Decision will be entered under Rule 50.
1. Under certain contracts with dealers in merchandise petitioner received conditional sales contracts and supporting installment notes executed by purchasers of merchandise from the dealers. Under the contracts with the dealers petitioner agreed to pay the dealers 100 percent of the amounts of the unmatured installments and of this 100 percent petitioner agreed to, and did, advance 70 percent less its "charges" when the paper was received and accepted by it. The remaining 30 percent was to be, and was, paid the dealers only after receipt by the petitioner, in the case of each installment note, of the full amount due thereon. In certain eventualities the dealers were obligated to repurchase the paper by payment of the entire unpaid balance thereof and payment of all installment notes at maturity was warranted by the dealers. Held, that the amount of its "charges" received by petitioner constituted interest; held, further, that petitioner was a personal holding company and the respondent did not err in taxing it as such.
2. Petitioner failed to file timely personal holding company tax returns. Held, that it is liable for the statutory penalty 1945 U.S. Tax Ct. LEXIS 195">*196 in failing to so file such returns.
3. Held, that certain additions to petitioner's reserve for bad debts were reasonable and therefore deductible from its gross income.
4. On March 1, 1941, petitioner declared a dividend payable in its stock or in cash. One stockholder requested and was paid his dividend in cash and the other stockholders requested and were paid their dividends in stock. Held, that the portion of the dividend paid in stock was a taxable dividend in the hands of the shareholders, and petitioner is entitled to have the entire dividend included as dividends paid in computing its basic surtax credit for the purpose of determining its dividends paid credit.
5. On August 25, 1941, petitioner declared a dividend and paid same during the taxable year ended August 31, 1941, in petitioner's stock. Held, that the dividend so paid was not taxable in the hands of the stockholders and is not to be included as dividends paid in computing the basic surtax credit in determining petitioner's dividends paid credit.
4 T.C. 1069">*1070 Respondent determined deficiencies and penalties as to petitioner's 1945 U.S. Tax Ct. LEXIS 195">*197 income tax, excess profits tax, and personal holding company surtax for the fiscal years ended August 31, 1940 and 1941, as follows:
| Personal holding company | ||||
| Deficiency | surtax | |||
| Year ended -- | ||||
| Excess profits | ||||
| Income tax | tax | Deficiency | 25% penalty | |
| Aug. 31, 1940 | $ 228.50 | $ 1,039.68 | $ 259.92 | |
| Aug. 31, 1941 | 2,934.49 | $ 2,957.04 | 22,106.25 | 5,526.56 |
| 1 990.18 | 247.55 |
Respondent conceded at the hearing that the penalty computed at 25 percent for the fiscal year ended August 31, 1941, should have been computed at the rate of 5 percent, and further conceded that petitioner had paid, on December 15, 1941, the tax of $ 659.84 assessed on its delinquent personal holding company return for the fiscal year ended August 31, 1941, and had also paid, on March 25, 1942, the 5 percent penalty of $ 32.99 assessed thereon. Effect to these concessions will be given under Rule 50. The foregoing deficiencies result from respondent's determinations:
(1) That the petitioner was a personal holding company during the years involved and was taxable as such.
(2) That petitioner is liable for the statutory penalties during the 4 T.C. 1069">*1071 years involved provided for failure to file 1945 U.S. Tax Ct. LEXIS 195">*198 timely personal holding company returns.
(3) That amounts deducted by the petitioner from gross income during the taxable years as a reserve for bad debts and as an addition thereto should be disallowed as "excessive."
(4) That petitioner had a net income of $ 1,828 instead of a net loss of $ 739.92 in the taxable year ended August 31, 1940, and that consequently petitioner is not entitled to a net operating loss deduction of $ 739.92 claimed in its income tax return for the taxable year ended August 31, 1941.
(5) That an excess profits credit of $ 443.84 claimed by petitioner for the taxable year ended August 31, 1941, and based on a claimed investment in that year of $ 2,000 for 81 days in petitioner's stock by its president, W. M. Redelsheimer, should be disallowed.
(6) That petitioner is not entitled to $ 23,400 of a $ 23,800 dividends paid credit claimed by petitioner in the computation of its personal holding company surtax liability for the year ended August 31, 1941.
Petitioner contests the foregoing determinations.
FINDINGS OF FACT.
Issue 1.
The petitioner is a corporation organized under the laws of the State of Florida, with its principal place of business at Miami, Florida. 1945 U.S. Tax Ct. LEXIS 195">*199 It was incorporated August 31, 1939, and began business operations March 27, 1940. It filed its tax returns on an accrual basis with the collector for the district of Florida. Its fiscal year ended on August 31.
Petitioner had 122.4 shares of capital stock outstanding on August 31, 1941, all of which was common stock. Of this stock 2.4 shares were owned by its president, W. M. Redelsheimer, and the remainder was owned or controlled by Charles Greenfield and Marvin Bronner, or members of their families.
Petitioner reported in its income tax returns for the taxable years that it was engaged in the business of "industrial and commercial loans." It was then actually engaged in the business of discounting and rediscounting conditional sales contracts, and supporting installment notes, chattel mortgages, and other evidences of debt. It also made direct loans, with or without collateral, charging interest thereon.
Petitioner's original customer, and the one from which it received the greater part of the conditional sales contracts and notes involved herein, was the Maxwell Co., which was engaged in the business of selling furniture and equipment for hotels and restaurants. A majority 4 T.C. 1069">*1072 of 1945 U.S. Tax Ct. LEXIS 195">*200 its stock was owned or controlled by the Greenfield and Bronner families, who also owned the controlling stock in petitioner. Petitioner's president and general manager had been credit manager of the Maxwell Co. for several years before the petitioner was organized.
Petitioner and the Maxwell Co., under date of July 24, 1941, executed a contract which governed their transactions with each other. It was retroactive and reflected the oral arrangements under which all such transactions between them had been conducted prior to its execution. This contract was, in part, as follows:
Witnesseth, That Whereas, the first party (The Maxwell Company Inc.) is desirous of obtaining the advantages of the services offered by the second party, which the second party hereby undertakes to perform, and desires to discount with second party Notes, Conditional Sales or Lease Contracts, and Chattel Mortgages or other Lien Instruments, hereinafter designated "Paper" evidencing sales and deliveries of merchandise usually dealt in by the first party, which paper shall reserve title to or a lien upon such merchandise.
Now, Therefore, in consideration of the premises, the parties hereby agree as follows:
First: 1945 U.S. Tax Ct. LEXIS 195">*201 Second party agrees to discount such paper belonging to first part [sic] as may be acceptable to second party and to advance thereon:
One Hundred per cent (100%) of the unmatured installments on paper acceptable to first party, of which Seventy per cent. (70%) of the actual net amount thereof, less the compensation and reimbursement of the second party as provided in Paragraph Fourth hereof, shall be paid in cash upon acceptance of such paper by the second party, and the remaining Thirty per cent. (30%), less any deductions and plus any interest paid by the respective debtors, shall, in the case of each installment, be paid to the first party on the tenth (10th) day of the following month: provided, however, that no payments of any such remainder need be made by the second party, so long as any paper discounted by the second party from the first party shall be in any manner affected by any breach or violation of any warranty of the first part [sic] herein, but such remainder and any moneys, paper or property of the first party which may come into the possession of the second party may be by it held and thereafter applied to the payment of any such paper or any other obligations of 1945 U.S. Tax Ct. LEXIS 195">*202 first party to second party whether due or not due.
* * * *
Third: The second party agrees to perform the following services for the first party:
1. To furnish by mail to the first party its credit information in hand about the customers of the first party, upon request of the first party.
2. Pay for all accounting, postage and credit investigations of paper discounted or offered for discount hereunder.
3. Obtain and have on hand at all times, sufficient funds to make prompt remittance to first party for all acceptable paper within the limits herein agreed upon.
4. Place its collection department at disposal of first party, and endeavor to collect from debtors any paper discounted hereunder.
5. Have its auditors give to the first party the report of each examination herein provided for, with full information and advice as to the most desirable method of keeping the books, records, and accounts of said first party.
4 T.C. 1069">*1073 Fourth: In consideration of the foregoing the first party agrees to pay the second part, [sic] as and for its total compensation for the obligation to render and/or the rendering of all services and other considerations herein set forth, an amount which reduces the face value of 1945 U.S. Tax Ct. LEXIS 195">*203 the paper discounted hereunder, and, which shall be a sum equal to one and two-tenths per cent. (1 2/10%) per month of the net balance scheduled to be due on paper each month.
Fifth: In consideration of the prompt discount of, and remittance for, paper acceptable to it, by second party, first party warrants to second party and agrees as follows:
1. That first party, and each debtor named in any paper, is solvent and will remain so until the maturity thereof, and every such paper discounted hereunder and all installments thereof, will be paid in full at maturity in cash or Miami par funds.
2. That the debtor mentioned in each paper has executed and delivered same for new and unused merchandise unless the paper provides otherwise, actually delivered, and that first party will obtain from the debtor a written acknowledgment of installation and deliver same to second party; and that each paper is an original obligation and does not represent a renewed, extended or rewritten obligation, and is the sole property of first party.
* * * *
Sixth: Second party and any of its officers or agents may endorse the name of the first party upon checks and other forms of payment received in respect to paper 1945 U.S. Tax Ct. LEXIS 195">*204 discounted and otherwise sign and endorse first party's name to carry out the intent of this agreement and correct any patent defects appearing on paper.
Seventh: If any warranty or covenant, express or implied, made herein or resulting from the provisions hereof with respect to any paper, or made in, or resulting from the provisions of the assignment of any paper to second party, or from the subject matter hereof, shall be broken or violated, whether through the act of first party or of others, the damages which second party shall be entitled to recover from the first party, as a result thereof, shall include a ten percent. collection charge on all amounts collected, all attorney's fees, court costs, and all other expenses which may be expended or incurred by second party to obtain or enforce payment of any paper purchased hereunder, either as against the debtor, first party, or any of its guarantors or sureties, or in the prosecution or defense of any action or proceeding, or concerning any matter growing out of or connected with the subject matter of this contract and paper discounted hereunder. Granting extensions to or adjustments of claims of debtors named in paper discounted 1945 U.S. Tax Ct. LEXIS 195">*205 hereunder, compromises, composition, or settlement of such paper either with the debtors or others, or the discount, assignment or transfer of paper by second party, shall not require first party's consent and shall not affect the liability of first party under any of its warranties.
Eighth: Upon a debtor failing or refusing to pay a paper or installment thereof at maturity, or failing to retain the merchandise or objecting to merchandise, or upon merchandise being repossessed, or upon a petition in bankruptcy, reorganization or extension being filed by or against a debtor, or the appointment of a receiver in equity for the debtor, or upon a debtor making an assignment for the benefit of creditors or committing any other act of insolvency, first party will, upon demand, repurchase from second party such defaulted paper and will pay therefor the entire unpaid balance thereof, together with interest, attorney's fees, costs and other expenses, incurred by second party in respect thereto, but less any reserve specifically applicable thereto held by second party. If first party fails to repurchase such defaulted paper within ten (10) days after demand, 4 T.C. 1069">*1074 or if first party should become insolvent 1945 U.S. Tax Ct. LEXIS 195">*206 or make an assignment for the benefit of creditors, or if a petition in bankruptcy or reorganization for the appointment of a receiver in equity be filed by or against first party, or if first party breaches or fails to perform any warranty or obligation hereof, then first party shall, on demand, repurchase from second party all of the paper discounted by second party, and pay unto the second party the aggregate unpaid principal amount thereof, plus interest and charges accrued and all expenses of collection incurred by second party in respect thereto, less any reserve thereon. If such demand be not complied with within ten (10) days, second party may, at its option, sell or assign the paper provided, however, ten (10) days notice thereof is first given by registered mail to first party, (all statutory requirements as to notice, publication, place of sale or otherwise being hereby expressly waived). The net proceeds derived therefrom shall be applied against the outstanding amount or amounts owing to the second party, and first party shall forthwith pay any deficiency and shall be entitled to any surplus.
Ninth: This agreement and all of its provisions shall inure to, and become binding 1945 U.S. Tax Ct. LEXIS 195">*207 upon, the heirs, executors, administrators, successors and assigns of the parties hereto. All acts, transactions, agreements, certificates, assignments and transfers hereunder, and all rights of the parties hereto, shall be governed as to their validity, enforcement, interpretation, construction, effect and in all other respects, by the laws and decisions of the State of Florida. * * *
Tenth: First party hereby agrees that any paper offered to any Finance Company for purchase or as collateral for advances will be first offered to second party hereunder.
* * * *
This Agreement shall take effect as of March 27th, 1940, at which said date the parties hereto commenced doing business.
Petitioner also had transactions with a number of other dealers under substantially similar contracts, except that paragraph "Fourth" of the four other contracts in evidence provided a different basis from paragraph "Fourth" of the agreement with the Maxwell Co. for petitioner's charges, as follows:
Fourth: In consideration of the foregoing, the first party agrees to pay the second party, as and for its total compensation for the obligation to render and/or the rendering of all services and other considerations 1945 U.S. Tax Ct. LEXIS 195">*208 herein set forth, an amount which reduces the face value of the paper discounted hereunder, and, which shall be a sum equal to Eight percent (8%) per annum of the net face amount of paper for the total period embraced within the paper from date of purchase to and including date of final payment to second party; * * *
The conditional sales contracts received by petitioner under the contracts with its dealers were substantially alike in form. The provisions thereof are incorporated herein by reference. They provide, in part, for the purchase of:
Furniture and furnishings, fixtures and equipment as covered by itemized statement attached and made a part hereto, for which I or we agree to pay you or your assigns $ /(Full contract price) of which $ /(Down payment) is to be paid in hand and $ as balance of purchase price payable according to the terms of promissory notes of even date herewith made by me or us, and payable to the order of the seller as follows:
4 T.C. 1069">*1075 The title to the property, and to each item thereof, shall remain in the Seller until the entire purchase price with interest thereon and all lawful charges and expenses, is fully paid.
The "itemized statement attached" 1945 U.S. Tax Ct. LEXIS 195">*209 in the case of the contracts received by petitioner from the Maxwell Co. listed the items purchased, the price of each, and the total price of all the items listed, and added to such total an amount designated as "Time Price Differential." The resulting total of price plus "Time Price Differential" was the amount inserted in the conditional sales contract as the "Full Contract Price."
The "itemized statement attached" in the case of contracts received by petitioner from dealers other than the Maxwell Co. was similar, except that the sum added to the total price of the items listed was designated "8% CC." The resulting total of price plus "8% CC" was the amount inserted in the conditional sales contract as the "Full Contract Price."
In connection with the conditional sales contract and supporting notes received by petitioner, it sent the obligor on the notes and purchaser of the merchandise a notice reading, in part, as follows:
We are pleased to advise that we have purchased for value from of the contract notes listed below, with the signatures of authorized to sign as .
* * * *
We will expect these notes to be paid in full at maturity.
If the above items, figures, down 1945 U.S. Tax Ct. LEXIS 195">*210 payment and authorized signatures are correct, please sign at the bottom and return in the envelope enclosed.
When in need of cash petitioner pledged some of the paper received by it to banks as collateral for loans and discounted some with other finance companies under contracts which were similar to those under which petitioner had acquired the paper from its customers, except that the rate and method of determining the charges paid by petitioner were as follows:
THIRD: Customer agrees to pay monthly to ABC Corporation, as and for its total compensation 1/40th of 1% per day of the daily net cash balance due ABC Corporation on Paper purchased. ABC Corporation will bill customer for such charges at the end of each month, and customer will pay said charges within five (5) days after date of such billing.
On receipt of the conditional sales contracts and notes from the Maxwell Co. petitioner examined the credit responsibility of the makers and, if the paper was found to be acceptable, entered the transaction in its purchase journal by name of maker and amount of the notes. Petitioner then determined the amount of its charges as shown in a typical case as follows:
The M. Co. on January 1945 U.S. Tax Ct. LEXIS 195">*211 9, 1941, executed a contract and notes involving 4 T.C. 1069">*1076 a "full contract price" of $ 28,815.94, on which it made a down payment of $ 8,000, leaving a balance of $ 20,815.94, evidenced by four notes payable as follows: $ 3,060 on February 1, 1941; $ 3,605 on March 1, 1941; $ 3,640 on April 1, 1941; and $ 10,510.94 on April 15, 1941.
Petitioner received this paper two days later, January 11, 1941. It calculated its "charges" thereon at $ 758.80. It arrived at this figure by charging 1.2 percent per month on the deferred balance scheduled to be outstanding, as follows:
| Balance | |||
| outstanding | Charge for one month | ||
| Jan. 1, 1941 | $ 20,815.94 | At 1.2% | $ 249.79128 |
| Feb. 1, 1941 | 17,755.94 | At 1.2% | 213.07128 |
| Mar. 1, 1941 | 14,150.94 | At 1.2% | 169.81128 |
| Apr. 1, 1941 | 10,510.94 | At 1.2% | 126.13128 |
| Total | 758.80512 |
The full charge for one month of 1.2 percent on the balance of $ 10,510.94 on April 1, 1941, was made and collected without regard to or reduction by reason of the fact that the balance was due less than one month later, on April 15, and was in fact paid on April 17, 1941. The charge of 1.2 percent was made on the scheduled balance for the entire period of one month, regardless of whether the paper was received by petitioner 1945 U.S. Tax Ct. LEXIS 195">*212 on the first or the twenty-eighth of the month, and regardless of whether the scheduled balance was prepaid or paid when overdue. In some instances of past due payments received, petitioner charged the debtor interest thereon and retained such interest for itself. In other instances, where the debtor was not charged interest on his delayed payment, petitioner made no additional charge to the dealer from whom it received the paper. Neither did it make any refund or rebate to the dealer where payments were received prior to maturity, although it occasionally gave the debtor an allowance or discount on such prepayment.
Petitioner determined the amount of its charges in connection with contracts and notes received under contracts with dealers other than the Maxwell Co. by charging 8 percent per annum on the total face amount of all the notes for the period of time from the date of receipt of the paper to and including the date of final payment, without regard to periodic reductions resulting from payment of individual notes during the intervening period.
In all cases, after the amount of the charge was determined it was entered on petitioner's books in an account designated "Reserve 1945 U.S. Tax Ct. LEXIS 195">*213 to Unearned Charges." The charge was broken down into as many items as the account had months to run and as each month passed the portion of the charge for that month was carried over into petitioner's 4 T.C. 1069">*1077 "Interest Earned Account." Petitioner then calculated and entered in its "Reserve Payable" account a "reserve" equal to 30 percent of the unmatured installments on the notes received and paid the dealer from whom it received the paper an amount equal to the remaining 70 percent, less the amount of its "charges." While petitioner at no time advanced 100 percent of the face value of the paper to its dealer, it did not always retain the full 30 percent reserve permitted under its contract with the Maxwell Co.; for instance, in 1941 petitioner was entitled under its contract with the Maxwell Co. to withhold in the 30 percent in reserve $ 177,000, but actually withheld only $ 102,000. The 30 percent reserve on each installment balance in all cases was made available to the dealer on the tenth of the month following that in which the installment was collected.
Most of the installment collections were made by petitioner, although occasionally a debtor insisted on making his payments to the 1945 U.S. Tax Ct. LEXIS 195">*214 dealer from whom he had bought his merchandise. In the latter case the dealer immediately transmitted such payments to petitioner.
When replevin, foreclosure, or other court proceedings were required on any of the paper, petitioner instituted such proceeding in its own name.
The total face amount of the notes discounted and received by petitioner and its income from "charges" made thereon, during the fiscal years ended August 31, 1940 and 1941, were as follows:
| Amount of | Income from | |
| Year ended -- | notes | charges |
| August 31, 1940 | $ 282,074.92 | $ 10,675.86 |
| August 31, 1941 | Not shown | 93,934.01 |
The amount of direct loans made by petitioner in the same fiscal years, and its income from interest thereon and on delinquent accounts, were as follows:
| Income from | ||
| interest on | ||
| Year ended -- | Direct loans | direct loans |
| and delinquent | ||
| accounts | ||
| August 31, 1940 | $ 64,309.11 | $ 220.74 |
| August 31, 1941 | 375,786.13 | 2,776.38 |
Petitioner had two income accounts on its books, one for "Discounts" taken on small trade-bills, prepayments on certain obligations, annual license fees, etc., and the other, under the heading of "Interest," covered all other income from whatever source received, whether derived from interest on direct loans or from "charges" 1945 U.S. Tax Ct. LEXIS 195">*215 on discounted notes and contracts.
4 T.C. 1069">*1078 Petitioner's income tax returns for the years involved were prepared by certified public accountants, and petitioner's gross income was reported therein as follows:
| Interest on | |||
| loans, notes, | |||
| Year ended -- | Discounts | mortgages, | Gross income |
| bonds, bank | |||
| deposits, etc. | |||
| August 31, 1940 | $ 0.64 | $ 10,868.98 | $ 10,869.62 |
| August 31, 1941 | 16.50 | 96,693.89 | 96,710.39 |
The amounts reported on the returns as "interest" consisted of the earned "charges" on the paper received from the dealers and earned interest on direct loans.
The finance companies with whom petitioner rediscounted some of the paper received from the dealers billed petitioner at the end of each month for the amount of their charges computed at 1/40 of 1 percent per day on daily net balances due them. When paid, petitioner entered such charges on its books under "Interest Paid" and deducted same as an expense on account of "interest" paid in its tax returns for the years involved.
Petitioner had three or four employees during the taxable years whose salaries, as shown on its returns, aggregated $ 1,033.67 for the fiscal year ended August 31, 1940, and $ 2,565.65 for the fiscal year ended August 31, 1941. The salary 1945 U.S. Tax Ct. LEXIS 195">*216 of the president of petitioner, as shown on its returns, was $ 866.68 for the fiscal year ended August 31, 1940, and $ 5,410 for the fiscal year ended August 31, 1941.
Petitioner's income derived from the charges made and collected from its dealers on paper received from them was income derived from interest. Petitioner was a personal holding company during the taxable years involved.
Issue 2.
Petitioner did not file timely personal holding company returns for either taxable year involved, but filed such returns for both years on December 13, 1941, shortly after its accountant advised its president and general manager that he believed petitioner might be considered a personal holding company "because of some question that our income was all interest" and because of the manner in which its books were set up. This was the first time that the president had his attention called to the fact that petitioner might be held to be a personal holding company and he had not theretofore considered it.
Issue 3.
For the taxable years in question the paper discounted by the petitioner for dealers during the year, the direct loans made during the 4 T.C. 1069">*1079 year, and the direct loans outstanding at the close of 1945 U.S. Tax Ct. LEXIS 195">*217 the year were as follows:
| Aug. 31, 1940 | Aug. 31,1941 | |
| Paper discounted during the taxable year | $ 282,074.92 | (Not in evidence) |
| Direct loans made during year | 64,309.11 | $ 375,786.13 |
| Direct loans outstanding at close of year | 37,059.23 | 215,669.44 |
At the close of the fiscal year ended August 31, 1941, the total amount of the petitioner's accounts receivable, as shown by its income tax return, was $ 717,808.07.
At the close of the fiscal year ended August 31, 1940, the petitioner's president and general manager set up a reserve for bad debts of $ 2,567.92, which he computed on the basis of 1 percent of the face amount of the discounted paper and the amount of the direct loans which remained outstanding at the close of the year. At the close of the fiscal year ended August 31, 1941, he made an addition of $ 9,830.92 to the reserve for bad debts, which he computed on the basis of 1 percent of the face amount of the paper which had been discounted and the amount of the direct loans which had been made during that year. On August 5, 1941, he charged against the reserve a loss of $ 3,020.87 on account of demand notes of Milton Properties, Inc.
The petitioner did not sustain any loss on account of bad debts 1945 U.S. Tax Ct. LEXIS 195">*218 during the fiscal year ended August 31, 1940. In the fiscal year ended August 31, 1941, petitioner held demand notes of Milton Properties, Inc., in the amount of $ 3,020.87 representing advances made by the petitioner to that company, which notes were secured by its stock. Prior to August 5, 1941, the petitioner purchased a second mortgage on the property of Milton Properties, Inc. On August 5, 1941, the petitioner acquired the mortgaged property at a foreclosure sale upon a bid of $ 24,100, which was approximately the amount due on the mortgage. At the time of the foreclosure Milton Properties, Inc., had no other assets and it owed $ 6,800 in Federal income taxes. The demand notes of Milton Properties, Inc., became worthless on August 5, 1941.
The petitioner claimed a deduction of $ 2,567.92 on its return for the fiscal year ended August 31, 1940, and a deduction of $ 9,830.92 on its return for the fiscal year ended August 31, 1941, as additions to a reserve for bad debts. The respondent disallowed the deductions in their entirety. The amounts so claimed by petitioner were reasonable.
Issue 4.
The disallowance of the deduction of $ 2,567.92 converted a net loss of $ 739.92 claimed 1945 U.S. Tax Ct. LEXIS 195">*219 by petitioner in its return for the fiscal year ended August 31, 1940, into a net income of $ 1,828. The respondent disallowed 4 T.C. 1069">*1080 a net operating loss deduction of $ 739.92 claimed by petitioner in its return for the fiscal year ended August 31, 1941.
Issue 5.
Petitioner in its corporation excess profits tax return for the fiscal year ended August 31, 1941, claimed under schedule B, "Excess Profits Credit -- Based on Invested Capital," item 12, as "Money paid in for stock, or as paid-in surplus, or as a contribution to capital," the sum of $ 26,852.06. Of this sum, respondent disallowed $ 443.84 based on a claimed "Capital Stock Addition" of $ 2,000 on June 11, 1941, the credit being calculated for 81 days, or 81/365 of $ 2,000. This claimed credit was based on the following facts: On June 11, 1941, petitioner's board of directors adopted the following resolutions:
Be it resolved by the board of directors of Southeastern Finance Company in meeting duly assembled that in recognition of the valuable services rendered and to be rendered by W. M. Redelsheimer as an officer of the company there be granted and given to the said W. M. Redelsheimer a bonus of $ 2,000 to be payable from the 1945 U.S. Tax Ct. LEXIS 195">*220 surplus funds of the company. Be it further resolved that the proper officers of the company do pay this bonus to the said W. M. Redelsheimer immediately.
* * * *
Now, therefore, be it resolved by the board of directors of Southeastern Finance Company in meeting duly assembled that the offer of said W. M. Redelsheimer to purchase two shares of the common stock of the company at $ 1,000 per share, giving his demand note in settlement therefor, be and the same is hereby accepted.
* * * *
Be it further resolved that the proper officers of the company do issue to the said W. M. Redelsheimer certificate for two shares of the common stock of Southeastern Finance Company, and accept in payment therefor the note of the said W. M. Redelsheimer due on demand and payable to the order of the company, for the sum of $ 2,000.
On the same date, W. M. Redelsheimer gave the petitioner his demand note for $ 2,000 to purchase the stock. The bonus of $ 2,000 was used to cancel this note and he received two shares of the capital stock of petitioner. This transaction was entered on the books (1) as a debit of $ 2,000 to notes receivable from capital stock sales, (2) as a charge to surplus account of $ 2,000 1945 U.S. Tax Ct. LEXIS 195">*221 and credit to notes receivable of $ 2,000.
Issue 6.
On March 1, 1941, petitioner's board of directors adopted the following resolution:
Be it resolved by the Board of Directors of Southeastern Finance Company in meeting duly assembled, that a dividend of 10% be and the same is hereby declared, and that the same be payable in cash or stock of the corporation. Be it further resolved that the proper officer of the corporation do proceed to calculate and pay out the dividend of 10% so declared the same to be paid from the surplus of the corporation, or in capital stock of the corporation.
4 T.C. 1069">*1081 One shareholder requested cash payment of this dividend and was paid $ 400. The remaining shareholders requested and were issued stock in the total amount of $ 3,000. The total dividend of $ 3,400 was claimed as a dividends paid credit by petitioner in computing its personal holding company surtax liability in its return for the fiscal year ended August 31, 1941. Respondent allowed $ 400 paid in cash and disallowed the $ 3,000 issued in stock.
On August 25, 1941, petitioner's board of directors adopted the following resolution:
Be it resolved by the board of directors of Southeastern Finance Company, at 1945 U.S. Tax Ct. LEXIS 195">*222 meeting duly assembled, that a dividend of 20% be and the same is hereby declared, and that the same be payable in stock of the corporation to the stockholders of record on August 25, 1941. Be it further resolved that the proper officers of the corporation do proceed to calculate and issue the stock dividend of 20% so declared.
Pursuant to this resolution a dividend of $ 20,400 in stock was paid on August 25, 1941, and entries were made on the books of petitioner as follows: Charge of $ 20,400 to "surplus earned"; credit of $ 20,400 to "dividends declared payable" to record declaration of stock dividend to holders of record August 25, 1941, to be paid August 25, 1941, with capital stock of the corporation; debit to "dividends payable" and credit to "capital stock issued" of $ 20,400. The petitioner claimed the $ 20,400 as a dividends paid credit in computing its personal holding company surtax liability in its return for the fiscal year ended August 31, 1941. Respondent disallowed this claim in its entirety.
At all times during the taxable years petitioner's outstanding capital stock consisted of common stock.
OPINION.
Issue 1.
It is not disputed that petitioner qualifies as a personal 1945 U.S. Tax Ct. LEXIS 195">*223 holding company for the taxable years insofar as its stock ownership is involved under section 501 (a) of the Internal Revenue Code. 11945 U.S. Tax Ct. LEXIS 195">*224 It is also undisputed that that portion of its gross income 4 T.C. 1069">*1082 derived from "charges" collected on conditional sales contracts and notes received by it from its dealers, if added to the portion of its gross income admittedly derived from interest, meets the gross income percentage requirement of said section if such "charges" constitute interest within the meaning of section 502 (a) of the code. 2 The first issue therefore is whether such "charges" are interest within the meaning of section 502 (a), supra.
The respondent contends that petitioner's income derived from such "charges" constituted interest on loans made by it to the dealers, which loans were secured by the conditional sales contracts and notes of the dealers' customers as collateral. This is denied by petitioner, which contends that it purchased the contracts and notes 1945 U.S. Tax Ct. LEXIS 195">*225 and that the income derived from the "charges" collected thereon was gain derived from the purchase and liquidation thereof rather than interest on loans collaterally secured by such contracts and notes. The problem thus involves determining whether the transactions between petitioner and the dealers evidenced sales by the dealers to petitioner of the contracts and notes or whether they were received and held by petitioner as collateral security for loans made by it to the dealers.
The contracts of the petitioner with the dealers (hereinafter sometimes referred to as the covering contracts) under which petitioner received the conditional sales contracts and notes contained provisions as follows: That petitioner would discount the paper received from the dealers and advance thereon 100 percent of the unmatured installments, of which 70 percent of the net amount thereof less the compensation "for all services and other considerations" to be rendered by petitioner was to be paid in cash upon acceptance of the paper; that the remaining 30 percent less any deductions and plus any interest paid by the respective original debtors should in the case of each installment be paid to the dealers 1945 U.S. Tax Ct. LEXIS 195">*226 on the tenth day of the month following payment of such installment, except that no payments of any such remainder were required to be made by petitioner to the dealers so long as any paper discounted was in any manner affected by breach of any warranty of the dealer, including the warranty that each installment be paid when due, but such remainder might be held by petitioner and thereafter applied to the payment of any paper with regard to which the warranty of the dealers had been breached; that payment in cash of all the paper discounted and all the installments thereof in full at maturity was warranted by the dealers; that if a debtor failed to pay an installment at maturity or made an assignment for the benefit 4 T.C. 1069">*1083 of creditors the dealers would, upon demand, repurchase from petitioner such defaulted paper and pay the entire unpaid balance thereof after certain adjustments; and that if the dealers failed to repurchase such defaulted paper within ten days after such demand, and in certain other eventualities, such as a dealer becoming insolvent, etc., then the dealers would, on demand, repurchase from petitioner all of the discounted paper, paying the aggregate unpaid principal amount 1945 U.S. Tax Ct. LEXIS 195">*227 thereof after certain adjustments, and in case such demand was not complied with in ten days the petitioner might after ten days notice sell or assign the paper and apply the net proceeds against the amounts owing to the petitioner, any deficiency resulting therefrom to be paid by the dealers and the dealers being entitled to any surplus.
The transactions between petitioner and the dealers were carried on in compliance with the covering contract. The petitioner made the initial advances of 70 percent, less its charges, upon acceptance of the paper and made payment of the remaining 30 percent of installments on the tenth of the month following that in which collections of the installments were made and not until after such collection.
We think the above enumerated provisions of the contract and the conduct of the parties thereunder are controlling as to the character of the transactions between petitioner and the dealers, and it is our opinion that those transactions by which the paper in question was received by petitioner from the dealers constituted loans collaterally secured by the paper, and not a sale of such paper, as is contended by petitioner. This would seem to be so clear 1945 U.S. Tax Ct. LEXIS 195">*228 as to need no further comment, under the authority of National Trust & Credit Co. v. Orcutt & Son Co., 259 F. 830; National Discount Co. v. Evans, 272 F. 570; Sponge Exchange Bank v. Commercial Credit Co., 263 F. 20; Le Sueur v. Manufacturers' Finance Co., 285 F. 490; Brierley v. Commercial Credit Co., 43 Fed. (2d) 730, affirming 43 Fed. (2d) 724; In re Gotham Can Co., 48 Fed. (2d) 540; Cf. Home Bond Co. v. McChesney, 239 U.S. 568">239 U.S. 568; and Commercial Security Co. v. Holcombe, 262 F. 657, in which cases transactions similar in all material respects to the ones here involved were held to be loans rather than sales.
While most of the cited cases considered the question of whether the transactions involved represented sales or loans as such question related to whether or not certain amounts charged on sums paid for paper or accounts constituted usury, it can be said here, as was said in Gotham Can Co., supra, in which case there was no question of usury, but merely a question of whether certain transactions constituted sales of accounts or collateral loans: "In decisions construing usury statutes contracts of this kind have uniformly been held to be collateral loans. We see no reason 1945 U.S. Tax Ct. LEXIS 195">*229 to give them any other interpretation here."
4 T.C. 1069">*1084 The provisions in the contracts whereby in certain eventualities the dealers were to repurchase the paper from petitioner in no wise stamp the transactions by which the paper was received by petitioner as a sale. A contrary result follows as to such provisions when they are considered in connection with the other provisions of the contracts. 239 U.S. 568">Home Bond Co. v. McChesney, supra;Le Sueur v. Manufacturers' Finance Co., supra;National Discount Co. v. Evans, supra; and Commercial Security Co. v. Holcombe, supra.
Western Acceptance Corporation, 46 B. T. A. 828, upon which petitioner relies as on "all fours" with the instant case is distinguishable, inter alia, in that the finance company in that case, upon receipt of the conditional sales contracts, paid the dealer the full cash price of the car and acquired the dealer's contract with the dealer's customer, purchaser of the car, who was to pay a greater amount than the full cash price of the car in periodic installments. The dealer was never to receive anything further than the initial cash payment made by the finance company. Here, the petitioner advanced to the dealers only 70 percent of 1945 U.S. Tax Ct. LEXIS 195">*230 the face value of the installment notes, less petitioner's charges, while the balance of 30 percent was to be, and was, paid to the dealers only after the collection of the notes from the original makers thereof. The fact that part of an amount agreed to be paid for conditional sales contracts is to be paid only after collections of the amounts due on such contracts are made has been considered as an important factor by the courts in determining whether a transaction is a loan or a sale. In Home Bond Co. v. McChesney, 239 U.S. 568">239 U.S. 568, 239 U.S. 568">575, where accounts receivable were transferred to a finance company under a contract providing for the payment in cash, at the time of the transfer, of a certain percentage of the face value of the accounts and for payments of the balance of their face value only after the collection of the accounts, the court in enumerating the factors which supported its conclusion that the transactions were really loans with the accounts receivable transferred as collateral security, stated, as one of the determining factors, the following: "What is claimed to have been deferred payment of the purchase price was simply a return to the bankrupt [transferor of the accounts] 1945 U.S. Tax Ct. LEXIS 195">*231 of the excess of the collection over and above the advance and discount; * * *." In Sponge Exchange Bank v. Commercial Credit Co., supra, a bank under a contract with a credit company agreed to transfer by endorsement to the credit company certain notes which had been transferred through endorsement to the bank by a supply company. These notes represented accounts which were due the supply company from its customers and had been executed by the customers to the supply company as payee. The credit company agreed to pay the bank 100 percent of the face amount of the notes, of which 4 T.C. 1069">*1085 77 percent was to be advanced in cash upon acceptance of the notes by the credit company and the remaining 23 percent, less certain adjustments, was to be paid the bank immediately upon payment by the makers of such notes to the credit company. The court, in holding that the arrangement constituted a loan and not a sale, said:
The collection by the credit company of the amount called for by a note so acquired would not entitle it to retain that amount if it exceeded the sum of the advance, or advances [77%] * * *. The acquisition by the credit company of a note in the manner provided for was essentially 1945 U.S. Tax Ct. LEXIS 195">*232 different from a purchase. That there was no sale follows from the fact that the endorsing payee was not divested of ownership. Neither the bank nor the credit company became entitled as owner to the amount paid in satisfaction of a note. * * * When by the terms of a transaction by which an endorsee acquires a note he is required to pay, or account, to the endorser for, so much of what is collected on it as is in excess of an amount advanced * * * the transaction is not the sale of a note and the endorsee is not the buyer of it.
See also National Trust & Credit Co. v. Orcutt & Son Co., supra; Brierley v. Commercial Credit Co., supra; Commercial Security Co. v. Holcombe, supra; and In re Gotham Can Co., supra.We think the authorities above cited establish the principle that where, as here, part of the amounts paid for accounts or paper is to be paid only after such accounts, or papers, are collected, such factor is a vital one in determining whether the transaction constituted a loan or a sale; and that the presence of such a factor in this case and the absence thereof in the Western Acceptance Co. case clearly distinguish the two cases.
The other cases cited by petitioner are not 1945 U.S. Tax Ct. LEXIS 195">*233 apposite.
Since the filing of the briefs in this case this Court has decided the case of Elk Discount Corporation, 4 T.C. 196, and the holding in that case is also distinguishable from the instant case in the same manner as is the Western Acceptance Co. case.
Having decided that the transactions here involved constituted loans, the question remains of whether the amounts received by petitioner as compensation for such loans constitute interest in whole or in part.
Paragraph fourth of the Maxwell Co. contract provides that petitioner should receive, as its total compensation for the rendering of all services and other considerations, an amount equal to 1.2 percent per month of the net balance scheduled to become due on the paper each month. Corresponding provisions of the contracts with the other dealers differ with this paragraph only as to the rate of compensation, those other contracts providing compensation of 8 percent of the net face amount of the paper from the date of its acquisition to the date of payment.
Under paragraph third of the Maxwell Co. contract and under the agreements with the other dealers containing like provisions, petitioner 4 T.C. 1069">*1086 agreed to perform certain services, 1945 U.S. Tax Ct. LEXIS 195">*234 among others being to "place its collection department at disposal of the first party [the dealers] and endeavor to collect from debtors any paper discounted hereunder." The facts show that of the services enumerated in paragraph third of the Maxwell Co. contract and the other contracts the only substantial service rendered by petitioner was the collection of installments when a debtor did not insist on making his payments direct to the dealer. Assuming, without deciding, that the cost, or value, of such rendered services would not constitute interest, such fact would be of no avail to petitioner, since nowhere in the record is such cost, or value, shown. Only the total amount of the charges of 1.2 percent made and received by petitioner in the case of paper received by it under the Maxwell Co. contract and the total charges of 8 percent made and received by it under its contracts with the other dealers are shown and no allocation is shown as between the cost, or value, of petitioner's services for collection of the paper and amounts received by it as "other considerations" for making the advances. It is obvious that such "other considerations" constitute interest or compensation 1945 U.S. Tax Ct. LEXIS 195">*235 paid by the dealers for the use of petitioner's money. As was aptly stated in Brierley v. Commercial Credit Co., 43 Fed. (2d) 724, 727; affd. (C. C. A., 3d Cir.), 43 Fed. (2d) 730, "What it [dealers here] paid for the accommodation of getting the money from the credit company, [petitioner here] instead of having to wait to collect it from its customers, was really interest * * *."
On cross-examination, petitioner's president, when asked a question as to what "charges" were attributable to services rendered by the petitioner under its contracts, at first made no responsive answer to the question, but, instead, answered: "It isn't the cost of the services rendered, but the value of the services rendered." Upon insistence that the question be answered he said: "All of our cost of operation was reflected in the returns." The returns for both years involved show deductions claimed as to certain items in a lump sum for each item, such as for "compensation of officers," "salaries and wages," "rent," "taxes," "interest," "and other deductions authorized by law." These entries on the returns afford no information upon which the cost or value of any services rendered by petitioner under its 1945 U.S. Tax Ct. LEXIS 195">*236 contracts could be determined. There being nothing in the record upon which we could determine the cost or value of such "services" as we rendered by petitioner under its contracts with the dealers, we hold, even on the assumption stated above, that the entire amount received by petitioner under those contracts constituted interest and that the respondent did not err in determining petitioner to be a personal holding company and taxing it as such. Cf. Noteman v. Welch, 108 Fed. (2d) 206; and Seaboard Small Loan Corporation, 42 B. T. A. 715.
4 T.C. 1069">*1087 Issue 2.
In consequence of petitioner being a personal holding company in the taxable years and failing to file timely personal holding company returns for those years, the next issue is the question of whether petitioner is liable for the statutory penalty imposed for such failure under section 291 of the Internal Revenue Code. It is so liable under this section unless its failure is shown to have been "due to reasonable cause and not due to wilful neglect."
Petitioner urges that there was no negligence on its part in failing to timely file a personal holding company tax return, because it "had no knowledge of the fact it might be held a personal 1945 U.S. Tax Ct. LEXIS 195">*237 holding company until it was so advised by its accountant in December 1941 * * * and that upon being advised of the fact * * * it immediately filed personal holding company returns for the two years in question." The petitioner does not specifically urge that the failure to timely file the return was due to reasonable cause.
The most that can be said of the evidence introduced to show that petitioner's failure to timely file the returns was "due to reasonable cause" is that, shortly prior to December 13, 1941, the president and general manager of petitioner first had his attention called, by petitioner's accountant, to the fact that petitioner might be held to be a personal holding company. There is no evidence that petitioner prior to that time had sought advice, official or otherwise, as to whether or not it was a personal holding company. Under the circumstances, even though it be assumed that petitioner's officers were innocently mistaken as to the necessity for timely filing personal holding company returns, we nevertheless think that its delay in filing such returns is not shown to have been "due to reasonable cause," and we can not, therefore, hold that the penalty was improperly 1945 U.S. Tax Ct. LEXIS 195">*238 imposed; and this is so even if it might be said that the liability of petitioner for personal holding company tax was "by no means clear" at the times of its failures to timely file its personal holding company returns. West Side Tennis Club v. Commissioner, 111 Fed. (2d) 6, 9; Sabatini v. Commissioner, 98 Fed. (2d) 753; Fides v. Commissioner, 137 Fed. (2d) 731, affirming 47 B. T. A. 280; R. Simpson & Co., 44 B. T. A. 498, and authorities cited therein; and Seaboard Small Loan Corporation, supra.We hold as to the second issue that respondent did not err in imposing the penalties for the taxable years, except, as conceded by him, the penalty for the taxable year ended August 31, 1941, should be computed at the rate of 5 percent rather than at the rate of 25 percent as specified in the deficiency notice.
4 T.C. 1069">*1088 Issue 3.
The third issue is whether the petitioner is entitled to deductions of $ 2,567.92 for the fiscal year ended August 31, 1940, and $ 9,830.92 for the fiscal year ended August 31, 1941, as additions to a reserve for bad debts, under section 23 (k) of the Internal Revenue Code.
The petitioner began business at the end of March 1940, and after operating five months, or up to August 1945 U.S. Tax Ct. LEXIS 195">*239 31, 1940, it had discounted notes and conditional sales contracts for dealers of the face amount of $ 282,074.92 and had made direct loans, secured and unsecured, of $ 64,309.11. The amount of both classes of accounts outstanding at August 31, 1940, was $ 256,792, of which $ 37,059.23 consisted of direct loans. The petitioner's president and general manager estimated that 1 percent of this amount would be adequate to take care of possible losses on the outstanding accounts, and set up and deducted on the return for the fiscal year ended August 31, 1940, the sum of $ 2,567.92 as the petitioner's initial reserve. The respondent disallowed the deduction in its entirety on the ground that it was excessive.
The evidence shows that in the course of the petitioner's business some makers of the discounted notes and conditional sales contracts did default on their obligations, and, although the petitioner was entitled under its contracts with the dealers to reimbursement for losses resulting from such defaults and had the right to repossess the merchandise sold, we think that it was reasonable for the petitioner to anticipate losses on business of this character as well as on the direct loans. 1945 U.S. Tax Ct. LEXIS 195">*240 The amount of $ 2,567.92 does not seem to us to be an unreasonable estimate of possible losses on business of the volume shown by this record, and the reasonableness of that amount as an initial reserve is corroborated by the loss of $ 3,020.87 which was actually sustained by the petitioner in the ordinary course of its business in the following fiscal year, when the demand notes of Milton Properties, Inc., in that amount became valueless by reason of the foreclosure of its hotel property and that company was left without any assets and was indebted to the United States for $ 6,800 income taxes. In cases of this kind there must be clear proof that the action of the respondent is unreasonable. C. P. Ford & Co., 28 B. T. A. 156; Walter H. Goodrich & Co., 40 B. T. A. 960; Apex Brewing Co., 40 B. T. A. 1110. We think that respondent's action in not allowing any deduction for a reserve is unreasonable, and, on the facts here shown, we conclude that the deduction claimed by the petitioner for the fiscal year ended August 31, 1940, is fair and reasonable and should be allowed.
4 T.C. 1069">*1089 With respect to the following year, the fiscal year ended August 31, 1941, the evidence shows a great increase 1945 U.S. Tax Ct. LEXIS 195">*241 in the volume of business transacted by the petitioner and in the accounts outstanding at the close of the year. The direct loans made during that year were $ 375,786.13 as against $ 64,309.11 during the preceding year, and the direct loans outstanding increased from $ 37,059.23 at the beginning of the year to $ 215,669.44 at the close of the year. The evidence does not show the total amount of paper discounted during the year, but the petitioner's income tax return discloses that at the close of the year the petitioner's outstanding accounts receivable amounted to $ 717,808.07. In other words, the petitioner's outstanding accounts had increased during the year to the extent of over $ 460,000. We think that the recited facts justified an addition to the reserve in the amount of $ 9,830.92, and that the petitioner is entitled to a deduction of that amount for the fiscal year ended August 31, 1941.
Issue 4.
The fourth issue arose as a consequence of respondent's disallowance of petitioner's addition of $ 2,567.92 to its reserve for bad debts in the taxable year ended August 31, 1940, which addition to reserve we have sustained as reasonable under the third issue.
Respondent's disallowance 1945 U.S. Tax Ct. LEXIS 195">*242 of such addition to reserve eliminated it as a deduction from gross income in that year and converted the net loss of $ 739.92 reported by petitioner into a net income of $ 1,828. In consequence of the foregoing, respondent also disallowed the "net operating loss deduction" of $ 739.92 claimed by petitioner in its return for the taxable year ended August 31, 1941. As we have found under the third issue that the $ 2,567.92 addition to reserve for bad debts should have been allowed, that amount was properly deductible from gross income for the taxable year ended August 31, 1940, with the result that petitioner had an excess of deductions over gross income of $ 739.92 for that year, which amount it was entitled to deduct from its gross income for the taxable year ended August 31, 1941, as a net operating loss carry-over. Secs. 23 (s) and 122, I. R. C. We hold that respondent erred in denying that deduction.
Issue 5.
The fifth issue presented involves petitioner's contention that it is entitled to an additional excess profits tax credit of $ 35.50 for the fiscal year ended August 31, 1941, by reason of a claimed addition to invested capital in that year of $ 2,000 for a period of 81 1945 U.S. Tax Ct. LEXIS 195">*243 days.
4 T.C. 1069">*1090 Section 201 of the "Second Revenue Act of 1940" added a new subchapter to the Internal Revenue Code providing for an excess profits tax on certain corporations. Section 727 (e) of the Internal Revenue Code, 3 as thus amended, exempts personal holding companies from excess profits tax. We have determined under the first issue herein that petitioner was a personal holding company in the year involved. The fifth issue, involving the determination of an excess profits tax on petitioner, consequently presents a moot question and has become immaterial.
Issue 6.
Since we have held that petitioner is a personal holding company, we shall now consider, for the purpose of ascertaining the amount of its net income subject to personal holding company surtax for the fiscal year ended August 31, 1941, the sixth issue, which involves the computation of petitioner's "dividends paid credit."
Under section 27 (a) of the Internal Revenue Code, as operative during the taxable years, one of the components of the "dividends 1945 U.S. Tax Ct. LEXIS 195">*244 paid credit" is a corporation's "basic surtax credit" which as defined in section 27 (b) (1) includes "The dividends paid during the taxable year." Section 27 (f) provides that in computing the basic surtax credit the dividends paid include stock dividends which are a "taxable dividend in the hands of shareholders under section 115 (f)." 41945 U.S. Tax Ct. LEXIS 195">*245
Petitioner contends that all of the $ 3,400 dividend declared on March 1, 1941, and paid during the fiscal year ended August 31, 1941, should be included in its "dividends paid credit" instead of only the amount of $ 400 thereof, as allowed by respondent, and it further contends that the entire dividend of $ 20,400 declared and paid August 25, 1941, no part of which was allowed by respondent as a "dividends paid credit," 4 T.C. 1069">*1091 should be so allowed. Was the $ 3,000 paid in stock on the dividend declared March 1, 1941, a taxable dividend in the hands of the stockholders? The answer to the question depends on whether or not the shareholders had an election under section 115 (f) (2), supra, as to the medium in which the dividends were to be paid, i. e., whether in its stock or in money.
This dividend was paid pursuant to a resolution which provided in part "that the same be payable in cash or stock of the corporation. * * * the same to be paid from the surplus of the corporation or in capital stock of 1945 U.S. Tax Ct. LEXIS 195">*246 the corporation." One shareholder requested, and was paid, his dividend in cash, amounting to $ 400. Respondent allowed this as a deduction. The remaining shareholders requested, and were paid, their dividends in stock in the amount of $ 3,000, which amount respondent has not allowed as a deduction. It is obvious from the mere statement of these facts that the shareholders had and exercised their election "after" the "declaration" of the "distribution," in strict conformity with the terms of section 115 (f) (2), supra. This being true, the $ 3,000 paid in stock on the first dividend was a taxable dividend in the hands of the shareholders and should be included as dividends paid in computing the basic surtax credit for the purpose of determining petitioner's dividends paid credit. Cf. Capital Estates, Inc., 46 B. T. A. 986.
As to the dividend declared August 25, 1941, the resolution specifically provided that "the same be payable in stock of the corporation." No provision was made for payment in cash or for an election to receive cash. The entire dividend of $ 20,400 was declared and on the same day paid as a stock dividend. At all times petitioner had only one class of stock 1945 U.S. Tax Ct. LEXIS 195">*247 outstanding and that was common stock. That stock dividend consequently was not taxable to the shareholders receiving it, section 115 (f) (1), supra, and Eisner v. Macomber, 252 U.S. 189">252 U.S. 189; Helvering v. Griffiths, 318 U.S. 371">318 U.S. 371; Helvering v. Sprouse, 318 U.S. 604">318 U.S. 604, and is therefore not to be included as dividends paid in computing the basic surtax credit for the purpose of determining petitioner's dividends paid credit. Sec. 27 (i), I. R. C.5 The action of the respondent with respect thereto is sustained.
Decision will be entered under Rule 50.
Footnotes
1. Further personal holding company surtax occasioned by certain adjustments.↩
1. SEC. 501. DEFINITION OF PERSONAL HOLDING COMPANY.
(a) General Rule. -- For the purposes of this subchapter and chapter 1, the term "personal holding company" means any corporation if --
(1) Gross income requirement. -- At least 80 per centum of its gross income for the taxable year is personal holding company income as defined in section 502; but if the corporation is a personal holding company with respect to any taxable year beginning after December 31, 1936, then, for each subsequent taxable year, the minimum percentage shall be 70 per centum in lieu of 80 per centum, until a taxable year during the whole of the last half of which the stock ownership required by paragraph (2) does not exist, or until the expiration of three consecutive taxable years in each of which less than 70 per centum of the gross income is personal holding company income; and
(2) Stock ownership requirement. -- At any time during the last half of the taxable year more than 50 per centum is value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals.↩
2. SEC. 502. PERSONAL HOLDING COMPANY INCOME.
For the purposes of this subchapter the term "personal holding company income" means the portion of the gross income which consists of:
(a) Dividends, interest (other than interest constituting rent as defined in subsection (g), royalties (other than mineral, oil, or gas royalties), annuities.↩
3. SEC. 727. EXEMPT CORPORATIONS.
The following corporations shall be exempt from the tax imposed by this subchapter:
* * * *
(e) Personal-holding companies, as defined in section 501↩.
4. SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
(f) Stock Dividends. --
(1) General rule. -- A distribution made by a corporation to its shareholders in its stock or in rights to acquire its stock shall not be treated as a dividend to the extent that it does not constitute income to the shareholder within the meaning of the Sixteenth Amendment to the Constitution.
(2) Election of shareholders as to medium of payment. -- Whenever a distribution by a corporation is, at the election of any of the shareholders (whether exercised before or after the declaration thereof), payable either (A) in its stock or in rights to acquire its stock, of a class which if distributed without election would be exempt from tax under paragraph (1), or (B) in money or any other property (including its stock or in rights to acquire its stock, of a class which if distributed without election would not be exempt from tax under paragraph (1)), then the distribution shall constitute a taxable dividend in the hands of all shareholders, regardless of the medium in which paid.
5. SEC. 27. CORPORATION DIVIDENDS PAID CREDIT.
(i) Nontaxable Distributions. -- If any part of a distribution (including stock dividends and stock rights) is not a taxable dividend in the hands of such of the shareholders as are subject to taxation under this chapter for the period in which the distribution is made, such part shall not be included in computing the basic surtax credit.↩