Wilson v. Commissioner , 10 T.C. 251 ( 1948 )

W. T. Wilson, Petitioner, v. Commissioner of Internal Revenue, Respondent. Wilson Bros. & Co., Petitioner, v. Commissioner of Internal Revenue, Respondent

Wilson v. Commissioner

Docket Nos. 11852, 11853

United States Tax Court

10 T.C. 251; 1948 U.S. Tax Ct. LEXIS 271;

February 5, 1948, Promulgated

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Decisions will be entered under Rule 50.

1. Two brothers, sole equal shareholders of the taxpayer corporation, contributed to it cash as paid-in surplus in 1931 and orally agreed that either might make withdrawals up to $ 150,000. Each did so in succeeding years, making no notes and paying no interest. The withdrawals were carried in an account receivable by the corporation and some deposits by the brothers were later credited to it. The shareholders' withdrawals, held, on the evidence to be distributions of dividends and not loans.

2. Amounts paid by the taxpayer corporation to its two shareholding officers, held, on the evidence to be excessive as salaries and deductible as such only to a lesser amount determined.

3. The taxpayer, a trader in securities, borrowed shares from a broker to maintain a "short" position, and paid the lender fees and amounts equivalent to dividends on the shares. Such amounts, held, deductible as expense. Commissioner v. Wilson, 163 Fed. (2d) 680; certiorari denied, 332 U.S. 842">332 U.S. 842.

4. The taxpayer corporation owned two lumber schooners which it used in its lumber business in 1929 and "laid up" thereafter, incurring expense in their maintenance but deriving no income from them. In 1938 it discontinued the lumber business, and its assets thereafter consisted principally of securities. Amounts representing depreciation and maintenance expenses of the schooners, held, not deductible in computing the personal holding company surtax since the evidence fails to establish that no income was obtainable, that the schooners were held in the course of business, and that there was a reasonable expectation of profit from the property, as required by section 505 (b), Internal Revenue Code, to support such deduction in the absence of income from the property.

5. Increase in credits for dividends paid, held, proper to the extent that distributions, stipulated or held to be dividends, were made pro rata and without preference among shareholders. Sec. 27 (h), Internal Revenue Code.

George M. Naus, Esq., C. N. Whitehead, C. P. A., and A. Thomas Murphy, C. P. A., for the petitioners.

T. M. Mather, Esq., for the respondent.

Johnson, Judge.

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JOHNSON

The Commissioner determined against W. T. Wilson an income tax deficiency of $ 18,504.76 for 1939, of $ 11,158.19 for 1940, and of $ 5,644.55 for 1941, and against Wilson Bros. & Co. deficiencies in income tax, personal holding company surtax, and penalties as follows:

	Income tax		Personal holding company
			tax
Year
	Deficiency	Penalty	Deficiency	Penalty
1938	$ 432.68		$ 10,066.65	$ 2,516.66
1939	315.26		23,494.70	5,873.68
1940	298.25		32,019.46	8,004.87
1941	224.87		17,763.09
1942	484.87	$ 338.49	20,152.40	5,038.10

Petitioner Wilson charges the Commissioner with error in treating his withdrawals of funds from the corporation as dividends rather than loans; in treating portions of the amounts paid him as salary by the corporation as dividends and hence not community income; and in disallowing the deduction of amounts paid by him to brokers for the loan of securities in which he held a "short" position. The petitioner corporation charges error in the Commissioner's disallowance, as deductions, of the full amounts paid as salaries to its two shareholding officers; and in the disallowance, for personal holding company surtax purposes, of the deduction of depreciation and expenses on two unused lumber schooners. It claims further additional credits for dividends paid and the deduction of certain miscellaneous expenses, the subject of a stipulation.

FINDINGS OF FACT.

Petitioner W. T. Wilson (hereafter called petitioner), an individual residing at Los Angeles, California, filed income tax returns, prepared on the cash basis, for the years 1939, 1940, and 1941 with the collector of internal revenue for the sixth district of California. Petitioner Wilson Bros. & Co. (hereafter called the corporation), a Nevada corporation with principal office at San Francisco, California, filed income tax returns, prepared on an accrual basis, for the years 1929 to 1941, inclusive, with the collector for the same district. During the years 1938 to 1942 the corporation was a personal holding company.

1. The corporation was organized in December 1928 by petitioner and his brother, F. A. Wilson, each of whom paid $ 500 for one-half of its capital stock of $ 1,000, represented by 40 shares, and thereafter they jointly contributed to paid-in surplus $ 624,000 and two schooners. Each has since owned 20 shares. The brothers were successfully engaged as partners in the milling, shipping, and selling of lumber on the west coast of the United States. They operated logging camps and sawmills, manufacturing lumber in Washington and shipping it on the two schooners, the Oregon and the Idaho, for sale in San Francisco, Los Angeles, and San Diego. The business was begun by their grandfather and continued by their father, and they participated in it from early youth. After 1928 it was conducted by the corporation. The schooner Oregon, in which the brothers owned a 100 per cent interest, and the schooner Idaho, in which they owned a 75 per cent interest, were transferred to the corporation at a value of $ 175,000. As an additional contribution to paid-in surplus, the brothers on March 20, 1931, transferred to the corporation a bank account of $ 480,372.24, which they had received as a gift from their mother. At the time of this transfer it was orally agreed between them that either might at any time make withdrawals not exceeding $ 150,000 from the corporation and repay the amounts without interest when convenient to the drawer or necessary for the corporation's business.

In 1932 petitioner made an initial withdrawal of $ 17,717.88, and on January 1, 1939, the balance due from him, as shown on the corporation's books, was $ 75,417.88. In 1939 and 1940 he made withdrawals aggregating $ 45,000 and $ 16,000, respectively, increasing the balance shown as due from him to $ 136,417.88. In and after 1938 F. A. Wilson likewise made substantial withdrawals, $ 50,000 in 1939 and $ 11,000 in 1940. Both have made occasional payments, which were credited to their respective accounts. As of January 2, 1945, the corporation's books showed as due from them on account of withdrawals, $ 99,917.88 and $ 94,500, respectively. At all times each has been financially able to repay the amount of his withdrawal. No notes were made to evidence an indebtedness, but the debits and credits reflecting withdrawals and payments were carried on the corporation's books in an account receivable. Petitioner's accumulated earnings and profits were at the end of 1938, $ 89,420.45; at the end of 1939, $ 93,247.38; and at the end of 1940, $ 91,907.32, without adjustments for tax deficiencies determined or to be determined. Petitioner's withdrawals were not loans, but dividends.

2. With the cash contributions of petitioner and his brother the corporation purchased stocks, principally of domestic corporations. In 1938 and succeeding years its security holdings exceeded $ 800,000 in value, and it derived over 80 per cent of its income from dividends. F. A. Wilson, its president and general manager, and petitioner, its secretary and treasurer, gave attention to its investments. During the taxable years they followed market reports, made some slight changes in holdings, exercised rights, and once purchased stocks with the proceeds of some matured bonds. F. A. Wilson had charge of maintaining and repairing the two schooners, which were not in use, of finances and collections, and the preparation of tax returns. In 1940 he exerted unusual efforts in preparing for the presentation of a tax case by the corporation. He and petitioner were both active in seeking a purchaser or lessor for the schooners, and in 1939 he made an unsuccessful trip to the northwestern states in search of lumber. He was a member of the San Francisco Stock Exchange and operated a brokerage business. He also looked after his personal security portfolio, containing stocks of a value of about $ 200,000. Petitioner kept the corporation's accounts. He also engaged in a retail lumber business at Los Angeles, which he took over from the corporation in 1938 and from which he reported gross income of $ 184,000 in 1939, $ 127,000 in 1940, and $ 187,000 in 1941. He engaged a manager at $ 300 a month for this business. In 1938 the corporation ceased to deal in lumber, and its only business was the care of investments and the collection of dividends and a small amount of rent.

Prior to 1936 petitioner and his brother received no salaries from the corporation. In 1936, 1937, and 1938 each received an annual salary of $ 12,000, and in 1938 F. A. Wilson was paid a special fee of $ 6,000 for his work in connection with the tax litigation. In 1939, 1940, and 1942, each was paid an annual salary of $ 8,000 and in 1941 of $ 6,000. Petitioner and his wife each reported one-half of this salary for 1939, 1940, and 1941 as community income. A reasonable annual compensation for the services of petitioner and his brother to the corporation during the taxable years was $ 6,000 each.

3. During 1939, 1940, and 1941 petitioner was a trader in securities, and to maintain a "short" position, he borrowed certain stocks. He paid to the lender brokerage firms amounts equivalent to dividends on the stocks as follows: 1939, $ 3,900; 1940, $ 4,150; 1941, $ 4,400. In addition he paid the lenders $ 20 in 1939 and $ 339.85 in 1941 as premiums for loan of the stocks. The Commissioner disallowed the deduction of $ 3,900 in 1939, $ 4,150 in 1940, and $ 4,736 in 1941, treating these amounts as part of the cost of covering purchases.

4. The two schooners which were transferred to the corporation are wooden-hull boats of 1,800 tons dead weight, with cargo space for 1,200,000 board feet of lumber. After being operated by the corporation for a part of the year 1929, they were "laid up" because a lull in the lumber market left petitioner with large unsold stocks on hand. For some years thereafter petitioner and his brother expected to put the boats back into service, to ship lumber in them again when market conditions should improve. But in succeeding years such conditions grew worse, and the boats have never been used. They have been kept moored, however, under the care of a watchman, who cleans and paints the superstructure, and at intervals of 15 to 18 months they are placed in drydock for general overhauling, caulking and repairs. While not seaworthy since 1929, they have been maintained in such a condition that they could be made so within a period of 60 to 90 days.

In 1938 petitioner took over individually a retail branch of the corporation's business, selling pine to motion picture studios and others from the office and lumber yard which the corporation formerly used. Since that year the corporation has not dealt in lumber or derived any income from its sale. During the years 1938 to 1942 numerous efforts were made to sell or lease the boats; some offers were received, but not accepted. Being of wood, the schooners are inferior to ships having steel hulls and can not be as readily leased or sold. During the war they were not desired by the Maritime Commission because they were slow and small. For the years 1938 to 1942 the following amounts were claimed and allowed for income tax purposes as depreciation and expenses connected with them:

Year	Total	Depreciation	Expenses
1938	$ 12,459.96	$ 10,002.08	$ 2,457.88
1939	15,094.35	10,002.08	5,092.27
1940	15,028.68	10,002.08	5,026.60
1941	16,166.87	10,002.08	6,164.79
1942	12,898.05	10,002.08	2,895.97

These amounts were not allowed as deductions in the determination of the corporation's personal holding company surtax. The corporation received no rent or other compensation for the use of the boats in 1938, 1939, 1940, 1941, and 1942; the boats were not held in the course of the corporation's business in those years, and were not necessary for the conduct of that business.

OPINION.

1. Petitioner assails the determination that withdrawals of $ 47,500 (stipulated, however, to be $ 45,000) in 1939 and of $ 16,000 in 1940 were dividends paid to him by the corporation and not loans, as he contends. He stresses in support of his view the informal understanding between his brother and himself when their mother's gift of cash was contributed to paid-in surplus; the charging of the withdrawals to their personal accounts; the crediting of them to the corporation's accounts receivable; and some repayments made by each shareholder. By section 115 (a) of the Internal Revenue Code a dividend is defined to be any distribution made by a corporation to its shareholders out of earnings or profits, and by 115 (b) "every distribution is made out of earnings or profits to the extent thereof." Hence petitioner's withdrawals are to be deemed dividend distributions, as determined, unless he can affirmatively establish their character as loans, and since the corporation was wholly owned by the two withdrawers, their control invites a special scrutiny. Ben R. Meyer, 45 B. T. A. 228.

We are of opinion that the evidence indicates dividends rather than loans. While true that the absence of notes, the failure to pay interest, and the lack of a written agreement are not of themselves conclusive of this view, it is equally true that the recording of withdrawals in accounts receivable and the credits entered in such accounts are likewise inadequate to establish loans. The issue must be decided upon an examination of all the pertinent facts found, and when they are examined, the emerging picture is that of two brothers, always closely associated in business, who own and completely control a corporation to which they jointly contributed over a million dollars in cash as paid-in surplus and from which they drew money at will, making occasional returns of lesser amounts credited to their accounts. The ceiling for such withdrawals and the obligation to repay them on call, being unevidenced by written agreement or corporate resolution, could have been changed by an oral understanding between the brothers as easily and as informally as it was made. Such a vague arrangement is not determinative for tax purposes; and, as the corporation had earnings and profits in 1939 and 1940, we hold that the withdrawals were dividend distributions to the extent thereof. Ben R. Meyer, supra;James J. Gravley, 44 B. T. A. 722; Moses W. Faitoute, 38 B. T. A. 32; Roy J. Kinnear, 36 B. T. A. 153; dismissed (C. C. A., 9th Cir.), 95 Fed. (2d) 997; George P. Marshall, 32 B. T. A. 956; M. Jackson Crispin, 32 B. T. A. 151. Petitioner cites Weaver v. Commissioner (C. C. A., 9th Cir.), 58 Fed. (2d) 755, as to the contrary, but we perceive a material distinction in that the $ 100,000 which was therein contributed to a corporation by its several shareholders under an oral understanding that it would be returned, was simultaneously repaid to all in the exact amount of each one's contribution.

The Commissioner's determination that the withdrawals were dividends is sustained as to $ 45,000 in 1939 and $ 16,000 in 1940.

2. The corporation paid $ 12,000 to petitioner and $ 18,000 to F. A. Wilson in 1938 as salary and so paid to each $ 8,000 in 1939, 1940, and 1942, and $ 6,000 in 1941. Under the view that the services of each were worth no more than $ 3,000 in each year, the Commissioner disallowed to the corporation the deduction of the excess paid above that amount and treated such excess as dividends, not salary, in determining petitioner's tax for each of those years. Both determinations are assailed.

To justify the salary paid, petitioner and his brother testified that each devoted an average of 35 hours a week to business of the corporation. As the corporation ceased to deal in lumber in 1938, such services were limited to care of investments, maintenance of the schooners, and efforts to sell or lease them. There is also testimony that a search was made for a lumber supply with which to revive the corporation's lumber business, but this purpose seems hardly consonant with the transfer of its retail business to petitioner in 1938 and efforts to dispose of the schooners which had been used in that business. While the investment portfolio had a market value in excess of $ 800,000 during the years in controversy, the witnesses mentioned in general terms only "slight changes in holdings" and the purchase of stock with the proceeds of some matured bonds. They stressed the need for following market reports closely, work on income tax matters, and attention to the schooners (which, however, were not in operation or even seaworthy) and their repeated but unsuccessful efforts to sell or lease them. They also stressed that no salaries were paid them prior to 1936, but such prior years are not in controversy.

We are not persuaded that the value and extent of the brothers' services to the corporation were as great as they asserted. Petitioner was operating a lumber business of his own, from which he reported a gross annual income of from $ 127,000 to $ 187,000, and F. A. Wilson, a member of the San Francisco Stock Exchange, was operating a brokerage firm. Under such circumstances, it is not reasonable to suppose that their principal activities were connected with affairs of a personal holding company, which held only securities and "laid up" lumber boats, and their testimony confirms rather than rebuts this view. Neither could cite any steady corporate business, but referred vaguely to occasional need for attention to the boats, occasional efforts to sell or lease them, to tax work, and to "slight changes" in investments. On these facts, we deem an annual salary of $ 6,000 for each reasonable and reverse the Commissioner's determination to this extent. Cf. Wagegro Corporation, 38 B. T. A. 1225.

3. Petitioner was a trader in securities, and, having borrowed shares from a broker to maintain a "short" position, he paid the lender $ 3,900 in 1939, $ 4,150 in 1940, and $ 4,400 in 1941 as the equivalent of dividends on such shares. He also paid a premium or fee of $ 20 in 1939 and $ 339.85 in 1941. The Commissioner determined that "amounts of $ 3,900.00, $ 4,150.00 and $ 4,736.00" paid as dividends on borrowed stock were "not allowable as deductions from gross income, but are held to be a part of the cost of stock purchased to cover the short sales." Petitioner assails this determination as error, and we agree. Amounts so paid "were not incurred as an incident to either the acquisition or the sale of the property involved, but were more in the nature of carrying charges incurred during the progress of the deal," and they are deductible. Commissioner v. Wiesler (C. C. A., 6th Cir.), 161 Fed. (2d) 997; affirming 6 T. C. 1148; certiorari denied, 332 U.S. 842">332 U.S. 842; Commissioner v. Wilson (C. C. A., 9th Cir.), 163 Fed. (2d) 680; certiorari denied, 332 U.S. 842">332 U.S. 842.

4. In determining the corporation's personal holding company surtax for the years 1938-1942, the Commissioner disallowed as deductions the amounts representing depreciation and expenses connected with the two schooners, although such amounts were deducted in his determination of the corporation's income tax. The corporation assails the disallowance and respondent defends his action on the ground that the schooners were not property of the kind required by section 505 (b), Internal Revenue Code, to support the deduction. This section, defining Subchapter A net income for computation of surtax on a personal holding company, limits the deductions available under section 23 (a), relating to expenses, and section 23 (l), relating to depreciation, to an amount equal to rent or other compensation from the property affected, unless it is established to the Commissioner's satisfaction:

(1) That the rent or other compensation received was the highest obtainable, or, if none was received, that none was obtainable;

(2) That the property was held in the course of a business carried on bona fide for profit; and

(3) Either that there was reasonable expectation that the operation of the property would result in a profit, or that the property was necessary to the conduct of the business.

Since the corporation derived no income whatever from the boats, it is entitled to the deductions claimed only if it proves that the three conditions are fulfilled in respect of them.

In our opinion, fulfillment of none of the conditions has been affirmatively shown. The boats were "laid up" in 1929, and while plausible that they could not have been leased during the depression, we can not believe that leasing or income-producing operation was impossible in 1938 and succeeding years, especially after the outbreak of war. Petitioner and his brother admitted that offers to buy or lease them were received. They failed to give any details or explain the business justification for refusing all of them, and, since the boats could have been made seaworthy, we can not on this record make the essential finding that some income could not have been obtained from them. As the corporation ceased to deal in lumber in 1938 and the boats had not been used since 1929, it is manifest that they were not held in the course of the corporation's business, and that they were not necessary to the conduct of its business. Petitioner's professed wish to lease or sell them, indeed, is so indicative. Conceivably, there could have been a "reasonable expectation that the operation of the property would result in a profit," but petitioner's testimony, directed to establishing that the boats could not be used, leased, or sold advantageously, even though not convincing, obviously does not support an affirmative finding that they could have been.

In his brief petitioner's counsel urges that section 505 (b) be interpreted according to its spirit, rather than its letter; he quotes excerpts from a report of the Congressional Joint Committee on Tax Evasion and Avoidance (75th Cong., 1st sess., House Document No. 337) and from other official statements to show that its provisions were intended to deny deductions to a corporation formed by a wealthy taxpayer with no other purpose than to hold his securities and pleasure yachts and enjoy deductions to which the taxpayer individually would not be entitled. Petitioner's corporation, it is argued, was organized for a genuine business purpose and does fall within the class envisaged by the statute. We agree that in its genesis and original operation petitioner corporation bore no resemblance to the personal holding company which the legislation was designed to cover. But, during that period it actively engaged in the lumber business, and, we may presume, derived more than 20 per cent of its income from that business, so that it did not then qualify as a personal holding company and was not subject to the taxing provisions here considered. But its status changed in 1938; it discontinued the lumber business; its assets consisted almost entirely of securities, having a market value in excess of $ 800,000, and two lumber boats; it became in effect for its two stockholder brothers "the incorporated pocketbook," which Congress had in mind in enacting section 505 (b). It is not material that the boats were not yachts. The significant fact is that, if the brothers had owned them directly, they would not have been entitled to deductions for depreciation and maintenance expense, because the boats were not used in a business or transaction for profit. And in our opinion it was the intention of Congress in enacting 505 (b) that the corporation holding them be in no more favorable a position for claiming such deductions. Accordingly, we sustain the Commissioner's disallowance.

5. The corporation charges error in that the Commissioner failed to allow credit for dividends paid "beyond $ 12,000" in 1941, $ 23,500 in 1942 and a dividend carry-over of $ 21,414.71 from 1937. Just what additional credits are sought is not clear from the assignment of error, but in a stipulation the Commissioner "concedes" that the corporation "paid a cash dividend of $ 12,000.00 in December 1940, at the rate of $ 6,000.00 each to F. A. Wilson and W. T. Wilson." On brief, petitioner contends that any parts of the salaries which may be disallowed should likewise be treated as dividends paid, while respondent, adverting to shareholders' withdrawals, which he contends and which we hold to have been dividend distributions, argues that, since different amounts were distributed to each shareholder, no additional credit should be given the corporation because the distribution was not pro rata, as required to support a credit by section 27 (h), Internal Revenue Code, and he stresses that this section has been strictly construed. Safety Convoy Co. v. Thomas (C. C. A., 5th Cir.), 139 Fed. (2d) 219. See also Black Motor Co. v. Commissioner (C. C. A., 6th Cir.), 125 Fed. (2d) 977.Obviously, the condition is not met in respect of the withdrawals and the $ 6,000 special fee paid to F. A. Wilson in 1938, and no dividends paid credit should be allowed on account of those distributions. Spring Street Realty Co. v. Commissioner (C. C. A., 3d Cir.), 123 Fed. (2d) 146, affirming a memorandum opinion entered July 21, 1941. But as the regular salaries paid and the excesses disallowed were equal and therefore proportionate to shareholdings, the amounts of the excesses should be reflected in the credits sought. The same is true of the $ 12,000 covered by stipulation.

In addition the parties have stipulated that the corporation is entitled to a number of itemized expense deductions in addition to those allowed by the Commissioner, and these should be reflected in the computation of tax.

Decisions will be entered under Rule 50.