*7 Decision will be entered for respondent.
From 1935 to 1943 petitioners served as officers and employees of a corporation which was organized as a result of a corporate reorganization incident to financial difficulties of a predecessor corporation. The plan of such reorganization provided that a part of the stock of the new corporation should be paid to its management upon certain success being attained by the new corporation in its operation. Petitioners were paid regular salaries by the new corporation. As additional compensation for their services as officers and employees of the corporation they were awarded parts of the "management" stock in 1943 by the directors of the corporation. Held, petitioners are not entitled to the benefits of section 107, Internal Revenue Code, since the stock payments did not constitute 80 per cent of the compensation received for acting as officers, directors, or employees in the taxable year.
*1057 In these cases, consolidated for hearing, the Commissioner determined income tax deficiencies for the year 1943, as follows: *1058
| George J. Hoffmann, Jr., Docket No. 15252 | $ 3,328.05 |
| Roy C. Goddin, Docket No. 15253 | 1,423.12 |
| Josiah P. and Jeannette W. LeMaster, Docket No. 15281 | 6,520.98 |
These deficiencies were determined, in large part, by reason of respondent's including in the gross income of petitioners the entire value of certain stock received by them during the taxable year. The sole issue for determination *9 is whether petitioners are entitled to the benefit of section 107 (a) of the Internal Revenue Code in computing income tax upon the receipt of this stock. An issue of whether receipt of the stock constituted a gift, rather than compensation, has been abandoned.
FINDINGS OF FACT.
The petitioners, George J. Hoffmann, Jr., Roy C. Goddin, and Josiah P. LeMaster, were officers, directors, or employees of the Mortgage Bond Co. of New York, and thereafter of the company's successor, the Mortbon Corporation of New York, up to and including the time of the stock payments in question made June 30, 1943. Federal income tax returns of the petitioners, including the joint return of Josiah P. and Jeannette W. LeMaster, were filed for the calendar year 1943 with the collector of internal revenue for the fifth district of New Jersey, at Newark, New Jersey.
In 1933 the Mortgage Bond Co., sometimes hereinafter referred to as the company, was in the business of granting mortgage loans and servicing loans, mortgages, and real estate. The mortgage loans made on the company's own behalf were financed under a trust indenture of 1906 and supplemental indentures by eighteen outstanding series of collateral*10 trust mortgage bonds in the principal amount of $ 22,952,000. Default on these bonds in 1933 was inevitable, due primarily to the "bank holiday" proclamation of March 6, 1933, and other legal restrictions, as well as increasing financial difficulties of the mortgagors.
Under the circumstances the bondholders, pursuant to a bondholders' agreement dated April 5, 1933, promulgated a plan of reorganization, which was amended, supplemented, and finally approved by the Supreme Court of New York on May 10, 1935.
The plan provided for the incorporation of the Mortbon Corporation, sometimes hereinafter referred to as the corporation. The new corporation was to take over the business and the assets of the old company. The corporation was to issue its bonds as follows: For each $ 1,000 bond of the old company, a $ 200 bond, maturing in 1941, a $ 200 bond maturing in 1946, a $ 200 bond maturing in 1951, and a $ 250 bond maturing in 1956. In addition, 15 per cent, or $ 150, was paid in cash to the old bondholder. The new bonds called for the payment, in any event, of 2 1/2 per cent interest each year, and the payment of 2 1/2 *1059 per cent interest when earned or absolutely at maturity, *11 a total of 5 per cent interest.
The stock of the new corporation, of a par value of $ 1 per share, was to be distributed as follows:
| Per cent | ||
| of total | Shares | |
| To old bondholders in ratio to bond interest | 60 | 114,756 |
| Reserved for management | 10 | 19,125 |
| To old stockholders | 30 | 57,369 |
| Total | 100 | * 191,250 |
The plan set forth with regard to the management stock was as follows:
For the management of the new company there will be reserved or deposited in escrow voting trust certificates for 10% of its stock, i. e. 19,125 shares, for delivery at the end of the first two year period during which the new company shall have paid all arrears of interest on all its bonds at the time outstanding and shall have kept interest currently paid at the full rate of 5% on all its bonds outstanding during such period. The certificates so reserved will be distributable to such persons as its board of directors may determine.
The plan also provided that all of the new stock should be placed in a voting trust for a period of ten years or until retirement of all bonds issued according to the plan. The voting trustees were given*12 the right to elect 70 per cent of the board of directors. The old stockholders, who were issued voting trust certificates, class B, were given the right to elect 30 per cent of the board of directors by the voting trust agreement dated October 1, 1935.
The plan also provided for a collateral trust indenture. This indenture, dated as of June 1, 1935, provided that the security under the old trust indenture, as well as other collateral, should be set aside on bahalf of the bondholders. This indenture also provided that no additional bonds in excess of the initial series could be issued unless all of the 5 per cent interest on outstanding bonds had been paid in full for a period of at least two years, and unless collateral equal to 105 per cent of the principal amount of the additional bonds was deposited with the trustee.
The collateral trust indenture also provided:
That so long as any bonds remain outstanding hereunder, the Company shall not purchase or otherwise retire any of its stock nor shall any dividend or distribution be made on any stock of the Company except out of earned surplus; and in no event shall any dividends be paid upon stock of the Company nor shall it purchase*13 any of its stock unless interest on outstanding bonds of the initial issue has been paid at the full rate of 5% and on all other bonds outstanding hereunder at the full rate or rates borne by such bonds, up to and including the last interest payment date preceding the date of payment of any dividends or of purchase of any stock nor unless funds have been set aside for making *1060 the next interest payment at the same rate or rates on every series outstanding hereunder.
The new corporation was incorporated August 6, 1935, as the Mortbon Corporation of New York. The bonded indebtedness of the new corporation was secured by the collateral trust indenture agreement with the United States Trust Co. of New York as of June 1, 1935. The trust company was also appointed the depository and agent of the voting trustees. These agreements were acknowledged and accepted on October 21, 1935, but were to be effective as of the date of June 1, 1935. Also, on October 21, 1935, made effective by appropriate bookkeeping entries as of June 1, 1935, all the assets and business of the company were transferred to the corporation in exchange for the stock of the corporation, with the exception of*14 the three qualifying shares of the incorporator's stock. The stock was endorsed to the voting trustees. The voting trustees deposited the stock with the trust company, which thereafter acted as agent and issued the voting trust certificates. The bonds were also issued in accordance with the trust indenture.
A voting trust certificate for the 10 per cent of the corporation's stock, hereinafter referred to as the management stock, was issued May 21, 1936, in the name of the comptroller of the corporation as escrow agent, endorsed in blank by him and returned to the trust company as depository. The steps were taken pursuant to instructions from the voting trustees to the trust company.
In the succeeding years the business proved more successful than anticipated. The corporation called for a redemption on July 1, 1943, of the balance of its collateral trust mortgage bonds. Interest payments had been made for a two-year period as follows:
| Dec. 1, 1941 | 2 3/4% |
| June 1, 1942 | 3 1/4% |
| Dec. 1, 1942 | 4 1/4% |
| June 1, 1943 | 6 1/4% |
There was no interest in arrears on any bonds on June 1, 1943. Thus, under the terms of the plan of reorganization, the management stock became distributable*15 pursuant to the terms of the plan of reorganization above set forth.
On June 30, 1943, the board of directors divided the 19,125 shares of management stock among 13 individuals, stating:
Now, Therefore, be it Resolved, that this Board of Directors does hereby determine that the said voting trust certificates for 19,125 shares of the Capital Stock of this Corporation, held in escrow for the purpose of carrying out the aforesaid provisions of Article IV of the Plan of Reorganization of The Mortgage-Bond Company of New York, dated November 15, 1933, be distributed on June 30, 1943, to the following named persons in the amounts set opposite their respective names: *1061
| Number of | |
| Names | shares |
| Arthur M. Hurd | 7,000 |
| J. P. LeMaster | 3,250 |
| George J. Hoffmann, Jr | 2,100 |
| E. T. Johnson | 1,800 |
| Roy C. Goddin | 1,200 |
| W. E. Fitzpatrick | 1,000 |
| R. R. Rossell | 1,200 |
| W. C. Miller | 575 |
| E. Thompson | 250 |
| S. Blankenhorn | 187 |
| E. Davis | 250 |
| E. Mulligan | 187 |
| E. Peterson | 126 |
The petitioners, J. P. LeMaster, George J. Hoffmann, Jr., and Roy C. Goddin, received 3,250, 2,100, and 1,200 shares of management stock, respectively. The value of this stock was $ 5 per share. The corporation claimed*16 no deduction for income tax purposes on account of such distribution.
J. P. LeMaster was vice president of the company in 1935. He resigned this position on March 29, 1935, but continued as director and advisor. He remained as a director of the corporation. In 1942 he was elected vice president of the corporation, and after June 1943 he was elected president. Roy C. Goddin handled the accounting department of the company and continued in that capacity for the corporation. In 1938 he became comptroller. George J. Hoffmann, Jr., was assistant secretary to the company in 1927. In 1929 he became assistant treasurer. He continued in this capacity for the corporation. Subsequently, he became vice president and secretary. He was at all times a director.
The record discloses only the following payments of compensation to petitioners for personal services:
| Director | ||
| 1942 | Salary | fees |
| LeMaster | $ 5,000 | $ 240 |
| Hoffmann | 6,750 | 240 |
| Goddin | 4,000 |
| Director | Value of | ||
| 1943 | Salary * | fees | stock |
| LeMaster | $ 7,500 | $ 340 | $ 16,250 |
| Hoffmann | 3,750 | 300 | 10,500 |
| Goddin | 2,000.04 | 6,000 |
*17 The management stock paid to petitioners in 1943 for services rendered by them in the management of the new corporation up to and including June 30, 1943, did not constitute 80 per cent of the total compensation for such services.
*1062 OPINION.
Petitioners seek the benefit of section 107 (a) of the Internal Revenue Code1 with respect to the management stock received in 1943 for their managerial services rendered to a corporation from 1935 to 1943.
*18 Respondent contends that petitioners are not entitled to the benefit of this section of the code because the management stock was not 80 per cent of the total compensation for their personal services rendered, since there must be added to the value of this stock the payments of salaries and fees received by petitioners from the corporation for acting as officers, directors, and employees in calculating whether the value of this stock constituted 80 per cent of their total compensation for personal services.
On the other hand, petitioners, although conceding on brief that the value of the management stock received by them in 1943 constituted compensation rather than gifts, 2 contend that it was the entire compensation for personal services received pursuant to a compensation arrangement separate and distinct from their compensation arrangement with the new corporation and, in effect, was paid to them by the bondholders of the old company rather than by the new corporation. Therefore, they urge that the compensation received by them from the new corporation is to be disregarded in determining whether the value of the management stock was "at least 80 per centum of the total compensation*19 for personal services" received by them.
Assuming, without deciding, that petitioners are correct in their position that the management stock was compensation which they received from an ultimate source other than the new corporation, of which they were officers and employees, and pursuant to an arrangement separate from their compensation arrangement with the corporation, nevertheless, we are unable to conclude that the management stock was the total compensation for personal services received by them within the meaning of section 107.
The principal criterion to be applied in cases such as this is the divisibility of the personal services rendered rather than the divisibility of the source of the compensation. See Civilette v. Commissioner, 152 Fed. (2d) 332; Smart v. Commissioner, 152 Fed. (2d) 333. These cases, as we interpret *20 them, are to the effect that divisible sources *1063 of the payment of compensation do not result in the divisibility of the services for which compensation is paid; and, unless the services themselves are divisible, the compensation received therefor, regardless of source, must be lumped together in considering the applicability of section 107.
Here the compensation received by petitioners, including the management stock, can be considered only as in payment for their managerial services rendered as officers and employees of the new corporation, which were of direct benefit to the corporation and of indirect benefit to the holders of securities in that corporation who had been bondholders of the old company. To hold that these services were divisible, in that a part of them were rendered to the corporation and a part of them were rendered to the bondholders of the old company, would ignore reality. In addition, any arrangement between the bondholders and petitioners which would tend to create divergent interests as between the corporation and its security holders with regard to the services of the corporate officers and employees, or which would promote other than the utmost*21 loyalty of the latter to the corporation, would be looked upon with disfavor. See New York General Corporation Law, secs. 27 and 60; Fletcher, Cyclopedia Corporations, vol. 3, sec. 1012.
We are of the opinion that a sense of reality and public policy require the interpretation of the facts (including the assumptions of ultimate fact in favor of petitioners already noted) to be essentially as follows: Petitioners were employed as officers and employees by the new corporation, which compensated them for their personal services rendered pursuant to this employment. The bondholders of the old company, who became the holders of bonds and stock of the new corporation, were indirectly, although vitally, interested as such security holders in the success of the new corporation. In order to encourage petitioners and other officers and employees to render to the new corporation the utmost in loyal and effective managerial services, the security holders of the corporation arranged that, when those services should effect certain financial results of direct benefit to the corporation and of indirect benefit to them, additional compensation in the form of stock would be paid to the officers *22 and employees for the services already rendered to the corporation. The services thus compensated from two sources, were the same, and, as between the corporation and the bondholders, were indivisible. Since the services were the same and indivisible, the compensation therefor received from all sources must be combined in determining "the total compensation for personal service" under section 107.
It should be noted that the recent case of Heath v. Early, Fed. (2d) (C. C. A. 4, Oct. 9, 1948), affirming 77 Fed. Supp. 474, is in *1064 apparent conflict with the views which we have expressed. However, in that case it seems that the principal question considered by the court was whether the required percentage of the total compensation must be received in one taxable year. This appears from the citation in the Circuit Court's opinion of two cases as dispositive of the question there involved. Those two cases, Bergh v. Pedrick, 168 Fed. (2d) 663, and Slough v. Commissioner, 147 Fed. (2d) 836, are pertinent only as to the question of whether the compensation must be received*23 in one year. If the opinion of the Circuit Court of Appeals for the Fourth Circuit indicates a view that compensation must be treated separately under section 107 because it is derived from different sources, although in payment for the same services, then, in spite of our respect for that court, we must note our inability to arrive by reason at the same result.
Decision will be entered for respondent.
Footnotes
*. 3 shares of stock were issued to the incorporators↩
*. The services of all the officers and employees except J. P. LeMaster terminated on July 1, 1943. J. P. LeMaster drew salary for the entire year.↩
1. SEC. 107. COMPENSATION FOR SERVICES RENDERED FOR A PERIOD OF THIRTY-SIX MONTHS OR MORE AND BACK PAY.
(a) Personal Services. -- If at least 80 per centum of the total compensation for personal services covering a period of thirty-six calendar months or more (from the beginning to the completion of such services) is received or accrued in one taxable year by an individual or a partnership, the tax attributable to any part thereof which is included in the gross income of any individual shall not be greater than the aggregate of the taxes attributable to such part had it been included in the gross income of such individual ratably over that part of the period which precedes the date receipt of such of accrual.↩
2. This conclusion is in accord with Batterman v. Commissioner↩, 142 Fed. (2d) 448.