Gossett v. Commissioner

JAMES P. GOSSETT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. SALLIE BROWN GOSSETT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Gossett v. Commissioner Docket Nos. 43038, 43049. United States Board of Tax Appeals 22 B.T.A. 1279; 1931 BTA LEXIS 1971; April 23, 1931, Promulgated *1971 1. In all cases before the Board, the primary issue is the correctness of the ultimate determination of deficiency, and the usual presumption of correctness of the Commissioner's determination is not destroyed by the reason given, even if it be unsound or badly expressed. 2. Where a corporation, after consummating a sale of its assets under a contract requiring it promptly to take steps to dissolve, declares and pays a dividend many times greater than the usual annual rate from the cash received from the sale, and the evidence clearly indicates that sale, liquidation and dissolution were the dominating considerations from the time the offer to purchase was made and subsequent activities were not in ordinary course of carrying on business for current profit, the distribution will be treated as one in liquidation. 3. The activities of the corporation in disposing of finished goods and goods in process for a brief period after the sale of the other assets, including the purchase and sale of a substantial quantity of new material, were within the contemplation of the agreement to dissolve and were consistent with rather than a departure from the plan of liquidation. 4. Neither*1972 the question whether the particular distribution reduced assets below the par value of outstanding shares - "impaired capital," nor the designation of the distribution in the corporate resolution, is determinative of its character; and the fact that a mere resolution to dissolve is insufficient under the State law to bring about a state of dissolution is not important. 5. The distribution in question was "one of a series in complete cancellation or redemption of all or a portion of [the corporation's] stock," within section 201(h), Revenue Act of 1926. James Craig Peacock, Esq., for the petitioners. Otis J. Tall, Esq., for the respondent. STERNHAGEN *1280 Respondent has asserted against James P. Gossett deficiencies of $302.99 and $595.15 in income taxes for 1925 and 1926, respectively, and against Sallie Brown Gossett a deficiency of $1,789.49 for 1926. In determining these deficiencies he has treated sums received by petitioners from the Brogon Mills on December 21, 1925, as distributions in liquidation involving gain subject to both normal and surtax. Petitioners contend that they were ordinary cash dividends subject only to surtax. *1973 FINDINGS OF FACT. Petitioners are individuals residing at Williamston, S. C. During 1925 they were shareholders in the Brogon Mills, a South Carolina corporation, engaged in the manufacture of two-colored cotton fabrics - flannels and Lad-Lassie cloth. The Mills had then been in existence twenty-five years, and had established certain patterns which were well known in the trade. On September 10, 1925, the board of directors of the Mills passed a resolution calling for a shareholders' meeting to be held on October 13 following, for the purpose of considering certain offers made for the purchase of its assets and also for considering a resolution recommended by the directors authorizing "said Brogon Mills to go into liquidation and wind up its affairs and dissolve." At the same meeting the board of directors voted "that the regular quarterly cash dividend of 2 per cent be paid on October 1, 1925, to all stockholders of record September 25, 1925." The shareholders held a meeting on October 13, 1925, and considered two propositions of the Appleton Company of Massachusetts. The said company offered to purchase for $1,100,000 the buildings, improvements, equipment, "and all*1974 other property of *1281 said Brogon Mills, Inc., real, personal or mixed, both tangible and intangible, excepting only stock in process, manufactured goods, raw cotton, coal and current assets, and registered trade-marks and brands," provided title and possession were transferred on or before November 2, 1925. The offer was made upon the condition and understanding that on acceptance prompt proceedings would be taken for the dissolution of the Mills. The Appleton Company further offered to purchase from the Mills all raw cotton and coal at market price November 2, 1925; to allow the seller to leave its manufactured goods stored free of charge until January 1, 1926; to process for the seller's account and at its expense all unifinished cloth, provided the seller should reduce the stock in process to a minimum before November 2, 1925, and to purchase at an appraised value all dyestuffs and unused supplies which could be used or resold. Both offers were made to and transmitted through the Whitin Machine Works, the Draper Corporation, and Crompton & Knowles Loom Works, shareholders of the Mills. The shareholders duly passed resolutions authorizing the board of directors*1975 to accept both offers in the terms made, and to cause proper deeds and instruments of transfer to be executed. At the same meeting they also resolved as a condition upon which the first two resolutions were passed that it was further understood that the Whitin Machine Works, the Draper Corporation, and Crompton & Knowles Loom Works, referred to as the machinery group of shareholders, would abide by their agreement bearing date September 4, 1925, "that in case the Brogon Mills vote to accept the offer of the Appleton Company as outlined in their letter of August 25, the above three concerns wtll accept in full liquidation of their stock, amounting to 4,306 shares, a figure sufficiently less than a pro rata distribution, to allow the stock held by other persons than the three corporations above named, namely, 8,910 shares, to receive in liquidation the same amount that they would have received if Appleton Company had paid $100,000 more for the physical property than the amount stated in its offer, and the distribution in liquidation had been pro rata to all the shares. And in consideration of this offer it is agreed that the tickets, brands and registered trade-marks of the*1976 Brogon Mills, which are excepted in the offer of the Appleton Company, will be transferred and assigned to us." A fourth and fifth resolution passed at the same meeting were as follows: IV. BE IT RESOLVED, that this corporation be, and same is hereby dissolved, and that the directors be vested with full power to sell and dispose of all property, *1282 pay the debts of this corporation, and distribute any remainder of assets among the stockholders. V. BE IT RESOLVED, that the directors be, and they are hereby authorized, at their discretion, to certify to the Secretary of State the resolution for the dissolution of this corporation, and to surrender the charter. On the same date the board of directors of Brogon Mills passed resolutions, accepting the offers of the Appleton Company and that of the Whitin Machine Works, Draper Corporation, and Crompton & Knowles Loom Works, and authorized the president and treasurer on compliance with the terms of sale to execute the necessary instruments of transfer. On November 2, 1925, the sale was carried out as set forth in the minutes, and the purchase price paid. On December 15, 1925, the Mills' board of directors voted*1977 "that a cash dividend of Fifty Per cent (50%) be paid out of surplus on December 21, 1925, to all stockholders of record on December 15, 1925." When this dividend, totaling $660,800, was declared and paid, the capital stock of the Mills amounted to $1,321,600, divided into shares of the par value of $100. On December 1, 1925, the Mills' books showed a surplus of $831,936.81; on January 1, 1926, a surplus of $135,432.26. In declaring the dividend, the directors were aware of the existence of the substantial surplus. As their respective shares of said dividend James P. Gossett received $3,000 and Sallie Brown Gossett $13,100. When the Mills' plant was taken over by the Appleton Company, the finished goods on hand amounted to $498,349.76. These goods were not included in the sale to said company, and there was an understanding with the largest stockholders that the Mills would continue selling them. This it did until August 31, 1926, through its regular sales connections - some of its customers not knowing that the plant had been sold. The approximate gross sales during the period from October, 1925, to August, 1926, totaled $670,000. The sales were of the finished goods carried*1978 over and also of new goods made from raw materials costing $114,000, and bought to supply the demands of the trade. Arrangements were made to process this new material in the Toxaway Mills, another mill of the Gossett group. During this period, the Brogon Mills had from twenty to forty active employees, including executive officers, sales, and clerical force, and a superintendent for inspection, packing and shipping. The superintendent remained at the old plant until January 1, 1926, when the manufacture of the goods there in process was complete. The Mills' expenses during this period included salaries, wages, purchase of materials, and rents paid the Toxaway Mills. Its *1283 monthly profits averaged $5,000. The minutes of the special meeting of the board of directors on July 22, 1926, contain the following entry: The president then advised the board that, in view of the fact that Lad-Lassie Mills would soon be functioning and would then assume the salaries of all its officers and employees that no further salaries would be paid by Brogon Mills after August 31, 1926. In August, 1926, the business was transferred to a new corporation called the Lad-Lassie Mills, *1979 which continued along the same lines formerly followed by the Brogon Mills. During 1926 the board of directors of the Brogon Mills declared a "liquidating dividend" of $50 a share payable January 25 to all shareholders; of 25 per cent payable March 25 to all shareholders; of 10 per cent payable May 20 to all shareholders; of $10 payable August 2 to shareholders other than the machinery group; of $5 payable December 20 to shareholders other than the machinery group; and in 1929, of $8.23 payable April 1, 1929, to shareholders other than the machinery group; and of $2 payable when available to all. After the declaration of January 2, 1926, of the dividend payable January 25, all shareholders were advised by letter to surrender their stock certificates to the Hanover National Bank of New York City, which was in charge of the disbursement of this and subsequent liquidating dividends. All of said dividends were paid. On December 7, 1927, the "resolution of dissolution was executed" and on December 9, certified to by the Secretary of State of South Carolina. OPINION. STERNHAGEN: By virtue of the directors' resolution of December 15, 1925, the petitioners as shareholders of the*1980 corporation received in 1925, $3,000 and $13,100, respectively, indicating that they were the owners of 60 shares and 262 shares, respectively. The respondent in determining the deficiencies advised each of the petitioners that "Your contention that the dividend received in 1925 from the Brogon Mill was not a liquidating dividend has been denied. You are advised that this office has consistently held that the dividend distributed by the Brogon Mill December 21, 1925, was a liquidating dividend inasmuch as the resolution to dissolve and liquidate the corporation had been previously adopted." The Revenue Act of 1926 governs, Title II thereof being, by section 286, effective January 1, 1925. The controlling sections are sections 201 and 202 and related sections, prescribing in some detail the treatment of distributions by corporations. For present purposes, it is enough to say that dividends as defined are, by section *1284 216, credited for the purpose of normal tax and, therefore, measure only the surtax; while amounts distributed in liquidation are treated as sale price of shares with consequent gain or loss to measure both normal and surtax. The petitioners contend that*1981 the 50 per cent distribution was a dividend in 1925, while respondent defends his determination that this distribution and those subsequently made were in liquidation. We must first dispose of the contention of petitioners that the reason stated by respondent in the notice of deficiency is inadequate to support the determination and that, therefore, the determination is not fortified by the usual presumption of correctness. The respondent held the distribution to be in liquidation "inasmuch as the resolution to dissolve and liquidate had been previously adopted." Petitioner urges that in , the Board held that the prior resolution to dissolve was not controlling of the statutory category of the distribution, and that this takes the ground out from under the determination and deprives the determination of its favorable presumption. The Board has consistently held that the subject matter of the proceeding before it is the tax liability of the petitioner. When a deficiency is determined, the reasons given do not constitute or confine the issues. *1982 . The petitioner may in his petition assail the deficiency for reasons not theretofore suggested and may go so far as thereby to convert the deficiency into an overpayment, and the respondent may, on the other hand, defend on new grounds, and the Board has jurisdiction to increase the deficiency. ; . The primary issue is the correctness of the ultimate determination of deficiency, and the ordinary presumption is not destroyed by the reason given, even if it be unsound or badly expressed. From the evidence it appears clear that sale, liquidation and dissolution were the dominating considerations of the corporation from the time of the offer of the Appleton Company to buy the business. Whatever was done thereafter was not in ordinary course of carrying on the business for current profit. With the acceptance of the offer on October 13, 1925, the program of winding up the business and dissolving the corporation began. The question, however, is whether such general considerations are a*1983 sufficient test of the nature of this distribution. If they are, there can be little doubt that it was a distribution in liquidation, for it was but a step in the process of giving to shareholders the entire assets and ending the business. It was not an ordinary or a regular dividend, *1285 for it exceeded not only the usual annual rate of 8 per cent, but also the entire earnings of the current fiscal period. Nor was it merely an "extra" dividend from enlarged or accumulated earnings, because the fund from which it was paid was the cash received as the sale price of its plant. All of the general circumstances characterize the distribution as one in liquidation. But petitioner argues that there are legal considerations requiring that for our present purpose it be regarded as a dividend not in liquidation. These considerations are, that it is like the dividends in the Guild case, supra, which were held to be not in liquidation, and unlike those in other cases held to be in liquidation; that it did not impair capital and no shares were retired; that it was not called a liquidation distribution although the later ones were; that since the mere resolution to dissolve*1984 is not enough in South Carolina to bring about dissolution, liquidation was not in process. Furthermore, it is argued that this is not such a liquidation distribution as is contemplated by the Revenue Act of 1926, however it might be under the Revenue Act of 1918, involved in prior decisions. The Guild case is, we think, clearly distinguishable. From all the numerous circumstances there in evidence, it was apparent that the intention of 1915 to liquidate and dissolve was later changed, and that at the time of the dividends several years later the corporation was carrying on business for its own sake and earning currently the profits distributed. The dividends were not incidental to a continuing purpose to wind up the business, for the purpose itself was discontinued and business was flourishing. Here the business was sold, there was a continuing purpose to dissolve, and the corporation's activities were at one with this purpose. Although petitioner emphasizes its business in Lad-Lassie cloth over a period of several months, including the purchase and sale of a substantial quantity of new material, we do not regard this as inconsistent with winding up its affairs. It is*1985 palpably different in genesis and scope from the revival of business shown in the Guild case and is not sufficient to indicate a departure from the plan of liquidation. On the contrary, the disposition of finished goods and goods in process was embodied in the contract containing the offer of purchase and the agreement to dissolve and was within the contemplation of the plan. In , the dividend was declared before there was a resolution to dissolve, and the Board held that the inference of an intention to liquidate existing at the time of the dividend was not enough to stamp the dividend as a liquidation distribution. It should be readily apparent that a mere intention to dissolve, before its manifestation, could not be taken as the test. While it *1286 may be fair to say that a dividend declared before the first official step in dissolution will generally be regarded as not in liquidation, such a proposition still leaves open the question whether a subsequent distribution is of one class or the other. The question whether the particular distribution reduced the amount of assets below the par value of outstanding shares - *1986 "impaired capital" - is not determinative of its character. Nor is the corporation's own designation in its resolutions. Here the corporation, being in process of liquidation and dissolution from October 13, 1925, called its first distribution of 50 per cent simply a dividend, while those subsequently declared were called liquidating dividends. It is not stated when these distributions began to invade capital nor is it readily ascertainable from the evidence. If this were decisive, it would require an analysis of asset values to determine the effect of each distribution and consequent controversy far beyond the reasonable intendment of the statute. It would then result that all distributions above the total par value of shares would be taxed as dividends and thus the statute itself would be stultified. Such an interpretation must be rejected, and for the same reason is it immaterial whether at the time of the distribution all or any part of the shares were surrendered or retired. Obviously the South Carolina statute requiring the filing of the resolution with the secretary of state to complete dissolution has no significance in the present issue. The issue here is not whether*1987 dissolution was complete in 1925. Clearly it was not. The issue is only whether the distribution of 1925 is subject to one or the other measure of Federal income tax by reason of the circumstances in which it is found. Furthermore, the decision on that tax question contains no intimation, as petitioners suggest, that the corporation improperly exercised its powers in its declaration or description of the distribution. The petitioners contend that the definition of distribution in liquidation of the Revenue Act of 1926 by its terms excludes the one at bar. We are, however, for reasons already stated, of opinion that the distribution was "one of a series in complete cancellation or redemption of all or a portion of its stock" and, therefore, within section 201(h). This is in harmony with prior decisions. ; ; ; ; ; *1988 ; . A word may be added to demonstrate further that the distribution of 1925 was an intentional part of liquidation. The shareholders *1287 agreed that in liquidation the nonmachinery group of 8,910 shares were to get more than their pro rata share and the machinery group of 4,306 shares were to get less, the measure of the former being a hypothetical sale price of $1,200,000 or $100,000 more than the actual price. Although all the figures for an accurate computation are not in evidence, such as there are indicate to a fair assurance that this plan was fulfilled only by including the December, 1925, distribution among those of the plan of liquidation. Judgment will be entered under Rule 50.