*62 Decisions will be entered under Rule 50.
Held, that payments by a corporation of 20 per cent of its profits to a former stockholder as part of the consideration for the sale and transfer by him of all of his stock to an existing stockholder who, through the acquisition of said stock and the purchase of additional shares from another source, became the owner of a controlling interest in said corporation and continued in control during the periods in which the corporation made the payments in question, constituted dividends to the stockholder who acquired said stock.
*115 The proceedings were consolidated pursuant to agreement of the parties.
Deficiencies were determined by respondent as follows:
| Docket No. | Petitioner(s) | Year(s) | Deficiency |
| 45765 | Earle F. Tucker | 1947 | $ 9,257.69 |
| 45764 | Earle F. Tucker and Martha Tucker | 1948 | 6,096.30 |
| 1949 | 5,467.12 |
*116 Petitioners assigned no error with respect to a minor adjustment involving salary for the year 1948.
The issues in controversy for all 3 years relate to the determination by *63 the respondent that payments made by Universal Motor Company, a corporation, of 20 per cent of its profits to Gordon V. Cox, a former stockholder, as part of the consideration for the sale and transfer by Cox of all of his stock in the company to Earle F. Tucker, one of the petitioners (already owning some of the stock of said corporation) with the result that Tucker, by the acquisition of the holdings of stock previously owned by Cox, the acquisition of additional shares from another source, and the retention of the shares already owned by him, acquired a controlling interest in said corporation and continued in control during the periods in which the payments were made to Cox, constituted dividends to Tucker.
FINDINGS OF FACT.
The case was submitted on stipulation of facts (with exhibits attached and made a part thereof) and oral testimony and exhibits presented at the trial. To the extent stipulated, the facts are incorporated herein by reference.
Petitioners Earle F. Tucker and Martha Tucker are now, and were during and since the taxable years herein involved, husband and wife.
Petitioners are individuals residing at Bismarck, North Dakota.
For the year ended December 31, 1947, *64 petitioner Earle F. Tucker filed his individual Federal income tax return with the collector of internal revenue for the district of North Dakota on or about the 15th day of March 1948.
For each of the years ended December 31, 1948, and December 31, 1949, petitioners Earle F. Tucker and Martha Tucker filed a joint Federal income tax return with the collector of internal revenue for the district of North Dakota, respectively on or before March 15, 1949, and on or before March 15, 1950.
The Universal Motor Company is a corporation duly organized and existing under and by virtue of the laws of the State of North Dakota, and having its principal office and place of business in Bismarck, North Dakota, from and after the date of its organization up until the present date. The Universal Motor Company was organized as a corporation on or about the 2d day of May 1934.
John R. Fleck, J. A. Fleck, and Gordon V. Cox were the original incorporators of Universal Motor Company.
John R. Fleck is and has been a resident of Bismarck, North Dakota, for over 30 years, and has been in the automobile business in that city *117 since 1923. In 1935, John R. Fleck was interested in, and a stockholder*65 of, two corporations engaged in the automobile business, namely, the Universal Motor Company, which held the Ford franchise, and the Fleck Motor Sales Company, which held a General Motors franchise.
In addition to his activities in the automobile business, John R. Fleck was a member of the North Dakota State Legislature for seven consecutive sessions, and during World War II organized three maintenance companies and was a consultant on the National Rationing Board in Washington, D. C., for automobiles.
J. A. Fleck, sometimes called Jack Fleck, a brother of John R. Fleck, was a resident of Bismarck, North Dakota, and was also interested in and a stockholder of both the Universal Motor Company and the Fleck Motor Sales Company.
Gordon V. Cox, one of the original incorporators of Universal Motor Company, is a resident of Bismarck, North Dakota, and has been an attorney-at-law actively practicing his profession in that city since 1919.
Earle F. Tucker is and has been a resident of Bismarck, North Dakota, since 1935. Prior to that time he was employed by the Ford Motor Company as a zone manager and sales promotion manager. In 1935 he was hired as sales manager of the Universal Motor *66 Company.
The Universal Motor Company was incorporated for the purpose of holding a franchise with the Ford Motor Company to sell, distribute, and service Ford, Lincoln, and Mercury automobiles and Ford parts.
The Universal Motor Company at all times material hereto operated under a sales agreement or franchise with the Ford Motor Company. This agreement, at paragraph 10 thereof, provides for termination at any time at the will of either party.
From 1935 to 1939, John R. Fleck was the active manager of the Universal Motor Company.
From 1935 to 1939, J. A. Fleck was the active manager of the Fleck Motor Sales Company.
In 1939 John R. Fleck purchased the stock interest of Jack Fleck in both the Fleck Motor Sales Company and the Universal Motor Company. He then left the Universal Motor Company to take over the active management of the Fleck Motor Sales Company and promoted Earle F. Tucker from sales manager to general manager of the Universal Motor Company.
Earle F. Tucker first became an officer of Universal Motor Company in 1938 or 1939.
It was, during the periods here material, the policy of the Ford Motor Company that the manager of a Ford agency should have the *118 controlling*67 stock interest in that agency in order that the fieldmen in making their contacts could get a yes or no answer.
The operation of the Universal Motor Company after 1939 was in conflict with this policy of the Ford Motor Company by reason of the fact that Earle F. Tucker, who was a minority stockholder of the company, was the general manager of the Ford agency, whereas John R. Fleck, the company's majority stockholder, was devoting his time to the management of a competing distributorship, the Fleck Motor Sales Company, which held a General Motors franchise.
C. H. Arnold of Des Moines, Iowa, a district sales manager for the Ford Motor Company, was the acting manager of the Fargo, North Dakota, district of the Ford Motor Company in 1944 and 1945, and in such capacity was responsible for the supervision of the Bismarck, North Dakota, Ford agency, namely, the Universal Motor Company.Early in the year 1945, Arnold contacted Tucker and Fleck to discuss this conflict with the policy of the Ford Motor Company and to attempt to effect a change in the operational setup of the Universal Motor Company.
Arnold stated that in order for the Universal Motor Company to continue with its Ford franchise*68 it was necessary that the manager have 51 per cent of the outstanding stock. He suggested that either Fleck leave the Fleck Motor Sales Company and return to take over the active management of the Universal Motor Company, or that he sell Tucker enough stock to give him control of the corporation.
The Universal Motor Company was advised that if its affairs were not arranged so that its manager owned the controlling stock interest, termination of its Ford franchise would be considered. Tucker was told that if it were possible for him to buy the entire interest or a controlling interest in Universal Motor Company, Ford would consider him as a dealer.
Cox was not in the automobile business. The representative of the Ford Motor Company did not discuss the franchise with him.
Fleck was not able to return to the active management of the Universal Motor Company since his full time was required in the operation of the Fleck Motor Sales Company. Fleck, however, did not want to withdraw altogether from stock ownership in the Universal Motor Company. Cox was ultimately prevailed upon to sell his stock interest in the company to Tucker which gave Tucker the controlling interest.
Fleck assisted*69 in the negotiations between Tucker and Cox as to the purchase of the latter's stock in the Universal Motor Company. Fleck advised Cox that it was very important to keep the company together, and if Cox would sell his stock to Tucker, the corporation would pay Cox 20 per cent of its earnings during the next 5 years plus $ 2,000 for each of those years as attorney fees.
*119 Following negotiations between Cox, Fleck, and Tucker, a contract dated in March of 1945 was entered into between Cox and Tucker, under the terms of which Cox agreed to sell 80 shares of stock of Universal Motor Company at $ 225 per share, or a total of $ 18,000, payment to be made on May 1, 1945. Tucker paid the above amount with his personal check dated April 30, 1945, payable to the order of Cox.
Under date of April 30, 1945, Cox entered into an agreement with Universal Motor Company, the material provisions of which are as follows:
* * * *
In consideration of said Gordon V. Cox selling to Earle F. Tucker eighty (80) shares of stock in said Universal Motor Company and, whereas, such sale is necessary in order for the Universal Motor Company to continue to operate as a Ford Agency in the City of Bismarck, *70 it is hereby agreed between the parties hereto:
1. The Universal Motor Company hereby agrees to pay the said Gordon V. Cox, his heirs or assigns, on September 1, 1945, and January 1, 1946, the sum of $ 1,000.00 on each of said dates; and on September 1, 1946 and January 1, 1947, the sum of $ 1,000.00 on each of said dates; and on September 1, 1947 and January 1, 1948, the sum of $ 1,000.00 on each of said dates; and on September 1, 1948, and January 1, 1949, the sum of $ 1,000.00 on each of said dates; and on September 1, 1949 and January 1, 1950, the sum of $ 1,000 on each of said dates; said money to be paid said Gordon V. Cox, his heirs or assigns, in consideration of the sale above referred to and as attorney for the Universal Motor Company.
It is further agreed between the parties hereto that in the event Universal Motor Company fails to earn the amount now being paid in officers' salaries, namely, the sum of $ 10,000.00, above operating expenses, that said payment of $ 2,000.00 per year shall be decreased in the same proportion as such earnings fail to amount to the $ 10,000.00 now being paid as officers' salaries by the Universal Motor Company. It is further agreed the officers' *71 salaries in the total amount of $ 10,000.00, for this five-year period, shall be divided as follows: 41% to Earle F. Tucker, 39% to John R. Fleck, and 20% to Gordon V. Cox, as attorney.
2. In addition to the $ 2,000.00 referred to in the paragraph above, Universal Motor Company agrees to pay for the consideration above mentioned the sum of twenty per cent (20%) of the net earnings of the Universal Motor Company for the fiscal years ending May 1, 1946, May 1, 1947, May 1, 1948, May 1, 1949, and May 1, 1950, to Gordon V. Cox, his heirs or assigns, such payments to be made on the first day of June following the close of the fiscal year on May first of the year or years involved.
It is further agreed in the computation of the twenty per cent (20%) of the net earnings, that net earnings shall mean the actual net earnings of the corporation after deduction of all expenses, federal and state income taxes, and any other legitimate charges against the gross income of said business, but shall not include any deduction for officers' salaries in excess of $ 10,000.00.
* * * *
It is further agreed that this contact is an obligation of the Universal Motor Company, a corporation, and that if the*72 Universal Motor Company continues to operate for the five year period as a corporation, there is no personal liability *120 on behalf of John R. Fleck or Earle F. Tucker. It is agreed by John R. Fleck and Earle F. Tucker that if it is determined by the stockholders of the Universal Motor Company to discontinue operating as a corporation and to operate as a partnership, that all obligations under this contract and agreement will be assumed by said partnership and that such partnership will ratify and adopt this agreement in the same manner as if this agreement had been entered into by the partnership originally.
It is further agreed that said Gordon V. Cox, being the owner of eighty (80) shares of the Universal Motor Company until the close of the fiscal year ending May 1, 1945, is entitled to his salary of $ 2,000.00 for said year, and it is hereby agreed that said salary has been paid to January 1, 1945, and that there will be due the said Gordon V. Cox his proportionate share of the $ 2,000.00 only for the months of January, February, March and April.
It is further agreed that said Gordon V. Cox shall be entitled to his share of the dividends declared based on the earnings*73 of the Universal Motor Company for the year ending May 1, 1945.
It is further agreed that a monthly statement of the earnings of the Universal Motor Company will be furnished to Gordon V. Cox during the five year period mentioned in this contract.
The Ford Motor Company had then and still has a policy with respect to the price it will permit an incoming purchaser to pay for a Ford dealership which is to the effect that no payment may be made for goodwill.
The transaction in question did not involve a change of dealership. It involved a sale of stock by one stockholder to another, and the Ford representative was not interested, and had nothing to do with the price at which the stock was sold.
The book value of the stock of Universal Motor Company at the close of its fiscal year ended April 30, 1945, was $ 147.84 per share.
Pursuant to the terms of the contract between Cox and the Universal Motor Company, dated April 30, 1945, the following amounts were paid to Cox during the years indicated below:
| 1946 | $ 4,484.73 |
| 1947 | 14,761.88 |
| 1948 | 12,386.64 |
| 1949 | 11,146.74 |
The payments of 20 per cent of its profits which the Universal Motor Company made to Cox for each year involved were*74 treated on the company's books as a direct charge to surplus, and no deductions for such payments were claimed on its income tax returns for any year.
There is no mention in the corporation's minute book about the contract between Universal Motor Company and Gordon V. Cox. It was not the policy of the corporation to put contracts into the minutes.
On May 1, 1945, Tucker purchased 12 shares of Universal Motor Company stock from Blanche E. Fleck, wife of John R. Fleck, for a total of $ 6,000.
*121 Tucker paid for the 12 shares of stock purchased from Blanche E. Fleck with his personal check dated May 1, 1945, payable to the order of John R. Fleck.
Fleck conducted all the negotiations for the sale of stock by Blanche E. Fleck. Tucker never discussed the matter directly with Blanche E. Fleck.
Tucker offered $ 6,000 for the stock. Fleck accepted the offer on behalf of his wife and there was no dispute over the price nor any counter proposals.
The Universal Motor Company reports its income for Federal income tax purposes on a fiscal year basis ending April 30.
The correct taxable net income of Universal Motor Company, before and after a Federal tax thereon, is as shown below for*75 the years indicated:
| Net income | |||
| For fiscal year ended April 30 | Taxable net | Less taxes | after deduction |
| income | measured by | for Federal tax | |
| income | on income | ||
| 1942 | $ 22,668.17 | $ 9,757.69 | $ 12,910.48 |
| 1943 | 10,167.28 | 2,697.07 | 7,470.21 |
| 1944 | 34,928.10 | 23,150.70 | 11,777.40 |
| 1945 | 39,205.39 | 25,449.18 | 13,756.21 |
| 1946 | 59,810.72 | 36,699.62 | 23,111.10 |
| 1947 | 122,713.38 | 46,436.08 | 76,277.30 |
| 1948 | 101,993.17 | 38,643.74 | 63,349.43 |
| 1949 | 89,858.13 | 34,045.34 | 55,812.79 |
Pursuant to appropriate action taken by the board of directors of Universal Motor Company, dividends were declared in the amounts and percentages as shown below at meetings of said board of directors held on the dates indicated:
| Date | Percentage | Amount |
| Jan. 15, 1936 | 10 | $ 2,500 |
| May 24, 1937 | (Not stated) | 4,000 |
| May 19, 1943 | 10 | 4,000 |
| May 15, 1944 | 12 1/2 | 5,000 |
| Apr. 24, 1945 | 12 1/2 | 5,000 |
| June 25, 1946 | 12 1/2 | 5,000 |
| May 21, 1947 | 25 | 10,000 |
| Mar. 20, 1948 | 25 | 10,000 |
| Dec. 15, 1948 | 25 | 10,000 |
| June 15, 1949 | 25 | 10,000 |
| Dec. 9, 1950 | 25 | 10,000 |
The above information constitutes all formal dividend action of Universal Motor Company from its inception through December 9, 1950. All such dividends*76 were paid in due course to stockholders on a pro rata basis.
*122 The capital stock, surplus, and net worth of the Universal Motor Company for each of the fiscal years April 30, 1942, to April 30, 1949, both years inclusive, are shown below for the years indicated:
| For fiscal year ended April 30 | Capital stock | Surplus | Net worth |
| 1942 | $ 40,000 | $ 9,353.68 | $ 49,353.68 |
| 1943 | 40,000 | 12,136.05 | 52,136.05 |
| 1944 | 40,000 | 16,139.40 | 56,139.40 |
| 1945 | 40,000 | 19,137.27 | 59,137.27 |
| 1946 | 40,000 | 34,806.93 | 74,806.93 |
| 1947 | 40,000 | 98,569.87 | 138,569.87 |
| 1948 | 40,000 | 125,780.79 | 165,780.79 |
| 1949 | 40,000 | 156,716.19 | 196,716.19 |
The outstanding shares of the capital stock of the Universal Motor Company were owned and held by the following persons as of the following designated dates:
| Date | Stockholders | Number of | Per cent of |
| shares held | total | ||
| Jan. 3, 1939 | Blanche E. Fleck | 180 | 72.00 |
| Gordon V. Cox | 50 | 20.00 | |
| Earle F. Tucker | 20 | 8.00 | |
| Total | 250 | 100.00 | |
| Apr. 30, 1939 | Same as for Jan. 3, 1939 | ||
| Apr. 30, 1940 | Same as for Jan. 3, 1939 | ||
| Apr. 30, 1941 | Blanche E. Fleck | 202 | 57.714 |
| John R. Fleck | 50 | 14.286 | |
| Gordon V. Cox | 70 | 20.000 | |
| Earle F. Tucker | 28 | 8.000 | |
| Total | 350 | 100.00 | |
| Apr. 30, 1942 | Blanche E. Fleck | 231 | 57.714 |
| John R. Fleck | 57 | 14.286 | |
| Gordon V. Cox | 80 | 20.000 | |
| Earle F. Tucker | 32 | 8.000 | |
| Total | 400 | 100.000 | |
| Apr. 30, 1943 | Same as for Apr. 30, 1942 | ||
| Apr. 30, 1944 | Same as for Apr. 30, 1942 | ||
| Apr. 30, 1945 | Blanche E. Fleck | 151 | 37.75 |
| John R. Fleck | 57 | 14.25 | |
| Gordon V. Cox | 80 | 20.00 | |
| Earle F. Tucker | 112 | 28.00 | |
| Total | 400 | 100.00 | |
| May 1, 1945 | Blanche E. Fleck | 139 | 34.75 |
| John R. Fleck | 57 | 14.25 | |
| Earle F. Tucker | 204 | 51.00 | |
| Total | 400 | 100.00 | |
| Apr. 30, 1946 | Same as for May 1, 1945 | ||
| Apr. 30, 1947 | Same as for May 1, 1945 | ||
| Apr. 30, 1948 | Same as for May 1, 1945 | ||
| Apr. 30, 1949 | Same as for May 1, 1945 | ||
| Apr. 30, 1950 | Same as for May 1, 1945 |
*77 *123 OPINION.
The issue before us revolves around the following circumstances. Universal Motor Company, during the periods in question, was a Ford dealer. Earle F. Tucker was the general manager. In 1945, just prior to the 1st of May, when the transactions in question were consummated, the stockholdings were as follows:
| Shares | |
| Blanche E. Fleck | 151 |
| John R. Fleck | 57 |
| Gordon V. Cox | 80 |
| Earle F. Tucker | 112 |
In accordance with the policy of the Ford Motor Company, its representative insisted that at least 51 per cent of the stock of Universal Motor Company be owned by the individual who was responsible for its active management. Failure to comply would have resulted in cancellation by Ford Motor Company of the dealer agreement, and the selection of a new Ford dealer, who might have been Tucker. In all events, if Universal Motor Company was to continue as a Ford agency, a recasting of its structure was necessary. Since Tucker was to continue to manage the business, it was logical that he should become the owner of 51 per cent of the stock. Fleck was active in another business, to which he gave substantially all of his time and attention. Cox was an attorney with *78 an active practice who would not have had the time to devote to Universal Motor Company. There is nothing to indicate that he had any experience which would qualify him to manage the company. Likewise, there is nothing to indicate that Blanche E. Fleck had such experience or qualifications.
Fleck and Tucker had been closely associated for some time. Fleck wanted to retain a substantial interest in the business, either directly, or through his wife, or both. If Fleck were to retain a substantial interest, and Tucker were to own 51 per cent of the stock, any solution of the problem necessitated the acquisition of the Cox stock interest by Tucker. Cox was by no means anxious to sell. In the negotiations which ensued, the interests of Tucker and Fleck were interrelated, and they cooperated with each other in dealing with Cox. The latter evidently realized he was in a key bargaining position.
The negotiations ultimately resulted in Tucker's acquisition of 12 shares of stock from Blanche E. Fleck, and all of the stockholdings of Cox. The latter transaction was accomplished in several steps, which were interrelated and an integral part of the whole.
Tucker personally paid Cox $ 225*79 per share for all of the stock owned by the latter. At the same time, the Universal Motor Company entered into an agreement with Cox in which it obligated itself to pay him 20 per cent of its profits for 5 years, together with other amounts *124 not here in issue. The contract between Universal Motor Company and Cox, in referring to the consideration, used the following language:
In consideration of said Gordon V. Cox selling to Earle F. Tucker eighty (80) shares of stock in said Universal Motor Company, and, whereas, such sale is necessary in order for the Universal Motor Company to continue to operate as a Ford Agency in the City of Bismarck, it is hereby agreed * * *.
The contract further provides, in part, as follows:
In addition to the $ 2,000.00 referred to in the paragraph above, Universal Motor Company agrees to pay for the consideration above mentioned the sum of twenty per cent (20%) of the net earnings of the Universal Motor Company for the fiscal years ending May 1, 1946, May 1, 1947, May 1, 1948, May 1, 1949, and May 1, 1950, to Gordon V. Cox, his heirs or assigns, such payments to be made on the first day of June following the close of the fiscal year on May first*80 of the year or years involved.
Respondent determined that the payments to Cox in the years in question in the amount of 20 per cent of the profits of Universal Motor Company constituted constructive dividends to Tucker and were taxable to him as such. Tucker urges that respondent's determination was in error on the theory that the payments were made by the corporation for a valuable consideration in accordance with the requirements of a separate contract with Cox, and, therefore, that such payments cannot be deemed dividends to Tucker for tax purposes.
It is our view that the several steps taken to effect the transfer of the Cox stockholdings to Tucker were part of a single transaction. Part of the consideration was paid by Tucker direct to Cox at the rate of $ 225 per share. It is clear from the record that Cox would not and did not sell his stock at that figure. Whether or not Tucker had sufficient personal resources to have paid personally the additional consideration demanded by Cox, the purchase was implemented, with the full accord of Tucker and the Flecks, through payments to Cox by Universal Motor Company of 20 per cent of its profits. Without such payments (or some equivalent*81 satisfactory to Cox) Tucker could not have acquired the stock owned by Cox. With such payments, Tucker did acquire the stock. The payments were made consciously and deliberately to achieve this end, with the full knowledge and consent of all of the stockholders of Universal Motor Company, pursuant to a contract entered into at a time when it was clearly understood (and affirmatively intended) that Tucker would forthwith become the majority stockholder. The payments were made for his benefit, with his cooperation, and at his direction (together with that of the other stockholders).
We think it clear from the foregoing that Tucker in purchasing the stock from Cox indirectly paid the additional consideration to Cox through the medium of the use of corporate funds, which were paid *125 out with the knowledge and consent of the holders of all of its stock. The tangible result was the acquisition of the stock by Tucker for the combined considerations of the money paid out directly by him and the money paid through the medium of the corporation.
We add, for completeness, that Cox rendered no services and performed no duties for the benefit of the corporation as a consideration for*82 the above payments. The record is not clear as to whether he rendered any services for the annual payments of $ 2,000, but the respondent has not taxed these payments to Tucker, and they give rise to no issue in this case.
The law is well established that the disbursement of corporate earnings serving the ends of a stockholder may constitute a dividend to such stockholder notwithstanding that the formalities of a dividend declaration are not observed; that the distribution is not recorded on the corporate books as such; that it is not in proportion to stockholdings; or even that some of the stockholders do not participate in its benefits. . See also 1 Mertens, Law of Federal Income Taxation, sec. 9.108 (1942), and 1954 Cumulative Pocket Supplement, secs. 9.11 and 9.12.
It is urged on Tucker's behalf that the payments of 20 per cent of profits made by the corporation to Cox were supported by a valuable consideration accruing to the corporation itself as distinct from Tucker or any other stockholder. His position is that the very life of the corporation was in the balance, *83 because Ford Motor Company would have canceled the dealer franchise if Tucker had not been able to acquire 51 per cent of its stock. It is clear that the transaction produced an intangible benefit to the corporation. By the same token, a like intangible benefit passed to Tucker, both as stockholder and as an officer holding a lucrative position. We point out, however, that we are not here dealing with niceties relating to the general principles of law upon which, in a different setting, we might be called upon to determine, as the decisive issue in a case, whether or not a particular contract was supported by a valuable consideration. We are now dealing with the practical application of the tax laws to the particular transaction before us which involves several steps with more than one element comprising the consideration.
Keeping before us the practical aspects of the application of the tax laws, the core of the problem is that Tucker acquired stock from Cox; that his acquisition of such stock was a material factor not only in acquiring control of the corporation, but also in insuring his position and compensation as general manager; that he paid part of the price directly and*84 out of his own funds; that the balance was paid by unanimous consent of all interested parties out of the funds of the *126 corporation, the control of which was acquired by him at the time the arrangement to purchase the Cox stock was consummated; and that the payments made by the corporation to Cox were for Tucker's benefit although they also brought intangible benefits to the corporation and others in varying degrees.
We hold that, under the foregoing circumstances, Tucker was the constructive recipient of dividends arising out of the payments to Cox by the corporation of 20 per cent of its profits for the years in question, such payments being part of the consideration for the sale and transfer to Tucker by Cox of all of the latter's stock in said corporation.
Decision will be entered under Rule 50.