Cahn v. Commissioner , 41 T.C. 858 ( 1964 )

Sammy Cahn, Petitioner, v. Commissioner of Internal Revenue, Respondent; Gloria Cahn, Petitioner, v. Commissioner of Internal Revenue, Respondent

Cahn v. Commissioner

Dockets Nos. 84038, 84039

United States Tax Court

41 T.C. 858; 1964 U.S. Tax Ct. LEXIS 132;

March 19, 1964, Filed

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Decisions will be entered for the respondent.

T paid $ 14,128.10 to CFC purportedly as interest with respect to an alleged loan of $ 141,812.84. Held, no such loan was in fact made to T and the payment was not deductible as "interest paid * * * on indebtedness." Sec. 163(a), I.R.C. 1954.

Edward R. McHale, for the petitioners.

Douglas W. Argue, for the respondent.

Raum, Judge.

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RAUM

The Commissioner determined a deficiency in each petitioner's 1957 income tax in the amount of $ 4,702.22. At issue is whether the Commissioner erred in disallowing as a deduction, under section 163(a), I.R.C. 1954, an amount paid allegedly as "interest" on funds purportedly borrowed from Corporate Finance Corp. allegedly to purchase securities.

FINDINGS OF FACT

The facts stipulated by the parties and exhibits introduced in evidence are incorporated herein by this reference.

The petitioners, husband and wife residing in southern California, filed their separate Federal income tax returns for 1957, on the cash basis, with the district director of internal revenue in Los Angeles, Calif. The income and deductions reported related primarily, if not entirely, to the husband's activities, but the returns, based on California community property law, were substantially identical. The husband will hereinafter be referred to as petitioner.

Petitioner is a song composer and lyric writer. In their separate 1957 returns he and his wife each reported combined professional income of $ 152,079.19 and net income from other sources totaling $ 1,705.86. On each of the returns one of the components of the deduction claimed for "interest" paid was an amount of $ 14,128.10, one-half of which was deducted on each of the separate returns as "interest" paid to Corporate Finance Corp. of Boston, Mass. It is the Commissioner's disallowance of that deduction which is the sole issue in this case.

M. Eli Livingstone, hereinafter referred to as Livingstone, is a security dealer in Boston, Mass., doing business in the form of a sole proprietorship under the name of Livingstone & Co.; he also conducts his business activities through a wholly owned corporation, Livingstone Securities Corp.

Corporate Finance Corp., hereinafter referred to as CFC, a Massachusetts corporation incorporated in November 1956 with a capital contribution of $ 1,000, was organized for the purpose of doing business as a finance company. No further capital contributions have been made. Its only offices were in the law offices of its president and treasurer, Harry N. Cushing, who was one of the 10 initial shareholders; the remaining 9 shareholders were relatives, clients, and friends of Cushing. The directors, in addition to Cushing, were his son Malcolm and his wife Jeannette.

Cushing is a lawyer; he is not an investment banker, nor has he ever dealt in Government securities. He is a longtime friend and former law associate of Livingstone. Cushing at various times has also been the principal officer of seven other "finance" companies similar to CFC, all incorporated in Massachusetts. All were organized and operated like CFC; these eight companies received substantially all, if not all, of their business "on reference" from Livingstone. Their principal offices were the law offices of Cushing at 70 State Street, Boston. These law offices consisted of three rooms and a waiting room; one of the rooms was occupied by another lawyer on a space-sharing arrangement. Although Cushing had a secretary, all correspondence and instructions of CFC relating to its "clients" were dictated and typed at Livingstone's office, where a supply of CFC stationery was kept for this purpose. The files and records of CFC as well as of the other seven corporations were kept in Cushing's office in a single four-drawer cabinet, under the names of the "clients" of the various corporations and not under the corporate names. In addition to having Cushing as their principal officer, the corporations also had a salaried part-time clerk, either a son or daughter of Cushing. The clerk rendered services only at stockholders' and directors' meetings which were held two or three times a year and lasted about one-half hour each time.

The business of CFC was purportedly the making of loans to persons in high-income-tax brackets. A substantial part of the "interest" received was paid to Livingstone as a "finder's fee." Such "interest" was CFC's principal income item, and the "finder's fees" paid to Livingstone its principal item of expense. Livingstone was neither a shareholder nor a director of CFC. CFC never asked for nor received a credit report on any of the persons to whom it purportedly lent money.

CFC listed its assets and liabilities as of December 31, 1956 and 1957, as follows:

ASSETS	Dec. 31, 1956	Dec. 31, 1957
Cash		$ 196,369.91
Accounts receivable, customers		1,423,744.98
Accounts receivable, others	$ 1,000.00
Notes receivable, customers		47,479,833.70
Prepaid insurance, interest, taxes		60.84
Total assets	1,000.00	49,100,009.43
LIABILITIES
Accounts payable		385,599.39
Notes and acceptances payable		13,000.00
Deferred interest		1,948,134.07
Accrued taxes		7,623.25
Bonds -- borrowed		46,732,805.96
Capital stock without par value (number of
shares, 200)	1,000.00	1,000.00
Surplus		11,846.76
Total liabilities	1,000.00	49,100,009.43

Edward Traubner is the president and chief executive officer of Edward Traubner & Co., Inc., of Beverly Hills, Calif., a management firm. Its clients are prominent in the entertainment field; their incomes vary from approximately $ 75,000 to $ 400,000 or $ 500,000 per year. Traubner has known petitioner for approximately 34 years and has managed petitioner's business affairs for approximately 26 years. Traubner's company, as a service to its clients, keeps books of account, prepares monthly statements, files tax returns, invests money for its clients and manages their investments, which are primarily in stocks, bonds, and real estate, and helps them with their budgets. The company performed all of these various services for petitioner. It has prepared petitioner's income tax returns since 1944 or 1945 and prepared his return for the taxable year 1957.

Petitioner has complete confidence in Traubner and follows his advice with respect to financial matters implicitly. He has, on Traubner's advice, borrowed substantial sums of money with which to enter into various business ventures or to make other investments. Petitioner has given Traubner a general power of attorney which Traubner has exercised in petitioner's behalf. Traubner has also signed checks for petitioner.

On two occasions prior to 1957, in 1953 and in 1944 or 1945, petitioner, upon the advice of Traubner, purchased U.S. Government securities on credit. In the transaction which took place in 1944 or 1945, notes were purchased in the face amount of $ 100,000; petitioner borrowed 95 percent of the purchase price of the notes from the Cleveland Trust Co., depositing the notes as security for the loan and paid the other 5 percent of the purchase price himself. In 1953, Traubner, in behalf of petitioner, entered into a transaction involving the purported purchase of Federal land bank notes. All of the funds necessary to purchase the notes were borrowed from the Gibraltar Financial Corp. In a statutory notice of deficiency dated February 5, 1959, the Commissioner disallowed claimed interest deductions in the years 1953, 1954, and 1955 in connection with this transaction; the controversy was disposed of pursuant to stipulation of the parties.

Subsequent to 1957, Traubner entered into transactions in behalf of his clients whereby he purchased bonds through a broker and borrowed the requisite funds from banks, depositing the bonds as security; in all of these transactions he has never borrowed on any other basis except 95 percent. The only such transactions in which he has "borrowed" 100 percent of the purchase price were those involving Livingstone.

Traubner first became acquainted with Livingstone in either 1956 or 1957 in connection with Livingstone's inquiry into the progress of the controversy between some of Traubner's clients, including petitioner, and the Government involving the disallowance of deductions for interest purportedly paid to Gibraltar Financial Corp.

In the fall of 1957 Livingstone proposed to Traubner that he enter into a transaction in behalf of certain of his clients whereby they would "purchase" Treasury notes and "borrow" all of the funds necessary to effectuate this purchase from Livingstone. Traubner professed not to be interested in this proposal; he explained to Livingstone that he would not be interested unless there was "some form of economic gain" in the transaction. Traubner felt that one of the reasons a tax deduction was being disallowed by the Internal Revenue Service for interest paid on funds "borrowed" to purchase Treasury bonds or notes was that there was no "economic gain" in the transaction. When Livingstone inquired of Traubner as to the type of deal that would appeal to him, Traubner asked Livingstone if stocks and corporate securities could be purchased on the same basis as Livingstone's offer of the Treasury notes; namely, the borrowing of 100 percent of the total purchase price of the stocks and corporate securities. Livingstone replied that he would work out some kind of arrangement with Traubner if Treasury notes were included in the agreement. Subsequently, Livingstone suggested that for each purchase of Treasury notes in the face amount of $ 125,000, Traubner's clients could purchase corporate securities in the amount of $ 25,000 and that they could "borrow" 100 percent of the purchase price of both the corporate securities and the Treasury notes.

Livingstone and Traubner agreed that the corporate securities in the amount of $ 25,000 to be purchased with respect to each unit of Treasury notes in the face amount of $ 125,000 would be selected by Traubner and would be in the proportion of $ 15,000 of corporate common stock to $ 10,000 of corporate convertible debentures.

It was Traubner's understanding of his agreement with Livingstone that the corporate securities purchased by his clients, including petitioner, would be registered in their respective names.

As a result of the discussions and negotiations with Livingstone, Traubner, in behalf of 15 clients, including petitioner, entered into similar arrangements with Livingstone involving the alleged purchase, with 100 percent "financing," of Treasury notes and corporate securities in the aggregate amount of about $ 2,500,000. Petitioner, in respect of this agreement, relied upon the advice and recommendation of Traubner. The aggregate amount allegedly loaned to finance the alleged purchase of the Treasury notes and corporate securities was approximately $ 2,500,000, the entire purchase price.

All of Traubner's clients executed promissory notes payable to CFC and purportedly borrowed the requisite funds from it. Traubner did not check into the financial solvency of CFC. At Traubner's request, petitioner signed a nonnegotiable note dated November 27, 1957, in favor of CFC. Petitioner did not inquire about the interest rate or his personal liability on this note, did not read the terms of the note, and was not aware that according to the terms of the note, he was undertaking an obligation to repay an alleged loan of $ 141,812.84. Neither Traubner nor petitioner met or dealt in person with any officer or employee of CFC. The note provided in part as follows:

November 27, 1957

$ 141,812.84

On May 1, 1962, I promise to pay to the Corporate Finance Corporation, 70 State Street, Boston, Massachusetts (hereinafter referred to as the obligee) the sum of --

One Hundred Forty One Thousand Eight Hundred Twelve and 84/100 Dollars

together with interest at the rate of 4 1/2% per annum, subject to the following rights and conditions, having deposited with the said obligee the following securities as collateral --

$ 125,000	U.S. Treasury 1 1/2% Notes due April 1, 1962.
$ 5,000	Niagara Mohawk Power Corp. Cv. Deb. 4 5/8% of 2/1/72
$ 5,000	Consolidated Edison Co. of New York Inc. Cv. Deb. 4 1/2% of 2/15/72
100	Shares General Motors Corporation
100	Shares Standard Oil Company (New Jersey)
11	Shares International Business Machines Co.
50	Shares General Electric Company

The total interest charge is to be $ 28,256.20, of which $ 14,128.10 is paid herewith and the income accruing on the collateral deposited is to be applied in payment of the balance due. Any excess or deficiency is to be adjusted upon liquidation of the loan.

The undersigned gives to the obligee a lien against the securities pledged for the amount of the obligation set forth herein and gives to the obligee the right to hypothecate and use the securities pledged for any purpose while so pledged. Said right is not to be inconsistent in any manner with the ownership by the undersigned of the said collateral, and with the right to the undersigned to obtain the return of the collateral at any time upon tender of payment of the amount due hereunder.

Livingstone and Traubner orally agreed that Traubner could, at any time, pay off the loan or any part thereof without any penalty and obtain delivery of the securities for which payment on the loan was made, and that interest actually charged would be calculated only to the date of the payment on the loan and adjustments or reductions would accordingly be made.

To insure Traubner's clients of obtaining the ultimate appreciation in the Treasury notes, namely, the difference between the alleged purchase price of the Treasury notes in 1957 at a discount and their face value at maturity in 1962, Livingstone pledged certain negotiable bonds and assigned a nonnegotiable promissory note due from a third party. Thus, at approximately the time petitioner and Traubner's other clients entered into their respective agreements with Livingstone, the latter delivered to Traubner in pledge in behalf of all of the clients negotiable bonds having a value of approximately $ 100,000 at the time of delivery. Also, on January 3, 1958, Livingstone assigned to Traubner the nonnegotiable promissory note of John O. Snyder, Jr., in the amount of $ 100,000 payable to Livingstone & Co. The note was dated July 17, 1957, and bore a maturity date of July 17, 1962. Snyder's attorney did not object to this assignment.

The individual steps involved in petitioner's purported purchase of the Treasury notes were as follows:

On November 21, 1957, petitioner purportedly purchased $ 125,000 principal amount of U.S. Treasury 1 1/2 percent notes due April 1, 1962, from C. F. Childs & Co., Inc., hereinafter referred to as Childs, a securities dealer in New York. The purchase was at 92 20/32 plus accrued interest of $ 293.61, resulting in a total purchase price of $ 116,074.86. A confirmation slip from Childs dated November 21, 1957, bore a delivery date and a payment date of November 27, 1957.

Petitioner, by letter dated November 22, 1957, instructed Childs to deliver the Treasury notes to CFC against payment of $ 116,074.86; at the bottom of the letter there was the notation: "Delivery -- Nov. 27, 1957."

Petitioner, also, by letter dated November 22, 1957, instructed CFC to receive the Treasury notes against payment to Childs of $ 116,074.86; at the bottom of the letter there was the notation: "Delivery -- Nov. 27, 1957."

On November 21, 1957, R. W. Pressprich & Co., hereinafter referred to as Pressprich, a securities dealer in New York, issued a confirmation to CFC confirming the purchase of the U.S. Treasury 1 1/2 percent notes from that corporation at 92 35/64 plus accrued interest in the amount of $ 293.61, resulting in a total purchase price of $ 115,977.20. The confirmation bore a settlement date of November 27, 1957.

CFC, by letter of November 22, 1957, instructed Childs to deliver the U.S. Treasury 1 1/2 percent notes to Pressprich against payment of $ 115,977.20. The letter stated that $ 97.66 (the difference between the alleged purchase price paid by petitioner and the selling price to Pressprich) was being forwarded to Childs' Boston office.

CFC, by letter dated November 22, 1957, instructed Pressprich to receive the U.S. Treasury 1 1/2 percent notes against payment to Childs in the amount of $ 115,977.20. The letter bore the notation: "Del: Nov. 27, 1957."

All correspondence by petitioner and CFC in respect of the Treasury notes transaction was prepared by Livingstone or his organization.

The identical Treasury notes purportedly purchased by petitioner from Childs were the ones purportedly sold by CFC to Pressprich. It does not appear that there was one moment in time when either petitioner or CFC had any control over the notes. In substance, the notes were transferred directly from Childs to Pressprich, the true purchaser thereof, but the transaction was carried out in such manner as to give the appearance of an intermediate sale of the notes to petitioner and thus to furnish the basis for an alleged loan by CFC to finance such alleged purchase by petitioner. In fact there was no such purchase of notes by petitioner and there was no such loan by CFC in respect thereto. The only transfer of funds was the $ 97.66 forwarded by CFC to Childs.

The individual steps involved in the purported purchase of the corporate securities were as follows:

On November 21, 1957, petitioner purchased on the New York Stock Exchange, through Merrill Lynch, Pierce, Fenner & Beane, ¹ hereinafter referred to as Merrill Lynch, $ 5,000 Niagara Mohawk Power Corp. convertible debentures, $ 5,000 Consolidated Edison Co. of New York, Inc., convertible debentures, 100 shares of General Motors Corp., 100 shares of Standard Oil Co (New Jersey), 11 shares of International Business Machines Co., and 50 shares of General Electric Co.; the total purchase price was $ 25,737.98. Separate confirmation slips confirming the purchase of each of the above securities were sent to petitioner and showed trade dates of November 21, 1957, and settlement dates of November 27, 1957. Petitioner had an account with Merrill Lynch prior to, during, and after 1957, and he bought and sold various securities actively through that account for a number of years. However, that account was utilized in respect of the securities mentioned in this paragraph as a step in carrying out the transaction directed by Livingstone through CFC and other means as hereinafter set forth.

Petitioner, by letter dated November 22, 1957, instructed Merrill Lynch to deliver "for [his] account" the corporate securities to CFC against payment by the latter of $ 25,737.98; at the bottom of the letter there was the notation: "Delivery -- Nov. 27, 1957."

Petitioner, also by letter dated November 22, 1957, instructed CFC to receive the corporate securities from Merrill Lynch against payment of $ 25,737.98. At the bottom of the letter was the notation: "Delivery -- Nov. 27, 1957."

In carrying out the arrangements between Traubner and Livingstone, corporate securities were similarly purchased at the same time, also through Merrill Lynch, for four other clients of Traubner. The instructions in respect thereof were substantially identical with the instructions issued in respect of petitioner's securities, and the securities thus purchased by the other four clients were in the identical corporations in substantially the same proportions as those purchased by petitioner. The aggregate purchase price of such corporate securities for all five clients, including petitioner, was $ 141,395.49. The other four clients were Norman Luboff, Paul Francis Webster, Tony Martin, and Gene DePaul.

Livingstone, on or about November 25, 1957, through Garvin, Bantel & Co., a "money broker," arranged for a loan in the amount of $ 100,000 for 90 days from the First National Bank & Trust Co. of Scranton, Pa., hereinafter referred to as the Scranton Bank. The corporate securities purchased by petitioner and these other four clients of Traubner on November 21, 1957, were used as collateral for this loan, as hereinafter set forth.

CFC, by letter dated November 26, 1957, instructed Merrill Lynch to deliver the corporate securities purchased by petitioner and these other four clients of Traubner to the Bankers Trust Co. in New York, the name of which was later changed to the Marine Midland Trust Co. (hereinafter referred to as Marine Midland) for "safekeeping for the * * * [Scranton Bank] * * * for the account of M. Eli Livingstone * * * against payment by them of [the amount of the respective purchase price for each of these five clients of Traubner]." However, CFC, by letter dated November 27, 1957, superseded its instructions contained in the letter to Merrill Lynch dated November 26, 1957, and directed Merrill Lynch to deliver the aforementioned corporate securities, including petitioner's, to the Chemical Corn Exchange Bank, hereinafter referred to as Chemical Bank, for safekeeping for the Pilgrim Trust Co. for the account of M. Eli Livingstone against payment of $ 100,000.

Livingstone, by letter dated November 27, 1957, directed the Scranton Bank to instruct Marine Midland to receive from Chemical Bank the corporate securities purchased by petitioner and the other four clients of Traubner against payment of $ 100,000.

A letter dated November 26, 1957, from CFC to Merrill Lynch provided in part the following: "Enclosed is our difference check due you in the amount of $ 41,395.49. Please deliver the stocks in 'street form.'" ²

Pursuant to Livingstone's instructions of November 27, 1957, the Scranton Bank, by letter dated November 27, 1957, authorized Marine Midland to pay $ 100,000 to Chemical Bank in exchange for the corporate securities.

On or about December 4, 1957, Merrill Lynch delivered the corporate securities, including petitioner's, to Chemical Bank.

Marine Midland, by advice dated December 4, 1957, advised the Scranton Bank that it had received the corporate securities which included the securities purchased by petitioner on November 21, 1957, and had charged the Scranton Bank's account in the amount of $ 100,000.

The short-term loan from the Scranton Bank was recorded in the journal of CFC by an entry dated December 4, 1957. The following explanation was contained in the journal:

MLPF&B received payment from Marine Midland Trust of NY, safekeeping for 1st Nat'l Bk of Scranton, Pa., Accts. of T. Martin, G. DePaul, N. Luboff, P. Webster, S. Cahn.

Loan in name of M.E.L. as Nominee 5 1/4%, collateral as follows:

$ 28,000 Niagara Mo. Pwr. 4 5/8% of 72

$ 27,000 Con. Ed. NY 4 1/2% of 72

550 Shs. Stand. Oil NJ

550 Shs. Gen'l Mtrs.

275 Shs. Gen'l Elec.

60 Shs. Int. Bus. Mach.

The Scranton Bank, by letter bearing the date December 6, 1957, advised Livingstone that it had received certain corporate securities from Chemical Bank "vs. $ 100,000." The letter further provided: "Your note executed December 4, 1957 for $ 100,000.00, to mature March 4, 1958, at 5 1/4%."

On December 9, 1957, Pressprich executed orders to sell for the account of M. Eli Livingstone the corporate securities, purchased by petitioner and the other four clients of Traubner on November 21, 1957, which had been deposited as collateral for the loan from the Scranton Bank.

Livingstone, by letter bearing the date December 9, 1957, advised the Scranton Bank to instruct Marine Midland to deliver the corporate securities, including those purchased by petitioner on November 21, 1957, to Pressprich against payment of $ 100,000, plus interest.

Livingstone, by letter bearing the date December 10, 1957, instructed Pressprich to receive the corporate securities, including the corporate securities purchased by petitioner on November 21, 1957, from Marine Midland.

The Scranton Bank, by a letter bearing the date December 11, 1957, authorized Marine Midland to deliver the corporate securities, including the corporate securities purchased by petitioner on November 21, 1957, to Pressprich against payment of $ 100,000.

Marine Midland, by "advice of credit" dated December 16, 1957, advised the Scranton Bank that its account had been credited in the amount of $ 100,437.50.

The Scranton Bank, by letter bearing the date December 17, 1957, advised Livingstone that the corporate securities had been delivered to Pressprich against payment of $ 100,437.50. The letter further stated as follows:

This amount has been distributed by us as follows:
Payment your note dated 12/4/57, due 3/4/58
Note enclosed, stamped PAID	$ 100,000.00
Interest & Service Charge, as per enclosed
receipted statement	437.50
		$ 100,437.50

On December 16, 1957, the corporate securities purchased by petitioner on November 21, 1957, were delivered, at the direction of Livingstone, to Pressprich in partial satisfaction of the sale of corporate securities by Livingstone on December 9, 1957.

All correspondence by petitioner and CFC in respect of the above corporate securities transaction was prepared by Livingstone or his organization.

The identical corporate securities involved in the purchase by petitioner through Merrill Lynch and allegedly put up as collateral by him with CFC were ultimately sold by Pressprich on December 9, 1957. Subsequent to December 16, 1957, when the securities were delivered to Pressprich, there were no corporate securities of any kind held by CFC in any manner as collateral for any loan to petitioner.

Petitioner, by check dated December 1, 1957, drawn on his commercial account, paid CFC $ 14,128.10; this amount represented the amount of "interest" as specified as "paid herewith" in petitioner's note bearing the date November 27, 1957.

Petitioners reported a deduction for "interest" in the amount of $ 14,128.10 paid to CFC in their 1957 income tax returns, each claiming one-half thereof.

Between March 31, 1958, and December 31, 1959, CFC periodically rendered an accounting to petitioner, in care of Traubner, of his interest account with CFC. This accounting commenced with the transaction of November 27, 1957, and, on that date, showed interest due, computed over the term of petitioner's loan, in the maximum amount of $ 28,256.20; against this amount CFC applied petitioner's foregoing payment in the amount of $ 14,128.10. Thereafter, CFC's statements reflected earnings on the collateral purportedly held by CFC as reductions against this maximum outstanding interest amount due over the term of the loan.

On May 20, 1958, CFC advised petitioner, in care of Traubner, that one of his five Consolidated Edison convertible debentures had been called for redemption and stated that it was purchasing that debenture from him at the market price on May 20, 1958; CFC credited petitioner's account in the amount of $ 1,193.88, the purchase price of the debenture. However, petitioner did not in fact own any such debenture at that time, and CFC did not in fact purchase any such debenture from him. Also, CFC failed to reduce the outstanding interest amount balance in petitioner's account by the amount of interest that would not be owed by petitioner because of the alleged redemption of the debenture.

CFC, by letter dated August 27, 1958, advised petitioner, in care of Traubner, that his remaining Consolidated Edison convertible debentures in the amount of $ 4,000 had been converted into 88 shares of Consolidated Edison common stock at a price of $ 45.45 per share; that the total cost of this common stock was $ 3,999.60, and that the difference of $ 0.40 was credited to his account. No such debentures were then held by CFC, and no such 88 shares were in fact received pursuant to any such conversion.

Early in 1958, Traubner received a letter addressed to one of his other clients from Standard Oil of New Jersey stating that it was sorry the client had sold his stock and hoped that sometime in the future he would again be one of the corporation's stockholders. Traubner called Livingstone and inquired whether he had sold the stock. Livingstone stated to Traubner that he had. Traubner then told Livingstone that his sale was not in keeping with their agreement and asked him to repurchase the securities and keep them in his clients' names.

Between April 10, 1958, and July 24, 1958, Traubner and Livingstone engaged in correspondence relating to the registration of the corporate securities in the names of Traubner's various clients. A letter dated April 10, 1958, from Edward Traubner & Co., addressed to Livingstone & Co. provided in part as follows:

Enclosed are the signed stock powers and [hypothecation] agreements for the following people:

Sammy Cahn

Traubner, by letter dated June 20, 1958, forwarded to Livingstone stock collateral assignments signed by petitioner in respect of each of the corporate securities purchased in his name on November 21, 1957. Livingstone & Co., by letter dated July 24, 1958, forwarded a "Hypothecation Agreement" covering the corporate securities purchased by petitioner on November 21, 1957, for signature and return. The hypothecation agreement was signed by petitioner.

Notwithstanding the matters set forth in the two preceding paragraphs, neither Livingstone nor CFC had repurchased the corporate securities in behalf of Traubner's clients at that time. Meanwhile, the corporate securities had appreciated in value, and Traubner proposed that Livingstone and CFC purchase the securities in the open market and deliver them to petitioner, who would pay an amount equal to the price therefor at the time of the original purported purchase on November 21, 1957. Traubner did not trust Livingstone to hold the securities in his clients' names. The payment for the securities by petitioner was to take the form of a reduction of his "loan" to the extent of the amount to be paid by him for such securities. Livingstone finally agreed.

The repurchase of the corporate securities was accomplished in the following manner: Livingstone and CFC directed Pressprich to purchase, as agent for Livingstone & Co. and CFC, the corporate stocks and debentures, except the $ 5,000 Niagara Mohawk Power Corp. convertible debentures, on the New York Stock Exchange on either November 11 or 12, 1958, for delivery to Traubner's clients. Pressprich issued confirmation slips dated either November 11 or 12, 1958, to Livingstone and CFC confirming the purchase of certain corporate securities at the then market price. Traubner did not know why Livingstone did not want to deliver the Niagara Mohawk debentures; however, he kept after Livingstone to deliver these also.

CFC, by letters dated November 12, 1958, requested Traubner to receive from Pressprich for the account of petitioner against payment by Traubner the following:

50	shares of General Electric	$ 3,090.99
100	shares Standard Oil Co. of New Jersey	16,090.70
100	shares General Motors Corp
88	shares Consolidated Edison Co
11	shares IBM
	Total	19,181.69

Livingstone and CFC, by letters dated November 13, 1958, instructed Pressprich to deliver the corporate securities purchased on either November 11 or 12, 1958, including those acquired for petitioner's account, to Traubner against payment.

Pressprich sent sight drafts dated either November 18 or November 19, 1958, to Traubner in respect of corporate securities purchased by it on behalf of its clients, CFC and Livingstone & Co.

On November 24, 1958, petitioner paid Edward Traubner & Co., Inc., the sum of $ 19,181.69; this amount represented petitioner's portion of the total payment to be made to Pressprich in respect of the corporate securities which that company was to deliver to Traubner at that time.

On November 25, 1958, Traubner paid the sum of $ 40,059.54 in satisfaction of the sight drafts sent by Pressprich.

As a result of his payment in the amount of $ 19,181.69, petitioner obtained corporate securities similar to those purchased by him on November 21, 1957, with the exception of the Niagara Mohawk debentures.

By letter dated November 25, 1958, Traubner directed Merrill Lynch to register the corporate securities received from Pressprich in the names of Traubner's various clients, including petitioner.

The regular periodic statement of account that CFC made to petitioner, in care of Traubner, of his interest due account for December 31, 1958, reflected, under date of November 18, 1958, an "interest credit" in the amount of $ 2,980.36, for the remaining term of the "loan," arising from petitioner's payment in the amount of $ 19,181.69 which reduced his alleged loan outstanding.

In the latter part of November 1959, petitioner, upon payment of $ 5,362.01, acquired through Hirsch & Co., a New York firm, $ 5,000 Niagara Mohawk Power Corp. debentures. The delivery of such debentures to petitioner against payment was arranged by a letter to Hirsch & Co. signed by Cushing on behalf of CFC.

Petitioner has made the following disposition of the securities acquired by him, as set forth above, in November of 1958 and November of 1959:

(a) On December 1, 1960, the five Niagara Mohawk bonds with a total face value of $ 5,000 were redeemed by Niagara Mohawk Power Corp. for $ 5,196.50 and $ 30.85 interest. Petitioner reported a capital loss of $ 165.51 on redemption.

(b) On May 12, 1961, petitioner sold the 50 shares of General Electric Corp. common stock on the New York Stock Exchange through the brokerage firm of Lehman Bros. for the net sales price of $ 3,176.76. Petitioner reported a capital gain of $ 85.77 on this sale.

(c) On September 26, 1961, petitioner sold 96 shares of Consolidated Edison common stock on the New York Stock Exchange through Merrill Lynch. Included in these 96 shares were the 88 shares delivered to him by CFC. The 88 shares were sold for a net sales price of $ 6,651.91, and petitioner reported a capital gain thereon in the amount of $ 2,372.31.

(d) On September 26, 1961, petitioner sold through Merrill Lynch on the New York Stock Exchange the 100 shares of Standard Oil of New Jersey common stock for a net sale price of $ 4,303.29, reporting a capital loss on the transaction of $ 623.65.

(e) On June 6, 1962, petitioner sold 52 shares of common stock of IBM on the New York Stock Exchange through Merrill Lynch. Due to stock splits the 11 shares of which petitioner received delivery in November 1958 had by June 6, 1962, amounted to 24.75 shares. Of said 52 shares sold, 13.75 thereof represented 13.75/24.75 of the 11 shares delivered to petitioner in 1958 and they were sold for the net sales price of $ 5,015.93. Petitioner reported a capital gain of $ 3,162.37 from said sale.

(f) As of the time of the trial herein, petitioner still held the 100 shares of General Motors delivered to him in November 1958. On the day this case was called for trial these shares had a fair market value of $ 7,125.

(g) As of the time of the trial herein petitioner still held 11 shares of IBM, which constituted a portion of the IBM shares delivered to him in November 1958. By reason of stock splits, the 11 shares now held represent 11/24.75 of the original 11 shares delivered. On the day this case was called for trial, these shares had a fair market value of $ 4,939.

Traubner, by a letter dated March 3, 1961, sent by "Certified Mail -- Return Receipt Requested," requested CFC to "sell" the Treasury 1 1/2 percent notes in the face amount of $ 125,000 for the account of petitioner which it was purportedly holding as collateral against its "loan" to petitioner. It in fact held no such collateral at that time. Traubner requested that he be furnished a confirmation of the sale. The letter was received by CFC on March 6, 1961. A confirmation slip bearing a "contract date" of March 8, 1961, sent by the Livingstone Securities Corp. to petitioner, in care of Traubner, stated that the corporation, "as agent for another" purchased U.S. Treasury 1 1/2 percent notes due to mature on April 1, 1962, for $ 124,238.07, of which $ 839.63 was accumulated interest and the remainder principal.

A confirmation slip bearing a "contract date" of March 8, 1961, sent by the Livingstone Securities Corp. to CFC, showed that the Livingstone Securities Corp., as CFC's agent, bought for its account the U.S. Treasury 1 1/2 percent notes due to mature on April 1, 1962, for $ 124.316.20, of which $ 839.63 was accrued interest, $ 78.13 was commissions, and the remainder principal.

Traubner did not know whether any Treasury notes were actually purchased or sold on or about March 8, 1961.

Livingstone refused to return the difference between the market price of the Treasury notes on November 21, 1957, and their purported purchase price on March 8, 1961.

On August 17, 1962, Traubner sold at a public pledge sale in Los Angeles, Calif., the negotiable bonds pledged by Livingstone. From this sale Traubner realized $ 122,151.84. Of this amount, Traubner applied, but did not distribute, as petitioner's portion, the sum of $ 9,003.50 against an amount of $ 10,809.24 which petitioner contended was due and owing to him by CFC and Livingstone. Livingstone does not agree that this amount is due petitioner.

At the time of the hearing of this case, Livingstone was contesting Traubner's right to have sold the negotiable bonds pledged as collateral. In an action filed by Livingstone against Traubner in the Superior Court of the State of California for the County of Los Angeles, Traubner has instituted a cross-complaint to quiet title to the promissory note of Snyder in order to apply the proceeds of that note to the remaining indebtedness Traubner contends is owing petitioner and the other clients secured by the assignment of the Snyder note.

The following is a table of the fair market value of the various securities involved in this case on the dates shown:

Closing prices
		Standard	International
Date	General	Oil of New	Business	General
	Motors	Jersey	Machines	Electric
Nov.  21, 1957	35 3/4	49 1/8	301 3/4	62 1/8
May   20, 1958	37 7/8	53 3/8	350 1/2	58 3/4
Aug.  27, 1958	43	63 7/8	373 1/2	55 7/8
Sept. 19, 1958
Nov.  12, 1958	50	60 1/4	444	70 1/4
Nov.  21, 1958	47 3/4	59	439 1/2	70 1/2
Nov.  25, 1958	47 1/8	57	431	67 3/4
Dec.  29, 1960	40 5/8	41 1/8	593 1/2	75 1/2
Mar.  8, 1961	44 3/4	44	681	68 1/4
May   18, 1961	48 1/8	46 3/8	451	66 7/8
Sept. 26, 1961	48 1/2	43 3/8	527	73 5/8
June  6, 1962			365 1/2
June  24, 1963	71 1/4		449

Closing prices
	Con. Ed.	Con. Ed.	Niagara
Date	debentures	common	Mohawk
	4 1/2/1972	stock	Power 1
			4 5/8/1972
Nov.  21, 1957	106 3/4		105 3/4
May   20, 1958	120 1/4		114 1/2
Aug.  27, 1958	114 3/4	52 1/2	111 1/2
Sept. 19, 1958		54 3/8
Nov.  12, 1958		59 1/4	119
Nov.  21, 1958			120 3/8
Nov.  25, 1958			119
Dec.  29, 1960
Mar.  8, 1961
May   18, 1961
Sept. 26, 1961		76 1/8
June  6, 1962
June  24, 1963

In January of 1959, Traubner, in behalf of several of his clients, including petitioner, entered into an agreement with Livingstone involving the purchase of Treasury notes. A dispute arose over this agreement and in January of 1960, Traubner filed suit in Massachusetts against Livingstone. The agreement was adjudged by the U.S. District Court for the District of Massachusetts to be enforceable, and petitioner and his coplaintiffs there were awarded a judgment in the amount of $ 40,663.25, plus interest and costs, for their lost profits on Livingstone's breach of contract of sale.

OPINION

The only question for decision is whether a payment by petitioner in the amount of $ 14,128.10 to Corporate Finance Corp. (CFC) by check dated December 1, 1957, was deductible under section 163(a) of the 1954 Code as "interest paid * * * on indebtedness." ³ It is petitioner's position that he obtained a loan of $ 141,812.84 from CFC and that the payment in issue was "interest" on the "indebtedness" thus created. We hold that although the transaction was indeed cast in that form there was in fact no such bona fide "indebtedness" and that the payment did not in fact represent "interest."

The statutory language "interest * * * on indebtedness" has been defined to mean "compensation for the use or forbearance of money," Deputy v. Dupont, 308 U.S. 488">308 U.S. 488, 498, or "the amount which one has contracted to pay for the use of borrowed money," Old Colony R. Co. v. United States, 284 U.S. 552">284 U.S. 552, 560. See also Autenreith v. Commissioner, 115 F.2d 856">115 F. 2d 856, 858 (C.A. 3). We are fully satisfied on this record that CFC did not make a "loan" to petitioner in the amount of $ 141,812.84; that, whatever may have been the legal relationships between petitioner and CFC, there was no "indebtedness" in any such amount running from petitioner to CFC; and that the $ 14,128.10 paid by petitioner did not represent "compensation for the use or forbearance of money."

The disallowance of the deduction is in accord with what we referred to recently in J. George Gold, 41 T.C. 419">41 T.C. 419, 427, as "an ever lengthening line of decisions reaching like results in a variety of situations comparable to the one before us." Carl Shapiro, 40 T.C. 34">40 T.C. 34;Eli D. Goodstein, 30 T.C. 1178">30 T.C. 1178, affirmed 267 F. 2d 127 (C.A. 1); Broome v. United States, 170 F. Supp. 613 (Ct. Cl.); Sonnabend v. Commissioner, 267 F. 2d 319 (C.A. 1), affirming per curiam a Memorandum Opinion of this Court; Lynch v. Commissioner, 273 F. 2d 867 (C.A. 2), affirming 31 T.C. 990">31 T.C. 990 and Leslie Julian, 31 T.C. 998">31 T.C. 998; Egbert J. Miles, 31 T.C. 1001">31 T.C. 1001; Becker v. Commissioner, 277 F. 2d 146 (C.A. 2), affirming a Memorandum Opinion of this Court; Rubin v. United States, 304 F. 2d 766 (C.A. 7); Morris R. DeWoskin, 35 T.C. 356">35 T.C. 356, appeal dismissed (C.A. 7); Perry A. Nichols, 37 T.C. 772">37 T.C. 772, affirmed 314 F. 2d 337 (C.A. 5); Empire Press, Inc., 35 T.C. 136">35 T.C. 136. Cf. Knetsch v. United States, 364 U.S. 361">364 U.S. 361; Amor F. Pierce, 37 T.C. 1039">37 T.C. 1039, affirmed 311 F. 2d 894 (C.A. 9); A. A. Helwig, 37 T.C. 1046">37 T.C. 1046; United States v. Roderick, 290 F. 2d 823 (C.A. 5); Bridges v. Commissioner, 325 F. 2d 180 (C.A. 4), affirming 39 T.C. 1064">39 T.C. 1064; MacRae v. Commissioner, 294 F. 2d 56 (C.A. 9), affirming in part and remanding in part 34 T.C. 20">34 T.C. 20, certiorari denied 368 U.S. 955">368 U.S. 955; Kaye v. Commissioner, 287 F. 2d 40 (C.A. 9) affirming per curiam 33 T.C. 511">33 T.C. 511; Weller v. Commissioner, 270 F. 2d 294 (C.A. 3), affirming 31 T.C. 33">31 T.C. 33 and W. Stuart Emmons, 31 T.C. 26">31 T.C. 26, certiorari denied 364 U.S. 908">364 U.S. 908; William R. Lovett, 37 T.C. 317">37 T.C. 317.

The principal component of the alleged "indebtedness" of $ 141,812.84 was an item of $ 116,074.86, the price for the $ 125,000 face amount of Treasury notes allegedly purchased by petitioner and put up by him as collateral with CFC. However, the record convincingly indicates that this was a sham. Notwithstanding documents that were impeccably correct in form, such as confirmation slips and letters of instruction involving presumably reputable brokerage firms and financial institutions, which gave the appearance of a purchase and pledge of $ 125,000 Treasury notes by petitioner, we are satisfied on this record that he in fact bought no such notes and never received any loan from CFC for that purpose. It does not appear that any such notes were ever under the control or dominion of petitioner or CFC for even a split second. The only exchange of funds in respect of this purported purchase was CFC's payment of $ 97.66 to Childs, the difference between petitioner's purported purchase price and the price obtained from Pressprich in a simultaneous sale. In substance, all that happened was the movement of the notes from one broker or dealer (Childs) to another (Pressprich), with an illusion that there had meanwhile been a sale of these notes to petitioner and that he had put them up with CFC as collateral to secure the loan he had obtained from CFC in order to buy the notes. This was merely documentary sleight of hand. CFC made no loan to petitioner in respect of these notes, and petitioner paid no "interest" in respect of any resulting "indebtedness."

While it is true that Traubner was successful in obtaining certain negotiable bonds from Livingstone as a "pledge" on behalf of all 15 of Traubner's clients who had entered into like transactions, this circumstance does not change the result. It simply gave those clients protection in a bucket-shop-type transaction in respect of obtaining any ultimate increase in the value of the Treasury notes at maturity as though the clients were the owners of such Treasury notes. But that pledge could not convert into reality the clients' ownership of any such nonexistent Treasury notes. After the smoke cleared away on November 27, 1957, there were no such notes owned by petitioner and deposited as collateral with CFC; on that day the Treasury notes moved directly from Childs to Pressprich, and there was no resting place on the way. Whatever contractual rights the clients may have had against CFC or Livingstone, no loans were in fact made to them to purchase any Treasury notes. ⁴ Cf. Lynch v. Commissioner, 273 F. 2d 867, 870 (C.A. 2); Rubin v. United States, 304 F. 2d 766, 770 (C.A. 7).

Nor does the otherwise nonexistent "indebtedness" relating to the purported purchase of the Treasury notes become real by reason of the simultaneous purchase of corporate securities in the amount of $ 25,737.98 which accounted for the remainder of petitioner's note to CFC. It is plain to us that the introduction of the corporate securities into the transaction was merely to provide window dressing for the Treasury notes. Moreover, in view of the relative amounts of corporate securities and Treasury notes involved, it was, to change the metaphor, an attempt to make the tail wag the dog, and a rather sickly tail at that.

It must not be forgotten that the basic question in this case is whether petitioner in fact borrowed $ 141,812.84 from CFC and paid "interest" on the resulting "indebtedness." As indicated above, it is clear that no such "indebtedness" was created in respect of the major component of the transaction, the Treasury notes. And even if the corporate securities were to be considered separately, there was no bona fide loan by CFC to petitioner. To be sure, petitioner had an account with Merrill Lynch, and had traded actively in securities through that account for a number of years. Further, corporate securities in the amount of $ 25,737.98 were actually purchased through that account in petitioner's name. But control over those securities, along with others allocable to other clients of Traubner, was in the hands of Livingstone who, through a series of maneuvers during a comparatively short period that followed such purchase, caused the securities to be sold on the market. After December 16, 1957, no such corporate securities were in fact owned by or for petitioner, nor were any such corporate securities held by CFC as collateral for any loan to petitioner. Thus, what has been described as a "financial round robin," Broome v. United States, 170 F. Supp. 613">170 F. Supp. 613 (Ct. Cl.), in respect of transactions involving simultaneous purchases and sales of Government obligations, also occurred here, except that the transaction was stretched out over a comparatively short period of time.

Regardless of whether Livingstone's actions were contrary to Traubner's understanding with Livingstone, the fact remains that no corporate securities belonging to petitioner were held thereafter by CFC in any manner as security for any loan to him. And we cannot conclude that there was any bona fide loan by CFC to petitioner. The fact that various legal rights and obligations may have been created or that Livingstone may have become liable to petitioner on some contractual basis is beside the point. Cf. Rubin v. United States, 304 F.2d 766">304 F. 2d 766, 770 (C.A. 7). Indeed, as a result of pressure by Traubner, Livingstone at a considerably later time (November 1958 and November 1959) finally made arrangements for petitioner actually to acquire an equivalent amount of corporate securities at the lower prices that prevailed in November 1957 when such securities were purchased through Merrill Lynch and purportedly put up as collateral with CFC. Petitioner has made much of the fact that he thereafter sold some of these securities, reporting either capital gain or capital loss on such sales, and that he continues to hold the remaining securities. But the point in respect of the problem before us is that the securities which he thus sold or which he now owns were acquired by him in 1958 and 1959, not in November 1957. CFC did not lend him money to buy those securities. The fact that Livingstone in 1958 and 1959 enabled petitioner to obtain an equivalent amount of corporate securities at November 1957 prices does not establish that CFC made the controverted loan of $ 141,812.84 to petitioner or a bona fide loan in any other amount. Nor is the existence of a bona fide "loan" established by the mere fact that petitioner's contractual relationship with Livingstone may have furnished the basis for some sort of potential "economic gain." The question still remains whether there was in fact a bona fide loan of $ 141,812.84 by CFC to petitioner, and we are convinced on this record that that question must be answered in the negative. The presence of a risk of gain or loss cannot make a bona fide loan out of one that exists only on paper. Certainly, the $ 14,128.10 paid by petitioner did not represent "interest" on "indebtedness."

Decisions will be entered for the respondent.

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Footnotes

• 1. The name of the firm was later changed to Merrill Lynch, Pierce, Fenner & Smith.↩

• 2. This $ 41,395.49 amount plus the $ 100,000 borrowed from the Scranton Bank was equal to the purchase price of the securities purchased through Merrill Lynch.↩

• 1. The entire issue was called at 103.93, Sept. 15, 1960.↩

• 3. By amendments to their pleadings, petitioners attempted to raise two additional alternative issues, namely, that the amount in question allocable to each of them was deductible "as a loss sustained * * * in a transaction entered into for profit," and that it was also deductible "as an ordinary and necessary expense incurred * * * for the production or collection of income." However, these additional issues were not subsequently presented to the Court at the trial, nor were they argued on brief. In the circumstances, they must be deemed to have been abandoned.↩

• 4. Petitioner has objected to a considerable amount of evidence relating to CFC which might establish the absence of any bona fide loan. While it is true that neither petitioner nor Traubner may have been aware of all the matters covered by that evidence, it was fully competent and material to show that there was in fact no such loan or "indebtedness" as the one relied upon by petitioner for his claimed deduction. Cf. Perry A. Nichols, 37 T.C. 772">37 T.C. 772, 788-789, affirmed 314 F. 2d 337, 338 (C.A. 5); MacRae v. Commissioner, 294 F.2d 56">294 F. 2d 56, 59 (C.A. 9), affirming in part and remanding in part 34 T.C. 20">34 T.C. 20, certiorari denied 368 U.S. 955">368 U.S. 955; Lynch v. Commissioner, 273 F. 2d 867, 872 (C.A. 2), affirming 31 T.C. 990">31 T.C. 990 and 31 T.C. 998">31 T.C. 998↩.