Bass v. Commissioner of Internal Revenue

• Citation: 129 F.2d 300
• Decision Date: 24 June 1942
• Docket Number: No. 3769.,3769.
• Parties: BASS v. COMMISSIONER OF INTERNAL REVENUE.
• Court: United States Courts of Appeals. United States Court of Appeals (1st Circuit)

129 F.2d 300 (1942)

BASS v. COMMISSIONER OF INTERNAL REVENUE.

No. 3769.

Circuit Court of Appeals, First Circuit.

June 24, 1942.

COPYRIGHT MATERIAL OMITTED

Edward C. Thayer, of Boston, Mass., and Erwin N. Griswold, of Cambridge, Mass. (E. Barton Chapin, of Boston, Mass., on the brief), for petitioner.

Samuel H. Levy, Sp. Asst. to the Atty. Gen., and J. P. Wenchel, Chief Counsel, and Claude R. Marshall, Sp. Atty., Bureau of Internal Revenue, both of Washington, D. C. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key and Gerald L. Wallace, Sp. Assts. to the Atty. Gen., on the brief), for Commissioner.

Before MAGRUDER, MAHONEY, and WOODBURY, Circuit Judges.

MAGRUDER, Circuit Judge.

Edith B. Bass, petitioner herein, brings for review a decision of the Board of Tax Appeals upholding the Commissioner's determination that there is a deficiency of $150,596.51 in petitioner's income tax for the calendar year 1937. Practically the entire amount of the deficiency resulted from a ruling that an issue of preferred stock by Bird & Son, Inc. to its shareholders incident to a readjustment of the corporation's capital structure constituted a taxable stock dividend under the Revenue Act of 1936, 49 Stat. 1648. Relevant provisions of the Act are copied in the footnote.¹

Bird & Son, Inc. was incorporated under the laws of Massachusetts in 1918, and has been profitably engaged in the business of manufacturing and selling paper and paper products. On September 14, 1937, its authorized and outstanding capital stock consisted of 600,000 shares of common stock without par value, representing a stated capital of $6,000,000. The earned surplus, as then shown on the books, stood at the figure of $5,701,003.82. All of the stock was held in a voting trust which was to terminate on October 9, 1937. The voting trust certificates for most of the stock were held by officers and employees of the corporation and by members of the Bird family.

In anticipation of the expiration of the voting trust, consideration was given to revising the capital structure of the corporation. There was no market for the voting trust certificates and many holders thereof had requested that some arrangement be made to afford a satisfactory market on which they could sell a portion of the holdings. On May 3, 1937, the board of directors appointed a committee to consider the matter. This committee made its report on August 17, 1937. The plan which it proposed was ultimately approved and carried out.

The plan called for the authorization of an issue of 50,000 shares of cumulative preferred stock with a par value of $100 each. 30,000 of such shares, representing $3,000,000 of capital, were to be issued in place of 300,000 common shares, the common stock to be simultaneously reduced by such amount. There was further to be a split-up of the remaining 300,000 of common shares, which represented $3,000,000 of capital, on a basis of two for one; 600,000 common shares representing a stated capital of $5 each were to be issued in exchange for the said 300,000 of common shares representing a stated capital of $10 each. The remaining 20,000 shares of preferred stock were to be held in reserve, to be issued later at the discretion of the directors. Application was to be made for listing the preferred and common stock on the Boston Stock Exchange.

In all the formal steps which were duly taken by the directors and the stockholders to effectuate the plan, it was made clear that the readjustment of the capital structure was to be carried through "without any capitalization or impairment of any existing surplus or accumulated and undivided profits". As the Board specifically found, the directors "believed that $6,000,000 was a sufficient and proper capitalization for the corporation and surplus should not be changed but should be left as it was for future corporate purposes".

The plan as proposed by the committee was prompted by a desire, first, to provide marketable shares and thus to satisfy the needs of the shareholders and, second, to provide the corporation with some additional marketable shares which might later be sold to liquidate large bank loans theretofore incurred by one of the corporation's subsidiaries, or which might be issued as stock dividends so as to capitalize accumulated profits, if that should later prove to be desirable. It was felt that an issue of preferred stock would be more likely than the common stock to command a market price approximating its intrinsic value. The establishment of a market for the shares would tend to benefit the corporation in case it should desire later to sell the remaining 20,000 of preferred shares. It does not appear just what business reason moved the directors to propose the two-for-one split-up of the common shares.

On September 14, 1937, the Commissioner of Corporations and Taxation approved the certificate of the directors setting forth the amendment to the articles of association as duly voted by the stockholders in accordance with the plan. Thereupon the directors proceeded immediately to execute the plan. The single certificate for 600,000 shares of the outstanding common stock held by the voting trustees was surrendered and cancelled, in exchange for which there were issued in the names of the voting trustees a temporary certificate for 30,000 shares of the preferred stock and a temporary certificate for 300,000 shares of common stock without par value. In effectuation of the split-up of the common shares, this temporary certificate for 300,000 shares of common was in turn cancelled and a temporary certificate for 600,000 shares of common was issued in the names of the voting trustees. This all took place on September 15, 1937. Appropriate entries were made on the books of the corporation. The capital stock account, which on September 14, 1937, had showed a stated capital of $6,000,000 represented by 600,000 shares of common stock without par value, was changed to indicate a stated capital of $3,000,000 represented by 600,000 shares of common stock without par value and $3,000,000 represented by 30,000 shares of preferred stock with a par value of $100 per share. No entries were made in the surplus account as a result of the transactions; the earned surplus, as shown on the books, remained at $5,701,003.82.

The holders of the voting trust certificates, at the termination of the voting trust on October 9, 1937, turned in these certificates for their proportionate amounts of common and preferred stock. The petitioner, who had held voting trust certificates for 54,510 shares received in exchange therefor certificates for 54,510 shares of common stock and 2,725½ shares of preferred stock. The fair market value of the preferred stock at the time Mrs. Bass received it was agreed to be $86 per share.

It was ruled by the Commissioner that receipt by petitioner of these 2,725½ shares of preferred stock constituted income derived from a taxable stock dividend during the year 1937 in the sum of $234,393. The Board took the same view.

We assume in favor of the Government, without deciding, that where a corporation having only common stock outstanding declares a stock dividend of preferred stock, the stockholders thereby receive taxable income. It was so held in Strassburger v. Commissioner, 2 Cir., 1941, 124 F.2d 315, now pending before the Supreme Court on certiorari. But that decision is not controlling in the case at bar, because here the corporation declared no stock dividend, either avowedly or in disguised form. See Hood Rubber Co. v. Commonwealth, 1921, 238 Mass. 369, 371, 372, 131 N.E. 201. So far as we are aware, the present case and Jacob Fischer v. Commissioner, 46 B.T.A. ___, decided April 28, 1942,² are the only cases where the Commissioner has laid claim to tax an alleged stock dividend though there had been no capitalization of earnings. The Government's position here is not supported by any court decision.

"A stock dividend always involves a transfer of surplus (or profit) to capital stock." Graham and Katz, Accounting in Law Practice, 2d ed. 1938, § 80. As the court said in United States v. Siegel, 8 Cir., 1931, 52 F.2d 63, 65, 78 A.L.R. 672: "A stock dividend is a conversion of surplus or undivided profits into capital stock, which is distributed to stockholders in lieu of a cash dividend." Congress itself has defined the term "dividend" in § 115(a) of the Act as meaning any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits. In Eisner v. Macomber, 1920, 252 U.S. 189, 40 S.Ct. 189, 64 L.Ed. 521, 9 A.L.R. 1570, both the prevailing and the dissenting opinions recognized that within the meaning of the revenue acts the essence of a stock dividend was the segregation out of surplus account of a definite portion of the corporate earnings or profits theretofore available for dividends, the freezing of such segregated earnings as part of the permanent capital resources of the corporation by the device of capitalizing the same, and the issuance to the stockholders of additional shares of stock representing the profits so capitalized.³ See 252 U.S. at pages 210, 211, 220, 221, 228, 229, 40 S.Ct. at pages 194, 197, 198, 200, 201. Where the court divided was on the question whether a stock dividend was equivalent to a distribution of earnings. Compare page 211 with pages 227-229.

Whether profits are to be capitalized is not a mere matter of bookkeeping; there are important business differences according as one course or the other is pursued. If profits are capitalized by means of a stock dividend such profits are no longer available for the declaration of a dividend at the discretion of the directors but become part of the permanent capital of the corporation, thereby tending to enhance the corporation's credit. If profits are not capitalized they may be distributed as dividends some time in the future; and it would be a...