LEMMON, District Judge.
Appellant brought suit in the District Court against the appellee to recover income taxes paid for the years 1943 and 1944. The appeal followed a judgment adverse to appellant.
The facts are undisputed. Appellant is the successor in interest to the Arizona Power Corporation, referred to herein as the Prescott Company, pursuant to a consolidation effected in 1945. The Prescott Company was a public utility concern engaged in the sale of electric energy and gas at rates established or approved by the Corporation Commission of the State of Arizona.
In the year 1935 Prescott Company issued 12,037.5 shares of its preferred stock. These shares had no par value but they were entitled to $100 on an involuntary dissolution and $105 in the event of a voluntary dissolution. On both types of dissolution the holder could receive accumulated dividends.
Each share of preferred was entitled to an annual dividend of $6 before dividends could be paid on the common stock, but this dividend accumulated only if and to the extent that there were net earnings. When the dividend was earned but not declared or paid it persisted as a charge on the company’s earnings and assets senior to the common stock.
Prescott Company kept its books, computed. its income, and paid its taxes, on a calendar year basis. During the year 1943 it paid $55,334.44 and during the year 1944, $44,194.32 as dividends on its preferred stock. We are here confronted with the question as to whether the Prescott Company may deduct these dividends for the purpose of computing its 16% corporate surtax.
Section 133 of the Revenue Act of 1942, 26 U.S.C.A., Int. Rev.Acts, page 200, defines preferred
stock as being stock the dividends in respect of which are “cumulative, limited to the same amount, and payable in preference to the payment of dividends on other stock.” Appellant, as the corporate successor of the Prescott Company, filed timely and sufficient claims for refunds for these calendar years. These claims were disallowed and this action to recover them followed.
The Collector contends that dividends are not cumulative if they depend upon net earnings; that to be cumulative the rate of return must be fixed or guaranteed in express terms so that it may not be changed by a vote of the board of directors.
1. The dividends payable on the preferred stock were cumulative.
The articles of incorporation provide, as noted, “The holders of the $6 Preferred Stock shall be entitled to receive, but only out of the surplus profits of this corporation, dividends in each year at a rate determined by dividing the net earnings of the corporation for the next preceding calendar year by the number of shares of such $6 Preferred Stock outstanding at the end of that year, but in no event in excess of $6 per share in any one year. Such dividends shall be paid on March 1 of each year, commencing March 1, 1935.” The articles define net earnings (note 1, supra).
“Cumulative” means that which augments by addition; that which is added to something;
that which is superadded to another thing of the same character and not substituted for it.
A preferred stockholder is not a creditor of the corporation in which he holds his stock. The dividends thereon are not payable absolutely but only out of the net earnings or net assets in excess of capital and only when and as declared. A dividend is that which the corporation has set aside from its net earnings or profits to be divided among the stockholders. The preference is limited to profits when earned.
The agreement to pay dividends on preferred stock is to be construed as an agreement to pay them from profits.
This is the rule unless corporations are expressly authorized by statute to resort to capital in payment of such dividends.
Dividends on preferred stock are ordinarily regarded as cumulative.
Ap-pellee would tie the word “cumulative” to a fixed, determined rate. We agree with appellant that “cumulative” does not refer to the manner in which the rate is determined. The test is survival. Where, as here, the rate or amount is determinable with precision, in deciding whether it is cumulative it matters not if the rate varies from year to year with the amount of the net earnings. When once earned the dividend survives as a preferential right and is subject to the will of the board of directors only as to when it shall be declared and paid. If the dividend is earned but is passed it remains as a charge senior to that of other shares of stock.
This brings into focus the distinction between a cumulative and a noncumulative dividend. A cumulative dividend survives as a senior charge on earnings. A non-eumulative dividend disappears if not declared and ceases to be a preferential right.
The word “limited” used in the statute suggests a fluctuating dividend. The statute expresses a maximum and is concerned only with the right of survival, not the rate or the method of its determination.
Appellee reminds us that there is no specific statement in the articles that the preferred stock is cumulative. But references are made in the articles to “accumulated and unpaid dividends” on the preferred stock (note 1, supra). Furthermore, Section (2) of the Third Article (note 1, supra) provides that dividends may not be declared or set apart for payment on the common stock until “dividends calculated as aforesaid for all preceding calendar years shall have been fully paid upon the Preferred Stock * * *. ” We hold that this provision effectively stamps the dividends on the preferred stock as being cumulative. It is unnecessary that the word “cumulative” be used. It is sufficient if the stipulated preferences make it such.
2. The dividends were “limited to the same amount”.
It is noted that Section (1) of Article Third of the articles of incorporation provides the dividend on the preferred may not exceed $6 per share for any one year. Though the dividend for any one year may be less than $6, depending upon the net earnings for the year, it may not exceed $6. In other words, $6 is the maximum dividend. It is “limited” to that amount.
The Arizona Supreme Court has defined “limited” as “narrow and restricted”.
The word means within limits, circumscribed.
Here the preferred stockholder has no right to participate in net earnings beyond the $6 per year limit on that stock. The dividend was limited to that amount as a maximum in each year.
It is evident to us that Congress intended to mark an outside limit so as to exclude participating preferred stock.
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LEMMON, District Judge.
Appellant brought suit in the District Court against the appellee to recover income taxes paid for the years 1943 and 1944. The appeal followed a judgment adverse to appellant.
The facts are undisputed. Appellant is the successor in interest to the Arizona Power Corporation, referred to herein as the Prescott Company, pursuant to a consolidation effected in 1945. The Prescott Company was a public utility concern engaged in the sale of electric energy and gas at rates established or approved by the Corporation Commission of the State of Arizona.
In the year 1935 Prescott Company issued 12,037.5 shares of its preferred stock. These shares had no par value but they were entitled to $100 on an involuntary dissolution and $105 in the event of a voluntary dissolution. On both types of dissolution the holder could receive accumulated dividends.
Each share of preferred was entitled to an annual dividend of $6 before dividends could be paid on the common stock, but this dividend accumulated only if and to the extent that there were net earnings. When the dividend was earned but not declared or paid it persisted as a charge on the company’s earnings and assets senior to the common stock.
Prescott Company kept its books, computed. its income, and paid its taxes, on a calendar year basis. During the year 1943 it paid $55,334.44 and during the year 1944, $44,194.32 as dividends on its preferred stock. We are here confronted with the question as to whether the Prescott Company may deduct these dividends for the purpose of computing its 16% corporate surtax.
Section 133 of the Revenue Act of 1942, 26 U.S.C.A., Int. Rev.Acts, page 200, defines preferred
stock as being stock the dividends in respect of which are “cumulative, limited to the same amount, and payable in preference to the payment of dividends on other stock.” Appellant, as the corporate successor of the Prescott Company, filed timely and sufficient claims for refunds for these calendar years. These claims were disallowed and this action to recover them followed.
The Collector contends that dividends are not cumulative if they depend upon net earnings; that to be cumulative the rate of return must be fixed or guaranteed in express terms so that it may not be changed by a vote of the board of directors.
1. The dividends payable on the preferred stock were cumulative.
The articles of incorporation provide, as noted, “The holders of the $6 Preferred Stock shall be entitled to receive, but only out of the surplus profits of this corporation, dividends in each year at a rate determined by dividing the net earnings of the corporation for the next preceding calendar year by the number of shares of such $6 Preferred Stock outstanding at the end of that year, but in no event in excess of $6 per share in any one year. Such dividends shall be paid on March 1 of each year, commencing March 1, 1935.” The articles define net earnings (note 1, supra).
“Cumulative” means that which augments by addition; that which is added to something;
that which is superadded to another thing of the same character and not substituted for it.
A preferred stockholder is not a creditor of the corporation in which he holds his stock. The dividends thereon are not payable absolutely but only out of the net earnings or net assets in excess of capital and only when and as declared. A dividend is that which the corporation has set aside from its net earnings or profits to be divided among the stockholders. The preference is limited to profits when earned.
The agreement to pay dividends on preferred stock is to be construed as an agreement to pay them from profits.
This is the rule unless corporations are expressly authorized by statute to resort to capital in payment of such dividends.
Dividends on preferred stock are ordinarily regarded as cumulative.
Ap-pellee would tie the word “cumulative” to a fixed, determined rate. We agree with appellant that “cumulative” does not refer to the manner in which the rate is determined. The test is survival. Where, as here, the rate or amount is determinable with precision, in deciding whether it is cumulative it matters not if the rate varies from year to year with the amount of the net earnings. When once earned the dividend survives as a preferential right and is subject to the will of the board of directors only as to when it shall be declared and paid. If the dividend is earned but is passed it remains as a charge senior to that of other shares of stock.
This brings into focus the distinction between a cumulative and a noncumulative dividend. A cumulative dividend survives as a senior charge on earnings. A non-eumulative dividend disappears if not declared and ceases to be a preferential right.
The word “limited” used in the statute suggests a fluctuating dividend. The statute expresses a maximum and is concerned only with the right of survival, not the rate or the method of its determination.
Appellee reminds us that there is no specific statement in the articles that the preferred stock is cumulative. But references are made in the articles to “accumulated and unpaid dividends” on the preferred stock (note 1, supra). Furthermore, Section (2) of the Third Article (note 1, supra) provides that dividends may not be declared or set apart for payment on the common stock until “dividends calculated as aforesaid for all preceding calendar years shall have been fully paid upon the Preferred Stock * * *. ” We hold that this provision effectively stamps the dividends on the preferred stock as being cumulative. It is unnecessary that the word “cumulative” be used. It is sufficient if the stipulated preferences make it such.
2. The dividends were “limited to the same amount”.
It is noted that Section (1) of Article Third of the articles of incorporation provides the dividend on the preferred may not exceed $6 per share for any one year. Though the dividend for any one year may be less than $6, depending upon the net earnings for the year, it may not exceed $6. In other words, $6 is the maximum dividend. It is “limited” to that amount.
The Arizona Supreme Court has defined “limited” as “narrow and restricted”.
The word means within limits, circumscribed.
Here the preferred stockholder has no right to participate in net earnings beyond the $6 per year limit on that stock. The dividend was limited to that amount as a maximum in each year.
It is evident to us that Congress intended to mark an outside limit so as to exclude participating preferred stock. Congress was providing relief to corporations that were under obligation to pay dividends out of profits in determined amounts, which had some of the characteristics of interest upon indebtedness, but was excluding stock entitled to unlimited participation in profits.
3. The Treasury Regulation.
Treasury Regulations III, Section 29.26-5 provides in part that for the purposes of Section 26(h) of the Internal Revenue Code — ■
“preferred stock means stock which was issued prior to October 1, 1942, * * * and which during the whole of the taxable year * * was stock non-participating as to earnings or profits either currently or in liquidation, the dividends on respect of which were cumulative and payable in preference to the payment of dividends on other stock. In addition, the preferred stock must be such that the rate of return is fixed and cannot be changed by a vote of the board of directors or by some similar method.”
Appellee leans upon this regulation and particularly upon the last sentence thereof as an interpretation of “limited to the same amount”. But the Regulation itself is subject to interpretation. If it was its purpose to require that the dividend be constant to qualify as “limited to the same amount” there is present an attempted change of the statute. This, of course, may not be done administratively.
Therefore, the fair and logical construction of the Regulation is that the right to the dividend shall be a firm contractual right not subject to change “by a vote of the board of directors or by some similar method”.
Reversed and remanded with directions to enter judgment in favor of appellant.