Tulane Hardwood Lumber Co. v. Commissioner

Tulane Hardwood Lumber Co., Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent Tulane Hardwood Lumber Co. v. Commissioner Docket No. 49860 United States Tax Court 24 T.C. 1146; 1955 U.S. Tax Ct. LEXIS 84; September 30, 1955, Filed *84 Decision will be entered under Rule 50. Cost of debentures of plywood manufacturer bought by petitioner, a lumber dealer, in 1946 to insure it a source of plywood held deductible in full in 1950 as a business expense or loss upon worthlessness of debentures and failure of issuer as a supplier of plywood. Bagley & Sewall Co., 20 T. C. 983, affirmed sub nom. Commissioner v. Bagley & Sewall Co., (C. A. 2) 221 F. 2d 944. Abner E. Hughes, Esq., for the petitioner. Robert B. Wallace, Esq., for the respondent. Opper, Judge. OPPER *85 *1146 The Commissioner has determined a deficiency in income tax for 1950 in the amount of $ 4,188.66. The petitioner contests the determination and claims an overpayment of tax in the amount of $ 11.34. The only issue remaining is the propriety of respondent's treatment of a $ 10,000 debenture which became worthless in 1950 as a loss sustained from the sale of a capital asset rather than as a cost of goods sold, as an ordinary and necessary business expense, or as a business loss. FINDINGS OF FACT. Some of the facts have been stipulated and they are hereby found. Petitioner is a Louisiana corporation, organized in 1924 and having its principal office in New Orleans. Its return for the calendar year 1950 was filed with the collector of internal revenue for the district of Louisiana. *1147 Petitioner's principal source of income since its incorporation has been from the sale of lumber and plywood as a wholesaler. For many years prior to 1945 its principal source of supply of gum plywood was Mengel Company of Louisville, Kentucky. In October 1944, the Mengel Company reorganized under the name, U. S. Mengel Plywoods, Inc., and opened a branch office in New Orleans, selling*86 on a direct wholesale basis. After opening this branch office, U. S. Mengel Plywoods, Inc., was in competition with and ceased to sell plywood to petitioner. Petitioner considered it necessary to locate a new source of supply for gum plywood in order to replace this previous source from which it had purchased approximately 95 per cent of this type of plywood. Petitioner's efforts along these lines met with little success, until, during the latter part of 1945, its vice president learned that a new plywood company was being organized for the construction of a plant in Brunswick, Georgia. In December 1945, he contacted the organizers of the new plywood company, known as Tidewater Plywood Company, and requested that petitioner be considered for selection as the outlet in the New Orleans area for Tidewater's production. Tidewater created an issue of series A debentures and was financed as follows: Capital stock and surplus $ 38,324.09 Debentures due January 1, 1956: Series A 5% 150,000.00 Series B 6% 500,000.00 Series C 3% 100,000.00 It proposed to issue the series A debentures to a limited number of distributors who would undertake the distribution of a substantial*87 portion of its plywood production. It reserved $ 10,000 of such debentures for sale to petitioner and agreed to allocate to petitioner a portion of Tidewater's production. The proposed arrangement would hold for the original term of the debentures, subject to termination on December 31, 1950, or thereafter at the end of any calendar year upon 6 months' notice by either party. If the proposed arrangement was terminated by either party, Tidewater would redeem the debentures or, if not permitted in accordance with other financing restrictions, endeavor to find a market for the debentures. In order to obtain the anticipated supply of plywood, petitioner, by check dated June 26, 1946, purchased for $ 10,000 Tidewater Plywood Company Debenture, series A, No. 6, dated July 1, 1946, with a face amount of $ 10,000. The purchase of the debenture was entered upon petitioner's books as a charge to an account designated "Bonds," and was shown on petitioner's corporate income tax returns for the years 1946 through 1950 as an investment. In addition, the $ 10,000 debenture is among the assets listed on line 1, schedule EP-2 (B), *1148 page 3 of Form 1120, of petitioner's 1950 corporate*88 excess profits tax return as an asset includible in equity invested capital at the beginning of the first taxable year ending after June 30, 1950. Petitioner received the following interest payments from the debenture: January 1947 $ 252.08 July 1947 247.97 January 1948 252.08 July 1948 250.00 Total 1,002.13 Tidewater's plant was constructed during the calendar year 1946 and petitioner received from Tidewater and paid for the following amounts of gum plywood during the next 3 succeeding years: — 1947 — — 1948 — January 24 $ 7,143.90 August 23 $ 6,553.38 February 25 7,328.41 October 15 6,668.99 April 15 6,744.62 November 5 5,521.98 May 24 5,022.90 June 20 4,642.08 Total $ 18,744.35 July 14 5,271.43 August 15 6,224.40 — 1949 — September 13 7,991.10 March 23 $ 152.78 December 18 5,065.28 April 14 245.68 Total $ 55,434.12 Total $ 398.46 For the year ended January 4, 1948, 73 per cent of Tidewater's production was allocated to debenture holders, and for the 8 weeks ended February 29, 1948, 87 per cent of its production was allocated to debenture holders. During the calendar year 1949, Tidewater experienced supply and production*89 difficulties so that petitioner received a very small amount of production from Tidewater during that year, and none in 1950. In March 1950, the properties of Tidewater were advertised for public sale in order to meet the obligations of the mortgage indebtedness. During 1950, it became apparent that petitioner could obtain no further production through its debenture holding, nor could it expect to realize any return on the cost of its debenture. In its income tax return for 1950, petitioner deducted the amount of $ 10,000 as a "bad debt." The $ 10,000 debenture was the only security ever owned by petitioner during its existence, and petitioner never owned any investments of any nature. It considered the debenture unattractive as an investment, but purchased it as a means of getting the plywood. It did not intend to hold the debenture for a longer period than was necessary. It had substantial bank loans against which it would have been advantageous to apply the proceeds of the debenture. *1149 Petitioner did not intend to hold the debenture as an investment. The debenture bond was a security within the meaning of section 23 (k) (3) of the Internal Revenue Code of 1939, and*90 became worthless in 1950. OPINION. Although it is not easy to distinguish these facts from Bagley & Sewall Co., 20 T. C. 983, affirmed sub nom. Commissioner v. Bagley & Sewall Co., (C. A. 2) 221 F. 2d 944, Western Wine & Liquor Co., 18 T. C. 1090, and Charles A. Clark, 19 T. C. 48, it is even more difficult to reconcile such cases as Logan & Kanawha Coal Co., 5 T. C. 1298, 1303. There the circumstances of acquisition were that "Petitioner purchased the Standard Banner Coal Co. shares to enable it to acquire and maintain a source of supply of coal." Here, as petitioner phrases it, "It is obvious that * * * the purchase and retention of the debenture by the taxpayer was only for the purpose of obtaining plywood production and merely incidental thereto." In Logan & Kanawha Coal Co., supra, we said: "Under the facts presented, no one of the three exceptions applies to the shares of stock of the Standard Banner Coal Co. They are capital assets, as defined by section 117 (a), and the loss from the *91 sale is not one falling within section 23 (f) of the code." It is true that in the Logan & Kanawha Coal Co. case the stock was sold and the loss claimed was the difference between the basis of $ 27,500 and the sale price of $ 600 whereas here the deduction is claimed as a total loss. But section 23 (k) (2) treats as a "loss from the sale or exchange, on the last day of such taxable year, of capital assets" in the case of "securities" becoming "worthless within the taxable year" and we think there can be no doubt this debenture was a "security." While the cases seek to create a distinction according to the intent with which the purchase was made and the property held, it seems reasonably evident that when, as in Logan & Kanawha Coal Co., supra, the purpose of acquisition can be described as to enable "it to acquire and maintain a source of supply" of its stock in trade the implication must be that there was no "investment" purpose there any more than there was here. And the facts scarcely warrant a finding of "investment" purpose in the acquisition by a concessionaire of essential World's Fair debentures ( Exposition Souvenir Corp. v. Commissioner, (C. A. 2) 163 F. 2d 283)*92 and not in the purchase of Government bonds to be used as security for performance of a contract ( Bagley & Sewall Co., supra.) Approached realistically, the trend of the later cases can only be rationalized by borrowing a part of the language in Commissioner v. Bagley & Sewall Co., supra, (at p. 947): "that business expense, *1150 Section 23, has been many times determined by business necessity without a specific consideration of Section 117." So considered the present problem becomes relatively simple. Petitioner's action in purchasing the debenture was a reasonable and necessary act in the conduct of its business. The loss of the purchase price was proximately related to that acquisition. Hence under section 23 the amount was a deductible business expense, or business loss, properly taken in the instant year since that was the first time the reason for holding the debenture disappeared and the extent of the loss could be accurately measured. Insofar as anything in the language or conclusion of Logan & Kanawha Coal Co., supra, conflicts with what has been said, it will no longer*93 be regarded as authoritative. Decision will be entered under Rule 50.