*970 A distribution by a corporation to its shareholders in the course of a general plan to wind up the business as soon as it can best be done is held in all the circumstances to be a liquidation distribution, notwithstanding the continued, but narrowing, operation of the business.
*216 Respondent determined the following deficiencies in petitioners' income taxes for 1928:
| Tecla M. Straub | $14,300.97 |
| Frederick Hertenstein | 5,571.72 |
| Carolyn L. Moser | 14,235.34 |
| Freda M. Hertenstein | 14,828.68 |
In making these determinations he added to the reported income of each petitioner that part of a dividend received which represented corporate earnings accumulated since March 1, 1913. Petitioners contend that the amounts distributed were in partical liquidation of their shares, and should not be treated as an ordinary dividend.
*217 FINDINGS OF FACT.
Petitioners Frederick Hertenstein, Carolyn L. Moser and Freda M. Hertenstein are residents of Cincinnati, Ohio; petitioner*971 Tecla M. Straub is a resident of Canonsburg, Pennsylvania. During 1928 they were the owners of all the outstanding capital stock (except one share) of the Charles Moser Co., a corporation engaged in the sale and manufacture of paints. They are the daughters and son-in-law of Charles Moser, founder of the business, who conducted it as a partnership until 1893, when it was incorporated under the laws of Ohio with a capital stock of $250,000, of which 490 shares of a par value of $500 each were issued. On November 29, 1922, the capital stock was increased to $500,000, a 100 percent stock dividend was declared, and 980 shares of a par value of $500 were issued and outstanding. Moser was the active head of the business until his death on May 11, 1924, at the age of 91. The company's paints were manufactured by his formulae, which he changed from time to time in meeting competition. After his death the old formulae were followed, but no new ones were introduced. Several important employees who died during 1924 were not replaced, and thereafter business began to decrease. The company's 80 colors of paint were reduced to 50, and complaints about quality were frequently received from*972 customers.
After Moser's death the shareholders discussed what should be done with the business, and decided to have the company purchase the shares belonging to certain widows of former employees for $500 each. In this manner the company acquired 180 shares of its stock prior to November 12, 1928, and retained them in its treasury. The remaining shares were then held as follows:
| Shares | |
| Tecla M. Straub | 233 |
| Frederick Hertenstein | 100 |
| Carolyn L. Moser | 233 |
| Freda M. Hertenstein | 233 |
| Carl F. Hertenstein | 1 |
| Total | 800 |
In 1906 Frederick Hertenstein had acquired 50 shares for $500 each, which were doubled by the stock dividend of 1922. The other petitioners had each acquired 50 shares on April 10, 1917, and 50 shares on April 2, 1919, by gift from their father, these shares being likewise doubled by the stock dividend, and 33 shares on May 24, 1924, by bequest from their father's estate. The fair market value of each share of stock in the Charles Moser Co. was $550 on March 1, 1913, $1,000 on April 10, 1917, $1,050 on April 2, 1919 and $535 on May 11, 1924.
On November 12, 1928, the company's board of directors resolved that the 180 treasury shares*973 be retired and canceled; that the outstanding *218 capital stock be reduced from $490,000 to $400,000, divided into shares of $500 each; and that the president and secretary file a certificate of such reduction with the Secretary of State. This certificate was filed November 27, 1928.
On November 12, 1928, the company sold certain real estate, known as The Ninth Street Property, to Moser's three daughters, petitioners herein, for $220,000 in cash. This property had been acquired by Moser in 1903 at a cost of $220,000, and was rented to the company at 4 percent of the cost, plus taxes. On April 10, 1917, Moser conveyed it to his three daughters, and on November 29, 1922, they conveyed it to the Charles Moser Co. under a contract whereby the company undertook to reconvey it to the daughters for $220,000 upon a two-year notice of their intention to purchase. The sale in 1928 was made pursuant to this agreement.
At a special meeting of the Moser Co.'s stockholders, held December 17, 1928, the president stated that the company had on hand $220,000 from the sale of the above property, $75,559.27 cash in bank, and government and municipal bonds of the par value of $76,000, *974 for which the Western Bank & Trust Co. had offered $75,723.04. He stated further that the company had no debts, and that the money and bonds "were not necessary for the operation of the business and it was his judgment that a distribution might be made to the stockholders." Thereupon the stockholders adopted a resolution which recited that the aggregate of the three amounts, $371,282.31, was not needed in the operation of the business, and that "$360,000 could easily be distributed without inpairing the efficiency and operation of the business," and the officers were directed to sell the bonds, withdraw the bank account and establish a fund of $360,000. It was further resolved that:
* * * a partial liquidation dividend of ninety per cent (90%) of the par value of the capital stock of $400,000 now outstanding be paid to the stockholders, thereby reducing the par value of each share from Five Hundred ( $500) Dollars to Fifty ( $50) Dollars per share, and * * * that a notation be placed upon the outstanding stock certificates representing said $400,000 of capital stock, stating that a partial liquidating dividend of ninety per cent (90%) of the par value has been paid, and that the*975 par value of each share has been reduced from Five Hundred ( $500) Dollars to the amount of Fifty ( $50) Dollars, * * *
The officers were then directed to distribute the fund of $360,000 to the shareholders, as follows:
| Freda M. Hertenstein | $104,850 |
| Carolyn L. Moser | 104,850 |
| Tecla M. Straub | 104,850 |
| Frederick Hertenstein | 45,000 |
| Carl F. Hertenstein | 450 |
| 360,000 |
*219 At the shareholders' direction a "certificate of Amendment to Articles of the Charles Moser Company," containing the above resolution, was filed with the Secretary of State of Ohio on February 1, 1927.
The stockholders surrendered their respective certificates of $500 par value stock; the company stamped across the face of each a notice showing reduction in par value from $500 to $50 a share, and reissued the stamped certificates on December 22, 1928, to the identical parties in the precise number of shares shown in the certificates surrendered.
When the 100 percent stock dividend was declared on November 30, 1922, the company had accumulated surplus of $350,620.99, which was reduced by the $245,000, then capitalized, to $105,620.99. The company operates on a fiscal year basis ending*976 November 30. On December 17, 1928, its earnings accumulated since March 1, 1913, amounted to $329,002.41, which was 91.3897 percent of the dividend of $360,000 paid on that date; the remaining $30,997.59 distributed, representing 8.6103 percent of the dividend, was paid from other than earnings. The company's surplus was then $203,976.28. After payment of the dividend the company still had a stock of paints, machinery and fixtures, accounts receivable and cash and a lease on The Ninth Street Property which it has renewed from year to year. It has continued doing business in the same place, manufacturing and selling paints as before, and has continued its agency in New York City, but the volume of its business and stock of merchandise have decreased, although not rapidly. The value of its inventory dropped from $130,000 in 1928 to $90,000 in 1933. While it still manufactures paints, its stock has not been kept complete and the variety of its colors has been reduced to 25. Since 1928 its sales, profits and losses have been as follows:
| Sales | Profit or loss | |
| 1928 | $383,230.88 | $22,248.81 |
| 1929 | 350,754.55 | -3,675.04 |
| 1930 | 299,805.55 | -40,622.78 |
| 1931 | 236,730.29 | -51,772.93 |
| 1932 | 175,265.30 | -37,361.31 |
*977 No dividends were declared during these years.
Respondent has added to the reported incomes of Tecla M. Straub, Carolyn L. Moser and Freda M. Hertenstein $95,530.93 in each case, and to the reported income of Frederick Hertenstein $32,552.90, additions representing 91.112 percent of the $360,000 dividend of the Charles Moser Co.
*220 OPINION.
STERNHAGEN: The petitioners assail the respondent's determination that the amounts received by them in 1928 were taxable as ordinary dividends as defined in section 115(a), Revenue Act of 1928 1 and contend, on the contrary, that they were distributions in liquidation within the provisions of subsection (c). If they are held to be, as petitioners contend, distributions in liquidation, the respondent raises the subalternate issue whether they are nevertheless taxable as dividends by virtue of subsection (g). If this contention fails, the fair market value of the petitioners' shares when received on the several dates shown in the findings must be determined for the purpose of establishing the basis for gain or loss as prescribed in section 113.
*978 1. The evidence, in our opinion, establishes that the distribution of 1928 was made in partial liquidation of the corporation's capital stock. This is true notwithstanding the fact that the method was that of reducing the face value of each outstanding share and not that of reducing the number of outstanding shares. There is ample evidence that from 1924, when Moser and several of the experienced employees died, the business declined; that the stockholders were conscious of the decline and were directing the activities of the corporation toward winding up the business with a minimum loss; while the business continued in operation, its scope was steadily narrowed. That it was not immediately discontinued is not, as *221 respondent contends, necessarily an indication that liquidation was not taking place. . It is entirely consistent with a purpose to liquidate that the corporation and its management should continue the operation of the business as long as there was a reasonable justification for their judgment that this was the wisest course. It is entirely compatible that the resolution of December 17, 1928, should*979 correctly designate the distribution as a "liquidation dividend of 90 percent," and at the same time recite that the $360,000 was not necessary in the operation of the business, for it is apparent that such business operations as were sought to be protected were those involved in most successfully winding it up. It is true that the statute, providing for a difference in treatment of dividends, on the one hand, and liquidation distributions, as thus defined, on the other, is likely to create an opportunity for avoiding surtax by reason of the subtle distinctions in the language of the section. This, however, is no ground for refusing to apply the liquidation provisions when the evidence shows that such a distribution has taken place.
2. We are of opinion that the distribution was not "at such time and in such manner as to [be] * * * essentially equivalent to the distribution of a taxable dividend," as provided in subsection (g). This section has already been sufficiently expounded in other decisions of the Board. ; *980 ; ; ; . We think the evidence shows that the distribution of 1928 had no relation to the stock dividend of 1922, but that it was related to a later purpose to liquidate and discontinue the business, and that it was not within the reach of subsection (g).
3. Both parties seek the recognition of widely divergent values for the Moser stock from the evidence of the history and prospects of the corporation upon each of the basic dates, and more particularly the evidence of earnings of the corporation. Both appear to entrust the valuation question to the selection of a mathematical formula for the capitalization of earnings. While this has often been said to be an unsatisfactory foundation for determining value, it must be recognized that with a close corporation such as this there may be little else available. At all events, it is necessary to make a determination of these values in accordance with the preponderance of evidence in the record. Giving all of the evidence full and careful consideration, *981 we have reached the conclusions of value set forth in the findings.
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.
* * *
(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.
* * *
(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. In the case of the cancellation or redemption of stock not issued as a stock dividend this subsection shall apply only if the cancellation or redemption is made after January 1, 1926.