Howard Paper Co. v. Commissioner

*546 The commissioner has determined a deficiency in petitioner's income tax liability for the year 1936 of $645.31. This deficiency is due mainly to the addition to petitioner's income of $3,750 representing an amount deducted by petitioner on its income tax return for 1935 as compensation credited to five of its officers and stockholders which was never paid to them but was canceled and forgiven by them to the corporation in 1936.

The commissioner in his deficiency notice explained this adjustment*1489 as follows:

In schedule "M" of your 1936 Federal income tax return appears a credit of $3,750.00 which is explained therein as "Indebtedness to officers cancelled". This item was not returned by you as taxable income. The facts demonstrate that said amount of $3,750.00 was claimed as a deduction in your 1935 tax return on account of additional compensation of $750.00 for each of your five stockholders who were employed by you, none of whom ever returned the said additional compensation for income tax purposes. As the result of claiming the said deduction in 1935 you received a benefit in tax saving commensurate with the amount of deficiency now asserted for the year 1936. It is held that since the amount of $3,750.00 recovered in 1936 had been deducted in 1935 to offset income and a benefit in income tax saving was thus realized, the said amount of $3,750.00 is includible in gross income for the year 1936 when recovered.

The petitioner by an appropriate assignment of error contests this action of the Commissioner. The other minor adjustments made by the Commissioner are not contested.

FINDINGS OF FACT.

A stipulation of facts was filed at the hearing, which we adopt*1490 as a part of our findings of fact. We state the following facts taken from the stipulation and the exhibits attached thereto.

The petitioner is a corporation duly organized under the laws of the Commonwealth of Massachusetts and has its usual place of business in Boston.

Petitioner's income tax return for the year 1936 was filed with the collector of internal revenue for the district of Massachusetts.

In the calendar year ended December 31, 1935, the petitioner deducted from its taxable income as additional compensation voted to its five officers (who were also stockholders) the amount of $3,750, that is, $750 to each. The amount of $3,750 was not actually paid in 1935 but was set up as a liability on petitioner's records in the month of December 1935. The petitioner deducted the amount of $3,750 as additional compensation on its income tax return filed for the taxable year 1935. The Commissioner allowed the amount of $3,750 as an expense in computing the petitioner's taxable income for that year. The petitioner kept its books of account and filed its tax return on the accrual basis.

*547 During the years 1935 and 1936 the stock of the petitioner was owned by*1491 its officers as follows:

The above five officers and stockholders filed their income tax returns on a cash basis for the year 1935 and did not include any part of the $3,750 as income on their returns.

The five officers and stockholders canceled the obligation of the petitioner amounting to $3,750 in the year 1936 and the amount so forgiven was credited to the surplus account of the petitioner for that year. Such amount was not reported as a part of petitioner's taxable income for the year 1936. In schedule M of the petitioner's return for the year 1936 appears a credit of $3,750 which is explained therein as "Indebtedness to officers canceled."

The following tables show the gross sales, total income after deducting cost of sales, net income, and tax liability for the years 1935 and 1936, and also the financial condition as at January 1, 1935, and December 31, 1935 and 1936, of the petitioner, as disclosed by its income tax returns for 1935 and 1936:

The corporation had no fixed assets during the years 1935 and 1936. Its only assets were the current assets as shown above.

The paid-in surplus of $6,400, named above, represents actual cash paid into the corporation by the stockholders of the corporation. To this was added in 1936 the $3,750 canceled in the manner above stated, making the paid-in surplus of the corporation as reflected in its income tax return $10,150 at the close of 1936.

Petitioner introduced the testimony of one witness, from whose testimony we make the following findings of fact in addition to *548 those shown above: At some time during the year 1936 the five officer-stockholders of petitioner, named above, held a meeting and agreed that because of unsatisfactory business conditions which had existed during the year they would cancel the indebtedness which the corporation*1493 owed them for compensation credited to their account in 1935. They considered that to do so would improve the credit of the corporation with the banks and the paper mills with which it did business.

OPINION.

BLACK: Petitioner, in resisting the Commissioner's determination that the $3,750 in question was income to it in 1936 the year in which the stockholders canceled the indebtedness, relies upon the decision of the Second Circuit in , and the recent case of In re Triple Z Products, Inc., Bankrupt, decided by the United States District Court for the Southern District of New York on September 9, 1940.

The respondent relies upon ; certionari denied, , and , which followed Helvering v.Jane Holding Corporation. The decision of the court in the Jane Holding Corporation case reversed the decision of the Board reported in *1494 . An examination of the Board's opinion in that case shows that we relied for our holding upon our decision in ; affd., .

The petitioner, in insisting that our decision in , was sound, and that the decision of the Second Circuit in affirming us was sound and should be followed in the instant case, points out that the court in the Jane Holding Corporation case, supra, distinguished the facts in that case from those present in the AutoStrop Safety Razor Co. case on the ground that in the latter the forgiveness of indebtedness by the stockholder was gratuitous, whereas in the Jane Holding Corporation case it was for a consideration and was not gratuitous.

In , we discussed briefly the holding of the court in the Jane Holding Corporation case and in that connection we said:

* * * Furthermore, the court in the recent case of Helvering v.Jane Holding Corporation * * *, regarded as of primary importance the fact that, as here, the corporation had received*1495 the benefit of a deduction to which, in the light of later events, it was not entitled.

That was the point which the Board emphasized as of controlling importance. It is true, as petitioner points out, there are some differences in the facts of , from *549 those which are present in the instant case, but we do not regard those differences as of sufficient importance to justify us in making a distinction between the two cases. In the Beacon Auto Stores, Inc., case the taxpayer was on the accrual basis and accrued on its books as liabilities certain salaries to three of its officers and stockholders and took these accruals as deductions on its income tax return, but not all of the salaries were paid in the year when accrued. In the following year the unpaid portions of the salaries were canceled by debits to the individuals and credits to the surplus of the corporation. This same procedure took place in three different years. On these facts we held as to the two taxable years which were before us that the sums canceled in the taxable years which had been deducted in the prior years for income tax purposes were income*1496 to the corporation in the years when canceled.

We think we must so hold as to the $3,750 canceled by the officers and stockholders in the instant case. Petitioner, on an accrual basis, took $3,750 as a deduction in 1935 and received the benefit of that deduction for an amount which it has never been called upon to pay and which in 1936 it became certain it would never be called upon to pay. It seems only reasonable that this should be taxable income to petitioner in 1936, the year in which it was determined that petitioner would never have to pay that which it had previously accrued and deducted. On this issue we hold in favor of the Commissioner.

Decision will be entered for respondent.