*4119 The amounts charged to the undivided profits account of the Leland Mercantile Co., under the evidence adduced, are not dividends within the meaning of section 201 of the Revenue Act of 1918 and the respondent erred in so holding.
*391 This is a proceeding for the redetermination of deficiencies in income taxes for the calendar years 1918 and 1919, aggregating in amount, $13,103.20.
While the petition includes all of the taxable years 1917 to 1920, both inclusive, the only amount here in controversy is the deficiency of $10,488.11 asserted by the respondent for the year 1918.
The sole question for our consideration is whether the respondent committed an error in holding that certain charges to the surplus account of the Leland Mercantile Co. constituted dividends to the petitioner in the year 1918.
FINDINGS OF FACT.
The petitioner is a merchant and planter, with his residence and place of business in Leland, Miss.
The Leland Mercantile Co. (hereinafter referred to as the Company) is a corporation, *4120 of which the petitioner is president, with outstanding capital stock in 1918 of $25,000. The petitioner owned all of the capital stock of the Company with the exception of two qualifying shares issued to directors in accordance with the corporate laws of Mississippi.
The Company kept a set of books and records in which its business activities were recorded, together with the personal activities of the petitioner, who kept no books. The books of the Company were kept by F. H. Thompson under the supervision of the petitioner.
On March 4, 1918, the books of account of the Company having been out of balance by the amount of $7,658.44, the bookkeeper, having been unable to determine the reason therefor, was instructed by the petitioner to make an entry, which he did, debiting the undivided profits account to place the books in balance. The books were later audited and a great number of errors were found, the net amount of which exactly equaled the balancing entry of $7,658.44 above referred to.
The petitioner purchased a tract of land and the Company disbursed the sum of $3,026.67 as a payment thereon. He instructed the Company's bookkeeper to charge that amount to his personal*4121 account, in which there was an ample amount standing to his credit at the time, but contrary to those instructions, the amount was debited to the undivided profits account on February 18, 1918.
The record of the stockholders' meeting of January 1, 1919, contains the following statement:
It appeared that the profits of the Company for the year of 1918 was $13,694.65 net, it was voted, and carried that the above amount was to be carried to surplus, and thereby no stockholder drawing any dividend on his stock for the year 1918, as the full amount was carried to surplus.
*392 The record of the meeting of January 1, 1918, contains a similar statement with respect to the year 1917.
The Company's income and profits-tax return for the year 1918, in which the two sums in controversy were described as dividends, was prepared by an accountant.
In response to a letter mailed to the Company by the respondent the Company's public accountant prepared a communication which was signed by the petitioner, bearing the date March 31, 1920, and containing the following statement:
Our Company although organized as a corporation is in reality owned by one man - J. W. Thompson, and the*4122 debits to surplus account under the heading of J. W. Thompson are in effect dividends paid him and are so treated in his individual income-tax return.
Another communication, bearing date May 6, 1920, was prepared by the Company's accountant, signed by petitioner, and mailed to the respondent, which contained the following statement:
Cash dividends were declared and paid out of previous year's profits as follows:
| February 18, 1918 | $3,026.67 |
| March 4, 1918 | 7,658.44 |
The respondent found the total dividends payable by the Company for 1918 to be $10,685.11, the sum of the two amounts in controversy, of which sum the petitioner's share was held to be $10,599.63, or 99.02 per cent of the total. That amount was taxed to the petitioner at the rates of taxes prevailing in 1918.
OPINION.
MORRIS: The sole question for our consideration is whether the respondent erred in holding that the two amounts, $3,026.67 and $7,658.44, charged to the undivided profits account on the books of the Leland Mercantile Co. in 1918, constituted dividends to the petitioner.
Section 201 of the Revenue Act of 1918 provides in part:
(a) That the term "dividend" when used in this*4123 title (except in paragraph (10) of subdivision (a) of section 234) means (1) any distribution made by a corporation, other than a personal service corporation, to its shareholders or members, whether in cash or in other property or in stock of the corporation, out of its earnings or profits accumulated since February 28, 1913, or (2) any such distribution made by a personal service corporation out of its earnings or profits accumulated since February 28, 1913, and prior to January 1, 1918.
Notwithstanding the conflicting state of facts developed during the course of this hearing, we are convinced that the item of $7,658.44 can in no sense of the word be regarded as a dividend. We have the testimony of the petitioner himself that the books of the Company *393 were out of balance by $7,658.44 for some time; that the bookkeeper had taken considerable time endeavoring to locate the errors making up that difference, and that he instructed the bookkeeper to make this arbitrary entry to place the books in balance. We also have the oral testimony of a public accountant who examined the books of the Company, and who testified that a great number of erroneous debits and credits were*4124 located and verified by him in the net amount of $7,658.44. We, therefore, have no hesitancy in saying that under the evidence adduced the respondent was clearly in error in holding this amount to be a dividend.
As to the $3,026.67 item, there may be some reason for doubt. Let us briefly examine the testimony and evidence covering this amount. The evidence substantiating the contentions of the respondent will be found in the Company's return for 1918 wherein this amount, and for that matter the sum of $7,658.44, was described as a dividend by the accountant preparing the return. The admissions contained in those communications written for the petitioner to the respondent in 1920 also strongly favor the position taken by the respondent. However, the rights of the petitioner are not to be foreclosed because of those admissions if he can satisfactorily establish by the evidence that the amount in question was not in fact a dividend. The oral testimony of the petitioner at the hearing is that he, personally, bought a piece of land, and that $3,026.67 was paid on this land by the Company for his account; that he instructed the bookkeeper to charge that amount to his individual*4125 account; that there was an ample amount to his credit in the books of the Company with which to discharge this obligation to the Company; that the bookkeeper erred in charging this amount to the undivided profits account. We have the minutes of the stockholders' meeting of January 1, 1919, in which it is expressly stated that no stockholder would draw any dividend on his stock for the year 1918. Petitioner testifies that an auditor prepared the Company's 1918 return and that he was not employed to audit the books at that time; consequently, it is reasonable to infer that the return as prepared would reflect any errors then existing in the books of account. Furthermore, the witness testified that his accountant prepared the communicatioons referred to hereinabove and that he, without knowing the contents thereof or understanding them, signed those communications. The error was not discovered until some time in 1923 when the books were checked, long after the filing of the 1918 return and the mailing of those letters to the respondent; therefore, we may assume that any and all explanations offered prior to the discovery of this error in 1923, were also erroneous. The witness emphatically*4126 denies that this sum was a dividend in the stricter sense and that it was ever so intended.
*394 Notwithstanding all of the conflicting statements that have been made by or on behalf of the petitioner, we must weigh those statements, together with the petitioner's recent oral testimony, made after due deliberation and thought and after thorough examination into the facts and discovery of the true state of affairs, in arriving at our conclusion. While the evidence offered by the respondent, the admission contained in the 1918 tax return of the Company, the further admissions in the communications between the Company and the respondent, and the fact that the sum in question was paid by the Company for the benefit of the petitioner, tend most strongly to substantiate the contentions of the respondent, we are of the opinion that the petitioner has established by a preponderance of the evidence that no dividends were declared or paid for 1918 within the meaning of section 201 of the Revenue Act of 1918.
Judgment will be entered on 15 days' notice, under Rule 50.