Docket Nos. 6226 6231.
Harold H. Bowman, Esq., for the petitioners. Bernard J. Long, Esq., for the respondent.
Husbands holding corporate common stock caused reissuance thereof in two classes equal in amount. One class they conveyed 15 days later to their wives, pursuant to a plan adopted prior to the reissuance of stock. The stock received by the wives had voting power only in limited situations provided by law, and had a value of only $1 a share on dissolution. Dividends were payable thereon, after certain dividends to the husbands, only in the husbands' discretion. Later, an agreement was made restricting alienation of the stock held by wives and requiring an offer thereof to the other stockholders at $1 per share. Dividends in large amounts were paid to the wives. Held, on all the facts, that the dividends belonged to the husbands and, as to one of the husbands, were the subject of gift by him to his wife. Harold H. Bowman, Esq., for the petitioners. Bernard J. Long, Esq., for the respondent.
These proceedings were consolidated for hearing and involve deficiencies of $332.26 and $195.27 in gift tax and penalties of $83.06 and $48.82 for the calendar years 1936 and 1937, respectively, in Docket No. 6226 and a deficiency of $358.02 in income tax for the calendar year 1941 in Docket No. 6231. The issues in Docket No. 6226 are whether certain dividends on class B stock of Castle & Overton, Inc., paid to petitioner's wife are subject to gift tax, and, if so, whether the resulting tax is subject to a penalty of 25 percent under section 3612(d)(1) of the Internal Revenue Code. The issue in Docket No. 6231 is whether certain dividends on like stock paid to the petitioner's wife are taxable to petitioner.
FINDINGS OF FACT.
The petitioners are residents of New York, New York. Petitioner George W. Oliphant filed his income tax return for 1941 with the collector for the upper New York division.
Castle & Overton, Inc., a New York corporation, engaged in the business of buying and selling raw material to make paper, was organized in 1923 for a perpetual existence and with a capital stock consisting of 4,000 shares of 8 percent cumulative preferred and 1,000 shares of common, and immediately thereafter it took over and continued a business previously conducted by a partnership known as Castle & Overton, of which William A. Castle and Frank C. Overton, father of Carlton B. Overton, were the sole members. The business of Castle & Overton was previously carried on by another partnership known as Castle, Gottheil & Overton. Gottheil died in 1922. The business has always been closely held within the families of the original partners and Abner Koplik, who has been connected with it for 49 years.
The liquidating value of the common stock of Castle & Overton, Inc., increased from nothing in 1924 to between $120 and $150 a share in 1935 and 1936, the years in which the corporation's earnings were greatest. At about that time the stockholders of the corporation gave serious consideration to the question of increasing the number of shares of existing stock and to other plans for changes in the corporation's capital for the purpose of transferring stock to their wives. The stockholders felt that, as they were managing the business and producing its profits, they should have first call on the corporation's dividends and they did not wish to place unrestricted voting stock in the hands of their wives. The plan agreed upon and consummated for reclassifying the corporation's stock and transferring substantially all of the B stock to the wives of stockholders, as hereinafter set forth, was adopted for the purpose of reducing the taxes payable by the holders of each class of common stock to the minimum required by law and enabling the corporation to charge the interest on bonds against income.
On May 26, 1936, the corporation filed a certificate with the Secretary of State of New York for a reduction of capital and reclassification of its stock. The certificate provided for cancellation and retirement of the corporation's outstanding 3,249 shares of preferred stock at its par value of $324,900; for changing its authorized and outstanding common stock of 1,000 shares without par value into 2,000 shares of like stock equally divided between class A and class B shares, each class without par value; for the exchange of one share of outstanding common stock for one share of each class of the new stock; that except in 1936 the holders of class A stock should be entitled to receive, when declared by the board of directors, non-cumulative dividends at the rate of $10 a share each year before paying dividends on class B stock in such year; that, if the board of directors should decide in their discretion that dividends might in any year be paid in excess of $10 a share on class A stock, such excess dividends should be paid on both classes of stock, one-fifth thereof on class A and the remainder on class B; that all dividends for 1936 should be paid in the proportion of one-fifth to holders of class A stock as a unit and the remainder to class B stockholders as a unit; that in any distribution of the corporation's capital holders of class B stock should receive $1 for each share of such stock, all other assets to be paid proportionately to class A stockholders, and that, except as otherwise provided by law, voting rights for all purposes should vest in and be exercised by the holders of class A stock.
Promptly after the filing of the certificate all of the preferred stock was retired and canceled, and it was replaced, dollar for dollar, in par value by debenture bonds of the corporation bearing 8 percent interest, which was the rate of dividends which had been regularly paid on the preferred stock. The purpose of the exchange was to save taxes through deductions of interest on the bonds. On May 26, 1936, the new common stock was issued in exchange for the old common in accordance with the provisions of the certificate. Immediately after the exchange the old stockholders held the following shares of each class of stock:
+-----------------------------------------------------------+ ¦Frank C. Overton, 247 shares ¦Abner Koplik, 197 shares ¦ +------------------------------+----------------------------¦ ¦George W. Oliphant, 247 shares¦Alexander S. Ware, 52 shares¦ +------------------------------+----------------------------¦ ¦Carlton B. Overton, 247 shares¦George H. French, 10 shares ¦ +-----------------------------------------------------------+
The first four of the stockholders listed above for some years prior to the exchange had been officers and directors of the corporation and had general charge and direction of its affairs. Of all the stockholders of the corporation, they were the most familiar with its business and the most able to conduct the business for the benefit of the stockholders in general. W. A. Castle was also a director.
In 1935 and 1936 Frank C. Overton was president of the corporation, George W. Oliphant vice president and secretary, Carlton B. Overton vice president and treasurer, and Abner Koplik vice president.
On June 10, 1936, each of the corporation's stockholders, except George H. French, in accordance with an intention had when the reclassification of the corporation's stock was decided upon, assigned his class B stock to his wife and new certificates were issued in the names of the respective assignees. The certificates were deposited by each wife in a safe deposit box rented in her name, to which her husband had access. Petitioners did not have a power of attorney from their respective wives authorizing them to dispose of their property. Neither petitioner had, prior to or at the time of the transfer of the stock, ‘a conversation‘ with his wife respecting the use to which she should put any dividends received from the stock or the disposition she should make of the stock by will or otherwise.
On December 4, 1930, and December 31, 1935, stockholders of the corporation entered into written agreements limiting their rights to dispose of their stock of the corporation.
On April 8, 1937, the petitioners and Frank C. Overton and Abner Koplik and their respective wives agreed in writing not to dispose of or lose full control of any of the bonds or capital stock of the corporation held or thereafter acquired by them except as provided for in the agreement. The agreement otherwise provided that no party to the agreement could transfer, pledge, encumber or in any other manner dispose of or lose full ownership or control of his or her bonds or stock, without the written consent of the other parties or their survivors; that if any party was discharged from the employment of the corporation or voluntarily left the service and associated himself with another business or desired to dispose of all or part of his or her bonds, the bonds in excess of $10,000 face or par amount were to be offered to the other parties then living for purchase at face value, plus accrued interest, ratably according to their holdings of common A stock of the corporation, on terms of 10 percent cash and the remainder in equal installments over a period of nine years, with a right of anticipation, all payments to be regarded as payment in full for bonds to the extent of the payment. The contract contained a similar provision respecting common A stock of the corporation at a cash price of $100 a share, or its book value without any amount for good will, whichever was higher, unless the book value was less then $50 a share, in which event the price was to be $50 a share. Under like circumstances, owners of class B common stock were to offer their holdings to other holders of such stock for purchase, according to their percentages of ownership of that class of stock, at a cash price of $1 a share. In the event of death or insolvency of any party to the agreement, his or her holdings of stock, and bonds in excess of $10,000, were to be deemed to have been offered to the surviving parties for purchase on the terms hereinbefore mentioned for bonds and stock, and upon the death of any of the husbands, parties to the agreement, his wife was to offer her stock, and bonds in excess of $10,000, upon the same terms. If the wife of any party to the agreement should predecease her husband while owning common B stock and leaving a will bequeathing all of such stock, and bonds in excess of $10,000, to her husband, no other party was to have a right to purchase any part of the common B stock owned by the deceased wife at the time of her death and so bequeathed to her by her husband.
The agreement also provided that if any party thereto, or his executor, trustee in bankruptcy, receiver, or assignee, should sell or encumber any of the stock, or bonds in excess of $10,000, contrary to the terms of the contract, the remaining parties, having fully complied with the agreement, might demand that all interest and dividends upon such bonds and stock be paid to them in the proportion which their holdings of A stock should bear to the aggregate holdings of such stock by other parties to the agreement.
In January 1941 Johannes Westergaard entered the employ of the corporation as vice president. Prior thereto the corporation's stockholders agreed that he could purchase stock of the corporation in such amount as all parties concerned might agree upon. The price agreed upon was $155 a share for class A stock, a figure based upon a rough estimate of the book net worth of the corporation, and $20 a share for class B stock, an arbitrary price.
On or about February 28, 1941, holders of B common stock transferred to Johannes Westergaard the following shares of such stock for $20 a share:
+--------------------------------------------------------+ ¦Anne K. Oliphant ¦29 shares¦Rose Koplik ¦24 shares¦ +-------------------+---------+----------------+---------¦ ¦Virginia W. Overton¦29 shares¦Marion L. Ware ¦20 shares¦ +-------------------+---------+----------------+---------¦ ¦Jennie H. Overton ¦29 shares¦George H. French¦2 shares ¦ +--------------------------------------------------------+
As part of the same transaction Johannes Westergaard acquired for $155 a share a like number of shares of A common stock from the holders of such stock.
Frank C. Overton died on November 5, 1941. On December 1, 1941, his widow, Jennie H. Overton, transferred the 218 shares of common B stock she held of the corporation at the time of her husband's death as follows:
+--------------------------------+ ¦Castle & Overton, Inc¦100 shares¦ +---------------------+----------¦ ¦Anne K. Oliphant ¦34 shares ¦ +---------------------+----------¦ ¦Virginia W. Overton ¦34 shares ¦ +---------------------+----------¦ ¦Rose Koplik ¦27 shares ¦ +---------------------+----------¦ ¦Johannes Westergaard ¦23 shares ¦ +--------------------------------+
She received for the stock $1 a share, the price fixed in the option agreement of April 8, 1937. At or about the same time, the corporation acquired 100 shares of A stock from the estate of Frank C. Overton, and the holders of options under the agreement of April 8, 1937, acquired the remaining shares. Stockholders holding an option to purchase the stock consented to the transfers to the corporation. They consented to have the corporation acquire the stock to enable it to give or sell the shares to its young employees.
Dividends of $40 a share were paid on the old common stock in 1935 and 1936, including a dividend of $10 a share in May 1936. Thereafter, dividends were paid on each share of the new common stock as follows:
+---------------------------+ ¦ ¦Stock ¦ +-------------+-------------¦ ¦Year ¦A ¦B ¦ +-------------+------+------¦ ¦1936 ¦$15.00¦$60.00¦ +-------------+------+------¦ ¦1937 ¦19.00 ¦36.00 ¦ +-------------+------+------¦ ¦1938 ¦20.00 ¦40.00 ¦ +-------------+------+------¦ ¦1940 ¦12.60 ¦10.40 ¦ +-------------+------+------¦ ¦1941 (about) ¦11.00 ¦4.00 ¦ +---------------------------+
The dividends paid by the corporation to the petitioners and their wives during the years 1936 to 1941, inclusive, were as follows:
+------------------------------------------+ ¦¦George W.¦Anne K. ¦Carlton B.¦Virginia W.¦ ++---------+--------+----------+-----------¦ ¦¦Oliphant ¦Oliphant¦Overton ¦Overton ¦ ++---------+--------+----------+-----------¦ ¦¦ ¦ ¦ ¦ ¦ +------------------------------------------+
$14,820.00 (3,705.00 3,705.00 1937 4,693.00 8,892.00 4,693.00 8,892.00 1938 4,940.00 9,880.00 4,940.00 9,880.00 1940 3,112.20 2,568.80 3,112.20 2,568.80 1941 2,772.00 1,008.00 2,772.00 1,008.00
The dividends on the class B stock outstanding in the names of Anne K. Oliphant and Virginia W. Overton were paid by checks of the corporation payable to their order. The checks were endorsed by each of the respective payees and deposited in her personal bank account.
Petitioners did not at any time receive any of the dividends paid to their respective wives.
In 1935, 1936, 1937, 1938, 1939, 1940, and 1941 Carlton B. Overton and George W. Oliphant each received salaries of $26,250, $25,000, $22,000, $15,000, $19,000, $13,500, and $15,600, respectively, from the corporation.
The petitioners did not file gift tax returns in 1936, and Carlton B. Overton did not file such a return in 1937. Overton's failure to file a gift tax return for 1936 was because he believed the class B stock transferred to his wife did not have a value in excess of $247 in connection with his ownership of class A stock. The reason for Oliphant's failure to file a like return for the transfer of shares of the same stock to his wife was a belief that the value of ‘$1 plus‘ a share for the stock was not sufficient to require the filing of a return.
The chief questions are whether petitioner Overton is liable in 1936 and 1937 for gift taxes and petitioner Oliphant in 1941 for income tax on dividends paid in those years to their respective wives on class B stock of the corporation.
The petitioners admit that the reclassification of stock of the corporation, the replacement of preferred stock by debenture bonds carrying the same rate of interest as the dividends paid on the replaced stock, and the transfers by stockholders to their wives of class B stock received, with class A stock, in exchange for old common stock, were made for the purpose of reducing income taxes to a legal minimum, and contend that, regardless of such purpose and other considerations bearing on the question, the transfers of class B stock to their respective wives were bona fide gifts of the securities, and, consequently, they, as donors, should not be regarded as the owners of the stock in the taxable years for tax purposes. The position of the respondent upon brief is that the transfers of class B stock by petitioners to their respective wives were not bona fide gifts, but a plan to distribute income of petitioners under the guise of dividends paid directly to their wives.
The fundamental difference between the parties is whether the transactions, in the light of all of the evidence, were real, such as the law permits for reducing tax liability, or a sham, and therefore ineffective for tax purposes.
Numerous cases illustrate the rule that strict compliance with the letter of the statute may not be effective for tax reduction purposes on account of being contrary to the intent of Congress. In Gregory v. Helvering, 293 U.S. 465, the plan of reorganization followed the pattern set by the statute, but tax relief was denied upon the ground that the plan had no relation to the business of the corporation involved in the transaction. The Court said:
* * * The rule which excludes from consideration the motive of tax avoidance is not pertinent to the situation, because the transaction upon its face lies outside the plain intent of the statute. To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.
Neither is legal title to the property from which the income was derived the sole governing factor. Lucas v. Earl, 281 U.S. 111.
To the same general import are Griffiths v. Helvering, 308 U.S. 355; Higgins v. Smith, 308 U.S. 473; and Commissioner v. Court Holding Co., 324 U.S. 331. See also Alice H. Bagley, 4 T.C. 897, where the form of the transaction constituted a recapitalization under the reorganization provisions of the governing statute, but the exchange of common stock for new common stock and debenture bonds of the corporation lacked a business purpose and was essentially equivalent to the distribution of a taxable dividend; also Adam A. Adams, 5 T.C. 351, a similar case.
The corporation is not before us in these proceedings and it is not necessary to decide whether it passed through a statutory reorganization. However, the plan adopted and followed by it with the knowledge and consent of its stockholders constitutes material evidence on the question at issue and may not be ignored. Without it, petitioners and the other stockholders could not have consummated the plan they devised for reducing their tax liability.
The stockholders considered a plan to increase the number of shares of common stock in order to provide stock of a lower value for gifts to their wives. Such a plan would have given the wives stock control and dividend rights on a basis equal to their own, rights the stockholders finally concluded to avoid conferring on account of a determination that they, as administrators of the business, were entitled to all of the first profits available for dividends and did not wish to have the women voting on current management matters. The plan put into effect, however, placed greater restrictions upon the class B common stock created for the express purpose of transferring it to the wives of the old stockholders for tax avoidance purposes.
One of these restrictions was the limitation in the stock certificates of the right to participate in distributions of the corporation's capital to $1 a share. No contention is made that this nominal figure has any relation to the value the stock would have had at that time if the class B stock had been authorized to participate in capital distributions on an equality with class A stock, which was retained by the old stockholders. It is evident that the amount is an arbitrary figure. This restriction enabled the old common stockholders to retain all of their interest in the corporation's assets, except $1,000, the dissolution value of the class B stock, and gave petitioners a basis they regarded as plausible to contend that the class B stock did not have a value greater than $1 a share for gift tax purposes. Without, however, transferring greater interest in corporate assets, ownership of the stock conferred upon the transferees rights to participate in dividends grossly disproportionate to the dissolution value of their stock. These rights, conferred upon stock otherwise lacing more than nominal value, had great potential earning power, and such benefits, without tax liability to the petitioner (as intended), constituted the substance of the transfers, rather than the liquidation value of the stock. The object was part of the general plan to divide corporate earnings among family units with a corresponding reduction in tax liability of the heads of the units. This is definitely shown by testimony in the record.
Petitioner Overton, after pointing out that the corporation was emerging from a period of high profits and that the officers believed that it might be entering a period of low earnings, testified:
* * * Therefore, we felt that when the income from the common stock in addition to our salaries reached a certain figure, that it would be good business on our part to let our wives have an additional income during that period of our lives when we can see how they handle money. * * *
This testimony was followed by a remark of the witness that he was speaking only for himself. The success of the plan to distribute earnings among B stockholders having practically no capital at stake in the business is shown by dividend payments made in and after 1936.
After June 10 in 1936 the class B stock earned $60 a share, in comparison with $15 on class A stock. Of the class B dividends so paid, $28 a share was paid on June 18, a date only 8 days after the stock was transferred by the A stockholders to their wives. Less dividends were paid in subsequent years, yet the ratio of 1 to 4, after deducting the $10 a share payable on class A stock before dividends on class B, was maintained. For the 6-year period ended in 1941 (dividends were not paid in 1939) the dividends on class B stock aggregated $150.40 a share, an average of $25 a year, and on class A stock $77.60, including the preferential dividend of $10 a share except in 1936, an average of $13 a share. Thus the class B stockholders, with no capital investment, over a period of 6 years received more than twice the amount of dividends paid to the A stockholders, who alone had capital at risk in the business. The amount payable on the class B stock was regarded as the excess of what the officers of the corporation should receive as salary for administering the business and a fair return on their investment in class A stock. The class B stock, under the circumstances, was in the nature of a device for assignment of future income.
The control retained by the old stockholders was substantial. The respondent argues that the voting control was complete, contrary to contentions of petitioners that class B stock had voting privileges in proceedings for mortgaging the property and franchises of the corporation, for guaranteeing bonds of another corporation, for sale of the franchises and property, or establishing priorities or creating preferences between classes of stock, for consolidation, for voluntary dissolution, or for a change of name, each privilege under a specified provision of the Stock Corporation Law of New York, pursuant to section 51 of such law.
It is unnecessary to resolve the difference of the parties on this point. The class A stock was intended to, and it is not denied that it did, have exclusive voting rights as to general routine matters for conducting the affairs of the corporation, including the selection of directors. The owners of all except 62 shares of the old common stock were the directors and officers of the corporation for some years prior to the reclassification of its stock and were its officers at least for the remainder of 1936. The matters on which the class B stockholders had a right to vote, according to the contentions of petitioners, were extraordinary, and therefore unlikely to arise for a vote of stockholders.
Limitations were placed upon the ownership and enjoyment of the stock by the agreement of April 8, 1937, among petitioners and Frank C. Overton and Abner Koplik, owners of 93.8 per centum of the class A stock, and their wives. The general purpose of the agreement was to keep the stock and bonds among the family groups and their survivors by purchase at artificial prices. For instance, holders of A stock had an option to acquire, upon the happening of specified contingencies, bonds in excess of $10,000 and A stock. B stockholders had the same right as to the B stock, and, in the event of disposition of stock or bonds contrary to the terms of the agreement, nondefaulting A stockholders were entitled to the interest and dividends on such securities upon demand. The B stockholders could not, without the consent of all other stockholders, receive more than $1 a share for the stock, and a wife was required to sell her stock at that price upon the death of her husband.
This restrictive agreement was entered into after the transactions of June 10, 1936, and is therefore not controlling. Nevertheless, it is, in our view, corroborative, for it demonstrates the willingness of the wives unhesitatingly to give up valuable rights without consideration, even in the face of prior receipt of large dividend payments.
Marshall v. Commissioner, 57 Fed.(2d) 633, and other cases involving similar facts, cited by the petitioners to support their view that the transfers of class B stock to their wives constituted bona fide gifts and should be recognized as such, are distinguishable on their facts and for that reason do not control the question here. Considering the control and interest retained by petitioners in connection with the transactions, and other evidence bearing upon the question at issue, we are of the opinion, and hold, that the substance of the plan was a device to distribute, in the guise of dividends, income earned by class A stock retained and owned by the petitioners.
We therefore hold that the petitioner Carlton B. Overton made gifts to his wife in each of the years 1936 and 1937, in the amount of the income from the class B stock in her name; and that the income in 1941 from the class B stock, in the name of the wife of George W. Oliphant, was his income.
Petitioner Overton does not question the applicability of the gift tax provisions of the statute, or section 3612(d)(1) of the code respecting the penalty imposed for failure to file gift tax returns under the conclusion reached by us. Accordingly,
Decisions will be entered for the respondent.