Lockhart
v.
Comm'r of Internal Revenue

Tax Court of the United States.Feb 28, 1947
8 T.C. 436 (U.S.T.C. 1947)
8 T.C. 436T.C.

Docket No. 8927.

1947-02-28

L. M. LOCKHART, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Robert Ash, Esq., and Carl F. Bauersfeld, Esq., for the petitioner. J. Marvin Kelley, Esq., for the respondent.


A corporation of which petitioner was sole stockholder distributed to him all of its assets, aggregating in value approximately $2,650,000, except a drilling rig having a depreciated book value of about $34,000, and he assumed all of its liabilities, aggregating approximately $1,680,000, whereupon 16,245 of the 17,000 outstanding shares of stock were canceled. The reasons for the distribution were: The view that the corporate properties could be more efficiently and more economically operated under individual ownership; the necessity of raising about $223,000 to pay petitioner's individual income tax liability, then pressing; the desire to separate the drilling business and its potential liabilities from the rest of the business, primarily that of production of oil and recycling; and the petitioner could not completely liquidate the corporation because a contract with his former wife tied up some of its stock, the 755 shares not canceled being sufficient to satisfy that contract. Petitioner did not wish the name Lockhart Oil Co. used by any one else and was advised that it was necessary, to prevent such use, that some assets be left in the corporation. The drilling rig was left in the corporation, which conducted drilling operations with it, while the petitioner individually continued the other business. Held, the cancellation of the stock and distribution of assets was not at such time and in such manner as to be essentially equivalent to distribution of a taxable dividend under section 115(g), Internal Revenue Code, but, under section 115(c), was a distribution in partial liquidation. Robert Ash, Esq., and Carl F. Bauersfeld, Esq., for the petitioner. J. Marvin Kelley, Esq., for the respondent.

In this case there is involved income tax liability for the calendar year 1943. Deficiency was determined in the amount of $70,147.01. At trial the parties each conceded an issue, and agreed upon another. Such concessions will be reflected in decision to be rendered under Rule 50. This leaves for our consideration the single issue as to whether certain corporate stock belonging to the petitioner was canceled or redeemed at such time and in such manner as to require treatment of the distribution and cancellation as a taxable dividend (to the extent of corporate earnings or profits since February 28, 1913), under section 115(g) of the Internal Revenue Code, or whether, on the other hand, there was distribution in partial liquidation, to be treated as in exchange for the stock, under section 115(c). From evidence adduced we make the following findings of fact.

FINDINGS OF FACT.

The petitioner, a resident of San Antonio, Texas, filed his Federal income tax return for the calendar year 1943 with the collector for the first district of Texas at Austin, Texas. He has at all times owned all of the 17,000 shares of the outstanding stock of Lockhart Oil Co. of Texas. The company was organized by him in 1939. It was engaged in the business of oil production, drilling, and operating a recycling plant. On December 28, 1943, the stockholders and directors voted to liquidate the corporation in part. The resolution of the stockholders' meeting, omitting formal parts, read as follows:

Whereas, it is the opinion of all of the owners of stock in the Lockhart Oil Company of Texas that such corporation should be partially liquidated by transferring, conveying, assigning and delivering all of its physical properties and assets, including cash on deposit in banks and accounts receivable, materials on hand, prepaid and deferred charges, except its drilling rig and equipment incident thereto, in consideration of the transfer and delivery to the corporation of shares of its capital stock and of the assumption of the corporate liabilities;

Whereas, all of the stockholders are of the opinion that all of the productive and non-productive properties of the corporation can and will be more efficiently and more economically operated if owned by individuals rather then by the corporation as such;

Whereas, all of the stockholders believe that such a liquidation will enable them to use assets and properties now vested in the corporation for the purpose of collaterally securing loans to be made to stockholders for the purpose of enabling such stockholders to raise funds with which to meet their outstanding personal obligations, including income tax deficiencies that have been individually assessed on account of prior transfer of a portion of the identical properties, title to which is now vested in the corporation;

Whereas, all the stockholders deem it advisable that the drilling operations of the corporation be separated and segregated from its producing operations in order that potential liabilities incident to the conduct of drilling operations should not in any manner jeopardize or endanger the producing and non-producing leases and other assets of the corporation;

Now, therefore, be it resolved as follows: That the President and Secretary of the Lockhart Oil Company of Texas are hereby fully and finally authorized and empowered to transfer, assign, convey, and deliver for the consideration hereinafter set out unto L. M. Lockhart, individually, all of the productive and non-productive oil, gas and mineral leasehold estates working interests therein, and over-riding royalties attached thereto; all automobiles, trucks, all lease equipment, all the recycling plant and plant site located near the town of Banquete, Texas, all fee real estate, all pipelines, all casing, tubing, xmas trees and other well equipment and oil field supplies now on hand, all furniture and fixtures, all accounts receivable, all cash on hand in banks, all prepaid and deferred charges, work in progress, all benefits to be delivered under any existing contracts or agreements which have heretofore been made in connection with, or affecting any of the properties of the corporation to be so transferred, conveyed and assigned, and all other assets of every kind or character now belonging to the Lockhart Oil Company of Texas save and except, however, that certain drilling rig and all equipment incident thereto which is now owned by the corporation and is located near the town of Banquete, Nueces County, Texas;

Further resolved that as consideration for the above authorized transfers, assignments and conveyances of assets, that the corporation shall be entitled to receive therefor from L. M. Lockhart 16,245 shares of the capital stock of the Lockhart Oil Company of Texas now owned and held by him, and that in addition thereto the said L. M. Lockhart shall, in each and every conveyance of assets made to him as here authorized, assume and agree to pay and to discharge all of the debts and obligations of every kind or character owed by, or claimed to be owed by the Lockhart Oil Company of Texas on the date that such transfer and conveyance is effective;

And, further, that the said L. M. Lockhart shall be by all contracts and agreements and conveyances executed pursuant to the authority here granted, bound and obligated to fully perform and discharge all of the obligations, duties, and liabilities of every kind or character which are now, or may have heretofore been imposed upon or undertaken by the Lockhart Oil Company of Texas under the terms and provisions of any and all valid and existing contracts and agreements heretofore made with any and all persons whomsoever which cover or affect either any or all of the assets and properties of the corporation to be so transferred to the said L. M. Lockhart;

And, that the said L. M. Lockhart shall further in all such contracts; conveyances, transfers, or assignments as may be executed pursuant to the authority here vested, be firmly bound and obligated to maintain in full force and effect all of the productive and non-productive oil, gas and mineral leasehold estates according to the terms thereof until such time as the said L. M. Lockhart shall have fully and finally paid each and all of the obligations and debts and shall have fully performed all of the contracts and agreements of the corporation, all of which he is to assume hereunder.

The resolution of the directors' meeting was the same as that of the stockholders, except as referring to directors instead of stockholders.

The corporation's charter was amended on December 29, 1943, to reduce the authorized capital stock from 20,000 shares to 755 shares; and 16,245 shares of the outstanding 17,000 shares were canceled. Lockhart Oil Co. conveyed to the petitioner all of its assets, except a drilling rig of the depreciated book value of $33,938.93, which was retained by the corporation. Assets of a value of $2,646,994.82 were transferred to the petitioner, who assumed liabilities in the amount of $1,679,729.23, leaving the net value distributed $967,265.59. The petitioner had signed and guaranteed the corporate notes. The transferred assets included $249,874.64 cash in bank. As of the date of the redemption and cancellation of the stock, the corporation had earnings and profits in the amount of $114,946.05.

The petitioner wished to get rid of the corporation and, for no particular reason, to operate as an individual. He had a contract to make certain monthly payments to a former wife. The contract had required him to deposit certain shares of stock of the Lockhart Oil Co., and he could not secure a release of the stock. Originally 1,000 shares had been deposited, but 50 shares could be secured by payment of $5,000 and the 755 shares remaining after the distribution were sufficient to satisfy the contract. The petitioner wished to retain the name of Lockhart Oil Co. (which he was advised could not be done without leaving assets in the corporation) and to separate the drilling business from the other corporate business, so it was decided to leave the drilling rig in the corporation, as was done. The drilling business was hazardous, and putting the drilling operations in a corporation of limited capital would limit liability.

The petitioner owed the corporation $85,987.12 on account and $50,000 on notes, at the time of stock cancellation. At that time he also owed the Federal Government the sum of approximately $223,000 on income tax liability for the year 1939. This was paid in three payments from January 25 to July 3, 1944. Petitioner had, at the date of cancellation of stock, received demand for payment. Arrangements were made with the collector for partial payments, and it was not necessary to pledge the assets for a loan. Petitioner, however, always needed money. The tax liability was the result of transfer of assets to the corporation upon its organization in 1939.

After the cancellation of stock and distribution, the corporation did not engage in oil or gas production, or recycling operations. The petitioner individually continued the recycling and oil and gas production, with the same properties, personnel, and expenses as had the corporation, except that he did not draw a salary. He withdrew what money he needed. He did not engage in drilling. The corporation, after doing nothing for about six months after the cancellation of stock, resumed drilling operations, drilling several wells for a partnership in which the petitioner owned a 30 per cent interest. After that, war caused a big demand for drilling rigs. The corporation, in its business, needed substantial amounts of money, its bills running from $100,000 to $150,000 a month.

At the time of cancellation of the corporate stock the corporation was not financially embarrassed. Banks were not pressing it, nor urging or advising change of capital structure. Petitioner advised them what was being done, and got their consent. Inability of the corporation to meet creditors' demand had no bearing on the change. The corporation had never paid any dividends.

OPINION.

DISNEY, Judge:

The problem here is whether, as the Commissioner determined, under section 115(g) of the Internal Revenue Code, there was a taxable distribution to the petitioner to the extent of $114,946.05, the corporation's accumulated earnings, or whether, as the petitioner argues, there was a distribution in partial liquidation under section 115(c), so that the distribution should be treated as in exchange for the stock. Both subsections are set forth in the margin.

SEC. 115. DISTRIBUTIONS BY CORPORATIONS.(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 distribution resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. * * *(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.

Was the cancellation or redemption of stock here involved made at such time and in such manner as to make it essentially equivalent to distribution of a taxable dividend? We have examined all of the facts presented. The question is one of fact. Randolph v. Commissioner, 76 Fed.(2d) 472 (476); Vesper Co. v. Commissioner, 131 Fed.(2d) 200. No definite rules of construction have been formulated. Hyman v. Helvering, 71 Fed.(2d) 342; William H. Grimditch, 37 B.T.A. 402. ‘Time‘ and ‘manner‘ of cancellation appear to permit no such rules.

The petitioner urges primarily that cases where taxable dividend has been found involved continuation of the corporate business as before without material change, whereas here only a small fraction of the corporate business—that of drilling— was so continued. We do not agree that such a test may be viewed as conclusive, for any partial liquidation involves to some degree abandonment of former business, and merely because there is partial liquidation is not ground for denial of application of section 115(g). The general construction of section 115 indicates that section 115(g) presents exception to section 115(c). If subsection (g) did not apply to partial liquidation under subsection (c), the former would appear without meaning, since it is not necessary in case of ordinary dividends, which, in the absence of any other special considerations, are taxable anyway. Hence, we regard petitioner's reference to Regulations 111, section 29.115-1, as defining dividend as a ‘distribution in the ordinary course of business,‘ as not helpful here. Subsection (g) might, under some circumstances, apply, though the distribution was not in the ordinary course of business. Nevertheless here, after consideration of all of the facts, it is our conclusion that we have no case of distribution of what is in essence a taxable dividend. The reasons for the redemption are mixed, but, evaluating them all, we think they do not permit conclusion that the distribution should be taxed as dividend. That one of the purposes causing the distribution was to raise funds, including those to pay income taxes, is plain. Yet, that is not the only purpose, nor the one first set forth in the corporate resolutions, which primarily recite in part:

Whereas, all of the stockholders are of the opinion that all of the productive and non-productive properties of the corporation can and will be more efficiently and more economically operated if owned by individuals rather than by the corporation as such.

The partial distribution of corporate assets in order that they may, in the opinion of the stockholders, be more efficiently or better used or operated in some other way, such as by individuals, appears clearly no reason for application of subsection (g); rather, the negation thereof. That the idea of raising funds for tax-paying purposes was not the principal or controlling consideration is well indicated by the fact that such taxes approximated $223,000, whereas the properties and money distributed approximated $2,640,000 gross, or about $967,000 net, after deduction of the $1,679,729.23 debts assumed by the petitioner. Obviously, it was not necessary to distribute all of such assets in order to meet the income taxes. The corporation had cash in bank of $247,874.64, more than enough to take care of the income taxes. As the matter transpired, by paying the income taxes in installments, the petitioner did not have to borrow money on the corporate assets. Had there been complete liquidation, subsection (g) would not have applied. The petitioner had reasonable cause for not completely liquidating (as he wished to do) in the contract with his former wife, which tied up a minor portion of the corporate stock, and in the understandable desire that the Lockhart name not be used by another corporation. Whether rightly or not, he was advised that in order to prevent such use he must leave some assets in the corporation, as was done with the drilling rig.

Another reason for the distribution was the desire to separate the drilling business, and its potential liabilities, from the rest of the business, primarily production of oil and conduct of a recycling business. Such a reason appears sound, and no reason for application of subsection (g). Such separation was accomplished.

Still another reason appears to us to indicate that we have here no distribution essentially equivalent to a dividend: There was consideration for the distribution, aside from the mere cancellation of stock; for the resolutions set forth that, ‘as consideration for the above authorized transfers, * * * the said L. M. Lockhart shall, * * * assume and agree to pay and to discharge all of the debts and obligations of every kind or character owed by, or claimed to be owed by the Lockhart Oil Company of Texas * * * . ‘ In addition, it is set forth that he should ‘maintain in full force and effect all of the productive and non-productive oil, gas and mineral leasehold estates according to the terms thereof,‘ until he had paid all debts assumed. Such assumption of obligations and such agreement to maintain leases, in effect, appear as no ordinary incidents of a dividend. We think they demonstrate a situation not essentially equivalent to distribution of taxable dividend. It will be noted that the petitioner was required to pay all debts and claims, which would include those against the assets (the drilling rig) retained by the corporation; so that the drilling rig, and the corporation owning it, were relieved from all debts, to the extent of the petitioner's worth. Such situation would not be effected by an ordinary dividend.

Considering the above discussed facts and circumstances, we have not regarded it necessary to discuss, though we have reviewed, and studied, the various cases touching this question, for upon such facts, and considering both purpose and result of the distribution, we conclude and hold that subsection (g) does not here apply, and that the cancellation and distribution of stock of Lockhart Oil Co. to the petitioner was not at such time and in such manner as to be essentially equivalent to distribution of a taxable dividend under section 115(g), Internal Revenue Code, but was in partial liquidation under section 115(c). Because of concessions made by the parties, as above noted,

Decision will be entered under Rule 50.