Iverson v. Commissioner

RUPHANE B. IVERSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. I. C. IVERSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Iverson v. Commissioner Docket Nos. 48837, 48838. United States Board of Tax Appeals 29 B.T.A. 863; 1934 BTA LEXIS 1470; January 23, 1934, Promulgated *1470 1. During the taxable year a corporation of which I. C. Iverson was the sole stockholder made certain payments. Part of these were made directly to him and part of them were made to a bank, but all of them were applied toward the payment of the purchase price of certain stock in the corporation which Iverson had acquired from a former stockholder. Held, that under the circumstances here presented such payments constituted taxable dividends. 2. Respondent's determination of penalty not sustained. Harry Ballinger, Esq., for the petitioners. Nathan Gammon, Esq., for the respondent. TRAMMELL *864 These proceedings, which were consolidated for hearing, are for the redetermination of a deficiency in income tax for 1926 in the amount of $767.56 in the case of Ruphane B. Iverson, and in the case of I. C. Iverson of a deficiency in income tax of $770.09 for the same year as well as a 50 percent penalty of $385.04. The questions presented for determination are: (1) The correctness of the respondent's action in including in the taxable income of each of the petitioners, who are husband and wife and residents of the State of Washington, the*1471 amount of $22,950.11 as dividends from a corporation in which I. C. Iverson was a stockholder, and (2) the determination of a penalty against I. C. Iverson. FINDINGS OF FACT. The petitioners are husband and wife and residents of Hobart, Washington. All their property at the times herein mentioned was community property under the laws of Washington. About the end of 1898 petitioner I. C. Iverson, hereinafter referred to as Iverson, purchased a shingle mill which he had theretofore operated on a rental basis. Being without funds he entered into a partnership with W. W. Wood, hereinafter referred to as Wood, for the conduct of a logging and lumbering business, each partner haing an equal interest in the enterprise. About 1905 a corporation known as Wood & Iverson, Inc., was organized under the laws of Washington for taking over and conducting the business theretofore carried on by the partnership. The corporation's capital stock consisted of 100,000 shares of a par value of $1 each. Wood and Iverson each owned 50,000 shares. The corporation prospered and in 1925 owned a sawmill and equipment, a logging railroad, logging equipment, a store and about 200,000,000 feet of timber, *1472 all of an estimated value of $1,120,000. For about a year prior to the spring of 1925 the relations between Wood and Iverson, who were managing the affairs of the corporation, began to become unpleasant and by May 1925 had reached the point where it was necessary for one of them to cease his connection with the corporation. As a result of negotiations between them, they entered into an agreement on May 19, 1925, which is incorporated in its entirety in these findings by reference. By this agreement Wood sold, conveyed, and set over his 50,000 shares of stock in the corporation to Iverson for $560,000, of which $60,000 was cash and the balance was to be paid in monthly installments with interest thereon. The installment payments were to be made on the 15th of each month and were to be measured by the amount of timber of the corporation at $2 per thousand feet sawed or cut and sold during the first year and contingently during the second year and at $3 per thousand feet *865 for the third and succeeding years. There were also provisions for the discontinuance of interest and for the suspension of payments of principal upon the happening of certain specified contingencies. *1473 Under the agreement Iverson did not undertake in any event to keep the operation of the corporation going and installment payments were not required to be made unless logs were sawed or sold. Iverson had the right to accelerated such payments if he desired. Under the agreement and pending full payment of the purchase price to Wood, Iverson's salary was not to be unreasonably increased over the then present amount nor was any officer or employee to receive a salary out of propertion to the services rendered. The business affairs of the corporation were to be conducted along the same lines of general policy as theretofore, with certain qualifications. Without the consent of Wood the property of the corporation was not to be encumbered, and, except to acquire lumber in the regular course of business, the corporation was not to borrow money nor create indebtedness in any material amount nor sell any substantial assets without his consent. Contemporaneously with the execution of the agreement Wood delivered his stock in the corporation to Iverson and Iverson caused to be executed in his own favor a certificate for one half of all of the capital stock of the corporation which he*1474 endorsed in blank and, together with an original copy of the agreement, deposited with the Dexter-Horton National Bank of Seattle as escrow agent. The charges of the escrow agent were to be paid equally by Iverson and Wood; Upon completion of the payment of $560,000 to Wood with interest as provided in the contract, the certificate of stock was to be delivered back to Iverson by the escrow agent. Upon Iverson's failure to make such payment and after default for a specified period Wood was, upon demand, to receive the stock from the escrow agent, with the right at once to be elected trustee of the corporation and the right to nominate one half of the board of trustees if the number exceeded two. In such event the agreement thereby was to be terminated and all money theretofore paid thereunder to be forfeited to Wood as liquidated damages, but in such event Wood was not to have any personal claim against Iverson for any unpaid balance of the purchase price. Pending final payment to Wood the corporation was not to declare any dividends beyond such amounts as were required to enable Iverson to make the payments due to Wood under the contract and the taxes arising to him as a result*1475 of the declaration of such dividends. During the period the stock was to be in the hands of the escrow agent, Iverson had the right to vote it and to receive all dividends thereon. During 1925 the corporation declared dividends amounting to $102,600.67, all of which were paid by check to Iverson except one *866 for $32,000 which, at his direction, was drawn directly to Wood. The checks drawn to Iverson were endorsed by him, delivered to the bank as escrow agent, and paid to Wood. Iverson and his wife returned and paid taxes on the dividends of $102,600.67 received from the corporation in 1925. About June or July 1925 Wood consulted a certified public accountant in Washington, D.C., respecting his income tax liability arising from the agreement of May 19, 1925. The accountant advised him that the payments being made to him by Iverson constituted a liquidation of the corporation; that the matter had not been properly handled; that it could be fixed so that Iverson would not be liable for any taxes on the money he paid to Wood under the agreement and informed him that he would be in Seattle that summer on other business and would get in touch with Iverson at that time. *1476 Upon his return to Seattle, wood told Iverson of what the accountant had advised him. Late in the summer of 1925 the accountant came to Seattle and discussed the matter with Iverson and his (Iverson's) attorney. The accountant advised Iverson that by having the corporation take over the contract between him and Wood, Iverson would not be liable for any tax on the payments made to Wood. Iverson's attorney concurred in the advice given by the accountant. It was agreed at that time that effective as of the first of 1926 an assignment of the contract of May 19, 1925, would be made to the corporation. At a special meeting of the trustees of the corporation, consisting of Iverson and his son, held on January 3, 1926, there was adopted a resolution accepting Iverson's offer to assign his interest under the contract to the corporation in consideration of the corporation undertaking to perform according to its terms and without the corporation binding itself further than Iverson had bound himself thereby. On the same day Iverson in his individual capacity, and he and his son as president and secretary, respectively, of the corporation, executed an instrument which provided in part*1477 as follows: Whereas first party (Iverson) on the 19th day of May, 1925 entered into a contract with W. W. Wood whereby he agreed to purchase from the said W. W. Wood 50,000 shares of the stock of the second party (Wood & Iverson Inc.) for the sum of $560,000 upon which contract the balance owing his been reduced to $472,092.29, now therefore in consideration of the payment of the sum of One Dollar by party of the second part to party of the first, the receipt of which is acknowledged and of the promise of the party of the second part to perform the said agreement according to its terms does hereby assign over unto the said second party all of his rights under and by virtue of the said contract, and agrees that when the said stock shall have been released from escrow that he will endorse the same over unto the said second party. *867 During 1926 the corporation declared and paid no dividends eo nomine. However, during the year it issued checks as follows which were applied on the purchase price of the stock held by the bank: Jan. 14, 1926 $3,104.96 Feb. 22, 1926 11,679.00 Mar. 16, 1926 3,908.64 Apr. 14, 1926 3,918.28 May 14, 1926 10,818.87 June 15, 1926 3,676.32 July 14, 1926 4,396.11 Aug. 14, 1926 10,082.20 Sept. 15, 1926 3,791.40 Oct. 11, 1926 3,509.61 Nov. 15, 1926 10,267.95 Dec. 15, 1926 4,034.55 Total $73,187.89 *1478 The checks issued down through July 14, 1926, totaling $41,502.18, were made payable to Iverson and were endorsed by him for deposit in the escrow account with the bank. The remainder of the checks were made payable to the bank for deposit in the escrow account. Of the Twelve checks issued by the corporation during the year, eight were signed by Iverson as president, and of the seven issued down to and including July 15, 1926, four were signed by him. The corporation is still in existence and owns property. On the total amount of $73,187.89 paid by the corporation as indicated above, the respondent determined that $45,900.22 constituted dividends paid to Iverson. One half of that amount, or $22,950.11, he allocated to and included in the income of each of the petitioners in determining the deficiencies in controversy. With respect to Iverson the respondent also determined theat there was a penalty of 50 percent, or $385.04, under section 275(b) of the Revenue Act of 1926. OPINION. TRAMMELL: The only assignment of error contained in the petitions is as follows: The Commissioner has erroneously included in gross income - as dividends received from a domestic corporation*1479 - moneys paid to one William W. Wood for the purchase by the said corporation of stock owned by the said william w. Wood. In support of their position the petitioners contend that it was the intention of Wood and Iverson in entering into the agreement of May 19, 1925, to liquidate one half of all the property of the corporation and to make payment of the value thereof to Wood. They also urge that the resolution of the board of trustees providing for the corporation's taking over of the agreement from Iverson and his assignment *868 of his interest thereunder to the corporation was intended to make it more apparent that no profit had accrued or would accrue to Iverson under the agreement. The respondent contends that the payments made by the corporation and applied on the purchase price of Wood's stock were not made in liquidation of the corporation's assets; that the attempted assignment from Iverson to the corporation of his agreement with Wood respecting the purchasing of the stock was illegal, invalid, and ineffective for Federal income tax purposes; and that the payments made by the corporation and applied on the purchase price of Wood's stock were constructive dividends*1480 to Iverson. In 1925 the relations between Iverson and Wood became so strained that it was necessary for one of them to terminate his connection with the corporation. After negotiations between them the agreement of May 19, 1925, was entered into, whereby Iverson purchased Wood's one half of the capital stock of the corporation for $560,000, or an amount equal to one half of the estimated value of the corporation's total assets at that time. Neither Iverson nor the corporation had available any large amount of money; consequently, the agreement, after providing for an initial cash payment of about one tenth of the purchase price, provided for monthly payments to be measured at certain amounts per thousand feet of the corporation's timber sawed and cut or sold. Relying on this situation and the provision for monthly payments in the agreement, together with other portions thereof, the petitioners insist that the intent of the agreement was merely to liquidate one half of the corporation's assets and to turn the value thereof over to Wood. We are unable to accept this contention of the petitioners. The agreement of May 19, 1925, took the form of and was a purchase and sale. The*1481 amount to be paid for the stock was definitely fixed at $560,000 and was not subject to revision either upwards or downwards, irrespective of an increase or decrease in the price of the corporation's products. The stock was actually delivered to Iverson and transferred to his name on the books of the corporation. With the exception of the possession of the certificate of the stock, he exercised practically all the rights of ownership therein, including the voting of it. Although the stock was placed in escrow pending the performance of the terms of the agreement of May 19, 1925, Iverson could, at any time he paid the balance due on the purchase price, take the stock out of escrow and do what he pleased with it. Nowhere in the record is there anything to indicate that the parties intended to liquidate the affairs of the corporation or in any wise reduce its capitalization as would be consistent with the contention advanced here by the petitioners. While the agreement placed certain restraints upon Iverson with respect to the disposition of the *869 receipts of the corporation, such restraints apparently were intended to prevent Iverson, as sole stockholder and manager of*1482 the corporation, from squandering or diverting its assets into other channels prior to the time he had completed payment for the stock. These restraints are in no wise inconsistent with the view of a purchase and sale of the stock. So far as we are able to determine from the record the agreement of May 19, 1925, was one whereby Wood sold his stock to Iverson, and not one whereby the parties sought to effect a partial liquidation of the corporation. There is nothing to indicate but that all payments made upon the purchase price of the stock, either in 1925 or 1926, were made out of earnings of the corporation for the current years. Having reached the conclusion that the agreement of May 19, 1925, was a sale by Wood of his stock to Iverson, we will consider the effect of the resolution of the trustees of the corporation of January 3, 1926, respecting the acquisition by the corporation of Iverson's rights thereunder and of his purported assignment of that date of his rights under the contract. While the statutes of Washington permit a corporation to own shares of stock in another corporation (par. 3810, Remington's Compiled Statutes of Washington, 1922), we do not find nor has*1483 the petitioner called our attention to anything contained therein authorizing a corporation to purchase or deal in shares of its own stock. In fact the decisions of the Supreme Court of Washington are to the contrary. In ; , it was contended that the bylaws of a corporation, as well as the agreement between it and a certain stockholder, gave the corporation the right to purchase the stock from the stockholder. The court said: Viewing these by-law and contract provisions as assuming to give to the company the right to purchase the stock for itself, as their terms plainly indicate, they are void, because a corporation organized under the laws of this state has no right or power to purchase its own stock. It was squarely so held by this court in , in which decision the subject was exhaustively reviewed. In the light of the decisions of the Supreme Court of Washington, the instrument of January 3, 1926, executed by Iverson and the corporation by which he purported to assign to*1484 the corporation the right to acquire the 50,000 shares of its stock then in escrow was void, since the corporation was without power to acquire its own stock. As a consequence Iverson did not transfer anything to the corporation by the assignment and it never received anything from him as a result thereof. During 1926 the corporation did not formally declare any dividends; however, it issued checks totaling $73,187.89 which were applied *870 either directly by it or through Iverson on the purchase price of the stock Iverson had purchased from Wood. The respondent has determined that $45,900.22 of that amount constituted dividends paid to Iverson. Why he did not determine that the full amount was dividends is not disclosed by the record. But be that as it may, we are called upon to pass upon his action as to the amount determined to be dividends. Of the amount in controversy $41,502.18 represents checks issued and payable to Iverson, while the remainder of the checks were issued by the corporation and were payable to the bank which was holding the stock. The amount in controversy represents the payments made by the corporation to its sole stockholder and payments made*1485 by it in his behalf. While these payments were not made pursuant to formal declarations of dividends, as were the payments made in 1925, we think, however, that under the circumstances here presented they were none the less dividends in so far as Iverson was concerned. Iverson was the recipient of part of them from the corporation and was the sole beneficiary of the others. It is clear that they were not intended as loans to him. In our opinion they fall within the same class as withdrawals made by a sole or dominant stockholder, which have been held to be taxable as dividends. ; affd., ; ; . In view of the foregoing and inasmuch as there is nothing to indicate that the amount in controversy was not paid from earnings subsequent to March 1, 1913, the action of the respondent in determining that such amount constituted dividends to Iverson is approved. On the question of fraud, it is our opinion that the evidence is not sufficient to warrant the imposition of the penalty. Reviewed by the Board. *1486 Decision for the respondent for the amount of the deficiencies without penalty will be entered. SEAWELL SEAWELL, dissenting: I find myself unable to agree with the majority opinion. I think a closer scrutiny of the case will show nothing more than an awkward attempt between two honest but uninformed men, acting under poor advice, to sever the joint ownership of property which their toil had built up, in a way to leave each in possession and ownership of his own part. A superficial view of the case shows only the method used by them; a deeper view discloses the true intent and purpose to do that which no statute ever intended or attempted to tax. *871 The stock of the corporation was held in equal moieties by Wood and Iverson. Personal differences between the two stockholders made their separation advisable. But separation of the property, principally standing trees, was not a simple matter like dividing personal property between two individuals. Standing timber is real estate and is partitioned like land. Value for sawmill purposes of a tract of timber may be materially lessened by a division; and a quick sale for partition of such a large holding, *1487 estimated at two hundred million feet, could not reasonably have been made without much sacrifice of value. Trees severed from the land and manufactured into lumber become personal property. Considering the situation as the evidence pictures it to me, the natural thing for the two men, in their perplexity, to have done was to convert enough of their assets into liquid form to compensate one of them for his interest, leaving the other to proceed with the remaining assets as he might see fit. This is what I understand the two men undertook to do. Wood's interest in the corporate property was adjudged between them to be one half the book value of the assets, or $560,000. If he received that much out of the assets, he should no longer claim an interest in the corporation or its property. Iverson had no money with which to buy Wood's stock and in that way retain the whole property for himself, and he never agreed to undertake to do so, as will appear when the contract is held and considered by its four corners. Iverson was willing to and did agree to cause the corporation to convert timber into lumber and it into money to be distributed through him to Wood until Wood's interest should*1488 be thereby wholly withdrawn from the corporation and Iverson should be, in the process, left the owner, through his stock in the corporation, of its remaining assets. Iverson further agreed that he would forego all dividends or distributions to himself by the corporation till Wood was paid for his interest in the property. The installment payments were by the contract to be measured by, and contingent upon, the amount of timber cut and sold from the corporation's holdings. Incidentally, $3 per thousand feet for the stumpage of two hundred million feet of timber held by the corporation would approximate Wood's interest as calculated. If, however, it was intended, as the majority opinion seems to hold, that Iverson, under the contract, was to receive one half of the assets of the corporation thus converted into lumber by way of dividends to himself, and with the cash derived from the sale thereof purchase Wood's stock in the corporation, in the end Iverson would have had twice as many shares of stock in the corporation, but the corporation would have had only one half as much assets and Iverson's 100,000 shares of stock would have been of a value no greater than his 50,000 before*1489 the deal. *872 The Board had a very similar case before it in . There Youell and Garretson were the sole stockholders, each owning 500 shares, of the Pacific Fruit & Produce Co. Personal differences arose between the stockholders and they desired to separate. Neither had the money with which to buy out the other. Some employees were willing to buy Garretson's stock on terms that he would not accept. Youell relied on the employees to purchase the stock later, and entered into a contract with Garretson wherein he agreed to purchase from Garretson, and Garretson agreed to sell to Youell, garretson's stock at the price of $272,168.32. Garretson endorsed his stock and placed it in escrow with a bank. The Pacific Fruit & Produce Co. declared a dividend out of surplus accumulated after March 1, 1913, of cash and property to Garretson and Youell in equal amounts; and under the direction of Youell his dividend of more than $65,000 was delivered to Garretson as part payment for the stock. Youell then gave Garretson his promissory note for the balance of the purchase money for the stock. The notes were later paid and the stock released*1490 from the escrow. In an opinion reviewed by the Board, without a dissent, we held Youell was not taxable on his dividend. This result was arrived at solely by looking through the taxable form of the transaction to the true intent and purpose of the parties. ARUNDELL and MCMAHON agree with this dissent.