Hirsch v. Commissioner of Internal Revenue
| Decision Date | 29 November 1941 |
| Docket Number | No. 9812.,9812. |
| Citation | 124 F.2d 24 |
| Parties | HIRSCH et al. v. COMMISSIONER OF INTERNAL REVENUE. |
| Court | U.S. Court of Appeals — Ninth Circuit |
COPYRIGHT MATERIAL OMITTED
Robert T. Jacob and Samuel B. Weinstein, both of Portland, Or., for petitioners.
Samuel O. Clark, Jr., Asst. Atty. Gen., and J. Louis Monarch, Bernard Chertcoff, and Warren F. Wattles, Sp. Assts. to the Atty. Gen., for respondent.
Before GARRECHT, HANEY, and HEALY, Circuit Judges.
Although the questions involved on this petition for review are quite clearly defined, by reason of the fact that only one issue is common to all the petitioners and each taxpayer does not raise every question, it is deemed expedient to dispense with a general statement of facts, and to set forth separately the facts relating to each question along with the discussion of that question. The petition for review charges that the Board of Tax Appeals erred in deciding that there were deficiencies in the income tax, in the case of L. B. Hirsch, for the years 1935 and 1936, and in the case of Max S. and Clementine Hirsch, for the year 1935. The petitioners Max S. and Clementine Hirsch are husband and wife, and filed a joint income tax return for the year in question.
The Stock Transfer.
During 1935 and 1936, Max S. Hirsch and L. B. Hirsch were president and vice-president, respectively, of the Hirsch-Weis Manufacturing Co., a corporation engaged in the business of manufacturing and selling work and sports clothes, canvas materials, and related lines, with its principal place of business at Portland, Oregon. The Hirsch-Weis Manufacturing Co. (hereinafter referred to as the Company), was incorporated under the laws of the state of Oregon in 1912, with an authorized capital stock of $100,000, divided into 1000 shares of common stock on a par value of $100 each. Of the original issue Max S. Hirsch subscribed and paid for 600 shares; L. B. Hirsch, 160 shares; Clara Behrens, sister of Max S. and L. B. Hirsch, 40 shares; H. A. Weis, 100 shares; and E. A. Gerst, 100 shares. On or about December 20, 1920, the authorized capital stock of the Company was increased to $700,000 (7,000 shares of $100 par value each), and a 500 per cent. stock dividend was declared and paid. At about the same time seven shares of stock were issued to a son of Max S. Hirsch, thirty-four shares to a nephew and twelve shares to a niece, the consideration for these latter shares not appearing. The following is a statement of ownership, as of 1920 and as of 1935:
Stockholder: Shares owned
Dec. 21, 1920 Dec. 20, 1935
Max S. Hirsch 3600 3600
L. B. Hirsch 960 1000
H. A. Weis 600 634
E. A. Gerst 600 598
Clara Behrens 240 74
H. Minsch 34 34
E. Doering 12 12
H. Hirsch 7 7
____ ____
Total 6053 5959
For several years prior to 1935 it had been the practice of both Max S. and L. B. Hirsch to borrow large sums of money from the Company, borrowing both on promissory note and open account, paying interest on the sums so borrowed, and from time to time to discharge their obligations by repayment of the loans, some payments, if not all, being made out of dividends received from the Company. On May 6, 1932, Max S. Hirsch owed no money on notes to the Company; by January 1, 1935, he was indebted to it in the sum of $47,100. Max S. Hirsch's indebtedness to the Company was increased in the remainder of the year 1935 to $58,010.51 on December 20, 1935, of which $41,100 was represented by promissory notes, $13,123.10 was on open account, $1,287.41 was accrued interest, and $2,500 represented a note of a third party which Max had assumed. On January 1, 1929, L. B. Hirsch owed no money to the Company on promissory notes; by December 14, 1935, he was indebted to it, on his notes, in the sum of $14,186.18.
Prior to June, 1934, the Company made a practice of borrowing operating funds from banks at interest rates ranging from five to six per cent. In 1934 it began selling its commercial paper through brokers, and was able to secure the much more favorable rates of one to one and one-quarter per cent. The marketing brokers requested an audit of the Company's books by certified public accountants, and as a result of the audit, the auditors recommended that the loans to stockholders appearing on the Company's books be liquidated in order to protect the Company's financial rating.
On or about December 21, 1935, an informal meeting of the directors for the Company was held, at which it was decided that Max S. and L. B. Hirsch should liquidate their indebtedness to the Company by turning in to it at par value of $100 a share, ten per cent. of the stock they held in the Company, and the other stockholders were granted the same privilege, that is, of turning in ten per cent. of their stock holdings at $100 a share. On December 21, 1935, Max S. turned in 500 shares of stock and L. B. Hirsch surrendered 100 of his shares of stock, in partial liquidation of their loans. In the Company's books closing journal entries were made under date of December 31, 1935, showing a debit of $62,600 to "Treasury Stock" and a credit of a like amount to "General Ledger," with the notation "To take up charges from General Ledger." Also there was a debit to "Capital Stock" of $62,600 and a corresponding credit to "Treasury Stock," with the notation "To show cancellation of Stock." Twenty-six shares were turned in by two other stockholders in 1935, and in subsequent years additional shares were surrendered by other stockholders under the same arrangement.
No minutes of this informal directors' meeting of December 21, 1935, were made or written at the time, but some years later a recitation purporting to be minutes of said meeting was prepared and inserted in the Company's records. After setting forth the date and place of the meeting and the presence of the directors, this writing went on to recite that there was no way the two Hirschs could pay off their indebtedness excepting to sell to the corporation a part of their respective holdings of shares in the corporation. The plan, as heretofore outlined, was set forth and, following this, it was stated that inasmuch as Max S. Hirsch's indebtedness was in excess of ten per cent. of his holdings in the Company, he should be accorded the privilege of surrendering an additional four per cent. of his holdings, or a total of fourteen per cent., in order to pay the complete indebtedness of Max S. Hirsch to the Company.
The Company had substantial net earning ings in every year from 1914 through 1935, except the depression years of 1930, 1931, and 1932, when losses were shown. No dividends had been declared or paid since 1928, although there were net earnings in four of the intervening years. There were listed on the balance sheets of the Company undivided profits on December 31, 1933, of $86,322.54; 1934, of $125,891.17; and 1935, of $150,924.34. The corporate by-law on "Dividends" as originally written provided that "A dividend of not less than six per centum of the par value of the capital stock of the corporation shall be declared annually by the Board of Directors. * * *" Max Hirsch, on a date prior to the hearing before the Board, on his own responsibility, changed the word "shall" to "may" by striking out the former word and inserting the latter, with pen and ink. On the hearing Max said the change was made fully ten years prior thereto, but the certified public accountant who audited the Company's books said that the by-law read "shall" at the time he made his audit in 1935.
In his income tax return for 1935 Max S. Hirsch reported the surrender of his stock, in payment of his indebtedness to the Company, as a capital transaction. The Commissioner determined the transaction constituted a redemption or cancellation of such stock by the Company within the meaning of Section 115(g) of the Revenue Act of 1934.1 L. B. Hirsch did not report the transaction at all in his return, and for failure to do so the respondent assessed a fraud penalty of 50% under § 293(b) of the Revenue Act of 1934, 48 Stat. 680, 747, 26 U.S.C.A. Int.Rev.Code, § 293(b).
The Board of Tax Appeals found that the redemption of the stock was at such time and in such manner as to make the redemption essentially equivalent to the distribution of a taxable dividend and that the failure of L. B. Hirsch to report the transaction was not due to fraud with intent to evade tax.
In the consideration of this case, as in other litigation of a kindred nature, it must be borne in mind that the ruling of the Commissioner has "the support of a presumption of correctness, and the petitioner has the burden of proving it to be wrong" before the Board. Welch v. Helvering, 290 U.S. 111, 115, 54 S.Ct. 8, 9, 78 L.Ed. 212; Allen v. Commissioner, 1 Cir., 117 F.2d 364, 365. The Board's decision indicates that, in its judgment, petitioners did not overcome this burden.
The courts uniformly have held that the question whether a distribution in connection with the cancellation or redemption of stock is essentially equivalent to the distribution of a taxable dividend is one of fact. Commissioner v. Babson, 7 Cir., 70 F.2d 304, 306; Randolph v. Commissioner, 8 Cir., 76 F.2d 472, 476; Commissioner v. Champion, 6 Cir., 78 F.2d 513, 514; Brown v. Commissioner, 3 Cir., 79 F.2d 73, 74. It is almost axiomatic that the determination of questions of fact by the Board of Tax Appeals must be accepted on review if there is substantial evidence to support its conclusion. Helvering v. Kehoe, 309 U. S. 277, 279, 60 S.Ct. 549, 84 L.Ed. 751; Phillips v. Commissioner, 283 U.S. 589, 600, 51 S.Ct. 608, 75 L.Ed. 1289; Randolph v. Commissioner, supra. In looking to this question —...
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