Graf v. Commissioner

HERBERT R. GRAF, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. ETHEL ALFRED GRAF, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Graf v. Commissioner Docket Nos. 104623, 104624. United States Board of Tax Appeals 45 B.T.A. 386; 1941 BTA LEXIS 1125; October 21, 1941, Promulgated *1125 INCOME OF ASSIGNOR. - Dividends were not taxable to an assignor who had sold, for a valuable consideration in cash, a participating interest in the shares which gave to the assignees ownership of a substantial beneficial interest in the shares, including the right to and control over the dividends. Fernando J. Cuquet, Jr., Esq., for the petitioners. Stanley B. Anderson, Esq., for the respondent. MURDOCK *386 The Commissioner determined a deficiency of $44.08 as to each petitioner for the calendar year 1937. The sole issue for decision is whether or not dividends in the amount of $1,650 should be included in the community income of these petitioners. FINDINGS OF FACT. The petitioners are a husband and wife, residing in New Orleans, Louisiana. Each filed a separate return for the taxable year reporting one-half of the income of the community. Herbert R. Graf, hereinafter referred to as the petitioner, has been in charge of the New Orleans branch of C. E. Bickford & Co. for many years. That corporation engaged in the coffee brokerage *387 business. Its principal office is in San Francisco and it has branch offices in New Orleans*1126 and New York. Harold V. Alfred and Joseph J. Morris have been the chief and only assistants of the petitioner at the New Orleans branch for many years. The petitioner and those two men owned shares of the nonvoting preferred stock of the corporation up to 1930, the petitioner owning 170, Alfred 50, and Morris 10 shares. The company was reorganized in 1930, at which time all of the preferred stock was called in and canceled. The stock of the company thereafter consisted of 1,000 shares of common stock, each of the par value of $100. The petitioner was allotted 163 1/3 shares, others were allotted to the manager of the New York branch, and the remaining 510 shares were retained by a New York interest. The 163 1/3 shares allotted to the petitioner thereafter remained in his name at all times material hereto. No shares of the reorganized company were allotted to Alfred or Morris. The petitioner considered them to be very important to his successful operation of the New Orleans branch and desired that they should participate in the earnings of the company as they had participated prior to the reorganization. He sought to transfer some of his shares to them. The minority stockholders*1127 were obligated to offer their shares to the owner of the majority of the stock before they could dispose of them to any third party. The petitioner believed that if he offered his shares to the owner of the majority of the stock, that owner would purchase his shares. He, personally, drew up and entered into a contract, as follows, to enable Alfred and Morris to have an interest in the company as far as that was possible: It is agreed by all three undersigned parties that Herbert R. Graf, for the cash consideration of Five Thousand ($5,000.00) Dollars, payment of which is hereby acknowledged, sells to Harold V. Alfred, the participating interest in forty (40) shares out of Herbert R. Graf's entire holdings of One Hundred Sixty Three and One Third (163 1/3) shares of stock in C. E. Bickford & Co., and that Herbert R. Graf, for the cash consideration of One Thousand ($1,000.00) Dollars, payment of which is hereby acknowledged, sells to Joseph J. Morris, the participating interest in ten (10) shares out of Herbert R. Graf's entire holdings of One Hundred Sixty Three and One Third (163 1/3) shares of stock in C. E. Bickford & Co. It is clearly understood by all of the undersigned*1128 parties that the entire One Hundred Sixty Three and One Third (163 1/3) shares of stock in C. E. Bickford & Co. are owned solely by Herbert R. Graf and that the above sale refers only to the participating interest. It is also understood that in the event of the death and/or severance of connection of Herbert R. Graf from C. E. Bickford & Co., Harold V. Alfred and Joseph J. Morris shall receive the full sale value of forty and ten shares respectively. It is further understood that in the event of the death and/or severance of connection with C. E. Bickford & Co. of Harold V. Alfred and/or Joseph J. *388 Morris that their stock participation will be settled in full by returning to them their original investment of Five Thousand ($5,000.00) Dollars and One Thousand ($1,000.00) Dollars respectively. It is also understood by all parties that in the event that at some subsequent date C. E. Bickford & Co. should issue additional stock or inaugurate a system of cash bonus whereby Harold V. Alfred and/or Joseph J. Morris should receive, in the estimation of Herbert R. Graf, a fair and equitable compensation, then this agreement would again be subject to cancellation by the*1129 refunding to both Harold V. Alfred and Joseph J. Morris of Five Thousand ($5,000.00) Dollars and One Thousand ($1,000.00) Dollars respectively. Alfred and Morris were also parties to the above contract, but the corporation was not a party to it. The petitioner received the $5,000 from Alfred and the $1,000 from Morris, referred to in the above contract, and thereafter whenever dividends were paid on the 163 1/3 shares of stock, he transferred to Alfred an amount equal to the dividends on 40 shares and to Morris an amount equal to the dividends on 10 shares. Dividends in the total amount of $33 a share were declared in 1937, as a result of which the petitioner received $6,750. He then paid Alfred $1,320 and Morris $330 in 1937. The entire amount of $6,750 received by the petitioner as dividends on the 163 1/3 shares of stock was reported by the petitioners as income on their returns for 1937. They claimed deductions on those returns for the amounts paid to Alfred and Morris. The Commissioner, in determining the deficiencies, disallowed the deductions. OPINION. MURDOCK: The respondent contends that the dividends in question were properly taxed to the petitioner, since*1130 the latter had not sold any property right in the stock from which the dividends flowed but had assigned only the right to receive dividends to be declared in the future, citing ; ; and . Those cases, and also the recent case of , involved gifts, whereas the present case involves a sale for a valuable and substantial consideration in cash. Bond coupons, soon to become due and payable, were assigned in the Horst case. The right to receive renewal commissions on insurance was given in the Eubank case. The gift in the Schaffner case was of specified amounts in dollars to be paid from the income for the following year of a testamentary trust of which the taxpayer was the life beneficiary. The Court held in each of those cases that the income was taxable to the assignor upon the principle that control over income or the power to dispose of it is the equivalent of ownership and the exercise of that power by procuring payment to another is a realization of*1131 income within section 22(a). That is, the one who owns or *389 controls the source of the income, and with it controls the disposition of the income, can not escape tax by any anticipatory assignment of the income, since such an assignment is the satisfaction of his wants and a realization of income. The Court recognized, however, that a gift of the ownership, or equitable ownership, of the property producing the income relieves the donor from tax on the income thereafter arising from that property. . See also ; ; . The beneficiary of a trust in the Blair case assigned a share of the income to another for life without retaining any form of control over the interest assigned. The Court held that the assignment was a transfer in praesenti ofa life interest in the corpus and the income was, therefore, taxable to the donee. The Court said in the last paragraph of the Schaffner opinion that future decisions will have to determine precisely where the line shall be drawn between*1132 gifts of income-producing property and gifts of income from property of which the donor remains the owner for all substantial and practical purposes. The transaction in the present case is described in the contract as a sale. A purchase price was agreed upon and paid in cash. There was no element of a gift involved. The petitioner was free to do as he pleased with the purchase price. The record shows that he intended to sell to Alfred and Morris just as great an interest in the shares as was possible and went as far in that direction as he could. His contract with the corporation prevented him from making a complete transfer of the 50 shares to Alfred and Morris, in accordance with his desire, and required him to retain legal title to the shares. That is apparently what is meant in the second paragraph quoted above from the agreement. The respondent makes no contention that the contract was illegal or failed to accomplish the purpose of the parties. It effected some present transfer of interest in the shares. The interest sold was substantial. It was greater than the mere right to receive dividends and carried that latter right as an incident of the larger interest transferred. *1133 Thus, the petitioner did not remain the owner of the shares for "all substantial and practical purposes." The full sale price was to go to Alfred and Morris, not to the petitioner, if the shares were ever thereafter sold. The parties could cancel the agreement under certain circumstances, but in that case the petitioner was required to repurchase the shares and pay $6,000 for them. He was required to do the same in case Alfred or Morris should die or sever connection with the firm. The contract does not clearly show the extent to which Alfred and Morris could control any later sale of the shares or whether they acquired any voting rights in the shares. It is unnecessary to determine just exactly *390 how many incidents of ownership in the shares were acquired by Alfred and Morris, since the taxing acts are not so much concerned with the refinements of title as with the actual command over the income which is taxed and the actual benefit for which the tax is paid. Dividends are not mentioned in the contract, but it is obvious that the parties, by the words "participating interest", meant something more than the mere right*1134 to receive dividends. Alfred and Morris obtained substantial rights of ownership in the shares as a result of which they obtained command over the dividends, if any should ever be paid, and they alone benefited from subsequent dividends. The petitioner received the dividends on the 50 shares, not as his own property or not as dividends on property which he owned, but on behalf of Alfred and Morris, who owned beneficial interests in the shares which entitled them to all dividends. Cf. . The $1,650 was not properly a part of the income of these petitioners. Reviewed by the Board. Decision will be entered under Rule 50. VAN FOSSAN and KERN dissent. LEECH LEECH, dissenting: Despite the payment or deposit of money by Alfred and Morris, I think the disposition of this case is controlled by the underlying rationale of James D. Robinson,45 B.T.A. 39. Respondent should be affirmed. MELLOTT agrees with the above dissent.