McLean County Service Co. v. Commissioner

MCLEAN COUNTY SERVICE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. CHAMPAIGN COUNTY SERVICE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. McLean County Service Co. v. Commissioner Docket Nos. 101830, 101831. United States Board of Tax Appeals 45 B.T.A. 1004; 1941 BTA LEXIS 1039; December 16, 1941, Promulgated *1039 1. Petitioners were engaged in the distribution of petroleum products on a cooperative basis, doing business with members and nonmembers. The corporate charters, bylaws, and certificates of stock prohibited the payment of dividends except on class A preferred stock not in excess of 7 percent. Holders of common stock were entitled to patronage dividends only. Held, in computing surtax on undistributed profits such corporate charters, bylaws, and certificates of stock are not "written contracts executed by the corporation" within the meaning of section 26(c)(1), Revenue Act of 1936, and petitioners are not entitled to a credit thereunder. 2. Gains derived through transactions with nonmembers were distributed to members in proportion to the amount of business the member did through the cooperative. Held, such distributions were not "pro rata, equal in amount and with no preference to any share of stock as compared with other shares of the same class" within the meaning of section 27(g), Revenue Act of 1936, and petitioners are not entitled to a dividends paid credit for such distributions. 3. Held, Federal income taxes are not deductible from apparent net income*1040 before applying the percentage of member sales to total sales to determine the amount of patronage dividends. C. C. Chapelle, Esq., for petitioners. Gerald W. Brooks, Esq., for respondent. ARNOLD *1004 These consolidated proceedings involve deficiencies in income tax as follows: Docket No. Year Amount 101830 Fiscal year ended November 30, 1938 $215.63 101831 Fiscal year ended October 31, 1937 208.05 The questions involved are as follows: (1) Whether, under section 26(c)(1) of the Revenue Act of 1936, petitioners are entitled to a credit to the extent of their respective net incomes in computing surtax on undistributed profits; (2) whether petitioners are entitled to a dividends paid credit in the amount of the excess of the accrued or paid patronage refunds over the amount allowed by respondent as a deduction from gross income; and (3) whether income taxes paid during the taxable year should be deducted from income before applying the percentage of member sales to total sales to determine the amount of patronage dividends deductible. The record made in each proceeding consists of the pleadings, a written stipulation*1041 *1005 of facts, and a joint exhibit. All facts contained in the stipulation not set forth herein are incorporated in our findings of fact by reference. FINDINGS OF FACT. The McLean County Service Co., hereinafter referred to as the McLean Co., and the Champaign County Service Co., hereinafter referred to as the Champaign Co., were incorporated under the laws of Illinois on November 10, 1926, and August 12, 1930, respectively. The business of each is the distribution of petroleum products on a cooperative basis. Each does business with nonmembers as well as with members. The capital stock of each company consists of the following: Class McLean Co. Champaign Co. Shares Shares Class A preferred stock, $25 a share par value 4,000 2,000 Class B preferred stock, no par value 12,000 2,500 Common stock, no par value 7,500 2,500 Under the provisions of the charter and bylaws of each company class A preferred stock is entitled to dividends not in excess of 7 percent per annum, payable only out of earnings. The class B preferred stock is entitled to no dividends, either capital, patronage, or liquidating, but each share is entitled*1042 to one vote. The preferred stock of the McLean Co. outstanding at the beginning and end of the fiscal year ended November 30, 1938, amounted to $54,775.54 and $69,558.22, respectively. The preferred stock of the Champaign Co. outstanding at the beginning and end of the fiscal year ended October 31, 1937, amounted to $20,050 and $22,375, respectively. The 7 percent dividends paid by the McLean Co. and the Champaign Co. on class A preferred stock during the taxable year amounted to $3,604.75 and $2,801.32, respectively. Each company deducted the amount of class A preferred stock dividends paid as a dividends paid credit in its return in computing the surtax on undistributed profits, whcih credit was allowed by the respondent. No common stock is shown on the balance sheet of either petitioner. Each company issued its common stock to members of county farm bureaus only. The bylaws of the McLean Co. provide that only three shares of common stock shall be held by a member. 1 The bylaws of the Champaign Co. provide that a member must be the holder of at least one share of common stock. The charter and bylaws of each company provide, among other things, that distribution to members*1043 *1006 or common stockholders may be made from time to time at the discretion of the board of directors on the basis of patronage only, and that if the holder of common stock ceases to be a member of a county farm bureau his stock is forfeited to the company. The charter and bylaw provisions pertaining to the rights and privileges of the preferred and common stock, including the provisions above set forth relating to the payment of dividends thereon, are set forth in the class A preferred and common stock certificates issued by the Champaign Co. and in the class A preferred stock certificates issued by the McLean Co. The common stock certificates of the McLean Co. contain the provision that the "preferred stock * * * shall bear 7% non-cumulative dividends payable annually", but contain no statement as to dividends, if any, payable to common stockholders. During its taxable year the McLean Co. accrued on its books patronage refunds of*1044 $88,263.93. It actually paid patronage refunds of $85,724.18. Patronage refunds payable are shown in its balance sheets at the beginning and end of its taxable year in the amounts of $83,519.65 and $86,313.68. Such patronage dividends represent the share of the common stockholders, as declared by the board of directors, in the net savings, prorated solely on the basis of their patronage and not in proportion to stockholdings. The McLean Co. filed a corporation income and excess profits tax return for the fiscal year ended November 30, 1938, with the collector of internal revenue for the eighth district of Illinois, showing net income of $13,485.03. The respondent increased reported net income by the amount of $773.55, representing excessive depreciation claimed, which adjustment is not in controversy. In arriving at the reported net income the McLean Co. deducted from gross receipts patronage dividends or refunds in the amount of $80,835.61, which amount was determined as follows: Net profits per books $3,777.73 Plus patronage dividends 88,263.93 Accrued income tax 2,279.01 $94,320.67 Less: Preferred stock dividends $3,604.75 Income taxes paid 2,390.30 $5,995.05 Amount available for patronage business $88,325.62 Patronage dividends deductible (91.52% of $88,325.62) 80,835.61 *1045 This deduction was allowed by respondent. During its taxable year the Champaign Co. accrued on its books patronage dividends of $58,340.35, representing the savings to be distributed to common stockholders solely in proportion to their patronage and not in proportion to stockholdings. The books of *1007 the company reflect liability for patronage refunds payable at the beginning and end of its taxable year in the respective amounts of $50,930.26 and $60,719.46. The Champaign Co. filed a corporation income and excess profits tax return for the fiscal year ended October 31, 1937, with the collector of internal revenue for the eighth district of Illinois. In recomputing the tax liability of the Champaign Co. respondent increased the reported net income by adding thereto $1,419.79 designated patronage refunds forfeited and $2,004.67 representing a reduction in patronage refunds, resulting in a corrected net income of $10,041.04. The respondent computed patronage dividends allowable as follows: Net profits per books $5,466.58 Patronage dividends accrued 58,340.35 Accrued income tax 1,150.00 Patronage dividends forfeited 1,419.79 $66,376.72 Less: Preferred stock dividends $1,497.82 Income tax paid during year 1,183.47 2,681.29 2,681.29 Patronage dividends deductible (88.4454% of $63,695.43) $56,335.68 Patronage dividends deducted 58,340.35 Excessive patronage refund $2,004.67 *1046 During the taxable year the Champaign Co. paid Federal income taxes of $1,183.47. OPINION. ARNOLD: Petitioners contend that, under section 26(c)(1) of the Revenue Act of 1936, in computing the surtax on undistributed profits they are entitled to a credit to the extent of their respective net incomes upon the ground that the payment of dividends is prohibited by their charters, bylaws, and class A preferred stock, and common stock certificates, except dividends not in excess of 7 percent on class A preferred stock. To be entitled to the claimed credit the petitioner must show the existence of "a written contract executed by the corporation prior to May 1, 1936" containing a provision which "expressly deals with the payment of dividends." It has been held that corporate charters and bylaws are not "written contracts executed by the corporation" within the meaning of the statute. Lehigh Structural Steel Co.,44 B.T.A. 422 (on appeal, C.C.A., 3d Cir.); Metal Specialty Co.,43 B.T.A. 891 (on appeal, C.C.A., 6th Cir.); *1047 Warren Telephone Co.,43 B.T.A. 451 (on appeal, C.C.A., 6th Cir.); Midland Cooperative Wholesale,44 B.T.A. 824; *1008 Atlas Supply Co.,43 B.T.A. 324 (on appeal, C.C.A., 10th Cir.), and Davison-Joseph Campau Realty Co.,41 B.T.A. 675. Section 26(c)(1) refers to "routine contracts dealing with ordinary debts." Helvering v. Northwest Steel Rolling Mills, Inc.,311 U.S. 46. Whether the stock certificates are contracts within the meaning of section 26(c)(1) was decided in the negative in Bishop & Babcock Manufacturing Co.,45 B.T.A. 776. Stock certificates are not "routine contracts dealing with ordinary debts." Helvering v. Northwest Steel Rolling Mills, supra. The petitioners are therefore not entitled to a credit under section 26(c)(1), Revenue Act of 1936. Petitioners contend that if it is held the charter, bylaws, and stock certificates do not constitute a contract restricting the payment of dividends as contemplated in section 26(c)(1), Revenue Act of 1936, then the excess of the amount of patronage dividends accrued over the amount allowable*1048 as a deduction from gross receipts should be allowed as a dividends paid credit under section 27 of the Revenue Act of 1936. Section 27(g) provides that: No dividends paid credit shall be allowed with respect to any distribution unless the distribution is pro rata, equal in amount, and with no preference to any share of stock as compared with other shares of the same class. 1 Each of the petitioners distributed nonpreferential pro rata dividends on shares of class A preferred stock in the amount of $3,604.75 and $2,801.32, respectively, which were allowed as dividends paid credits by respondent. Under the charter and bylaw provisions the holders of common stock of petitioners are entitled to a distribution of income on the basis of patronage only, which distributions are designated patronage dividends as distinguished from ordinary dividends on stock. The McLean Co. accrued patronage dividends of $88,263.93 for the fiscal year on its books, but actually distributed only $85,724.18. The*1049 Champaign Co. accrued patronage dividends of $58,340.35 on its books for the taxable year. The amount of patronage dividends paid by it during the taxable year was not stipulated. The respondent allowed as deductions from gross income patronage dividends in the amounts of $80,835.69 and $56,335.68, respectively. It was stipulated that the patronage refunds represented the common stockholders' share of the net savings prorated solely on the basis of their patronage and not in proportion to stockholdings. Holders of one share of common stock who transacted no business *1009 with petitioners would be entitled to no dividends, whereas holders of one or more shares of common stock who transacted business with petitioners would be entitled to dividends in varying amounts, depending upon the amount of business transacted. A holder of two or three shares who did not transact business would not be entitled to any dividends, whereas the holders of only one share each who did transact business would be entitled to dividends, depending upon the amount of business transacted. Hence such distribution would not be pro rata equal in amount and with no preference to any share of stock*1050 as compared with other shares of the same class. The language and meaning of section 27(g) is clear. It is not ambiguous. There is no need for construction of a statute where no ambiguity exists. Osaka Shosen Kaisha Line v. United States,300 U.S. 98, 101; Wilbur v. United States ex rel. Vindicator Consolidated Gold Mining Co.,284 U.S. 231; United States v. Missouri Pacific R. Co.,278 U.S. 269, 278. The petitioners are not cooperatives exempt from Federal income taxes under section 101 of the Revenue Act of 1936. Council Bluffs Grape Growers Association,44 B.T.A. 152; Farmers Union Cooperative Co., Guide Rock, Nebraska,33 B.T.A. 225; affd., 90 Fed.(2d) 488. However, the respondent has allowed each petitioner the deduction of a substantial amount of so-called patronage dividends "to the end that substantial justice may be done to an association which is engaged in the cooperative marketing or purchasing work which may not be exempt from taxation." *1051 Fruit Growers Supply Co.,21 B.T.A. 315, 326; affd., 56 Fed.(2d) 90. The allowance of the deduction rests upon the theory that the so-called patronage dividends are "in reality rebates upon the business transacted by the association with its members rather than true income of the association." Midland Cooperative Wholesale,44 B.T.A. 824. See Cooperative Oil Association, Inc. v. Commissioner, 115 Fed.(2d) 666. Where a cooperative deals with nonmembers who are not entitled to any rebates upon the business transacted, the earnings from such business is taxable gain. Central Co-Operative Oil Association,32 B.T.A. 359. To that extent the business of each petitioner was not upon a cooperative basis, but upon the same basis as that of any other organization engaged in business for profit. It can not be denied that Congress favors true cooperatives by exempting them from Federal income tax. We are not permitted on that account to extend such exemption by allowing a dividends paid credit to cooperatives not exempt from Federal income tax merely because they transact business partly on a cooperative*1052 basis. See Taft v. Commissioner,304 U.S. 351. To allow a dividends paid credit to cooperatives which are not exempt from tax under section 101 and which distribute taxable income on a patronage basis would in effect *1010 grant them exemption from taxation and violate the clear provisions of section 27(g). We can see no injustice or unfairness in treating a cooperative not exempt from tax the same as other business organizations. What was stated in United States v. Ewing,184 U.S. 140, 149, wherein it was claimed that great injustice would result in many cases if the clear directions of the law involved were required to be followed, is apposite here. The Court stated: * * * although the result may be to withhold the benefits from some who might be regarded as otherwise entitled to it, yet we can not for that reason alter its terms so as to include them, and thus ourselves enact instead of construing [sic] the law. Furthermore, section 27(g) provides that "the dividends paid credit shall be the amount of dividends paid during the taxable year." (Emphasis supplied.) The amount of patronage dividends paid in the taxable*1053 year by the Champaign Co. was not stipulated. It was stipulated that the McLean Co. actually paid patronage dividends in the amount of $85,724.18 in the taxable year. It was also stipulated that at the beginning of the year the balance sheet of the McLean Co. showed patronage refunds payable at the beginning of the taxable year in the amount of $83,519.65 and that during the taxable year patronage dividends were accrued in the amount of $88,263.93. The stipulation, however, fails to disclose whether the payment in the taxable year was applied against the patronage dividends accrued in the taxable year or against patronage dividends accrued in prior years and unpaid at the beginning of the taxable year as reflected in the amount of $83,519.65 standing in the patronage refunds payable account at the beginning of the taxable year. In other words, the amount of $85,724.18 paid during the taxable year may have been, and probably was, first applied against the balance of patronage dividends remaining unpaid at the beginning of the taxable year of $83,519.65, leaving the amount of only $2,204.53 to apply on the patronage dividends accrued during the taxable year. If that be so, the McLean*1054 Co. did not pay any patronage dividends declared in the taxable year in excess of the amount of $80,835.81 allowed as a deduction by the respondent. This is also true with respect to the Champaign Co. Patronage dividends, if any, paid by it during the taxable year may have been applied against the balance of patronage dividends accrued on the books prior to the taxable years and unpaid at the beginning of the taxable year in the amount of $50,930.26. The claim is made that petitioners are entitled to a dividends paid credit of the excess of the amount of patronage dividends accrued in the taxable year over the amount allowed by the respondent. There is not sufficient evidence which would support a finding that such excess was actually paid or allocated and credited to the members' *1011 accounts without restriction as to withdrawal. See John Gerber Co.,44 B.T.A. 26. We therefore hold that the petitioners are not entitled to a dividends paid credit as claimed. The petitioners contend that Federal income taxes paid during the taxable year are not deductible from apparent net income before applying the percentage of member sales to total sales thereto*1055 to determine the amount of patronage dividends. This question was before the Board in Farmers Union Cooperative Exchange,42 B.T.A. 1200 (appeal dismissed by Tenth Circuit, 122 Fed.(2d) 718), wherein it was held that in computing the amount of patronage dividends under A.R.R. 6967, C.B. III-1, p. 287, the "apparent net income" referred to therein is the net income accruing upon the business for the year, without reduction on account of Federal taxes and penalties paid. This decision is controlling herein. Valparaiso Grain & Lumber Co.,44 B.T.A. 125, cited by respondent, is not applicable or in conflict with Farmers Union Cooperative Exchange, supra.Therein the question involved here was not raised. The taxpayer therein contended that in computing the amount of patronage dividends allowable as a deduction the fixed dividends paid on capital stock were to be considered as having been paid out of profits realized on business done with nonmembers, leaving profits realized on business done with members available for distribution as patronage dividends. Decision will be entered under Rule 50. Footnotes 1. The form of certificate for common shares attached to the stipulation of facts as representing a true copy of such certificates issued by the McLean Co. provides that "Only five shares of common stock shall be held by a member." ↩ 1. SEC. 1001. DEFINITIONS. (a) When used in this Act - * * * (8) The term "stock" includes the shares in an association, joint stock company, or insurance company. * * * ↩