36 T.C. 201 (1961), 78850, Fowler Hosiery Co., Inc. v. C.I.R.

Docket Nº:78850.
Citation:36 T.C. 201
Opinion Judge:SCOTT, Judge:
Party Name:FOWLER HOSIERY COMPANY, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Attorney:Leo J. Schwartz, Esq., and Arthur S. Freeman, Esq., for the petitioner. Delman H. Eure, Esq., for the respondent.
Case Date:April 28, 1961
Court:United States Tax Court

Page 201

36 T.C. 201 (1961)

FOWLER HOSIERY COMPANY, INC., PETITIONER,

v.

COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

No. 78850.

United States Tax Court.

April 28, 1961

Leo J. Schwartz, Esq., and Arthur S. Freeman, Esq., for the petitioner.

Delman H. Eure, Esq., for the respondent.

1. Petitioner owned six United States subsidiaries and one wholly owned Canadian subsidiary. Petitioner and its subsidiaries sold all of their assets to Julius Kayser & Co. with the exception of their fixed assets which were leased to Kayser for 5 years. On the expiration of the leases, Kayser was required to purchase the assets at book value. The Canadian subsidiary distributed $1,500,000 on December 27, 1956, to petitioner. Held, the distribution by the Canadian subsidiary to the petitioner was a distribution in partial liquidation and not an ordinary dividend. Held, further, the petitioner is not entitled to the credit for foreign tax deemed to have been paid under sec. 902, I.R.C. 1954, on the receipt of a distribution in partial liquidation.

2. Petitioner transferred its rights as exclusive licensee of certain machines and released its claim for damages against its licensor in return for the delivery of $10,000 in cash and 40 machines worth $120,000. Held, petitioner has failed to prove that it received the 40 machines in exchange for its release of the exclusive license and not for the surrender of claims for damages.

SCOTT, Judge:

Respondent determined a deficiency of $205,850.70 in income tax of the petitioner for the calendar year 1955. The issues for decision are whether the amount of $1,500,000 received by petitioner from its wholly owned Canadian subsidiary was an ordinary dividend as petitioner contends or a distribution in partial liquidation as determined by respondent; if the amount was a liquidating distribution, whether petitioner in accordance with its alternative contention is entitled to a credit for foreign taxes deemed to have been paid; and whether the value of certain machines received

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by petitioner represents capital gain as reported by it or ordinary income as determined by respondent.

FINDINGS OF FACT.

Petitioner is a Wisconsin corporation, incorporated in 1904. Its principal office is presently located at 835 Merchandise Mart, Chicago, Illinois. Its income tax return for the calendar year 1955 was filed with the district director of internal revenue at Milwaukee, Wisconsin, on July 12, 1956.

On September 9, 1955, petitioner changed its name from Holeproof Hosiery Company to Fowler Hosiery Company, Inc. Before 1955 petitioner's principal office was located at 404 West Fowler Street, Milwaukee, Wisconsin. Until July 1955 petitioner was engaged in the manufacture and sale of hosiery, socks, sleepwear, underwear, and lingerie.

Petitioner's authorized capital stock consisted of 1 million shares of common stock, $5 par value. As of June 30, 1955, it had issued and outstanding 537,420 shares, 336,027 (approximately 62 1/2 percent) of which were held by six voting trustees for the beneficiaries of a voting trust, and the remaining 201,393 were held by approximately 700 other individuals. The voting trust was established in 1950.

During 1955 petitioner had six wholly owned United States subsidiaries and one wholly owned Canadian subsidiary, Fowler Hosiery Company (Canada), Ltd., hereinafter referred to as Fowler of Canada. The six United States subsidiaries were: Athco, Inc.; Winston Mfg. Co., Inc.; Quitman Manufacturing Company; Quitman Knitting Company; Cooper, Wells & Co.; and 301 N. Water Building Corp.

Fowler of Canada was incorporated under the Dominion Companies Act of Canada (1952 Rev.Stats.Canada, ch. 53) by letters patent dated April 11, 1911, under the name of Holeproof Hosiery Company of Canada, Ltd. On September 9, 1955, it changed its corporate name to Fowler Hosiery Company (Canada), Ltd. In 1946 and for many years prior thereto, Fowler of Canada's authorized and issued capital stock consisted of 3,500 shares with a par value of $100 per share. As of January 1946 petitioner owned 1,750 shares of the stock of Fowler of Canada which it had acquired at various times at a cost of $78,814.75. During 1946 petitioner acquired the remaining 1,750 shares of stock of Fowler of Canada at a cost of $303,225, giving petitioner a total cost basis for the 3,500 shares of stock of Fowler of Canada of #382,039.75. Petitioner owned all of the issued and outstanding shares of stock of Fowler of Canada from the date of acquisition in 1946 of the 1,750 shares until June 17, 1960. During 1955 and prior thereto, Fowler of Canada

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was engaged in the manufacture of hosiery, lingerie, and cloth, with its principal office located in London, Ontario, Canada.

Gustave Frankel is now president of petitioner and has been president since 1945 and a member of its board of directors since 1944. He was one of the six voting trustees of the voting trust of petitioner's stock. Including Gustave Frankel, five of the nine members of petitioner's board of directors were voting trustees and three others were beneficiaries of the voting trust. Gustave Frankel and the immediate members of this family owned about 10 or 11 percent of petitioner's stock and his brother, Louis Frankel, and the immediate members of his family owned approximately the same amount of petitioner's stock.

During 1955 the board of directors of Fowler of Canada were: L. W. Turner, Gustave Frankel, Gerald Frankel, Burt Myron, and J. C. Lacey. Its officers were L. W. Turner, president, and J. C. Lacey and Burt Myron, vice presidents. These officers were employees of the corporation, regularly engaged in its operation. In 1956 L. T. Schroeder was assistant secretary and treasurer of Fowler of Canada, and in 1957 he was treasurer of Fowler of Canada. L. T. Schroeder was also an officer of petitioner.

In the early part of 1955 petitioner began negotiating with Julius Kayser & Co. (hereinafter referred to as Kayser), a New York corporation, for the sale by petitioner to Kayser of its entire business as a going concern. Petitioner was willing to sell to Kayser its fixed assets at book value in installments payable over a 5-year period, provided it received cash for the remaining operating assets. Kayser could not purchase the fixed assets on this basis because of restrictions on the indebtedness it could incur. There was worked out between petitioner's stockholders who were the voting trustees under the voting trust agreement of 1950 and Kayser (subject to the approval of petitioner's board of directors and stockholders which these voting trustees would undertake to procure) an agreement which was incorporated into a formal written agreement dated July 1, 1955, whereby petitioners and its six wholly owned United States subsidiaries would sell to Kayser all of their inventories, supplies, prepaid expenses, accounts receivable, patents, trademarks, licenses, and goodwill, including the corporate name ‘ Holeproof.’ Pursuant to this same agreement Fowler of Canada would sell its inventory, prepaid expenses, accounts receivable, and goodwill to Julius Kayser & Co., Ltd., of Canada (hereinafter referred to as Kayser of Canada), a wholly owned subsidiary of Kayser. Simultaneously with these sales and pursuant to the same agreement, petitioner and its United States subsidiaries would lease to Kayser, and Fowler of Canada would lease to Kayser of Canada all of their fixed assets, consisting of land, buildings, machinery, and equipment for a 5-year period commencing July 1, 1955, and

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ending June 30, 1960. Forms of the contract and leases were attached to the July 1, 1955, agreement and the leases, with the exception of the amounts of rent to be paid, were identical. The agreement provided that upon the expiration of such leases, the lessees would purchase the leased properties at their then book value, provided they had been depreciated on petitioner's books of account at rates previously and customarily used, Kayser having the option to accelerate the purchase of the assets at their book value on the date of exercise of that option.

The proposed contract provided that the sale of the current operating assets was to be effective and the prices determined as of the close of business on June 30, 1955, with the purchase prices to be paid at the date of closing. Petitioner and Fowler of Canada were to continue the normal and customary operation of the business for the account of Kayser and Kayser of Canada until the closing date under the agreement. All sales made after June 30, 1955, were to be for the benefit of Kayser, and all liabilities incurred, chargeable to Kayser. Similar adjustments were provided with respect to vacation pay, pensions, bonuses, rent, and other items. Kayser was to collect for petitioner all accounts receivable outstanding on June 30, 1955.

Petitioner agreed to change its name and that of its subsidiaries to exclude the use of the word ‘ Holeproof.’

Petitioner agreed to supply Kayser a complete list of its customers for the purpose of permitting Kayser to solicit them as its customers and to transfer to Kayser all of its unfilled orders for sales of its manufactured products. Kayser was to assume all service contracts, union agreements, pension plans, and other executory contracts of petitioner and Fowler of Canada. Petitioner would agree that on and after the closing date and during the term of the leases neither it nor its subsidiaries would manufacture or sell any product then being manufactured or sold by them. Petitioner was to use its best efforts to make and keep available to Kayser the services of all employees in any way connected with the production and sales of its products and to furnish Kayser with...

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