*2972 1. Where an employee who had contracted with the employer corporation to pay back purported salary payments at once for stock never received cash, but was transferred stock, held, under the 1921 Act, his income on account thereof was measured by the realizable market value of the stock.
2. Market value of stock received as compensation for services determined from evidence of sales, opinion testimony, and the condition of the employer corporation.
*437 These proceedings result from deficiencies asserted in income taxes for the years 1921 and 1922 in the amounts of $11,534.57 and $14,701.18, respectively, all of which is in controversy. The questions *438 raised as to both years are identical and the two appeals were consolidated for hearing and decision. Error is alleged in respondent's determination that under a contract of employment petitioner received cash payments rather than stock. Also, the extent to which such stock, if payment be held to have been made in that form, represented income is at issue.
FINDINGS OF FACT.
*2973 Petitioner is an individual citizen of the United States residing in Chicago, Ill. In 1915 an auto truck business which he founded was incorporated under the laws of Illinois as the Diamond T. Motor Car Co. In 1917 he entered into a contract with said company in which he agreed to act as its manager for a 5-year period beginning January 1, 1917. His compensation was to be measured by a percentage of the company earnings, the percentage being 10 per cent of the first $100,000 and increasing 5 per cent for each additional $50,000 until it reached 25 per cent for $200,000 or over.
The business was successful and expanded rapidly during the years following incorporation as is shown by the taxable income returned as follows:
| 1916 | $46,417.26 |
| 1917 | 115,439.42 |
| 1918 | 452,475.56 |
| 1919 | 427,531.35 |
In 1919, the company desired additional working capital for expansion. It was advised that petitioner's salary contract would render difficult the securing of new capital, and, as petitioner wished to acquire new stock to keep his holding in proportion, the parties on January 1, 1920, entered into the following contract:
WHEREAS, under date of February 12, A.D. 1917, *2974 a certain agreement was entered into by and between the parties hereto whereby the party of the first part for a stated compensation employed the party of the second part as General Manager for a term of five years and whereby the party of the second part agree to perform certain specified services as Manager of the party of the first part; and
WHEREAS, the parties to the said agreement now propose to terminate the said contract of employment and to substitute in its place a new agreement; and
WHEREAS, it is desired that of the payments herein required to be made to the said Manager, the sum of one hundred thousand dollars ($100,000) shall immediately upon such payments being made be invested in the Common Stock of the Company:
NOW, THEREFORE, in consideration of the mutual covenants, promises and agreements hereinafter expressed, the parties hereto covenant, promise and agree as follows:
1: The aforesaid contract of employment of February 12, 1917, is hereby rescinded and cancelled on condition, and only on condition, that the parties hereto shall make and execute a new contract of employment for the period of *439 five (5) years commencing January 1, 1920, on substantially*2975 the same terms and conditions contained in a certain draft of such new contract this day tentatively agreed upon, a copy of which draft is hereto attached for identification. If such new contract of employment is not executed the old contract shall remain in full force and effect until it expires by its own limitations.
2: Prior to , 1920, the Company shall issue to PERCY B. ECKHART, as Trustee, for the uses and purposes hereinafter mentioned, five hundred seventy-one (571) shares of the Company's Common Stock of the present par value of one hundred dollars ( $100) per share, or, if prior to said date the Common Stock shall be changed to stock of no par value, then the Company shall issue six (6) shares of such nonpar value stock in place of each share of one hundred dollars ( $100) par value stock required by this agreement.
3: Prior to March 1, 1920, the said Manager shall cause two (2) policies (or combination of policies) of life insurance on his life in the amount of fifty thousand dollars ($50,000) each, in insurance companies to be approved by the directors of the Company, to be made payable to Percy B. Eckhart as Trustee, and delivered to said Trustee, for the uses and*2976 purposes hereinafter specified. One of the said policies (or combination of policies) hereinafter referred to as Policy Number 1, shall require the insurance company in the event of the death of said Manager prior to January 1, 1921, to pay to said Trustee the sum of fifty thousand dollars ($50,000) of insurance. The other insurance policy (or combination of policies), hereinafter referred to as Policy Number 2, shall require the insurance company in the event of the death of said Manager prior to January 1, 1922, to pay to the said Trustee the sum of fifty thousand dollars ($50,000) of insurance in addition to the amount payable on Policy Number One (1).
In the event of the death of said Manager prior to January 1, 1922, the said Trustee shall forthwith collect such insurance money from the insurance company or companies and distribute the same as hereinafter provided.
4: The Company covenants and promises to make the following payments to the said Manager:
(a) The company shall pay the sum of twenty-five thousand seventy-five dollars ($25,075) in cash when and as it may be thereunto requested by the said Manager.
(b) In the event that the said new contract of employment*2977 to be executed between the parties hereto shall not have terminated prior to January 1, 1921, or shall have terminated prior thereto because of the death of said Manager, then the Company shall on February 1, 1921, pay to said Manager the further sum of forty-nine thousand nine hundred twenty-five dollars ($49,925) under this contract. Upon such payment being made to the said Manager the said Manager shall at once pay the whole amount back to the Company to apply to the purchase of two hundred eighty-five and two-sevenths (285 2/7) shares of the Common stock in the hands of the said Trustee of the par value of one hundred dollars ( $100) each.
(c) In the event that the said new contract of employment to be executed between the parties hereto shall not have terminated prior to December 31, 1921, then the Company shall on February 1, 1922, pay to said Manager the further sum of forty thousand dollars ($50,000) under this contract. Upon such payment being made to the said Manager the said Manager shall at once pay the whole amount back to the Company to apply to the purchase of two hundred eighty-five and five-sevenths (285 5/7) shares of the Common stock in the hands of the said*2978 Trustee of the par value of one hundred dollars ( $100) each.
*440 5: In the event of the termination of the new employment contract between the said Company and the said Manager prior to January 1, 1921, for any reason other than the death of the said Manager, then the said Manager, his administrators, representatives or assigns shall on February 1, 1921, pay to the said Company the sum of forty-nine thousand nine hundred twenty-five dollars ($49,925) and the said Trustee, upon notification by the Company that the said amount has been paid, shall thereupon transfer to the said Manager, his administrators, representatives, or assigns, two hundred eighty-five and two-sevenths (285 2/7) shares of the stock issued to such Trustee as aforesaid, with all dividends or income paid to and received by such Trustee upon the said two hundred eighty-five and two-sevenths (285 2/7) shares, less a proportionate amount of all taxes, charges and other expenses incurred by said Trustee in connection with said trust.
6: In the event of the death of said Manager prior to January 1, 1921, the said Trustee shall forthwith collect from the insurance company or companies all the insurance money*2979 due on Policy Number 1 and Policy Number 2, and shall pay therefrom to the Company the sum of ninety-nine thousand nine hundred twenty-five dollars ($99,925). After such payment the said Trustee shall transfer to the administrators, representatives or assigns of said Manager the five hundred seventy-one (571) shares of stock together with all dividends and income received thereon by the said Trustee after deducting therefrom all taxes, charges and all other expenses incurred by him under said trust.
In the event that the said new contract of employment shall not have been terminated prior to January 1, 1921, the said trustee shall transfer said Policy Number 1 back to the said Manager. In such event the said Trustee shall on February 1, 1921, transfer two hundred eighty-five and two-sevenths (285 2/7) shares of the aforesaid stock and pay over all the dividends and income he may have received upon such two hundred eighty-five and two-sevenths (285 2/7) shares, less a proportionate amount of all taxes, charges and other expenses incurred by him in connection with the trust, to the said Manager, his administrators, representatives or assigns; provided that said Manager, his administrators, *2980 representatives or assigns shall first have paid over to the Company the sum of forty-nine thousand nine hundred twenty-five dollars ($49,925) as required in paragraph 4 hereof.
7: In the event of the death of the said Manager during the year 1921, the said Trustee shall forthwith collect from the insurance company or companies the insurance money due on Policy Number 2 and shall therefrom pay over to the Company the amount by which fifty thousand dollars ($50,000) exceeds the sum payable to said Manager under Paragraph 8 hereof for the year 1921, and pay the balance of such insurance money over to the administrators, representatives or assigns of the said Manager; and shall transfer to such administrators, representatives or assigns two hundred eighty-five and five-sevenths (285 5/7) shares of the stock issued to said Trustee as aforesaid and also pay over to said administrators, representatives or assigns all the dividends and income received by said Trustee thereon after deducting from such amount all taxes, charges and other expenses in connection with the said trust.
The balance of any such insurance money not hereby required to be paid to the Company, shall be paid over*2981 to the administrators, representatives or assigns of said Manager. If the said Manager shall survive December 31, 1921, the said Trustee shall hold or transfer such policies in such manner and to such person as the said Manager may direct.
*441 8: (a) In the event that the said new contract of employment shall for any reason other than the death of said Manager be terminated prior to January 1, 1921, the said Company shall on February 1, 1921, pay to the said Manager, or to his personal representative or assign, in the manner provided in Paragraph No. 7 hereof, such preparation of the sum of forty-nine thousand nine hundred twenty-five dollars ($49,925) then due as that portion of the year 1920 preceding the termination of the contract shall bear to the whole year; which said sum shall be paid back by the Manager, his representative or assign, as part of the sum of forty-nine thousand nine hundred twenty-five dollars ($49,925) required to be paid to the Company under Paragraph 5 hereof for the stock issued in the name of the Trustee.
(b) In the event that the said new contract of employment shall for any reason be terminated during the year 1921, and prior to December 31, 1921, the*2982 said Company shall on February 1, 1922, pay to the said Manager, or to his personal representative or assign, as provided in Paragraph No. 7 hereof, such proportion of the fifty thousand dollars ($50,000) then due as the portion of the year 1921 preceding the termination of the contract shall bear to the whole year; which said sum shall be invested in the stock of the Company and together with that portion of the insurance money required to be paid to the Company under Paragraph 7 shall equal fifty thousand dollars ($50,000.)
9: Upon payment to the manager, his administrators, representatives or assigns, of each of the sums required in Clauses "b" and "c" respectively of Paragraph 4 hereof, the said Manager, his administrators, representatives or assigns, shall immediately invest such sums and pay the same over to the Company for the Common Stock issued to and held by Percy B. Eckhart as Trustee, paying for the said stock at its present book value of one hundred seventy-five ( $175) dollars per share.
10: It is further covenanted, understood and agreed that in the event of the change of the present common stock of the par value of one hundred dollars ( $100) per share to stock*2983 of no par value, six (6) shares of such new non-par value stock shall stand in the place of and be considered the equivalent of each one (1) share of common stock of the par value of one hundred dollars ( $100) per share wherever such par value common stock is referred to herein.
Another employment contract was entered into at about the same time. By its terms petitioner agreed to manage the company for five years from January 1, 1920, for a specified compensation of $30,000 for the first two years, $35,000 for the third year, and $40,000 for each of the last two years, plus percentages of the net income amounting to 5 per cent of the first $500,000, 4 per cent on the next $250,000, 3 per cent on the next $250,000, 2 per cent on income between $1,000,000 and $1,500,000 and 1 per cent of all in excess of $1,500,000. Other provisions permitted the petitioner to be removed upon three months' notice for incapacity, and provided for proportionate compensation for any portion of a year of employment.
In entering into the above quoted contract the parties thereto considered such contract as entitling petitioner to $25,075 in cash and 571 shares of common stock. The stock was issued*2984 to the trustee as agreed. On April 1, 1920, pursuant to a refinancing plan, this stock was exchanged by the trustee for 3,426 shares of no par value stock *442 at the rate of six of the new for each of the old shares. Petitioner continued in the employ of the company throughout the period in controversy. No payments as provided by the formal terms of the contract were ever made to petitioner to be invested by him in such stock. The stock was transferred to him. Record transfers of 1,711 and 1,715 shares on February 1 of 1921 and 1922, respectively, were made to him from the trustee.
The books and returns of the petitioner for the years 1921 and 1922 were kept and made upon the basis of the cash receipts and disbursements methods of accounting. The commissioner determined that his taxable net income for 1921 and 1922 should be increased in the amounts of $49,904.26 and $50,000, respectively.
On January 1, 1920, the old $100 par value stock of the company had a fair market value of $175 per share. On April 1, 1920, the new no par value stock was subscribed for at $29 per share.
At the beginning of the year 1920 the business of the company had excellent prospects, *2985 which continued until the latter part of May, 1920. About that time a rapid change took place. Expansion continued for some sixty days thereafter but business dropped off almost immediately. Few failures resulted during the remainder of 1920, but approximately 50 per cent of such enterprises failed during the two subsequent years. Motor truck companies were trying to get on a national production basis. Efforts to stem the adverse business tide resulted in unusual advertising expenditures. In keeping with this trend in the industry petitioner's advertising expenditures were extraordinarily large during such time.
The company's prospects on February 1 of 1921 and 1922 were very poor. Considerable overproduction led to sales below cost. It had sustained operating losses in excess of $197,000 for the year 1920 and the losses for the years 1921 and 1922, as reported on income-tax returns for those years, were $435,106.33 and $344,495.59, respectively. Some of the company's stockholders suggested liquidation. Its properties could only have been disposed of at a great sacrifice, if at all.
The company's stock had always been closely held by comparatively few stockholders, *2986 never having been listed on any exchange. The only sales of stock taking place about the period in question were:
| Date | Vendor | Purchaser | Number of shares | Price per share |
| Dec. 8, 1920 | J. G. Theurer | F. J. Birk | 1,000 | $10.00 |
| Dec. 31, 1920 | C. A. Tilt | C. J. Bush | 172 | 10.00 |
| Mar. 1, 1921 | J. G. Theurer | L. F. Bryant | 40 | 12.50 |
*443 Though there was no agreement not to sell stock to other than stockholders, the only market existing was among stockholders. J. G. Theurer was an employee and prior to such sales, owned 3,196 shares of stock. Tilt, the petitioner, sold 172 shares of his holdings at what he considered their then worth. Carl J. Bush was the sales manager and had, theretofore, owned no stock. Birk and Bryant were small stockholders not in the company's employ.
The fair market value of the stock received by petitioner did not exceed $10 per share at the date of receipt.
OPINION.
SIEFKIN: In view of the considerations that prompted the substitution of the two new contracts for the old one, the prior intent of the parties as shown by testimony and their interpretation of the terms of the contract raising the question presented, *2987 as well as the provisions of the contract itself, we find little difficulty in holding the contract in question primarily a contract of employment supplementing the other new contract, which dealt more specifically with the actual terms of employment. The parties to this proceeding do not urge any other interpretation of the contract. The only controversial point, as regards the contract, is whether the income petitioner received thereunder was cash or stock.
The contention that petitioner received cash is not persuasive. Even if entitled to cash he was required by the terms of the contract to pay it back for stock. The substance of a contract prevails over its form; ; . In , we said:
The method and manner adapted by the bank to pay the stock dividend by issuing its check in favor of the petitioner "stock dividend check" * * * was merely a matter of form and did not affect the substance of the matter.
In one important particular this case differs from those cited. In the cases cited the form prescribed by the several agreements*2988 was followed in their execution. In the instant case the parties to the contract made no pretense of acting in accordance with the terms of the instrument. Petitioner received stock without any intervening gestures as to cash payment. We think such fact conclusive against the respondent's contention. We have no concern with the abstract legal rights of petitioner under the contract. He was content to take stock which was all he considered himself entitled to receive. Being on the cash basis, he can not be taxed on any income not actually or constructively received, as the income-tax law operates only on income as it finds it.
There remains the question as to the extent the stock represented income. Stock received as compensation, under the Revenue Act of *444 1921, is measured in income by the readily realizable market value thereof at the time received. ; . From the evidence of sales of stock, and the precarious financial position of the company at the respective dates, we have found the market value did not exceed $10 per share on the dates received. Respondent argues that*2989 the sale of 40 shares on March 1, 1921, indicates the shares exceeded the value found, and, when compared with the prior sales at $10 per share, show a trend upward in market values. This contention is rebutted by the continued operating losses of the company, the general trend of the industry, and lack of knowledge on the part of the buyer. We think such facts are entitled to greater weight than the sale of such a small block of stock.
Reviewed by the Board.
Judgment will be entered under Rule 50.