Allied Chemical & Dye Corp. v. McMahon

• Decision Date: 30 March 1957
• Parties: ALLIED CHEMICAL & DYE CORPORATION, Plaintiff, v. Denis J. McMAHON, Individually and as District Director of Internal Revenue for Lower Manhattan, New York, Defendant.
• Court: U.S. District Court — Southern District of New York

156 F. Supp. 275

ALLIED CHEMICAL & DYE CORPORATION, Plaintiff, v. Denis J. McMAHON, Individually and as District Director of Internal Revenue for Lower Manhattan, New York, Defendant.

United States District Court S. D. New York.

March 30, 1957.

Lawrence A. Coleman, New York City, for plaintiff.

Paul W. Williams, U. S. Atty., New York City, George M. Vetter, Jr., Asst. U. S. Atty., New York City, of counsel, for defendant.

WALSH, District Judge.

This is an action to recover an alleged overpayment of the documentary stamp tax, in the amount of $49,817.25. Both parties move for summary judgment. Defendant's motion is granted; plaintiff's motion is denied.

The controversy grows out of a recapitalization of the plaintiff, in the year 1950, in which it issued to the holder of each share of common stock three additional shares of the same stated value. Plaintiff claims that the new stock certificates were not taxable because they were not accompanied by a dedication of additional capital. Defendant claims that they were.

Both motions are based upon a stipulation of the underlying facts.

Plaintiff, a New York corporation, was organized on December 17, 1920, to acquire the stock of five constituent companies. It issued preferred stock with a par value of $100 a share and no-par common stock with a stated value of $5 a share in a combined amount of $48,043,675.¹ This amount was entered upon its books in its capital stock account.

In March, 1921 plaintiff's certificate of incorporation was amended to state its total capital in the amount of $113,043,675. This was to conform with the then existing New York statute which required corporations to state their capital upon the basis of the stated value of their authorized stock rather than issued stock.² No new stock was issued. The surplus account was divided into two accounts, "capital surplus" and "further surplus". The capital surplus account was fixed at the difference between the capital stock account, and the amount stated as capital in the certificate of incorporation, $113,043,675. No tax was paid as the result of this transaction.

In 1930 and 1931 plaintiff issued to each holder of twenty shares one additional share of common stock with a stated value of $5 a share. The capital stock account was increased to show the addition of the newly issued shares at this stated value. The capital surplus account was reduced by the same amount so that it continued to maintain the difference between the total of the capital stock account and the amount of $113,043,675 stated as capital in the certificate of incorporation.³ The stipulation of facts does not disclose whether a stamp tax was paid.

In 1936 the entire issue of preferred stock was retired. Although the stipulation of facts is silent as to how this was accomplished, apparently the holders of this stock were paid off in cash. The capital stock account was reduced by the aggregate par value of the preferred and this reduction was apparently offset by a reduction of the cash account. At the same time it became necessary to increase the capital surplus account so that it would continue to express the difference between the reduced capital stock account and $113,043,675, the amount stated as capital in the certificate of incorporation. This was done by transferring from "Further Surplus" an amount equal to the par value of the retired stock.

On August 1, 1950, the instant recapitalization occurred. Three additional shares of stock with a stated value of $5 a share were issued to the holders of each share outstanding. An amount equal to the stated value of these additional shares was added to the capital stock account. A corresponding reduction was made in the capital surplus account so that it continued to express the difference between the issued capital stock and the amount stated as capital in the certificate of incorporation.⁴

For purposes of comparison the capital stock and surplus accounts appeared as follows on January 1, 1921, December 31, 1921, 1924, 1931, 1936 and August 1, 1950:

                                          Jan. 1,       Dec. 31,       Dec. 31,      Dec. 31,     Dec. 31,    Aug. 1
                                           1921           1921          1924           1931        1936         1950
                                          ----------------------------------------------------------------------------------
                Capital Stock—
                   Preferred Stock ..... $ 37,326,400  $ 38,951,700   $ 39,284,900   $ 39,284,900  $.........    $
                   Common Stock ........   10,717,275    10,847,195     10,890,545     12,006,440   12,006,440     44,281,290
                                         ____________  ____________   _____________  ____________  ___________   ____________
                Total ...................$ 48,043,675  $ 49,798,895   $ 50,175,445   $ 51,291,340  $ 12,006,440  $44,281,290
                Surplus—
                   Capital Surplus ......$126,369,006  $ 63,244,780   $ 62,868,230   $ 61,752,335  $101,037,235  $68,761,695
                   Further Surplus ......                59,414,300     78,419,869    103,416,917    69,073,984  (Not given)
                                         ____________  ____________   ____________    ____________  ___________   ___________
                Total ...................$126,369,006  $122,659,080   $141,288,099   $165,169,252  $170,111,219  $68,761,695
                

In 1950, Section 1800 of the Internal Revenue Code of 1939, 26 U.S.C.A. § 1800, imposed a tax on certificates of stock measured, as provided in Section 1802(a), 26 U.S.C.A. § 1802(a), as follows:

"On each original issue, * * * of shares or certificates of stock, * * * Provided further, That where such certificates * * * are issued in a recapitalization, the tax payable shall be that proportion of the tax computed on such certificates * * * that the amount dedicated as capital for the first time by the recapitalization, whether by a transfer of earned surplus or otherwise, bears to the total par value (or actual value if no par stock)⁵ of such certificates or shares issued in the recapitalization. * * *"

The appropriate regulation, Regulation 71, 26 C.F.R. § 113.23(e)(1) (1949) provides as follows:

"Sec. 113.23—Rate and computation of tax.

* * * * *

"(e) * * *

"(1) A tax is not payable with respect to stock issued in a recapitalization unless the recapitalization results in the dedication of an amount as capital which amount is so dedicated for the first time.

Thus, where a corporation transferred an amount from capital to capital surplus in a prior recapitalization, and such corporation in a subsequent or second recapitalization transfers such amount from capital surplus to capital under such circumstances that the amount so restored to capital is clearly identifiable, a tax is not payable with respect to the amount so rededicated as capital. However, the tax is payable with respect to a transfer of capital surplus to capital by way of a recapitalization where the amount so transferred had not been previously dedicated as capital. * * * Regs. 71, 6 F.R. 6015, as amended by T.D. 5613, 13 F.R. 2407."

Plaintiff claims that there was no dedication of capital whatever, that this was a mere stock split. The controversy turns on the meaning of the words "dedicated as capital" as used in the statute.

"Capital", in the sense of the original investment by the owners of a corporation, is usually shown in the capital stock account.⁶ According to the type of stock, this is the aggregate of the par value or the stated value or the actual value of the shares issued. This account remains unchanged except insofar as the stockholders contribute additional funds to the corporation or withdraw their original investment from it. The fluctuation in the value of the business is not shown by a change in this account but rather by the fluctuations of the surplus account.

"Capital" in a less precise sense is also used to describe the proprietorship interest of the owners of the corporation at any given time. In this sense it is shown by the total of the capital stock and the surplus accounts. The surplus account may be derived from earnings or from amounts paid into the corporation from various sources, including contributions or payments by stockholders in excess of the amounts shown in the capital stock account. Capital in this sense, however, is not spoken of as "dedicated". Capital in this sense is simply the excess of assets over liabilities at the time in question.

It is my belief that the statute uses "capital" in the former sense, meaning the contribution of the stockholders to the corporation. In such a sense it is shown by the capital stock account.

Plaintiff, however, eschews the use of the word "capital" in either of these senses. It claims that the word must be used in whatever sense defined by the statutes of the state of a taxpayer's residence or incorporation. In the present case, it claims, this would be the $113,043,675, stated as "capital" in plaintiff's certificate of incorporation.

Viewed on the basis of accounting theory, this figure is completely artificial. It was based upon its authorized stock. It was and has always been unrelated to either the stated value or the actual value of plaintiff's issued stock or the stated or the actual value of the investment of the stockholders. It has always been equally unrelated to the tax paid upon plaintiff's stock, either in determining whether a tax should be paid or the amount of the tax.

Plaintiff protests that the New York statute provides that the capital of a corporation shall be the amount stated in its certificate of incorporation.⁷ But although this amount may furnish a satisfactory basis for state regulation, for the protection of creditors, and for other state policies, it must not be used to distort the uniform application of a national tax. See Burnet v. Harmel, 287 U.S. 103, 110, 53 S.Ct. 74, 77 L.Ed. 199; Lyeth v. Hoey, 305 U.S. 188, 193, 59 S.Ct. 155, 83 L.Ed. 119; United States v. Pelzer, 312 U.S. 399, 402, 61 S.Ct. 659, 85 L.Ed. 913; City Athletic Club v. United...