*28 Decision will be entered under Rule 50 in Docket Nos. 104152, 104154, 104159, and 104160; and for the petitioners in Docket Nos. 104153, 104155, 104156, 104157, and 104158.
C corporation, owner of 164,250 shares of common stock, being all the outstanding stock of G corporation, agreed to sell such stock to petitioners for 40,000 shares of its own stock valued at $ 1,280,000 and $ 1,348,000 cash, or the same number of shares of new common stock after recapitalization of G corporation and sale of 50,000 shares of new common and 62,500 shares of new preferred to New York bankers for $ 1,800,000, out of which $ 1,348,000 was to be paid by G corporation as a dividend to C corporation. The deal was consummated under the second plan. Held, there was no obligation on petitioners' part under the second plan to pay the $ 1,348,000 and, having received no economic benefit from the payment of the dividend by G corporation to C corporation, petitioners derived no taxable income as a result of the payment of such dividend.
*139 These consolidated proceedings involve deficiencies in income tax as determined by the respondent for the year 1936 as follows:
| Docket | |
| No. | Deficiency |
| 104152 | $ 66,417.50 |
| 104153 | 66,905.95 |
| 104154 | 67,622.04 |
| 104155 | 65,039.17 |
| 104156 | 67,863.79 |
| 104157 | $ 65,572.88 |
| 104158 | 3,479.57 |
| 104159 | 7,126.21 |
| 104160 | 10,571.47 |
The question common to all proceedings is whether the amount of $ 1,348,000 paid in 1936 by the Detroit Gasket & Manufacturing Co. to the Crown Cork & Seal Co. in the form of a dividend was, to the extent of the earnings available for that purpose, taxable income to petitioners. In Docket Nos. 104152 and 104154 two additional issues were raised which were disposed of by stipulation. In his amended answer the respondent made claim for increased deficiencies on the ground that earnings in the amount of at least $ 1,348,000 were available March 13, 1936, for dividends instead of $ 832,196.08 as originally determined by him.
The evidence of record consists of a stipulation of facts, with exhibits thereto supplemented by two other exhibits and a supplemental stipulation of facts. We adopt both stipulations of facts together*30 with the exhibits, as our findings of fact, but set forth herein only facts sufficient for an understanding of the issue involved.
*140 The petitioners are individuals, residing in Detroit, Michigan. Their returns for the year 1936 were filed with the collector of internal revenue for the district of Michigan.
Prior to 1929 the entire stock of the Detroit Gasket & Manufacturing Co., hereinafter referred to as the Gasket Co., was owned by Lloyd H. Diehl and Edward W. Diehl and a limited group of associates. In 1929 additional stock of the company was sold to the public and the stock listed on the stock exchange, but the two Diehls and their associates remained in control of the company. In 1931 substantially all, and after 1931 all, of the outstanding capital stock of the Gasket Co., consisting of 164,250 shares, was acquired by the Crown Cork & Seal Co., hereinafter referred to as the Crown Co., by means of a nontaxable exchange of stock whereby common stock of the Crown Co. was issued to the stockholders of the Gasket Co. in exchange for their Gasket Co. stock on the basis of one share of Crown Co. stock for two shares of Gasket Co. stock. After the acquisition of the entire*31 outstanding stock of the Gasket Co. by the Crown Co. the Diehls and their immediate associates were left in control of the management of the Gasket Co., constituting a majority of the board of directors and holding all of the offices of Gasket Co., and they remained in such capacities through March 13, 1936.
For some months prior to December 16, 1935, conversations were had between the Crown Co. and the Diehls, acting in behalf of themselves and their associates, relating to the purchase by them from the Crown Co. of all the outstanding stock of the Gasket Co. A written agreement dated December 16, 1935, was executed whereby the Crown Co., as first party, granted to the Diehls, as second parties, an option, exercisable on or before March 16, 1936, to purchase 164,250 shares of Gasket Co. stock as it "is now constituted, or as the same may be reconstituted on the date of purchase" for the sum of $ 2,628.000, payable by the delivery of 40,000 shares of Crown Co. common stock at the agreed valuation of $ 32 a share, or, at the option of the Crown Co., the proceeds from the sale of half or all thereof at $ 32 a share to a purchaser secured by the Crown Co., and cash in the sum of $ 1,348,000. *32 The agreement further provided, inter alia, that if, after the exercise of the option by the Diehls and the delivery of the 20,000 shares of Crown Co. stock the Diehls failed to perform their agreements, then the contract should terminate and the 20,000 shares or proceeds thereof should become the absolute property of the Crown Co. as agreed liquidated damages for the breach of the agreement, and:
(4) It is agreed that the purchase price herein provided for to be paid by the parties of the second part to the party of the first part in the event of *141 the exercise of this option, may be paid by the parties of the second part, or the parties of the second part may cause all or any part of such payment to be made by the Detroit Gasket & Manufacturing Company if the manner and form of such payment be agreed upon by the parties hereto. The term "manner and form" herein used contemplates, among other things, dividends out of earnings, dividends by way of liquidation, distribution of assets, etc. Nothing in this paragraph (4) shall affect the obligation on the part of the parties of the second part to deliver, or cause to be delivered, as part of the purchase price, the aforementioned*33 Common Stock of Crown Cork & Seal Company, Inc.
On January 16, 1936, the agreement of December 16, 1935, was amended and supplemented by a written agreement in letter form. On the same date the Diehls gave notice in writing exercising the option given them under the agreement of December 16, 1935, as amended and supplemented. The amended agreement provided inter alia, as follows:
* * * It is understood that you [Diehls] will not cause any of the preferred stock or the common stock of the Detroit Gasket & Manufacturing Company, after the same is reconstituted as provided herein, to be sold or pledged or otherwise alienated or permit any bond issue to be placed upon the assets of the Company prior to the date when the full purchase price provided in the agreement of December 16, 1935, has been paid.
It is understood that the Detroit Gasket & Manufacturing Company may pay the $ 1,348,000 provided to be paid to us in cash in the form of dividends, either normal or liquidating, or both, as we may agree, or otherwise, prior to the time or simultaneous with the time that we deliver to you the 164,250 shares of Detroit Gasket & Manufacturing Company common stock as the same is then *34 constituted, but permitting such payment to be made by said Detroit Gasket & Manufacturing Company shall not in default of payment by the Gasket Company release you from the payment of the same in accordance with the agreement of December 16, 1935, as amended by this agreement.
Pursuant to the terms of the agreement of December 16, 1935, as amended and supplemented by the agreement of January 16, 1936, the Diehls delivered 20,000 shares of stock of the Crown Co. to Paine, Webber & Co. as purchaser thereof, which company on January 20, 1936, paid $ 640,000 therefor to the Crown Co.; the Gasket Co. was recapitalized with the consent of the Crown Co. to provide for 300,000 shares of common stock of the par value of $ 1 a share and 62,500 shares of preferred stock of the par value of $ 20, a share. F. Eberstadt & Co. and Shields & Co., New York bankers, in an agreement under date of January 28, 1936, with the Gasket Co., approved by the Crown Co., agreed to purchase 62,500 shares of the new preferred stock and 50,000 shares of the new common stock and warrants for 62,500 shares of the new common stock of the Gasket Co. for $ 1,800,000; on February 10, 1936, the directors of the Gasket*35 Co. declared a cash dividend in the amount of $ 1,348,000, conditional *142 upon, and payable immediately after, the purchase by the New York bankers of the new Gasket Co. stock and warrants as agreed upon on 164,250 shares only of the common stock of the par value of $ 1 a share issued and outstanding as of February 20, 1936, it having been agreed with the New York bankers that the new preferred and common stock, other than the 164,250 shares held by the Crown Co., would not be entitled to the dividend of $ 1,348,000 or any part of it; the Crown Co. on or before February 19, 1936, exchanged its 164,250 shares of no par value stock of the Gasket Co. for the same number of shares of new common stock of the par value of $ 1 a share of the latter company; by March 13, 1936, the Gasket Co. had received the proceeds of $ 1,800,000 from the sale of its 50,000 shares of new common stock and 62,500 shares of its new preferred stock and warrants for 62,500 shares of its new common stock; on March 13, 1936, the Gasket Co. paid the sum of $ 1,348,000 to the Crown Co. in payment of the dividend previously declared by it; the Diehls on March 1, 1936, delivered the second 20,000 shares of *36 stock of the Crown Co. to Paine, Webber & Co., which company on March 13, 1936, paid $ 640,000 to the Crown Co. therefor; and on the same day the Crown Co. delivered to the Diehls the 164,250 shares of the new common stock of the Gasket Co. In all the negotiations had and agreements executed by Lloyd H. and Edward W. Diehl, as purchasers of the 164,250 shares of common stock of the Gasket Co., they acted not only for themselves but also for their associates, including all the petitioners herein.
On March 13, 1936, the earned surplus of the Gasket Co. was at least $ 733,000, exclusive of (1) the amount of $ 503,100 representing a capitalization of earned surplus in 1929 as a result of the issuance of capital stock as a nontaxable dividend, which stock was still issued and outstanding on January 1, 1936; and (2) the amount of $ 98,160.99 representing goodwill charged against earned surplus in 1929.
The Crown Co. reported the amount of $ 1,348,000 on its income tax return for 1936 as ordinary dividends received and also reported a profit of $ 223,409.21 ($ 2,010,000-$ 1,786,590.79) upon the sale of the stock of the Gasket Co. The return was audited by a revenue agent of the Atlantic*37 Division, at Baltimore, Maryland, and the report of the transaction involved in the return was treated as correct. The Central Division at Detroit, Michigan, questioned such treatment and subsequently it was decided by the Atlantic and Central Divisions that the Central Division would proceed with the trial of petitioners' cases and the Atlantic Division would suspend all action on the case of the Crown Co. A deficiency notice has not been issued to Crown Co., but the statutory period for issuing such notice has not expired and is being held open by a waiver.
*143 Under the plan as consummated for the purchase of the Gasket Co. stock held by the Crown Co., the petitioners were not obligated under the terms of the agreement to pay the amount of $ 1,348,000 in cash to the Crown Co. and they derived no income taxable to them as a result of the payment of that amount as a dividend by the Gasket Co. to the Crown Co.
OPINION.
The respondent determined that the payment of $ 1,348,000 by the Gasket Co. to the Crown Co. was an ordinary dividend but applied to the discharge of petitioners' obligation to the Crown Co. for the balance of the purchase price of the 164,250 shares of stock*38 of the Gasket Co., and that therefore such dividend, to the extent of $ 832,196.08, earnings available on March 13, 1936, for the payment of dividends, represented taxable income to petitioners measured by the number of shares of Crown Co. stock held by each of them. By amended answer respondent alleged that earnings of the Gasket Co. available for dividends amounted to at least $ 1,348,000 and that each petitioner's share thereof should be increased proportionately, and he claimed increased deficiencies accordingly. On brief the respondent submits that, since the tax liability of petitioners is based upon the satisfaction and discharge of their liability by the Gasket Co., the amount of earnings of the Gasket Co. available for dividends is immaterial, the tax liability of petitioners being the same whether the company had earnings available for dividends or not.
The respondent's theory is based primarily on certain language of the agreements entered into between the Crown Co. and the Diehls. He calls attention to the part of the contract giving the Diehls the right to purchase the 164,250 shares of Gasket Co. stock "as then [at the time of the execution of the option agreement] *39 constituted, or as the same might later be reconstituted, for the sum of $ 2,628,000.00"; to the provision permitting payment of $ 1,348,000 by the Gasket Co. as a dividend to the Crown Co., which permission "shall not in default of payment by the Gasket Company release you [the Diehls] from the payment of the same in accordance with the agreement of December 16, 1935, as amended" by the agreement of January 16, 1936; and to the reference in the agreements to the 40,000 shares of Crown Co. stock "as part of the purchase price" and to the reference to the $ 1,348,000 as the "balance of said purchase price." It is a well established rule in construing contracts that particular words or phrases may not be "isolatedly considered, but that the whole contract must be brought into view and interpreted with reference to the nature of the obligations between the parties, and the intention which they have manifested in forming them." ; . It is also well established *144 that the construction placed upon a contract by the parties to*40 it should be given great weight, the United States Supreme Court, in , stating in that regard: "There is no surer way to find out what the parties meant, than to see what they have done."
Notwithstanding the statements and phrases in the contract relied upon by the respondent to support his theory, a careful consideration of the agreement, as amended, as well as the action of the parties in carrying out the agreement, discloses two plans, under either of which the Diehls could acquire the Gasket Co. stock from the Crown Co. Under one plan the Diehls had the option of purchasing the entire outstanding issue of the Gasket Co. stock, then represented by 164,250 no par value shares owned by the Crown Co., for 40,000 shares of Crown Co. stock at an agreed value of $ 1,280,000 and $ 1,348,000 cash. Under the other plan, the one followed in closing, the Gasket Co. was to be recapitalized by increasing its common stock to 300,000 shares of $ 1 par value and 62,500 shares of $ 20 preferred, the preferred and 50,000 shares of the common to be sold and the proceeds, to the extent of $ 1,348,000, paid to the Crown *41 Co. by way of a dividend by the Gasket Co. in lieu of the cash payment by the Diehls.
Thus, under the first plan the Diehls would receive 164,250 shares representing the entire outstanding capital stock of the Gasket Co., while under the second plan they would receive the same number of new shares, representing a portion only of the outstanding shares.
On February 10, 1936, the Gasket Co. declared a dividend of $ 1,348,000 payable to stockholders of record of February 20, 1936. On February 19 1936, the Crown Co. exchanged its 164,250 no par value shares of Gasket Co. stock for the same number of new $ 1 par value shares. The Crown Co. was the sole stockholder of record of the Gasket Co. on February 20, 1936. On March 13, 1936, the Gasket Co. received from the bankers $ 1,800,000 from the sale of additional stock under the agreement of January 28, out of which and on the same day it paid the dividend of $ 1,348,000 to the Crown Co., and the Diehls received not the stock representing the entire outstanding issue, for which they agreed to pay $ 2,628,000 under the first plan, but the same number of shares diluted by the issuance and sale of the additional preferred and common stock. *42 It must not be overlooked that, although the Diehls and immediate associates managed the Gasket Co. as officers and directors, they were not stockholders of the Gasket Co. from 1931 until the time of the completion of the agreement of March 13, 1936. What the Diehls and associates did as officers and directors of the Gasket Co. to cause it to recapitalize, sell part of its stock, and pay the dividend of $ 1,348,000 was done by them not as owners of the company, but pursuant to the express permission of and authorization by the Crown Co., the sole stockholder of the Gasket Co.
*145 It was left to the decision of the Diehls and associates whether they desired to take the old stock of the Gasket Co. or the new stock. But in the event they decided to take the new stock they were not obligated to pay the $ 1,348,000 under the agreement, except in default of payment by the Gasket Co. If the Gasket Co. defaulted, the second plan became inoperative or ineffective and the deal would necessarily have to be closed under the first plan. The language of the agreement, viz:
* * * permitting such payment to be made by said Detroit Gasket & Manufacturing Company shall not in default of*43 payment by the Gasket Company release you [the Diehls] from the payment of the same in accordance with the agreement of December 16, 1935, * * *
together with other provisions of the agreement, is clearly amenable to such a construction. To construe the agreement so as to impose an obligation upon the Diehls and associates for the payment of the $ 1,348,000, whether they received the 164,250 shares of old stock or 164,250 shares of the new stock after payment of the dividend by the Gasket Co. is unwarranted.
If the Diehls received an economic benefit in the amount of $ 1,348,000 by reason of the dividend discharging their obligation to that extent, as contended by the respondent, that benefit would necessarily have to be represented in the value of the 164,250 shares of new stock received by the Diehls from the Crown Co., as that is all they received in the transaction as closed. Shares of stock represent an interest on the assets of a corporation and right to share in earnings and profits in the proportion that the number of shares held bears to the entire number of shares issued and outstanding. No business man would bind himself to pay the same price for the 164,250 shares*44 of new stock of the Gasket Co. after payment of the dividend that he would have paid for the same number of shares of the old stock. The parties placed a value of $ 16 a share on the old stock. ($ 2,628,000 purchase price/164,250, total number of shares outstanding.) The Gasket Co. received $ 1,800,000 on the sale of some of its new common and preferred stock. Adding this amount to the agreed value of the old shares and deducting from the total the dividend of $ 1,348,000 and the par value of the 62,500 shares of preferred stock at $ 20 a share, there remains a balance of $ 1,830 000 applicable to the common stock. Dividing this amount by 214,250, the number of shares of new common stock outstanding after the second plan was consummated, gives a quotient of approximately $ 8.54. Thus the value of the new stock was about half of the agreed value of the old stock. While the above method may not accurately measure the value of the new stock, it fairly illustrates the probable difference in value between the old and the new stock. It is obvious that there was a substantial difference in the value of the old stock and the same number of shares of new stock after the payment of the*45 dividend and *146 the issuance of 50,000 additional shares of common stock and 62,500 shares of preferred. The petitioners received no monetary benefit or enrichment as a result of the payment of the dividend by the Gasket Co. to the Crown Co. The Diehls under the second plan were obligated to pay the $ 1,348,000 only if the Gasket Co. defaulted, i. e., if the second plan failed, or if the first plan was adopted and consummated. In either event the assets of the Gasket Co. would not have been depleted to the extent of $ 1,348,000.
In , cited by respondent, the taxpayer's employer paid taxpayer's income taxes as additional compensation for his services. In that case the Court held that the amount of the taxes paid by the employer was paid by the employer "in consideration of the services rendered by the employee, and was again derived by the employee for his labor." It was held in that case that the taxpayer received income not merely because the employer paid his tax obligation but because the taxpayer received, although constructively, "income derived from salaries, wages, or compensation*46 for personal service", as defined in section 213 of the Revenue Act of 1924. In , the transferee of taxpayer assumed and paid its bonded and other indebtedness, as a result of which the Court held that the gain realized by the transferor was recognizable under the provisions of 112 of the Revenue Act of 1928 to the extent of the amount of the indebtedness, since the gain to that extent was neither "stock or securities" nor distributed to its stockholders "in pursuance of the plan of reorganization." The Court also held that the amount assumed and paid by the transferee was income to the transferor as though the amount had been paid directly to the latter, since it was "the beneficiary of the discharge of its indebtedness." Herein the petitioners were neither obligated to pay the $ 1,348,000 under the plan as adopted and consummated, nor received any monetary benefit from the payment of that amount by the Gasket Co. It would serve no useful purpose to discuss other cases cited by the respondent. They are either not applicable or are distinguishable, and they were determined upon their own peculiar facts.
In*47 view of our conclusion it is not necessary to consider or determine the amount of earned surplus of the Gasket Co. available for dividends or whether the amount thereof would have been material if the petitioners had derived income taxable to them from the transaction involved.
Decision will be entered under Rule 50 in Docket Nos. 104152, 104154, 104159, and 104160; and for the petitioners in Docket Nos. 104153, 104155, 104156, 104157, and 104158.
Footnotes
1. Proceedings of the following petitioners are consolidated herewith: Irene E. Diehl; Edward W. Diehl; Ruth R. Diehl; Walter E. Ritter; Edna M. Ritter; Howard A. Church; Herbert F. Doolittle; and Edward F. Tannewitz.↩