Staley v. Commissioner

WILMER C. STALEY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Staley v. Commissioner

Docket No. 10750.

United States Board of Tax Appeals

9 B.T.A. 1038; 1928 BTA LEXIS 4310;

January 3, 1928, Promulgated

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Where it appears that a corporation has no earnings accumulated since February 28, 1913, at the time it had shares of stock in a new corporation issued to its stockholders in consideration of the transfer of certain of its assets to the new corporation, the stockholders receiving the new stock have not received taxable income.

Robert E. Kline, Jr., Esq., for the petitioner.

C. H. Curl, Esq., for the respondent.

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MURDOCK

This proceeding is for the redetermination of a deficiency in income taxes for the calendar year 1920 in the amount of $802.28. The error alleged is that the Commissioner included in the petitioner's taxable income $11,504.22, representing a part of a distribution out of surplus of the Tipp Whip Co. received by the petitioner in 1920.

FINDINGS OF FACT.

The petitioner is an individual residing in Tippecanoe City, Ohio. In the latter part of January, 1920, he owned 182 shares of stock in the Tipp Whip Co., which shares had been acquired from time to time prior to 1911.

The Tipp Whip Co. was incorporated in 1889, under the laws of the State of Ohio, for the purpose of manufacturing whips and of doing a general manufacturing business, with $15,000 authorized capital stock. The capital stock was increased in 1892 to $50,000, and made to consist of 500 shares, each having a par value of $100. At all times material hereto up to January, 1920, all of these shares were issued and outstanding. The principal place of business of this corporation was in Tippecanoe City, Ohio.

The gradual development of the automobile seriously affected the sale of whips. The Tipp Whip Co. began to feel the effects of the use of automobiles about 1908 and every year thereafter it felt these effects more and more. In the year 1919, it closed out its whip business by selling its stock of whips to a competitor and giving its machinery to the same company.

On December 20, 1916, the directors of the Tipp Whip Co. passed the following resolution:

WHEREAS: That, because of the fact that the increase in the number of automobiles has made, and is making, a corresponding decrease in the demand for whips, we believe it advisable to engage in some other line of business, and divert the capital and credit of this company to that purpose as rapidly as possible, and

WHEREAS: That, after several months of investigation of numerous businesses, we find we can secure the plant and business of the Peoria Amole Soap Company of Peoria, Illinois, with the view of removing it to Tippecanoe City, Ohio; and believing we can operate it successfully, therefore be it

RESOLVED, That the Officers of this Company be, and hereby are, authorized to purchase from the Peoria Amole Soap Company, of Peoria, Illinois, the manufacturing plant and machinery, tools, patterns, fixtures, furniture, merchandise, material manufactured and unmanufactured, and in process of manufacture, bills receivable, book accounts, debts, trade marks, patent rights, good will, and all its property and assets of every description and nature wherever situated, with the exception of its equity in the building, and the steam boilers and engine, steam and water piping, and the main line shafting, for the sum of $13,575.00, one fourth in cash, one fourth within one year, one fourth within two years, and one fourth within three years, deferred payments to consist of notes of the Tipp Whip Co. bearing interest at the rate of six percent per annum, and may be paid before the due dates.

Also, to pay Charles J. Walter, the present Manager of the business, an additional sum of $4,372.50 for his interest in the business.

And give B. W. Brayshaw, and W. W. Brayshaw, at the time of the organization of a Company to manufacture and conduct the soap business, $500.00 par value, each, of the Capital Stock of the Company, and to further pay to them during the term of a contract for employment and the formulas, receipes, and processes of manufacture, etc., ten per cent of the net profits of the business each year, one half to each until an amount not to exceed $4000.00 shall have been paid, not more than one half of which may be taken in the Capital Stock of the Company at par, and the balance in cash, or the entire amount may be taken in cash, at the option of the Brayshaws at the end of the year.

The stockholders in a meeting held January 16, 1917, approved the above action of the directors.

Thereafter, in 1917, the Tipp Whip Co. purchased the assets of the Peoria Amole Soap Co., in accordance with the above resolution, and operated the business in Peoria, Ill., for several months and then moved all of its property to Tippecanoe City, Ohio, and continued to operate the business as a separate department.

It opened an account on its books in the name of Amole Soap Co. and charged to this account all money spent for the purchase and operation of the soap business. On January 27, 1920, this account had a debit balance in the amount of $84,778.49.

During 1917, the Tipp Whip Co. sold its whip factory building and the real estate connected therewith to the Miami Conservancy District for $40,000. In the meanwhile it had established the soap factory elsewhere in Tippecanoe City. Thereafter the Tipp Whip Co. merely operated the soap business and collected and paid certain accounts of the old whip business. The stockholders and directors of the Tipp Whip Co. decided to organize a new company to operate the soap business and to continue the old company only for the purpose of collecting and paying its accounts.

On January 20, 1920, the directors of the Tipp Whip Co. passed the following resolutions:

Resolved: That we pay a dividend of 20 per cent using for same our earnings for the year 1919 amounting to	$8,648.70
And from surplus account	1,351.30
Total (the same to be payable on and after this date as our funds may warrant)	10,000.00
Resolved: That when the amole Soap Co. is organized we accept $75,000.00 of their stock at par, crediting their account with that amount, isued pro rata in names of the Tipp Whip Co. stockholders of record.
That we make a refund of 80 per cent of our capital stock amounting to	40,000.00
That we distribute the amount set aside for real estate replacement	15,429.43
That we distribute the amount set aside for moving expense and sprinkler pipe line replacement, as both these funds have been used in moving building and equipping the Amole Soap Co. plant	6,800.00
That we distribute from surplus fund	12,770.57
A total of	75,000.00

That the above refund and distributions be made pro rata in capital stock of The Amole Soap Co. so soon as that company is incorporated.

That the amount refunded on capital stock be indorsed on each stock certificate when above distribution is made.

That the balance due on capital stock, together with balance of our surplus account be distributed as fast as the condition of the company will warrant.

On January 27, 1920, the Amole Soap Co. was incorporated under the laws of the State of Ohio for the purpose, inter alia, of manufacturing soap. The amount of its authorized capital stock was $100,000, divided into 1,000 shares, each having a par value of $100. Only 760 of these shares were issued. Five shares were issued to each of the Brayshaws in accordance with the resolution of December 20, 1916, and 750 were issued to the stockholders of the Tipp Whip Co. at the rate of one and one-half shares of Amole stock for each share of Tipp Whip Co. stock held. On each certificate for shares of Tipp Whip Co. stock a notation was made that a refund of 80 per cent of the stock had been made and paid by Amole Soap Co. stock. The Tipp Whip Co. certificates were retained by the original owners and the corporation was not dissolved. No additional capital was invested in the Amole Soap Co. at the time of its incorporation. The Amole Soap Co. account on the Tipp Whip Co. books was credited with $75,000 and the balance of $9,778.49 remained on the books as an asset. The Amole Soap Co. then opened new books of its own. All of the assets of the Tipp Whip Co. pertaining to this soap business were transferred to the new corporation.

As his share of the 20 per cent dividend declared on January 20, 1920, the petitioner received $3,640 cash during January, 1920. About the same time he received 273 shares of Amole Soap Co. stock and the notation referred to above was made on his certificates representing 182 shares of Tipp Whip Co. stock.

The stock of the Tipp Whip Co. has been closely held and none has been sold since about 1911.

The following is a statement of the assets and liabilities of the Tipp Whip Co. on December 1, 1912, as disclosed by its books:

Assets
Liabilities
Merchandise on hand	$41,280.50	Bills payable	$3,000.00
Accounts receivable	18,777.57	Due agents	385.19
Tipp National Bank	958.39	Capital stock	50,000.00
Citizens National Bank	155.83	Surplus account	22,127.61
Real estate	8,400.00	Gain for 1912	3,092.77
Machinery and fixtures	7,000.00
Due from agents	2,033.28
Total	78,605.57	Total	78,605.57

For the years from 1908 to 1920, inclusive, the books of the Tipp Whip Co. show the following:

Year	Net profit	Dividends paid
1908	$8,996.20	8,000.00
1909	8,560.00	2,000.00
1910	5,283.13	2,250.00
1911	2,327.78	3,780.00
1912	3,092.77	3,000.00
1913	3,348.86	3,000.00
1914	3,000.00
1915	$289.27	None.
1916	85.97	None.
1917	554.94	None.
1918	1None.
1919	8,648.70	None.
1920	1 1,543.73	$10,000

Of the $3,000 dividend paid in 1913, $1,500 only was entered on the books and paid prior to March 1, 1913.

The following is a statement of the Tipp Whip Co.'s assets and liabilities on January 1, 1920, as disclosed by its books:

Assets		Liabilities
Tipp National Bank	$5,472.37	Bills and accounts payable	$9,282.77
Citizens National Bank	14.48	Real estate replacement fund	15,429.43
Accounts receivable	22,417.60	Moving expense and sprinkler pipe	6,800.00
		fund
Amole Soap Co	84,605.72
		Capital stock	50,000.00
		Surplus fund	22,349.27
		Gain for 1919	8,648.70
Total	112,510.17	Total	112,510.17

The income tax on the income of the Tipp Whip Co for the year 1919 amounted to $667.74.

OPINION.

MURDOCK: The tax liability of this petitioner for the calendar year 1920 is before us. In the early part of that year he received two things as a result of the fact that he held 182 shares of stock in the Tipp Whip Co. First he received 182/500 of $10,000, or $3,640, being his share of a 20 per cent cash dividend declared and paid by the Tipp Whip Co. He admits that all of this was taxable, being paid out of earnings accumulated since February 28, 1913. Second, he received 273 shares of stock in a new corporation, organized by the group of men who owned the Tipp Whip Co. to take over its only active business. He received this stock because the Tipp Whip Co. had agreed to transfer the assets connected with its soap business to the new company provided the new company would issue its stock to the Tipp Whip Co. stockholders in the proportion of one and one-half of the new for one of the old. The petitioner contends that after the cash dividend the Tipp Whip Co. had no more "earnings accumulated since February 28, 1913," to distribute and that anything which he received from this company was not taxable upon receipt by him. He also had an alternative contention.

The Commissioner, in determining the deficiency, did not compute a normal tax on the income in question in this case, but treated this income as an ordinary dividend subject to surtax only. He has never since contended that it was a distribution of assets or a liquidating dividend, in whole or in part. Therefore, we do not feel called upon to discuss that question.

The Commissioner's statement enclosed with the deficiency letter referring to these items is as follows:

You further state that you were in error in reporting $12,740.00 in Schedule H, as income for the year 1920, as this amount consisted of your share of the surplus and profit of the Tipp Whip Company, which was earned and acquired before January 1, 1909. You are advised that information on file in this office indicates that of the total amount of dividends declared by the Tipp Whip Company in 1902, 90.3% were taxable, and 9.7% were nontaxable. Schedule H has been adjusted disclosing that of the amount of dividends reported from this source, $11,504.22 was taxable.

Counsel for the respondent filed no brief and he has never explained how the Commissioner arrived at his conclusion. We can not find any justification for the Commissioner's action. On the other hand, the books of the Tipp Whip Co. and the testimony and other evidence which is before us support the petitioner's contention as it is stated above. When we analyze the books and records of the Tipp Whip Co. in connection with the other facts established by the evidence to find the amount of earnings accumulated between February 28, 1913, midnight, and the last of January, 1920, when the petitioner received the stock from or through this company, we find that only a negligible amount, if any, of such earnings remained undistributed after the payment of the January, 1920, dividend of $10,000. Consequently, our decision on this point must be for the petitioner and we do not deem it necessary to discuss the petitioner's alternative contention.

Judgment will be entered in accordance with the foregoing opinion on notice of 15 days, under Rule 50.

Considered by MORRIS, SIEFKIN, and TRAMMELL.

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Footnotes

• 1. Loss. ↩

• 2. Changed to a gain of $4,389.25 by an audit in the Bureau of Internal Revenue in connection with the settlement of tax liability for the year 1918. This was after January, 1920, and the change was never entered on the books. Additional tax of $258.02 was paid as a result of this change. ↩