author: Smith :

text:
    Farmers Mutual Cooperative Creamery, of Sioux Center, Iowa, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 70940.
    Promulgated September 30, 1935.

      A. O. B. Swensen, Esq., and Arthur ¡S. French, O. P. A., for the petitioner.

      J. H. Yeatman, Esq., for the respondent.
   OPINION.

Smith :

This case involves a deficiency in income tax of $714.50 for the calendar year 1980. There seems to be no dispute as to the amount of the deficiency, provided the petitioner is not entitled to the exemption from income tax which it claims.

Petitioner claims that, under section 103 (12) of the Revenue Act of 1928 and article 532 of Regulations 74, it is a corporation or association organized and operated on a cooperative basis for the purpose of marketing dairy products of its members and other producers, and turning back to them the proceeds of sales, less the necessary marketing expenses, on the basis of the quantity or value of the products furnished by them, thus entitling it to exemption from income tax. The section of the act and article of the regulations referred to are as follows:

The following organizations shall be exempt from taxation under this title—

*******
(12) Farmers’, fruit growers’, or like associations organized and operated on a cooperative basis (a) for the purpose of marketing the products of members or other producers, and turning back to them, the proceeds of sales, less the necessary marketing expenses, on the basis of either the quantity or the value of the products furnished by them, or (b) for the purpose of purchasing supplies and equipment for the use of members or other persons, and turning over such supplies and equipment to them at actual cost, plus necessary expenses. Exemption shall not be denied any such association because it has capital stock, if the dividend rate of such stock is fixed at not to exceed the legal rate of interest in the State of incorporation or 8 per centum per annum, whichever is greater, on the value of the consideration for which the stock was issued, and if substantially all such stock (other than nonvoting preferred stock, the owners of which are not entitled or permitted to participate, directly or indirectly, in the profits of the association, upon dissolution or otherwise, beyond the fixed dividends) is owned by producers who market their products or purchase their supplies and equipment through the association; nor shall exemption be denied any such association because there is accumulated and maintained by it a reserve required by State law or a reasonable reserve for any necessary purpose. Such an association may market the products of nonmembers in an amount the value of which does not exceed the value of the products marketed for members, and may purchase supplies and equipment for nonmembers in an amount the value of which does not exceed the value of the supplies and equipment purchased for members, provided the value of the purchases made for persons who are neither members nor producers does not exceed 15 per centum of the value of all its purchases;

Article 532 of Regulations 74:

Akt. 532. Farmers’ cooperative marketing and purchasing associations, and corporations organised to finance crop operations. — (a) Cooperative associations engaged in the marketing ol farm products for farmers, fruit growers, livestock growers, dairymen, etc., and turning hack to the producers the proceeds of the sales of their products, less the necessary operating expenses, on the basis of the products furnished by them, are exempt from income tax and shall not be required to file returns. Thus cooperative dairy companies which are engaged in collecting milk and disposing of it or the products thereof and distributing the proceeds, less necessary operating expenses, among the producers upon the basis of the quantity of milk or of butter fat in the milk furnished by such producers, are exempt from the tax. If the proceeds of the business are distributed in any other way than on such a proportionate basis, the association does not meet the requirements of the Act and is not exempt. An association which has capital stock will not for such reason be denied exemption, (1) if the dividend rate of such stock is fixed at not to exceed the legal rate of interest in the State of incorporation or 8 per cent per annum, whichever is greater, on the value of the consideration for which the stock was issued, and (2) if substantially all of such stock (with the exception noted below) is owned by producers who market their products or purchase their supplies and equipment through the association. Any ownership of stock by others than such actual producers must be satisfactorily explained in the association’s application for exemption. The association will be required to show that the ownership of its capital stock has been restricted as far as possible to such actual producers. If by statutory requirement all officers of an association must be shareholders, the ownership of a share of stock by a nonproducer to qualify him as an officer will not destroy the association’s exemption. Likewise, if a shareholder for any reason ceases to be a producer and the association is unable, because of a constitutional inhibition or other reason beyond the control of the association, to purchase or retire the stock of such nonproducer, the fact that under such circumstances a small amount of the outstanding capital stock is owned by shareholders who are no longer producers will not destroy the exemption. The restriction placed on the ownership of capital stock of an exempt cooperative association shall not apply to nonvoting preferred stock, provided the owners of such stock are not entitled or permitted to participate, directly or indirectly, in the profits of the association, upon dissolution or otherwise, beyond the fixed dividends. The accumulation and maintenance of a reserve required by State statute, or the accumulation and maintenance of a reasonable reserve or surplus for any necessary purpose, such as to provide for the erection of buildings and facilities required in business or for the purchase and installment of machinery and equipment or to retire indebtedness incurred for such purposes, will not destroy the exemption. An association will not be denied exemption because it markets the products of nonmembers, provided the value of the products marketed for nonmembers does not exceed the value of the products marketed for members.
(6) Cooperative associations engaged in the purchasing of supplies and equipment for farmers, fruit growers, live-stock growers, dairymen, etc., and turning over such supplies and equipment to them at actual cost, plus the necessary operating expenses, are exempt. The provisions of paragraph (a) relating to a reserve or surplus and to capital stock shall apply to associations coming under this paragraph. An association which purchases supplies and equipment for nonmembers will not for such reason be denied exemption, provided the value of the purchases for nonmembers does not exceed the value of the supplies and equipment purchased for members, and provided the value of the purchases made for nonmembers who are not producers does not exceed 15 per cent of the value of all its purchases.
In order to be exempt under either (a) or (6) an association must establish that it has no net income for its own account other than that reflected in a reserve or surplus authorized in paragraph (a). An association engaged both in marketing farm products and in purchasing supplies and equipment is exempt if as to each of its functions it meets the requirements of the Act.
(e) Corporations organized by farmers’ cooperative marketing or purchasing associations, or the members thereof, for the purpose of financing the ordinary crop operations of such members or other producers are also exempt, provided the marketing or purchasing association is exempt under section 103 (12) (see paragraphs (a) and (6) of this article), and the financing corporation is operated in conjunction with the marketing or purchasing association. The provisions of paragraph (») relating to a reserve or surplus and to capital stock shall also apply to corporations coming under this paragraph.

It is the contention of the respondent that petitioner is not entitled to the exemption because it does not treat its member and nonmember patrons alike, in that, from its yearly savings or profits after declaring and paying dividends on its capital stock, it declares and pays a patronage dividend to its stockholder patrons, but does not declare or pay a patronage dividend to nonmember patrons. The savings or profits resulting from the sale of the products of the nonmember patrons were placed in a reserve or sinking fund against which from time to time stock dividends were issued and cash dividends of 8 percent thereon paid to the stockholders in addition to the cash dividend of 8 percent paid on their original stock and investment.

The petitioner was incorporated in 1913 under the general incorporation laws of Iowa for the purpose of buying and selling cream and all dairy products, the manufacture of butter and ice cream, and buying and selling hogs and poultry products.

The authorized capital stock of the petitioner is $50,000, of the par value of $10 per share. It was provided that no person should own or have an interest in more than 50 shares, that no shares should be issued except on actual payment in cash therefor, and that no shareholder should have more than one vote in conducting corporate affairs. The bylaws provided that any practical farmer or dairyman could become a member by the purchase of one share of stock, and that an account with the shareholders should be taken once a year and if the business warranted, a dividend or interest of 8 percent should be paid on each share, and if there was a deficit each shareholder should be assessed according to the amount of business transacted with the corporation. No shareholder was permitted to withdraw from the funds of the corporation any of the accrued profits on his shares except upon a vote of the directors declaring a dividend. Buttermilk from the creamery was to be fed to hogs, if possible, otherwise to be sold, and the profit from hogs and buttermilk was to be paid to shareholders pro rata to the amount of butter fat furnished. Upon dissolution of the corporation the assets, after payment of liabilities, were to be divided among the shareholders in proportion to their shares of paid-up stock.

The petitioner operates a creamery at Sioux Center, Iowa. It sends out trucks through contiguous territory, which collect the cream from member and nonmember patrons. There were about 1,300 of the former and 200 of the latter during the taxable year. The cream is brought into the creamery, tested for butter fat, manufactured into butter, and sold principally in the eastern markets. The buttermilk is dried and sold in powdered form.

No distinction is made between member and nonmember patrons in the collection of the cream, its testing, manufacture, or in the price paid or advanced therefor. The price or advancement is fixed by the manager every two weeks according to the price on the New York market, and both member and nonmember patrons are paid or advanced such a sum below the New York market as will constitute a safe margin for the transaction of the business.

At the end of each year, after the payment of the necessary marketing expenses, the net profits are divided as follows: First, a dividend of 8 percent is declared and paid on the outstanding capital stock; second, a patronage dividend is declared and paid to stockholder members, based on the amount of butter fat furnished by each; third, the balance, which represents the amount of savings or profits resulting from the products furnished by the nonmember producers, is not paid or credited to them, but is credited to a sinking fund account, which is nothing but a reserve or earned surplus.

In the taxable year petitioner had a net income or savings of $34,025.97, which it disposed of as follows:

Dividend on capital stock_$3,939. 02
Patronage dividend to stockholders_ 24, 966. 80
Profits on nonmembers’ business credited to sinking fund_ 4, 756. 02
Percentage adjustment to sinking fund- 364.13

The item of percentage adjustment of $364.13 represented the odd percentage on stockholders’ patronage dividends, thus, in the taxable year the patronage dividend to which members were entitled was 3.94 percent. They were paid 3.9 percent and the odd percentage of .04 percent, amounting to $364.13, was carried into the sinking fund, whereas the entire 3.94 percent, amounting to $4,756.02 profits resulting from the business of nonmembers, was carried into the sinking fund and no nonmember was paid or credited with any amount therefor. The 1,300 members contributed $364.13 to the sinking fund during the taxable year and the 200 nonmembers contributed $4,756.02. The business for the year amounted to $762,446.17, of which the member business was $640,496.92, being 84 percent of the whole, and the nonmember business was $121,949.25, being 16 percent.

The petitioner has never paid or credited patronage dividends to a nonmember, and it is the policy of the company that no patron can participate in its profits or savings until after he becomes a stockholder, and then only as to profits accruing thereafter. On December 31, 1930, the outstanding capital stock of the petitioner was $45,680, of which $27,140 represented stock dividends for which the stockholders paid nothing, issued in the following manner: January 1,1926, there was in the sinking fund $16,693.19, which had been accumulated from savings on nonmember business. On January 31, 1925, at a stockholders’ meeting a motion was made and carried “ to divide part of sinking fund to shareholders, same to be paid out in shares and to give three-fourths share additional stock on every share owned.” This was done in 1926 by .the issuance of $11,782.50 in stock dividends, and charged against the sinking fund.

The balance in the sinking fund account January 1, 1929, was $28,146.86. On January 14,1928, the directors “ moved and seconded to pay dividend to shareholders and non-shareholder profits to be put in sinking fund.”

On January 12, 1929, at a meeting of the directors, the following was adopted:

Moved and seconded that profit for year 1928 he declared a dividend and non-shareholders profit be put in sinking fund. Motion carried. Moved and seconded to declare a stock dividend of half a share on a share to be taken out of the sinking fund and pay interest on dividend [sie] profits for ensuing year.

These resolutions were carried out in 1929 by the issuance of $15,440 in stock dividends, which was charged against the sinking fund. In every year since the issue of the stock dividends the stockholders have received a dividend of 8 percent on their original investment and also 8 percent on the stock dividends.

On December 31, 1930, there was $23,917.87 in the sinking fund and petitioner’s assets were of the value of $73,413.26, with practically no liabilities to creditors. It started operations in 1913 in a small way. In 1930, the taxable year, it did business for 1,500 producers and made sales to the amount of $810,624.19, approximately 3,000,000 pounds of butter.

It seeks to justify the accumulation of the sinking fund or surplus on the ground that its manufacturing plant is too small and its machinery needs replacement, and that, in order to manufacture economically and meet competition, it must have larger quarters and new, improved machinery, and that the sinking fund is for that purpose, or some other emergency. Informal discussion has taken place among the officers on the subject, but nothing has been done except the purchase of two small lots of ground in 1926 for $1,000.

At the time petitioner was organized there was no special law in Iowa relative to the organization of a cooperative corporation or association, but from 1915 to the present Iowa has had such statutes. Petitioner seeks to bring itself within these statutes and benefits, if any, but it has failed to show that it has accepted the cooperative law by formal action of the corporation, as required by section 8481, Iowa Code, 1927,1981. But whether it has accepted and is governed by the Iowa laws referred to is immaterial, as we are governed in this case by the Federal income tax laws.

It is the settled doctrine of the courts and this Board that a taxpayer claiming an exemption from taxation must bring himself strictly within the law allowing such exemption. Register v. Commissioner, 69 Fed. (2d) 607; Producers Creamery Co. v. United States, 55 Fed. (2d) 104; Bank of Commerce v. State of Tennessee, 161 U. S. 134; Heiner v. Colonial Trust Co., 275 U. S. 232; Riverdale Co-operativie Creamery Assn. v. Commissioner, 48 Fed. (2d) 711.

In order to be entitled to the exemption the claimant should be, first, organized and operated on a cooperative basis; second, organized and operated for the purpose of marketing the products of members or other producers, and turning back to them the proceeds of sales, less the necessary marketing expenses, on the basis of either the quantity or the value of the products furnished by them; third, it must show that the dividend on its capital stock does not exceed 8 percent on the value of the consideration for which the stock was issued; fourth, it must show that it has not accumulated an excessive or unnecessary reserve.

This petitioner has failed to qualify for the exemption, as it has plainly violated some of these requirements.

Equality of treatment to all of the producer patrons, members, and nonmembers is essential.

In Central Co-operative Oil Association, 32 B. T. A. 359, we had before us a purchasing cooperative association which claimed an exemption for the year 1930 under section 103 (12) of the Be venue Act of 1928. It bought and sold gasoline for its members and others, including transients. At the end of the year it divided among its patrons, who could prove their purchases, the share of its profits attributable to their purchases, and the balance, attributable to nonmember business or to those who had failed to prove their purchases, was deemed and accounted for as undivided profits. We held that “ obviously some patrons, local as well as tourists and transients, paid a profit to petitioner, which, under the scheme, was not returned to them, while other members and patrons received the benefits of such profit.” The exemption was denied.

The case of Riverdale Co-operative Creamery Assn. v. Commissioner, 48 Fed. (2d) 711, affirming 18 B. T. A. 1159, ivas a case of a dairy association arising under the Acts of 1918 and 1921. The taxpayer had capital stock and, after paying a dividend of 8 percent thereon, the balance above operating expenses was turned into a sinking fund or reserve to pay the indebtedness of the association, the cost of the plant and equipment in which nonmembers had no interest. The court there said in part:

* * * And, taking the statutes as our guide, we are of opinion that the exemptions claimed cannot he allowed, because the petitioner was not organized and operated during the years in question as a sales agent for the purpose of marketing the products of its members, and more especially because it did not turn back to its members and producers the proceeds of sales less necessary selling expenses. In addition to necessary selling expenses, there was deducted or reserved from the proceeds of sales a sinking fund sufficient to retire the indebtedness of the petitioner, to provide for the erection of buildings and facilities required in the business, and for the purchase and installation of machinery and equipment. From this reserve there has developed a plant of considerable value, which belongs exclusively to the petitioner and its members. Expenses incurred for such purposes do not, in our opinion, fall within any reasonable definition of the term necessary selling expenses.

In Producers Creamery Co. v. United States, 55 Fed. (2d) 104, the taxpayer was in the business of marketing milk. It purchased milk from both stockholders and nonstockholders. It paid the stockholders the regular market price plus a bonus on milk brought in up to 10 gallons per day for each $100 of stock owned. To nonstock-holder patrons it paid the regular market price without bonus. After quoting the requirement that the proceeds of sales, less necessary marketing expenses, must be distributed among the producers on the basis of the quantity of milk or butter fat in the milk, the court in that case said:

Appellant does not distribute the proceeds less expenses among the producers with whom it deals in this way. It does not distribute them in any way to 30% of its producer customers (nonstockholders). These get no bonuses, are entitled to no dividends, have no interest in the company.

In holding that the corporation was not exempt the court said:

It is plain, therefore, that appellant was not in 1924 either under the terms of the statute standing alone, or, as liberalized by the regulations, a cooperative association as contemplated in the act. South Carolina Produce Ass’n. v. Commissioner, (C. C. A.) 50 F. (2d) 742. We think it equally clear that it was not exempt under the 1926 Act. This act does expressly extend the exemption to corporations Raving a capital stock, paying dividends on the stock, and accumulating a reserve, and does specifically provide tliat such an association may market the products of non-members to the extent of 50 per cent, of its business. It, however, just as the 1924 statute does, bases the tax exemption upon the fact that the association is organized to, and in operation does, turn back to those for whom it markets their produce the proceeds of the sales, less operating costs. Here the undisputed proof shows that appellant makes at least 30 per cent, of its profit from non-members to whom it turns nothing back.
In Fruit Growers' Supply Co. v. Commissioner, 56 Fed. (2d) 90, affirming 21 B. T. A. 315, the taxpayer was a fruit growers’ sales association, and also acted as a purchasing agent and manufacturer of shook for crating fruit. After furnishing its members it sold the excess to nonmembers, to whom it paid no patronage dividends. It was held that the profits or savings on the nonmember business constituted profit to the association or its members and that such association was not entitled to exemption on the income from supplies sold nonmembers. See also Burr Creamery Corporation, 23 B. T. A. 1007; 62 Fed. (2d) 407; South Carolina Produce Association, 19 B. T. A. 1028; 50 Fed. (2d) 742.

The act expressly provides:

Exemption shall not be denied any such association because it has capital stock, if the dividend rate of such stock is fixed at not to exceed the legal rate of interest in the state of incorporation or 8 per centum per annum, whichever is greater, on the value of the consideration for which the stock was issued.

Article 3 of the petitioner’s articles of incorporation provides: “ and no shares shall be issued to anyone except on actual payment in cash therefor.”

Admittedly, in this case $27,140 of the outstanding capital stock of $45,680 was issued as stock dividends and the shareholders paid nothing therefor. This fact alone bars the petitioner from claiming, exemption from income tax; for after the declaration of the stock' dividends, the stockholders were receiving from 12 to 18 percent per annum on the amounts invested by them.

Belative to the right to accumulate and maintain a reserve required by state law or for any necessary purpose, it is sufficient to say that it used its reserve for an entirely different purpose. A part of it was capitalized in the form of stock dividends upon which dividends were paid at the rate of 8 percent per annum.

Petitioner relies mainly upon the case of Farmers Union State Exchange, 30 B. T. A. 1051, in support of its right not to turn back to nonmembers the profits resulting from their business, but to turn it into a sinking fund or reserve.

The facts in that case, however, are considerably different from those in the instant case. There one of the activities of the State Union, a cooperative, was the operation of livestock commission houses for the benefit of its members, but they also marketed livestock and received commissions from nonmembers. All patrons were treated alike except that a nonmember patron was not entitled to receive, and did not receive any patronage dividend until he had qualified as a member of the State Union. Upon becoming a member, his patronage dividend was paid him. We there said:

Although the livestock commissions were operated and originally financed by the Union for its members, no part of the undistributed earnings of the commissions inured to the benefit of the Union.
If the question before us' were whether the three livestock commissions are such cooperative sales agents as are exempt from tax under the statutes, they would meet the test prescribed. From about 82 to 90 percent of the net earnings of the livestock commissions was distributed to the patrons each year on a proportionate basis. The undistributed earnings of the livestock commissions were small in proportion to the business done and were certainly no more than were necessary to be reserved for the exigencies of the business. The business with nonmembers was negligible, and upon the nonmember patron becoming a member he received his patronage dividend. The retention of such a small proportion of the savings would not be sufficient to destroy the exempt status of a cooperative sales agent. The operation of the commissions by the Union did not have the effect of taking the Union out of the exempt class.

It will be observed that in that case it was expressly shown and held that the dividends withheld from the nonmember patrons did not inure to the benefit of the State Union or its members. It was further held that the withheld dividends would be paid to the nonmember whenever he qualified as a member. There was no question in that case of the issuance of stock dividends and payment of interest or dividends thereon in excess of 8 percent, and, instead of holding the nonmember patronage dividends to be delivered to him on qualification, the petitioner’s policy and practice was not to pay a nonmember such accrued dividends when he became a stockholder.

We conclude that petitioner is not entitled to the exemption.

Decision will be entered, for the respondent.


source: Caselaw Access Project

author: Smith:

license: Public Domain

text:
    Mary Duke Biddle, Petitioner, v. Commissioner of Internal Revenue, Respondent. George W. Elkins, Petitioner, v. Commissioner of Internal Revenue, Respondent. Leslie H. Reed, Petitioner, v. Commissioner of Internal Revenue, Respondent. State-Planters Bank and Trust Company, Administrator d. b. n. c. t. a., Estate of Marie Cooke Hickey, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent. State-Planters Bank and Trust Company, Executor, Estate of James J. Hickey, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 62025, 75742, 75812, 75849, 75852.
    Promulgated September 30, 1935.

      Forrest Hyde, Esq., F. J. Daniels, Esq., W. B. Spoford, Esq., and R. E. Cabell, Esq., for the petitioners.

      Dean P. Kimball, Esq., and H. B. Linton, Esq., for the respondent.

      Albert L. Hophins, Esq., as amicus curiae.
   OPINION.

Smith:

¡.These cases, consolidated for hearing, involve deficiencies in income tax for the years and in the amounts as follows:

The issues raised by the pleadings in the case of Mary Duke Biddle, Docket No. 62025, were settled by the parties prior to the hearing, except as noted below, and were disposed of by stipulation of counsel filed at the hearing as a part of the record in these proceed-rags. In the deficiency notice issued to Mary Duke Biddle a portion of the amount of United Kingdom income tax “ appropriate ” to the dividends received by her from United Kingdom corporations was allowed by the respondent as a credit against her income tax due the United States and the balance not available as a credit was allowed as a deduction. The respondent now alleges error in allowing such credit. The stipulation entered into by the parties in the determination of the tax liability for 1929 provides :

(3) That there be reserved, for determination by the United States Board of Tax Appeals the question of whether (1) all or any portion of the sum of $47,380.27, alleged to have been paid by Petitioner as income taxes to Great Britain, should be allowed as a credit on Federal Income Taxes and the balance thereof deducted from gross income, or (2) the whole of said amount should be excluded from gross income.

In all of the other cases the respondent has disallowed the petitioners’ claims for credit against Federal income taxes of United Kingdom income taxes “ appropriate ” to the dividends received.

At the hearing of these proceedings counsel for the respondent conceded that the amounts of surtaxes (additional income taxes) paid by the petitioners directly to the Crown were proper credits against the income taxes due the United States and that the disallowance of such credits was improper.

The same question is presented in each case, namely, whether under section 131 of the Kevenue Act of 1928 all or any portion of the amounts of United Kingdom income tax “ appropriate ” to the dividends paid to the petitioners by the United Kingdom corporations should be allowed as a credit against Federal income taxes and the balance thereof not available as a credit deducted from gross income under section 23 (c) of the Kevenue Act of 1928, as contended by the petitioners, or the whole of said amount of tax “ appropriate ” to said dividends should be excluded from gross income, as contended by the respondent.

The evidence before the Board in these proceedings consists of an agreed statement of facts in each case, certain documentary evidence, and the testimony of Frank Heyworth Talbot, barrister, of London, England, an authority on British income tax law, who was introduced by the petitioners.

The agreed stipulation of facts in each case is adopted as a part of our findings by reference.

During the taxable years all the petitioners were citizens and residents of the United States and were owners of shares of stock in corporations organized under the laws of Great Britain and Ireland. During the years involved those corporations declared and paid dividends on their shares of stock. The Tobacco Securities Trust Co., Ltd., declared its dividends, so far as the record shows, less British or United Kingdom income taxes. Although the dividend declarations are not in evidence, it appears that the dividends were declared in gross amount, from which were deducted United Kingdom income taxes “ appropriate ” thereto, and checks for the balance were sent to the stockholders. The British-American Tobacco Co., Ltd., and Imperial Tobacco Co. of Great Britain and Ireland declared their dividends “ free of income tax.” A dividend declared by a United Kingdom corporation “ free of income tax ” is in substance and effect a dividend of such gross amount as after the deduction of income tax at the rate “ appropriate ” thereto amounts to the net sum actually paid to the stockholder. All of the dividend checks transmitted by the respective companies to their stockholders were accompanied by statements which indicated on their face the amount of United Kingdom income tax “ appropriate ” to the dividend paid to each stockholder.

All of the petitioners kept their books of account and made their income tax returns upon the cash receipts and disbursements basis. Petitioners reported in their respective returns as “ dividends from foreign corporations” the amounts actually received from dividend-paying corporations plus the amounts of United Kingdom income taxes “ appropriate ” thereto. Thereafter an income tax was calculated on net income before taking any credit or deduction for foreign taxes paid. The amount of the credit was then computed by applying the ratio which the foreign net income bore to the total net income to the provisional tax in order to determine the portion of foreign taxes allowable as a credit. After ascertaining the proper credit for foreign taxes, Federal net income was finally computed by deducting from gross income the balance of foreign taxes not allowable as a credit. Petitioners claimed the credit as determined aforesaid against Federal income tax and in support of their claims filed certain documents received from the dividend-paying corporations. The respondent has disallowed the credits claimed (except as indicated above in the case of Mary Duke Biddle) in the determination of the deficiencies.

Income taxes have been continuously in force in the United Kingdom of Great Britain and Ireland since 1842. In 1918 various acts and amendments thereto then in force were consolidated in the Income Tax Act of 1918. The Act of 1918 is continued in force from year to year by the annual finance acts. Some of the provisions of these finance acts have modified the basic Income Tax Act of 1918.

In general the English income tax acts are based upon the principle of collection of tax at the source. The income tax is imposed at a standard rate. The person or corporation paying certain determinable income is required to pay over to the Crown income tax at the standard rate and the balance is paid to the one entitled to receive the income. Thus, a lessee pays to the Crown income tax at the standard rate upon the rental to be paid by him and only the balance is paid over to the landlord; a corporation paying interest upon its bonds likewise deducts from the interest payable to the bondholder income tax at the standard rate which it pays to the Crown and only the balance is paid over to the bondholder.

Rule 1 of the General Rules made a part of the Income Tax Act of 1918 applicable to schedule D provides that tax under that schedule (which is a tax upon a particular type of income, including among other things the profits of a business) shall be levied and paid by the individuals or bodies of persons receiving or entitled to receive the income which is the subject matter of the tax under that schedule.

Section 231 of the act defines a “ body of persons ” to mean “ any body politic, corporate, or collegiate, and any company, fraternity, fellowship and society of persons, whether corporate or not corporate.” The various types and kinds of income that are taxed are enumerated in schedules A to E, inclusive, of the first schedule of the 1918 Act. Section 1 of part (1) of the act provides that when any finance act levies income tax for any year at any rate the income which is so taxed shall be that which is> described in schedules A to E, inclusive.

Rule 20 of the General Rules applicable to schedules A to E provides as follows:

Tlie profits or gains to be charged on any body of persons shall be computed in accordance with the provisions of this Act on the full amount of the same before any dividend thereof is made in respect of any share, right or title thereto, and the body of persons paying such dividends shall be entitled to deduct the tax appropriate thereto.

A United Kingdom corporation pays income tax upon its gains and profits whether a dividend is paid within the taxable year or not. The balance of the profits not taken as a tax may be added to the corporation’s surplus, utilized for betterments or improvements, or paid out in dividends. The undistributed profits of one year may be distributed in a subsequent year. The standard rate of tax in the subsequent year may be different from the standard rate in effect when the profits were earned by the corporation. The British income tax acts provide that wherever a dividend is paid the recipient thereof shall be advised of the rate and amount of tax appropriate ” to the dividend. Such rate is that which is in effect at the time the dividend is paid. The stockholder receiving the dividend is regarded by the English income tax acts as having paid by deduction or otherwise ” the tax “ appropriate ” to the dividend. The stockholder is not required to pay any income tax at the standard rate upon the amount of cash distributed to him by the corporation. He may, however, be subject to a surtax, and in making his surtax return the stockholder is required to include in his gross income not only the amount of the distribution received from the corporation but that amount plus the tax “ appropriate ” thereto. On the other hand, the stockholder receiving the dividend may not, by reason of exemptions and relief provisions of the income tax acts, be required to pay the .full amount of the tax represented by the tax “ appropriate ” to the dividend. In such case the stockholder is entitled to file a claim for refund with the English authorities and upon the proof of claim is entitled to recover a part or all of the tax “ appropriate ” to the dividend.

The British income tax acts in force in the taxable years further provide that the corporation in paying the dividend may deduct from the dividend the tax “ appropriate ” thereto. Thus, where the earnings of a corporation in a given year amount to £1,000 and the standard rate of income tax is 25 percent, the corporation pays to the Crown a tax of £250 and has left £750 to distribute to its stockholders. It may declare a dividend in the gross amount of £1,000 “ less income tax ”, in which event the stockholders receive £750. On the other hand, it may declare a dividend “ free of income tax ”, in which event the dividend is declared in the amount of £750 and the stockholders receive £750. In either case the stockholders are regarded as having paid an aggregate income tax of £250 in respect of the dividends received by them. This is by virtue of section 32, subsection (2) of the British Income Tax Act of 1918, which provides in part as follows: “ If any such person is charged to tax under any Schedule and has paid that tax, or has paid or has teen charged with tax hy deduction or otherwise, he shall, on a claim being made to the special commissioners, and on production * * * ” be entitled to relief. (Italics supplied.)

The petitioners’ expert witness, Talbot, stated unequivocally that under the English income tax acts and in their administration a stockholder receiving a dividend from a corporation is regarded as having paid the amount of tax “ appropriate ” to the dividend.

The question before us in these proceedings is, first, whether under the Federal income tax acts the petitioners are required to include in their gross income not only the amounts actually received by them as dividends from United Kingdom corporations, but in addition thereto the amount of tax “ appropriate ” to those dividends which the United Kingdom income tax acts regard as having been paid by the stockholders, and. secondly, whether the petitioners are entitled to a credit against their Federal income taxes of any portion of the amounts “ appropriate ” to the dividends received' by them from United Kingdom corporations.

Ordinarily a taxpayer on a cash receipts and disbursements basis is required to include in gross income only the cash or value of property which comes into his ownership or control. The requirement of the statute that persons keeping their books of account and making their returns on a cash receipts and disbursements basis must be construed according to its usual acceptation. Avery v. Commissioner, 292 U. S. 210.

Section 22 (a) of the Kevenue Act of 1928 provides that “ gross income ” includes gains, profits, and income derived from * * * dividends.”

Section 115 of the same act defines a “ dividend ” to mean “ any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28,1913.”

Kegardless of any provision of the United Kingdom income tax acts or any practice thereunder, we think it clear that the only amounts distributed by a United Kingdom corporation within the meaning of section 115 are the amounts of money paid over to and received by the stockholders. If, in truth, the stockholder owed United Kingdom income tax at the standard rate in respect of the dividend received, it might be argued that the word “ distributed ” as used in section 112 had application not only to the amount of cash paid to the stockholder but the amount of his liability in respect of the dividend paid by the corporation from which he received the dividend. But, as shown below, a stockholder has no liability for income tax at the standard rate upon dividends received by him.

We are furthermore of the opinion that the amount of income derived by any one of the petitioners from the United Kingdom corporations was the amount of cash actually received by them. This we think follows from Avery v. Commissioner, supra. We, therefore, are of the opinion that the respondent did not err in excluding from the petitioners’ gross incomes the amounts of tax “ appropriate ” to the dividends under the provisions of the English income tax acts.

The second question, which we think is dependent upon the first, is as to whether the petitioners are entitled, under section 131 of the Kevenue Act of 1928, to credits against their Federal income taxes of the amounts of United Kingdom income tax “ appropriate ” to the dividends. Section 131 of the Kevenue. Act of 1928 provides as follows:

SEC. 181. TAXES OE FOREIGN COUNTRIES AND POSSESSIONS OF UNITED STATES.
(a) Allowance of credit. — -The tax imposed by tliis title shall be credited with:
(1) Citizen and domestic cokpokatton. — In the case of a citizen of the United States and of a domestic corporation, the amount of any income, war-profits, and excess-profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States; and
* * * *4: * * * *
(b) Limit on credit. — In no case shall the amount of credit taken under this section exceed the same proportion of the tax (computed on the basis of the taxpayer’s net income without the deduction of any income, war-profits, or excess-profits tax any part of which may be allowed to him as a credit by this section), against which such credit is taken, which the taxpayer’s net income (computed without the deduction of any such income, war-profits, or excess-profits tax) from sources without the United States bears to his entire net income (computed without such deduction) for the same taxable year.

In Welch v. St. Helens Petroleum Co., Ltd., 78 Fed. (2d) 631, it was held that under section 234 of the Revenue Act of 1921 a foreign corporation with income from sources within the United States is entitled to deduct any income tax paid to Great Britain even though it is entitled to deduct such foreign taxes under the laws of Great Britain from the dividends paid its stockholders. In other words, the court held that the income tax paid by a United Kingdom corporation to the Crown was an income tax for which it alone was liable; that it did not pay the tax as agent for the stockholders; and that its right to reimbursement afforded by the United Kingdom income tax acts did not prevent it from deducting from gross income in determining the amount of the Federal income tax the full amount of the tax paid to the Crown. Although that case did not cover income taxes due the United States for the years 1929 and 1931, we have been unable to find any provision of the United Kingdom income tax acts or Federal income tax acts that would show the inapplicability of that ruling to the tax years before us.

The petitioners’ witness, Talbot, made no contention that the income tax paid by the United Kingdom corporation was paid as agent for its stockholders. The decisions of the British courts are to the contrary.

In Welch v. St. Helens Petroleum Co., Ltd., supra, the Circuit Court of Appeals for the Ninth Circuit stated:

In a recent tax case before the House of Lords, (Newmann v. Commissioners of Inland Revenue, (K. B.) 49 T. L. R. 1, (C. A. 1933) 1 K. B. 728, and (H. L. 1934) A. C. 215) the relation of the stockholder to a tax paid by a corporation and subsequently deducted from a dividend paid to him was considered. In discussing the ease Lord Wright said:
The shareholder and the company are no doubt separate entities; the company is not an agent for the shareholder to pay tax on the dividend, nor is the company the collector for the Revenue to deduct the tax from the dividend. The company is the taxpayer. The shareholder has no right to any share in the profits till a dividend is declared; the company may use the profits in any way it pleases vis-a-vis any shareholder; it may put them to reserve or capitalize them or use them for extensions or improvements; the profits declared and paid as dividends in one year may have been made in previous years when the standard rate of tax was different; it is only very rarely and in exceptional cases that dividends are paid out of any particular source of profit; usually they are paid out of the general revenue fund of the company. What is essential to the requirements of the Inland Revenue is that all the profits of the company should be taxed and if that is done the Revenue is not concerned with what is done with these profits. The company is not bound but only authorized to deduct tax in paying dividends; whether it deducts or not is left to its discretion because the profits once having been taxed in the company’s hands, do not bear further tax (apart from surtax) in the shareholders’ hands. There is in fact only one profit, no new profit being created from the fact that the shareholder gets his share: the tax is a tax on the profits and not on the dividend. But if tax is deducted from the dividend the Acts have provided that it is to be at the standard rate of tax of the year of the dividend, in order to avoid obvious difficulties which might arise because profits divided in one year may have been earned in other years.
Lord Tomlin, in the same case, states: “ Now I may say at once that, having regard to the view which I have expressed as to the general scheme and operation of the Income Tax Acts in regard to dividends, I am unable to accept the view that dividends as such are taxable under Sch. D. I do not think they are. I think it is accurate to say as Rowlatt, J. said in Purdie v. The King (1): ‘ There is, strictly speaking, no tax upon dividends at all.’ They are, however, under r. 20 of the General Rules and s. 39 of the Finance Act, 1927, and apart altogether from s. 7 of the Finance Act, 1931, liable, where the dividends are made out of profits or gains charged on the Company, to suffer deduction of a sum equal to tax at the standard rate on the gross amount of the dividends, and in such cases the gross amount of the dividend is the income tax income to be taken into account whether it be for computing the amount of tax which the shareholder is entitled to have returned or for fixing his liability to surtax.” The order proposed by Lord Tomlin, concurred in by Lord Wright and Lord Warrington of Clyffe, was adopted by the House of Lords.

The above cited case in our opinion is authority for the statement that the United Kingdom income tax acts impose no tax upon the payment of a dividend; that the stockholder has no liability to United Kingdom income tax at the standard rate in respect of the dividend received by him. It can not therefore be said that when a United Kingdom corporation pays income tax to the Crown it pays a tax for the stockholder or discharges any obligation resting on the stockholder. In making the payment the corporation simply discharges its obligation to pay United Kingdom income tax.

The action oí the respondent in denying credit to the petitioners of any amount representing United Kingdom income tax “ appropriate ” to the dividends received by them is approved.

In Basil Robillard, Executor, 20 B. T. A. 685, we said:

On final determination under Rule 50, petitioner should be allowed credit against the tax of income taxes paid to the British Government by the Spirella Co. of Great Britain on dividends disbursed direct to petitioner’s decedent, as a stockholder in the Spirella Go. of Great Britain, and as a life tenant of the stock owned hy the estate of her deceased husband, Marcus M. Beeman.

This can not be taken as the opinion of this Board that a citizen of the United States, a stockholder of a United Kingdom corporation, is entitled to a credit of United Kingdom income tax “ appropriate ” to the dividend received. The ruling made by the Board in the above cited case was merely for the purpose of carrying into effect a stipulation of the parties litigant in that case.

Reviewed by the Board.

Judgment will be entered under Rule 50.


author: Leech;

text:
    A. D. Saenger, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 68117.
    Promulgated September 30, 1935.

      8. L. Herold, Esq., and 8. P. Cousin, Esq., for the petitioner.

      DeWitt M. Eva/ns, Esq., and F. B. 8ehlosser, Esq., for the respondent.
   OPINION.

Leech;

Respondent determined that petitioner was formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholder through the medium of permitting its gains and profits to accumulate instead of being distributed. Thereupon, pursuant to section 104 (a), Revenue Act of 1928, he levied a tax of 50 percent upon petitioner’s net income for 1929, and gave due notice to petitioner of a deficiency of $65,808.05 in 1929 income taxes, the entire amount of which results from that determination. Petitioner challenges the correctness of that determination. Alternatively, petitioner alleges error in respondent’s determination of its 1929 net income, determinable with reference to section 104 (c); and, also, it contends that section 104 is unconstitutional.

Petitioner, a Louisiana corporation with its principal office at Shreveport, was organized on August 7, 1929, to take over all of the shares in the A. &. J., Inc., owned by A. D. Saenger. It keeps its books and renders returns on a cash basis.

Prior to 1927, A. D. and J. H. Saenger, brothers, conducted many different and varied lines of business, including a drug store, motion picture theaters, real estate, and investments in securities, as a partnership, under the firm name and style of Saenger Brothers. They organized the A. & J., Inc., a Louisiana corporation, on March I, 1927, and conveyed to it all of the partnership assets, except certain shares in Saenger Theatres, Inc., for all of the 15,000 shares of that company’s stock, which, except for two shares to qualify a director, were divided equally between them, 7,499 to each.

On August 7, 1929, A. D. Saenger caused the petitioner to be organized and conveyed to it, in exchange for all ($500,000 par value) of its capital stock, his 7,499 shares in the A. & J., Inc. The fair market value of those 7,499 shares, as of the date of the exchange, was $2,077,522.96, but they were entered on petitioner’s books at $749,900, their par value. On the same day, J. H. Saenger caused J. PI. Saenger, Inc., to be organized and conveyed to it, in exchange for all of its capital stock, his 7,499 shares in the A. & J., Inc. The two brothers and one Oliphint were the officers and directors of these two companies and of the A. & J., Inc.

The petitioner’s only income in 1929 was dividends on stocks of domestic corporations. Its cash receipts in 1929 from that source amounted to $23,804.90, of which $22,204.90 was dividends on shares in the A. & J., Inc. Its cash disbursements in 1929, to meet current expenses, amounted to $1,233.91.

On October 31, 1929, the A. & J., Inc., declared “ a dividend of 17Yz per cent on the outstanding stock of the A. & J., Inc.”, which amounted to $262,500, of which $131,250 was payable to petitioner. The sum of $262,500 was “ appropriated from the surplus earnings of the company for the said dividend,” the dividend was “ due and payable as of this date ”, the treasurer was “ directed to notify the stockholders of this dividend, and to pay same by crediting said dividend to the individual accounts ”, and the remainder due the stockholders, after offsetting any amounts owing to the company, was to be “ drawn out as the said stockholders desire.” The A. & J. Co. did not have in 1929, after the dividend declaration, sufficient cash with which to pay either its current liabilities or the dividend; it did have, however, marketable securities, most of which were listed and actively dealt in on the New York Stock Exchange, having a then fair market value of at least $1,750,000, which is about $1,250,000 more than its then current liabilities and dividend obligation.

Within the taxable year, the petitioner charged the A. & J., Inc., on its books, with its $131,250 share of the dividend declared on October 31, 1929, and it reported that amount in its tax return. It actually received $22,204.90 in cash from the A. & J., Inc., in 1929, on account of that dividend.

On December 31, 1929, the petitioner had cash funds of $8,001.83 and outstanding current liabilities of $91,953.54. The fair market value of the securities which it owned on December 31, 1929, including the aforesaid 7,499 shares in the A. & J., Inc., was, as of that date, $1,561,396.24; and the fair market value of its net assets, as of the same date, over and above the par value of its capital stock, was $1,108,750.83.

The petitioner did not declare or pay any dividends in 1929, 1930, and 1931. Whether or not it had any gains or profits in 1930 and 1931 does not appear from the record. At the close of those years, A. D. Saenger, sole shareholder, was indebted to it, on account of cash loans, in the amounts of $22,261.20, $101,061.77, and $185,025.26, respectively. Also, A. D. Saenger was further obligated to the petitioner at the close of 1931, in the sum of $193,000, the explanation of which is not clear on the record.

Section 104 of the Revenue Act of 1928 lays a tax of 50 per centum upon the net income, including corporate dividends, of any corporation formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed; and the fact that any corporation is a mere holding or investment company, or that the gains or profits are permitted to accumulate beyond the reasonable needs of the business, is prima facie evidence of a purpose to escape the surtax. Construing the substantially similar provisions of section 220, Revenue Act of 1921, the Circuit Court of Appeals, Second Circuit, in affirming 19 B. T. A. 809, stated in United Business Corporation of America v. Commissioner, 62 Fed. (2d) 754; certiorari denied, 290 U. S. 635, as follows:

The section declares that when a company is formed or used “ for the purpose of preventing the imposition of the surtax upon its stockholders ” by allowing “ its gains and profits to accumulate instead of being divided or distributed,” it shall pay twenty-five per cent more than its proper tax. It is presumptive evidence of such a purpose that it is “ a mere holding company, or that the gains and profits are permitted to accumulate beyond the reasonable needs of the business,” provided that the Commissioner shall so certify. Ordinarily it will indeed be difficult to prove the forbidden purpose, unless the accumulations are too large for the fair needs of the business. But it may not be impossible to do so, even though the profits arise out of normal business, as they did not here. The management may for example be shown to have always been sanguine, and to have withheld only small reserves, though prudence justified more. A sudden change of policy, coincident with large increases in the surtax rates, might in that situation betray a purpose to accumulate against a season more propitious for distribution. Or the officers might unguardedly disclose a scheme to avoid surtaxes, though the other evidence was not enough. A statute which stands on the footing of the participants’ state of mind may need the support of presumption, indeed be practically unenforceable without it, but the test remains the state of mind itself, and the presumption does no more than make the taxpayer show his hand.

But, as the court there indicated, the display of that “ hand ” does not relieve the taxpayer if it discloses the state of mind the statute condemns.

At the time the petitioner was organized, the two Saenger brothers had a substantial investment in the A. & J., Inc., which they owned in equal proportions and without any adverse interest. At that time, A. I). Saenger had a minor daughter, who, he was advised, by virtue of the “ Louisiana Community Law ”, could tie up his estate, in the event of his death before she attained her majority. At the same time, J. H. Saenger had become involved in a social relation, which needs no more definitive specification here. In connection with this latter situation, it was testified that there was some uncertainty in the minds of the two brothers, as well as their confidential adviser, as to the place a third party might attain in the affairs of the A. & J., Inc., in the event of the prior decease of J. H. Saenger. What that uncertainty was based upon we have not been advised, nor have we been sufficiently informed of the facts of the situation to justify any conclusion as to its reality. At any rate, so the testimony goes, the brothers were apprehensive of the effect these conditions would have upon their estates and the extent to which they would “ interfere with the policy ” of the A. & J., Inc., in the event of the death of either. So they resolved to remove this uncertainty by creating separately owned corporations to hold their shares in the A. & J., Inc., and making new wills under which control of these corporations would be placed in the surviving brother and their confidential ad visea1. This they did; and so the petitioner was brought into being. These, it is further testified, are the antecedent facts and circumstances to petitioner’s birth, and in them rests the motive or purpose of its creation. But we are not convinced that such are the antecedent facts and circumstances.

Conceding the brothers’ objectives — control of their estates and of the A. & J., Inc., in the surviving brother — nothing was or could be done toward the attainment of those objectives by the interposition of the separately owned corporations. The only change wrought by creating these corporations is that, upon the death of either brother, the shares in his separately owned corporation will pass to his estate, instead of the shares in the A. & J., Inc., which he formerly owned. This change could in nowise vest post-mortem control of the estate of either in the surviving brother. Nor could control of the A. & J., Inc., in the surviving brother be made any more secure by the change, for that control is dependent upon control of the shares in the separately owned corporations. Control of their estates, which would include the shares of the separately owned corporations with accompanying control of the A. & J., Inc., could only vest in the surviving brother by appropriate testamentary provisions. It is thus evident that the creation of the separately owned corporations was not a necessary step in the carrying out of the brothers’ purpose to place control of their estates and of the A. & J., Inc., after death, in the hands of the surviving brother. Being an unnecessary one, why then was the step taken? On that score the record is entirely silent, and we can think of no plausible reason or explanation. Under the circumstances, other evidence of record must be examined to determine, if possible, the real purpose of petitioner’s organization.

The petitioner was organized as a mere holding company, to take over and hold the shares owned by A. D. Saenger, in the A. & J., Inc., and, it is assumed, to collect and distribute the dividends thereon. Saenger’s income in prior years is not disclosed. Within the taxable year, and prior to the organization of petitioner, he had received, in one form or another, his proportionate share of a dividend of $150,000 declared by the A. & J., Inc., in February of that year. The surtax on that share, assuming no other income, amounted to $6,960. Within three months after petitioner was organized, and during the taxable year, the A. & J., Inc., declared a further dividend of $262,500, of which $131,250 was payable to petitioner. The petitioner had the unqualified right, under the dividend resolution, to demand and receive payment of its share of the dividend within the taxable year. Had not Saenger organized and turned over to petitioner his shares in the A. & J., Inc., he would have had the same unqualified right to demand and receive the same share of the dividend as went to the petitioner, and the surtax thereon, assuming no income other than dividends from the A. & J., Inc., would have amounted to an additional $34,290, making a total surtax of $41,250 for the year on dividends of the A. & J., Inc. By organizing the petitioner to hold his shares in the A. & J., Inc., Saenger was enabled to escape the additional surtax. (See later discussion of when the dividend was income to petitioner.) Of its entire share of the dividend, petitioner received $22,204.90, cash, in 1929. Its cash receipts for the year, consisting entirely of dividends, less cash expenses amounted to $22,510.99. No dividend was declared or paid by the petitioner in 1929, but, instead, Saenger borrowed from it $22,261.20, or all but $300 of its net cash income. Of the balance of $109,045.10 due the petitioner from the A. & J., Inc., on account of the October dividend, $92,206.62 was received by petitioner in 1930; and again in that year it did not declare or pay a dividend, but, instead, Saenger borrowed from it the further sum of $18,800.57. Such loans, alone, are significant of the proscribed intention. William G. De Mille Productions, Inc., 30 B. T. A. 826; United Business Corporation of America v. Commissioner, supra.

Nor is that all. The Saenger brothers and their confidential adviser were the officers and directors of the petitioner, J. H. Saenger, Inc., and the A. & J., Inc. The Saenger brothers were dominant in the A. & J., Inc., and each was dominant in his separately owned corporation. All three companies were bent to their will. As officers and directors of the A. & J., Inc., they withheld from petitioner more than 80 percent of its share of the October dividend, and, as officers and directors of the petitioner, they withheld demand for full payment of that dividend. Their conduct of the affairs of the one was made to fit their conduct of the affairs of the other. By declaring the dividend, crediting it on its books to stockholders’ accounts and making it available as the stockholders desire ”, they avoided any charge that the A. & J., Inc., was availed of in 1929 for the purpose of preventing the imposition of the surtax upon its shareholders; and, by causing the withholding of payment to petitioner of its full share of the dividend and the failure to make demand therefor, they evidently hoped to avoid a like charge in the case of the petitioner. The amount actually paid to petitioner within the year was comparatively small. What other reasonable explanation can there be for the failure to demand and make payment of the full dividend due the petitioner, especially when the A. & J., Inc., had sufficient assets out of which to make payment and the petitioner had maturing current obligations almost equal to the amount of the dividend? It is said, in explanation, that the A. & J., Inc., was not in any position during the taxable year to make full payment of the October dividend, and, therefore, that petitioner’s share was never subject to withdrawal. It is true that at no time after the dividend declaration did the A. & J., Inc., have sufficient cash to pay its current liabilities at maturity, much less its dividend obligations, and that the market value of the securities in its portfolio had sunk to a level much below their cost. It is equally true, however, that the dividend was declared and made subject to immediate withdrawal by the stockholders in the face of those very conditions, and the A. & J., Inc., had marketable securities, which, at their depreciated values, were worth $1,250,000 more than the total of its current and dividend obligations, out of which to pay the dividend. At the time the dividend was declared, the A. & J., Inc., had cash of $4,500 and its outstanding current liabilities amounted to $215,000. It is evident, therefore, that, if it was intended to pay the dividend at all, the intent was to pay it out of borrowed funds or out of the proceeds from the sale of securities in the company’s portfolio. Furthermore, the dividend was declared 15 days after the inception of the stock market crash and at a time when much of the force of the crash had been spent. The directors must have been fully aware then of the admittedly large decline in value of the company’s assets. Neither lack of funds nor decline in value of its assets prevented the A. & J., Inc., from declaring the dividend. There was no refusal of payment thereof on its part. So, the reasons advanced contain no extenuating circumstances for the directors’ failure to demand and make payment of the full dividend due the petitioner. We think that was a designed and deliberate failure, in order that the petitioner might not redistribute to its lone shareholder the dividend which, were it not for its interposition, would have gone directly and been taxable to that shareholder, while at the same time avoiding any appearance of a large undistributed surplus of petitioner for the taxable year.

It is contended by the petitioner that its cash position in 1929 was never such as to enable it to distribute the gains and profits of the year. But the contention entirely overlooks the fact that the petitioner received $22,204.90 in cash from the A. & J., Inc., during the year, and immediately, or shortly thereafter, loaned that much and more to its shareholder. Apparently, the petitioner had no need for this cash, at the time it received it, otherwise it would have been retained m the treasury or used for legitimate business purposes. It could have been distributed as well as loaned to the petitioner’s shareholder.

It is further contended that, in view of the adverse business and economic conditions inaugurated by the stock market crash in the fall of 1929, sound business practice dictated “ the retention of funds which otherwise might and should have been distributed ”; and that it would have been an economic foil}'', considering the surrounding circumstances and the befogged prospects of the future, to have depleted the treasury by distribution of a cash dividend. It seems to us, however, that the petitioner’s conduct is a complete answer to these representations. It did deplete its treasury by loans to its sole shareholder. These loans are incompatible with a purpose to strengthen the petitioner’s financial position, but entirely accord with the shareholder’s desire to secure the equivalent of his dividends under another guise.

Petitioner finally argues that, because of a $400,000 shrinkage in the value of its assets in 1929, it had no “ bona fide cash surplus of profits ” within the meaning of section 1, Act No. 241 of 1908, General Assembly of Louisiana, and, therefore, it was prohibited by statute from paying any dividend in that year. That statute, however, has been superseded by section 26, Act No. 250 of 1928, General Assembly of Louisiana, by the provisions of which a corporation may lawfully pay a dividend in cash or property out of, among other things not material here, the surplus of the aggregate of its assets over the aggregate of its liabilities, plus the amount of its capital stock. Even at the depreciated values of its assets, after the stock market crash in the fall of 1929, the aggregate of petitioner’s assets over the aggregate of its liabilities, plus the amount of its capital stock, was more than $1,100,000. There was, therefore, no statutory bar to the payment of a dividend by the petitioner in 1929.

In view of the foregoing, we find as a fact and hold that the petitioner was formed and availed of for the purpose of preventing the imposition of the surtax upon its shareholder through the medium of permitting its gains and profits to accumulate instead of being divided or distributed; and that, under the circumstances, the respondent has correctly asserted against the petitioner the 50 percent tax imposed by section 104 (a).

This brings us to the first of petitioner’s alternative issues, that respondent has incorrectly included in the net income, subject to the 50 percent tax imposed by section 104 (a), the entire amount of petitioner’s share of the October dividend of the A. & J., Inc., that is, $131,250, instead of $22,204.90, the amount actually received in cash in the taxable year. Since petitioner kept its books and rendered its tax return on a cash basis, the respondent evidently included the larger amount on the theory that it was constructively received by petitioner in the taxable year. We think the respondent is right.

The question of whether a taxpayer on a cash basis is constructively in receipt of income in the form of the presently involved dividend, is one of fact. Avery v. Commissioner, 292 U. S. 210.

Here we have an unequivocal declaration of a dividend that was payable within the taxable year, an appropriation for its payment, notification to the stockholders of the declaration, authority to the treasurer to pay the dividend, and the dividend made available for withdrawal by the stockholders as and when they chose, subject to the single limitation or restriction, which did not apply to this petitioner, that payment was to be made in the first instance by offsetting against any shareholder’s share of the dividend any indebtedness of said shareholder to the company. The dividend of $131,250 was fully and unqualifiedly available to the petitioner and could have been reduced to actual possession and realization merely for the asking. “ The income that is subject to a man’s unfettered command and that he is free to enjoy at his own option may be taxed to him as his income, whether he sees fit to enjoy it or not.” Corliss v. Bowers, 281 U. S. 376. It was constructively received by the petitioner in the tax year, and was thus properly so taxed by respondent. Adler v. Commissioner, 77 Fed. (2d) 733, affirming 30 B. T. A. 897; Loose v. United States, 74 Fed. (2d) 147; James E. Lewis, 30 B. T. A. 318. Cf. C. E. Gullett, 31 B. T. A. 1067. The case of Avery v. Commissioner^ supra, which petitioner cites in support of its position that so much of the dividend as was not actually reduced to possession within the taxable year is not income for that year, is clearly distinguishable upon the facts.

The constitutional questions presented by the petitioner’s second alternative issue have heretofore been considered, and decided adversely to the petitioner. United Business Corporation of America v. Commissioner, supra; Williams Investment Co. v. United States, 3 Fed. Supp. 225.

Reviewed by the Board.

Judgment wild be entered for the respondent.

       (a) If any corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there shall be levied, collected, and paid for each taxable year upon the net income of such corporation a tax equal to 50 per centum of the amount thereof, which shall be in addition to the tax imposed by section 13 and shall be computed, collected, and paid upon the same basis and in the same manner and subject to the same provisions of law, including penalties, as that tax.
      (b) The fact that any corporation is a mere holding or investment company, or that the gains or profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to escape the surtax.
      (c) As used in this section the term “ net income ” means the net income as defined in section 21, increased by the sum of the amount of the dividend deduction allowed under section 23 (p) and the amount of the interest on obligations of the united States issued after September 1, 1917, which would be subject to tax in whole or in part in the hands of an individual owner.
      (d) The tax imposed by this section shall not apply if' all the shareholders of the corporation include (at the time of filing their returns) in their gross income their entire distributive shares, whether distributed or not, of the net income of the corporation for such year. Any amount so included in the gross income of a shareholder shall be treated as a dividend received. Any subsequent distribution made by the corporation out of the earnings or profits for such taxable year shall, if distributed to any shareholder who has so included in his gross income his distributive share, be exempt from tax in the amount of the share so included.

       That it shall he unlawful for any domestic corporation, or for any foreign corporation doing business in this State, to make or declare any dividend on its capital stock except from its actual and bona fide cash surplus of profits; or to divide, withdraw or in any manner to pay to the stockholders, any portion of the company’s capital stock.

       Divioends : Method of Estimating Eund for Payment of. I. No corporation shall pay dividends in cash or property, (a) except from the surplus of the aggregate of its assets over the aggregate of its liabilities, plus the amount of its capital stocks ; or (b) out of any surplus due or arising from (1) any profit on treasury shares before resale; or (2) any unrealized appreciation in value or revaluation of fixed assets; or (3) any unrealized appreciation in value or revaluation of inventories before sale; or (4) the unaccrued portion of unrealized profit on notes, bonds or obligations for the payment of money, purchased or otherwise acquired, unless such notes, bonds or obligations are readily marketable, in which case they may be taken at their actual market value; or (5) the unaccrued or unearned portion of any unrealized profit in any form whatever, whether in the form of notes, bonds, obligations for the payment of money, installment sales, credits or otherwise, except as provided in the preceding subparagraph (4).
      II. In case all or any part of any cash dividend is paid out of paid-in surplus, the shareholders shall at the time of payment be notified of that fact.
      III. No corporation shall pay dividends in shares of the corporation, except from the surplus of the aggregate of its assets, which, for this purpose only, may include items mentioned in Subdivision I (b), over the aggregate of its liabilities, plus the amount of its capital stock.


author: Murdock:

text:
    Hay Foundry & Iron Works, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 75820.
    Promulgated September 30, 1935.

      Louis A. Gravelle, Esq., for the petitioner.

      Arthur L. Mwrray, Esq., for the respondent.
   OPINION.

Murdock:

The Commissioner determined a deficiency of $78,834.84 in the income tax of the petitioner for the period January 1 to April 30, 1931. The petitioner has waived all assignments of error except one. The parties have stipulated the facts. The sole question for decision is whether the gain which the petitioner admits it realized from the transfer of its assets to the Bethlehem Steel Corporation (hereinafter called Bethlehem) in exchange for bonds of the latter and cash is recognized for tax purposes.

The petitioner wrote a letter dated March 21, 1931, to Bethlehem granting to the latter an option to “ acquire ” subsantially all of the assets of the petitioner in exchange for $2,000,000 principal amount of Bethlehem’s 4% percent serial gold bonds and $26,250 in cash. The cash “ was in adjustment of interest ” on the bonds. The bonds were part of an issue of $25,000,000 made in 1930, and had a market value equal to par at the time of the exchange. The letter stated that the petitioner desired “ to be a party with you [Bethlehem] to a reorganization of the undersigned pursuant to which ” the properties of the petitioner should be acquired by Bethlehem in exchange for the securities and cash and the petitioner should thereafter be dissolved. It further stated that in the letter exercising the option Betblebem should, inter alia, “ state your desire that the agreement made by the exercise by you of the Option shall constitute a plan of reorganization of the undersigned to which you shall be a party.” Bethlehem wrote a letter dated April 22, 1931, stating that it elected to exercise the option and that it desired that the agreement should constitute a plan of reorganization of the petitioner to which Bethlehem should be a party. References were made to a “ plan of reorganization ” in the resolutions of the board of directors and of the stockholders of the petitioner approving and authorizing the exchange. The exchange was made on April 22, 1931. The petitioner distributed the bonds and cash to its stockholders in proportion to their stockholdings without the surrender by them of their stock in the petitioner. The petitioner was dissolved on June 27, 1931.

The petitioner concedes that it realized a profit in the amount determined by the Commissioner, but contends that the gain is not recognized because subsections (b) (4) and (d) (1) of section 112 of the Revenue Act of 1928 apply. The bonds received by the petitioner were clearly securities within the meaning of section 112 (b) (4). If there was a reorganization, then both the petitioner and Bethlehem were parties to it. Furthermore, if there was a reorganization, the exchange and the distribution were made pursuant to the plan of reorganization. Thus the case seems to depend upon whether there was or was not a reorganization.

The Commissioner contends that there was merely a sale of assets for bonds and cash and a “ reorganization ” was prominently mentioned by the petitioner in the records and evidence of the exchange just for the purpose of avoiding tax. The petitioner contends that there was a reorganization within the definition of that term as given in section 112 (i) (1) (A), which provides that “ the term £ reorganization ’ means (A) a merger or consolidation (including the acquisition by one corporation of * * * substantially all the properties of another corporation).” Although there was neither a merger nor a consolidation, Bethlehem acquired substantially all of the properties of the petitioner. The words within the parenthesis “ expand the meaning of ‘ merger ’ or consolidation ’ so as to include some things which partake of the nature of a merger or consolidation but are beyond the ordinary and commonly accepted meaning of those words.” Pinellas Ice & Gold Storage Co. v. Commissioner, 287 U. S. 462.

Did the transaction “ partake of the nature of a merger or consolidation?” The properties of two existing businesses were combined, as in a merger or consolidation, and the petitioner was promptly dissolved. Cf. Alfred R. L. Dohme, 31 B. T. A. 671. The interest of the stockholders of the combining corporations continues in a merger or consolidation. Neither the petitioner nor its stockholders received any stock of Bethlehem. But section 112(b)(4) says “ stock or securities ” and the petitioner, therefore, contends that this transaction, in which the property was exchanged for securities, comes precisely within the provisions of section 112(b) (4); since the word “ securities ” was used as an alternative to stock in section 112(b) (4) and section 112(d), it is unreasonable to conclude that Congress meant to nullify that use of the word “ securities ” by the provisions of section 112 (i) (1) (A); therefore the bonds of Bethlehem furnish the necessary continuity of interest to bring the transaction within section 112(i) (1) (A).

The rule that some continuity of interest was necessary in a statutory reorganization was first laid down by the Court of Appeals for the Second Circuit in Cortland Specialty Co. v. Commissioner, 60 Fed. (2d) 937; certiorari denied, 288 U. S. 599. The Supreme Court approved that rule in Pinellas Ice & Cold Storage Co. v. Commissioner, supra. In each of those cases the court held that the necessary continuity of interest was not furnished by the receipt of short term promissory notes. The Circuit Court of Appeals for the Second Circuit, with the author of the Gortland Specialty Co. opinion sitting as a member of the court, has recently held, in Worcester Salt Co. v. Commissioner, 75 Fed. (2d) 251, that bonds do not give the necessary continuity of interest to the transferor to make the transfer partake of the nature of a merger or consolidation. The time within which an application for a writ of certiorari could have been made in that case has expired and no writ has been applied for. The courts, in the cases just cited, fully realized that the word “ securities ” was disjunctively coupled with the word “ stocks ” in the statute. Not only is the Worcester Salt Co. opinion direct authority against the contention of the petitioner in this case, but it is the only authority on the subject which has come to our attention. We hold, on authority of the opinion of the court in the Worcester Salt Co. case, that the transaction here in question was in reality a sale and the general rule of section 112(a) applies rather than any of the exceptions contained in section 112.

Beviewed by the Board.

Decision will be entered for the respondent.

       Sec. 112 (b). (4) Same — Gain of corporation. — No gain or loss shall be recognized if a corporation a party to a reorganization exchanges property, in pursuance of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization.
      * * # * * * *
      (cl) Same — gain of corporation. — If an exchange would be within the provisions of subsection (b) (4) of this section if it were not for the fact that the property received.in exchange consists not only of stock or securities permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then—
      (1) If the corporation receiving such other property or money distributes it in pursuance of the plan of reorganization, no gain to the corporation shall be recognized from the exchange * * *.


text:
    Daniel H. Burnham, Petitioner, v. Commissioner of Internal Revenue; Respondent. Hubert Burnham, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 67330, 68008.
    Promulgated October 3, 1935.

      Arthur R. Foss, Esq., for the petitioners.

      George D. Brabson, Esq., for the respondent.
   OPINION.

Murdock:

The Commissioner determined deficiencies in income tax for the year 1929 as follows:

The Commissioner conceded at the hearing that each petitioner had erroneously reported certain interest and profits on his return. The only issue for decision in each case is whether the petitioner is entitled to deduct a loss from the exchange of notes of the Courts Building Corporation for stock of that corporation in pursuance of the plan of reorganization of that corporation. The cases have been consolidated and the facts have been stipulated.

The petitioners owned practically all of the stock of the Courts Building Corporation. They and their wives owned unsecured promissory notes of the corporation as shown in the following table:

Two hundred and fifty thousand dollars had been paid on the notes. The notes were due “ on or before ten years after date.” They contained powers of attorney to confess judgment. The notes were given originally in consideration of loans made to the corporation by the owners and prior owners of the notes. Other outstanding obligations of the corporation were a first mortgage 15-year note for $1,500,000, general mortgage bonds amounting to $125,000, and junior mortgage bonds amounting to $599,000. Refinancing became necessary in 1929 and the corporation was then recapitalized. The recapitalization was a reorganization within the definition of that term contained in section 112 (i) (1) of the Revenue Act of 1928, as the parties agree. The holders of the promissory notes exchanged the notes and their rights to accrued interest for new stock of the corporation in pursuance of the plan of reorganization. The petitioners also exchanged their old stock for new in pursuance of the same plan. The bases of the notes has been stipulated, as has the fair market value of the stock received in exchange for them. The latter was less than the former. The petitioners and their wives were not in control of the corporation immediately after the exchange within the meaning of control as defined in section 112 (j).

The petitioners contend that their losses upon the exchange • of the notes are recognized under the general rule of section 112(a). The respondent’s contention is that the exchange falls under either (3) or (5) of 112(b) and, therefore, no loss (or gain) can be recognized. Clearly (5) does not apply, since part of the stock necessary to give the petitioners and their wives control was not theirs at any time immediately after the exchange, but at that time belonged to others under the agreements which constituted the plan of reorganization. Cf. Wilbur F. Burns, 30 B. T. A. 163, and cases there cited. Section 112(b)(3) is as follows:

(3) Stock fob stock on beoraanization. — No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.

The question for decision narrows to this, Were these particular promissory notes which these petitioners exchanged for new stock of the corporation securities within the meaning of that term as used in the above quoted provision of the act ? The word securities ” is not defined either in the act or in the regulations. The petitioners concede that the word, as generally used, might be broad enough to include such notes, since, when so used, it means something given to make certain the fulfillment of an obligation, the evidence of a debt or of property. But they argue that, as used in section 112(b) (3) it was not intended to include promissory notes, such as they exchanged, but was intended to include only more formal evidence of property, such as, long-term series notes designed for distribution among investors, bonds, stock, and the like. They cite Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462, and Cortland Specialty Co. v. Commissioner, 60 Fed. (2d) 937, to show that not all promissory notes are securities within the in-tendment of section 203 (b) (3) and (e) of the Revenue Act of 1926.

Although section 203 of the Revenue Act of 1926 was the immediate predecessor of section 112 of the Revenue Act of 1928, nevertheless section 112 (b) (3), with which we are now concerned, is quite different from subsection (b) (3) of section 203, with which the courts were concerned in the above cited cases. Furthermore, the facts and issues in the cited cases were materially different from the facts and issues in the present proceedings. In each of those cases the court was considering the notes only as they indicated whether there had been a reorganization or whether there had been a sale. Here there was clearly a reorganization, and the only question is whether these promissory notes were securities. For these reasons different considerations are determinative in the present case.

The Supreme Court held in the Pinellas case that a sale rather than a reorganization occurred and in the course of its opinion said, in regard to secured promissory notes payable in 45, 75, and 105 days, given as evidence of an obligation to pay a part of the purchase price of assets, that they “ were not securities within the intendment of the Act and were properly regarded as the equivalent of cash.” The next sentence in the opinion is as follows:

It would require clear language to lead us to conclude tliat Congress intended to grant exemption to one wIlo sells property and for the purchase price accepts well secured, short-term notes (all payable within four months), when another who mates a like sale and receives cash certainly would be taxed.

The same kind of an issue was decided the same way in the Cortland Specialty case. The court there said:

As no stock was issued against the transfer, the conditions for an exemption were not fulfilled unless the notes, all payable within fourteen months of the date of the transfer, and all unsecured, can be considered “ securities ” under section 203(e). Inasmuch as a transfer made entirely for cash would not be enough, it can not be supposed that anything so near to cash as these notes payable in so short a time and doubtless readily marketable would meet the legislative requirements.
* * * The word “securities” was used [in 203(e)] so as not to defeat the exemption in cases where the interest of the transferor was carried over to the new corporation in some form.

It is apparent from reading the two cases cited that the courts were there determining the legislative intent of provisions different from the one involved herein. They did not mean to say that in a provision such as that of section 112(b)(3) the word “securities” was not intended to include promissory notes of the kind exchanged by these petitioners. Section 112(b) (3) must apply just the same whether gain or loss is involved. Here the reasoning of the courts, as above disclosed, can be used to show that section 112(b) (3) applies, for there can be no justice or propriety in taxing (or recognizing the loss of) one who transfers stock and notes of the corporation in exchange for its new stock and in relieving (or failing to recognize the loss of) another who transfers bonds of the corporation (instead of notes) for the new stock.

The court further said in the Oortlancl Specialty case:

Section 203 of the Revenue Act of 3926 must be interpreted in its setting. Its purpose was to relieve those interested in corporations from profits taxes in cases where there was only a change in the corporate form in which business was conducted without an actual realization of any gain from an exchange of properties.

That statement is apposite here. See also Ways & Means Committee Report, H. R. 179, 68th Cong., 1st sess., pp. 13, 14. These petitioners realized no gain and suffered no loss. There was only a change in the corporate form and in the kind of property which they held. There was a reorganization. The notes went back to the maker and were canceled. The note holders merely changed their interest in the corporation to that of stockholders. This was the kind of an exchange which Congress intended to relieve by eliminating the income tax consequences. It likewise intended that no loss should be recognized from such a transfer. These notes were securities within the meaning of section 112(b)(3). Consequently, the petitioners are not entitled to deduct their losses.

Reviewed by the Board.

Decision will he entered under Rule 60.

VAN FossaN dissents.