Docket Nos. 41495 41497.
John J. Hooker, Esq. , and Albert B. Maloney, C. P. A. , for the petitioners. Homer F. Benson, Esq. , for the respondent.
REORGANIZATION—DISTRIBUTION IN LIQUIDATION—SEC. 112(c)(2)—SEC. 115(c), I. R. C. OF 1939.—An old corporation in liquidation sold some of its assets to a new corporation. At the time petitioners held more than 80 per cent of the stock in both corporations. Shortly thereafter petitioners acquired the remaining assets of the old corporation in exchange for their stock. Held, that the liquidation of the old corporation was under a plan of reorganization, and the gain resulting from the liquidation of the old corporation was taxable to petitioners under section 112(c)(2). John J. Hooker, Esq., and Albert B. Maloney, C. P. A., for the petitioners. Homer F. Benson, Esq., for the respondent.
Respondent determined the following deficiencies in income tax for 1948:
+------------------------------------------+ ¦Docket No.¦Petitioner ¦Deficiency¦ +----------+--------------------+----------¦ ¦41495 ¦William M. Liddon ¦$26,598.77¦ +----------+--------------------+----------¦ ¦41497 ¦Maria Prothro Liddon¦22,058.15 ¦ +------------------------------------------+
The issue is whether the gain resulting from the liquidation of a closely held corporation is taxable as ordinary income, section 112(c)(2), Internal Revenue Code of 1939, or as capital gain, section 115(c), section 111, section 112, and section 117.
FINDINGS OF FACT.
William M. Liddon and Maria Prothro Liddon, husband and wife in 1948, were residents of Nashville, Tennessee. They filed their separate tax returns for 1948 with the collector of internal revenue for the district of Tennessee. William M. Liddon will be hereinafter referred to as the petitioner.
Petitioner had been in the automobile business as a distributor of automobiles in Nashville from 1936 to the time of the hearing. During some of these years his business was operated as a closely held corporation, while in other years as a partnership. Prior to August 1, 1946, the business was a partnership composed of petitioner, his wife, and R. H. Davis. On August 1, 1946, certain assets of the partnership were transferred to a corporation known as Liddon Motors, Inc., hereinafter referred to as the old corporation.
The old corporation, with an authorized capital stock of 10,000 shares with a par value of $10 per share, was organized under the laws of Tennessee to carry on an automobile business. As a result of the initial stock distribution petitioner held 680 shares, his wife 680 shares, and Davis 340 shares. Later there were stock dividends so that on April 26, 1948, petitioner held 4,000 shares, his wife 4,000 shares, and Davis 2,000 shares.
Davis was the general manager of the old corporation. However, sometime in April 1948, because of ill health, he tendered his resignation as general manager. He also notified the stockholders and directors that he had decided to sell or liquidate his interest in the corporation as soon as possible.
The minutes of a special meeting of the stockholders on April 26, 1948, stated that Davis offered to sell his stock to the other stockholders, that is, petitioner and his wife, but they did not accept. The minutes related that after further discussion the stockholders decided to liquidate the old corporation and surrender the corporate charter. At this meeting Oscar Sanders was elected to the board to fill the vacancy caused by Davis's resignation.
The old corporation had an agreement with the Pontiac Motor Division of the General Motors Corporation, hereinafter referred to as Pontiac. In general this agreement was a form contract between Pontiac and one of its dealers, and the dealer might be an individual, a partnership, or a corporation. However, one of the paragraphs in the contract, designated paragraph ‘THIRD,’ contained a blank space so that individual names could be inserted. This paragraph attempted to make the agreement a personal contract even though a corporation or a partnership was denominated elsewhere in the contract as the dealer authorized to buy and resell cars. For the agreement in effect on April 26, 1948, Liddon Motors, Inc., was named the dealer. Paragraph ‘THIRD’ without the inserts was as follows:
THIRD: This Agreement constitutes a personal contract, having been entered into in reliance upon and recognition of ________ (jointly), the Dealer, or partner(s) in the dealership, or representative(s) of the Dealer who actively and substantially participate(s) in the ownership and/or operation of the dealership. Dealer shall not transfer nor assign this Agreement or any part thereof, nor make nor suffer to be made any substantial change in the ownership, financial interests or active management of Dealer.
Another part of this agreement also provided that Pontiac could terminate the agreement upon ‘Death, incapacity, or the removal, resignation, withdrawal, or elimination from the dealership for any reason of Dealer or any person named in Paragraph Third of this Agreement.’ In the agreement between the old corporation and Pontiac the names of petitioner and Davis were entered on the third paragraph.
On May 1, 1948, a certificate of incorporation for Liddon Pontiac, Inc., hereinafter referred to as the new corporation, was filed with the secretary of state of Tennessee. This new corporation was authorized to issue 30,000 shares of common stock with a par value of $10. The initial capital contributions were $3,000 for 300 shares by petitioner, $2,000 for 200 shares by his wife, and $10 for 1 share by Sanders. The new corporation was authorized to do a general merchandising business. On the same date the new corporation entered into an agreement with Pontiac to buy and resell its automobiles. Only petitioner's name was entered in paragraph ‘THIRD’ of the new agreement. Except for this change in paragraph ‘THIRD,’ the agreement between Pontiac and the old corporation was essentially the same as the agreement between Pontiac and the new corporation.
On May 6, 1948, at a special meeting of the board of directors the old corporation was directed to sell some of its assets to the new corporation at book value. The minutes of the meeting contain the following statement:
it was the consensus of opinion of the Board of Directors that in view of the fact that Liddon Pontiac, Inc. was the only logical prospective purchaser of the remaining assets of this Corporation, and that would entail untold expenses and many months of processing the liquidation to attempt to sell these other assets out individually, and under the terms of the franchise, Liddon Pontiac, Inc. has a right to purchase these, that it was agreeable for Liddon Pontiac, Inc. to utilize the use of these other assets without charge during the period of inventory, negotiation, etc.
Prior to May 21, 1948, petitioner and his wife invested an additional $20,000 in the capital stock of the new corporation.
On June 4, 1948, it was explained to the board of directors of the old corporation that Davis would accept $11 per share from the corporation for his 2,000 shares. The board voted to call Davis's stock and pay him $11 per share. Davis was given a check dated June 4, 1948, for $22,000. This was paid by the drawee bank on June 5, 1948.
Among the assets of the old corporation, on or about July 13, 1948, was a $60,000 note receivable. At a special meeting of the stockholders and directors on July 13, 1948, the following was authorized:
W. M. Liddon and Maria P. Liddon, being holders of all the outstanding stock at this time in equal shares, agreed to accept from Liddon White Truck Co., Inc. two notes of $30,000.00 each payable to W. M. Liddon and Maria P. Liddon as partial settlement of Liddon Motors, Inc. as liquidating dividend to be payable to them.
In addition to this, the President was authorized to issue the Shareholders final liquidating dividend of the corporation which represented $90,000.00, in addition to the above note, to liquidate the entire outstanding stock.
The money and property petitioner and his wife each received in final liquidation of the old corporation was $75,618.64 for 4,000 shares of stock, or approximately $18.90 a share.
On July 17, 1948, an instrument entitled ‘State of Tennessee Surrender of Charter of Incorporation,’ was filed with the secretary of state. By virtue of this instrument the corporate charter of the old corporation was surrendered and the corporation dissolved.
The old corporation filed a corporation income tax return for the period from January 1, 1948, to September 30, 1948. A summary of the balance sheets for the beginning and end of the period is as follows:
+----------------------------------------------+ ¦ ¦Jan. 1, 1948¦Sept. 30, 1948¦ +------------------+------------+--------------¦ ¦Cash ¦$66,431.76 ¦$18,498.41 ¦ +------------------+------------+--------------¦ ¦Notes receivable ¦88,719.87 ¦100,000.00 ¦ +------------------+------------+--------------¦ ¦Inventory ¦29,859.68 ¦ ¦ +------------------+------------+--------------¦ ¦Depreciable assets¦13,762.21 ¦ ¦ +------------------+------------+--------------¦ ¦Other ¦11,512.92 ¦ ¦ +------------------+------------+--------------¦ ¦Total ¦$210,286.44 ¦$118,498.41 ¦ +------------------+------------+--------------¦ ¦ ¦ ¦ ¦ +------------------+------------+--------------¦ ¦Accounts payable ¦$15,750.77 ¦ ¦ +------------------+------------+--------------¦ ¦Other liabilities ¦61,735.15 ¦$57,162.42 ¦ +------------------+------------+--------------¦ ¦Capital stock ¦34,000.00 ¦ ¦ +------------------+------------+--------------¦ ¦Earned surplus ¦98,800.52 ¦61,335.99 ¦ +------------------+------------+--------------¦ ¦Total ¦$210,286.44 ¦$118,498.41 ¦ +----------------------------------------------+
On their 1948 tax returns petitioner and his wife each reported $75,618.64 less $6,800 as a long-term capital gain from Liddon Motors, Inc.
The respondent in the statement explained the adjustment in petitioner's deficiency notice as follows:
(a) In your return you reported as capital gain, income received from the liquidation of Liddon Motors, Inc., $68,818.64, taxable at 50%, or $34,409.32. It is held that income so received is ordinary income, taxable at 100%, and accordingly, net income is increased in the amount of $34,409.32.
The liquidation of the old corporation was pursuant to a plan of reorganization, and the distribution of its assets in exchange for its stock had the effect of the distribution of a taxable dividend.
An epitomization of the facts will aid us in discussing this case. The old closely held corporation was organized in 1946; it engaged in a successful automobile business for 2 years. Prior to July 17, 1948, the date of the surrender of the old corporate charter, the stock of the old corporation had been liquidated and some of its assets sold to a new corporation. This new corporation had been incorporated on May 1, 1948. The old corporation held a franchise to sell Pontiac automobiles, but this franchise was terminated prior to the liquidation of the old corporation. Another Pontiac franchise was issued to the new corporation on May 1, 1948. Petitioner and his wife held 80 per cent of the stock in the old corporation and more than 80 per cent of the stock in the new corporation. They each received a gain of $68,818.64 from the liquidation of the old corporation in 1948. In the beginning of this series of transactions petitioner and his wife held stock in the old corporation; at the termination they held stock in the new corporation plus ‘money-to-boot.’
Petitioner contends that there was a complete liquidation of the old corporation under section 115(c), and the gain therefrom was capital gain. In opposition respondent urges that the transactions, in substance as distinguished from form, constitute a reorganization within the meaning of section 112(b)(4) or (5) and 112(g)(1)(D), with the result that the gain was taxable under section 112(c). In the alternative respondent maintains that the redemption or cancellation of the stock of the old corporation was essentially equivalent to the distribution of accumulated earnings and profits and was a taxable dividend under section 115(g).
We shall consider the first item of dispute between the parties, that is, whether there is a taxable gain to petitioner under the provisions of section 112(c). The pertinent provisions of this section are as follows:
SEC. 112. RECOGNITION OF GAIN OR LOSS.
(c) GAIN FROM EXCHANGES NOT SOLELY IN KIND.
(1) If an exchange would be within the provisions of subsection (b)(1), (2), (3), or (5), * * * of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph * * * to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.
(2) If a distribution made in pursuance of a plan of reorganization is within the provisions of paragraph (1) of this subsection but has the effect of the distribution of a taxable dividend, then there shall be taxed as a dividend to each distributee such an amount of the gain recognized under paragraph (1) as is not in excess of his ratable share of the undistributed earnings and profits of the corporation accumulated after February 28, 1913. The remainder, if any, of the gain recognized under paragraph (1) shall be taxed as a gain from the exchange of property.
The first question to be considered is whether there was a ‘plan of reorganization.’ The 1939 Code does not define a plan of reorganization but it does define the term ‘reorganization’ in section 112(g)(1). There, under (D), a reorganization means ‘a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its shareholders or both are in control of the corporation to which the assets are transferred.’ Control, under section 112(h), means ownership of stock possessing at least 80 per cent of the total voting power. It is immediately apparent that the transfer of some assets of the old corporation to the new, while petitioner and his wife controlled at least 80 per cent of the voting stock of both corporations, is a reorganization as defined by the 1939 Code.
In our opinion the transfer of these assets was only one step in a series of transactions under a single plan. Even though there was no formal written plan, the various transactions—the sale of Davis's stock, the formation of a new corporation, the transfer of assets from the old to the new corporation, the liquidation of the old corporation after the new corporation was in business—all indicate a master plan of reorganization rather than the mere liquidation of the old corporation. When we must determine whether there has been a reorganization, a liquidation, a sale, or an exchange in a series of transactions, it is proper for us to look at the beginning and end of the series. See Illinois Water Service Co., 2 T. C. 1200, 1231. See also William H. Redfield, 34 B. T. A. 967, and Richard H. Survaunt, 5 T. C. 665, affd. 162 F. 2d 753. Cf. Standard Realization Co., 10 T. C. 708; Charles R. Mathis, Jr., 19 T. C. 1123. It is also proper for us to consider all of the transactions together rather than separately. Helvering v. Alabama Asphaltic Limestone Co., 315 U. S. 179. And if in fact there was a ‘reorganization’ of the old corporation, the liquidation was merely one of the steps in the integrated transactions. W. N. Fry, 5 T. C. 1058, 1067.
Now that we have determined that there was a plan of reorganization and a distribution to petitioner and his wife pursuant to that plan, we must determine if the distribution was within the provisions of paragraph (1) of section 112(c). Paragraph (1) refers to section 112(b)(3) which deals with exchanges solely in kind when stock is exchanged for stock. That section is as follows:
(b) EXCHANGES SOLELY IN KIND.
(3) STOCK FOR STOCK ON REORGANIZATION.—No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization. When section 112(b)(3) is read under the provisions of section 112(c)(1) there must be an exchange of stock for stock plus something ‘to boot.’
Returning to the facts again, during the liquidation of the old corporation petitioner exchanged his stock for money. In form this was not an exchange of stock for stock plus something ‘to boot.’ However, all of the transactions, when viewed as one plan of reorganization, culminated in an exchange of stock for stock plus money. Under section 112(c)(1) the gain in the amount of money that petitioner received should be recognized.
If this gain is recognized should it be taxed? Section 112(c)(2) answers ‘yes' if the distribution ‘has the effect of the distribution of a taxable dividend.’ It should be pointed out that for this section of the 1939 Code there is no difference between liquidating dividends and ordinary dividends. John S. Woodard, 30 B. T. A. 1216, 1227. Cf. sec. 115(c).
An examination of the legislative history of section 112(c)(2) will aid us in determining the legislative intent of this section. In John S. Woodard, supra, we established that section 112(c)(2) first appeared in the Revenue Act of 1928 as section 203(d)(2) of the 1924 Act. From an analysis of the House Ways and Means Committee and the Senate Finance Committee reports on the Revenue Bill of 1924, we pointed out that the primary purpose of Congress in enacting section 203(d)(2) was to prevent the taxing of liquidating dividends, to the extent of accumulated earnings, at the capital gain rate. It is significant that the wording of section 112(c)(2) as found in the 1928 Act has been unchanged through the years.
We recognize that the money petitioner received was not in fact dividends, but we also believe that to the extent of the accumulated earnings, the liquidation of the stock had the effect of the distribution of taxable dividends. The record fully supports this conclusion. There was no evidence that the old corporation paid any dividends other than stock dividends during the 2 years of its operation as a successful corporation. In the beginning of 1948 the earned surplus account had a credit balance of $98,800.52 and on September 30, 1948, after the stock had been liquidated, the credit balance was $61,335.99. While there was a business purpose in the liquidation of the minority stockholder's interest, there is doubt in our minds that the old corporation was liquidated for a business purpose other than tax savings. Cf. Estate of John B. Lewis, 10 T. C. 1080, affd. 176 F. 2d 646. No one can ignore the fact that the substance of the old corporation's business was carried on by the new corporation; in fact initially the business was carried on in the same building. In addition, control of both corporations was vested in the same two stockholders. It is our conclusion that the distribution was made pursuant to a plan of reorganization and that the distribution was in effect a taxable dividend. Therefore, it should be taxed to each distributee under section 112(c)(2). The respondent must be sustained.
Perhaps a word about petitioner's contentions would be proper. Petitioner maintains that the gains he received were the result of a transaction within the contemplation of section 115(c).