*1211 Petitioner issued preference shares and provided for annual dividends thereon, and for the payment by petitioner of the state income tax imposed by the State of Massachusetts on shareholders on the dividends from such shares or reimbursement to the shareholders of such taxes were paid by them. Held, the amounts paid representing the state income tax imposed on the shareholders as to dividends paid to them are not deductible by petitioner either as ordinary and necessary expenses or as taxes paid under section 23 of the Revenue Acts of 1934 and 1936; held, further, that the amounts paid for shareholders' state income taxes were distributions of earnings and should be treated both as net income and a distribution of earnings in computing the adjusted declared value of petitioner's capital stock in a subsequent year for the purposes of the excess profits tax.
*1226 The respondent determined deficiencies in income and excess profits taxes against petitioner for the calendar years 1934, 1935, and 1936 as follows:
| Year | Income tax | Excess profits tax |
| 1934 | $14,014.90 | $3,489.25 |
| 1935 | 12,351.78 | 4,459.02 |
| 1936 | 9,046.43 | none |
| Total | 35,413.11 | 7,948.27 |
*1212 The petitioner contests the respondent's determination and alleges error in disallowing as deductions from income sums paid to the Commonwealth of Massachusetts for 1934, 1935, and 1936 of $101,926.52, $99,801.13, and $95,926.38, respectively. Petitioner alleges in the alternative that the respondent erred in understating the adjusted declared value of its capital stock for excess profits tax purposes for the year 1935 in the amount of $101,926.52.
FINDINGS OF FACT.
The facts were all stipulated and we adopt the facts as stipulated as our findings of fact. We state herein only such of the facts as we deem necessary to an understanding of the issues involved.
Petitioner is a voluntary association, taxable as a corporation. It was organized under the laws of the Commonwealth of Massachusetts, and has its principal office in Boston, Massachusetts. It filed its Federal income tax return for the years here under consideration with the collector of internal revenue for the district of Massachusetts.
Petitioner was organized on July 18, 1929, for the purpose, among others, of acqiring the preferred and common shares of the Massachusetts Gas Companies, the Connecticut Coke*1213 Co. and Philadelphia Coke Co.
The Massachusetts Gas Companies is a voluntary association formed on September 25, 1902, under the laws of the Commonwealth of Massachusetts.
During 1916 Massachusetts enacted an income tax law which provided for the taxation at 6 percent of dividends on transferable shares in partnerships, associations, or trusts. An exception was made if the partnerships, association, or trust furnished proof that at least two-thirds of its properties were taxed within the Commonwealth and filed an agreement to pay the Commonwealth annually a tax of 6 percent of the income derived from its properties.
Immediately after the enactment of this law the Massachusetts Gas Companies furnished the required proof that two-thirds of its property *1227 was taxed within the Commonwealth, and filed an agreement to pay the annual tax of 6 percent of its income. This agreement remained in force from 1916 throughout 1929. Pursuant to the agreement the Massachusetts Gas Companies paid said taxes during these years to the Commonwealth of Massachusetts. Petitioner never filed such an agreement and never paid such a tax.
Pursuant to the purposes for which it was organized, *1214 petitioner on August 14, 1929, sent to each of the holders of common and preferred shares of the Massachusetts Gas Companies an offer to exchange its own shares for such shares. In order to induce the holders of Massachusetts Gas Companies' shares who were inhabitants of Massachusetts to exchange such shares for its own shares, petitioner agreed in this offer, among other things, as follows:
Eastern Gas and Fuel Associates will reimburse Massachusetts holders of the Prior Preference and the 6% Cumulative Preferred Stocks for any Massachusetts income taxes paid with respect to any dividends thereon up to but not exceeding 6%. In the absence of any request to the contrary Eastern Gas and Fuel Associates will pay the Massachusetts income taxes on dividends of these stocks so that dividends to Massachusetts holders will be free of tax in that respect.
A provision to this effect was incorporated in its declaration of trust, which provided in part as follows:
Article 23. C. This trust will, out of the balance of the net profits or surplus remaining after all dividends accrued on the Prior Preference to the preceding quarterly dividend day have been paid or declared and set aside*1215 for payment, refund to each holder of Prior Preference, or arrange for the payment of, any Massachusetts income tax in respect of dividends on the Prior Preference received by such holder, to an amount not exceeding six per cent (6%) of such dividends, or refund or arrange for the payment of any personal property tax of the Commonwealth of Pennsylvania or any municipality or sub-division thereof in respect of the ownership of Prior Preference, not exceeding four (4) mills on each dollar of taxable value of Prior Preference held by such holder (all such refunding or payment, as well as any similar refunding or payment hereinafter or in votes of resolutions of the Trustees provided in respect of the Preferred Stock, being in this Article 23 referred to as "reimbursement for taxes") - all in such manner and under such regulations as the Trustees may from time to time prescribe.
* * *
Article 23. I. Holders of Preferred shall be entitled pro rata out of the balance of the net profits or surplus remaining after all dividends accrued on the Preferred to the preceding quarterly dividend day have been paid or declared and set aside for payment to such reimbursemevt for taxes, of*1216 any, as may have been established for the particular series in such manner and under such regulations as the Trustees may from time to time prescrbe.
Thereafter on August 6, 1929, the board of trustees of petitioner adopted a resolution establishing a series of preferred stock to be *1228 known as 6 percent cumulative preferred stock, a portion of which reads as follows:
(b) Reimbursement for taxes shall be by refunding to each holder of Preferred, or arranging for the payment of, any Massachusetts income tax in respect of dividends on the Preferred received by such holder, to an amount not exceeding six per cent. (6%) of such dividends, or by refunding or arranging for the payment or any personal property tax of the Commonwealth of Pennsylvania or any municipality or subdivision thereof in respect of the Ownership of Preferred, not exceeding four (4) mills on each dollar of taxable value of Preferred held by such holder, such reimbursement for taxes to be made in such manner and under such regulations as the Trustees may from time to time prescribe.
In order to comply with its contract and agreement with its shareholders, petitioner took up with the Commissioner of*1217 Corporations and Taxation of Massachusetts the matters of paying the taxes on its dividends to Massachusetts stockholders, and it was agreed that the Old Colony Trust Co. of Boston, would act as trustee for that purpose.
Thereafter, in 1934, 1935, and 1936, petitioner paid to the Old Colony Trust Co. for the payment of the taxes imposed by the Commonwealth of Massachusetts on the dividends of holders of its prior preference shares and preferred shares residing in Massachusetts and subject to such tax the sums of $101,926.52, $99,801.13, and $95,926.38 for the respective years.
In determining petitioner's taxable net income the respondent disallowed as deductions for the years 1934, 1935, and 1936 the amounts of $101,926.52, $99,801.13, and $95,926.38, respectively, claimed by petitioner in its return as taxes paid to the Commonwealth of Massachusetts.
Petitioner filed a capital stock tax return for the fiscal year ended June 30, 1935, showing an adjusted declared value of $30,167.58. This adjusted declared value was computed on the basis of petitioner's net income for 1934 of $92,858.40 as shown on its return. In computing the deficiency in question the respondent added*1218 to petitioner's income for 1934 the sum of $101,926.52, but did not change the adjusted declared value of petitioner's capital stock as shown in petitioner's capital stock return for the year ended June 30, 1935.
OPINION.
BLACK: The petitioner contends that the sums of $101,926.52, $99,801.13, and $95,926.38 paid by it to a trustee and paid by the trustee to the Commonwealth of Massachusetts in the respective years 1934, 1935, and 1936 are deductible as ordinary and necessary expenses or as taxes paid under section 23 of the Revenue Acts of *1229 1934 or 1936. The applicable paragraphs of section 23 are printed in the margin. 1 It contends in the alternative that if the respondent is correct in adding to income for the year 1934 the sum of $101,926.52, this sum should be added in determining the adjusted declared value of its capital stock for excess profits tax purposes for the year 1935.
*1219 In his statement attached to the deficiency notice the respondent explains his action in disallowing the deductions claimed by petitioner as follows:
The amount of $101,926.52, $99,801.13 and $95,926.38, claimed as deductions in your returns (Forms 1120) for the calendar years 1934, 1935 and 1936 respectively, representing income taxes imposed by the Commonwealth of Massachusetts upon the shareholders of your association, based upon the dividends received by the shareholders, which are paid by the association without reimbursement from the shareholders, do not constitute allowable deductions from gross income under Section 23(d) of the Revenue Acts of 1934 and 1936, because the said taxes are based upon the income derived by the said shareholders from their interest as shareholders and are not taxes upon the interest upon which the dividends were paid.
In his brief the respondent argues that the claimed deductions are not allowable either as ordinary and necessary expenses under section 23(a) or as taxes paid or accrued within the taxable year under section 23(c), or as taxes of shareholders paid by the corporation under section 23(d), and contends that the amounts in question*1220 represent dividends paid by the corporation in addition to the regular preferred stock dividends and are not deductible from gross income in the respective taxable years. We agree with the respondent.
The payments here in question were amounts paid on behalf of certain shareholders, residents of Massachusetts, in order to induce them to exchange their shares in the Massachusetts Gas Companies for the shares of petitioner. In order to effect the exchange petitioner agreed to pay, in addition to the fixed dividend, an amount equal to the state tax imposed on the dividend in the hands of the shareholder. Payments of this nature are obviously not ordinary and necessary expenses of carrying on a trade or business within the meaning of section 23(a). They are, in a practical sense, we think, an amount added to the fixed dividend and should be so regarded.
*1230 Petitioner contends that the payments in question are not dividends because they were not made pro rata to all shareholders and the petition was obligated to pay them whether it had sufficient earnings to pay them or not. While distributions by a corporation to its shareholders in proportion to their shares is the*1221 usual and customary thing and is evidence that such distributions are dividends, a distribution may be a dividend whether made in proportion to stockholdings or not.
All of petitioner's prior preference shares contained the same provisions and all shareholders who came within the class of residents of Massachusetts were entitled to reimbursement or its equivalent for state income taxes on the dividends received by them. This we think was a sufficient classification and only operated to make the net dividend of all shareholders equal. Petitioner does not contend that the payments here were not made from earnings or profits.
The statute defines dividends as any distribution made out of earnings or profits accumulated since February 28, 1913, or earnings or profits of the taxable year (sec. 115, Revenue Acts of 1934 and 1936). As we have already stated, there is no contention by the petitioner that the payments involved here were not made out of earnings or profits. We must, therefore, consider them as having been made out of earnings or profits and we think it is immaterial whether the shareholder could have required payment if there had been no earnings or profits.
The*1222 petitioner argues that in acquiring the stock of the Massachusetts Gas Companies it transferred two things; One, its stock; the other its obligation to pay the 6 percent state income tax imposed on the dividends of its Massachusetts stockholders; that the agreement to pay the tax imposed on the dividends was an obligation separate and distinct from the relationship of corporation and stockholder and represented an annual charge which the petitioner had to incur and pay out, and the amount so paid is therefore deductible as an ordinary and necessary expense of doing business. We think this contention must be denied.
In ; affd., , the taxpayer corporation in 1926 acquired all the common capital stock of the A.B. & C. Railroad Co. for $3,600,000, and guaranteed payment of dividends on its preferred stock. The preferred stock had exclusive voting power in case of default in payment of dividends. During the taxable years which were before us the taxpayer had paid to the preferred stockholders, under its guaranty agreement, amounts equal to the dividends. *1223 On these facts we held that the payments so made were not deductible as ordinary and necessary business expenses. Cf. .
*1231 We shall next discuss petitioner's contention that such payments are deductible as taxes paid. The general rule is that a taxpayer can not deduct payments made for taxes on behalf of another unless they come within section 23(d) of the statute. In order to be entitled to a deduction for taxes paid under section 23(c) of the statute it is necessary for a taxpayer to show, not only that he paid the taxes claimed, but that the taxes were imposed upon him by the taxing authority. See , and cases there cited. The taxes in question were not imposed upon petitioner by the laws of the Commonwealth of Massachusetts and it was under no obligation to the state to pay them. Had it failed to pay them the stockholders upon whom they were imposed would have been liable for their payment. It is true that the stockholders might have proceeded against petitioner for reimbursement under the terms of their stock agreement. *1224 But petitioner's obligation was imposed by the agreement under which it issued its stock in exchange for the stock of the Massachusetts Gas Companies. It was obligated to its stockholders and not to the state. Obviously the payments in question are not deductible under section 23(c) as taxes paid. Cf. ; .
In the case of taxes of a shareholder paid by a corporation, section 23(d) furnishes an exception to the general rule that taxes are deductible only by taxpayer upon whom they are imposed, but this exception only extends to cases where a corporation pays taxes imposed upon a shareholder of the corporation upon his interest in the corporation as a shareholder without reimbursement from the shareholder.
The laws of Massachusetts imposed an income tax on a shareholder of certain associations or trusts on dividends received by him. This was not a tax on any interest of the shareholder in the association or trust, but upon moneys which had been separated from the association or trust and paid over to the shareholders. It*1225 was not a tax upon his shares or on any property of the association or trust represented by the shares, but a tax on the income from his investment in such shares, and in our opinion does not come within the purview of section 23(d). Cf. ; .
We now come to consider petitioner's alternative contention that if the amount of $101,926.52 is not deductible from income for the year 1934, the adjusted declared value of its capital stock should be increased by that amount for excess profits tax purposes for 1935.
Section 701(f) of the Revenue Act of 1934 expressly provides that, in determining the adjusted declared value of capital stock for capital stock and excess profits tax purposes for any subsequent year, *1232 the original declared value shall be increased by (among other things) the amount of net income and decreased by the amount of earnings cistributed in such subsequent year.
In its capital stock tax return for the fiscal year ended June 30, 1935, petitioner added, among other things, to its original declared value net income in the amount of $92,858.40. *1226 The respondent determined that petitioner's net income should be increased in the amount of $101,926.52, and has treated this amount as earnings distributed during the year. We agree with the respondent that a recomputation of the adjusted declared value of petitioner's capital stock for the year in question would require an addition of net income in the amount of $101,926.52 and a subtraction of earnings distributed in the same amount. This would result in no change in the adjusted declared value of $30,167.58 as shown on petitioner's capital stock tax return for the year ended June 30, 1935, which amount was used by the respondent in computing petitioner's excess profits tax for the year 1935. The action of the respondent is sustained.
Decision will be entered for the respondent.
Footnotes
1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall ne allowed as deductions:
(a) EXPENSES. - All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * *.
* * *
(c) TAXES GENERALLY. - Taxes paid or accrued within the taxable year * * *.
(d) TAXES OF SHAREHOLDER PAID BY CORPORATION. - The deduction for taxes allowed by subsection (c) shall be allowed to a corporation in the case of taxes imposed upon a shareholder of the corporation upon his interest as shareholder which are paid by the corporation without reimbursement from the shareholder, but in such cases no deduction shall be allowed the shareholder for the amount of such taxes. ↩