Bennett v. Comm'r of Internal Revenue

• Decision Date: 30 May 1972
• Docket Number: Docket No. 6790-70.
• Citation: 58 T.C. 381
• Parties: RICHARD B. BENNETT AND LUANNE BENNETT, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

58 T.C. 381

RICHARD B. BENNETT AND LUANNE BENNETT, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 6790-70.

United States Tax Court

Filed May 30, 1972.

James P. Brody, Benjamin F. Garmer III, and Joseph R. Barnett, for the petitioners.

Matthew W. Stanley, Jr., for the respondent.

Held, an integrated transaction whereby the stock interest of a majority shareholder in a closely held corporation was terminated did not result in a distribution essentially equivalent to a dividend to the minority shareholder within the meaning of sec. 302(b)(1), I.R.C. 1954.

FEATHERSTON, Judge:

Respondent determined a deficiency in petitioners' Federal income tax for 1965 in the amount of $47,850.40. The sole issue for decision is whether petitioner Richard B. Bennett, owner of a minority of the shares of a corporation, realized income, taxable under section 301,¹ as the result of a transaction in which the stock ownership of the majority shareholder was terminated.

FINDINGS OF FACT

Richard B. Bennett (hereinafter referred to as petitioner) and Luanne Bennett, husband and wife, were legal residents of Eau Claire, Wis., at the time they filed their petition. They filed a joint Federal income tax return for 1965 with the district director of internal revenue, Milwaukee, Wis.

Petitioner was graduated from the University of Wisconsin at Madison, Wis., in 1948. Thereafter, for about 2 years, he worked for the Coca-Cola Bottling Co. of Bay City, Mich. In 1950, he took a job with the Coca-Cola Bottling Co. of Eau Claire, Inc. (hereinafter the corporation), as a warehouse manager at Menomonee, Wis. About a year later, he moved to Eau Claire and became sales manager of the corporation. Sometime between 1951 and 1956, he was made vice president and general manager of the corporation, and in 1956, he became its president.

Between 1941 and 1946, Robert T. Jones, Jr. (hereinafter Jones), acquired 1,000 of the 1,500 outstanding shares of the voting common stock of the corporation. Prior to September 1, 1965, he had transferred 999 of these shares to various members of his family or to the First National Bank of Atlanta (hereinafter the Atlanta bank) to hold in trust for them; the 1 remaining share was retained by Jones. These 1,000 shares of stock will be hereinafter referred to as the Jones stock or the Jones interest. The remaining 500 shares were, by September 1, 1965, owned by petitioner (275), his wife (5), his mother (104), and his father (116). The directors of the corporation at this time were Jones, Mary Malone Jones, and petitioner.

During 1964, Jones expressed a desire to sell a portion of the stock held by the trusts for members of his family. Initial consideration was given to the immediate purchase by petitioner of 133 1/2 shares of stock and the subsequent redemption of other stock so that petitioner's family would control the corporation. However, Jones was not willing to assume a minority position, and petitioner did not want merely to increase his minority interest in the corporation. The negotiations, therefore, turned to a procedure which would terminate the entire Jones interest.

As early as April 22, 1965, Jones suggested to petitioner that an arrangement whereby the corporation would redeem at least part of the Jones stock would be to petitioner's tax advantage. Through consultations with the corporation's legal counsel and accountant, petitioner learned that the corporation could legally redeem the Jones stock. A price for the Jones interest, based on an objective appraisal, was negotiated, and petitioner contacted two banks and an insurance company in efforts to arrange financing for a corporate redemption. Petitioner never contemplated purchasing the entire Jones interest for himself, and he did not have enough money or borrowing capacity to enable him to do so.

During the summer of 1965, petitioner received oral assurances from each of the two banks that they would loan the corporation the amount needed to redeem the Jones stock. Thereafter, in late July, petitioner and Jones agreed in principle to the termination of the entire Jones interest at a price of $226,700. During the ensuing discussions as to the details of the transfer, Jones insisted that the transaction take the form of a sale of the stock to petitioner rather than directly to the corporation. He stated that he was concerned that a debt incurred by the corporation to redeem the stock while he was a director might involve him and his wife in an impairment of capital of the corporation for their own benefit and, thereby, cause them to be liable to creditors of the corporation. The transaction took the form which Jones requested; however, Jones was informed in advance that the corporation was to borrow the money required to purchase the Jones interest and immediately redeem the Jones stock.

On August 10, 1965, the First Wisconsin National Bank of Eau Claire, Wis. (hereinafter the Eau Clair bank), formally agreed to loan the corporation $227,000 in order to redeem the Jones stock. This loan was to be secured by mortgages on the real estate, equipment, and machinery of the corporation; personal guaranties by petitioner, his wife, and his father; and an insurance policy on petitioner's life. The Eau Claire bank would not have made this loan to petitioner individually.

By letter dated August 18, 1965, the Jones stock, accompanied by appropriate stock powers, was sent to the Eau Claire bank to be held in escrow until the purchase price of $226,700, less any applicable transfer taxes, had been paid.

On September 1, 1965, meetings of the corporation's board of directors and stockholders were held at the Eau Claire bank. These meetings did not last more than a total of one-half hour. While the directors, the corporation's attorney, Jones' representative, and the Eau Claire Bank's representatives were present, petitioner executed on behalf of the corporation a note in the amount of $226,700, together with the agreed mortgage on the real estate and chattel security agreement. The Eau Claire bank deposited $226,700 in the corporation's checking account. The corporation drew a check in the same amount to petitioner. He deposited the check in his checking account and drew a certified check payable to the Atlanta bank in the amount of $226,609.32, the net purchase price of the stock after stock-transfer taxes.

Immediately following these meetings, stock transfers were made on the books of the corporation to reflect the above-described series of transactions, i.e., the transfer of the Jones shares to petitioner and the retirement of those shares. The certificates for the 1,000 shares of Jones stock were canceled and put in the stock-record book, and one certificate representing those shares were issued to petitioner and immediately canceled and redeemed by the corporation. Stock-transfer stamps were affixed to each certificate.

The minutes of these meetings reflect that they were held for the purpose of considering the purchase and retirement of 1,000 shares of stock, the borrowing of $226,700 from the Eau Claire bank to finance such purchase, and the execution of required security agreements. The minutes of the board of directors meeting reflect that there was presented a ‘Waiver of Notice and Consent to the transaction of any business that might come before the meeting,’ signed by Jones and Mary Malone Jones. The minutes of the stockholders meeting reflect that all 1,500 outstanding shares of stock were represented and that petitioner voted the Jones stock. Such minutes also reflect that the officers and board of directors of the corporation were authorized to ‘retire 1,000 shares of stock in * * * (the corporation), now held in the name of * * * (petitioner) upon the books of this corporation,‘ and in order to finance the redemption the officers and directors were authorized to borrow the necessary funds from the Eau Claire bank.

Upon the completion of this series of events, petitioner, his wife, his mother, and his father continued to own their 500 shares of stock in the same proportions as they had before the redemption. A new board of directors was elected, composed of petitioner, his wife, his mother, and his father. The 1,000 shares of stock previously owned by the Jones group were held as treasury stock.

Respondent determined that petitioner ‘realized a taxable dividend in the amount of $92,649.66 during the calendar year 1965 with regard to the redemption by the Coca-Cola Bottling Company of Eau Claire, Inc. of one-thousand shares of its capital stock from * * * (him) on September 1, 1965.’

OPINION

Respondent has taken the position that petitioner received a distribution ‘essentially equivalent to a dividend’ within the meaning of section 301(a) ² or section 302(b)(1)³ in the transaction in which the Jones stock was redeemed. Petitioner contends that he was a mere conduit or agent through which the corporation redeemed the stock owned by the Jones interest and that he did not, therefore, realize taxable income from the transaction. The issue is basically factual, and we hold for petitioner.

Respondent seeks to support his determination on two theories. First, he argues that petitioner initially obligated himself personally to buy the Jones stock, and that he realized income when the corporation distributed to him the money required to discharge that obligation. See, e.g., Sullivan v. United States, 363 F.2d 724 (C.A. 8, 1966), certiorari denied 387 U.S. 905(1967); Wall v. United States, 164 F.2d 462 (C.A. 4, 1947); Louis H. Zipp, 28 T.C. 314(1957), affirmed per curiam 259 F.2d 119 (C.A. 6, 1958), certiorari denied 359 U.S. 934(1959), acq. 1957-2 C.B. 7. Second, respondent contends that, since section 318(a)(1)⁴ attributes to petitioner the ownership of all the Bennett family stock, petitioner is to be treated as the sole shareholder of the corporation during the moment when the stock certificate covering the Jones...