*3966 1. The actual cash value of notes bona fide paid in to a Wisconsin corporation for its stock may be included in invested capital from the date so paid in.
2. Actual cash value of said notes determined.
3. The value which may be included in invested capital is the value of the notes at the time received by the corporation. Additional value which would be given by the endorsement thereof by the corporation is not to be included in invested capital, nor is the value of the stock purchased with the notes, and pledged as security for their payment, to be considered.
*1085 This proceeding is for the redetermination of a deficiency of $2,402.34 in income and profits tax for the calendar year 1920.
FINDINGS OF FACT.
The petitioner is a Wisconsin corporation with its principal office at Columbus.
In January, 1920, the stockholders of petitioner authorized the sale of one thousand shares of its stock without par value at such consideration as the directors might deem fair and proper to such of the employees as the directors might deem*3967 worthy and whose services were by them considered essential to the continued successful operation of the business. At a directors' meeting held March 15, 1920, petitioner's directors voted to offer certain employees the new stock on the following conditions: Price $100 per share, to be paid for in notes running two years without interest, after that time with interest at 5 per cent per annum; the stock certificates to be deposited with petitioner as collateral security; the purchasers to sign an agreement not to offer stock for sale until paid for, without giving the company the first opportunity to purchase; all dividends to be applied on the purchase price.
They then voted to offer stock to the following employees in the amounts specified:
| Shares | |
| J. L. Allbright | 250 |
| C. O. Davidson | 400 |
| F. A. Welk | 50 |
| Miss Blakeslee | 25 |
| William Evans | 25 |
*1086 At this time, Allbright had been connected with petitioner for 12 years; Davidson, 8 years; Welk, about 14 years; Miss Blakeslee, 10 years; and Evans about 1 or 2 years.
On March 19, 1920, these five employees signed promissory notes for the amounts of $25,000, $40,000, $5,000, $2,500, and $2,500, respectively, *3968 and entered into five separate agreements with petitioner, the form and terms of each agreement being the same. The notes were in the following form:
$
COLUMBUS, WISCONSIN, March 19, 1920.
January 1, 1925, after date, for value received, I promise to pay to the order of The Columbus Canning Company $ at the First National Bank, Columbus, Wisconsin, with interest after January 1, 1922, at the rate of five per cent per annum, until paid. Payable annually.
(Signed)
The agreements were in the following form:
THIS AGREEMENT, Made this nineteenth day of March, 1920, by and between The Columbus Canning Company, party of the first part, and one of its employees, party of the second part,
WITNESSETH, Whereas, The Columbus Canning Company has sold shares of its capital stock to the said , and has issued a certificate therefor to said second party, which stock has been paid for by said second party giving, executing and delivering to the said company his promissory note for the amount of dollars ( ) payable in five years from January first, 1920, without interest until January, 1922, and at five percent (5%) per annum payable annually thereafter, and
Whereas, said*3969 second party has deposited the certificate for said stock so issued with the treasurer of said company as collateral security for the payment of said note, with the express understanding that all dividends annually declared on said stock shall be applied in payment of the principal of said stock until said stock is fully paid. The second party also agrees to pay the interest on the note as it becomes due annually in addition to the dividend payments on the principal.
If the party of the second part desires to sell said stock it is agreed that he is first to offer the same to the said first party at the lowest price which he will accept therefor.
This sale of stock has been made to said employee for the purpose of giving him an opportunity to become interested in the company and providing for easy payments therefor, but should said employee sever his connections with said company and desire to sell said stock, he is to give said company the first opportunity to buy the same.
This agreement to be binding upon said parties, their successors, their heirs, administrators and assigns.
IN WITNESS WHEREOF, The parties hereto have set their hands and seals the day and year first*3970 above written.
At the date of the hearing in 1927, payments had been made on these notes as follows: Allbright, $18,000; Davidson, $28,000; Welk, $3,600; Miss Blakeslee, $2,500; Evans, $1,800. With the exception of $1,375 paid in cash by Miss Blakeslee, these payments represented dividends paid on the stock.
*1087 There was never any demand made on the makers of the notes to pay them and petitioner never made any attempt to realize anything on the notes.
The Commissioner has allowed as invested capital for the year 1920 the amounts which had been actually paid in on the principal of the said notes from the dates of such payment. At the time paid in, said notes had an actual cash value of $10,000.
OPINION.
PHILLIPS: The petition alleges two errors. One was abandoned at the hearing, leaving for consideration only the question whether the Commissioner erred when he included in invested capital for 1920 only the amounts paid to petitioner on account of the notes given by certain of its employees for stock and in refusing to include in invested capital for that year the face amount of such notes.
*3971 Section 326 of the Revenue Act of 1918 provides that invested capital means, among other things, "(2) Actual cash value of tangible property, other than cash, bona fide paid in for stock or shares, at the time of such payment * * *." The primary purpose of the issue of stock to employees was to give them an interest in the business, and while it appears that all parties expected that payment of the notes should be made largely, if not exclusively, from dividends, the obligation to pay was unconditional and the bona fides of the transaction seems beyond question. In such circumstances the actual cash value of the notes may be included in invested capital unless, by reason of some provision of the Wisconsin statutes, the transaction is void. ; 5 Am.Fed.Tax.Rep. 5909; ; ; . The Wisconsin courts have indicated that notes given in such a transaction are enforceable. *3972 ; ; .
To establish the value of the notes, petitioner relies largely upon the testimony of bankers that they would have discounted them. Upon further examination it appeared that this testimony was based largely upon the value which would be given the notes by the endorsement of the petitioner. Such testimony is of little or no value; it expresses only the borrowing capacity of petitioner and not the value of the notes when paid in. The thing that is to be included in invested capital is the actual cash value of the notes given to the petitioner; not the amount which it could realize thereon when backed by its own credit. Any other decision would permit the corporation *1088 to include its borrowing capacity in its invested capital, despite the provisions of the statute excluding borrowed capital.
In considering the value of the notes we must also exclude the value of the stock purchased with the notes and pledged as security for their payment. It would seem evident that a corporation does not increase the value of*3973 its assets or increase its invested capital by increasing its capital stock. Until it receives property of value in exchange for such stock, its assets remain the same. If the corporation issues its stock for notes which in themselves have no value, there is still no increase in the value of the assets. Such value is not increased by pledging the stock so issued as security for the payment of the notes, for the only thing of value which it has received for its stock is such stock. If it does not increase its assets by issuing its own stock to itself, it does not do so when it receives such stock as the only thing of value in payment therefor. The notes can be paid only out of such security and the value of such security can be realized only from the assets already existing. The net worth of the corporation is the same as it was before the transaction took place. Only the amount of the outstanding capital stock has been increased and the effect is the same as that of a stock dividend; it serves to decrease the value of each share but not to increase the value of the assets.
It is said that the corporation could borrow on such collateral notes. The answer is that it is not*3974 borrowing on any value existing in the notes but is borrowing on its own stock. This is only another way of saying that it is borrowing on its own credit, as reflected in the credit value attaching to its stock. To permit the value of the stock so sold and pledged as security for the notes to be used to measure the value of the notes, would be to include in invested capital the value of the assets back of the stock, which have already been once included to the full amount allowed by the statute.
The argument proceeds in a closed circle and would permit the duplication of the same values in invested capital. Carried to its logical conclusion, the contention made would permit the same values to be included several times, in whole or in part, by reason of successive increases of outstanding capital stock and the pledging thereof as collateral for notes. Invested capital means something more substantial than this.
In the instant case the notes were not wholly valueless. While most of the testimony related to the amount which could have been obtained for the notes and their collateral or upon the notes when endorsed by the corporation, there is some testimony of the financial*3975 responsibility of the makers and it is upon this that we base our finding that at the time these notes were paid in for stock they had a *1089 cash value of $10,000. To this extent the cash value of the assets of the petitioner were increased, and such value should be included in the invested capital from March 19, 1920.
Reviewed by the Board.
Decision will be entered on 20 days' notice, under Rule 50.
MURDOCK concurs in the result.