Salt Lake Hardware Co. v. Commissioner

SALT LAKE HARDWARE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Salt Lake Hardware Co. v. Commissioner Docket Nos. 46911, 56901. United States Board of Tax Appeals 27 B.T.A. 482; 1932 BTA LEXIS 1059; December 30, 1932, Promulgated *1059 1. Petitioner, a domestic corporation, received from another domestic corporation stock dividends which were later redeemed at par for cash. Held, such redemption was not equivalent to the distribution of taxable dividends under section 201(g) of the Revenue Act of 1926. Held, further, the amounts paid to redeem the stock constituted amounts distributed in partial liquidation, under section 201(c) and (h) of the Revenue Act of 1926. 2. Respondent's determination of the basic value of the stock sustained. Paul E. Shorb, Esq., and Harold C. Anderson, C.P.A., for the petitioner. Frank B. Schlosser, Esq., for the respondent. MARQUETTE *483 These proceedings, which were consolidated for hearing, are for the redetermination of deficiencies in income taxes asserted by the respondent for the years 1926 and 1927 in the amounts of $1,399.90 and $1,484.58, respectively. It is alleged that respondent erred in determining that retirements of preferred stock of another company, issued to petitioner as stock dividends, resulted in taxable income to petitioner. At the hearing it was further contended that respondent erred in basing the*1060 value of the preferred stock so retired upon the March 1, 1913, value of the common stock of the same company. Respondent contended that his computation of the basic value of the preferred stock was incorrect and made claim for any increased deficiency which might result from the Board's decision respecting the correct valuation. FINDINGS OF FACT. Petitioner is a corporation. During the year 1909 it purchased 2,000 shares of the common stock of the Strevell-Paterson Hardware Company, all the outstanding capital stock, at a cost of $219,564.73. The par value was $200,000. Subsequently in that year the Strevell-Paterson Hardware Company issued to petitioner 500 shares of common stock as a stock dividend. That company has continued in business up to the present and no liquidation has ever been contemplated. Petitioner owned the 2,500 shares of common stock on December 31, 1912, and on March 1, 1913. The Strevell-Paterson Company paid cash dividends on its stock amounting to $20,000 in 1909, $25,000 in 1911, and $15,000 in 1912. Both companies are domestic corporations, located in Salt Lake City, Utah. In addition to its outstanding capital stock, the liabilities of*1061 the Strevell-Paterson Company at the close of each year from 1908 to 1913, and interest paid, were as follows: Year Accounts payable Notes payable Interest paid [1908] $12,422.01 $135,000 [1909] 10,940.52 167,500 $11,446.50 [1910] 24,293.20 108,500 12,318.54 [1911] 17,050.24 110,000 10,465.47 [1912] 29,248.53 130,000 10,212.79 [1913] 24,736.41 120,000 12,347.55 *484 Exclusive of any good will, the Strevell-Paterson Company's books showed, as of December 31: Year Shares of stock outstanding Surplus [1912] 250,000 $59,483.61 [1916] 250,000 142,144.43 1 250,000 [1919] 2 60,000 229,092.94 The earnings of the Strevell-Paterson Hardware Company, according to its books, from 1909 to 1916, were: [1909] $28,016.44 [1910] 24,050.51 [1911] 18,024.91 [1912] 33,056.30 [1913] $32,409.17 [1914] 30,771.78 [1915] 42,596.36 [1916] 99,383.51 On January 30, 1917, the Strevell-Paterson Company declared and issued to petitioner a stock dividend of 600 shares of 7 per cent preferred stock of the par value of $60,000. On January 2, 1920, it declared and issued to petitioner another*1062 stock dividend of 900 shares of 7 per cent preferred stock, par value $90,000. All of the preferred stock so issued was authorized but not issued or outstanding on March 1, 1913. Although the Strevell-Paterson Company had sufficient surplus with which it might have paid each dividend in cash, the other method was adopted, first, to keep the surplus cash available for growth of the business and, second, to stimulate the managers of the business to greater efforts for earning larger dividends. It was fully intended, at the times the preferred stocks were issued, to retire them just as soon as the company's cash account justified such action. On or about April 23, 1926, the 600 shares issued in 1917 were redeemed and retired by the payment of $60,000 to petitioner. On March 31, 1927, 400 shares of the stock dividend issued in 1920 were redeemed and retired by the payment of $40,000 to petitioner. Seven per cent dividends have always been promptly paid on the preferred stock since its issuance. The Strevell Company was organized, under another name, in the year 1890. Its reputation and standing in its community and in trade circles were high. By March 1, 1913, it had acquired*1063 substantial good will, but that was not carried on the books of the company at any amount. When the preferred shares were issued in 1917 and 1920 they were worth somewhat more than par. Prior to and including the year 1922 the petitioner and the Strevell-Paterson Hardware Company filed consolidated income tax returns. *485 That practice was discontinued after 1922 and petitioner's returns thereafter did not include the income or deductions of any other company with which it may have been affiliated. In determining the deficiencies in question the respondent treated the amounts paid to redeem the Strevell-Paterson Company's preferred stock as distributions in partial liquidation, and in computing taxable gain from the redemption of this stock he used the following values as shown by the books of that company as of December 31, 1912 (the nearest balance sheet to March 1, 1913): capital stock, $250,000; surplus, $59,483.61; total, $309,483.61. As the book value of the Strevell-Paterson Company at the close of 1916 was: capital stock, $250,000; surplus, $142,144.13, he found that the preferred stock dividend of 600 shares issued in January, 1917, was worth par, $60,000. *1064 He then used the following computations: Mar. 1, 1913, value of 2,500 shares common stock $309,483.61 83.761% Par value of 600 shares preferred stock, January, 1917 60,000.00 16.239% 100% * * * Per share. 2,500 shares common stock 83.761% of $309,483.61 = $259,226.57, or $103.69 600 shares preferred stock 16.239% of $309,483.61 = $50,257.04, or $83.76 * * * Realized in 1926, par value of 600 shares preferred stock $60,000.00 Cost, as determined above 50,257.04 Taxable gain 9,742.96 By the same method respondent determined the cost to petitioner of the 900 shares of preferred stock dividend issued in 1920 to be $74.25 per share, with a resulting taxable gain of $10,300 on 400 shares redeemed in 1927. OPINION. MARQUETTE: The petitioner contends that the payment to it of $60,000 in 1926 and of $40,000 in 1927, in redemption of preferred stock issued as dividends, was "essentially equivalent to the distribution of taxable dividends" under section 201(g) of the Revenue Act of 1926. If that contention is correct, then such dividends are not taxable income to the petitioner by virtue of section 234(a)(6) *1065 of the act. The respondent takes the position that, as dividends received by a corporation are not taxable as such, therefore the term "taxable dividend" as used in section 201(g) was not intended to apply to corporate stockholders. Respondent further contends that the payments *486 in question constitute "amounts distributed in partial liquidation" under section 201(c) and (h) of the Revenue Act of 1926. The statutes in question, so far as here applicable, read as follows: Sec. 201. (c) * * * 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 202 * * *. Sec. 201. (h) 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. Sec. 201. (g) If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and*1066 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. * * * Not all dividend distributions come within the purview of the section quoted. It applies only to "taxable dividends," that is, such dividends as are subject to income tax. It can not apply in the case before us, for the reason that both petitioner and the Strevell-Paterson Hardware Company are domestic corporations and dividends received by one from the other are not taxable, under section 234(a)(6) of the Revenue Act of 1926. Petitioner argues that, as there was never any intention to liquidate the Strevell-Paterson Company, payments by that company in redemption of part of its stock can not be considered as a partial liquidation under section 201(c) and (h), supra. That argument can have persuasive force only by using the word "liquidation" in the sense of winding up the affairs of the company. *1067 Admittedly, that is the usual meaning given to the word. But here we can not ignore the fact that Congress has established a different meaning for income tax purposes. As set forth in the statute, section 201, supra, a partial liquidation takes place whenever a corporation distributes money or assets in complete cancellation or redemption of a part of its capital stock. No particular portion is mentioned, nor is the word "part" in any way limited. Whether the amount so redeemed be all of a series or class, or only a part thereof, apparently makes no difference under the definition adopted by Congress. Subdivision (h) is supplemental to subdivision (c) of section 201, which provides that amounts so distributed are to be considered as payments in exchange for the stock, upon which gain or loss to the stockholder is to be determined. It is our opinion that the payments here involved *487 constitute distributions in partial liquidation within the meaning of the Revenue Act of 1926. What, then, is the proper basis upon which to determine the amount of gain or loss resulting from those transactions? Section 204(a) of the Revenue Act of 1926 provides: The basis for*1068 determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property, * * * Then follow a number of exceptions, none of which apply here. Subdivision (b) of the section reads: The basis for determining the gain or loss from the sale or other disposition of property acquired before March 1, 1913, shall be (A) the cost of such property * * * or (B) the fair market value of such property as of March 1, 1913, whichever is greater. * * * The parties agree that the fair market value as of March 1, 1913, is the proper basis for determining gain or loss. Respondent has taken the book value of the common stock as of March 1, 1913, as being the fair market value on that date. Although good will does not appear on the books as an asset item, respondent has considered it in his computations to the extent of offsetting probable shrinkage of asset values in the event of dissolution. Petitioner does not challenge the accuracy of the computations, but insists that the method is wrong and that Strevell-Paterson Company preferred stock, if issued March 1, 1913, would have been worth par on the market. To support*1069 that contention several witnesses testified that in their opinions the preferred stock would have been worth par if issued March 1, 1913. All of those witnesses, except two, are or have been officers of either the petitioner or the Strevell-Paterson Company. The other two were experienced bankers in Salt Lake City, but their opinions were in response to hypothetical questions which did not include any detail of assets nor of accounts respecting their fluid condition. With all due respect to their opinions, we do not consider them sufficient, under the circumstances, to overthrow the presumption that respondent's determination is correct. But we are not impressed with his argument that the basic value of the preferred stock should be further depressed by using the surplus of December 31, 1916, and of December 31, 1919, to increase the value of the common stock. We therefore sustain that determination as set forth in the deficiency notices. Reviewed by the Board. Decision will be entered for the respondent. Footnotes 1. Common. ↩ 2. Preferred. ↩