*1014 1. Liquidating dividends paid by a personal holding company (Revenue Act of 1934, sec. 351), which had no accumulated earnings, held, not to entitle it to a dividends-paid credit. Foley Securities Corporation,38 B.T.A. 1036">38 B.T.A. 1036; Gaston & Co.,39 B T.A. 640, followed.
2. Running accounts in which credits prior to the tax year exceeded debits as of December 31, 1933, held, not to constitute indebtedness incurred prior to January 1, 1934, so as to entitle personal holding company to a credit for payments thereon.
*341 The proceeding in Docket No. 94218 was brought to redetermine a deficiency in section 351 surtax of the Pembroke Realty & Securities Corporation for the taxable year ended September 30, 1936, in the sum of $18,348.43. The proceedings in the remaining docket numbers assail respondent's determination of transferee liability for the tax on the respective petitioners.
*342 The issues presented are: (1) Whether*1015 the Pembroke Realty & Securities Corporation, a personal holding company under section 351 of the Revenue Act of 1934, is entitled to a deduction for dividends paid under the provisions of section 351(b)(2)(C) of that act; (2) whether this corporation is entitled to a deduction under section 351(b)(2)(B) for amounts "used or set aside to retire indebtedness incurred prior to January 1, 1934", and (3) whether petitioners in Docket Nos. 95837, 95838, and 65839 are liable for the deficiency, if any, as transferees.
FINDINGS OF FACT.
All of the facts are stipulated by the parties and they are hereby found accordingly. They are in substance as follows:
The Pembroke Realty & Securities Corporation, hereinafter referred to as "petitioner" or "the corporation", was duly organized under the laws of the State of New York in 1929, and was, during its taxable year ended September 30, 1936, a "personal holding company" within the meaning of section 351 of the Revenue Act of 1934.
The corporation commenced business October 1, 1929, and was engaged in the business of buying and selling securities as a trader. It operated on a fiscal year basis commencing October 1 and ending September*1016 30 of the following year.
All of the corporation's outstanding stock was held by three stockholders. Arthur M. Loew (petitioner in No. 95837) was the holder of 250 shares of class A stock. The City Bank Farmers Trust Co., as trustee for Arthur M. Loew, Jr., under an agreement dated December 31, 1930 (petitioner in No. 95838), was the holder of 1,500 shares of class B stock, and the City Bank Farmers Trust Co., as trustee for Jane C. Loew, under an agreement dated December 31, 1930 (petitioner in No. 95839), was the holder of 1,500 shares of class B stock. The corporation had received $325,000 cash for the 250 shares of class A stock and the 3,000 shares of class B stock which it had issued to the above named stockholders.
During the six-year period commencing October 1, 1929, and ending September 30, 1935, the corporation suffered operating losses aggregating $353,646.97.
On October 1, 1935, the beginning of the taxable year in question, the corporation had total assets (at cost) of $75,544.43 and total liabilities (not including capital stock) of $104,191.40, its liabilities exceeding its assets by $28,646.97. The assets, which at cost aggregated $75,544.43, had a fair*1017 market value on October 1, 1935, of $94,869.43.
The following are the corporation's assets and liabilities on October 1, 1935:
| Assets: | ||
| Cash | $1,929.64 | |
| 3,900 shares of Houdaille Hershey B stock, at cost | 70,375.00 | |
| Dividends receivable on the above | 975.00 | |
| Accounts receivable | 2,264.79 | |
| Total assets | 75,544.43 | |
| Liabilities: | ||
| Due to Mervin Ash & Co | $63,890.65 | |
| Due to Arthur M. Loew | 33,800.00 | |
| Interest accrued on above loan | 6,500.75 | |
| Total liabilities | 104,191.40 | |
| Capital stock. A (250 shares) | $25,000.00 | |
| Capital stock, B (3,000 shares) | 300,000.00 | |
| 325,000.00 | ||
| Operating losses for preceding years | 353,646.97 | |
| 28,646.97 | ||
| Total | 75,544.43 |
*343 During the fiscal year commencing October 1, 1935, and ending September 30, 1936 (in fact, up to and including September 15, 1936, when the corporation ceased doing business and distributed its net assets to its shareholders), the corporation had a net income of $77,683.21 from operations and also received $9,450 representing dividends on stock of domestic corporations, making a total net income of $87,133.21.
The corporation filed a Federal income tax return on form 1120*1018 for the taxable year commencing October 1, 1935, reporting a net taxable income of $77,683.21, under Title I of the Revenue Act of 1934, and a tax thereon of $10,681.44, which was paid on December 15, 1936.
The assets and liabilities of petitioner on September 11, 1936, after giving effect to the net earnings and not including any liability for possible Federal surtax under section 351 now in controversy, were as follows:
| Assets: | |||
| Cash | $13,166.67 | ||
| Securities - 3,289 shares of Collins & Aikman Corp., at cost | 144,857.85 | ||
| Total assets | 158,024.52 | ||
| Liabilities: | |||
| Due to Mervin Ash & Co | $60,144.17 | ||
| Due to Arthur M. Loew | 32,800.00 | ||
| Due to Arthur M. Loew - interest | 6,575.00 | ||
| Federal income tax for fiscal year ended Sept. 30, 1936 | 10,681.44 | ||
| Total liabilities | $110,200.61 | ||
| Capital stock | $325,000.00 | ||
| Deficit at 10/1/35 | 353,646.97 | ||
| Difference | 28,646.97 | ||
| Less refund of 1934 Federal income tax | $19.11 | ||
| $28,627.86 | |||
| Less net income 10/1/35 to 9/11/36 | $87,133.21 | ||
| Less provision for Federal income tax | 10,681.44 | ||
| 76,451.77 | |||
| $47,823.91 | |||
| Total | 158,024.52 |
*344 The fair market value of the 3,289 shares*1019 of Collins & Aikman Corporation stock on September 11, 1936, was $181,511.69.
On September 11, 1936, a special meeting of the board of directors of the corporation was held at its office, at which meeting steps were taken to liquidate and dissolve the corporation. A resolution which was duly adopted provided for its complete liquidation and the distribution of all of its assets by September 15, 1937. The resolution, in part, stated:
(b) That such distributions by the corporation shall be made in complete cancellation and redemption of all of its stock.
* * *
(e) That all distributions made shall, to the extent of the earnings and profits accumulated since February 28, 1913, viz., as a practical matter, since the beginning of the current fiscal year, be made, first, out of such earnings and profits accumulated subsequent to February 28, 1913.
Recommendations were made at the meeting that the corporation obtain an advance from its broker, Mervin Ash & Co., of an amount sufficient to pay off the obligation to Arthur M. Loew, with interest; that 91 shares of the Collins & Aikman common stock be retained and the proceeds used to defray liquidation expenses; and that the balance*1020 of 3,198 shares be distributed in kind to the stockholders, who would individually make arrangements with the broker with reference to unpaid portions of their stock.
A further resolution, duly adopted, in part provided:
(a) That a dividend be declared and paid to stockholders of record September 15th, 1936, of all the current undistributed profits accumulated during the present year, after making provision for Federal income, excess profits tax, if any, and capital stock taxes, and that such distributions, so far as the corporation is concerned, be as and for a dividend, notwithstanding the fact that such distributions, when received by the stockholders, may, under the provisions of the applicable Revenue Acts, and particularly Section 115(c) and Section 27(f) of the Revenue Act of 1936, be received by them as distributions in complete liquidation of the corporation.
*345 Distribution in kind and necessary attending adjustments were then provided for.
On September 15, 1936, a special meeting of the stockholders of the corporation was held, at which meeting Arthur M. Loew, as the holder of all class A capital stock and as proxy for the holders of all the class B capital*1021 stock, was present. At this meeting all action taken by the board of directors at their meeting on September 11, 1936, was confirmed.
On or about September 15, 1936, and after the stockholders' meeting, the corporation paid over and distributed to its shareholders all of the assets in its hands, with the exception of sufficient assets to provide for the payment of the Federal income tax liability of $10,681.44, as shown on the return filed, and for dissolution expenses of $4,748.22, which were thereafter paid. The total net assets thus distributed to the shareholders aggregated at cost to the corporation the sum of $43,075.61, which is approximately the amount of the netassets assets of $47,823.91 less the $4,748.22 reserve for dissolution expenses.
The assets of the corporation, in addition to cash, consisted of 3,289 shares of the capital stock of the Collins & Aikman Corporation, which cost the corporation $144,857.85. Of these 3,289 shares of stock, 91 shares were sold and the cash added to the cash account, as previously directed, in order to have money available for the payment of Federal income tax and dissolution expenses. The remaining 3,198 shares were distributed*1022 in kind to the shareholders in proportion to their holdings. Such distributions were made subject to the liabilities due to Mervin Ash & Co., the stockbrokers holding the stock as security for the advances they had theretofore made, including the amount necessary to pay the loans due to Arthur M. Loew and the interest thereon. Thereupon, on or about September 15, 1936, the stockholders of the corporation surrendered their certificates of capital stock, which were duly canceled.
The shareholders were charged upon the books of the corporation with net distributions to them aggregating $43,075.69 at cost to the corporation. By reason of the fact that the Collins & Aikman Corporation stock distributed by the corporation in kind had increased in value since the time of its purchase by the corporation during the taxable year in question, the value of the net distributions received by the corporation's shareholders (the petitioners herein, other than the corporation) were as follows:
| Arthur M. Loew | $6,429.86 |
| City Bank Farmers Trust Co., as trustee for Arthur M. Loew, Jr | 38,579.09 |
| City Bank Farmers Trust Co., as trustee for Jane C. Loew | 38,579.09 |
| Total | 83,588.04 |
*1023 *346 In accordance with the resolutions adopted by the board of directors the corporation was dissolved on October 31, 1936, pursuant to article 10 of the Stock Corporation Laws of the State of New York.
On December 31, 1933, the indebtedness of the corporation to Arthur M. Loew was $65,616.98. The debits, credits, and balances in the account of Arthur M. Loew with the corporation were, on the respective dates shown, as follows:
| Sept. 30, 1933, | Credits | $770,030.47 | |
| Debits | 704,413.49 | ||
| Balance Sept. 30, 1933 | 65,616.98 | ||
| Sept. 30, 1934, | Credit | 1,863.75 | |
| Total | 67,480.73 | ||
| Debits | $616.98 | ||
| 7,200.00 | 7,816.98 | ||
| Balance Sept. 30, 1934 | 59,663.75 | ||
| Jan, 10, 1935, | Credit | 82,000.00 | |
| Balance Jan. 10, 1935 | 141,663.75 | ||
| Mar. 7, 1935, | Debit | 3,000.00 | |
| Balance Mar. 7, 1935 | 138,663.75 | ||
| Sept. 27, 1935, | Debit | 103,000.00 | |
| Balance Sept. 27, 1935 | 35,663.75 | ||
| Sept. 30, 1935, | Debit | 1,863.75 | |
| Balance Sept. 30, 1935 | 33,800.00 | ||
| Dec. 18, 1935, | Check | 1,000.00 | |
| Balance Dec. 18, 1935 | 32,800.00 | ||
| Sept. 15, 1936, | Check | 32,800.00 | |
| Balance Sept. 15, 1936 | None |
The corporation also carried on its books*1024 an account for interest accrued on the indebtedness to Arthur M. Loew. The amount of the accrued interest on September 15, 1936, as shown by that account, was $7,788.73. On September 15, 1936, the corporation gave Arthur M. Loew its check for $40,588.73 covering the balance of $32,800 due him, plus interest of $7,788.73. In order to obtain sufficient cash to meet the payment of this check, which was duly cashed by Arthur M. Loew on September 17, 1936, the corporation obtained cash of $38,063.73 on September 15, 1936, from Mervin Ash & Co. and was charged upon the latter's books with this sum in an account entitled "#2 New A/C." The liability to Mervin Ash & Co. so created, together with the other amounts owing to Mervin Ash & Co. in the *347 "#2 New A/C," was assumed by the individual stockholders upon distribution to them of the Collins & Aikman Corporation stock above referred to. Aside from the payment of the $32,800 and the accrued interest, the only other charge to the account of Arthur M. Loew on the corporation's books during the taxable year in controversy was an item of $1,000 representing a payment by check to Arthur M. Loew on December 18, 1935. The amount of*1025 money advanced to the corporation by Arthur M. Loew from January 1, 1934, to the beginning of the taxable year exceeded the amount it owed to him on September 15, 1936.
The corporation was indebted to Mervin Ash & Co. prior to January 1, 1934. The corporation opened an account with Mervin Ash & Co. in September 1931, and purchased and sold securities through this account. It was indebted to them on the dates and in amounts as follows:
| June 30, 1933 | $90,729.00 |
| Sept. 30, 1933 | 41,308.20 |
| Dec. 31, 1933 | 55,104.50 |
A total of $85,203.44 was paid on this account by the corporation between October 1 and December 12, 1935, when the account was closed out, the debit balance having been completely liquidated.
Between March 7, 1934, and August 5, 1935, credits were made to this account as follows:
| Mar. 7, 1934, sale of stock | $4,732.00 |
| Apr. 2, 1934, dividend received | 19.00 |
| May 1-2, 1934, sales of securities | 4,387.50 |
| June 4, 1934, sale of securities | 13,917.50 |
| June 5, 1934, sale of securities | 13,405.00 |
| Aug. 28, 1934, sale of securities | 17,024.50 |
| Aug. 29, 1934, sale of securities | 1,880.50 |
| Aug. 2, 1935, sale of securities | 27,194.88 |
| Aug. 5, 1935, sale of securities | 24,941.48 |
*1026 On August 2, 1935, the corporation opened another account with Mervin Ash & Co., known as "#2 New A/C," heretofore referred to, which was still in existence on September 15, 1936, and in which the Collins & Aikman Corporation stock transactions appeared. The account was closed out on September 30, 1936. The corporation also had two other accounts with Mervin Ash & Co., one designated as a "Put & call account" and the other a "Short account." The "Put & call account" was opened in June 1936 and closed on September 10, 1936, and the "Short account" was opened in July 1936 and closed in August 1936.
In determining petitioner's undistributed adjusted net income, respondent allowed no deductions for "dividends paid during the taxable *348 year" nor for "amounts used or set aside to retire indebtedness incurred prior to January 1, 1934."
The deficiency and interest thereon has not been paid.
OPINION.
OPPER: The corporate petitioner is a personal holding company within the meaning of section 351 of the Revenue Act of 1934. It has claimed deductions from its "adjusted net income" under that section on account of certain amounts assertedly distributed as dividends, 1*1027 and for others as being "used or set aside to retire indebtedness incurred prior to January 1, 1934." 2 In this proceeding it contests the disallowance of these deductions.
It appears that the distributions to the corporation's stockholders are not "dividends" within the meaning of the applicable section for two reasons. There were no accumulated earnings or profits. ; affd., (C.C.A., 8th Cir.). And the distributions were in liquidation. . Petitioners seek to distinguish the corporation's position from the circumstances there appearing on the ground that, *1028 since distribution of its assets was complete, it had no "undistributed net income." But we think this contention results from a misapprehension of the purport of the provision. Income is "distributed" for the purpose of section 351 only to the extent that it falls within the exceptions there defined. And it is clear that the reference to "dividends" as one of such exceptions does not reach the corporate petitioner's distribution. Neither the plain language of the section nor its fundamental design to tax income to the corporation if its shareholders escape tax, permit the acceptance of petitioners' contention. ;
The "indebtedness" for the payment of which credit is claimed was in each case a running account having its inception long before the beginning of 1934. But respondent contends that the amount remaining unpaid in the tax year was contracted subsequent to the *349 significant date, and therefore is not such "indebtedness" as the statute describes.
It seems reasonable to assume that Congress intended the reference to indebtedness to designate debts which under applicable*1029 law would be so regarded as between debtor and creditor. See . Similarly, we may assume that "indebtedness incurred prior to January 1, 1934" was intended to refer to debts which, under the local law governing the relations of debtor and creditor, would be treated as having been incurred prior to that date. See .
In the courts of New York, as well as under the common law generally, it is the settled rule that on running accounts payments will ordinarily be applied to the earliest indebtedness "so that the credits are to be deemed payments pro tanto of the debts antecedently due." ; ; (C.C.A., 2d Cir.). There are, of course, exceptions, but "* * * the formula is expressive of a rule that must prevail in the absence of persuasive reasons for qualification or exception." *1030 And nothing is shown here to suggest that this case would fall within any of such qualifications.
The record shows that in the account of one creditor the balance due on December 31, 1933, was $65,616.98. Prior to October 1, 1935, the beginning of the tax year under consideration, $115,680.73 was repaid. Applying the legal formula just noted, it seems evident that during the tax year no part of the indebtedness incurred prior to 1934 remained unpaid, and hence none could have been "retired." The same applies to the other account, where the balance at the end of 1933 was $55,104.50 and repayments prior to the beginning of the tax year were $107,502.36. The result is that the corporation's claim for a deduction on this ground must also be disallowed.
There is apparently no present dispute between the parties as to the existence or amount of transferee liability imposed upon the remaining petitioners. Accordingly,
Decision will be entered for the respondent in Docket Nos. 94218, 95838, and 95839, and under Rule 50 in Docket No. 95837.
Footnotes
1. SEC. 351. SURTAX ON PERSONAL HOLDING COMPANIES.
* * *
(b) DEFINITIONS. - As used in this title -
* * *
(2) The term "undistributed adjusted net income" means the adjusted net income minus the sum of:
* * *
(B) Amounts used or set aside to retire indebtedness incurred prior to January 1, 1934, if such amounts are reasonable with reference to the size and terms of such indebtedness; and
(C) Dividends paid during the taxable year.
* * * ↩
2. See footnote 1, supra.↩