Budd Wheel Co. v. Commissioner

BUDD WHEEL COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Budd Wheel Co. v. Commissioner Docket No. 99625. United States Board of Tax Appeals 45 B.T.A. 963; 1941 BTA LEXIS 1041; December 10, 1941, Promulgated *1041 By an amendment to petitioner's bylaws adopted April 7, 1925, it was provided that "No cash dividend shall be paid to the holders of Stock other than First Preferred Stock" except out of surplus earned subsequent to April 1, 1925, which would deplete the earned surplus below what it was on that date. This provision of the bylaws was incorporated in all stock certificates of the petitioner outstanding during 1936 and 1937. Held, that the provision of the bylaws above referred to which was incorporated in the stock certificates does not constitute a "written contract" respecting the payment of dividends within the meaning of section 26(c)(1) of the Revenue Act of 1936, and the petitioner is not entitled to the credit claimed. Frederick E. S. Morrison, Esq., for the petitioner. Philip M. Clark, Esq., for the respondent. SMITH *964 This proceeding is for the redetermination of deficiencies in income tax for 1936 and 1937 of $99,077.77 and $55,666.19, respectively. The petitioner alleges that in computing undistributed net income for the years 1936 and 1937 the respondent erroneously and illegally disallowed for each year "credit for contract*1042 restricting dividend payments," and thereby erroneously and illegally determined undistributed distributed net income of $589,288.40 for the year 1936 and $757,071.64 for the year 1937. Petitioner contends that not only does it not owe the deficiencies, but that it is entitled to refunds of taxes paid for 1936 and 1937 in the amounts of $2,904.88 and $83,610.60, respectively. Most of the evidence introduced by the petitioner to sustain its contentions is contained in a written stipulation of facts which is made a part of our findings by reference. FINDINGS OF FACT. 1. The petitioner is a corporation organized under the laws of Pennsylvania on June 29, 1921, with its principal office and place of business in Philadelphia, and a second office and place of business at Detroit, Michigan. It filed its income tax returns for the years 1936 and 1937 with the collector at Detroit. 2. The petitioner's income tax returns for 1936 and 1937 show tax liabilities of $154,397.46 and $257,587.15. The tax shown for 1936 was paid quarterly during 1937 and that shown for 1937 was paid quarterly during 1938. All such tax payments were made within three years from the date of the filing*1043 of the petition herein. 3. Shortly after April 7, 1925, the petitioner proposed to and did issue 15,000 shares of first preferred stock, par value of $100 each, for cash through the underwriting firm of Lee, Higginson & Co. At that time the petitioner had authorized common stock of 200,000 shares of which 158,136 shares were outstanding. The common stock was without nominal or par value but had a stated capital of $4,307,715.21. Thereafter, and throughout the years 1936 and 1937, the petitioner had only two classes of stock outstanding, viz., the first preferred stock and the common stock. *965 4. Before Lee, Higginson & Co. would undertake the underwriting of the preferred stock it demanded that the petitioner should issue no obligations which would come ahead of the securities which they were considering underwriting. In compliance with this demand the bylaws of the petitioner were amended on April 7, 1925. The provisions of petitioner's amended bylaws which relate to the payment of dividends and the restriction of the payment of dividends, together with the other right, privileges, limitations, preferences, voting powers, terms of redemption, and the prohibitions, *1044 restrictions, and qualifications of voting and other rights and powers in respect of the first preferred stock were from the date of issuance of such stock in 1925 to the present time contained in its issued common and preferred stock certificates, respectively. These common stock and preferred stock certificates were executed and issued by the petitioner on and after April 7, 1925, and prior to May 1, 1936, and were outstanding throughout the years 1936 and 1937. 5. The amendment to the bylaws provided in part as follows: (2) Restriction on Dividends on Stock other than First Preferred. No cash dividend shall be paid to the holders of Stock other than First Preferred Stock: (a) Except out of surplus earned subsequent to April 1, 1925; (b) Which will deplete the surplus below that as of said date; (c) Unless the total current assets are at least double total current liabilities. The bylaws also provided for the creation of a sinking fund for the retirement of shares of first preferred stock and provided that the sinking fund should be operated by a separate trustee, that the petitioner should pay over to the trustee certain percentages of its earnings, and that*1045 the trustee should expend the amounts paid over to it, together with any income thereon, for the purchase and retirement of the first preferred stock at a price not to exceed $120 per share. The bylaws further provided that so long as any of the first preferred stock should be outstanding no mortgage should be placed upon the property of the petitioner without the consent of at least two-thirds of the holders of preferred stock; also, that no amendment should be made to the bylaws which would operate to reduce the dividend rate, the redemption price, or the amount payable upon dissolution, in respect of any shares of outstanding first preferred stock, without the consent of two-thirds of the holders thereof. 6. After May 6, 1925, and from time to time during the years 1936 and 1937, the petitioner under the requirements and operation of its first preferred stock sinking fund retired shares of preferred stock, but at the end of 1936 and 1937 a number of shares of preferred stock still remained outstanding. *966 7. The petitioner's earned surplus, as shown by its books of account on April 1, 1925, was in the amount of $665,130.66. There was an increase in the earned*1046 surplus on December 31, 1931. The petitioner suffered a large operating loss in 1932 which wiped out all of its earned surplus and a part of its capital surplus. 8. During the years 1932 to 1935 petitioner was in arrears on its first preferred stock dividends, including the then current year 1935, in the sum of $195,926.50, which it paid off in cash by the end of the year 1935. Thereafter, and during the years 1936 and 1937, the petitioner, having paid in full the cash dividends due on the first preferred stock, was not in arrears on the preferred stock dividends. 9. During the years 1932 to 1935, inclusive, petitioner was in arrears on payments due the first preferred stock sinking fund under the stock provisions in the sum of $210,000, which petitioner paid off in the year 1936. During the years 1936 and 1937 petitioner paid in full the sums of $72,846.56 and $74,394.84, respectively, due the first preferred stock sinking fund and thereby had no arrearage during the years 1936 and 1937. 10. (a) The earnings and profits of the petitioner for the calendar year 1936 were, as shown by its books of account, $954,498.41 before deducting Federal income tax payable for that*1047 year. (b) Petitioner's Federal normal income tax for 1936 was $151,492.58, as set forth in the notice of deficiency attached to the petition. (c) Petitioner's adjusted net income for 1936 was $878,849.50, as set forth in the notice of deficiency. (d) During 1936 petitioner paid cash dividends to its shareholders as follows: Dividends in full on preferred stock - cash $52,390.00 Dividends on common stock - cash 193,051.60 Total 245,441.60 (e) During 1936 the sinking fund purchased for retirement 2,399 shares of petitioner's preferred stock, for which a premium of $44,119.50 in excess of par was paid. (f) Petitioner on its 1936 return claimed credit for dividends paid of $289,561.10, comprising the sums of $245,441.60 and $44,119.50 set forth in the two preceding paragraphs, and such credit was allowed by the respondent in his notice of deficiency. 11. (a) The earnings and profits of the petitioner for the calendar year 1937 were, as shown by its books of account, $873,991.43 before deducting Federal income tax for the year 1937. (b) Petitioner's Federal normal income tax for the year 1937 was $173,976.55, as set forth in the notice of deficiency. *1048 *967 (c) Petitioner's adjusted net income for the year 1937 was $1,002,039.27, as set forth in the notice of deficiency. (d)(1) During 1937 petitioner paid cash dividends to its shareholders as follows: Dividends in full on preferred stock - cash $41,378.00 Dividends on common stock - cash 193,051.60 Total 234,429.60 (2) During 1937, 648 shares of petitioner's outstanding preferred stock were purchased for retirement through the sinking fund, on which a premium of $10,538.03 in excess of par was paid. (3) Petitioner in its 1937 return claimed credit for dividends paid of $244,967.63, comprising the sums of $234,429.60 and $10,538.03 set forth above, and such credit was allowed by the respondent in the notice of deficiency. 12. During the years 1936 and 1937 petitioner's total current assets were at least twice its total current liabilities. OPINION. SMITH: In his audit of the petitioner's income and excess profits tax returns for 1936 and 1937 the respondent made numerous adjustments which to some extent increased the taxable net income. The petitioner does not question the correctness of those adjustments in this proceeding. The net*1049 income as adjusted by the respondent for 1936 was $1,030,342.08 and for 1937 was $1,176,015.82. From the net incomes as adjusted the respondent deducted $151,492.58 for 1936 and $173,976.55 for 1937 for taxes payable, leaving adjusted net incomes for the computation of the surtax on undistributed profits of $878,849.50 and $1,002,039.27, respectively. The petitioner in this proceeding does not question the correctness of such determinations. In its tax returns for 1936 and 1937 the petitioner claimed dividends paid credits under section 27(a) of the Revenue Act of 1936 of $289,561.10 and $244,967.63, respectively. Included in these claimed credits were $44,119.50 and $10,538.03, respectively, representing the amount of premiums on outstanding shares of preferred stock which were purchased for retirement in each taxable year through the sinking fund. In the computation of the deficiencies the respondent has allowed the dividends paid credit claimed on the returns. In the returns the petitioner claimed additional credits for contracts restricting dividend payments of $524,043.04 for 1936 and $181,172.53 for 1937. These credits have been disallowed by the respondent in the*1050 determination of the deficiencies. In this proceeding *968 the petitioner claims that the respondent erred in making such disallowances and that the amounts which he should have allowed as credits for contracts restricting the payment of dividends are $878,849.50 for 1936 and $586,297.71 for 1937. We consider first the contention of the petitioner that the provisions of its bylaws contained in its certificates of common stock and preferred stock outstanding constitute a written contract executed by the corporation prior to May 1, 1936, within the contemplation of section 26(c)(1) of the Revenue Act of 1936, which prohibited it from declaring dividends on its common stock in the taxable years. Section 26(c)(1) provides in material part as follows: SEC. 26. CREDITS OF CORPORATION. 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*1051 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. The petitioner first argues that the stock certificates issued by it, incorporating therein the provisions of the bylaws restricting the payment of dividends, constitute the written contract required by section 26(c)(1), supra. The provisions of the bylaws standing alone do not constitute the written contract required by the section referred to above. See ; ; . The petitioner argues, however, that the provisions of the bylaws above referred to, incorporated in its stock certificates, do constitute a written contract within the meaning of section*1052 26(c)(1) of the statute. In , the question before the Court was whether a provision of a corporation's charter restricting the payment of dividends was within the meaning of section 26(c)(1) and (2). The Court held that it was not. The Court stated: * * * The natural impression conveyed by the words "written contract executed by the corporation" is that an explicit understanding has been reached, reduced to writing, signed and delivered. * * * In *969 that case the argument was made that, even if the charter provision was not a written contract within the purview of section 26(c) of the statute, nevertheless the issuance of stock certificates containing such charter provisions constituted a written contract within the purview of the section. In a footnote to its opinion the Supreme Court said: 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. This issue is determined in favor of the respondent upon the authority of *1053 ;; ; ; and . It may further be noted that the restriction upon the payment of dividends contained in the petitioner's stock certificates is at most a prohibition against the payment of cash dividends to the holders of stock other than first preferred stock. The respondent argues that this provision would in no even prevent the petitioner from paying other than cash dividends, such as dividends in property or dividends in second preferred stock, and his contention is that, since the petitioner was not restricted in the payment of such dividends, it has not met the requirements of section 26(c)(1) of the statute. The respondent relies upon the following provision of Regulations 94, viz., article 26-2(b), which provides in part as follows: (b) Prohibition on payment of dividends. - The credit provided in section 26(c)(1) is allowable only with respect to a written*1054 contract executed by the corporation prior to May 1, 1936, which expressly deals with the payment of dividends and operates as a legal restriction upon the corporation as to the amounts which it can distribute within the taxable year as dividends. If an amount can be distributed within the taxable year as a dividend - (1) in one form (as, for example, in stock or bonds of the corporation) without violating the provisions of a contract, but can not be distributed within the taxable year as a dividend in another form (as, for example, in cash) without violating such provisions, * * * * * * then the amount is one which, under section 26(c)(1), can be distributed within the taxable year as a dividend without violating such provisions. We think that this contention of the respondent is likewise sound. Decision will be entered under Rule 50.