CIR v. Fender Sales, Inc.

• Decision Date: 14 January 1965
• Docket Number: No. 19074-19079.,19074-19079.
• Citation: 338 F.2d 924
• Parties: COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. FENDER SALES, INC., Respondent. COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Donald D. and Jean RANDALL, Respondents. COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Esther FENDER, Respondent. COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Jean E. RANDALL, Respondent. COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Donald D. RANDALL, Respondent. COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. E. Leo FENDER, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

338 F.2d 924 (1964)

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. FENDER SALES, INC., Respondent.

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Donald D. and Jean RANDALL, Respondents.

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Esther FENDER, Respondent.

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Jean E. RANDALL, Respondent.

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Donald D. RANDALL, Respondent.

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. E. Leo FENDER, Respondent.

Nos. 19074-19079.

United States Court of Appeals Ninth Circuit.

December 1, 1964.

Rehearing Denied January 14, 1965.

Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, Melva M. Graney, Arthur E. Strout, Dept. of Justice, Washington, D. C., for petitioner.

William C. Jordan, Paul F. Loveridge, Santa Ana, Cal., for respondents.

Before POPE and BARNES, Circuit Judges, and THOMPSON, District Judge.

Rehearing Denied in 19075-19079 January 14, 1965.

THOMPSON, District Judge.

These are petitions by the Commissioner of Internal Revenue for review of decisions of the Tax Court of the United States of which this Court has jurisdiction under Section 7482 of the Internal Revenue Code of 1954 (26 U.S.C. § 7482). The Tax Court held neither the corporate taxpayer, Fender Sales, Inc., nor the individual stockholder-taxpayers, Donald D. and Jean Randall, and C. Leo and Esther Fender, liable for a deficiency of income taxes on account of the transactions set forth in the following statement of the case, as made in petitioner's opening brief and concurred in by respondents.

The taxpayer Fender Sales, Inc. was incorporated in 1953 as a California corporation. It was authorized to issue 2,500 shares of common stock with a par value of $100 per share. At the commencement of the events material to this case, only 100 shares were outstanding, 50 of which were held by the taxpayer Donald D. Randall, and the other 50 by the taxpayer C. Leo Fender. Randall and Fender were also employees of Fender Sales and as such, were entitled to receive, as compensation for their services, $15,000 a year plus amounts equal to four per cent and one per cent, respectively, of annual sales.

Fender Sales was the exclusive sales agent for Fender Electric Instrument Co., Inc., a corporation owned entirely by C. Leo Fender.

Although Fender Sales has always been financially solvent, from its inception it has been plagued by a shortage of cash. This financial predicament was brought about primarily because it had to pay for its purchases upon receipt of the merchandise while it was often required to finance the dealers who purchased merchandise from it. Accordingly, in 1955, Fender Sales found it necessary to seek bank financing. Originally the bank did not ask for security for its loan, but later it required the subordination of other liabilities and personal guarantees from the corporate officers. In addition it became concerned about accrued (but unpaid) officers' salary liabilities that appeared on Fender Sales' balance sheet; it felt that these liabilities could represent potential priority claims over the bank's claim. To remedy this, the bank suggested that these liabilities be capitalized.

In each of its fiscal years ending May 31, 1954, 1955 and 1956, Fender Sales, which used the accrual method of accounting for federal income tax purposes, accrued $30,000 on its books of account as representing officers' salaries payable, but unpaid, in the amount of $15,000 a year each to Randall and Fender. In each of those years, Fender Sales deducted the $30,000 on its federal income tax return. Accordingly, as of August 6, 1956, Fender Sales owed Randall and Fender each $45,000 for salaries payable for the fiscal years ended May 31, 1954 through 1956.

On or about August 6, 1956, Randall and Fender, in order to comply with the bank's suggestion, offered to discharge Fender Sales' liability for salaries due and payable to them by accepting from Fender Sales an additional share of $100 par value common stock for each $100 of salary debt. On August 6, 1956, the board of directors of Fender Sales, consisting of Mr. and Mrs. Randall and Mr. and Mrs. Fender resolved to accept the offers by Randall and Fender. After obtaining a permit from the Commissioner of Corporations of the State of California, Fender Sales, on December 3, 1956, issued to Randall and to Fender 450 shares each of its $100 par value common stock in discharge and cancellation of its indebtedness of $45,000 owing to each of them. As a result of this issuance of stock, Sales' capital stock account was increased from $10,000 to $100,000 and its $90,000 liability for salaries owed to Randall and Fender was discharged and cancelled.

During the fiscal year ended May 31, 1957, Fender Sales accrued on its books of account $30,000 which represented officers' salaries payable, but unpaid, of $15,000 each to Randall and Fender. Fender Sales deducted this amount of $30,000 on its federal income tax return for the fiscal year ended May 31, 1957.

On or about February 3, 1958, when Fender Sales was still indebted to Randall and Fender for $15,000 each for salary for the fiscal year ended May 31, 1957, Randall and Fender offered to discharge Fender Sales' liability for salaries due and payable to them by accepting from Fender Sales an additional share of $100 par value common stock for each $100 of salary debt. On February 3, 1958, the Board of Directors of Fender Sales resolved to accept the offers by Randall and Fender. On May 9, 1958, Fender Sales issued to Randall and Fender 150 shares each of its $100 par value common stock in discharge and cancellation of its indebtedness of $15,000 owing to each of these individuals. On the same date, it issued to Randall and Fender 350 shares each of its $100 par value common stock as a stock dividend. As a result, Fender Sales' capital stock account was increased from $100,000 to $200,000, its earned surplus account was decreased $70,000, and its $30,000 liability for salaries owed to Randall and Fender was discharged and cancelled.

On their federal income tax returns for the years 1956 and 1958, Fender and his wife did not report any amount as taxable income resulting from Fender's receipt of 450 shares of Fender Sales' stock on December 3, 1956, and 150 shares of Fender Sales' stock on May 9, 1958. On their federal income tax returns for the year 1956 and on their joint federal income tax returns for the year 1958, Randall and his wife did not report any amount as taxable income resulting from Randall's receipt of 450 shares of Fender Sales' stock on December 3, 1956, and 150 shares of Fender Sales' stock on May 9, 1958. On its corporate federal income tax returns for the fiscal years ended May 31, 1957 and May 31, 1958, Fender Sales did not report any amount as taxable income resulting from the discharge and cancellation on December 3, 1956 and May 9, 1958 of its indebtednesses for officers' salaries payable to Fender and Randall.

The Commissioner determined that the receipt of the stock constituted taxable salary income to Fender and Randall and, alternatively, that if it did not constitute taxable income to them, Fender Sales realized taxable income upon the cancellation of the salary indebtedness. The Tax Court held, however, that the cancellation of the indebtedness and issuance of the stock did not result in taxable income either to Fender and Randall or to Fender Sales. From that holding the Commissioner has sought review by this Court.

It is implicit in the foregoing fact statement and is conceded by respondents that the shares of Fender Sales, Inc. issued to each of the shareholders, Fender and Randall, had a fair market value of $100 per share (par value).

TAX LIABILITY OF FENDER AND RANDALL

Cases numbered 19075 to 19079, inclusive, present petitions by the Commissioner to review decisions by the Tax Court that the individuals, Donald D. Randall and his wife, Jean Randall, and C. Leo Fender and his wife, Esther Fender, incurred no income tax liability arising from the transactions related in the statement of facts. The complete rationale of the Tax Court decision is found in the following quotation:

"Fender and Randall were the sole shareholders of Sales regardless of whether they each owned 50 shares or 1,000 shares. Their wealth was no more increased by the issuance of additional shares than if the corporation had caused its stock to be split 20 for 1. The issuance of such additional shares to Fender and Randall did not constitute income to them within the meaning of the 16th Amendment to the Constitution regardless of whether it represented a stock dividend or represented compensation for services. Eisner v. Macomber 252 U.S. 189, 40 S.Ct. 189, 64 L.Ed. 521, supra. See also Deloss v. Daggitt, 23 T.C. 31 (1954)."

We disagree, and reverse the decision of the Tax Court in these cases.

The stockholder-employees received and accepted capital stock in discharge of the delinquent obligations of the corporation to them for salaries. If these were not equal stockholders to whom the corporation owed equal sums for unpaid salaries, there would be no semblance of a basis for dispute. The law and regulations plainly tax "all income from whatever source derived" (26 U.S.C. § 61), and provide: "* * * if a corporation transfers its own stock to an employee * * * as compensation for services, the fair market value of the stock at the time of transfer shall be included in the gross income of the employee." Regulations, § 1.61-2(d) (4). Here the parties agree the fair market value of the stock of Fender Sales, Inc. equalled its par value, and the additional stock issued is, in any event, presumptively equal in value to the liquidated obligations discharged. Regulations, § 1.61-2(d).

Respondents say this case is different because the taxpayers were stockholders as well as employees and the equal (50-50) stock ownership by Fender and Randall remained equal...