Mutschler Bros. Co. v. Commissioner

*732 This is a proceeding for the redetermination of deficiencies in income and profits taxes for the calendar years 1919 and 1920, in the respective amounts of $3,159.57 and $5,015.51. The petitioner alleged errors as follows:

(1) In computing invested capital for calendar year 1919 the Commissionerreduced the capital paid in on account of dividends paid during the first sixty days of 1919 which were in excess of the surplus and undivided profits as of the beginning of the taxable year 1919 but not in excess of earning for 1919available on the date the dividends were payable.

(2) In computing invested capital for calendar year 1919 the Commissionerreduced the capital paid in on account of income and*3468 profits taxes for 1918, prorated, notwithstanding that the amount of income and profits tax for 1918did not exceed the sum of the earned surplus as of January 1, 1919 available on the date said 1918 taxes were due plus the earnings for 1919 available on the dates said 1918 taxes were due.

(3) The Commissioner failed to compute the tax liability for 1919 and 1920under the provisions of Sections 327 and 328 of the Revenue Act of 1918.

(4) In computing invested capital for the taxable years 1919 and 1920, the Commissioner erroneously failed to include the undivided profits earned during the years 1917 and 1918, but reduced such undivided profits by the sum of operating losses sustained in years prior to the year 1917.

The facts were all either stipulated or admitted.

FINDINGS OF FACT.

The petitioner is an Indiana corporation with its principal office at Nappanee, Ind.

Its net income for 1919, as computed by the Commissioner $37was,279.23, and its income and profits-tax liability for 1919, as computed by the Commissioner was $11,842.59. The capital paid in for stock prior to January 1, 1919, and not withdrawn prior to that date was $92,500. Earned surplus at December 31, 1918, was*3469 $1.341.60, which is made up of:

Additional taxes for 1917 amounted to $385.15. Net income for the taxable year 1919, as adjusted by the Commissioner, was $37,379.23. Dividends paid in the first 60 days of 1919 were:

Income and profits taxes for 1918 due and payable in 1919 were $2,863.14. Earned surplus at December 31, 1919, was $31,844.58.

*733 The Commissioner computed invested capital for 1919, as follows:

*3470 The Commissioner computed invested capital for 1920, as follows:

OPINION.

MURDOCK: The petitioner has apparently abandoned its allegation of error in regard to special assessment under sections 327 and 328 of the Revenue Act of 1918. If it has not, nevertheless, we must affirm the Commissioner on this point since the evidence fails to support the allegation.

The case of , was cited in support of the fourth alleged error set out above. Since the hearing in the present case the Supreme Court of the United States has reversed the Circuit Court of Appeals for the*3471 Eighth Circuit in the Milton Dairy Co. case, and in , has held that a preexisting deficit must be offset *734 by subsequent earnings before those earnings can serve to increase invested capital.

Distributions called dividends may serve to reduce invested capital below the amount paid in for stock or shares where the distribution exceeds the surplus and profits of the corporation, since to the extent of the excess, the distribution is a liquidation or return of capital. From the record in the present case we can not say that the Commissioner's computation of invested capital contained any error relating to the treatment of dividends.

Section 1207 of the Revenue Act of 1926 provides as follows:

The computation of invested capital for any taxable year under the Revenue Act of 1917, the Revenue Act of 1918, and the Revenue Act of 1921, shall be considered as having been correctly made, so far as relating to the inclusion in invested capital for such year of income, war-profits, or excess-profits taxes for the preceding year, if made in accordance with the regulations in force in respect of such taxable*3472 year applicable to the relationship between invested capital of one year and taxes for the preceding year.

The regulations which were in force at the time the Revenue Act of 1926 became effective, in respect of the taxable years here involved, were, in part, as follows:

For the purpose of computing invested capital Federal income and war profits and excess profits taxes are deemed to have been paid out of the net income of the taxable year for which they are levied. * * * Amounts payable on account of such taxes for the preceding year may be included in the computation of invested capital only until such taxes become due and payable. A deduction from the invested capital as of the beginning of the taxable year must therefore be made for such taxes or any installment thereof, averaged for the proportionate part of the taxable year after the date when the tax or the installment is due and payable. (Art. 845, Regulations 45, Revised January 28, 1921; Art. 845, Regulations 62.)

We interpret the law as thus enacted to mean that taxes for prior years, whether paid or unpaid, serve to reduce invested capital from the dates when due, where invested capital would otherwise include*3473 surplus or undivided profits, but such taxes can not reduce invested capital below the amount paid in for stock or shares. It has been frequently held that neither expenses nor operating deficits can reduce invested capital below the amount paid in for stock or shares. Taxes are expenses which obviously reduce profits, but which do not affect the amount paid in for stock or shares. The wording of the regulations applicable to the taxable years, confirmed by section 1207, is somewhat ambiguous on this point. One sentence states that "Amounts payable on account of such taxes for the preceding year may be included in the computation of invested capital only until such taxes become due and payable." The only way that such amounts would ever be included in invested capital would be by way of surplus or undivided profits. The next sentence of the regulations *735 states that "A deduction from the invested capital as of the beginning of the taxable year must therefore be made for such taxes or any installment thereof, * * *." This sentence seems to depend upon the preceding sentence and under the circumstances we think that the proper interpretation is the one above indicated. *3474 In the computation of invested capital for 1919, the Commissioner added a surplus of $1,341.60 and then deducted taxes in the total amount of $1,595.25. The excess of the taxes over the surplus should not have been deducted.

Judgment will be entered under Rule 50.