*3367 1. Where stockholders of a corporation leave in the business moneys placed to their credit in separate accounts representing the accumulation of salaries, and profits, income from other sources, and dividends, if some of the stockholders withdraw the entire amount of their credits or if withdrawals are not made in proportion to stock ownership, the amounts left to the credit of the stockholders on the books of the corporation represent moneys belonging to the stockholders, and therefore, do not represent a part of the invested capital of the corporation.
2. Increase of invested capital based upon appraisals of assets in 1908 and 1915 disallowed where it is not shown that such increase was based upon cost of assets on the date when acquired.
*1313 In this proceeding the petitioner seeks a redetermination of the income and profits taxes for the years 1918, 1919, and 1920, for which the Commissioner has determined deficiencies of $2,742.48, $5,642.10, and $2,046.23, respectively. The petitioner alleges error on the part of the Commissioner in excluding*3368 from invested capital certain moneys left in the business by the stockholders. Second, in refusing to allow an additional amount for invested capital on account of revaluation of the plant and equipment based upon an appraisal in 1915.
FINDINGS OF FACT.
The petitioner is a corporation organized in 1891 under the laws of the State of Illinois, with an original capital stock of $100,000 par value. Its principal offices are located at Elgin, Ill. The stockholders of the petitioner were the members of one family consisting originally of Casper Schmidt and his six sons. Each stockholder possessed the same amount of stock and devoted his time to the business of the company.
Early in the history of the corporation an executive committee was formed, consisting of six of the stockholders, who had the power to pass on all matters at any time that did not conflict with the authority or the duties of the board of directors. At first there were only three directors, but later on the number was increased to include all of the seven stockholders.
On July 8, 1903, at the semiannual meeting of the directors Casper Schmidt was voted an annual salary of $600, and each of the six sons, *3369 *1314 $1,500. At the meeting on January 8, 1907, the board of directors fixed the salary of Casper Schmidt of $2,100 a year, and the six sons at $3,000 a year each, beginning with August 1, 1906.
In operating the company the stockholders agreed among themselves that they would endeavor to leave in the business as much of their salaries, undivided profits and other income as they would conveniently do, but each stockholder was entitled to and permitted to withdraw sums necessary for his living expenses. In this connection it was recognized that certain of the stockholders had heavier expenses than others, and, accordingly, such stockholders withdrew greater amounts than the others. However, all such withdrawals were charged against their accounts on the books of the corporation. As a result of this circumstance the balances in the accounts of the various stockholders on the books of the corporation varied greatly with each other and from year to year.
The corporation carried an account for each of the seven stockholders crediting the accounts with all salaries, undivided profits, other income and dividends, and debiting the accounts with withdrawals or other charges.
*3370 The accounts in 1910 were as follows:
| Name | Balance, Jan. 1, 1910 | Balance, Dec. 31, 1910 |
| Casper Schmidt | $921.71 | $2,078.46 |
| Charles Schmidt | 968.20 | 2,064.14 |
| Edward Schmidt | 198.16 | 774.78 |
| George Schmidt | 402.57 | 1,626.95 |
| Henry Schmidt | 564.30 | (Minus) 517.44 |
| John Schmidt | 707.81 | 1,415.81 |
| Louis Schmidt | 467.30 | 887.60 |
During this year the salaries were credited to the accounts of the various stockholders, and the accounts were debited with the withdrawals. In the case of Henry Schmidt his withdrawals exceeded his credits.
During the years following these accounts were kept in the same manner. In some years the accounts were credited with distributed shares of undivided profits, shares of trustees' income, and in 1918 with dividends, and the accounts were debited with the withdrawals by the various stockholders, and in 1919 by taxes paid by the corporation for the individuals.
In December, 1909, the stockholders entered into an agreement whereby certain assets of the petitioner, consisting of some warehouse and factory property not directly connected with the business of the petitioner and some bank stocks, were placed in the hands of trustees. *3371 There were also turned over to the trustees certain notes payable of the petitioner amounting to $160,000. These notes were given by the corporation to the stockholders in payment of undrawn *1315 salaries and dividends standing on the corporate books to the credit of the various individual stockholders. The notes were noninterest bearing and were due in 10 years from date. The amounts of the notes were as follows:
| Casper Schmidt | $19,000 |
| Charles Schmidt | 28,000 |
| Edward Schmidt | 19,000 |
| George Schmidt | 25,000 |
| Henry Schmidt | $26,000 |
| John Schmidt | 24,000 |
| Louis Schmidt | 19,000 |
The corporation opened the trustees' account on its books and charged it with the amount of the assets so transferred and credited it with the amount of the liability for the notes. The petitioner credited to the trustees' account on its books the amounts received by it as dividends on the bank stock and rents from the properties. A credit entry was also made to the trustees' account each year, designated interest on the credit balance due the trustees, which included the amount of the stockholders' notes. This credit amounted to $7,000 or $8,000 a year. Although this annual*3372 payment was designated interest applying on the notes made out to the stockholders it was not credited in proportion to the amounts of the notes but was distributed equally among the seven stockholders. Certain credits to stockholders' accounts for undivided profits and shares of trustees' income were made as the result of resolutions passed at stockholders' meetings as follows:
January 30, 1913. - Motion made by George Schmidt, seconded by Louis Schmidt, that the undivided profits of the company amounting to $24,211.96 and that the credit to the trustees' income account, amounting to $29,244.79, be apportioned to the stockholders, namely, Casper, George, Henry, Charles, John, Louis and Edward Schmidt in equal amounts.
The motion was duly put before the meeting and carried unanimously, and the secretary was instructed to make the entries upon the books of the company accordingly.
July 6, 1915. Motion was made and seconded that the undivided profits of the company, amounting to ,9.550.84, and that the credit to the trustees income account, amounting to $9,931.20, be apportioned and divided among the stockholders in equal amounts, Casper Schmidt Estate, Henry Schmidt, *3373 Louis Schmidt, Edward Schmidt, and John Schmidt, respectively.
January 20, 1916. Motion duly made and seconded that the undivided profits for the fiscal year ending December 31, 1915, of the company amounting to $25,426.57, and that the credit to the trustees' income account, amounting to $9,928.46, be apportioned and distributed to the following named persons in equal amounts, Mrs. Casper Schmidt, George Schmidt, Charles Schmidt, John Schmidt, Henry Schmidt, Louis Schmidt and Edward Schmidt. (The motion carried.)
The dividend for 1918 was voted at the directors' annual meeting on the following motion:
On motion made and seconded, it was resolved that a dividend of 15 per cent be paid on the capital stock of the company from the earnings of the past fiscal period, and that same be charged to undivided profits account.
*1316 In 1916, the trust agreement entered into in December, 1909, was revoked and the assets and liabilities previously transferred to the account of the trustees in 1910, were transferred back to the corporate accounts. The liabilities consisted of the above-mentioned notes given by the corporation to the stockholders prior to the date of the*3374 trust agreement. The note due Casper Schmidt in the amount of $19,000, and the credit balance of $10,853.90 in his account as at January 1, 1914, had, due to his death, been transferred to the accounts of the six sons and also to the account of a daughter. There was charged against the trustees $19,000 and against the estate of Casper Schmidt $10,852.90. Each of the six sons was credited with $3,574.90, and the daughter with $8,404.50.
In 1917 additional capital stock was issued, amounting to $300,000 par value, of which $50,000 par value was in the name of each of the six sons. The payment for this stock was made by debiting the stockholders' balances with $50,000 each. The stockholders' balances, just prior and subsequent to this transaction, were as follows:
| Name | Total credits | Capital stock | Withdrawals | Balance, Dec. 31, 1917 |
| Casper Schmidt | 7,898.20 | $1,396.77 | $6,501.43 | |
| Charles Schmidt | 63,891.34 | $50,000 | 2,965.65 | 10,925.69 |
| Edward Schmidt | 53,719.75 | 50,000 | 2,373.41 | 1,346.34 |
| George Schmidt | 60,423.82 | 50,000 | 1,996.45 | 8,427.37 |
| Henry Schmidt | 47,257.52 | 50,000 | 3,556.77 | 6,299.25 |
| John Schmidt | 57,845.55 | 50,000 | 2,345.76 | 5,499.79 |
| Louis Schmidt | 54,476.61 | 50,000 | 2,123.95 | 2,352.66 |
*3375 The accounts of the stockholders, increased by salaries, dividends, and other credits, and reduced by withdrawals, showed the following balances for the years under review:
| Name | Dec. 31, 1918 | Dec. 31, 1919 | Dec. 31, 1920 |
| Casper Schmidt | $6,383.36 | ||
| Charles Schmidt | 19,360.89 | $16,675.91 | $28,578.67 |
| Edward Schmidt | 10,761.34 | 8,902.07 | 21,341.51 |
| George Schmidt | 18,385.51 | 18,097.96 | 31,097.44 |
| Henry Schmidt | 1,403.56 | -806.27 | 10,270.85 |
| John Schmidt | 16,008.35 | 14,011.17 | 11,646.20 |
| Louis Schmidt | 10,633.94 | 11,331.73 | 35,248.27 |
The withdrawals by the various stockholders were usually made without formal action by the stockholders or the officials of the company, but on two occasions formal action was taken as follows: At a special meeting of the stockholders August 25, 1913, the following resolution was adopted:
The matter with relation to granting stockholders permission to draw a proportion of the amounts held to the credit of their personal accounts was next considered and decided, and upon motion of George Schmidt, seconded by *1317 Louis Schmidt, the stockholders were given permission to withdraw the following amounts, said amounts to be*3376 charged to their respective accounts:
| Casper Schmidt | $2,500 |
| George Schmidt | 2,500 |
| Charles Schmidt | 2,500 |
| Henry Schmidt | 3,500 |
| Edward Schmidt | 2,500 |
| Louis Schmidt | 1,500 |
| John Schmidt (to apply on his notes amounting to | |
| $3,500 held by the company) | 3,500 |
| Henry Schmidt (in addition to the above mentioned | |
| $3,500 opposite his name, said $1,500 to be covered by his note for $1,500) | 1,500 |
Again by the minutes of a special meeting of the stockholders under date of January 20, 1916, the following appears:
On motion duly made and seconded, that the stockholders be allowed to draw $1,500 each, the same to be charged to their respective accounts. Motion carried unanimously.
During the year 1918, the withdrawals of two of the stockholders exceeded their salaries. During the year 1919, the withdrawals of five of the stockholders exceeded their salaries. During the year 1920, the salaries of all the stockholders except John Schmidt were increased from $3,000 a year to $17,000 a year, and John Schmidt's salary was reduced from $1,125 a year to nothing.
Beginning about the year 1900, the petitioner began improving a certain piece of land for the purpose of*3377 erecting thereon a new plant. A great part of the work was done by employees and laborers of the petitioner during the slack season. None of this factory labor was capitalized on the books of the petitioner. Company labor also was used in laying foundations, making plans, drawings, and patterns, and assembling machines, and none of the cost of this labor was capitalized on the books.
In 1908 the petitioner had an appraisal of all of its assets made by the American Appraisal Co., and in 1915 it had a second appraisal made by the Rau Appraisal Co. Both appraisals were based upon reproductive cost new of the assets as at the date of the appraisal less accrued depreciation.
In 1917 the petitioner adjusted its books to conform to the values shown by the 1915 appraisal, taking into consideration additions made since the appraisal. As a result of such adjustment surplus was increased by $46,266.13.
In 1904 the balance in the machinery account stood at $24,513.18. At the close of 1905 an increase of $10,202.89 was made to this account.
From 1913 to 1917 the balance in the machinery account was kept at a round figure of $48,000 by charging off the additions made during each*3378 year.
*1318 Beginning in 1910 the following credits were made to the machinery account at the close of each year, representing the charge-off of additions made to the account during the year:
| 1910 | $2,876.30 |
| 1911 | 373.67 |
| 1912 | |
| 1913 | 195.40 |
| 1914 | $689.05 |
| 1915 | 68.50 |
| 1916 | 925.44 |
| 1917 | 7,602.70 |
Repairs to machinery were as follows:
| 1903 to 1906 | $3,121.97 |
| 1907 to 1909 | 3,069.31 |
| 1910 | 684.33 |
| 1911 and 1912 | 1,136.28 |
| 1914 | $497.24 |
| 1915 | 960.91 |
| 1916 | 1,625.82 |
There were no credits to the asset accounts previous to 1910 for depreciation. Beginning in 1910 a depreciation reserve was established. Depreciation at the following rates was credited to the reserve:
| Year | Machinery and equipment | Buildings |
| Per cent | Per cent | |
| 1910 | 10 | 2 |
| 1911 and 1912 | 7 1/2 | 2 |
| 1914, 1915, and 1916 | 5 | 2 |
| 1917 to 1920, inclusive | 10 | 3 |
Practically all of the plant consisting of buildings, machinery, equipment, etc., was acquired in years prior to 1908.
OPINION.
LOVE: In passing upon the question as to whether or not the amounts appearing on the books to the credit of the various stockholders should be included in the*3379 invested capital of the petitioner, it is necessary to examine into the character of the account and to determine whether the amounts thus entered were the property of the petitioner or the property of the stockholders, or whether the amounts were so held by the petitioner as to be ostensibly the property of the petitioner. Numerous court decisions have been rendered and numerous decisions by the Board have been promulgated on circumstances somewhat similar. An examination of those decisions shows that no definite or fixed rule is set forth thereby which would apply in all cases. Each case has its own peculiarities and the circumstances in each case govern in making the decisions. The petitioner relied upon the decision in the case of ; ; ; . Practically all of these cases dealt with the question of whether or not a dividend had been declared, and whether if declared, such dividend had been available in cash and set*3380 aside for the benefit of the stockholders, the main point being whether or not it had passed out of the control and ownership of the corporation.
The respondent relied upon the case of , and upon the following decisions by this Board: ; ; ; ; ; ; . In , a father and two sons owned the stock of a corporation. An oral agreement entered into between them provided that the salaries allowed the sons in excess of $20 per week for one, and $25 a week for the other, should remain in the business, that the father should not draw any salary, and that all dividends were to remain in the business. The corporation kept personal accounts of each of the individuals, and the shares of the surplus, dividends, *3381 and the portions of the salaries that remained in the business were credited to each of the individuals. Under the agreement the stockholders were not permitted to withdraw any money from the business except the portions of the salaries indicated. They had no control of the money placed to their account and could not withdraw it from the corporation under the terms of their agreement, and all of the stockholders were in practically the same situation. Therefore, the court held that the accumulated salaries were not different in character from the accumulated dividends, and that the accumulation of both dividends and salaries should be treated as an invested capital and not borrowed money. To the contrary see , affirmed in , by the United States Circuit Court of Appeals for the Fifth Circuit, June 7, 1928.
We think the case of , is not in point here. In this case there was no prohibition against withdrawals by the stockholders. Any stockholder was entitled to withdraw from the corporation against the amounts credited to him, and this was*3382 done. Some of the stockholders drew considerably more than others, and occasions arose when the balance at the end of the year for at least one of the stockholders was less than zero. In other words, the stockholder had drawn from the corporation money in excess of the account standing in his name. This occurred in the case of Henry Schmidt, December 31, 1910, and again December 31, 1917, and again December 31, 1919. The credit balances of the stockholders, all of whom were equal owners of the stock, were far from *1320 uniform in other years. For instance, in the year 1918, Casper Schmidt had a credit balance of $19,360.89, whereas, Henry Schmidt had a balance of only $1,403.56. This would indicate that the stockholders were in practical control of the balances credited to their accounts.
On the occasions when one stockholder had withdrawn his entire balance, there appears to have been no objection on the part of the other stockholders or the corporation, nor was there any liability set up in the account except in so far as such account was overdrawn. Under the arrangement all stockholders could have made similar withdrawals from their accounts.
It has been shown*3383 in the statement of facts that $300,000 par value of stock was issued in 1917. This stock was paid for by debiting the stockholders' balances with $50,000 each. In this transaction it is apparent that the corporation did not consider that it was making a stock dividend, but was actually selling for cash to its stockholders the additional stock. The debiting of the account of Henry Schmidt in this transaction resulted in a deficit in his account of $6,299.25. Such a deficit, of course, would not have occurred if the stock was paid out as a stock dividend. There appears to be no controversy in respect to this $300,000 of capital stock, and apparently it has been included in invested capital.
The circumstances in this case place it in an entirely different class from the cases cited by the petitioner in that the accounts are made up of salaries, shares of trustees' income, amounts inherited from the estate of Casper Schmidt, dividends, and allocated undivided profits. The amounts credited to the various stockholders were available to the extent that on some occasions the entire balance of at least one stockholder was withdrawn by him, and other stockholders had withdrawn the*3384 major portion of their accounts. On two occasions it appears that the stockholders, acting together as stockholders, agreed upon the withdrawal of certain sums without the formality of the declaration of a dividend by the directors.
From all of these facts it would appear that the corporation itself considered the stockholders' balances as being the property of the stockholders. The stockholders themselves appeared to have complete control of such balances. If it is possible for one of the stockholders to withdraw his entire balance it would seem to be in the power of any of the others to do likewise. We, therefore, are of the opinion that the sums placed to the credit of the various stockholders were not the property of the corporation, and accordingly, can not be included in invested capital of the corporation.
The petitioner has claimed that its invested capital should be increased because of undervaluation of its assets, and has endeavored to base such increase upon a current appraisal made in 1915.
*1321 Section 326 of the Revenue Act of 1918 defines invested capital as:
(1) Actual cash bona fide paid in for stock or shares;
(2) Actual cash value of tangible*3385 property, other than cash, bona fide paid in for stock or shares, * * *
(3) Paid-in or earned surplus and undivided profits; not including surplus and undivided profits earned during the year.
* * *
We have to deal here with the third provision since the expenditures made on plant and equipment occurred several years after the date of organization, and the payments were made out of surplus. From the evidence submitted it is apparent that during the years when the plant was being constructed and the land being prepared many expenditures were made which properly should have been classed as capital expenditures but which were charged to expense. These expenditures extended over a period of some six years during the construction of the plant, and in later years in the construction of machinery. The petitioner has not endeavored to show what these expenditures were in the years when made. The appraisals of 1908 and 1915 do not contain sufficient information to enable us to determine the actual expenditures of this nature that were made in the various years. The value of the property in 1915 or in 1908 is immaterial, and is of no assistance in determining the cost of the assets. *3386 The action of the Commissioner in excluding from invested capital the amount claimed by the petitioner is, therefore, sustained.
Judgment will be entered for the respondent.