Docket No. 9077.
Dorothy Ann Kinney, Esq., and Walter G. Russell, C.P.A., for the petitioner. Allen T. Akin, Esq., for the respondent.
Petitioner bank in previous years charged off and was allowed deduction of notes as worthless. In the taxable year it declared a dividend in kind and distributed such notes to its stockholders. Later in the year recoveries were made on the notes. Held, the taxpayer is not taxable upon such recoveries. General Utilities & Operating Co., v. Helvering, 296 U.S. 200, followed. Dorothy Ann Kinney, Esq., and Walter G. Russell, C.P.A., for the petitioner. Allen T. Akin, Esq., for the respondent.
In this case there are involved declared value excess profits tax of $813.91 and excess profits tax of $28,793.28, both for the calendar year 1942. The questions presented are, first, whether the petitioner realized taxable income from the declaration and payment of a distribution in kind of notes which it had in a previous year charged off as worthless, the deduction being allowed; and, second, whether collections made on the notes, after such dividend in kind, constituted taxable income to the petitioner. From admissions made and evidence adduced, we make the following findings of fact.
FINDINGS OF FACT.
The petitioner is a corporation, organized under the law of Texas, and engaged in the business of banking at Stratford, Texas. It has outstanding 500 shares of stock. It filed its income and excess profits tax return for the calendar year 1942 with the collector for the second collection district of Texas. On October 17, 1942, the bank had 9 stockholders, of whom 5 were directors. Three of the directors worked in the bank. On that date, at a regular monthly meeting of the board of directors, all directors (L. M. Price, A. E. Pronger, P. J. Pronger, U. N. Price, and Hose Flores) being present, a dividend in kind was declared, consisting of notes which had been charged off as worthless and deducted as bad debts in income tax returns in earlier years. These notes had been charged out of assets and did not appear on the bank's books. They had been kept in a case by themselves. They were brought to the directors' meeting and the possibility of their collection discussed. About $25,000 had previously been collected on the notes included in the dividend, and on some of the notes included in the dividend payments were then being currently made. The minutes of the action taken by the directors read:
The following recoveries were read and discussed by the directors:
+--------------------------+ ¦Troy Plunk ¦5.00 ¦ +------------------+-------¦ ¦E. O. Palmer ¦15.00 ¦ +------------------+-------¦ ¦Arthur Cartrite ¦1200.00¦ +------------------+-------¦ ¦Dortha S. Daniels ¦4.00 ¦ +------------------+-------¦ ¦J. L. Turner ¦8.00 ¦ +------------------+-------¦ ¦Dortha S. Daniels ¦4.00 ¦ +--------------------------+
The payment of a dividend by the bank was next considered. Attention was called, however to the matter of increased income and excess profits taxes and the advisability of deferring the payment of a cash dividend until later in the year when more would be known about the new Income Tax Law about to be enacted in Congress. It was pointed out that the bank had a number of charged off accounts of doubtful value, also real estate carried on the books at a nominal sum of $1.00. Advisability of paying a dividend of a portion or all of these properties was discussed and fully considered. Upon motion duly made and seconded, the following resolution was adopted:
WHEREAS, This bank is the owner of several thousand dollars of charged off notes, some of which may be collected in future, and the balance of which are of doubtful value.
NOW, THEREFORE, Be it resolved that the following charged off notes be assigned to the stockholders of this bank without recourse on it, said notes being paid as a dividend in kind and without any value being placed thereon by this bank.
Then follows a listing of the notes included in the dividend. No valuation was placed on the notes by the resolution. The bank's officers hoped that the majority of the notes would be collected, but their value was difficult to determine. Notes of about $160,000 to $170,000 (the amounts unpaid thereon) were examined as to collectibility, of which about $57,000 were considered notes with remote chance of collection, and the notes were listed in the dividend resolution with an amount set opposite each, totaling $111,254.38, as to all. These included the following
+--------------------------------------------------+ ¦Troy Plunk ¦$32.29 ¦J. L. Turner ¦$676.56 ¦ +------------------+--------+-------------+--------¦ ¦E. O. Palmer ¦1,101.54¦H. B. Ritchie¦75.00 ¦ +------------------+--------+-------------+--------¦ ¦Arthur Cartrite ¦4,664.35¦H. B. Ritchie¦5,103.07¦ +------------------+--------+-------------+--------¦ ¦Dorothy S. Daniels¦82.00 ¦ ¦ ¦ +--------------------------------------------------+
Notes considered completely collectible were not included in the dividend.
After the directors' meeting, the directors, as stockholders, further discussed the matter. L. M. Price suggested, with the approval of P. J. Pronger, that W. n. Price take charge for the stockholders of the notes which had been included in the dividend. The matter was discussed and the notes included in the dividend were endorsed, within the next few days, to W. N. Price, as follows: ‘Pay to the order of W. N. Price, Special, without recourse, First State Bank of Stratford, by Hose Flores, Assistant Cashier.‘ Amounts thereafter collected in 1942 on the dividend notes were deposited in the bank in an account designated, ‘W. N. Price, Special.‘ W. N. Price, in attempting collection of the dividend notes, did nothing special that he did not do in collecting notes owed to the bank. At various times he worked after banking hours collecting the dividend notes. No system of bookkeeping for the dividend notes was set up by the stockholders in 1942.
On November 15, 1942, the board of directors held a meeting, at which they discussed recoveries as follows: J. L. Turner, $8; H. B. Ritchey, $40; and a loss on H. B. Ritchey loan, $75. H. B. Ritchie had two notes, one of $75 and one of $5,103.07; J. L. Turner, one of $676.56. The $40 collection from H. B. Ritchey and $8 from J. L. Turner were deposited in the W. N. Price special account on December 19, 1942.
From October 17, 1942, to December 31, 1942, collections of $11,662.71 were made on the dividend notes. The record does not indicate what part is interest, or principal. No report as to collections on the dividend notes was made to the directors by W. N. Price. On several occasions he reported the amounts collected to the stockholders, by telephone or personally. The debtors were not notified of the assignment of their debts to the stockholders. The notes when paid were stamped ‘paid‘ with a stamp on which appeared the bank's name, but not the stockholders' committee. The stockholders could withdraw such collections from the W. N. Price special account; they were not available to the bank. Between 60 and 70 per cent of the dividend notes have been collected. The first distribution to stockholders of money collected was in November 1943. This was decided on by the stockholders who were directors, not by all of the stockholders. There was no particular reason for delay. The stockholders did not particularly need the money. They did not demand the money in 1942. W. N. Price did not report any of the collections for taxation in 1942.
In the deficiency notice the Commissioner determined:
(a) On 17 October 1942, at a regular meeting of your board of directors, a dividend was declared in kind consisting of certain notes which you charged off and deducted as bad debts in your income tax return for prior years. Payments totalling $11,662.71 were made on such notes during the period from 17 October 1942 to 31 December 1942, of which $10,548.20 is held to be taxable to you as recoveries on bad debts or as a profit on the distribution of a dividend in kind.
The amount of this adjustment also includes increase in taxable recoveries in amount of $202.80 and $321.25 increase in interest collected in taxable year on the notes involved.
Did the petitioner realize taxable income by the distribution in kind of notes on October 17, 1942? It relies upon General Utilities & Operating Co. v. Helvering 296 U.S. 200, as authority that there was no such income. That case, followed by others to the same effect (Estate of H. H. Timken, 47 B.T.A. 494 (518); National Carbon Co, 2 T.C. 249 (266), laid down the rule that the distribution, as a dividend in kind, of property which has appreciated in value since acquisition, does not result in gain where the dividend is declared only in the property, not in money the obligation to pay is then discharged by payment in appreciated property. The petitioner therefore argues that, since it merely distributed the notes in kind to its stockholders, it incurred no tax. The respondent, however, says in substance that, having recovered its capital investment in the notes through deduction for worthless debts in prior years, the petitioner was in 1942 ‘in the position of realizing income only, from the amounts collected. The petitioner had no asset in the charged off notes which could be the subject of a dividend in kind. Thus the petitioner in declaring the worthless notes as a dividend and assigning them to the stockholders had done nothing more than assign the right to receive prospective income from a loss which it had sustained in a prior year. ‘ Respondent therefore cites and quotes Helvering v. Horst, 311 U.S. 112, and cites Helvering v. Eubank, 311 U.S. 122, both as to nonassignability of income. National Bank of Commerce of Seattle, 40 B.T.A. 72; affd, 115 Fed.(2d) 875; and Atlas Steamship Co., 18 B.T.A. 654, are also relied on. We have studied closely these cases on this interesting question, but in our opinion they do not sustain the respondent's position.
We have here, on its face, a dividend in kind which under the settled law indicated in the General Utilities & Operating Co. case, supra, is no ground for realization of taxable income; and our problem therefore is: Does the fact of previous charge-off, as worthless, of the notes involved, distinguish that case? We do not think so. Though it is true that the National Bank of Commerce of Seattle case, supra, states as respondent points out, that after the loans there involved were charged off and deducted from income, they ‘were no longer a capital asset but represented income,‘ yet it was held that when they were transferred to another bank, in a nontaxable reorganization, recoveries thereafter made were income, within the broad meaning of section 22(a), Internal Revenue Code, of the the transferee, the transferee having the same basis of zero which the transferor had after the charge-off and deduction from income. Here, instead of transfer in a reorganization, we find a transfer in a dividend in kind, and the National Bank of Commerce case seems to us recognition of the principle that, despite their nature as representing income after deduction by the transferor bank, such loans nevertheless are subject to transfer as property and may constitute income to the transferee. The Horst and Eubanks cases, supra, do not help the respondent. That line of authority involves transfers of rights to income, without consideration, where it was denied that the transferor was freed from tax. Here, it can not be said that there was assignment of the notes for no consideration. Distribution of a dividend in kind to stockholders is not gift, and is not without consideration— which appears inherent in the original cost of the stock upon which the dividend in kind is received. We think the logic of the Horst and similar cases is not applicable here. The Atlas Steamship case involved assignment by a corporation (to its stockholders, for stock canceled) of rights to insurance, after complete loss of a ship. Some of the insurance had already been collected. Held, no dividend of the ship in kind. Here the notes were not lost, nor the mere right to receive future income from them assigned. Though representing, after the charge-off and deduction, income which had replaced the original capital investment in them, they were nevertheless still owned by the petitioner, were property, and were assigned and transferred— unlike the ship in the Atlas case or the bond in the Horst case. Not mere interest coupons, but the notes, with all their rights, were assigned to the stockholders. The property which produced the income was assigned— the tree and the fruit. Though not carried on the bank's books as live assets, the notes can not fail to be seen as in fact assets, belongings of the bank, regardless of what they were worth. As such they passed to the ownership of the stockholders, in a transaction which under the authority above noted entailed no income to the petitioner, whether or not values had appreciated. Here the value had appreciated (after a recovery of base, reducing it to zero, by the charge-off and deduction), but that is of no import. If, as is said in the National Bank of Commerce case, such loans (though called mere representation of income) became capital assets in the hands of the transferee in a reorganization, here in our view they passed as property to the stockholder distributees-in-kind, bearing with them the right to income, so that the later recoveries on them in 1942 belonged to the stockholders, not to the petitioner. That the petitioner had in previous years recovered its base by deducted charge-off does not eliminate application of the General Utilities case and those following it.
Though the respondent also suggests application of Helvering v. Clifford, 309 U.S. 331, because he says the bank retained control, after the dividend, of the disposition of the money collected, we do not view this as a case involving the principles enunciated in that authority, nor the facts as sufficient for its application. The stockholders were owners of the notes after the assignment, and neither the fact that the stockholder managing their collection was also a director, nor the fact of decision by stockholders who were directors as to time of disposition of recoveries, nor discussion, after the dividend, of the dividend notes by the directors, indicates such control as comes within the ambit of the Clifford doctrine. The stockholders plainly could have recovered the notes against the bank and were aware of the distributions.
We conclude and hold that the recoveries on the notes in 1942 were not income to the petitioner.
Reviewed by the court.
Decision will be entered under Rule 50. OPPER, J., dissenting: If a distribution in property is made to stockholders and all that the transaction envisages is a receipt in kind, it may be that the aspect of gain to the corporation lacks significance. But where the circumstances are such as to suggest that the true character of the operation is the receipt of cash the courts will, as ordinarily in surveying tax consequences, renounce the shadow and grasp the substance, and will treat as distributed that which it becomes plain the parties intended the corporation should relinquish and the stockholders should obtain. The principle broadly involved is that an assignment of anticipated future income will not relieve the assignor of tax.
But the loss gander does not follow the gain goose. R. D. Merrill Co., 4 T.C. 955.
Thus, in Commissioner v. Court Holding Co., 324 U.S. 331, the gain from a sale purportedly carried out by stockholders was, notwithstanding a distribution of the property to them, attributed to the corporate predecessor. And the much earlier case of Atlas Steamship Co., 18 B.T.A. 654, the proceeds of insurance policies on a lost vessel were viewed as cash distributions to the corporate taxpayer's shareholders, resulting in a gain to it, notwithstanding ‘that the stockholders were assigned the right to receive the proceeds of the insurance policies direct from the (insurance) companies rather than from the petitioner.‘ Of course, in that case the corporation, being on a cash basis, would not have been chargeable with the gain represented by the excess of the insurance over the basis of the vessel until the insurance had actually been collected. On the assumption of the present case that a dividend in kind of the insurance could be declared before the cash was actually received, which would exculpate the corporation, Atlas Steamship Co. should have been decided the other way.
If it be suggested that the present petitioner is on the accrual basis, the case against it becomes even stronger. In that event, when the notes reached the point of being apparently collectible, as they clearly did in the present tax year, they were thereupon automatically accruable to petitioner as income. Clifton Manufacturing Co., v. Commissioner (C.C.A., 4th Cir.) 137 Fed.(2d) 290; certiorari denied, 302 U.S. 720.
The atlas Steamship doctrine in fact goes back to Ormsby McKnight Mitchel, 1 B.T.A. 143, decided in 1924, which is in turn the direct progenitor of Lucas v. Earl, 281 U.S. 111, and Burnet v. Leininger, 285 U.S. 136, and the collateral ancestor of such more modern and familiar pronouncements as Griffiths v. Helvering, 308 U.S. 355, Helvering v. Horst, 311 U.S. 112; and Lusthaus v. Commissioner, 327 U.S. 293.
And see Mitchel v. Bowers (Dist. Ct., S. Dist. N.Y.), 9 Fed. (2d) 414; affd. (C.C.A., 2d Cir.), 15 Fed.(2d) 287; certiorari denied, 273 U.S. 759.
It hence seems totally unnecessary to attempt to extend the doctrine of General Utilities & Operating Co. v. Helvering, 296 U.S. 200, to such a proceeding as this. The facts make it clear that it was not property in the true sense of which petitioner was making a distribution. Petitioner was about to collect in cash the proceeds of the notes, which would then have been income to it upon receipt, and merely assigned to its stockholders this anticipated right to expected cash income. It was the prospective receipt of income from notes which had incidentally a zero basis that was anticipated and in fact dealt with. The course of conduct of the parties, the fact that the notes were manifestly838 regarded as collectible at least to a significant extent, the actual process of collection, the details of receipt and distribution, all unite in convincing proof that only upon the collection of the anticipated cash was there to be any real transfer from corporation to stockholder. Since respondent is proposing to add to petitioner's income only the amount actually realized upon the notes in the month or two of the tax year succeeding the purported assignment, it seems to me this was clearly the income of the corporation before it came to the stockholders and that the deficiency should accordingly be sustained.