The opinion of the court was delivered by: LEVET
This is an action under Title 28 U.S.C.A. § 1346 to recover federal income taxes paid for the year 1955. Plaintiffs reported profits from the sale of corporate stock as capital gains and paid the tax on this basis. The Commissioner of Internal Revenue determined that under the circumstances the entire amount received by plaintiffs for their stock was taxable as ordinary income and thereupon issued a deficiency assessment, totaling some $ 12,722.76, which was paid under protest by plaintiffs. There are no material issues of fact. Both parties have moved for summary judgment pursuant to Rule 56 of the Federal Rules of Civil Procedure, 28 U.S.C.A.
The plaintiffs, husband and wife, filed a joint return of their income for the year 1955. Together they owned 72 shares of the Turner Hall Corporation (hereinafter designated as 'New York Turner Hall'), a New York corporation, which had issued and outstanding some 240 shares of stock. New York Turner Hall itself owned all of the issued and outstanding stock of Tylon Products, Inc. (hereinafter designated as 'Tylon'), another New York corporation. Plaintiffs also owned 15 shares of the New Jersey Turner Hall Corporation (hereinafter designated as 'New Jersey Turner Hall'), a New Jersey corporation, which had outstanding 100 shares of capital stock, 50 of which were also owned by New York Turner Hall. The individual shareholders of New Jersey Turner Hall together owned 90% Of the stock of New York Turner Hall.
During the latter part of December, 1955, the plaintiffs, together with the other individual stockholders of New Jersey Turner Hall, sold all of their shares in this corporation to Tylon. As already noted, New York Turner Hall owned all of Tylon's stock, as well as the remaining 50% Of the shares in New Jersey Turner Hall not individually owned.
A total of $ 75,000 was paid by Tylon for all 50 shares of New Jersey Turner Hall stock so transferred. Thus, each New Jersey Turner Hall stockholder received $ 1,500 per share. The plaintiffs, whose 15 shares had originally cost them $ 7,500, received $ 22,500, giving them a profit of some $ 15,000. There is no evidence to indicate that the consideration for plaintiffs' shares was furnished by anyone other than Tylon.
The issue is whether the amount of $ 22,500 received by plaintiffs in 1955 was taxable as dividend income, as determined by the Commissioner. The defendant maintains that the above stock transfers constituted redemptions under Section 304 of the Internal Revenue Code of 1954, 26 U.S.C.A. § 304, and that the entire amount received by plaintiffs was taxable as a dividend pursuant to the rules of Sections 301, 302, 304 and 316 of the Code, 26 U.S.C.A. §§ 301, 302, 304, 316. On the other hand, plaintiffs contend that since the transaction involved no distribution of Tylon's corporate assets or earnings and no reduction in its assets, the amount received by the plaintiffs could not be taxed as a dividend.
Section 304 of the Internal Revenue Code of 1954 provides in its relevant part as follows:
'304. Redemption through use of related corporations.
'(a) Treatment of certain stock purchases. --
'(1) Acquisition by related corporation (other than subsidiary). -- For purposes of sections 302 and 303, if --
'(A) one or more persons are in control of each of two corporations, and
'(B) in return for property,
one of the corporations acquires stock in the other corporation from the person (or persons) so in control, then * * * such property shall be treated as a distribution in redemption of the stock of the corporation acquiring such stock.'
This section purports to prevent tax avoidance in transactions where persons controlling all or substantially all of the stock in two corporations, the so-called 'class B affiliation,' sell some of their stock in one corporation to the other. For purposes of Section 304, 'control' is defined in Section 304(c) (1)
as denoting ownership of at least 50% Of the total stock of a corporation, and encompasses subsidiaries of such a corporation in which it has at least 50% Ownership.
Under Section 304(c)(1), therefore, persons controlling a corporation which itself controls another corporation are deemed to control the latter corporation as well. This rule is said to extend the 'class B affiliation' case to purchases by a subsidiary corporation of stock in a corporation which is a 'class B affiliate' of its parent. See Mertens, Federal Income Taxation (Code Commentary), Sec. 304(c):1, at 55 (1956).
Plaintiffs and the other individual stockholders who sold their shares in New Jersey Turner Hall controlled this corporation in view of their aggregate 50% Stock ownership thereof. Due to their collective 90% Ownership of New York Turner Hall stock, they also controlled that corporation and thus controlled its wholly-owned subsidiary, Tylon, as well. Since plaintiffs' transfer of their stock holdings was admittedly part of 'substantially one transaction,' whereby all individually-held shares in New Jersey Turner Hall were to be sold to Tylon, see deposition of Samuel E. ...