Opinion
Docket No. 14083.
1948-12-30
MAVERICK-CLARKE LITHO COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Leroy G. Denman, Esq., and W. M. Aikman, Esq., for the petitioner. J. Marvin Kelley, Esq., for the respondent.
1. EXCESS PROFITS TAX— EQUITY INVESTED CAPITAL— PROPERTY PAID IN—DISTRIBUTION IN STOCK— SECTION 718(a).— Equity invested capital was not created either through property paid in for stock or a distribution in stock of earnings and profits within the meaning of section 718(a) where, as a part of an integrated plan, a dividend was declared and the stockholders agreed to its immediate use as a subscription for stock.
2. DEDUCTION— ADDITIONS TO RESERVE FOR BAD DEBTS— SECTION 23(k).—Reasonable additions to a reserve for bad debts determined. Leroy G. Denman, Esq., and W. M. Aikman, Esq., for the petitioner. J. Marvin Kelley, Esq., for the respondent.
The Commissioner determined deficiencies of $12,514.38 and $10,148.99 in the petitioner's excess profits tax for 1942 and 1943. The issues are (1) whether an increase of $125,000 in capital stock in 1917 constituted additional equity invested capital within the meaning of section 718(a) of the Internal Revenue Code, and (2) whether the respondent erred in disallowing deductions for additions to a reserve for bad debts in 1942 and 1943.
FINDINGS OF FACT.
The petitioner is a Texas corporation, organized in 1896. It is engaged in the business of printing and lithographing and selling stationery and office equipment.
The capital stock outstanding immediately prior to November 20, 1917, consisted of 750 shares, each of the par value of $100. Those shares were then held as follows:
+-----------------------------+ ¦W. E. Milligan ¦205 shares¦ +------------------+----------¦ ¦Ned McIlhenny ¦173 shares¦ +------------------+----------¦ ¦I. M. McIllhenny ¦111 shares¦ +------------------+----------¦ ¦Pauline Milligan ¦256 shares¦ +------------------+----------¦ ¦Alice B. Milligan ¦5 shares ¦ +-----------------------------+
The stockholders were also the directors.
The minutes of a meeting of the stockholders duly called on November 20, 1917, at 12:30 p.m. were in part as follows:
On motion duly made * * * and duly seconded * * * and unanimously carried, it was decided to increase the capital stock of the Maverick-Clarke Litho Co. from Seventy-five Thousand ($75,000.00) Dollars to Two Hundred Thousand ($200,000.00) Dollars, the additional stock increase to be divided into shares of One Hundred ($100.00) Dollars each, amounting to Twelve Hundred and Fifty (1250) shares, and that the old stock be recalled, cancelled and new stock certificates reissued to take place of the old stock as well as certificates for the new stock be issued.
On motion duly made * * * and seconded * * * , the Board of Directors were duly instructed to take all necessary steps for the purpose of increasing the capital stock of Two Hundred Thousand ($200,000.00) Dollars and take subscriptions and make such disposition of the stock as will be to the benefit of the corporation.
The minutes of a meeting of the directors duly called on November 20, 1917, at 1 p.m. were in part as follows:
On motion duly made * * * and seconded * * * , it was decided to divide the surplus profits of the Maverick-Clarke Litho Co. amounting to One Hundred and Twenty-five Thousand Dollars ($125,000.00) among the following stockholders: W. E. Milligan, Ned McIllhenny, I. M. McIllhenny, Mrs. Alice B. Milligan, Mrs. Pauline Milligan in proportion to the amount of stock held by each of said stockholders.
On motion duly made * * * and seconded * * * , it was agreed in pursuance to the direction given by over two-thirds of the stockholders at a meeting of the stockholders duly held on the 20th of November, 1917, to increase the capital stock of the Maverick-Clarke Litho Co. from Seventy-five Thousand ($75,000.00) Dollars to Two Hundred Thousand ($200,000.00) Dollars, the increase of capital stock to be by Twelve Hundred and Fifty shares (1250) of the par value of One Hundred ($100.00) Dollars each, making the total amount of the stock as so increased in the Maverick-Clarke Litho Co. Two Hundred Thousand ($200,000.00) Dollars, and that the Seventy-five Thousand ($75,000.00) Dollars outstanding stock be recalled and new stock certificates be issued in accordance with the amount of shares of stock to each holder respectively.
President, W. E. Milligan, presented the following statement from the stockholders of the Maverick-Clarke Litho Co. agreeing to subscribe and pay for the additional Twelve Hundred and Fifty shares (1250) of stock of One Hundred ($100.00) Dollars each in the Maverick-Clarke Litho Co. as follows:
* * * and asking that the same be incorporated in the minutes of the Board of Directors.
On motion duly made * * * and seconded * * * , it was moved and seconded that the Twelve Hundred and Fifty shares (1250) of stock of the par value of One Hundred ($100.00) Dollars per share and non-assessable be sold and issued to the above parties, now stockholders, in the foregoing proportion and amounts, and that the respective shares of profits now due and owing them by the Maverick-Clarke Litho Co. be applied to the payment of said respective shares of stock, and said respective shareholders receipting said Maverick-Clarke Litho Co. in full payment of their said part of the earned profits now due them and apportioned to them. Also issue new certificates for the Seventy-five Thousand ($75,000.00) Dollars outstanding stock in accordance with the amount of shares of stock to each holder respectively upon receipt and cancellation of old stock.
The petitioner and its stockholders entered into the following stock subscription on the same day:
STOCK SUBSCRIPTION
We, the undersigned, hereby agree to subscribe the following increased capital stock of the Maverick-Clarke Litho Company of San Antonio, Bexar County, Texas, for the number of shares of stock set opposite our names, and we hereby agree and each of us agree to accept the undivided property dividends declared by the Board of Directors of the Maverick-Clarke Litho Company at a meeting duly called by the directors at the Maverick-Clarke Litho Company's office in San Antonio, Texas, at one o'clock P.M. on the 20th day of November, A.D. 1917, in lieu of a cash dividend, and we hereby by these presents re-assign and reconvey the whole of our respective interests in the said undivided property dividends to the Maverick-Clarke Litho Company in payment of our respective stock subscription to the increased capital stock of said corporation to the aggregate amount of One Hundred and Twenty-five Thousand ($125,000.00) Dollars. Said amount that is due to us by said property dividends will equal the amount of stock set opposite our names. Said stock to be of the par value of One Hundred ($100.00) Dollars non-assessable and hereby fully paid up.
+--------------------------------------------------------+ ¦Name ¦Residence ¦No. of Shares ¦ +----------------------+-----------------+---------------¦ ¦Ned McIlhenny ¦San Antonio Texas¦288¦$28,800.00 ¦ +----------------------+-----------------+---+-----------¦ ¦Mrs. Alice B. Milligan¦San Antonio Tex ¦8 ¦$800.00 ¦ +----------------------+-----------------+---+-----------¦ ¦I.M. McIlhenny ¦San Antonio Tex ¦185¦$18,500.00 ¦ +----------------------+-----------------+---+-----------¦ ¦W.E. Milligan ¦San Antonio Tex ¦342¦$34,200.00 ¦ +----------------------+-----------------+---+-----------¦ ¦Mrs. Pauline Milligan ¦San Antonio Tex ¦427¦$42,700.00 ¦ +----------------------+-----------------+---+-----------¦ ¦By Her Attorney ¦ ¦ ¦ ¦ +----------------------+-----------------+---+-----------¦ ¦W.E. Milligan ¦ ¦ ¦ ¦ +--------------------------------------------------------+
We, the Maverick-Clarke Litho Company, a corporation duly acting by and through its duly authorized officer, W. E. Milligan president and agent, hereby accept of said stock subscription as above set out, and hereby agree to the payment of same as above set out. The undivided property dividends due respectively to said above subscribers is hereby applied to the payment of said stock in amounts and in numbers as above set opposite their respective names and in the manner hereinabove stated.
MAVERICK-CLARKE LITHO COMPANY, By W. E. MILLIGAN, President.
The petitioner increased its authorized and issued capital stock on November 20, 1917, from $75,000 to $200,000. It certified the proceedings to the proper county and state officials in part as follows:
NOW, THEREFORE, we, W. E. Milligan, Ned McIllhenny, I. M. McIllhenny, Pauline Milligan and Alice B. Milligan, the Directors of said corporation, in compliance with the action of the stockholders, have this 20th day of November, 1917, increased the capital stock from Seventy-five Thousand ($75,000.00) Dollars to Two Hundred Thousand ($200,000.00) Dollars, said capital stock so increased to be divided into two thousand (2000) shares of the par value of One Hundred ($100.00) Dollars each non-assessable and fully paid up; and we certify that all of the capital stock, including the increased capital stock, has been subscribed and paid in as per affidavit hereto attached.
That on November 20th, 1917, at one o'clock P.M. at its office in San Antonio, Bexar County, Texas, the Directors of the Maverick-Clarke Litho Company declared a dividend of the undivided property and ordered the same paid to the different stockholders in the amounts as shown as subscribed for the increased capital stock of this corporation hereinabove stated, and that each of said named stockholders subscribing for said above increased capital stock as set opposite their names accepted the undivided property dividends so declared by the Board of Directors on said date in lieu of a cash dividend, and they re-assigned and re-conveyed the whole of their respective interests into said undivided property dividends to the Maverick-Clarke Litho Company in payment of their respective stock subscription to the increased capital stock of said corporation to the aggregate amount of One Hundred and Twenty-five Thousand ($125,000.00) Dollars as shown hereinabove in this affidavit, and that the Maverick-Clarke Litho Company accepted said re-assignment and re-conveyance of said undivided property dividends in payment of said stock subscription hereinabove set out.
The petitioner had earned surplus of not less than $125,000 immediately prior to November 20, 1917. $125,000 was transferred from surplus to capital at that time.
The petitioner described the 1917 increase in capital stock as a ‘stock dividend‘ in its income and excess profits tax return covering November 1917 and in its claim for abatement of taxes for the years 1917 through 1920.
The stockholders and directors did not intend that the petitioner should pay a cash or a property dividend.
No property was paid in for the stock issued on November 20, 1917.
The Commissioner excluded the capital stock issued in 1917 in the amount of $125,000 in the computation of the petitioner's equity invested capital for 1942 and 1943.
Over 90 per cent of the petitioner's sales regularly are credit sales. Its terms of sale are payment in cash or thirty days. Most of its accounts receivable are unsecured. The petitioner has maintained a reserve for bad debts since 1926. The reserve was accumulated as follows:
+---------------------------------------------------+ ¦¦¦¦ ¦Addition ¦Addition ¦¦ ¦ ¦ ++++--------+----------+----------++-------+--------¦ ¦¦¦¦Bad debt¦to reserve¦to reserve¦¦Charges¦Bad debt¦ +---------------------------------------------------+
Receivables reserve (charge (bad to bad reserve to Year Sales end of beginning profit debts Total debt end of and year of year loss) collected) reserve year 1926 $452,198 $107,629 None $2,700 None $2,700 None $2,700 1927 466,401 123,476 $2,700 6,181 a 1,786 10,667 $7,967 2,700 1928 561,920 117,049 2,700 6,672 None 9,372 None 9,372 1929 512,182 145,546 9,372 6,821 37 16,231 2,091 14,140 1930 413,595 103,535 14,140 5,758 1,203 21,102 20,571 530 1931 392,949 54,986 530 5,440 1,327 7,299 25,338 b (18,039) 1932 245,715 42,640 None 2,834 3,342 6,177 4,940 c 1,236 1933 258,325 55,096 None 3,727 740 4,468 4,165 302 1934 290,133 61,894 302 4,471 1,203 5,977 897 5,080 1935 353,531 79,639 5,080 4,122 1,399 10,602 2,430 8,172 1936 393,235 73,043 8,172 2,796 939 11,908 4,444 a 5,227 1937 429,189 99,596 5,227 None 4,740 9,968 1,567 e 5,772 1938 391,662 74,821 5,722 None 1,924 7,647 2,377 5,270 1939 449,780 75,379 5,270 3,296 750 9,317 4,571 4,746 1940 547,018 123,693 4,746 3,642 974 9,362 3,709 5,653 1941 689,149 101,817 5,653 2,742 1,178 9,573 2,473 7,100 1942 1,016,444 111,516 7,100 2,926 1,745 11,772 2,313 9,459 1943 1,019,422 115,280 9,249 2,155 2,644 14,259 2,460 11,798 FNa Credit balances in customers' accounts credited to bad debt reserve.FNb Debit balance in bad debt reserve charged to surplus 12/31/1931.FNc Credit balance in bad debt reserve credited to surplus 12/31/1932.FNd 1934 bad debt reserve decreased by Bureau of Internal Revenue by $2,235.FNe 1935 bad debt reserve decreased by Bureau of Internal Revenue by $2,678.
The large bad debt loss in 1931 was due to the depression and bank failures.
The petitioner claimed deductions of $2,926.69 and $2,155.51 as additions to the reserve for bad debts for 1942 and 1943. The Commissioner disallowed the deduction of the net additions to the reserve in the amounts of $2,359.15 for 1942 and $2,339.16 for 1943.
$2,359.15 of the 1942 addition to the reserve was not a reasonable addition.
The 1943 addition to the reserve in the amount of $2,155.51 was not a reasonable addition.
OPINION.
MURDOCK, Judge:
The petitioner contends that it had equity invested capital of $125,000 within the meaning of section 718(a) of the Internal Revenue Code as a result of the transactions which took place on November 20, 1917. It would have to show, in order to sustain that contention, that money or property was paid in for stock or that there was a distribution in stock which would be considered a distribution of earnings and profits and it would further have to show, if relying upon property paid in for stock, the basis of the property for loss to the person paying it in. The petitioner does not argue that money was paid in for stock, but it does argue that ‘undivided property‘ was paid in for stock. It cites no cases in support of its argument.
Actually no money was distributed by the corporation on November 20, 1917, and no money was paid in by the stockholders for stock. Furthermore, the corporation did not have sufficient cash at that time to pay a dividend in money and it made no effort and had no plans for obtaining money for that purpose.
The corporation did not distribute any property to the stockholders on November 20, 1917, and the stockholders did not actually pay in any property to the corporation for stock. The petitioner argues, however, that ‘undivided property‘ was paid in for stock. Apparently its reasoning is that the declaration of a dividend gave to the stockholders claims against the corporation and when they subscribed for stock they surrendered those claims. It points to various statements in the resolutions and the stock subscription agreement to support its contention that there was a declaration and distribution of an ‘undivided property‘ dividend. It seems necessary in a situation like this to look through the form of the transaction in order to find and rely upon what actually took place. Jackson v. Commissioner, 51 Fed.(2d) 650. There were but five persons involved. Their relationship is not shown, but their names indicate that they were closely related. Those five persons were stockholders and directors. All of the transactions, the resolutions at the two meetings, the action of the directors, and the agreement of the stockholders to subscribe, were but steps in an integrated and indivisible plan. At least the petitioner has failed to show the contrary. It would also appear that the five persons had no intention of having the petitioner pay any dividend in property. No dividend in property or in ‘undivided property‘ could have been paid without completely disrupting the business. It is fair to conclude from the entire record that the whole arrangement was agreed to in advance. The results were accomplished by transferring $125,000 from surplus to capital on the books and by the issuance of stock certificates. The action was a pro rata stock dividend of common on common. Cf. Jackson v. Commissioner, supra; Irving v. United States, 44 Fed.(2d) 246; W. Q. Wright, 10 B.T.A. 806, 822. Such a dividend is not considered a distribution of earnings and profits and is not taxable to the stockholders. Sec. 115(h), I.R.C. Eisner v. Macomber, 252 U.S. 189; Helvering v. Griffiths, 318 U.S. 371. The determination of the Commissioner that this transaction did not affect equity invested capital is thus supported by the evidence. At least the evidence does not show that it was wrong.
Section 718(a)(2) provides that property paid in for stock is to be included in equity invested capital in an amount equal to its basis for determining loss upon sale or exchange. There is a complete failure of proof as to the basis for loss of any property or ‘undivided property‘ in the hands of anyone, and that circumstance alone would be fatal to the petitioner's contention.
The petitioner makes some argument based upon the law of Texas which prohibits the issuance of stock except for money paid, labor done, or property actually received. The petitioner argues from this law that a stock dividend was not permitted and the procedure followed was designed to comply with the laws of Texas. The question here is the effect of the transaction for the purpose of Federal taxes. It is proper to look through form to substance in determining that question, and it is not necessary to determine exactly what the transaction would have been under the laws of Texas.
Section 23(k) allows the deduction of a reasonable addition to a reserve for bad debts. The petitioner claimed deductions of additions to a reserve for bad debts in the amount of $2,926,69 for 1942 and $2,155.51 for 1943. The Commissioner disallowed $2,359.15 of the deduction claimed for 1942 and he added to income $2,339.16 for 1943, although the deduction claimed by the petitioner for that year was only $2,155.51. He obviously erred in adding back to income more than the petitioner took as a deduction. The evidence has been carefully examined and the conclusion has been reached that the Commissioner did not err in disallowing $2,359.15 of the deduction claimed for 1942 and in disallowing the entire deduction claimed for 1943. The reserve was ample without those additions. The history of this reserve, including the charges made for bad debts, the subsequent collections on those debts, and the additional amounts added to the reserve, is convincing evidence that the amounts in controversy were not necessary as additions to the reserve at the end of 1942 and at the end of 1943.
Decision will be entered under Rule 50.