1937 BTA LEXIS 644">*644 Petitioner, the owner of 2,914 shares of stock of a corporation having 3,000 shares outstanding, regularly drew from the corporation sums of money amounting altogether, in 1929, to $66,679.22. The corporation had made a profit each year since its incorporation and had amassed a considerable surplus, but only two cash dividends had been declared. Similar withdrawals by petitioner in 1930 were treated as "informal" dividends and taxed as such. A note dated December 31, 1929, was given by petitioner to the corporation in the sum of $66,679.22, the amount of his withdrawal account on that date. On December 31, 1932, petitioner delivered to the corporation 843 shares of his stock, and in consideration therefor the corporation canceled the note. Held, that this constituted a redemption essentially equivalent to the distribution of a taxable dividend under section 115(g) of the Revenue Act of 1932.
36 B.T.A. 866">*866 This case arises on the determination by respondent of a deficiency of $14,051.27 in the petitioner's income1937 BTA LEXIS 644">*645 tax for the calendar year 1932, and involves the single question whether respondent erred in treating as a redemption essentially equivalent to the distribution of a taxable dividend, under section 115(g) of the Revenue Act of 1932, the redemption in that year of certain stock held by petitioner in a corporation of which he was the majority stockholder. A secondary issue, the cost to petitioner of the stock so redeemed, was conceded by respondent's counsel at he hearing. We have found the following facts.
FINDINGS OF FACT.
Petitioner has been engaged in the lumber business since 1920. On December 29, 1924, he incorporated the business under Maryland law as J. Natwick & Co., Inc., with powers to carry on a general lumber and milling business, and also to carry on mining. By an amendment of the charter on March 23, 1932, the company's powers were enlarged to permit it generally to engage in agriculture and horticulture and to pack its products; to raise and slaughter cattle; to own and lease farm implements; and to sell fertilizer, seeds, and agricultural machinery. The total authorized capital stock was 5,000 shares of no par value. The corporation, by a resolution of its1937 BTA LEXIS 644">*646 directors adopted on December 30, 1924, took over all the assets of J. Natwick & Co., the name under which petitioner had hitherto been trading, which consisted of accounts receivable, standing timber, 36 B.T.A. 866">*867 manufactured lumber, and all mills and other equipment; assumed all that company's obligations; and transferred to petitioner in exchange therefor 3,000 shares of its capital common stock fully paid for. The valuation placed by the directors on the assets so received was $321,000, but this was an error which was corrected on the corporation's records by appropriate resolution on February 2, 1925, to $237,209. The old company's property was transferred to the corporation and the stock was issued to petitioner after this latter date. This valuation of the assets was the same as the amount which had been carried as cost on petitioner's books as an individual trader, although the actual cost of these assets to petitioner was greater. On February 2, 1925, petitioner was president of the corporation, and he was still president at the time of the hearing; Charles A. Minton was vice president, and Ella Sullivan was secretary and treasurer. These three were directors and stockholders, 1937 BTA LEXIS 644">*647 the two latter holding only one qualifying share each at the time of the incorporation of the company, which was received from petitioner. They remained stockholders, the changes in their holdings resulted from Christmas gifts or bonuses made by petitioner to the others from his own stock. The three stockholders' respective holdings at the end of each year were as follows:
| Petitioner | Minton | Sullivan | |
| 1926 | 2,980 | 10 | 10 |
| 1927 | 2,960 | 20 | 20 |
| 1928 | 2,940 | 30 | 30 |
| 1929 | 2,920 | 40 | 40 |
| 1931 | 2,914 | 43 | 43 |
| 1932 | 2,067 | 45 | 45 |
The disposition made by petitioner of 843 shares of his stock in December 1932, the circumstances of which are given below, accounts for the difference between the amount of his holding at the end of 1932, as set out above, and the 2,910 shares which he held on December 1, 1932. On April 26, 1929, there was entered on the company's capital account the sum of $62,791, which was, in turn, debited in the surplus account, the corporation's minute book on February 12, 1929, showing an increase in the capital stock authorized by the directors on that day to $300,000.
The company made substantial earnings. While the corporation borrowed1937 BTA LEXIS 644">*648 money during these years, it did so in order to conduct its business, not to lend to petitioner. On only two occasions were cash dividends formally declared by the company through corporate resolutions, a dividend of $30,000 on December 10, 1929, and a 3 percent dividend of $9,000 on December 31, 1932. Under date of December 31, 1930, however, there was entered on the surplus account is an "informal dividend" the amount of $13,388.84. The company's 36 B.T.A. 866">*868 surplus account from 1925 to 1932, inclusive, as shown by its books, was as follows:
| Date | Debit | Date | Earnings for year | Credit | |
| Dec. 31, 1925 | 1925 | $26,396.79 | |||
| Dec. 31, 1926 | 1926 | 28,449.94 | |||
| Dec. 31, 1927 | 1927 | 25,772.40 | |||
| Dec. 31, 1928 | 1928 | 34,910.04 | |||
| 1929 | |||||
| Apr. 26 | Transfer from surplus to capital account | $62,791.00 | Dec. 31, 1929 | 1929 | 24,612.10 |
| Dec. 10 | C. A. Minton (div.) | 300.00 | |||
| Do | Ella Sullivan (div.) | 300.00 | |||
| Do | J. Natwick (div.) | 29,400.00 | |||
| Dec. 31, 1930 | 1930 | 16,848.74 | |||
| Dec. 31, 1931 | 1931 | 19,842.24 | |||
| 1932 | |||||
| Dec. 31 | 3% dividend on $300,000 | 9,000.00 | Dec. 31, 1932 | 1932 | 5,416.89 |
| Do | Interest, 1929 | 1,901.39 | |||
| Do | Informal dividend, 1930 | 13,388.84 |
1937 BTA LEXIS 644">*649 The total debits were, therefore, $117,081.23, the total credits were $182,249.14, and the surplus of the company's account on its books on December 31, 1932, was $65,167.91.
Petitioner had been accustomed to borrow from the company for three or four years before 1929, until by the end of that year he was indebted to the corporation in the sum of $66,679.72. No large sum was borrowed at any one time. Any salary or dividends were credited to this withdrawal account and petitioner's loans debited, the balance representing petitioner's debit balance to the company. Petitioner's debit balance with the company at the end of each year was as follows:
| 1929 | 1930 | 1931 | 1932 |
| $66,679.22 | $79,908.06 | $95,460.08 | $11,461.48 |
The debit balance for 1932 above was that remaining after a credit had been given petitioner on 843 shares of the company's stock returned to it. Petitioner had no understanding with the company's officers that he should pay interest on the open account.
On December 31, 1932, the company held a demand note made by petitioner to the company for $66,679.22, representing petitioner's debit balance on December 31, 1929. On1937 BTA LEXIS 644">*650 May 23, 1932, petitioner had stated in an affidavit to the internal revenue agent in charge at Baltimore, the note having been called to the latter's attention, that this sum was considered a loan at the time the money was received by him and that he still so regarded it and acknowledged the obligation, which he would repay when possible. This note was dated December 31, 1929, although probably not then executed. It bore no interest and there was no understanding with the company's officers with regard to interest. The note was canceled on December 31, 1932, in consideration of the delivery by petitioner to the corporation of 843 shares of the latter's stock. Petitioner delivered to the corporation his original stock certificate and received a new certificate 36 B.T.A. 866">*869 for the reduced amount, leaving outstanding a total of 2,157 shares. This transaction was carried through in the form of a sale of the 843 shares to the company for the amount of petitioner's indebtedness as of December 31, 1929, or at a price of $79.0975 a share, having been authorized by a resolution of the company's directors, unanimously carried and ratified by a resolution of the company's stockholders. The1937 BTA LEXIS 644">*651 directors' resolution is in part as follows:
WHEREAS, Mr. J. Natwick is indebted to the Company for an amount in excess of sixty six thousand six hundred seventy nine dollars twenty two cents ($66,679.22); and
WHEREAS, Mr. Natwick is the owner and holder of more than 843 shares of the capital stock of the Company and it is deemed advisable that the Company purchase from Mr. J. Natwick 843 shares of the capital stock of the Company in consideration of the payment of the indebtedness of Mr. Natwick to the Company to the extent of $66,679.22.
RESOLVED
That the Company purchase from Mr. J. Natwick 843 shares of the capital stock of the Company at $79.09 3/4 per share in consideration of the payment of the debt of Mr. J. Natwick to the Company in the amount of $66,679.22 said shares so purchased to be held as Treasury Stock of the Company, the Company having a surplus in excess of the purchase price of said shares; said purchase not being by way of, or equivalent to, the payment of a dividend.
The nature of the transaction is thus set out as a minute entered in the company's journal:
December 31, 1932
Treasury Stock $66,679.22
J. Natwick $66,679.22843 Shares of J. Natwick1937 BTA LEXIS 644">*652 & Co., Inc., stock purchased from J. Natwick at 79.09 3/4 per share in accordance with minutes authorizing this purchase. This is not a dividend but a return of a portion of Mr. Natwick's original investment. Nor is it a redemption or cancellation of stock; the shares purchased to be transferred into the name of the company and held as treasury stock. This has been taken up and ruled upon unofficially by conferees Hahn & Byerly at Custom House.
The persons referred to in the minute above as "at Custom House" were in the office of the internal revenue agent at Baltimore.
The corporation still retains as treasury stock the 843 shares, which have never been reissued. The corporation's minutes contain nothing after December 31, 1932, indicating what disposition the corporation intends to make of these 843 shares. On February 12, 1935, petitioner stated in an affidavit filed with the Commissioner, that the company's stock was worth $99.49 in December 1932. Petitioner and the other directors of the corporation determined, however, after discussing the matter for some time, to fix the purchase price at $79.0975, as that was the original sale price to petitioner, and it was feared1937 BTA LEXIS 644">*653 that otherwise the cancellation of petitioner's indebtedness in consideration of his surrender of 843 shares would resemble too closely a dividend distribution.
36 B.T.A. 866">*870 At the time the affidavit of May 23, 1932, earlier referred to, was filed with the Commissioner, an investigation was being made by the internal revenue agent of the tax due on petitioner's income for the year 1929, the fact which brought it in question being a certain loan, the circumstances of which need not be detailed here, which had been erroneously charged through petitioner's account when it should have been charged through that of the corporation. This error was corrected, the entry of "interest 1929" under December 31, 1932, in the company's surplus account set out above referring to this transaction. About the same time petitioner's income tax for 1930 was brought into question and was settled by treating petitioner's withdrawals of $13,388.84 from the corporation as a dividend subject to tax, the adjustment on the books of this amount as an "informal dividend" on December 31, 1932, as above, giving effect to petitioner's agreement with the Commissioner of June 2, 1932, so to treat the transaction.
1937 BTA LEXIS 644">*654 In December 1932 petitioner had, in addition to his stock in the company, his house, worth from $10,000 to $12,000, and a farm in Wisconsin worth $1,500; and, as he owed no debts other than that of $78,140.70 to the company, he had, all told, enough property to liquidate that debt. He did not consider himself or the corporation then insolvent, even if his debt to the corporation should not be regarded as an asset of the corporation.
The corporation had been affected by the general economic depression, for its gross sales for 1931 to 1934, inclusive, were as follows:
| 1931 | 1932 | 1933 | 1934 |
| $504,511.68 | $240,784.34 | $198,605.42 | $536,342.81 |
The company's borrowings were $135,000 in 1925, but these were paid off in the next two or three years. At the end of 1930 and of 1931 it had no outstanding indebtedness; at the end of 1932, $45,000; and at the end of 1933, $50,000. The company started borrowing in February 1932, giving its first note in February and its second in May, which were renewed until paid in 1933. One note was reduced by $5,000 in November 1932. During the latter part of 1932 the Equitable Trust Co., which held a note of1937 BTA LEXIS 644">*655 the company for $20,000, began pressing for the payment of its loan, calling up the petitioner three or four times. It was impossible for petitioner to obtain new loans for the company at that time. Petitioner was an endorser on the company's notes outstanding at the end of 1932, and also at the end of 1933. The banks apparently regarded unfavorably petitioner's indebtedness to the company, but there was no suggestion or insistence on the part of the banks that any alteration be made in the capital structure of the company. There was no plan, at the time of the transfer of petitioner's stock to the corporation, of discontinuing the business or any department of it.
36 B.T.A. 866">*871 On December 31, 1932, the company had outstanding two notes, both made in November 1932, one for $25,000 made payable to the Union Trust Co. which was renewed in February 1933 and paid off in May 1933, and the other for $20,000 to the Equitable Trust Co. which was paid off in March 1933, so that the company owed no debts to banks after May 1933 until a new loan was obtained in the following October. By corporate resolution on November 16, 1933, the officers of the corporation were authorized to borrow1937 BTA LEXIS 644">*656 $25,000 from the Equitable Trust Co. of Baltimore. This was the only formal authorization to borrow made in 1932 or 1933.
OPINION.
KERN: The present proceeding arises on respondent's determination of a deficiency of $14,051.27 in petitioner's income tax for the year 1932, and involves the single question of whether the cancellation of a debt of $66,679.22 owed the corporation by the petitioner in exchange for his surrender of 843 shares of the company's stock constituted a transaction "essentially equivalent to the distribution of a taxable dividend", within the meaning of section 115 of the Revenue Act of 1932, the relevant provisions of which are set out in the margin. 1 As the price at which the stock was surrendered to the corporation was the same as that paid for it originally by the petitioner, 36 B.T.A. 866">*872 respondent concedes that no gain was realized on the transaction unless it is to be treated as a dividend under section 115(g).
1937 BTA LEXIS 644">*657 Since petitioner and the corporation eventually treated the withdrawals made by petitioner in 1929 and prior years, as set out in our findings, as a loan, by the subsequent execution of a demand note dated December 31, 1929, and no question has been raised either on the pleadings or in argument that these withdrawals constituted income to petitioner in the years of withdrawal, we will consider the sum of such withdrawals as an obligation owing by petitioner to the corporation and canceled by it in 1932 as a part of the transaction herein considered.
The legislative genesis of section 115(g) has been traced at length in our decisions, Pearl B. Brown, Executrix,26 B.T.A. 901">26 B.T.A. 901, at 26 B.T.A. 901">906, 26 B.T.A. 901">907; affd., 69 Fed.(2d) 602 (C.C.A., 7th Cir.); Henry B. Babson,27 B.T.A. 859">27 B.T.A. 859, at pages 866, 867; affd., 70 Fed.(2d) 304; see also note, 49 Harvard Law Review 1344 (1936); and we need do no more now than recall that the comparative immunity from taxation which stock dividends acquired under the doctrine of 1937 BTA LEXIS 644">*658 Eisner v. Macomber,252 U.S. 189">252 U.S. 189, and the ultimate avoidance of tax on the distribution which could be accomplished by the redemption of such a dividend led to the enactment of the prototype of the present provision in 1921 and to the enlargement of its base in 1926 to include all redemptions in the nature of a dividend distribution.
The present section or its prototypes have been considered by this Board and the courts in thirty odd cases, many of which have been cited by counsel in the present proceeding, and are set out in the margin. 2
1937 BTA LEXIS 644">*659 Without deciding whether the question presented here is purely one of fact or a mixed question of fact and law, we are of the opinion that the respondent is correct in maintaining in this case that his determination under this, as under other provisions of the statute, 36 B.T.A. 866">*873 carries a presumption of correctness which must be overthrown by a preponderance of the evidence on the part of the petitioner. We said in George Hyman,28 B.T.A. 1231">28 B.T.A. 1231, at page 1233: "From such facts it is just as conceivable that the redemption and cancellation were essentially equivalent to a dividend as it is that they were not; and, since the respondent has determined that they were, and the burden of proof is on petitioner, we can not affirmatively find that it was not."
Subsection (g) embraces any cancellation or redemption of stock, regardless of whether it was issued as a stock dividend, if it is made "at such time and in such manner" as to make the redemption "essentially equivalent" to the distribution of a taxable dividend. Petitioner relies on certain expressions in earlier cases decided by this Board and the courts, which, if read alone, would seem to support the proposition1937 BTA LEXIS 644">*660 that in order for this subsection to apply there must be an intimate causal relation between the issuance and the redemption of the stock. In 26 B.T.A. 901">Pearl B. Brown, Executrix, supra, for instance, we spoke of the absence of any relation between issuance and redemption and of any evidence of a "continuing plan" or of "artifice" (at page 908); and we used the same or similar language in other cases in justifying a judgment favorable to the taxpayer; see 27 B.T.A. 859">Henry B. Babson, supra, at page 870; T. Pierre Champion,27 B.T.A. 1312">27 B.T.A. 1312; Alfred A. Laun,26 B.T.A. 764">26 B.T.A. 764, at page 770; Rockwood Sprinkler Co.,13 B.T.A. 393">13 B.T.A. 393; James A. Connelly,30 B.T.A. 331">30 B.T.A. 331, at page 336; Louis Rorimer,27 B.T.A. 871">27 B.T.A. 871, at page 878; but what we have said elsewhere and in later cases clearly indicates that motive, while highly important, is not determinative. In Annie Watts Hill,27 B.T.A. 73">27 B.T.A. 73, we said at pages 75, 76:
But the search for a relationship between the issuance of the stock and its redemption, evidencing a continuing, unified plan to distribute surplus, is not the sole test to which1937 BTA LEXIS 644">*661 a distribution, coupled with a redemption, may be subjected, and it may fall within the statute even in the absence of those elements. The statute invites scrutiny of the time and manner of the cancellation or redemption of stock. It makes no requirement that the issuance and redemption be related; indeed, under its terms, the manner of the issuance (whether or not as a dividend) is not material. Consequently, we must also scrutinize the redemption and distribution with respect to the time and manner when they occur, and the circumstances surrounding them at that time. With that in mind, it is quite apparent that a redemption and distribution may fall within the statute although at the time the stock was issued there was no intention to redeem it later as a means of surplus distribution, or plan to avail of such method as a device by which to circumvent the usual tax upon dividends.
See also 28 B.T.A. 1231">George Hyman, supra, at page 1234, and Elwood W. McGuire,32 B.T.A. 1075">32 B.T.A. 1075. The Circuit Court (7th Cir.), in affirming the latter case reaffirmed this principle, as follows:
Neither artifice, subterfuge or bad faith need be present to bring a transaction1937 BTA LEXIS 644">*662 within the meaning of the statute here involved for as we read the law 36 B.T.A. 866">*874 a taxpayer may well act with the utmost good purpose and without evil intent and yet his transactions may in effect be the equivalent of the distribution of a taxable dividend.
In the light of these cases the fact that we are unable to find any relation here between the issuance of the stock to petitioner in 1925 and the redemption of the 843 shares on December 31, 1932, or any "continuing plan" or "artifice" does not determine the matter.
Nor does the fact that the redemption was not pro rata, and affected only the petitioner, take it out of the class of distributions "essentially equivalent" to dividends. James D. Robinson,27 B.T.A. 1018">27 B.T.A. 1018; 32 B.T.A. 1075">Elwood W. McGuire, supra;Leopold Adler,30 B.T.A. 897">30 B.T.A. 897. Neither need distributions to stockholders be pro rata in order to constitute dividends. Lincoln National Bank, Executor,23 B.T.A. 1304">23 B.T.A. 1304; affd., 63 Fed.(2d) 131; Ennalls Waggaman,29 B.T.A. 473">29 B.T.A. 473; affd., 1937 BTA LEXIS 644">*663 78 Fed.(2d) 721; certiorari denied, 296 U.S. 618">296 U.S. 618; Hugh H. Miller,25 B.T.A. 418">25 B.T.A. 418; dismissed, C.C.A.2d Cir., August 15, 1933. As we said in Shelby H. Curlee,28 B.T.A. 773">28 B.T.A. 773, at page 782, it is not necessary that a redemption to come within the definition of subsection (g) must meet all the legal requirements of a regular dividend. Nor would the distribution's similarity be destroyed if it were greater than the company's earnings. 28 B.T.A. 1231">George Hyman, supra.Nor does it matter that the stock redeemed was held in the company's treasury and not canceled; 27 B.T.A. 1018">James D. Robinson, supra.And we have held that the return of stock by a stockholder to the corporation in consideration of the cancellation of his debt constitutes a taxable dividend, William C. Huntoon,14 B.T.A. 459">14 B.T.A. 459; General Counsel Memorandum 11304, C.B. XII-1, p. 135.
The respondent, while admitting that no relation exists between the stock issuance and its redemption in 1932, finds the explanation of the transaction in December 1932 in the conference which took place in 1932 between the company's bookkeeper and1937 BTA LEXIS 644">*664 the internal revenue agent in Baltimore, when the latter contended that certain withdrawals made by the petitioner in 1929 and in 1930, similar in all respects to the ones involved in this case, constituted dividends taxable to petitioner in those years. The controversy respecting 1929 income was settled through the correction of an error in bookkeeping which is set out in our findings, but it was conceded by petitioner as to the 1930 withdrawals that they were, in fact, an "informal dividend" and the sum of $13,388.84 was consequently charged on the books of the company as such, and petitioner paid tax on it as a dividend. Petitioner urges that the redemption was motivated by a business purpose. Where both the issuance and the subsequent redemption of stock were dictated by legitimate business purposes, as, for example, where there was an expansion of the corporation's 36 B.T.A. 866">*875 business and a subsequent contraction of its business necessitating a change in its capital structure, we have held in numerous cases that proof of such facts will remove the redemption from the effect of subsection (g); 1937 BTA LEXIS 644">*665 27 B.T.A. 1312">T. Pierre Champion, supra;Alfred E. Fuhlage,32 B.T.A. 222">32 B.T.A. 222; George A. Lembcke,33 B.T.A. 700">33 B.T.A. 700. Cf. Commissioner v. Quackenbos, 78 Fed.(2d) 156; Commissioner v. Cordingly, 78 Fed.(2d) 118. But petitioner has shown no necessity existing in 1932 for contracting the company's business. In fact, in March of that year, by an amendment to its charter, the company was empowered to carry on many new functions not originally contemplated, such as the sale of agricultural products, etc.; a fact which certainly does not support the contention of a contracting business. It is true that the company's gross sales had fallen off sharply from 1931 and that it did not recover its 1932 position until 1934, but in that period of general economic depression this was probably true of most businesses. The petitioner's contention rests solely on the demands which were being made on the company in 1932 by the banks which had lent it money.
In the light of these contentions let us consider briefly the history of the corporation and petitioner's relation to it, with special emphasis, of course, on the facts involved1937 BTA LEXIS 644">*666 in petitioner's transfer of stock to the corporation in 1932.
Petitioner had complete control of the corporation from the beginning. This, in itself, is not decisive, cf. 26 B.T.A. 901">Pearl B. Brown, supra;27 B.T.A. 1312">T. Pierre Champion, supra; but it is nevertheless a significant fact which must not be lost sight of. On December 31, 1932, when the redemption took place, petitioner held 2,910 shares and the two other officers and directors 45 shares each. Exercising the complete control of the company's policy which he did, petitioner found it convenient to borrow large sums from the corporation. At the end of 1929 his debt was $66,679.22, the cancellation of which in 1932, in lieu of the returned 843 shares, is here in question. This sum had risen to nearly $80,000 by the end of the next year, 1930, and had soared to over $95,000 by the end of 1931. Throughout this period the company's earnings had been substantial, varying from over $26,000 in 1925 to nearly $35,000 in 1928. The next year saw a drop to $24,000, and a still further drop to $16,000 in 1930, which rose again to $19,000 in 1931, only to fall to a new low of $5,000 in 1932.
1937 BTA LEXIS 644">*667 Throughout this period of the company's substantial earnings and of large withdrawals by petitioner, very few dividends were declared. This is a fact of the first importance, for a survey of the cases clearly shows that the regularity of cash dividend distributions has been more than once dwelt upon by this Board and the courts as demonstrating that a particular stock redemption did not have a dividend 36 B.T.A. 866">*876 character. Cf. 27 B.T.A. 859">Henry B. Babson, supra, at pages 861-870; 27 B.T.A. 1312">T. Pierre Champion, supra: "Such a record is not compatible with a studied intent to avoid tax." (P. 1320.) Here only two formal cash dividends were made, the one a 10 percent dividend of $30,000 on December 10, 1929, and the other a 3 percent dividend of $9,000 on December 31, 1932. The accumulated surplus as shown on the company's books was $65,167.91 by December 31, 1932. However, the minutes of the board of directors of the corporation on December 31, 1932, state definitely that the company had "a surplus in excess of the purchase price of said shares", which was $66,679.22. The only dividend other than the two already mentioned was the "informal" dividend of $13,388.34 entered1937 BTA LEXIS 644">*668 on the books in 1932, but as of December 31, 1930, the reason for which has already been set out. It was a withdrawal by petitioner, treated by the Commissioner as a taxable dividend, conceded by petitioner to be such, and, therefore, afterwards entered on the books as an "informal" distribution.
The petitioner, who was a majority stockholder, and to all intents and purposes sole stockholder, made a practice of availing himself during the period from 1926 to 1932 of the accumulated earnings of the corporation by the indirect method of borrowing, and borrowing without even the formality of interest paid on the open account or on such part of his debt as was covered by notes. At the same time we see the company possessed on December 31, 1932, of a substantial surplus, but making very few distributions of it by way of cash dividends. At this juncture, on December 31, 1932, petitioner surrendered 843 shares of his stock to the company and had his 1929 debit balance of $66,679.22 canceled. He had owned 2,910 shares of a total 3,000; he now owned 2,067 of a total 2,157. His position as majority stockholder had not changed materially.
With regard to the contention of petitioner1937 BTA LEXIS 644">*669 that the transaction directly involved here was solely motivated by pressure from the banks, these facts are pertinent.
At the end of 1930 and again at the end of 1931 the company had no outstanding indebtedness. In February 1932 it obtained a loan of $25,000 from a Baltimore bank and another loan of the same amount from another Baltimore bank in May. Notes were given by the company for these loans, which petitioner endorsed. No pressure for repayment was made by the banks in the summer of 1932, but, petitioner testified, the Equitable Trust Co., which held one of the notes, called him up several times in the fall of that year and asked for payment. The note payable to this bank was, accordingly, curtailed by $5,000 in November and renewed. It was paid off in March 1933, and the other note, payable to the Union Trust Co., was paid in May, so that after May 1933 the company owed no money. It borrowed 36 B.T.A. 866">*877 no more until November 1933. The only evidence of any "pressure" being brought to bear by the banks on the company is petitioner's testimony that one of the banks called him up several times, and that it regarded unfavorably his large debt to the company. Petitioner, 1937 BTA LEXIS 644">*670 it should be recalled, was endorser on the company's notes, and was himself solvent, and considered the company solvent without regard to his indebtedness. There is no evidence of any demand for the reduction of capital, nor is it shown how the company's financial condition would be bettered by such reduction. We are unable to see how the company was so financially distressed in 1932, able as it was to pay off its loans out of earnings in 1933, that it would have found it necessary to heed the bank's indefinite suggestions in 1932. In support of this argument, petitioner relies strongly on 26 B.T.A. 1025">Harry A. Koch, supra.The following quotation from out opinion in that case sufficiently well states the facts and indicates the wide divergence of the situation there considered from that present here.
The purpose is made clear by the evidence. In 1928 the corporation owed the First National Bank of Omaha about $149,000 on loans. The bank was dissatisfied with the financial statement rendered to support the loan and insisted that it be improved by a reduction of the corporation's outstanding capital stock by $38,000. To comply with this demand, and for no other reason, 1937 BTA LEXIS 644">*671 the corporation adjusted its capital structure in the manner set forth in our findings, which change satisfied the bank in every particular and enabled the corporation to continue its line of credit with the bank.
The habit of petitioner's withdrawing regularly large sums from the corporation, coupled with the sparseness of its cash dividends, notwithstanding an ample surplus in each year up to 1932; the failure to show any reason for the company's contracting its capital account at a time when its charter amendment might suggest, on the contrary, an expansion of the business; the failure to show and business advantage to the company from such a redemption; the failure to show any serious, or even any financial embarrassment other than such as might result from a general reduction of its business, a situation readily attributable to the general economic depression; the failure to show any pressure by its bank creditors to alter the capital structure of the company or its inability to meet its obligations to them without such alteration; the failure, in short, on the part of petitioner to put forward and convincing affirmative reason for the redemption other than the motive apparent1937 BTA LEXIS 644">*672 on the record of tax evasion, convinces us that the redemption of the 843 shares of the Natwick Co.'s stock on December 31, 1932, was essentially equivalent to a taxable dividend within the meaning of section 115(g) and should be, accordingly, so treated.
Reviewed by the Board.
Judgment will be entered under Rule 50.
Footnotes
1. SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
(a) DEFINITION OF DIVIDEND. - The term "dividend" when used in this title (except in section 203(a)(4) and section 208(c)(1), relating to insurance companies) means any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913.
(b) SOURCE OF DISTRIBUTIONS. - For the purpose of this Act every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits. Any earnings or profits accumulated, or increase in value of property accrued, before March 1, 1913, may be distributed exempt from tax, after the earnings and profits accumulated after February 28, 1913, have been distributed, but any such tax-free distribution shall be applied against and reduce the basis of the stock provided in section 113.
(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. In the case of amounts distributed in partial liquidation (other than a distribution within the provisions of section 112(h) of stock or securities in connection with a reorganization) the part of such distribution which is properly chargeable to capital account shall not be considered a distribution of earnings or profits within the meaning of subsection (b) of this section for the purpose of determining the taxability of subsequent distributions by the corporation.
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(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.
(h) 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. 27 B.T.A. 859">Henry B. Babson, supra;26 B.T.A. 901">Pearl B. Brown, Executrix, supra;T. Pierre Champion,27 B.T.A. 1312">27 B.T.A. 1312; affd., 78 Fed.(2d) 513 (C.C.A., 6th Cir.); Girard Trust Co. et al., Administrators,32 B.T.A. 926">32 B.T.A. 926; August Horrmann,34 B.T.A. 1178">34 B.T.A. 1178; Harry A. Koch,26 B.T.A. 1025">26 B.T.A. 1025; Alfred A. Laun,26 B.T.A. 764">26 B.T.A. 764; Commissioner v. Rockwood, 82 Fed.(2d) 359, affirming B.T.A. (C.C.A., 7th Cir.); Salt Lake Hardware Co.,27 B.T.A. 482">27 B.T.A. 482; Commissioner v. Cordingly, 78 Fed.(2d) 118 (C.C.A., 1st Cir.), affirming B.T.A.; Commissioner v. Quackenbos, 78 Fed.(2d) 156 (C.C.A., 2d Cir.), affirming B.T.A.; James A. Connelly,30 B.T.A. 331">30 B.T.A. 331, appeal dismissed February 26, 1936 (C.C.A., 3d Cir.); Commissioner v. Ahlborn, 77 Fed.(2d) 700, affirming B.T.A. (C.C.A., 3d Cir.); Parker v. United States, 88 Fed.(2d) 907 (C.C.A., 7th Cir.), reversing District Court; Louis Rorimer,27 B.T.A. 871">27 B.T.A. 871; Robert H. Meyer,27 B.T.A. 44">27 B.T.A. 44; Alfred E. Fuhlage,32 B.T.A. 222">32 B.T.A. 222; George A. Lembcke,33 B.T.A. 700">33 B.T.A. 700; Rudolph Boehringer,29 B.T.A. 8">29 B.T.A. 8; William C. Huntoon,14 B.T.A. 459">14 B.T.A. 459; James D. Robinson,27 B.T.A. 1018">27 B.T.A. 1018; affd., 69 Fed.(2d) 972 (C.C.A., 5th Cir.); Shelby H. Curlee, Trustee,28 B.T.A. 773">28 B.T.A. 773; affd., subnom. Randolph v. Commissioner, 76 Fed.(2d) 472; certiorari denied, 296 U.S. 599">296 U.S. 599; George Hyman,28 B.T.A. 1231">28 B.T.A. 1231; affd., 71 Fed.(2d) 342; certiorari denied, 293 U.S. 570">293 U.S. 570; Elwood W. McGuire,32 B.T.A. 1075">32 B.T.A. 1075; affd., 84 Fed.(2d) 431; certiorari denied, 299 U.S. 591">299 U.S. 591; Brown v. Commissioner, 79 Fed.(2d) 73, affirming B.T.A. (C.C.A., 3d Cir.); Annie Watts Hill,27 B.T.A. 73">27 B.T.A. 73; affd., 66 Fed.(2d) 45 (C.C.A., 4th Cir.); Leopold Adler,30 B.T.A. 897">30 B.T.A. 897; affd., 77 Fed.(2d) 733 (C.C.A., 5th Cir.); C.A. Goding,34 B.T.A. 201">34 B.T.A. 201; Arthur M. Godwin,34 B.T.A. 485">34 B.T.A. 485↩.