Commissioner of Internal Rev. v. Schmoll Fils Associated, 214.
| Decision Date | 18 March 1940 |
| Docket Number | No. 214.,214. |
| Citation | 110 F.2d 611 |
| Parties | COMMISSIONER OF INTERNAL REVENUE v. SCHMOLL FILS ASSOCIATED, Inc. |
| Court | U.S. Court of Appeals — Second Circuit |
Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key and Berryman Green, Sp. Assts. to Atty. Gen., for petitioner Commissioner of Internal Revenue.
George A. Spiegelberg, for respondent Schmoll Fils Associated, Inc.
Before SWAN, AUGUSTUS N. HAND, and PATTERSON, Circuit Judges.
The Commissioner of Internal Revenue assessed income tax deficiencies against the taxpayer Schmoll Fils Associated, Inc. in the amount of $2,212.35 for the year 1932, of which $1,790.25 was in controversy before the Board of Tax Appeals; $1,079.30 for the year 1933, of which $988.56 was in controversy, and $834.07 for the year 1934, of which the entire amount was in controversy. The Board of Tax Appeals determined income tax deficiencies against the taxpayer of $422.10 and $90.75 for the years 1932 and 1933 respectively and an income tax overpayment of $723.72 for the year 1934. This determination was made by allowing the taxpayer to deduct payments upon its non-maturing debentures upon the ground that such payments were "interest paid or accrued within the taxable year on indebtedness" within the meaning of Sections 23(b) of the Revenue Acts of 1932 and 1934, 26 U.S.C.A. Int.Rev.Acts. Four members of the Board dissented from the ruling of the majority.
The question before this court is whether, in computing the income taxes of Schmoll Fils Associated, Inc., the payments made by it on its non-maturing debentures were allowable deductions as interest, or were dividends and, therefore, not deductible. Payments of $13,020 were made to debenture holders in the year 1932, of $12,449.50 in the year 1933, and of $11,329.50 in the year 1934. In our opinion, the payments were in substance dividends rather than interest and consequently should not have been allowed by the Board as deductions in computing taxable net income.
The persons owning the debentures formerly held cumulative 7% preferred stock. Under a plan of refinancing, the company purchased the preferred stock and out of the proceeds the preferred stockholders agreed to purchase 7% debentures at par to the extent of their holdings. Under this plan the preferred stock would be surrendered and extinguished and the former preferred stockholders would receive 7% debentures having no maturity date. The interest upon the debentures would be payable exclusively from the profits of the company, on the 15th days of January and July of each year, until the principal should be paid or the debentures should be called for redemption, and was to be cumulative. The common stock of the company was not to be entitled to any dividends until a two years surplus had been accumulated sufficient to pay the debenture interest. The debentures were to be redeemable at 105 upon notice and at the option of the taxpayer. The principal was not to become due except at the option of the company, unless in case of bankruptcy, dissolution or any other liquidation, whether voluntary or involuntary, in any of which events the principal and interest accrued and unpaid were to become immediately due, "it being understood, however, that the indebtedness represented by these debentures shall continue to be subordinated to any and all amounts owing to any bank or banker and that the holders shall not be entitled to receive any dividends or other payments thereof until the full amount of principal and interest owing to the company's banks or bankers shall have been fully paid."
In making income tax returns for the years 1932, 1933 and 1934 the taxpayer deducted each year the interest accrued on the debentures. The right to do this is claimed under Section 23(b) of the Revenue Act of 1932 and 1934 which allowed as deductions in computing net income: "All interest paid or accrued within the taxable year on indebtedness * * *".
Not only is there no provision of law allowing deduction of dividends in computing net income, but Article 141, Treasury Regulations 77 of 1932, a similar article of Treasury Regulations 74 of 1928 and Article 23(b)-1 of Treasury Regulations 86 of 1934 preclude such deductions. The Articles read as follows: "Interest * * * socalled interest on preferred stock which is in reality a...
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