*214 Decision will be entered for the respondent.
1. Income -- Accrual -- Fees -- Prior Commitment as to Use. -- Fees, which a wholly owned subsidiary agreed to pay to its parent for services, did not cease to be income to the parent on an accrual basis after the parent, in order to strengthen the credit of the subsidiary and to give it more capital, agreed to invest the fees, up to a stated amount, in capital stock of the subsidiary.
2. Income -- Accrual -- Fees -- Collectibility. -- There was no reason during the taxable years to doubt the ability of the subsidiary to pay the fees because of poor financial condition or business prospects.
*1082 The Commissioner determined a deficiency of $ 55,040.44 in income tax for the petitioner's fiscal year ended September 30, 1949. The *1083 only issue for decision is whether the Commissioner erred by including engineering fees of $ 120,277 in income.
FINDINGS OF FACT.
The petitioner, a Pennsylvania corporation, filed its return for the taxable year with the collector of internal revenue*215 for the twenty-third district of Pennsylvania. It is engaged in the manufacture and sale of mining and construction machinery and equipment. It maintains its books and records and computes its income on an accrual method of accounting.
Joy-Sullivan, Ltd. (hereafter sometimes referred to as J-S), a British corporation, was engaged in a business in Great Britain similar to that of the petitioner. The petitioner acquired all of the stock of J-S in February 1946 and since then has owned all of the outstanding stock of J-S. The issued outstanding common capital stock of J-S as of September 30, 1948, consisted of 27,387 shares each having a par value of £ 1.
J-S had had an arrangement with its prior parent for the payment of engineering fees to that parent and the same arrangement was continued thereafter between J-S and the petitioner. The agreement, as reduced to writing on August 15, 1949, provided that the petitioner would furnish J-S with drawings, plans, machine and material specifications, patent rights, engineering data, information, and advice referred to as "confidential matter"; granted J-S the exclusive right to manufacture in Great Britain and Eire and to sell, certain*216 of the petitioner's products, and to act as the exclusive distributor in Great Britain and Eire of all of the petitioner's imported products; and required J-S to pay to the petitioner, at the latter's option either in English pounds or in United States funds at the petitioner's office in Pittsburgh, as an engineering and service fee, a sum equal to 10 per cent of the cost of the products manufactured, provided that the sum should not exceed 7 1/2 per cent of the selling price of the products. The written contract varied the prior agreement only in that it placed a ceiling of 7 1/2 per cent of the selling price of the products on the amounts to be paid by J-S to the petitioner.
The British coal mines were short of machinery after World War II, and a program was under way to modernize the industry. The petitioner decided to enter the British market in a substantial way by strengthening J-S, sending over the petitioner's drawings and engineering know-how, and acquiring manufacturing facilities for J-S in Great Britain through a subcontractor.
The business of J-S began to grow and was soon in need of additional working capital. J-S applied to the Bankers Trust Company in London (hereafter*217 sometimes called Trust Company) on October 2, 1947, *1084 for an overdraft facility in the maximum amount of £ 110,000 as temporary financing during the period October 1, 1947, to August 31, 1948. J-S represented in a letter to the Trust Company, in October 1947, that, after consultation with the petitioner, it would be premature to state what additional permanent capital it might need but temporary working capital would have to be provided to finance the time lag between payables to subcontractors and the collection of receivables; J-S had authority from the petitioner to arrange "for such temporary finance"; the petitioner would leave in England the major portion of the engineering fees and all profits, which funds would eventually be used in the reconstruction of the capital structure of J-S, and during the period of indebtedness to the bank the engineering fees would not be remitted to the petitioner, and thereafter not more than 10 per cent of the engineering fees would be remitted for a period of at least 2 or 3 years; and some British capital on a minority basis would be desired in J-S when the anticipated alteration of its capital structure would take place.
The "overdraft*218 facility" would entitle J-S to draw upon the Trust Company, and as overdrafts occurred they would represent loans from the Trust Company, on which interest would accrue.
The British Exchange Control Act of 1947 required consent of the Treasury before loans could be made to controlled companies. The Bank of England acted for the Treasury in giving such consents. A controlled company was one controlled directly or indirectly by a corporation outside of "the scheduled territories." J-S was a controlled company. Consent of the Bank of England was a requirement for loans from the Trust Company to J-S at all times material hereto at least until July 1954. The Trust Company was an agency of the British Treasury for compliance with the law and regulations on its loans to controlled companies.
The Trust Company applied to the Bank of England on October 3, 1947, for permission to establish the overdraft facility in favor of J-S. The application was approved subject to the proviso that no application to transfer engineering fees or dividends would be approved while any overdraft was outstanding under the facility. The Bank of England also noted on the approval that "This approval is unlikely*219 to be renewed after 31-8-48."
It became apparent early in 1948 that the needs of J-S for temporary finances would continue after August 1948, and discussions took place between its representatives and those of the Trust Company on the possibility of negotiating another overdraft facility after the expiration of the first. The Trust Company advised J-S that its experience in other cases led it to believe that the Bank of England would not approve another overdraft facility in the amount being discussed *1085 unless some action were taken to increase the capitalization of J-S. The petitioner was advised of this and the matter was discussed by representatives of J-S and the petitioner.
J-S sent an unsigned memorandum dated August 26, 1948, to the Trust Company, requesting approval of an overdraft facility up to £ 50,000 for 12 months to cover delays in collections beyond the normal trading period, and stating, inter alia:
It is suggested that the best procedure would be to increase the authorized capital of the Company to £ 250,000, and to make an immediate substantial investment out of the accrued engineering fees in the following manner:
* * * *
Joy will subscribe to 72,613*220 Ordinary Shares of £ 1 each, which will be issued at par, thus cancelling a dollar liability of over $ 290,000. and increasing the issued capital of the Company to £ 100,000. It will also be the policy of Joy to continue investing the major portion of engineering fees as and when they accrue, until the issued capital of Joy-Sullivan, Ltd. amounts to £ 250,000. By this means, Joy will, over the next few years, have invested in the British Company nearly $ 900,000. which would otherwise have remained as a dollar liability.
It will be appreciated that as and when these investments are made by Joy, they will have to pay American Tax in dollars on this investment. It is, therefore, our desire to remit at the present time £ 10,000. of the accrued engineering fees, and to declare a dividend out of surpluses in the amount of £ 10,000. The accrued surplus at May 31st, 1948, amounts to £ 44,000. If this programme is approved, Joy will in fact, be immediately investing £ 72,613. of engineering fees on which they will have to pay tax in America equivalent to an amount of £ 27,592., to offset this they will be receiving a dividend of £ 10,000. tax-free income and £ 10,000. of engineering *221 fees on which latter amount they will again have to pay tax in America amounting to £ 3,800., so that whilst they will have received remittances amounting to £ 20,000., their total disbursement for taxation in America to cover this income and the new investment, will be £ 31,392. In other words, they will not only be cancelling the dollar liability of £ 72,600. but will also be paying out additional dollars to an amount equal to approximately £ 11,400.
It was further stated in the memorandum that J-S had never used the maximum facility approved by the Bank of England but had more than lived within the estimate of its requirements for temporary finance which had been used purely to meet delays in collection of accounts, the parent company "in furtherance of the policy outlined in our memorandum of October, 1947" had agreed to invest its engineering fees in stock of J-S, and "it will be the policy of the parent Company to remit only a nominal amount of the accrued engineering fees, and to reinvest the major portion in the British Company until the issued capital reaches the figure of £ 250,000."
The memorandum was the subject of discussions between J-S and the Trust Company and between*222 the Trust Company and the Bank of England, after which the Bank of England wrote a letter dated September 24, 1948, to the Trust Company as follows:
*1086 With reference to the various applications made by the above-mentioned Company which were submitted to Mr. Phipps in memorandum form on the 27th August, I write to state that the Bank are prepared to authorise the remittance of a dividend of £ 10,000 free of tax to be made to the U. S. A. and a further sum of £ 10,000 on account of accrued engineering fees due to Joy Manufacturing Company.
The Bank are also prepared to approve the issue of 72,613 shares of £ 1 each at par by Joy-Sullivan Limited to its parent Company in reduction of the debt due on account of accrued engineering fees but prior consent of the Capital Issues Committee should be obtained before the increase is effected. In addition, approval will be granted on the submission of a Form "LO" to authorise overdraft facilities to Joy-Sullivan Ltd., of up to £ 50,000 for a period of six months commencing 15th October, 1948.
Finally, the Bank will raise no objection to the proposed variation in the terms of the existing agreement between Joy-Sullivan Limited and Joy*223 Manufacturing Company, whereby the latter Company will be paid engineering and service fees calculated on the basis of 10% of the cost of the products sold in lieu of 7 1/2% on the net sales of the above-mentioned Company on the condition that the amounts payable on the revised basis do not exceed 7 1/2% of the net sales. A copy of the revised agreement should be submitted to Regulations General Office of the Bank for inspection.
In considering these applications, due note has been taken of the statement by your customers that the issued capital is to be built up to £ 250,000 and until that position is obtained only nominal remittances will be made to its parent Company on account of engineering fees, dividends, etc.
The Trust Company made an application to the Bank of England dated September 27, 1948, requesting approval of an overdraft facility for J-S in the maximum amount of £ 50,000 for 6 months from October 15, 1948, and stating, inter alia: "Authorized Capital to be increased to £ 250,000 and Issued Capital to £ 100,000 wholly owned by Joy Manufacturing Co., Pittsburgh, U. S. A." That application was approved.
The petitioner accrued during its fiscal year ended September*224 30, 1948, $ 415,419.50 representing engineering fees receivable from J-S, and during that year it received from J-S $ 40,275 on account of engineering fees, and $ 40,275 as dividends.
A principal customer of J-S was the National Coal Board which managed the nationalized coal industry in Great Britain during 1948 and 1949. The Board purchased in London for the entire mining industry and had pressed J-S and other manufacturers to increase their capacity drastically because of the shortage of machinery. J-S had complied. The Board later found that it was receiving machinery faster than installation could be made in the mines and, as a consequence, restricted the reception of machinery causing inventory to pile up on J-S in the early part of 1949. The Board encouraged sales abroad to relieve the situation. J-S persuaded its subcontractor to retard its production but the latter refused to cancel existing orders. Additional financing for J-S became necessary.
*1087 The Trust Company applied on March 18, 1949, to the Bank of England to allow J-S an overdraft facility in the maximum amount of £ 135,000 to May 31, 1949, and £ 50,000 from June 1 to December 31, 1949. The application*225 contained a reference to the proposed increased capitalization. The Bank of England promptly approved the application with the following proviso: "Approval for £ 135,000 to 31st May 1949 subject to your oral understanding not to remit to Joy-Sullivan Company, U. S. A., on account of the inter-company debt of £ 147,750 : 17 : 10 as at 30th November 1948. This application will not be renewed."
The Trust Company, in a letter to J-S dated March 24, 1949, announcing the approval of the overdraft facility in the maximum amount of £ 135,000, stated, inter alia: "In this connection we have received your letter of to-day's date enclosing copy of the order for the equipment to a total of £ 300,000 from the Polish Purchasing Mission in the United Kingdom."
The Trust Company made an application to the Bank of England, dated July 20, 1949, for permission to grant an overdraft facility to J-S in the maximum amount of £ 160,000 to September 30, 1949, and £ 135,000 from October 1 to December 31, 1949, the loan to be used "To finance sale of coal cutting machines and conveyors to Polish Purchasing Mission." The proposed increase in capitalization was mentioned. The application was approved *226 on July 21, 1949.
J-S owed money to the Trust Company on overdrafts at all times material hereto.
J-S and the petitioner, pursuant to the request of the Bank of England, put their agreement relating to engineering fees into the written agreement dated August 15, 1949. Engineering fees for the 12-month period ended September 30, 1949, amounting to $ 120,277 were shown on the books of J-S as an account payable to the petitioner in the amount of £ 42,955 17s. J-S claimed that amount as an expense on its income tax return filed with the Government of Great Britain.
Engineering fees of the type involved herein could be converted from pounds sterling to American dollars at the rate of $ 2.80 per pound, and sales of exchange were made to British corporations for legitimate trade requirements providing that the contract requiring payment had received the approval of the Exchange Control authorities and an appropriate application for remittance was made and approved.
The agreement between J-S and the petitioner had received the approval of the Exchange Control authorities prior to the close of the taxable year. Remittances of engineering fees in the amount of £ 5,000 were made in each of*227 the petitioner's fiscal years 1950 and 1951.
*1088 The Capital Issues Committee, on December 9, 1948, granted a request of J-S to issue 72,613 of its shares of £ 1 each, at par, to the petitioner in reduction of the debt due to the petitioner on account of accrued engineering fees. J-S, pursuant to that approval, issued and delivered in October 1949, 72,613 of its shares to the petitioner at par and transferred to the capital account of J-S £ 72,613, representing engineering fees accrued prior to September 30, 1948. That increased the outstanding capital stock of J-S to £ 100,000.
Later applications on behalf of J-S for overdraft facilities were approved, as was an application for the issuance of an additional 70,000 shares of its stock to the petitioner. 39,275 of those shares, issued to the petitioner in May 1950, were paid for by the transfer to the capital account of J-S of £ 39,275 representing a part of the engineering fees accrued during the 12-month period ended September 30, 1949. Thirty thousand additional shares were issued by J-S to the petitioner in January 1951 and part of the consideration for that stock was £ 3,680 of engineering fees representing the balance*228 of the engineering fees outstanding which accrued during the 12-month period ended September 30, 1949.
The record does not show what, if anything, the petitioner did each time prior accrued fees belonging to it were used to purchase stock of J-S.
Engineering fees due from J-S to the petitioner continued to accrue after the taxable years, the amounts being $ 87,466 for 1950, $ 89,127 for 1951, $ 163,912 for 1952, and $ 218,288 for 1953.
There was no reasonable doubt during the taxable year of the collectibility of the $ 120,277 of engineering fees which accrued and became due to the petitioner from J-S during that taxable year.
All stipulated facts are incorporated herein by this reference.
OPINION.
The petitioner tries unsuccessfully to explain that "'engineering fees' is a misnomer," they were "not actually fees" but only a "formula" to determine the appropriate number of shares of J-S stock to be issued to the petitioner which "was only entitled to stock, not money" and "hence petitioner had no taxable income based on such engineering fees." It then tries to shift the question of taxable income to the issuance of the stock, saying that the rule applicable here is that of ,*229 which stands "for the proposition that taxable income must be an actual gain or benefit derived by the taxpayer"; this case is precisely like a stock dividend (common on common) in which the taxpayer owns, after the dividend, only what he had before, evidenced by more pieces of paper; and "Once the September 27, 1948 commitment was made, petitioner could receive *1089 only more pieces of paper to evidence its already-existing 100% ownership of Joy-Sullivan."
That argument is unsound 1 and does not go to the real issue in the case. The question here is not whether the petitioner received taxable income from the issuance to it of additional stock of its wholly owned subsidiary. No stock was issued during this year and the Commissioner has not determined that the income arises from the later issuance of the stock but instead that it arose from the earning and accrual of the engineering fees during the taxable year. The engineering fees due from J-S to the petitioner, pursuant to their agreement, were fees in a correct meaning of the word, i. e. compensation or payment for services and privileges. They represented proper expenses of J-S and they were income, as they accrued, *230 to the petitioner, an accrual basis taxpayer. .
*231 The petitioner, soon after acquiring the stock of J-S, decided to expand the operations of its new subsidiary to take advantage of the opportunities then present in Great Britain. It realized that J-S would need additional funds with which to operate on the larger scale. The petitioner did not choose, as it might have, to send its funds from the United States to Great Britain either as subscriptions to capital stock or as loans, but sought other means of meeting the needs of J-S. It tried to have J-S borrow funds in England, found that the small capital of J-S limited the latter's ability to borrow, and decided to solve the problem by purchasing additional stock of J-S with funds belonging to it which were already in England, the engineering fees then owed to it by J-S, and by assuring the creditor and the Bank of England through its subsidiary that it would use additional engineering fees, as they would accrue, for the same purpose until it had increased the outstanding capital stock of J-S to £ 250,000. The agreement whereby J-S was required to pay the petitioner engineering fees was already in existence and was quite separate from the arrangements later made by J-S for obtaining*232 loans from the Trust Company.
No doubt the petitioner could have settled the whole matter by transferring sufficient funds from the United States to subscribe for the entire proposed increase. But the petitioner preferred and chose for its own convenience and purpose to use only the engineering fees *1090 and, consequently, the increase in capital had to be piecemeal, since the Capital Issues Committee would not authorize an increase in capital except to the extent that engineering fees had actually accrued and become the property of the petitioner available for purchase of stock. The first actual increase in the capital stock of the petitioner was not made until after the taxable year although more than sufficient funds for the purchase of that increase were available in engineering fees earned and accrued prior to the beginning of the taxable year. That increase brought the capital of J-S up to £ 100,000. Later increases brought it up to £ 250,000, and later still the petitioner again voluntarily invested an additional £ 50,000 in the stock of J-S, bringing it up to £ 300,000.
The petitioner desired, throughout the taxable year and prior thereto, that J-S should obtain *233 the various overdraft facilities for which it was applying, and the petitioner, directly or indirectly, had authorized J-S to make the representations which it made to the Trust Company and which the Trust Company in turn made to the Bank of England to obtain the loans. However, the facts that the petitioner had voluntarily decided and agreed, prior to the taxable year, to use the engineering fees, which would accrue during the taxable year under a separate contract, to subscribe for additional stock of J-S, and after the taxable year actually used for that purpose the engineering fees which accrued during the taxable year, are entirely consistent with the recognition of the fees as income to the petitioner as they accrued, since the petitioner used an accrual method of accounting for and reporting its income. It is clear that the petitioner earned during the taxable year all of the fees involved herein; those fees as earned were accrued on the books of both J-S and the petitioner; they then belonged to the petitioner and represented taxable income to the petitioner on an accrual basis. The prior voluntary agreement of the petitioner to use those fees after they accrued for purposes*234 desirable to it, the purchase of additional stock of J-S, thereby providing its subsidiary not only with necessary additional operating capital but also with the basis for needed credit, in no way relieved the petitioner of liability for income tax on the fees as they accrued. Cf. ; , affd. .
The petitioner did not use any of the engineering fees to purchase stock until after the close of the taxable year. Substantial amounts of engineering fees which accrued after the granting of the first overdraft facility were actually paid to the petitioner, some prior to the taxable year and some thereafter. The petitioner would report those portions of the fees as if it were on a cash basis accounting and reporting, but it is not entitled to report its income that way and must report all of its income as it accrues without waiting to see what use *1091 may be made of the income later. Cases involving taxpayers using a cash basis of reporting income are not in point.
The petitioner concedes that this is not a case of blocked*235 currency. It contends on two grounds only that the engineering fees were not income to it as they accrued. The first, which has been discussed, is that the commitment to invest them in stock of J-S rendered them nontaxable as income to the petitioner, and the other is that in any event they were not collectible and should not be accrued by the petitioner during the taxable year. There are cases holding that an amount need not be accrued and taken into income by a taxpayer on an accrual basis where it appears in the year of accrual that the amount is uncollectible and, because of conditions then existing such as the poor financial condition of the debtor, "there is little or no likelihood of collection in the future." ; . Cf. . This, however, is not such a case, although the finance vice president and treasurer of the petitioner testified that the fees were not collectible on September 30, 1949, or "in the foreseeable future." The question is not whether*236 J-S had current assets sufficient to pay the entire amount of these fees on September 30, 1949, but is whether it was then reasonable to believe that they would ever be collected. The evidence shows clearly that there was no reason at any time during the taxable year of the petitioner to believe that the engineering fees which accrued during that year would be uncollectible because of the poor financial condition of J-S or the poor prospects of its business. It shows, to the contrary, that J-S was in good financial condition and the prospects for the continued success of its business were good. The slow-up of the National Coal Board in accepting delivery of machinery was temporary and, so far as this record shows, was being met successfully by J-S. The balance sheets, sales records, and earnings statements of J-S all tend to show that there was no reason why these engineering fees did not represent taxable income to the petitioner as they accrued. Furthermore, J-S transmitted some of them to the petitioner along with a dividend in the preceding year and did the same thing later.
Decision will be entered for the respondent.
Footnotes
1. The situation here does not resemble a stock dividend of common on common which, as the Supreme Court pointed out in , involves "merely bookkeeping that does not affect the aggregate assets of the corporation or its outstanding liabilities" or increase the intrinsic value of the aggregate holdings of the stockholder but "simply [increases] the number of the shares, with consequent dilution of the value of each share." Here, if it is of importance, a liability of J-S owing to the petitioner was invested in later years by the petitioner in additional stock of its wholly owned subsidiary with a consequent decrease in the liabilities of the subsidiary and an equal increase in the assets of the subsidiary. A corporate resolution to pay salaries but to pay them in stock was held to be a stock dividend in . This is not such a case. See also , involving facts unlike those here present.↩