Howell v. Commissioner , 26 T.C. 846 ( 1956 )

Jackson Howell and Virginia Howell, Petitioners, v. Commissioner of Internal Revenue, Respondent. James A. Kenyon Trust, James A. Kenyon, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent. F. Norman Phelps and Alice Phelps, Petitioners, v. Commissioner of Internal Revenue, Respondent

Howell v. Commissioner

Docket Nos. 51216, 51265, 51282

United States Tax Court

26 T.C. 846; 1956 U.S. Tax Ct. LEXIS 123;

July 19, 1956, Filed

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Decision will be entered under Rule 50 in Docket No. 51216; decision for the petitioner in Docket No. 51265, and decision for the respondent in Docket No. 51282.

Distributions in redemption of stock owned by a trust as a first step in an integrated plan to eliminate the trust as a stockholder held not to have been made at such time and in such manner as to be essentially equivalent to distributions of taxable dividends under section 115 (g), I. R. C. 1939. Cf. Carter Tiffany, 1443">16 T. C. 1443. However, distributions to other stockholders in redemption of some of their shares in such manner as to leave them with the same fractional interests in the corporations held to be governed by section 115 (g). Cf. James F. Boyle, 14 T. C. 1382, affirmed 187 F. 2d 557 (C. A. 3).

Cameron B. Aiken, Esq., for the petitioners in Docket No. 51216.

Wellman P. Thayer, Esq., for the petitioners in Docket Nos. 51265 and 51282.

Mark Townsend, Esq., for the respondent.

Raum, Judge.

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RAUM

The respondent determined the following deficiencies in the income taxes of petitioners:

	Year	Amount
Jackson Howell and Virginia Howell	1948	$ 20,957.40
	1949	2,729.16
James A. Kenyon Trust, James A. Kenyon, Trustee	1948	96,057.27
F. Norman Phelps and Alice Phelps	1948	107,926.06

The question presented is whether distributions made by three corporations to the petitioners during 1948 in the redemption of a portion of their stock in such corporations were made at such time and in such manner as to be essentially equivalent to the distribution of taxable dividends.

In the case of petitioners Jackson Howell and Virginia Howell an issued raised with respect to the amount of compensation received by Jackson Howell from Howell Chevrolet Co. during the years 1948 and 1949 has been settled by stipulation.

FINDINGS OF FACT.

A portion of the facts have been stipulated; they are incorporated herein by reference as part of these findings.

Petitioners Jackson Howell and Virginia Howell, husband and wife, reside in Los Angeles County, California. They filed a joint return for the calendar year 1948 with the then collector of internal revenue for the sixth district of California.

The James A. Kenyon Trust was created on August 8, 1941, by James A. Kenyon for the benefit of his adopted daughter, Patricia May Kenyon. It is sometimes referred to as the Patricia May Kenyon Trust and/or Patricia Kenyon Pearson Trust. The trustee was its creator, James A. Kenyon (hereinafter referred to as Kenyon). It was irrevocable and Kenyon had no beneficial interest in the income or corpus thereof other than a remote reversionary interest. Kenyon, as trustee, was specifically given power in the trust instrument to deal with the property of the trust as absolute owner including the power of sale.

Petitioners F. Norman Phelps (hereinafter referred to as Phelps) and Alice Phelps, husband and wife, reside in Piedmont, California. They filed a joint return for the calendar year 1948 with the then collector of internal revenue for the sixth district of California.

At all times material herein J. A. K. Co. was a corporation, all of the stock of which was owned by Kenyon, individually. It was a holding company with shares of stock of Capitol Chevrolet Co., Mid-Valley Chevrolet Co., and Howell Chevrolet Co. constituting substantially all of its assets.

Capitol Chevrolet Co. was incorporated on April 10, 1946, and had but one class of stock outstanding. Phelps, Kenyon, and Alice Phelps were president, vice president, and secretary-treasurer, respectively. From the date of its incorporation to December 21, 1948, the ownership of all of its outstanding stock was as follows:

Shareholder	No. of shares
F. Norman Phelps	212
Alice Phelps	213
James A. Kenyon, Trustee of Patricia May Kenyon Trust	170
J. A. K. Co	255

Howell Chevrolet Co. was incorporated on April 10, 1946, and had but one class of stock outstanding. Jackson Howell, Phelps, and Kenyon were president, vice president, and secretary-treasurer, respectively. From the date of its incorporation to December 21, 1948, the ownership of all of its outstanding stock was as follows:

Shareholder	No. of shares
Jackson Howell	300
F. Norman Phelps	150
Alice Phelps	150
James A. Kenyon, Trustee of Patricia May Kenyon Trust	120
J. A. K. Co	180

Mid-Valley Chevrolet Co. was incorporated on April 10, 1946, and had but one class of stock outstanding. Phelps, Joseph E. Carpenter, and Kenyon were president, vice president, and secretary-treasurer, respectively. From the date of its incorporation to December 21, 1948, the ownership of all of its outstanding stock was as follows:

Shareholder	No. of shares
F. Norman Phelps	213
Alice Phelps	212
James A. Kenyon, Trustee of Patricia May Kenyon Trust	170
J. A. K. Co	255

At all times herein material each of the corporations, Capitol Chevrolet Co., Mid-Valley Chevrolet Co., and Howell Chevrolet Co., was engaged in the business of operating a Chevrolet dealership under a separate "Direct Dealer Selling Agreement" with the Chevrolet Motor Division of the General Motors Corporation (hereinafter referred to as Chevrolet). Each of these dealerships was located within the Pacific coast region.

From the year 1921 to April 10, 1946, petitioner Phelps was employed by Chevrolet, and during that period he occupied, successively, the positions of retail salesman, used car manager, sales manager, district manager, office manager, assistant zone manager, city sales manager, zone manager, assistant regional manager, and regional manager for the Pacific coast region of Chevrolet.

Kenyon had practically the same background of experience with Chevrolet Motor Division of General Motors Corporation as Phelps.

From 1929 until 1933 Jackson Howell was employed by General Motors Acceptance Corporation, and from 1933 until 1944 he was employed by Chevrolet. During the latter period he occupied, successively, the offices of district manager, organization manager of Los Angeles, assistant zone manager of Los Angeles, branch manager in Great Falls, Montana, branch manager at Oakland, California, and assistant regional manager at Oakland, California.

The terms and conditions governing "all transactions, dealings and relations" between Chevrolet and each of its dealers are set forth in a written agreement called a Direct Dealer Selling Agreement. This agreement is in force for a period of 1 year ending on October 31. Paragraph Third contains the names of the individuals who actively participate in the ownership and are responsible for the operation of the dealership. Paragraph 28 provides that either Chevrolet or the dealer may terminate the agreement by written notice of termination in the event that the other party violates or fails to comply with any of its terms or provisions, and also lists certain other causes which might result in its termination by Chevrolet. The last paragraph of the agreement states that "There are no other agreements or understandings, either oral or in writing, between the parties affecting this Agreement or relating to the sale or servicing of Chevrolet motor vehicles, chassis, parts or accessories."

On or about September 1, 1948, J. L. Connell, the regional manager of the Pacific coast region of Chevrolet, called Phelps to his office for a conference. Connell then informed Phelps that Chevrolet had established a new policy that no trust or holding company could own stock in a Chevrolet dealership, and that steps should be taken to eliminate the stock ownership of the James A. Kenyon Trust and J. A. K. Co. in the three corporations. Phelps assured Connell that he had been with Chevrolet long enough to know that when it requested them to take the trust and holding company out of the dealerships, this would have to be done, and they would comply with this request immediately. At this conference Connell also suggested to Phelps that, because the operation of the dealerships had been mutually satisfactory, he felt that it would be more than fair that the Phelps, Kenyon, and Howell interests each retain, after meeting the new policy, the same per cent of ownership in the dealerships. In making this suggestion Connell was not "quoting" Chevrolet policy, and did not intend any implied threat whatsoever that if it were not followed a new selling agreement would not be issued. The only policy Chevrolet had with respect to stock ownership was that any person listed in paragraph Third of the Direct Dealer Selling Agreement must own outright a minimum of 25 per cent of the issued stock of the corporation.

Following his conference with Connell, Phelps got in touch with Kenyon and informed him of his conversation with Connell. Phelps suggested to Kenyon that he confer with Thomas E. Dempsey, attorney for the petitioners and for the three corporations, and have him work out some plan by which the requirements of Chevrolet could be met. Kenyon discussed the matter with Dempsey. In the course of their discussions the possibility of Kenyon personally purchasing all of the stock of the three corporations owned by the trust was considered. This possibility was deemed not feasible because Kenyon did not have the money to make the purchase. Kenyon did not want the stock held by the trust sold to someone other than himself because he was desirous of maintaining his relative proportional voting interest and control in the dealerships. Kenyon and Dempsey also considered the possibility of eliminating the J. A. K. Co. ownership of stock by means of a liquidation. Dempsey recommended that this not be done during the year 1948 because it would cost about $ 90,000 in taxes whereas if it were postponed until the Revenue Act of 1949 were passed the liquidation might be accomplished tax free.

After being advised of the attorney's recommendation against the liquidation of J. A. K. Co. in 1948, Phelps wrote the zone manager of Chevrolet at Oakland, California, on October 16, 1948, stating, among other things, the following:

As you know, the J. A. K. Co., which is a Nevada corporation owned by James A. Kenyon, now owns 30 per cent of the stock in Capitol Chevrolet Company, 30 per cent in Mid-Valley Chevrolet, and 20 per cent in Howell Chevrolet. Our attorney advises that if this J. A. K. Co. were to be liquidated at the present time, the tax situation is such that Mr. Kenyon and I would be subject to approximately $ 90,000 in tax.

It would seem that if it were possible for you to permit us to postpone the change until the Revenue Act of 1949 passes both the House and the Senate it would be most helpful to us.

* * * *

At the present time we are working on a way to buy out the Trust by the different corporations. We believe this can be handled because although it is an irrevocable Trust, Mr. Kenyon has jurisdiction over the Trust until his daughter becomes of age.

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Because of the complications, I would appreciate Chevrolet Motor Division giving us six months or a year to work out of the seeming difficulties with which we are faced at the present time.

In addition to writing the foregoing letter Phelps also discussed the matter with Connell, the regional manager, and asked him whether or not it would be satisfactory if the liquidation of J. A. K. Co. were delayed until the new law was passed, and it was agreed by Connell that some extension would be given.

Pursuant to a prior agreement between Kenyon and Phelps, any tax liability which would result from the liquidation of J. A. K. Co. was to be shared between them. This company was not liquidated in 1948 because of the income tax liabilities that would result from such liquidation and the possibility that they would be reduced by new tax legislation in 1949.

On November 1, 1948, concurrently with the delivery to the three corporations of the new Direct Dealer Selling Agreements for the year commencing on that date, each of the corporations received two letters from Chevrolet. In one of these letters each corporation was notified that its operations were unsatisfactory in that all or a part of the ownership in the dealership was held by a trust and in the other that its operations were unsatisfactory in that all or a part of the ownership in the dealership was held by a holding company. Each letter stated that "it is the desire and policy of Chevrolet Motor Division that all ownership of the Chevrolet dealership be held directly by individuals approved by Chevrolet Motor Division" and that the new Chevrolet selling agreement was being delivered "upon the express representation by you that action will be taken to effect the foregoing objective not later than" a specified date. The date specified for elimination of ownership of stock by the trust was April 30, 1949, and by the holding company September 30, 1949. The probable consequence of failure to take the action required to satisfy the stock ownership policy would be that each corporation would receive a letter from Chevrolet stating that a new selling agreement would not be offered upon the expiration of the November 1, 1948, agreement because of noncompliance with its policy.

Dempsey formulated a plan for eliminating the trust as a stockholder of each corporation and it was presented at meetings of their boards of directors held in his office on December 21, 1948, and approved. The plan had two separate steps:

(1) The purchase by each of the three corporations of a certain number of shares in such corporation from the trust, as well as the purchase by each of these corporations of a sufficient number of shares from the other stockholders (except J. A. K. Co.), so that the Phelps-Kenyon control in Capitol Chevrolet Co. and Mid-Valley Chevrolet Co. would remain at 50 per cent each and the Phelps-Kenyon-Howell control in Howell Chevrolet Co. would remain at 33 1/3 per cent each; and

(2) The purchase by James A. Kenyon, personally, of the remaining shares owned by the trust in each of the three corporations which were not to be purchased in step 1.

The second step in the plan was expressly conditioned on the ability of Kenyon to secure the authorization of the Superior Court of the State of California of his purchase of the stock from the trust; and, as an alternative to be used in the event the court should fail to authorize such purchase, the plan provided that the three corporations would, respectively, purchase the remaining shares owned by the trust and that Kenyon would purchase the same number of shares from the other stockholders of each corporation, in such manner as to preserve the same percentage of control.

At the meetings held on December 21, 1948, the directors of each corporation adopted the following resolution:

Whereas the purchase and redemption of stock according to the plan hereinabove set forth will reduce the corporation's working capital below its minimum requirements;

Now, Therefore, Be It Resolved that the officers of this corporation be and they hereby are authorized and directed to borrow, in behalf of this corporation, from such banks or trust companies as they may in their judgment determine, an amount not exceeding $ 200,000, for such period of time and upon such terms and rate of interest as may to them in their discretion seem advisable and to execute notes in respect thereto in the name of the corporation for the payment of the amounts so borrowed.

Step 1 of the plan was executed on December 21, 1948, with the result that on that date the three corporations made distributions to stockholders in redemption of shares of stock, as follows:

Capitol Chevrolet Co.
	Amount	Shares
Shareholder	distributed	redeemed
F. Norman Phelps	$ 37,759.15	65
Alice Phelps	37,759.15	65
Patricia May Kenyon Trust	75,518.30	130
Mid-Valley Chevrolet Co.
F. Norman Phelps	$ 37,170.25	65
Alice Phelps	37,170.25	65
Patricia May Kenyon Trust	74,340.50	130
Howell Chevrolet Co.
F. Norman Phelps	$ 23,254.00	50
Alice Phelps	23,254.00	50
Patricia May Kenyon Trust	46,508.00	100
Jackson Howell	46,508.00	100

Prior to December 21, 1948, Dempsey sent Phelps copies of proposed minutes of the directors' meetings which he had prepared. Before receiving these minutes Phelps was aware of the nature of the plan which was to be submitted to the directors, but its details had not theretofore been presented to him in writing. Howell was not present at the December 21, 1948, meeting of the directors of the Howell Chevrolet Company and had no knowledge of the details of the plan until after it was adopted. Neither Phelps and his wife nor Howell needed the money distributed to them in redemption of their stock.

The shares of stock redeemed by the corporations were canceled and the stated capital reduced accordingly. The operations of the corporations were not curtailed as a result of the redemptions, and they did not enter into any program of liquidation.

The stock ownership in Mid-Valley Chevrolet Co. and Capital Chevrolet Co. immediately before and after the redemptions was as follows:

	Before		After
F. Norman Phelps	213 shares 25%	50%	148 shares 25%	50%
Alice Phelps	212 shares 25%		147 shares 25%
J. A. Kenyon, Trustee	170 shares 20%	50%	40 shares  7%	50%
J. A. K. Co	255 shares 30%		255 shares 43%

The stock ownership in Howell Chevrolet Co. immediately before and after the redemptions was as follows:

	Before		After
F. Norman Phelps	150 shares 16 2/3%	33 1/3%	100 shares 16 2/3%	33 1/3%
Alice Phelps	150 shares 16 2/3%		100 shares 16 2/3%
J. A. Kenyon, Trustee	120 shares 13 1/3%	33 1/3%	20 shares  3 1/3%	33 1/3%
J. A. K. Co	180 shares     20%		180 shares     30%
Jackson Howell	300 shares 33 1/3%	33 1/3%	200 shares 33 1/3%	33 1/3%

In the redemptions, the price paid per share in each of the corporations was as follows:

Mid-Valley Chevrolet Co	$ 571.85
Capitol Chevrolet Co	580.91
Howell Chevrolet Co	465.08

The total amounts actually distributed by each corporation through the distributions in issue were as follows:

Mid-Valley Chevrolet Co	$ 148,681.00
Capitol Chevrolet Co	151,036.60
Howell Chevrolet Co	139,524.00

If the corporations had purchased all the shares of the trust without redeeming shares of the other stockholders, only the following amounts would have been required:

Mid-Valley Chevrolet Co	$ 97,214.50
Capitol Chevrolet Co	98,747.70
Howell Chevrolet Co	55,809.60

If only the shares of the trust had been redeemed by the three corporations, their capital would not have fallen below the capital standard requirements set by Chevrolet.

Because of the fact that the shares of other stockholders were redeemed along with the trust shares, the capital of the corporations fell below the standards set by Chevrolet. The additional cash distributions to the other stockholders placed a hardship on the corporations by requiring them to borrow funds. Failure to meet the capital standard requirements is reason for termination of a dealer's franchise.

The 1948 redemptions did not eliminate either the trust or the holding company as stockholders of the three corporations.

At the time of the 1948 distributions, the accumulated earnings and profits of each of the corporations were in excess of the total amount distributed to the shareholders. Earned surplus and undivided profits of each of the corporations as of December 31, 1948, after the distributions had been made, were as follows:

Mid-Valley Chevrolet Co	$ 275,536.12
Capitol Chevrolet Co	285,666.90
Howell Chevrolet Co	223,970.73

No dividends were ever declared or paid by any of the three corporations.

The consummation of step 2 of the plan was commenced on June 1, 1949, by the filing by Kenyon, as Trustee of the Patricia May Kenyon Trust, of a petition to the Superior Court of the State of California, in and for the County of Los Angeles, for an order to sell the remaining trust stock in the three corporations to himself as an individual. Proceedings in this action were continued until July 1950, when the need for the order prayed for in the petition disappeared by reason of the sales of the remaining trust stock in Capitol Chevrolet Co. and Howell Chevrolet Co. to those corporations, respectively, and by the liquidation of Mid-Valley Chevrolet Co.

During the year 1950 and prior to July 26, 1950, J. A. K. Co. was completely liquidated and all of the stock held by it in each of the three corporations was distributed to Kenyon.

On July 26, 1950, Capitol Chevrolet Co. purchased from Kenyon the 255 shares of its stock then owned by him and also purchased from the trust the 40 shares of its stock owned by the trust. Howell Chevrolet Co. purchased from Kenyon the 180 shares of its stock then owned by him and also purchased from the trust the 20 shares of its stock owned by the trust; and Mid-Valley Chevrolet Co. purchased from Phelps the 148 shares of its stock then owned by him, and from Alice Phelps the 147 shares of its stock then owned by her. Thereafter during the year 1950 Mid-Valley Chevrolet Co. was completely liquidated and dissolved and all of its assets transferred to its stockholders.

Chevrolet did not object to the changes in the proportionate ownership and control of the three dealerships made during the year 1950.

The distributions to the trust in redemption of stock of the three corporations on December 21, 1948, were not made at such time and in such manner that they were essentially equivalent to distributions of taxable dividends.

The distributions to the other stockholders on December 21, 1948, were made at such time and in such manner that they were essentially equivalent to distributions of taxable dividends.

OPINION.

The distributions in this case resemble to a considerable extent those involved in Carter Tiffany, 1443">16 T. C. 1443, and James F. Boyle, 14 T.C. 1382">14 T. C. 1382, affirmed 187 F. 2d 557 (C. A. 3), certiorari denied 342 U.S. 817">342 U.S. 817. Although the situations are not identical, they are sufficiently similar, in our judgment, to call for the same results.

We hold that the redemptions of the trust shares did not constitute dividends under section 115(g), Internal Revenue Code of 1939. Not only did these transactions sharply reduce the fractional interest of the trust in each of the corporations, but they represented a first step in an integrated plan to eliminate the trust completely as a stockholder. As to the trust, therefore, we think it plain that the distributions represented in substance as well as in form merely the purchase price for the shares, and not the payment of a taxable dividend. Cf. Carter Tiffany, supra;Zenz v. Quinlivan, 213 F. 2d 914 (C. A. 6).

However, as in the Boyle case, which presented other distributions by the same corporation involved in the Carter Tiffany case, we think that the distributions to the Howell and Phelps interests herein do fall within section 115(g) as taxable dividends. The plan was so formulated and executed that the stockholders in question emerged with the identical fractional interests in the corporations which they had owned before; the distributions were not in partial liquidation of the corporations, and the operations of the businesses were in no way curtailed. In substance the distributions simply transferred to these stockholders accumulated earnings and profits of their corporations. It is no answer to say that these transactions had their origin in the demand of Chevrolet that the trust be eliminated as a stockholder. That objective could have been achieved, and indeed with less strain upon the corporations, merely by redeeming the shares of the trust. However, Kenyon did not wish to have his control diluted, and Connell, the regional manager for Chevrolet, had himself suggested to Phelps that it would be fair to preserve the same ratios of control. But that suggestion did not represent Chevrolet policy, and we do not believe, on the evidence, that Phelps regarded it as such. ^{*143 inconsistent with the application of section 115(g), is in our judgment a consideration that tends rather to fortify the applicability of those provisions. For, in substance, the aim of the parties was to pay out corporate funds to stockholders in such manner that the distributions were in proportion to control and at the same time leave the distributees with the same fractional interests in the corporations. We find and hold that the distributions to the Phelps and Howell interests were made "at such time and in such manner as to make the [distributions] * * * essentially equivalent" to the distribution of taxable dividends. Sec. 115(g).}

Decision will be entered under Rule 50 in Docket No. 51216; decision for the petitioner in Docket No. 51265, and decision for the respondent in Docket No. 51282.

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Footnotes

• 1. In reaching this conclusion we do not rely upon the testimony given by Connell in his deposition, objected to by petitioners, that Phelps understood the suggestion as being his (Connell's) "rather than General Motor's suggestion or policy."↩