*1044 Petitioner, president of corporation, was granted an option to purchase stock thereof at a price substantially the same as at market price at date of the option. The option was granted in order that the petitioner and other officers, likewise situated, should become substantial stockholders of the corporation. The option was exercised in a later year at a time when the value of the stock had approximately doubled. Held, on the facts, that the option was not granted as compensation for services rendered by the petitioner and that the petitioner did not, in the taxable year, have income to the extent of the difference between the option price and the fair market value of the stock. Delbert B. Geeseman,38 B.T.A. 258">38 B.T.A. 258, and Gordon M. Evans,38 B.T.A. 1406">38 B.T.A. 1406, followed.
*387 This proceeding involves income taxes for the calendar year 1935. Deficiency was determined by the Commissioner in the amount of $26,158.13. The only question*1045 for our determination is whether or not petitioner should return as income by way of compensation received from his corporate employer the difference between a price at which he was granted an option to buy stock from his corporation-employer, and the fair market value at the date when he later purchased same under the option.
*388 FINDINGS OF FACT.
Petitioner has been connected with the Air Reduction Co. (hereinafter usually referred to as the corporation) since July 1918, and from February 1921 to July 1937 was president of that corporation. On January 11, 1928, the corporation entered into an agreement of trust with Frederick B. Adams and Charles S. Munson (both officers of the corporation) as trustees. The purpose of that agreement, as stated therein, was to provide a fund to be used in the acquisition of shares of stock in the corporation to be from time to time distributed and/or sold to the officers and employees, or to be otherwise distributed as from time to time might be prescribed by the board of directors, or advisory committee of the board of directors of the corporation. On December 23, 1932, the trustees under that agreement held 38,633 19/75 shares, *1046 representing a net cost of $2,227,287.94, or an average of $57.65 per share. On December 31, 1932, the trustees purchased an additional 700 shares, paying therefor $42,172.50, and on April 18, 1933, the trustees held 39,333 19/75 shares at a net cost of $2,269,460.44, being an average of $57.70 per share. The corporation had furnished the funds with which to purchase said shares. Practically every officer of the corporation was in financial difficulties and some of them had pledged stock of the corporation to secure loans. The National Carbide Corporation, a subsidiary of the Air Reduction Co., had taken over such loans. In 1933 these loans were liquidated by selling the stock of Air Reduction Co. which had been pledged as collateral.
For a number of years the corporation had maintained a plan of compensation for employees. Such compensation bore a relationship to the earnings of the company and depended entirely upon the amount of money that the company earned. Originally it had been based on 6 percent of the company's earnings. Funds were allocated to all officers and all employees in the more responsible positions. This allocation was in the form of credit on the books*1047 of the company, and was used to purchase stock of the company from the trustees appointed for that purpose. The plan had been in effect from 1919, except in those years when the company did not make sufficient money to put it in operation. It did not operate in 1922, 1932, 1933, and 1934.
On January 16, 1935, the board of directors received and approved a report of the special committee appointed on December 26, 1934, to study the subject ot additional compensation, and in accordance with the report authorized distribution to officers and employees as and for additional compensation for the year 1934 of a fund of 20 cents per share. The committee report stated that salaries and wages of officers and employees had been reduced 5 percent on June 1, 1932, *389 and again reduced 9 percent on April 16, 1933, the first reduction being restored on September 1, 1933, and the balance on February 1, 1934; and that the net earnings for the year 1934 had a substantially exceeded $4.50 per share, the requirement for the dividend, and that the 20 cents per share was reasonable extra compensation and should be allocated 57 percent to a senior group consisting of the chairman of the board, *1048 the president and vice presidents of the company, and 43 percent to a junior group. The salaries and wages of officers and employees had been reduced and restored as recited in the committee report. In 1935 petitioner received from the compensation plan $25,836 in addition to his regular salary of $50,000.
The directors of the corporation were early in 1933 perturbed about the large loans to officers, and were also perturbed over the fact that responsible executives of the company, in most cases, had ceased to be stockholders, and it was felt that the management without investment in the corporation was a mistake. The directors of the corporation believed that the officers should have a personal investment in the corporation which they were managing and wanted to give an incentive to them to make the stock worth more money because the destiny of the company was largely in their hands. They felt that if they could give the officers an opportunity to restore their position as stockholders, without any cost to the company and entirely at the expense of the officers, they would do a favor to the stockholders, but the result must be accomplished entirely at the expense of the officers*1049 and not through any cost to the company. They wanted, if it was possible to do so without getting the officers who lost their stock overextended at any time, to have them through means available to themselves, rather than through loans of the National Carbide Corporation, or any other agency, put in a position to become permanent stockholders of the company. They would have been very willing to have sold the entire 16,000 shares to the officers, if they had been able to step up to the bank and pay $57.65 per share all at once.
On February 8, 1933, the executive committee of the corporation held a meeting at the request of the chairman of the board of directors. The minutes thereof recite loans to officers by the National Carbide Corporation in the amount of $378,024.18, on December 31, 1932; since then reduced to $274,410.68, and that a course of action had been decided upon which would result in their being paid in full. These minutes refer to the fact that the trustees of the company's additional compensation and stock-purchase plan held 39,332 shares of stock of the company acquired at an average cost of $57.65 per share. Recommendation was made to the board that a special*1050 committee of directors be appointed to consider the entire matter of *390 advances made by the National Carbide Corporation and the advisability of formulating a stock-option and subscription plan for executive officers. On the same day, referring to the feeling of the executive committee on the subject, the board of directors appointed a special committee for the purpose named in the recommendation of the executive committee. Such special committee on February 21, 1933, made a report recommending that 16,000 shares of stock of the corporation held by Frederick B. Adams and Charles S. Munson as trustees be used for the following purposes: That the president, each vice president, and each assistant vice president, the secretary, and the treasurer be granted an option for five years to acquire shares of the stock in amounts fixed with the approval of the executive committee at an option price of $57.65, being the average cost of the 39,322 shares purchased by the trustees; that no optionee should have the right to exercise the option within the first year of its date nor for more than one-fourth of the amount in each following year (except any portion not theretofore taken), *1051 that the options be nonassignable and terminable prior to the expiration date upon the death of the optionee or upon his leaving the employ of the company; and that the options provide that the optionee at the time of exercising option satisfy the executive committee that it is being exercised for the purpose of holding the stock, and not for immediate resale, and that the exercise is prudent.
Upon receiving the report of the special committee, the board of directors adopted same and authorized the executive committee to request Frederick B. Adams and Charles S. Munson, as trustees, to take such action as might be necessary to carry out the plan, subject to the approval of the executive committee; with the reservation that the corporation reserve the right to terminate the plan at any time and to cancel and agreements as to which option had not been exercised at time of cancellation whenever such action might be deemed necessary by the board for the best interests of the stockholders as a whole. The trustees, pursuant to such action of the board of directors, allotted the 16,000 shares to the officers of the corporation as follows:
| Shares | |
| C. E. Adams, president | 4,000 |
| A. R. Ludlow, first vice president | 3,500 |
| C. S. Munson, vice president | 3,000 |
| F. J. Metzger, vice president | 1,000 |
| M. W. Randall, vice president | 1,000 |
| H. Van Fleet, vice president | 1,000 |
| R. W. Ryder, treasurer | 500 |
| R. B. Davidson, secretary | 500 |
| W. C. Keeley, Jr., assistant vice president | 500 |
| C. D. W. Gibson, assistant vice president | 500 |
| E. C. Turner, assistant vice president | 500 |
*1052 *391 On April 18, 1933, options were entered into by the trustees and the officers named as to the number of shares as set forth above. This action of the trustees was ratified and approved by the executive committee on September 5, 1933. The option agreement dated April 18, 1933, between the petitioner and the trustees granted the petitioner an option from the date of the agreement to December 31, 1937, to acquire 4,000 shares of the capital stock of the Air Reduction Co. at $57.65 per share; provided that the optionee should have no right to exercise the option prior to December 26, 1933, nor for more than one-fifth of the shares in each calendar year thereafter (except that optionee might take up any portion of the allotment not theretofore taken up); provided that the option was nonassignable and terminable prior to expiration upon death of the optionee or upon his leaving the employ of the company; provided that optionee should, at time of exercise of option, satisfy the executive committee that the option was being exercised not for the purpose of immediate resale of such stock, and that the exercise of option was prudent; and provided that the trustees should have*1053 the right to cancel all agreements as to which option had not been exercised at time of cancellation whenever the board of directors for good cause (not including increase in market value of stock), might deem such action for the best interests of the stockholders. The option also provided that the trustees might assign the agreement at any time to the corporation. It was so assigned, and on December 30, 1933, the trust agreement between the trustees and the corporation was terminated.
Stock of the Air Reduction Co. had, as shown by transactions on the New York Stock Exchange, the following values on the following dates:
| Date | High | Low |
| April 10, 1933 | 60 7/8 | 58 1/2 |
| 11, 1933 | 60 7/8 | 60 |
| 12, 1933 | 60 | 58 3/4 |
| 13, 1933 | 60 5/8 | 58 1/4 |
| 14, 1933 (no quotations - Good Friday) | ||
| April 15, 1933 | 58 3/4 | 57 |
| 16, 1933 (no quotations - Sunday) | ||
| 17, 1933 | 56 7/8 | 55 3/8 |
| 24, 1933 | 66 | 62 1/2 |
On December 26, 1933, upon which date petitioner first had a right to exercise the option, the stock of the corporation was selling at a high of 99 1/4 and a low of 98 on the New York Stock Exchange.
The petitioner exercised the options given to him under the agreement of*1054 April 18, 1933, by purchasing at $57.65 per share stock in the corporation as follows:
| December 27, 1933 | 800 shares |
| April 18, 1934 | 800 shares |
| April 19, 1935 | 800 shares |
*392 The market value of stock in the corporation on April 19, 1935, was $116.25. Petitioner did not sell during 1935 any part of the 800 shares of stock purchased on April 19, 1935. At the time of each exercise of the options the petitioner informed the corporation that he was not taking up the stock for purpose of immediate resale and that he was financially fully able to handle the required payment.
The provision in the option enabling the corporation to cancel the option, so far as not exercised, ofr good cause, was inserted solely to enable the corporation to cancel the option in the event the Federal or State Government should enact legislation which would make consummation of the agreement illegal, and it was so understood by both parties at the time.
On April 17, 1935, the executive committee approved the sale of 3,200 shares of stock at $57.65 to the executive officers above listed, said officers having presented letters stating that they desired to exercise their options.
*1055 The Commissioner in the deficiency notice added to petitioner's income as additional compensation for services the amount of $46,880, representing the difference between $93,000, the market value of 800 shares of stock of the corporation on April 19, 1935, and $46,120, the amount paid therefor by the petitioner.
OPINION.
DISNEY: The question for determination here is whether benefits flowing to the petitioner under the option agreement were by way of compensation to him, or whether the transaction was a mere purchase and sale of stock, the gain or loss thereon to be determined at the time of resale of the stock. He did not resell any of the stock in the taxable year.
We have very recently determined this question in , and in . On facts in both proceedings very similar to those herein, we held that the acquisition of stock by the petitioner did not constitute the receipt of compensation.
Respondent suggests that , is distinguishable in the same manner as *1056 , and that the latter is distinguishable because in the instant proceeding the petitioner could not exercise the option prior to December 26, 1933, though the option was granted and accepted on April 18, 1933. We think there is no such distinction between the present proceeding and , and , for examination of the former discloses that, as in the instant proceeding, the option was not exercisable at the *393 date given. It was offered on March 11, 1931, but the optionee could not purchase before September 1, 1931. Likewise in , the optionee could purchase only when the stock, which was at the time of option selling from $30.50 to $45 per share, should sell on the market at $55 per share in lots of 1,000 shares. We find, therefore, in this respect no reason to deviate from our conclusions in In *1057 , the option was offered on September 13, 1929, but provided for delivery of stock not earlier than December 1, 1929, and it is apparent that the situation is not essentially different from that in the instant proceeding.
Respondent suggests as further distinction that the option herein could be canceled at any time by the trustees. This fact does not appear in , or in ; but in our opinion, the contention is too broad. There was not an absolute right to cancel the option. It could be canceled, so far as not already exercised, only for good cause (which specifically should not include increase in market value of the stock), if the board of directors of the corporation deemed such action for the best interests of the stockholders of the company. We can not think that such a qualified power to cancel the option would cause each sale of stock to constitute a new transaction, or sever the connection with the original agreement of option. Moreover, the evidence showed that the object of this provision, as understood by both parties to the agreement at the time, *1058 was to safeguard against possible legislation which might have the effect of making consummation of the agreement illegal. Respondent vigorously excepted to such evidence on the theory that it tended to modify or contradict the written option, but such rule governs only as between the parties to an agreement, and not to this proceeding. . As we construe the provision for cancellation, the corporation could have canceled the option only upon a showing of good cause. We think the record herein fairly negatives such good cause. The option was not canceled, and the optionee satisfied the corporation that he was fully able financially to make payment. We are therefore unable to find in the cancellation provision any distinction between this proceeding and , and The principles there enunciated control here. The option price was not substantially different from the fair market price at the date of the option. Indeed, the option was at a price slightly higher than the market price at the time. There was undoubtedly connection between petitioner's position*1059 as an employee and the granting of the option to him, but it did not amount, by any means, to the option being granted as *394 compensation for services rendered. In , referring to the optionee, it was stated:
* * * Undoubtedly he had been accorded this right of purchase because he was a valued employee of the company and it wished to retain his services. * * *
Yet it was held that the option was not compensation for services rendered. The distinction between compensation for services and the granting of an option to employees in order to benefit the company by making the employees more interested in the welfare of the company has, in that case, and in Delbert B. Geeseman, Gordon M. Evans, and Rossheim v. Commissioner, all cited above, been fully, and we think soundly, set forth, so that further extended discussion is not here necessary. The situation in the present proceeding offers no difference in principle and no facts to indicate payment of compensation for services rendered, more than in the cases above noted. Indeed, in *1060 , there was some language indicating that the agreement was "designed to compensate those who continue to give to the company their best efforts", etc., though it was contradicted by other provisions of the agreement; whereas the evidence herein tends throughout, we think, to negative any agreement to compensate for services. Compensation for services was handled on a different basis, dependent upon the earnings of the corporation; the granting of the options to purchase stock had no such limitation. We think the situation amounted to nothing more than an incentive to loyal support of the organization much in the same manner as approved in the cases above cited.
Respondent's reference to article 22(a)(1) of Regulations 84 and to similar provisions in prior regulations does not, in our opinion, offer reason for deviating from the opinion already expressed above and in previous cases, for the various cases upon this subject have not permitted, and obviously should not permit, the regulations to add anything to the statute.
We therefore hold that the petitioner did not have income in the taxable year represented by the difference between the*1061 option price and the fair market value of the stock in the corporation.
Decision will be entered for the petitioner.