[648]*648OPINION.
Smith:
The questions here presented are purely legal. The taxpayer claims the right to deduct from gross income of the year 1919 $30,000, representing dividends paid upon $500,000 par value debenture stock outstanding during the year, and $25,000 amortized discount upon such stock. The Commissioner denies the right of the taxpayer to make such deductions. The claim of the taxpayer is that the debenture stock outstanding represents bonds or obligations of the taxpayer, while the claim of the Commissioner is that the debenture stock is a part of the capital stock of the taxpayer.
Section 234 (a) (2) of the Revenue Act of 1918 provides that a corporation may deduct from gross income in its tax return “ all [649]*649interest paid or accrued within the taxable year on its indebtedness * ⅜ Was the $500,000 debenture stock of the taxpayer outstanding during the year 1919 indebtedness of the taxpayer during that year ?
Whether or not the holder of a particular instrument or certificate is to be regarded as a stockholder or creditor is a question of interpretation, and depends upon the terms of his contract as evidenced by such instrument and the corporate charter and the statutes of the state. Fletcher on Corporations, p. 6020. Cf. Heller v. National Marine Bank, 89 Md. 602.
In Appeal of I. Unterberg & Co., 2 B. T. A. 274, we said:
It can not be doubted that the nature of an instrument may, because of its terms and the circumstances of its issuance and substance, be held to be different from what it is denominated. The decisions are numerous in which the' courts have held bonds to be stock. Cf. Appeal of The Baker & Taylor Company, 3 B. T. A. 57.
The first thing to be considered in the determination of whether the shares of debenture stock issued by the taxpayer and outstanding during the year 1919 are obligations of the taxpayer or a part of its capital stock, is the name which has been given to such shares of debenture stock. It is not a thing to be ignored, for it is not lightly to be assumed that parties have given an erroneous name to their transaction. The instruments are designated as “ shares of debenture stock.»” They provide for 6 per cent cumulative dividends and no more, payable only out of surplus profits, earnings or assets; these dividends are to have priority over dividends on issues designated as preferred and common stock. They contain a provision for their retirement at the option of the corporation after three years and in any event at the expiration of 10 years. The holders have no right to vote, except in case of default in payment of dividends. In case of dissolution, liquidation or insolvency, the assets are to be first applied in payment of the indebtedness of the corporation. They are then to be applied:
First: To tlie payment to tlie holders of the Debenture stock of the full amount of the par value of their shares and unpaid dividends accrued thereon.
Second: To the payments to the holders of the Preferred Stock of the full amount of the par value of their shares and the unpaid dividends accrued thereon; and
Third: The remaining to the Common Stock.
The question whether debenture stock is to be regarded as a part of the capital stock of a corporation has been before the courts in many different jurisdictions.
[650]*650In People v. Miller, 180 N. Y. 16; 72 N. E. 525, there was a question, in determining the franchise tax of a corporation, whether $100,000 representing certain certificates should be deducted as a debt. The certificate of incorporation provided for $100,000 “preferred debenture stock,” entitled to cumulative dividends at 6 per cent, and $50,000 common stock. The certificates of preferred stock as issued provided for a cumulative dividend of 6 per cent, and no more, before dividends on common stock, and for preference over common stock on dissolution of the corporation. They also contained an agreement for redemption at par value on a specified date. In its decision the court said:
When, therefore, a certificate is declared to be a preferred debenture share of capital stock, it presents a legal contradiction; a debenture being the acknowledgment of a debt, and a share of stock representing a contribution of capital to a corporate business equal to the amount of its face value, either in money or in property.
The court held that where the construction of instruments purporting to be certificates of preferred stock of a corporation is a debatable one, the corporation, in face of the declaration in its articles of association that money represented by these certificates constitutes a part of the capital stock of the corporation, is estopped from asserting to the contrary in a proceeding to determine its liability to the franchise tax.
In Rider v. Delker & Sons Co., 145 Ky. 634; 140 S. W. 1011, it was held that, even though the certificate of incorporation and the certificate of stock itself provided that after five years the holder of preferred stock might demand back his money in the corporation, he can not enforce this provision until the corporate creditors are paid. The court said:
Tbe capital of a corporation is the sum total of its stock, whether common or preferred. Certificates of stock are mere evidences that the holders thereof have invested the sums called for in the certificates in the enterprise. They run the risk of losing their stock if the business is not a success. As between themselves and third persons who deal with the corporation and give it credit, their stock is equally liable. It is only in cases where the corporation is solvent and the rights of creditors will not be injuriously affected thereby that agreements as to preferences among themselves may be enforced. The entire capital, without regard to any arrangement which may exist between common and preferred stockholders, is at all times subject to and liable for the debts of the corporation, and no part of the capital can be withdrawn from the business until the debts of the corporation are satisfied.
In the case of Reagan Bale Co. v. Heuermann, 149 S. W. 228, a Texas corporation issued preferred stock entitled to a preferred divi[651]*651dend of 8 per cent and to share equally with common stockholders in all dividends after a similar dividend1 had been earned and paid on common stock. It also provided that, if the company should fail for two years to declare and pay dividends on the preferred stock of at least 8 per cent, the owners at their option might mature the shares into an obligation of the corporation to pay on demand the par value thereof, together with interest at 8 per cent from August 10, 1907, provided that the corporation should then be entitled to be credited with all dividends declared and paid on the stock. The preferred stock had no voting power, and the company was also given the option, after the aggregate dividends thereon amounted to 100 per cent, to retire the shares at par. It was held that the holders of such stock were stockholders and not creditors, and, on default of dividends, could not, by electing to mature the shares, become creditors entitled to share in the assets of the corporation with or in advance of creditors.
In Warren v. Queen & Co., 240 Pa.
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[648]*648OPINION.
Smith:
The questions here presented are purely legal. The taxpayer claims the right to deduct from gross income of the year 1919 $30,000, representing dividends paid upon $500,000 par value debenture stock outstanding during the year, and $25,000 amortized discount upon such stock. The Commissioner denies the right of the taxpayer to make such deductions. The claim of the taxpayer is that the debenture stock outstanding represents bonds or obligations of the taxpayer, while the claim of the Commissioner is that the debenture stock is a part of the capital stock of the taxpayer.
Section 234 (a) (2) of the Revenue Act of 1918 provides that a corporation may deduct from gross income in its tax return “ all [649]*649interest paid or accrued within the taxable year on its indebtedness * ⅜ Was the $500,000 debenture stock of the taxpayer outstanding during the year 1919 indebtedness of the taxpayer during that year ?
Whether or not the holder of a particular instrument or certificate is to be regarded as a stockholder or creditor is a question of interpretation, and depends upon the terms of his contract as evidenced by such instrument and the corporate charter and the statutes of the state. Fletcher on Corporations, p. 6020. Cf. Heller v. National Marine Bank, 89 Md. 602.
In Appeal of I. Unterberg & Co., 2 B. T. A. 274, we said:
It can not be doubted that the nature of an instrument may, because of its terms and the circumstances of its issuance and substance, be held to be different from what it is denominated. The decisions are numerous in which the' courts have held bonds to be stock. Cf. Appeal of The Baker & Taylor Company, 3 B. T. A. 57.
The first thing to be considered in the determination of whether the shares of debenture stock issued by the taxpayer and outstanding during the year 1919 are obligations of the taxpayer or a part of its capital stock, is the name which has been given to such shares of debenture stock. It is not a thing to be ignored, for it is not lightly to be assumed that parties have given an erroneous name to their transaction. The instruments are designated as “ shares of debenture stock.»” They provide for 6 per cent cumulative dividends and no more, payable only out of surplus profits, earnings or assets; these dividends are to have priority over dividends on issues designated as preferred and common stock. They contain a provision for their retirement at the option of the corporation after three years and in any event at the expiration of 10 years. The holders have no right to vote, except in case of default in payment of dividends. In case of dissolution, liquidation or insolvency, the assets are to be first applied in payment of the indebtedness of the corporation. They are then to be applied:
First: To tlie payment to tlie holders of the Debenture stock of the full amount of the par value of their shares and unpaid dividends accrued thereon.
Second: To the payments to the holders of the Preferred Stock of the full amount of the par value of their shares and the unpaid dividends accrued thereon; and
Third: The remaining to the Common Stock.
The question whether debenture stock is to be regarded as a part of the capital stock of a corporation has been before the courts in many different jurisdictions.
[650]*650In People v. Miller, 180 N. Y. 16; 72 N. E. 525, there was a question, in determining the franchise tax of a corporation, whether $100,000 representing certain certificates should be deducted as a debt. The certificate of incorporation provided for $100,000 “preferred debenture stock,” entitled to cumulative dividends at 6 per cent, and $50,000 common stock. The certificates of preferred stock as issued provided for a cumulative dividend of 6 per cent, and no more, before dividends on common stock, and for preference over common stock on dissolution of the corporation. They also contained an agreement for redemption at par value on a specified date. In its decision the court said:
When, therefore, a certificate is declared to be a preferred debenture share of capital stock, it presents a legal contradiction; a debenture being the acknowledgment of a debt, and a share of stock representing a contribution of capital to a corporate business equal to the amount of its face value, either in money or in property.
The court held that where the construction of instruments purporting to be certificates of preferred stock of a corporation is a debatable one, the corporation, in face of the declaration in its articles of association that money represented by these certificates constitutes a part of the capital stock of the corporation, is estopped from asserting to the contrary in a proceeding to determine its liability to the franchise tax.
In Rider v. Delker & Sons Co., 145 Ky. 634; 140 S. W. 1011, it was held that, even though the certificate of incorporation and the certificate of stock itself provided that after five years the holder of preferred stock might demand back his money in the corporation, he can not enforce this provision until the corporate creditors are paid. The court said:
Tbe capital of a corporation is the sum total of its stock, whether common or preferred. Certificates of stock are mere evidences that the holders thereof have invested the sums called for in the certificates in the enterprise. They run the risk of losing their stock if the business is not a success. As between themselves and third persons who deal with the corporation and give it credit, their stock is equally liable. It is only in cases where the corporation is solvent and the rights of creditors will not be injuriously affected thereby that agreements as to preferences among themselves may be enforced. The entire capital, without regard to any arrangement which may exist between common and preferred stockholders, is at all times subject to and liable for the debts of the corporation, and no part of the capital can be withdrawn from the business until the debts of the corporation are satisfied.
In the case of Reagan Bale Co. v. Heuermann, 149 S. W. 228, a Texas corporation issued preferred stock entitled to a preferred divi[651]*651dend of 8 per cent and to share equally with common stockholders in all dividends after a similar dividend1 had been earned and paid on common stock. It also provided that, if the company should fail for two years to declare and pay dividends on the preferred stock of at least 8 per cent, the owners at their option might mature the shares into an obligation of the corporation to pay on demand the par value thereof, together with interest at 8 per cent from August 10, 1907, provided that the corporation should then be entitled to be credited with all dividends declared and paid on the stock. The preferred stock had no voting power, and the company was also given the option, after the aggregate dividends thereon amounted to 100 per cent, to retire the shares at par. It was held that the holders of such stock were stockholders and not creditors, and, on default of dividends, could not, by electing to mature the shares, become creditors entitled to share in the assets of the corporation with or in advance of creditors.
In Warren v. Queen & Co., 240 Pa. 154; 87 Atl. 595, there was a suit to recover amounts represented by certificates in the following form:
This is to certify that J. Henry Warren is owner of fifty shares of the preferred stock of Queen & Company, Incorporated. * * * This certificate is part of an issue of preferred shares amounting in the aggregate to fifty thousand dollars ($50,000) which are entitled to dividends at the rate of eight per centum annually, clear 'of all taxes, cumulative, from the first day of March, 1906, out of the earnings of the company applicable to the purpose, and before any dividend is declared on the common stock. * ⅜ * The shares represented by this certificate shall be redeemed by the company ■on March 1, 1911, at par. The preferred stock, of which these shares are a part, constitute under all circumstances a lien on all the assets of the company to be first paid in full prior to any right of the common stock to participate in •or receive anything from such assets.
The court held that these instruments were shares of stock and not certificates of indebtedness, and that the agreement to redeem them could not be enforced unless there were surplus profits which could be used for that purpose.
In the case of In re Fechheimer Fishel Co., 212 Fed. 357, the certificates were designated on their face as debenture bonds. These so-called bonds prescribed a certain date of payment, and a certain amount of interest, but also contained a provision that the interest should be paid out of earnings and that all of these instruments should be subordinate to the claims of creditors. They further provided that, upon liquidation or dissolution of the company, the holders of the bonds should, after payment of debts, be. entitled to the residue of the company’s assets. The court held that the instru[652]*652ments were shares of stock and refused to enforce a promissory note given to one of the holders, upon surrender of some of the so-called bonds, because to do so would deprive general creditors of funds to satisfy their claims.
In Miller v. Ratterman, 47 Oh. St. 141; 24 N. E. 496, the certificates involved purported to be shares of preferred stock, to guarantee dividends for which a mortgage had been given. They were held to be stock.
After a consideration of the entire record and of the decisions of the courts bearing upon the issues raised by this appeal, we are of the opinion that the conclusion of the Commissioner that the dividends paid by the taxpayer upon its shares of debenture stock outstanding during the year 1919 were not the equivalent of interest paid on indebtedness, and, therefore, that the amount of dividends paid upon such stock is not a legal deduction from gross income. We are also of the opinion that the amount claimed as amortized discount upon such debenture stock is not a legal deduction from gross income.
LittletoN concurring.