*1233 The contracts under the stock subscription plan here involved being contracts of purchase and sale of stock and not contracts of employment, the difference between the subscription price of stock and its market value when issued is not deductible as additional compensation to employees; nor is the value of preferred stock issued in lieu of dividends deductible as additional compensation.
*1171 These proceedings were brought to redetermine deficiencies in the income taxes of the Gardner Governor Company for the year 1926 in the sum of $676.68 and of the Gardner-Denver Company for the year 1928 in the sum of $50,274.77. The Gardner Governor Company also claimed a refund of $12,403.13 and the Gardner-Denver Company an overpayment of $12,409.74.
The petitioners allege the following errors:
Docket No. 46459.
(1) Determining dividend credits on employees' stock subscriptions to be a contingent liability and not deductible as additional compensation to such employees.
(2) Denying a deduction from income of $91,875 on account of called preferred*1234 stock of petitioner held by employee under a stock subscription plan.
Docket No. 57652.
(1) Disallowing as a deduction and adding to the petitioner's income the sum of $328,799, representing the difference between the market price at time of issue and the subscription price of the common stock of the petitioner and its predecessor, issued to certain employees of the petitioner and claimed by it to be added compensation to such employees.
(2) The same question as in the second allegation of error above, but relating to the preferred stock issued to employees of the Denver Rock Drill Manufacturing Company.
*1172 In Docket No. 46549 the respondent affirmatively asserts that he erroneously deducted from the petitioner's gross income the sum of $5,548.02 representing interest paid by employees on the unpaid balance of their stock subscriptions.
In Docket No. 57652 the respondent asserts that he erroneously allowed as deductions the sum of $40,990.30 representing the amount of certain dividends paid to employees in connection with the purchase of corporate stocks and the sum of $2,560.82 representing interest on said dividends.
By amended answers he asks that*1235 the deficiency in each case be increased accordingly.
FINDINGS OF FACT.
Certain facts were stipulated substantially as follows:
The Gardner Governor Company is a corporation organized under the laws of the State of Illinois, in 1883, with its principal office in the city of Quincy, Illinois. On April 1, 1927, it had an authorized capital stock of $4,000,000, consisting of 20,000 shares of preferred stock of the par value of $100 per share, and 40,000 shares of common stock of the par value of $50 per share. On the same day there were outstanding 13,000 shares of preferred stock, which were not involved in any of the subscription agreements here considered. There were also outstanding 38,028 shares of common stock, which were not involved in any of the subscription agreements here considered.
The Denver Rock Drill Manufacturing Company is a corporation organized under the laws of the State of Delaware, in 1913, with its principal office in Denver, Colorado. On April 1, 1927, its authorized capital stock consisted of 5,500 shares of preferred stock of the par value of $100 per share, and 100,000 shares of common stock, having no par value. Of such authorized capital stock*1236 there were issued or subscribed on April 1, 1927, 4,500 shares of preferred stock and 80,271 shares of common stock.
Under date of June 30, 1927, the Gardner Governor Company and the Denver Rock Drill Manufacturing Company executed a memorandum of agreement, providing for the creation of a new corporation under the laws of the State of Delaware, to be known as the Gardner-Denver Company, to take over the business of the two companies.
All of the assets of the Gardner Governor Company were turned over to the Gardner-Denver Company except the following:
| Stocks and bonds | $783,271.81 |
| Accrued interest | 4,677.50 |
| Total withheld at date of merger | 787,949.31 |
*1173 All of the assets of the Denver Rock Drill Manufacturing Company were turned over to the Gardner-Denver Company.
Subsequent to the above reorganization, the two constituent companies retained their corporate existence. All of their capital stock excepting qualifying shares was taken over by the Gardner-Denver Company. The Gardner Governor Company and the Denver Rock Drill Manufacturing Company are still in existence and franchise taxes are paid annually on their behalf to the respective states*1237 under which they exist. The authorized capital stock of such companies has, however, been reduced in amount.
We find the following additional facts:
About June 1, 1923, certain selected employees of Gardner Governor Company were offered the opportunity of subscribing for a limited number of common shares of the company in accordance with the terms and conditions of a stock purchase plan. The offer made by the Gardner Governor Company to its employees was as follows:
THE GARDNER GOVERNOR COMPANY,
Quincy, Illinois.
To the employees of The Gardner Governor Company:
The Board of Directors of The Gardner Governor Company believing it to be in the common interest of the company and its employees, has arranged for the sale of shares of common stock to employees, and said stock is now offered by the company under the following terms and conditions:
First - All subscriptions shall be made upon the express condition and agreement that all questions concerning the said subscriptions, and the allotments and interests thereunder, shall be decided by the board of directors of The Gardner Governor Company in the discretion of the board and such decision shall be final and conclusive*1238 upon all parties.
Second - Subscriptions shall be for one or more shares of common stock at the purchase price of $55 per share.
Third - The right to subscribe for the stock as above is given to you personally and with the express understanding that until the stock shall be fully paid for by you and issued and delivered to you at the end of five years as hereinafter provided, you shall have no right to assign or transfer such stock or any dividend thereon, or any interest therein.
PAYMENT FOR STOCK.
FOURTH - Cash payments on the amount of stock to which an employee subscribes must be made at the minimum rate of $6.00 and is limited to $15 per share in any one year. Installments may be paid in cash - monthly, quarterly, semi-annually or annually. All cash dividends will be credited to the subscriber's account and any stock dividends will be retained and not delivered until the stock subscribed for is paid in full and said stock transferred and delivered as herein provided. Interest will be charged semi-annually on the first days of January and July in each year at the rate of 6% per annum on the full amount of the subscription price of stock. Credit will be given each*1239 subscriber for the full amount of his payments and cash dividends with 6% *1174 interest thereon from the time of such payment. As soon as payment has been fully made, but not before five years from date, the stock will be transferred to the subscriber and future dividends will go direct to the holder of such stock.
CANCELLATION REFUND OF INSTALLMENTS.
Fifth - Subscriptions may be cancelled any time at the request of the subscriber.
Subscriptions may be cancelled at the option of The Gardner Governor Company upon the subscriber leaving the service of the company or upon his discontinuance of the prescribed payments. The cancellation of a subscription forfeits all interest and benefits which the subscriber would have received if such subscription had been continued. Upon cancellation, there will be returned to the subscriber the full amount of all payments on the subscription so cancelled with interest at 6% per annum, no credit being given him for dividends and no interest being charged on deferred payments.
Should the subscriber complete the payment of $55.00 per share for all shares of stock subscribed before the five years of this agreement have expired, then*1240 the cash dividends on the subscriber's stock shall be paid to him in full from the date that payment for stock was completed. Title to the stock will not pass to purchaser until five years have elapsed from above agreement date.
The subscriber of the stock herein shall have no right to vote this stock or any part thereof at any stockholders' meeting until said stock is fully paid for and issued, transferred and delivered as herein provided and not before five years from the date hereof.
PERMANENT DISABILITY OR DEATH.
Sixth - If a subscriber is permanently disabled or dies while rendering faithful service and his subscription has not been paid in full, The Gardner Governor Company will pay to him or his estate the money theretofore paid in by him on account, together with the cash dividends paid on the stock subscribed for less interest at 6% per annum on unpaid subscription price.
LIMITS OF SUBSCRIPTION.
Seventh - Subscriptions will be received until .
You have been alloted shares, but may subscribe for any less number. In the event of an oversubscription, the board of directors reserve the right to change the allotment to bring the total shares subscribed within*1241 the limits of stock available.
A subscription blank is herewith enclosed on which you will please indicate the number of shares of your allotment you wish to subscribe for.
THE GARDNER GOVERNOR COMPANY,
Treasurer.
To
The employees who desired to accept the stock offered to them on this plan, did so by signing an acceptance which was worded as follows:
*1175 TO THE GARDNER GOVERNOR COMPANY,
Quincy, Ill.
Upon the terms and conditions of your stock purchase plan a copy of which is hereto attached, I hereby subscribe for shares of the common stock of The Gardner Governor Company, and agree to pay to said company $ per share therefor, upon the terms and conditions set forth in said stock purchase plan hereto attached and made a part hereof.
I hereby authorized The Gardner Governor Company to deduct and to apply in payment for such common stock the sum of $ per month out of my wages or salary until I have given notice to the contrary; hereby reserving the right to increase or decrease the amount of such deduction at my pleasure, within the limits stated.
Signature Dated 19These contracts were handled on the books of the Gardner Governor*1242 Company as the 1923 stock subscription accounts. Under this plan, which went into effect as of July 1, 1923, 23 employees originally subscribed for a total of 535 shares of common stock, while in 1925 the company permitted two employees to subscribe for 35 and 50 shares, respectively.
The individual stock subscription accounts were charged with the stock subscribed for on the basis of $55 per share. These accounts were credited with any cash payments or deductions from wages, and they were also credited with an amount measured by the dividends paid on other stock at each common stock dividend date. On July 1 and January 1 of each year, the subscription accounts were charged with interest at 6 per cent on the full amount of the subscription price of the stock, being credited with interest at 6 per cent on all payments made on the accounts, and also being credited with interest at 6 per cent on all dividends credited to the accounts.On December 24, 1924, the officers of the Gardner Governor Company gave each subscriber credit for an amount equal to $5 on each share of stock subscribed for as a bonus and an appreciation of the action of the employees in subscribing for*1243 common stock of the company.
In the latter part of 1925 the company again offered a selected group of their employees the opportunity of subscribing for shares of the common stock of the company on a stock subscription contract similar to the 1923 contract. The price of the stock, however, was to be $72 per share. These contracts were handled in the same manner as the 1923 accounts. Under the 1925 offering there were 26 subscribers for a total of 374 shares of common stock.In 1926 the officers of the Gardner Governor Company offered a much larger selected group of employees an opportunity of subscribing to the common stock of the company under a stock subscription *1176 contract identical with their 1923 and 1925 contracts except that the price was to be $85 per share. The 1926 plan went into effect on April 1, 1926. Under this plan 711 shares of common stock were subscribed for by 84 individual subscribers. The handling of this stock subscription on the books of the Gardner Governor Company was identical with the handling of the 1923 and 1925 contracts.
On May 8, 1926, at a special meeting of the board of directors of the Gardner Governor Company,*1244 the following resolutions were passed:
RESOLVED, whereas from the books of accounts of the corporation, it appears there is a surplus in excess of $2,000,000 the directors hereby declare a stock dividend of 20,000 shares of 7% cumulative preferred stock of $100.00 par value to the owners of record on May 15th of the 40,000 shares of $50.00 par value common stock, this preferred stock to be retirable on May 15th, 1926, at $105.00 per share, or if called at a later date at $105.00 per share with accrued dividends from payment of last dividend; and be it further RESOLVED, that notice be sent to all holders of 550 shares and less that their stock is hereby called as of May 15, 1926.This stock dividend applied to the stock subscription accounts as well as to other common stock. However, since the crediting of the call value of this preferred stock to the stock subscription accounts at $105 per share would have caused practically all of the 1923, 1925 and 1926 stock subscription accounts to be paid up in full, thereby making cash dividends payable, the call value of the preferred stock was not credited to the employees' stock subscriptions on the books of the Gardner*1245 Governor Company. In lieu thereof a memorandum of the amount due each stock subscriber was made. After May 15, 1926, whenever a preferred stock dividend was paid in cash to the holders of other preferred stock, the employees' stock subscription accounts were credited with an amount measured by the dividends paid on such other stock.
At the time of the consolidation of the Gardner Governor Company and the Denver Rock Drill Manufacturing Company the officers of the Gardner Governor Company elected to retain its liability to the subscribing stockholders on account of the stock dividend of May 8, 1926, and withheld from the consolidation $87,000 in cash and certain stocks and bonds, on which they had an unrealized book profit of approximately $60,000, turning into the new company, in lieu of the stocks and bonds, an amount in cash equal to the book value of these stocks and bonds. J. W. Gardner was named as trustee for the Gardner Governor Company stockholders. Gardner immediately sold a portion of the stocks and bonds, which they held out of the consolidation, and with the proceeds and the $87,000 cash purchased preferred stock of the Gardner-Denver Company in the open market*1246 *1177 and held this preferred stock in trust for the employees of the former Gardner Governor Company, to take care of the called preferred stock due those employees when their common stock should be fully paid for and deliverable at the end of the subscription contracts.
From the time the Gardner Governor Company assumed the liability in respect to the preferred stock, whenever a preferred stock dividend was paid to the other holders of the preferred stock the employee subscribers were credited with an amount measured by the dividends paid on the other preferred stock. These credits given to the employees of the Gardner Governor Company on the Gardner-Denver Company books on the preferred dividend accounts were then charged to the Gardner Governor Company, but these credits were offset by dividends paid the trustee of the stockholders on the preferred stock, which was held in trust for the employees of the Gardner Governor Company.The subscribers to the stock of the Gardner Governor Company were allocated the same number of shares in the Gardner-Denver Company as other stockholders of the former, namely, 2.6 shares of common stock of the Gardner-Denver Company*1247 for each share of common stock of the Gardner Governor Company.
On July 1, 1927, a limited number of employees of the Gardner Governor Company were again given the opportunity to subscribe for shares of the common stock of the Gardner Governor Company on a stock subscription plan identical with the former plans, with the exception that the price was $90 per share. The handling of this stock subscription account was identical with the other subscription accounts on the books of the Gardner Governor Company.On July 1, 1928, the five years of the 1923 stock subscription account having expired, and the subscribers to the 1923 stock subscription accounts having expressed a desire to receive preferred stock of the Gardner-Denver Company in lieu of the call value of the preferred stock of the Gardner Governor Company due them on account of dividends, J. W. Gardner, trustee for the Gardner Governor Company's stockholders, transferred the proper number of shares of preferred stock to the individual subscribers of the 1923 stock subscription offering. At the same time they also received the common stock to which they were entitled, based on the distribution of 2.6 shares of*1248 the Gardner-Denver Company common stock for each share of Gardner Governor Company common stock subscribed for.
On November 1, 1928, the following resolution was passed by the board of directors of the Gardner-Denver Company:RESOLVED, that certificates of stock be issued to all the subscribers to the common stock of this company in the amounts as shown by said subscriptions, and which have been fully paid as of the date of December 10, 1928, and that *1178 as other subscriptions mature and become fully paid, certificates of stock be issued to subscribers in the amounts as shown by said subscriptions, both as to common and as to preferred stock allotted to said subscribers.
In accordance with this resolution, the common stock to which they were entitled was issued to the subscribing employees of Gardner Governor Company, the stock subscription accounts of such employees were credited with the call value of the preferred stock held for them by J. W. Gardner, trustee, this amount being charged to treasury stock on the books of the Gardner-Denver Company and the stock turned over to the Gardner-Denver Company for cancelation.ncome Any balance due on the*1249 stock subscription accounts of the Gardner Governor Company stock subscribers was paid in cash by the subscribers, or if their accounts were overpaid, the company refunded the overpayment and the accounts were closed on the books of the company.
In 1923 common stock of the Gardner Governor Company was sold outright to J. W. Gardner, president, Henry W. Lehbrink, works-manager, and Ralph G. Governor, secretary and treasurer, at the same price as that contained in the stock subscription agreement with the employees. Dividends paid on the stock so sold to the said individuals were not treated as compensation nor were deductions claimed for such payments. In the 1923 stock subscription accounts, there was only one cancelation. In the 1925 stock subscriptions there were no cancelations. As to the 1926 stock subscriptions there were three cancelations and some transfers from stockholders leaving the employ of the company to other employees.On the books of the Gardner Governor Company the stock purchase contracts were treated as assets and were styled "Employees' instalment subscription accounts receivable stock." Interest charges on the contracts were also designated*1250 as assets. Payments on such contracts were classed as liabilities and were listed as "Employees' cash payments on Subscription Stock." Likewise, there were included among the petitioner's liabilities the following items:
Interest credits on cash payments Subscription Stock Dividend credits on Employees' Installment Accounts Receivable Stock Interest Credits on Dividend Credits Stock Preferred Stock - Stock Dividend on Subscriptions Common Stock - subscribed In December, 1925, a similar plan of offering stock ownership to employees was adopted by the Denver Rock Drill Manufacturing Company.The original subscription to stock of the Denver Rock Drill Manufacturing Company was made in the latter part of 1925, being *1179 entered on the books of the Denver Rock Drill Manufacturing Company in January, 1926. Under the original subscription 106 employees of the Denver Rock Drill Manufacturing Company subscribed for 11,953 shares of common stock of the company at a price of $23 per share.
During the period from August 1, 1926, to December 31, 1926, under this same subscription plan, 100 shares of common stock were subscribed for*1251 at $27 per share, 50 shares at $27.50 per share, and 355 shares at $30 per share. During the year 1927, 100 shares of common stock were subscribed for at $30 per share, 40 shares at $45 per share, and 50 shares at $40 per share, under this same subscription plan. There were no cancelations on any of these subscriptions except the $23 stock, on which there were cancelations of 819 shares in 1926 and 1,040 shares in 1927.
To record these transactions on the books of the Denver Rock Drill Manufacturing Company, "Employees' Installment Accounts Receivable" were debited for the contract price of the common stock subscribed for. Treasury stock for "Employees' Installment Subscriptions" was credited with the cost of this stock when it was bought in for the treasury, and "Anticipated Earned Surplus" was credited with the excess of contract price over cost. "Accounts Receivable Special" was debited with the monthly payments due on all stock subscription accounts. "Employees' Stock Subscription Credits' was credited with the portion of the monthly payments on stock subscription accounts which applied to principal. "Interest Received" was credited with the interest portion of the*1252 monthly payments. "Accounts Receivable Special" was credited with all cash payments or all deductions from salaries or wages of the employees. "Employees' Dividend Reserve" was credited with an amount equal to dividends paid on common stock at each dividend date payable.
Pursuant to the resolution of November 1, 1928, passed by the directors of the Gardner-Denver Company, the stock subscription accounts of many of the employees of the Denver Rock Drill Manufacturing Company were credited with the preferred stock allotted to them on the basis of one-tenth of one share for each share of common stock subscribed for, credit being allowed on the basis of $105 per share. On any stock subscriptions of the Denver Rock Drill Manufacturing Company where the employee did not wish to have the preferred stock applied to his stock subscription account, he was allowed to pay up his stock subscription account in cash, and receive in addition to the common stock the preferred stock on the basis of one-tenth of one share for each share of common. Stock subscriptions of the Denver Rock Drill Manufacturing Company *1180 representing 9,849 shares of common stock were fully paid for,*1253 and the common stock of the Gardner-Denver Company was issued therefor on December 10, 1928. On the same 9,849 shares of common stock, the preferred stock to which they were entitled was credited to the individual stock subscription accounts on the basis of $105 per share.
The balance of the common stock of the Gardner-Denver Company due subscribers to the common stock of the Denver Rock Drill Manufacturing Company was issued during the year 1929 and amounted to 940 shares. The preferred stock to which the subscribers to the 940 shares of common stock were entitled was either applied to their stock subscription accounts or was issued to the employees at the time the common stock was issued. In the merger the Gardner-Denver Company assumed the liabilities of the Gardner Governor Company and the Denver Rock Drill Manufacturing Company except as above indicated, including the agreement to issue stock to the subscribers to the stock of both merged companies.In 1929 the Gardner-Denver Company made an offer to and agreement with its employees for the purchase of stock, similar to those made by the Gardner Governor Company in 1923, 1925, 1926 and 1927, but, due to*1254 the decline in the price of the stock to a point below the subscription price, the plan was canceled and the subscription installments returned to the subscribers.
During the operation of the stock subscription plan in both the Gardner Governor Company and the Denver Rock Drill Manufacturing Company there was very little labor turnover and there were no labor troubles. At the time the stock was offered under the subscription plans there was no necessity of raising additional capital. The stock subscription plans of the petitioners were modeled after similar ones used by the Ingersoll-Rand Company, the United States Steel Corporation, and others. The petitioner, Gardner-Denver Company, kept its accounts and made its return on the accrual basis.On filing its original return for the year 1926 the Gardner Governor Company did not claim as a deduction the value of the preferred stock issued as a stock dividend and credited to the accounts of the employee subscribers to the common stock of that corporation. On June 15, 1928, this petitioner filed a claim for refund covering the cost of the stock so issued as additional compensation to employees. The amount*1255 so determined was $91,875. The respondent disallowed the claim on the ground that such credits were a contingent liability.
*1181 Based on an opinion rendered by the general counsel of the Bureau of Internal Revenue, the petitioner, the Gardner-Denver Company, in its return for 1928 treated the value of the preferred stock callable under the 1923, 1925 and 1926 stock subscription agreements and the difference between the contract and the market price at the time of issue of the common stock as compensation of employees deductible for income tax purposes. Accordingly, it took a deduction of $471,561.74 as "Special compensation paid employees in stock." Respondent disallowed $420,674 of the item. He now contends that he erroneously allowed other deductions of $43,551.12. OPINION.VAN FOSSAN: The underlying question in the cases before us is whether or not the issuance of the common and preferred stock of petitioners was pursuant to a sale of stock to employees or was the payment of additional compensation. This question can be answered only by determining whether the stock subscription plan was essentially a contract of purchase and sale or a contract*1256 of employment. ; . If the former, then the deductions are not allowable in any event. If the latter, then totally different considerations govern.
The offer made by the companies and the acceptances by the employees together constituted the contracts under which the stock subscriptions were made and stock later issued. On its face the contract contains all of the essentials of an agreement of purchase and sale. It speaks specifically in terms usually employed to connote a sale. There was an offer to sell and an agreement to subscribe and pay for. The price was definitely fixed, being approximately the then market price. Payments were to be made by deductions from wages. Cash dividends were to be credited to the subscriber's account conditionally, the employee losing his claim to such dividends if he failed to complete the purchase or if the subscription was canceled. Sales of the same stock were made to the officers of the company at the same price as employees, but there is no claim that such stock or the dividends thereon were additional compensation to such officers.
*1257 Though terminology is not conclusive of the intent of the parties (), if supported by similar collateral evidences and circumstances it is a fact of weight. The collateral evidences all support the conclusion that the contract was one of purchase and sale. There is no evidence that in 1923 when the plan was started either the employees or the company considered the stock or its earnings as additional compensation. The face of the contract making a prima facie case of *1182 purchase and sale, the burden was on the petitioners to show that the situation was otherwise. This they failed to do. For aught the record shows the employees were, previous to 1923, adequately paid and were happy in their employment. There is no evidence that the plan reduced petitioners' labor overturn. There was not a suggestion at the inception of the plan that it was a veiled policy of paying additional compensation.
Nor is the fundamental legal character of the plan to be controlled by the fact that certain benefits flowed to the employer under its operations. There were obvious mutual benefits to employer and*1258 employee alike.
On the corporate books the employee contracts were treated as assets and the interest paid thereon by the employee as income. Likewise, all credits of cash, dividends and interest were listed as liabilities. The common stock held to complete the subscription contracts was also classed as a liability, being placed in the same category as other stock of the corporations.
On the record before us we are of the opinion that the stock subscriptions, under the plans in question, constituted contracts of purchase and sale and not employment contracts.
The above conclusion disposes of the contention that petitioners should be permitted to deduct the difference between the contract price and the market price at the time issued. It likewise disposes of the contention as to dividends and the preferred stock issued on account thereof.
The interest amounting to $5,548.02, paid by the employees on account of the deferred payments on subscription contracts, was income to the petitioners and should be accounted for as such. The item of interest amounting to $2,560.84 credited by petitioner, the Gardner-Denver Company, on dividends credited but not paid was an accrual*1259 of interest due for money borrowed and was an allowable deduction. The company kept its accounts and made its return on the accrual basis.
Reviewed by the Board.
Decision will be entered under Rule 50.