Title Guarantee & Trust Co. v. Comm'r of Internal Revenue (In re Estate of Bedford) , Docket No. 107302.

• Decision Date: 26 January 1943
• Docket Number: Docket No. 107302.
• Parties: ESTATE OF EDWARD T. BEDFORD, TITLE GUARANTEE AND TRUST COMPANY, EXECUTOR, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

1 T.C. 478

ESTATE OF EDWARD T. BEDFORD, TITLE GUARANTEE AND TRUST COMPANY, EXECUTOR, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 107302.

Tax Court of the United States.

Promulgated January 26, 1943.

Cash distributed as part of a tax-free exchange of stock under section 112(b)(3) of the Revenue Act of 1936 pursuant to a plan of recapitalization, held taxable as a dividend under section 112(c)(2) where the corporation, disregarding charges to surplus account upon the issuance of nontaxable stock dividends in prior years (see section 115(h), had sufficient earnings and profits accumulated since February 28, 1913, to cover the cash distribution. H. S. McKinney, Esq., for petitioner.

H. C. Clark, Esq., for the respondent.

OPINION.

ARUNDELL, Judge:

The Commissioner determined an income tax deficiency for the calendar year 1937 in the amount of $13,887.24. The sole issue is whether cash of $45,240 received by petitioner pursuant to a plan of recapitalization is taxable as a dividend, as determined by respondent, or as capital gain to the extent of 40 percent thereof, as reported by petitioner. The material facts are stipulated and may be briefly summarized.

Petitioner is the executor of the estate of Edward T. Bedford, who died May 21, 1931. Its income tax return for 1937 was filed with the collector for the second district of New York.

In 1937 petitioner owned 3,000 shares of 7 percent cumulative preferred stock of the Abercrombie & Fitch Co., having a par value of $100 per share. The stock had been owned by Bedford at the time of his death and at that time it had a fair market value of $210,000. In accordance with a plan of recapitalization duly approved by the directors and stockholders of the Abercrombie & Fitch Co., petitioner in January 1937 exchanged its 3,000 shares of 7 percent cumulative preferred stock for 3,500 shares of $6 cumulative preferred stock with a par value of $75, 1,500 shares of common stock, and cash in the amount of $45,240. The fair market value of the securities and cash received by petitioner under said plan was $349,740. The number of shares of 7 percent cumulative preferred stock outstanding at the time of the recapitalization was 17,973. The cash payable to the holders of such shares upon the exchange was at the rate of $15.08 per share, or a total on the outstanding shares of $271,032.84.

On January 31, 1936, the surplus account on the books of the Abercrombie & Fitch Co., showed a deficit of $399,771.87, after the deduction of three stock dividends. There had been charged to surplus account the following amounts upon the issuance of stock dividends: $161,700 on April 30, 1920, upon the issuance of a common stock dividend paid in common stock; and the amounts of $323,400 and $359,000 upon the issuance on February 20, 1928, and January 21, 1930, respectively, of common stock dividends paid in preferred stock. The company's surplus account on January 1, 1913, had a balance of $8,170.25. For its fiscal year ended January 31, 1937, the company had net earnings of $309,073.70 after taxes.

The parties are agreed that the exchange of stock for stock pursuant to the plan of recapitalization was a nontaxable transaction under section 112(b)(3) of the Revenue Act of 1936. Petitioner concedes that gain in excess of the amount of cash received was realized upon the exchange and that, therefore, the cash is to be ‘recognized‘ as taxable gain under the provisions of section 112(c) as ‘other property or money.‘ It maintains, however, that subdivision (1) of section 112(c) governs: that consequently the recognized gain is taxable as a capital gain, limited by the provisions of section 117(a). Respondent takes the view, and has so determined, that the distribution of the cash had ‘the effect of the distribution of a taxable dividend,‘ and as such is to be taxed as a dividend under the plain language of subdivision (2) of section 112(c). The material provisions of the statute are set forth below. ¹

Petitioner has failed to demonstrate any error in the Commissioner's determination. Its principal position is that the cash distributed did not have the effect of a taxable dividend because the distributing corporation had no earnings or profits accumulated since February 28, 1913, with which to pay dividends. While it is true that the books showed a deficit on January 31, 1936, of nearly $400,000, it is undisputed that the amount of $844,100 had been charged to earnings upon the issuance of stock dividends in prior years. Since these dividends were tax-free, the first one under the rule of Eisner v. Macomber, 252 U.S. 189, and the last two under the revenue act in force when they were made,² they do not serve to reduce earnings and profits available for future distribution. There were thus earnings and profits in January 1937 greatly in excess of the cash payment connected with the recapitalization.

Petitioner argues with respect to two of the stock dividends, which took the form of preferred stock on common stock, that the distributions constituted income under the Sixteenth Amendment, Koshland v. Helvering, 298 U.S. 441, Helvering v. Gowran, 302 U.S. 238, and that, therefore, they were distributions of earnings and profits even though the revenue act then in force saw fit to exempt them from tax. This argument completely overlooks section 115(h) of the Revenue Act of 1936, which provides as follows:

SEC. 115. DISTRIBUTIONS BY CORPORATIONS.

(h) EFFECT ON EARNINGS AND PROFITS OF DISTRIBUTIONS OF STOCK.— The distribution (whether before January 1, 1936, or on or after such date) to a distributee by or on behalf of a corporation of its stock or securities or stock or securities in another corporation shall not be considered a distribution of earnings or profits of any corporation—

(1) if no gain to such distributee from the receipt of such stock or securities was recognized by law, or

(2) if the distribution was not subject to tax in the hands of such distributee because it did not constitute income to him within the meaning of the Sixteenth Amendment to the Constitution or because exempt to him under section 115(f) of the Revenue Act of 1934 or a corresponding provision of a prior Revenue Act.

This section is merely an enactment of what the law had been for many years prior to 1936. Senate Rept. 2156, 74th Cong., 2d sess., p. 19; August Horrmann, 34 B.T.A. 1178, 1184; F. J. Young Corporation, 35 B.T.A. 860; affd., 103 Fed.(2d) 137; Mertens Law of Federal Income Taxation, vol. 1, Sec. 9.47; John K. Bretta, 1 T.C. 86.

Petitioner also appears to argue that there was a mere exchange pursuant to a plan of recapitalization and that cash distributed in an exchange can not be treated as a dividend, citing Humphreys Manufacturing Co., 45 B.T.A. 114. But section 112(c)(2) applies by its terms not to distributions which take the form of a dividend, but to any distribution which has the effect of the distribution of a taxable dividend. It contemplates the very situation under consideration, for it is applicable only if a distribution falls first within section 112(c)(1), and...