Appeal from the District Court of the United States for the Eastern District of Pennsylvania; William H. Kirkpatrick, Judge.
Before MARIS, JONES and GOODRICH, Circuit Judges.
The pending appeals, which were argued together, present the same legal question, namely, whether the undistributed earnings of two predecessor corporations (accumulated after February 28, 1913, and not distributed up to the time of a successor company's acquisition of the predecessors' businesses and assets as a result of a taxfree reorganization) may be included in determining whether cash distributions made by the successor company in later years to its stockholders were taxable in full as dividends paid out of its earnings and profits within the meaning of Sec. 115(a) of the Revenue Acts of 1932 and 1934, 26 U.S.C.A. Int. Rev. Acts, pages 520, 703, the successor company's net earnings from the time of its incorporation being insufficient to provide for the distributions in question.
The facts which, as stipulated, were found by the court below disclose the following situation.
Sharp & Dohme, Inc. (hereinafter referred to as the New Company) was incorporated in July 1929 with an authorized capital stock consisting of preferred and common shares. On August 6, 1929, pursuant to a contract of June 28, 1929, between bankers and the stockholders of a previously existing corporation of the same name (hereinafter referred to as the Old Company), the New Company acquired the business and assets of the Old Company, subject to its liabilities, in exchange for a certain amount of cash and a portion of the preferred and common shares of the New Company's capital stock. In accordance with the contract the preferred shares given in exchange were issued directly to the stockholders of the Old Company and the common shares and cash were issued to the Old Company and by it distributed pro rata to its stockholders. To obtain the cash necessary for the purpose, the New Company sold to the bankers a portion of its remaining common shares and, through the bankers, sold to clients of the latter, a portion of the remaining preferred shares.
When the contract plan had been fully carried out, the stockholders of the Old Company were in possession of the agreed upon cash distribution and 46% of the common and 37% of the preferred capital stock of the New Company then outstanding and the latter was in possession of the entire business and assets of the Old Company. Although the transaction qualified as a reorganization under Sec. 112(i)(1)(A) of the Revenue Act of 1928, 26 U.S.C.A. Int. Rev. Acts, page 379, for the purpose of determining that no gain or loss was to be recognized from the Old Company's transfer of its assets and the exchange of securities, the stockholders of the Old Company were taxable by virtue of Sec. 112(c) to the extent of the gain realized on account of the cash received by them in the exchange. See Starr v. Commissioner, 4 Cir., 1936, 82 F.2d 964, 966, certiorari denied 298 U.S. 680, 56 S. Ct. 948, 80 L. Ed. 1401.
Prior to the sale and transfer of the Old Company's assets and business to the New Company, the former had accumulated large earnings and profits since February 28, 1913 which remained undistributed.
On October 7, 1929, pursuant to a contract of September 24, 1929, between the New Company and H. K. Mulford Company (an unrelated company hereinafter referred to as Mulford), which superseded a contract of August 2, 1929, between stockholders of Mulford and the bankers, the New Company acquired the business and assets of Mulford, subject to its liabilities, in exchange for a certain amount of cash and a portion of the preferred and common shares of the remaining authorized capital stock of the New Company. The cash and stock were distributed pro rata to the stockholders of Mulford in complete redemption and cancellation of the outstanding shares of stock of that company.
As in the case of the Old Company, the New Company's acquisition of the business and assets of Mulford in exchange for stock and cash was in a reorganization which resulted in a tax-free exchange except for the cash idstributed to the stockholders of Mulford. The stipulated effect of the Mulford transaction was identical with the result attained in the case of the Old Company.
Prior to the sale and transfer of Mulford's assets and business to the New Company, Mulford also had accumulated large earnings and profits since February 28, 1913 which remained undistributed.
Both plaintiffs are holders of preferred shares of the New Company*fn1 and in 1933 and 1934 received cash distributions on account of their stock which each respectively returned as taxable dividends*fn2 for the years in question. Subsequently each filed a claim for refund on the ground that a portion of the income so reported as taxable dividends constituted a return of capital by the distributing corporation which was, therefore, rightly to be reflected in reduction of the cost base of the taxpayers' stock and not as taxable income.
As appears by the stipulation, the earnings of the New Company from the time of its incorporation in 1929 were insufficient to provide in full for the distributions which it made to its stockholders in 1933 and 1934.It is also stipulated that the total distributions made by the New Company on account of its preferred shares through the year 1934 did not equal the cost base of the stock of either of the plaintiffs. Consequently, no gain or loss to them was to be recognized as upon a sale or other disposition of their stock. The Commissioner rejected the claims for refund and the taxpayers severally brought the suits here involved for the recovery of the portions of the taxes which, allegedly, were improperly assessed and collected. The court below, holding that the distributions were dividends from accumulated earnings of the distributing company, entered the judgments for the defendant from which the plaintiffs respectively took the present appeals.
A literal reading of the Revenue Acts of 1932 and 1934 would seem to call for the conclusion that the district court was in error. Although distributions of money or property made by a corporation to its stockholders may be distributed as dividends, only those distributions are taxable as dividends which are made by the ...