Opinion
Docket No. 31549.
1953-03-25
CHARLES R. MATHIS, JR., AND KATHERINE S. MATHIS, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
John W. Donahoo, Esq., for the petitioners. Ralph V. Bradbury, Esq., for the respondent. FN2. SEC. 112. RECOGNITION OF GAIN OR LOSS.(b) Exchanges solely in kind.— (3) Stock for stock on reorganization.— No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization. (4) Same— Gain of corporation.— No gain or loss shall be recognized if a corporation a party to a reorganization exchanges property, in pursuance of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization.
John W. Donahoo, Esq., for the petitioners. Ralph V. Bradbury, Esq., for the respondent.
In 1927, Corporation A, an Alabama corporation, was dissolved to ‘get rid of‘ Alabama taxes. Nine months later, Corporation B was organized by the former majority stockholder of Corporation A in order to give his family interests in various properties. Assets formerly owned by Corporation A and other assets were transferred to Corporation B, and stock was issued to petitioner, her father (the majority stockholder of Corporation A), and various members of the family. The respondent determined that the transactions constituted a tax-free reorganization and that, consequently, the surplus of Corporation A was earned surplus of Corporation B so that a distribution by Corporation B, in 1945, was 100 per cent taxable as a dividend. Held, under all the facts, the dissolution of Corporation A and the subsequent formation of Corporation B and did not constitute a tax-free reorganization and the earned surplus of Corporation A became paid-in or donated surplus of Corporation B, and did not constitute net earnings and profits of Corporation B available for the distribution of a dividend.
The respondent determined a deficiency in income tax for the year 1945 in the amount of $1,519.24.
The issue to be decided is whether a distribution received from a corporation by Katherine S. Mathis, in 1945, in the amount of $9,600, is fully taxable as a dividend.
FINDINGS OF FACT.
Petitioners are husband and wife, residing in Washington, D.C. They filed a joint return for the year 1945 with the collector of internal revenue for the district of Florida.
W. C. Sherman (hereinafter referred to as Sherman) was engaged in the business of operating a shingle mill in 1908. In March 1914, he and the Spann Brothers of Dothan, Alabama, organized an Alabama corporation known as Sherman-Spann Lumber Company. Sherman purchased the stock of the Spann Brothers in 1918 and, thereafter, owned all of the capital stock, except the qualifying shares which were held by M. M. Glasgow (hereinafter referred to as Glasgow) and J. M. Barrow. The name of the corporation was changed to Sherman Lumber Company (hereinafter referred to as the Company) on November 12, 1924.
By 1927, the activities of the Company in Alabama consisted of a retail lumber business in Dothan. Its principal income was from dividends on stocks it held in companies operating in Florida. It also dealt in real estate in Florida.
The Company was dissolved under the laws of Alabama on September 29, 1927. The purpose of dissolving the Company was to ‘get rid of‘ the Alabama corporation because of taxes which had to be paid to the State of Alabama. The company owed no debts at the time it was dissolved.
The property was distributed to the directors of the Company, who were Sherman and the two qualifying shareholders, as trustees under the laws of Alabama. Sherman instructed the trustees as to their actions and they were subject to his directions at all times. All of the stock owned -y the Company in other corporations was carried in Sherman's name for convenience in voting. Some of the real estate owned by the Company was also in his name.
The Company filed a corporation income tax return for the year 1927 showing all transactions from January 1 through December 31. Such return did not show the dissolution of the Company in September of that year, and included profits from the sale of real estate made by the directors and trustees of the Company on December 10, 1927.
On May 25, 1928, Sherman organized Sherman & Sons, Inc., a Florida corporation (hereinafter referred to as the Corporation). The incorporators were Sherman, Glasgow, and T. J. Sherman. They also were named directors of the Corporation and subscribed to its stock as follows:
+-------------------------+ ¦Sherman ¦400 shares¦ +--------------+----------¦ ¦Glasgow ¦10 shares ¦ +--------------+----------¦ ¦T. J. Sherman ¦45 shares ¦ +-------------------------+
The first meeting of the board of directors was held on June 20, 1928. The minutes provided as follows:
Mr. Sherman stated that in place of the cash subscription to the capital stock of the Company in the amount of Fifty thousand Dollars ($50,000.00) made by W. C. Sherman, M. M. Glasgow, and T. J. Sherman, he was prepared to give the Company in exchange for all its capital stock all the assets of the Sherman Lumber Company now in liquidation, consisting of stocks, bonds, notes, bills, and accounts receivable, lumber yard property in Dothan and land in Bay County; that the said property was worth not less than Fifty Thousand ($50,000.00) Dollars. After discussion it was moved, seconded and carried, as follows:
Whereas the property offered to be transferred to the corporation by W. C. Sherman is reasonably worth in the opinion of the Board not less than Fifty Thousand ($50,000). Be it resolved that the same be accepted (sic) in satisfaction of subscription in like amount and that said stock issue to the said subscribers or their nominees. It was stated that for convenience in voting, the stock stood in the name of W. C. Sherman, also that in order to avoid taxes and expenses incident to foreign corporations in Alabama, the property in Dothan had best be carried in individual names.
Therefore, it was on motion made, seconded and carried: Resolved that the said stock be carried in the name of W. C. Sherman for convenience in voting as heretofore, and that W. C. Sherman, T. J. Sherman and John Henry Sherman take title to the Dothan property in their names for the account of the corporation.
On June 20, 1928, the directors and trustees of the Company transferred title to all the assets which they held to the Corporation. The Corporation was formed by Sherman in order to give members of his family an interest in the properties which were to be transferred to the Corporation. Assets held by the trustees and other assets which had never been part of the Company's assets were transferred to the Corporation. The original stock of the Corporation was issued as follows:
+---------------------------------------------+ ¦Name ¦Certificate No. ¦Shares ¦ +------------------+-----------------+--------¦ ¦ ¦ ¦ ¦ +------------------+-----------------+--------¦ ¦Mrs. W. C. Sherman¦1 ¦80 ¦ +------------------+-----------------+--------¦ ¦T. J. Sherman ¦2 ¦80 ¦ +------------------+-----------------+--------¦ ¦John Henry Sherman¦3 ¦80 ¦ +------------------+-----------------+--------¦ ¦Katherine Sherman ¦4 ¦80 ¦ +------------------+-----------------+--------¦ ¦Martha Sherman ¦5 ¦80 ¦ +------------------+-----------------+--------¦ ¦M. M. Glasgow ¦6 ¦10 ¦ +------------------+-----------------+--------¦ ¦W. C. Sherman ¦7 ¦90 ¦ +---------------------------------------------+
Original Certificate No. 6 was acquired by Sherman from Glasgow, and Certificate No. 8 for 10 shares was issued to Sherman. The stock, at the time of the hearing, was still outstanding in this same ownership and form.
The ledger accounts of the Company for the calendar year 1927 and the ledger accounts of the Corporation for the year 1928 are contained in the same binder, and the closing balances of the Company are the opening balances of the Corporation.
There was only one surplus account on the books of the Corporation, and no segregation of this account into the various types of surplus which might have been included therein had ever been attempted until the end of 1940. At that time, the certified public accountant who audited the books of the Corporation analyzed the surplus account in order to determine its various components for use in computing the Corporation's excess profits tax credit. The account was segregated into paid-in or donated surplus, and earned surplus. Subsequent examination by a revenue agent of respondent resulted in some changes in these figures. The paid-in or donated surplus, which was placed on the books, was determined on the theory that the surplus figure on the books of the Company became paid-in surplus on the books of the Corporation.
The Corporation's tax return for 1928 was prepared by Glasgow, and covered the period from January 1 through December 31. Such return disclosed the answer of ‘No‘ to the question, ‘Did the corporation file a return under the same name for the preceding taxable year?‘ and ‘Yes‘ to the question, ‘Was the corporation in any way an out-growth, result, continuation, or reorganization of a business or businesses in existence during this or any prior year since December 31, 1917?‘ The name of the predecessor business was stated to be ‘Sherman Lumber Company.‘ The return was signed by Sherman as president and Glasgow as treasurer. The Corporation continued to use the same acquisition dates on its land and its depreciable property as had been used by the Company.
The directors and stockholders of the Company did not adopt any written resolution or motion to reorganize the Company. Sherman was the dominating influence in the operation and dissolution of the Company. At the time of dissolution, he had no plans as to what he would do with the assets of the Company after it was dissolved. His only interest was to ‘get rid of‘ the Alabama corporation because of Alabama state taxes. After the dissolution, Sherman was, for all practical purposes, the sole owner of the Company's assets.
Katherine S. Mathis (formerly Katherine Sherman and hereinafter referred to as the petitioner) owned 80 shares of stock in the Corporation. She received a distribution from the Corporation in 1945 in the amount of $9,600. No part of this distribution was considered by her to be taxable as income, and was not included as taxable income in her joint 1945 income tax return. The respondent determined, after an audit, that part of the distribution was taxable, and included that amount in petitioner's taxable income for the year 1945. The deficiency resulting therefrom was paid by petitioner. Later, the respondent issued a 90-day letter, dated September 1, 1950, determining that the distribution was taxable in its entirety as an ordinary dividend, and determined an additional deficiency which is the subject of the present appeal.
The accumulated earnings and profits of the Corporation, available for distribution as taxable dividends on December 31, 1945, were $43,228.09. During 1945, the Corporation made total distributions in the amount of $86,966.17.
OPINION.
RICE, Judge:
The basic question to be decided is whether there was a reorganization in 1928 under the provisions of section 112(i)(1)(B)(D) of the Revenue Act of 1928, /1/ resulting in a nontaxable gain under the provisions of section 112(b)(3) or (4) of the Revenue Act of 1928. /2/ If the dissolution of the Company and the formation of the Corporation constituted a tax-free reorganization under the above cited sections, the earned surplus of the Company would constitute earned surplus of the Corporation. In such case, there would have been sufficient accumulated net earnings and profits available in 1945 so that the entire distribution to petitioner would be taxable as a dividend. However, if the dissolution and subsequent incorporation did not result in a tax-free reorganization under the provisions set forth above, the earned surplus of the Company would constitute paid-in or donated surplus and the Corporation would not have had sufficient accumulated net earnings and profits as of the end of 1945 for the entire distribution to be taxable as a dividend.
Whether or not the transactions occurring in 1927 and 1928 resulted in a tax-free reorganization depends upon whether the dissolution of the Company and subsequent formation of the Corporation are to be regarded as two separate and entirely unrelated transactions or as preconceived steps in one integrated over-all plan. Petitioner contends that it is the former, and respondent contends it is the latter.
This Court has held that it is unnecessary for the plan to be written and incorporated into the minutes of a corporation if, in fact, the evidence clearly shows that the transaction was a result of a preconceived plan. Hortense A. Menefee, 46 B.T.A. 865 (1942); Wilgard Realty Co., 43 B.T.A. 557 (1941), affd. 127 F.2d 514 (C.A. 2, 1942), certiorari denied 317 U.S. 655 (1942). In the instant case, however, the evidence establishes that the two transactions were not steps in one over-all preconceived plan. The Company was dissolved in 1927 for one purpose only, and that was to do away with an Alabama corporation and resultant Alabama taxes, when most of the operations were in Florida. The assets were distributed to the directors of the Company as trustees.
Section 7069 (3516) of the Code of Alabama of 1923 provides that corporations which are dissolved:
* * * exist as bodies corporate for the term of five years after such dissolution, for the purpose of prosecuting or defending suits, settling their business, disposing of their property, and dividing their capital stock, but not for the purpose of continuing their business; and the directors shall be trustees thereof with full power to settle their affairs, collect their debts, sell and convey the property and divide the moneys and other property among the stockholders, after paying its debts; and may act under the by-laws of the corporation, prescribe the terms and conditions of the sales of the property of the corporation, sue for and recover the debts and property of the dissolved corporation, in the corporate name; and are jointly and severally liable to its creditors and stockholders to the extent of the property which may come into their hands. * * *
While it is true that the assets of the Company were not distributed to Sherman by the trustees, they were held for his beneficial interest and, for all practical purposes, were his. Sherman testified that he considered such assets to be his own. The trustee acted entirely at his direction and the assets were under his control. The Corporation was not formed until May 1928, which was nine months after the dissolution of the Company. The purpose of its formation was so that Sherman could distribute interests in the property to members of his family. Assets held by the trustees were transferred to the Corporation, but, in addition, assets which had not been in the Company were also transferred to the Corporation.
Respondent relies upon the answer to the question appearing in the Corporation's tax return for 1928, in which the answer ‘Yes‘ appears to the question, ‘Was the corporation in any way an outgrowth, result, continuation or reorganization of a business or businesses in existence during this or any prior year since December 31, 1917?‘ The return is not controlling where the evidence strongly indicates that the dissolution of the Company and formation of the Corporation were two separate and independent transactions. Cf. Calvin Zimmerman, 31 B.T.A. 754 (1934).
Morley Cypress Trust, Schedule ‘B,‘ 3 T.C. 84 (1944), is cited by respondent as controlling this case. In the Morley case, the petitioners were equal shareholders of a West Virginia timber corporation which, having completed its operations in 1926, resolved to discontinue and surrender its franchises. The Secretary of State of West Virginia declared its ‘dissolution to be authorized‘ in that same year. Through its liquidating directors, liquidating distributions were made in 1935, 1937, and 1938 of all assets except 16,000 acres of unmarketable land. In 1938, oil was discovered on this land and a new corporation was organized. Its shares were issued to the taxpayers in a ratio of 25 shares for 1, and the assets of the timber corporation were transferred to it. The shareholders surrendered their shares in the prior corporation to it for cancellation. We held that the timber corporation continued to be in the process of liquidation in 1938, although the situation had changed by the discovery of oil and a different method of disposing of its property was devised. We said:
It was, nevertheless, still in process of liquidating all its assets, but, instead of distributing either the assets in kind or the proceeds from their sale directly to its shareholders, a clear method whereby the shareholders would enjoy a realization of gain upon which they would incur liability for tax, it devised a reorganization, by which the shareholders merely changed the form of their evidence of interest in the same property as the Morley corporation had held. The fact that the exchange by the shareholders of their old shares for new was an incident character of a reorganization exchange, which requires that a reorganization, otherwise within any of the definitions of section 112(g)(1), is not to be so regarded because it occurs in the progress of a liquidation. Love v. Commissioner, 113 Fed. (2d) 236; cf. Anna V. Gilmore, 44 B.T.A. 881.
As we said in that case, the fact that a corporation is in the process of liquidation will not deprive an exchange of its classification as a statutory reorganization, if in truth that is what it is. Here, the Company had been dissolved and, looking through form to substance, its assets had been distributed to Sherman, its principal stockholder, and we have found that Sherman had received its assets and exercised complete control over them. In our opinion, therefore, the Morley case is not controlling here.
Considering all the facts in the record, we hold that the dissolution of the Company and the subsequent formation of the Corporation were separate and independent transactions, and not part of one overall plan conceived prior to the de facto distribution of all the Corporation's assets. As a result, the earned surplus of the Company became paid-in surplus of the Corporation, and did not constitute a part of the net earnings and profits available for the distribution of a dividend in 1945. The total net earnings and profits of the Corporation, available for the distribution of a dividend as of December 31, 1945, were $43,228.09. The Corporation's total distribution was $86,966.17. Therefore, 49.71 per cent of the $9,600, received from the Corporation during 1945, is taxable to petitioner as a dividend.
Reviewed by the Court.
Decision will be entered under Rule 50. 1.Sec. 112. RECOGNITION OF GAIN OR LOSS.(1) Definition of reorganization.— As used in this section and sections 113 and 115—(1) The term ‘reorganization‘ means * * * (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or * * * (D) a mere change in identity, form, or place of organization, however effected. 2. SEC. 112. RECOGNITION OF GAIN OR LOSS.(b) Exchanges solely in kind.— (3) Stock for stock on reorganization.— No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization. (4) Same— Gain of corporation.— No gain or loss shall be recognized if a corporation a party to a reorganization exchanges property, in pursuance of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization.