*1109 1. Where a stockholder, on behalf of the corporation, received payments due upon sales of real estate, paid therefrom operating expenses of the company and retained the balance, and was charged with such funds upon the corporate records as an account receivable from him until offset by dividends later declared, held, such amounts were not income to stockholder in the years when received and retained.
2. Where a corporation has completed the development and sale of certain real property, for which purpose it was organized, and is continued only to collect installments, execute deeds, and other acts incident to completing sales contracts, and its sole stockholder manifests an intention to liquidate and proceed to wind up the company's affairs without engaging in new or current business, held that dividends declared during that period and resulting in impairment of the company's capital were in partial liquidation of the corporation.
*162 In this proceeding petitioner assails an asserted deficiency of $1,416.29 for*1110 the year 1925, claiming that he has already overpaid his income tax liability for that year by $3,657.13.
It is alleged that respondent erred in refusing to treat as liquidating dividends amounts distributed by the Lakemont Company and to tax the excess thereof over the cost of petitioner's stock as capital net gain, in accordance with petitioner's election. Upon brief, petitioner urges further that respondent erred in his determination of the amount of such distributions received by petitioner in 1925, claiming that amounts he received on behalf of the corporation, and retained, in years prior to 1925, should be regarded as distributions to him in those years when received, with the result that the amount distributed to him in 1925 would be but $28,333.50.
FINDINGS OF FACT.
Fred T. Wood is a resident of Oakland, California, and has been engaged in the real estate business in that city for many years. From 1920 to 1923 he and R. B. Ayer conducted a real estate business as partners under the firm name of Fred T. Wood Company. In 1923 the petitioner purchased Ayer's interest therein and thereafter conducted the business as an individual. The Fred T. Wood Company carried*1111 on a real estate brokerage business and also acted as *163 the selling agent for numerous subdivisions developed and promoted by others. It had a force of about 100 salesmen.
In 1920 the petitioner obtained an option on a tract of land called Lakemont. He then formed a corporation, the Lakemont Company, for the express purpose of buying, developing, promoting and selling the property as a subdivision. The charter powers of the corporation were quite broad. The option was assigned to the Lakemont Company, which purchased the land at a cost of $199,700 and proceeded with its development. No other land or property was ever acquired by the Lakemont Company. The outstanding capital stock consisted of 475 shares of the par value of $100 each. Originally Ayer and others owned stock in the company, but by May 15, 1923, the petitioner had acquired all the capital stock thereof, at a cost of $60,841.53.
The Lakemont Company graded, developed and subdivided the property into 148 lots and sold them, usually on the installment basis for 20 per cent in cash and the remainder in installments of 1 per cent a month, plus interest. The purchase contracts were subject to discount*1112 for cash, collection commissions and other charges.
Lot sales and collections thereon were as follows:
| Year | Number of lots | Sale price | Collections |
| 1920 | 80 | $186,085.00 | $73,134.23 |
| 1921 | 5 | 13,532.00 | 33,709.00 |
| 1922 | 21 | 48,200.00 | 47,282.38 |
| 1923 | 28 | 56,743.50 | 62,901.72 |
| 1924 | 11 | 30,330.00 | 45,534.66 |
| 1925 | 3 | $6,490.00 | $62,045.26 |
| 1926 | 13,049.64 | ||
| 1927 | 3,532.40 | ||
| Total | 148 | 341,380.50 | 341,189.29 |
Profits of $15,341.55, $5,785.84 and $1,680.89 were realized by the Lakemont Company for the years 1925, 1926 and 1927, respectively.
The Lakemont Company did not keep a complete set of books and was conducted without regard to the usual corporate methods. The petitioner, originally for the Fred T. Wood Company and later individually, collected the installments paid on the lot-purchase contracts, paid the company's expenses, and retained the balance. The Lakemont Company never had a bank account. The amounts so collected and retained by petitioner were charged to his account on the company's books. The books show the amounts so due to it from the petitioner as follows:
| July 28, 1920 | $300.00 |
| December 31, 1920 | 4,385.28 |
| December 31, 1921 | 9,373.49 |
| December 31, 1922 | 22,547.14 |
| December 31, 1923 | $60,883.68 |
| December 31, 1924 | 61,138.60 |
| December 31, 1925 | 18,222.10 |
| December 31, 1926 | 9,574.54 |
*1113 The petitioner's account was treated as an account receivable on the Lakemont Company's books.
*164 Having sold all the lots prior to December 15, 1925, the petitioner, the president and sole stockholder of the Lakemont Company, decided to liquidate the company as quickly as it could be done. However, it was deemed desirable to continue the existence of the corporation, for there were collections to be made, covenants to be enforced, deeds to be executed, and taxes to be paid, all of which could be done more conveniently by the company than by petitioner as an individual. In February, 1926, George W. Marsden became the bookkeeper for petitioner and was instructed to liquidate the Lakemont Company as quickly as possible. He summarized the entries and figures appearing on the petitioner's books and made corresponding entries in the Lakemont Company's books for the year 1925.
During the course of its operations the Lakemont Company had been financed in part by bank loans, but on December 31, 1925, it had no indebtedness. In 1926 the company borrowed $11,000, pledging as collateral security unpaid purchase contracts valued at $15,698.81. The loan was repaid in full*1114 in 1926. During 1926 and 1927 the company also collected its outstanding purchase contract installments, executed deeds for lots, enforced restrictions contained in covenants incorporated in its deeds, received and paid interest, paid its debts and expenses, including taxes, and sold certain property to the petitioner.
On December 15, 1925, the board of directors of the Lakemont Company passed the following resolution:
On motion duly made by Fred T. Wood, seconded by W. M. Wood, and carried by unanimous vote, the following resolution was adopted:
Resolved, that a dividend at the rate of ninety Dollars ($90.00) per share, payable in cash, to the stockholders of record of December 15, 1925, be and it is hereby declared from the earnings of this corporation, said dividend to be payable December 30, 1925.
On Motion duly made by Fred T. Wood, seconded by Alex R. Schmidt, and carried by unanimous vote, the following resolution was adopted:
Resolved, that a liquidating dividend of Sixty Dollars ($60.00) per share, payable in cash, to the stockholders of record of December 15, 1925, be and it is hereby declared from any available funds of this corporation, said dividend to be*1115 payable December 30, 1925.
At this time petitioner had no other plan or purpose than to liquidate the Lakemont Company as soon as possible. Although he signed the resolution, he did not read it; did not know its contents; gave no directions concerning its preparation, and was told "it was a resolution they wanted for the purpose of liquidating the Lakemont Company."
On December 31, 1924, the petitioner's open account showed a charge of $61,138.60. The dividends declared pursuant to the above resolution, or $71,250, were credited on the petitioner's account, leaving *165 a balance of $18,222.10 on December 31, 1925. The sum of these two, $89,472.10, represents the total reflected by the books, as charged to petitioner's account on December 31, 1925, before crediting the dividends. In 1926 and 1927 subsequent dividends were treated in the same manner, resulting in the complete extinguishment of the petitioner's account on December 1, 1927. At the end of 1925, before the distribution was made, the surplus of the Lakemont Company was $50,204.18.
On September 29, 1927, the Lakemont Company passed a resolution authorizing the sale to the petitioner of two remaining deferred*1116 purchase-money contracts and also a certain triangular piece of land. On October 17, 1927, the stockholders of the Lakemont Company passed formal resolutions dissolving the corporation and on the same day its board of directors did likewise. The resolutions authorized formal application to the court for an order of dissolution. On December 31, 1927, the board of directors declared as a final liquidating dividend the sum of $4,881.70, to be paid pro rata on all stock which should be surrendered for cancellation, payable when so canceled. On December 27, 1927, the corporation was dissolved by court order.
In his income tax return for 1925 the petitioner reported the sum of $42,750 received by him as ordinary dividends from the Lakemont Company. The respondent determined that on December 30, 1925, the Lakemont Company had an earned surplus of $50,204.18 and that a corresponding portion of the dividends received by the petitioner from that company was taxable under the provisions of subdivision (a) of section 201 of the Revenue Act of 1926. The income so increased resulted in a deficiency of $1,416.29. The petitioner under date of November 6, 1928, filed an amended return in*1117 which he reported $71,250, the entire amount distributed to him under the resolution of December 15, 1925, as a distribution in liquidation.
OPINION.
GOODRICH: While the issue expressly raised by the pleadings relates to the character of the distributions received by petitioner from the Lakemont Company under the resolutions adopted by its directors on December 15, 1925, the further problem called to attention upon brief naturally arises under the issue presented and, since its determination is necessary to the ascertainment of petitioner's tax liability for the year 1925, we will consider it. Petitioner, relying mainly upon ; affd., ; certiorari denied, ; and ; affirming , contends that, because he was the sole owner of the stock of this corporation and gave to the corporation no notes representing his indebtedness *166 for the funds received by him on its behalf and by him retained in years prior to 1925, such funds should be treated as distributions made by the*1118 corporation to him in those years, without the necessity of corporate declaration, and taxable to him when received, despite the fact that the company's books of account reflected these sums as accounts receivable from petitioner.
We think those decisions are not controlling of the case at bar. There, the taxpayers had received money from the corporations without the formal declaration of dividends, and the Commissioner treated such sums as income to them when received. The taxpayers failed to convince the courts that the Commissioner's action was erroneous. Here, the Commissioner has treated the sums received by petitioner according to the facts as presented by the records of the corporation, that is, he has regarded them, not as income to petitioner when received, but as debts owing to the company. Petitioner has failed to convince us that this action is erroneous. Prior to May 15, 1923, petitioner was not the sole owner of the stock of the corporation, yet had received and withheld substantial amounts of the corporate funds. What arrangements, if any, he had made with the other stockholders respecting this matter, we do not know. This record discloses no reason why the*1119 amounts charged to petitioner should not be regarded as accounts receivable from him as reflected by the books, notwithstanding the fact that the conduct of the corporate business was exceedingly informal. The company might have undertaken a new venture - its powers were sufficiently broad - and called upon petitioner for payment; former stockholders might have demanded pro rata payment of the funds retained by petitioner; creditors of the corporation might have required repayment - such occurrences were possible during the course of the company's operation. True, book entries are not necessarily binding if proved to be in error, but, we repeat, petitioner has failed to prove to us that the corporate records reflecting the sums retained by petitioner as an account receivable from him did not disclose the facts and that such sums now should be treated as distributions and taxable to him when received.
However, we are convinced that the distributions declared by the resolution of December 15, 1925, were in liquidation of the corporation. Liquidation has been defined as the operation of winding up the affairs of a corporation by realizing upon its assets, paying its debts and appropriating*1120 the amount of its profit or loss. , and cases there cited. It differs from the normal operation of the corporation for current profit in that it ordinarily results in the winding up of the corporation's affairs. There must be a manifest intention to liquidate, a continuing purpose to terminate its affairs and dissolve the corporation, and its activities *167 must be directed and confined thereto. It contemplates an impairment of capital or a retirement of outstanding stock, though a distribution, if one of a series of distributions in liquidation, may be a liquidating dividend even if it, of itself, does not impair capital. Liquidation can not be brought about by mere declaration, and the question of whether a corporation is in liquidation is therefore one of fact. See ;; affd., ; ; affd., ; *1121 ; .
In the case before us, the facts show that the Lakemont Company was in the process of liquidation at the end of 1925. Its ordinary business had been the subdivision, development and sale of a certain tract of land. This it had accomplished - there remained to do only certain incidents necessary in installment sales and it engaged in no other activities. There was a declared intention to liquidate, manifest by the instructions given respecting compliance with the formal requisites of the distribution of the company's assets, and there was an impairment of its capital. It was engaged in winding up its affairs and was dissolved when that had been accomplished. We hold, therefore, that the distribution declared by the resolution of December 15, 1925, was one made in partial liquidation of the corporation within the meaning of paragraph (h) of section 201 of the Revenue Act of 1926; that the gain resulting to petitioner upon the receipt thereof should be determined as provided in paragraph (c) of that same section, and taxed as capital net gain in accordance with petitioner's election. *1122 Cf. .
Reviewed by the Board.
Judgment will be entered under Rule 50.
SMITH, dissenting: The respondent has treated the 1925 dividends, to the amount of the corporation's surplus at the date of the payment of the dividends ($50,204.18), as ordinary dividends under section 210(a) of the Revenue Act of 1926. The respondent followed the letter of the law in such treatment. There were no distributions in complete liquidation under section 201(d) in 1925, and none in partial liquidation as that term is defined in section 201(h), which subdivision reads:
As used in this section the term "amounts distributed in partial liquidation" means a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock.
There was clearly an intent that the dividend of $60 per share declared in 1925 should be a liquidating dividend. The petitioner recognized, however, that the dividend of $90 per share in 1925 was *168 not in partial liquidation of his stock and returned*1123 the amount as a taxable dividend in his original return. There was no actual liquidation until 1927.
VAN FOSSAN, dissenting: I find myself in disagreement with the majority of the Board in this case. The question originally raised by the parties, i.e., whether under the facts dividends credited to petitioner's account by the Lakemont Company were liquidating dividends, involves consideration of the legal effect of the prior conduct of the company's affairs under which, from 1920 to 1925, petitioner, the sole stockholder of said company, retained all moneys collected by him as selling agent, paid all expenses, and was charged on the company's books with the net amount so retained.
Petitioner contends in his brief that the sums so retained by him were tantamount in law to distributions by the corporation and became income to petitioner in the years collected by him and charged on the books of the company. He relies on ; affd., ; certiorari denied, ; *1124 ; affirming , and other cases.
As appears from the findings of fact, petitioner during and prior to the taxable year was the sole stockholder of the Lakemont Company. After 1923 he was also, in his individual capacity, its selling agent. He or his sales force made all sales, collected all money, and paid all expenses and Wood pocketed what remained. No money was ever turned in to the corporation and it had no bank account. The company kept incomplete books, but did charge to Wood's account the net amount above expenses paid retained by Wood. There is no evidence of an intention later to account or pay to the corporation. Wood gave no notes or other evidence of indebtedness to the corporation and paid no interest, and, being the sole stockholder, was in as full enjoyment and use of the funds so retained as though the usual formalities of business - payment into the corporation of funds collected, entries on the books, payment of corporate expenses, formal declaration and payment of dividends to him as a stockholder - had been strictly complied with. Were the Government here contending that*1125 the amounts so received and retained were income to petitioner in the years when received regardless of the year when formal dividends were later declared, ample authority would be found for sustaining its position. In , the court said:
In order to be dividend for the purposes of income tax, a distribution need not be called a "dividend." There need be no formal declaration. Holmes' Federal Taxes, p. 774, sec. 407. This fund constituted a portion of the earnings or profits of the Key-James Brick Company for the year 1920, and was as a matter of fact distributed to its two shareholders in that year.
*169 I cannot concur in the proposition, so plausibly advanced by able counsel, that the resolution of the board of directors of July 14, 1921, declaring a dividend and ordering a distribution, ipso facto impressed this fund with the characteristics of income for 1921. At the date of this resolution directing that "the sum of $70,805.52 be withdrawn from the surplus account and distributed to the stockholders in proportion to their shareholding," and the further direction that distribution be made to James and*1126 Key, the corporation did not have the money to withdraw or distribute. The money had the year before been withdrawn and distributed by Mr. Key.
Real facts, rather than record resolutions, give rise to income. Resolutions of directors, after all, are no more than evidential. (T.D. 2723); , 171 C.C.A. 563 (T.D. 2944); . In other words, the government is not precluded from going behind the corporation's books and assessing the tax upon the basis of actual facts. If the distribution of the money by Mr. Key in 1920 was a distribution at all, as distinguished from a loan, then it by the very terms of the act of 1918 - section 201, subsec. (a) - was conclusively presumed to be taxable for 1920, and this because it was not the policy of Congress, as pointed out in the cases of (T.D. 3420), and *1127 , to allow taxpayers by means of bookkeeping or otherwise to determine for themselves to what year such distribution should be allocated.
And in , the court observes as follows:
It is elementary that the mere declaration of a dividend does not constitute either a dividend or a distribution. Before there can be a dividend there must be a declaration of such by the proper officers and funds set aside for its payment. It then becomes the property of the stockholder to the extent that he may maintain an action against the corporation for its recovery. While there was no declaration of a dividend in this case, there was a determination of the amount of profits or earnings to which the respective stockholders were entitled. One stockholder was paid his share in cash. The shares of the others were credited to their respective accounts on the books of the corporation in such a manner as to bring the fund within the absolute and unqualified dominium and control of the stockholder. While, technically speaking, this would not amount to the declaration of a dividend, it would amount*1128 to a distribution of the assets in such manner that the theory of corporate entity is not affected or disregarded, since it is settled law that the division of profits of a corporation among its stockholders amounts to a constructive dividend whether it is intended by the directors or stockholders to constitute a dividend or not. , certiorari denied .
After commenting on the Chattanooga Savings Bank case, to which it referred with approval, the court further states:
It does not clearly appear whether the taxpayer rendered his returns on a cash or accrual basis, but we think this is not material, since the mere credit of his account with the earnings constituted an accrual. . However, according to the practice of the Department, the amounts were constructively received when credited. Under article 4, paragraph 51, Treasury Regulations 33, art. 53, it is provided as follows: "Income which is credited to the account of or set apart *170 for a taxpayer*1129 and which may be drawn upon by him at any time is subject to tax for the year during which so credited or set apart, although not then actually reduced to possession. To constitute receipt in such a case the income must be credited to the taxpayer without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made. A book entry, if made, should indicate an absolute transfer from one account to another. If the income is not credited, but is set apart, such income must be unqualifiedly subject to the demand of the taxpayer. * * * The distinction between receipt and accrual must be kept in mind. Income may accrue to the taxpayer and yet not be subject to his demand or capable of being drawn on or against by him."
Clearly, under this rule the earnings set aside in the present case must be construed as a receipt instead of an accrual, since the share of the earnings belonging to the appellant was not only placed to his credit on the books of the corporation, but was brought unqualifiedly subject to his demand. It was money available for his use as much as if it had been placed in his bank account subject to check.
*1130 See also ; .
In the instant case it does not clearly appear whether petitioner's returns are on a cash or an accrual basis, but in line with the above reasoning I deem it immaterial to this decision.
Here the parties are reversed as respects position. The taxpayer is urging the soundness of the above propositions of law and the Government has determined that the sums in the hands of the petitioner constitute income in the year in which dividends were declared, without regard for when the funds came into petitioner's hands. Such, at least, is the effect of respondent's determination.
However, the law is not fixed by the relative positions of the respective parties. It is based on principles of logic and reason. The immediate incidence of a ruling is usually of small concern. We believe the authorities cited, and others to the same effect, require a holding that formal declarations by the corporation of dividends were not necessary to the fixation of petitioner's income and that the funds collected and retained by him became income in the year when so collected. It*1131 follows that the action of the corporation in declaring dividends in any year was a futile gesture and was of no legal effect, except in so far as they applied to earnings of the current year. As to this year such declarations constitute ratification of the action of petitioner in retaining the funds, but added nothing to income already acquired by him when the funds were received and retained.
The effect in this case of the above conclusions is that for the taxable year 1925 petitioner should be held liable for tax on income received measured by the amount actually received and retained by him. There being no evidence that leads me to conclude that at the time the funds were received by Wood they were, under the above *171 principles, other than ordinary distributions of earnings, the amount received in 1925 should be taxed as an ordinary dividend. From Exhibit 10 it appears that the amount added to Wood's account in 1925 was $28,333.50. In my view of the case this amount should be taken as his taxable income for that year. The balance of the Wood account, having been received by Wood in prior years, would not be taxable in 1925.