1940 BTA LEXIS 867">*867 UNDISTRIBUTED PROFITS TAX - DIVIDENDS PAID CREDIT - PREFERENTIAL DISTRIBUTION. - A dividend paid pro rata on outstanding shares was not preferential within the meaning of section 27(g), Revenue Act of 1936, even though two large stockholders had previously made substantial contributions to the capital of the corporation without receiving any stock in exchange.
42 B.T.A. 1410">*1410 The Commissioner determined a deficiency of $11,654.10 in the petitioner's income taxes for the calendar year 1936. The sole question for decision is whether or not the petitioner is entitled to a dividends paid credit of $50,000 in determining its surtax on undistributed profits for that year.
FINDINGS OF FACT.
The petitioner is a corporation, organized under the laws of the State of New York on November 14, 1925. It filed an income tax return for the taxable year with the collector of internal revenue for the twenty-first district of New York.
The petitioner has been engaged in the wholesale feed business. That business was owned, prior to the petitioner's formation, by Edwin1940 BTA LEXIS 867">*868 W. Elmore. Edwin became the petitioner's president and the owner of 4,995 of its 5,000 shares of stock. The remaining 5 shares were purchased by and issued to Harry M. Goldsmith at the time of incorporation. Goldsmith had been employed in the business for many years. Edwin died in 1927. He had sold 500 of his 4,995 shares to his son, Earle P. Elmore, in 1926; so that at the time of his death he owned 4,495 shares. Those shares were distributed, prior to May 1935, in accordance with the directions of his last will and testament, as follows: 60 shares to Goldsmith and Marcus C. Hemstreet in trust for the life benefit of his aunt, Lulu Elmore; 1,478 1/3 shares to Goldsmith and Hemstreet in trust for his wife, Florence Elmore; and to his son, Earle, and his daughter, Mabel 42 B.T.A. 1410">*1411 E. Rucker, 1,478 1/3 shares each. No other changes in the ownership of the petitioner's stock occurred before the end of the taxable year. Edwin left the remainder of his property, including bonds representing obligations of the Government of the United States, to Earle and Mabel, share and share alike.
Goldsmith became the petitioner's president and Earle its vice president in 1927.
The petitioner1940 BTA LEXIS 867">*869 from time to time prior to May 1935 borrowed funds from a bank. The petitioner in May 1935 owed the bank about $118,000, which indebtedness was secured by bonds having a face value of about $139,500. Approximately $92,000 face amount of those bonds was owned by the petitioner. The remainder, or about $47,500, was bonds which Earle and Mabel had received from their father's estate, owned equally, and had loaned to the petitioner for the purpose of supplying it with bankable collateral.
The interest rate on the bonds held as collateral was lower than the rate charged by the bank on the petitioner's indebtedness. The petitioner's board of directors, because of that circumstance, decided to sell the bonds held by the bank as collateral and apply the proceeds on its indebtedness to the bank. Accordingly, the board of directors, at a special meeting held on May 20, 1935, adopted a resolution directing Goldsmith to dispose of the bonds and apply the proceeds on the indebtedness. The board of directors was advised at that meeting that the proceeds from the sale of the bonds owned by the petitioner would not be sufficient to pay off the bank loans. Earle, who was one of the petitioner's1940 BTA LEXIS 867">*870 directors and present at the meeting, proposed on behalf of himself and his sister, Mabel, that their bonds should be sold, the proceeds made available to the petitioner for the payment of the bank loans, and such proceeds should be considered as an additional investment by them in the petitioner's capital. This proposal, upon motion duly made and seconded, was unanimously accepted. Thereafter the bonds were considered to be the property of the petitioner.
Bonds in the face amount of $113,000 were sold by the bank, upon instructions from Goldsmith, between May 20 and May 28, 1935. The proceeds from the sale, about $120,000, were used to pay off the petitioner's bank loans and the balance was credited to the petitioner's account with the bank. Proceeds from the sale in the amount of $21,732.60 were from bonds given to the petitioner by Earle and Mabel. The petitioner credited that amount to its capital stock account on July 31, 1935, as representing additional capital contributed to the petitioner by Earle and Mabel pursuant to the proposal accepted by the board of directors at the meeting of May 20, 1935. The remaining bonds given to the petitioner by Earle and Mabel were1940 BTA LEXIS 867">*871 not sold until about December 22, 1936. The proceeds from their 42 B.T.A. 1410">*1412 sale, $28,272.04, were credited to the petitioner's capital stock account on December 29, 1936, and also as a capital contribution by Earle and Mabel. The petitioner did not issue any stock to them in exchange for those contributions.
The petitioner, on December 15, 1936, declared ordinary and extra dividends aggregating $10 a share, or a total of $50,000, payable on December 31, 1936. The dividends were paid by checks dated December 31, 1936, and signed by Goldsmith as president of the petitioner. The checks were delivered to and made payable to the following persons in the amounts set opposite their names:
| Florence G. Elmore | $14,783.33 |
| Earle P. Elmore | 19,783.34 |
| Harry M. Goldsmith | 50.00 |
| Lulu Elmore | 600.00 |
| Mabel E. Rucker | 12,283.33 |
| Total | 47,500.00 |
Mabel, as the owner of 1,478 1/3 shares of stock, was entitled to dividends of $14,783.33, or $2,500 more than the $12,283.33 actually paid to her on December 31, 1936. She had borrowed $2,500 from the petitioner earlier in the year in anticipation of the dividends. Her loan was repaid in full and canceled and her dividend was1940 BTA LEXIS 867">*872 paid in full by the payment to her of $12,283.33. The dividends paid to Florence G. Elmore and Lulu Elmore were paid directly to them at the direction of their trustees. Goldsmith deposited his $50 dividend check for collection in his personal bank account and within a few days returned the $50 to the petitioner. He was not under any obligation to return the dividend, but did so for personal reasons. He had always followed either that practice or the practice of giving his dividends from the petitioner to charity.
The petitioner reported on its 1936 return net income of $72,849.53 and adjusted net income of $63,082.10, upon which it claimed a dividends paid credit of $50,000 for the purpose of computing its undistributed net income subject to surtax under section 14 of the Revenue Act of 1936. The Commissioner disallowed the $50,000 dividends paid credit upon the ground that the dividends for which credit was claimed were preferential within the meaning of section 27(g).
The dividends paid by the petitioner on December 31, 1936, were distributed pro rata, equal in amount, and with no preference to any share of stock as compared with other shares of the same class.
OPINION.
1940 BTA LEXIS 867">*873 MURDOCK: The sole question for decision is whether the dividend distribution of $50,000 made on December 15, 1936, was preferential 42 B.T.A. 1410">*1413 within the meaning of section 27(g) so as not to entitle the petitioner to a dividends paid credit under section 27(a) of the Revenue Act of 1936. The argument of the respondent is that Earle and Mabel, by reason of the contributions of capital which resulted from their contribution of bonds to the petitioner, became the owners of interests in the corporation in addition to those represented by their shares and, consequently, they received less than their pro rata share of the $50,000 dividend. The facts show, however, that they donated the bonds to the corporation without any intention of increasing their proportionate interest in the corporation. The donation of those bonds, of course, added to the value of the interests of all of the stockholders, including those who had made no contribution whatsoever. The stockholdings remained the same, and every share received its pro rata equal share of the dividend distribution without any preference. There was no connection whatsoever between the capital contribution made by Earle and Mabel1940 BTA LEXIS 867">*874 and the dividend of December 15, 1936. The capital contribution was made on May 20, 1935, over a year and a half before the dividend was declared. The respondent makes no point of the fact that Goldsmith returned the $50 which he received as a dividend. The evidence clearly shows that he did that from personal choice and not because of any agreement or understanding either expressed or implied. Neither does the Commissioner make any point of the fact that a portion of Mabel's dividend was used to cancel a loan which she had obtained from the petitioner. The Commissioner erred in disallowing the dividends paid credit claimed by the petitioner for 1936.
Decision will be entered for the petitioner.