The Commissioner has determined a deficiency in petitioner's income tax for the year 1941 of $938.71. The principal part of the deficiency is due to the determination by the Commissioner that a gain of $12,930.15 which petitioner had from the disposition in 1941 of 750 shares of preferred stock in the A. J. Tower Co. was a short term capital gain, 100 percent of which should be taken into taxable income, instead of being a long term capital gain, only 50 percent of which is taken into account, as the petitioner contends. The Commissioner explained his determination in the deficiency notice as follows:
The entire gain of $12,930.15 realized by the transfer of 750 shares of preferred stock of A. J. Tower Company to that corporation for which you received $75,000.00 in cash is taxable under the provisions of section 115 (c) of the Internal Revenue Code as an amount received in partial liquidation of A. J. Tower Company in the year 1941.
The petitioner contests this determination by an appropriate assignment of error. The Commissioner made another adjustment, the correctness of which petitioner concedes.
FINDINGS OF FACT.
Many of the facts have been stipulated and we adopt these as part of our findings and incorporate them herein by reference.
The petitioners are trustees under the will of Abner J. Tower, with their principal office in Boston, Massachusetts. The petitioners' income tax return for the calendar year 1941 was filed with the collector of internal revenue at Boston, Massachusetts. During the calendar year 1941 the trustees under the will of Abner J. Tower were Robert F. Herrick, Edward A. Taft, and Francis C. Gray. Since that year Robert F. Herrick has died and the Boston Safe Deposit Trust Co. was appointed trustee in his place.
Abner J. Tower died March 17, 1900. Among the assets of his estate was all the stock of A. J. Tower Co., which had been formed prior to his death and manufactured waterproof garments. Under the provisions of his will Tower authorized and directed his executors and trustees "to actively carry on my business of manufacturing oil clothing and other articles until it can be closed out as a whole and the great value of its good will thus secured, and they are further authorized for the better accomplishment of the above purpose to form a corporation to carry on the said business, and as executors and trustees to subscribe for all or a majority of its stock and to become officers of the said corporation until the said stock can be sold at a price equal to its great value." In accordance with such authorization, the trustees carried on the business of A. J. Tower Co. through the ownership of all of its outstanding stock during the period up to 1926.
In order to carry out the purposes of the will regarding the sale of the stock, a plan was entered into in 1926 whereby the present A. J. Tower Co., hereinafter referred to as the company, was organized under the laws of Massachusetts, and the old company was liquidated and ceased doing business. The new company acquired all of the assets of the old company in consideration of its issuance to the petitioner of short term notes in the amount of $400,000, preferred stock consisting of 10,000 shares of $100 par value, and common stock of 6,000 shares without par value. In 1927 the number of authorized shares of common stock of the company was increased to 6,500 and the 500 additional shares were issued for cash to certain employees of the company. All of the notes issued by the new A. J. Tower Co. in 1926 were paid off prior to 1941.
The purposes of the will were to be accomplished under such plan in 1926 by giving the beneficiaries of A. J. Tower trust the right to purchase shares of common stock of the company from the trustees for $100 a share and by a sinking fund arrangement whereby the preferred stock of the company acquired by the petitioner was to be retired. At about the time the plan of 1926 was carried into effect, all of the common stock of the company was sold to the beneficiaries of the A. J. Tower trust and others. The trust never reacquired any of this stock. In 1941 the beneficiaries of the trust owned 5,564 of the 6,500 shares of the outstanding common stock of the company.
The preferred stock provisions, which were incorporated in the agreement of association of the company and on the back of the preferred stock certificates, provided in part as follows:
During the calendar year 1928 and during every calendar year thereafter until all the preferred stock outstanding has been retired or its retirement provided for, there shall be set apart as a Sinking Fund out of the net profits of the Corporation or its surplus the sum of $50,000. If at the close of any such year less than that amount has been so set apart, no dividends on the common stock shall subsequently be paid or set apart, until such deficiency in the Sinking Fund requirement for any previous year shall have been made up. If the Sinking Fund requirement for all previous years has been met, dividends may . . . be declared and paid on the common stock out of the net profits of the corporation or its surplus; provided, however, that if in the year 1929 or in any year thereafter dividends aggregating $200,000 are declared or paid on the common stock, no additional dividends on the common stock shall be declared or paid during that year unless prior to the declaration of any such additional dividend there shall first have been transferred to the Sinking Fund a sum equal to one-quarter of the amount by which such additional dividend exceeds $200,000 and in addition one-half of the amount by which such additional dividend exceeds $300,000; and the sum so transferred to the Sinking Fund shall not apply against the annual Sinking Fund requirement of $50,000, but shall be supplemental thereto. Additional amounts may in any year be transferred to the Sinking Fund, and in that event the excess may apply on account of the amount due in any subsequent year.
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Preferred stock purchased out of the Sinking Fund appropriations shall be canceled and never again issued.
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After all Sinking Fund requirements for prior years have been met and all accumulated dividends and the current quarterly dividend on the outstanding preferred stock has been paid or a sufficient sum from which to make such payment when due has been set apart, the Directors may use and apply any portion of the surplus of the corporation or its net profits in the purchase of the preferred stock, to such extent and in such manner and upon such terms as the Directors may determine.
On April 12, 1926, a short time prior to the adoption of the plan in 1926, the petitioner, wrote a letter to the beneficiaries of the trust under the will of Abner J. Tower in which, among other things, it was said:
The entire authorized preferred stock of the new company aggregating $1,000,000 par value is to be retained for the time being by the Trustees. By the provisions of the preferred stock the company is to set aside, commencing with the year 1928, at least $50,000 out of earnings in each year before dividends on the common stock are paid, such sum to constitute a sinking fund for the retirement of the preferred stock. Thus the Trustees will have the alternative of holding their preferred stock until it is retired by action of the sinking fund or of selling their stock as a whole or in part from time to time if and as favorable opportunity arises.
The plan of 1926 in no way involved an intent on the part of the trustees or the company to curtail the business of the company. Its principal purpose was to ultimately get the trustees under the will of Abner J. Tower out of the business and the business of the company into the hands of the beneficiaries of the trust.
The method employed by the company in setting apart net profits for the sinking fund was to purchase preferred stock of the company specifically for the sinking fund. The company never set apart cash or other property as such to meet the sinking fund requirements. In every instance where preferred stock was transferred to the sinking fund, either from the petitioner or from the treasury of the company, there was a specific authorization by the board of directors of the company to that effect. Likewise, in every instance where preferred stock was purchased to be held in the treasury of the company pending further action by the board of directors, there was a specific authorization by the board of directors of the company to that effect.
On January 31, 1940, the board of directors of the company passed a vote authorizing the transfer of 333 shares of preferred stock then held in the treasury "in satisfaction of sinking fund requirements to and including December 31, 1939." At the time this vote was passed, the directors of the company were of the impression that 333 shares were all that were needed to fulfill the sinking fund requirements through December 31, 1939. As a matter of fact, 167 more shares were needed to fulfill such requirements. The mistake was the result of misinformation given to the directors by a bookkeeper of the company who, in looking over the records, had seen that 167 additional shares over the annual 500 requirement had been purchased in 1929 and had assumed that to meet the requirements for 1939 only 333 shares were needed. The 167 additional shares purchased in 1929 were, in fact, required for that year under the sinking fund provisions by reason of the declaration and payment of dividends in 1929 in excess of $200,000.
During 1941 the company had cash which was greater than its immediate needs. The board of directors of the company decided that it would be to the interest of the company to use this idle cash to purchase 750 shares of preferred stock of the company and thereby relieve the company from paying the annual $6 dividends on the outstanding preferred stock. Thereupon the board of directors of the company passed the following vote on May 27, 1941:
To authorize the Treasurer to purchase from the trustees u/w Abner J. Tower on July 1, 1941, 750 shares of preferred stock of A. J. Tower Company at $100 per share, such stock to be transferred into the treasury of the Company and held as treasury stock pending further action by the Board of Directors.
Pursuant to the vote the company on July 2, 1941, purchased from the petitioner 750 shares of preferred stock. Thereafter the company held such shares in its treasury until March 2, 1942, when 1,167 shares out of the total of 1,250 shares of preferred stock then held in the treasury were transferred to the sinking fund pursuant to a vote of the board of directors "in satisfaction of sinking fund requirements to and including December 31, 1941." The remaining 83 shares in the treasury were never transferred to the sinking fund, but were nevertheless retired and canceled in 1942. At the time of the vote of the board of directors on May 27, 1941, and the purchase of the 750 shares on July 2, 1941, the company had in its treasury account 500 shares of preferred stock, which the board of directors believed were sufficient at that time to meet sinking fund requirements through December 31, 1940. Except for the shortage of 167 shares referred to above, no additional preferred stock was needed to meet sinking fund requirements until December 31, 1941.
The company's anticipated need for cash by reason of Government orders became a realized fact, and in 1941 and 1942 the need for working capital became such that it was necessary for the company to borrow money. No longer able to meet the sinking fund requirements except by resorting to bank borrowings or by discontinuing dividends on the common stock, the company on December 31, 1942, refunded all the remaining outstanding preferred stock and gave in exchange therefore a 5-year promissory note of the company in the amount of $275,000. Upon receipt of the 2,750 remaining outstanding shares of preferred stock such shares, plus the 83 shares still held in the treasury of the company, were retired and canceled.
During the period from 1928 through 1942 the books and balance sheets of the company and the certificates of condition filed annually with the Massachusetts Commissioner of Corporations and Taxation showed as separate items the amount of preferred stock held in the treasury and the amount held in the sinking fund. The certificate of condition filed for the year ended December 31, 1941, listed, inter alia, the following items in the balance sheet of the company as of December 31, 1941: Treasury stock, $125,000; and preferred stock in sinking fund, $600,000. The amount shown as treasury stock in such certificate of condition consisted of the 500 shares acquired in 1940 and the 750 shares acquired in 1941.
Old Colony Trust Co., the transfer agent of the company, recorded the transfers of preferred stock on transfer sheets showing the certificates canceled and those issued in place thereof and also on three separate ledger sheets. The transfer sheets of the transfer agent indicated which shares were transferred to the sinking fund account and which shares were transferred to the company for purposes other than the sinking fund account. The ledger sheet used to record transfers to the company for its sinking fund was headed: "SHARES COVERED BY THIS CERTIFICATE HAVE BEEN TRANSFERRED TO SINKING FUND AND MAY NOT BE REISSUED AGAIN AS PREFERRED STOCK." The ledger sheet used to record transfers to the company to be held for purposes other than the sinking fund was headed "A. J. Tower Co." The 750 shares of preferred stock acquired on July 2, 1941, were entered by the transfer agent in the debit columns on the ledger sheet headed "Trustees under Will of Abner J. Tower" and in the credit columns on the ledger sheet headed "A. J. Tower Co." No entry regarding this transfer was made on the sinking fund ledger sheet.
Whenever transfers of preferred stock of the company were made by petitioner to the company, the transfer agent did not know whether they were destined for the treasury account or for the sinking fund unless he received some specific notice of how they were being transferred. In every instance in which transfers were made to the sinking fund, no matter whether from the petitioner or from the treasury account of the company, certified copies of the votes of the board of directors of the company earmarking these shares for the sinking fund, together with instructions from the company to that effect, were received by the transfer agent.
Certificates representing preferred stock held in the sinking fund were always registered by the transfer agent in the name of "A. J. Tower Co.," with the following legend marked on the face of the certificate: "THE SHARES COVERED BY THIS CERTIFICATE HAVE BEEN TRANSFERRED TO THE SINKING FUND AND MAY NOT BE ISSUED AGAIN AS PREFERRED STOCK." Certificates representing preferred stock of the company held in its treasury account were always registered in the name of "A. J. Tower Co.," with no legend appearing thereon.
To effect the transfer of the 750 shares here in question, the petitioner delivered one certificate for 3,500 shares of preferred stock to the transfer agent, and it issued a new certificate in the name of the company for 750 shares and new certificate in the name of the petitioner for 2,750 shares. The old certificate for 3,500 shares was canceled. On March 5, 1942, when all except 83 of the 750 shares were transferred to the sinking fund, the transfer agent wrote on the back of the old certificate representing the 750 shares: "Legend to appear on face of certificate — 'The shares covered by this certificate have been transferred to the Sinking Fund and may not be issued again as preferred stock'." The new certificate representing the shares transferred to the sinking fund on March 5, 1942, including all of the 750 shares except 83 of such shares which remained in the treasury of the company, was registered in the name of the A. J. Tower Co., with the following legend marked on the face of the certificate: "The shares covered by this certificate have been transferred to the Sinking Fund and may not be issued again as preferred stock."
In every instance when preferred stock of the company not then designated for the sinking fund was transferred by the petitioner to the company, the transfer tax stamps were affixed to the certificates representing the stock transferred; in every instance when preferred stock of the company was transferred to the sinking fund either from the petitioner or from the treasury of the company no transfer tax stamps were affixed. Transfer tax stamps were affixed to the certificate representing the 750 shares of preferred stock transferred on July 2, 1941.
The company, as has been stated, acquired preferred stock from the petitioner from time to time and also transferred certain of the shares so acquired to the sinking fund, all as shown by the following schedule: Date Items Debit Credit Balance 1926 ..... Acquired 1,000 shs. pfd. stock .. $100,000 1927 ..... Acquired 1,000 shs. pfd. stock .. 100,000 1928 ..... Acquired 500 shs. pfd. stock .... 50,000 $250,000 12-18-31 . Trans. to sinking fund a/c 2,167 shs. pfd. stock ......... $216,700 33,300 6-31-33 .. Acquired 500 shs. pfd. stock .... 50,000 5-31-33 .. Trans. to sinking fund a/c 500 shs. pfd. stock ............. 50,000 12-8-33 .. Acquired 1,000 shs. pfd. stock .. 100,000 133,300 9-4-34 ... Acquired 1,000 shs .............. 100,000 9-4-34 ... Trans. to sinking fund a/c 1,000 shs. pfd. stock ......... 100,000 133,300 11-25-35 . Acquired 500 shs. pfd. stock .... 50,000 11-25-35 . Trans. to sinking fund a/c 500 shs. pfd. stock ........... 50,000 133,300 12-11-36 . Trans. to sinking fund a/c 500 shs. pfd. stock ........... 50,000 9-17-37 .. Trans. to sinking fund a/c 500 shs. pfd. stock ........... 50,000 33,300 12-1-38 .. Acquired 500 shs. pfd. stock .... 50,000 1-30-39 .. Trans. to sinking fund a/c 500 shs. pfd. stock ........... 50,000 33,300 1-31-40 .. Trans. to sinking fund a/c 333 shs. pfd. stock ........... 33,300 None 6-7-40 ... Acquired 500 shs. pfd. stock .... 50,000 7-21-41 .. Acquired 750 shf. pfd. stock .... 75,000 125,000 3-5-42 ... Transfer to sinking fund a/c 1,167 shs. pfd. stock ......... 116,700 8,300 12-31-42 . Acquired 2,750 shares pfd. stock 275,000 12-31-42 . Cancellation of pfd. stock ...... 283,300 None --------- -------- -------- Total ...................... 1,000,000 1,000,000 Petitioner was the sole holder of the outstanding preferred stock of the company at all times and none of the shares acquired by the company were ever reissued by it at any time.
Cash dividends were declared and paid by the company to its common stockholders in the years 1928, 1929, 1930, 1931, 1934, 1935, 1940, 1941, and 1942. Among the above cash dividends was one for $2.50 per share on December 27, 1940; one for $1.50 per share paid July 1, 1941; and one for $10 per share paid on December 18, 1941. The 500 shares of its preferred stock acquired by the company in 1940 from petitioner and held by the company in its treasury until March 5, 1942, were short by 167 shares of the number needed to satisfy the requirements of the sinking fund up to December 31, 1940. Of the 750 shares of its preferred stock acquired from petitioner on July 2, 1941, pursuant to a vote of the board of directors of the company on May 27, 1941, and held in its treasury until March 5, 1942, all but 83 were needed to satisfy the sinking fund requirements to and including December 31, 1941, under the provisions of the "Agreement of Association" of the company.
OPINION.
BLACK, Judge:
We have but one issue to decide in this proceeding and that is whether the 750 shares of preferred stock acquired by the A. J. Tower Co. from petitioner July 2, 1941, were acquired by it as a partial liquidation, as that term is defined in the applicable statute, or whether they were acquired as an ordinary purchase by a corporation of its own stock, to be held as an asset in its treasury for the purpose of subsequent reissue.
If the transaction amounted to a partial liquidation, then petitioner must take into its income account 100 percent of its gain. If it was an ordinary purchase and sale and not a partial liquidation, then petitioner has to take into its income account only 50 percent of the gain, since it had owned and held the shares of stock for a period of more than 10 years prior to its transfer in 1941. The provision requiring gains from partial liquidations to be treated as short term capital gains only was repealed by the 1942 Act (sec. 147, amending I. R. C. sec. 115 (c)). However, it was in full force and effect during the year 1941, which is the year we have before us. The applicable statute as it was prior to its amendment by the 1942 Act is printed in the margin.
SEC. 115. [I. R. C.] DISTRIBUTIONS BY CORPORATIONS.
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(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, the gain so recognized shall be considered as a short-term capital gain, except in the case of amounts distributed in complete liquidation. 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, from the close of the taxable year during which is made the first of the series of distributions under the plan, (1) three years, if the first of such series of distributions is made in a taxable year beginning after December 31, 1937, or (2) two years, if the first of such series of distributions was made in a taxable year beginning before January 1, 1938. * * *
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(i) DEFINITION OF PARTIAL LIQUIDATION. — As used in this section the term "amounts distributed in partial liquidation" means a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock.
There is a line of cases which hold that where a corporation acquires its stock not for the purpose of cancellation and retirement, but for the purpose of holding it as an asset in its treasury for subsequent reissue for some corporate purpose, the transaction between the corporation and its stockholder is one of purchase and sale and for income tax purposes is to be treated as such and not as a partial liquidation. See Alpers v. Commissioner, 126 F.2d 58; William A. Smith, 38 B. T. A. 317; W. C. Robinson, 42 B. T. A. 725; and R. W. Creech, 46 B. T. A. 93.
On the other hand, there is a line of cases which hold that where a corporation purchases a portion of its own stock for the purpose of cancellation and retirement the seller receives a distribution in partial liquidation, and this is so even though the seller may not know that his stock is being purchased for cancellation and retirement. See Cohen Trust v. Commissioner, 121 F.2d 689; Hill v. Commissioner, 126 Fed. 2d 570; Hamilton Allport, 4 T.C. 401, now on review by the Seventh Circuit; Williams Cochran, 4 T.C. 942; and L. B. Coley, 45 B. T. A. 405; appeal dismissed by the Fifth Circuit.
Petitioner contends that the facts of the instant case bring it within the ambit of the first group of cases above cited, whereas the Commissioner contends that the case falls within the ambit of the second group of cases cited. We think the Commissioner must be sustained on the strength of the evidence which we have before us.
In the first place, we think, in deciding the question of intent it must be borne in mind that the very purpose of the reorganization of the A. J. Tower Co. in 1926 was the adoption of a plan whereby the ownership of the corporation by the trust was to gradually cease and the trust beneficiaries were to become the owners of the company. An important part of this plan was the issuance of 10,000 shares of preferred stock to the trust, with a definite provision that each year after 1928, where the profits were sufficient, the corporation was to set aside $50,000 as a sinking fund for the acquirement of 500 shares of preferred stock in that year and the stock when so acquired was to be canceled and was never to be reissued. In addition to this mandatory requirement that $50,000 of the profits in each year should be used for the purchase of preferred stock for the sinking fund, there was also a provision that "the Directors may use and apply any portion of the surplus of the corporation or its net profits in the purchase of the preferred stock, to such extent and in such manner and upon such terms as the Directors may determine."
On July 2, 1941, the corporation purchased from petitioner 750 shares of its preferred stock. These shares were purchased under an authorization set out in our findings of fact and were carried on the corporation's books for the remainder of that year as "treasury stock" and were not canceled and retired until the following year, 1942, as detailed in our findings of fact. However, we do not think these latter facts have any important significance when all the facts and circumstances are taken into consideration.
In the first place it is clear that the corporation was under an obligation, well known to its directors, to purchase 500 shares of the corporation's preferred stock at sometime in that year in order to comply with the sinking fund provision. As a matter of fact, due to an error made by its bookkeeper in a prior year, the company was under an obligation to purchase for the sinking fund 667 shares in 1941, instead of 500 shares. How this error occurred in a prior year is detailed in our findings of fact and it is unimportant to repeat them here. Regardless of whether the board of directors of the corporation thought in 1941 that only 500 shares of the preferred stock had to be purchased for the sinking fund or whether they thought 667 shares had to be purchased for that purpose, we think the whole 750 shares were purchased as a part of the general plan put into effect in 1926 to ultimately acquire the whole of the corporation's 10,000 shares of preferred stock and cancel and retire it.
The corporation declared two dividends on its common stock in 1941. Certainly if the sinking fund requirements for 1941 had not been met the corporation would have had no legal right to declare the dividends on its common stock. It seems only reasonable to assume that when the corporation acquired the 750 shares of preferred stock July 2, 1941, it fully intended to meet its sinking fund requirements for that year and perhaps to exceed them, which it had a right to do. And even though its board of directors did honestly believe at the time of purchase, July 2, 1941, that only 500 shares were required for the sinking fund for 1941, nevertheless it seems to us they were only exercising the right provided in the charter to acquire other shares when the company had surplus funds with which to do it. This was nothing unusual. The company, apparently in other prior years as shown in our findings of fact, had purchased more than its sinking fund requirements. None of such purchases were ever reissued. It seems to us it would be unrealistic to hold, under all the evidence which is in the record, that the 750 shares in question were in fact purchased for any other purpose than ultimate cancellation and retirement.
It is true that at the hearing the corporation's president, who was also one of its directors, testified in substance with reference to the purchase of the 750 shares that the board of directors of the company considered it advisable not to transfer the stock direct to the sinking fund account, but to hold it in its treasury, because it anticipated that it might need additional cash to fulfill Government contracts for goods produced by the company; that from the company's experience in the last war greater working capital was needed to carry out Government contracts because (1) the Government does not pay its bills as promptly as regular customers, (2) larger inventories were required to manufacture goods ordered by the Government, and (3) additional manufacturing facilities might be required; that it was thought that by holding the 750 shares of preferred stock in its treasury rather than its sinking fund account the company would have an additional source from which it could obtain cash in the future should it need it; and that at the time the 750 shares were purchased by the company it was not known whether those shares would eventually be transferred to the sinking fund or whether they would be sold to supply the company with additional working capital.
We have no disposition to question the good faith of the testimony of the corporation's president to which we have just referred. The board of directors may well have had in mind the possibility that they might use all or a part of the 750 shares in the manner which he indicated. However, the fact remains, we think, that this was a mere possibility and that the primary and controlling purpose of the board of directors in directing the purchase of the 750 shares in question was for the ultimate cancellation and retirement of the shares, either through the sinking fund or otherwise. This accords with the general plan of purchase and retirement of the preferred shares which had existed since 1926 and which was fully consummated in 1942 by the cancellation and retirement of all the remaining shares.
A statement in our findings of fact shows the details of these purchases and retirement of the 10,000 shares of preferred stock over the period of years, and this statement shows that none of the stock was ever reissued. It seems to us that it would be wholly unrealistic, in the face of all the evidence which is in the record, to hold that the particular 750 shares purchased in 1941 were purchased for the purpose of resale and reissue to future stockholders. The fact that these shares were carried in the company's accounts as "treasury stock" until in March 1942, when all but 83 of the shares were transferred to the sinking fund, we think is without any important significance in view of all the other evidence in the record.
Respondent's determination is sustained.
Decision will be entered for the respondent.
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