Mackay v. Commissioner

HATTIE W. MACKAY, EXECUTRIX, ESTATE OF WALTER S. MACKAY, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. SHIRLAW W. MACKAY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. HATTIE W. MACKAY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Mackay v. Commissioner Docket Nos. 56914-56916. United States Board of Tax Appeals 29 B.T.A. 1090; 1934 BTA LEXIS 1431; February 13, 1934, Promulgated *1431 A corporation agreed to sell two separate groups of assets theretofore used in its manufacturing business at a price fixed for each group and thereafter declared a dividend in kind, payable by transferring one of such groups to its stockholders. Held, that the stockholders received the agreed purchase price for such assets and not the book value thereof as a taxable dividend. William M. Maxwell, Esq., for the petitioners. Deam P. Kimball, Esq., for the respondent. LANSDON *1090 The respondent has determined deficiencies for the year 1928 in the respective amounts of $4,040.72, $26.12, and $2,387.70. The only issue is whether certain amounts received by the petitioners from the sale of assets alleged to have been distributed to them as a dividend in kind, by a corporation in which each was a stockholder, were, in fact, distributions by the corporation taxable to the recipients at surtax rates. The three proceedings have been consolidated for hearing and report. FINDINGS OF FACT. The petitioners are individuals residing at Oakland, California. In the taxable year each was a stockholder of the California Bag & Paper Co., hereinafter*1432 called the corporation. In the taxable year the corporation had authorized and outstanding stock of the par value of $300,000, divided into 3,000 shares of the par value of $100 each and held as follows: Estate of Walter S. Mackay, 1,322 shares; Shirlaw W. Mackay, 120 shares; Hattie W. Mackay, 928 shares; Hawley Pulp & Paper Co., 600 shares; David Johns, 25 shares; C. E. Swick, 2 shares; Jeannette T. Mackay, W. P. Hawley, and W. P. Hawley, Jr., each one share. Except the Hawley Pulp & Paper Co., all the shareholders were members of the Mackay family or employees of the corporation. Something like two months before September 14, 1928, Shirlaw W. Mackay, general manager of the corporation, and representatives of the St. Helens Paper Co., hereinafter called St. Helens, an Oregon corporation, began negotiations for the sale of the assets of the corporation to St. Helens. Such negotiations resulted in an agreement as to price prior to said date in the amount of $332,125.31, payable *1091 in two amounts, viz., $182,125.31 directly to the corporation for certain inventories at cost, and $150,000 to the stockholders of the corporation for a body of assets of the book value of*1433 $84,705.31. On September 14, 1928, the directors of the corporation declared a dividend in kind, payable to its stockholders of that date, by distribution to them as an undivided whole of certain equipment that it then owned, together with "patents, patent application and any and all good will, processes, formulae, and all personal property of every kind and description used, or intended to be used in connection with the paper bag factory and paper bag factory's formulae belonging to the California Bag and Paper Company." The property so distributed was carried on the books of the corporation at its depreciated cost of $84,705.31, but its fair market value at that date was $150,000, the amount for which the corporation prior thereto had agreed to sell to St. Helens. The stockholders of the corporation gave a joint receipt for the dividend in kind which summarized the assets distributed to them as follows: All paper bag making machines and accessories and spare parts, line transmission, machine pulleys, machine beiting, electric motors, electric switches, power feed wiring and conduits, printing presses, bag bundling presses, all repair shop tools, factory and office furniture*1434 and fixtures, motor trucks, mechanical lift trucks, truck platforms and separator boards; all patents or patent applications and any and all good will, processes, formulae, and all personal property of every kind and description used or intended to be used in connection with the paper bag factory and paper bag factory business formerly belonging to the California Bag & Paper Company, and by it declared as a dividend in kind to its stockholders, by resolution of its Board of Directors made on the 14th day of September 1928. At the date of such distribution the books of the corporation disclosed earned surplus and undistributed profits in the amount of $81,697.47. At the same meeting on September 14 the directors of the corporation authorized the sale of certain other of its asetes to St. Helens, and ordered that the corporation's manufacturing operations cease at noon on September 15, that salaries of all officers should terminate as of that date, and that its function as a selling agency for the Graham Paper Co. should end 30 days thereafter, with the payment of all amounts due by such company to the corporation for the sale of bags up to December 12. On September 15, 1928, the*1435 corporation executed the agreement to sell to St. Helens, for $182,125.31, all personal property described as follows: All wrapping paper, twine, paper bags, flour, starch, dextrine, ink, labels, and any and all materials used in or intended for use in the manufacture of paper bags, whether the same be located at the factory or plant of the California Bag and Paper Company in Emeryville, California, or elsewhere, and including all paper bags belonging to California Bag & Paper Company *1092 now located at Oregon City, Oregon, and including all property of the California Bag and Paper Company of the character above set forth and of which the California Bag and paper Company is the owner at 12 O'clock Noon on September 15, 1928. On September 15 all the stockholders of the corporation executed a contract to sell all the property alleged to have been distributed to them as a dividend in kind to St. Helens for $150,000, and the transfer of such property to the purchaser was evidenced by a bill of sale signed by each of them. The amount of $150,000 duly received for the assets sold as above stated was ratably distributed to the stockholders of the corporation and in such distribution*1436 the estate of Walter S. Mackay, Hattie W. Mackay, and Shirlaw W. Mackay received the respective amounts of $66,100, $46,400, and $6,000. The assets sold for $182,125.31 were included in the inventory of the corporation at that amount and the sale thereof resulted in no profit or addition to corporate surplus. The assets covered by the resolution of distribution were sold at a price in excess of book value in the amount of $65,294.69, which was properly chargeable to surplus when realized. In their respective income tax returns for the year 1928, each petitioner reported a ratable share of $84,705.31 as dividends from a domestic corporation and the difference between that amount and $150,000 as a nontaxable return of capital. Upon audit the Commissioner held that the entire amount of $150,000 should be regarded as dividends and determined the deficiencies here in controversy. OPINION. LANSDON: The real issue here is whether the California Bag & Paper Co. sold both groups of assets in question. If there was such a sale prior to September 14, 1928, the profit realized was that of the corporation, and, added to book surplus as of that date, it was almost sufficient to distribute*1437 a dividend out of earnings accumulated after March 1, 1913, as determined by the respondent. The petitioners contend that the corporation declared and distributed a dividend in kind to them, consisting of the group of assets that had a book value of $84,705.31, and that they sold such assets on the next day to St. Helens for $150,000. Comparison of the diverse contentions of the parties discloses that each is asking us to look through the form of the corporate and other acts by which the assets involved were finally passed to the purchaser for a price agreed to before any procedure to minimize Federal income taxes and to base our conclusions on the substance of what was actually done. The respondent ignores the terms of the resolution of distribution and argues that prior to its adoption by the *1093 directors the group of assets in question had already been sold by the corporation and so were not available for distribution in kind on September 14, 1928. Upon this theory he asks us to determine that dividends in the amount of $150,000 were received by the petitioners and that their ratable parts thereof are taxable at surtax rates provided in the Revenue Act of 1928. To*1438 affirm his determination we must hold that the corporation realized a profit from the sale in the amount of the difference between the book value of the assets and $150,000 and that such profit, plus surplus at date of sale, was available for distribution as dividends on September 14, 1928. It is somewhat difficult to determine the real contentions of the petitioners. They plead (1) that the Commissioner erroneously failed to recognize the distribution of assets of the book value of $84,705.31 as a tax-free distribution of capital under the provisions of section 115(d) of the Revenue Act of 1928, 1 (2) that he erroneously held that all of such distribution was taxable as dividends, and (3) that he erroneously failed to recognize and adopt the findings of an internal revenue agent allowing an overassessment to each of the petitioners in certain specified amounts. It is perfectly clear that these allegations are inconsistent with the facts relied on by the petitioners. Only one dividend was declared on September 14 and that in terms was the book value of the assets in question in the amount of $84,705.31. On that date the corporation had surplus available for dividends in the*1439 amount of $81,697.47 and therefore capital could not have been included in the distribution in excess of $3,007.84. To bring this contention within the provisions upon which they rely the petitioners include appreciation or depreciation reserves in the amount of $65,294.69 and thereby in their view of the facts increase the distribution to $150,000. The resolution, however, provides for the distribution of only $84,705.31, practically all of which could be paid out of surplus. It is clear, therefore, that petitioners are asking us to look through the form of the resolution and determine its real substance as something quite different. *1440 If the terms of the corporate and other acts under review are literally applied, the petitioners received a body of assets as a dividend in kind valued by the resolution at $84,705.31 and on the next day sold the same property for $150,000 and realized a gain, after one day of ownership, in the amount of $65,294.69. It thus appears *1094 that petitioners are foreclosed from any attempt to have us hold that the nature of all the transactions of September 14 and 15 is clearly shown by the form thereof, unless they are willing to pay both normal and surtaxes on the profit clearly indicated by the procedure adopted. The record discloses that negotiations for the sale in question were begun some two months before the corporate and other acts of September 14, 1928. Such negotiations resulted in a complete meeting of the minds of the seller and purchaser. There was an agreement as to price and it was understood that as a matter of form the purchaser would pay $182,125.31 directly to the seller and the remaining $150,000 to the stockholders thereof. On the morning of September 14 it remained only to embody the terms arrived at by negotiation into corporate and other acts necessary*1441 to effect the transfer of the assets to the buyer. The assets sold to St. Helens did not include all the property of the corporation. It retained some valuable real estate and all its accounts receivable. The combined value of the retained property and the selling price of the assets purchased by St. Helens exceeded the cost of all the corporation property by an amount which counsel for petitioners admit was between $60,000 and $70,000. Since there is no evidence on this point, it may have been much more. It was obvious, therefore, that a direct sale would result in a substantial tax liability against the corporation. Admittedly, upon the advice of counsel, the procedure on September 14 and 15 was for the purpose of reducing such liability to a minimum. In , the court, in reference to a similar contention but involving the taxability of the profits realized from a sale, said: "Such anticipatory arrangements and contracts, intended to circumvent the taxing statutes, are not looked upon with favor", and cited *1442 ; and ; certiorari denied, . It is plain, therefore, that such arrangements must be carefully scrutinized and approved only when their facts show beyond any doubt that the purposes thereof have been legally accomplished. In our opinion the plans adopted failed to accomplish their purpose for the reason that all the assets in question had been sold before the alleged distribution. It follows, therefore, that the amount of $150,000 was not in fact received by the stockholders from St. Helens, but from the corporation. On September 14 the corporation had already sold such assets to St. Helens for $150,000 and the distribution in fact was in that amount instead of in the book value of $84,705.31 and included profit from the sale properly chargeable to *1095 surplus in the amount of $65,294.69, which, in addition to the book value of $84,705.31, was at once available for distribution as earnings or surplus accumulated after March 1, 1913. On very similar facts in *1443 , we decided that assets alleged to have been distributed to the stockholders of a corporation in liquidation were in fact sold by the corporation to which the profits of the sale therefrom accrued. This result was affirmed by the United States Circuit Court of Appeals for the Fifth Circuit in ; certiorari denied, . See also ; ; affd., ; ; affd., ; On brief petitioners argue that the cases cited and relied on by the respondent are not in point, since they relate to profits realized by a corporation and taxable to it as such and have no bearing here, where the Commissioner seeks to tax after distribution to the stockholders. This argument is not convincing. In each of the cited cases the question was whether the profit was realized by the corporation or*1444 by someone to whom the assets had been transferred in some fashion by the corporation after sale had actually been accomplished. In each instance if the property was actually sold by the corporation the realized profit was an addition to the surplus and available for distribution of dividends. In such a situation it is obvious that the profit realized by the corporation is taxable to it and that distributions of such profit from surplus are taxable to the stockholders at surtax rates as ordinary dividends. On their face the facts here indicate that the distribution of $150,000 was made from surplus and capital in the respective amounts of $146,992.16 and $3,007.84, but, even if section 115(d) of the Revenue Act of 1928 is applicable to the lesser amount, there is no evidence of the basic cost of the shares of stock which may be reduced to that extent, or that the remaining assets of the corporation were not, in fact, equal to the par value of all its outstanding capital stock. In addition to their contention as to the nature of the transaction involved, the petitioners also plead that the failure of the Commissioner to approve and adopt the findings of a revenue agent allowing*1445 each of them an overpayment of taxes in 1928 was erroneous. This allegation of error is not argued in their brief, but the record does not show that it has been abandoned. It is without merit. . The determinations of the respondent are affirmed. Reviewed by the Board. Decision will be entered for the respondent. Footnotes 1. SEC. 115. (d) Other distributions from capital.↩ - If any distribution (not in partial or complete liquidation) made by a corporation to its shareholders is not out of increase in value of property accrued before March 1, 1913, and is not out of earnings or profits, then the amount of such distribution shall be applied against and reduce the basis of the stock provided in section 113, and if in excess of such basis, such excess shall be taxable in the same manner as a gain from the sale or exchange of property. The provisions of this subsection shall also apply to distributions from depletion reserves based on the discovery value of mines.