Opinion · United States Tax Court
Snite v. Commissioner
10 T.C. 523
- Type
- Opinion
- Court
- United States Tax Court
- Jurisdiction
- Federal
- Date
- 1948-03-25
- Topic
- general
OPINION. Arunpeix, Judge: Initially We are met with the petitioners’ contention that in determining the deficiencies the respondent was barred by the statute of limitations, section 275 (a), Internal Revenue Code, from making any adjustments to their 1942 income, inasmuch as the deficiency notices were mailed more than three years after their 1942 returns were filed. The question involves the interrelationship of the statute of limitations and the forgiveness features of section 6 of the Current Tax Payment Act of 1943. Admittedly the deficiency notices were mailed within three years after the filing of the 1943 returns. Since the briefs in'this case were received, this Court has decided an identical question adversely to the position of the petitioners.
Citator
UpLaw has not yet analyzed Snite v. Commissioner. The absence of a flag is not a finding that it is good law.
- Authority status
- pending
- Cited by
- 3 opinions
2. Petitioners, husband and wife, were majority stockholders of a closely held corporation. They agreed to transfer a portion of their respective holdings to the corporation so as to enable key employees to acquire the treasury stock at a fixed price determined after bargaining with the employees. On December 28, 1942, petitioners transferred 2,000 shares to the corporation, for which they received total payments in the amount of $300,000. On December 8, 1943, they made similar transfers of 1,500 shares and were paid $225,000.Held,the proceeds did not constitute a distribution essentially equivalent to a taxable dividend under section 115 (g), Internal Revenue Code.
The principal question in dispute is whether amounts received by petitioners from the Local Loan Co. in 1942 and 1943 were equivalent to distributions of taxable dividends within the meaning of section 115 (g) of the Internal Revenue Code. A minor adjustment to Fred B. Snite's 1942 reported capital gain is not challenged, except for the bar of limitations.
Prior to July 1, 1928, both petitioners operated separate small loan businesses, which were conducted in both individual proprietorship and corporate form. On July 1, 1928, they incorporated Local Loan Co. in Delaware, with a capital structure comprising 20,000 shares of common stock (par value $100). In 1934 authorized common stock was increased to 50,000 shares (par value $100). The charter authorized Local Loan Co.inter alia,"to purchase, hold, sell, and transfer the shares of its own capital stock * * *."
In September 1928 petitioners transferred physical assets owned by them to the Local Loan Co., for which Fred B. Snite and Loretto M. Snite received their first holdings of common stock, in the amounts of 4,111 shares and 3,280 shares, respectively. Additional shares were issued to the parties on January 1, 1932, in consideration for the transfer of additional assets. The company conducted business in several states and maintained its central office in Chicago, Illinois.
Petitioners created a "Funded Insurance Trust" on December 24, 1935, to which Fred B. Snite transferred insurance policies on his life in the amount of $675,000. In order to meet premium payments on these policies, Loretto M. Snite simultaneously transferred 3,000 shares of her Local Loan Co. stock to the trustees. Both parties duly reported these gifts in 1935 gift tax returns. The primary beneficiaries of this irrevocable trust were petitioners' two children. The trusteesPage 525who have served since December 18, 1942, are petitioners' daughter, her husband, and Thomas D. Griffin. Griffin is executive vice president of Local Loan Co., acting in direct supervision of all phases of its operation.
On December 30, 1935, Fred B. Snite established another irrevocable trust, known as the "Living Trust," for the benefit of his two children. He then transferred to this trust 3,000 shares of his common stock of Local Loan Co. also reporting this gift in his gift tax return for 1935. The parties named as trustees of the "Funded Insurance Trust" have also been the fiduciaries of the "Living Trust" since December 18, 1942.
Fiduciary income tax returns have been filed for each of the above trusts since their creation, and the income taxes shown on such returns have been paid.
On December 22, 1941, Fred B. Snite sold 840 shares of Local Loan Co. stock to the "Living Trust," whereas his wife, Loretto B. Snite, sold 400 shares to the "Funded Insurance Trust."
Several of the key employees of Local Loan Co., led by Griffin, were desirous of acquiring interests in the business. Snite was willing to increase salaries (and did increase Griffin's compensation from $18,000 in 1929 to $65,000 in 1942) but was very reluctant to allow the employees to acquire stock. Prior to the war, several overtures were made by these staff members, but they received only indefinite promises from Snite to "work something out."
One Murphy, an employee, proposed a plan whereby Local Loan Co. could purchase its own stock from petitioners and later make this treasury stock available for purchase by the employees pursuant to stock option. The employees felt that the death of Fred B. Snite prior to the purchase of stock directly from him would preclude completion of the deal, whereas an unexercised option from the company would be protected in such event. Early in 1942 Griffin submitted this proposal to Snite, at which time he informed the latter of other business offers then under consideration by him.
Late in 1942 Fred B. Snite finally adopted the treasury stock plan, on the advice of his attorneys and auditors. Under the plan each petitioner was to sell the company 1,000 shares of stock, and 1,000 shares each were to be made available to Griffin and Murphy at $150 a share. This concession was granted with an understanding that any employee desiring to dispose of his holdings at a later date would be required to sell the stock back to Local Loan Co. The price of $150 per share was determined after extended negotiations among the parties; the employees wished to obtain a lower price, and SnitePage 526thought $150 too low. In 1943 petitioners were persuaded to make 1,500 additional shares available to other employees.
On December 17, 1942, the directors of Local Loan Co. adopted a resolution which provided as follows:
WHEREAS, FRED B. SNITE and L. M. SNITE, his wife, have each offered to sell to this corporation 1000 shares of stock of this corporation at a price of $150.00 per share on condition said offers are accepted and the sales consummated on or before December 31, 1942; and
WHEREAS, it is deemed desirable for the corporation to purchase said stock at said price and retain the same as treasury stock to be used in such manner as the Board of Directors may hereafter determine;
NOW, THEREFORE, BE IT RESOLVED that the Officers of this corporation be and they are hereby authorized and directed to purchase 1000 shares of the stock of this corporation from FRED B. SNITE, and 1000 shares of the stock of this corporation from L. M. SNITE, at $150.00 per share; said sale to be consummated on or before December 31, 1942, and said stock to be retained as treasury stock of this corporation, to be disposed of in such manner as the Board of Directors may hereafter determine.
Each of the petitioners, pursuant to this resolution, delivered 1,000 shares of common stock to the company on December 28, 1942, and received separate checks for $150,000. These checks were deposited by the parties in their respective personal bank accounts on December 30, 1942. The corporate drawing accounts of Fred B. Snite and his wife were balanced by payments on December 29, 1942, of $56,000 and $24,500, respectively. Fred B. Snite and Loretto M. Snite on December 30, 1942, made loans to Local Loan Co. of $60,000 and $130,000, respectively, for which notes were separately issued in these amounts. These loans were both repaid in installments during 1943.
The directors of Local Loan Co. on December 2, 1943, adopted a resolution similar to the one quoted above, which authorized the further acquisition at $150 a share of 360 shares of common stock from Fred B. Snite and 1,140 shares from his wife. The latter parties delivered these shares of stock to Local Loan Co. on December 8, 1943, and received checks therefore in the amounts of $54,000 and $171,000, respectively. These checks were likewise deposited in their respective personal bank accounts.
On December 8, 1943, Local Loan Co. borrowed $100,000 from Fred B. Snite and $175,000 from Loretto M. Snite, delivering a note for $100,000 to the former, and two notes, one for $125,000 and another for $50,000, to the latter petitioner. These loans were paid off in installments during 1944 and 1945. In early December 1943 Fred B. Snite placed $31,663.58 in his personal drawing account to balance prior withdrawals during the year. Loretto M. Snite made a deposit of $40,000 on December 6, 1943, for a similar purpose.Page 527
The book value of Local Loan Co. stock was in excess of $150 a share at the time of the petitioners' transfers of stock in 1942 and in 1943. Local Loan Co. carried the stock acquired from petitioners, 2,000 shares in 1942 and 1,500 shares in 1943, as treasury stock. This stock had been originally acquired by petitioners, not as stock dividends, but in exchange for assets transferred to the company prior to the declaration of any stock dividends. New certificates for these shares were issued in the company's name and placed in its safety deposit box.
Pursuant to the Stabilization Act of 1942 (56 Stat. 765,50 U.S.C. § 961et seq.), and Executive Order No. 9250, issued October 3, 1942, by authority thereof, the Commissioner promulgated regulations denying salary increases without governmental approval. Section 1002.28 thereof (1942-2 C. B. 359) provided that, in the event a salary was increased without such approval, the entire payment, and not merely the increase, would be disregarded in the calculation of income tax deductions. Those limitations were modified by Executive Order No. 9599, issued August 18, 1945.
The employees applied no further pressure for the formal establishment of the option plan during the war years, because of the Stabilization Act and tax uncertainties. Their accountants advised that the tax authorities might determine that the fair market value of the stock was in excess of $150 a share and hold that the excess constituted additional income under both the wage and revenue laws. Another reason for their reluctance to arrange a direct purchase of stock from Fred B. Snite was their fear that such a transaction would be considered a subterfuge to evade salary limitations and income tax. The employees felt that the agreement with Fred B. Snite and the placing of 3,500 shares in the corporate treasury satisfied their immediate objective. They anticipated that the stock would be made available for purchase after salary restrictions were lifted.
A resolution was adopted on August 20, 1946, by the directors of Local Loan Co. authorizing the issuance to key employees of "options to purchase * * * [the 3,500] shares of the common stock of LOCAL LOAN CO. now in its treasury, at the price of $150.00 per share * * *." In the options, conditions were to be imposed requiring any employee desiring to dispose of his stock during the first five years after acquisition to sell it to Local Loan Co., and obligating the company to buy the stock, at set prices. After five years, any employee desiring to sell was obligated to give the company a first option to purchase his stock at the price obtainable elsewhere. Another resolution, adopted by the directors on December 20, 1946, designated the employees and allotted the 3,500 shares among them. Thereupon,Page 528options were granted to the 17 designated employees. Five employees exercised their options to the extent of 40 shares on January 6, 1947. They wished to test the income tax consequences of such purchases before they and the other employees exercised their options in full. Prior to the hearing, no other options had been exercised.
The net income after taxes, the dividends paid, and the surplus and undivided profits, per books, of Local Loan Co. for the years indicated are set forth in the following table:
1930 ..... $298,726.16 $15.00 $110,865 1931 ..... 237,758.04 6.72 1/2 50,000 $260,900.00 $331,200 1932 ..... 1,091,670.5315.00 68,000 1,349,057 1933 ..... 360,038.1815.00 100,000 640,000.00 961,522 1934 ..... 363,621.29 8.50 170,000 150,000.00 1,044,073 1935 ..... 454,806.74110.00 215,000 161,200.00 1,293,676 1936 ..... 561,785.11115.00 346,680 1,494,117 1937 ..... 584,788.01 12.00 277,344 1,790,342 1938 ..... 823,784.61 10.00 231,120 188,653.06 2,195,772 1939 ..... 1,735,687.7819.00 225,000 999,920.00 2,697,739 1940 ..... 801,819.92 9.00 315,000 3,177,505 1941 ..... 787,570.58112.00 420,000 3,544,423 1942 ..... 512,120.43 8.00 280,000 3,777,139 1943 ..... 490,004.76 8.00 264,000 3,868,617 1944 ..... 708,898.56 2.00 63,000 4,509,439 1945 ..... 698,180.0628.00 252,000 4,953,977 1946 ..... 887,409.6728.00 252,000 5,589,387
Petitioners in 1942 received the regular cash dividends declared on the 2,000 shares prior to their sale to the company, and in 1943 they received the regular cash dividends declared on the 1,500 shares prior to the sale of those shares to the company. No stock other than these 3,500 shares has been acquired by the company from any of its stockholders.
All transactions involving the issuance or transfer of stock of the Local Loan Co. from the date of its incorporation through December 27, 1942, were as follows:Page 529
7-1-28 ..... Transfer of assets ............ 7,391 7,391 12-15-31 ... Stock dividend ................ 2,609 10,000 1-1-32 ..... Transfer of assets ............ 3,600 13,600 5-1-33 ..... Stock dividend ................ 6,400 20,000 12-31-34 ... Stock dividend ................ 1,500 21,500 Dec. 1935 .. Gifts to trusts ............... 21,500 12-31-35 ... Stock dividend ................ 1,612 23,112 12-31-38 ... Stock dividend ................ 1,888 25,000 11-30-39 ... Stock dividend ................ 10,000 35,000 12-22-41 ... Sale of 1,240 shares to trusts 35,000
Ownership of shares Date Funded Fred Loretto Living insurance B. Snite M. Snite trust trustShares Shares SharesShares
7-1-28 ..................... 4,111 3,280 12-15-31 ................... 1,451 1,158 1-1-32 ..................... 7,276 6,324 5-1-33 ..................... 10,700 9,300 12-31-34 ................... 11,502 9,998 Dec. 1935 .................. 8,502 6,998 3,000 3,000 12-31-35 ................... 9,139 7,523 3,225 3,225 12-31-38 ................... 9,885 8,137 3,489 3,489 11-30-39 ................... 13,839 11,391 4,885 4,885 12-22-41 ................... 12,999 10,991 5,725 5,285
12-31-42 ............ 2,000 11,999 9,991 5,725 5,285 12-31-43 ............ 3,500 11,379 8,851 5,915 5,355
Fred B. Snite included $37,595.25 in 1943 net income as long term capital gain from the sale of 620 shares of stock of the Local Loan Co. during that year. Similarly, Loretto M. Snite reported $69,131.03 long term capital gain, which was derived from the sale of 1,140 shares in 1943. Again, the respondent held that the entire proceeds from the stock transferred to the company, $54,000 to Fred B. Snite and $171,000 to Loretto M. Snite, constituted ordinary income. Having made these adjustments to income in both 1942 and 1943, respondent determined the deficiencies for 1943 pursuant to the forgiveness features of section 6 of the Current Tax Payment Act of 1943.Page 530
We pass, therefore, to the main question at issue, which is whether the stock transactions between the petitioners and Local Loan Co. in 1942 and 1943 were, as they purported to be, sales, or were cancellations or redemptions of stock at such times and in such manner as to be essentially equivalent to the distribution of taxable dividends under section 115 (g) of the code.1Petitioners' first argument as to why section 115 (g) is not applicable is that here there was no cancellation or redemption of stock. It is clear enough that the stock was not actually canceled or retired, nor was it intended to be. Whether it was redeemed may be a different question. Petitioners recognize that in certain decisions, such asAbraham Kirschenbaum,T. C. memorandum opinion, March 27, 1945; affd.,155 F.2d 23; andJames D. Robinson,27 B. T. A. 1018; affd.,69 F.2d 972, section 115 (g) has been held applicable even though the stock was held in the corporate treasury; but they contend that these cases are distinguishable because of the "patent tax evasion" schemes there involved. Be that as it may, in the view we take of this case we need not express any opinion as to whether every purchase by a corporation of its own stock amounts to a "redemption" as that term is used in section 115 (g). Cf.Rollin C. Reynolds,44 B. T. A. 342.
Assuming that the stock transactions in this case were redemptions,Page 531the question still remains whether they occurred at such times and in such manner as to be essentially equivalent to the distribution of taxable dividends. Respondent insists it is now established law that the net effect of the transaction, rather than the motives and purposes of the corporation or its stockholders, is the test of taxability. It must be recognized that the net effect rationale inheres in a number of decisions. SeeBazleyv.Commissioner,331 U.S. 737;Hirschv.Commissioner,124 F.2d 24;Flanaganv.Helvering,116 Fed. 2d 937;Hymanv.Helvering,71 F.2d 342; cf.Commissionerv.Bedford's Estate,325 U.S. 283. But all that this means is that no one factor is controlling. It surely does not mean that the mere existence of sufficient earnings and profits to cover the acquisition of the stock automatically brings the transaction within the provisions of section 115 (g). If that were so, it would seem that practically no room would be left for the operation of the provisions of section 115 (c), relating to distributions in partial liquidation. Just as the presence of a legitimate business purpose will not, standing alone, conclusively determine that section 115 (g) is inapplicable, so the mere fact that the corporation has sufficient surplus available does not conclusively determine that the section is applicable. All relevant factors must be considered in determining the net effect of the transaction.
On brief, the respondent argues that the "real purpose of the transactions was to distribute earnings and profits of $525,000 to the Snites, and to do so under the guise of sales in order to avoid Federal income taxes." Implicit at least in this argument is a recognition by the respondent of the purpose of section 115 (g) and the background of tax avoidance which gave rise to that statute. We do not, however, agree with the respondent's view of the evidence in this case.
The record before us is overwhelmingly convincing that the initiative for the stock transactions in question came entirely from the employees of the Local Loan Co., who for many years had been striving to acquire a proprietary interest in the business, and that the only reason for the transfers was to make stock available to the employees. Griffin, the general manager, testified that in the early 1930's he had begun trying to persuade Snite to let him and other key employees acquire stock in the company, but was continually put off with an indefinite promise to work something out in the future. His drives for stock participation usually resulted in an increase in his salary. Finally, in 1942, after the salary control provisions of the Stabilization Act prevented further increases in salary, Griffin received a favorable offer from a competing company and was determined to force the issue on stock participation. It appears that Snite was very reluctant to agree either to the plan of stock participation or to the price of $150 a share, which was arrived at only after much bargaining between Snite andPage 532the employees. It was the employees themselves who suggested that the transactions be handled through the company. That would facilitate the financing of their purchases and also the imposition of conditions relating to repurchase.
There was a definite understanding that the 2,000 shares which the petitioner sold the company in 1942 were to be made available, 1,000 shares each, to Griffin and Murphy. Other employees, upon learning of that transaction, were dissatisfied and also wanted to be included in the stock participation plan. It was to provide for them that the petitioners transferred the additional 1,500 shares in 1943. Though the Stabilization Act prevented the full fruition of the plan during the war years, as the employees realized, nevertheless the employees felt they had won their fight when the stock came into the hands of the company and they were assured that it would be available to them whenever the relaxation of wartime controls would permit.
The proceeds of the sales of petitioners' stock were in no sense a substitute for regular dividends which would otherwise have been payable. The dividend record of the company over its existence has been liberal, despite the fact that in the type of business in which the company engages cash capital is a vital element. In each of the taxable years the petitioners received on the stock they sold the company in that year the regular cash dividends which had been declared prior to the sales. No compelling personal need of either of the petitioners for funds — a factor to which great weight is usually attached in decisions holding section 115 (g) applicable — can successfully be argued on the basis of the instant record. On the contrary, in 1942 each of the petitioners returned to the company, by way of loans, substantial amounts of the proceeds of their stock sales; and in 1943 they both loaned the company even more money than the proceeds they received. If there was need for funds, it would appear to have been on the part of the company rather than the petitioners.
The petitioners parted with their title to 3,500 shares of stock, representing 10 per cent of the total outstanding shares; and those 3,500 shares are irrevocably optioned to the several employees of the Local Loan Co., whose interests may well be adverse to those of the petitioners as stockholders. The petitioners' proportionate ownership has been substantially changed. These results, it is obvious, could never follow from the distribution of an ordinary taxable dividend; nor could the distribution of such a dividend in any way accomplish the purpose of making the stock available to satisfy the insistent demands of the employees.
In our opinion, the various factors present in this record add up to the conclusion that the stock transactions in question did not have the net effect of a dividend. They were, as the petitioners reportedPage 533them, sales of capital assets. We hold that the transactions did not occur at such times and in such manner as to be essentially equivalent to the distribution of taxable dividends.Decisions will be entered under Rule 50.
- These items include nontaxable dividends received, liquidating dividends, and other nontaxable income credited to surplus. ↩
- Based on returns not yet audited by Bureau of Internal Revenue. ↩
- SEC. 115. DISTRIBUTION BY CORPORATIONS.
* * * * * * *
(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. ↩