Opinion
Docket No. 7555.
1949-10-31
NORMAN G. NICOLSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
George E. H. Goodner, Esq., and Scott P. Crampton, Esq., for the petitioner. Frank M. Thompson, Jr., Esq., for the respondent.
Petitioner's rights to subscribe at a bargain price to stock of his employer, given him in his capacity as an employee for the best interests of the company, held not to result in income on exercise of rights. Delbert B. Geeseman, 38 B.T.A. 258, followed. George E. H. Goodner, Esq., and Scott P. Crampton, Esq., for the petitioner. Frank M. Thompson, Jr., Esq., for the respondent.
This proceeding was brought for a redetermination of deficiencies in petitioner's income tax as follows:
+----------------+ ¦1939¦$100.78 ¦ +----+-----------¦ ¦1940¦135,217.50 ¦ +----+-----------¦ ¦1941¦248.39 ¦ +----------------+
The assignment of error relating to respondent's disallowance of expenses claimed by petitioner for the operation of an automobile has been waived by petitioner, and the only issue left for our consideration is whether respondent erred in including in petitioner's income for 1940 an amount determined to have been received by him on the purchase of 1,000 shares of the common stock of Waterman Steamship Corporation.
By reason of an order of severance, this consideration is presently limited to the question of whether the transaction resulted in taxable income to petitioner; the issue as to the amount thereof, if any, not having as yet been heard.
FINDINGS OF FACT.
Petitioner is an individual, with his principal office in the Merchants National Bank Building, Mobile, Alabama. He has been connected with Waterman Steamship Corporation since 1919, when he was captain of one of the corporation's first ships. In 1933 he became an officer and director of the corporation, and in 1936 he became its executive vice president. During 1940 he served in that capacity. Petitioner keeps his books and files his Federal income tax returns on a calendar year cash receipts and disbursements basis. His Federal income tax returns for the periods involved were filed with the collector of internal revenue for the district of Alabama.
The Waterman Steamship Corporation is an Alabama corporation, chartered June 10, 1919. On July 28, 1931, its charter was amended to read in part as follows:
The capital stock of the corporation shall henceforth, unless hereafter changed in the manner provided by law, consist of two thousand five hundred shares of first preferred stock, each share of the par value of $100.00; two thousand five hundred shares of second preferred stock, each share of the par value of $100.00, and twenty thousand shares of common stock, each share without nominal or par value. distributed by the Board of Directors to the respective subscribers therefor upon payment of $100.00 for each and every share. The common stock of the corporation is valued now at $25.00 per share (but without changing its non par value character) and 7,000 shares thereof shall be emitted in lieu of and exchanged for the company's now outstanding 1,000 shares of capital stock which is appraised as being worth $175,000.00. The remainder of said twenty thousand shares of common stock may be emitted from time to time for such consideration as may be fixed by the Board of Directors, provided that every share of the common stock shall always be equal to every other share of such stock. The first preferred stock shall in preference and priority to any payment of dividends on the second preferred and on the common stock, be entitled, out of the surplus net profits of the corporation whenever ascertained to cumulative dividends at the rate of $7.00 per share per annum. The second preferred stock shall then be entitled, in preference and priority to any payments of dividends on the common stock, to cumulative dividends at the rate of $7.00 per share per annum, after which the common stock shall be entitled, in preference and priority to any further payment of dividends on the first preferred stock to dividends, when earned, and if and as the same may be declared, to the extent of $2.50 per share per annum. Thereafter each share of the first preferred and each share of the common stock shall be entitled to dividends, when earned, and if and as the same may be declared, in the proportion of $4.00 for each share of first preferred to $1.00 for each share of common, until each share of first preferred stock shall have received an additional $13.00 for that year and each share of common stock shall have received an additional $3.25 for that year, after which the first preferred stock shall not be entitled to any further dividends for that year. All dividends which are in effect distributions of profits earned in prior years and held undistributed, shall be treated, as between the first preferred stock and the common stock, as having been declared in the year in which such profits accrued and shall be apportioned accordingly. From and after the time of issue of said preferred stocks, the preferred dividends thereon shall be a charge upon the surplus net profits of the corporation until paid in the order of their respective priorities. All dividends shall be declared, payable then or thereafter, by the Board of Directors out of the surplus net profits of the corporation not, in the opinion of the Board of Directors, required to be retained or used in the business or businesses of the corporation, at such time and from time to time as may be determined by the Board of Directors. Upon dissolution of the corporation or liquidation of its business and affairs any and all assets and property of the corporation shall be applied, first to the payment of $100.00 per share on the first preferred stock and all cumulative dividends thereon in preference and priority to any payment upon the common stock; and, third, to the payment of $27.50 per share on the common stock. Any balance or surplus then remaining shall be paid on the first preferred stock and common stock then outstanding in the proportion of $4.00 to each share of first preferred stock to $1.00 to each share of common stock, until there thus shall have been paid $10.00 per share on the first preferred stock and $2.50 per share on the common stock, after which the said balance shall be distributed exclusively and ratably to and upon the outstanding shares of common stock. All voting powers shall be vested solely in the holders of the common stock of the corporation, each of whom shall be entitled, either in person or by proxy, to one vote for each share of said common stock held by him and a fractional vote for each fractional share. The first preferred stock of the corporation shall on September 30th, 1941, and at any time thereafter, be subject to call and retirement in whole or in part by the Board of Directors upon payment by the corporation to the then holders thereof of the sum of $120.00 per share and all accrued cumulative dividends, the method of calling and retirement and the manner of selecting the shares to be called and retired to be determined by the Board of Directors. The second preferred stock shall in like manner be subject to call and retirement at any time upon payment by the corporation to the then holders thereof of $100.00 per share and all accumulated dividends.
These charter provisions were in effect throughout 1940, except that in May 1940 the authorized common stock was increased from 20,000 to 30,000 shares. These provisions are the only provisions in the charter relating to the payment of dividends and the bylaws of the Waterman Steamship Corporation are silent on the subject of the payment of dividends.
On May 8, 1940, Waterman's board of directors unanimously passed a resolution recorded in the minutes as follows:
Upon request, Director Nicolson withdrew temporarily from the meeting. After Captain Nicolson's departure, Mr. Roberts stated that at the time the company was organized and subscriptions to the Common Stock were available to the officers and employees of the Company, Captain Nicolson had not been financially able to purchase as much as he desired and that he thought more stock should be made available to him. Thereupon, Mr. T. M. Stevens offered and moved for adoption the following resolution:
WHEREAS, while it is not desired at this time to make any general offering of this company's common stock, yet it is deemed to be to the interest of the company to permit its Executive Vice President, Norman G. Nicolson, to purchase 1,000 shares of the said stock; therefore
BE IT RESOLVED by the Board of Directors of Waterman Steamship Corporation that, subject to all other holders of the Company's Stock waiving their preferential right to participate ratably in the purchase, this company do emit and sell to the said Norman G. Nicolson 1,000 shares of its authorized unissued no par value common Capital Stock at the price of $40.00 per share, the same being the price at which were sold the shares of said stock last emitted by the company.
The previous issuance of the stock referred to in this resolution was made on December 31, 1938, when over 1,700 shares were sold pro rata to all of the holders of common stock at $40 per share. After a general discussion the board of directors fixed the price of $40 per share as being a fair and reasonable price for the sale of this stock to petitioner. Petitioner had not made any offer at that time setting forth the amount he would pay for the stock. In 1940 he had, however, requested the right to purchase additional stock.
At the time the foregoing resolution was adopted petitioner owned 923 shares of the corporation's no par value common stock. There was a total of 19,786 shares of this stock outstanding, of which 11,252 shares were owned by the officers and directors, including petitioner, who attended the meeting of May 8, 1940. The resolution was carried out; Waterman issued and delivered to petitioner its certificates for 1,000 shares of its no par value common stock on June 24, 1940; and petitioner paid Waterman $40,000 cash. There were 20,786 shares of this common stock outstanding immediately after this sale, of which 12,252 shares were owned by the officers and directors, including petitioner, who attended the meeting of May 8, 1940, of which 1,923 shares were owned by petitioner.
Pursuant to the above resolution of the board of directors the other holders of the common stock were requested to waive any rights which they might have to participate in the purchase, and were requested to consent to the sale. In writing to these stockholders the corporation set forth the resolution adopted by the board of directors and advised the stockholders that:
The entire management considers it to be to the interest of the Company that the said Norman G. Nicolson be permitted to acquire a substantial interest in the stock of the Company, and all officers and directors have signed a waiver of their right to participate in the said purchase which waiver also embraces their consent to the proposed sale.
Substantially all of the holders of the common stock waived their rights to participate in the purchase of stock by the execution of a statement reading as follows:
The undersigned as a holder of common stock of Waterman Steamship Corporation hereby consents to the sale of stock to Captain Norman G. Nicolson tentatively authorized by the above quoted resolution (of May 8, 1940) and waives all preferential right to participate in the purchase.
Two of the holders of common stock, holding a total of 33 shares, could not be located and accordingly did not execute the consent referred to above. Had these two stockholders subsequently demanded their pro rata shares of the stock sold to petitioner, they would have been entitled to purchase approximately one and two-thirds shares of the corporation's common stock at $40 per share, and the corporation would have recognized their right to do so. In order to protect itself against such a contingency, the Waterman Steamship Corporation obtained from petitioner on June 24, 1940, an agreement to indemnify the corporation which read as follows:
Referring to the action of the Board of Directors authorizing the sale to me of 1,000 shares of your common stock, and to (the) fact that said sale is being concluded after substantially all of the stockholders have waived their prior right to participate in said purchase, and there are only a few shares not embraced in such waivers, I hereby agree, in consideration of the sale and issuance of said stock to me as authorized by your Directors, to indemnify and protect you and all other interest against any and all valid claims, based on said sale, by the holders of any shares of your stock who failed to waive their priority as aforesaid. No claim has ever been made by these two nonassenting stockholders.
On October 15, 1940, the stockholders of the Waterman Steamship Corporation at their annual meeting ratified the sale here involved by a resolution reading as follows:
H. C. Slaton stated that pursuant to resolution adopted by the Board of Directors at a meeting held on May 8th, 1940, notice has been sent to all stockholders requesting waiver of their preferential rights in connection with the sale of one thousand shares of stock to Captain N. Nicolson. Waivers consenting to the sale were received from all stockholders except six, who held a total of one hundred shares, and that, after consultation with the President of the company it was decided that the sale be made to Captain Nicolson, upon receipt of a letter from Captain Nicolson, indemnifying the company against any claims that might arise by reason of all of the stockholders not having given their consent. He asked that to conclude the matter, and to have a permanent record, that the stockholders approve of this action. Thereupon by motion made, duly seconded and unanimously carried, resolution was adopted ratifying and approving the action of the officers in concluding the sale of stock to Captain Nicolson and in issuing the said certificate.
After the sale of this stock to petitioner, the assets and the net worth of the Waterman Steamship Corporation were greater than they were immediately preceding the sale. The Waterman Steamship Corporation was not a deficit corporation and in 1940 its balance sheet would have warranted the payment of a dividend in the amount determined by respondent in this proceeding. No common stock has been sold by the corporation since the sale here involved.
During the discussions which preceded the drafting of the resolution of May 8, 1940, there was no discussion as to making a gift to petitioner, or compensating him for past or future services.
Respondent has determined that the stock here involved had a value of $195,000 in excess of the price petitioner paid for it, and that the excess represents a distribution to petitioner by agreement of all the stockholders and as such is taxable as a dividend.
The stock issued to petitioner had a value substantially in excess of the price paid for it.
The transaction was effected for the best interest of the company and was made available to petitioner in his capacity as an employee.
OPINION.
OPPER, Judge:
Although respondent's contention is that this stock was received as a taxable dividend, we think the record makes it clear that it was issued to petitioner in his capacity as an employee and not as a stockholder at all, thus eliminating the necessity, for the purpose of dealing with it as as a dividend, that it be viewed as a distribution of profits by the corporation to its stockholder as such. See Palmer v. Commissioner, 302 U.S. 63. The record seems to us to show that this stock was sold to petitioner as operating vice president because it was considered to be in the best interests of the company that he be satisfied and that his interest in the company be represented by a larger participation.
It is true that in presenting the case to us the parties agree that there is no issue with respect to receipt of this stock as compensation. This, however, does not impinge upon the possibility, and in this case upon the necessity, of viewing the transaction as a bargain purchase upon the necessity, of viewing the transaction as a bargain purchase made available to petitioner because he was an employee. Delbert B. Geeseman, 38 B.T.A. 258. Rights to subscribe may be treated as received by an employee as such, notwithstanding that he happens also to be a stockholder. Gordon M. Evans, 38 B.T.A. 1406; Edward J. Epsen, 44 B.T.A. 322.
Under such circumstances, the test of whether options to purchase stock exercised by employees are additional compensation and so taxable or are mere bargain purchases not giving rise to taxable income until final disposition is whether the arrangements between employer and employee lead to the conclusion that by express contract, or necessary implication from the surrounding facts, the opportunity to purchase stock at below the market is a part of the bargain by which the employee's services are secured and his compensation is paid. Cf. Delbert B. Geeseman, supra, and Gordon M. Evans, supra, with Estate of Edward J. Connelly, 45 B.T.A. 374, and Edward J. Epsen, supra. We have examined all of the circumstances,
including the corporate action,
Testimony shows that the record contains all material evidence.
and have come to the conclusion that what we said in Delbert B. Geeseman, supra, 264, 265, is equally applicable here:
It is not without significance— Willkie v. Commissioner (C.C.A., 6th Cir.), 127 Fed.(2d) 953; certiorari denied, 317 U.S. 659—that no effort was apparently made by the employer to take any deduction for compensation paid on account of the transaction in controversy. Cf. United States Steel Corporation, 2 T.C. 430.
* * * It is true that the prospective purchasers were selected solely because they were valued employees of Continental Can Co., and there is no doubt that the added interest of these employees and the proprietary attitude toward the company which would result from their ownership of the stock constituted one of the motives for the granting of the option. It is equally obvious, however, that the continued employment of the petitioner was not dependent upon the receipt by him of the right to purchase the stock at less than the market price. The terms and conditions of his employment and the compensation he was receiving were in no way changed by the receipt of the privilege of purchasing of stock. * * *
We come to this conclusion notwithstanding that there are certain aspects of the technical details by which the transaction was accomplished which give it the guise of a stock dividend. The stated purpose of the parties, and the evident necessity of conforming to the requirements of Alabama laws seem to us to demonstrate that these phases of the transaction were mere formalities and may be disregarded in determining the true nature of the transaction. ‘The substance of the plan rather than its form must be ascertained. ‘ United States Steel Corporation, 2 T.C. 430, 438. In fact, the prior assurance that virtually all other stockholders would waive their subscription rights, thus limiting the field of recipients to petitioner, apparently was considered necessary to make it certain that the transaction would be a sale of stock to petitioner alone. This is the antithesis of a distribution to stockholders, and especially of any effort to bring about a dividend by the transfer of a part of the employer's accumulated earnings. Choate v. Commissioner (C.C.A., 2d Cir.), 129 Fed.(2d) 684. No such intention can be drawn from the facts.
Reviewed by the Court.
Decision will be entered under Rule 50.