*2788 1. Held, that Adam, Meldrum & Anderson Co. was a joint-stock association taxable as a corporation under the Revenue Act of 1917, and not a partnership.
2. Held, that amounts credited on the books to the various stockholders constituted borrowed capital and may not be included in invested capital.
*812 In this proceeding the petitioner seeks a redetermination of the income and profits taxes for the year 1917 for which the Commissioner has determined a deficiency of $226.79. The petitioner alleges error on the part of the Commissioner (1) in holding that Adam, Meldrum & Anderson Co., during the year 1917, was a joint-stock association, taxable as a corporation instead of a copartnership; (2) *813 in failing to include in the computation of invested capital the credit balances in the members' accounts; (3) in refusing to grant the association consideration under section 210 of the Revenue Act of 1917.
FINDINGS OF FACT.
In March of 1867 a copartnership was formed for the purpose of dealing in dry goods and carpets in Buffalo, N. *2789 Y., under the name of Adam, Meldrum & Whiting. Shortly thereafter the name of this partnership became Adam, Meldrum & Anderson, and the business expanded into a general department store.
On or about November 14, 1892, an association styled Adam, Meldrum & Anderson Co. was organized under the articles of association wherein the organization was termed a joint-stock association. The purposes in the formation of this association were to include certain buyers and department store managers as participants in the business, and to overcome the necessity of liquidation which, previously, would have resulted upon the death of one of the partners.
The articles of association represented by the agreement of 1892 and minor amendments subsequently made, provided in part as follows:
This agreement, dated the fourteenth day of November, 1892, contains the Articles of Association of the Adam, Meldrum and Anderson Company, a joint-stock association, organized under the laws of the state of New York, for the purpose of transacting the business of buying and selling merchandise at Buffalo and elsewhere, and such other business as may conduce to the interests of the organization's undertakings.
*2790 ARTICLE 1.
Section 1. The following persons associate themselves as members of a joint stock association to be known as the "ADAM, MELDRUM AND ANDERSON COMPANY" for the purpose of dealing in merchandise, and such other business as may conduce to the interests of the organization's undertakings, with its principal place of business at Buffalo, New York, and such other persons as shall under the provisions and restrictions of these articles of association, and the by-laws adopted pursuant thereto, become stockholders in the association shall while they remain owners of stock in such association, be also associates and bound by these Articles of Association.
Section 2. The number of associates required by these Articles shall be three, and the names of the associations signing this agreement are Robert B. Adam, William Anderson and Robert B. Adam, Jr.
Other persons shall become members of the association and bound by these Articles of becoming stockholders herein.
* * *
Section 3. The purposes of the Association are to deal in such kinds and classes of merchandise, and such other business as may conduce to the interests of the organization's undertakings, as to the*2791 managing partners shall seem expedient, and for that purpose the capital of the association is declared to be *814 FIVE HUNDRED THOUSAND DOLLARS ($500,000.00) which capital is to be represented by stock issued in the form of certificates under the signatures of the President, Secretary and Treasurer of the association, and registered in proper stock books provided for that purpose. This stock shall represent the property of the association and the death of any stockholder or the assignment of his stock shall not work a dissolution of the association, but the association shall continue as before any such death or assignment.
Section 4. The Capital Stock of the Association shall be divided into two classes which shall be plainly designated in the stock certificates representing the same respectively as Capital Stock and Employees' Capital Stock and in the certificates representing each class of stock shall be printed the sections of these articles of association which limit its assignability and provide for its being purchased by the association or managing partners.
* * *
Section 5. The Capital Stock of the association fixed at Five Hundred Thousand Dollars ($500,000.00) *2792 is divided into Five Thousand (5,000) shares of One Hundred Dollars ($100.00) each; of these Three Hundred and Fifty Thousand Dollars ($350,000.00) shall be issued as Capital Stock and One Hundred and Fifty Thousand Dollars ($150,000) as Employees' Capital Stock, each certificate shall be authenticated as above provided.
Section 6. No transfer of the stock of the association shall be made upon the books of this association except upon surrender to the Secretary of the original certificate, except such stock as may be transferred by operation of law or by the Treasurer of the association pursuant to these Articles; in either case the original certificate, whether surrendered or not, representing the stock transferred, shall be void. No stockholder indebted to the association, nor any one to whom notice has been mailed by the Secretary under the next succeeding paragraphs of these Articles, shall be permitted to transfer the whole or any part of his stock without the written consent of the managing partners.
Section 7. Within twenty days after the semiannual stock-taking of the association the managing partners shall inspect the books, accounts and stock in trade of the association*2793 and thereupon fix and report the fair value of the stock of the association and thereupon for all the purposes of these Articles the value fixed by them shall be and remain the fair value of the capital stock for the ensuing half-year and until such value shall be changed pursuant to these Articles.
Section 8. The managing partners may purchase all the stock of any stockholder at any time by giving him a notice in writing signed by the Secretary, sent postpaid to his address as the same is recorded by the Secretary, stating therein that the managing partners have elected to purchase his stock at the price fixed by them as the fair value thereof for the current half year, unless said price shall be less than par, when said notice shall state that the managing partners elect to purchase said stock at the par value thereof, and that the stockholder may receive the purchase price at any time by calling at the office of the association and surrendering his certificate of stock.
* * *
Section 10. The Employees' capital stock shall be issued and held only by persons in the actual employment of the association and shall not be transferable by the person to whom it is issued. In*2794 case any person holding Employees' capital stock shall cease to be employed by the association either because of his death, voluntary resignation or his being discharged by the managing partners; or in case any employee shall part with any employee's capital stock allotted to him; in either case said stock shall immediately revert to the managing *815 partners and such employee or his representatives shall be entitled to receive therefor the value of the stock as fixed by the managing partners for the then current half year. The managing partners shall from time to time allot said employees' capital stock in such proportions and to such persons as in their discretion shall seem best but without allotting the whole thereof until such time as they shall deem proper.
* * *
ARTICE II.
* * *
Section 1. Officers - The officers of this association shall be:
1. A President
2. A Secretary
3. A Treasurer
4. Five Directors
5. Five Managing Partners
Section 2. The Managing Partners or a majority of them shall have the sole management of the business of the association; they shall intrust the proper officers and employees of the association with the care and*2795 management of its property; the transaction of the details of its business, fixing their duties, obligations and responsibilities, as in their discretion shall seem meet; they shall see to it that proper books of account of all the financial operations of the association are kept; they shall on a day to be fixed by them semi-annually cause an account of stock to be taken of the property and effects of the association upon a basis to be determined by them and ascertain the indebtedness, liability and obligations of the association and make the proper deduction as their discretion shall dictate for bad debts, depreciation of property and other causes, and thereupon shall declare an apportionment of the net profits to be paid for the current half year to the associates upon the basis of the amount of the capital stock of the association held by each, and also fix its fair value for the purposes of these Articles for the current half-year. In doing this they may deduct and set apart a portion of the profits as a fund to be used to extinguish any indebtedness of the association which shall not be paid.
Section 3. All Capital Stock and Employees' Capital Stock, which under Article 1*2796 of these Articles of Association shall vest in the managing partners, is to be held by them for the benefit of the Capital Stockholders of the association and in the case of capital stock may be by them resold to new parties, held in reserve and the profits thereon divided among the other capital stockholders in proportion to the capital stock held by each, or it may be held by them subject to being extinguished by a reduction of the capital stock of the association pursuant to law. Employees' Capital Stock held by the managing partners shall be transferred by them only to persons in the actual employ of the Company and can be held by no other person. The managing partners shall determine the amount of employees' capital stock which any employee shall be entitled to hold.
Section 4. The President shall preside at all meetings of the association of the Board of Directors, and of the Managing Partners and sign with the Treasurer all certificates of stock and bonds; he shall also see that the provisions of these articles are carried out.
Section 5. The Treasurer shall in the name of the association sign or endorse all commercial paper; execute all leases, deeds, and other conveyances*2797 of the association and countersign all certificates of stock and bonds; keep in his *816 possession all deeds, evidences of property and other valuable papers of the association, and keep a register of all stockholders showing the number of shares held by them, in books kept for that purpose. He shall also perform all other duties with which he shall be charged by the managing partners in relation to the financial business of the association and shall in all things obey their instructions relating thereto.
Section 6. The Secretary shall keep the records and minutes of the Board of Directors; he shall keep a register of the names and post-office addresses of the stockholders of this association; prepare and send notices of meetings and all other notices provided for in these Articles and attend to all such correspondence relating to the affairs of the association as may be allotted to him by the managing partners.
* * *
Section 9. All offices provided for in these Articles shall be filled annually by a vote of the stockholders, each share of stock to be entitled to one vote, at a meeting to be held on the last Monday in January of each year at the office of the association*2798 in the City of Buffalo at ten o'clock A.M. Except that the offices of Managing Partners shall be filled by the persons named in these Articles until such office shall become vacant by the death of the incumbent or by his ceasing to be a stockholder. Then the vacancy shall be filled at a special stockholders' meeting to be called by the Secretary upon ten days' notice at the office of the association at Buffalo, N.Y., at which meeting each share of stock shall be entitled to one vote.
ARTICLE III.
EXISTENCE OF ASSOCIATION.
Section 1. This association shall continue in existence for the term of twenty-five years.
Section 2. The association may be dissolved before said period of twenty-five years in the following manner or for the following causes: - (a): In the event of the death of a stockholder holding one-third of the capital stock of the company not counting employees' capital stock in case the association or the associates neglect or refuse upon application to purchase the stock held by such deceased stockholder at the fair value fixed for the current half year of the stockholder's death or at par in case such fair value is less than par. (b): In case any stockholder*2799 having one-third of the capital stock shall give notice that he desires such dissolution after the profits upon his investment have been less than four per cent per annum upon the par value of the stock held by him for one entire year of two semi-annual apportionments of profits, but in this case the managing partners for the association may purchase the stock of such stockholder at its fair value for the current half-year or at par, if such value is less than par as they may elect. (c): In case the managing partners shall determine to wind up the affairs of the association.
ARTICLE IV.
STOCKHOLDERS.
All persons becoming stockholders in this association whether as holders of the capital stock or as holders of employees' capital stock shall while they remain stockholders become subject to and bound by all the stipulations and *817 obligations of these Articles of Association as fully and effectually as if they had signed these Articles.
In accordance with the above articles of association the association's authorized life would expire November 14, 1917. No formal extension of the period was ever made, but the association continued to function thereafter in the same*2800 manner that it had functioned prior to November 14, 1917, until 1923, when the organization was changed to a corporation.
During the period under review the real estate of Adam, Meldrum & Anderson Co. was held in the name of R. B. Adam.
About 1907 the petitioner added to its business the operation of a private bank. The right of the petitioner to operate a private bank was investigated by the Superintendent of Banks of Albany, but the petitioner was permitted to continue the operation thereof.
During the life of the association it was the general policy of the stockholders to leave with the association various amounts representing bonuses and increases in salaries. These amounts were credited to the various stockholders on the books of the association, and each year interest at the rate of 6 per cent was computed semiannually upon the balances and credited to the various accounts.
In addition to the accounts of the various stockholders, which were termed "partners' accounts," petitioner accepted accounts from private investors who were not stockholders, entered such credit to each individual on the books and computed interest thereon in the same manner as was done in*2801 the case of stockholders. There was a third account, known as "employees' investment account," which represented deposits by employees. These also were entered in the same manner to the credit of the various employees, and interest was computed in the same manner as in the case of stockholders. These accounts were shown on the books as liabilities, in the following amounts:
| Year | Partners' accounts | Private investors' accounts | Employees' investment accounts |
| 1916 | $478,059.93 | $199,812.64 | $64,481.15 |
| 1917 | 500,778.62 | 199,584.27 | 80,000.00 |
| 1918 | 578,176.15 | 195,185.57 | 97,831.77 |
| 1919 | 640,622.84 | 144,000.00 | 141,168.62 |
Upon incorporation in 1923 the above class of accounts was converted into preferred stock of Adam, Meldrum & Anderson Co., Inc. Previous to incorporation, upon the death of the owner of an account, his heir or designated person was substituted.
*818 During the year 1916 petitioner filed an income-tax return on the form provided for corporations. For the year 1917 the petitioner also filed an income-tax return on the form provided for corporations but crossed out the word "corporation" and wrote above "joint stock association. *2802 "
The respondent computed the tax of Adam, Meldrum & Anderson Co. for the year 1917, holding that that company was a joint-stock association taxable as a corporation. The respondent excluded from invested capital the accounts above listed as "partners' accounts," "private investors' accounts," and "employees' investment accounts."
OPINION.
VAN FOSSAN: The first question for decision arises from the classification of petitioner by respondent as an association taxable as a corporation, petitioner contending it was a partnership. So far as the record shows, petitioner functioned in substantial accordance with the procedure laid down in its articles of association. It is our opinion that the history and expressed purposes in forming the association, its plan and method of procedure and its actual operation bring it squarely within the category of joint-stock companies or associations as that term is used in the Revenue Act of 1917. ; .
The second issue concerns invested capital. Petitioner's books showed at the end of the taxable year large accumulations of*2803 undrawn salary increases and bonuses, and interest on the same, all credited to the stockholders and appearing as liabilities on the balance sheet of the company. The books also showed deposits accepted by the company from employees and other persons and interest credited on such accounts in similar manner. The funds represented by these credits were at the use of the company and were employed in its business. Though it was tacitly understood these accounts were to be left with the company, there was no agreement that the money should be left for any definite period of time and there is nothing in the record negativing the right of any party to withdraw the account to his credit at any time. The company paid 6 per cent interest on all funds thus left or deposited with it, said interest being credited on the books and added to the account. The company also deducted the interest so paid or credited in computing its net income.
It is our opinion that these accounts which petitioner carried as liabilities and on which it paid interest represented borrowed money and were properly excluded from invested capital. See *2804 ; , *819 affd., . The facts distinguish this case from , were there was a definite agreement to leave funds with the company and no interest was paid thereon.
No evidence was introduced in support of the third issue raised by the pleadings and the same is, therefore, considered to have been abandoned.
Judgment will be entered for the respondent.