*2062 Where a corporation agreed to purchase one-fourth of all certain stock deposited in escrow and by the same agreement was given options to purchase one-fourth of such stock in each of the three succeeding years at increased prices, and where it was provided that if the corporation failed to exercise its option and pay for the stock in any one of said years, the corporation would forfeit all it had paid, held that the excesses of the deferred payments over the cash payment did not constitute interest deductible under section 234(a)(2) of the Revenue Act of 1921.
*651 This proceeding involves a deficiency in income tax for the fiscal year ending March 31, 1923, in the sum of $35,112.53. The error alleged is that respondent has included in the gross income of petitioner three-fourths of the sum of $34,937.50 and the further sum of $54,437.50, both of which amounts are deductible as interest paid. *652 The facts were stipulated and from the stipulation and exhibits filed therewith we make the following findings of*2063 fact.
FINDINGS OF FACT.
Petitioner is a corporation organized under the laws of North Carolina, with its principal office at Caroleen.
On March 16, 1920, J. C. Plonk, R. P. Roberts, and J. A. Carroll, as parties of the first part; petitioner, together with W. S. Forbes and E. B. Springs, parties of the second part; and John A. Miller, Jr., as party of the third part entered into a written contract, the material parts of which read:
The parties of the first part on behalf of themselves and others, for and in consideration of the sum of Ten ($10.00) Dollars, cash in hand to them paid by the parties of the second part, receipt whereof is hereby acknowledged, agree to sell to the parties of the second part, who hereby agree to buy, subject to the terms and conditions hereinafter set forth, Twenty Five (25%) per cent of a majority of all of the outstanding stock of the CHEROKEE FALLS MANUFACTURING COMPANY, of Cherokee Falls, South Carolina, together with an option to purchase the remaining Seventy Five (75%) per cent of said majority of said stock as follows:
1. The parties of the first part agree to deposit with the said party of the third part, on or before the 1st day of*2064 April, 1920 Fifty One (51%) per cent or more of the entire outstanding Capital Stock of the said Cherokee Falls Manufacturing Company, with the privilege of depositing for their own account, or for the account of others, with the said party of the third part, on or before the 1st day of July, 1920 any or all of the remaining outstanding Capital Stock of the said Cherokee Falls Manufacturing Company, and the said parties of the second part agree to buy out-right Twenty five (25%) per cent of all of the stock of the said Company so deposited with the said party of the third part together with an option to buy the remaining Seventy , five (75%) per cent of said stock, and to pay for said option and said Twenty Five (25%) per cent of said stock an amount equal to Six Hundred and Fifty ($650.00) Dollars, per share, to be paid to the party of the third part not later than April 10, 1920, for each share of said Twenty Five (25%) per cent of the majority of said stock deposited with the said party of the third part on or before April 1, 1920, and with respect to said additional stock deposited with the said party of the third part after April 1st., 1920, and on or before July 1st., 1920, the*2065 payment of Six Hundred and Fifty ($650.00) Dollars a share therefor shall be made to the said party of the third part within Ten (10) days from the date that he shall tender to the parties of the second part any part of said additional stock but settlement for the full Twenty Five (25%) per cent of such additional stock shall be made by the parties of the second part not later than July 10th, 1920; and the said option purchased being as follows:
(a) An option to purchase on January 15th, 1921, an additional Twenty-Five (25%) per cent of all of said stock deposited with the party of the third part up to and including July 1st., 1920, upon paying therefor to the party of the third part on the said 15th day of January, 1921, the sum of Six Hundred and Eighty and 87 1/2/100 ($680.87 1/2) Dollars, per share; (b) An option to purchase on January 15th, 1922, an additional Twenty Five (25%) per cent of all of said stock so deposited, upon paying therefor to the party of the third part on said *653 15th day of January 1922, the sum of Seven Hundred and Nineteen and 87 1/2/100 ($719.87 1/2) Dollars, per share; and (c) An option to purchase on January 15th, 1923, the remaining Twenty*2066 Five (25%) per cent of all of said stock so deposited, upon paying therefor to the said party of the third part on said 15th day of January, 1923, the sum of Seven Hundred and Fifty Eight & 87 1/2/100 ($758.87 1/2) Dollars, per share.
2. It is understood and agreed that the parties of the first part will have all of the stock deposited with the party of the third part under this agreement, indorsed, assigned, and transferred on the books of the Cherokee Falls Manufacturing Company in such manner as the party of the third part shall direct; that the entire Twenty-Five (25%) per cent of said stock first purchased by the parties of the second part as herein-before set forth, shall within a reasonable time after the date of such purchase, be properly transferred on the books of the Cherokee Falls Manufacturing Company to the parties of the second part, who shall at once assign the same in blank and deliver the same to the party of the third part, who shall hold the same until all provisions of this contract shall have been carried out, or the contract otherwise terminated; and likewise as each option is taken up by the parties of the second part, and the stock optioned thereunder is*2067 paid for in full as herein provided, such stock shall be promptly transferred on the books of the Cherokee Falls Manufacturing Company to the parties of the second part, who shall at once assign the same in blank, and deliver the same to the said party of the third part, to be by him held until all the provisions of this contract shall have been carried out, or the contract otherwise terminated; and when all of the provisions of this contract shall have been carried out, the said party of the third part shall then deliver all of said stock to the parties of the second part.
But in event the parties of the second part shall fail to take up any part of the said option as herein-before provided, or shall fail to pay to the said party of the third part within thirty (30) days from the date such option should have been taken up, the full amount of purchase money required to be paid for the stock optioned to be purchased on such date, the said party of the third part is hereby authorized, empowered, and directed, at the expiration of said Thirty (30) days, without further notice to any party, to transfer on the books of the said Cherokee Falls Manufacturing Company, and deliver to the*2068 sellers as their interests may appear, all of said stock transferred under the contract to the said parties of the second part, and held by the party of the third part as herein-before provided; and the entire amount of money paid by the parties of the second part to the party of the third part for the account of the parties of the first part as consideration for the said stock and the said option, shall be deemed and considered to have been paid for that portion of said option which was not exercised and carried out, and the parties of the second part shall have no right, claim or demand, upon or against the parties of the first part, or against the party of the third part, or the First National Bank of Richmond, Virginia, for any part of said money, or of said stock. And when the said stock shall have been transferred and delivered to the sellers, the said party of the third part shall thereupon make final settlement under this contract, returning to the various parties of the first part any balance of money or stock due to them, as their interests may appear, and all rights and obligations between the parties of the first part and the parties of the second part under this contract*2069 shall thereupon cease, and this contract shall thereupon be terminated.
3. It is understood and agreed that promptly after April 1st, 1920 all payments then required from the parties of the second part having been made, the parties of the first part will furnish to the parties of the second part the voting *654 control of the stock of the said Cherokee Falls Manufacturing Company, by means of proper proxies for not less than Fifty One (51%) per cent thereof, to the said parties of the second part, which proxies, so long as the parties of the second part shall comply with all of the provisions of this contract, and until the stock represented by said proxies shall have been purchased by and transferred on the books of the Company to the parties of the second part, shall be irrevocable; that the present officers and Directors of the Company will promptly resign when and as requested by the parties of the second part, and that full management and control of the Company shall be vested in the parties of the second part from the time that all payments required to be made on April 1st, 1920 shall have been made. But it is distinctly understood and agreed that no dividends are*2070 to be paid by the said Company after April 1st, 1920, until all the provisions of this contract required of the parties of the second part shall have been by them fully complied with, and that no lien or encumbrance shall be placed on any of the property belonging to the Company until the provisions of this contract shall have all been complied with by the parties of the second part, and should the parties of the second part issue any additional stock, all of such additional stock indorsed in blank shall be deposited with the party of the third part, and be subject to all of the provisions of this contract in event of any failure of the parties of the second part to comply with the provisions thereof required of them.
* * *
6. It is understood and agreed that a reasonable fee and commission, together with all necessary expenses in connection with carrying out this contract, shall be paid by the parties of the first part to the party of the third part; and that if in the discretion of the said party of the third part, it is advisable at any time subsequent to the signing of this contract, to emply counsel to protect the rights of the parties of the first part, the said party of*2071 the third part shall have the right to employ such counsel, and the reasonable fees and expenses of such counsel, approved by the party of the third part, shall be paid by the parties of the first part. It is understood that the parties of the second part upon making to the party of the third part any payment called for under this contract to be so made, shall be under no obligation to see to the application of such payment; that when the said party of the third part shall receive any such payment, he may deduct therefrom his proper fees, commissions, and all expenses of every kind incurred in connection with carrying out this contract, including fees and expenses of any counsel employed by him as herein provided, and within a reasonable time, he shall make distribution of the remainder pro rata to the sellers who are entitled to receive the same; that before making final settlement, the said party of the third part shall determine his fees, commissions and all expenses in connection with this contract proper to be paid by the parties of the first part, including fees and expenses of any attorneys employed by the party of the third part as herein provided, and deduct the total amount*2072 thereof from the money in his possession, and then within a reasonable time make distribution of the remainder to the sellers as their interests may appear.
It is understood and agreed that all of the stock deposited under this agreement with the party of the third part shall be by him safely kept in the vaults of the First National Bank of Richmond, Virginia, and that all funds received by him shall be deposited with and disbursed by the said First National Bank of Richmond, Virginia, under instructions of the said party of the third part, but no additional compensation other than that hereinbefore provided for, shall be paid for such service.
*655 The agreement was carried out according to its provisions, and petitioner acquired thereunder 2,000 shares of stock of Cherokee Falls Manufacturing Co., payments being made as follows:
| April 1, 1920, 500 shares @ $650.00 | $325,000.00 |
| January 15, 1921, 500 shares @ $680.87 1/2 | 340,437.50 |
| January 15, 1922, 500 shares @ $719.87 1/2 | 359,937.50 |
| January 15, 1923, 500 shares @ $758.87 1/2 | 379,437.50 |
Respondent has treated the full amounts of $359,937.50 and $379,437.50, paid January 15, 1922, and January 15, 1923, respectively, *2073 as a part of the cost of the stock.
On March 15, 1923, petitioner filed its income-tax return for the calendar year 1922 and, with the permission of the Commissioner, it changed the basis of its returns to a fiscal year ending on March 31, and in September, 1924 it filed its income-tax return for the fiscal year beginning April 1, 1922, and ending March 31, 1923.
Net income for the fiscal year ended March 31, 1923, was reported by petitioner, and has been computed by respondent, by taking ninetwelfths of the income for the calendar year 1922 and the entire income for the three-month period of January 1 to March 31, 1923.
Petitioner kept its books of account and rendered its Federal income-tax returns on the accrual basis of accounting.
OPINION.
PHILLIPS: Petitioner claims that under the contract set forth in our findings the agreed price to be paid for all the stock purchased was $650 per share, which was the price paid for the stock purchased April 1, 1920, and for the options and that the differences between this price and the prices agreed to be paid and actually paid on the 15th day of January, 1922, and 1923, respectively, represent interest. It points out that*2074 these excesses precisely equal interest at the rate of 6 per cent from April 1, 1920, to the date of each respective payment. Upon this basis it asserts that the payments made on January 15, 1922, and January 15, 1923, include interest in the respective amounts of $34,937.50 and $54,437.50. In this connection our attention is invited to the provision of the contract by which the control of the corporation was vested in the purchasers until the contract was completed by performance or terminate by forfeiture, and to the further agreement that during such period no dividends were to be declared or paid. The deduction is claimed under section 234(a)(2) of the Revenue Act of 1921, which provides:
All interest paid or accrued within the taxable year on its indebtedness, except on indebtedness incurred or continued to purchase or carry obligations or securities (other than obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest upon which is wholly exempt from taxation under this title.
The interest alloved as a deduction under the above provision is that which is paid or accrued on the "indebtedness" of a corporation*2075 *656 and the term "interest" is defined as "a consideration paid for the use of money or for forbearance in demanding it when due." See . In order to deserve the benefit of this deduction petitioner must show that it incurred an indebtedness to the sellers of the stock which was binding on it as of April 1, 1920. . If the excess of the amounts paid over the initial price in fact represents interest, then the whole of such excess is not deductible in the year paid, since petitioner kept its books of account and made its income-tax returns upon an accrual basis. Upon such a basis all interest should be accrued ratably over the period from April 1, 1920, to the date of each payment. ; . This brings us to the question whether petitioner did incur any interest which it had the right to accrue and deduct.
The agreement is open to two interpretations. The first and most obvious is that disclosed by the words used. Thus construed, it appears that petitioner did*2076 not agree to purchase all the stock deposited on that date and pay for it in four installments, but that it agreed to purchase one-fourth of the shares deposited, to be paid for at once, coupled with options to purchase one-fourth on January 15, 1921; to purchase another one-fourth January 15, 1922, and to purchase the remaining fourth on January 15, 1923. Until such options were exercised by petitioner, it incurred no obligation to the sellers which the latter might have enforced against it. There being no binding obligations until the options were exercised, there was no indebtedness on which interest might have accrued. The contention made by petitioner's counsel that the options were exercised when the final payment was made in April, 1920, and that thereafter petitioner was bound to carry out the purchase of the remaining shares is not supported by the agreement. The first payment created the option on the remaining 75 per cent, to be exercised by making payment.
The other interpretation is that, taking into consideration the large forfeitures which petitioner would have suffered if it had not complied with the terms of the agreement, and considering also that petitioner*2077 was to vote the stock and control the corporation, the contract was one of sale and purchase, as of April 1, 1920, of all the stock deposited, to be paid for in four installments. We do not believe this to be the true construction; but if, for our present purpose, it be so conceded, we find nothing in the contract with reference to interest and we can not insert therein stipulations which it does not contain. The most that can be said is that a resort to computation discloses that the various excess amounts paid equal 6 per cent on the amount paid on April 1, 1920, from that date to the respective *657 dates of payment. But this was not all the contract provided. The sum paid April 1, 1920, was not paid solely for stock but also for the options. The sellers had the right to deposit additional stock up to July 1, 1920. The price to be paid for such stock was the same as that paid for the stock deposited on April 1, 1920.
Petitioner had 30 days after January 15 of each of the years 1921, 1922, and 1923 to make the payments in such years and there is no provision for any additional payment or interest because of such delay. Construing the contract as petitioner requests, *2078 we would be compelled to find that the parties have agreed upon a purchase price for the stock, payable in installments and not for the payment of any interest. The fact that the later installments exceed the first payment does not constitute the excess interest. This question has often arisen in the courts when purchasers have sought to have such excess declared usurious. The courts have held that the excess of such payments over cash prices was not interest but that the whole of the payments constituted the agreed purchase price. Such has been the consistent holding of the Board. ; ; ;. Under neither construction of the contract did petitioner incur any interest which it might have accrued on its books and deducted from its gross income.
Decision will be entered for respondent.