55 T.C. 501">*502 In these consolidated cases respondent determined the following deficiencies in petitioners' Federal income taxes for the year 1965: 1970 U.S. Tax Ct. LEXIS 8">*12

By amendment to his answer, respondent has claimed the following additional deficiencies:

The key issues presented for decision are: (1) Whether the sale by petitioners of all of their stock in Washington Industrial Products, Inc., to CAM Industries, Inc., on May 20, 1965, was a redemption through the use of a related corporation under section 304(a) (1), I.R.C. 1954; ² (2) whether the redemption of all of the stock in Washington Industrial Products, Inc., by CAM Industries, Inc., was essentially equivalent to a dividend1970 U.S. Tax Ct. LEXIS 8">*13 to petitioners under section 302 (b) (1) so that the amounts received by them are taxable as ordinary income; and (3) the fair market value of the contracts received by petitioners from CAM Industries, Inc., on May 20, 1965. There is a preliminary question as to whether the Rose Ann Coates Trust and the Trust Under Will of Sidney N. Coates are proper parties in these proceedings.

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulation of facts, supplemental stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference.

Petitioners Peter M. Coates, Charles N. Coates, Pamela L. Coates, and Cathy A. Coates are brothers and sisters who filed their individual income tax returns for 1965 with the district director at Tacoma, 55 T.C. 501">*503 Wash. They were residents of Bellevue, Wash., at the time they filed their petitions herein.

Petitioner Rose Ann Coates1970 U.S. Tax Ct. LEXIS 8">*14 Trust, Robert N. Coates, trustee, is a trust created under the laws of the State of Washington. Robert N. Coates, trustee, caused the trust to file its Federal fiduciary income tax return for 1965 with the district director at Tacoma, Wash. Robert N. Coates, trustee, resided in Bellevue, Wash., at the time the trust filed its petition herein.

Petitioner Trust Under Will of Sydney N. Coates, Robert N. Coates, trustee, is a trust existing under the laws of the State of Washington. Robert N. Coates, trustee, caused the trust to file its Federal fiduciary income tax return for 1965 with the district director at Tacoma, Wash. Robert N. Coates, trustee, resided in Bellevue, Wash., at the time the trust filed its petition herein.

Sydney N. Coates and Rose Ann Coates were husband and wife. Sydney N. Coates died on January 31, 1963. Rose Ann Coates is still living. Robert N. Coates, Ruby Boyd, and Molly Heinen are the children of Sydney N. Coates and Rose Ann Coates.

Robert N. Coates is the husband of Marjorie Coates. Peter Coates, Cathy Coates, Pamela Coates, and Charles N. Coates are their children.

Ruby Boyd is the wife of R. Morgan Boyd. Robert M. Boyd, Jr., and James Boyd are1970 U.S. Tax Ct. LEXIS 8">*15 their children.

Molly Heinen is the wife of A. C. Heinen. Barbara Heinen, Gary Heinen, and Richard Heinen are their children.

CAM Industries, Inc. (hereinafter sometimes called CAM), began its existence as the sole proprietorship of Sydney Coates, doing business as the Coates Electric Manufacturing Co.Coates Electric manufactured a line of commercial and industrial electrical equipment, including ovens and water-heating equipment for government and private customers. The company was incorporated on June 1, 1948, and on May 18, 1965, changed its name to CAM Industries, Inc.

At the time of Coates Electric's incorporation in 1948 Sydney Coates received 696 shares of stock and Robert N. Coates, R. Morgan Boyd, Arthur C. Heinen, and Zena M. Gilbert received 1 share each. Subsequently the number of shares issued to Sydney Coates was reduced from 696 to 426 since the original allotment should have been 426 shares.

On May 31, 1960, Coates Electric amended its articles of incorporation as follows:

The capital stock of the corporation shall be 2,500 shares of Class A voting common stock at a par value of $ 30.00 per share and 7,500 shares of Class B non-voting common stock at a par value1970 U.S. Tax Ct. LEXIS 8">*16 of $ 30.00 per share. Class A and Class B shareholders shall have identical and equal rights to dividends or to any other 55 T.C. 501">*504 incidents arising from the ownership of said stock except that only Class A voting common stock shareholders shall be entitled to vote.

Shareholders were required to surrender their old shares:

For each ten shares delivered to the corporation each shareholder shall receive twenty-five shares of non-voting stocks together with 8 1/3 shares of voting common stock.

On October 13, 1960, the shares of Coates Electric were held as follows:

The single share of the original stock issued to Zena M. Gilbert had been purchased from her on August 23, 1960. The shares held by the children of Sydney Coates and their spouses were received by them as gifts from Sydney and Rose Ann Coates. Sydney and Rose Ann Coates made additional gifts of stock on October 13, 1960, January 2, 1961, and January 10, 1962, so that by May 20, 1965, prior1970 U.S. Tax Ct. LEXIS 8">*17 to the acquisition by CAM of all the stock of Washington Industrial Products, Inc. (hereinafter sometimes called WIP), the stock of CAM was held as follows:

WIP was incorporated on August 2, 1951, for the purpose of purchasing the assets of the Western Bakery Supply Co., Inc., which was doing business as the J.A. Campbell Co. The officers of Coates Electric had intended to purchase a large piece of machinery from the Campbell Co. Finding the Campbell Co. in financial difficulty and near default on its government contracts, the officers of Coates Electric organized WIP to take over the assets and the contracts of Campbell. At that time Campbell manufactured ovens for the food industry (dissimilar to Coates Electric ovens) and an industrial1970 U.S. Tax Ct. LEXIS 8">*18 oven.

55 T.C. 501">*505 The original incorporators of WIP, Sydney Coates, Robert Coates, Arthur Heinen, and Morgan Boyd, each received 75 shares of stock. Each received a salary from WIP, from which each deducted amounts sufficient to pay off the bank note covering the purchase of the Campbell assets.

On May 20, 1965, prior to the acquisition by CAM of all the stock of WIP, all the stock of WIP and all the stock of CAM were held as follows:

WIP and Coates Electric operated as separate corporate entities until 1965. Robert N. Coates managed Coates Electric, and succeeded his father as president in 1963. 1970 U.S. Tax Ct. LEXIS 8">*19 WIP was managed initially by the Campbell Co. manager, and then by Arthur Heinen from 1955 until 1965.

In 1951 the premises of WIP and Coates Electric were located a half mile apart. Soon WIP was moved to the Coates Electric plant, but operations remained physically distinct except for the sharing of some heavy equipment. In 1955 Coates Electric required more room, so WIP was relocated 6 miles away.

Under the management of Arthur Heinen, WIP began to compete with Coates Electric, particularly in the industrial oven area. The two corporations also began subcontracting work to one another. Coates Electric sold some products to WIP for resale.

During this period Robert N. Coates was generally familiar with the operations of WIP, and made himself and the resources of Coates Electric available to WIP. He did not preside over day-to-day operations of WIP.

In 1964 and 1965 WIP and Coates Electric discussed combining their businesses. They determined that by combining office personnel, 55 T.C. 501">*506 salesmen, inventories, purchasing, and machinery, they would realize substantial economies.

Before his death, Sydney Coates had transferred most of the stock of CAM from his estate, and, in 1970 U.S. Tax Ct. LEXIS 8">*20 the process, left his only son, Robert N. Coates, in complete control of CAM. It was the wish of Sydney Coates to give Robert N. Coates control of two-thirds of the voting stock and 51 percent of the total stock of CAM. At his death Sydney Coates had accomplished his purpose.

In combining CAM and WIP, Robert N. Coates insisted that he should have two-thirds voting control and at least 51 percent of the ownership of the resulting entity. The only manner in which this could be accomplished was by having CAM purchase WIP. A merger would have reduced Robert N. Coates' interests below the amounts he insisted upon.

On May 20, 1965, CAM and the shareholders of WIP entered into agreements of the following form:

Agreement For Sale of Stock

Agreement made this 20th day of May, 1965, by and between the undersigned "Seller" and CAM INDUSTRIES, INC., a corporation, hereinafter called the "Buyer".

Seller hereby sells to Buyer, and Buyer hereby purchases from Seller,     shares of the common stock of Washington Industrial Products, Inc., a Washington corporation, at the price and on the terms and conditions herein set forth.

1. Purchase Price. The price to be paid by Buyer to Seller for 1970 U.S. Tax Ct. LEXIS 8">*21 said shares of common stock shall be $ 1,000.00 per share or an aggregate purchase price of    .

2. Delivery of Stock and Payment of Purchase Price.

(a) The certificate or certificates for the shares of common stock sold hereunder by Seller are herewith delivered to Buyer, duly endorsed for transfer to Buyer, and Buyer hereby acknowledges receipt of said certificate or certificates.

(b) The purchase price shall be paid    , or more at Buyer's option, on or before May 31, 1966, and a like sum, or more at Buyer's option, on the 31st day of May of each year thereafter until the 31st day of May, 1975, at which time the entire unpaid balance of the purchase price shall be due and payable. Buyer shall pay interest on the diminishing balance of said purchase price at the rate of four percent per annum from the 1st day of June, 1965, which interest shall be deducted from each installment payment and the balance of each payment applied in reduction of principal.

3. Successors and Assigns. The provisions of this agreement shall inure to the benefit of and bind the successors and assigns of Buyer and the executors, administrators, heirs, successors and assigns of Seller.

In Witness 1970 U.S. Tax Ct. LEXIS 8">*22 Whereof, the parties hereto have executed this agreement the day and year first above written.

CAM liquidated WIP on May 31, 1965. On May 30, 1965, the accumulated earnings and profits of CAM were $ 183,000.

The fair market value of the contracts between CAM and the shareholders of WIP as of May 20, 1965, were $ 600 per $ 1,000 face value.

55 T.C. 501">*507 Sydney N. Coates and Rose Ann Coates executed mutual wills. Sydney Coates' will gave the house, automobile, bank accounts, and personal effects to Rose Ann Coates, and the residue of his estate went to the Trust Under Will of Sydney N. Coates. Rose Ann Coates' will provided that, in the event Sydney N. Coates predeceased her, she agreed to convey by separate instrument her interest in any community property "to the Trustee or Trustees as named under the terms of the Trust created by the Will of Sydney N. Coates."

The Trust Under Will of Sydney Coates provided, in part, that:

The Trustee or successor Trustee or Trustees shall pay a sum of not less than $ 500.00 a month to the said ROSE ANN COATES to keep her and maintain her in the manner to which she is accustomed, and to raise said amount as the Trustee in his discretion may see fit, 1970 U.S. Tax Ct. LEXIS 8">*23 for any reason whatsoever, such as for sickness or for travel, but not limited thereto, said monthly income to come out of the income of the property in Trust, or from the principal thereof, provided that the said ROSE ANN COATES may, by an instrument in writing, waive said monthly payments or take a lesser sum during business depressions or emergencies.

It further provided:

NINTH: In the event of the death of the said ROSE ANN COATES, then the Trustee or successor Trustee or Trustees is directed to distribute the remaining corpus of the estate as follows:

A. To ROBERT N. COATES, a percentage of the estate interest of the partnership assets of COATES & COATES, equivalent to the percentage needed to give the said ROBERT N. COATES fifty per cent (50%) of said partnership assets.

B. The remainder of the corpus shall be distributed to the children of SYDNEY N. COATES and ROSE ANN COATES, to-wit: ROBERT N. COATES, RUBY N. BOYD and MOLLY M. HEINEN, share and share alike.

By order of the Superior Court of the State of Washington for King County dated September 23, 1965, Robert N. Coates as trustee of the Trust Under Will of Sydney N. Coates received:

4. 332 shares common stock in CAM Industries, 1970 U.S. Tax Ct. LEXIS 8">*24 Inc.

* * * *

8. An undivided one-third interest in the contract dated May 20, 1965, for the sale of 75 shares of Washington Industrial Products common stock.

The Rose Ann Coates Trust, established by an agreement dated August 21, 1965, provided:

ARTICLE II

Distribution from the Trust Estate

In that certain trust established under the Will of Sydney N. Coates, it is provided that:

"The Trustee or successor Trustee or Trustees shall pay a sum of not less than $ 500.00 a month to the said ROSE ANN COATES to keep her and maintain her in the manner to which she is accustomed, and to raise said amount as the 55 T.C. 501">*508 Trustee in his discretion may see fit, for any reason whatsoever, such as for sickness or for travel, but not limited thereto, said monthly income to come out of the income of the property in Trust, or from the principal thereof, provided that the said ROSE ANN COATES may, by an instrument in writing, waive said monthly payments or take a lesser sum during business depressions or emergencies;"

To the extent that the payments provided for Rose Ann Coates in the trust established under the Will of Sydney N. Coates are not made as provided therein, payment shall be made from 1970 U.S. Tax Ct. LEXIS 8">*25 the trust herein established, provided, however, that said payments hereunder shall in no event exceed $ 250.00 per month.

* * * *

ARTICLE V

Ultimate Distribution

Upon the death of Trustor, the Trustee or successor Trustee or Trustees are directed to distribute the remaining corpus of the trust to the children of SYDNEY N. COATES and ROSE ANN COATES, to-wit: ROBERT N. COATES, RUBY N. BOYD and MOLLY M. HEINEN, share and share alike.

On March 25, 1966, Robert N. Coates, as trustee of the Rose Ann Coates Trust, received by order of the Superior Court of the State of Washington for King County:

4. 332 shares common stock in CAM Industries, Inc.

* * * *

8. An undivided two-thirds interest in the contract dated May 20, 1965, for the sale of 75 shares of Washington Industrial Products common stock.

In his notice of deficiencies the respondent treated the "sale" of the WIP shares as a redemption by a related corporation within the scope of section 304.

On October 24, 1969, the Tax Court of the United States entered decisions of no deficiency in the following listed cases. With respect to the following listed stockholders of Washington Industrial Products, Inc., the respondent determined that1970 U.S. Tax Ct. LEXIS 8">*26 the redemption of their stock in Washington Industrial Products, Inc., by Cam Industries, Inc., was substantially disproportionate pursuant to section 302(b)(2), I.R.C. 1954:

55 T.C. 501">*509 OPINION

This case arises out of a transaction between the members of a family group and two corporations controlled by them. Sydney and Rose Ann Coates, together with their children, children's spouses, and grandchildren, owned all the shares of two corporations conducting related businesses. After the death of Sydney Coates, the family group agreed to combine the two corporations by having CAM "purchase" the shares of WIP.

Respondent's position is that the transaction was a redemption through the use of a related corporation, within the scope of section 304(a)(1). ³ Under sections 302(d)⁴1970 U.S. Tax Ct. LEXIS 8">*28 and 301 (a) and (c), ⁵ respondent would treat the amount of the distribution to the petitioners herein1970 U.S. Tax Ct. LEXIS 8">*27 as dividends. Some members of the family group have escaped dividend treatment under section 302(b)(2). The case of Robert N. Coates and Marjorie Coates was not joined herein with these petitioners.

1970 U.S. Tax Ct. LEXIS 8">*29 The trial of these related cases took place before the decision of the Supreme Court in United States v. Davis, 397 U.S. 301">397 U.S. 301 (1970). Much of the proof, therefore, was directed at the issue of whether the transaction 55 T.C. 501">*510 between the stockholders and their two corporations had a "business purpose" which might bring it within the scope of section 302(b)(1). Respondent's opening brief is devoted largely to this issue. However, because of several extensions of time for filing their brief, petitioners' opening brief was filed after the Davis case was decided. Consequently, the petitioners have shifted their primary position from the "business purpose" issue to another ground, namely, the question of proper parties. Respondent, in turn, was caught off balance in framing his reply. As a result, we are faced with briefs reflecting the turmoil of events. Moreover, both the parties and the Court are handicapped by the vagaries of a record created primarily for an issue which is now of uncertain status.

1. Proper Parties. -- Petitioners' initial argument is that "the Rose Ann Coates Trust and the Trust Under Will of Sydney Coates did not1970 U.S. Tax Ct. LEXIS 8">*30 transfer shares in Washington Industrial Products, Inc., to CAM Industries, Inc., and consequently are not chargeable with a dividend." Petitioners point out that the Rose Ann Coates Trust was created after the agreement to transfer the WIP shares. They argue that the agreement was made by the Estate of Sydney Coates, administering community property, and that the proper taxpayers are Rose Ann Coates and the Estate of Sydney Coates.

In its reply brief, respondent "agrees with petitioners that, if the [75 shares of WIP] stock of Sydney Coates was the community property of Sydney and Rose Ann Coates, then the transaction would be taxable one-half to Rose Ann Coates and one-half to the Estate of Sydney Coates. Rose Ann Coates is not a party to this action." Respondent's position with respect to the Estate of Sydney Coates is that the contract distributed to the testamentary trust would be deductible by the estate, and reported by the trust. However, respondent contends that "The argument that the stock of Syndey Coates was community property was never raised in the pleadings or in petitioners' opening statement."

Paragraph 5 (f) of the petition alleges:

Washington Industrial Products, 1970 U.S. Tax Ct. LEXIS 8">*31 Inc., is a Washington corporation incorporated on August 2, 1951. As of March 19, 1953, its shares were held by the following families -- 75 shares each:

Mr. and Mrs. Robert N. Coates

Mr. and Mrs. Sydney N. Coates

Mr. and Mrs. R. Morgan Boyd

Mr. and Mrs. Arthur C. Heinen