*2207 Where stockholders of a holding company voluntarily and without obligation contributed proportionately to a fund raised to reward officers and employees of the operating company for their long and faithful services, and the fund was distributed by a committee of such stockholders to such officers and employees, among whom were the petitioners, held that the amounts received were gifts and not additional compensation.
*1002 These proceedings were consolidated for hearing and determination. They involve deficiencies in income taxes for 1924 in the following amounts: William C. Barnes, $122.13; Adelaide C. Barnes, *1003 $191.08; Eugene Fox, $1,307.71. The errors alleged in the petition of William C. Barnes and in the petition of Adelaide C. Barnes are that respondent erroneously determined that $10,000 given William C. Barnes by a committee representing stockholders of the El Paso & Southwestern Co. during 1924 and 1925 should be included as a portion of taxable income for 1924; and respondent erroneously determined*2208 the $10,000 to be compensation for services rendered rather than a gift; and that respondent erroneously determined that all of the said $10,000 was received during 1924.
The errors complained of by the petitioner, Eugene Fox, are that respondent erroneously determined his income tax and taxable net income for 1924; that respondent erroneously determined that $16,250 received from a committee representing stockholders of the El Paso & Southwestern Co. constituted taxable income for 1924; and that respondent erred in failing to find and determine that the said sum was a gift or gratuity and, therefore, should be excluded from taxable income for 1924.
FINDINGS OF FACT.
During the period January 1, 1924, to November 1, 1924, the petitioners, Eugene Fox and William C. Barnes, were employed as vice president in charge of traffic, and general traffic manager, respectively, of the El Paso & Southwestern Railroad Co. The stock of this corporation and the stock of the other corporations composing the ,4. Paso & Southwestern System were owned by the El Paso & Southwestern Co., with offices at 99 John Street, New York.
By letter dated November 10, 1924, the secretary of the El Paso*2209 & Southwestern Co., hereinafter referred to as the holding company, addressed a letter to the stockholders of the holding company regarding a "Statement of Plan of Reorganization." The pertinent portions of this letter are as follows:
2. After the acquisition by the El Paso & Southwestern Company of the stock of the California companies and the Tucson, Phoenix and Tide Water Railroad Company, your company entered into a plan for a reorganization of your company which was authorized by your Board of Directors at a meeting on June 12, 1924, copy annexed. In pursuance of such plan, your company entered into a contract on the 20th day of June, 1924, with the Southern Pacific Company under which plan the Southern Pacific Company acquired all of the stock of the Southwestern system, including the stock of the Tucson, Phoenix and Tide Water Railroad. Your company also simultaneously therewith entered into a second contract with the Southern Pacific for the construction of certain lines of railroad by the Southern Pacific Company. Copies of said contracts, both dated June 20, 1924, are hereto annexed.
3. After the said contracts of June 20, 1924, were executed, application was made*2210 to the Interstate Commerce Commission for permission to consummate the contracts with the Southern Pacific Company and for permission to issue *1004 the securities set forth in said contracts, and also permission for the construction and extension of new lines covered by the second contract of June 20, 1924. The Interstate Commerce Commission granted this permission under decision dated September 30, 1924, a copy of which is hereto annexed.
On October 30, 1924, at a meeting of the Board of Directors of your company, resolutions were passed authorizing the officers of your company to transfer and deliver to the Southern Pacific Company the securities referred to in contracts of June 20, 1924, and to receive securities to be issued to the El Paso & Southwestern stockholders pursuant to the terms of said contract and to carry the plan into effect. The resolutions adopted by your Board of Directors are hereto annexed.
In pursuance of said order and of said resolutions on October 31, 1924, the main contract with the Southern Pacific was consummated and all securities were exchanged thereunder, and the Southern Pacific delivered to the Hanover National Bank of New York City, *2211 in pursuance with the terms of the said resolutions of the Board of Directors, $28,000,000.00 par value of Southern Pacific stock and $29,400,000.00 of Southern Pacific collateral trust bonds dated May 1, 1924, maturing May 1, 1944, and bearing interest at 5%, payable semiannually, and also deposited as collateral for such bonds, bonds owned by the Southern Pacific Company with a face value of approximately $39,915,000.00. These transactions have left the El Paso & Southwestern Company without assets other than its franchises.
While the exchange of securities between the El Paso & Southwestern Company and the Southern Pacific Company took place and was completed on October 31, 1924, for the purpose of accounting and adjustment of accounts, the transaction takes place as of May 1, 1924, from which period the interest on the bonds of the Southern Pacific began to run and certain debits and credits are to be balanced since that date under the terms of said contract between the Southern Pacific and the El Paso & Southwestern Company, as determined by a final accounting. It is possible that on the completion of such accounting the El Paso & Southwestern Company may owe the Southern*2212 Pacific a substantial sum. In addition to this sum, the Directors of the El Paso & Southwestern Company request that the stockholders of the company authorize them, in recognition of the long and faithful service of the officers and employees of the railroad, to pay to officers and employees, to be designated by the Board of Directors, additional compensation to be decided by the Board of Directors, and that they be authorized to set aside for such compensation a sum not to exceed $1,000,000. The Southern Pacific bonds now deposited or such part of them as may seem to be necessary will be held subject to a pro-rate charge for the balance due the Southern Pacific, the payment to officers and executive employees, and to charges and liabilities for taxes, expenses, counsel fees and costs and charges of the reorganization.
The stock of the Southern Pacific Company has been issued in the name of the stockholders of the El Paso & Southwestern Company in proportion to their present holdings subject to adjustment of fractions and has been delivered to the Hanover National Bank for account of the stockholders. The stock is not subject to any charges on account of the company. Dividends*2213 on this stock will be paid direct to the stockholders.
The Southern Pacific bonds were delivered to the Hanover National Bank for account of the stockholders of El Paso & Southwestern Company and are now being held by it subject to the charges above mentioned. In these distributions the special stock does not participate but is to be retired at $112.50 per share.
*1005 The committee appointed by the stockholders for the purpose of determining the disposition of the bonds will formulate a plan for the final disposition of these securities and make a report to the stockholders as soon as possible.
Your Directors now ask your full approval, ratification and confirmation of this plan and all the acts of the Directors in carrying out the same, request the stockholders to sign and return the proxy herewith enclosed to be used at a meeting of the stockholders, notice of which has already been sent to you, and also ask the execution and return of the enclosed letter addressed to George Notman, Secretary of the El Paso & Southwestern Company.
Yours truly,
GEORGE NOTMAN,
Secretary.
Enclosed with the above communication was the following letter which the stockholders*2214 were requested to sign and return:
GEORGE NOTMAN, Esq.,
Secretary, El Paso & Southwestern Co., 99 John Street, New York City.
DEAR SIR: I have your letter of November 10th, in connection with notice of special meeting of stockholders, enclosing copy of Statement of Plan of Reorganization of the El Paso & Southwestern Company, and statement of resolutions and actions taken thereunder, including the delivery to The Hanover National Bank of the City of New York of the stocks and bonds of the Southern Pacific Company for the account of the stockholders under the Plan.
As a stockholder of the El Paso & Southwestern Company, I hereby ratify, approve and confirm the Plan of Reorganization and the actions of the Board of Directors and the officers, as set forth in said Plan of Reorganization, and the documents accompanying your letter.
I understand that there are certain unsettled expenses, obligations to the Southern Pacific Company, bonuses to the employees, agreed upon by the Board of Directors, estimated at about $1,000,000, and other debts, expenses and liabilities incidental to the Plan of Reorganization and otherwise.
I appoint Messrs. A. C. James, E. Hayward Ferry, *2215 Walter Douglas, C. E. Dodge and Wm. Church Osborn as a Committee to pay the expenses, to compensate employees, to adjust and settle the accounts, to discharge and provide for the debts and liabilities of the Company and generally to do every act and thing necessary or proper in pursuance of the provisions of the Plan of Reorganization of the El Paso & Southwestern Company. For the purposes above named, I authorize and empower the Committee to charge my pro rata share of the costs thereof against the bonds of the Southern Pacific Company deposited in The Hanover National Bank for my account, and this letter may be used as a direction to The Hanover National Bank to that effect; also to formulate and submit plans for future co-operation among the security holders.
There was also enclosed in this communication a proxy form appointing George Notman, U. M. Van Varick, and W. K. Flora to act for the stockholders of the holding company.
The proposed plan and the appointment of the committee was unanimously approved by the stockholders of the holding company, and at a meeting of the committee on November 20, 1924, A. C. James was appointed chairman, U. M. Van Varick, secretary, and*2216 W. K. Flora, assistant secretary. Upon motion the committee adopted the following resolution:
*1006 The Committee may from time to time borrow from the Hanover National Bank of the City of New York such sums as may be necessary to pay expenses, to compensate employees, to adjust and settle the accounts, to discharge and provide for the debts and liabilities of the El Paso and Southwestern Company, and may pledge with said bank the temporary bond of the Southern Pacific Company for $29,400,000, now deposited with said bank (and/or the definitive bonds replacing the same when issued or any part thereof) to the extent of the interests represented by the Committee. The note or notes evidencing such loan or loans shall be signed by Upson M. Van Varick, Secretary, or W. K. Flora, Assistant Secretary, and countersigned by any member of the Committee and shall be accompanied by a certified copy of the resolution of the Committee authorizing such loan or loans, and a certified list of the persons and corporations at that time represented by the Committee and their respective interests in the bond or bonds thereby pledged.
The Officers are hereby authorized to open an account with*2217 the Hanover National Bank of the City of New York, in which all moneys of the Committee shall be deposited to its credit. Checks on such account shall be signed by the Secretary or Assistant Secretary and countersigned by any member of the Committee.
At this meeting the secretary was authorized to send the following letter to the stockholders and bondholders:
My dear Sir:
The committee appointed under your letter to George Notman, Secretary, dated November - , 1924, desires to inform you that the stock of the Southern Pacific Company held for your account by the Hanover National Bank is now ready for delivery and can be had upon the proper application by you.
The Hanover National Bank requests us to say that inasmuch as you may wish to have the certificates split up into different multiples, it will be glad to undertake the same for your convenience.
The Hanover National Bank now holds one bond for $29,400,000. Definitive bonds are now being printed and we are informed that they will be ready for delivery during the month of January. We hope by that time that all of the charges authorized by your letter will have been adjusted and delivery can be made of the bonds belonging*2218 to you.
It will be necessary to sell a certain number of these bonds to meet the charges above referred to. It has been suggested that some bondholders might be desirous of disposing of all or a portion of the bonds which they may receive at that time. If, after consideration, you desire to dispose of all or part of the bonds coming to you and will be kind enough to notify the committee to that effect, we will be glad to negotiate a sale of the bonds in a block through some banking house or otherwise. For your further information, we would say that the estimated sum of the charges above named is in the neighborhood of One and one-half Million Dollars, but that there may be a necessity of holding some further amount in bonds against possible unforeseen contingent liabilities. In any event, we believe that a distribution can be made of these bonds in January, 1925 in the amount of $25,000,000 which would mean a par value of bonds equal to the par value of your holdings of El Paso & Southwestern Company stock.
* * *
Yours very truly,
U. M. VAN VARICK,Secretary.
*1007 Pursuant to the resolution of the board of directors of the holding company and the authorization*2219 from the stockholders, the committee began functioning without further formal action. On November 25, 1924, by resolution, the committee officers were authorized to secure a loan of $30,000 from the Hanover National Bank, and on December 23, 1924, the committee passed the following motions:
Upon motion duly seconded and carried, the Secretary was authorized to release the checks in payment of certain bonuses to amount of $893,690.00 as per memo on file.
On motion, the following resolution was duly adopted:
RESOLVED: That the officers be authorized to secure a loan of $1,000,000 from the Hanover National Bank.
The amounts of the various checks to the railroad company's employees were determined by Shoemacher, president of the railroad company; Hawley, general auditor of the railroad company; and Fox, rice president in charge of traffic of the railroad company. They were guided in their determinations by no set rule or formula, merely exercising their arbitrary discretion based on their knowledge of all the facts in connection with each individual case. Some of the railroad company's employees were entirely omitted from consideration. The petitioner, Fix, had nothing to*2220 do with the determination of the amount that was paid to him, although he did request the committee to split his payment. Upon request from any individual employee the committee split up the amount to be paid.
Included among the checks which were released under the committee's resolution were the following:
No. 371
New York, Dec. 22, 1924
THE HANOVER NATIONAL BANK of the City of New York
| Pay to the order of | W. C. Barnes | $4000.00 |
| Four thousand & 00/100 | Dollars | |
| Good only when countersigned by, Cleveland E. Dodge. |
Secretary.
Similar checks were issued by the committee to Fox and William C. Barnes, as follows:
Check No. 651, dated January 2, 1925 to W. C. Barnes for $6,000;
Check No. 657, dated December 22, 1924 to Eugene Fox for $16,250;
Check No. 658, dated January 2, 1925 to Eugene Fox for $16,250.
Each check was accompanied by a card upon which was printed "With appreciation and best wishes of El Paso & Southwestern Company from Committee appointed Nov. 18th, 1924."
*1008 The checks, with the possible exception of check No. 657, which has no stamped date with the endorsement, were cashed in the month in*2221 which issued. When the committee issued these checks to the petitioner, the latter had no contract, right, or claim against the committee, or the holding company, or the stockholders of the holding company, which entitled them to a portion of the fund distributed. Neither Eugene Fox nor William C. Barnes was a stockholder, director, or officer in the holding company, nor was either of them a member of the committee that distributed the fund. On and after November 1, 1924, they were employed by the Southern Pacific Co. - Eugene Fox as assistant traffic manager of the eastern district of the Southern Pacific System, and William C. Barnes as general freight agent.
The committee's statement of its finances, as submitted by its secretary at a meeting held at 99 John Street, New York, on January 20, 1925, showing that the committee had procured loans totaling $1,155,000, and that its disbursements included, among other items, the following:
| Dec. 22, 1924, bonus | $619,940 |
| Jan. 2, 1925, bonus | 273,750 |
At the same meeting the committee authorized the sale of $1,500,000 par value of Southern Pacific Co. 20-year, 5 per cent collateral trust gold bonds.
Under date of*2222 February 24, 1925, the committee submitted a letter to the stockholders entitled "Interim Report to Stockholders of the El Paso & Southwestern Company by Committee appointed By Letter To George Notman, November, 1924." This statement in part reads as follows:
TO THE STOCKHOLDERS OF THE EL PASO & SOUTHWESTERN COMPANY:
We beg to submit the following report:
The letter to George Notman of November, 1924, approving the Plan of Reorganization of the El Paso & Southwestern Company, and appointing this committee, has been signed by 100% of the stockholders.
In pursuance of the plan reported to you on November 10, 1924, there has been delivered to the stockholders of the El Paso & Southwestern Company, in proportion to their holdings in that company, $28,000,000 par value of Southern Pacific stock.
There is now ready at the Hanover National Bank for delivery to you in proportion to your holdings in the El Paso & Southwestern Company, $25,000,000 par value of Southern Pacific Twenty-Year Five Per Cent. Gold Coupon Bonds dated May 1, 1924, due May 1, 1944, in denominations of $1,000 each, being a part of total issue of $29,400,000 of such bonds received from the Southern Pacific*2223 Company, now at the Hanover National Bank of the City of New York, less $1,500,000 bonds sold as advised below.
* * *
This distribution leaves your Committee accountable for $4,400,000 of such bonds, or the proceeds thereof. Of that sum $1,500,000 par value has been sold *1009 to provide cash for the various matters stated in your letter of November 1924. Your Committee has made rap d progress in meeting the unsettled expenses, obligations to the Southern Pacific Company, bonuses to the employes and expenses and liabilities incidental to the plan of reorganization mentioned in the letter, and is glad to report that the above sale of bonds has, in its judgment, produced sufficient to cover such payments. There remains a possibility of certain unforeseen contingent liabilities, such as Federal and State taxes, against which your Committee has determined to hold the remaining assets until the same may be fully determined. The time of this is uncertain and may require five years or even more. Your Committee considers that the parties to the reorganization are entitled to a transferable security represent ng their interest in these assets, and to the distribution of income*2224 thereon, except so far as the same shall be needed for the purposes of the Committee. They have, therefore, prepared a certificate of interest. These certificates are ready for delivery at The Hanover National Bank of the City of New York to the stockholders of the El Paso & Southwestern Company in proportion to their holdings in that company.
The petitioners, Adelaide C. Barnes and William C. Barnes, are husband and wife, and filed separate returns for the calendar year 1924, reporting their income on the community property basis.
OPINION.
MORRIS: The question presented by these proceedings is whether the payments made by the committee to Eugene Fox and William C. Barnes were gifts, or whether these payments constituted additional compensation. The petitioners contend that the payments which they received were gifts either from the stockholders of the holding company, or from the holding company itself. Respondent contends that the holding company and the railroad company were parts of one system, and that since the various letters, minutes, and resolutions repeatedly used the terms "payment," "additional compensation," and "bonuses to the employes," etc., it is clear*2225 that the intention was to pay the petitioners additional salaries rather than to make gifts.
The facts have been set forth in considerable detail so that a complete picture of what transpired during the period of readjustment and merger would be clearly presented. The acquisition of the El Paso & Southwestern System by the Southern Pacific Co. was accomplished by an exchange of stocks and bonds of the Southern Pacific Co. for the various stocks, including the stock of the railroad company, that were owned by the El Paso & Southwestern Co. By virtue of this exchange the holding company lost all of its assets and was left with only its franchise, because under the proposed plan the stocks and bonds of the Southern Pacific Co. were paid over to the Hanover National Bank of New York City for distribution directly to the stockholders of the El Paso & Southwestern Co.
*1010 As a part of the proposed plan, the directors of the holding company requested their stockholders to authorize them, in recognition of the long and faithful services of the officers and employees of the railroad company, to pay such officers and employees "additional compensation," and that they be authorized*2226 to set aside a sum for that purpose, not to exceed $1,000,000, from the bonds turned over by the Southern Pacific Co. This disbursement was authorized by the stockholders of the holding company by signing and returning the letter addressed to George Notman, secretary of the holding company, which has been set forth in our findings. The letter of authorization was signed by all the stockholders of the holding company and the committee forthwith, and without further corporate action, undertook, among other things, to distribute the fund, in the amounts that were designated by the heads of the various departments of the railroad company, to the officers and employees of that company. The funds distributed were secured by selling the $1,500,000 of Southern Pacific Co's bonds, which bonds were appropriated for that purpose under and by virtue of the authorization from each stockholder of the holding company, thereby diminishing his or her proportionate interest of the amount secured from the Southern Pacific Co.
We have heretofore said, in *2227 , that "the essential elements of a gift are an intention to give, a transfer of title or delivery, and an acceptance by the donee." The intention to give in these proceedings is to be found in the letters and reports, portions of which are set forth in the findings. While these letters indicate that the payments to officers and employees were denominated under various terms as bonuses, additional compensation, etc., it clearly appears that there was an intention to give a sum, not to exceed $1,000,000, to the officers and employees of the railroad company. There can be no doubt, and it is not questioned, that there was a transfer or delivery of the amounts here in question, nor is there any doubt as to the acceptance of these amounts by the petitioners. It remains to be determined whether the terminology used, namely, "additional compensation" and "bonuses to employees" actually portrays the results that were here accomplished.
It is our opinion that the petitioners actually received gifts rather than additional compensation or bonuses and that the situation is very similar to that decided by the Circuit Court for the Third*2228 Circuit in . In each case we have the stockholders individually, without obligation on their part and without any consideration then or theretofore having been received or rendered, giving money or securities *1011 for the purpose of creating a fund to reward the officers and employees for long continued and efficient services. So far as the stockholders of the holding company were concerned, no possible benefit could accrue to them from their donations, and their contributions were inspired only by the desire fittingly to reward past services from which they had indirectly benefited. In fact this case would seem to be a stronger case for petitioners than the Jones case, supra, because the donors were stockholders of a corporation other than the one by which petitioners had been employed.
We are, therefore, of the opinion that the respondent erred in including the amounts in question in the petitioner's income for the taxable year.
Reviewed by the Board.
Judgment will be entered under Rule 50.