*2824 Transaction held to be a sale of stock by the stockholders and not a sale of assets by the corporation.
*570 The Commissioner determined a deficiency in income and profits tax for 1920 of $48,975.87 against the Caudill Branch Coal Co., a Kentucky corporation now dissolved, and notified petitioner, who was a stockholder of said corporation, that "As provided in section 280 of the Revenue Act of 1926 there is proposed for assessment against you the amount of $21,450 constituting your liability as a transferree of the assets of the Caudill Branch Coal Co., of Lexington, Kentucky, for unpaid income and profits taxes in the amount of $48,975.87 assessed against the Caudill Branch Coal Company for the year 1920."
Among other things, petitioner claims (1) that the Commissioner erred in determining that the Caudill Branch Coal Co. had sold its assets in 1920 to the Dudley Coal Co. and realized a profit thereon of $111,483.49, it being the claim of petitioner that the transaction held by the Commissioner to be a sale by the corporation of its assets was, *2825 in fact, a sale by the stockholders of the Caudill Branch Coal Co. of their stock and that no profit accrued to the corporation; and (2) that section 280 of the Revenue Act of 1926 is unconstitutional and void because its provisions conflict with sections 1 and 2 of
FINDINGS OF FACT.
The petitioner is an individual and a resident of Lexington, Ky. During the period in controversy in 1920 he was a stockholder in the Caudill Branch Coal Co.
The Caudill Branch Coal co. (hereinafter sometimes referred to as the Caudill Company) was incorporated under the laws of the State of Kentucky on February 12, 1918, with an authorized capital stock of $50,000, all of which was paid in. Its capital stock was *571 increased from time to time so that on June 30, 1920, there had been paid in in cash a total of $250,000. The corporation was organized for the purpose of developing a certain coal lease in Litcher County, Kentucky.
On June 1, 1920, the stockholders of the Caudill Branch Coal Co. made the following written offer to the petitioner:
WHEREAS, we, the undersigned, are the owners of certain shares of stock in the Caudill Branch Coal Company, *2826 a corporation created under the laws of Kentucky as follows:
| P. M. McClanahan | owning | 250 shares |
| Charles T. Harther | owning | 125 shares |
| S. T. Walbolt | owning | 125 shares |
| Walter S. Wood | owning | 130 shares |
| W. M. Puckett | owning | 65 shares |
| G. H. Caperton | owning | 130 shares |
| John L. Dickinson | owning | 65 shares |
| Quinn Morton | owning | 65 shares |
| James F. Brown | owning | 260 shares |
| Malcolm Jackson | owning | 260 shares |
| Edward W. Knight | owning | 260 shares |
| Maud B. Walbolt | owning | 125 shares |
| Avery L. Sterner | owning | 15 shares |
| Edna S. Harther | owning | 110 shares |
| W. H. Ball | owning | 65 shares |
| R. B. Crane | owning | 42 shares |
| E. J. Marshall | owning | 43 shares |
| Total | 2,135 shares |
Now, therefore, we, each of us agreeing severally only and not jointly, that we will sell, subject to the provisions hereinafter contined in favor of Mrs. P. M. McClanahan, said shares of stock at any time before the first day of July, 1920, to W. S. Dudley, of Lexington, Kentucky, acting for himself and his associates, at the price of One Hundred Fifty Dollars ($150.00) per share, of which $100.00 per share shall be paid in cash and the balance in the notes of a new corporation as*2827 hereinafter stated, and upon the cash payment being made the said shares of stock shall be transferred to said Dudley; but before electing to purchase said shares of stock, said Dudley shall cause a new corporation to the formed under the laws of Kentucky, with the necessary and proper powers for the purpose of acquiring the leasehold estate and all the property and assets of said Caudill Branch Coal Company and assuming all its debts and liabilities and of operating said leasehold estate as a mining corporation.
If said Dudley purchases said shares of stock he shall do or cause to be done, in a lawful manner, and required to fulfill, the following things:
(1) Within fifteen days after such purchase of said shares of stock, said new corporation shall purchase and acquire the leasehold estate and all the property and assets of said Caudill Branch Coal Company and shall assume as part of such purchase all its debts and liabilities.
(2) The consideration to be paid to said Caudill Branch Coal Company in addition to assuming all its debts and liabilities, by said new corporation, shall be its notes in the amount of One Hundred Nineteen Thousand Two Hundred Fifty Dollars ($119,250.00) *2828 and such an amount of cash as may be agreed upon between said companies, so that the only indebtedness incurred by said new *572 corporation in making said purchase shall be said amount of notes and the said debts and liabilities of said Caudill Branch Coal Company, which it will assume and pay.
(3) Said new corporation shall sell enough of its capital or treasury stock to have in its treasury therefrom before it makes such purchase of the Caudill Branch Coal Company, enough cash to make and complete its said purchase from the Caudill Branch Coal Company and in addition thereto no less than the sum of One Hundred Twenty-five Thousand Dollars ($125,000.00) which shall be used by said new corporation in improvements and betterments upon said leasehold estate when acquired by it.
(4) The said Caudill Branch Coal Company shall be would up and liquidated under the laws of Kentucky.
(5) Such steps shall be taken and proceedings had in the said purchase by the new corporation of said leasehold estate, property and assets of said Caudill Branch Coal Company and in winding up and liquidating said last named company, as will enable the said Dudley to deliver to the parties from*2829 whom he purchases said shares of stock of said Caudill Branch Coal Company and to Mrs. P. H. McClanahan, the said notes of said new corporation in the amount of One Hundred Nineteen Thousand Two Hundred Fifty Dollars, ($119,250.00) so that each of said parties will receive Fifty Dollars ($50.00) per share in said notes and in addition thereto Mrs. P. H. McClanahan will receive Twelve Thousand Five Hundred Dollars ($12,500.00) of said notes. The said notes shall be in equal installments payable to the order of the party receiving the same at one, two and three years after date, with interest from date at the rate of six per cent (6%) per annum, payable annually, with provisions in case any of said notes is not paid at maturity, the principal of all notes shall thereupon become due and payable; for example, P. M. McClanahan, would receive one note for $4,166.66 and two notes for $4,166.67 each, making a total of $12,500.00 in such notes.
(6) Until all the notes aforesaid shall be paid by it, said new corporation shall not, by mortgage or otherwise create any lien upon its property to be acquired as aforesaid from said Caudill Branch Coal Company, or which it may otherwise acquire.
*2830 (7) Within twenty (20) days after the purchase of said shares of stock as aforesaid by said Dudley he shall deliver to the parties entitled thereto the notes aforesaid of said new corporation, and he agrees that he will have the right to deliver said notes and that the same when so delivered shall be legal and binding obligations of said new corporation.
The stock of the Caudill Branch Coal Company, when transferred to the said Dudley as aforesaid, shall be fully paid up shares of stock.
Any purchase of said shares of stock by said Dudley must be a purchase of all said shares of stock, and not otherwise.
If said Dudley does not purchase all of said shares of stock as hereinbefore specified, before the first day of July, 1920, then all his rights hereunder shall end and terminate, and this agreement shall then become null and void.
Given under our hands this first day of June, 1920.
QUINN MORTON,
MALCOLM JACKSON,
E. J. MARSHALL, S. T. WALBOLT,EDNA S. HARTHER,
G. H. CARPENTER, W. H. BALL, BY W. M. PUCKETT, W. S. WOOD,J. F. BROWN FOR SELF AND O. P. FITZGERALD AND B. B. BROWN HOLDING 10 SHARES EACH OF STOCK SUBSCRIBED IN MY NAME,
JNO. L. DICKINSON,
*2831 E. W. KNIGHT, R. B. CRANE,MAUDE B. WALBOLT,
AVERY L. STERNER,
CHARLES T. HARTHER,
W. M. PUCKETT, P. H. MCCLANAHAN.*573 I hereby accept the foregoing option, and hereby purchase the shares of stock therein mentioned on the terms and conditions therein stated, this 20th day of June, 1920.
(Signed) W. S. DUDLEY.
On July 1, 1920, the Dudley Coal Co. (hereinafter sometimes referred to as the Dudley Company), having been previously organized and all of its capital stock paid in in cash, passed the following resolution:
At a meeting of the Board of Directors of the Dudley Coal Company, held on June 25th, 1920, at its offices in the First & City National Bank Building, in the City of Lexington, Kentucky, there were present Messrs. W. S. Dudley, G. P. Morison, John P. Gorman, W. O. David, and Richard Godson.
On motion made and duly seconded the following resolution was unanimously adopted.
Resolved: That the negotiations and agreements heretofore and at present existing and pending between W. S. Dudley and Caudill Branch Coal Company in reference to the purchase of the property and all business interests of the Caudill Branch Coal Company, as set*2832 forth in a written agreement between said W. S. Dudley, and said Caudill Branch Coal Company, (which agreement is now in the possession of said W. S. Dudley) by the Dudley Coal Company, is hereby approved and ratified, and said W. S. Dudley, as President, of the Dudley Coal Company, is hereby authorized and directed to purchase said Caudill Branch Coal Company property and all its business interests as set forth in said written agreement for the sum of $387,500.00, on the terms mentioned in said agreement, and G. P. Morison as Treasurer of the Dudley Coal Company is authorized and empowered to draw his check on the funds of said Dudley Coal Company for any cash sum or sums necessary to effect the purchase of said Caudill Branch Coal Company and said W. S. Dudley as President of said Dudley Coal Company, is hereby authorized and empowered to execute and deliver to said Caudill Branch Coal Company any note or notes of the Dudley Coal Company, for any deferred payment or payments that may be required to meet the full amount necessary for a compliance with the terms of purchase of said Caudill Branch Coal Company and said W. S. Dudley and G. P. Morison, or either of them, is hereby fully*2833 authorized and empowered to do any all acts necessary to complete and give full effect to any and all agreements for the purchase of said Caudill Branch Coal Company and all its business interests.
(Signed) W. S. DUDLEY,
President.
(Signed) RICHARD GODSON,
Secretary.
On June 30, 1920, the Dudley Coal Co. issued its checks to the following stockholders of the Caudill Branch Coal Co. in settlement *574 of their stock as provided in the offer made to W. S. Dudley on June 1, 1920:
| Payable to | Amount | For |
| Walter S. Wood | $13,000 | Caudill Branch Coal Co. stock in name Walter Wood |
| Nos. 10 & 27, for 50 shares each & Lucy S. Wood | ||
| No. 52, 30 shares. | ||
| Quinn Morton | 6,500 | Caudill Branch Coal Co., certificate #14, 25 shares |
| ; #26, 25 shares; #51, 15 shares. | ||
| G. H. Caperton | 13,000 | Caudill Branch Coal Co., certificate #12, 50 shares |
| ; #28, 50 shares; #53, 30 shares. | ||
| Quinn Morton | 6,500 | Caudill Branch Coal Co., stock in name of W. H. |
| Ball, #19, 25 shares;#30, 25 shares; #55, 15 shares | ||
| W. M. Puckett | 6,500 | Caudill Branch Coal Co., stock certificate No. 18, |
| 25 shares; #29, 25 shares; #54, 15 shares. | ||
| John L. Dickinson | 6,500 | Caudill Branch Coal Co., stock certificate No. 13, |
| 25 shares; #31 for 25 shares; #56, 15 shares. | ||
| James F. Brown | 26,000 | Caudill Branch Coal Co. stock cert. #15, 100 shares |
| ; #32, 100 shares, #46, 10 shares; #48, 40 shares; | ||
| #47, 10 shares. | ||
| Malcolm Jackson | 26,000 | Caudill Branch Coal Co., stock cert. #33, 100 |
| shares; #17, 100 shares; #49, 60 shares. | ||
| Edward W. Knight | 26,000 | Caudill Branch Coal Co. stock cert. #16, 100 shares |
| ; #34, 100 shares, #50, 60 shares. | ||
| Kanawha Valley Bank | 15,000 | Caudill Branch Coal Co., stock in name of P. M. |
| McClanahan #1, 100 shares; #3, 50 shares. | ||
| 145,000 |
| Stock of Caudill Branch Coal Company sent to Phoenix and Third National | |||
| G. P. Morison, Treasurer, in payment for same | |||
| Date | Owner of stock | Shares of stock | Amount |
| 7/7/20 | Maude B. Walbolt | #38, 40 shares, #37, 25 shs | $6,500.00 |
| 7/7/20 | Edna S. Harther | #42, 25 shares, #43, 40 shs | 6,500.00 |
| 7/7/20 | R. P. Crane | #45, 25 shares, | 4,200.00 |
| 7/7/20 | E. J. Marshall | #44, 43 shares, | 4,300.00 |
| 7/7/20 | Maude R. Walbolt | #36, 25 shares, #35, 35 shs | 6,000.00 |
| 7/7/20 | S. T. Walbolt | #7, 25 shares, | 2,500.00 |
| 7/7/20 | P. M. McClanahan | #9, 50 shares, | 5,000.00 |
| 7/7/20 | Charles T. Harther | #5, 25 shares, | 2,500.00 |
| 7/7/20 | Edna S. Harther | #40, 20 shares, #41, 25 shs | 4,500.00 |
| 7/7/20 | Avery L. Sterner | #39, 15 shares, | 1,500.00 |
| 7/7/20 | S. T. Walbolt | #6, 100 shares, | 10,000.00 |
| 7/7/20 | P. H. McClanahan | #8, 50 shares | 5,000.00 |
| 7/7/20 | Charles T. Harther | #4, 100 shares, | 10,000.00 |
| 68,500.00 | |||
| Summary of cash payments | |
| By check to stockholders Caudill Branch Coal Co | $145,000 |
| By check to Phoenix and Third National Bank | 68,500 |
| Total of cash payments | 213,500 |
*575 Also a schedule of the notes issued and to whom issued: *2835
| Notes | |||||
| Name | Total of | Total of | 1 year | 2 years | 3 years |
| stock held | notes | ||||
| P. M. McClanahan | $25,000.00 | $12,500.00 | $4,166.67 | $4,166.67 | $4,166.66 |
| Charles T. Harther | 12,500.00 | 6,250.00 | 2,083.33 | 2,083.33 | 2,083.34 |
| S. T. Walbolt | 12,500.00 | 6,250.00 | 2,083.33 | 2,083.33 | 2,083.34 |
| Walter S. Wood | 10,000.00 | 5,000.00 | 1,666.67 | 1,666.67 | 1,666.66 |
| W. M. Puckett | 6,300.00 | 3,250.00 | 1,083.33 | 1,083.34 | 1,083.33 |
| G. H. Caperton | 13,000.00 | 6,500.00 | 2,166.66 | 2,166.67 | 2,166.67 |
| John L. Dickinson | 6,500.00 | 3,250.00 | 1,083.33 | 1,083.33 | 1,083.34 |
| Quinn Morton | 6,500.00 | 3,250.00 | 1,083.34 | 1,083.33 | 1,083.33 |
| James Brown | 24,000.00 | 12,000.00 | 4,000.00 | 4,000.00 | 4,000.00 |
| Benjamin Brown | 1,000.00 | 500.00 | 166.67 | 166.67 | 166.66 |
| O. P. Fitzgerald | 1,000.00 | 500.00 | 166.66 | 166.67 | 166.67 |
| Edward W. Knight | 26,000.00 | 13,000.00 | 4,333.33 | 4,333.34 | 4,333.33 |
| Malcolm Jackson | 26,000.00 | 13,000.00 | 4,333.34 | 4,333.33 | 4,333.33 |
| W. H. Ball | 6,500.00 | 3,250.00 | 1,083.33 | 1,083.33 | 1,083.34 |
| Maude B. Walbolt | 12,500.00 | 6,250.00 | 2,083.34 | 2,083.33 | 2,083.33 |
| Avery L. Sterner | 1,500.00 | 750.00 | 250.00 | 250.00 | 250.00 |
| Edna S. Harther | 11,000.00 | 5,500.00 | 1,833.34 | 1,833.33 | 1,833.33 |
| E. J. Marshall | 4,300.00 | 2,150.00 | 716.67 | 716.66 | 716.67 |
| R. B. Crane | 4,200.00 | 2,100.00 | |||
| Lucy Wood | 3,000.00 | 1,500.00 | |||
| Luch Wood | 3,000.00 | 1,500.00 | 500.00 | 500.00 | 500.00 |
| Mrs. P. M. McClanahan | 12,500.00 | 12,500.00 | 4,166.66 | 4,166.67 | 4,166.67 |
| Total | 213,500.00 | 119,250.00 | 39,750.00 | 39,750.00 | 39,750.00 |
*2836 W. S. Dudley, petitioner, the owner of 143 shares of the Caudill Branch Coal Co., J. N. Camden, the owner of 130 shares, W. S. Hunter, the owner of 36 shares, J. C. Kinzer, the owner of 36 shares, Ann Mayes, the owner of 10 shares, and Logan T. Davis, the owner of 10 shares, on July 1, 1920, surrendered their respective shares to the Dudley Coal Co. and received in exchange therefor the following shares of stock in the Dudley Coal Co. each of the same par value:
W. S. Dudley, 214 1/2 shares; J. N. Camden, 195 shares; W. S. Hunter, 54 shares; J. C. Kinzer, 54 shares; Ann Mayes, 15 shares; and Logan T. Davis, 15 shares.
On June 30, 1920, the Caudill Branch Coal Co. surrendered all of its assets of every kind and description to the Dudley Coal Co., which at this time held the entire capital stock of the former company, and pursuant to the laws of the Commonwealth of Kentucky, surrendered its charter and wound up its affairs.
The Caudill Branch Coal Co.'s correct depletion for the taxable year 1920 was $476.86, and its correct depreciation for the same period was $8,554.02.
OPINION.
LITTLETON: The liability here in question is predicated upon the theory that there was a*2837 sale by the Caudill Branch Coal Co. of its assets to the Dudley Coal co. in which the former company realized a profit, and that since the Caudill Company has been dissolved and *576 has been divested of all of its assets, the petitioner, as a former stockholder of this corporation, should be held liable as a transferee, under the provisions of section 280 of the Revenue Act of 1926, for a part of the tax due from the corporation. The first defense made by the petitioner is that this was not a sale of assets by the Caudill Company, but rather a sale of stock by the stockholders of the Caudill Company through which the Dudley Company first acquired the stock of the Caudill Company and then came into ownership of the assets of the Caudill Company through a liquidation to it by the Caudill Company.
At the outset it should be observed that what finally happened was that the assets which were owned by the Caudill Company at the beginning of these negotiations were owned by the Dudley Company when the final plan was carried out, nor do we think that it can admit of doubt that this was the end in view and in contemplation of the parties from the very beginning. The controversy*2838 arises, however, because the Commissioner contends that the end was accomplished through a sale of assets by the Caudill Company to the Dudley Company, whereas the petitioner contends that it was accomplished through an acquisition of the stock of the Caudill Company by the Dudley Company and then a liquidation of the former company to the latter. On a consideration of the entire record, we are of the opinion that the petitioner's view must be sustained. In the first place, the agreement under which the assets of the Caudill Company found their way to the Dudley Company was an agreement between the petitioner and the stockholders of the Caudill Company, and not an agreement to which the Caudill Company was in any sense a party. It is too well established to require a citation of authority that the assets of a corporation are not owned by the stockholders, but by the corporation itself, and that the stockholders (even if all had been a party to the offer to the petitioner, which is not true in this instance) can not dispose of the corporation's assets. In *2839
With these principles in mind, it is difficult to reach any other conclusion than that this contract was a sale of stock by the stockholders. To construe the contract as one of sale of assets of the corporation would, in effect, be to declare it an unenforceable contract, because it is well settled that stockholders, as such, under the Kentucky law, cannot sell the assets of a corporation. It is true that, under section 883b of Kentucky Statutes (Acts Ky. 1918, c. 15), no sale of all of a corporation's assets in valid, unless consented to by the holders of not less than three-fourths of the capital stock of the vendor corporation, which consent must be evidenced in writing, or by a vote at a special *577 meeting of the stockholders called for that purpose; but such consent does not effectuate a sale of the assets. Under the Kentucky law the affairs of*2840 the corporation must be conducted by a board of directors, and, notwithstanding the consent of the stockholders to the sale of the corporation's assets, the contract of sale must be executed by the board of directors of the corporation. No such action on the part of the board of directors is shown in this record. Therefore the instrument should be construed as a sale of stock by the stockholders, rather than as an attempt by the stockholders to sell corporate assets, if the instrument and the evidence heard reasonably admit of such a construction.
It is true that in the offer made by the stockholders in the case at bar it was specified that the corporation required to be formed as a condition precedent to accepting the offer, should have the necessary powers to acquire the assets of the Caudill Company and that after it was formed it should acquire the assets in question, but we do not understand this to be sufficient to bind the Caudill Company to an act to which it was not a party, nor to give to the stockholders authority to do something concerning which they did not otherwise have authority.
Likewise, we fail to see wherein the resolution of the Dudley Company, purporting*2841 to ratify the agreements of petitioner and the Caudill Company with respect to the purchase of the properties of the Caudill Company, could amount to making the Caudill Company a party to the agreements when the evidence is to the effect that the agreements were between the petitioner and the stockholders of the Caudill Company. The Dudley Company could hardly ratify more than had taken place, nor could it act for an entirely separate corporate entity, the Caudill Company. Petitioner appears to have been acting in contemplation of the formation of the Dudley Company and to have formed the Dudley Company for the purpose of having this corporation own and operate the properties of the Caudill Company, but the mere fact that the Dudley Company ratified acts of the petitioner leading to the acquisition would not, of itself, make the Caudill Company a party to these negotiations.
Another important factor in our conclusion is that the consideration mentioned in the negotiations between petitioner and the stockholders of the Caudill Company was paid direct to the stockholders and not to the Caudill Company itself. The argument of the Commissioner that this consideration was constructively*2842 received by the Caudill Company, and then paid to the stockholders would have more force had the Caudill Company, in its corporate capacity, been a party to the negotiations, but, as we have stated above, this was not true. It can not be questioned that a stockholder may contract with an individual or a corporation for the sale of his stock and that the consideration paid for his stock becomes his absolute property without any participation on the part of the corporation. To *578 hold otherwise would be contrary to the well established principle of a corporate entity separate and apart from the stockholders. What happened here was that the petitioner contracted for the purchase of a majority of the stock of the Caudill Company and that, through appropriate corporation action, the Dudley Company completed the negotiations by paying direct to the stockholders the consideration agreed upon and received the stock. We do not conceive the situation would have been different had the Dudley Company, without the intervention of petitioner or another individual, secured the assets of the Caudill Company through an acquisition of the stock of the Caudill Company and the subsequent*2843 liquidation of the Caudill Company. In such a situation the profit would have been to the stockholders on account of their sale of stock, and also a possible profit to the Dudley Company of the difference between the price paid for the stock by it and the value of the assets received in liquidation.
Much is said in the Commissioner's argument to the effect that substance, rather than form, should be our guilding principle in the determination of the question here at issue and this, of course, is so well established as to be almost axiomatic, but we do not understand that this principle goes to the extent of requiring a finding that something occurred which, in fact, did not occur. To accomplish the purpose contemplated by the parties, at least two equally effective methods were open to them, namely, a purchase of the stock of the Caudill Company from its stockholders, followed by a liquidation of this company to the purchaser, *2844 or the purchase of the assets direct from the Caudill Company, followed by a liquidation to its stockholders. The fact that in either case the assets of the Caudill Company would find their way to the Dudley Company would not require us to say that the substance of the transaction for tax purposes was the same regardless of the method pursued. Nor do we understand that a taxpayer is subject to legal censure because he has been so fortunate as to select a method of carrying out a given transaction that produces less tax than if a different plan had been followed, provided good faith is shown, and there is no intimation of fraud or bad faith in this transaction. We must determine tax liability of the basis of what occurred and not on the possible or probable course which would have produced a greater tax.
When viewed in the light of the foregoing considerations, we are unable to escape the conclusion that the transaction in question amounted to a sale of stock by the stockholders of the Caudill Company *579 and not a sale of assets by the Caudill Company. It follows, therefore, that the Caudill Company is not taxable on a profit from the transaction and that the liability*2845 sought to be asserted against the petitioner on account thereof is erroneous.
In view of the foregoing conclusion it is unnecessary to consider the second issue.
Judgment will be entered for the petitioner.