Court Opinion

ID: 4602048
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:28:53.29452+00
Date Added: 2024-06-11T07:52:36.171720
License: Public Domain

WILLIAM H. GRIMDITCH, PETITIONER, ET AL., 1v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.  Grimditch v. CommissionerDocket Nos. 78002, 78003, 78004, 78005, 78006, 78015, 78016, 78047.United States Board of Tax Appeals37 B.T.A. 402; 1938 BTA LEXIS 1045; February 23, 1938, Promulgated *1045  Redemptions of preferred stock held to be essentially equivalent to the distribution of taxable dividends within the provisions of section 115(g) of the Revenue Act of 1928.  Charles C. Norris, Esq., and Philip D. Dechert, Esq., for the petitioners.  R. P. Hertzog, Esq., for the respondent.  VAN FOSSAN *402  These proceedings were brought for the redetermination of deficiencies in petitioners' income taxes for the year 1931.  The deficiencies are as follows: William H. Grimditch$8,990.62J. H. Carmine200.48E. W. Shepherd496.83Thomas A. Kennally1,438.31D. J. MacKillop1,598.65Estate of Mrs. C. L. McWhorter, Deceased, Charles L. McWhorter, Executor$406.27Charles L. McWhorter255.34Louis M. Kelly785.16The sole issue is whether redemptions of first preferred and second preferred stock of the Philadelphia Storage Battery Co. during 1931 were distributions essentially equivalent to taxable dividends within the meaning of section 115(g) of the Revenue Act of 1928.  The parties filed a stipulation of facts, including various exhibits, which stipulation was supplemented by oral testimony presented at*1046  the hearing.  FINDINGS OF FACT.  The petitioners herein, during the year 1931, were stockholders of the Philadelphia Storage Battery Co. and received certain sums during that year upon the redemption of its preferred stock.  These amounts were treated as proceeds from the sale of stock and were reported as such on the income tax returns filed by the respective petitioners.  *403  The Philadelphia Storage Battery Co., hereinafter referred to as the corporation, was organized under the laws of Pennsylvania in 1906 to engage in the business of manufacturing electric storage batteries.  The authorized capital stock of the corporation in the early part of 1917 consisted of 5,000 shares of common stock of the par value of $100, of which there were 3,000 shares issued and outstanding in the name of five individuals.  The surplus at this time was approximately $300,000.  The stock issued and outstanding originally was 2,000 shares, but this was increased to 3,000 shares by a 50 percent stock dividend shortly prior to 1917.  Early in 1917 it became necessary to rearrange the executive personnel and to increase the number of persons actively engaged in the management of the corporation. *1047  A plan was formulated to provide means whereby the younger executives and employees might acquire stock in the corporation, thereby increasing their interest in the corporation's success.  The operation of this plan over the period from its formulation to the end of 1931 worked a gradual increase of the proportionate interest of the younger employee-executives in the common stock of the corporation and at the same time a gradual decrease in the proportionate interests of the older inactive stockholders, and of the older active stockholders as their efficiency decreased.  The plan provided that the corporation would pay modest salaries and award common stock as additional compensation.  This stock was held out as an inducement to encourage the employees to give their best efforts.  Preferred stock was provided for, to be issued as a stock dividend to the five original stockholders.  The plan did not contemplate the retirement of the entire interest in the corporation of any stockholder at any one time.  It recognized the investments of the older stockholders, both active and inactive, as their interests were being gradually diluted.  To accomplish this it was agreed to redeem the*1048  preferred stock proportionately by purchase and then immediately to exchange the preferred stock for a proportionate amount of the shares of common stock of all the then common stockholders.  The common stock thus acquired would be used for issue as compensation to the younger and newer executives as well as to the older executives who were active in the management of the corporation.  After the institution of the plan a definite flow of the common stock to the younger employees occurred, thus increasing their proportionate interest in the corporation.  In the period from 1913 to 1917 all of the common stock was held by five persons.  By 1931 the number of common shareholders had increased to 63.  In the former period four persons each held 22.80 percent of the stock, while at the latter *404  date only one had that percentage.  In 1931 only three persons held over 7 percent each of the common stock.  In consideration of the interest of the inactive older stockholders as well as the active stockholders, it was contemplated that stock dividends of shares of common stock would be issued from time to time.  In order to protect the investment of the preferred stockholders it*1049  was provided in the preferred stock that if default should be made in the payment of any preferred dividend the voting power should pass to the preferred stock.  The plan further provided for the retention of the common stock among those who were actively engaged in the management of the corporation by preserving to the corporation the first right to purchase at a stipulated price, and by pooling agreements among the stockholders themselves.  The stock of the corporation has never been held by, or offered to, the general public.  From 1917 to 1931, inclusive, numerous changes were made in the capital structure of the corporation.  These were effected by the issuance of stock dividends, by the exchange of common stock for first preferred stock and second preferred stock, by the retirement and reissuance of first preferred stock and second preferred stock, and by the distribution of stock to officers and employees as compensation for services rendered the corporation.  During the period last above mentioned preferred stock was issued, redeemed, and exchanged as follows: Shares of first preferredShares of second preferredDateIssuedRedeemedIssuedRedeemedExchanged3/12/17Dividend on common stock3,0003/12/17Preferred stock issued in exchange for 2/3 original common2,00011/28/22Second preferred issued in exchange for common5,0001/15/24Redeemed for cash at $1102503/31/24Redeemed for cash at $1102509/29/24Redeemed for cash at $11050011/8/27Redeemed for cash at $1104,00011/8/27First preferred issued in exchange for second preferred5,0005,00011/8/27Second preferred issued in exchange for common5,0002/14/28Redeemed for cash at $1105,0002/14/28First preferred issued in exchange for second preferred5,0005,0002/14/28Second preferred issued in exchange for common5,0003/19/29Redeemed for cash at $1102,5003/19/29First preferred issued in exchange for second preferred2,5002,50012/10/29Second preferred issued in exchange for common2,5001/16/31Redeemed for cash at $1105,0005,0001/16/31Issued in exchange for common5,0005,00010/23/31Redeemed for cash at $1105,00011/20/31Redeemed for cash at $1105,00012/15/31Issued in exchange for common4,970.754,970.75Totals27,470.7522,50027,470.7510,00012,500Balances4,970.754,970.75*1050 *405  The detailed changes which occurred in both the common and first and second preferred stock during 1931 are as follows: CommonFirst preferredSecond preferredJan. 16Total shares outstanding20,0005,0005,000Redeemed5,0005,000Balance outstanding20,00000Exchange of 50% common for preferred10,0005,0005,000Balance outstanding10,0005,0005,000250% stock dividend25,000Total outstanding35,0005,0005,000Issued to officers and employees for services4,060.2196Total shares outstanding39,060.21965,0005,000Oct. 231st preferred redeemed5,000Nov. 202nd preferred redeemed5,000Balance outstanding39,060.219600Dec. 15Issued to officers and employees for services304Cash sales to employees for $110 a share401.7804Total shares outstanding39,76600Authorized exchange of 25% common stock for preferred (certificates issued 1/2/32)9,941.54,970.754,970.75Balance outstanding29,824.54,970.754,970.75For the years preceding 1922 the business of the corporation was manufacturing electric storage batteries.  During the following*1051  year they also manufactured a device known as a "trickle charger" for charging storage batteries in the home.  In 1924 they developed and manufactured a device known as a "socket power" or "battery eliminator", which provided a means of connecting the home radio receiver with the house light circuit and thus eliminating the need for storage batteries.  The AC tube, which obviated the necessity of socket powers or storage batteries in radio receivers, was introduced in September 1927.  The corporation's principal business at that time was manufacturing "socket powers." Upon the introduction of the AC tube this business ceased.  The corporation, on February 10, 1928, obtained a license from the Radio Corporation of America to manufacture radio receivers, which they proceeded to do under the trade name of "Philco." In March 1929, in order to increase plant facilities, it was necessary to make major changes in the factory.  New buildings were purchased and assembly lines and a conveyor system were installed.  This change over was made at great expense and taxed the financial resources of the corporation.  By May of 1930 the effects of the depression were being felt.  The corporation*1052  had great difficulty at that time in marketing a new line of radio sets.  In order to offset this, they brought out a small table radio and sold it on a narrow margin of profit.  In 1930 they began manufacturing automobile radios and experimenting in television.  By the end of 1930 the corporation's *406  competitors also began the manufacture of a small radio.  The effect of this competition was felt in 1931.  In the spring of that year their license from the Radio Corporation of America was extended to include the superheterodyne.  Late in May of 1931 the corporation introduced a small table model superheterodyne at a lower price than they had formerly sold their original table model.  By the end of 1931 competition and price cutting had invaded this field and the prospects for 1932 were not favorable.  At each of the crucial points in the history of the corporation the older and more conservative stockholders opposed taking the risk involved and made demand that the extent of their risk be diminished.  The corporation bought in their preferred stock which was then reissued in exchange for their common stock.  This brought this common stock into the treasury and it was passed*1053  on as compensation to the younger executives.  The net income, the cash dividends, stock dividends, and redemptions of the preferred stock of the corporation for the years 1917 to 1931, inclusive, were as follows: YearNet incomeCash dividendsStock dividends in common stockRedemption of preferred stock at $110 a sharePercent and class of preferred stock redeemed1917$141,271.36$30,000.001918205,630.2835,000.001919375,465.9550,225.001920279,972.8450,225.00$100,0001921204,864.3765,000.001922377,311.1670,000.00500,0001923247,391.9770,000.001924294,997.5166,135.4250,000$110,00025% of 1st pfd.1925581,364.0663,000.0019261,948,360.91121,000.00140,000440,00080% of 1st pfd.19271,966,955.16163,000.00200,0001928995,819.08136,000.00460,000550,000100% of 1st pfd.19291,716,353.94141,875.001,000,000275,00050% of 1st pfd.19304,559,576.09269,692.0019314,072,227.73694,992.002,500,0002,200,000100% of 1st pfd.2nd pfd. twice.Total17,967,562.412,026,144.423,950,0003,575,000The cash on hand and surplus account of the corporation*1054  at the beginning and end of 1931 were as follows: Jan. 1, 1931Dec. 31, 1931Cash$4,598,119.84$3,323,020.09Surplus7,737,731.787,696,197.11In addition to the cash on hand December 31, 1931, the corporation also held $4,606,875 in United States Liberty bonds, which were acquired during 1931.  *407  A fraction over 16,214 shares of common stock were issued as compensation between 1918 and 1931, as follows: DatesharesMay 23, 1918920Apr. 8, 19191,125Oct. 20, 1920955Dec. 16, 1924300Dec. 15, 19251,200Dec. 15, 19261,600Dec. 13, 19272,950Dec. 11, 1928300Dec. 31, 19291,233 1/2Jan. 2, 19301,189 1/2Nov. 13, 193077Jan. 16, 19314,060.2196Dec. 15, 1931304Certain of the stockholders transferred large blocks of preferred stock to their respective wives.  The aggregate of the 20,000 shares of preferred stock which were redeemed January 16, October 23, and November 20, 1931, and are here in question was composed of 213.55 shares (1.07 percent of the total) derived from stock issued and outstanding prior to the enactment of any income tax law; 6,765.67 shares (33.83 percent of*1055  the total) were acquired in payment of salaries and income tax was paid on these salaries; and 13,020.78 shares (65.10 percent of the total) originated from stock dividends which were issued from time to time during the years from 1917 to 1929.  The resolutions of the board of directors of the corporation under which the first redemption and reissuance of first and second preferred stock was made on January 16, 1931, are as follows: That the Treasurer of the Corporation be and he hereby is authorized and directed to retire by purchase Five Thousand (5000) Shares of the First Preferred Stock of the Corporation and Five Thousand (5000) Shares of the Second Preferred Stock of the Corporation now issued and outstanding, and on January 16, 1931, to pay to the respective holders thereof the sum of One Hundred and Ten Percentum (110%) of the par value of the said shares of First Preferred Stock and the said shares of the Second Preferred stock, together with the stipulated dividends thereon accumulated to the date of such payment.  * * * That after the receipt by the Corporation of certificates for Five Thousand (5000) Shares of its First Preferred Stock in accordance with the foregoing*1056  resolutions, the proper officers of the Corporation be and they hereby are authorized and directed to offer to each of the holders of the Common Stock of the Corporation to exchange one-fourth (1/4) of the number of shares of Common Capital Stock held by them respectively for an equal number of shares of the First Preferred Stock of the Corporation.  * * * That after the receipt by the Corporation of certificates for Five Thousand (5000) Shares of its Second Preferred Stock in accordance with the foregoing resolutions, the proper officers of the Corporation be and they hereby are authorized and directed to offer to each of the holders of the Common Stock of the Corporation to exchange one-fourth (1/4) of the number of shares of the Common Capital Stock held by them respectively for an equal number of shares of the Second Preferred Stock of the Corporation.  * * * *408  That after all of the shares of the First Preferred Stock and of the Second Preferred Stock of the Corporation which are now issued and outstanding shall have been retired by purchase, and after the holders of the Common Capital Stock of the Corporation shall have exchanged one-fourth (1/4) of the number*1057  of the said shares held by them for First Preferred Stock and shall have exchanged one-fourth (1/4) of the number of shares held by them for Second Preferred Stock of the Corporation, with the effect that there will then be and remain issued and outstanding in the ownership of the Common stockholders Ten Thousand (10,000) Shares of the Common Capital Stock of the Corporation, then and upon such condition there be and there is hereby declared a stock dividend of Two Hundred and Fifty Percent (250%) upon the then remaining shares of the Common Capital Stock, payable in shares of the Common Capital Stock of the Corporation, of which stock dividend Twenty Thousand (20,000) Shares shall be the increased number of shares authorized by action of the stockholders of the Corporation on this date, and Five Thousand (5000) shares thereof shall be of the shares received by the Corporation from its Common stockholders in exchange for shares of the First Preferred Stock and the Second Preferred Stock of the Corporation.  The resolutions of the board of directors of the corporation under which the second redemption and reissuance of first and second preferred stock were made in the latter part*1058  of 1931 are as follows: (October 23, 1931.) That the Treasurer of the corporation be and he hereby is authorized and directed to retire by purchase Five Thousand (5000) Shares of the First Preferred Stock of the Corporation now issued and outstanding, and on October 23rd, 1931 to pay the respective holders thereof the sum of One Hundred and Ten Percentum (110%) of the par value of the said shares of First Preferred Stock.  (November 16, 1931.) That the Treasurer of the Corporation be and he hereby is authorized and directed to retire by purchase Five Thousand (5000) Shares of the Second Preferred Stock of the Corporation now issued and outstanding, and on November 17th, 1931 to pay the respective holders thereof the sum of One Hundred and Ten Percentum (110%) of the par value of the said shares of Second Preferred Stock.  (December 8, 1931.) That after the receipt by the corporation of certificates for Five Thousand (5000) Shares of its First Preferred Stock in accordance with the foregoing resolutions, the proper officers of the Corporation be and they are hereby authorized and directed to offer to each of the holders of the Common Stock of the Corporation to exchange*1059  one-eighth (1/8) of the number of shares of Common Capital Stock held by them respectively for an equal number of shares of the First Preferred Stock of the Corporation.  That after the receipt by the Corporation of certificates for Five Thousand (5000) shares of its Second Preferred Stock in accordance with the foregoing resolutions, the proper officers of the Corporation be and they hereby are authorized and directed to offer to each of the holders of the Common Stock of the Corporation to exchange one-eighth (1/8) of the number of shares of the Common Capital Stock held by them respectively for an equal number of shares of the Second Preferred Stock of the Corporation * * *.  *409  The changes in the capital stock owned by the petitioner, William H. Grimditch, from 1924 to 1931, inclusive, are typical of the changes affecting all the petitioners, and were as follows: DateCommon stockFirst preferred stockSecond preferred stock12/16/24Compensation stock received10 12/15/25Compensation stock received25 Total then held35 12/15/26Stock dividend, 20%7 12/15/26Compensation stock received48 Total then held90 11/8/271/2 Common exchanged for 2nd preferred(less) 45 45 Total then held45 45 11/8/27Stock dividend, 40%18 12/13/27Compensation stock received62 Total then held125 45 2/14/28Exchanged 2nd preferred for 1st preferred45 (less) 45 2/14/28Exchanged 1/2 common for 2nd preferred(less) 62.5 62.5 Total then held62.5 45 62.5 2/14/28Stock dividend, 20%12.5 12/11/28Stock dividend, 60%45 12/11/28 Compensation stock received5 Total then ehld125 45 62.5 3/19/29Retired 1/2 1st preferred(less) 22.5 3/19/291/2 2nd preferred exchanged for 1st preferred31.25(less) 31.253/19/29Stock dividend, 50%62.5 12/10/29Stock dividend, 33 1/3%62.5 Total then held250 53.7531.2512/10/2912 1/2% common exchanged for 2nd preferred(less) 31.2531.2512/31/29Compensation stock received87.5 Total then held306.2553.7562.501/2/30Compensation stock received87.5011/13/30Purchased at $225 per share206.25Total then held600 53.7562.501/16/31Retired 1st and 2nd preferred(less) 53.75(less) 62.50Total then held600 0 0 1/16/311/2 common exchanged for 1st and 2nd preferred(less) 300 150 150 Total then held300 150 150 1/16/31Stock dividend, 250%750 1/16/31Compensation stock received150 10/23/31Retired 1st preferred(less) 150 11/20/31Retired 2nd preferred(less) 150 Total then held1,200 0 0 12/15/3112 1/2% of common exchanged for 1st and 2nd preferred(less) 300 150 150 Total then held900 150 150 *1060  At all times between March 12, 1917, and December 31, 1931, the book value of the common stock was in excess of $110 per share.  The total common stock issued by the corporation up to December 31, 1931, was 69,266 shares, which were issued as follows: For cash or property 651.7804As compensation for services16,214.2196As stock dividends52,400.0000Total issued69,266.0000Less exchanged for preferred29,500Balance outstanding 12/31/3139,766*410  The redemptions of the first preferred and second preferred stock of the corporation during 1931 were essentially equivalent to the distribution of taxable dividends.  OPINION.  VAN FOSSAN: The issue presented is whether the amounts of money received by the petitioners upon redemptions of first and second preferred stock of the corporation in 1931 are taxable as dividends within the purview of section 115(g) of the Revenue Act of 1928. 1 The answer to this question depends upon whether in point of time and manner the redemptions were essentially equivalent to the distribution of taxable dividends.  It is a question of fact.  *1061 ; certiorari denied, . The courts and the Board have consistently held that each case of the type here presented must stand on its own particular facts.  No definite rule of construction has been laid down by which to determine all cases.  *1062  (D.C. App.); ; . The court, in , observed: Neither artifice, subterfuge or bad faith need be present to bring a transaction within the meaning of the statute here involved, for as we read the law a taxpayer may well act with the utmost good purpose and without evil intent and yet the transaction may in effect be the equivalent of the distribution of a taxable dividend.  Thus the intention or motive of the corporation is not controlling.  The crux of the statute is whether in making such redemptions the corporation is thereby in effect distributing its earnings, the shareholders thus avoiding the taxes that are due on such distribution.  It may be conceded that the plan conceived by the corporation in the present cases gradually to diminish the interests of the older stockholders in the corporation and increase the interests of the younger men was accomplished by the transactions, but a business plan wholly legitimate in its inception may so operate as to effect a distribution*1063  essentially equivalent to a taxable dividend.  The results are controlling.  With this in mind a review of the facts is enlightening.  The preferred stock, both first and second issues, was redeemed not once but *411  twice in the taxable year.  The stock first redeemed was simultaneously reissued and in the same year again redeemed and then reissued.  Also, simultaneously with the first redemption of preferred, a dividend was declared in common stock.  Thus the corporation during this year paid $2,200,000 in cash to its preferred stockholders by means of the stock redemptions, as compared with $694,992 paid in cash as dividends on all its stock. The corporation's net income for the year was in excess of $4,000,000.  In 1930, when the net income was in excess of $4,500,000, only $269,692 was paid out as cash dividends.  See . In January 1931 there were 20,000 shares of common stock and 5,000 shares each of first and second preferred stock outstanding, while at the end of the year after the two redemptions of the preferred stock, effecting the distribution of $2,200,000 in cash, had*1064  occurred there were outstanding 29,824.5 shares of common stock and 4,970.75 shares each of first and second preferred.  In other words, the preferred stock at the end of 1931, after the two redemptions, was reduced less than 1 percent and the common stock outstanding was increased by almost 50 percent.  See , affirming . Moreover, there were accumulated undivided earnings largely in excess of the amounts distributed.  The surplus on hand January 1, 1931, was more than three times greater than the preferred stock redeemed shortly thereafter and there was but slightly less surplus on hand after the second redemption of preferred stock in the latter part of the year.  At the time of the first redemption in 1931 the corporation had a surplus of $7,737,731.78.  After the second redemption in that year there remained in the surplus account the sum of $7,696,179.11.  Although cash dividends were paid during the period from 1917 to 1931 in the aggregate amount of $2,026,144.42, of which $694,992 was paid in 1931, the earnings of the corporation during the same period totaled $17,967,562.41, of which $4,072,227.73*1065  was earned in 1931.  See , where the stock redeemed represented a distribution of earnings of approximately three times the amount distributed as cash dividends.  During this period from 1917 to 1931 total preferred stock redemptions effected total distributions to stockholders of $3,575,000, of which, as above pointed out, $2,200,000 was paid in 1931. When these facts are faced it would seem beyond question that the redemptions of preferred stock accomplished a distribution of profits.  Petitioner Grimditch, for example, at the end of the year 1931, without considering compensation stock, had substantially increased *412  holdings of both common and preferred stock and received $45,787.50 in cash by means of the two redemptions.  The contention that the redemptions should not be treated as dividends, because at the time they were made some of the preferred stockholders were not owners of common stock, lacks merit.  The stockholdings need not be identical.  Moreover, in all of the instances referred to, the record owners are the wives of the holders of substantially the same proportion of common stock, which had been turned over*1066  to them as gifts shortly before the stock was redeemed.  Otherwise, there is little difference in the percentage ownership of common and preferred stock.  See . Furthermore, as was held in the case of , it is not essential that there be a direct relationship between the issuance of the stock and its subsequent redemption.  The petitioners have pointed to many cases where redemptions have been held not essentially equivalent to taxable distributions.  They rely strongly on the recent case, , where the corporation had a "plan" with somewhat similar objectives to that in the present cases.  Aside from the similarity of the plans the facts in the two cases have little in common.  The facts in that case revealed no such results as we find here.  The other decisions cited also turn on the facts therein present.  We find none that suggests that, under the facts of these cases, petitioners' contentions should be sustained.  We are of the opinion that the redemptions of first and second preferred stock of the corporation during 1931*1067  were made at such time and in such manner as to be essentially equivalent to the distribution of taxable dividends.  Reviewed by the Board.  Decisions will be entered for the respondent.Footnotes1. Proceedings of the following petitioners are consolidated herewith: J. H. Carmine; E. W. Shepherd; Thomas A. Kennally; D. J. MacKillop; Estate of Mrs. C. L. McWhorter, Deceased, Charles L. McWhorter, Executor; Charles L. McWhorter; and Louis M. Kelly. ↩1. SEC. 115.  DISTRIBUTIONS BY CORPORATIONS.  * * * (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.  In case of the cancellation or redemption of stock not issued as a stock dividend this subsection shall apply only if the cancellation or redemption is made after January 1, 1926.