Edison Sec. Corp. v. Commissioner

EDISON SECURITIES CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Edison Sec. Corp. v. Commissioner Docket No. 52662. United States Board of Tax Appeals 29 B.T.A. 483; 1933 BTA LEXIS 933; December 5, 1933, Promulgated *933 1. Distributions made by a corporation not in excess of earnings held under the circumstances to be ordinary and not liquidating dividends, no dissolution or winding up having at that time been decided upon or definitely planned, and notwithstanding the fact that liquidation had been suggested as a means of resolving a dispute between shareholders, and the fact that a later determination to liquidate and dissolve was carried out. 2. The statutory definition of reorganization is applicable to the events and occurrences therein described and does not embrace mere intends, plans or executory agreements among shareholders. 3. When a statutory reorganization through exchange of shares of one corporation for shares of another is authoritatively determined upon by the corporation which is to acquire voting control of the shares of the other, and promptly carried out by several partial acquisitions, each such partial acquisition may be treated as a step in reorganization and subject to the reorganization provisions of the Revenue Act of 1926. J. Marivin Haynes, Esq., C. J. McGuire, Esq., and James O. Wynn, Esq., for the petitioner. M. B. Leming, Esq., and*934 John R. Gaskins, Esq., for the respondent. STERNHAGEN *483 Respondent determined deficiencies of $10,471.41 and $68,791.31 in petitioner's income taxes for 1925 and 1926, respectively, by treating as a liquidating dividend a distribution made in 1925 by a corporation in which petitioner held stock and by increasing the taxable profit on distributions made in 1926, conceded to be liquidating. Respondent also added to 1926 income profits on exchanges of stock and bonds for stock, bonds, and cash. Petitioner contends that the dividends of 1925 were ordinary in character and that the determined profits in 1926 resulted from a nontaxable reorganization. *484 FINDINGS OF FACT. Petitioner is a corporation, with principal place of business at 120 Broadway, New York City, and is controlled by Eastman, Dillon & Co. 1. During 1925 and 1926 it owned 5,000 shares of the capital stock of Stevens & Wood, Inc., consisting of 3,126 class A shares and 1,874 class B shares, which it had acquired at a cost of $47,500. Stevens & Wood, Inc., was organized in 1922, under the laws of Delaware, to render engineering, construction, and managerial services to public*935 utilities. R. P. Stevens and F. B. Wood, two engineers, were connected with it from the beginning; Eastman, Dillon & Co., one of its organizers, controlled a substantial majority of its stock. After organization, serious disagreements arose between Eastman, Dillon & Co. and Stevens, who was a shareholder, in respect of the corporation's activities. Stevens favored a policy of acquiring properties and undertaking contracts that would require considerable cash, and wished to build up a large surplus for this purpose; Eastman, Dillon & Co. disapproved of this plan. While conducting fruitless negotiations for a working adjustment and for the purchase of petitioner's stock, Stevens organized "Stevens & Wood Company, Incorporated" (later designated "Stevens & Wood, Incorporated"), under the laws of Maryland, in the autumn of 1924, with the idea of conducting his business under that company, and all the stockholders of the Delaware corporation, except the Eastman, Dillon & Co. interests, exchanged their shares for stock in it. It was dormant, however, until June 1925, when Stevens and Eastman, Dillon & Co. settled their differences by an agreement contemplating the liquidation of the*936 Delaware corporation. Prior to that time and on May 7, 1925, Stevens and Freeman, treasurer of the Delaware corporation, called in consultation F. J. Clowes, an accountant, who agreed with them that a distribution of the Delaware corporation's earnings prior to a liquidation was a proper step. On May 12, its president reported to the board of directors that "the corporation had as of April 30, 1925, surplus and net profits available for dividends in the amount of $316,464.39"; a resolution authorizing payment of a dividend of $25 a share on each class of stock, amounting to $282,250, was passed, and petitioner received $125,000 on its 5,000 shares. On May 27 the president reported that surplus and profits in excess of $39,515 were available for dividends; dividends were thereupon declared in this amount at the rate of $3.50 a share on each class of stock, and petitioner received $17,500 as its part. The corporation's earnings accumulated since February 28, 1913, amounted *485 to $314,711.57 on May 1; during May its net income was $11,029.03. Its stock was owned as follows at this period: Class A Class B John J. Beatty (nominee of an Eastman, Dillon partner) [415] 1,251 Stevens & Wood, Inc. (Maryland) 2,084 2,540 Edison Securities Corporation 3,126 1,874 Total shares outstanding 5,625 5,665 *937 On April 27, 1925, Stevens resigned as president and director of the Delaware corporation, and on May 15, 1925, demanded that his name be removed from the corporate title in accordance with his right under a contract of December 20, 1922. At a directors' meeting held May 27 compliance with this demand, which came as a surprise, was postponed for consideration. At the same meeting vacancies caused by the resignations of several directors were filled by men favorable to Stevens. One of those resigning referred in his letter of resignation to two pieces of work in which he considered his participation unnecessary, but offered his services if any unsettled matters should require his attention. Prior to this meeting a dissolution of the Delaware corporation had been suggested among the schemes for settling the disputes, but no agreement to dissolve was reached until thereafter. On June 22, 1925, the directors and stockholders of the Delaware corporation and Stevens & Wood, Inc., of Maryland, subscribed a formal instrument which recited that the Delaware corporation was in liquidation and had ceased business at the end of May 31, 1925, except for the purpose of completing dissolution, *938 and provided for the sale and assignment of its contracts and the properties to the Maryland corporation; trustees were designated to carry out these provisions, which they did. On October 27, 1925, the directors of the Delaware corporation declared a liquidating dividend of $7.50 a share, and on May 12, 1926, another liquidating dividend of $1.50 a share. As its portion of these dividends, petitioner received $37,500 in 1925 and $7,500 in 1926. The minutes of the directors' meeting of October 27, 1925, contain the following entry: The President then reported on the progress in connection with the liquidation of the affairs of the corporation and also presented the audit of Touche, Niven & Company, dated October 21, 1925, covering the books and accounts of Stevens & Wood, Inc., in liquidation for the nine months ended September 30, 1925. Said audit was thereupon discussed and ordered filed with the records in liquidation. The accounting firm's letter transmitting the audit has a comma after liquidation, in line 5. Prior to May 12, 1925, the Delaware*486 corporation had made no distributions which reduced the cost of its stock, and during the period 1923 to 1925*939 all of its gross income was derived from sources within the United States. In computing petitioner's income taxes for 1925 and 1926, respondent treated the four dividends as liquidating. 2. During 1925 and 1926 petitioner owned common and preferred shares of the Republic Railway & Light Co., a New Jersey corporation, which had outstanding 62,050 common and 51,914 preferred shares, both classes having equal voting rights. This corporation had been financed by Eastman, Dillon & Co., with which in 1923 Bonbright & Co. became associated in the financing. In January 1925 a committee headed by Stevens proposed to exchange each of its common shares for two common shares and $25 in bonds of a corporation to be organized under the name of Penn-Ohio Securities Corporation; in this wise the new corporation was expected to acquire the voting control of the Republic Co. But as there were then unpaid accrued dividends on the preferred shares of the latter, Eastman, Dillon & Co., fearing that the preferred shareholders would not be protected, opposed the plan, and finally instructed their attorneys to institute suit to prevent its consummation. On February 28, 1925, the Penn-Ohio Securities*940 Corporation was organized as a holding company under the laws of Delaware. Its authorized capital stock was 124,120 shares without par value. On October 27, 1925, it issued 65,256 of its own shares (in addition to other consideration of an undisclosed character and amount) for 32,628 common shares of Republic. Of the shares so issued Bonbright & Co. received 12,954. The outstanding Republic shares were then held as follows: Common Preferred stock stock Penn-Ohio Corporation 32,628 Petitioner 11,506 9,993 Bonbright & Co 2,312 Others 17,926 39,609 After a year of negotiation the controversy over the plan of the Stevens committee was settled by an agreement between Eastman, Dillon & Co. (acting on its own behalf and as agent for petitioner) and Bonbright & Co., embodied in a letter dated January 29, 1926. In this letter Bonbright & Co. advised Eastman, Dillon & Co. that it had made arrangements to acquire $391,700 face amount of Penn-Ohio 7 percent bonds, 12,954 shares of its common stock at $31.67 a share, and 2,312 shares of preferred at $110 a share. It confirmed *487 a purchase by itself from Eastman, Dillon & Co. of one half*941 of the latter's Republic holdings, or 5,753 shares of common at $90, and 3,840.5 shares of preferred at $110, and its sale to Eastman, Dillon & Co. of one half of the above Penn-Ohio bonds, i.e., $195,850 face value, at par and accrued interest, and 6,477 shares of Penn-Ohio common at $31.67 a share, as a result of which transactions the two interests owned equal amounts of the four types of securities. It was then agreed that upon completion of the foregoing purchases and sales each party would contribute all its holdings, the subjects of the above transactions, to a joint account, and use its best endeavors (A) to have the Republic common shares exchanged each for two common shares of Penn-Ohio and $25 face amount of Penn-Ohio 7 percent bonds; (B) to have Penn-Ohio split its common shares into four for one and offer common shares in an amount sufficient to raise the sums required for items specified below; (C) to have Penn-Ohio call all of its bonds; (D) to have Penn-Ohio exchange its preferred shares for Republic preferred shares, share for share, and pay in cash an amount equivalent to the unpaid back dividend on Republic preferred, which was $34.50 a share; (E) to offer jointly*942 to underwrite the offering of Penn-Ohio common and invite Harper, Turner, and Stevens to take a 20 percent interest in such underwriting. It was further understood that details of the plan could be modified with the approval of the parties' attorneys and that the joint account could be dissolved by either party at any time. On February 1, 1926, in accordance with the recited purchases and sales, petitioner received 6,477 shares of Penn-Ohio common of a total value of $205,126.59; Penn-Ohio bonds of a face value of $195,850, plus interest, making a total of $199,277.38. Petitioner delivered 5,753 shares of Republic common of a total value of $517,770 and 3,840 1/2 shares of Republic preferred of a total value of $422,455. On the same date it received from Bonbright & Co. a check for $535,821.03, representing the difference due it. The accounting entries made upon the books of both Eastman, Dillon & Co. and Bonbright & Co. are similar to numerous other entries which on their face purport to reflect purchases and sales of securities; They are in the form of debits and credits in respect of the blocks of shares and bonds described in the foregoing letter at the prices and amounts*943 therein set forth. The Bonbright books also contain an entry showing the transfer of a check for $535,821.03. The record ownership of the 6,477 Penn-Ohio shares was not changed on the Penn-Ohio books until the certificates were surrendered by petitioner for new shares of Penn-Ohio at the rate of four for one, on May 10, 1926. *488 Petitioner's accounts show that on February 1, 1926, it received 11,506 shares of Penn-Ohio common and $143,825 in face value of Penn-Ohio bonds. On February 3, 1926, Penn-Ohio acquired 12,006 shares of Republic common, which included the 5,753 shares which petitioner had placed in the joint account with Bonbright. On February 4, 1926, the president of Penn-Ohio, after stating that the corporation then owned 70 percent of the common shares of Republic, submitted a plan to the directors, and they resolved (subject to stockholders' approval) to issue and exchange its preferred shares and $34.50 each for preferred shares of Republic; to redeem its outstanding bonds; to split each of its common shares into four and issue 450,000 additional common shares of which five were to be offered at $6.75 each to each holder of an old share. Eastman, *944 Dillon & Co., Bonbright & Co., and Harper & Turner agreed to buy all unaccepted shares at $6.75 in the respective proportions of 40 percent, 40 percent, and 20 percent. This action was approved by the Penn-Ohio stockholders on February 27, 1926, and the corporate charter was amended to authorize the issuance of 51,914 preferred shares and 1,000,000 common shares of stock. On February 19, 1926, petitioner purchased 31 shares of Penn-Ohio common and bonds of a face value of $387.50 for $1,449.25. On March 10, 1926, petitioner received rights to purchase 90,070 shares of the new issue of Penn-Ohio common at $6.75 for $607,972.50. It exercised these rights on March 30, 1926, delivering in part payment the Penn-Ohio bonds which it then owned and which had a value with accrued interest of $349,902, these bonds being redeemable. On March 30, 1926, it exchanged its 6,152 1/2 shares of Republic preferred for 6,153 shares of Penn-Ohio preferred (paying $42.13 for the extra half share) and $34.50 a share, or a total of $212,278.50, the amount of unpaid dividends on its Republic preferred. On April 3, 1926, Penn-Ohio secured voting control of the Republic Co., acquiring its stock as*945 follows: Preferred Common stock stock October 25, 1925 32,628 February 3, 1926 12,006 February 16, 1926 [366] March 30, 1926 6,153 April 3, 1926 23,060 April 5 to 12, 1926 12,549 On April 5, 1926 petitioner purchased 14,239 shares of Penn-Ohio new common for $217,613.25. On April 15 and May 12 it exchanged its 18,014 shares of Penn-Ohio old common for 72,056 shares of new common. *489 In its income tax return for 1926 petitioner reported a profit of $212,278.50 on the exchange of 6,153 preferred shares of Republic for 6,153 preferred shares of Penn-Ohio, and a profit of $204,290.24 on the sale of "$340,062.50 Penn-Ohio Securities Co. 7 per cent bonds." Respondent determined that petitioner realized the following gains: 1. Sale of 5,753 Republic common, costing $154,031.59 and 3,840 1/2 Republic preferred, costing $226,608.70 $380,840.29 For 6,477 Penn-Ohio common, $205,126.56, Penn-Ohio bonds (redeemed), $195,850.00 and $539,248.40 cash 940,225.00 Profit $559,584.71 2. Exchange of 5,753 Republic common, costing $173,162.19 for 11,506 Penn-Ohio shares, $364,395.02 and bonds, $143,825 143,825.00 Proportionate value of bonds 49,005.00 Taxable profit on redeemed bonds 94,820.00 3. Exchange of Republic preferred for Penn-Ohio preferredplus $34.50. Value of pfd. received $70. Taxable profit limited to $34.50 per share 212,278.50 Total profit 866,683.21 *946 OPINION. STERNHAGEN: 1. In our opinion, the distributions of May 12, 1925, and May 27, 1925, made by Stevens & Wood, Inc., of Delaware, were dividends and not distributions in liquidation, both in fact and in the contemplation of the statute. At the time they were declared by the corporation, no dissolution of the corporation or winding up of the business had been decided upon or definitely planned. The mere fact that liquidation had been suggested as one method of resolving the dispute between shareholder interests does not stamp the distribution as one in liquidation. We have found no case to support such a view. The decisions in Gossett v. Commissioner, 59 Fed.(2d) 365, and Tootle v. Commissioner, 58 Fed.(2d) 576, relied upon by respondent, disclosed clear evidence that the distributions were made as part of a plan theretofore clearly manifested to wind up and dissolve. Here no such plan took shape until after these distributions of surplus. After the determination to liquidate and dissolve, the distributions of October 1925 and May 1926 were clearly in liquidation; but these are not contested by the petitioner. We think that*947 neither the statement of Clowes nor the ambiguous punctuation in the minutes relating to the Touche, Niven audit points *490 to liquidation; and if they did, they would be of too little weight to control the determination of the character of the distribution. 2. (a) The petitioner contends that what it received in 1926 because of its ownership of Republic shares was the result of a transaction in a statutory reorganization, and that the recognition of gain is forbidden by section 203(b)(2), Revenue Act of 1926. The major premise of its argument is that the entire sequence of events constitutes a reorganization, and that its tax is determinable by a comparison of its position at the end with its position at the beginning. In its return and in this proceeding, it has not adhered consistently to this broad concept; but this is not important if the proposition itself is sound. In our opinion, there is no warrant in the statute for such a wide and formless concept of reorganization. Cf. Robert D. Green,24 B.T.A. 719. In considering the several subdivisions of section 203, from (a) to (g), which lay down the rules for the recognition of gain or loss and*948 its extent, the first inquiry is not whether there has been an intent, purpose, or plan to reorganize, but whether there has been a "reorganization" as defined in subdivision (h). It is only after the situation is found to be a reorganization within subdivision (h), that the preceding subdivisions, withholding the recognition of gain or loss in reorganization transactions, require examination. When this is understood, it becomes plain that the words "plan of reorganization" found in some of the subdivisions preceding (h) are not the dominating words which give character to the situation itself, but are words of limitation upon the recognition of gain or loss. Where the expression "plan of reorganization" appears, its effect is not to broaden the definition of (h), but to confine the nonrecognition of gain or loss to such transactions as are pursuant to the plan as well as part of the consummated statutory reorganization itself, and, in a proper case, by a party to the reorganization. Thus the scheme of the statute preserves the full effect of all its terms and phrases, while otherwise the integrity of the definition in (h) would be lost. *949 The definition in (h), broad as it is (cf. Pinellas Ice & Cold Storage Co. v. Commissioner,287 U.S. 462; Cortland Specialty Co. v. Commissioner, 60 Fed.(2d) 937; certiorari denied, 288 U.S. 599), is by its terms clearly restricted to actual events and occurrences, and does not embrace mere intents, plans or executory agreements. It is the merger or consolidation, the acquisition, the transfer, and not the plan or agreement, with which the definition deals. This definition, so confined, is hard enough at best to apply, as the numerous decisions and extensive literature on the subject will testify; but the difficulties would be multiplied and unduly try the powers of administration if, by interpretation, the scope of the definition were so broadened *491 as to embrace a mere plan. This involves no question of liberal or strict construction, since every interpretation which is liberal to him who realizes gain is harsh to one who realizes loss. At what stage would a plan come within the statute? If there should be several plans of, say, conflicting interests, which would the statute recognize? In the present case, the*950 original Stevens plan was to be available "to a limited number of stockholders." Although the new corporation was formed in 1925 as a step in the Stevens plan, and in 1925 received a comparatively small part of the Republic shares from Bonbright, the Stevens plan was frustrated, and a substantially different plan was formulated in 1926. Clearly, there was no reorganization in 1925, notwithstanding the existence of a "plan" and its partial realization. The petitioner contends that the mutual transactions set forth in the Bonbright letter of January 29, 1926, and carried out on February 1, 1926, constituted an exchange in reorganization within subdivision (b)(2). This can not be sustained. At that time there was no reorganization. If it be said that there was a plan, and that the transaction was in pursuance thereof, still there was no statutory reorganization and hence no statutory party to a reorganization the stock or securities of which were transferred or received. The petitioner does not specify which of the parts of the disjunctive definition of (h) is applicable, and we are unable to bring it within (A), (B), (C), or (D). The transaction was between two large shareholders*951 and was, as the Bonbright letter called it, a purchase and sale by each of some of the shares which each owned, with the necessary transfer of cash. The fact that it was preliminary to their mutual promises, looking to a further promotion of a plan to have the Republic shares controlled through the Penn-Ohio corporation, does not give it the character of a reorganization. It was a separate and complete transaction, E. F. Simms,28 B.T.A. 988. But if it were a reorganization within subdivision (h), and could be regarded as an exchange, the transaction of February 1, 1926, set forth in the Bonbright letter, would not be covered by subdivision (b)(2) and thus free from present tax, but would be within subdivision (d)(1) in case of gain or subdivision (f) in case of loss, for money was received as well as securities. That need not, however, be determined, since the transaction was not an exchange, but a group of sales and purchases, each for a fixed price. Cf. Sarther Grocery Co.,22 B.T.A. 1273. This is what the contracting parties intended, as manifested by their express language, and it is the way they both accounted for the transaction on their*952 books. There is no evidence to the contrary. While the effect may have been similar to that of an outright exchange, the liability is fixed by *492 the legal character of what was done and not by its practical effect, United States v. Phellis,257 U.S. 156; E. F. Simms, supra.The nature of the transaction as a sale is not affected by a fixed obligation to use the proceeds in an agreed way, Sarther Grocery Co. v. Commissioner, 63 Fed.(2d) 68; Clemmons v. Commissioner, 54 Fed.(2d) 209; Lonsdale v. Commissioner, 32 Fed.(2d) 537; Detroit Egg Biscuit & Specialty Co.,9 B.T.A. 1365, or, a fortiori, by the conditional or tentative obligation which petitioner assumed in respect of the joint account and the underwriting of the Penn-Ohio proposed new common. It is held, therefore, that the petitioner's income for 1926 includes the gain derived from the sale to Bonbright of 5,753 shares of Republic common and 3,840 1/2 shares of Republic preferred. (b) This must likewise be true as to the transaction in February consisting of the disposition by petitioner of*953 the 5,753 shares of Republic common and the acquisition of 11,506 shares of Penn-Ohio common. It is difficult from the facts available in this record to determine just what happened and when. The Commissioner determined that this was an exchange by the petitioner, and this determination is presumptively correct and must be adopted as the fact unless the evidence is otherwise. We can not say that the evidence overwhelms the presumption, although it leaves the details of this transaction in confusion. It is, however, clear that this transaction must have occurred prior to the plan suggested by the president of the Penn-Ohio corporation on February 4 for securing control of the Republic preferred, without which there could be no voting control. Apparently, as a step in the "endeavors" undertaken in the Bonbright letter, the shares of Republic common which were iv the joint account were delivered to Penn-Ohio for double the number of Penn-Ohio common plus bonds at the rate of $25 per share. The Penn-Ohio corporation did this apparently upon the same authority as that upon which in October 1925 it issued its 65,256 shares "and other consideration" for 32,628 shares of Republic common. *954 Thus it stands with no greater significance as a part of a statutory reorganization than did the earlier issue, and not pursuant to an authoritative plan of reorganization but to the same undefinitive plan of two minority, although substantial, shareholders. Unless, therefore, this transaction is to have its statutory character held in suspense until some future events occur to determine whether any statutory reorganization is in process, and then is to be retrospectively recognized as part of such reorganization, there is still no such reorganization, no merger or consolidation, and no acquisition by Penn-Ohio of a majority of the outstanding 113,964 shares of voting stock of Republic. *493 As above indicated, the statute does not, as a general proposition, require that whenever a reorganization is found to have at some time occurred, all transactions in the shares before and after shall be embraced within the reorganization, so that losses and gains may not be recognized. Such a rule would be impracticable and should not be adopted unless fairly required by the statute. A loose construction of the reorganization provisions would promote confusion rather than certainty, *955 and if uniformly applied, as any rule should be, it would work as harshly in one case as it would liberally in another. The provisions are available to all according to their terms, and if one fails to bring himself within them his tax must be determined by the general method, Sarther Grocery Co., supra. The February transaction, which the respondent has called an exchange, is a fully taxable transaction. Within the limits of the deficiency already determined, since no increase was claimed or pleaded, the determination is sustained. (c) When the exchange of March 30 occurred, the petitioner giving 6,152 1/2 shares of Republic preferred and $42.13 for 6,153 shares of Penn-Ohio preferred and $212,278.50, this was but a step in the acquisition by Penn-Ohio of voting control of Republic, and this was an exchange by petitioner in pursuance of the very plan for such acquisition and consequent reorganization. While it was not the culminating acquisition which determined the control, it was indubitably a part of the reorganization which at that time was definitively planned and had been approved by the Penn-Ohio shareholders on February 27. Given a clear and authoritative plan*956 by one corporation to acquire stock control of another in an arrangement which partakes of the nature of a merger or consolidation, it is not essential that the acquisition be in a single transaction. While preliminary or casual acquisitions of less than a majority are not within the reorganization, those which are directly related to the process of deliberately acquiring control must be held to be so. In our opinion, therefore, this transaction would, were it not for the $212,278.50 received in money, have been within section 203(b)(2), and there was, in accordance with section 203(d)(1), recognizable gain limited by the $212,278.50. Reviewed by the Board. Judgment will be entered under Rule 50.