Smith v. United States

Decision Date26 June 1941
Docket NumberNo. 7652.,7652.
Citation121 F.2d 692
CourtU.S. Court of Appeals — Third Circuit

William H. Foulk, of Wilmington, Del., for appellant.

James P. Garland, Sp. Asst. to Atty. Gen. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key and J. Louis Monarch, Sp. Assts. to Atty. Gen., and Stewart Lynch, U. S. Atty., of Wilmington, Del., on the brief), for appellee.

Before MARIS, JONES, and GOODRICH, Circuit Judges.

JONES, Circuit Judge.

In 1923 Smith, the appellant, formed a personal holding corporation under the laws of Delaware. He contributed to the company all of its assets and received in return all of its issued and outstanding capital stock, both preferred and common. Since then, he has continuously been the company's sole stockholder, as well as its president and a member of its board of directors, throughout the period covered by the matters in suit. In the years 1934 and 1935, Smith sold to the company a certain number of its preferred shares for which he received in payment both property and cash. The shares so purchased were immediately cancelled by the company.

In his income tax returns for 1934 and 1935, the taxpayer treated his receipts for the stock, which he had sold to the company, as distributions by the corporation in partial liquidation. The Commissioner of Internal Revenue, asserting that the stock transaction was a redemption essentially equivalent to the distribution of taxable dividends within the meaning of Section 115(g) of the Revenue Act of 1934,1 assessed deficiencies against Smith for each of the years in question. The taxpayer paid the assessments, filed claims for refund which were refused, and then instituted suit in the District Court (Delaware) to recover the amount of his payments on account of the deficiency assessments. The court below, to which the case was tried without a jury, made findings of fact wherefrom it concluded that the company's payments for the stock were taxable to Smith as dividends under Section 115(g) of the Act. The court accordingly entered judgment for the defendant, from which the plaintiff took the pending appeal.

In view of the findings of fact made by the trial court, which are supported by substantial evidence, it is unnecessary to recite in detail the company's corporate or financial history. The question of law incidental to the present appeal is as to the applicability of Section 115(g) of the Revenue Act of 1934 to the facts found by the trial court to which we shall now refer in material part.

The company, according to the plaintiff's testimony, was organized to relieve his estate later from having to pay a multiplicity of state inheritance taxes. The company was never engaged in any business except that of holding and selling the real and personal property contributed by its sole stockholder and of investing and reinvesting the proceeds from its sales of property. It was never indebted except for current and incidental office expenses; and, from the time of its incorporation, the company prospered and showed annual earnings (some years in large amounts) from 1924 to 1935, both inclusive. Except for one year (1932) a portion of the earnings was declared in each year as cash dividends; and at various times between January 12, 1927 and January 14, 1931, both inclusive, a portion of the accumulated earnings was capitalized, for which preferred stock was issued and paid to Smith as a stock dividend in the aggregate amount of 1,892 shares. In December 1933 the capital of the corporation was reduced from $765,000 to $640,000, Smith surrendering the certificates for the outstanding 7,650 shares of old preferred stock and receiving certificates for the 6,400 shares of new preferred. By 1934 the company then had on hand accumulated earnings in excess of $240,000.

In May 1934 Smith offered to buy from his company certain stocks in two other companies for a total price of $88,000, for which he was to give his company 880 shares of its preferred stock. The offer was accepted by formal resolution of the board of directors (Smith not voting), the resolution also providing for the immediate cancellation of the 880 shares of preferred stock upon their surrender by Smith. The value of the shares of stock thus acquired by Smith from his company was, at the time of their transfer, $49,500. At trial, Smith gave as a reason for this transaction his desire to protect the interest of minority stockholders (business associates) in the two companies whose stock was the subject matter of the transaction between him and his company. In November 1934 Smith proposed to assign to his company 435 shares of his preferred stock in exchange for certain mortgages owned by the company. The bonds which the mortgages secured aggregated in principal amount $43,500. This proposal was accepted by formal resolution of the company's board of directors. The bonds and mortgages were transferred to Smith, who surrendered to the company 435 shares of its preferred stock, which was immediately cancelled. Smith testified that the purpose of this transaction was to enable him to increase the corpus of a trust which he had created for his wife and daughter. In November 1935 the company, at Smith's instance, purchased from him 425 shares of the company's preferred stock, for which the company paid him $42,500 in cash. This stock was likewise immediately cancelled upon its receipt by the company. Smith testified that the purpose of this transaction was to enable him to invest the proceeds in annuity bonds for the benefit of legatees under his will. All told, the plaintiff surrendered to his company 1,740 shares of its preferred stock and received therefor shares of other companies, mortgages, bonds and cash of a total value of $135,500.

The trial court found that 34 F.Supp. 947, 951: "In the instant case for no apparent business reason, Company issued stock dividends. In 1934 and 1935 for no reason connected with its business, Company redeemed 1,740 shares of its preferred stock which was less than the amount of stock dividends issued to plaintiff. The purpose for the redemption was the desire of plaintiff to withdraw certain funds and property from Company. No one else was interested in the corporation and no creditor would be affected." And further: "* * * There can be no doubt that in the instant case the sole purpose for the redemption or alleged sale was to get into plaintiff's hands a portion of the undistributed profits of the corporation. Plaintiff arranged to relieve company of a portion of its earnings, to cancel a few shares of stock, and continue to hold 100% of the outstanding stock of the corporation."

The evidence in the case fully supports the trial court's findings; and the findings justify the court's conclusion that "the stock was cancelled or redeemed at such a time and in such a manner as to make the distribution and cancellation or redemption equivalent to the distribution of taxable dividends within the meaning of the statute."

The present case cannot be distinguished in its material features from the case of Brown v. Commissioner, 3 Cir., 79 F.2d 73, where this court affirmed a decision of the Board of Tax Appeals, holding that the stock sale in that case...

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