1933 BTA LEXIS 1212">*1212 Where the facts reveal cogent reasons for the issuance by a corporation of a stock dividend of preferred stock and equally sound reasons for the subsequent retirement of part of such preferred stock, there appearing no concerted plan or observable connection between the two transactions and the corporate cash dividend policy evidencing no studied intent to avoid taxation, the redemption of such stock is not essentially equivalent to the distribution of a taxable dividend under section 115(g) of the Revenue Act of 1928.
27 B.T.A. 1312">*1312 These proceedings were brought for the redetermination of deficiencies in income taxes as follows:
| T. Pierre Champion, for the year 1928 | $260.09 |
| David J. Champion, for the year 1928 | 576.70 |
| David J. Champion, for the year 1930 | 5,523.70 |
The questions presented for solution are:
(1) Whether or not the redemption of stock of the Champion Rivet Company in the taxable years was essentially equivalent to the distribution of a taxable dividend, and
1933 BTA LEXIS 1212">*1213 (2) If such redemption was not essentially equivalent to the distribution of a taxable dividend, what are the bases upon which gain or loss upon the redemption of the stock should be computed?
In Docket No. 55569 the petition alleged as error the failure of the respondent to allow an exemption to the petitioner of $3,500 as the head of a family. This allegation of error has been stricken without prejudice on motion of the petitioner in that proceeding. The petition 27 B.T.A. 1312">*1313 in Docket No. 55569 also alleged as error the failure of the respondent to allow a deduction of $16,240 as a loss sustained in 1928 when the stock of the Ohio Trust Company became worthless. This issue has been settled by a stipulation between the parties to the effect that the petitioner is entitled to a deduction of the full amount claimed.
Part of the facts were stipulated.
FINDINGS OF FACT.
The petitioner, David J. Champion, is an individual having his office at the Champion Rivet Company, Cleveland, Ohio, and residing at Cleveland Heights, Ohio. The petitioner, T. Pierre Champion, is a son of David J. Champion and one of the four children for whose benefit his father transferred 1,920 shares1933 BTA LEXIS 1212">*1214 each of common and preferred stock of the Champion Rivet Company on March 14, 1925, as hereinafter stated.
In 1903 the petitioner, David J. Champion, was one of the organizers of the Champion Rivet Company, hereinafter called the company, and since that time he has been and still is a director and president of the company. Prior to March 1, 1913, he was the owner of 238 shares of the common stock of the company recorded in his own name and the actual owner of two additional shares of the same stock standing in the names of his nominees, M. P. Mooney and W. R. Reilley. On January 8, 1922, upon the death of Rose A. Champion, his wife, he inherited from her 240 additional shares of common stock of the company, which had a value on that date of $2,850 per share, so that on December 18, 1922, he was the owner of 480 shares of such stock.
The company's main plant was at Cleveland. About the year 1919 the company purchased a plot of ground in a suburb of Pittsburgh, Pennsylvania, at a cost of $165,000, for the purpose of building a plant thereon if that should become desirable or, in any event, for the purpose of holding the land as an investment. Subsequently, plans for the plant1933 BTA LEXIS 1212">*1215 were prepared, the estimated cost of the plant being approximately $2,000,000.
The company purchased its raw material in the vicinity of its plants, but it was forced to pay for the raw material the base price at Pittsburgh plus the freight from Pittsburgh to its plants, the freight rate in 1922 from Pittsburgh to Cleveland being 19 cents per hundredweight or $3.80 per ton. The cost of raw material represented about 70 per cent of the cost of the company's finished products and the excess cost of the raw materials due to the "Pittsburgh plus" method of pricing steel placed the company at a disadvantage in respect to its competitors located in the Pittsburgh district.
27 B.T.A. 1312">*1314 At a meeting of the stockholders of the company held on December 18, 1922, at its office in Cleveland, a resolution was adopted increasing the authorized capital stock from $100,000 to $1,600,000, consisting of $800,000 of common stock divided into 8,000 shares of the par value of $100 per share and $800,000 of 7 per cent cumulative preferred stock consisting of 8,000 shares of the par value of $100 each, the preferred shares having full voting rights and being redeemable, in whole or in part, upon1933 BTA LEXIS 1212">*1216 30 days' notice at $105 per share, any redemption, however, to be prorated among the then preferred stockholders according to their respective holdings of preferred stock. The company reserved the right to purchase the preferred stock in the open market at not to exceed the redemption price. The resolution which authorized the increased capitalization and stock dividend was as follows:
WHEREAS, The Champion Rivet Company has had under consideration for a number of years the question of enlarging and extending its plants with a view to increased economy in the cost of production and also to overcome the effect of discriminating freight rates existing against the company at the present time, and to that end heretofore acquired a tract of property outside of the City of Pittsburgh, Pennsylvania; and
WHEREAS, the Company for some time past has experienced difficulty in obtaining regular supplies of the necessary raw materials for the manufacture of its product, which condition makes it desirable for the company to consider the advisability of establishing a steel finishing mill upon the output of which it can depend for its regular supply of materials; and
WHEREAS, on account of1933 BTA LEXIS 1212">*1217 the war and the period of depression in business following the war, the plans of the company in the foregoing matters have been necessarily held in abeyance until such time as conditions improved sufficiently to justify further action thereon; and
WHEREAS, it now seems probable that the post-war depression in business is drawing to its close and that a return to normal business conditions is likely at an early date, making it necessary for the company to be prepared to take advantage of improved conditions by capitalizing a portion of its surplus and making same available for use in the operations of the company; and
WHEREAS, to carry out said purposes, the stockholders of the company, at a meeting held this day, have authorized and approved an increase of the company's capital stock from its present authorized capital of $100,000 common stock to $1,600,000 consisting of $800,000 common stock and $800,000 7% Cumulative Preferred Stock, and have amended the company's Articles of Incorporation in accordance therewith, as set forth in the resolutions adopted at this day's meeting of the stockholders; said increased stock, both common and preferred to be distributed among the stockholders1933 BTA LEXIS 1212">*1218 as a stock dividend, pro rata, in proportion to their holdings in the present capital stock of the company;
NOW, THEREFORE, BE IT RESOLVED, That the Board of Directors of this company be, and they are hereby, authorized and empowered to declare a stock dividend to the present stockholders of record in proportion to their respective holdings, consisting of eight shares of said preferred stock and seven shares of said common stock for each share of $100.00 each of the 27 B.T.A. 1312">*1315 present capital stock of the company to stockholders, as shown by the books of the company at the close of business on the 18th day of December, 1922; and that the President and Secretary be directed to issue proper stock certificates representing the same to such stockholders on said date.
At a meeting of the board of directors held December 27, 1922, a stock dividend of eight shares of preferred and seven shares of common for each share of common stock held was authorized for distribution on December 30, 1922. At the same meeting a resolution authorizing the transfer of $1,500,000 from earned surplus to capital stock was adopted.
On December 30, 1922, and prior to the transfer from surplus to capital1933 BTA LEXIS 1212">*1219 there was an existing earned surplus amounting to $2,667,407.22, of which $545,814.97 had been earned prior to March 1, 1913, and $2,121,592.25 had been earned and accumulated subsequent to that date.
The dividends paid in cash by the Champion Rivet Company from 1913 to 1930, both inclusive, were as follows:
| 1913 | $30,000 |
| 1914 | 20,000 |
| 1915 | 10,000 |
| 1916 | 30,000 |
| 1917 | 100,000 |
| 1918 | 130,000 |
| 1919 | 120,000 |
| 1920 | 120,000 |
| 1921 | 120,000 |
| 1922 | 120,000 |
| 1923 | $170,000 |
| 1924 | 184,000 |
| 1925 | 184,000 |
| 1926 | 184,000 |
| 1927 | 120,000 |
| 1928 | 56,000 |
| 1929 | 42,000 |
| 1930 | 24,500 |
| 1,764,500 |
On December 21, 1922, a certificate was duly filed in the office of the Secretary of State of the State of Ohio, setting forth the increase of capital from $100,000 to $1,600,000.
On December 30, 1922, the new stock was issued to stockholders of record as of December 18, 1822, and in exchange for 480 shares of old common stock, then owned by the petitioner, David J. Champion, he and his nominees received the following certificates, aggregating 3,840 shares each of preferred and new common stock:
| Certificate number | Issued to | Number of shares - common stock |
| C 34 | D. J. Champion | 478 |
| C 35 | D. J. Champion | 1,000 |
| C 36 | D. J. Champion | 1,000 |
| C 37 | D. J. Champion | 1,000 |
| C 38 | D. J. Champion | 346 |
| C 39 | M. P. Mooney | 1 |
| C 40 | M. P. Mooney | 7 |
| C 41 | W. J. Reilley | 1 |
| C 42 | W. J. Reilley | 7 |
| Total | 3,840 | |
| P 27 | D. J. Champion | 1,000 |
| P 28 | D. J. Champion | 1,000 |
| P 29 | D. J. Champion | 1,000 |
| P 30 | D. J. Champion | 824 |
| P 31 | M. P. Mooney | 8 |
| P 32 | W. J. Reilley | 8 |
| Total | 3,840 |
1933 BTA LEXIS 1212">*1220 27 B.T.A. 1312">*1316 The certificates for the new stock issued on December 30, 1922, were not identified with particular certificates from the old stock then surrendered.
The plant proposed to be erected in the neighborhood of Pittsburgh was not constructed. The president of the company vacillated in his opinion as to the expediency of erecting it, having a "premonition" that the Pittsburgh "plus method" of fixing the price of steel would be abolished. In July, 1924, the Federal Trade Commission issued a "cease and desist" order for the abolition of the Pittsburgh plus basis for fixing the price of steel to the consumer, and shortly thereafter it became possible for the company to buy its raw materials at prices permitting competition on an equality with competitors in the Pittsburgh district. The "cease and desist" order rendered the building of a plant in the Pittsburgh district unnecessary. The building project was abandoned by the company when in 1927 it made a contract for a term of five years for the purchase of its raw material from a steel concern in Cleveland.
On March 14, 1925, the petitioner, David J. Champion, gave 1,920 shares of preferred and 1,920 shares of common1933 BTA LEXIS 1212">*1221 stock of the company to D. J. Champion and M. P. Mooney, trustees for petitioner's four children, which left the petitioner and his nominees with 1,920 shares each of preferred and common stock of the company. The certificates surrendered in effecting said gift were numbers P 28 and P 29, aggregating 2,000 shares, of which 80 shares were reissued to the petitioner. The trust agreement under which these shares were transferred for the benefit of the children contains the following recital, among others:
6. That the DONOR herein now desires to give, assign, transfer and set over to, and for the benefit of, the said four children hereinabove named as BENEFICIARIES, in equal shares, all shares in the capital stock of The Champion Rivet Company so bequeathed to him by the last will and testament of said Rose A. Champion, deceased, including all shares of common capital stock and preferred capital stock of The Champion Rivet Company into which said original 240 shares have since been converted, and to divest himself of any and all right, title and interest in and to the said shares of stock and all income and profits hereafter accruing thereon, but in such manner as to insure that the1933 BTA LEXIS 1212">*1222 said shares of stock and all proceeds thereof and all income and profits hereafter arising therefrom shall accrue to the sole benefit, in equal shares, of the above named BENEFICIARIES, and that, until the time arrives for the distribution of the said shares of stock, or the proceeds thereof as herein provided, the voting power of the said stock shall be vested in the TRUSTEES herein designated.
* * *
No power of revocation was reserved to the donor by the trust agreement, the power to vote the stock was vested in the trustees and the agreement provided for distribution of the corpus of the 27 B.T.A. 1312">*1317 trust and any accumulations of income 10 years after the death of David J. Champion. By an instrument dated October 1, 1928, modifying the trust agreement, it was agreed in effect that the money payable to the trustees upon the redemption of the preferred stock in 1928, as hereinafter set forth, should be paid directly in equal amounts to the four beneficiaries of the trust.
An analysis of the surplus account of the company from December 30, 1922, to December 31, 1930, is as follows:
| Earnings available for dividends | Dividends paid in cash | Reduction of surplus each year | Surplus at end of year | |
| Dec. 30, 1922 - | ||||
| Balance before transfer | $2,667,407.22 | |||
| Less transfer to capital | 1,500,000.00 | |||
| Balance after transfer | 1,167,407.22 | |||
| Year 1923 | $248,624.92 | $170,000.00 | 1 $78,624.92 | |
| Dec. 31, 1923. balance | 1,246,032.14 | |||
| Year 1924 | 2 198,219.01 | 184,000.00 | 382,219.01 | |
| Dec. 31, 1924, balance | 863,813.13 | |||
| Year 1925 | 2 54,296.97 | 184,000.00 | 238,296.97 | |
| Dec. 31, 1925, balance | 625,516.16 | |||
| Year 1926 | 2 43,799.89 | 184,000.00 | 227,799.89 | |
| Dec. 31, 1926, balance | 397,716.27 | |||
| Year 1927 | 2 8,868.35 | 134,000.00 | 142,868.35 | |
| Dec. 31, 1927, balance | 254,847.92 | |||
| Year 1928 | 95,223.47 | 52,500.00 | 1 42,723.47 | |
| Dec. 31, 1928, balance | 297,571.39 | |||
| Year 1929 | 110,929.82 | 38,500.00 | 1 72,429.82 | |
| Dec. 31, 1929, balance | 370,001.21 | |||
| Year 1930 | 8,052.56 | 23,000.00 | 12,947.44 | |
| Dec. 31, 1930, balance | 357,053.77 | |||
| Total | 157,646.55 | 968,000.00 |
| Summaries to Dates of Redemptions in 1928 and 1930 | ||||
| Redemption Oct. 1, 1928 | Redemption July 1, 1930 | |||
| Dec. 30, 1922: | ||||
| Balance before transfer | $2,667,407.22 | $2,667,407.22 | ||
| Less transfer to capital | 1,500,000.00 | 1,500,000.00 | ||
| Balance after transfer | 1,167,407.22 | 1,167,407.22 | ||
| Earnings available for dividends | $14,858.30 | $153,620.27 | ||
| 898,000.00 | 961,000.00 | |||
| 883,141.70 | 807,379.73 | |||
| 284,265.52 | 360,027.49 |
The business of the company did not improve in the years following the recapitalization in 1922 to the extent expected. On the contrary, the demand for rivets of the sort produced by the company decreased. One of the reasons for the decreased demand was the increasing use of the process of electric welding instead of riveting in joining metals. Electric welding of metal joints was a relatively new process, but by 1928 it had passed the experimental stage and its use materially reduced the demand for rivets. After its use became more common the company was compelled to go into the processing 27 B.T.A. 1312">*1318 of welding1933 BTA LEXIS 1212">*1224 rods in order to keep its trade. At the time of the hearing herein it had been engaged in such manufacture for about 13 months.
At the annual meeting of the stockholders of the company held April 10, 1928, the president stated, among other things in his annual report, that because of similar action by its competitors the company had been forced to sell its boiler rivets at the same price as its structural rivets. Its boiler rivets had theretofore sold at $4 per ton more than the price of the structural rivets. Previous to this reduction the company had supplied 70 per cent of the demand for boiler rivets. Boiler rivets are more expensive to produce than structural rivets because of the difference in tolerance permitted to the manufacturer.
At a meeting of the stockholders of the Champion Rivet Company held September 18, 1928, at the company's office in Cleveland, the following resolution was adopted:
RESOLVED, that this corporation redeem 2000 shares of its preferred stock at the redemption value thereof, to-wit, $105.00 per share; that the shares so redeemed be surrendered pro-rata by the present holders of preferred stock in the Company in the proportion of their respective1933 BTA LEXIS 1212">*1225 holdings of said stock, and that the shares so redeemed be canceled and retired and not thereafter reissued, said redemption to become effective as of October 1, 1928; and that the stated capital of this corporation be reduced accordingly and a certificate of said action be filed with the Secretary of State of Ohio.
Before and after the redemption authorized by the foregoing resolution the proportionate interests of the various stockholders of the company were the same, except that of Henry Chisholm, who held 16.37 per cent of the total stock and voting power before the redemption, and 16.46 per cent thereafter, and that of Henry Chisholm, Jr., whose interest in the company was reduced from .63 per cent to .54 per cent, owing to the fact that he had owned 100 shares of preferred stock but no common stock. Before and after the redemption the petitioner, David J. Champion, and his nominees owned 24 per cent of each class of stock and the trustees for the children of David J. Champion held a like amount.
On October 1, 1928, David J. Champion received $50,400 upon the surrender of 480 shares of the preferred stock for redemption and T. Pierre Champion received $12,600 upon the redemption1933 BTA LEXIS 1212">*1226 of 120 shares surrendered by the trustees for his account.
On October 1, 1929, the company redeemed 2,000 additional shares of its preferred stock at $105 per share, pro rata among the preferred stockholders.
On or about March 5, 1930, the company sold about two acres of land adjacent to its Cleveland plant for $30,000 in cash.
In a meeting of the stockholders of the company held June 3, 1930, the board of directors was authorized to redeem 2,000 shares of preferred 27 B.T.A. 1312">*1319 stock on July 1, 1930, at $105 per share, which redemption was accordingly effected and a certificate was duly filed in the office of the Secretary of State of the State of Ohio showing that the capital stock had been further reduced in 1930 from $1,200,000 to $1,000,000. This redemption was pro rata among the preferred stockholders. From this redemption the petitioner, David J. Champion, received $50,400 for 480 shares of preferred stock surrendered by him.
In 1931 the company redeemed 1,000 additional shares of its preferred stock at $105 per share, pro rata among its preferred stockholders. The redemptions of preferred stock mentioned above were pro rata among the common stockholders, with1933 BTA LEXIS 1212">*1227 the exception of Henry Chisholm and Henry Chisholm, Jr.
There were no transfers of stock between October 1, 1928, and December 31, 1931.
If the March 1, 1913, value applicable to the preferred stock is to be used as the basis, that value is agreed to be $23.3365 per share. If the value as of January 8, 1922, applicable to the preferred stock is to be used as the basis for said stock, that value is agreed to be $102.9844 per share. If an average value is to be used as the basis for the stock, such value is agreed to be $63.16 per share.
In the deficiency notices addressed to the respective petitioners the respondent held that the several amounts received by them as a result of the redemption in the taxable years are taxable in the same manner as ordinary dividends.
OPINION.
VAN FOSSAN: The respondent contends that the redemptions of the preferred stock of the Champion Rivet Company in the taxable years were made at such times and in such manner as to be the essential equivalents of taxable dividends and that consequently, in accordance with the provisions of section 115(g) of the Revenue Act of 1928, the amounts paid are taxable as such. The provisions of section 115(g) 1933 BTA LEXIS 1212">*1228 of the Revenue Act of 1928 are the same as those of section 201(g) of the Revenue Act of 1926.
The facts in the case at bar are strikingly like those appearing in . As in that case, there is here no suggestion or indication that the issuance of the stock dividend by the Champion Rivet Company in 1922 was a part of a continuing plan to distribute corporate earnings freed from the tax burden of ordinary dividends. The capitalization of surplus accomplished by that method was iv complete accord with the company's purpose to expand its business along legitimate and necessary lines.
27 B.T.A. 1312">*1320 Thus, if the provisions of section 115(g) are applicable at all to this case, they must relate to the redemptions effected in 1928, 1929, 1930 and 1931. As we said in , "we must also scrutinize the redemption and distribution with respect to the time and the manner when they occur and the circumstances surrounding them at the time."
Upon examination of the record we find that logically and chronologically the reasons for reducing the company's capital stock1933 BTA LEXIS 1212">*1229 in 1928 and the following years were sound and cogent. Following the recapitalization in 1922 the demand for the company's product decreased. The development of the electric welding process was materially diminishing the use of rivets. In the spring of that year the company had been forced to reduce the price of its boiler rivets to that of structural rivets, although the production cost of the former remained higher. The contemplated erection of the Pittsburgh plant had been wholly abandoned in 1927. Due to the encroachment of electric welding upon the rivet manufacturing industry, the company was compelled to undertake the processing of electric welding rods in order to continue in business. In March, 1930, it sold land adjacent to its Cleveland plant. Thus, by reason of a diminished market, curtailed production, reduced land area (a potential plant facility), and the gradual substitution of electric welding for riveting, the company was confronted with an excess of capital which it found impossible to utilize profitably. Therefore, it proceeded to redeem and cancel portions of its outstanding stock at such times and in such amounts as business exigencies demanded. The diminution1933 BTA LEXIS 1212">*1230 of the capital stock of the company was in harmony with the shrinkage of its own business and the lessened market demand for the product which it manufactured.
When we examine the table of dividends declared from 1913 to 1931, inclusive, we are further impressed with the lack of any purpose on the part of the petitioners and their company to distribute corporate earnings by means of an artifice in order to escape the tax. The company was a closely held corporation. From prior to March 1, 1913, to January 8, 1922, David J. Champion owned approximately one-fourth of its capital stock. From January 8, 1922, to March 14, 1925, he owned almost one-half thereof. Members of his family and intimate business associates owned practically all of the remainder. During the high tax years his company declared large dividends and he and the stockholding associates and members of his family paid their taxes thereon though such dividends had been declared from surplus rather than from operating income. Such a record is not compatible with a studied intent to avoid taxation.
27 B.T.A. 1312">*1321 A further issue is the proper basis for computing profit on the shares of stock of each petitioner upon1933 BTA LEXIS 1212">*1231 redemption by the company. The petitioners contend that the profit should be computed according to the "first-acquired, first-sold" rule as set forth in articles 58 and 600, Regulations 74. See ; . The respondent's theory is that the shares of stock transferred by David J. Champion on March 14, 1925, to D. J. Champion and M. P. Mooney, trustees, are the same shares, or their equivalent under the expanded stock issue, as those inherited by him from his wife, Rose Champion, on January 8, 1922.
The material parts of articles 58 and 600 are as follows:
ART. 58. Sale of stock and rights. - When shares of stock in a corporation are sold from lots purchased at different dates and at different prices and the identity of the lots can not be determined, the stock sold shall be charged against the earliest purchases of such stock. The excess of the amount realized on the sale over the cost or other basis of the stock will constitute gain. In the case of stock in respect of which any stock dividend was paid, the basis for determining gain or loss from a sale of a share of such stock1933 BTA LEXIS 1212">*1232 shall be ascertained in accordance with the principles laid down in article 600. * * *
ART. 600. Stock or securities distributed in reorganization. -
* * *
(4) Where the stock in respect of which a distribution in reorganization is made was purchased at different times and at different prices, and the stock distributed in reorganization can not be identified as having been distributed in respect of any particular lot of such stock, then any sale of the stock distributed in reorganization will be presumed to have been made from the stock distributed in respect of the earliest purchased stock.
The only question, therefore, is wehther or not the 1,920 shares of preferred and the 1,920 shares of common stock of the company transferred by David J. Champion on March 14, 1925, to the trustees can be identified as having been distributed to him on December 30, 1922, in respect of the lot of 240 shares acquired by him from his wife's estate. The evidence before us demonstrates that such identification of the shares is impossible. From prior to March 1, 1913, to January 8, 1922, David J. Champion owned 240 shares of the common stock of the company. On the latter date he acquired1933 BTA LEXIS 1212">*1233 240 additional shares from his wife's estate. Thus, on December 18, 1922, at the time of the recapitalization, he was the actual owner of 480 shares. On December 30, 1922, pursuant to the order of the board of directors of the company entered on December 27, 1932, he exchanged his 480 shares for 3,840 shares of preferred and 3,840 shares of common stock, representing his original holdings increased by the stock dividend of 8 shares of preferred and 7 shares of common stock for each original share so exchanged. The common stock was issued to David J. Champion in five certificates, three for 27 B.T.A. 1312">*1322 1,000 shares each, one for 478 shares and one for 346 shares. The remaining shares were issued to his nominees, P. H. Mooney and W. J. Reilley, in four certificates, each nominee receiving one certificate for 7 shares and one for one share. The preferred stock was issued to Champion in four certificates, three for 1,000 shares each and one for 824 shares. The remaining shares of that stock were issued to the said nominees in two certificates of 8 shares each.
From this record it is apparent that David J. Champion pooled his original stockholdings, offered them in exchange for1933 BTA LEXIS 1212">*1234 the new issue and received certificates for the new stock in amounts that bore no relation to his original stock. It was not until more than two years later that he executed the trust assignment for the benefit of his children. In paragraph 6 of that instrument he sought to indicate the source of the bequest as being the same heritage he had received through his wife's will. But since his wife's stock had lost its identity upon the distribution of the stock dividends and the reissuance of the entire stock interests in the company on December 30, 1922, no descriptive words or acts of his could restore it. The gift to the children was equivalent in number of shares to the bequest from the wife, but they were not the same shares, nor was it possible to effect identification with the original shares.
The values to be used in recomputing the deficiencies are set out in the findings of fact.
Decision will be entered under Rule 50.