Petition for Review of Decision of United States Board of Tax Appeals.
Before EVANS, SPARKS, and MINTON, Circuit Judges.
The sole question presented by this petition to review a decision of the United States Tax Court is whether the distribution of certain funds by petitioner constituted payments in the nature of dividends or of ordinary and necessary business expenses.
Petitioner is, as its name implied, a holding company, organized under the Business Corporation Act of Illinois, Ill. Rev. Stat. 1941, c. 32, § 157.1 et seq., to hold and deal in the securities of other corporations. It is an affiliate of the Illinois Agricultural Association, which is a non-profit corporation organized under the Illinois laws to promote the welfare of agriculture in that State, with a membership of about 63,000 whose dues constitute its principal source of revenue.
Petitioner states that it was organized during the course of the carrying out of a plan formulated by the Association to set up an old-line legal reserve life insurance company upon a capital stock basis, the earnings of which, ordinarily accruing to shareholders, might be distributed to members of the Association in proportion to the amount of their insurance with the company, thereby converting the old-line legal reserve company into a cooperative insurance company, paying its earnings as patronage dividends to members of the Association having policies with the company.
In carrying out its plan, the Association brought about the incorporation of petitioner, with an authotized capital of 2000 shares of first preferred stock of a par value of $25; 600 shares of second preferred at $100 par value; and 3000 shares of common of no par value. The first preferred was sold at par to various County Farm Bureaus and individuals in Illinois; the Association took all the second preferred at par and all the common for $5 a share. Thus the total proceeds from the sale of petitioner's stock aggregated $125,000.
With the proceeds from the sale of its own stock, petitioner purchased the entire stock (4000 shares with a par value of $25) of the Country Life Insurance Company which was also organized under the laws of Illinois, giving it a capital of $100,000 and a surplus of $25,000. In order to make possible the distribution of profits from the insurance company among the policy-holder members of the Association, petitioner and the latter entered into a contract providing for the following distribvution of all dividends received by petitioner on its stock in the insurance company:
"1. Payment of all proper corporate expenditures for management, administration and contractual obligations, including taxes and fees.
2. Payment of annual cumulative dividends of 7% on both classes of preferred stock, and 35 cents a share on the common, all of which totalled $8,750 a year.
3. Setting aside annually in a surplus fund, at the option of petitioner, not to exceed 10% of the annual gross dividends, up to a total surplus fund of $150,000, to be used only for increasing the capital stock of the insurance company.
4. Apportionment of the balance between certain classes of policyholders.
a. 25% among Association members in good standing at the time of the distribution, who were also policy holders, according to the ratio between the policy holder's gross annual premium and the total gross annual premiums of all policies held by Association members.
b. Remaining 75% among the holders of charter policies, those being the first 8000 policies issued, in accordance with the provisions of a non-transferable certificate of ...