BELLE-VUE MANUFACTURING COMPANY v. COMMISSIONER OF INTERNAL REVENUE
| Decision Date | 06 December 1940 |
| Docket Number | Docket No. 99564. |
| Citation | 43 BTA 12 |
| Parties | BELLE-VUE MANUFACTURING COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Board of Tax Appeals |
Norman Block, Esq., for the petitioner.
Lloyd W. Creason, Esq., for the respondent.
The Commissioner determined deficiencies of $8,914.13 and $11,668.80 in petitioner's undistributed profits taxes for 1936 and 1937, respectively. Petitioner assails the disallowance of credits claimed under section 26 (c) (1) and (2) of the Revenue Act of 1936, contending that it was subject to a contractual prohibition of dividends and a requirement that it use its earnings and profits in the satisfaction of debts.
FINDINGS OF FACT.
Petitioner, a North Carolina corporation with principal office at Hillsboro, North Carolina, is engaged in the manufacture and sale of cotton fabrics. In 1928 it suffered a loss of markets for its products; serious financial difficulties followed in 1929, and representatives of its three principal creditors, Crompton & Knowles Loom Works, William Iselin Co., and S. B. Alexander, met to discuss measures for the protection of their interests. Believing that continued operation would be better than a receivership, they proposed to the shareholders that a creditors' committee be empowered to control the business. A majority of the shareholders consented. At that time petitioner's voting stock consisted of 2,196 common and 2,000 preferred shares. On May 1, 1929, owners of 1,920 common and 1,305 preferred shares transferred their shares to Edmund Strudwick, Jr., Oliver Iselin, and S. B. Alexander, as trustees under an agreement:
deemed necessary in order to insure the continuity and stabilization of the policy and management, and to protect the interests of the present and future stockholders and creditors * * *. Under its terms the trustees were given the right to vote the transferred shares "as though they were the sole, unrestricted owners of such stock * * *", and were directed to "receive all dividends that may be declared and paid from time to time upon the stock * * *", and "immediately pay out the same to the registered holders of the Stock Trust Certificates * * *" which were issued to the transferees for the shares placed in trust.
On May 7, 1929, the shareholders authorized the board of directors:
to enter into an agreement on behalf of the corporation with its creditors in such form as the Board may approve, providing for an extension of its indebtedness for such period not exceeding five years, as the Board may be able to agree upon with its creditors, and upon such terms and conditions as the Board may approve * * *.
On July 17, 1929, the board approved a plan which gave to a creditors' committee, composed of the persons who were trustees under the shareholders' trust, the right to select the president and treasurer, who should take charge of the operation of the business, consult with the committee on business policy, and make monthly financial reports. Borrowings and capital expenditures were to be made only on authority of the committee; requests for advances to meet running expenses were to be sent to all committee members. The committee selected L. E. Beard as president and treasurer. He immediately took charge of the business, and on August 21, 1929, advised the committee that the financial condition was worse than he had expected and that no interest payments could be made for at least a year. At a stockholders' meeting on January 23, 1930, attended by the trustees representing the shares in trust and a proxy representing shares not in trust, Beard presented a financial statement as of December 31, 1929, which was approved. He expressed the opinion that the shareholders could not expect to receive anything for many years, if ever. There were operating deficits for the years 1930, 1931, and 1932, and a profit in 1933.
When the trust agreement expired on May 1, 1934, the trust was continued in effect by a new instrument, dated April 9, 1934, which contained similar terms. On the same date a contract was executed whereby the creditors agreed to extend the time for payment of petitioner's indebtedness, then amounting to $438,848.99 plus accrued interest of $92,158.29, which was incorporated in the principal of new notes given, aggregating $531,007.28 and bearing petitioner's promise to pay on May 1, 1939, or prior thereto. Petitioner agreed to pay expenses of the creditors' committee, not to borrow money without the committee's unanimous approval, and, if its property could be sold at a price sufficient to pay its debts and interest, to cooperate in making a sale. Petitioner made a profit of $15,630.47 in 1934 and of $248.23 in 1935. Its sales increased and its plant was improved, but no payments were made on its notes in those years.
In 1936 petitioner made a profit of $44,049.36 and, pursuant to a directors' resolution of December 11 directing that 10 percent of the principal of each note be paid from profits made during the year, it paid $53,100.73 on the notes. In 1937 it made a profit of $56,920.94 and paid $77,906.55 on the notes. Its balance sheets show $216,950.45 excess of liabilities (inclusive of capital stock) over assets for 1936 and an excess of $160,044.51 for 1937. Petitioner's business is still under the control of the creditors' committee and a majority of its shares are still held in trust. Its balance sheet at the end of 1939 shows notes payable of $300,000 and $90,667.38 excess of liabilities (inclusive of capital stock) over assets. No shareholder has ever demanded the payment of a dividend.
Because of petitioner's financial difficulties, substantially all of its shares were in 1929 transferred in trust to representatives of its principal creditors with the voting rights. The same persons formed a creditors' committee and took the control and management of the business. In 1934 the trust was continued for a five-year period, and the creditors agreed to an equal extension of time for payment of the debts. After sustaining steady losses, petitioner made a profit in 1933 and 1934, but made no payment on its notes. It made profits in 1936 and 1937, and paid $53,100.73 and $77,906.55, respectively, on the notes. It claimed a credit of $53,100.73 for 1936 and of $56,920.94 (the amount of its net income) for 1937 in the computation of its undistributed profits tax. It assails the Commissioner's disallowance of these credits.
By section 14 of the Revenue Act of 1936, a surtax is imposed upon the net income of corporations. By section 26 (c) the following credits are allowed:
(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. * * *
Petitioner invokes both subsections. It contends that a prohibition against dividends was implicit in the trust agreement and the 1934 contract with the creditors extending the time of payment, the shareholders having been told not to expect anything for many years, if ever; that these agreements were made to avoid a receivership; and that the creditors' control, given to assure a payment of debts, precludes dividends until the debts are paid. No provision of the contract, however, "expressly deals with the payment of dividends", or "with the disposition of earnings and profits", which is the condition upon which the statute bases the credit. As petitioner suggests, the term "earnings and profits" need not appear literally in the contract if it is clear from other terms that debt payments from earnings and profits are required. G. B. R. Oil Corporation, 40 B. T. A. 738; Michigan Silica Co., 41 B. T. A. 511 (on review C. C. A., 6th Cir.). But the present contract, instead of forbidding dividends, expressly contemplates the possibility of...
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