Sammons v. C.I.R., 061771 FEDTAX, 3964-67

Docket Nº:3964-67.
Opinion Judge:IRWIN, Judge:
Party Name:CHARLES A. SAMMONS, Individually and ESTATE OF ROSINE S. SAMMONS, Deceased, CHARLES A. SAMMONS, Independent Executor, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Attorney:B. Thomas McElroy and David P. Smith, for the petitioners. Roy E. Graham, for the respondent.
Case Date:June 17, 1971
Court:United States Tax Court

30 T.C.M. (CCH) 626

CHARLES A. SAMMONS, Individually and ESTATE OF ROSINE S. SAMMONS, Deceased, CHARLES A. SAMMONS, Independent Executor, Petitioners

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 3964-67.

United States Tax Court

June 17, 1971

Held, the purchase of Aero preferred stock (80 percent of whose common stock was indirectly held by petitioner) by four insurance corporations, all of whom were controlled by petitioner, was part of an integrated plan designed to fund Aero with cash so that it could repay petitioner for amounts spent and borrowed by him on Aero's behalf. Accordingly, when paid to petitioner, such amounts constituted constructive dividends to petitioner from his four insurance companies.

B. Thomas McElroy and David P. Smith, for the petitioners.

Roy E. Graham, for the respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

IRWIN, Judge:

Respondent determined a deficiency of $965,258.96 in petitioners' income tax for the calendar year 1961. The only issue presented is whether petitioner Charles A. Sammons and his now deceased wife, Rosine Sammons, received dividend income during 1961 in the amount of $1,108,121.20.

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference.

Petitioner Charles A. Sammons (C. A. Sammons) and Rosine S. Sammons (Rosine) were husband and wife during the year in issue. They filed a joint income tax return for the calendar year 1961 with the district director of internal revenue, Dallas, Tex. Rosine died on August 26, 1962. Accordingly, her estate is a party to the within proceeding and is represented by Charles A. Sammons as independent executor. Petitioner Charles A. Sammons was a resident of Dallas, Tex., at the time the petition herein was filed.

In the interest of expediency, the term ‘ petitioner’ will hereinafter refer to petitioner Charles A. Sammons, in his individual capacity. Also wherever the term ‘ petitioners' is used, such reference will denote petitioner and his wife, Rosine. Finally wherever petitioner is treated as being the owner of stock, it is to be assumed that such stock was held jointly with either his wife or her estate.

The Aero-Test Equipment Company (Aero) was, during the years pertinent to the discussion herein, a corporation organized under the laws of the State of Texas. During the late 1950's and early 1960's, Aero was primarily involved in the development and construction of test facilities for both the armed forces and various commercial airlines. Most of its work was obtained by way of competitive bids.

Sometime prior to 1959, Aero began to encounter financial difficulties. Ultimately, its financial problems necessitated that it file a plan of arrangement under chapter XI of the Bankruptcy Act. Accordingly, in April 1958, the bankruptcy court took jurisdiction and appointed a receiver to manage the affairs of the company. During this time all of Aero's 500 shares of common stock were owned by certain individuals who will be referred to as the Shine Group.

Around the fall of 1958, one of petitioner's financial advisors, Thomas A. Rose, Jr. (Rose), was alerted to the existence of the Aero company and the circumstances in which it found itself. Believing that the large backlog of orders held by Aero could, with proper management and capital, be parlayed into substantial profits, Rose recommended that petitioner, either directly or indirectly, invest in the Aero company. Accordingly, on December 31, 1958, The Jack Tar Company (hereinafter Jack Tar), a Texas corporation indirectly controlled by petitioner,[1] acquired 400 shares of Aero common stock from the Shine Group under the following terms:

(1) Jack Tar agreed to a deferred purchase price of $160,000 which was to be contingent upon Aero's later productivity;

TABLE A

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(2) Jack Tar received an option to purchase the remaining 100 shares of common stock under terms not relevant herein;

(3) Jack Tar agreed to make available to Aero a line of credit of up to $1,000.000 in such a manner as to release the Shine Group from their contingent liability on certain notes which had been issued by Aero in the aggregate of $300,000; and

(4) the Shine Group warranted that Aero had a backlog of orders approximating $2,500,000.

On January 1, 1959, Jack Tar assigned its ownership in Aero to a corporation called the Standard Steel Works, Inc. (Standard). Like Jack Tar, Standard was indirectly controlled[2] by petitioner. As a term of the assignment Standard agreed to assume all of Jack Tar's obligations under the Jack Tar-Shine contract, including the obligation to make available to Aero the million dollar line of credit. However, for reasons not disclosed, the First National Bank of Dallas (the ‘ bank’ )-the bank involved in the transaction, refused to advance such sums to Aero-unless the underlying loans were personally guaranteed by petitioner. On January FN2, 1959, petitioner gave the bank a letter of guarantee in which he guaranteed all loans made to Aero up to $1,000,000.[3] On that same day. Standard agreed to indemnify petitioner against any payments which he might be called upon to make pursuant to the guarantee agreement described above.

As of June 1959, there was outstanding against Aero approximately $405,000 in unsecured claims which were held by approximately 230 of Aero's creditors. To facilitate Aero's removal from the bankruptcy court's jurisdiction, a plan was designed whereby the claims held by these people would be converted, at face value, into five-year deferred notes. Accordingly, sometime during July 1959, the original plan of arrangement which had been filed with the bankruptcy court was amended to provide for the discharge of the $405,000 in unsecured claims held against Aero. Pursuant to this amended plan, all holders of unsecured claims would be entitled to exchange such obligations, at face value, for five-year noninterest-bearing promissory notes. This plan was determined to be in the best interests of Aero's creditors, and was approved by the bankruptcy court in August 1959. In the days that followed, almost all of Aero's unsecured creditors redeemed their claims for the five-year promissory notes. Of the obligations redeemed, $354,529.06 worth were received from petitioner who had, during the previous month, purchased them from their original holders at a total cost of $142,121.20. The face value of the notes received from Aero by petitioner in exchange for these unsecured claims totaled $354,529.06.

Finally, when almost all of the deferred notes were issued, the receiver in bankruptcy was discharged, the property of Aero was returned to it, management was once again vested in its board of directors and all proceedings under chapter XI of the Bankruptcy Act were terminated.

By October 7, 1960, Aero's indebtedness to the bank had reached the sum of $966,000. This amount was evidenced by 13 bank notes, all of which were guaranteed by petitioner pursuant to the guarantee agreement of January 2, 1959. At about this time, the bank notified petitioner that the bank's examiners would be more favorably disposed toward Aero's indebtedness to it if petitioner would substitute his personal note for the notes which had been executed to the bank by Aero. Accordingly, on October 7, 1960, petitioner issued to the bank his personal note in the face amount of $966,000 and received, in exchange, the $966,000 in notes which had been issued to the bank by Aero, and which were now endorsed in favor of petitioner. The note given to the bank by petitioner bore a due date of December 6, 1960; however, it was later renewed with the due date being extended to March 6, 1961.

Contemporaneous with the above transaction, Aero issued to petitioner a new note, payable on April 5, 1961, in the face amount of $966,000. The new note served as both a consolidation and renewal of the 13 notes which had been endorsed over to petitioner by the bank.

As a backdrop to several events which occurred during the first week of March 1961, and which will be described shortly, reference will now be made to certain aspects of Aero's early financial history while under petitioner's control.

From the start Aero's experience under petitioner was at best uphill. For the fiscal year ending September 30, 1960, Aero showed a deficit of $677,021-a $394,613 increase over what its deficit had been one year prior to that date. In addition to its contract operations (which were discontinued in December 1961) Aero's major manufacturing activities during the fiscal year beginning October 1, 1960, consisted of three product lines. The profit and loss experience for each of these product lines for the month of March 1961, and for the period October 1, 1960, through March 31, 1961, is depicted in the following table:

TABLE I
____
ATECO PERFECTO-PEEN[2]
10-1-60 10-1-60 10-1-60
thru Mar. thru March thru
Mar. 1961 3-31-61 1961 3-31-61 1961 3-31-61
Net sales $361,381 $572,269 -0- -0- $4,570 $19,561
Less, Cost of
Sales 281,386 491,366 -0- -0- 3,274 15,455
Gross Profit [3] $ 79,995 $ 80,903 $1,296 $ 4,106
Current Expenses
G & A $ 14,643 $ 91,255 $695 $695 $2,062 $12,282
Mfg. Expense 9,195 68,429 282 282 78 1,207
Mfg. Expense 3,014 21,108 347 347 -0- 1,596
Operating
Profit $ 53,143 ($99,889) ($1,324) ($1,324) ($ 844) ($10,979)
1The ‘ Gascool‘ line was acquired in March 1961, and consisted of gas engine-driven air conditioning equipment. On February 28, 1961, Standard...

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