*1344 1. The legal character of transactions covered by a written contract is determinable from the operative provisions of the contract, which prevail over the less clear recital.
2. A corporation is legally distinct from its shareholders, and in the absence of fraud or unfairness their separate transactions will not be disregarded, although part of a general plan.
3. A contract, after reciting that the shareholders of a corporation desired to sell their interests in the business and property of the corporation, as well as their shares, provided that the corporation would sell its assets for $630,000 and declare a dividend of its surplus, and that the shareholders would sell their shares for $200,000. Held, that the shareholders received a dividend of $400,000 and sold their shares for $200,000; and did not sell their shares for $630,000.
*224 The respondent determined deficiencies in income and profits taxes for 1920 as follows:
| Petitioner | Docket No. | Deficiency |
| E. H. Nielsen Co | 8899 | $26,855.91 |
| The Goetjen & Metson Co | 17875 | 25,180.73 |
| G.M. and S. Co | 16383 | 3,762.64 |
*1345 The issue is whether the petitioners in Docket 8899 and 17875 realized any profit upon the disposition of certain shares of stock in 1920, and, if so, the amount thereof. In Docket No. 8899 the respondent contends for a lower basis for computing profit then that used in determining the deficiency, and claims an increase in the deficiency. The G.M. and S. Company and the Goetjen & Metson Company were affiliated during the taxable year, and the deficiency against the former arises solely from the assignment to it of its proportionate part of the additional tax of the Goetjen & Metson Company resulting from the inclusion in the consolidated income of its profit from the disposition of the above mentioned shares of stock.
FINDINGS OF FACT.
The petitioner, E. H. Nielsen Company, is a California corporation organized June 3, 1919. The petitioners, the Goetjen & Metson Company and G.M. and S. Company, are Nevada corporations organized, respectively, on July 31, 1906, and April 2, 1908. The principal office of each of the petitioners was in San Francisco, California. During 1920 the Goetjen & Metson Company and G.M. and S. Company were engaged in general farming and were (it is*1346 not disputed) affiliated within the meaning of the Revenue Act of 1918.
The Golden State Asparagus Company is a California corporation organized on December 19, 1901. Prior to March 1, 1913, E. H. Nielsen subscribed for 800 shares of its capital stock and paid therefor the par value of $100 per share. On November 30, 1914, he purchased from another of the shareholders the latter's entire holdings, consisting of 400 shares, or 20 per cent of the total issued shares, at a price of $150 per share. In 1919 E. H. Nielsen transferred certain property, including his 1,200 shares in the Asparagus Company, to the Nielsen Company, in exchange for all its 6,000 shares, having an aggregate par value of $600,000, and the assumption *225 of certain of his liabilities. Prior to March 1, 1913, the Goetjen & Metson Company purchased 800 shares, or 40 per cent, of the capital stock of the Asparagus Company at a price less than the March 1, 1913, value thereof.
On January 13, 1920, the Asparagus Company; all of its then shareholders, namely, the Nielsen Company, the Goetjen & Metson Company, E. H. Nielsen, E. H. Nielsen, Jr., W. H. Metson, H. H. Goetjen, L. A. Maison; the Western Canning*1347 Company, a corporation of California organized in 1919; Thomas Nom; Herbert P. Chan, and Chin Hing, entered into a contract containing the following recital:
THAT, WHEREAS, the present stockholders of the Golden State Asparagus Company desire to sell, and the Western Canning Company desires to buy from said stockholders, upon the terms and conditions hereinafter set forth, all of the interests of said stockholders in the business and property of the Golden State Asparagus Company (with certain exceptions hereinafter mentioned), together with all the stock of said Golden State Asparagus Company held and owned by said stockholders, at the total purchase price of $630,000.00, payable $230,000.00 in cash and the balance of $400,000.00 in promissory notes secured by mortgage upon the property of said Golden State Asparagus Company, as hereinafter particularly specified, and all of the parties desire that the Golden State Asparagus Company shall continue its corporate existence and that its business shall continue to be carried on in its corporate name in order that the value of its good will and prestige may not be impaired or interfered with, and all of the parties thereto have determined*1348 upon the transactions hereinafter set forth and agreed to as being the most practicable method in which the said desires of the parties hereto can be carried into effect.
The contract contained the following provisions:
* * * the Golden State Asparagus Company agrees to sell and convey to Thomas Nom, as the representative of the Western Canning Company, and the Western Canning Company agrees to purchase from the Golden State Asparagus Company, in the name of Thomas Nom as its said representative as aforesaid, all of the following described real and personal property now belonging to the said Golden State Asparagus Company, to-wit: - [Here follows a detailed description of the property to be sold.]
The contract expressly excepts from the sale money on hand and on deposit, Government bonds of $26,000 face value, and all claims, bills, notes and accounts due the Asparagus Company as of January 1, 1920. With the exception of specific payments to be made to the Asparagus Company for the assignment of its rights under several enumerated contracts, the contract provides that the total purchase price for the real and personal property to be sold and conveyed is $630,000. It acknowledges*1349 the amount of $15,000 as paid at the signing of the contract; provides that $215,000 be paid upon delivery of a deed and a bill of sale; that the balance of $400,000 be paid in semiannual installments over a period of years, represented by the joint and several interest-bearing promissory notes *226 of Thomas Nom, Chin Hing and the Canning Company, payable to the Asparagus Company; that for each deferred payment, two separate notes shall be executed and delivered - one for 60 per cent and one for 40 per cent of the amount of the payment; that all said notes be secured by a mortgage of all of the real and personal property sold and conveyed, executed by Thomas Nom to the Asparagus Company.
It is further provided that, after a fixed period for examination of title, a deed and bill of sale shall be executed and delivered by the Asparagus Company to Thomas Nom, and at the same time the sum of $215,000 and the notes and mortgage for $400,000 shall be paid and delivered to the Asparagus Company. Paragraph IX of the contract is as follows:
When the purchase and sale of said real and personal property has been consummated by payment of the balance of the said initial cash payment*1350 and delivery of the said deed and bill of sale and notes and mortgage as above provided, then the Board of Directors of the Golden State Asparagus Company shall within ten days thereafter meet and declare a dividend of all of its property and surplus over and above the sum of two hundred thousand dollars in cash, being the full amount of its subscribed capital stock, which said sum of two hundred thousand dollars shall be retained in cash in its treasury, and shall immediately pay or deliver the amount of said dividend in money or property to its stockholders in proportion to their interests. And upon the declaring of such dividend the said E. H. Nielsen, E. H. Nielsen, Jr., and L. A. Maison, shall and each of them does hereby assign, transfer and set over unto the said E. H. Nielsen Company, a corporation, all of their and each of their respective, individual interests in such dividend, their holdings of the stock of said Golden State Asparagus Company being nominal only in amount, for the purpose and to the effect that the said E. H. Nielsen Company, a corporation, shall be entitled to and shall receive sixty (60) per cent of the full amount of such dividend. And upon the declaring*1351 of such dividend the said W. H. Metson and H. H. Goetjen shall and each of them does hereby assign, transfer and set over unto the said Goetjen & Metson, a corporation, all of their and each of their respective individual interests in such dividend, their holdings of the stock of said Golden State Asparagus Company being likewise nominal only in amount, for the purpose and to the effect that the said Goetjen & Metson, a corporation, shall be entitled to and shall receive forty (40) per cent of the full amount of such dividend. And the said E. H. Nielsen Company, a corporation, and Goetjen & Metson, a corporation, hereby agree that they will accept in settlement pro tanto of such dividend their respective proportions or interests of sixty per cent and forty per cent of said notes secured by mortgage upon the property to be so sold and conveyed as hereinbefore provided, the said E. H. Nielsen Company, a corporation, to receive the said notes for sixty per cent of each and all of said deferred payments, and the said Goetjen & Metson, a corporation, to receive the said notes for forty per cent of each and all of said deferred payments, all of said notes being secured by the said mortgage, *1352 and the said mortgage to be by said Golden State Asparagus Company assigned to the said E. H. Nielsen Company, a corporation, and the said Goetjen & Metson, a corporation, in proportion to their said respective interests of sixty and forty per cent therein.
*227 The contract further provides that, as soon as the aforesaid dividend has been declared and paid so as to reduce the assets of the Asparagus Company to $200,000 in cash in its treasury, its shareholders will sell their shares, comprising the entire issued shares, to Herbert P. Chan for $200,000 in cash; that the shares and the last mentioned $200,000 in cash to be placed in escrow, and, after substitution of new directors by the Canning Company, the escrow agent shall cause the shares to be transferred on the books of the Asparagus Company and delivered to Herbert P. Chan or his nominees, and shall pay over to the Nielsen Company and the Goetjen & Metson Company the said $200,000 cash in the proportions of 60 and 40 per cent, respectively. The contract further provides that all debts of the Asparagus Company existing on January 1, 1920 (except a few specifically mentioned), and its income tax for 1919, shall be paid*1353 by the Asparagus Company or its shareholders, without drawing upon or reducing the $200,000 remaining in its treasury after the declaration of the dividend.
Paragraph XVI of the contract is as follows:
It is understood that when the sale and purchase of said real and personal property * * * has been consummated, and the said dividend * * * has been declared and paid * * *, and all of the stock * * * has been sold to and purchased by the said Herbert P. Chan, * * * it is the intention of the said Thomas Nom, as the representative of the Western Canning Company, to then resell and reconvey all of the said real and personal property back to the Golden State Asparagus Company, subject to said mortgage hereinbefore mentioned, for a cash consideration of two hundred thousand dollars ($200,000.00).
The Nielsen Company and the Goetjen & Metson Company, the proposed holders of the mortgage, expressly consented to such sale and conveyance.
The board of directors of each corporation ratified the execution by the corporate officers of the aforesaid contract of January 13, 1920, and early in April, 1920, the directors of each corporation authorized its officers to execute the instruments*1354 and perform the acts necessary to carry the contract into effect. Pursuant to the contract, the Asparagus Company, with the approval of its shareholders, conveyed its property to Thomas Nom by deed of real property, a bill of sale of personal property, and an assignment of leasehold, all dated April 15, 1920. Two hundred and thirty thousand dollars (of which $30,000 was commission) was paid to the Asparagus Company. Thomas Nom and his wife executed to the Asparagus Company a mortgage of the property so conveyed, transferred and assigned, as security for the payment of twenty concurrently executed joint and several promissory notes of Thomas Nom, Chin Hing, and the Canning Company, payable to the Asparagus Company, and aggregating the total principal sum of $400,000.
*228 On April 17, 1920, the directors of the Asparagus Company passed a resolution providing:
* * * that a dividend be and is hereby declared of all of its assets and property of any and every kind over and above and excepting the sum of two hundred thousand dollars ($200,000) in cash, being the total amount of its subscribed and issued capital stock, which said sum of two hundred thousand dollars ($200,000) *1355 in cash shall remain in the treasury of said corporation and shall be the only property of said corporation remaining after the declaring and payment and delivery of this dividend.
The resolution further provided for the transfer and delivery of the money and other property constituting the dividend to the Nielsen and Goetjen companies in the proportions of 60 and 40 per cent, respectively, and authorized the execution and delivery of all assignments, transfers and other instruments necessary to pay and transfer the money and property covered by said dividend.
On the same day the Asparagus Company executed a general transfer and assignment of all of its property and assets in excess of $200,000 in cash to the Nielsen and Goetjen companies, in the proportions designated in the resolution, and, by separate instrument, assigned the mortgage and the notes secured thereby in the same proportions, ten of the notes in the aggregate sum of $240,000 being assigned to the Nielsen Company, and ten in the aggregate sum of $160,000 to the Goetjen Company.
The cash, Liberty bonds, war savings stamps and accounts receivable, which were included in the aforesaid dividend, were, on April 17, 1920, transferred*1356 by the Nielsen and Goetjen companies to E. H. Nielsen, as trustee for the shareholders of the Asparagus Company, to be used as a fund for settling obligations of that company and expenses incurred in the sale which, under the contract of January 13, 1920, were to be paid by its shareholders.
In April, 1920, the Asparagus Company had outstanding 2,000 shares of the par value of $100 per share. The Nielsen and Goetjen companies transferred to Thomas Nom 1,995 shares of the Asparagus Company, and on April 17, 1920, a certificate for those shares was issued to him and the remaining five shares held in the names of certain individuals were transferred by them and certificates were issued to other individuals interested in the Canning Company. On April 18, 1920, Thomas Nom transferred the 1,995 shares to the Canning Company. Pursuant to the contract of January 13, 1920, the amount of $200,000 in cash was paid to the shareholders of the Asparagus Company in 1920 in payment of the purchase price of their shares. The Nielsen Company received as its portion of this payment $120,000 in cash for its 1,200 shares, and the Goetjen Company received as its portion $80,000 in cash for its 800*1357 shares.
*229 During the year 1920, $25,000 was paid on the mortgage notes, and no payments of interest or principal were made after June 30, 1920. On January 24, 1921, the Canning Company agreed in writing to transfer all of the shares, except one qualifying share, to the Nielsen and Goetjen companies, on condition that the latter would cause the Asparagus Company to issue $325,000 of bonds and from the proceeds discharge the mortgage, and would operate the business for five years and permit the Canning Company to repurchase the shares on specified terms and conditions. On the same day the five individuals who held one share each of the stock of the Asparagus Company transferred their shares to other individuals interested in the petitioner corporations, and on the next day, January 25, 1921, the Canning Company transferred 1,197 shares to the Nielsen Company and 798 shares to the Goetjen Company. At that time, as well as in April 1920, the total outstanding shares of the Asparagus Company were 2,000 shares of the par value of $100 per share. The proposed bond issue could not be negotiated, and, on April 23, 1921, the Canning Company, with the approval of its directors*1358 and shareholders, assigned and transferred all its right, title and interest in all of the shares of the Asparagus Company to the Nielsen and Goetjen companies in the proportions of 60 and 40 per cent, respectively, in consideration of the payment of $5,000, the cancellation and release of the unpaid mortgage notes for $375,000 and accrued interest at the time of execution and delivery of the instrument of assignment, and the further payment of $12,500 within 15 days after such execution and delivery. The amount of $17,500 was paid pursuant to this agreement by the Nielsen and Goetjen companies.
On April 23, 1921, the Canning Company agreed in writing to assume all debts of the Asparagus Company incurred during its operation of the business prior to January 1, 1921; and it also executed a quitclaim deed and assignments, releasing and transferring to the Asparagus Company the real and personal property conveyed by the latter to Thomas Nom in April, 1920. On the same date Thomas Nom executed a bill of sale and assignment transferring to the Asparagus Company such personal property, and the Nielsen and Goetjen companies as assignees of the mortgage, executed a release of the mortgage*1359 and the indebtedness thereby secured. The notes were cancelled. On April 25, 1921, the Asparagus Company and the Nielsen and Goetjen companies executed a release to the Canning Company, Thomas Nom, Chin Hing and Herbert P. Chan of all liability in connection with the mortgage and notes, the operation of the Asparagus Company, the holding of its shares and its real and personal property, saving and excepting only outstanding debts of *230 the Asparagus Company incurred during the operation of its business by the Canning Company prior to January 1, 1921.
In the period during which the Canning Company operated the business of the Asparagus Company, the ranches, operating properties and factory were not properly maintained, and at the time they were reconveyed to the Asparagus Company it was estimated that it would cost about $100,000 to restore them to the condition in which they were at the time of the original transfer.
The respondent determined that the Neilsen and Goetjen companies received their pro rata share of the mortgage notes as part of the purchase price of the shares of the Asparagus Company, and that the total purchase price was $630,000 less a commission*1360 of $30,000, or $300 per share; that the value of the shares as of March 1, 1913, was $208.25 per share; and that the shareholders realized a profit per share of the difference between these amounts, and that the total profits of the Nielsen and Goetjen companies were $110,100 and $73,400, respectively. The deficiencies determined by the respondent against the Goetjen & Metson Company and G.M. and S. Company are their proportionate parts of the additional tax resulting from the inclusion of the profit of the Goetjen & Metson Company in the consolidated income of those companies.
OPINION.
STERNHAGEN: The petitioners prior to April, 1920, were the shareholders of the Golden State Asparagus Company. On April 17, 1920, they, in performance of a contract of January 13, 1920, sold their shares to the agent of the Western Canning Company for the stated price of $200,000. They so treated the transaction on their 1920 income-tax returns and deducted the resulting loss. The respondent has now determined that the price received by petitioners was not only the stated purchase price, but also included mortgage notes aggregating $400,000, which petitioners have treated as a dividend received*1361 by them from the Asparagus Company. Respondent defends his determination on the theory that by virtue of a single plan reflected in the contract of January 13, 1920, it was intended only that petitioners should transfer their shares to the Canning Company and receive instead cash and mortgage notes.
The determination, in our opinion, can not be sustained. It requires too wide a departure from accepted legal doctrines and would override plain provisions of the tax law, so as to assess a tax beyond that imposed by Congress.
The plan is found in the contract of January 13, 1920, and the evidence leaves no doubt that it was performed in strict accordance with its terms. The recital is drawn with less artistic accuracy *231 perhaps than the operative provisions, but it is fairly clear that more was contemplated than the sale and purchase of shares; and in so far as this may be doubtfully expressed, the doubt is immediately removed by the detailed transaction set forth in the integration. A doubt in the recital would not serve to take from any of the enumerated transactions their legal character. "Whatever may be said of the recitals in the contract under consideration, *1362 the operative part is clear, and must therefore prevail under the rule adopted." ; . "What was done rather than the design and purpose of the participants should be the test." .
By the operative provisions of the contract, the Asparagus Company agreed to sell and the Canning Company to but the business and most of the assets for $230,000 in cash and $400,000 in periodic promissory notes secured by a mortgage on the property; the Asparagus Company agreed to declare and distribute a dividend of its entire surplus, which would include the mortgage notes; and the shareholders agreed to sell and the Canning Company to buy all the shares at par, which, as a result of the dividend, coincided with actual and book value. There were provisions for subsequent steps whereby the Canning Company was to reconvey to the Asparagus Company so that the business would be continuously carried on by the Asparagus Company, but this did not affect the shareholders. The transactions thus clearly provided for were precisely carried out, and the legal integrity of each*1363 step is cleary sustained by the evidence. The assets were in fact conveyed by the Asparagus Company and the cash and notes in the amount of $630,000 received, the dividend was properly declared and actually distributed, consisting of all the Asparagus Company's assets above $200,000, and the shares were delivered by the shareholders to the Canning Company, and the $200,000 cash received by them. Thus in form, in fact, and in legal substance what these petitioners received were two separate and necessarily distinct things from two different sources by virtue of two different transactions with two different people - one, a dividend from the Asparagus Company payable to them only while and because they were shareholders, and the other, the purchase price from the Canning Company for these very shares. Whatever the effect of these events may be upon the petitioner's taxes (or, for that matter, upon the taxes of any other party to these transactions), this is what happened and what in law must be recognized.
It has too often been held that a corporation is legally distinct from its shareholders, and that in the absence of fraud or unfairness their separate acts are not to be confused*1364 with each other, to admit of the disregard here of the intervening transactions. ; ; *232 ; . To sustain the respondent would logically require ignoring the true gain or loss to the Asparagus Company from its sale of its assets. Furthermore, it would confuse the separate costs to the Canning Company of the assets and of the shares, for if the shareholders are to be treated as receiving for their shares not only the $200,000 price which they did receive, but also the $400,000 of the $630,000 paid to the Asparagus Company, then the Canning Company must by cognate reasoning be treated as paying $600,000 to petitioners for the shares and $230,000 to the Asparagus Company for the assets. Furthermore, since the dividend of the Asparagus Company was of all its surplus and this, as shown by the findings, included not only the mortgage notes, but also the cash on hand, bonds of $26,000, and receivables, to say nothing of*1365 the withholding of the $200,000 capital, the respondent's idea would require more than Procrustean treatment.
It may be added too that in California as elsewhere, the shareholders could not convey title to the corporate assets, ; Phelan v. all , and to ignore the sale by the Asparagus Company would be to take from the transaction the very element which gives it force. ; .
For the respondent, it is suggested that, even if the petitioners are to be regarded as receiving the mortgage notes from the Asparagus Company, such distribution was in liquidation and hence not tax free as a dividend, sec. 234(a)(6), but taxable as a gain under section 201(c), citing . This suggestion, which counsel does not expound, can be readily dismissed, since the evidence lends no support to a finding of liquidation, but clearly establishes that the Asparagus Company was expected to and did continue as a going concern.
It must not be forgotten that*1366 Congress has not left this situation to be dealt with by judicial construction of doubtful language. It is squarely and outspokenly dealt with in the Revenue Act of 1918. Dividends of incorporated shareholders are by section 234(a)(6) called deductions and thus serve to reduce taxable net income, the purpose obviously being to avoid taxing the same income more than once in the course of consecutive corporate ownership. Gain or loss from sale is covered by section 202. It is not the rpovince of judicial determination to override this clear statutory scheme, and, by disregarding the legal substance expressly contemplated by the statute, find a greater tax than Congress has imposed. From this record we are not in position to say how the tax revenue from *233 the transactions in their entirely works out, but the fact that these petitioners may be free from tax at the time and point of their contact with the plan is because the method which the parties chose has been by Congress given this effect. The Commissioner has no rightful power to deprive them of it directly or to distort the legal significance of their proper conduct to bring about such deprivation.
Since we thus*1367 decide that the theory applied by the Commissioner is basically incorrect, it is unnecessary to consider whether the notes when received as a dividend had a fair market value and, if so, how much, and it is also unnecessary to consider the fair market value on March 1, 1913, of the Asparagus Company's properties, since the value of the shares acquired prior to that date seems to have been regarded by both parties as higher than prior cost. In respect of the shares acquired by petitioners after that date, the cost is of course the basis of gain or loss.
Reviewed by the Board.
Judgment will be entered under Rule 50.
SMITH: dissenting: The prevailing opinion places undue emphasis upon the steps and forms adopted to effectuate the intent of the parties at interest in the transaction before us, those parties being the Nielsen, Goetjen & Metson, and Canning companies - individuals mentioned were merely the nominees or representatives of these companies. The intent of the parties is clearly expressed in the original contract, to wit, that the stockholders of the Asparagus Company "desire to sell" and the Canning Company "desires to buy" from them all of their*1368 interest in the Asparagus Company "at the total purchase price of $630,000.00, payable $230,000.00 in cash and the balance of $400,000.00 in promissory notes secured by mortgage upon the property" of the Asparagus Company. In order to provide the security mentioned, the Nielsen and Goetjen & Metson companies (owning 100 per cent of the stock of the Asparagus Company) caused the Asparagus Company to convey its assets to a nominee of the Canning Company, who then executed the mortgage to provide the security for the notes of the Canning Company. The legal forms used to accomplish the desired result did not change the substance of the transaction, which is controlling here, unless each step, although comprehended by the original plan, is nevertheless, for tax purposes, distinguishable and separable from the whole transaction (cf. J. D. Bigger,19 B.T.A. 797">19 B.T.A. 797); but, as we said in George G. Moore,19 B.T.A. 364">19 B.T.A. 364, 370, 371:
* * * Where a general purpose is carried out by a series of separate contracts such as those here involved, all interdependent and all intended *234 to effect a definite result understood and agreed upon before any one of the*1369 several obligations is assumed, the realization of taxable income by one of the individual parties is determined by the result to him of the several transactions. Cf. ; ; .
* * *
* * * these several related transactions were in effect one transaction and the methods used or forms adopted to effect the result agreed upon were not material, the taxability of this petitioner being determined not by the form, but by the result. Cf. ; ; ; . * * *
In the taxable year before us, the Nielsen and Goetjen & Metson companies received, net, $200,000 cash upon the sale of their interests (which was nothing more than their stock) in the Asparagus Company, and a lien upon the property of the Asparagus Company for the balance of the net purchase price of $600,000. Upon default of the*1370 purchaser in 1921, the parties were placed in Status quo, which the prevailing opinion indicates was accomplished by the Nielsen and Goetjen & Metson companies paying $17,500 and "the cancellation and release of the unpaid mortgage notes." From a consideration of the expressed intent of the parties, the various interrelated contracts, the result accomplished in 1920, and the default and reconveyance in 1921, I am satisfied that the transaction was in truth and substance a sale of the stock for a net consideration of $600,000 upon which the Nielsen and Goetjen & Metson companies realized a gain, and not for a net consideration of $200,000 upon which the prevailing opinion allows them a loss. See ; ; ; ; ; . Cf. *1371 ; ; .