Opinion
Docket No. 110007.
1943-05-27
THE KORFUND COMPANY, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Joseph A. Fagnant (an officer), for the petitioner. B. W. Berg, Esq., for the respondent.
Contracts were made, inside the United States, by nonresident aliens, not to perform within the United States acts competitive in nature with the business of the petitioner, which paid certain amounts as consideration for such contracts. Held, the income so paid to the nonresident aliens was from sources within the United States, under section 119 of the Revenue Act of 1938, and subject to the withholding tax under sections 143(b) and 144 of the Revenue Act of 1938. Joseph A. Fagnant (an officer), for the petitioner. B. W. Berg, Esq., for the respondent.
This proceeding involves the redetermination of a deficiency of $772.67 in income tax for 1938. The issue is whether petitioner is liable for withholding taxes on amounts paid to a nonresident alien and corporation.
FINDINGS OF FACT.
Petitioner is a New York corporation organized in 1924, with its principal place of business in New York City, for the purpose of manufacturing and selling foundation material, such as cork plates and vibration absorbers. Of the 1,000 shares of stock issued at that time, Hugo Stoessel, a nonresident alien and citizen of Germany, received 925 shares and Siegfried Rosenzweig the remaining shares. Petitioner filed its return for the taxable year on the accrual basis with the collector for the first district of New York.
The Emil Zorn Aktiengesellschaft, hereinafter referred to as Zorn, is a nonresident foreign corporation engaged in the same business as petitioner, with its principal office in Berlin, Germany. In 1928 its stock was held equally by Stoessel and Werner Genest, a nonresident alien and citizen of Germany. In 1932 or 1933 Stoessel became the sole owner of stock of Zorn.
On October 22, 1926, petitioner entered into a written contract in the United States with Zorn whereby Zorn agreed (a) not to compete with petitioner in this country and Canada or to form, or give any data for the purpose of forming, a competitive company in that territory until the end of 1945, and (b) to give technical and business advice to petitioner upon its request, and petitioner agreed (a) not to furnish material, for the isolation of noise and vibration, outside of the United States and Canada prior to December 31, 1945, except specified territory outside of European countries. Each party agreed to turn over inquiries received from territory of the other and to exchange without charge improvements, inventions, and patents involving isolation against noise and vibration. Zorn was to receive from petitioner quarterly ‘a royalty of 1 1/2% for the year 1926 and 2% thereafter of the sale of all cork plates with iron frames and of 4% of the sale of all vibration absorbers,‘ computed in a specified manner, with a minimum payment of $400 for 1926, $1,000 for 1927, and $1,250 thereafter through 1940. Zorn did not own any patents at that time. One of the purposes of the contract was to eliminate competition.
On September 21, 1928, the stock of petitioner was held as follows: Stoessel and Genest each 250 shares, Herman Hoevel 299 shares, and Siegfried Rosenzweig 201 shares. At that time the Cork Foundation Co., all of whose stock was owned by Dore Sundland, was competing with petitioner in the United States. Petitioner desired to eliminate such competition. Its stockholders realized that, if it was accomplished in a transaction involving the acquisition of stock by Sundland, Sundland would acquire an interest in petitioner's surplus. They also concluded that distribution of the surplus in cash would deprive petitioner of necessary working capital. To meet the situation, on September 21, 1928, petitioner's directors adopted a resolution providing:
* * * that the net surplus of the corporation as of October 1, 1928 be distributed among the stockholders of the corporation in proportion of their respective holdings of the capital stock of the corporation.
FURTHER RESOLVED that the offer of the shareholders of the corporation to leave the said surplus with the corporation, pursuant to the provisions of the said offer, evidenced by a writing bearing this date, be and the same hereby is accepted.
and the four old stockholders executed an agreement providing:
* * * that the surplus in the corporation as of October 1, 1928, which by a resolution of the Board of Directors at a meeting now being duly held, was distributed among the undersigned as of October 1, 1928, shall not be withdrawn for the period of four (4) years, except by mutual consent, and that an offer be made to the corporation to leave the said surplus with it for the said period.
Subsequently, on the same day, petitioner's stockholders acquired all of the stock of the Cork Foundation Co., and Sundland acquired stock of petitioner.
On September 21, 1928, petitioner entered into a written agreement with Stoessel in the United States whereby Stoessel undertook to act as consultant and adviser of petitioner in matters relating to the business of petitioner and to communicate to it information of value to petitioner's business until December 31, 1939, for 10 percent of the net earnings of petitioner payable at the end of each year. He also agreed not to act in a similar capacity for any other person, association, or corporation in the United States engaged in the same or a similar business. One of the purposes of the agreement was to eliminate competition.
The surplus account of petitioner had a credit balance of $23,710.40 on September 30, 1928. No entries were made in the account thereafter until December 31, 1928, when 1,200 was credited to the account, thus creating a credit balance of $24,910.40 in the account at the close of the year. A notation was made in the account that in accordance with the directors' resolution of September 21, 1928, the surplus of $24,910.40 was ‘to be divided equally‘ among the stockholders and distributed pursuant to the terms of the stockholders' agreement. The return of petitioner for 1928 reported a surplus of $23,710.40 at the close of 1928 and undivided profits of $5,574.68. The balance sheet included therein at the close of 1928 did not contain a liability to petitioner's old stockholders.
Zorn and Stoessel faithfully performed their agreements not to compete with petitioner and not to give advice to its competitors. On about January 1, 1933, petitioner canceled the contracts of September 21, 1928, and October 22, 1926, with Stoessel and Zorn, and refused to make further payments to them. The contract with Stoessel was canceled on account of his failure to communicate technical information relating to petitioner's business as required by the agreement.
The stockholders of petitioner on September 21, 1928, each received, as distributions of dividends out of the surplus existing at that time, $1,000 in August and November 1929 and June and November 1930, leaving a balance of $2,227.60 in favor or each stockholder. Hoevel received an additional payment of $1,000 on January 31, 1931, when his employment contract was terminated, and another payment on April 30, 1931, to balance his account. The balances of $2,227.60 in the accounts of Genest and Rosenzweig were paid in 1935. The distributions of $4,000 in August and November 1929 were charged to petitioner's surplus account. On September 10, 1930, the charges were eliminated by a credit to the account and $23,910.40 of the balance in the account was transferred to ‘Special Surplus‘ and the remainder of $1,000 to ‘Capital Stock.‘
On July 30, 1934, Zorn assigned to Bernard Voges, New York City, all sums due it from petitioner under the agreement of October 22, 1926, and Stoessel assigned to the same individual salary in the amount of $1,984.04 alleged to be payable by petitioner for services rendered prior to October 1, 1932, and the balance of $2,227.60 payable to him from surplus account, plus interest on the claims of each, with power to recover the amount, plus interest on the claims of each, with power to recover the amounts for the account of the assignors. Voges instituted suit against petitioner in August 1934 under the assignments. An understanding was reached in 1934 to settle the claims by a payment of $2,750 to Stoessel and $3,250 to Zorn. The claim of Zorn for $3,250 and the claim of Stoessel for $2,227.60 were allowed in full. The remaining amount allowed Stoessel was for demands made under the agreement of September 21, 1928. The total amount was placed at interest and earned interest of $80, pending approval of the settlement by the German Government. Final settlement was made in 1938 when $2,508 was paid to Stoessel and $2,964 to Zorn and $608 was withheld for payment of withholding taxes.
OPINION.
DISNEY, Judge:
In his determination of the deficiency the respondent held that the allowance of $2,786.67 to Stoessel and $3,293.33 to Zorn, which amounts include the proportionate share of each in the interest of $80, constituted income from sources within the United States on which petitioner, as withholding agent, should have paid a tax equal to 10 percent of the former amount and 15 percent of the latter amount in accordance with the provisions of sections 143 and 144 of the Revenue Act of 1938. The item of $2,786.67 includes the principal sum of $2,227.60 representing Stoessel's share of petitioner's old surplus of $24,910.40. Respondent admits that, of the total amount paid to Stoessel in 1938, $2,227.60 represented the dividend and the remainder compensation under the contract. The parties differ only on whether this item of $2,227.60 was received by Stoessel in the taxable year. The contention of petitioner is that it was distributed and taxable to Stoessel in 1928, not, as respondent determined, in 1938, when the amount, less withholding tax, was actually paid.
Petitioner does not contend that the dividend was actually paid to Stoessel in 1928. Its position is, however, that the amount was constructively received by him in that year and then loaned to petitioner.
The mere declaration of a dividend does not give rise to taxable income. There must be not only a declaration of a dividend but the setting aside of funds for its payment. Hadley v. Commissioner, 36 Fed.(2d) 543.
There was no setting aside of funds here for payment of the dividend. The aggregate amount of $8,000 paid to the old stockholders in 1929 was charged to the surplus account. In 1930 the original surplus, less $1,000 transferred to capital stock for an unexplained reason, was set up in a ‘Special Surplus‘ account. The amount is not listed as a liability in the closing balance sheet included in petitioner's return for 1928 and the accounts of the stockholders were not credited with the surplus in 1928. Such credits were not made until installments were paid. This treatment of the transaction on the books is opposed to the idea of a distribution in 1928 coupled with a loan to petitioner. There is some testimony in the record that the stockholders considered the question of lending the surplus to petitioner. If such was ever their intention, it was not proposed to petitioner. The agreement among the stockholders and the resolution of petitioner contain nothing to indicate that a loan was intended. On the contrary, they clearly show intent not to withdraw the surplus for a period of four years without mutual consent of the stockholders. The agreement of the stockholders provides for withdrawal of surplus, not payment of loans. Furthermore, the evidence does not show, and petitioner makes no contention, that any of the stockholders reported their proportionate part of the surplus as income in 1928 from dividends, or otherwise.
The dividend was not at any time in 1928 subject to the unqualified demand of the stockholders. Aside from no setting aside of funds for payment of the dividend or crediting of the dividend to accounts of the stockholders, as already shown, the stockholders as directors (three of the four being present at the directors' meeting) specifically provided against making the dividend subject to their demands except by mutual consent. Thus Stoessel could not have obtained any part of his share of the surplus without unanimous consent of the other stockholders. Obviously this restriction was not imposed by Stoessel himself and he alone was never in a position to alter the situation so as to make withdrawals. On the contrary, after the refusal of petitioner to make further payments to him, Stoessel resorted to litigation to recover his share of the surplus. The record also shows that, notwithstanding the resolution accepting the offer of the stockholders, petitioner exercised control over the amount. One of the stockholders, Hoevel, received his final payment in 1931; petitioner agreed in 1934 to pay Stoessel, and in 1935 paid the other two stockholders. It has not been shown that any of this action was taken with the common consent of the stockholders concerned.
We hold that the item of $2,227.60 was not paid to Stoessel, actually or constructively, until the taxable year.
Under their contracts Zorn and Stoessel agreed, in general, to act as consultants to petitioner. In addition Zorn agreed not to compete with petitioner or give any information for the formation of a competitive company and Stoessel agreed not to act as consultant to a competitor of petitioner. All of the amount paid to Zorn and the amount paid to Stoessel in excess of the surplus item were paid for these two general classifications of undertakings without any segregation of the amount paid for each. The respondent subjected the entire amounts to withholding tax, presumably in the absence of any basis of segregation, for he does not contend that the income from services performed as consultants is subject to the tax. Not only was no evidence offered on which to make an apportionment, but petitioner does not, upon brief, suggest or request an allocation. Under the circumstances, no apportionment is possible and we will regard all of the amounts in question under this point as having been earned by the nonresident aliens for obligations under the contracts other than service as consultants. See Estate of Alexander Marton, 47 B.T.A. 184.
The sole point of difference between the parties as to this income is whether it was earned from sources within the United States within the meaning of section 119 of the Revenue Act of 1938, and that, as already indicated, turns upon the source of the income derived from agreements not to compete with petitioner in the United States and Canada or give advice for the organization of, or to, a competitor.
The petitioner's contention is based upon the theory that the income was paid for agreements to refrain from doing specific things— negative acts. No defaults occurred and during the period of compliance the promisors were residents of Germany. Petitioner's contention is that negative performance is based upon a continuous exercise of will, which has its source at the place of location of the individual, and that, as the mental exertion involved herein occurred in Germany, the source of the income was in that country, not in the United States where the promise was given. The respondent's view of the question is, in short, that, as the place of performance would be in the United States if Zorn and Stoessel had violated their contractual obligations, abstinence of performance occurs in the same place. Petitioner relies upon Piedras Negras Broadcasting Co., 43 B.T.A. 297; affd., 127 Fed.(2d) 260.
In the Piedras Negras Broadcasting Co. case the taxpayer, a Mexican corporation, owned and operated a radio broadcasting station in Mexico, from which it broadcast programs primarily for listeners in the United States, for which it received compensation in the United States from citizens thereof. In holding that the source of such income was not within the United States, we pointed out that the studio and broadcasting plant were located, and operated by the employment of capital and labor, in Mexico; that the source of the income was, accordingly, in such studio and power plant, and that the reception of the radio impulses in receiving sets in this country was secondary, not the primary source. The court in affirming the decision said that ‘the source of income is the situs of the income-producing service‘ and that the source of the income was ‘the act of transmission.‘ This reasoning is said to be equally applicable to the situation here.
In Sabatini v. Commissioner, 98 Fed.(2d) 753, the taxpayer was an author and a subject of Great Britain. He was not in the United States before, nor during, the taxable years. By contract executed outside the United States he gave to a publisher in this country, among other rights, the right to publish certain books, as to some of which copyrights were not obtainable. As to these the taxpayer, by the contract above mentioned, agreed not to authorize any other publisher to publish the books in the United States so long as the publisher left in print its editions of the books. The taxpayer was to receive under the contracts amounts determinable from the number of volumes sold. In holding that the income paid based upon the sale of these books was derived by the taxpayer from sources within the United States, the court said:
The payments were received in consideration of his granting the publisher the exclusive right to publish here. To be sure, that may not have been of great value but the parties did value it and the author received the payments as agreed. We are not now concerned with the quality of the consideration he gave but only with the taxability of that which he received. The payments were made to him for foregoing his right to authorize others for a time to publish the works here. Though others may, perhaps, lawfully have published them they could not do so under his express authority. The rights he granted were an interest in property in the United States, in the one instance the statutory copyrights obtainable and in the other the exclusive right to publish with his permission.
In Ingram v. Bowers, 47 Fed.(2d) 925; affd., 57 Fed.(2d) 65, Enrico Caruso, a nonresident alien, entered into a contract in the United Stated to sing for the Victor Talking Machine Co. for the purpose of making phonograph records of selections rendered by him. The agreement contained a provision that Caruso would not permit any records of his voice to be made by any other concern. He was to receive under the contract a specified amount of the selling price of records sold, with a minimum yearly payment. In holding that the income received by Caruso under the contract from foreign sales constituted income from sources within the United States, the court pointed out that the decisive feature was the fact that the services were rendered in the United States and that those services were the source of all income derived from the contracts. No point appears to have been made of the fact that some part of the income was paid for the promise to refrain from singing for others, as it is not discussed in the opinion. Under petitioner's theory here, such part would not have been taxable.
In Commissioner v. Ferro-Enamel Corporation, 34 Fed.(2d) 564 (Apr. 7, 1943), the taxpayer agreed to purchase the entire output of the mines of a Canadian corporation for a period of three years and as a part of the contract purchased shares of the corporation's stock, for the sole purpose of obtaining raw material for its domestic business. Later in the year the corporation went out of existence and its stock became worthless. In holding that the loss occurred in Canada, the court said:
The statute in question undertakes to classify the sources of income within the United States and without the United States by the nature and location of the activities of the taxpayer or his property which produces the income. * * *
* * * The loss grows out of an activity or use of property and the situs of the loss is not transferred to the home of respondent because respondent wished to obtain a source of raw material.
We think the question here is governed by the principles laid down in the Sabatini, Ingram and Ferro-Enamel Corporation cases. Zorn had a right to compete with petitioner in the United States and Canada and for that purpose to form a competitive company or to assist others in forming one. Likewise, Stoessel had a right to serve other corporations or individuals in the United States engaged in a business similar to petitioner's as a consultant and to furnish them information of value to their business. They were willing to and did give up these rights in this country for a limited time for a consideration payable in the United States, just as did Sabatini in ‘foregoing his right to authorize others for a time to publish the works here.‘ The Circuit Court in that case calls the exclusive right to publish an interest in property in the United States; so here, in our opinion, the rights of Stoessel and Zorn to do business in this country, in competition with the petitioner, were interests in property in this country. They might have received amounts here for services or information, but were willing to forego that right and possibility for a limited period for a consideration. What they received was in lieu of what they might have received. The situs of the right was in the United States, not elsewhere, and the income that flowed from the privileges was necessarily earned and produced here. Petitioner is merely using it, so to speak, for a specified time, subject to periodical payments to the owners of the rights. Upon the termination of the contracts the rights reverted to Zorn and Stoessel, and they were then free to exercise them independent of the agreements entered into with petitioner. These rights were property of value and the income in question was derived from the use thereof in the United States.
The Piedras Negras Broadcasting Co. case is distinguishable. It involved employment of capital and labor in a foreign country in connection with the rendition of service— not the foregoing, for a consideration, of a right to transact business in the United States.
We find and hold that the source of all of the income in question was in the United States and is subject to withholding tax in the taxable year. Accordingly,
Decision will be entered for the respondent.