*2887 The evidence does not sustain the claim of petitioner that noninterest-bearing notes given for stock should be included in invested capital in an amount greater than that allowed by the respondent.
*247 In this proceeding the petitioner seeks a redetermination of the deficiencies asserted by the Commissioner for the fiscal years ended September 30, 1920 and 1921, in the amounts of $2,863.74 and $3,360.88, respectively. Petitioner alleges error on the part of the Commissioner (1) in disallowing as a deduction from income of 1920 an item of $1,041.81, representing the cost of painting; (2) in disallowing as deductions from income of 1920 and 1921, alleged donations of $200 and $50, respectively; (3) in deducting a tentative tax in determining the amount of earnings available for distribution in 1920, for invested capital purposes; (4) in disallowing as invested capital of both years a portion of the aggregate face value of promissory notes of stockholders paid in for shares of stock; and (5) in disallowing as a deduction from income of 1921 an alleged*2888 liability of $2,011.89, for income tax to the State of North Carolina. At the hearing, the Commissioner admitted the errors set out in the first and fifth assignments, and conceded that the decision of this Board in L. S. Ayers & Co.,1 B.T.A. 1135">1 B.T.A. 1135, was controlling as to the third assignment. The petitioner withdrew the second assignment of error.
FINDINGS OF FACT.
Petitioner, a North Carolina corporation with its principal office at Gastonia, was organized in 1916 for the purpose of engaging in the manufacture of cotton yarns.
The petitioner was organized by C. B. Armstrong, who, at the time, was regarded as one of the outstanding cotton mill operators in the United States. Armstrong had established a chain of cotton mills in North Carolina, all of which were successful, and he was a man of large means and of recognized ability as an organizer and operator of cotton mills. In 1916 Armstrong conceived the idea of incorporating one of his chain of cotton mills located at Gastonia, in which the residents of that community would be permitted to acquire an interest and participate in its profits. It was with this end in view that the petitioner was organized, *2889 and the idea was carried out *248 by offering a certain class of petitioner's capital stock to the residents of Gastonia for subscription, and on a credit basis.
Petitioner was authorized to issue two classes of stock, designated as "Class A" and "Class B," each of a total par value of $100,000, and each class divided into shares of the par value of $100. Class A stock was entitled to a preferred cumulative dividend of 7 per cent per annum, and was to be paid for in cash. Class B stock was to share in the profits equally with class A stock after payment of the preferred and cumulated dividends on the latter.
Class B stock was offered for subscription to the residents of Gastonia, in quantities not to exceed 10 shares to any one person. This stock was offered with the understanding that the subscribers thereto would subscribe for an equal number of shares in a local building and loan institution; that they would execute promissory notes for the payment of their subscriptions, payment therefor to be made out of the proceeds of their building and loan certificates when the same shall have matured; and that the certificate of shares of petitioner's stock to be issued to*2890 them and the certificate of building and loan shares were to be deposited as collateral for the payment of their notes. The following note, executed by one of the subscribers to class B stock, is identical, except in figures, with that executed by every other subscriber to that stock to whom such stock was issued under the conditions already enumerated:
$1000.00
GASTONIA, N.C., Jan. 20th, 1917.
On or before maturity of the 16th Series, dated 7th day of October, 191 , of the capital stock of the Home Building and Loan Association, Gastonia, North Carolina, for value received I promise to pay to the MUTUAL COTTON MILLS COMPANY, a corporation, having its principal place of business in the city of Gastonia, North Carolina, or order at The Citizens National Bank, Gastonia, North Carolina, One Thousand Dollars, with interest after maturity at the rate of six per cent per annum, having deposited as collateral security, for the payment of this liability to the holder thereof, the following property, viz: Cert. #1014, series #16 for ten shares of the Home B & L Association, Cert. #53, for ten shares of class "B" stock of the Mutual Cotton Mills Co. Gastonia, N.C.
With authority*2891 to sell, transfer or hypothecate said collateral, it being understood that on payment or tender of the amount so due the holder thereof may return to the undersigned an equal quantity of like securities instead of the securities deposited herewith.
Full power and authority are hereby given the holder hereof, to sell, assign and deliver the whole of the above mentioned securities or any part thereof or any substitute therefor or any additions thereto, at any banking house, or at a public or private sale, at the option of the said holder or his assigns, on the nonperformance of this promise or any part of same, or on failure to pay when due any assessment, proper charges or dues on the stock herein hypothecated to secure this obligation at any time or times thereafter, without demand, advertisement or notice, and after deducting all legal or other costs and expenses of collection, sale and delivery, to apply the residue of the proceeds of such sale or sales so made to the payment of the liability above mentioned, as said holder *249 or assigns shall deem proper, returning the overplus to the undersigned. It is also understood that upon any sales of any of said collateral securities, *2892 said holder may become the purchaser thereof absolutely free from any claim of the undersigned.
Protest, presentment and notice of dishonor waived by all makers and endorsers of this note.
(Signed) J. L. GRIBBLE.
The subscription agreement before organization contains the signatures of 89 subscribers to 695 shares of petitioner's class B stock. All of these subscribers were honest and industrious persons, and, with one exception, were engaged in some gainful occupation in Gastonia or its environs.
The petitioner and the Home Building and Loan Association, to which reference is made in the collateral notes of subscribers, were not affiliated in any way and no business relationship existed between them.
Payments for shares of capital stock of the Home Building and Loan Association were made by subscribers thereto at the rate of 25 cents a week per share.
Shortly after organization there were some sales of petitioner's class B stock at prices ranging from $135 to $150 per share.
Dividends on class B stock were paid direct to the record holders thereof, and were not applied toward payment of the notes given for such stock.
At the date of the hearing, all of the*2893 collateral notes given by subscribers for class B stock had been paid.
In computing petitioner's invested capital for the years in controversy, the Commissioner included collateral notes given by subscribers for petitioner's class B stock at the values of $32,160 for 1920, and $43,818 for 1921, holding that the value which could properly be included in invested capital of each year was the aggregate sum which the subscribers had paid on the building and loan shares, plus accumulated interest, to the beginning of the year. In addition to those sums, the Commissioner included the sum of $5,226, for both years, as representing one-half of the aggregate sum paid during each year by the subscribers on the building and loan shares.
In computing the amount of earnings available for distribution in 1921, for invested capital purposes, the Commissioner reduced the gross earnings by the amount of a tentative income and profits tax.
OPINION.
LITTLETON: The Commissioner has included the collateral notes of subscribers to class B stock in invested capital at the values of $37,386 for 1920, and $49,044 for 1921. The petitioner contends *250 that these notes should have been*2894 included in the invested capital of both years at their aggregate face value, which it alleges is $80,000.
Sections 326(a)(2) of the Revenue Acts of 1918 and 1921 require that tangible property paid in for capital stock shall be included in invested capital at its actual cash value as of the date of payment. This is the controlling statutory provision in the decision of the issue presented by this case. The Commissioner's determination appears to ignore this statutory principle, for in place of a constant includable value, which the statute undoubtedly contemplates, he has determined upon progressive values based upon the aggregate sums paid, plus accumulated interest, to the beginning of each year, by the makers of the notes on the purchase price of a part of the collateral security. He treats the payments made by the makers of the notes, in payment of building and loan shares which they have deposited as collateral for the payment of their notes, as though such payments were made to the petitioner in payment for petitioner's class B stock. We entertain no doubt that this is not correct. What the statute contemplates, in the circumstances of this case, is that the notes paid*2895 in by subscribers for petitioner's class B stock shall be included in the invested capital of each year at their actual cash value as of the date of payment, until they shall have been converted to some other form of asset, or otherwise disposed of. However, though the underlying theory of the Commissioner's determination appears to be incorrect, we can not say, from the evidence at hand, that petitioner is entitled to include these notes in invested capital at any greater values than those determined upon by the Commissioner.
The notes in question, as previously stated, were given in payment for petitioner's class B stock. Each of the subscribers to that stock entered into the subscription agreement, and gave their notes in payment of their respective subscriptions, with the explicit understanding, which was tantamount to a binding agreement, that such notes were to be paid out of the proceeds of their matured shares of building and loan stock. Indeed, the notes themselves provide for payment thereof "On or before maturity of the 16th Series" of the capital stock of the Home Building and Loan Association. None of these notes bore interest until after maturity. There is no*2896 evidence as to when the "16th Series" of capital stock of the Home Building and Loan Association matured; but it is a matter of common knowledge that shares in building and loan associations may mature anywhere from 5 to 11 years. We call attention to the finding that payments for shares of capital stock of the Home Building and Loan Association were made by subscribers thereto at the rate of 25 cents a week per share. This fact indicates that the maturity of the series of building and loan shares was several years subsequent to the dates of *251 the notes in question. It is inconceivable that these noninterest-bearing notes maturing several years later would have an actual cash value, at the date of their making - which presumably was the date when paid in for petitioner's stock, equal to their full face value.
Only one witness was called in petitioner's behalf; and he was not called upon for an expression of opinion as to the value of these notes when paid in to petitioner. He did testify that he and Armstrong agreed between themselves to stand back of these notes; but we believe that could have but little bearing upon the value of the notes when paid in. At best, *2897 it could be regarded as a mere assurance of payment of the notes when they matured. He stated that both he and Armstrong had made bank borrowings on their holdings of petitioner's class B stock, and that any one of the makers of the notes in question could have borrowed from the bank an amount equal to the par value of the shares of class B stock deposited as collateral for their notes. We were not given any of the details of the borrowings of the witness and of Armstrong on the strength of their holdings of class B stock, and we regard the witness's statement as to the ability of any of the several makers of the notes in question to consummate like transactions as merely an expression of opinion. But assuming these facts to be true, they could have only a very remote bearing upon the value of the notes for the payment of which they were deposited as collateral.
Furthermore, there is no evidence as to the total amount, or aggregate face value, of the notes in question. It was alleged in the petition that the total amount was $80,000; but that allegation was included in the general denial of the Commissioner, and the petitioner offered no proof to support it. So, even if petitioner*2898 was entitled to include these notes in invested capital at full face value, we would still be at a loss to find just what that value is. Furthermore, without knowing what the face amount of these notes is, and the length of time they were to run from the date paid in, and without any sufficient evidence as to their value at the date paid in, we are wholly without facts upon which to base a conclusion as to what their value may have been at the basic date. It is true that we have found that the subscription agreement before organization contains the signatures of 89 subscribers to 695 shares of class B stock, who apparently subscribed under the conditions outlined in the findings of fact, but there is no evidence that class B stock was actually issued to these subscribers in the amounts subscribed for.
We are unable to determine, from the evidence at hand, the actual cash value of the notes in question when paid in for petitioner's class B capital stock, and, consequently, we may not disturb the Commissioner's determination as to said value.
*252 The Commissioner's reduction of the gross earnings by the amount of a tentative income and profits tax, for the purpose of*2899 determining the earnings available for distribution, is contrary to the decision of this Board in L. S. Ayers & Co.,1 B.T.A. 1135">1 B.T.A. 1135, and, accordingly, is disapproved.
In accordance with the admissions of the Commissioner's counsel, made at the hearing, net income for 1920, as determined in the deficiency notice, should be reduced by $1,041.81, on account of the expense incurred for painting, and net income for 1921 should be reduced by $2,011.89, on account of income tax due to North Carolina for that year.
Judgment will be entered under Rule 50.