*2017 In 1922 petitioners, who were stockholders of the W. L. Phelps Co., transferred all of their stock (with the exception of W. L. Phelps, who retained 300 shares) to the corporation in exchange for $130 per share in cash. Held that the transaction is taxable under the provisions of sections 201, 213, 216, and 211 of the Revenue Act of 1921 rather than sections 202 and 206.
*866 These proceedings, which have been consolidated, are for the redetermination of deficiencies in income taxes for the calendar year 1922, in the respective amounts of $42,666.97, $52,589.07, $10,726.37, $12,395.87 and $8,403.78. The several petitions allege error on the part of the respondent in determining that certain amounts received by petitioners during the year 1922 from the W. L. Phelps Co. (formerly known as the Star & Crescent Milling Co.) were received by them as "distributions" in liquidation and taxable at surtax rates only under section 211(a)(2) of the Revenue Act of 1921, instead of as proceeds from the sale of petitioners' stock*2018 in the W. L. Phelps Co., and taxable as "capital gains" under section 206 of the same act. The petitions also allege that the respondent erred in determining the March 1, 1913, fair market value of the stock of the W. L. Phelps Co., which issue has been agreed upon by a stipulation of the parties.
FINDINGS OF FACT.
Clinton Briggs died testate during September, 1908. Under the terms of his will there was created a trust for the benefit of his two daughters, Mrs. Jane Briggs Voorhees and Mrs. Martha Briggs *867 Phelps. The Northern Trust Co. (one of the petitioners herein) was named as trustee of this trust.
W. L. Phelps, the son-in-law, died testate on June 30, 1923. Martha Briggs Phelps is the duly appointed executrix of the estate of W. L. Phelps, deceased.
The Star & Crescent Milling Co. was incorporated on September 18, 1882, under the laws of the State of Illinois. It was engaged in the flour-milling business. During April, 1922, it sold the greater part of its assets, including its plant, tools, and equipment used in the flour-milling business, and the good will, brands, and trade-marks of the business. On June 26, 1922, it changed its corporate name*2019 to W. L. Phelps Co.
The total outstanding common stock of the W. L. Phelps Co. (formerly known as the Star & Crescent Milling Co. and hereafter referred to as the W. L. Phelps Co.) as of March 1, 1913, consisted of 2,500 shares of the par value of $250,000. The number of shares of common stock outstanding thereafter remained the same until December 27, 1920, upon which date there was declared and paid a stock dividend of 200 per cent upon the common stock, increasing such common stock to 7,500 shares of the par value of $750,000. Each of the petitioners herein received the respective proportionate amounts of the aforesaid stock dividend applicable to the number of shares of common stock owned by them as of the date of declaration of the aforesaid stock dividend.
On December 27, 1922, the board of directors of the W. L. Phelps Co. at a special meeting adopted the following resolution:
RESOLVED, that until further action by the Board of Directors of this corporation, the President of this corporation be and he is hereby authorized, empowered and directed for and in the name and on behalf of this corporation to purchase shares in its outstanding capital stock, in such amounts, *2020 at such times and at such prices as he in his discretion may see fit, such price, however, in no event to exceed the sum of $130.00 per share; provided, however, that the holder or holders of such shares from whom the same may be purchased pursuant to the terms of this resolution, shall at the time of such purchase by this Company enter into an agreement whereby such holder or holders covenant and agree that in the event that during the period of ten years from and after the date of such respective purchases there shall be legally demanded of this corporation any sum or sums whatsoever on account of any liabilities or indebtedness of this corporation which may exist at the time of such purchase and which are not then shown on the books of account of any contingent liabilities of the Company, by reason of any matter, transaction or thing of whatever kind, nature or description theretofore done or omitted by the Company, or that if the Company shall be compelled to pay any sum or sums of money on account of such undisclosed, contingent or inchoate liabilities at any time during said period of ten years, that then such holder or holders, their heirs, executors, administrators or assigns, *2021 respectively, will on demand pay to the Company the proportionate part of all such sum or sums of money, together with all reasonable costs and expenses (including interest) of the Company *868 growing out of any such claim or incurred by the Company in resisting, contesting or defending against any such claim or claims, such proportionate part to be computed according to, and based upon, the proportion which the number of shares so purchased, respectively, bears to the total number of shares in the outstanding capital stock of the company, to-wit, seventy-five hundred (7500) shares, such agreement to be in such form and to contain such provisions as the President of this corporation may see fit.
Pursuant to negotiations conducted by W. L. Phelps (the president of W. L. Phelps Co.) in accordance with the above resolution, all the shareholders in December, 1922, except the president, transferred all of their stock to the corporation, and the corporation paid to the several stockholders sums of money equal to $130 per share for each share of stock so transferred by the shareholders. W. L. Phelps likewise in December, 1922, transferred to the corporation all except 300 shares*2022 of the stock owned by him and received from the corporation a sum equal to $130 per share for each of the shares so transferred by him.
The number of shares of the common capital stock of the W. L. Phelps Co. owned by each petitioner on March 1, 1913, the number of shares received as a stock dividend in December, 1920, the number of shares owned after the declaration of the stock dividend in December, 1920, the number of shares transferred to the W. L. Phelps Co. in December, 1922, to wit, on or after December 28, 1922, and the amount of cash received by petitioners in 1922 from the W. L. Phelps Co., together with the respondent's determination as to how the amounts received should be treated, are as follows:
| Petitioner | Shares | Received | Shares | Shares | |
| owned | as stock | owned | trans- | Cash | |
| on | dividend | after | ferred | received | |
| Mar. | Dec., 1920 | stock | to W. L. | in | |
| 1-13 | divi- | Phelps | 1922 | ||
| dend | Co. | ||||
| Northern Trust Co., trustee | 750 | 1,500 | 2,250 | 2,250 | $292,500 |
| Martha Briggs Phelps, executrix | 750 | 1,500 | 2,250 | 2,250 | 292,500 |
| Martha Briggs Phelps | 300 | 600 | 900 | 900 | 117,000 |
| Jane Briggs Voorhees | 300 | 600 | 900 | 900 | 117,000 |
| Frank B. Rice | 200 | 600 | 900 | 850 | 110.500 |
| Treated by respondent as- | ||
| Petitioner | ||
| Return of | Distribution | |
| capital | ||
| Northern Trust Co., trustee | $ 118,608.75 | $ 173,891.25 |
| Martha Briggs Phelps, executrix | 132,794.25 | 59,705.75 |
| Martha Briggs Phelps | 47,443.50 | 69,556.50 |
| Jane Briggs Voorhees | 47,443.50 | 69,556.50 |
| Frank B. Rice | 38,493.25 | 72,006.75 |
During 1916 Frank B. Rice purchased 100 shares of the common capital stock of the W. L. Phelps Co. for a cash consideration of $9,500. During 1920 but after the declaration of the stock dividend during that year, Rice disposed of 50 shares taken from the 200 shares which he owned on March 1, 1913, and the 400 shares received as a stock dividend thereon.
During the year 1922, and prior to December 27, 1922, W. L. Phelps (now deceased) purchased 300 shares of the common capital stock of the W. L. Phelps Co. for $30,000. These 300 shares were *869 among the 2,250 shares transferred and surrendered to the corporation by the late W. L. Phelps and shown in the above schedule opposite the name of Martha Briggs Phelps, Executrix. Of the 300 shares retained by Phelps and not transferred by him to the corporation, 100*2024 shares had been acquired by him prior to March 1, 1913, and 200 shares in 1920 as a stock dividend upon the 100 shares acquired before March 1, 1913.
The respondent determined that the fair market value as of March 1, 1913, of the total common stock of the W. L. Phelps Co. outstanding as of that date was $395,362.23, and that the fair market value as of March 1, 1913, of each share of common stock outstanding after December 27, 1920, was $52.715. The parties have now agreed by stipulation that the fair market value as of March 1, 1913, of the total common stock of the W. L. Phelps Co. outstanding as of that date was $411,871.59, and that the fair market value as of March 1, 1913, of each share of common stock outstanding after December 27, 1920, was $54.916.
The factors used by the respondent in determining the March 1, 1913, fair market value of the common stock of the W. L. Phelps Co. used by him in his deficiency letter are the following:
| 2,500 shares common stock par value | $250,000.00 |
| Surplus as at Mar. 1, 1913 | 145,362.23 |
| Mar. 1, 1913, fair market value of 2,500 shares common stock outstanding | 395,362.23 |
| Stock dividends, 5,000 shares | None. |
| Mar. 1, 1913, fair market value of 7,500 shares common stock outstanding after Dec. 27, 1920 | 395,362.23 |
| Mar. 1, 1913, value of 1 share | 52.715 |
*2025 The "return of capital" as determined by the respondent and shown in the above schedule was determined by him with respect to each petitioner as follows:
| (1) Nothern Trust Co., Trustee: | |
| 2,250 shares at a Mar. 1, 1913, value of $52.715 per share or | $118,608.75 |
| (2) Martha Briggs Phelps, executrix: | |
| 1,950 shares at a Mar. 1, 1913, value of $52.715 per share or | 102,794.25 |
| 300 shares at a cost in 1922 of $100 per share or | 30,000.00 |
| 2,250 shares | 132,794.25 |
| (3) Martha Briggs Phelps: | |
| 900 shares at a Mar. 1, 1913, value of $52.715 per share or | 47,443.50 |
| (4) Jane Briggs Voorhees: | |
| 900 shares at a Mar. 1, 1913, value of $52.715 per share or | 47,443.50 |
| (5) Frank B. Rice: | |
| 550 shares at a Mar. 1, 1913, value of $52.715 per share or | $28,993.25 |
| 100 shares at a cost in 1916 of $95 per share or | 9,500.00 |
| 200 shares as a stock dividend on shares purchased in 1916 | None. |
| 850 shares | 38,493.25 |
*870 The amount which the respondent determined to be a "distribution" and taxable at surtax rates in the case of each petitioner, as set forth in the first schedule above, was determined by deducting from the amount of cash received by each petitioner in 1922 the amount*2026 determined by the respondent to be a "return of capital." The respondent further determined that the entire amount of the "distribution" so found represented a distribution of earnings or profits accumulated since February 28, 1913. The factors used by him in making the latter determination consisted of the following:
| Surplus at time of distribution in 1922 | $259,277.75 |
| Add: Stock dividend declared in 1920 | 500,000.00 |
| 759,277.75 | |
| Deduct: Surplus as at Mar. 1, 1913 | 145,362.23 |
| Earnings or profits accumulated since Feb. 28, 1913 | 613,915.52 |
| Earnings per share accumulated since Feb. 28, 1913 (7,500 shares) | 81.855 |
At the time the W. L. Phelps Co. sold the greater part of its assets in April, 1922, it retained a warehouse and a lot of land called the Jefferson Street property. It was W. L. Phelps' intention that the corporation would thereafter conduct a flour-brokerage business instead of a flour-milling business.
At a meeting of all of the stockholders of the W. L. Phelps Co. held on January 9, 1923, the following resolution was adopted:
RESOLVED, That the authorized capital stock of this Company be decreased from Seven Hundred Fifty Thousand Dollars ($750,000) *2027 consisting of Seven Thousand Five Hundred (7500) shares of the par value of One Hundred Dollars ( $100) each to Thirty Thousand Dollars ($30,000) consisting of Three Hundred (300) shares of the par value of One Hundred Dollars ( $100) each. The amount of the capital stock issued and outstanding before such decrease is effected is Seven Hundred Fifty Thousand Dollars ($750,000) consisting of Seven Thousand Five Hundred (7500) shares of the par value of One Hundred Dollars ( $100) each and the manner by which such decrease is effected is as follows, to wit: By retiring and cancelling said Seven Thousand Two Hundred (7200) shares of the par value of One Hundred Dollars ( $100) each.
On January 13, 1923, the Secretary of State for the State of Illinois issued certificate No. 14318, in which he certified that "I, Louis L. Emmerson, Secretary of State of the State of Illinois, by virtue of the powers vested in me by law, do hereby certify that *871 W. L. Phelps Company has legally decreased capital stock from $750,000 to $30,000, as provided" in an act entitled "An Act In Relation To Corporations For Pecuniary Profit" approved June 28, 1919, in force July 1, 1919, and all acts*2028 amendatory thereof.
At the time of the hearing in these proceedings, to wit, December 4, 1929, the W. L. Phelps Co. was still in existence. Since the year 1922 it has rented its Jefferson Street property at a rental of approximately $5,000 per annum. It has rendered corporation income-tax returns annually since and including the calendar year 1922. On page one of its return for the year 1922 it stated that its "Kind of Business" was "Milling business in liquidation." On page four of the same return, in answer to question number 3(b) asking what was the main income-producing business and to "state if inactive or in liquidation" the corporation reported "Milling of wheat and other grain and wholesale distribution of flour and feed. Now in process of liquidation." On the 1924 capital-stock-tax return of the W. L. Phelps Co. the following statement was written across the face of the return: "This corporation was not engaged in business during the preceding year."
OPINION.
LOVE: The question in these proceedings, stated in its broadest sense, is what section or sections of the Revenue Act of 1921 are applicable to the facts as set forth in our findings. Petitioners contend*2029 that they sold or disposed of their stock in the W. L. Phelps Co. to the corporation itself; that the "basis for ascertaining the gain derived or loss sustained from a sale or other disposition of property" is plainly provided for in section 202; and that the gain so derived was a "capital gain" taxable at 12 1/2 per cent under the provisions of section 206. The respondent contends that the amounts received by petitioners in 1922 were "dividends" within the meaning of that term as defined in section 201, to wit, that "the term 'dividend' when used in this title * * * means any distribution made by a corporation to its shareholders or members, whether in cash or in other property, out of its earnings or profits accumulated since February 28, 1913" (italics supplied); that the dividends constituted income under section 213, to wit, that "the term 'gross income' - (a) Includes * * * dividends"; and that such income was exempt from the normal tax under section 216, but taxable at the graduated surtax rates provided for in section 211(a)(2) of the 1921 Act. Consequently, the question, restated in a narrower sense, is, Did Congress intend to treat transactions such as the ones*2030 before us as a sale or other disposition of stock by petitioners to the corporation or as a distribution of earnings or profits by the corporations to petitioners? We think it intended the latter.
*872 Section 201(c) of the Revenue Act of 1918 provided in part that:
* * * Amounts distributed in the liquidation of a corporation shall be treated as payments in exchange for stock or shares, and any gain or profit realized thereby shall be taxed to the distributee as other gains or profits.
Notwithstanding the specific language contained in the abovequoted provisions of the 1918 Act, it was the contention of taxpayers generally, under that act, that amounts distributed in the liquidation of a corporation were, nevertheless, "distributions," and should be taxed at surtax rates only, rather than at both normal and surtax rates, there being no provision in the 1918 Act corresponding to section 206 of the Revenue Act of 1921. This contention was denied by the United States Supreme Court in , the court holding that under the Revenue Act of 1918 amounts distributed in the liquidation of a corporation should be treated as*2031 payments in exchange for stock or shares, and the gain or profit realized thereby taxed at both normal and surtax rates.
In the course of the enactment of the Revenue Act of 1921 the House Bill had provided, in section 201(c), for the treatment of liquidating dividends in the identical language of the same section of the Revenue Act of 1918 quoted above. The Senate amendment eliminated the provision entirely and substituted as subdivision (c) the provision as to stock dividends appearing as subdivision (d) in the act as passed. The House accepted the amendment with an amendment which appears as subdivision (c) in the act as finally passed.
Due to the omission from the Revenue Act of 1921 of the above quoted provision of section 201(c) of the Revenue Act of 1918, we held in , that under the Revenue Act of 1921 "There would seem to be no doubt that Congress intended its definition of 'dividends' to include liquidating dividends to the extent of earnings accumulated since February 28, 1913," and in *2032 , it was held that a liquidating dividend received in 1921 on stock which had been owned for more than two years prior thereto and held as an investment was not taxable as a capital gain under section 206 of the Revenue Act of 1921 but at surtax rates under section 211. Cf. , and .
But petitioners contend that what they received from the corporation were not "liquidating dividends" and that the above cited cases are not in point. They contend that the amounts received by them constituted payments by the corporation in exchange for their *873 stock, or, stated in other words, that the essential character of the transaction here in question is a "sale or other disposition of property" (1921 Act, sec. 202) by petitioners to the corporation. They point out in their brief that the word distribution "is the appropriate word where action is taken by a corporation to turn over or transfer money or property to its stockholders without reference to any surrender of stock or other consideration given or offered by the stockholders"; *2033 that in the instant cases the stock was surrendered with the exception of the 300 shares retained by Phelps; that "distributions must be made ratably to all stockholders"; that from the evidence we should find that "no liquidation of the corporation was contemplated in 1922"; that the corporation is still in existence; that under the decisions of the Supreme Court of the State of Illinois an Illinois corporation has the right to purchase its own shares from its stockholders; and that even where there is a complete liquidation it is possible under the Board's decision in , to treat the transaction as falling within section 202 rather than section 201.
The test of a distribution is not whether the stockholder does or does not surrender his stock. Cf. Neither is it necessary that alleged dividends always be pro rata to stockholdings. ; . Relative to the request for a finding that "no liquidation of the corporation was contemplated in 1922," we think the evidence is clear that no complete liquidation*2034 was intended. Nevertheless, we believe that the legal effect of the transactions here in question, as far as the Revenue Act of 1921 is concerned, is that when the board of directors, comprising as it did the entire unified mind and interest of all the stockholders, instructed the president to purchase the outstanding stock at a definite maximum price, such action was to all intents and purposes an agreement among the stockholders to surrender their stock in exchange for a pro rata share of the distributable surplus, and that the 300 shares retained by the president represented only the value of the undistributable property, and when all other stockholders were eliminated he was left with 300 shares of stock as the sole owner of the corporation and virtual owner of all that remaining property. The other stockholders had completely liquidated, as was their intent, and as was clearly disclosed by the resolution adopted on January 9, 1923, only twelve days after the resolution of December 27, 1922, was adopted, by which the capital stock was reduced to the value of the 300 shares retained by the president. And we think this is true regardless of whether under the laws of the State*2035 of Illinois a corporation may *874 purchase its own stock. . The case of , cited by petitioners is distinguishable upon its facts.
Although we agree with the respondent that section 201 of the Revenue Act of 1921 is applicable to the facts in these proceedings, we do not entirely agree with his method of application, which we have set out in considerable detail in our findings. See Section 201 reads in part as follows:
(b) For the purposes of this Act every distribution is made out of earnings or profits, and from the most recently accumulated earnings or profits, to the extent of such earnings or profits accumulated since February 28, 1913; but any earnings or profits accumulated or increase in value of property accrued prior to March 1, 1913, may be distributed exempt from the tax, after the earnings and profits accumulated since February 28, 1913, have been distributed. If any such tax-free distribution has been made the distributee shall not be allowed as a deduction from gross income any loss sustained from the sale*2036 or other disposition of his stock or shares unless, and then only to the extent that, the basis provided in section 202 exceeds the sum of (1) the amount realized from the sale or other disposition of such stock or shares, and (2) the aggregate amount of such distributions received by him thereon.
(c) Any distribution (whether in cash or other property) made by a corporation to its shareholders or members otherwise than out of (1) earnings or profits accumulated since February 28, 1913, or (2) earnings or profits accumulated or increase in value of property accrued prior to March 1, 1913, shall be applied against and reduce the basis provided in section 202 for the purpose of ascertaining the gain derived or the loss sustained from the sale or other disposition of the stock or shares by the distributee.
Applying the above quoted provisions of section 201 to the facts stated in our findings, the amount of cash received by each petitioner in the year 1922 is held to be distributed from the following sources:
| (1) | (2) | (3) | |
| Name of petitioner | Earnings or | ||
| Earnings or | profits prior | Otherwise | |
| profits since | to | than from | |
| Feb.28, 1913 | Mar. 1, 1913 | (1) or (2) | |
| Northern Trust Co., trustee | $ 179,221.73 | $ 48,561.30 | $ 64,716.97 |
| Martha Briggs Phelps, executrix | 179,221.73 | 48,551.30 | 64,716.97 |
| Martha Briggs Phelps | 71,688.69 | 19,424.52 | 25,886.79 |
| Jane Briggs Voorhees | 71,688.69 | 19,424.52 | 25,886.79 |
| Frank B. Rice | 67,705.99 | 18,345.38 | 24,448.63 |
*2037 With the exception of 300 shares in the case of Martha Briggs Phelps, Executrix, and 300 shares in the case of Rice, the record does not show the cost of the stock transferred by petitioners to the W. L. Phelps Co. during 1922. It is impossible, therefore, save for the two exceptions noted, to ascertain from the record the gain derived or loss sustained as required in section 201(c), supra. See Martha Briggs Phelps, Executrix, sustained a deductible loss in the year 1922 of $14,896.23 on the 300 shares *875 purchased and disposed of during that year. Rice derived neither a taxable gain nor sustained a deductible loss on the 300 shares referred to in the first sentence of this paragraph.
The deficiencies should be redetermined by including in gross income the dividends from earnings or profits accumulated since February 28, 1913, as set forth in column (1) above, instead of the amounts treated by the respondent as distributions, and by allowing Martha Briggs Phelps, Executrix, to deduct the loss of $14,896.23 referred to in the preceding paragraph.
Reviewed by the Board.
Judgment will be entered under Rule 50.*2038