Tiffany v. Commissioner , 16 T.C. 1443 ( 1951 )

Carter Tiffany, Petitioner, v. Commissioner of Internal Revenue, Respondent

Tiffany v. Commissioner

Docket No. 27780

United States Tax Court

16 T.C. 1443; 1951 U.S. Tax Ct. LEXIS 135;

June 29, 1951, Promulgated

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Decision will be entered under Rule 50.

Payment received by petitioner from corporation in exchange for stock therein in circumstances whereby he no longer retained any beneficial stock interest in the corporation, held not a taxable dividend under section 115 (g), Internal Revenue Code. James F. Boyle, 14 T.C. 1382">14 T.C. 1382, distinguished.

Randolph Paul, Esq., Meyer Kurz, Esq., and Howard Rea, Esq., for the petitioner.

John J. Madden, Esq., for the respondent.

Raum, Judge.

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RAUM

The respondent determined a deficiency in income and victory taxes in the amount of $ 126,223.63 for the calendar year 1943. The only issue now in dispute is whether $ 200,669.34 received by petitioner for 3,202 shares of stock of Air Cruisers, Inc., is taxable as a dividend under section 115 (g) of the Internal Revenue Code.

FINDINGS OF FACT.

A stipulation of facts filed by the parties is adopted as part of our findings.

Petitioner, an individual residing in Englewood, New Jersey, filed his income and victory tax return for 1943 with the collector of internal revenue for the third district of New York.

In 1929 petitioner became associated with Anthony H. Fokker, an airplane designer, inventor, and manufacturer, and remained with Fokker until Fokker's death in 1939, when he became sole executor under Fokker's will.

Air Cruisers, Inc., referred to sometimes hereinafter as the company, was a corporation engaged in manufacturing and selling airplane safety equipment. It was organized under the laws of Delaware in 1929 with an authorized capital stock of 10,000 shares, which was increased during the same year to 15,000 shares, but no more than 10,705 shares were ever issued and outstanding. In 1931 and for some years thereafter the financial condition of the company was exceedingly precarious. Petitioner, at the suggestion of Fokker, purchased 5,600 shares of Air Cruisers stock for one dollar in 1931. He became a vice president and director in 1932.

Prior to his death in July 1943, Earl F. Glover was the business manager and financial head of the company, serving as president and treasurer. James F. Boyle was secretary and chief engineer; he became president after Glover's death. Thomas P. Vaughan succeeded Glover as treasurer.

During the early days, Glover and Boyle received small salaries. Petitioner received no salary until 1941; he had various other interests both before and after 1941, and his services to the company were not on a full-time basis. In August 1939, petitioner transferred as a gift 2,150 shares of Air Cruisers stock to Glover and 448 shares to Boyle. These gifts made the stockholdings of petitioner, Boyle and Glover approximately equal. Beginning with the period immediately prior to May 11, 1943, the stockholders of record of Air Cruisers were, on the dates and for the periods indicated, as follows:

		5/11/43	12/13/43	12/18/43
Stockholder	Prior to	to	to	to
	5/11/43	12/13/43	12/18/43	5/16/44
James F. Boyle	3,095	3,602	300	300
Glover	2,995	3,501	3,501	3,501
Petitioner	2,995	3,502	300	300
H. P. Morris	100	100	100
Pelham Bissell	710
Adrian Van Muffling	810
Treasury Stock			6,504	6,504
Vaughan				50
Harry A. Gerrish				50
Total	10,705	10,705	10,705	10,705

	5/16/44	5/18/45
Stockholder	to	to	After
	5/18/45	5/29/45	5/29/45
James F. Boyle	300	300	300
Glover	3,501
Petitioner
H. P. Morris
Pelham Bissell
Adrian Van Muffling
Treasury Stock	6,504	10,005	9,805
Vaughan	200	200	300
Harry A. Gerrish	200	200	300
Total	10,705	10,705	10,705

The foregoing table is based upon the records of the company, and is not necessarily accurate as to beneficial ownership of the stock for the periods involved.

The 2,995 shares owned by petitioner immediately prior to May 11, 1943, were part of the shares originally acquired by him in 1931. On May 11, 1943, petitioner purchased 507 shares, Glover 506 shares, and Boyle 507 shares of the total of 1,520 shares owned by Pelham St. George Bissell and Adrian Van Muffling. Petitioner paid $ 20 a share, or a total of $ 10,140 for his 507 shares.

The company's gross sales rose from practically zero in 1939 to about $ 10,000,000 in 1942 and 1943, and were about $ 7,000,000 in 1944. During these latter years over 95 per cent of its sales were to the United States Government. The company was indebted to the Fokker estate on a note in the amount of $ 107,316.56. The parties appear to be of the impression that no dividends could be paid while the note was outstanding. However, no such prohibition appears on the face of the note. By the end of 1942, the company was in a strong financial position, and the note could easily have been paid at that time. Moreover, by its terms, the note could have been discharged by the issuance of preferred stock, but petitioner opposed the issuance of preferred stock as adverse to the interests of the estate, and Glover and Boyle had told petitioner that they would not cause the note to be paid off in preferred stock over his objections.

Petitioner's relationships with the other officers and directors of the company were generally cordial from 1931 to 1940, but beginning in 1940 friction developed, particularly between Glover and petitioner. A disagreement also arose in 1943 between Boyle and petitioner, after Glover's death, that resulted in strained relations.

Notwithstanding the company's prosperity during the war, it had never declared or paid any dividends, nor had it taken any steps to discharge the Fokker note, which may have been regarded as an obstacle to the payment of dividends. During 1943, a salary of $ 62,500 was paid to Glover or to his estate, $ 62,500 to Boyle, $ 20,000 to petitioner, and $ 15,083.31 to Vaughan.

In the spring of 1943 the company's war contracts were renegotiated, and during 1943 it paid a renegotiation liability of $ 1,700,000 for 1942. Subsequent thereto, the prices charged by the company were scaled downward, and the possibility of renegotiation for subsequent periods was considerably diminished. The company's December 31, 1943, balance sheet made no provision for any renegotiation liability for 1943, and renegotiation proceedings for the year 1943 in fact resulted in a determination of no liability. The company's cash on hand as of December 31, 1943, after the purchases of stock from petitioner and Boyle on December 13, 1943, hereinafter described, was $ 476,294.05. The surplus shown on the company's books as of December 31, 1943, was $ 629,317.24.

Glover's will appointed Harry A. Gerrish, the company's attorney, as executor. Caveats protesting probate of the will were filed by Glover's divorced wife and son on August 6, 1943, and September 7, 1943, respectively. On March 30, 1944, the Passaic County Surrogate's Court, New Jersey, dismissed the caveats and authorized Gerrish to administer the estate. No temporary administrator was appointed prior to March 30, 1944.

Petitioner was dissatisfied with the company's failure to pay dividends. In addition, as a result of strained personal relations, and possibly for other reasons as well, petitioner was anxious to dispose of his stock in the company.

At a meeting with Glover and Boyle some time prior to the fall of 1942 at which there was violent disagreement between Glover, Boyle and petitioner, petitioner offered to sell all his stock to Glover and Boyle for $ 75,000. They did not accept his offer. Late in 1942 or early in 1943, petitioner offered his stock to Gerrish and Clyde D. Yeomans, the company auditor, but the offer was not accepted.

In 1942 and 1943, petitioner participated in various negotiations looking towards the sale of all of his stock as well as Glover's and Boyle's stock to outside interests. After Glover's death in July 1943, petitioner held conferences with a Colonel Davis regarding a possible sale of petitioner's and of Boyle's stock to the Pharis Tire and Rubber Company. Gerrish had not yet qualified as executor of Glover's will as a result of the litigation which delayed probate of the will. Boyle agreed orally to the Pharis sale, but withdrew at the last moment when the contract was to be signed. Since Pharis was interested in acquiring at least a majority of the outstanding stock, the entire deal collapsed. Petitioner was incensed at Boyle because of Boyle's refusal to adhere to his oral commitment. Petitioner was so angry that he refused to see Boyle again, stayed away from the factory, and threatened Boyle with lawsuits.

Thomas P. Vaughan had been an employee of the company since 1931. He became assistant treasurer and assistant secretary in 1941. He first became a stockholder in the company on December 18, 1943, when he and Gerrish each purchased 50 shares of the 100 shares owned by H. P. Morris.

Late in November 1943, Gerrish visited petitioner in his New York office and proposed a sale of petitioner's stock to the company itself at book value. Petitioner assented. On December 1, 1943, at a subsequent meeting between Gerrish and petitioner, Gerrish requested petitioner to turn over to him 300 shares in connection with the transaction. Petitioner agreed to do so. However, at Gerrish's request, the transfer of the 300 shares was not made to Gerrish outright. Instead, petitioner, on December 1, 1943, signed an option agreement, conferring on Gerrish the right to purchase 300 shares of the company's stock at 10 cents a share at any time prior to 1954. The option agreement recited that petitioner would deposit the 300 shares with one Otto Cooper (an associate of Gerrish), as trustee, and petitioner in fact endorsed a certificate for 300 shares in blank on December 1, 1943, and simultaneously delivered it to Gerrish. Petitioner also conferred on Gerrish the irrevocable right to vote the stock, and simultaneously executed a document, appointing Gerrish as his proxy from December 1, 1943, until January 1, 1954. Gerrish took the documents to his office and put them in the safe of Otto Cooper, whom petitioner had never met. Petitioner never saw the documents again.

The book value of the stock on December 1, 1943, was $ 62.67 per share. It was understood between petitioner and Gerrish that the consideration of 10 cents a share mentioned in the option agreement would not be paid, and in fact it was never paid, nor was any other consideration paid in connection with the option agreement. Beginning with December 1, 1943, Gerrish considered himself as having supplanted petitioner as the owner of the 300 shares.

At some time on or before December 1, 1943, petitioner learned that the company's purchase of his shares at book value was to be accompanied by a similar purchase at the same price of stock owned by Boyle.

On December 13, 1943, the directors and shareholders of the company, at special meetings held for the purpose, agreed to accept the offers of petitioner and Boyle to surrender to the company 3,202 shares and 3,302 shares, respectively, of the stock of the company for the respective amounts of $ 200,669.34 and $ 206,936.34. On the same day, petitioner and Boyle each delivered to the company certificates representing the number of shares ascribed to him above.

The shares acquired by the company from petitioner and Boyle were not cancelled but were held by the company as treasury stock and were carried on its books as assets in an investment account with no reduction of or charge to surplus therefor. The balance sheets set forth on the income tax return filed by the company for 1943, 1944, and 1945 indicate that a charge to surplus was made in connection with the transfer of the shares of petitioner and Boyle to the company.

After his transfer of 3,302 shares to the company on December 13, 1943, Boyle continued to hold 300 shares of stock of the company. He also continued to play an active role in the management of the company as president and director. For the year 1944 Boyle received $ 45,000 as salary or compensation for services rendered.

After December 1, 1943, petitioner had no beneficial interest in the 300 shares delivered to Gerrish. After his transfer of 3,202 shares to the company on December 13, 1943, he had no further beneficial stock interest in the company.

The directors' meeting of December 13, 1943, was attended by Boyle, Vaughan, Gerrish and petitioner. Boyle was elected president and secretary of the company to succeed Glover. Vaughan was elected vice president and treasurer. Petitioner was elected a vice president to serve until the next annual meeting and accepted the office. Petitioner had stated that he would like to be elected vice president and director so that he would be in a position to discharge his duties to the Fokker estate. However, he was reminded that his salary would stop at the end of 1943, and petitioner acquiesced. Petitioner did not in fact serve after December 13, 1943, and was not thereafter reelected at the directors' and stockholders' meetings in March 1944.

Gerrish assumed and performed the duties of vice president and director formerly performed by petitioner shortly after December 1943. He was formally elected vice president on March 30, 1944, receiving compensation retroactively to January 1, 1944, at $ 20,000 a year. Petitioner's annual salary of $ 20,000 terminated in December 1943, and he received no salary for 1944 from the company.

On December 29, 1943, petitioner received payment in the amount of $ 200,669.34 for the stock which he sold to the company. In 1944 he received a check representing a small balance of his 1943 salary. After December 13, 1943, he never received any payments, other than the foregoing, from the company.

After December 13, 1943, petitioner did no further work for the company. He had no further association or contact with the stockholders and officers of the company, except for communications with Gerrish regarding payments of principal and interest on the Fokker note, and was never consulted by the stockholders or officers in any capacity. Petitioner never saw the officers or stockholders again until he was called as a witness in the case involving Boyle's tax liability for 1943, except for a brief chance encounter in 1947. Petitioner never visited the company's plant again except for a five-minute visit on December 29, 1943, to collect the check for the purchase of his stock. Petitioner regularly attended all meetings of the directors and shareholders of the company until December 13, 1943. After December 13, 1943, he never received notice of or attended any directors' or shareholders' meeting of the company.

Gerrish was in a position at any time after December 13, 1943, to record or to have recorded on the stock book of the company the transfer of the certificate for 300 shares to himself or anyone else. On May 16, 1944, Gerrish did fill in the blank on the back of the certificate with his name and the name of Vaughan, recorded the transfer on the stock book of the company, and caused two certificates for 150 shares each to be issued in lieu thereof to himself and Vaughan. Vaughan paid nothing to Gerrish for these 150 shares. Petitioner never received any notice that the option of December 1, 1943, had been exercised and that Gerrish had transferred the 300 shares to himself and Vaughan; he never expected to receive any such notice.

On May 17, 1945, at meetings of the company's board of directors and stockholders, it was determined to offer to purchase the 3,501 shares held by the Glover estate for $ 62.67 per share. The book value of the stock was considerably higher at that time. The residuary legatees were granted an option to repurchase any portion of the stock so acquired by the company, to the extent of their respective legacies for $ 62.67 per share, provided that the option were exercised on or before June 1, 1945. Vaughan and Gerrish were among the residuary legatees, and shared to the extent of one-sixth each. They were the only residuary legatees to exercise the option, and although each could have repurchased over 500 shares, each in fact repurchased 100 shares. As a result, Boyle, Vaughan, and Gerrish thereafter owned 300 shares each, and no other shares were outstanding, apart from the repurchased shares being held as treasury stock.

Petitioner did not learn until 1947 that there had been a sale of the stock of the Glover estate. Whatever may have been the plans of Boyle, Gerrish, and Vaughan, petitioner's sole purpose in selling his stock to the company was to part with all his interest in the company.

During 1943 and prior years petitioner had activities outside of the company and other sources of income. He handled various matters for Fokker until Fokker's death in 1939. He was a partner in the brokerage house of Gamwell & Company from 1941 to 1945, although he was relatively inactive in that concern in 1943. He received substantial receivership fees in 1943. Air Cruisers, Inc., furnished practically the sole activity for Boyle and Glover.

None of the sales of stock to the company was based upon any purpose to decrease any of the company's activities. The company remained in business and was later dissolved in 1949.

The transfer of shares owned by petitioner and transferred to Air Cruisers, Inc., constituted an outright purchase by the company and a sale by petitioner. The payment of $ 200,669.34 to petitioner in December 1943 was not made at such time and in such manner as to be a dividend or essentially equivalent to a taxable dividend.

OPINION.

In James F. Boyle, 14 T.C. 1382">14 T.C. 1382, affd. (C. A. 3), 187 F.2d 557">187 F.2d 557, we held that Boyle's proceeds from the December 13, 1943, sale of stock to the company constituted a taxable dividend to him under section 115 (g) of the Internal Revenue Code. ¹ We gave weight to the fact that at the inception of the transaction there were three principal stockholders, and that upon completion of the various steps (including the disposition of the stock of the Glover estate), three principal stockholders remained holding their shares in virtually equal proportions.

Thus, when all the smoke cleared away, Boyle emerged with a substantially identical fractional interest in the corporation. We noted that the transaction had "too many appearances of being interrelated parts of a single operation to discard the suggested test of the Flanagan case [Helvering v. Flanagan (C. A. D. C.), 73 App. D.C. 46">73 App. D.C. 46, 116 F.2d 937">116 F.2d 937, 939] as to the 'net effects of the distribution.'" As to Boyle, the December 1943, payment constituted in practical effect nothing more than a distribution of corporate profits to one whose ultimate fractional stock interest in a going concern was not substantially altered.

Respondent contends that the same result is required here, placing great stress upon the fact that petitioner similarly retained 300 shares (the same number of shares retained by Boyle), and that it was not until some months later, in May 1944, that petitioner ceased being a stockholder of record. We think there is a crucial difference between this case and the Boyle case.

We are satisfied that petitioner did not retain any beneficial interest whatever in any stock of the company after December 13, 1943. Although it is true that he remained a stockholder of record, to the extent of 300 shares, until May 16, 1944, the fact is that he delivered those shares, endorsed in blank, to Gerrish on December 1, 1943, accompanied by an irrevocable proxy entitling Gerrish to vote the stock. There was never any intention that the formalities described in the option agreement would ever be carried out; it was the understanding of both petitioner and Gerrish that by the transfer of December 1, 1943, petitioner parted permanently with all interest in the 300 shares at that time. Thus, after the sale of December 13, 1943, petitioner no longer retained any beneficial stock interest whatever. His situation was wholly different from Boyle's. He sold all of his stock. The transaction was not the equivalent of the distribution of a taxable dividend as to him. We conclude that, on the facts of this case, section 115 (g) has no application to petitioner.

Decision will be entered under Rule 50.

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Footnotes

• 1. SEC. 115. DISTRIBUTIONS BY CORPORATIONS.

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  (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.↩