S. A. Woods Machine Co. v. Commissioner

S. A. WOODS MACHINE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. S. A. Woods Machine Co. v. Commissioner Docket No. 32015. United States Board of Tax Appeals 21 B.T.A. 818; 1930 BTA LEXIS 1783; December 19, 1930, Promulgated *1783 GAIN OR LOSS. - Where petitioner had a claim for unliquidated damages and accepted shares of its own capital stock in a settlement thereof, and immediately canceled and retired the stock and added the par value thereof to surplus, no gain or loss resulted. Henry H. Dinneen, Esq., for the petitioner. R. W. Wilson, Esq., for the respondent. BLACK *818 The taxes in controversy are income taxes for the calendar year 1924 in the sum of $51,893.65, representing the deficiency and a penalty of $2,594.68, making a total of $54,488.33. Petitioner alleges that the respondent erred in holding (a) that 1,022 shares of its capital stock received in 1924 from the P. B. Yates Machine Co. constituted income to it for said year; (b) that said corporate capital stock was worth $433,200.04; and (c) that the penalty should be imposed. By an order duly entered the hearing was limited to the trial of the issue of whether the petitioner realized income as a matter of law by the receipt of 1,022 shares of its own capital stock from the P. B. Yates Machine Co. The questions of the value of the stock and correctness of adding penalty are to await decision of the*1784 question of law. The facts have been stipulated and we adopt them in our findings of fact, so far as pertinent. FINDINGS OF FACT. The S. A. Woods Machine Co. since 1923 continuously has been a corporation duly incorporated under the laws of Massachusetts, with its principal office at 27 Damrell Street, Boston, Mass. In 1923 said Woods Co., as the owner of the United States Patent No. 1041234 (known as the Blood patent), for the manufacture of wood-working machinery, brought an action in equity in the United States District Court for the Western District of Wisconsin against the P. B. Yates Machine Co., a corporation, for the alleged infringement *819 of the aforesaid Blood patent; said case against the Yates Co. culminated in a decree in favor of the Woods Co. On February 18, 1924, the Woods Co. and the Yates Co. made an agreement in writing in settlement of the foregoing litigation. This agreement was subsequently recognized in the final decree of the United States District Court of the Western District of Wisconsin, under date of August 15, 1924. Thereafter, the said Yates Co. delivered 1,022 shares of the common stock of said S. A. Woods Machine Co. to the*1785 Woods Co. pursuant to the settlement which had been agreed upon. At the time of the consummation of the agreement of February 18, 1924, the total outstanding capital stock of the Woods Co. was 3,000 shares of common stock. Upon receipt from the Yates Co. of said 1,022 shares of its common capital stock the said Woods Co. canceled such certificate and retired such stock, thereby effectuating a reduction in its capital stock liability of $102,200 and coincidentally increasing its surplus to a similar extent, the Woods Co. assuming the value of the stock for such readjustment purpose to be the par thereof - $100 per share. Thereafter the respondent herein, having ascertained from the Woods Co.'s books its receipt in 1924 of the aforesaid 1,022 shares under the stated circumstances, determined that they were taxable income and in 1924 were worth $433,200.04, and asserted an additional tax against petitioner for the calendar year 1924 in the sum of $54,488.33, of which amount $51,893.65 represents an alleged deficiency in tax and $2,594.68 represents penalty. Petitioner made no report of the transaction and contends that no income was received thereby. OPINION. *1786 BLACK: A number of cases have been considered by the Board involving the purchase by a corporation of its own capital stock and we have uniformly held that the corporation realizes no gain or loss from the purchase or sale of its own stock. Simmons & Hammond Mfg. Co.,1 B.T.A. 803; Farmers Deposit National Bank,5 B.T.A. 520; H. S. Crocker Co.,5 B.T.A. 537. While the circumstances under which petitioner acquired the shares of its own common stock from the Yates Co. in this proceeding are by no means the same as in the cases above cited, we think the same rule must govern. When the petitioner acquired the shares of its common stock from the Yates Co. and retired it, it was in possession of no additional assets thereby. The situation would be different if petitioner had acquired Liberty bonds or stocks and bonds of another corporation. *820 For example, if petitioner had acquired 1,022 shares of the common stock of the U.S. Steel Corporation, it would have then owned something which it did not own before, viz., an interest in the U.S. Steel Corporation to the extent of the common stock acquired, and its income in the transaction*1787 would be measured by the value of the common stock at the time it was acquired. United States v. Phellis,257 U.S. 156. But when it received 1,022 shares of its own common stock, it owned no property which it did not own before. The corporation, S. A. Woods Machine Co., was already the owner of all the property of the corporation and the acquirement of these 1,022 shares added nothing to this ownership. It is true that the book value of the remaining 1,978 shares of common stock was increased by the acquirement and cancellation of these 1,022 shares, but that added nothing to the income of the corporation. It simply caused an appreciation in the value of the remaining shares of the common stock of the corporation. In this proceeding we can not see where petitioner received anything which fits into the definition of income as approved in Eisner v. Macomber,252 U.S. 189, and Towne v. Eisner,245 U.S. 418. See also Houston Bros. Co.,21 B.T.A. 804. Reviewed by the Board. Decision will be entered under Rule 50. VAN FOSSAN did not participate in the consideration of or decision in this report. *1788 ARUNDELL ARUNDELL, dissenting: In my dissenting opinion in Houston Bros. Co., decided this day, which case involves the same fundamental question as is here presented, I have pointed out some of the reasons for the conclusions reached. The certificate representing 1,022 shares of the stock of the petitioner herein was delivered to it by the Yates Co. pursuant to the agreement of February 18, 1924, in lieu of profits and/or loss damages to which petitioner was entitled under the court decree. It will not be questioned that if petitioner had received cash royalties for the use of its patents or cash in settlement for the infringement of the patents, the amount received would constitute income. Money so received would be income derived from property. The same thing is true if the royalties or damages for infringement are paid in property other than cash, say Liberty bonds or capital stock of some other corporation. The essential thing is that a liability owing to the taxpayer for the use of its property is being liquidated, and that which is received in liquidation is income. Such is not the case where the taxpayer buys or sells its own stock for cash, for in*1789 neither transaction is there a liquidation of a liability owing to it. *821 It is not shown upon what basis the taxpayer kept its records, but assuming that it was the accrual basis, as is generally true of corporate taxpayers, then upon the court decree being rendered for the taxpayer and the ascertainment of the amount of damages, such amount became immediately accruable as income. The effect of the prevailing opinion is to say that if the taxpayer neglected to enter the receivable as such on its books, but recorded the liquidation of it as a capital stock transaction, there would be no income. Carrying out the idea expressed in the prevailing opinion, a corporation selling a bill of goods at a profit would escape tax on that transaction if it subsequently accepted payment in its own capital stock. The Simmons & Hammond, Farmers Deposit, and Crocker decisions cited are not in point. There the corporations purchased and/or sold for cash their own stock or stock of affiliated companies. In the case of a purchase of its own stock by a corporation for cash, any part of the money so used that represents income has already been taxed in the year in which it was*1790 realized. To state the proposition more specifically: Assume that in 1925 a corporation has cash on hand in the amount of $100,000, and a surplus of equal amount, of which $75,000 represents paid-in surplus and the remaining $25,000 is made up of $15,000 profits earned in 1923 and $10,000 earned in 1924. If in 1925 the corporation expended the entire $100,000 cash for its own stock, quite clearly there would be no tax, for the only thing entering into the transaction that ever represented income, namely the $25,000, was subject to tax in 1923 and 1924 when realized. To make the present case analogous to the cases cited, the property exchanged for the stock must first be taken up on the books of the taxpayer. When this is done such property (i.e. the amount owing to it for royalties or damages as the case may be), becomes income either at the time the amount becomes fixed or when liquidated, depending upon the basis on which the records are kept. This is the point that has been overlooked in the majority opinion. As pointed out above, if the corporation was on the accrual basis, the account receivable became accruable as income when the amount was determined, if on the cash basis, *1791 the receivable became income when it was liquidated whether the liquidation was in cash or property. The real question for decision is whether petitioner realized income as the result of the infringement of its patents and not whether gain or loss may arise out of transactions in capital stock as the case is treated in the majority opinion. If it is once determined that the infringement gave rise to income, it would seem that the only thing remaining to be determined is the amount actually received. The only function that the character of the property has in this determination *822 is to aid in fixing its value. At the present stage of this proceeding we are not concerned with values. MORRIS, MARQUETTE, SMITH, PHILLIPS, and MATTHEWS agree with this dissent.