RJ Reynolds Tobacco Company v. COMMISSIONER OF INTERNAL REVENUE, Docket No. 71901.
| Decision Date | 27 April 1937 |
| Docket Number | Docket No. 71901. |
| Parties | R. J. REYNOLDS TOBACCO COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Board of Tax Appeals |
J. G. Korner, Jr., Esq., D. H. Blair, Esq., and M. A. Braswell, Esq., for the petitioner.
A. H. Fast, Esq., and E. C. Adams, Esq., for the respondent.
At its inception this proceeding involved a deficiency of $15,990.65, income taxes for 1929. The parties, however, have disposed of this deficiency by stipulation as hereinafter set forth. A new deficiency of $39,036.91 has been asserted by respondent in an amended answer based upon his determination that petitioner realized a taxable profit of $286,581.21 from sales of its own new class B common stock during 1929. Petitioner's reply challenges the correctness of this latest determination of respondent.
The record consists of a written stipulation of facts with attached documents as a part thereof, oral testimony, and exhibits received in evidence at the hearing.
FINDINGS OF FACT.
The petitioner is a corporation organized in 1899 under the laws of the State of New Jersey. Its principal office and place of business is Winston-Salem, North Carolina. It is engaged in the manufacture and sale of tobacco products, including plug, twist, smoking tobacco, and cigarettes.
From time to time since 1901 the capital structure of the corporation has been changed by increases in the common stock, by the issuance of new classes of common stock known as class B common, later eliminated in favor of new class B common, by the issuance and subsequent retirement of preferred stocks, by stock dividends, and by stock split-ups due to reduction in the par value of the common stock, all of which is more particularly set forth in the stipulation submitted by the parties hereto. During the taxable year 1929 the total capitalization of R. J. Reynolds Tobacco Co. was:
1,000,000 shares common stock at $10 par value ___________________ $10,000,000
9,000,000 shares new class B common stock at $10 par value _______ 90,000,000
__________ ____________
10,000,000 shares outstanding capital stock _______________________ $100,000,000
The principal difference between common stock and new class B common is that the latter had no voting power and was not considered under the company's plan providing for participation by officers and employees in certain profits of the company. There was no authorization during the taxable year by charter amendment whereby the authorized number, class, or par value of petitioner's shares of stock was increased or decreased.
In 1912 the petitioner was young in the tobacco industry, being a very small corporation whose stock was owned by one family until other stockholders were brought in from time to time. Its principal stockholder and founder was R. J. Reynolds, whose practice it was to bring as many employees as possible into the company as stockholders. Under the bylaws of the company the holders of the only stock then outstanding were entitled to a special distribution each year based on the profits realized, and as a result the owners of this class of stock retained their holdings in order to participate in the profits.
At 1912 petitioner was in vigorous competition with three other tobacco companies, each having many times the capital of petitioner. After 1912 petitioner's growth was rapid. Its business prospered to such an extent that maintaining the capitalization of the company at a point where it could support the rapid expansion of the business, and meet competitive conditions, presented a serious problem. At the same time the management of the petitioner desired to preserve (1) the reputation of the company, (2) the reputation of the stock, and (3) the behavior of the stock on the market, including its behavior in comparison with other similar stocks.
In 1918 the petitioner created the class B common stock which did not participate in the special distribution based on the company's profits, and which was, therefore, available on the open market. Later this class B stock was eliminated by charter amendment in April 1926.
In July 1918 R. J. Reynolds, petitioner's largest stockholder, died. It became necessary for his estate to sell a substantial portion of the stock in order to pay the inheritance taxes on his estate. The stockholders of the petitioner were not large enough to absorb the stock sold by the founder's estate. This stock was purchased by several individuals, but subsequently, and prior to 1921, it was finally concentrated in the single ownership of United Retail Stores, which controlled United Cigar Stores Co., a large distributor of petitioner's tobacco products. United Retail Stores publicized the fact that it owned a substantial block of petitioner's stock. Rumors developed and the suspicion grew that United Retail Stores was dictating petitioner's business policies and was able to buy petitioner's tobacco products at lower prices and for better discount than other distributors and retailers. Furthermore, the dividends regularly paid by the petitioner made it possible for United Retail Stores to operate its approximately 2,000 retail stores without profit, and yet have a substantial amount with which to pay dividends to its own stockholders.
It was the judgment of petitioner's management that the reputation of the company, and the necessity of protecting its business required the purchase of this United Retail Stores' stock. Petitioner had recognized in 1918 the necessity of broadening its stockholding base, and the acquisition of this block of stock afforded petitioner an opportunity to remove a harmful situation and at the same time permitted petitioner to expand its stockholding list by feeding the stock back onto the market. The law department of the petitioner considered and ruled that petitioner was authorized to make the 1921 purchase, and the other purchases hereinafter related, and reissue the stock, although petitioner had no charter authority to deal in its own stocks.
For the reasons aforementioned the petitioner purchased during 1921 the block of old class B common stock held by United Retail Stores, the number of shares purchased being undisclosed. The purchase was made at a private sale, the stock in question not being listed on any exchange in 1921. The consideration paid was $607,200.96 in cash, which was slightly under the market price by reason of the amount of stock involved. As the result of subsequently effected stock split-ups and stock dividends that portion of this purchase here involved came to represent 75,000 shares of new class B common stock, the certificates therefor being held by petitioner on January 31, 1929.
During all the years 1921 to 1929, inclusive, and thereafter, the petitioner followed the same general policy of availing itself of all opportunities that were presented for extending its stockholding base. The effectiveness of this general policy is revealed by the increase in the number of petitioner's stockholders over a period of years. In March 1922, when petitioner's stock was listed on the New York Stock Exchange, petitioner had less than 2,000 stockholders, counting common stock and class B common stock. At the time of the market crash in 1929 there were 9,136 shareholders of B stock alone. In 1933 there were 41,000 stockholders and in April 1936 there were 52,000 holders of B stock.
In 1924 petitioner sold for cash 21,067 shares of the stock purchased in 1921 from United Retail Stores. The sales were made in the second and third quarters of 1924 on a rising market, following a substantial drop of the market in the first quarter.
In 1925 the petitioner sold for cash 11,000 shares of the stock purchased in 1921 from United Retail Stores. These shares were sold or reissued between February 10 and August 13, 1925. The management took advantage of a rising market to dispose of these shares without hurting its stock or the reputation of the petitioner.
By reason of a charter amendment in 1926, the management of petitioner feared that speculators on the market might start a rumor that petitioner would declare a stock dividend. To protect the reputation of the stock, which included keeping it from jumping and precipitately dropping, the petitioner purchased through a broker for cash, 21,400 shares of its stock. After fear of the rumor had passed the 21,400 shares were gradually fed back into the market.
In 1927 the petitioner's only transaction respecting its own stocks was the disposition of certain fractional shares accumulated in its hands in connection with the issuance of rights to subscribe or receive additional stock. These fractional shares, which had cost petitioner nothing, were disposed of for cash in the amount of $240.83.
During April 1928 petitioner reduced the price of its cigarettes from $6.40 to $6 per thousand. Following this reduction the volume of petitioner's stock offered on the market was greatly multiplied. Petitioner, with a view to protecting the reputation of the stock of the company, its business and its brands, purchased for cash 43,300 shares of its stock, expecting thereby to protect the market against a precipitate fall in prices. After the market steadied the 43,300 shares were fed back into the market, together with 1,240 shares of the stock acquired from United Retail Stores in 1921.
During each of the aforesaid years, 1924 to 1928, inclusive, the petitioner, R. J. Reynolds Tobacco Co., reissued solely for cash, certain shares of its new class B common stock, theretofore acquired solely for cash, in a manner similar to that hereinafter set forth with respect to the taxable year 1929. Such transactions were made under circumstances and for reasons substantially similar to those surrounding the said similar transactions in the year 1929. For the purpose only of showing generally the result of such...
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