Commissioner of Internal Rev. v. Columbia River PM

• Decision Date: 29 April 1942
• Docket Number: No. 9868.,9868.
• Citation: 127 F.2d 558
• Parties: COMMISSIONER OF INTERNAL REVENUE v. COLUMBIA RIVER PAPER MILLS.
• Court: U.S. Court of Appeals — Ninth Circuit

127 F.2d 558 (1942)

COMMISSIONER OF INTERNAL REVENUE v. COLUMBIA RIVER PAPER MILLS.

No. 9868.

Circuit Court of Appeals, Ninth Circuit.

April 29, 1942.

Samuel O. Clark, Jr., Asst. Atty. Gen., and J. Louis Monarch, Gerald L. Wallace, William L. Cary, and Edward Hammond, Sp. Assts. to Atty. Gen., for petitioner.

Clarence D. Phillips, of Portland, Or. (Griffith, Peck, Phillips & Nelson, of Portland, Or., of counsel), for respondent.

Before GARRECHT, HANEY, and HEALY, Circuit Judges.

HANEY, Circuit Judge.

The question presented by the present petition for review arises under the provisions of the Revenue Act of 1936, relating to undistributed profits tax on corporations.

Respondent is a Washington corporation organized in 1923. As amended in 1925 its articles of incorporation provided for an authorized common capital stock of $2,000,000 divided into 20,000 shares, each having a par value of $100. The articles also authorized issuance of $750,000 shares of 8% cumulative preferred stock divided into 7,500 shares, each having a par value of $100. Respondent's by-laws as amended provided that the preferred stock was

"* * * to be issued upon the following terms and conditions, which shall be set out in each certificate of preferred stock * * *.

"* * * Said preferred stock is issued to and accepted by the holders thereof on the express understanding and agreement entered into between this corporation and present and future holders of the preferred and common stock as follows:

"(A) The holders of the preferred stock shall be entitled to receive out of the surplus or net profits of the corporation, dividends at the rate of eight per cent (8%) per annum, and no more, such dividends to be cumulative * * * All dividends which shall have accumulated on preferred stock shall be paid before any dividend is declared on common stock."

On April 1, 1927, respondent executed its indenture in the nature of a trust deed to secure payment of its bonds. On September 20, 1932, there was outstanding in the hands of the public bonds having a face value of $800,000. On the date last mentioned, respondent executed a supplemental indenture, by the terms of which it agreed to "pay no cash dividends" with exceptions not important here. The holder of each bond executed an extension agreement, in which it was stated that respondent had agreed to "neither declare nor pay any cash dividends prior to April 1, 1937", with exceptions not important here, and that the bondholder's extension promise was not made in consideration of respondent's covenant.

All respondent's common stock was issued prior to, and outstanding during, the year 1936. As of December 31, 1936, respondent's outstanding preferred stock was 6,804½ shares, all of which was issued under the provisions of the by-laws quoted above, or a similar prior one. No dividends have been paid on such stock since April 1, 1932. The accumulated dividends after that date amounted to $258,571 on December 31, 1936.

Respondent's adjusted net income for 1936 was $23,091.15. Section 14(b) of the Revenue Act of 1936, 26 U.S.C.A.Int.Rev. Acts, page 823, levies a surtax equal to a particular percentage of the undistributed net income of a corporation. Under subdivision (a) (2), "undistributed net income" is defined to be the adjusted net income less "the credit provided in section 26(c), relating to contracts restricting dividends". The credit allowed by § 26(c) (1), 26 U.S.C.A.Int.Rev. Acts, page 836, is: "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 * * *."

Respondent claimed, in its income tax return for 1936, that it was entitled to a credit under the quoted provision because a written contract prohibited the payment of any dividend.

Petitioner audited respondent's return and disallowed the credit claimed on the ground that the contract with the trustee prohibited payment of only "cash" dividends and not dividends in other forms such as in stock or bonds. On petition for redetermination, the Board held that the respondent "could not have made any distribution to its stockholders except in the form of cash" 43 B.T.A. 263, 266. The Board's reasoning was that under respondent's by-laws it could have paid no dividend of any kind to the common stockholders until the arrears in dividends upon the preferred stock had been disposed of, and that only a "cash" dividend would satisfy the provision for dividends on the preferred stock. The Board said nothing about the possibility that a dividend in some form other than money might be distributed to the preferred stockholders. The Board entered its decision that there was no deficiency in respondent's income tax for 1936. This petition to review such decision was then filed.

The original House Bill authorized a credit only when payment of dividends in any "form" were prohibited by a written contract executed by the corporation prior to March 3, 1936, which expressly dealt with the payment of dividends. Seidman's Legislative History of Federal Income Tax Laws, p. 217. That provision was amended by the Senate Finance Committee, but as amended, credit was not allowed unless the written contract prohibited payment of dividends in any "form". The...