Bazley v. Commissioner of Internal Revenue
| Decision Date | 16 April 1946 |
| Docket Number | No. 8947.,8947. |
| Citation | 155 F.2d 237 |
| Parties | BAZLEY v. COMMISSIONER OF INTERNAL REVENUE. |
| Court | U.S. Court of Appeals — Third Circuit |
Henry S. Drinker, Jr., of Philadelphia, Pa. (Frederick E. S. Morrison, Calvin H. Rankin, and Drinker, Biddle & Reath, all of Philadelphia, Pa., on the brief), for petitioner.
Helen Goodner, of Washington, D. C. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key and Helen R. Carloss, Sp. Assts. to the Atty. Gen., on the brief), for respondent.
Before BIGGS, MARIS, GOODRICH, McLAUGHLIN, and O'CONNELL, Circuit Judges.
This is a petition to review the decision of the Tax Court sustaining an income tax deficiency assessed against J. Robert Bazley.1
Mr. and Mrs. J. Robert Bazley owned all but one share of J. Robert Bazley, Inc. As of February 1, 1939, the corporation had accumulated an earned surplus of $855,783.82. On March 16, 1939, the corporation distributed to Mr. and Mrs. Bazley and the one qualifying shareholder in amounts proportionate to their shareholdings, $400,000 in twenty year debenture bonds.2 A corresponding reduction in earned surplus was made on the books of the corporation. Is this $400,000 in twenty year debenture bonds, callable at the option of the obligor, freely marketable and admittedly worth their face value, taxable as ordinary income to the distributees? The Commissioner assessed a deficiency against the Bazleys for the year 1939 on the ground that the $400,000 in bonds represented taxable income in the hands of the recipients. The Tax Court upheld the Commissioner, concluding that the distribution of the bonds was "essentially equivalent to the distribution of a taxable dividend." Internal Revenue Code, Section 115(g).3 We are asked to reverse the Tax Court, chiefly on the assertion that the $400,000 in bonds are exempt from taxation because they were distributed in pursuance of a plan of reorganization of J. Robert Bazley, Inc., within the meaning of Section 112 of the Code.
Shortly prior to February 1, 1939, J. Robert Bazley, Inc., was engaged in general heavy contracting business with most of its operations consisting of coal mining by the open-pit method. As previously indicated, the corporation's stock was owned by J. Robert Bazley, Alice H. Bazley, his wife, and Alfred Day, all of whom constituted the board of directors. On February 16, 1939, these three people as owners of the outstanding capital stock of the corporation held a special meeting pursuant to resolutions adopted by themselves as the board of directors on February 6, 1939, and formally approved a proposed plan of reorganization. Resolutions authorizing the necessary corporate action for consummation of this plan were passed. On March 6, 1939, the Commonwealth of Pennsylvania approved the amendments to the company's Articles of Incorporation increasing the authorized common stock.
The reorganization is reflected in the table set forth below which indicates stock ownership and capitalization of the corporation before and after the occurrence of the transaction under scrutiny here.
Old New
Number Number Debenture
Name of of Principal
Shares Shares Amount
J. Robert Bazley 798 3,990 $319,200.00
Alice H. Bazley 201 1,005 80,400.00
Alfred Day ...... 1 5 400.00
_____ _____ ___________
Total ...... 1,000 5,000 $400,000.00
Capital Structure Of Corporation
February 1, 1939 (Before proposed
reorganization)
1,000 shares common stock
par value of $100 per share $100,000.00
Earned Surplus ...................... 855,783.82
___________
$955,783.82
===========
March 16, 1939 (After reorganization)
Outstanding Debenture Bonds $400,000.00
5,000 shares common stock
without nominal or par
value, the stated capital
applicable to which is .......... 300,000.00
Earned Surplus .................... 255,783.82
___________
$955,783.82
===========
On March 16, 1939, the stockholders delivered their 1,000 shares of old common stock to the corporation and received from the corporation the 5,000 shares of the new common stock4 and debenture bonds in the aggregate principal amount of $400,000. The old common stock was cancelled by the corporation.
Whether a corporation has cancelled its stock at such time and in such manner as to make the distribution and cancellation in whole or in part essentially equivalent to the distribution of a taxable dividend is a question of fact: Brown v. Commissioner, 3 Cir., 1935, 79 F.2d 73; Commissioner v. Champion, 6 Cir., 1935, 78 F.2d 513; Commissioner v. Babson, 7 Cir., 1934, 70 F.2d 304; Randolph v. Commissioner, 8 Cir., 1935, 76 F.2d 472; Hirsch v. Commissioner, 9 Cir., 1941, 124 F.2d 24. Consequently, we are powerless to disturb the Tax Court's determination of such a factual question if substantial evidence to support it exists. Helvering v. Kehoe, 1940, 309 U.S. 277, 60 S.Ct. 549, 84 L.Ed. 751. Nor will we controvert the Tax Court's holding by "treating as questions of law what really are disputes over accounting." Dobson v. Commissioner, 1943, 320 U.S. 489, 499, 64 S.Ct. 239, 245, 88 L. Ed. 248. Indeed, such determinations seem to fall clearly within the Dobson rule. Cf. John Kelley Co. v. Commissioner (Talbot Mills v. Commissioner), 66 S.Ct. 299.
In any event, as we view the record in this case, we believe the Tax Court, applying the correct criterion, reached the correct conclusion. Actually, no "sole decisive" test for the application of Section 115(g)5 has been laid down: Flanagan v. Helvering, 1940, 73 App.D.C. 46, 116 F.2d 937, per Vinson, J. The history of Section 115(g), beginning with the Act of 1926, throws some light on the desired objective of Congress in passing such legislation. In the House, Senate and Conference Reports6 an illustration of the type of situation intended to be covered by this section was given thus: Suppose 7
We see no real distinction between a case where the corporation pays cash for its outstanding stock and where the corporation pays in the form of debenture bonds for its old stock. See Doerschuck v. United States, D.C.E.D.N.Y.,1921, 274 F. 739. In each case the application of Section 115(g) to the transaction under scrutiny depends on the particular facts. McGuire v. Commissioner, 7 Cir., 1936, 84 F.2d 431; certiorari denied, 1936, 299 U. S. 591, 57 S.Ct. 118, 81 L.Ed. 435.
Under Section 115(a)8 a distribution out of accumulated earnings and profits is a "dividend". "Recapitalization does not alter the `effect'". Commissioner v. Estate of Bedford, 1945, 325 U.S. 283, 292, 65 S.Ct. 1157. The net worth of the corporation, i.e., the value of the stock in the hands of the stockholders, prior to the reorganization, was $955,783.82. This value, after reorganization, was $555,783.82. Clearly, the corporation has thus distributed $400,000 out of accumulated earnings and profits. The face and market value of the bonds is admittedly $400,000. By their distribution to the stockholders, the corporation effectively consumed that much of the earned surplus which would otherwise be available for declaration of subsequent dividends. The Bazleys admit this.
To issue bonds, it would not have been necessary to adjust the value of the capital stock ($100,000) on the books of the corporation. Normally, the bonds would have been sold for cash, in which event no charge would have been made against earnings. But had the normal procedure been followed, to transfer the cash into the hands of the stockholders would necessitate a declaration of a dividend with the obvious consequent tax to the recipient. Such dividend would be a charge against earnings. Consider what was accomplished here. The same results were obtained. Instead of the stockholders paying cash into the treasury of the corporation and subsequently receiving an equivalent amount back, the bonds were distributed directly to the stockholders on the same basis as if declared as a dividend. But to accomplish the actual transfer of the bonds to the stockholders without technically declaring a dividend, the plan of cancelling the old stock was adopted. This distribution by the corporation of other property (the bonds) out of its earnings and accumulated profits as a result of the cancellation of its old stock thus occurred at such time and in such manner as to make the distribution and cancellation essentially equivalent to the distribution of a taxable dividend.
In connection with the application of Section 115(g) to this transaction, we need not inquire into motive. The "basic criterion" is the net effect of the distribution rather than the motives and plans of the taxpayer or his corporation. Smith v. United States, 3 Cir., 1941, 121 F.2d 692. Here, as pointed out above, the net effect of the distribution of the debenture bonds was to distribute to the petitioner a substantial segment of the previous earnings of the corporation. Cf. Commissioner v. Estate of Bedford, supra.9
The Tax Court's factual conclusion that this was...
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