Guinness v. United States 109 Ct. Cl. 84

*102OPINION

Madden, Judge,

delivered the opinion of the court:

The plaintiff was a partner in the investment banking firm of Ladenburg, Thalmann, and Company. In 1930, 165,000 shares of the stock of Standard Power and Light Corporation, which stock was owned, directly or indirectly by the partnership, was sold to the United States Electric Power Corporation at a large profit. The question here is the extent to which the plaintiff became liable for federal income tax upon his share of this profit.

From 1925, and up to the time of the sale which produced the profit in question, the stock sold stood in the name of the Standard Utilities Corporation, which corporation was wholly owned by the partnership. As shown by our finding 7, on December 21,1929, the partnership, purporting to represent the owner of the stock sold, but not naming the owner, made a written agreement with the United States Electric Power Corporation to sell and buy respectively the stock for *103$10,000,000 in cash, and $15,000,000 in notes of the purchaser. According to the agreement, the transfer was to take place on January 2, 1930, if, three business days before that date, the certificate of incorporation of the Standard Power and Light Corporation had been amended in specified respects. If the amendments had not been made by that date, the transfer was to be postponed to await them, but if they had not been made by January 28,1930, the obligations of the agreement were to terminate unless extended as provided in the agreement.

The stock to be sold had been placed in escrow some years before by an agreement described in our finding 6. On December 31,1929, the partnership and the other party to the escrow agreement delivered a letter to the bank which held the stock in escrow. The letter terminated the escrow agreement, provided the sale agreed to on December 21, 1929, was consummated. On January 6, 1930, written instructions were given to the bank by the partnership and the prospective purchaser with respect to the consummation of the sale. On the same day the purchaser deposited with the bank $10,000,000 in cash and four notes for $15,000,000, also payable to the partnership. Arrangements were made with the bank to send a representative to Dover, Delaware, on January 7,1930, with the stock, a check for $10,000,000 payable to the partnership, and the purchasers’ notes for $15,000,000.

On January 7, in Dover, the stockholders of Standard Power and Light met at 12:30 p. m. and amended the certificate of incorporation, as contemplated in the agreement of December 21, 1929. In New York, the Board of Directors of Standard Utilities Corporation, which owned the stock the sale of which is here involved, met at 1:30 p. m. on January 7, 1930, and adopted two resolutions, one authorizing the partnership to sell on behalf of the Corporation to United States Electric Power Corporation, 15,000 shares of stock of the Standard Power and Light Corporation. The other resolution declared a dividend of the remaining 150,000' shares of the Standard Power and Light Corporation, to be paid immediately to the stockholders of record. A ticket evidencing the transfer of the dividend stock was immediately made out and delivered to the partnership, the sole stock*104holder of Standard Utilities. Federal and New York State stock transfer stamps in the amount of $3,300 were affixed to the ticket.

Mr. Rosen, an officer of Standard Utilities and a member of the partnership then telephoned Mr. Rosenthal, likewise an officer and a partner, at Dover and told him what had been done. Then the amendments to the articles of incorporation of Standard Power and Light were filed with the Secretary of State of Delaware at Dover, a certified copy of them was given to the representative of the bank, the certificate for the 165,000 shares was transferred on the books of Standard Power and Light by its transfer agent at Dover, to the purchaser. The certificate for 165,000 shares included the 15,000 and the 150,000 shares covered by the two resolutions described above. Again transfer stamps were attached. Then the representative of the bank delivered the check and notes to Mr. Rosenthal. The check for $10,000,000 was cashed by the partnership and the proceeds were distributed $7,750,000 to the partnership and $2,250,000 to Standard Utilities. The notes for $15,000,000 which had a then present worth of $14,100,000 were held and collected by the partnership. The plaintiff owned a 21.345 percent interest in the partnership.

The question disputed by counsel is whether or not the sale of the 150,000 shares was made by the corporation, Standard Utilities Corporation, or by the partnership of which the plaintiff was a member. If it was made by the corporation, then the corporation realized a profit of $19,-226,753.61 and hence had earnings or profits of that amount to distribute as a dividend to its shareholder, the partnership, hence the partners, receiving this amount as a result of the transaction would be taxable, each in his proper proportion, upon this amount as ordinary income. On the other hand, if the corporation merely distributed the stock as a dividend in kind to its shareholder, the partnership, without itself realizing the profit involved in the sale, then the partners did not, except to the extent to which the corporation had on hand realized earnings or profits, i. e., to the extent of $4,361,964.25, receive from the corporation a dividend paid out of earnings or profits.

*105Section 115 (d) of the Kevenue Act of 1928 says:

Other distributions from capital. — If any distribution (not in partial or complete liquidation) made by a corporation to its shareholders is not out of increase in value of property accrued before March 1, 1913, and is not out of earnings or profits, then the amount of such distribution shall be applied against and reduce the basis of the stock provided in section 113, and if in excess shall be taxable in the same manner as a gain from the sale or exchange of property. * * *

Since all except $4,361,964.25 of the value of the distribution was “not out of earnings or profits” the shareholder could, at his option, return as a capital gain that portion of his proportionate share of the distribution which was in excess of the corporation’s earnings or profits.

The concurring opinion expresses the view that whether the plaintiff received the money, in effect, from the corporation, or received the stock which he immediately sold for the same amount of money, is immaterial since in either case he would be taxable upon the same amount, as ordinary income. We discuss this divergence of views hereinafter.

We think that, in legal effect, the corporation sold the stock and hence, in effect, distributed the dividend to the partnership out of realized earnings. The real owners of Standard Utilities Corporation, and hence of the stock of the Standard Power and Light Corporation, which the Utilities Corporation held, were, of course, the partners, one of whom was the plaintiff. There is something unreal in disputing about whether the partners or the Utilities Corporation sold the stock, when the corporation was a creature of the partners, completely subject to their will, which had to sell when it was told to do so, and could not sell unless it was permitted to do so. But the partners had chosen this kind of a depositary in which to place their property, and if legal consequences, in the form of tax expense, attaches to this choice, they must bear this burden until Congress is persuaded to disregard, for tax purposes, the existence of the helpless juridical person. The stock, then, was admittedly owned by the corporation. The purpose was to get the ownership of the stock into the United States Electric Power Corporation, *106in return for some $25,000,000 which was to be divided among the partners. The simple and direct way to get the stock over to the Electric Power Corporation would have been for the Utilities Corporation, which had it, to transfer it to the Electric Power Corporation which was buying it. But, solely in order to minimize taxes, the formalities of a transfer from the Utilities Corporation to the partnership, which did not want the stock and did not intend to keep it, except momentarily and for the purpose of satisfying the order of procedure decided upon, were gone through. Then the partnership, in turn, made its prearranged move and transferred the stock to the person who was at all times intended to have it, the Electric Power Corporation.

We think that the intermediate move, useless and without any purpose except to reduce taxes, ought to be disregarded. The plaintiff says that this is holding, in effect, that parties must so shape their transactions as to produce the maximum of taxes. We think not. We do think that either of two methods of accomplishing exactly the same result ought to produce the same tax liability as the other; that the tendency in the administration of tax laws should be toward that end and that the amount of tax liability should be that which would arise out of accomplishing the intended result by the simple and direct course that would be followed if the tax liability were not in question. One should not be able to throw the tax gatherer off the scent merely by traveling to the same destination by a roundabout route.

We think we are bound to come to this conclusion by the Supreme Court’s decision in Commissioner v. Court Holding Company, 324 U. S. 331. We recognize that the opinion in that case stressed the finding by the Tax Court that the shareholders acted for the corporation in selling the property which there produced the profit which was taxed to the corporation. As we see it, that “finding” was not so much a finding of fact as the decision of the case after considering the law and the policy applicable to it. There, as here, the corporation was a puppet, and if other laws and policies had been in question, it would have been as easy there as here, and perhaps more realistic, to find that whatever was done, *107whether in the name of the corporation or of the shareholders, was done for the shareholders, the real owners and controllers of the corporation’s acts. In the Court Holding Company case, as in ours, the shareholders caused the corporation to first distribute the property which it owned to the stockholders, which they, in turn, transferred immediately to the intended purchaser, the indirect route being traveled there, as here, for the purpose of escaping the tax on the corporation which was applicable to the corporation’s profit. We think that uniformity of tax administration requires that we reach the same result in what we regard as essentially the same kind of case.

The concurring opinion presents the view that it is immaterial whether or not the corporation made the sale, since, according to Article 627 of Regulations 74 the distribution by the corporation was taxable to the recipients at its market value at the time it was distributed. The Government did not present this view in brief or argument though it would have, if valid, summarily disposed of the case. We do not, therefore, have the assistance of counsel on the point. Our finding number 25 shows that the Commissioner’s administration of the law was not in accordance with this view. Whefi he was of the opinion that Standard Utilities Corporation had first distributed the stock in question as a dividend to the partnership, which had in turn sold it, he taxed the distribution to the plaintiff, not as ordinary income but as a capital gain. Section 115 (d) of the Revenue Act of 1928, quoted supra, seems to us to cover the point, and to make it necessary for us to decide whether the corporation or the partnership made the sale. We have, as appears above, concluded that the corporation made it.

In one item of the plaintiff’s claim he complains that the gains to him from the exercise by the partnership of a certain option were over-assessed. The option was to purchase 266,666 shares of stock of the United States Electric Power Corporation for $75,000, which was much less than their market value. The option was exercised on February 4,1980, at which time the stock was worth $18.72 a share. By December 31,1930, it was down to $5.50 per share, and went still *108lower thereafter. The plaintiff ceased to be a partner on December 31, 1929. He made a settlement with the continuing partners on April 22,1930, which provided, inter alia, the extent and manner in which he was to participate in profits of the firm resulting from the completion of business which had been initiated while he was a partner. Under this agreement he was to receive his share of the option stock in three equal annual installments, the first to be turned over to him on December 31, 1930. We think that, in these circumstances the value of the stock on December 31, 1930, should be taken in computing his profit, and not the value on February 4,1930, or some other earlier time. But we cannot determine from the record whether, or how much, if anything, the plaintiff is entitled to recover. Exhibit D, attached to the plaintiff’s petition, shows a contention by the Bureau of Internal Bevenue, when it passed upon the plaintiff’s claim for refund, that the plaintiff had been under-assessed on his whole income for 1930, that further assessment was barred by the Statute of Limitations, and that for that reason he would not be entitled to recover upon his claim for refund even if it were otherwise meritorius, since he had not overpaid his 1930 taxes. We cannot, from the record, determine whether the position of the Buréau was correct, nor what amount of refund the plaintiff would be entitled to if the Bureau’s position was not correct. We must, therefore, remand this branch of the case to a Commissioner .for an accounting. The accounting and the arguments to us on the return of the case should cover the question of whether the value on December 31, 1930, of the whole of the plaintiff’s share of the option stock, or only the value of the one-third of that share, which third was to be delivered on that date, should be considered in determining the plaintiff’s 1930 income.

The case will be remanded to a Commissioner of this court for further proceedings in accordance with this opinion and report to the court.

It is so ordered.

Jones, Judge, concurs.

*109WhitakeR, Judge,

concurring:

I concur in the result reached, but' I cannot concur in the reason given therefor. I do not agree that a taxpayer may not avail himself of any legal method of handling a transaction that will reduce the amount of taxes to be paid on account of it. The Supreme Court has so held more than once. In Gregory v. Helvering, 293 U. S. 465, 469, the Supreme Court said:

The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted.

The court cites as authority for this statement United States v. Isham, 17 Wall. 496, 506; Superior Oil Co. v. Mississippi, 280 U. S. 390, 395-6; and Jones v. Helvering, 63 App. D. C. 204; 71 F. (2d) 214, 217.

In the Isham case the Supreme Court said:

* * * To this objection there are two answers: 1st. That if the device is carried out by the means of legal forms, it is subject to no legal censure. To illustrate. The Stamp Act of 1862 imposed a duty of two cents upon a bank check, when drawn for an amount not less than twenty dollars. A careful individual, having the amount of twenty dollars to pay, pays the same by handing to his creditor two checks of ten dollars each. He thus draws checks in payment of his debt to the •amount of twenty dollars, and yet pays no stamp duty. This practice and this system he pursues habitually and persistently. While his operations deprive the government of the duties it might reasonably expect to receive, it is not perceived that the practice is open to the charge of fraud. He resorts to devices to avoid the payment of duties, but they are not illegal.' He has the legal right to split up his evidences of payment, and thus to avoid the tax. The device we are considering is of the same nature.

Ladenburg, Thalmann & Company had the legal right to organize the Standard Utilities Corporation for the sole purpose of holding its stock in the Standard Power & Light Corporation, and then, when this partnership wanted to dispose of the stock, it had the legal right to cause this hold*110ing company to transfer the stock to it as a dividend in kind, and then the partnership had the right to sell it.

The partnership was not required to cause the corporation to make the sale because, perchance, this method of handling the transaction might result in more taxes to the Government. See Howell Turpentine Co. v. Commissioner, decided by the Circuit Court of Appeals for the Fifth Circuit, June 4, 1947, reported in C. C. H. 1947-1, U. S. T. C., 12605, par. 9281.

In its negotiations with the United States Electric Power Corporation for a sale to it of the stock of the Standard Light & Power Company, the partnership did not represent that it was acting for the Standard Utilities Corporation, in whose name the Standard Light & Power Corporation stock was held; the partnership was acting for itself, insofar as the United States Electric Power Corporation knew, at least. This was not the case in Commissioner v. Court Holding Co., 324 U. S. 331, upon which the majority rely. There the corporation initiated the negotiations for the sale, and then, realizing that a sale by it would result in more taxes than if it declared a liquidating dividend, and if the stockholders receiving the dividend carried out the sale, it decided that the latter method would be adopted.

In that case the Supreme Court did not hold that this method could not have been adopted in the beginning, and that the tax liability would not have been determined accordingly. It based its decision expressly on the finding of the Tax Court that “despite the declaration of a ‘liquidating dividend’ followed by the transfers of legal title, the corporation had not abandoned the sales negotiations; that these were mere formalities designed Ho make the transaction appear to be other than what it was’ in order to avoid tax liability.” (Italics ours.) It called attention to the fact that the Circuit Court of Appeals had held that “the corporation had ‘called off’ the sale,” but held that “there was evidence to support the findings of the Tax Court, and its findings must therefore be accepted by the courts,” citing cases. It said:

*111On the basis of these findings, the Tax Court was justified in attributing the gain from the sale to respondent corporation.

We have not these facts in the case before us, and I do not think, therefore, the Gowrt Holding case, supra, is controlling. Howell Turpentine Co. v. Commissioner, supra.

However, insofar as the tax payable by the partners is concerned — the sole question presented — I do not think it makes any difference who made the sale, whether the corporation or the partnership.

If the corporation made it, the partners are taxable on the cash they received as if the corporation had declared an ordinary cash dividend out of earnings and profits. The parties agree on this.

On the other hand, if the corporation distributed the stock as a dividend, the partners are taxable on the market value of the stock so received, if the distribution of the stock can be said to have been out of earnings or profits. Article 627 of Regulations 74 says:

Dividends paid in securities or other property (other than its own stock) in which the earnings of a corporation have been invested, are income to the recipients to the amount of the market value of such property when receivable by the shareholders. * * * Where a corporation declares a dividend payable in stock of another corporation, setting aside the stock to be so distributed and notifying the shareholders of its action, the income arising to the recipients of such stock is its market value at the time the dividend becomes payable. * * *

The validity of this regulation has not been questioned. See Commissioner v. Wakefield, 139 F. (2d) 280; Commissioner v. Young, 103 F. (2d) 137.

The market value of the stock is established, prima facie at least, by the price for which it was sold immediately after the dividend was paid. This is the amount the plaintiff included in his return as a dividend.

Whatever is the correct view of the transaction, therefore, the resulting tax liability of the partners is the same, provided the distribution of the stock was out of earnings and profits.

*112That this distribution was out of earnings and profits, I have no doubt. It is stipulated that on January 7,1930, the date of the dividend, the earnings of the Standard Utilities Corporation were $4,361,963.25. The cost to the Standard Utilities Corporation of the 150,000 shares of stock declared as a dividend was not more than $3,010,000. This is so because this stock was acquired through an exchange of the notes of the Universal Utilities Corporation of $4,700,-000, held by the Standard Utilities Corporation, for $1,690,-000, in cash and 150,000 shares of this stock. The stock, therefore, could not have cost the Standard Utilities Corporation more than $3,010,000. It is agreed that it had a fair market value when acquired by the Standard Utilities Corporation of $3,010,000.

If the corporation did not sell this stock, it must be carried on its books at its cost in determining earnings and profits of the Standard Utilities Corporation. Appreciation or depreciation in value is an unrealized gain or loss and, hence, cannot be taken into account. See Article 71 of Regulations 74. Gould, et al. v. Commissioner, 21 B. T. A. 824; United States v. White Dental Co., 274 U. S. 398, 401. In arriving at the earnings of $4,361,963.25 the stock was in fact carried at $3,010,000. When it was distributed as a dividend, this asset was merely stricken from its balance sheet, reducing earnings to $1,351,963.25.

It results that after the distribution of the stock and the reduction of earnings by the cost of it, $3,010,000, there was still left profits of $1,351,963.25. It follows that the distribution could not have been out of capital because there were sufficient earnings out of which it could have been made.

If, on the other hand, we treat the sale as having been made by the corporation, then the corporation realized the appreciation in value of the stock, being the difference in the cost of the stock to it of $3,010,000 and the sale price of $21,850,000, the figure the parties agree on, a gain of $18,-840,000. This would have increased the corporation’s earnings from $4,361,963.25 to $23,201,963.25. Then after the corporation had distributed the amount received of $21,850,-000, it would have left earnings of $1,351,963.25.

*113So it is that in neither case can the distribution be said to have been out of capital, since in both cases the earnings were sufficient to take care of it.

It results that the taxpayer correctly returned the amount received for the stock as a dividend.

We have not before us the tax liability of the corporation and I do not think it is necessary to decide what it was.

Littleton, Judge,

dissenting in part:

I concur in the opinion of Judge Madden, except to the extent that it is held “that the intermediate move, unless and without any purpose except to reduce taxes, ought to be disregarded,” and the conclusion therefrom on authority of the case of Commissioner v. Court Holding Company, 324 U. S. 331, that plaintiff and the other partners of Laden-burg, Thalmann & Company were not entitled in their income tax returns to treat the distribution by the Standard Utilities Corporation of the 150,000 shares of stock of the Standard Power and Light Corporation, as a dividend in kind and compute their tax with respect to such dividend at the capital gain rate of 12y2 percent to the extent that the fair market value of said 150,000 shares at the time of the distribution exceeded the sum of $4,361,964.25 representing the earnings and profits of the corporation available for distribution as a dividend.

I think, as pointed out by Judge Whitaker in his concurring opinion, that the distribution by the corporation of the 150,000 shares of stock as a dividend was in all respects a legal and valid distribution, and that the sale of such stock was made by the partnership for its own account and not for and on behalf of the Standard Utilities Corporation ; and on the facts of this case it is clearly distinguishable from the ultimate finding by the lax Court in the Court Holding Company case, supra, and the decisions of the Tax Court and of the Supreme Court on such finding. In the case of Commissioner v. Court Holding Company, supra, the facts which formed the basis of the decisions therein disclosed that, between October 1, 1937 and February 1940, while the corporation still had legal title to the *114property, which it attempted later to distribute to its stockholders as a liquidating dividend, negotiations for the sale by the corporation of this property took place, and these negotiations were between the corporation and the lessees of the property. As a result of these negotiations an oral agreement was reached as to the terms and conditions of sale by the corporation to said lessees, and on February 22, 1940, the parties met to reduce the agreement to writing. The purchaser was thereupon advised by the corporation’s attorney that, for tax reasons, the sale could not be consummated, and on the next day the corporation declared a liquidating dividend, which passed the property involved to its two stockholders, who then made the sale to the same person or persons who had agreed to purchase the property from the corporation, substantially the same as had been previously agreed upon by the corporation and such person. We do have such facts in this case.

I am, therefore, of the opinion that the first decision of the Commissioner of Internal Kevenue in plaintiff’s case on June 19,1933, was correct. In this decision he treated the value of the 150,000 shares of stock of the Standard Power and Light Company as a dividend taxable to the partners as a net capital gain, to the extent that the fair market value of such stock at the time of distribution exceeded $4,361,962.25, representing the earnings and profits of the corporation available for distribution as a dividend.

The plaintiff argues, and I agree with his argument that the case before this Court does not involve the creation of an artificial or temporary device to escape taxation. In fact, the parties did not even foresee the result for which plaintiff now contends. The corporation declared a valid dividend in kind. Both the corporation and its shareholders continued in business. Not being aware that the dividend was taxable, as such, only to the extent of the earnings and profits available for distribution, the shareholders reported the full value thereof as ordinary income. There is no basis for failing to give full effect to what was done. (Chisholm v. Commissioner, 79 F. (2d) 585 (C. C. A. 2nd).) To the extent that the dividend exceeded the accumulated earnings *115and profits, plus the shareholders’ bases for the stock, the distribution is admittedly taxable as a capital gain.

The sale of the stock involved in this case was negotiated and contracted for by the partnership. The purchaser did not know of the existence of any other owner. Having negotiated the sale, the partnership then, as it had a perfect right to do, had the corporation declare the dividend. The partnership paid a tax for the right of thus taking down the stock. If the sale had been halted, as was threatened by a minority group at the last minute, the choice would have resulted in a substantial detriment to the partnership. Having elected to follow this course, the partnership is entitled to be taxed accordingly.

Whauey, Chief Justice, took no part in the decision of this case.

In the above case, in conformity with the opinion of the court a stipulation was filed in which it was stated, besides other things, that “recomputation of the plaintiff’s Federal income tax liability for the year 1930 on the basis of the decision of the Court of Claims dated July 7, 1947, will show a deficiency in Federal income taxes due from plaintiff in the amount of $6,511.50”.

The report of the commissioner of the court to whom the case was referred recommended that “since the statute of limitation bars the assessment of any deficiency at this time” an order be entered dismissing plaintiff’s petition. Whereupon, on December 1, 1947, the petition was dismissed.