Humphryes Mfg. Co. v. Commissioner

THE HUMPHRYES MANUFACTURING COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Humphryes Mfg. Co. v. Commissioner Docket No. 99261. United States Board of Tax Appeals 45 B.T.A. 114; 1941 BTA LEXIS 1182; September 12, 1941, Promulgated *1182 In 1936 petitioner's issued and outstanding stock consisted, in part, of 8 percent cumulative preferred stock on which undeclared dividends were in arrears. In pursuance of a plan of recapitalization, holders of the 8 percent preferred stock surrendered the stock in exchange for new 6 percent preferred stock and new common stock. The stockholders received a small amount of cash in payment of fractional shares involved in the exchange. Petitioner claims that part of the new preferred stock which was distributed was a stock dividend and that the undeclared dividends in arrears were paid by a part stock and part cash dividend, taxable to the distributees. Petitioner claims a dividends paid credit under section 27(e) of the Revenue Act of 1936 for an alleged stock dividend in the amount of $35,100, and a credit for the $3,610 cash distributed. Petitioner concedes that there was a reorganization and that the exchange of stock for new stock and cash comes within sections 112(b)(3) and (c) (1) of the Revenue Act of 1936. Held: (1) That part of the new stock received by the stockholders was not a stock dividend, no stock dividend being involved in the exchange. (2) Petitioner*1183 is not entitled to a dividends paid credit of $35,100 under section 27(e). South Atlantic Steamship Line,42 B.T.A. 705; Skenandoa Rayon Corporation v. Commissioner, 122 Fed.(2d) 268; J. Weingarten, Inc.,44 B.T.A. 798. (3) Petitioner is not entitled to a dividends paid credit for the cash distributions of $3,610. E. G. Rarey, Esq., for the petitioner. W. W. Kerr, Esq., for the respondent. HARRON *114 Respondent determined deficiencies of $8,127.74 in income tax and $90.81 in excess profits tax for the year 1936. The sole question is whether in the computation of the surtax imposed by section 14 of the Revenue Act of 1936 petitioner is entitled under section 27 to a dividends paid credit in the amount of $38,710 representing $35,100 in par value of its new preferred stock and $3,610 in cash which it distributed in the taxable year to the holders of its old preferred stock in payment of dividend arrears thereon. Other adjustments made by respondent are not contested. The facts have been stipulated. It has been stipulated that the cash distributions for fractional shares amounted to*1184 $3,610. FINDINGS OF FACT. Petitioner is an Ohio corporation, with its principal office at Mansfield, Ohio. The return was filed with the collector of internal revenue for the eighteenth district of Ohio. *115 In 1936 petitioner's outstanding stock consisted of 8 percent cumulative preferred stock of a par value of $25 per share and no par value common stock. Dividends on the cumulative preferred stock were payable at the rate of $2 per share. As of January 1, 1936, there were outstanding approximately 15,455 shares of no par common stock and 5,530 shares of 8 percent cumulative preferred stock. As of January 1, 1936, dividends on the preferred stock had become in arrears for 3 1/2 years in the amount of $7 per share, in the aggregate amount of $38,710. In November of 1936 petitioner's directors approved an improvement program involving construction of some additions to plant at a cost of about $30,000. In November of 1936 petitioner's directors approved amendments to the articles of incorporation in order to effect a change in the capital structure through a recapitalization. On December 1, 1936, the stockholders approved and adopted the amendments, and thereafter*1185 the certificate of amendment was duly issued by the secretary of state. The plan of recapitalization called for the issuance of new preferred stock of a par value of $100 per share, with cumulative dividends at the rate of 6 percent; an increase in common stock and the issuance of new common stock; and "liquidation" or a wiping out of the accrued dividends on the old preferred stock. Because of decreasing the rate of dividends on the preferred stock there was to be distributed to preferred stockholders one-third of a share of new common stock along with each share of new preferred stock issued in exchange for old preferred stock. The plan stated in part, as follows, with respect to the wiping out of the accumulated dividends in arrears: "For the unpaid cumulative preferred dividends prior to 1936, new preferred stock shall be issued pro rata in full liquidation of the same." In the case of any fractional shares in connection with the recapitalization, fractions were to be liquidated in cash. The plan of recapitalization called for the issuance of new shares of stock "in place of such outstanding shares of stock as follows": 1. For each share of outstanding common stock there*1186 shall be issued in exchange therefor 1 share of new common stock. 2. For 4 shares of outstanding 8 percent preferred stock of a par value of $25 there shall be issued in exchange therefor 1 share of new 6 percent preferred stock of a par value of $100, and along with each share of new preferred stock given in exchange for old, there shall be issued 1/3 of 1 share of new common stock. 4. New preferred stock shall be issued pro rata in full liquidation of unpaid, cumulative dividends prior to 1936. 5. In case of fractional shares, the Corporation will liquidate the fractions in cash. With respect to current dividends for the year 1936 the directors declared in November of 1936 a full dividend of $2 per share on the *116 $25 par value 8 percent preferred stock, payable out of earnings as of December 5, 1936, to stockholders of record November 20, 1936. At a meeting on December 1, 1936, the directors declared a dividend out of current earnings of $2.50 per share on the outstanding common stock to stockholders of record November 30, 1936, to be paid in cash or in common stock at $40 per share. Petitioner paid the above authorized and declared dividends in 1936 as*1187 follows: $11,060 in cash on the 8 percent preferred stock, and $38,637.50 in cash on the 15,455 shares of common stock outstanding. The Commissioner allowed petitioner a dividends paid credit under section 27(a) with respect to the above dividends paid in the total amount of $49,697.50. After November 30, 1936, all of petitioner's stockholders except 1 holder of 14 shares of the old 8 percent preferred stock entered into the plan of recapitalization. He refused the new preferred stock. Petitioner understood that under the laws of Ohio a stockholder could dissent from a recapitalization plan and, in that event, should be paid for his stock in cash. Accordingly, petitioner paid the dissenting stockholder $420 for his 14 shares of stock at the rate of $30 per share, plus $126 for accumulated dividends at the rate of $9 per share. The holders of the remaining outstanding old preferred 8 percent stock, in the total number of $5,516 shares, surrendered that stock in exchange for new 6 percent preferred stock in the number of approximately 1,379 shares of new stock, and they received, also, in the exchange approximately 459 shares of new common stock. The holders of common stock*1188 received 15,455 shares of new common in exchange for the same number of shares of the old common. In "liquidation" of the accumulated dividends in arrears on the old 8 percent preferred stock the holders thereof received 351 shares of new 6 percent preferred stock. Petitioner paid $3,610 in cash for fractional shares in connection. with all of the above in the recapitalization. In its income tax return for 1936 petitioner claimed a total dividends paid credit under section 27 in the amount of $88,407.50, of which amount respondent allowed a dividends paid credit in the amount of $49,697.50 for dividends paid in 1936 on outstanding preferred and common stocks prior to the recapitalization. Respondent disallowed credit for $38,710 representing $35,100 par value new 6 percent preferred stock distributed pursuant to the recapitalization, and $3,610 cash distributed in payment of fractional shares involved in the exchange of stock. OPINION. HARRON: Petitioner admits that there was a recapitalization in 1936 within the provisions of section 112(g)(1)(D) of the Revenue Act of 1936, and, consequently, a reorganization. There is no dispute about the facts. The stockholders of*1189 petitioner exchanged old stock *117 for new stock of the same corporation as an incident to a reorganization by recapitalization. A small amount of cash was distributed to the stockholders along with the new stock. In spite of petitioner's recognition that the exchanges in question were made pursuant to a reorganization, petitioner endeavors to find in the transaction a distribution of a taxable dividend to its stockholders so as to obtain a dividends paid credit under section 27(e). 1 Petitioner argues that old preferred stockholders received the new preferred stock in two ways: (1) That new preferred stock was given in exchange for old preferred stock at the rate of 1 share of new preferred stock for 4 shares of old preferred stock; and (2) that other new preferred stock was given in exchange for a release by each stockholder of his right to arrears in dividends, at the rate of 1 share of new stock having a par value of $100 per share for each $100 worth of dividends in arrears, or fractional shares of new stock were given for a lesser amount of dividends in arrears. The substance of this argument is that petitioner contends that it distributed a stock dividend along with*1190 the exchanges of preferred stocks in the transactions carried out pursuant to the reorganization. The main question is whether the distribution of part of the new preferred stock was a taxable dividend. The same question was presented in . Upon practically the same arguments from the taxpayer in that case, the court, in affirming this Board (see ), rejected the taxpayer's claim. The question here is, therefore, controlled by the Skenandoa case. See also, ; . In this case 5,516 shares of 8 percent preferred stock were exchanged for approximately 1,730 shares of new 6 percent preferred*1191 stock and 459 shares of new common stock. If we accept the contention, for purposes of argument only, that "the right to arrears of undeclared dividends was something in addition to the shares" of the old stock, and that, consequently, the stockholders received 351 shares of the new stock for release of a claim to arrears of undeclared dividends, nevertheless the 351 shares of new stock were "securities in a corporation a party to a reorganization." See As such, the exchange comes within section 112(b)(3), being an exchange of stock for stock and securities in a corporation a party to a reorganization, and the exchange is a nontaxable *118 exchange. It follows that a dividends paid credit can not be allowed for the 351 shares of the new stock because they were distributed in a nontaxable distribution, and section 27(h) 2 prohibits allowance of a dividends paid credit for nontaxable distributions. *1192 It is also pointed out that, even if it could be held, by some ingenious reasoning, that the 351 shares of new stock constituted a stock dividend, as petitioner claims, proof of the fair market value of the new stock was required, but none was offered at the hearing. See It should be noted, also, that petitioner did not declare a stock dividend and, consequently, section 115(f) is not applicable. See Petitioner also argues that the 351 shares of new preferred stock constituted a stock dividend within the meaning of section 115(f)(2). 3. We have already stated that we consider section 115(f) inapplicable. But, in further answer to petitioner's argument, the following applies. Petitioner refers to the General Code of Ohio, section 8623-72. Those provisions of the Ohio Code relate to relief to be given to a dissenting shareholder where articles of incorporation have been amended, or where reorganization of a corporation has been authorized. The "relief" given to a dissenting shareholder is payment of the fair cash value of his shares of stock, which is to be*1193 determined by a court of common pleas, as a last resort. Because of such relief provisions in the Ohio Code, petitioner argues that its shareholders had an election as to the medium of payment of the alleged "dividend." The plan of reorganization did not give petitioner's stockholders an election to take shares of new stock or cash at their option. The court in the Skenandoa Rayon case heard a similar argument, and answered it in the following words, which we apply here: "Had a large number of holders stood out for cash, the plan of recapitalization would no doubt have been abandoned." *1194 *119 It is held that petitioner is not entitled to a dividends paid credit under section 27(e) in the amount of $35,100 with respect to the distribution of the 351 shares of new stock. There is one other question remaining for consideration. Petitioner included in the total amount of the dividends paid credit which respondent has denied the $3,610 cash which was distributed in payment of fractional shares in the exchange of preferred stocks. Petitioner does not make clear under what subsection of section 27 it claims a credit for the cash distribution. No dividends, in cash or in stock, were declared on the old 8 percent stock which was surrendered under the exchange. The holders of the old stock received the cash as part of the exchange and only upon surrender of old stock. The cash distributed in the exchange can not be treated as a dividend for the same reasons that no part of the stock distributed can be treated as a dividend, under the rule of the South Atlantic Steamship Line and Skenandoa Rayon cases. Furthermore, under section 27(h), if any part of a distribution is not a taxable dividend in the hands of the shareholders, no dividends paid credit*1195 may be allowed. It appears that petitioner's claim for this credit must be on the ground that the cash distribution is a taxable dividend in the hands of the shareholders, and that a credit is allowable under section 27(a). Upon this issue the burden of proof is upon the petitioner. In , we held that a credit was allowable for similar distributions of cash which were made along with distributions of new stock in exchange for old stock, but the reason the credit was allowed was that the cash distributions were not shown to be not taxable to the distributees by the party upon whom the burden of proof rested. In other words, the credit was allowed for a failure of proof on the issue. In that case the respondent had allowed a dividends paid credit in an amount which included the cash distributions; later, he disallowed the credit by amending his answer, and, accordingly, the burden was upon the respondent to show that the credit should not be allowed. That burden required proof that the cash distributions were nontaxable in the hands of the distributees, so as to be barred from a credit by section 27(h). In this case, the burden is upon*1196 the Petitioner to prove that the cash distributions were taxable dividends in the hands of the distributees, so as to remove the bar to the credit contained in section 27(h). Petitioner has failed to meet the burden of proof, and, accordingly, must be denied a cedit for the cash distributions. The issue must be treated here in the same way that we treated the issue in the Weingarten case, although the result is the reverse. It is held that petitioner is not entitled to a dividends paid credit for the $3,610 cash distributions. Decision will be entered for the respondent. Footnotes 1. SEC. 27. CORPORATION CREDIT FOR DIVIDENDS PAID. * * * (e) TAXABLE STOCK DIVIDENDS. - In case of a stock dividend or stock dividend or stock right which is a taxable dividend in the hands of shareholders under section 115(f), the dividends paid credit with respect thereto shall be the fair market value of the stock or the stock right at the time of the payment. ↩ 2. SEC. 27. CORPORATION CREDIT FOR DIVIDENDS PAID. * * * (h) NONTAXABLE DISTRIBUTIONS, - If any part of a distribution (including stock dividends and stock rights) is not a taxable dividend in the hands of such of the shareholders as are subject to taxation under this title for the period in which the distribution is made, no dividends paid credit shall be allowed with respect to such part. ↩ 3. SEC. 115. DISTRIBUTIONS BY CORPORATIONS. * * * (f) STOCK DIVIDENDS. - * * * (2) ELECTION OF SHAREHOLDERS AS TO MEDIUM OF PAYMENT. - Whenever a distribution by a corporation is, at the election of any of the shareholders (whether exercised before or after the declaration thereof), payable either (A) in its stock or in rights to acquire its stock, of a class which if distributed without election would be exempt from tax under paragraph (1), or (B) in money or any other property (including its stock or in rights to acquire its stock, of a class which if distributed without election would not be exempt from tax under paragraph (1), then the distribution shall constitute a taxable dividend in the hands of all shareholders, regardless of the medium in which paid. ↩