Opinion
Docket No. 5535.
Promulgated December 28, 1945.
1. Congress in 1942 repealed the provision taxing the gain from amounts distributed in partial liquidation as short term capital gain, without making the repeal retroactive. Held that, since Congress did not make the repeal retroactive, we can not do so by construction; held, further, that the separate entity of a corporation in which the petitioner was a stockholder may not be disregarded. Moline Properties, Inc. v. Commissioner, 319 U.S. 436.
2. Petitioner, who was president and general manager of a corporation in which she owned one-half the stock, instituted foreclosure proceedings against the corporation with respect to certain mortgages it had given her as security for advances. The owners of the other half of the stock intervened as defendants. Pursuant to the terms of an agreement by which the litigation was settled, the corporation sold certain of its lands, paid its indebtedness and certain expenses, distributed one-half of the remaining proceeds among its stockholders in partial liquidation, and distributed one-half of its remaining lands to petitioner, who surrendered to it her one-half of its stock. Held, that the cash and lands distributed to petitioner constituted distributions in partial liquidation of the corporation and that the full amount of the gain recognizable thereon is to be taken into account in computing her net income.
J. Mark Wilcox, Esq., and Paul J. Weiss, C. P. A., for the petitioner.
Edward L. Potter, Esq., for the respondent.
The respondent determined a deficiency of $32,827.36 in the petitioner's income tax for 1940. The only issue presented is whether the respondent erred in determining that the surrender of 12 1/2 shares of the capital stock of the Girard Realty Co. for one-half of the corporate assets constituted a partial liquidation of the corporation and the gain realized was a short term capital gain, the entire amount of which was subject to taxation.
FINDINGS OF FACT.
Petitioner is an individual, residing in Miami, Florida. Her income tax return for the year 1940, on a cash basis, was filed with the collector of internal revenue for the district of Florida.
Prior to 1932 petitioner's husband, J. B. Jeffries, and William L. Austin each owned 12 1/2 of the 25 shares of the common stock of Girard Realty Co., a corporation. The corporation had been organized by them and a third party to own and sell lands in the Everglades section of Florida, and subsequent to formation and prior to 1932 it had disposed of 55,000 acres. In 1932 Austin died and his estate, which was administered in Pennsylvania, succeeded to the shares owned by him. Thereafter, on February 8, 1936, Jeffries, still owning his shares, died.
After the death of Jeffries a "wash" sale of the 12 1/2 shares of Girard Realty Co. stock was made to a friend to protect the estate from a large claim made against it. The purchase price of $2,500 ($2,750?) was furnished by petitioner. Subsequently, upon settlement of the claim, the stock was transferred to petitioner in 1937. $2,750 has been accepted by both parties as petitioner's basis for the computation of gain or loss upon the disposition of the property.
During the years following the death of Jeffries until 1940 the assets of Girard Realty Co. consisted of undeveloped lands situated in Florida which were held for sale, but none of which, so far as appears, were sold during that time. While some rent was received, it was not nearly sufficient to pay the taxes on the land.
From and after 1937 the petitioner was president of the company and the active manager of its affairs. The heirs of Austin and the executrices of his estate (sometimes hereinafter referred to as the Austins), not maintaining any representation on the board of directors or among its officers, left everything relating to the company to the petitioner.
Taxes having accumulated against the lands and the company being without funds to pay them, the petitioner called upon the Austins to contribute towards their payment. They refused and petitioner advanced the money for paying the taxes, taking mortgages from the company on its property to secure the sums advanced. On January 24, 1940, the petitioner filed against the company a bill in chancery in the Circuit Court of the Fifteenth Judicial Circuit of Florida, in and for Palm Beach County, for the foreclosure of the mortgages. On February 5, 1940, a decree pro confesso was entered against the company. On the same day the Austins petitioned to be allowed to intervene as defendants in the proceeding and to file an answer. On February 19, 1940, the petition was granted, their answer was filed, the pro confesso decree was vacated, and the plaintiff was allowed 10 days to plead to the answer. It was alleged in the answer that the plaintiff had been guilty of fraud and that the mortgages were not valid. It was also alleged that the company had not filed a corporation report with the Secretary of State for the State of Florida for 1938 and 1939, as required by law, and that such failure had forfeited or suspended its corporate and charter privileges. The intervenors requested, among other things, that "an accounting be had under the direction of this Court to determine the actual amounts, if any, due plaintiff and the nature and extent of the assets and liabilities of the corporation," and further that "a Receiver be appointed for said corporation to take custody of said assets and to assume the management and control of said corporation and its affairs under the direction of this Court, for the purpose of liquidating the assets of said corporation, paying its indebtedness and protecting the interests of stockholders thereof, and Intervenors further pray that this foreclosure may be stayed pending said Receivership."
Thereafter negotiations for a settlement of the litigation were entered into by petitioner and the Austins. On or about March 27, 1940, they agreed upon a settlement of the issues. The agreement signed by them fixed the value of certain sections of the land which were to be sold for the purpose of raising funds to take care of the expenses of the litigation and to pay petitioner the amount advanced by her for the payment of taxes, etc.; stated that it was the desire of the Austins "to obtain one-half (1/2) of the net proceeds from said sale in cash, whereas party of the first part [petitioner] desires her proportion thereof in mortgages"; specified the disbursements to be made; and recited inter alia: "That the parties hereto agree that it is desirable forthwith to enter upon negotiations for a fair division of the remaining lands of Girard Realty Company on a pro rata basis among all stockholders and that they will attempt, on or before settlement day, to arrive at an agreed plan for a fair division." It was further provided that, in the event the parties could not agree upon a division of the lands, three nominees would be appointed who would make a division which would be binding upon all.
The original agreement providing for complete liquidation of the company was drafted by the attorneys in Florida and forwarded to Philadelphia for execution by the Austins. Before executing the contract representatives of the estate redrafted it, inserting a provision that the Girard Realty Co. should not be completely liquidated or dissolved nor the lands allocated to the Austins be transferred to them by the Girard Realty Co. "except upon such terms and at such time as the Austins may specify in writing, but no failure on the part of the Austins to authorize or approve the distribution to them of the lands allocated to them * * * shall be construed to qualify or limit the right of Mrs. Jeffries to have distributed to her the lands allocated to her upon surrender by her to Girard Realty Company of the stock held by her on the basis of which such pro rata division was originally determined."
The agreement, as changed, was signed by the Austins on March 25 and March 26, 1940, and forwarded to Florida for execution by petitioner. When presented to her she refused to sign it. It was her understanding that there was going to be a complete dissolution of the company and she objected to the Austins retaining title in the name of the corporation. She was told that the Austin estate wished to retain the title in the name of the corporation for its convenience, because the estate was in the process of administration. She was assured by her attorneys and an advisor in income tax matters that the retention of the corporation by the Austins would in no wise affect her legal or income tax status. Upon this assurance she executed the agreement on March 27, 1940.
The Girard Realty Co. was not a party to the negotiations between petitioner and the Austins for the division of the land held by it. The settlement was arrived at by the parties in interest as a division of the property to which the company held title and as a settlement of the foreclosure suit which had been instituted by petitioner. On March 28, 1940, a stipulation for dismissal of the proceeding was signed by the attorney for petitioner and the attorneys for the Austins. On April 3, 1940, the cause was dismissed by order of the court.
At a called meeting of the board of directors of the Girard Realty Co. on April 4, 1940, previously prepared minutes, containing resolutions providing for confirmation of the settlement theretofore agreed upon by petitioner and the Austins, were adopted. A copy of these minutes was given to petitioner after the meeting. The minutes contained, among other things, the following:
Mr. Russell Morrow, one of the attorneys for the Austins surrendered stock certificate #8 for 12 1/2 shares issued to Wm. L. Austin, Jr., with the request that the same be reissued to Mary Austin and Rebecca J. Austin, as Executrices of the Estate of William L. Austin, deceased, and the same being duly indorsed by the record owner, the proper officers were instructed to comply with said request.
The minutes then set out a rather involved accounting, the result of which was that petitioner paid the company $10,093.30 in cash which, together with the advancements previously made by her for taxes, etc., entitled her to receive the mortgages executed by the purchaser, aggregating $45,249.38. The $15,083.12 paid by the purchaser of the lands in cash, plus the $10,093.30, or $25,176.42 was disbursed: $12,974.80 to the Austins and the remainder to attorneys and auditors and for other expenses, "all of which was embodied in the agreement of stockholders." The net effect of the accounting, after adjustment of another item, was that petitioner and the Austins each received $12,951.69 in cash or property, the attorneys and auditors received $12,201.62, petitioner was reimbursed for advancements aggregating $22,181.27, and petitioner received one-half of the then remaining lands of the company. The value of the lands so received was $87,802. The Austins became entitled to receive the other half of the lands having approximately the same value.
The cash allocated to the Austins ($12,951.69) was paid over to them. The title to the lands not transferred to petitioner remained in the corporation. The minutes, after reciting the details of the accounting and authorizing the corporation to release petitioner from all claims against her, state:
The Chairman then stated that, in accordance with the agreement heretofore adopted by the company, it was necessary for Mrs. Jeffries and the Austins to determine a fair division of the remaining lands of Girard Realty Company and to arrive at a fair division. She stated that it appeared that it was possible to arrive at a fair division and that she desired to have distributed to her 1/2 of the lands now remaining in the company. She also stated that she had been advised that the Austins did not wish a direct conveyance but wished to leave their lands in the company and to retain their stock. The Board decided that upon Mrs. Jeffries determining which lands she wished deeded to her and upon securing a letter from the Austins' representative that they were agreeable to such a division, that then in that event a deed should be issued to her forthwith, and it was, upon motion duly made, seconded and unanimously carried.
RESOLVED that the Vice-President and Secretary of this company be and they are hereby authorized and directed to execute a Warranty Deed for and on behalf of this company and in favor of Lillian M. Jeffries to such lands of this company as the said Lillian M. Jeffries shall direct; provided, however, that the said Mrs. Jeffries shall at the time of her demand for such deed deliver over to said officers of this company a statement in writing from the Austins' representatives that the lands so demanded by Mrs. Jeffries are agreeable to them as a fair division of this company's lands.
IT BEING FURTHER RESOLVED by this company that at the time of the issuance of the deed to Mrs. Jeffries, she shall surrender to the Treasury of this company for cancellation the 12 1/2 shares of stock of this company which she holds in her name.
Thereupon, after due discussion, it was, upon motion duly made, seconded and unanimously carried,
RESOLVED that the moneys, to-wit: the sum of $12,974.81 paid to Lillian M. Jeffries, and the sum of $12,974.80 paid to the Austins, be and the same are hereby determined to be a return of capital investment and in no sense are the same to be considered a dividend out of profits of the company.
IT BEING FURTHER RESOLVED that the consideration for the issuance of the deed hereinabove referred to to Mrs. Jeffries be and the same is hereby determined to be in exchange for the surrender and cancellation of the stock so held by the said Lillian M. Jeffries.
IT BEING FURTHER RESOLVED that the payment of the moneys and the issuance of the deed as in this resolution referred to be and the same are hereby determined to have been made for the purpose of liquidating and dividing the assets of this company.
* * * * * * *
Petitioner was given a deed, executed by the Girard Realty Co., for the portion of the property which she was to receive under the agreement with the Austins. This deed recited: "That the said party of the first part [Girard Realty Co.] for and in consideration of Ten Dollars and other valuable considerations * * * has granted, bargained, sold" etc., to the party of the second part [petitioner] the lands described therein. Upon the delivery of the deed to petitioner she surrendered her stock (12 1/2 shares) in the Girard Realty Co.
After receipt of the deed petitioner caused the property conveyed to her to be appraised by an appraiser of the Federal Land Bank of Palm Beach County, Florida. Upon receipt of the appraisal she felt that the value placed on the property was too low and had it increased to an amount in keeping with her idea of its value. The value so fixed has been accepted by the respondent as the value of the property received by petitioner.
In her income tax return for 1940 petitioner reported the gain on the property transferred to her as a long term capital gain, 50 percent of which was taken into account in computing her net income. The tax shown to be due was paid. The Commissioner determined that the gain resulted from a distribution in partial liquidation of the Girard Realty Co., and therefore that it is to be "considered as a short-term capital gain," 100 percent of which is to be taken into account in computing net income.
OPINION.
Under section 115 (c) and (i) of the Internal Revenue Code as it stood during 1940, gain recognized in a partial liquidation of a corporation is considered as a short term capital gain, and, under section 117 (b), 100 percent thereof is to be taken into account in computing net income. Under section 115 (i), partial liquidation is defined to mean "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." In the instant case, the Girard Realty Co. distributed one-half of its assets (land and money) to the petitioner and she thereupon surrendered to it her one-half of its stock. No previous or subsequent distribution of assets or cancellation of stock appears to have been made. In this situation we must conclude that the distribution of assets to the petitioner was one in complete cancellation or redemption of a part of the company's stock unless there is something inherent in the situation which requires a contrary conclusion. In support of her request that we reach a contrary conclusion, the petitioner contends that the provision in section 115 (c) that gain recognized in a partial liquidation "shall be considered as a short-term capital gain" was not intended by Congress to apply unless the distribution was a taxable dividend disguised as a liquidation; that the corporate entity of Girard Realty Co. should be disregarded on the ground that it was a mere "dummy" which held the bare legal title to assets of which the petitioner and the Austins were the beneficial owners and therefore acted merely as trustee, agent, or conduit for the owners; and that, regardless of the form adopted by petitioner and the Austins in consummating a settlement of the litigation between them, their intention was to make a division of the assets between them, and consequently, the transaction was not a partial liquidation of the corporation, but a division of assets, and the fact that the Austins retained title to their half of the assets in the name of the corporation did not convert the transaction into a partial liquidation.
While, as petitioner contends, the committee reports on what became section 147 of the Revenue Act of 1942 and which amended section 115 (c) so as to eliminate the provision that gain recognized in a partial liquidation would be considered as short term gain, recited that inequalities had resulted and that it was believed that proper application of section 115 (g) would prove adequate to prevent taxable dividends disguised as liquidations from receiving capital gain treatment, Congress did not see fit to make the amendment retroactive. To grant the petitioner's contention here as to the meaning of section 115 (c) as it stood prior to amendment would require the giving of retroactive effect to the amendment. This we are without authority to do.
While the separate entity of a corporation is sometimes disregarded, it is done only in rare instances. We are unable to find from the situation presented that such action would be warranted here. According to the testimony of the petitioner, the Girard Realty Co. had been in existence for a number of years and had transacted a substantial amount of business of the type which it was organized to transact. It was still holding considerable amounts of land for sale and, during 1940, sold some of it. Both the petitioner and the Austins in their dealings with the company recognized its separate entity. Likewise did the Florida court in permitting the Austins to intervene in the foreclosure proceeding. This contention of the petitioner is denied. Moline Properties, Inc. v. Commissioner, 319 U.S. 436.
As to the remaining contention of the petitioner, the evidence shows that the negotiations between her and the Austins for a settlement of the litigation contemplated a complete liquidation and a dissolution of the company and that originally an agreement was reached by them to this effect. However, this was never carried out. When it came to the final draft of the settlement agreement, the Austins decided that they did not desire a complete liquidation. They desired to continue the company as a holder of what would be distributed to them in the way of lands if the company should be completely liquidated, but were agreeable to the petitioner surrendering her shares to the company and receiving from it all the property which would come to her in a complete liquidation. The final draft of the agreement was prepared accordingly and petitioner accepted the change in plan and signed, though with reluctance. It was the plan as thus changed that was carried out. The company has continued in existence. The petitioner surrendered her stock to it and received from it all the property that she would have received if there had been a complete liquidation. It is true that this was done in settlement of the litigation. Nevertheless, it effected a partial liquidation of the company, an effect which was clearly contemplated by the final agreement as made by the parties. The fact that the original agreement providing for complete liquidation was not accepted as the final agreement, but in the latter provision was made for partial liquidation, definitely refutes the idea that the parties intended in the final agreement that there should be complete liquidation of the company. A partial liquidation having occurred, the full amount of the petitioner's recognizable gain thereon is to be taken into account in computing her net income.
Reviewed by the Court.
Decision will be entered for the respondent.
With considerable reluctance I respectfully note my dissent in this case. It was tried before me and, while I recognize the fact that the mechanics adopted point strongly to a mere partial liquidation of the corporation, actually what occurred was a division of the assets of the corporation in kind, the Austins engineering the whole plan for the purpose of making use of the corporation as the nominal title holder for the portion of the property distributed to them.
The whole record indicates such good faith on the part of the petitioner that it may well be my desire to do equity somewhat colors my interpretation of the law. In this connection I am conscious of the fact that she caused the property to be reappraised rather than accepting the appraisal made in connection with winding up her affairs with the Austins, accepted the higher value for the purpose of computing her tax liability, and thereby appreciably increased her tax liability. Moreover, looking realistically at the situation, I have considerable doubt that the amount paid by her for the stock in what both parties designate to have been a "wash sale" was the basis to be used by her for the computation of gain or loss. This point, however, was not raised or discussed, so can not be made the basis of decision.
The component parts of a single transaction should not be treated separately, and substance rather than form should control. In determining it all of the evidence should be considered. It is clear that the purpose of the agreement was twofold: (1) To settle the claim of petitioner for advances and to pay the attorneys, auditors, and other debts; and (2) to divide the remainder of the property. Both were accomplished. The net effect, therefore, was a complete division of the assets of the corporation between the two groups of stockholders. There is some analogy between the instant case and the rationale of United States v. Brager Building Loan Corporation, 124 F.2d 349, and North Jersey Title Insurance Co. v. Commissioner, 84 F.2d 889, although I recognize that the more recent expression by the Supreme Court in Moline Properties, Inc. v. Commissioner, 319 U.S. 436, cited in the opinion of the majority, weakens their pertinency here. The facts here, however, are not similar to those before the Court in the Moline Properties case. I believe petitioner should prevail.
ARUNDELL, BLACK, and HARRON, JJ., agree with this dissent.