Opinion
No. K-338.
May 2, 1932.
Action by the Louden Machinery Company against the United States.
Petition dismissed.
This case having been heard by the Court of Claims, the court, upon the evidence and the report of a Commissioner, makes the following special findings of fact: 1. The plaintiff is, and was at all material times, a corporation organized and existing under the laws of the state of Iowa and engaged in the manufacture of barn tools and other similar products.
2. The plaintiff duly filed its income tax return for the year 1925 and therein deducted from its gross income the sum of $13,958.13, representing a refund to certain of its stockholders of interest aggregating that amount which they had paid to the plaintiff during the years 1920, 1921, and 1922 on their several promissory notes. Thereafter the Commissioner of Internal Revenue caused an examination to be made of the books and records of the plaintiff, and following that examination assessed against the plaintiff an additional tax of $2,099.28, $1,814.57 of which resulted from his disallowance of the deduction of $13,958.13 hereinabove referred to.
On November 24, 1928, the plaintiff paid to the collector of internal revenue at Dubuque, Iowa, an additional tax of $2,099.28, which included the aforesaid sum of $1,814.57.
3. On or about March 3, 1929, plaintiff duly filed a claim for refund for the amount of $1,814.57 collected from it as above set out, which said refund claim was denied by the Commissioner of Internal Revenue on June 28, 1929.
4. No action upon this claim other than above set out has been taken before Congress or any of the departments of the government.
Plaintiff is a citizen of the United States and loyal to the United States government, and has not at any time aided or abetted in any manner or given comfort to any sovereign government that is, or ever has been, at war with the United States.
5. The circumstances under which said interest was refunded by plaintiff in 1925 were as follows:
In June, 1920, plaintiff purchased all of the capital stock of the Porter Company, a corporation, for $150,000 and paid therefor with cash and stock of the plaintiff corporation. Thereupon, plaintiff recapitalized the Porter Company at $400,000, of which $200,000 was represented by preferred stock and $200,000 by common stock.
Plaintiff thereafter and on or about June 16, 1920, sold at par to twelve of its stockholders, all except one of whom were officers or employees of the plaintiff company, $150,000 of the new common stock of the Porter Company, said purchases ranging in amounts from $5,000 to $25,000. At that time the stockholders of the plaintiff numbered between two hundred and two hundred and fifty.
6. The twelve purchasers of the Porter Company stock paid therefor by their respective interest-bearing demand promissory notes in the amounts of their respective purchases, each note being secured by the stock of the Porter Company purchased by the makers of the notes. Said notes were dated June 16, 1920. The notes in each instance were prepared by A.E. Lebagh, treasurer of the plaintiff company, for the signature of their respective makers. Mr. Labagh used the ordinary form notes usually used by the company in its business transactions, and these forms recited that the notes bore interest at the rate of six per cent. per annum, payable annually.
Plaintiff kept its books on the accrual and calendar year basis. No interest was accrued on the plaintiff's books on account of the said notes at the close of the calendar year 1920 because of the brief period of time between the execution of the notes and the end of the year, but on December 31, 1921, the interest on the notes was accrued on the plaintiff's books from June 16, 1920, in the amount of $13,875.
Mr. Labagh was one of the subscribers to the stock of the Porter Company. He paid to the plaintiff the interest which accrued on the note executed by him, and insisted that the other subscribers pay the interest which had accrued on the notes given by them. At the request of the subscriber, $50 per month was deducted from his salary to pay these interest charges. When Mr. Labagh on several occasions attempted to collect interest on the notes, certain of the makers thereof protested against the payment of interest on their respective notes, on the ground that it had not been contemplated at the time of their purchase of the Porter stock that interest would be charged on the notes given in payment thereof. Mr. Labagh continued to insist, however, that, inasmuch as the notes which they had given were interest-bearing, the interest would have to be paid.
During the year 1920 the plaintiff collected $250 in interest on the said notes and during the year 1921 it collected $1,312.50 on the same account. As a result of the dissatisfaction which had been engendered among several of the stockholders and officers of the plaintiff by reason of their being charged with interest on their respective notes, the original notes were on January 1, 1922, returned to their makers and non-interest-bearing renewal notes were taken in lieu thereof. That exchange was made at the instance of certain of the officers and directors of the company, but no formal action was taken thereon at that time by the plaintiff's board of directors. On December 31, 1921, there was due on the original notes according to the terms thereof an aggregate balance of $12,312.50 in unpaid interest. That accrued interest was paid to the plaintiff during the year 1922, $8,574.20 thereof being paid in cash and the remaining $3,738.30 thereof being paid by notes. The several amounts, aggregating $13,875, were credited on the books of the plaintiff, as collected, to its interest account. Although no agreement had been entered into between the plaintiff and the makers of the said notes prior to the payment of the interest charges aforesaid, whereby the said payments of interest were to be refunded, there had been some informal discussion among some of the officers and directors concerning the possibility of an ultimate refund of such payments. The said payments of interest aggregating $13,875 were reported by the plaintiff as income in its returns for federal tax purposes during the years in which the interest payments were collected and taxes were duly paid thereon.
7. On August 1, 1925, at a special meeting of the board of directors of the plaintiff company, the following resolution was adopted: "Minutes of special meeting of the board of directors of the Louden Machinery Company held at company's office August 1, 1925. Moved by Bruce Louden, seconded by A.C. Louden, that the interest paid by certain stockholders of this company on notes dated June 21, 1920, given for stock, be refunded. Carried. Signed, Bruce Louden. Meeting adjourned."
Pursuant to said resolution there was refunded during the year 1925 to the makers of said notes the sum of $13,958.13, representing interest theretofore paid by them on the original interest-bearing notes executed June 16, 1920. The amount refunded was $83.13 in excess of the amount paid. Of the amount refunded $10,569.83 was refunded in cash and the balance by canceling the unpaid interest notes theretofore given the plaintiff by the subscribers to the stock of the Porter Company.
The payments made by the plaintiff to its officers and employees as aforesaid were charged on plaintiff's books to an account styled "Gratuities," and later the plaintiff's auditors transferred the entries to an account styled "Interest refunded." The account "Gratuities" was usually charged with amounts expended by the plaintiff for donations to business associations, trade organizations, charities, etc.
The return of the interest to the stockholders was not an ordinary and necessary expense of the business of the company. It was a gratuity.
Jesse I. Miller, of Washington, D.C., for plaintiff.
Joseph H. Sheppard, of Washington, D.C., and Charles B. Rugg, Asst. Atty. Gen., for the United States.
Before BOOTH, Chief Justice, and WHALEY, WILLIAMS, LITTLETON, and GREEN, Judges.
The plaintiff is suing to recover the sum of $1,814.57, being the amount of interest returned by it to certain of its stockholders in the year 1925, having been paid by the said stockholders on certain demand promissory notes bearing interest at the rate collected.
It is contended by the plaintiff that the amount returned to its stockholders was an ordinary and necessary business expense and deductible from its gross income for that year. The plaintiff was the owner of the capital stock of the Porter Company. It sold to a certain number of its stockholders a certain number of shares of the Porter Company common stock at par and took in payment therefor the demand promissory notes of each stockholder, and these notes were secured by the assignment of the shares of stock of the Porter Company as collateral for the payment of the notes. The notes were in the ordinary form of collateral notes and bore interest at the rate of 6 per cent. per annum, payable annually. The plaintiff kept its books on an accrual basis and made its tax return on the calendar year basis. At the end of the calendar year 1921 there had accrued on the company's books interest to that date in the sum of $13,875, and this amount was included in its taxable income for the year 1921. On January 1, 1922, these interest-bearing notes were canceled and non-interest-bearing notes were given in lieu thereof. Certain of the stockholders had protested, and continued to protest, that it was never intended the notes should carry interest, but the treasurer of the plaintiff, who was one of the originators of the plan to purchase this stock, not only paid the interest on his note, but insisted and required the other note makers to pay interest as called for in the notes. As the interest payments were made to the plaintiff company, they were reported as income in its federal tax return for the years in which the payments were collected, and taxes were duly paid thereon. In January, 1925, more than two years after these interest-bearing notes had been canceled and the interest collected in cash, or by notes, the board of directors of plaintiff company passed a resolution directing that the interest be refunded to those stockholders who had paid it. This was done, either by payments in cash, or by cancellation of the notes given in payment of the interest. The plaintiff deducted from its gross income for the year 1925 the amount of the interest refunded. The Commissioner of Internal Revenue disallowed this deduction, and, by reason of its disallowance, assessed against and collected from the plaintiff an additional tax of $1,814.57. A claim for refund was filed and rejected.
The sole question in this case is whether the refunding of this interest is an ordinary and necessary expense or a "gratuity." The makers of the notes were legally bound to pay the interest, and as it was collected it was entered on the books of the company as income and returned as part of the gross income of the company, and taxes were paid thereon. No question was made at that time that the collection of the interest was erroneous, or an illegal collection. If there had been any doubt as to the illegality of its payment, then the plaintiff overstated its income for the years in which the interest charges were collected by the amount of such interest, and could have filed a claim for overpayment for those years. This was not done, but, on the contrary, the company treated it as part of its income and returned it for taxation. In 1925 the board of directors refunded these interest charges to the makers of the notes. The resolution is silent as to any illegal collection, or any notation that the notes should not have carried interest, and indicates in no way that the interest had been improperly collected. After the passage of this resolution the treasurer of the company who had prepared the notes originally, and was one of those who paid the interest and was entirely familiar with the transaction from the making of the notes to the passage of the resolution, entered on the books of the company the refunding of this amount under the head of "gratuities."
The company was under no legal obligation to repay the interest collected as it had been legally collected under legal contracts entered into by the respective stockholders. It was under no moral obligation to refund this amount. It was a voluntary and gratuitous act. The taking of this amount out of the assets of the company and paying it over to certain stockholders by order of the board of directors could not in any way or any manner be construed as an ordinary and necessary expense paid or incurred in carrying on the trade or business. The record does not show that the company received any benefit as a consideration for this refundment. On the other hand, those who purchased the stock and gave their notes did receive a benefit in that for years they did not have to pay any carrying charges on their notes given in payment for the stock. See Northwestern Cabinet Company v. Commissioner, 13 B.T.A. 533, and Dieckerhoff, Raffloer Co. v. Commissioner, 17 B.T.A. 1251.
In our opinion, the Commissioner was correct in holding that the return of the interest was not an ordinary and necessary business expense and deductible as such. The petition should be dismissed. It is so ordered.