Opinion of the Court 149 C. Cls. proposed adjustments were the elimination from plaintiffs' income of the amounts retained by Pope & Talbot in the guaranty fund, as provided by the Gilmore contract, and the disallowance to the plaintiffs of the benefits of section 117(k) (1) of the Internal Revenue Code of 1939 for the years 1952 and 1953 and the benefits of section 631 (a) of the Internal Revenue Code of 1954 for the year 1954. The plaintiffs, on or about December 6, 1955, executed Treasury Department Forms 870, consenting to the immediate assessment of the following deficiencies in income tax for the pertinent years, as follows: Year 1952 1953 1954 Total Deficiency $70, 359. 56 31, 020. 98 9, 133. 52 110,514. 06 26. Under date of December 9, 1955, the plaintiffs forwarded to the District Director of Internal Revenue at Portland, Oregon, their check in the amount of $125,514.06, in payment of the aforesaid total deficiency of $110,514.06, plus an additional payment of $15,000 toward interest thereon. On or about March 6, 1956, plaintiffs also paid the additional sum of $115.29 as interest on these deficiencies. 27. On or about February 16, 1956, plaintiffs duly filed with the District Director of Internal Revenue in Portland, Oregon, their claims for refund of income taxes in the following amounts: Year 1952. 1953. 1954 Amount $82, 036. 22 44, 066. 61 16, 637.92 Claims were also made for each of these years for the amount of the interest paid on the deficiencies shown in finding 25. These claims for refund were based upon the same grounds as those set forth in the petition filed herein. 28. Under date of July 17, 1956, plaintiffs received statutory notices of the disallowance of each of the refund claims, by registered mail, as required by section 3772(a)(2) of the Internal Revenue Code of 1939 and section 6532(a) (1) of the Internal Revenue Code of 1954. 54 Syllabus 29. The parties have agreed, with the approval of the commissioner, that the trial of this case be limited pursuant to Rule 38 (c) to the issues of fact and law relating to the right of the plaintiffs to recover, reserving the determination of the amount of recovery, if any, for further proceedings. CONCLUSION OF LAW Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes as a matter of law that plaintiffs are entitled to recover, and judgment will be entered to that effect. The amount of recovery will be determined pursuant to Rule 38 (c) of the Rules of this court. In accordance with the opinion of the court and on a memorandum report of the commissioner as to the amount due thereunder, it was ordered on May 6, 1960, that judgment for the plaintiffs be entered for $157,856.04, with interest thereon as provided by law. HERCULES POWDER COMPANY v. THE UNITED STATES [Nos. 135-57, 152–58 and 318–58. Decided February 3, 1960] ON THE PROOFS Taxes, income; deductions; expenses-salaries.-Plaintiff in 1930, 1931, and 1932, purchased a quantity of its own issued and outstanding common stock, and in 1948 it distributed a portion of that stock, which had greatly increased in value, to certain of its employees as a bonus. The Government assessed and collected capital gains tax on the amount by which the donated stock exceeded in 1948 the basis in 1930, 1931, and 1932. The court held (1) that under Treasury Regulations 111, sec. 29.22 (a)-15, and the ruling of this court in Anderson, Clayton & Co. v. United States, 129 C. Cls. 295, affirmed 350 U.S. 55, the plaintiff was not dealing in its own shares as it would have dealt in the shares of another corporation and therefore the increase in value of the stock distributed as bonuses to its employees was not income to the corporation and was not subject to the capital gains tax; and (2) that the transactions in 625946-627 Opinion of the Court 149 C. Cls. question did not produce income, taxable or otherwise, and the value of the stock was properly claimed as a deduction for compensation paid to plaintiff's employees. Plaintiff is entitled to recover. Internal Revenue 546, 823 Taxes, income; gross income; gains and profits from sales and exchanges; dealing by corporation in its own stock.-Where a corporation distributes its treasury stock as bonuses to employees and the market value of the stock at the time of distribution exceeds the basis of such stock, there is no resulting taxable gain to the corporation since the corporation is not dealing in its own shares as it would in the shares of another corporation. Treasury Regulations 111, sec. 29.22 (a)-15. Internal Revenue 546 Taxes, income; deductions; expenses-bonuses to employees-stock bonuses. The value of treasury stock which a corporation gives to its employees as a bonus is deductible as an ordinary and necessary business expense representing salary or other compensation. Internal Revenue 546 Taxes, income; administrative regulations; operation and effect.-A treasury regulation cannot create an exemption of income from taxation. Thus, a transaction which does not produce any income for tax purposes will not produce income which is exempt from taxation. For example, the increase in value over its basis of treasury stock given as a bonus to corporate employees is not taxable income but the value of the stock is deductible by the corporation as a business expense in the form of salary or bonus or other compensation to the employees. Internal Revenue 317 Mr. David W. Richmond for the plaintiff. Mr. Robert N. Miller and Mr. Frederick O. Graves were on the briefs. Mr. Garry A. Pearson, with whom was Mr. Assistant Attorney General Charles K. Rice, for the defendant. Messrs. James P. Garland and Lyle M. Turner were on the briefs. MADDEN, Judge, delivered the opinion of the court: The plaintiff seeks to recover income taxes paid for the years 1948 through 1952. It paid the taxes as capital gains taxes upon the sale of shares of its own stock. It later concluded that the transactions were not taxable, and filed timely claims for refunds, which claims were denied. The plaintiff is a Delaware corporation, whose stock is listed on the New York Stock Exchange. As of December 77 Opinion of the Court 31, 1929, its capital structure consisted of 200,000 shares of preferred stock and 1,600,000 shares of no par value common stock. Only 114,241 shares of preferred and 598,000 shares of common stock were issued and outstanding. On January 2, 1930, the plaintiff began purchasing shares of its own common stock, and continued to do so until September 21, 1932. The purchases were in lots ranging from 1 share to 1,600 shares, and amounted to 34,886 shares in all. The average price paid was $9.10 a share and the lowest price paid was in 1932 and was $3.47. Some 12,000 of the shares were purchased from the plaintiff's employees who had subscribed for the shares before the depression at $15 a share and did not wish to complete their purchases. The rest were bought through brokers on the open market. During 1931 the plaintiff used 10,000 shares of the purchased stock, which we will call treasury stock, to buy the Paper Makers Chemical Corporation. During 1930, 1931, and 1932 the plaintiff sold 1,331 shares on the open market. In 1934, 800 shares were used to purchase the business of Universal By-Products Company. In 1937, and again in 1946, two for one split-ups were made in the plaintiff's stock. The figures used hereinafter with regard to the number of shares are adjusted to make them represent original shares. Between 1933 and 1937 the plaintiff used 3,276 shares to pay bonuses to its employees. After 1937 the plaintiff did not sell nor otherwise dispose of any of the remaining 19,479 shares, until 1948. On December 9, 1948, the plaintiff's board of directors voted a year end "B" bonus of $2,233,133 to certain of its employees who had been recommended by their superiors. Of the bonus, $1,750,038 was to be paid in cash, and the balance in treasury common stock at its then market value. The plaintiff's "B" bonus was a profit sharing device. Only once between 1930 and 1948, viz in 1937, had any part of the "B" bonus been paid in common stock. When the bonus stock was distributed to the employees, an accompanying letter from the president of the plaintiff said: We believe the key personnel who share in the bonus will appreciate this opportunity to increase their interest in the company and to participate as stockholders Opinion of the Court 149 C. Cls. as well as employees in its continued growth and prosperity. No restrictions were placed upon the employees as to the disposition of their bonus stock. A survey of 1,097 employees who received stock as bonuses in 1948 showed that only 49 of them had disposed of the stock during 1949. The market value of the stock distributed as a bonus in December 1948, which was the value attributed to it in computing the amount of each employee's bonus, was greatly in excess of what the plaintiff had paid for the stock in 1930, 1931, and 1932. It is this excess which the Government asserts, and the plaintiff denies, was taxable income. Similar bonus distributions of treasury stock were made at the ends of the four succeeding years, and those distributions present the same legal questions as the 1948 distribution. Section 22(a) of the Internal Revenue Code of 1939, 26 U.S.C. (1952 ed.), § 22(a), gives a broad definition of what is "gross income" for income tax purposes. It concludes with the words or gains or profits and income derived from any source whatever. That is all that the statutes have to say about our principal problem. Obviously, some elaboration by some authority was required. Treasury Regulations 111 says: Sec. 29.22(a)-15. Acquisition or disposition by a corporation of its own capital stock. Whether the acquisition or disposition by a corporation of shares of its own capital stock gives rise to taxable gain or deductible loss depends upon the real nature of the transaction, which is to be ascertained from all its facts and circumstances. The receipt by a corporation of the subscription price of shares of its capital stock upon their original issuance gives rise to neither taxable gain nor deductible loss, whether the subscription or issue price be in excess of, or less than, the par or stated value of such stock. But if a corporation deals in its own shares as it might in the shares of another corporation, the resulting gain or loss is to be computed in the same manner as though the corporation were dealing in the shares of another. Any gain derived from such transactions is subject to tax, and any loss sustained is allowable as a |