Prudential Financial Corp. v. Commissioner , 46 B.T.A. 796 ( 1942 )

PRUDENTIAL FINANCIAL CORPORATION OF QUINCY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Prudential Financial Corp. v. Commissioner

Docket No. 105634.

United States Board of Tax Appeals

46 B.T.A. 796; 1942 BTA LEXIS 811;

March 31, 1942, Promulgated

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In the taxable year petitioner had outstanding "Certificates of Indebtedness" issued under a contract whereby petitioner agreed to set aside irrevocably 50 percent of its net earned income of each calendar year for retirement of such certificates. In the taxable year the board of directors of petitioner duly resolved to set aside irrevocably the sum of $1,200. In accordance with that resolution, entries were made on petitioner's books, "Reserve for the retirement of Certificates of Indebtedness" being credited, and surplus charged with the sum of $1,200. Held, that petitioner irrevocably set aside in the taxable year the sum of $1,200 within the meaning of section 26(c)(2) of the Revenue Act of 1936 and section 351(b)(2)(B) of the Revenue Act of 1936, as amended.

Sidney Cobacker, Esq., for the petitioner.

Robert S. Garnett, Esq., for the respondent.

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ARUNDELL

The Commissioner determined deficiencies in petitioner's income tax and personal holding company surtax for the year 1937 in the sums of $7.59 and $573.13, respectively. The sole question before the Board is whether or not petitioner irrevocably set aside in the taxable year an amount for the retirement, payment, or discharge of an indebtedness within the meaning of section 26(c)(2) of the Revenue Act of 1936 and section 351(b)(2)(B) of the Revenue Act of 1936, as amended by section 355(b) of the Revenue Act of 1937.

FINDINGS OF FACT.

The facts were stipulated substantially as follows:

The petitioner is a corporation organized on September 11, 1929, under the laws of the State of Massachusetts and during the taxable year 1937 was engaged in the business of making small personal loans. For the year 1937 the petitioner duly filed returns on Forms 1120 and 1120(H) in the State of Massachusetts, which returns were on the cash basis. The petitioner was a personal holding company during the taxable year 1937.

The petitioner issued "Certificates of Indebtedness" on December 31, 1931, and from time to time thereafter. The face amount of said certificates issued by the petitioner and outstanding on January 1, 1934, amounted to $87,000.

The pertinent provisions of the said certificates are as follows:

2. The certificate holders shall have no voice in the management or control over the assets or business of the Corporation, as they are creditors and not stockholders.

3. It is expressly agreed by and between the corporation and the holder hereof, and such agreement is a condition precedent to the purchase of this certificate by the holder, that the corporation shall not declare or pay any dividends on its capital stock, whether in cash, stock, bonds, or otherwise, nor set aside any funds or assets for the payment of same, unless and until the corporation shall have an earned surplus available for the payment of dividends, and until all "Business Development Expenses" have been fully amortized or charged to earned surplus.

4. The intent of the above provision (Paragraph #3) is to insure that the corporation shall not declare or pay any dividends on its capital stock unless the net assets of the corporation (after deducting Business Development Expenses) shall at least equal the par value of the Certificates of Indebtedness of all series outstanding plus the capital stock; and as further protection of the holders of the Certificates of Indebtedness it is agreed that no officer of United States Banking Corporation who may be or become an officer of this corporation shall receive any salary from this corporation unless and until this corporation shall have an earned surplus, after fully amortizing or charging off the Business Development Expenses as above set forth.

5. It is further expressly agreed by and between the corporation and the holder hereof, and such agreement is a condition precedent to the purchase of this certificate by the holder, that after the "Business Development Expenses" have been fully amortized or charged to earned surplus the corporation shall irrevocably set aside fifty per cent (50%) of its net earned income each calendar year for the retirement or payment of the principal amount of Certificates of Indebtedness outstanding and that the only net income of the corporation available for the declaration or payment of dividends on its capital stock, whether in cash, stocks, bonds, or otherwise, shall be the amount remaining after the payment or setting apart of said fifty per cent (50%) of the net income for the retirement of payment of Certificates of Indebtedness.

In 1937 the petitioner's adjusted net income subject to undistributed profits tax amounted to $2,183.87 and its undistributed adjusted net income was $2,081.74. Petitioner paid dividends of $1,200 during the year 1937 on its capital stock pursuant to resolutions of the board of directors adopted on December 10, 1937. Credit has been allowed by the respondent for the dividends paid credit of $1,200 and for contract restricted dividend payments of $875.45.

The minutes recorded of the special meeting of the board of directors of petitioner on December 10, 1937, pertinent hereto, are as follows:

After discussion, and upon motion duly made, seconded, and carried, it was,

VOTED: That the proper officials of the company be, and hereby are, authorized and instructed to irrevocably set aside in a special fund or reserve account the sum of $1,200., being an amount equal to the dividends declared on the capital stock of the company for the calendar year 1937, to be used exclusively for the retirement of the Certificates of Indebtedness dated December 31, 1931; that this sum together with other sums of like nature to be set aside from time to time pursuant to the requirements of the Certificates of Indebtedness shall, in the discretion of the President and Treasurer, be either paid to the holders of the Certificates; retained in the form of bank deposits; or used to make loans if they are considered to be choice risks; and it was further VOTED,

That the proper officials of the Company be, and hereby are, authorized and instructed to set aside at the end of each calendar year a sum at least equivalent to the dividends declared for that year, or half the net profits if that amount be greater, in the above special fund or reserve account to be used exclusively for the retirement of the Certificates of Indebtedness, dated December 31, 1931, and said fund to be handled as above provided; and it further VOTED,

That such sums so set aside from time to time in the special fund or reserve account shall be irrevocably set apart and shall not be used for any other purpose; and the Treasurer is hereby authorized and instructed to turn said funds over to the Certificate holders at any time if they request it in writing.

Pursuant to the terms of the "Certificates of Indebtedness" and the resolution set forth herein, the petitioner entered an amount on its books entitled "Reserve for the retirement of Certificates of Indebtedness" and credited thereto the sum of $1,200 in 1937, and at the same time charged its surplus account with $1,200.

The said sum of $1,200 was not paid over to a trustee or other person designated to hold such funds for the purpose of the retirement of the indebtedness in question, nor way any trustee or other person ever designated to whom such payment might have been made, except as set forth herein.

None of the said $1,200 was paid to holders of the "Certificates of Indebtedness" during the taxable year 1937, and it has actually remained in the bank account of the petitioner at all times.

No further action other than set forth in the stipulation was taken by the petitioner during the taxable year involved to segregate or set aside the said sum of $1,200 referred to in a foregoing paragraph.

OPINION.

ARUNDELL: The instant proceeding has been presented by the parties on the narrow question of whether the resolution of the board of directors of petitioner plus the entries on petitioner's books in the taxable year constituted an irrevocable setting aside of an amount for the payment or discharge of a debt. Although sections 26(c)(2) and 351(b)(2)(B), as amended, with which we are here concerned, contain different requirements for the credit and deduction respectively granted, the parties seem agreed that the provisions of both sections are fulfilled if in fact petitioner irrevocably set aside the claimed amount in the taxable year. In order to obtain the benefit of the cited sections, petitioner must show that the amounts were set aside and that such setting aside was irrevocable. Accordingly, we shall consider the components of the phrase" irrevocably set aside" severally.

The resolution of the board of directors of petitioner directed that the amount in question be "irrevocably set aside in a special fund or reserve account * * * to be used exclusively for the retirement of the certificates of indebtedness * * *." In accordance with this direction an account entitled "Reserve for the retirement of Certificates of Indebtedness" was set up on petitioner's books and the amount directed by the board of directors was credited thereto. Petitioner's surplus account was charged with a corresponding amount. This treatment of the amount by petitioner without doubt constituted a setting aside. While it is true that the amounts were not delivered to a trustee, we do not think that material. If Congress had intended that the setting aside be accomplished by delivery to a trustee or other person outside the corporation, it would have made its intent known. .

We now turn to the question of whether the setting aside was irrevocable. The provisions of the contract between petitioner and the certificate holders required petitioner to "irrevocably set aside fifty per cent (50%) of its net earned income each calendar year for the retirement or payment of the principal amount of Certificates of Indebtedness outstanding * * *." This provision was a condition precedent to the purchase of certificates from petitioner. Thus it is clear that there was consideration for the resolution of the board of directors of petitioner. It is likewise clear that, because of the presence of such consideration, the book entries made pursuant to the resolution of the board of directors could not be reversed at the will of the directors. The rights of the certificate holders would intervene if petitioner attempted to treat the amount deposited in the special account as its own.

Nor does , require a different result. In that case the resolution of the board of directors, coupled as it was with the appropriate book entries, was a purely voluntary act of the taxpayer. The contract with the creditors did not call for such setting aside and we found that there was no consideration for the action. In such circumstances the setting aside was not deemed "irrevocable."

Respondent raises a further barrier to the coveted credits. The resolution of the board of directors stated that the amounts paid into the special account might be paid to the certificate holders, retained in the form of bank deposits, or "used to make loans if they are considered to be choice risks." Inasmuch as petitioner is engaged in the business of making loans, respondent urges that the resolution, allowing as it does the investment of the funds in choice risks, in effect permits the use of the money in petitioner's business. It is possible that the phrase read by itself may be so interpreted. The resolution provided, however:

That such sums so set aside from time to time in the special fund or reserve account shall be irrevocably set apart and shall not be used for any other purpose; and the Treasurer is hereby authorized and instructed to turn said funds over to the Certificate holders at any time if they request it in writing.

Thus read in its entirety, the resolution clearly prohibits the use of the funds of the special account in petitioner's business. It seems clear that the investment of the funds in choice risk loans if made would enure to the benefit of the certificate holders rather than to the petitioner. It is not unusual that funds set aside for particular purposes be put to work with proper safeguards rather than to lay idle and there have been times when the safety of such a fund was better guarded by this method than when left in the form of cash in the bank. However, if this be an objection it should be observed that the funds actually were retained in petitioner's bank account at all times and were neither used in the business of petitioner nor in the making of choice risk loans.

The surtax on undistributed profits and the personal holding company surtax were designed to force a distribution of corporate earnings to the stockholders. But Congress recognized that there were many legitimate reasons which prevent corporations from distributing their entire earnings and the credit and deduction provisions were designed to care for these cases. There is no occasion to construe the sections before us so as to deny the very relief Congress sought to grant. The revenue may be safeguarded without so harsh a construction.

Our conclusion is that there was an irrevocable setting aside of the sum of $1,200 in the taxable year. It follows that petitioner is entitled to the claimed credit under section 26(c)(2) for purposes of the surtax on undistributed profits and to the deduction from adjusted net income granted by section 351(b)(2)(B), as amended, for purposes of the personal holding company surtax.

Decision will be entered for the petitioner.