*1230 DIVIDENDS - PAYMENTS INVOLVED IN THIS PROCEEDING WERE PAYMENTS MAKE AS PART OF AGREED PURCHASE PRICE OF STOCKS AND WERE NOT DIVIDENDS. Where the owners of the entire capital stock of a corporation contracted to sell their shares of stock for $400,000, and before the contract was completed or performed an alleged dividend of $103,919.40 was declared and ordered paid by the directors of the corporation, but on account of lack of available funds to pay it the purchasers of the stock paid said sum into the treasury of the corporation at the request of the stockholders and were given credit therefor as part of the agreed consideration of $400,000, and said sum was thereupon distributed to the stockholders, it is held that said payment and distribution was not a dividend, but was a part of the sale price of the stock and the profits resulting from such sale are subject to both normal and surtax rates.
*863 These proceedings were consolidated for hearing, as all involve the same issue and depend upon the same facts. Deficiencies were determined as follows*1231 for the year 1928: Docket No. 55303, Estate of W. B. S. Aull, $609.37; Docket No. 55304, Cema S. Chrietzberg, $2,791.70; Docket No. 55305, E. N. Sitton, $1,737.74; Docket No. 55325, Henrietta s. aull, $623.37.
Petitioners allege as error that the respondent erroneously treated payments to them aggregating $103,919.40 as part of the sale price of stock sold by them, when in fact said payments were dividends upon corporate stock and not subject to normal tax.
FINDINGS OF FACT.
The petitioners are all individuals and are residents of South Carolina.
The Pendleton Manufacturing Company was a South Carolina corporation, organized in 1920. At the time of the transactions involved herein it had capital stock outstanding in the amount of $126,200, all of which was common stock and was owned by the petitioners.
On February 2, 1928, the petitioners entered into a written agreement with the La France Textile Industries, a corporation chartered under the laws of Pennsylvania, providing for a sale of the entire capital stock of the Pendleton Manufacturing Company to said corporation for the sum of $400,000. Pertinent paragraphs of this written agreement are as follows:
Now this*1232 agreement witnesseth, That the parties hereto, for and in consideration of the sum of One Hundred Fifty and no/100 Dollars to each Eugene N. Sitton and Cema Chrietzberg, and Fourteen Thousand, Eight Hundred and no/100 Dollars to each Wm. B. S. Aull and Mrs. Henrietta Sitton Aull, in hand paid, the receipt whereof is hereby acknowledged, for the purpose of reducing their verbal agreement to writing, do hereby agree each with the other as follows:
1. The parties of the first part do hereby agree to assign, transfer and set over unto the party of the second part, all their right, title and interest of, in and to all the shares of common stock which they hold in Pendleton Manufacturing Company, which is as follows:
| E. N. Sitton | 483 shares |
| Cema Chrietzberg | 483 shares |
| Wm. B. S. Aull | 148 shares |
| Mrs. Henrietta S. Aull | 148 shares |
* * *
3. The parties hereto mutually agree each with the other, their heirs, executors, administrators, successors and assigns, that settlement for said stock shall take place*1233 on or before March 15, 1928, and shall be payable in cash or in such manner as the parties hereto by subsequent agreement, may determine.
* * *
7. The parties hereto hereby agree that this agreement is merely a temporary agreement to indicate the sale as aforesaid, but that a final agreement, embodying all the terms of sale will be entered into at a later date.
The stock was not settled for on or before March 15, 1928, as required by the foregoing contract of February 2, 1928, but time was extended therefor to a later date by agreement of the parties. On June 25, 1928, a final agreement of sale in writing was reached and pertinent paragraphs of this agreement are as follows:
Whereas, the parties hereto did on the second day of February, 1928, enter into an agreement in writing whereby the parties of the first part did agree to sell and convey unto the party of the second part all of the common stock of Pendleton Manufacturing Company for a consideration of Four Hundred Thousand ($400,000) Dollars to be paid by party of the second part, a copy of said agreement being hereto attached as Exhibit "A"; and
Whereas, party of the second part in performance of said agreement, *1234 in part, paid to parties of the first part simultaneously with the execution of said agreement the sum of $29,900.00; and,
Whereas, by mutual agreement and for valuable consideration the time for the compliance with the terms of said agreement was duly extended to the present time, with the agreement that the unpaid portion of said purchase price should bear interest at the rate of six per cent per annum from March 15, 1928, until this date;
Now, therefore, for the purpose of supplementing said agreement of February second, 1928, and of more fully setting forth the rights and liabilities of the parties hereto, it is agreed as follows:
1. Said agreement of sale and purchase of all of the shares of common stock of Pendleton Manufacturing Company for the sum of Four Hundred Thousand ($400,000.00) Dollars is hereby confirmed by all parties hereto.
2. The purchase price of said stock shall be payable to the following parties in the following manner [Here follows a complete statement of how and when and to whom the payments were to be made.]
On June 23, 1928, it was determined by the directors of the Pendleton Manufacturing Company to make a disbursement to the stockholders*1235 of $82.34 per share, making a total of $103,919.40. This disbursement was termed a dividend in the minutes of the corporation, but the funds to pay same did not come out of funds belonging to the corporation, but came from funds paid by La France Textile Industries as a part of the purchase price of the stock which it had agreed to purchase from petitioners. The minutes declaring said alleged dividend are dated June 25, 1928, and read in part as follows:
*865 Minutes of meeting of the Directors of Pendleton Manufacturing Company, held at the office of the Company, at Autun, in the State of South Carolina, on the 25th day of June, A.D., 1928 at 12:30 P.M.
* * *
The following resolution was offered: Whereas, in the judgment of the Directors the earnings of the corporation largely exceed such sum as would be required to pay a dividend of eighty-two and thirty-four one-hundredths (82.34) per cent on all the common stock of said corporation; and,
Whereas, it is the judgment of the Board of Directors that a dividend of said amount should be declared and paid.
Now, therefore, be it resolved that of the surplus fund of said corporation the sum of One Hundred and Three*1236 Thousand, Nine Hundred Nineteen and 40/100 ($103,919.40) Dollars be used by the executive officers of said corporation in paying a dividend of 82.34 per cent on all of the common stock of said corporation.
The adoption of said resolution was duly moved by Cema S. Chrietzberg, was seconded and was unanimously carried.
On the same date that the foregoing minutes were entered on the books of said corporation, the following written agreement was entered into by petitioners and La France Textile Industries, purchaser of said stock:
Whereas, by instrument bearing even date herewith between Eugene N. Sitton, of Autun, in the State of South Carolina, Cema S. Chrietzberg, of Spartanburg, in the State of South Carolina, William B. S. Aull and Henrietta S. Aull, both of Pendleton, in the State of South Carolina, as parties of the first part, and La France Textile Industries, a corporation duly chartered and organized under the laws of the State of Pennsylvania, as party of the second part, the party of the second part agrees to pay in cash unto the parties of the first part the aggregate sum of $103,919.40, and which sum is a part of the consideration for the purchase of the common stock*1237 of the parties of the first part in Pendleton Manufacturing Company by the parties of the second part; and,
Whereas, the party of the second part has been informed that prior to execution of said agreement the parties of first part by resolution declared a dividend to the stockholders of record of Pendleton Manufacturing Company of 82.34 per cent, amounting to the sum of $103,919.40; and,
Whereas, the said party of the second part had been informed that there is not sufficient cash in said treasury of said Pendleton Manufacturing Company to pay said dividend, although the earnings of said company warrant the declaration thereof; and,
Whereas, the parties of first part are desirous that the party of the second part shall instead of paying the said aggregate sum of $103,919.40 to them under said agreement, pay said sum into the Treasury of Pendleton Manufacturing Company.
Now know ye that we the said parties of the first part do hereby acknowledge that we have this day had and received from the party of the second part, the sum set opposite our respective names, as follows:
| Eugene N. Sitton | $49,850.00 |
| Cema Chrietzberg | 49,850.00 |
| Henrietta Sitton Aull | 2,109.70 |
| William B. S. Aull | 2,109.70 |
And we do further acknowledge that said payment to Pendleton Manufacturing Company shall be constituted a performance of that part of said agreement, which calls for the payment to said parties of the first part of said aggregate sum of $103,919.40.
The $103,919.40 mentioned in the above agreement was paid by La France Textile Industries to the Pendleton Manufacturing Company as directed therein, and the Pendleton Manufacturing Company thereupon disbursed it to petitioners by the checks of said corporation, and they claim that such disbursement was an ordinary dividend paid out of surplus and taxable only at surtax rates. Respondent contends that the disbursement was not a dividend at all, but merely a payment of part of the agreed purchase price for petitioners' stock and that the total profits made by petitioners in the sale of such stock are taxable as any other ordinary income at both normal and surtax rates. It is on this basis that respondent has determined the deficiencies.
At the time the alleged dividend was declared and paid the Pendleton Manufacturing*1239 Company had earned surplus more than sufficient to pay a dividend of that amount, but such earned surplus consisted of property and not cash.
OPINION.
BLACK: We sustain the respondent in his action in treating the $103,919.40 in question as a part of the payment of the purchase price of petitioner's stock and not as a dividend taxable only at surtax rates. Petitioners in their brief lay much stress on the fact that the contract of February 2, 1928, was a mere executory contract to sell certain shares of stock and that title to said shares did not pass by the contract to La France Textile Industries, the proposed purchasers, but remained in petitioners until June 25, 1928, when the final contract was signed and the transfer completed.
We agree with this contention, but do not agree that such fact is determinative of the main issue in petitioner's favor as they seemingly contend. The main issue is whether or not the disbursement of the $103,919.40 was an ordinary dividend. If it was, then petitioners are taxable on the amounts so received at surtax rates only. If it was not the disbursement of an ordinary dividend, but was, as respondent contends, the payment of part of*1240 the purchase price of certain shares of stock which petitioners had contracted to sell for an agreed price, then it is clear that the profits from such transaction are taxable as other ordinary income, at both normal and surtax rates.
*867 The applicable revenue act is the 1928 Act. Section 115(a) of that act reads:
The term "dividend" when used in this title * * * means any distribution made by a corporation to its stockholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913. [Italics supplied.]
The evidence clearly shows that the Pendleton Manufacturing Company had sufficient accumulated surplus on June 25, 1928, to have paid a dividend of $103,919.40, but this dividend would have had to have been paid in kind because the company did not have sufficient cash funds on hand to have paid it. If any such dividend in kind had been declared and paid, doubtless the proposed purchasers of the stock would have required a corresponding reduction in its price. But, be that as it may, the Pendleton Manufacturing Company did not pay a dividend of $103,919.40, either in cash or in kind, "out of its earnings and*1241 profits," within the meaning of the language of the revenue act quoted above. What happened, as shown by the evidence, was that the purchaser of the stock of the Pendleton Manufacturing Company was ready to pay petitioners' part of the agreed purchase price of the stock, and petitioners induced it to pay $103,919.40 of said sum over to the Pendleton Manufacturing Company to be immediately disbursed by it to petitioners in the form of a dividend.
The La France Textile Industries had bought nothing from the Pendleton Manufacturing Company and owed it nothing and it is clear that this payment of $103,919.40 to the Pendleton Manufacturing Company was a payment of part of the purchase price of the stock from petitioners and not a payment for assets purchased from the Pendleton Manufacturing Company. This fact is conclusively established by the written agreement signed at the time such payment was made (set out in the concluding part of our findings of fact), which contained the following clause: "And we do further acknowledge that said payment to Pendleton Manufacturing Company shall be constituted a performance of that part of said agreement, which calls for the payment to said parties*1242 of the first part of said aggregate sum of $103,919.40."
The use of the Pendleton Manufacturing Company in this manner - as the conduit through which part of the purchase price for the stock was made - could not convert such payment into an ordinary dividend as claimed by petitioners. Cf. .
Decision will be entered for the respondent.