Kent Oil Co. v. Commissioner

THE KENT OIL COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Kent Oil Co. v. Commissioner Docket No. 88743. United States Board of Tax Appeals 38 B.T.A. 528; 1938 BTA LEXIS 858; September 13, 1938, Promulgated *858 The petitioner was the owner of all of the capital stock of the Jayhawk Oil Co. On January 25, 1934, that corporation declared a dividend of $15,267.21, equaling the amount of its surplus, payable to stockholders of record on January 31, 1934, and on the last named date turned over to the petitioner all of its remaining assets in exchange for $15,000 par value of petitioner's preferred stock. On March 5, 1934, the Jayhawk Oil Co. issued $15,000 of its own preferred stock for gas and oil leases. The owners of this preferred stock then exchanged that stock for all of the outstanding stock of the Jayhawk Oil Co. owned by the petitioner. The petitioner then exchanged the $15,000 par value of preferred stock of the Jayhawk Oil Co. for $15,000 par value of its own preferred stock held by the Jayhawk Oil Co. and the issues of preferred stock were immediately canceled by each company. Held, that there was a liquidation of the Jayhawk Oil Co. and that the petitioner is liable to income tax upon the profit realized from the liquidation. Ellis D. Bever, Esq., and Vincent A. Smith, C.P.A., for the petitioner. James C. Maddox, Esq., for the respondent. *859 SMITH *529 This is a proceeding for the redetermination of a deficiency in income tax for 1934 in the amount of $2,365.62. The deficiency arises from the respondent's determination that the Kent Oil Co. derived a profit from the liquidation of its subsidiary, the Jayhawk Oil Co., in the amount of $14,637.25. In his brief the respondent states as follows: In computing petitioner's deficiency respondent reduced the basis of the petitioner's Jayhawk stock by $2,079.81 because of a loss shown by Jayhawk in the consolidated return by petitioner and its subsidiaries filed in 1933. Since such loss was not offset against any income of the parent corporation, such reduction was contrary to Article 34, Regulations 86, and respondent concedes error as to this point. FINDINGS OF FACT. The petitioner is a Kansas corporation, organized in 1926, with its principal office at Salina, Kansas. Since organization it has engaged in the business of selling petroleum products. During the taxable year a majority of the petitioner's outstanding capital stock was owned by the Vickers Petroleum Co. In June 1927 the petitioner joined with the Service Oil Co. of Colby, Kansas, *860 and the Keeton Oil Co. of Salina, Kansas, both of which were engaged in a business similar to that of the petitioner, in organizing the Jayhawk Oil Co., to manufacture lubricating oils for those three corporations. Upon its organization, 1,500 shares of common stock having no par value were issued by the Jayhawk Oil Co. and paid for as follows: Shares Cash paid in Kent Oil Co [600] $6,000 Keeton Oil Co [600] 6,000 Service Oil Co [300] 3,000 *530 Some time in 1930 the Keeton Oil Co. sold its marketing business to the Prairie Oil & Gas Co. and in that year the petitioner bought the 600 shares of stock of the Jayhawk Oil Co. owned by the Keeton Oil Co. for $10,000 cash. In 1933 the petitioner bought the 300 shares of stock of the Jayhawk Oil Co. owned by the Service Oil Co. for $7,600 cash, which made a total cost to the petitioner of $23,600 for all of the outstanding stock of the Jayhawk Oil Co. as of December 31, 1933. On November 8, 1933, the Jayhawk Oil Co., through its president, R. L. Kent, who was also president of the petitioner, entered into an agreement with C. L. Henderson and J. A. Vickers, which reads as follows: MEMORANDUM OF AGREEMENT *861 November 8, 1933. Mr. R. L. Kent, President of The Jayhawk Oil Company, was in the office, at which time a discussion was had with J. A. Vickers and C. L. Henderson as to the advisability of discontinuing the operations of The Jayhawk Oil Company as a separate corporation. A plan was decided upon whereby The Kent Oil Company would take over the assets of The Jayhawk Oil Company at some later date, possibly December 31, 1933, or as soon as possible thereafter. If this is done, it is then the understanding that J. A. Vickers and C. L. Henderson will take over the common stock of The Jayhawk Oil Company, amend the charter, change officers and directors, and do what is necessary so that the company will have broader powers in handling future business. It will take considerable time to complete such plans, including the amendment of the charter and get ready to do business on a wider scope as stated above; therefore, J. A. Vickers is authorized to act in the meantime as Agent for The Jayhawk Oil Company and use his best judgment and ability in acquiring leases and disposing of them if the occasion presents itself, for the benefit of The Jayhawk Oil Company, and at such time*862 as the organization is perfected, the properties acquired by J. A. Vickers during the period from this date to such time of perfection, will be transferred over to The Jayhawk Oil Company on a basis to be approved later. WITNESS our hands this 8th day of November 1933. THE JAYHAWK OIL COMPANY. By [Signed] R. L. KENT, President. C. L. HENDERSON On January 25, 1934, the board of directors of the Jayhawk Oil Co. declared a dividend of its entire earned surplus, payable to stockholders of record as of January 31, 1934. This dividend was paid to the petitioner by crediting its debit account with the Jayhawk Oil Co. Also, on January 31, 1934, the Jayhawk Oil Co. transferred all of its remaining assets and liabilities to the petitioner and received in exchange therefor petitioner's preferred stock in the amount of $15,000. At or about the time all the former assets of the Jayhawk Oil Co. went over to petitioner, the Jayhawk Oil Co.'s charter was *531 amended to enable it to acquire and develop certain oil leases which J. A. Vickers had been acquiring for that company as agent, pursuant to the agreement of November 8, 1933. On March 5, 1934, the leases thus*863 acquired by J. A. Vickers were turned over to the Jayhawk Oil Co., which issued preferred stock of the face value of $15,000 to J. A. Vickers and C. L. Henderson in exchange therefor. The net cost of the leases to Vickers and Henderson had been $14,954.62. J. A. Vickers and C. L. Henderson then exchanged their Jayhawk Oil Co. preferred stock for all of the petitioner's Jayhawk Oil Co. common stock. After this exchange petitioner had Jayhawk Oil Co. preferred stock of a face value of $15,000 and the Jayhawk Oil Co. had petitioner's preferred stock of a like amount. The preferred shares held by each were then mutually exchanged and canceled, leaving the petitioner with all of the Jayhawk Oil Co.'s former assets and liabilities and none of its stock, and leaving the Jayhawk Oil Co. in new hands, engaged in a new business, under a new charter. The petitioner and its subsidiary corporations filed a consolidated income tax return for 1933, disclosing a consolidated loss of $7,609.99. The petitioner's loss included in the consolidated return for that year amounted to $6,189.13, while the Jayhawk Oil Co.'s loss included in the consolidated return amounted to $2,079.81. The transactions*864 by which the petitioner acquired all of the assets of the Jayhawk Oil Co. in exchange for the shares of stock of that company owned by the petitioner represented a liquidation of the Jayhawk Oil Co. OPINION. SMITH: It is the petitioner's contention in this proceeding that the payment to it on January 31, 1934, of $15,267.21, representing the amount of the earned surplus of the Jayhawk Oil Co., was a taxable dividend, deductible by it from gross income under section 23(p) of the Revenue Act of 1934, which provides for the deduction from gross income of "the amount received as dividends from a domestic corporation which is subject to taxation under this title." The respondent, on the other hand, contends that there was a liquidation of the Jayhawk Oil Co. on or about January 31, 1934, and that the payment of the dividend above referred to was merely a step in effecting that liquidation. The provisions of the statute relied upon by the respondent are embodied in section 115 of the Revenue Act of 1934, which provides in material part as follows: (a) DEFINITION OF DIVIDEND. - The term "dividend" when used in this title (except in section 203(a)(4) and section 207(c)(1), relating*865 to insurance companies) means any distribution made by a corporation to its shareholders, *532 whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913. (b) SOURCE OF DISTRIBUTIONS. - For the purposes of this Act every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits. * * * (c) DISTRIBUTIONS IN LIQUIDATION. - Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. * * * * * * (i) DEFINITION OF PARTIAL LIQUIDATION. - As used in this section the term "amounts distributed in partial liquidation" means a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock. Article 115(5) of Regulations 86, promulgated under the provisions of the Revenue Act of 1934, provides as follows: Distributions in liquidation.*866 - Amounts distributed in complete liquidation of a corporation are to be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation are to be treated as in part or full payment in exchange for the stock so canceled or redeemed. The phrase "amounts distributed in partial liquidation" means a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock. A complete cancellation or redemption of a part of the corporate stock may be accomplished, for example, by the complete retirement of all the shares of a particular preference or series, or by taking up all the old shares of a particular preference or series and issuing new shares to replace a portion thereof, or by the complete retirement of any part of the stock, whether or not pro rata among the shareholders. In , the court said: "Where a plan of action is proven the courts will consider it as a whole rather than divide it into independent steps. *867 " A rule which is equally well established and is applicable to the facts in this case is that in matters of taxation the substance, rather than the form, will be regarded. See ; ; certiorari denied, ; ; . When the facts in this case are regarded in the light of the above rules, the real nature of what was done is immediately apparent. The petitioner liquidated the business of the Jayhawk Oil Co., receiving in exchange for its shares of stock all of the assets of that company. It turned over the corporate shell to third parties. The effect of the agreement of November 8, 1933, and the acts done thereunder amounted to a liquidation of the Jayhawk Oil Co. The transactions had pursuant to the agreement merely camouflaged the picture. In *868 , it was stated: *533 That taxing statutes cannot be intentionally circumvented by anticipatory arrangements and contracts is settled by the principle laid down in . It is obvious that if the stockholders of the W. L. Phelps Company intended to, and in fact did, liquidate wholly or partially by distributing its assets to its stockholders and taking up their stock, the earnings and profits so received by them would be governed by section 201, supra. * * * The petitioner contends that the dividend paid to it by the Jayhawk Oil Co. on January 31, 1934, was a taxable dividend within the purview of section 23(p) of the Revenue Act of 1934. It was not an ordinary dividend within the meaning of the rule laid down in ; affd., . In our opinion the proceeding at bar is ruled by ; affd. (C.C.A., 3d Cir.), *869 ; certiorari denied, . That case presented a situation very similar to the one here involved. There, as here, all the assets were turned over to the original stockholders. There, as here, the corporate shell was made the vehicle for a new business under new stockholders. The Board said in its opinion: A full consideration of all of the facts in this case leads us, as it did the Commissioner, to the conclusion that all of the amounts distributed on December 26, 1928, were distributed in liquidation of the corporation. Although the Dealers Finance Co. was suthorized to do a number of things under its charter, as theretofore amended, there can be no question as to the business in which it was actually and regularly engaged prior to March 1928. In March 1928 it disposed of all of its assets with which it had carried on that business and never thereafter engaged in that business. Cf. ; affd., ; ; affd., *870 . From that time until it made the distributions here in question, it carried on no business but limited its activities to the conversion into cash of some of the securities received in exchange for its former assets and to the retirement of its class B stock. Then came December 26, 1928, with the resolutions and distributions described above. Thereafter the corporation was dead so far as its old business was concerned, a mere empty shell without shareholders or property. Cf. . Later, new stockholders refilled the shell with different property. The corporation then went into a new and totally different life. Its failure to dissolve is not inconsistent with our holding that the distributions were in liquidation of the corporation. Frelmort Realty Corp., supra.The facts here show that the corporation was in the course of liquidation at the time of the distribution and that it completed its liquidation on the same day. The distribution of the $500,509.69 was a step in that process. *871 . Cf. . We are of the opinion that the respondent did not err in determining the deficiency in income tax for 1934 upon the basis that there was a liquidation of the Jayhawk Oil Co., and that the petitioner is taxable upon the gain realized therefrom. Judgment will be entered under Rule 50.