Before SPARKS, MAJOR, and KERNER, Circuit Judges.
These are petitions by Eli Roy Lowenthal and Sol G. Cogan for review of separate decisions of the Tax Court, entered June 26, 1947, determining deficiencies in the income tax of each of the petitioners for the years 1940 and 1941. The petitions have here been consolidated for hearing and decision. A third petitioner before the Tax Court, William Shapiro, who also received an adverse decision, has not here filed a petition for review. (Before this court, Lowenthal and Cogan are referred to as petitioners, while they, together with Shapiro, are sometimes referred to as the taxpayers.)
The deficiency determined by the Tax Court in the income tax of Cogan was $2,154.12 for the year 1940 and $5,066.37 for the year 1941, and in the income tax of Lowenthal, $1,298.43 for the year 1940 and $4,804.93 for the year 1941. The deficiencies for the year 1940 were predicated upon a transaction by which the Manheimer Watch Company, an Illinois corporation (hereinafter referred to as the corporation), acquired 68 shares of its common stock from each of the taxpayers at a price of $155.40 per share, or $10,567.20 for each. The deficiencies for 1941 were predicated upon a similar transaction by which the corporation on April 17, 1941 acquired 76.5 shares of its common stock from Lowenthal at $155.40 per share, or $11,888.10, and 76 shares of such stock, each from Cogan and Shapiro at $155.40 per share, or $11,810.40 for each.
The Tax Court in determining the deficiencies held that Sec. 115(g) of the Internal Revenue Code, 26 U.S.C.A. Int. Rev. Code, § 115(g), was applicable to these transactions between the corporation and the taxpayers during the years 1940 and 1941. The primary issue before this court is whether the record affords substantial support for the Tax Court's finding that the distributions thus made by the corporation to petitioners in redemption of the corporation's stock were essentially equivalent to the distribution of taxable dividends within the meaning of the section referred to. Another issue raised by petitioners is that the Tax Court erred in striking certain evidence asserted to show an understanding or arrangement, the purpose and net effect of which were such as to preclude the applicability of Sec. 115(g).
The evidentiary facts as found by the Tax Court were based in the main upon a stipulation of the parties. The Manheimer Watch Company during the period here material was engaged in the business of distributing American manufactured watches under franchises from the Hamilton, Elgin and Waltham watch companies. It was well established and had an outstanding reputation. In the spring of 1939, Waltham changed its method of distribution in a manner which led the officers of the corporation to believe that it would lose a large percent of the volume of its Waltham business. To meet this situation, the corporation on May 6, 1939 organized the Hampden Watch Company, an Illinois corporation, as a wholly owned subsidiary. Hampden was to import Swiss watch movements and sell them to customers which the corporation expected to lose as a result of the change in Waltham's merchandising policy. This action was characterized by the parties as sub rosa due to the attitude of American watch manufacturers toward competition by foreign products.
By the fall of 1939, it developed that the corporation would be in danger of losing its franchise with Waltham should its connection with Hampden and its activities be discovered. Arthur Manheimer, president of the corporation, decided he would take the business represented by Hampden and sever his connections with the corporation. The authorized capital of the corporation on December 31, 1939 consisted of 500 shares of preferred stock of a par value of $100 per share, and 1,500 shares of common stock of a par value of $100 per share. On February 5, 1940, the 1295.5 shares of outstanding common stock of the corporation were owned as follows:
Arthur E. Manheimer 725 55.963
Trustees of the Manheimer Trust 150 11.579
William Shapiro 188 14.512
E. Roy Lowenthal 105.5 8.143
On February 5, 1940, Mannheimer and the trustees transferred to the corporation a total of 219 shares of its common stock, Mannheimer transferring 183, and the trustees 36. They received as consideration all the stock of the Hampden Watch Company and the assignment of a $10,000 note of Hampden payable to the corporation March 19, 1940.
On February 6, 1940, petitioners and Shapiro entered into a written agreement with Manheimer and the trustees by which they purchased the remaining 656 shares owned by them for $155.40 per share, or a total of $103,962.40, of which amount the purchasers became obligated to pay the sellers $36,000 in cash on or before February 29, 1940, and the balance, plus interest, on or before January 15, 1941. Petitioners and Shapiro in February, 1940, paid Manheimer and the trustees the $36,000 ($12,000 each) as agreed, from their own funds but were unable individually to raise the necessary money to pay the balance due under the contract.
On the date of the execution of the contract, the 656 shares sold by Manheimer and the trustees to petitioners and Shapiro were delivered to the corporation for transfer and new certificates were issued by which Shapiro acquired 245 shares, Cogan 223 shares and Lowenthal 188 shares. A second written agreement was entered into on February 6, 1940, between the petitioners and Shapiro, by which the latter agreed to transfer to Cogan 20 shares and to Lowenthal 60 shares of the stock which Shapiro had purchased from Manheimer and the ...