Commissioner of Internal Revenue v. Proctor Shop, 7735.

• Decision Date: 20 March 1936
• Docket Number: No. 7735.,7735.
• Citation: 82 F.2d 792
• Parties: COMMISSIONER OF INTERNAL REVENUE v. PROCTOR SHOP, Inc.
• Court: U.S. Court of Appeals — Ninth Circuit

82 F.2d 792 (1936)

COMMISSIONER OF INTERNAL REVENUE v. PROCTOR SHOP, Inc.

No. 7735.

Circuit Court of Appeals, Ninth Circuit.

March 20, 1936.

Frank J. Wideman, Asst. Atty. Gen., Sewall Key, Norman D. Keller, and Francis I. Howley, Sp. Assts. to Atty. Gen., and Harry Marselli, of Washington, D. C., for petitioner.

Dey, Hampson & Nelson, Roscoe C. Nelson, and Richard R. Morris, all of Portland, Or., for respondent.

Before WILBUR, GARRECHT, and HANEY, Circuit Judges.

GARRECHT, Circuit Judge.

This petition involves income taxes of the respondent corporation for the fiscal year ending January 31, 1930.

Respondent is an Oregon corporation organized on October 6, 1927. Upon its organization it purchased the assets of an existing business known as Proctor's, Incorporated, which was engaged in selling ready to wear women's apparel on the installment basis. Respondent took over the assets and business as of October 1, 1927, and continued to conduct the business on the installment basis.

Prior to the organization of respondent, conferences relative to the question of financing the venture were held between M. H. Holtz, who became president of respondent, and his father, Aaron Holtz. Aaron Holtz was willing to lend the necessary funds to the contemplated organization, but was not willing to accept stock because he desired to be assured that his advances would be repaid, and he also wanted a definite income from the funds. It was deemed inadvisable to issue bonds to cover the loans, as that would affect the credit of the corporation. It was finally decided to have the new corporation issue what was denominated "debenture preference stock" to Aaron Holtz as evidence of the amounts advanced by him.

Respondent's articles of incorporation filed with the corporation department of the state of Oregon on October 6, 1927, state that the authorized capital stock consists of 10 shares of common stock of the par value of $100 each, and 990 shares of debenture preferred stock of the par value of $100 each.

Upon incorporation 990 shares of the stock described as "debenture preference stock" were issued to Aaron Holtz.

In its annual report to the state corporation department for the year ended January 31, 1928, respondent reported its authorized capital stock to consist of 10 shares of common stock and 990 shares of debenture preference stock, each of the par value of $100 per share.

Amounts representing 6 per cent. per annum on the amount of $99,000 were paid by petitioner to Aaron Holtz, and accrued on its books for the period ended January 31, 1928, and its fiscal years ended January 31, 1929 and 1930. The amounts so paid and accrued were claimed as interest deductions by respondent and were disallowed by the commissioner.

The articles of incorporation of respondent provided for a stock structure as set out in the facts above stated, which were found by the board, and, in addition, provided that the said "debenture preference stock" should be entitled to cumulative "interest" at the rate of 6 per cent. per annum, payable quarterly, commencing October 1, 1927, before any dividends were paid on the common stock, and that the common stock was entitled to "dividends" in excess of said 6 per cent. In addition, provision was made in the articles that in the event of dissolution of the corporation, or of distribution of the assets that the debenture preference stock outstanding at that time be first paid at par, plus all accumulated unpaid interest, and the remainder of the corporate assets be divided ratably among the holders of the common stock. The voting power was vested exclusively in the holders of the common stock. The corporation, in the articles, reserved the right to redeem any number or all of the certificates of debenture preference stock at par plus accumulated interest at any time after December 1, 1927, and bound itself to redeem monthly, beginning December 1, 1927, debenture preference stock of the par value of $1,500 as a minimum. Failure of the corporation for a period of two years to pay any quarterly interest thereon, as the same became due and payable, rendered the corporation in default as to such payment and entitled the owners of certificates as to which such delinquency occurred, to declare the principal amount of such certificates due and to institute action against the corporation for the par value of said certificates and the accumulated interest thereon. A further provision read: "The rights of the holders of debenture stock shall, however, be limited in the following respect: In the payment of their several claims all general creditors shall rank superior to the holders of debenture preference stock, but all holders of debenture preference stock shall rank pari passu with each other and superior to holders of any other class of stock of the corporation."

Petitioner states the question to be: "Whether amounts paid by the taxpayer corporation to the holder of `debenture preference stock' were deductible as interest or whether such amounts were in the nature of a dividend on preferred stock." If the sums paid were interest, they were deductible in arriving at the taxable net income of the taxpayer; if they were dividends, they were not deductible. Section 23(b) of the Revenue Act of 1928, 45 Stat. 791 (26 U.S.C.A. § 23 and note); Article 141 of Treasury Regulations 74, promulgated under the Revenue Act of 1928.

The commissioner argues that: "The nature of the certificates issued and the manner in which they were authorized show that they were certificates of preferred stock and not evidences of ordinary indebtedness."

"The transcript does not contain the evidence upon which the Board of Tax Appeals acted, and, consequently, the question...