International F. Corp. v. Commissioner of Int. Rev., 135 F.2d 310 (2d Cir. 1943)

*311 Before L. HAND, CHASE and FRANK, Circuit Judges.

Paul E. Shorb, and Marion P. Wormhoudt, both of Washington, D. C., and David C. Moore, of Wilmington, Del. (Covington, Burling, Rublee, Acheson & Shorb, of Washington, D. C., of counsel), for petitioner.

Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key and Warren F. Wattles, Sp. Assts. to the Atty. Gen., for respondent.

During the years 1933 to 1935, inclusive, E. I. duPont deNemours and Company, Inc., owned all of taxpayer's stock and during the year 1936 it owned two-thirds of taxpayer's stock, the balance being owned by the General Motors Corporation. During the years 1933 to 1936, inclusive, taxpayer informally adopted the bonus plan of the duPont Company as its own bonus plan. Class A or class B bonus awards, or both, might be made to employees under that plan. Class B bonus awards (the only ones here involved) might be granted to those employees who, by their ability, efficiency and loyalty, had contributed most in a general way to the taxpayer's success, and were to be made from the portion of taxpayer's profits which its finance committee had set aside in the class B bonus fund. Only those employees were eligible for class B awards who on January first of the year in which the awards were made had been in the continuous employ of taxpayer at least two years. Recommendations for bonuses were to be made by the president or the heads of departments and were to be acted on by the executive committee or the board of directors. It was not incumbent on the executive committee or the board of directors to distribute the entire amount available in the fund. The taxpayer reserved the right at any time to discontinue the awarding of any bonuses.

Bonuses were in the form of common stock of the duPont Company or in the form of cash to be invested in such stock. Class B bonuses were to be awarded during February of each year "for services rendered *312 during the preceding year." Annually upon the granting of awards, a "bonus custodian" was to notify each beneficiary of his bonus award. This bonus custodian, appointed by the executive committee, was to manage all matters relating to bonus awards. When a class B bonus was awarded or invested in the common stock of duPont Company, a certificate for one-fourth of the shares, free from all restrictions, was to be delivered to the beneficiary immediately, and certificates for the balance were to be delivered to the bonus custodian who was to hold them for release to the beneficiary as follows: One-fourth of the total number of shares after the end of one year; one-fourth after the end of two years; and one-fourth after the end of three years. The bonus custodian was to open account with each beneficiary charging, i. e., debiting, him with the total number of shares in his award of investment, crediting him immediately with the one-fourth thereof then released to him, and crediting him thereafter each month at the rate of 1/48 of such total number of shares beginning with January of the year in which the award was made. If, however, the beneficiary left taxpayer's service or was dismissed, the portions of his stock represented at the time by the debit balance of his account might be sold at the then market value and the proceeds transferred to the class B bonus fund, but a certificate for the remaining portion of the stock was to be delivered to the beneficiary. An award in stock was to vest in the beneficiary all the rights of a stockholder in such stock, subject (1) to the right of the bonus custodian to possession of certificates evidencing the portion of the stock not immediately released; and (2) the right of the taxpayer, in case the beneficiary left taxpayer's service or was dismissed, to have that portion of the stock represented at the time by the debit balance of the beneficiary's account sold at the market value and the proceeds transferred to taxpayer. As to shares not immediately deliverable to the beneficiary, the bonus custodian was to procure from each beneficiary an irrevocable power of attorney (1) permitting the sale of the shares in the custody of the custodian at the time the beneficiary ceased to be an employee of the company, (2) providing that the beneficiary would not dispose of stock in such custody, and (3) providing that stock dividends were to be held by the custodian until release of the stock upon which it was a stock dividend.

Pursuant to the bonus plan, taxpayer's board of directors made class B bonus awards to certain of its employees in common stock of the duPont Company as follows: 100 shares in 1934 being awards for 1933; 128 shares in 1935 being awards for 1934; 188 shares in 1936 being awards for 1935. During the calendar year 1936 taxpayer paid over and distributed to the beneficiaries of its class B bonus award, certificates representing 150 shares of the common stock of the duPont Company, whose cost to taxpayer at the date of delivery was $16,153.36 and whose market value was then $24,858.75. Each of the employees receiving those shares in 1936 paid a tax thereon, computing the market value at the time of delivery as taxable income.

Taxpayer took a deduction of $24,858.75 in its income tax return for 1936 on account of the 150 shares of stock distributed in that year to its employees. In a notice of deficiency the Commissioner reduced the deduction from $24,858.75 to $16,153.35, a difference of $8,705.39, determining that, as the bonus was paid in property, "the basis for calculation of the amount thereof is the cost of such property and not its market value as claimed on the return." This was the only adjustment which the Commissioner made to taxpayer's return and, as a result, the Commissioner determined a deficiency in the amount of $2,156.76, in taxpayer's tax liability for the year. Taxpayer filed a petition with the Tax Court for a redetermination of the deficiency thus determined. By an amended answer, the Commissioner, in the alternative, alleged that if it were held that taxpayer was entitled to a deduction in the amount of $24,858.75 on account of the payment of bonus in stock, then taxpayer realized a taxable profit of $8,705.39 on the disposition of the shares, and taxpayer's net taxable income otherwise determined should be increased accordingly.

The Tax Court held that taxpayer was entitled to a deduction for compensation paid in the year 1936 in the amount of $24,858.75. The Tax Court decided for the Commissioner, however, on the defense set forth in the Commissioner's amended answer, holding that taxpayer realized a gain of $8,705.39 in 1936 by paying the class B bonus in stock which had cost taxpayer $8,705.39 less than its market value when taxpayer transferred the stock to its employees. The deficiency resulting from this decision *313 was $2,156.76. From that decision taxpayer seeks review.

FRANK, Circuit Judge.

1. Up to the time in 1936 when the shares were delivered to the employees, the taxpayer retained such control of the shares that title had not passed to the employees.^[1] We think the Tax Court correctly held that the market value at the time of delivery was properly deducted by the taxpayer as an ordinary expense of the business under Revenue Act 1936, § 23(a), 26 U.S.C.A. Int.Rev.Code § 23(a), because that delivery was an additional reasonable compensation for past services actually rendered. Cf. Lucas v. Ox Fibre Brush Co., 281 U.S. 115, 50 S. Ct. 273, 74 L. Ed. 733.^[2] The payment depleted the taxpayer's assets in an amount equal to that market value fully as much as if taxpayer had, at the time of delivery, first purchased those shares.

2. We turn to the question whether the transaction resulted in taxable gain to taxpayer. We think that the Tax Court correctly held that it did. The delivery of those shares was not a gift, else (1) it would have been wrongful as against taxpayer's stockholders, (2) the value of the shares could not have been deducted as an expense under § 23(a), and (3) the employees as donees would not be obliged to pay, as they must,^[3] an income tax on what they received. It was not a gift precisely because it was "compensation for services actually rendered," i. e., because the taxpayer received a full quid pro quo. Accordingly, cases holding that one is not liable for an income tax when he makes a gift of shares are not in point. Nor is General Utilities & Operating Co. v. Helvering, 296 U.S. 200, 56 S. Ct. 185, 80 L. Ed. 154, pertinent. For there the distribution was by way of a dividend to the taxpayer's own shareholders; in effect they received in altered form what they had theretofore owned collectively; as no quid pro quo passed to the taxpayer from those distributees, there was no closed taxable transaction; by the same token, that taxpayer could not have deducted anything from its income on account of that distribution.

But, as the delivery of the shares here constituted a disposition for a valid consideration, it resulted in a closed transaction with a consequent realized gain. It is of no relevance that here the taxpayer had not been legally obligated to award any shares or pay any additional compensation to the employees; bonus payments by corporations are recognized as proper even if there was no previous obligation to make them; although then not obligatory, they are regarded as made for a sufficient consideration.^[4] Since the bonuses would be invalid to the extent that what was delivered to the employees exceeded what the services of the employees were worth, it follows that the consideration received by the taxpayer from the employees must be deemed to be equal at least to the value of the shares in 1936. Here then, as there was no gift but a disposition of shares for a valid consideration equal at least to the market value of the shares when delivered, there was a taxable gain equal to the difference between the cost of the shares and that market value.

For § 111(a) of the Revenue Act of 1936, 26 U.S.C.A. Int.Rev.Code § 111(a) provides that the gain from "the sale or other disposition of property" shall be the excess of "the amount realized therefrom" over "the adjusted basis" provided in § 113(b), and § 113(b) in the light of § 113(a), 26 U.S. C.A.Int.Rev.Code § 113(a) makes the "basis" the cost of such property. True, § 111(b) provides that "the amount realized" is the sum of "any money received plus the fair market value of the property (other than money) received." Literally, where there is a disposition of stock for services, no "property" or "money" is received by the person who thus disposes of the stock. But, in similar circumstances, it has been held that "money's worth" is received and that such a receipt comes within § 111(b). See Commissioner v. Mesta, 3 Cir., 123 F.2d 986, 988; cf. Commissioner v. Halliwell, 2 *314 Cir., December 1, 1942, 131 F.2d 642; Kenan v. Commissioner, 2 Cir., 114 F.2d 217.^[5]

The taxpayer properly asks us to treat this case "as if there had been no formal bonus plan" and as if taxpayer "had simply paid outright 150 shares of duPont stock to selected employees as additional compensation." On that basis, surely there was a taxable gain. For to shift the equation once more, the case supposed is the equivalent of one in which the taxpayer in the year 1936, without entering into a previous contract fixing the amount of compensation, had employed a transposition expert for one day and, when he completed his work, had paid him 5 shares of duPont stock having market value at that time of $500 but which it had bought in a previous year for $100. There can be no doubt that, from such a transaction, taxpayer would have a taxable gain. And so here.

The order of the Tax Court is affirmed.

[1] Cf. Olson v. Commissioner, 7 Cir., 67 F.2d 726, 729.

[2] § 23(a) permits deduction of "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered."

[3] Old Colony Trust Co. v. Commissioner, 279 U.S. 716, 49 S. Ct. 499, 73 L. Ed. 918; Fisher v. Commissioner, 2 Cir., 59 F.2d 192; Olson v. Commissioner, supra.

[4] Cf. the cases cited in the preceding footnote.

[5] In these cases the taxpayer paid a money claim by delivering stock. What the taxpayer received was literally neither property nor money, yet it was held that there was a taxable transaction under § 111(b).