Court Opinion

ID: 4600566
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:25:51.858361+00
Date Added: 2024-06-11T07:52:19.360413
License: Public Domain

TRUST UNDER THE WILL OF SARAH B. MCLEAN, GERMANTOWN TRUST COMPANY AND WILLIAM L. MCLEAN, JR., TRUSTEES, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.McLean v. CommissionerDocket No. 101688.United States Board of Tax Appeals44 B.T.A. 820; 1941 BTA LEXIS 1272; June 25, 1941, Promulgated *1272  A distribution in liquidation in 1937 held taxable upon 30 percent of the gain, since earlier distributions in 1935 and 1936 are shown not to have been in liquidation.  Frederick H. Knight, Esq., and Henry Gross, Esq., for the petitioners.  Brooks Fullerton, Esq, for the respondent.  STERNHAGEN *820  The Commissioner determined a deficiency of $55,601.25 in income tax for 1937, by imposing a capital gain tax upon 100 percent of the gain realized from a liquidation distribution.  FINDINGS OF FACT.  Petitioners, Germantown Trust Co., a Pennsylvania corporation with its principal place of business in Philadelphia, and William L. McLean, Jr., an individual, a resident of Wynnewood, Pennsylvania, are trustees under the will of Sarah B. McLean, who, prior to her death in 1929, was a resident of Pennsylvania.  Mrs. McLean was the sole shareholder of the Queen Lane Investment Co., a holding company which was formed in 1921.  It was authorized to issue 1,000 shares of the par value of $100 each.  It actually issued and had outstanding $100 shares.  Upon her death, the petitioners acquired these shares under her will and held them until the*1273  corporation was dissolved in 1939.  Mrs. McLean acquired the 100 shares on February 8, 1921, for $10,000 in cash.  No more shares were issued.  On February 9 she transferred to the company securities having a market value of $1,007,097.75, and this amount was set up on the books of the company as a "special capital" account.  By the transfer of these securities, they were removed from Mrs. McLean's prospective estate and from the probable incidence of inheritance taxes of other states and the Pennsylvania personal property tax.  The assets of the company consisted of securities and the income from them was distributed annually in dividends.  Some securities were sold and others purchased over a period of years, its capital transactions for 1935 showing purchases of $451,783.62 and sales of $463,211.62.  The last transaction was a purchase of $1,907.50 in 1936.  On December 30, 1935, a distribution was made of $25,000 in cash and of $60,250.32 book value securities, which distribution was charged to the special capital account of the company.  The balance of that account immediately after the distribution was $878,245.35.  *821  At the meeting to consider this distribution, *1274  the board discussed the effect of new Pennsylvania tax laws, but were advised by sounsel that the franchise tax act and the corporation net income tax act were either unconstitutional or not applicable to the company.  The board discussed the advisability of liquidating the company, and came to the conclusion that there should be no distribution made either in partial or complete liquidation, but that the corporation should be continued.  The board dicided that it was not necessary to have so much taxable property in Pennsylvania, and adopted the following resolution: Whereas, the distributions next referred to are not, and are not intended to be, in partial or complete liquidation and are not out of earnings or profits; Resolved, That in proportion to their respective holdings of record of the capital stock of this company there be immediately distributed to stockholders of record * * * said amounts to be charged to special capital account.  Certain securities of the company that would not be subject to the personal property tax in the hands of the petitioners were accordingly distributed.  The outstanding shares were not reduced and none were redeemed or canceled.  In 1935*1275  there was no plan of liquidation and no amount was distributed in liquidation.  On December 2, 1936, a similar distribution was made, pursuant to a resolution of December 1, 1936, of the board, the provisions of which were similar to those of 1935.  The same Pennsylvania tax acts were considered and were thought not to be applicable to the company, although the board decided to reduce the company's taxable property in Pennsylvania.  A distribution was made of securities having a book value of $462,397.05, which amount was charged to the special capital account, leaving a balance in that account of $415,848.30.  The outstanding shares were not reduced and none were redeemed or canceled.  In 1936 there was no plan of liquidation and no amount was distributed in liquidation.  In 1935 the Pennsylvania capital stock tax act was amended by the franchise tax act.  In several respects, petitioners considered this act to be inapplicable to the company.  Its 1935 return showed no tax to be due.  In 1937 the company for the first time received a statement of its franchise tax liability for 1935, and this tax was paid.  In March of 1937 the company filed a 1936 franchise tax return and paid*1276  a tax.  One of the reasons for the 1936 distribution of securities was to reduce the tax.  In 1937 the Pennsylvania corporation net income tax act was amended so that the company for the first time was brought within the 7 percent tax.  On the basis of these two Pennsylvania acts it was estimated that about 70 percent of the company's income would be paid out in taxes, and comparison was made with the smaller percentages in 1935 and 1936.  *822  This factor of increasing taxes was discussed in the latter part of 1937 by the president of the company and the chairman of the board of the trust company, and under date of October 27, 1937, the chairman wrote to the president: Believing, as I do, that under the present tax laws a personal holding company may be a liability, it seems to me that in the ordinary case it is preferable to dissolve such corporation and pay the tax on any profits thus realized rather than continue the corporation in existence.  * * * On the other hand, the dissolution of the corporation may result in considerable income tax payable to the stockholders, but such taxes can be minimized if dissolution be undertaken in accordance with provisions of Section*1277  115(c) of Revenue Act of 1936, * * * Again, when it comes to taking action on any dissolution, you should take the matter up with counsel and have him carefully draw the resolutions so that the action will clearly fall under Section 115(c) in question.  On December 27, 1937, the stockholders requested the board "to take steps to distribute the assets of the corporation in complete cancellation and redemption of all the outstanding stock of the company, such liquidation to be completed on or before December 15, 1939." The board, at a meeting held on December 27, 1937, adopted the following resolution: Resolved, that the corporation proceed to make a series of distributions in complete liquidation and cancellation of all its outstanding capital stock.  * * * Resolved, further, that the proper officers of the company be and they are hereby authorized and directed to make all necessary transfers, and to do all acts and things necessary to liquidate the company and to legally dissolve the same not later than December 15, 1939.  Immediately thereafter securities of the book value of $229,385.77 were transferred, leaving a balance in the special capital account of $186,462.53. *1278  The plan to liquidate and dissolve the corporation was adopted in 1937, and the first distribution in liquidation was made in 1937.  In a resolution of December 29, 1938, the board provided for another distribution of securities, of the book value of $134,489.06.  Assets of the value of $49,891.14 were distributed, pursuant to a resolution, on January 5, 1939, and on November 29, 1939, a final distribution was made of $2,082.33.  The stock was surrendered, and the company was dissolved on December 5, 1939.  The distribution of $229,385.77 made on December 28, 1937, exceeded the basic cost to petitioners of the stock of the company by the sum of $154,742.74.  OPINION.  STERNHAGEN: The Commissioner, in determining the deficiency, stated that 100 percent of the gain realized in the 1937 distribution of the assets of the Queen Lane Investment Co. should be taken into *823  account in computing net income in accordance with section 115(c), Revenue Act of 1936. 1 No facts are stated to throw light on the ground of the determination.  The petitioner admits that the distribution was one in liquidation and contends that under section 115(c) only 30 percent of the gain is taxable. *1279  The argument of both parties is focused upon the question whether the liquidation, which admittedly was taking place in 1937, began in 1935.  The respondent treats the deficiency determination as equivalent to holding that the distribution in question for 1937 was but a step in a process of liquidation which began in 1935, and upon this postulate reasons that the 1935 plan of liquidation did not contemplate its consummation within two years and hence that the distribution in 1937 is taxable to the extent of 100 percent of the gain.  *1280  The petitioner, adopting the respondent's treatment of the deficiency determination as a determination of all the facts necessary to support it, has undertaken to establish that the 1935 and 1936 distributions were not in liquidation and that the distribution in 1937 was the first such distribution in a plan which was to be concluded within two years.  The evidence supports the petitioner's contention.  The directors of the corporation were fully alert to the effects of their conduct on Federal and state taxes of both the corporation and its shareholders.  They had been fully advised by counsel.  The reasons for the distributions of 1935 and 1936 out of special capital account had to do entirely with taxes of Pennsylvania.  The directors gave consideration in 1935 and 1936 to the advisability of liquidation and decided against it.  They intended to make a distribution of the sort described in section 115(d).  There is no evidence to indicate that liquidation was intended or was consciously or inadvertently being carried out.  Nothing was done looking to a winding up of business; there was no cessation of normal activities; aside from a reduction of the assets by the distributions, *1281 *824  there was nothing to indicate liquidation, and there was no thought of canceling shares.  If the issue before the Board today were the applicability of section 115(c) to the distributions of 1935 and 1936, for the purpose of determining tax for those years, the evidence would establish that the distributions were not in liquidation and that the section was not applicable.  The evidence shows why the liquidation did not begin until 1937.  It was not until then that the franchise tax of Pennsylvania became so burdensome as to arouse an inquiry by the directors as to whether it was cheaper, from a tax standpoint, to continue the existence of the corporation with the new burden of Pennsylvania taxes or to liquidate the corporation with the consequent immediate burden of taxes upon the shareholders.  As a result of that inquiry and upon advice, the directors decided to liquidate.  This was the first time such a decision was made.  The character of a distribution as one in liquidation is determinable as a fact upon all the evidence, including evidence of the directors' intention and the attendant circumstances, *1282 , affirming ; , affirming ; , affirming . The conclusion has been reached that the distributions of 1935 and 1936 were not distributions in liquidation; that there were no plan for liquidation and no liquidation activities prior to 1937; and that the distribution made in 1937 was a distribution in liquidation under a plan to be completed within two years from the close of 1937.  The petitioners now concede that they should have used $154,742.74 as the basis for the 30 percent gain instead of the $147,724.91 which they used.  Except for this change, the Commissioner's determination is reversed.  Decision will be entered under Rule 50.Footnotes1. (c) DISTRIBUTIONS IN LIQUIDATION. - Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock.  The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112.  Despite the provisions of section 117(a), 100 per centum of the gain so recognized shall be taken into account in computing net income, except in the case of amounts distributed in complete liquidation of a corporation.  For the purpose of the preceding sentence, "complete liquidation" includes any one of a series of distributions made by a corporation in complete cancellation or redemption of all of its stock in accordance with a bona fide plan of liquidation and under which the transfer of the property under the liquidation is to be completed within a time specified in the plan, not exceeding two years from the close of the taxable year during which is made the first of the series of distributions under the plan.  In the case of amounts distributed (whether before January 1, 1934, or on or after such date) in partial liquidation (other than a distribution within the provisions of subsection (h) of this section of stock or securities in connection with a reorganization) the part of such distribution which is properly chargeable to capital account shall not be considered a distribution of earnings or profits. ↩