1941 BTA LEXIS 1500">*1500 1. Petitioner's claim to a credit under section 26(c)(1), Revenue Act of 1936, by reason of the provisions of its charter, held, disallowed. Helvering v. Northwest Steel Rolling Mills, Inc.,311 U.S. 46">311 U.S. 46, and Crane-Johnson Co. v. Helvering,311 U.S. 54">311 U.S. 54, followed.
2. Neither bond indenture provision prohibiting payment of dividends "except out of net earnings" and requiring observance of statutes and regulations, nor order of state public utilities commission restricting payment of dividends "until and as the same are available from its corporate net operating income", held to justify credit under section 26(c)(1), supra.
43 B.T.A. 451">*452 This proceeding was brought for a redetermination of a deficiency in income tax for the year 1936 in the sum of $12,177.98.
Petitioner admits the correctness of the deficiency to the extent of $1,442.10 but challenges the remaining deficiency on the grounds (a) that it is entitled to a deduction in the sum of $18,000 by reason of refunds made by it to1941 BTA LEXIS 1500">*1501 its subscribers in the taxable year in question and charged against its income for that year pursuant to the decree of the United States District Court for the Southern District of Ohio, Eastern Division; and (b) that it is entitled to a credit under section 26(c)(1) of the Revenue Act of 1936 in computing the surtax on its undistributed profits.
FINDINGS OF FACT.
Substantially all the facts are stipulated and are hereby found accordingly. Those facts hereinafter appearing which are not from the stipulation are facts found from the record made at the hearing.
Petitioner is a corporation organized and existing under the laws of the State of Ohio, in the business of supplying telephone service in the city of Warren, the villages of Newton Falls and Phalanx, and adjacent territory, all located in Trumbull County in the State of Ohio, and is a public utility subject to the jurisdiction of the Public Utilities Commission of Ohio in the rendition of its services and in the matter of rates and charges therefor. Its principal office is located at 220 South Park Avenue in the city of Warren, Ohio.
Petitioner was incorporated under the general corporation laws of Ohio on April 13, 1926, the1941 BTA LEXIS 1500">*1502 articles of incorporation expressly so state. On July 1, 1928, petitioner acquired all of the assets of the Warren & Niles Telephone Co. in exchange for all of the securities issued by petitioner, and commenced business. Its operations since then, its net income, dividends paid, and statement of its surplus account down to and including December 31, 1936, were as follows:
| Net income | Preferred dividends | Surplus | |
| July 1, 1928 | None | ||
| Dec. 31, 1928 | L $17,606.32 | None | D $17,606.32 |
| Year 1929 | 31,191.79 | $25,725 | D 12,139.53 |
| 1930 | 28,423.66 | 17,150 | D 865.87 |
| 1931 | L 21,037.94 | 17,150 | D 39,053.81 |
| 1932 | L 46,188.54 | None | D 85,242.35 |
| 1933 | 546.28 | ||
| Adjustment for prior years | 4,990.04 | None | D 79,706.03 |
| Year 1934 | 17,942.24 | None | D 61,763.79 |
| 1935 | 14,632.30 | None | D 47,131.49 |
| 1936 | 1 23,880.31 | None | D 23,251.18 |
1941 BTA LEXIS 1500">*1503 43 B.T.A. 451">*453 On September 24, 1928, petitioner executed and delivered to the Continental National Bank & Trust Co. of Chicago, as trustee, and William P. Kopf, as contrustee, an indenture dated as of May 1, 1928, securing an issue of petitioner's first mortgage 6 percent gold bonds, series A, in the aggregate principal amount of $800,000.
The indenture, inter alia, provided (article eight):
Section 6. That it will not declare or pay any dividends on any of its capital stock at any time outstanding except out of net earnings remaining after payment of all fixed charges, and after payment of all accrued installments of interest and sinking fund, if any, and maintenance fund in respect of bonds hereby secured and interest on all other funded and unfunded indebtedness and after proper observance of all the covenants hereof.
* * *
Section 9. That it will diligently preserve and maintain all the rights, privileges and franchises to it granted and upon it conferred * * *.
* * *
Section 14. * * * that so long as any bonds are outstanding hereunder it will preserve its corporate organization and its right to transact business in every state in which it owns any property, 1941 BTA LEXIS 1500">*1504 and will do no act by which it might incur a forfeiture of its corporate existence or its right to so transact business, and that it will comply with all lawful statutes, acts and regulations affecting the Company or the mortgage property.
As a result of a controversy concerning rates and proceedings arising therefrom four suits were filed against petitioner, a receiver was appointed, and the Public Utilities Commission of Ohio, on April 12, 1933, issued an order to the directors and officers of petitioner to show cause why they should not restore unlawfully declared and distributed dividends of the sum of $60,025 paid to the holders of the issued and outstanding preferred stock of petitioner within the period 1928 to 1932, inclusive. Under date of July 26, 1933, the commission made its order requiring the restoration by the individuals named. It also:
ORDERED, That, effective forthwith, the said Warren Telephone Company cease and desist from declaring, distributing and paying dividends to the holders of any of its issued and outstanding shares of capital stock, until and as the same are available from its corporate, net, operating income. * * *
As a further result of the1941 BTA LEXIS 1500">*1505 rate proceeding and receivership, the management and control of petitioner was changed. All of its former directors and officers resigned in July of 1933 and were superseded by a new board consisting of four citizens of the city of Warren and one of Chicago. No recourse was had against the former directors and officers because they were without the jurisdiction or not financially responsible.
Petitioner, pursuant to resolution of its board of directors, passed December 29, 1936, made application to the trustee under the trust indenture for permission to pay a cash dividend in the amount of 43 B.T.A. 451">*454 the estimated net profit of petitioner for 1936 upon its preferred stock, so that receipt thereof might be had by the preferred stockholders by December 31, 1936. The trustee denied permission, stating in its telegraphed reply that it could not consent "because of deficit in your surplus account shown by audit report December 31, 1935, which deficit not removed by your estimated earnings this year stop payment of dividends would constitute violation covenant under trust indenture dated May 1, 1928, Section 6, Article 8."
In December of 1936, all petitioner's preferred stock was1941 BTA LEXIS 1500">*1506 owned by a single shareholder so that the payment of a preferred dividend within that year could have been accomplished by a single payment.
By the terms of the indenture petitioner was not required to set up a sinking fund, nor did it do so. The only provision contained in the indenture in this respect was that the bond interest be on deposit by a certain date. In the taxable year in question petitioner had met all its obligations to the bondholders with respect to payment of interest and other charges. The interest was paid on May 1 and November 1, 1936.
OPINION.
OPPER: Petitioner contests a part of the deficiency determined by respondent with respect to normal tax on the ground of his erroneous refusal to permit it to deduct an item of $18,000 which it refunded to its subscribers in the taxable year; and with respect to the surtax on undistributed profits on the ground that it was entitled to a credit up to the full amount of its undistributed income pursuant to the provisions of section 26(c)(1), Revenue Act of 1936.
Respondent apparently agrees that the $18,000 item raises an issue identical with one previously decided by an unpublished Board decision in petitioner's1941 BTA LEXIS 1500">*1507 favor and from which an appeal to the Circuit Court of Appeals for the Sixth Circuit was dismissed on November 10, 1939. Petitioner contends that the point is therefore res judicata in its favor. Since the contrary is not argued by respondent in his brief, we regard it as conceded. Accordingly this item is determined in favor of petitioner on the ground of its prior adjudication and without reexamination on the merits in this proceeding.
The issue with respect to the undistributed profits tax credit, in so far as it involves the concept of petitioner's corporate charter as a contract incorporating state statutes prohibiting the payment of dividends by deficit corporations, is determined in favor of respondent upon the authority of , and .
Petitioner seeks to bring itself within 26(c)(1) for the further reason that its bond indenture, a written contract, contained a provision 43 B.T.A. 451">*455 that petitioner would not declare or pay any dividends "except out of net earnings"; and also that there was at the time outstanding an order1941 BTA LEXIS 1500">*1508 of the state Public Utilities Commission directing that petitioner "cease and desist from declaring, distributing and paying dividends * * * until and as the same are available from its corporate net operating income." This, argues petitioner, prevented it from paying dividends because of a requirement of the same indenture that there be "proper observance of all the covenants hereof", one of which was "that it will comply with all lawful statutes, acts and regulations."
Without attempting to consider what would be the result if either the indenture or the commission's order unconditionally forbade the declaration of dividends, cf. , it will suffice here to note that both indenture and order limit their scope to the availability of corporate net operating income or net earnings. No suggestion is made that there were no such earnings, after deduction of all current items of expense, or that these were insufficient to declare the entire amount of dividends necessary for petitioner to obtain the dividends paid creit. Indeed, that it had such earnings is apparent from the stipulated facts and the normal tax to which it was concededly1941 BTA LEXIS 1500">*1509 subject. See . If they were not "available" the most that could be suggested is that deficits inherited from prior years, perhaps the result of unauthorized dividend declarations in the past, had to be offset before there could arise an earned surplus. No doubt this situation effectually circumscribed petitioner's action in declaring any dividend. But it seems to us this clearly resulted, not from the terms of the relevant documents 2 but from the same fundamental situation taht existed in the Northwest and Crane-John-son cases, supra, namely, that accepted principles of corporation law as embodied in the state statutes preclude the payment of dividends in the absence of a corporate surplus. This was no more the result here than it was in those cases of any provision of a written contract expressly dealing with the declaration of dividends.
1941 BTA LEXIS 1500">*1510 Respondent's determination, in so far as it disallowed the deduction under section 26(c)(1) is approved.
Reviewed by the Board.
Decision will be entered under Rule 50.
Footnotes
L. Net loss. ↩
D. Deficit. ↩
1. This is a stipulated fact and is therefore found accordingly but does not appear reconcilable with concession by petitioner's counsel at the hearing. His statement, appearing on page 5 of the record, was as follows:
"Mr. HOPPE: With that $18,000 out of our income, as found by the Respondent, our income for the year 1936 is $29,028.97 the normal tax upon which would be $3,413.77, of which Petitioner has paid $1,971.67, leaving an admitted deficiency in income tax of $1,442.10." ↩
2. There is no reason to assume that indenture or order was concerned with an accumulated deficit. The indenture requires payment only of current items, such as interest; and the purpose of the order appears with sufficient clarity from the citation whcih preceded it. It is there charged that "the commission has cause to believe and finds that the directors and officers of the said Warren Telephone Company are preparing to and will, unless prevented, declare and pay further unearned dividends." ↩