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Royal Mfg. Co. v. Commissioner of Internal Revenue.

December 30, 1943


On Petition for Review from United States Board of Tax Appeals.

Author: Jones

Before JONES, Circuit Judge, and WATSON and MEANEY, District Judges.

JONES, Circuit Judge.

The corporate petitioner in computing its surtax for the year 1936 on its undistributed profits, as defined by Sec. 14(a) of the Revenue Act of 1936,*fn1 took credit in the sum of $50,000 for a dividend allegedly paid within the meaning of Sec. 27(a) of the same Revenue Act.*fn2 The Commissioner disallowed the credit and determined a deficiency. The matter is now here on the taxpayer's petition for a review of the decision of the Board of Tax Appeals which sustained the action of the Commissioner.

The attending circumstances and the action taken by the taxpayer in respect of the dividend for which it claims a credit are as follows:

In 1936 the taxpayer had capital stock, issued and outstanding, consisting of prior preferred, preferred and common shares. Under the terms of issuance of the prior preferred and the preferred, no dividends were payable on the common stock unless and until all dividends due on both preferred issues were paid and, so long as any prior preferred stock remained outstanding in a name other than that of the taxpayer, no cash dividends could be declared or paid upon the common stock in excess of 25% of the net earnings of the company.

By written agreement of December 2, 1936, signed by all of the stockholders of the company, it was provided that in respect of any and all dividends up to but not exceeding $50,000, which might thereafter, but before January 15, 1937, be declared and paid by the taxpayer upon its common stock, the holders of the preferred stocks would waive and relinquish the above mentioned restrictions with respect to the declaration and payment of cash dividends upon the common stock.

The agreement also provided that, -

"(4) Each and Every of the undersigned who is a holder of common stock of the Royal Manufacturing Company hereby promises and agrees that if Royal Manufacturing Company declare and pay a dividend upon said common stock on or before January 15, 1937, that he in consideration of such mutual promises of the stockholders and of such declaration and payment will turn over, give and donate all dividends upon said common stock received by him prior to said date to said corporation, less only such amounts as he shall be compelled to pay as Federal or State income taxes by reason of the receipt of such dividends."

"Each stockholder hereby authorizes Royal Manufacturing Company to endorse in his name any and all checks for dividends upon common shares declared and made payable on or before January 15, 1937 and to redeposit the same in the bank accounts of Royal Manufacturing Company, and agrees that he shall and will report in his Federal and State income tax reports the receipt thereof, and does hereby constitute and appoint Royal Manufacturing Company as agent to receive the same on his behalf. In case Royal Manufacturing Company as agent for a stockholder endorses and redeposits in its own account any such dividend check, it shall upon demand of the stockholder, reimburse him for any Federal or State income taxes paid by the stockholder by reason of the receipt of such dividends."

Shortly thereafter, viz., on December 21, 1936, the taxpayer declared a dividend on its common stock in the aggregate sum of $50,000, which was to be payable in cash to the eleven common stockholders of the company of record on that day (December 21, 1936) and was to be paid on or before December 28, 1936. It was on December 29, 1936, however, that the taxpayer drew eleven checks on a New York bank payable respectively to the order of each of the eleven holders of the company's outstanding common stock of record on December 21, 1936. The words "Dividend Common Stock" appeared on each of the checks. After drawing the dividend checks the taxpayer on the same day (December 29, 1936), as agent for the common staockholders, under authority conferred by the agreement of December 2, 1936, endorsed each of the eleven checks in the names of the respective payees and deposited them to its own credit with the New York bank which accepted them and credited the taxpayer's account with $50,000. The taxpayer reflected the transaction on its books on December 29, 1936, by charging to its surplus account and crediting to its cash account the amoung of the above mentioned checks as dividends paid. It also debited its cash account and credited its surplus account with $50,000 as cash contributed by its common stockholders.

Each of the common stockholders reported the amount of the respective dividend check issued in his or her name as income received in 1936 and paid income taxes thereon accordingly.

While the taxpayer had sufficient earned surplus between December 21 and December 31, 1936, to warrant the declaration of a $50,000 divivend, it was not in a cash position during the period indicated to make a distribution of such an amount in cash. According to its bank statement of December 28, 1936, the day before the "dividend checks" were drawn, the taxpayer had a credit balance of $19,864.72; on December 29, 1936, the day the checks were drawn, endorsed and deposited, $45,115.08; and on December 30, 1936, the day after the dividend check transaction, $43,586.47.

The relevant statute specifies that the dividends paid credit shall be the amount of dividends paid by a corporation during a taxable year. This means nothing less than that the control of property distributed by way of a dividend must have passed absolutely and irrevocably from the distributing corporation to its stockholders. The provisions of the statute have been competently, and we believe, correctly so construed for ...

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