The opinion
GUARANTY STATE SAVINGS & LOAN CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Guaranty State Sav. & Loan Co. v. Commissioner
Docket No. 12039.
United States Board of Tax Appeals
14 B.T.A. 72 ; 1928 BTA LEXIS 3037 ;
November 7, 1928 , Promulgated
*3037 1. Petitioner held not a building and loan association entitled to exemption from taxation during the year 1923 within the meaning of section 231(4) of the Revenue Act of 1921.
2. Amounts paid by the petitioner (as dividends) to owners of its withdrawable stock held not allowable as interest or expense deductions from income.
Herbert W. Nauts, Esq., Cleaveland R. Cross, Esq., and W. E. Lewis, C.P.A., for the petitioner.
J. Arthur Adams, Esq., for the respondent.
VANFOSSAN
*72 This proceeding is an appeal from the determination of the Commissioner that the petitioner is not entitled to exemption under the provisions of section 231(4) of the Revenue Act of 1921 for the year 1923. If it is held that the petitioner is not so exempt there is a further issue as to whether or not the amounts paid by the petitioner (as dividends) to owners of its withdrawable stock are allowable as interest or expense deductions from income.
At the hearing the respondent amended his answer so as to increase the petitioner's net taxable income from $12,482.86 to $47,090.05 by adding the amount of $34,820.28, representing the dividends paid on its *3038 stock.
FINDINGS OF FACT.
The petitioner is a corporation organized under the laws of the State of Ohio and has its principal office at Cleveland, Ohio.
It was organized on January 16, 1916, with an authorized capital stock of $1,000,000, divided into 10,000 shares of the par value of $100 each. On or about January 1, 1922, its capital stock was increased to $5,000,000, divided into 50,000 shares of a par value of $100 each.
The charter of the petitioner shows that it was formed "for the purpose of raising money to be loaned to its members and others on such terms, conditions and securities as may be provided for by its by-laws; receiving money on deposit from time to time to the extent necessary to meet the demands made upon it by its members and others, and generally doing all things and transacting all business authorized by the laws of Ohio to be done and transacted by Building & Loan Companies."
The comparative balance sheets of the petitioner as of December 31, 1922, and December 31, 1923, respectively, are as follows: Dec. 31, 1922 Dec. 31, 1923
ASSETS
Cash $46,312.63 $31,616.37
Loans on mortgage security 891,535.56 1,142,592.03
Loans on stock, certificate, and pass-book security 46,940.14 39,068.90
Furniture and fixtures 3,600.00 1,500.00
Real estate - office building 101,000.00 101,000.00
1,089,388.33 1,315,777.30
LIABILITIES
Running stock and dividend credits 230,575.79 225,777.51
Paid-up stock 63,900.00 87,200.00
Permanent stock 211,300.00 221,000.00
Deposits and accrued interest and certificates of deposit 305,437.64 436,040.96
Reserve fund 55,000.00 57,500.00
Undivided profit fund 89.32 8,979.33
Borrowed money and accrued interest 60,000.00 15,000.00
Due borrowers - unfinished buildings 116,354.75 186,779.50
Deposits - other building and loan companies 31,317.74 77,500.00
Reserved for Jan. 1, 1924, dividend 15,413.09
1,089,388.33 1,315,777.30
*3039 *73 The statement of its cash receipts and disbursements during the year 1923 is as follows: Receipts Amount
Dues on running stock $95,526.00
Paid-up stock 35,000.00
Permanent stock 19,200.00
Deposits 655,738.33
Credits on mortgage loans 339,128.22
Loans on stock, certificates and passbook security 61,014.20
Unfinished building account 602,344.07
Borrowed money 200,000.00
Deposits - other building and loan companies 80,000.00
Interest 84,162.50
Premium on loans - inspection fee Loan fees:
Loan fee $5.00
Appraisal fee 16.60
21.60
Rents - company's real estate - gross 5,200.00
Miscellaneous earnings 658.28
2,181,439.70
Cash received for company checks on depositories 406,911.51
2,588,351.21
Disbursements Amount
Loans - mortgage security $590,184.69
Loans - stocks, certificate and passbook security 53,142.96
Unfinished building account 531,919.32
Withdrawals of running stock 100,324.28
Withdrawals of paid-up stock 11,700.00
Withdrawals of deposits 525,135.01
Withdrawals of borrowed money 245,000.00
Dividends on paid-up stock 4,989.40
Dividends on permanent stock 15,212.31
Interest on deposits 20,578.22
Interest on borrowed money 2,520.10
Salaries of officers and directors 7,720.00
Office help, rent and legal expense 5,862.25
All other expenses 7,522.44
Taxes 975.58
Deposits by other building and loan companies withdrawn 33,817.74
Reserved for Jan. 1, 1924, dividend 15,413.09
Permanent stock withdrawn 9,500.00
Dividends - running stock 14,618.57
2,196,135.96
Checks on company depositories issued for cash or private check 406,911.51
2,603,047.47
*3040 The difference in the cash receipts and cash disbursements is reflected in the decrease of cash on hand on January 1, 1924, from the amount on hand on January 1, 1923.
Summarized, the petitioner derived its funds from the following sources: Dec. 31, 1922 Dec. 31, 1923
Paid-up stock $63,900.00 $87,200.00
Permanent stock 211,300.00 221,000.00
Deposits - savings accounts 305,437.64 436,040.96
Deposits - other loan companies 31,317.74 15,000.00
Borrowed money 60,000.00 77,500.00
Other sources 230,575.79 225,777.51
*74 During the year 1923, the petitioner paid interest on deposits and dividends as follows: Dividends Interest
Per cent Per cent
Running stock 7
Paid-up stock 7
Permanent stock 7
Deposits - savings accounts 5
Deposits - certificate of deposit 6
Deposits - other loan companies 6
Borrowed money 6
The capital stock of the petitioner was subscribed for and certificates therefor issued pursuant to the following sections of the by-laws:
SECTION 16. Members who do not pay the face value of their stock at the time of subscribing, may pay the same in installments of not *3041 less than 50 cents per month on each $100.00 thereof, for which payments credit shall be given them in a pass-book, and a certificate of paid-up stock may be issued for the even hundred thereof.
SECTION 17. Where the face value of the stock is paid at the time of subscribing, a certificate therefor shall be executed by the President and Secretary, and delivered to the member.
SECTION 18. Permanent stock of the par value of $100.00 per share may be issued which shall constitute the permanent capital of the Company and can not be withdrawn until the final dissolution of the Company.
SECTION 18 (as amended Aug. 6, 1923). Permanent stock of the par value of $100.00 per share may be issued, which shall constitute the permanent capital of the company and may be withdrawn by the holders thereof at the discretion of the Board of Directors under the general withdrawal rules of the Company.
SECTION 19. Loan stock may be issued at the option of the Board of Directors to any one desiring to make a mortgage loan. Each owner of this stock shall make such payment thereon as shall be agreed upon in making the mortgage loan.
The dividends were paid by the petitioner on its withdrawable *3042 stock pursuant to the following sections of its by-laws:
SECTION 28. At the first regular meeting of the Board of Directors in January and July of each year such dividend as the Board may declare shall be divided among the members in proportion to the amount of money paid on stock by each and length of time the same has been held by the Company, less the withdrawals, except as may be otherwise provided in these By-Laws.
SECTION 29. Dividends shall be computed on all payments made from the first to the tenth of each month. On all payments made after the tenth of each month, dividends shall be computed from the first of the following month.
* * *
SECTION 32. The dividends declared shall be credited on the pass books of the members in January and July of each year, and holders of certificates of paid-up stock shall be entitled to receive the dividends thereon in cash within ten days after the same have been declared, at the office of the Company.
*75 Section 26 of the petitioner's by-laws, governing the withdrawal of stock or deposits, is as follows:
GENERAL WITHDRAWAL RULE
SECTION 26. Members and special depositors whose stock or deposits are not pledged *3043 to this Company may, as a general rule, upon written application to the Secretary, withdraw all or any part of their stock, credits or deposits at any time without previous notice, but to protect the interest of depositors and borrowers and avoid sacrifices of securities notices of withdrawal may at any time be required and the liability to pay further dues, and the right to dividend on stock credits and interest on special deposits shall cease with any application to withdraw. All persons withdrawing shall be entitled to receive the amount of all credits at the time of the application to withdraw, less any member's share of the Company's loss in excess of the reserve fund. The required notices to withdraw shall be filed in the order in which they are received and paid from the regular receipts of the Company in the order in which they are filed as fast as 25 per cent of the regular receipts of the Company will pay them, but the Board of Directors may, at its discretion, use all the regular receipts of the Company to pay withdrawals.
During the year 1923 the petitioner made 67 real estate mortgage loans to stockholders in the aggregate amount of $589,250, as follows: Number of loans Amount Per cent
To enable borrowers to build or purchase homes for their own use and occupancy 20 $120,950.00 20,53
To building contractors for construction of 1-family homes, 2-family homes or apartments, and 4-family homes or apartments 42 436,550.00 74.0
For constructing a building consisting of 2 stores on the first floor and 3 apartments above 1 22,000.00 3.73
To purchase vacant lots 4 9,750.00 1.65
67 1 589,250.00 100.00
*3044
The mortgage loans outstanding at the beginning and end of the year 1923 were as follows: Jan. 1, 1923 Dec. 31, 1923
Number of loans Amount Per cent Number of loans Amount Per cent
Nonstockholders 12 $97,808.17 10.97 11 $81,065.52 7.09
"Loan stockholders" 108 700,455.53 78.57 137 923,695.67 80.85
Running stockholders 4 26,550.40 2.97 3 23,884.32 2.09
Paid-up stockholders 1 9,500.00 1.07 0
Unaccounted for 57,221.46 6.42 113,946.52 9.97
891,535.56 100.00 1,142,592.03 100.00
The petitioner held title to leasehold shown on the balance sheet of a value of $101,000. The income during 1923 from the rentals of a portion of the office building located on the leased property was $5,200.
*76 The receipts from deposits and payments on stock may be classified further as follows: Jan. 1, 1923 Dec. 31, 1923
Per cent Amount Per cent Amount
Nonstockholders 74.90 $228,782.70 73.28 $319,540.22
So-called loan stockholders .74 2,269.64 .52 2,273.73
Running stockholders 3.10 9,459.05 5.57 24,303.38
Paid-in stockholders 11.99 36,612.29 11.34 49,420.67
Permanent stockholders 9.27 28,313.96 9.29 40,502.96
100.00 305,437.64 100.00 436,040.96
*3045 The petitioner paid dividends to its various classes of stockholders, as follows: Permanent stock $15,212.31
Paid-up stock 4,989.40
Running stock 14,400.87
Loan stock 217.70
34,820.28
It was the policy of the petitioner to require all borrowers to subscribe to "loan stock." During the year 1923 all loans, except one, were made to loan stock subscribers. It does not appear that the borrowers were required to subscribe to more than one share of loan stock. The loans were made on a basis to yield the petitioner 8 per cent. Borrowers paid initial amounts varying from $5 to $25 on their subscriptions to loan stock.
The petitioner did not require the borrowers to pay any additional installments on their loan stock but permitted them to do so if they so desired. In only a few cases did the borrowers pay additional sums on their loan stock accounts and in a number of instances they withdrew a major part, if not all, of their payments and credits thereon. No stock was ever issued to them - they merely made application for that stock. No membership fee was charged to the borrowers, but the holders of the regular classes of stock were required to pay from *3046 $2 to $5 per share as an issuance fee. Borrowers were credited with so-called dividends on the amount actually paid in by them on their so-called loan stock at the rate which installment and other stockholders received. No objection was made by the petitioner to the withdrawal of a part or all of the amounts paid by borrowers on their loan stock.
OPINION.
VAN FOSSAN: The Board has recently had occasion in other cases to consider the primary question involved in the instant proceeding. *77 In those cases we have observed that when Congress provided that certain domestic building and loan associations should be exempt from tax it used the term in its ordinary and accepted meaning and that to qualify under this exception petitioner must establish a bona fide compliance with the intendment of the law. Among the well recognized attributes of a building and loan association is mutuality. This mutuality relates generally to the control and management of the business and its assets and in a larger and more fundamental sense to the opportunity and means it affords the members for saving and borrowing for home owning. Though isolated or infrequent exceptions to this rule might *3047 not defeat a claim for exemption, we are of the opinion that such exceptions must not be so considerable in number or amount as to alter the true nature and character of the corporation's business. Where a building and loan association does not substantially meet these requirements it is not such an association as is entitled to exemption under the statute, however it may style itself. The name is no safe criterion by which to judge the true character of the business. See ; ; ; ; affd. .
The stipulated record discloses that during the year 1923 the petitioner made 67 real estate mortgage loans to stockholders, aggregating $589,250, and that 42 of such loans, aggregating $436,550, or 74.09 per cent, were made to building contractors for the purpose of constructing one-family and two-family houses and four-family houses or apartments. Five additional loans, aggregating $31,750, or 5.38 per cent, were made for the *3048 purpose of constructing a store building (also containing apartments) and for purchasing vacant lots. Hence, during that year only 20 loans, aggregating $120,950, or 20.53 per cent, were made for the purpose of enabling the borrowers to build and purchase homes for their own use and occupancy.
On January 1, 1923, the mortgage loans of the petitioner were 125 in number and totaled $891,535.56. Of these loans twelve, aggregating $97,808.17, had been made to nonstockholders, while 108 thereof, aggregating $700,455.53, were in the names of persons who had attempted to qualify as members by subscribing to so-called "loan stock," on which they had made a nominal payment, and, except in very few instances, had made no further payments during the life of their loans. By the end of 1923 the loans to "loan stock" subscribers had increased substantially in both number and amount, while the loans to nonstockholders had decreased by one in number and by over $16,000 in amount.
*78 It will also be observed that a large proportion of the petitioner's revenue was derived from the deposits made by nonmembers, borrowed money, and other sources - activities of a kind apt to undermine *3049 and destroy the aims, purposes and reasons for existence of a true building and loan association.
In view of the facts as above stated and under the cases cited, we are clearly of the opinion that the petitioner is not entitled to exemption from taxation for the year 1923 under the provisions of section 231(4) of the Revenue Act of 1921.
The second issue presented is whether or not the amounts paid by the petitioner as dividends on withdrawable stock should be allowed as deductions from gross income as either business expenses or interest on borrowed money.
It will be observed that the petitioner does not ask to be classified as a mutual savings bank under section 231(2) of the said Act, but maintains that its so-called withdrawable stock, paid for either in full or in part, is not the capital stock of the corporation but is in the nature of deposits subject to withdrawal at the will of the depositor. Included in the classification of such stock payments or deposits as described by the petitioner are the payments made on the above-mentioned "loan stock."
Careful examination of the by-laws of the petitioner, quoted above, convinces us that the holders of the paid-up and *3050 running stock were in fact members of the association and as such entitled to all the rights and privileges of stockholders therein. From the provisions of the by-laws relating to the payment of dividends it is evident that dividends are to be paid out of the earnings of the association in proportion to the amounts paid by the stockholders or members on the installment and full paid capital stock of the association. The "General Withdrawal Rule" (section 26 of the petitioner's by-laws) clearly distinguishes between the stock credits accruing to the members or stockholders and the interest payable to depositors. In the former class "all persons withdrawing shall be entitled to receive the amount of all credits at the time of the application to withdraw, less any member's share of the Company's loss in excess of the reserve fund." (Italics ours.)
As to these classes of stock the rule laid down in , governs. As to the so-called loan stock, however, we are constrained to a different view.
It is our opinion that the makers of such applications were not bona fide stockholders of the petitioner either actually or potentially. They *3051 were under no obligation to make any payments subsequent to the initial one. The facts strongly indicate that the petitioner merely attempted to qualify its borrowers as members under the provisions *79 of section 231(4) of the Revenue Act of 1921 and that there was no true intent on the part of either the petitioner or the borrowers themselves to establish them as actual participating members of the association. This conclusion is supported by the fact that even the small initial payments were frequently withdrawn and that only in rare instances were further payments made toward the acquisition of the so-called stock. Therefore, we conclude that the $217.70 alleged to represent dividends on loan stock was in the nature of interest paid to the borrowers for the use of the money required to be deposited by them at the time their loans were granted. The facts as to this stock distinguish it from the case of
Judgment will be entered under Rule 50.
Footnotes
1. One additional loan of $1,000 was made to a nonstockholder. ↩