Ciro of Bond Street, Inc. v. Commissioner

Ciro of Bond Street, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent Ciro of Bond Street, Inc. v. Commissioner Docket No. 15420 United States Tax Court 11 T.C. 188; 1948 U.S. Tax Ct. LEXIS 105; August 19, 1948, Promulgated *105 Decision will be entered under Rule 50. Petitioner is a New York corporation with a small capital stock and is wholly owned by a parent corporation located in London, England. Petitioner's invested capital was insufficient to enable it to get started in business. In 1939, the year of its incorporation, the parent corporation made advancements to petitioner of some $ 96,000 to enable it to get started in business. Petitioner at the time of these advancements did not execute to the parent corporation any evidence of such indebtedness, but at the end of the year it wrote letters to the parent corporation acknowledging that it was indebted for the advancements. Held, the letters were not "certificates of indebtedness" as that term is used in section 719 (a) (1) and the advancements can not be included as "borrowed invested capital" under section 719, I. R. C. Harold Manheim, Esq., for the petitioner. J. J. Madden, Esq., for the respondent. Black, Judge. BLACK *188 The Commissioner has determined a deficiency in petitioner's income tax for the year 1940 of $ 169.55, a deficiency in petitioner's declared value excess profits tax for the same year of $ 64.07, and a deficiency in *189 petitioner's excess profits tax for the same year of $ 1,120.92. He has also determined a deficiency in petitioner's excess profits tax for the year 1941 of $ 2,006.46. The petitioner contests only the deficiencies in excess profits tax and as to that determination assigns error as follows: In computing invested capital, the Commissioner failed to include any part of the amount due from taxpayer during the taxable year to Ciro Pearls, Ltd., London as a part of its average borrowed capital. The Commissioner, in making the adjustment against which the petitioner complains in its assignment of error, explained it as follows in his deficiency notice: It is held that in computing equity invested capital, no part of the amount allegedly due Ciro Pearls, Ltd., *107 London, England, should be included as a part of the average borrowed capital. FINDINGS OF FACT. Most of the facts have been stipulated and the stipulation of facts is incorporated herein by reference. The petitioner is a New York corporation, organized on April 24, 1939. It is engaged in the business of selling costume jewelry and pearls. Its returns for the taxable years involved herein were filed with the collector of internal revenue third district of New York. Petitioner is wholly owned by Ciro Pearls, Ltd., a British corporation which has its principal office at London, England. Petitioner was organized in 1939 with a paid-in capital of $ 10,000. The paid-in capital of the petitioner was insufficient to take care of its capital needs. During the taxable years in question petitioner required for its business capital investments of sums substantially in excess of $ 100,000 for the following purposes, among others: For the alteration of its business premises at 711 Fifth Avenue and for furnishing the same, in excess of $ 20,000, and for merchandise inventory between $ 75,000 and $ 100,000. During the year 1939 Ciro Pearls, Ltd., advanced to petitioner the sums of $ 67,657.75*108 and # 6,966.6.6. This sterling amount was converted by petitioner into dollars on its books at the rates of exchange prevailing when the advances in question were made, making a total advance in terms of dollars amounting to $ 96,201.10. Petitioner at the time of the advances did not issue in connection therewith any evidence of indebtedness. The amount of this indebtedness was set forth by petitioner in the amount of $ 96,201.10 in its annual statements for the two taxable years rendered by it to Ciro Pearls, Inc., which were retained by the latter without objection. Exhibits "1A" and "2B" attached to the stipulation of facts are letters written by petitioner to Ciro Pearls, Ltd., dated December 30, 1939, certifying for *190 the purpose of audit that at such time there was owing to Ciro Pearls, Ltd., certain sums of money. These letters were as follows: Thirtieth December [1939] Ciro Pearls Ltd., 178, Regent Street, London . . . W. 1. Dear Sirs, For the purpose of your audit we hereby certify that there is owing to you at this date from this Company the sum of 67,657.75 U. S. Dollars. No interest is payable in respect of this indebtedness, which is to be repaid when this*109 Company is in a position to do so. Yours faithfully, p. p. Ciro of Bond Street, Inc. [Signed] H. M. Penney Thirtieth December [1939] Ciro Pearls Ltd., 178, Regent Street, London . . . W. 1 Dear Sirs: For the purpose of your audit we hereby certify that there is owing to you at this date from this Company the sum of # 6,096.6.6 sterling. No Interest is payable in respect of this indebtedness, which is to be repaid when this Company is in a position to do so. Yours faithfully, p. p. Ciro of Bond Street, Inc. [Signed] H. M. Penney The moneys advanced by Ciro Pearls, Ltd., to petitioner were used exclusively for business purposes and represented a necessary part of the capital funds used in petitioner's business. OPINION. The only issue we have to decide in this proceeding is whether the petitioner is entitled, under section 719 (a) (1) of the Internal Revenue Code, 1 to include in borrowed capital sums advanced to petitioner by its parent corporation, Ciro Pearls, Ltd., of London, England. *110 Petitioner's brief lays much stress on the fact that the advancements made to petitioner by its parent corporation were made for bona fide business purposes and were fully recognized by petitioner on its books as an indebtedness which it owed its parent corporation. We have no doubts at all as to the bona fide character of the advancements in question nor that they represented an indebtedness of a sort to the parent *191 corporation, but we do not think these advancements represented "borrowed invested capital" as defined in section 719 (a) (1) of the code. The contention which petitioner makes is very similar to that which was made by the taxpayer in Pendleton & Arto, Inc., 8 T. C. 1302. In that case we pointed out the taxpayer's contentions as follows: * * * The petitioner, contending that the statute is satisfied by the situation presented, reviews many cases to demonstrate that there is indebtedness, arguing also that the money advanced to the petitioner had a business purpose, and that the transaction was bona fide. * * * We then went on to point out that these things were not enough, that the "borrowed capital" which the statute prescribed*111 must be in the form described by the statute. In discussing that particular requirement we said: * * * The statute enumerates certain forms of indebtedness as coming within its bounds. Inclusio unius est exclusio alterius. Other forms were, we think, clearly intended to be excluded. This can only fairly mean that the mere presence of operating capital obtained can not, alone, satisfy the statute, but it must be represented by established forms of debt. Mere open account was not included, and we have heretofore considered it was not intended. Flint Nortown Theatre Co., 4 T. C. 536. Economy Savings & Loan Co., 5 T. C. 543, involving certificates of deposit, does not demonstrate the arrangement here to be a certificate of indebtedness. It has no attribute of an investment security, such as issued by corporations. Regulations 112, sec. 35.719-1 (d), covering the section here involved. * * * We then decided that the advancements which the parent corporation had made to the taxpayer in that case did not represent "borrowed invested capital" within the meaning of section 719 (a) (1). Of course, the facts in the *112 instant case are somewhat different from those present in Pendleton & Arto, Inc., supra, but the controlling principle is, we think, the same. Petitioner does not contend that in the instant case there was any bond, note, bill of exchange, debenture, mortgage, or deed of trust mentioned in section 719, but it does contend that the advancements to it by the parent corporation were evidenced by "certificates of indebtedness" within the meaning of that term as used in section 719 (a) (1). Section 35.719-1 (d), Regulations 112, to which we referred in Pendleton & Arto, Inc., supra, reads as follows: The term "certificate of indebtedness" includes only instruments having the general character of investment securities issued by a corporation as distinguishable from instruments evidencing debts arising in ordinary transactions between individuals. * * * It seems clear that in the instant case the advancements made by the parent corporation to the petitioner were not evidenced by "certificates of indebtedness" within the meaning of the statute or the foregoing regulations. The only written evidence here to evidence petitioner's*113 *192 indebtedness to its parent corporation for the advances made to it were letters written for audit purposes and dated December 30, 1939, which are embodied in our findings of fact. It seems clear to us that these letters can not qualify as "certificates of indebtedness" within the meaning of the applicable statute and regulations, and we so hold. Even if the letters to which we have referred qualified as "certificates of indebtedness" in matter of form, they would still be lacking one essential quality, and that is a maturity date. The letters contain this provision: "No interest is payable in respect of this indebtedness, which is to be repaid when this Company is in a position to do so." Clearly, the above language fixes a very indefinite maturity date and does not meet the requirements of that part of Regulations 112, section 719-1 (d), which reads: * * * The name borne by the certificate is of little importance. More important attributes to be considered are whether or not there is a maturity date, the source of payment of any "interest" or "dividend" specified in the certificate (whether only out of earnings or out of capital and earnings), rights to enforce payment, *114 and other rights as compared with those of general creditors. Cf. Frankel & Smith Beauty Departments, Inc. v. Commissioner, 167 Fed. (2d) 94, affirming T. C. memorandum opinion. We think the facts of the instant case are clearly distinguishable from the facts of the cases cited and relied upon by petitioner, among which are Brewster Shirt Corporation v. Commissioner, 159 Fed. (2d) 227, and Economy Savings & Loan Co., 5 T. C. 543; modified on other grounds, 158 Fed. (2d) 472. These cases are not controlling on the facts which we have here. We sustain the Commissioner in his disallowance of the "borrowed invested capital" claimed by petitioner. Decision will be entered under Rule 50. Footnotes 1. SEC. 719. BORROWED INVESTED CAPITAL. (a) Borrowed Capital. -- The borrowed capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following: (1) The amount of the outstanding indebtedness (not including interest, and not including indebtedness described in section 751 (b) relating to certain exchanges) of the taxpayer which is evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust * * *.↩