Laing v. Commissioner

*380 Proceeding for the redetermination of deficiency in income tax and a negligence penalty for 1924 in the respective amounts of $6,596.81 and $102.57. The errors alleged are the inclusion in gross income of the sum of $19,158.88 as interest and the assessment of a penalty for negligence in reporting income.

FINDINGS OF FACT.

In 1921 and 1922 the petitioner invested large sums of money in capital stock of the Hutchinson Lumber Company, a West Virginia corporation, hereinafter referred to as the corporation, holder of practically all of the capital stock of the Hutchinson Lumber Company, a California corporation owning and operating large timber tracts. Many of the purchases were made in order to provide the corporation with funds*2128 to meet overdue obligations and current liabilities.

The financial condition of the corporation was never good. During 1923 and 1924 the corporation made frequent demands on its stockholders for loans. Prior to the summer of 1923 the petitioner endorsed the corporation's notes to enable it to borrow funds from banks to meet operating expenses and guaranteed the purchasers of some of its preferred stock against loss. By the fall of 1923 the corporation was unable to borrow money from ordinary sources, did not expect to be able to meet its pay rolls due on October 20, 1923, was in default under a first mortgage given on all of its tangible property to secure a $2,000,000 bond issue, and was threatened with receivership proceedings.

During the summer and fall of 1923 the stockholders and directors of the corporation held several meetings for the purpose of formulating a plan to raise money for the corporation and prevent it from going into the hands of a receiver. These meetings resulted in a decision to float a bond issue of $1,000,000, the bonds to bear *381 8 per cent interest, sell for 90 per cent of their par value, and be secured by a second mortgage on the corporation's*2129 property. The financial standing of the corporation at that time was such that the bonds could not be sold to other than stockholders of the corporation.

On November 3, 1923, the petitioner and the corporation executed an agreement in which petitioner agreed to subscribe or obtain subscriptions for $600,000, par value, of the bonds, and was appointed the proxy, agent and attorney in fact of the corporation for a period of five years. The agreement also provided that the petitioner vote the stock of the corporation in such a way as to have himself elected its president for five years, with full power to manage and control its affairs. The petitioner was president of the corporation throughout the taxable year.

On November 1, 1923, November 7, 1923, December 11, 1923, February 21, 1924, and February 25, 1924, petitioner paid the respective sums of $63,000, $55,000, $40,000, $10,000, and $23,900, a total of $281,900, to the corporation on his bond subscription. The bonds were not issued by the corporation until about November, 1924. The corporation was then without funds to pay petitioner the interest, amounting to $19,158.88, which had accrued on his subscription payments, *2130 and requested petitioner to accept its second mortgage bonds therefor. The petitioner agreed to accept the bonds for the interest due him, and after paying the sum of $441.18 to balance the subscription account, the corporation delivered to him its bonds of a par value of $335,000. The bonds delivered to petitioner for the accrued interest had no market value in 1924.

Foreclosure proceedings were brought in August, 1926, under the mortgage securing the bonds. Thereafter the petitioner and other stockholders organized a Nevada corporation to take over the corporation's business. The stock which petitioner acquired of the new corporation for his stock and bonds of the old corporation was sold in 1928 at a big loss.

OPINION.

ARUNDELL: This proceeding was submitted for decision without oral argument or briefs. Respondent seems to have included the item of $19,158.88 in petitioner's gross income on the theory that it represented interest constructively received in the taxable year or else that the bonds received in payment constituted income in that amount. On either theory we think petitioner should prevail.

In November, 1924, when bonds of a par value of $335,000 were*2131 issued and delivered to petitioner covering his subscription, the corporation was without funds to pay him the amount of interest *382 which may have been due and requested that he accept its second mortgage bonds in settlement of such indebtedness. Notwithstanding the fact that the bonds lacked value, he agreed to accept them. We find in this situation no basis for saying that petitioner has received taxable income.

The respondent has imposed a negligence penalty in the amount of $102.57. The petitioner has offered evidence as to only the item entering into the determination of the deficiency found against him and no direct evidence covering the matter of the penalty. Under the circumstances we have no cause but to affirm the respondent on this issue.

Decision will be entered under Rule 50.