*738 The Hudson & Dugger Co., by resolution of its board of directors, ordered that the accounts of its stockholders be credited with amounts equal to the debit balances due and owing from the stockholders by charges against surplus, but further provided that the stockholders at such time as might be "convenient and appropriate" would make proper settlement of the accounts. Held, that the action taken effected the declaration and payment of a dividend within the meaning of section 115(a) of the Revenue Act of 1928.
*155 These proceedings, which were consolidated for hearing, are based on the determination by the respondent of deficiencies in income tax, and in one case a penalty for failure to file a return for the year 1929, as follows:
| Tax | Penalty | |
| Kate Hudson | $5,127.99 | |
| Kate Hudson, Trustee for Marie Hudson | 1,431.60 | $357.90 |
| Galvin Hudson | 3,709.20 |
The question involved is whether or not the petitioners received dividends from Hudson & Dugger Co. during the*739 taxable year. No issue is raised by petitioner Marie Hudson as to the imposition of the penalty for failure to file a return.
FINDINGS OF FACT.
At the time of his death on December 24, 1924, Charles Hudson, who was the husband of Kate Hudson and father of Galvin and Marie Hudson, was the president and principal stockholder of the Hudson & Dugger Co., hereinafter referred to as the corporation, a Tennessee corporation located at Memphis, Tennessee. He owned 6,731 1/4 shares of the capital stock of the corporation, the remaining 768 3/4 shares being owned by his son, Galvin Hudson.
It had been the practice of Charles Hudson for a number of years to withdraw various sums of money from the corporation from time *156 to time. His personal account on the books of the corporation was charged with the amounts so withdrawn and was credited with his salary and other amounts paid in to the corporation by him. During the six-year period prior to his death, the credits other than salary amounted to approximately $91,000. His account at the time of his death showed a debit balance of $43,910.19.
Charles Hudson died intestate and his son, Galvin Hudson, was appointed administrator*740 of his estate. In addition to the capital stock of the Hudson & Dugger Co., the estate consisted of a small amount of personal effects and capital stock in other corporations of a value of approximately $5,000. In addition to the sum of $43,910.10 due the Hudson & Dugger Co., there were outstanding debts of approximately $5,300. The petitioners herein were the heirs of Charles Hudson and were entitled to share equally in his estate. The widow, Kate Hudson, was appointed irrevocable trustee for Marie Hudson.
During the period from December 27, 1924, to February 24, 1928, Galvin Hudson, administrator, withdrew from the corporation various sums, totaling $62,861.53, in order to pay the following expenses of winding up the estate of Charles Hudson:
| Cost of cemetery lot | $1,750.00 Forest Hill Cemetery |
| Funeral expenses | 1,546.00 J. W. Norris |
| Monument | 2,410.00 McNeil Marble Co. |
| Income taxes 1924 | 3,078.67 |
| Administrator bond | 1,684.33 Smith & Bell |
| State inheritance taxes | 10,585.33 |
| Federal inheritance taxes | 10,676.18 |
| Notes due by deceased | 4,500.00 Mrs. Hudson & Miss Galvin |
| Interest on above notes | 420.00 Mrs. Hudson & Miss Galvin |
| Year's support of widow | 15,000.00 Mrs. Hudson |
| Administration fees | 10,000.00 Galvin Hudson |
| Sundry small bills of deceased | 882.08 Misc. |
*741 The amounts so withdrawn were charged on the books of the corporation to the account of Galvin Hudson, administrator. Collections made for the estate totaling $4,092.72 were credited to the account, leaving a balance due the corporation of $58,768.81.
In December 1926, by order of the Probate Court of Shelby County, Tennessee, Galvin Hudson, administrator, distributed the capital stock of the corporation held by him for the estate of Charles Hudson to the following persons:
| Kate Hudson | 2,243 3/4 shares |
| Galvin Hudson | 2,243 3/4 shares |
| Kate Hudson, trustee for Marie Hudson | 2,243 3/4 shares |
In March 1930, he was discharged as administrator of the estate.
During the period from January 1, 1925, to March 15, 1929, Kate Hudson withdrew various sums from the corporation, which were *157 charged to her account on its books. Her account was credited with various amounts from time to time. The principal credits so made were $15,000 described as "year's support as allowed by the commissioners of estate of Charles Hudson", and entered December 18, 1925; $5,000 cash, entered March 15, 1926; and $7,500 designated as salary from March 1, 1928, to March 1, 1929, and*742 entered on March 15, 1929. After the application of the credits, the account reflected a debit balance on March 15, 1929, of $16,271.96.
During the period from March 4, 1925, to February 11, 1929, Marie Hudson, with the consent of her mother, Kate Hudson, as trustee, withdrew various sums from the corporation, which were charged to her account on the books thereof. On March 15, 1929, the debit balance in her account amounted to $2,089.64. The total credits to the account amounted to less than $500 and consisted of four unexplained items.
On March 1, 1929, the directors of the corporation took action, in respect of the debit balances of stockholders, disclosed by the corporate minutes, as follows:
Attention of the board was called to the fact that the accounts against Charles Hudson, Galvin Hudson, Administrator, Mrs. Charles Hudson and Miss Marie Hudson were being carried on the books of the company and upon the company's balance sheets and have so been carried for some time when there appears to be little probability of the company realizing upon these accounts for at least some time to come. The Company's accountant, Mr. Taylor E. Cress suggests that these accounts be*743 closed into surplus account to the end that there may be no overstatement of the company's assets in its balance sheet. After a discussion of the matter the following motion was made by D. R. Bailey which was seconded by M. H. Jenkins, To-wit:
BE IT RESOLVED that the overdrafts shown on the accounts of Charles Hudson, Galvin Hudson, Administrator, Mrs. Charles Hudson and Miss Marie Hudson be cleared out of the assets of the Hudson and Dugger Company by charging them and each of them to surplus, it being the sense of this resolution and so understood by all that the accounts above set out are not being forgiven and that Hudson and Dugger Company still owns its equity therein; that at such time as may be convenient and appropriate proper settlement will be made to the company by the parties of such account.
The above motion was carried unanimously upon a vote of all the Directors whereupon the President was instructed to have the proper entries made upon the books of the company therefor.
In accordance with the resolution so adopted, the accounts of Kate Hudson, Marie Hudson, Charles Hudson, and Galvin Hudson, administrator, were credited with amounts equal to the debit balances*744 shown in the said accounts, and charges were made against undivided profits in the same amounts and on the dates shown, as follows:
| March 15, 1929, Kate Hudson | $16,271.96 |
| March 15, 1929, Marie Hudson | 2,089.64 |
| May 31, 1929, Charles Hudson | 43,910.19 |
| May 31, 1929, Galvin Hudson, administrator | 58,768.81 |
In the year 1925, Galvin Hudson received $10,000, covering his fee as administrator of the estate of Charles Hudson, and reported and paid normal tax and surtax on the said amount in his income tax return for that year.
At the time of the adoption of the resolution on March 1, 1929, above, directing that the accounts of Charles Hudson, Galvin Hudson, administrator, Kate Hudson, and Marie Hudson be cleared out of assets and charged to surplus, neither Kate Hudson nor Marie Hudson had the means of paying their indebtedness to the corporation other than the stock which they had received in distribution from the estate of Charles Hudson.
On September 22, 1931, at a meeting of the stockholders of the corporation, action was taken, *745 as follows:
* * * Thereupon the President stated the purpose of the meeting more fully than set out in the notice to the stockholders. The President stated that, since it was expressly understood and agreed by all concerned, that there was no intention to charge these accounts off or to forgive them, and that it was the intention of all the parties to settle these accounts with the company whenever it became possible for them to do so; that after advice from the auditor of the company and from counsel, he thought the only thing to do under the circumstances was to carry out that which would have had to be done before the estate of Charles Hudson, deceased, was distributed. The President further stated that on account of conditions, and the fact that the company had been going back into the woodworking bubiness, it was not possible for the company to pay cash dividends, and that he regretted very much that the parties interested were not able to pay the money back in cash. There was some discussion of the matter by the stockholders present, and the following resolution was offered by Donald R. Bailey.
Whereas, there has been considerable controversy between the stockholders*746 and the Hudson & Dugger Company, and between the stockholders themselves, and also with the Federal Government with reference to the accounts against the estate of Charles Hudson, deceased, Galvin Hudson administrator of said estate, Mrs. Kate Hudson and Miss Marie Hudson, and
Whereas, it is deemed advisable that stock in this company be surrendered and cancelled by each of the stockholders liable for said accounts of Charles Hudson, deceased, and Galvin Hudson administrator, to cancel and pay off said indebtedness and each and every item of it, by surrendering a sufficient number of shares out of the certificates transferred to them by the administrator, at the rate of $100 per share, to fully liquidate the accounts in question; and,
Whereas, all of said parties, including Miss Marie Hudson, whose assent hereto is given by her Trustee, Mrs. Kate Hudson, have agreed and consented that said reductions and cancellations be made.
Whereas, it is considered to be desirable, and the corporation being advised that the proper procedure is to have the face amounts of the certificates issued to said parties by the corporation, upon the transfer of certificates to them by the administrator, *747 reduced on their face by memorandum written across the face of the certificate reciting that the number of shares covered by said certificates was reduced in accordance with this resolution.
*159 Now therefore, be it resolved, by the stockholders of Hudson & Dugger Company in special meeting called for the purpose of considering this resolution, and the matters dealt with herein, that the number of shares of stock outstanding be reduced from 7,500 shares of par value of $100 to 6,473.21 of par value of $100 and that the cancellation and reduction be made in the certificates issued to the stockholders in transfer from Galvin Hudson, administrator, and that the capital of the company be reduced on the books in accordance with this resolution.
Be it further resolved, that the Secretary and the President shall write across the face of said certificate issued to Galvin Hudson the following:
"By consent of the holder, and on a unanimous vote of the stockholders of Hudson & Dugger Company, the amount of shares of stock in Hudson & Dugger Company represented by this certificate is reduced from 2,234.25 shares to 1,893.98 shares, and this certificate represents only 1,893.98*748 shares."
The same shall be written across the face of the certificates held by Mrs. Kate Hudson, showing a reduction from 2,243.75 shares to 1,900.49 shares, and the same shall likewise be written across the stock certificate held by Mrs. Kate Hudson, Trustee for Miss Marie Hudson, showing a reduction from 2,243.75 shares to 1,900.49 shares.
Be it further resolved, that when said certificates are so written across, they shall represent only the number of shares and fractions of shares, as shown by said memorandum so signed by the President and Secretary of the company.
Be it further resolved, that the company accepts the surrender and cancellation of said shares of stock and fractions of shares in full settlement and payment of the accounts of Charles Hudson, and of Galvin Hudson, administrator, and hereby releases all of said parties from any other or further liability on account of said accounts.
Be it further resolved, that the President of the company is authorized and directed to enter into negotiations with Mrs. Kate Hudson, on her own account, and as Trustee for Miss Marie Hudson, looking to a settlement of the account of Mrs. Kate Hudson and Mrs. Kate Hudson, Trustee*749 for Miss Marie Hudson; Mrs. Kate Hudson's account amounting to $16,271.96 and the Trustee account amounting to $2,089.64, and if said accounts can be paid, the President is hereby authorized and empowered to enter into contract to accept from Mrs. Kate Hudson and Mrs. Kate Hudson, Trustee, a sufficient number of shares of stock at a price to be agreed upon between them for the settlement in full of said two accounts.
By an agreement between the corporation and Kate Hudson on March 13, 1932, the latter surrendered to the corporation in her own right and as trustee for her daughter, Marie Hudson, sufficient shares at $100 each to cover the amounts with which their respective accounts had previously been credited on March 15, 1929, in accordance with the resolution of March 1, 1929.
At no time during the period covered by these findings did the Hudson & Dugger Co. make a formal declaration of dividends.
In the determination of the deficiencies against the petitioners, the Commissioner held that each petitioner received a dividend of $34,226.33, representing one third of $102,679.04, the total of the accounts of Charles Hudson and Galvin Hudson, administrator. In the case of*750 Kate Hudson, he held, further, that the sum of $16,271.96 credited *160 to her account on March 15, 1929, in accordance with the resolution of March 1 of the same year, constituted a dividend to her and, further, that the credit of $2,089.64, under the same conditions and circumstances, to the account of Marie Hudson was a dividend to the said Marie Hudson.
OPINION.
TURNER: The question here is whether the action taken by the corporation under the resolution of March 1, 1929, whereby the debit balances of the stockholders were satisfied by charges against surplus, constituted dividends.
By section 115(a) of the Revenue Act of 1928, the term "dividend" is defined as "any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913." In section 115(b) of the same act, it is provided that "every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits."
No question is raised as to the sufficiency of corporate surplus for the payment of a dividend in the amounts herein, and since the facts show that*751 the amounts in question were charged against surplus, we must assume that surplus was sufficient for the payment of such a dividend.
It is also assumed that all of these amounts were originally paid or credited to the stockholders as loans or advances, since there is no contention by either party that the amounts in question were dividends or other than loans prior to the resolution of March 1, 1929, and the action taken thereunder.
The respondent contends that the resolution constituted a release to the debtor stockholders of their obligations, and, in substance, the declaration of a dividend. The petitioners deny that the corporation released, or intended to release, the stockholders of any indebtednesses and call attention to the eventual formal surrender of stock in 1931 and 1932, in settlement of the debit balances involved as evidencing the fulfillment of an intention on the part of both the corporation and its stockholders that the withdrawals should be repaid in full. It is also argued that, even though the forgiveness by a corporation of the indebtedness of its stockholders does under certain circumstances amount to the payment of a dividend, it can not be said that*752 a dividend was declared and paid in the cases of these petitioners with reference to the amount of $102,679.04, representing advances made to Charles Hudson and to Galvin Hudson, administrator of the estate of Charles Hudson, since the advances were not made to these petitioners. The further contention is made *161 that there was no formal declaration of a dividend at any time and it is unreasonable to assume the declaration and payment of a dividend in the manner described, since petitioner Galvin Hudson had received no advances personally, and a distribution such as this, not being in proportion to ownership of the stock, would result in a loss to him personally of at least $10,000.
The last contention of the petitioners has been decided adversely to them in several cases. It is not necessary that a dividend be paid to the stockholders in proportion to their stock holdings. Lincoln National Bank, Executor,23 B.T.A. 1304">23 B.T.A. 1304; affd., 63 Fed.(2d) 131; Ida L. Dowling,13 B.T.A. 787">13 B.T.A. 787; *753 Joseph Goodnow & Co.,5 B.T.A. 1154">5 B.T.A. 1154. Neither is it necessary that a dividend be formally declared. Chattanooga Savings Bank v. Brewer, 17 Fed.(2d) 79; certiorari denied, 274 U.S. 751">274 U.S. 751; Security First National Bank of Los Angeles et al., Executor,28 B.T.A. 289">28 B.T.A. 289; Leo G. Hadley,6 B.T.A. 1031">6 B.T.A. 1031; affd., 36 Fed.(2d) 543.
It is also well settled that the cancellation of indebtedness of stockholders of a corporation is sufficient to constitute payment of a dividend. Moses Cohen,28 B.T.A. 190">28 B.T.A. 190; affd., 77 Fed.(2d) 184; certiorari denied, 296 U.S. 610">296 U.S. 610; Ennalls Waggaman,29 B.T.A. 473">29 B.T.A. 473; affd., 78 Fed.(2d) 721; certiorari denied, 296 U.S. 618">296 U.S. 618; Hugh H. Miller,25 B.T.A. 418">25 B.T.A. 418; Ida L. Dowling, supra;F. W. Fitch,27 B.T.A. 615">27 B.T.A. 615; affd., 70 Fed.(2d) 583. In the cases cited there was normal cancellation of the indebtedness of stockholders, while here the petitioners contend that there was no cancellation or release by the Hudson & Dugger Co. of the balances owing*754 by them.
Giving careful consideration to the resolution and to the action taken in connection therewith, we are unable to reach a conclusion other than that reached by the respondent. There is no question that on the accounts of the corporation, the stockholders were relieved of liability. Surplus was reduced by the amount of the debit balances and the stockholders were relieved of the charges therefor by credits to their accounts from surplus. This was regular and in order. The corporation had a distributable surplus and the directors had authority to order distribution. If the stockholders desired that surplus be used to relieve themselves of the charge for balances owing by them to the corporation, they were within their rights and there was no one to complain. These petitioners say, however, that while the action taken was in the form described, there was an understanding that they would repay the amounts with which they were credited. That understanding was expressed in the resolution to the effect that the company still owned its "equity" in the debit balances and at such time as might be "convenient and appropriate" proper settlement would be made. This understanding*755 *162 was not couched in terms ordinarily applicable to an agreement between debtor and creditor for payment of the debtor's account. Just what was meant by the equity of Hudson & Dugger Co. is conjectural, but the meaning of the remainder of the resolution relied on by the petitioners seems to us apparent and is that the stockholders, if and when "convenient and appropriate" to them, would restore the surplus so exhausted. There is nothing in this language which indicates that the debtor-creditor relationship was intended to continue.
The petitioners also rely on their subsequent action in 1931 and 1932 in surrendering stock of a par value equal to the amount of the debit balances. Consideration of the practical effect of the surrender of the stock and the occasion therefor gives little support to that argument. In the first place the resolution providing for the surrender of the stock shows on its face that one of the principal reasons for taking any action was the controversy with the Federal Government over the issues involved in these cases. Furthermore there is nothing to show that the actual value of the stock surrendered had any relation whatever to the amount*756 of the debit balances in satisfaction of which the said stock was surrendered. Keeping in mind the fact that the resolution of March 1, 1929, had, by its expressed terms, eliminated the stockholders' accounts from corporate assets, the surrender of the stock in 1931 and 1932 did not serve in any way to either increase or decrease the assets of the corporation, and except for a slight change of the proportions in which the stock was held, the position of the stockholders with reference to the corporation and its assets was not changed. It served only as an adjustment of the stock holdings between the members of the Hudson family.
With reference to the contention that the advances to Charles Hudson and to Galvin Hudson, as administrator, can not be considered as advances to these petitioners and a release thereof treated as a dividend to them, it is interesting to note that by their own argument as to the effect of the resolution of March 1, 1929, and of the surrender of stock in 1931 and 1932, the petitioners treat themselves as having been liable in equal proportions for the total amount of these advances. Furthermore, there is no doubt that they were actually liable therefor. *757 The amounts so advanced to Charles Hudson and to the administrator of his estate were liabilities of the estate, and the facts show that the only assets out of which these liabilities could have been satisfied were the shares of stock in Hudson & Dugger Co. The petitioners point out that this stock was distributed in 1926 by order of the probate court. Under the law of Tennessee, however, as in other states, a probate court is not permitted *163 to make a distribution of the assets of an estate without making provision for the payment of outstanding liabilities; and while it is true that under section 8335 of the Tennessee Code provision is made that surplus assets of an estate be distributed within 18 months after administration is granted, it is further provided in section 8336 that "every legatee and distributee, before receiving his portion of the decedent's estate, or some other for him, shall give bond with two or more sufficient sureties, or one corporate surety, in a penalty double the amount of his share, payable to the state, conditioned that if any debt or debts truly owing by the deceased shall be afterwards sued for and recovered or otherwise duly made to appear, *758 said legatee or distributee shall refund and pay his ratable part of such debt or debts out of the part or share so allotted to him." We may not assume that in making the distribution in this case the provisions of the law of Tennessee were not complied with. By accepting the distribution of the stock in 1926, the petitioners assume the liability for the debts of the estate to the extent of the stock so distributed, and a release of liability so incurred, in so far as the question in this case is concerned, is no different from a release of liability incurred as a result of advances made directly to the petitioners themselves.
Accordingly we conclude that the liabilities of the petitioners for the debit balances in question were released and canceled in the taxable year and hold that such release and cancellation was a dividend within the meaning of section 115(a), supra.
Reviewed by the Board.
Decision will be entered for the respondent.