Thomas v. Commissioner

Joseph B. Thomas, Petitioner, v. Commissioner of Internal Revenue, Respondent Thomas v. Commissioner Docket No. 110986 United States Tax Court 2 T.C. 193; 1943 U.S. Tax Ct. LEXIS 131; June 22, 1943, Promulgated *131 Decision will be entered under Rule 50. Moneys advanced by petitioner to a corporation in 1938 and early 1939 constituted a capital investment in and not a loan to that corporation. Since this investment became worthless in the tax year the loss thus sustained is a capital loss, the deductibility of which is limited by section 23 (g) (1) and (2) of the Revenue Act of 1938. I. Bernard Halpern, Esq., for the petitioner. James A. Taylor, Esq., for the respondent. Leech, Judge. LEECH *193 Respondent determined a deficiency in income tax against petitioner for the calendar year 1939 in the amount of $ 2,160.81. The deficiency resulted from respondent's disallowance of a deduction of $ 18,661.90 as a bad debt that had been so ascertained in the taxable year. FINDINGS OF FACT. Petitioner is a resident of New York City and filed his income tax return for 1939 with the collector of internal revenue for the second district of the State of New York. In that return petitioner gave his principal business as that of "organizer." In February 1938 petitioner met one H. W. McCulloch, who claimed to own a patented car wash formula. He interested petitioner in proving the efficacy*132 of this car wash and in manufacturing and marketing it. For this purpose they agreed that a corporation should be organized to develop, manufacture, and distribute the product. It was agreed that petitioner should furnish the finances, and that petitioner *194 and McCulloch would divide the stock to be issued by the company equally between them. On April 23, 1938, the Pylac Products Co. (hereinafter called Pylac), a New Jersey corporation, was formed with 10,000 shares of no par value common stock. The directors of this corporation were McCulloch, petitioner, and one Burton, who was a friend of McCulloch's. None but qualifying shares to the directors were ever issued. McCulloch was president. Petitioner was secretary and treasurer until about January 31, 1939. Between February 16 and July 1, 1938, petitioner furnished to Pylac directly or through McCulloch the sum of $ 7,320 for the purposes above indicated. From July 1 to December 31, 1938, petitioner similarly furnished that company the further sum of $ 11,041.90, and on January 3, 1939, the further sum of $ 300. At the request of petitioner, Pylac on December 21, 1938, passed the following resolution: Be it resolved*133 that all expenditures and obligations of the corporation be approved by the Treasurer effective with this meeting and the President and Vice-President agree not to further obligate the Corporation without the approval of the Treasurer. Resolved that the Directors recognize and the Corporation assumes obligation for the funds advanced by Mr. Joseph B. Thomas, as shown by Book Account as of this date which funds totalled $ 17,786.90 as of November 30, 1938. It is also resolved that any further funds advanced by Mr. Joseph B. Thomas subsequent to November 30, 1938 be recognized and the obligation therefor assumed. Petitioner was not in the business of loaning money. He never received any notes of Pylac. There was no date fixed for repayment of the money furnished, no obligation to pay interest. From time to time petitioner received from the bookkeeper of Pylac statements of that company, including purported balance sheets which showed the total amounts furnished by petitioner as of the dates of the respective statements as a liability of the company along with accounts payable. The bookkeeper was employed by McCulloch and was not under petitioner's control. On January 31, 1939, petitioner*134 resigned as an officer and director of Pylac upon learning that McCulloch was untrustworthy and dishonest. Thereafter and before May of that year petitioner, personally and through his attorney, negotiated with Pylac, through McCulloch, its president, for a settlement of Pylac's "obligation." These negotiations were not consummated and on May 3 petitioner instituted suit in New Jersey against Pylac to recover the above amounts. In this suit petitioner alleged that the money had been loaned to Pylac. In its answer Pylac denied that they were loans. Petitioner did not prosecute the case to judgment. During the period *195 following petitioner's resignation as an officer and director of Pylac, that company continued to do business, but its condition grew progressively worse. In the fall of 1939 it became unable to pay the salaries of its employees and its rent, and was then finally dispossessed of its premises by the landlord. Petitioner never received any repayment of the amounts furnished McCulloch and Pylac. In his income tax return for the calendar year 1939 petitioner deducted the entire amount of the moneys furnished to McCulloch and Pylac, to wit, the aggregate amount*135 of $ 18,661.90, as a bad debt which petitioner ascertained to have become worthless in that year. Respondent disallowed the deduction in his notice of deficiency with this comment: It is held that you are not entitled, in computing net income for the current year, to a deduction of $ 18,661.90 representing advances made to Pylac Products Company. These advances constituted a capital investment by petitioner in Pylac which became worthless in 1939. OPINION. Respondent now concedes that petitioner sustained a loss in the admitted amount of the moneys he furnished to Pylac. His position apparently is, however, that these advances were a capital investment in the form of "rights to * * * receive [Pylac] shares" which became worthless during the tax year, and that the resulting loss was therefore a capital loss, the deductibility of which is limited by section 117 of the Revenue Act of 1938. See section 23 (g) (1), (2), and (3) of that act. Petitioner opposes this position. He contends that his admitted advancements constituted a loan which thus created a debt from Pylac to him, the whole of which became deductible in the tax year under section 23 (k) (2) and (3) of the same revenue*136 act. The single issue therefore is whether by virtue of petitioner's advances to Pylac he became a creditor of or an investor in that company. The difference between loans to and investments in corporations has been discussed many times by the courts and the Board of Tax Appeals, now this Court. See among others, American Cigar Co. v. Commissioner, 66 Fed. (2d) 425; Daniel Gimbel, 36 B. T. A. 539; Commissioner v. O. P. P. Holding Corporation, 76 Fed. (2d) 11, affirming 30 B. T. A. 337; United States v. South Georgia Railway Co., 107 Fed. (2d) 3, and cases cited therein. We think nothing will be gained here by repeating or attempting to add to that discussion. The decision of the dispute rests necessarily upon the facts revealed in this record. In re McLean-Bowman Co., 138 Fed. 181. There is some superficial evidence that the advances were loaned to Pylac. Though *196 neither the books nor the balance sheets of that company are in evidence, its bookkeeper gave petitioner statements*137 on which petitioner's advances were carried as liabilities with accounts receivable. But this treatment is certainly not conclusive. Doyle v. Mitchell Bros. Co., 247 U.S. 179. And whatever weight to which it might be entitled under some circumstances is, at least, largely reduced here by its setting, which includes the denial by Pylac that petitioner's advances were loans, in the unfinished litigation in New Jersey involving that specific question. This same circumstance similarly affects any evidentiary value in the belated corporate resolution of December 21, 1938. Moreover, petitioner was not a lender of money. He was an "organizer." Petitioner never knew McCulloch before their meeting in connection with the car wash proposition. He received no note of Pylac or any other evidence of indebtedness, unless the tardy resolution may be considered as such. No provision was made for the payment of interest. No date for the payment of the so-called advances was fixed. Petitioner admits having received no security other than the business itself, the value of which petitioner must have known as highly speculative. On the other hand, the evidence, *138 we think, is convincing that petitioner's advances were contributions to the capital of and not loans to Pylac. Petitioner was a shareholder in Pylac. In fact he was a half owner of the equity in that company. True, none but qualifying shares had been issued, but he was entitled to receive half of these shares when issued. Thus, the value of that equity would reflect any contribution he made to the capital of the company. To be noted also is the fact that, so far as the record reveals, unless these advances of petitioner were capital contributions, Pylac was actually incorporated without paid-in capital. But under the law of New Jersey, the state of its incorporation, that was legally impossible. N. J. S. A. 14: 2, 3. We can not presume it violated that law. Bank of United States v. Dandridge, 25 U.S. 64. The essence of the situation was that McCulloch agreed to and did furnish technical knowledge and services, and petitioner supplied the funds with which to develop and market the car wash. In exchange for these respective contributions, McCulloch and petitioner were each to receive half the issued stock of Pylac. We hold, therefore, that*139 petitioner's admitted advances were contributions to the capital or investments in rights to receive the stock of Pylac, which constituted a capital asset that became worthless in the taxable year. The result follows that the deductibility of the loss thus sustained must be limited in accordance with the provisions of section 117 of the Revenue Act of 1938. See section 23 (g) (1), (2), and (3) of that act. Decision will be entered under Rule 50.