Van Ameringen-Haebler, Inc. v. Commissioner

VAN AMERINGEN-HAEBLER, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Van Ameringen-Haebler, Inc. v. Commissioner

Docket No. 101416.

United States Board of Tax Appeals

45 B.T.A. 1085; 1941 BTA LEXIS 1029;

December 23, 1941, Promulgated

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Under date of June 1, 1929, petitioner entered into an agreement with a trust company, as trustee of an issue of bonds by petitioner, in which petitioner agreed not to declare dividends upon common stock while those bonds were outstanding. The agreement provided that a certain amount should be paid each year as amortization of the bonds. During the taxable years there were outstanding cumulative first preferred stock and preferred stock of petitioner on which there were arrears in excess of the net earnings and profits of petitioner in the taxable years. Held, that petitioner is not entitled to a credit under either section 26(c)(1) or section 26(c)(2) of the Revenue Act of 1936.

J. F. Condon, Jr., Esq., for the petitioner.

Charles Oliphant, Esq., for the respondent.

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HILL

The Commissioner determined deficiencies in petitioner's income tax for the years 1936 and 1937 in the amounts of $4,112.57 and $4,400.14, respectively. The sole issue before the Board is whether or not petitioner is entitled to a credit under section 26(c)(1) or section 26(c)(2) of the Revenue Act of 1936.

FINDINGS OF FACT.

Petitioner is a corporation organized and existing under the laws of the State of New York and has an office and place of business in New York, New York. Petitioner's Federal income and excess profits tax returns for the taxable years were filed with the collector of internal revenue for the second district of New York.

Prior to 1929 petitioner was known as Morana, Inc. (hereinafter referred to as Morana). In the latter part of 1928 the financial condition of Morana was poor and it was decided that new management should be obtained. William T. Haebler, treasurer of Morana, asked Arnold L. van Ameringen, president of van Ameringen, Inc., to become an officer of Morana. After inquiring into the condition of Morana, van Ameringen refused to become connected with the corporation unless certain current bank loans aggregating approximately $400,000 were liquidated or placed upon a long term basis.

Under date of May 9, 1929, Haebler, his father, Theodore Haebler, holder of a large block of Morana stock, and van Ameringen entered into a contract whereby it was agreed that van Ameringen, Inc., should be merged with Morana and that stock of Morana should be sold to liquidate the current bank loans. Shortly after the agreement of May 9, 1929, it was found that the financial status of Morana was such that the stock of the corporation was not readily salable and it was decided to liquidate the loans by a bond issue.

On May 25, 1929, the shareholders of Morana held a special meeting at which the name of the corporation was changed to its present title, an offer of van Ameringen, Inc., to sell its assets to petitioner for $120,000 and 25,000 shares of no par value common stock of petitioner was accepted, 10-year employment contracts were entered into with van Ameringen and William T. Haebler, and a resolution was passed directing that the authorized capital stock of the corporation be increased from 25,000 to 60,000 shares.

Haebler, van Ameringen, and the shareholders of Morana and van Ameringen, Inc., found that the current bank loans might be reduced to the sum of $300,000 by the sale of certain property owned by petitioner upon which $100,000 would be realized by petitioner. Under date of June 1, 1929, a mortgage or deed of trust was entered into between petitioner and the American Trust Co., trustee, by which coupon bonds in the total sum of $420,000 were issued in denominations of $7,500 each, secured by the assets of petitioner. The following provisions of the deed of trust are material:

ARTICLE II.

Sec. 1. The Mortgagor [petitioner] covenants and agrees that it will fully and entirely pay off and satisfy the whole of said bonds which shall be issued hereunder, principal and interest, according to the terms thereof without delay. * * *

Sec. 2. The Mortgagor covenants that while any bond hereby secured is outstanding and unpaid it will declare and/or pay no dividends whatever upon its common stock.

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ARTICLE IV.

The Mortgagor covenants that it will for the further security of said bonds, pay to the Trustee on the 1st days of September, December, March and June in each and every year beginning with September 1, 1929, upon account of the principal sum secured hereby, the sum of Seven thousand five hundred dollars ($7,500). Provided, however, that no default shall be declared, or foreclosure had, or any cause of action whatsoever maintained against the Mortgagor because of failure to make any one or more of such payments on account of principal falling due prior to June 1, 1932, unless the net profits of the Mortgagor for the period of three months prior to the maturity date of such payments respectively shall be in excess of the sum of Eight hundred and seventy-five ( $875). In determining whether such profits for each of said periods have been made a certified statement by the Mortgagor's auditor as to the profits of the corporation shall be accepted and binding upon the Mortgagor and the Mortgagee and the holders of bonds secured hereby. Nothing herein contained, however, shall be construed as a waiver of the right of the Mortgagee or such bondholder to receive such payments on account of principal which shall fall due prior to June 1, 1932. Upon the 1st day of June, 1932, the aggregate amount of such accrued payments on account of principal then due and unpaid shall be pro-rated over the remaining seven years and the quarterly installments maturing during such period shall be increased accordingly.

All sums so paid on account of principal, together with any other sums that may be added thereto and any interest that may accrue thereon, shall constitute a fund herein called the Sinking Fund. Such Sinking Fund shall be held by the Trustee, such interest being allowed thereon by the Trustee as it shall allow on other deposits of similar character until applied as herein provided.

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ARTICLE V.

In the event that default shall be made for six months in the payment of interest on any of the bonds hereby secured, or default shall be made in the making of any payment on account of sinking fund subject to all the provisions hereof, and shall continue for six months or default shall be made in payment of said bonds or any of them at maturity, or default shall be made in performance on the part of the Mortgagor of any of the provisions hereof and shall continue for thirty days after written notice of default and demand by the Trustee for performance, which notice the Trustee may give in its discretion and must give upon request in writing so to do by the holders of one-fourth or more of the bonds outstanding, the Trustees shall declare the whole indebtedness secured hereby due and payable and may take such action as may be proper to foreclose this mortgage or deed of trust; and in such event it shall begin foreclosure proceedings upon written request by the holders of one-fourth or more of the bonds outstanding upon being properly indemnified as is hereinafter specified. In such event it shall be entitled as a matter of right and without reference to the adequacy of the security, to the appointment of a Receiver of the property covered by this instrument.

Of the aggregate of $420,000 bonds issued pursuant to the deed of trust dated June 1, 1929, bonds in the amount of $300,000 were issued at par to Theodore Haebler and the proceeds used to redeem the currently due bank loans. The remaining $120,000 of the bonds was issued to the shareholders of van Ameringen, Inc., as partial consideration for the assignment of the assets of van Ameringen, Inc., to petitioner.

After the bank loans had been liquidated with the proceeds of the $300,000 bonds issued to Theodore Haebler and the sale of property upon which petitioner realized $100,000, the former shareholders of van Ameringen, Inc., exchanged their $120,000 of petitioner's bonds for 7 percent cumulative first preferred stock of petitioner, hereinafter referred to as first preferred, and 8 percent cumulative preferred stock of petitioner, hereinafter known as preferred, having an aggregate par value equal to the face amount of the bonds exchanged Petitioner had a continuous deficit from 1929 to 1935. At the end of the year 1935 petitioner had a deficit of $62,721.90.

On January 1, 1936, petitioner had outstanding 618 shares $100of par value first preferred, approximately 6,945 shares of preferred, and 60,000 shares of no par common stock. During the years 1936 and 1937 petitioner had outstanding first preferred and preferred stocks.

On February 4, 1936, the capital of petitioner was reduced by decreasing the number of shares of stock without par value from 60,000 shares to 600 shares. All no par value shares had a stated value of $1 per share. The result was a transfer of $59,400 from capital to surplus and a consequent reduction of the deficit of $62,721.90 which existed December 31, 1935, by the amount of $59,400.

Petitioner's net income for the taxable year 1936 was $37,806.21. Petitioner's net income for the taxable year 1937 was $39,146.48.

In each of the years 1936 and 1937 petitioner paid dividends in the amount of $8,652 on its first preferred stock. These dividends payments were made on arrears of dividends on the first preferred stock.

Subsequent to the year 1929 no dividends were ever paid on the preferred stock. During the years 1936 and 1937 there were arrearages on the first preferred and preferred stocks of petitioner greatly in excess of the net earnings, profits or income of the petitioner for those years.

OPINION.

HILL: The sole issue for our determination is whether or not petitioner is entitled to a credit under section 26(c)(1) or (c)(2) of the Revenue Act of 1936. ¹ Petitioner contends that it is entitled to a credit under section 26(c)(1), arguing that we must read the contracts together with the actions of petitioner and its officers as imposing a dividend restriction within the purview of section 26(c)(1).

The basis for petitioner's claim for credit under section 26(c)(1) or section 26(c)(2) must be found in the mortgage or deed of trust dated June 1, 1929, since that is the only instrument in evidence which was executed by petitioner prior to May 1, 1936. The provision of this instrument which relates to the restriction of dividend payments requires that petitioner "declare and/or pay no dividends whatever upon its common stock" so long as any bond is outstanding. Respondent contends that since this provision does not prohibit petitioner from paying dividends upon preferred stock there is no contractual restriction of dividends within the meaning of the statute.

We are of the opinion that the dividend restricting provision of the mortgage or deed of trust is not a provision which would be violated by the declaration of dividends upon the first preferred or preferred stocks of petitioner. Cf. . The arrears on the preferred stock of petitioner were greatly in excess of the net income of petitioner in the taxable years. Petitioner could have declared and paid a dividend on the first preferred or preferred stocks in payment of the arrearages. The fact that if petitioner had declared such a dividend continued operation of petitioner might have been impaired can not change the result. The statute is specific and allows the credit only where a provision, expressly dealing with the payment of dividends, of a contract executed by the taxpayer prior to May 1, 1936, would be violated by payment of a dividend. There is no provision in the contract under consideration which would be violated by payment of dividends other than on common stock. It is obvious, therefore, that petitioner is not entitled to a credit under section 26(c)(1) of the Revenue Act of 1936.

Petitioner also contends that it is entitled to a credit under section 26(c)(2) of the Revenue Act of 1936. Petitioner maintains that the mortgage or deed of trust dated June 1, 1929, required petitioner to pay bond amortization of $30,000 in each of the taxable years and that it did pay such amortization. Respondent admits that the mortgage instrument required petitioner to make the amortization payments in each of the taxable years and that the payments were made. He argues, however, that petitioner must be denied the credit on the ground that the mortgage instrument contained no provision expressly dealing with the disposition of earnings and profits of the taxable year which required the payment or irrevocable setting aside of amounts in discharge of a debt.

Petitioner's argument on this point seems based on the premise that if petitioner were to pay the amortization on the bonds the payments must necessarily be made from earnings and profits. While we believe this premise to be false, the assumption of its truth would not entitle petitioner to prevail. The statute stipulates that the provision requiring the payments to be made be one dealing with earnings and profits of the taxable year. The controlling provision of the mortgage instrument of June 1, 1929, merely required that petitioner "pay to the trustee on the first days of September, December, March and June in each and every year." The mortgage instrument contains a provision which prevented a default or foreclosure on account of principal payments falling due prior to June 1, 1932, in the event that net profits of petitioner for the period of three months prior to the maturity date of such payment were less than $875. This provision, however, has no effect on events of the taxable year and can not be said to be one which "expressly deals with the disposition of earnings and profits of the taxable year." Since there is no provision in the mortgage instrument for which the credit may be obtained, petitioner's claim must fail. We do not feel that we may look to parol evidence to determine whether the mortgage instrument "expressly deals" with earnings and profits of the taxable years. .

In , we considered the case of a taxpayer which alleged that the circumstances were such that the payments were required to be made out of earnings and profits. There we held that, even where earnings and profits of the taxable year were applied to the payment made in discharge of a debt, such application without more is not sufficient to fulfill the requirement of the statute that the provision of the contract expressly deals with disposition of earnings and profits of the taxable year. More recently, in , upon facts similar to those of the instant proceeding, we made the following statement:

Regardless of whether petitioner realized any earnings and profits in the taxable year, the regular annual payment was still required by the indenture of trust. Without earnings, petitioner would have had to resort to some other manner of obtaining the necessary funds. This could have been done by applying accumulated surplus, if any, by the sale of assets, by issuing additional stocks or bonds, or by any other method of borrowing. Since the indenture does not require the payments to be from current earnings and profits or to be measured by current earnings and profits, it becomes immaterial whether the payments actually were out of earnings and profits of the taxable year. Provisions granting special exemptions are to be strictly construed. .

We are of the opinion that disposition of petitioner's claim under section 26(c)(2) of the Revenue Act of 1936 is controlled by the Sandura, Lamm, and Eastern Building cases. Petitioner's contention that section 26(c)(1) and (2) as herein construed in its application to the facts here is unconstitutional and void is without merit. . Accordingly, respondent's determination is sustained.

Decision will be entered for respondent.

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Footnotes

• 1. SEC. 26. CREDITS OF CORPORATIONS.

  In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax -

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  (c) CONTRACTS RESTRICTING PAYMENT OF DIVIDENDS. -

  (1) PROHIBITION ON PAYMENT OF DIVIDENDS. - An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. * * *

  (2) DISPOSITION OF PROFITS OF TAXABLE YEAR. - An amount equal to the portion of the earnings and profits of the taxable year which is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of the taxable year) to be paid within the taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt; to the extent that such amount has been so paid or set aside. * * * ↩