Commissioner of Internal Revenue v. OPP Holding Corp.

• Decision Date: 04 March 1935
• Docket Number: No. 220.,220.
• Citation: 76 F.2d 11
• Parties: COMMISSIONER OF INTERNAL REVENUE v. O. P. P. HOLDING CORPORATION.
• Court: U.S. Court of Appeals — Second Circuit

76 F.2d 11 (1935)

COMMISSIONER OF INTERNAL REVENUE v. O. P. P. HOLDING CORPORATION.

No. 220.

Circuit Court of Appeals, Second Circuit.

March 4, 1935.

Frank J. Wideman, Asst. Atty. Gen., and Sewall Key and Thomas A. Carpenter, Sp. Assts. to Atty. Gen., for petitioner.

Louis A. Gravelle, of Washington, D. C. (A. Loeb Salkin, of New York City, of counsel), for respondent.

Before L. HAND, SWAN, and CHASE, Circuit Judges.

SWAN, Circuit Judge.

This case involves the income tax liability of O. P. P. Holding Corporation, hereafter referred to as the taxpayer, for the fiscal year ending July 31, 1930. The Commissioner disallowed a deduction of $20,000 from gross income which the taxpayer claimed to be a payment of interest on its debenture bonds. The Board of Tax Appeals reversed this determination, with the result that no deficiency in tax exists. The Commissioner has appealed.

The taxpayer was incorporated under the laws of New York on June 20, 1929, with an authorized capital of $20,000, consisting of 2,000 common shares. On June 25th it purchased all the capital stock of Oneida Paper Products, Inc., a New York corporation, and paid the sellers thereof 1,000 shares of its own stock and $250,000 of its debenture bonds dated as of July 1, 1929, maturing June 30, 1954, and bearing interest at 8 per cent. per annum. The stock of Oneida Paper Products, Inc., had a book value of $129,785.51, taking the inventories and fixed assets at cost and including nothing for good will. A schedule of net sales, net income, and compensation to officers shows that the Oneida Company has enjoyed a progressive increase in its business and had a net income of $26,000 for the year ending July 31, 1929. On its books the taxpayer set up on the asset side the Oneida stock at $260,000, and on the liability side put its debenture bonds at $250,000 and its capital stock at $10,000. Payments on the bonds were always recorded as "interest." During the fiscal year ending July 31, 1930, the taxpayer received a dividend of $20,000 on the Oneida stock. During the same period it paid to holders of its debenture bonds the sum of $20,000 as interest. The taxpayer and its wholly owned affiliate, Oneida Paper Products, Inc., filed a consolidated income tax return, including in gross expense the said interest payment on the debenture bonds. This deduction the Commissioner disallowed on the theory that it represented a dividend payment, since he regarded the bonds as of the nature of preferred stock. The Board disagreed with his ruling. The sole question is whether the "interest" payment constituted a legal deduction under section 23 (b) of the Revenue Act of 1928 (45 Stat. 799, 26 USCA § 2023 (b). See, also, Treas. Reg. 74, art. 141.

The debenture bonds contain certain unusual provisions upon which the petitioner strongly relies in urging that they should be treated as certificates of preferred stock. They are subordinated, both as to principal and interest, to the claims of all other creditors; and the company may at its option suspend or defer the payment of interest, "but such suspension of payment shall in nowise relieve the Corporation of the obligation to pay the same at some future time." It was also provided that the company should pay no dividend upon its stock unless all interest on its debenture bonds should have been paid in full. The bonds had a definite maturity date (unless sooner called), namely, June 30, 1954, although holders of two-thirds of the outstanding bonds might extend the date for all.

We do not think it fatal to the debenture holder's status as a creditor that his claim is subordinated to those of general creditors. The fact that ultimately he must be paid a definite sum at a fixed time marks his relationship to the corporation as that of creditor rather than shareholder. The final criterion between creditor and shareholder we believe to be the contingency of payment. The shareholder is entitled to nothing, prior to liquidation, except out of earnings. Even on liquidation, at least in New York, arrears of cumulative dividends are confined to earnings. Michael v. Cayey-Caguas Tobacco Co., 190 App. Div. 618, 180 N. Y. S. 532. These debenture bondholders were not so limited. The interest could be deferred, but it was not lost, though the company had no earnings; it could be collected, together with the principal, in 1954, from the corpus of the debtor's property, regardless of whether there should be a surplus. See Warren v. King, 108 U. S. 389, 399, 2 S. Ct. 789, 27 L. Ed. 769. This distinction marks the vital difference between the shareholder and the creditor. The shareholder is an adventurer in the corporate business; he takes the risk, and profits from success. The creditor, in compensation for not sharing the profits, is to be paid independently of the risk of success, and gets a right to dip into the capital when the payment date arrives. The courts have very frequently been called upon to...