book of the corporation. The loan carried interest at 6 per cent. All the payments made by the appellant were used by the appellee for its corporate purposes. Interest payments were made on the mortgage from time to time. Prior to this loan, the appellee employed a firm in Boston to act as its factors. When this loan was made, it entered into a contract for such services with Lowenstein Bros., the copartnership. That agreement provided:

"The firm agrees to give and extend to the company such service, advice, and pecuniary assistance as, in its discretion, it may deem advisable for the term of six years from the 1st day of April, 1920, and ending and expiring on the 31st day of March, 1926, but the firm shall not be held liable, bound, or obligated to do or perform any act during the said period for the company, unless in the exercise of its discretion and judgment it may deem such act to be fit, prudent, and proper so to do, and in connection thereof the company agrees to pay to the firm a compensation or commission of 5 per cent. on the net sales of the entire products of the company's mill, which shall be ascertained by taking the invoice price of said sales, and deducting therefrom all trade discounts extended, and crediting against the same all returns allowed, deductions, offsets, allowances, cancellations of merchandise by the customers or parties to whom the said goods may or shall be sold or consigned.

"The company agrees to furnish and render to the firm, on the 16th day of each and every month during the said period, complete and accurate statements showing the net sales for the preceding month, and disclosing and including all trade discounts, claims, deductions, offsets, allowances, returns, and cancellations, and said statement shall be accompanied by the company's check for the said commissions and compensation of 5 per cent. aforesaid."

Additional payments were provided for by way of compensation running over a period of 6 years. Negotiations for the mortgage covered a period of 60 days. The mortgage was executed first, and on the same day the agreement with Lowenstein Bros. was executed. No part of the principal has been paid. The appellee has been successful in resisting the foreclosure suit below upon the claim that the mortgage was usurious under the Connecticut statutes (provisions of 1918, sections 4798, 4799, 4801, 4802, 4803 as amended by chapter 118 of the Laws of 1921), although due and author

ized execution of the mortgage is found. The court below stated that the corporation was bound by the terms of the mortgage unless the defense of usury prevailed, and, after consideration of the Connecticut statutes which he applied to the facts, he found that the mortgage was usurious and void.

The claim of the appellee in support of this conclusion is that the corporation had been in a situation where advantage was taken of it by the connivance of the appellant and Lowenstein Bros.; that exorbitant interest was charged through the agreement of Lowenstein Bros. and by the instrumentality of the appellant. The mortgage calls for the payment of 6 per cent., but it is claimed that the appellant used Lowenstein Bros.' agreement for services as a mere cloak, and covered up the usurious charge. The argument proceeds that it is impossible to avoid the conclusion that the corporation was paying for the use of the money and not for any services that Lowenstein Bros. might possibly have decided to render. is pointed out that the agreement to pay as salary a sum of money, which lasted while the loan decreased, amounted to about 2 per cent. of the loan, and, since the agreement and the mortgage were one transaction, it calculated upwards of 12 per cent. per annum. The pertinent sections of the Connecticut statutes are as follows:

It

"Sec. 4798. Loans at Greater Rate than Twelve Per Centum Prohibited. No person and no firm or corporation or agent thereof, other than a pawnbroker as provided in section 3011, shall, as guarantor or otherwise, directly or indirectly, loan money to any person and, directly or indirectly, charge, demand, accept or make any agreement to receive therefor, interest at a rate greater than twelve per centum per annum."

And section 4803, which reads as follows: "Loans to Which the Preceding Sections Do Not Apply. The provisions of sections 4798, 4799 and 4800 shall not affect any loan made prior to September 12, 1911, nor any loan made by any national bank or any bank or trust company duly incorporated under the laws of this state, nor any bona fide mortgage of real property exceeding the sum of five hundred dollars."

It appears from the foregoing statutes that no person in any capacity, shall make a loan to any person and charge or accept or make an agreement to receive therefrom interest at the rate of more than twelve per cent. per annum, but this provision has no application to a bona fide mortgage on real es

949.

[1-3] This mortgage is within the provisions of 4803, for it is a bona fide mortgage on real property exceeding the sum of $500. It was found below that the amount advanced was $125,000, and the instrument was authentic and validly executed. It may cover some chattels, but it has well covered real estate and fixtures, and must be deemed a mortgage on real estate. The agreement with Lowenstein Bros. was a separate instrument, and can only be considered with the mortgage in testing the question of a usurious transaction. It could not affect the bona fide character of the mortgage transaction. There is no fraud or illegality proven, and the only effort to show infirmity in the mortgage depends upon the charge of usury. At best for the appellee the Lowenstein Bros. contract could be considered a plan to secure illegal interest, but the statute (section 4803) is plain that, if the mortgage be over $500, section 4798 has no application. Bona fide in its accepted meaning is good faith without fraud or deception; that is, good faith and honesty as distinguished from bad faith. Ware v. Hylton, 3 Dall. 241, 1 L. Ed. 568. The learned district judge considered the Lowenstein Bros. agreement for service as an additional payment of interest, holding that it was but a cloak to add interest to the 6 per cent. interest contained in the mortgage. Assuming that it may be so determined, and that by such a consideration the rate of interest was increased above 12 per cent., still that would not affect the bona fide character of the mortgage. It would therefore be immaterial, since the amount is more than $500, whether or not Lowenstein Bros.' contract was connected with it as a means to avoid the usury statute. At all times it was a $125,000 mortgage, and that amount was paid. It is not argued that anything in the making of or in the contract of Lowenstein Bros. constitutes a scheme to defraud or invalidates the mortgage other than through the claim of usury. The contract is in no way security for the mortgage, nor is it secured in any way by the mortgage. Usury cannot be established unless there be shown a defi

nite agreement to pay, in any event, an amount in excess of the legal rate of interest, and where, as here, the legal rate of interest is less, an agreement to pay additional sums which may or may not make the amount greater, would not of itself render the transaction usurious. A contract to violate the 12 per cent. usury statute of Connecticut, must require the payment of more than 12 per cent. per annum by its terms.

It appears from the mortgage that personal property may be deemed to be covered by it. An examination of the reports of Connecticut show a policy of that state against usual chattel mortgages and provision for the essentially real estate mortgages in the manufacturing and mechanical establishments. Gen. St. § 5206, provides:

"Sec. 5206. Certain Chattel Mortgages Good Without Possession. When any manufacturing or mechanical establishment, together with the machinery, engines or implements, cases, types, cuts or plates situated and used therein; shall be mortgaged by a deed containing a condition of defeasance, and a particular description of such personal property, executed, acknowledged and recorded as mortgages of lands, the retention by the mortgagor of the possession of such personal property shall not impair the title of the mortgagee. When such personal property shall be mortgaged together with the real estate such mortgage may be foreclosed as if wholly of real estate.

This statute permits certain fixed personal property, such as machinery in a mill, to be mortgaged without a change of possession. The mortgages are to be treated as mortgages of land and to be foreclosed as if wholly of real estate. Here the major security is real estate, it will be regarded as a real estate mortgage for the purpose of considering its security, validity, or procedure in foreclosure.

[4] Nor do we think that Lowenstein Bros.' agreement was in any way or in any sense an expression of the real terms of the mortgage. The instruments were separately executed and acknowledged, imposing distinct obligations on the parties. They were each authorized by corporate action. Why it should be regarded as a secret agreement is not established by the evidence. There is no reason why it should have been. It calls for services desired by the appellee, as it had previously received from the Boston firm. It in no way created further security for the $125,000 which was loaned.

Any defense of usury must be based upon the theory that the mortgage and the employ. ment agreement were part of one transaction and that the latter was a mere guise to conceal a further consideration for the loan.

This was recognized below, and the court added that in addition, it was necessary to show a secret agreement, but there was no evidence to warrant such a conclusion. The agreement for services was independent of the mortgage and based upon a valid consideration. It stands unimpeached and independent of the mortgage. The burden of establishing this claim was upon the appellee, and it may not be established by mere inference. Houghton v. Burden, 228 U. S. 161, 33 Sup. Ct. 491, 57 L. Ed. 780; White v. Benjamin, 138 N. Y. 623, 33 N. E. 1037; Wood v. Babbitt (C. C.) 149 F. 822; Shotwell v. Dixon, 163 N. Y. 43, 57 N. E. 178. The court below granted affirmative judgment in favor of the appellee for the moneys which had been paid as interest during the period the lien was recognized. Concluding, as we do, that the mortgage is valid and enforceable as against the appellee's property, it necessarily follows that the decree awarding this affirmative relief must fall.

The decree below is reversed, with direction to enter a decree of foreclosure.

Decree reversed.

EATON, Collector of Internal Revenue, v. ENGLISH & MERSICK CO.

(Circuit Court of Appeals, Second Circuit. April 13, 1925.)

declare dividend as shown by failure to comply with Gen. St. Conn. 1918, § 3423.

[Ed. Note.-For other definitions, see Words and Phrases, First and Second Series, Dividend.]

3. Evidence 65-Corporate directors presumed to know law of state in which corporation organized.

Corporate directors presumed to know law of state which gave them corporate existence and governed their action.

4. Internal revenue 7-Net profits for surplus, retained in treasury and used in business, held "invested capital" and not "borrowed capital."

The net profits or surplus of corporation, retained in treasury and used in business for purchase of machinery and materials, though divided each year and credited to individual but not distributed, held "invested capital" withsurplus accounts of stockholders pro rata, in Revenue Act, § 326 (Comp. St. Ann. Supp. 1919, § 63361⁄4ci), and not "borrowed capital."

In Error to the District Court of the United States for the District of Connecticut.

Action by the English & Mersick Company against Robert O. Eaton, Collector of Internal Revenue for the District of Connecticut. Judgment for plaintiff (299 F. 646), and defendant brings error. Affirmed.

This case comes here on writ of error to the United States District Court for the District of Connecticut.

The plaintiff in error was defendant below, and is hereinafter referred to as defendant. The defendant in error was plaintiff below, and is hereinafter referred to as plaintiff.

No. 288.

Tax statutes will not be extended by implication beyond clear import of language used, and any doubt will be resolved in favor of the taxpayer and against the government.

2. Internal revenue 7-Resolution providing for division of net profits to be credited to stockholders' individual surplus accounts held not declaration of "dividends."

Resolution providing that net profits for preceding year be divided among stockholders, and proportionate amounts credited to their individual surplus accounts, held not to constitute a "dividend" within meaning of Revenue Act, §§ 201a, 300 (Comp. St. Ann. Supp. 1919, §§ 6336b, 63366a), in absence of provision for payment at any particular time by setting aside a sum therefor; there being no intent to

The plaintiff is engaged in the manufacture and sale of automobile and carriage hardware, although in the year 1918 its facilities, capital, and surplus were practically exclusively devoted to the manufacture of motor truck and aeroplane radiators for the United States.

The plaintiff duly filed its return for inIt alleged that its net income for that year come and profits taxes for the year 1918. was $47,238.21 and it paid in that year for income and profits taxes the sum of $6,251.78, believing at the time that amount to be the correct amount of the tax due. It admitted in its petition that, owing to various corrections made to its return, the correct

amount of tax due, as nearly as the plaintiff could ascertain, was $7,706.99.

The Commissioner of Internal Revenue, on February 12, 1921, notified the plaintiff that an additional tax for the year 1918 as income and profits taxes, would be assessed in the sum of $17,254.40. Thereafter a hearing was had before the Income Tax Unit of the Treasury Department, and the plaintiff prosecuted an appeal before the Committee on Appeals and Review, and on or about July 20, 1921, after notice that the additional tax had been assessed, it filed with the department a claim for its abatement. Thereafter the Commissioner of Internal Revenue disallowed the appeal and denied the claim for abatement.

Thereafter defendant, as collector of internal revenue, demanded payment of the assessment with interest, the whole amount ing to $18,203.39, and threatened to enforce payment by distraint and sale of plaintiff's property. Thereupon the plaintiff paid, under protest, the amount demanded, and stated that it paid under duress and compulsion.

Thereafter, and on August 11, 1922, the plaintiff appealed to the Commissioner of Internal Revenue and demanded repayment of the tax. The Commissioner, having made no decision thereon within the six-month period, as provided for in the Revenue Act, the plaintiff instituted this suit at common law to recover from the collector the sum of $18,203.39 so paid by it, with interest there on from July 20, 1922.

The case was heard in the District Court, and a written stipulation of the attorneys on both sides was entered on the records that the case might be submitted to the court without the intervention of a jury.

Judgment was entered for the plaintiff in the sum of $16,608.92, with interest at 6 per cent. per annum from July 20, 1922, with costs to abide the event. It was entered, together with a certificate of probable cause, under the provision of section 989 of the Revised Statutes (Comp. St. § 1635).

John Buckley, U. S. Atty., and Allan K. Smith, Sp. Asst. U. S. Atty., both of Hartford, Conn., Nelson T. Hartson, Solicitor, of Internal Revenue, and John R. Wheeler, Sp. Atty., Bureau of Internal Revenue, both of Washington, D. C., for plaintiff in error.

Henry F. Parmelee, of New Haven, Conn., for defendant in error.

Before ROGERS, HOUGH, and HAND, Circuit Judges.

ROGERS, Circuit Judge (after stating the facts as above). This action was tried on an agreed statement of facts supplemented by the testimony of two witnesses who between them held the whole of the stock of the plaintiff corporation, with the exception of a qualifying share held by a third person. These two witnesses were called on behalf of the plaintiff, and their testimony is uncontradicted. No witnesses were called by the defendant. There is no dispute as to the facts.

The plaintiff is engaged in manufacturing carriage hardware and supplies. The business was carried on for many years under a partnership, but in 1895 it was converted into a corporation with a capital of $20,000. In its income tax return for the year of 1918, as corrected, it claimed an invested capital of $438,504.72. It appears that beyond the initial $20,000 represented by the capital stock, no further capital was put into the business except out of the earnings of the company. The Commissioner of Internal Revenue, upon auditing the return, disallowed the sum of $391,892.13 as part of the plaintiff's invested capital, and, redetermining the taxes, assessed against the plaintiff the additional sum of $17,254.40. It was the payment, under protest, of this $18,203.39, which has occasioned this acsum with interest, the whole amounting to tion. The question to be determined therefore is as to what is the plaintiff's invested capital. It is undisputed that the plaintiff's net income from its regular business in 1917 was in excess of $200,000. And it is stipulated in the agreed statement of facts that, if the plaintiff is entitled to its surplus as invested capital, it is entitled to judgment for the recovery of an overpayment of $15,659.93, with interest thereon, paid to the collector, or a total of $16,608.92, with interest thereon from July 20, 1922, until the date of judgment.

Its original capital stock of $20,000 remained such until the end of 1918, when a part of the surplus in controversy was capitalized by the issue of new stock, and again in 1921, when new stock was issued against surplus, so that its present capitalization is $407,400. Prior to the year 1918 earnings of the business had been accumulated amounting to $391,892.13. This accumulated surplus the court below has found was invested in machinery, material in process, manufactured stock on hand, in accounts due from customers, and in cash, all of which was essential to the operation of the business. The

court also found that no physical division of the property was ever made to the several stockholders.

It appears that the plaintiff included this surplus as assets in all of its balance sheets and annual financial statements submitted at the annual stockholders' meetings, which also were filed with its bank from which it borrowed money, and which it furnished regularly to Dun and Bradstreet, and on the strength of which it received a credit rating of from $300,000 to $500,000.

Prior to the year 1917 the corporate stock was owned as follows: John B. Kennedy, 522 per cent., Fred T. Bradley, 462 per cent., Carl W. Johnson, 1 per cent. During the years 1917 and 1918, the latter being the year of the tax assessment under consideration, the stockholders were as follows: John B. Kennedy, 52 per cent.; Fred T. Bradley, 45 per cent.; Carl W. Johnson, 12 per cent.; Seymour M. Bradley, 12 per cent.

For a number of years prior to 1918 the board of directors passed in January of each year a resolution which was identical in wording except as to the designation of the year to which reference was had-as passed in 1917 for example. The vote passed in 1917 was as follows: "It was moved and voted that the net profit for the year ending December 31, 1916, be divided pro rata with the stockholders as the individual holdings appear, and credit the amount to the individual surplus accounts standing in the names of the stockholders."

In January, 1918, the resolution passed was as follows: "It was moved and voted that the net profits remaining after deducting salaries, expenses, and war excess profits taxes be divided in the following proportions, and the amounts credited to the individual surplus accounts of the stockholders: John B. Kennedy, 52 per cent.; Fred T. Bradley, 45 per cent.; Carl W. Johnson, 112 per cent.; Seymour M. Bradley, 12 per cent."

There was established in the books of the corporation a "Division of Surplus" account. In this account there is set up as a credit, corresponding to the name of each shareholder, a sum closely approximating the amount of surplus attributable to the number of shares of stock held by each stockholder. There is debited from month to month the amounts paid by the corporation to the several stockholders. The salary of each officer was credited in the same account. These accounts did not bear interest, and were not understood by the stock

holders (except for salary items) to be an indebtedness of the corporation to them.

While the sums paid the stockholders from earnings, were not absolutely in proportion to their stockholdings from month to month, they were substantially so, and practically so averaged from year to year.

The sole issue is as to the status of the accumulated surplus of $391,892.13, which the government claims represented capital borrowed from the stockholders.

The decision of the court below is in effect that amounts credited on the books of the corporation to the accounts of stockholders, even though pursuant to resolution, nevertheless constituted invested and not borrowed capital, if such amounts were never actually distributed but were used in the business. This decision is contrary to the rulings made by the Treasury Department. See A. R. R. 102 (Cumulative Bulletin 2, p. 277), and A. R. R. 356 (Cumulative Bulletin 3, p. 330); Montgomery's Income Tax Procedure (1925), 1627.

The question involved arises under the Revenue Act of February 24, 1919 (40 St. c. 18, p. 1057). The term "invested capital" is defined in part 5, § 326, p. 1092, of the act, as follows:

"Sec. 326. (a) That as used in this title the term 'invested capital' for any year means (except as provided in subdivisions (b) and (c) of this section); (1) actual cash bona fide paid in for stock or shares; (2) actual cash value of tangible property, other than cash bona fide paid in for stock or shares. (3) paid-in or earn

ed surplus and undivided profits; not including surplus and undivided profits earned during the year. (4) (5)

"(b) As used in this title the term 'in'vested capital' does not include borrowed capital.

"(c) [Relates to deductions based on inadmissible assets and is not material to this case.]" Comp. St. Ann. Supp. 1919, § 63367/16i.

It will be observed that the act, section 326 (a) (3), defines "invested capital" as including "paid-in or earned surplus and undivided profits; not including surplus and undivided profits earned during the year."

The item of $20,000 actual cash bona fide paid in for stock, when the corporation was organized, is conceded to be included within the definition of invested capital. The dispute relates to the item of $391,892.13, which is claimed by the plaintiff and denied by the defendant to be any part of the "invested capital."