Kolor-Thru Corp. v. Commissioner

KOLOR-THRU CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Kolor-Thru Corp. v. Commissioner Docket No. 104016. United States Board of Tax Appeals 44 B.T.A. 1303; 1941 BTA LEXIS 1196; August 29, 1941, Promulgated *1196 Corporation A and corporation B entered into a contract whereby A was to incorporate petitioner and transfer to it certain patent rights in exchange for all of petitioner's stock, a portion of which was later sold to B. The agreement between A and B provided that petitioner should pay no dividends until a specified surplus should have been accumulated for the defense and prosecution of patent infringement suits. Petitioner's directors considered it bound by the agreement and declared no dividends during the taxable year, since the required amount had not been accumulated. Held, the contract entered into by the promoters of petitioner was not executed by petitioner within the meaning of section 26(c)(1) of the Revenue Act of 1936, and petitioner is not entitled to the credit provided for in that section. Fred L. Rosenbloom, Esq., and Joseph L. Lord, III, Esq., for the petitioner. Paul E. Waring, Esq., for the respondent. VAN FOSSAN *1303 Respondent determined a deficiency of $2,262.43, of which $1,153.52 is in dispute, in petitioner's income tax for the year 1936. Petitioner contends that respondent erred in refusing to allow a credit*1197 under section 26(c)(1) of the Revenue Act of 1936 of at least $9,517.58, the amount of petitioner's adjusted net income. FINDINGS OF FACT. A majority of the facts are stipulated and we hereby adopt the stipulation as a part of our findings of fact. The stipulated facts may be summarized as follows: Petitioner is a corporation, organized under the laws of the State of Delaware on December 23, 1932. Its business is that of a patent holding company. During 1936 its principal office was located at 317-25 South State Street, Dover, Delaware. Petitioner reports its income on an accrual basis and filed its income and excess profits tax return for the calendar year 1936 with the collector of internal revenue for the district of Delaware at Wilmington, Delaware. In 1932 the Sandura Corporation, Inc. (whose name was later changed to Paulsboro Manufacturing Co.), hereinafter referred to as Sandura, a New Jersey corporation, owned an exclusive license under certain United States letters patent and application for United *1304 States letters patent and certain other applications for letters patent. It also owned the entire right, title, and interest in and to certain other*1198 United States letters patent. On December 21, 1932, Sandura and the Armstrong Cork Co., hereinafter referred to as Armstrong, a Pennsylvania corporation, entered into a written agreement whereby Sandura agreed, inter alia, to set up the petitioner for the purpose of owning, holding, and administering the patent rights owned by Sandura and of granting sublicenses and collecting and distributing the profits realized from the patents. The agreement provided that petitioner's authorized capital stock should consist of 2,400 shares of class A common and 2,400 shares of class B common stock, all of no par value, a majority of the directors to be elected by the class A stock and the remaining directors by the class B stock. Class B stock was to be entitled to receive no distribution whatsoever either by way of dividends or by way of liquidation. Armstrong agreed that all of both classes of stock should be issued to Sandura in exchange for the transfer of the patent rights. Armstrong was to be granted a license under the various patents transferred. Prior to incorporation of the petitioner Sandura subscribed to all of the stock. On December 31, 1932, Sandura by agreement in writing*1199 transferred the patent rights to the petitioner and petitioner issued all of its stock to Sandura. On January 5, 1933, Armstrong purchased 240 shares of class A and 800 shares of class B stock from Sandura and Sandura transferred the remaining 1,600 shares of petitioner's class B stock back to petitioner. The written agreement between Sandura and Armstrong provided that no dividends should be paid by the petitioner directly or indirectly until petitioner had accumulated $25,000 to be kept available for distributions solely in connection with defense or prosecution of patent infringement suits. Up to the end of 1936 petitioner had not accumulated $25,000 surplus. Petitioner paid no dividends during 1936. A surplus in excess of $25,000 was accumulated during 1937 and dividends were paid on the class A stock twice during that year: $6.50 per share on August 23, and $2.50 per share on November 19. The balance, after payment of dividends, was in both instances just slightly in excess of $25,000. The record discloses the additional facts that the petitioner was incorporated by Sandura pursuant to the agreement, that Armstrong and Sandura have at all times owned the controlling*1200 interest in petitioner's stock, and that petitioner's directors considered it bound by the portion of the agreement between Sandura and Armstrong dealing with the payment of dividends. *1305 OPINION. VAN FOSSAN: Petitioner claims a credit under section 26(c)(1) of the Revenue Act of 1936, 1 by reason of a contract executed prior to May 1, 1936, prohibiting the payment of dividends during 1936. The contract in question was executed by the promoters of petitioner prior to petitioner's incorporation and is said to have been adopted by petitioner immediately upon its incorporation in December 1932. The question presented is whether a contract executed by the promoters of a corporation and subsequently adopted or ratified by that corporation can be said to have been executed by the corporation within the meaning of section 26(c)(1) of the 1936 Act. *1201 There is some doubt in the case at bar whether petitioner ever actually adopted or ratified the contract entered into by Armstrong and Sandura. No formal action was ever taken. The only evidence of adoption or ratification is the testimony that petitioner's directors considered petitioner bound by the contract and hence did not declare dividends until the required $25,000 surplus had been accumulated. Assuming, however, that the contract was adopted by it, petitioner is not entitled to the credit claimed. Since section 26(c)(1) is a provision granting a special credit, strict compliance with its terms must be shown. Cf. ; see . Petitioner has failed to show such strict compliance. In , the petitioner was set up by the Machinery & Welder Corporation as the result of a written agreement between the principal creditor of the prior owner of petitioner's assets and the Machinery & Welder Corporation. We held that that agreement could not possibly satisfy the requirement*1202 of section 26(c)(1), since Airtherm was not in existence at the time the contract was entered into. Likewise, in , we held that a contract entered into by the lumber company's predecessor did not entitle the lumber company to a credit even though it had orally assumed the predecessor's liabilities under *1306 the contract. In , we held that a contract entered into by the taxpayer's parent corporation did not entitle the subsidiary to a credit even though the parent customarily acted for the subsidiary in such matters. With respect to the fact that the officers of the subsidiary considered it bound by the contract, we said: "The testimony to the effect that an officer of petitioner who was also an officer of the several holding companies considered the petitioner as bound by the contract to which it was not a party, is in no way controlling." In the case at bar the contract in question was never executed by petitioner. The most that can be said is that petitioner by its actions ratified or adopted the contract and considered itself bound by it. That is not sufficient*1203 to entitle petitioner to the credit claimed. Decision will be entered for the respondent. Footnotes 1. SEC. 26. CREDITS OF CORPORATIONS. In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax - * * * (c) CONTRACTS RESTRICTING PAYMENT OF DIVIDENDS. - (1) PROHIBITION ON PAYMENT OF DIVIDENDS. - An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account. ↩