Before BIGGS, Chief Judge, and KALODNER and HASTIE, Circuit Judges.
In determining a deficiency in the 1949 income tax of Joy Manufacturing Company, the Commissioner of Internal Revenue ruled that a disputed item of $120,277 constituted income accrued to the taxpayer during the taxable year for certain engineering services. The Tax Court sustained that ruling and the taxpayer has asked us to review the decision.
There is no serious disagreement about the essential facts as found by the Tax Court. Joy Manufacturing Company is a Pennsylvania corporation engaged in the manufacture and sale of mining and construction equipment and machinery. It maintains its accounts and computes its income on an accrual basis. Joy-Sullivan, Ltd., a British corporation, is the taxpayer's wholly-owned subsidiary doing business in Great Britain and Eire.
Some time prior to 1949 the two corporations had obligated themselves to each other by a contract under which the taxpayer undertook to furnish certain services and materials to Joy-Sullivan and in return Joy-Sullivan agreed to pay the taxpayer "as an engineering and service fee, a sum equal to 10 (ten) per cent of the cost of the products manufactured * * *." Thereafter, Joy-Sullivan found itself in continuing need of additional working capital, which it sought to borrow in London from Bankers Trust Co. However, the prospective lender wanted such additional security as would be afforded if the amounts payable to the taxpayer under the foregoing agreement should be used to increase the capital of its British subsidiary. At the same time, monetary restrictions enforced by the British government were impeding the transfer of funds from England to the United States.
Accordingly, before the beginning of the taxable year it was agreed by the taxpayer, Joy-Sullivan and Bankers Trust, with the required approval of the Bank of England for the British government, that, thereafter, for a period which included 1949, the obligation to compensate taxpayer for services and materials under the preexisting agreement should be discharged by the issuance of additional stock of Joy-Sullivan to the taxpayer. At the same time it was agreed that this capitalization arrangement should not preclude "nominal remittances" in the nature of "token payments" for services rendered. However, under the then existing British law each such transfer thereafter proposed would require an application to and approval by the Bank of England.
During 1949 the obligations incurred by Joy-Sullivan to the taxpayer, computed under the terms of the original contract, amounted to $120,277, the sum now in controversy. No part of this sum was then or ever transferred to the taxpayer. Rather, after the end of the taxable year, additional shares of capital stock, of par value aggregating $120,277, were issued by Joy-Sullivan and delivered to the taxpayer in full settlement of the obligation arising out of the engineering and services contract.
The Tax Court also found that for each of the two years immediately following the taxable year the sum of 5000, about one-sixth of the contract value of the taxpayer's services rendered during the year, was actually paid to the taxpayer. Apparently this was accomplished by agreement of all concerned under the provision authorizing "nominal remittances", although there has been no finding on this.
We approach this problem by considering the income tax consequences of a simple agreement by a parent corporation to receive additional stock of its wholly-owned subsidiary in return for beneficial services to be rendered by the parent to the subsidiary. After such a transaction is fully executed, the parent has more shares of stock than before and the value of its holdings has been increased by whatever economic benefit the subsidiary has realized from the parent's services. But it is also true that before such a transaction, no less than after, all the stock of the subsidiary belongs to the parent. Therefore, the increase in the total value of the parent's stock caused by the parent's services is the same whether the subsidiary does or does not issue additional stock to the parent. In substance the services rendered by the parent have amounted to a capital contribution to the subsidiary.
The importance of this point seems to justify stating it again in a different way. While the services of the parent enrich the subsidiary, the additional stock or the promise of additional stock in subsidiary does not and cannot in any way enrich the parent. The parent obtains an economic advantage in the increased value of its wholly owned subsidiary, but the value is created directly by the parent's services. It is not a realized gain and its character taxwise is not affected by the issuance of additional stock of the subsidiary. Here, as in the cases which apply the doctrine of Eisner v. Macomber,*fn1 the peculiar circumstances under which additional stock is issued to a stockholder prevent the promise or transfer of the additional paper from amounting to a realization of gain.
The Tax Court itself has recognized the soundness of this analysis. Josephson v. Commissioner, 1947, 6 T.C.M. 788; Jacksonville Paper Co. v. Commissioner, 1954, 13 T.C.M. 728. Cf. Michaels v. McLaughlin, D.C.N.D.Cal.1927, 20 F.2d 959. Indeed, in the Josephson case Judge MURDOCK, who also rendered the Tax Court decision from which the present appeal is taken, said, "He [the taxpayer] was the sole stockholder of the corporation. * * * His wealth was not increased by the issuance of the 200 additional shares. The issuance of such shares to him did not constitute income to him * * * regardless of whether it was stock dividend or for salary. * *" 6 T.C.M. at 789. Similarly in the Jacksonville Paper case the Tax Court reasoned that "it seems to us that the amounts of * * * undrawn salaries [payable to the owners of a business] resulting in the issuance of additional capital stock * * * in proportion to * * original holdings, are in the nature of a stock dividend and, hence, not taxable * * *" We think it clear, therefore, that the issuance of additional stock to the sole stockholder for services rendered to a corporation, or the vesting of a right to such stock, does not result in the realization of taxable gain.
We next consider whether such a situation differs in any essential way from what was agreed and what was done in the present case. Here there were two transactions, an original service contract between a corporation and its sole stockholder and a subsequent multilateral agreement affecting the rights thereafter to be acquired under that contract. As a result of these agreements, when the stockholder rendered services to the corporation during the taxable year it received in return nothing of legal or economic significance except a right to additional stock.
To avoid the tax consequences of this conclusion the Commissioner analizes the stockholder's right to money under the original agreement as something distinct from the correlative obligation, superimposed by subsequent agreement, to accept stock in satisfaction of its claim.Relying upon that conceptual separation the Commissioner would treat the original agreement to pay money as the basis of a taxable accrual, ignoring the overriding obligation to accept stock in lieu thereof. This reasoning is unsound because both the original service agreement and the subsequent agreement to capitalize the value of the services antedated 1949 and were in effect throughout the taxable year. Whether we reason in two steps or in one the only enforceable claim acquired by the taxpayer for services rendered during 1949 was a right to receive stock. Therefore, the case differs in no essential way from the simple agreement to receive stock, the tax consequences of which we already have determined.
There remains the matter of "nominal remittances." As already pointed out the general agreement to capitalize the engineering and service fee claims was qualified by a provision that token payments in money would be considered proper. However, it was not indicated in any way how large or small a sum would be regarded as a "nominal remittance." Moreover, as the Tax Court expressly found, any such payment to a non-British corporation would require an application to and approval by the appropriate public authority. Therefore, we think this permissive exception to the capitalization arrangement can reasonably be read only as an agreement in principle, subject to later determination of amount and governmental approval of that amount. Moreover, no attempt was made to exercise that privilege for the taxable year. Instead, the entire claim was capitalized.
The rule with reference to the accruing of income in such circumstances is clear and well established. This court has stated it in the following language:
"It is 'the right to receive and not the actual receipt' of an amount which determines its accruability. But the right to receive must have become fixed before the right can be said to have accrued. Spring City Foundry Co. v. Commissioner, 292 U.S. 182, 184, 185, 54 S. Ct. 644, 78 L. Ed. 1200. Consequently, until the right to an amount becomes accruable through the fixation of the right to receive, the taxpayer is under no obligation to return it as income. Otherwise he would be required to pay a tax on income which he might never have a right to receive." Keasbey & Mattison Co. v. ...