1928 BTA LEXIS 3782">*3782 Transaction between corporation and principal stockholders construed and held to be contributions to capital rather than reductions of salary.
11 B.T.A. 524">*524 These are proceedings under Docket Nos. 12390, 12391 and 12392, consolidated for hearing and decision, for the redetermination of deficiencies in income taxes for the calendar year 1920, in the amounts of $7,626.84, $4,349.64 and $8,456.92, respectively.
The error assigned in each case is the disallowance by the respondent, as a deduction from gross income, of the amount of $19,661.45, representing an alleged reduction of compensation from Morana, Incorporated.
FINDINGS OF FACT.
The petitioners in this case are individuals who, in 1920, and prior thereto, were officers of Morana, Incorporated, a corporation having its principal office in New York City.
The following sets forth a list of the employees and stock holdings in 1920:
| Name | Duties | Time | Shares of | Total com- |
| devoted | stock owned | pensation | ||
| to duties | ||||
| Carl Schaetzer | President and salesman | All | 666 common | $89,884.48 |
| 540 1st pfd | ||||
| 250 2d pfd | ||||
| Warren E. Burns | Vice president and salesman | All | 667 common | 120,137.04 |
| 640 1st pfd | ||||
| 75 2d pfd | ||||
| Willard A. Walsh | Treasurer and salesman | All | 667 common | 142,654.99 |
| 430 1st pfd | ||||
| Walter Mueller | Secretary and manager | All | 100 common | 9,050.00 |
| 361,726.51 | ||||
| Walter Mueller was appointed secretary on October 1, 1920, and his | ||||
| compensation of $9,050.00 was paid to him as manager for the year | ||||
| 1920 and which is included in ordinary expenses under Schedule | ||||
| A-12 | 9,050,00 | |||
| Total compensation as per entry of Schedule A-13 | 352,676.51 |
| Name | Duties | Time | Shares of | Total |
| devoted | stock owned | compensation | ||
| H. F. Croen | Salesman | All | 50 common | $3,214.83 |
| 8 1st pfd | ||||
| A. Fortune | Salesman | All | 25 common | 11,721.05 |
| 15 1st pfd | ||||
| H. J. Kohl | Salesman | All | 50 common | 11,219.60 |
| 2 1st pfd | ||||
| W. H. Rowse | Salesman | All | 125 common | 9,000.93 |
| 41 1st pfd | ||||
| 878 2d pfd | ||||
| Edward Stange | Chemist | All | 50 common | 5,290.99 |
| 23 1st pfd | ||||
| F. W. Stechmann, Jr | Salesman | All | 50 common | 14,453.56 |
| 20 1st pfd | ||||
| H. C. Wright | Purchasing | All | 10 common | 4,780.00 |
| agent | 10 1st pfd |
11 B.T.A. 524">*525 These three petitioners, Burns, Schaetzer, and Walsh, in 1914, turned over to Morana, Incorporated, a concern which had been in existence since about 1909, certain foreign contracts, the only one of which had any great value being one with Compagnie Morana of Zurich, Switzerland, which was under German ownership. These contracts were set up on the books of the corporation at a value of $119,900. The entry of the United States into the World War rendered it impossible for Morana, Incorporated, to obtain merchandise from the Swiss concern. As a result of this, in 1919, there1928 BTA LEXIS 3782">*3784 was charged off from surplus the amount of $60,915.66, leaving a balance in the contract account of $58,894.34.
In 1920 the business of Morana, Incorporated, decreased, and Burns, who was in Europe, was recalled.
The following is the balance sheet of Morana, Incorporated, for the year 1920.
| Jan. 1, 1920 | Dec. 31, 1920 | |
| ASSETS | ||
| Cash | $9,466.17 | $48,992.22 |
| Trade accounts and notes receivable | 218,437.14 | 326,706.52 |
| Inventories | 141,317.16 | 513,874.30 |
| Investments: Stock in other corporations | 5,750.00 | 5,750.00 |
| Loans to others | 1,908.51 | |
| Furniture and fixtures | 12,482.48 | 21,267.24 |
| Foreign contracts | 58,984.34 | |
| Machinery and equipment | 53,531.42 | |
| Buildings and realty | 65,650.00 | |
| Premium on unexpired insurance | 3,019.53 | |
| State of taxes for 1921 | 2,301.30 | |
| Deficit | 87,174.50 | |
| 533,545.80 | 1,128,267.03 | |
| LIABILITIES | ||
| Notes payable: | ||
| Banks | 110,000.00 | 250,000.00 |
| Trade acceptances | 15,627.68 | 5,350.00 |
| Foreign acceptances | 151,446.89 | |
| Accounts payable | 1,938.81 | 31,205.84 |
| Others | 40,995.87 | 71,838.18 |
| Reserve for accounts | 5,664.87 | |
| Reserve for adjustment of laboratory | 10,966.24 | |
| Employees account payments on stock | 2,300.00 | |
| Reserve for dividend on preferred stock | 14,926.12 | |
| Capital stock outstanding: | ||
| First preferred | 131,100.00 | 222,500.00 |
| Second preferred | 132,500.00 | |
| Common | 200,000.00 | 248,500.00 |
| Surplus and undivided profits | 14,922.33 | |
| 533,545.80 | 1,128,267.03 |
1928 BTA LEXIS 3782">*3785 11 B.T.A. 524">*526 The minutes of a meeting of the stockholders of Morana, Incorporated, on January 6, 1921, contained the following:
The subject of commissions and salaries coming up, reference was made to the proceedings and authority contained in the minutes of the last annual meeting of stockholders of the Company. It appearing that Mr. Carl Schaetzer, Mr. Warren E. Burns and Mr. Willard A. Walsh had received during the year 1919, commissions on the sales aggregating $95,904.10 and the selling expenses aggregating $20,850.00 and that those gentlemen had received a regular salary of $30,500.00 each amounting to $91,500.00 and other compensation known as salaries "B" aggregating $147,701.82;
It was on motion duly made, seconded and unanimously carried:
RESOLVED: That said payments be and each of them are in all respects ratified and confirmed. The subject of compensation for 1920 coming up the business of the company was considered and it was on motion duly made, seconded and unanimously carried.
RESOLVED: That Mr. Carl Schaetzer, Mr. Warren E. Burns and Mr. Willard A. Walsh be paid a stated salary each at the rate of Fifty Thousand ($50,000) Dollars per year, and it was further1928 BTA LEXIS 3782">*3786 resolved that each salesman in addition to his regular salary or drawing account be allowed a sufficient amount to cover expenses incurred in selling goods, * * *
* * *
WHEREAS, On January 13, 1914, Carl Schaetzer, Willard A. Walsh and Warren E. Burns received in exchange for their assignment of all interest in this contract capital stock of the Compagnie Morana of a par value equal to $162,900, and
WHEREAS, the fact that this contract is, at the present time of no value to Morana Incorporated will cause a loss to Morana Incorporated of $58,984.34, it is hereby
RESOLVED: That the officers of the company be instructed to charge this amount of loss $58,984.34, one-third each, to Carl Schaetzer, Willard A. Walsh, and Warren E. Burns on the books of the company, and that the proper officers be and hereby are instructed to collect said amount as soon as possible from said Carl Schaetzer, Willard A. Walsh and Warren E. Burns.
* * *
Each of the petitioners was formerly paid $30,550 salary and also a bonus and commissions. Salary B, or bonus, was determined by the class of merchandise sold by each of the parties. Commissions were dependent entirely upon sales.
The income-tax1928 BTA LEXIS 3782">*3787 returns of the three petitioners for 1920 reported the following income received from salaries, wages, commissions, bonuses, etc.:
| Carl Schaetzer | 89,884.48 |
| Willard A. Walsh | 142,654.99 |
| Warren E. Burns | 120,137.02 |
On the returns each petitioner took as a deduction one-third of the balance in the contract account, or $19,661.45.
To each of these returns was attached the following rider:
11 B.T.A. 524">*527 Explanation of loss of $19,661.45:
In the year 1914, the taxpayer received capital stock of Company Morana for certain foreign contracts on the assertion that they had the value of the par of the stock issued. It has transpired that said contracts were not of that value, and the company made a claim for payment back of part of the purchasing price. This claim has been liquidated by the taxpayer being charged with the above sum of $19,661.45. The taxpayer faced the alternative of being charged in this manner or by having his salary charged or reduced to the same extent. It is a loss in either event.
The tax return of Morana, Incorporated, for 1920 showed compensation of officers (including salaries, commissions, and other compensation) in the amount of $352,676.51. 1928 BTA LEXIS 3782">*3788 The attorney who prepared the minutes of the meeting of January 6, 1921, also prepared the returns herein referred to.
OPINION.
SIEFKIN: The single question raised by this proceeding is whether the amount of $19,661.45 which each of the petitioners herein claims as a reduction of his salary from Morana, Incorporated, was such or was in the nature of a payment for the worthlessness of certain contracts.
In 1914 the three petitioners turned over to Morana, Incorporated, certain foreign contracts for $162,000 of its capital stock. These contracts became worthless in 1920 and the balance in the contract account of the corporation at that time was $58,984.34.
The income-tax returns of each of the petitioners showed that the following salaries were received in 1920:
| Carl Schaetzer | $89,884.48 |
| Willard A. Walsh | 142,654.99 |
| Warren E. Burns | 120,137.02 |
Each of the returns contains a deduction of $19,661.45, which is explained by a notation attached to each in the following language:
Explanation of loss of $19,661.45:
In the year 1914, the taxpayer received capital stock of Company Morana for certain foreign contracts on the assertion that they had the value1928 BTA LEXIS 3782">*3789 of the par of the stock issued. It has transpired that said contracts were not of that value, and the company made a claim for payment back of part of the purchasing price. This claim has been liquidated by the taxpayer being charged with the above sum of $19,661.45. The taxpayer faced the alternative of being charged in this manner or by having his salary charged or reduced to the same extent. It is a loss in either event.
The minutes of a meeting of the stockholders of Morana, Incorporated, held on January 6, 1921, contained the following:
* * *
WHEREAS, On January 13, 1914, Carl Schaetzer, Willard A. Walsh and Warren E. Burns received in exchange for their assignment of all interest in 11 B.T.A. 524">*528 this contract capital stock of the Compagnie Morana of a par value equal to $162.900, and
WHEREAS, the fact that this contract is, at the present time of no value to Morana Incorporated will cause a loss to Morana Incorporated of $58,984.34, it is hereby
RESOLVED: That the officers of the company be instructed to charge this amount of loss $58,984.34, one-third each, to Carl Schaetzer, Willard A. Walsh, and Warren E. Burns on the books of the company, and that the proper1928 BTA LEXIS 3782">*3790 officers be and hereby are instructed to collect said amount as soon as possible from said Carl Schaetzer, Willard A. Walsh and Warren E. Burns.
* * *
At this meeting the stated salary of each of the petitioners was increased from $30,500 to $50,000 per year. Nothing in the minutes of this meeting would indicate that a reduction in salary to the petitioners was contemplated by the corporation.
The only evidence in the case supporting the contention of the petitioners that the item of $19,661.45 constituted a reduction in the salary of each is the testimony of the petitioners. They stated that in 1920, the business of the corporation having fallen off, they decided at an informal conference that they would accept a reduction in salary in the above amount. They testified that this was the customary manner of conducting the business of the corporation as they were the principal stockholders. The bookkeeper of the corporation was instructed to make proper entries on the books of the corporation, and the corporation's attorney was instructed to draw up proper minutes to cover this reduction in salary, to be formally ratified at a regular stockholders' meeting. They testified1928 BTA LEXIS 3782">*3791 that these instructions were not carried out, and that the minutes of the stockholders' meeting do not truly reflect the intention of the parties in the matter. They further testified that the same person who prepared the minutes of the meeting also prepared the income-tax returns of the petitioners, and that the explanation of the deduction of the $19,661.45 contained in the said reduction is not a proper explanation of the deduction. They testified that at the same time that they agreed to accept a decrease in salary, salaries of other employees were reduced, and some employees were discharged, all in line with a general retrenchment plan.
The fact that the stated salaries of the petitioners were increased from $30,500 to $50,000 was certainly not in conformity with a retrenchment plan, since this is purely an increase in salary. The bonus and commission which the petitioners were entitled to was an uncertain amount.
From all the evidence we must conclude that the amount of $19,661.56, claimed by each of the petitioners in this proceeding as a deduction, was a further contribution to the capital of Morana, Incorporated, to cover the corporation's loss due to the worthlessness1928 BTA LEXIS 3782">*3792 11 B.T.A. 524">*529 of the contracts which they had transferred to Morana, Incorporated, for capital stock.
In , we held that assessments on stock paid by individual stockholders represented additional cost of the stock and are not deductible as losses until the stock is sold or becomes worthless. See also .
In , we held that a taxpayer owning all the stock of a corporation, not a personal service corporation, may not deduct under the Revenue Act of 1918, as losses sustained in the business or as debts ascertained to be worthless, advances made to such corporation in the amount of the losses actually sustained by the corporation during a year so long as the corporation has net assets from which recovery in part is possible.
In accordance with these decisions we must hold that the deductions claimed can not be allowed.
Judgment will be entered for the respondent.