Smith v. Commissioner , 38 B.T.A. 317 ( 1938 )

WILLIAM A. SMITH, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Smith v. Commissioner

Docket No. 90703.

United States Board of Tax Appeals

38 B.T.A. 317; 1938 BTA LEXIS 882;

August 11, 1938, Promulgated

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1. The acquisition of its stock by a corporation from petitioner constituted a purchase of such stock and not a distribution by the corporation in partial liquidation. Northern Trust Co., Trustee,20 B.T.A. 866">20 B.T.A. 866; affd. sub nom. Phelps v. Commissioner, 54 Fed.(2d) 289, distinguished.

2. Since such stock had been held by the petitioner for more than five and less than ten years, only 40 percent of the realized gain is recognized for tax purposes under the Revenue Act of 1934, section 117.

Edward J. Brunenkant, Esq., for the petitioner.

Elmer L. Corbin, Esq., for the respondent.

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LEECH

Respondent determined a deficiency in income tax against the petitioner for the calendar year 1935 in the amount of $3,735.82. The petitioner admittedly realized a profit of $44,550 upon the transfer of 45 shares of stock of the Smith Incubator Manufacturing Co. to that company for a consideration of $45,000. The respondent has taxed the entire gain thereon as a distribution of the corporation in partial liquidation, under the provisions of the Revenue Act of 1934, section 115(c). Having owned this stock for over five years, petitioner claims that only 40 percent of the gain is recognized for tax purposes under the provisions of section 117 of that revenue act.

From the stipulation of facts and testimony, we make the following findings of fact.

FINDINGS OF FACT.

The petitioner is a citizen of the State of Ohio, and was a director, treasurer, and general manager of the Smith Incubator Manufacturing Co. That company is an Ohio corporation with its principal place of business at Cleveland, Ohio. It was organized in 1925 with an authorized capital stock of 1,000 shares, all of which was owned by its president, Samuel B. Smith, a brother of the petitioner. On July 9, 1930, the petitioner purchased from Samuel B. Smith 45 shares of the common stock of the Smith Incubator Manufacturing Co. for $10 per share. The common stock of this company was without par value but had a stated value on its books of $10 per share. Petitioner, in need of money, offered to sell his stock to the corporation. A special meeting of the board of directors of the corporation was held at Cleveland, Ohio, on August 31, 1935, to consider that offer. In the minutes of that meeting appears the following:

Pursuant to the foregoing waiver of notice, The Board of Directors of The Smith Incubator Manufacturing Company met at the office of the Company at Cleveland, Ohio, at 10:30 A.M. on the 31st day of August 1935.

The following Directors of the Corporation were present: Samuel B. Smith, C. R. Jenny, W. A. Smith, S. Harold Smith.

The meeting was called to order by the President, Dr. Samuel B. Smith. The President stated that the purpose of the meeting was to consider an offer made, by W. A. Smith, to sell forty-five (45) shares of the Common Stock of The Smith Incubator Manufacturing Company to the company. After considerable discussion it was decided that Samuel B. Smith be authorized, on behalf of the company, to enter into an agreement with W. A. Smith for the purchase of said stock at a price to be agreed upon between them. The following resolution was, upon motion duly made and seconded, unanimously passed by the affirmative vote of all Directors present.

RESOLUTION

"BE IT RESOLVED, That Samuel B. Smith, President of The Smith Incubator Manufacturing Company, be and he is hereby authorized to purchase, on behlf of the company, forty five (45) shares of the Common Stock of The Smith Incubator Manufacturing Comapny, from W. A. Smith, for a price to be agreed upon between said Samuel B. Smith and W. A. Smith."

There being no further business to come before the meeting, the same was, by motion duly made, seconded and unanimously adopted, adjourned.

[Signed] S. B. SMITH,

President.

[Signed] A. H. DORENKOTT, Secretary.

A price of $1,000 per share having been agreed upon between the petitioner and Samuel B. Smith, president of the company, the petitioner transferred his 45 shares of stock to the company for $1,000 per share or an aggregate consideration of $45,000. The book value of that stock was then in excess of $1,000 per share. This stock has never been canceled but has, at all times since this acquisition, been carried on the books of the company as treasury stock. During 1935, after the acquisition of the 45 shares of stock by the corporation from the petitioner, Samuel B. Smith transferred, by gift, 448 shares of stock to seven or eight employees and relatives, including the petitioner who was then given 10 shares. No shares of the stock of this company, other than the 45 shares belonging to petitioner, were acquired by the company during 1935. In 1936, 20 shares of such stock were acquired by the company from Harold Smith and a like amount from Mrs. E. P. Smith for a consideration of $450 per share. After such acquisition, these shares were not canceled but were also carried as treasury stock by the company. The 20 shares acquired from Harold Smith were later reacquired by him from the corporation for $450 per share plus accrued interest at 6 percent.

Each such acquisition of 20 shares was accomplished by the issuance of a voucher of the corporation for $9,000 and was reported on the books of the company by charging $200 to treasury stock and the balance to surplus. The reacquisition of the 20 shares by Harold Smith for $9,000 was reflected on the books of the company by the entry of a credit of $9,000 to cash, the entry of a credit of $200 to treasury stock, and the balance of $8,800 credited to the surplus account.

The transaction, in which the Smith Incubator Manufacturing Co. acquired 45 shares of its common stock from the petitioner, in 1935, constituted a sale of that stock by the petitioner to the company and was not a distribution in partial liquidation.

OPINION.

LEECH: The sole question for consideration is whether the transaction, upon which the disputed tax arises, was a sale of stock to the corporation or a distribution in partial liquidation by the corporation to the petitioner. If it was a sale, only 40 percent of the gain therefrom is taxable to petitioner under the provisions of section 117 of the Revenue Act of 1934. If it constituted a distribution by the company in partial liquidation, the entire gain is taxable to the petitioner under the provisions of section 115(c) of the same revenue act.

Obviously, the transaction purported to be a sale. It was so designated by resolution of the corporation. Petitioner testified it was a sale. Apparently, all the elements of a sale were present. Thus, unless it actually constituted a distribution in partial liquidation, the transaction must have been a sale and the gain therefrom so taxable.

In , the Board states:

* * * Liquidation is not a technical status which can be assumed or discarded at will by a corporation by the adoption of a resolution by its stockholders, but an existing condition brought about by affirmative action, the normal and necessary result of which is the winding up of the corporate business.

Section 115(i) of the Revenue Act of 1934 defines the term "partial liquidation" as a "distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock."

Partial liquidation is merely liquidation less than complete. Whether the transaction in question constituted a distribution in partial liquidation is entirely factual. ; ; affd., .

In , the Board considered a somewhat similar question which arose on very different facts. There, pursuant to resolution authorizing the president to purchase, for the corporation, shares of outstanding capital stock for a price not exceeding that designated, the president acquired all the stock of four of the five stockholders and a part of the stock held by its president, within two weeks after which, by proper resolution, the authorized capital stock of the company was decreased from 7,500 to 300 shares, consisting of that held by its president, and the remaining 7,200 shares were then retired and canceled. In its return for 1922, it was stated that the corporation was "now in process of liquidation." In its return for 1924 it was stated that "This corporation was not engaged in business during the preceding year."

The Board decided, on those facts, that the acquisition of this stock from the stockholders constituted a distribution by the corporation in partial liquidation. In that case four of the five stockholders of the corporation sold all of their stock to it and one retained only sufficient of his to represent the assets retained by the corporation. The stock thus acquired by the corporation was, by resolution, canceled. The outstanding capital stock was, by proper action, correspondingly reduced. The company was thus partially liquidated. It did not continue business but proceeded to wind up its affairs and so stated in its income tax return to the Government. The evidence, thus, clearly established that the intention of the corporation was not to purchase its stock but to liquidate it. That was what it did.

The evidence discloses the opposite situation here. The record convincingly supports the correctness of the designation of the transaction by the parties. The petitioner owned only 45 shares of the 1,000 outstanding shares of stock. That stock has never been canceled but has always been carried by the corporation was treasury stock since its acquisition. The two blocks of 20 shares, each, acquired from stockholders in 1936, were not canceled and were similarly carried as treasury stock, 20 shares of which were subsequently reissued. The dissimilarity of the consideration received by the petitioner and those who transferred their stock to the corporation in 1936 is not persuasive of anything here. The corporation has never reduced its outstanding capital stock. Its capital structure has never been changed. It has not, in fact, liquidated to any extent. Although in no sense controlling, the purchase of its stock by a corporation is legal in Ohio. General Code of Ohio, sec. 8623-41.

The distinction between the facts in the , and those here is pointedly drawn by the Seventh Circuit Court of Appeals in its opinion affirming that case in . The court there said:

It is quite probable, as petitioners suggest, that the sale of stock to a corporation by one shareholder would be considered as a sale rather than as a liquidating dividend, for the action of one of several stockholders could not well be considered as evidence of an intention of all the stockholders; but in the instant case the Board evidently considered the concerted action of all the directors and stockholders in the disposition of practically all the stock as probative of the intention of the company to liquidate, and we think the Board was right in so considering it.

In short, there is not the slightest evidence that the corporation intended a liquidation of petitioenr's stock except a possible inference from the treatment on its books of the two similar transactions in 1936. In no event are these records controlling. ; .

We conclude that the acquisition of petitioner's 45 shares of its stock by the Smith Incubator Manufacturing Co. was, as it was intended and purported to be, a purchase of that stock by the corporation and not a distribution in partial liquidation.

Decision will be entered for the petitioner.