Court Opinion

ID: 4615397
Source: CourtListenerOpinion
Date Created: 2020-11-21 02:32:16.187801+00
Date Added: 2024-06-11T07:54:56.574272
License: Public Domain

HOUSTON COTTON EXCHANGE BUILDING COMPANY, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Houston Cotton Exchange Bldg. Co. v. CommissionerDocket No. 103805.United States Board of Tax Appeals45 B.T.A. 53; 1941 BTA LEXIS 1189; September 5, 1941, Promulgated 1941 BTA LEXIS 1189">*1189  The petitioner issued first and second mortgage bonds in 1923, secured by mortgage contracts which were amended in 1933 and 1934 respectively.  On February 1, 1937, the petitioner called and retired the first mortgage bonds, borrowing money from banks for that purpose, and issued new bonds to the banks secured by a mortgage contract executed on February 1, 1937.  Each of the first mortgage contracts required petitioner to set aside annually its earnings and profits to retire the first mortgage bonds.  The second mortgage bonds were deposited with a trustee and on February 1, 1937, petitioner paid 20 percent of face value in cash and issued new bonds, secured by a new mortgage, to each of the old second mortgage bondholders.  Pursuant to the requirement of the 1937 first mortgage, the petitioner set aside in the taxable year, out of its earnings and profits, an amount equal to its adjusted net income to discharge the first mortgage bonds.  The first mortgage indenture of 1937 was the only contract prohibiting the payment of dividends.  Held, the only contract which required the petitioner to set aside its earnings and profits in the taxable year to discharge a debt or which prohibited1941 BTA LEXIS 1189">*1190  it from paying dividends was executed after May 1, 1936, and petitioner is therefore not entitled to credit under the provisions of section 26(c)(1) or (2) of the Revenue Act of 1936.  Charles Dillingham, Esq., for the petitioner.  Wilford H. Payne, Esq., for the respondent.  SMITH 45 B.T.A. 53">*54  This is a proceeding for the redetermination of a deficiency in income tax for the fiscal year ended January 31, 1938, in the amount of $5,069.76.  The deficiency results from the respondent's holding that petitioner is not entitled to a credit in computing the surtax on undistributed profits under section 26(c) of the Revenue Act of 1936.  The facts are substantially stipulated and we find them as stipulated.  Testimony of one witness was adduced at the hearing.  The material facts are set forth below.  FINDINGS OF FACT.  The petitioner is a Texas corporation with its principal office in Houston, Texas, and filed its return for the taxable year with the collector of internal revenue for the first collection district at Austin, Texas.  As of February 1, 1923, the petitioner executed a first mortgage and deed of trust, designating the St. Louis Union Trust1941 BTA LEXIS 1189">*1191  Co. as trustee, pursuant to which the petitioner issued its first mortgage bonds, in the principal amount of $1,000,000, secured by a mortgage on petitioner's real property.  The indenture provided that the mortgagor would make monthly deposits with the trustee to pay current taxes, insurance, interest, maturing principal bonds, and other charges - the monthly deposits to be one-twelfth of the estimated aggregate annual charges.  After payment of the monthly deposits, and after setting aside a sufficient sum to pay interest on any junior liens, the agreement provided for a "Net Rental Surplus Fund", into which petitioner was to pay its entire remaining net rentals.  "Net rentals" were defined as net earnings from the building and real estate less current operating expenses.  45 B.T.A. 53">*55  The "Net Rental Surplus Fund" was to be used only to purchase and retire bonds prior to maturity.  Deposits into the fund were to continue only until the aggregate value of bonds secured by the indenture had been reduced to $750,000.  Thereafter the surplus net rentals were to belong to the petitioner for its own use.  As of June 30, 1933, there were outstanding first mortgage bonds in the amount1941 BTA LEXIS 1189">*1192  of $530,000.  A supplemental indenture was executed, as of that date, with the consent of 97.8 percent of the holders of outstanding first mortgage bonds, extending the dates of maturity of all consenting bonds to February 1, 1938.  In addition, the 1933 agreement provided that all surplus revenues, after payment of interest and taxes, should be paid over to the trustee annually for a "principal sinking fund", to be used solely to retire the first mortgage bonds.  Except as modified by the 1933 supplement, the 1923 indenture remained in full force and effect.  The petitioner retained the power to retire bonds before maturity.  No provision in either the 1923 first mortgage, or the 1933 supplement thereto, expressly prohibited or restricted the payment of dividends.  On February 1, 1937, there remained outstanding and unpaid $409,000 in principal sum of the first mortgage bonds.  Prior to that date petitioner entered into negotiations with four Houston banks to obtain money for the purpose of retiring its first mortgage bonds, and on or before February 1, 1937, the banks deposited with the indenture trustee a sum equal to the aggregate of the unpaid principal and the interest due1941 BTA LEXIS 1189">*1193  on February 1, 1937.  On February 1, 1937, the holders of the outstanding first mortgage bond certificates surrendered them to the trustee, and were paid and satisfied in full, both principal and interest.  On the same day the petitioner issued, to the same four banks, $500,000 of new first mortgage bonds, carrying 4 1/2 percent interest, secured by a deed of trust and mortgage on petitioner's real property, naming the South Texas Commercial National Bank of Houston as trustee.  The amount paid by the banks, in excess of that used to retire the old first mortgage bonds, was used by the petitioner to pay interest on the second mortgage bonds, plus certain other costs.  The new trust indenture, dated February 1, 1937, was substantially similar to that of 1923 and the 1933 supplement thereto.  It required the petitioner to deposit its entire surplus net earnings with the trustee each month for the sole purpose of retiring the new first mortgage bonds.  The only material difference was that the 1937 indenture contained a provision expressly prohibiting payment of dividends until all first mortgage bonds were fully paid off and discharged.  The 1937 indenture also contained a provision1941 BTA LEXIS 1189">*1194  stating that the intent and purpose of the paragraph calling for the setting aside 45 B.T.A. 53">*56  of all surplus earnings and profits to retire the bonds was to "continue, renew and carry forward in full force and effect all of said terms and provisions of said first lien deed of trust [1923] as amended * * * setting aside as security for the payment of all outstanding and unpaid first lien bonds all net earnings after the payment of interest and taxes and the company's agreement that no dividends shall be paid until all of * * * outstanding bonds are fully paid." The indenture of 1937 constituted a new contract, and the 1923 indenture and its supplement were no longer effective after February 1, 1937.  During the taxable year ended January 31, 1938, petitioner paid on the principal of its outstanding first mortgage bonds, issued under the 1937 indenture, not less than $26,628.84 out of its earnings and profits for that year, which is the amount of the adjusted net income determined by the respondent for that taxable year.  As of February 1, 1923, the petitioner executed a second mortgage deed of trust, issuing bonds in the principal sum of $375,000, secured by a second mortgage1941 BTA LEXIS 1189">*1195  on its property.  The bonds were to mature on February 1, 1938, unless paid prior to maturity.  The second mortgage indenture of 1923 did not contain any provision expressly dealing with the payment of dividends, nor did it contain any provisions requiring any amount to be paid, or set aside, out of earnings and profits to discharge a debt.  On April 5, 1934, a supplemental second mortgage agreement was executed by petitioner, which provided for a reduction in the interest rate on the second mortgage bonds and further provided that such interest would be paid only when earned under the terms of the first mortgage supplemental agreement.  On or after August 3, 1936, the holders of the second mortgage bonds deposited their bonds with the First National Bank of Houston, pursuant to an agreement between that bank and the petitioner whereby the bondholders agreed to accept not less than 20 percent of the face value of the bonds, plus new 4 1/2 percent second mortgage bonds, to be issued in amounts equaling 80 percent of the face value of the old bonds.  The agreement was carried out under a second mortgage and deed of trust dated February 1, 1937.  In the taxable year 1938 petitioner1941 BTA LEXIS 1189">*1196  set aside the sum of $11,506 out of its earnings and profits for that year as interest on the new second mortgage bonds.  In the taxable year petitioner did not pay or set aside any part of its earnings to discharge the principal of any second mortgage bonds.  The 1937 second mortgage indenture did not contain any provision expressly dealing with the payment of dividends, nor did it contain 45 B.T.A. 53">*57  any provision expressly dealing with the disposition of earnings and profits for the taxable year and requiring the same, or any portion thereof, to be paid or set aside to discharge a debt.  OPINION.  SMITH: The petitioner claims that it is entitled, in computing the surtax on its undistributed profits for the fiscal year ended January 31, 1938, to a credit under section 26(c)(1) or (2) of the Revenue Act of 1936, the material provisions of which are as follows: 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 adjusted1941 BTA LEXIS 1189">*1197  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.  * * * (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 for the discharge of a debt, 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.  The only written contract of the petitioner now before us which prohibited1941 BTA LEXIS 1189">*1198  the payment of dividends or required the setting aside of earnings or profits to discharge a debt during the taxable year was the first mortgage indenture executed on February 1, 1937.  Such a contract does not fall within the provisions of section 26(c) because it was not executed prior to May 1, 1936.  However, the petitioner asserts that we should carry forward into the 1937 indenture the provisions of the 1923 indenture and the supplement thereto, to hold that the payment of dividends and the setting aside of earnings were controlled by a written contract executed prior to May 1, 1936.  The 1923 first mortgage and supplement and the 1923 second mortgage and supplement do not contain any provision expressly prohibiting the payment of dividends.  It is, therefore, clear that no credit is allowable under section 26(c)(1), even if petitioner should be sustained in its contention that we should carry forward the provisions of the old indentures.  Respondent is sustained on this issue.  45 B.T.A. 53">*58  The petitioner's second contention is that it is entitled to a credit under section 26(c)(2) for the reason that it set aside its earnings and profits for the taxable year pursuant to the1941 BTA LEXIS 1189">*1199  requirements of a written contract.  To bring itself within the grace of section 26(c)(2) the taxpayer must prove a written contract, executed prior to May 1, 1936, which requires the payment or the setting aside of earnings to discharge a debt incurred on or before April 30, 1936.  We may assume, without deciding the question, that this petitioner's debt, in existence in the taxable year, was incurred on or before April 30, 1936.  . However, the second condition imposed by the statute remains unsatisfied, for the contract here in question was executed after May 1, 1936.  The Board, in the Sun Pipe Line Co. case, supra, was called upon to construe the phrase "indebtedness incurred prior to January 1, 1934" in section 351(b)(2)(B) of the Revenue Act of 1936, as amended by section 355(b) of the Revenue Act of 1937.  After the statutory date the petitioner had refinanced its old bonds by an arrangement substantially similar to that made by the present petitioner on February 1, 1937.  The Board there held that the new debt was incurred prior to the statutory date, as it was not new in the economic sense, but merely replaced1941 BTA LEXIS 1189">*1200  the old indebtedness.  The statute there construed did not contain any reference to the execution date of a contract.  It must be remembered that the debt and the contract mentioned in section 26(c)(2) are two different and independent things, and Congress has set forth a separate date to be used in the treatment of each one.  It would be unwarranted for us to disregard the plain meaning of the language used in the statute.  We do not find in either of the second mortgage agreements any provisions expressly dealing with the disposition of earnings and profits and requiring any portion thereof to be paid in discharge of a debt incurred prior to May 1, 1936, or to be set aside for that purpose.  The 1934 supplemental second mortgage indenture provides that interest on the bonds shall be payable "if and when earned, under the terms * * * of the First Mortgage Supplemental Agreement." This is the only clause to which petitioner has directed our attention in any of the second mortgage deeds, and clearly it does not expressly deal with the disposition of earnings and profits.  It is not necessary to go into that question, however, because, as we said with respect to the first mortgage1941 BTA LEXIS 1189">*1201  contracts, the provisions of the 1923 second mortgage deed, and its supplement, can not be carried forward into the 1937 second mortgage deed.  Furthermore, no part of petitioner's earnings were set aside in 1938 to pay principal on the second mortgage bonds.  45 B.T.A. 53">*59  We hold that in the taxable year the petitioner was not required by a written contract executed prior to May 1, 1936, to pay or set aside its earnings and profits, or any part thereof, to discharge a debt.  The petitioner has urged that its position is supported by . We do not agree, for the reason that the Sutcliffe case is distinguishable on its facts.  There the original contract continued in effect, and was not discharged by a second contract which was executed after the statutory date and which merely modified the original contract. , also involved a contract which, although executed after the statutory date, merely modified the original contract, which continued in full effect so that its restrictive provisions controlled rather than the provisions of the new contract. 1941 BTA LEXIS 1189">*1202 Decision will be entered for the respondent.