Kerr v. Comm'r of Internal Revenue

• Decision Date: 27 August 1962
• Docket Number: Docket No. 89256.
• Citation: 38 T.C. 723
• Parties: THOMAS KERR AND BARBARA KERR, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

38 T.C. 723

THOMAS KERR AND BARBARA KERR, PETITIONERS,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 89256.

Tax Court of the United States.

Filed August 27, 1962.

John P. Apicella, Esq., and Guy J. Rappleyea, Esq., for the petitioners.

John D. Picco, Esq., for the respondent.

Petitioner owned 100 percent of the stock of X and Y corporations. On October 24, 1955, petitioner sold his Y corporation stock to X corporation for $50,000. Held, the amount received by petitioner is to be treated as a distribution in redemption of the stock of X corporation under section 304, I.R.C. 1954. Held, further, the redemption by X corporation of petitioner's stock in Y corporation was a redemption essentially equivalent to a dividend under section 302, I.R.C. 1954. Held, further, an income tax imposed on a distribution which is essentially equivalent to a dividend is not repugnant to article I, section 9, of the Constitution.

FAY, Judge:

Respondent has determined a deficiency in the income tax of petitioners for the year 1955 in the amount of $26,036.45. The basic issue presented for decision is whether the amount received by petitioners from a corporation whose outstanding capital stock was owned by petitioners, in exchange for 100 percent of the outstanding capital stock of another corporation owned by petitioners, is taxable as a distribution essentially equivalent to a dividend pursuant to the provisions of sections 302 and 304 of the Internal Revenue Code of 1954. ¹

If the answer to this question is in the affirmative, the petitioners contend that sections 302 and 304 of the Code are unconstitutional in that they cause the imposition of a direct property tax not apportioned among the several States as required by article I of the Constitution of the United States.

FINDINGS OF FACT.

Some of the facts are stipulated and are incorporated herein by this reference.

The petitioners are Thomas Kerr and Barbara Kerr, husband and wife. Their residence was in Portland, Oregon, and they filed a joint income tax return with the district director of internal revenue at Portland, Oregon, for the year 1955. (For convenience, Thomas Kerr will hereinafter be referred to as the petitioner.)

Petitioner's family has been engaged in the grain and milling business in Portland and the Pacific Northwest area since before the turn of the century. The petitioner entered the employ of the family grain business, known in later years as Kerr Gifford and Co., Inc., upon his graduation from college in 1932, and he has been engaged in the grain business and related activities continually since that date to the present. Kerr Gifford & Co., Inc., was acquired by Cargill, Incorporated, in June 1953, and petitioner thereafter entered the employ of the latter corporation as an executive.

In 1947 petitioner organized the Helix Milling Company, an Oregon corporation (hereinafter referred to as Helix), for the purpose of engaging in the business of milling and selling flour. The outstanding stock of Helix, consisting of 100 shares, $100-par-value stock, was issued to petitioner in exchange for the mill property. Since Helix's corporation, petitioner has been its president, its chief executive officer, and a director.

Helix, after its incorporation, was operated by Kerr Gifford and Co., Inc., and later by Cargill, Incorporated, under an arrangement whereby the latter corporations handled the financing of Helix's operations in return for a share of its profits. Helix produced flour almost exclusively for overseas markets in the Far East. In early 1954 in an effort to improve and stabilize its income and to expand its operations, Helix commenced construction of a modern grain elevator as an adjunct to its flour mill. To finance this facility Helix borrowed $200,000 from the United States National Bank of Portland (hereinafter referred to as the Portland bank) on a 10-year-term loan secured by a first mortgage on the grain elevator. The petitioner gave his personal guaranty to the bank as additional security for the construction loan. The grain elevator was completed sometime around the end of 1954.

During this same period Cargill, Incorporated, pursuant to its arrangement with Helix, advanced substantial sums to Helix for working capital and for use in connection with the construction of the grain elevator.

Helix made a net profit before income tax deductions of $43,438.90 during its fiscal year ended June 30, 1954. The minutes of the special meeting of the directors of Helix held on June 29, 1954, provided, in part, as follows:

The Board of Directors expressed their unanimous approval of the company's past operations and of the policies of the management which have produced the present satisfactory condition of the company. The minutes also noted that no officers' salaries had heretofore been fixed or paid because of the other financial requirements of the company. A resolution was then unanimously adopted whereby a salary of $9,000 was established for the petitioner for the fiscal year ended June 30, 1954, and was made payable in cash as of June 30, 1954.

In November 1954 petitioner had a meeting with representatives of Cargill, Incorporated, and was informed by them that his employment with Cargill was to be terminated within the next several months. However, nothing was said at the meeting regarding the status of the financing arrangement between Cargill and Helix.

As a result of this meeting, petitioner realized that he would have to seek other means of livelihood, since his salary from Cargill, Incorporated, was his principal source of income. Because the Northwest area was encountering a problem regarding the storage of Government surplus grains, or so petitioner believed, petitioner decided to go into the grain storage business. On January 19, 1955, petitioner organized the Kerr Grain Corporation for the purpose of engaging in the grain brokerage and grain storage business. In forming Kerr Grain, petitioner was hopeful that the corporation would be able to obtain business from the Federal Government. Petitioner was aware that, in the absence of such business, the corporation would experience difficulty. The outstanding stock of Kerr Grain consisted of 5,000 shares, $100-par-value stock, all of which was issued to petitioner at the time of organization for $50,000 in cash. The petitioner at all times pertinent to this proceeding has been president and chief executive officer of Kerr Grain.

Even though petitioner's employment with Cargill, Incorporated, was to be terminated, Cargill Incorporated, was still interested in the operation of Helix and offered to make additional loans to Helix in return for certain sales and competitive concessions by petitioner. The offer by Cargill was made before its president learned that petitioner had organized the Kerr Grain Corporation. Upon learning of the formation of Kerr Grain, Cargill's president notified petitioner that unless petitioner halted his plans to go into the grain storage business the arrangement between Cargill and Helix would be terminated and Helix would have to repay its current indebtedness to Cargill.

Petitioner contacted the Portland bank and was able to secure loan commitments which would be sufficient to liquidate the Cargill indebtedness, which by this time totaled approximately $325,000. Petitioner then notified Cargill that he was going to pay off its loans. In order to obtain the necessary funds, petitioner executed personal notes to the Portland bank totaling $150,000 and pledged as security for said loans his expected inheritance from the estate of a deceased relative. After petitioner obtained the money from the Portland bank, he loaned money to Helix and received Helix's demand promissory notes for $150,000. By March 1955 Helix had succeeded in paying off its indebtedness to Cargill.

Due to the fact that several months elapsed between the time Helix first purchased the wheat and the time it received the proceeds from the sale of its flour, Helix usually found itself in a tight working-capital position. Consequently, even after liquidating the Cargill loans, Helix found it necessary to borrow money for working-capital purposes, and since the agreement with Cargill was no longer in effect Helix had to turn to other sources, notably the Portland bank, for funds. The Portland bank permitted Helix to borrow up to $500,000 for operating purposes. However, since the Portland bank considered the business of Helix to be hazardous and from a financial statement point of view considered Helix to be a marginal credit risk, it required the personal guaranty of petitioner to the extent of $300,000 on all operating loans to Helix.

As of June 30, 1955, Helix had total assets of $704,499, total liabilities of $474,448, and earned surplus of $130,051. For its fiscal year ended June 30, 1955, Helix sustained a net loss of $12,198.89.

Kerr Grain commenced operations in January 1955 and derived the principal part of its income in 1955 from the grain storage business. It did not become active in the grain-merchandising business until 1956. As of June 30, 1955, the end of its first fiscal year, Kerr Grain had total assets of $266,148 and total liabilities of $218,034. For its first fiscal year, Kerr Grain sustained a net loss of $1,886.40.

Following its organization, Kerr Grain lacked sufficient working capital to finance its operations and was forced to seek outside financing. The Portland bank extended it a credit ceiling of $150,000, and as in the case of Helix and for the same reasons, required the personal guaranty of petitioner as security. Helix also advanced various sums to Kerr Grain and paid its office expenses until August 1955.

The grain storage business in the Northwestern United States turned out to be extremely competitive with practically every large grain firm taking part in the storage business. In addition, a below-average wheat crop in 1955, coupled with...