Opinion
No. 273.
June 29, 1943.
Petition to Review a Decision of the Tax Court of the United States.
Petition by the Commissioner of Internal Revenue to review a decision of the Tax Court of the United States, 46 B.T.A. 801, redetermining a deficiency in the tax imposed by the Commissioner of Internal Revenue against the Oswego Falls Corporation.
Reversed.
Taxpayer, a New York corporation, on July 1, 1926, executed a mortgage indenture to secure an issue of its bonds due in fifteen years, on July 1, 1941. $2,256,000 of such bonds were outstanding on December 31, 1936. Under that indenture the taxpayer mortgaged and pledged, through a conveyance to the Trustee named in the indenture, all its then-existing and after-acquired property excepting only certain quick assets. The indenture contained the following provisions: "That no dividend shall be paid or declared upon or set apart for the preferred stock ($750,000 issue) or for the Common Stock of the Company if such action will result in the reduction of its net current assets below One Million Dollars ($1,000,000).
The excluded property is described as follows: "Cash on hand or in banks, shares of stock, bonds and other securities included in the term `current assets' as defined in § 39 hereof, bills, notes and accounts receivable, acquired in the ordinary course of business, raw material, supplies intended for consumption in the operation of the plants of the Company, manufactured products and products in process of manufacture, unless hereafter deposited with the Trustee or otherwise specifically subjected to the lien of this Indenture by the Company."
Italics added.
"The term `net current assets' shall be taken to mean the excess of the value of the current assets over the amount of current liabilities, as said terms `current assets' and `current liabilities' are hereinafter defined.
"The term `current assets' shall be taken to mean (a) cash on hand and in bank (other than cash deposited with the Trustee hereunder), (b) good and collectible customers' notes, bills, trade acceptances and customers' accounts receivable, acquired or contracted in the ordinary course of business which are unpledged and which by their terms mature within one year after their date, excluding notes and accounts of subsidiaries, (c) accrued interest, rents and royalties receivable, (d) stocks of merchandise manufactured, produced or in process of manufacture, including by-products, raw material and supplies, which shall be taken at cost exclusive of interest, or at a fair market value, whichever is lower, (e) bonds and certificates of indebtedness of the United States of America which shall be taken at not exceeding their fair market value, (f) shares of stock, bonds and other securities (other than shares of stock of subsidiaries), which shall be taken at their fair market value, and (g) the cash surrender value of any policies of life insurance carried by the Company on the lives of any of its officers. The current assets of any subsidiary the entire capital stock of which is owned by the Company shall be included in the current assets of the Company.
"The term `current liabilities' shall be taken to mean all current liabilities of the Company, whether absolute or contingent, including (a) notes, bills, acceptances, accounts payable and other obligations, which mature within one year after their date, (b) loans from banks or bankers, (c) accrued salaries, wages, interest, rent, royalties and taxes, including income and profits taxes, and (d) any overdue Sinking Fund payment or any part thereof. In determining contingent liabilities arising out of endorsements or guarantees, credit shall be allowed as a corresponding current asset for the recourse of the Company against prior obligors of the obligation endorsed or guaranteed, but only if such prior obligors are solvent and responsible. The contingent liabilities for account of subsidiaries and the current liabilities of any subsidiary the entire capital stock of which is owned by the Company shall be included in the current liabilities of the Company.
"That it will not, except as herein allowed, do or suffer any act or thing whereby the trust estate might or could be impaired, and that it will at all times maintain, preserve and keep the mortgaged property and every part thereof, in good condition, repair and working order."
The granting clause of the indenture contained a transfer to the mortgage Trustee of all patents "now owned, held or enjoyed or hereafter acquired by the Company, including, but not in limitation of the foregoing general description, the following," after which were set forth certain specified patents.
Taxpayer's surplus or undivided profits were $1,139,014.08 as of December 31, 1936. Its net income for 1936 was $350,090.83. Deducting from this sum its normal tax of $51,352.62, there remained a balance of $298,731.31. Taxpayer, in 1936, paid cash dividends on its preferred and common stocks in the total amount of $135,101.20. This left undistributed net income subject to surtax, under §§ 14 and 27 of the Revenue Act of 1936, 26 U.S.C.A. Int.Rev.Acts, pages 823, 837, of $163,636.01, unless the taxpayer, under § 26 of the Act, 26 U.S.C.A. Int.Rev.Acts, page 835, was entitled to a "credit for contracts restricting dividend payments" equal to that amount. Taxpayer, in its return for 1936, claimed such a credit, relying on the limitation on payment of dividends contained in its mortgage indenture, since its "net current assets," after paying dividends, were less than $1,000,000. The preferred stock referred to in the indenture provision quoted above was a second preferred stock which was retired in September, 1936; there then remained outstanding shares of first preferred stock on which all current and cumulative dividends were fully paid in 1936; in these circumstances there was nothing in taxpayer's charter preventing the payment of further dividends on the common stock in an amount at least equal to the credit claimed. The Commissioner disallowed the credit and determined a deficiency accordingly. The Tax Court decided that the credit should be allowed. The case is here on the Commissioner's petition to review that decision.
The pertinent portion of that Section reads as follows:
"§ 26. Credits of Corporations
"In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax * * *
"(c) Contracts Restricting Payment of Dividends.
"(1) Prohibition on payment of dividends. An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account. * * *"
For that reason we need not consider whether or to what extent the corporation charter is a "contract" within the meaning of § 26, a question as to which there is disagreement among the Circuit Courts.
Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key, J. Louis Monarch, and Carlton Fox, Sp. Assts. to the Atty. Gen., for petitioner.
A.H. Cowie and Gerald H. Henley, both of Syracuse, N.Y., for respondent.
Before L. HAND, AUGUSTUS N. HAND, and FRANK, Circuit Judges.
The Commissioner contends that the taxpayer, without violation of the mortgage indenture, could have paid dividends in its unsecured notes (or other unsecured obligations) maturing more than "a year after their date." There may perhaps be some doubt whether such obligations, if maturing before the mortgage bonds, would have violated the provisions of the indenture; but that is a question we need not consider. For, if dividends had been paid in unsecured obligations maturing after July 1, 1941, when the mortgage bonds were payable, those unsecured obligations would not have violated the indenture provisions. The definition of "current liabilities," by specifying certain kinds of obligations, excluded others of a substantially dissimilar kind, according to the familiar rules of expressio unius and ejusdem generis. The obligations which were expressly included in the definition of "current liabilities" were, except "loans from banks or bankers," either those which matured within one year or which had "accrued" or were "overdue."
The purpose of the "net current assets" limitation on dividend payments was obviously to ensure that taxpayer would not be so burdened with net "quick" obligations before the mortgage bonds matured as to impair its business operations and thus court the danger of a default in the payment of the mortgage bonds. If taxpayer were unable to pay the mortgage bonds when due, the existence of unsecured obligations shortly thereafter becoming due would not have the effect which the "current assets" limitation was designed to prevent. Had the bonds issued pursuant to the indenture been unsecured debentures, perhaps the interpretation of the "current assets" provision would have been affected by the fact that, on default and resultant liquidation of taxpayer, the distribution to the bonds would be reduced by the participation of the obligations issued in payment of dividends; but here the bonds are secured by the major part of the taxpayer's assets, and the bonds, on liquidation, would share with other creditors only in the unmortgaged assets.
We cannot ignore the fact that the identure is a detailed instrument which covers 87 printed pages of the record and contains some 37,000 words — facts which serve to show that those who represented the mortgage bankers in the drafting of that instrument were not overlooking any possibilities of protection for the bondholders. If they had intended to prevent the issuance, in payment of dividends, of unsecured obligations coming due after five or more years, it is impossible to believe they would have spared the few extra words needed to express that intention. If they had intended to negate the application of the usual rules of expressio unius and ejusdem generis to the clause defining "current liabilities," they would surely have done so by inserting, before the enumeration of the specifically described kinds of current liabilities, the phrase — found in the granting clause of the indenture quoted above — "including, but not in limitation of the foregoing, the following," or some equivalent phrase, examples of which appear in the form books.
Accordingly, "without violating a provision of a contract," the taxpayer could have paid dividends in its unsecured obligations maturing after July 1, 1941. Even if one were to question that conclusion as to such obligations maturing shortly after that date, it would be impossible to do so as to such obligations maturing several years thereafter, say in 1946. It follows that the taxpayer was not entitled to a credit under § 26.
It is suggested that such an interpretation of the statute is unfortunate since, thus interpreted, the legislation creates an incentive to indulge in undesirable corporate financial practices in order to obtain savings in taxes. Doubtless it does, as do other provisions of our revenue laws which deserve Congressional re-examination from that point of view. But such policy considerations are not for the courts; it cannot be said too often that judicial legislation, while at times unavoidable and indeed desirable, must, so far as it affects statutes, be confined to filling in small gaps in legislative legislation in accordance with what appears to have been the legislative purpose. Moreover, we cannot forget that the Supreme Court has admonished us that § 26 is to be strictly construed against taxpayers.
See, e.g., Taxation of Corporate Enterprise, Monograph No. 9 (1941) Temporary National Economic Committee, 76th Congress, 3d Sess., pp. 91-92, to the effect that federal tax laws discriminate undesirably in favor of debt financing.
See discussion and cases and other authorities cited in Commissioner v. Beck's Estate, 2 Cir., 129 F.2d 243, 245, 246; Hoffman v. Palmer, 2 Cir., 129 F.2d 976, 987, and note 21, affirmed February 1, 1943, 318 U.S. 109, 63 S.Ct. 477, 87 L.Ed. ___.
Helvering v. Northwest Steel Mills, 311 U.S. 46, 49, 61 S.Ct. 109, 85 L.Ed. 29; Helvering, Commissioner, v. Ohio Leather Co., November 9, 1942, 317 U.S. 102, 63 S.Ct. 103, 87 L.Ed. ___. See, also, Helvering v. Magnus Beck Brewing Co., Inc., 2 Cir., December 7, 1942, 132 F.2d 379; Buffalo Slag Co. v. Commissioner, 2 Cir., 131 F.2d 625, 626; Van Ameringen-Haebler, Inc., v. Helvering, 2 Cir., December 28, 1942, 132 F.2d 855.
Reversed.