Wm. H. Davidow Sons Co. v. Commissioner

1 B.T.A. 1215, 1925 BTA LEXIS 2616

• Court: United States Board of Tax Appeals
• Decided: May 23, 1925
• Docket: Docket No. 1898.
• Status: Published

Opinion

OPINION.

Marquette :

The taxpayer relies upon the decision in the case of English & Mersick Co. v. Eaton, 299 Fed. 646, recently affirmed by the Circuit Court of Appeals of the Second Circuit in Eaton v. English & Mersich Co., 7 Fed. (2d) 54, as authority for its position that the portion of the dividend declared by the taxpayer which remained in the business constituted a part of its invested capital. We think the facts in this appeal clearly distinguish it from the English & Mersich case, and that the decision therein is not authority for the taxpayer’s position. On the contrary, the reasoning of the court and the authorities cited make against, rather than for, the taxpayer’s conclusion. The decision' in that case was based upon two primary propositions: First, that the resolutions set forth did not constitute the declaration of dividends; and second, that the resolutions did not create an indebtedness. Consequently they did not serve to affect the corporation’s surplus, and the amounts credited to the stockholders’ accounts remained a part of the corporation’s invested capital. Here we have an entirely different situation. There can be no question but that the resolution of June 28, 1918, constituted a declaration of a dividend out of the existing surplus and a portion of the dividend was actually paid.

The effect of the declaration of a dividend is to create the relation of debtor and creditor between the corporation and its stockholders, and the holders of the stock, with respect to the dividend, are on a par with the other creditors of the corporation. Staats v. Biograph Co., 236 Fed. 454; United States v. Guinzburg, 278 Fed. 363. This indebtedness reduces the corporation’s surplus in the amount of the dividend declared, and there is a corresponding reduction in the invested capital.

In Appeal of A. H. Stange, 1 B. T. A. 810, the Board said:

The outstanding features of a dividend declaration are that,' by the mere declaration, the dividend becomes thereby separated and segregated from the stock and exists independently of it; the right thereto becomes immediately fixed and absolute in the stockholders, and the corporation becomes a debtor to its stockholders for their pro rata shares. There is an apportionment or division of the assets of the corporation, to the extent of the dividend, to its stockholders. The corporation is at once poorer in the amount of the dividend declaration, and the stockholder becomes richer in his own right, to the extent of his pro rata share. What theretofore existed as undivided profits or surplus has become divided profits and the surplus is reduced to the extent of the dividend declared. It has ceased to be the property of the corporation and has become the property of the stockholder, and his interest therein becomes adverse to the corporation and to every other stockholder. We think this division or segregation of the amount of the dividend from the general mass of the corporate property and its apportionment to the stockholders is included in the words any distribution made, as used in the statute, and that those words must be given the same legal effect as results from the declaration of a dividend.

The Revenue Act of 1918 defines invested capital as follows:

Sec. 325. (a) That as used in this title * * *

The term “ borrowed capital ” means money or other property borrowed, whether represented by bonds, notes, open accounts, or otherwise.

Sec. 320. (a) That as used in this title the term “invested capital” for any year means (except as provided in subdivisions (b) and (e) of this section) :

(1) Actual cash bona fide paid in for stock or shares;

(2) Actual cash value of tangible property, other than cash, bona fide paid in for stock or shares, at the time of such payment, * * *;

(3) Paid-in or earned surplus and undivided profits; not including surplus and undivided profits earned during the year; * * *

(b) As used in this title the term “invested capital” does not include borrowed capital.

It is clear, therefore, that the amount of the dividend declaration herein can not be included in invested capital as a part of the corporation’s surplus. Since $6,000 of the dividend remained in the business, it must have been either invested capital or borrowed capital, and we are of opinion that it comes within the terms of the latter as defined in the statute, and is not properly a part of invested capital. Appeal of Electrical Supply Co., 1 B. T. A. 658; Appeal of Kelly-Buckley Co., 1 B. T. A. 1154. The Commissioner properly excluded this amount from the invested capital of the taxpayer for the year 1919 to December 28, when the right thereto was waived by the stockholders and the amount returned to the surplus account of the corporation.