Blum v. Commissioner

*1034 This is a proceeding for the redetermination of deficiencies in income tax for 1924 as follows:

The proceedings were consolidated for hearing.

The question involved is whether the transaction in 1924, whereby the partnership of which the petitioners were members earned income, was closed in 1924, or whether the two contracts together constitute one transaction which was not closed and resulted in no gain or loss until 1925.

FINDINGS OF FACT.

The petitioners were partners of the firm of Stein, Alstrin & Company for the year 1924, and were entitled to the following proportions of the net income of said firm for that year:

Stein, Alstrin & Company was a stock and bond brokerage concern, being members of the New York and Chicago Stock Exchanges, and the New York Curb Market.

On September 23, 1924, a*1262 preliminary underwriting agreement was entered into between Stein, Alstrin & Company, as bankers, and one Sidney C. Anschell, as owner of substantially all of the capital stock of Universal Theatres Concession Company, which contract provided that the bankers would undertake an investigation of the legal, financial and physical conditions of the company and if found satisfactory would notify said Anschell to that effect and thereupon he would cause the company to be reorganized, as provided therein and would cause to be sold to said bankers 40,000 shares of Class "A" stock at $20 per share.

It was further provided in the preliminary contract that the bankers were not obligated to carry out any of the undertakings with respect to the purchase of said stock unless (1) certain attorneys mentioned therein should furnish their approving legal opinion as to the organization, titles, etc., of the company; (2) the stock were qualified for sale in the State of Illinois; and (3) the bankers *1035 satisfied themselves that they would succeed in having said shares of stock regularly listed on the Chicago Stock Exchange.

Under date of September 23, 1924, and at the same time as the*1263 aforesaid preliminary contract was executed, it was also agreed between said Stein, Alstrin & Company and said Sidney C. Anschell as follows:

SEPTEMBER 23, 1924.

Mr. SIDNEY C. ANSCHELL:

In connection with the contract between you and ourselves of even date herewith, it is understood that we will conduct and operate a trading pool or syndicate for the purpose of establishing and protecting a free and open market for the Class A shares of the new "company," mentioned in said contract.

It is further understood that you will contribute $50,000.00 toward the capital of said pool and that we will contribute such additional amounts as may be required for the proper operation and conduct of said pool, up to an additional amount of $50,000.00. You will receive fifty percent of any profits which may be earned by the operations of the pool, and you shall be chargeable with fifty percent of any loss which may be incurred in the operation of said pool.

The above capital contribution to be paid by you, shall be held by us in the account of said pool or syndicate for a period of ninety days from date of payment, and we shall have the right to retain same in said account for a further*1264 period of ninety days in case we deem same necessary.

We are to have exclusive management and control of the operations of the pool and shall determine in our own discretion at what times and in what manner payments shall be made therefrom.

Upon termination of the pool, all monies or shares of stock remaining therein shall be equally divided between you and ourselves.

STEIN, ALSTRIN & Co.,

By BENJAMIN F. STEIN.

Approved and accepted by:

SIDNEY C. ANSCHELL (Seal)

On October 7, 1924, the aforesaid preliminary agreement was consummated by two final contracts:

(1) Agreement between Sidney C. Anschell and his associates, who owned or controlled all of the capital stock of the Universal Theatres Concession Company, thereinafter referred to as the "Concession Company," and Stein, Alstrin & Company, a partnership, thereinafter referred to as "Bankers," which contract provided in part as follows:

C. It is understood that of its authorized capitalization the New Company will issue to the stockholders of the Concession Company forty thousand (40,000) shares of Class "A" Stock and forty thousand (40,000) shares of Class "B" stock, and that said stockholders will sell to*1265 the Bankers, and the Bankers will purchase from said stockholders, forty thousand (40,000) shares of Class "A" stock at Twenty ($20.00) Dollars per share, delivery of said shares and payment therefor to be made at the office of the Bankers in the *1036 City of Chicago, Illinois, on or before (at the option of the Bankers) ninety (90) days from the date hereof.

* * *

E. Notwithstanding anything hereinbefore contained, it is expressly understood and agreed that the Bankers shall not be obligated to carry out any of the undertakings herein contained with respect to the purchase of said stock of the New Company unless

1. Moses, Rosenthal & Kennedy, counsel for the Bankers, shall furnish their approving legal opinion as to the organization of the New Company, its title to its properties and assets, including trade-names, trade brands, etc., the validity and due issuance of the stock to be purchased by the Bankers hereunder and all other pertinent legal matters, and

2. The New Company shall have taken such steps that the shares of stock to be purchased by the Bankers may legally be sold under the Illinois Securities Law in at least as favorable a class as class "C" securities, *1266 and

3. The Bankers shall have satisfied themselves that they will succeed in having such shares of stock regularly listed on the Chicago Stock Exchange (the Bankers to sponsor said stock and use all reasonable efforts to have same listed), it being understood that the New Company will make and submit all necessary papers to enable such stock to be listed and will duly appoint a Registrar and Transfer Agent of its capital stock as provided by the rules of said Exchange.

(2) Agreement as follows:

Memorandum of Agreement, Made and entered into this Seventh Day of October, 1924, by and between Sidney C. Anschell of Chicago, Illinois, and Stein, Alstrin & Co., a copartnership of Chicago, Illinois.

Witnesseth:

In consideration of the execution of a contract of even date herewith between Sidney C. Anschell (and the other stockholders of the Universal Theatres Concession Company) and Stein, Alstrin & Co., the parties hereto hereby agree with each other as follows:

In order to facilitate and increase the sales from time to time upon the open market of the Class "A" shares of stock mentioned in said contract of even date herewith, and to maintain an active, free and open market*1267 for said shares, Sidney C. Anschell hereby agrees to contribute Fifty Thousand ($50,000) Dollars towards the capital of a trading account to be conducted through Stein, Alstrin & Co., by a trading group, which account shall be maintained for a period not to exceed six (6) months from the date that said Class "A" shares shall be admitted to trading on the Chicago Stock Exchange. Stein, Alstrin & Co. or its nominee shall act as manager for said trading group and said firm of Stein, Alstrin & Co. (or such other broker as may by said firm be appointed in writing) shall act as exclusive and sole broker for said group. The members of said trading group shall be Sidney C. Anschell and Stein, Alstrin & Co. (or the nominee of Stein, Alstrin & Co.).

Stein, Alstrin & Co. shall from time to time contribute such additional amounts toward the capital of said trading account as in its discretion may be required for the proper operation and conduct of said account, provided that the aggregate of such additional contributions shall not exceed the sum of Fifty Thousand ($50,000) Dollars.

Said Manager of said trading group shall have full power to use all or any part of said capital fund for*1268 the purpose of buying or selling the said Class "A" *1037 shares of stock and shall have full discretion as to the management of said account and of the times when and the prices at which to buy and sell said shares; and shall have the right to charge against said account all commissions, interest, expenses and losses, if any, incurred as a result of trading in behalf of said trading group.

Said account shall be continued in operation for such period of time as may from time to time be determined by said Manager, provided, however, that the same shall not continue longer than six months from the date said Class "A" shares shall be admitted to trading upon the Chicago Stock Exchange without the written consent of the members of said trading group.

Upon the termination of the operations of said trading group, all of the assets remaining in or belonging to said trading account, whether the same be cash or stock, shall be distributed in two equal parts among the aforesaid members of said trading group. In case of ultimate loss in said account, each member of said group shall pay one-half thereof.

Pursuant to the above two contracts, the Class "A" stock of the Universal*1269 Theatres Concession Company was qualified under the Illinois Securities Act on or about October 25, 1924, and application to list the stock on the Chicago Stock Exchange was filed on or about November 1, 1924, and hearings were had before the Stock List Committee on the 3rd day of November, 1924.

During the hearings before the Stock List Committee, inquiry was had as to what arrangements had been made to take care of the "market" for the stock or the "secondary distribution" thereof after it was listed for trading on the exchange. The exchange would not permit the listing of new stock for trading unless there was (1) a satisfactory primary distribution of the stock, and also (2) the assurance of proper "sponsorship" for the "secondary distribution" to create an active market for the stock in order to insure a "bid" and "ask." The aforesaid two requirements were ordinarily and customarily insisted upon as a prerequisite to the listing of new stock. The aforesaid syndicate or trading group contract, dated October 7, 1924, was then disclosed and explained to the committee. The committee was thereupon satisfied that the market operations would have sufficient "sponsorship" and recommended*1270 the stock for listing. Thereafter, the recommendation of the committee was approved by the Board of Governors of the Chicago Stock Exchange.

The stock was duly listed and admitted to trading on the Chicago Stock Exchange as of November 7, 1924.

Prior to this date, Stein, Alstrin & Company had allotted the 40,000 shares of stock referred to in the above contract to several hundred subscribers and the proceeds from this transaction were in the amount of $280,209.21.

The bookkeeper, without instructions from any of the partners of Stein, Alstrin & Company, entered this amount on the books, and *1038 the same was included in arriving at the net income of the partnership for the year 1924.

Stein, Alstrin & Company kept its books and made its income tax returns on the accrual basis.

On the same day that the stock of the Universal Theatres Concession Company was listed (November 7, 1924) the trading group or syndicate account commenced operations pursuant to the above syndicate contract. Stock was purchased and sold in said account from day to day during the balance of the year 1924 and thereafter during the year 1925.

The syndicate operations were carried on continuously*1271 from the inception of the account until the end of 1925, when the account was closed out and the resulting loss was charged off on the books. There was carried in said syndicate account the following shares on the dates set forth below:

Prior to the expiration of the six-month period mentioned in the syndicate agreement (May 7, 1925) the capital of the syndicate account was entirely exhausted and thereafter the partnership continued to conduct the transactions on its own account, resulting in a loss to the partnership from the operations of said account during the year 1925 in the amount of $434,173.

It was at that time and still is a customary and usual requirement of the Chicago Stock Exchange, before allowing any new stock issue to be listed, that arrangements satisfactory to it be made to insure free and open trading in the market. The purpose of such requirement is to insure a market for the sale of stock when holders desire to sell and a reasonable offering*1272 of stock when purchasers desire to acquire stock in the open market. The maintenance of such free and open trading is also required in order to foster a broad public interest in the stock. Inactive stocks (and stocks in which there is no broad public interest) are not as valuable as collateral in loans as are stocks which enjoy active trading and a broad public interest. Therefore, when listing new stocks, the stock exchange requires such arrangements as will result in creating a broad public interest and active trading in such stock.

The syndicate or trading group operations are usual and customary immediately following the listing of new issues and are commonly called the "secondary distribution." These secondary distribution operations are for the purpose of "seasoning" or stabilizing the quotations for such stocks after they have become listed.

*1039 The usual and customary accounting practice employed by bankers and brokers, when they not only underwrite or purchase new issues of stock but also participate in the syndicate operations with regard to the secondary distribution thereof, is to return the loss or profit from the entire transaction (both the original*1273 underwriting and the secondary distribution) after the syndicate operations with regard to the secondary distribution have been completed.

Stein, Alstrin & Company would not have purchased the 40,000 shares, and under the terms of the agreement of October 7, 1924, need not have purchased said stock, if the same had not been listed and admitted to trading on the Chicago Stock Exchange.

The Chicago Stock Exchange would have refused to list said stock and admit same to trading unless it was assured that proper arrangements had been made for the secondary distribution or syndicate operations in the market.

In computing the distributable income of the partnership for the year 1924, the Commissioner has included the sum of $280,209.21, being the proceeds from the original underwriting or primary distribution of the above stock issue; and, in computing the taxable net income of each of the petitioners upon which the alleged deficiencies have been determined, he has included the proportionate share of each petitioner of said proceeds derived from the original underwriting operation or primary distribution of the stock.

It was stipulated that, should the Board hold in determining*1274 the distributable income of the partnership for the year 1924 that the aforesaid proceeds derived from the primary distribution of the 40,000 shares of stock should not be included in the distributable income of the partnership for that year, then the correct partnership income for the year 1924 would be $569,982.71, and the distributable share of the respective partners therein would be their respective proportions thereof as set forth in paragraph one of the stipulation.

OPINION.

TRAMMELL: It is the contention of the petitioners that the stock transaction was not completed in 1924 so as to be taxable in that year; that the "secondary distribution" of the stock was only a part of the underwriting scheme; and that it is necessary to look to the 1924 transaction as well as the 1925 transaction in order to determine whether there is a profit. The petitioners' brief states their contention as follows:

The agreement to purchase the stock and the undertaking with respect to the "secondary distribution" thereof constituted a single transaction.

*1040 We do not understand that the Commissioner has determined a tax for the year 1924 based upon the purchase of stock alone. *1275 The fact is that the petitioners acquired the stock and sold it in 1924 and the partnership realized, according to the Commissioner's determination, $280,209.21 as profit, which it prorated to the individual partners. In 1925, in order to support the market and afford a secondary distribution of the stock, the partnership lost money. We agree that pursuant to the obligation of the partnership it was necessary for it to continue to deal in stock in 1925 for the purpose of supporting the market and afford the secondary distribution, which obligation it was necessary to assume in order to put the stock upon the stock exchange and to carry out its original obligation in connection with the underwriting. However, we see nothing in this transaction or undertaking inconsistent with the Commissioner's theory that the profit made in 1924 should be subject to tax in that year, and that any profit or loss in 1925, as the result of buying and selling stock in that year in order to bolster up the market, should be treated for tax purposes separately. If a profit was made in 1925 it should be taxed in that year and any loss sustained in that year would be deductible in computing income, if*1276 any, for that year. Even considering the underwriting agreement and the agreement with respect to the secondary distribution of the stock in order to protect the market as one transaction, in our opinion, it would be governed by the rule laid down by the Board in the case of , where we said:

It is quite true that not all amounts received constitute income; but when a taxable corporation in the course of its business of making profits receives contractual compensation for work done and material furnished, it cannot contend that a part of the amount received is not income because the taxpayer is subject to a collateral obligation, the fulfillment of which may require it to spend some of the amount.

The petitioners rely on our decision in . In that case two individuals named Kinne and Lyon, in 1919, approached the partnership of Colgate, Parker & Company with a proposition to acquire the stock of the Mercer Motors Company and sell the same through a syndicate. The partnership agreed to the arrangement on the basis of dividing the profits, one-half to the partnership and one-half*1277 to Kinne and Lyon. Thereupon, the partnership and Kinne and Lyon (purchase group) purchased 89,000 shares of Mercer Motors stock and at the same time it entered into an agreement with Kinne and Lyon to form a syndicate (selling group) to sell the stock. The partnership was to be the manager of the syndicate, with power to purchase and sell said stock at such time or times and upon such terms as the partnership should determine. *1041 The principal function of this selling group was to make secondary distribution of the stock. The purchase group, after purchasing the stock went through the form of selling it to the same individuals as the selling group and erroneously entered on their books a profit from this transaction. This so-called profit we held was not income. The question there was whether the transfer from the purchasing group to the selling group was a closed transaction resulting in gain or loss. The partnership and Kinne and Lyon were working together. When the transfer was made from the purchase group to the selling group no profit actually resulted, because it was agreed that it was merely turned over for sale and no sale to outsiders had actually occurred. *1278 It could not be determined what the profit would be until there were some actual sales. The selling group which received the stock was to sell the stock and profits to be derived from sales were to be divided. We held in that case that there was no gain or loss until the transaction was completed.

But here we have a different situation. In this case profit was actually realized in 1924. The partnership received the cash in that year from the purchase and sale of the stock. The agreement to protect the market for a reasonable time after 1924, although it may be held to be in substance and effect a part of the original agreement, does not prevent what was received as income in 1924 from being taxed as income in that year. This case is in some respects similar to the case of ; affd., . In that case two individuals sold one-half of the corporation's stock and made a collateral agreement to do other things. It was contended that no gain should be reported upon the sale of the stock until the collateral agreement had been complied with. The court rejected this theory and held that there was gain or loss*1279 on the sale of the stock, notwithstanding the fact that the sellers were obligated to do other things in the future. The court said:

They (the sellers) received and receipted for the cash payment, and the notes representing the balance of the purchase money were payable to them. The proceeds were deposited by them in bank to their own credit. The written agreement to help build a theatre in the future did not require that any particular money be used; and, if it had, it would not prevent the gain from the sale which produced the money being taxable, there being merely an investment provided for it in advance of its receipt. ; ; .

* * *

There was a completed sale of the stock by Gordon and Clemmons in 1925 resulting in gain; in nowise defeated by the collateral agreement to make future contribution to or for the use of the corporation, or by the pledge of *1042 the purchase price to secure this being done, or by the actual use of part of it in making the contribution.

*1280 The case at bar is even stronger on its facts than the Clemmons case, supra. In this case the petitioners bought and sold stock in 1924 and realized a profit therefrom. In 1925 the partnership of which the petitioners were members bought and sold stock resulting in a loss. The money received in 1924 was not deposited for the purpose of securing the carrying out of the contract to protect stock.

Even if we should hold that the two contracts involved in this case are tied up together and each mutually dependent upon the other, it does not follow that the determination of gain or loss from the purchases and sales of one contract is dependent upon the amount of gain or loss from the purchases and sales under the other contract. Even if there had been one contract and not two, which ran over from one year into the next and involved purchases and sales, the gain or loss in one year should not be postponed until the gain or loss in the subsequent year is determined. On the petitioners' theory, if gain had been realized in 1925 out of the dealings in stock to protect the market, all of the gain in 1924 should be added to the gain in 1925 and taxed in that year. We think*1281 this is inconsistent with the theory of taxation, which is based upon an annual accounting. The gains should be taxed in the year in which received. Each year is on a separate basis. This contract does not involve one single transaction even though we consider the two contracts as one. Even if it were one which involves several transactions, it would not be necessary to wait until all the transactions had been completed to determine the gain. If this were true, a person who secured a contract for a term of years to sell stock on a commission basis and agreed to pay his own expenses would have to wait until the expiration of his contract to determine his gain or loss. We think the more correct method would be to determine the gain or loss on a contract involving separate transactions computed on an annual basis.

The sales made in 1924 by the partnership were fully completed and closed in 1924. Title to the stock passed to the purchasers and payment therefor was received. The partnership was not under obligation to the purchasers to buy this stock back at any time or at any price. The partnership's participation in the syndicate formed to trade in stock, and the fact that*1282 it did trade in stock in the following year, does not prevent the gain received in a previous year from buying and selling stock being taxable in that year. It is our opinion, therefore, that the Commissioner properly determined the tax upon the 1924 gains and that those gains should not be offset by 1925 losses in dealings in stock.

Judgment will be entered under Rule 50.