Court Opinion

ID: 4618639
Source: CourtListenerOpinion
Date Created: 2020-11-21 02:39:02.798788+00
Date Added: 2024-06-11T07:55:30.481081
License: Public Domain

NORTHWESTERN CABINET CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Northwestern Cabinet Co. v. CommissionerDocket No. 12257.United States Board of Tax Appeals13 B.T.A. 533; 1928 BTA LEXIS 3231; September 25, 1928, Promulgated *3231  In 1920 the petitioner entered into agreements with certain of its employees for the sale of shares of its capital stock to them, the agreements requiring the employee to pay a percentage of the purchase price at the date of signing the agreement, and interest at 6 per centum per annum on the unpaid balance of the subscription price and the petitioner to credit the employee with dividends declared on the stock subscribed for.  The stock was to remain in possession of the petitioner until the purchase price was fully paid.  Held, that the amount of the unpaid stock subscriptions may not be included in invested capital.  Held, further, that interest accrued on the unpaid stock subscriptions constitutes taxable income of the petitioner.  George D. Wick, Esq., for the petitioner.  J. E. Marshall, Esq., for the respondent.  SMITH *533  This is a proceeding for the redetermination of a deficiency in income and profits tax for 1920, in the amount of $5,841.39.  The assignments of error stated in the petition are (1) that the Commissioner excluded from invested capital unpaid subscriptions upon capital stock; (2) that he included in gross income*3232  interest received and accrued upon such unpaid subscriptions; and (3) that he disallowed the deduction from gross income of $3,913.02 of a reasonable allowance for depreciation.  The third assignment of error was waived at the hearing.  *534  FINDINGS OF FACT.  The petitioner is an Iowa corporation, with its principal office at Burlington.  On January 1, 1920, it had paid-up capital stock of $100,000.  On or about the same date it was authorized to increase its capital stock to $400,000.  It paid a stock dividend as of January 1, 1920, and during the early part of the year entered into contracts with certain of its employees for the sale to them of 735 shares of its capital stock at a price of $150 per share, the par value of each share being $100.  The conditions under which the stock was sold were that the employees should pay 10 per centum of the purchase price in cash and interest at the rate of 6 per centum per annum upon the unpaid purchase price.  The employees had five years within which to complete the payments.  Dividends upon the stock subscribed for by them were to be credited to their accounts against the purchase price.  Each of the subscribers executed an*3233  agreement with the petitioner, reading as follows: AGREEMENT FOR THE SALE OF STOCK.  THIS AGREEMENT, Made and entered into this day of 19 , between the Northwestern Cabinet Company, an Iowa corporation, having its principal place of business in Burlington, Iowa, party of the first part, and of Burlington, Iowa, party of the second part, WITNESSETH: Whereas, the second party is desirious of purchasing certain of the Common Stock of the Northwestern Cabinet Company for an agreed consideration of One Hundred and Fifty Dollars ($150.00) per share, and, Whereas, the first party is willing to sell said second party shares of said stock for said price, IT IS HEREBY MUTUALLY AGREED: That the party of the second part will pay to the party of the first part Dollars upon the signing of this agreement, being per cent of the entire purchase price of said stock.  The said second party further agrees to pay the balance of said stock on or before five years from the date hereof, together with six per cent, interest on all unpaid sums, which said interest the second party agrees to pay irrespective of the earnings or dividends upon the stock purchased.  All dividends declared upon*3234  the stock purchased to be applied to the payment of the purchase price until the same is fully paid for.  Said stock to be and remain in the possession of the first party until fully paid for.  It is further agreed that should the second party desire to dispose of his stock or interest therein, he shall first offer it to the Directors of the first party, and they shall have an opportunity for a period of thirty days to purchase the same for its then book value.  Should the first party fail to purchase said stock within the said thirty days then the second party shall be at liberty to dispose of it elsewhere.  *535  In any sale made prior to the time when said stock is fully paid for there shall be deducted the unpaid balance of the purchase price with interest to date of sale.  Witness our hands this day of 19 .By President.Secretary.(Interest paying dates January 1st and July 1st.) These agreements, 33 in number, were all dated as of January 1, 1920, and interest was computed upon unpaid subscriptions from that date.  The subscriptions were not signed on January 1, 1920, but were signed during the first three or four months of the year.  Stock*3235  certificates were in no case delivered to the subscribers until they had completed payments under their agreement.  A few of the subscribers paid the full amount of their subscriptions within the calendar year 1920.  In two cases the subscribers desired to dispose of their stock or of their interest therein before the end of the year 1920 and were permitted to cancel their subscriptions and receive back the amounts standing to their credit at the time.  Subsequent to 1920 two other subscribers desired to cancel their subscriptions and there was refunded to them the net credits standing to their account.  Twenty-nine of the employees completed payments in accordance with the terms of their contracts and received certificates for the shares of stock acquired by them.  The president of the petitioner considered the employees who subscribed for stock financially responsible for the amount of the unpaid subscriptions.  They had all worked for the petitioner for a number of years, and many of them owned their own homes.  In its income-tax return for 1920 the petitioner included in invested capital $110,250, representing the sale price of the 735 shares of stock subscribed for by employees. *3236  Of this amount the respondent excluded $83,791.79, but allowed the inclusion in invested capital of cash paid in by subscribers for their stock from the dates of payment to the amount of $26,458.21.  The amount of unpaid stock subscriptions on December 31, 1920, was $72,800 and was carried on the ledger as an asset on that date under the caption of "Unpaid stock subscriptions." The deficiency is ascribable in large part to the reduction in invested capital made by the respondent.  The interest actually collected by the petitioner from the subscribers during 1920 was $2,406.98, and the amount accrued but uncollected on unpaid stock subscriptions at the close of the year was $2,573.84, the sum of which amounts the petitioner included in gross income in its income-tax return for 1920.  Petitioner's books of account were kept on the accrual basis.  *536  OPINION.  SMITH: Petitioner contends that it is entitled to include in invested capital as of January 1, 1920, $110,250, representing the sale price of 735 shares of its capital stock subscribed for by its employees during the early part of the year.  The respondent has allowed the inclusion in invested capital of only the*3237  amounts of cash paid in by the employees under the subscription agreements from the date of such payments and has disallowed the inclusion of the balance.  The petitioner insists that if it is not entitled to include the unpaid stock subscriptions it likewise should not be required to include in gross income of 1920 the interest which accrued upon such unpaid subscriptions.  The stock subscription agreements were all dated January 1, 1920.  It is in evidence, however, that they were not signed on that date and that many of them were not signed until on or after March 27, 1920.  It would appear from the evidence that the agreements were signed on or about April 1, 1920.  Section 326(a) of the Revenue Act of 1918 permits a corporation to include in invested capital, among other items: (1) Actual cash bona fide paid in for stock or shares; (2) Actual cash value of tangible property, other than cash, bona fide paid in for stock or shares, at the time of such payment, * * * Section 325(a) defines the term "tangible property" as meaning "stock, bonds, notes, and other evidences of indebtedness, bills and accounts receivable, leaseholds, and other property other than intangible*3238  property." The petitioner contends that the contracts were worth their face value at the time they were executed and that the contracts were "paid in" for the shares of stock subscribed for.  In , it was stated: In order to adhere to this restricted meaning [of the word "invested"] and avoid exaggerated valuations, the draftsman of the act resorted to the test of including nothing but money, or money's worth, actually contributed or converted in exchange for shares of the capital stock, or actually acquired through the business activities of the corporation or partnership (involving again a conversion) and coming in ab extra, by way of increase over the original capital stock.  How consistently this was carried out becomes evident as the section is examined in detail.  Cash paid in, and tangible property paid in other than cash, are confined to such as were contributed for stock or shares in the corporation or partnership; and the property is to be taken at its actual cash value "at the time of such payment" - distinctly negativing any allowance for appreciation in value.  The court further stated*3239  in the same opinion: A scrutiny of the particular provisions of section 207 [Revenue Act of 1917] shows that it was the dominant purpose of Congress to place the peculiar *537  burden of this tax upon the income of trades and businesses exceeding what was deemed a normally reasonable return upon the capital actually embarked.  The observation of the court in the above-entitled case had reference to the provisions of the Revenue Act of 1917, but they are equally applicable to the Revenue Act of 1918.  The question for our determination is whether $150 or tangible property of an equal value was actually "paid in" to the petitioner for each share of stock subscribed for by the employee of the petitioner at the date of the signing of the subscription agreement in such a way as to be "embarked" in the business enterprise.  In , we held that a stock subscription of itself can not be regarded as property paid in for shares of capital stock under the invested capital provisions of the Revenue Act of 1918; that consequently a corporation may not include in invested capital the amount of unpaid subscriptions to*3240  its capital stock.  We have also held that only payments on stock subscriptions may be included in invested capital from the date of such payments. ; ; ; . We have also held that the requirement that the subscriber should pay interest upon deferred payments of the subscription price did not warrant the inclusion of the unpaid stock subscriptions in invested capital.  ;An inspection of the subscription agreement shows that each employee signing the same was required to pay into the corporation $150 cash for each share subscribed for.  The respondent has permitted the inclusion in invested capital of the amounts of cash paid in under those subscription agreements from the dates of payment.  How can it be contended that anything more should be included in invested capital?  A subscriber for the capital stock of a corporation is often bound by his subscription to make the payments*3241  agreed to be made.  But are the amounts to be included in invested capital in advance of the payments?  If so, the invested capital may be built up to a large extent by the subscriptions of stockholders and the stockholder himself have the use of the money.  We think that a proper interpretation of the statute requires that there be included in the invested capital only the amounts paid in under stock subscription agreements.  This case is sharply to be differentiated from a case where promissory notes are paid in by a subscriber for stock and received by the corporation in payment for the stock.  In , we held that promissory notes of a responsible and solvent maker actually and in good faith paid in for stock of a corporation was includable in invested capital.  To the same effect see . In the instant *538  proceeding the evidence is not satisfactory that the contracts, which were bilateral contracts between the employees and the petitioner, were paid in to the petitioner for the shares of stock.  If the contracts are claimed to be property other than cash paid in*3242  for the shares of stock, it does not appear that the provisions of the Iowa statutes relating to the issuance of stock for property other than cash were complied with.  The Code of Iowa (1924) provides in part as follows: 8412.  Par Value Required. No corporation organized under the laws of this state, except building and loan associations, shall issue any certificate of a share of capital stock, or any substitute therefor, until the corporation has received the par value thereof.  [Session 1913, § 1641-b; 40 Ex. Gen. Assembly, House File 202, § 3.] 8413.  Payment in Property Other Than Cash. If it is proposed to pay for said stock in property or in any other thing than money, the corporation proposing the same must, before issuing capital stock in any form, apply to the executive council of the state for leave so to do.  Such application shall state the amount of capital stock proposed to be issued for a consideration other than money, and set forth specifically the property or other thing to be received in payment for such stock.  [S., '13, § 1641-b; 40 Ex. G.A., H.F. 202, § 4.] 8414.  Executive Council to Fix Amount. The executive council shall make investigation, *3243  under such rules as it may prescribe, and ascertain the real value of the property or other thing which the corporation is to receive for the stock.  It shall enter its finding, fixing the value at which the corporation may receive the same in payment for capital stock; and no corporation shall issue capital stock for the said property or thing in a greater amount than the value so fixed.  [S., '13, § 1641-b; 40 Ex. G.A., H.F. 202, § 5.] * * * 8416.  Certificate of Issuance of Stock. It shall be the duty of every corporation to file a certificate under oath with the secretary of state, within ten days after the issuance of any capital stock, stating the date of issue, the amount issued, the sum received therefor, if payment be made in money, or the property or thing taken, if such be the method of payment.  [S., '13, § 1641-c.] 8417.  Cancellation of Stock - Reimbursement. The capital stock of any corporation issued in violation of the terms and provisions of the five preceding sections shall be void, and in a suit brought by the attorney general on behalf of the state in any court having jurisdiction, a decree of cancellation shall be entered; * * * [S., '13, *3244  § 1641-d.] The subscription contract specifically provides that the stock should "be and remain in the possession of the first party until fully paid for." The fact that dividends were paid upon the stock subscribed for and that the subscribers were notified of stockholders' meetings subsequent to the date of their subscriptions is not, in our opinion, sufficient to show that the stock was issued for the contracts.  The petitioner claims that it is entitled to include in invested capital the subscription contracts in question, under the provisions of article 833 of Regulations 45, which provides: *539 Tangible property paid in: evidences of indebtedness. - Enforcible notes or other evidences of indebtedness, either interest-bearing or noninterest bearing, of the subscriber received by a corporation upon a subscription for stock may be considered as tangible property in computing its invested ccapital to the extent of the actual cash value of such notes or other evidences of indebtedness at the time when paid in, but only (a) if such notes or evidences of indebtedness could under the laws of the jurisdiction in which the corporation was organized legally be received*3245  in payment for stock, and (b) if they were actually received by the corporation as absolute, and not as conditional, payment in whole or in part of the stock subscription.  The evidence does not show, however, that the contracts were received by the petitioner "as absolute, and not as conditional, payment in whole or in part of the stock subscription." Upon the evidence of record the exclusion from invested capital of unpaid subscriptions to capital stock is sustained.  Petitioner makes the alternative contention that, if it is not to be allowed to include in invested capital the unpaid subscriptions to its capital stock, it should not be required to return as income the interest which accrued upon such unpaid subscriptions.  This does not follow, however.  Invested capital must be computed in accordance with the statute.  The fact that an instrument upon which interest is received by the taxpayer may not be included in invested capital is no ground for holding that the interest itself is not taxable as income.  For instance, if a corporation had developed a patent without cost to itself subsequent to March 1, 1913, and sold the patent under a contract on which it was to receive*3246  interest and did receive interest, the value of the contract would not be includable in invested capital, provided, of course, the corporation was organized prior to the date the patent was secured.  Is it any valid argument that, because the value of the contract may not be included in invested capital, the interest received upon the contract should not be included in gross income?  Section 213(a) of the Revenue Act of 1918 defines gross income as including "gains, profits, and income derived from * * * interest, * * *." The petitioner derived income from interest in 1920 on stock subscription agreements.  The interest was available to the petitioner for any purpose, the same as income from any other source.  We think that the amount of interest accrued upon the subscription agreements was properly included in the gross income of the petitioner.  We have held to the same effect in That decision is controlling here.  Reviewed by the Board.  Judgment will be entered for the respondent.LANSDON and ARUNDELL dissent.