Carlston v. Commissioner

*218 This proceeding is for the redetermination of a deficiency in income tax asserted by the respondent for the year 1923 in the amount of $3,160.08. The questions presented*2154 are: (1) Whether the transfer in the years 1922 and 1923 of amounts from the surplus fund to the capital stock account of the Central Savings Bank resulted in income to the petitioner, as a stockholder of that bank; (2) whether the petitioner sustained a net loss in the year 1921 within the meaning of section 204 of the Revenue Act of 1921; and (3) whether interest amounting to $15,755.66 was paid by the petitioner to one C. J. Berry in 1922. The years 1921 and 1922 are involved only to the extent that the petitioner claims that in each of those years he sustained a "net loss" within the meaning of section 204 of the Revnue Act of 1921, which he is entitled to deduct from his income for 1923.

FINDINGS OF FACT.

The petitioner is, and has been continuously since some time prior to the year 1921, president of the Central Savings Bank and president of the Central National Bank, both of which are located in Oakland, Calif.

In 1922 and 1923 he owned 125 shares of the capital stock of the Central Savings bank out of total of 10,000 shares, of the par value of $100 each, then authorized and outstanding. On June 7, 1922, the board of directors of the Central Savings Bank, by resolution*2155 duly adopted, authorized and directed the cashier "to charge the surplus account the sum of One Hundred Thousand ($100,000.00) Dollars and credit same to the capital stock account." At that time only 60 per cent of the par value of the capital stock issued and outstanding had been paid up, and no calls for payments on stock subscriptions had been made since 1916. In the year 1923, by direction of the board of directors, $100,000 was transferred from the surplus fund of the said bank to the capital stock account. In each year, after transferring the said amount of $100,000 from surplus *219 to capital stock account, the outstanding stock certificates were called in and new ones were issued showing that an additional 10 per cent of the subscription price had been paid. These transfers had the effect of reducing the amount due from the petitioner to the said Central Savings Bank on account of his unpaid subscriptions in the amount of $10 per share, or $1,250 in each of the years 1922 and 1923. The petitioner did not include said amounts in his income tax returns for either 1922 or 1923. Upon audit of said returns the respondent increased the petitioner's income for 1922 and*2156 1923 by the amount of 1,250.

In addition to his banking interests, the petitioner in his individual capacity engaged in numerous other business activities which had nothing to do with his duties as president of the Central Savings Bank and the Central Antional Bank. These enterprises included, among other things, real estate, fire insurance, irrigation projects, oil prospecting, a deal in railroad stocks, mining, cotton, sales of tractors, terminal railway, water supplies, a hotel, and a theatre. They were not all carried on at the same time, nor with the same associates. In all or nearly all of these ventures the petitioner advanced money and endorsed notes.

In the year 1920 a firm known as Weissbaum & Company chartered from the Robert Dollar Company a steamship for a certain voyage, at a total charter hire of $300,000, payable at the rate of $30,000 per month. The said charter hire was guaranteed by the Central National Bank, of which the petitioner was president. Weissbaum & Company had part of the moeny for the charter hire, but not sufficient to make the total payment. As the payments became due the Central National Bank advanced the money, but finally reached the*2157 point where it could not legally make any further loans to Weissbaum & Company. In the meantime the voyage for which the steamship was chartered proved a financial failure and the ship was unable to return with the cargo for which it was chartered. Weissbaum & Company did not have at that time sufficient money to complete the payment of charter hire to the Robert Dollar Company, and the Central National Bank could not legally loan Weissbaum & Company any more money. The petitioner obtained for Weissbaum & Company the amount necessary to complete the payment of said charter hire from the Anglo & London Paris National Bank of San Francisco, by personally guaranteeing the application of Weissbaum & Company. If the petitioner had not made this guarantee and obtained the money for Weissbaum & Company, the charter contract would have been canceled and the Central National Bank would have lost the money it had advanced to Weisbaum & Company. The petitioner believed that by completing the charter hire for Weissbaum & *220 Company, he and the Central National Bank would be able to recover the full amount of the charter hire from the Robert Dollar Company.

The notes of Weissbaum*2158 & Company to the Anglo & London Paris National Bank, which the petitioner had guaranteed, became due in the year 1921 and the petitioner was called upon to pay them. The petitioner borrowed from the said Anglo & London Paris National Bank the amount of $105,575.15, giving his own promissory note therefor, and paid said notes of Weissbaum & Company to the said Anglo & London Paris National Bank. The petitioner paid his own notes so made in 1922. The petitioner was, during all the time these transactions took place, the owner of not less than 300 shares of the capital stock of the Central National Bank, out of a total of 10,000 shares outstanding. Said shares of stock had a book value of $300 per share.

Subsequently the petitioner, as a result of a suit or suits brought by him or the Central National Bank against the Robert Dollar Company on account of the amounts advanced by the said bank or the petitioner, or both of them, to Weissbaum & Company, recovered $60,000 of the amount he had paid to the Anglo & London Paris National Bank on account of his guaranty of Weissbaum & Company's note.

The petitioner, in his income tax return for the year 1921, deducted and a debt ascertained*2159 to have become worthless and charged off in that year, the said amount of $105,575.15, and reported a loss for that year in the amount of $7,798.71.

From 1907 to 1925 the petitioner had business transactions in association with one C. J. Berry. From time to time Berry advanced money for the furtherance of their joint ventures and charged the petitioner with his proper proporation thereof, together with interest at the rate of 6 per cent. In December, 1921, the petitioner owed Berry about $63,000 on account of said advances. At that time he gave Berry his promissory note for $20,000, due four months later, covering principal items in the amount of $4,244.34 and accrued interest in the amount of $15,755.66. The petitioner paid said note in 1922, and deducted the amount of said interest in computing his net income for that year. The respondent, upon audit of the return, allowed $891.90 of the deduction claimed and disallowed the remainder thereof.

The petitioner during the years 1921, 1922, and 1923 kept his accounts and made his returns of income of the basis of cash receipts and disbursements. In his income tax return for 1923 he deducted, as net losses for the years 1921*2160 and 1922, the amounts of $12,644.51 and $8,772.69, respectively. The respondent did not allow any *221 deduction on account of said alleged net loss for 1621 and allowed only $741.85 as a loss for 1922.

OPINION.

MARQUETTE: This proceeding involves the petitioner's tax liability for the year 1923 but, in order correctly to determine that liability we must also inquire into certain phases of the petitioner's gross income and deductions for the years 1921 and 1922, for the reason that he claims that he sustained in each of those years a "net loss" within the meaning of section 204 of the Revenue Act of 1621, which should be deducted from his net income for 1923, thus reducing the amount of net income for 1923 subject to tax.

The petitioner in his amended return for 1921, which is the only return for that year that has been brought to our attention, reported a net loss of $7,798.71. In his return for 1923 he deducted from net income the amount of $12,644.51 as a "net loss" sustained in 1921. How he arrived at the latter amount we are not advised. However, in computing his claimed "net loss" for 1921, whether it be $7,798.71 or $12,644.51, he deducted, as a debt ascertained*2161 to have become worthless and charged off in that year, $105,575.15, representing the amount of Weissbaum & Company's notes which he took up with his own notes, as set forth in the findings of fact. The position of the respondent is: (1) That the petitioner is not entitled to any deduction either in 1921, when he took up the Weissbaum notes he had guaranteed, or in 1922, when he paid his own notes; and (2) that even if he is entitled to a deduction in 1921 or 1922 on account of the Weissbaum notes, any loss for either of those years, in so far as it is due to said deduction, is not a "net loss" within the meaning of section 204 of the Revenue Act of 1921, because the Weissbaum transaction was not in connection with any trade or business regularly carried on by the petitioner.

It is our opinion that the first contention of the respondent is well taken, and that it is therefore unnecessary to discuss whether the Weissbaum transaction was entered into by the petitioner in connection with any trade or business regularly carried on by him. The facts are that the petitioner, in 1920 or 1921, guaranteed the notes of Weissbaum & Company at the Anglo & London Paris National Bank, in the*2162 amount of $105,575.15; that in 1921, Weissbaum & Company being unable to meet their obligations, the petitioner borrowed the amount of $105,575.15 from the Anglo & London Paris National Bank, giving his own note therefor and taking up the Weissbaum notes that he had guaranteed. He paid his own notes in 1922. The evidence also shows that the petitioner and the *222 Central National Bank, of which he was president and which had also advanced money to Weissbaum & Company, did not regard the transaction as having necessarily resulted in a loss and that they "stepped into the shoes" of Weissbaum & Company and prosecuted an action against the Robert Dollar Company, which resulted in the recovery of a large part of the amount the bank and the petitioner had advanced to, or paid for Weissbaum & Company, the petitioner's share of the amount so recovered being at least $60,000. We are unable to perceive how the petitioner could have a worthless debt against Weissbaum & Company, and at the same time as a creditor of Weissbaum & Company and subrogated to its rights against the Robert Dollar Company, have what he must have considered a good and valid claim against that company. In view*2163 of the situation it is clear that the petitioner was not entitled to any deduction in 1921 and 1922 on account of the Weissbaum notes, and it follows that he did not have a "net loss" in 1921.

The respondent has determined that the petitioner sustained a "net loss" for 1922 in the amount of $741.85, which he has deducted in computing the petitioner's taxable net income for 1923. The petitioner contends, however, that the respondent erred in including in his net income for 1922 the amount of $1,250 credited on his stock subscription by the Central Savings Banks as described in the findings of fact, and in allowing as a deduction only $891.90 of interest payment amounting to $15,755.66 made by him to C. J. Berry in 1922.

The question raised with respect to the transfer from surplus to capital stock account by the Central Savings Bank is also presented with respect to the petitioner's income for 1923, and what we say in regard to this issue as to 1922 will also apply to the latter year. The facts are that the petitioner and the other stockholders of the Central Savings Bank had subscribed for their stock many years prior to 1916. No payments had been made by any of the stockholders*2164 on their stock subsequent to the year 1916, and on June 7, 1922, the capital stock outstanding was only 60 per cent paid up. On that date the board of directors, by resolution duly adopted, authorized and directed the cashier to charge the surplus account the amount of $100,000 and to credit same to the capital stock account. In the year 1923 the amount of $100,000 was transferred from surplus account to the capital stock account in the same manner. The petitioner was the owner of 125 shares of the capital stock of the Central Savings Bank, and the effect of each one of these transfers was to reduce the amount of his unpaid subscription in the amount of $10 per share, or $1,250. The question presented is whether the petitioner received taxable income as the result of these transfers from surplus to capital stock account. This identical question *223 was decided by the District Court for the Northern District of California in . The Court, in holding that transfers from surplus to capital account, made under circumstances in all essential respects the same as those found herein, did not result in income to the stockholders, *2165 said:

What, then, was the effect of the resolution debiting the profit and loss account with $193,240, and crediting the capital account with the same amount, so that the capital stock account should equal the par value of the stock issued? In determining this question the court will look through the form of the corporate transaction to the substance. . So viewed, the transaction now before me appears to be one which does not give rise to taxable income. It complies with each of the three tests commonly applied by the Supreme Court in dealing with nontaxable stock dividends. , L.R.A. 1918 D. 254; ; .

The stockholders have the same value before and after the transfer of the authorized amount from the profit and loss account to the capital stock account. The proportional interest of each stockholder remains the same. If the stockholders*2166 had surrendered 20 per cent. of their stock and received a 25 per cent, stock dividend, the transaction would clearly have had this effect, and would have been a stock dividend without question. The situation is in its effect the same, where there was no surrender of old shares, no issue of additional shares. ; , L.R.A. 1918 D. 254. The fact that the original shares evidenced the increase in the capital stock account created by the transfer from the surplus accumulated by the corporation is immaterial. The original investment of the stockholder and its accumulations still remain the property of the company and subject to the hazards of the business. He holds the same proportion of that property, but has received nothing for his individual use. The incidental extinction of the contingent and, in view of the existing surplus, remote liability to pay $20 a share in the event to formal call, cannot be regarded as an individual gain subject to tax. *2167 , S.Ct. 540, .

The stockholder has received no present tangible gain by reason of the increase of the capital stock account, but has in fact suffered a postponement of realization of profit. The portion of the accumulated surplus transferred to the capital stock account is no longer available for distribution to the stockholders. It is retained for corporate purposes. .

We agree with both the reasoning and conclusion of the Court in , and accordingly hold that the petitioner did not realize any income in 1922 or 1923 as a result of the transfers from surplus to capital stock account made by the Central Savings Bank.

The only other question presented is whether the petitioner is entitled to a further deduction for 1922 on account of interest claimed by him to have been paid in that year to one C. J. Berry. The respondent's contention is that only $891.90 of the amount claimed *224 by the petitioner was paid as interest. The*2168 evidence establishes to our satisfaction that the petitioner paid to Berry in 1922 interest in the amount of $15,755.66, and that he is entitled to a deduction in that amount for 1922. The effect of the additional deduction will be to increase the statutory "net loss" for 1922 heretofore allowed by the respondent.

Reviewed by the Board.

Judgment will be entered under Rule 50.