*4057 The crediting of certain amounts on the corporation's books to its sole stockholder constituted distributions of profits.
*633 This is a proceeding for the redetermination of a deficiency in income and profits taxes for the years 1919 and 1920 in the amounts *634 of $5,994.11 and $9,950.30, respectively. The petition contained two assignments of error, namely (1) that in determining invested capital for each of the years involved the Commissioner failed to include in invested capital an amount which had been credited to the sole stockholder on the books of the corporation in prior years, and (2) that the Commissioner prorated and deducted 1919 income and profits taxes in determining the invested capital for 1920. The latter assignment of error was withdrawn at the hearing, leaving only the one question to be determined.
FINDINGS OF FACT.
The petitioner is a corporation organized under the laws of Arizona, the date of incorporation being April 1, 1908.
During the years 1909 to 1911, the corporation did not have any surplus account set up*4058 on its books.
The corporation, on the dates and in the amounts shown below, transferred on its books profits from the corporation's loss and gain account to the account of L. H. Manning:
| Date | Amount |
| Apr. 10, 1909 | $11,666.66 |
| Nov. 15, 1910 | 20,250.00 |
| Dec. 30, 1911 | 12,500.00 |
| June 30, 1916 | 30,438.85 |
| Dec. 31, 1916 | 44,096.39 |
| Total | 118,951.90 |
On December 31, 1919, the above amount was transferred from the account of L. H. Manning on the books of the corporation to a surplus account which was set up on the books for the first time.
The said amount of $118,951.90 has not been included by the Commissioner in the invested capital of the petitioner for the years 1919 and 1920.
The corporation had never formally declared any dividends, but credited the above amounts on its books to L. H. Manning, who owned all the stock except qualifying shares.
The corporation did not have the cash on hand available for the payment of the above amounts which were credited on the books to Manning on the dates on which they were credited to him. The corporation, however, did have earnings and profits at the time the credits were made to Manning sufficient to have paid the*4059 above amounts as dividends on the respective dates on which they were credited to Manning.
The corporation had a running account with Minning, various amounts being debited and credited to that account. Manning actually *635 withdrew various amounts from the corporation during the years involved and advanced them to other corporations of which he was the sole stockholder. When the amount of $118,951.90, which is the sum of the credits to his account, was transferred back to the corporation and his account debited to that extent, the running or open account that he had with the corporation had a total debit of $466,562.78. There were credits to that account as of December 31, 1919, in the amount of $205,717.01. This left Manning owing the corporation a substantial sum of money at the close of 1919.
The first three items credited to Manning's account, that is, those credited in 1909, 1910, and 1911, represented only a portion of the profits of the corporation for those years. The balance of the profits for those years remained in the profit and loss account.
The amounts were credited to the account of Manning upon the advice and suggestion of a revenue agent, who*4060 advised that the profits should not be permitted to accumulate but that they should be credited to the personal account of the sole stockholder who should pay taxes thereon. The petitioner, acting upon this advice, made the transfers to Manning's account and Manning paid the taxes upon such amounts credited to his account as being income to him. Subsequently, in 1919, when the books were audited by certified public accountants, and after the petitioner had been advised by another revenue agent that it was not necessary that the earnings and profits be distributed or credited to Manning's account, the corporation charged Manning's account with the total of the amount credited thereto from 1909 up to December 31, 1916, or a total amount of $118,951.90 and credited surplus account with the same amount at the same time.
OPINION.
TRAMMELL: The question here involved is whether the amounts credited to Manning's account constituted distributions of profits. If they were, the earned surplus of the corporation should be reduced to the extent of such distributions.
We think from all the facts and circumstances of the case, the credits to Manning's account did constitute distributions*4061 of the earnings and profits of the corporation. Manning was the sole stockholder of the company and had a running account with the corporation. He withdrew funds from the corporation to finance other corporations in which he was the sole stockholder. The crediting to his account reduced to that extent the indebtedness of Manning to the corporation. Manning received the benefit of the credits in the reduction of his liability or indebtedness to the same extent as if he had *636 received the money in cash, and the assets of the corporation were correspondingly reduced.
We have heretofore held that it was not necessary that formal action be taken by a corporation in order to declare dividends or to make distributions of the earnings and profits. This may just as effectually be done informally, and is frequently so done in the case of close corporations. We must look to the substance of what was done rather than to the form. If the effect of the action of the corporation is to distribute its earnings and profits by the method pursued it is not necessary that formal action declaring dividends be taken. The real question is, Were the earnings and profits effectually distributed*4062 to the stockholders? See ; ; ; ; certiorari denied May 31, 1927.
We are strengthened in the view that the action of the petitioner was a distribution of profits by the testimony to the effect that the purpose of the crediting of the amounts on the books was to avoid the accumulation of profits and by the action of Manning, the sole stockholder, in treating the amounts as his taxable income in the prior years and the payment of the taxes due thereon.
With respect to the year 1920, a different situation is presented. On December 31, 1919, Manning's account was debited with $118,951.50, the amount which had been credited to his account on account of profits from 1909 to 1916, and a credit made to surplus in the same amount. The function of this bookkeeping entry was to reverse all prior entries by which the profits of the years 1909 to 1916 had been distributed to Manning. The distributions of 1909 to 1916 were evidenced by bookkeeping entries but were just as effective*4063 as though they had been made in cash or other property. When made, invested capital was decreased by their respective amounts. The effect of the entry of December 31, 1919, was to restore Manning's account, in so far as it was affected by the distributions, and surplus to precisely their same conditions as prior to the distributions. Manning became obligated to the petitioner for the profits of 1909 to 1916 which had been distributed to him and surplus became correspondingly greater. As the latter was reduced by the distributions of 1909 to 1916, so it was correspondingly increased when the amounts distributed to Manning were released to the petitioner by the entry of December 31, 1919, and invested capital became correspondingly greater with the unqualified return of these distributions to the uses of the petitioner company. In view of the foregoing, *637 we are of the opinion that the respondent erred in failing to include the amount in question in invested capital for 1920.
Reviewed by the Board.
Judgment will be entered on 15 days' notice, under Rule 50.
ARUNDELL concurs in the result.
LANSDON and TRUSSELL dissent.