*1280 Petitioner corporation entered into contracts with its four shareholders for the purchase of milk products from the shareholders. The contracts provided for a base price per hundredweight of milk products and called for a bonus of petitioner's entire net profit to be distributed to the contract holders, computed in accordance with the butterfat content of the milk furnished by each shareholder. Petitioner also purchased milk products from a nonstockholder at a price less than it paid its shareholders. Petitioner is not a cooperative exempt from tax under section 101 of the Revenue Act of 1936. Petitioner paid a bonus at the end of the taxable year to its shareholders only and treated it in its Federal income and excess profits tax return as a part of cost of goods sold. Held, that the bonus was in the nature of a dividend and was not a part of cost of goods sold. Peoples Gin Co.,41 B.T.A. 343">41 B.T.A. 343; affd., 118 Fed.(2d) 72, followed.
*759 Respondent determined deficiencies in petitioner's*1281 income and excess profits taxes for the year 1937 in the sums of $628.80 and $202.97, respectively. The sole issue before the Board is whether or not amounts distributed by petitioner to its shareholders, in accordance with the terms of contracts entered into by petitioner with the shareholders for the purchase of products, were deductible from petitioner's gross income as part of cost of goods sold.
FINDINGS OF FACT.
Petitioner is a corporation organized and existing under the laws of the Territory of Alaska, with its principal office in Juneau, Alaska. Petitioner's income and excess profits tax return for the taxable year was filed with the collector for the district of Washington. Petitioner's books of account are kept and its Federal income tax returns are filed on the accrual basis.
Petitioner was incorporated July 1, 1936. At all times material herein petitioner's shareholders were four farmers, George Danner, Frank Maier, Joe Kendler and Lee H. Smith. Prior to December 27, 1937, each shareholder owned 25 percent of petitioner's stock.
Under date of June 26, 1936, petitioner entered into separate identical contracts with each of its four shareholders for the*1282 purchase of milk products from the individuals. Each contract was for a 15-year *760 period and contained the following provisions by which petitioner agreed to pay each vendor:
* * * the sum of Five ($5.00) Dollars per hundred weight, to be arrived at on a butterfat basis, at the approximate rate of 40?? per gallon for 4% whole milk, and in addition to said $5.00 per hundred weight, said Second Party agrees to pay Party of the First Part a bonus out of any and all net profits made by said Second Party, which bonus shall consist of the entire net profit of said Second Party, as and when declared by the Directors of said Company; HOWEVER, anything to the contrary herein notwithstanding, said bonus or dividend shall be pro-rated to each and every person, firm, partnership or corporation which has a similar contract, as this contract, with said Party of the Second Part, and said bonus or dividend shall be pro-rated in proportion to the number of butterfat pounds of milk, milk products, dairy or dairy products, sold to Second Party, measured by hundred weight, to be arrived at on a butterfat basis at the approximate rate of 40?? per gallon for whole milk.
On or about July 1, 1936, petitioner*1283 entered into a one-year contract with Jensine Pederson for the purchase of milk products. This contract provided that petitioner would pay Pederson the sum of 35 cents per gallon of 4 percent whole milk, established and arrived at on a butterfat basis. The contract contained no provision for a "bonus or dividend" such as was provided for in the contracts which petitioner entered into with each of its shareholders. The contract with Pederson has been renewed annually and was in effect throughout the taxable year. In the taxable year petitioner had no contracts for the purchase of milk products other than those with its four shareholders and with Pederson.
Prior to December 27, 1937, the following amounts were paid to the four shareholders of petitioner in payment for dairy products delivered to petitioner:
| Danner | $12,304.44 |
| Kendler | 17,771.93 |
| Maier | 11,446.63 |
| Smith | 8,408.53 |
On or about October 21, 1937, each of the shareholders contributed $800 to capital of petitioner. This was accomplished by the shareholders accepting stock in exchange for cash due them for milk products delivered to petitioner.
On December 27, 1937, the board of directors of petitioner*1284 held a special meeting at which the following resolution was adopted:
* * * that a sum of approximately four thousand dollars be paid out to the four stockholders, prorated according to the amount of milk delivered to the plant during the calendar year 1937, it being understood that this payment does not constitute a dividend but is made as additional purchase cost of raw milk delivered to the plant during the above-mentioned period.
*761 The $4,000 mentioned in the resolution of the directors adopted December 27, 1937, was prorated among the shareholders as follows:
| Danner | $985.70 |
| Maier | 917.00 |
| Kendler | 1,423.70 |
| Smith | 673.60 |
Petitioner did not have cash in its treasury sufficient to pay the sum of $4,000 to the shareholders. On December 31, 1937, petitioner had cash on hand in the sum of $140.39. This sum was within $20 of that on hand immediately prior to the $4,000 distribution. the shareholders agreed to accept stock in lieu of cash and received stock of petitioner having an aggregate par value of $3,980. The sum of $20, the difference between the par value of the stock and the amount of the distribution, was distributed to the shareholders*1285 in cash. The four stockholders were credited with having received cash and capital stock as follows:
| Cash | Par value of stock | |
| Danner | $5.70 | $980 |
| Maier | 7.00 | 910 |
| Kendler | 3.70 | 1,420 |
| Smith | 3.60 | 670 |
| Total | 20.00 | 3,980 |
On petitioner's books the distribution of $4,000 in stock and cash was reflected by debit of the "milk purchases" account $4,000 and the credit of accounts payable with the same amount. Accounts payable was then debited $4,000 and the capital stock and cash accounts were credited in the amounts of $3,980 and $20, respectively. The books contained notations to the effect that entries were made to record "bonus on the basis of the milk purchased" from the shareholders and "payment of liability" by the distribution of stock and cash.
As of January 1, 1937, petitioner had capital stock outstanding in the amount of $13,000. By virtue of the contribution to capital of October 21, 1937, and the distribution of December 27, 1937, the capital stock of petitioner outstanding as of December 31, 1937, was in the amount of $20,180.
On petitioner's Federal income and excess profits tax return for the year 1937 the $4,000 distribution was treated*1286 as an additional cost of goods sold and was deducted from petitioner's gross income. Respondent restored the amount of the distribution to gross income.
*762 OPINION.
HILL: The question at issue is whether the amounts which petitioner distributed to its shareholders at the end of the taxable year constituted additional cost of goods sold or were in the nature of dividends. Petitioner contends that the payment of $4,000 to the shareholders was not a dividend, but an adjustment of the purchase price of milk products sold to petitioner by the shareholders. It maintains that the payments could not be dividends, since they were not in proportion to stockholdings but were computed in accordance with contracts which were binding upon petitioner. Respondent argues that the $4,000 distribution was in effect a dividend consisting of the net profits earned by petitioner on sale of goods purchased from the shareholders. He asserts that treatment of the payment as part of the cost of goods sold would free from tax the entire earnings of petitioner attributable to goods purchased from the shareholders.
Counsel for petitioner concedes that petitioner is not a cooperative exempt*1287 from tax under section 101 of the Revenue Act of 1936. The problem before us is whether the $4,000 distribution is a proper addition to the cost of goods. We are of the opinion that it is not.
The facts in the instant case are similar to those considered by us in ; affd., . There the petitioner was a corporation organized for the purpose of purchasing and operating a public cotton gin. Petitioner ginned cotton for both stockholders and nonstockholders at the same charge. After the profits for the taxable year had been earned the stockholders adopted bylaws providing that the net profits of petitioner allocable to cotton ginned for its shareholders should be divided among the shareholders in proportion to the number of bales of cotton ginned for each shareholder. We held that that distribution constituted the payment of a dividend and was not deductible in determining the taxpayer's net income.
The facts in the present proceeding differ from those in the Peoples Gin case in that the basis for the distribution here was established by contracts entered into between petitioner and the shareholders. *1288 We believe, however, that this distinction is not material. The contracts were made by the shareholders with an entity of their own creation, an organization operated and controlled by them. The contracts provided that the bonus should consist of the entire net profit of petitioner "as and when declared by the directors" of petitioner. This provision, like that in the bylaws of petitioner in , had the effect of authorizing a dividend. The contracts, although binding on petitioner, might be changed with the same ease as bylaws in the Peoples Gin case.
*763 We consider that the distribution in question was made pursuant to the resolution of petitioner's board of directors, but, even if it were made in accordance with provisions of the contracts, it would not be the less a dividend. In the recent case of , we stated:
Neither are we impressed by petitioner's argument that the payments involved here, made by petitioner to its stockholders for so many years, can not be considered as distributions in the nature of dividends because (1) they were made pursuant to a contract and not*1289 pursuant to the rights of the payees as stockholders, and (2) the distributions consisted of the net earnings and not the surplus profits technically available for dividends. We are persuaded that the contract was executed and the distributions were made for so many years pursuant thereto because the Fontana Co. and/or the Water Co. were the holders of all of the stock of petitioner (except qualifying shares). It was because of this latter fact that the arrangement proved so permanently satisfactory to petitioner's controlling stockholders, and if we are to recognize the realities we must conclude that the ultimate reason for the distributions made to the Fontana Co. and/or the Water Co. was because, for all practical purposes, they were the sole stockholders of petitioner.
Here the distribution was made to the shareholders because they were shareholders. The nonshareholder who had a contract with petitioner was denied the advantages of the distribution and in fact received a smaller base price for her products under her contract than the shareholders. The distribution was a dividend despite the statement in the authorizing resolution to the contrary. A resolution of directors*1290 is not necessary for a distribution to have the effect of a dividend.
Petitioner argues that, since the distribution was not in proportion to shares held by the stockholders, it can not be considered a dividend. The authorities are clear, however, that a distribution of profits may be made on a basis other than stockholdings and still be a dividend distribution. ;; ; affd., , certiorari denied, . We hold that the $4,000 distribution was in the nature of a dividend and hence can not be included as part of the cost of goods sold.
Decision will be entered for respondent.