Opinion
Docket No. 15065.
Promulgated September 27, 1948.
1. Wholly owned subsidiary's purchase of parent corporation's stock from petitioners, who were practically the sole owners of parent, held not to result in a distribution to petitioners substantially equivalent to a taxable dividend under Internal Revenue Code, section 115 (g), since the subsidiary corporation did not cancel or redeem "its stock." Mead Corporation v. Commissioner (C.C.A., 3d Cir.), 116 F.2d 187, followed.
2. Income applied by petitioners, trustees of Pennsylvania testamentary trust, pursuant to agreement with beneficiaries, to the payment of state inheritance taxes previously paid by petitioners, held to entitle petitioners to a deduction from gross income under Internal Revenue Code, section 162 (b).
C. Walter Randall, Jr., Esq., for the petitioners.
William H. Best, Jr., Esq., for the respondent.
This proceeding was brought for a redetermination of deficiencies in income tax as follows:
1942 ........................................ $38,449.16 1943 ........................................ 31,224.24 1944 ........................................ 44,923.43
The questions presented are whether cash receipts by petitioners resulting from transactions between wholly owned corporations constituted distributions taxable as dividends under Internal Revenue Code, section 115 (g); and whether petitioners are entitled to a deduction from gross income under section 162 (b) of the Internal Revenue Code by reason of income realized but applied pursuant to an agreement with the beneficiaries to the payment of state inheritance tax heretofore paid by petitioners.
Respondent has conceded that, if petitioners prevail upon the first issue, they are entitled to a capital loss deduction under the statute.
The record is comprised of a stipulation of facts and joint exhibits introduced by the parties.
FINDINGS OF FACT.
The facts so stipulated are hereby found accordingly.
Petitioners are the surviving and succeeding trustees of a testamentary trust created by the will of Rodman Wanamaker, who died March 9, 1928. The fiduciaries' income tax returns for the trust for 1942, 1943, and 1944, were filed with the office of the collector of internal revenue for the first district of Pennsylvania at Philadelphia.
On October 10, 1923, Rodman Wanamaker, hereinafter sometimes referred to as the decedent, entered into a written agreement with Violet Wanamaker, his wife, from whom he was afterwards divorced, providing for the payment to her of $6,000 per month until her remarriage, and thereafter for the payment of $3,000 per month for life. Decedent's will referred to this agreement and directed his executors and trustees to make the payments called for in the agreement. Violet remarried prior to January 1931.
All of the common stock of John Wanamaker Philadelphia, being 75,000 shares, was owned by decedent at the time of his death. His will directed that all of the stock be held in trust, with specific directions as to the distribution of the income therefrom. This stock was valued for Federal estate tax purposes at $800 per share as of the date of decedent's death.
John Wanamaker Philadelphia at all times held all of the capital stock of John Wanamaker New York and A. T. Stewart Realty Co. Both of these corporations are New York corporations; John Wanamaker Philadelphia is a Pennsylvania corporation.
In its adjudication of the first account of decedent's executors, the Orphans' Court of Montgomery County, Pennsylvania, held that the payments to Violet, as provided in the agreement of August 10, 1923, should constitute charges against the principal of the common stock trust. It was also adjudicated that certain debts of decedent, aggregating over $3,000,000, of which $2,974,832.99 was to John Wanamaker Philadelphia, were charges against the principal of the trust.
In each of the years 1942, 1943, and 1944 the minutes of petitioners recite their obligation under the will to provide funds for the monthly payments to Violet; the nonavailability of funds for this purpose; the offer of John Wanamaker New York to purchase 100 shares of John Wanamaker Philadelphia at $495 a share, stated to be its approximate book value as of February 1, 1942 and 1943, and $505 a share, stated to be its approximate book value as of February 1, 1944; and the acceptance of the offers by petitioners and the authorization for the transactions.
The minutes of meetings of the board of directors of John Wanamaker New York evidence corporate authorizations for the transactions. John Wanamaker New York, by check dated December 29, 1943, paid petitioners $49,500.
Sometime prior to August 1942, petitioners transferred 10,000 shares of the common stock of John Wanamaker Philadelphia to A. T. Stewart Realty Co., and also prior to this date and on December 30, 1941, it transferred 100 shares to John Wanamaker New York and received $47,000.
John Wanamaker New York has at all times to date retained the shares of common stock of John Wanamaker Philadelphia purchased from the trustees.
During the calendar years here involved John Wanamaker Philadelphia paid cash dividends on its common stock as follows:
Year Paid to — Amount 1942 .......... Trustees of Common Stock Trust .......... $535,425.00 A. T. Stewart Realty Co. .............. 82,500.00 John Wanamaker N.Y. .................. 825.00 ----------- 618,750.00 =========== 1943 .......... Trustees of Common Stock Trust .......... 534,600.00 A. T. Stewart Realty Co. .............. 82,500.00 John Wanamaker N.Y. .................. 1,650.00 ----------- 618,750.00 =========== 1944 .......... Trustees of Common Stock Trust .......... 533,775.00 A. T. Stewart Realty Co. .............. 82,500.00 John Wanamaker N.Y. .................. 2,475.00 ----------- 618,750.00During the fiscal years February 1, 1942, to January 31, 1945, inclusive, John Wanamaker Philadelphia, John Wanamaker New York, and A. T. Stewart Realty Co. filed separate Federal corporation income tax returns and excess profits tax returns. A. T. Stewart Realty Co. and John Wanamaker New York included in their returns as income the dividends paid them by John Wanamaker Philadelphia in 1942, 1943, and 1944.
The ledger of John Wanamaker New York contains the following account: 1941 1942 1943 1944 1945
Investment in John Wanamaker Philadelphia Common Stock: Dec. 31 Cash $47,000.00 Dec. 31 Cash 49,500.00 Dec. 31 Cash 49,500.00 Dec. 11 Journal 50,500.00 Dec. 31 Journal 51,500.00 The sale prices of $495 and $505 per share were the approximate book values of the stock as shown by the consolidated balance sheets of John Wanamaker Philadelphia, John Wanamaker New York, and A. T. Stewart Realty Co. as of the close of the fiscal years immediately preceding the respective transactions.John Wanamaker Philadelphia, John Wanamaker New York, and A. T. Stewart Realty Co. had surpluses available for distribution as taxable dividends as of the close of the fiscal years as follows:
John Wanamaker John Wanamaker A. T. Stewart Philadelphia New York Realty Co. Jan. 31, 1943 .......... $10,974,741.66 $4,679,624.57 $2,917,946.49 Jan. 31, 1944 .......... 11,377,660.60 4,730,026.74 3,039,023.14 Jan. 31, 1945 .......... 11,996,282.25 4,905,903.80 3,226,129.83 In petitioners' fiduciary income tax returns for the three years here involved they reported the above transactions as sales of stock to John Wanamaker New York, and deducted the resulting capital loss to the extent of $1,000.On May 13, 1931, after a hearing held January 28, 1931, the Orphans' Court of Montgomery County, Pennsylvania, ordered and decreed that a certain agreement dated January 26, 1931, be entered into by the executors of the estate of Rodman Wanamaker, deceased, petitioners, and certain guardians for minor beneficiaries under the trust; and the court approved the execution of this agreement. The agreement provided in part as follows:
WHEREAS Rodman Wanamaker died on the 9th day of March, 1928, having first made and published his last Will and Testament dated October 6, 1923, with Codicils thereto, all duly probated in the Office of the Register of Wills in and for the County of Montgomery, State of Pennsylvania, wherein and whereby he appointed said William L. Nevin, William P. Gest and Levi L. Rue, Executors, to whom Letters Testamentary were duly granted by the said Register of Wills;
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AND WHEREAS the assets of the said Estate, other than the said common stock of John Wanamaker Philadelphia and the said assets and properties specifically bequeathed or devised by the terms of the said Will, are not nearly sufficient to provide the funds required for the payment of the said debts of decedent, administration expenses, and Federal and State inheritance taxes, not including the normal State inheritance taxes;
AND WHEREAS in view of the large surplus of the said John Wanamaker Philadelphia and its subsidiary corporations, it is practicable and feasible through a sale of a portion of the said stock to the A. T. Stewart Company, one of said subsidiary corporations, or through the declaration of dividends payable out of said surplus, or through a combination of both means, to provide sufficient funds for the payment of said debts, taxes and administration expenses;
AND WHEREAS no serious disadvantage or loss will result to any of the parties interested in the said Estate, if the burden of paying the said taxes, debts and administration expenses shall be placed upon the said stock of John Wanamaker Philadelphia, after exhausting for this purpose such of the assets of the Estate as have not been specifically disposed of by the Will;
AND WHEREAS it was purported by the second Codicil to said Will, dated August 5, 1927, in clause EIGHTH thereof, to create an annuity of Twenty thousand Dollars ($20,000.) for each of the above named grandchildren of the said Rodman Wanamaker; and in the NINTH clause thereof of an annuity of Twenty thousand Dollars ($20,000.) for his nephew, Rodman Wanamaker, 2nd; and in the TENTH clause an annuity of One hundred thousand Dollars ($100,000.) for his sister, Mary Brown Warburton, all parties hereto;
AND WHEREAS by the ELEVENTH clause of the said Codicil it was provided in respect to said annuities, as follows:
ELEVENTH. In creating the annuities under the eighth-ninth-tenth paragraphs, of this Codicil, such income to be paid, semi-annually, to each of the beneficiaries designated without power, on the part of any one, to anticipate or assign the same, in any form whatever, or be subject to any attachment, alienation or sequestration for the debts, contracts, or engagements of any of said beneficiaries, and upon the death of any one, or all, of said beneficiaries, such annuity to terminate at that time.
Such yearly income, upon each and all of said annuities to be declared at such times, and in such amounts, as the Corporation of John Wanamaker Philadelphia may deem advisable, in the interest of the business, but such annuities, in no sense to be a charge on the Corporation, or the business, or any direct, or indirect, obligation thereon, or upon any Trust I have created, but shall simply be a yearly income to be received and enjoyed by such beneficiaries, as, and when, it may be declared, and made payable by the Board of Directors of John Wanamaker Philadelphia, in the exclusive exercise of their own free will, and action, for the best interest not only of said business, but for the respective beneficiaries.
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AND WHEREAS the parties hereto deem it to be in their interest and in the interest of the said Estate and its proper administration, that all questions in regard to the payment of debts of decedent, administration expenses and taxes, as well as the questions relating to the payment of income from the common stock of John Wanamaker Philadelphia to said children of decedent, as well as to said annuitants, should be settled and determined as hereinafter provided;
NOW THEREFORE in consideration of the premises, IT IS AGREED by and between the parties hereto, as follows, to wit:
I.
The said Executors and Trustees shall, either through the sale of common stock of John Wanamaker Philadelphia to A. T. Stewart Realty Company, a subsidiary of said Corporation, or through causing dividends to be declared on said stock out of earnings accumulated prior to March 9, 1928, or by either or both of said means, in their discretion, provide such sums of money as may be necessary to pay debts of the Estate, administration expenses, and all Federal or State inheritance taxes, other than normal inheritance taxes, after applying for these purposes such other assets of the Estate as have not been specifically devised or bequeathed by the said Will of Rodman Wanamaker, deceased.
II.
The Executors shall pay and distribute to the annuitants named in the EIGHTH, NINTH and TENTH paragraphs of the said second Codicil of August 5, 1927, out of dividends heretofore received by the said Executors, declared out of earnings on the common stock of John Wanamaker Philadelphia, accumulated since March 9, 1928, sums aggregating Five hundred and fifty thousand Dollars ($550,000.) to be distributed amongst them in accordance with the provisions of paragraphs EIGHTH, NINTH, TENTH and ELEVENTH of the said Codicil, as follows:
Mary Brown Warburton, the sum of .................... $250,000 Rodman Wanamaker, 2nd, the sum of ................... 50,000 To the Guardian of the Estate of Rodman A. Heeren, the sum of ........................................ 50,000 To the Guardian of the Estate of John R. Wanamaker, the sum of ........................................ 50,000 To the Guardian of the Estate of Fernanda P. Wanamaker, the sum of ............................. 50,000 To the Guardian of the Estate of Gurnee Munn, Jr., the sum of ........................................ 50,000 To the Guardian of the Estate of Fernanda Munn, the sum of ........................................ 50,000
PROVIDED HOWEVER, that the Executors shall have the right at the time of making settlement hereunder, to deduct from the aforesaid sums thus to be paid to guardians of the estates of grandchildren of Rodman Wanamaker, normal inheritance taxes levied upon their annuities in the following sums:
On the annuity of Rodman A. Heeren .......... $5,686.80 On the annuity of John R. Wanamaker ......... 6,055.60 On the annuity of Fernanda P. Wanamaker ..... 6,016.40 On the annuity of Gurnee Munn, Jr. .......... 6,017.20 On the annuity of Fernanda Munn ............. 6,090.40
AND PROVIDED FURTHER, that the Executors at the time of making said settlement hereunder shall have the right to deduct and retain out of the sums as aforesaid allotted to MARY BROWN WARBURTON and RODMAN WANAMAKER, 2ND, Ten per cent. (10%) thereof to be applied toward reimbursement of the said Executors in part for normal inheritance taxes paid by them on the said annuities of said Rodman Wanamaker, 2nd, and Mary Brown Warburton, namely:
On account of the annuity of Rodman Wanamaker, 2nd, the sum of ....... $26,556 and On account of the annuity of Mary Brown Warburton the sum of ......... 89,990
And it is hereby FURTHER EXPRESSLY AGREED that the said Executors or Trustees as the case may be, shall hereafter retain out of each semi-annual payment of income which may fall due to the said Mary B. Warburton and Rodman Wanamaker, 2nd, and apply to the payment of the balance of the said normal inheritance taxes upon their annuities, ten per cent. (10%) of the amount of such payment, until in this manner the whole balance due on account of the said taxes so advanced by the Executors shall have been paid in full.
It is not intended hereby to create any personal obligation upon the said Mary Brown Warburton or the said Rodman Wanamaker, 2nd, to repay to the Executors or Trustees the amount of the said taxes so advanced, it being understood that such payment is to be made only out of recurring semi-annual payments which may fall due to them in accordance with the terms of the said Codicil. It is also FURTHER AGREED that if the whole of said taxes shall not have been paid in manner as herein provided, because of the death of the said annuitants or either of them prior to such payment, or for any other reason, the said Executors and/or Trustees shall be relieved from all further responsibility in respect thereto, and any deficiency shall be charged against the principal of said Stock Trust.
The balance of the said earnings from the common stock of John Wanamaker Philadelphia, accumulated since March 9, 1928, and received by the said Executors as dividends aforesaid, after payment thereout of the said sums aggregating Five hundred and fifty thousand Dollars ($550,000.) to said annuitants, shall be payable as income due the said children of Rodman Wanamaker, in equal shares.
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V.
This Agreement shall become effective only when and as approved by the Orphans' Court of Montgomery County.
The amounts of income payable by petitioners to Rodman Wanamaker II and Mary Brown Warburton out of the trust income for the years 1942, 1943, 1944, before taking into account any reduction called for in the agreement of January 26, 1931, were as follows: Mary B. Warburton, $100,000 per year, and Rodman Wanamaker II, $20,000 per year.
Pursuant to the agreement of January 26, 1931, the trustees retained in each of the three years here involved $10,000 per year from Mary B. Warburton's share and $2,000 per year from Rodman Wanamaker II's share. In their third and fourth accounts filed with the Orphans' Court of Montgomery County, Pennsylvania, petitioners showed the unreduced amounts of income as having been paid by them to Mary B. Warburton and Rodman Wanamaker II. These same accounts also showed the amounts as having been repaid to the principal account by Mary B. Warburton and Rodman Wanamaker II.
In a letter dated April 10, 1940, to Mary B. Warburton from Rodman Barker it is stated:
Under the aforesaid agreement entered into January 26th, 1931, an advance of $89,990.00 was made you on account of Estate Taxes, which advance was made to be repaid by you when and as payments on annuity account were made to you, one-tenth of every such payment to be used for repayment of advance until liquidated. Repayments to date amount to $35,000.00; present balance outstanding $54,990.00.
We have, accordingly, drawn two checks to your order, one for $4,090.91, the other for $36,818.23, a total of $40,909.14.
As we have just received from Major Warburton check for $4,090.91 which we have applied against advance made to you for estate taxes, reducing balance due on this account to $50,899.09, we are depositing both checks, as per his request, to your credit in the Pennsylvania Company for Insurances on Lives and Granting Annuities.
Other communications relating to the matter indicate that the trustees withheld 10 per cent of their payments pursuant to the agreement. By the end of 1946 the trustees had been reimbursed in full for the money previously advanced.
In his notice of deficiency respondent stated:
The proceeds from the alleged sales of 100 shares of common stock of John Wanamaker Philadelphia in each of the taxable years 1942, 1943 and 1944 to John Wanamaker New York are determined to have been taxable dividends within the meaning of section 115 (g) of the Internal Revenue Code.
OPINION.
The first issue turns on whether section 115 (g) fits the transaction here involved. The provision is:
(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.
Petitioners insist that when John Wanamaker New York bought the stock of its parent, John Wanamaker Philadelphia, it did not deal in "its stock" at all, much less cancel or redeem it. The contention is virtually identical with that upheld in Mead Corporation v. Commissioner (C.C.A., 3d Cir.), 116 Fed. 2d 187, upon which petitioner relies, and in which it was held (reversing 38 B. T. A. 687) that section 104 of the 1928 Act, penalizing the accumulation of a corporation's earnings for the purpose of avoiding surtax upon "its" shareholders, did not apply to the accumulations of a subsidiary, even though for the purpose of avoiding surtax upon the shareholders of the parent.
In reversing our decision, the Circuit Court said in words equally applicable here: "To say that the term 'its shareholders' means not only the corporation's actual shareholders but also the shareholders of its shareholders would be to add to the statute something that is not there and to give it an effect which its plain words do not compel."
If application of the word "its" to a subsidiary was unauthorized in the Mead case, it must be even more so here. There we were able to gather from the legislative history of the section involved a congressional purpose calling for the broader interpretation. Here no assistance can be drawn from that quarter, the committee reports and other usual sources of information being completely silent on the point of the present controversy. Following Mead Corporation v. Commissioner, supra, we conclude that the New York subsidiary did not cancel or redeem its stock when it bought the stock of its Philadelphia parent, and hence that section 115 (g) is inapplicable to the present facts.
In the 1934 Act Congress broadened section 104 (then 102) to include specifically "the shareholders of any other corporation." If we are mistaken in our view of the scope of section 115 (g), similar action can be taken in that sphere.
The remaining issue arises from respondent's disallowance, as a deduction for fiduciary income "to be distributed currently," of amounts applied to the reduction of the normal state inheritance taxes originally paid by petitioners. The money withheld concededly would have been distributed in the taxable years to Mary Brown Warburton and Rodman Wanamaker II but for the agreement dated January 26, 1931, between petitioners and other interested parties beneficiary. Pursuant to this agreement the amounts in dispute were applied to the repayment of the state tax obligation.
SEC. 162. * * *
The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that —
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(b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the legatees, heirs, or beneficiaries, but the amount so allowed as a deduction shall be included in computing the net income of the legatees, heirs, or beneficiaries whether distributed to them or not. * * *
Respondent's objection appears to be that the contract was couched in such contingent language that there was no personal obligation on the beneficiaries to make the repayments. But the agreement that the repayments would be made out of "semi-annual payments which may fall due" to the beneficiaries "until in this manner the whole balance due on account of the said taxes so advanced by the Executors shall have been paid in full," is without equivocation. The further proviso that in the event of death "or for any other reason" there was a failure to repay the advancements, the trustees were to be relieved of further responsibility and the deficiency charged against the principal of the trust, whatever might be its purpose and legal effect, was not operative in the years in question.
The obligation for the taxes was that of the beneficiaries, not only under a contract made between parties having adverse interests, but also under Pennsylvania law without reference to the contract. Reimbursement for the state succession tax was due from the legatee. See Purdon's Penna. Statutes Ann., Title 72, sec. 2352; In re Constable's Estate, 299 Pa. 509; 149 A. 743. Acceptable procedure in Pennsylvania permits payment by the estate and repayment by life tenants out of the periodic income payments to them. Crane's Estate, 314 Pa. 193; 170 A. 284. "Normally the life tenant pays his tax from installments of income received in his lifetime. See Henris's Estate, 53 Pa. Super. 633." Crane's Estate, supra. In this respect the law of Pennsylvania appears to differ from that of Ohio, New York, Texas, and California, under which Albert W. Russell, 35 B. T. A. 602; Keith v. Johnson, 271 U.S. 1; United States v. Mitchell, 271 U.S. 9; and Gillette v. Commissioner (C.C.A., 2d Cir.), 76 F.2d 6, were respectively decided. The amounts in question must accordingly be regarded as having been in effect paid to Mary Brown Warburton and Rodman Wanamaker II, and in turn paid over by them to petitioners. Bergan v. Commissioner (C.C.A., 2d Cir.), 80 F.2d 89. The liability of the beneficiaries for the income tax on trust income applied to the discharge of their indebtedness, Helvering v. Blumenthal, 296 U.S. 552, fulfills the alternative requirement of section 162 (b), permitting the deduction to the estate. See Bergan v. Commissioner, supra.
Although the record on the subject is not clear, a claim for refund of the beneficiaries' tax appears to have been filed, presumably as an alternative to the position of the present petition. No point is made by respondent as to the payment or nonpayment of tax by the beneficiaries on their distributable shares.
It follows from this that respondent erred and these deductions should have been allowed.
Reviewed by the Court.
Decision will be entered under Rule 50.