Court Opinion

ID: 4604555
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:34:30.108722+00
Date Added: 2024-06-11T07:53:01.800062
License: Public Domain

CHAMPION MILLING AND GRAIN COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Champion Milling & Grain Co. v. CommissionerDocket No. 102106.United States Board of Tax Appeals45 B.T.A. 988; 1941 BTA LEXIS 1044; December 10, 1941, Promulgated *1044  Under article 5 of a mortgage trust deed executed in 1930, petitioner was entitled to retain possession, use, and control of the mortgaged property and all its income and profits, "including all rights to declare dividends out of such profits", so long as no default occurred.  Petitioner defaulted in the payment of taxes, bond interest, and principal from and after 1931.  On January 6, 1937, it executed a new deed of trust, effective January 1, 1936, containing like provisions.  On December 12, 1936, the trustee-bank required petitioner to execute a separate contract which expressly prohibited the distribution of dividends until certain bonds were fully paid, both as to principal and interest.  Held, the provision of the trust deed relative to the payment of dividends, being contingent on default and imposing a restriction by implication only, was not a written contract restricting the payment of dividends within the meaning of section 26(c)(1), Revenue Act of 1936, entitling petitioner to a credit thereunder.  Perry W. Shrader, Esq., for the petitioner.  Angus R. Shannon, Jr., Esq., for the respondent.  ARNOLD *988  This proceeding involves*1045  a deficiency in income tax for 1937 in the sum of $2,652.40.  Petitioner denies its liability as to $2,119.38 of said deficiency representing surtax on undistributed profits.  The issue is whether petitioner is entitled to a credit for a contract restricting the payment of dividends under section 26(c)(1), Revenue Act of 1936.  FINDINGS OF FACT.  Petitioner is an Lowa corporation, engaged in milling and manufacturing commercial feeds at Clinton, Iowa.  Its income tax return for 1937 was filed with the collector of internal revenue for the district of Iowa.  On or about November 24, 1930, petitioner executed a trust deed or mortgage to the City National Bank of Clinton, Clinton, Iowa, as trustee, to secure an issue of $60,000 of 6 1/2 percent gold serial bonds.  *989  The bonds matured serially, beginning December 1, 1931, in the amount of $10,000 per year for each of the next six years.  Article 4 of the trust deed required petitioner to pay all taxes levied against the mortgaged property.  If petitioner failed to pay the taxes the trustee had the option of paying them and it would then be entitled to reimbursement from petitioner with interest at 6 1/2 percent, the deed*1046  of trust or mortgage to be security for any such payments made by the trustee.  Article 5 of the trust deed provided as follows: It is further covenanted and agreed that so long as no default shall be made in the payment of the principal or of the interest on the bonds secured hereby according to the terms and effect thereof, and so long as all of the other terms, conditions, agreements and covenants of this deed of trust shall be fully performed, the Company, its successors and assigns, shall be entitled to retain possession and the use and control of said mortgaged property and all its income and profits, including all rights to declare dividends out of such profits except that the Company shall make all the payments out of such income, which they are to make as in this deed of trust or mortgage provided and at the time or times herein set forth.  In 1935 petitioner was in default in the payment of its state and county taxes for the years 1931 to 1934, inclusive.  Tax sales certificates were issued as a result of the defaults and these certificates were acquired by the City National Bank on December 2, 1935.  During December 1936, the City National Bank paid petitioner's taxes*1047  for 1936, which were due one-half in April and one-half in September 1936.  From and after December 1, 1931, petitioner was in default on its bond principal and interest payments.  On March 2, 1936, petitioner's directors appointed a committee to formulate plans and make arrangements for the reorganization of the petitioner.  A plan was formulated and put into effect whereby a new trust deed or mortgage was executed securing an issue of bonds aggregating $86,000, the proceeds to be used to redeem the property from tax sale and to refund the outstanding bonds of the petitioner.  The trust indenture, dated January 1, 1936, was actually executed by petitioner and the City National Bank as trustee, more than a year later, namely, January 6, 1937.  Article 5 of this trust deed is identical with article 5 of the trust deed dated November 24, 1930.  Under the plan of reorganization, bonds in the principal sum of $26,000 were designated class A bonds and bonds in the principal amount of $60,000 were designated class B bonds.  Class A bonds were prior to class B bonds in every respect except the payment of interest.  Class A bonds bore interest at 5 percent and matured serially $4,000*1048  per year for the first five years and $6,000 in the sixth year.  Class B bonds matured in ten years and bore interest at 3 percent per annum for the first five years and thereafter 5 percent *990  per annum.  Interest was payable semiannually and was evidenced by coupons attached to the bonds.  The plan of reorganization contemplated that the City National Bank would accept senior bonds (class A) in satisfaction of the amount of taxes it had paid.  Pursuant to the plan class A bonds in the principal sum of $22,000 were issued to the City National Bank.  Prior to the execution of the trust indenture of January 6, 1937, and under date of December 12, 1936, petitioner and the City National Bank executed a contract which restricted the payment of dividends.  After setting forth that proceedings were being had for the reorganization of petitioner's credit structure, that the bank may be required to carry petitioner's class A bonds in order to successfully complete the reorganization, that the bank desired assurance that no dividends will be paid until said class A bonds are paid in full as to both principal and interest, and that it (the bank) was unwilling to carry any of said*1049  bonds unless provision was made for their complete payment before dividends were paid or set apart for stock, the contract recites that "no dividends shall be paid or set apart on the stock of the said company until the 'Class A' bonds have been paid in full as to principal and interest." Throughout the taxable year 1937 petitioner was endeavoring to secure the acceptance of the plan of reorganization by its bondholders.  At least two bondholders refused to participate and petitioner purchased their bonds, four bonds from one party in March 1937 and two bonds from a deceased bondholder's estate in August 1938.  After the plan of reorganization was consummated, petitioner was able to meet the principal and interest payments on its bond issues.  On its income tax return for 1937 petitioner reported a net income of $10,770.98 and a normal tax of $1,124.81.  Petitioner claimed a credit of $9,646.17 for contracts restricting dividend payments, which was the entire amount of its adjusted net income ($10,770.98 minus $1,124.81).  Respondent made certain adjustments to petitioner's net income which are not here in dispute, and refused to allow a credit in any amount for contracts restricting*1050  the payment of dividends.  OPINION.  ARNOLD: Section 26(c)(1) of the Revenue Act of 1936, set forth in the margin, 1 grants a credit as to the surtax imposed on undistributed *991  profits where a corporation is prohibited by contract from paying dividends.  The statute requires that the contract be in writing, that it be executed prior to May 1, 1936, and that the provision thereof which would be violated by a dividend distribution expressly deals with the payment of dividends.  Petitioner's entire argument is premised upon the proposition that the trust deed provisions meet the statutory requirements.  *1051  We can not agree.  In our opinion the trust deed of November 24, 1930, which was the only written contract executed prior to May 1, 1936, was not such a contract as is contemplated by the statute.  It does not expressly restrict the payment of dividends.  On the contrary, it expressly contemplates the declaration of dividends.  By implication it restricts dividend payments upon the happening of certain contingencies, but this restriction exists only by implication.  Petitioner would have us convert the provisions of article 5 into an express restriction upon a showing made that the contingencies mentioned have happened.  But the statute specifically conditions the credit upon a provision which expressly deals with the payment of dividends, and the Supreme Court has held that section 26 is to be strictly construed. . We can not by construction of the contract convert an implied restriction into the express restriction called for by the statute.  ; *1052 ;  (now on appeal, C.C.A., 9th Cir.). Our conclusion as to the legal effect of article 5 of the 1930 trust indenture is fortified by the actions of petitioner and the City National Bank.  Under the proposed plan a new trust deed was to be executed, which carried the same article 5 as appeared in the trust deed dated November 24, 1930.  Nevertheless, before the City National Bank would accept the class A bonds and consummate the plan of reorganization, it required petitioner to execute a separate contract on December 12, 1936, which expressly restricted the payment of dividends until the interest and principal of petitioner's class A bonds were completely paid.  The execution of the contract of December 12, 1936, shows that the parties themselves construed the language of article 5 as insufficient to restrict the payment of dividends.  We think effect should be given to their construction.  The December 12, 1936, contract is too late, however, in point of time to entitle petitioner to the credit.  Decision will be entered for the respondent.*1053 Footnotes1. 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.  * * * ↩