Duveen Bros., Inc. v. Commissioner

Duveen Brothers, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent Duveen Bros., Inc. v. Commissioner Docket No. 25864 United States Tax Court 17 T.C. 124; 1951 U.S. Tax Ct. LEXIS 116; July 31, 1951, Promulgated *116 Decision will be entered under Rule 50. The petitioner, in order to sell a large block of special preferred, 6 per cent, Kress & Co., stock, which was callable at $ 11 per share, agreed to pay to purchasers of the stock the difference between the purchase price and $ 11 per share, plus dividends received between the purchase and the redemption. The stock was purchased at different times in 1943 and 1944 at prices ranging from $ 11.75 to $ 12.50 per share. The stock was called and redeemed in December 1944. The petitioner, under its agreement, paid the purchasers from 50 cents to $ 1.20 per share in December of 1944, in its 1945 fiscal year, the total sum of $ 30,950. The petitioner reports income on an accrual basis, and for a fiscal year ending on April 30. Held, that the payment in the 1945 fiscal year constituted a long term capital loss, and that it is not deductible as an ordinary loss under section 23 (f). Henderson Mathews, Esq., for the petitioner. Sheldon V. Ekman, Esq., for the respondent. Harron, Judge. Black, J., dissenting. Arundell, Johnson, and Tietjens, JJ., agree with this dissent. HARRON *124 The Commissioner determined deficiencies in the petitioner's income tax and excess profits tax for the fiscal year ended April 30, 1945, in the respective amounts of $ 7,845.10 and $ 1,853.41. The petitioner, under its pleadings, claims that it is entitled to a carry-back from the 1946 fiscal year to the 1945 fiscal year of unused excess profits credit in the amount of $ 67,415.85, and that no excess profits tax is due for its 1945 fiscal year. The respondent concedes *125 that the petitioner's unused excess profits credit for 1946 applicable to 1945 was in excess of its adjusted excess profits net income for 1945 as determined in the notice of deficiency. *118 The issue which is presented for decision is raised by the following pleading of the petitioner: The respondent erred in determining that a loss of $ 30,950 incurred in the fiscal year 1945 on the satisfaction of a guaranty was not deductible as an ordinary loss under section 23 (f) of the Internal Revenue Code. In the statement attached to the notice of deficiency, the respondent gave the following explanation for his determination: In your income tax return for the year ended April 30, 1945 you claimed as a deduction $ 30,950.00, representing an amount paid by reason of agreements entered into by you in connection with the sale of certain shares of 6% special preferred stock of S. H. Kress & Company. It has been determined that the amount paid is not deductible under the provisions of section 23 of the Internal Revenue Code but constitutes a long-term capital loss. The petitioner reported total long term capital gain for its 1945 fiscal year in the amount of $ 22,609.44. The respondent did not adjust such long term capital gain for 1945. Under section 117 (d) he offset the aforesaid capital gain against capital loss, as he determined, of $ 30,950 and disallowed deduction of the*119 difference, $ 8,340.56. FINDINGS OF FACT. We find as facts those facts which have been stipulated and admitted under the pleadings. Petitioner is a New York corporation engaged in the business of selling works of art. It keeps its books and files its returns on an accrual basis of accounting on the basis of a fiscal year ending on April 30 and beginning on May 1. It filed its returns with the collector for the third district of New York. For its fiscal year ended April 30, 1946, the petitioner reported normal tax net income of $ 8,588.03 and excess profits income of $ 8,072.40. Its excess profits credit based upon income was $ 67,415.85. Its excess profits net income for 1944 was less than its specific exemption. Its unused excess profits credit for 1946 was in excess of its adjusted excess profits net income for 1945. Prior to 1943 petitioner acquired upwards of 50,000 shares of 6 per cent special preferred stock of S. H. Kress & Company at $ 11 per share in payment for works of art sold in the course of its business. The stock had a par value of $ 10 per share. The stock was redeemable at the option of S. H. Kress & Company at the price of $ 11 per share. Sales of 50,000 *120 shares of S. H. Kress & Company stock, having a cost of $ 550,000, were made by the petitioner through Messrs. Brown Brothers, Harriman & Company, investment bankers (hereinafter referred *126 to as Brown Bros.) at various times during petitioner's 1944 and 1945 fiscal years, as follows: Selling Sales date Shares price Total 8/31/43 10,000 $ 12.25 $ 122,500 10/7/43 10,000 12.25 122,500 11/18/43 10,000 12.25 122,500 2/24/44 10,000 11.75 117,500 6/13/44 10,000 12.50 125,000 Total 50,000 $ 610,000 Prior to the initial sale, Brown Bros. expressed reluctance to undertake sales of such large blocks of stock without arranging for some protection of its clients against possible loss in the event of an early redemption of the stock by Kress & Company under its option to redeem the stock at the redemption price of $ 11 per share. Petitioner agreed to give a guaranty to purchasers under which, in substance, they would receive from the petitioner, in the event that the stock was called for redemption, the difference between the redemption price of $ 11 per share, the total amount of dividends received by them after purchase and before redemption, *121 and the price per share which they paid for the stock. Accordingly, in connection with each sale the petitioner furnished to the purchasers a written guaranty in the following form (except for appropriate changes in dates and figures): This is to confirm our understanding with regard to indemnification against loss through redemption of 10,000 shares 6% Special Preferred Stock of S. H. Kress & Company, which you purchased from us on August 30, 1943 for the accounts of certain of your clients (hereinafter referred to as the purchasers). These shares, which were purchased at $ 12.25 per share, are callable at $ 11.00 per share plus accrued dividends. Should redemption of the stock occur at such a time that the dividends paid or accrued to the Purchasers shall have amounted to less than $ 1.25 per share, we agree to pay you for the account of your clients the amount by which such dividends paid or accrued to the Purchasers fail to equal $ 1.25 per share. It is understood that this agreement applies only to those clients of yours who purchased the stock from us through you in the first instance and who continue to hold such stock up to the date of redemption thereof. You [Brown Bros.] *122 are hereby authorized to establish an account on your books designated Duveen Brothers, Inc. Special Account (hereinafter referred to as the Special Account) and to place to the credit of that account the sum of $ 12,500, utilizing for that purpose funds due us from the sale of August 30, 1943. The sum of $ 12,500 and amounts deposited in the Special Account in the future will constitute the aggregate amount of our contingent obligations to you as set forth in this letter and any similar letters of indemnity which we may sign and deliver to you in the future and the funds in the Special Account are placed with you to assure payment under our indemnities, if required under the terms of the letters of indemnity referred to above. In the event that sums become due under any of our letters of indemnity by reason of the redemption of any of the aforementioned shares, you are hereby authorized to debit the Special Account, without further order from us but under advice to us, with such sums. *127 It is understood that as dividends on the 6% Special Preferred stock are received by your clients, our obligations to you for the account of those clients will be reduced by the aggregate*123 amounts of the dividends paid and that you will then remit to us corresponding amounts to be withdrawn from the Special Account. It is understood also that we shall make no withdrawals from the funds on deposit with you in the Special Account and that we shall not request you to effect remittances to ourselves or others from that account with the exception of the remittances, mentioned above, reflecting reductions of our commitments to you for losses of your clients. On December 14, 1944, the preferred stock of S. H. Kress & Company was redeemed at $ 11 per share, and on or about such date in accordance with the terms of its guaranty the petitioner paid the purchasers from it of preferred stock the sums by which the dividends after purchase and before redemption were less than the excess of the purchase price over the redemption price, amounting to $ 30,950, computed as follows: Sales date Shares Per share Total 8/31/43 9,500 $ 0.50 $ 4,750 10/7/43 9,400 .50 4,700 11/18/43 10,000 .65 6,500 2/24/44 10,000 .30 3,000 6/13/44 10,000 1.20 12,000 Total 48,900 30,950 In its Federal income tax return for its fiscal year ended April 30, 1944, the petitioner*124 reported in respect of its sales of Kress preferred stock in that year long term capital gain of $ 45,000 (of a total long term capital gain of $ 77,905.80), and in its Federal income tax return for its fiscal year ended April 30, 1945, it reported in respect of its sales of Kress preferred stock in that year long term capital gain of $ 15,023 (of a total long term capital gain of $ 22,609.44). For 1945 it deducted, as an ordinary loss, the loss of $ 30,950 resulting from the payment of liability under its guaranty. In the deficiency notice of August 24, 1949, income adjustments were made treating said loss of $ 30,950 as a capital loss. OPINION. The question is whether the petitioner sustained an ordinary loss in its fiscal year ended April 30, 1945, under section 23 (f) in the amount of $ 30,950, the sum paid to purchasers of Kress & Company stock. The respondent has determined that the payment represents a long term capital loss. The parties have chosen to narrow the issue by the pleadings. No question is presented as to whether the total price per share accrued at the dates of the sales, regardless of the contingencies under the agreement involved. *128 The petitioner*125 has referred to the agreement as a guaranty, and the reimbursement payments as "guaranty payments." In our opinion both expressions are misleading. In any event, terminology is not controlling. In reality, the agreement was to return to purchasers part of the purchase price per share, the time of the payment, if any, and the amount thereof being contingent upon the happening of several events. The redemption of the stock in December 1944 at the call price of $ 11 per share brought about the occurrence of the contingencies, and the petitioner refunded the total sum of $ 30,950 to the purchasers. The total amount realized upon the sales of the block of 50,000 shares of stock was $ 610,000. The net amount realized after the refund of $ 30,950 was $ 579,050. The substance of the agreement was that, instead of disposing of the stock at from $ 11.75 to $ 12.50 per share, the stock was sold at lesser amounts per share. The payments to the purchasers were refunds per share of parts of the purchase prices. The sales transactions were completed in fiscal years prior to the year ended April 30, 1945. They gave rise to long term capital gains which properly were reported in the years of*126 the sales. In our opinion, the refunds of parts of the purchase price paid for the stock are unquestionably part of the general transaction involving sales of capital assets. The refunds to the purchasers of the stock represent a loss to the petitioner. Since the loss was sustained in connection with the sale of stock, it is a capital loss. Cf. Stanley Switlik, 13 T. C. 121, affd. (C. A. 3, 1950) 184 F. 2d 299. The Switlik case presented a different factual situation and is distinguishable from this proceeding. The respondent's determination is sustained. Some of the stock, 10,000 shares, was sold during petitioner's 1945 fiscal year. The amount of $ 12,000 was refunded to the purchasers of the 10,000 shares of stock in the same fiscal year as the stock was sold. Therefore, the refund of $ 12,000 in the same fiscal year simply reduces the amount of the capital gain. Under Rule 50, the parties shall give effect to this item by reducing the amount of the capital gain attributable to the sale of the 10,000 shares of stock. Instead of a capital gain of $ 15,023 on this stock, the petitioner realized a capital gain *127 of only $ 3,023. Cf. Albert W. Russel, 35 B. T. A. 602. The petitioner relies chiefly upon Stanley Switlik, supra. That case is not in point. There, the taxpayers were some of the transferees of the assets of a liquidated corporation, who had received liquidating distributions in 1941 upon which they reported long term capital gains. Subsequently, in 1944, the taxpayers entered into an agreement with the Commissioner of Internal Revenue to pay, pro rata, the tax deficiencies of the dissolved corporation for 1940 and 1941, and they made those payments in 1944. The Commissioner conceded, in the Switlik case, that the later payments of the corporation's tax *129 deficiencies, in 1944, did not represent losses from "the sale or exchange" of capital assets. Also, the payments of the deficiencies were not part of any contract or agreement relating to the distribution of the corporation's assets upon liquidation. This Court and the Court of Appeals held, under the facts, that the loss sustained upon the payment of the tax deficiencies, which grew out of transferee liability, was not a part of "a sale or exchange" *128 of capital assets. The situation in this proceeding is not analogous. Under each contract for the sale of Kress stock, the petitioner agreed to refund part of the purchase price of the stock to the vendee if certain events occurred, and the later payments to the vendees, involved here, were made in compliance with the terms of the very contracts of sales. The payments in question constituted reductions in the sales prices, and they were part of each sales transaction. There was a continuing relation under each sales contract between the total payment received at the time of each sale and the subsequent refund of part of the purchase price. The petitioner realized capital gain as a result of the sales of the Kress stock. In the taxable year, the refunds of parts of the purchase prices should be taken into account as capital loss so that the earlier capital gain is correspondingly adjusted, but by no more than the capital gains provisions of the Code allow. This conclusion is consistent with the rationale of Dobson v. Commissioner, 321 U.S. 231 (1943). Cf. Margery K. Megargel, 3 T. C. 238, 242-247. Decision will*129 be entered under Rule 50. BLACK Black, J., dissenting: I dissent from the majority opinion wherein it holds that a loss of $ 30,950 which petitioner incurred in its fiscal year 1945 on the payment of a guaranty which it had made was not deductible as an ordinary loss but must be taken as a long term capital loss subject to the limitations prescribed by the statute. The facts show that at various times during its fiscal years 1944 and 1945, petitioner sold 50,000 shares of 6 per cent special preferred stock of S. H. Kress & Company which it owned. Petitioner's gain on the sale of these shares is not in dispute nor is it disputed that petitioner's gain from the sale of these shares is taxable as long term capital gain. In connection with the sale of these 50,000 shares petitioner gave to Brown Brothers, Harriman & Company, through which the shares were sold, a guaranty which contained, among other things as illustrated in the case of the shares which it sold for $ 12.25 per share, the following provision: * * * Should redemption of the stock occur at such a time that the dividends paid or accrued to the Purchasers shall have amounted to less than $ 1.25 per share, we agree to*130 pay you for the account of your clients the amount by which such dividends paid or accrued to the Purchasers fail to equal $ 1.25 per share. *130 On December 14, 1944, the preferred stock of S. H. Kress & Company was redeemed at $ 11 per share and as a result of the guaranty which petitioner had made it had to pay out in fulfillment of such guaranty, $ 30,950. This loss it took as an ordinary loss in the taxable year in which it was incurred and I think it was entitled to do so under the applicable provisions of the Internal Revenue Code. Section 23 (g) (1), I. R. C. reads: "Losses from sales or exchanges of capital assets shall be allowed only to the extent provided in section 117." (Emphasis added.) Was petitioner's loss of $ 30,950 which it incurred in the payment of its guaranty a loss from the sale or exchange of capital assets within the meaning of the applicable statute? I do not think so. When petitioner sold the five different blocks of stock aggregating 50,000 shares during its fiscal years 1944 and 1945, it realized capital gains on each of these sales. The sales were complete when made and the fact that petitioner gave a guaranty with these sales did not postpone*131 in the least petitioner's obligation to report gain from the sales. When subsequently Kress & Company redeemed the shares at $ 11 per share and petitioner incurred the loss in question in the fulfillment of its guaranty, it was not a loss which was occasioned by the sale or exchange of any capital asset. In fact petitioner incurred no loss in the sale of the 50,000 shares of stock in Kress & Company at any time. It incurred a gain in each of these sales. Its loss was from the fulfillment of its guaranty and that loss was a transaction entirely separate from the sales of stock and, in my judgment, should be separately treated. Petitioner's loss in the fulfillment of its guaranty was, of course, related to its prior sales of Kress stock but not "from sales or exchanges of capital assets." Inasmuch as this loss does not fall within the definition of a capital loss as provided in the statute, I think petitioner is entitled to deduct the loss as an ordinary loss. I, therefore, respectfully dissent from the majority opinion.