Sale v. COMMISSIONER OF INTERNAL REVENUE, Docket No. 53133.

• Decision Date: 23 April 1937
• Docket Number: Docket No. 53133.
• Citation: 35 BTA 938
• Parties: LOREN D. SALE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Board of Tax Appeals

35 B.T.A. 938 (1937)

LOREN D. SALE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 53133.

Board of Tax Appeals.

Promulgated April 23, 1937.

Claude I. Parker, Esq., for the petitioner.

Thomas F. Callahan, Esq., for the respondent.

OPINION.

MURDOCK:

The Commissioner determined a deficiency of $3,187.80 in the petitioner's income tax for the year 1925. The sole issue is whether or not the Commissioner erred in including in the petitioner's income $19,670.13 as taxable dividends from the Cudahy Walnut Land Co. The facts have been stipulated and may be summarized for present purposes.

The petitioner throughout the year 1925 owned common stock of the Cudahy Walnut Land Co. He received in 1925, as a stockholder of the company, distributions totaling $46,545.50. He did not report any part of this amount as income. The Commissioner held, in determining the deficiency, that 42.26 percent, or $19,670.13, of the total amount received by the petitioner was a taxable dividend representing earnings of the corporation during the period November 15, 1924, to August 5, 1925.

The company at the time of its organization in 1912 acquired real estate in exchange for its stock of the par value of $250,000, and notes of the face value of $875,000. This land was its principal asset and it still owned the land on March 1, 1913, at which time the land had a fair market value of $2,050,000. The company had no accumulated earnings or profits on March 1, 1913. Thereafter and prior to January 31, 1919, the company acquired a paid-in surplus of $321,235.65 by way of stock assessments. The company paid no dividends prior to June 1, 1923, but during the calendar years 1923 and 1924 it made certain distributions to its stockholders. The last distribution for 1924 was made on November 15. It distributed $278,550 to its stockholders during 1925, the last distribution for that year having been made on August 5.

The parties have stipulated that the expenses of the company for the period from March 1, 1913, to July 31, 1922, exceeded by $798,053.08 its profits from the sale of real estate during that period, using as a basis for the computation of the profits the fair market value of the real estate on March 1, 1913. They have also stipulated that the company had earnings as follows:

                Period Amount
                       8/1/22 to 11/28/23 _______________________   $180,414.17
                       11/28/23 to 11/15/24 _____________________    197,783.65
                       11/15/24 to 8/6/25 _______________________    117,725.99
                

The petitioner contends that no part of the distributions of 1925 represented taxable dividends. He argues that the paid-in surplus of $321,235.65 was impaired by the operating losses and had to be restored before there could be any earnings or profits accumulated after February 28, 1913, within the meaning of section 201 (a) of the Revenue Act of 1924; although the fair market value of the property on March 1, 1913, represented an appreciation over the cost of the property of $925,000, that appreciation was unrealized, had not been recognized even on the books of account, and did not represent a true surplus by which losses could be absorbed; and if the unrealized appreciation on March 1, 1913, must be considered, it was at most an enhancement of capital which, if impaired by losses, must be restored before there can be any earnings and profits accumulated after February 28, 1913, within the meaning of section 201 (a) of the Revenue Act of 1924.

There is a rule of law that every impairment of capital or paid-in surplus resulting from operating losses must be restored before any earnings can be available for the distribution of a taxable dividend within the meaning of section 201 (a) of the Revenue Act of 1924. Crystal Ice Co., 14 B. T. A. 682; J. L. Washburn, 16 B. T. A. 1091; Arthur C. Stifel, 29 B. T. A. 1145; Willcuts v. Milton Dairy Co., 275 U. S. 215. But the facts in this case fail to show that either the capital or the paid-in surplus of the Cudahy Walnut Land Co. was ever impaired by operating losses.

The stipulation is clear that, in the computation of the operating loss of $798,053.08, the gain or loss from the sale of real estate was computed by using the fair market value of the real estate on March 1, 1913, as a basis. The use of that basis was, of course, entirely proper for the purpose of computing the income tax liability of the corporation. However, the tax liability of the corporation is not involved in the present case. The taxpayer here is an individual, and the question is whether or not he received a dividend taxable to him. Dividend is defined as "any distribution made by a corporation to its shareholders * * * out of its earnings or profits accumulated after February 28, 1913." Sec. 201 (a). The statute is not specific as to how "earnings or profits accumulated after February 28, 1913" shall be computed. The question might arise as to whether cost or March 1, 1913, value should be used in the computation of those earnings or profits.¹ However, the solution of that question is not important in the decision of this case, for the parties have stipulated what the earnings of the corporation were for the period beginning immediately after the last distribution of 1924 and ending with the last distribution of 1925, the Commissioner has taxed only that portion of the total distributions of 1925, and he does not claim an increased deficiency.

The value of the property of the Cudahy Walnut Land Co. had increased, before March 1, 1913, $925,000 over and above its cost to the corporation. Although this increase had not been realized by the corporation, and although the corporation had no earned surplus on that date, nevertheless the increase in value had accrued within the meaning of section 201 (b). The stipulation shows the subsequent distributions and earnings of the corporation. The real question in the case is to determine the effect, if any, upon the 1924 distributions of that part of the stipulation which shows that the expenses of the company for the period from March 1, 1913, through July 31, 1922, exceeded by $798,053.08 its income, consisting entirely of profits from the sale of real estate during that period computed on the basis of the fair market value of the real estate on March 1, 1913. The petitioner contends that the operating loss of $798,053.08, thus computed, was an operating loss in every sense and impaired the paid-in surplus and capital of the corporation, therefore, the capital and paid-in surplus must be fully restored from earnings before there are any "earnings or profits accumulated after February 28, 1913" from which a taxable dividend could be distributed.

The statute does not provide that impaired capital or paid-in surplus must be restored before earnings are available for the distribution of a taxable dividend. That rule of law was laid down by the Board and the courts, which had in mind the fundamental principle that a corporation, the capital of which had been impaired by...