*1 Decision will be entered under Rule 50.
1. Petitioner, a corporation which in its inception was not organized for profit, constructed approximately 100 houses and leased them to a milling company at a rental sufficient to amortize petitioner's indebtedness and to pay 6 percent per annum on its outstanding certificates of beneficial ownership. Held, petitioner is not exempt from tax under section 101 (7) or (8) of the 1936 Act and corresponding sections of the 1934 and 1932 Acts; held, further, petitioner was not engaged in carrying on or doing business during the years 1933 to 1936, inclusive.
2. Payments to certificate holders designated interest held not deductible as interest paid, inasmuch as the certificates were not evidences of indebtedness.
*378 The Commissioner determined deficiencies in income tax and excess profits tax, together with penalties for failure to file returns within the time prescribed by law, as follows:
| Income tax | Excess profits tax | |||
| Year | ||||
| Deficiency | Penalty | Deficiency | Penalty | |
| 1932 | $ 640.74 | $ 160.19 | ||
| 1933 | 177.05 | 44.26 | $ 64.38 | $ 16.10 |
| 1934 | 2,327.44 | 581.86 | 846.34 | 211.59 |
| 1935 | 4,339.50 | 1,084.88 | 1,578.00 | 394.50 |
| 1936 | 1,080.68 | 270.17 | 882.33 | 220.58 |
*2 *379 The principal issue is whether petitioner is exempt from taxation under section 103 (7) or (8) of the Revenue Act of 1932 and section 101 (7) or (8) of the Revenue Acts of 1934 and 1936. If petitioner is not exempt, the alternative issues are (1) whether it was carrying on or doing business during the years 1933 to 1936, inclusive, and (2) whether amounts paid as interest upon certificates of beneficial ownership are deductible as interest paid, or in reality constituted dividends.
FINDINGS OF FACT.
Petitioner is a corporation, with its principal office in Dyersburg, Tennessee. No returns for the periods here involved were filed.
During the year 1926 certain business men and other individuals in the city of Dyersburg were desirous of inducing industry to locate in Dyersburg or its vicinity in order to relieve an unemployment problem which then existed. The Civic Club of Dyersburg was interested in the project, and a committee of five individuals conducted preliminary negotiations with certain cotton milling companies in Michigan and New York. After a tentative agreement was reached, and to accomplish the purpose of procuring industry to locate in Dyersburg, petitioner*3 was incorporated under the laws of Tennessee on November 27, 1926. The charter provided that the general welfare of society, not individual profit, was the object for which the charter was granted, and the members were not stockholders in the legal sense of the term and no dividends or profits should be divided among the members. Petitioner was incorporated, as stated in the charter, "for the purpose of encouraging, inducing, and contracting with industrial institutions to locate in the Town of Dyersburg, or the immediate vicinity thereof, to raise the necessary funds by such means as they may deem wise, and to disburse said funds so raised by gift, purchase of stock or loan to any such industry, and for the general welfare of the community."
The general powers of the corporation were to sue and be sued, use a common seal, establish bylaws, acquire and sell personal property and real estate necessary for the transaction of its business, and appoint subordinate officers and agents. The board of directors was granted the power to elect other members, who, upon acceptance of membership, were to become corporators equal with the original corporators; and the board of directors was *4 granted the further power to determine the amount of money required to be paid for membership, whether to be paid in a lump sum or annually, and failure to pay such amount would justify expulsion of a defaulting member in the discretion of the board of directors. In all elections each member was to be entitled to one vote. The corporation could be voluntarily dissolved by the members by a conveyance of its assets to another corporation not organized for individual profit; and the corporation was subject *380 to dissolution at the instance of the state upon violation of any provision of its charter.
On March 22, 1928, a contract was executed between petitioner and cotton milling companies whose plants were then located in Michigan and New York, whereby the latter agreed to locate their plants in Dyersburg on a site to be donated by petitioner, and petitioner agreed to pay to the companies the amount of $ 100,000 to defray expenses involved in moving. In addition, the milling companies received assurances that their plants would be relieved of city and county taxes for a period of 10 years. Petitioner's expenses in negotiating the contract, including railroad fares to Michigan*5 and New York, were borne by the individuals who were acting in behalf of petitioner. Performance of the contract on the part of petitioner was guaranteed by 47 individuals of Dyersburg.
The parties connected with the cotton mills subsequently formed a corporation known as the Dyersburg Cotton Products Co. Petitioner acquired a tract of land of approximately 100 acres, and in order to raise cash funds proceeded to sell undivided interests in the land on the basis of $ 300 per unit. The purchasers of the undivided interests in the land allowed title to remain in the name of petitioner. Many of the subscribers considered that they were making donations to a civic cause. On April 13, 1928, certain of the purchasers entered into a "lot-pool agreement" which recited that they had purchased lots in the addition of the Industrial Addition Association; and they agreed to pool the number of lots set opposite their names and to "pay for the number of lots set opposite our names at the rate of $ 300 per lot and after a certain portion of land is set apart so as to divide 100 lots, said land so set apart not to exceed 25 acres, we hereby agree to permit the title to said lots to remain in*6 the Industrial Addition Association and will permit the said association or corporation to borrow money on the strength of said title * * * and execute a mortgage upon said lots to secure the necessary funds with which to erect 100 houses * * *." The agreement also provided that the houses so built by petitioner would be rented to the employees of the milling company or other suitable persons, and that the rents collected would be used to discharge the mortgage indebtedness. It was further agreed that petitioner's officers would have the right to sell any or all of the houses and lots and to use the proceeds to discharge the mortgage indebtedness and to divide any excess proceeds arising from such sale "among the undersigned certificate holders in proportion to the number of certificates held by each of them."
On September 5, 1928, an agreement supplemental to that of March 22, 1928, between petitioner and the milling company was executed whereby petitioner agreed to construct upon lots belonging to it or to its members adjacent to the mill site 100 dwellings houses and to rent *381 all of the houses to the company. The milling company agreed to rent all of the houses from *7 petitioner at a rental charge which would yield to petitioner a net return of 6 percent per annum on its investment, and it further agreed to maintain the houses in a reasonable state of repair. The contract granted the milling company the option to purchase the houses at any time within 10 years at actual cost of construction plus the value of each lot.
In order to procure funds for the construction of the houses petitioner sold first mortgage 6 percent bonds dated February 1, 1929, having an aggregate principal of $ 75,000, for $ 67,500. On February 1, 1929, petitioner leased the lots which were the subject of the "lot-pool agreement" to the Dyersburg Cotton Products Co., and obligated itself in the lease to erect on the leased premises 95 dwelling houses and to deliver possession thereof to the lessee. As rent, the lessee agreed to pay "the lessor, or its assigns, or as otherwise directed in said mortgage" amounts sufficient to discharge the interest and principal of the $ 75,000 mortgage, and, in addition, to pay to the holders of petitioner's certificates of beneficial ownership the sum of 6 percent per annum on the face value of such certificates. The lessee further agreed*8 to pay all assessments, taxes, and insurance. The lease was for a period of 13 years from February 1, 1929, to January 31, 1942, and the lessee was granted the option to renew for a period of five years, that is, to January 31, 1947, upon the same terms and conditions, except that the rental during the renewal period was to be an amount to net petitioner or the holders of its ownership certificates then outstanding 6 percent per annum on the value of the leased land, exclusive of buildings and improvements. For the purposes of the lease the value of the leased premises, exclusive of buildings and improvements, was determined and agreed to be $ 300 per lot. The lessee was also granted the option to purchase the leased premises, together with the buildings and improvements thereon, at any time during the term of the lease or renewal thereof by the payment or assumption of any balance remaining due on the mortgage, principal or interest, plus the payment of the sum of $ 300 per lot to each of petitioner's certificate holders and any accumulated interest thereon, and the payment of any remaining balance of an amount of $ 9,650 due by the lessee to petitioner.
The interest of a subscriber*9 to the lot-pool agreement was represented by a certificate issued by petitioner upon the payment of $ 300 per lot. The back of the certificate carried the words "Certificate for Shares of the Capital Stock of Industrial Addition Association." It certified that the holder was the beneficial owner of a $ 300 undivided interest in certain lots (which were the lots leased to the Dyersburg Cotton Products Co.), subject, however, to the terms and conditions of the mortgage in the amount of $ 75,000 and subject also to the terms and provisions of the lease to the Dyersburg Cotton *382 Products Co. The certificate provided that so long as it remained outstanding the holder was entitled, by virtue of said lease, to demand and receive from the Dyersburg Cotton Products Co. simple interest at the rate of 6 percent per annum upon the principal amount of the certificate from the date thereof to the date of the termination of the lease or any renewal thereof, unless the lease was sooner terminated under the provisions thereof or by mutual consent. The certificate also provided that the holder would, upon demand, surrender the same to petitioner for cancellation upon payment to the holder*10 of the principal amount of the certificate plus interest then accrued and unpaid, whereupon the beneficial interest of the holder in the lots should cease. The certificates were transferable on the books of petitioner.
Such certificates were issued by petitioner in the aggregate amount of $ 30,000 under date of July 1, 1929. The following amounts were paid in the respective years 1932 to 1936, inclusive, in accordance with the provisions of the certificates, described therein as simple interest at the rate of 6 percent per annum: $ 1,125, $ 2,061, $ 3,537, $ 1,827, and $ 1,863.
In accordance with the terms of the lease the Dyersburg Cotton Products Co. rented the houses to its employees and paid to or for petitioner amounts to cover both interest and principal upon the mortgage and also interest on the certificates of beneficial ownership. All of these payments were made directly by the lessee to the mortgagee or to the certificate holders. On January 28, 1942, the lessee exercised its option to renew the lease for the period of five additional years. The mortgage had been entirely paid by that time, so that the only rental to be paid by the lessee was $ 1,800 per year, representing*11 6 percent interest on the outstanding $ 30,000 face value of certificates.
No compensation or payment for services of any kind was ever made by petitioner. Its officers and directors and the lawyer who prepared the legal papers for petitioner all donated their services. No financial statements have ever been prepared by petitioner. There were no meetings of any kind held by petitioner after 1929, inasmuch as the purpose of its organization had been accomplished, and no permanent books of record were kept except a minute book containing the subscriptions to petitioner. No corporate business was transacted during the taxable years. Petitioner was not carrying on or doing business during the years 1933 through 1936.
The parties have stipulated that petitioner is entitled to the following deductions which were not allowed in the notice of deficiency: interest paid, $ 165.71 and $ 102.78 for the years 1932 and 1933, respectively; taxes paid, $ 211.40 for 1934; and amortization of bond discount, *383 the amounts of $ 882.35, $ 801.37, $ 713.24, $ 625, and $ 536.76, respectively, for the years 1932 to 1936, inclusive.
OPINION.
Petitioner claims to be exempt from tax under subsection*12 (7) or (8) of section 101 of the Revenue Act of 1936 and corresponding provisions of the 1932 and 1934 Acts. The two subsections, which were reenacted without change in each of the three acts, are set forth below. 1 Petitioner asserts that its position is generally supported by either or both of these subsections, though it does not state with clarity which provision governs the particular facts presented here.
*13 Two factors must appear as a prerequisite to exemption under either paragraph. One of these is common to both, namely, that the corporation must not have been organized for profit. To fall within subdivision (7) it must further appear that no part of the net earnings inures to the benefit of any private shareholder or individual; and subdivision (8) requires that the civic organization be operated exclusively for the promotion of social welfare.
We think it clear in the instant case that in its inception petitioner was not organized for profit, but rather was a civic enterprise designed to meet a community problem. Its purpose was to induce industry to locate in Dyersburg and there was no intent to conduct a business for the benefit of private individuals. To secure the necessary funds to accomplish that purpose, instead of merely asking for donations, it acquired a large tract of land and proceeded to sell undivided interests therein.
Incidental to the main plan there was a need to furnish sufficient dwellings to house the employees of the milling company. For this purpose certain of the individuals who had purchased undivided interests in the land pooled their interests and, *14 by agreement among themselves and with petitioner, authorized petitioner to construct houses on lots represented by such interests, which were leased to the milling company and by it to the employees. In return, these individuals received certificates from petitioner entitling them to 6 percent *384 on their investment. The certificates, if called, were redeemable at face value, and the lease granted the lessee the option to purchase the houses and lots by discharging the mortgage incurred to erect the houses and by paying the certificate holders the face amount of their certificates plus accrued interest. The lot-pool agreement specified that petitioners could sell the houses and lots, in which event the proceeds of sale in excess of the amount of the mortgage were to be divided among the certificate holders.
When petitioner thus subdivided some of its property and erected houses thereon with a view to renting them, it projected itself into a business of a kind that is ordinarily carried on privately for profit. It entered a competitive field. In these circumstances, to enjoy the advantage of tax exemption it must demonstrate that it falls strictly within one of the favored*15 classifications. ; ; ; .
We think it has failed to do so. The premises were rented at a sum sufficient to discharge petitioner's indebtedness and to return to the certificate holders 6 percent per annum on their investment. The 6 percent payments concededly represented a part of petitioner's earnings, and obviously inured to the benefit of private shareholders or individuals. Exemption under subsection (7) must consequently be denied.
Nor do we think it can be said that a company is operated exclusively for the promotion of social welfare where, however laudable its aims, a portion of its profits is paid to investors and there is, in addition, a possibility of a distribution to them of the net proceeds from the sale of its assets. Petitioner appears to rest its argument upon the proposition that exemption is*16 allowable if the certificate holders were entitled only to a return of their investment plus interest in the meantime. It states that the holders "were willing to risk their own money with the possible chance of receiving their principal back with interest, and no more." But we think the exemption would have to be denied even if the certificate holders could receive only a return of their investment plus interest. We denied exemption in ; affd. per curiam, , to limited dividend housing corporations the stockholders of which could not sell their stock for more than par plus accrued dividends and, upon dissolution, could receive no more than par plus accrued dividends, the balance to be paid to the state. Dividends in that case could not exceed 6 percent per annum. In declining to follow the opinion of the Seventh Circuit in , upon which the present petitioner relies, we said:
* * * The provision for 6 per cent on the stock was deliberately designed to encourage*17 the use of private capital * * *. * * * The corporations during the taxable years * * * were operated in such a way as to permit the payment of dividends on the preferred shares. * * * Each was organized in part for profit, even though the profit was limited, and neither was operated exclusively for the promotion of social welfare.
We see no merit in petitioner's contention that the certificate holders were merely creditors who had no right to vote or take part in the management of its affairs. Whether they were creditors or investors depends upon whether the real transaction, as intended by the parties, was an investment in the corporation or a loan to it. ; affd., . There can be no question but that the certificates involved here did not evidence debts. Neither they nor the lot-pool agreement contained any promise on petitioner's part to repay the principal amount of $ 300. Even the right to receive the so-called interest was to cease upon termination of the lease, although the certificates might then remain outstanding. "There is, thus, an entire absence here*18 of the most significant, if not the essential feature of a debtor and creditor as opposed to a stockholder relationship, the existence of a fixed maturity for the principal sum with the right to force payment of the sum as a debt in the event of default." ; . We think it clear that petitioner's subscribers, whether they pooled their interests or not, constituted its members; but even if the certificates carried no voting rights, that fact would not be decisive. "Preferred stock is frequently issued without such rights." . Some of the subscribers testified that they regarded their payments as donations, and petitioner states on brief that while interest has been paid, "little if anything of the $ 300 subscription [was] ever expected to be returned." Thus, both the form and the intent negative the creation of a debt.
Petitioner places much reliance upon the fact that it was organized under provisions of the Tennessee Code relating *19 to nonprofit corporations and that its charter prohibited the distribution of dividends. It is well settled, however, that these factors are not determinative. We said in :
* * * The fact that the corporation was organized under the state laws relating to nonprofit corporations and the officers had no intention to conduct its operations at a profit is less important than its actual operations. * * *
We conclude that respondent correctly determined that petitioner is not entitled to the exemption it seeks.
*386 On the second issue, however, we are satisfied that during the years 1933 to 1936, inclusive, petitioner was not carrying on or doing business and therefore is not subject to the excess profits tax. The record establishes that petitioner's primary aim had been accomplished by the end of 1929. Industry had been located in Dyersburg; petitioner had rented the houses and lots for a period of 13 and possibly 18 years; the lessee had assumed the burdens of management and repair of the premises, including the payment of taxes and insurance; and the rental did not even pass through petitioner's*20 hands, but was paid directly by the lessee to petitioner's creditor and certificate holders. No meetings of any kind were held, no records were kept, no compensation for services was paid, and, so far as appears, no corporate business of any kind was transacted. On this issue petitioner is sustained. ; ; dismissed on stipulation, ; ; ; .
The remaining issue is whether the 6 percent payments to the holders of certificates may be deducted as interest paid. We have already stated our conclusion that the certificates were not evidences of indebtedness. The payments, therefore, may not be deducted as interest paid upon indebtedness.
Since*21 petitioner failed to file returns, and there is no showing of reasonable cause for such failure, it is liable for the penalty imposed by section 291 of the applicable revenue acts. See .
Decision will be entered under Rule 50.
Footnotes
1. SEC. 101. EXEMPTIONS FROM TAX ON CORPORATIONS.
The following organizations shall be exempt from taxation under this title --
* * * *
(7) Business leagues, chambers of commerce, real-estate boards, or boards of trade, not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual;
(8) Civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare, or local associations of employees, the membership of which is limited to the employees of a designated person or persons in a particular municipality, and the net earnings of which are devoted exclusively to charitable, educational, or recreational purposes;
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