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Commissioner of Internal Revenue v. Meridian & Thirteenth Realty Co.

November 5, 1942


Petition for Review of Decision of the United States Board of Tax Appeals.

Author: Evans

Before EVANS, MAJOR, and KERNER, Circuit Judges.

EVANS, Circuit Judge.

Whether a corporate distribution was a dividend or an interest payment, is the major issue on this appeal which involves Federal income taxes. The M. & T. Co., made an $1,800 payment in 1936, which it claims was interest on its indebtedness, but which the Commissioner asserts was a devidend on preferred stock. The Board of Tax Appeals concluded that the payment was one of interest on indebtedness, and therefore deductible Sec. 23(b)*fn1 of the Revenue Act of 1936, 26 U.S.C.a. Int. Rev. Acts, page 827, and held that the taxpayer had overpaid its income tax by $234.

A second question is the propriety of an allowance, by the Board, of a credit, in determining the undistributed net income, which credit was based upon a finding that the Company's funds were not available for distribution as dividends, because of a contract limitation imposed upon the Company in 1922."*fn2

The facts are free from dispute - rather the problem is the construction of documents*fn3 to ascertain the real intention of the parties as to the nature of the interest which the "preferred" stockholders held in the corporation.

The Company was organized in Indiana in 1922 for the purpose of erecting and owning a single building, a large building, in the City of Indianapolis. It entered into an underwriting agreement to finance the erection of the building, and, pursuant to the agreement, issued what was called "preferred" stock, of $4,250 shares of $100 par value each, and 2,000 shares of common stock.

The preferred stock had definite maturity dates. The Company, on December 31, 1936, retired $20,000 of the stock, and there then remained unretired, only $10,000.

Although the quere is simple, i.e., Is the relationship that of creditor or stockholder of a corporation? its determination may often be difficult because it is the result of adding and weighing several elements of a situation some of which may give rise to conflicting inferences. Precedents*fn4 are abundant, but because of the widely-varying fact based upon wich the conclusions are reached, they serve only as guides. Many are the criteria*fn5 named to aid in the determination. Sometimes a particular one is called decisive, - or the most important test, - sometimes a combination of the elements sways the determination.

We cannot agree with the Board. Our conclusion is that the legal status here involved was that of a preferred stockholder, and not that of a creditor.

We feel impelled so to conclude, for unmerous reasons, chief of which is that most of the attributes which are here claimed to be inherent in, and only compatible with, the creditor status, were here craated in order to comply with, and follow, the Indiana statutes*fn6 relative to the issuance of preferrd stock. They are therefore not at all indicative of intention of the parties to create a debtor-creditor relation. The intent of the parties in the establishment of the relation is of extreme importance, and where, as here, there is a simple explanation for the existence of provisions which might otherwise be associated with a creditor relationship, which explanation disproves that relationship, the ambiguous provisions lose most, if not all, of their weight.

We have cited the Indiana Stature solely to aid in the interpretation of the documents under consideration. We are fully congizant of the holding of the Court in the case of United States v. Pelzer, 312 U.S. 399, 61 S. Ct. 659, 85 L. Ed. 913, where it was held that Federal tax laws are to be construed with a national uniform view point and not according to individual state constructions.

We have no such extreme case as was presented in Arthur R. Jones Syndicate v. Commissioner, 23 F.2d 833, a case before this court, where there was obviously a misnomer of the parties' relationship in order to evade a usury statute. It was certain, there, that the parties called the obligation a preferred stock because they couldn't effect their illegal purpose otherwise. We believe the parties in the instant case intended the corporate certificate, by them termed "preferred stock," to be just that.

It is often said that the essential difference between a creditor and a stockholder is that the latter intends to make an investment and take the risks of the venture, while the former seeks a definite obligation, payable in any event. But this variant in the relationship - while sharp in the case of a common stockholder and a bondholder - is less wide and distinct in the case of the preferred stockholder has bondholder. The preferred stockholder has fortified his security with more safeguards than the common stockholder enjoys - and has deprived himself of some of the nebulous and speculative rights of the residuary claimant which the common stockholder enjoys. But, though the preferred stockholder's status is more secure, he has not quite achieved the protection which a creditor or bondholder enjoys, ...

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