Chamberlin v. Commissioner of Internal Revenue

• Decision Date: 14 October 1953
• Docket Number: No. 11693-11698.,11693-11698.
• Citation: 207 F.2d 462
• Parties: CHAMBERLIN v. COMMISSIONER OF INTERNAL REVENUE (two cases). TONER v. COMMISSIONER OF INTERNAL REVENUE. CARL v. COMMISSIONER OF INTERNAL REVENUE. SCHROCK v. COMMISSIONER OF INTERNAL REVENUE. PIERCE et al. v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Sixth Circuit

207 F.2d 462 (1953)

CHAMBERLIN v. COMMISSIONER OF INTERNAL REVENUE (two cases).

TONER v. COMMISSIONER OF INTERNAL REVENUE.

CARL v. COMMISSIONER OF INTERNAL REVENUE.

SCHROCK v. COMMISSIONER OF INTERNAL REVENUE.

PIERCE et al. v. COMMISSIONER OF INTERNAL REVENUE.

Nos. 11693-11698.

United States Court of Appeals Sixth Circuit.

October 14, 1953.

Randolph E. Paul, Washington, D. C., Louis Eisenstein, Washington, D. C., Raymond H. Berry, Ralph W. Barbier, Detroit, Mich., on brief, for petitioners.

Hilbert Zarky, Washington, D. C., H. Brian Holland, Ellis N. Slack, Lee A. Jackson, Washington, D. C., on brief, for respondent.

Before SIMONS, Chief Judge, and McALLISTER and MILLER, Circuit Judges.

MILLER, Circuit Judge.

Petitioner C. P. Chamberlin seeks a review of an income tax deficiency determined by the Respondent for the calendar year 1946, and sustained by the Tax Court. In the Tax Court the proceeding was consolidated with the proceedings of five other taxpayers similarly situated, all of which proceedings involved the same factual and legal questions. The taxpayers, all of whom were stockholders of Metal Moulding Corporation, about which this litigation centers, and their respective deficiencies were as follows:

                  C. P. Chamberlin ........ $343,650.86
                  Grace A. Chamberlin, his
                     wife ................    63,225.55
                  John H. Toner ..........    19,620.37
                  Benjamin James Carl ....     7,244.29
                  Guy V. Schrock .........     9,177.83
                  Robert and Josephine
                     Pierce ..............    14,635.19
                

The Tax Court upheld the deficiency assessment in each proceeding. Each of the taxpayers has petitioned for a review; the causes have been consolidated in this Court; but the record has been made and filed only in the case of C. P. Chamberlin with the agreement, evidenced by an order of this Court, that the decision of this Court in this case shall be the decision of the Court in the other five related cases, with a separate judgment entered in each of the six cases.

The facts in the main are stipulated and are not in dispute. They are set out in detail in the findings of fact of the Tax Court, reported in 18 T.C. 164, to which reference is made for a more detailed statement than will be included in this opinion.

The Metal Moulding Corporation, hereinafter referred to as the Corporation, is a Michigan corporation engaged in the business of manufacturing metal mouldings and bright work trim used in the manufacture of automobiles. It was incorporated on December 2, 1924 with an authorized common capital stock of $25,000, which was increased in 1935 to $150,000, represented by 1,500 shares of $100 par value voting common stock. From 1940 until December 20, 1946, the issued and outstanding common stock totaled 1,002½ shares, of which Chamberlin and his wife together owned 83.8%. The directors of the corporation from 1940 to February 12, 1946 consisted of C. P. Chamberlin, Grace A. Chamberlin and Edward W. Smith. On February 12, 1946, John H. Toner and Raymond H. Berry were added. On October 11, 1946, Smith died and during the remainder of 1946 the board consisted of the four remaining members. From 1940 to the end of 1946, C. P. Chamberlin was president and treasurer, John H. Toner was vice-president and general manager, and Grace Chamberlin was for various periods vice-president, assistant treasurer, and secretary. Benjamin J. Carl was assistant secretary and treasurer until February 12, 1946.

The business of the Corporation prospered, and after paying substantial cash dividends over a period of years, its balance sheet at the end of the first six months in 1946 reflected total assets of $2,488,836.53 and included in current assets $722,404.56 cash and $549,950 United States Government Bonds and notes.

On December 16, 1946, the Corporation's authorized capital stock was increased from $150,000 to $650,000, represented by 6,500 shares of $100 par value common stock. On December 20, 1946, a stock dividend was declared and distributed of five shares of common for each share of common outstanding, and the Corporation's accounts were adjusted by transferring $501,250 from earned surplus to capital account.

On December 26, 1946, the articles of incorporation were amended so as to authorize, in addition to the 6,500 shares of common stock, 8,020 shares of 4½% cumulative $100 par value preferred stock. On December 28, 1946, a stock dividend was declared of 1 1/3 shares of the newly authorized preferred stock for each share of common stock outstanding, to be issued pro rata to the holders of common stock as of December 27, 1946, and the Company's accounts were adjusted by transferring $802,000 from earned surplus to capital account. The preferred stock was issued to the stockholders on the same day. Prior to the declaration of the preferred stock dividend, the Corporation at all times had only one class of stock outstanding.

On December 30, 1946, as the result of prior negotiations hereinafter referred to, all of the holders of the preferred stock, except the estate of Edward W. Smith, deceased, which owned 20 shares, signed a "Purchase Agreement," with The Northwestern Mutual Life Insurance Company and The Lincoln National Life Insurance Company, which instrument was also endorsed by the Corporation for the purpose of making certain representations, warranties and agreements. Under the "Purchase Agreement" 4,000 shares of the preferred stock was sold to each of the two insurance companies at a cash price of $100 per share plus accrued dividends from November 1st, 1946 to date of delivery. Pursuant to the "Purchase Agreement" the holders of the preferred stock, with the exception of the estate of Edward W. Smith, delivered their stock certificates endorsed in blank to agents of the two insurance companies, who transferred to C. P. Chamberlin as agent for the stockholders funds for the amount of the purchase price, which Chamberlin distributed to the stockholders in proportion to their interests by delivery of his personal checks.

Immediately thereafter, on December 30, 1946, the insurance companies delivered the stock certificates to the Corporation for transfer. The Corporation cancelled the certificates and in lieu thereof issued its certificate dated December 30, 1946 to the Northwestern Mutual Life Insurance Company for 4,000 shares of its preferred stock and its certificate likewise dated December 30, 1946 to the Lincoln National Life Insurance Company for 4,000 shares of its preferred stock. The expenses incident to the sale of the stock, including legal fees, commissions and federal documentary stamps totaled $13,500.22, which were paid by Chamberlin, who in turn was reimbursed by the selling stockholders.

In the latter part of 1945, the Corporation's attorney and Chamberlin discussed with an investment firm in Chicago the possibility of selling an issue of preferred stock similar to the stock subsequently issued. The Corporation had such a large accumulated earned surplus it was fearful of being subjected to the surtax provided for by Sec. 102, Internal Revenue Code, but at the same time Chamberlin, the majority stockholder, was not willing to have the Corporation distribute any substantial portion of its earned surplus as ordinary dividends because his individual income was taxable at high surtax rates. It was proposed that the issuance of a stock dividend to the stockholders and the sale of it by the stockholders would enable the stockholders to obtain accumulated earnings of the Corporation in the form of capital gains rather than as taxable dividends. The investment counselor contacted The Lincoln National Life Insurance Company of Fort Wayne, Indiana, and during October 1946, furnished the Insurance Company financial information relative to the Corporation. On November 7, 1946, a representative of the Insurance Company came to Detroit and made an inspection of the plant and properties of the Corporation. On November 20, 1946, The Lincoln National Life Insurance Company's finance committee approved the proposed issue and the purchase of one-half thereof. The Northwestern Mutual Life Insurance Company was contacted for the purpose of participating in the purchase of the preferred stock. It made a detailed investigation of the Corporation and of the terms and conditions of the proposed preferred stock issue, and about two weeks before December 30, 1946, its committee on investments approved the purchase of 4,000 shares of the preferred stock to be issued, and passed the matter over to its legal department for the conclusion of the transaction.

The preferred stock contained the following provisions among others: The holders were entitled to cumulative cash dividends at the rate of $4.50 per annum payable quarterly beginning November 1, 1946; the stock was subject to redemption on any quarterly dividend date in whole or in part at par plus specified premiums and accrued dividends; it was subject to mandatory retirement in amounts not exceeding 2,000 shares on May 1, 1948 and 1,000 on May 1st on each succeeding year, depending upon the Corporation's net earnings for the preceding year, until fully retired on May 1, 1954; in the event of certain default of dividend payments or annual retirements, the holders were entitled to elect a majority of the directors; as long as any preferred shares remained outstanding the consent of the holders of at least 75% thereof was required to validate certain actions, including changing the articles of incorporation or capital structure, the sale of the Company's property, or the incurrence of indebtedness for borrowed money in excess of a certain amount; the Corporation could not pay any cash dividend upon any stock junior to the preferred if there was any default in the payment of dividend upon and the annual retirements of the preferred, or if such dividend reduced the net working capital of the Corporation below an amount equal to 150% of the aggregate par value...