Peet v. Commissioner

E. M. PEET, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. W. A. RUEHLMAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Peet v. Commissioner Docket Nos. 96594, 96596. United States Board of Tax Appeals 43 B.T.A. 852; 1941 BTA LEXIS 1438; March 11, 1941, Promulgated *1438 In 1931, pursuant to a plan of expansion entered upon in 1930, a corporation in which the petitioners were the principal stockholders increased its capital stock from $60,000 to $250,000 by the issuance of a stock dividend. By reason of this and a prior stock dividend 82 percent or more of the corporation's outstanding capital stock represented former earnings of the corporation. Due to the depression and a decline in business the corporation changed its method of making sales from largely on long term credit to principally for cash, with a limited amount of sales on short term credit, and held in abeyance attempts to expand to the extent contemplated in 1930. By September 1935 it was decided to postpone indefinitely the completion of the plans for expansion. At that time the corporation had a large amount of surplus and undivided profits. Since the corporation had accumulated a large amount of cash which was not required in its business and which it was contemplated would not be required in the future, the corporation acquired for cash and at par from each of its three stockholders 10 percent of their respective holdings of its stock. Held, that the redemption of the stock*1439 was essentially equivalent to the distribution of a taxable dividend under section 115(g) of the Revenue Act of 1934. Raymond A. Smith, Esq., and John LeRoy Peterson, Esq., for the petitioners. Benjamin L. Bird, Esq., for the respondent. TURNER *852 The Commissioner determined the following deficiencies in income tax for 1935: Docket No. Amount E. M. Peet 96594 $976.70 W. A. Ruehlman 96596 196.73 The only issue involved is whether certain payments made in 1935 to the petitioners by a corporation in which they were stockholders *853 for certain shares of its stock were essentially equivalent to the distribution of a taxable dividend. FINDINGS OF FACT. The Peet Stock Remedy Co. was organized on January 1, 1917, with an authorized capital stock of 3,000 shares of a par value of $10 each. On May 28, 1918, the articles of incorporation were amended and the authorized capital stock was increased to 6,000 shares of a par value of $10 each. On March 4, 1931, there was another amendment by which the authorized capital stock was increased to 25,000 shares of a par value of $10 each and the name of the corporation*1440 was changed to "E. M. Peet Manufacturing Company." Petitioner Peet has been president of the corporation continuously since its organization and petitioner Ruehlman has been secretary and treasurer for about twenty years. Aside from Peet and Ruehlman, the only other stockholder of the corporation during the taxable year and for sometime prior thereto was George Morse. The E. M. Peet Manufacturing Co., sometimes hereinafter referred to as the corporation, has its principal place of business in Council Bluffs, Iowa, and it was and is engaged in the manufacture, sale, and distribution of stock feeds, mineral feeds, and feeds for hogs and farm livestock. In 1930 the corporation had a branch warehouse at Fortville, Indiana, which served as a distributing point in that state for its products. The corporation, however, had been distributing its prodacts in Indiana since 1920, when it first established an office and warehouse in that state. Prior to 1930 the corporation distributed its products on the west coast through a jobber. The amount of the corporation's business in that section was small, but it was believed that it could be developed considerably and on various occasions Ruehlman*1441 had made investigations as to a factory site in San Francisco and Oakland, California. During 1930 the corporation's three stockholders discussed among themselves the possibility of expanding its business to cover more territory and concluded to take such action. In that year it established an office and warehouse in Oakland, California, with a manager in charge, and employed a sales force. In 1930 or 1931 it established a manufacturing branch in Indianapolis, employed more salesmen on a salary, and transferred to that point the activities theretofore conducted at Fortville. In establishing the branch in Indianapolis the corporation contemplated manufacturing products at that plant to supply the territory east of the Mississippi River as far as Pennsylvania. Since the corporation had a sufficient surplus which it was contemplated would be required in its business by reason of the expansion then under way and which was available for capitalization, *854 and being of the opinion that a larger capitalization would give the corporation more prestige with the public, the stockholders took appropriate action to increase the amount of the capital stock from $60,000 to $250,000. *1442 The necessary permission having been obtained from the Executive Council of the State of Iowa, the corporation on August 31, 1931, distributed to its stockholders a stock dividend of 19,000 shares of a par value of $10 each. During 1930 farming conditions and the general trend of agriculture in the middle west were fair. During the latter part of 1931 a noticeable decline set in, which became rapid in 1932 when market values of livestock dropped very low. Agricultural conditions during 1933 were comparable to those existing in 1932. In 1933 the Agricultural Adjustment Act came into existence and the Government's purchases of small shoats, sows, cows, and sheep checked the trend of low prices for livestock. The general trend of agricultural conditions in that section continued very low in 1934 because of the extreme drought that year, which covered the greater portion of the corn belt. The same low trend in agriculture in that section obtained in 1935, with the drought continuing into that year and with farms becoming infested with grasshoppers. Prior to 1931 approximately 85 percent of the corporation's sales were made on credit, with the period of payment ranging from*1443 6 to 8 months and in some instances to a year. During and following 1931 the corporation restricted considerably the sales made on credit and reduced to a much shorter period the time theretofore allowed for making payment. Also, many stockmen were out of business and those remaining in business would buy in smaller quantities and largely for cash. As a result of these changes the corporation's sales shifted from about 85 per cent on credit to the point where about 65 percent of them were for cash, and of those made on credit the time for payment was limited to from 30 to 90 days. In the fall of 1935 the corporation's business continued to be at a "low ebb" and it continued to sell principally for cash, as it had been doing since 1931. With the corporation operating to such a large extent on a cash basis and a short time allowed for the payment of credit sales, it did not require the use of such a large amount of cash as when it was operating largely on a credit basis, with a long time allowed for making payment. While the stockholders of the corporation have never abandoned entirely the idea of carrying out the plan of expansion decided upon in 1930, they had decided by September*1444 1935 that the corporation should not make any large expenditures in execution of the plan until business and agricultural conditions improved to the point where such expenditures were justified. The stockholders of *855 the corporation being of the opinion in September 1935 that the corporation did not at that time need in its business all of the cash then on hand and possibly concluding that they individually might have some use for the money, decided that the corporation should acquire 2,500 shares of its outstanding stock at par, or $25,000, and hold it in its treasury so that in the event it was decided to proceed with expansion of the business or the corporation otherwise needed the money the stock could be reissued. On September 9, 1935, the corporation authorized the acquisition of 2,500 shares of its stock from its three stockholders in such proportions as the stockholders might agree upon. In 1935 the stockholders proportionately from the number of shares held by each delivered to the corporation 2,500 shares of its stock, Peet surrendering 1,626.2 shares and receiving $16,262, Ruehlman surrendering 832.1 shares and receiving $8,321, and Morse surrendering 41.7*1445 shares and receiving $417. The corporation has continued to hold these 2,500 shares in its treasury. In September 1935 the stockholders had no intention of liquidating the corporation and going out of business. In fact, the corporation has continued to operate in about the same manner in which it was operating prior to September 1935. Apparently such subsequent operation has been at a profit and without any steps being taken for completing the expansion contemplated in 1930. By stipulation of the parties the year of acquisition of stock in the corporation, the number of shares acquired, and the amount paid or method of acquisition with respect to the three stockholders are shown as follows: E. M. Peet W. A. Ruehlman George Morse Year Number of shares Amount paid or method of acquisition Number of shares Amount paid or method of acquisition Number of shares Amount paid or method of acquisition [1917] 1,700 $17,000.00 [700] $7,000.00 [566] (1) (2) [233] (1) (2) [750] 7,500.00 [250] 2,500.00 [13] 212 1/2 [100] $1,000.00 [134] 3 3,015.00 496 1/2 3 11,171.25 [210] 4,725.00 [105] 2,362.50 [1931] 12,359 (1) 6,324 (1) [317] (1) *1446 During the period from August 31, 1931, to September 9, 1935, Peet was the owner of a total of 16,262 shares, or 65.05 percent, of the corporation's capital stock; Ruehlman was the owner of a total of 8,321 shares, or 33.28 1/3 percent; and Morse was the owner of 417 shares, or 1.66 2/3 percent. *856 With respect to the corporation's gross sales, surplus and undivided profits, and net income as of the dates indicated, the parties stipulated the following: December 31 Gross sales Capital surplus and undivided profits Net income [1925] $229,111.14 $34,147.05 [1926] 348,245.48 29,383.76 [1927] 456,964.07 62,669.09 [1928] 547,226.40 42,104.83 [1929] 514,079.63 64,916.04 [1930] 499,866.51 $274,245.73 28,177.47 [1931] 414,925.07 283,149.14 (24,651.44) [1932] 209,230.11 186,303.15 (96,944.03) [1933] 108,310.42 168,522.89 (18,691.03) [1934] 104,120.87 181,238.06 11,198.33 [1935] 162,240.87 195,741.24 15,341.95 The following schedule "of working capital", showing the amount of cash on hand, the*1447 total amount of trade accounts and notes receivable, liabilities, and balances of the corporation on the dates indicated is also set forth as stipulated: 12-31-30 12-31-31 12-31-32 12-31-33 12-31-34 12-31-35 Cash on Hand $92,480.72 $108,869.40 $112,061.83 $136,947.44 $165,695.41 $162,602.44 Trade Accounts & Notes Receivable 346,211.65 290,012.89 135,538.10 23,622.80 21,402.16 27,560.23 Totals 438,692.37 398,882.29 247,599.93 160,570.24 187,097.57 190,162.67 Less: Liabilities * 266,860.35 221,468.71 162,300.78 105,238.96 98,752.73 94,647.89 Balances $171,832.02 $177,413.58 $85,299.15 $55,331.28 $88,344.84 $95,514.78 The cash dividends paid by the corporation during the years 1925 through 1935 and the percentage they represented of the corporation's outstanding stock as shown by agreement of the parties were as follows: Year Dividends Percentage of outstanding stock [1925] None None [1926] $12,000.00 20% [1927] None None [1928] 6,000.00 10% [1929] 12,000.00 20% [1930] 3,000.00 5% [1931] None None [1932] None None [1933] None None [1934] None None [1935] None None *1448 In his income tax return for 1935 Peet reported a capital net gain of $3,911.69 from the corporation's acquisition of his stock in that year. Ruehlman in his 1935 return reported a capital net gain of *857 $1,803.23 from the corporation's acquisition of his stock in that year. In determining the deficiencies in controversy the respondent eliminated from the income of the respective petitioners the amounts of capital net gain thus reported by them, determined that the amounts received by them from the corporation, namely, $16,262 received by Peet and $8,321 received by Ruehlman, were taxable as dividends, and as his reason for such action, notified the petitioners as follows: The distribution received from E. M. Peet Manufacturing Company in redemption of 10 per cent of its outstanding stock was made in such a manner as to make the redemption essentially equivalent to the distribution of a taxable dividend as provided in section 115(g) of the Revenue Act of 1934. OPINION. TURNER: The petitioners contend that, by reason of the agricultural depression, the change of the corporation from a long term credit business to a cash and short term credit business, which resulted*1449 in the accumulation of a large amount of cash and the decision of the stockholders in 1935 to postpone indefinitely the completion of plans for expansion, the payment of $25,000 made in 1935 by the corporation in connection with the acquisition of 2,500 shares of its stock does not come within the provisions of section 115(g) of the Revenue Act of 1934. 1 The respondent contends that the facts here bring the payments within the provisions of section 115(g), and that the amounts so received by the petitioners are under that section taxable as dividends. The question whether a given payment or distribution*1450 by a corporation comes within the intendment of similar provisions of the various revenue acts has been considered in numerous cases and, as often pointed out, the question is to be determined on the facts of each individual case. The petitioners urge that there was good faith on the part of the stockholders in increasing the capital stock of the corporation in 1931 by the issuance of a large stock dividend and that there was no thought or continuing plan for a later purchase or acquisition of all or a portion of such stock dividend by the corporation. The respondent does not contend that bad faith was employed by the corporation or its stockholders. He does contend, however, *858 that the absence of bad faith, artifice, or subterfuge or of a casual relationship between the issuance of the stock and its redemption alone is not determinative of the question. In this we think he is correct. See , and cited cases. A consideration of the history of the corporation discloses that it began business in 1917 with an authorized capital stock of $30,000, at least $24,000 of which, if not all, was issued in that year apparently for cash; *1451 that in 1918 the authorized capital stock was increased to $60,000, all of which increase was subsequently issued, and that at least $15,545 of the increase, if not more, was issued by means of stock dividends; that in 1931 the authorized capital stock was increased to $250,000, the issuance of all of such increase of $190,000 being by means of a stock dividend. Therefore of the corporation's authorized and outstanding capital stock of $250,000 in 1931 and as late as September 1935, at least $205,545, or 82 percent, represented former earnings of the corporation. We are not informed as to what cash dividends were paid prior to 1925, but the evidence shows that during the years 1925 through 1930 the net income of the corporation amounted to $261,398.24 and that in four years of that six-year period the corporation paid cash dividends totaling only $33,000, or approximately oneeighth of its earnings for the period. While the corporation sustained substantial losses during the years 1931 through 1933, its surplus and undivided profits amounted to $168,522.89 at the end of 1933 and by the end of 1935 had increased to $195,741.24. The amount of the corporation's cash on hand increased*1452 from $92,480.72 at December 31, 1930, to $165,695.41 at December 31, 1934, and amounted to $162,602.44 at December 31, 1935, after payment of $25,000 had been made by the corporation in acquiring shares of its stock. During the years 1933 through 1935, when the corporation was operating principally on a cash basis, the cash on hand at the end of each year was in excess of the gross from sales, both cash and credit, and substantially so at the end of the years 1933 and 1934. The net income of the corporation for 1934 was $11,198.33 and for 1935 was $15,341.95, a total of $26,540.28, or $1,540.28 in excess of the amount paid by the corporation in 1935 for its stock. Subsequent to 1930 and prior to the distribution here in question there had been no cash distribution to the stockholders. Peet testified that in their discussions the stockholders of the corporation first considered having the corporation acquire $50,000 par value of its stock, but concluded that the corporation had better retire only $25,000 par value at a time as conditions might change so as to require the corporation to extend "quite a bit" of credit. He testified further that he knew at the time the stockholders*1453 authorized the acquisition by the corporation of shares of its stock that, if the corporation declared a *859 cash dividend payable to himself and the other stockholders, such a distribution would be taxable to them. In short, we find that in 1935 the stockholders of the E. M. Peet Manufacturing Co., desiring distribution of a part at least of the idle funds of the corporation and having decided to postpone indefinitely any further execution of the plan for expansion which had been the cause for capitalizing the earnings in 1931, decided to retire 2,500 shares of the stock of the corporation pro rata instead of declaring a cash dividend payable out of surplus and undivided profits as they then existed. The effect of such action was merely a reversal in part of what was done in 1931 in furtherance of a plan never carried out and a restoration of the amount represented by the said 2,500 shares of stock to earnings, followed by the payment of a dividend therefrom. It is our conclusion that the facts bring this case within the purview of section 115(g), supra, and that the distributions herein are taxable to petitioners as dividends. *1454 ; certiorari denied, , wherein a similar conclusion was reached, is in our opinion directly in point. See also ; ; ; and . Cf. ; and . For a contrary view holding for an extreme limitation of the application of section 115(g), supra, see . Reviewed by the Board. Decisions will be entered for the respondent. DISNEY concurs only in the result. BLACK BLACK, dissenting: I respectfully dissent from the conclusion reached by the majority opinion. Section 115(g) quoted in the majority opinion is a familiar statute and has been often construed by the Board and the courts. In *1455 , in construing and applying this statute the court, among other things, said: * * * Under these acts it is the settled view of the Board of Tax Appeals that sums paid in retirement of stock were not taxable as dividends, unless the retirement was made in pursuance of a plan formed at the time when the stock was originally issued or as a cloak for the distribution of earnings. * * * See also . To the same effect is our decision in (reversed on another point, ). These cases, I think, lay down *860 the correct rule that section 115(g) is only applicable where the cancellation or redemption of a corporation's stock is made in pursuance of a plan formed at the time when the stock was originally issued, or, if there is no such plan, then where the disbursement is made as a cloak for the distribution of earnings. Of course, it requires no authority to support the proposition that the Commissioner, having in his deficiency notice determined that the redemption of the stock in*1456 question was made in such a manner as to make the redemption essentially equivalent to the distribution of a dividend, the burden of proof to show to the contrary is on petitioners. Have they met that burden of proof? I think they have. It seems to me that they have proved that the increase of capital stock of the E. M. Peet Manufacturing Co. from $60,000 to $250,000 in 1931 was for entirely legitimate business purposes and that at the time the increase was made no plan was formed for the later retirement of all or part of the stock so as to make it essentially equivalent to the distribution of a dividend. Thus the first named device in the above mentioned cases was not present. Even though it be conceded that when the stock in question was issued, there was no such plan formed, was its later redemption determined upon in 1935 nevertheless a mere cloak for the distribution of a dividend? I willingly concede that there can be such cases even where the original issue of the stock was for entirely proper and legitimate business purposes. See *1457 . I think, however, that petitioners in the instant case have proved an entirely legitimate business reason for the redemption of the 2,500 shares of stock in question in 1935 and that it was not done as a cloak for the distribution of earnings. Under these circumstances it seems to me that the redemption of the stock was a partial liquidation of the corporation as defined by section 115(i) of the Revenue Act of 1934 and should be taxed accordingly, and not taxed under section 115(g) of the same act. LEECH agrees with this dissent. Footnotes 1. Stock dividend. ↩ 2. Purchased from corporation as part of an increase in capital stock. ↩ 3. Purchased from third party. ↩ *. Liabilities represented merchandise sold but not delivered, salaries, commissions and expense items advanced to employees. ↩ 1. SEC. 115. DISTRIBUTIONS BY CORPORATIONS. * * * (g) REDEMPTION OF STOCK. - If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend. ↩