Carolina-Florida Realty Co. v. Commissioner

CAROLINA-FLORIDA REALTY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Carolina-Florida Realty Co. v. Commissioner Docket No. 104800. United States Board of Tax Appeals 46 B.T.A. 777; 1942 BTA LEXIS 819; March 27, 1942, Promulgated *819 Where, under a trust indenture securing bonds of petitioner, part of rents were required to be paid monthly to the trustee for deposit in a sinking fund for purchase and cancellation of bonds, held, petitioner is entitled to the credit provided by section 26(c)(2) of the Revenue Act of 1936. H. A. Mihills, C.P.A., for the petitioner. Charles Oliphant, Esq., for the respondent. HARRON *777 The Commissioner determined deficiencies in income tax in the amount of $1,063.65 for the year 1936 and $1,951.16 for 1937. The only question is whether petitioner is entitled in each year to credits in the amount of $7,500 under section 26(c)(2) of the Revenue Act of 1936. The facts have been stipulated. FINDINGS OF FACT. Petitioner is a South Carolina corporation, having its principal office in Charleston. It filed income and excess profits tax returns for 1936 and 1937 with the collector for the district of South Carolina. Its business is renting, holding, and dealing in real estate. It keeps its books and reports income on the accrual basis. The entire capital *778 stock of petitioner is owned by the Cameron & Barkley Co. of Charleston. *820 On or about October 1, 1923, petitioner issued bonds in the amount of $150,000 face value, secured by a first mortgage on several pieces of real estate and buildings thereon. The bonds were dated October 1, 1923, and they were to mature fifteen years later, being due and payable on October 1, 1938. They were designated "First Mortgage Real Estate Fifteen Year 7% Sinking Fund Bonds." The bonds constituted an indebtedness of petitioner. On October 1, 1923, petitioner executed a trust indenture with the Charleston Security Co., corporate trustee. The trust indenture constituted the mortgage securing the bonds. Under the trust deed petitioner conveyed title to particular parcels of real property with buildings to the trustee in trust for the bondholders, and the mortgage was a first lien on the property to secure payment of the principal and interest on the bonds. Under the trust indenture it was required that interest and sinking fund payments should be made to the trustee and failure to make such payments, as well as to pay taxes, assessments, and other charges on the property, constituted defaults. In the event default continued for 60 days the trustee had the right to*821 declare the principal of all of the bonds in default, to have a receiver appointed, and to do other things. With respect to a sinking fund the following is provided: Article III, section 2. For the purpose of creating a Sinking Fund to aid in the payment of the principal of the Bonds hereby secured, the Company has entered into a lease to The Cameron & Barkley Company of the premises and property hereby mortgaged, which lease among other things provides that the said The Cameron and Barkley Company shall, commencing on the First day of April, 1924, pay to the Trustee to be deposited in the Bank of Charleston, National Banking Association, annually in monthly installments, an amount which will equal 5% of the total issue of said bonds, upon which sums of money the said Bank of Charleston, National Banking Association, will pay to the Trustee interest at the rate of 4% per annum. The Trustee from said funds, whenever the same shall amount to Seven thousand ($7,000.00) Dollars, may at the request of the Company, purchase for the account of the Sinking Fund, any bonds that are offered during the period of two months following the accumulation of the Sinking Fund to the amount above*822 set forth, provided the same can be acquired at not exceeding the prices named herein for the retirement of the said bonds in full and accrued interest, and if the same cannot be so purchased at or below such prices, then the Trustee shall, upon request of the Company, select by lot and call for retirement a sufficient number of bonds to exhaust the Sinking Fund then available for such purpose, notice thereof to be given as provided in Section I hereof. On the same day that petitioner executed the trust indenture securing the bonds, October 1, 1923, petitioner entered into a lease agreement with the Cameron & Barkley Co., its parent, leasing the property and premises described in the trust indenture to the Cameron & *779 Barkley Co. for 15 years to September 30, 1938, subject to the right of the lessee to cancel the lease if it paid in full $150,000 of the bonds with accrued interest. As and for the rental of the premises the lessee agreed to pay taxes, assessments, insurance, repairs, interest on the outstanding bonds, and sinking fund installments. The Cameron & Barkley Co. thereby was obligated to pay to the trustee under the trust indenture, on the first of every month, *823 $625 for the sinking fund, or $7,500 a year. In the event of any default by the lessee, the lessor (petitioner) had the right to repossess the premises and expel the lessee, its successors, or assigns. In the taxable years, 1936 and 1937, the above lease was still operative as was the trust. In each year the Cameron & Barkley Co., on behalf of petitioner, paid to the trustee $7,500, and bonds of equal or greater amount were retired in each year. In its income tax returns for 1936 and 1937 petitioner reported income from rents in the respective amounts of $35,355.50 and $37,440.08, and net income in the respective amounts of $11,070 and $8,154. In each year petitioner deducted $7,500, as a credit under section 26(c)(2), and gave the following explanation for the deduction: The entire amount of rental charged the Cameron & Barkley Company for use of the properties is taken into income of Carolina-Florida Realty Company. The actual monthly payments into the Sinking Fund are made by the Cameron & Barkley Company and charged to Carolina-Florida Realty Company to be applied against the rent account. It will be noted from the above that $7,500 (5% of $150,000) of the Company's*824 income is never physically received by it, as it is irrevocably set aside within each taxable year for the discharge of a debt incurred before April 30, 1936. Respondent disallowed the deductions of $7,500 for the reason that the bond indenture did not expressly deal with the disposition of earnings and profits of the taxable year. Included in rent paid each year for the property covered by the trust indenture and mortgage dated October 1, 1923, and the lease dated October 1, 1923, was $7,500 paid to the trustee by the petitioner's lessee. In each year that amount was income to the petitioner and part of its "earnings and profits" of each taxable year. Under the terms of a contract executed prior to May 1, 1936, $7,500 of petitioner's earnings and profits in each year was required to be irrevocably set aside within the year for the discharge of a debt, and in the taxable years was set aside. OPINION. HARRON: The question and the discussion relates to $7,500 in each taxable year, which was paid by petitioner's lessee to the trustee under the trust indenture and was used by the trustee each year to *780 redeem and retire bonds having the equivalent face value. The*825 factors to be considered are as follows: (a) Petitioner had a debt in the amount of outstanding bonds. . (b) Petitioner was entitled to receive rent for the leased property (which was mortgaged to secure the bonds). (c) Petitioner, in effect, assigned part of the rents to the trustee, by directing its lessee to pay a portion of the rents each month to the trustee. (d) The lessee paid $7,500 a year to the trustee. (e) The trustee used the $7,500 paid to it in each year to purchase bonds which were canceled and petitioner's debt evidenced thereby was thus, and to such extent, paid in each year. The net result of this arrangement was that a portion of petitioner's earnings of the year was set aside within the year for the discharge of its debt; and, also, a portion of petitioner's earnings of the year was applied in discharge of a debt within the taxable year. This conclusion necessarily follows from the facts and from the law of constructive receipt of income. When B pays money to C to discharge an indebtedness running from A to C, A receives income, constructively, and is taxable upon it. *826 . Since part of petitioner's earnings in each taxable year was used within the year to discharge part of petitioner's debt, it would be equitable, at least, to hold that petitioner is entitled to the credit claimed in each year under the terms of section 26(c)(2), 1 because so much of petitioner's earnings were withdrawn, thereby, from distribution to its stockholders in dividends. The question to be determined is whether the prerequisites for the credit as set forth in the statute are met, and the material part of the statute is found in the parenthetical clause of section 26(c)(2). The question, then, is as follows: Was that portion of petitioner's earnings of the taxable year which was irrevocably set aside and applied in discharge of petitioner's debt, which was incurred prior to May 1, 1936, so dealt with by "a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings *781 and profits of the taxable year"? The answer to this question requires our construction of section 2 of article III of the trust indenture, *827 which has been set forth in the findings of fact. *828 In our opinion that section of the trust agreement meets the statutory requirements. The words "earnings and profits of the taxable year" do not appear in the written contract but that is not always necessary in order to apply section 26(c)(2). See ; ; affd., ; ; ; ; . The meaning of section 2 of article III of the trust indenture is clear. It is that the petitioner, a party to the trust agreement, having a right to receive rents under a lease, has directed the lessee to pay a definite amount out of such rents to the trustee, monthly, to be deposited in the sinking fund. Monthly rental, being earnings of each taxable year, had to be set aside and paid to trustee. Under these restrictions upon the use of receipts from the property covered by both the trust agreement and the lease, petitioner could not use such income derived from the lease to*829 pay dividends to its stockholders until the bonds had been paid in full. In , we held that income from oil leases was "earnings and profits" under section 26(c)(2). In , we held that income from real estate was "earnings and profits." In , we held that proceeds from the sales of land were "earnings and profits." In each case we held that a provision which "required" the payment of ascertainable amounts into a sinking fund or to discharge a debt was a "provision [which] expressly deals with the disposition of earnings and profits of the taxable year." In none of these cases, in the written agreements involved, was there an express mention of "earnings and profits", and respondent placed reliance on that fact, as he does here, in support of his contention that the contracts did not contain any provision expressly dealing with the disposition of the taxpayer's earnings and profits. In the Michigan Silica case it was pointed out that the statute does not require that such terms be used in the written contract, but only that the written contract contain a*830 provision which expressly deals with the disposition of earnings and profits of the taxable year. As has been pointed out above, the disposition of a part of petitioner's earnings in each year was dealt with in the trust indenture. The property which was leased by petitioner to the Cameron & Barkley Co. was the property mortgaged to secure the bonds. Petitioner, as owner of the equity in the property and as lessor, was entitled to rents from the property. The effect of the lease provision requiring the lessee to make fixed monthly payments to the trustee for *782 payment into the sinking fund was that petitioner made an assignment of a portion of the rents to the trustee. It is stated to be a general rule that no particular form of assignment is necessary, in the absence of restrictions imposed by statute, and any acts or words are sufficient which show an intention of transferring the owner's interest. 6 Corpus Juris Secundum, 1090, par. 41. We find no statutory requirements in South Carolina on the mode or form of an assignment. Under the lease it was clear that petitioner gave up its right, in favor of the trustee, to a portion of rents, and under section*831 2 of article III of the trust it is clear that the trustee could look to the lessee for receipt of ascertainable amounts each month. Failure of the lessee to make the payments to the trustee constituted default under the lease. The situation is similar to that in the G. B. R. Oil Corporation case. It is held that petitioner is entitled to the claimed credit in each year under section 26(c)(2). Reviewed by the Board. Decision will be entered under Rule 50. DISNEY concurs only in the result. VAN FOSSAN and MELLOTT dissent. 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. - * * * (2) DISPOSITION OF PROFITS OF TAXABLE YEAR. - An amount equal to the portion of the earnings and profits of the taxable year which is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of the taxable year) to be paid within the taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt; to the extent that such amount has been so paid or set aside. For the purposes of this paragraph, a requirement to pay or set aside an amount equal to a percentage of earnings and profits shall be considered a requirement to pay or set aside such percentage of earnings and profits. As used in this paragraph, the word "debt" does not include a debt incurred after April 30, 1936. ↩