*1199 Pro rata redemption by a corporation of a portion of its stock at a value computed upon net current earnings for the taxable year with the intention of legally distributing such earnings, thus avoiding the surtax thereon, held, essentially equivalent, on the facts, to the distribution of a taxable dividend under section 115(g) of the Revenue Act of 1936.
*1274 These consolidated proceedings involve deficiencies in income taxes determined against the respective petitioners for the year 1936 as follows: Waldo W. Wilson, $116.42; Vesper Co., $2,947.09. Certain issues raised by the pleadings have been stipulated and effect will be given thereto under Rule 50.
The sole issue submitted is whether the respondent erred in treating distributions of the West Side Buick Auto Co. (hereinafter called the *1275 West Co.) to petitioners during the taxable year as taxable dividends under section 115(g) of the Revenue Act of 1936.
FINDINGS OF FACT.
The taxpayers filed their income tax returns with the collector of internal revenue for the first district*1200 of Missouri, at St. Louis, Missouri.
The West Co. was and is a Missouri corporation. It was a dealer in Buick automobiles under a franchise or contract from the Buick Motor Co. It was organized in 1930 with a stated capital of $100,000, represented by 1,000 shares of common capital stock without nominal or par value. At January 1, 1936, stock was owned by D. E. Castles, 350 shares; Waldo W. Wilson, 200 shares; Vesper Co., 450 shares (one share of which was recorded in the name of F. W. A. Vesper).
The 450 shares owned by the Vesper Co., petitioner, had been purchased by that company in 1930 for $45,000. The 200 shares owned by Waldo W. Wilson, petitioner, had been purchased by him for $20,000 in 1930. On repeated occasions, from 1930 to 1936, the St. Louis district manager of the Buick Motor Co. had suggested to the president of the West Co. that it was over capitalized in view of the volume of business available. The dollar volume of business of West Co. for the years ended July 31 of the following years was as follows:
| 1931 | $535,107 |
| 1932 | 314,871 |
| 1933 | 346,033 |
| 1934 | 409,050 |
| 1935 | 478,491 |
| 1936 | $665,230 |
| 1937 | 724,396 |
| 1938 | 673,926 |
| 1939 | 873,452 |
| 1940 | 1,384,073 |
*1201 On or about January 1, 1936, the West Co. had a deficit of $27,395.90 in its stated capital resulting from operating losses sustained in prior years. During the first 11 months of 1936 the West Co, had net earnings of approximately $12,000 before provision for Federal or state income taxes and, on December 1, 1936, it was anticipated that the company would earn an additional sum in the month of December 1936, but that the net profits for the year would not be sufficient to eliminate the deficit which had accrued to the beginning of the year. The net income for the year ended December 31, 1936, before provision for Federal or state income taxes, was $13,462.12.
On or about December 1, 1936, the officers and stockholders of the West Co. were desirous of distributing net earnings of the corporation for 1936 in such a manner as would be legal under the laws of the State of Missouri, considering the then existing capital deficit of the company, and for which the company would be entitled to a dividends paid credit under the provisions of section 27 of the Revenue Act of 1936. Thereupon, at a special meeting of the stockholders of *1276 the West Co. on December 1, 1936, upon*1202 advice of counsel the following resolution was ruled passed:
RESOLVED that the capital stock or stated capital of the West Side Buick Auto Company be reduced from $100,000.00, divided into 1000 shares without nominal or par value, to $70,000.00, divided into 700 shares of stock without nominal or par value; that said reduction in the capital stock or stated capital of the corporation be accomplished by retiring 300 shares of the issued and outstanding stock of the corporation, the shares to be retired to be taken from the stockholders holders in proportion to their present holdings, so that in lieu of the stock now held each stockholder of the company upon surrender of his certificate of stock shall receive a new certificate for 7/10ths of the number of shares now held, and
RESOLVED FURTHER that there shall be, and is hereby, declared a liquidating dividend of $12,500.00, in full payment and exchange for the 300 shares of capital stock of the corporation to be retired as a result of the reduction in the capital stock thereof, which dividend shall be paid to the stockholders of record in proportion to their holdings of stock of this corporation, with the understanding and upon condition*1203 that the amount so paid to each stockholder shall be paid and received in full payment for the shares of stock of each stockholder retired as a result of the reduction of the capital stock of the corporation.
Thereupon, and pursuant to this resolution, the capital stock of the West Co. was reduced to $70,000, divided into 700 shares. Also pursuant thereto, on December 29, 1936, the West Co. paid $12,500 to the stockholders of record in proportion to their stockholdings in the company. Waldo W. Wilson, petitioner, then received $2,500, and the Vesper Co., petitioner, received $5,625 of this distribution. All of the then issued and outstanding certificates of stock of the West Co. were then endorsed in blank, delivered and surrendered to the company, and canceled. New certificates, representing the proportionately decreased stockholdings of all the old stockholders, were then forthwith issued to the old stockholders. The stockholdings were then as follows:
| D. E. Castles | 245 shares |
| Waldo W. Wilson | 140 shares |
| F. W. A. Vesper | 1 share |
| Vesper Co | 314 shares |
Respondent has now allowed the West Co. a dividends paid credit for the amount of this distribution in*1204 the computation of its surtax on undistributed profits, under section 27 of the Revenue Act of 1936.
After giving effect to this decrease of the capital stock of the West Co. and the distribution of $12,500, the surplus of the West Co. on December 1, 1936, was approximately $1,787.57.
OPINION.
LEECH: Petitioners contend that the distribution in 1936 was a liquidation of their canceled stock in the West Co. and that they sustained *1277 losses, respectively, measured by the difference between the cost of the stock and the payments received in its liquidation. Secs. 115(c) and (i), Revenue Act of 1936. 1 Respondent determined the present deficiency and now maintains that the contested distribution to the petitioners was taxable to them as an ordinary dividend, on the premise of fact that it occurred "at such time and in such manner as to [be] * * * essentially equivalent to the distribution" of such a dividend, under section 115(g) of the same revenue act. 2 Petitioners cite and rely particularly upon . Whether or not the facts in that case and this are effectively distinguishable, it is true that the Second*1205 Circuit in the Kelly case stated that "section 115(g) was intended to cover a situation where there is capitalization of earnings with no honest business object but merely to avoid taxes." Petitioners therefore argue that the purpose of distribution here was an honest business one and not to evade taxes. But here an admitted purpose of the distribution was to avoid the corporate surtax on undistributed profits. Sec. 14, Revenue Act of 1936.
*1206 Did the premise exist upon which the disputed tax was imposed?
In its last analysis, section 115(g), supra, itself, has been said to be as "dispositive" of this question of fact as the decisions construing that section. (on appeal, C.C.A., 9th Cir.).
*1278 The officers of the West Co. had been advised, since 1930, that their capitalization was too high. Despite this repeated advice nothing was done about its reduction until 1936. Then it was reduced although the volume of its business had consistently increased from 1932 and, in 1936, was more than double the amount of that earlier year.
However, of more significance, is the situation of the West Co. in 1936. Prior to that year the company had accumulated a capital deficit. During 1936, it enjoyed net earnings, though not in an amount sufficient to repair its deficit. Because of that situation no ordinary dividend could be paid under Missouri law, sec. 5347, Revised Statutes of Missouri 1939; ; *1207 , and if the earnings were not distributed the company would be liable for surtaxes on those undistributed profits. Sec. 14, Revenue Act of 1936; . The officers and stockholders of the West Co., upon advice of counsel, met this dilemma by declaring and paying the dividend in question. True, it was designated in the authorizing resolution as a "liquidating dividend." Stock of petitioners was delivered to the company and was canceled upon its receipt of the stock. The stated capital of the company was formally reduced in the amount of the canceled stock. But, the real reason for all this, we think, was not a belated intent to reduce capital. It was done to legalize the distribution as a liquidating dividend under Missouri law. But that characterization is not effective here. See , reversing . The alleged price per share at which the stock is said to have been liquidated is not fixed upon any basis of its value, book or otherwise. This "price" was computed solely by dividing substantially*1208 all the net earnings for 1936, which it was desired to distribute, among the outstanding shares of capital stock. Thus, net earnings of the company for 1936, alone, were intended to be and were distributed to petitioners. The company did avoid the imposition of surtax on these earnings, under section 27 of the Revenue Act of 1936. And, each of the three shareholders of the company owned the same proportion of its business and assets after the "liquidation" as before.
We think the distribution in dispute occurred "at such time and in such manner as to [be] * * * essentially equivalent to the distribution" of a taxable dividend. Respondent is sustained.
Decisions will be entered under Rule 50.
Footnotes
1. SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
* * *
(c) DISTRIBUTIONS IN LIQUIDATION. - Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. Despite the provisions of section 117(a), 100 per centum of the gain so recognized shall be taken into account in computing net income, except in the case of amounts distributed in complete liquidation of a corporation. For the purpose of the preceding sentence, "complete liquidation" includes any one of a series of distributions made by a corporation in complete cancellation or redemption of all of its stock in accordance with a bona fide plan of liquidation and under which the transfer of the property under the liquidation is to be completed within a time specified in the plan, not exceeding two years from the close of the taxable year during which is made the first of the series of distributions under the plan. In the case of amounts distributed (whether before January 1, 1934, or on or after such date) in partial liquidation (other than a distribution within the provisions of subsection (h) of this section of stock or securities in connection with a reorganization) the part of such distribution which is properly chargeable to capital accounts shall not be considered a distribution of earnings or profits.
* * *
(i) DEFINITION OF PARTIAL LIQUIDATION. - 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. ↩
2. (g) REDEMPTION OF STOCK. - If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend. ↩