Action by Herman Speier against the United States.
Judgment for plaintiff.
Plaintiff paid on income tax of $865.76 for 1922, and subsequently the Commissioner of Internal Revenue assessed and collected an additional tax of $1,303.64, together with interest of $224.21, totaling $1,527.85, as a result of the inclusion in plaintiff's income of an alleged dividend of $20,000, claimed by the Commissioner to have been a cash dividend constructively received by plaintiff from the corporation of Speier Simon.
Plaintiff contends that the corporation did not at any time during 1922 pay nor make available to him a cash dividend in any amount, and that the only dividend paid or made payable to him during 1922 was a dividend consisting of the corporation's capital stock.
Special Findings of Fact.
1. Plaintiff, a resident of Lincoln, Neb., filed his income tax return for 1922 on March 15, 1923, and paid the collector the tax of $865.76 disclosed therein. Later the Commissioner of Internal Revenue determined that plaintiff's net income as reported for 1922 should be increased by the amount of $20,000, representing an alleged cash dividend payable to plaintiff as a stockholder of Speier Simon, a corporation. Accordingly, he redetermined plaintiff's net income at $31,340.02, and made an additional assessment of $1,303.64, together with interest of $224.21. Such additional tax and interest, totaling $1,527.85, were collected from plaintiff July 1, 1926. Thereafter plaintiff duly filed a claim for refund of the additional tax and interest collected on the ground that he did not receive, constructively or otherwise, any corporate dividend in that year and that the inclusion in income of the alleged dividend of $20,000 was erroneous. This claim was rejected August 9, 1929, and this suit was timely instituted.
2. The corporation of Speier Simon, was incorporated in 1905 by plaintiff and Benjamin Simon and their wives. The original authorized capital was $30,000, comprising 300 shares. Of this amount, $18,000, or 180 shares, were issued, 88 shares each to plaintiff and Simon, and 2 shares to each of their wives. Simon was made president, and the plaintiff secretary and treasurer.
3. For many years plaintiff and Simon worked together without friction in conducting the corporate business, which consisted of the sale of clothing, furnishings, goods, hats, and shoes. Simon had three sons who were employed by the corporation to work in the store. Early in 1922 differences arose between plaintiff and Simon concerning the salaries being, paid to the three Simon boys and the desire of Simon that his sons secure an interest in the business by the purchase of some of plaintiff's stock. As a result of these differences, plaintiff and Simon decided to separate.
4. On March 10, 1922, Simon and his wife, who had sufficient funds of their own with which to acquire the interest of Speier under the terms of an offer made by them, hereinafter mentioned, submitted a formal written offer to plaintiff and his wife as follows:
"You own 90 shares of the capital stock of Speier Simon, a corporation of Lincoln, Nebraska; and we, Benjamin Simon and Addie Simon, own 90 shares of the capital stock in the same corporation, the total issue of stock in said corporation being 180 shares. You also own 100 shares of stock in the Kansas-Nebraska Investment Company, and we own 100 shares of the capital stock in the same company, said company being capitalized for $20,000. With reference to these holdings we make you the following proposals, the same to be accepted or rejected by you on or before March 17, 1922;
"Speier Simon, a corporation, shall at the time of the acceptance of either one of the proposals hereinafter made declare a cash dividend of $40,000, payable to stockholders now on record.
"After payment of such dividend we propose to buy from you your 90 shares in Speier Simon, a corporation, and pay you therefor the sum of $90,000 in cash, and in addition to transfer you all of our holdings as above listed in the Kansas-Nebraska Investment Company.
"As an alternative we propose to sell to you our 90 shares in Speier Simon, a corporation, and to accept in payment thereof $90,000 in cash and a transfer from you to us all of your stock holdings as above listed in the Kansas-Nebraska Investment Company."
5. At the time the written offer was made by Simon and his wife, the corporation of Speier Simon had 180 shares of capital stock outstanding; 88 shares were held each by plaintiff and Benjamin Simon; and 2 shares were held each by their respective wives. At that time the corporation owned assets consisting chiefly of merchandise and accounts receivable of an approximate worth of $300,000. The corporation's balance sheet at the end of 1921 showed $221,902.85 as its undivided profits and surplus. The corporation had a cash surplus of between $3,000 and $4,000, which was maintained for current expenses, and was indebted to banks in a considerable amount for borrowed money.
6. During the discussions between Speier and Simon with reference to the offer made by Simon to acquire Speier's interest and during the course of negotiations it was agreed that, if Simon should acquire the stock of Speier or if the corporation should acquire the stock of Simon, the interest of the one retaining his stock in the corporation of Speier Simon could turn in to the one who sold his stock in that corporation on the purchase price thereof his (the seller's) interest in another corporation known as the "Kansas-Nebraska Investment Company," in which Simon and his wife and Speier and his wife each had a 50 per cent. interest. The total purchase price was finally fixed at $150,000 and the value of the Kansas-Nebraska Investment Company stock at $40,000, leaving a balance of $110,000 to be paid to the one who should sell his stock in the corporation of Speier Simon.
7. In his offer of sale, and during the negotiations, Simon insisted that prior to the sale a dividend of $40,000 should be declared and paid by the corporation of Speier Simon to its stockholders then of record. Plaintiff did not have sufficient funds of his own to purchase the stock of Simon and his wife, and was not able personally to raise sufficient money to accept Simon's offer of sale. Accordingly, arrangements were made by the then stockholders and directors of the corporation of Speier Simon for the corporation to purchase the stock of Simon and his wife, and, as the corporation did not have a cash surplus, the amount of $110,000 was borrowed by the corporation for the purpose of purchasing the 90 shares of stock owned by Simon and his wife. These arrangements were carried out. The corporation borrowed from banks $110,000 and purchased the stock of Simon and his wife, and they received payment for their stock as follows:
Dividend from Speier Simon Corporation ............ $20,000 Cash payments by the corporation .................... 86,060 Note due to corporation by Kansas-Nebraska Investment Company, canceled ....................... 4,000 Indebtedness owing from Kansas-Nebraska Investment Company to third party assumed by the corporation ........................................ 2,950 One-half interest in Kansas-Nebraska Investment Company transferred to the Simons by the Speiers on behalf of the corporation ....................... 40,000
Total ........................................... 153,010 Less note with accrued interest due from the corporation to Simon, which was canceled ........... 3,010
Total amount paid for stock ..................... 150,000
The Simons indorsed their stock in blank. The stock was delivered by them to the corporation and the certificates were placed back in the stock book and subsequently canceled.
8. At the time the Simons made their offer, the corporation did not have sufficient cash to pay a $40,000 dividend. Simon persisted in his demand that the corporation declare a dividend, and Speier finally agreed that the corporation might pay Simon a $20,000 dividend out of the money borrowed, and to this Simon agreed. It was clearly understood, however, by the corporation and by Speier and Simon that no cash dividend was to be paid to Speier, and no cash dividend was declared for or paid or made available to him. The corporation had not, in fact, sufficient funds to pay Speier a cash dividend of $20,000 or any sum near that amount, and could not have borrowed the money for the purpose, since its credit was exhausted when it borrowed the $110,000 with which to purchase Simon's stock. Simon received the cash dividend of $20,000 and reported it in his tax return for 1922. Plaintiff did not receive any cash dividend and did not report any amount as a dividend in his 1922 return. The only dividend ever paid to or received by him, constructively or otherwise, was a stock dividend declared in July, 1922, of which he received 1,197 shares.
9. Under date of March 21, 1922, which was the date the corporation acquired the stock of Simon and his wife, the dividend account in the corporation's general ledger showed offsetting entries of a credit and debit each in the sum of $40,000; $20,000 of the sum represented by these entries was the cash dividend paid to Simon in accordance with the understanding and agreement between the corporation and its officers and stockholders. The remaining $20,000 of the entry, which was not intended by the corporation or any of the parties to the transaction to represent a cash dividend, was disposed of by crediting $9,000 to treasury stock and $11,000 to capital stock. No dividend was paid or intended to be paid to plaintiff by the corporation as a result of these transactions.
10. For 1922 plaintiff kept his books and made his returns on the cash receipts and disbursements basis. This method of accounting clearly reflected his income and was accepted by the Commissioner of Internal Revenue as proper.
LITTLETON, Judge.
Defendant contends that the declaration of a cash dividend of $40,000, payable $20,000 to Simon and $20,000 to Speier, was a condition precedent in the offer of sale of Simon's stock which was accepted by Speier, that such a dividend was declared by the corporation, and it must be held to have been constructively received by Speier.
The sole question in the case, therefore, is whether plaintiff constructively received a cash dividend from the corporation of Speier Simon in 1922 in such manner as to make him taxable on $20,000 under article 53 of Regulations 62 under the Revenue Act of 1921 providing that "dividends on corporate stock are subject to tax when unqualifiedly made subject to the demand of the stockholder." The facts and circumstances in this case show that the dividend of $20,000 alleged by defendant to have been constructively received by plaintiff was not a cash dividend declared by the corporation and payable to him and that it was not constructively received within the meaning of the statute and the regulations.
Counsel for the defendant is in error in contending that the transaction whereby the stock of Simon and his wife was acquired was in all respects in conformity with the proposition made by Simon to Speier March 10, 1922, when the matter originated. The record shows that the proposition made by Simon and his wife setting forth the terms and conditions under which he would acquire Speier's stock was materially modified and that the offer made by Simon was not carried out under the agreement finally reached whereby the corporation acquired Simons' stock. The corporation was a party to the transaction as finally carried out, and all the parties understood and agreed before anything was done that only a $20,000 dividend was to be declared and paid by the corporation in cash and that Speier was not to receive a cash dividend, and no cash dividend was ever made available to him. The record discloses that the corporation only had about $3,000 in cash, which was maintained and required for the current operation of the business, and that its borrowing capacity had been exhausted in obtaining funds for the purchase of Simons' stock. It cannot, therefore, be said that the corporation might have paid Speier a dividend inasmuch as it had a surplus in the form of merchandise, for the reason that such stock of merchandise had been used as a basis of credit, and any payment of a dividend in excess of the amount which the corporation disclosed to the bank that it intended to pay out, in the acquisition of Simons' stock, would have been an act of bad faith. It is established that dividends may, where the parties agree, be paid without regard to the proportions in which the shares of stock are held. Lincoln National Bank v. Burnet, 61 App.D.C. 54, 63 F.2d 131; Joseph Goodnow Co. v. Commissioner, 5 B.T.A. 1154. And we are not here dealing with a case where a corporation has declared a cash dividend which it is able to pay and which is unqualifiedly subject to the demand of the stockholder, and the taxpayer elects to take stock in the corporation instead of cash, or where the stockholders agree among themselves, without the corporation being a party, that stock in lieu of cash will be taken by them in satisfaction of a regular dividend declared by the corporation out of its surplus. Articles 52 and 53 of Regulations 62 under the Revenue Act of 1921 contemplate a case where a dividend is declared, with no conditions attached to the declaration, and made unqualifiedly subject to withdrawal by the stockholder and has no application to a case like the one at bar.
The plaintiff is entitled to recover $1,527.85, with interest as provided by law. Judgment will be entered accordingly. It is so ordered.