Tri-State Realty Co. v. Commissioner

Tri-State Realty Company, Petitioner, v. Commissioner of Internal Revenue, Respondent Tri-State Realty Co. v. Commissioner Docket No. 17256 United States Tax Court 12 T.C. 192; 1949 U.S. Tax Ct. LEXIS 276; February 14, 1949, Promulgated *276 Decision will be entered under Rule 50. Upon the facts, held, the credit balances of an open account in petitioner's accounts payable ledger did not constitute equity invested capital within the meaning of section 718 (a) of the Internal Revenue Code prior to April 18, 1942. Robert A. Littleton, Esq., for the petitioner. F. S. Gettle, Esq., for the respondent. Hill, Judge. HILL *192 The respondent determined deficiencies against the petitioner as follows: Year Amount Excess profits tax [1942] $ 10,956.11 Income tax [1943] 524.31 Respondent's determination of petitioner's income tax liability for the year 1942 disclosed an overassessment of $ 6,125.72 and his determination of excess profits tax liability for the taxable year 1943 disclosed an overassessment of $ 714.33. By an amended answer respondent requests*277 an increase in the deficiency in petitioner's excess profits tax for 1942 in the amount of $ 2,982.57. Petitioner assigned error only as the respondent's determination with respect to its excess profits tax liability for 1942. The determinative question for decision is whether during the years 1940 and 1941 and from January 1 to April 18, 1942, the credit balances *193 of a certain account carried in petitioner's books constituted a part of its equity invested capital as defined in section 718 (a) of the Internal Revenue Code. Petitioner's tax returns for the period involved were filed with the collector of internal revenue for the district of Louisiana, at New Orleans. FINDINGS OF FACT. Petitioner is a corporation, organized under the laws of the State of Delaware and qualified to do business as a foreign corporation in the States of Louisiana, Mississippi, and Tennessee. The charter of the corporation was issued in the year 1936 and the business it was authorized to transact was commenced on or about December 22, 1938. The corporation commenced business with a paid-in capital of $ 1,000, which was paid in by W. H. Johnson, petitioner's president. Its capital stock, consisting*278 of 100 shares, was issued to him, with the exception of 2 shares which were issued to other persons to qualify them as members of petitioner's board of directors. The original property acquired by petitioner consisted of farm lands in Caddo Parish and unimproved property in Shreveport, Louisiana. The funds used to pay for the property to which petitioner took title at the time acquired were advanced to petitioner by W. H. Johnson, as its principal stockholder. During the years 1938 and 1939 petitioner acquired considerable property (consisting of real estate and improvements) in the territory in which the Tri-State Transit Co. of Louisiana, Inc., operated bus lines. The property acquired by petitioner along the bus lines operated by the above company was improved by petitioner for use as bus depots and garages under a lease thereof to the Tri-State Transit Co. The property thus acquired by petitioner was used in its business as a capital asset and the funds used to acquire and improve the property for use as bus depots and garages were advanced to petitioner by its president and principal stockholder, W, H. Johnson. Johnson began advancing sums of money to petitioner for use as*279 above described in the latter part of 1937 or early 1938. He continued this action from that date to 1942. During the years 1938 to 1942, inclusive, he made withdrawals of part of the amounts advanced to petitioner. These transactions were recorded by petitioner's bookkeeper in its journal and the entries were then posted in petitioner's account payable ledger under an account designated "W. H. Johnson -- Account No. 422." The credit balances in that account for the years indicated were as follows: Dec. 31, 1939, $ 83,444.25; Dec. 31, 1940, $ 109,757.40; and Dec. 31, 1941, $ 112,000. *194 The above account was kept in petitioner's accounts payable ledger until April 18, 1942, when W. H. Johnson sent a letter to his accountants authorizing them to transfer that account to the paid-in surplus account. This letter reads as follows: With reference to the status of my open account on the books of the Tri-State Realty Company, which shows a credit balance of $ 112,179.74, represented by advances made by me to Tri-State Realty Company, it is my desire, and you are authorized, to transfer $ 112,000.00 of the above amount from my account and credit paid-in surplus account. The balance*280 in the account at January 1, 1941, amounting to $ 83,444.25 shall also be regarded as paid-in surplus on the January 1, 1941 balance sheet. This letter was sent to petitioner's accountant at the time its Federal tax returns for the year 1941 were being prepared. In 1940, 1941, 1942, and 1943, petitioner submitted to the Department of Revenue for the State of Louisiana at Baton Rouge, foreign corporation franchise tax returns. It was required that petitioner include in the franchise tax return certain balance sheet items. Those returns for the years indicated reflected the following paid-in surplus: Dec. 31, 1939 $ 90,724.16 Dec. 31, 1940 143,047.86 Dec. 31, 1941 112,000.00 Dec. 31, 1942 112,000.00 For the calendar year 1940 petitioner filed a "United States Corporation Income, Declared Value Excess-Profits, and Defense Tax Return," in which it showed a "Paid-in or capital surplus" of $ 143,047.86. For the calendar year 1941 petitioner filed a "United States Corporation Income and Declared Value Excess-Profits Tax Return." There was submitted, together with this return, a balance sheet of petitioner which showed a paid-in surplus as of January 1, 1941, in the amount of*281 $ 83,444.25 and a paid-in surplus as of December 31, 1941, of $ 112,000. In the statement attached to the deficiency notice respondent stated as follows: It is held that, prior to December 31, 1941, on which date $ 112,000.00 was credited to paid-in surplus, no part of the account carried on your books as "W. H. Johnson -- Account No. 422," constituted a part of your equity invested capital, as defined in Section 718 (a) of the Internal Revenue Code. In the amended answer filed by respondent it is stated that the evidence at the hearing showed that no part of the account involved constituted a part of petitioner's invested capital as defined by section 718 (a) of the code prior to April 18, 1942. Consequently, he requested an increase of the deficiency in the amount of $ 2,982.57. The amount of $ 112,000 in question became paid-in surplus on April 18, 1942, and not prior thereto. *195 OPINION. The question we have to decide is whether the credit balances in the open account on petitioner's books headed "W. H. Johnson -- Account No. 422," in the respective amounts of $ 83,444.25, $ 109,757.40, and $ 112,000, represented loans or represented paid-in surplus for the years 1940 *282 and 1941 and for that part of 1942 prior to April 18, 1942. Respondent contends that these credit balances represented loans and, therefore, did not constitute equity invested capital as defined by section 718 (a) (1) of the Internal Revenue Code. 1 Petitioner, on the other hand, contends that such credit balances represented paid-in surplus and, hence, must be taken into account in determining the amount of equity invested capital. We are convinced from the evidence that respondent's contention must be sustained. The amounts Johnson advanced to petitioner were carried in its accounts payable ledger as an open account. The facts disclose that*283 the entries in this account were made from petitioner's journal, indicating that petitioner's book of original entry showed that such advances were loans rather than paid-in surplus. The transaction involving the advances to petitioner by its president were consistently treated on its books as loans from 1938 until on or about April 18, 1942. Petitioner states, however, that the designation of account No. 422 as an account payable of petitioner was in error and that book entries are evidentiary merely and not conclusive, citing Doyle v. Mitchell Bros. Co., 247 U.S. 179, and other cases. Petitioner points to the foreign corporation franchise tax returns filed with the Department of Revenue of the State of Louisiana as well as the Federal tax return filed for the year 1940 as proof of its contention that the credit balances of the W. H. Johnson account really represented equity invested capital. It was required that petitioner include in those tax returns certain balance sheet items which on the state tax returns included an item for paid-in surplus and on the Federal tax return included an item for paid-in or capital surplus. These returns petitioner*284 states "are evidence of actual use of said funds as paid-in surplus; and said returns are documentary evidence of the manner in which the corporation regarded the funds as 'paid-in surplus'." It should be noted, however, that there is a discrepancy between the credit balances shown in the open account and the totals indicated as *196 paid-in surplus in certain of the above mentioned tax returns. The state tax returns, upon which respondent relies principally in support of his contention, show that paid-in surplus as of December 31, 1939 and 1940, was $ 90,724.16 and $ 143,047.86, respectively, whereas the credit balances of the open account on those same dates were $ 83,444.25 and $ 109,757.40, respectively. The Federal tax return filed in 1940 likewise indicates a paid-in surplus different from the credit balance contained in the open account for the same period. We can not find in the record before us any satisfactory explanation of these discrepancies. The balance sheet attached to the Federal tax return for 1941 is not convincing evidence in support of petitioner's contention, as it was not made out until April 1942, when, so far as the record shows, Johnson first*285 authorized the transfer of the credit balance in the open account involved to paid-in surplus. We are convinced, not only that the recitals in respect of the character of the advances in question contained in petitioner's state income and Federal income tax returns hereinabove mentioned present insufficient evidence to overcome the presumption of correctness of respondent's determination that the advances in question were merely loans, but also that the entire record of evidence affirmatively establishes that prior to April 18, 1942, such advances were intended by both petitioner and Johnson as loans and not as paid-in surplus. It is our belief that the entries in the accounts payable ledger under the open account involved were not deemed erroneous until petitioner's president discovered that petitioner would benefit taxwise if the credit balances in that account were considered as paid-in surplus and, therefore, as equity invested capital under the Internal Revenue Code. It will be noted that the letter of April 18, 1942, does not mention any error then existing in the books with respect to carrying the open account involved in the accounts payable ledger. Petitioner's president*286 stated in his letter of April 18, 1942, that "it is my desire * * * to transfer $ 112,000.00 of the above amount from my account and credit paid-in surplus." That quotation indicates to us only a present intention as of that date to make the credit balances in the account involved paid-in surplus. We think our conclusion is strengthened by the fact that the record leaves unanswered the question, What was the nature of the withdrawals which Johnson made from the open account? If they were from surplus, as petitioner contends, they must have been dividends. If they were dividends, they should have been declared by petitioner's directors. See Delaware Corporation Law Annotated, 1947, sec. 34. But we do not have before us any resolution of its board of directors *197 authorizing the declaration of dividends. If the withdrawals were dividends, then Johnson should have reported them as income in his tax returns. His individual returns were not placed in evidence, so we are unable to ascertain how he treated the withdrawals. The failure of such proof leads us to believe that prior to April 18, 1942, Johnson considered the advances he made to petitioner as loans and that the withdrawals*287 which he made were repayments thereof. The argument that no interest was paid is of little moment, for the loans may have been interest-free. In view of the above, we are of opinion that petitioner has failed in its burden of proving that the credit balances in the open account in question were not loans from its principal stockholder and president prior to April 18, 1942. It follows that respondent must be sustained both as to the deficiency determined in the notice of deficiency and as to the additional deficiency requested in his amended answer. Decision will be entered under Rule 50. Footnotes 1. SEC. 718. EQUITY INVESTED CAPITAL. (a) Definition. -- The equity invested 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 amounts reduced as provided in subsection (b) -- (1) Money paid in. -- Money previously paid in for stock, or as paid-in surplus, or as a contribution to capital. * * * *↩