Crown v. Comm'r of Internal Revenue
| Decision Date | 14 August 1972 |
| Docket Number | Docket Nos. 3359-70— 3366-70. |
| Citation | 58 T.C. 825 |
| Parties | ARIE S. CROWN, ET AL.,1 PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Byron S. Miller, Alan L. Reinstein, and Merrill A. Freed, for the petitioners.
Seymour I. Sherman, for the respondent.
On Mar. 10, 1966, GD paid a dividend on its common stock, without paying or setting aside for payment a dividend on its preferred stock for the first quarter of 1966. On Mar. 14, 1966, On Mar. 14, 1966, a plan for the redemption of the preferred stock was adopted, and the redemption price expressly included an amount representing the unpaid dividend for the first quarter of 1966. Held: (1) Under the terms of GD's certificate of incorporation, the dividends on the preferred stock must be declared and paid, or set apart for payment, before common stock dividends are declared or paid; (2) as a result of the payment of the dividends on the common stock, the preferred shareholders had a legally enforceable right to compel GD to pay the dividends on the preferred stock; and (3) the portion of the proceeds received by a preferred shareholder in satisfaction of his rights against GD is taxable as a dividend under sec. 301, I.R.C. 1954.
The respondent determined deficiencies in the petitioners' income taxes for the year 1966 as follows:
+-------------------------------+
¦Petitioner ¦Deficiency ¦
+------------------+------------¦
¦Arie S. Crown ¦$55,669.64 ¦
+------------------+------------¦
¦James S. Crown ¦33,141.57 ¦
+------------------+------------¦
¦Patricia A. Crown ¦28,749.60 ¦
+------------------+------------¦
¦Daniel M. Crown ¦22,457.34 ¦
+------------------+------------¦
¦Debra L. Crown ¦26,098.36 ¦
+------------------+------------¦
¦Nancy J. Crown ¦175.42 ¦
+------------------+------------¦
¦Richard C. Goodman¦3,429.35 ¦
+------------------+------------¦
¦Laurie J. Crown ¦2,308.99 ¦
+-------------------------------+
Most of the issues in this case have been settled; the one issue remaining for decision is whether all the proceeds received by a petitioner when his stock was redeemed are taxable as a capital gain under section 302(a) of the Internal Revenue Code of 19542 or whether a portion of the proceeds is taxable as a dividend under section 301.
Some of the facts have been stipulated, and those facts are so found.
Each of the petitioners resided in the State of Illinois at the time his petition was filed in this case. Each is unmarried and filed his individual Federal income tax return for 1966 with the district director of internal revenue, Chicago, Ill.
Effective December 31, 1959, an Illinois corporation known as the Material Service Corp. (MSC) was merged into the General Dynamics Corp. (GD), a Delaware corporation. As a result of the merger, the common shareholders of MSC received convertible preference stock of GD. The convertible preference stock issued to the common shareholders of MSC was the only GD preference stock outstanding from 1959 until its redemption in 1966. During this time, trusts for the benefit of the petitioners held shares of the convertible preference stock as follows:
+-------------------------------------+
¦Trust for ¦Number of shares ¦
+------------------+------------------¦
¦Arie S. Crown ¦2,400 ¦
+------------------+------------------¦
¦James S. Crown ¦1,528 ¦
+------------------+------------------¦
¦Patricia A. Crown ¦1,254 ¦
+------------------+------------------¦
¦Daniel M. Crown ¦1,124 ¦
+------------------+------------------¦
¦Debra L. Crown ¦1,275 ¦
+------------------+------------------¦
¦Nancy J. Crown ¦21 ¦
+------------------+------------------¦
¦Richard C. Goodman¦269 ¦
+------------------+------------------¦
¦Laurie J. Crown ¦188 ¦
+-------------------------------------+
Each trust was required to distribute all of its net income, including capital gains, to its beneficiary. Although the trusts were the record shareholders of the stock, the petitioners shall be treated as the owners of the stock for the purpose of this opinion.
The agreement and plan of merger, which under Delaware law became part of the certificate of incorporation of GD, set forth the dividend rights of the preference shareholders as follows:
The holders of the Preference Stock shall be entitled to receive dividends, commencing April 1, 1964, but not before, when and as declared by the Board of Directors from the surplus or net profits of the Surviving Corporation (GD) available for the payment thereof, at the rate of $2,90625 per share per annum, and no more.
Dividends on the Preference Stock shall be payable quarterly, commencing on April 1, 1964, on the first days of January, April, July and October in each year * * * . The dividends on the Preference Stock shall be cumulative from and after January 1, 1964 and shall be deemed to accumulate from day to day thereafter, and shall be paid or set apart for payment before any dividend on the Common Stock shall be paid or set apart; so that, if in any dividend period, dividends at the above rate shall not have been paid thereon, the deficiency shall be paid or set apart for payment before any dividends shall be paid upon or set apart for the Common Stock.
After full cumulative dividends on all shares of Preference Stock outstanding shall have been declared and paid, or set apart for payment for all previous dividend periods and for the current dividend period, * * * then and not otherwise, * * * subject to the provisions of the next paragraph hereof, dividends may be declared and paid, or set apart for payment, on the Common Stock, payable then or thereafter, out of any remaining surplus or net profits available for the payment of dividends.
So long as any of the Preference Stock shall be outstanding, the Surviving Corporation shall not (i) declare or pay any dividend (whether in cash, stock of any other corporation or otherwise) or make any distribution on the Common Stock * * * , or (ii) directly or indirectly, either in its own capacity or through any subsidiary or otherwise, purchase, redeem or otherwise acquire for value * * * any shares of Common Stock * * * , if:
(1) the Surviving Corporation shall not have declared and paid, or set apart for payment, full cumulative dividends on all outstanding shares of Preference Stock for all previous dividend periods and for the current dividend period; * * *
If any of the preference stock dividends were not claimed within 6 years of their payment date, they were to become corporate property.
The agreement also provided a procedure by which the holders of the preference stock, subject to certain variations not relevant here, could convert their stock into common stock at the ratio of 1 share of preference stock for 1.056818 shares of common stock. No adjustments were to be made in the ratio on account of dividends, and in the event the preference stock was called for redemption, all such stock was immediately convertible into common stock until the close of business on the 15th day prior to the date fixed for such redemption. The preference stock was redeemable at the option of the GD board of directors at any time on or after January 2, 1964, in whole or in part, at a price equal to the sum of an amount designated as the current optional redemption price plus an amount equal to unpaid dividends accrued to the date fixed for the redemption.
The corporation could not adopt a resolution adversely affecting the preferences, rights, or powers of the preference stock without the affirmative vote of two-thirds of the then outstanding preference stock.
The entire agreement was conditioned on MSC's obtaining a favorable tax ruling from the Internal Revenue Service. In applying for this ruling, the attorney for MSC described the dividend rights of the preference stock as follows:
Beginning in 1964, the Preference Stock will be entitled to dividends at the rate of 5% per annum on the liquidating preference, which dividends will be cumulative and payable quarterly; no dividends will be declared or paid on the Common Stock of Dynamics unless all current and accumulated dividends on the Preference Stock have been paid * * * .
A substantially favorable ruling was issued on December 4, 1959.
After the merger of MSC into GD, the first action taken by the GD board of directors with respect to dividends on the preference stock occurred at a meeting held January 29, 1965, when the following resolution was adopted:
RESOLVED, that the cumulative dividends for the four quarterly dividend periods in 1964 aggregating $2,90625 a share be, and hereby are, declared on the Convertible Preference Stock of the Corporation payable March 1, 1965 to stockholders of record at the close of business on February 10, 1965; and further
RESOLVED, that a quarterly dividend of $0.7265625 a share be, and hereby is, declared on the Convertible Preference Stock of the Corporation payable April 1, 1965 to stockholders of record at the close of business on March 15, 1965; and that the amount of such dividends be, and hereby is, set apart for payment; and further
RESOLVED, that a quarterly dividend of $0.25 per share be, and hereby is, declared on the Common Stock of the Corporation, payable on March 10, 1965 to stockholders of record at the close of business on February 10, 1965.
At subsequent meetings in April, August, and October of 1965, the board, in language paralleling that of the last two paragraphs of the January 29 resolution, declared quarterly dividends on both the preference and common stock.
Early in 1966, the GD board of directors was desirous of declaring a dividend on the common stock of GD. However, because it was also contemplating both the possible sale of the material services division of GD for a consideration...
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