Redding v. Comm'r of Internal Revenue , Docket Nos. 5174-75
| Decision Date | 22 January 1979 |
| Docket Number | Docket Nos. 5174-75,5176-75. |
| Citation | 71 T.C. 597 |
| Parties | GERALD R. REDDING and DOROTHY M. REDDING, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENTTHOMAS W. MOSES and ANNE M. MOSES, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioners were stockholders in Water Co. On Jan. 7, 1971, they received from Water Co. stock subscription rights, evidenced by transferable warrants, entitling them to purchase stock in Shorewood, a wholly owned subsidiary of Water Co., for less than its fair market value. The subscription period expired on Jan. 22, 1971, after which time the rights and warrants were totally worthless. Petitioners exercised their rights during the subscription period, and after tendering their rights and the requisite cash consideration, on Feb. 2, 1971, the date of the stock distribution, received shares of Shorewood stock. Held: Viewing the transaction as a whole, Water Co. distributed “solely stock or securities” of a controlled corporation to petitioners-shareholders “with respect to its stock” as part of a transaction in which it “distributed” over 80-percent control of Shorewood within the meaning of subparas. (A) and (D) of sec. 355(a)(1), I.R.C. 1954. The other requirements of sec. 355 having been satisfied, no amount is includable in the income of petitioners as a result of either their receipt or exercise of their stock subscription rights. Robert N. Davies, for the petitioners.
Thomas L. Kummer, for the respondent.
Respondent determined deficiencies in the Federal income taxes of petitioners for the calendar year 1971 as follows:
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¦Docket No. ¦Petitioners ¦Deficiency ¦
+------------+----------------------------------------+------------¦
¦ ¦ ¦ ¦
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¦5174-75 ¦Gerald R. Redding and Dorothy M. Redding¦1 $3,397.91¦
+------------+----------------------------------------+------------¦
¦5176-75 ¦Thomas W. Moses and Anne M. Moses ¦10,665.39 ¦
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These consolidated cases raise two significant and complex issues concerning the taxability of corporate distributions. The threshold question is whether petitioners received taxable dividend income as a result of either their receipt or exercise of rights issued to them by the Indianapolis Water Co. (Water Co.) to acquire stock in its wholly owned subsidiary, the Shorewood Corp. (Shorewood), for less than its fair market value. Resolution of this question depends upon (1) whether, if the rights distribution and stock distribution to petitioners are viewed as an integrated whole for tax purposes, the overall transaction satisfies the requirements of section 355,2 and if so, (2) whether the rights distribution to petitioners is to be accorded independent tax significance or is but a step in an integrated transaction, which step is to be ignored for tax purposes. In the event the transaction is not governed by section 355, we must determine the proper measure of the tax, i. e., whether it is the rights distribution or the exercise of the rights which triggers the dividend provisions of the 1954 Code. The amount of gain realized by petitioner Thomas W. Moses upon his sale of 8,000 shares of Shorewood stock is also at issue herein, but resolution of that dispute has been treated by the parties as entirely dependent upon our determination of the principal questions.
The facts have been fully stipulated by the parties, and, with one exception (see n. 3 infra ), we adopt them as our findings.
Petitioners Gerald W. and Dorothy M. Redding and petitioners Thomas W. and Anne M. Moses are respectively husbands and wives with their legal residences in Indianapolis, Ind. Each timely filed joint Federal income tax returns for the calendar year 1971 with the Office of the Internal Revenue Service at Memphis, Tenn. Water Co., an Indiana corporation organized in 1881, is a public utility engaged in the distribution and sale of water throughout Indianapolis, Ind. Shorewood is an Indiana corporation organized on November 7, 1960, primarily for the purposes of acquiring, operating, developing, and selling certain real estate, initially, at least, certain property originally acquired by Water Co. incident to its acquisition of land for water supply reservoirs. Since 1964 and through the present time, each corporation has engaged in the active conduct of its own trade or business.
From the date of its incorporation until December 24, 1970, Shorewood had 1,000 shares of common stock outstanding, all of which were owned by Water Co. On December 24, 1970, Shorewood's authorized common stock was increased from 1,000 shares with a par value of $100 per share to 2,500,000 shares with a par value of $1 per share. The same day, Shorewood issued 481,291 shares of the $1 par value common stock to Water Co. in exchange for the 1,000 shares of $100 par value common stock then outstanding. On January 6, 1971, Shorewood and Water Co. entered into a stock purchase agreement for the acquisition by Water Co. of 855,630 additional shares of Shorewood common stock. At no time prior to or during 1971 did Shorewood have shares of stock outstanding other than shares of its common stock.
On January 7, 1971, Water Co. distributed, with respect to its stock, to its shareholders of record at the close of business on January 6, 1971, rights, evidenced by transferable warrants, to acquire an aggregate of 1,069,537 shares of Shorewood common stock. The aggregate shares offered were comprised of the 855,630 shares to be acquired by Water Co. pursuant to the January 6 agreement with Shorewood and 213,907 shares of the 481,291 Shorewood shares already held by Water Co. Each Water Co. shareholder received one right for each share of common stock held by him.
Each right distributed by Water Co. consisted of (1) a primary subscription right to subscribe for 1 share of Shorewood common stock upon the surrender to two rights plus the subscription price of $5, and (2) an additional subscription privilege to subscribe at the same subscription price of $5 per share to all shares not subscribed for pursuant to exercise of the primary subscription rights, subject to allotment and to the right of the *.600 underwriters, under certain conditions, to purchase up to 50,000 shares (at the subscription price less minimum commissions). The subscription offer expired at 3:30 p. m. on January 22, 1971, and thereafter the rights and warrants were totally worthless.
During the subscription period, Water Co. shareholders or their transferees or assignees subscribed to all 1,069,537 Shorewood shares offered, except for 50,000 shares acquired by the underwriters. The 1,069,537 Shorewood shares distributed by Water Co . on February 2, 1971, constituted more than 80 percent of the total number of shares of the only class of Shorewood stock outstanding and represented control of Shorewood as defined in section 368(c). Immediately after the distribution, Water Co. continued to own 267,384 Shorewood shares, and Water Co. shareholders held substantially more than 50 percent of the Shorewood stock outstanding. Water Co. shareholders have continued to maintain continuity of interest in Shorewood, and Water Co.‘s retention of Shorewood shares was not pursuant to a plan having as one of its purposes the avoidance of Federal income tax.
The reason for Water Co.‘s distribution of Shorewood stock was adverse criticism from the Indiana Public Service Commission. Water Co.‘s retained control of Shorewood's real estate business was thought to be incompatible with Water Co.‘s public utility business. The use of the rights that required payment of a subscription price as the method of distributing Shorewood stock was dictated by Shorewood's need for capital to develop its assets and business. The distribution was not used as a device for distributing Water Co.’ s earnings and profits, of which it had accumulated as of January 7, 1971, in excess of $8 million.
The distribution by Water Co. to its shareholders or their assignees consisted exclusively of the rights to acquire Shorewood stock and the 1,069,537 shares which were subsequently distributed upon the exercise of those rights.
The rights were traded over the counter during the subscription period, and the following are representative transactions:
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¦ ¦Number ¦Selling price ¦ ¦
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¦Date ¦rights sold ¦per right ¦Total ¦
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¦ ¦ ¦ ¦ ¦
+-------+-------------+---------------+---------¦
¦1/11/71¦2,960 ¦$0.625 ¦$1,850.00¦
+-------+-------------+---------------+---------¦
¦ ¦900 ¦0.6306 ¦567.50 ¦
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¦1/12/71¦1,290 ¦0.44 ¦567.60 ¦
+-------+-------------+---------------+---------¦
¦ ¦2,926 ¦0.4928 ¦1,441.93 ¦
+-------+-------------+---------------+---------¦
¦1/13/71¦15,180 ¦0.45 ¦6,831.00 ¦
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¦1/14/71¦1,200 ¦0.5253 ¦630.36 ¦
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¦1/15/71¦13,924 ¦0.4815 ¦6,704.42 ¦
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¦1/18/71¦15,268 ¦0.44 ¦6,717.92 ¦
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¦1/19/71¦10,988 ¦0.3903 ¦4,288.61 ¦
+-------+-------------+---------------+---------¦
¦1/20/71¦4,766 ¦0.5271 ¦2,512.16 ¦
+-------+-------------+---------------+---------¦
¦1/21/71¦4,682 ¦0.955...To continue reading
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