*773 Petitioners were stockholders of a Columbia, South Carolina, wholesale grocery company which in turn owned the majority of stock in a Charleston, South Carolina, wholesale grocery company. In November 1936 the Columbia company transferred all the stock which it owned in the Charleston company to its stockholders in substantially the same proportions as they owned stock in the Columbia company, and these stockholders in turn paid the Columbia company $100 per share in cash for each share of the Charleston company transferred to them. The stock of the Charleston company had a fair market value of $150 per share at the time of the transaction. Held, that the transaction represented a dividend distribution by the Columbia company to its stockholders of the excess of fair market value of the stock over the $100 which the stockholders paid for it, and petitioners are taxable on their part of the dividend. George W. Van Vorst, Executor,22 B.T.A. 632">22 B.T.A. 632; affd., 59 Fed.(2d) 677, distinguished.
*1082 The Commissioner determined*774 a deficiency of $7,033.36 in income tax against petitioner J. E. Timberlake for the year 1936, and a deficiency of $120.80 in income tax against Estelle Flintom Timberlake for the same year.
In each instance the deficiency is due to the addition by the Commissioner to the income reported by the taxpayer on his return filed for the year 1936 of dividends which the Commissioner alleges were received by the taxpayers from a corporation of which they were stockholders. The Commissioner's action in thus increasing the income of each petitioner over that reported on his return was explained in the deficiency notices.
The explanation in the deficiency notice addressed to petitioner J.E. Timberlake is typical of both, and is as follows:
(a) - The facts show that you were a stockholder in the corporation, Thomas & Howard Company of Columbia, South Carolina. This corporation owned the capital stock of Thomas & Howard Company of Charleston, South Carolina. On November 9, 1936, Thomas & Howard Company of Columbia, South Carolina, sold to its stockholders the stock of Thomas & Howard Company of Charleston, South Carolina, in the same proportion that the stock of the Columbia Company*775 was held. This stock was sold for $100.00 per share while the fair market value of the stock at date of acquisition was $200.00 per share. The Thomas & Howard Company of Columbia had a substantial surplus at both January 1, 1936 and *1083 December 31, 1936 out of which dividends could have been paid. Since you acquired 184 shares of the capital stock of Thomas & Howard Company of Charleston at a cost of $100.00 per share, or $18,400.00 and the stock had a fair market value of $200.00 per share, or $36,800.00, it is held that, under the circumstances under which this stock was sold, you received a taxable dividend of $18,400.00, the difference between the purchase price and the fair market value of the stock.
The facts in the instant case appear to bring it within the purview of Article 22(a)-1 of Regulations 94 as amended by T.D. 4879, I.R.B. 1939-3, 18, providing, in part:
If property is transferred by a corporation to a shareholder, or by an employer to an employee, for an amount substantially less than its fair market value, regardless of whether the transfer is in the guise of a sale or exchange, such shareholder or employee shall include in gross income*776 the difference between the amount paid for the property and the amount of its fair market value to the extent that such difference is in the nature of (1) compensation for services rendered or to be rendered or (2) a distribution of earnings or profits taxable as a dividend, as the case may be. In computing the gain or loss from the subsequent sale of such property its basis shall be the amount paid for the property, increased by the amount of such difference included in gross income.
The petitioners, by appropriate assignments of error, each assign this action of the Commissioner as error. This presents the only issue for our determination.
The proceedings have been consolidated.
FINDINGS OF FACT.
The following facts have been stipulated:
1. The petitioners are citizens residing at Columbia, South Carolina.
2. The petitioners filed their income tax returns for the taxable year ended December 31, 1936, with the Collector of Internal Revenue for the Collection District of South Carolina.
* * *
4. In 1936 the petitioners were stockholders of Thomas & Howard Company of Columbia, South Carolina, whose capital stock was owned by petitioners, and others, as follows*777 and in the following percentages:
| Shares | Percentage | |
| Mrs. Jessie W. Thomas | 1,074 | 54.7959 |
| C. L. Howard | 381 | 19.4388 |
| J. E. Timberlake | 465 | 23.7245 |
| Estelle Flintom Timberlake | 40 | 2.0408 |
| 1,960 | 100.0000 |
5. In 1938 Thomas & Howard Company of Columbia invested $77,500. in 775 shares of the capital stock of a new corporation, to-wit, Thomas & Howard Company of Charleston, South Carolina, whose issued capital stock consisted of 1,000 shares of the par value of $100,000.00.
6. Thomas & Howard Company of Columbia carried its investment in the capital stock of Thomas & Howard Company of Charleston, upon its books at cost and included the said investment as an asset in its financial statements.
*1084 7. On Novermber 5, 1936, the directors of Thomas & Howard Company of Columbia formally authorized the sale of the 775 shares of the capital stock of Thomas & Howard Company of Charleston at cost or $100.00 per share.
8. On or about November 9, 1936, the said Thomas & Howard Company of Columbia trnasferred the said 775 shares of the capital stock of the Thomas & Howard Company of Charleston to these petitioners and other stockholders as follows*778 and in the following percentages, and for which it received from each stockholder the payment stated:
| Shares | Percentage | Payment | |
| Mrs. Jessie W. Thomas | 437 | 56.3871 | $43,700 |
| C. L. Howard | 138 | 17.8065 | 13,800 |
| J. E. Timberlake | 184 | 23.7419 | 18,400 |
| Estelle Flintom Timberlake | 16 | 2.0645 | 1,600 |
| 775 | 100.0000 | $77,500 |
9. For the taxable year 1936 Thomas & Howard Company of Columbia had net income per books of $53,059.12, which after adjustments and credit for a twenty per cent cash dividend of $39,200.00 was subjected to a surtax on undistributed profits.
10. Throughout the year 1936 the capital stock of Thomas & Howard Company of Columbia was 1960 shares of the par value of $196,000.00. Its surplus account for 1936 was as follows:
| January 1, 1936 - Surplus | $254,088.07 | |
| Book Profits 1936 | 53,059.12 | |
| Total | $307,147.19 | |
| Less: | ||
| Dividends Paid | 39,200.00 | |
| Fed. Income Tax | 4,328.76 | |
| 43,528.76 | ||
| December 31, 1936 - Surplus | $263,618.43 |
11. For the taxable year 1936 Thomas & Howard Company of Charleston had net income of $41,540.18. In January 1936 this company paid a cash dividend of 10% or $10,000. In December 1936*779 this company paid a further cash dividend of 40% or $40,000.00.
12. On or about February 8, 1937, C. L. Howard sold to Mrs. Jessie W. Thomas, 68 shares of the capital stock of Thomas & Howard Company of Charleston at the price of $150.00 per share.
13. In November 1936 the book value of the 1,000 shares of the capital stock of Thomas & Howard Company of Charleston was approximately $200.00 per share.
From the oral testimony and documentary evidence introduced at the hearing, we make the following findings of fact in addition to those stipulated:
The Thomas & Howard Co. of Charleston, South Carolina, sometimes hereinafter referred to as the Charleston company, was engaged in the wholesale grocery business, serving a fan-shaped, rural territory extending inland from Charleston for about 125 miles. At *1085 December 31, 1936, the assets and liabilities of the Thomas & Howard Co. of Charleston were as follows:
| Assets | Liabilities | ||
| Cash | $30,901.51 | Accounts payable | $57,552.86 |
| Account receivable | 140,177.36 | Notes payable | 130,660.38 |
| Delivery equipment | 7,461.09 | Notes discounted | 1,140.25 |
| Furniture and fixtures | 1,446.66 | Reserve for taxes | 1,280.86 |
| Investments | 6,100.00 | Capital stock | 100,000.00 |
| Inventory | 98,676.44 | Undivided profits | 68,443.00 |
| Real estate | 6,000.00 | ||
| Buildings | 25,910.23 | ||
| Merchandise in transit | 32,260.36 | ||
| Advances | 5,500.00 | ||
| Notes receivable | 4,643.70 | ||
| Total | 359,077.35 | Total | 359,077.35 |
*780 The net earnings of the Thomas & Howard Co. of Charleston for the years indicated were as follows:
| 1928 | $15,448.72 |
| 1929 | (1,614.16) |
| 1930 | 11,589.43 |
| 1931 | 150.08 |
| 1932 | (13,274.59) |
| 1933 | $1,424.16 |
| 1934 | 11,702.86 |
| 1935 | 28,208.93 |
| 1936 | 41,540.18 |
The average net earnings for the years 1928 to 1936, inclusive, were $10,575.08. The fair market value of each share of the capital stock of the Thomas & Howard Co. of Charleston on November 9, 1936, at the time that the Thomas & Howard Co. of Columbia, sometimes hereinafter referred to as the Columbia company, transferred 775 of such shares to its stockholders, including those transferred to petitioners for $100 per share, was $150 per share.
OPINION.
BLACK: The first question we have to decide in these proceedings is the fair market value of the shares of stock in the Thomas & Howard Co. of Charleston at the time they were transferred by the Thomas & Howard Co. of Columbia to its stockholders, including petitioners, at $100 per share. If these shares had no greater fair market value at the time of the transfer than $100, it is manifest that petitioners received no dividend in the transaction from the Columbia*781 company of which they were stockholders. Where a corporation sells to its stockholders stock which it owns in another corporation at a price which represents its fair value at the time of sale, there is no dividend in the transaction to the stockholder, even though it does turn out that he has made an advantageous purchase. The stockholder will realize his income if and when he sells his stock at a profit. Palmer v. Commissioner,302 U.S. 63">302 U.S. 63. Petitioners strongly contend that the fair market value of the stock of the Charleston company was $100 per share on November 9, 1936, at *1086 the time they allege it was purchased from the Columbia company. We think the facts are against petitioners on this contention and we have found that the stock had a fair market value of $150 per share on the date in question. We are convinced from the evidence that the stock had at least that much fair market value.
Petitioners rely principally for their contention that the stock had a fair market value of only $100 per share upon the testimony of their witness, Erskine E. Boyce. Boyce was a representative of Mrs. Jessie W. Thomas, who was the principal stockholder*782 in the Columbia and Charleston companies. He was executive vice-president of the Charleston company and had charge of its finances and credits. He testified that in his opinion the fair market value of the stock of the Charleston company was $100 per share at the time of the transfer November 9, 1936. He conceded that he was no expert in the valuing of corporate stocks and that his opinion as to the valuation of $100 per share was largely arrived at by capitalizing the earnings of the Charleston company over a period extending from 1928 to 1936, inclusive, at 10 percent and that on this basis he arrived at a figure of $105.75 per share. We think there are other facts and figures in the record which demonstrate that this figure of $100 per share given by Boyce as his opinion of the fair market value of the stock at the time of the purported sale was too low. Among these is the fact that already in January of the taxable year a dividend of $10 per share had been paid on the stock and the company had the best earnings in its history in 1936. There is no reason to believe but that petitioners were fully aware of this latter fact.
On December 31, 1936, the Charleston company paid*783 a dividend of $40 per share to its stockholders, including petitioners, who had acquired their stock on November 9, 1936, in the manner already detailed.
On or about February 8, 1937, C. L. Howard sold to Mrs. Jessie Thomas 68 shares of the capital stock of the Charleston company at the price of $150 per share. This sale was made after the Charleston company had diminished its assets by the payment of a 40 percent cash dividend to its stockholders on December 31, 1936. It is true that the witness testified that Mrs. Thomas was influenced to pay $150 per share for these 68 shares of the stock by the fact that she needed these shares for the control of the Charleston company. However, when we consider the large earnings of the Charleston company in 1936 and that 68 of its shares were sold early in 1937 at $150 per share after a dividend of $40 per share had been paid on December 31, 1936, we think it is not unreasonable to conclude that the shares of stock of the Charleston company had a fair market value of at least $150 per share on November 9, 1936, and that the *1087 sale of 775 shares of such stock on that date by the Columbia company to its stockholders, including*784 the petitioners herein, for $100 per share was not an arm's length transaction.
We shall consider next whether the difference between the amounts which petitioners paid the Columbia company for the shares of Charleston company stock and the amounts of the fair market value of the shares at the time they were acquired represented a distribution of earnings and profits of the Columbia company to petitioners that are taxable to them as dividends within the meaning of section 115 of the Revenue Act of 1936. The applicable Treasury regulation is article 22(a)-1 of Regulations 94, as amended by T.D. 4879, which was quoted by the Commissioner in his determination of the deficiencies and has been set out above.
Petitioners, in their contention that this excess if any did not represent a taxable dividend, make point of the fact that the Columbia company carried the shares of stock which it owned in the Charleston company on its books at cost, and therefore when it sold the stock to its shareholders at $100 per share, which was its cost, the earnings and surplus of the Columbia company were not diminished by the sale and, therefore, there was no distribution of a dividend*785 within the meaning of section 115. To this contention we remark that if the stock had been distributed by the Columbia company to its stockholders as a dividend in kind, the stockholders would undoubtedly have been taxable on the fair market value of the stock at the time of the payment of the dividend, rather than on the amount of the cost of the stock to the Columbia company, regardless of the fact that the Columbia company carried the stock on its books at cost.
That was the effect of the court's decision in Binzel v. Commissioner, 75 Fed.(2d) 989; certiorari denied, 296 U.S. 579">296 U.S. 579, which affirmed the Board's memorandum opinion in that proceeding. In affirming the Board the court, among other things, said:
As the taxpayer has the burden of proof, we must assume that the stock of the City Bank was purchased out of earnings accrued after March 1, 1913. If so, its increase in value resulted from earnings out of which the stock was originally purchased and pro tanto was added to its surplus available for dividends or for any other purpose. It does not follow, because the United Cork Companies realized no taxable profit while it held the shares*786 of the National City Bank, that there was no profit in fact, or that the dividend was not subject to taxes based upon a valuation of the stock that included the increment. That the market value at the time of distribution should be the basis for the income tax is evident from the decisions of the Supreme Court in United States v. Phellis,257 U.S. 156">257 U.S. 156, * * *, Rockefeller v. United States,257 U.S. 176">257 U.S. 176, * * * as well as under article 627 of Regulations 74.
If the unrealized increment of the stock of the National City Bank represented a distribution of earnings by the United Cork Companies to its stockholders in the Binzel case, as the Board and the court *1088 held that it did, then we see no reason why the unrealized increment of the stock in the Charleston company did not represent a distribution of earnings by the Columbia company when it transferred the stock of the Charleston company, which had a fair market value of at least $150 per share, to its stockholders for $100 per share. It seems clear to us that such transaction was a distribution by the Columbia company to its stockholders of earnings to the extent of $50 per*787 share of the unrealized increment on the shares of stock of the Charleston company. Certainly the transaction seems to fall within the ambit of article 22(a)-1 of Regulations 79, as amended by T.D. 4879, referred to by the Commissioner in his deficiency notices.
The petitioners, however, contend that a Treasury regulation can not make income where none is present and that the regulation in question undertakes to do that very thing and is therefore invalid, and cite in support of their contention Palmer v. Commissioner, supra.
We do not think the Supreme Court's decision in the Palmer case supports the contention of petitioner. The Court in that case took particular pains to point out that at the time Superpower committed itself to the sale of United stock to its stockholders the price which it was to obtain for the stock represented its fair market value. The Court pointed out that the mere fact that the stock increased in value between the time Superpower had agreed to sell United stock to its stockholders, and the time the stock was actually delivered to them, did not result in the payment of a dividend by Superpower to its stockholders. *788 Among other things, the Court said:
* * * We accept the findings as at least establishing that the plan was adopted by Superpower in good faith as a means of effecting a sale of its assets to stockholders at fair market value. Hence the issue for decision, in so far as the first allotment of stock is concerned, is narrowed to the question of law whether the commitment of Superpower, by formal action of its Board, to the sale of United stock at its then fair market value and the ensuing distribution to stockholders is taken out of the category of sales and placed in that of dividends by the fact that, pending execution of the project, rights to subscribe sold on the exchange at substantial prices, or that the stock itself sold at prices substantially above the stipulated purchase price. [Italics supplied.]
We have already stated above that, if $100 per share had represented the fair market value of the shares of the Charleston company at the time they were transferred to the stockholders by the Columbia company for $100 per share, there would be no ground to hold that there was any distribution of a dividend by the Columbia company. That is the principle we understand*789 the Supreme Court to have laid down in the Palmer case, supra. The Supreme Court did not hold that there is not a taxable dividend in a case where, as here, a corporation transfers stock which it owns in another corporation proportionally *1089 to its stockholders for $100 per share, which stock in fact has a fair market value of at least $150 per share at the time of transfer, and the corporation making the transfer has ample earnings to pay a dividend of the amount in question. On the contrary the Court expressed the view that such a transaction would be a taxable dividend to the extent of the excess of the fair market value of the stock over the purported sale price received. In discussing that phase of the subject, the Court said:
On the other hand, such a sale, if for substantially less than the value of the property sold, may be as effective a means of distributing profits among stockholders as the formal declaration of a dividend. The necessary consequence of the corporate action may be in substance the kind of a distribution to stockholders which it is the purpose of section 115 to tax as present income to stockholders, and such a transaction may appropriately*790 be deemed in effect the declaration of a dividend, taxable to the extent that the value of the distributed property exceeds the stipulated price. But the bare fact that a transaction, on its face a sale, has resulted in a distribution of some of the corporate assets to stockholders, gives rise to no inference that the distribution is a dividend within the meaning of section 115. To transfer it from the one category to the other, it is at least necessary to make some showing that the transaction is in purpose or effect used as an implement for the distribution of corporate earnings to stockholders. [Italics supplied.]
In the instant case we think the facts embodied in the stipulation and brought out by other testimony at the hearing make such a showing as is referred to by the Supreme Court in the language which we have emphasized above. We, therefore, sustain the Commissioner in his determination that petitioners received dividends in the manner detailed in the deficiency notices.
We do not sustain the Commissioner in his determination of the amounts of the dividends which petitioners received, for we have held on the facts that the shares of stock of the Charleston company*791 had a fair market value of $150 per share at the time they were transferred to petitioners instead of $200 per share, as the Commissioner determined.
One of the reasons urged by petitioners as to why we should not sustain the Commissioner in his determination that the distributions in the amounts stated were dividends is that the stock of the Charleston company was not transferred to the stockholders of the Columbia company in ratable proportions. In view of the facts stipulated in the record, this contention is not sustained. An examination of the figures in the record shows that, while there was some slight variation in the proportions, it was so small as to be negligible. We hold that the stock in question was distributed by the Columbia company to its stockholders in substantial proportion to the stock which they owned in the company.
One of the cases strongly urged by petitioners in support of their position that there was no dividend distribution in the transaction *1090 in question is George W. Van Vorst, Executor,22 B.T.A. 632">22 B.T.A. 632; affd., *792 59 Fed.(2d) 677. We think that case is distinguishable on its facts from the instant case. In that case the Board laid emphasis on the fact that there was a disproportionate distribution in that only one stockholder had profited by the advantageous purchases and there was no evidence that the other stockholders had consented to such disproportionate arrangement. In that case, among other things, we said:
* * * A taxable distribution may be made without the formal declaration of a dividend. Furthermore, a dividend need not be distributed in proportion to shareholdings if the shareholders consent. But here there has been no declaration of a dividend in any certain amount, in fact no declaration of any dividend which bore any relation to this transaction, and no evidence of the stockholders consenting to a disproportionate distribution. In our opinion the stipulated facts, including the stipulation that the decedent "purchased" the property, made a prima facie case for the petitioner and it was then incumbent upon the respondent to show that although this was in form a sale, nevertheless it occurred under circumstances which indicate that in fact it was a distribution*793 of earnings or profits accumulated since February 28, 1913. In this connection we see no reason to infer that the stockholders ever agreed to an unequal distribution. This majority stockholder undoubtedly purchased at a bargain price and there were stockholders who did not share in the bargain. But bargain purchases do not ipso facto require an explanation by the purchaser to avoid tax. Proof of a prima facie case does not require the elimination of all unfavorable possibilities. * * * [Italics supplied.]
We think the foregoing facts recited by the Board in its opinion in the Van Vorst case make it distinguishable from the instant case, and not authority for the contention urged by petitioners.
Decision will be entered under Rule 50.