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UNITED STATES DISTRICT COURT, EASTERN DISTRICT OF NEW YORK.
Richard R. Doerschuck v. United States of America.
Ralph M. Thomas v. United States of America.
(March 17, 1921.) CHATFIELD, J.: The plaintiff in each of the above actions has paid income tax on one-quarter of an issue of debenture bonds of the North American Brewing Company, which came into the hands of the plaintiffs because of the ownership by each of 1,230 shares (or one quarter) of the entire capital stock of said North American Brewing Company. The directors of said corporation had voted an issue of $738,000 of debenture bonds from a surplus or undivided profits amounting to $810,368.09, which had accrued between 1906 and July 1, 1916.
The portion of the bonds representing surplus earned before March 1, 1913, was not taxed and hence is not involved in these actions. The balance, viz, $262,334.44 was assessed as income for the year 1916, during which year each of the plaintiffs had received his one-quarter part of said funds.
In the case of Eisner v. Macomber, 252 U. S. 189, shares of stock were issuell in the form of a dividend to stockholders, leaving ownership of the property in the stockholders the same as before the issuance; that is, the property representing the value of the stock was the same, and the only change was that each stockholder held two certificates representing in the aggregate and in theory the same stock value as previously had been represented by one certificate. It was held in that case that such stock dividend was not equivalent, for the purposes of income tax, to the payment of a dividend in property or in cash, and was not to be taxable as income under the law of September 8, 1916, sections 1, 2, and 3.
The plaintiffs in the present action rely upon the case of In re Fechheimer Fishel Co., 212 Fed. 357, which holds that debenture bonds, having the characteristic features of preferred stock, are, from the standpoint of creditors of the corporation when the corporation becomes insolvent, no different than such preferred stock.
It would follow from this that for the purpose of liquidation or dissolution of the corporation, or for consideration in insolvency or bankruptcy proceedings, such debenture holders would not rank as general creditors.
Plaintiffs also cite the case of Cass v. Realty Securities Co., 148, App. Div. 96, which held that bonds having a definite date and conditioned as were the debenture bonds in the present action, were for the purposes under consideration in that case equivalent to preferred stock and should not be considered as bonds in the usual meaning of that word.
It has been held in Peabody v. Eisner, 247, U. S. 347, that a dividend of shares in another corporation, is taxable as income of the corporation owning the shares and distributing it as a dividend in specie rather than in money.
In Stratton's Independence v. lloubert, 231, U. S. 399, it was held that the transformation of ores in a mine into cash proceeds through the business of mining, was a production of income in so far as net profits were concerned, and that the amount by which the body of ore was reduced should not be added as a part of the expenses of conducting the business. This illustrates the difference between the production of income and the mere changing of form in which capital may be owned by the individual stockholder.
In Eisner v. Macomber, supra, at p. 208, the court says:
“The stockholder has the right to have the assets employed in the enterprise, with the incidental rights mentioned; but, as stockholder, he has no right to withdraw, only the right to persist, subject to the risk of the enterprise, and looking only to dividends for his return."
It is apparent, therefore, in the present case that the plaintiffs received an actual payment (in the form of securities available for disposition in the market, and entirely severed or distinguished from their control of the property as stockholders) of profits which the company wished to distribute as earnings to its stockholders. It did this by distribution of obligations which, like a promissory note, called for the payment of cash, and did not invest the nolder with merely a different form of holding of stock.
There is no question here between the persons receiving this dividend and creditors, as to priority of payment. Evidently so far as these debenture bonds are concerned, the corporation was solvent, and to whatever extent they might be of value, this value was separated from any stockholders' control of the corporation. As stated in Eisner v. Macomber, supra, at p. 212:
* It is said that a stockholder may sell the new shares acquired in the stock dividend; and so he may, if he can find a buyer. It is equally true that if he does sell, and in doing so realizes a profit, such profit, like any other, is income, and so far as it may have arisen since the Sixteenth Amendment is taxable by Congress without apportionment."
The debenture bonds in the suit at bar fall into the class of stock sold rather than stock held in a continued status of shareholder.
The complaints should be dismissed.
SECTION 201, ARTICLE 1544: Dividends paid in
A. R. R. 435 (Also Section 202, Article 1563: Section 214(a) 1, Article 105.)
Recommended in the appeal of the M Company that there be allowed as deductions in the taxable year 1917 (1) the full amount of salaries and bonuses earned by and paid to the officers for that year; (2) losses actually sustained in the distribution in that year, as a cash dividend, of certain securities owned by the corporation; and (3) losses actually sustained in that year in the conversion of
securities of the N Company into new securities of the O Company. The M Company was organized as a corporation in 1891. For the taxable year 1917 the Income Tax Unit has disallowed officers' salaries in the amount of 9x dollars and losses on investments amounting to 12x dollars; and from this action on the part of the Unit the taxpayer has appealed.
It seems, according to a statement from the taxpayer, that ever since 1900 'this company has been in the habit of paying to its officers a stipulated yearly salary and in addition thereto bonuses of varying amounts, neither the salary nor the bonuses being in any manner based upon the stockholdings of the various officers, but upon their efficient services.
For the year 1916 these bonuses were paid as in prior years, but were not included as deductions on the taxpayer's return for the reason, according to its statement, that it was informed by the revenue agent that it was not entitled so to do. These bonuses for the ensuing year were authorized annually by the board of directors at their meetings held during the month of March in each year, but in May, 1917, the board of directors ordered that all bonuses cease and that in lieu thereof the salaries of the president and the secretary be increased by 2!« dollars per annum each, and only the March bonus was paid for that year.
The taxpayer claims that for the year 1917 its net profits, after the deduction of officers' salaries, represented a return of 17 per cent on its invested capital, and that the salaries paid in that year did not equal the sums paid in prior years for similar services. It is not entirely clear from the record whether the amount of 21x dollars actually reported as paid to the company's officers in the year 1917 included any part of the bonuses which had been actually paid but not included in the return for 1916. To the extent, however, that this amount represents salaries and other compensation actually earned in the year 1917 by the officers of the corporation, the Committee is of the opinion that it should be allowed as a deduction.
It appears that in the year 1917 the taxpayer declared a cash dividend and distributed in payment of such dividend certain securities theretofore held in its treasury, in which distribution it claims a net loss of 110 dollars, representing the net difference between the established market value of these securities as at March 1, 1913, and their established market value at the date of the dividend.
At the date of the dividend the taxpayer unquestionably parted with title to these securities and thus closed the transactions in them. Therefore, if the net value of the securities at that date was less than their net value on March 1, 1913, the taxpayer, as a matter of fact, sustained a loss in their distribution: Provided, That in such distribution their market value as at the date of the dividend was used. From the facts before it, the Committee can not undertake to determine the amount of such loss, if any, but that the taxpayer is entitled to claim such loss to the amount that it can be actually substantiated, there can be no doubt.
The third contention arises from the denial by the Unit of the loss claimed by the taxpayer resulting from the conversion of certain securities of the N Company into other securities of the O Company. Here the facts appear to be in dispute, the revenue agent merely saying that “No loss has been established on the N Company securities as they are still in the possession of the corporation."
This statement the taxpayer flatly contradicts, and says in its brief: “ This is incorrect. These bonds were exchanged by this company, through a reorganization, for stocks, as is supported by exhibit attached hereto." This statement of the taxpayer seems to be borne out by copies of documents from the P Company, from which it appears that the securities in question were actually exchanged in 1917, under a plan of reorganization, for the securities of an entirely new and distinct corporation; and if the taxpayer can show that the value of the securities parted with was more on March 1, 1913, than the value of the securities received by it in exchange therefor, it is without doubt entitled to claim the difference as a deduction.
The record is so incomplete that the Committee, in deciding this case, can enunciate principles only, but can not specify the actual amounts involved, which are left for determination by the Unit in accordance with the Committee's findings.
It is therefore recommended (1) that the full amount of salaries and bonuses actually earned by and paid to the officers in 1917 be allowed as a deduction ; (2) that the net difference between the market value on March 1, 1913, of the securities distributed as a dividend in 1917 and their lesser market value at the date of the dividend be allowed as a deduction; and (3) that the difference between the market value of the securities of the N Company at March 1, 1913, and the lesser market value of the new securities received in exchange therefor under the plan of reorganization be allowed as a deduction.
SECTION 201, ARTICLE 1547: Sale of stock
5-21-1412 received as dividend.
O. D. 781 The resolution of the board of directors of a corporation, declaring a stock dividend, provided that no fractional shares of stock should be issued, but that all fractions of shares should be united into whole
shares and sold by the treasurer and the proceeds thereof paid to the stockholders entitled thereto, such resolution having been approved by the stockholders. Held, that the stockholders by approving the action of the board of directors approved and, in fact, authorized the action of the treasurer in uniting and selling the fractional shares and paying over the proceeds therefrom to those stockholders entitled to the fractional shares, and that those stockholders entitled to receive fractional shares, but who actually received cash representing their portion of the proceeds of the sale of the fractional shares, should compute the gain or loss thereon under the provisions of Treasury Decision 3059.
SECTION 201, ARTICLE 1547: Sale of stock
received as dividend.
22-21-1659 A. R. M. 128
Held, that the purchase of 3y shares of stock at a cost of 1: dollars a share constitutes an investment of capital; and that upon a sale of the stock received, the profit realized or loss sustained should be computed in accordance with Treasury Decision 3059.
The Committee is in receipt of a memorandum from the Income Tax Unit in which two inquiries are submitted: (1) Whether the acquisition of 3y shares of stock by A in 1916, under the conditions hereinafter stated, constituted an investment of 14x dollars and a stock dividend of the same amount, and (2) whether Treasury Decision 3059 (article 1547 of Regulations 45), is applicable in computing the profit arising from the sale in 1917 of a number of shares of the stock so acquired.
It appears that the stockholders of the M Company, a corporation, held a meeting April —, 1916, and voted to increase the capital stock of the corporation from 20x dollars to 25. dollars, par value of the shares being z dollars each. The resolution provided further that the increase in the capital stock of the corporation of 5x dollars should be sold to the stockholders of such corporation at 12 dollars per share in the proportion of one new share for each four shares of the old stock then held.
The corporation pursuant to this resolution issued 5y shares of stock of the par value of a dollars per share and received therefor from its stockholders 2x dollars and transferred from surplus to capital 2 dollars.
It appears that A owned 12y shares of stock of the corporation on April --, 1916, which were acquired by him prior to March 1, 1913. It is submitted that the fair market value of such stock on March 1, 1913, was 112 dollars per share. A, in accordance with the rights granted by the resolution, purchased 3y shares of the stock on April 4, 1916, par value of a dollars per share, or a total par value of 3x dollars, paying therefor 12 dollars per share, or a total of 1}dollars.
During the year 1917 the taxpayer sold by shares of this stock at 142 dollars per share and by shares at 22 dollars per share. The taxpayer through his attorneys contends that a stock dividend of 110 dollars was received in 1916, which represented a transfer of surplus to capital and that the taxable gain derived from the sale of the stock during the year 1917 should be computed in accordance with the provisions of Treasury Decision 3059 (article 1547 of Regulations 45).
The Supreme Court, in the case of Eisner v. Macomber (Treasury Decision 3010, C. B. 3, p. 25), held that a true stock dividend was not income. Treasury Decision 3059 was promulgated to meet the peculiar difficulties arising as a result of that decision and the reasoning thereof, namely, that while in the case of a true stock dividend there is an issue of stock represented by a transfer from surplus to capital, yet the proportional interest of the stockholder has not changed, and he is no richer after the transaction than before, but has, in fact, suffered a postponement of realization of profits, since the amount transferred from surplus to capital is no longer available for a cash dividend. This Treasury decision ruled that in order to determine the cost of each share of the old and new stock the quotient be taken of the cost or fair market value as of March 1, 1913, if acquired prior to that date, of the old shares divided by the total of both the old and the new.
In the instant case there was an issue of new shares of stock for which A paid 12 dollars a share, the difference between that amount and par being represented by a transfer from surplus to capital. Whether this was or was not, strictly speaking, a stock dividend, a portion of the surplus of the corporation was capitalized; was no longer available for distribution, the proportional interest of A remained unchanged; and as to the surplus transferred to capital he suffered a postponement of realization of profits in the same degree as would be true in the case of a stock dividend. Whether the difference between the cash paid for the stock and its par value be considered a true stock dividend or not, the effect on the taxpayer in relation to the determination of the cost of the new stock is similar to a stock dividend, and the same principles are applicable in determining the cost of such stock.
In view of the foregoing the inquiries contained in the memorandum referred to are, therefore, answered as follows: The profit realized or loss sustained by A from the sale of the new stock in 1917 should be computed in accordance with the provisions of Treasury Decision 3059.
SECTION 201, ARTICLE 1548: Distribution in
0. D. 912 The M corporation surrendered its charter on January 31, 1920, and the business was thereafter continued as a partnership by the stockholders. It distributed its surplus and undívided profits as of December 31, 1919, as a liquidating dividend. The net income of the company for the one month of its existence in 1920 was distributed by crediting the amounts to the profit and loss account of the partnership
Held, that such a liquidating dividend credited to the partnership is taxable to the former stockholders as if actually distributed to them.
SECTION 201, ARTICLE 1548: Distribution in