Rev. Rul. 56-153

Advice has been requested whether amounts received by an individual, such amounts representing dividends paid on shares of stock which he sold and holds in trust to secure payment of a promissory note given for the purchase price of the stock, the dividends to be applied as payment of interest and principal on the note until fully paid, constitute dividends to him within the meaning of section 316(a) of the Internal Revenue Code of 1954. Advice has also been requested whether such shares of stock represented a capital asset as defined in section 1221 of the Code, and whether the payments received on the principal of the note may be reported, for Federal income tax purposes, on the installment basis as provided in section 453(b) of the Code.

Taxpayer, together with another individual and a separate corporation, none of whom are dealers in securities, owned all of the issued and outstanding stock of M company. The three stockholders, after having held their shares of stock in M company for more than six months, sold such shares of stock to X corporation for a sum of 3,000 x dollars, payable 1,700 x dollars to the taxpayer and the balance to the second individual and the separate corporation. An initial cash payment of 735 x dollars was made to the sellers at the time of the sale, of which 136 x dollars was paid to the taxpayer, the balance to the other two sellers. Taxpayer received, in addition to the cash, a negotiable promissory note made by X corporation, payable to his order, for the balance of his share of the purchase price. The note and interest thereon are payable in quarter-annual installments, with a final payment payable ten years after the date of the note. X corporation, maker of the note, is unconditionally liable for payment of the note and interest. At the time of the sale entries were made on the books of M company indicating the transfer of the stock to X corporation.

Both corporation X and corporation M are actively engaged in retail merchandising. Prior to the consummation of the above-described sale, none of the stockholders of M company owned, directly or indirectly, any stock of X corporation; neither did any of the stockholders of X corporation own, directly or indirectly, any stock of M company.

Concurrently with the sale of the shares of stock of M company, a collateral trust agreement was entered into between taxpayer and X corporation whereby X corporation transferred to taxpayer, as trustee, to hold and possess for the security and benefit of the holders of the notes until fully paid, all of the shares of the stock of M company as well as all the shares of stock of a wholly-owned subsidiary company previously acquired by X corporation. The trust agreement grants to the trustee the power to vote the shares of both M company and the subsidiary company provided, inter alia , that the shares be voted so as to elect designees of X corporation to the boards of directors of both M company and the subsidiary company as specified therein. If further provides that the trustee, having voting rights of all the common stock, shall use his best efforts to cause the directors of the two companies to declare and pay out of earnings as dividends on common stock such amounts as shall be designated by X corporation to provide funds for quarterly payments on the promissory note, but not for any other purpose unless with written consent of X corporation. The trustee is to collect all dividends so paid by M company and the subsidiary company, and apply them to principal and interest on the note. If the cash received by the trustee is not sufficient to make such quarter-annual payments, payment of interest and principal is to be deferred, and X corporation is required to make out of its funds, other than those held by the trustee, payments up to the amount required for an annual payment on the note. The trustee will not deliver the shares of M company's stock to X corporation until the note is paid in full.

Section 316(a) of the Code defines dividends as any distribution made by a corporation to its shareholders, whether in money or in other property. Section 39.115(a)-1 of Regulations 118, made applicable herein by virtue of Treasury Decision 6091, C.B. 1954-2, 47, states that a taxable distribution made by a corporation to its shareholders shall be included in gross income of the distributees when the cash or other property is unqualifiedly made subject to their demands.

In the case of Estate of Arthur L. Hobson et al. v. Commissioner , 17 T.C. 854, acquiescence, C.B. 1952-1, 2, Hobson agreed to sell certain shares of stock. The total consideration involved was payable over a designated period of time during which Hobson, the vendor, was to remain record owner and in possession of the shares until the purchase price was fully paid. Hobson was to credit any and all dividends paid to him by reason thereof against the purchase price. The court held that the amounts received by Hobson by reason of retaining title to the stock, but applied by him against the purchase price thereof, were not ordinary income to Hobson but were dividends which belonged to the vendee and were taxable to him.

To similar effect are the cases of Charles B. Long v. United States , 66 Ct.Cl. 475, and Frederick M. Lee v. Commissioner , 143 Fed.(2d) 4, where the legal title to the stock sold was held by a trustee in trust for the sole purpose of securing the payment of the purchase price; and the cases of Fay Harvey Moore v. Commissioner , 124 Fed.(2d) 991, Helen A. DeGuire, Executrix under will of George N. DeGuire v. Higgins , 159 Fed.(2d) 921, certiorari denied, 331 U.S. 858, and Northern Trust Co. of Chicago, Executor under will of Aleta M. Gomoll v. United States , 193 Fed.(2d) 127, certiorari denied, 343 U.S. 956, where stock certificates and purchase money notes were placed in escrow pending payment of the purchase price and legal title to the stock sold was retained by the vendor for the sole purpose of securing payment of the purchase price.

The principle of the cases referred to above is considered applicable to the instant case where legal title to the stock sold is held by the vendor, as trustee, pending payment of the notes of the vendee issued in part payment therefor, for the sole purpose of securing payment of the purchase price.

Section 1221 of the Code, so far as here pertinent, defines the term `capital asset' as meaning property held by the taxpayer, whether or not connected with his trade or business, which is not stock in trade, property which is properly to be included in inventory, or property held primarily for sale to customers in the ordinary course of business, and which is not property used in trade or business which is subject to the allowance for depreciation.

Section 453(b) of the Code provides that income from a casual sale or other casual disposition of personal property, other than property of a kind which should properly be included in inventory, may be reported on the installment basis as provided in section 453(a) if the sale price exceeds $1,000 and the payments made during the taxable year in which the sale was made, exclusive of evidence of indebtedness of the purchaser, do not exceed 30 percent of the selling price. Section 39.44-1(b) of Regulations 118, made applicable herein by Treasury Decision 6091, C.B. 1954-2, 47, provides that if a taxpayer makes a proper election pursuant to section 44 of the Internal Revenue Code of 1939 to report income on the installment basis, there is reportable as income in any taxable year only that proportion of the installment payments actually received in that year which the gross profit realized or to be realized when payment is completed bears to the total contract price.

Accordingly, in view of the foregoing, it is held:

1. That the amounts representing dividends on the M company's stock received by the instant taxpayer (vendor) in his capacity as trustee of the stock to secure the payment of principal and interest on the note of X corporation which he holds for the balance of the sale price of such stock, which amounts are applied against installments falling due under the note, do not constitute dividends to him within the meaning of section 316(a) of the Code. Such dividends constitute ordinary income to the X corporation, the vendee.

2. Since this taxpayer is not a dealer in securities, and his shares of stock in M company were not held for sale to customers in the ordinary course of business, his shares of stock in M company constituted a capital asset, and since such shares were held for more than six months, any gain on the sale of the shares constitutes long-term capital gain subject to the provisions of section 1202 of the Code.

3. Inasmuch as the initial payments for the purchase of the stock of M company, received by the taxpayer during the taxable period in which the sale was made were less than 30 percent of a selling price exceeding $1,000, the sale qualifies as an installment sale of personalty, the gain from which may be reported for Federal income tax purposes on the installment basis as provided in section 39.44-1 of Regulations 118, made applicable herein by Treasury Decision 6091, C.B. 1954-2, 47.

I.T. 1958, C.B. III-1, 111 (1924), which held that dividends received by a bank as depositary of shares of stock sold by a taxpayer (vendor) and credited to his account, but subsequently applied to reduce the purchaser's (vendee's) liability for the unpaid balance of the purchase price of the stock, constituted taxable income to the vendor, is hereby revoked.

Under the provisions of section 7805(b) of the Internal Revenue Code of 1954, the Service will not require the provisions of this Revenue Ruling to be applied retroactively, in the case of a vendee, to taxable years beginning prior to July 1, 1952, the beginning of the month following the announcement in the Internal Revenue Bulletin of the Commissioner's acquiescence in the decision of the Tax Court of the United States in Estate of Arthur L. Hobson et al. v. Commissioner, supra .