Rorimer v. Commissioner

LOUIS RORIMER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Rorimer v. Commissioner Docket No. 58850. United States Board of Tax Appeals 27 B.T.A. 871; 1933 BTA LEXIS 1287; March 7, 1933, Promulgated *1287 Held, that the redemption of certain stock in question was not made at such time and in such manner as to make it, in whole or in part, essentially equivalent to the distribution of a taxable dividend. H. A. Mihills, C.P.A., for the petitioner. Hartford Allen, Esq., and E. A. Beck, Esq., for the respondent. VAN FOSSAN *872 This proceeding was brought for the redetermination of a deficiency in income tax for the year 1927 amounted to $4,100. The issue is whether or not the total amount received by the petitioner in that year upon the redemption of certain shares of the preferred stock of the Rorimer-Brooks Studios Company is taxable income. FINDINGS OF FACT. The petitioner is a resident of Cleveland, Ohio, and during the years 1917 to 1927, inclusive, was the president and principal stockholder of the Rorimer-Brooks Studios Company, hereinafter called the corporation. This corporation had been operating more than seven years prior to 1917. It was engaged in the business of interior decorating, including the setting of fabrics, rugs, carpets and furniture, and the manufacture of furniture for residences, hotels and clubs. It*1288 was a close corporation and was capitalized in the sum of $50,000, consisting of 500 shares of common stock of a par value of $100 each. On February 6, 1917, at a meeting of the directors of the corporation the following motion, among others, was adopted: On motion duly made, seconded and carried the Treasurer was instructed to pay a dividend of 80 per cent on capital stock, payable at the convenience of the Treasurer. Stockholders of December 31, 1916 participating. At the date of the foregoing declaration of a cash dividend the corporation was in a prosperous condition. At about that time it was engaged in decorating and furnishing one of the Statler hotels. This operation involved a large cash outlay and large credit obligations. The directors, therefore, desired to conserve the corporation's cash reserves. For that reason the cash dividend declared on February 6, 1917, which was payable at the convenience of the treasurer, was not paid immediately. At a meeting of the directors of the corporation held November 26, 1917, the following statement was made and the following resolution adopted: Mr. Webster stated that by reason of the fact that there was due to stockholders, *1289 on account of a dividend declared February 6th 1917 amounting to Forty Thousand Dollars ($40,000.00) which has not been paid, but was credited to them on special dividend accounts, and as there was also due to Mr. Louis Rorheimer 1 on his personal account, an amount exceeding Ten Thousand Dollars ($10,000.00) it being deemed best to keep the money in the business, he offered the following resolution, and moved its adoption: RESOLVED, That the capital stock of said, The Rorheimer-Brooks Studios Company be and the same is hereby increased from Fifty Thousand Dollars ($50,000.00) to One Hundred Thousand Dollars ($100,000.00) *873 and that Fifty Thousand Dollars ($50,000.00) of said increase be issued and disposed of as preferred stock, in Five Hundred (500) Shares of One Hundred Dollars ($100.00) each and that the holders thereof be entitled to receive a dividend on said preferred stock of seven per cent, per annum, payable out of the surplus profits of the Company for each year, in preference to all other stockholders, and such dividends shall be cumulative. Such preferred stock may be redeemed*1290 at not less than par at the time and price hereby fixed, and to be also expressed in the stock certificates thereof: to-wit: I. The preferred stock or any part thereof may be redeemed in the discretion and at the option of the Board of Directors, upon sixty-(60) days written notice to such effect to the preferred stockholders of record, at par and accumulated dividends. II. The holders of the preferred stock shall further be entitled, in case of the insolvency, liquidation or dissolution of the Company, or the sale of all its assets, or in any distribution of its assets other than by way of dividends from surplus profits arising from the conduct of its business, to be paid the full face value of their shares of preferred stock and all accumulated dividends after the payment or the making of adequate provision for the payment of the liabilities of the Company, and before any amount shall be paid to the holders of the preferred stock the remaining After such payment to the holders of the preferred stock the remaining assets of the Company shall belong to and be divided among the holders of the Common stock. And further, that the President and Secretary of said Company be instructed*1291 to file a certificate of such increase with the Secretary of State. The new preferred stock was distributed to the stockholders as of December 5, 1917. Thereupon the petitioner purchased from the other stockholders for $4,640 all of their preferred stock so issued and the following entries were made upon the books of the corporation to record the complete transaction as to the preferred stock: [1917] Dec. 5 L. Rorimer $4,640.00 To record sale of Preferred stock distributed as a dividend W. H. Webster $4,000.00 A. Stearn 80.00 R. W. Irvin 400.00 E. H. Brooks 80.00 F. C. Adams 80.00 Dec. 5 L. Rorimer (Personal a/c) 10,000.00 L. Rorimer (Dividend a/c) 35,360.00 W. H. Webster (Dividend a/c) 4,000.00 A. Stearn (Dividend a/c) 80.00 R. W. Irvin (Dividend a/c) 400.00 E. H. Brooks (Dividend a/c) 80.00 F. C. Adams (Dividend a/c) 80.00 To record issue of Preferred stock in payment of dividends declared Feb. 6, 1917 and not heretofore paid as deemed desirable to retain money in the business Preferred stock "Unissued" $50,000.00 As a result of the transaction so recorded the petitioner became the owner of all the 500 shares of preferred*1292 stock issued pursuant to *874 the resolution of November 26, 1917, 100 shares being issued to him on account of the $10,000 owed to him by the corporation; 353-6/10 shares being issued to him as a stock dividend and 46-4/10 shares having been purchased by him from other stockholders at par. At a meeting of the directors of the corporation held March 17, 1920, the following resolution was adopted: RESOLVED that the capital stock of the Rorimer-Brooks Studios Company be and the same is hereby increased from $100,000.00 to $150,000.00 and that $50,000.00 of said increase be issued and disposed of as preferred stock, in 500 shares of $100.00 each and that the holders thereof be entitled to receive a dividend on said preferred stock of seven percent, per annum, payable out of the surplus profits of the Company for each year, in preference to all other stockholders, and such dividends shall be cumulative. Such preferred stock may be redeemed at not less than par at the time and price hereby fixed, and to be also expressed in the stock certificates thereof, to wit: I. The preferred stock or any part thereof may be redeemed in the discretion and at the option of the Board*1293 of Directors, upon sixty (60) days written notice to such effect to the preferred stockholders of record, at par and accumulated dividends. II. The holders of the preferred stock shall further be entitled, in case of the insolvency, liquidation or dissolution of the Company, or the sale of all its assets, or in any distribution of its assets other than by way of dividends from surplus profits arising from the conduct of its business, to be paid the full face value of their shares of preferred stock and all accumulated dividends after the payment or the making of adequate provision for the payment of the liabilities of the Company, and before any amount shall be paid to the holders of the common stock. After such payment to the holders of the preferred stock the remaining assets of the Company shall belong to and be divided among the holders of the common stock. And further, that the President and Secretary of said Company be instructed to file a certificate of such increase with the Secretary of State. Forty thousand dollars of the $50,000 additional preferred stock authorized by the resolution of March 17, 1920, were issued as a stock dividend and distributed to the stockholders*1294 of the corporation. It appears by entries on the corporation's books that as a result of the distribution the petitioner acquired 288 shares of this issue of preferred stock. In February, 1925, the petitioner purchased from William H. Webster, the vice president and one of the stockholders of the corporation, for a cash consideration of $8,000, 80 shares of the preferred stock which had been issued to the latter pursuant to the resolution of March 17, 1920. At a meeting of the directors of the corporation held September 4, 1924, the following proceedings were had: On motion duly made by W. H. Webster, seconded by R. W. Irvin that a 10% dividend be declared on the common stock, paid at the convenience of the Treasurer, the same was put and carried by unanimous vote. *875 A discussion followed, regarding the Preferred stock which was issued to Louis Rorimer in 1917 in lieu of moneys owed him for salary and commissions, and it was decided upon motion made by W. H. Webster, seconded by R. W. Irvin that the Treasurer be instructed to retire all the Preferred stock as speedily as possible, as our available surplus funds would permit, preference to be given to the retirement*1295 of preferred stock issued to Louis Rorimer. The motion was regularly put and carried by unanimous vote. The clause in the motion above set forth giving preference to the retirement of the preferred stock owned by the petitioner was inserted therein because of the thought of the other officers of the company that since the petitioner was the largest stockholder of the corporation it might be an embarrassment to them if anything happened to him and they were compelled to take over his preferred stock. They, therefore, decided to redeem it as rapidly as the company's finances would permit. One hundred shares of the preferred stock owned by the petitioner were redeemed by the corporation in 1924 and 400 shares of his preferred stock were redeemed in 1925. In this latter year eight shares of the corporation's preferred stock owned by minority stockholders were also redeemed. Two hundred of the 500 shares of preferred stock redeemed in 1924 and 1925 were acquired by the petitioner as a stock dividend in 1920. The other 300 so redeemed were acquired as at December 5, 1917, 87-84/100 shares thereof having been purchased by the petitioner for cash and 212-16/100 shares thereof having*1296 been acquired as a stock dividend. On February 15, 1927, by resolution of the board of directors the corporation declared a further stock dividend of 11-2/10 per cent on its common stock. On April 1, 1927, 150 shares of preferred stock (Certificate No. 70) were issued to the petitioner. W. H. Webster, vice president, also received 150 shares of preferred stock at this time (Certificate No. 69). The preferred stock issued on April 1, 1927, was so issued to reimburse the petitioner and Webster for common stock surrendered by them to the company for reissuance to certain employees of the corporation as a bonus. On January 1, 1917, the corporation's cash on hand amounted to $18,442.08; on November 30, 1917, its amount was $15,441.17; on September 30, 1920, it had cash on hand in the sum of $9,179.07; on March 31, 1927, $70,489; and on September 30, 1927, $74,110.26. The corporation's surplus on January 31, 1917, amounted to $99,261.70; on November 30, 1917, its surplus was $148,150.21; on September 30, 1920, $212,321.45; on March 31, 1927, $287,844.75; and on September 30, 1927, $421,326.91. In 1926 the corporation's net income was $52,347.89. In 1927 the net income was $279,158.56*1297 and in 1928 the net income was $207,185.33. *876 Dividends of 7 per cent per annum were paid in cash on preferred stock from 1918 to 1927, inclusive. Dividends were paid on the common stock of the corporation as follows: Year Per cent [1917] None. [1920] None. [1922] None. [1923] 16 1/2 [71] On October 1, 1927, the corporation redeemed 285 shares of the petitioner's preferred stock for cash at par. The book entries showing the retirement of this stock and also the retirement of 50 shares owned by W. H. Webster are as follows: OCTOBER 1927 Debit Credit Oct. 1. Preferred stock-treasury $28,500.00 Retiring preferred stock #100 - 58 shares 96 - 142 shares 88 - 80 shares 80 - 5 shares = 285 shares Louis Rorimer $28,500.00 Oct. 1. Preferred - treasury 5,000.00 Retiring preferred stock Cert. No. 70 - 50 shares W. H. Webster 5,000.00 Of the 285 shares redeemed and retired in 1927 58-56/10 shares were purchased for cash in 1917 at par; 80 shares were purchased for cash at par in 1925; 141-44/100 shares were received as a stock dividend as at December 5, 1917, and*1298 5 were received in 1920 as a stock dividend. It is stipulated that in the event it should be held that the redemption transaction in 1927 was in the nature of a sale, the allocated cost basis of the 146-44/100 shares received as stock dividends was $10,438.30. All of the preferred stock dividends were declared on a pro rata basis. The corporation had not liquidated and was still in existence at the date of the hearing herein. In his income tax return for 1927 the petitioner reported cash dividends on the common stock of the corporation in the total sum of $83,890. In the notice of deficiency the respondent conceded that the cost of 80 shares of preferred stock of the corporation purchased by the petitioner in 1925 for $8,000 should be deducted from the total amount received upon the redemption of 285 shares in 1927 and that the purchase and redemption of the 80 shares involved no taxable *877 gain. The respondent held that the sum of $20,500 received upon the redemption of the remaining 205 shares is taxable income under the provisions of section 201(g) of the Revenue Act of 1926. At the hearing he stipulated in effect that 58-56/100 shares of such 205 shares*1299 were purchased by the petitioner for the sum of $5,856 and that the purchase and retirement of these 58-56/100 shares involve no taxable gain. OPINION. VAN FOSSAN: The issue is whether or not the amount of $14,644 received by the petitioner upon the redemption in 1927 of 144-64/100 shares of the preferred stock of the Rorimer-Brooks Studios Company, which were issued to him as stock dividends in 1917 and 1920, is taxable as income under the provisions of section 201(g) of the Revenue Act of 1926. The petitioner contends that as a result of the redemption he realized a gain of $4,205.70 which is taxable as a capital gain for the reason that the stock was held by him for more than two years. The parties have stipulated to the effect that if the petitioner's contention prevails in this proceeding the taxable gain is $4,205.70. Section 201(g) of the Revenue Act of 1926 reads as follows: 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*1300 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. In the case of the cancellation or redemption of stock not issued as a stock dividend this subdivision shall apply only if the cancellation or redemption is made after January 1, 1926. The preferred stock here involved was admittedly issued to the petitioner as stock dividends in 1917 and 1920 and the redemption was effected after January 1, 1926. Consequently the question for determination is whether the redemption of the stock in 1927, under the circumstances set out in the findings of fact, was "at such time and in such manner" as to make the amount paid by the corporation essentially equivalent to the payment of a taxable dividend. We have heretofore considered the principles underlying the provisions of section 201(g) and the manner of their application. ; ; *1301 ; ; . In , we stated that the purpose of the quoted provisions of the statute "is to make futile the employment of a roundabout plan of distributing *878 corporate earnings which, if made as dividends are ordinarily paid, would be taxable." In , we said: While the obvious device, by a close corporation having a surplus, consisting of an expansion of capitalization, a stock issue and stock redemption, all within a short time pursuant to a unified plan, is plainly within the statute (see C.B. VIII-2, p. 133), the flexible language of the provision makes it clear also that its burdens were not to be imposed arbitrarily (see C. B. VI-2, p. 14). As the taxpayer may not, in view of this statute, avoid the tax by an artificial device of empty forms, cf. , so the Government may not, under this statute, impose a tax merely because there has been a stock redemption, where the circumstances are free from artifice and beyond the terms*1302 and fair intendment of the provision. Of course, where the language of the statute is specific and inelastic there is no room for avoiding its effect, whatever the inconsistency with the general purpose as disclosed by later enactments, cf. ; but, generally speaking, the provisions should be treated as special and applied to promote its special purpose (see ). This proceeding is distinguished from , in which we held that the existence of a relationship between the issuance and redemption of stock, evidencing a continuing unified plan to distribute surplus, is not the sole test to be applied in determining whether or not a distribution coupled with a redemption or cancellation of stock is equivalent to the distribution of a taxable dividend. We said that: "We must also scrutinize the redemption and distribution with respect to the time and manner when they occur and the circumstances surrounding them at that time." In that proceeding preferred stock was redeemed and canceled at a time when it was supplanted simultaneously in the capital*1303 structure of the corporation by a like amount of common stock. Consequently, the corporation's liability upon its outstanding capital stock was unchanged in amount because of the transaction. We, therefore, held that this fact, coupled with the existence at that time of accumulated undivided earnings available for the payment of a dividend, brought the redemption and cancellation within the provisions of section 201(g). Manifestly, the facts in the present proceeding are not such as to bring it within the purview of our decision in In the present proceeding the respondent concedes in his brief that there was no premeditated plan or artifice on the part of petitioner in connection with the entire transaction and that the element of tax avoidance or evasion is not present. That petitioner was motivated in all respects by a perfectly lawful purpose adequately appears from our findings of fact. The redemption and retirement of the stock worked a reduction in the capital structure. The 285 shares of stock redeemed in 1927, included 58-56/100 shares bought *879 from other stockholders at par in 1917; 80 shares similarly acquired*1304 in 1925; 141-44/100 shares received as a stock dividend in 1917 and 5 shares likewise received in 1920. There is no evidence of a subsequent reissuance of all or any part of this stock. We find nothing in the present proceeding to distinguish it essentially from , and We, therefore, hold that the redemption in question was not made at such time and in such manner as to make it "in whole or in part essentially equivalent to the distribution of a taxable dividend." The petitioner owned the stock redeemed for more than two years. His gain is, therefore, taxable as a capital gain, amounting to the sum stipulated. Decision will be entered under Rule 50. Footnotes 1. The name of petitioner was legally changed from Rorheimer to Rorimer. ↩