Mills v. Comm'r of Internal Revenue, Docket No. 1066.
Decision Date | 21 January 1944 |
Docket Number | Docket No. 1066. |
Citation | 3 T.C. 95 |
Parties | TALBOT MILLS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioner, a family corporation, in 1939 issued, in exchange for four-fifths of its outstanding capital stock, ‘registered notes‘ in face value equal to the par value of the stock surrendered, having a maturity date, and bearing interest at a variable rate from 2 of 10 percent computed with reference to profits. The interest was deferrable in the discretion of the directors, and interest and principal were subject to subordination to outside creditors. Held, the security is more in the nature of a capital investment than a loan to the corporation, and payments made as interest are in fact dividends, not deductible from gross income under section 23(b) of the Internal Revenue Code. Melville F. Weston, Esq., for the petitioner.
M. L. Sears, Esq., for the respondent.
The Commissioner determined deficiencies of $7,588.69 in corporation income tax and $2,196.12 in declared value excess profits tax for the fiscal year ending September 30, 1940. Certain minor concessions have altered the amounts in controversy to $6,940.15 and $2,415.73, respectively. These deficiencies resulted from a disallowance by the Commissioner of a claimed deduction of $40,000 for interest paid by the petitioner on certain securities issued in exchange for part of its stock. The sole question is whether this amount was properly deductible as interest within the meaning of section 23(b) of the Internal Revenue Code.
The essential facts, most of which are stipulated and are hereby found accordingly, are as follows:
The petitioner, a Massachusetts corporation with principal offices in North Billerica, filed its return for the fiscal year in question with the collector for the district of Massachusetts. Prior to the transactions out of which arose the present controversy the petitioner had outstanding as its total capital stock 5,000 shares of common stock, par value $100. This stock was held on September 30, 1939, by 15 stockholders who, with the exception of one holder of 10 qualifying shares, were all members of the Talbot family by descent or marriage, or were trusts created by such members.
For several years the company had been gradually losing money and in 1937 there was some discussion among the stockholders as to liquidation. However, upon the basis of a proposed renovation of plant and personnel, plus a possible recapitalization, they decided to continue the business. On May 8, 1939, by corporate resolution, the treasurer was authorized ‘to retain counsel to examine the capital structure of the company with the view to seeing if any modification can be made in same to the advantage of the company.‘ On September 14, 1939, a plan of reorganization was submitted to the directors and adopted by them. The stockholders gave their unanimous approval on September 29, 1939. The tax advantage was one of the motivating facts in the adoption of this plan.
In pursuance of the plan each holder surrendered four-fifths of his stock, which was duly retired by the corporation and the capital stock accordingly reduced. In return for the stock so surrendered the petitioner issued ‘registered notes‘ in aggregate face values equal to the aggregate par value of the stock retired. The total amount of the notes issued was thus $400,000.
The notes are voluminous and complex. Maturity is set for December 1, 1964, slightly more than 25 years from the date of issue. They provide for annual interest payable on December 1 of each year, but payment of interest may be deferred by vote of the board of directors for such time as they ‘may in good faith determine to be necessary by reason of the condition of the corporation * * * provided that such suspension of payment shall in no wise relieve the corporation of the obligation to pay the amount suspended at some future time and shall in no event operate to defer payment beyond December 1, 1964.‘
The rate of interest was provided as follows:
The notes further provided that no dividends were to be paid on any shares of stock until all then due interest on the notes was satisfied. In the event of bankruptcy, receivership, dissolution, or liquidation, the principal and interest were to become immediately due, with interest at the rate of 6 percent from the close of the preceding fiscal year.
No mortgage of the real estate of the corporation or of its machinery or equipment to secure an obligation maturing after December 1, 1964, other than a purchase money mortgage, could be made while the notes were outstanding without the consent of the holders of three-fifths in interest of the notes. Power to subordinate to any obligation maturing not later than December 1, 1964, was vested in the directors, such subordination to impose upon the holders no personal liability other than a liability to deliver to the unsatisfied creditors any sums or securities paid to the holder in connection with any reorganization, or in any substitution of the notes. The corporation might at any time pay and retire the notes at par plus accrued interest, except as otherwise provided in any subordination agreement. There then followed this provision:
* * * With the written consent of the corporation and of the holders of three-fifths (3/5ths) in amount of the total amount of these notes at the time outstanding, filed with the corporation, any of the terms and provisions of this series of notes may be altered or amended so as to bind the corporation and every holder, whether consenting or not, provided that no such change shall: (a) extend the date for the maturity of the principal of the notes; (b) alter the rate of interest or the method of computing the rate of interest, except in so far as required for an adjustment to a changed fiscal year as above; (c) diminish the...
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