. is taxable as a dividend, instead of as a capital gain of $ 98,398.17 on the sale of assets. The 3,302 shares transferred by petitioner to the company on December 13, 1943, were redeemed by the company at such time and in such manner as to make the distribution of the $ 206,936.34 essentially equivalent to the distribution of a taxable dividend. OPINION. Placing upon the operative events the construction most favorable to petitioner, the most that can be said is that a desire arose on the part of the principal stockholders to get their money out of *1388 the business, but that conditions prevented an outright sale to outsiders. Much of the significant detail remains a mystery, 1 but we know that a plan was suggested and ultimately carried out by which the corporation acquired most of the stock of two of the stockholders, and subsequently the third, at an identical figure, and that there*148 then remained at the disposal of petitioner his identical proportion of the original interests in the enterprise. No benefit accrued to the business nor is one even suggested. 2 There was a large earned surplus and an unnecessary*149 accumulation of cash, both of which were reduced as they would have been by the declaration of a true dividend. The business did not curtail its operations nor enter upon a program of liquidation. By all of the tests this transaction is governed by section 115 (g). 3 *150 The redemption was not dictated by the reasonable needs of the business, but originated with and was designed for the benefit of the stockholders who received its fruits. A. E. Levit, 43 B. T. A. 1077. The reduction in the capitalization was not to bring it to a figure more nearly approximating the value of the assets nor to create a surplus. The company did not contract its business. Elwood W. McGuire, 32 B. T. A. 1075, affirmed (C. C. A., 7th Cir.), 88 Fed. (2d) 1013. There was no other suggested purpose such as the creation of a stock pool for employee purchases, and the company had no record of prior distributions of earnings. Cf. Fred B. Snite, 10 T. C. 523, affirmed (C. A., 7th Cir.), 177 Fed. (2d) 819. And if we borrow the language of Judge (now Chief Justice) Vinson in Flanagan v. Helvering (C. A. D. C.), 116 Fed. (2d) 937, 939: *1389 "But the net effect of the distribution rather than the motives and plans of the taxpayer or his corporation, is the fundamental question in administering*151 § 115 (g)," we must likewise conclude that the identical result would have been accomplished (except for the hope of saving taxes) by the outright declaration of a cash dividend. Much is made of the suggested inequality of the distribution as among the stockholders. The contention is not impressive on either the law or the facts. Legally it is not alone distributions which are true dividends to which the section applies. "* * * this theory assumes that the distribution must in fact meet the legal test of a dividend to fall within section 201 (g) [the predecessor of 115 (g)]. If this were sound, that provision of the statute would be surplusage, as such a dividend would be taxable under other provisions. Cf. United States v. Katz, 271 U.S. 354. The purpose of this section is to tax distributions which effect a cash distribution of surplus otherwise than in the form of a legal dividend * * *." Shelby H. Curlee, Trustee, 28 B. T. A. 773, 782, affirmed (C. C. A., 8th Cir.), 76 Fed. (2d) 472, certiorari denied, 296 U.S. 599. In addition, however, the record implies, *152 and we are certainly not persuaded to the contrary, 4*153 that the distribution to Tiffany was no more than simultaneous with his disposition of his remaining shares. 5 That would leave the two principal stockholders (or the assignee of one) with the same proportionate interest after the distribution. Similarly, the fact that the payment to the Glover Estate, although it had to be delayed for technical reasons, was eventually at the same price per share to the penny and for almost the same number of *1390 shares, 6 is at least suggestive that the subsequent distribution was pursuant to a pre-arranged agreement. Although it took something over a year to accomplish, the upshot was, as our findings show, that a corporation, with three principal stockholders holding their shares in virtually equal proportions, distributed to them the bulk of its accumulated earnings and that ultimately there remained three shareholders again with identical holdings. The transaction has too many appearances of being interrelated parts of a single operation for us to discard the suggested test of the Flanagan case as to the "net effects of the distribution." So approached, it is not merely "essentially equivalent," it is identical with the distribution of an ordinary dividend. We need not here, any more than has been done in a number of other situations, determine whether under such circumstances every deposit in the corporate treasury is a redemption. 7 It suffices to say that there was evidently no intention here of reissuing the stock, and it seems to have been permanently acquired and put to rest in the treasury for all practical purposes as truly as though the number of shares*154 had been formally reduced. See Dr. Pepper Bottling Co. of Mississippi, 1 T. C. 80, 84. *155 No adequate grounds have been advanced by petitioner, upon whom the burden lay, George Hyman, 28 B. T. A. 1231, affirmed (C. A. D. C.), 71 Fed. (2d) 342, certiorari denied, 293 U.S. 570, to persuade us that this was not, as determined by respondent, the essential equivalent of the distribution of a taxable dividend within the meaning of section 115 (g). Decision will be entered for the respondent. Footnotes 1. For example, it is repeatedly emphasized that one of the other stockholders, Tiffany, gave up his rights in the remaining shares. We are not apprised of the reason he did so, his explanation being that it was to compensate the attorney who represented the company and himself, the attorney's explanation being that it was a "gratuity" to him, but neither shedding adequate light on the question of whether Tiffany could not as well have continued to hold the stock for all that appears as to the accomplishment of any purpose of the whole transaction. This is not to say that an explanation is necessary since petitioner could have received the equivalent of a dividend without proportional participation by the remaining stockholders. J. Natwick, 36 B. T. A. 866, 874↩. 2. The desire of Tiffany to withdraw from active participation is emphasized. Tiffany testified: "I disagreed with the management and the management disagreed with me. * * * I felt that the only solution for me, at any rate↩, was to sell my interest in the company. That I found was impossible. Outside interests would not buy my share alone. They would buy only all of the outstanding stock." (Emphasis added.) That, however, sheds no light on the simultaneous and identical payment by the company to petitioner who not only did not retire from the company but became its president and apparently continued in that capacity for a number of years until dissolution. 3. "SEC. 115. DISTRIBUTIONS BY CORPORATION. * * * * "(g) 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."↩ 4. It is stipulated that: "13. The stockholders of record of Air Cruisers, Inc. and the number of shares held by them subsequent to December 13, 1943, are as follows: ↩ From December 13, 1943, to December 18, 1943 James F. Boyle 300 Shares Earl F. Glover 3,501 Shares Carter Tiffany 300 Shares H. Preston Morris 100 Shares Treasury Stock 6.504 Shares 10,705 Shares From December 18, 1943, to May 16, 1944 James F. Boyle 300 Shares Earl F. Glover 3,501 Shares Carter Tiffany 300 Shares Thomas P. Vaughan 50 Shares Harry A. Gerrish 50 Shares Treasury Stock 6,504 Shares 10,705 Shares 5. Mr. Tiffany was asked: "Q. You had just sold 3,202 shares of stock for $ 62.67, at the same time you gave this option to Mr. Gerrish for ten cents a share, is that correct? "A. That is right. "Q. Was that compensation to Mr. Gerrish for producing sale of your stock? "A. That is how I considered it."↩ 6. Glover, 3,301 shares; Tiffany, 3,202 shares; petitioner, 3,302 shares.↩ 7. "Webster's New International Dictionary defines the word 'redeem' as, 'To regain possession of by payment of a stipulated price; to repurchase. (2) To recover or regain, as pledged or mortgaged property * * *. (3) To buy off, take up, or remove the obligation of, by payment or rendering of some consideration.' "The word 'redemption' has its origin in the Latin words 're' and 'emers' and means to repurchase or to regain possession by payment of a stipulated price. Murphy v. Caselman, 139 N. W. 802 (N. D.); Maxwell v. Foster, 45 S. E. 929; Pace v. Bartles, 20 Atl. 352 (N. J.); Miller v. Ratterman, 24 N. E. 496 (Ohio). Considering the word 'redeem' in the light of the above definitions, the corporation involved here redeemed the stock from the petitioner. It acquired it back or repurchased it. The statute does not refer to 'retirement' of stock. If the statute had used the expression 'cancels or retires' the stock there would be another question. But the contention of the petitioner is that 'redeems' or 'redemption' means 'retires' or 'retirement.' We do not think the statute should be so limited. * * *" James D. Robinson, 27 B. T. A. 1018, 1021, affirmed (C. C. A., 5th Cir.), 69 Fed. (2d) 972. See also J. Natwick, 36 B. T. A. 866; Lowenthal v. Commissioner (C. C. A., 7th Cir.), 169 Fed. (2d) 694; cf. Kirschenbaum v. Commissioner↩ (C. C. A., 2nd Cir.) 155 Fed. (2d) 23.