Bradley v. Commissioner

1 B.T.A. 111, 1924 BTA LEXIS 242

• Court: United States Board of Tax Appeals
• Decided: November 29, 1924
• Docket: Docket No. 47.
• Status: Published

Opinion

OPINION.

James:

The taxpayer in this case contends that, stripped of all but the essential elements, the series of transactions whereby he acquired 50 shares of the stock of the Delaware Co. represented a mere purchase by him of such shares from the Trust Co. for $250. The Commissioner contends that the taxpayer acquired such stock by virtue of participation in the Bankers’ Syndicate, and since the stock was worth $40 per share he thereby realized a gain of the difference between the value of the stock so acquired and the cost of such stock to him.

In our view of the case neither position as actually presented to the Board is sound.

The chronological analysis of the steps taken in the flotation of the stock of the Delaware Co. as set forth in the foregoing findings of fact, discloses the following situation at the time Bradley received his letter from the Trust Co. on August 22d and sent his remittance on the 23d:

1. The Bankers’ Syndicate had been formed and the sale of stock by the Delaware Co. in two lots, one of 83,000 shares at $5 and one of 417,000 shares at $35, had already been determined upon.

2. The option to complete the purchase of the stock of the Georgia Co. did not expire until September 20 and no present obligation to pay therefor existed either on the part of the Bankers’ Syndicate or the Trust Co.

3. The purchase of 417,000 shares at $35 by the Common Stock Syndicate was arranged for with the Trust Co. as syndicate.manager.

4. It was apparent that: (a) The Trust Co. would receive 24,900 shares of the $5 stock; (b) the stockholders of the Trust Co. would participate in the profit of the Trust Co. either directly or indirectly; (o) a distribution in kind of the syndicate stock would not require the registering on the books of the Trust Oo. of a profit on the syndicate stock measured by the difference between its cost and its selling price.

Within five days after the Trust Co. sent its letter to Bradley and the other stockholders, it announced that the public had purchased at $40 a share all the shares of stock allotted to it at $35 a share, and hence the Bankers’ Syndicate was definitely assured that its entire liability under its original commitments was limited to $5 a share on 83,000 shares of stock which was readily salable at $40 per share, as shown by the oversubscription in the Common Stock Syndicate.

It seems to us that we are dealing here, then, not. with a purchase and sale of stock but with a plan arranged to avoid, if possible, two taxable profits under the Revenue Act of 1918, one to the Trust Co. on the sale of its Bankers’ Syndicate stock, and the other to Bradley, if and when a dividend was declared of the extraordinary profit realized by such sale if made. This result was sought to be avoided by a distribution in kind. We are to inquire whether this plan meets the legal tests of avoidance or is merely ineffective evasion.

It is important to note that the Trust Co. on August 2 provided for participation by other parties in the risks and profits of the Bankers’ Syndicate but that the resolution on August 13 and the letter to the stockholders dated August 22, after the allotment of the $5 stock, read together, do not in fact call for syndicate participants but set out quite another and a more attractive proposal. It was then known that the stock of the Bankers’ Syndicate would cost $5 per share. It was proposed to the stockholders that they deposit $195 for each share of stock held in the Trust Co., hut “ this company will divide with him the stock of the Coco-Cola Co. * * * in proportion to his holdings * * * returning to said stockholders, upon the termination of said syndicate, the amou/nt of money deposited by him, less the cost of the stock on the basis that this company acquired same.” (Italics ours.)

This offer was dated August 22d; Bradley accepted it August 23d. Three days later the Common Stock Syndicate reported through this same Trust Co. as syndicate manager that the public subscription at $40 per share had been oversubscribed 143,000 shares. The absolute agreement to return the stockholders’ money proffered in the resolution of the 13th and the letter of the 22d, read together, was clearly no empty promise; it was based upon a not surprising foreknowledge of events soon to happen. Not only by specific agreement of the Trust Co. but by the facts surrounding the flotation of the public stock it is clear that Bradley did not place any funds at the risk of the venture and that the deposit of $9,750 was the merest shadow cast in front of the real transaction, which was a distribution in kind of the common stock of the Delaware Co. to the stockholders of the Trust Co. By this plan, if success crowned the effort to avoid the tax, the Trust Co. would escape tax on the sale of the proceeds of its Bankers’ Syndicate operation, and the stockholders could assert the claim made here that they were merely purchasers of securities and had made no profit at all. The stockholders were all offered participation — a natural and significant precaution — since if any were excluded those so excluded could properly and effectively, by virtue of their rights as stockholders to participate pro rata in the profits of the corporation, prevent the successful carrying out of the plan. To make assurance doubly sure the offer was held open until August 27, the day after the Common Stock Syndicate reported on the sale of the 417,000 shares.

It is clear also that, since tire payment for the stock of the Georgia Co. was not required to be made until September 20, and the Common Stock Syndicate would receive the proceeds of the sale of the 417,000 shares long before that time, the Trust Co. was aware on August 22 (and, judging from the resolution, apparently also knew on August 13), that no funds of its own except $5 per share on 24,900 shares would be required for advances or for any other purpose in connection with its participation in the Bankers’ Syndicate.

But, even if the above be so, is the transaction none the less beyond the reach of the tax collector by reason of the fact that Bradley did pay $5 to the Trust Co. on account of e'ach share of Delaware Co. stock received by him? If it be true that this plan is adequate to this purpose, then all income taxation upon corporate dividends or distribution is at an end, for it is only necessary in order to avoid the tax upon the stockholder that the corporation contemplating a dividend purchase a suitable security, susceptible of division among its stockholders, and “ sell ” it to them for an inadequate price.

The law is not so easily defeated. It deals not alone with the form but with the substance of transactions, looks if necessary through the form to the substance, and predicates its findings upon realities rather than upon fictions.

Tax evasion is as old as the taxgatherer, and the would-be evader has not infrequently tested in the courts the product of his fertile brain. If his plan really avoids the tax, if he actually conducts his operations outside the scope of its effectiveness, his device is said to be avoidance' and succeeds; if on the contrary he merely screens an operation by making it seem the thing it is not then he fails and suffers the consequences of failure. To this effect are many cases.

In the case of Holly Springs Savings & Insurance Co. v. Supervisors of Marshall County, 52 Miss. 281, the bank invested its available funds in United States Government bonds shortly before the assessment date and reconverted the bonds into cash shortly after that date. In deciding that such 'a plan although perfectly legal in itself was an evasion of tax and therefore ineffective, the court said:

* * * We declare that when the capital of a banking institution, used throughout the year in the conduct of its business, is converted for a few days into Government securities for the express purpose of defeating the imposition of any or all taxes, such investment is colorable and fraudulent, and its capital remains taxable to the same extent and in the same manner as if such conversion had never taken place. In such case the tenure by which they are held, being a fraud and a cheat, will be disregarded, and the bankers will be cons'dered as still the owners of that property which for the moment they have attempted to hide beneath the protection of the General Government.

Under like circumstances and under similar facts, the Supreme Court of the State of Illinois in Re People’s Bank of Vermont, Illinois. 61 N. E. 177, said:

While such institutions have the right to invest in such securities, and courts are bound to recognize that right, when it becomes a question between them and the State, and that question relates to the purpose of the purchase, and the facts tend to show that such purpose was the evasion of taxation, then the courts may look upon such transaction as none other than fraudulent in law and of such character that the beneficiaries can not be allowed, under the cloak of an apparent legitimate transaction, to thus avoid their duty and responsibility to the State.

In Pollard v. First National Bank of Newton, Kansas, 28 Pac. 202, the supreme court of that State held that where a banking corporation transferred $40,000 of its surplus to stockholders’ account by a resolution in form declaring a dividend, but in fact providing a mere allocation of surplus by reason of the fact that the so-c'alled dividend was required to be retained in the hands of the bank, it was held that the transaction was a subterfuge to avoid taxation and that an assessment in which was included the said value of $40,000 as part of the capital and surplus of the bank was valid.

Many cases might be cited to the same general effect of which particular note may be made of People ex rel. Carman v. Sawyer, 27 N. Y. Supp. 202, and Ransom v. City of Burlington, 82 N. W. 427.

A case of more than ordinary interest is Durham v. State ex rel. Anderson, 32 N. E. 104. This case arose in the State of Indiana, action having been begun in the name of the State against Durham to recover a penalty for evading taxation of personal property. It appears that Durham temporarily converted a portion of an open deposit account in the First National Bank of Crawfordsville into United States currency just prior to April 1, 1888, and reconverted it into the bank deposit just subsequent to that date. The property was assessable in Indiana as of April 1 of each year, the penalty sought to be recovered being one imposed under the following provision of Indiana law (section 6339, Rev. St. 1881) :

If any person or corporation shall * * * temporarily convert any part of his personal property into property not taxable, for the fraudulent purpose of preventing such property from being listed, and of evading the payment of taxes thereon, he or it shall be liable to a penalty of not less than $00, nor more than $5,000, to be recovered in any proper form of action, in the name of the State of Indiana, on the relation of the prosecuting attorney.

In upholding the imposition of the penalty the court says:

It seems to be sufficiently clear that the complaint sets forth a state of facts constituting a fraudulent attempt against the collection of the public revenue provided for by law, and shows conduct on the part of the appellant punishable by penalty, as prescribed by the statute.

Three significant cases of tax evasion have been passed upon by the Supreme Court of the United States. In David H. Mitchell v. The Board of County Commissioners of Leavenworth, Kansas, 91 U. S. 206, there was involved the question of a temporary conversion of a bank deposit into United States currency. The taxing officers assessed the amount so converted nothwithstanding the fact of conversion, and the taxpayer, Mitchell, filed a bill of equity seeking to restrain collection of the tax. Being defeated in the Supreme Court of Kansas he sued out a writ of error to tlm Supreme Court of the United States. The court in sustaining the decree of the Supreme Court of Kansas said:

We think the decision in this case was correct. United States notes are exempt from taxation by or under State or municipal authority; but a court of equity will not knowingly use its extraordinary powers to promote any such scheme as this plaintiff devised to escape his proportionate share of the burdens of taxation. His remedy, if he has any, is in a court of law.

In Stewart B. Shotwell v. Samuel A. Moore, 129 U. S. 596, the same state of facts was before the court as in the case of Mitchell v. Leavenworth County, supra. The taxpayer instead of being assessed, was sued for the tax in the courts of the State of Ohio and was therefore in a court of law and not in a court of equity in bringing this case to the Supreme Court. The case is decided primarily under the provisions of the Ohio statute which imposed the tax on personal property on the basis of the average amount held during the year rather than upon the amount on any particular day. The device adopted by the taxpayer was here ineffective for the reason that he converted the securities only for a short period. It appears, however, that the court was fully prepared to dispose of the case merely upon the question of evasion, if necessary, and in indicating'that conclusion said:

* * * the courts look upon this transaction as indefensible, and consider it an improper evasion of the duty of the citizen to pay his share of the taxes necessary to support the Government which is justly due on his property.

In George D. Horning v. District of Columbia, 254 U. S. 135, Horn-ing was convicted of carrying on the busines of a pawnbroker in the District of Columbia without a license. It appears from the testimony that Horning, with intent to evade the laws of the District, opened an office at the south end of one of the bridges across the Potomac River where he conducted negotiations respecting loans and received pledges on account of loans made. He maintained an office and storehouse in Washington where pledges were stored and redelivered to pledgors upon the payment of the loans and from which free automobile transportation was provided to the office in Virginia. In holding that that was an unsuccessful attempt to evade the District laws, Mr. Justice Holmes says:

It is said with reference to the charge of the judge, to which we shall advert, that there was a question for the jury as to the defendant’s intent. But we perceive none. There is no question that the defendant intentionally maintained his storehouse and managed his business in the way described. It may be assumed that he intended not to break the law, but only to get as near to the line as he could, which he had a right to do; but if the conduct described crossed the line, the fact that he desired to keep within it will not help him It means only that he misconceived the law.

The evidence in this case shows that the Trust Oo. was both a member of the Bankers’ Syndicate and manager of the Common Stock Syndicate; that on August 21 the Bankers’ Syndicate became assured of the ultimate possession of 83,000 shares of $5 stock of which the Trust Co. would secure 24,900; that on August 22 the Trust Co. proposed to all its stockholders the deposit with it of $195 for each share of its stock held by them with a promise in effect to return $190 and one share of common stock of the Delaware Co.; that that offer was held open to the stockholders until August 27; that the taxpayer did deposit $9,750 under this arrangement on August 23; that on August 26 the Trust Co., as manager of the Common Stock Syndicate, revealed to all the world that the common stock of the Delaware Co. was oversubscribed at $40 per share to the extent of 143,000 shares and no syndicate funds except $5 per share on 83,000 shares would be required to finance the acquisition of the stock of the Georgia Co.; that on or before September 5 all the common stock subscriptions allotted were paid for; that the Delaware Co. duly carried out the syndicate arrangements and that payment on account of the purchase of the stock of the Georgia Co. was not required under the options theretofore taken until September 20. Under these circumstances the alleged purchase of 50 shares of Delaware Co. stock at $5 by the taxpayer from the Trust Co. was no purchase at all, but a mere distribution of the assets of that company to him as a stockholder therein, he sharing with all the others as was his right as a stockholder.

The stock so received by the stockholder was income and is defined by section 201(a) of the Revenue Act of 1918 as a dividend as follows:

That the term “ dividend ” when used in this title * * * means * * * any distribution made by a corporation * * * to its shareholders or members, whether in cash or in other property * * *.

The determination of the Commissioner that there is a deficiency in income tax of this taxpayer for the year 1919 must be approved unless in the computation of such deficiency he has subjected the sum of $1,750 income to normal tax for the said year, in which event the computation must be modified by subjecting the said sum to surtax alone.