Court Opinion

ID: 4618390
Source: CourtListenerOpinion
Date Created: 2020-11-21 02:38:30.879923+00
Date Added: 2024-06-11T07:55:27.475043
License: Public Domain

CHARLES WATSON HULL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Hull v. CommissionerDocket No. 11749.United States Board of Tax Appeals13 B.T.A. 299; 1928 BTA LEXIS 3268; September 10, 1928, Promulgated *3268 Held, that certain payments and credits on notes owing by the petitioner to a corporation of which he was a stockholder were dividends of a domestic corporation and subject to surtax in the taxable year.  David J. Shorb, Esq., for the petitioner.  Arthur H. Murray, Esq., for the respondent.  LANSDON *299  The respondent originally asserted a deficiency in income surtax for the year 1923, in the amount of $10,809.21.  At the hearing he was permitted to offer proof that the amount of $3,987 had been erroneously allowed as a deduction from the gross income of the petitioner for the taxable year.  The only issue is whether the amount of $49,787 credited to petitioner on the books of a corporation of which he was a stockholder at January 11, 1923, was a stock dividend.  FINDINGS OF FACT.  1.  During the taxable years 1919 to 1923, inclusive, petitioner, an individual residing at Omaha, Nebr., was a stockholder and director of the Lyman-Richey Sand Co.  2.  On or about March 1, 1919, the board of directors of the Lyman-Richey Sand Co. authorized an increase in its capital stock in the amount of 1,002 shares of stock.  3.  Of the foregoing*3269  issue of stock petitioner purchased 234 shares at a cost of $31,590.  4.  In consideration of the issue to him of such stock petitioner executed and delivered to the Lyman-Richey Sand Co. his note for $31,590, said note being dated March 1, 1919, and having attached thereto an assignment to the Lyman-Richey Sand Co. of petitioner's right to receive dividends declared by that corporation during the indebtedness to it of petitioner.  5.  Under date of February 17, 1920, the board of directors of the Lyman-Richey Sand Co. authorized an increase of its capital stock in the amount of 1,498 shares.  *300  6.  Of the said 1,498 shares petitioner purchased 458 shares for the amount of $45,800.  7.  In consideration of the issue to him of the said 458 shares of stock petitioner executed and delivered to the Lyman-Richey Sand Co. his note in the amount of $45,800, said note being dated March 1, 1920, and having attached thereto an assignment to the Lyman-Richey Sand Co. of petitioner's right to receive dividends declared by that corporation during the indebtedness to it of petitioner.  8.  The notes of petitioner were affixed to the certificates of stock and remained in the possession*3270  of the Lyman-Richey Sand Co. until on and after January 2, 1923.  9.  The said notes dated March 1, 1919, and March 1, 1920, provided that annual payments on the principal amount thereof should be made by petitioner.  10.  Payments on account of the notes dated March 1, 1919, and March 1, 1920, were made during the years 1920, 1921, and 1922.  11.  On December 31, 1922, petitioner was indebted to the Lyman-Richey Sand Co. on account of the note dated March 1, 1919, in the amount of $20,475, and on account of the note dated March 1, 1920, in the amount of $29,312, a total indebtedness of $49,787.  12.  On November 21, 1922, the board of directors of the Lyman-Richey Sand Co. passed a resolution authorizing the declaration of a 40 per cent dividend to be paid at the convenience of the company on stock of record January 2, 1923.  13.  Petitioner's share of the said 40 per cent dividend amounted to $61,120.  14.  Said amount of $61,120 was credited on January 2, 1923, to petitioner's personal account, and on the same day his indebtedness for the two notes referred to above was liquidated.  15.  This liquidation of the two notes in question was effected by crediting petitioner's*3271  personal account with $61,120 and by debiting was paid to petitioner by check on January 11, 1923, and debited to his personal account.  17.  In filing his income-tax return for the taxable year 1923 petitioner reported dividends received from the Lyman-Richey Sand Co. in the amount of only $11,333.  18.  In determining the deficiency tax in controversy respondent increased the amount of dividends reported in petitioner's return by $49,787, representing the difference between the amount of $11,333 received during 1923 from the Lyman-Richey Sand Co. and the amount of dividends credited to his account on the books of that corporation, namely $61,120.  *301  19.  During the year 1923 petitioner was indebted to the Lyman-richey Sand Co. only on account of the two notes.  He paid no interest on account of such notes to the Lyman-Richey Sand Co. during the year 1923.  20.  In his return for the taxable year 1923 petitioner deducted on account of interest paid the sum of $12,008.36.  21.  In his supplemental report the revenue agent who examined petitioner's return for the taxable year 1923 increased the amount of interest paid and deducted in petitioner's return by the amount*3272  of $3,987.  22.  At the time of his examination the revenue agent knew of the existence of only the note for $45,800, and assumed that the debit of $49,787 in petitioner's personal account on the books of the Lyman-Richey Sand Co. represented a debit of the note for $45,800 and interest of $3,987.  23.  Upon the assumption that the debit of $49,787 appearing in petitioner's personal account represented petitioner's indebtedness upon his note of $45,800 and interest thereon, the examining officer increased the deduction reflected on petitioner's return for interest paid during 1923 by the amount of $3,987.  OPINION.  LANSDON: The evidence discloses that at March 1, 1919, and February 17, 1920, the petitioner purchased shares of stock of the Lyman-Richey Sand Co. and gave his notes therefor in the respective amounts of $31,590 and $45,800.  The stock certificates representing such purchases were attached to the notes as collateral to secure the payment thereof, and dividends accruing to the petitioner by reason of such purchases and stock ownership were assigned to the corporation to be applied to the principal of the notes.  Prior to January 1, 1923, the petitioner was credited*3273  with certain payments on such notes which reduced his obligations to the amount of $49,787 at that date.  By regular corporate action on November 21, 1922, the Lyman-Richey Sand Co. declared a dividend of 40 per cent on its capital stock outstanding at January 2, 1923.  By this action the petitioner at that date became entitled to receive a dividend from such company in the amount of $61,120.  He received this amount in the taxable year in two payments, viz, cash in the amount of $11,333 and a credit against his indebtedness to the corporation for stock as set forth above in the amount of $49,787.  The petitioner contends that the credit of $49,787 should be regarded as part of a stock dividend transaction and therefore not taxable under the decision of the Supreme Court in , *302  and several other cases.  In our opinion there is nothing in the record to support this theory.  At November 22, 1922, the corporation had surplus and undivided profits more than equal to the dividend declared.  The fact that a substantial part of its assets consisted of bills receivable owing to it by its own directors and shareholders did not*3274  hinder, but rather facilitated the distribution of the dividends declared since it made it unnecessary to borrow funds or convert inventories or other property into cash for such purposes.  It is hardly tenable that in March of 1919 and 1920 the corporation declared and issued stock dividends against surplus that could then be foreseen as resulting from future profits.  Stock dividends are not charges against future earnings, but against surplus already accumulated.  The simple facts here are that the petitioner purchased certain shares of stock which were issued in his name, gave his notes therefor with the stock certificates attached as collateral security, and later paid his notes out of the dividends received from the corporation.  The evidence is clear that the petitioner paid no interest to the corporation in the taxable year.  The amount of $3,987 was a part of the unpaid balance of the petitioner's notes.  Its allowance as a deduction from petitioner's income in the taxable year was erroneous and it should be added to income.  If the amount of $49,787 had been paid the petitioner in cash and he had then paid his indebtedness to the corporation and received his notes and*3275  shares of stock as evidence of such payment, there would have been no question of a stock dividend.  In effect this is what was done, even though a part of the payment took the form of bookkeeping entries which reduced the petitioner's obligations in the amount of $49,787, and correspondingly reduced the surplus account of the corporation.  In our opinion the petitioner received dividends from the Lyman-Richey Sand Co. in the taxable year, subject to surtax rates in effect at that time, in the amount of $61,120.  Decision will be entered under Rule 50.