1947 U.S. Tax Ct. LEXIS 99">*99 Decision will be entered under Rule 50.
Petitioner is a New York corporation, engaged in the business of advertising agency. It has no stockholders except employees. Its staff consists largely of creative writers, artists, and radio directors, upon whose work the success of the business depends. Petitioner's stockholders, upon its organization in 1928, donated to its treasury 20 per cent of the shares initially issued to them for the purpose of having shares of stock available for issuance to employees who demonstrated talent and ability and who contributed to the success of the business. Petitioner, after its organization, also purchased stock from some of its stockholders, which it carried as treasury stock. All purchases and sales were made at book value. There was no negotiation as to price. In 1939 and 1941, under its plan of operation, petitioner sold some of this treasury stock to its employees at a price which showed a gain. Held, that the corporation was not dealing in its own shares as it might have dealt in the shares of another corporation within the meaning of section 19.22 (a)-16 of Regulations 103 and petitioner is not taxable on the gain which the Commissioner1947 U.S. Tax Ct. LEXIS 99">*100 has determined.
9 T.C. 448">*449 This proceeding involves deficiencies in petitioner's income tax for the taxable years 1939 and 1941, declared value excess profits tax for the year 1939, and excess profits tax for the year 1941, as follows:
| 1939 | 1941 | Total | |
| Income tax | $ 15,882.18 | $ 4,001.48 | $ 19,883.66 |
| Declared value excess profits tax | 5,335.56 | 5,335.56 | |
| Excess profits tax | 5,492.74 | 5,492.74 |
The deficiencies result from several adjustments made by the respondent in the income tax returns filed by petitioner for the years in question. The only adjustment for 1939 which petitioner contests is adjustment (a), which consisted of adding $ 88,925.99, as1947 U.S. Tax Ct. LEXIS 99">*101 "gain on the sale of treasury stock," to the net income reported by petitioner on its return. The Commissioner explained this adjustment in his deficiency notice as follows:
(a) It is held that a net gain of $ 88,925.99 was realized from sales of 11,591 shares of treasury stock and that such gain is properly includible in gross income.
The only adjustment for 1941 which petitioner contests is adjustment (d), which consisted of adding $ 4,769.15, as "gain on the sale of treasury stock," to the net income reported by petitioner on its return. The respondent explained this adjustment in his deficiency notice as follows:
(d) It is held that a net gain of $ 4,769.15 was realized from sales of 7,877 shares of treasury stock and that such gain is properly includible in gross income.
Petitioner, by appropriate assignments of error, contests the correctness of these adjustments. The case was submitted upon a stipulation of facts, exhibits, and oral testimony. The facts stipulated are so found. Other facts are found from the evidence.
FINDINGS OF FACT.
The petitioner is a New York corporation, organized in 1928, with an authorized capital stock of 50,000 shares without par value and all1947 U.S. Tax Ct. LEXIS 99">*102 of one class. The returns for the periods here involved were filed with the collector for the third district of New York. Petitioner's business is that of an advertising agency. The petitioner's staff, apart from the usual clerical and similar employees, consists largely of skilled creative writers, artists, and radio directors, upon whose work the success of the business depends.
Upon the organization of the petitioner in 1928 it issued 50,000 shares, its entire capital stock. Simultaneously each stockholder 9 T.C. 448">*450 donated to the petitioner's treasury 20 per cent of the shares initially issued to him. The aggregate number of shares so contributed to the petitioner's treasury by its stockholders was 10,000 shares. The reason for this transfer to the treasury was to have shares of stock available for issuance to other employees who demonstrated talent and ability and to insure their loyalty and retention in the firm.
Shares of stock were allotted and sold to these employees from time to time upon the recommendation of the department heads and approval by the petitioner's executive committee. Commencing in 1939, the purchasers of stock gave a note for the purchase price and1947 U.S. Tax Ct. LEXIS 99">*103 the stock was left with petitioner as security for the note. Dividends on the stock held as collateral were to be used, first, to pay interest on the note and, second, to pay on the principal of the note. It was also provided that every pay day (the 15th and 30th or 31st of each month) petitioner was to deduct from the employees' salary check an amount not less than 20 cents a share on the number of shares purchased or the amount of not less than $ 4.80 per share per annum, which was to be applied on the principal of the note. As soon as payments on the principal of the note equaled the purchase price of one or more full shares, the number of shares thus paid for was to be released to the purchaser, if so requested. The application form for purchase of stock provided in part as follows:
I shall have the right to cancel the unpaid balance of my note whenever I please at any time up to seven years from the date thereof by reselling to the company, at my original cost, the shares held by you as collateral for my note at the time I elect to resell . . . but this resale right shall not apply to shares actually paid for as per item 7 above. Nor, in event of termination of my employment1947 U.S. Tax Ct. LEXIS 99">*104 for any reason other than death, shall this right apply to shares then unpaid for, as to which shares and in which event you shall have the right to repurchase at my original cost.
The petitioner also purchased shares from stockholders or their estates pursuant to the stockholders' agreement dated March 3, 1933, which provided in part as follows:
2. In event any Stockholder who is an officer or employee of the Corporation resigns or dies or is discharged, he or his executors or administrators must forthwith offer for sale to the Corporation the shares of stock then registered in his name, and the Corporation within ninety days must buy the shares of such deceased or discharged Stockholder and shall have the right and option within ninety days to purchase the shares of such resigned Stockholder; all on the terms for payment and other conditions hereinafter set forth and at a price determined in the manner hereinafter described.
3. Upon obtaining the written consent of the Corporation, any Stockholder may at any time sell a part of the shares held by him to any other Stockholder or to the Corporation at such price and upon such terms and conditions as may be approved by the Corporation. 1947 U.S. Tax Ct. LEXIS 99">*105 No stockholder may sell any part or the whole of the shares of stock registered in his name without the written consent of the Corporation unless he shall have first offered such shares for sale to the Corporation9 T.C. 448">*451 and the Corporation shall have not exercised the option hereby granted it to purchase the same within ninety days after receipt of said offer in writing on the terms for payment and other conditions hereinafter set forth and at a price determined in the manner hereinafter described; but if the Corporation does not exercise said option to purchase, such shares of stock shall, after said ninety days, be free from all the terms and provisions of this agreement but shall nevertheless continue to remain subject to any voting trust agreement then in effect respecting them.
All purchases and sales of stock by the petitioner were made at book value. There was no negotiation as to price and the petitioner did not attempt to choose a time favorable to it for the purchase or sale of stock. All of the petitioner's outstanding capital stock is owned by the employees or trustees for employees and all shares of stock are held subject to the stockholders' agreement to which1947 U.S. Tax Ct. LEXIS 99">*106 petitioner and all its stockholders are parties. At the end of 1939, 78 employees were stockholders and, at the end of 1941, 110 employees were stockholders. These shares were widely distributed among the employees. The shares were not listed on any stock exchange and there is no "over the counter" market for the stock.
The petitioner did not at any time carry treasury stock as an asset on its books or on its balance sheet. Treasury stock was not voted and no dividends were paid on it. No changes were made in petitioner's capital structure by reason of the purchase and sale of treasury stock. During the years 1928 to 1941, inclusive, petitioner acquired, by either purchase or donation, 55,957 shares of its capital stock, which thereby became treasury stock, and during the same period petitioner sold 35,383 shares of this stock, of which 10,000 were donated shares and 25,383 were purchased shares.
During the calendar year 1939 the petitioner sold to officers and employees 11,591 shares of treasury stock at an average price of $ 55.93 per share. Of this amount 5,583 shares were part of the original 10,000 shares donated to its treasury by the stockholders upon its organization1947 U.S. Tax Ct. LEXIS 99">*107 in 1928 and the remaining 6,008 shares represented shares which it had previously purchased at various times from its stockholders. In the deficiency notice the respondent included in petitioner's gross income for the year 1939 the amount of $ 88,925.99 representing the gain on the sale of this stock, including the gain on the sale of the aforesaid 5,583 shares of donated stock which had been donated to the taxpayer's treasury by its stockholders ratably.
There were two principal reasons for the large sales in 1939 of petitioner's stock: First, there was a change in the management of petitioner's business and there was instituted the "stock plan of 1939," whereby additional shares were allotted and sold to employees, and, secondly, petitioner was in need of additional working capital. A representative of the Periodical Publishers Association called on petitioner 9 T.C. 448">*452 and pointed out that petitioner's "net current assets" were low and indicated that it might be recommended to the publishers that petitioner be denied credit and be required to pay its accounts in cash "at the closing date when the magazines went to press." Petitioner always met its accounts payable when due and1947 U.S. Tax Ct. LEXIS 99">*108 always took the customary cash discount of 2 per cent. It was anxious to continue to do so.
During the calendar year 1941 petitioner sold 7,877 shares of stock at an average price of $ 66.74 per share, all of which had been previously purchased at various times from its stockholders. The respondent in the deficiency notice included in petitioner's gross income for the year 1941 the amount of $ 4,769.15 as a gain on the sale of this stock. During this same period petitioner purchased 1,319 shares at an average price of $ 67.30.
Petitioner's gross annual business in 1938, 1939, 1940, and 1941 was $ 17,475,115.17, $ 20,191,368.83, $ 21,685,106.77, and $ 23,546,319.64, respectively. Petitioner's cash on hand on December 31, 1939 and 1941, was $ 850,126.39 and $ 1,096,820.45, respectively.
OPINION.
The issue presented in this proceeding is whether petitioner realized taxable income upon sales in 1939 and 1941 of shares of its own stock.
The parties are in agreement that the applicable regulation is section 19.22 (a)-16 of Regulations 103. 1
1947 U.S. Tax Ct. LEXIS 99">*109 Respondent contends that all of the gain from the sale of petitioner's treasury stock is taxable. He argues that, in view of the extensive activity in petitioner's stock, petitioner was dealing in its own shares "as it might in the shares of another corporation."
Petitioner does not question the correctness of respondent's determination of the amount of the gain in each of the taxable years, if under the applicable statute and regulations it is taxable thereon. It contends, however, that it did not in either of the taxable years deal in its own capital stock "as it might in the shares of another corporation" 9 T.C. 448">*453 and the transactions did not give rise to taxable gain under section 22 (a) of the Internal Revenue Code and the regulation. Petitioner also contends, in the alternative, that, if we should sustain the Commissioner's determination, our so doing should be limited to the shares of stock which petitioner had acquired by purchase and should not apply to the shares of stock which had been donated to petitioner by its stockholders following immediately upon its organization in 1928; that the sale of these latter shares was certainly, in any event, a transaction to raise1947 U.S. Tax Ct. LEXIS 99">*110 needed capital and was not taxable.
We first take up petitioner's main contention. The answer to the question involved therein turns upon whether petitioner in thus dealing in its own capital stock was doing so "as it might in the shares of another corporation." The evidence shows that petitioner was engaged in the advertising agency business and its staff consisted largely of skilled creative writers, artists, and radio directors, upon whose work the success of the business depended. Upon its organization in 1928 it issued its entire capital stock of 50,000 shares to its officers and employees and simultaneously each stockholder donated to the petitioner's treasury 20 per cent of the shares initially issued to him, or a total of 10,000 shares. The purpose of this transfer was to have shares of stock available for issuance to other employees who had displayed talent and ability and to secure their loyalty and to retain them in the firm.
Since its organization, petitioner's stock has been restricted to its employees and has been allotted and sold on the basis of the employees' ability and capacity to contribute to the success of petitioner's business. Petitioner acquired stock 1947 U.S. Tax Ct. LEXIS 99">*111 from time to time from various stockholders who had resigned or were discharged, or their estates in case of death, in liquidation of their interests in accordance with the stockholders' agreement of March 3, 1933. Petitioner on occasion acquired stock from some of its stockholders if they urgently desired to sell. All purchases were made at book value and there was no negotiation as to price. The evidence is to the effect that profit was neither behind the purpose in acquiring these shares nor behind the purpose in distributing them to its officers and employees. Petitioner did not at any time carry treasury stock as an asset on its books or on its balance sheet. The fact that the same stock which had been previously donated or purchased and held in the treasury was used to sell to the employees is not determinative of the question of whether petitioner dealt in its own shares "as it might in the shares of another corporation."
In Brockman Oil Well Cementing Co., 2 T.C. 168, in speaking of the issuance to a stockholder in a capital transaction of the same 12 1/2 shares which had been acquired from a retiring stockholder several 9 T.C. 448">*454 months1947 U.S. Tax Ct. LEXIS 99">*112 prior thereto and had been held by the taxpayer as treasury stock, we said:
If upon acquiring these 12 1/2 shares from Calvert petitioner had canceled and retired them, instead of holding them in its treasury, then there seems but little question that the subsequent issue of the same number of shares to stockholder Swift at their then book value would have been a capital transaction and not taxable under the Treasury regulation quoted above; and we do not think that the fact that it was not done in that way, but in the manner recited in the stipulation of facts, changes the nature of the transaction in so far as the question we have here to decide is concerned and converts it into a transaction where petitioner "deals in its own shares as it might in the shares of another corporation."
We so hold in the instant case.
In Rollins Burdick Hunter Co., 9 T.C. 169, we find many similarities to the instant proceeding. In that case the taxpayer was engaged in business as an insurance broker and was dependent primarily upon the personal efforts, endeavors, and abilities of the principal individuals to carry on its business. Its stock, consisting of 1,000 shares1947 U.S. Tax Ct. LEXIS 99">*113 of no par common, had always been allocated among and held by those individuals according to the capacity of each to contribute personal services to the business, as determined by the judgment of the group. Changes in stockholdings were made to take new individuals into the group, to take up the stock of deceased or retiring members of the group, and to reallocate the shares on the basis of the relative capacities of the shareholders to contribute personal services to the business. The taxpayer also reserved the right to reacquire its stock upon the death or retirement of a stockholder and in any case where there was occasion to dispose of the stock. The taxpayer purchased and sold its stock only pursuant to that plan. In that case we said:
* * * The petitioner had no profit motive in buying or selling, but was merely arranging that its shares should be held, and held only, by those who were its officers and principally responsible, through their personal services, for its success and should be held by them in proportion to their relative abilities to contribute personal services of value to the petitioner. Those purposes could not be accomplished by dealing in any other stock. 1947 U.S. Tax Ct. LEXIS 99">*114 The petitioner did not buy stock and sell it to create employee interest. It bought, as was required by agreement, so that the stock would never get into outside hands but would be used only to indicate ownership in the business by those principally responsible for its success. The purchases and sales readjusted the capital for this purpose only. * * *
We sum up our reasons for thinking that petitioner was not dealing in its own shares "as it might in the shares of another corporation" as follows:
All sales were made on terms that permitted the employee to turn back his shares which were not paid for and were held by petitioner as collateral, at his purchase price at any time within seven years. 9 T.C. 448">*455 No business corporation would deal in the shares of another corporation in that manner as a general method doing business. In our opinion no business corporation dealing in shares of another corporation would invaribly commit itself to repurchase, at book value, the holdings of each and every purchaser upon the death, resignation or retirement of that purchaser. Yet that is what the taxpayer did in the case at bar. This followed from the fact that all outstanding shares are1947 U.S. Tax Ct. LEXIS 99">*115 held subject to the stockholders' agreement. It is stipulated that during the taxable years in question "all purchases and sales were made at book value"; there was no negotiation as to price. The taxpayer did not carry its treasury stock on its books as an asset. The taxpayer did not attempt to choose a time favorable to it for the purchase or sale of shares. For these and other reasons, we do not think petitioner was dealing in its own shares of stock "as it might in the shares of another corporation." We decide this issue in petitioner's favor on authority of Brockman Oil Well Cementing Co., supra;Dr. Pepper Bottling Co. of Miss., 1 T.C. 80; Cluett, Peabody & Co., 3 T.C. 169; and Rollins Burdick Hunter Co., supra.
The respondent, in his brief, relies principally upon Helvering v. Edison Bros. Stores, Inc., 133 Fed. (2d) 575; Brown Shoe Co. v. Commissioner, 133 Fed (2d) 582; Commissioner v. Air Reduction Co., 130 Fed. (2d) 145; and M. Conley Co., 6 T.C. 250.1947 U.S. Tax Ct. LEXIS 99">*116 We think these cases are clearly distinguishable on their facts from the facts of the instant case and are not controlling.
Having decided the main issue in petitioner's favor, it becomes unnecessary to decide its alternative contention.
Decision will be entered under Rule 50.
Footnotes
1. Sec. 19.22 (a)-16. Acquisition or disposition by a corporation of its own capital stock. -- Whether the acquisition or disposition by a corporation of shares of its own capital stock gives rise to taxable gain or deductible loss depends upon the real nature of the transaction, which is to be ascertained from all its facts and circumstances. The receipt by a corporation of the subscription price of shares of its capital stock upon their original issuance gives rise to neither taxable gain nor deductible loss, whether the subscription or issue price be in excess of, or less than, the par or stated value of such stock.
But if a corporation deals in its own shares as it might in the shares of another corporation, the resulting gain or loss is to be computed in the same manner as though the corporation were dealing in the shares of another. So also if the corporation receives its own stock as consideration upon the sale of property by it, or in satisfaction of indebtedness to it, the gain or loss resulting is to be computed in the same manner as though the payment had been made in any other property. Any gain derived from such transactions is subject to tax, and any loss sustained is allowable as a deduction where permitted by the provisions of the Internal Revenue Code.↩