author: Lansdon:

text:
    Appeal of THE COLUMBIA THEATRE CO.
    Docket No. 1414.
    Submitted October 14, 1925.
    Decided February 9, 1926.
    1. Stockholders surrendered and authorized the cancellation of certain notes evidencing money advanced by them to a corporation. Held, that, in the circumstances of this appeal, the amount of the notes so surrendered and canceled became paid-in surplus from the date of such surrender and cancellation.
    2. In response to proper corporate action stockholders paid in to a corporation certain assessments. Held, that such payments were additions to paid-in surplus.
    3. During the period required for the construction of buildings on leased land, such construction being a condition of the lease, a corporation expended various amounts for interest, ground rents, and other expenses designated by it as carrying charges. Held, that such so-called carrying charges may not be included in statutory invested capital for excess-profits tax purposes.

      James P. Maginn, Esq., for the taxpayer.

      Arthur J. Seaton, Esq., for the Commissioner.
    Before Sternhagen, Lansdon, and Artjndell.
    This appeal is from the determination of a deficiency in income and profits taxes for the year 1919 in the amount of $4,881.20, all of which is in controversy. The taxpayer asserts that the Commissioner erred in disallowing amounts claimed as invested capital for the Mid-City Realty Co. and the Middleton Theatre Co., in computing the statutory invested capital of certain affiliated companies.. The parties agree that the income tax for the year in question is correctly computed and that the appeal has to do only with profits tax.
    FINDINGS OF FACT.
    The taxpayer is a Missouri corporation, with its principal office in St. Louis. During the year 1918, it was affiliated, for income and profits tax purposes, with the Middleton Theatre Co., the Vaudeville Theatre Co., the Mid-City Realty Co.-, and the American The-atre Co., and for that year made a consolidated income and profits-tax return for itself and all other members of such affiliated group. The return so made was accepted and audited by the Commissioner.
    The Mid-City Realty Co. was incorporated in 1907, under the laws of Missouri, with an authorized capitalization of $50,000, all of which was subscribed for' and paid in by nine shareholders. On September 14, 1909, the company, by appropriate corporate action, increased its authorized capitalization to $100,000, and at that date the additional $50,000 of capital stock was subscribed for and paid in by the nine shareholders. In 1909, subsequent to the increase in capital, the company borrowed $100,000 from the Mercantile Trust Co. on a fifteen-year bond issue and, as a condition of such loan, agreed to make annual payments of $3,000 on the principal of the loan during a term of fifteen years and to pay the balance in the fifteenth or sixteenth year. Such annual payments were made regularly from the funds of the company. At the beginning of the year 1918, the bonded debt had been reduced by the agreed annual payments to the amount of $16,000.
    Some time in the year 1907, the Mid-City Eealty Co. acquired a 99-year lease on a parcel of real estate, located at the southeast corner of the intersection of Grand Avenue and Olive Street, in St. Louis. This ground was fully improved at the time with a three-story hotel building that was rented for $15,000 per annum. A condition of the lease required the construction of a new building on the land within ten years and at a cost of not less than $150,000. To assure the fulfillment of this condition, the nine stockholders made a bond in the amount of $50,000.
    In conformity with the terms of its lease, the Mid-City Eealty Co. began the construction of a new building in 1909. In such construction, in reconstruction and repairs of the old building, and in annual payments on its bonded debt, it expended the following amounts: All its paid-in capital of $100,000, all the proceeds of its bond issue of $100,000, the sum of $75,000 borrowed from the Mercantile Trust Co. on the notes of the corporation, and the sum of $10,800, paid in to the company by the shareholders in response to assessments made by proper corporate action — or a total of $285,800. Before 1917, the money borrowed from the Mercantile Trust Co. on the notes of the company was paid with cash advanced by the nine shareholders, each of whom contributed about $8,300 for that purpose. As consideration for such contributions, each of the nine stockholders received the note of the company in the amount of about $8,300, but all such notes were surrendered to the company and canceled, without any cash payments having been made thereon, prior to 1917. Assessments in the amount of $10,800 were paid in to the company by the shareholders during the year 1915.
    In 1917, the nine original shareholders of the Mid-City Eealty Co. sold all their stock to the Columbia Theatre Co., which, between that date and January 1, 1919, expended the amount of $63,874.56 for alterations and additions to the properties.

      The Middleton Theatre Co. Avas incorporated, under the laws of Missouri, on June 13, 1899, with a paid-in capital of $25,000. On June 16, 1899, with the proceeds of its capital stock, it acquired the unexpired term of a lease on the Grand Opera House, terminating on July 1,1912. As additional consideration for such lease, it agreed to pay and did pay $15 per week for 40 weeks in each of the four following years, and such payments, in the total amount of $12,000, were charged to profit and loss on its books of account. On October 31, 1910, it subleased the Grand Opera House to the St. Louis Theatre Co. for the remaining term of its lease on that building. On November 1, 1900, it purchased an underlying lease, expiring July 1, 1912, on the ground occupied by the Grand Opera House and certain adjacent buildings, from Pierre Chouteau, and paid therefor the amount of $62,500. By these purchases and payments, aggregating $99,500, it acquired the use and enjoyment of the land and buildings thereon until July 1, 1913, subject to the rights of certain persons who had subleases on portions of the premises.
    In 1906, the Middleton Theatre Co. secured a renewal of the lease on the ground above described for a period of 99 years from July 1, 1912. For such 99-year lease, it paid a bonus of $10,000, in five annual payments of $2,000 each. Among other conditions of the lease, the lessee agreed to erect a hotel building, at a cost of not less than $40,000, and to remodel the Grand Opera House theatre building, at a cost of not less than $150,000. To enable it to enter into full possession of the leased premises and begin the building operations to which it was obligated by the terms of its 99-year lease, the taxpayer, some time in 1912, paid the St. Louis Theatre Co. $9,999 for the unexpired term of the sublease given to that concern on October 1, 1900:
    Some time during the year 1912, the Middleton Theatre Co., in conformity with the terms of its 99-year lease, began building operations on the hotel and theatre buildings. For a period of nearly three years, while construction was in progress, there was little income from the property and, at the same time, in addition to amounts expended in construction, there were net payments, designated by the taxpayer as carrying charges, which the parties agree were as follows:
    Ground rentals_$24, 594. 99
    Taxes- 11, 252.40
    Attorneys’ fees_ 6, 350.00
    Insurance_ 5, 028. 59
    Interest on borrowed money used In construction- 39, 097.38
    Sundry expenses from Nov. 1, 1910, to Dec. 31, 1913_ 9, 632.23
    Sundry expenses in connection with contracts, 1913_ 7, 567.01
    Total_ 103, 522.60

      The remodeled Grand Opera House was opened for business in March, 1913; the American Annex Hotel, constructed by the Middleton Theatre Co. under the terms of its contract, was turned over to lessees in January, 1914. The balance sheet of the Middleton Theatre Co. as of December 31, 1914, showed an improvement account of $434,348.35, and an equipment account of $49,925.45, on a total property investment in the amount of $484,273.80. Its authorized capital stock in May, 1913, was $100,000 common and $150,000 preferred, and so remained to January 1, 1919. On December 31, 1914, the company owed money borrowed from St. Louis banks in the amount of $310,000.
    From December 31, 1914, to December 31, 1918, the Middleton Theatre Co. used considerable amounts of its earnings to make payments on its loans, and at the latter date had reduced its obligations for borrowed money to the amount of $24,500 owed on notes to banks and $200,000 secured by mortgage on its properties. Its balance sheet as of December 31,1918, was as follows:

      Balance sheet

    Equipment_$52. 553.10 St. Louis Union Bank_$20, 000.00
    Improvement___ 445, 485.48 Common stock_ 100, 000.00
    Leasehold_ 255, 519.13 Preferred stock_ 150, 000.00
    Columbia Theatre Oo- 7, 650. 00 St. L. Un. Bk. Fourth
    Fourth Liberty loan_ 5, 000. 00 Liberty loan-_ 4, 500.00
    Vaudeville managers P. A_ 35. 80 War tax_ 3, 262.50
    Frank E. Tate_ 600. 00 Lawton-Byrne-Bruner_ 5, 427.28
    Imperial Theatre Co_ 2, 600. 00 Mortgage account_ 200, 000.00
    Harry Wilson- 40.00 Capital investment_ 380, 307.62
    Loan a/c Vaudeville Th— 167, 540. 30 Reserve for depreciation_ 112,436.45
    Southern R. E. & F. Co_ 14, 900.00
    Mercantile Trust Co_ 16, 703. 03
    Change- 300. 00
    Loss & gain_ 2,148.03 Balance- 4, 858.98
    975, 933.85 975,933.85
    Upon audit of the consolidated return made by the taxpayer for itself and affiliated corporations, the Commissioner reduced the invested capital of the group to $607,123.93, by disallowing certain amounts included by the taxpayer in the computation of the statutory invested capital of the Mid-City Realty Co. and the Middleton Theatre Co., and determined the deficiency in controversy.
    DECISION.
    The deficiency should be computed in accordance with the following opinion. Final determination will be made on 15 days’ notice, under Rule 50.
   OPINION.

Lansdon:

This appeal involves the correct determination of the statutory invested capital of a group of affiliated companies, which made a consolidated income and profits-tax return for the year 1919 through the taxpayer, which is the parent corporation. The questions involved must be resolved by ascertaining the correct invested capital of the Mid-City Realty Co. and the Middleton Theatre Co.

The Mid-City Realty Co. had capital paid in for shares in the amount of $100,000, concerning which there is no controversy. The taxpayer contends that the amounts of $75,000 loaned to the company by its stockholders, who received therefor the notes of the company which subsequently were voluntarily surrendered and canceled without any payments having been made thereon, and $10,800 paid in by the shareholders in response to assessments legally made by the directors, should also be included in the computation of its statutory invested capital, together with any earned surplus indicated by its books on January 1, 1919.

Each of the amounts in question was embarked in and at risk in the business. Except in the event of liquidation, none of the contributors had any legally enforceable claim against the company for any part of the principal amounts so paid in, or for dividends or interest thereon. Their only hope of repayment or profit was in the success of the company. If it earned substantial profits, they might receive dividends sufficiently large to pay them some return on their entire contributions. If it made enough profits, such dividends could be paid and the surplus resulting from the transactions now under consideration would continue to represent tangible property and be evidenced to the shareholders in the book value and market price of the shares of the company. From every point of view, it would seem that these amounts were actually embarked in the business and were at risk, in exactly the same way as the money originally paid in for shares.

It has been argued that corporate funds obtained as set forth in our findings of fact can not, from their very nature, become unchangeable capital items. Why not? The law provides that property paid in for shares of stock shall be included in the computation of invested capital for excess-profits tax purposes, even though such assets may thereafter entirely disappear. We have held above that, in the circumstances of this appeal, there is no inherent difference between the nature of paid-in surplus and of property paid in for shares. Together they make up the total capital contributions embarked in an enterprise and are entitled to a fair return before the provisions of the excess-profits tax law are applied, and therefore must be regarded as a single and inseparable body of statutory invested capital. In this connection, the Board has recently held, in the Appeal of Guarantee Construction Co., 2 B. T. A. 1145:

We are of the opinion, therefore, that capital and surplus actually paid in remain part of the invested capital of a corporate taxpayer, except where such capital or surplus has been directly or indirectly returned to the stockholders.

In the case at bar, there has been no such return, by distribution of dividends or otherwise. We are of the opinion that the payments here in question were contributions to capital, and, as they are not specifically excluded as inadmissibles under section 325 of the Revenue Act of 1918, they must be included in the taxpayer’s statutory invested capital. Lincoln Chemical Co. v. Edwards, 289 Fed. 458; Appeal of Guarantee Construction Co., supra; United States v. Oregon-Washington R. & Nav. Co., 251 Fed. 211.

The expenditure of $63,874.56 by the Columbia Theatre Co., for capital additions to the property of the Mid-City Realty Co., after it had become the owner of all the capital stock of such Mid-City Realty Co., which the taxpayer also seeks to have included in the consolidated invested capital of the affiliated group, must be regarded as an inter-company transaction. Before this money was so used, it was a part of the capital or surplus of the Columbia Theatre Co. Its investment in capital assets belonging to an affiliated-company does not change its status. It is already included in the consolidated invested capital of the group.

The taxpayer also, contends that the amount of $24,000 paid on the bonded debt of the Mid-City Realty Co., for the most part out of operating income, should be included in the computation of invested capital. Since the repayment of borrowed money out of profits results in the inclusion of the assets represented by such borrowed capital in the earned surplus of the company, the Board holds that this item is already included in the invested capital of the company, if the books of account properly reflect such transactions.

The Board is of the opinion that the statutory invested capital of the Mid-City Realty Co. for the year involved in this appeal was made up of the amounts of $100,000 paid in for shares of capital stock, $85,800 paid-in surplus, and such earned surplus as may be disclosed by the company’s balance sheet as of December 31, 1918.

The taxpayer contends that certain expenditures and investments made by the Middleton Theatre Co. should be included in the consolidated invested capital of the affiliated companies. These expenditures fall into three groups: (1) Payments made to obtain the use and enjoyment of the unexpired term of a 30-year lease on the premises occupied by the Grand Opera House and the American Annex Hotel; (2) payments in the form of bonus and expenses, to secure a 99-year lease on tbe same premises; and (3) certain so-called carrying charges, incurred during the period of construction of the hotel and reconstruction of the theatre.

The 30-year lease, which was acquired by the taxpayer at a cost of $99,500, expired on July 1, 1912. Its cost or value can not be regarded as an element of invested capital for the year 1919.

Although the 99-year lease on the same property is frequently designated by the witnesses of the taxpayer as the “ 105 year lease,” there is nothing in the evidence to indicate that it was anything more than a 99-year lease, which began to run on July 1, 1912. This lease was not offered in evidence. Any expenditures, in the way of cost or bonus, incurred in connection with its acquisition, should be capitalized and exhausted ratably over the 99-year period beginning July 1, 1912. The $10,000 bonus paid to secure this lease and the $9,999 paid to the St. Louis Theatre Co., in order that the lessee company might enter into full possession of the premises and begin its building operations in season to enable it to enjoy its 99-year lease for the full term thereof, are costs in connection with the acquisition of such lease, and should be included in the consolidated invested capital of the affiliated group.

During the period of its building operations, from 1910 to 1913, the taxpayer was without any substantial income from its property, and was required to make disbursements for ground rentals, taxes and other expenses incident to its ownership of the two leases and its improvement of the ground, as required by the terms of its contract with the owner of the fee. These payments, in the total amount of $103,522.60, the taxpayer seeks to have included in its invested capital. The Board is of the opinion that the amounts of $6,350 attorneys’ fees, paid in connection with the acquisition of leases; $5,028.59, cost of insurance during ■ building operations; and $5,-067.01, sundry expenses in connection with contracts, are capital expenditures, and, to the extent that they are reflected in the surplus for the years in question, should be included in the statutory invested capital of the taxpayer. The remaining items, listed as carrying charges, appear to be ordinary -and necessary expenses. Westerfield v. Rafferty, 4 Fed. (2d) 590; Appeal of Hotel De France Co., 1 B. T. A. 28.

The Board is of the opinion that the following amounts, as the invested capital of the Middleton Theatre Co., should be included in the consolidated invested capital of the affiliated group: $250,000 paid in for common and preferred stock; $19,999 cost of securing 99-year lease and the earned surplus of the Middleton Theatre Co. as of December 31, 1918, with proper adjustment resulting from deducting accrued exhaustion of the 99-year leasehold from July 1,1912, to December 31, 1918.


source: Caselaw Access Project

author: Marquette

license: Public Domain

text:
    Appeal of RAY F. MUDD MOTOR CO.
    Docket No. 1192.
    Submitted June 29, 1925.
    Decided February 9, 1926.
    1. Liability incurred within the year for premiums on insurance policies effective during the year is properly deductible as business expenses in the year in which the liability was incurred, where the taxpayer’s books of account are kept on the accrual basis.
    2. The reasonable allowance for wear and tear and exhaustion of certain assets determined.
    3. Evidence helé insufficient to show that certain items treated on the taxpayer’s books as capital expenditures were ordinary and necessary business expenses.

      D. E. Currier, C. P. A., for the taxpayer.

      B. G. Simpich, Esq., for the Commissioner.
    Refore Ivins and MaRquette.
    This appeal involves additional income and profits taxes for the years 1919 and 1920, in the amount of $3,448.81, and an overassessment for the year 1921 in the amount of $902.09.
    FINDINGS OP PACT.
    The taxpayer is an Illinois corporation, with its principal office at Chicago, and it is, and was during the years 1919 to 1921, inclusive, engaged in selling Ford and Lincoln automobiles and service parts therefor. Its books of account are, and were during the years named, kept on the accrual basis.
    The taxpayer, during the years 1919, 1920, and 1921, purchased from J. A. Mudd, Jr., an insurance agent, large- amounts of insurance on its stock of automobiles and equipment. The amount of the premium on each policy of insurance was accrued on the taxpayer’s books in the year in which the insurance was purchased, and was also charged to the taxpayer on the books of the insurance agency, but frequently payment was not actually made until the following year. During the years 1919, 1920, and 1921, the taxpayer entered on its books of account premiums on insurance purchased in those years, in the amounts of $5,541.51, $4,912.39, and $5,640.84, respectively. These amounts were deducted as business expenses in the taxpayer’s returns for the years mentioned. The Commissioner, upon audit of the returns, allowed as deductions in each year only so much of the cost of the insurance in question as was actually paid in that year.
    The Commissioner, upon audit of the taxpayer’s returns for the years 1919, 1920, and 1921, allowed deductions for depreciation on small tools, computed at the rate of 10 per cent per annum, and on service trucks and “lesson” cars, commonly known as demonstrators, at the rate of 25 per cent per annum. The small tools used by the taxpayer in its business had a very short life and had to be constantly replaced; a considerable part of them was lost each year, and their average life was not to exceed three years. The “ lesson ” cars were used by the taxpayer in teaching its customers to drive and operate cars purchased by them, and were almost continuously operated by inexperienced drivers. They were subjected to unusually hard service and were driven as many miles in one year as cars ordinarily cover in several years. The average life of these cars was not to exceed two years. Service trucks were used by the taxpayer to haul in wrecked and disabled cars and trucks. They were required to be maintained at a high degree of efficiency, in order to be powerful enough to pull loaded trucks out of ditches, and were only serviceable to the taxpayer for periods of 6 to 18 months. The average life of the service trucks was not to exceed 2 years.
    DECISION.
    The deficiency should be computed in accordance with the foregoing findings of fact and the following opinion. Final determination will be settled on 10 days’ notice, under Hule 50.
   OPINION.

Marquette

: The taxpayer’s books were kept on the accrual basis, and it accrued thereon its liability incurred during each of the years in question for premiums on insurance purchased during those years. It does not appear that any of this insurance extended over a period longer than one year. They constituted ordinary and necessary business expenses in each of the years in question, and must be allowed as deductions from gross income in the years in which accrued.

The evidence satisfies us that a reasonable allowance for the wear and tear and exhaustion of the small tools used in the taxpayer’s business is 33½ per cent, and that a reasonable allowance for the wear and tear and exhaustion of the “ lesson ” cars, is 50 per cent.

The taxpayer alleged in its petition, and it claimed at the hearing, that certain items of expense had been charged to its capital assets account in the amounts of $2,069.09 in the year 1919 and $3 in the year 1921, and that these amounts should be allowed as deductions from gross income in those years. At the hearing the taxpayer offered certain exhibits, which It. F. Mudd, general manager of the taxpayer, testified were copies of original entries on the taxpayer’s books. Objection was made by the counsel for the Commissioner to the introduction of these exhibits, for the reason that the taxpayer’s witness was unable to verify or substantiate the various items contained therein. In order to determine the character of these items, it was agreed between the taxpayer and the Commissioner that the exhibits should be sent to a revenue agent for comparison with the taxpayer’s books, in order that a stipulation might be entered into by the taxpayer and the Commissioner as to the facts. The exhibits were sent to a revenue agent, who visited the taxpayer’s place of business and compared them with the taxpayer’s books of account. The agent reported that some of the exhibits consisted of copies of entries found on the taxpayer’s books and correctly entered thereon, and that others appeared to be recapitulations from entries on the books. He also reported that the taxpayer refused to permit him to examine the books, in order to ascertain whether or not there were any offsetting entries to the various entries contained in the exhibits, and that it was not possible for him to ascertain whether or not the items in question represented capital expenditures or ordinary and necessary business expenses, inasmuch as there were no invoices from which to check. Under the circumstances, we are unable to determine whether the items aré properly ordinary and necessary business expenses or capital expenditures, and we must, therefore, confirm the action of the Commissioner with respect thereto.

The taxpayer in its petition claimed that certain State' and county taxes had been improperly treated by the Commissioner in ascertaining its net income. No evidence was presented showing the amount of the taxes or when they became a liability, and, in the absence of such proof, the Commissioner’s determination thereon is approved.


author: Morris

text:
    Appeal of V. J. BULLEIT.
    Docket No. 2709.
    Submitted June 1, 1925.
    Decided February 9, 1926.
    1. A corporation bad a contract for tbe acquisition of oil leases, wbieb it assigned to its stockholders upon their agreement to assume all of the obligations under the contract, each stockholder to pay cash to the seller in an amount equal to 40 per cent of his stockholding in the company and the balance of the purchase price to be paid out of the oil run. The stockholders, also out of the oil run, were to have returned to them the amount of cash which they had paid. Upon completion of both payments from the oil run, the stockholders were to transfer the oil leases to the company and receive therefor stock of par value equal to the amount of cash they had paid under the contract and for which they had received reimbursement out of the oil run. After the payments had been made by the stockholders to the former owners of the oil leases, of cash and out of the oil run, the agreement between the stockholders and the company was changed. No cash was returned to the stockholders out of the oil run, but the ■oil leases were transferred to the company for stock in the company having a par value equal to twice the amount of cash that the stockholders had paid under the purchase contract. The taxpayer paid $1,200 in cash in 1918, along- with other stockholders, and in 1919 received 2,400 shares, of $1 par value each, of stock for his interest in the oil leases. Held, the taxpayer realized a gain in 1919 of the difference between his cash investment of $1,200 and the fair market value of the 2,400 shares of stock on the date of transfer and receipt.
    2. The taxpayer acquired several parcels of certain stock at different prices and later sold some of it. It is impossible to identify the shares sold with any particular shares acquired. Some of the shares held were acquired through exercise of stock rights. Held, that the average cost per share of all stock acquired is the proper basis for computing gain or loss on the shares sold.
    3. Value of stock of Belle Point Oil Co., received in exchange for property, for purpose of determining gain or loss, fixed, in the light of the evidence, at 50 cents per share.

      W. Pratt Dale, Esq., and W. H. Hartman, G. P. A., for the taxpayer.

      Lee I. Parle, Esq., for the Commissioner.
    Before IviNS, Marquette, and Morris.
    This appeal is from the determination of a deficiency in income tax for the year 1919, in the amount of $16,619.04.
    The deficiency letter also showed a deficiency in tax for 1920 of $262.04, and an overassessment for 1921 of $6.79. No question is raised relative to the determinations for 1920 and 1921.
    The questions raised are whether the taxpayer realized gains from three different transactions. The Commissioner, in his answer, presents the further question whether the deficiency should be increased over the amount shown in the deficiency letter.
    FINDINGS OF FACT.
    The taxpayer is a resident of Louisville, Ky., and was a stockholder in the Old Dominion Oil Co. during the years 1918 and 1919.
    At a meeting of the stockholders of the Old Dominion Oil Co., held on August 17, 1918, the following resolution was adopted:
    Resolved, That^the contract made by the officers and directors of this company with the Southwestern Petroleum Co. and the Cliff Petroleum Co., as-shown by the minutes of the meeting of the directors of this company held August 16, 1918, be, and the same is now hereby in all things confirmed and ratified; and that the officers and directors be further advised to pay the-sum of $30,000 to M. C. Clay and W. J. Flesher, and be authorized and directed' to accept $6,000 rebate on some of the cash payments mentioned in said contract, by reason of the royalties being somewhat higher than the original negotiations on the M. J. Brandenburg lease of 19.25 acres.
    Said resolution so offered was unanimously carried, there being no stockholder voting in the negative; and it was so ordered.

      Whereupon the following resolution was offered by Charles W. Schindler, and seconded by Michael Zier, both stockholders of record and' personally in attendance at said stockholders meeting;
    Resolved, That the officers and directors of the company be, and they are now hereby authorized and directed to amend the articles of incorporation of the Old Dominion Oil Co., increasing the shares of the capital stock from $500,000 to $750,000, and that the president and a majority of the board of directors be authorized and directed to execute such amended articles of incorporation and record the same, and file the same with the Secretary of State of the Commonwealth of Kentucky, in order to effect such increase; and that the officers and directors of such corporation be authorized and directed to do any and all other necessary and proper things to be done, and sign all other necessary and proper papers to be signed in order to effectually carry out this resolution, and to amend said articles of incorporation increasing the capital stock from $500,000 to $750,000.
    After a full discussion, the motion was unanimously carried, and the following amended articles of incorporation were presented.
    [Form of such amended articles was omitted.]
    After which your committee reported, which report was unanimously adopted, that the Old Dominion Oil Company’s contract with the Southwestern Petroleum Co. and the Cliff Petroleum Co. be sold and assigned to and assumed by each of the stockholders of the Old Dominion Oil Co. agreeing thereto equally and ratably, in proportion to their present holdings of stock in the Old Dominion Oil Co. and that each agreeing stockholder furnish the necessary sums of money required of him to pay the gross sum of $200,000 in cash to the Southwestern Petroleum Co. and the Cliff Petroleum Co., as provided in and by the contract of August 12, 1918.
    There being $500,000 of outstanding capital stock of the Old Dominion Oil Co., this will require a payment by each of such stockholders of 40 per cent, of their present holding of stock in the Old Dominion Oil Co.
    That when each of said stockholders have paid said sums of money equivalent to 40 per cent of their present stockholdings in the Old Dominion Oil Co., aggregating a total of $200,000, that they and each of them making such payments be the owners of all the rights, title and interest in [and] to the aforesaid contract of August 12, 1918, in proportion to their said respective payments; and that the officers of the Old Dominion Oil Co. be required to and keep a record of all such payments so made by each of its said several stockholders, with a contract running to each of them individually, which likewise shall run to all of them jointly and severally, to pay to them out of the oil runs from the property purchased in and by the said contract of August 12, 1918, the full sum of $200,000 in cash, without interest, along with and at the times that the $200,000 in oil mentioned in said contract of August 12, 1918, is paid to the Southwestern Petroleum Co. and the Cliff Petroleum Co.
    That further, when each of said payments have been fully made out of the oil runs from said property, namely, $200,000, to the Southwestern Petroleum Co. and the Cliff Petroleum Co., and $200,000 to the stockholders furnishing the aforesaid $200,000 in cash, as shown by the books of company, then that there be immediately purchased from said parties said contract, by issuing to each party this company’s stock at par value equal to the amount of money payable by him.
    That is to say, when the property «purchased by and as a result of the oil runs under such contract of August 12, 1918, has paid for itself in full, then. and not until then, shall stock be issued to each of the parties furnishing the aforesaid funds. The consideration being that the furnishing of such $200,-000 in cash, without interest, for the period necessary and proper that may be required to secure all of said money from the production of oil runs on the property so purchased, enables said Old Dominion Oil Oo. to own the property purchased in and by the contract of the 12th day of August, 1918, without paying for it out of its own resources, and without being at any expenditures whateyer on account of the purchase price of the property, or any other sum than amounts required to drill in and operate said property.
    It is understood that the sums mentioned herein to be paid are to be produced from said properties out of the net working interest, after payment of oil royalties, and that one-half of said net working interest is to go to the Southwestern Petroleum Co. and the Cliff Petroleum Co., and the other half of such working interest is to be credited to and ultimately paid to the parties furnishing the $200,000, as shown by the books of the corporation, and as mentioned herein; and that the stock issue following that fact is to be paid to the parties furnishing said funds, in exact proportion to the amount of moneys so furnished by them.
    And further, that when .each of said parties so furnishing said $200,000 have been fully paid as mentioned herein, without interest, and stock issued to them as mentioned herein, and the Southwestern Petroleum Co. and the Cliff Petroleum Co. have likewise been paid the $200,000 mentioned in the contract of August 12, 1918, then the properties shall become the sole and absolute property of the Old Dominion Oil Co., and all the rights, interests and privileges mentioned in the contract of August 12, 1918, shall automatically revert to and become the absolute property of the Old Dominion Oil Co.
    The taxpayer owned stock of par value $3,000, and, on October 7, 1918, he paid $1,200 to the sellers of the oil properties. On August 20, 1919, he received 2,400 shares of Old Dominion Oil Co. stock of the par value of $1 each. No cash was paid to him in accordance with the resolution, but he accepted 2,400 shares of stock for his interest in the two oil leases. The fair market value of the stock on August 20, 1919, was $1.75 per share.
    On the basis of the market value of the stock being $1.75 per share, the Commissioner determined that the taxpayer had loaned $1,200 to the Old Dominion Oil Co. and had received interest from that transaction in the amount of $2,100, and increased his taxable income by that amount.
    During the year 1919, the taxpayer was the owner of shares of stock in the Pyramid Oil Co., represented by three certificates, as follows:
    3, 895 shares, which had cost him $2 a share, represented by one certificate.
    5, 000 shares, which had cost him $0.50 a share, represented by one certificate. 1, 500 shares, which had cost him nothing, represented by a certificate for 5,000 shares, the other 3,500 shares having been given by him to his daughter, without being transferred on the company’s books, he having undertaken to sell them for her.
    10, 395

      The taxpayer, during 1919, sold in one lot 7,000 shares oí this stock, at $1.20 a share. He forwarded for transfer the certificate for 3,895 shares, which had cost $2 a share, with instructions that it be transferred in full, and the certificate for 5,000 shares, which had cost 50 cents a share, with instructions that from it there be transferred the needed balance to complete the 7,000 shares sold.
    At the time of this sale the taxpayer was the beneficial owner of no other stock in this corporation than that mentioned above.
    The taxpayer reported a loss on this transaction. The Commissioner, on the theory that, at the time of sale, the taxpayer was the owner of 42,743 shares, which had cost him an average of 57.82 cents per share, found a gain of $4,352.60.
    On February 21, 1919, the taxpayer, in his own name, but acting for a syndicate composed of two other individuals and himself, entered into a contract with the Hopewell Petroleum Co. to purchase all of its capital stock, or, if all of the stockholders would not assent, then to purchase all of the assets of that company, and to pay therefor:
    basil-$200,000
    200,000 shares of the capital stock of a company to he organized, at 50 cents a share_ 100, 000
    From oil production- 60, 000
    Total_ 360, 000
    The syndicate then organized a company, known as the Belle Point Oil Co., under the laws of Delaware, having an authorized capital stock of 1,000,000 shares of the par value of $1 each. The certificate of incorporation, dated February 27, 1919, provided, in part, as follows :
    The total authorized capital stock is one million dollars ($1,000,000), divided into one million (1,000,000) shares of the par value of One Dollar ($1.00) each.
    Of the One Million Dollars authorized capital stock Nine Hundred Thousand ($900,000.00) Dollars shall be fully paid up and non-assessable and delivered to V. J. Bulleit, or upon his order to such other persons as he may request, in the transfer and delivery to this corporation of the following leases, bearing a royalty to the lessors of one-eighth (l/8th), together with such sub-leases as have been made with and to others for the active drilling of said leases.
    The properties referred to were all previously owned by the Hopewell Petroleum Co. and were included within the transfer covered by the contract with the taxpayer, hereinbefore referred to.
    The certificate of incorporation further provided:
    And the $100,000 shall be sold for cash at par. By “ cash ” it is meant herein that the subscriptions to said stock shall be paid in cash within a reasonable time, which shall be construed to mean from one to four months.

      The syndicate then transferred to the Belle Point Oil Co. all of the property previously owned by the Hopewell Petroleum Co. The syndicate received in its own right 900,000 shares of the capital stock of the Belle Point Oil Co., and the latter assumed the liability of the syndicate to pay the $60,000 in oil produced; the syndicate also obligated itself to sell the $100,000 of treasury stock retained by the Belle Point Oil Co., at $1 a share, so that the corporation would have $100,000 of cash in its treasury for development purposes.
    The syndicate delivered to the Hopewell Petroleum Co., or to its stockholders, the 200,000 shares of stock in the Belle Point Oil Co., at the agreed value of 50 cents a share. The syndicate then took subscriptions for stock in the Belle Point Oil Co., under an arrangement by which it sold its own stock at 50 cents a share, every subscriber to a thousand shares of syndicate stock being required to subscribe for 150 shares of the treasury stock at $1 a share. The syndicate sold 546,421 shares at 50 cents a share, thereby realizing $278,210.50, of which amount $200,000 was paid to the Hopewell Petroleum Co., $9,180 was paid to the Belle Point Oil Co., to make up the balance of $100,000, agreed upon for its development purposes. In disposing of the stock throughout the entire transaction, the syndicate incurred net expense amounting to $16,446.51. One hundred and fifty three thousand five hundred and seventy nine unsold shares remained in the hands of the syndicate.
    The Commissioner determined a gain to the taxpayer from the transaction last referred to in the amount of $44,518, and, by reason thereof, and other matters mentioned in our findings, determined a deficiency in tax for the year 1919 in the amount of $16,619.04.
    DECISION.
    The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 7 days’ notice, under Rule 50.
   OPINION.

Morris

: The transaction involving the stock of the Old Dominion Oil Co. we conclude to have been as follows: The company had a contract for the acquisition of two oil leases, being obligated to pay, $200,000 in cash and $200,000 out of the oil production, or a total of $400,000. It assigned the contract to its stockholders, each of whom agreed to pay an amount of cash equal to 40 per cent of his holdings in the company. The taxpayer owned $3,000 par value of stock, and, accordingly, was obligated to pay $1,200 to the owners of the two properties in the contemplated purchase. He did so, and presumably all of the stockholders did likewise. Thereupon, they became associated as owners of the enterprise related to those two properties, subject to the performance of the contract and Compliance with the resolution. Apparently, the company was to operate the two oil properties so acquired by the stockholders and, out of the oil production, to pay the balance of $200,000 of the purchase price and to credit to, and ultimately repay, the stockholders $200,000 for the cash they had paid. When those payments had been made, the stockholders were to transfer the two properties to the company and receive as a group (but with division based upon their proportionate ownership of stock at the time of their joint payment of the $200,000 to the former owners of the two properties) $200,000 par value in stock of the company. In other words, taking the taxpayer as an illustrative stockholder, for an investment of $1,200 in cash in the oil properties there was to be a return of $1,200 in cash during the period of the joint ownership with other stockholders (or the return of the investment) and 1,200 shares of stock upon a transfer of the properties to the company. But the transaction was not so carried out. The taxpayer received nothing in cash, and thereby must have agreed to some new arrangement. The oil properties were transferred to the company on August 20, 1919, and the taxpayer then received 2,400 shares of stock of the par value of $1 each, but having a then market value of $1.75 a share, or a total value to the taxpayer of $4,200. He had paid for his interest in the two properties $1,200, and so had a resulting gain from the transaction of $3,000.

The Commissioner construed the transaction to be a loan by the taxpayer of $1,200, which was paid back in the form of $1,200 par value in stock, which payment he treated as the equivalent of $1,200 in cash, and the other $1,200 par value in stock to be in the nature of interest for the use of the money so loaned. In determining the amount of interest received, the Commissioner noted the market value of the stock on the date of receipt to be $1.75 a share, and credited the taxpayer with the receipt of income, in -the form of interest, in the sum of $2,100. Upon the record presented to us there was no evidence that the transaction was a loan, but rather an investment. It is true that the resolution of the company states that the individuals were to receive out of the oil runs “ the full sum of $200,000 in cash, without interest,” but no money was, in fact, paid to the company as a loan or otherwise. To the contrary, the contract obligations of the company were assigned absolutely to the individual stockholders, and the $200,000 payment was made by them direct to the former owners. So, the “ $200,000 in cash, without interest,” could only mean that the company would have no right to insist upon a transfer to it until the individuals had received the flat amount, and no more, of $200,000. Accordingly, it is our conclusion that the addition to income was not tbe $2,100 determined by the Commissioner, but the sum of $8,000 gain, resulting from the transfer.

The taxpayer, at the time of making a sale of Pyramid Oil Co. stock in 1919, was the owner of 10,395 shares. The cost to him of these shares was as follows:

3,895 shares at $2_ $7, 790
5,000 shares at 50 cents_ 2, 500
1,500 shares at 0 cents- 0
10,395 shares, at a total cost of-10, 290

Of these, he sold 7,000 for $8,400. He forwarded his certificate for 3,895 shares (which we shall call A for convenience), and his certificate for 5,000 shares (which we shall call B) to the transfer agent of the corporation, with instructions to transfer to his vendee all of the 3,895 shares represented by certificate A, and 3,105- shares out of those represented by certificate B. It does not appear whether this was done or not — the Commissioner acted on a theory which made it unimportant, and whether the wishes of the taxpayer had been carried out or whether (as the Commissioner claimed but did not prove) the transfer agent actually transferred all 5,000 shares represented by certificate B and 2,000 out of certifiicate A. He found, for the purpose of making his determination, that the taxpayer had acquired the $2 stock through the exercise of rights to subscribe at that price which had been issued to stockholders, and applied article 39, Regulations 62, as amended by T. D. 3403, averaging the cost of stock held, and computing the profit on stock sold on the basis of this average cost. But he also found that the taxpayer was the owner of 42,743 shares of stock which had cost him an average of 57.82 cents per share.

But the taxpayer contends that he intended to sell his $2 stock first and his 50-cent stock next. He made somebody his agent to transfer the stock on the books of the company, and the Commissioner claims that the agent did not carry out instructions but transferred the 50-cent stock first and the $2 stock second.

The taxpayer adduced no proof of the order of sale; neither did the Commissioner. We have a situation where we are unable to find affirmatively which stock was sold first and which second; where we can not identify the sold stock with the different parcels of held stock. The Commissioner acted on the theory that some of the stock was acquired under rights to subscribe issued on account of the taxpayer’s stockholdings. There is nothing in the record to refute this. And there is nothing to show to which of the 50-cent stock or the stock which cost the taxpayer nothing (it must have been received as a bonus or as a dividend,) the rights to subscribe for the $2 stock were ascribable. In the circumstances, we think the Commissioner was right in theory — that the gain or loss should be computed on a basis of the average cost of all the stock acquired, just as in the case of a sale of stock after a stock dividend. But the Commissioner’s theory must be applied to the existing facts.

The uncontroverted evidence of the taxpayer shows that he was trustee of certain stock, that prior to the gift of 3,500 shares to his daughter he was the owner of 13,895 shares which cost him $10,290, or an average of 74.05 cents per share. He sold 7,000 shares of the 10,395 which he owned at the date of sale, at $1.20 a share, realizing a gain therefrom of 45.95 cents per share, or a total gain of $3,216.50, instead of $4,352.60 as determined by the Commissioner.

Relative to the gain resulting from the syndicate transaction in Belle Point Oil Co. stock, the taxpayer’s argument is predicated upon the premise that 900,000 shares of that company’s stock cost the syndicate 40 cents a share, or $360,000. The syndicate delivered 200,000 shares to the Hopewell Petroleum Co., at a value which was agreed upon for their purposes of 50 cents a share, with the result that the apparent total purchase price was $360,000. But the Belle Point Oil Co. relieved the syndicate of the $60,000 obligation, and the syndicate actually sold 546,421 out of the 700,000 shares at 50 cents a share, realizing therefrom $273,210.50. Of the latter amount the syndicate paid out as follows:

Hopewell Petroleum Co_j._$200, 000. 00
Syndicate expense (net)- 16,446.51
Belle Point Oil Co. to balance $100,000 for development purposes_ 9,180.00
225, 626.51

The resulting cash profit was $47,583.99. In addition, the three members of the syndicate had 153,579 shares of stock free and clear. At a valuation of 50. cents a share, the total gain to the syndicate was $124,373.49, and the portion attributable to the taxpayer was $41,457.83, instead of $44,518 determined by the Commissioner and $29,548.58 contended for by the taxpayer. The latter amount results from disregarding entirely the 153,579, shares and from increasing the gain of the syndicate by the $60,000 liability assumed by the Belle Point Oil Co. with the adjustments.

To be sure, there are syndicate transactions in which it is not proper to treat unsold stock on the basis of the sale price of sold stock, but we do not consider that such a situation is now before us. There was no evidence in this appeal that the syndicate could find no market for the 153,579 shares. It is just as permissible to assume that the shares were not sold because the three members of the syndicate expected to sell later for more than 50 cents a share, as it is to assume that the market was saturated. That they saw fit to pay $9,180 in cash to the company, is not inconsistent with their desire to retain stock rather than to sell it to others at a lower price than they expected to realize later. Certainly those who bought the syndicate stock at 50 cents considered it worth more, since they simultaneously bought treasury stock at $1 a share. We have had presented to us no better evidence of the value of the 153,579 shares than the market price obtained on sales of the 546,421 shares of like stock, which was 50 cents a share. Accordingly, the gain realized by the taxpayer from the sale of the assets of the Hopewell Petroleum Co. to the Belle Point Oil Co. was $41,457.83.


text:
    Appeal of BENJAMIN J. SCHIFF.
    Docket No. 4742.
    Submitted November 30, 1925.
    Decided February 9, 1926.

      M. Manning Marcus, Esq., for the taxpayer.

      A. H. Murray, Esq., for the Commissioner.
    Before Maequette, Moeeis, GeeeN, and Love.
    This is an appeal from the determination of a deficiency in income tax for the years 1921 and 1922 in the amount of $3,453.52. The deficiency arises from the Commissioner’s determination that certain moneys received by the taxpayer were dividends.
    FINDINGS OF FACT.
    1. During 1917, the taxpayer was president of the Schiff & Co. State Bank, of Chicago, Ill., and the owner of 1,860 shares out of a total of 2,000 outstanding shares of its capital stock.
    2. The bank sustained serious losses during 1917 through its dealings in Russian rubles. To make good these losses, the taxpayer contributed to the bank $49,000, which was accepted by a formal resolution of the directors expressing appreciation of Schiif’s action, but declining to assume any liability for the deposit. The bank sustained a net loss of $33,805.20 for 1917. No contribution was made by any of the other stockholders.
    3. The payment to the bank was set up on its books as a credit to the “ Reserve for Contingencies Account.” No interest was ever credited or paid thereon, and the amount was included in the bank’s invested capital for income-tax purposes as paid-in surplus, from October 30,1917, to December 31, 1921.
    4. On December 22, 1921, the bank’s directors, by formal resolution, ordered the payment to the taxpayer of $25,000, as a partial refund of the $49,000 advanced by him in 1917, as follows:
    By the unanimous approval of all the five Directors present at this meeting, it was resolved and ordered that the sum of twenty-five thousand dollars ($25,000.00) be paid to Benjamin J. Schiff within thirty days from date, as a partial refund to him, to apply on tlie forty-nine-tliousand dollars ($49,000.), winch he advanced as a capital contribution to the funds of this bank in September, 1917, to help the bank cover a large depreciation in Russian Rubles Account, which transaction is mentioned in paragraph 3, of the Minutes of Directors’ Meetings, as of October 30, 1917; and it is also ordered that the said Twenty Five Thousand Dollars ($26,000.00) shall be charged to*the reserve for Contingencies Account.
    5. On March 17,1922, the payment of the $24,000 balance was likewise ordered by the following resolution:
    By the unanimous approval of all the five Directors present at this meeting, it was resolved and ordered that the sum of Twenty-Four Thousand and no/100 Dollars ($24,000.00) be paid to Mr. Benjamin J. Schiff, within thirty days from date, as a refund to him, to apply on the balance of the Forty Nine Thousand and no/100 Dollars ($49,000.00), which he advanced as a capital contribution to the funds of this bank in September 1917, to help the bank cover a large depreciation in Russian Ruble Account. This transaction is mentioned in paragraph 3 of the Minutes of the Director’s meeting, as of October 30, 1917.
    ■ 6. The bank’s earnings, accumulated since 1917 and on hand at the time payments were made to the taxpayer in 1921 and 1922, were more than sufficient to meet the total payment of $49,000.
    7. During 1917, the bank’s stockholders, in addition to the taxpayer, were five in number, who held 140 shares out of 2,000 shares outstanding. In 1921 and 1922, there were six stockholders, in addition to the taxpayer, and their holdings were 240 shares out of 2,000 shares.
    8. At the time the payments were made to the taxpayer during 1921 and 1922, no dividends or other payments were made to any of the other stockholders of the bank.
   DECISION.

The deficiency determined by the Commissioner is disallowed.


text:
    Appeal of CALIFORNIA POULTRY CO.
    Docket No. 112.
    Submitted June 30, 1925.
    Decided February 9, 1926.

      Hayes Hall, G. P. A., for the taxpayer.

      A. Oalder Mackay, Esq., for the Commissioner.
    Before Gsaupner, Trammell, and Phillips.
    This is an appeal from the determination of a deficiency in income and profits taxes for 1918 and 1919 in the amount of $5,332.84. The deficiency arises from certain adjustments made by the Commissioner, increasing the taxpayer’s net income for those years, to which adjustments the taxpayer takes no exception, and from the exclusion from the taxpayer’s invested capital of certain amounts, which it claims to be the actual cash value of good will alleged to have been acquired from the Miller & Campagno Co. and the Bianchi Poultry & Produce Co. for stock.
    FINDINGS OF FACT.
    The taxpayer is a corporation, organized under the laws of the State of California in the year 1905, with a capital stock of $50,000, divided into 1,000 shares of the par value of $50 each, and it is, and has been since its organization, engaged in wholesale and retail trading in live and dressed poultry. The principal office of the corporation is at San Francisco.
    On October 5, 1910, the General Supply Co., a corporation, acquired 997 shares of the taxpayer’s capital stock, and on the same day it also acquired 495 shares, of the total of 500 shares, of the capital stock of the Miller & Compagno Co. On October 6, 1910, the General Supply Co. acquired 495 shares, of the total of 500 shares, of the capital stock of the Bianchi Poultry & Produce Co. The Miller & Compagno Co. and the Bianchi Poultry & Produce Co. were California corporations, and they were engaged in the same business as the taxpayer.
    On December 20, 1916, the capital stock of the taxpayer was increased to $250,000, divided into 5,000 shares of the par value of $50 each.
    By a resolution of the board of directors of the taxpayer, duly adopted on February 27, 1917, the secretary of the corporation was authorized and directed to offer the 4,000 shares of the then unissued stock of the taxpayer to the General Supply Co., in exchange for the 495 shares of the capital stock of the Miller & Compagno Co. and the 495 shares of the capital stock of the Bianchi Poultry & Produce Co., then held by the General Supply Co. The offer was made to and was accepted by the General Supply Co., and the exchange of stock was effected on the same day that the resolution authorizing the offe • was adopted, to wit, February 27, 1917, the taxpayer receiving 495 shares of the capital stock of the Miller & Compagno Co. and 495 shares of the capital stock of the Bianchi Poultry & Produce Co., and issuing therefor 3,998 shares of its own stock to the General Supply Co. On the same day, the taxpayer reissued to the General Supply Co., by a new certificate, the 997 shares of the taxpayer’s capital stock, which had originally been issued to the General Supply Co. on October 5, 1910. As the result of the-exchange of stock made on February 27, 1917, the taxpayer became the owner and holder of all but five shares of the capital stock of' the Miller & Compagno Co., and all but five shares of the capital stock of the Bianchi Poultry & Produce Co., and the General Supply Co. became the owner and holder of all but five shares of the capital stock of the taxpayer. The remaining shares of the capital stock of the Miller & Compagno Co. and the Bianchi Poultry & Produce Co., were held by the directors thereof as qualifying shares.
    Soon after it acquired the capital stock of the Miller & Compagno Co. and the Bianchi Poultry & Produce Co. the taxpayer took up the assets of those companies on its own books, as if it had actually acquired the assets instead of the capital stock. However, no formal transfer of the assets of the two companies was ever made by them to the taxpayer, nor has either of the two corporations ever been formally dissolved. The Miller & Compagno Co. forfeited its charter on March 3, 1917, on account of its failure to pay license and franchise tax, and its charter has never been reinstated and all its assets have actually been taken over by the taxpayer and used by it. The Bianchi Poultry & Produce Co. is still in existence and, it appears from the record, still holds title to certain real estate, which it owned on February 27,1917. For several years prior to February 27, 1917, the taxpayer and the Bianchi Poultry & Produce Co. had occupied the same building, the principal operations of both companies were recorded on the books of the Bianchi Poultry & Produce Co. and the profits of both companies during that period were closed into the surplus account of the latter company. Subsequent to the acquisition of the stock of the Miller & Campagno Co. and the Bianchi Poultry & Produce Co. by the taxpayer in the year 1917, the business theretofore carried on by the three companies was conducted as a single business, under the corporate name of the taxpayer. The taxpayer filed income and profits-tax returns for the years 1918 and 1919, from which it appears that it treated the Miller & Campagno Co. as having been dissolved and its assets taken over by the taxpayer, but that it recognized that the Bianchi Poultry & Produce Co. was still in existence, and, as a subsidiary of the taxpayer, a consolidated return for the two companies was filed.
    The General Supply Co., which never had any assets, except the stock of its subsidiaries, forfeited its charter on March 3,1917. By a resolution adopted on May 15, 1917, the taxpayer agreed to assume the debts and obligations of the General Supply Co., in consideration of the return to it by the General Supply Co. of 374 shares of its own stock. This was carried into effect, and 374 shares of the taxpayer’s stock were returned to it, leaving its outstanding capital stock at $231,300. The remainder of the taxpayer’s stock held by the General Supply Co. was divided among the stockholders of the General Supply Co., in proportion to their holdings in that company.
    On February 27, 1917, the Miller & Campagno Co. owned tangible assets of the value of $30,316.42 in excess of liabilities, and the Bianchi Poultry & Produce Co. owned tangible assets of the value of $87,811.77 in excess of liabilities. The average net profits of the Miller & Campagno Co. for the 6½ years ended December 31, 1916, were $3,307.55, and the average value of the tangible assets in excess of liabilities of the company for that period was $18,604.64. The average net profits of the Bianchi Poultry & Produce Co. for the 6¾ years ended December 31, 1916, were $12,878.48, and the average value of the company’s tangible assets in excess of liabilities for that period was $57,527.69.
    The taxpayer filed original and amended income and profits-tax returns for the years 1918 and 1919. In its amended return for the year 1918, it reported its consolidated invested capital as $211,627.94. In its amended return for the year 1919, it reported its consolidated invested capital as $231,432.35. In each year the amo'unt included in invested capital, on account of good will alleged to have been purchased from the Miller & Compagno Co. and the Bianchi Poultry & Produce Co., was about $55,000. The Commissioner eliminated from the taxpayer’s invested capital, for the years 1918 and 1919, the amounts claimed on account of good will alleged to have been purchased, and, after making certain minor adjustments, determined the taxpayer’s invested capital to be $156,326.63 for the year 1918, and $178,164.76 for the year 1919.
   DECISION.

The determination of the Commissioner is. approved.


author: Smith: GeeeN,

text:
    Appeal of KENTUCKY RIVER COAL CORPORATION.
    Docket No. 2008.
    Submitted April 30, 1925.
    Decided February 9, 1926.
    During tbe taxable year 1919 the taxpayer had outstanding debenture stock, preferred stock, and common stock. During the year “ dividends ” were paid upon the debenture stock. Held, upon the evidence, that the shares of debenture stock outstanding were not obligations of the taxpayer for money borrowed, and that the taxpayer was not entitled to deduct from gross income for the year 1919 the dividends paid upon the debenture stock, or an amount for amortized discount upon such stock.

      Elwood Hamilton, Esq., for the taxpayer.

      Ellis W. Manning, Esq., for the Commissioner.
    Before Smith, Littleton, and Green.
    This is an appeal from the determination of a deficiency in income and profits tax for the calendar year 1919 in the amount of $716.64. The questions presented by the appeal are whether the taxpayer is entitled to deduct from gross income (1) dividends paid upon debenture stock during the year 1919, and (2) an amount representing the amortized discount upon such stock allocable to the year 1919.

      FINDINGS OF FACT.
    The Kentucky Kiver Coal Corporation is a Virginia corporation with its principal office at Lexington, Ky. It was organized in April, 1915, for the purpose of acquiring the assets of five smaller coal companies.
    It was not intended to and never has functioned as an operating company. Its principal activities have been the leasing or selling of its lands. The pertinent provisions of its charter are contained in article 5 thereof, as amended on October 23, 1916. The amended article differs from the original only in the amounts of preferred and common stock which might be issued, and reads as follows:
    The amount of the total authorized minimum Capital Stock of said Corporation, which shall be Common Stock, shall be Three Thousand ($3,000.00). Dollars, and the amount of the total authorized maximum Capital Stock of said Corporation shall be Five Million, ($5,000,000.00) Dollars; which shall be composed.of three classes of stock, designated as Debenture, Preferred and Common; each of the par value of One Hundred ($100.00) Dollars, per share, as follows;
    (1) Debenture stock- $500,000.00
    (2) Preferred stock_ 2,000,000.00
    (3) Common stock_ 2,500, 000.00
    The dividends on the said Debenture Stock shall be six (6%) per cent cumulative dividends from the date of issue payable semi-annually on the last days of January and July of each year; and said stock shall be retirable at the option of the Corporation after three years from the issue thereof at any dividend period at one hundred and five ($105)' dollars per share, and unless prior retired, the Corporation shall retire the same at the expiration of ten (10) years from the date of issue at par; said stock shall contain the customary and usual provisions and regulations concerning the issue of stock, but not including voting rights, unless and in ease of and only when in default of payment of dividends, and shall have priority both as to assets and income (up to six per cent) over both the preferred and common stocks.
    The preferred stock shall likewise be a six (6%) per cent cumulative stock after January 1st, 1917, and may be retired at the option of the Corporation after three years from the issue thereof at any dividend period upon the payment of One Hundred and Five ($105) dollars per share, said dividends to be payable semi-annually on the 1st day of January and July of each year; and shall contain the customary and usual provisions and regulations concerning the issue of such stock, but not including voting rights, unless and in case of and only when in default in the payment of dividends, and shall have priority both as to assets and income (up to said six per cent) over the Common Stock.
    No profits or income of said Corporation shall be applicable to the payment of dividends upon the Common stock, until and unless there is in the Treasury of the Corporation, and available for dividends, an amount sufficient to pay all dividends due upon the Debenture Stock and the Preferred Stock, and also at the dividend period next thereafter ensuing.

      The assets of the Corporation, in case of the sate of its property or dissolution, and after the payment of its indebtedness, shall be applied:

      First: To the payment to the holders of the Debenture stock, of the full amount of the par value of their shares and unpaid dividends accrued thereon.

      Second: To the payments to the holders of the Preferred Stock of the full amount of the par value of their shares and the unpaid dividends accrued thereon; and

      Third: The remaining to the Common Stock.

    The five hundred thousand ($500,000.00) dollars, debenture and five hundred thousand ($500,000.00) dollars, Common stock, to remain in the Treasury, and he disposed of as Treasury Stock for the benefit of this Corporation, and as its necessities may require; less such as may be necessary or required for expenses of organization and incidental thereto; but the proceeds of the Rive Hundred Thousand ($500,000.00) Dollars Debenture Stock to be used exclusively in the discharge of the indebtedness of such Companies as may be assumed by this corporation, or for betterments, prospecting or acquiring additional property; and no debt in excess of Twenty-five thousand ($25,000.00) Dollars shall be incurred by this Corporation until the Debenture stock is retired.
    All considerations received from sales of tracts of lands, mineral lands, or timber, shall be applied by this Corporation to the liquidation of the Debenture or Preferred Stock outstanding, and not otherwise, first liquidating the Debenture Stock, PROVIDED, that the provisions shall not apply to the exchange of lands or mineral rights for the purpose of rounding up a proposition, nor to the amount received as royalty upon coal mined, nor to timber included in leases, or construction of improvements upon the property, or used for railway ties or other railroad equipment. (Italics ours.)
    The debenture stock certificate reads as follows:
    Incorporated under the laws of the State of Virginia.
    No.- -Shares.
    Kentucky River Coal Coepobation.
    Maximum authorized Capital Stock $3,329,800.00 Divided into
    Debenture Stock $500,000.00 Preferred Stock $1,164,900.00 Common Stock $1,664,900.00
    This certifies that-is the owner of-full paid and non-assessable shares of the Debenture Capital Stock of the Kentucky River Coal Corporation, transferable in person or by attorney upon the surrender of this certificate, properly endorsed. The holders of the Debenture Stock shall be entitled to receive, and the Corporation shall be obligated to pay, but only out of the surplus profits, earnings or assets of the Corporation, dividends at the rate of six (6) per cent, per annum, and no more, payable semiannually in each year on the first days of Jany. and July, before any dividend shall be paid upon, or set apart for the Preferred or Common Stock. Dividends on the Debenture Stock shall be cumulative from date of issue. The holders of the Preferred Stock shall be entitled to receive, and the Corporation shall be obligated to pay, but only out of the surplus profits, earnings or assets of the Corporation, dividends at the rate of six (6) per cent per annum, and no more, payable semi-annually in each year, on the first days of Jany. and July, before any dividends shall be paid upon, or set apart for the Common Stock. Dividends on the Preferred Stock shall be cumulative from and after January 1st, 1917. In no event shall any dividends whatsoever be declared or paid on the Common Stock, until and unless there Is in the Treasury of the Corporation, and available for dividends an amount sufficient to pay all dividends due upon the Debenture Stock, and the Preferred Stock, and also at the dividend period nest thereafter ensuing, subject to the foregoing provisions, and not otherwise, such dividends as may be determined by the Board of Directors may be declared and paid on the Common Stock from time to time out of the surplus profits, earnings or assets of the Corporation. The Board of Directors shall have power from time to time, to fix and determine, and to vary the amount of the working capital of the Corporation, and to direct and determine the use and disposition of any surplus profits of the Corporation, over and above the Capital Stock paid in. The Debenture and the Preferred Stock shall be retirable at the option of the Corporation after three years from the issue thereof, at any dividend period, upon the payment of $105.00 per share, and all accumulated unpaid dividends thereupon, and unless prior retired, the Corporation shall retire the Debenture Stock at the expiration of ten years from the date of issue at par with all accumulated and unpaid dividends thereupon. Neither the holders of shares of the Debenture or Preferred Stock shall have voting rights, unless and in case of, and only when in default of payment of dividends, but when so in default, and only when so in default, the holders of the Debenture and Preferred Stock shall have the same voting rights as the holders of the shares of the Common Stock. Upon any dissolution or liquidation of the Corporation, or upon any distribution of capital, or in the event of insolvency of the Corporation, the assets of the Corporation shall be applied: First, to the payment to all the holders of \the Debenture Stock of the full amount of the par value of their shares, and unpaid dividends accrued thereon; Second, to the payment to all the holders of the Preferred Stock of the full amount of the par valúe of their shares and the unpaid dividends accrued thereon; and Third, the remainder to the holders of the Common Stock. The Proceeds of the $500,000.00 Debenture Stock shall be used exclusively for the purposes specified and set forth in the Certificate of Incorporation; and no debt in excess of $25,000.00 except that to be assumed by the Corporation to retire which the Debenture Stock is in part to be used, shall be incurred by this Corporation, until the Debenture stock is retired. All consideration received from the sources specified in the Certificate of Incorporation shall be applied to retire the Debenture or Preferred Stock outstanding, and not otherwise, first retiring the Debenture Stock.
    This certificate is not valid until countersigned by the Transfer Agent and registered by the Registrar.
    Witness the seal of the Corporation, and the signatures of its duly authorized officers, this-
    -Secretary -President
    Countersigned-
    The Fidelity Trust Company, (of Baltimore), Md.
    Transfer Agent
    By-
    Secretary Asst. Secretary.
    Registered-
    Union Trust Company op Maryland
    Registrar
    By
    Secretary
    Asst. Secretary

      SHARES
    Full paid and — $100—non-assessable
    EACH
    “ Charter amended ” October 23rd, 1916: Capital Stock authorized thereby $5,000,000.00, divided into Debenture Stock $500,000.00. Preferred Stock $2,000,000.00 and Common Stock $2,500,000.00.
    All of the preferred stock and a like amount of the common stock were exchanged for the assets of stock of the five companies. The $500,000 par value of debenture stock and a like amount of common stock were placed on the market and sold together, the price of one share of debenture stock and one share of common stock being $50. The first shares of debenture stock were issued on May 2, 1915, and the last on January 24, 1917. The entire issue of $500,000 was outstanding during the entire year 1919. The taxpayer began to retire the debenture stock in 1922, and up to April 14, 1925, the amount retired was $245,200. The amount outstanding on that date was $254,800. The holders of the debenture stock have never participated in the activities of the corporation. They have received annually dividends amounting to 6 per cent on the par value of the shares outstanding.
    The taxpayer in its income-tax return for 1919 claimed as deductions from gross income dividends paid upon the debenture stock in the aggregate amount of $30,000, and amortized discount in the amount of $25,000. Both of these deductions have been disallowed by the Commissioner.
    DECISION.
    The determination of the Commissioner is approved.
   OPINION.

Smith:

The questions here presented are purely legal. The taxpayer claims the right to deduct from gross income of the year 1919 $30,000, representing dividends paid upon $500,000 par value debenture stock outstanding during the year, and $25,000 amortized discount upon such stock. The Commissioner denies the right of the taxpayer to make such deductions. The claim of the taxpayer is that the debenture stock outstanding represents bonds or obligations of the taxpayer, while the claim of the Commissioner is that the debenture stock is a part of the capital stock of the taxpayer.

Section 234 (a) (2) of the Revenue Act of 1918 provides that a corporation may deduct from gross income in its tax return all interest paid or accrued within the taxable year on its indebtedness * ⅜ Was the $500,000 debenture stock of the taxpayer outstanding during the year 1919 indebtedness of the taxpayer during that year ?

Whether or not the holder of a particular instrument or certificate is to be regarded as a stockholder or creditor is a question of interpretation, and depends upon the terms of his contract as evidenced by such instrument and the corporate charter and the statutes of the state. Fletcher on Corporations, p. 6020. Cf. Heller v. National Marine Bank, 89 Md. 602.

In Appeal of I. Unterberg & Co., 2 B. T. A. 274, we said:

It can not be doubted that the nature of an instrument may, because of its terms and the circumstances of its issuance and substance, be held to be different from what it is denominated. The decisions are numerous in which the' courts have held bonds to be stock. Cf. Appeal of The Baker & Taylor Company, 3 B. T. A. 57.

The first thing to be considered in the determination of whether the shares of debenture stock issued by the taxpayer and outstanding during the year 1919 are obligations of the taxpayer or a part of its capital stock, is the name which has been given to such shares of debenture stock. It is not a thing to be ignored, for it is not lightly to be assumed that parties have given an erroneous name to their transaction. The instruments are designated as “ shares of debenture stock.»” They provide for 6 per cent cumulative dividends and no more, payable only out of surplus profits, earnings or assets; these dividends are to have priority over dividends on issues designated as preferred and common stock. They contain a provision for their retirement at the option of the corporation after three years and in any event at the expiration of 10 years. The holders have no right to vote, except in case of default in payment of dividends. In case of dissolution, liquidation or insolvency, the assets are to be first applied in payment of the indebtedness of the corporation. They are then to be applied:

First: To tlie payment to tlie holders of the Debenture stock of the full amount of the par value of their shares and unpaid dividends accrued thereon.
Second: To the payments to the holders of the Preferred Stock of the full amount of the par value of their shares and the unpaid dividends accrued thereon; and
Third: The remaining to the Common Stock.

The question whether debenture stock is to be regarded as a part of the capital stock of a corporation has been before the courts in many different jurisdictions.

In People v. Miller, 180 N. Y. 16; 72 N. E. 525, there was a question, in determining the franchise tax of a corporation, whether $100,000 representing certain certificates should be deducted as a debt. The certificate of incorporation provided for $100,000 “preferred debenture stock,” entitled to cumulative dividends at 6 per cent, and $50,000 common stock. The certificates of preferred stock as issued provided for a cumulative dividend of 6 per cent, and no more, before dividends on common stock, and for preference over common stock on dissolution of the corporation. They also contained an agreement for redemption at par value on a specified date. In its decision the court said:

When, therefore, a certificate is declared to be a preferred debenture share of capital stock, it presents a legal contradiction; a debenture being the acknowledgment of a debt, and a share of stock representing a contribution of capital to a corporate business equal to the amount of its face value, either in money or in property.

The court held that where the construction of instruments purporting to be certificates of preferred stock of a corporation is a debatable one, the corporation, in face of the declaration in its articles of association that money represented by these certificates constitutes a part of the capital stock of the corporation, is estopped from asserting to the contrary in a proceeding to determine its liability to the franchise tax.

In Rider v. Delker & Sons Co., 145 Ky. 634; 140 S. W. 1011, it was held that, even though the certificate of incorporation and the certificate of stock itself provided that after five years the holder of preferred stock might demand back his money in the corporation, he can not enforce this provision until the corporate creditors are paid. The court said:

Tbe capital of a corporation is the sum total of its stock, whether common or preferred. Certificates of stock are mere evidences that the holders thereof have invested the sums called for in the certificates in the enterprise. They run the risk of losing their stock if the business is not a success. As between themselves and third persons who deal with the corporation and give it credit, their stock is equally liable. It is only in cases where the corporation is solvent and the rights of creditors will not be injuriously affected thereby that agreements as to preferences among themselves may be enforced. The entire capital, without regard to any arrangement which may exist between common and preferred stockholders, is at all times subject to and liable for the debts of the corporation, and no part of the capital can be withdrawn from the business until the debts of the corporation are satisfied.

In the case of Reagan Bale Co. v. Heuermann, 149 S. W. 228, a Texas corporation issued preferred stock entitled to a preferred dividend of 8 per cent and to share equally with common stockholders in all dividends after a similar dividend1 had been earned and paid on common stock. It also provided that, if the company should fail for two years to declare and pay dividends on the preferred stock of at least 8 per cent, the owners at their option might mature the shares into an obligation of the corporation to pay on demand the par value thereof, together with interest at 8 per cent from August 10, 1907, provided that the corporation should then be entitled to be credited with all dividends declared and paid on the stock. The preferred stock had no voting power, and the company was also given the option, after the aggregate dividends thereon amounted to 100 per cent, to retire the shares at par. It was held that the holders of such stock were stockholders and not creditors, and, on default of dividends, could not, by electing to mature the shares, become creditors entitled to share in the assets of the corporation with or in advance of creditors.

In Warren v. Queen & Co., 240 Pa. 154; 87 Atl. 595, there was a suit to recover amounts represented by certificates in the following form:

This is to certify that J. Henry Warren is owner of fifty shares of the preferred stock of Queen & Company, Incorporated. * * * This certificate is part of an issue of preferred shares amounting in the aggregate to fifty thousand dollars ($50,000) which are entitled to dividends at the rate of eight per centum annually, clear 'of all taxes, cumulative, from the first day of March, 1906, out of the earnings of the company applicable to the purpose, and before any dividend is declared on the common stock. * ⅜ * The shares represented by this certificate shall be redeemed by the company ■on March 1, 1911, at par. The preferred stock, of which these shares are a part, constitute under all circumstances a lien on all the assets of the company to be first paid in full prior to any right of the common stock to participate in •or receive anything from such assets.

The court held that these instruments were shares of stock and not certificates of indebtedness, and that the agreement to redeem them could not be enforced unless there were surplus profits which could be used for that purpose.

In the case of In re Fechheimer Fishel Co., 212 Fed. 357, the certificates were designated on their face as debenture bonds. These so-called bonds prescribed a certain date of payment, and a certain amount of interest, but also contained a provision that the interest should be paid out of earnings and that all of these instruments should be subordinate to the claims of creditors. They further provided that, upon liquidation or dissolution of the company, the holders of the bonds should, after payment of debts, be. entitled to the residue of the company’s assets. The court held that the instruments were shares of stock and refused to enforce a promissory note given to one of the holders, upon surrender of some of the so-called bonds, because to do so would deprive general creditors of funds to satisfy their claims.

In Miller v. Ratterman, 47 Oh. St. 141; 24 N. E. 496, the certificates involved purported to be shares of preferred stock, to guarantee dividends for which a mortgage had been given. They were held to be stock.

After a consideration of the entire record and of the decisions of the courts bearing upon the issues raised by this appeal, we are of the opinion that the conclusion of the Commissioner that the dividends paid by the taxpayer upon its shares of debenture stock outstanding during the year 1919 were not the equivalent of interest paid on indebtedness, and, therefore, that the amount of dividends paid upon such stock is not a legal deduction from gross income. We are also of the opinion that the amount claimed as amortized discount upon such debenture stock is not a legal deduction from gross income.

LittletoN concurring.

GeeeN,

dissenting: I am unable to concur with the foregoing decision and opinion. As therein stated, the questions are purely legal. We are first called upon to determine whether the security sold by the corporation is a stock or a bond. In determining this question the courts have consistently disregarded the name which the parties have given to the security and have determined its true character from the qualities and properties of the security and the rights and obligations of the parties. It is obvious that this security is not the conventional preferred stock, though it has some of the characteristics of preferred stock. It is provided in the charter that it shall be retired at par within ten years from the date of issue. The holders thereof have voting rights only in case of default in the payment of the so-called dividends. No indebtedness in excess of $25,000 should be incurred until the stock is retired. It was given a priority, both as to income and assets, over the preferred and common stock. The so-called dividend was cumulative and at a fixed rate. The proceeds of all sales of assets are to.be applied first to the payment to the holders of the debenture stock of the full amount of the par value of their stock and the unpaid dividends thereon.

Summarizing the foregoing, it appears that there is a promise to pay a specific sum of money, on or before a certain date, with interest at a specified rate, which promise to pay is guaranteed by the limitation on general indebtedness and a preference given as to payment. It is not necessary to hold that there is a lien or a mortgage to secure the payment. The limitation of indebtedness, coupled with the preference, accomplishes practically the same result.

The relative priority between -a general creditor and the holder of a security is commonly and properly considered to be one of the important factors in determining whether a security is a stock or a bond. It is an important factor in this case. The position of the holders of this debenture stock would be vastly different if there were no limit on the amount of indebtedness to general creditors which could be incurred by the corporation. Considering the value of the assets behind this corporation, the maximum indebtedness to general creditors permitted by the charter is a mere trifle.- For all practical purposes, so far as the holders of this stock are concerned, there are and can be no general creditors. Assuming that the maximum permitted indebtedness to general creditors was incurred and paid, the impairment of assets as the result thereof would be insignificant.

The purpose of the corporation was not to mine coal but was, instead, to sell or lease the coal-bearing lands which it owned. The continued use of large amounts of capital was not necessary. The holders of the certificates were not investors in the business. They knew at the time they acquired the stock that the company would soon start retiring it. There is nothing in the record to indicate that any of the interested parties considered the holders of the certificates to be stockholders in the commonly accepted sense of that term. On the contrary, all of the indications are that they were considered as creditors.

The courts have always given careful consideration to the interpretation of a contract by the parties thereto, as evidenced by their performance of its terms, and there is no occasion to depart from a rule so well established.

The problem is simplified by reversing it. Are these certificates shares of stock? Could the cash or property paid in therefor properly be included in invested capital?

In the Appeal of I. Unterberg & Co., 2 B. T. A. 214, we said:

It [the certificate] promises to pay a specified amount, with interest, to a definite person at a definite time. Then follows the restrictive condition that it is subordinate to the claims of general business creditors at maturity or on liquidation. This latter condition, the taxpayer contends, is such that it converts the instrument into preferred stock. The contention is that by subordinating the right of the holder to that of the general creditors the instrument represents property placed at the risk of the business and not property loaned to the corporation. In other words, the dominant feature is said to he the condition and the risk and not the promise to pay.

There we also said:

Examining the terms and effect of the instrument, we are unable to hold it to be a certificate of stock. It is evidence of a restricted indebtedness. The fact that the principal amount is subordinated to the claims of general business creditors is not sufficient to warrant this Board’s determination that it is stock for the purpose of invested capital, when for all other purposes so far as we are advised the parties have treated it as a note. The interest is payable semi-annualy in any event. Has it been paid, and has it been deducted as interest in computing taxable net income? Has the capital-stock-tax return included the amount of these instruments as the basis of tax? Have the amounts of these notes ever been subjected to apy of the tests or vicissitudes of stock? The evidence does not inform us. We are not inclined therefore didactically to say that these are certificates of stock for tax purposes in the absence of convincing evidence that they are regarded as such for other purposes or convincing argument that they must be held to be such for all purposes notwithstanding the apparent intention of the interested parties to the contrary. As counsel for the taxpayer says, they can not be both stock and notes, and having presumably given them full effect as notes during their life, we will not now say they were stock.

It is clear that the certificates now being considered are in their essentials very similar to those in Unterberg's Appeal, supra, and the Appeal of A. H. Stange Co., 1 B. T. A. 58. If in those appeals the certificates were bonds, the conclusion should be the same here.

In Unterberg's Appeal (similar in facts, except that the limit of general indebtedness is lower), we state:

They were payable at maturity, subject to the claims of general creditors. They were an obligation of the corporation, enforeible in all respects except that the general creditors might insist that assets should not be impaired below the amount of their claims. They were of lower degree than such claims, and yet fixed in amount and time so as to distinguish them from stock. Indeed, it may be asked why, if after all they were stock, such care was used to limit the stock to $200,000 and issue notes for the rest? Apparently it may be inferred that the owners were willing to venture $200,000 in the business, but desired to be assured of the return of the $236,000 except in case of failure within three years. One was a business risk and the other a reasonably safe three-year investment.

A consideration of all of the factors in this case leads me directly to the conclusion that the holders of these debenture stocks are creditors of the corporation, and that the sums paid therefor are loans rather than contributions of capital. The so-called dividend is in reality interest and sho'uld be deducted as an expense when paid or accrued, depending upon the method of accounting employed by the taxpayer.

The sale of these debentures at a discount is analogous to the sale of bonds at a discount, and the amount of the discount should be amortized- and the aliquot part deducted annually.