The opinion of the court was delivered by: BURKE
On August 1, 1940 plaintiff made a gift to his daughter of 100 shares of Class B stock of Schlegel Manufacturing Company. On February 10, 1941 he made a gift to his wife of 680 shares of Class B stock of the same company. The latter gift was incorrectly reported in plaintiff's gift tax return as a gift of 400 shares. The tax liability on the excess of 280 shares not reported is not involved in this action. In plaintiff's gift tax returns the stock was valued at $ 220 per share. The Commissioner assessed deficiencies in each case on the ground that the fair value of the stock was $ 360 per share. The deficiencies were paid. Claims for refund were filed and rejected. This suit is brought to recover the deficiencies assessed and paid. The question involved is the fair market value of 500 shares of Class B stock on February 10, 1941, the parties having stipulated that the valuation on that date will be determinative for each of the years in question.
Schlegel Manufacturing Company was incorporated in 1910. Its principal business is the manufacture of narrow weave fabrics for the automobile trade. The business was started as a partnership about 1890 under the firm name of Schaefer and Schlegel and was then engaged in making trimmings for furniture, caskets and carriages. It went through a number of changes in the type of its output, but since about 1920 its principal business has been supplying narrow weave items for the automobile trade. In 1940 and 1941 about 98% of its sales were to automobile companies of which General Motors purchased about 50%, Standard Products Company about 35%, and Chrylser, Briggs, Ford and Packard the balance. The plaintiff was one of the original founders of the business and has been actively managing it since its beginning. He is now 81 years old. The company had issued and outstanding on February 10, 1941, 660 shares of Class A stock and 6,600 shares of Class B stock. The two classes of shares have the same preferences, privileges and rights except that Class B stock has no voting rights. The plaintiff is the principal stockholder. On February 10, 1941 he held 378 shares of Class A stock and 3,680 shares of Class B stock. All of the stock was closely held by members of the Schlegel family. The company owns all of the capital stock of the Schlegel Company of Canada, Limited, whose principal place of business is in Toronto. It is engaged in the same business and sells to the same customers. Neither class of stock of Schlegel Manufacturing Company nor the stock of the Schlegel Company of Canada, Limited, is listed on any exchange and no sales have ever been made to the public of the stock of either company.
Upon the trial the plaintiff called two expert witnesses who testified regarding the value of the stock on February 10, 1941, one of whom testified that the value was $ 171 per share and the other $ 202.50 per share. The Government called three, the first of whom testified to a value of $ 449.28 per share; the second $ 400 per share; the third $ 428.47 per share.
The large discrepancy between the valuation of the plaintiff's and defendant's witnesses occurs because of the relative consideration given by the witnesses to investment securities held by Schlegel Manufacturing Company and Schlegel Company of Canada Limited. On the date in question Schlegel Manufacturing Company owned common stocks, preferred stocks, and bonds having a total market value of $ 1,437.491. The Canadian company held on that date common stocks and bonds having a market value of $ 244,407. Each share of stock of Schlegel Manufacturing Company represented on that date, in addition to its equity in the manufacturing business, ownership of securities having a value per share in excess of $ 230. Thus it is seen that the valuation testified to by the plaintiff's witnesses was less than the value per share which it represented in ownership of the investment securities alone of the two companies.
It can hardly be denied that the market value of the readily saleable securities owned by the two companies was 'a relevant fact bearing upon the value of the capital stock.' Ray Copper Co. v. United States, 268 U.S. 373, 45 S. Ct. 526, 528, 69 L. Ed. 1003. If so, under Treasury Regulation 108, Section 86.19(c), in valuing the stock, since actual sales or bona fide bid and asked prices were not available, the value is to be arrived at upon the basis of that factor as well as the company's net worth, earning power, dividend-paying capacity, and all other relevant factors. Apparently the plaintiff's witnesses did not take that factor into consideration in valuing the stock or, if they did, they discounted it as a factor advancing no sound reason for doing so. One of the plaintiff's experts said that he counted it as nothing. He was asked on cross-examination: 'Q. So that the asset of $ 1,400,000 in investments does not weigh very heavily in determining the value, fair market value, of the Schlegel stock on February 10th, according to your formula. A. In my judgment it weighs nothing. It is just so much more working capital.' Later in cross-examination he was asked: 'Q. I will ask you to assume that it is a part of the majority holding. Wouldn't you consider liquidating value in determining the fair market value? A. No sir, I would not.' There was no suggestion in any of the testimony that the investments were unsound. Just why the stock should be worth less than its participating value per share in the investment securities of the American and Canadian companies, wholly apart from the value of the manufacturing end of the business, is hard to understand. So also is it difficult to comprehend the testimony of the same witness who testified that if the plaintiff had come to him on February 10, 1941 and stated he had been offered $ 171 per share for a block of 400 or 500, or 600 shares of Schlegel Manufacturing stock and had asked him as an expert as to the advisability of accepting that price, he would have advised him 'to jump at it * * * .' On that date the plaintiff was the controlling stockholder and could have accomplished complete liquidation of the investment accounts of the two companies and thereby realized about $ 230 per share for but a part of its assets or he could have procured a distribution of the investment securities to the stockholders in kind. It is quite apparent that the witness in valuing the stock, contrary to the command of the Treasury Regulation above referred to, considered only the earnings of the company and disregarded 'the company's net worth' and 'other relevant factors having a bearing upon the value of the stock. * * * ' On direct examination he testified: 'Q. Is that, in your opinion, the prime determining factor of fair market value, the earnings? A. In my opinion that is the only thing that determines price level, the only factor.' I think it is apparent that the other expert witness called by the plaintiff fell into the same error of basing his valuation on earnings alone, disregarding the company's net worth and other relevant factors having a bearing upon the value of the stock. This method of valuation was wrong as a matter of law. Cf. Commissioner v. McCann, 2 Cir., 146 F.2d 385.
For the five year period prior to the date in question the Canadian company showed annual average net income of $ 43,045.96, an average per share of $ 36.33 but has never declared nor paid dividends on its capital stock. Despite this record of earnings, under the method adopted by the plaintiff's witnesses, the valuation of the stock of Schlegel Manufacturing Company was not increased by reason of its ownership of the stock of the Canadian company because it had paid no dividends. This method of valuation disregards a relevant factor affecting the value of the stock of the parent company.
The method of valuation adopted by the plaintiff's witnesses treated the investment activities of the parent company as a part of the manufacturing business, although the surplus invested in securities was neither required nor used in the company's manufacturing business. The balance sheets for the ten preceding fiscal years show that it always maintained a favorable position of liquidity apart from its investments. The evidence demonstrated no need for the large reserve represented by investments, either for anticipated conversion costs or possible changes in its business. The same is true of the Canadian subsidiary. The indefiniteness of the plan of the Canadian company to construct a new building for its manufacturing operations was not sufficient justification of a reserve for that purpose. In view of all the circumstances the defendant's valuation witnesses were warranted in viewing the investment activities of both the parent company and its Canadian subsidiary as ventures independent of the manufacturing business and in basing their valuations in part on the consolidated balance sheets and income accounts of the parent company and its subsidiary, and in considering the manufacturing operations of both companies separate and apart from the investment activities.
The plaintiff cannot succeed in this suit because he has not sustained the burden of showing that the value adopted by the Commissioner was move than the fair market value of the stock in accordance with the standards of valuation fixed by the statute, 26 U.S.C.A.Int.Rev.Code, § 1005, and the Treasury Regulation regarding valuation of stocks, supra.
Judgment for defendant dismissing the complaint. Separate Findings of Fact and Conclusions of Law are filed herewith.
1. On August 1, 1940, plaintiff made a gift to his daughter, Dorothy S. Gray of 100 shares of Class B stock of Schlegel Manufacturing Company.
2. On February 10, 1941, plaintiff made a gift of 680 shares of Class B stock of Schlegel Manufacturing Company to his wife, Louise M. Schlegel.
3. The market value of Class B stock of Schlegel Manufacturing Company on August 1, 1940, and February 10, 1941, was the same.
4. Schlegel Manufacturing Company was incorporated in 1910. It was the outgrowth of a business which commenced as a partnership under the name of Schaefer and Schlegel in 1890 Its business has always been the manufacture of narrow weave fabrics. In the beginning of the partnership its business was the manufacture of trimmings for furniture, caskets and carriages. Throughout the years it had a number of changes in the character of its output but since about 1920 its principal business has been supplying narrow weave items for the automobile trade. In 1940 and 1941 about 98% of its sales were to automobile companies. General Motors purchased about 50%, Standard Products ...