*936 1. A corporation is not entitled to a dividends paid credit under section 27(a) of the Revenue Act of 1936, to the extent that the dividend checks were endorsed back to the corporation by the stockholders before the effective dividend declaration date.
2. A credit for dividends paid is allowable, following Valley Tractor & Equipment Co.,42 B.T.A. 311">42 B.T.A. 311, where the dividend checks were not endorsed back to the corporation until after they had become due and payable.
*915 In this proceeding we are asked to redetermine deficiencies in the income and excess profits taxes of the petitioner for the year 1936 in the sums of $17,518.48 and $151.77, respectively.
The sole issue is whether or not the issuance of dividend checks by the petitioner, with the understanding that its directors would endorse the checks payable to them and return them to the petitioner uncashed and that the directors would persuade other stockholders to act likewise, followed by actions taken pursuant to that understanding, constituted payments*937 of dividends under the provisions of section 27(a) of the Revenue Act of 1936.
FINDINGS OF FACT.
The facts were stipulated substantially as follows:
The petitioner is a corporation, organized under the laws of the State of California. During the year 1936 its capital stock consisted of 100,000 shares of $1 par value common stock, all of which was issued and outstanding.
On December 30, 1936, a meeting of the board of directors of the petitioner was held, at which the following resolution was adopted:
Moved by E. R. Hawke, seconded by R. K. Whitmore and unanimously adopted that a dividend of 95% be declared on stock of record December 30th, 1936, to be paid December 31st, 1936.
The meeting was actually held on December 30, 1936, although the minutes of the meeting are dated December 31, 1936. The following directors, also stockholders of the petitioner, were present:
S. F. Triplett, president of petitioner J. U. Gartin E. R. HawkeGeorge K. Beard, secretary of petitioner
W. P. Reinhart R. K. WhitmoreDividend checks signed by S. F. Triplett as president of petitioner, and drawn on the petitioner's account with the Modesto Trust & Savings Bank, had been*938 made out on December 30, 1936, covering the 95 percent dividend referred to in the above resolution. The checks were dated December 31, 1936. Dividend checks in the following amounts were presented to the directors at that meeting:
| S. F. Triplett | $40,623.32 |
| J. U. Gartin | 95.95 |
| 11,457.00 | |
| E. R. Hawke | 10,963.00 |
| Geo. Beard (power of attorney for Modesto Terminal Co.) | 1,900.00 |
| W. P. Reinhart | 3,577.80 |
| R. K. Whitmore | 1,741.35 |
*916 Such stockholders endorsed their checks to the petitioner's order and the checks so endorsed were returned uncashed to the petitioner's treasurer.
It was understood, prior to this meeting, that the directors would endorse their checks and return them uncashed to the corporation, and that the officers and directors would persuade other stockholders to similarly endorse their checks and return them uncashed to the corporation. Pursuant to this understanding the following stockholders were requested by letter or telephone or personal contact on or before December 28, 1936, to call at the offices of petitioner in Modesto prior to December 31, 1936, and endorse their checks. Checks in the following amounts for such stockholders*939 were endorsed to the order of the petitioner and returned to the petitioner uncashed prior to December 31, 1936:
| Name | Amount |
| I. C. Baker | $95.00 |
| Glynn Cochran | 95.00 |
| A. W. Covert | 95.00 |
| W. E. Davis | 475.00 |
| Ann Gartin | 791.40 |
| Burton Gartin | 1,187.62 |
| G. W. Holtz | 47.50 |
| Hazel Wicking Hawke | 2,508.00 |
| R. S. Hiatt | 237.50 |
| G. F. Johnson | 2,073.96 |
| H. M. Kline | 190.00 |
| H. E. and Mabel P. Lennon | 950.00 |
| Archie Lyons | 95.00 |
| Chas. Ransom | .47.50 |
| Jack K. Ransom | 47.50 |
| Josephine D. Ransom | $47.50 |
| Aleck Rasmussen | .95 |
| Donald Reinhart | 380.00 |
| Sophia Rutley | 950.00 |
| H. L. Rogers | 593.75 |
| Edith Rutley | 950.00 |
| F. D. Salter | 190.00 |
| L. E. Service | 95.00 |
| W. W. Service | 791.40 |
| H. R. Stephens | 95.00 |
| D. W. Triplett | 1,377.50 |
| G. D. Turner | 6,238.75 |
| Alice A. Walthall | 2,375.95 |
| W. A. Zane | 47.50 |
| Mary E. Gartin | 475.05 |
Checks were mailed to the following stockholders on December 31, 1936, and were returned to the petitioner, uncashed and endorsed to the order of the petitioner, on the following dates:
| Name | Date | Amount |
| Frank Long | Jan. 4, 1937 | $9.50 |
| S. M. Love | Jan. 4, 1937 | 95.00 |
| Ora R. Whitmore | Jan. 4, 1937 | 8.55 |
| W. H. Wright | Jan. 4, 1937 | 190.00 |
| Musetta M. Davis | Jan. 19, 1937 | $285.00 |
| W. L. Woodward | Feb. 5, 1937 | 47.50 |
| F. L. Laird | Mar. 13, 1937 | 190.00 |
| V. C. Updike | Mar. 17, 1937 | 142.50 |
*940 The following checks to stockholders were retained by the petitioner for the reason that the addresses of the stockholders were unknown. Those checks have never been cashed.
| Fred Heller | $19.00 |
| L. A. McBride | 47.50 |
| Annabell R. Palmer | 7.60 |
| H. C. Wannecke | 47.50 |
| Mattie E. Langdon | 7.60 |
The balances in the petitioner's account with the Modesto Trust & Savings Bank against which the above checks were drawn from December 24 to December 30, inclusive, ranged from $5,735.92 to $15,762.20. *917 On December 31, 1936, the balance was $115,579.38. On January 4, 1937, it was $18,334.17 and on January 5, 1937, $13,299.67.
Shortly prior to December 31, 1936, George K. Beard, secretary of petitioner, and L. L. Dennett, attorney for and assistant secretary of the petitioner, saw W. W. Giddings, president of the Modesto Trust & Savings Bank, for the purpose of securing a credit to the account of the petitioner with the bank, sufficient to cover the amount of the dividend declared on December 30, 1936. Giddings was informed that the purpose of the dividend was to permit the petitioner to reduce its liability for surtax on undistributed profits under the Revenue*941 Act of 1936, without impairing its working capital. On December 31, 1936, Beard and S. F. Triplett executed a promissory note in the usual form, in the name of the petitioner, to the bank, in the amount of $95,000, with interest payable at 6 percent per annum. The amount of $95,000 was credited to the account of the petitioner at 3 o'clock p.m., December 31, 1936, at the close of banking hours. No security was furnished to the bank by the petitioner and no interest was ever paid on the loan by the petitioner. At the time the note was executed it was understood by Giddings that no substantial amount of the sum of $95,000 would be withdrawn from the petitioner's account, and that all, or nearly all, of the stockholders to whom dividend checks had been or would be delivered, had, or would, endorse their checks and return them uncashed to the petitioner. It was understood that the checks so endorsed would be used to offset or eliminate the credit in the amount of $95,000. Endorsed checks in the amount of $93,902.75 were charged against the petitioner's account on January 2, 1937, the first business day following December 31, 1936. The note was returned to the petitioner and canceled*942 on January 2, 1937, by the charge against its account of an amount equal to the difference between $95,000 and the amount of $93,902.75.
No stock or obligations of petitioner were issued to stockholders in consideration of the endorsement of their dividend checks to the petitioner, nor did the corporation enter on its books any credits to such stockholders for the amount of such checks. The corporation treated the amount of such checks on its books as donated surplus.
In its income tax return for the year 1936 the petitioner claimed a dividends paid credit in the amount of $106,450.32 in computing its surtax on undistributed profits. In his notice of deficiency the Commissioner disallowed $94,870.80 of such amount as a dividends paid credit.
OPINION.
LEECH: The question at issue is whether or not the petitioner is entitled to a credit for dividends paid under the provisions of section *918 27(a) of the Revenue Act of 1936, 1 in ascertaining its undistributed net income upon which a surtax is imposed pursuant to section 14(b) of that act. 2 The term "undistributed net income" is defined in section 14(a)(2). 3
*943 Respondent determined the deficiency on the following ground:
* * *
It is held that by these devices no dividend was paid in the year 1936. Since an actual payment of dividends to stockholders within the year 1936 was required by Section 27(a) of the Revenue Act of 1936 in order to secure credit in computing surtax on undistributed profits for the year 1936, and since no such payment was made as to the $94,870.80, it is held that you are not entitled to a dividend paid credit for the said $94,870.80.
The petitioner contends that it has complied strictly with the requirements of the statute by passing a resolution authorizing unequivocally the declaration of a 95 percent dividend within the taxable year and by issuing and delivering to its stockholders its checks covering such dividend. It affirms that its stockholders accepted such checks as a dividend payment and used them in making a voluntary contribution to the company's surplus by endorsing and delivering them to the company for that purpose. It argues that what the stockholders chose to do with their checks was their own affair and had nothing to do with the petitioner's payment of its dividend and its arrangement*944 to pay the dividend checks if and when presented.
Since petitioner is asking not only for a credit but also for a credit sought to be secured by a scheme admittedly adopted for the purpose of avoiding taxes, its transactions in the year before us, 1936, are subject to severe scrutiny. ; ; appeal dismissed, . The vital premise upon which petitioner's right to the credit under section 27(a) depends is that the dividends shall have been "paid during the taxable year." . The only issue before us is whether petitioner has carried its burden of proving this essential point.
The facts are that, prior to the directors' meeting at which the so-called dividend was declared, an understanding was reached that the *919 director-stockholders would endorse their dividend checks and return them uncashed to the corporation and that they would persuade other stockholders to do the same. The meeting was held on December 30, 1936, and the checks were drawn on that day. On December*945 28 at least 30 stockholders had been notified to call at petitioner's offices and endorse their checks back to petitioner, and had complied with this request "prior to December 31." On December 30, the director-stockholders, who owned the bulk of the stock of petitioner, received their checks at the meeting and endorsed them back to petitioner immediately. Eight other stockholders, whose holdings were small, returned their endorsed, uncashed checks to petitioner during the first three months of 1937, and petitioner retained the checks of five others because their addresses were unknown.
The dividend was declared on December 30, 1936, on stock of that record date, to be paid December 31, 1936. But the minutes of the meeting were dated December 31, 1936. The checks were also dated December 31, 1936.
The inescapable significance of these facts is that the liability of petitioner on all but $1,097.25 worth of dividend checks, 4 or almost 99 percent of that liability, was released and canceled prior to its accrual. Civil Code of California, sec. 3200(5); *946 ; . Thus, even if petitioner were on the accrual basis (a fact which is not proven here) it can not be heard to say that this still-born liability represents an accruable item that would found a right either to a deduction or to a credit. . The same holds true a fortiori if petitioner is on the cash basis. ;.
The arguments of petitioner, that the stockholders could have enforced payment of the dividends to them and that they had a free choice as to whether they would cash the checks or endorse them back to petitioner, are devoid*947 of merit. The minutes of the directors' meeting at which the dividend was declared were deliberately misdated December 31, 1936, the meeting actually having been held on the preceding day. It was thus petitioner's intention to become liable for payment of the dividends on December 31, the date which the checks therefor bore. ; . But petitioner was released from 99 percent of that liability the day before it arose. The checks purporting to pay that liability thus became nullities because they were returned to petitioner before they were payable. The proceeds *920 of these checks were never available to these stockholders. Cf. ; .
That the stockholders reported the dividends received in their individual returns as income and paid a tax thereon has likewise not been proved. Cf. . We can not indulge a presumption in favor of petitioner in this regard.
*948 Thus, not only has petitioner failed to meet its burden of proving payment of the greater bulk of the dividend in 1936, but also the facts show unmistakably and affirmatively that no such payment was ever made.
Inasmuch as the evidence shows that certain stockholders did not endorse their dividend checks back to petitioner until after the close of the taxable year, we hold that petitioner must be allowed a dividends paid credit equal to the face amount of those checks, $968.05. In the case of these checks, the liability of petitioner thereon was not extinguished before it arose and accrued, the stockholders could have kept and cashed them, and the case is pro tanto indistinguishable from
We hold, therefore, that petitioner is entitled to a credit in the amount of only $968.05.
Reviewed by the Board.
Division will be entered under Rule 50.
DISNEY dissents.
VAN FOSSAN, dissenting: Being unable to agree with the action of the Board in disallowing in part the claimed dividend credit, I respectfully dissent.
Footnotes
1. SEC. 27. CORPORATION CREDIT FOR DIVIDENDS PAID.
(a) DIVIDENDS PAID CREDIT IN GENERAL. - For the purposes of this title, the dividends paid credit shall be the amount of dividends paid during the taxable year. ↩
2. SEC. 14. SURTAX ON UNDISTRIBUTED PROFITS.
* * *
(b) IMPOSITION OF TAX. - There shall be levied, collected, and paid for each taxable year upon the net income of every corporation a surtax equal to the sum of the following, subject to the application of the specific credit as provided in subsection (c):
7 per centum of the portion of the undistributed net income which is not in excess of 10 per centum of the adjusted net income.
* * * ↩
3. (a) DEFINITIONS. - As used in this title -
* * *
(2) The term "undistributed net income" means the adjusted net income minus the sum of the dividends paid credit provided in section 27 and the credit provided in section 26(c), relating to contracts restricting dividends. ↩
4. Checks returned to petitioner with endorsements after December 31, 1936, i.e., in first three months of 1937, totaled $968.05. The checks which petitioner retained because the addresses of the payees were unknown totaled $129.20. This latter figure is not contested by respondent as an allowable credit, but the former figure is included in the total amount disallowed by him, $94,870.80. ↩