Swindells v. Commissioner

WILLIAM SWINDELLS AND IRENE G. SWINDELLS, HUSBAND AND WIFE, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Swindells v. Commissioner Docket No. 97172. United States Board of Tax Appeals 44 B.T.A. 336; 1941 BTA LEXIS 1346; April 29, 1941, Promulgated *1346 In 1934 the corporation in which taxpayers were stockholders increased its capital stock from $500,000 to $1,000,000, consisting of 7,400 shares common and 1,000 shares of class A and 1,600 shares of class B preferred. The increase of $500,000 in capital was effected by a capitalization of earnings and profits accumulated since February 28, 1913. The increase was made in part to improve the financial status of the corporation and in part to aid stockholders who needed funds because of financial reverses, for which latter purpose the preferred stock, and in particular class B preferred, was issued and distributed as a stock dividend in 1934. The preferred stock was redeemed as determined by the president of the company to such holders thereof whose need for funds was the most urgent. Held, that the redemption of the class B preferred stock of taxpayers in 1935 and 1936 was essentially equivalent to the distribution of a taxable dividend under section 115(g) of the Revenue Acts of 1934 and 1936. Charles E. McCulloch, Esq., for the petitioners. John H. Pigg, Esq., for the respondent. ARNOLD *336 The Commissioner determined a deficiency*1347 in income tax against petitioners for the year 1935 in the amount of $258.84 and for the year 1936 in the amount of $80.92. The only question involved is the amount of the gain, if any, realized by the petitioners in the redemption in 1935 and 1936 of certain preferred stock received by them as a stock dividend in 1934. The record made consists of a written stipulation and oral testimony. All facts contained in the stipulation not set forth herein are incorporated in our findings by reference. FINDINGS OF FACT. The petitioners are husband and wife and reside in Dallas, Oregon. For each of the years 1935 and 1936 they made a joint return. The Willamette Valley Lumber Co. was organized under the laws of Oregon in 1906 and engaged in the business of logging and lumber manufacturing. The company's authorized capital on May 24, 1934, consisted of 4,000 shares of common stock and 1,000 shares of class A preferred stock, both of the par value of $100 a share. The common stock was all issued and outstanding and was owned or controlled in equal number by members of the Gerlinger family and members of the Clark family. Of the class A preferred stock 800 shares were issued and*1348 760 outstanding. The remaining 200 shares were carried *337 as an asset on the balance sheet of the company as of May 31, 1934. On May 24, 1934, the company's issued and outstanding stock was owned and held as follows: Common stock Class A Preferred stock Stockholders Shares Par value Shares Par value William Swindells [195] $19,500 Irene G. Swindells [20] 2,000 [10] $1,000 Geo. T. Gerlinger 1,035 103,500 [62] 6,200 Irene H. Gerlinger [45] 4,500 [10] 1,000 Louis H. Gerlinger, Jr [455] 45,500 [57] 5,700 Carl F. Gerlinger [210] 21,000 Georgianna Stevens (nee Gerlinger) [20] 2,000 [10] 1,000 Jean Kirkwood [20] 2,000 [10] 1,000 Joseph E. Sibley [95] 9,500 Estate of Mary Jane Ross Woodward [126] 12,600 Clark & Wilson Investment Co 2,000 200,000 [380] 38,000 Total 4,000 400,000 [760] 76,000 On May 24, 1934, and at all times material to this proceeding, the entire outstanding capital stock of the Clark & Wilson Investment Co., consisting of 15,000 shares, was owned and held as follows: Wilson W. Clark, 4,850 shares; Wilson W. Clark, as testamentary trustee, estate of O. M. Clark, deceased, 9,650 shares; C. G. Kinney, *1349 250 shares; H. M. Krebs, 250 shares. Prior to May 24, 1934, the officers of the company concluded that the capital stock of the company should be increased. In doing so, it was important and necessary to maintain the equal division of voting control between the members of the two families, and to maintain such division of voting control it was necessary to provide additional stock, other than common stock, to those stockholders who were financially distressed for the purpose of obtaining credit or money to avoid the sale of common stock, which would effect a change in the control of the company. On May 24, 1934, by action of the stockholders and directors, the capital stock of the company was increased from $500,000 to $1,000,000, consisting of 10,000 shares of the par value of $100 each. The 10,000 shares consisted of 7,400 shares of common stock, 1,000 shares of class A 6 percent cumulative preferred stock, and 1,600 shares of class B 6 percent cumulative preferred stock. The common stock alone had voting power so long as the dividends on the class A preferred stock were not more than six months overdue or so long as the dividends on the class B preferred stock were not*1350 more than a year overdue. In the event of liquidation or dissolution the holders of class A preferred stock were entitled to receive its par value plus any unpaid accrued dividends. Subsequent to payment in full to class A preferred stockholders the holders of class B preferred stock were entitled to receive the par value plus unpaid accrued dividends. The class A stock was subject to redemption and retirement at par plus accumulated dividends *338 by the company in equal annual installments of 200 shares beginning January 1, 1935. The class B preferred was subject to redemption and retirement at par plus accumulated dividends by the company as follows: 200 shares on or before June 1 in each year from 1936 to 1939, inclusive, and 400 shares on or before June 1 in 1940 and 1941. At the special meeting of the directors held on May 24, 1934, it was resolved that the additional 5,000 shares, totaling $500,000, consisting of 1,600 shares of preferred stock and 3,400 shares of common stock, be set up and taken out of the surplus account and capitalized. At the same meeting the directors declared a stock dividend of 5,200 shares payable June 1, 1934, to the stockholders of*1351 record on May 24, 1934, out of the increase of stock and remaining class A preferred stock unissued as follows: on each share of common stock 5/100 of a share of class A preferred, 40/100 of a share of the 1934 class B preferred, and 85/100 of a share common stock. The stock dividend was issued accordingly on June 1,1934, as follows: Common stock Class A preferred Class B preferred Stockholders Shares Par value Shares Par value Shares Par value William Swindells [166] $16,600 [10] $1,000 [78] $7,800 Irene G Swindells [17] 1,700 [800] Geo. T. Gerlinger [880] 88,000 [52] 5,200 [414] 41,400 Irene H. Gerlinger [38] 3,800 [18] 1,800 Louis H. Gerlinger, Jr [387] 38,700 [23] 2,300 [182] 18,200 Carl F. Gerlinger [178] 17,800 [10] 1,000 [84] 8,400 Georgianna Stevens (nee Gerlinger) [17] 1,700 [800] Jean Kirkwood [17] 1,700 [800] Clark & Wilson Investment Co 1,700 170,000 [100] 10,000 [800] 80,000 Total 3,400 340,000 [200] 20,000 1,600 160,000 On June 1, 1934, the company's earned surplus and undivided profits amounted to $572,898.51. The basis of the 215 shares of the original common*1352 stock owned by petitioners is $33,780. The class A preferred, the class B preferred, and the common stock issued by the company as a stock dividend each had a fair market value of $100 per share on June 1, 1934. During November and December of 1934, on various days, in various amounts, 190 shares of class A preferred issued prior to June 1, 1934, and 512 shares of class B preferred, owned by various stockholders, were redeemed by the company. During 1935 and 1936 preferred stock was redeemed as follows: Class A preferred stock Shares Par value Stockholders Date Shares Par value Carl F. Gerlinger 6- 1-35 Clark & Wilson Investment Co 8- 1-35 [100] $10,000 William Swindells 1-31-35 Jean Kirkwood 3- 1-35 L. H. Gerlinger, Jr 3- 1-35 Carl F. Gerlinger 6- 1-35 William Swindells 7- 6-35 Irene H. Gerlinger 7-15-35 Carl F. Gerlinger 7-22-35 William Swindells 9-23-35 L. H. Gerlinger, Jr 9- 1-35 Carl F. Gerlinger 11-25-35 Gerorgianna Stevens (nee Gerlinger) 12-12-35 Geo. T. Gerlinger 3-11-36 [400] L. H. Gerlinger, Jr 3-11-36 [500] Clark & Wilson Investment Co 6-30-36 [15] 1,500 Geo. T. Gerlinger 6- 9-36 [10] 1,000 L. H. Gerlinger, Jr 6- 9-36 [10] 1,000 Clark & Wilson Investment Co 7- 1-36 [150] 15,000 Clark & Wilson Investment Co 7-20-36 [25] 2,500 William Swindells 6-30-36 Irene G. Swindells 10-31-36 *1353 *339 The president of the company determined from time to time what stock should be redeemed. His determination was controlled by the urgent necessity of financial assistance of stockholders for the purpose of paying their debts and meeting other business obligations. At all times during 1934, 1935, and 1936 there were earnings and profits available, accumulated subsequent to February 28, 1913, equal to or in excess of the total amounts disbursed by the company in the redemption of class A and B preferred stock during such years. In their joint returns for 1935 and 1936 the petitioners reported gains of $787.69 and $148.62 on account of the redemption of the 53 shares and the 17 shares of class B preferred stock, respectively, received by them as stock dividends on June 1, 1934. The gains so reported were calculated by petitioners upon the theory that a portion of the cost of their original common stock was allocable to the dividend stock and that the date of acquisition of the original stock (1930) was to be used in determining the length of time their dividend stock was held to compute the amount of gain to be taken into account in computing net income under the*1354 provisions of section 117 of the 1934 and 1936 Revenue Acts. In his recomputation of petitioners' tax liability for 1935 and 1936 the respondent determined that the 53 shares and 17 shares of class B preferred stock had a zero basis, that they realized a profit of $5,300 and $1,700, that the stock dividend was acquired by petitioners *340 on June 1, 1934, within the meaning of section 117, and included in their taxable income the respective amounts of $5,100 and $1,020, as the taxable gain realized by them on the redemption of the stock. The redemption of petitioners' class B preferred stock was pursuant to a plan formed at the time the stock dividend was declared to distribute earnings and profits of the corporation to stockholders and was essentially equivalent to a distribution of a taxable dividend. OPINION. ARNOLD: The petitioners contend that the amount of gain realized by them from the redemption in 1935 and 1936 of the 53 shares and 17 shares of class B preferred stock of the Willamette Valley Lumber Co. must be determined in accordance with the provisions of section 214(e) of the Revenue Act of 1939. 1 *1355 The stock dividend distributed in 1934 by the Willamette Valley Lumber Co. was not taxable to the recipients thereof. Sec. 115(f), Revenue Act of 1934; Helvering v. Gowran,302 U.S. 238. The petitioners must prevail (Kelly's Trust v. Commissioner, 106 Fed.(2d) 1002; 38 B.T.A. 1014; Gerlinger v. Commissioner, 106 Fed.(2d) 997; and Smith v. Commissioner, 107 Fed.(2d) 1020; 39 B.T.A. 80, each remanded to the Board for further proceedings in accordance with the provisions of section 214 of the Revenue Act of 1939) unless the proceeds received upon redemption are taxable under section 115*341 (g) of the Revenue Acts of 1934 and 1936, 2 as contended by the respondent. *1356 In determining the gain realized by the petitioners on the redemption of the stock involved the respondent applied a zero basis and held that the period for which the dividend stock was held did not include the period for which the common stock was held. This would be correct, Helvering v. Gowran, supra; and Koshland v. Helvering,298 U.S. 441, were it not for the provisions of section 214 of the Revenue Act of 1939. In his amended answer the respondent affirmatively alleges that the redemption and retirement of the 53 shares of class B preferred stock in 1935 and of the 17 shares of class B preferred stock in 1936 by the Willamette Valley Lumber Co. was essentially equivalent to the distribution of a taxable dividend under section 115(g), supra, that the amounts of $5,300 and $1,700 constituted taxable dividends to petitioners in 1935 and 1936, respectively, and that the deficiencies in tax would therefore be no less than $100.06 for 1935 and $148.92 for 1936. He made claim for the increased deficiency for 1936 of $148.92 instead of $80.92. George T. Gerlinger, the president of the company, testified that it was found that the*1357 capital of $500,000 was not favorable to certain large deals and contracts and in the purchase of timber and that terefore it was decided to increase the capital stock of the company to about 1913 values of approximately $820,000. He also testified that certain of the stockholders were, due to financial reverses, in urgent need of funds or means of obtaining credit and that, since it was not desired that such stockholders dispose of their common stock, which might affect the equal stock control as between the Clark and Gerlinger families, preferred stock was issued which could be used as collateral. He stated: "We could not declare cash dividends and we wanted to preserve at all times the common stock relationship, and we didn't want them selling [common] stock in order to realize that money if they had to have it, so we put part of it in preferred." It appears that the increase of the capital stock was motivated by two objectives - one, the improvement of the company's financial and business standing, and, two, the extension of financial assistance to stockholders in need thereof by distributing to them profits of the company in the form of preferred stock to be used as collateral*1358 or redeemed if the need for funds was urgent. The preferred stock was set up as capital and redeemed out of earnings and profits accumulated subsequent to February 28, 1913. It is apparent that the redemption *342 and retirement of the class B preferred stock was made in pursuance of a plan to distribute earnings and profits formed at the time when such stock was issued and hence the amounts received by petitioners on redemption of their class B preferred stock were taxable as dividends under section 115(g). See Commissioner v. Cordingley, 78 Fed.(2d) 118. That the redemption was not made pro rata among the preferred stockholders is not a controlling factor. Leopold Adler,30 B.T.A. 897, 906. It does show, however, a consummation of the original plan to assist, by distribution of cash, those who needed such aid most urgently. The fact that a business purpose was associated with the distribution of the stock dividend in 1934 does not make the redemption of the class B preferred stock any the less "essentially equivalent to the distribution of a taxable dividend * * * to the extent it represents a distribution of earnings or profits" *1359 under the statute. The question before us is the taxable effect on a stockholder upon the redemption of class B stock. The redemption of the stock pursuant to a plan to distribute earnings and profits formed at the time the stock was issued is the controlling element. The redemption was not for a business purpose of the corporation, but was solely a part of the means adopted for the distribution of earnings and profits of the corporation to its stockholders for their own personal use. In our opinion the evidence shows that the class B preferred stock involved herein was redeemed "at such time and in such manner" as to make the redemption "essentially equivalent to the distribution of a taxable dividend" under section 115(g). See E. M. Peet,43 B.T.A. 852. No useful purpose would be served by discussing the many cases cited by bothe parties, as the solution of each case depends upon its own peculiar facts. McGuire v. Commissioner, 84 Fed.(2d) 431; certiorari denied, 299 U.S. 591. Decision will be entered under Rule 50. Footnotes 1. SEC. 214. BASIS OF STOCK DIVIDENDS AND STOCK RIGHTS. * * * (e) BASIS UNDER PRIOR ACTS. - The following rules shall be applied, for the purposes of the Revenue Act of 1938 or any prior revenue Act as if such rules were a part of each such Act when it was enacted, in determining the basis of property acquired by a shareholder in a corporation which consists of stock in such corporation, or rights to acquire such stock, acquired by him after February 28, 1913, in a distribution by such corporation (hereinafter in this subsection called "new stock"), or consisting of stock in respect of which such distribution was made (hereinafter in this subsection called "old stock") if the new stock was acquired in a taxable year beginning before January 1, 1936, or acquired in a taxable year beginning after December 31, 1935, and its distribution did not constitute income to the shareholder within the meaning of the Sixteenth Amendment to the Constitution: (1) The basis of the new stock and of the old stock, respectively, shall, in the shareholder's hands be determined by allocating between the old stock and the new stock the adjusted basis of the old stock; such allocation to be made under regulations which shall be prescribed by the Commissioner with the approval of the Secretary. * * * (f) DETERMINATION UNDER PRIOR ACTS OF PERIOD FOR WHICH HELD. - For the purposes of the Revenue Act of 1938 or any prior revenue Act, in determining the period for which the taxpayer has held stock or rights to acquire stock, received upon a distribution, if the basis of such stock or rights is determined under section 214(e)(1) of the Revenue Act of 1939, there shall (under regulations which shall be prescribed by the Commissioner with the approval of the Secretary) be included the period for which he held the stock in the distributing corporation prior to the receipt of such stock or rights upon such distribution. This subsection shall be applicable as if it were a part of each such Act when such Act was enacted. ↩ 2. (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. ↩