*1347 1. Sums of money received by petitioner from R corporation were loans and not taxable dividends.
2. Where petitioner transferred certain stock to R corporation for the same consideration at which he had repurchased it from employees of R corporation, together with contracts of sales of stock to employees upon which balances were still owing, and was credited with the consideration for the stock and the unpaid balances on the stock sale contracts, the transaction was not a distribution having the effect of a taxable dividend under section 115(g) of the Revenue Act of 1934.
3. The petitioner may deduct interest paid by him to R corporation upon his indebtedness to the latter.
*343 In these duly consolidated proceedings petitioner seeks redetermination of deficiencies in income tax as follows:
| Docket No. | Year | Deficiency |
| 97718 | 1934 | $21,827.20 |
| 97718 | 1935 | 113,247.32 |
| 98015 | 1936 | 7,650.35 |
The proceedings were consolidated for hearing with R. C. Reynolds, Inc., Docket Nos. 98014 and 98017, *1348 decided this day. The issues submitted in the instant proceedings are (1) whether certain sums of money received in 1934, 1935, and 1936 from R. C. Reynolds, inc., by petitioner were loans or dividends; (2) whether sums received by petitioner in 1935 upon the transfer of certain stock by him to R. C. Reynolds, Inc., were a return of cost or a distribution having the effect of a taxable dividend under section 115(g) of the Revenue Act of 1934, and (3) whether interest charged by R. C. Reynolds, Inc., in 1934 and 1935 on petitioner's indebtedness to that corporation is deductible from his income under section 23(b) of the Revenue Act of 1934.
FINDINGS OF FACT.
Petitioner is an individual, residing in Troy, New York. His income tax returns for the years here involved were filed with the collector of internal revenue for the fourteenth district of New York, at Albany, New York.
During and prior to 1920, petitioner had been engaged in the retail furniture business, operating stores in Albany and Troy. In 1920 he decided to incorporate his business in order not only to enable his employees to share in the ownership of the business, but also to tie in and retain the services of*1349 key men so that the business could continue in case anything should happen to him. On September 29, 1920, R. C. Reynolds, Inc., hereinafter referred to as the company, was organized under the laws of New York for the purpose of carrying on a wholesale and retail furniture business. Its $2,000,000 par value authorized capital stock was divided into 10,000 shares of cumulative 8 percent preferred stock and 10,000 shares of common stock. Each class of stock had a par value of $100 per share. Upon any liquidation, dissolution or winding up of the company, holders of *344 preferred stock were to be entitled to $110 per share plus the amount of dividends accumulated on their shares, and the common stockholders were to receive the balance. Outstanding preferred stock was to be subject to purchase in whole or in part by the company at $110 per share and accumulated dividends. A sinking fund was to be set up for such purchase, and in the event any purchases were thus consummated the reacquired stock was to be held in the company's treasury. The company was to commence business with a capital of $1,000,000.
At the first meeting of stockholders and directors, held September 29, 1920, the*1350 company was tendered and accepted a bill of sale from petitioner covering all the assets, stock in trade, etc., of his furniture business. As a part of the bill of sale the company agreed "to pay all expenses, liabilities, contracts and indebtedness amde, accrued, incurred and accruing, both actual and contingent, in the conduct of the said business by the said Rollin C. Reynolds and including any and all assessments, taxes, liens and incumbrances as well as the Federal and State Income Taxes which may become assessed and imposed upon the said Rollin C. Reynolds by reason of any and all income received or accruing to him in the conduct of the said businesses from the commencement of said Income Tax levies up to the date hereof."
The additional consideration given by the company to petitioner upon the above transfer was 9,997 shares of the company's common stock and 10,000 shares of its preferred stock. The three remaining shares of common stock were issued as qualifying shares. At petitioner's direction the stock was issued as follows:
| Preferred | Common | |
| Rollin C. Reynolds | 4,000 shares | 3,999 shares. |
| Grace S. Reynolds | 6,000 shares | 5,998 shares. |
Petitioner*1351 was made president of the company and his wife was made vice president.
Petitioenr, upon the incorporation of the company, transferred 1,460 units of stock, each unit consisting of one share of preferred and one share of common, to 55 employees, at a price of $100 per unit. The stock so transferred consisted partly of stock which had originally been issued to Reynolds, and partly of stock which he had acquired from his wife. Each such transfer was made pursuant to a written agreement which provided that the purchase price should be paid out of dividends declared on the stock, 6 percent interest on the balance due being payable meanwhile. The employee had the privilege of buying the stock in any other manner. The stock was to be "issued *345 in the name of" the purchasing employee and by him "endorsed in blank and delivered to" petitioenr as collateral security for the payment of the price. The agreement was to terminate fine years after its date, or earlier if the employee should die or be separated from his employment, or if petitioner should die or retire. All dividends up to the time of termination, however, were to enure to the benefit of the purchaser, and stock*1352 scrip to the extent paid for was to be issued. The employee could terminate the agreement at any time prior to its appointed termination and receive cash to the extent of the stock scrip to which he should then be entitled.
From 1920 to 1929, inclusive, the company annually declared and paid 8 percent dividends on its preferred stock. Employees who were parties to astock purchase agreements reported the dividends in their income tax returns and applied the dividends, together with outright cash payments, in some instances, on the purchase price of the stock. Petitioner reported the interest paid on balances in his returns. No dividends were declared from 1930 to 1935, inclusive. On December 30, 1936, the preferred dividends due in 1930 were declared in part.
After his transfer in 1920 of 1,460 units of the company's stock to employees, petitioner transferred 600 additional units to employees in 1923, 1924, and 1925 at the same price and on the same terms. Whenever an employee desired to transfer his stock back to petitioner, petitioner reacquired it at $100 per unit, whether or not he was obligated to do so under the original agreements, because he wished to hilp his employees. *1353 The following table shows the units of the stock of the company which petitioner transferred to and reacquired from employees from 1920 to 1935:
| Transferred to employees | Reacquired from employees | |||
| Year | Number | Units | Number | Units |
| 1920 | 55 | 1,460 | ||
| 1922 | 6 | 60 | ||
| 1923 | 3 | 150 | 1 | 20 |
| 1924 | 11 | 375 | ||
| 1925 | 4 | 75 | 1 | 20 |
| 1926 | 1 | 50 | ||
| 1927 | 4 | 75 | ||
| 1928 | 3 | 80 | ||
| 1929 | 2 | 70 | ||
| 1930 | 4 | 65 | ||
| 1931 | 19 | 635 | ||
| 1932 | 3 | 125 | ||
| 1933 | 3 | 90 | ||
| 1935 | 1 | 50 | ||
| Total | 2,060 | 1,403 |
From the time of the incorporation of the company in 1920, petitioner was accustomed to draw against his salary as president, which was credited to his account on the books of the company at the end of *346 the year. Sometimes he returned to the company for credit to his account dividends which he received on his stock or made other loans to it. From 1921 to 1929, inclusive, petitioner had a credit balance on the company's books on which the company credited him with interest. After 1929, the company's earnings and business were diminished by the depression and it had temporarily unneeded funds. It was believed that loans to petitioner by the*1354 compant would be a good investment for it, and accordingly such loans were made, interest being charged on his debit balances. The rate of interest varied from approximately 2 1/2 percent to about 4 percent and was paid. Petitioner had assets other than his stock investment in the company sufficient to cover all his borrowings and he expected to repay the loans either from such assets or from his share of profits of the business whenever these should again exist.
The following is a summary of petitioner's account with the company from 1930 to 1939, inclusive:
| Year | Debits | Credits | Debit balance on Dec. 31 | ||||
| Principal | Interest | Cash | Salary | Interest | Miscellaneous | ||
| 1930 | $102,611.16 | $25,000 | $800.95 | $18,325.04 | $9,739.25 | ||
| 1931 | 126,591.12 | $4,015.25 | 10,000 | 719.85 | 129,625.77 | ||
| 1932 | 116,842.46 | 10,046.73 | 2,000 | 303.75 | 254,211.21 | ||
| 1933 | 45,388.93 | 11,007.50 | 2,000 | 98.84 | 308,508.80 | ||
| 1934 | 74,945.91 | 10,110.09 | 10,000 | 271.33 | 383,293.47 | ||
| 1935 | 53,149.86 | 6,445.32 | 10,000 | 1147,582.82 | 285,305.83 | ||
| 1936 | 40,504.04 | 11,000.00 | 132.66 | 314,677.21 | |||
| 1937 | 23,337.92 | 35,531.55 | 1,678.10 | 300,805.48 | |||
| 1938 | 14,253.51 | 14,299.19 | 82.59 | 300.677.21 | |||
| 1939 | 13,564.73 | 12,714.82 | 849.91 | 300,677.21 |
*1355 In the above table, interest debits after 1935 cease because petitioner thereafter paid his interest by check. His entire salary is shown as a credit for each year from 1930 to 1935, inclusive. Thereafter his salary was paid to him by check instead of being credited to his account. He included his salary in his tax returns for 1934, 1935, and 1936. The miscellaneous credits represent largely returns of merchandise, except for the large amount shown for 1935, which is explained below.
The company included in its income tax returns all the interest which it charged petitioner. The directors of the company did not specifically authorize each individual advance to petitioner, but at the end of each year they approved the balance sheets, which plainly *347 disclosed the advances that had been made, as loans the petitioner during that year.
Grace S. Reynolds had credit balances on the books of the company from 1925 to 1939, inclusive, on which the company paid her interest. She included such interest in her income tax returns.
| Computation of Earned Surplus Considering Withdrawals of Reynoldsas Loans. | ||
| Earned income per books 1920-1934 incl.: | ||
| Profits 1921-1929 | $1,134,826.58 | |
| Less losses 1930-1934 | 60,460.03 | |
| $1,074,366.55against income on books:paid by corporation as part consideration for transfer to it of business and charged as expenses against income on bools: | ||
| 1919 Federal income tax | 7,125.67 | |
| 1920 Federal income tax | 6,878.71 | |
| New York state tax | 714.93 | |
| 1917 Federal income tax | 1,455.77 | |
| 1918 Federal income tax | 1,353.15 | |
| 1920 Federal income tax | 1,121.03 | |
| 18,649.26 | ||
| 1,093,015.81 | ||
| Eliminate from earned income refunds on Reynolds' taxes paid by corporation, as part consideration for transfer to it of assets, which refunds were included in income: | ||
| 1919 Federal income tax | 206.82 | |
| 1920 Federal income tax | 20,197.59 | |
| 20,404.41 | ||
| 1,072,611.40 | ||
| Add 9 mos. depreciation charged against income to which corporation was not entitled in 1920 | 6,621.56 | |
| 1,079,232.96 | ||
| Deduct dividends on preferred stock 1921-1929, inc | 720,000.00 | |
| 359,232.96 | ||
| Deduct items of prepaid rent which was lost on giving up lease and charged to Surplus in 1934 | $9,600.00 | |
| Earned surplus as of December 31, 1934, available for dividends, treating prior withdrawals by Reynolds as loans - as respondent does | 349,632.96 |
| Computation of Earned Surplus for 1934, 1935 and 1936, treating prior withdrawals by Reynolds as loans, and withdrawals during 1934, 1935 and 1936 as dividends under section 115(g), as respondent does. | ||
| Earned surplus 1934 | $349,632.96 | |
| Less withdrawals during 1934 | 64,674.58 | |
| Earned surplus 12/31/34 | 284,958.38 | |
| Add earnings 1935 | 19,631.53 | |
| 304,589.91 | ||
| Less withdrawals during 1935: | ||
| Cash and miscellaneous | $42,538.66 | |
| Purchase of stock | 176,000.00 | |
| 218,538.66 | ||
| Earned surplus 12/31/35 | 86,051.25 | |
| Add earnings 1936 | 13,259.64 | |
| 99,310.89 | ||
| Deduct: | ||
| Dividends on preferred stock | 25,530.00 | |
| Withdrawals during 1936 | 29,371.38 | |
| 54,901.38 | ||
| Earned surplus 12/31/36 | 44,409.51 |
*348 Petitioner reported and paid an income tax for 1920 of $6,878.71. Following an audit by respondent, petitioner paid an additional tax of $1,121.03 for that year in 1924. The company reimbursed petitioner for both payments. In 1925, after further claims by respondent, petitioner paid an additional tax for 1920 of $247,079.38. Of this amount he secured a refund of $20,197.59. Thereafter petitioner brought a suit for refund for the use of the company, *1357 sub nom. Reynolds v. Durey, in the United States District Court for the Northern District of New York for the balance of the tax. On September 1, 1934, judgment was rendered in favor of petitioner for $117,135.22, with interest from December 9, 1925. In March 1935, petitioner received a check from the Treasurer of the United States for $182,066.51, representing the amount of the judgment plus interest. On June 1, 1935, he turned this recovery over to the company, less counsel fees - a net amount of $136,575.52.
The above amount was turned over to the company at a meeting of its board of directors held on June 1, 1935, which ratified all of petitioner's acts and transactions in connection with the suit for refund. The directors were petitioner, Grace S. Reynolds, and William H. Prentice. At this meeting, Grace S. Reynolds suggested that, inasmuch as the corporate funds had been increased because of the refund, consideration should be given to the reduction of the outstanding capital stock, and called attention to the provisions of the certificate of incorporation authorizing redemption of the preferred stock at 110. It was her idea that because of present financial*1358 *349 conditions, employees who had agreed in better times to buy stock of the company at $100 per unit might want to surrender their stock to the company at the same price, and that this privilege should be extended to petitioner, who had already reacquired 1,340 units at a price of $100 per unit from employees. But the following resolution was adopted:
WHEREAS Mr. Reynolds has heretofore sold to employees of the corporation at $100 per unit 2,010 units of 1 share of preferred and 1 share of common stock pursuant to contracts providing for payment for such stock out of the dividends thereon, and acting with regard for the interests of the corporation has since repurchased 1,340 of such units at the same price of $100 per unit and has been ready to repurchase the remaining 670 of such units if and when desired by the holders thereof; and
WHEREAS employees still holding 250 of such units have fully paid therefor, and employees holding 420 of such units have paid $29,028.38 on account of the purchase price thereof and have still to pay $12,971.62 thereon; and
WHEREAS, in the judgment of the board of directors, the outstanding capital stock of this corporation should be reduced*1359 and the first opportunity to surrender stock should be offered to employees and to Mr. Reynolds in respect of the stock which he has personally reacquired from employees as above set forth:
RESOLVED that this corporation offer to such employees as are stockholders and to Mr. Reynolds in respect of the stock acquired by him from employees that, upon surrender and delivery of certificates for such stock, this corporation will pay therefor the sum of $100 per unit of 1 share of preferred and 1 share of common stock, such price to be paid in cash where no part of the original purchase price of such stock remains unpaid, and where part of the purchase price of such stock remains unpaid, such price to be paid to such extent by the cancellation of the liability for such remaining payment and in cash to the extent that payment has heretofore been made on account of the purchase price of such stock:
RESOLVED, upon the assignment by Mr. Reynolds to this corporation of the contracts with employees for the purchase of said 420 units of stock in respect of which payment has not yet been completed, that this corporation pay to Mr. Reynolds therefor the sum of $12,971.62, representing the remaining*1360 liability of the purchasers of such stock, and take over and assume the rights and obligations which Mr. Reynolds has had and to which he has been subject in respect of such stock purchase contracts; * * *
Thereupon petitioner transferred to the company the 1,340 units which he had previously reacquired from employees and assigned to the company the contracts for the transfer by him to employees of 420 units of stock, upon which there was still unpaid and due a total of $12,971.62. The amount paid by the company to petitioner on these transfers was paid by crediting his account on the books of the company with the sum of $146,971.62, of which sum $134,000 represented the consideration paid for the stock and the balance the consideration paid for the contracts. In 1936 and 1937 the company reacquired from employees 150 and 20 units respectively at a price of $100 per unit. Stock so reacquired by the company was held as treasury stock.
*350 Although in 1934 the company had formally reduced the par value of its common stock in order to permit the charging off of good will and certain prepaid rent, it did not cause its authorized capital stock to be reduced upon acquiring*1361 the shares of its own stock in 1935 as above set out, nor did it amend its certificate of incorporation in any other respect.
The stock of the company was held as follows in 1934, 1935, and 1936 (figures represent units of stock):
| Year | Grace S. Reynolds | Petitioner | Employees of R. C. Reynolds, Inc. | R. C. Reynolds, Inc. |
| 1934 | 5,151 | 4,079 | 770 | |
| 1935 | 5,151 | 2,789 | 720 | 1,340 |
| 1936 | 5,151 | 2,789 | 570 | 1,490 |
Petitioner was 76 years of age at the date of the hearing herein, and his health was failing. He was present during two days of the hearing and absent thereafter. The following certificate by petitioner's physician was filed, explaining that absence:
To Whom it May Concern:
This is to certify that I have been the medical adviser of Mr. R. C. Reynolds over many years and that I now find him in such physical condition that it is necessary & vital that he not be allowed to undergo physical or mental strain.
Petitioner's books were kept on the cash basis. The books of the company were kept on the accrual basis, with one exception not here material.
OPINION.
LEECH: The following table gives effect to the corrections in the computation of*1362 the deficiencies in the deficiency notices which respondent concedes:
| Withdrawals | Stock redemption | Total received | |
| 1934 | $64,674.58 | $64,674.58 | |
| 1935 | 42,538.66 | $176,000 | 218,538.66 |
| 1936 | 29,371.38 | 29,371.38 |
The first issue is whether the sums withdrawn by petitioner from R. C. Reynolds, Inc., in 1934, 1935, and 1936 were loans or dividends.
Withdrawals by petitioner during 1930 to 1933, inclusive, are treated by respondent as loans, while he seeks to characterize those occurring during the three following years as dividends.
The evidence reveals no reasonable basis for these opposite positions. It is obvious, however, that he is compelled to take such an inconsistent position in order to have any basis at all for his contention that *351 the withdrawals in the taxable years were dividends. If it were admitted that the withdrawals occurring in the earlier years were dividends, his present contention would fall because such dividends would be chargeable against earned surplus and there would be no earned surplus from which dividends could have been paid in the taxable years.
*1363 The withdrawals in dispute were treated on the books of the company as loans. Petitioner was charged with interest thereon at a rate varying from approximately 2 1/2 to about 4 percent. Considering the period from 1931 to 1934, inclusive, as a whole, and giving effect to all credits reflected on the books of the company, including the item of the consideration for the transfer of petitioner's stock and contracts to the company in 1935, and properly attributing those credits first to interest (see ), $41,624.89, the total interest charged to petitioner was paid, together with $141,351.70 on account of his principal indebtedness.
Petitioner had the means of repaying these advances, consisting of assets other than this stock in the company. He intended to repay them. These advances bore no determinable relation either to earnings or surplus and no comparable withdrawals were made by other stockholders. In fact, the largest stockholder, Grace S. Reynolds, had credit balances with the company prior to and during the years here involved, on which the company paid her interest. Respondent attempts to discredit the veracity and*1364 character of petitioner by pointing out that he absented himself from the hearing after the second day; by the introduction of testimony on the part of certain employee-stockholders that they knew nothing of the loans; and by urging that there was no specific authorization by the stockholders or directors for such borrowings on the part of the corporation's president.
The age and physical condition of the petitioner, in our judgment, completely explain his absence from the witness stand after the second day of the hearing. We believe he is entirely worthy of credence.
So far as respondent's other contentions as to the advances are concerned, we find nothing seriously affecting their character as loans. Though it is true no specific authorization for them was made by the directors, the balance sheets of the company, disclosing fully these transactions between the petitioner and the company as loans, were approved by the directors at the close of each year. It is true, as respondent argues, that, under laws of New York passed in aid of creditors of corporations, loans to stockholders are forbidden. See Stock Corporations Law, P59; *1365 . But what engages us here is the actual conduct of the parties, not the legality of that conduct. .
*352 It is our opinion that the advances to petitioner are what they purported to be - loans, and not dividends. See ; ; ; ; ; reversed on other grounds, ; ; ; certiorari denied, , affirming
The next question is whether petitioner realized income upon the transfer of shares to R. C. Reynolds, Inc., in 1935 either under section 115(g) of the 1934 Act 2 or under section 111. 3 Although respondent advances possible liability under section 111 as an alternative position, we consider it first, in order to present more clearly the 1935*1366 transaction. As is noted below, the amount which respondent seeks to tax to petitioner is not the same under both contentions.
*1367 Petitioner wanted key employees to own stock in the business. Respondent argues that stock was never sold to the employees, but that they were merely given equities through what were nothing more than conditional sales contracts. Hence, he says, petitioner's basis for the 1,340 units transferred to the company in 1935 was their original 1920 cost to petitioner, not the price which petitioner paid for them in the alleged "reacquisition" from employees who wished to surrender their rights to stock. This 1920 basis, he contends, was decided to be $92.37 per unit in Reynolds v. Durey, which fact is therefore res judicata in this proceeding. It is thus respondent's position that petitioner was in receipt of gain in the 1935 transaction measured by the difference between what he received ( $100 per unit) for the 1,340 units of stock and the cost basis of $92.37 per unit.
*353 The agreements by which the employees acquired stock in the company provided that the stock should be issued in the name of the purchaser, that dividends declared thereon should be applied toward the purchase price, that interest should be paid to petitioner on the balance due, that the employee*1368 should endorse his stock in blank and give it to petitioner as collateral security for full payment of the price, and that each agreement should terminate in five years. As to the last condition it is apparent from the record that neither of the parties to these agreements regarded them as terminated at the end of five years. Petitioner testified without contradiction that he repurchased stock from dissatisfied employees entirely without regard to any contractual obligations in that respect. This course of dealing by the parties to the contracts in effect established new agreements at variance in that particular with the terms of the original understanding. Gibbs-Preyer Trust #1,. As to whether the original agreements embodied sales of stock to employees, we are convinced they did. Title passed to each buyer, who thereafter included the dividends on his shares in his tax returns, and pledged his shares to petitioner by way of security. The rule is well stated in 4 Williston on Contracts (Rev. Ed.) P1044: "* * * there seems no reason why one should hesitate to say that a pledgee merely has possession of the goods coupled with a power to sell them*1369 on default by the pledgor, but the latter retains the ownership subject to a lien to the extent of the debt enforceable by exercise of the power of sale * * *." See also ; ; .
In view of these considerations, it is our opinion that petitioner sold this stock to employees and repurchased it from some of them for the same price at which it had been sold ( $100 per unit). If as respondent well argues alternatively, the reacquisition of this stock by the company in 1935 was a purchase by the company from petitioner, then it follows that petitioner realized no gain under section 111. This result renders it unnecessary to pass on the question of whether Reynolds v. Durey is res judicata of any fact material in this proceeding.
Respondent's principal contention with respect to petitioner's 1935 transaction with the company is that it was a cancellation or redemption of stock essentially equivalent to the distribution of a taxable dividend under section 115(g) of the Revenue Act of 1934. *1370 Respondent charges petitioner with having so received the amount of $176,000. This includes $134,000 which the company paid petitioner for the stock he had repurchased from employees; $12,971.62 which was the unpaid balance on petitioner's sales of stock to employees under contracts *354 assigned to the company; and $29,028.38 which petitioner had already received from the employees on those contracts.
On brief respondent urges that there was "camouflage" and "manipulation" of the corporation's books and apparently takes the position that the corporation could neither have "redeemed" nor "purchased" the stock because it did not comply with the provisions of its charter to the effect that the preferred stock was subject to purchase in whole or in part at $110 per share plus accumulated dividends.
We agree with petitioner that the company might repurchase its stock otherwise than in accordance with the provisions in its charter and that the charter provision was inserted only to force the preferred stockholders to sell on the terms indicated if the company so desired. It is entirely permissible for a corporation to purchase its own stock by mutual agreement with the seller*1371 under these circumstances. .
In order that section 115(g) may be applied, the company must have (1) canceled or redeemed petitioner's stock and (2) that cancellation or redemption must have occurred "at such time and in such manner" as to be "essentially equivalent to the distribution of a taxable dividend." Here, significantly, the reacquired stock was not retired. It was retained as treasury stock. No reduction of authorized stock was ever authorized. The reacquisitions were not pro rata from all stockholders, but were limited to the stock of the employees and that which petitioner had repurchased from them. Cf. ; affd., . The corporate resolution under which these reacquisitions occurred does not, in the face of the other facts, characterize them as in redemption or cancellation of stock. In short, it seems doubtful that these reacquisitions were such at all. They may well have been merely sales of stock to the company. *1372 ; . Cf. ; affd., .
However, assuming the reacquisition of this stock from petitioner was a redemption or cancellation of his stock, the question remains, did it occur "at such time * * * [as to be] essentially equivalent to the distribution of a taxable dividend"? We think not.
Obviously, there was no connection between the issuance and redemption or cancellation of this stock. None of it had been issued as a stock dividend. Though originally issued to petitioner, the affected stock had been sold to key employees to retain their services and had been repurchased from them for their relief for the same price at which it had been sold to them. These repurchases occurred during a period beginning in 1922 - long before the reacquisition of the stock by the company at the same prices. This reacquisition was not prorated among the stockholders. Only the petitioner and such employees as desired were included. And, of emphatic importance, when the company *355 reacquired petitioner's stock, he owned less*1373 than 50 percent of the outstanding stock. Cf. . No artifice is revealed here. By this transaction, petitioner actually disposed of an interest in the company measured by the percentage of the stock he relinquished. Cf. . The redemption or cancellation, if such it was, was therefore not "at such time * * * [as to be] essentially equivalent to the distribution of a taxable dividend." ; ; ; ; ; .
This discussion and conclusion have directly to do with the $134,000 item which was the credit petitioner received from the company in 1935 for the stock it then acquired from petitioner.
However, the same result, we think, follows as to the item of $29,028.38 which constituted the sum already received by petitioner on his contracts of sale with*1374 employees when those contracts were assigned to the company, and to the item of $12,971.62, the balance unpaid on those contracts, which was credited by the company to petitioner in that year upon his assignment of those contracts to it.
The item of $29,028.38 was received in earlier years, not from the company, but from employees on account of the purchase price of stock which we have already decided was sold by the petitioner to those employees. The title to that stock passed to those purchasers in those prior years. Petitioner did not own this stock in 1935. It was not then canceled or redeemed. Nor did the company acquire it. All the company then acquired was petitioner's rights under his contracts with the employees, which included the right to receive that unpaid balance on this stock from the purchasing employees. Obviously, therefore, neither of those items is taxable to petitioner under section 115(g), supra.
The last issue is whether petitioner may deduct the interest charged by the company on his indebtedness for 1934 and 1935. Petitioner's books were kept on the cash basis. His salary was not paid to him by check, but was credited to his account on the*1375 books of the company. Nevertheless he included it in his taxable income for both years, in the amount of $10,000 for each year. On the books of the company, petitioner's account was debited with interest charges for those years in the respective amount of $10,110.09 and $6,445.32. We may assume that his salary was credited directly against these interest charges, for such is the proper practice. ; ; When . Although it is true that certain entries in Reynolds' loan account with the company prior to 1931 are not satisfactorily explained, we are satisfied that the account, as to the taxable years, fairly represents *356 the true situation, namely, advances to Reynolds upon which interest was charged and upon which he repaid interest and principal from time to time. It is our conclusion that interest in the amounts charged him by the company was paid by petitioner in each year by a method entirely consistent with the cash sustem of accounting and that the deduction is allowable. Cf. *1376 . For 1934, the excess of interest charged over salary credited, $110.09, should be disallowed, there being no showing that payment of this excess was made during the taxable year.
Decision will be entered under Rule 50.
Footnotes
1. Of this sum $134,000 represents the price of 1,340 units (consisting of one share of preferred and one share of common) of the capital stock of R. C. Reynolds, Inc., which it acquired from R. C. Reynolds in 1935; and $12,971.62 represents the unpaid balance in 1935 on 420 units of the capital stock of R. C. Reynolds, Inc., previously sold to employees thereof by R. C. Reynolds, which he assigned to the corporation in 1935 for $12,971.62. ↩
2. SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
* * *
(g) REDEMPTION OF STOCK. - If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend. ↩
3. SEC. 111. DETERMINATION OF AMOUNT OF, AND RECOGNITION OF, GAIN OR LOSS.
(a) COMPUTATION OF GAIN OR LOSS. - The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 113(b) for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining loss over the amount realized.
(b) AMOUNT REALIZED. - The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received.
(c) RECOGNITION OF GAIN OR LOSS. - In the case of a sale or exchange, the extent to which the gain or loss determined under this section shall be recognized for the purposes of this title, shall be determined under the provisions of section 112.
(d) INSTALLMENT SALES. - Nothing in this section shall be construed to prevent (in the case of property sold under contract providing for payment in installments) the taxation of that portion of any installment payment representing gain or profit in the year in which such payment is received. ↩