By this rеview the correctness of a decision of the Board of Tax Appeals holding the taxpayer entitled to a credit under section 26(c) (1) of the Rеvenue Act of 1936, 26 U.S.C.A. Int.Rev.Acts, page 836, because of a covenant in its written contract with its noteholders which prohibited certain dividends, is questioned.
Respоndent is an Indiana corporation with a capital of 60,000 shares of common stock of par value of $50 each. Of 52,000 shares issued, it has repurchasеd 946 and retains them in its treasury. In 1932 it borrowed $400,000 secured by pledge of certain collateral, upon notes maturing serially from March 1, 1933 to March 1, 1937. The indenture under whiсh the collateral was deposited provided that the pledgor should not, so long as any of the notes remained unpaid, declare any dividends, provided, however, that the covenant should “not be construed to prevent declaration of dividends payable in stock of the company.” At the end оf the taxable year 1936, a substantial amount of the debt remained unpaid. In both 1935 and 1936 a deficit existed in the surplus and capital accounts of the company. For the year 1936 the taxpayer, in computing its undistributed net income tax, claimed a credit under Section 26(c) (1). This the Commissioner disallowed. The Board held with rеspondent and that decision is now on review.
The Revenue Act of 1936 levied a tax upon the undistributed net income of corporations, allowing, however, certain credits, among these being that provided for by Section 26(c) (1) as follows: “An amount equal to the excess of the adjusted net income over thе aggregate of the amounts which can be distributed within the taxable year as dividends without violating * * * a written contract * * * which * * * expressly deals with the payment of dividends.” Petitioner contends that inasmuch as the contract providing security for payment of the notes prohibited only distribution of cash or property, the сompany might have issued stock dividends
When Congress created a credit for the amounts “which can be distributed” its plain intent was to include amounts which might be legally distributed. The judiciary will not attribute to the legislature an intent, in defining credits, to include dividends in violation of law or any other than those which might be distributed in accord with the statutеs of the domicile of the corporation.
Likewise, when the parties voluntarily framed their contract for security of these notes, we can not, without violence to logic, assume that they meant to include illegal acts by the corporation. Consequently, in the provision allowing distribution of stock dividends we can attribute no intent to the parties contemplating stock dividends other than those which might be legally issued. We can not assume that they meant to exсept not only stock dividends legally authorized but also those in fraud or violation of the laws of the state.
It follows that the specific question confronting us is whеther under the restrictive contract governing the noteholders’ rights, there were any amounts earned in 1936 which might legally have been distributed as stock dividends.
The Indiana Statutes (Burns’ Indiana Statutes Annotated, Vol. 6, sec. 25-211) provide that directors shall have power to declare dividends out of surplus earnings, net profits or surplus but that none shall be paid if the corporation is, or is thereby rendered insolvent or if its capital is, or thereby becomes impaired. The clear purport of this enactment is decisive that in 1936 the corporation could not legally have paid any dividends, because the record is undisputed that its capital was then impaired. The taxpayer, therefore, was by statute prohibited from declaring any dividends of any character in the year 1936.
Any distribution that further impаired or lessened the assets would have been a breach of the contract securing the notes. The purpose of that agreement was, without doubt, to prevent transfer of assets to stockholders or impairment of capital at the peril of the noteholder creditors. So any dividend in cash or property would have been a breach of the covenant. And a common stock dividend, in order to be permitted by the contract, must have been a legal one. Such a dividend represents no taxable gain to stockholders. Eisner v. Macomber,
Surely there is nothing in the terms of the contract indicating that the parties intended to deviate in the slightest from the universally accepted meaning of a stock dividend or that the parties contemplated disregarding the fundamental principle of corporation law, that to justify a proper stock dividend thеre must be a transfer of surplus to capital. There having been no surplus, there could have been no addition to capital back of a stock dividend.
Petitioner suggests that respondent could have applied to the Secretary of State for an amendment to its charter authorizing preferred stock and that this it might have issued as a stock dividend. But the Statute of Indiana forbids issuance of any dividends when the capital is impaired and indicates clearly that the state would not authorize the issuance of preferred stock against non-existing assets. There having been a deficit in the corporation’s surplus aсcouunt, there remained nothing which the company could transfer to the capital accont to justify an issuance of preferred stock. It is unbelievable that the Secretary of State would have allowed such action. We must assume that in the conduct of a public office, everything will be done properly and according to the ordinary legal course of affairs. Schell’s Ex’rs v. Fauché,
The statute of Indiana, (Burns’ Indiana Statutes Annotated, Vol. 6, Sec. 25-221), in Section 22 authorizes an amendment to articles of incorporation if the amendment would have been authorized as an original article and our attеntion is directed to no
The Government relies upon Helvering v. Northwest Steel Rolling Mills,
The decision is affirmed.