*1507 The petitioner in the taxable year 1936 set aside for and paid to lessor certain rentals due in the following year and certain life insurance premiums provided for in a contract with the lessor. In the taxable year 1937 it set aside for and paid the balance of the rentals due in that year, and also set aside for and paid certain rentals due in 1938, and set aside for the lessor certain life insurance premiums. The contract, though executed prior to May 1, 1936, and requiring payment of rentals and insurance premiums, did not require either rentals or insurance premiums to be paid or irrevocably set aside from earnings or profits of the taxable years. Petitioner had other assets. Held, the petitioner was not entitled to credit under section 26(c)(2) of the Revenue Act of 1936.
*417 The above proceedings, duly consolidated, involve income tax in the amount of $11,887.69 in proceeding number 100296 for the year 1937 and in the amount of $10,484.38 in proceeding number 100297 for the year 1936. In the former*1508 proceeding petitioner claims overpayment of tax in the amount of $1,807.34.
The petitioner filed its Federal income and excess profits tax returns for 1936 and 1937 with the collector of internal revenue for the twenty-third collection district of Pennsylvania, at Pittsburgh, Pennsylvania.
FINDINGS OF FACT.In each proceeding a stipulation of facts was filed, and by reference we find the facts as so stipulated. We set forth the pertinent recitations thereof, involving both proceedings, as follows:
On or about March 30, 1936, and prior to May 1, 1936, a written contract and agreement was made, executed, and entered into by and between the petitioner, as party of the one part and The Colonial Trust Company, a corporation, as party of the other part. Said written agreement consists of a lease in which The Colonial Trust Company is trustee and lessor, and petitioner is lessee. Simultaneously, there was executed by The Colonial Trust Company a Declaration of Trust covering the same equipment mentioned and described in the above lease.
On or about March 30, 1936, petitioner made and executed a written "Consent and Acceptance" of the said Declaration of Trust whereby it consented*1509 to said Trust Agreement and agreed to be bound by its terms. Copies of said Lease, of *418 said Trust Agreement, and of said Consent and Acceptance, are attached to and made a part of the petition as Exhibit B thereto, and are by this reference made a part of this stipulation as if herein fully set out in detail.
The petitioner set aside for the said lessor the following amounts during the year 1936:
| (a) Equipment rentals applicable to 1936 paid to lessor on December 30, 1936 | $33,880.00 |
| (b) Amortized life insurance premiums paid in 1936 | 8,747.57 |
| 42,627.57 |
The payments to the trustee amounting to $33,880.00 made on December 30, 1936, were not due and payable until March 1, 1937.
The petitioner set aside for the said lessor the following amounts in and during 1937:
| Annual Equipment Rental due March 1, 1937 | $40,000.00 |
| Less: Payment December 30, 1936 | 33,880.00 |
| Payment February 25, 1937 | 6,120.00 |
| Payment on December 30, 1937 on account of March 1, 1938 rental | 42,328.77 |
| Annual Premium - Life Insurance | 9,514.00 |
| Total | 57,962.77 |
The payments to the trustee amounting to $42,328.77 made on December 30, 1937, were not due and payable*1510 until March 1, 1938.
The contracts referred to above were carried out at all times herein mentioned according to their terms without default of any kind.
The agreements referred to in the stipulation of facts and made a part thereof consisted of a lease executed February 29, 1936, from the Colonial Trust Co. to the petitioner, a declaration of trust as of the same date by the Colonial Trust Co., as trustee, and a "Consent and Acceptance" by the petitioner dated on or about the 30th day of March 1936. By the terms of the lease the petitioner leased from the Colonial Trust Co. certain river equipment for a term of 10 years, agreeing to pay as rental, semiannually, on August 25 and February 25 of each year (beginning on August 25, 1936) a sum equal to 2 1/4 percent of $600,000, the payment to be reduced by an amount equal to 2 1/4 percent of sums also to be paid on or before February 25 of the years shown below, to the lessor in reduction of the $600,000, as follows:
| 1937 | $40,000 |
| 1938 | 50,000 |
| 1939 | 60,000 |
| 1940 | 60,000 |
| 1941 | 65,000 |
| 1942 | $65,000 |
| 1943 | 65,000 |
| 1944 | 65,000 |
| 1945 | 65,000 |
| 1946 | 65,000 |
The lease further provided that the petitioner had the*1511 right to anticipate payment of the yearly rentals by giving 60 days' notice and paying a premium of 2 1/4 percent and certain costs; *419 that as and when demanded the petitioner would pay a sum equal to the annual premiums on a $200,000 life insurance policy on the life of its general manager; also the expenses of enforcing the lease; also fees to the lessor as trustee and to its counsel, and taxes upon the equipment leased. The lease also provided that at the end of the 10-year period and upon payment of all sums required by the lease, the petitioner as lessee should have the election to purchase the leased equipment for the sum of $10.
The declaration of trust by the Colonial Trust Co. above referred to, called "Campbell Transportation Company Equipment Trust," provided in substance that the $600,000 representing the purchase price of the river equipment leased should be secured from subscribers to trustee's certificates, in denominations of $1,000 each, bearing the same rate of interest to be paid by the petitioner under the lease, i.e., 4 1/2 percent per annum, and becoming due and payable in the same amounts and at the dates as the payments of interest and as above*1512 listed to be made by the petitioner upon the $600,000 purchase price. The petitioner guaranteed the payment of the principal and interest upon the trustee's certificates. The declaration of trust further provided for the $200,000 life insurance policy upon the life of petitioner's general manager, the premiums to be payable from sums paid in by the petitioner and the principal, in case of death, to be payable one-half to the petitioner and one-half to the trustee for the benefit of the certificate holders, the trustee to hold possession of the policy until payment of all certificates, and then assign it to the petitioner. Provision was further made that upon default by the petitioner the trustee might, and upon request of holders of 25 percent of the principal amount of the trust certificates should, take possession of the leased equipment, declare the principal of the trust certificates due and payable, and, if possession of the equipment be taken, hold or lease the equipment or dispose of same by sale and apply the proceeds to payment of the trust certificates. The lease was made a part of the declaration of trust.
The petitioner consented to and accepted, in writing, the*1513 terms of the declaration of trust, on or about March 30, 1936.
In addition to the stipulated facts, above found and summarized, there were placed in evidence the original and amended income and excess profits tax returns of the petitioner for the taxable years. We find therefrom the following material facts:
*420 Covering the period in question here, petitioner had assets and liabilities as follows:
| Jan. 1, 1936 | Dec. 31, 1936 | Dec. 31, 1937 | |
| ASSETS | |||
| Cash | $44,603.86 | $13,630.69 | $114,464.65 |
| Accounts receivable | 23,733.53 | 66,994.10 | 60,164.37 |
| Investments | 13,389.17 | 26,457.09 | |
| Deferred charges | 13,679.68 | 34,264.57 | 40,864.16 |
| Capital assets a | 501,443.26 | 1,089,007.86 | 1,097,133.59 |
| Other assets | 129,678.67 | 161,828.36 | 27,959.08 |
| Total assets | 713,139.00 | 1,379,114.75 | 1,367,042.94 |
| LIABILITIES | |||
| Notes payable | 270,000.00 | 111,587.50 | 118,856.78 |
| Accounts payable | 85,536.98 | 210,795.82 | 82,917.76 |
| Deferred income | 10,130.99 | ||
| Mortgages | 566,120.00 | 558,387.50 | |
| Accrued expenses | 15,943.34 | 3,925.08 | 5,252.55 |
| Other liabilities: | |||
| State income tax | 1,338.84 | 1,022.07 | |
| Deferred income | 10,130.99 | 29,206.91 | |
| Federal taxes and contingencies | 23,638.25 | 41,557.35 | 43,806.22 |
| Surplus | b 50,000.00 | 50,000.00 | |
| Undivided profits | 68,020.43 | c 133,659.17 | 227,593.15 |
| Capital stock (common) | 250,000.00 | 250,000.00 | 250,000.00 |
For the year 1936 dividends paid credit of $25,000 was claimed in petitioner's return; and appears not disallowed; for the year 1937 the same is true in the amount of $30,000.
OPINION.
DISNEY: The question here presented is whether the petitioner is entitled to credit under section 26(c)(2) of the Revenue Act of 1936, 1 for the amount of $33,880 set aside by the petitioner during 1936 and paid to the lessor on December 30, 1936 (though not due until March 1, 1937), as rental, and $8,747.57 set aside and paid in 1936 upon amortized life insurance premiums on the life of its general manager; and $6,120 rental set aside during 1937 and paid *421 February 25, 1937, $42,328.77 set aside as rental during 1937 and paid December 30, 1937, on account of rental due March 1, 1938, and $9,514 annual premium on the life insurance policy. In other words, the question is whether the contract, consisting*1515 of lease, declaration of trust, and acceptance thereof, constitutes a contract expressly dealing with the disposition of earnings and profits of the taxable years and requiring them to be paid or irrevocably set aside, within the taxable years, in discharge of a debt.
*1516 In these proceedings there is no dispute about the fact that the amounts were set aside, and were paid, nor that the contract was executed prior to the date required by statute.
The petitioner, citing , argues, in effect, that as an "eminently practical" matter of taxation it was, regardless of the absence from the contract of express words required by the statute, required to set aside and pay the rental on the dates due in order to keep its river equipment; that such river equipment was its source of income; that such income and the retention of the equipment depended on the making of the payments as due under the lease; that such payments were due on February 25 and August 25 of each year; that the only way "in all reasonable possibility" that the February 25 payment could be made was to accrue and set aside part of it before the close of the preceding calendar year (the petitioner being upon the calendar year basis) because its income from January 1 to February 25 was clearly insufficient for the payment; that it could not sell its equipment without violating the terms of the lease; and that it could not pay its earnings*1517 out in dividends. Petitioner points out that in , the express words "earnings and profits" are found not to be requisite and contends that, as in that case it was said that "the language of the assignments was certainly broad enough to include the taxable year 1936 and the parties have so construed the contract", so here the provision as to payment of rentals was broad enough to require the setting aside of current earnings to pay them, and that the parties here so construed the instant contract.
We are unable to agree with this contention. In the G. B. R. Oil Corporation case the language was considered sufficiently broad for the reason that all of the company's receipts from the property purchased, comprising the petitioner's total income, with the exception of $154, were required to be paid to the creditor. Obviously "all receipts" were properly considered to cover "earnings and profits." Here there is no requirement that any receipts, earnings, or profits be devoted to the payment of rentals under the lease, but we find merely an ordinary provision for payment of rentals. The petitioner had other assets with*1518 which the rentals might have been paid *422 and perhaps, at least in part, were paid. It had large assets on January 1, 1936, prior to the contract here involved, including cash of $44,603.86, more than the $33,880 set aside during 1936 and paid on December 30, 1936, and on December 31, 1936, still had $13,630.69. It is obvious that the $33,880 may have been paid, not with earnings or profits of 1936, but with such cash or with other assets on hand January 1, 1936, and not covered by the agreement here considered, and that the same is true of the payments on rental made in 1937. Moreover, there was under the agreement to requirement that any payment here involved (except possibly insurance hereinafter discussed) be made or amount irrevocably set aside during 1936; for, although the 2 1/4 percent interest due August 25, 1936, amounted to about $13,500, it is stipulated that the $33,880 paid December 30, 1936, was not due and payable until March 1, 1937. The mere fact of payment or setting aside of funds does not satisfy the terms, and we think the intent, of the statute. Unless it was required by the contract to be paid or irrevocably set aside, the petitioner*1519 would be free to elect whether to so treat its earnings or to pay dividends. Such is not the situation contemplated by the statute, which concerns itself, as we said in the G. B. R. Oil Corporation case, with contracts which "inevitably require in their performance a drawing on current earnings." (Italics supplied.) The use of the word "irrevocably" indicates that no election was intended to be within the taxpayer's power. We think it clear that here there was no such inevitable drain upon the current earnings or profits as to apply the statute, as to rental payments in 1936. That a payment was required to be made February 25, 1937, is not sufficient. Petitioner says its income in the interim was not sufficient to make the payment. If that were material, as we think it plainly is not, there is no evidence to that effect. The income during that period may have been much more than the payment to be met. The same thought applies to the payment which was due March 1, 1938, but accumulated and paid December 30, 1937.
As to the payments to provide life insurance upon the life of petitioner's general manager, under the agreement, we think the same general thought above expressed*1520 clearly applies - the contract did not require such expense to be from the earnings or profits of the years here involved, but only that they be, in some manner, paid. As to whether there was "a debt" to the extent (one-half) that the insurance was payable to the petitioner itself, and not the lessee, may well be questioned, but is not necessary of decision here, under our conclusion above. Moreover, since the agreement provided for payment of the amount of the insurance premiums only "as and when demanded", it seems clear that there is no contractual requirement that the amounts be paid in the taxable years here involved, and that the statute therefore does not *423 apply. We can discern no requirement that petitioner's earnings and profits during the taxable years be devoted to payment of insurance. Like the rental payments, the insurance was not payable from any particular fund. The petitioner's undivided profits of $68,020.43 on hand January 1, 1936, prior to the agreement here involved, as well as other assets then appearing, may have been applied either to insurance or rentals; certainly it could have been so utilized - which takes away the requirement or*1521 necessity of using current earnings or profits. During 1936 it appears that $50,000 was paid into surplus, since that amount of "paid in or capital surplus" appears on January 1, 1937, where none had appeared before. Moreover upon that date there was $133,659.17 earned surplus and undivided profits, as well as other assets above referred to. Payment therefrom in 1937 would not have been from current earnings or profits. This serves to emphasize the fact that throughout the taxable years here involved, though the petitioner was under a duty to make certain payments, there was neither express nor implied requirement that they be made from the earnings or profits of the taxable years. The creditor could not, we think, have prevented distribution of dividends. Its right was merely to payment, however made. Under all of the facts appearing herein, in our opinion there was not, in the contract involved, that requirement of use or irrevocable reservation of current earnings and profits which, within the intendment of the statute, forms the basis for the credit claimed. Therefore,
Decision will be entered for the respondent.
Footnotes
a. Machinery, equipment, furniture and fixtures, after deduction of reserve of $68,086.26 for depreciation on January 1, 1936; of $117,765.67 on December 31, 1936; and of $189,249.83 on December 31, 1937. ↩
b. Paid-in or capital surplus. ↩
c. Earned surplus and undivided profits. ↩
1. SEC. 26. CREDITS OF CORPORATIONS.
In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax -
* * *
(c) CONTRACTS RESTRICTING PAYMENT OF DIVIDENDS. -
* * *
(2) DISPOSITION OF PROFITS OF TAXABLE YEAR. - An amount equal to the portion of the earnings and profits of the taxable year which is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of the taxable year) to be paid within the taxable year in discharge of a debt, or to be irrevocable set aside within the taxable year for the discharge of a debt; to the extent that such amount has been so paid or set aside. For the purposes of this paragraph, a requirement to pay or set aside an amount equal to a percentage of earnings and profits shall be considered a requirement to pay or set aside such percentage of earnings and profits. As used in this paragraph, the word "debt" does not include a debt incurred after April 30, 1936. ↩