Adams v. Comm'r of Internal Revenue
| Decision Date | 29 June 1945 |
| Docket Number | Docket No. 4109. |
| Citation | 5 T.C. 351 |
| Parties | ADAM A. ADAMS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Debentures distributed to petitioner by a corporation of which he was the principal common stockholder in connection with elimination of old common stock and issuance of new without par value, held, on facts failing to show corporate business purpose for the transaction, to constitute a taxable dividend to the extent of their value and of the corporation's accumulated earnings, notwithstanding that surplus account remained unchanged on corporate books. Sydney A. Gutkin, Esq., for the petitioner.
Jonas M. Smith, Esq., for the respondent.
Respondent determined a deficiency in petitioner's income tax for the calendar year 1941 in the amount of $113,021.44.
Aside from one small item not in dispute, the deficiency results from respondent's finding that an exchange by petitioner of common stock of the Newark Theatre Building Corporation for new common stock and debenture bonds of the same corporation in January 1941, in connection with the plan of recapitalization of that company, resulted in the distribution of a dividend to petitioner constituting fully taxable income.
The petitioner contends that the transaction was a recapitalization and reorganization within the meaning of section 112 of the Internal Revenue Code and was not a distribution of a dividend; and, in the alternative, he contends that there was a loss from the transaction rather than a gain, that if there was a gain it was taxable as a capital gain, and that if it is to be treated as a dividend it was a dividend of no value.
Petitioner is an individual, residing in New Jersey, and he filed his income tax return for the calendar year 1941 with the collector of internal revenue for the fifth district of New Jersey.
He was the president and principal stockholder of the Newark Theatre Building Corporation, a New Jersey corporation. On January 26, 1941, he owned 5,903 shares of a par value of $100 each, out of a total of 5,914 shares issued and outstanding. The authorized capital was 6,000 shares.
Petitioner and his brother were originally engaged in business together as partners. Later on, they conducted their business affairs through corporations organized by them, and in connection with the financing of the Newark Theatre Building Corporation's operations, both individuals guaranteed the indebtedness of that corporation secured by a mortgage on its property. In 1935 they divided their business interests, and petitioner became the principal stockholder of the Newark corporation. Thereafter, his brother repeatedly demanded that he be relieved of his liability on the bonds. The Prudential Insurance Co., which held the mortgage, declined to release him, and petitioner foresaw the necessity of making other financial arrangements when the Prudential mortgage matured in 1941.
On December 6, 1940, the directors of the corporation met to consider the desirability of ‘revamping the capital structure of the company.‘ The president pointed out that, in his opinion, the whole capital structure was not well balanced, and that it was not good business to have so top-heavy a capital set-up. He stated that a simple plan of recapitalization could be evolved which would bring about the desired change at comparatively little expense to the company; that he had consulted legal and accounting counsel, who could see no difficulty in consummating the plan of recapitalization.
The following plan was then proposed and adopted:
(1) A reduction in the authorized capital stock from $600,000, represented by 6,000 shares of a par value of $100 each, of which 5,914 shares, or $591,400 were issued and outstanding, to $295,700, to be divided into 5,914 shares without nominal or par value.
(2) The issuance of debenture bonds in the aggregate principal amount of $295,700, bearing interest at the rate of 6 percent per annum, payable semiannually, the principal to be payable in 20 years from the date thereof, plus 5,914 shares of the new no par common stock, in exchange for the present shares of capital stock, on the basis of one $50 bond and one share of no par value common stock for each of the present $100 par value shares surrendered.
The directors adopted the appropriate resolution to amend the certificate of incorporation to provide for the reduction of authorized capital, and the issuance of no par value stock, and the stockholders duly ratified and approved the actions of the directors with respect thereto.
It was anticipated that there would be a saving of New Jersey franchise taxes in excess of $400 per year and a reduction of the corporation's Federal income tax liability in substantial amounts each year by the deduction of the interest paid on the bonds.
The recapitalization was carried out in exact accordance with its terms. Petitioner on January 27, 1941, surrendered his 5,903 shares of $100 par value stock and received for each share thereof one share of no par value stock of a stated value of $50, and one $50 debenture bond. The bondholders were to rank pari passu with unsecured creditors in event of dissolution.
On the books of the corporation the old par capital stock account was debited with $591,400, the new no par capital stock account was credited with $295,700, and the balance of $295,700 was credited to a ‘Debentures Payable‘ account. The surplus account was not affected.
Subsequently, petitioner gave to each of his two sons who worked with him in the business of the corporation debenture bonds of the face value of $24,000, or a total of slightly more than 16 percent of his holdings. He duly reported these transfers for gift tax purposes and attributed to the bonds their full face value, paying gift tax thereon.
The corporation's balance sheet as of December 31, 1940, was as follows:
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