Opinion
Docket No. 2309.
1945-01-17
CHARLES L. HUISKING & CO., INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
A. Loeb Salkin, Esq., for the petitioner. Ellyne E. Strickland, Esq., for the respondent.
Debenture bonds unsecured, subordinate to the claims of all creditors, and containing a provision for interest payments by the corporation at its option, held to be in the nature of an investment and payments thereon not deductible as interest. A. Loeb Salkin, Esq., for the petitioner. Ellyne E. Strickland, Esq., for the respondent.
The Commissioner has determined a deficiency of $7,491.10 in petitioner's income tax and of $1,417.13 in its declared value excess profits tax for the year 1939.
The sole issue before us for determination is whether certain payments made by petitioner during the taxable year 1939 to the holders of its ‘series A debenture bonds‘ constitute dividends on stock which were not deductible from gross income, as determined by respondent, or whether they constitute payments of interest within the meaning of section 23(b) of the Internal Revenue Code, and are deductible as such.
Two other issues raised by the pleadings have been agreed upon and settled by the parties and will be given effect under Rule 50.
Some of the facts have been stipulated by the parties and are found accordingly. Other material facts are found from the evidence.
FINDINGS OF FACT.
The petitioner, Charles L. Huisking & Co., was incorporated under the laws of the State of New York in August 1927, under the name of Five Platt Street Corporation. Its purposes were manufacturing, importing, purchasing, selling, and dealing in, as principal or agent, upon commission or otherwise, drugs, medicines, chemicals, oils, and general merchandise. Petitioner kept its books on the accrual basis of accounting and filed its tax returns for the year 1939 with the collector for the second district of New York.
Charles L. Huisking had started a similar business in 1910, which he operated as proprietor until 1917. In that year the business was incorporated under the laws of New York, with the corporate title of Charles L. Huisking, Inc.
On August 29, 1927, the petitioner was incorporated as Five Platt Street Corporation, pursuant to a plan sponsored by Huisking. Its business purposes were as above described.
All of the stockholders of Charles L. Huisking, Inc., assigned and transferred their stock to the Five Platt Street Corporation and received therefor one share of its stock and a debenture bond, Series A., having a face amount of $100 for each share so transferred. The shares issued by the Five Platt Street Corporation were without par value.
The holders of debenture bonds and the stockholders of Five Platt Street Corporation on or about October 6, 1927, were as follows:
+----------------------------------------------------------------------------+ ¦ ¦ ¦Debenture¦ ¦ ¦Debenture¦ +---------------------+---------+---------+-----------------+------+---------¦ ¦Name ¦Shares ¦bonds ¦Name ¦Shares¦bonds ¦ +---------------------+---------+---------+-----------------+------+---------¦ ¦Charles L. Huisking ¦2,929 ¦$292,900 ¦John J. Lantz ¦18 ¦$1,800 ¦ +---------------------+---------+---------+-----------------+------+---------¦ ¦Catherine F. Huisking¦1,580 1/2¦158,050 ¦George W. La Cour¦9 ¦900 ¦ +---------------------+---------+---------+-----------------+------+---------¦ ¦George P. Huisking ¦306 1/2 ¦30,650 ¦William E. Martin¦9 ¦900 ¦ +---------------------+---------+---------+-----------------+------+---------¦ ¦Joseph A. Huisking ¦300 ¦30,000 ¦Cyril F. Mathias ¦14 ¦1,400 ¦ +---------------------+---------+---------+-----------------+------+---------¦ ¦Peter A. Dirr ¦300 ¦30,000 ¦ ¦ ¦ ¦ +---------------------+---------+---------+-----------------+------+---------¦ ¦William J. Dawson ¦60 ¦6,000 ¦Total ¦5,551 ¦555,100 ¦ +---------------------+---------+---------+-----------------+------+---------¦ ¦Kurt J. Kohler ¦25 ¦2,500 ¦ ¦ ¦ ¦ +----------------------------------------------------------------------------+
The debenture bonds issued by the petitioner contained a definite promise to pay a specified principal sum on a fixed and certain maturity date in 1950, and provided for the payment of interest until the principal was paid, at the rate of 6 percent per annum on specified semiannual dates. The rights of the bondholders however, were set forth with particularity and the debentures contained, among other provisions, the following:
1. This debenture is subject in all respects and subordinate to the claims of all creditors of the Corporation, and upon the dissolution or liquidation of the Corporation no payment shall be due or payable on this debenture unless and until all other creditors of the Corporation shall have been paid in full, or the amount of any disputed claim has been duly bonded.
2. Interest on the debentures of this series may, at the option of the Corporation, be deferred or suspended without limit of time, and may be paid or unpaid and/or, at the option of the Corporation, whole or in part.
3. The debentures of this series are subject to redemption at par and accrued interest, if any is authorized by the Board of Directors, to be paid on any interest date in whole or in part, pro rate at any time on thirty days prior notice given to the registered holders in such manner as the Board of Directors may by resolution authorize, and after the date fixed in such notice of redemption, interest, if any authorized, shall cease.
5. No holder of this debenture shall have any right to institute any suite, action or proceeding in equity or at law upon this debenture unless the holders of sixty percent in amount of all debentures of all series voluntarily consent and join in such suit, action or proceeding.
Under its certificate of incorporation the Five Platt Street Corporation was authorized to issue a total of 7,500 shares of stock, all of one class and without par value, and to issue notes, bonds, and debentures, and other obligations.
On November 3, 1927, by a certificate which was in conformity with the requirements of law of the State of New York, the Five Platt Street Corporation duly merged with it the corporation known as Charles L. Huisking, Inc., and, on November 25, 1927, by appropriate certificate the name was changed to ‘Charles L. Huisking & Co., Inc.,‘ which is the present name of the petitioner.
At the time the corporate reorganization was consummated the total assets of Charles L. Huisking, Inc., as shown by its balance sheet, were $860,152.47, with liabilities listed in the sum of $198,155.57, plus outstanding common stock at an aggregate par value of $555,100, and a surplus of $106,896.90.
By an appropriate certificate which was executed on August 23, 1935, the authorized capital stock of the petitioner corporation was reduced from 7,500 shares without par value to 100 shares having a par value of $100 per share. Thereafter the outstanding capital stock of petitioner, consisting of 5,081 shares without par value, was surrendered to the company for cancellation, in exchange for which petitioner issued one share of the new par value ‘100 stock for every 60 shares of its previously authorized stock. At that time the stockholders and their respective interests were as follows:
+------------------------------------+ ¦ ¦Shares ¦ +--------------------------+---------¦ ¦Huisking Investments, Inc.¦4,509 1/2¦ +--------------------------+---------¦ ¦Joseph A. Huisking ¦300 ¦ +--------------------------+---------¦ ¦Peter A. Dirr ¦211 1/2 ¦ +--------------------------+---------¦ ¦William J. Dawson ¦60 ¦ +--------------------------+---------¦ ¦ ¦5,081 ¦ +------------------------------------+
Huisking Investments, Inc., was a family holding company, all of its capital stock being owned by Charles L. Huisking, his wife, and their children. Charles L. Huisking, the founder and president of the petitioner corporation, owned all of the voting stock of Huisking Investments, Inc.
Petitioner has paid the several bondholders the sums called for as interest on all of its issued and outstanding debenture bonds, with the exception of a nine-month period in 1931. In the years 1934, 1935, and 1938 payments were made even though the corporation's net income was of a lesser amount than required for the interest payments. In 1931 petitioner suffered a loss of approximately $192,000 and the bondholders agreed to waive ‘interest‘ for the last nine months of that year. At the same time Huisking agreed to surrender for cancellation, without further consideration, $150,000 in petitioner's debenture bonds.
In 1939 the outstanding debenture bonds of the petitioner amounted to $357,150 and were owned as follows:
+----------------------------------+ ¦Huisking Investments, Inc¦$300,000¦ +-------------------------+--------¦ ¦Joseph A. Huisking ¦30,000 ¦ +-------------------------+--------¦ ¦Peter A. Dirr ¦21,150 ¦ +-------------------------+--------¦ ¦William J. Dawson ¦6,000 ¦ +----------------------------------+
Joseph A. Huisking, a brother of Charles L. Huisking, was secretary of the petitioner corporation. William J. Dawson was treasurer of the petitioner corporation, having been associated with Charles L. Huisking since 1915. Peter A. Dirr was also a ‘key man‘ of the petitioner corporation, being in the purchasing and selling end of the business, and he had been with Charles L. Huisking since 1911.
The bonds held by Joseph A. Huisking in the principal sum of $30,000 were redeemed by petitioner on June 15, 1939, at par, plus accrued interest at the date of redemption.
A dividend of $13,118.75 was paid to the stockholders in 1939 and a dividend of $12,000 was paid in 1941. In 1941 Peter Dirr and William J. Dawson sold their stock to the petitioner corporation for $650 per share and purchased petitioner's debenture bonds with all or part of the proceeds.
During the taxable year 1939 petitioner paid the sum of $20,454 to the holders of its debentures and deducted that amount on its income tax return for that year as interest paid on indebtedness. The respondent disallowed the deduction.
OPINION.
ARUNDELL, Judge:
The only issue before us is whether petitioner's payments to the holders of its debenture bonds were payments of interest on an indebtedness within the meaning of section 23(b) of the Internal Revenue Code, or whether they were dividend distributions.
As we said in Proctor Shop, 30 B.T.A. 721; affd., 82 Fed.(2d) 792, none of the decided cases lays down any comprehensive rule by which the question presented may be decided in all cases, and the decision in each case turns upon its own particular facts and circumstances. The cases have developed criteria which are used as a basis for the determination. Some of the factors relied upon are: The name given the instrument, the presence or absence of fixed maturity date, whether annual payments are dependent upon earnings, the credit status of the holders of the instruments, that is, whether they are superior to or inferior to other creditors of the corporation, and whether the instrument carries with it any right to participate in the management of the company. None of the factors is necessarily controlling. In some cases one factor or another is said to be decisive and in other cases the determination is predicated upon a combination of them.
The instrument has been designated a ‘debenture bond‘ and the payments thereunder have been called ‘interest.‘ While the name given by the parties may not be lightly disregarded, Pacific Southwest Realty Co., 45 B.T.A. 426, 436; affd., 128 Fed.(2d) 815, neither is the designation given the instrument conclusive. Jewel Tea Co. v. United States, 90 Fed.(2d) 451, 452. The debentures provided for payment of the principal sum at a specified maturity date in 1951, but this again is not decisive, for it is not unusual for preferred stock to have maturity or retirement date. Commissioner v. Meridan & Thirteenth Realty Co., 1,5 Fed.(2d) 182, 186; Commissioner v. Kelley Co., 146 Fed.(2d) 466 (C.C.A., 7th Cir.), reversing 1 T.C. 457; Talbot Mills, 3 T.C. 95; affd., 146 Fed.(2d) 809 (C.C.A., 1st Cir.).
The fundamental basis for our conclusion that these securities are more nearly like preferred stock than indebtedness is the fact that the debentures are unsecured and are subordinated to the claims of all creditors of the petitioner and the payment of interest is not absolute.
Indeed, the instrument provides that interest may be ‘paid or unpaid‘ at the option of petitioner. This alone is sufficient to distinguish the instant case from Commissioner v. O.P.P. Holding Corporation, 76 Fed.(2d) 11, affirming 30 B.T.A. 337, and Commissioner v. Hood & Sons, Inc., 141 Fed. (2d) 467, upon which petitioner strongly relies. In the O.P.P. Holding Corporation case, supra, the instrument contained a provision permitting the corporation at its option to suspend or defer the payment of interest, but this suspension of payment did not relieve the corporation of the obligation to pay the same at some future time. The accumulated interest could be collected, together with the principal, at the maturity date from the corpus of the debtor's property. In the instant case the holders of the debentures are entitled to the payment of the principal sum at maturity, but they are entitled only to such interest as the debtor corporation shall determine they may have. While in the Hood case, supra, the interest was payable ‘only out of and to the extent of the net earnings of the company,‘ it was cumulative and payable absolutely at the date of maturity or call, irrespective of the earnings of the company. The taxpayer in the instant case has not contracted to pay any interest, but has the right to pay or not to pay interest as it sees fit. ‘Stockholders have no absolute right to dividends until they are declared. A creditor has a right to his interest in any event. ‘ Commissioner v. Meridan & Thirteenth Realty Co., supra.
Nor is any significance to be attached to the fact that the debenture holders had no voting right, for that again is quite characteristic of preferred shares. See Hood & Sons, Inc., supra. A review of the cases which have been decided discloses none where payments have been held to be interest when such payments could be made solely at the option of the board of directors of the debtor corporation, without an ultimate obligation that interest be paid in any event.
The circumstances under which the debentures in question were issued make it clear that their terms were dictated by Huisking and not arrived at by negotiation between the so-called debtor and creditors. No new capital came into the corporation by reason of this financing, and, while there may have been the interest of certain key men to be considered in the plan as undertaken, their interest was small compared with that of Huisking and his family. Section 23(b) of the Internal Revenue Code is designed to permit of the deduction of genuine interest on a genuine indebtedness. For the reasons already set forth we do not think either are here present. The respondent is sustained.
Decision will be entered under Rule 50.