author: Sternhagen :

text:
    Estate of James Smith, Worcester County Trust Company and William B. Smith, Executors, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105515.
    Promulgated February 18, 1942.

      James A. Grotty, Esq., for the petitioner.

      J. P. Haslam, Esq., for the respondent.
   OPINION.

Sternhagen :

1. The petitioner insists that the fair market value of decedent’s shares at the time of his death was limited to the stipulated book value of $15.46 each, because the articles of the corporation required the shareholder, if he wanted to sell shares, to offer them first to the corporation at book value. The Commissioner determined the value, “based upon its [the corporation’s] income, balance sheets, and other relevant factors”, at $35.

The petitioner’s principal contention is that the fair market value of the shares can not be greater than the price at which the corporation could have bought them if decedent had wanted to sell. The shareholder was not required to sell or prohibited from selling. He had the right to retain the shares until death and make a testamentary transfer, and this the decedent did. His successor owner could continue the ownership under the same conditions. Only if a shareholder chose to sell was he required to make an offer to the corporation at book value of the time. The corporation had no absolute right to demand sale — it had no “call” — which fixed the price at which the shareholder could be required to sell. If the corporation wanted his shares before the shareholder wanted to sell at book value, it could dicker with him for a price and book value would not be a determinant of the price. He and the corporation would be the ordinary willing seller and buyer, and fair market value would be the price upon which they would agree, with a presumed knowledge of the facts. The restriction leaves the value unaffected and only restricts the field of available purchasers in the first instance, if the shareholder should wish to sell. It can not be said that such a restriction necessarily affects the fair market value. In James Couzens, 11 B. T. A. 1040, 1165, the Board said:

Our problem requires tbe assumption of a fair and willing seller and a fair and willing buyer under all the circumstances. . The stock provision does not prevent a transaction between such persons and it is the value arrived at in a free and open transaction between them which must be determined. This can not be checkmated by a statement at the outset that the stock is not readily marketable. We do not construe a fair market as meaning that the whole world must be a potential buyer, but only that there are sufficient available persons able to buy to assure a fair and reasonable price in the light of the circumstances affecting value.

In Estate of George H. Walker, 23 B. T. A. 663, 668, the Board said:

The petitioners contend that since the contract of December 31, 1920, restricted the sale of this stock by requiring that it should first be offered to the other stockholders at its book value without taking into consideration any good will, it had no higher value than that fixed by the contract. The contract provided that any stockholder desiring to sell his stock should first offer it for sale to the other stockholders, but, if after sixty days none of the other stockholders wished to purchase it, he could then offer the stock to outsiders. It is apparent, however, that the stock must have had a' value in excess of the book value. The company had been in business since 1907, first as a partnership and then as a corporation. It had made substantial earnings and had a good will of a considerable value. Although the parties can restrict the sale price of the stock as between themselves they can not, by such a contract, restrict the right of the Government to collect taxes upon the actual value of the stock.

See also Estate of Richard B. Messer, 27 B. T. A. 556; Estate of Frederick A. Koch, 28 B. T. A. 363.

Gases which hold that restrictions obligating the owner to sell at a fixed price provide a ceiling for valuation are distinguishable. Cf. Helvering v. Salvage, 297 U. S. 106; Commissioner v. Bensel, 100 Fed. (2d) 639; Wilson v. Bowers, 57 Fed. (2d) 682; Lomb v. Sugden, 82 Fed. (2d) 166.

Since the restrictive provision of the share is held not to affect the value, it is not necessary to consider whether the restriction had practical force to constrain the decedent in view of the large proportion of shares which he and his son owned, giving them the power to cause the repeal of the restriction, or a waiver by the directors.

The evidence does not establish that in fact the fair market value of the shares was less than $35, as the Commissioner has determined. It is stipulated that the net earnings of the corporation were as follows:

1933_ $173,550.50
1934_ 46,484.26
1935_ 222, 726. 77
1936_ 131,753. 25
1937_ 87, 833. 65

The total for the five years is $662,348.43, and the straight average is $132,469.69. The evidence does not give life to these figures and the wide variations are not explained. By themselves they provide an inadequate foundation upon which to form a judgment as to actual value of the shares. The stipulation contains the statement, “if the Board should find that notwithstanding the restriction on the sale and transfer of the Southwell Wool Combing Company Stock the value should be computed upon the basis of average net income of the past five years, such value would be as follows:

10 times average earnings $35.00 per share
9 times average earnings 34.06 “ “
8 times average earnings 30.00 “ “
7 times average earnings 26.49 “ “
6 times average earnings 22.71 “ “
5 times average earnings 18.92 “ “

It is not agreed that the value of this stock should be computed on this basis.”

The Board is in no position to “find that the value should be computed on the basis of average net income”, for the question of fair market value is ever one of fact and not of formula. Net earnings are important but they are only one of the many factors upon which value of shares may be considered, and the significance to be given to such figures depends upon the evidence of all the circumstances in which they are found. Cf. James Couzens, supra, (at 1170). Without knowledge of the setting in which the earnings appear, they lack substantial evidentiary force from which a useful inference of fair market value can be drawn. Furthermore, it would be entirely unwarranted for the Board, without evidence supporting it, to select a multiple of average earnings as the basis for a finding of fair market value.

Other than these stipulated figures, the evidence consists of the opinions of two witnesses largely based upon a supposed analogy of shares of New England textile corporations. The Southwell corporation was not a textile corporation and these opinions do not lead to a conclusion as to the fair market value of the Southwell shares on the date of death. The evidence does not contain data upon which a finding can be made that the fair market value of the shares was less than the $85 a share which the Commissioner has determined. That value must be adopted, not because of the stipulated formula of ten times average earnings, but because there is no adequate evidence proving it to be incorrect or another figure to be correct.

2. The respondent concedes that the income of the period between the date of death and the selected valuation date was improperly included by him in the gross estate and that it should be eliminated.

3. The respondent reduced the deduction for bequests to charity to $182,951.02, and now, by affirmative answer, pleads error in allowing any such deduction, on the ground that the amount thereof is too uncertain for computation.

The only uncertainty in the bequest to the charities of the various securities other than the Southwell shares rested in the power of the son to direct the trustee to change investments and in the normal fluctuations in such investments during the lives of the son and his wife. Both these uncertainties are commonplace circumstances in a bequest to charity after intervening lives, and the value of such bequests is readily determinable by the application of actuarial data of the probable period before ultimate distribution to the charity, Ithaca Trust Co. v. United States, 279 U. S. 153; Regulations 80, art. 44.

Of the 12,760 shares of the Southwell corporation, one-third, or 4,253% shares, was bequeathed conditionally to Southwell if he should buy the other two-thirds, and the petitioner does not contend that this one-third is within the charitable deduction. The uncertainty is only applicable to the one-third. There is no uncertainty as to the two-thirds; they must, after the second life expires, be converted into cash and distributed to the charities. Since the restriction upon the sale of the shares did not affect the fair market value at the time of death, such fair market value of $35 a share is no less the factor upon which to base the deduction of such shares as were bequeathed to charity than it is a factor of the value of the gross estate. The fair market value of the 8,506% Southwell shares at the date of death must be added to the uncontested fair market value of the various other securities to determine the total basis to which to apply the actuarial factor for calculating the’ value of the future expectancy of the charities.

The decisions upon which the respondent relies for the proposition that uncertainty precludes a charitable deduction involve uncertainties other than the mere possibility of fluctuation in value before the charity is to receive. In Gammons v. Hassett, 121 Fed. (2d) 229; certiorari denied, 314 U. S. 673, the charity could only expect to receive such property as would be left after the decedent’s widow during her life had without constraint exercised her “desire.” The court held that this untrammeled power of the widow over the property made it uncertain whether any property whatever would ultimately be distributed to the charity. Nothing, however, in the present bequest to charity discloses an uncertainty except the possibility that the securities could not survive the possibility of the exercise by the son of his reasonable discretion in changing investments. Such a possibility of disappearance of the corpus is too remote to defeat the deduction.

Decision will he entered v/nder Rule 60.

       See Bonbright, Valuation of Property, chs. XI, XII, XXI, XXIX; Paul, Federal Estate and Gift Taxation, ch. 18.

       Paul, supra, ch. 12, § 12.24.


source: Caselaw Access Project

author: Smith :

license: Public Domain

text:
    The Brown Fence & Wire Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101481.
    Promulgated February 18, 1942.

      Sydney A. Davies, Esq., and V. J. Moore, G. P. A., for the petitioner.

      'Walter W. Kerr, Esq., for the respondent.
   OPINION.

Smith :

This proceeding is for the redetermination of a deficiency in income tax in the amount of $2,083.41 for the fiscal year ended June 30, 1937. Two issues are presented for our consideration: (1) Whether expenditures incurred in connection with the issuance of stock are deductible when that stock is called in and new stock issued in its place, and (2) whether stock transfer tax upon a transfer which occurred in an earlier year accrued in 1937, the year in which litigation with respect to such tax terminated.

The petitioner is a Delaware corporation, with its principal office and place of business in Cleveland, Ohio. Petitioner has always kept its books and filed its returns in accordance with the accrual method of accounting. Its return for 1937 was filed with the collector of internal revenue for the eighteenth district of Ohio.

In March 1935 the stock certificates which petitioner had issued at the time of its incorporation were retired by the issuance of new certificates of stock having no par value. It incurred expenses in connection with the issuance of the new certificates in the total amount of $5,465, representing the cost of stock certificates, attorneys’ fees, and stock transfer agents’ fees. These were capital expenditures and accordingly were not deducted in petitioner’s return for the fiscal year ended June 30, 1935. During the taxable year the stated value of petitioner’s class B stock was changed from $1 to $2 per share by a charge to surplus of $139,882. The class B stock of no par value was then changed to $1 par value and two shares of the new stock were issued for each share of the old.

In changing the par value and stated value of its stock and listing the new stock on exchanges in 1937 petitioner incurred expenses of $8,415.31 which it deducted on its return for the taxable year. Respondent disallowed the deduction on the ground that the costs of changing capital structure were capital expenditures. Petitioner now concedes that respondent’s action was correct but claims that it is entitled to deduct for the taxable year 1937 the $5,465 expended in 1935 on the theory that that amount represents the cost of a capital asset which was abandoned during the taxable year. It contends that, since the stock certificates issued in 1935 were called in during the taxable year and other stock certificates substituted therefor, the old stock certificates were abandoned, and accordingly that the petitioner is entitled to the deduction claimed.

In Malta Temple Association, 16 B. T. A. 409, it was held that the cost of acquiring a corporate franchise was deductible in the year in which the corporation dissolved because in that year the franchise, which constituted a capital asset, was abandoned. That case is the sole authority relied upon by the petitioner to sustain its claim to the deduction of the cost of stock certificates, attorneys’ fees, and transfer agents’ fees, but it is not in point in this proceeding for the reason that the petitioner here did not abandon any capital asset. Even complete loss of separate identity through merger does not entitle a corporation to deduct organization expenses as a loss when the corporation carries into the surviving company all of its “rights, powers, liabilities, and assets.” Citizens Trust Co., 20 B. T. A. 392. In the instant case the petitioner simply effected a change in the par value of its common stock, issuing new certificates to evidence the change. It is clearly not entitled to deduct at this time the amount previously expended in connection with the issuance of the old stock. Motion Pictures Capital Corporation, 32 B. T. A. 339; affd., 80 Fed. (2d) 872; James I. Van Keuren, 28 B. T. A. 480; Pacific Coast Biscuit Co., 32 B. T. A. 39.

The second issue presented for our consideration is whether petitioner is entitled to a deduction in the taxable year for stock transfer lax which it claims accrued during the taxable year. The petitioner acquired the assets of the Brown Fence & Wire Co., an Ohio corporation, under a contract whereby, in consideration for the assets of the Ohio corporation, it issued its stock directly to the stockholders of the Ohio company. Revenue stamps on the issuance of this stock were duly purchased and canceled. On June 15, 1932, the Commissioner proposed to assess against the petitioner a transfer tax in the amount of $5,100 on the transfer by the Ohio corporation to its stockholders of the right to receive the petitioner’s stock. Petitioner disputed its liability to pay the tax. A suit was then brought by the Commissioner against the petitioner for the tax. Decision was adverse to the petitioner and was affirmed on appeal to the United States Circuit Court of Appeals in a decision rendered during the taxable year 1937. The petitioner contends that liability for the tax in question accrued in 1937, and accordingly is deductible for that year.

It is not clear on the facts that petitioner was liable to pay the transfer tax qua tax. The court in United States v. Brown Fence & Wire Co., 9 Fed. Supp. 1008; affd., 88 Fed. (2d) 1005, held that this petitioner was liable to pay the transfer tax here in question because it had assumed all the liabilities of its predecessor. If this was the only basis for its liability it may not deduct for the accrual of the tax at any time; for the payment of the liability was a part of the cost of the assets acquired. Even if the liability to pay was a tax liability imposed by statute upon this petitioner, it can not prevail here. The tax accrued, in the year for which the tax was imposed. Cf. Rawlings Manufacturing Co., 44 B. T. A. 161; Floyd, Inc., 43 B. T. A. 101. It accrued in the year in which the transfer was effected, for in that year all the events upon which the tax is predicated occurred, and the amount of the tax liability was definitely fixed by statute. United States v. Anderson, 269 U. S. 422; Dougherty’s Sons, Inc. v. Commissioner, 121 Fed. (2d) 700; Commissioner v. Central United National Bank, 99 Fed. (2d) 568; Continental Baking Corporation, 30 B. T. A. 354; affd., 77 Fed. (2d) 119.

Decision will he entered for the respondent.


author: Opper:

text:
    Trico Products Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98154.
    Promulgated February 24, 1942.

      J olm Lord O’Brian, Esq., and Ralph Ulsh, Esq., for the petitioner.

      Harold D. Thomas, Esq., and L. C. Mitchell, Esq., for the respondent.
   OPINION.

Opper:

Respondent has found that petitioner’s accumulation of earnings in the taxable years was in violation of Revenue Act of 1934, section 102. The burden is upon petitioner to disprove facts leading to such a determination. United Business Corporation of America v. Commissioner (C. C. A., 2d Cir.), 62 Fed. (2d) 754; certiorari denied, 290 U. S. 635. See Mellbank Corporation, 38 B. T. A. 1108, 1116; Wilson Brothers & Co. v. Commissioner (C. C. A., 9th Cir.), 124 Fed. (2d) 606. Cf. Dill Mfg. Co., 39 B. T. A. 1023, 1030.

In applying section 102 the triers of the issue are given the benefit of two statutory rules of prima facie evidence as aids in determining the existence of the forbidden purpose. One applies against a mere holding or investment company, but petitioner’s position as an operating company, as respondent concedes, is so clear that no question need trouble us on that score. The other operates if the taxpayer’s gains and profits are permitted to accumulate beyond the reasonable needs of the business.

Since one party to this proceeding asserts and the other denies that such was the case, it is not unnatural that much of the evidence and a great part of the argument should be directed toward aspects of this question. In order to sustain its burden of showing that the accumulations did not exceed business needs, petitioner relies upon the facts that stock sold to the public yielded a price greatly in excess of the book value of the corporation’s assets, which it accordingly attempted to build up; and that its principal product, a windshield wiper, was protected by a basic patent which would expire in 1942.

Petitioner’s case, however, is founded upon the assertion that neither of these represented an exclusive nor indeed primary purpose for retaining accumulations which grew from about $500,000 in the year of petitioner’s recapitalization to something over $8,000,000 in the nine years that ended with the last tax year before us. It is in that posture of the record that we must analyze the problem inherent in the application of the provisions of section 102.

The primary issue in these cases is purpose. Cecil B. deMille, 31 B. T. A. 1161, 1174. The prima facie case which the statute creates in respondent’s favor where earnings are accumulated beyond the reasonable needs of the business is accordingly to be read as it affects that underlying issue. The prima facie case is an affirmative one created in respondent’s favor. The statute does not provide that if accumulations are within the reasonable needs of the business we must find an absence of purpose. Nor is it to be read in such a manner as to insulate ultimate from contributory evidence. So that if the reasonable needs of the business are to he relied upon as a means of convincing us of the complete innocence of petitioner’s purpose, this must at least require a demonstration that there was a purpose to provide for those business needs so satisfying and persuasive that it is unnecessary to look further for a motive for the action under criticism. And to this it must be added that a demonstrated purpose may be “not inconsistent with another purpose to reduce income taxes by having a corporation accumulate its gains and profits rather than distribute them.” Nipoch Corporation, 36 B. T. A. 662, 668. And “It is to this complete lack of the condemned purpose that its evidence must be directed and if it does not fairly prove an absence of such purpose it must fail regardless of what other purposes it may prove.” R. L. Blaffer & Co., 37 B. T. A. 851, 856; affd., 103 Fed. (2d) 487; certiorari denied, 308 U. S. 576.

That being the case, the incidental purposes which petitioner advances as justifying the accumulations are all of but secondary importance. Even if they satisfied us that the accumulations were caused in part by the plan or purpose to provide for reasonable business needs, there would remain to be examined what is expressly advanced as the principal purpose. The incidental ones would still appear as excuses, or afterthoughts, rather than evidence of an absence of the purpose described by the statute.

' But ill fact the record fails to convince us as to a business purpose in either of these instances. The evidence purporting to sustain an intention to increase petitioner’s assets so that the book value of the stock would equal the figure at which it- was sold to the public is less than persuasive. One of the bankers testified that the details of the capitalization effected when the stock was sold to the public were devised in order “to make the management work, and make these patents valuable, develop the business, build up earning power.” Becognizing that there was nothing inherent in this part of the plan to prevent a speedy dissolution of the corporation even before the earning power of the business had been built up, a provision was ultimately inserted forbidding change in capital structure or voluntary dissolution until a restriction upon dividends, which will be more specifically dealt with later, had been released as to all shares. There was no reference to the creation of asset value in that provision. And, of course, if the corporation continued in operation for a sufficient time during which its earnings were satisfactory, which was inevitable under the provision forbidding dissolution, and if the earnings distributable to the public were declared as dividends, the minority stockholders could have built up their own reserve against the possibility of ultimate dissolution. In fact, there was no thought of dissolving the corporation even when, in 1942, the basic patent was due to expire; and petitioner’s president expressed the belief that the preeminent position of petitioner would continue after that time. Not only was there no enforceable contract to devote the corporation’s earnings to the creation of asset value, but if there were even a nebulous plan of that kind it was not so inflexible but that as soon as there came to be a pecuniary advantage in the distribution of larger dividends as the result of the undistributed surplus tax in 1936 and 1937, the corporation had no difficulty in departing from the program and practically doubling its dividend declarations.

The requirements of the business said to result from petitioner’s patent situation are equally unsatisfying. It is urged that upon the termination of the basic patent, petitioner’s business would be adversely affected unless it were prepared to maintain its position, either in a competitive market or by means of new products or in some other way. But we can not believe that there is no limit to the sum, no matter how great, which would be a proper accumulation, under those circumstances and for those purposes. It may be that the amount of accumulations appropriate to the situation would be a matter of opinion. But the question is the reasonable needs of petitioner’s business; and the determination of what is reasonable under a given set of circumstances is typically a judicial question. See United Business Corporation of America v. Commissioner, supra; L. Schepp Co., 25 B. T. A. 419, 429; United States v. Ragen, 314 U. S. 513. “What would be reasonable in one situation or fox-one business might be clearly uni’easonable in another.” William C. deMille Productions, Inc., 30 B. T. A. 826, 830. We can not satisfy ourselves that our function would be performed merely by accepting the decision of petitioner’s interested officers in the place of our independent judgment as to what was reasonably necessary to protect petitioner’s future position. See L. Schepp Co., supra.

We know that at the beginning of 1934, the first taxable year before us, petitioner’s capital and surplus was nearly $7,000,000; that at the end of 1935 it was over $10,000,000; that the general trend of its earnings had been upward since its organization; that its business was stable and assured; and that on the basis of past experience petitioner could look forward to surplus earnings running into the millions annually. The initial cost to petitioner of all its patents was trifling; and while the basic patent would expire in 1942, petitioner had constantly improved and protected the development of its product by improvement patents. We are given no basis in the facts for a determination as to what the expense to petitioner would be of meeting competition or supplying itself with a new product, except in one respect. And that raises an inference unfavorable to petitioner’s contention, for it was testified that at tile time of the hearing there had been developed a device for raising automobile windows, and it is suggested tliat this will be available to take the place of the windshield cleaner. But the cost of preparing for the manufacture of that article was said to be from three to five million dollars, which could be deferred over a period of time. Even without considering that petitioner’s surplus prior to the instant years would have more than covered it, this amount would not constitute an undue burden on petitioner’s current excess earnings. And, of course, there would still remain the petitioner’s existing plant, either for conversion to the new use or for continued operation on the old product. We could not find from these facts -that there were no accumulations beyond the reasonable needs of petitioner’s business.

It is also urged, somewhat casually, that later events have demonstrated the necessity of these accumulations. The difficulty with the suggestion is that admittedly there was no such thought in the minds of petitioner’s responsible officers during the years in issue. It is contended that whereas at the end of 1935 petitioner’s total capital and surplus, including all accumulations of undistributed earnings in whatever form, were approximately $10,500,000, by 1939 operating capital alone was in the • neighborhood of $10,800,000. Respondent by no means concedes the accuracy of these figures. He contests the propriety of including depreciation reserves in operating capital and objects to the inclusion of current assets without the deduction of current liabilities. But we have included in our findings of fact figures substantially in accord with those proposed by petitioner, since we are not satisfied that its position is wholly untenable.

The objection to it, as we have said, is that if this was a result, it was not a purpose. The record abounds in references to the belief on the part of petitioner’s officials that its operating income and manufacturing business was static and would not increase. Petitioner’s president, in answer to a request on cross-examination for his opinion as to the necessity of the accumulation of earnings .in 1934 and 1935 in the operation of the business, as then being conducted, testified:

If you bring that word “business” down merely, down to the operation of a manufacturing plant, there might be some question as to what more money was needed, but we considered the business, the enterprise, an enterprise involving the interests of stockholders who had a contract to release stock * * *.

The testimony thus supports the view that the natural growth of the business bore no relation to the corporate purpose, was not a ground for the accumulations, and was not foreseen at the time by those responsible for them. The connection between accumulations and reasonable business needs, particularly if prospective rather than immediate, would have no helpful bearing on the resolution of an inquiry as to the application of section 102 unless it were intended that retained earnings limited to the requirements of the business should be so designed and thus throw light upon the purpose of the accumulation, which must always be the main object of our investigation. Since it is clear from the record that the prospective needs of the business in its ordinary and anticipated expansion contributed in no degree toward the determination to accumulate earnings, we can not place upon the growth and extension of the business the importance required for the conclusion that by that showing petitioner has demonstrated the absence of a purpose to accumulate earnings for reasons dictated by the tax situation of its stockholders.

This brings us to a consideration of what was, on the theory of the taxpayer, the real purpose motivating the accumulation of its earnings. That was an outgrowth of the recapitalization in the course of which the public distribution of petitioner’s stock took place. In order, apparently, to make more attractive the stock available to the public, the bankers insisted that a dividend restriction be imposed upon most of the stock retained by the original group of controlling stockholders. The restriction took the form of an agreement with , the petitioner, the terms of which were endorsed upon the certificates / representing the restricted stock, providing that no dividends would ¡ be paid thereon until $2.50 per share had been paid annually upon the unrestricted stock; that after such payment earnings distributed would be shared equally by restricted and unrestricted stock; and that the restricted shares might be released from the agreement from time to time in accordance with a formula which required an increasing amount of annual earnings per share to the point where the last share to be released would require that the corporation have annual earnings of $9 per share for all of its stock or a total of approximately $6,000,000.

Petitioner urges as its principal contention that it was a reasonable need of the business to build up an invested capital which, by increasing total earnings, would enable the controlling stockholders to release a larger amount of stock from the restriction originally placed upon it. This may have been a natural course for the majority of the stockholders to cause the corporation to adopt for their own private ends, but it had nothing to do with the needs of the business, and in fact to the extent that it benefited the controlling stockholders there was a corresponding detriment to the remainder. Congress can not have intended that the term “reasonable needs of the business” should be satisfied by the financial interests of a limited stockholding group. For, of course, the interests of these stockholders as individuals were also served by the company’s policy of withholding dividends in so far as their income taxes were correspondingly reduced. But that can not be a reasonable need of the business, for it is that result which the statute is designed to attack.

Although it was repeatedly asserted that the benefit to the stockholders, from the standpoint of saving taxes, was never discussed or referred to as an element either ill the original plan of recapitalization or in the policy adopted by the company of limiting its dividends to the minimum preferred amount, the pecuniary weight of the tax-saving was so overwhehningly greater than the benefit derived ' by the majority stockholders from the release of shares that it is difficult to believe that it was only the latter and never the former to which they allowed their purposes to stray. See Helvering v. National Grocery, 304 U. S. 282.

For example, according to figures in petitioner’s brief, the total shares which were released as a result of interest and dividends paid on accumulated and invested funds to the end of 1985 were approximately 20,000. All the other shares released had been the result of earnings derived from operations, of which of course, the stockholders would have had the benefit without the accumulation of prior earnings from the investment of which the interest and dividends were derived. They received during the taxable years 1934 and 1935 on these 20,000 shares dividends of $2.50 a year or a total of $100,000 for the two years. In those same two years they saved in surtaxes not less than $340,000. Or, again employing petitioner’s figures, the total dividends received on all shares released through income derived from invested accumulation of prior earnings for all the years from 1927 through 1935 is only $336,205, less than half the tax saving for the two years here in issue. We are not advised what surtaxes ivere saved for the years prior to 1934 or for those subsequent to 1935. Finally, if we take all the dividends received by the controlling stockholders on shares released by income resulting from investment of accumulated earnings for the full history given by the record, 1927 through 1939, the figure is only $720,000, which is still less than the tax saving for only two years. It may be that “In the absence of the condemned purpose, the effect alone is no foundation for the tax.” But “This is not to say that the effect is of no significance, for * it may, and perhaps often does, indicate the probability of a purpose to induce it. In ordinary life it is not unreasonable to infer that the effect of a voluntary act is among the purposes of the actor. * * * And in determining the purpose, the actor’s categorical statement may be of less weight than the facts and circumstances which affect it.” R. L. Blaffer & Co., supra. “Admittedly, circumstances may evidence a purpose, and circumstances such as we find here, without a further showing, justify the finding of the prohibited purpose at which these provisions are aimed.” Cecil B. deMille, 31 B. T. A. 1161.

If the unrestricted stock had been represented by preferred shares with the provision that the common shares corresponding to the restricted stock would share in earnings only after preferred dividends, the situation would not be dissimilar to the present arrangement. But it could hardly be contended that a reasonable need of the busi-"\ ness, as opposed to the interests of the controlling stockholders, would j require the accumulation of funds for the retirement of the preferred \ shares and the consequent vesting in the common stockholders of the J right to monopolize total corporate earnings. Chicago Stock Yards, 41 B. T. A. 590; Mead Corporation, 38 B. T: A. 687; reversed other grounds (C. C. A., 3d Cir.), 116 Fed. (2d) 187.

But forsaking narrow procedural matters such as presumptions and burden of proof, we can not read the record as a whole without being satisfied that a preponderance of the evidence affirmatively establishes that petitioner was “availed of for the purpose of preventing the imposition of the surtax upon its shareholders or the shareholders of any other corporation through the medium of permitting gains and profits to accumulate instead of being divided or distributed.”

Some of the factors leading to this conclusion appear in the foregoing discussion. The preponderant fiscal advantage to the individual stockholders comprising the controlling group, all having large incomes protruding heavily into the surtax brackets, would be reason enough for the corporate act of curtailing distribution. There is an absence of conviction in any other explanation offered. The insiders were in undisputed control and the corporation could readily be made the instrument of their individual intention and molded to the effectuation of their private advantage as, in fact, it concededly was. The avowed primary purpose of the dividend policy pursued was admittedly one involving comparable, though less important, discriminatory benefits. The stockholders and the corporate officers are shown to have been aware of the tax situation confronting themselves. They apparently had no financial need for the dividends. It seems to us that a naive and credulous tribunal would be required for the assumption that in the confirmed practice of methodical accumulation there was no taint of a purpose to procure so desirable a monetary result for the individuals responsible for the petitioner’s decisions.

The business of the corporation was as free from hazard, as firmly established, and as favorable in prospect as could well be imagined. Production costs were constant, sales certain, collection losses negligible. If at the beginning of the tax years in issue petitioner’s officers had looked back over its history since the recapitalization in 1927, they would have seen a constantly mounting record of earnings, with the exception of the three depression years 1930 through 1932; and that even in those years the requirement for the $2.50 dividend was approximately doubled, except in the single low depression year of 1932, when it was safely met. If, at the beginning of the years in issue the corporation had had no surplus, the record fails to show a probable future need to justify accumulations of approximately one and three-fourths millions of dollars (petitioner’s entire stated capital) in one year and two and one-half millions in the next. But in fact there were accumulations of over five and over seven millions at the beginnings of the respective years. And, as bearing upon purpose, we may look to the history following this period which discloses ultimate accumulations of seventeen millions of dollars in an interval of a dozen years; or, in matter of ratio, approximately ten times the stated capital with which the corporation began operations so short a time before.

Even if the $2.50 dividend had been cumulative, as petitioner urges, there was thus an overabundant assurance that it would not default. But in fact the documents show that it was not cumulative, and we have so found. And even if the restricted stock were deprived of all share in the earnings, the record shows the normal operation of the business was sufficient to release shares which had in a few years placed the dominant stockholders where they could garner the larger proportion of corporate earnings. But in fact there was no prohibition upon an equal division of earnings between restricted and unrestricted stock after the payment of a dividend in the preferential amount; and on the record if surplus earnings had been so distributed in accordance with a recognized and confirmed corporate policy, instead of the reverse, the income on the restricted shares would have been so considerable and their future prospects so satisfactory, that we can not concede the absence of marketability and market value upon which petitioner insists. In fact in 1936 and 1987, when it became advantageous to do so, dividends on the restricted stock were paid “because of the Undistributed Profits Tax Law.” That the payments in these years were not larger may well be due, as respondent suggests, to the mathematical result that at some point increased individual surtaxes on the controlling stockholders would exceed the undistributed profits tax levied against the corporation for failing to distribute current income.

We have already seen to what extent the pecuniary benefit to the controlling stockholders from tax savings exceeded that secured from the release of stock. By a similar comparison we know that as of, say, the beginning of 1934, the earnings from operations furnished a much more probable source for the release of future stock than would any such inconsequential addition to income as could be expected in the not too remote future from earnings on invested accumulations. This result is due in part to the form of petitioner’s investments wrhich were largely in the highest grade securities with the lowest yield.

In sum, petitioner advances, as its controlling reason for these excessive accumulations, the personal advantage to its principal officers to be attained by securing earning power for the restricted stock; and complains of a lack of value in those shares until that could be done. But it was from operations that the great bulk of the earnings was to be expected; the remedy for the restriction on dividends lay in large part in the hands of these very individuals, who could cause their shares to participate in earnings by the simple process of a more complete distribution; and all the facts involved in the history and background of petitioner and its moving spirits are consistent with no explanation for these distributions so much as with a desire to secure the greatest possible personal benefit to the individuals in control, an end which could not have overlooked the tax aspect. In greater detail, the situation is reflected in our findings. Alone or in combination, these preponderate in favor of respondent’s position. All explanations failing, we can not ignore the inferences from these affirmative facts. We regard them as sufficient justification for respondent’s determination and for our ultimate finding that petitioner was availed of for the inhibited purpose.

Finally, petitioner urges as a matter of law that the section is to be construed so as to require that the purpose to avoid surtax extend to all the stockholders, a situation not shown to exist here. Without stopping to suggest that petitioner in this way seeks to avail itself of a failure of proof on an issue requiring it to sustain the burden of the affirmative, we reject the contention on its merits. The words of the statute furnish no support for it, and the purpose to be served affirmatively repudiates it. If it Avere necessary for all the stockholders to escape surtax, the condemned intent and the detriment to the revenue could remain and still the stipulated penalty fail of application. A construction calling for an enforcement so capriciously dependent on fortuitous and irrelevant circumstance is certainly to be avoided. Even more detrimental to the evident statutory goal is the open and facile method of avoidance afforded, if the provision meant that a corporation could secure one impoverished stockholder not subject to the surtax rates and thus laugh in the face of any practical effort to prevent surtax avoidance through corporate accumulations. We are satisfied that the section can not carry the suggested meaning.

The second issue involves petitioner’s claim under Revenue Act of 1934, section 131, to a credit against its taxes for amounts said to have been paid as income tax to the British Crown. The dispute is whether the amounts admittedly paid Avere income taxes of petitioner so as to afford it the benefits conferred by the section relied upon. Respondent contends that petitioner is not entitled to have the amount of the taxes deducted from its income tax to the United States, but should have treated the British payments as though forming no part of its compensation, which of course would reach the same result as though the payments of British taxes were regarded as income to petitioner and then as deductions from gross income in computing net income and the United States tax thereon.

We can not distinguish this proceeding from Biddle v. Commissioner, 302 U. S. 573. Although that case involved dividends paid to the taxpayers from British sources, and this concerns patent royalties, the taxing device established by the British legislation appears to be essentially the same. And the question under section 131 is whether petitioner paid “the tax within the meaning of our own statute. That must ultimately be determined by ascertaining from an examination of the manner in which the British tax is laid and collected what the stockholder (here the patent licensor) has done in conformity with British law and whether it is the substantial equivalent of payment of the tax as those terms are used in our own statute.” Biddle v. Commissioner, supra.

On the question of fact presented in determining the British law, we have before us only “The Income Tax Act, 1918” and statutory amendments thereto. We must accordingly consider that recourse to British case law and interpretation would be beyond the scope of this record; though that is not to say, of course, that any further light would be shed on the subject if such authorities were available to us.

Confining ourselves then to the statutory scheme, we find that income tax payments were required from petitioner’s licensees to the British taxing authorities to be computed upon the “full amount” of their “profits and gains”, and that they are specifically forbidden to deduct therefrom in computing their own income tax the amount of “any royalty or other sum paid in respect of the user of a patent.” General Rule 19. This is essentially identical with the situation applicable to a corporation which is to pay the tax on the “ ‘full amount’ of the profit ‘before any dividend thereof is made in respect of any share * * Biddle v. Commissioner, supra, footnote 3.

In the case of patent royalties the licensee is authorized to deduct the tax payment from the amount of royalties remitted to the licensor and the latter is commanded to receive the diminished amount in full satisfaction of his claim. This, however, is no different from the situation applicable to a corporation which upon “paying such dividend shall be entitled to deduct the tax appropriate thereto.”. Op. Cit.

In the case of individual stockholders such as those involved in the Biddle case there is a further requirement that the stockholder include as part of his surtax income the tax paid by the corporation as so required; and in the Biddle case the taxpayers had in fact included that tax in the income shown by their returns to the British Government, had paid the surtax thereon, and had treated the payments in the same way in making their United States income tax returns. That element, together with the privilege given the British taxpayer to claim a refund of the proportionate share of the tax paid by the corporation under appropriate circumstances, were the principal contentions relied upon by the taxpayers in the Biddle case; and the Court there acknowledged that “for these limited purposes which do not affect the assessment and payment of the tax it is true that the British acts treat the stockholder as though he were the taxpayer.”

Notwithstanding these circumstances and a series of administrative interpretations favorable to the taxpayers, the Court concluded “that the taxpayer has not paid or become subject to the foreign tax here in question.”

Since petitioner is a corporation and not subject to the British surtax and since we are not advised that this petitioner might have successfully appealed from the tax paid by its licensees or whether or to what extent it would be liable for the tax upon default of the British taxpayer primarily responsible for its payment, cf. Biddle v. Commissioner, supra, we can not find in petitioner’s situation even those considerations apparently thought to be favorable to the taxpayers in the Biddle case. If any of these elements are a part of the British law, no deficiency in the presentation of evidence thereof can operate in petitioner’s favor. What we have before us is even less an indication that this tax was either assessed upon or paid by petitioner than was the case in Biddle v. Commissioner, supra.

In Crawford Music Corporation, 40 B. T. A. 284, upon which petitioner primarily relies, the payments of British tax were with respect to “royalties or sums paid periodically for or in respect of * * * a copyright * * concerning which an altogether different series of provisions “for the taxation of copyright royalties by deduction in cases where the usual place of abode of the owner of the copyright is not within the United Kingdom” appears in the British statutes. General Bules 18 and 25. The tax is not paid as a part of the income tax of the British obligor, who owes the royalty, but that person is required to “deduct thereout a sum representing the amount of the tax thereon at the rate of tax in force at the time of payment.” And “that person shall forthwith deliver to the Commissioners of Inland Revenue, * * * an account of the payment * * This is the same procedure as that required where a British obligor remits payments out of sources other than or in excess of his own t&xable income (General Bule 21), a circumstance which, of course, makes it impossible to collect the tax by the expedient of levying it upon him and prohibiting the deduction from his income of the payment due his obligee. This difference in British statutory treatment prevents Crawford Music Corporation, supra, from serving as a precedent for the disposition here.

We find no evidence that Parliament has chosen to make this petitioner liable for the British tax except at most through the indirect economic results of its payment which Biddle v. Commissioner, supra, found insufficient. Since the principle for which that case stands, as we view it, is that section 131 does not treat “as taxpayers those upon whom no legal duty to pay the tax is laid”, respondent’s position on this issue is sustained; and we find it unnecessary to consider his further argument that the form of the contracts in any event placed the burden of the tax upon the English licensee and relieved petitioner of it.

Beviewed by the Board.

Decision-will be entered wider Rule SO.

       This substitute product was not in existence in the instant tax years, so that it really formed no premise for any accumulations at that time.

       * * * It requires no argument to support the premise that the cited sections do not contemplate that a business should remain static; it must be assumed that any business shall have the right to grow. Necessarily incident to the exercise of this right are the making and pursuit of plans both as to organization and as to finances which will permit the accomplishment of the contemplated development. [William C. de Mille Productions, Inc., 30 B. T. A. 826, 830.]

       Petitioner’s brief concedes that “Distributions in excess of $2.50 a share * * * would be to the disadvantage of the original stockholders because the other stockholders would receive a preponderant part of the total dividend distribution in such case.” And, “That the carrying out of those purposes and intentions [to release the restricted stock] is of benefit of 75 percent of the stockholders, including the principal stockholders.”

       Respondent computes the shave's so released- at a very much smaller figure, less than 1 percent of the total.

       SEC. 131. TAXES OF FOREIGN COUNTRIES AND POSSESSIONS OF UNITED STATES.
      '(a) Allowance of Credit. — If the taxpayer signifies in his return his desire to have the benefits of this section, the tax imposed by this title shall be credited with :
      (1) Citizen and domestic corporation. — 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; * * *

       A small portion of the payments was for interest, but the parties do not contend that these should be disposed of differently.


author: Mellott : SteRnhagen, Leech,

text:
    Charles Chaplin, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98795.
    Promulgated February 24, 1942.

      Hersohel B. Green, Esq., Loyd Wright, Esq., and J. R. White, C. P. A., for the petitioner.

      Frank T. Homer, Esq., and Byron M. Coon, Esq., for the respondent.
   OPINION.

Mellott :

The first question is whether respondent erred in including in petitioner’s income the fair market value of the stock released from escrow and delivered to him in 1935. This question may be answered by determining whether petitioner owned the shares prior to their delivery to him in that year.

Petitioner contends that ownership vested in him on June 9, 1919, when certificates for 1,000 shares were issued; that the consideration for the issuance of the shares was the execution by him of the distribution agreement of February 9, 1919; that the ¿liares were placed in escrow merely as security for the performance of his part of the contract; that the “dividends” were impounded “to encourage compliance by each artist with his distribution contract”; that he was regarded by the corporation as the owner, at all times, of the stock and “exercised all incidents of ownership”, except physical possession; and that he realized no taxable income when the stock was released from escrow and delivered to him.

Respondent determined that “the fair market value of the 334 shares * * * received * * * in the taxable year which value has been determined to he $104,709, represents income taxable to [petitioner] under the provisions of section 22 (a) of the Revenue Act of 1934.” In support of- this determination respondent places considerable reliance upon the provisions of the agreement of August 5, 1919 (escrow agreement); contends that the entire record shows petitioner was not the owner of the 334 shares until they were released and delivered to him in 1935; argues it was the intention of the parties, as indicated by the various exhibits, that petitioner should not become the owner of the stock until and unless the photoplays were delivered; and insists that petitioner acquired no vested interest in it until he delivered the photoplays according to his agreement. The value of the stock at the time it was released from escrow and delivered to petitioner is not contested.

Title to personal property generally passes when the parties to a transaction intend that it shall pass. United States v. Utah, Nevada & California Stage Co., 199 U. S. 414. Intention is primarily a question of fact. In determining it the agreements which they signed, if unambiguous, are entitled to great weight, though consideration may also he given to the circumstances under which they were executed, the objects sought to be accomplished, the interpretation placed upon them by the parties prior to the controversy in issue, and any and all relevant facts and circumstances tending to show what the actual intention was. The basic facts, which are not seriously in dispute, are shown in our| findings. No attempt will be made to summarize them. Brief allusion will, however, be made to some of them.

On February 5, 1919, petitioner and other artists, for reasons immaterial here, agreed in writing to become associated in the organization of a corporation for the purpose of exploiting, distributing, and exhibiting motion pictures produced by them. This agreement provided that 1,000 shares of the common stock of such corporation should be issued to each of the parties and paid for “in part consideration of the execution and fulfillment” by each of a contract pertaining to the exploiting, marketing, and distributing of his or her motion pictures. Pursuant to this agreement petitioner entered into a contract with the corporation for exploiting, marketing, and distributing 9 motion pictures to be produced by him, and an agreement with the corporation and an escrow agent was prepared and signed. These agreements set out the terms and conditions under which the 1,000 shares of common stock (which included the 334 shares here in question) were to be issued and delivered to petitioner. The terms and conditions were specific and definitely provided that petitioner should not receive any of the 1,000 shares of common stock unless and until he had produced and delivered one or more photoplays, and that all of the stock should be received when, ana only when he had delivered the required number of photoplays.

The later agreement of November 22,1924, is equally positive in its terms. Under it petitioner became “obligated to deliver to the corporation for distribution only five (5) additional photoplays, described in the original contract instead of eight (8) undelivered pictures provided for in said contract. The balance of the common stock of the corporation, which is now held in escrow for the benefit of Chaplin shall be delivered to him in the proportion of one-fifth (hs) thereof upon the delivery of each motion picture photoplay by Chaplin to the Corporation.” (One-sixth of the total 1,000 shares was delivered to petitioner leaving five-sixths in escrow.) This agreement was partially carried out and under it the escrow agent delivered three additional certificates of stock to petitioner prior to 1935. The other two — the two in issue in this proceeding — were released by the corporation and delivered to petitioner in September 1935.

The terms and conditions of the agreements briefly referred to above and the actions of the parties under them indicate, in our judgment, it was the intention of the parties that ownership of the stock should not pass to petitioner until and unless he “fulfilled” the terms and conditions of his contract and delivered to the corporation the photoplays stipulated therein. Tn reaching this conclusion we have not overlooked the fact that the corporation prior to 1935 treated petitioner, for many purposes, as the owner of 1,000 shares of its common stock. Clearly, all parties intended that he should ultimately become such owner; and, since he was permitted under the escrow agreement to vote the stock, it is not surprising that he was given the usual notice of meetings, participated in elections, and exercised other rights commonly exercised only by a stockholder. The right to vo'te corporate stock may be conferred by contract, as it was in the instant proceeding, even though no property in the stock has passed, cf. Cattlemen's Trust Co. of Ft. Worth v. Turner, 182 S. W. 438. Stock is frequently voted by persons having no beneficial ownership of it. Alger-Sullivan Lumber Co. v. Commissioner, 57 Fed. (2d) 3. Nor do we think that the recitation in the corporate resolution of May 29,1919, to the effect that the corporation was authorized to issue stock to the artists “in consideration of the delivery of [the distribution] contracts”, justifies a conclusion that the artists thereby became the “owners” of the stock; for the shares were to he held “in escrow in accordance with the provisions of said contracts” and were so held.

The whole idea of the enterprise was cooperative. The corporation was formed for the specific purpose of distributing pictures of the artists. Each agreed to execute a contract with the corporation for the exclusive right “to market, exploit, distribute and turn to account the motion pictures that each shall produce.” The contract ultimately entered into by petitioner with the corporation granted it “the exclusive right and privilege to market and turn to account, exhibit, distribute or cause to be distributed or exhibited” the pictures which he was to produce. “All moneys derived from the license to use” the pictures were to be divided 70 or 80 percent to the artist and 20 or 30 percent to the corporation. It is apparent the corporation would have no income unless the pictures, either those produced by petitioner or those produced by the other artists, were delivered to it for distribution and exploitation. The artists did not contemplate that one of them should share in the profits of the corporation — except to a limited extent as purchasers and owners of the preferred stock— unless he delivered his proportion of the pictures which were to produce the income. The mere execution of the contract was not sufficient. The “fulfillment” of the contract was equally important. Indeed it was the very essence, the sine qua non of the contract, a condition precedent to petitioner acquiring either equitable or legal ownership of the common stock. Cf. United States v. Fourth National Bank in Wichita, Kansas, 83 Fed. (2d) 85. We are therefore of the opinion that petitioner’s contention, to the effect that ownership of the stock vested in him on June 9, 1919, is untenable. He became the owner of the stock in 1935 when it was released from escrow, by the corporation, and delivered to him. In this connection it may be pointed out that the escrow agreement required the depositary to hold the stock until “the corporation shall notify * * * [it] in writing that the artist is entitled” to receive it and this agreement was carried out.

Petitioner places considerable reliance upon the decision of the District Court for the District of New Jersey in Schneider v. Duffy, 43 Fed. (2d) 642, and E. L. Carnahan, 21 B. T. A. 893. The cited cases are, in our judgment, distinguishable upon their facts. In the first mentioned case there was a conditional assignment to the taxpayer of an equitable ownership in 1,500 shares of stock in consideration of his agreement to remain with the corporation for five years. He was “to receive and enjoy all dividends declared and paid from the date” of the assignment, including any distribution “of money, property, stocks or rights that the common stockholders * * * become entitled to * * One-fifth of the shares were to be delivered to him at the end of each year during the five-year period; but in the event of his death or refusal to carry out his obligation, the equitable assignment as to the undelivered stock was to be null and void. In deciding that the parties intended ownership of the stock to vest' when the contract was signed rather than when delivery was made at the end of the year, the court emphasized the fact that the taxpayer acquired a present, fixed right to the enjoyment of all the income of the property when the contract was- signed and that the parties had specifically agreed the undelivered stock was “intended only as collateral security” that the employee would carry out his obligation. In the instant case the dividends were to be held in escrow and delivered to the petitioner only when and if the stock should be delivered to him. Here, also the stock was not held as collateral security for the performance of petitioner’s obligation but remained the property of the corporation until “delivery by the artist to the corporation” of the photoplay as agreed.

In H. L. Carnahan, the petitioner, in 1922, had performed services entitling him to receive 5,000 shares of corporate stock. The stock was issued to him and he became entitled to receive all dividends and to exercise all rights as a stockholder; but the certificate was required to be, and was, delivered in escrow pending further order of the “Blue Sky” Commissioner. The certificate was released and delivered to the petitioner in 1924 and the question before the Board was whether he was in receipt of income in the earlier year or in the later year. In holding that income was realized in 1922 it was pointed out that the taxpayer had received the stock in that year, had deposited it in escrow in accordance with the requirements of the state law, and “received all the benefits possible from * * * [it] except the right of actual physical possession and unrestricted power of sale * * *.” In the instant proceeding petitioner did not receive such “benefits” from the stock and could not receive them unless and until he complied with his obligation.

It is apparent we must hold, and we do hold, that petitioner became the owner of the 334 shares of stock in 1935 rather than in 1919. The following cases, in addition to those heretofore cited and discussed, tend to support this view. Martin D. Thomas, 44 B. T. A. 735; Charles F. Mitchell, 45 B. T. A. 300.

Issues (b), (c), and (d) require determination of the treatment to be accorded the accumulated dividends. Respondent contends that if petitioner was not the owner of the shares of stock prior to 1935, then the amount representing dividends declared on the stock prior to that date did not represent dividends to him. The gist of his contention seems to be that the sum paid over to petitioner was merely an additional amount paid for fulfilling the contract. The question is not free from doubt; but we think we are justified in resolving it in favor of petitioner. The amount deposited in escrow represented the portion of the earnings of the corporation allocable to the shares of stock which, under the contract, the parties intended should ultimately belong to petitioner. The contract provided that if and when the stock should be delivered to petitioner by the escrow agent, the corporation would pay to him all dividends which had been deposited in the trust account. This was done. If the amounts deposited in the trust account represented dividends — and they seem clearly to have been distributions by the corporation out of earnings or profits accumulated after February 28, 1913, and hence within the definition of a dividend contained in section 115 of the Revenue Act of 1934— then they did not lose their character as dividends merely because they were not actually delivered to petitioner in the year declared. The right to receive dividends may be assigned without making the assignee a stockholder, Roscoe E. Aldrich, 3 B. T. A. 911, 919; Anthony Schneider, 3 B. T. A. 920, 926; Matchette v. Helvering, 81 Fed. (2d) 73, though some question may arise as to the taxability of the dividends to the assignor under the rationale of such cases as Helvering v. Horst, 311 U. S. 112, and Helvering v. Eubank, 311 U. S. 122. That question, however, is not before us. Both parties admit that the amount should be included in' petitioner’s income and the issue is solely whether it constituted dividends, as reported, or ordinary income. Since the amount set aside did not, in our opinion, lose its character as dividends, we think it was properly treated by the petitioner in his return. But if respondent’s view be accepted that the amounts set aside in each year were not true dividends, then it would seem that the action of the corporation in the taxable year, making them unconditionally available to petitioner, was tantamount to the declaration and payment by the corporation of a dividend in the aggregate amount of $44,532.22 upon the 334 shares which petitioner had just received. In either event, we are of the opinion that the amount was “received as dividends from a domestic corporation which is subject to taxation” under Title I of the Bevenue Act of 1934 and hence the credit for normal tax, as specified in section 25 (a) of such act, should be allowed.

The deficiency shall be recomputed in accordance with the views herein expressed and

Reviewed by the Board.

Decision will be entered it/nder Rule 50.

SteRnhagen,

dissenting: In my opinion, the amount received by petitioner from the escrow agent which was attributable to the accumulated dividends which the escrow agent had received from the corporation was not received by petitioner as dividends and is not the subject of normal tax credit.

Leech,

dissenting: I think the two basic holdings in the majority opinion, expressed in the headnote, are inconsistent with each other and are both wrong. In my judgment, the stock in United Artists Corporation was intended to be and was received by the petitioner in 1919 when it was issued in the name of petitioner and delivered to the escrow agent. The stock was held by the escrow agent merely to guarantee performance of petitioner’s contract to deliver pictures. The dividends declared and paid on this stock were taxable to petitioner as such when received by the escrow agent. See Bonham v. Commissioner, 89 Fed. (2d) 725, affirming 33 B. T. A. 1100.


author: Disney:

text:
    Ticker Publishing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. C. G. Wyckoff, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 101252, 101280, 101606.
    Promulgated February 24, 1942.

      Benjamin Grand, O, P. A., for the petitioner.

      Allen T. Alcin, Esq., for the respondent.
   OPINION.

Disney:

The primary question is whether the so-called income bonds are evidence of indebtedness entitling Ticker to deductions for interest accrued thereon during the taxable year or, in substance, certificates of stock, with no right to deductions for amounts paid or accrued thereunder.

The respondent’s contention here is that the so-called income bonds issued by Ticker were not more than preferred stock issued as a stock dividend without consideration. The petitioners contend that Ticker was indebted to the bondholders under the agreement of May 20, 1926, and that the securities were issued under a debtor and creditor relationship.

As proof of the consideration running from Ticker to the Wyckoffs for the issuance of the income bonds, petitioners rely upon paragraphs 2 and 17 of the agreement of May 20,1926. The second paragraph of the agreement is in substance that $500,000 class A and class B bonds would be issued to Bichard D. Wyckoff and his wife, respectively; chat upon receipt of the class A bonds or preferred stock Bichard D. Wyckoff would assign to his wife his interest in common stock in, and claims against, Ticker, and that the bonds or preferred stock would be received by him in full payment of his interest in the common stock and in the claims. The seventeenth paragraph contained an acknowledgment of Cecelia G. Wyckoff that she had no claim against her husband for an interest in stock owned by her husband except the ten shares of Ticker which he had agreed to transfer to her, and that she had and made no claims against “any of the Corporations issuing such stocks, except the TickeR Publishing Company.” It also provided for a general release by Bichard D. Wyckoff in favor of his wife and Ticker and a general release from Ticker in favor of Bichard D. Wyckoff, excepting in each case obligations to be performed under the contract and an obligation of Bichard D. Wyckoff to pay accounts known as the “Bichard D. Wyckoff Analytical Staff Inc. Accounts.”

The preamble of the agreement recites that “the parties hereto are each possessed of certain property, and differences have arisen between them and claims made in respect to their ownership of and their interest in said properties, * * *.” No specific claims of either Richard D. Wyckoff or his wife against Ticker are set forth in the agreement and at the hearing there was no proof of the existence of such claims. Cecelia G. Wyckoff testified upon cross-examination, in response to a question as to the indebtedness of Ticker to her and her husband in 1926, that “Mr. Wyckoff claimed that in view of the fact we had spent about $2,000,000 in building up this company, that he either wanted it outright or wanted the Ticker Publishing Co. to give him money. Finally he agreed to take half a million dollars.” She further testified that this was the debt her husband “claimed Ticker owed him.” Other provisions of the agreement disclose that the Wyckoffs were having domestic difficulties and that the agreement was in the nature of a property settlement in anticipation of a divorce. Upon brief petitioners admit that the matrimonial disputes led to the claims of Richard D. Wyckoff against Ticker and differences as to ownership of its stock. That the agreement was one to settle disputes between Richard D. Wyckoff and his wife is clearly shown by paragraph twenty-first of the agreement, reading as follows:

In consideration of the settling of the disputes between Mr. and Mrs. Wyckoff and the benefits to be derived by the Corporation by reason thereof, the Corporation joins in this agreement to the extent that the provisions thereof are or may be applicable to it.

This language, in our opinion, clearly shows that the only connection the corporation had with the Wyckoffs was as stockholders, and not as creditors. No proof was made of the expenditure of any sum by the Wyckoffs or either of them “in building up the company” for which Ticker was liable. The plan had as its purpose the settlement of differences between the Wyckoffs and they, as sole stockholders of Ticker, used it to compromise their personal disputes. We conclude from all of the evidence that the Ticker Publishing Co. was not indebted to either of the Wyckoffs at the time the preferred stock and income bonds were issued.

If there were proof that Ticker was indebted to the Wyckoffs at the time of issuance of the income bonds and that the securities were issued in satisfaction of the debts, such facts would not control the issue, for obviously there would still be the question of whether the securities issued were in fact bonds, evidence of indebtedness, payable with interest, or preferred stock, on which only dividends were payable.

The reports contain numerous cases involving questions like the one before us. They do not lay down a definite rule to follow in determining the answer. Each case turns largely upon its own peculiar facts. Commissioner v. O. P. P. Holding Corporation, 76 Fed. (2d) 11, affirming 30 B. T. A. 337; Commissioner v. Schmoll Fils Associated, Inc., 110 Fed. (2d) 611, reversing 39 B. T. A. 411; Proctor Shop, Inc., 30 B. T. A. 721; affd., 82 Fed. (2d) 792. The fact that the securities were called income bonds by Ticker and that the payments to be made semiannually thereunder were classified as interest is not decisive. United States v. South Georgia Railway Co., 107 Fed. (2d) 3.

In United States v. South Georgia Railway Co., supra, the court held that the most significant, if not the essential, feature of a debtor and creditor relationship is the existence of a fixed maturity date with a right to enforce payment in the event of default. In Commissioner v. O. P. P. Holding Corporation, supra, the court said:

* * * The fact that ultimately he [holder of debenture bonds] must be paid a definite sum at a fixed time marks his relationship to the corporation as that of creditor rather than shareholder. The final criterion between creditor and shareholder we believe to be the contingency of payment. * * *

To the same effect are Jewel Tea Co. v. United States, 90 Fed. (2d) 451, and Haffenreffer Brewing Co. v. Commissioner, 116 Fed. (2d) 465. In Commissioner v. Schmoll Fils Associated, Inc., supra, the court held that the absence of a maturity date, the obligation to pay income from net earnings, and the giving to bank creditors rights over holders of the debentures made the payments more like dividends than interest, and the securities like preferred stock rather than bonds. In Warren v. King, 108 U. S. 389, the Court emphasized the fact that certificate holders had to look to net earnings for income, as grounds for holding that no debtor and creditor relationship existed.

Though the income bonds were a liability of the corporation, there may be liability without debt. Journal Co., 44 B. T. A. 460. Here the parties were very careful to provide that the so-called interest on the bonds was payable only out of net profits computed after creating a reserve for unexpired subscriptions. Thus they were like preferred stock, which does not give the holder any right to income except out of earnings or to his capital on a specified maturity date. Petitioners contend that the liability of Ticker to pay principal and interest to the extent of earnings gave the bonds a maturity date, and fixed the liability to pay. This was not a definite maturity date or a liability to pay regardless of net profits. The distinction is one which the courts in the cited cases point to as strong indication of intent to issue preferred stock rather than evidence of indebtedness. The bondholders did not, except upon liquidation of Ticker, have a right to have their claims for interest paid out of anything other than net profits. Creditors have a right to enforce their claims against the assets of the debtor. That right did not exist here as to income on or the principal of the securities, prior to liquidation.

The fact that the bonds did not carry voting rights does not overcome other more material factors. Preferred stock is frequently issued without such rights. It is worthy of note that in addition to the requirement that “interest” be paid only from net profits', payment could be made under the terms of the “income bonds” only if the directors declared it to be then payable. Such a provision is not in harmony with the idea of a debt payable at all events, except as to net profits, but on the contrary is similar to the usual necessity of declaration of a dividend on preferred stock.

Petitioners argue that an opinion of the New York Supreme Court, affirmed by the Appellate Division, in an action instituted by executors of the estate of Eichard D. Wyckoff against Ticker and a recognition in stipulations involving income tax liability for prior years, during which amounts were paid under the bonds as interest, is res adjudicata on the question.

The opinion relied upon was rendered in connection with a motion filed by the plaintiff in an action to inspect the books of Ticker. Neither the record here nor the opinion discloses the issue involved in the proceeding. Mere reference by the court to the owners of the securities as bondholders has no binding force. They were so designated in the certificates, but, as we have seen, a certificate may be something other than the name assigned to it by the issuing corporation.

Petitioners’ reply to respondent’s amended answers alleges that in settling the proceedings before this Board for prior years amounts paid out under the bonds were allowed as interest. There is no proof of that fact. The stipulation here is that the amounts were held to be dividends by the respondent in determining the deficiencies; There is no proof of recognition by the Commissioner in those cases that the amounts represented interest, not dividends. In short, we do not know how the parties arrived at the stipulated deficiencies; moreover, there were no decisions on the merits. Clearly, upon the facts before us, res adjudicata may not be applied here. Almours Securities, Inc., 35 B. T. A. 61; affd., 91 Fed. (2d) 427; certiorari denied, 302 U. S. 765.

We conclude and hold that the so-called income bonds were, in substance, preferred stock and the amounts in controversy constitute dividends on preferred stock, not interest, as originally determined by respondent.

Ticker contends, in the alternative, that in case it is held that the “income bonds” interest constitutes dividends on stock, then it is entitled to a credit of $9,362.36 in 1936 and a credit of $48,587.04 in 1987 on account of alleged prohibitions in the agreement of May 20, 1926, and the income bonds, on the payment of dividends. The provisions of section 26 (c) (1) and (2) of the Revenue Act of 1986, and Joell Co., 41 B. T. A. 825, and G. B. R. Oil Corporation, 40 B. T. A. 738, are relied upon.

In the Joell Co. case the taxpayer was required by a written contract to apply the income realized from Veal estate to discharge the mortgage indebtedness on the property at the time of its acquisition by the taxpayer. We regarded the mortgage as a debt, although it was not assumed in the purchase of the property. In the G. B. R. Oil Corporation case the taxpayer was required to turn over to a bank all of the proceeds of oil leases for credit on indebtedness to the' bank for loans to develop the leases. In each case we held that section 26 (c) (2), supra, entitled the taxpayer to the credit provided for therein.

The cases relied upon by Ticker are not controlling. In those cases earnings and profits of the taxable year were required by written contracts to be paid in discharge of a debt.

The statutory provisions granting the credit must be strictly complied with. Nevada-Massachusetts Co., 43 B. T. A. 1127; Union Telephone Co., 44 B. T. A. 607. Section 26 (c) (1) relates to contracts under the provisions of which no dividends can be distributed without violating its terms and section 26 (c) (2) deals with agreements requiring the payment or setting aside of earnings for the discharge of debts. Since we have above held that no corporate debt was involved in the “income bonds”, it follows that section 26 (c) (2) does not here apply and we held, therefore, that the petitioner is not entitled to the dividend credit claimed under that subsection. Of course, petitioner is entitled to credit, under section 27 (a), for the amounts paid which, under the respondent’s concession, cover all of the adjusted net income for 1936, and $25,624.83 for 1937. The question arises then whether the balance of adjusted net income for 1937, $40,722.52, is basis for a claim of credit under section 26 (c) (1). Section 26 (c) (1) does not apply, for though existence of debt is not a prerequisite to its application, there must be a contract restricting payment of dividends, and here there was no such restriction. The contract indeed provided for, and not against, the payment of dividends, and the petitioners could have paid them without violation of any provision of the contract, but in compliance therewith. The adjusted net income could all have been devoted to payment of dividends. In fact, the entire amount was within the taxable year declared payable, and payment followed in March 1938.

Ticker also contends that it is entitled to dividends paid credits in computing surtax on any resulting undistributed net income for 1936 and 1937, and that it is also entitled to a dividend carry-over credit of $5,000 in computing surtax on undistributed profits for 1937.

The respondent concedes that Ticker is entitled to a dividends paid credit of $44,939.10 for 1936 and a dividend carry-over credit to 1937 as a result thereof. The parties agree that the amount should be determined under Rule 50. As to the year 1937, the respondent contends that as no part of the amount of $40,722.52 credited to Cecelia G. Wyckofi: as interest on the class A bonds was paid in 1937, Ticker is not entitled to any credit in respect thereto. Concerning the class B bonds he concedes that the credits totaling $25,624.83 to C. G. Wyckofi, Inc., constituted the payment of a dividend, but that the amount of the dividends paid credit is limited to 15 percent thereof, or $3,843.72, by the provisions of sections 26 (b) and 27 (h) of the Revenue Act of 1936.

We agree with respondent on the dividends paid on the class A bonds. They were declared on December 30, 1937, credited the next day, but were not payable or paid until March 7,1938. The crediting under the circumstances did not constitute payment under section 27 (a) of the Revenue Act of 1936. There must be payment to obtain the benefits of the statute. Schinebro, Inc., 45 B. T. A. 580. Atlantic Land Co., 48 B. T. A. 74, and Valley Lumber Co. of Lodi, 48 B. T. A. 423, are clearly distinguishable. The stipulation relied upon by Ticker to show that the amount was reported by Cecelia G. Wyckoff as income in 1937 relates to “interest” paid by Ticker, not “interest” declared by it.

The respondent cites no authority other than sections 26 (b) and 27 (h), supra, to support his contention that the dividends paid credit on the distribution made to C. G. Wyckoff, Inc., is limited to 15 percent of the amount thereof. We find no decided cases on the question.

The gist of the contention of respondent seems to be that as 85 percent of the dividend paid on the class B bonds escaped tax by reason of the credit allowed to corporations under section 26 (b) for dividends received from domestic corporations, to that extent the payment was a nontaxable distribution of Ticker.

Dividends are expressly includible in gross income by the provisions of section 22 (a) of the Revenue Act of 1936. Definitions of gross income in prior statutes contained a similar provision. Sec. 22 (a), Revenue Acts of 1928,1932, 1934; sec. 213 (a), Revenue Acts of 1918, 1921, 1924, 1926. These revenue acts granted, in general, deductions to corporations for amounts received as dividends from domestic corporations. Sec. 234 (a) (6), Revenue Acts of 1918, 1921, 1924, 1926; sec. 23 (p), Revenue Acts of 1928, 1932, 1934. By amendment to the 1934 Act, the Revenue Act of 1935 restricted the deduction to 90 percent of the amount received. Sec. 102 (h).

The Revenue Act of 1936 did not permit a deduction from gross income for dividends received by corporations from domestic corporations, but allowed as a deduction from net income, for normal tax purposes, the credit allowed by section 26 (b), which is 85 percent of the amount of dividends received from a domestic corporation. Sec. 13 (a) (2). This change in the 1936 Act did not alter the necessity of including in gross income, as before, dividends from domestic corporations. It merely piovided for a deduction from net income for normal tax purposes instead of, as theretofore, a deduction from gross income. Thus there was clear provision recognizing the distribution as a taxable dividend and we do not think it was otherwise because Congress, by another provision, allowed a portion thereof to escape normal tax by a credit against net income.

Aside from the taxability of the dividend for normal tax purposes, the whole of the amount is subject to surtax on undistributed profits and personal holding company surtax. Secs. 14 and 351.

We hold that Ticker is entitled to a dividends paid credit for the entire amount of the dividends paid to C. G. Wyckoff, Inc.

The next contention of Ticker is that, since the respondent’s claim for an increased deficiency for 1936 was not filed in the proceeding within the three-year period allowed by section 275 (a) of the Revenue Act of 1986 for assessment, the request was not timely.

On November 8,1939, well within the three-year period allowed for assessment, respondent mailed a notice of deficiency and within the 90 days allowed by section 272 (a) Ticker petitioned this Board for a redetermination of the deficiency. The provisions of section 277 suspended the running of the statute of limitations until the decision of the Board becomes final and for 60 days thereafter. Before the hearing herein, while the statutory period of limitations was under suspension, the respondent, by an amended answer, on February 12, 1941, asserted a claim for an increased deficiency as permitted by section 272 (e), claiming that amounts allowed by him as interest were dividends on preferred stock. Petitioner filed an amended petition at the hearing, and the respondent filed answer thereto and again asked for increased deficiency.

The petitioner cites Commissioner v. Rieck, 104 Fed. (2d) 294; certiorari denied, 308 U. S. 602; reversing 35 B. T. A. 1178. In that case the court declined to permit an amendment to the petition of a taxpayer claiming refund of an overpayment because it constituted a new cause of action and was filed after the expiration of the period of time allowed by statute for the filing of claims for refund. In that case the taxpayer did not have the benefit of a statute authorizing him to make claim for a refund at any time before or at the hearing before this Board. Respondent had such right here. This statutory right serves to distinguish the two proceedings. The claim was filed within the time allowed by the statute and respondent is entitled to any increased deficiency redetermined under Rule 50. Helena Liebes, Executrix, 20 B. T. A. 731; affd., 63 Fed. (2d) 870; Rowan Drilling Co., 44 B. T. A. 189.

Ticker contends that in the event we hold that the payments made by it under the income bonds constitute dividends for 1936, and not interest, then it is entitled to an additional deduction of $2,000 in 1937 for New York State franchise tax.

At the hearing counsel for respondent made no reply to the statement of counsel for Ticker that the amount of New York State franchise tax would be determined under Rule 50. Upon brief he does not contest the allowance of any additional amount properly accruable, but argues that, as the burden of proof was upon petitioner and the record does not show the amount of taxes claimed as a deduction and if there is additional liability for the taxes it can not be ascertained until the decision herein is rendered, we should not allow any amount.

Ticker claimed in its return for 1937 the sum of $742.79 as a deduction for New York State franchise tax, all of which the respondent allowed except $25 paid for another corporation. The earnings of Ticker as recorded in its books were stipulated and no claim is being made by the respondent that the books do not reflect its true profits, except for adjustments made necessary by our holdings herein. The rate of tax on these earnings is a matter of state statute, of which this Board takes judicial notice. In an early decision we held that New York State franchise tax accrues on November 1 each year. Jamestown Worsted Mills, 1 B. T. A. 659. The New York State franchise tax accruable as a deduction for 1937 depends upon income for 1936. After the amount of income for 1936 is determined in accordance with this opinion, the parties should have no difficulty in arriving at the amount of New York State franchise tax properly deductible for 1937. However, if they are unable to agree upon this item in their computations under Rule 50, a further motion in respect thereto can be made.

Decision will Toe entered under Rule 50.

       SEC. 26. CREDITS OF CORPORATIONS.
      In the ease of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax—
      *******
      (e) Contracts Restricting Payment on Dividends.—
      (1) Prohibition on payment op dividends. — An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account.
      (2) Disposition op propits op taxable year. — An amount equal to the portion of the earnings and profits of the taxable year which is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of the taxable year) to be paid within the taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt; to the extent that such amount has been so paid or set aside. For the purposes of this paragraph, a requirement to pay or set aside an amount equal to a percentage of earnings and profits shall be considered a requirement to pay or set aside such percentage of earnings and profits. As used in this paragraph, the word “debt” does no^ include a debt incurred after April 30, 1936.

       SEC. 26. CREDITS OE CORPORATIONS.
      In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax—
      *******
      (t>) Dividends Received. — 85 per centum of the amount received as dividends from a domestic corporation which is subject to taxation under this title. * * *
      'SEC. 27. CORPORATION CREDIT FOR DIVIDENDS PAID.

        *******

      (h) Nontaxable Distributions. — If any part of a distribution (including stock dividends and stock rights) is not a taxable dividend in the hands of such of the shareholders as are subject to taxation under this title for the period in which the distribution is made, no dividends paid credit shall be allowed with respect to such part.

       SEC. 27. CORPORATION CREDIT FOR DIVIDENDS PAID.
      (a) Dividends Paid Ceedit in Genebal. — For the purposes of this title, the dividends paid credit shall be the amount of dividends paid during the taxable year.

       SEC. 275. PERIOD OF LIMITATION UPON ASSESSMENT AND COLLECTION.
      Except as provided in section 276 —.
      (a) General Rule. — The amount oí income taxes imposed by this title shall be assessed within three years after the return was filed, and no proceeding in court without assessment for the collection of such taxes shall be begun after the expiration of such period.