1960 U.S. Tax Ct. LEXIS 9">*9
Petitioner was a mutual water company exempt from tax under
1. The capital gain must be included in income in determining petitioner's qualification as an exempt organization under
2. Petitioner adopted a plan of complete liquidation1960 U.S. Tax Ct. LEXIS 9">*10 on April 25, 1955, and distributed all of its assets, less assets retained to meet claims, within 12 months thereafter, and petitioner's gain on the sale of all its operating assets is not recognized under
35 T.C. 418">*418 OPINION.
Respondent determined a deficiency in petitioner's income tax for the calendar year 1955 in the amount of $ 45,457.36. The issues for decision are: (1) Whether gain from the involuntary sale of all of petitioner's assets is includible in "income" for the purpose of applying the limitation in
All the facts are stipulated and are so found.
Petitioner was a corporation organized and doing business under the laws of the State of California from its incorporation on March 5, 1960 U.S. Tax Ct. LEXIS 9">*13 1924, until the year 1955, when it sold its operating assets and 35 T.C. 418">*419 undertook steps toward complete liquidation. With its principal office in the city of La Crescenta, California, petitioner filed its final tax return on an accrual basis for the period January 1, 1955, to July 31, 1955, with the district director of internal revenue, Los Angeles, California.
Petitioner was incorporated for the purpose of conducting a mutual water company business. As required by its articles of incorporation and bylaws, petitioner was operated from the date of its formation solely to supply water for domestic and commercial use to its shareholders and to no others. In each year of its existence prior to the year 1955, petitioner met the requirements for and was exempt from Federal income taxation as a mutual water company under
In or about 1950, the Crescenta Valley County Water District (herein, county water district) was formed as a political subdivision of the State of California for the purpose of acquiring and consolidating certain existing mutual water companies, including petitioner. 1960 U.S. Tax Ct. LEXIS 9">*14 Funds for the acquisition of such mutual water companies were secured from bonds issued by the county water district pursuant to the authority under which it was created. An offer by the county water district to purchase the assets of petitioner was rejected by petitioner, and the county water district thereupon commenced condemnation proceedings against the operating assets of petitioner pursuant to the power of eminent domain held by the county water district. Petitioner determined by a formal canvass of opinion that its members did not wish its assets to be acquired by the county water district. Petitioner thereupon defended the condemnation action in an effort to increase the condemnation award to an amount greater than the authorized bond capacity of the county water district. The trial court before which the condemnation case was tried reached a decision on January 13, 1955, that petitioner should be awarded $ 600,884 for its assets, subject to an adjustment for proration of property taxes.
A meeting of the board of directors of petitioner was held January 14, 1955, and it was determined among other things that the shareholders of petitioner should be advised of the results1960 U.S. Tax Ct. LEXIS 9">*15 of the condemnation proceedings, and that a joint meeting should be held as soon as possible with the directors of the county water district to discuss the many details in dissolving the company in an orderly fashion. Thereafter, during the month of January 1955, a communication was mailed to the shareholders of petitioner, advising them of the judgment of the trial court and stating that the county water district would shortly take possession of the assets. The shareholders were 35 T.C. 418">*420 also informed that petitioner would be dissolved and the value of each share would be computed as quickly as possible.
At a special meeting held on January 24, 1955, to consider matters related to petitioner's future, the board of directors of petitioner discussed and postponed a decision on whether its counsel should waive the findings of fact and conclusions of law in the condemnation proceedings. At a regular meeting on January 31, 1955, it was determined upon the advice of counsel not to file such a waiver so that petitioner's right to appeal the trial court's decision would be preserved.
Notice of the regular annual meeting of the shareholders of petitioner to be held March 7, 1955, was 1960 U.S. Tax Ct. LEXIS 9">*16 mailed to its shareholders prior to the date of the meeting. The notice, among other things, advised the shareholders of the amount of the award of the trial court in the condemnation proceedings and advised the shareholders that this award should result in each shareholder's receiving $ 165 per share. The notice further advised the shareholders that a number of legal steps must be followed before final dispersal of each shareholder's distributive share could be made. The first step was stated to be the assumption by the county water district of the responsibility for the operation of petitioner's water system and "From that point on your Company will proceed to dissolve itself and disperse all monies * * * as quickly as the law allows."
A quorum of the shareholders failed to appear in person or by proxy at the annual meeting of the shareholders on March 7, 1955, and, as a result, no formal action was taken at the meeting. Minutes of the meeting were not transcribed by the stenographer present, under instructions that in the absence of a quorum no meeting was held.
A meeting of the board of directors of petitioner was held April 25, 1955. At this meeting the findings of fact and1960 U.S. Tax Ct. LEXIS 9">*17 conclusions of law found by the trial court were reviewed by counsel for the corporation and grounds for an appeal of the trial court's decision were discussed. It was finally determined that no appeal from the condemnation judgment should be taken. Immediately thereupon, a representative of the county water district presented its check to the board of directors of petitioner in the amount of $ 598,905.62, which amount constituted the trial court's judgment ($ 600,884, less taxes) and was $ 181,829.45 greater than the adjusted cost basis of the assets transferred. A satisfaction of judgment was signed by the officers of petitioner and delivered to the representative of the county water district. The board of directors of petitioner then turned to the matter of winding up the affairs of petitioner. In a series of motions the board agreed to accept the county water district's offer of office space and part-time personnel for the "winding-up" period, to request refunds on various sums that were on deposit with several governmental 35 T.C. 418">*421 authorities, to retain certain employees and services required to wind up, and to notify lending institutions that shares of stock would not1960 U.S. Tax Ct. LEXIS 9">*18 be transferred after May 5, 1955. The board also agreed to secure the shareholders' consent to dissolution by "consent cards" mailed with an explanatory transmittal letter as soon as practical to all shareholders of record. The letter and consent cards were sent to stockholders under date of April 29, 1955, explaining that voluntary dissolution by shareholders (under
On April 25, 1955, petitioner sold all of its operating assets to the county water district; the latter took possession on April 26, 1955.
The board of directors of petitioner again met on June 7, 1955, "for the purpose of canvassing the Consent Cards and considering Plans and Methods for Liquidation of the Company." A tabulation of the returned consent cards was made and disclosed that 2,420 of the outstanding 3,622 shares of petitioner had consented to its dissolution. The consent requisite under California law having been so secured, the board of directors of petitioner by resolution directed the appropriate officers of petitioner to execute and file a certificate of election to wind up and dissolve. 1960 U.S. Tax Ct. LEXIS 9">*19 Such a certificate was filed with the California secretary of state on June 14, 1955.
Subsequently, by letter of June 20, 1955, all stockholders were advised that:
The Board of Directors of the Mountain Water Company, having been directed by a majority of the shareholders to liquidate your Company, have determined to do so at the earliest possible moment, by resolution dated June 7, 1955, which appears on the reverse side of this letter.
The shareholders were further instructed in the steps to be taken to secure their liquidation distributions, amounting to somewhat more than $ 165 per share. By the resolution on the reverse side all shareholders and claimants were formally --
Notified that the proceedings for the winding up of said corporation commenced on June 7, 1955, upon the filing with said corporation on and before said date of the written consents of the shareholders of said corporation representing 50% or more of the voting power thereof stating such election to wind up and dissolve.
On June 30, 1955, petitioner filed Return of Information under
35 T.C. 418">*422 During the year 1955, petitioner's only receipts, excluding the condemnation proceeds, were $ 38,461.89 from the sale of water to its shareholders and $ 2,057.51 from discounts earned and interest received from the deposit of the condemnation award. Petitioner suffered a loss from operations for the year 1955, excluding the excess of condemnation proceeds over the cost basis of assets condemned.
Petitioner had 3,622 shares of its capital stock outstanding in June 1955. Distribution checks covering 3,618 of the shares were prepared and held for mailing as stockholders turned in their certificates for cancellation. The 4 shares for which checks were not prepared involved, respectively, a stockholder who had disclaimed his interest, two who were in default in their water bills, and a decedent, the distributee of whose estate was being sought. By appropriate1960 U.S. Tax Ct. LEXIS 9">*21 action by the board of directors of petitioner all but the last mentioned of these latter 4 shares had been canceled by February 27, 1956.
As of December 31, 1955, petitioner had cash in banks and on hand of $ 75,776.26. Its accounts receivable totaled $ 2,001.54. Of this amount, $ 1,969.89 represented a property tax refund, which was collected in January 1956. Petitioner also carried as an asset $ 441.24 of prepaid insurance, covering comprehensive liability and fidelity insurance which was maintained by petitioner during the period of its liquidation. Petitioner had a liability of $ 243.29 for payroll taxes which had been withheld or incurred during the last quarter of 1955 with respect to employees employed by it to assist in its liquidation. The balance of petitioner's funds was held to complete distribution to shareholders entitled thereto and as a reserve for possible Federal income and California franchise taxes that might be due and for closing expenses. Upon the advice of counsel, the board of directors of petitioner had determined prior to December 31, 1955, that the balance amount was a proper and adequate reserve to meet claims against petitioner.
As of April 15, 1960 U.S. Tax Ct. LEXIS 9">*22 1956, there were 5 shares of stock outstanding. One was being held by petitioner at the request of an attorney still seeking the distributee of the deceased shareholder's estate. Of the other 4 shares, 2 shares were held by a couple involved in divorce proceedings and 2 shares were held by another deceased shareholder. Certificates representing these latter 4 shares were received by petitioner for cancellation between April 16 and April 30, 1956 -- petitioner's records do not reveal the actual date of receipt. Distribution checks in respect to these 4 shares were signed April 30, 1956, and were mailed immediately thereafter. Petitioner's officers had adopted a practice of meeting only twice each month to handle distribution matters.
Only the share held for the missing distributee remained outstanding after April 30, 1956. As of April 24, 1956, and April 5, 1957, 35 T.C. 418">*423 checks which had been delivered in respect to 8 shares involving 3 shareholders and $ 1,320 had not been negotiated or deposited for collection.
The first issue is whether petitioner was exempt from tax under
The applicable portions of
Benevolent life insurance associations of a purely local character, mutual ditch or irrigation companies, mutual or cooperative telephone companies, or like organizations; but only if 85 percent or more of the income consists of amounts collected from members for the sole purpose of meeting losses and expenses.
Petitioner, recognizing that "gross income" has long been defined in the revenue laws as including "gains * * * derived from * * * dealings in property," 2 contends that Congress intended "income" as used in
Petitioner cites no authority for this position but relies on the legislative history of
Mutual insurance companies or associations other than life or marine * * * if the gross amount received during the taxable year from interest, dividends, rents, and premiums (including deposits and assessments) does not exceed $ 75,000.
We have examined the legislative history of these two sections, and the congressional committee reports referred to by petitioner in its brief and have concluded1960 U.S. Tax Ct. LEXIS 9">*25 that they do not support petitioner's contention. 35 T.C. 418">*424 This seems particularly apparent from the fact, without going into details of the legislative history, that in the Revenue Act of 1926 Congress separated the requirements for exemption of mutual casualty or fire insurance companies (sec. 231(11)) and the requirements for exemption of benevolent life insurance associations of a purely local character and mutual water companies and like organizations (sec. 231(10)), and since that time has consistently provided different income standards for qualification under the two provisions, and the further fact that in 1942 Congress specifically amended the income standards provided for mutual casualty companies to include only amounts received from investment income and premiums, while making no amendment to the income standards provided for mutual water companies and like organizations.
It may well be that, if1960 U.S. Tax Ct. LEXIS 9">*26 faced with the specific problem, Congress would not deny exemption to a mutual water company which otherwise meets the requirements of
We conclude that petitioner was not tax exempt in 1955. Cf.
The second issue is whether
The pertinent part of
(a) General Rule. -- If -- (1) a corporation adopts a plan of complete liquidation on or after June 22, 1954, and (2) within the 12-month period beginning on the date of the adoption of such plan, all of the assets of the corporation are distributed in complete liquidation, less assets retained to meet claims,
Respondent contends that
(a) The
It is clear from the cases that the existence of a plan of liquidation, within the meaning of sections 115(c), 112(b)(6), and 112(b)(7) of the 1939 Code, does not require the formal adoption of a resolution by the directors or stockholders, and is dependent on the facts in each case. In
"Liquidation is a question of fact." * * * The adoption or failure to adopt a resolution of dissolution or liquidation is not controlling or determinative, * * *
In affirming, the Court of Appeals said:
The determining element was the intention to liquidate the business, coupled with the actual distribution of the cash to the stockholders. * * *
See also
The general propositions concerning liquidation were again applied and further amplified in
A plan is a method of putting into effect an intention or proposal. The statute does not require a formal plan. Here the proposal was the liquidation, and the method proposed of effecting the liquidation was the plan. * * *
It was against this background of judicial construction of the requirements in sections 115(c), 112(b)(6), and 112(b)(7) of the 1939 Code for existence of a plan of liquidation that Congress enacted
The purpose of
We think it is clear from the evidence in this case that a plan of liquidation was adopted by petitioner on April 25, 1955, when the directors decided to accept the condemnation award without appeal and in fact accepted a check for the net amount thereof. Prior to that date the directors had recognized the probability that all the 35 T.C. 418">*427 operating assets of the company would be taken by the county water district and the purpose for existence of the company would cease; and it is apparent that the consensus of opinion was that if the condemnation was successful, the proceeds from the involuntary sale should be distributed in liquidation. But in view of the reluctance of the stockholders1960 U.S. Tax Ct. LEXIS 9">*33 to sell without a fight, no final decision was made until the meeting of April 25, 1955. When the decision to accept the award was made at that meeting, the plan of liquidation was put into effect even though no formal resolution of liquidation or dissolution was adopted. Obtaining the consent of the stockholders to dissolve the company and the subsequent adoption of a resolution of dissolution at the directors meeting on June 7, 1955, was only one of the formal steps taken in carrying out the plan of liquidation. Liquidation can occur without dissolution -- dissolution is a formal step taken to terminate the existence of a corporation which would normally follow liquidation, although not necessarily so.
Respondent relies primarily on
(b) Respondent also contends that because at least 1 and possibly 35 T.C. 418">*428 5 shares of stock had not been surrendered for cancellation by April 25, 1956, and because a few checks that had been mailed to stockholders prior to that date in payment for their stock had not been cashed by that date, the requirements of the statute were not met and the gain should be recognized to the corporation. Again in the light of the purpose of the statute, we do not think the application of such a strict construction of the statute is warranted on the facts here present. True, the statute uses the language "all of the assets of the corporation are distributed in complete liquidation," but it also provides for retention of sufficient assets "to meet claims." Respondent again relies on
A corporation will be considered to have distributed all of its property other than assets retained to meet1960 U.S. Tax Ct. LEXIS 9">*36 claims even though it has retained an amount of cash equal to its known liabilities and liquidating expenses plus an amount of cash set aside under arrangements for the payment after the close of the 12-month period of unascertained or contingent liabilities and contingent expenses. Such arrangements for payment must be made in good faith, the amount set aside must be reasonable, and no amount may be set aside to meet claims of shareholders with respect to their stock. If it is established to the satisfaction of the Commissioner that there are shareholders who cannot be located, a distribution in liquidation includes a transfer to a State official, trustee, or other person authorized by law to receive distributions for the benefit of such shareholders. * * *
We recognize the justification for a rule which precludes the corporation from retaining substantial amounts to do with as its officers and directors please under the pretext of holding it to meet claims of stockholders with respect to their stock. Such could be utilized to circumvent the statute. But to apply this section of the regulations in the manner suggested by respondent here so as to require, for compliance with 1960 U.S. Tax Ct. LEXIS 9">*37 the statute, a distribution to some third party of every penny of cash admittedly due and in a fixed amount to redeem a few shares of stock the true ownership of which, or the identity and location of the owners thereof, cannot be determined within the 12-month period would not, in our opinion, be justified or warranted under the statute. One of the objectives of the statute was to avoid having the tax consequences of such transaction depend primarily on the formal manner in which transactions are arranged, thus causing a trap for the unwary. H. Rept. No. 1337, 83d Cong., 2d Sess., p. A106.
The statute specifically authorizes retention of amounts "to meet claims." The regulations authorize the retention of amounts set aside in good faith to meet unascertained or contingent liabilities and expenses. If amounts set aside to meet claims prove to be in excess of the amounts required, the excess would have to be distributed pro rata to the stockholders. We see no need for any greater formality 35 T.C. 418">*429 with respect to amounts set aside in specified small amounts to redeem stock where it is clear from the facts that they would be used for that purpose alone and within a reasonable time.
1960 U.S. Tax Ct. LEXIS 9">*38 We do not think the regulations either preclude or were intended to preclude application of
We conclude that petitioner complied with all the requirements of
1. All references are to the 1954 Code unless otherwise noted.↩
2. See
3.
4. It may well be that Congress believes it has already provided any relief warranted in such a situation by provisions such as
5. The stipulation of facts does not state how much this was as of April 25, 1956.↩
