Metropolitan Tobacco Co. v. Commissioner ( 1929 )

METROPOLITAN TOBACCO CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Metropolitan Tobacco Co. v. Commissioner

Docket No. 15664.

United States Board of Tax Appeals

16 B.T.A. 525; 1929 BTA LEXIS 2574;

May 13, 1929, Promulgated

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1. Instruments executed by employees of the petitioner corporation as a part of the transaction by which they purchased its stock, held to be evidences of indebtedness received in payment for such stock, which may be included in invested capital at their actual cash value at the time paid in.

2. The actual cash value of such obligations is their value when received in payment of the stock; their value in the market if offered without the stock in payment for which such obligations were given and without recourse against the petitioner.

3. Evidence insufficient to establish the actual cash value of such obligations when paid in for stock.

W. W. Spalding, Esq., for the petitioner.

L. A. Luce, Esq., for the respondent.

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PHILLIPS

The Commissioner asserted a deficiency in income and profits taxes of $2,430.75 for the year 1920 and $1,303.98 for the year 1921. The petitioner has instituted this proceeding for a redetermination of its liability. It is alleged that the respondent erred in excluding from petitioner's invested capital for the year 1921 the sum of $274,635.83, representing unpaid subscriptions to petitioner's capital stock in the amount of $278,460, par value of the stock of the petitioner, prorated from the date the stock was issued in 1921 to the end of that year.

FINDINGS OF FACT.

The petitioner is a corporation organized under the laws of the State of New York, with its principal office in New York City. It is engaged in the business of buying and selling tobaccos and tobacco products such as cigars, cigarettes, and chewing tobacco.

At a special meeting of the board of directors of petitioner held on the sixth day of October, 1920, the following resolution was adopted:

RESOLVED that, at the special meeting of the stockholders to approve, ratify and confirm the payment of a stock dividend on the Common Capital Stock of the Company, permission be asked of the stockholders to issue and sell, after the payment of such stock dividend, not exceeding $1,000,000 par value of the Common Capital Stock of the Company at a price not less than par to the Officers and employees of the Company, in such amounts at such times and on such terms and conditions, as the Board of Directors deem for the best interest of the Company.

At a special meeting of the stockholders of the petitioner held on October 27, 1920, the following resolution was adopted:

RESOLVED that the Directors of the Company be, and they hereby are, authorized after the payment of the stock dividend, to issue and sell, not exceeding $1,000,000 par value of the Common Capital Stock of the Company, at a price not less than par, to the Officers and employees of the Company, in such amounts, at such times and on such terms and conditions as the Board of Directors deem for the best interest of the Company, provided however, that on each allotment of such stock, the aggregate of such stock allotted to employees, shall be twice the aggregate amount of such stock allotted to Officers, Branch Managers and Assistant Branch Managers.

Pursuant to this resolution a plan for the sale of the stock to the employees of petitioner and contracts for the sale of such stock were prepared and presented to the board of directors and approved and ratified by them in a resolution adopted December 15, 1920. Pursuant to this plan agreements were prepared which were signed and executed by the employees subscribing to this stock. These agreements provided as follows:

WHEREAS, METROPOLITAN TOBACCO COMPANY, a corporation organized and existing under the laws of the State of New York, hereinafter called the Company, has this day sold to me shares of the Common Capital Stock of the said Company, represented by certificate number for the sum of Dollars, and I have paid to the Company, on account of the purchase price thereof, the sum of Dollars, and there is still due on account of the said purchase price the balance of Dollars; and

WHEREAS, the Company has sold to me such shares of stock at the price aforesaid, and will allow me to pay said balance as hereinafter set forth, on my promise to agree and do as hereinafter provided on my part;

NOW THEREFORE, THIS AGREEMENT WITNESSETH: That for and in consideration of the premises and of such sale on the terms aforesaid, and of One ( $1) Dollar to me in hand paid, the receipt whereof is hereby acknowledged, I of the City of County of and State of do hereby agree with the said Company as follows:

FIRST: I agree to pay to the Company an account of the said unpaid remainder of said purchase price at least five per centum (5%) thereof on August 1, 192 , and five per centum (5%) thereof on each February 1st and August 1st thereafter, together with interest on all unpaid parts of said purchase price at the rate of five per centum (5%) per annum, payable February 1st of each year until such purchase price and all interest thereon shall be fully paid, having deposited with the Company, until full payment of such purchase price with interest as aforesaid, but not as collateral security for such payment, the said certificate endorsed in blank, and I do hereby agree with the Company that, in case I make any default in any of the payments either on account of said balance or of said interest, and such default continues for one hundred and twenty (120) days, the Company shall have and I do hereby give it, the right of acquiring, at its option, within one hundred and twenty (120) days thereafter, said shares of stock represented by such certificate, in its absolute right, by repaying to me the exact amount which I shall have paid to the said Company on account of said purchase price of such shares of stock and without repaying to me any interest I may have paid thereon, the acceptance of the said option to be signified by mailing to me a written notice of acceptance and payment to be made by certified check tendered me at the office of the Company ten (10) days after such mailing, at which time and place I agree to attend to receive such payment.

SECOND: I further agree with the Company that in case I leave or am discharged from its employ before the expiration of five (5) years from the date of this agreement or before I shall have completed the payment of the purchase price of said shares of stock, whichever period is longer, (except in case of discharge because of total and permanent physical disability, in which event the provisions of paragraph (g) hereof shall become effective) the Company shall have, and I hereby give it, the right of acquiring, at its option, within one hundred and twenty (120) days after I shall leave the employ of, or be discharged by, the Company, the said shares of stock, in its absolute right, by repaying to me the exact amount which I shall have paid to the said Company on account of said purchase price of such shares of stock and without repaying to me any interest I may have paid thereon, the acceptance of said option to be signified by mailing to me a written notice of acceptance and such payment to be made by a certified check of the Company tendered to me ten (10) days after such mailing at the Company's office on the surrender by me of the certificate representing said stock, provided said certificate be then in my possession, at which time and place I agree to attend to receive such payment and to endorse, deliver and surrender said certificate.

THIRD: I further agree with the Company that, in case it shall become entitled to acquire the absolute ownership of such shares of stock under the foregoing provisions, and before possession of the said certificate shall have been delivered to me as hereinafter provided, no act, other than the payment to me of the exact amount above provided to be paid by it within the period and in the manner aforesaid, and no notice whatsoever, except as aforesaid, shall be required for the acquisition of such ownership by said Company, and, upon such payment, the Company shall become and be the sole and absolute owner of the said shares of stock, free and clear of any claim thereto or right therein on my part or on the part of any one claiming through or under me, and shall be entitled to have the said certificate forthwith transferred to it upon the books of the Company, and to that end, do all necessary acts, including the appropriate filling in of the blanks in the transfer endorsed thereon. But, if, at the time the Company becomes entitled to acquire the absolute ownership of said stock, the said certificate shall have been delivered to me, as hereinafter provided, I hereby agree that, upon repayment to me of the said exact amount within the time and in the manner and at the place hereinbefore specified, I will surrender the said certificate to the Company with the transfer endorsed thereon duly signed by me, and I will do and perform any and all acts, necessary and proper, to enable the Company to acquire the absolute ownership of such shares of stock, free and clear of any and every claim thereto or right thereon on my part or on the part of any one claiming through or under me, and to enable the Company to transfer title to the said certificate to itself in its own right.

IT IS EXPRESSLY UNDERSTOOD AND AGREED AS FOLLOWS:

(a) That the sale of the said stock to me is a conditional sale made on the express condition that I perform each and every the terms of this agreement, both as to payment and otherwise;

(b) That I shall be entitled to receive any dividends paid on the stock represented by such certificate while the same shall remain in the possession of the Company, and shall not have been acquired by the Company in its own right under the foregoing provisions;

(c) That I shall have the right to anticipate on either February 1st or August 1st of any year any and all payments on account of the said unpaid balance of the purchase price;

(d) That when, prior to any acquisition by the Company under the foregoing provisions, I shall have made full payment of the purchase price of the said stock together with all interest thereon accrued, I shall be entitled to the possession of the said certificate which will have endorsed upon its face a notice that it is issued subject to the terms, conditions and limitations of this agreement;

(e) That until after the expiration of five (5) years from the date of this agreement or the completion by me of the payment of the remainder of the purchase price, whichever period is longer, I will not sell, assign or transfer the said stock or any part thereof, or the certificate representing the same, without first offering, in writing, to sell the said stock to the Company at a price equal to the exact amount paid in cash by me to the Company on account of the purchase price thereof, and without repayment to me of any interest I may have paid thereon, which offer the Company shall have one hundred and twenty (120) days to accept, (except in case of a sale to the Company under the conditions hereinabove provided for or except in case of my total and permanent physical disability or death before the expiration of five (5) years from the date of this agreement or the completion by me of the payment of the remainder of the purchase price, whichever period is longer, hereinafter provided for), such acceptance to be signified by mailing to me a written notice of acceptance and such payment to be made by a certified check of the Company tendered to me ten (10) days after such mailing at the Company's office on the surrender by me of the certificate representing said stock, provided said certificate be then in my possession, at which time and place I agree to attend to receive such payment and to endorse, deliver and surrender said certificate; nor will I, until after the expiration of said period, pledge, hypothecate or in any way incumber the said stock or any part thereof or the certificate representing the same;

(f) That after the expiration of said five (5) years and after I shall have completed the payment of the purchase price of said shares of stock, (unless said shares of stock shall, prior thereto, have been acquired by the Company under the foregoing provisions) I shall be entitled to surrender the said certificate of stock this day sold to me, upon which is endorsed a reference to this agreement and, in return therefor, I shall be entitled to receive a certificate for a like number of shares, made out in my name or in the name of my nominee, upon which certificate no reference to this agreement shall be endorsed, and which certificate shall be held by me in my own right, free and clear of any and all conditions, restrictions and limitations whatsoever;

(g) In case I am totally and permanently physically disabled or die prior to the expiration of five (5) years from the date hereof or after five (5) years and prior to the time when I shall have completed the payment of the purchase price of the said shares of stock (unless said shares of stock shall prior to said disability or death have been acquired by the Company under the foregoing provisions) the Company shall, within one hundred and twenty (120) days after such disability or the appointment of my executor or administrator, have the right of acquiring, at its option, the said shares of stock in its absolute right, the acceptance of such option to be signified by mailing to me or my personal representatives a written notice of acceptance, and payment to be made ten (10) days thereafter by tender to me or my personal representatives of a certified check of the Company at the office of the Company for the purchase price thereof, determined as hereinafter set forth, on the surrender to the Company of the said certificate ready for transfer; at which time and place I agree I or they will attend to receive such payment and to endorse, deliver and surrender said certificate; such purchase price shall be the par value of the stock fully paid for by me, plus either the difference between the par value of the stock sold to me and the value of such stock at One hundred and ten ( $110) Dollars per share or the difference between the par value of the stock sold to me and the book-value thereof, whichever is higher, such book-value to be computed as follows: The financial statement of the Company last presented to, and approved by the Board of Directors of the Company before the exercise of such option by the Company, shall determine and be binding and conclusive evidence of the value of the assets of the Company and the amount of its liabilities, and the amount by which the former exceed the latter divided by the total number of shares then issued and outstanding, shall be the book-value of one share of such stock for the purpose of the sale last above mentioned and shall be accepted by both parties hereto as binding and conclusive on both of them; but in case the Company shall not, within said one hundred and twenty (120) days, elect to purchase said shares of stock, I or my personal representatives shall have the option to be exercised within one hundred and eighty (180) days after my disability or death either.

(1) Upon surrender to the original certificate (if in my or their possession) properly endorsed for transfer, of receiving in exchange a new certificate for such a number of whole shares of stock of the Company as the exact amount already paid by me to the Company on account of said purchase price, but not the interest paid thereon, will purchase, computed at the price of One hundred ( $100) Dollars per share, together with a refund in cash of any excess paid by me over the amount necessary to purchase full shares of such stock, which stock shall be held by me or them in my own or their own right, free and clear of any and all conditions, restrictions or limitations whatsoever and the certificate for which shall not have endorsed thereon any reference to this agreement, or

(2) Of carrying out the terms of paragraph "First" of this agreement as to payments for said stock and upon payment of the full purchase price, together with interest as aforesaid (or in case the said stock shall, at the time of my disability or death have been fully paid for and the certificate shall then be in my possession, then immediately upon the happening of such disability or death) I or they shall be entitled, upon the surrender of such certificate, to receive a new certificate of the number of shares of the capital stock of the Company I was originally entitled to receive under the provisions of the first recital hereof, which new certificate is to be made out in my own name or in the name of my personal representatives or in the name of my or their nominee and no reference to this agreement shall be endorsed thereon and this new certificate shall be held by me or them in my or their own right, free and clear of any and all conditions, restrictions and limitations whatsoever.

If after the acceptance of any option given to the Company hereunder, or whenever called on so to do, I or my personal representatives or assigns shall, in any respect, fail to carry out and completely perform all of the provisions of paragraphs "First," "Second," "Third," (e) and (g) hereof on my part to be performed, in that event I further agree that the Company shall forthwith have the right to cancel the certificate of stock then or formerly standing in my name on the books of the Company, to refuse to pay any further dividends on such stock so cancelled, to refuse to make any payment or payments to retire such stock and, disregarding such outstanding certificate, to issue a new certificate in the Company's name or otherwise as it may elect for the shares represented by such outstanding certificate, as if such certificate were properly retired and cancelled on the books of the Company.

If during the period covered by this contract, the Company shall declare a stock dividend and I shall receive a certificate for one or more additional shares of such stock in payment thereof, I further agree that every provision of this contract applicable to the stock covered thereby shall be equally applicable to the stock issued to me as such stock dividend, on such stock; and none of such stock dividend shall be freed or released from any provision of this contract until all the stock covered by it shall be also so freed or released.

Every provision for the giving of notice contained herein, shall be deemed fulfilled by written notice personally served on me or mailed to me at my address, as the same shall appear on the stockbook of the Company.

Wherever, in this contract, the phrase "total and permanent physical disability" occurs, the date on which such disability takes place, for the purposes of this contract, shall be the date on which a reputable physician acceptable to the Company shall certify to the Company, in writing, that I am permanently and totally physically disabled.

The terms of this agreement shall be binding upon, and apply to myself, my personal representatives and assigns.

On or about February 1, 1921, petitioner entered into agreements with 332 of its employees, who had been in its employ at least five years, for the purchase of its capital stock in the amount of $572,200, par value. Certificates of such stock having a par value of $572,200 were issued in the names of the respective employees in consideration of partial payments in cash and signed agreements, in the form provided by petitioner, for the payment of the balance of the purchase price in installments. The stock certificates were endorsed in blank by the employees and returned to the corporation to hold until all installments were paid by those employees subscribing to the stock, according to their agreement. On the stock so issued the sum of $293,740 was paid in cash on or about February 1, 1921, as partial payments on the purchase price and the remainder, $278,460, was payable in installments in accordance with the terms of the signed agreements.

Each certificate of the stock issued to the employees had stamped upon its face the following notation:

The stock represented by this certificate is issued and held subject to the terms, conditions and limitations of a certain agreement made by and between the person whose name appears on this certificate and the Metropolitan Tobacco Co., dated February 1, 192 , a copy of which agreement is on file in the office of the said Company.

METROPOLITAN TOBACCO COMPANY.

Interest was charged by petitioner on the deferred payments at the rate of 5 per cent per annum. During the year 1921, petitioner received interest on such deferred payments in the amount of $13,245.91, which was included in its income-tax return for that year. Petitioner paid dividends on the stock issued at the annual rate of 6 per cent.

No notes were executed, and none were required by the petitioner, for the deferred payments under the contract. Approximately 100 of the employees failed to live up to their installment contract agreements. In the computation of the petitioner's invested capital for the year 1921, the initial payments of $293,740 made by the employees of petitioner on the subscription price of the stock were allowed by the respondent as invested capital from the date when paid and included in petitioner's invested capital, in the prorated amount of $248,966.36, but the amount of the deferred payments, $278,460, was excluded by the respondent from petitioner's invested capital.

OPINION.

PHILLIPS: Petitioner contends that it is entitled to include in invested capital for the year 1921 the prorated amount of $274,636.83, representing $278,460 par value of the deferred payments on the capital stock subscribed for by its employees on or about February 1, 1921. The respondent has included in petitioner's invested capital for 1921 the initial cash payments of $293,740 made by the employees of petitioner on the subscription price of the stock, at the time the stock was issued, in the prorated amount of $248,966.36, and has disallowed the inclusion of the balance represented by deferred payments.

Section 326(a) of the Revenue Act of 1921 provides that the term "invested capital" for any year means, among other things, "(1) actual cash bona fide paid in for stock or shares"; "(2) actual cash value of tangible property other than cash bona fide paid in for stock or shares, at the time of such payment * * *."

Section 325(a) defines the term "tangible property" to mean stocks, bonds, notes, and other evidences of indebtedness, bills and accounts receivable, leaseholds, and other property other than the "intangible property."

The petitioner contends that the contracts under which the employees agreed to pay the balance of the purchase price of stock issued to them were "tangible property" and were "evidences of indebtedness" within the meaning of section 325(a) of the Revenue Act of 1921, and should be included in invested capital at their cash value at the time they were executed. It further contends that said contracts were "paid in" for the shares of stock issued by it.

The respondent contends that the instruments in question are not evidences of indebtedness received in payment for the stock but that they are in effect subscription agreements. He relies upon our decision in . We are of the opinion that the two cases are not similar. There the agreement was one to purchase. Here the sale was completed and the instrument in question evidenced an indebtedness for stock issued. The agreement contains no provision for voting the stock, and in this situation the purchaser, being the owner of record on the books of the corporation, was entitled to vote the stock at stockholders' meetings. The agreement provides for a number of conditions under which petitioner is given the option to repurchase the stock, but it is an enforcible agreement against the purchaser in case the right of repurchase is not exercised by petitioner.

There is no question of the bona fides of the transaction. Under such circumstances, we are of the opinion that the agreements were "evidences of indebtedness" within the meaning of the Revenue Act of 1921 and that they were paid in for stock which was actually issued. In this situation they may be included in invested capital at their actual cash value at the time paid in. ; affd. C.C.A., 7th Cir., not yet reported; .

The actual cash value to be included in invested capital is the value of the property received in exchange for the stock. We must therefore value these obligations at their actual cash value when received by petitioner. How much cash or property did petitioner receive from the purchasers of its stock? In determining this value we must consider the actual cash value of the note itself; its cash value in the market if offered without the stock in payment for which it was given, and without recourse against the petitioner, for only by this means may we determine the extent to which additional assets have been risked in the business of the petitioner. ; .

The only testimony as to the value of the notes is that of two officers of the bank with which petitioner did business. Neither had ever purchased or sold such obligations as these. Their business was to make loans and to value the assets and collateral back of such loans. When asked to state their opinion of the actual cash value of these obligations their answer was that these instruments had a value of from 80 to 100 per cent of their face amount. We are of the opinion that when their testimony is considered as a whole it goes no further than to establish that as bank officers they would have been willing to accept these instruments as collateral for a loan to petitioner of 80 per cent of their face amount. They expressly negative any idea that their bank could have purchased these instruments. The value expressed by them seems to give consideration to the borrowing capacity of the petitioner. They were familiar with the financial condition of the petitioner, but they had none of the information which would have permitted them to determine the financial responsibility of the respective obligors. Nor, indeed, does it appear that they knew who the obligors were, except that they had been in the employ of the petitioner for some time. We are unable to accept this testimony as establishing the actual cash value of the instruments in question at the time they were received by the petitioner.

Reviewed by the Board.

Decision will be entered for the respondent.