Lewis v. Commissioner

Estate of John B. Lewis, Harriet S. W. Lewis, John B. Lewis, Jr., Arthur H. W. Lewis, Trustees, Petitioners, v. Commissioner of Internal Revenue, Respondent

Lewis v. Commissioner

Docket No. 6901

United States Tax Court

6 T.C. 455; 1946 U.S. Tax Ct. LEXIS 264;

March 14, 1946, Promulgated

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Decision will be entered for the respondent.

Corporation A in 1941 was engaged in three lines of business. In July of that year it sold two branches of its business outright for cash and marketable securities. Thereafter, it conducted the third branch -- a chemical manufacturing business -- until December 27, 1941, at which time it was decided to organize corporation B. Corporation B was organized on December 29 and on the same date a part of the cash of corporation A and the operating assets used in the chemical manufacturing business were transferred to corporation B in exchange for all the stock of B. Immediately thereafter, on the same day, corporation A liquidated by distributing to its stockholders in exchange for their stock all its assets, consisting of cash, marketable securities, and the stock of corporation B. Petitioners, as trustees of the estate, were the sole stockholders of A. They realized a gain of $ 66,000 on the transaction, which was less than the amount of cash received by them and less than the accumulated earnings and profits of A. Held, that there was a reorganization within the meaning of section 112 (g) (1) (D), I. R. C., and that the distribution to petitioners was made in pursuance of the plan of reorganization and had the effect of the distribution of a taxable dividend within the meaning of section 112 (c) (2).

James F. Armstrong, Esq., for the petitioners.

A. J. McDowell, Esq., for the respondent.

Arundell, Judge.

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ARUNDELL

An income tax deficiency of $ 22,347.28 for the calendar year 1941 has been asserted by respondent against the petitioners. Petitioners contest the deficiency to the extent of $ 22,089.53, certain minor adjustments made by respondent not being controverted. The question for decision is whether respondent erred in taxing a gain realized by the estate of John B. Lewis as an ordinary dividend under section 112 (c) (2) of the Internal Revenue Code, rather than as a distribution in complete liquidation under sections 115 (c) and 117.

Most of the facts have been stipulated and are found accordingly. Other facts found are based on the testimony.

FINDINGS OF FACT.

Petitioners, Harriet S. W. Lewis and Arthur H. W. Lewis, are the surviving trustees under the will of John B. Lewis, who died December 29, 1930, the third trustee, John B. Lewis, Jr., having died September 1, 1945. The fiduciary income tax return of the estate of John B. Lewis for the year 1941 was filed with the collector for the district of Rhode Island.

John D. Lewis, Inc., a Rhode Island corporation, was organized January 9, 1931, to take over a business which John B. Lewis had theretofore operated. On the same day petitioners, as trustees, acquired all the issued and outstanding stock of the corporation, consisting of 4,000 shares of common stock, having a basis of $ 435,000 in their hands.

In 1941 the corporation was engaged in three different lines of business -- the manufacture of synthetic resins, the manufacture of chemicals for the textile industry, and the distribution of chemicals. On June 30, 1941, the corporate name was changed to "John D. Lewis Company." In the next month, July 1941, two branches of the business were sold, the synthetic resin business for a consideration of approximately $ 269,000, and the chemical distributing business for a consideration of approximately $ 56,000, in cash and marketable securities.

On December 27, 1941, the board of directors of John D. Lewis Co., at a special meeting, adopted the following:

Voted: That this Corporation transfer, convey and assign to John D. Lewis Company, a corporation to be incorporated on or about December 29, 1941, under the laws of the State of Rhode Island, all of its assets other than (1) securities and (2) cash in excess of $ 90,000, including, but without limiting the generality of the foregoing, its real estate located in Mansfield, Massachusetts, and in Providence, Rhode Island, and its manufacturing business, together with the assets, property, equipment and goodwill of such business, and accounts receivable, insurance, inventories and office furniture, such transfer, conveyance and assignment to be made in consideration of the issuance to this Corporation of all of the capital stock of said new corporation and in consideration of the assignment to be made in consideration of the issuance to this Corporation and that John B. Lewis, President of this Corporation, be and he hereby is authorized and empowered, on behalf of and in the name of this Corporation and under its corporate seal where necessary or desirable, to make, execute and deliver such deeds, bills of sale, assignments, agreements, instruments of transfer, and including, but without limiting the generality of the foregoing, the instruments described in the following vote and resolution, and any other instruments which he may deem necessary or desirable in order to effect the foregoing, and to do such further acts and things as he may deem necessary or desirable in connection therewith.

The action of the directors was ratified at a special meeting of the stockholders held the same day, at which it was also voted to change the name of the corporation to Traverse Street Corporation (hereinafter called the old company). The change of name was accomplished by filing an amendment of the articles of association with the Secretary of State of Rhode Island on December 29, 1941.

On December 29, 1941, John D. Lewis Co. (hereinafter called the new company) was incorporated under the laws of Rhode Island, with an authorized capital of 500 shares of no par common stock. At 11 a. m. on the same day the directors of the new company met and effected a transfer of the assets of the company to the new company in exchange for the stock of the new company and the assumption of all the obligations of the old company. All the authorized capital stock of the new company was issued to the old company as consideration for the transfer. The assets transferred to and the liabilities assumed by the new company, valued at the figures at which they were recorded on the books of the old company, with proper adjustments, were as follows:

Cash	$ 90,500.00
Accounts receivable	18,896.49
Inventory	21,040.71
Life insurance policies	19,880.86
		$ 150,318.06
Land	12,140.00
Buildings, net	30,753.84
Machinery and equipment	16,919.53
		59,813.37
Total assets		210,131.43
Less liabilities taken over --
Accounts payable	16,473.50
1941 Federal tax reserve	27,364.15
		43,837.65
		166,293.78
Less 1941 additional Federal tax		9,695.17
Net		156,598.61

At 11:30 a. m. on the same day, after the acquisition of the stock of the new company, the directors of the old company met and adopted the following:

Voted: That in the judgment of the Board of Directors of this Corporation it is advisable to adopt a plan of liquidation of this Corporation and to make distribution of the assets of this Corporation in complete cancellation or redemption of all of its stock, and to transfer all the property of this Corporation under the plan of liquidation during the month of December, 1941.

Voted: That this Corporation shall distribute in complete liquidation of the Corporation and in complete cancellation or redemption of its 4,000 shares of Common stock, its remaining assets and its entire holdings, namely securities and cash, such distribution to be made pro rata among Stockholders of this Corporation, such distribution and liquidation to be made to stockholders on December 29, 1941.

Voted: That this Corporation liquidate its affairs and distribute its assets pursuant to the foregoing vote.

Voted: That John B. Lewis, President of this Corporation, be and he hereby is authorized and empowered, on behalf of and in the name of this Corporation and under its corporate seal where necessary or desirable, to make, execute and deliver such assignments, agreements, instruments of transfer, and including, but without limiting the generality of the foregoing, the instruments described in the following two votes, and any other instruments which he may deem necessary or desirable in order to effect such distribution and liquidation, and to do such further acts and things as he may deem necessary or desirable in connection therewith.

Immediately after the directors' meeting the stockholders of the old company met and ratified the action of the directors. Thereupon, the following assets, at the fair market values indicated, were distributed to petitioners, the sole stockholders of the old company, in complete cancellation and redemption of all the issued and outstanding stock of that company:

Cash	$ 166,375.74
Stock of John D. Lewis Co	156,598.61
Other stocks and bonds	177,496.15
Notes	636.80
Total	501,107.30

The purposes of the transfer of the operating assets from the old company to the new company were to continue the chemical manufacturing business under the new company and to liquidate and distribute the remaining assets of the old company to its stockholders.

Petitioners reported, as a long term capital gain under sections 115 (c) and 117 of the Internal Revenue Code, the amount of $ 64,525.48 realized upon the liquidation of the old company. The correct amount of gain actually realized was $ 66,107.30. The undistributed earnings or profits of the old company accumulated since January 9, 1931, were not less than $ 66,107.30 on December 29, 1941. Respondent has determined that the entire gain is taxable as a dividend under section 112 (c) (2) of the Internal Revenue Code.

OPINION.

Petitioners' argument is that the distribution involved was in complete liquidation of the old company and that the gain realized is taxable as a capital gain by virtue of section 115 (c) of the Internal Revenue Code. ¹ The result, they say, is not made different by the fact that some of the assets of the old company were transferred to the new company in exchange for the latter's stock. Respondent's position is that there was in fact a reorganization, and that the gain realized has the effect of a taxable dividend within the meaning of section 112 (c) (2) of the code, ² since it is not in excess of the money received by petitioners and not in excess of the accumulated earnings and profits of the old company.

The facts, briefly reviewed, are that the old company in the first part of 1941 was engaged in three separate lines of business. About the middle of the year it sold two branches of its business outright for cash and marketable securities. Thereafter, the old company was in possession of a considerable amount of cash and liquid assets, in addition to the operating assets and properties used in the chemical manufacturing business. Toward the end of the year, on December 27 to be exact, the old company voted to transfer some of the cash and the property used in the chemical manufacturing business to a new corporation to be organized on or about December 29. The new company was organized on December 29 and the said assets were transferred to it by the old company in exchange for all the stock of the new company and the assumption of the liabilities of the old company. On the same day the old company was liquidated by the distribution of its remaining assets, consisting principally of cash and marketable securities and the stock of the new company, to petitioners as trustees of the estate, who were the sole stockholders of the old company, in complete cancellation and redemption of all the stock of the old company.

One of the statutory definitions of the term "reorganization" is "a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its shareholders or both are in control of the corporation to which the assets are transferred." Sec. 112 (g) (1) (D). Here the old company transferred a part of its assets to the new company, and immediately thereafter the old company or its shareholders were in "control" of the new company, as that term is defined in section 112 (h). Clearly, therefore, what occurred here exactly fits the statutory definition of a reorganization.

But even so, the petitioners urge, there was no plan of reorganization. They contend that the plan was simply one of complete liquidation of the old company and that the new company was organized merely to facilitate that liquidation. Do the facts bear out the petitioners' contention? The testimony shows that one of the reasons for the transfer of assets from the old company to the new was the wish to continue the chemical manufacturing business. It does not appear that the new company is liquidating or disposing of the assets transferred to it, or that it was formed for that purpose. In George D. Graham, 37 B. T. A. 623, upon which petitioners rely, the new company, to which the old company in liquidating transferred approximately 5 percent of its assets, was organized, not to carry on any business enterprise, but to liquidate the remaining assets of the old company. It proceeded to do so and, having completed the undertaking within four years after the transfer, was then itself voluntarily dissolved. To assert that the primary purpose in this case was the complete liquidation of the old company and that the organization of the new company was but an incident thereof is to obscure the essential nature of the transaction. From the evidence, it seems to us that the real end desired was not complete liquidation, but rather partial liquidation. There was no purpose to wind up the business completely. The chemical manufacturing business, one of the three lines of business formerly conducted by the old company, was to be continued.

After the December 1941 transactions the new company had the same stockholders as the old and was engaged in the same chemical manufacturing business, using the operating assets and properties that had belonged to the old company. So far as the "plan" is concerned, it is of course unnecessary that there be a formal written document embodying it, for it is sufficient if the facts and circumstances indicate that a plan of reorganization existed. William H. Redfield, 34 B. T. A. 967. We conclude that there was a plan of reorganization within the meaning of the statute and that the distribution to petitioners in liquidation of the old company was but one step in the integrated transaction. Richard H. Survaunt, 5 T. C. 665; Love v. Commissioner, 113 Fed. (2d) 236, affirming 39 B. T. A. 172.

Section 112 (b) (3) of the code provides that 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. On December 29, 1941, petitioners exchanged their stock in the old company for stock in the new company and other property (i. e., cash, notes, and other stocks and bonds). Had they received only the stock of the new company in exchange, section 112 (b) (3) would have operated to prevent recognition of gain or loss. Section 112 (c) (1) provides, however, that if the exchange would be within section 112 (b) (3) were it not for the fact that money or other property besides the stock was received, then the gain is to be recognized partially, that is, in an amount not in excess of the money and the fair market value of the other property. Here the gain, $ 66,107.30, was less than the amount of the cash and the value of the other property received by petitioners, and it is therefore to be recognized in its entirety.

Section 112 (c) (2) then provides that if a distribution made in pursuance of a plan of reorganization is within the provisions of section 112 (c) (1) -- as is the distribution in the instant case -- but has the effect of the distribution of a taxable dividend, so much of the gain recognized as is not in excess of his ratable share of accumulated earnings and profits shall be taxed to each distributee as a dividend. Petitioners owned all the stock of the old company, and the gain recognized was not in excess of the accumulated earnings and profits of the old company at the time of distribution. The question therefore is whether the distribution "has the effect of the distribution of a taxable dividend." We think the answer must be that it has. See Commissioner v. Bedford, 325 U.S. 283">325 U.S. 283, and cases therein cited. There the Supreme Court said that the definition of "dividend" in section 115 (a), i. e., "any distribution made by a corporation to its shareholders * * * out of its earnings or profits accumulated after February 28, 1913, * * *" is infused into section 112 (c) (2). It held that a distribution of earnings and profits pursuant to a reorganization has the effect of a distribution of a taxable dividend within section 112 (c) (2).

It follows that respondent did not err in taxing the gain as a dividend under section 112 (c) (2).

Decision will be entered for the respondent.

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Footnotes

• 1. SEC. 115. DISTRIBUTION BY CORPORATIONS.

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  (c) Distributions in Liquidation. -- Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. Despite the provisions of section 117↩, the gain so recognized shall be considered as a short-term capital gain, except in the case of amounts distributed in complete liquidation. * * *

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

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  (c) Gain from Exchanges Not Solely in Kind. --

  (1) If an exchange would be within the provisions of subsection (b) (1), (2), (3), or (5), or within the provisions of subsection (1), of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph or by subsection (1) to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.

  (2) If a distribution made in pursuance of a plan of reorganization is within the provisions of paragraph (1) of this subsection but has the effect of the distribution of a taxable dividend, then there shall be taxed as a dividend to each distributee such an amount of the gain recognized under paragraph (1) as is not in excess of his ratable share of the undistributed earnings and profits of the corporation accumulated after February 28, 1913. The remainder, if any, of the gain recognized under paragraph (1) shall be taxed as a gain from the exchange of property.

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