*881 1. Petitioner corporation agreed, in writing, to liquidate an indebtedness at the rate of $10,000 per month and that no cash dividends would be paid until the loan was liquidated. It interpreted the contract as not preventing it from declaring and distributing a stock dividend and this was done. The correct interpretation was placed upon the contract. Held, petitioner is not entitled to any credit under section 26(c)(1) of the Revenue Act of 1936 in computing its undistributed net income.
2. The agreement made by the corporation with its creditor did not expressly deal with the disposition of its earnings and profits of the taxable year, require that a portion of them be paid within the taxable year in discharge of a debt, or require that a portion of them be irrevocably set aside within the taxable year for such purpose. Held, petitioner is not entitled to any credit under section 26(c)(2) of the Revenue Act of 1936.
3. The stock dividends declared and distributed by petitioner effected a change in the proportionate interests of the stockholders. Held, they were taxable dividends within section 115 of the Revenue Act of 1936; Held, further, that the*882 aggregate fair market value of the stock at the time it became income to the shareholders should be allowed as a dividends paid credit under section 27 of the Revenue Act of 1936 in computing petitioner's undistributed net income.
4. The stock received by the corporation's stockholders as dividends should be included in the stockholders' incomes to the extent of its fair market value at the time of receipt.
5. The trust instrument and evidence aliunde indicate that the settlors intended to establish three separate trusts for the benefit of their children. Held, that the trustee correctly reported the receipt of one-third of the stock dividends for each of his children, though he erred in failing to include it in the income of the three trusts.
*309 These consolidated proceedings involve the following deficiencies in income tax for the year 1936:
| Docket No. 102603, Helms Bakeries | $15,843.69 |
| Docket No. 102602, Paul H. Helms, trustee | 1,316.00 |
| Docket No. 102604, Paul H. Helms and Pearl E. Helms | 12,508.71 |
Stated generally, *883 the question in Helms Bakeries is whether petitioner is entitled to a credit under section 26(c)(1) or (2) or under section 27 of the Revenue Act of 1936 in computing its net income and, if so, the amount thereof. For convenience this corporation will hereinafter be referred to as petitioner. The question in the other proceedings is whether stock of the Helms Bakeries distributed to the petitioners constituted income to them and, if so, in what amount. Inasmuch as all of the transactions in Docket No. 102604 were carried out by Paul H. Helms, the petitioners in this proceeding will be referred to Simply as "Helms." In Docket No. 102602 the petitioner will be referred to as "Helms, Trustee."
After issues were joined the respondent, by an amended answer filed at the hearing, claimed an increased deficiency in Docket No. *310 102603 (Helms Bakeries). Upon brief, however, he expressly waived all claim for an increased deficiency.
Most of the basic facts were stipulated and are found accordingly, whether specifically set out in our findings or not. Other facts shown in our findings are based upon evidence adduced at the hearing.
FINDINGS OF FACT.
Petitioner is a*884 corporation organized under the laws of the State of California. Its principal office and place of business is located in Los Angeles, California. It filed its Federal income and undistributed profits tax return for 1936 with the collector of internal revenue for the sixth district of California on March 15, 1937, and paid the tax shown to be due as follows:
| Date | Amount |
| 3-15-37 | $3,105.67 |
| 6-14-37 | 3,105.67 |
| 9-14-37 | 3,105.66 |
| 12-14-37 | 3,105.65 |
| 12,422.65 |
Its petition was filed on May 13, 1940, and taxes in the aggregate amount of $9,316.98 were paid within three years of the filing of the petition.
Helms and his wife filed a joint income tax return for the calendar year 1936 with the dollector of internal revenue for the sixth district of California on March 15, 1937, and paid $1,086.34, shown to be due on the return, as follows:
| Date | Amount |
| 3-15-37 | $271.59 |
| 6-11-37 | 271.59 |
| 9-3-37 | 271.58 |
| 12-1-37 | 271.58 |
| 1,086.34 |
Their petition was filed on the 13th day of May 1940, and $814.75 of their 1936 tax was paid within three years of the filing of their petition.
Helms, trustee, is a fiduciary under a trust indenture dated June 5, 1935, wherein*885 Paul H. Helms and Pearl E. Helms, as trustors, transferred shares of stock in Helms Bakeries to Paul H. Helms, as trustee, for the benefit of their three children. Three separate fiduciary returns for the calendar year 1936 were filed by the trustee with the collector of internal revenue for the sixth district of California. No tax was shown to be due or paid thereon.
*311 Petitioner was incorporated June 8, 1931. Its articles of incorporation, as amended, authorized the issuance of 16,000 shares of no par value capital stock as follows: 4,000 shares of $7 cumulative first preferred stock; 4,000 shares of $7 cumulative second preferred stock; and 8,000 shares of common stock.
The holders of first preferred stock were entitled to cumulative dividends of $7 per share out of the surplus or net profits of the corporation in preference to the holders of the second preferred stock and in preference to the holders of common stock; to $105 per share plus cumulative dividends upon redemption; and to $105 per share plus cumulative dividends upon dissolution before any distributions to the second preferred or common stockholders. The holders of second preferred stock were entitled*886 to cumulative dividends of $7 per share and, on redemption or dissolution, to $105 per share plus cumulative dividends in preference to the common stockholders. The holders of all classes of stock were entitled to vote in person or by proxy the number of shares standing in their names.
On August 2, 1935, petitioner, by resolution of its board of directors, fixed the amount of stated capital to be attributed to its various classes of stock as follows:
| First Preferred | $100 per share |
| Second Preferred | $100 per share |
| Common | $1 per share |
As of December 31, 1934, the unpaid cumulative dividends on first preferred stock aggregated $44,345. No dividend on first or second preferred had ever been paid. In 1935 the board of directors authorized the issuance of 443 fully paid first preferred shares to holders of first preferred shares of record August 1, 1935, plus $45 in cash, in payment of the cumulative dividends on first preferred shares as of December 31, 1934. No dividends were paid on the second preferred at this time.
No dividends were declared by petitioner in 1935. The accumulated dividends on its first preferred shares for the years 1935 and 1936*887 amounted to $40,885.25, and the accumulated dividends on its second preferred shares as of June 30, 1932, amounted to $26,250.
On December 18, 1936, petitioner's board of directors adopted the following resolution:
It appearing to the Board of Directors that the corporation has an earned surplus permitting it so to do, it is hereby
RESOLVED that dividends be declared by this corporation to shareholders of record as of noon on the 18th day of December, 1936.
RESOLVED FURTHER, that the dividends shall be as follows:
(a) On the first preferred shares at the rate of $7.00 on each $100.00, accumulated annually covering the period from December 31st, 1934, to and including *312 December 31st, 1936, which dividend shall be paid in first preferred shares of the corporation at $100,00 per share;
(b) On the second preferred shares at the rate of $7.00 on each $100.00, accumulated annually for the period commencing February 28, 1931, to and including June 30th, 1932, which dividend shall be paid in second preferred shares of the corporation at $100.00 per share.
RESOLVED FURTHER, that the fractional portion of the dividend on the first preferred stock amounting to $85.25*888 be paid in cash to the holders of the first preferred shares, to be divided in accord with their respective holdings as of the effective time of the declaration of the dividend.
RESOLVED FURTHER, that actual distribution of this dividend be made only upon approval by the Commissioner of Corporations of the State of California after application and after the holders of the stock of this corporation have consented in writing to this method of declaration of dividends.
Further resolutions were adopted authorizing and directing the officers of the corporation, subject to obtaining a permit from the Commissioner of Corporations of the State of California, to issue 408 fully paid first preferred shares on the basis of $100 per share, plus $85.25, in full payment of the cumulative dividends in the amount of $40,885.25 on the issued and outstanding 3,420 first preferred shares to December 31, 1936, to issue 263 fully paid second preferred shares on the basis of $100 per share, in full payment of the cumulative dividends in the amount of $26,250 on the issued and outstanding 3,000 second preferred shares to and including June 30, 1932, and to sell, to the persons who received the share*889 dividends, 671 shares of the common stock for the price of $1 per share, each shareholder to be entitled to purchase one common share for each first preferred share and for each second preferred share dividend.
The stockholders executed a written consent to the declaration of a share dividend in payment of cumulative dividends on first preferred and second preferred shares and agreed to exchange all of the certificates held by them for new certificates. They also agreed to purchase one common share for each preferred share received as a share dividend.
A permit to issue first and second preferred stock dividends was obtained from the Commissioner of Corporations and the dividend shares were issued December 18, 1936. The share dividends issued paid the accumulated dividends on the first preferred shares up to December 31, 1936, and the accumulated dividends on the second preferred shares up to June 30, 1932, but left unpaid accumulated dividends on second preferred shares of approximately $31.50 per share.
The stock, issued and distributed as a stock dividend on December 18, 1936, had the following fair market value: First preferred, $90 per share; second preferred, $25 per*890 share.
The number of shares of preferred and common stock held by each stockholder, the number of shares received by each as dividends, *313 and the percentage of stockholdings of each before and after the stock dividends were issued were as follows:
| First Preferred. | |||||
| 12-17-36 | Percent | Dividends | After dividends | Percent | |
| Paul H. Helms | 50 | 0.0146 | 8 | 58 | 0.0152 |
| Pearl E. Helms | 2,468 | .7216 | 283 | 2,751 | .7186 |
| P. H. Helms, trustee | 902 | .2638 | 117 | 1,019 | .2662 |
| Total | 3,420 | 100 | 408 | 3,828 | 100 |
| Second Preferred. | |||||
| Paul H. Helms | 2,500 | 0.8333 | 218 | 2,718 | 0.8330 |
| Pearl E. Helms | |||||
| P. H. Helms, trustee | 500 | .1667 | 45 | 546 | .1670 |
| Total | 3,000 | 100 | 263 | 3,263 | 100 |
| Common. | |||||
| 12-17-36 | Percent | Purchased with dividends on preferred | After purchases | Percent | |
| Paul H. Helms | 50 | 0.0078 | 226 | 276 | 0.0389 |
| Pearl E. Helms | 4,968 | .7738 | 283 | 5,251 | .7405 |
| P. H. Helms, trustee | 1,402 | .2184 | 162 | 1,564 | .2206 |
| Total | 6,420 | 100 | 671 | 7,091 | 100 |
Included in the above figures shown for Pearl E. Helms, were 367 shares of first preferred and 367 shares of common purchased by her from petitioner during*891 the year 1936 for cash. The first preferred stock, which she purchased during 1936, participated in the stock dividend only in part, since there were no accumulations on this new stock prior to its issuance.
The net book income of petitioner for each of the years 1931 to 1936 was as follows:
| Year | Net Income |
| 1931 | (Loss) $25,920.07 |
| 1932 | 20,564.25 |
| 1933 | 9,845.76 |
| 1934 | $6,925.75 |
| 1935 | 59,113.87 |
| 1936 | 60,399.97 |
The surplus on December 31, 1936, was $58,591.43.
Petitioner's business had expanded so rapidly that it had been required to borrow large sums of money to expand its plant and to purchase necessary equipment. About December 5, 1935, it owed California Bank in Los Angeles approximately $121,000. On that date it wrote the bank in reference to an additional loan of $50,000 which would bring its total borrowing from that bank to $171,000. It suggested that the loan be made payable at the rate of $8,000 per month plus interest. An executive vice president of the bank inspected *314 its plant, discussed the matter with Helms, and insisted that the rate of repayment be $10,000 a month plus interest. Helms agreed. The bank desired that*892 the assets of the corporation be kept intact until the loan was paid and Helms agreed that there would be no dividends paid until the loan should be liquidated.
Under date of December 6, 1935, Helms, for petitioner, wrote the bank confirming the understanding with its vice president. This letter stated:
In confirmation of my understanding of our conference of yesterday, I am agreeing to step up the payments on the 20th of each month from $8,000.00 to $10,000.00 plus interest.
Also, we agree that no cash dividends will be paid until this loan is liquidated on the above terms.
We will not increase Executives salaries in an excessive amount, particularly applying to my own (PHH).
With this mutual understanding we will go ahead and put through our Note as of tomorrow, December 7th, which will make our total indebtedness on this date $171,000.00.
On November 10, 1936, Helms wrote the bank asking it to waive the agreement prohibiting the payment of cash dividends until the loan was paid. The bank refused to do so, calling attention to the fact "that you have a definite obligation to this bank not to declare dividends until the indebtedness is settled in full." Petitioner*893 did not secure permission of the bank to declare stock dividends, nor did it ever notify the bank that it was going to declare such dividends.
Petitioner's net income for the calendar year 1936 as shown by the deficiency notice was $90,018.26, its normal and excess profits tax was $12,342.74, and its adjusted net income was $77,675.52.
Prior to June 5, 1935, Helms instructed his attorney to draw up an instrument creating three trusts, one for each of his three minor children. A "Declaration of Trust" was drawn up by the attorney, who advised Helms that it created three trusts for his children. It was dated June 5, 1935, and provides inter alia:
TWO (b): The Trust Estate shall be apportioned, segregated and divided into three equal shares, one of said shares shall be used for the benefit, support, maintenance, comfort and education, and shall vest in, and be distributed to each of our respective children, Paul H. Helms, Jr., Elizabeth Jane Helms and Lois Margaret Helms, as hereinafter set forth;
TWO (c): The net income from one of said shares of the Trust Estate, apportioned and segregated to and for the use and benefit of our son Paul H. Helms, Jr., or such portion*894 of such income as is deemed necessary in the discretion of the Trustee, shall be paid to, or used for the support, maintenance, comfort and education of said Paul H. Helms, Jr., AND on January 1, 1956, the corpus of said share then remaining and the accumulations thereon, if any, shall go to, vest in and be distributed to said Paul H. Helms, Jr.;
[TWO (d) and TWO (e) contain provisions identical to TWO (c) except for the names of the children.]
*315 TWO (f): Should each or any of the aforesaid children decease prior to January 1, 1956, the share of the Trust Estate apportioned for his or her benefit, it, or the part thereof not distributed, shall, at the time of such child's decease, vest in and shall be distributed to his or her then living lawful issue in equal shares; should no such issue be then living then the share of such deceased child shall go to augment equally the shares apportioned for the benefit of our other children named in this Trust and then living and the then living lawful issue of any deceased child named herein by right of representation, and upon the same terms and conditions as herein set forth in this Trust. Should all of the children named herein*895 decease prior to the distribution of the Trust Estate, leaving no lawful issue surviving any of them, the trust Estate, or the part thereof not distributed on the date of the decease of the last child, shall forthwith be relinquished, free and clear of this Trust, to the Trustors. Paul H. Helms and Pearl E. Helms, in equal shares if then living, or to the survivor of them, and if neither of them are then living one-half (1/2) of such Trust Estate shall go to the heirs at law of said Paul H. Helms, and one-half (1/2) of such Trust Estate shall go to the heirs at law of said Pearl E. Helms.
THREE: If, in the discretion of the Trustee, the income from the respective shares to which the respective beneficiaries may be entitled, may be insufficient to provide the respective beneficiaries with reasonable support, maintenance, comfort and education, the Trustee may pay to, apply, or expend for the use of the benefit of such person so much of the principal of his or her share up to and including the whole thereof, as the trustee may deem advisable.
The trust was expressly made irrevocable.
On June 13, 1935, the grantors executed an instrument transferring additional shares of Helms*896 Bakeries stock to the trust estate.
The consent of the shareholders of Helms Bakeries to accept preferred stock in satisfaction of accumulated dividends shows that the trustee signed separately as trustee for each of his three children, beneficiaries, and that the stock dividends were allocated in equal amounts to him as trustee for Elizabeth J. Helms, Paul H. Helms, Jr., and Lois M. Helms.
The Commissioner determined that the shares received by Helms and his wife and by Helms, trustee, constituted income to them in the amount of the stated value of the shares. He accordingly added to income the respective amounts of $50,900 (Docket No. 102604) and $16,200 (Docket No. 102602). Having determined that the income was received by one trust rather than three, he transmitted but one letter to the trustee. In the petition filed by the trustee he alleges that he is the trustee under three trusts, the beneficiaries being his three children.
OPINION.
MELLOTT: The petitioner contends it is entitled to a credit for dividends paid in an amount equal to its adjusted net income of $77,675.52, under section 26(c)(1) or (2) of the Revenue Act of *316 1936, 1 either by reason*897 of a contract restricting the payment of dividends or by reason of a contract requiring a portion of its earnings and profits of the taxable year to be paid in discharge of a debt. It also contends that, in the event the preferred stock dividends declared and distributed by it during 1936 are held to be taxable, it is entitled to a credit for the purposes of the undistributed profits tax to the extent of the fair market value thereof under section 27 of the Revenue Act of 1936. The respondent concedes that the latter contention is sound.
*898 Section 14 of the Revenue Act of 1936 imposes a surtax on the net income of a corporation not distributed in the taxable year. Section 26(c)(1) allows as a credit, in computing the surtax, the adjusted net income which can not be distributed as dividends within the taxable year without violating a provision of a written contract executed by the corporation prior to May 1, 1936, expressly dealing with the payment of dividends. Section 26(c), under which petitioner claims, grants a special exemption from tax and should, therefore, be strictly construed. Pacific Co. v. Johnson,285 U.S. 480">285 U.S. 480; Helvering v. Intermountain Life Insurance Co.,294 U.S. 686">294 U.S. 686; Deputy v. DuPont,308 U.S. 488">308 U.S. 488; Helvering v. Northwest Steel Rolling Mills, Inc.,311 U.S. 46">311 U.S. 46. It is necessary for petitioner to bring itself squarely within the statute if the claimed credit is to be allowed.
Petitioner was operating a rapidly expanding business and it was necessary to borrow large sums of money to carry on. In December 1935, it owed a bank a substantial sum and opened negotiations for an additional loan of $50,000. About December 5, 1935, Helms, *899 president of petitioner, had a conference with a representative of the bank and an agreement was reached concerning the terms of the additional loan. The agreement made at that time was confirmed in writing and petitioner agreed to liquidate the total loan at the rate of $10,000 *317 per month plus interest. It also agreed "that no cash dividends will be paid until this loan is liquidated on the above terms." A portion of the loan was outstanding throughout the calendar year 1936. Payments at the agreed rate were made regularly during 1936.
Respondent contends that petitioner's contract with the bank only prohibited the payment of "cash dividends"; that it could (and did) distribute a stock dividend in 1936 without violating a provision of its agreement; and that under such circumstances the provisions of the law and the regulations 2 have not been met.
*900 Petitioner contends that, since its preferred stockholders were entitled to cumulative cash dividends of $7 per share, as evidenced by the provisions as to dividends printed on the stock certificates, before any dividends could be paid on its common stock and since, in 1936, the accumulated dividends on its preferred stock exceeded its surplus, only "cash dividends" could be distributed without the consent of the preferred stockholders. It insists that since it could not distribute cash dividends in 1936 without violating its agreement with the bank, it is entitled to the credit granted in section 26(c)(1).
The fact that the stockholders were the beneficial owners of the corporation and their interest was its interest can not be overlooked. Cf. Henry Mill & Timber Co.,43 B.T.A. 1073">43 B.T.A. 1073. The preferred stock certificates did not constitute written contracts restricting the payment of dividends within the meaning of section 26(c)(1). Bishop & Babcock Manufacturing Co.,45 B.T.A. 776">45 B.T.A. 776; Helvering v. Northwest Steel Rolling Mills, Inc., supra.The consent of petitioner's stockholders to receive a dividend in stock instead of cash*901 in settlement of accumulated dividends was merely an assent to corporate policy by members of the corporate group. Whether such consent was necessary before petitioner could distribute stock dividends instead of cash is not material in determining whether petitioner's agreement with the bank is within the requirements of section 26(c)(1). The fact that petitioner obtained such consent and distributed *318 dividends in preferred stock, after refusal of the bank to waive the agreement prohibiting the payment of "cash dividends" until the loan was paid, is some evidence petitioner considered the agreement with the bank restricting dividends to extend only to "cash dividends." Petitioner construed its contract with the bank as not restricting its right to distribute additional stock to its stockholders and additional stock was distributed. To say that its contract prohibited the payment of all dividends within the meaning of section 26(c)(1) in the face of its admitted action, is, to say the least, somewhat inconsistent. Moreover, since petitioner had outstanding in the taxable year both preferred and common stock it could have distributed a taxable stock dividend if it chose*902 to do so. Cf. Koshland v. Helvering,298 U.S. 441">298 U.S. 441; Sprouse v. Commissioner, 122 Fed.(2d) 973. It, therefore, is not within the rule recognized by the Board in Paraport Theatre Leasing Corporation,44 B.T.A. 108">44 B.T.A. 108. Cf. Regulations 94, art. 26-2(b).
Petitioner relies on Columbia River Paper Mills,43 B.T.A. 263">43 B.T.A. 263 (appeal pending C.C.A. 9th Cir.). In that case the taxpayer could not have made any distribution to its stockholders except in cash. In the opinion it was said: "We agree with the respondent that if a dividend could have been paid by the petitioner during 1936 in any form other than cash the petitioner has not brought itself within the letter of section 26(c)(1) of the Taxing Statute." In the instant proceeding petitioner not only could have distributed a dividend in a form other than cash without violating a provision of a written contract, but it actually did so. It is obvious that Columbia River Paper Mills is distinguishable upon its facts and can not be regarded as controlling here. Petitioner has failed to bring itself within the letter of section 26(cv)(1) and its claim for credit under*903 that subsection must be denied. within the letter of section 26(c)(1) and its claim for credit under 26(c)(2) is also untenable. Its letter to the bank in confirmation of the oral agreement, is the only written agreement in evidence and it provides only for the stepping up of payments on the loan from $8,000 to $10,000 per month, plus interest. It does not expressly deal with the disposition of earnings or profits of the taxable year, nor does it require that the monthly payments be made out of earnings and profits, or that earnings or profits be irrevocably set aside for the discharge of a debt. Cf. G.B.R. Oil Corporation,40 B.T.A. 738">40 B.T.A. 738; Michigan Silica Co.,41 B.T.A. 511">41 B.T.A. 511; affd., 124 Fed.(2d) 397; Strong Mfg. Co.,41 B.T.A. 1273">41 B.T.A. 1273; affd., 124 Fed.(2d) 360; Magnus Beck Brewing Co.,46 B.T.A. 78">46 B.T.A. 78. The agreement to pay $10,000 per month merely fixed the amount of the monthly payments. It had nothing to do with the source from which the payments would be *319 made. A mere probability that a part or all of the monthly payments would be derived from earnings and profits is not sufficient*904 to meet the requirements of the statute. Belle-Vue Manufacturing Co.,43 B.T.A. 12">43 B.T.A. 12; Campbell Transportation Co.,43 B.T.A. 417">43 B.T.A. 417 (on appeal C.C.A., 3d Cir.); Van Ameringen-Haebler, Inc.,45 B.T.A. 1085">45 B.T.A. 1085. It is immaterial, therefore, that petitioner did in fact make payments out of current earnings. In order to be entitled to credit under section 26(c)(2) it must bring itself precisely within the statute. This it has failed to do. Cf. Helvering v. Moloney Electric Co., 120 Fed.(2d) 617; Lamm Lumber Co.,45 B.T.A. 1">45 B.T.A. 1; Eastern Building Corporation,45 B.T.A. 188">45 B.T.A. 188. The claimed credit under section 26 must therefore be denied.
The next question is whether the dividends in first and second preferred stock distributed by petitioner to the holders of its first and second preferred shares were taxable dividends within section 115 of the Revenue Act of 1936. 3
*905 Petitioner contends that the agreements of the preferred stockholders to exchange the certificates representing shares of the corporation for new certificates representing the same shares, to accept first and second preferred shares in satisfaction and payment of certain accumulated dividends, and to purchase one share of common stock for each share of first or second preferred stock received as a dividend, amounted to a recapitalization of the company and hence a reorganization and there was a nontaxable exchange of stock under section 112(b)(2) or (3) of the Revenue Act of 1936. This contention is without merit. Skenandoa Rayon Corporation,42 B.T.A. 1287">42 B.T.A. 1287; affd., 122 Fed.(2d) 268; and South Atlantic Steamship Line,42 B.T.A. 705">42 B.T.A. 705, cited by petitioner in support of this contention are distinguishable upon their facts. In each there was a recapitalization and reorganization in pursuance of a definite plan. Here there was no plan of reorganization, but only a plan to distribute a *320 dividend in first and second preferred stock in lieu of accumulated cash dividends. It is true that the old certificates were exchanged by the*906 shareholders for new ones; but the question here is not whether there was any gain upon an exchange of shares. It is simply whether the distributions which were made are taxable as dividends under section 115 of the Revenue Act of 1936. We think that they were and accordingly so hold.
But, says petitioner, no substantial change was made in the proportionate interests of the stockholders and the distribution resulted in a mere proliferation within the rationale of Eisner v. Macomber,252 U.S. 189">252 U.S. 189. The cited case held that a dividend in the corporation's common stock distributed to the then common stockholders, which did not give such stockholders an interest in the corporation's assets different from that which they already had, was not income within the Sixteenth Amendment. The decision was based upon a broad perspective of the relations between a corporation and its stockholders. Following it, Congress, in the Revenue Act of 1921 and subsequent revenue acts, up to and including the Revenue Act of 1934, incorporated in the law a provision that: "A stock dividend shall not be subject to tax * * *." In 1936 the Supreme Court in *907 Koshland v. Helvering,298 U.S. 441">298 U.S. 441, laid down the rule that where a stock dividend gives the stockholder a proportionate interest in the net assets of the corporation different from that which his former stockholdings represented, he receives income which is taxable under the Sixteenth Amendment. Following the decision in the Koshland case, the Revenue Act of 1936 was enacted providing, in effect, that a stock dividend is taxable if it constitutes income to the shareholders within the meaning of the Sixteenth Amendment to the Constitution. (Sec. 115(f)(1), Revenue Act of 1936.)
In Helvering v. Gowran,302 U.S. 238">302 U.S. 238, the Court had before it a case arising under the Revenue Act of 1928, where a dividend, payable in preferred stock, had been declared on common stock. It held that the common shareholder had received an interest different in character from that which his common stock represented and that the dividend was constitutionally taxable, although under the law as it existed at that time it was not subject to tax.
In *908 Sprouse v. Commissioner, 122 Fed.(2d) 973 (C.C.A., 9th Cir.), a corporation distributed a 10 percent stock dividend in nonvoting common stock to holders of voting common and nonvoting stock. The petitioner owned only voting common stock prior to the declaration of the dividend. The court held that the real test whether such a distribution constitutes income is not "differences in such characteristics as preference in interest in assets and in dividends, and in the right to vote", but "whether the distribution effects a change in the *321 proportionate interests of the stockholders"; for example, "where the corporation has more than one class of stock outstanding, and distributes a stock dividend to one class only, then the proportionate interests in the corporation are changed, because the class of stockholders who receive the dividend then have a greater interest in the assets of the corporation than those who did not receive the stock dividend, Koshland v. Helvering, supra.There being a change in the proportionate interests, the recipients of the stock dividend have derived income."
*909 In Strassburger v. Commissioner, 124 Fed.(2d) 315, affirming memorandum opinion of this Board, the court held that distribution of preferred stock to the sole owner of the common stock, which was the only class of stock outstanding, was income within the meaning of the Sixteenth Amendment. The rationale of the decision seems to be that the stockholder received property rights of actual and exchangeable value representing an interest different from that which his common stock represented.
In the instant proceeding there was outstanding first and second preferred and common stock. The corporation distributed first preferred stock to the owners of first preferred shares and second preferred stock to the owners of second preferred shares. No distribution was made to the owners of common shares. It is obvious the preferred stockholders received property rights of actual and exchangeable value which changed the proportionate interest in the net assets of the corporation as between the preferred and the common stockholders. This distribution was in our opinion a dividend and constituted taxable income to the shareholders within the meaning of the Sixteenth Amendment*910 and under section 115(f) of the Revenue Act of 1936. Petitioner is, therefore, entitled to a dividends paid credit under section 27(e) of the Revenue Act of 1936 in the amount of the fair market value of the preferred stock distributed to its stockholders.
Docket No. 102604.
The respondent included in the income of Helms and his wife for 1936 $50,900 representing the value of the first and second preferred stock distributed to them by Helms Bakeries, computed at $100 per share. Helms contends that the preferred stock was not income within the meaning of the Sixteenth Amendment. If it is held to be income, however, then he contends that the amount thereof should be determined to be the fair market value of the preferred stock which he received. This has been stipulated to be $90 per share for the first preferred and $25 per share for the second preferred.
*322 It has been held that the preferred stock distributed by Helms Bakeries in 1936 was taxable income to the shareholders within the meaning of the Sixteenth Amendment and under section 115(f). The corporation is being allowed a dividends paid credit equivalent to the fair market value of the stock at the*911 time it was distributed. The respondent concedes that, if taxable as a dividend to the recipients, it should be included in their gross income at its fair market value at the time it was received by them rather than at par. This concession accords with our view of the law. The deficiency in this proceeding should therefore be recomputed, including in the income of Helms and his wife only the fair market value of the stock at the time it was received.
Docket No. 102602.
The issues in the proceeding of Helms, trustee, are: (a) Was taxable income realized in 1936 through distribution to the trustee of the first and second preferred stock of Helms Bakeries? and (b) did respondent err in failing to find there were three separate trusts - one for each of the three children - instead of one trust for the three of them?
Issue (a) has already been discussed. For the reasons set out above it is held that the preferred stock was income for the taxable year to the extent of its fair market value at the time received.
The answer to the remaining question may be found by ascertaining the intention of the settlors of the trust. *912 Green v. Green, 23 Wall. (90 U.S.) 486. The instrument which they signed is the best evidence. It should be examined from its "four corners." McGinley v. Commissioner, 80 Fed.(2d) 692; Huntington National Bank v. Commissioner, 90 Fed.(2d) 876. Evidence Aliunde may be received to aid in the construction but not to contradict the plain and unambiguous language used. 65 C.J. 248. The only evidence offered or received in the instant proceeding bearing upon this issue was the testimony of Helms and his attorney upon which finding has been made that instructions were given to prepare three trusts, one for each of the children, and that the attorney, who drew up the instrument, advised Helms it created three separate trusts. Notwithstanding this evidence we choose to rest our conclusion chiefly upon the instrument itself; so it will be discussed at some length.
The trust estate (Two (b)) was to "be apportioned, segregated and divided into three equal shares", one for each child. The net income from each (Two (c), (d) and (e)) was to be "apportioned and segregated to and for the use and benefit of" each of the three*913 named children. Under Two (f) "the share of the Trust Estate apportioned" to each child was to be treated separately in the event *323 of his or her decease and under Three, if "the income from the respective shares to which the respective beneficiaries may be entitled" should be insufficient for the purposes contemplated by the settlors, the trustee was to use "so much of his or her share up to and including the whole thereof, as the trustee may deem advisable." All of these provisions indicate that three separate trusts were created. The trustee so interpreted the trust instrument, signing separately, as trustee for each of his children, the consent to accept stock and, after it was received, allocated one-third of it to each of the children. Separate returns were filed by him for each of the children, listing therein one-third of the stock received as "stock dividends on stock held in trust for the beneficiary." Some of the circumstances set out above are only self-serving and have been given little weight. We are convinced, however, from an examination of the trust instrument, that three separate trusts were created and we so hold.
Decision in each of the proceedings*914 will be entered under Rule 50.
Footnotes
1. SEC. 26. CREDITS OF CORPORATIONS.
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(c) CONTRACTS RESTRICTING PAYMENT OF DIVIDENDS. -
(1) PROHIBITION ON PAYMENT OF DIVIDENDS. - An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account.
(2) DISPOSITION OF PROFITS OF TAXABLE YEAR. - An amount equal to the portion of the earnings and profits of the taxable year which is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of the taxable year) to be paid within the taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt; to the extent that such amount has been so paid or set aside. For the purposes of this paragraph, a requirement to pay or set aside an amount equal to a percentage of earnings and profits shall be considered a requirement to pay or set aside such percentage of earnings and profits. As used in this paragraph, the word "debt" does not include a debt incurred after April 30, 1936. ↩
2. Article 26-2(b) of Regulations 94 provides:
(b) Prohibition on payment of dividends. - The credit provided in section 26(c)(1) is allowable only with respect to a written contract executed by the corporation prior to May 1, 1936, which expressly deals with the payment of dividends and operates as a legal restriction upon the corporation as to the amounts which it can distribute within the taxable year as dividends. If an amount can be distributed within the taxable year as a dividend -
(1) in one form (as, for example, in stocks or bonds of the corporation) without violating the provisions of a contract, but can not be distributed within the taxable year as a dividend in another form (as, for example, in cash) without violating such provisions, or
(2) at one time (as, for example, during the last half of the taxable year) without violating the provisions of a contract, but can not be distributed as a dividend at another time within the taxable year (as, for example, during the first half of the taxable year) without violating such provision -
then the amount is one which, under section 26(c)(1), can be distributed within the taxable year as a dividend without violating such provisions. ↩
3. SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
(a) DEFINITION OF DIVIDEND. - The term "dividend" when used in this title (except in section 203(a)(3) and section 207(c)(1), relating to insurance companies) means any distribution made by a corporation to its shareholders, whether in money or in other property, (1) out of its earnings or profits accumulated after February 28, 1913, or (2) out of the earnings or profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made.
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(f) STOCK DIVIDENDS. -
(1) GENERAL RULE. - A distribution made by a corporation to its shareholders in its stock or in rights to acquire its stock shall not be treated as a dividend to the extent that it does not constitute income to the shareholder within the meaning of the Sixteenth Amendment to the Constitution.
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(j) VALUATION OF DIVIDEND. - If the whole or any part of a dividend is paid to a shareholder in any medium other than money the property received other than money shall be included in gross income at its fair market value at the time as of which it becomes income to the shareholder. ↩