Makransky v. Commissioner

HARRY AND DOROTHY MAKRANSKY, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Makransky v. Commissioner Docket No. 78237. United States Board of Tax Appeals 35 B.T.A. 395; 1937 BTA LEXIS 880; February 5, 1937, Promulgated *880 A dividend was declared on preferred stock. The dividend check in favor of one stockholder was issued and delivered in the ordinary course of business. Checks were drafted in favor of the other stockholders, including the petitioners, and, after being endorsed by or on behalf of the payees thereof, they were signed by the corporation and applied against subscriptions for preferred and common stock in amounts in excess of the dividend. Held, under the circumstances, that the dividend was a cash dividend. D. Hays Solis-Cohen, Esq., D. Benjamin Kresch, Esq., and A. E. James, Esq., for the petitioners. George D. Brabson, Esq., for the respondent. DISNEY *396 This proceeding involves the redetermination of a deficiency of $4,870.47 in income tax for 1931. The sole issue is whether a dividend is a taxable dividend. FINDINGS OF FACT. S. Makransky & Sons, Inc., is a Pennsylvania corporation organized in August 1930, with a small capital stock, as the successor to a partnership which was dissolved as of June 1, 1930. On September 2, 1930, the authorized capital stock of the corporation was increased to 17,500 shares of preferred stock*881 of the par value of $100 each, and 175,000 shares of common stock of the par value of $1 per share. Stock of the corporation was issued September 2, 1930, as of June 1, 1930, as follows: Shares Preferred Common Simon Makransky 1,843 1/3 11,666 2/3 Anne Makransky 1,193 1/3 11,666 2/3 Harry Makransky 3,002 1/2 32,500 Dorothy Makransky 3,002 1/2 32,500 Edward Makransky 2,382 1/2 25,000 Sadye Makransky 2,382 1/2 25,000 Louis Makransky 1,193 1/3 11,666 2/3 Total 15,000 150,000 On March 31, 1931, 100 shares of preferred stock and 1,000 shares of common stock were issued to Frank Metz, an employee of the corporation. These individuals held the same number of shares of each class of stock on June 25 and 27, 1931. Simon and Anne are the parents of Harry, Edward, and Louis. Harry and Dorothy, the petitioners, are husband and wife. Sadye is the wife of Edward. The preferred stock certificates provided that the holders thereof should be entitled to dividends at the rate of 6 percent per annum, payable quarterly from June 1, 1930, out of surplus or net profits, and interest at the same rate on accumulated dividends. No dividends could*882 be paid on common stock until dividends on the preferred, together with accrued interest on unpaid dividends, had been paid. Upon liquidation or dissolution of the corporation the preferred stockholders were entitled to redemption of their stock at par, and payment of accrued dividends, with interest, if any, and the holders of common were entitled to any assets remaining after such payments. The preferred was redeemable at par, plus accrued dividends and *397 interest thereon, if any, and had no voting power. The certificates further provided that: (6) Holders of Preferred Stock shall not be entitled to share in any increase of the capital stock of the Corporation whether such increase be by way of stock dividends, rights to subscribe to additional stock or obligations convertible into stock or otherwise, all preemptive rights in regard to such sharing being the exclusive property of the holders of Common Stock, excepting, however, that the holders of the Preferred Stock shall have full preemptive rights to the purchase of any additional Preferred Stock or obligations convertible into Preferred Stock which may be authorized and/or issued by the Corporation. On May 31, 1931, the*883 corporation had a surplus of $99,887.91, and cash on hand of $278,972.99, with current accounts payable of $40,935.52. On June 25, 1931, it had a cash balance of $189,123.67, which was needed to meet operating expenses during the next three or four months. On June 30, 1931, accounts payable were $172,811.66, and the cash balance was $139,224.46. During June 1931, but prior to the 25th, Harry, Edward, and Louis, as stockholders of the corporation, agreed that if the corporation's board of directors adopted a resolution at its next meeting, which was scheduled for June 25th, declaring a dividend on its preferred stock, payment thereof should be made without loss of working capital, by issuance, endorsement and deposit of checks and issuance of stock. Later all of the members of the Makransky family, except Anne, subscribed for shares of preferred and common stock and the family agreed to the idea of a stock dividend. The board of directors of the corporation consisted of Simon and his three sons. The minutes of a directors' meeting held on June 25, 1931, read in part as follows: The Treasurer thereupon stated that the earnings of Company to June 1, 1931 were amply sufficient*884 to pay the dividend next hereinafter referred to. On motion duly made and seconded, it was unanimously RESOLVED that a dividend at the rate of 6% be declared upon the outstanding preferred stock of the Company, payable June 27th, 1931 to stockholders of record, as of the close of business at 3 o'clock P.M. (D.S.T.) on June 25, 1931, representing the four quarterly dividends payable September 1, 1930, December 1, 1930, March 1, 1931 and June 1, 1931, respectively. The Treasurer stated that the persons set forth in the following resolution had offered to purchase the amount of preferred and common stock set beside their respective names at the price of $100 per share of preferred stock and $1.00 per share of Common stock. On motion duly made and seconded, it was unanimously RESOLVED that this corporation accept the following offers to purchase the preferred and common stock of this corporation, at the price or sum or $100 per share of preferred stock and $1.00 per share of common stock and the President and Treasurer be and they hereby are authorized and empowered to issue stock to the following persons in the amounts set beside their respective *398 names, as and*885 when paid for in cash; provided, however, that such stock shall not be entitled to any share in the dividend hereinbefore declared: No. of Shares Name Preferred Common Harry Makransky [1750] Dorothy Makransky [1750] Edward Makransky [1300] Sadye Makransky [1300] Louis Makransky [2000] Simon Makransky [1000] The attorney for the corporation was present at the meeting of the directors and advised them that the stock should not be issued until the dividend checks were endorsed. The minutes of the meeting were prepared by the attorney, signed by Louis, as secretary, and approved by the other directors. Metz was not consulted about the declaration of the dividend or the manner in which any dividend declared should be paid. No dividend was declared on the common stock. On June 27, 1931, the corporation drafted the following checks in favor of the record owners of its preferred stock: Simon Makransky $11,060 Anne Makransky 7,160 Harry Makransky 18,015 Dorothy Makransky 18,015 Edward Makransky 14,295 Sadye Makransky $14,295 Louis Makransky 7,160 Frank Metz [100] Total 90,100 The checks issued*886 in favor of the Makranskys recite that they are in full payment of dividends. The checks, unsigned, were presented for endorsement. Harry endorsed the check issued to him and endorsed his wife's name on the check issued to her. Edward made a like endorsement on his check and his wife's check. Louis endorsed his own check and also the ones issued in favor of his father and mother. The corporation then signed the checks, entered them in its cash book on June 29, 1931, as dividend payments, and charged the various amounts to surplus. It did not have a dividend account. The checks never left the control of the corporation. During the early part of June 1931, the parents of Louis declared an intention to give him all of their stock, except 650 shares of preferred owned by the father, the transfers to be made at the next stockholders' meeting, which was held on June 25, 1931. Such stock was transferred, and the additional shares subscribed for on June 25, 1931, were issued on July 6, 1931. The difference of $1,235 between the dividend checks in the amount of $18,015 issued in favor of each of the petitioners and each of their stock subscriptions, $17,500 for preferred and $1,750*887 for common, a total of $19,250, was paid by Harry. The corporations' office manager asked Harry for the difference of $2,470, and was told to draw *399 a check for the amount and charge it to his personal account, which was done. The difference of $5 between the dividend checks issued to Edward and Sadye, $14,295 in each case, and their stock subscription, $13,000 for preferred and $1,300 for common, was adjusted by issuing to Edward, and charging to his personal account, a check of the corporation for $10. In his application of the dividend checks issued in favor of Simon, Anne, and Louis in payment of the stock subscriptions of Simon and Louis, the corporation's office manager considered 1,193 1/3 shares of the 1,843 1/3 shares of preferred outstanding in the name of Simon and considered the $1,193 1/3 shares of preferred owned by Anne, as transferred to Louis. On such basis he applied all of the dividend checks of $7,160 each issued to Anne and Louis, and a like amount out of the check for $11,060 issued in favor of Simon (leaving $3,900 applicable to the 650 shares of preferred regarded as still belonging to Simon), a total of $21,480, in part payment of Louis' stock*888 subscription, $20,000 for preferred and $2,000 for common. The remainder of $520 was paid by application of a check of the corporation issued for that purpose, the amount of the check being charged to Louis. The subscription of Simon, amounting to $11,000, $10,000 for preferred and $1,000 for common, was paid in part by application of $3,900 of the amount of his dividend check and a credit balance of $6,870 which he had in his personal account, a total of $10,770. The remainder of $230 was paid by a personal check of Simon. On June 30, 1931, the corporation deposited the dividend checks and the checks issued in favor of Harry, Edward, and Louis for $2,470, $10 and $520, respectively, and the one received from Simon in the amount of $230, in its bank account and recorded them in its cash book by the following entries as payments received from the respective parties for preferred and common stock: Dorothy Makransky Preferred 17,500 Dorothy Makransky Common 1,750 Harry Makransky Preferred 17,500 Harry Makransky Common 1,750 Edward Makransky Preferred 13,000 Edward Makransky Common 1,300 Sadye Makransky Preferred 13,000 Sadye Makransky Common 1,300 Louis Makransky Preferred 20,000 Louis Makransky Common 2,000 Simon Makransky Subscription a/c 4,130 *889 The dividend checks issued to Harry and Dorothy and the other corporate check issued to Harry in the amount of $2,470 are reflected in the entries relating to Harry and Dorothy. Like checks in favor of Edward and Sadye are reflected in the entries relating to them. The entries relating to Louis represent his dividend check for $7,160, *400 the one issued in favor of Anne for $7,160, plus a like amount of the dividend check issued in favor of Simon, and the check of the corporation in favor of Louis in the amount of $520. The entry relating to Simon reflects his cash payment of $230 and $3,900 of the amount of the dividend check issued to him. During the taxable year the petitioners received a taxable dividend in the amount of $36,030 from S. Makransky & Sons, Inc. OPINION. DISNEY: Cases are cited by the parties as authority for a holding in accordance with their respective contentions. There is similarity in this proceeding both as to cases where the dividend has been held to be stock and as to those in which it has been held to be cash. Our decision, in the final analysis, must turn upon the facts in the record, and in reaching it, we may not ignore what was*890 actually done in favor of substance alone. The resolutions have all of the earmarks of a cash dividend on preferred stock and a purchase by all of the stockholders, except Metz, of unissued preferred and common stock. There is nothing in the dividend resolution expressing intention to pay the dividend in stock at par or any other value. The stock subscription resolution was passed in reliance upon a statement of the corporation's treasurer that the Makranskys had "offered to purchase", as therein set forth, stock, and it authorizes the officers to issue the stock subscribed for only "as and when paid for in cash." The resolution discloses intent to pay accumulated dividends on the preferred stock in cash and to issue additional shares of common and preferred stock of a par value in excess of the dividend, as subscribed for, for cash. Only for cash could the new stock be issued within the authority of the resolution. All of the stockholders had a clear right to demand their dividends in cash and there is nothing in the resolutions requiring the Makranskys to apply their dividends against their stock subscriptions or to pay for their stock concurrently with the distribution of*891 the dividend. One of the stockholders, Metz, received his dividend in cash in a regular way and was not consulted about the dividend payment or extended the privilege of subscribing for additional shares of stock at par or any other value. The dividend check in favor of all of the stockholders was signed by Harry Makransky, president of the corporation and one of the petitioners in this proceeding. As a director he voted for the resolution and approved the minutes of the meeting. This corporate act under the resolution, the regularity of which is not being questioned here, discloses that promptly after the adoption of the resolution Harry Makransky construed it to contain *401 authority for the payment of the dividend in cash. The effect of the argument now being made is that the corporation had the option to pay the dividend in cash or stock, for if there was power to pay Metz in cash, authority also existed for like payments to the other stockholders. If the resolution authorized only a stock dividend, as we are asked to construe it with reference to the issue here, no authority existed to make the payment to Metz. Clearly, to the extent that the par value of the*892 stock exceeded the dividend, there was an ordinary sale of stock for cash. We find nothing in the resolutions and other evidence to warrant a finding that the remaining stock was received as a stock dividend. To do so would be equivalent to saying that the resolution required the payment of a cash dividend to one stockholder and a stock dividend to all others. Its plain terms do not warrant such a finding. The declaration of the dividend created a debtor and creditor relationship between the corporation and its stockholders, as held in , a case in which the language of the resolution is similar to the dividend resolution involved here. The resolution accepting offers to purchase stock as and when paid for in cash created a definite contractual relationship between the corporation and its stockholders which can not be made subservient to the understanding between the stockholders, to which the corporation as such was no party. Such an understanding between stockholders is not sufficient to overcome the relation which the resolutions of the directors' meetings created in this case. There was obligation by the stockholder to buy and*893 pay cash for both common and preferred stock; there was obligation by the corporation to pay a dividend upon outstanding preferred stock. It had cash on hand sufficient to pay same and the fact that these funds were needed to meet operating expenses is not controlling. The provision of the preferred stock certificate quoted above suggests prohibition against the holder of preferred stock receiving a stock dividend out of increase of the capital stock. Petitioner argues that this language means increase of the authorized capital stock, but language immediately following states an exception in that the holder of preferred stock shall have preemptive right to the purchase of additional preferred stock authorized or issued by the corporation, and it therefore seems to us that the prohibition goes against any stock issued, whether out of the stock presently authorized or authorized in the future. We conclude that the preferred stock certificate indicates that the holder shall not share in additional stock issued, by way of stock dividends, even within the capital stock authorized at the time of issuance of the certificate. It may be that such a prohibition, however positive, would*894 not prevent *402 a waiver of its provisions by the unanimous consent of the stockholders, but the record herein negatives any idea of unanimous consent in the transaction here considered. In any event, such a provision as quoted above raises a presumption that it was not violated, which it would be if the stock dividend contended for by the petitioner were sustained. The evidence before us does not, in our opinion, overcome such presumption, and therefore for this additional reason we conclude and hold that the dividend was one in cash. In , the corporation's board of directors was fully aware of the plan among the holders of substantially all of the stock to accept a 100 percent dividend in stock and to take, at par, such shares of stock as minority stockholders did not accept as a dividend payment, and passed the resolution upon the faith of the agreement. As the court pointed out, the whole plan was in "reality a refinancing of the corporation, in which this defendant and other large stockholders bound themselves to pay, and in fact did pay, into the company's treasury the additional capital which it required. *895 Their position was not that of having an option to take stock or to take money, but it was an obligation to take stock for which they agreed to pay." In , the board of directors relied upon an agreement of the corporation's principal stockholders that they would turn their dividend checks in for stock as they had done for several years prior thereto and the corporation had insufficient cash to pay the dividend. In each case the proportionate interests of the taxpayers in the respective corporations were not changed by the transaction, a circumstance not present here. The dividend declared was payable and paid in cash. The fact that the Makranskys applied the amounts received against the purchase of additional stock did not have the effect of changing it to a stock dividend. See ;; ; . Reviewed by the Board. Decision will be entered for the respondent.