Palmer, Stacy-Merrill, Inc. v. Commissioner

PALMER, STACY-MERRILL, INC., A DELAWARE CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Palmer, Stacy-Merrill, Inc. v. Commissioner Docket No. 87997. United States Board of Tax Appeals 37 B.T.A. 530; 1938 BTA LEXIS 1023; March 25, 1938, Promulgated *1023 The petitioner issued its preferred stock to the vendors of assets acquired at the time of organization. Essential conditions in the purchase agreements, without which the vendors would not have sold, bound petitioner to pay quarterly dividends on the shares so issued, whether earned by it or not, and to redeem all shares for cash at par, in fixed numbers at specified dates. Held, preferred stock shares issued in these circumstances constituted evidences of debt, and the so-called dividends paid or accrued under these terms amounted to interest on indebtedness within section 23(b), Revenue Act of 1934. Commissioner v. Proctor Shop, Inc., 82 Fed.(2d) 792, affirming 30 B.T.A. 721. Tom S. Patterson, Esq., for the petitioner. B. M. Coon, Esq., for the respondent. ARUNDELL *530 Income tax deficiencies and penalties, in the respective amounts of $4,615.88 and $230.79 for 1934, are at dispute in this proceeding. *531 The parties are in accord on the facts and submit only an issue of law for decision; namely, whether the conditions under which the petitioner, a corporation, issued its preferred stock*1024 made the shares debts, in the sense that payments thereon to the holders of the certificates constituted "interest paid or accrued" on indebtedness within section 23(b) of the Revenue Act of 1934. Respondent treated the payments as dividends. FINDINGS OF FACT. The petitioner was incorporated some time in 1932 by the General Fruit Corporation, hereinafter called the Fruit Co., to serve a purpose in the latter's plans as hereinafter shown. Prior to, and at the time of, the petitioner's incorporation the Fruit Co. was engaged in marketing fresh fruit, vegetables, and other food commodities in a territory which covered a number of the northwestern states of the United States and some provinces in British Columbia and eastern Canada. During the year 1931 the Fruit Co. agreed with several of its business competitors, operating in the same trade territory, to buy their businesses, trade names, good wills, and essential assets, under certain terms and conditions. In the proposed purchase and sale, to economic situations of both buyer and sellers played an important part in the forms adopted to carry out the transactions. The situations of the sellers were such that, whereas they*1025 desired to sell, it was only because their principal owners were elderly men who desired to retire completely from business and be relieved from business worries. These owners therefore desired cash, or its equivalent, for their holdings. The Fruit Co. could not command sufficient cash to purchase the properties, nor was its credit sufficiently strong, according to the judgment of its officers, to risk trying to raise outside capital through flotation of its bonds, notes, or other forms of debentures. The sellers refused to accept payment for their assets in any form of petitioner's capital stock, but finally consented to accept payment in preferred stock of a new corporation to which the assets might be transferred, provided the Fruit Co. would cause such new corporation to ratably redeem all of such stock in cash at times certain and, further, pay 6 percent dividends on the stock at quarterly intervals, whether earned or not. These conditions were accepted by the Fruit Co. and written into the several sales contracts, the first being executed November 28, 1931. Pursuant to these agreements the Fruit Co. caused the petitioner to be incorporated under the laws of the State of*1026 Delaware, with authorized capital stock consisting of 10,000 shares of no par common, and 10,000 shares of 6 percent cumulative preferred of a par value of $100 each. Charter provisions made the preferred stock dividends payable quarterly, beginning March 31, 1932, out of the *532 corporation's earnings and surplus, and gave the corporation's board of directors authority to prescribe the time, manner, and amount in which the preferred stock might be redeemed. Transfers of the assets acquired under the aforesaid contracts were made to the petitioner in 1932. On April 21, 1932, its stockholders and directors held their first corporate meetings. At these meetings petitioner's stockholders and directors formally ratified and adopted all contracts made by the Fruit Co. in the acquisition of assets, and authorized payment therefor to the sellers by issuance to them of shares of its preferred stock. At the same meeting resolutions were adopted which approved the Fruit Co.'s guarantee of payment of dividends on the preferred stock and redemption of the shares at times designated, with specific provision that such guarantee be evidenced by the Fruit Co.'s endorsement on the face*1027 of each certificate. According to a schedule included in the resolution, 20 preferred stock certificates, numbered 1 to 20, inclusive, each for 180 shares, were issued to Stacy Brothers & Merrill Co., and 20, numbered 21 to 40, inclusive, each for 95 shares, to S. G. Palmer, trustee. All of these shares, beginning with certificate Nos. 1 and 21 and following in that order, were made redeemable, two each year, on December 31 of each year beginning with 1932 and ending with 1951. Petitioner's operations for 1932 resulted in loss, but it nevertheless paid the dividends on its preferred stock for that year, per agreement. In 1933 the petitioner transferred all of its assets to subsidiary corporations in consideration for the latter's 6 percent serial promissory notes, equal to its outstanding preferred stock. All interest and principal payments on the notes were timed to mature simultaneously with petitioner's obligations to meet payments on its preferred stock. Thereafter, to and including the taxable year, the petitioner had conducted no business except that of collecting interest and principal on its notes and paying its preferred stock obligations under its contracts. Petitioner*1028 reports its income upon an accrual basis. In 1934 the petitioner collected $33,570 from its notes, all of which its paid and/or accrued in discharge of dividend accruals upon preferred stock. In its income tax return for that year the petitioner treated the aforesaid sums as "interest" accrued on indebtedness, within the meaning of section 23(b) of the Revenue Act of 1934, and deducted them from its gross income. The respondent's rejection of such deduction resulted in the deficiency and penalty here in issue. OPINION. ARUNDELL: Section 23(b), supra, which petitioner pleads, provides that in computing net income for income tax purposes there *533 shall be allowed deductions from gross income of all interest paid or accrued within the taxable year on indebtedness. The petitioner contends that the circumstances under which it issued its preferred stock, together with the commitments it undertook at the time, created debts which it was bound to pay through redemption in cash, and not mere investments in its capital. In this view it argues that the dividends paid on the preferred stock amounted to interest on debts. The respondent contends for a strict construction*1029 of the preferred stock certificates, as held in (affirming ); (affirming ); (affirming ); and . If the disbursements here involved were made solely on petitioner's obligations under its preferred stock certificates, then the respondent's contention would prevail, since the issuance of preferred stock certificates, without more, can not create debts against a corporation even though a time fixed for their retirement is agreed upon. Fletcher, Cyclopedia Corporations, permanent ed., vol. 11, sec. 5294. ; . On the other hand, corporation stock certificates are no exception to the general rule of construction for written instruments, which places intent of the parties above mere form. *1030 ; ; ; ; ; . In the case at bar the holders of the stock certificates were not investors in any sense of that word. They were sellers who accepted the stock at the time of the transfer of their properties only on condition that the stock would be redeemed in cash and the dividends paid on dates certain, without regard to petitioner's earnings. In other words, the sale consideration included not alone the stock issued to the sellers, but in addition the purchaser's agreement to redeem all of the stock for cash at fixed times. Obviously, cash payments at times certain formed the essence of the sales agreements, and created indebtedness which could be discharged only by cash payments. This interpretation of the transactions finds undisputed support in the testimony of the Fruit Co.'s president, who negotiated them. He stated that the intention was to make possible ultimate cash payments to the sellers, *1031 not available when the sales took place but without which they would not sell, and, further, that the sellers rejected the proposal to accept payment in corporation stock, either common or preferred, as investments, insisting that they desired no interest in the buying corporation. This testimony was not disputed. *534 In all cases cited by the respondent the facts are clearly distinguishable from these at bar, and in none of them were there contracts which created debts independent of the stocks involved. However, in , such an agreement was present, and the court there sustained the loan theory. , cited by the respondent, by implication at least, approved the loan theory announced in the Jones Syndicate case by distinguishing its facts in language which we quote from the opinion, as follows: * * * There were other stipulations not here applicable. The preferred stock was a direct obligation with a definite date for payment. In the instant case the preferred stock could, at the option of the corporation, be redeemed within*1032 three years at 110. In the Jones Syndicate there was an express provision to pay at five years. It was in effect a bond payable in five years. The petitioner has cited numerous authorities to support its version of the transactions, but in view of the conclusions we have reached it is unnecessary to review them in detail here. The Fruit Co. purchased assets which the petitioner took over, issuing to the seller its preferred stock, agreeing in the same transaction to redeem all of the stock in determined installments on dates certain over a period of 20 years, and to pay dividends on the stock at the rate of 6 percent, payable quarterly. This created an indebtedness which could only be discharged by payment in money. The stock was accepted by the sellers not as an investment, but as security for the consideration which was to be liquidated in 20 installments, the sellers in the meantime to receive 6 percent on the deferred installments. The record convinces us that the petitioner's outstanding issue of preferred stock should be regarded as debts, and not an investment in its capital stock; also that the dividends provided for in the stock certificates were intended to represent*1033 compensation for deferred payments on the indebtedness thus created. ; affd., . In these circumstances the disputed disbursements amounted to interest on indebtedness, and we so hold. There being no deficiency in tax, there is no basis for assertion of the ad valorem negligence penalty. Decision will be entered for the petitioner.