*215 Decisions will be entered under Rule 50.
Pursuant to proper corporate authority, the X corporation made payment of dividends to its stockholders, including petitioners. This was done pursuant to a plan by which X was to acquire all of its own stock with the exception of that owned by petitioners. Petitioners deposited these payments in their bank accounts and the following day returned the amount of these payments to X. This they did pursuant to an understanding with a finance company which had advanced money to X with which the plan referred to could be carried out. Held, petitioners thereby received taxable dividends.
*871 Respondent determined a deficiency in the income tax of petitioner Edgar M. Soreng for the year 1940 in the sum of $ 1,213.89, and of petitioner Mary Soreng for the year 1940 in the sum of $ 237.75. That part of these deficiencies is in issue here which arises from respondent's determination that petitioners received during the taxable year dividends from the Soreng-Manegold Co.
FINDINGS OF FACT.
A stipulation of facts has been filed by the parties and we find those facts to be as stipulated. They may be summarized as follows:
Petitioners, husband and wife, filed their income tax returns for the year 1940 with the collector of internal revenue at Chicago, Illinois. They are owners of common stock of the Soreng-Manegold Co., an Illinois corporation with offices in Chicago, engaged in the manufacture and sale of electrical appliances. As of January 22, 1940, Frank W. Manegold was its president, petitioner Edgar M. Soreng was its vice president and general manager, and Mary F. Farrell was its secretary. All three were*217 directors.
The stock of the Soreng-Manegold Co., on January 22, 1940, was held as follows:
| Shares | Shares | |
| common | preferred | |
| Frank W. Manegold, Greenville, Del | 4,074 1/4 | 350 |
| Mina Manegold, Greenville, Del | 850 | |
| Molly A. Manegold, Greenville, Del | 200 | |
| Alice R. Manegold, Greenville, Del | 200 | |
| Richard F. Manegold, Greenville, Del | 200 | |
| Roy M. Hood, Detroit, Mich | 401 | |
| 5,925 1/4 | ||
| Edgar M. Soreng, Skokie, Ill | 1,645 3/4 | |
| Mary Soreng, Skokie, Ill | 665 | |
| Total | 8,236 | 350 |
Under date of January 15, 1940, Soreng-Manegold Co. obtained options from all the above members of the Manegold family and from Roy M. Hood to acquire their preferred shares at $ 100 per share and their common shares at $ 8 per share. The options expired at 5 p. m. on January 26, 1940. None of the options could be exercised unless all were exercised.
*872 The deficit of the Soreng-Manegold Co. for income tax purposes as of December 31, 1939, was $ 1,335.14. The paid-in surplus as of December 31, 1939, was $ 45,667.68, according to the books of the company.
The Soreng-Manegold Co. filed its corporation income tax return and its excess profits tax return for the calendar *218 year 1940 with the collector of internal revenue at Chicago, Illinois. Its correct net income for 1940 was $ 71,953.51. The income and defense tax of the corporation for 1940 totaled $ 17,268.85, and its excess profits tax totaled $ 9,206.22. Its earnings for 1940 available for dividends totaled $ 45,478.44. In 1940 it paid dividends of $ 434 on its preferred stock. The 1940 earnings of the corporation available for dividends on common stock totaled $ 45,044.44. A dividend of $ 1 per share, aggregating $ 2,410.75, was paid on common shares on August 5, 1940.
A special meeting of the Soreng-Manegold Co. was held on January 22, 1940. The minutes of that meeting read in part as follows:
The President then announced that the officers of the corporation deemed it advisable to redeem 290 of the 350 preferred shares of the corporation held by Frank W. Manegold, at the redemption price of $ 105 per share, to pay a liquidating dividend in cash out of paid-in surplus, of $ 5.35 per share on all common stock of the corporation, to common stockholders of record as of January 22, 1940, to acquire the 5,925 1/4 shares of common stock of the corporation now held by Frank W. Manegold, Molly*219 A. Manegold, Mina Manegold, Alice R. Manegold, Richard F. Manegold and Roy M. Hood, to procure cash from Walter E. Heller & Company, of Chicago, Illinois, to authorize the execution and delivery of all instruments necessary in connection with the procurance of such cash, and to call a special meeting of the stockholders of the corporation to approve the payment of said liquidating dividend and to approve the sale of accounts receivable and the execution and delivery of a chattel mortgage to said Walter E. Heller & Company.
Thereupon, upon motion duly made, seconded and unanimously carried, the following resolutions were adopted:
Be it Resolved, that 290 of the 350 preferred shares of the corporation now issued and outstanding in the name of Frank W. Manegold be redeemed at the redemption price of $ 105.00 per share, which said 290 preferred shares shall, after the redemption thereof, be held by the corporation as treasury stock, and the officers of the corporation are hereby authorized and directed to do all things necessary in connection with said redemption; and
Be it Further Resolved, that it be recommended to the stockholders of the corporation that a liquidating dividend of $ *220 5.35 per share be paid in cash out of paid-in surplus on all common stock of the corporation, said liquidating dividend to be paid to common stockholders of record as of January 22, 1940, and the President of the corporation is hereby authorized and directed to call a special meeting of the stockholders of the corporation for the purpose of submitting the question of the payment of said liquidating dividend to the stockholders of the corporation; and
Be it further resolved, that the 5,925 1/4 shares of common stock of the corporation issued and outstanding in the names of the following persons, be purchased *873 by the corporation for a total purchase price of $ 13,189.26, and that said stock after the acquisition thereof be held by the corporation as treasury stock:
| Frank W. Manegold | 4,074 1/4 |
| Molly A. Manegold | 200 |
| Mina Manegold | 850 |
| Alice R. Manegold | 200 |
| Richard F. Manegold | 200 |
and that the 401 shares of common stock of the corporation issued and outstanding in the name of Roy M. Hood be purchased by the corporation for a total price of $ 1,062.65, and that said stock after the acquisition thereof be held by the corporation as treasury stock; * *221 * *
The directors also authorized the sale of accounts receivable to Walter E. Heller & Co., and the borrowing of $ 15,825 from that company.
On the same date a special meeting of the shareholders of the Soreng-Manegold Co. was held. The minutes of that meeting read in part as follows:
The President then announced that the meeting had been called pursuant to a resolution adopted by the Board of Directors at a special meeting held on Monday, January 22, 1940, at which meeting the Board of Directors (a) recommended the payment of a liquidating dividend, in cash, of $ 5.35 per share on all common stock of the corporation now issued and outstanding, said liquidating dividend to be paid out of paid-in surplus, and (b) authorized the redemption by the corporation of 290 of the 350 shares of preferred stock of the corporation now held by Frank W. Manegold, for $ 105.00 per share, and of the acquisition by the corporation of all or any portion of 5,925 1/4 shares of common stock of the corporation now held by various shareholders for $ 14,251.91.
The President further announced that the corporation did not have sufficient cash on hand for the purposes specified above, and that it would, *222 therefore, be necessary to obtain additional cash from Walter E. Heller & Company, and to transfer, sell and assign all or a part of the accounts receivable of the corporation to Walter E. Heller & Company, and to execute and deliver a chattel mortgage on the plant, tools, equipment and fixtures of every kind and description of the corporation to Walter E. Heller & Company for the purpose of securing such cash.
Thereupon, upon motion duly made, seconded and unanimously carried, the following resolutions were adopted:
Be it Resolved, that the officers of the corporation be and they hereby are authorized to pay a liquidating dividend, in cash, of $ 5.35 per share on all shares of common stock of the corporation to all owners of such common stock of record as of January 22, 1940, which such liquidating dividend shall be paid out of paid-in surplus of the corporation pursuant to the terms and provisions of Section 60 of the Business Corporation Act of Illinois; and * * *
The stockholders also authorized the sale of accounts receivable to Walter E. Heller & Co. and the borrowing from that company of $ 15,825.
The actions of the directors and stockholders were by unanimous vote.
*874 *223 On January 26, 1940, the Soreng-Manegold Co. made dividend payments in accordance with the resolutions enacted at the said meetings with respect to its common stock equal to $ 5.35 per share. The dividend was disbursed by checks delivered in the office of Glore, Forgan & Co. All dividend checks, except those in favor of petitioners, were made payable to the order of Glore, Forgan & Co., and each was identified for the particular person for whose benefit the checks were issued on the reverse side thereof. Dividend checks were issued payable to the order of Mary Soreng for $ 3,557.75 and to Edgar M. Soreng for $ 8,804.75.
On January 26, 1940, a check was made payable by the Soreng-Manegold Co. to the order of Glore, Forgan & Co. in the sum of $ 30,450. On the reverse side of this check notation as follows is contained: "Redemption of 105 of 290 Prfd. shrs. of Frank W. Manegold." Also delivered to Glore, Forgan & Co. on January 26, 1940, were checks of private individuals aggregating $ 6,000, for the purchase of 60 preferred shares, at $ 100 per share, owned by Frank W. Manegold.
On January 26, 1940, there were also delivered checks of the Soreng-Manegold Co. for the purchase of *224 its common shares held by all stockholders except Edgar and Mary Soreng. All of these checks were made payable to Glore, Forgan & Co. and were identified on the reverse side thereof as the purchase price of common stock held by the various stockholders.
On January 26, 1940, after the completion of the payments described above, certificates, endorsed in blank, evidencing all the preferred and common shares of the Manegold family and Roy M. Hood were delivered through Glore, Forgan & Co. to Soreng-Manegold Co. Thereafter 60 shares were transferred on the stock records of the company to the private individuals purchasing the preferred stock. After these stock transactions were completed, there were 60 shares of preferred and 2,310 3/4 (being the shares owned by Edgar and Mary Soreng) shares of common stock issued and outstanding, the remaining shares thus acquired from the Manegold family and Roy M. Hood being held in the treasury of the company.
The $ 5 per share premium on the redemption of the 290 preferred shares and the dividend of $ 5.35 per share on the common shares were debited against paid-in surplus on the books of Soreng-Manegold Co. Of the amount of the checks of the *225 Soreng-Manegold Co. issued in purchase of the common stock, $ 8,326.66 was debited against surplus on the books of the company.
The dividend checks of January 26, 1940, payable to Edgar M. Soreng in the sum of $ 8,804.75 and Mary Soreng in the sum of $ 3,557.75, were deposited by them in their respective personal bank accounts. Each of them issued his own personal check, dated January 27, 1940, for the respective amounts received by them as dividends, *875 payable to the Soreng-Manegold Co. The Soreng-Manegold Co. deposited these checks in its bank account on January 30, 1940. The Soreng-Manegold Co. credited to its donated surplus the cash shown above as received from petitioners, and debited its cash account in a like amount.
The petitioners issued their personal checks dated January 27, 1940, for the respective amounts received by them as dividends to the Soreng-Manegold Co. in accordance with a prior understanding between petitioners and Walter E. Heller & Co.Walter E. Heller & Co. wanted to be satisfied that the cash position of the Soreng-Manegold Co. would not be impaired with respect to its future ability to repay the loan made to it.
Accounts receivable of $ 34,463*226 of the Soreng-Manegold Co. were sold to Walter E. Heller & Co., for which $ 31,016.70 cash was received on January 26, 1940, and a chattel mortgage loan was obtained by the company from Walter E. Heller & Co., the note being dated January 26, 1940, in the face amount of $ 15,825. The Soreng-Manegold Co. received a check from Walter E. Heller & Co. in the amount of $ 15,000 on January 26, 1940, pursuant to said loan.
On January 26, 1940, prior to the issuance by it of the checks described above, the Soreng-Manegold Co. had a cash balance of $ 46,191.64. The company received from Walter E. Heller & Co. on that day $ 31,016.70 from the sale of its accounts receivable and $ 15,000 from the chattel mortgage loan. The total cash of the company was, therefore, $ 92,208.34. After paying the checks, dated January 26, 1940, and an appraisal fee to Walter E. Heller & Co. of $ 100, the balance of the company's cash on hand was $ 3,343.84, exclusive of the amounts received from petitioners and deposited January 30, 1940.
From oral testimony we find as follows:
The procedure outlined above and set out in detail in the stipulation was adopted by the parties to the transaction because of the *227 advice given by counsel for the Soreng-Manegold Co. and counsel for Walter E. Heller & Co. to the effect that a direct lump sum payment by the Soreng-Manegold Co. for the stock held by the Manegold family and by Hood would result in a violation of section 6 of the Illinois Business Corporation Act, forbidding the purchase by a corporation of its own stock "when its net assets are less than the sum of its stated capital, its paid-in surplus, any surplus arising from unrealized appreciation in value or revaluation of its assets and any surplus arising from surrender to the corporation of any of its shares, or when, by so doing, its net assets would be reduced below such sum."
OPINION.
The sole question presented in this proceeding is whether the amounts of $ 8,804.75 and $ 3,557.75; or any part thereof, *876 received by petitioners from the Soreng-Manegold Co. on January 26, 1940, were dividends as defined by section 115 (a) of the Internal Revenue Code, 1 and therefore are taxable income to petitioners pursuant to section 22 (a).
*228 Petitioners contend that the so-called dividends were paid to them by the Soreng-Manegold Co. only as an unavoidable legal step in its exercise of the option to purchase the Manegold and Hood stock, the company being prevented from making a lump sum payment of the option price by its lack of cash and the provisions of the Illinois Business Corporation Act; that petitioners had surrendered and waived all of their rights to the dividend before it was paid because of their understanding with Walter E. Heller & Co., by reason of which they returned to the Soreng-Manegold Co. the amount of the dividend the next day after it was paid to them; and that therefore the so-called dividend was not "a distribution made by a corporation to its shareholders * * * out of the earnings or profits of the taxable year * * *" and, as such, taxable income.
The respondent, on the other hand, points out that the distribution in question was not a liquidating dividend, since it was not paid by the corporation in complete cancellation or redemption of a pair of its common stock; that it was paid (at least to the extent of over 96%) out of earnings and profits for the taxable year; that it falls literally within*229 the definition of a dividend given in section 115 (a); and that petitioners received it and were enriched thereby in that they came out of the transaction owning all the outstanding stock of the corporation. Furthermore, respondent contends, if the payment and receipt of the dividend distribution was intended by the corporation and petitioners to be merely a sham in order to circumvent the Illinois law, "the government may look at actualities and upon determination that the form employed for * * * carrying out the challenged tax event is unreal or a sham may sustain or disregard the effect of the fiction as best serves the purpose of the tax statute." ( Higgins v. Smith, 308 U.S. 473">308 U.S. 473).
Neither party has cited any cases directly in point, but both refer to cases involving the question of whether, under certain circumstances, a corporation is entitled to a dividend paid credit under section 27 (a) of the Revenue Act of 1936. Royal Manufacturing Co. v. Commissioner, *877 139 Fed. (2d) 958; Pacific Grape Products Co., 42 B. T. A. 914.
In the latter case almost all of the stockholders, *230 by agreement with the directors and other stockholders, endorsed their dividend checks back to the corporation before the date borne by the checks. In the first case the stockholders agreed that the corporation should have the power to endorse the dividend checks in their names and deposit them in the corporation's account, and this was done. In both cases it was held that the corporation was not entitled to a dividends paid credit because the dividend checks were never received by the stockholders or were endorsed back by them before the date fixed for the payment of the checks. Petitioners argue that those cases are analogous to the instant cases, and if the "dividends" in them were not considered as paid by the corporation, it would follow that in the instant cases they should not be considered as received by stockholders.
In the Pacific Grape Products Co. case, supra, a small percentage of the stockholders did not endorse their dividend checks back to the corporation until after the date upon which they became payable. For a short time they held the checks after the checks might have been paid, subject only to an understanding that they would be endorsed and returned*231 to the corporation. As to these checks we held that the corporation was entitled to a dividends paid credit.
It would follow in the instant cases that the petitioners should be considered as having received the dividends in question.
The rule given in the Royal Manufacturing Co. case is that, in order for a dividend to be considered as having been paid, "the control of property distributed by way of a dividend must have passed absolutely and irrevocably from the distributing corporation to its stockholders."
If, as in that case, the "dividend" checks are never delivered to the stockholders but are deposited by the corporation in its own bank account, it is obvious that the corporation has never parted with control over the property distributed by way of dividend. If the corporation actually delivers the dividend checks to the stockholders at a time when they may be cashed (see Pacific Grape Products Co., supra), but the stockholders are under obligation to the corporation or to each other as stockholders to return the checks or an amount equivalent to the corporation, our holding in Pacific Grape Products Co. would indicate that a dividend *232 has thereby been paid, and the logical inference is that a dividend has been received by the stockholders. If, as in the instant cases, dividend checks are issued by the corporation to stockholders who deposit them in their own bank accounts and the only restriction upon the stockholders is an understanding, not with the corporation or with other stockholders, but with a creditor of the issuing corporation, that the amount of the dividend will be returned *878 to the corporation, we are of the opinion that a dividend has been both paid and received within the meaning of the revenue acts. Another fact which persuades us to this view in the instant cases is that the petitioners, at the time of the return by them of the amount distributed by way of dividend, were the owners of all the common stock of the corporation and had become the sole owners of this stock by reason of the transaction in question.
We decide the issue presented in favor of respondent.
Decisions will be entered under Rule 50.
Footnotes
1. SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
(a) Definition of Dividends. -- The term "dividends" when used in this chapter (except in section 203 (a) (3) and section 207 (c) (1), relating to insurance companies) means any distribution made by a corporation to its shareholders, whether in money or in other property, (1) out of its earnings or profits accumulated after February 28, 1913, or (2) out of the earnings or profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made.↩