*10 Decisions will be entered under Rule 50.
1. Petitioners are a parent corporation and two subsidiaries. During 1933 because of financial difficulties the stockholders of the parent corporation agreed to turn the management of all three corporations over to three voting trustees, two of whom were large creditors of the parent company. On April 1, 1933, the parent company entered into a four-party agreement, the substance of which was that in consideration for an extension by the creditors of payment of liabilities the parent company would within thirty days "After the close of each calendar year" determine the net profits of the parent company and pay over 60 percent of such net profits proportionately to the creditors. On May 12, 1933, the three voting trustees agreed among themselves not to pay any dividend "except with the unanimous consent" of all three voting trustees. Held, in computing the surtax on undistributed profits under section 14 of the Revenue Act of 1936, as amended by section 501 of the Revenue Act of 1942, petitioners are not entitled to any credit under either section 26 (c) (1) or section 26 (c) (2) of the same act as amended by section 501 of the Revenue*11 Act of 1942.
2. In 1928 petitioner (Ahrens Publishing Co.) purchased at the top of the market the stock of another corporation, partly on credit. Thereafter the purchased stock continuously depreciated in value. In 1933 petitioner sought a reduction of the purchase price of the stock, but failed. It then gave a note for the unpaid balance. In 1937 the seller agreed to accept $ 6,200 less than the balance due on the note in full settlement thereof. Petitioner was solvent at the time. Held, petitioner did not realize any taxable income from the settlement in 1937. Hirsch v. Commissioner, 115 Fed. (2d) 656, and Helvering v. Killian Co., 128 Fed. (2d) 433, followed.
*346 These proceedings, duly consolidated for hearing, involve deficiencies in income tax determined by the respondent against petitioners for the years 1936 and 1937, as follows:
| Deficiency | |||
| Petitioner | Docket No. | ||
| 1936 | 1937 | ||
| Gehring Publishing Co | 107046 | $ 1,306.17 | $ 207.59 |
| Ahrens Publishing Co | 107047 | 5,511.22 | 8,979.51 |
| Restaurant Publications, Inc | 107048 | 912.01 | 206.07 |
*12 In a statement attached to each deficiency notice each petitioner was advised that, under section 26 of the Revenue Act of 1936, for the years 1936 and 1937: "It is held that no credit is allowable under the provisions of section 26 (c) (1) and (2) in computing the surtax on undistributed profits." By appropriate assignments of error each petitioner has contested that holding.
In the statements attached to the respective deficiency notices the respondent also made adjustments to the net income of petitioners for one or both years, respectively, which adjustments, except one, are not contested. The contested adjustment occurs in the statement attached to the deficiency notice addressed to the Ahrens Publishing Co., for the year 1937, wherein the respondent determined "additional income" in the nature of "Gain realized from settlement of a debt for less than its full amount" of $ 6,200, explained as follows: "It is held that the gain of $ 6,200.00 was realized in the year 1937 in settlement of a debt of $ 26,000.00 due the Bohn Estate for $ 19,800.00." By an appropriate assignment of error petitioner Ahrens Publishing Co. contests that adjustment.
Each petitioner also alleges that *13 the respondent erred in not finding an overpayment of tax for the years 1936 and 1937, respectively.
FINDINGS OF FACT.
The petitioners, Gehring Publishing Co., Ahrens Publishing Co., and Restaurant Publications, Inc., are corporations organized under the laws of the State of New York and are engaged in the business of publishing trade periodicals. (These petitioners will sometimes hereinafter be referred to as Gehring, Ahrens, and Restaurant, respectively.) *347 Petitioners filed their corporate income and excess profits tax returns for the calendar years 1936 and 1937 with the collector of internal revenue for the third collection district of New York.
Ahrens is, and was during each of the taxable years 1936 and 1937, the parent company of Gehring and Restaurant, owning all of the outstanding common stock of Gehring and all of the outstanding voting common stock of Restaurant.
Ahrens and its subsidiaries, Gehring and Restaurant, filed consolidated income tax returns for the year 1933 and for several years prior thereto, as permitted by the applicable law then in effect.
In the early part of 1933, after the financial position of Ahrens had become insecure by reason of operating*14 losses and its inability to meet its obligations when due, it became apparent that some arrangement would have to be worked out with the creditors whereby it could be permitted to continue in business.
On April 1, 1933, a voting trust agreement was entered into between E. H. Ahrens and certain other individuals holding a majority of the outstanding voting stock of the Ahrens Publishing Co., who were referred to therein as the "Stockholders," and A. M. Adams, E. H. Ahrens, and W. C. Gehring as "Trustees." The substance of this agreement was that the majority stockholders of Ahrens agreed to surrender their stock in Ahrens to the trustees for a period of ten years or until the then present indebtedness of Ahrens would be paid, and to amend the bylaws of Ahrens so as to reduce the number of directors of Ahrens and any of its subsidiaries to three and to cause to be elected as directors thereof the said three trustees. Each stockholder who thus surrendered his stock was given a certificate issued by the trustees for the number of shares thus surrendered. The certificate, among other things, provided that upon the expiration of the voting trust agreement the shares would be returned *15 to the stockholder "and in the meantime" the stockholder "shall be entitled to receive payments equal to any dividends that may be collected by the undersigned trustees upon a like number of such shares held by him under the terms of the trust agreement aforesaid."
On the same day, April 1, 1933, a written agreement was entered into between Ahrens, referred to therein as the "Publisher," party of the first part, the Gehring estate, party of the second part, other creditors of the publisher, including the Bohn estate, parties of the third part, and the three voting trustees, parties of the fourth part. This agreement provided, in part, as follows:
Whereas, the Publisher, although solvent, is unable to pay its indebtedness to its creditors at this time, or as it falls due, and desires an extension of time in which to pay such indebtedness in full and with interest as herein provided; and
*348 Whereas, a majority of the stockholders of the Publisher, entitled to vote, have entered into a voting trust agreement, selecting as voting trustees the parties of the fourth part, with a view to reducing expenses and protecting all creditors;
Now, Therefore, in consideration of the mutual*16 promises hereinafter contained and other valuable considerations, the parties hereto agree as follows:
1. The Publisher will deliver to each of the parties of the third part a promissory note * * *.
2. The Publisher agrees to pay, and the parties of the third part agree to accept payment of the principal amount of the said notes on the following basis:
After the close of each calendar year, the net profits of the Publisher will be determined within thirty (30) days. The Publisher will then pay over to each holder of the said notes, upon presentation thereof for endorsement, his pro rata share in an aggregate of sixty per cent of the said net profits; and the Publisher will continue so to do until each note has been satisfied in full with interest, at which time this agreement shall terminate as to such note holder.
* * * *
On May 12, 1933, a special meeting of the stockholders of Ahrens was held, at which it was agreed that the corporation's affairs would be entrusted to the voting trustees and a resolution was passed authorizing the interchange of funds in the bank accounts of Ahrens and its subsidiaries and vice versa for financial purposes.
Under date of May 12, 1933, it was agreed*17 by the three voting trustees that as directors and voting trustees of Ahrens they would not declare, or cause to be declared, or permit to be declared any dividend upon any of the outstanding stock of Ahrens, or any of its subsidiaries, except with the unanimous consent of all three of the voting trustees. This agreement was in the form of a letter addressed to William C. Gehring by E. H. Ahrens and A. M. Adams, and William C. Gehring affixed his signature thereto as evidence of his acceptance.
Payments of principal were made to the principal creditors of Ahrens as follows:
| Gehring | Bohn | Trade | |
| estate | estate | creditors | |
| March 24, 1933, balance owed | $ 112,000.00 | $ 26,000.00 | $ 43,486.16 |
| Jan. 31, 1935, paid | 6,013.42 | ||
| Jan. 1, 1936, balance owed | 112,000.00 | 26,000.00 | 37,472.74 |
| Jan. 1, 1936, adjusted | 655.80 | ||
| Jan. 31, 1936, paid | 7,845.79 | ||
| July 31, 1936, paid | 14,813.46 | ||
| Sept. 30, 1936, paid | 14,813.49 | ||
| Dec. 31, 1936, paid | 1,500.00 | ||
| Jan. 1, 1937, balance owed | 111,344.20 | 24,500.00 | None |
| Jan. 31, 1937, paid | 18,300.00 | ||
| Jan. 31, 1937, adjusted | 6,200.00 | ||
| May 31, 1937, paid | 16,344.20 | ||
| Jan. 1, 1938, balance owed | 95,000.00 | None | None |
| Jan. 1938, paid | 10,000.00 | ||
| Jan. 1, 1939, balance owed | 85,000.00 | None | None |
*18 On July 27, 1936, E. H. Ahrens, as president of the Ahrens Publishing Co., addressed a letter to each of the trade creditors, advising *349 them, among other things, that "Operations since the first of the year have been sufficiently satisfactory to warrant a payment on your note in advance of the regular date at the end of the year" and that one-half of the balance, with interest, would be paid "Upon presentation of your note by your representative or through your bank."
On September 11, 1936, E. H. Ahrens, as president of the Ahrens Publishing Co., addressed a letter to each of the trade creditors, advising them, among other things, that "It is a pleasure to advise you that we will make final payment on your note of April 1, 1933."
Any part of the stipulation of facts filed in these proceedings not specifically set forth herein is incorporated herein by reference and made a part of these findings of fact.
The remaining findings concern only the $ 6,200 question, and are applicable only to the tax liability of the Ahrens Publishing Co. for the year 1937.
In 1928, the Ahrens Publishing Co. purchased from the Bohn estate at the top of the market the stock of the Hotel World Publishing*19 Co. for a consideration of $ 40,000. Thereafter that stock depreciated in value on account of the corporation continually having losses and the stock continued to depreciate in value until the liquidation of the Hotel World Publishing Co. by petitioner in 1939. Payments totaling $ 14,000 were made for this stock, leaving a balance due the Bohn estate in 1931 of $ 26,000. At or about the time the above mentioned creditors' agreement of April 1, 1933, was entered into, petitioner's president, E. H. Ahrens, had several conferences with a representative of the Bohn estate with a view to persuading the Bohn estate to reduce the amount which the petitioner still owed them for the stock purchased in 1928. These conferences failed for the reason that the Bohn estate insisted on receiving the full contract price agreed upon in 1928. Petitioner then gave the Bohn estate its promissory note for the amount of $ 26,000, and the latter became a party to the above mentioned creditors' agreement of April 1, 1933.
In 1936 E. H. Ahrens again had several conferences with a representative of the Bohn estate relative to a readjustment downward of the purchase price of the Hotel World Publishing Co. *20 stock, and along in November or December of that year there was some intimation on the part of the Bohn estate that it might be willing to make a readjustment thereof, at which time petitioner made a payment on account in the amount of $ 1,500. Early in January 1937 the Bohn estate agreed to accept $ 18,300 in full settlement of the unpaid balance of the purchase price of the stock of the Hotel World Publishing Co. which amount was paid to them by petitioner. At the time this agreement was entered into petitioner was solvent.
*350 The Hotel World Publishing Co. was finally liquidated by petitioner in 1939. At that time the Hotel World Publishing Co. was indebted to petitioner for advances petitioner had made to it, and petitioner suffered a loss on the liquidation.
The respondent determined that petitioner realized additional income in 1937 of $ 6,200, by reason of the above mentioned settlement it made with the Bohn estate in that year.
OPINION.
These proceedings involve two questions. The first question is common to all the petitioners for both of the taxable years 1936 and 1937, and is whether, in computing the surtax on undistributed profits under section 14 of the Revenue*21 Act of 1936 as amended by section 501 of the Revenue Act of 1942, petitioners are entitled to credits such as are provided in section 26 (c) of the same act, as also amended by the said section 501, relating to restrictions on payment of dividends. The second question involves only petitioner Ahrens Publishing Co. for the taxable year 1937, and it is whether the respondent erred in increasing the income of that petitioner for the year 1937 by $ 6,200, which is the amount by which its liability under a purchase agreement was adjusted downward in that year.
Section 26 (c) (1) and (2) of the Revenue Act of 1936, as amended, is set forth in the margin. 1 Under the first question petitioners contend primarily that each petitioner is entitled to a credit under section 26 (c) (1) of 100 percent of its respective adjusted net income for the taxable years 1936 and 1937, on the ground that the creditors' agreement of April 1, 1933, plus the agreement of May 12, 1933, between *351 the three voting trustees not to declare or cause to be declared or permit to be declared any dividend upon any of the outstanding stock of the parent company or any of its subsidiaries, except with the unanimous*22 consent of all three of the voting trustees, should be considered together as representing one single contract executed by each petitioner prior to May 1, 1936. If the two instruments of April 1, 1933, and May 12, 1933, can not be construed as together representing a single contract, then, as a first alternative, petitioners contend that on the basis of the creditors' agreement of April 1, 1933, the parent company (Ahrens Publishing Co.) is entitled to a credit under section 26 (c) (2) for the taxable years 1936 and 1937 equal to 60 percent of the consolidated net earnings and profits of the petitioners for those years, or if not 60 percent of the consolidated net earnings and profits, then, as a second alternative, petitioners contend that on the basis of the creditors' agreement of April 1, 1933, each petitioner is entitled to a credit under section 26 (c) (2) for the taxable years 1936 and 1937 equal to 60 percent of each petitioner's own net earnings and profits for those years. The respondent contends that petitioners are not entitled to any credits under either section 26 (c) (1) or section 26 (c) (2).
*23 We think petitioners' primary contention that each petitioner is entitled to a credit under section 26 (c) (1) of 100 percent of its respective adjusted net income is without merit. The Ahrens Publishing Co. is the only petitioner that executed any written contract prior to May 1, 1936. That was the contract of April 1, 1933, between that petitioner, as first party, the Gehring estate, as second party, the other creditors, as third party, and the three voting trustees, as fourth party, sometimes referred to herein as the creditors' agreement of April 1, 1933. That contract did not "expressly" deal "with the payment of dividends", which is a statutory prerequisite before any credit may be allowed under section 26 (c) (1). Petitioners contend, however, that the creditors' agreement was only half of the contract and that the other half consisted of the agreement among the three voting trustees. This latter agreement was in the form of a letter dated May 12, 1933, from two of the trustees, Ahrens and Adams, addressed to the other trustee, Gehring, and accepted by him. The body of the letter or agreement is as follows:
As an inducement to your acceptance and execution of a Voting*24 Trust Agreement of stockholders of the Ahrens Publishing Company, dated April 1, 1933, and in consideration thereof, the undersigned, being your co-voting trustees, do hereby consent and agree that as Directors and Voting Trustees of the company they will not declare, or cause to be declared, or permit to be declared, any dividend upon any of the outstanding stock of the Ahrens Publishing Company, or any of its subsidiaries, except with the unanimous consent of the undersigned and yourself, as Voting Trustees and Directors.
If this is agreeable to you, will you please so signify by signing an acceptance
*352 Petitioners contend that these two agreements (the creditors' agreement and the agreement between the voting trustees) are not separate contracts, but that they are interdependent and together they become a single contract. At the hearing trustee Gehring testified that the original draft of the creditors' agreement contained a clause prohibiting dividends, but that trustee Ahrens felt that with such a clause he would not be able to secure the consent of the remaining stockholders of the Ahrens Publishing Co. to the voting trust agreement of April 1, 1933, so they compromised*25 their differences by eliminating the clause prohibiting dividends from the creditors' agreement and entering into the trustees' agreement of May 12, 1933.
We do not agree with petitioners that the two agreements are interdependent and together form a single contract. The trustees' agreement of May 12, 1933, was no more than a declaration of policy by the voting trustees not to declare any dividends, except with the unanimous consent of all three trustees. The three trustees retained the power within themselves to either declare or not declare dividends. If at any time the trustees had unanimously agreed to declare a dividend, no other party to the creditors' agreement could have legally objected. This is independency, not interdependency. During the time that the voting trustees' agreement of April 1, 1933, was in effect the affairs of all three petitioners were to be directed and managed by the three voting trustees. Even without the agreement of May 12, 1933, the three trustees would have had to agree to declare dividends before any dividend could have been declared. Even with the agreement of May 12, 1933, they could have declared a dividend "without violating a provision*26 of a written contract executed by the corporation prior to May 1, 1936." The only effect of the May 12, 1933, agreement was that, as far as the dividend policy of the three corporations was concerned, it would take a unanimous vote of the trustees instead of a majority vote to declare a dividend. That is not a contract executed by the corporations restricting the payment of dividends. The agreement was not executed by the corporations at all. We hold that petitioners are not entitled to any credit under section 26 (c) (1), supra. Cf. Thibaut & Walker Co., 42 B. T. A. 29; Union Telephone Co., 44 B. T. A. 607; Kolor-Thru Corporation, 44 B. T. A. 1303; Atlas Supply Co. v. Commissioner, 123 Fed. (2d) 356; Caroline Mills v. Commissioner, 126 Fed. (2d) 857; and Metal Specialty Co. v. Commissioner, 128 Fed. (2d) 259.
Petitioners' first and second alternatives are contentions for credits under section 26 (c) (2). Both these contentions are grounded upon the provisions of the written contract*27 of April 1, 1933, entered into between petitioner Ahrens Publishing Co. as party of the first part, the Gehring estate, as parties of the second part, certain creditors, as parties of the third part, and the three voting trustees as parties of *353 the fourth part. Among other things that contract provided that "After the close of each calendar year, the net profits of the Publisher will be determined within thirty (30) days" and 60 percent thereof paid over first to the parties of the third part until paid in full and then to the parties of the second part. Since this was not required to be done until "After the close of each calendar year" there was no contractual requirement on the part of any of the petitioners that any portion of the earnings and profits of the taxable year of any of the petitioners was "to be paid within the taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt."
It is true that petitioners anticipated some of the payments which they were required to make under the creditors' agreement and paid them in the taxable year when such profits were earned rather than to wait until the following*28 year to calculate such profits and make the required payments, but that was voluntary on their part and was not required by the contract. As pointed out by the Supreme Court in its recent decision in Helvering v. Ohio Leather Co., 317 U.S. 102">317 U.S. 102, such voluntary payments are not sufficient to give a credit under section 26 (c) (2).
Petitioners, in their brief, strongly rely upon Strong Manufacturing Co., 41 B. T. A. 1273; affd., 124 Fed. (2d) 360, certiorari granted April 16, 1942, by the Supreme Court. Since the filing of petitioners' brief the Supreme Court has reversed Strong Manufacturing Co., supra, and has held against the contentions here made by petitioners. Helvering v. Ohio Leather Co., supra.On this issue we sustain respondent.
Turning now to the second question, it is petitioner's (Ahrens Publishing Co.) contention that the net effect of the transaction whereby the petitioner's remaining liability to the Bohn estate for Hotel World Publishing Co. stock purchased from the estate in 1928 was settled in 1937 for $ *29 6,200 less than the balance due thereon, was that the basis to petitioner for the stock so purchased was $ 6,200 less than the amount originally agreed to be paid, and that the question is controlled by Hirsch v. Commissioner, 115 Fed. (2d) 656, and Helvering v. Killian Co., 128 Fed. (2d) 433. The respondent contends that, because of the fact that petitioner was solvent when the 1937 settlement occurred, the instant proceeding comes within the general rule that if the indebtedness of a solvent taxpayer is canceled or forgiven in whole or in part, the taxpayer realizes income in the amount of the indebtedness canceled. In support of this contention the respondent relies upon United States v. Kirby Lumber Co., 284 U.S. 1">284 U.S. 1; Helvering v. American Chicle Co., 291 U.S. 426">291 U.S. 426; and Commissioner v. Coastwise Transp. Corporation, 71 Fed. (2d) 104; certiorari denied, 293 U.S. 595">293 U.S. 595.
*354 The taxpayers in the two cases relied upon by petitioner had purchased certain real estate in a prior year *30 by paying part of the consideration in cash and by either giving or assuming a mortgage for the balance. In both cases the value of the particular real estate involved had depreciated until in the taxable year the fair market value thereof was less than the respective mortgage indebtedness. In both cases the taxpayer offered to convey the real estate to the mortgagee in full satisfaction of the debt, and in both cases the mortgagee refused but agreed to take a lesser sum in satisfaction of the debt. In both cases it was held that such reduction of the mortgage indebtedness did not constitute taxable income to the particular taxpayer there involved. The Eighth Circuit, in the Killian Co. case, compared and distinguished the three above cited cases relied upon by the respondent in the instant proceeding.
The respondent has attempted to distinguish the instant proceeding from the two cases relied upon by petitioner upon the ground that petitioner here had not yet disposed of the stock of the Hotel World Publishing Co. in 1937. We fail to see in what respect this is material. In neither of the cases relied upon by petitioner had the respective taxpayer disposed of the respective*31 real estate in the taxable years there involved. Petitioner in the instant proceeding has shown that the value of the stock purchased in 1928 at the top of the market had continuously depreciated from the date it was purchased down to the taxable year 1937 and that because of this fact petitioner was able to persuade the Bohn estate to readjust the purchase price of the stock downward and to take in full settlement of the promissory note representing the unpaid balance of the purchase price $ 6,200 less than the balance due on the note. We think this makes the instant proceeding undistinguishable in principle from the two cases relied upon by petitioner. In line with those two cases, we hold that the net result of the settlement in 1937 was in substance a reduction of the purchase price of the Hotel World Publishing Co. stock from $ 40,000 to $ 33,800, and thereafter Ahrens' cost basis of the stock was $ 33,800 instead of $ 40,000, and that the respondent erred in determining that Ahrens realized additional income in the amount of $ 6,200 for the taxable year 1937.
Decisions will be entered under Rule 50.
Footnotes
1. SEC. 26. CREDITS OF CORPORATIONS.
In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax --
* * * *
(c) Restrictions on Payment of Dividends. --
(1) Prohibition on payment of dividends. -- An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account.
(2) Disposition of profits of taxable year. -- An amount equal to the portion of the earnings and profits of the taxable year which is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of the taxable year) to be paid within the taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt; to the extent that such amount has been so paid or set aside. For the purposes of this paragraph, a requirement to pay or set aside an amount equal to a percentage of earnings and profits shall be considered a requirement to pay or set aside such percentage of earnings and profits. As used in this paragraph, the word "debt" does not include a debt incurred after April 30, 1936.↩