Court Opinion

ID: 4610234
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:46:26.276993+00
Date Added: 2024-06-11T07:54:01.826312
License: Public Domain

THE LIQUID CARBONIC CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Liquid Carbonic Corp. v. CommissionerDocket Nos. 50985, 61319, 72270.United States Board of Tax Appeals34 B.T.A. 1191; 1936 BTA LEXIS 584; October 22, 1936, Promulgated 1936 BTA LEXIS 584">*584  1.  Petitioner retired some of its outstanding bonds by exchanging therefor shares of its capital stock.  Held, the amount of the unamortized bond discount and expenses attributable to the bonds retired in that manner was not deductible from gross income during the years of retirement.  2.  Commissions paid for underwriting shares of petitioner's capital stock used in an exchange for some of its outstanding bonds and their retirement held not allowable as deductions from gross income.  3.  Where petitioner, by action of its board of directors, voted to pay its employees additional compensation at fixed amounts in dollars and cents, and later paid the amounts partly in stock which it had purchased with the fund established for that purpose and partly in cash, held, the amounts deductible as business expenses are the amounts fixed in dollars and cents and actually expended for that purpose, rather than the fair market value of the stock at the time of distribution plus the cash paid.  Package Machinery Co.,28 B.T.A. 980">28 B.T.A. 980, distinguished.  Wm. N. Haddad, Esq., for the petitioner.  C. R. Marshall, Esq., for the respondent.  BLACK1936 BTA LEXIS 584">*585 34 B.T.A. 1191">*1191  Petitioner complains of income tax deficiencies of $34,459.64, $13,132.70, and $3,920.97 for fiscal years ending September 30, 1928, 1929, and 1930, respectively.  Instead of deficiencies, it claims that it has overpaid its tax for each of the respective years.  On the other hand, respondent makes claim for an increased deficiency for 1928.  The issues are (1) whether respondent erred in disallowing as deductions from gross income for 1928 and 1929 the respective amounts of $277,859.06 and $91,532.97 deducted by petitioner on its returns for those years as unamortized discount and expenses incurred in the issuance of its bonds in 1926, which bonds were retired during the fiscal years 1928 and 1929 by the issuance of petitioner's capital stock in payment therefor; (2) whether petitioner is entitled to a deduction of $33,310 from its gross income for 1929 on account of alleged expenses, not claimed on its return or allowed by respondent, which petitioner now cntends it incurred in that year in connection with the redemption of the balance of its 1926 bond issue; and (3) whether, as petitioner alleges, the respondent erred in allowing insufficient deductions for1936 BTA LEXIS 584">*586  bonuses incurred and paid to petitioner's officers and employees for all the years involved, or whether, as respondent affirmatively alleges, he erred in allowing an excessive deduction for bonuses in the fiscal year 1928.  34 B.T.A. 1191">*1192  On May 28, 1934, respondent notified the Board that $9,576.24 of the deficiency for 1928 and $6,275.21 of the deficiency for 1929 had been assessed under section 272 of the Revenue Act of 1928.  Certain facts relating to the overpayments claimed by petitioner were stipulated at paragraphs 34 and 35 of the stipulation and are incorporated herein by reference, to which effect will be given under Rule 50 to the extent that they are material when the recomputations of petitioner's tax liabilities are made.  The proceedings were consolidated for hearing.  Aside from the oral testimony of one witness, the facts were stipulated.  FINDINGS OF FACT.  1.  Petitioner is a corporation, organized under the laws of the State of Delaware on July 23, 1926, with an original authorized capital of 100 shares of common stock.  On July 29, 1926, its authorized capital stock was duly increased to 200,000 shares, all of which were without nominal or par value.  It1936 BTA LEXIS 584">*587  is engaged in the manufacture and jobbing of soda fountains and carbonic gas and has its principal office at Chicago, Illinois.  On August 1, 1926, petitioner issued $4,000,000 principal amount of first mortgage convertible sinking fund 6 percent gold bonds dated August 1, 1926, and maturing on August 1, 1941.  The bonds were issued under and pursuant to the provisions of a comprehensive first mortgage consisting of 134 printed pages.  Under article III of the mortgage any of the bonds at the election of the respective holder or registered owner thereof could be converted at their principal amount at any time prior to maturity, or, if called for redemption, at any time up to and including the fifteenth day prior to such date of redemption, into shares of petitioner's common capital stock at a conversion value of not to exceed $60 per share, "that is to say, upon the delivery of $60 aggregate principal amount of Bonds in exchange for one share of said common stock * * *." Section 8 of article III provided in part as follows: The authorized capital stock of the Company, at the date of the execution hereof, consists of 200,000 shares, without par value, of which 100,000 shares have1936 BTA LEXIS 584">*588  been issued or are about to be issued and outstanding.  The board of directors of the company has duly reserved 66,667 shares of said authorized and unissued common stock solely for the purpose of converting the $4,000,000 principal amount of Bonds issued pursuant to Section 1 of Article II hereof at the conversion price herein specified.  The Company covenants that at all times so long as Bonds are outstanding said 66,667 shares shall be reserved * * *.  Under article IV of the mortgage petitioner had the right, upon giving the prescribed notice, to redeem the bonds in whole or in part at the price of 105 percent if called before August 1, 1936, and at lower prices if called thereafter.  34 B.T.A. 1191">*1193  Petitioner issued the said $4,000,000 par value of bonds at a discount of 10 percent ($400,000) and incurred expenses in connection therewith of $42,533.09, thereby receiving $3,557,466.91 as the net proceeds from the sale and disposition of the bonds.  During the fiscal year ended September 30, 1928, pursuant to article III of the mortgage, $2,848,000 par value of the bonds were converted into common stock at a conversion price of $58 per share; and during the same year, pursuant1936 BTA LEXIS 584">*589  to article IV of the mortgage, $174,000 par value of the bonds were redeemed in cash from the sinking fund in the hands of the trustee.  During October 1928 petitioner decided to exercise its right under article IV of the mortgage to redeem the remaining $978,000 par value of bonds outstanding, and in order to obtain the cash funds necessary for such redemption it entered into an agreement with its bankers, Potter & Co., which was as follows: Confirming our conversation, we hereby agree to underwrite at $58 a share (the conversion price of the Liquid Carbonic Bonds outstanding) the number of shares of stock into which the bondholders have the right to convert their bonds, if any shares of stock are not taken up by the bondholders under their right, for a commission of $2 a share.  It is our understanding that there are practically 17,000 shares of stock held for conversion purposes and we will underwrite the stock at the conversion price on behalf of ourselves, Messrs. Spencer Trask & Company and Messrs. Merrill Lynch & Company.  At a meeting of the Board of Directors on Monday, the bonds will be called for payment at the earliest possible date under the indenture of the mortgage. 1936 BTA LEXIS 584">*590  The necessary resolution of petitioner's board of directors was adopted, the trustees were duly notified, and a notice of intention to redeem was immediately sent out to all remaining bondholders calling in the bonds for redemption.  The market value of petitioner's common stock fluctuated between $52.75 and $78.75 per share during the month of December 1927, but on the days in that month when bonds were converted into stock the market value of the stock was more than the conversion price of the bonds.  The conversion price was eventually fixed at $58 per share.  The market value of petitioner's stock was in excess of $58 per share throughout the remainder of its fiscal year 1928 and throughout its entire fiscal year 1929.  During November 1928 petitioner sold 30,000 shares of its stock at $90 per share; and during March 1929 it sold 44,448 shares at $70 per share.  On or before the 15th day prior to the date of redemption the bondholders, pursuant to article III of the mortgage, elected to convert the remaining $978,000 par value bonds into common stock at a conversion price of $58 per share, and they were so converted into common stock during the fiscal year 1929.  They were1936 BTA LEXIS 584">*591  not redeemed for cash, as had been originally planned.  34 B.T.A. 1191">*1194  Petitioner charged the said bond discount and expenses in the total amount of $442,533.09 to its surplus account, and in its income tax returns for the fiscal years ending September 30, 1926, 1927, 1928, and 1929 it deducted from its gross income, as amortization of bond discount and expense, the respective amounts of $4,800.22, $29,619.06, $315,354.04, and $92,759.77.  The respondent did not disturb the deductions taken for the years 1926 and 1927, and those years are not before us.  For the taxable year 1928 the respondent allowed $37,494.98 of the amount deducted on the return as being applicable to the bonds redeemed in cash, but disallowed as a deduction the amount of $277,859.06, giving as his reason the statement that "Discount on bonds converted into stock is held to be an unallowable deduction in accordance with I.T. 2347, C.B. VI-1, page 86." For the taxable year 1929 the respondent allowed $1,226.80 of the amount deducted on the return, but disallowed as a deduction the amount of $91,532.97, giving as his reason substantially the same statement as for the previous year.  Petitioner kept its books and1936 BTA LEXIS 584">*592  made its income tax returns for the years involved on the accrual basis of accounting.  The proper amount of the unamortized bond discount and expense which is allocable to the $2,848,000 par value of bonds converted during the taxable year 1928 is $277,859.06.  The proper amount of the unamortized discount and expense which is allocable to the $978,000 par value of bonds converted during the taxable year 1929 is $91,532.97.  2.  During the fiscal year ended September 30, 1929, petitioner paid to Potter & Co. the amount of $33,310 as a commission for underwriting 16,665 shares of its stock pursuant to the agreement between petitioner and Potter & Co. quoted in our findings above.  Petitioner reported this amount on its return for the fiscal year 1929 as "underwriting fee bond conversion", but did not deduct it from its gross income.  Petitioner now claims this payment as a deduction from its gross income for the fiscal year 1929, but the respondent has refused to allow it.  3.  Deductions for bonuses. - Paragraph fourth of petitioner's certificate of incorporation provides that whenever petitioner's net profits for any fiscal year shall exceed a certain amount: * * * the1936 BTA LEXIS 584">*593  Board of Directors may, in its discretion, at any time after the close of such fiscal year, set aside a Management-Participation Fund, out of the surplus or net profits of the Corporation (Petitioner), to be applied, as hereinafter provided, to the purchase of shares of the common stock of the Corporation, without nominal or par value, for and delivery to such of the officers, department heads, branch managers and other employees of the Corporation, poration, in such amounts as the Board of Directors may determine or may have determined as and for additional compensation for services rendered to the Corporation during such fiscal year.  * * * 34 B.T.A. 1191">*1195  In accordance with its articles of incorporation petitioner set up on its books an employees' profit sharing reserve, which had a credit balance on September 30, 1927, of $115,991.88.  For each of the fiscal years ended September 30, 1927, to and including September 30, 1930, and before the books were closed for those years, petitioner, pursuant to the provisions of its certificate of incorporation, made provisions for the payment of bonuses or additional compensation, as follows: September 30, 1927$105,231.88September 30, 1928185,000.00September 30, 1929140,000.00September 30, 1930125,000.001936 BTA LEXIS 584">*594  The above amounts were credited on petitioner's books to the employees' profit sharing reserve account, and are the amounts which it was estimated would be paid as additional compensation pursuant to the provisions of petitioner's certificate of incorporation.  During each of the fiscal years ended September 30, 1928, to and including September 30, 1930, the directors by informal action fixed the amount to be distributed during the fiscal year in accordance with the management-participation fund provisions of petitioner's certificate of incorporation, and the amounts so fixed and actually expended for this purpose were as follows: September 30, 1928$103,266.64September 30, 1929161,540.89September 30, 1930163,700.00The above amounts were debited on petitioner's books to the employees' profit sharing reserve account, and are the amounts which were actually fixed and expended for the payment of additional compensation to employees as previously estimated.  A part of these amounts was used to buy stock of the petitioner, which stock in turn was distributed to the employees, and the balance was paid to the employees in cash.  Of the $103,266.64 actually1936 BTA LEXIS 584">*595  fixed and expended for the fiscal year 1928, $101,266.64 was used to buy 2,000 shares of petitioner's stock, and $2,000 was paid to the employees in cash.  The 2,000 shares of petitioner's stock were paid to the employees on December 5, 1927, on which date their fair market value was $106,250.  Of the $161,540.89 actually fixed and expended for the fiscal year 1929, $147,040.89 was used to buy 2,000 shares of petitioner's stock, and $14,500 was paid to the employees in cash.  The latter 2,000 shares of petitioner's stock were paid to the employees on December 13, 1928, on which date their fair market value was $214,000.  The amount of $163,700 actually fixed and expended for the fiscal year 1930 was paid to the employees entirely in cash.  The petitioner's stock which was included in the payments to the 34 B.T.A. 1191">*1196  employees was included and computed on petitioner's books at its cost to the petitioner and not at its market value on the date of payment.  The amounts of bonuses (1) deducted by petitioner as additional compensation on its income tax returns for the fiscal years here involved, (2) the amounts allowed by the respondent in his dificiency notices, (3) the amounts now claimed1936 BTA LEXIS 584">*596  by petitioner, and (4) the amounts which the respondent now contends are deductible, are all summarized as follows: Fiscal year endedPetitioner's returnsRespondent's determinationPetitioner's contentionRespondent's contentionSeptember 30, 1928$183,034.76$183,034.76$108,250.00$103,266.64September 30, 1929116,540.89116,540.89228,500.00161,540.89September 30, 1930148,700.00126,000.00163,700.00163,700.00OPINION.  BLACK: 1.  Petitioner contends it is entitled to deduct from its gross income for the fiscal years ending September 30, 1928 and 1929, unamortized bond discount and expense in the amounts of $277,859.06 and $91,532.97, respectively, which amounts are allocable to the $2,848,000 and $978,000 par value of bonds converted into petitioner's common capital stock during those respective years.  This alleged right is denied by respondent.  On at least three occasions we have had this identical question before us and have held contrary to petitioner's contention each time.  See 1936 BTA LEXIS 584">*597 Chicago, Rock Island & Pacific Railway Co.,13 B.T.A. 988">13 B.T.A. 988, 13 B.T.A. 988">1035; affd., 47 Fed.(2d) 990; certiorari denied, 284 U.S. 618">284 U.S. 618; 375 Park Avenue Corporation,23 B.T.A. 969">23 B.T.A. 969; Pierce Oil Corporation,32 B.T.A. 403">32 B.T.A. 403, 32 B.T.A. 403">421. These holdings are also in accord with the respondent's consistent treatment of the question over a long period of years.  See I.T. 2347, C.B. VI-1, p. 86; G.C.M. 9674, C.B. X-2, p. 354; T.D. 4603, C.B. XIV-2, p. 58, 59. The ground upon which these decided cases stand is that the conversion of bonds into capital stock of the obligor is purely a capital transaction; that is, a readjustment of the obligor's capital structure, which does not result in either a deductible loss or a taxable gain.  The obligor does not pay out anything.  It merely readjusts its capital.  As we said in 375 23 B.T.A. 969">Park Avenue Corporation, supra, "Instead of suffering the outlay of money in excess of the amount borrowed, it created a new distribution of its shares, thus avoiding its fixed financial obligation and devoting the borrowed money to the ordinary risks of its business." 1936 BTA LEXIS 584">*598 34 B.T.A. 1191">*1197  In its briefs petitioner contended that the cases of 13 B.T.A. 988">Chicago, Rock Island & Pacific Railway Co., supra, and 37523 B.T.A. 969">Park Avenue Corporation, supra, were decided on premises and assumptions which are no longer tenable.  In support of this contention petitioner has cited and discussed several cases wherein a corporation taxpayer has dealt in its own stock in one way or another and has been held to have had gain or loss by reason of the transaction.  Not any of these cited cases involves the situation that is present here, and, in view of the decisions referred to above, it is believed that no useful purpose would be gained in discussing these several cases in this opinion. We hold, therefore, that the respondent was correct in disallowing the two items of $277,859.06 and $91,532.97.  2.  The second assignment of error is that respondent erred in not allowing as a deduction from petitioner's gross income for 1929 "expenses of $33,310 incurred by petitioner in said year in redeeming $978,000 par value of its First Mortgage 6% Convertible Gold Bonds." In the stipulation of facts filed by the parties it was agreed that during the fiscal1936 BTA LEXIS 584">*599  year 1929 petitioner paid Potter & Co., bankers, $33,310 "as a commission for underwriting 16,665 shares of its stock pursuant to the agreement" between petitioner and the bankers, which agreement is quoted in our findings of fact.  It is well settled that commissions paid for underwriting shares of a corporation's capital stock are not allowable as deductions from gross income.  See Alamo Coal Co.,31 B.T.A. 869">31 B.T.A. 869, 31 B.T.A. 869">875, and cases there cited; footnote 3 in Helvering v. Union Pacific Railroad Co.,293 U.S. 282">293 U.S. 282; Surety Finance Co. v. Commissioner, 77 Fed.(2d) 221; and Baltimore & Ohio Railroad Co. v. Commissioner, 78 Fed.(2d) 460. While it is true that this underwriting fee was incurred in connection with the retirement of $978,000 of petitioner's bonds by conversion into 16,665 shares of petitioner's common stock, nevertheless it seems to us that the $33,310 remains an underwriting fee, incurred and paid in connection with the issuance of shares of petitioner's common stock.  We do not see where there is any warrant to treat the expenditure differently from the ordinary underwriting fee incurred and paid1936 BTA LEXIS 584">*600  by a corporation in the sale or other disposition of its shares of capital stock.  Petitioner's contentions on this issue are denied.  3.  Both parties have departed from their original positions on the bonus issue and are now in agreement as to the fiscal year 1930 that $163,700 is the amount deductible as additional compensation for that year.  This is the amount that was stipulated as having been actually fixed and expended during that year.  The parties also stipulated that the amounts actually fixed and expended for the fiscal years 1928 and 1929 were $103,266.64 and 34 B.T.A. 1191">*1198  $161,540.89, respectively.  For the year 1928 the respondent has affirmatively alleged that petitioner's income for that year should be increased by $79,768.12 representing the difference between $183,034.76 and $103,266.64.  For the year 1929 the respondent in his brief concedes that petitioner's income for that year should be decreased by $45,000 representing the difference between $161,540.89 and $116,540.89.  Petitioner contends that, because the amounts actually fixed and expended for the fiscal years 1928 and 1929 were paid partly in stock and partly in cash, the amount that is deductible for1936 BTA LEXIS 584">*601  each year is measured by the fair market value of the stock at the time of payment, plus the amount of cash paid rather than the amount of the liability that was extinguished by the payment of the stock and cash.  In other words, it is petitioner's contention that, since the 2,000 shares of stock paid during the fiscal year 1928 had a fair market value of $106,250 on the date of payment, the amount allowable for that year is $106,250 plus the $2,000 in cash that was also paid during that year; and that, since the 2,000 shares of stock paid during the fiscal year 1929 had a fair market value of $214,000 on the date of payment, the amount allowable for the fiscal year 1929 is $214,000 plus the $14,500 in cash that was also paid during that year.  Petitioner relies principally upon our decision in Package Machinery Co.,28 B.T.A. 980">28 B.T.A. 980. In that case we stated the situation and our conclusion as follows: The respondent's position, we think, is premised upon an erroneous interpretation of the resolution authorizing the additional compensation.  The resolution provided that 25 per cent of the profits, after certain specified deductions had been made, should be set aside1936 BTA LEXIS 584">*602  to pay the officers, in certain proportions, additional compensation, payment to be made in petitioner's common stock at par.  Its effect was to create a liability on the part of the petitioner to its officers, not for a specific sum in terms of dollars and cents, but for a number of shares of stock of an aggregate par value equal to the profits in which the officers were entitled to participate.  In other words the amount set aside was not the petitioner's absolute liability, but merely the measure of the number of shares to be issued. Thus the petitioner's liability for additional compensation to officers for the taxable year involved was 931 shares of its common stock, plus fractional shares for which cash was paid.  This liability must, of course, for the purposes of the tax, be translated into dollars and cents; and we have consistently held that the translation must be based upon the fair market value of the stock as of the date of issue.  [Emphasis supplied.] Respondent contends that the doctrine of this case is inapplicable here, and further suggests that, since it is now settled that a corporation may realize gain or loss upon dealings in its own stock, depending upon1936 BTA LEXIS 584">*603  the real nature of the transaction involved, Allyne-Zerk Co.,29 B.T.A. 1194">29 B.T.A. 1194; affd., 83 Fed.(2d) 525, it would make no difference in the final result whether petitioner be allowed deductions for additional compensation paid its employees on the basis of the cost of 34 B.T.A. 1191">*1199  the 4,000 shares in question, or on the basis of the fair market value of such shares on the dates of payment, for the reason that if petitioner were allowed to deduct the compensation on the latter basis, it would at the same time realize taxable income measured by the difference between the cost to it of the 4,000 shares and the fair market value such shares on the date they were disposed of in payment of a liability equal to their fair market value, and that the taxable income thus resulting would exactly equal the increased deduction now claimed by petitioner.  We think the issue we have here to decide may be decided without consideration of this argument and solely by reference to the facts that were stipulated.  It is true that for the fiscal years 1928 and 1929 the bonuses were paid partly in stock and partly in cash.  But it is by no means clear, as petitioner contends, 1936 BTA LEXIS 584">*604  that petitioner's directors were to pay the bonuses in stock, as the resolution provided in the Package Machinery Co. case.  On the contrary, it was stipulated by the parties that during each of the fiscal years in question "the directors by informal action fixed the amount to be distributed" and that the amounts "so fixed and actually expended for this purpose" were $103,266.64 for the fiscal year 1928 and $161,540.89 for the fiscal year 1929.  Upon such a stipulation we can not find that the measure of petitioner's bonus liability was shares rather than an amount fixed in dollars and cents.  All that petitioner was obligated to pay as additional compensation for the years 1928 and 1929 were the amounts fixed by its board of directors of $103,266.64 and $161,540.89, respectively, and set up on its books as a liability, and that was all it actually expended for that purpose.  We know of no authority in law for allowing petitioner a greater deduction for business expenses than that for which it was legally obligated to pay, namely, $264,807.53, for the two years in question.  Furthermore, as a matter of fact, petitioner was out of pocket only the amount of $264,807.53.  It used1936 BTA LEXIS 584">*605  $248,307.53 of the amount fixes as additional compensation to purchase 4,000 shares of its own stock which it distributed to its employees, together with the balance of $16,500 in cash.  In this respect we think the instant case is distinguishable from 28 B.T.A. 980">Package Machinery Co., supra, and cases there cited, and requires a different treatment of the allowable deductions.  In the Package Machinery Co. case there was no absolute monetary liability from the corporation to the officers and employees to distribute any definite amount of monetary bonus.  The obligation to distribute was in certain shares of stock, which in that case figured 931 shares.  So we understand the cases cited and relied upon in the Package Machinery Co. case to mean.  In the instant case the amounts in the years which we have 34 B.T.A. 1191">*1200  before us were definitely fixed in dollars and cents by petitioner's board of directors and in one of the years, 1930, the amount fixed in dollars and cents was actually paid in cash, and in the other two years, to wit, 1928 and 1928, most of the amount fixed was expended by the corporation in the purchase of stock to be distributed to the employees.  We fail1936 BTA LEXIS 584">*606  to see where this latter method gives petitioner the right to a deduction greater than the amount which it had incurred on its books for the payment of bonuses and which it actually expended for that purpose.  It is our opinion, and we so hold, that petitioner is entitled to deduct from its gross income for the fiscal years 1928 and 1929, as additional compensation incurred and paid to its officers and employees, the amounts of $103,266.64 and $161,540.89, respectively.  As we have already stated, the parties are in agreement that the allowable deduction in this respect for the fiscal year 1930 is $163,700.  Reviewed by the Board.  Decisions will be entered under Rule 50.