Okonite Co. v. Commissioner of Internal Revenue, 9030.

• Decision Date: 18 April 1946
• Docket Number: No. 9030.,9030.
• Citation: 155 F.2d 248
• Parties: OKONITE CO. v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Third Circuit

155 F.2d 248 (1946)

OKONITE CO. v. COMMISSIONER OF INTERNAL REVENUE.

No. 9030.

Circuit Court of Appeals, Third Circuit.

Argued January 22, 1946.

Decided April 18, 1946.

Edmund S. Kochersperger, of Washington, D. C. (Stephen A. Wilson, of New York City, on the brief), for petitioner.

I. Henry Kutz, of Washington, D. C. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key, Helen R. Carloss, and Hilbert P. Zarky, Sp. Assts. to the Atty. Gen. on the brief), for respondent.

Before BIGGS, MARIS and GOODRICH, Circuit Judges.

GOODRICH, Circuit Judge.

This is a petition for review of a decision by the Tax Court. The Commissioner, respondent here, has determined certain deficiencies in income and excess profits taxes for 1936 and 1937 against Okonite, petitioner here. The Tax Court found in favor of the Commissioner, following full finding of facts and an opinion thereon. 4 T.C. 618. Only such facts will be stated here as are necessary to show the legal points presented by the taxpayer to this Court.

In 1927, Okonite issued and sold $2,000,000 face amount of 15-year 5½ percent debentures and $1,000,000 par value of 7 percent cumulative preferred stock. The terms under which debentures and stock were issued required Okonite to pay into a sinking fund sums sufficient to retire annually at least 3½% ($70,000) of the bonds and at least $40,000 of preferred stock.¹

In 1934, Okonite was, in the words of the Tax Court, "feeling the effects of the depression." It had operated at a loss for three years and was being drained of cash by the sinking fund requirements. It therefore proposed a plan to modify the sinking fund provision for the bonds. Acceptance of the plan was optional with the holders. In that year 77.2% of the debentures were deposited to evidence acceptance, enough to render the plan operative. The new bonds carried a rate of 6%. For those who did not assent, and there were some, the terms of the old 5½% bonds remained in effect. The provisions of the plan are set out by the Tax Court. In essence the 1934 arrangement eased the requirements of the 1927 sinking fund provisions for bonds.

In 1936, the first of the tax years in question, Okonite, seeking to comply with sinking fund requirements, purchased $99,500 face value of the 6% bonds and $5000 face value of the 5½% bonds. The next year, for the same purpose, it bought $93,000 face amount of 6% bonds and $3,500 of 5½% bonds. So far as the 6% bonds of 1934 were concerned there was no deficiency in either 1936 or 1937. With respect to the 5½% bonds of 1927, however, while there was no deficiency at the end of 1937, the Tax Court found, "there remained a deficiency of $14,000 in the sinking fund at the end of 1936."

So much for the relevant history of Okonite bonds. The other set of legally significant facts has to do with its preferred stock.

In the spring of 1936, dividends on the preferred stock were unpaid and in arrears by $31.50 per share. Furthermore, the Tax Court found that "The company was also in arrears on the sinking fund requirements on the preferred stock and was short of cash." It will be recalled that the preferred stock issued in 1927 carried a minimum sinking fund provision of $40,000 annually. This preferred stock had a 7% cumulative dividend rate² and a call provision at $115 per share, "plus all unpaid dividends, whether or not earned or declared, to the date of redemption thereof." On August 17, 1936, a dividend of $1.50 a share was declared on the preferred stock. Within a short time in the same year, Okonite's certificate of incorporation was amended to permit adoption of a plan "whereby the dividends arrears on the preferred stock would be eliminated". The latter fact finding by the Tax Court renders clear the motivation and nature it attributed to the 1936 plan and shows, we think, a statement of corporate purpose. See Bazley v. Commissioner, 3 Cir., 1946, 155 F.2d 237.

Under the 1936 corporate amendment, a new class of 11,000 shares of $100 par value 6% preferred stock, in addition to preferred and common then outstanding, was authorized. Dividends on the new 6% preferred were to be cumulative and prior to common. The new preferred was callable at $105, plus all unpaid dividends. Sinking fund requirements were to be an amount equal to 10% of net income after certain deductions.

Toward the close of 1936 the plan³ became effective since 6,824 shares out of a total of 6,952 outstanding had been turned in to be exchanged, retired and cancelled. The following provision contains the language which is the basis for taxpayer's most heavily pressed argument in this Court: "to each holder of said stock the right to exchange each share of his seven per cent preferred stock of the Company for one share and 15/100ths of a share of the Company's new six per cent preferred stock, plus an extra dividend on each share of his seven per cent stock of one-tenth of a share of the Company's new six per cent preferred stock and in connection with such exchange, to receive in payment of all arrears of dividends up to and including the quarterly dividend period ending September 1, 1936, on each share of the seven per cent preferred stock exchanged as aforesaid, a stock dividend of three-tenths (3/10ths) of a share of new six per cent stock of the Company at par."

The small amount of remaining outstanding 7% stock was retired, part in 1936, the residue in 1937, by payment of the accumulated dividends and calling it at the stipulated price. Dividend and sinking fund requirements for the 6% stock were met by the Company for 1937.

Tax Effect of Preferred Stock Transaction.

The first legal issue with which we are concerned arises from the terms of the 1936 plan. Did that transaction involve a taxable stock dividend which Okonite could take as a dividends paid credit or was it a non-severable recapitalization and therefore included in the type of statutory reorganization for which no credit for dividends paid could be taken by the corporation? Okonite contends for the former view while the Commissioner, with whom the Tax Court agrees, maintains the latter.

Okonite relies upon section 27(e) of the Revenue Act of 1936, 26 U.S.C.A. Int. Rev.Acts, page 837, and maintains that four tenths of each share of new 6% stock was a taxable dividend to the shareholders. The Commissioner relies on section 112(b) (3) and section 27(h), 26 U.S.C.A. Int.Rev. Acts, pages 838, 855, maintaining that 7% stock was exchanged for 6% stock and that the distribution of the new stock was not a taxable transaction to the shareholders. The pertinent portions of the statutes involved are set out in the margin.⁴ There can be no argument that a recapitalization is within the statutory definition of a reorganization.⁵ Nor is there dispute that there was a recapitalization at least to the extent of the exchange of 1.15 shares of the new 6% stock for each share of old 7% stock. May the transaction be cut into two parts or is it entire? If the former, Okonite may no doubt treat four tenths of each 6% share as a dividend taxable to stockholders and upon which the Company is entitled to credit.

The Tax Court decided that "the consideration for the exchange of each share of 7 percent stock was the receipt of 1.55 shares of 6 percent stock and that it cannot be separated into two or more independent steps." This is a factual conclusion made upon examination of the terms of the plan in light of the financial situation of Okonite. There is no statute or regulation directing the conclusion of what is a whole transaction and what is a transaction of several steps. It is a matter of drawing a factual inference from the evidential facts. This is therefore precisely the kind of question that is not determinable as a matter of its own judgment by this Court. The Dobson decision⁶ directly precludes the substitution of our judgment on a matter of this kind for that of the Tax Court. Nor do we think that Dobson, as to this point, has been modified by anything which the Supreme Court has decided since.

Is there that basis for the Tax Court's result whch protects it against successful attack in this Court? Okonite points to the language of the plan which talks in terms of payment of dividends and adds that its journals show entries consistent only with this view. All of that establishes nothing more than the taxpayer's desire to have the transaction regarded in a particular way. It does not characterize the real nature of the transaction, which was the question the Tax Court had to answer.

There is ample evidence to sustain its conclusion. The financial predicament of Okonite in early 1936, it will be recalled, was characterized by large arrears in dividends on the 7% preferred, plus arrears in sinking fund requirements relative thereto, plus a shortage of cash. When such circumstances call forth a plan, it is certainly reasonable to conclude that elimination of the source of difficulty was its essential nature. Furthermore, the plan did not offer to shareholders a choice between retention of old stock plus dividend or acquisition of new stock plus dividend. A stockholder received no dividend by retaining his old 7% stock. It is reasonable enough to infer that no stockholder received a dividend by electing to take new 6% stock. It is true that a cash dividend was paid in full to the 7% holders very shortly after enough stockholders had exchanged their stock so as to make the plan operative. But unless the bulk of shareholders had exchanged their shares as they did, Okonite would have been in no position to give the cash dividend to the surviving 7% shareholders. The cash dividend actually paid only serves to emphasize the weakness of the stock dividend theory.

The Tax Court points to the Skenandoa⁷ case and the Knapp-Monarch case⁸ as presenting similar conclusions in comparable situations. The Commissioner adds the Morainville case⁹ to this group. Okonite seeks to distinguish them on their...