Rheinstrom v. Conner

• Decision Date: 13 February 1942
• Docket Number: 8851.,No. 8850,8850
• Citation: 125 F.2d 790
• Parties: RHEINSTROM v. CONNER, Collector of Internal Revenue. FIRST NAT. BANK, Cincinnati, Ohio v. SAME.
• Court: U.S. Court of Appeals — Sixth Circuit

125 F.2d 790 (1942)

RHEINSTROM v. CONNER, Collector of Internal Revenue. FIRST NAT. BANK, Cincinnati, Ohio v. SAME.

Nos. 8850, 8851.

Circuit Court of Appeals, Sixth Circuit.

February 13, 1942.

Jerome Goldman, of Cincinnati, Ohio (Thomas C. Lavery and A. Julius Freiberg, both of Cincinnati, Ohio, on the brief), for petitioners.

Paul S. McMahon, Sp. Asst. to Atty. Gen. (Samuel O. Clark, Jr., Asst. Atty. Gen., J. Louis Monarch, Sp. Asst. to Atty. Gen., Calvin Crawford, of Dayton, Ohio, and Frederic W. Johnson, of Cincinnati, Ohio, on the brief), for respondent.

Before SIMONS, ALLEN and McALLISTER, Circuit Judges.

McALLISTER, Circuit Judge.

These cases were heard separately before the court, without a jury, but, because they arise out of the same facts, were disposed of in the same findings, and are presented on the same record on review.

On appellants' suits claiming refund of income taxes claimed to have been erroneously assessed, the District Court entered judgments in favor of the Collector of Internal Revenue.

In 1908, the Karl Kiefer Machine Company was organized as an Ohio corporation, with authorized capital of $500,000.00, consisting of 3,000 shares of common stock, with a par value of $100.00 per share, and 2,000 shares of preferred stock, with a similar par value. 1,500 shares of common stock and 420 shares of preferred stock were fully paid for, the total paid in capital, amounting to $192,000.00. Karl Kiefer owned all of the outstanding preferred stock and 748 shares of the common stock. Minna W. Rheinstrom owned 748 shares of common stock. The remaining 4 shares of common stock were held in the names of other individuals in order to qualify them as directors. With this variously divided ownership of stock, on November 30, 1914, a reduction of capital stock from $500,000.00 to $70,000.00, was properly authorized. The preferred stock was reduced to 420 shares, which was the amount previously issued; and the common stock was reduced to 280 shares. Kiefer continued as the owner of all the preferred stock, and ownership of the common stock was equally divided between Kiefer and Minna Rheinstrom. On the books of the company, the reduction of $122,000.00, representing the reduction of 1,220 shares of common stock, was taken from the common stock account and placed in the "earned surplus" account, increasing the latter from $31,006.80 to $153,006.80. In 1921, this amount of $122,000.00 was transferred to a new account, designated as "paid in surplus"; but no actual distribution of any kind was made, and there was no physical segregation of assets, nor any other action taken in regard to the capital stock reduction until 1934. In that year, the company, in addition to the payment of a dividend of $90,000.00, distributed the $122,000.00 to the stockholders and canceled the "paid in surplus" account, designating this payment as having arisen by reduction of the common stock in 1914. Half of this sum, amounting to $61,000.00, was distributed to Minna Rheinstrom; and the other half, to the beneficiaries under the will of Karl Kiefer. It appears that the earnings for the year 1934 were more than sufficient to pay the $90,000.00 dividend and the above mentioned sum of $122,000.00.

On October 1, 1937, Minna Rheinstrom died and the Collector of Internal Revenue assessed her estate on the amount of $61,000.00 on the ground that it was subject to income tax as a dividend. A similar tax was assessed against the estate of Karl Kiefer. The executor under the will of Minna Rheinstrom, and the trustee under the will of Karl Kiefer, sued for a refund of the tax so assessed and collected, claiming that the distribution of the sum of $122,000.00 was not a dividend, but a return of capital on partial liquidation, or the payment of a debt owed by the corporation to its shareholders. The first question to be determined is whether the distribution of the amount of $122,000.00, to Minna Rheinstrom and the beneficiaries under the will of Karl Kiefer, was actually a dividend or a return of capital on partial liquidation. If it was a dividend, it is taxable.

The term "dividend," as used in the 1934 Revenue Act, in so far as here applicable, means any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits, accumulated after February 28, 1913 (§ 115(a), 26 U.S.C.A. Int.Rev. Acts, page 703); and every distribution is presumed made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits (§ 115(b).

The Act further provides, however, in § 115(c), that where amounts are distributed in complete liquidation of a corporation, they shall be treated as in full payment in exchange of stock; and where amounts are distributed in partial liquidation of a corporation, they shall be treated as in part or in full payment in exchange for stock. In so far as this controversy is concerned, it is provided that in the case of amounts distributed in partial liquidation, the part of such distribution which is properly chargeable to capital stock, is not considered a distribution of earnings or profits within the meaning of § 115(b). In other words, that part of an amount distributed in partial liquidation of a corporation, which is properly chargeable to capital stock, is not considered a distribution of earnings or profits to the extent thereof, and from the most recently accumulated profits (§ 115(c); and it is provided that the general definition of a dividend in § 115(a) is not intended to apply to distributions made to stockholders in the liquidation of a corporation, but that it was intended that such distributions should be governed by § 115(c). But if a corporation cancels or redeems its stock at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings accumulated after February 28, 1913, shall be treated as a taxable dividend (§ 115(g).

As used in the statute, the term "amounts distributed in partial liquidation" means a distribution by the corporation in complete cancellation or redemption of a part of its stock or one of a series of distributions in complete cancellation or redemption of all, or a portion of its stock. See § 115(i).

We come, therefore, to the consideration of that part of a distribution in partial liquidation, which is properly chargeable to capital stock; and whether the distribution, in this case, was a redemption of stock at such a time and in such a manner as to be essentially equivalent to the distribution of a taxable dividend. With regard to whether a redemption of stock is essentially equivalent to the distribution of a taxable dividend, this depends upon the circumstances of each case, and under the statute, consideration must be given to the time at which and the manner in which the redemption is made. Commissioner v. Champion, 6 Cir., 78 F.2d 513.

On these questions it is held that the Commissioner's determination is prima facie correct and the burden is on the taxpayer to prove that it was wrong. Helvering v. Taylor, 293 U.S. 507, 55 S.Ct. 287, 79 L.Ed. 623; Wiese v. Commissioner, 8 Cir., 93 F.2d 921; Whitlow v. Commissioner, 8 Cir., 82 F.2d 569; Tate v. Commissioner, 8 Cir., 97 F.2d 658.

With regard to the proposition before us, the many adjudications have resulted in some difficulty in distinguishing the various statements therein found. See Patty v. Helvering, 2 Cir., 98 F.2d 717; Hyman v. Helvering, 63 App.D.C. 221, 71 F.2d 342; certiorari denied 293 U.S. 570, 55 S.Ct. 100, 79 L.Ed. 669. Aside from certain conflict, however, it can be said that a degree of apparent contradiction has resulted from the language of the statute, respecting a somewhat abstract area of corporate finance, as well as because of the great diversity of factual situations presented in the cases.

Whether a dividend is a distribution in liquidation, is held to be a question of fact; and one of the factors to be considered, is the intent of the directors of the corporation. Tate v. Commissioner, supra; Tootle v. Commissioner, 8 Cir., 58 F.2d 576. It is also said that it is the effect of the distribution which classifies it, and not the motives of the taxpayer or corporation. Flanagan v. Helvering, 73 App.D.C. 46, 116 F.2d 937; Smith v. United States, 3 Cir., 121 F.2d 692.

In Commissioner v. Champion, 6 Cir., 78 F.2d 513, a decision of the Board of Tax Appeals, holding that a distribution in redemption of stock was not essentially equivalent to the distribution of a taxable dividend, was affirmed. It appeared that an increase in capital stock anticipated improvements in business, which failed to materialize, and, instead, the corporation business declined. The court held that there was a reasonable inference that the shrinkage in the business brought the corporation to the realization that the capital was in excess of its needs, and to that extent, unprofitable, and that good business judgment might naturally suggest a redemption of stock proportionate to the decline in business.

In Flanagan v. Helvering, supra, it was said that neither the courts nor the Board of Tax Appeals have laid down a sole decisive test to determine whether a transaction is equivalent to a taxable dividend or a partial liquidation, under the statutory provisions here under consideration. In that case the factors considered by the court in arriving at its determination that a distribution was taxable as a dividend, were that the major part of the capitalization of the corporation represented former earnings; only two relatively small dividends were ever paid; the proportional ownership of the shareholders was not changed; the corporation did not manifest any policy of contraction; the...