Bateman v. Comm'r of Internal Revenue

• Decision Date: 27 May 1963
• Docket Number: Docket No. 93310.
• Citation: 40 T.C. 408
• Parties: WILLIAM H. BATEMAN AND ANNABELLE P. BATEMAN, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

40 T.C. 408

WILLIAM H. BATEMAN AND ANNABELLE P. BATEMAN, PETITIONERS,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 93310.

Tax Court of the United States.

Filed May 27, 1963

Sydney C. Winton and Sherwin Kamin, for the petitioners.

Alvin C. Martin, for the respondent.

Upon the merger of two corporations, petitioner exchanged his common stock in one for common stock and common stock purchase warrants in the surviving corporation. The merger was a tax-free reorganization within the provisions of section 368(a), I.R.C. 1954. Held:

1. The warrants were not stock within the meaning of section 354(a)(1), I.R.C. 1954, and therefore constituted ‘other property’ within the meaning of section 356(a), I.R.C. 1954.

2. The exchange did not have the effect of the distribution of a dividend under the provisions of section 356(a)(2), I.R.C. 1954.

OPINION

SCOTT, Judge:

Respondent determined a deficiency in petitioners' income tax for the calendar year 1958 in the amount of $11,212.36.

The issues for decision are:

(1) Should gain to petitioners be recognized under the provisions of section 356(a)(1) of the Internal Revenue Code of 1954 to the extent of the fair market value of common stock purchase warrants of the Symington Wayne Corp. which were received by William H. Bateman in addition to common stock of that corporation in exchange for common stock of the Wayne Pump Co. upon its merger into Symington Wayne Corp.?

(2) Did the exchange have the effect of the distribution of a dividend within the meaning of section 356(a)(2) of the Internal Revenue Code of 1954?

All of the facts have been stipulated and are found accordingly.

William H. Bateman and Annabelle P. Bateman, husband and wife, residing in Salisbury, Md., filed a joint income tax return on the cash basis of accounting for the calendar year 1958 with the district director of internal revenue, Baltimore, Md. On March 12, 1958, William H. Bateman (hereinafter referred to as petitioner) was the owner of 7,350 shares of common stock of the Wayne Pump Co. which he had acquired more than 6 months prior to that date. The Wayne Pump Co. was a Maryland corporation incorporated in 1928. Its only class of outstanding stock on March 12, 1958, was common stock. On March 12, 1958, the Wayne Pump Co. was merged into the Symington-Gould Corp. Symington-Gould Corp., the surviving corporation upon the merger with its name changed to Symington Wayne Corp., was a Maryland corporation incorporated in 1924. The only class of stock of Symington-Gould Corp. outstanding at the date of the merger was common stock. The merger was a tax-free reorganization within the terms of section 368(a) of the Internal Revenue Code of 1954 to which both the Wayne Pump Co. and Symington Wayne Corp. were parties.

Pursuant to the terms of the merger, each shareholder of the Wayne Pump Co. was entitled to receive 2 1/4 shares of Symington Wayne Corp. common stock and one stock purchase warrant for each share of the Wayne Pump Co. stock surrendered. The warrants were assignable and each warrant entitled the holder, subject to the conditions stated therein, to purchase 1 share of common stock of Symington Wayne Corp. at any time during the 10-year period from June 1, 1958, to May 31, 1968, at $10 per share if purchased before June 1, 1963, and at $15 per share if purchased thereafter. The corporation was required to reserve from its authorized and unissued common stock a sufficient number of shares to provide for the then outstanding warrants. The provisions of the merger agreement with respect to the warrants were set forth in substance on the face of the stock-purchase warrant certificates and were in part as follows:

Notwithstanding any other provisions hereof, in the event of the liquidation, dissolution or winding up of the affairs of the Corporation (excluding any merger or consolidation), the right to exercise the Warrants shall terminate at the close of business on the fourth full business day before the earliest date fixed for the payment of any distributable amount on the Common Stock of the Corporation. At least 30 days' notice of such payment date shall be given to the registered holders of the Warrants determined as of the date of notice.

In the event that:

(a) The shares of Common Stock at any time outstanding shall be subdivided by reclassification, recapitalization or otherwise, into a greater number of shares without the actual receipt by the Corporation of any consideration for the additional number of shares so issued, or the Corporation shall declare a dividend on Common Stock payable in Common Stock, or the number of shares of Common Stock at any time outstanding shall be reduced, by reclassification, recapitalization, reduction of capital stock or otherwise; or

(b) The outstanding shares of Common Stock shall be reclassified or changed other than in a manner referred to in clause (a) of this paragraph; or

(c) The Corporation shall merge or consolidate with or into another corporation or shall sell its property as an entirety or substantially as an entirety, the number of shares issuable upon the exercise of Warrants shall be adjusted, to the nearest one-hundredth shares of Common Stock, so that each holder of Warrants then outstanding shall have the right thereafter, so long as the right to exercise same shall exist, to purchase the kind and amount of securities or property, if any, which the holder would have received had the Warrants been exercised in the same manner and to the same extent immediately prior to any such event. In the event that any adjustment results in the inclusion of a fraction of a share, no fractions of shares of Common Stock shall be issued upon the exercise of Warrants, but in lieu thereof the Corporation shall pay cash based on current market values as determined by resolution of the Board of Directors of the Corporation or by the Treasurer of the Corporation pursuant to such resolution (which determination shall be conclusive). Upon each such adjustment pursuant to this paragraph, a computation and summary thereof shall be filed by an officer of the Corporation at the office of the Warrant Agent.

In the event that the Corporation shall offer any shares of Common Stock, or securities convertible into Common Stock to the holders of the Common Stock as a class for subscription, each registered holder of Warrants then outstanding shall have the same right to subscribe for the same number of shares of Common Stock or amount of such securities, within the same period of time, and at the same price, as he would have been entitled to subscribe for had the Warrants been exercised immediately prior to any such event. The date for the determination of registered holders of Warrants entitled to such subscription rights shall be the same as the record date for the determination of the holders of Common Stock entitled thereto.

Until the valid exercise of the Warrants represented hereby the holder hereof as such shall not be entitled to any rights of a stockholder of the Corporation.

Pursuant to the terms of the merger, petitioner on March 12, 1958, received 16,537 shares of common stock of Symington Wayne Corp. and 7,350 stock purchase warrants in exchange for his 7,350 shares of common stock of the Wayne Pump Co.

On March 12, 1958, the fair market value of each of the 7,350 warrants received by petitioner in the exchange was $2.875 making a total fair market value of $21,131. Since March 13, 1958, the stock purchase warrants have been traded on the American Stock Exchange.

On March 12, 1958, the fair market value of each of the 16,537 shares of common stock of Symington Wayne Corp. received by petitioner in the exchange was $8.375 making a total fair market value of $138,497.38. Prior to the merger the stock of both the Symington-Gould Corp. and the Wayne Pump Co. was traded on the New York Stock Exchange and since the merger the stock of Symington Wayne Corp. has continued to be traded on the New York Stock Exchange.

The cost and basis of the 7,350 shares of the Wayne Pump Co. common stock in the hands of petitioner was $82,400.

For the purpose of section 356(a)(2) of the Internal Revenue Code of 1954, ¹ petitioner's ratable share, at the time of the merger, of the undistributed earnings and profits of the Wayne Pump Co. accumulated after February 28, 1913, was in excess of $21,131, the fair market value on March 12, 1958, of the warrants received by petitioner.

On March 12, 1958, the earned surplus and undivided profits of the Wayne Pump Co. accumulated after February 28, 1913, was $6,654,386.

Petitioner sold 4,000 of his 7,350 warrants during the period from September 22 to October 9, 1958, for a total of $28,437.50.

Petitioner attached to his income tax return for the calendar year 1958 an ‘Appendix A,‘ which he entitled ‘Statement Required By Income Tax Reg. 1.368-3(b),‘ in which he set forth the fact of his exchange of his stock in the Wayne Pump Co. for stock and stock purchase warrants in Symington Wayne Corp. Petitioner reported no gain from this exchange. On his return petitioner reported a long-term capital gain in the amount of $21,894 from the sale of 4,000 warrants of Symington Wayne Corp. which amount was the difference between a sales price of $28,438 and basis of $5,937.

Respondent in his notice of deficiency increased petitioner's ordinary income as reported by $21,131, denominated as dividend income, with the following explanation:

It is held that on the exchange of 7,350 shares of Wayne Pump Company stock for 16,537 shares of Symington Wayne Corporation stock and 7,350 warrants to purchase additional shares of Symington Wayne Corporation stock gain is recognized to the extent of the fair market value of the warrants received. It is further held that the gain recognized is taxable as a dividend. Since the fair market value of the warrants received by you was $2.875 each, your taxable income is increased in the amount of...