*1169 1. Expenses incurred in connection with the issuance of preferred stock which by its terms was to be retired at the rate of 3 percent per year, held not deductible either in the year paid, or ratably over the contemplated life of the stock.
2. In 1926 the petitioner gave certain employees the right to purchase shares of the common stock annually for three years at a price less than its fair market value, provided they continued as employees for prescribed periods. Held, the difference between the sale price of the stock and its fair market value at the time the right to purchase it was acquired by service is deductible as additional compensation for services rendered. Haskell & Barker Car Co.,9 B.T.A. 1087">9 B.T.A. 1087, followed.
3. During 1926 the petitioner credited to the accounts of the employees for the purchase of the stock sums for cash dividends declared on the stock, including the shares subject to purchase for continuous employment in the two successive years. Held, the sums credited to the accounts are not deductible as additional compensation for services rendered.
*143 These proceedings were consolidated for hearing and report and involve the redetermination of deficiencies in income taxes for 1924, 1925 and 1926, in the respective amounts of $10,203.29, $2,260.08, and $78,782.01. The petitioner abandoned an issue raised respecting the deductibility in 1925 of an amount paid in connection with an issue of notes, and three issues have been settled by stipulation. The issues agreed upon will be reflected in the recomputations to be filed under Rule 50. The questions remaining for decision are (1) whether expenses incident to the issuance of preferred stock in 1924 and 1925 may be deducted in the respective years in which incurred or, in the alternative, ratably over the alleged life of the securities; (2) whether the excess of the market value over the sale price of common stock sold by petitioner to employees is deductible in 1926 as additional compensation for services rendered; and (3) whether a deduction may be taken in 1926 for dividends on said stock credited to the accounts of the employees for the purchase of the stock.
FINDINGS OF FACT.
The petitioner is a Delaware corporation*1171 owning all of the stock of a number of operating subsidiary corporations. During and prior to the taxable years these corporations were engaged principally in *144 the financing of business through the purchase of various kinds of receivables. For these purposes the petitioner required a very large capital and extensive credit facilities.
Prior to 1924 the stockholders of the Commercial Investment Trust, Inc., the predecessor of petitioner as the parent corporation, and its predecessors were able to supply the capital needed to meet the increasing activities of the group of corporations. During 1924 the requirements for capital exceeded the ability of the stockholders to furnish it, and it was concluded to solicit capital from the public.
Pursuant to this decision the petitioner was organized January 28, 1924, with a perpetual charter. Its authorized capital consisted of 60,000 shares of 7 percent first preferred stock, each of the par value of $100, and 360,000 shares of no par value common stock. One half of the preferred stock and 300,000 shares of the common stock were issued in 1924 to stockholders of the Commercial Investment Trust, Inc., in exchange for stock*1172 of that corporation. The other half of the preferred stock and 50,000 shares of the common stock were sold during the same year to Dillon, Read & Co., dealers in securities.
The petitioner in 1924 incurred liabilities for the following items in connection with its organization and the issuance of its common and preferred stock:
| Legal fees | $15,702.83 |
| Printing | 3,353.35 |
| Temporary stock certificates | 440.00 |
| Engraving permanent stock certificates | 2,750.00 |
| Corporation Trust Co. | |
| Fee and expense | 523.48 |
| Miscellaneous | 45.00 |
| American Bank Note Co., miscellaneous | 45.00 |
| Printing listing applications | 231.77 |
| Various | 396.52 |
| Total | 23,487.95 |
The legal fees were incurred for services performed by attorneys for Dillon, Read & Co. The attorneys, in cooperation with an officer of petitioner's immediate predecessor, were charged with the duty of organizing petitioner and issuing its stock. These duties included drafting of the provisions of petitioner's charter and preferred stock certificates in a manner acceptable to Dillon, Read & Co. A large part of the work performed by the attorneys was on the provisions of the preferred stock certificates, and preferred*1173 stock provisions of petitioner's charter.
The petitioner's books do not show an allocation of the item of $23,487.95 between the common and preferred stock. A large portion of the amount was incurred incident to the organization of petitioner.
*145 In 1925 the petitioner issued 75,000 additional shares of 6 1/2 percent first preferred stock, each share of the par value of $100. The entire issue was sold to Dillon, Read & Co. as of January 1, 1926.
The following expenses were incurred by the petitioner in connection with the issuance of the stock and the amendment made to its charter authorizing the additional stock issue:
| Revenue stamps | $23.10 |
| Gratuity to employees | 50.00 |
| Legal expenses: | |
| Tolles, Hogsett, Gin & Morley | 50.00 |
| McLoughlin & Royce | 5,263.25 |
| Root, Clark, Howland & Ballantine | 8,184.50 |
| Printing and engraving | 3,350.00 |
| Listing stock, N.Y. Stock Exchange | 2,266.66 |
| Evening Post, notices and proxies | 488.56 |
| Corporation Trust Company: | |
| Recording fees | 2,700.00 |
| Services | 164.95 |
| Audit expense | 2,000.00 |
| Printing | 493.94 |
| Registrar's expense | 4,350.00 |
| Financial advertising | 399.53 |
| Miscellaneous expenses | 280.60 |
| Total | 30,065.09 |
*1174 On December 31, 1925, the petitioner paid to Dillon, Read & Co. the sum of $28,437.50 representing interest on $7,500,000 at the rate of 6 1/2 percent per annum for the 21 days intervening between the payment of the sale price of petitioner's issue of 6 1/2 percent preferred stock and the delivery of certificates for the stock.
The petitioner's charter and the certificates for the 7 percent preferred stock provide that the stock may be redeemed on any dividend date upon 60 days' previous notice at the cash price of $100 per share, plus accumulated dividends, and that the petitioner shall annually, commencing on or before January 31, 1925, acquire out of surplus or net profits, if sufficient, after all accumulated and unpaid dividends, if any, upon the first preferred stock shall have been paid, at least 3 percent of the largest amount in par value of such stock that shall have been at any time issued and outstanding. They also contain provisions for making good out of the surplus or net profits in subsequent years any deficiency in annual acquisitions of stock. The certificates for the 6 1/2 percent first preferred stock contain like provisions.
In each of the years 1924, *1175 1925 and 1926 the petitioner purchased in the open market $180,000 par value of its 7 percent first preferred stock, and in 1926 it acquired in the same manner $225,000 par value of its 6 1/2 percent first preferred stock. These amounts are equal to *146 3 percent of the largest amount in par value of the two classes of preferred stock at any one time outstanding.
The petitioner kept its books and filed its returns on the accrual basis.
Prior to 1926 petitioner's operating companies paid to their principal executives as compensation for services rendered a small fixed annual salary and an agreed percentage of profits. This plan was abandoned in the fall of 1925, when a committee was appointed by the directors of petitioner to make an adjustment with the employees on some other basis and consider the sale to them of petitioner's unissued common stock. The committee worked out a plan whereby selected employees would be permitted to purchase petitioner's common stock at a price slightly in excess of its book value but less than the current market value.
The plan formulated by the committee was considered and approved by the directors of the petitioner. At or about*1176 January 1, 1926, oral agreements were reached with employees concerning their fixed annual compensation for the next three years and for the purchase of petitioner's common stock as additional compensation. The oral agreements were reduced to writing by instruments executed on June 1, 1926, between the petitioner and the employees. The written agreements fixed the yearly salary of the employees for three years commencing January 1, 1926, and as additional compensation gave them the right to purchase a specified number of shares of petitioner's common stock at $35 per share. The stock allotted each employee was to be taken up annually in equal amounts for three years. The shares to be taken up in the respective years were designated in the contracts as allotments A, B, and C. Other material provisions of the agreements read as follows:
All of the above mentioned shares of stock have been issued and fully paid for by others than yourself. Certificates numbered as hereinafter set forth have been made out in your name, endorsed by you and deposited with us as security for an advance of $ made to you by us to assist you in purchasing the stock. This sum, together with interest*1177 at the rate of 5% per annum from January 1, 1926, on the unpaid balance thereof as it exists from time to time, you will by acceptance of this letter agree to repay to this Corporation. If you fail to take up any of the allotments of stock hereinafter described at the time and on the terms stated, all your rights as to all stock held in your account are automatically terminated, but you shall then be under no obligation to the Corporation with respect to the loan or otherwise subject to liability because of your failure to take up the stock; but if you shall have made prepayment of or on account of any stock not at such time deliverable to you the amount of such prepayment shall be refunded to you.
A. If you shall repay to the Corporation on or before January 2, 1927, the sum of $ together with interest on the entire balance of your account to the date of payment, you will be entitled to receive Allotment A on January 2, 1927 (but not before that date unless the Corporation shall elect to advance the date of delivery) free and clear of all indebtedness provided that on July 1, *147 1926, you were still in the employ of a subsidiary or affiliated company and provided further*1178 that if for any reason you shall on or before June 30, 1926, cease to be in such employ, then upon repayment on or before July 1, 1926, of one-half of the sum above stated in the Paragraph "A" together with interest on the entire balance of your account to the date of payment, you will be entitled to receive one-half of Allotment A and you will have no further rights or obligations hereunder, or with respect to any of the stock allotted to you.
Provision was made in the contracts for the delivery of allotment B of the stock on January 2, 1928, and allotment C one year later.
The subsidiary corporations executed such contracts as affected their individual employees "for the purpose of accepting the benefits thereby conferred upon it and of assuming and being bound by the obligations and liabilities thereby imposed upon it."
There were allotted to employees in accordance with the terms of the agreements 12,295 shares of stock. Of this number 11,770 shares were allotted on January 2, 1926, 225 shares on April 12, 1926, and 300 shares on July 1, 1926. The common stock of petitioner had a fair market value on January 2, 1926, April 12, 1926, and July 1, 1926, of $71.50, $55, and*1179 $62.50 per share, respectively.
Certificates for the number of shares to be delivered each year were issued in the names of the employees, who endorsed the certificates in blank and redelivered them to petitioner's treasurer, who held them as collateral for the loans made to the employees in connection with their purchase of the stock. The accounts of the employees were charged with the amounts they were to repay to the petitioner. Thereafter the accounts were charged with interest on the balance due at the rate of 5 percent per annum and credited with dividends paid on the allotted stock, and cash payments made by the employees on the principal.
One of the employees discharged his indebtedness for his allotment of 3,000 shares prior to February 17, 1926. All of the employees complied with the terms of the contracts and took up their stock, except one, who failed to take up his allotment of 100 shares deliverable in 1929.
In the consolidated return filed by the petitioner and its subsidiaries for 1926, the sum of $439,655, representing the excess of the fair market value of all the stock allotted to employees over the sale price thereof, was claimed as a loss sustained*1180 on the sale of stock to employees. The respondent disallowed the claimed deduction.
The contract with the employees also provided that:
While any stock not theretofore taken up by you is being held for your account, cash dividends when received thereon will be credited first to interest on the loan to you, then to the principal thereof; stock dividends when received will be added to the respective Allotments of stock held for your account, and certificates representing any rights to subscribe issued to the record holder of *148 the stock immediately upon receipt will be turned over to you or your assigns as above defined.
As additional consideration for entering into the employment contracts the employees were entitled to have credited to their accounts on January 2, 1927, 1928 and 1929, for the purchase of the stock, an amount equal to the saving in corporate income tax resulting from the deduction of the amounts to be credited to the employees under the terms of the contracts for the preceding year. During 1926 there were credited to the accounts of the employees for the purchase of the stock amounts aggregating $32,454, a sum equal to the quarterly dividends of*1181 90 cents per share declared on the allotted stock, commencing April 1, 1926.
OPINION.
ARUNDELL: The decided cases are uniform in holding that costs incurred in corporate organization, sales of capital stock, and amendments to corporate charters are not ordinary and necessary business expenses deductible in the year paid or incurred. ; ; affd., ; certiorari denied, ; ; ; ; certiorari denied, ; . Such items as are here sought to be deducted have consistently been treated as relating to capital and not to current operations. As said in , the expense of selling preferred stock "represents a capital expenditure, and should be charged against the proceeds of the stock, and not recouped out of operating earnings."
The cases above cited likewise dispose of petitioner's alternative claim that the costs*1182 incident to the preferred stock issues be spread over 33 1/3 years, during which period it was contemplated that the stock would be redeemed. An item that is not essentially an ordinary and necessary expense can not be placed in that category by spreading it rather than by taking it in full in the year paid or incurred. While costs of issuing stock are spoken of as capital expenditures, they may not result in the acquisition of a wasting capital asset as, for instance, a leasehold for a definite term. The fact that the stockholders hope to get their investment back within a certain period does not convert the cash paid in into an exhaustible asset. We accordingly hold that costs incurred in connection with the preferred stock issues may not be deducted under either the expense or exhaustion provisions of the statute.
This disposition of the claim for a deduction of the capital expenditures makes it unnecessary to pass upon the sufficiency of the proof *149 directed toward establishing the amount attributable to the first issue of preferred stock separately from the other expenditures in connection with the organization of petitioner and the issuance of its common stock. *1183 It appears that the entire amount of $30,065.09 paid or incurred in 1925 may properly be ascribed to the issuance of the 6 1/2 percent preferred stock. For reasons above given, however, none of this amount may be deducted except the amount of $23.10 allowable as a tax.
At the hearing it was shown that $28,437.50 of the amount originally claimed as a deduction for expenses incurred in 1925 in the issuance of stock was for interest paid to Dillon, Read & Co. on $7,500,000 at 6 1/2 percent per annum for the period of 21 days between the payment by Dillon, Read & Co. of the sale price of petitioner's 6 1/2 percent preferred stock and the delivery of stock certificates. The amount is deductible in 1925 as interest paid within the year on indebtedness.
The item of $23.10 was incurred for revenue stamps incident to the issuance of preferred stock in 1925 and represents a tax, deductible from gross income of that year. ; .
The petitioner has abandoned so much of the next issue as relates to the deductibility in 1926 of the difference between the sale price and market value*1184 of the stock held for delivery in 1928 and 1929.
The reasonableness of the remaining amount in controversy as compensation for services rendered to petitioner is not questioned. The arguments of the respondent on the question are directed to the deduction in 1926 of the excess of market value over the selling price of all the stock. The contentions made are that in 1926 employees did not have a vested right to receive the stock, and the petitioner was under no obligation to deliver it within the year. When applied to allotments B and C, as to which the claim has been withdrawn, the contentions have some force, but they are without merit as to allotment A.
The facts here are very much the same as in , where the taxpayer contracted to sell its capital stock to employees at less than the market value. It appears that in that case only a part of the stock was paid for and taken up by the employees during the taxable year, but it was held that the difference between selling price and market value of all the stock covered by the contracts was allowable as a salary deduction for the current year. If there is any distinction*1185 between the two cases, the one before us is the more favorable to the taxpayer. Here it appears that on June 1, 1926, when the written contracts were executed, the petitioner had been paid for the stock allotted to the *150 employees. This was accomplished by means of advances to the employees to pay the petitioner for the stock, the issuance of the stock to the employees, and its endorsement back as collateral security for the loans. The conditions precedent had been fulfilled within the year, that is, the allottees were employees on the designated dates in 1926, and the stock had been issued to them. The only contingency we see in the case is that in the event of failure to repay the loan to the company, the employees' stock might be forfeited and used to satisfy the loan. This was a condition subsequent and would not change the character of the stock as issued and paid for within the year nor affect the status of the employees as stockholders in the year. We accordingly hold that petitioner is entitled to the deduction claimed in connection with allotment A, as salaries accrued within the year.
There remains for determination the basis for the deduction. We have*1186 heretofore held that where stock is delivered as compensation for services rendered, the taxable income to the recipient is the fair market value of the stock at the time received. ; . The same basis is used in the computation of gain realized on the sale of stock received under such circumstances. . In , we allowed the deduction on the basis of the market value of the stock at the time the allotments were made.
Here most of the stock was allotted on January 2, 1926, when it had a fair market value of $71.50 per share. Other allotments were made on April 12, 1926, and July 1, 1926, when the fair market value was $55 and $62.50 per share, respectively. The employees acquired the right to one half of allotment A when the stock was allotted, and to the other half for continuous service to and including July 1, 1926. At those times the employees became owners of the stock and petitioner was under a definite obligation to turn over all of it on January 2, 1927, provided only that the employees*1187 had discharged their obligations for the loan. These facts, in our opinion, were sufficient to warrant the accrual of the deduction on petitioner's books. The deduction, measured by the difference between the fair market value of the stock and the selling price of $35 per share to the employees, for one half of allotment A earned by services performed prior to July 1, 1926, should be on the basis of a fair market value of $71.50 for the stock allotted on January 2, 1926, and $55 for the stock allotted on April 12, 1926. The allowance for the remaining half of the allotment and all of the shares allotted on July 1, 1926, should be on the basis of a fair market value of $62.50 per share.
*151 The sum of $32,454, representing credits made in the accounts of the employees in 1926 for dividends declared on the stock allotted to them, is claimed to be deductible as additional compensation for services rendered. We have already held that petitioner may deduct the difference between the selling price and the fair market value of the stock included in allotment A, as compensation for services. The value of the stock on the date of allotment was based on the right to receive dividends*1188 thereon, and to permit the deduction of dividends as such and also the market value of the shares would be to allow a double deduction. The entire plan between petitioner and the employees contemplated their acceptance as stockholders from the date of allotment, with a right to receive dividends on the allotted stock, and with a charge for interest on the advances made the employees for the purchase of the stock, On the record we sustain the respondent's disallowance of the amount as a deduction.
Reviewed by the Board.
Decision will be entered under Rule 50.
STERNHAGEN, dissenting: As to the deduction allowed as compensation for services of the value of a corporation taxpayer's shares, I have already expressed my disagreement in Haskell & Barker Car Co.,9 B.T.A. 1087">9 B.T.A. 1087. The confusion disclosed by the issue raised in the present proceeding as to the time and amount of the accrual, as suggested by my brother Murdock, has its genesis in the fallacy of regarding the disposition by a corporation of its own shares as an expense. The corporation has spent or incurred nothing. The transaction was a sale or issuance of shares to*1189 a restricted class for a price. The earnings and profits remain, throughout these stock transactions, entirely in the corporation's possession, subject to its use and disposition, and distributable, in its discretion, by way of dividends. What then serves to reduce its income? Nothing, unless the redistribution of share interests can be said to do so. If a partnership were to give an employee an interest in the business, there would probably be no suggestion of deduction. The concept of capital stock in Eisner v. Macomber,252 U.S. 189">252 U.S. 189, leads to the same result. Since, as the prevailing opinion holds, the payment of cash dividends to the employees fails to reduce income, it is difficult to see why the issuance of the stock upon which the dividends are paid should do so. It may be added, lest there be doubt as to the importance of this question, that the facts in Rogers v. Guaranty Trust Co.,288 U.S. 123">288 U.S. 123, give some idea of the possible extent of its effect. A close corporation could by this method earn profits year after year, and by distributing shares of an increasing value for services *152 avoid all tax whiie distributing*1190 its earnings, which to the distributee are free from normal tax. And it certainly adds nothing to the argument for deductibility that instead of an outright issuance for service, there is a sale for less than value.
MURDOCK agrees with this dissent.
MURDOCK, dissenting: I see neither statutory nor factual authority for the deductions allowed in this case on account of the "A" allotment of stock. The prevailing opinion attempts to justify the accrual of definite amounts on the theory that certain employees on January 2 and on April 12, 1926, purchased certain stock. An accrual must be made as of the time when the facts determinative of the obligation and its amount become fixed. How could this corporation accrue any amount until there was an agreement, which not only bound it to deliver a definite number of shares to a certain employee, but bound some employee to accept and pay for those shares? The findings do not show any such agreement prior to June 1, 1926. Therefore, accruals based on fair market value of stock on January 2 and April 12 are clearly improper. But aside from this, the deduction is wrong in principle. See the dissenting opinions in *1191 . Other stockholders of the parent are the only ones adversely affected by the issuance of additional stock for less than its fair market value. Thereafter they have to be content with a smaller share of corporate distributions. But the income of the issuing corporatiov certainly is not reduced. Its assets are not reduced. The transaction is unique and is not covered by any provision of the statute allowing deductions to a corporation.
STERNHAGEN, MCMAHON, and GOODRICH agree with this dissent.