*72 Decisions will be entered under Rule 50.
Petitioner, Kaufmann Department Stores Securities Corporation, in 1928 executed a collateral trust agreement containing provisions (a) prohibiting the payment of dividends except in shares of stock of the company, only common shares being authorized and all having been issued, (b) requiring payment, into the sinking fund, of certain amounts and additional amounts equal to the total net income for specified periods, and (c) granting petitioner the option to purchase its notes and deposit them with trustee in lieu of sinking fund deposits. In 1938, petitioner, Kaufmann Department Stores, Inc., under merger and recapitalization plan, assumed the liabilities and distributed the stock received in exchange under the plan, direct to stockholders of petitioner, Kaufmann Department Stores Securities Corporation. Held:
(1) Petitioner was not entitled to credit either under section 26 (c) (1) or (2) of the Revenue Act of 1936.
(2) The year in which the petitioner purchased its notes rather than the year they were surrendered to the trustee controls the credit that may be taken under section 355 (b) of the Revenue Act of 1937.
(3) Petitioner, *73 Kaufmann Department Stores, Inc., is liable as transferee for the contested tax deficiencies of petitioner, Kaufmann Department Stores Securities Corporation, as redetermined under Rule 50.
*657 Docket No. 106133 involves the redetermination of deficiencies in income taxes for the years 1936 and 1937 in the respective amounts of $ 123,245.22 and $ 91,236.03; also a deficiency in personal holding company surtax for the year 1937 in the amount of $ 265,163.29. Docket No. 106753 involves transferee liability for the total of those deficiencies, aggregating $ 479,644.54.
The issues are (1) whether petitioner, Kaufmann Department Stores Securities Corporation, is entitled to a credit for the taxable years 1936 and 1937 in computing the surtax on its undistributed profits under section 26 (c) (1) or (2) of the Revenue Act of 1936; (2) whether, as a personal holding company, it is entitled to the benefit of section 355 (b) of the Revenue Act of 1937; (3) whether petitioner, Kaufmann Department Stores, Inc., *74 is liable as transferee for these tax deficiencies with interest thereon.
A further issue, whether petitioner, Kaufmann Department Stores Securities Corporation, was entitled to a deduction for state franchise taxes for the year 1937, and deductions of $ 1,772.88 and $ 43.13 representing state corporate loans taxes for the years 1936 and 1937, was raised by amended petition. The respondent has stipulated the allowance of these deductions.
The cases were submitted on a formal stipulation of facts, together with exhibits. Each petitioner filed its respective tax returns for the years involved with the collector for the twenty-third district of Pennsylvania at Pittsburgh, Pennsylvania.
FINDINGS OF FACT.
The petitioner, Kaufmann Department Stores Securities Corporation (hereinafter called "Securities"), was organized under the laws of the State of Delaware, with its principal office located at Fifth Avenue and Smithfield Street, Pittsburgh, Pennsylvania. It is a personal holding corporation. Its total authorized capital stock was 100,000 shares of no par value -- all of its authorized capital stock was issued and outstanding from date of its incorporation on February 25, 1925, until*75 February 18, 1936, when 9 shares were acquired by purchase and on December 19, 1936, when 15 shares were acquired in exchange for 30 shares of the capital stock of Kaufmann Department Stores, Inc., hereinafter called "Stores" Securities had no charter authority to issue any additional stock.
*658 On or about June 15, 1928, petitioner, Securities, executed a collateral trust indenture to the Union Trust Co. of Pittsburgh, Pittsburgh, Pennsylvania, as trustee. Promissory notes, known as "Kaufmann Department Stores Securities Corporation Eight-Year 5 1/4% Collateral Trust Notes, Due June 15, 1936," were issued to the amount of $ 3,000,000. On June 10, 1936, $ 1,760,000 of said notes, held by various and numerous creditors of Securities, were outstanding and unpaid. The trustee had no funds in the sinking fund with which to pay the notes at maturity.
The trust indenture contained the following pertinent provisions:
Article III.
Particular Covenants of the Company.
Section 14. That the Company will not pay or declare any dividend, except dividends payable in shares of stock of the Company, or make any other distribution on its capital stock or to its stockholders, or purchase or*76 retire or otherwise acquire for a consideration, any shares of its capital stock, except out of the proceeds of additional stock issues.
* * * *
Article V.
Sinking Fund.
Section 1. The Company covenants and agrees that, semi-annually on the first day of May and on the first day of November in each year commencing with May 1, 1929, and ending with November 1, 1935, and also on February 1, 1936, it will pay to the Trustee at its principal office in the City of Pittsburgh, Pennsylvania, as a Sinking Fund for the retirement of Notes, the following respective sums:
| On May 1, 1929 | $ 62,231.25; |
| On November 1, 1929 | $ 62,231.25; |
| On May 1, 1930 | $ 62,081.25; |
| On November 1, 1930 | $ 62,081.25; |
| On May 1, 1931 | $ 61,931.25; |
| On November 1, 1931 | $ 61,931.25; |
| On May 1, 1932 | $ 61,781.25; |
| On November 1, 1932 | $ 61,781.25; |
| On May 1, 1933 | $ 61,631.25; |
| On November 1, 1933 | $ 61,631.25; |
| On May 1, 1934 | $ 61,481.25; |
| On November 1, 1934 | $ 61,481.25; |
| On May 1, 1935 | $ 61,181.25; |
| On November 1, 1935 | $ 61,181.25; |
| On February 1, 1936 | $ 135,885.94; |
that on May 1, 1929, it will pay to the Trustee, for the Sinking Fund, an additional sum in cash equal to the total net income of the Company for *77 the period from November 1, 1928, to May 1, 1929, inclusive, to the extent that the same is in excess of the fixed Sinking Fund payment payable on May 1, 1929 as hereinabove specified; and that semi-annually on each November first and May first *659 thereafter, until November 1, 1935, inclusive, it will pay to the Trustee, for the Sinking Fund, an additional sum in cash equal to the total net income of the Company for the six months' period ending on and including such November first or May first, as the case may be, to the extent that the same is in excess of the fixed Sinking Fund payment payable on said semi-annual date as hereinabove specified.
Section 2. However, the Company may from time to time purchase Notes at or below the redemption price thereof current at the time, including accrued interest to the date of purchase, and, upon filing with the Trustee an officers' certificate setting forth the serial numbers of such Notes and the respective dates and prices of purchase thereof, may surrender such Notes to the Trustee, with all unmatured coupons thereto attached, for cancellation, in lieu of the deposit, under the provisions of Section 1 of this Article, of cash in amount*78 equivalent to the aggregate purchase price so paid by the Company for the Notes so surrendered.
Section 3. Moneys deposited with the Trustee under the provisions of Section 1 of this Article shall constitute a Sinking Fund for the retirement by purchase or redemption of Notes, and may be applied by the Trustee to the purchase of Notes, at prices not exceeding the redemption price thereof current at the time, including interest accrued only to the date of purchase.
* * * *
Section 6. All Notes surrendered to or purchased by the Trustee, pursuant to the provisions of this Article, shall be forthwith cancelled by it, and such Notes, together with all Notes redeemed through operation of the Sinking Fund, shall thereafter be cremated by the Trustee, which shall deliver its certificate thereof to the Company; and no Notes shall be issued in lieu thereof.
* * * *
Article XII.
Amendment at Meetings of Noteholders.
Section 1. Amendments of this Indenture or of any indenture supplemental hereto, and of the rights and obligations of the Company or of the holders of the Notes and coupons, may be made in any respect except:
(a) the extension of the maturity of any Note or coupon,
(b) a reduction*79 in the rate of interest on any Note or
(c) any other modification in the terms of payment of principal of or interest on any Note,
* * * *
On June 6, 1936, the petitioner, Securities, sent to its noteholders the following notice:
NOTICE TO THE OWNERS OF EIGHT-YEAR 5 1/4% COLLATERAL TRUST NOTES DUE JUNE 15, 1936, OF KAUFMANN DEPARTMENT STORES SECURITIES CORPORATION.
The form in which Congress will finally pass the Revenue Bill of 1936 may seriously affect Kaufmann Department Stores Securities Corporation, and the present uncertainty in regard to the Revenue Bill of 1936 makes it impossible for us to arrive at a decision with regard to paying at maturity the outstanding Eight-Year 5 1/4% Collateral Trust Notes due June 15, 1936, of which you are an owner.
Under these circumstances the principal of these Notes will not be paid on June 15, 1936, the due date, but arrangements have been made for these Notes to be purchased at par upon presentation at the principal place of business of *660 The Union Trust Company of Pittsburgh, 439 Fifth Avenue, Pittsburgh, Pennsylvania, and for the payment of the transfer taxes involved in the sales.
The interest coupon due June 15, 1936, will be*80 paid at the office of the Trustee in the ordinary course. We shall appreciate your detaching said coupon and sending it through for collection.
We shall also appreciate your forwarding at once your Notes for sale as aforesaid, together with the letter of transmittal enclosed herewith.
Kaufmann Department Stores Securities Corporation
Edgar J. Kaufmann, President.
June 6, 1936.
An agreement dated June 10, 1936, was executed between the petitioner, Securities, and the Union Trust Co. of Pittsburgh, as trustee, which contained, inter alia, the following:
1. The maturity date of each of the Notes owned by a person consenting to this agreement is hereby extended to August 1, 1941. The Notes so extended shall bear interest at the rate of 4% per annum from June 15, 1936, payable semiannually on August 1 and February 1 in each year up to and including August 1, 1941. Both the principal of, and the interest on, the Notes so extended shall be payable in lawful money of the United States of America.
2. The interest payable on the Notes so extended shall be represented by eleven (11) coupons to be affixed to such Notes. * * * [The agreement then sets out in full the form of the coupons. *81 It then states that the note to which this coupon appertains was issued prior to January 1, 1934.]
3. The consent of the owners of the Notes to this agreement shall be evidenced by the presentation to the Trustee by such owners of their Notes for the endorsement thereon by the Trustee of a legend reading substantially as follows: * * * [The legend is then set forth in full.]
4. When the Notes are presented to the Trustee for the endorsement thereon of the foregoing legend, the Company will affix to the Notes Federal and Pennsylvania documentary stamps in the proper amount.
5. Artile [sic] III of this Indenture shall be, and hereby is, amended by the addition thereto of Section 19 worded as follows:
"Section 19. The Company covenants and agrees that while the Notes are outstanding it will not mortgage or pledge any of its current assets, except in the ordinary course of business, and the Company also covenants and agrees that while the Notes are outstanding it will vote against, and make every effort to prevent, the mortgaging or pledging by any of its subsidiaries of any current assets except in the ordinary course of business or of any interest in the property bounded by Fifth*82 Avenue, Cherry Way, Diamond Street and Smithfield Street in the City of Pittsburgh, Pennsylvania, or in the property bounded by Reedsdale Street, Sturgeon Street, South Avenue and Allegheny Avenue in the City of Pittsburgh, Pennsylvania."
Section 6 amends Article IV, section 2, of the indenture relating to redemption to the extent of not requiring notice of redemption to be published in daily newspapers published in Manhattan.
7. Section 1 of Article V of the Indenture shall be, and hereby is, amended to read as follows:
"Section 1. The Company covenants and agrees that semiannually on May 1 and November 1 in each year, commencing with May 1, 1937, and ending with May 1, 1941, it will pay to the Trustee at the latter's principal office in the City *661 of Pittsburgh, Pennsylvania, as a sinking fund for the retirement of Notes, the following respective sums on the following respective dates:
| On May 1, 1937 | $ 60,000 |
| On November 1, 1937 | 60,000 |
| On May 1, 1938 | 60,000 |
| On November 1, 1938 | 60,000 |
| On May 1, 1939 | 60,000 |
| On November 1, 1939 | 60,000 |
| On May 1, 1940 | 60,000 |
| On November 1, 1940 | 60,000 |
| On May 1, 1941 | 60,000 |
that on May 1, 1937, it will pay to the Trustee for*83 the sinking fund an additional sum in cash equal to the excess of the total net income of the Company for the period from November 1, 1936, to May 1, 1937, inclusive, over the fixed sinking fund payment payable on May 1, 1937, as hereinabove specified; and that semiannually on each November 1 and May 1 thereafter, up to and including May 1, 1941, it will pay to the Trustee for the sinking fund, an additional sum in cash equal to the excess of the total net income of the Company for the six months' period ending on and including such May 1 or November 1, as the case may be, over the fixed sinking fund payment due on said semiannual date as hereinabove specified."
8. Section 4 of Article V of the Indenture shall be, and hereby is, amended to read as follows:
"Section 4. Any sinking fund moneys, if in excess of Ten Thousand Dollars ($ 10,000), remaining in the hands of the Trustee on November 10 or on May 10 in any year, commencing with November 10, 1936, and ending with May 10, 1941, inclusive, shall be applied by it, upon the next ensuing December 15 or June 15, as the case may be, to the redemption, at the then current redemption price as fixed in Article IV hereof, of an amount of*84 Notes sufficient to exhaust, as near as may be, such moneys. Notes to such an amount shall be selected by the Trustee for redemption in the manner provided in Article IV hereof and notice shall be given by the Trustee to the Company, and the Company hereby irrevocably authorizes the Trustee, in the name of and at the expense of the Company, to give notice on behalf of the Company of the call of such Notes for redemption, all in the manner and with the effect in said Article IV specified; provided, however, that the Trustee shall not be required to take any such action or give any such notice unless theretofore indemnified by the Company against all costs and expenses in connection therewith."
9. Section 5 of Article V of the Indenture shall be, and hereby is, amended to read as follows:
"Section 5. In case the unexpended moneys in the sinking fund on May 10 or November 10 in any such year are less than Ten Thousand Dollars ($ 10,000), such moneys shall continue to be held by the Trustee to be applied to the purchase or subsequent redemption of Notes as herein provided."
10. Except as hereby modified, all the terms and provisions of the Indenture shall remain and continue to be in*85 full force and effect.
Under date of June 10, 1936, the Union Trust Co. of Pittsburgh and the Mellon National Bank of Pittsburgh, jointly and severally, entered into an agreement with Securities. This agreement contained, inter alia, the following pertinent provisions:
1. For One Dollar and other good and valuable considerations paid to them severally by the Securities Corporation, the receipt of which is hereby acknowledged, *662 the Trust Company and the Bank hereby severally covenant and agree with the Securities Corporation that they will severally in the respective amounts agreed upon by them purchase for cash, at the face value thereof, all Notes presented for sale at the principal place of business of the Trust Company, 439 Fifth Avenue, Pittsburgh, Pennsylvania, on or before June 15, 1936, and that they will present all Notes so purchased by them to The Union Trust Company of Pittsburgh, as Trustee, for the stamping thereon of an endorsement in substantially the form of the endorsement set forth in Paragraph 3 of "exhibit A". The Trust Company and the Bank also hereby severally covenant and agree with the Securities Corporation that they will each pay all transfer*86 taxes required to be paid in connection with the sales to each of them of the Notes to be purchased by each of them respectively pursuant to this agreement.
2. In consideration of the aforesaid several covenants of the Trust Company and the Bank, the Securities Corporation hereby covenants and agrees with each of them that it will on June 15, 1936, pay to each of them interest at the rate of 4% per annum from the respective dates of purchase to and including June 15, 1936, on all Notes purchased by the Trust Company and the Bank respectively prior to June 15, 1936, pursuant to this agreement. In consideration of the aforesaid several covenants of the Trust Company and the Bank, the Securities Corporation also hereby covenants and agrees with each of them that it will promptly, upon demand, reimburse the Trust Company and the Bank for all amounts paid by each of them respectively for transfer taxes in connection with the purchases of Notes by each of them on or before July 15, 1936. In consideration of the aforesaid several covenants of the Trust Company and the Bank, the Securities Corporation further hereby covenants and agrees with each of them that it will use for the payment*87 or retirement of Notes the cash which it now has on hand and its entire income for the period from June 15, 1936, to November 1, 1936, after deducting all interest paid or accrued up to and including October 31, 1936, and all taxes and expenses paid or accrued by it up to and including October 31, 1936. Any cash or income not applied to, or required for, these purposes at the close of business on October 31, 1936, shall be paid to The Union Trust Company of Pittsburgh, as Trustee, as an additional payment for sinking fund purposes.
On June 10, 1936, the Union Savings Bank of Pittsburg entered into an agreement with Securities. This agreement contained, inter alia, the following provisions:
1. For One Dollar and other good and valuable consideration paid to it by the Securities Corporation, the receipt of which is hereby acknowledged, the Bank hereby covenants and agrees with the Securities Corporation that it will purchase for cash, at the face value thereof all Notes presented for sale at the principal place of business of The Union Trust Company of Pittsburgh, 439 Fifth Avenue, Pittsburgh, Pennsylvania, after June 15, 1936, and on or before July 15, 1936, and that it will *88 present all Notes so purchased by it to The Union Trust Company of Pittsburgh, as Trustee, for the stamping thereon of an endorsement in substantially the form of the endorsement set forth in Paragraph 3 of "Exhibit A". The Bank also hereby covenants and agrees with the Securities Corporation that it, the Bank, will pay all transfer taxes required to be paid in connection with the sales to it of the Notes to be purchased by it pursuant to this agreement.
2. As part of the consideration for the aforesaid covenants of the Bank, the Securities Corporation hereby covenants and agrees with the Bank that it will promptly, upon demand, reimburse the Bank for all amounts paid by the Bank *663 for transfer taxes in connection with purchases of Notes by the Bank pursuant to this agreement.
The minutes of a special meeting of the board of directors of Securities held on June 10, 1936, contain the following:
Mr. E. J. Kaufmann presented to the meeting a copy of a proposed agreement with The Union Trust Company of Pittsburgh, Trustee under an Indenture dated June 15, 1928 between Kaufmann Department Stores Securities Corporation and The Union Trust Company of Pittsburgh, (a copy of the said*89 agreement being attached to these minutes and made a part hereof) amending said Indenture and extending the Eight-Year 5 1/4% Collateral Trust Notes for a period of five years from June 15, 1936.
Upon motion duly made and seconded it was unanimously resolved that the proper officers of the Corporation be and they hereby are authorized and directed to execute the said agreement and to do all other things they may deem necessary or advisable in order to comply with the provisions of the agreement.
Prior to the execution of the agreements of June 10, 1936, the Union Trust Co. of Pittsburgh and the Mellon National Bank of Pittsburgh owned respectively $ 132,000 and $ 38,000 par value of these notes. On or before June 15, 1936, the Union Trust Co. of Pittsburgh purchased from individual noteholders $ 842,000 par value of these notes for its own account and purchased for the account of the Mellon National Bank of Pittsburgh $ 462,000 par value of these notes. On and after June 15, 1936, the Union Savings Bank of Pittsburgh purchased $ 202,000 par value of the notes. The total par value amount owned or purchased by the three banks was $ 1,677,000. Each of the notes, aggregating $ 1,677,000, *90 was stamped with the legend as provided in the agreement between Securities and the Union Trust Co. as trustee, dated June 10, 1936. Notes in the amount of $ 83,000 par value held by individual holders were not stamped with the legend. These $ 83,000 of notes were subsequently purchased by the trustee with cash deposited by Securities. After the $ 1,677,000 par value of the notes was stamped, the Union Savings Bank sold $ 57,000 par value thereof to the Mellon National Bank and $ 145,000 par value thereof to the Union Trust Co. The above described notes were all the notes ever issued.
Securities did not declare or pay dividends of any kind upon its outstanding capital stock during the taxable years ending December 31, 1936, and December 31, 1937. In its income and excess profits tax returns for the years 1936 and 1937, it claimed and took as a credit for contracts restricting dividend payments under section 26 (c) of the Revenue Act of 1936 the following amounts: For the year ended December 31, 1936, $ 601,000, and for the year ended December 31, 1937, $ 465,000.
The respondent disallowed any credit under section 26 (c) in determining the deficiency.
*664 Securities returned*91 as income dividends for the year 1936, $ 690,444.75, and for the year 1937, $ 490,977.60, which were received as follows:
| 1936 | |
| Jan. 28 | $ 76,722.75 |
| Apr. 30 | 76,715.25 |
| July 31 | 76,715.25 |
| Oct. 28 | 76,715.25 |
| Dec. 15 | 383,576.25 |
| Total | 690,444.75 |
| 1937 | |
| Jan. 31 | $ 122,744.40 |
| Apr. 28 | 122,744.40 |
| July 28 | 122,744.40 |
| Oct. 31 | 122,744.40 |
| Total | 490,977.60 |
Throughout the years 1936 and 1937, Securities was a holding company within the meaning of Title IA of the Revenue Act of 1936, and as amended by the Revenue Act of 1937. On its personal holding company tax returns, Form 1120 H, which it filed for the years 1936 and 1937, it claimed and took as a credit against adjusted net income amounts as used or irrevocably set aside to pay or retire indebtedness of any kind incurred prior to January 1, 1934, as follows: For the year ended December 31, 1936, $ 601,000, and for the year ended December 31, 1937, $ 465,000.
Respondent in determining the deficiency under section 351 allowed a credit for the year ended December 31, 1936, of $ 1,898,000. No credit was allowed for the year ended December 31, 1937.
The books of Securities as of January 1, 1936, reflected outstanding *92 notes as follows:
| Authenticated notes outstanding | $ 1,898,000 |
| Less notes held in Treasury | 104,000 |
| Net note liability to creditors | 1,794,000 |
This note liabliity was retired between January 1, 1936, and December 16, 1938, by cash deposited with the trustee and the purchase of notes. The moneys thus used came from earnings and profits of the year in which so used.
The balance sheets of Securities for the years ending December 31, 1935, 1936, and 1937 were as follows:
| Dec. 31, 1935 | Dec. 31, 1936 | |||
| Assets | ||||
| Investments: | ||||
| 304,000 shares common stock Kaufmann | ||||
| Department Stores, Inc., at cost | $ 9,287,896.27 | $ 9,287,896.27 | ||
| 2,891 shares at cost -- 1935 | 62,578.90 | |||
| 2,861 shares at cost -- 1936-1937 | 61,929.40 | |||
| Sinking fund deposited with trustee | ||||
| of collateral trust notes | 3,268.87 | |||
| Cash in banks | 10,423.55 | 1,282.05 | ||
| Deferred charges: | ||||
| Unamortized note discount and expense | 4,155.80 | |||
| Organization expense | 787.65 | 787.65 | ||
| Total | 9,369,111.04 | 9,351,895.37 | ||
| Liabilities | ||||
| Capital stock: | ||||
| Authorized and issued -- 100,000 shs. common | ||||
| no par value -- note A | $ 6,309,117.44 | |||
| Less held in treasury, $ 1,514.16 | $ 6,307,603.28 | |||
| Eight-yr. 5 1/4 collateral trust notes due | ||||
| June 15, 1936: | ||||
| Issued | $ 3,000,000 | |||
| 1935 outstanding | 1,898,000 | |||
| Less held in treasury | 104,000 | |||
| 1,794,000.00 | ||||
| 1936 outstanding | 1,300,000 | |||
| Less held in treasury | 100,000 | |||
| Less cash on deposit with trustee | ||||
| to retire notes | 3,000 | |||
| 1,197,000.00 | ||||
| 1937 outstanding | 832,000 | |||
| Less held in treasury | 35,000 | |||
| Accrued interest on collateral trust | ||||
| notes | 39,243.75 | 19,950.00 | ||
| Reserve for taxes | 9,204.31 | 1,500.00 | ||
| Surplus | 1,217,545.54 | 1,825,842.09 | ||
| Total | 9,369,111.04 | 9,351,895.37 |
| Dec. 31, 1937 | |||
| Assets | |||
| Investments: | |||
| 304,000 shares common stock Kaufmann | |||
| Department Stores, Inc., at cost | $ 9,287,896.27 | ||
| 2,891 shares at cost -- 1935 | |||
| 2,861 shares at cost -- 1936-1937 | 61,929.40 | ||
| Sinking fund deposited with trustee | |||
| of collateral trust notes | |||
| Cash in banks | 42,205.43 | ||
| Deferred charges: | |||
| Unamortized note discount and expense | |||
| Organization expense | 787.65 | ||
| Total | 9,392,818.75 | ||
| Liabilities | |||
| Capital stock: | |||
| Authorized and issued -- 100,000 shs. common | |||
| no par value -- note A | |||
| Less held in treasury, $ 1,514.16 | $ 6,307,603.28 | ||
| Eight-yr. 5 1/4 collateral trust notes due | |||
| June 15, 1936: | |||
| Issued | $ 3,000,000 | ||
| 1935 outstanding | 1,898,000 | ||
| Less held in treasury | 104,000 | ||
| 1936 outstanding | 1,300,000 | ||
| Less held in treasury | 100,000 | ||
| Less cash on deposit with trustee | |||
| to retire notes | 3,000 | ||
| 1937 outstanding | 832,000 | ||
| Less held in treasury | 35,000 | ||
| 797,000.00 | |||
| Accrued interest on collateral trust | |||
| notes | 13,283.33 | ||
| Reserve for taxes | 4,200.00 | ||
| Surplus | 2,270,732.14 | ||
| Total | 9,392,818.75 |
Note A. -- The quoted market value at December 31, 1937, was $ 5,216,637.
*665 The income and surplus account*94 for the respective years ending December 31, 1935, 1936, and 1937, was as follows:
| Dec. 31, 1935 | Dec. 31, 1936 | Dec. 31, 1937 | ||
| Income -- dividends | $ 306,891.00 | $ 690,444.75 | $ 490,977.60 | |
| Deduct | ||||
| Fees of trustees, taxes, &c | 1,390.87 | 747.64 | 2,218.66 | |
| Interest on 5 1/4% collateral | ||||
| trust notes | 101,415.55 | 77,152.94 | 39,668.89 | |
| Discount and expenses on | ||||
| collateral trust notes | 10,259.17 | 4,155.80 | ||
| Interest on notes payable | 475.69 | 754.13 | ||
| Deduct 1936-1937: | ||||
| Provision for federal income | ||||
| taxes | 1,500.00 | 4,200.00 | ||
| Deduct 1936: | ||||
| Expenses in connection with | ||||
| extension of 5 1/4% | ||||
| collateral trust notes | 6,087.45 | |||
| Net income for year | 193,349.72 | 600,046.79 | 444,890.05 | |
| Add -- 1935: | ||||
| Discount on notes redeemed | 32,770.00 | |||
| Add -- 1936: | ||||
| Transfer to surplus of excess in | ||||
| reserve for taxes Dec. 31, 1936 | 7,585.10 | |||
| Discount on Treasury stock | ||||
| acquired | 664.66 | |||
| Surplus at Jan. 1, 1935 | 991,425.82 | |||
| Surplus at Dec. 31, 1935 | 1,217,545.54 | |||
| Surplus at Jan. 1, 1936 | 1,217,545.54 | |||
| Surplus at Dec. 31, 1936 | 1,825,842.09 | |||
| Surplus at Jan. 1, 1937 | 1,825,842.09 | |||
| Surplus at Dec. 31, 1937 | 2,270,732.14 |
The petitioner, Stores, is a *95 corporation organized under the laws of the State of New York, with its principal office at Fifth Avenue and Smithfield Street, Pittsburgh, Pennsylvania.
The two petitioners herein, together with the Investment Land Co., Luke Swank, Inc., and Sampeck Clothes, Inc., subsidiary or affiliated corporations, entered into a nontaxable joint plan of merger and recapitalization, effective as of December 19, 1938. A certificate of consolidation was duly filed with the Secretary of State for the State of New York on the 17th day of December 1938. Copies of the articles of merger were filed with the Secretary of State of Delaware and with *666 the Department of State of the Commonwealth of Pennsylvania on the 17th and 19th days of December 1938, respectively.
On December 15, 1938, Securities was the owner of 306,861 shares of the old common stock of petitioner, Stores. Under the plan of merger and recapitalization Securities received new shares in the new company in exchange for the old shares, as follows: 306,861 shares of new common, and 30,686.1 shares of new 5% cumulative preference stock.
On and after December 15, 1938, there were 99,973 shares of the common stock of Securities outstanding*96 and owned by its shareholders. Pursuant to the merger agreement, each of its shareholders received pro rata in proportion to his respective holdings, 0.3069438 of a share of new preference stock and 3.069438 of a share of the new common stock of the petitioner, Stores.
The balance sheet of Securities as of the effective date of the merger and consolidation in December 1938 showed assets and liabilities as follows:
| ASSETS | ||
| Investments: | ||
| 304,000 shares common stock of Kaufmann Department | ||
| Stores, Inc., at original book value | $ 9,287,896.27 | |
| 2,861 shares, at cost | 61,929.40 | |
| Total | 9,349,825.67 | |
| Current assets: | ||
| Cash in banks | * 5,428.35 | |
| Deferred charges: | ||
| Organization expenses | 787.65 | |
| Total | 9,356,041.67 | |
| Capital stock: | ||
| LIABILITIES | ||
| Authorized and issued -- 100,000 shares of common stock | ||
| of no par value | $ 6,309,117.44 | |
| Less 27 shares in treasury | 1,589.16 | |
| Total | 6,307,528.28 | |
| Current liabilities -- reserve for taxes | 16,500.00 | |
| Paid-in capital | 449,999.00 | |
| Surplus | 2,582,041.39 | |
| Total | 9,356,041.67 |
*97 The petitioner, Securities, on June 15, 1936, had sufficient assets to discharge its liability as to principal and interest on the then outstanding 5 1/4% collateral trust gold notes due June 15, 1936.
The petitioner, Stores, under the merger and recapitalization plan effective December 19, 1938, asumed the liabilities of the petitioner, Securities.
*667 OPINION.
The petitioner, Securities, contends that it is entitled to the larger of the credits under sections 26 (c) (1) and 26 (c) (2) of the Revenue Act of 1936. 1 Credit is claimed under both of these sections by reason of the provisions of the collateral trust agreement executed June 15, 1928, and referred to in our findings. Petitioner contends that the subsequent agreement of June 10, 1936, was merely an amendment extending the period of the original contract of June 15, 1928, reducing the interest rate and sinking fund requirements of that instrument; that the original contract, so amended, was in full force and effect in the taxable years; that it expressly dealt with and restricted the payment of dividends within the purview of section 26 (c) (1), and also expressly dealt with the disposition of earnings of the taxable*98 years and required them to be paid or irrevocably set aside, within the taxable year in which earned, in or for discharge of indebtedness incurred prior to May 1, 1936, within the purview of section 26 (c) (2).
*99 Respondent contends, first, that the contract of June 10, 1936, did not have the effect of merely amending the existing contract but was a new contract which embodied by reference some of the terms of the former contract. It is then argued that the indebtedness paid in the taxable years was incurred under the new contract and consequently no credit is allowable under section 26 (c). His second contention is that, even though the controlling contract was executed and the indebtedness incurred prior to May 1, 1936, there was no restriction imposed by the contract of the character specified by section 26 (c) as entitling petitioner to either one of the credits claimed.
As to respondent's first contention we do not agree that a new indebtedness was created by the contract of June 10, 1936. The transaction did not in fact extinguish the old debt created in 1928. Securities paid nothing. The only payments were by the banks and these were in the acquisition of the notes of the petitioner which remained outstanding and unpaid. It was the intention of the parties that the old debt not be extinguished. They intended only that its maturity date be extended, and this is what was done. *100 Respondent calls attention to the fact that Securities had the assets and credit necessary to obtain funds sufficient to have paid the notes at maturity. The answer to this is that they did not pay the debt, but, on the other hand, procured an extension of the time for payment from the then creditors. *668 This it had a perfect right to do and the fact that a tax saving was the inducing motive for this action does not deprive it of that right. Gregory v. Helvering, 293, U.S. 465; Bullen v. Wisconsin, 240 U.S. 625">240 U.S. 625; Chisholm v. Commissioner, 79 Fed. (2d) 14; Marshall v. Commissioner, 57 Fed. (2d) 633.
Having reached the conclusion that the old debt was not extinguished, the question as to whether the contract of June 10, 1936, was a new and separate agreement or merely an amendment of the existing contract of June 15, 1928, appears to be immaterial, since it unquestionably carried the same restrictive terms as the latter contract and Securities was bound by such restrictions continuously from June 15, 1928, to and including the taxable years with respect to the unextinguished*101 indebtedness. The conditions as to time of execution of the restrictive agreement prescribed by section 26 (c) have, therefore, been met. Haskelite Manufacturing Corporation, 44 B. T. A. 636; affd., 128 Fed. (2d) 902; Commissioner v. Sun Pipe Line Co., 126 Fed. (2d) 888; Commissioner v. Struthers Iron & Steel Co., 132 Fed. (2d) 995.
This brings us to the second contention by the respondent, that other conditions of the restrictive agreement here do not meet the requirements of section 26 (c)(1) or (2). By section 14 of article III of the trust indenture it is provided that Securities "* * * will not pay or declare any dividend, except dividends payable in shares of stock of the Company * * *." This provision meets the requirement of section 26 (c)(1) that the contract expressly deal with the payment of dividends but, on the other hand, it does not prohibit but expressly permits the payment of dividends in stock.
In answer to this Securities points out that it was only authorized by its charter to issue common stock and the shares so authorized were already*102 issued. It argues that this condition, together with section 14 of the trust indenture, resulted in its being precluded from paying a dividend of any character. The argument, however, disregards the requirement that the prohibition be embodied in the contract under which the credit is claimed. We cannot go beyond the contract and supply the prohibition from a charter restriction. Helvering v. Northwest Steel Mills, 311 U.S. 46">311 U.S. 46. Nor does it avail the *669 petitioner that the restriction exists by reason of some condition neither fixed nor controlled by the contract, and especially a restriction which is subject to change or removal by action on the part of the petitioner. United States v. Dakota Tractor & Equipment Co., 125 Fed. (2d) 20. The contract upon which petitioner relies does not prohibit it from charter amendment. The Corporation Law of the State of Delaware (ch. 65, art. 1, sec. 26) permits such amendment at any time.
The further, and strong, argument is made that even if the payment of a dividend in stock were possible it would be a nontaxable dividend and that we should construe section 26*103 (c) (1) so as to limit the meaning of the word "dividends" to "taxable dividends." It is, of course, settled that a common stock dividend on common stock does not constitute income to the recipient. Eisner v. Macomber, 252 U.S. 189">252 U.S. 189; Helvering v. Griffiths, 308 U.S. 355">308 U.S. 355; Helvering v. Sprouse, 318 U.S. 604">318 U.S. 604. But here we are dealing with a statute granting a special credit in the nature of a deduction. Such a statute requires strict construction and the taxpayer must show exact compliance with its conditions. Helvering v. Ohio Leather Co., 317 U.S. 102">317 U.S. 102; Helvering v. Northwest Steel Mills, supra.Although Congress there used the word "dividends" without qualifying or limiting its meaning, yet in some of the first cases arising under the cited section we accepted the construction of the statute for which petitioner contends. Paraport Theatre Leasing Corporation, 44 B. T. A. 108; Oswego Falls Corporation, 46 B. T. A. 801; reversed on another ground, Commissioner v. Oswego Falls Corporation, 137 Fed. (2d) 173.*104 See also Bates Valve Bag Corporation v. Higgins, Fed. Supp. (June 24, 1943) However, in later decisions we have held that where the contract did not forbid or expressly permitted the payment of "stock dividends," without limitation of that term to those taxable or nontaxable, and taxable stock dividends could therefore have been paid without violating the terms of the contract, the requirements of section 26 (c) (1) were not met. This view has received approval by decisions of several of the Circuit Courts. Oregon Pulp & Paper Co., 47 B. T. A. 772; Helms Bakeries, 46 B. T. A. 308; Valentine-Clark Corporation, 46 B. T. A. 821; affd., 137 Fed. (2d) 481; United States v. Dakota Tractor & Equipment Co., supra;Commissioner v. Columbia River Paper Mills, 127 Fed. (2d) 558; Northwestern Steel & Wire Co., 1114">1 T. C. 1114. This, of course, is merely an application of the rule that the restriction must be one effected by the contract itself and not by extrinsic conditions. *105 In such latter case the payment of a taxable stock dividend might be a violation of a charter provision or a statute, but it would not be a violation of a contract within the statute. We adhere to this rule and hold that this petitioner is not entitled to credit under section 26 (c) (1).
*670 The credit claimed under section 26 (c)(2) is upon the contention that the sinking fund requirements of the trust indenture, as set out in our findings, obligated Securities to set aside and pay from its earnings of each of the taxable years the amounts paid in such year. Upon examination of the conditions laid down by that instrument, we do not agree. There is nothing in the instrument expressly requiring the setting aside or the use of income of the current year to pay the sinking fund installments nor are the amounts to be paid computed as a percentage of earnings. Of the total amount payable in each year, $ 240,000 was to be paid even if there were no earnings. The additional amount payable was to be fixed by the earnings from November of the prior year to the same month of the current year. Moreover, Securities is given the right to buy in its outstanding notes without restriction*106 on the source of the funds so used and turn in these notes to the trustee in satisfaction of its sinking fund obligation. Cf. Fox River Paper Co., 44 B. T. A. 986; Northwestern Steel & Wire Co., supra.We hold that this petitioner is not entitled to the credit claimed under section 26 (c)(2).
The next issue is whether petitioner, Securities, is entitled to credit for the year 1937 under section 351 (b)(2)(B) of the Revenue Act of 1936 as amended by section 355 (b) of the 1937 Act. The material part of these sections is set forth in the margin. 2 On its personal holding company tax return Securities claimed a credit against adjusted net income of the sum of $ 465,000, as having been used or irrevocably set aside to pay or retire indebtedness incurred prior to January 1, 1934.
*107 The respondent disallowed any credit for that year and determined a deficiency in surtax in the amount of $ 265,163.29. In arriving at the amount of the credit, Securities included two notes purchased August 4, 1936, and December 16, 1936, in the respective amounts of $ 40,000 and $ 60,000, because the notes were not surrendered to the trustee until April 30, 1937. It did not include in its claimed credit a note of $ 35,000 purchased on May 1, 1937, and surrendered to the trustee on December 1, 1938. The respondent contends that the notes purchased and cash surrendered to the trustee were not made to retire *671 an indebtedness incurred prior to January 1, 1934; that, in any event, the two notes purchased in 1936 aggregating $ 100,000 could only be taken as a credit in 1936 and not in 1937. The respondent argues that the indebtedness incurred under the original trust indenture of June 15, 1928, which became due on June 15, 1936, was discharged and that a new debt was created under the agreement of June 10, 1936. We have already held, however, that the original debt was not discharged. Nevertheless, we are convinced that the date of purchase of the notes and not the date*108 of their surrender to the trustee controls the year in which credit can be taken. When the corporation purchased its own notes it thereby reduced its indebtedness. See Transylvania R. Co. v. Commissioner, 99 Fed. (2d) 69. Securities improperly took credit in 1937 for the sum of $ 100,000, but is properly entitled to an additional credit of $ 35,000. In computing its adjusted net income for 1937, the credit allowable under the applicable sections of the revenue act is $ 400,000.
The remaining issue is whether the petitioner, Stores, is liable for the deficiencies found with interest, as transferee. Liability is denied on the ground that under the merger agreement it exchanged its own new stock for its old stock. It asserts that the stockholders of Securities received the assets and are the real transferees. We are concerned only with Stores. Article IV, section 7 B of the agreement of merger provides that the shares of preference and common stock received in exchange for the old common shares of Stores, owned by Securities, shall be distributed among the stockholders of Securities pro rata in proportion to their respective holdings of stock*109 in Securities. Such distribution left Securities without assets to discharge its indebtedness. Obviously to meet this situation it was provided in article VII of the articles of merger that "* * * all rights of creditors and all liens upon the property of any of the constituent corporations shall be preserved unimpaired * * *; and all debts, liabilities and duties of any of the constituent corporations shall forthwith attach to the Surviving Corporation [petitioner transferee] and may be enforced against it to the same extent as if * * * incurred or contracted by it * * *" The distribution to the stockholders of Securities, and the assumption of liabilities by Stores, imposed a legal and equitable liability upon the transferee. Many decisions so hold. We cite but two. Helvering v. Wheeling Mold & Foundry Co., 71 Fed. (2d) 749; certiorari denied, 293 U.S. 603">293 U.S. 603; Shepard v. Commissioner, 101 Fed. (2d) 595, 599; certiorari denied, 307 U.S. 639">307 U.S. 639.
We hold the petitioner, Stores, is liable as transferee for the deficiencies determined against the petitioner, Securities.
*110 Decisions will be entered under Rule 50.
Footnotes
*. Cash item $ 5,428.35 was transferred to E. R. Clarkson, as agent, for purpose of paying liability of the company pursuant to article IV, paragraph 9 (a) of the certificate of consolidation and has since been used for that purpose. No asset or property except the 306,861 shares of Kaufmann Department Stores, Inc., was transferred to the new company.↩
1. SEC. 26. CREDITS OF CORPORATIONS.
(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. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account.
(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 in discharge of a debt, or to be 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.↩
2. SEC. 351. SURTAX ON PERSONAL HOLDING COMPANIES.
(b) Definitions. -- As used in this title --
* * * *
(2) The term "undistributed adjusted net income" means the adjusted net income minus the sum of:
* * * *
(B) Amounts used or set aside to retire indebtedness incurred prior to January 1, 1934, if such amounts are reasonable with reference to the size and terms of such indebtedness.
"SEC. 355. UNDISTRIBUTED ADJUSTED NET INCOME.
"For the purposes of this title the term 'undistributed adjusted net income means the adjusted net income (as defined in section 356) minus --
"(a) * * *
"(b) Amounts used or irrevocably set aside to pay or to retire indebtedness of any kind incurred prior to January 1, 1934 if such amounts are reasonable with reference to the size and terms of such indebtedness."↩