Opinion
No. E-452.
April 7, 1930.
Suit by George A. Hormel Co. against the United States.
Judgment for defendant.
This suit is for the recovery of income and profits tax alleged to have been erroneously and illegally collected in the amount of $55,306.24 for the fiscal year ending October 31, 1917, and $40,333.67 for the fiscal year ending October 31, 1918, with interest as provided by law.
The question is whether certain notes given by employees for stock should be included in invested capital from the dates received by plaintiff. The defendant excluded the notes in computing invested capital, and allowed as invested capital only the payments made on the notes from the dates of such payments.
Substantially all of the facts were stipulated.
Findings of Fact.(1) Plaintiff, a Minnesota corporation, filed its income and profits tax return for the fiscal year ending October 31, 1917, showing a total tax of $192,110.49, of which $156,483 was paid on May 16, 1918, and the balance on June 29, 1918. In April, 1922, the Commissioner of Internal Revenue determined and assessed an additional tax of $14,972.57 for this fiscal year. A portion of this additional tax was paid, and the remainder was offset by credits as follows:
June 3, 1922 (paid) .............. $1,067.61 Credited a/c overpayment fiscal year October 31, 1916 ........... 25.34 Credit a/c overpayment fiscal year October 31, 1919 ................ 13,879.62 _________ Total ........................ 14,972.57
(2) January 2, 1919, plaintiff filed its return for the fiscal year ending October 31, 1918, disclosing a tax of $66,903.24, which was paid March 24, 1919. It filed a supplemental return for this taxable year on June 25, 1919, disclosing a further tax of $54,496.24, which was discharged by payments and credits as follows:
March 17, 1919 (paid) ......... $19,811.20 June 17, 1919 (paid) .......... 6,061.92 September 25, 1919 (paid) ..... 13,624.06 December 15, 1919 (paid) ...... 14,435.25 Credited a/c overpayment fiscal year October 31, 1919 ....... 484.58 Credited a/c overpayment fiscal year October 31, 1920 ....... 79.23 __________ 54,496.24
On December 24, 1918, plaintiff also paid a tax of $3,954.13 assessed against Hormel Milling Company; the total payments and credits aforesaid for the fiscal year being $125,353.61.
(3) January 16, 1922, plaintiff filed an amended return for the fiscal year 1918 claiming a total tax liability for said year of only $84,919.94. In March, 1924, the Commissioner determined and assessed an additional tax of $9,834.62 for said fiscal year. This additional tax was not paid in cash, but was offset by a credit of an overpayment for the fiscal year ending October 31, 1920, being a part of an overpayment of $17,247.95, as determined by the Commissioner for said fiscal year 1920.
(4) January 15, 1920, plaintiff filed its return for the fiscal year ending October 31, 1919, disclosing a tax of $30,454.02, which was paid as follows:
January 16, 1920 ................. $7,616.01 April 15, 1920 ................... 7,616.01 July 15, 1920 .................... 7,616.01 October 15, 1920 ................. 7,605.99 _________ Total ......................... 30,454.02
Thereafter the Commissioner determined that the tax for this year had been overpaid in the amount of $14,364.20, for which he issued a certificate of overassessment, which overpayment was credited as hereinbefore set forth; i.e., $484.58 to the tax shown on the plaintiff's supplemental return for the fiscal year ending October 31, 1918, and $13,879.52 to the additional assessment for the fiscal year ending October 31, 1917.
(5) January 15, 1921, plaintiff filed its return for the fiscal year ending October 31, 1920, disclosing a tax of $22,997.25, upon which the following payments were made:
January 20, 1921 ................. $5,749.31 April 16, 1921 ................... 5,749.32 July 16, 1921 .................... 5,749.32 _________ Total ......................... 17,247.95
Thereafter the Commissioner determined that there was no tax due for the fiscal year ending October 31, 1920, and issued a certificate of overassessment for $22,997.25. The amount of $17,247.95 paid was credited to outstanding taxes, as follows:
To tax due on supplemental return for fiscal year ended October 31, 1918 ............................. $79.23 To additional tax for fiscal year ended October 31, 1918 ........... 9,834.62 To tax for fiscal year ended October 31, 1923 ......................... 7,334.10 _________ Total .......................... 17,247.95
(6) March 9, 1922, plaintiff filed a claim for the abatement of $13,904.96 of the additional tax assessed for the fiscal year ending October 31, 1917. This claim was rejected by the Commissioner January 11, 1924.
July 3, 1925, plaintiff filed a claim for refund of $13,904.96 for the fiscal year ending October 31, 1917, which claim was rejected by the Commissioner July 21, 1926.
(7) January 16, 1922, plaintiff filed a claim for refund of $40,333.67 for the fiscal year ending October 31, 1918, which claim was rejected by the Commissioner March 24, 1924. On the same date it filed a claim for refund of $20,770 for the fiscal year ending October 31, 1919. This claim was allowed by the Commissioner for $14,364.20, as hereinbefore set forth, and rejected for $6,405.80. The overpayment allowed was credited against the tax for the fiscal year 1917 and the fiscal year 1918.
(8) January 16, 1922, plaintiff filed a claim for refund of $17,247.95 for the fiscal year ending October 31, 1920. This claim was allowed and the amount credited to the tax due by plaintiff, as hereinbefore set forth in finding 5.
(9) Sections 1, 2, and 3 of article V of plaintiff's articles of incorporation, as amended November 21, 1916, provide as follows:
"Capital Stock"Section 1. The capital stock of this corporation shall be three million two hundred thousand dollars ($3,200,000), which shall be paid in at such times and in such amounts as the board of directors shall determine, and which shall be divided into thirty-two thousand (32,000) shares, the par value of which shall be one hundred dollars ($100.00) each. The shares of stock shall be divided into two classes: Ten thousand (10,000) shares of preferred stock, twenty-two thousand (22,000) shares of common stock. Out of the twenty-two thousand shares of common stock there shall be set aside in the treasury six thousand (6,000) shares which shall be issued to the employees of this corporation in the manner hereinafter provided.
"Sale and Disposal of New Issues of Stock
"Section 2. When the board of directors so determine the increased preferred stock provided by these amended articles of incorporation, and any further increase of same, or any portion thereof, shall first be offered, at par, pro rata to the preferred stockholders who may desire to subscribe for such stock; and the increased common stock herein provided shall be issued pro rata to the common stockholders in relation to their then present holdings, excepting only six thousand (6,000) shares of the common stock set aside for employees as provided in section 1, Article V, and which shall be disposed of as follows:
"To each holder of employees stock of record November 1, 1916, there shall be issued and dated November 1, 1916, four (4) shares of common stock in exchange for each share of employees stock owned by him on the date named. After making such distribution of the common stock, the remainder of the common-stock shares shall be placed in the treasury and may thereafter be issued to employees, as such, at such time and in such amounts as the board of directors shall determine.
"Sale of Common Stock to Employees
"Section 3. Any employee entitled to purchase the common stock of this corporation as provided in sections 1 and 2 of Article V, shall at the time of receiving such stock execute a non-interest-bearing promissory note or notes payable to the corporation for an amount equal to its book value as determined by the last previous annual inventory, or, if the purchaser of the stock so desires, he may pay to the corporation its book value in cash, or part payment may be made in cash and part by note; the notes to be of such denominations as the board of directors may determine.
"If a note or notes are given by an employee in payment for common stock, he shall be required to apply toward the redemption of these notes any or all of the cash dividends he may receive on the stock, as the board of directors may determine, and may make additional payments on his notes from time to time as he may elect. In case the owner thereof wishes to sell common stock on which there are still unpaid notes to the company, he shall be required to pay the company that portion of the funds, resulting from the sale of the stock, which shall be required to fully liquidate his notes, any balance remaining from the proceeds of the sale of the stock, after the liquidation of the notes, shall be paid to the employee."
November 24, 1916, in accordance with these amended articles, the preferred and common capital stock was increased 400 per cent., and the increased common stock, with the exception of 6,000 shares set aside for employees, was issued to the common stockholders in proportion to their then holdings. Before the increase of capitalization, the book value of the common stock which had been issued to certain of plaintiff's officers, known as class A stockholders, was, by reason of the cumulation of dividends, $220 a share, and the book value of the common stock which had been issued to certain employees, known as class B stockholders, was $100 a share. As a result of the increase, the respective book values of the stock held by officers and employees became $55 and $25. Under a resolution of the board of directors of December 30, 1916, the employees owning common stock, designated as class B stockholders, were authorized, upon the surrender of their stock outstanding on October 31, 1916, to give plaintiff their notes for the difference between $55 a share and $25 a share, amounting to $30 a share, in order to bring the book value of their stock up to the book value of the common stock held by the officers of the corporation, known as class A stockholders. This resolution was as follows:
"Be it resolved, That on the surrender of the employees' stock outstanding October 31, 1916, by the holders thereof, the book value of each certificate (being the par value thereof less the amount paid thereon, if any) shall be applied toward the payment of the common stock issued to each employee under the provisions of the second paragraph of section 2 of Article V of the articles of incorporation; and, as provided in section 3 of Article V of said articles, such employee stockholder shall execute to the company his non-interest-bearing promissory note or notes for an amount equal to the difference between the book value of the common stock and employees' stock at the close of business October 31, 1916, less the dividends paid thereon November 21, 1916."
Accordingly and during the fiscal year ending October 31, 1917, the employee stockholders severally gave plaintiff the following written promises: "For value received I promise to pay to the order of Geo. A. Hormel Company, at its office at Austin, Minnesota, the sum of $______ payable without interest at the times and in the manner provided in section No. 3 of article No. V of the present articles of incorporation of said company and the resolution of the board of directors passed at December 30, 1916."
Subsequently, on December 31, 1917, the board of directors, in order to make the book value of the common stock equal the par value of $100 a share, adopted the following resolution:
"Whereas there has been issued 21,038 shares of the common stock of this corporation to various stockholders, the par value of which is $100 per share, and
"Whereas said shares of stock have been delivered to the various owners thereof, who now hold the same, but which has been paid for to the extent only of $55 per share. Now, therefore, be it
"Resolved, That for the purpose of protection and security to this corporation and as payment in full for said shares of stock, promissory notes be accepted from the holders of said stock to the amount of $45.00 per share for each share of stock so held, said notes to bear date September 1, 1917, and to draw interest after maturity at the rate of six per cent, and to be accepted by said corporation in lieu of cash payments. Be it further
"Resolved, That payments shall be made on said notes by endorsing thereon such dividends as may be declared on said shares of stock from time to time by the board of directors for such specific purpose.
"For value received I promise to pay Geo. A. Hormel Company ______ dollars, with interest after maturity at the rate of six per cent per annum until fully paid.
"This note is given in part payment of ______ shares of common stock of Geo. A. Hormel Co. in compliance with the resolution of its board of directors."
The officers of the corporation, designated as class A stockholders, and the employees of the corporation, designated as class B stockholders, each gave plaintiff his written promise, as provided in the resolution, as of September 1, 1917, for the difference between $55 a share and $100, or $45 a share, in order to make the book value of their stock equal to the par value thereof.
Plaintiff at all times retained the amounts paid in by the class B stockholders on account of the stock issued to them, and paid no interest thereon. It likewise paid no dividends in cash during the taxable years involved on stock held by class B stockholders; the dividends declared thereon being credited on the books as part payments on the stock. The stock was sold by plaintiff to its employees at par, regardless of the actual value, in order to stimulate their interest in the business.
(10) The Commissioner of Internal Revenue rejected plaintiff's abatement and refund claim for $13,904.96 for the fiscal year ending October 31, 1917, for the reason that he determined that there should be excluded from invested capital the amount of the aforesaid notes, known as class B notes, given to plaintiff by its employees for shares of stock. An amount equivalent to $151,825.51 of said notes was excluded from invested capital for said fiscal year 1917 in passing upon said abatement claim and in determining the additional tax of $14,972.57, which was assessed in April, 1922.
The Commissioner rejected plaintiff's refund claim for $13,904.96 for said fiscal year 1917 also for the reason that he determined that invested capital for said fiscal year should be further reduced by the amount of $172,736.13 on account of class B notes in excess of $151,825.51, held by plaintiff in the amount of $226,260, which amount adjusted for 9 5/31 months equaled $172,736.13.
(11) The Commissioner rejected the refund claim for $40,337.67 for the fiscal year ending October 31, 1918, for the reason that he determined that there should be excluded from invested capital for said fiscal year the amount of $337,174.93, being class B notes held by plaintiff in the amount of $381,589.31 less payments made thereon amounting to $44,423.38.
The earnings on the common stock of plaintiff, as shown by its books for the years 1913 to 1917, inclusive, were $148,111.12 for 1913, $214,505.34 for 1914, $185,253.61 for 1915, $289,917.84 for 1916, and $564,055.37 for 1917.
L.L. Hamby, of Washington, D.C., for plaintiff.
George H. Foster, of Washington, D.C., and Herman J. Galloway, Asst. Atty. Gen., for the United States.
Argued before BOOTH, Chief Justice, and LITTLETON, WILLIAMS, GREEN, and GRAHAM, Judges.
The facts do not sustain the claim of plaintiff that so-called promissory notes given by the employee stockholders for stock constituted invested capital during the fiscal years 1917 and 1918. Under the provisions of section 207 of the Revenue Act of 1917 ( 40 Stat. 306), and section 326 of the Revenue Act of 1918 ( 40 Stat. 1092), it is necessary that the actual cash value of the notes, or evidences of indebtedness, be established. The facts do not convince us that the written promises of the employee stockholders given to plaintiff for stock had a cash value on the dates given. Plaintiff argues that the notes given by employees were bona fide paid in for stock, and should therefore be included in invested capital. This is only one of the facts necessary to be established under the statute. The notes must not only be bona fide paid in, but they must have an actual cash value, and this value has not been established.
It is further argued by plaintiff that the defendant permitted plaintiff to include in its invested capital the notes given by the officers of the corporation, designated as class A stockholders, and that, since these notes were in form the same as the notes given by the employees, designated as class B stockholders, the latter notes should also have been included in invested capital to the amount of their face value. This does not necessarily follow.
The question of the correctness of the action of the defendant in including the notes of the officers in invested capital is not before the court, and the mere fact that the defendant was satisfied that those notes were bona fide paid in and had a cash value is not proof that the class B notes given by other persons had a cash value equal to the amounts stated therein.
It is further argued that, if it is necessary that the actual cash value of these notes be shown, this is established by the fact that the earnings of the corporation from 1913 to 1917 were large, and gave the stock issued for the notes a substantial value; that under the articles of incorporation plaintiff had a lien upon the stock while the notes were outstanding, and that the makers of the notes were receiving salaries from the plaintiff. The stock issued for the notes was not held by the plaintiff as security for the notes. The only method of payment provided in the notes was through the application of dividends on the stock and the application of the proceeds from the sale thereof in the event the stockholders should desire to sell the stock. No interest was payable on the notes until after maturity, whatever the maturity date might be.
It is not the value of the stock issued that determines the amount at which the notes given in payment therefor may be included in invested capital but the actual cash value of the property received in exchange for the stock, and the earnings on the common stock for prior years do not prove the cash value of the notes given by the employees.
We do not know what salaries were paid to the employee stockholders, nor do we know what indebtednesses they had in addition to the notes given the plaintiff.
It is clear that noninterest-bearing notes are not worth their face value at the time they are executed. Kosmerl v. Commissioner of Internal Revenue (C.C.A.) 25 F.2d 87.
The defendant has included in invested capital such amounts as were paid for the stock by the employee stockholders from the dates of payment thereof, and we are not convinced that it should have included a greater amount. The petition must therefore be dismissed, and it is so ordered.