is published for the information of internal-revenue cfficers and others concerned. G. E. FLETCHER, Acting Commissioner of Internal Revenue. SUPREME COURT OF THE UNITED STATES. No. 246. OCTOBER TERM, 1915. Charles W. Anderson, collector of internal revenue, etc., petitioner, v. Forty-Two Broadway Co. ON WRIT of Certiorari to the United States Circuit Court of Appeals for the Second Circuit. [Nov. 8, 1915.] Mr. Justice PITNEY delivered the opinion of the court: This was an action to recover a tax alleged to have been erroneously imposed upon respondent for the year 1910 under the corporation tax act of August 5, 1909 (36 Stat. 112, ch. 6, sec. 38), and paid under protest, respondent contending that in ascertaining its net income for the purposes of the tax the entire amount of the interest paid by it within the year upon its mortgage indebtedness ought to have been allowed, the result of which would have been to leave no net income to be taxed; whereas the assessing officer allowed a deduction of interest upon an amount equal only to the capital stock of the company. Respondent is a corporation of the class commonly known as realty corporations, was organized for the purpose of constructing and renting a building In the city of New York, and transacts no other business. Its paid-up capital stock is only $600, while it has a bonded indebtedness of $4,750,000, secured by mortgages upon its real estate, consisting of a piece of land purchased and a building constructed upon it substantially with borrowed money, to secure the repayment of which the bonds and mortgages were given. Both the District Court (209 Fed., 991) and the Circuit Court of Appeals (213 Fed., 777) held that the interest payments upon the entire mortgage indebtedness were deductible from the gross income of the corporation under clause 1 of paragraph 2 of section 38 of the act and gave judgment against the collector for a refund of the entire tax. Those portions of the section that are essential to a determination of the coutroversy are set forth in the margin.' The District Court, conceding that the provision of the third clause of the second paragraph, standing alone, would constitute sufficient authority for the action of the assessor, nevertheless held that the force of this provision must be limited, in view of the general purpose 1 Sec. 38. That every corporation organized for profit and having a capital stock represented by shares shall be subject to pay annually a special excise tax with respect to the carrying on or doing business by such corporation equivalent to one per centum upon the entire net income over and above five thousand dollars received by it from all sources during such year • *: Provided, however, that nothing in this section contained shall apply to [certain specified classes of organizations, not including realty corporations]. Second. Such net income shall be ascertained by deducting from the gross amount of the income of such corporation * * * received within the year from all sources, (first) all the ardinary and necessary expenses actually paid within the year out of income in the maintenance and operation of its business and properties, including all charges such as rentals or franchise payments, required to be made as a condition to the continued use or possession of property; * (third) interest actually paid within the year on its bonded or other indebtedness to an amount of such bonded and other indebtedness not exceeding the paid-up capital stock of such corporation, and in the case of a bank, banking association or trust company, all interest actually paid by it within the year on deposits; * 66 of the section to tax only "net income (construed to mean gross income after deducting all outgo necessarily incident to the business"), and also in view of the first clause of the second paragraph, which permits of a deduction of “all the ordinary and necessary expenses actually paid within the year out of income in the maintenance and operation of its business and properties, including all charges such as rentals or franchise payments, required to be made as a condition to the continued use or possession of property." The court therefore held that, in the case of such a corporation as respondent, the amounts paid for interest on the mortgages must be deducted in order to arrive at net income. The Circuit Court of Appeals entertained a similar view, holding that such interest payments, in the case of a realty corporation, were ordinary and necessary expenses in the maintenance and operation of the business, and were also charges required to be paid as a condition to the continued use or possession of its property, within the meaning of subdivision 1; and that subdivision 3 must be limited in its effect to "the usual corporate indebtedness which is not an ordinary expense of maintenance, nor a charge, payment of which is a condition of the continued use or possession of property." With these views we can not agree. There was error, as it seems to us, in seeking a theoretically accurate definition of "net income," instead of adopting the meaning which is so clearly defined in the act itself. As has been repeatedly pointed out by this court in previous cases (Flint v. Stone Tracy Co., 220 U. S., 107, 145, 150, 151; McCoach v. Minehill Railway Co., 228 U. S., 295, 306, et seq.; United States v. Whitridge, 231 U. S., 144, 147; Stratton's Independence v. Howbert, 231 U. S., 399,.414), the act of 1909 was not in any proper sense an income tax law, nor intended as such, but was an excise upon the conduct of business in a corporate capacity, the tax being measured by reference to the income in a manner prescribed by the act itself. And it is very clear, from a reading of section 38, that the phrase "entire net income," as used in its first paragraph, has no other meaning than that which is particularly set forth in the second paragraph, which declares, in terms, how "such net income shall be ascertained." It may well be that mortgage interest may, under special circumstances, be treated as among the “ordinary and necessary expenses," or as included among the charges "required to be made as a condition to the continued use or possession of property." (See 28 Opin. A. G., 198.) But interest upon the "bonded or other indebtedness" of the corporation, whether such indebtedness be secured by mortgage or not, comes within the specific provision of the third clause, whose effect, in our opinion, is not in this respect limited by anything contained in the first. Congress evidently had in view the fact that some corporations (other than banks and like institutions, which, for obvious reasons, are separately considered), carry a current indebtedness exceeding the amount of the paid-up capital stock, and with respect to such corporations intended to limit the interest deduction to so much of the indebtedness as did not exceed the capital. Nor can we see the least ground for the insistence that this results in an arbitrary classification. It is not necessary to attribute to Congress a purpose to discourage or impose an extra burden upon corporations carrying on their operations with a nominal capital stock, or with an indebtedness largely exceeding the amount of the capital. It is more reasonable to say that Congress deemed that where the indebtedness does exceed the capital it should no longer be treated as an incident, but that the carrying of the indebtedness should be considered as a principal object of the corporate activities, that the operations of such a corporation are conducted more for the benefit of the creditors than of the stockholders, and that the contribution of the corporation to the expenses of the Government should be admeasured with this fact in view. There is no question of the power of Congress to adopt such a basis of distinction, and, since the line must be drawn somewhere, it was certainly not arbitrary to draw it at the precise point where the pecuniary interest of creditors overbalanced that of stockholders. Judgment reversed, and the cause remanded to the district court for further proceedings in accordance with this opinion. Mr. Justice MCREYNOLDS took no part in the consideration or decision of this case. (T. D). 2262.) Corporation Tax-Deductions-Court decision. 1. DEDUCTIONS FROM GROSS INCOME. When a company composed of two stockholders divide the profits between them, calling it compensation, the same can not be deducted as an expense of business. 2. INCOME. Money paid out under these circumstances is equivalent to dividend and must be treated as income of the corporation. 3. JUDGMENT OF UNITED STATES DISTRICT COURT AFFIRMED. The decision of the lower court is affirmed by the Circuit Court of Appeals. TREASURY DEPARTMENT, OFFICE OF COMMISSIONER OF INTERNAL REVENUE, Washington, D. C., November 15, 1915. The appended decision of the United States Circuit Court of Appeals for the Second Circuit in the case of Jacobs & Davies (Inc.) v. Anderson, collector of internal revenue, is published for the infor mation of internal-revenue officers and others concerned. G. E. FLETCHER, Acting Commissioner of Internal Revenue. UNITED STATES CIRCUIT COURT OF APPEALS FOR THE SECOND CIRCUIT. Jacobs & Davies (Inc.), plaintiff in error (plaintiff below), v. Charles W. Anderson, collector of internal revenue of the United States for the second district of New York, defendant in error (defendant below). Before LACOMBE, COXE, and WARD, Circuit Judges. ON WRIT of error to review a judgment entered March 3, 1915, upon a verdict in favor of the defendant pursuant to the direction of the court. Howard Van Sinderen and Thomas C. Curtis, jr., for plaintiff in error. H. Snowden Marshall, United States Attorney, and Ben A. Matthews, Assistant United States Attorney, for defendant in error. COXE, Judge: This action was brought to recover under the corporation tax law of 1909 sums aggregating $3,829.29 paid under' the protest of the plaintiff as taxes for the years 1909 and 1910. The business of the corporation, which was incorporated in April, 1909, is civil engineering, which business had previously been carried on by the parties individually. Prior to the enactment of the corporation tax act of August 5, 1909, the partners entered into an agreement with the corporation to devote their time and energies to the corporation for a salary of $6,000 to be paid to each. The corporation also agreed to pay them on a percentage basis the net surplus profits, as defined in the agreement. The sixth clause of the agreement is as follows: 66 In determining the amount of net surplus profits for division and distribution between the parties of the first and second parts under the terms of this agreement the receipts shall be charged with the expense of conducting the business of the corporation, including said salaries and every share of profits which may be paid as compensation for services, except as hereinabove provided, and 10 per centum of the remaining surplus profits shall be carried to the credit of the dividend account and declared and paid as a dividend on the capital stock of the corporation. The credit balance which shall then remain will be net surplus profits distributable under the terms of this agreement, as above provided. The amounts paid to the partners as 66 further compensation was during 1909 $73,136, during 1910 $204,810, and during 1911 $114,986. The trial judge held that the parties by a series of agreements divided everything received as profits among themselves as though it were a case of partnership and not of corporation assets. They called these sums compensation," but the court held that they must be treated as income of the corporation. To enable the company to deduct these amounts it must appear that they were paid as salaries for services actually rendered. If the payments were based upon the stock holdings of the parties, as we think they were, they can not be considered as expenses of administration. They were not compensation, because the salaries of both the parties are fully provided for in the agreement of April, 1909. It seems plain that they were profits of the business and as such were subject to the tax. Their payment did not depend on the services rendered. Whether the stock was distributed among a large number of holders or only two, it can hardly be maintained that the amount paid out in dividends should be deducted in order to ascertain the amount of the net income of the corporation. That must be determined by deducting from the gross amount of the income all ordinary and necessary expenses actually paid within the year. The distribution of surplus profits was not an ordinary and necessary expense paid in the maintenance and operation of the business. The judgment is affirmed. (T. D. 2263.) Emergency revenue law. Revoking T. D. 2249, regarding special-tax liability as brokers by dealers in notes and other securities. TREASURY DEpartment, OFFICE OF COMMISSIONER OF INTERNAL REVENUE, Washington, D. C., November 15, 1915. To collectors of internal revenue, revenue agents, and others concerned: Upon further consideration, this office has decided to revoke the ruling laid down in T. D. 2249. Accordingly, special-tax liability as broker is not incurred on account of a person negotiating purchases of stocks, bonds, etc., solely for himself. W. H. OSBORN, Commissioner of Internal Revenue. Approved: BYRON R. NEWTON, Acting Secretary of the Treasury. (T. D. 2264.) Emergency revenue law--Bills of lading. Ruling construing T. D. 2136 of January 28, 1915. TREASURY DEPARTMENT, OFFICE OF COMMISSIONER OF INTERNAL REVENUE, SIR: You are informed that under date of the 17th instant was advised, in reply to a communication addressed to the Secretary of the Treasury by him, that a ruling has been made construing T. D. 2136, second paragraph, as follows: When goods have not been actually delivered to the original consignee or the car containing them set for delivery, they will not be regarded as having reached their destination and therefore when reconsignment is made under such circumstances no new bill of lading will be required, though if a new bill of lading is issued, it must be stamped. You are therefore requested, in giving information with respect to T. D. 2136, to take the above ruling of this office into consideration. Respectfully, DAVID A. GATES, Mr. Acting Commissioner of Internal Revenue. (T. D. 2265.) Emergency revenue law. Renewals of promissory notes. TREASURY DEPARTMENT, OFFICE OF COMMISSIONERS OF INTERNAL REVENUE, Washington, D. C., November 22, 1915. SIR: In response to your communication of the 16th instant, you are advised that a promissory note issued prior to December 1, 1914, and renewed or extended after that date would be taxable under the act of October 22, 1914. (See T. D. 2170.) With respect to what constitutes a renewal of a promissory note, this office has made the following ruling: A written agreement, either attached or unattached to a promissory note, or in the form of an indorsement on the note, such as "Renewed" or "Extended" to a certain date, evidencing payment and acceptance of interest in advance to a time certain, subsequent to maturity, constitutes a renewal of the note and is subject to tax as such under the above act. On the other hand, part payment of a note after it has become due, or payment of accrued interest after maturity, the note being allowed to run, and the holder neither losing nor postponing his right of action, is merely in the nature of a forbearance, and is not taxable under said act as a renewal. Respectfully, DAVID A. GATES, Acting Commissioner of Internal Revenue. Mr. |