1934 BTA LEXIS 1311">*1311 1. ALLOCATION OF COST - FAILURE OF PROOF TO OVERCOME RESPONDENT'S DETERMINATION. - During 1926 the Boxboard Products Co., of which petitioner Carey was a preferred and common stockholder, redeemed all of its preferred stock. Respondent, in determining the gain on the redemption, made an allocation of costs in accordance with his regulations, which is prima facie correct. Petitioner introduced no evidence to show that respondent's allocation of cost was incorrect. Respondent sustained.
2. DIVIDENDS - MOST RECENTLY ACCUMULATED EARNINGS OR PROFITS DETERMINED WHERE ENTIRE ISSUE OF DECLARING COMPANY'S PREFERRED STOCK WAS REDEEMED WITH MONEY BORROWED FROM 100% OWNED SUBSIDIARY, A REORGANIZED CORPORATION, AND THE SUBSIDIARY WAS THEN LIQUIDATED PRIOR TO THE DIVIDEND DECLARATION IN QUESTION. - Held, the most recently accumulated earnings and profits of the subsidiary corporation were not available to the parent corporation for purposes of redeeming its preferred stock, but were available for payment of the 1927 dividend. John B. Stewart,29 B.T.A. 809">29 B.T.A. 809, distinguished.
30 B.T.A. 572">*572 These three proceedings, which were consolidated for hearing, involve deficiencies in income taxes as follows: Docket No. 46599, W. Gibson Carrey, Jr., 1926, $1,056.20; Docket No. 61445, W. Gibson Carey, Jr., 1927, $2,878.08; Docket No. 58009, Isaac Harter, 1927, $969.91. The issues presented by the pleadings may be stated as follows:
(1) Docket No. 46599. Did the Commissioner err in determining the base used by him for computing the profit from the exchange and redemption of certain corporate stock held by the petitioner during 1926?
(2) Docket No. 61445. Was the petitioner taxable on the amount of $25,575, or any part thereof, received by him during the year 1927 as dividends from the Boxboard Products Co.?
(3) Docket No. 58009. Was the petitioner taxable on the amount of $4,531.25, or any part thereof, received by him during the year 1927 as dividends from the Boxboard Products Co.?
Respondent in an amended answer asks that, if the Board should sustain petitioners' contentions as to the nontaxability of all or part of the 1927 dividends of the Boxboard Products Co., then the redemption of the preferred stock in1934 BTA LEXIS 1311">*1313 1926 should be treated as an 30 B.T.A. 572">*573 ordinary dividend and taxed at surtax rates and that the deficiency should be increased accordingly.
FINDINGS OF FACT.
The Philadelphia Paper Manufacturing Co. was a corporation, organized under the laws of Pennsylvania in 1896 (hereinafter referred to as the old company). The Fibre Container Co. was a corporation, organized under Pennsylvania laws in 1916. On June 30, 1923, these two corporations were consolidated into a new corporation, to be known as the Philadelphia Paper Manufacturing Co., hereinafter referred to as the new company. In the reorganization each stockholder in the old company received 50 shares of stock in the new company for 1 share held in the old, and the stockholders in the Fibre Container Co. received 5 for 1. At the time of the reorganization the capital stock and surplus of the two old companies were:
| Company | Capital stock | Surplus | Total |
| Philadelphia Paper Manufacturing Co. (old) | $100,000 | $4,195,334.44 | $4,295,334.44 |
| Fibre Container Co | 350,000 | 211,799.79 | 561,799.79 |
| Total | 450,000 | 4,407,134.23 | 4,857,134.23 |
The combined surplus of $4,407,134.23 as at June 30, 1923, was made1934 BTA LEXIS 1311">*1314 up as follows:
| Surplus as at March 1, 1913, including appreciation due to Mar. 1, 1913, value of tangibles | $1,189,014.45 |
| Surplus as at Mar. 1, 1913, due to valuation of good will | 1,032,532.00 |
| Surplus accumulated since Mar. 1, 1913 | 2,185,587.78 |
| Total | 4,407,134.23 |
Upon reorganization the capital stock of the Fibre Container Co. in the amount of $350,000 was canceled and the capital stock of the old company in the amount of $100,000 was increased by $3,064,750, which resulted in a capital stock and surplus of the new company as of June 30, 1923, the date of its organization, being set up on its books as follows:
| Capital stock | $3,164,750.00 |
| Surplus | 1,692,384.23 |
| Total | 4,857,134.23 |
30 B.T.A. 572">*574 The capital stock and surplus of the new company as at December 31, 1923, 1924, 1925, and 1926, as shown by its books, were as follows:
| Date | Capital stock | Surplus | Total |
| 12-31-23 | $3,164,750 | $1,603,619.67 | $4,768,369.67 |
| 12-31-24 | 3,164,750 | 1,748,361.17 | 4,913,111.17 |
| 12-31-25 | 3,164,750 | 1,912,519.94 | 5,077,269.94 |
| 12-15-26 | 3,164,750 | 2,069,194.66 | 5,233,944.66 |
Tht net increases in surplus from December 31, 1923, to December 15, 1926, above1934 BTA LEXIS 1311">*1315 stated, were due to earnings from operation of the business during that period over and above dividends and other surplus adjustments.
Another reorganization was accomplished in April 1926, by which the Boxboard Products Co., a Delaware corporation, hereinafter sometimes referred to as Boxboard, acquired the entire outstanding stock of the new company, of the par value of $3,164,750, by giving the stockholders of that company one share of 7 percent preferred stock of $50 par value and one share of no par common stock for each share they held in the new company. This resulted in Boxboard becoming the owner of the entire 63,295 shares of common stock of the new company and the former stockholders of that company became the owners of 63,295 shares of preferred stock of the par value of $3,164,750 and a like number of no par common stock of Boxboard, and the new company became a subsidiary of Boxboard.
The original capital stock of Boxboard was $66,945 no par value common stock before the reorganization in which it acquired the stock of the new company.
The assets of the new Philadelphia Paper Manufacturing Co. were sold to the Container Corporation of America in September 1926, 1934 BTA LEXIS 1311">*1316 as of July 1, 1926, for which the former company received $2,500,000 in cash and $2,500,000 par value 7 percent preferred stock of the Container Corporation of America.
In September 1926, as of July 1, 1926, Boxboard redeemed its entire issue of 7 percent preferred stock of a par value of $3,164,750, or $50 per share, which it had issued in partial consideration for the new Philadelphia Paper Manufacturing Co. common stock. It redeemed the preferred stock at $52.50 per share, or a total of $3,322,987.50. This redemption was in complete liquidation and cancellation of its entire issue of preferred stock and there was no preferred stock of Boxboard in existence as at the end of the calendar year 1926.
To get the money to redeem this preferred stock Boxboard borrowed the money from its subsidiary, the new Philadelphia Paper Manufacturing Co., for which it executed its promissory note.
30 B.T.A. 572">*575 On December 15, 1926, Boxboard liquidated the new company and took over all of the assets and liabilities of the latter company, except $5,000 in cash and $5,000 in preferred stock. The notes receivable on the books of the new company representing the money borrowed by Boxboard with1934 BTA LEXIS 1311">*1317 which to redeem and to retire its 7 percent preferred stock was written off against the notes payable on the books of the latter company representing the same transaction. Boxboard received through this liquidation $2,055,816.72 of the total surplus of $2,069,194.66 of the new Philadelphia Paper Manufacturing Co. existing as at December 15, 1926.
The reorganizations above mentioned in u923 and in 1926 were reorganizations within the definition of the revenue acts and resulted in no taxable gain or loss to the corporations.
The Commissioner determined that in the reorganization and recapitalization in 1923 the increase of $100,000 capital stock of the old Philadelphia Paper Manufacturing Co. by $3,064,750 to the total of $3,164,750 issued by the new Philadelphia Paper Manufacturing Co. should be charged against surplus and applied in the following manner:
| To that portion of surplus representing earnings prior to 3-1-13 and appreciation in tangible assets as at 3-1-13 | $1,189,014.45 |
| To that portion of surplus representing increase due to valuation of good will as at 3-13-13 | 1,032,532.00 |
| To surplus representing earnings subsequent to 3-1-13 | 843,203.55 |
| Total | 3,064,750.00 |
1934 BTA LEXIS 1311">*1318 The Commissioner determined that the entire amount of the surplus of the new Philadelphia Paper Manufacturing Co. as at December 31, 1923, namely, $1,603,619.67, and at all times subsequent thereto, consisted of surplus accumulated subsequent to March 1, 1913.
Upon redemption and retirement of the 7 percent preferred stock of Boxboard in 1926, the par value of that stock was charged to the par value set up by Boxboard in its preferred capital stock account, namely, $3,164,750, and the premium of $158,237.50 ($2.50 per share on 63,295 shares) which was the excess over the par value, was charged to surplus. The preferred capital stock account was thus eliminated as well as the capital stock, and the surplus was reduced by the amount of the premium, namely, $158,237.50. The Commissioner determined the amount available to Boxboard for the distribution of dividends to be $1,807,814.47 as at December 31, 1926.
Boxboard paid out in cash dividends in 1927 the sum of $980,210, and according to the determination of respondent still had a surplus available for dividends as at December 31, 1927, in the amount of $1,037,978.31.
30 B.T.A. 572">*576 There is no dispute as to the cost basis of1934 BTA LEXIS 1311">*1319 the stock which petitioner Carey owned in the new company and which he exchanged for preferred and common shares of Boxboard in the nontaxable reorganization.
In order to determine that portion of the total cost of petitioner's stock in the new company which is applicable to the preferred stock in Boxboard for which it was exchanged in part, the Commissioner allocated the total cost on the basis of the respective market values of each class received in exchange at the date of the exchange in April 1926, namely, $50 per share for the preferred and $10 per share for the common stock, and determined the profit as follows:
| Amount received upon redemption of 1,000 shares 7% preferred stock Boxboard Products Company | $52,400.00 | |
| Cost of 50 shares, 5/6 X $2,500 | $2,083.33 | |
| Cost of 950 shares, 5/6 X $44,982.50 | 37,485.42 | |
| 39,568.75 | ||
| Profit on redemption | $12,831.25 |
The cases of 13 other stockholders in which the profit on redemption of the 7 percent preferred stock was computed by allocating the cost on the same basis, namely, $50 and $10, or 5/6 and 1/6, respectively, have been made the subject of closing agreements under section 606 of the Revenue Act of 1926. 1934 BTA LEXIS 1311">*1320 The case of one other stockholder, which was computed on the basis of $52.50 and $7.50, respectively, was also made the subject of closing agreement under section 606.
W. Gibson Carey, Jr., reported on his income tax return for 1926 as profit from the redemption of the preferred stock of Boxboard here in question the net amount of $5,280 based upon an alleged cost of $52,500 and an alleged amount received of $57,750.
On February 26, 1926, as a separate transaction, W. Gibson Carey, Jr., exchanged 100 shares of Philadelphia Paper Manufacturing Co. stock which cost him $4,867.50 for 1,100 shares no par value common stock of the Boxboard Products Co. which had a market value at that date of not less than $7 per share, or a total of $7,700. The Commissioner computed the profit on this transaction as follows:
| Market value of stock acquired | $7,700.00 |
| Cost of stock disposed of | 4,867.50 |
| Profit | 2,832.50 |
The Boxboard Products Co. reported on Form 1097 for the calendar year 1927 dividends in the amount of $948,887.50 paid out of its earnings or profits accumulated since February 28, 1913, and listed the shareholders to whom the dividends were paid.
30 B.T.A. 572">*577 1934 BTA LEXIS 1311">*1321 OPINION.
BLACK: We will dispose of the issues in the order of their statement. The first issue is as to the amount of taxable gain received by petitioner Carey on the redemption in 1926 of preferred stock which he owned in Boxboard. Respondent made the allocation of costs in accordance with his regulations, approved in ; affd., . Petitioner introduced no evidence to show that respondent's allocation of cost between the rn respondent's allocation of cost, it remains unchanged. Petitioner's assignment of error on that point is denied.
Petitioners' next contention is that the dividends received by them in 1927 from Boxboard are taxable only in small part and that the balance thereof was a return of capital and therefore nontaxable.
This claim is based upon the contention that when Boxboard redeemed its preferred stock in September 1926, it did so out of the most recently accumulated earnings of the new Philadelphia Paper Manufacturing Co. and that hence when Boxboard declared and paid the $980,210 dividends in 1927, only a small part thereof was paid out of accumulated earnings and the balance was out1934 BTA LEXIS 1311">*1322 of capital. For reasons we shall presently state, we do not think this contention can be sustained.
In the recent case of , we had occasion to pass on a somewhat similar question, but we think that case is distinguishable on its facts from the facts of the instant case. In that case a corporation in 1926 bought and paid for 50 percent of its outstanding shares from two of its four shareholders and afterwards distributed this stock as a stock dividend to its two remaining shareholders. We held that the amounts paid for the stock in 1926 were statutory distributions as defined by section 201(b) and (c), Revenue Act of 1926, and should be charged to profits accumulated since March 1, 1913, and if such profits were consumed by such distribution, additional distributions by way of dividends later made should be charged to earnings and profits accumulated prior to March 1, 1913, and treated accordingly. But it should be observed that in the Stewart case it was the earnings of the Windsor Tobacco Growers' Corporation, the company which did the purchasing of its own stock, which we said were distributed out of most recently accumulated1934 BTA LEXIS 1311">*1323 earnings of that company. Here it was Boxboard which redeemed its own preferred shares in September 1926, and sought to apply thereto, not its own accumulated earnings, for at that time it had very little, if any, accumulated earnings, but the accumulated earnings of its subsidiary.
30 B.T.A. 572">*578 Boxboard, although at that time owning all of the capital stock of the new Philadelphia Paper Manufacturing Co., did not own its assets and therefore did not own its accumulated earnings. Cf. ; affirmed on another point, . The property of a corporation is owned by the corporation and not its stockholders. Boxboard got the money from its subsidiary by borrowing and executing its promissory note therefor. It was not until December 15, 1926, that Boxboard became the owner of the assets of the new Philadelphia Paper Manufacturing Co., through a complete merger and liquidation of the latter company with the former. Then it was, under the authorities which we will presently cite, that the accumulated earnings of the new Philadelphia Paper Manufacturing Co. became the accumulated earnings of Boxboard and therefore1934 BTA LEXIS 1311">*1324 available for dividend distribution. The Commissioner determined that the amount available to Boxboard for the distribution of dividends as at December 31, 1926, was $1,807,814.47. We do not find it necessary to decide whether the respondent's determination of this amount was precisely correct or not. From the facts we have stated in our findings of fact, we are certain, and so hold, that when Boxboard paid dividends of $980,210 in 1927 it had ample earnings accumulated since February 28, 1913, with which to pay them, and that the dividends which petitioners Carey and Harter received were paid out of earnings accumulated since February 28, 1913, and not out of capital and were therefore taxable. On this issue we find for respondent.
In view of our holding on this issue, it becomes unnecessary to consider respondent's alternative contention.
Upon the question of whether earned surplus of the constituent companies remains earned surplus of the successor company in nontaxable reorganizations, we deem it necessary to cite only the cases of 1934 BTA LEXIS 1311">*1325 , and , in which the Circuit Court of Appeals for the Second and Ninth Circuits both held "that a corporate reorganization which results in no 'gain or loss' under section 202(c)(2) (42 Stat. 230) does not toll the company's life as continued venture under section 201, and that what were 'earnings or profits' of the original, or subsidiary company remain, for purposes of distribution, 'earnings or profits' of the successor, or parent, in liquidation." To the same effect are our decisions in , and .
Reviewed by the Board.
Decision will be entered under Rule 50.
GOODRICH dissents.