1930 BTA LEXIS 2375">*2375 The respondent's determination as to the fair market value of certain shares of stock received by the petitioners in 1920 sustained.
19 B.T.A. 541">*541 These proceedings, which were consolidated for hearing and decision, are for the redetermination of deficiencies in income tax asserted by the respondent for the year 1920 as follows:
| George M. Wright | $14,530.65 |
| William A. Moorehead | 2,563.84 |
FINDINGS OF FACT.
The petitioners, George M. Wright and William A. Moorehead, are individuals residing respectively at Laurens, S.C., and Goldville, S. C. George M. Wright was, during the year 1920, a married man with four dependent children.
The Banna Manufacturing Co. was a corporation organized under the laws of South Carolina in the year 1907, and from the date of 19 B.T.A. 541">*542 its organization until some time in the year 1924 it was engaged in operating a cotton mill of 14,224 spindles located at Goldville, S.C. In the years 1919 and 1920 its outstanding capital stock was $248,300, divided into 2,483 shares of the par value1930 BTA LEXIS 2375">*2376 of $100 each, and consisted of three classes of stock as follows: 1,000 shares of common stock ($100,000); 967 shares of guaranteed stock ($96,700); and 516 shares of preferred stock ($51,600).
On January 1, 1920, and for some time prior thereto, the common stock of the Banna Manufacturing Co. was owned and held as follows:
| Shares | |
| George M. Wright | 225 |
| G. E. Shand, Columbia, S.C | 225 |
| W. A. Moorehead | 100 |
| Ivy M. Mauldin, as Trustee, Columbia, S.C | 215 |
| Carolina Realty & Trust Co., Columbia, S.C | 10 |
| J. P. Matthews, as Trustee, Columbia, S.C | 225 |
In November or December, 1919, a written contract was executed by and between S. H. McGhee as buyer, and J. P. Matthews, Ivy M. Mauldin, W. A. Moorehead, G. E. Shand and George M. Wright, as sellers. The agreement was also signed by the Carolina Realty & Trust Co. The agreement was in part as follows:
1. That the Sellers agree to sell and the Buyer agrees to buy on January 2, 1920, all of the stock of Banna Manufacturing Company at a price to be arrived at on the basis of thirty-four dollars ( $34.) per spindle for each and every spindle of the said Banna Manufacturing Company amounting to fourteen thousand two1930 BTA LEXIS 2375">*2377 hundred and twenty-four (14,224) spindles, and in addition to buy and pay for all quick assets as provided in paragraph 3.
2. Previous to January 2, 1920, Sellers agree that they will distribute all quick assets of Banna Manufacturing Company except such as are necessary for the operation of the plant, which Buyer does not buy.
3. The Buyer agrees to pay for all the quick assets which he buys at invoice price, and to buy and pay for stock in process, the price of which shall be arrived at by a representative of the Buyer and a representative of the Sellers, and if these two cannot agree it is agreed that third party shall be called in whose decision shall be final and binding on both parties.
* * *
5. It is agreed that all of the stock of Banna Manufacturing Company shall be transferred to a holding company, and that such holding company shall be organized with a capital stock of five hundred thousand ($500,000) dollars, of which amount two hundred and fifty thousand ($250,000) dollars shall be common stock and two hundred and fifty thousand ($250,000) dollars shall be preferred stock. The two classes of stock shall have the rights and preferences hereinafter set forth, 1930 BTA LEXIS 2375">*2378 which rights and preferences shall constitute a part of this agreement. The Buyer shall pay all expenses of the trustee and any disbursements it may make either as depository of the stock as herein provided, or as trustee under the agreement.
* * *
8. 19 B.T.A. 541">*543 The Palmette Trust Company shall be the depository of the said stock and trustee under the agreement, and the Buyer agrees to deposit with said trust company all the capital stock of the Banna Manufacturing Company, and such trustee shall hold the said stock until all the agreements and terms of purchase shall have been carried out in full, after which it shall deliver the stock to the parties entitled thereto.
9. The preferred stock shall have the following rights, preferences, conditions and limitations:
The holders of the preferred stock shall be entitled to receive when and as declared by the Board of Directors, from the surplus or net profits arising from the business of the corporation, cumulative dividends at the rate of but never exceeding, eight per centum (8%) per annum from and after January 1, 1920, payable semi-annually on June 30, and December 31, in each and every fiscal year, in preference and1930 BTA LEXIS 2375">*2379 priority to the declaration or payment of any dividends upon the common stock.
If for any dividend period a dividend at the rate of eight per centum (8%) per annum upon the par value of the preferred stock shall not be declared and paid, the deficiency shall be a charge upon the surplus and net profits arising from the business of the corporation and shall be payable, but without interest, before any dividend shall be declared or paid in respect to common stock.
In the event of any liquidation or dissolution or winding up (whether voluntary or involuntary) of the corporation, the holders of the preferred stock shall be entitled to be paid one hundred ( $100) dollars per share and the unpaid dividends accrued thereon out of the capital or funds of the corporation or the proceeds thereof, before any amount shall be paid therefrom to the holders of the common stock.
The holders of the preferred stock shall not be entitled to any other or further share than as above specified, in surplus, or net profits, or in the capital or funds of the corporation, either prior to or in the event of liquidation and final winding up of the company.
Subject to the prior rights of holders of1930 BTA LEXIS 2375">*2380 preferred stock, as above specified and limited, the holders of the common stock shall be entitled to all the assets and funds of the corporation and to all profits realized therefrom, and to all rights accruing to stockholders in said company.
The preferred stock, or any part or any particular shares thereof, shall be subject to the right of the corporation, at its option, to redeem, purchase and acquire the same upon the first day of January, or the first day of July in any year after the first of January, A.D. 1920, at par, together with any dividends accrued and unpaid thereon. In case the corporation shall so elect to redeem, purchase or acquire any of the said stock and shall notify the registered holder thereof or any part thereof of its election so to do, the right of said holder of said stock or of any assignee thereof to receive dividends upon said stock subsequent to the dates specified in said notice for such redemption, purchase or acquisition, shall cease and determine.
The holders of preferred stock shall have no voting power in respect to any of said stock, except as herein otherwise expressly provided, nor shall they be entitled to any notice of meetings of1930 BTA LEXIS 2375">*2381 stockholders, nor shall their consent, except as otherwise provided by law, be requisite for any act of the corporation or of the stockholders: provided, however, that if in or for any fiscal year the corporation shall fail to declare and pay or set apart for payments dividends upon said preferred stock outstanding aggregating for such fiscal year eight(8%) per centum upon such stock, then the holders of said preferred stock shall be entitled to vote in any meeting held after the expiration of such fiscal year 19 B.T.A. 541">*544 and while the corporation shall be in default with respect to the declaration or payment of such dividends and until all dividends accrued and unpaid upon such preferred stock shall have been declared paid or set apart for payment, and while such dividends are so in default the holders of common stock shall have no right to vote at any stockholders meeting. In the event that the debt of the Banna Manufacturing Company or its successor or successors shall exceed its quick assets then the common stock of the company shall have no vote whatever. Upon the happening of a default in dividends, or upon the debt, the holders of the preferred stock shall have the right to1930 BTA LEXIS 2375">*2382 call a stockholders' meeting, elect directors from among the preferred stockholders, call a meeting of the stockholders of Banna Manufacturing Company and elect directors of Banna Manufacturing Company from among the preferred stockholders of this company.
The preferred stock shall be redeemed at par and accumulated dividends five years from January 1st, 1920.
* * *
11. Sellers shall swap $248,300 of stock of Banna Manufacturing Company for $248,300 of the preferred stock of the holding company and in addition sellers shall take $1,700 of the preferred stock at par and the difference over $250,000 shall be paid in cash.
The owners of the common stock of Banna Manufacturing Co. did not own all of the preferred and guaranteed stock of that company, and in order to consummate the sale to McGhee, George M. Wright, on behalf of the common stockholders, bought up the outstanding preferred and guaranteed stock. The entire capial stock of Banna Manufacturing Co. was then delivered to Banna Mills, a corporation organized on the 29th day of December, 1919, under the laws of the State of South Carolina, pursuant to he agreement above set forth, and on or about January 2, 1920, the1930 BTA LEXIS 2375">*2383 said sellers received from the said McGhee, or Banna Mills, $234,116 in cash and $250,000 par value of the preferred stock of the said Banna Mills. Part of the cash received was used to pay the expenses of the sale and for the guaranteed and preferred stock of the Banna Manufacturing Co., which the common stockholders purchased as above set forth, and the remainder was distributed to the common stockholders in payment, at par, for their original shares of guaranteed and preferred stock of the Banna Manufacturing Co., and for their common stockholdings at the rate of $70 per share. The preferred stock of Banna Mills was also distributed among said common stockholders in proportion to the number of shares owned by them. The petitioner George M. Wright received, on account of the 225 shares of the common stock of the Banna Manufacturing Co. owned by him, the sum of $15,750 in cash and 563 shares of the preferred stock of Banna Mills. The petitioner William A. Moorehead received, on account of the 100 shares of common stock of the Banna Manufacturing Co. owned by him, the sum of $7,000 in cash an 250 shares of the preferred stock of Banna Mills.
19 B.T.A. 541">*545 Paragraph three of the1930 BTA LEXIS 2375">*2384 agreement of sale was not carried out according to its terms. Instead of the "quick assets" of the Banna Manufacturing Co. being converted into cash or acquired by McGhee for cash, it was determined that the equivalent hereof would be distributed to the common stockholders of the Banna Manufacturing Co. as of December 31, 1919, in the form of dividends. To provide funds for such dividends the Banna Manufacturing Co. borrowed from banks and increased notes payable, and all the physical assets of the Banna Manufacturing Co. remained in the ownership and control of that corporation, which continued to operate as a going concern until sometime in the year 1924. The distribution of the so-called "quick assets" in the form of special dividends to the common stockholders as of December 31, 1919, amounted to a total of 138 1/2 per cent, one distribution of 75 per cent being made in 1919 and two of 60 per cent and 3 1/2 per cent, respectively, being made early in 1920. A regular dividend of 6 per cent was also paid on the common stock in 1919.
The financial statement of the Banna Manufacturing Co. as of January 1, 1920, which was after the payment of the special dividend of 75 per cent1930 BTA LEXIS 2375">*2385 but before the payment of the special dividends of 60 per cent and 3 1/2 per cent, was as follows:
| BANNA MANUFACTURING COMPANY. | |||
| GOLDVILLE, S.C. | |||
| CONDENSED FINANCIAL STATEMENT | |||
| January 1, 1920 | |||
| ASSETS | |||
| Cash on hand and in bank | $29,507.81 | ||
| United States Liberty bonds | 1,000.00 | ||
| United States war savings stamps | 838.00 | ||
| Cotton (at 32.965?? per lb.) | 17,440.42 | ||
| Stock in process (at 39?? per lb.) | 29,158.35 | ||
| Goods unsold (at net market) | 15,145.92 | ||
| Supplies, fuel, and waste | 10,476.03 | ||
| Accounts receivable | 1,846.28 | ||
| Store (merchandise stock) | 4,216.16 | ||
| Current assets | 109,628.97 | ||
| Deferred assets: | |||
| Insurance (unexpired) | $827.15 | ||
| Office furniture and fixtures | 666.48 | ||
| 1,493.63 | |||
| 111,122.60 | |||
| Property and plant | 294,750.66 | ||
| Total assets | 405,873.26 |
| LIABILITIES | |||
| Notes payable | None. | ||
| Accounts payable and wages | $5,063.52 | ||
| Current liabilities | $5,063.52 | ||
| Capital stock: | |||
| Common | $100,000.00 | ||
| Preferred | 51,600.00 | ||
| Guaranteed | 96,700.00 | ||
| 248,300.00 | |||
| Profit accounts: | |||
| Credit balance January 1, 1919 | 158,020.02 | ||
| Operating profits for year | 146,884.97 | ||
| Interest on United States Liberty bonds | 820.33 | ||
| 305,725.32 | |||
| Dividends paid: | |||
| Common - 81% | $81,000.00 | ||
| Preferred - 7% | 3,612.00 | ||
| Guaranteed - 7% | 6,769.00 | ||
| 91,381.00 | |||
| Federal taxes, 1918 | 52,409.06 | ||
| Renewals and replacements | 8,326.18 | ||
| Loss on sale of Liberty bonds | 993.50 | ||
| Written off (worthless accounts) | 105.84 | ||
| 153,215.58 | |||
| 152,509.74 | |||
| Depreciation reserve account | 55,672.17 | ||
| Undivided profits | 96,837.57 | ||
| Total profits, including depreciation | |||
| reserve | 152,509.74 | ||
| Total liabilities 1 | 405,873.26 |
The net earnings of Banna Mills for the year 1920 were approximately $133,000.
Concurrently with the sale and delivery of the capital stock of the Banna Manufacturing Co., said stock was placed in trust by the buyers for the benefit and security of the holders of the $250,000 of preferred stock of Banna Mills. In effect, this trust agreement amounted to a mortgage of the entire outstanding stock of Banna Mills in respect of said preferred stock, to permit the holders of said preferred stock, if necessary, to take over the control and management of the Banna Manufacturing Co., and to guarantee to said preferred stockholders the prompt payment of dividends and the redemption of said preferred stock at par within five years from January 1, 1920.
For two or three years preceding the sale of the Banna Manufacturing Co. stock the 7 per cent dividends on the preferred and guaranteed stock were promptly paid. After the sale of said stock to S. H. McGhee and Banna Mills, the 8 per cent cumulative on the 19 B.T.A. 541">*547 preferred stock of Banna Mills was promptly paid until the stock was redeemed. Said preferred stock was1930 BTA LEXIS 2375">*2387 redeemed in 1924 at $95 per share.
The assets of the Banna Manufacturing Co. were sold in 1924 for $415,000. The value of said assets was greater in January, 1920, than at the time of the sale in 1924.
At and after January 2, 1920, the preferred stock of Banna Mills was closely held and was not listed or dealt in on any exchange. In January or February, 1920, the petitioner, George M. Wright, sold 50 shares of said preferred stock to one J. B. Wharton, who purchased the stock as an investment at $100 per share. There were no other sales or offers for sale of said preferred stock in the year 1920.
The petitioners in their income-tax returns for the year 1920 did not report any profit from the sale of their common stock of the Banna Manufacturing Co. The respondent, upon audit of the returns, determined that the preferred stock of Banna Mills received by the petitioners as part of the consideration for the sale of their common stock of the Banna Manufacturing Co. had a fair market value at that time of $95 per share and he computed a profit to the petitioners on that basis. The petitioner George M. Wright was allowed a personal exemption of $2,000.
OPINION.
MARQUETTE: 1930 BTA LEXIS 2375">*2388 The controversy in these proceedings arises from the respondent's determination that the petitioners in 1920 realized a profit from the sale of their shares of the common stock of the Banna Manufacturing Co. The amounts received by the petitioners from the sale of their preferred stock of the Banna Manufacturing Co. and as special dividends from that company are not involved. The material facts are that the petitioner Wright sold 225 shares of the common stock of the Banna Manufacturing Co. that cost him $100 per share, or $22,500, and received therefor $15,750 in cash and 563 shares of the preferred stock of Banna Mills, and that the petitioner Moorehead sold 100 shares of the common stock of the Banna Manufacturing Co. which had cost him $100 per share, or $10,000, and received therefor $7,000 in cash and 250 shares of the preferred stock of Banna Mills. The respondent has determined that the preferred stock of Banna Mills had a fair market value $95of per share when the petitioners received it and on that basis that the petitioner Wright realized a profit of $46,640 and the petitioner Moorehead a profit of $20,750.
The contentions of the petitioners are: (1) That the preferred1930 BTA LEXIS 2375">*2389 stock of Banna Mills which they received in the transaction was in substance a stock dividend from the Banna Manufacturing Co., or the equivalent thereof, and hence taxable in the year in which they 19 B.T.A. 541">*548 disposed of it, and (2) that the stock had no fair market value; that the cash they received, which was at the rate of $70 per share, should be applied to reduce the cost of the stock sold in 1920, and that there was no taxable gain to them from the transaction until 1924, when the preferred stock of Banna Mills was retired.
The first contention of the petitioners is obviously wihout merit and needs no extended discussion. The transaction by which the petitioners secured the preferred stock of Banna Mills has none of the characteristics of a dividend. However, assuming that it does constitute a dividend, it is not a stock dividend from the Banna Manufacturing Co., since i was not paid in the stock of that company. The transaction was clearly one giving rise to gain or loss within he meaning of the Revenue Act of 1918. 1930 BTA LEXIS 2375">*2390 ; , affirmed by the Court of Appeals of the District of Columbia, December 2, 1929. We will, therefore, take up the petitioners' contention that the preferred stock of Banna Mills had no fair market value.
At the outset of the discussion of this phase of the case it should be pointed out and borne in mind that the respondent has determined that the stock in question had a fair market value of $95 per share. The burden is upon the petitioners, and they must establish by at least a preponderance of the evidence that the stock did not have any fair market value, or that it had a fair market value other than that determind by the respondent, before we would be justified in disturbing the respondent's determination.
The evidence establishes that the preferred stock of Banna Mills was closely held and that it was not traded in or listed on any exchange. The only sale of the stock in 1920, so far as we are informed, was that of ten shares by the petitioner Wright to one Wharton at $100 per share. That sale was at arms' length between a willing buyer and a willing seller, and1930 BTA LEXIS 2375">*2391 Wharton purchased the stock as an investment and not because of any official or financial relationship between him and Banna Mills or between him and Wright. Aside from this transaction, the evidence presents a case of closely held stock in which there were neither offers to sell nor offers to buy, and in which there was no listing or dealing on a stock exchange. It seems to be the theory of the petitioners that absence of actual trading in the stock proves that it had no fair market value. We do not think that this contention is warranted. The fact that the owners of the stock did not wish to sell it, or did not offer it for sale, does not prove that it could not have been sold in 1920 at a price fairly commensurate with its intrinsic value. The absence of active trading in a stock does not necessarily show tack of fair market value, and under the circumstances other evidence, 19 B.T.A. 541">*549 including evidence as to the intrinsic value of the assets back of the stock, should be considered in determining whether the stock had a fair market value. 1930 BTA LEXIS 2375">*2392 ; ; ; ; . The evidence shows that the $250,000 of preferred stock of Banna Mills which was paid to the petitioners and the other stockholders of the Banna Manufacturing Co., was secured by all of the capital stock of the Banna Manufacturing Co., which in turn was backed by assets worth in 1920 more than $415,000. It further appears that the Banna Manufacturing Co. was prosperous in 1920 and that its operations in that year resulted in a net profit of approximately $133,000. The dividends on the preferred stock of Banna Mills were promptly paid from the time it was issued until it was retired in 1924.
In the light of all the evidence we are of opinion that the petitioners have failed to show that the respondent erred in determining that the preferred stock of Banna Mills had a fair market value of $95 per share when it was received by them. The respondent's determination must, therefore, be approved.
The petitioner Wright1930 BTA LEXIS 2375">*2393 was during the year 1920 a married man with two dependent children, and is therefore entitled to a personal exemption of $2,800 instead of $2,000, as heretofore allowed.
Judgment will be entered under Rule 50.
Footnotes
1. NOTE: Federal taxes, 1919 ($42,923.54), not yet booked. ↩