Bishop & B. Mfg. Co. v. Commissioner

*776 The respondent determined a deficiency in income tax for 1937 in the amount*1071 of $25,997.73. The issue is whether in computing the surtax on undistributed profits imposed under section 14 of the Revenue Act of 1936, petitioner is entitled under section 26(c)(1), to a credit against its adjusted net income by reason of a contract restricting the payment of dividends.

FINDINGS OF FACT.

Petitioner is an Ohio corporation, with its principal office and place of business at Cleveland, Ohio, and is engaged in the business of manufacturing and selling automobile parts and accessories and various other products. It filed its income tax return for 1937 with the collector for the eighteenth district at Cleveland.

On August 14, 1925, petitioner filed with the Secretary of State of the State of Ohio an amendment to its articles of incorporation under which its authorized capital stock was increased from 500 shares of *777 common stock without par value to 150,000 shares, consisting of 3,000 shares of 6 percent cumulative prior preference stock of the par value of $100 each, 2,000 shares of 7 percent cumulative preferred stock of the par value of $100 per share, and 145,000 shares of common stock without par value. Before the end of 1925 petitioner had*1072 issued and outstanding 3,000 shares of 6 percent cumulative prior preference stock, 2,000 shares of 7 percent cumulative preferred stock, and 140,000 shares of common stock. In 1929 petitioner issued 3,750 additional shares of common stock and the said 148,750 shares of stock have all remained outstanding at all times since their issuance to and including December 31, 1937. All of the issued shares of stock, both upon the original issue and upon all transfers thereof, were evidenced by stock certificates which were executed by petitioner, being signed in its name and behalf by its president and its secretary. The certificate of increase of capital stock, the certificate of amendment of the articles of incorporation, each executed by petitioner and filed in the office of the Secretary of State of the State of Ohio on August 14, 1925, and each stock certificate for the prior preference stock, the preferred stock, and the common stock contained the following provisions:

(1) The holders of the Prior Preference Stock shall be entitled to receive, when and as declared by the Board of Directors, out of the surplus or net profits of this Company, cumulative dividends at the rate of Six*1073 Per Cent, (6%) per annum, and no more, payable quarter-yearly on the first day of January, of April, of July and of October in each year, before any dividend shall be set aside or paid on the Preferred Stock or on the Common Stock. The dividends on said Prior Preference Stock shall accumulate from the day of issue.

* * *

(1) The holders of the Preferred Stock shall be entitled to receive, when and as declared by the Board of Directors, out of the surplus or net profits of this Company, cumulative dividends at the rate of Seven Per Cent. (7%) per annum, and no more, payable quarter-yearly on the first day of January, of April, of July and of October in each year, after payment of all accumulated dividends on the Prior Preference Stock and before any dividend shall be set aside or paid on the Common Stock. The dividends on said Preferred Stock shall accumulate from July 1, 1927.

The stock certificates outstanding on May 1, 1936, remained outstanding without change through December 31, 1937, except certificates for 13,839 shares of common stock which were surrendered to the transfer agent for transfer and reissuance, and the new certificates contained the same provisions as*1074 quoted above.

The dividends accumulated on petitioner's prior preference stock and on its preferred stock to and including January 1, 1928, were paid on or before that date, but no dividends were thereafter paid or declared on either the prior preference or preferred stock and the dividends accruing since that date to the end of 1937 were unpaid and in arrears at the end of that year. No dividends have ever been declared or paid on the common stock.

*778 Petitioner's balance sheet at the beginning of the taxable year 1937 under earned surplus and undivided profits disclosed a deficit of $1,720,631 and its balance sheet at the end of that year a deficit of $1,293,402.50. A deficit of at least $1,293,402.50 existed in petitioner's surplus account throughout the taxable year 1937.

OPINION.

TURNER: Petitioner contends that the stock certificates issued to its stockholders constitute written contracts executed by the corporation within the meaning of section 26(c)(1) of the Revenue Act of 1936, ¹ that under the provisions of said contracts it could pay dividends on its prior preference and preferred stock only from "surplus or net profits" and could not pay dividends*1075 on its common stock if it was in arrears in paying accumulated dividends on its prior preference and preferred stock, that at all times during 1937 it was in arrears in paying accumulated dividends on its prior preference and preferred stock, that at no time during 1937 did it have any "surplus or net profits" but on the contrary had a huge profit and loss deficit, and for that reason it could not distribute during the year 1937 any sum as a dividend without violating the provisions of a written contract, and it is accordingly entitled to the credit provided for in the act. On brief the respondent contends that the provisions contained in petitioner's stock certificates were obviously meant to conform to the usual requirements of state law respecting the payment of dividends by deficit corporations, but he argues that, even if it be assumed that the stock certificates constituted a contract between petitioner and its stockholders, "it is not the contract required under section 26(c)(1) to obtain the benefit of the credit." On this latter point his argument is that the contract must be one executed by the corporation with a creditor, rather than mere stockholders.

*1076 We think this question has already been decided by the Supreme Court adversely to the petitioner's contentions. In Helvering v. Northwest Steel Rolling Mills, Inc.,311 U.S. 46, the Supreme Court, *779 in holding that the taxpayer was not entitled to the credit claimed under section 26(c)(1), supra, had the following to say with respect to the proper interpretation of that provision:

That the language used in section 26(c)(1) does not authorize a credit for statutorily prohibited dividends is further supported by a consideration of section 26(c)(2). By this section, a credit is allowed to corporations contractually obligated to set earnings aside for the payment of debts. That this section referred to routine contracts dealing with ordinary debts and not to statutory obligations is obvious - yet the words used to indicate that the section had reference only to a "written contract executed by the corporation" are identical with those used in section 26(c)(1). There is no reason to believe that Congress intended that a broader meaning be attached to these words as used in section 26(c)(1) than attached to them under the necessary limitations of*1077 26(c)(2).

In a footnote to that case the Supreme Court stated:

(17) Respondent contended that the stock certificates satisfied the statutory requisites even if the charter did not; but what we have here said with respect to the charter applies equally to the certificates.

We followed that decision in Lehigh Structural Steel Co.,44 B.T.A. 422. There the petitioner's amended charter provided for a sinking fund for the retirement of preferred stock, whereby a percentage of net earnings of the taxable year after payment of preferred dividends was to be set aside before any other dividends could be paid. The charter provision was set out in preferred stock certificates. In holding that petitioner was not entitled to the credit claimed under section 26(c)(1), supra, we said that the charter provision was not a contract within the meaning of the act, and further that "It derives no greater strength from the fact that it is spread upon the share certificate, for this is but a reprint of the charter provision." In *1078 Thibaut & Walker Co.,42 B.T.A. 29, we said that the legislative history of section 26(c)(1), supra, "indicates that Congress was trying to relieve situations in which a corporation had contracted with creditors to retain its earnings for their protection, but did not have in mind contracts such as this one, entered into by parties inside the corporate group to refrain from declaring dividends for their own mutual benefit." Cf. Atlas Supply Co.,43 B.T.A. 324 and Trianon Hotel Co.,44 B.T.A. 1073.

Petitioner relies on several rulings of the respondent which seem to support its contention, I.T. 3139, Cumulative Bulletin 1937-2, p. 111, and I.T. 3152, Cumulative Bulletin 1938-1, p. 155, and on Airtherm Manufacturing Co.,43 B.T.A. 736, and Holden & Reaume, Inc., decided under authority of Airtherm Manufacturing Co. by memorandum opinion. In Airtherm Manufacturing Co., supra, the petitioner issued preferred stock certificates in 1936 which contained a provision that dividends on preferred stock would be cumulative, beginning with the *780 year commencing May 1, 1939, and paid annually, *1079 before any dividend would be set apart or paid on the common stock. In the course of our opinion and with respect to the preferred stock certificates, we said: "The petitioner was a party to the issuance of these certificates, and, consequently, if there is any express provision contained therein restricting the payment of dividends during the taxable year, it would appear to be such a contract as is provided for in section 26." We then pointed out, however, that the restriction stated in the stock certificate did not become operative until May 1, 1939, and held that there was no restriction on the payment of dividends on the common stock in the taxable year ended March 31, 1937. In addition to being dicta in Airtherm Manufacturing Co., supra, the above quoted statement is contrary to the conclusions reached in the cases previously cited and the holding here and should not be regarded as controlling.

The stock certificates issued by petitioner do not constitute contracts within the meaning of section 26(c)(1), supra, and the respondent's disallowance of the credit is sustained. *1080 Northwest Steel Rolling Mills, Inc., supra.

Reviewed by the Board.

Decision will be entered under Rule 50.

ARUNDELL dissents.