Youell v. Commissioner , 18 B.T.A. 599 ( 1929 )

GEORGE YOUELL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Youell v. Commissioner

Docket No. 20756.

United States Board of Tax Appeals

18 B.T.A. 599; 1929 BTA LEXIS 2012;

December 31, 1929, Promulgated

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Raymond G. Wright, Esq., for the petitioner.

J. Arthur Adams, Esq., and George Adams, Esq., for the respondent.

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GREEN

In this proceeding, the petitioner seeks a redetermination of his liability for income taxes, for the year 1919, for which year the respondent has assessed additional taxes in the amount of $14,185.70. The petitioner alleges that the respondent erred in holding that his income should be increased by the amount of $68,534.16, which amount the Commissioner determined to have been dividends on the stock of the Pacific Fruit & Produce Co. owned by the petitioner. By an amendment to the petition, petitioner asserts that the dividend, if any, was community property and that one-half thereof should be included in his income. Thereafter, the respondent amended his answer to allege affirmatively that the petitioner sold certain stocks of the above-named corporation and thereby derived income within the taxable year in the amount of $73,767.59.

FINDINGS OF FACT.

The petitioner is a resident of the State of Washington, where he has resided continuously since 1893, with the exception of the period from 1914 to 1920, when he was a resident of Portland, Oreg. Previous to going to Portland, he was a resident of Tacoma, Wash., and subsequent to his Portland residence, he has been a resident of the City of Seattle, State of Washington.

In 1897 he was married to May V. Youell, his present wife.

In 1898 he formed a copartnership with Lloyd Garretson, under the name and style of Pacific Fruit & Produce Co., each partner contributing $325 to the partnership. Youell's $325 was earned by him subsequent to his marriage. In 1909, the assets of the partnership were assigned to a corporation organized in the State of Washington, under the name of Pacific Fruit & Produce Co., with a capitalization of $100,000, divided into 1,000 shares of the par value of $100 each. Fifty per cent of the stock was issued to each partner as fully paid.

Garretson and Youell remained the only stockholders until 1919, when Garretson sold out in the manner hereinafter set forth.

In the latter part of 1918, differences arose between Garretson and Youell. Up to that time, neither had withdrawn any of the earnings of the corporation, except such as might be necessary to pay their respective living expenses. Neither was prepared individually to buy out the other.

During the latter part of 1918, Youell and Garretson had various conferences relative to the settlement of their differences, and the purchase of Garretson's stock. Youell saw various employees of the company, in particular, O.J. and H. F. Schumacher, each of whom agreed to purchase 100 shares of the Garretson stock at the book value. Youell also saw other employees during this period, who agreed to purchase various amounts of the Garretson stock at the same price, so that ultimately Youell was able to complete the sale of the Garretson stock, if given sufficient time for the various employees to raise enough money to pay for their respective shares.

Garretson was unwilling to deal with the number of employees, or with the corporation, but was willing to deal with Youell, in order to effect the sale.

The parties who agreed to buy the 500 Garretson's shares were all employees, with the exception of M. E. Callender, a relative of Youell's wife.

Relying upon his arrangement with his employees, on January 21, 1919, Youell signed the following contract:

WHEREAS Lloyd Garretson, hereinafter called Garretson, and George Youell, hereinafter called Youell, are owners in equal part of the capital stock of the Pacific Fruit & Produce Company, a corporation, herein called the corporation, the capital stock of which is One Thousand Shares of the par value of $100 per share, each owning Five Hundred Shares, and the two being the only stockholders and both being trustees of said corporation, now, this

AGREEMENT WITNESSETH that Garretson hereby agrees to sell and assign to Youell and Youell hereby agrees to buy from Garretson the entire 500 shares of the capital stock of said corporation, owned by Garretson for the sum of $272,168.32, which said Youell agrees to pay in amounts, at times, and in manner following, to-wit:

Youell does hereby sell, assign and warrant to Garretson the sole right to receive all the one-half interest of Youell, being the one-half interest in and to all that portion of the surplus capital of said corporation, this day duly distributed by resolution of said corporation, and consisting of the lands and improvements of the said corporation's ranch on Unit One of the Tieton Project, Yakima, Washington, with all of the machinery, stock, tools, supplies and produce on hand and all equipment of every kind (making special mention of one White Truck and one Ford Automobile) together with the Parker Lease and all other leases and appurtenances and all matters pertaining to said farming industry with the produce undelivered from same and including the residence occupied by Garretson on Chase Hill, Yakima, all of the agreed value of $37,168.32, as shown by the books of said corporation, and also the right to receive from said corporation the sum of $100,000.00 cash specified in said resolution, all of which real estate, leases and appurtenant property shall be deeded and properly conveyed to Garretson by said corporation, by proper deed and conveyances of warranty on or before ten days from the date hereof and said cash shall, at the same time be paid to Garretson and shall be credited on said agreed purchase price as the first payment thereon.

That in case it should hereafter be determined by proper Government authority that said surplus capital so set aside is, in fact, a dividend on which income tax shall have to be paid, it is agreed and warranted by and between the parties hereto for themselves and for said corporation, that said income tax shall be paid by said corporation.

That at the time of and as a part of the same transaction of delivering the deed and conveyance before specified, and the payment of said cash, Youell shall make a promissory note in usual commercial banking form and substance, agreeing to pay to order of Garrentson, on or before June 15th, 1919, $85,000, with interest at six per cent per annum, and one promissory note in like form and substance agreeing to pay to the order of Garretson the balance of $50,000 on or before January 1, 1919, interest at six per cent, both notes giving five days' grace, and thereupon and as a part of the same transaction, garretson shall execute an assignment in blank of all of said stock, in said corporation, and Youell shall execute an assignment in blank of 167 shares of his said stock in said corporation and all of said stock so assigned in blank shall be deposited in a sealed envelope, with said promissory notes attached outside of said envelope, in the First National Bank of Yakima, Washington, with the escrow agreement attached hereto and marked "A" and made a part hereof, attached to said envelope, filling in the blank in the first note above specified, and the party hereto or the properly authorized assign, heir, administrator or executor of the party hereto to whom said escrow shall be properly delivered according to the true intent thereof, shall have and is hereby given the authority to fill in the blank for the assignee of said stock and shall be the absolute owner thereof.

Until the expiration of the five days of grace on the said $50,000 above referred to, that is until and including the 5th day of January, 1920, or until the payment of said notes if same are paid prior to said date Garretson agrees that acting as trustee for the Pacific Fruit & Produce Company he will concur with Youell in whatever legal actions that Youell may designate in the entering of resolutions or otherwise to apply all of the profits on all of the stock of said corporation contained in said escrow or owned by Youell or under his beneficial control in payment of the amount or balance due on said notes and escrow agreement and during all said time Youell shall, for all purposes of profits, be the full beneficial owner of said stock, that is, shall, for the purposes before specified, have the right to all the proceeds and benefits of said stock and until the full payment of said sums or the termination of said escrow according to the terms thereof, none of the profits or surplus of said corporation accruing or accrued on any of the stock of said corporation in escrow or owned or beneficially controlled by Youell, whatsoever, shall be applied to any purpose whatsoever other than the payment of the sum or balance of said notes and said escrow, except to use for capital in ordinary course of business, during the life of this agreement. Garretson shall have the right to vote 500 shares of said stock and it is his right and shall be his duty to so act as trustee of said corporation until the termination of said escrow agreement by delivery of said stock to Youell or the person by him duly authorized to receive the same under said escrow agreement. It being strictly the intention of this agreement that Youell shall make the payments on said escrow agreement, it shall not be considered the duty of said corporation to make the same except as same may be ordered by proper resolution or otherwise, as accruing to Youell for said purpose as the beneficial owner of said stock as aforesaid during said period provided for said payments.

If Garretson is required to pay Federal Income Tax by reason of the transactions covered by this agreement, then, Youell agrees to pay one-half of the said tax added by reason of this transaction up to but not exceeding $10,000 said limit referring to the one-half of said additional tax to be paid by Youell, and this liability on the part of Youell is limited to and must be determined by the 1st day of January, 1922, unless the same and the payments of the same and the Government's right to collect the same be in litigation by consent of Youell. In case Garretson shall have to bring suit against Youell for payment of said portion of said tax, then Youell shall pay, in addition to costs, if suit be properly brought, all attorney's fees and such damages as Garretson may sustain in that regard, and if judgment be entered, same shall include said items of recovery.

Until the final termination of this agreement, all of said business and its assets shall be carefully conserved for purposes herein provided, and Youell shall keep Garretson fully informed of all transactions he has or contemplates in that regard.

This agreement shall be binding upon the parties hereto and on their heirs, executors, administrators and assigns.

This agreement shall take effect as of January 1, 1919. Dated January 21, 1919.

(Signed) LLOYD GARRETSON

GEO. YOUELL.

Attached to said agreement, was the following escrow agreement:

On or before the 15th day of June, 1919, there shall be paid to the First National Bank of Yakima, holder hereof, $85,000, and on or before January 1st, 1920, $50,000 shall be paid additionally to First National Bank of Yakima. holder hereof, for Lloyd Garretson, with interest on deferred payments at six per cent per annum and five days grace is allowed on each said sums, but aside from these days of grace, time is of the essence hereof and on failure to make the first payment or either of said payments, as herein prescribed, as time is hereby understood, then the within shall be delivered to Loyd Garretson or his agent or representative duly authorized in writing to receive the same.

In case said payments be made, however, as herein provided, then and thereupon, the within escrow shall be delivered to George Youell or to such person as he may designate in writing duly authorized to receive the same.

No verbal statement shall alter, vary, modify, control or in any way affect this agreement of escrow.

January 31, 1919.

(Signed) GEORGE YOUELL.

LLOYD GARRETSON.

At a special meeting of the trustees of the Pacific Fruit & Produce Co., held on January 21, 1919, a dividend on the capital stock of said Pacific Fruit & Produce Co. was declared, amounting to $137,168.32, payable $100,000 in cash, and certain property, said property having an agreed value of $37,168.32. Of the total dividend declared, the petitioner was entitled to receive cash and property in the amount of $68,584.16. The minutes of the meeting of the trustees authorizing the payment of the said dividend read as follows:

A special meeting of the trustees of the Pacific Fruit & Produce Co. was held at Tacoma, Washington, on Tuesday, January 21st, 1919.

There were present at said meeting: Messrs. George Youell, and Lloyd Garretson, the full board of trustees of said corporation, Mr. Youell presiding.

From a financial statement submitted, there appeared that there was on hand a surplus in excess of $400,000. The following resolution was thereupon introduced and after full discussion was adopted by the unanimous affirmative vote of the board of trustees.

WHEREAS, this corporation has a surplus in excess of $400,000, and,

WHEREAS, this corporation is the owner of the following described real property and leases, to-wit:

The Southeast Quarter of Section Eight (8), Township Thirteen (13) North, Range Eighteen (18) E.W.M.

The Southwest quarter of the Northwest quarter of Section Nine (9), Township Thirteen (13) North, Range Eighteen (18) E.W.M., containing forty (40) acres, more or less.

All of the Southeast Quarter of the Northeast Quarter of Section 8, Township 13 North, Range 18 E.W.M., except the following: Commencing at the Southwest corner of the Southeast Quarter of the Northeast quarter of said Section 8, Township 13 North, Range 18 E.W.M., and running thence East along the South line of the said Southeast Quarter of the Northeast Quarter, a distance of 728 feet; thence North and parallel to the West line of said Southeast Quarter of the Northeast Quarter, a distance of 418.8 feet; thence West and parallel to the South line of said Southeast quarter of the Northeast Quarter, a distance of 728 feet; thence South along the West line of said Southeast Quarter of the Northeast Quarter, a distance of 418.8 feet to point of beginning, containing 7 acres, also except two rights of way for waste water along two draws one leading from the Northwest corner and the other leading from the Northeast corner of above described land, the land conveyed containing 33 acres, more or less.

Lot two (2) of the Chase Hill Residence Tracts, according to the official plat thereof now of record in the office of the Auditor of Yakima County, together with one share of water in the Yakima Valley Canal Company; also the privilege to tap the city water main for domestic uses.

All of the above property being situated in Yakima County, Washington.

And, WHEREAS, this corporation is also the owner of certain machinery, live stock, tools, supplies and produce appertaining to said above described property, and,

WHEREAS, this corporation is the owner of certain leases known as the Eversole lease and Parker lease, and,

WHEREAS, said real property and leases and $100,000 in cash can be distributed to the stockholders from the surplus of this corporation without impairing its capital and without detriment to its working capital.

NOW, THEREFORE, BE IT RESOLVED, that the above described real property and leases and the sum of $100,000 be distributed to the stockholders of this corporation as their interests may appear, and,

BE IT FURTHER RESOLVED, that the officers of this corporation be and hereby are authorized to execute and deliver any and all necessary documents to effect the transfer of said real property and leases and to distribute said cash.

Thereupon Mr. Youell stated that by reason of a certain personal business transaction between himself and Mr. Garretson he desired his interest or share in the above real property, leases and cash ordered distributed according to the above resolution, should be transferred by the corporation directly to Mr. Garretson.

Thereupon the following resolution was adopted:

WHEREAS, George Youell has requested that his part or interest in the real property, leases and cash this day ordered distributed to the stockholders of this corporation, be transferred by the corporation direct to Lloyd Garretson.

NOW, THEREFORE, BE IT RESOLVED, That the officers of this corporation be and hereby are authorized to transfer the interest of said George Youell in the above described real property, leases and cash direct to Lloyd Garretson upon the said George Youell and May V. Youell, his wife, confirming and ratifying this action on the minutes of this corporation by attaching their signature thereto.

There being no further business to come before the meeting, the same was adjourned.

(Signed) LLOYD GARRETSON,

Secretary.

I, George Youell, and I, May V. Youell, his wife, hereby ratify, confirm and approve the action authorized by the above minutes and direct the corporation to transfer the real property and leases and distribute the cash according to the above minutes.

(Signed) GEORGE YOUELL

MAY V. YOUELL

The Pacific Fruit & Produce Co., on January 21, 1919, had a true surplus of over $400,000.

The books of the Pacific Fruit & Produce Co. contain the following journal entries dated January 31, 1919, in which are recorded the payments of the Dividend which was declared at the special meeting of the trustees held January 21, 1919:

H.O. No. 91, January 31, 1919	Debit	Credit
Surplus	$137,168.32
Cash Dividend		$100,000.00
Property Dividend		37,168.32
Dividend	137,168.32
Lloyd Garretson		68,584.16
Geo. Youell		68,584.16
L. Garretson	18,584.16
G. Youell	18,584.16
Ranch Property		25,887.55
Yakima Property		11,280.77
L. Garretson	50,000.00
G. Youell	50,000.00
Cash		100,000.00

Shortly after the making of said agreement, in accordance therewith, the Pacific Fruit & Produce Co. transferred to Garretson certain property of the value of $37,168.32 and paid to him $100,000 in cash, which amount the corporation was enabled to pay to him by negotiating a loan at different banks. Within a short time, Youell had completed his arrangements with the various employees who paid into the corporation the purchase price of the Garretson stock, and, in the early part of March, 1919, the balance of the purchase price was paid to Garretson. His stock was released from the escrow and distributed to the various purchasers listed in petitioner's Exhibit 1. Fifty shares of the Garretson stock were purchased by Youell, who paid the same price to the corporation per share as the other stockholders had paid. The total purchase price paid by the various employees was $285,548.15, which was a little more than the price paid to Garretson, for the reason that the Garretson stock was sold at the book value as of December 31, 1919, while the purchase price paid by the employees to the corporation was based upon the book value at the time they made their payments, in order to offset the profit made by the corporation during the early months of 1919. After the Garretson purchase had been completed, on March 27, 1919, the new board of trustees of the Pacific Fruit & Produce Co. passed the following resolution:

WHEREAS up to the 1st day of January, 1919, George Youell and Lloyd Garretson owned the entire issued and authorized stock of the Pacific Fruit & Produce Company in the following amounts, to-wit:

George Youell	500 shares
Lloyd Garretson	500 shares

AND WHEREAS for a number of years past George Youell has been in the active management and control of said business, and the said Lloyd Garretson, by reason of sickness has not been active in the management of said business, and

WHEREAS differences of opinion and controversies had prior to said 1st day of January, 1919, arisen between the said George Youell and the said Lloyd Garretson, which differences had become so acute as to affect the business and its financial standing, and

WHEREAS by the equal division of stock between the two parties and by reason of the fact that each of the parties was on the Board of Trustees there was no possibility of securing a deciding vote on any question at issue, and

WHEREAS certain of the employees of the business and others financially able were willing to purchase the stock of Mr. Garretson provided Mr. Youell stayed in the business, and

WHEREAS the said Lloyd Garretson refused to sell his stock, or any portion thereof, to anyone save and except George Youell as an individual, and

WHEREAS the said Lloyd Garretson refused to sell his said stock to the corporation as such, claiming that it was illegal and that there was no right or authority so to do, and

WHEREAS for the purpose of saving his interest in the business as well as saving the business from receivership by reason of the evenly divided voting power in the stockholders' and board of trustees' meetings, the said George Youell, at the request of the said Lloyd Garretson, consented to having declared a cash dividend of $100,000 and consented to the execution of a deed by the corporation conveying certain of its real property as a dividend in kind, all of which dividend after being declared was to go to and did in fact go to Lloyd Garretson as a first payment under a certain contract entered into between Lloyd Garretson and George Youell for the purchase of the stock of this corporation, made by the said George Youell in his own name, but in fact and in trust for the benefit and use of the corporation in order to secure the stock of the said Lloyd Garretson as treasury stock for the purpose of distributing it to employees and others wishing to purchase the same for cash, and

WHEREAS it was never the intent on the part of the said George Youell to purchase said stock for his own benefit, or to cause a dividend or distribution of property to be made for his own benefit, and

WHEREAS in truth and in fact it was intended that said cash and said property so taken from the business should be used solely for the purpose of transfering the same to Lloyd Garretson in payment for his stock, and

WHEREAS it was intended that said capital so removed was to be immediately replaced with said resolution, declaring said dividend, and the contract on which it was based, and

WHEREAS various of the employees and others are willing at this time and have in fact paid to the corporation the full value for said stock thereby replacing said capital,

NOW, THEREFORE, BE IT RESOLVED, that the proper officers of this corporation be and hereby are allowed to make such entries on the books of this corporation as may be necessary to show said transaction declaring and paying said dividend of $100,000 in cash and the transfer of said real property to be in truth and in fact a delivery of the assets of the corporation to said Lloyd Garretson in payment for said stock for the use and benefit of the corporation for the purpose of securing said stock as treasury stock in order that it might be issued to employees and others willing and able to pay therefor.

In accordance with said resolution, any entry having theretofore been made showing dividends was corrected on the books of the corporation.

The petitioner did not report in his income-tax return filed for the year 1919, any amount as representing a dividend received by him from the Pacific Fruit & Produce Co. during said year 1919.

Lloyd Garretson, who owned one-half of the outstanding capital stock of the Pacific Fruit & Produce Co., on January 21, 1919, reported in his Federal income-tax return, $68,584.16 as representing a dividend received by him from the said Pacific Fruit & Produce Co., and paid in accordance with resolution adopted by the board of trustees on January 21, 1919.

OPINION.

GREEN: The facts, briefly, are these. Youell and Garretson each owned 50 per cent of the stock of a corporation. They disagreed. Garretson would sell only to Youell and Youell did not have the wherewithal to pay the purchase price. The purchase price was $272,168.32. Certain employees agreed to buy the stock from Youell if he could buy from Garretson. The employees were to pay an amount equal to the amount paid Garretson. The corporation had a substantial surplus and good credit standing. Youell conceived the idea of having the corporation finance the purchase, in the following manner. The corporation was to declare a dividend, so called, in the amount of $137,168.32, all of which was, by agreement between Garretson and Youell, paid to Garretson. Two notes secured by stock of the corporation were to be given for the balance. In only this part of the plan did Garretson have any interest. The remainder of the plan contemplated the sale of the stock, so purchased, to the employees, for cash, which cash was to be paid in to the corporation. The plan was carried out with but one material variation. Youell purchased for cash, for himself, 50 shares of the Garretson stock.

The result of the transactions was that Garretson sold his 500 shares of stock for $272,168.32. This stock was purchased by Youell and the employees of the corporation. The corporation's assets were neither increased nor diminished. Youell received no cash or property for his own use. His situation afterwards was precisely the same as before, except for the purchase of 50 shares for cash.

The respondent contends that the petitioner, Youell, was the recipient of a taxable dividend and that he sold the stock at a profit. He computes the petitioner's income from the entire transaction to be $142,301.75, and this regardless of the fact that after the transaction, Youell had only his original stock and 50 additional shares for which he paid full value.

It seems clear to us that the petitioner derived no gain from either the dividend or the sale of the stock, or in any other way from the various transactions. Under such circumstances, we can not hold that he had income.

Reviewed by the Board.

Judgment will be entered under Rule 50.