Sunshine Cloak & Suit Co. v. Commissioner

*540 This is a proceeding for the redetermination of a deficiency in income and profits taxes for a fiscal year ended November 30, 1918, in the amount of $20,047.39. Two issues are presented - (1) whether an item of $190,000, known as the C. K. Sunshine-Exchange Account, should be included in the petitioner's invested capital for the year in question (and, incident to that issue, whether the respondent erred in allowing the petitioner a deduction for interest thereon), and (2) whether assessment and collection of the deficiency are barred by the statute of limitations. The second issue was presented to the Bord and decided adversely to the petitioner in our decision reported at 10 B.T.A. 971.

*2559 FINDINGS OF FACT.

The petitioner is an Ohio corporation with its principal office and place of business at Cleveland. It was incorporated in 1899 and took over a business of manufacturing women's clothing theretofore conducted by C. K. Sunshine, who succeeded a partnership established in 1893. The corporation originally had, and still has, outstanding stock of the par value of $50,000, divided into 500 shares having a par value of $100 each. Sunshine became the principal stockholder with approximately 340 shares, the remainder being held in relatively *541 small blocks by old employees of the business or by relatives who were associated with him in the enterprise. The stock has always been closely held and practically all shares were owned by Sunshine or his relatives. At the time the alleged contribution to surplus took place, petitioner held 225 of the 500 shares outstanding, the remainder (excepting 75 shares held by an old employee) being held by his relatives.

During the year in question Sunshine was the president of petitioner corporation, as he had been from the beginning. He, apparently, conducted the business much as if it were his individual business*2560 without regard to corporate formalities.

The petitioner had, from an early date, carried on its books an account termed "C. K. Sunshine Exchange Account." This recorded income of C. K. Sunshine from sources outside the petitioner's affairs, as well as income from petitioner in the form of interest, dividends and salary. Against such accounts were debits showing withdrawals made by him from time to time. This account at one time amounted to approximately $400,000 and was available for use by petitioner, Sunshine having always arranged for needed finances. About the year 1911 Sunshine built a building costing about $170,000 for petitioner's use out of funds from this account, which building is still owned by Sunshine and is still occupied by petitioner.

The business prospered until 1911, when heavy losses were sustained. By 1916 prices had increased until it was thought necessary that petitioner have a larger capital available for credit purposes. No formally recorded corporate action was taken, but $190,000 of the amount credited to Sunshine in the "Exchange Account" was, at his instruction, set up by his nephew, a stockholder, who was then the bookkeeper, in an account captioned: *2561

Below this caption was the entry of $190,000 dated December 1, 1916. The "Exchange Account" was not terminated at that time but was continued and still exists.

In the latter part of 1916 the bookkeeper severed his connection with the business and went west for his health. The bookkeeper who was employed in his stead considered the above entry an improper one to show the $190,000 as surplus of the petitioner. He so stated to Sunshine and was instructed by him to make whatever entries he thought proper to show the $190,000 simply as surplus, as Sunshine wanted to contribute that sum to petitioner's capital. Accordingly, he noted on the sheet containing the account the word "trans." under date of November 30, the date the books were closed, *542 and under date of December 1, 1917, he opened up a new account captioned:

Under such caption in the "date" column was written December 1, 1917, and under the column "credits" was entered $190,000. Thereafter, if not after the opening of the account so transferred, the $190,000 was included in the surplus of petitioner corporation*2562 in making financial statements to petitioner's bank or factors, and was so included by petitioner in making out its stock tax return for the year in question. It was kept separate on the books from the general surplus account. Sunshine has never claimed the $190,000 and holds no notes or other evidence of indebtedness concerning it. No stock has been issued therefor as Sunshine preferred for credit purposes to have a small stock capitalization and a large surplus rather than a large stock capitalization with no substantial surplus.

It had long been the practice of petitioner to credit the stockholder's account with 6 per cent on their capital stock before it was considered any earnings had resulted or dividends were declared. After the $190,000 transfer to surplus, and during the year in question, interest on the $190,000 at 6 per cent was credited to Sunshine's "Exchange Account," as well as like credits being entered to the accounts of the several stockholders on the stock account of $50,000. Six per cent interest was also paid on the "Exchange Account." There was a general or earned surplus, but no such charge was made against income in respect to such surplus. The respondent*2563 adjusted taxable income to include the interest deduction taken on account of the $50,000 stock capitalization, but allowed the interest deduction amounting to $11,400 on the $190,000 account, and excluded that amount from invested capital.

It is stipulated that the amounts used by respondent for the prewar period in computing invested capital are correct. It is also agreed that, if the $190,000 in question is allowable as invested capital, the $11,400 deduction claimed and allowed should be restored to income.

OPINION.

SIEFKIN: The petitioner renews his motion for judgment on the ground that the statute of limitations interposes a bar to the deficiency asserted in view of the numerous decisions involving questions of the statute of limitations since our decision, Sunshine Cloak & Suit Co.,10 B.T.A. 971, denying that motion. Petitioner cites and relies on Joy Floral Co. v. Commissioner, 29 Fed.(2d) 865. We do not think that decision in point. Nor have we been able to find any other decision in conflict with the result of our former holding on the point. The motion is again denied.

*543 Turning to the merits of the case, *2564 we find the petitioner's contention persuasive. Sunshine testified that he intended to contribute the $190,000 to the capital of the corporation and gave instruction to that effect. The bookkeeping acts, as well as the bookkeeper's testimony, not only confirm the testimony, but show his instructions were carried out. The only questionable fact is the credit to Sunshine's personal (Exchange Account) account of interest thereon, which, taken by itself, would indicate the sum to be borrowed money. Such indication, however, is negatived by the undisputed showing that a like interest credit was made on behalf of all stockholders on capital invested in stock of petitioner. This long established, though erroneous, practice of crediting interest on capital paid in adequately explains the one fact which tends to defeat the petitioner's contention. The exclusion of $190,000 from invested capital was error. The interest deducted thereon will be restored to income.

Judgment will be entered under Rule 50.