Freshman v. Commissioner ( 1935 )

SUSAN T. FRESHMAN, PETITIONER, ET AL., ^{v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.}

Freshman v. Commissioner

Docket Nos. 63964, 65358-65362, 68858, 69659, 69855, 72497.

United States Board of Tax Appeals

33 B.T.A. 394; 1935 BTA LEXIS 754;

November 8, 1935, Promulgated

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">*754 1. Where a parent corporation received a dividend from its wholly owned subsidiary which was paid in stock of a third corporation acquired by the subsidiary in a nontaxable exchange for stock purchased by the subsidiary in 1925, and the parent corporation immediately distributes the identical property to its stockholders as a dividend, held, the dividend is a distribution in property made out of earnings accumulated after February 28, 1931, and is taxable to the stockholders of the parent corporation to the amount of the fair market value of the property when receivable by the stockholders. Held, further, the fact that the parent corporation entered the stock received as a dividend from the subsidiary on its books at the basis of the property to the subsidiary and not at its value at the time received by the parent, is not conclusive as to the earnings of the parent from the dividend received.

2. Fair market value of stock determined.

3. Where rights to subscribe to bonds of a corporation are issued to a stockholder of the corporation and such rights are exercised and not sold, held, market value of the subscription rights does not constitute taxable income. ">*755 T. I. Hare Powel,27 B.T.A. 55">27 B.T.A. 55.

Valentine B. Havens, Esq., Charles B. McInnis, Esq., Robert B. Cumming, Esq., and Mary H. Donlon, Esq., for the petitioners.

R. W. Wilson, Esq., for the respondent.

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MATTHEWS

">*394 These proceedings, which have been consolidated, are for the redetermination of deficiencies in income tax for the year 1929 determined by the respondent as follows:

Docket No.	Deficiency
63964	$1,680.12
65358	3,825.30
65359	11,993.58
65360	1,789.88
65361	6,583.18
65362	$12,560.54
68858	1,630.54
69659	13,569.33
69855	3,880.17
72497	6,622.75

The issue for determination in each case is whether petitioner is taxable on a dividend received from the Niles-Bement-Pond Co. in stock of the United Aircraft & Transport Corporation and, if so, the amount to be included in income on account of the dividend received. An additional issue in the case of Howard E. Perry is whether the ">*395 petitioner is required to include in taxable income the market value of certain rights to subscribe to bonds of the American Telephone & Telegraph Co., which rights were received by the petitioner">*756 as a stockholder of that company.

The parties submitted in evidence an agreed stipulation of facts, to which certain exhibits were attached and made a part thereof. Petitioners also submitted in evidence additional documentary evidence and the oral testimony of two witnesses. Only such of the stipulated facts as are necessary to the determination of the issues will be incorporated in our findings of fact.

FINDINGS OF FACT.

All of the petitioners were stockholders of Niles-Bement-Pond Co. from a date prior to February 18 up to and including March 6, 1929. Each petitioner received from Niles-Bement-Pond Co., under date of March 6, 1929, a distribution of 2 1/8 shares of common stock of the United Aircraft & Transport Corporation for each share of Niles-Bement-Pond Co. common stock held. The number of shares of stock of Niles-Bement-Pond Co. owned by each petitioner, the total cost thereof, and the number of shares of stock of the United Aircraft & Transport Corporation received by each petitioner as a distributee on March 6, 1929, are set out in the stipulation of facts and need not be here repeated.

The Niles-Bement-Pond Co. is a New Jersey corporation and since 1910">*757 it has owned all the issued and outstanding common stock of the Pratt & Whitney Co., also a New Jersey corporation. The issued and outstanding preferred stock of the Pratt & Whitney Co., which had been publicly held, was wholly redeemed and retired for cash on or about December 21, 1928.

In 1925 Pratt & Whitney Aircraft Co. was incorporated under the laws of the State of Delaware, and commenced business with a paid-in capital of $1,000, consisting of 5,000 shares of common stock without par value. Pratt & Whitney Co. subscribed for one half of the original common stock of Pratt & Whitney Aircraft Co., paying therefor the sum of $500. The remaining half of the stock was subscribed for by individuals who likewise paid $500. The original 5,000 shares of common stock were subsequently increased to 400,000 shares of common stock without par value as a result of a split-up without any additional payment therefor by the stockholders. After the split-up Pratt & Whitney Co. then held in place of the 2,500 shares originally subscribed for, 200,000 shares of common stock without par value of the Pratt & Whitney Aircraft Co., which were carried on the books of Pratt & Whitney Co. at the">*758 cost to it of the original 2,500 shares, namely, $500.

">*396 From time to time Pratt & Whitney Aircraft Co. issued shares of preferred stock for cash at par. All of its outstanding preferred stock was held by Niles-Bement-Pond Co. at the time that the preferred stock was retired, which was on or about December 31, 1928.

During the latter part of the year 1928 negotiations were carried on by the National City Co., investment affiliate of the National City Bank of New York, for the merger or consolidation of several aircraft manufacturing and air transport corporations, or for their properties and business, through control by Boeing Airplane & Transport Corporation, a Delaware corporation, incorporated October 30, 1928. The corporation immediately acquired all of the stock of Boeing Airplane Co. and Boeing Air Transport, Inc., and a majority of the stock of Pacific Air Transport, solely in exchange for its common stock. The Boeing Airplane & Transport Corporation changed its name to United Aircraft & Transport Corporation on January 18, 1929, effective February 2, 1929, and it has ever since been known by that name and will be hereinafter referred to as the United Aircraft.

">*759 As a result of the negotiations with the stockholders of Pratt & Whitney Aircraft Co., an agreement was reached in December 1928 for the exchange of all the outstanding common stock of Pratt & Whitney Aircraft Co. solely for shares of common stock of United Aircraft without par value, and for the retirement of all the preferred stock of Pratt & Whitney Aircraft Co. at par, plus a premium of 7 percent. The preferred stock was accordingly retired and all the common stock of Pratt & Whitney Aircraft Co. was transferred in February 1929 by the holders thereof to United Aircraft, solely in exchange for 868,000 shares of the common stock of United Aircraft without par value. Pratt & Whitney Co., as the holder of 50 percent of the common stock of Pratt & Whitney Aircraft Co., received in such exchange 434,000 shares of the common stock of United Aircraft without par value. The other stockholders, three individuals, received the other 434,000 shares of the common stock of United Aircraft.

On February 7, 1929, the board of directors of Pratt & Whitney Co. adopted the following preambles and resolution:

WHEREAS this Company will receive in the near future 434,000 shares of the common">*760 stock of the United Aircraft & Transport Corporation in exchange for the common stock which it owns in the Pratt & Whitney Aircraft Co., and

WHEREAS the aeroplane and air transportation business is entirely different and apart from the regular business of the Company;

NOW, THEREFORE, be it resolved, that this Company declare a total dividend of 429,100 shares of common stock of the United Aircraft & Transport Corp., to be paid and distributed pro rata on the eleventh day of February, 1929, to stockholders of record of this Company at the close of business on the eighth ">*397 day of February, 1929, pro rata, in accordance with their respective holdings of stock at that time;

* * *

On the same date, February 7, the directors also authorized the sale at $30 per share to the officers and employees of the company, or others, of the remaining 4,900 shares of United Aircraft common stock, and the stock was sold pursuant to such resolution.

The 434,000 shares of common stock of United Aircraft were received by Pratt & Whitney Co. on February 11, 1929, and on the same date 429,100 shares thereof were distributed to the Niles-Bement-Pond Co., the sole stockholder of Pratt & ">*761 Whitney Co.

On the same date, that is, February 11, 1929, the board of directors of the Niles-Bement-Pond Co. adopted the following preambles and resolution:

WHEREAS this company will today receive a dividend from Pratt & Whitney Company consistion of 429,100 shares of the common stock of United Aircraft & Transport Corporation, and

WHEREAS United Aircraft & Transport Corporation is engaged in the manufacture of aircraft and in the air transport business, which business differs essentially from the regular business of this company and constitutes a relatively new enterprise, and this Board does not, therefore, feel justified in assuming the responsibilities of having this company continue to hold so large an amount of the stock of a company engaged in an enterprise of this nature, but deems it proper that the major portion of the holdings of this company in the stock of the United Aircraft & Transport Corporation be distributed to the common stockholders of this company, to the end that such stockholders may retain or dispose of the stock so distributed as their individual judgment may dictate; and

WHEREAS the preferred stock of this company has been called for redemption">*762 on June 29, 1929, and all accumulated back dividends have been paid thereon, and all future dividends thereon up to and including the date of redemption have been duly declared;

Now, THEREFORE, be it

RESOLVED, that a dividend be declared on the common stock of this company out of the earned surplus of this company payable in stock of the United Aircraft & Transport Corporation at the rate of two and one-eighth shares of common stock of United Aircraft & Transport Corporation for each share of the common stock of this company, said dividend to be payable on March 6, 1929, to the common stockholders of this company of record at the close of business on February 18, 1929.

* * *

Pursuant to the above mentioned resolution, Niles-Bement-Pond Co. distributed to its stockholders on March 6, 1929, a total amount of 409,062 1/2 shares of the common stock of United Aircraft without par value, this distribution being at the rate of 2 1/8 shares of United Aircraft common stock for each share of stock of the Niles-Bement-Pond Co. Each petitioner, as stockholder of Niles-Bement-Pond Co., ">*398 received the number of shares of United Aircraft to which he or she was entitled.

The">*763 434,000 shares of United Aircraft were entered on the books of Pratt & Whitney Co. under "investments" at $500, the cost at which the 200,000 shares of Pratt & Whitney Aircraft stock had been carried on its books. The cost of the 429,100 shares distributed to Niles-Bement-Pond Co. as a dividend was entered on the books at $494.35.

The books of Niles-Bement-Pond recorded the receipt of a dividend on February 11, 1929, of $494.35 and the 429,100 shares received as a dividend were entered under "investments" at a cost of $494.35. The 409,062 1/2 shares distributed by Niles-Bement-Pond to its shareholders as a dividend were charged off at $471.27, leaving in Niles-Bement-Pond's treasury, as an investment, 20,037 1/2 shares of United Aircraft stock at a cost of $23.08. On June 8, 1929, in accordance with instructions of the board of directors of the same date, the book value of the 20,037 1/2 shares of United Aircraft was increased to $30 a share, or a total of $601,125.

The books and records of Pratt & Whitney Co. reflected total earnings subsequent to March 1, 1913, up to and including March 6, 1929, after the payment of all dividends declared and paid during that period and">*764 after the restoration of certain write-offs made during the said period and charged to surplus but before the revaluation and resale of any of the common stock of United Aircraft & Transport Corporation received in exchange for stock of Pratt & Whitney Aircraft Co., amounting to $1,216,210.39.

The books and records of Niles-Bement-Pond Co. and subsidiaries other than Pratt & Whitney Co. reflect earnings for the period March 1, 1913, to March 6, 1929, inclusive, after the payment of all dividends declared and paid during the said period and after the restoration of certain write-offs made during the said period but before the revaluation of any part of the common stock of United Aircraft & Transport Corporation received from Pratt & Whitney Co., amounting to $1,540,744.56.

The Niles-Bement-Pond Co. and Pratt & Whitney Co., together with the other subsidiaries of the Niles-Bement-Pond Co., filed a consolidated income tax return for the calendar year 1929 and the tax liability of these companies for that year was computed by the respondent on the basis of this consolidated return.

The common stock of the Boeing Airplane & Transport Corporation, the name of which was changed to">*765 United Aircraft & Transport Corporation on February 2, 1929, was listed on the New York Curb Exchange early in November 1928 and was regularly quoted and sold on that exchange from November 3, 1928, until April 10, 1929, ">*399 on which latter date it was listed on the New York Stock Exchange, and since which date it has been quoted and sold on the New York Stock Exchange.

The fair market value of the common stock of the United Aircraft, on March 6, 1929, was $87.8125 per share.

The petitioners in these proceedings did not include in the income reported in their income tax returns for 1929, any portion of the fair market value of the common stock of the United Aircraft received as a dividend from Niles-Bement-Pond Co. The respondent determined that the shares of common stock of United Aircraft which were distributed to its stockholders on March 6, 1929, by the Niles-Bement-Pond Co. constituted taxable dividends and increased the taxable income of each petitioner by the amount of stock of the United Aircraft received from the Niles-Bement-Pond Co. valued at $87.8125 per share.

The petitioner, Howard E. Perry, owned 100 shares of the capital stock of the American Telephone">*766 & Telegraph Co. on May 10, 1929, and prior to July 1, 1929, received 100 subscription rights which entitled him to subscribe to a certain number of bonds of the American Telephone & Telegraph Co. at par, which bonds were later exchangeable for stock of the American Telephone & Telegraph Co. at certain prices. Petitioner exercised the rights. Respondent determined that the distribution of the rights constituted a taxable dividend to petitioner, Howard E. Perry, and that the value of the rights was $568.75, which amount he added to the taxable income of petitioner Perry.

OPINION.

MATTHEWS: Petitioners contend that the stock of the United Aircraft & Transport Corporation was distributed to the stockholders of Niles-Bement-Pond Co. in pursuance of a plan of reorganization and is not taxable in the hands of the stockholders of the Niles-Bement-Pond Co. If, however, the Board should decide against petitioners on that issue, then petitioners contend that the stock of the United Aircraft & Transport Corporation is taxable to them to the extent of its fair market value on March 6, 1929, limited, however, to the amount of earned surplus of the Niles-Bement-Pond Co. accumulated subsequent">*767 to March 1, 1913, and finally that the fair market value of the United Aircraft & Transport Corporation's common stock on March 6, 1929, was between $30 and $40 per share, but in no event in excess of $40 per share.

The petitioners argue that the benefits provided by section 112 of the Revenue Act of 1928 in the case of corporate reorganization should not stop with Pratt & Whitney Co., but that the nonrecognition ">*400 of gain thereunder should be extended to the stockholders of the Niles-Bement-Pond Co., it being contended that the Pratt & Whitney Co. was in substance the mere instrumentality of its parent corporation, the Niles-Bement-Pond Co., and that it is the latter company which should be deemed the real party to the reorganization.

The respondent admits that the Pratt & Whitney Aircraft Co. and United Aircraft Co. were parties to a reorganization and that the exchange of all of the stock in Pratt & Whitney Aircraft Co. solely for stock in United Aircraft is a nontaxable exchange under the provisions of section 112(b)(3). He denies, however, that either Pratt & Whitney or Niles-Bement-Pond were parties to a reorganization or that the distribution by Pratt & Whitney">*768 to Niles-Bement-Pond of United Aircraft stock and the distribution by Niles-Bement-Pond of United Aircraft stock were distributions of stock in pursuance of a plan of reorganization. He takes the position that such distributions were dividends paid in property and that the dividends received by the petitioners are income to them to the amount of the market value of United Aircraft stock on March 6, 1929, the date on which the dividend was payable and was paid to the shareholders. He determined this market value to be $87.8125 per share.

The pertinent provisions of section 112 of the Revenue Act of 1928 are 112(a), (b)(3), and (i)(1), and (2), which are quoted in the margin. ^{1935 BTA LEXIS 754">*769 We agree with respondent's contentions. It is clear that the acquisition by United Aircraft of all of the stock in Pratt & Whitney Aircraft Co. was a reorganization within the meaning of section 112(i) and that Pratt & Whitney Aircraft Co. and United Aircraft Co. were both parties to the reorganization within the meaning of the statute. The Pratt & Whitney Co. was not a party to the reorganization; it was merely one of the four stockholders of Pratt & Whitney Aircraft Co., which was a party to the reorganization. Although ">*401 Pratt & Whitney Co. and the other stockholders of the Pratt & Whitney Aircraft Co. realized a gain on the exchange of their Pratt & Whitney Aircraft stock for United Aircraft stock, the gain on such exchange was not recognized under the provisions of section 112(b)(3). In such a case the basis for determining gain or loss on the sale of United Aircraft stock is the same as in the case of the stock exchanged, under the provisions of section 113(a)(6). However, the cost or basis for determining gain or loss on the sale of property by a corporate owner is not necessarily the value at which stockholders of the corporation would have to report a dividend">*770 paid in such property.}

This is the case of a corporate stockholder receiving a dividend in property and immediately distributing the identical property to its stockholders as a dividend.

The term "dividend" is defined in section 115(a) as "any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913", and it is further provided in subsection (b) of section 115 that every distribution is made out of earning or profits to the extent thereof, and from the most recently accumulated earnings or profits. Article 627 of Regulations 74 reads in part as follows:

ART. 627. Dividends paid in property. - Dividends paid in securities or other property (other than its own stock) in which the earnings of a corporation have been invested, are income to the recipients to the amount of the market value of such property when receivable by the shareholders. * * *

The Pratt & Whitney Co. invested $500 of its earnings in 1925 in common stock of Pratt & Whitney Aircraft Co. This stock had increased enormously in value by 1929 and was exchanged in February 1929 solely for stock of United">*771 Aircraft Co. but the gain on the exchange was not recognized under the provisions of section 112(b)(3). The increase in value of the investment, which, after the exchange, was represented by the property received on exchange, was available for distribution as a dividend and was distributed by Pratt & Whitney to its sole stockholder, Niles-Bement-Pond. This dividend was an earning of Niles-Bement-Pond on its Pratt & Whitney stock, which earning was received on February 11, 1929, and was available for distribution by Niles-Bement-Pond to its stockholders. Niles-Bement-Pond immediately distributed practically all of the property received by it as a dividend to its stockholders. This was a distribution by a corporation to its stockholders in property out of earnings received after February 28, 1913.

The distribution meets all the requirements of section 115 and is a taxable dividend to petitioners to the amount of the market value of the stock on March 6, 1929.

">*402 The parties stipulated that the earnings for the period March 1, 1013, to March 6, 1929, inclusive, of the Niles-Bement-Pond Co. and subsidiaries other than Pratt & Whitney Co., reflected on the books and records">*772 of the companies, amounted to $1,540,744.56 before the revaluation of any part of the common stock of the United Aircraft received from Pratt & Whitney Co. The petitioners insist that this sum of $1,540,744.56 represents all the earnings of the Niles-Bement-Pond Co. subsequent to March 1, 1913, which were available for distribution on March 6, 1929.

Petitioners overlook the fact that the value at which Niles-Bement-Pond Co. entered the dividend received by it in United Aircraft stock on its books is not conclusive as to the earnings from such dividend. The dividend received by Niles-Bement-Pond on February 11, 1929, was entered on its books at $494.35 (the basis of the United Aircraft stock to Pratt & Whitney) and it is included in the accumulated earnings at this amount. As a matter of fact, therefore, the earnings since March 1, 1913, available for distribution on March 6, 1929, were the earnings accumulated prior to March 6, 1929, and also the 429,100 shares of United Aircraft stock. The distribution of 409,062 1/2 shares of United Aircraft as a dividend did not affect the earnings accumulated between March 1, 1913, and March 6, 1929. They were still available for distribution. ">*773 The distribution was a dividend in property, and it was paid out of earnings accumulated since March 1, 1913. It is taxable to petitioners to the amount of the market value of the property when received. ; ; ; , affirming an unreported Board decision; certiorari denied, .

The market value of the stock on March 6, 1929, is a question of fact. In finding that the value of the stock on March 6 was $87.8125, which is the same value as that determined by the respondent, we have carefully considered all the evidence and the arguments of petitioners in support of a lower value. While the evidence tends to show that the intrinsic value of United Aircraft stock, based on the assets of the constituent companies and their past earnings, was less than the market price of the stock, and that the stock was not recommended by Poor and other analysts as an investment, it had been selling for a period of over two months prior to the distribution">*774 at prices as high and higher than that determined by the respondent, and for a period of over six months after distribution, except for a period of about three weeks just prior to its listing on the New York Stock Exchange, the stock had sold for much more than the value determined.

On the first day of trading on the New York Curb Exchange, November 3, 1928, the common stock opened at 57. The high for ">*403 the common stock on that date was 63 and the low 55. The number of shares traded on the first day was 1,200. The highest number of shares traded in any one day prior to February 11 (the date the dividend was declared) was 11,000 shares on January 31, with a high of 98 3/4 and a low of 94. On March 1 the number of shares traded was 13,800, with a high of 91 and a low of 90. On March 6 (the date the stock was distributed) the number of shares traded was 4,500, at a high of 88 7/8 and a low of 86 3/4. From December 14, when the stock reached a high of 90, until March 6, the stock never went below 85 and was over 90 most of the time.

On the third day of trading on the New York Stock Exchange, the stock reached 90, when 28,100 shares were traded, and six days later">*775 it reached a high of 109, a low of 96, with 61,900 shares traded. Thereafter the stock never went below 100 until the last week of September. On May 1 it reached a high of 162, with 127,900 shares traded.

It is interesting to note that the closing quotation of Niles-Bement-Pond Co. common stock on the New York Curb on March 6 was 226, and that on March 8 (there was no quotation on this stock on March 7), the closing was 38 7/8, a difference of 187 1/8, which is slightly more than the market value as determined, of 2 1/8 shares of United Aircraft stock at time of distribution.

Reliance is placed by the petitioners on the testimony of two witnesses who qualified as experts in the valuation of securities and who testified that they both had knowledge of the common stock of the United Aircraft. One witness expressed the opinion that the stock was worth $37.50 per share on March 6, 1929, and the other fixed a fair market value on this date of $40 per share. In the opinion of one of these witnesses, the quotations on the New York Curb Exchange reflected a hysterical state of mind on the part of the speculative public in the early part of the year 1929, with the result that the">*776 stock quotations reached points unsupported by the assets back of the stocks and their earning power. But we have evidence of actual unrestricted sales of the stock of the United Aircraft over a long period of time at greater prices than the petitioners seek to establish as the fair market value on March 6, 1929. These reported sales, in our opinion, more nearly reflect the fair market value of this stock than does the opinion evidence. We hold, therefore, that the respondent did not err in his determination that the fair market value of the common stock of the United Aircraft was $87.8125 on March 6, 1929.

The question as to whether the market value of certain rights to subscribe to bonds of the American Telephone & Telegraph Co. is taxable income arises in the case of petitioner Howard E. Perry only, and requires little discussion. Petitioner exercised these rights ">*404 and did not dispose of them. The respondent concedes that this issue falls within the principle of , which case was dismissed by the Circuit Court of Appeals for the First Circuit on July 6, 1933; and ">*777 ; affd., on another issue, . See also ; ; ; . On authority of these decisions, we hold that the value of these rights did not represent taxable income to the petitioner.

Reviewed by the Board.

Judgment will be entered under Rule 50.

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Footnotes

• 1. Proceedings of the following petitioners are consolidated and decided herewith: Dorothy L. Low; Angeline Low Forbes; Josiah O. Low; Mary T. F. Low; Nathalie F. Baker; Louise S. Corwin; Walter E. Meyer; Howard E. Perry; Frank J. Porter. ↩

• 2. SEC. 112. RECOGNITION OF GAIN OR LOSS.

  (a) General rule. - Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.

  (b) Exchanges solcly 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.

  (i) Definition of reorganization. - As used in this section and sections 113 and 115 -

  (1) The term "reorganization" means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), * * *

  (2) The term "a party to a reorganization" includes a corporation resulting from a reorganization and includes both corporations in the case of an acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation. ↩