KOCH v. COMMISSIONER

HARRY A. KOCH, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. KOCH v. COMMISSIONER Docket No. 55318. United States Board of Tax Appeals 26 B.T.A. 1025; 1932 BTA LEXIS 1201; September 26, 1932, Promulgated *1201 A redemption in 1928 of stock owned by petitioner held not to have been made under circumstances essentially equivalent to the distribution of a taxable dividend so as to make the whole amount distributed in redemption of the stock taxable as a dividend under the provisions of section 115(g) of the 1928 Act. George E. H. Goodner, Esq., for the petitioner. Lloyd W. Creason, Esq., for the respondent. ARUNDELL *1025 This proceeding involves the redetermination of a deficiency of $1,058.06 in income tax for 1928. The issue is whether the sum of $14,350 received upon the surrender of shares of capital stock is taxable as a dividend. FINDINGS OF FACT. Prior to 1921 the petitioner, a resident of Omaha, Nebraska, and J. H. Friedel were partners, engaged in the insurance business as general agents. On or about January 1, 1921, they and several others organized the Harry A. Koch Company, Inc., to take over the business of the partnership. For the transfer on January 1, 1921, of the assets of the partnership to the corporation, subject to its liabilities, the corporation issue 550 shares of its capital stock, each of the par value of $100, *1202 to the petitioner for his interest in the partnership, and 200 shares to Friedel for his interest. The cost of petitioner's partnership interest was $15,715.12. In 1925, 1926, and 1927 the petitioner made capital contributions of $5,000, $6,600 and $4,800, respectively, to the corporation without receiving any additional stock therefor, making the cost of his 550 shares $32,115.12. Thereafter the corporation sold 138 shares of its stock to employees at par. In some cases notes were received from the employees for the stock, with the understanding that they could be paid out of dividends paid on the stock, plus such additional sums as they could afford to pay. The petitioner has been president of the corporation since its organization. Until some time in 1927 the corporation also was engaged in the investment business. In that year it sustained heavy losses on bonds of the Adair Trust Company of Atlanta, Georgia, which institution failed in April, 1927. At the time of the failure of the Adair Trust Company the corporation owed the First National Bank of Omaha about $149,000 *1026 on loans evidenced by notes guaranteed by the petitioner and Friedel and secured by securities*1203 which had depreciated in value. Subsequently the First National Bank informed the corporation that its financial condition, as disclosed by a statement, was not satisfactory; that a more healthy condition would have to be shown, and that for its purpose it would be sufficient if the corporation's outstanding capital stock were reduced from $88,000 to $50,000. This reduction was accomplished in November, 1928, by the purchase of 220 shares of the petitioner's holdings for $14,350, 80 shares of Friedel's stock for $5,200, and the 88 shares held by several of the employees at par. The purchase price of the stock acquired from the petitioner and Friedel was credited to their personal accounts on the corporate books and the difference between such amounts and the par value of the stock was credited to surplus. The stock of the employees was acquired by surrendering the notes given the corporation in connection with the issuance of the stock. After these transactions were completed, the petitioner held 330 shares, Friedel 120 shares, and the employees, about 11 in number, 50 shares. The reduction of the corporation's capital stock in the manner stated was satisfactory to the First*1204 National Bank and it continued to extend credit to the corporation. At the time the sale was made the financial condition of the corporation was such that it could not pay cash to the petitioner and Friedel for their stock. The amount due the petitioner was liquidated in 1930 by the acceptance at cost to the corporation of securities which had depreciated in value. OPINION. ARUNDELL: The petitioner contends that the transaction giving rise to the controversy is essentially a capital transaction and, accordingly, only the gain realized by him on the stock sale should be taxed. This profit of $1,504.20 he reported as taxable income. The respondent determined in his audit of the return, and still maintains, that the circumstances of the deal are within the provisions of section 115(g) of the Revenue Act of 1928 and a tax should be paid on the whole amount of $14,350 credited to the petitioner's account as a dividend. The petitioner is not making any point of the fact that he did not receive the amount within the taxable year. Section 115(g) of the 1928 Act reads: (g) Redemption of stock. - If a corporation cancels or redeems its stock (whether or not such stock was*1205 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, *1027 to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend. In the case of the cancellation or redemption of stock not issued as a stock dividend this subsection shall apply only if the cancellation or redemption is made after January 1, 1926. The purpose of this provision of the statute is to make futile the employment of a roundabout plan of distributing corporate earnings which, if made as dividends are ordinarily paid, would be taxable. . The stock disposed of by petitioner was acquired in 1921, not as a stock dividend, but by an assignment of his interest in a partnership. After a lapse of almost eight years the corporation saw fit to redeem part of its outstanding capital stock. The purpose is made clear by the evidence. In 1928 the corporation owed the*1206 First National Bank of Omaha about $149,000 on loans. The bank was dissatisfied with the financial statement rendered to support the loan and insisted that it be improved by a reduction of the corporation's outstanding capital stock by $38,000. To comply with this demand, and for no other reason, the corporation adjusted its capital structure in the manner set forth in our findings, which change satisfied the bank in every particular and enabled the corporation to continue its line of credit with the bank. Only the petitioner, Friedel, and several of the minority stockholders participated in the stock redemption. About 11 other stockholders, holding 50 shares, were not parties to the deal. The basis for the redemption was not uniform, the stock of the minority stockholders having been canceled at par, while the credits given the principal stockholders were on the basis of about $65 per share. The financial condition of the corporation at the time of the stock retirement precluded payment of the agreed purchase price of petitioner's stock in cash. The obligation was liquidated two years later by depreciated securities on the basis of cost to the corporation. Hence, there*1207 was neither a stock dividend in the first instance, nor a cash dividend payment in the taxable year. We find nothing in the evidence to bring the transaction within the provisions of section 115(g) of the governing statute. Accordingly, we hold that the petitioner correctly reported the gain realized on the transaction. Decision will be entered under Rule 50.