the meaning of section 26(c). The provisions recognized by the Act are of two general types, as follows: (1) Those which come within section 26(c) (1), in that they prohibit or limit the payment of dividends during the taxable year; and (2) Those which come within section 26(c) (2), in that they require the payment, or irrevocable setting aside, within the taxable year, of a specified portion of the earnings or profits of the taxable year for the discharge of a debt incurred on or before April 30, 1936. If a corporation is restricted with respect to the payment of dividends by two or more contract provisions coming within section 26(c) (1), only the largest of the credits computed with respect to each of such provisions, and not their sum, shall be allowable under section 26 (c) (1) and, for such purpose, if two or more credits are equal in amount, only one shall be taken into account. However, section 26(c)(3) provides that if both section 26(c)(1) and section 26 (c) (2) apply, only the one of such paragraphs which allows the greater credit shall be applied, and, if the credit allowable under each paragraph is the same, only one of such paragraphs shall be applied. (b) Prohibition on payment of dividends.—The credit provided in section 26(c) (1) is allowable only with respect to a written contract executed by the corporation prior to May 1, 1936, which expressly deals with the payment of dividends and operates as a legal restriction upon the corporation as to the amounts which it can distribute within the taxable year as dividends. If an amount can be distributed within the taxable year as a dividend— (1) in one form (as, for example, in stock or bonds of the corporation) without violating the provisions of a contract, but can not be distributed within the taxable year as a dividend in another form (as, for example, in cash) without violating such provisions, or (2) at one time (as, for example, during the last half of the taxable year) without violating the provisions of a contract, but can not be distributed as a dividend at another time within the taxable year (as, for example, during the first half of the taxable. year) without violating such provision— then the amount is one which, under section 26 (c) (1), can be distributed within the taxable year as a dividend without violating such provisions. The credit provided in section 26(c) (1) is equal to the excess of the adjusted net income, as defined in section 14(a), over the aggregate of the amounts which can be distributed within the taxable year without violating the provisions of such contract. [The requirement that the provisions of the contract expressly deal with the payment of dividends is not met in case (1) a corporation is merely required to set aside periodically a sum to retire its bonds, or (2) the contract merely provides that while its bonds are outstanding the current assets shall not be reduced below a specified amount. The computation of the credit allowable under section 26(c) (1) may be illustrated by the following examples: Example (1): For the calendar year 1936 the A Corporation (which was organized in 1918) has a net income (on the accrual basis) of $200,000, a normal tax liability of $28,840, and an adjusted net income of $171,160. At the beginning of the taxable year it had $50,000 of accumulated earnings and profits. Its earnings and profits of the taxable year before deducting Federal income taxes amount to $210,000. The corporation has second mortgage 6 percent bonds outstanding at the close of the year, issued prior to January 1, 1936, in the amount of $1,000,000. An amount of the earnings and profits sufficient to retire 10 percent of such bonds must, by the provisions of the underlying mortgage, be set aside annually before any dividends can be paid on its stock. The credit allowable under section 26 (c) (1) is $40,000, computed as follows: Adjusted net income___ Aggregate of amounts which can be distributed: Earnings and profits of the taxable year before deducting $171, 160 Federal income taxes__ Less normal tax $210,000 28, 840 181, 160 Plus earnings and profits at beginning of taxable year, accumulated after February 28, 1913_ 50,000 231, 160 Less amount required for retirement of bonds__. 100, 000 131, 160 Credit allowable___ 40, 000 Example (2): Under the terms of a contract entered into prior to January 1, 1936, Corporation B obtained a loan of $300,000. The contract provided that as long as the debt remains unpaid not more than 50 percent of the annual earnings shall be used for the payment of dividends. Corporation B has an adjusted net income (on the accrual basis) of $162,660 and a normal tax liability of $27,340. The current earnings and profits, amount to $140,000 before deducting Federal income taxes and in addition thereto the corporation had at the beginning of its taxable year $40,000 representing earnings and profits accumulated after February 28, 1913. The credit allowable · under section 26 (c) (1) is $66,330, computed as follows: Plus earnings and profits at beginning of taxable year 40, 000 Total____ 152, 660 Less amount restricted: 50 percent of current earnings, 56, 330 96, 330 66, 330 Credit allowable__. (c) Disposition of profits of taxable year.-Under the provisions of section 26 (c) (2), a corporation is allowed a credit in an amount equal to that portion of the earnings and profits of the taxable year which, by the terms of a written contract executed by the corporation prior to May 1, 1936, and expressly dealing with the disposition of the earnings and profits of the taxable year, it is required within the taxable year to pay in, or irrevocably to set aside for, the discharge of a debt incurred on or before April 30, 1936. The credit is limited to that amount which is actually so paid or irrevocably set aside during the taxable year pursuant to the requirements of such a contract. Only a contractual provision which expressly deals with the disposition of the earnings and profits of the taxable year shall be recognized as a basis for the credit provided in section 26 (c) (2). A corporation having outstanding bonds is not entitled to a credit under a provision merely requiring it, for example, (1) to retire annually a certain percentage or amount of such bonds, (2) to maintain a sinking fund sufficient to retire all or a certain percentage of such bonds by maturity, (3) to pay into a sinking fund for the retirement of such bonds a specified amount per thousand feet of timber cut or per ton of coal mined, or (4) to pay into a sinking fund for the retirement of such bonds an amount equal to a certain percentage of gross sales or gross income. Such provisions do not expressly deal with the disposition of earnings and profits of the taxable year. A contractual provision, however, shall not be considered as not expressly dealing with the disposition of earnings and profits of the taxable year merely because it deals with such earnings and profits in terms of "net income," "net earnings," or "net profits." [The term "debt" as used in section 26 (c) (2) does not include an obligation of the corporation to a shareholder, as such, as distinguished from a creditor. Accordingly, amounts paid into, or set aside for, a sinking fund by a corporation for the retirement of preferred stock, pursuant to the terms of an agreement underlying the preferred stock issue, shall not be considered as set aside for discharge of a debt.] An indebtedness evidenced by bonds or other similar obligations issued by a corporation is incurred as of the date such obligations are issued, and the amount of such indebtedness is the amount represented by the face value of the obligations. For the purpose of this article a bond or other similar obligation is not issued until it is executed and delivered to a person who holds it as a debt of the corporation. Bonds issued after April 30, 1936, in exchange in refunding a preexisting issue represent debts incurred after April 30, 1936, within the meaning of section 26(c) (2). ART. 26–3. Bank affiliates.-The credit provided in section 26(d) is allowed (1) to a holding company affiliate of a bank, as defined in section 2 of the Banking Act of 1933, which holding company affiliate holds, at the end of the taxable year, a general voting permit granted by the Board of Governors of the Federal Reserve System; (2) in the amount of the earnings or profits of such holding company affiliate which, in compliance with section 5144 of the Revised Statutes, has been devoted by it during the taxable year to the acquisition of readily marketable assets other than bank stock: (3) upon certification by the Board of Governors of the Federal Reserve System to the Commissioner that such an amount of the earnings or profits has been so devoted by such affiliate during the taxable year. No credit is allowable either for the amount of readily marketable assets acquired and on hand at the beginning of the first taxable year subject to the Revenue Act of 1936 or for an amount of readily marketable assets in excess of what is required, by such section 5144, to be acquired by such affiliate. Every taxpayer claiming and making a deduction for the credit provided for in section 26(d) shall attach to its return a supplementary statement, in duplicate, setting forth all the facts and information upon which the claim is predicated, including such facts and information as the Board of Governors of the Federal Reserve System may prescribe as necessary to enable it, upon the request of the Commissioner subsequent to the filing of the return, to certify to the Commissioner the amount of earnings or profits devoted to the acquisition of such readily marketable assets. A certified copy of such supplementary statement shall be forwarded by the taxpayer to the Board of Governors at the time of the filing of the return. The holding company affiliate shall also furnish the Board of Governors such further information as the Board shall require. For the requirements with respect to the amount of such readily marketable assets which must be acquired and maintained by a holding company affiliate to which a voting permit has been granted, see subsections (b) and (c) of section 5144 of the Revised Statutes (paragraph 56 of the Appendix to these regulations). SEC. 27. CORPORATION CREDIT FOR DIVIDENDS PAID. (a) Dividends paid credit in general.—For the purposes of this title, the dividends paid credit shall be the amount of dividends paid during the taxable year. ART. 27(a)-1. Dividends paid credit in general.-(a) Allowance.— The amount of the dividends paid credit provided by section 27 is the amount of the dividends paid during the taxable year, subject, however, to the qualifications, limitations, and exceptions prescribed in subsections (b) to (h), inclusive, of section 27. See also section 121 with respect to dividends paid on preferred stock owned by the United States or instrumentalities thereof. (b) When dividends are considered paid.-A dividend will be considered as paid when it is received by the shareholder. A dividends paid credit can not be allowed unless the shareholder receives the dividend during the taxable year for which the credit is claimed. If a dividend is paid by check and the check bearing a date within the taxable year is deposited in the mails, in a cover properly stamped and addressed to the shareholder at his last known address, at such time that in the ordinary handling of the mails the check would be received by the shareholder within the taxable year, a presumption arises that the dividend was paid to the shareholder in such year. The payment of a dividend during the taxable year to the authorized agent of the shareholder will be deemed payment of the dividend to the shareholder during such year. If a corporation, instead of paying the dividend directly to the shareholder, credits the account of the shareholder on the books of the corporation with the amount of the dividend, the credit for a dividend paid will not be allowed unless it be shown to the satisfaction of the Commissioner that such crediting constituted payment of the dividend to the shareholder within the taxable year. |